S-1: General form for registration of securities under the Securities Act of 1933
Published on June 12, 1997
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 12, 1997
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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SCM MICROSYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
SCM MICROSYSTEMS, INC.
131 ALBRIGHT WAY
LOS GATOS, CA 95032
(408) 370-4888
(NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
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STEVEN HUMPHREYS
PRESIDENT AND CHIEF EXECUTIVE OFFICER
SCM MICROSYSTEMS, INC.
131 ALBRIGHT WAY
LOS GATOS, CA 95032
(408) 370-4888
(NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
AGENT FOR SERVICE)
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COPIES TO:
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
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If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
(1) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(o).
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES
MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE
REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH
OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO THE REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
PROSPECTUS (Subject to Completion)
Dated June 12, 1997
2,750,000 Shares
LOGO
Common Stock
-----------------------------
All of the 2,750,000 shares of Common Stock offered hereby are being sold
by SCM Microsystems, Inc. ("SCM Microsystems" or the "Company").
Prior to this offering, there has been no public market for the Common
Stock of the Company. Application has been made to have the Common Stock
approved for quotation on the Nasdaq National Market under the symbol "SCMM." It
is currently estimated that the initial public offering price will be between
$ and $
per share. See "Underwriting" for information relating to the determination of
the initial public offering price.
-----------------------------
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6 HEREOF.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses, estimated at $975,000, payable by the Company.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase up to an aggregate of 412,500
additional shares of Common Stock at the Price to Public less the
Underwriting Discount to cover over-allotments, if any. If all such
additional shares are purchased, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
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The Common Stock is offered by the several Underwriters named herein when,
as and if received and accepted by them, subject to their right to reject orders
in whole or in part and subject to certain other conditions. It is expected that
delivery of certificates for such shares will be made at the offices of Cowen &
Company, New York, New York, on or about , 1997.
COWEN & COMPANY HAMBRECHT & QUIST
, 1997
[ARTWORK]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMPANY'S COMMON
STOCK, INCLUDING STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS OR THE
IMPOSITION OF PENALTY BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
2
PROSPECTUS SUMMARY
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth under "Risk Factors" and elsewhere in this Prospectus.
The following summary is qualified in its entirety by the more detailed
information and the financial statements and notes thereto appearing elsewhere
in this Prospectus.
Except as set forth in the Consolidated Financial Statements or as
otherwise indicated, all information in this Prospectus assumes (i) the issuance
of an aggregate of 849,790 shares of Preferred Stock subsequent to March 31,
1997, (ii) the conversion of all of the Company's outstanding shares of
Preferred Stock into shares of Common Stock, effective upon the closing of this
offering (the "Automatic Conversion"), and (iii) that the Underwriters'
over-allotment option is not exercised. All information in this Prospectus,
including the Consolidated Financial Statements, reflects the conversion of
certain convertible debt into 377,580 shares of stock as if such conversion had
been completed as of March 31, 1997. See Note 3 of Notes to Consolidated
Financial Statements.
THE COMPANY
SCM Microsystems designs, develops and manufactures hardware, firmware and
software products for data security and access control applications. The Company
sells security and access products to OEM computer, telecommunication and
digital video broadcasting ("DVB") component and system manufacturers. The
Company's objective is to leverage its expertise in PCMCIA and smart card
technologies and its extensible, upgradeable smart card token-based security
architecture to capitalize on the growing demand for data and network security
and the need to control access to digital information. The Company markets,
sells and licenses its products through a direct sales and marketing
organization primarily to OEMs and also through distributors, VARs, system
integrators and resellers worldwide. OEM customers include Compaq, Dell, France
Telecom, IBM, Kirch Group (BetaDigital), Schlumberger, Security Dynamics,
Siemens/ Nixdorf, Sun Microsystems and Telenor.
The Company addresses the needs of the enterprise data security market by:
(i) providing a range of products which enable smart cards and other security
tokens to be read through standard PCMCIA slots thus bridging the gap between
smart cards and PCs, network computers and other devices; (ii) employing an
open-systems, remotely upgradeable architecture that provides compatibility
across a range of hardware platforms and software environments; and (iii)
including in certain of its smart card reader products encryption/decryption
capabilities that address the inherent speed and performance limitations of
smart cards. The Company addresses the needs of the DVB market by: (i) providing
smart card-based conditional access readers and modules which adhere to the
DVB-Common Interface ("DVB-CI") standard; (ii) including real time,
high-bandwidth decryption capabilities which can be unlocked by smart card-based
tokens, which by themselves are not capable of decrypting digital video data at
the rate required for DVB; and (iii) incorporating read/write capabilities which
permit DVB content and service providers to perform a virtually no-cost upgrade
of users' access rights as new products are developed and introduced and as
users' subscription desires change.
With the increasing proliferation and reliance upon digital data, data
security has become a paramount concern of businesses, government, educational
institutions and consumers. Whether the issue is controlling access to
proprietary or confidential information such as business data or health records,
or attempting to limit access to digital video broadcasts or paying subscribers,
content providers, network and data managers and users of digital data are
concerned with controlling access to data and maintaining data security.
Through 1994, the Company focused on PCMCIA peripheral products, including
flash memory and fax/modem devices. In 1994, the Company began emphasizing
security and access products. The Company made the final shipment of PCMCIA
peripheral products in the quarter ended March 31, 1997, completing its exit
from this business. As a result of the Company's shift in product focus, net
sales of security and access products increased from 22.1% of total net sales in
1994 to 77.3% of total net sales in 1996. Beginning in 1997,
3
the Company will be dependent upon the sales of its security and access
products. The Company has formed strategic relationships, including technology
sharing agreements, with a number of key industry players such as Intel, Matra
Communications, France Telecom and Telenor. In addition, Intel and Telenor made
equity investments in the Company of $2.0 million and $5.5 million,
respectively, in early 1997.
The Company was originally formed in 1990 as a German corporation, and in
1993 the Company merged with two affiliated companies. The Company
reincorporated in Delaware in December 1996. The Company maintains headquarters
in Los Gatos, California and Pfaffenhofen, Germany. The Company's address is 131
Albright Way, Los Gatos, California 95032 and its telephone number is (408)
370-4888.
THE OFFERING
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(1) Excludes 358,174 shares of Common Stock issuable upon exercise of stock
options outstanding as of March 31, 1997 at a weighted average exercise
price of $0.10 per share and an aggregate of 384,121 shares of Common Stock
and Preferred Stock issuable upon exercise of warrants issued subsequent to
March 31, 1997 at a weighted average exercise price of $7.17 per share. See
"Management -- Employee Stock Plans" and Notes 4 and 11 of Notes to
Consolidated Financial Statements.
"SwapBox" is a registered trademark of the Company. This Prospectus also
contains trademarks of other companies.
4
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- ---------------
(1) Through 1994, the Company focused on PCMCIA peripheral products, including
flash memory and fax/modem devices. In 1994, the Company began to shift its
focus away from these products toward security and controlled access
products. The Company made the final shipment of PCMCIA peripheral products
in the quarter ended March 31, 1997, completing its exit from this business.
(2) Share and per share information gives pro forma effect to the Automatic
Conversion. See Notes 1, 4 and 10 of Notes to Consolidated Financial
Statements.
(3) Reflects (i) the issuance of 849,790 shares of Preferred Stock subsequent to
March 31, 1997 and (ii) the Automatic Conversion.
(4) Adjusted to reflect the sale of 2,750,000 shares of Common Stock by the
Company hereby at an assumed initial public offering price of $ per
share, after deducting the estimated underwriting discounts and offering
expenses payable by the Company and the application of the estimated net
proceeds therefrom. See "Use of Proceeds" and "Capitalization."
5
RISK FACTORS
In addition to the other information in this Prospectus, the following risk
factors should be considered carefully in evaluating the Company and its
business before purchasing the shares of Common Stock offered hereby. This
Prospectus contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended (the "Securities Act"). All
forward-looking statements included in this Prospectus are based on information
available to the Company on the date hereof and assumptions which the Company
believes are reasonable, and the Company assumes no obligation to update any
such forward-looking statements. These forward-looking statements involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth in the following risk factors and elsewhere
in this Prospectus. In evaluating the Company's business, prospective investors
should consider carefully the following factors in addition to the other
information set forth in this Prospectus.
HISTORY OF OPERATING LOSSES; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS;
SEASONALITY
Although the Company was profitable for the fiscal quarters ended September
30, 1996 and December 31, 1996, the Company has incurred a loss for the fiscal
quarter ended March 31, 1997 and net operating losses on an annual basis since
its inception in 1993. As of March 31, 1997, the Company had an accumulated
deficit of $8.6 million. In view of the Company's loss history, there can be no
assurance that the Company will be able to achieve or sustain profitability on
an annual or quarterly basis in the future.
The Company's quarterly operating results have in the past varied and may
in the future vary significantly. Factors affecting operating results include:
the level of competition; the size, timing, cancellation or rescheduling of
significant orders; market acceptance of new products and product enhancements;
new product announcements or introductions by the Company's competitors;
adoption of new technologies and standards; changes in pricing by the Company or
its competitors; the ability of the Company to develop, introduce and market new
products and product enhancements on a timely basis, if at all; hardware
component costs and availability, particularly with respect to hardware
components obtained from sole or limited source suppliers; the Company's success
in expanding its sales and marketing organization and programs; technological
changes in the market for digital information security products; levels of
expenditures on research and development; foreign currency exchange rates; and
general economic trends. In addition, because a high percentage of the Company's
operating expenses are fixed, a small variation in the timing of recognition of
revenue can cause significant variations in operating results from quarter to
quarter. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
The Company has experienced significant seasonality in its business, and
the Company's business and operating results are likely to be affected by
seasonality in the future. The Company has typically experienced higher net
sales in the third quarter and fourth quarter of each calendar year followed by
lower net sales and operating income in the first quarter and second quarter of
the following year. The Company believes that this trend has been principally
due to budgeting requirements of the U.S. government which influence the
purchasing patterns of OEMs which supply PCs and workstations incorporating the
Company's products to the U.S. government. In addition, a significant portion of
the Company's net sales are generated during the fourth quarter as a result of
the year-end holiday buying season. The Company's dependence on fourth quarter
results is expected to increase to the extent that net sales of its Digital
Video Broadcasting - Conditional Access Module ("DVB-CAM") product increase.
Initial sales of the Company's products to a new customer typically involve
a relatively lengthy sales cycle, which can range from six to nine months,
during which the Company may expend substantial financial resources and
management time and effort with no assurance that a sale will ultimately result.
The length of the sales cycle may vary depending on a number of factors over
which the Company may have little or no control, including product and technical
requirements, and the level of competition which the Company encounters in its
selling activities. Any delays in the sales cycle for new customers could have a
material adverse effect on the Company's business and operating results.
6
Based upon the factors enumerated above, the Company believes that its
operating results may vary significantly in future periods and that
period-to-period comparisons should not be relied upon as necessarily reliable
indicators of future performance. It is likely that, in some future quarter, the
Company's operating results will be below the expectations of stock market
analysts and investors. In such event, the price of the Company's Common Stock
could be materially and adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Quarterly Results
of Operations."
DEPENDENCE ON EMERGING PRODUCT MARKETS; UNCERTAINTY OF MARKET ACCEPTANCE OF THE
COMPANY'S PRODUCTS
From the Company's inception through 1994, the Company focused on Personal
Computer Memory Card Industry Association ("PCMCIA") peripheral products,
including flash memory and fax/modem devices. In 1994, the Company began
emphasizing security and access products. The Company made the final shipment of
PCMCIA peripheral products in the quarter ended March 31, 1997, completing its
exit from this business. As a result of the Company's strategic shift in product
focus, the proportion of security and access product sales increased from 22.1%
of total net sales in 1994 to 77.3% of total net sales in 1996. Beginning in
1997, the Company's net sales will be dependent upon the success of its security
and access products.
The Company's future growth and operating results will depend to a large
extent on the successful marketing and commercial viability of the Company's
security and access product families, particularly smart card-based readers and
DVB-CAMs. Each of these product families addresses needs in different emerging
markets. Smart card token-based security applications are able to provide
protection from unauthorized access of digital information. The Company believes
that smart cards are ideally suited to serve as tokens for network and
electronic commerce security. Accordingly, the Company's SwapBox and SwapSmart
product families are targeted to provide token-based security for PCs. However,
there can be no assurance that the smart card will become the industry standard
for network and electronic commerce security applications. The Company's DVB
product family provides a means of controlling access to digital television
broadcasts. The Company's DVB-CAM product implements the Digital Video
Broadcasting-Common Interface ("DVB-CI") standard. To date, the Company's
DVB-CAM product has been implemented in a relatively limited number of DVB
set-top boxes in Europe. Although the Company believes that the DVB-CI standard
will eventually become the European standard for DVB conditional access
applications, there can be no assurance that the standard will be adopted, that
the European DVB market will further develop or that even if such standard is
adopted and the market further develops, the Company's DVB-CAM products will be
widely adopted. Furthermore, the market for DVB products in the United States
has only recently begun to develop and there can be no assurance whether, or to
what extent, this market will grow. In addition, the substantial installed base
of analog set-top boxes in the United States may cause the market for the
Company's DVB products to grow slower than expected, if at all.
If the market for the products described above or any of the Company's
other products fails to develop or develops more slowly than expected or if any
of the standards supported by the Company do not achieve or sustain market
acceptance, the Company's business and operating results would be materially and
adversely affected. See "-- Competition."
PRODUCT SALES CONCENTRATION
The Company's SwapBox product has historically represented and is expected
to continue to represent a substantial portion of the Company's net sales. Sales
of this product comprised 62.2% and 54.4% of net sales during fiscal 1995 and
1996, respectively. Should the demand for, or pricing of, this product decline
due to the introduction of superior or lower cost systems by competitors,
changes in the computer industry or other factors, the Company's business and
operating results would be materially adversely affected. While diversifying its
products is a key element of the Company's business strategy, there can be no
assurance that the Company will be able to successfully introduce or market
other products in a timely and cost effective manner or that any new products or
improvements will achieve market acceptance.
DEPENDENCE ON SALES TO OEMS
A substantial majority of the Company's security and access products are
intended for use as components or subsystems in systems manufactured and sold by
third party OEMs. In 1996, sales to IBM accounted for
7
12% of total net sales, sales to BetaDigital (a division of the Kirch Group)
accounted for 11% of total net sales and sales to the Company's top 10 customers
accounted for 55.0% of total net sales. In order for an OEM to incorporate the
Company's products into its systems, the Company must demonstrate that its
products provide significant commercial advantages to OEMs over competing
products. There can be no assurance that the Company can successfully
demonstrate such advantages or that the Company's products will continue to
provide any advantages. Moreover, even if the Company is able to demonstrate
such advantages, there can be no assurance that OEMs will elect to incorporate
the Company's products into their current or future systems, or if they do, that
related system and manufacturing requirements can or will be met. Failure of
OEMs to incorporate the Company's products into their systems or failure of such
OEMs' systems to achieve market acceptance would have a material adverse effect
on the Company's business and operating results. See "Business -- Customers and
Applications."
DEPENDENCE ON SALES TO GOVERNMENT CONTRACTORS
Approximately 50.6% and 39.2% of the Company's net sales during 1995 and
1996, respectively, were derived from sales of the Company's SwapBox product for
use by the U.S. government, all of which were made under contracts between the
Company and major OEMs that sell PCs to the United States Department of Defense
(the "DoD"). The Company believes that indirect sales to the DoD are subject to
a number of significant uncertainties, including timing and availability of
funding, unforeseen changes in the timing and quantity of government orders and
the competitive nature of government contracting generally. Furthermore, the DoD
has been reducing total expenditures over the past few years in a number of
areas and there can be no assurance that such funding will not be reduced in the
future. In addition, there is no assurance that the Company will be able to
modify existing products or develop new products that will continue to meet the
specifications of OEM supplies to the DoD. Absent significant future revenues
from alternative sources, a significant loss of indirect sales to the United
States government would have a material adverse effect on the Company's business
and operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
DEPENDENCE ON DEVELOPMENT OF INDUSTRY RELATIONSHIPS
The Company is party to collaborative arrangements with a number of
corporations and is a member of key industry consortia. The Company has formed
strategic relationships, including technology sharing agreements, with a number
of key industry players such as Intel, Matra Communications, France Telecom and
Telenor. In addition, Intel and Telenor made equity investments in the Company
of $2.0 million and $5.5 million, respectively, in early 1997. The Company
evaluates, on an ongoing basis, potential strategic alliances and intends to
continue to pursue such relationships. The Company's future success will depend
significantly on the success of its current arrangements and its ability to
establish additional arrangements. There can be no assurance that these
arrangements will result in commercially successful products. See
"Business -- Collaborative Industry Relationships."
COMPETITION
The market for digital data security is intensely competitive and
characterized by rapidly changing technology. The Company believes that
competition in this market is likely to intensify as a result of increasing
demand for security products. The Company currently experiences competition from
a number of sources, including (i) ActionTec, Carry Computer Engineering,
Greystone and Litronics in PC Card adapters, (ii) GemPlus, Hitachi and Toshiba
in smart card readers and universal smart card reader interfaces and (iii)
GemPlus in DVB-CAM modules. The Company also experiences indirect competition
from certain of its customers which currently offer alternative products or are
expected to introduce competitive products in the future. In some cases, these
vendors also support the Company's products and those of its competitors. The
Company may in the future face competition from these and other parties
including new entrants, such as Motorola, that develop digital information
security products based upon approaches similar to or different from those
employed by the Company. In addition, there can be no assurance that the market
for digital data
8
security products will not ultimately be dominated by approaches other than the
approach marketed by the Company.
Many of the Company's current and potential competitors have significantly
greater financial, technical, marketing, purchasing and other resources than the
Company, and as a result, may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or may be able to devote
greater resources to the development, promotion and sale of products, or to
deliver competitive products at a lower end user price. Current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address the needs of the Company's prospective customers. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Increased competition is likely to
result in price reductions, reduced operating margins and loss of market share,
any of which could have a material adverse effect on the Company's business and
operating results.
The Company believes that the principal competitive factors affecting the
market for digital data security products include support standards and
interoperability, technical features, ease of use, quality/reliability, level of
security, distribution channels and price. While the Company believes that it
competes favorably with respect to these factors, there can be no assurance that
the Company will be able to successfully incorporate these factors into its
products and to compete against current or future competitors or that
competitive pressures faced by the Company will not materially and adversely
affect its business and operating results.
MANAGEMENT OF GROWTH
The Company's business has grown substantially in recent periods, with net
sales increasing from $6.4 million in fiscal 1994 to $21.5 million in fiscal
1996. The growth of the Company's business has placed a significant strain on
the Company's management and operations. In addition, a number of key members of
the Company's management, including its President and Chief Executive Officer,
Chief Financial Officer, Vice President-Operations, and Vice President-Marketing
have joined the Company within the past 12 months. Furthermore, in 1993 the
Company commenced operations in North America which included the establishment
of a U.S. management team. As a result, the Company has a limited operating
history under its current U.S. management. In addition, the number of employees
has grown from 50 at December 31, 1995 to 64 as of March 31, 1997. If the
Company is successful in achieving its growth plans, such growth is likely to
place a significant burden on the Company's operating and financial systems,
resulting in increased responsibility for senior management and other personnel
within the Company. There can be no assurance that the Company's existing
management or any new members of management will be able to augment or improve
existing systems and controls or implement new systems and controls in response
to anticipated future growth. The Company's failure to do so could have a
material adverse effect on the Company's business and operating results. See
"-- Dependence on Key Personnel; Ability to Recruit Personnel," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
INTEGRATION OF GLOBAL LOCATIONS
The Company's headquarters are located in Los Gatos, California and
Pfaffenhofen, Germany, and the Company's research and development facilities are
located in Erfurt, Germany and La Ciotat, France. In addition, a significant
portion of the Company's contract manufacturing occurs in Singapore. Although
the Company seeks to mitigate its diverse geographic locations through the
extensive use of electronic mail and teleconferencing, there can be no assurance
that it will not encounter unforeseen difficulties or logistical barriers in
operating in diverse locations. Furthermore, operations in widespread geographic
locations require the Company's information systems to be consolidated, to
function in a complex environment and to be fully scalable. Although the Company
believes that its information systems are adequate, the Company may in the
future have to implement new information systems. Implementation of such new
information systems may be costly and may require training of personnel. Any
failure or delay in implementing these systems, procedures and controls on a
timely basis, if necessary, or in expanding these areas in an efficient manner
at a pace consistent with the Company's business could have a material adverse
effect on the Company's business and operating results.
9
PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY
The Company's success depends significantly upon its proprietary
technology. The Company currently relies on a combination of patent, copyright
and trademark laws, trade secrets, confidentiality agreements and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. The Company generally
enters into confidentiality and non-disclosure agreements with its employees and
with key vendors and suppliers. The Company's SwapBox trademark is registered in
the United States, and the SwapSmart trademark is the subject of an allowed,
pending application. The Company will continue to evaluate the registration of
additional trademarks as appropriate. The Company currently has one U.S. patent
issued; six U.S., one French and one Japanese patent applications pending; and
exclusive licenses under four other U.S. patents associated with its products.
