| SCM MICROSYSTEMS INC ITEM 1A RISK FACTORS Our business and results of operations are subject to numerous risks, uncertainties and other factors that you should be aware of, some of which are described below |
| The risks, uncertainties and other factors described below are not the only ones facing our company |
| Additional risks, uncertainties and other factors not presently known to us or that we currently deem immaterial may also impair our business operations |
| Any of the risk, uncertainties and other factors could have a materially adverse effect on our business, financial condition, results of operations, cash flows or product market share and could cause the trading price of our common stock to decline substantially |
| We have incurred operating losses and may not achieve profitability |
| We have a history of losses with an accumulated deficit of dlra192dtta8 million as of December 31, 2005 |
| We may continue to incur losses in the future and may be unable to achieve or maintain profitability |
| Our quarterly operating results will likely fluctuate |
| Our quarterly operating results have varied greatly in the past and will likely vary greatly in the future depending upon a number of factors |
| Many of these factors are beyond our control |
| Our revenues, gross profit and operating results may fluctuate significantly from quarter to quarter due to, among other things: • business and economic conditions overall and in our markets; • the timing and amount of orders we receive from our customers that may be tied to budgetary cycles, product plans, seasonal demand or equipment roll-out schedules; • cancellations or delays of customer product orders, or the loss of a significant customer; 14 _________________________________________________________________ [68]Table of Contents • our backlog and inventory levels; • our customer and distributor inventory levels and product returns; • competition; • new product announcements or introductions; • our ability to develop, introduce and market new products and product enhancements on a timely basis, if at all; • our ability to successfully market and sell products into new geographic or customer market segments; • the sales volume, product configuration and mix of products that we sell; • technological changes in the markets for our products; • reductions in the average selling prices that we are able to charge due to competition or other factors; • strategic acquisitions, sales and dispositions; • fluctuations in the value of foreign currencies against the US dollar; • the timing and amount of marketing and research and development expenditures; and • costs related to events such as organizational restructuring, litigation and write-off of investments |
| Due to these and other factors, our revenues may not increase or even remain at their current levels |
| Because a majority of our operating expenses are fixed, a small variation in our revenues can cause significant variations in our operational results from quarter to quarter and our operating results may vary significantly in future periods |
| Therefore, our historical results may not be a reliable indicator of our future performance |
| It is difficult to estimate operating results prior to the end of a quarter |
| We do not typically maintain a significant level of backlog |
| As a result, revenue in any quarter depends on contracts entered into or orders booked and shipped in that quarter |
| Historically, many of our customers have tended to make a significant portion of their purchases towards the end of the quarter, in part because they believe they are able to negotiate lower prices and more favorable terms |
| This trend makes predicting revenues difficult |
| The timing of closing larger orders increases the risk of quarter-to-quarter fluctuation in revenues |
| If orders forecasted for a specific group of customers for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, our operating results for that quarter could be materially adversely affected |
| In addition, from time to time, we may experience unexpected increases in demand for our products resulting from seasonal demand in our customers’ markets |
| These occurrences are not always predictable and can have a significant impact on our results in the period in which they occur |
| Our strategy to grow revenue and become profitable depends on our ability to identify and secure new customers and market opportunities at a faster rate than the rate of decline in our sales from legacy customers and products |
| Since 2003, sales of our legacy Digital TV products have been significantly lower than in previous periods, primarily due to competition for our traditional customer base |
| We have also experienced a reduction in sales of our PC Security products, due to the slow pace of anticipated large digital security projects that we believe could utilize our products |
| We have adopted a strategy to address our declining revenue that is based on introducing new Digital TV, PC Security and Flash Media Interface products to offset the rate of decline of our legacy Digital TV product sales and to address new market opportunities |
| To date, this strategy has been only partially successful |
| Our target markets have not grown or developed as quickly as we had expected, and we have experienced delays in the development of new products designed to take advantage of new market opportunities |
| Since new target markets are still evolving, it is difficult to assess the competitive environment or the size of the market that may develop |
