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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PERSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________.
Commission file number: 000-27257
SMARTDISK CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 65-0733580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3506 Mercantile Avenue, Naples, Florida 34104
(Address of principal executive offices) (Zip Code)
(941) 436-2500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of February 28, 2001, there were 17,512,969 shares of the
Registrant's Common Stock outstanding, and the aggregate market value of such
shares held by non-affiliates of the Registrant as of February 28, 2001 was
$29,788,000. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for the 2000 Annual
Meeting of Stockholders to be held on May 30, 2001, which will be filed within
120 days after the end of the Registrant's fiscal year ended December 31, 2000,
are incorporated by reference in Part III of this Form 10-K to the extent stated
herein.
SMARTDISK CORPORATION
FISCAL YEAR 2000 FORM 10-K ANNUAL REPORT
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TABLE OF CONTENTS
Page
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PART I.
Item 1. Business.......................................................... 3
Item 2. Properties.........................................................21
Item 3. Legal Proceedings..................................................22
Item 4. Submission of Matters to a Vote of Security Holders................22
PART II.
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters........................................22
Item 6. Selected Financial Data............................................23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........45
Item 8. Financial Statements and Supplementary Data........................46
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure...........................................46
PART III.
Item 10. Directors and Executive Officers of the Registrant.................46
Item 11. Executive Compensation.............................................47
Item 12. Security Ownership of Certain Beneficial Owners and Management.....47
Item 13. Certain Relationships and Related Transactions.....................47
PART IV.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...47
Signatures.........................................................79
2
Forward-Looking Statements
In addition to historical information, this report on Form 10-K and the
documents incorporated herein by reference, as well as our annual report to
stockholders, contain forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange
Act of 1934. Terminology such as "may," "will," "intend," "expect," "plan,"
"anticipate," "estimate," "believe," "continue," "predict," or other similar
words identify forward-looking statements. These statements discuss future
expectations, contain projections of results of operations or of financial
condition or state other forward-looking information. Forward-looking statements
appear in a number of places in this Form 10-K and include statements regarding
management's intent, belief or current expectation about, among other things,
the following: our anticipated growth strategies, including trends in revenues,
costs, gross margins and profitability; our intention to develop, market and
introduce new products; anticipated growth of digital appliances and technology
industries; anticipated trends in our businesses, including trends in the demand
for personal storage and digital appliances and, therefore, demand for our
products; expectations of consumer preferences and desires; future projections
of our financial performance, future expenditures for capital projects and
research and development; the emergence of certain competing technologies;
potential uses for and applications of our products; and our ability to continue
to control costs and maintain quality. Although our management believes that the
expectations reflected in these forward-looking statements are based on
reasonable assumptions, forward-looking statements are not guarantees of future
performance and involve risks and uncertainties that could cause actual results
to differ materially from those in such forward-looking statements. Readers are
cautioned not to place undue reliance on the forward-looking statements included
in this document, which are based on information available to us on the date
hereof. We make no commitment to update or revise any such forward-looking
statements or to disclose any facts, events, or circumstances after the date
hereof that may affect the accuracy of any forward-looking statement. Actual
results may differ materially from those predicted in the forward-looking
statements as a result of various factors, including those set forth below in
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operation--Factors That May Affect Future Results of Operations" and in other
documents that we file from time to time with the Securities and Exchange
Commission, including our Quarterly Reports on Form 10-Q to be filed in 2001.
All trade names referenced in this report are either trademarks or
registered trademarks of their respective holders.
PART I
Item 1. Business
Overview
We design, develop, manufacture and market technologies and products
that enable consumers and businesses to create, manage and use various types of
digital content in easy and enjoyable ways. With the growth of digital
appliances, such as digital still cameras, digital video cameras, digital audio
players, digital voice recorders and personal digital assistants, consumers are
increasingly using the personal computer, or PC, as the "multimedia center" of
the home or
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office. These digital appliances capture digital data on high capacity, reusable
flash memory cards that appeal to consumers because of their small size,
versatility and portability. Our digital connectivity products enable the easy
and convenient sharing of the information on the cards between the digital
appliance, PCs and the Internet. Our personal storage systems and related
software are designed to provide an easy way to store, organize and retrieve
this digital data on portable, high-speed, high-capacity disk drives. Our
innovative software is planned to offer consumers the capacity to create
multimedia DVDs and CDs that combine their digital pictures, videos and music
and then share them with or without using a PC.
Our digital connectivity products are designed to work across all
popular PC platforms, support all leading flash memory media types and use high
performance PC interfaces, such as Universal Serial Bus, or USB. Our patented
FlashPath digital connectivity products allow consumers to use the familiar
3.5-inch floppy drive - found on most PCs worldwide - to simplify the exchange
of images and other digital data between PCs and digital appliances. We market
three FlashPath products, one for each of three different flash memory cards:
SanDisk's MultiMediaCard, Sony's Memory Stick and Toshiba's SmartMedia card.
These flash memory cards are used in various digital appliances including
digital still cameras and digital video cameras made by a number of leading
camera manufacturers, including FujiFilm, JVC, Olympus, Panasonic, Sanyo, Sharp,
Sony and Toshiba. In the second half of 2000, we launched our high-speed USB
Flash Media Reader, a dual-slot flash memory reader, for both CompactFlash and
SmartMedia cards. In early 2000, we introduced our USB Tri-Media Reader, which
reads and writes to CompactFlash and SmartMedia cards, as well as rotational
media, such as a 1.44 Megabyte floppy disk. These readers address an expanding
installed base of PCs with USB cable interfaces and are compatible with both
Windows and Macintosh operating systems. We believe that as consumers embrace
the digital lifestyle, the number of applications for flash memory cards will
continue to grow.
Our USB- and FireWire-based personal storage systems include high
performance, portable hard disk drives and floppy disk drives for desktop and
notebook PCs, as well as expansion bay disk drives for notebooks. Substantially
all of our personal storage systems are compatible with Windows and Macintosh
operating systems. We believe that the significant increase in data intensive
digital content, such as imaging, music and video has created the need for
increased digital personal storage. Our personal storage systems and related
software enhance the user's ability to store, organize and retrieve digital
content. These systems support very high data transfer rates and offer up to 120
Gigabytes of capacity.
Since 1992, we have worked with Apple as an Apple preferred partner and
developer. Through this relationship, Apple has provided us access to product
road maps that have allowed us to focus on new opportunities in the development
and engineering of many FireWire and USB systems. Through our strategic
relationship with Iomega, we build Iomega Zip drive products for Apple. We were
one of the first companies to ship FireWire personal storage systems for both
Macintosh and Windows operating systems, as well as FireWire Zip drives. In the
third quarter of 2000, we introduced our 120 Gigabyte portable FireWire
Redundant Array of Independent Disks, or RAID, product.
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As digital applications and appliances proliferate, users are demanding
software that will allow them to collect digital images and audio files from a
variety of sources, create media shows via the PC, and then display them
anywhere, using a PC, DVD or CD. SmartDisk software, including our new MVP suite
of software solutions, is planned to enable consumers and businesses to create,
organize and use digital multimedia both with and away from the PC.
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Our executive offices are located at 3506 Mercantile Avenue, Naples,
Florida 34104, and our telephone number is (941) 436-2500. Our home page can be
located on the World Wide Web at http://www.smartdisk.com. The contents of our
website are not part of this Annual Report on Form 10-K.
Acquisitions
Acquisition of VST Technologies, Inc. On March 6, 2000, we completed
our acquisition of VST Technologies, Inc., or VST, a Delaware corporation whose
predecessor was incorporated in 1993. VST, located in Acton, Massachusetts,
designs, develops, manufactures and markets FireWire and USB-based high
performance personal storage systems and flash memory readers for Windows and
Macintosh operating systems. Our acquisition of VST has expanded our existing
product lines to include advanced FireWire and USB technologies and,
additionally, has expanded our access to the rapidly growing digital video and
digital music markets. VST's product line includes portable FireWire hard
drives, desktop FireWire hard drives, expansion bay devices, including a CD-R/W
drive and Zip 100 and Zip 250 drives for Apple notebooks, USB floppy disk
drives and a 120 Gigabyte portable FireWire RAID product.