Furthermore, the Company intends to obtain an exclusive license from one of its
employees to five other patents relating to its products. There can be no
assurance that any new patents will be issued, that the Company will develop
proprietary products or technologies that are patentable, that any issued patent
will provide the Company with any competitive advantages or will not be
challenged by third parties, or that the patents of others will not have a
material adverse effect on the Company's business.
There has also been substantial litigation in the technology industry
regarding intellectual property rights, and litigation may be necessary to
protect the Company's proprietary technology. The Company has from time to time
received claims that it is infringing upon third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
patents, trademarks or other proprietary rights. On April 28, 1997, Gemplus
served the Company with a complaint alleging that the Company's SwapSmart
product infringes certain claims of a French patent held by Gemplus. See
"Business -- Legal Proceedings." The Company expects that companies in the
computer and digital information security market will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
target markets grows. Any such claims or litigation may be time-consuming and
costly, cause product shipment delays, require the Company to redesign its
products or require the Company to enter into royalty or licensing agreements,
any of which could have a material adverse effect on the Company's business and
operating results. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information and software that the Company regards
as proprietary. In addition, the laws of some foreign countries do not protect
proprietary and intellectual property rights to as great an extent as do the
laws of the United States. There can be no assurance that the Company's means of
protecting its proprietary and intellectual property rights will be adequate or
that the Company's competitors will not independently develop similar
technology, duplicate the Company's products or design around patents issued to
the Company or other intellectual property rights of the Company.
DEPENDENCE ON CONTRACT AND OFFSHORE MANUFACTURING; LIMITED NUMBER OF SUPPLIERS
OF KEY COMPONENTS
The Company has implemented a global sourcing strategy that it believes
will enable it to achieve greater economies of scale, improve gross margins and
maintain uniform quality standards for its products. The Company currently
sources its products through three contract manufacturers in Europe and Asia. In
the event any of the Company's contract manufacturers are unable or unwilling to
continue to manufacture the Company's products, the Company may have to rely on
other current manufacturing sources or identify and qualify new contract
manufacturers. In this regard, one of the Company's contract manufacturers has
recently been involved in bankruptcy proceedings and may be unable to continue
manufacturing the Company's products. Although the Company believes it will be
able to rely on other manufacturing sources in order to meet its near-term
capacity requirements, there can be no assurance that the Company would be able
to identify or qualify new contract manufacturers in a timely manner or that
such manufacturers would allocate sufficient capacity to the Company in order to
meet its requirements. Any significant delay in the Company's ability to obtain
adequate supplies of its products from its current or alternative sources would
materially and adversely affect the Company's business and operating results.
10
In an effort to reduce manufacturing costs, the Company has shifted volume
production of many components of its products to Singapore. The Company is
currently considering shifting the production of other components of its
products to other suppliers in Europe or Asia. The potential transfer or
expansion of production in these facilities will require tight ongoing inventory
and cost controls. Difficulties encountered in transferring production may have
a disruptive effect on the Company's manufacturing process and increase overall
production costs. Due to the substantial concentration of the Company's
manufacturing operations in Singapore, a disruption of operations at its
facilities in Singapore could have a material adverse effect on the Company's
business and operating results. Foreign manufacturing is subject to a number of
risks, including transportation delays and interruptions, difficulties in
staffing, currency fluctuations, potentially adverse tax consequences and
unexpected changes in regulatory requirements, tariffs and other trade barriers,
and political and economic instability.
The Company relies upon a limited number of suppliers of several key
components utilized in the assembly of the Company's products. For example, the
Company purchases many of the components for use in its SwapSmart and SwapBox
products from Intellicard Systems, a Singapore corporation, and mechanical
components for use in its smart card reader product exclusively from Stocko, a
German corporation. The Company's reliance on its suppliers involves several
risks, including a potential inability to obtain an adequate supply of required
components, price increases, late deliveries and poor component quality.
Although to date the Company has been able to purchase its requirements of such
components, there can be no assurance that the Company will be able to obtain
its full requirements of such components in the future or that prices of such
components will not increase. In addition, there can be no assurance that
problems with respect to yield and quality of such components and timeliness of
deliveries will not occur. Disruption or termination of the supply of these
components could delay shipments of the Company's products and could have a
material adverse effect on the Company's business and operating results. Such
delays could also damage relationships with current and prospective customers.
See "Business -- Manufacturing."
DEPENDENCE ON NEW PRODUCTS; RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapid
technological change, changing customer needs, frequent new product introduction
and evolving industry standards and short product lifecycles. The introduction
by the Company or its competitors of products embodying new technologies and the
emergence of new industry standards could render the Company's existing products
obsolete and unmarketable. Therefore, the Company's future success will depend
upon its ability to successfully develop and to introduce new and enhanced
products on a timely and continuous basis that keep pace with technological
developments and emerging industry standards and address the increasingly
sophisticated needs of its customers. During the second half of 1997, the
Company intends to introduce several new products which incorporate new and
complex technologies and are expected to be critical to the Company's business
and operating results in future periods. The timing and success of product
development is unpredictable due to the inherent uncertainty in anticipating
technological developments, the need for coordinated efforts of numerous
technical personnel and the difficulties in identifying and eliminating design
flaws prior to product release. Any significant delay in releasing new products
could have a material adverse effect on the ultimate success of a product and
other related products and could impede continued sales of predecessor products,
any of which could have a material adverse effect on the Company's business and
operating results. There can be no assurance that the Company will be able to
introduce new products on a timely basis, that new products introduced by the
Company will achieve any significant degree of market acceptance or that any
such acceptance will be sustained for any significant period. Failure of new
products to achieve or sustain market acceptance could have a material adverse
effect on the Company's business and operating results. See
"Business -- Research and Development."
RISKS OF INTERNATIONAL SALES; CURRENCY FLUCTUATIONS
The Company was originally a German corporation and continues to conduct a
substantial portion of its business in Europe. As a result, approximately 82.5%,
49.0% and 52.5% of the Company's revenues in 1994, 1995 and 1996, respectively,
were derived from customers located outside the United States. Because a
11
significant number of the Company's principal customers are located in other
countries, the Company anticipates that international sales will continue to
account for a significant portion of its revenues. As a result, a significant
portion of the Company's sales and operations may continue to be subject to
certain risks, including tariffs and other trade barriers, difficulties in
staffing and managing disparate branch operations, currency exchange risks and
exchange controls and potential adverse tax consequences. There can be no
assurance that any of these factors will not have a material adverse effect on
the Company's business and operating results.
As a result of the Company's multinational operations and sales, the
Company's operating results are subject to significant fluctuations based upon
changes in the exchange rates of certain currencies, particularly the German
mark, in relation to the U.S. dollar. Although the Company does not currently
engage in hedging activities with respect to its foreign currency exposure, the
Company may evaluate hedging strategies intended to reduce such exposure in the
future. Although management will continue to monitor the Company's exposure to
currency fluctuations, and, when appropriate, may use financial hedging
techniques in the future to minimize the effect of these fluctuations, there can
be no assurance that exchange rate fluctuations will not have a material adverse
effect on the Company's business and operating results. In the future, the
Company could be required to denominate its product sales in other currencies,
which would make the management of currency fluctuations more difficult and
expose the Company to greater risks in this regard. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
PRODUCT LIABILITY RISKS
Customers rely on the Company's token-based security products to prevent
unauthorized access to their digital content. A malfunction of or design defect
in the Company's products could result in tort or warranty claims. Although the
Company attempts to reduce the risk of exposure from such claims through
warranty disclaimers and liability limitation clauses in its sales agreements
and by maintaining product liability insurance, there can be no assurance that
such measures will be effective in limiting the Company's liability for any such
damages. Any liability for damages resulting from security breaches could be
substantial and would have a material adverse effect on the Company's business
and operating results. In addition, a well-publicized actual or perceived
security breach involving token-based security systems could adversely affect
the market's perception of token-based security products in general, or the
Company's products in particular, regardless of whether such breach is
attributable to the Company's products. This could result in a decline in demand
for the Company's products, which would have a material adverse effect on the
Company's business and operating results.
DEPENDENCE ON KEY PERSONNEL; ABILITY TO RECRUIT PERSONNEL
The Company's future performance depends in significant part upon the
continued service of Robert Schneider, the Company's Chairman of the Board,
Steven Humphreys, the Company's President and Chief Executive Officer, and Bernd
Meier, the Company's Chief Operations Officer, as well as its other key
technical and senior management personnel. The Company provides compensation
incentives such as bonuses, benefits and option grants (which are typically
subject to vesting over four years) to attract and retain qualified employees.
The loss of the services of one or more of the Company's officers or other key
employees could have a material adverse effect on the Company's business and
operating results. The Company believes that its future success will depend in
large part on its continuing ability to attract and retain highly qualified
technical and management personnel. Competition for such personnel is intense,
and there can be no assurance that the Company can retain its key technical and
management employees or that it can attract, assimilate or retain other highly
qualified technical and management personnel in the future. See
"Business -- Employees" and "Management."
BROAD MANAGEMENT DISCRETION IN USE OF PROCEEDS; RISKS ASSOCIATED WITH POTENTIAL
ACQUISITIONS
The Company currently has no specific use planned for a substantial portion
of the net proceeds from this offering. As a consequence, the Company's
management will have broad discretion to allocate a large percentage of these
proceeds to uses which the stockholders may not deem desirable, and there can be
no
12
assurance that the proceeds can or will yield a return. Although it currently
has no present plans, agreements or commitments with respect to any material
transaction, the Company could use a portion of these funds for the acquisition
of complementary businesses, products and technologies.
Future acquisitions by the Company may result in potentially dilutive
issuances of equity securities, the incurrence of additional debt and
amortization of goodwill and other intangible assets, which could materially
adversely affect the Company's business and operating results. In addition,
acquisitions involve numerous risks, including difficulties in the assimilation
of the operations, products and personnel of the acquired company, the diversion
of management's attention from other business concerns, risks of entering
markets in which the Company has no direct prior experience and the potential
loss of key employees of both the acquired company and the Company. There can be
no assurance that the Company will ever successfully complete an acquisition.
The Company has no present plans, agreements or commitments with respect to any
material acquisitions of other businesses, products or technologies. See "Use of
Proceeds."
CONCENTRATION OF STOCK OWNERSHIP; ANTI-TAKEOVER PROVISIONS
Upon completion of this offering, the Company's executive officers and
directors, together with their affiliates, will beneficially own approximately
23.0% of the Company's outstanding shares of Common Stock. Accordingly, these
stockholders, acting together, will continue to be able to exert significant
influence over all matters requiring stockholder approval, including the
election of the Company's directors and the approval of mergers and other change
in control transactions involving the Company. See "Management," "Principal
Stockholders" and "Description of Capital Stock."
Certain provisions of the Company's Amended and Restated Certificate of
Incorporation, amended Bylaws, Delaware law and the Company's indemnification
agreements with certain officers and directors of the Company may be deemed to
have an anti-takeover effect. Such provisions may delay, deter or prevent a
tender offer or takeover attempt that a stockholder might consider to be in that
stockholder's best interests, including attempts that might result in a premium
over the market price for the shares held by stockholders.
The Company's Board of Directors may issue additional shares of Common
Stock or establish one or more classes or series of Preferred Stock, having the
number of shares (up to 10,000,000), designations, relative voting rights,
dividend rates, liquidation and other rights, preferences and limitations as
determined by the Board of Directors without stockholder approval. The Company's
Certificate of Incorporation, as amended and restated, and Bylaws, as amended,
also contain a number of provisions that could impede a takeover or change in
control of the Company, including but not limited to the elimination of
stockholders' ability to take action by written consent without a meeting and
the elimination of cumulative voting in the election of directors.
In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law. In general, the statute
prohibits a publicly-held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
Each of the foregoing provisions gives the Board of Directors, acting
without stockholder approval, the ability to prevent, or render more difficult
or costly, the completion of a takeover transaction that stockholders might view
as being in their best interests.
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to this offering there has been no public market for the Company's
Common Stock, and there can be no assurance that an active public market for the
Common Stock will develop or be sustained after the offering. The initial
offering price will be determined by negotiation between the Company and the
Underwriters based upon several factors and may not be indicative of future
market prices. The trading price of the Company's Common Stock could be subject
to wide fluctuations in response to a number of factors, including quarterly
variations in operating results, announcements of technological innovations or
new
13
products, applications or product enhancements by the Company or its
competitors, changes in financial estimates by securities analysts and other
events. In addition, the stock market has experienced volatility that has
particularly affected the market prices of equity securities of many high
technology companies and that often has been unrelated or disproportionate to
the operating performance of such companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock. See
"Underwriting."
SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock in the public
market after this offering could adversely affect the market price of the
Company's Common Stock and could impair the Company's ability to raise capital
through the sale of equity or equity-related securities. Upon completion of this
offering, the Company will have outstanding 9,404,489 shares of Common Stock,
assuming no further exercise of options or warrants outstanding as of March 31,
1997. Of these shares, the 2,750,000 shares offered hereby (3,162,500 shares if
the Underwriters' overallotment option is exercised in full) will be freely
tradeable without restriction or further registration under the Securities Act
of 1933, as amended (the "Securities Act"), unless purchased by "affiliates" of
the Company as that term is defined in Rule 144 under the Securities Act ("Rule
144") described below. The remaining 6,654,489 shares of Common Stock
outstanding upon completion of this offering are "restricted securities" as that
term is defined in Rule 144. Of the restricted securities, 57,618 shares will be
eligible for immediate sale upon commencement of this offering, an additional
94,751 shares will become eligible for sale beginning 90 days after commencement
of this offering. Upon expiration of certain Lock-Up Agreements (which occurs on
the date 180 days after commencement of this offering), an aggregate of
3,769,539 shares will become eligible for sale pursuant to Rule 144 or Rule 701
under the Securities Act, and 2,732,581 additional shares will become eligible
for sale thereafter under Rule 144. See "Shares Eligible for Future Sale."
Holders of an aggregate of 6,078,947 shares will have the right to require the
Company to register such shares for sale under the Securities Act. See
"Description of Capital Stock -- Registration Rights."
IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price is substantially higher than the net
tangible book value per share of Common Stock. At an estimated offering price of
$ per share, investors purchasing shares in this offering will incur
immediate dilution of $ per share. To the extent outstanding options and
warrants to purchase the Company's Common Stock are exercised, there will be
further dilution to new stockholders. See "Dilution."
14
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,750,000 shares of
Common Stock being offered hereby, based on an assumed initial public offering
price of $ per share and after deducting the estimated underwriting discount
and offering expenses payable by the Company, are estimated to be approximately
$ ($ if the Underwriters' over-allotment option is
exercised in full). The Company expects to use the net proceeds from this
offering for repayment of indebtedness, capital expenditures and general
corporate purposes, including working capital. The Company intends to repay
approximately $2.5 million, consisting of a term loan from a German bank. This
agreement terminates on December 31, 2005 and bears interest at rates ranging
from 5.0% to 6.0%. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources." A
portion of the net proceeds may also be used to acquire or invest in
complementary businesses or products or to obtain the right to use complementary
technologies. The Company has no present plans, agreements or commitments and is
not currently engaged in any negotiations with respect to any such transactions.
Pending use of the net proceeds for the above purposes, the Company intends to
invest such funds in short-term, interest-bearing, investment grade obligations.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its Common Stock
or other securities. The Company has a $2.5 million revolving line of credit
with a U.S. bank expiring in August 1997. Under such line of credit, the Company
must obtain the bank's prior written consent in order to declare or pay any cash
dividends. The Company currently anticipates that it will retain all of its
future earnings for use in the expansion and operation of its business and does
not anticipate paying any cash dividends in the foreseeable future.
15
CAPITALIZATION
The following table sets forth: (i) the total capitalization of the Company
at March 31, 1997; (ii) such capitalization adjusted on a pro forma basis to
give effect to (a) the issuance of 849,790 shares of Preferred Stock subsequent
to March 31, 1997 and (b) the Automatic Conversion; and (iii) such pro forma
capitalization as adjusted to give effect to the sale by the Company of the
2,750,000 shares of Common Stock offered hereby at an assumed initial public
offering price of $ per share (after deducting the underwriting discount
and estimated offering expenses) and the application of net proceeds therefrom.
See "Principal Stockholders." This table should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto included elsewhere in
this Prospectus.
- ---------------
(1) See Note 3 of Notes to Consolidated Financial Statements.
(2) As of March 31, 1997, there were outstanding options to purchase an
aggregate of 358,174 shares of Common Stock a weighted average exercise
price of $0.10 per share and 1,225,000 shares were reserved for future
issuance under the Company's stock plans. Subsequent to March 31, 1997, the
Company issued warrants to purchase an aggregate of 384,121 shares of Common
and Preferred Stock at a weighted average exercise price of $7.17 per share.
See "Management -- Employee Stock Plans" and Notes 4 and 11 of Notes to
Consolidated Financial Statements.
16
DILUTION
The pro forma net tangible book value of the Company as of March 31, 1997
was $14,795,000 or $2.22 per common share. Pro forma net tangible book value per
share is determined by dividing the net tangible book value of the Company
(total tangible assets less total liabilities) by the number of shares of Common
Stock outstanding at that date after giving pro forma effect to (i) the issuance
of an aggregate of 849,790 shares of Preferred Stock subsequent to March 31,
1997 and (ii) the Automatic Conversion. After giving effect to the sale by the
Company of the 2,750,000 shares of Common Stock offered hereby (at an assumed
initial public offering price of $ per share and after deduction of the
estimated underwriting discount and offering expenses payable by the Company),
the Company's pro forma net tangible book value at March 31, 1997 would have
been $ or $ per share. This represents an immediate increase in
net tangible book value to existing stockholders of $ per share and an
immediate dilution to new investors of $ per share. The following table
illustrates the per share dilution:
The following table sets forth, on the pro forma basis described above, as
of March 31, 1997, the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price per share paid by
(i) existing stockholders and (ii) new investors at an assumed offering price of
$ per share (before deducting the estimated underwriting discount and
offering expenses):
The foregoing computations assume no exercise of the Underwriters'
over-allotment option and no exercise of stock options outstanding at March 31,
1997. As of March 31, 1997, there were outstanding options to purchase an
aggregate of 358,174 shares of Common Stock at a weighted average exercise price
of $0.10 per share and 1,225,000 shares were reserved for future issuance under
the Company's stock plans. Subsequent to March 31, 1997, the Company issued
warrants to purchase an aggregate of 384,121 shares of Common Stock and
Preferred Stock at a weighted average exercise price of $7.17 per share. To the
extent that any of these options or warrants are exercised, there will be
further dilution to new investors. See "Capitalization," "Management -- Employee
Stock Plans" and Notes 4 and 11 of Notes to Consolidated Financial Statements.
17
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data at December 31, 1995 and
1996 and for each of the years in the three-year period ended December 31, 1994,
1995 and 1996 are derived from consolidated financial statements of the Company
that have been audited by KPMG Peat Marwick LLP, independent certified public
accountants, and are included elsewhere in this Prospectus. The consolidated
balance sheet data at December 31, 1994 is derived from the audited Consolidated
Financial Statements of the Company that are not included herein. The
consolidated statement of operations data for the year ended December 31, 1993
and the consolidated balance sheet data at December 31, 1993 are derived from
unaudited Consolidated Financial Statements of the Company that are not included
herein. The following selected consolidated financial data at March 31, 1997 and
for the three-month periods ended March 31, 1996 and 1997 are unaudited but have
been prepared on the same basis as the audited Consolidated Financial Statements
and, in the opinion of management, contain all adjustments, consisting only of
normal recurring adjustments, that management believes necessary for a fair
presentation of the financial position and results of operations for these
periods. The historical results are not necessarily indicative of the operating
results to be expected in the future. The following selected consolidated
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and Notes thereto included elsewhere in this Prospectus.
- ---------------
(1) Through 1994, the Company focused on PCMCIA peripheral products, including
flash memory and fax/modem devices. In 1994, the Company began emphasizing
security and access products. The Company made the final shipment of PCMCIA
peripheral products in the quarter ended March 31, 1997, completing its exit
from this business.
(2) Share and per share information gives pro forma effect to the Automatic
Conversion. See Notes 1, 4 and 10 of Notes to Consolidated Financial
Statements.
(3) Reflects (i) the issuance of 849,790 shares of Preferred Stock subsequent to
March 31, 1997 and (ii) the Automatic Conversion.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth in this section as well as those discussed
under the caption "Risk Factors" elsewhere in this Prospectus.