| If our target markets do not develop and create demand for our products, if we are not able to complete, sell and ship new 15 _________________________________________________________________ [69]Table of Contents products into the new markets we have identified, or if we are not able to compete against new or existing competitors in those markets, we may not be able to counter our revenue decline and our losses could increase |
| Our listing on the Prime Standard of the Frankfurt Stock Exchange exposes our stock price to additional risks of fluctuation |
| Our common stock is listed both on the Nasdaq Stock Market and the Prime Standard of the Frankfurt Stock Exchange and we typically experience a significant volume of our trading on the Prime Standard |
| For example, European investors may react differently and more positively or negatively than investors in the United States to events such as acquisitions, dispositions, one-time charges and higher or lower than expected revenue or earnings announcements |
| A positive or negative reaction by investors in Europe to such events could cause our stock price to increase or decrease significantly |
| The European economy and market conditions in general, or downturns on the Prime Standard specifically, regardless of the Nasdaq Stock Market conditions, also could negatively impact our stock price |
| Our stock price has been and is likely to remain volatile |
| Over the past few years, the Nasdaq Stock Market and the Prime Standard of the Frankfurt Exchange have experienced significant price and volume fluctuations that have particularly affected the market prices of the stocks of technology companies |
| For example, during the 12-month period from January 1, 2005 to December 31, 2005, the closing prices for our common stock on the Nasdaq Stock Market ranged between dlra2dtta61 and dlra4dtta92 per share |
| Volatility in our stock price on either or both exchanges may result from a number of factors, including, among others: • variations in our or our competitors’ financial and/or operational results; • the fluctuation in market value of comparable companies in any of our markets; • expected, perceived or announced relationships or transactions with third parties; • comments and forecasts by securities analysts; • trading patterns of our stock on the Nasdaq Stock Market or Prime Standard of the Frankfurt Stock Exchange; • the inclusion or removal of our stock from market indices, such as groups of technology stocks or other indices; • any loss of key management; • announcements of technological innovations or new products by us or our competitors; • litigation developments; and • general market downturns |
| In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation |
| If we were the object of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources |
| A significant portion of our sales typically comes from a small number of customers and the loss of one of more of these customers could negatively impact our operating results |
| Our products are generally targeted at OEM customers in the consumer electronics, digital photography, computer and conditional access system industries, as well as digital television operators, broadcasters and distributors, the government sector and corporate enterprises |
| Sales to a relatively small number of customers historically have accounted for a significant percentage of our total revenues |
| For example, three customers accounted for approximately 21prca of our total net revenue in the year ended December 31, 2005 and three customers accounted for approximately 19prca of our total net revenue in the year ended December 31, 2004 |
| We expect that 16 _________________________________________________________________ [70]Table of Contents sales of our products to a relatively small number of customers will continue to account for a high percentage of our total sales for the foreseeable future |
| The loss of a customer or reduction of orders from a significant customer, including those due to product performance issues, changes in customer buying patterns, or market, economic or competitive conditions in our market segments, would increase our dependence on a smaller group of our remaining customers and could result in decreased revenues, decreased margins, and/or inventory or receivables write-offs and otherwise harm our business and operating results |
| Sales of our products depend on the development of several emerging markets |
| We sell our products primarily to emerging markets that have not yet reached a stage of mass adoption or deployment |
| If demand for products in these markets does not develop further and grow sufficiently, our revenue and gross profit margins could decline or fail to grow |
| We cannot predict the future growth rate, if any, or size or composition of the market for any of our products |
| The demand and market acceptance for our products, as is common for new technologies, is subject to high levels of uncertainty and risk and may be influenced by various factors, including, but not limited to, the following: • general economic conditions; • the uncertain pace of adoption in Europe and Asia of open systems digital television platforms that require conditional access modules, such as ours, to decrypt pay-TV broadcasts; • the ability of our competitors to develop and market competitive solutions in emerging markets and our ability to win business in advance of and against such competition; • the strength of entrenched security and set-top receiver suppliers in the United States who may resist the use of removable conditional access modules, such as ours, and prevent or delay opening the US digital television market to greater competition; • the adoption and/or continuation of industry or government regulations or policies requiring the use of products such as our conditional access modules or smart card readers; • the timing of adoption of smart cards by the US and other governments, European banks and other enterprises for large scale security programs beyond those in place today; • the ability of financial institutions, corporate enterprises and the US government to agree on industry specifications and to develop and deploy smart card-based applications that will drive demand for smart card readers such as ours; and • the ability of high capacity flash memory cards to drive demand for digital media readers, such as ours, that enable rapid transfer of large amounts of data, for example digital photographs |