We acquired VST for approximately $16.4 million in cash, approximately
1.1 million shares of our common stock and options to acquire approximately
443,000 shares of our common stock with exercise prices ranging from $0.90 to
$4.45.
Acquisition of El Gato Software LLC. On April 21, 2000, we completed
our acquisition of substantially all of the intellectual property of El Gato
Software LLC, or El Gato. El Gato, a California limited liability company, is
located near San Jose, California. El Gato develops and markets USB and FireWire
drivers, applications and firmware support for leading personal storage systems,
including SmartMedia, CompactFlash, hard drives, Zip drives, floppy drives and
optical drives. We use El Gato's drivers in our FireWire hard drives, FireWire
Zip drives and USB-based products, including our Flash Media and Tri-Media
Readers. We acquired substantially all of the intellectual property of El Gato
for approximately $755,000 in cash and approximately 37,000 shares of our common
stock. We also retained the services of El Gato's staff of five software
developers under two-year consulting agreements.
Acquisition of Impleo Limited. On April 28, 2000, we completed our
acquisition of Impleo Limited, or Impleo. Impleo, a corporation established
under the laws of the United Kingdom in November 1999, is based in England.
Impleo manufactures and markets digital connectivity products and personal
storage systems under the Datawise brand. We are using Impleo as our primary
European distributor. We acquired all of the capital stock of Impleo for
approximately $200,000 in cash and 125,000 shares of our common stock.
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Acquisition of Multimedia Technology Center. On January 24, 2001, we
completed our acquisition of the intellectual property of Multimedia Technology
Center, or MTC, including its DVDMotion suite of software products, for
approximately $250,000 in cash. MTC is a leading provider of optical disc
authoring systems. As part of the transaction, MTC's Chief Technology Officer
joined SmartDisk as Chief Software Architect.
Industry Overview
Consumer lifestyles are being transformed by the increasing use of
digital information in the home and workplace. Individuals increasingly rely
upon PCs, computer networks and the Internet to access digital information for
entertainment and productivity purposes. The proliferation of PCs in both the
home and office, as well as the growth of Internet use, has led to widespread
consumer familiarity with the storage, manipulation, transfer and management of
digital data. In addition, the convergence of advanced consumer electronic
products, PCs and the Internet offers consumers the opportunity to personalize,
exchange, store and manage digital data generated from a wide range of sources.
This convergence has precipitated greater demand for connectivity, data storage
and management, and user-friendly content management and CD and DVD creation
software.
In recent years, digital computing and processing have expanded beyond
the boundaries of desktop computer systems to include a broader array of
sophisticated consumer electronic products. These products, often referred to as
digital appliances, include digital still cameras, digital video cameras,
digital voice recorders, digital audio players, electronic photo albums and
personal digital assistants. We believe that approximately 55 million of these
types of digital appliances were shipped in 2000, and we believe that this
number will grow to approximately 90 million in 2001 and more than 120 million
in 2002. One of the most popular digital appliances today is the digital camera.
Approximately 11 million digital cameras were shipped worldwide in 2000, and we
believe that this number will grow to approximately 18 million in 2001 and 28
million in 2002.
A major challenge created by the digitization of audio and video is the
increasing need for portable mass storage devices for the PC and high
performance interfaces, such as USB and FireWire, to connect these storage
devices to the PC. MP3 and other compression methods, voice recognition
software, video movies, video conferencing, the Internet, digital video cameras
and digital still camera images have all driven the digitization of audio and
video.
As a result of their high performance capabilities, USB and FireWire
interfaces are quickly beginning to be installed on new desktop and notebook
PCs. For example, all new PCs feature USB ports. In addition, FireWire ports
have recently started to appear on PCs from Compaq, Dell, Fujitsu, Gateway, IBM
and Sony and appear on all of Apple's desktop and notebook computers.
USB is a high performance PC interface technology that is replacing low
to medium speed CPU interfaces such as serial ports, which are generally used
for mice, keyboards, floppy disk drives and tablets. FireWire is Apple's trade
name for Institute of Electrical and Electronics Engineering, or IEEE, 1394, a
high speed PC interface that is replacing Small Computer System
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Interface, or SCSI, and parallel interfaces, which are generally used for
digital appliances, hard disk drives and Zip drives. Other manufacturers may
adopt the IEEE 1394 standard under their own trade names, such as Sony's iLink.
Sony and Apple are currently licensing these trade names at no charge. Both USB
and FireWire can support new digital appliance hot-plug and plug-n-play
connections so that storage devices can be connected and disconnected without
shutting down or restarting the PC. USB and FireWire can also accommodate
multiple devices connected to the PC and may be powered directly from the USB or
FireWire cable, eliminating the need for external power adapters.
One of the principal challenges to connectivity between digital
appliances and PCs is the variety of non-standardized flash memory cards
available in the market today. Flash memory cards are the miniature devices used
by many of the emerging digital appliances to store digital data. There are
currently five major removable flash memory cards, none of which has emerged as
an industry standard and none of which is compatible or operable with any of the
others:
/bullet/ the Toshiba SmartMedia card;
/bullet/ the SanDisk CompactFlash card;
/bullet/ the SanDisk MultiMediaCard;
/bullet/ the Sony Memory Stick; and
/bullet/ the SanDisk, Toshiba and Matsushita Secure Digital (SD) Card.
A second major challenge to connectivity between digital appliances and
PCs is the current lack of convenient connection methods. While consumers' use
of digital appliances is increasing, the inherent difficulty of connecting
digital appliances to PCs due to non-conforming interfaces continues to be a
major barrier to widespread acceptance. As a result, we believe that the
continued growth of the consumer-oriented digital appliance market will depend
in large part upon the ability of users to conveniently transfer stored digital
data that is captured by digital appliances. Therefore, one of the principal
challenges faced by manufacturers of consumer digital appliances is the
interface between their appliances and PCs or other digital appliances.
There are currently a number of interfaces used to transfer data from
digital appliances to personal computers:
/bullet/ Cable interfaces that connect to serial ports, parallel ports,
USB and FireWire; and
/bullet/ Non-cable interfaces such as infrared interfaces, Personal
Computer Memory Card International Association, or PCMCIA, and
floppy disk drive slots.
We believe that serial port and parallel port interfaces have
disadvantages that make them less desirable for use with consumer-oriented
digital appliances. Those interfaces require the use of cumbersome cables and
limited PC peripheral ports, which are frequently dedicated to
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connecting the PC to devices such as printers, scanners, modems and other
peripherals. In addition, direct digital appliance-to-PC connections via serial
or parallel port consume the appliances' battery power and render the appliances
unusable while data is being transferred.
While USB and FireWire solutions utilize direct cable connection, they
do not have the same limitations of serial or parallel port interfaces. In
general, USB and FireWire have the ability to provide a direct source of power
to the digital appliance and therefore do not drain the appliance's batteries.
Moreover, USB and FireWire interfaces allow much faster data transfer rates than
their traditional serial or parallel port alternatives, can accommodate numerous
serial devices and offer hot-plug and plug-n-play connections so that storage
devices can be connected and disconnected without shutting down or restarting
the PC. In addition, while many of the current installed base of desktop PCs
worldwide are not equipped with USB or FireWire ports, most new computers are
shipped with USB or FireWire support. Similarly, some of the non-cable
interfaces have inherent limitations. For example, while virtually all portable
PCs being sold today contain a PCMCIA slot or infrared interface as a
standardized feature, we believe that neither the PCMCIA slot nor the infrared
interface is generally available on desktop computers.