OVERVIEW
SCM Microsystems designs, develops and manufactures hardware, firmware and
software products for data security and access control applications. The Company
sells security and access products to OEM computer, telecommunication and DVB
component and system manufacturers. The Company's objective is to leverage its
expertise in PCMCIA and smart card technologies and its extensible, upgradeable
smart card token-based security architecture to capitalize on the growing demand
for data and network security and the need to control access to digital
information. The Company markets, sells and licenses its products through a
direct sales and marketing organization primarily to OEMs and also through
distributors, VARs, system integrators and resellers worldwide. OEM customers
include Compaq, Dell, France Telecom, IBM, Kirch Group (BetaDigital),
Schlumberger, Security Dynamics, Siemens/Nixdorf, Sun Microsystems and Telenor.
The Company focuses on security and access products that provide secure
access to digital data. The Company's security and access products are targeted
at OEM computer, telecommunication and DVB component and system manufacturers.
Through 1994, the Company focused primarily on PCMCIA peripheral products,
including flash memory and fax/modem devices, which carried a significantly
lower gross margin than the Company's current products. In 1994, the Company
began emphasizing security and access products. The Company made the final
shipment of PCMCIA peripheral products in the quarter ended March 31, 1997,
completing its exit from this business. As a result of the Company's strategic
shift in product focus, the proportion of security and access product sales
increased from 22.1% of total net sales in 1994 to 77.3% of total net sales in
1996. Beginning in 1997, the Company's net sales will be dependent upon the
success of its security and access products.
A substantial majority of the Company's security and access products are
intended for use as components or subsystems in systems manufactured and sold by
third party OEMs. In 1996, sales to IBM accounted for 12% of total net sales,
sales to BetaDigital, a division of the Kirch Group, accounted for 11% of total
net sales and sales to the Company's top 10 customers accounted for 55.0% of
total net sales. In addition, sales of the Company's SwapBox product accounted
for 62.2% and 54.4% of total net sales in 1995 and 1996, respectively. A
substantial majority of the SwapBox products sold by the Company are sold to a
number of major OEMs, including IBM, Dell and Packard Bell, each of which in
turn supplies products, such as desktop PCs, to the DoD. The Company expects its
business to continue to be substantially dependent upon sales of SwapBox
products to OEMs that are supplying the DoD, although such dependence may
decline as the Company expands its product lines and customer base. The Company
frequently enters into contracts with OEMs which provide for shipment of certain
quantities of products at specified future dates. Revenue from these contracts,
as well as from other sales, is recognized upon shipment of products.
As a result of the Company's multinational operations and sales, the
Company's operating results are subject to significant fluctuations based upon
changes in the exchange rates of certain currencies, particularly the German
mark, in relation to the U.S. dollar. For example, the Company's headquarters
are located in Los Gatos, California, its international headquarters are located
near Munich, Germany and its research and development facilities are located in
Erfurt, Germany and La Ciotat, France. In addition, the Company sources its
products from contract manufacturers located in Europe and Asia. As a result, a
substantial portion of the Company's costs and expenses are denominated in
currencies other than the U.S. dollar. For the year ended December 31, 1996, the
Company's sales denominated in U.S. dollars was $16.4 million, representing
76.3% of the Company's total net sales. Although the Company does not currently
engage in risk management activities with respect to its foreign currency
exposure, the Company may evaluate hedging strategies intended
19
to reduce such exposure in the future. Although management will continue to
monitor the Company's exposure to currency fluctuations, there can be no
assurance that exchange rate fluctuations will not have a material adverse
effect on the Company's business and operating results.
The Company experiences substantial seasonality in its business, with
approximately one-third of annual net sales being realized in the first half of
the year and the remaining two-thirds being realized in the second half of the
year. In recent periods, this seasonality has been primarily the result of the
Company's reliance on sales of its SwapBox products to OEMs that in turn are
selling to U.S. government agencies. The buying pattern of U.S. government
agencies tend to be substantially weighted to the third quarter and, to a
somewhat lesser extent, the fourth quarter of the calendar year. The strength in
net sales in the third quarter which results from the U.S. government buying
patterns is somewhat offset by relatively weaker sales in Europe in the same
quarter as a result of the traditional European summer vacation patterns. The
Company expects that as sales of its DVB products, which are sold to OEMs mainly
in Europe for the consumer market, begin to represent a larger percentage of net
sales, the seasonality that the Company experiences may be further exacerbated
as such sales are likely to be strongest in the fourth quarter of the year. In
contrast to net sales, operating expenses tend to be spread relatively evenly
across the year. As a result, the Company's operating results have tended to be
weakest in first and second quarter of the year. See "-- Quarterly Results of
Operations."
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated statement of operations as a percentage of total revenues for the
periods indicated:
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31, 1996
Net Sales. Net sales reflect the invoiced amount for goods shipped less
estimated returns. Revenue is recognized upon product shipment. Net sales for
the first quarter of 1997 were $4.4 million, compared with $4.3 million in the
first quarter of 1996. Sales of security and access products were $4.2 million
in the first quarter of 1997, compared to $2.8 million in the comparable quarter
of 1996, an increase of 48%, reflecting the Company's shift in product strategy
toward security and access products. This increase was primarily due to an
increase in sales of the Company's DVB products, which commenced in the fourth
quarter of 1996. The
20
Company made the final shipment of PCMCIA peripheral products in the quarter
ended March 31, 1997, completing its exit from this business.
Gross Profit. Gross profit for the first quarter of 1997 was $1.6 million,
or 35.9% of net sales, compared to $1.2 million, or 27.9% of net sales in the
comparable quarter of 1996. The increase in gross profit, both in absolute
amount and as a percentage of net sales, was primarily due to the increase in
DVB product sales and the corresponding mix shift away from lower margin PCMCIA
peripheral products. In addition, the Company's transition from the PCMCIA
peripheral products business resulted in reduced labor requirements. The Company
believes that its gross profit during 1997 will continue to be above the levels
experienced in 1996. The Company's gross profit has been and will continue to be
affected by a variety of factors, including competition, product configuration
and mix, the availability of new products and product enhancements which tend to
carry higher gross profit than older products and the cost and availability of
components. Accordingly, there can be no assurance that the Company will achieve
the forecasted levels of gross profit.
Research and Development. Research and development expenses consist
primarily of employee compensation and prototype expenses. To date, the period
between achieving technological feasibility and completion of software has been
short, and software development costs qualifying for capitalization have been
insignificant. Accordingly, the Company has not capitalized any software
development costs. Research and development expenses for the first quarter of
1997 were $628,000, compared to $624,000 in the first quarter of 1996, an
increase of less than one percent. In the first quarter of 1996, subcontractor
expenses for prototype manufacturing were unusually high, due to accelerated
development schedules for the Company's new line of smart card readers. Had
these expenses been consistent with prior levels, research and development
expenses would have shown a 9% increase in the first quarter of 1997 over the
comparable quarter of 1996, with this increase due primarily to higher
engineering headcount in the Company's French development center.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee compensation and trade show and other marketing costs. Sales and
marketing expenses for the first quarter of 1997 were $895,000, or 20.5% of net
sales, compared to $631,000 or 14.8% of net sales in the comparable period of
1996, an increase of 42%. This increase in absolute amount and as a percentage
of net sales was due primarily to growth of the Company's sales and marketing
headcount in the U.S. and initial promotional efforts in the Asia-Pacific
region. Sales and marketing expenses in 1997 are expected to increase in
absolute amounts as the Company continues to expand its headcount to support a
larger customer base and expanded product line, but to generally remain
consistent with or decline slightly from the 1996 results as a percentage of net
sales.
General and Administrative. General and administrative expenses consist
primarily of compensation expenses for employees performing the Company's
administrative functions. General and administrative expenses for the first
quarter of 1997 were $518,000, or 11.9% of net sales, compared to $441,000, or
10.4% of net sales in the first quarter of 1996, an increase of 17%. General and
administrative expenses increased in absolute amount in the first quarter of
1997 and as a percentage of net sales primarily as a result of an increase of
administrative headcount in the Company's U.S. and German offices in support of
higher levels of business activities. The Company believes general and
administrative expenses in 1997 will continue to increase in absolute amount as
a result of operating as a public company but that such expenses will remain
relatively consistent with the 1996 results as a percentage of net sales.
Interest Expense. Interest expense consists of interest on outstanding
debt, and was immaterial in the first quarters of 1997 and 1996. In future
periods, the Company expects that interest expense will be reduced as a result
of the conversion into equity of certain convertible debt on or before the
closing of this offering and that interest income will increase as a result of
the investment of the proceeds of this offering.
Income Taxes. The Company incurred losses in 1995, 1996 and the quarter
ended March 31, 1997, and therefore did not incur income tax obligations in
these periods. As of December 31, 1996, the Company had German net operating
loss carryforwards of approximately $4.6 million available to offset income from
the Company's German operations for an indefinite period. In addition, the
Company had net operating loss carryforwards of approximately $1.9 million and
$800,000 for United States federal and California income tax purposes,
respectively. The Company's utilization of United States federal net operating
loss carryforwards is limited to approximately $340,000 per year.
21
1996 COMPARED TO 1995
Net Sales. Net sales increased 19.1% to $21.5 million in 1996, compared to
$18.1 million in 1995. Sales of security and access products represented 77.3%
of total net sales in 1996 compared to 69.3% in 1995, reflecting the continued
shift in the Company's product strategy toward security and access products.
Security and access product sales increased 32.8% to $16.6 million in 1996
compared to $12.5 million in 1995. This increase resulted primarily from
increased sales of SwapBox products which began shipping in 1995, as well as
sales of security and access products introduced during 1996, including
SwapSmart and the Company's DVB products. Consistent with the Company's shift
away from PCMCIA peripheral products, sales of such products decreased 11.8% to
$4.9 million in 1996 compared to $5.5 million in 1995. In 1994, the Company
began emphasizing security and access products. The Company made the final
shipment of PCMCIA peripheral products in the quarter ended March 31, 1997,
completing its exit from this business.
Gross Profit. Gross profit for 1996 was $6.6 million, or 30.9% of net
sales, compared to $2.3 million, or 12.7% of net sales in 1995. The substantial
increase in gross profit as a percentage of net sales in 1996 was primarily
attributable to three factors: (i) during 1996, the Company benefited from
manufacturing cost efficiencies associated with the increased sales of security
and access products; (ii) as part of the continued shift in 1996 from PCMCIA
peripheral products to security and access products, the Company introduced
certain new security and access products during 1996 which carried higher gross
margins than other products in the security and access product family; and (iii)
during 1996, the Company received approximately $1.6 million in nonrecurring
engineering revenues with relatively minimal cost of sales.
Research and Development. Research and development expenses for 1996
totaled $2.4 million, or 11.1% of net sales, compared to $1.4 million, or 7.7%
of net sales in 1995. The increase in research and development spending during
1996 was primarily a result of increased headcount and development activity
associated with new product introductions and the opening of the Company's
research and development facility in France.
Sales and Marketing. Sales and marketing expenses for 1996 totaled $3.2
million, or 15.0% of net sales, compared to $2.1 million, or 11.4% of net sales
in 1995. Sales and marketing expenses in 1996 in absolute amount increased
primarily as a result of the costs associated with introducing several
significant new products during 1996 and the higher headcount costs associated
with supporting a broader base of customers and expanded line of products.
General and Administrative. General and administrative expenses for 1996
totaled $2.0 million, or 9.3% of net sales, compared to $1.4 million, or 8.0% of
net sales in 1995. General and administrative expenses increased in absolute
amount in 1996 and as a percentage of net sales primarily as a result of
increasing headcount and expanded facilities associated with the overall growth
in the business.
Interest Expense. Interest expense was immaterial as a percentage of sales
in both 1996 and 1995.
Income Taxes. The Company incurred losses in 1995 and 1996 and therefore
did not incur income tax obligations in these periods. As of December 31, 1996,
the Company had deferred tax assets of approximately $2.2 million, resulting
primarily from the net operating loss carryforwards. At December 31, 1996, the
Company recorded a full valuation allowance for these deferred tax assets as
management has concluded that it is more likely than not that the deferred tax
assets would not be realized in the future. A future change in the Company's
assessment of the likelihood of future realization of deferred tax assets could
result in a reduction of the valuation allowance, a corresponding reduction in
the Company's income tax expense recorded for financial statement purposes and a
corresponding increase in net income. This would not, however, result in a
change in actual income taxes payable by the Company in any future period. See
Note 6 to the Consolidated Financial Statements.
1995 COMPARED TO 1994
Net Sales. Net sales increased to $18.1 million in 1995, compared to $6.4
million during 1994. Sales of security and access products and sales of PCMCIA
peripheral products represented 69.3% and 30.7%, respectively, of total net
sales in 1995 compared to 22.1% and 77.9%, respectively, in 1994, reflecting the
shift in the Company's product strategy toward security and access products.
Security and access product sales increased to $11.1 million in 1995, compared
to $1.4 million in 1994. This substantial increase resulted
22
primarily from sales of SwapBox products which began shipping in 1995. PCMCIA
peripheral product sales increased to $5.5 million in 1995, compared to $5.0
million in 1994. This increase resulted primarily from the expansion in 1995 of
the Company's PCMCIA peripheral product line to include fax/modem PC Cards.
Gross Profit. Gross profit for 1995 was $2.3 million, or 12.7% of net
sales, compared to $1.4 million, or 21.1% of net sales in 1994. The substantial
decrease in gross profit as a percentage of net sales in 1995 was primarily
attributable to continuing price erosion for the Company's older PCMCIA
peripheral products, partially offset by the somewhat better margins associated
with the fax/modem product, and to relatively high manufacturing and procurement
costs associated with the security access products, particularly SwapBox which
was first shipped in 1995.
Research and Development. Research and development expenses for 1995
totaled $1.4 million, or 7.7% of net sales, compared to $1.2 million, or 18.0%
of net sales in 1994. The decrease in research and development spending in
absolute amount in 1995 resulted primarily from a lower level of development
effort being devoted to PCMCIA peripheral products and the transfer of certain
personnel from research and development functions to operating functions as the
Company's products, primarily SwapBox, moved from development stage to
production stage.
Sales and Marketing. Sales and marketing expenses for 1995 totaled $2.1
million, or 11.4% of net sales, compared to $1.2 million, or 19.0% of net sales
in 1994. Sales and marketing expenses increased in absolute amount in 1995 as
the Company's headcount expanded, particularly in the United States, and as the
Company expanded marketing activities in the U.S.
General and Administrative. General and administrative expenses for 1995
totaled $1.4 million, or 8.0% of net sales, compared to $580,000, or 9.0% of net
sales in 1994. General and administrative expenses increased in absolute amount
in 1995 primarily as a result of an increase in administrative personnel during
1995 to support the growth in the Company's business.
Interest Expense. Interest expense was immaterial as a percentage of net
sales in 1994 and 1995.
Income Taxes. Due to the Company's operating losses, the Company did not
incur income tax expense in 1994 or 1995.
23
QUARTERLY RESULTS OF OPERATIONS
The following tables present certain unaudited consolidated statement of
operations data for the third and fourth quarters of 1995, each of the four
quarters in the year ended December 31, 1996 and the first quarter of 1997, as
well as such data expressed as a percentage of the Company's total net sales for
the periods indicated. This data has been derived from unaudited consolidated
financial statements and has been prepared on the same basis as the Company's
audited Consolidated Financial Statements which appear elsewhere in this
Prospectus. In the opinion of the Company's management, this data includes all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of such data.
24
The Company experiences substantial seasonality in its business, with
approximately one-third of annual net sales being realized in the first half of
the year and the remaining two-thirds being realized in the second half of the
year. In recent periods, this seasonality has been primarily the result of the
Company's reliance on sales of its SwapBox products to OEMs that in turn sell to
U.S. government agencies. The buying pattern of U.S. government agencies tend to
be substantially weighted to the third quarter and, to a somewhat lesser extent,
the fourth quarter of the calendar year. The strength in net sales in the third
quarter which results from the U.S. government buying patterns is somewhat
offset by relatively weaker sales in Europe in the same quarter as a result of
the traditional European summer vacation patterns. The Company expects that as
sales of its DVB products, which are sold to OEMs mainly in Europe for the
consumer market, begin to represent a larger percentage of net sales, the
seasonality that the Company experiences may be further exacerbated as these
sales are likely to be strongest in the fourth quarter of the year. In contrast
to net sales, operating expenses tend to be spread relatively evenly across the
year. As a result, the Company's operating results have tended to be weakest in
first and second quarter of the year. This revenue seasonality is evident in the
table above, in which the Company's net sales in 1996 increased each quarter,
then declined in the first quarter of 1997.
Gross margin generally improved in the second half of 1996 due primarily to
the shift in focus away from lower margin PCMCIA peripheral products. Gross
margin in the third quarter of 1996 was higher than other quarters in the year
due primarily to favorable product mix shift driven by higher sales to OEMs
supplying the DoD, combined with volume purchasing which lowered certain
component costs.
Research and development expenses have generally increased each quarter,
due primarily to increased headcount and related expenses in the Company's
development centers in La Ciotat, France and Erfurt, Germany. Unusually high
research and development expenses were incurred in the first quarter of 1996 due
primarily to substantial prototype manufacturing and test expenses related to
accelerated project timetables on key development projects. Sales and marketing
expenses have generally increased each quarter. In addition, certain sales
compensation costs typically fluctuate based on the levels of revenue bookings
and shipments. General and administrative expenses have generally increased each
quarter to support the increase in business activity. In the fourth quarter of
1995, general and administrative expenses were higher than previous quarters due
primarily to additional legal expenses and achievement and accrual of year end
management bonuses. In the third quarter of 1996, general and administrative
expenses were impacted by costs associated with the recruitment of the Company's
President and CEO.
The Company's quarterly operating results have in the past varied and may
in the future vary significantly. In addition to seasonality, factors affecting
operating results include: level of competition; size, timing, cancellation or
rescheduling of significant orders; product configuration and mix; market
acceptance of new products and product enhancements; new product announcements
or introductions by the Company's competitors; adoption of new technologies and
standards; deferrals of customer orders in anticipation of new products or
product enhancements; changes in pricing by the Company or its competitors; the
ability of the Company to develop, introduce and market new products and product
enhancements on a timely basis; hardware component costs and availability,
particularly with respect to hardware components obtained from sole sources; the
Company's success in expanding its sales and marketing programs; technological
changes in the market for digital information security products; levels of
expenditures on research and development; foreign currency exchange rates;
general economic trends and other factors. Because a high percentage of the
Company's operating expenses are fixed, a small variation in the timing of
recognition of revenue can cause significant variations in operating results
from quarter to quarter. See "-- Overview."
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations to date principally through private
placements of debt and equity securities and, to a lesser extent, borrowings
under bank lines of credit. As of March 31, 1997, the Company's working capital
was $7.0 million. Working capital increased during the first quarter of 1997 due
to $5.1 million proceeds from the private placement of redeemable convertible
preferred stock, partially offset by $1.3 million in repayments of bank and
other debt, $1.1 million used in operations, and $100,000 for equipment
purchases. Working capital also benefited from the conversion of approximately
$4.2 million of
25
notes payable into redeemable convertible preferred stock. Subsequent to March
31, 1997, the Company raised an additional $7.0 million from the private
placement of redeemable convertible preferred stock.
The Company has revolving lines of credit with three banks in Germany
providing total borrowings of up to 4.5 million DM (approximately $2.7 million).
These lines expire at dates ranging from September 30, 1997 to March 31, 1998.
The German lines of credit bear interest at rates ranging from 8.0% to 8.75%.
Borrowings under the German lines of credit are unsecured. At March 31, 1997, no
amounts were outstanding under the German lines of credit. In addition, the
Company has a $2.5 million revolving line of credit with a U.S. bank expiring in
August 1997. The U.S. line of credit bears interest at the rate of prime plus
1.0% (9.25% at March 31, 1997). Borrowings under the U.S. line of credit are
secured by all of the Company's assets. At March 31, 1997, no amounts were
outstanding under the U.S. line of credit.
In addition to the lines of credit, the Company had outstanding debt at
March 31, 1997 totaling approximately $2.5 million, consisting of a term loan
from a German bank. This debt bears interest at rates ranging from 5.0% to 6.0%.
The term loan also contains certain profit sharing and prepayment provisions.
Subsequent to March 31, 1997, the Company and the German bank agreed to amend
the loan agreement to eliminate the prepayment provisions in exchange for a
warrant to purchase 138,000 shares of Common Stock at an exercise price of $5.72
per share. The Company expects to use a portion of the proceeds of this offering
to repay the term loan. See "Use of Proceeds."
The Company presently expects that the proceeds of this offering, together
with its current capital resources and available borrowings should be sufficient
to meet its operating and capital requirements through at least the end of 1998.
The Company may, however, seek additional debt or equity financing prior to that
time. There can be no assurance that additional capital will be available to the
Company on favorable terms or at all. The sale of additional debt or equity
securities may cause dilution to existing stockholders.
26
BUSINESS
SCM Microsystems designs, develops and manufactures hardware, firmware and
software products for data security and access control applications. The Company
sells security and access products to OEM computer, telecommunication and DVB
component and system manufacturers. The Company's objective is to leverage its
expertise in PCMCIA and smart card technologies and its extensible, upgradeable
smart card token-based security architecture to capitalize on the growing demand
for data and network security and the need to control access to digital
information. The Company markets, sells and licenses its products through a
direct sales and marketing organization primarily to OEMs and also through
distributors, VARs, system integrators and resellers worldwide. OEM customers
include Compaq, Dell, France Telecom, IBM, Kirch Group (BetaDigital),
Schlumberger, Security Dynamics, Siemens/Nixdorf, Sun Microsystems and Telenor.