| Our products may have defects, which could damage our reputation, decrease market acceptance of our products, cause us to lose customers and revenue and result in costly litigation or liability |
| Products such as our conditional access modules and smart card readers may contain defects for many reasons, including defective design, defective material or software interoperability issues |
| Often, these defects are not detected until after the products have been shipped |
| If any of our products contain defects or perceived defects or have reliability, quality or compatibility problems or perceived problems, our reputation might be damaged significantly, we could lose or experience a delay in market acceptance of the affected product or products and we might be unable to retain existing customers or attract new customers |
| In addition, these defects could interrupt or delay sales or our ability to recognize revenue for products shipped |
| In the event of an actual or perceived defect or other problem, we may need to invest significant capital, technical, managerial and other resources to investigate and correct the potential defect or problem and potentially divert these resources from other development efforts |
| If we are unable to provide a solution to the potential defect or problem that is acceptable to our customers, we may be required to incur substantial product recall, repair and replacement and even litigation costs |
| These costs could have a material adverse effect on our business and operating results |
| 17 _________________________________________________________________ [71]Table of Contents In addition, because our digital security customers rely on our products to prevent unauthorized access to their digital content, a malfunction of or design defect in our products (or even a perceived defect) could result in legal or warranty claims against us for damages resulting from security breaches |
| If such claims are adversely decided against us, the potential liability could be substantial and have a material adverse effect on our business and operating results |
| Furthermore, the publicity associated with any such claim, whether or not decided against us, could adversely affect our reputation |
| In addition, a well-publicized security breach involving smart card-based and other security systems could adversely affect the market’s perception of products like ours in general, or our products in particular, regardless of whether the breach is actual or attributable to our products |
| Any of the foregoing events could cause demand for our products to decline, which would cause our business and operating results to suffer |
| If we do not accurately anticipate the correct mix of products that will be sold, we may be required to record charges related to excess inventories |
| Due to the unpredictable nature of the demand for our products, we are required to place orders with our suppliers for components, finished products and services in advance of actual customer commitments to purchase these products |
| Significant unanticipated fluctuations in demand could result in costly excess production or inventories |
| In order to minimize the negative financial impact of excess production, we may be required to significantly reduce the sales price of the product to increase demand, which in turn could result in a reduction in the value of the original inventory purchase |
| Writing down inventory or reducing product prices could adversely impact our cost of revenues and financial condition |
| We have paid taxes related to products previously purchased by a customer for which we may not receive reimbursement |
| In order to resolve tax liabilities related to products that we previously sold to a Digital TV customer, in April 2005 we were required to pay the French government approximately dlra4dtta7 million in Value Added Taxes (“VAT”), for which we had previously accrued the expense |
| In connection with this payment, we entered into an agreement with the customer that committed the customer to seek a refund from the French government for the VAT paid with respect to the products it purchased from us and then remit the refunded amount to us |
| On October 13, 2005 the French government refunded approximately dlra4dtta7 million to the customer |
| However, in December 2005 the customer filed a claim in France alleging participation by SCM Microsystems GmbH in the counterfeiting of their product and has not remitted the refunded VAT amount to us |
| Pending this litigation, and even after it is resolved, there is no assurance that the customer will remit to us the amount that has been refunded to it |
| Legal actions to defend against the claims made against us and to pursue reimbursement from or to enforce this agreement with the customer could result in significant expense, use our management’s time and resources and may not be successful |