The SmartDisk Solution
Our digital connectivity and personal storage products include our
FlashPath flash memory card readers, USB flash media readers, FireWire and USB
external portable hard disk drives, USB floppy disk drives as well as expansion
bay devices for Apple notebook computers. These products are generally available
for both Windows and Macintosh operating systems, allowing the original
equipment manufacturers, or OEMs, that market our consumer products to reach a
large installed base of potential users. We also offer DVD and CD creation
software, which is compatible with Windows. Our current and planned digital
connectivity products, personal storage systems and software innovations are
designed to offer the following principal benefits:
Ease of Use. Our products are easy to use and install. FlashPath
transfers digital data to the PC through the familiar and ubiquitous 3.5-inch
floppy disk drive. This widely recognized format reduces consumer intimidation
frequently created by new technologies, facilitating the adoption of our
FlashPath products and various consumer-oriented digital appliances. A consumer
using a digital camera removes the flash memory card that serves as the camera's
digital film, places that flash memory card into our FlashPath product, and then
inserts the FlashPath into the PC's 3.5-inch floppy disk drive. While the flash
memory card stores the digital images captured by the digital camera, FlashPath
easily transfers the digital images from the flash memory card to the PC. Our
personal storage systems address the needs of today's consumers: portability,
user friendliness, reliability and seamless integration with the computer's
operating system, or plug-n-play. Our personal storage systems also offer our
proprietary product-specific software that enhances the user's experience,
further differentiating our products from our competitors'. Our software
products are planned to allow consumers to create multimedia DVDs and CDs that
combine their digital pictures, videos and music and then share them with or
without using a PC.
Products Compatible with Multiple Media. We believe that our
established ability to design products that support competing flash memory cards
is critical because of the lack of
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flash memory industry standards. Our FlashPath product is designed to transfer
digital data and images from the Toshiba SmartMedia card, the Sony Memory Stick
and the SanDisk MultiMediaCard to a standard 3.5-inch floppy disk drive. Our
USB-based flash media readers also support the SanDisk CompactFlash card and the
Toshiba SmartMedia card. Our ability to design products compatible with multiple
media is enhanced by our strategic relationships with the three leading
manufacturers of flash memory storage cards--SanDisk, Sony and Toshiba. By
supporting various media, we are able to address the data transfer needs of
purchasers of existing and emerging digital appliances that use different flash
memory cards. Our personal storage systems also support most leading rotational
storage media, including hard disk drives, floppy disk drives, Iomega Zip drives
and Imation SuperDisk drives. They can also store high quality digital still
images and video movies and digital music due to their ability to support very
high data transfer rates and capacity. Our software products are planned to
support an extensive array of technical standards for audio, data, enhanced
music and video CD or DVD.
Versatile. Our products can be used with a variety of PC hardware
platforms and software environments. Our driver software is included with our
products and can also be downloaded free of charge from the Internet. The
software enables our products to operate with Windows and Macintosh operating
systems. The versatility of our products will become more important as consumers
increasingly rely on flash memory cards to store and transfer digital data. Our
personal storage systems are also generally compatible with both Windows and
Macintosh operating systems.
Independent Power Source. Unlike serial and parallel port cables, our
flash memory and smart card reader products do not rely upon a digital
appliance's power source to transfer digital data from a flash memory card to a
PC. For example, our FlashPath products run on two replaceable batteries and our
USB-based flash media readers use the PC's power source. Our FireWire-based
personal storage systems also utilize the PC's power source rather than the
appliance's power supply. This is important because digital appliances, such as
digital cameras, consume significant amounts of power and require frequent
battery replacement or recharging. Products that use serial or parallel cable
interfaces quickly drain power from digital appliances, making those competing
products less attractive.
Quality. We believe that we have a reputation in the industry for
producing high quality products. We invest substantial resources in our product
development and test efforts to assure that our products work reliably across a
broad range of configurations.
Business Strategy
Our strategy is to use our patented and distinctive technologies to:
/bullet/ Establish our digital connectivity products as market leading
solutions to transfer data among digital appliances, PCs and
the Internet by strengthening our position as a technological
leader;
/bullet/ Bring our personal storage systems quickly to market with
industry leading solutions that emphasize ease of use and
portability;
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/bullet/ Introduce innovative software for the creation of multimedia
DVDs and CDs that combine digital pictures, videos and music
and that may be played with or without a PC; and
/bullet/ Capitalize on the growth of the PC as the "multimedia center"
of the home or office.
Key elements of this business strategy are to:
Capitalize on Technology Expertise to Expand Our Product Offerings. We
have developed extensive expertise, intellectual property and core capabilities
in digital connectivity, personal storage systems and software technologies. We
intend to capitalize on our technology base, partnerships and patents to design,
develop and market a broad range of digital connectivity and personal storage
systems that can operate across a variety of flash memory products, hardware
platforms and software environments. In addition, we are using our technology
expertise, patents and trade secrets to develop or license application-specific,
non-PC based devices that will permit flash memory cards to be used with other
existing technologies.
Expand Customer and Strategic Industry Relationships. We have formed
strategic relationships with a number of leading consumer product OEMs and other
key industry participants, including Apple, FujiFilm, Hitachi, IBM, JVC, NEC,
Olympus, Panasonic, SanDisk, Sony and Toshiba. We intend to continue to develop
long-term alliances with a diversified base of OEMs and other industry
participants in additional consumer electronics segments. We believe that these
relationships provide significant operating leverage and a number of other
important benefits:
/bullet/ Many of our OEM customers advertise, promote, package, sell
and distribute our products under some of the world's most
recognized brand names. OEM customers that perform some of or
all of these activities include Apple, FujiFilm, Hitachi, JVC,
Olympus, SanDisk, Sony and Toshiba. As a result, we have
access to extraordinary market strength without the need to
invest heavily in our own marketing programs and distribution
infrastructure.
/bullet/ Our product development relationships have provided access to
flash memory card and PC manufacturers early in the design
phase of their product development process. This has allowed
us to anticipate these manufacturers' future technological
requirements and to develop long-term relationships across a
number of products and through multiple product generations.
In addition, these partners have assisted with engineering and
design for manufacturability, which helps ensure that
mechanical and electrical considerations are integrated into a
total systems approach to achieve a high quality and
cost-effective product.
Maintain Media, Interface and Platform Neutrality. We are using our
flexible technology architecture and core capabilities to create connectivity
and personal storage products that enable consumers to use all leading flash
memory cards and rotational media. There is a rapidly growing number of digital
appliances that use competing flash memory technologies, none of
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which we currently expect to become an industry standard. We are committed to
maintaining media neutrality to enable users of various leading flash memory
technologies to transfer data quickly and easily among devices that use
different flash memory card formats, as well as to support all of the leading
rotational media with our personal storage systems, including hard disk drives,
floppy disk drives, Iomega Zip drives and Imation SuperDisk drives.
Promote Brand Awareness of Our Products. It is critical that we obtain
ultimate consumer acceptance of and demand for our products independent of sales
that occur in conjunction with sales of our OEMs' products. To this end, we
intend to promote the SmartDisk name wherever possible. We are able to benefit
from the powerful advertising and promotion of our products by the OEMs while
simultaneously building our brand identity. In addition, we intend to expand our
use of advertising and other marketing programs designed to promote our brands
and enhance brand awareness. We also intend to broaden our distribution into
more traditional consumer electronic and mass retail channels while continuing
to strengthen our Internet presence.
Emphasize User-Friendly Products. We are committed to capitalizing on
our patent portfolio of user-friendly digital connectivity products and personal
storage systems. These systems offer seamless integration with the PC's
operating system to enable consumers to conveniently transfer and store images,
music, voice and other types of digital data among consumer electronic devices,
the Internet and PCs, including portable personal storage systems. Our software
products are being developed using a familiar, easy-to-use format that allows
the user to easily manage content and create DVDs and CDs.