INDUSTRY BACKGROUND
Individuals and corporations increasingly rely upon computer networks, the
Internet and intranets and direct broadcast systems to access information,
entertainment and data in a digital form from their homes and workplaces. This
increasing proliferation and reliance upon digital data has caused data security
to become a paramount concern of businesses, government, educational
institutions and consumers. Regardless of whether the issue is controlling
access to proprietary or confidential information such as business data or
health records, or whether it is attempting to limit access to digital video
broadcasts to paying subscribers, content providers, network and data managers
and users of digital data are concerned with controlling access to data and
maintaining data security. The enterprise data security market, including
electronic commerce applications, and the market for DVB conditional access
require a range of products to address their needs.
ENTERPRISE DATA SECURITY AND ELECTRONIC COMMERCE
Enterprise Data Security
Enterprise computing has evolved from highly centralized mainframe
computers to widely distributed client/server network-based solutions. Modern
enterprises frequently employ one or more local area networks to connect
computer users located in a single facility, wide area networks and intranets to
connect users in disparate facilities, and the Internet or other direct
electronic link to provide internal users access to third party information and
to provide customers, vendors and other interested third parties with access to
an enterprise's computing resources or information. The growth in Internet usage
is expected to increase from approximately 35 million Web users worldwide in
1996 to approximately 160 million users worldwide by 2000 according to
International Data Corporation ("IDC"). This shift towards distributed computing
is being fueled in part by the growing number of mobile computer users and
telecommuters that perform some or all of their work from home or other remote
locations.
As enterprises move toward distributed computing and make data more
accessible to internal and external users, this data has become increasingly
vulnerable to unauthorized access. According to the Computer Security Institute
("CSI"), 42% of respondents to its 1996 CSI/FBI Computer Crime and Security
Survey acknowledged that they had experienced unauthorized use of their computer
systems within the last 12 months. Unauthorized access can range from users who
are authorized to access portions of an enterprise's computing resources
accessing unauthorized portions, to hackers who have no legitimate access
breaking into a network and stealing or corrupting data. The consequences of
unauthorized access, which can often go undetected, can range from theft of
proprietary information or other assets to the alteration or destruction of
stored data. Approximately 78% of respondents to the Fourth Annual Information
Week/Ernst & Young Information Security Survey reported that their company
suffered a loss related to information security and disaster recovery in the
past two years. Some companies reported losses of up to $1 million due to
security breaches. As a result of the consequences of unauthorized access, many
enterprises have been reluctant to make their computing resources as open as may
be desirable, and those that allow access are adopting various security measures
to guard against unauthorized access. The Company believes that enterprises seek
solutions which will allow them to expand access to data while maintaining
adequate security.
27
Electronic Commerce
The proliferation of PCs in both the home and office combined with
widespread access to the Internet have created significant opportunities for
online shopping and other electronic commerce. IDC estimates that the total
value of goods and services purchased over the Web grew from $3 billion in 1996
to $100 billion in 2000. The Company believes that a key factor constraining the
growth in online purchasing has been the lack of adequate data security. As a
result of the anonymity of the Internet, merchants and consumers need assurances
that customers are correctly identified and that the confidentiality of
information such as credit card numbers is maintained. Accordingly, the Company
believes that successful expansion of electronic commerce will require the
implementation of improved security measures which accurately identify and
authenticate users and reliably encrypt data transmissions over the Internet.
Common Solutions to Enterprise Data Security and Secure Electronic Commerce
Data security and secure electronic commerce generally involve implementing
a patchwork of hardware and software solutions operating at a variety of points
in a data environment, including router, gateway and server-based hardware
solutions, and operating system and applications-level software solutions.
[THE DATA SECURITY "PATCHWORK" ILLUSTRATION]
Currently, the most common security solution is the installation of one or
more firewalls that control the flow of data between segments of an internal
network or between an internal network and the Internet or other remote access
paths. Firewalls essentially serve as a funnel, analyzing whether a particular
communication passing through the funnel is authorized. With the increasing
volumes of network traffic, firewalls may no longer be capable of providing
adequate levels of protection without impairing the speed of communications.
Moreover, new Internet technologies such as Sun Microsystems' Java and
Microsoft's ActiveX, which involve the transfer of active programs (applets),
and broadcast applications such as PointCast and Marimba, present security risks
that are not readily addressed by firewalls.
The key to any security system is the ability to reliably identify users in
order to prevent unauthorized access to information and resources.
Authentication of a user's identification is generally accomplished by one of
two approaches: passwords, which are a code known only by a specific user; and
tokens, which are user-specific physical devices that only authorized users
possess. Passwords, while easier to use, are also the least
28
secure because they tend to be short and static, and are often transmitted
without encryption. As a result, passwords are vulnerable to decoding or
observation and subsequent use by unauthorized persons. Tokens are small devices
ranging from simple credit card-like devices to more complex devices capable of
generating time-synchronized or challenge-response access codes. Certain
token-based systems require both possession of the token itself and a personal
identification number ("PIN") to indicate that the token is being used by an
authorized user. Such an approach, referred to as two-factor authentication,
provides much greater security than single factor systems such as passwords or
simple possession of a token.
Early implementation of tokens include automatic teller machine ("ATM")
cards, which are plastic cards with data encoded on a magnetic strip on the
card. ATM cards require the user to possess the ATM card and to know the PIN
before engaging in any transaction. While suitable for certain applications, the
ATM type card is subject to counterfeiting, tampering and inadvertent data
deletion, and can hold only a very limited amount of information.
PC Cards represent a more advanced form of token, although their use in
security applications has been limited to date. PC Cards are computer
peripherals built into a form factor similar in width and length to, but
substantially thicker than, a credit card. The standards for PC Cards and the
corresponding slots were developed by the PCMCIA. With an installed base of
approximately 10 million PCMCIA slots in 1995 according to IDC, PC Card products
have been developed for a variety of functions including modems and memory
devices. While virtually all portable PCs being sold today contain at least one,
and in many cases two, PCMCIA slots as a standard feature, the PCMCIA standard
has generally not been widely adopted for desktop computers. The use of PC Cards
as security tokens has been endorsed by the DoD as part of its Defense Messaging
System ("DMS"). The DMS uses a PC Card known as "Fortezza" as its standard
security token. In connection with the DMS, the DoD has mandated that desktop
computers supplied to the DoD and its affiliated agencies must incorporate
PCMCIA slots in order to accept the Fortezza PC Card
identification/authentication token.
A further advancement in token implementation is the smart card. Smart
cards are credit card-sized plastic cards that contain an embedded
microprocessor, memory and a secure operating system. Smart cards have
significant advantages over PC Cards, including lower cost, portability and
greater durability. Smart cards have been used in applications such as stored
value cards, either for making general purchases or for specific applications
such as prepaid telephone calling cards, and as health care cards, which are
used to store patient and provider information and records. Smart cards are
useful as health care cards because they identify the holder for insurance or
government payment purposes and store health records that can be accessed and
updated by health care providers.
Smart card use for these applications has become widespread in Europe,
where the existence of multiple languages and currencies has created a demand
for common solutions that enable businesses and consumers to conduct their
affairs effectively and efficiently while moving from country to country.
According to Dataquest, the European market for smart cards has far outpaced
that of the United States. Dataquest estimates that in 1995 the U.S. accounted
for approximately 10 million units (2%) of the 544 million unit worldwide
microprocessor-based smart card market, and projects that this market will grow
to 3.4 billion units worldwide by 2001. By the year 2001, Dataquest estimates
that Europe, Asia/Pacific and the Americas will account for 40%, 25% and 20%,
respectively, of this market.
In addition to providing a common record-keeping and stored value solution
across multiple languages and currencies, the Company believes that smart cards
are ideally suited to serve as tokens for network and electronic commerce
security. Microsoft, with its PC/SC Workgroup, and Netscape, with its Security
Infrastructure group, have both endorsed smart cards as key components of their
respective data security architectures, have released application program
interfaces ("APIs") for smart cards and have stated their intentions to support
smart cards in future generations of their software products. The Company
believes that these companies, together with other enterprises with a financial
stake in securing access to digital data and enabling secure electronic commerce
such as Verisign and Security Dynamics, will drive the adoption of smart card
technology for security applications in the United States. The Company also
believes that as smart card-
29
based security systems become accepted in the United States, users outside the
United States will adopt similar systems.
To date, a number of factors have limited broad adoption of smart cards as
security tokens. These factors include the requirement for special purpose
readers which have been expensive and therefore not widely deployed and the lack
of standards governing the operating systems, communication protocols, APIs and
similar features of the tokens. These factors have resulted in the deployment of
proprietary, closed systems that are not compatible with other systems. In
addition, smart cards are relatively low speed serial interface devices which,
although capable of providing encryption of passwords or other limited data, are
not capable of providing the real-time bulk encryption required for many secured
access applications.
DIGITAL VIDEO BROADCASTING
DVB involves the transmission of video signals in a digital format. In
contrast to the traditional analog approach, digital signals allow content
providers ranging from broadcast television stations and cable carriers to
specialty programming producers to deliver very high resolution, high quality
video images. DVB may take the form of currently available direct satellite
broadcast services, or alternative services that are expected to be introduced
in the near future such as digital cable services and direct broadcast digital
television. DVB makes it possible to provide a broader range of private content
and nontraditional services than previously available. Businesses, educational
institutions and other enterprises could broadcast private content such as
product information updates and training or educational content to users in
disparate locations, or could provide various interactive products and services
via the DVB medium. The Company believes that a primary challenge for
broadcasters will be to limit access to their content to the intended users such
as those who have purchased appropriate subscriptions or event-by-event
pay-per-view privileges.
The traditional approach to controlling access has been to sell or lease
proprietary set-top boxes (and, in the case of satellite direct broadcast, a
receiving antenna) to subscribers. These set-top boxes descramble digital
signals and then convert them into analog signals in order to be compatible with
the viewer's analog television. While this approach provides the controlled
access desired by broadcasters, it limits the range of content available to the
consumer. Consumers wishing to obtain content or services from more than one
provider would be required to purchase multiple proprietary set-top boxes.
Similarly, the use of proprietary set-top boxes may limit broadcasters' ability
to upgrade systems that have already been installed in their customers' homes
without a costly replacement process.
To address the limitations of the closed-system set-top box, the DVB
Project, an international consortium of over 170 enterprises involved in varying
aspects of DVB including France Telecom, Deutsche Telekom, Nokia, Sony and
Philips, has developed standards for the DVB-CI. DVB-CI makes it possible to
deliver a universal set-top box capable of receiving content from a variety of
providers. The universal set-top box requires use of a smart card token that
"unlocks" the specific services to which a consumer has subscribed. With this
approach, multiple service providers can deliver digital content to the same
"open" set-top box and consumers, using the appropriate conditional access
module, can access the content to which they have subscribed. When consumers
subscribe to different or additional content services or parents seek to limit
the viewing privileges of their children, the service providers need only
provide the appropriate smart card to allow access to the new or additional
services. The DVB-CI standard addresses the limitations of the closed-system
set-top box by making it possible for (i) broadcasters to upgrade systems
installed in their customers' homes by downloading new operating system software
onto the universal set-top box, (ii) customers to use one universal set-top box
to access digital content from various service providers by inserting the
appropriate
30
conditional access module for each particular service provider and (iii) service
providers to secure access to new or additional services by issuing new tokens
coded for access to such services.
[SECURING DIGITAL VIDEO BROADCASTS ILLUSTRATION]
The Company believes that the members of the DVB Project and other
interested enterprises will continue to drive the adoption of DVB-CI as the
European standard for conditional access to digital content. Moreover,
legislation has been enacted in Spain (and may be enacted elsewhere in the
future) mandating that set-top boxes comply with the DVB-CI standard in order to
assure broad access to digital content without requiring consumers to purchase
multiple set-top boxes. The Company believes that similar standards may be
adopted in certain Asian countries and the United States in the future.
The Company believes that successful implementation of the DVB-CI standard
will require the development of hardware that is capable of real time, high
bandwidth decryption of the video signal and is remotely updatable to permit
providers to offer new content and services without the need to replace
equipment. While the current implementation of DVB-CI uses set-top boxes, the
Company believes that as the standard evolves and as flexible hardware solutions
become available, the DVB-CI capability will be built directly into televisions,
PCs and network computers. These devices would then contain the appropriate DVB
token slot and reader capabilities, thereby eliminating the need for the
separate set-top box while providing the same smart card-based conditional
access of current systems.
THE SCM MICROSYSTEMS SOLUTION
SCM Microsystems provides OEMs with key standards-compliant enabling
hardware, firmware and software products and technologies for smart card and
other token-based network security systems and conditional access to DVB content
and services. Through the use of its extensible core technologies, the Company
is able to offer products that address the specific needs of diverse market
applications such as enterprise data security and DVB conditional access.
31
Enterprise Data Security and Electronic Commerce. The Company's products
address the needs of the enterprise data security and electronic commerce
markets by providing:
PCMCIA BRIDGES FOR SMART CARDS. The Company offers a range of products
which enable smart cards to be read and written through standard PCMCIA ports,
which eliminates the requirement for special purpose smart card readers and
provides interoperability between smart cards and PCs, network computers and
other devices.
STANDARDS-BASED, INTEROPERABLE PRODUCTS. The Company's products employ
an open-systems architecture that provides unique compatibility across a range
of hardware platforms and software environments, and that are remotely
upgradeable, which provides OEMs with the assurance that their products will be
broadly compatible and can be updated as the security infrastructure evolves.
SPEED AND PERFORMANCE. The Company's products transparently extend the
speed and performance capabilities of smart cards used as security tokens by
including encryption/decryption capabilities in certain of its smart card reader
products.
Digital Video Broadcasting. The Company's products address the needs of the
DVB market by providing:
INEXPENSIVE, EASY TO DELIVER CONDITIONAL ACCESS MODULES. The Company
provides smart card-based conditional access readers and modules which adhere to
the DVB-CI standard. These products enable digital content and service providers
to control and meter access to content and services through the use of
inexpensive smart cards.
REAL TIME, HIGH-BANDWIDTH DESCRAMBLING CAPABILITIES. The Company's
products are structured to use smart cards as keys to activate the
high-bandwidth capabilities of PC Cards. By this approach, smart card-based
tokens, which by themselves are not capable of descrambling digital video data
at the rate required for digital video broadcast, can still be used to control
and meter access to DVB content and services.
REMOTE UPGRADE CAPABILITIES. The Company's DVB products incorporate
read/write capabilities which permits content and service providers to perform a
virtually no-cost upgrade of users' access rights as new products and services
are developed and introduced as users' subscription desires change.
STRATEGY
The Company's objective is to utilize its expertise in PCMCIA and smart
card technologies and its extensible, updatable smart card token-based security
architecture in order to capitalize on opportunities presented by the growing
demand for secure and controlled access to digital information. The Company
believes it is well positioned to capitalize on the significant growth projected
for smart card-based security and controlled access systems. Key elements of the
Company's strategy include the following:
Leverage Technology Base; Support Open Systems and Interoperability. The
Company has developed extensive expertise and intellectual property in both
PCMCIA and smart card technologies. The Company intends to continue to leverage
this technology base to provide smart card products that can operate across a
variety of hardware platforms and software environments. This technology
incorporates upgradeable, firmware-based features which enable smart card
readers to be upgraded as new smart card operating systems and communication
protocols are adopted. In addition to enabling the Company to respond quickly to
industry developments with properly tailored products, this upgradeable
architecture protects the investments in smart card hardware.
Expand Range of Product Applications. The Company's current products are
designed to provide flexible interoperability between smart cards and PCs or
set-top boxes. The Company intends to expand the range of its product offerings
to address specialized applications such as health care records and
identification, televisions and television set-top boxes, customer loyalty
programs, personal identification and Internet and intranet access. In addition,
the Company intends to develop chip set-based versions of certain of its
products in order to reduce their cost and facilitate their easy integration
into future generations of televisions, PCs and network computers.
32
Increase Penetration of Major OEM Customers; Expand Customer Base. The
Company currently sells its products to a number of OEM customers including
Bull, Dell, France Telecom, Gateway 2000, IBM, Kirch Group, Packard Bell,
Schlumberger, Siemens/Nixdorf and Sun Microsystems. The Company intends to
pursue additional opportunities with its existing customers by leveraging its
relationships to increase sales. For example, the Company's relationships with
its existing customers provide the Company with advanced insight into the
current and future needs of these customers, enabling the Company to design
specific products to meet the additional product needs of each customer.
Moreover, the Company believes that as the needs for data security increase and
smart cards gain wider market acceptance, a significant number of additional
participants will enter the market. The Company intends to expand its customer
base by pursuing opportunities with these new market entrants.
Expand Strategic Industry Relationships. The Company has formed strategic
relationships with a number of key industry players such as Intel, Matra
Communications, France Telecom and Telenor. These relationships provide the
Company with access to leading edge technology, marketing and sales leverage and
access to key customers and accounts. In addition, in certain cases, the
Company's strategic partners have provided funding to the Company in the form of
funded research, product purchase prepayment and equity investment. The Company
intends to continue to leverage these relationships and to identify additional
key industry players with which to form strategic relationships. See
"-- Collaborative Industry Relationships."
Support Standards Setting Organizations. The Company intends to continue to
participate in the standards setting activities for the industries it serves.
The Company is a founding member of the PCMCIA and the DVB Project and supports
the Common Data Security Access standard developed by Intel and adopted by
Netscape. The Company's products are compliant with the RSA public key
cryptographic system number 11 ("PKCS #11") standard. Through its participation
in standards setting organizations, the Company has successfully had the DVB-CI
specification adopted as the standard by the PCMCIA. The Company intends to
maintain an active role in these and other appropriate standards setting groups
in order to continue to have its technologies adopted as standards where
appropriate and to keep apprised of technological advancements as they are
developed.
TECHNOLOGY
The Company believes that smart cards are ideally suited to serve as tokens
for digital information security. A smart card is a credit card-sized plastic
card which contains a microprocessor, memory and a secure operating system. The
card is inserted into a device that reads the information contained on the card
and performs an appropriate function. The Company has used its extensible smart
card interface architecture to develop open and standard products that support
virtually all smart cards regardless of the manufacturer, are accessible through
a variety of operating systems and platforms and enable a wide range of secure
applications. The Company's extensible smart card interface architecture
consists of certain core technologies which provide this interoperability:
Silicon and Firmware for Smart Card Readers. SCM Microsystems has developed
physical interface technology which provides interoperability between PCs and
smart cards from many different smart card manufacturers. The Company's
interoperable architecture includes an ISO compliant layer as well as an
additional layer for supporting non-ISO compliant smart cards. Through its
proprietary integrated circuits and firmware, the Company's smart card reader
can be updated electronically to accommodate new types of smart cards without
the need to change the reader's hardware. Intel Corporation has become the first
company to license the Company's smart card interface.
Proprietary PC Card Case. The Company's proprietary PC Card case is an open
side case which has guides to ensure the smart card is positioned correctly into
the PC Card reader. This hardware technology solves the problem presented by the
fact that smart cards and PC Cards have the same width and length.
Proprietary Software. The Company has developed a flexible proprietary
software architecture for real-time downloading of firmware for new smart card
protocol handling requirements into a flash memory chip which resides on the
smart card reader. This software, combined with the Company's proprietary
integrated circuits and firmware described above, allows the reader to
accommodate new types of smart cards without the
33
need to change the reader's hardware. Additionally, the Company has developed
"flash filing" software, which enables PCMCIA flash memory to function as a
flash disk. The Company has filed patent applications with respect to both
software applications.
Hardware for PC Card Adapters. The Company has developed the interface
technology to accommodate multiple PCMCIA slots for ISA, SBus (Sun Microsystems)
and PCI bus structures, thus enabling desktop PCs and workstations to be
equipped with PCMCIA slots. In particular, the Company has developed a patented
dual cable solution with special grounding and termination methods which
prevents signal interference between the PCI/ISA bus slots and a large variety
of PC Cards.
PRODUCTS
By bridging smart cards and other secure devices with PCs, workstations and
set-top boxes, the Company's products provide cost-effective solutions for
conditional access to mobile and desktop computers, workstations, DVB, virtual
private networks, electronic files, e-mail and Internet firewalls and secure
electronic commerce. The Company's products have been developed utilizing the
Company's core competencies in smart card and PC interoperability, PC Card
expertise and flash memory chip experience, and all are compliant with the PKCS
#11 standard. SCM Microsystems provides high quality, easy-to-use solutions in
the following product categories:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
34
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SWAPBOX PC CARD ADAPTERS
Desktop PCs and workstations, in contrast to laptop and notebook PCs,
generally do not come equipped with PC Card slots. The Company's SwapBox
products are devices with PC Card slots designed to be installed by OEMs into
desktop computers, workstations and servers. Coupled with PC Card security
tokens, cards or smart card readers such as SCM Microsystems' SwapSmart reader,
SwapBoxes allow enterprises to effectively provide authentication, integrity,
and confidentiality services. Flash memory cards are widely used with SwapBoxes
and SCM Microsystems' proprietary SwapFTL software for data collection
applications. SwapBoxes accept any PC Card compliant cards including readers for
small form factor memory devices such as Compact Flash, SSFDC, Multimedia and
Miniature Cards, allowing flash memory cards to be connected to PCs for quick
and easy exchange of electronic images, digital audio recordings and text files.
SWAPSMART SMART CARD READERS
The SwapSmart reader is a device in a PC Card form factor that provides a
portable, universal, secure and cost effective bridge between smart cards and
the mobile PC or other products which have PC Card slots. The SwapSmart reader
supports all ISO 7816 smart card protocols as well as asynchronous and
synchronous smart cards. Furthermore, because the SwapSmart reader incorporates
an upgradeable firmware-based chip set, the functionality of SwapSmart products
can be automatically updated as additional smart card operating systems and
protocols come into use. In addition to broad smart card support, the SwapSmart
reader is easily accessible from a wide variety of operating systems and
platforms. The SwapSmart reader enables easy access to the growing number of
smart card applications such as network, VPN and firewall security as well as
local and remote computer access control. Additionally, the SwapSmart reader
makes it possible to use smart cards for user authorization and authentication,
for e-mail and for secure transactions required for electronic
35
commerce. Because of its encryption capabilities, the reader is particularly
well suited for security applications, in particular, mobile computing security.
Currently, the Company is working with Microsoft's PC/SC Workgroup and with
Netscape's Security Infrastructure group to ensure that the SwapSmart reader
supports the new open specifications for integrating smart cards with PCs. By
supporting a wide range of smart cards and complying with the open standards set
by the PC/SC Workgroup, SwapSmart provides maximum interoperability among smart
cards and easy access to smart card applications for mobile or desktop PCs. For
example, the SwapSmart reader is compliant with the B1 specification for smart
card readers developed by Deutsche Telekom, as well as the Common Data Security
Access specification developed by Intel and adopted by Netscape for use in
Netscape Communicator.
DVB-CAM MODULES
By combining SCM Microsystems' SwapSmart reader technology with the
proprietary descrambling code of a digital content provider, the Company's
DVB-CAM provides a cost-effective means of controlling access to digital
broadcasts through the use of a PC Card. The DVB-CAM is an all-in-one PC Card
that utilizes a smart card to determine if a viewer has access to a given
content provider's service. If the viewer is authorized, DVB-CAM descrambles the
signal for viewing.
The DVB-CAM is the world's first implementation of the DVB-CI standard
established by the DVB Project. The DVB-CAM technology enables a variety of
critical functions including video-on-demand, pay-per-view, interactive video,
home shopping, home banking and games. Since the DVB-CAM can be used in any
DVB-CI compliant "open" set-top box, the use of its proprietary technology will
allow universal acceptance of a single solution for different set-top box
systems. The Company believes that the use of smart card technology combined
with the DVB-CI standard will eliminate the need for multiple set-top boxes in
order for users to access a broad range of desired broadcast data. The Company's
DVB-CAM has already been selected by certain of the major content providers in
Europe, including France Telecom, Telenor (Norway Telecom) and The Kirch Group
(BetaDigital), who plan to implement the DVB-CI standard through 1997 and 1998.
The Company believes that similar standards may be adopted in certain Asian
countries and the United States in the future.
SMARTOS SMART CARD READER INTERFACES
Based on a unique chip and firmware technology which makes it possible to
easily integrate smart cards with a wide variety of PC and stand-alone devices,
the SmartOS allows companies to integrate smart card support cost-effectively
within desktop, notebook or network computers, USB or serial devices and
keyboards as well as point of sale (POS) terminals and vending machines. The
SmartOS solution allows integrators to utilize only essential components to
control cost and maximize design. Many hardware designs may already incorporate
a controller chip, such as a keyboard or network computer, but lack an interface
unit and firmware for the completion of a smart card reader solution. Instead of
being forced to purchase all components, the SmartOS solution offers just those
components an integrator needs and those tools necessary for the quick
implementation of smart card readers at a minimum cost.
36
CUSTOMERS AND APPLICATIONS
The Company's security and access products are targeted at OEM computer,
telecommunication and DVB component and system manufacturers. The following list
sets forth the customers who have purchased in excess of $300,000 of the
Company's products during the year ended December 31, 1996.
Sales to a relatively small number of customers historically have accounted
for a significant percentage of the Company's total sales. In 1996, sales to IBM
accounted for 12% of total net sales, sales to BetaDigital, a division of the
Kirch Group, accounted for 11% of total net sales and sales to the Company's top
10 customers accounted for 55% of total net sales. The Company expects that
sales of its products to a limited number of customers will continue to account
for a high percentage of the Company's total sales for the foreseeable future.
The loss or reduction of orders from a significant customer, including losses or
reductions due to manufacturing, reliability or other difficulties associated
with the Company's products, changes in customer buying patterns, or market,
economic or competitive conditions in the digital information security business,
could adversely affect the Company's business and operating results. See "Risk
Factors -- Dependence on Sales to OEMs."
Examples of applications of the Company's products include the following:
Siemens-Nixdorf/Deutsche Telekom. SNI markets SCM Microsystems smart card
readers under its own label and integrates them into its systems solutions for
sale to major corporate users. For example, Deutsche Telekom is providing its
employees with SNI's laptop computers equipped with smart cards and the
Company's smart card readers. This enables Deutsche Telekom's remote sales force
to gain secure access to the corporate intranet. In addition to controlling
initial access to the intranet, the smart card also holds information as to the
defined areas and information within the intranet to which the user is permitted
access. When the information systems group wants to change a user's access or
authorization, they simply download new instructions to the smart card during
the session. The next time the user accesses the intranet, his or her updated
access is already present on the smart card. This allows Deutsche Telekom to
provide extensive information over its intranet, since it knows that the user's
identity is verified before access is granted. Principal reasons for SNI's
selection of the Company's products were their compliance with the B1
specification for smart card readers developed by Deutsche Telekom, their
ability to offer a broad range of smart card support and their ability to offer
a broad range of operating system support.
The Kirch Group. SCM Microsystems has developed and provides DVB-CI
compliant and proprietary DVB-CAM modules under contract to BetaDigital, the
technology arm of the Kirch Group. These modules are installed in DVB compliant
set-top boxes which Kirch distributes to consumers to allow them to access the
Kirch digital entertainment services. These set-top boxes include a smart card,
the Company's smart card readers and a generic receiver/tuner unit to provide
secure access to its entertainment content and services. Customers can easily
add and change the services they receive, and Kirch can easily enable and
disable services. Also, individual customers can have different smart cards
which permit different services. Although used in the same set-top box, a
child's smart card could permit different programming from a parent's smart
card. Kirch also can download completely new services to the modules, permitting
new capabilities, such as pay-per-view and other electronic transaction-based
services, to be added with no additional hardware cost.
37
SCM Microsystems' DVB-CAM is the world's first implementation of the DVB-CI
standard established by the DVB Project. The principal reason for Kirch's
selection of the Company's products was their ability to provide Kirch's
customers with an open system that could be upgraded for new functions.
SALES AND MARKETING
The Company markets, sells and licenses its products primarily to OEMs, and
also through distributors, VARs, system integrators and resellers, worldwide
through a direct sales and marketing organization. As of March 31, 1997, the
Company had 18 full-time employees and consultants engaged in sales and
marketing activities. The Company's direct sales staff solicits prospective
customers, provides technical advice and support with respect to the Company's
products and works closely with customers, distributors and OEMs.
In support of its sales efforts, the Company conducts sales training
courses, comprehensive targeted marketing programs, including public relations,
advertising, seminars, trade shows and ongoing customer and third-party
communications programs. The Company also seeks to stimulate interest in digital
information security through its public relations program, speaking engagements,
white papers, technical notes and other publications.
At March 31, 1997, the Company's backlog was approximately $5.6 million, as
compared to approximately $6.1 million at December 31, 1996. The Company's
backlog consists of all written purchase orders for products which have a
scheduled shipment date within the next twelve months. Orders for the Company's
products are usually placed by customers on an as-needed basis and the Company
has typically been able to ship products within 30 days after the customer
submits a firm purchase order. The Company's contracts with its customers
generally do not require fixed long-term purchase commitments. In view of the
Company's order and shipment patterns and because of the possibility of customer
changes in delivery schedules or cancellation of orders, the Company's backlog
as of any particular date may not be indicative of sales in any future period.
COLLABORATIVE INDUSTRY RELATIONSHIPS
SCM Microsystems is party to collaborative arrangements with a number of
corporations and is a member of key industry consortia. The Company evaluates,
on an ongoing basis, potential strategic alliances and intends to continue to
pursue such relationships. The Company's future success will depend
significantly on the success of its current arrangements and its ability to
establish additional arrangements. There can be no assurance that these
arrangements will result in commercially successful products.
Matra Communications. In October 1995, the Company, Matra Communications
SAS ("Matra SAS") and TEMIC entered into an agreement to submit a proposal to
France Telecom, a major supporter of the open set-top box standard and a key
player in the DVB-CI specification based on the PC Card standard, for their
implementation of DVB-CAM products. In August 1996, France Telecom selected the
companies' joint proposal. Pursuant to a 10-year joint development and licensing
agreement effective February 1997, the Company and Matra SAS will collaborate in
the design, manufacture and sale of DVB-CI compliant products including France
Telecom's conditional access system called "Viaccess." In addition, Matra SAS
will supply its proprietary transport stream interface, DVB descrambler, DVB
demux and associated filtering and buffering for conditional access systems, SCM
Microsystems will supply its proprietary smart card reader and PC Card interface
and TEMIC will integrate these technologies at the silicon level into a one-chip
solution. Initial commercial shipments began in March 1997. Each party will
retain rights to the intellectual property it develops under the agreement,
subject to the non-exclusive licensing rights of the other party relating to the
manufacture of such products.
Intel Corporation. In March 1997, the Company and Intel entered into a
development and license agreement for cryptographic PC Card-based secure access
modules for the PC platform. The Company has granted a non-exclusive license to
Intel for certain Company designs and other intellectual property. Intel has
agreed to support the Company's programs to design a PC Card token. In addition,
Intel also made an equity investment of approximately $2.0 million in the
Company. Intel and the Company will jointly promote various industry standards
applicable to security products.
38
Telenor. In May 1997, the Company and Telenor entered into a development
and supply agreement pursuant to which the Company will design, manufacture,
test and supply DVB-CAM modules to Telenor. Pursuant to this agreement, Telenor
may pay up to an aggregate of $1.2 million to the Company for development costs
as the Company achieves certain development milestones. Once the prototype has
been approved by Telenor, the Company will supply these modules pursuant to the
terms of the agreement. As part of this arrangement, Telenor also made an equity
investment of approximately $5.5 million in the Company. Furthermore, the
Company has issued 34,965 shares of Preferred Stock to a Telenor affiliate,
fifty percent (50%) of which will remain unvested until the Company achieves the
mid-point milestone of the project and has been paid by Telenor for such
milestone completion. Each party will retain rights to its preexisting
intellectual property, and it is expected that any intellectual property that is
jointly developed under the agreement will be jointly owned.
PCMCIA. SCM Microsystems is an executive and founding member of PCMCIA, an
international standards body and trade association with over 500 member
companies that was founded in 1989 to establish standards for integrated circuit
cards and to promote interchangeability among mobile PCs. Other executive
members include Advanced Micro Devices, Apple Computer, Compaq, IBM, Intel,
Motorola, Texas Instruments and U.S. Robotics. Since 1990, the Company has been
a member of PCMCIA in Europe and currently holds the European Chair position. In
1996, the Company introduced to PCMCIA the DVB-CI standard which was adopted as
an extension to its PC Card standard Release 2.0.
DVB Project. The Company is a member of the DVB Project, an international
standards body with over 200 members that was founded in 1993 to define
platforms for the digital television industry. Other key members include France
Telecom, Deutsche Telekom, Telenor, Nokia, Sony and Philips. In 1994, the
Company was instrumental in the DVB Project's adoption of the PC Card standard
as the common interface for digital set-top boxes. As the DVB Project's
Compatibility Chair, the Company advances and oversees proposals to provide
optimum interoperability between PC Cards and digital set-top boxes.
Teletrust. The Company is a member of Teletrust, a German organization
whose goal is to provide a legally accepted means to adopt digital signatures.
Digital signatures are encrypted personal identifiers, typically stored on a
secure smart card, which allow for a high level of security through
internationally accepted authentication methods. The Company is actively working
on the smart card terminal committee which defines the standards for connecting
smart cards to computers for applications such as secure electronic commerce
over the Internet.
RESEARCH AND DEVELOPMENT
To date, the Company has made substantial investments in research and
development, particularly in the areas of physical, token-based access devices.
The Company's engineering design teams work cross-functionally with marketing
managers, applications engineers and customers to develop products and product
enhancements. The Company also strives to develop and maintain close
relationships with key suppliers of components and technologies which enables
the Company to quickly introduce new products that incorporate the latest
technological advances. The Company's future success will depend upon its
ability to develop and to introduce new products on a timely basis that keep
pace with technological developments and emerging industry standards and address
the increasingly sophisticated needs of its customers. See "Risk Factors --
Dependence on New Products; Rapid Technological Change."
The Company's expenses for research and development were approximately $1.2
million, $1.4 million and $2.4 million for the years ended December 31, 1994,
1995 and 1996, respectively. As of March 31, 1997, the Company had 24 full-time
employees engaged in research and development activities, including software and
hardware engineering, testing and quality assurance and technical documentation.
All of the Company's research and development activities occur in France and
Germany. The Company has in the past funded a portion of its research and
development activities from technology development revenues received from OEM
customers in connection with design and development of application specific
products. The Company recognized $562,000, $543,000 and $1,579,000 in technology
development revenues in 1994, 1995 and 1996, respectively.
39
MANUFACTURING AND SOURCES OF SUPPLY
The Company sources its products through three contract manufacturers in
Europe and Asia. The Company has implemented a global sourcing strategy that it
believes will enable it to achieve greater economies of scale, improve gross
margins and maintain uniform quality standards for its products. In the event
any of the Company's contract manufacturers were unable or unwilling to continue
to manufacture the Company's products, the Company may have to rely on other
current manufacturing sources or identify and qualify new contract
manufacturers. For example, one of the Company's contract manufacturers has
recently been involved in bankruptcy proceedings and may be unable to continue
manufacturing the Company's products. Although the Company believes it will be
able to rely on other manufacturing sources in order to meet its near-term
capacity requirements, there can be no assurance in the future that the Company
would be able to identify or qualify new contract manufacturers in a timely
manner or that such manufacturers would allocate sufficient capacity to the
Company in order to meet its requirements. Any significant delay in the
Company's ability to obtain adequate supplies of its products from its current
or alternative sources would materially and adversely affect the Company's
business and operating results.
The Company believes that its success will depend in large part on its
ability to provide quality products and services. As of March 31, 1997, the
Company had 11 full-time employees engaged in manufacturing activities. The
Company has a formal quality control program to satisfy its customers'
requirements for high quality and reliable products. To ensure that products
manufactured by others are consistent with its standards, the Company manages
all key aspects of the production process, including establishing product
specifications, selecting the components to be used to produce its products and
the suppliers of such components and negotiating the prices for such components.
In addition, the Company works with its suppliers to improve process control and
product design. The Company's quality control specialists conduct on-site
inspections throughout the production process. Finally, the Company's products
are tested by the Company's contract manufacturers prior to shipment.
The Company relies upon a limited number of suppliers of several key
components of the Company's products. For example, the Company purchases ASICs
for its DVB modules exclusively from TEMIC, PCBs for SwapBoxes exclusively from
Vertek in Taiwan and Degussa in Singapore, smart card connectors exclusively
from ITT Canon, SwapBox boards and completed products exclusively from
Intellicard Systems and SwapSmart mechanical components exclusively from Stocko.
The Company's reliance on its suppliers involves several risks, including a
potential inability to obtain an adequate supply of required components, price
increases, timely delivery and component quality. Although to date the Company
has been able to purchase its requirements of such components, there can be no
assurance that the Company will be able to obtain its full requirements of such
components in the future or that prices of such components will not increase. In
addition, there can be no assurance that problems with respect to yield and
quality of such components and timeliness of deliveries will not occur.
Disruption or termination of the supply of these components could delay
shipments of the Company's products and could have a material adverse effect on
the Company's business and operating results. Such delays could also damage
relationships with current and prospective customers. In the past, due to the
Company's quality requirements, the Company has experienced delays in the
shipments of its new products principally due to an inability to qualify
component parts from third-party manufacturers and other suppliers, resulting in
delay or loss of product sales. These delays have not had a material adverse
effect upon the Company's business and operating results. However, there can be
no assurance that in the future any such delays would not have a material
adverse effect upon the Company's business and operating results.
COMPETITION
The market for digital data security is intensely competitive and
characterized by rapidly changing technology. The Company believes that
competition in this market is likely to intensify as a result of increasing
demand for security products. The Company currently experiences competition from
a number of sources, including (i) ActionTec, Carry Computer Engineering,
Greystone and Litronics in PC Card adapters, (ii) GemPlus, Hitachi and Toshiba
in smart card readers and universal smart card reader interfaces, (iii) GemPlus,
Hitachi and Toshiba in DVB-CAM modules. The Company also experiences indirect
40
competition from certain of its customers which currently offer alternative
products or are expected to and may introduce competitive products in the
future. The Company may in the future face competition from these and other
parties that develop digital data security products based upon approaches
similar to or different from those employed by the Company. In addition, there
can be no assurance that the market for digital information security products
will not ultimately be dominated by approaches other than the approach marketed
by the Company.
Many of the Company's current and potential competitors have significantly
greater financial, technical, marketing, purchasing and other resources than the
Company, and as a result, may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion and sale of products, or to deliver
competitive products at a lower end user price. Current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address the needs of the Company's prospective customers. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Increased competition is likely to
result in price reductions, reduced operating margins and loss of market share,
any of which could have a material adverse effect on the Company's business,
operating results or financial condition.
The Company believes that the principal competitive factors affecting the
market for digital data security products include support standards and
interoperability, technical features, ease of use, quality/reliability, level of
security, distribution channels and price. While the Company believes that it
competes favorably with respect to these factors, there can be no assurance that
the Company will be able to successfully incorporate these factors into its
products and to compete against current or future competitors or that
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results or financial condition.
PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY
The Company's success depends significantly upon its proprietary
technology. The Company currently relies on a combination of patent, copyright
and trademark laws, trade secrets, confidentiality agreements and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. The Company generally
enters into confidentiality and non-disclosure agreements with its employees and
with key vendors and suppliers. The Company's SwapBox trademark is registered in
the United States, and the SwapSmart trademark is the subject of an allowed,
pending application. The Company will continue to evaluate the registration of
additional trademarks as appropriate. The Company currently has one U.S. patent
issued; six U.S., one French and one Japanese patent applications pending; and
exclusive licenses under four other U.S. patents associated with its products.
Furthermore, the Company intends to obtain an exclusive license from one of its
employees to five other patents relating to its products. There can be no
assurance that any new patents will be issued, that the Company will develop
proprietary products or technologies that are patentable, that any issued patent
will provide the Company with any competitive advantages or will not be
challenged by third parties, or that the patents of others will not have a
material adverse effect on the Company's business.
There has also been substantial litigation in the technology industry
regarding intellectual property rights, and litigation may be necessary to
protect the Company's proprietary technology. The Company has from time to time
received claims that it is infringing upon third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
patents, trademarks or other proprietary rights. On April 28, 1997, Gemplus
served the Company with a complaint alleging that the Company's SwapSmart
product infringes certain claims of a French patent held by Gemplus. See
"Business -- Legal Proceedings." The Company expects that companies in the
computer and digital information security market will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
target markets grows. Any such claims or litigation may be time-consuming and
costly, cause product shipment delays, require the Company to redesign its
products or require the Company to enter into royalty or licensing agreements,
any of which could have a
41
material adverse effect on the Company's business, operating results or
financial condition. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information and software that the Company regards
as proprietary. In addition, the laws of some foreign countries do not protect
proprietary and intellectual property rights to as great an extent as do the
laws of the United States. There can be no assurance that the Company's means of
protecting its proprietary and intellectual property rights will be adequate or
that the Company's competitors will not independently develop similar
technology, duplicate the Company's products or design around patents issued to
the Company or other intellectual property rights of the Company.
EMPLOYEES
As of March 31, 1997, SCM Microsystems had a total of 64 full-time
employees, of which 24 were engaged in engineering, research and development; 18
in sales and marketing; 11 in manufacturing; and 11 in general management and
administration. In addition, the Company had a total of 3 part-time employees as
of March 31, 1997. None of the Company's employees is represented by a labor
union. The Company has experienced no work stoppages and believes that its
employee relations are good.