Capitalize on First-to-Market Advantages. Our focus is on technologies
and market segments where we can maximize the first-to-market advantages
provided by our technical expertise to provide various digital connectivity,
personal storage and software solutions to the needs presented by the
proliferation of digital appliances. Our products are developed using a building
block approach which leverages previously developed technologies. This ability
to modify and extend our existing base of technologies to yield new product
offerings, allows us to rapidly respond to industry developments, provides
first-to-market advantages and reduces development costs for future products. To
augment the time-to-market advantages provided by our building block approach,
we also draw on the substantial capabilities of an extensive list of development
partners including major OEMs, key component suppliers, manufacturers and firms
that specialize in rapid prototyping. We intend to use these first-to-market
advantages to lengthen our product life cycles and increase our market share.
Our internal processes and external relationships are tightly integrated, and
are designed to enable us to rapidly develop products from design stage to
commercial launch.
Products
Our products are designed to easily transfer digital data among digital
appliances, PCs and the Internet, to store and manage that digital data and to
create multimedia DVDs and CDs.
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Digital Connectivity Products
FlashPath Products. FlashPath is a solid-state electronic device in the
shape of a 3.5-inch floppy diskette. It works in any standard 3.5-inch floppy
drive found in most PCs. The current principal use of FlashPath is to transfer
images from digital cameras using the SmartMedia, MultiMediaCard and Memory
Stick flash memory cards to PCs. Digital cameras use flash memory cards as film.
After the flash memory card captures and stores images, the flash memory card is
removed from the camera, placed into FlashPath, inserted into the PC's floppy
disk drive and the images are transferred to the PC. The consumer may then edit
the images, add text, graphics or sound or mail the images over the Internet.
Because FlashPath transfers images from the camera to the PC without using
cables or PC peripheral ports and without any hardware installation, the
consumer has a device that is familiar, easy to use, not intimidating and
transportable among multiple PCs. FlashPath uses our proprietary driver software
provided with our products and available free of charge from the Internet. Our
driver software enables our products to operate with Windows and Macintosh
operating systems.
USB-Based Digital Connectivity Products. Our USB Dual Media Reader
reads and writes to SmartMedia and CompactFlash. Our USB Tri-Media Reader reads
and writes to SmartMedia, CompactFlash and 3.5-inch floppy disks. These
products, which are USB cable powered, are compatible with both Windows and
Macintosh operating systems.
Personal Storage Systems
Expansion Bay Storage Devices. We provide many personal storage systems
for the expansion bays of the Apple PowerBook line, including the 100 Megabyte
and 250 Megabyte Iomega Zip drives, the Imation SuperDisk drive, a DVD-ROM
drive, a CD-R/W drive and additional hard drive storage.
USB-Based Products. We offer portable USB hard drives and floppy disk
drives that are compatible with both Windows and Macintosh operating systems.
They operate seamlessly with the PC's operating system, offering hot-plug and
plug-n-play connections so that storage devices can be connected and
disconnected without shutting down or restarting the PC. Our portable external
USB floppy disk drive is one of the highest volume products for all Macintosh
computers in the United States. In addition, our USB floppy disk drive provides
floppy disk capability for Macintosh users since Apple no longer includes floppy
disk drives in its PCs. Our USB floppy disk drive is very compact and
lightweight, and requires no external power supply.
FireWire-Based Products. We offer FireWire hard drives, CD-R/W drives
and Zip drives. Our line of ultra-slim FireWire hard drives provides the fastest
data transfer rates of any portable storage device. We believe that these drives
have great appeal to the mobile user of digital video cameras and digital music.
We also market a line of full-height FireWire hard drives in various capacities
and a 250 Megabyte Iomega FireWire Zip drive. Our 120 Gigabyte FireWire RAID
array offers even higher storage capacity than standard large hard disk drives.
It also offers data transfer rates fast enough to capture and store live digital
video. Our FireWire cardbus card allows users to plug these devices into
notebooks that do not yet have FireWire ports. Substantially all of these
products are compatible with both Windows and Macintosh operating systems. Our
FireWire hard drives combine portability, modularity and FireWire connectivity
to offer high performance, mobile storage solutions. Reflecting our expertise in
the notebook
12
market, our ultra-slim FireWire hard drives are compact and truly "portable"
with the smallest measuring only 3" x 5.5" x 0.7" and weighing as little as 6.5
ounces. The full-height FireWire drives address the demand for larger capacities
for a variety of digital video, audio and multimedia applications. Our FireWire
hard drives offer not only hot-plug and plug-n-play functionality, but also
offer data transfer rates fast enough for digital video recording and playback.
When our FireWire hard drive is connected to the computer with a single FireWire
cable, the drive interacts with the computer's operating system, automatically
configures itself and mounts to the desktop. This allows the user to easily
transport our FireWire hard drive from the "home office" to the "work office"
with all operating systems, applications, and document files intact.
Software
The quantity of digital content distributed over the Internet to the PC
is rapidly increasing, driven by high-speed Internet connections, the increasing
number of web sites focused on electronic content distribution and the
proliferation of digital consumer electronics. We expect this trend will
increase the need for products that allow users to organize, manage and create
multimedia slide shows. Consumers are increasingly using recordable CDs as a
medium for digital content because of their capacity, low cost, portability and
compatibility with a large installed base of play back devices. SmartDisk's new
DVD and CD creation software, SmartDisk MVP will allow consumers to create
multimedia DVDs and CDs that combine their digital pictures, videos and music.
The creations can be played back using a PC or with a CD or television.
Featuring a familiar entertainment center interface, SmartDisk MVP facilitates
ease of use in managing and organizing digital content. The software will also
allow users to print digital photographs singly or as an album in various sizes.
Digital picture album covers may be customized with any digital image or video
frame from a collection.
Other
We also offer a line of power management products such as power
adapters, smart-chargers and long-life, lithium-ion batteries for the Macintosh
PowerBook series.
Technology
Since our inception, we have focused our research and development
efforts in the area of digital connectivity, designing and developing products
that facilitate the transfer of data from digital appliances using flash memory
cards to PCs. We have been actively involved in all aspects of this development
process, including the development of a proprietary technology architecture that
supports all of our current FlashPath products and can be used as the basis for
new products. We believe that our patents provide substantial proprietary
protection relating to the transfer of digital data through floppy disk
interfaces. We also believe that we have developed particular expertise in
driver technologies, product design and product development of USB-based and
FireWire-based personal storage systems. We have extended our expertise to
include DVD and CD creation software that will allow users to create multimedia
DVDs and CDs that combine digital pictures, videos and music and that may be
played with or without a PC.
13
Another element of our business strategy is to enter into strategic
alliances without licensing our proprietary digital connectivity technology to
OEMs. Our strategic alliances with Hitachi, NEC, SanDisk, Sony and Toshiba began
with their initial inquiries to license our FlashPath technology. We believe
that the broad scope of our strategic alliances with these leading industry
participants demonstrates the appeal and strength of our proprietary technology.
Many of these alliances have led to equity investments and cooperative
development arrangements.
Digital Connectivity. Our digital connectivity products are compatible
with a broad range of hardware platforms and software environments. Our floppy
disk drive interface architecture builds upon key elements of our technology,
including digital and analog application specific integrated circuits (ASICs),
driver software and key mechanical components, and allows us to develop products
that support different flash memory cards. In addition, we believe that this
architecture improves reliability, decreases time to market and lowers new
product development costs. We are also utilizing our core technological
capabilities to develop products that conveniently transfer digital data from
competing flash memory cards to existing, non-PC technologies, as well as
products that support computer interfaces other than the 3.5-inch floppy disk
drive.
The technology in our digital connectivity product offerings consists
of five key components:
/bullet/ Flash Memory Read/Write System. This proprietary system uses
the central processing logic to store data on and retrieve
data from the flash memory card in the product.