FACILITIES
The Company's principal administrative, sales and marketing facilities are
located in approximately 5,300 square feet of space in Los Gatos, California and
in approximately 6,000 square feet of space in Pfaffenhofen, Germany. The
California facility is leased through October 1998, and the Germany facility is
leased through June 2000. The Company also leases its research and development
facilities in La Ciotat, France and Erfurt, Germany. The Company believes that
its existing facilities are adequate for its current needs.
LEGAL PROCEEDINGS
The Company is not party to any material legal proceedings at this time.
However, on April 28, 1997, Gemplus served the Company with a complaint alleging
that the Company's SwapSmart product infringes certain claims of a French patent
held by Gemplus. In an unrelated context, Gemplus has indicated that it will
offer licenses to the relevant patent on a non-exclusive, non-discriminatory
basis for a royalty not to exceed 1% of the net selling price of products
practicing the patent. While the outcome of any litigation is uncertain,
management of the Company believes that, based upon the defenses available to
the Company and Gemplus' stated licensing position, the matter can be resolved
without a material adverse effect on the Company's business and operating
results.
42
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, and their ages as of
March 31, 1997, are as follows:
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(1) Member of Compensation Committee.
(2) Member of Audit Committee
Robert Schneider founded the Company in May 1990 as President, Chief
Executive Officer, General Manager and Chairman of the Board. Mr. Schneider is
currently Chairman of the Board. Mr. Schneider is a Managing Director of the
Company's German subsidiary. Mr. Schneider holds a degree in engineering from
HTBL Salzburg and a B.A. degree from the Akademie for Business Administration in
Uberlinger.
Steven Humphreys joined the Company in August 1996 as President and
Chairman of the Board. Mr. Humphreys currently is President, Chief Executive
Officer and a Director of the Company. From April 1994 until February 1996, Mr.
Humphreys was President of Caere Corporation, an optical character recognition
software and systems company. From November 1990 until March 1994, he was Vice
President of General Electric Information Services, an electronic commerce
services provider. Mr. Humphreys holds a B.S. degree from Yale University and a
M.S. degree and a M.B.A. degree from Stanford University.
Bernd Meier joined the Company in January 1992 as General Manager and as a
Director of the Company. Mr. Meier is currently the Chief Operations Officer, a
Director of the Company and a Managing Director of the Company's German
subsidiary. Mr. Meier holds a degree in engineering from Fachhochschule Dieburg.
Nicholas Efthymiou has held various sales and marketing positions since
joining the Company as Vice President, Marketing in February 1992. Mr. Efthymiou
is currently Vice President, U.S. Sales and Business Development. Mr. Efthymiou
holds a B.S.E.E. degree from S.U.N.Y. at Buffalo and a M.B.A. degree from the
University of Texas.
David Hale has served as Vice President, Operations since October 1996.
From October 1991 until September 1996, Mr. Hale held various management
positions at a subsidiary of Solectron, an electronics manufacturing company,
where he most recently served as operations manager. Mr. Hale holds a B.S.I.E.
degree and a M.A. degree and a M.B.A. degree from Stanford University.
Jean-Yves Le Roux joined the Company in May 1995 as Manager, Research and
Development. Mr. Le Roux is currently Vice President, Engineering. From
September 1991 until March 1995, Mr. Le Roux was Manager, PCMCIA Research and
Development of Gemplus, a smart card products supplier. Mr. Le Roux holds an
engineering degree from E.O.E.S. Angers France.
43
Edward MacBeth joined the Company in August 1996 as Vice President,
Marketing. From September 1994 until August 1996, Mr. MacBeth was Director,
Marketing and Business Development of Caere Corporation, and from September 1992
until September 1994, he was President of Fit Software, a software development
company. Mr. MacBeth holds a B.S. degree from California Polytechnic State
University, San Luis Obispo and a M.B.A. degree from San Jose State University.
John Niedermaier joined the Company in April 1997 as Vice President,
Finance and Chief Financial Officer. From November 1995 until March 1997, Mr.
Niedermaier was Vice President, Finance and Chief Financial Officer of Voysys
Corporation, a provider of telecommunications systems for small businesses, and
from April 1994 until November 1995, he was Director, Business Planning at Octel
Communications Corporation, a voice messaging company. From November 1989 until
March 1994, Mr. Niedermaier was Vice President, Corporate Controller of VMX,
Inc., a voice processing company, which merged with Octel in March 1994. Mr.
Niedermaier holds a B.S. degree from Wayne State University.
Friedrich Bornikoel has served as a Director of the Company since September
1993. Mr. Bornikoel joined TVM Techno Venture Management GmbH, a venture capital
firm, in July 1987 and has been a Partner since 1990. Mr. Bornikoel is a
director of several privately held companies. Mr. Bornikoel holds a Masters
degree in Physics from the Technical University of Munich.
Bruce Graham has served as a Director of the Company since July 1995. Mr.
Graham has been a Partner of Bessemer Venture Partners, a venture capital firm,
since December 1996. From 1991 until December 1996, Mr. Graham was an Associate
and Vice President at Vertex Management, a venture capital firm. Mr. Graham is a
director of several privately held companies. Mr. Graham holds a B.S. degree in
Chemical Engineering from Princeton University and a M.B.A. degree from Stanford
University.
Randall Lunn has served as a Director of the Company since November 1993.
Mr. Lunn has been a Partner of TVM Techno Venture Management, L.P., a venture
capital firm, since May 1990. Mr. Lunn is a director of several privately held
companies. Mr. Lunn holds a B.A. degree, a B.S. degree in Engineering and a
M.B.A. degree from Dartmouth College.
Poh Chuan Ng has served as a Director of the Company since June 1995. Mr.
Ng is currently a Managing Director and Chairman of the Board of Global Team
Technology Pte. Ltd., a venture investment subsidiary of Intellicard Systems
Pte. Ltd., a contract manufacturing company ("Intellicard"). From September 1994
through May 1997, Mr. Ng served as Director, Business Development at
Intellicard. Prior to joining Intellicard, Mr. Ng was a product engineering
manager for Compaq Computer Corp. Mr. Ng is a director of several privately held
companies. Mr. Ng holds a B.S.E. degree from the National University of
Singapore.
Andrew Vought has served as a Director of the Company since March 1996. Mr.
Vought has been a Partner of Cheyenne Capital Corporation since January 1995 and
has been Vice President, Chief Financial Officer and Secretary of Advanced
Telecommunications Modules Ltd., an ATM networking equipment company, since May
1996. From May 1990 until April 1994, Mr. Vought was Vice President, Chief
Financial Officer and Secretary of MicroPower Systems, Inc., an analog and mixed
signal semiconductor company. Mr. Vought is a director of several privately held
companies. Mr. Vought holds a B.S. degree and a B.A. degree from the University
of Pennsylvania and a M.B.A. degree from Harvard University.
TERM OF OFFICE OF DIRECTORS AND OFFICERS
The Company's Bylaws and Certificate of Incorporation provide that
effective as of the date of the first regularly scheduled meeting of the
stockholders following the date on which the Company becomes subject to the
periodic requirements of the Securities Exchange Act of 1934, as amended, the
directors of the Company will be divided into three classes equal in size with
each class elected to a staggered three-year term. Each director will hold
office until the expiration of the term of his or her respective class and until
his or her respective successor has been duly elected and qualified.
44
BOARD COMMITTEES
In March 1997, the Board established an Audit Committee and a Compensation
Committee. The Audit Committee, currently comprised of directors Randall Lunn,
Poh Chuan Ng and Andrew Vought, recommends to the Board of Directors the
engagement of the Company's independent accountants, reviews with the
accountants the plan, scope and results of their examination of the consolidated
financial statements. The Compensation Committee, currently comprised of
directors Friedrich Bornikoel and Andrew Vought, reviews and makes
recommendations to the Board of Directors regarding all forms of compensation to
be provided to the executive officers, directors and consultants to the Company.
DIRECTOR COMPENSATION
Beginning April 1, 1997, nonemployee members of the Company's Board of
Directors ("Outside Directors") receive an annual fee of $10,000 plus $1,000 for
each board meeting attended in person for their services as directors. Prior to
that time, directors did not receive compensation for services as directors.
The Company's 1997 Director Option Plan (the "Director Plan") was adopted
by the Board of Directors in March 1997. A total of 50,000 shares of Common
Stock has been reserved for issuance under the Director Plan. However, an annual
increase will be made to the Director Plan on each anniversary date of adoption
of the Director Plan, in an amount equal to the number of shares underlying
options granted in the immediately preceding year or a lesser amount determined
by the Board. Each Outside Director of the Company will be granted an option to
purchase up to 10,000 shares of Common Stock (5,000 shares for outside directors
who are affiliated with entities holding 5% or more of the Company's voting
stock) upon the effective date of the Director Plan and will be granted a
subsequent annual option to purchase 5,000 additional shares of Common Stock
under the Director Plan. Options granted under the Director Plan are not
transferable unless approved by the Board. The Company's Director Plan will
terminate in 2007.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Company's Board of
Directors or Compensation Committee and the board of directors or compensation
committee of any other company, nor has any such interlocking relationship
existed in the past.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Certificate of Incorporation, as amended and restated, limits
the liability of directors to the maximum extent permitted by Delaware law.
Delaware law provides that directors of a corporation will not be personally
liable for monetary damages for breach of their fiduciary duties as directors
except for liability arising out of (i) a breach of their duty of loyalty to the
corporation or its stockholders, (ii) acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii)
unlawful payments of dividends or unlawful stock repurchases or redemptions as
provided in Section 174 of the Delaware General Corporation Law or (iv) any
transaction from which the director derived an improper personal benefit.
The Company's charter documents provide that the Company shall indemnify
its officers, directors and agents to the fullest extent permitted by law,
including those circumstances where indemnification would otherwise be
discretionary. The Company believes that indemnification under its charter
documents covers at least negligence and gross negligence on the part of
indemnified parties. The Company has entered into indemnification agreements
with each of its directors and officers which may, in some cases, be broader
than the specific indemnification provisions contained in the Delaware General
Corporation Law. The indemnification agreements may require the Company, among
other things, to indemnify each director and officer against certain liabilities
that may arise by reason of their status or service as directors or officers
(other than liabilities arising from willful misconduct of a culpable nature)
and to advance such persons' expenses incurred as a result of any proceeding
against him or her as to which such person could be indemnified.
45
At the present time, there is no pending litigation or proceeding involving
a director, officer, employee or other agent of the Company in which
indemnification would be required or permitted. The Company is not aware of any
threatened litigation or proceeding that could result in a claim for such
indemnification.
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth all compensation
awarded to, earned by, or paid for services rendered to the Company in all
capacities during the year ended December 31, 1996 for the Company's Chief
Executive Officer and the Company's most highly compensated other executive
officers whose salary and bonus for such year exceeded $100,000 (collectively,
the "Named Executive Officers").
- ---------------
(1) Mr. Humphreys began working at the Company in August 1996.
(2) Represents life insurance premiums.
Option Grants During 1996. The following table sets forth for each of the
Named Executive Officers certain information concerning stock options granted
during 1996.
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(1) Options generally vest as to 25% of the shares one year from the date of
grant and monthly thereafter for the succeeding 36 months. Options may
generally be exercised ahead of vesting, subject to a right of the Company
to repurchase the unvested portion of the shares if the optionee's status as
an employee or consultant is terminated or upon the optionee's death or
disability prior to the shares vesting.
(2) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission and do not
represent the Company's estimate or projection of the Company's future
Common Stock prices. The actual value realized may be greater or less than
the potential realizable values set forth in the table.
46
Year-End Option Values. The following table sets forth, for each of the
Named Executive Officers, the year-end value of unexercised options as of
December 31, 1996:
- ---------------
(1) Market value of underlying securities at year-end minus the exercise price.
Year-end market value of the Common Stock ($2.18 per share) was determined
by the Board of Directors by reference to an independent appraisal.
(2) Options are generally exercisable by the optionee ahead of vesting. Unvested
shares purchased on exercise of an option are subject to a repurchase right
of the Company, and may not be sold by an optionee until the shares vest.
Options indicated as "Exercisable" are those options which were both vested
and exercisable as of December 31, 1996. All other options are indicated as
"Unexercisable."
EMPLOYMENT CONTRACTS
The Company's German subsidiary has entered into substantially similar
employment agreements with each of Messrs. Schneider and Meier pursuant to which
each serves as a Managing Director of the subsidiary. Each agreement continues
for an indefinite term and each party may terminate the agreement at any time
with six months notice. Each executive receives an annual base salary of
$190,000 and an annual bonus of up to $75,000. Furthermore, each executive is
subject to a non-compete provision for a period of one year after the
termination of employment.
In addition, the Company has entered into an employment agreement, dated
June 2, 1995, with Mr. LeRoux. The initial salary under the agreement is FF
475,000 per year, including a bonus of FF 70,000. Either party may terminate the
agreement at any time.
EMPLOYEE STOCK PLANS
1997 Stock Plan
The Company's 1997 Stock Plan (the "1997 Plan") provides for the granting
to employees of incentive stock options within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"), and for
the granting to employees and consultants of nonstatutory stock options and
stock purchase rights ("SPRs"). The 1997 Plan was approved by the Board of
Directors in March 1997, and by the stockholders in April 1997. Unless
terminated sooner, the 1997 Plan will terminate automatically in March 2007. A
total of 1,000,000 shares of Common Stock are currently reserved for issuance
and 314,400 have been issued pursuant to the 1997 Plan. An annual increase will
be made to the 1997 Plan on each anniversary date of the adoption of the 1997
Plan, in an amount equal to the lesser of 500,000 shares, three percent of the
outstanding shares on such date, or a lesser amount determined by the Board.
The 1997 Plan may be administered by the Board of Directors or a committee
of the Board (the "Committee"), which Committee shall, in the case of options
intended to qualify as "performance-based compensation" within the meaning of
Section 162(m) of the Internal Revenue Code, consist of two or more "outside
directors" within the meaning of Section 162(m) of the Internal Revenue Code.
The Committee has the power to amend, suspend or terminate the 1997 Plan
(provided that no such action may affect any share of Common Stock previously
issued and sold or any option or SPR previously granted under the 1997 Plan), to
determine the terms of the options and SPRs granted, including the exercise
price, the number of shares subject to each or SPR option, the exercisability
thereof, and the form of consideration payable upon such exercise. In addition,
the Committee has the authority to prescribe, amend and rescind rules and
regulations
47
relating to the 1997 Plan. Pursuant to this authority, the Committee has
approved the 1997 Stock Option Plan for French Employees (the "French Plan") in
April 1997, pursuant to which stock options that qualify for preferential tax
treatment under French tax law may be granted. The French Plan will be submitted
to the Company's stockholders for their approval.
Options and SPRs granted under the 1997 Plan are not generally transferable
by the optionee, and each option and SPR is exercisable during the lifetime of
the optionee only by such optionee. Options granted under the 1997 Plan must
generally be exercised within three months of the end of optionee's status as an
employee or consultant of the Company, or within twelve months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option's term. In case of SPRs, unless the Committee
determines otherwise, the Restricted Stock Purchase Agreement shall grant the
Company a repurchase option exercisable upon the voluntary or involuntary
termination of the purchaser's employment with the Company for any reason
(including death or disability). The purchase price for Shares repurchased
pursuant to the Restricted Stock Purchase Agreement shall be the original price
paid by the purchaser and may be paid by cancellation of any indebtedness of the
purchaser to the Company. The repurchase option shall lapse at a rate determined
by the Committee. The exercise price of options granted under the 1997 Plan is
determined by the Committee, but with respect to incentive stock options, and
nonstatutory stock options intended to qualify as "performance-based
compensation" within the meaning of Section 162(m) of the Internal Revenue Code,
the exercise price must at least be equal to the fair market value of the Common
Stock on the date of grant. The term of options granted under the 1997 Plan
generally may not exceed ten years.
The 1997 Plan provides that in the event of a merger of the Company with or
into another corporation, a sale of substantially all of the Company's assets or
a like transaction involving the Company, each option shall be assumed or an
equivalent option substituted by the successor corporation. If the outstanding
options are not assumed or substituted for as described in the preceding
sentence, the Optionee shall fully vest in and have the right to exercise the
option or SPR as to all of the optioned stock, including shares as to which it
would not otherwise be vested or exercisable. If the Administrator makes an
option or SPR fully vested and exercisable in the event of a merger or sale of
assets, the Administrator shall notify the optionee that the option or SPR shall
be fully vested and exercisable for a specified period from the date of such
notice, and the option or SPR will terminate upon the expiration of such period.
1997 Employee Stock Purchase Plan
The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in March 1997 and by the stockholders in April
1997. A total of 175,000 shares of Common Stock has been reserved for issuance
under the Purchase Plan. However, an annual increase will be made to the
Purchase Plan on each anniversary date of the adoption of the Purchase Plan, in
an amount equal to the lesser of 150,000 shares, one percent of the outstanding
shares on such date, or a lesser amount determined by the Board. The Purchase
Plan, which is intended to qualify under Section 423 of the Internal Revenue
Code, is implemented by consecutive overlapping twenty-four month offering
periods beginning on the first trading day on or after May 1 and November 1 each
year, except for the first such offering period which commences on the first
trading day on or after the effective date of this offering and ends on the last
trading day on or after April 30, 1999. Each offering period contains four
purchase periods of approximately six months duration during which a participant
may accumulate payroll deductions and purchase Common Stock. The Purchase Plan
is administered by the Board of Directors or by a committee appointed by the
Board. Employees are eligible to participate if they are customarily employed by
the Company or any participating subsidiary for at least 20 hours per week and
more than five months in any calendar year. The Purchase Plan permits eligible
employees to purchase Common Stock through payroll deductions of up to 10% of an
employee's compensation (including commissions, overtime and other bonuses and
incentive compensation), up to a maximum of $5,000 for each purchase period. The
price of stock purchased under the Purchase Plan is 85% of the lower of the fair
market value of the Common Stock at the beginning of the offering period or the
end of the applicable purchase period. Employees may end their participation at
any time during an offering period, and they will be paid their payroll
deductions to date. Participation ends automatically upon termination of
employment with the Company.
48
Rights granted under the Purchase Plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the Purchase Plan. The Purchase Plan provides that, in
the event of a merger of the Company with or into another corporation or a sale
of all or substantially all of the Company's assets, each participant's right to
purchase Common Stock will assumed or an equivalent right substituted by the
successor corporation. If the successor corporation refuses to undertake such an
assumption or substitution, the Board of Directors shall shorten the offering
period then in progress (so that employees' rights to purchase stock under the
Purchase Plan are exercised prior to the merger or sale of assets). The Purchase
Plan will terminate in 2007. The Board of Directors has the authority to amend
or terminate the Purchase Plan, except that no such action may adversely affect
any outstanding rights to purchase stock under the Purchase Plan.
1997 Employee Stock Purchase Plan for Non-U.S. Employees
The 1997 Employee Stock Purchase Plan for Non-U.S. Employees (the
"International Purchase Plan") was adopted by the Board of Directors in April
1997. The number of shares reserved for issuance under the International
Purchase Plan equals the number of shares reserved for issuance under the
Purchase Plan, but not yet issued. The terms of the International Purchase Plan
are substantially similar to those of the Purchase Plan, except that employees
need not be customarily employed by the Company or a participating subsidiary
for at least 20 hours per week and more than five months per calendar year to
participate. The International Purchase Plan is not intended to qualify under
Section 423 of the Code.
CERTAIN TRANSACTIONS
From time to time, Robert Schneider loaned to the Company various amounts
up to approximately DM 240,000. As of December 31, 1996, the amount outstanding
under these loans was approximately DM 100,000.
In March 1997, the Company and Intel entered into a three-year development
and license agreement. As part of this arrangement, Intel has made an equity
investment of $2.0 million in the Company and beneficially owns approximately
5.2% of the Company's Common Stock, assuming the conversion of all of the
Company's outstanding shares of Preferred Stock into shares of Common Stock.
In May 1997, the Company and Telenor entered into a development and supply
agreement. As part of this agreement, Telenor has purchased 640,000 shares of
Preferred Stock for approximately $5.5 million, received 34,965 additional
shares of Preferred Stock in exchange for certain technology rights and received
a warrant to purchase an additional 194,930 shares of Preferred Stock for $5.72
per share. See "Business -- Collaborative Industry Relationships" and "Principal
Stockholders."
49
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of March 31, 1997 and as
adjusted to reflect the sale of the Common Stock offered hereby for (i) each
person or entity who is known by the Company to beneficially own five percent or
more of the outstanding Common Stock of the Company prior to this offering, (ii)
each of the Company's directors, (iii) each of the Named Executive Officers and
(iv) all directors and executive officers of the Company as a group.