/bullet/ Digital ASIC. Our proprietary digital ASIC prepares the
digital data to be retrieved from the flash memory, encodes it
and sends it to the analog ASIC. The digital ASIC also decodes
data from the analog ASIC for use with the flash memory
read/write system.
/bullet/ Analog ASIC. Our proprietary analog ASIC converts the digital
data to analog signals for retrieval from the flash memory
card.
/bullet/ Central Processing Unit. This unit consists of an industry
standard microprocessor, memory and other processing logic to
control the functions of the digital and analog ASICs and the
flash memory read/write system.
/bullet/ Driver Software. Our proprietary driver software enables our
products to operate with a variety of commonly installed PC
operating systems such as Windows and Macintosh.
Personal Storage Systems. Our personal storage systems are compatible
with a broad range of hardware platforms and software environments, as well as
with both Windows and Macintosh operating systems. Our Macintosh-compatible hard
drives also include key features,
14
such as encryption, password protection, boot capability and partitioning
features. Most of our personal storage systems are FireWire-based.
The technology comprised in our FireWire personal storage product
offerings consists of five components:
/bullet/ FireWire-based power sourcing. An embedded, integrated and
wide range power supply allows our FireWire drives to run from
FireWire bus power, so no external power supply is required.
/bullet/ Digital bridge ASIC. This device is an ASIC bridge that allows
high performance transmission of digital data from the disk
drive to the FireWire cable. We currently license this
technology and the firmware from LSI Logic.
/bullet/ FireWire drivers. We design and own separate and integrated
drivers for all of our FireWire products. These drivers
provide a high level of integration to the operating system
and, we believe, allow more flexibility and features than
those found on competitive products.
/bullet/ FireWire applications. We offer a fully integrated FireWire
formatting, benchmarking and updating application for FireWire
products. This application provides performance improvements,
data security and protection.
/bullet/ Integrated RAID family of products. Our FireWire storage
systems can be embedded into a RAID array system. This
hardware and software solution allows individual FireWire
drives to be used together to achieve higher data
transmission, or striping, and for data protection, or
mirroring.
Development Efforts. During 2000, our development efforts included the
following:
/bullet/ Expanding our FlashPath product line to support the SD flash
memory card and new operating systems, such as Millennium and
Linux;
/bullet/ Introducing USB flash media readers;
/bullet/ Expanding our FireWire product line to support the FireWire
RAID array and software;
/bullet/ Introducing our CD-R/W products;
/bullet/ Introducing FireWire and USB combo slim line hard drives for
both Macintosh and Windows platforms;
/bullet/ Further reducing our product costs;
/bullet/ Enhancing product performance; and
15
/bullet/ Developing media management software.
Marketing, Customers and Strategic Relationships
Sales and Marketing. We market and sell our products primarily through
a combination of OEMs, distributors and resellers. We sell our current flash
memory products to OEMs, including FujiFilm, JVC, Olympus, Panasonic, SanDisk,
Sony and Toshiba. These OEMs compete in some of the fastest growing segments of
the electronics industry, including digital still cameras, digital video cameras
and digital audio players. The marketing of our FlashPath product with
FujiFilm's, Olympus' and Sony's digital cameras illustrates the cooperative
relationships we have with some of our customers. Their marketing campaigns have
emphasized the convenience of using the FlashPath product to transfer digital
photographs to the PC.
Often, both the OEM's brand name and our FlashPath trade name appear on
the product packaging. As a result, we benefit from the powerful advertising and
promotion of our products by the OEMs without having to incur significant
additional marketing expenses. For example, our products have been featured in
OEM advertisements in major publications, including The Wall Street Journal,
Time Magazine and USA Today.
We market and sell most of our personal storage systems through
distributors and resellers. Ingram Micro and Tech Data handle our distribution
to the vast majority of our U.S. resellers. We also sell our personal storage
systems to major catalog and mail order houses, as well as directly to end users
through our website and various retailers. In addition, we sell our personal
storage system products to Apple, which, in turn, distributes them on a
consignment basis to their customers. Most of these sales are made through the
Apple Web Store, where our products may be configured and ordered along with a
Macintosh computer. We are pursuing broader markets for our personal storage
products through our European and Japanese operations.
We support the marketing activities of our customers with a dedicated
product manager for each of our principal product lines. In addition, we support
their sales efforts through sales training courses, public relations activities,
trade shows and industry education programs. We also employ marketing
communications personnel to develop packaging, brochures and other collateral
materials.
In addition to catalogs, we promote our products through print and Web
advertising. Some of the OEMs with whom we have developed or manufactured
products prohibit us from marketing those products outside of their own
marketing programs. We have also been featured in many ads and technical
write-ups in the press and magazines.
Strategic Relationships. An important element of our business strategy
is to develop strategic relationships with industry participants that can assist
us in the development of new products, provide us with access to leading-edge
manufacturing capabilities and market and distribute our products globally. This
approach allows us to concentrate our resources on our core expertise of product
design and development, reduces our capital requirements and generally provides
a high degree of operating leverage. We evaluate potential collaborative
16
arrangements on an ongoing basis and intend to continue to pursue additional
strategic relationships.
Set forth below are brief descriptions of some of our strategic
relationships:
Apple Computer. Apple has led the industry in forging transitions to
new interface technologies, such as USB, FireWire and Airport, or IEEE 802.11.
Since 1992, we have worked with Apple as an Apple developer. Through this
relationship, Apple has provided us access to selected product road maps, which
has allowed us to focus on new opportunities in the development and engineering
of many FireWire and USB systems.
Iomega Corporation. Through a strategic relationship with Iomega, we
build Iomega Zip drive products for Apple. Iomega designs, manufactures and
markets disk drives that can be purchased as aftermarket products to be added to
PCs and other electronic devices or as a built-in feature incorporated in PCs.
Our FireWire Zip drives enjoy the same Windows and Macintosh operating system
compatibility, ease of use and plug-n-play performance users expect from all of
our integrated FireWire products. We own portions of the source code required
for the operation of the Zip drive on the Macintosh operating system. Through a
cross-licensing agreement with Iomega, we have the exclusive right to produce
Zip drives for the PowerBook series of Macintosh computers.
SanDisk. We also have a co-development agreement with SanDisk, a
leading developer and marketer of flash memory storage products, including
CompactFlash, MultiMediaCard and the SD Card. Under this arrangement, we jointly
developed a FlashPath product to support the SanDisk MultiMediaCard. We funded
the development costs and are entitled to revenues derived from the sale of our
FlashPath for the MultiMediaCard. We pay SanDisk a royalty based on the portion
of those revenues derived from sales other than to SanDisk.
Sony. Under our co-development agreements with Sony, we have developed
FlashPath products for use with the Sony Memory Stick. Sony reimburses us for a
portion of our development expenses and pays us additional fees during the
course of development. We are manufacturing, and Sony is marketing and
distributing, these co-developed products.
Toshiba. Toshiba Corporation, a leading electronics company, played a
critical role in our early development stage. Toshiba made an equity investment
of approximately $10.0 million in SmartDisk and introduced us to most of the key
technical personnel that now constitute our Tokyo-based applied engineering and
production engineering team. Toshiba also assisted us in the development and
engineering of FlashPath, helped guide our selection of manufacturing
techniques, aided our introduction into mass production and introduced our
management to potential strategic partners. Toshiba continues to provide
cooperative support in several areas.
Research and Development
Our product research, design and development activities are conducted
in our offices in Naples, Florida; Alpharetta, Georgia; Acton, Massachusetts;
and Tokyo, Japan. Our research and
17
development teams at all locations regularly collaborate and share data and
research protocols in order to maximize innovation and development.
Naples. Our Naples team is primarily responsible for our core research
and development activities, including product conceptualization, software and
firmware development, technical writing, printed circuit board layouts and
mechanical engineering. Our Naples team has significant expertise with floppy
disk drive interfaces, flash memory media interfaces, driver, user and utility
software interfaces, firmware design, ASIC design and CD and DVD authoring. Our
engineers and other research and development employees also develop design
specifications based on customer requirements and supervise our quality
assurance activities. This team consists of executive management, line
management, engineers, developers and quality assurance personnel.
Acton. Our Acton research and development team designs and develops
FireWire, USB, notebook expansion bay and power products for Macintosh and
Windows-based systems. This team has primary responsibility for Macintosh
software integration, FireWire ASIC integration and ultra-compact industrial
product design, prototyping and tooling design functions.
Alpharetta. Our Alpharetta team focuses their research and development
activities on product conceptualization relative to audio and video digital
appliance hardware and software.
Tokyo. Our Tokyo research and development team actively assists in the
implementation of our product designs, with primary responsibility for applied
engineering, production engineering and the supervision of our contract
manufacturers. Our Tokyo team also plays a principal role in coordinating our
development activities with the leading flash memory card manufacturers and
refining the product requirements of our OEM customers. Other activities include
the localization/translation of our products for the Japanese market and quality
assurance.
In addition, we contract a team of developers in Los Gatos, California,
that designs and develops USB and FireWire drivers, applications and firmware
support for our personal storage systems and connectivity products for the
Macintosh platform.
We have endeavored to develop and maintain close relationships with key
suppliers of components and technologies in order to enable us to quickly
introduce new products that incorporate the latest technological advances. As a
result, the substantial resources of companies such as Apple, Hitachi, Iomega,
LSI Logic, Mitsumi, NEC, Rohm, SanDisk, Sony, Toshiba and Yamaichi augment our
internal research and development efforts.
Manufacturing and Sources of Supply
We currently outsource our manufacturing and plan to continue to
outsource manufacturing for the foreseeable future. This strategy allows us to
focus on our core research, product design and development capabilities and to
reduce the substantial capital investment required to manufacture our products.
We believe that our use of experienced, high-volume manufacturers provides
greater manufacturing specialization and expertise, higher levels of
18
flexibility and responsiveness and faster delivery of product than in-house
manufacturing. In addition, we frequently seek the advice of our experienced
manufacturers with respect to design changes that reduce manufacturing costs or
lead times or increase the manufacturing yields and the quality of our finished
products.
Our digital connectivity products are currently manufactured in the
Philippines and Japan at facilities operated by Yamaichi and Mitsumi. We
currently outsource all of our personal storage system manufacturing to contract
manufacturers located in Massachusetts, yet we maintain multiple global sourcing
capabilities for circuit board assemblies. We design and own substantially all
of our personal storage system tooling. Our personal storage system products are
distributed from fulfillment centers, which are located in or near
Massachusetts. Under our manufacturing arrangements, we receive fully assembled
and tested products based upon our proprietary designs and specifications. We
selected our manufacturers based upon their reputations for quality, their cost
structures, their production capacities and their support of state-of-the-art
manufacturing processes and systems. We continually seek additional
manufacturing capacity and, in particular, at least two manufacturers for each
of our products.
To ensure that our products manufactured by others meet our standards,
our production engineers generally work with our contract manufacturers
throughout the production process. We establish product specifications, select
the components to be used to produce our products, select the suppliers and
negotiate the prices for most of these components. We also work with our
contract manufacturers to improve process control and product design and conduct
periodic, on-site inspections of our manufacturers. In addition, our production
engineers conduct regular review meetings with our manufacturers to discuss
sales forecasts and the procurement of long lead-time parts, production
capacities and facilities.
Competition
The markets for digital connectivity products, personal storage
products and multimedia management and DVD and CD creation software are
intensely competitive and characterized by rapidly changing technology and rapid
changes in consumer preference. We believe that competition is likely to
intensify as a result of increasing demand for digital appliances and USB-based
and FireWire-based technology.
We believe that the principal competitive factors affecting the market
for digital connectivity products and personal storage systems include:
/bullet/ Ease of use;
/bullet/ Quality and reliability;
/bullet/ Rate of throughput, or data transfer speed;
/bullet/ Strength of distribution channels;
/bullet/ Price; and
19
/bullet/ The extent to which our products work with existing, and will
work with future, digital appliances.
We believe that our products compete successfully on most of these
bases.
There are no competitors known to us that offer a digital connectivity
product for flash memory using a 3.5-inch floppy drive. However, we face
competition from numerous providers of cable and other non-cable interfaces,
including ports, USB and infrared interfaces, including Hagiwara, SanDisk and
SCM Microsystems.
We face competition from numerous providers of stand-alone FireWire and
USB personal storage devices. These competing products are offered by a number
of companies, including, ADS Technologies, Evergreen Technologies, EZQuest,
FireWire Direct, iDrive, Imation, Iomega, LaCie, Maxtor, QPS, Seagate
Technologies, Teac, Western Digital and Yano.
We face competition from various providers of multimedia management
software including ArcSoft, MGI, Roxio, and Sonic.
Intellectual Property
We do not intend to license our proprietary FlashPath technology to
flash memory card manufacturers, consumer product OEMs or other third parties in
the future. We license technology that permits flash memory cards to be used
with conventional audio cassette players to a company under a license agreement
expiring in December 2002. We have granted certain USB and FireWire product
manufacturers who are competitors a limited, non-exclusive license to include
our USB and FireWire drivers in specific products for certain periods. In all
cases, these versions of the USB and FireWire drivers are base level drivers,
without the benefit of our complete feature set, which adds significant value to
our products. We license our SafeBoot software product to a company in Europe
under a one-year license agreement expiring in June 2001. The protection of our
intellectual property rights is critical to our future success, and we rely in
part on patent, trade secret, trademark, mask work and copyright law. We own 11
United States patents and approximately 60 foreign patents. We also have a
number of pending patent applications in various countries. Our patents and
patent applications cover various aspects of our technology.
Although we believe that our patent rights, when considered in
conjunction with our allowed patent applications and trade secret protection,
should limit another party's ability to manufacture and sell competing data
transfer products that use a floppy disk drive, we cannot guarantee that the
steps we have taken to protect our technology will be successful. The patents
issued to us may not be adequate to protect our proprietary rights, to deter
misappropriation or to prevent an unauthorized third party from copying our
technology, designing around the patents we own or otherwise obtaining and using
our products, designs or other information. In addition, patents may not be
issued under our current or future patent applications, and the patents issued
under those patent applications could be invalidated, circumvented or
challenged. It may also be particularly difficult to protect our products and
intellectual property under the laws of some countries in which our products are
or may be manufactured or sold.
20
Moreover, third parties could develop technologies that are similar or
superior to our technology or could make infringement claims against us.
Regardless of the outcome, an infringement claim would likely result in
substantial cost and diversion of our resources. In addition, we may not prevail
in litigation or be able to license any valid and infringed patents from third
parties on commercially reasonable terms, if at all. Any infringement claim or
other litigation against us or by us could therefore harm our business,
financial condition and results of operations.
Our FlashPath trademark is registered in the United States and a
variety of other countries in which we do business, and we will continue to
evaluate the registration of additional trademarks as appropriate. We also claim
copyright protection for some of our proprietary software and documentation. In
addition, we generally enter into confidentiality and non-disclosure agreements
with our employees and with key consultants, vendors and suppliers.
Employees
As of December 31, 2000, we had 125 full-time employees working in the
United States, Europe and Japan, including 48 employees engaged in research and
development, 20 engaged in sales and marketing and 57 engaged in general and
administrative activities, which includes certain executive officers, finance,
operations, technical support and information systems personnel. Our employees
are not represented by any collective bargaining agreements, and we have never
experienced a work stoppage. We believe our employee relations are good.
Backlog
Our backlog at December 31, 2000 was approximately $7.8 million
compared to approximately $5.4 million at December 31, 1999. The increase in
backlog of approximately $2.4 million resulted primarily from the acquisitions
of VST and Impleo during 2000. A substantial portion of our backlog is typically
scheduled for delivery within 60 days. Variations in the size and delivery
schedules of purchase orders received by us, as well as changes in customers'
delivery requirements, may result in substantial fluctuations in backlog from
period to period. Accordingly, we believe that backlog cannot be considered a
meaningful indicator of future financial results.