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(1) Assumes conversion of all of the Company's outstanding shares of Preferred
Stock into shares of Common Stock. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission. In
computing the number of shares beneficially owned by a person and the
percentage ownership of that person, shares of Common Stock subject to
options held by that person that are currently exercisable or exercisable
but not necessarily vested within 60 days of June 30, 1997
50
are deemed outstanding. Such shares, however, are not deemed outstanding
for the purpose of computing the percentage ownership of each other person.
Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, each stockholder named in the table has
sole voting and investment power with respect to the shares set forth
opposite such stockholder's name.
(2) Includes warrants to purchase 194,930 shares of Series F Preferred Stock
exercisable before June 30, 1997.
(3) Includes warrants to purchase 5,537 shares of Series D Preferred Stock
exercisable before April 15, 2003.
(4) Includes 32,010 shares held by Robert Schneider's wife, Ursula Schneider.
(5) Includes (i) warrants to purchase 2,872 shares of Series D Preferred Stock
exercisable before April 15, 2003, (ii) 259,315 shares held by TVM Eurotech
Ltd. and (iii) warrants to purchase 1,845 shares of Series D Preferred
Stock exercisable before April 15, 2003 held by TVM Eurotech Ltd.
(6) Includes (i) 16,005 shares held by Bernd Meier's wife, Sonja Meier, (ii)
48,015 shares held in trust for Reiner Pohl and (iii) 131,243 shares held
in trust for Nicholas Efthymiou.
(7) Includes warrants to purchase 8,017 shares of Series D Preferred Stock
exercisable before April 15, 2003.
(8) Includes options to purchase 276,570 shares of Common Stock exercisable
within 60 days of June 30, 1997, 74,904 of which will be vested as of such
date and the remainder of which would be subject to repurchase by the
Company until vested.
(9) Includes 131,243 shares held by Bernd Meier in trust for the benefit of Mr.
Efthymiou.
(10) Mr. Bornikoel is a partner of TVM Techno Venture Management GmbH. Mr.
Bornikoel disclaims beneficial ownership of shares beneficially owned by
such entity except to the extent of his pecuniary interest therein.
(11) Mr. Lunn is a partner of TVM Techno Venture Management L.P. Mr. Lunn
disclaims beneficial ownership of shares beneficially owned by such entity
except to the extent of his pecuniary interest therein.
(12) Includes 172,856 shares beneficially owned by Intellicard Systems Pte. Ltd.
Mr. Ng may be deemed to be an affiliate of such entity and thus may be
deemed to beneficially own such shares.
(13) Includes 24,327 shares held by Genevest Consulting Group and 74,300 shares
held by Index Special Fund, venture capital funds with which Mr. Vought is
affiliated.
(14) Includes shares and exercisable options and warrants which may be deemed to
be beneficially owned by certain directors and executive officers. See
Notes 3, 5, 8, 9, 10, 11, 12 and 13 above.
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DESCRIPTION OF CAPITAL STOCK
At the consummation of this offering, the authorized capital stock of the
Company will consist of 40,000,000 shares of Common Stock, $0.001 par value, and
10,000,000 shares of Preferred Stock, $0.001 par value.
COMMON STOCK
As of March 31, 1997, there were 6,654,489 shares of Common Stock
outstanding (after giving effect to the conversion of all Preferred Stock into
Common Stock) held of record by approximately 80 stockholders. Holders of Common
Stock are entitled to one vote per share on all matters to be voted upon by the
stockholders. Subject to preferences that may be applicable to any outstanding
Preferred Stock, the holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared from time to time by the Board of
Directors out of funds legally available therefor. See "Dividend Policy." In the
event of a liquidation, dissolution or winding up of the Company, the holders of
Common Stock are entitled to share ratably in all assets remaining after payment
of liabilities, subject to prior liquidation rights of Preferred Stock, if any,
then outstanding. The Common Stock has no preemptive or conversion rights or
other subscription rights. There are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock are fully
paid and non-assessable, and the shares of Common Stock to be outstanding upon
consummation of the offering will be fully paid and non-assessable.
PREFERRED STOCK
Upon the closing of this offering, 10,000,000 shares of undesignated
Preferred Stock will be authorized, and no shares will be outstanding. The Board
of Directors has the authority to issue the shares of Preferred Stock in one or
more series and to fix the rights, preferences, privileges and restrictions
granted to or imposed upon any unissued shares of Preferred Stock and to fix the
number of shares constituting any series and the designations of such series,
without any further vote or action by the stockholders. Although it presently
has no intention to do so, the Board of Directors, without stockholder approval,
can issue Preferred Stock with voting and conversion rights which could
adversely affect the voting power of the holders of Common Stock. The issuance
of Preferred Stock may have the effect of delaying, deterring or preventing a
change in control of the Company.
WARRANTS
Upon the closing of this offering, the Company will have outstanding
warrants to purchase an aggregate of 384,121 shares of Common Stock at a
weighted average exercise price of $7.17 per share.
ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Amended and Restated Certificate of
Incorporation, amended Bylaws, Delaware law and the Company's indemnification
agreements with certain officers and directors of the Company may be deemed to
have an anti-takeover effect. Such provisions may delay, deter or prevent a
tender offer or takeover attempt that a stockholder might consider to be in that
stockholder's best interests, including attempts that might result in a premium
over the market price for the shares held by stockholders.
The Company's Board of Directors may issue additional shares of Common
Stock or establish one or more classes or series of Preferred Stock, having the
number of shares (up to 10,000,000), designations, relative voting rights,
dividend rates, liquidation and other rights, preferences and limitations as
determined by the Board of Directors without stockholder approval. The Company's
Certificate of Incorporation, as amended and restated, and Bylaws, as amended,
also contain a number of provisions that could impede a takeover or change in
control of the Company, including but not limited to the elimination of
stockholders' ability to take action by written consent without a meeting and
the elimination of cumulative voting in the election of directors.
52
In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law. In general, the statute
prohibits a publicly-held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
Each of the foregoing provisions gives the Board of Directors, acting
without stockholder approval, the ability to prevent, or render more difficult
or costly, the completion of a takeover transaction that stockholders might view
as being in their best interests.
REGISTRATION RIGHTS
Upon the closing of this offering, the holders or their permitted
transferees ("Holders") of approximately 6,078,947 shares of Common Stock are
entitled to certain rights with respect to the registration of such shares under
the Securities Act. If the Company proposes to register any of its securities
under the Securities Act, either for its own account or for the account of other
security holders, the holders are entitled to notice of the registration and are
entitled to include, at the Company's expense, shares therein. In addition,
certain of the Holders may require the Company at its own expense, on not more
than two occasions, to file a registration statement under the Securities Act,
with respect to their shares of Common Stock, and the Company is required to use
its best efforts to effect such registration, subject to certain conditions and
limitations. Further, the Holders may require the Company, at its expense, to
register shares of Common Stock on a Registration Statement on Form S-3, when
such form becomes available to the Company, subject to certain conditions and
limitations. See "Shares Eligible For Future Sale."
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Company's Common Stock is First
National Bank of Boston.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have outstanding
9,404,489 shares of Common Stock, assuming no exercise of options or warrants
outstanding as of March 31, 1997. Of these shares, the 2,750,000 shares offered
hereby (3,162,500 shares if the Underwriters' over-allotment option is exercised
in full) will be freely tradeable without restriction or further registration
under the Securities Act of 1933, as amended (the "Securities Act"), unless
purchased by "affiliates" of the Company as that term is defined in Rule 144
under the Securities Act ("Rule 144") described below. The remaining 6,654,489
shares of Common Stock outstanding upon completion of this offering are
"restricted securities" as that term is defined in Rule 144. Of these shares,
57,618 will be eligible for immediate sale upon commencement of the offering, an
additional 94,751 shares will become eligible for sale beginning 90 days after
commencement of this offering. Upon expiration of the Lock-Up Agreements
described below (which occurs 180 days after the commencement of this offering),
an aggregate of 3,769,539 shares will become eligible for sale pursuant to Rule
144 or Rule 701 under the Securities Act ("Rule 701") and 2,732,581 additional
shares will become eligible for sale thereafter under Rule 144.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year (including the holding period of any prior owner except an affiliate from
whom such shares were purchased) is entitled to sell in "broker's transactions"
or to market makers, within any three-month period commencing 90 days after the
date of this Prospectus, a number of shares that does not exceed the greater of
(i) one percent of the number of shares of Common Stock then outstanding
(approximately 94,000 shares immediately after this offering) or (ii) generally,
the average weekly trading volume in the Common Stock during the four calendar
weeks preceding the required filing of a Form 144 with respect to such sale.
Sales under Rule 144 are generally subject to the availability of current public
information about the Company. Under Rule 144(k), a person who is not deemed to
have been an affiliate of the Company at any time during the 90 days preceding a
sale, and who has beneficially owned the shares proposed to be sold for at least
two years (including the holding period of any prior owner other than an
53
affiliate from whom such shares were purchased), is entitled to sell such shares
without having to comply with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Under Rule 701, persons who
purchase shares upon exercise of options granted prior to the effective date of
this offering are entitled to sell such shares 90 days after the effective date
of this offering in reliance on Rule 144, without having to comply with the
holding period requirements of Rule 144 and, in the case of non-affiliates,
without having to comply with the public information, volume limitation or
notice provisions of Rule 144.
Pursuant to the Lock-Up Agreements, the Company and certain stockholders
owning upon completion of this offering, in the aggregate, 6,338,065 shares of
Common Stock and certain holders of stock options have agreed not to, directly
or indirectly, offer, sell, offer to sell, contract to sell, grant any option to
purchase or otherwise sell or dispose (or announce any offer, sale, offer of
sale, contract of sale, grant of any option to purchase or other sale or
disposition) of any shares of Common Stock (including shares issuable under
options exercisable during the lock-up period described below) or any securities
convertible into or exercisable or exchangeable therefor (except for shares of
Common Stock they may acquire in the public market), until 180 days after the
date of this Prospectus without the prior written consent of Cowen & Company, on
behalf of the Underwriters.
As soon as practicable after the date of this Prospectus, the Company
intends to file registration statements on Form S-8 covering an aggregate of
approximately 1.1 million shares of Common Stock that have been reserved for
issuance under its employee stock option plans and purchase plans thus
permitting the resale of such shares in the public market without restriction
under the Securities Act.
Prior to this offering, there has not been any public market for the Common
Stock. Future sales of substantial amounts of Common Stock in the public market
could adversely affect the prevailing market prices and impair the Company's
ability to raise capital through the sale of equity securities.
54
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to each of the Underwriters named below, and each of
the Underwriters, for whom Cowen & Company and Hambrecht & Quist LLC are acting
as representatives (the "Representatives"), have severally agreed to purchase
from the Company, the respective number of shares of Common Stock set forth
opposite the name of such Underwriter below:
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters are committed to purchase all of the shares of Common Stock offered
hereby (other than those covered by the over-allotment option described below)
if any such shares are purchased.
The Underwriters propose to offer the shares of Common Stock directly to
the public at the public initially offering price set forth on the cover page of
this Prospectus and in part to certain securities dealers at such price less a
concession not in excess of $ per share. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $ per share
to certain brokers and dealers. After the shares of Common Stock are released
for sale to the public, the offering price and other selling terms may from time
to time be varied by the Representatives.
The Company has granted to the Underwriters an option exercisable for 30
days after the date of this Prospectus to purchase up to an aggregate of 412,500
additional shares of Common Stock to cover over-allotments, if any. If the
Underwriters exercise their over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares to be purchased by each of
them, as shown in the foregoing table, bears to the 2,750,000 shares of Common
Stock offered hereby. The Underwriters may exercise such option only to cover
over-allotments made in connection with the sale of the shares of Common Stock
offered hereby.
The Company has agreed to indemnify the several Underwriters against
certain liabilities, including liabilities under the Securities Act, and to
contribute to payments the Underwriters may be required to make in respect
thereof.
The Company, the Company's officers and directors and certain of the
Company's shareholders have agreed subject to certain limited exceptions, not,
directly or indirectly, to offer, sell, contract to sell, or otherwise dispose
of any shares of Common Stock or any securities convertible into or exercisable
or exchangeable for Common Stock or any right to acquire Common Stock for a
period of 180 days after the date of this Prospectus without the prior written
consent (which consent may be given without notice to the Company's shareholders
or other public announcement) of Cowen & Company. Cowen & Company has advised
the Company that it has no present intention of releasing any of the Company's
shareholders from such lock-up agreements until the expiration of such 180-day
period.
The Representatives have advised the Company that, pursuant to rules
promulgated by the Commission, certain persons participating in this offering
may engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids, which may have the effect of
stabilizing or maintaining the market price of the Common Stock at a level above
that which might otherwise prevail in the open market. A "stabilizing bid" is a
bid for or the purchase of the Common Stock on behalf of the Underwriters
55
for the purpose of fixing or maintaining the price of Common Stock. A "syndicate
covering transaction" is the bid for or the purchase of the Common Stock on
behalf of the Underwriters to reduce a short position incurred by the
Underwriters in connection with the offering. A "penalty bid" is an arrangement
permitting the Underwriters to reclaim the selling concession otherwise accruing
to an Underwriter or syndicate member in connection with the offering if the
Common Stock originally sold by such Underwriter or syndicate member is
purchased by the Underwriters in syndicate covering transactions, in
stabilization transactions or otherwise. The Underwriters have advised the
Company that such transactions may be effected on the Nasdaq National Market or
otherwise and, if commenced, may be discontinued at any time.
The Representatives have advised the Company that the Underwriters do not
intend to confirm sales in excess of 5% of the shares offered hereby to any
account over which they exercise discretionary authority.
Prior to this offering, there has been no public market for the Common
Stock of the Company. Consequently, the initial public offering price was
determined by negotiations between the Company and the Representatives. Among
the factors considered in such negotiations were prevailing market conditions,
the results of operations of the Company in recent periods, the market
capitalizations and stages of development of other companies that the Company
and the Representatives believe to be comparable to the Company, estimates of
the business potential of the Company, the present state of the Company's
development and other factors deemed relevant.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the
shares of Common Stock offered hereby will be passed upon for the Company by
Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Certain legal matters in connection with this offering will be
passed upon for the Underwriters by Rogers & Wells, London, England. Members of
the firm of Wilson Sonsini Goodrich & Rosati, Professional Corporation, own an
aggregate of 26,223 shares of Common Stock.
EXPERTS
The consolidated financial statements and schedule of the Company at
December 31, 1995 and 1996 and for each of the years in the three-year period
ended December 31, 1996 have been included herein and in the Registration
Statement in reliance upon the reports of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
56
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"),
Washington, D.C. 20549, a Registration Statement on Form S-1 under the
Securities Act with respect to the shares of Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules thereto. Certain items are omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and the exhibits and schedules
filed therewith. Statements contained in this Prospectus as to the contents of
any contract or any other document referred to are not necessarily complete,
and, in each instance, reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. A copy of the Registration
Statement, and the exhibits and schedules thereto, may be inspected without
charge at the public reference facilities maintained by the Commission in Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's
regional offices located at the Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, 13th
Floor, New York, New York 10048, and copies of all or any part of the
Registration Statement may be obtained from such offices upon the payment of the
fees prescribed by the Commission. The Commission maintains a World Wide Web
site (http://www.sec.gov) that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission.
57
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
SCM Microsystems, Inc.:
We have audited the accompanying consolidated balance sheets of SCM
Microsystems, Inc. and subsidiaries (the Company) as of December 31, 1995 and
1996, and the related consolidated statements of operations, stockholders'
equity (deficit), and cash flows for each of the years in the three-year period
ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of SCM
Microsystems, Inc. and subsidiaries as of December 31, 1995 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
March 31, 1997, except
as to Note 10, which is
as of May 30, 1997
F-2
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
See accompanying notes to consolidated financial statements.
F-3
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to consolidated financial statements.
F-4
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to consolidated financial statements.
F-5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See accompanying notes to consolidated financial statements.
F-6
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995 AND 1996
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
SCM Microsystems, Inc. (the Company) designs, develops and manufactures
hardware, firmware and software products for data security and access control
applications. The Company offers products that address the needs of the
enterprise data security market, digital video broadcasting market and PCMCIA
peripheral products. The Company currently sells its products to a number of OEM
customers. The Company is headquartered in California and maintains
international headquarters in Germany.
During 1994, the Company began emphasizing security and access products.
The Company made the final shipment of PCMCIA peripheral products in the quarter
ended March 31, 1997, completing its exit from this business.
Reincorporation
From inception in 1990 until December 1996, the Company was incorporated in
Germany. During 1993, the Company formed a U.S. subsidiary which is incorporated
in Delaware.
In December 1996, the Company incorporated a holding company in the state
of Delaware and entered into a stock exchange agreement with the stockholders of
the German corporation. The Board of Directors approved an exchange of one share
in the German corporation for 6.4021 shares in the new Delaware corporation
which effected a 6.4021 for 1 stock split of common and preferred stock. The
Certificate of Incorporation of the Delaware corporation authorizes 19,000,000
shares of common stock at $0.001 par value per share and 6,000,000 shares of
preferred stock at $0.001 par value per share. The accompanying consolidated
financial statements have been retroactively restated to give effect to the
reincorporation and stock split.
Registration Statement
In December 1996, the Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission permitting
the Company to sell shares of the Company's common stock in connection with a
proposed initial public offering (IPO). If the offering is consummated under the
terms presently anticipated, all the currently outstanding shares of preferred
stock will automatically convert into 3,948,743 shares of common stock upon the
effectiveness of the proposed IPO. The conversion of the preferred stock has
been reflected in the unaudited pro forma stockholders' deficit as of March 31,
1997 (see Note 11).
Principles of Consolidation
The accompanying consolidated financial statements include those of the
Company and its wholly owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the consolidated
financial statements and reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
F-7
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
Cash Equivalents
The Company considers all highly liquid investments with a remaining
maturity of three months or less at the date of acquisition to be cash
equivalents.
Concentration of Credit Risk
The Company sells its products to a diversified group of customers which
are typically large OEM computer manufacturers located mainly in the United
States and Europe. The Company extends credit based on an evaluation of each
customer's financial condition and generally requires no collateral from its
customers. Credit losses, if any, have been provided for in the consolidated
financial statements and have been within management's expectation.
Inventories
Inventories are stated at the lower of cost or market, using the first-in,
first-out method.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method based upon the useful lives of the respective assets or
the lease term, generally three to seven years. During 1996, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long Lived Assets and Long Lived Assets to Be Disposed Of. The
adoption of SFAS No. 121 did not have a material effect on the Company's
consolidated financial position or operating results.
Fair Value of Financial Instruments
The carrying amounts reflected in the consolidated balance sheets for cash,
accounts receivable, and accounts payable approximate their respective fair
values due to the short maturities of these instruments. The fair value of the
Company's notes payable, notes payable to related parties, and long-term related
party debt is not determinable as it is uncertain at what value the Company
could settle such financing or obtain replacement financings.
Revenue Recognition
Revenue from product sales is recognized upon product shipment. Provisions
for estimated warranty repairs and returns and allowances are provided for at
the time products are shipped. Revenue recognition under nonrecurring
engineering contracts generally is recognized upon the percentage of completion
basis.
Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements in
accordance with the provisions of Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations. As
such, compensation expense would be recorded on the date of grant only if the
fair value of the underlying stock exceeded the exercise price. On January 1,
1996, the Company adopted the disclosure provisions of SFAS No. 123, Accounting
for Stock-Based Compensation, which requires entities to provide pro forma net
income and pro forma earnings per share disclosures for employee stock option
grants made in 1995 and future years as if the fair value-based method defined
in SFAS No. 123 had been applied.
F-8
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
Income Taxes
Income taxes are accounted for using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiary is the local
foreign currency. The Company translates the assets and liabilities of its
foreign subsidiary to U.S. dollars at the rates of exchange in effect at the end
of the year. Net sales and expenses are translated at the average rates of
exchange for the year. Translation gains and losses are included in
stockholders' deficit in the consolidated balance sheets. Gains and losses
resulting from foreign currency transactions denominated in a currency other
than the functional currency are included in income and have not been
significant to the Company's consolidated operating results in any period.
Pro Forma Net Loss Per Share
Pro forma net loss per share data is based on the weighted-average number
of shares of common stock and, when dilutive, common equivalent shares from
stock options and warrants outstanding, using the treasury stock method, and
convertible preferred stock and notes payable on an "as if converted" basis.
Pursuant to certain SEC Staff Accounting Bulletins, common stock,
convertible preferred stock and convertible notes payable issued for
consideration below the assumed IPO price and stock options granted and warrants
issued with exercise prices below the assumed IPO price during the 12-month
period prior to the date of the initial filing of the registration statement,
even when antidilutive, have been included in the calculation of pro forma net
loss per share, using the treasury stock method based on the assumed IPO price,
as if they were outstanding for all periods presented.
The Financial Accounting Standards Board recently issued SFAS No. 128,
Earnings Per Share. SFAS No. 128 requires the presentation of basic earnings per
share (EPS) and, for companies with complex capital structures, diluted EPS.