Item 2. Properties
Our corporate headquarters and research and development offices, along
with a portion of the distribution of our digital connectivity products, are
located in Naples, Florida where we lease approximately 20,000 square feet of
space. We lease approximately 22,300 square feet of space in Acton,
Massachusetts to serve as the sales and distribution center of a major portion
of our personal storage systems products. Our Japanese subsidiary leases
approximately 5,000 square feet of office space in Tokyo, which serves as the
sales and distribution center of a major portion of our digital connectivity
products. Our UK subsidiary leases approximately 3,400 square feet of office
space and 5,000 square feet of warehouse space in Wokingham, England, which
serves as the sales and distribution center of our digital connectivity and
personal storage
21
products to the European market. We also lease approximately 1,400 square feet
of space in Alpharetta, Georgia for a portion of our research and development
efforts. We believe that our existing facilities are adequate to support our
existing operations and that, if needed, we will be able to obtain suitable
additional facilities on commercially reasonable terms.
Item 3. Legal Proceedings
A complaint was filed on June 26, 2000 in the Central District Federal
Court of the State of California by a party alleging our infringement of that
party's patent. On November 20, 2000, we prevailed in removing the venue for
such action from the State of California to the Middle District of Florida. We
consider this claim to be wholly without merit. We intend to vigorously defend
against this claim. See "Factors That May Affect Future Results of Operations--
Infringement claims by third parties could result in costly litigation and
otherwise adversely impact our business."
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of security holders during the
fourth quarter of our fiscal year ended December 31, 2000.
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters
Our common stock is listed on the Nasdaq National Market under the
symbol "SMDK." The following table sets forth the high and low closing sale
prices per share of our common stock for the periods indicated:
High Low
---- ---
Year ended December 31, 2000:
Fourth Quarter.............................. $13.25 $ 2.19
Third Quarter............................... $37.00 $14.38
Second Quarter.............................. $36.50 $16.38
First Quarter............................... $65.13 $24.13
Year ended December 31, 1999:
Fourth Quarter (beginning October 6, 1999).. $55.19 $23.44
As of February 28, 2001, there were approximately 183 holders of record
of our common stock. However, the majority of shares are held by brokers and
other institutions on behalf of stockholders; therefore, we are unable to
estimate the total number of stockholders represented by these record holders.
We believe that the number of beneficial owners of our common stock is in excess
of 1,000.
We have never declared or paid any cash dividend on our common stock.
Since we currently intend to retain all future earnings to finance future
growth, we do not anticipate
22
paying any cash dividends in the foreseeable future. In addition, the terms of
our line of credit agreement prohibit the payment of dividends on our common
stock.
On October 6, 1999, we completed our initial public offering of
3,450,000 shares of common stock from which we realized net proceeds of
approximately $39.1 million. These shares were registered under the Securities
Act of 1933, as amended, on a registration statement on Form S-1 (No.
333-82793), which the Securities and Exchange Commission declared effective on
October 5, 1999.
Through December 31, 2000, we used approximately $19.0 million of the
net proceeds from the offering for the acquisitions of VST Technologies, Inc.,
Impleo Limited and the intellectual property of El Gato Software, LLC. In
addition, we used $4.3 million to pay off VST's outstanding line of credit and
$4.8 million for the purchase of equipment and funding of operations. The
remaining $11.0 million has been invested in short-term, interest-bearing,
investment grade securities.
Item 6. Selected Financial Data
The following selected financial data should be read together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the consolidated financial statements and notes thereto and other
financial information included elsewhere in this Annual Report on Form 10-K. The
consolidated statements of operations data set forth below of SmartDisk for the
years ended December 31, 1998, 1999 and 2000 and the consolidated balance sheet
data as of December 31, 1999 and 2000 have been derived from SmartDisk's audited
consolidated financial statements which are included elsewhere in this Annual
Report on Form 10-K. The consolidated statement of operations data set forth
below for the years ended December 31, 1996 and 1997 and the consolidated
balance sheet data as of December 31, 1996, 1997 and 1998 have been derived from
SmartDisk's audited consolidated financial statements which are not included in
this Annual Report on Form 10-K.
Year Ended December 31,
--------------------------------------------------------
1996 1997 1998 1999 2000
--------- --------- --------- --------- ---------
(in thousands, except per share amounts)
Revenues $ 500 $ 893 $ 15,323 $ 40,319 $ 96,722
Cost of revenues 367 301 12,600 24,820 74,039
Gross profit 133 592 2,723 15,499 22,683
Operating income (loss) (11,818) (4,016) (5,581) 1,763 (30,044)
Net income (loss) (9,470) (3,964) (5,503) 958 (24,238)
Earnings (loss) per share - basic(1) (1.25) (0.51) (0.68) 0.09 (1.44)
Earnings (loss) per share - diluted(1) (1.25) (0.51) (0.68) 0.07 (1.44)
Total assets 250 1,607 11,136 63,444 125,021
Long-term debt 93 645 648 -- --
Redeemable common stock -- -- 9,992 -- --
Stockholders' equity (deficit) (2,017) (4,626) (6,336) 49,787 100,315
- ------------
(1) Shares used in computing earnings (loss) per share reflect the
retroactive adjustment of outstanding shares related to the mergers of
SmartDiskette Limited and SmartDisk Security Corporation into
SmartDisk, as well as the one for four reverse stock split completed in
August 1999.
23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere in this report. Except for
historical information contained herein, the following discussion contains
forward-looking statements that involve risks and uncertainties and other
factors that could cause actual results to differ materially. Such risks and
uncertainties are discussed under the caption "Forward-Looking Statements" in
Item 1 of this Form 10-K.
Results of Operations
General
Prior to 1998, we were primarily a development stage company with
limited revenues. We did not begin to recognize significant revenues from our
digital connectivity products, specifically FlashPath, until mid-1998. During
2000, we acquired VST Technologies, or VST, and Impleo Limited, or Impleo, which
provided us with a line of personal storage products and greater access to the
European market. These transactions were accounted for using the purchase method
of accounting. Accordingly, our consolidated financial statements include the
results of operations from the respective dates of acquisition. Because of the
development stage nature of our operations prior to mid-1998 and the
acquisitions of VST and Impleo during 2000, we do not believe that
period-to-period comparisons of our historical results are meaningful or
predictive of future performance.
Effective October 1, 2000, we adopted Staff Accounting Bulletin (SAB)
No. 101, Revenue Recognition in Financial Statements, issued by the Securities
and Exchange Commission in December 1999. Our adoption of SAB No. 101, as
amended, did not have a material effect on the results of operations during the
year ended December 31, 2000.
Comparison of Years Ended December 31, 2000 and 1999
Revenues
Our product revenues are recognized when title and risk of loss are
transferred to customers, which is generally at the time of shipment. We defer
recognition of revenue on shipments to certain distributors until the
distributors have resold the products. We record a provision for estimated
product returns at the time the related revenue is recognized on sales to
certain resellers that have rights of return. Product revenues at our Japanese
subsidiary are recognized upon acceptance by the customer. Total product
revenues were approximately $94.3 million for the year ended December 31, 2000
compared to approximately $37.3 million for the year ended December 31, 1999.
This increase was primarily attributable to sales of personal storage systems
subsequent to the acquisition of VST in March 2000 and an increase in sales of
our digital connectivity products.
24
For the period from March 6, 2000, the date we acquired VST, through
December 31, 2000, revenues from personal storage systems were approximately
$49.8 million. Sales of personal storage systems declined in the fourth quarter
of 2000, primarily attributable to a decrease in sales of our USB- and
FireWire-based personal storage products for the Apple market resulting from the
recent decrease in demand for that market. We plan to discontinue some lower
margin or non-strategic personal storage products in 2001.