SFAS No. 128 is effective for annual and interim periods ending after December
15, 1997. The Company expects that for profitable periods basic EPS will be
higher than earnings per share as presented in the accompanying financial
statements and diluted EPS will not differ materially from earnings per share as
presented in the accompanying consolidated financial statements. Computations
for loss periods should not change significantly.
Unaudited Interim Consolidated Financial Statements
The unaudited interim consolidated financial statements as of March 31,
1997, and for the three months ended March 31, 1996 and 1997, have been prepared
on substantially the same basis as the audited consolidated financial
statements, and in the opinion of management include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
financial information set forth therein.
F-9
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
2. BALANCE SHEET COMPONENTS
A summary of balance sheet components is as follows (in thousands):
3. NOTES PAYABLE, LONG-TERM DEBT, AND RELATED PARTY DEBT
Notes payable and long-term debt consisted of the following (in thousands):
Related party debt consisted of the following (in thousands):
F-10
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
Nonconvertible Loans
In October 1993, the Company's German subsidiary entered into a Deutsche
Mark (DM) 1,000,000 loan agreement, bearing interest at 5% per annum, expiring
on December 31, 2003. In June 1995, the Company entered into an additional DM
3,000,000 loan agreement with the same party, bearing interest at 6% per annum,
expiring on December 31, 2005. DM 2,000,000 was drawn under this second
agreement in June 1995, and the remaining DM 1,000,000 was drawn on April 2,
1996. The terms of these agreements also provide the lender with the option to
request an additional compensation of 25% of the then outstanding loan amount
after the fifth year of each of the respective agreements or upon early
termination of the loans by the Company. The Company may terminate this
agreement at the end of each half year with three months notice. The outstanding
balance on these loans was $2,070,000, $2,580,000, and $2,410,000 as of December
31, 1995 and 1996, and March 31, 1997, respectively.
Notes Payable to Banks
Notes payable to banks bear interest at 10% and are guaranteed by certain
stockholders of the Company.
Convertible Notes Payable, Series C
In February 1996, the Company's German subsidiary entered into a loan
agreement for DM 4,009,000. The loan bears interest at 4% per annum and is
convertible into 653,642 shares of Series C preferred stock. The outstanding
balance of this loan as of December 31, 1996, was $1,959,000 payable to third
parties and $627,000 payable to stockholders. In accordance with the provisions
of the loan agreement, the loan was converted into 653,642 shares of Series C
preferred stock in March 1997.
Line of Credit
In April 1996, the Company entered into a $2,500,000 revolving line of
credit agreement expiring in August 1997. The facility bears interest at the
bank's prime rate plus 1.5%, reduced to 1.0% under certain profitability
conditions contained in the agreement (9.25% as of December 31, 1996). The
agreement contains certain financial covenants and is secured by all assets of
the Company. As of December 31, 1996, the Company had outstanding borrowings of
$1,000,000 under this agreement.
The Company also has DM 4,500,000 in foreign lines of credit and other bank
facilities. These facilities bear interest at 8.0% to 8.75% and expire on
various dates through March 1998. As of December 31, 1996, there were no
borrowings under these lines.
Convertible Notes Payable, Series D
In December 1996, the Company's German subsidiary entered into a loan
agreement for a total of DM 3,179,000 with stockholders of which DM 2,564,000
was tendered at year-end. The loan agreement includes a conversion option which
may be exercised after June 30, 1997, and expires on December 31, 1997. Under
the terms of the agreement, the loan, if not converted, becomes payable on
demand. Under the agreement, the debt automatically converts to common stock in
the event of certain events including an IPO of equity securities. The loan
bears no interest and is convertible into 377,580 shares of Series D preferred
stock. Under the terms of this agreement, if the conversion option is not
exercised by December 31, 1997, the loan will bear interest at 12% per annum
from the date of issue. The outstanding balance of this loan as of December 31,
1996, was $1,654,000. In March 1997, the Company and the note holders agreed to
convert the debt into 377,580 shares of Series D preferred stock and the
accompanying consolidated financial statements
F-11
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
have been retroactively restated to reflect the conversion as if the conversion
had been completed as of March 31, 1997.
In connection with this loan agreement, the Company issued 22,652 warrants
to purchase Series D preferred stock at $5.72 per share. The fair value of these
warrants was not significant.
Stockholder Loans
Loans from stockholders accrue interest at 8.5% per annum. These loans from
stockholders are due on demand.
Convertible Notes Payable
In August 1994, certain stockholders advanced the Company loans totaling
$2,059,000. In June 1995, these loans and accrued interest of approximately
$242,000 were converted into Series B preferred stock.
4. STOCKHOLDERS' DEFICIT
Convertible Preferred Stock
As of December 31, 1996, the Company was authorized to issue 6,000,000
shares of convertible preferred stock, with a par value of $0.001. The Company
has designated 854,038 shares as convertible Series A and 1,211,914 shares as
convertible Series B.
In March 1997, the Company issued 388,284 shares of Series D redeemable
convertible preferred stock for proceeds of $2,221,000 and 463,285 shares of
Series E redeemable convertible preferred stock for proceeds of $2,650,000.
The rights and preferences of the holders of preferred stock are as
follows:
- Holders of preferred stock are entitled to noncumulative dividends when
and as declared by the Company's Board of Directors. Dividends are
distributable among all holders of preferred stock and common stock in
proportion to the number of shares of common stock which would be held by
each such holder if all shares of preferred stock were converted into
common stock.
- Holders of Series B, C, D, and E preferred stock have a liquidation
preference of $3.83, $4.29, $5.72 and $5.72 per share, respectively, plus
any declared but unpaid dividends.
- Holders of Series A, B, C, D, and E preferred stock may convert all or
part of their shares at any time after the date of issuance into such
number of shares of common stock as is determined by dividing $1.75,
$3.83, $4.29, $5.72 and $5.72, respectively, by the conversion price in
effect at the time.
- Holders of Series B, C, D, and E preferred stock have the right to
require the Company to redeem the then outstanding shares if the Company
has not made a public offering of its common stock pursuant to an
effective registration statement under the Securities Act of 1933 on or
before June 30, 1999, February 28, 2000, December 31, 2001 and February
28, 2002, respectively. An amount equal to the respective shares'
liquidation preference plus 6% compounded interest per annum on such
amount from the date of issuance shall be paid to the holders of such
preferred stock subject to certain provisions of the stock purchase
agreement.
F-12
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
In connection with the issuance of Series D redeemable convertible
preferred stock, the Company issued 28,539 warrants to purchase Series D
preferred stock at $5.72 per share to a stockholder. The fair value of these
warrants was not significant.
Stock Options
In October 1995, the Company authorized issuance of 376,443 options. The
options generally vest over a 4-year period, 25% vesting on the first
anniversary date of the employees' date of employment and 1/48th vesting each
additional full month thereafter, and are exercisable for a term of 10 years
after issuance. During July 1996, the number of shares authorized to be issued
was increased to 1,030,097 shares.
Stock option activity during the periods indicated is as follows:
As of December 31, 1996, 480,414 options were fully vested and exercisable.
The Company accounts for stock-based compensation in accordance with APB
Opinion No. 25 and, accordingly, no compensation cost has been recognized for
its stock options in the accompanying consolidated financial statements because
the fair value of the underlying common stock equals or exceeds the exercise
price of the stock options at the date of grant, except with respect to the
options and restricted stock granted in July and October 1996. The Company has
recorded deferred stock compensation of $377,000 for the difference at the grant
date between the exercise price and the fair value, as determined by an
independent valuation, of the restricted stock and the common stock underlying
the options. This amount is being amortized on the straight-line basis over the
vesting period of the individual options and restricted stock, generally four
years. For the year ended December 31, 1996, the Company expensed approximately
$153,000 of the deferred stock compensation reflecting the commencement of
vesting from the date of employment. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's compensation charge would have been $145,000, and the
Company's net loss would have been changed to the pro forma amounts indicated
below (in thousands):
F-13
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
The per share weighted-average fair value of stock options granted during
1995 and 1996 was $0.02 and $0.54, respectively, on the date of grant using the
minimum value method with the following weighted-average assumptions:
1995 -- expected dividend yield 0.0%, risk-free interest rate of 5.79%, expected
life of 4 years and remaining average contractual life of 9 years;
1996 -- expected dividend yield 0.0%, risk-free interest rate of 6.32%, expected
life of 4 years and remaining average contractual life of 10 years.
5. GEOGRAPHIC INFORMATION
Information regarding operations in different geographic regions is as
follows (in thousands):
The Company's European operations are in Germany and France. Intercompany
transfers between geographic areas are accounted for using the transfer prices
in effect for subsidiaries.
6. INCOME TAXES
As of December 31, 1996, SCM Microsystems GmbH had German net operating
loss carryforwards of approximately $4,600,000, which can be used to offset
GmbH's income. The German net operating loss carryforwards can be carried
forward indefinitely.
SCM Microsystems, Inc. had net operating loss carryforwards of
approximately $1,900,000 and $800,000 for federal and California income tax
purposes, respectively. The federal net operating loss carryforwards will expire
in the years 2008 through 2010. The California net operating loss carryforwards
will expire in the years 1998 through 2000.
Federal and California tax laws impose significant restrictions on the
utilization of net operating loss carryforwards in the event of a shift in the
ownership of the Company, which constitutes an "ownership change" as defined by
the Internal Revenue Code, Section 382. An ownership change occurred in 1996,
F-14
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
resulting in the U.S. subsidiary's federal and California net operating loss
carryforwards being subject to an annual limitation of approximately $340,000.
Any unused annual limitations may be carried forward to increase the limitations
in subsequent years.
The domestic and foreign components of net income (loss) before income
taxes are as follows (in thousands):
The Company has a deferred tax asset as of December 31, 1995 and 1996, of
approximately $1,100,000 and $2,200,000, which is fully offset by a valuation
allowance. The deferred tax asset principally results from the net operating
loss carryforwards. The Company has provided a valuation allowance due to the
uncertainty of generating future profits that would allow for the realization of
such deferred tax assets.
7. COMMITMENTS
The Company leases its facilities, certain equipment, and automobiles under
noncancelable operating lease agreements. These lease agreements expire at
various dates during the next four years. Rent expense was $251,000, $343,000,
and $467,000 in 1994, 1995, 1996, respectively.
Future minimum lease payments under noncancelable operating leases are as
follows as of December 31, 1996 (in thousands):
8. RELATED PARTY TRANSACTIONS
The Company purchased inventory under transactions negotiated on a basis
comparable to an arm's length basis totaling $3,478,000 and $3,294,000 in 1995
and 1996, respectively, from a stockholder. Included in accounts payable are
amounts owed this stockholder of $925,000 and $396,000 as of December 31, 1995
and 1996, respectively.
F-15
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
9. MAJOR CUSTOMERS AND SALES INFORMATION
A summary of the net sales to major customers that exceeded 10% of total
net sales during each of the years in the three-year period ended December 31,
1996, and the amount due from these customers as of December 31, 1996, follows
(accounts receivable in thousands):
During 1994, 1995, and 1996, net sales of PCMCIA peripheral products
amounted to 78%, 31%, and 23%, respectively, of sales. As discussed in Note 1,
during 1996, the Company phased out of these products.
10. SUBSEQUENT EVENTS
Series F Preferred Stock Financing
In April 1997, the Company issued 849,790 shares of Series F redeemable
convertible preferred stock for proceeds of $6,991,199, of which 34,965 shares
are subject to repurchase rights. The rights and preferences of Series F
preferred stock are substantially the same as the rights and preferences
underlying the holders of Series B, C, D, and E preferred stock with the
following exceptions:
- The liquidation preference of Series F shall be $8.58.
- Holders of Series F preferred stock may convert all or part of their
shares at any time after the date of issuance into such number of shares
of common stock as is determined by dividing $8.58 by the conversion
price in effect at the time.
- Holders of Series F preferred stock have the right to require the Company
to redeem the then outstanding shares if the Company has not made a
public offering of its common stock pursuant to an effective registration
statement under the Securities Act of 1933 on or before March 28, 2002.
Pursuant to the terms of the Series F Preferred Stock Purchase Agreement,
the Company issued a warrant for the purchase of an additional 194,930 shares of
Series F preferred stock at a price of $8.58 per share to one of the purchasers
of Series F preferred stock ("the warrant holder"). This warrant was issued as
partial consideration for the warrant holder entering into a Development and
Supply Agreement with the Company, which was executed effective April 30, 1997.
The fair value of these warrants was not significant.
In conjunction with the designation of Series F preferred stock, the
Company approved an increase to the authorized number of shares of common stock
and preferred stock to 40,000,000 shares and 10,000,000 shares, respectively.
Employee Stock Plans
1997 Stock Plan
In April 1997, the Company's stockholders approved the 1997 Stock Plan (the
1997 Plan) under which employees and consultants may be granted incentive or
nonqualified stock options for the purchase of the Company's common stock and
stock purchase rights. Unless terminated sooner, the 1997 Plan will terminate
F-16
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
automatically in 2007. A total of 1,000,000 shares of common stock are currently
reserved for issuance pursuant to the 1997 Plan.
1997 Employee Stock Purchase Plan
In April 1997, the Company's stockholders approved the 1997 Employee Stock
Purchase Plan which authorizes the issuance of up to 175,000 shares of the
Company's common stock. The plan permits eligible employees to purchase common
stock through payroll deductions at a purchase price of 85% of the lower of fair
market value of the common stock at the beginning or end of each offering
period.
1997 Director Option Plan
In April 1997, the Company's stockholders approved the 1997 Director Option
Plan (the Director Plan). A total of 50,000 shares of common stock has been
reserved for issuance under the Director Plan. Each outside director of the
Company will automatically be granted an option to purchase up to 10,000 shares
of common stock upon the effective date of the Director Plan and will
automatically be granted annual subsequent options to purchase additional shares
of common stock under the Director Plan. The price of stock purchased under the
Director Plan is 100% of the fair market value of the common stock as of the
grant date.
Legal Proceedings
On April 28, 1997, a third party served the Company with a complaint
alleging that certain of the Company's products infringe certain claims of a
French patent held by the third party. While the outcome of any litigation is
uncertain, management of the Company believes that, based upon the defenses
available to the Company and the third party's stated licensing position, the
matter can be resolved without material adverse effect on the Company's results
of operations.
F-17
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 1997 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1997 IS UNAUDITED.)
11. PRO FORMA INFORMATION (UNAUDITED)
The following table reflects the pro forma adjustments in the accompanying
consolidated balance sheet (in thousands):
- ---------------
(a) Gives effect to the conversion of the Company's Series B, C, D, and E
redeemable convertible preferred stock into 1,211,914, 653,642, 765,864, and
463,285 shares, respectively, of common stock.
(b) Gives effect to the conversion of the Company's convertible preferred Series
A stock into 854,038 shares of common stock.
(c) Gives effect to the subsequent offering and conversion into common of
849,790 shares of Series F convertible preferred stock (see Note 10).
F-18
APPENDIX
DESCRIPTION OF GRAPHICS
1 Inside Front Cover:
Picture depicts the major products provided by the Company and its customers to
implement security solutions using existing infrastructure, the Company's
products and third party hardware, software and systems.
2 Gatefold:
Picture depicts the market and product evolution of secured digital data access
and delivery in the corporate and consumer marketplaces, and the convergence of
these markets and products as facilitated by the Company's products, its OEM
partners and standards-setting organizations in which the Company actively
participates.
3 Inside Back Cover:
Picture depicts the Company's products and the consumer and corporate digital
systems (e.g., set-up boxes and network computers) utilizing these products.
4 Data Security "Patchwork":
Picture on page 28 depicts the different methods of data security implemented by
enterprise networks in order to accommodate the problems presented by different
information sources and types of users.
5 Securing Digital Video Broadcasts:
Picture on page 31 depicts the role of a Digital Video Broadcasting-Conditional
Access Module in securing digital video broadcasts and the different services
which such module enables.
============================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY, ANY OF THE UNDERWRITERS OR BY ANY OTHER
PERSON. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION
OF AN OFFER TO BUY, OF ANY SECURITIES OTHER THAN THE SHARES OF COMMON STOCK
OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN
OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO
SUCH PERSON. NEITHER DELIVERY OF THIS PROSPECTUS NOR ANY SALES MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
------------------------------
TABLE OF CONTENTS
------------------------------
UNTIL , 1997 (25 DAYS AFTER THE DATE OF THE PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
============================================================
============================================================
2,750,000 Shares
LOGO
Common Stock
------------------------------
PROSPECTUS
------------------------------
COWEN & COMPANY
HAMBRECHT & QUIST
, 1997
============================================================
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the sale of Common Stock being registered. All amounts are estimates except
the SEC registration fee, the NASD filing fee and the Nasdaq National Market
listing fee.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As permitted by Section 145 of the Delaware General Corporation Law, the
Registrant's Amended and Restated Certificate of Incorporation includes a
provision that eliminates the personal liability of its directors for monetary
damages for breach or alleged breach of their duty of care. In addition, as
permitted by Section 145 of the Delaware General Corporation Law, the Bylaws, as
amended, of the Registrant provide that: (i) the Registrant is required to
indemnify its directors and officers and persons serving in such capacities in
other business enterprises (including, for example, subsidiaries of the
Registrant) at the Registrant's request, to the fullest extent permitted by
Delaware law, including in those circumstances in which indemnification would
otherwise be discretionary; (ii) the Registrant may, in its discretion,
indemnify employees and agents in those circumstances where indemnification is
not required by law; (iii) the Registrant is required to advance expenses, as
incurred, to its directors and officers in connection with defending a
proceeding (except that it is not required to advance expenses to a person
against whom the Registrant brings a claim for breach of the duty of loyalty,
failure to act in good faith, intentional misconduct, knowing violation of law
or deriving an improper personal benefit); (iv) the rights conferred in the
Bylaws, as amended, are not exclusive, and the Registrant is authorized to enter
into indemnification agreements with its directors, officers and employees; and
(v) the Registrant may not retroactively amend the Bylaw provisions in a way
that is adverse to such directors, officers and employees.
The Registrant's policy is to enter into indemnification agreements with
each of its directors and officers that provide the maximum indemnity allowed to
directors and officers by Section 145 of the Delaware General Corporation Law
and the Bylaws, as amended, as well as certain additional procedural
protections.
The indemnification provisions in the Bylaws, as amended, and the
indemnification agreements entered into between the Registrant and its directors
and officers may be sufficiently broad to permit indemnification of the
Registrant's directors and officers for liabilities arising under the Securities
Act.
II-1
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere herein:
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
From January 1, 1994 through May 31, 1997 the Registrant has issued and
sold the following securities:
(i) the Registrant issued and sold 3,944,495 shares of Preferred Stock at
purchase prices ranging from $3.83 to $8.58 for aggregate consideration of
approximately $21,382,000; and
(ii) the Registrant issued and sold 549,934 shares of Common Stock to
employees and consultants at an exercise price of $0.10 for aggregate
consideration of approximately $55,000.
The issuances referred to in paragraph (i) were deemed exempt from
registration under the Securities Act in reliance upon Section 4(2) thereof. The
recipients of securities in each such transaction represented their intentions
to acquire the securities for investment only and not with a view to or for sale
in connection with any distribution thereof and appropriate legends were affixed
to the share certificates issued in such transactions. All recipients had
adequate access, through their relationships with the Registrant, to information
about the Registrant. The issuances of Common Stock described in paragraph (ii)
above were deemed exempt from registration under the Securities Act in reliance
upon Rule 701 promulgated under the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
II-2
- ---------------
* To be filed by amendment.
+ Certain information in these exhibits has been omitted and filed separately
with the Securities and Exchange Commission pursuant to a confidential
treatment request under 17 C.F.R. sec.sec. 200.80(b)(4), 200.83 and 230.46.
(b) FINANCIAL STATEMENT SCHEDULES
Schedule II -- Valuation and Qualifying Accounts
II-3
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities
Act, may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the California Corporation Law, the Registrant's
Certificate of Incorporation, as amended, the Registrant's Bylaws, as amended,
the Registrant's indemnification agreements or otherwise, the Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act, and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered hereunder, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a
form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1)
or (4) or 497(h) under the Securities Act shall be deemed to be part of
this Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.
II-4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement on Form S-1 to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Los Gatos,
State of California, on this 12th day of June 1997.
SCM MICROSYSTEMS, INC.
By: /s/ STEVEN HUMPHREYS
------------------------------------
Steven Humphreys
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steven Humphreys and John Niedermaier,
and each of them singly, as true and lawful attorneys-in-fact and agents with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities to sign the Registration Statement filed
herewith and any or all amendments to said Registration Statement (including
post-effective amendments and registration statements filed pursuant to Rule 462
and otherwise), and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission
granting unto said attorneys-in-fact and agents the full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the foregoing, as full to all intents and purposes as he or she
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or his substitute, may lawfully do
or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
II-5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
II-6
INDEX TO EXHIBITS
- ---------------
* To be filed by amendment.
+ Certain information in these exhibits has been omitted and filed separately
with the Securities and Exchange Commission pursuant to a confidential
treatment request under 17 C.F.R. sec.sec. 200.80(b)(4), 200.83 and 230.46.