Our product revenues from the sale of digital connectivity products
increased from approximately $37.3 million for the year ended December 31, 1999
to approximately $44.5 million for year ended December 31, 2000. We are starting
to see the anticipated decline in the use of the 3.5-inch floppy drive as a
flash memory card interface, as consumers move toward devices with higher data
transfer rates, such as our USB-based flash media readers. This is contributing
to the slow growth in sales of our FlashPath products. We expect 2001 revenues
from digital connectivity products to be flat or somewhat lower than 2000
revenues.
Our research and development revenue is recognized upon final customer
acceptance of our work performed under the terms of the agreement. We earned the
significant portion of our research and development revenues from a research and
development agreement, which was completed during the quarter ended March 31,
2000. Our total revenues from research and development agreements were
approximately $1.3 million for the year ended December 31, 2000 compared to
approximately $2.6 million for the year ended December 31, 1999. We intend to
enter into additional research and development agreements for the development of
new technologies.
Our license fees and royalty revenues primarily consist of fees earned
from license agreements on our SafeBoot and FlashTrax intellectual property.
Currently, these revenues represent less than two percent of our total revenues
for the year ended December 31, 2000. We intend to enter into additional
licensing agreements for our existing and future intellectual property.
Cost of Revenues
Cost of revenues includes the purchased cost of product, packaging,
storage, freight, scrap and inventory provisions, as well as royalties for some
of our digital connectivity products and personal storage systems. Cost of
revenues increased to approximately $74.0 million for the year ended December
31, 2000 compared to approximately $24.8 million for the year ended December 31,
1999. This increase in cost was due primarily to sales of personal storage
systems subsequent to the acquisition of VST and an increase in sales of our
digital connectivity products.
For the period from March 6, 2000, the date we acquired VST, through
December 31, 2000, cost of revenues from sales of personal storage products was
approximately $43.6 million. This amount includes approximately $5.2 million of
inventory writedowns in the fourth quarter arising from the recent decrease in
demand for personal storage products.
Our cost of revenues from the sales of digital connectivity products
increased to approximately $30.1 million for the year ended December 31, 2000
compared to approximately
25
$24.8 million for the year ended December 31, 1999. This increase is primarily
attributable to the increase in sales volume of our digital connectivity
products. In addition, part of this increase was due to inventory writedowns of
approximately $0.5 million associated with our Smarty smart card reader due to
our discontinuance of that product line.
Gross Profit
Our gross profit for the year ended December 31, 2000 increased to
approximately $22.7 million or 23% of total revenue, compared to approximately
$15.5 million or 38% of total revenue for the year ended December 31, 1999. This
increase in the amount of gross profit is primarily attributable to sales of
personal storage systems subsequent to the acquisition of VST in March 2000,
which also contributed to the decrease in our gross margin percentage since the
gross margin on personal storage products is typically less than on digital
connectivity products. In addition, we recognized inventory writedowns primarily
on our personal storage products during the fourth quarter of 2000, which
reduced margins from approximately 29% to the reported 23%.
For the period from March 6, 2000, the date we acquired VST, through
December 31, 2000, gross profit from sales of personal storage systems was
approximately $6.2 million or 12% of personal storage revenue. This amount
includes inventory writedowns in the fourth quarter arising from the recent
decrease in demand for personal storage products. Excluding the inventory
writedowns, the margins on our personal storage products would have been
approximately 23%. We expect margins on our personal storage products to
approximate this percentage going forward. However, if we are able to shift a
significant portion of the manufacturing of our personal storage products
overseas, we expect margins for these products to improve.
Our gross profit from sales of digital connectivity products for the
year ended December 31, 2000 decreased to approximately $14.4 million or 32% of
digital connectivity revenue, compared to approximately $15.5 million or 38% of
digital connectivity revenue for the year ended December 31, 1999. This decrease
was primarily attributable to inventory writedowns associated with our Smarty
smart card reader due to our discontinuance of that product line. Because we
expect original equipment manufacturers (OEMs) to continue to account for a
large portion of our digital connectivity sales, we expect gross margins on
those sales to remain relatively consistent with the current level.
Research and Development Expenses
Our research and development expenses consist primarily of salaries and
payroll-related expenses for our design and development engineers, as well as
prototype supplies and contract or professional services. These expenses
increased to approximately $9.2 million, or 9% of total revenues, for the year
ended December 31, 2000 compared to approximately $5.9 million, or 15% of total
revenues, for the year ended December 31, 1999. This increase in expenditures
was primarily attributable to the acquisition of VST, as well as hiring
additional technical personnel, including salaries and related payroll expenses,
costs incurred in conjunction with our research and development contracts and
the outsourcing of product development.
26
Research and development expenses related to digital connectivity
products were incurred to support the development of our USB Flash Media Reader,
other products to transfer digital content from flash memory cards to non-PC
technologies and enhanced versions of our FlashPath products. Research and
development expenses related to our personal storage products were incurred for
the development of our USB/FireWire combo hard disk drive for Windows, a bus
powered FireWire CD-R/W and higher capacity thin FireWire hard disk drives. We
believe that the continued introduction of new products with an emphasis on
being first-to-market is important to our growth and will require increases in
research and development expenditures. We expect that our research and
development expenses will continue to increase as we invest in the development
of software applications and new and refined digital connectivity and personal
storage products to conveniently create, transfer, store, manage and use digital
content.
Sales and Marketing Expenses
Sales and marketing expenses include salaries, benefits and travel
expenses for our sales, marketing and product management personnel in the United
States, Japan and the United Kingdom. These expenses also include other selling
and marketing expenditures for items such as trade shows, advertising, marketing
and other promotional programs. Sales and marketing expenses increased to
approximately $6.6 million for the year ended December 31, 2000 compared to $1.6
million for the year ended December 31, 1999. The change from 1999 to 2000 was
primarily attributable to the acquisition of VST and Impleo. With the
acquisition of VST in March 2000 and the acquisition of Impleo in April 2000, we
added a number of new products to our existing product lines, significantly
increasing our total sales and marketing expenses. These added products require
more catalog and magazine advertising than we have needed in the past due to our
OEM relationships. We expect our sales and marketing expenses to increase in the
future as we launch new products and broaden our distribution into more
traditional consumer electronic and mass retail channels.
General and Administrative Expenses
General and administrative expenses include the salaries and related
expenses of our executive management, finance, information systems, operations,
technical support, human resources, legal and administrative functions, as well
as leases, utilities, maintenance, insurance, professional services, legal and
accounting fees, depreciation and amortization. General and administrative
expenses increased to approximately $12.3 million for the year ended December
31, 2000 compared to approximately $6.3 million for the year ended December 31,
1999. This increase is primarily attributable to the acquisitions of VST and
Impleo, as well as increases in depreciation and amortization, professional
services, and legal and accounting fees. During the third and fourth quarters of
2000, we recognized non-recurring expenses of approximately $1.1 million for
costs associated with a withdrawn secondary stock offering, employee severance
and the forgiveness of a note receivable.
Amortization of Goodwill and Other Acquisition Related Intangible Assets
As of December 31, 2000, our intangible assets primarily consisted of
goodwill and separately identified intangible assets recognized in connection
with our acquisitions completed
27
in 2000, which were recorded under the purchase method of accounting. The
separately identified intangible assets acquired consist of non-compete
agreements, distribution channels, trade names, patents and workforce in place.
These intangible assets have lives ranging from one to five years from the date
of acquisition. Purchase price not allocated to separately identified intangible
assets was allocated to goodwill. Goodwill is amortized over a five-year life
from the date of acquisition. For the year ended December 31, 2000, amortization
of goodwill and other acquisition related intangible assets totaled
approximately $24.7 million.
Interest and Other Income
Interest and other income increased to approximately $1.5 million for
the year ended December 31, 2000 compared to approximately $0.5 million for the
year ended December 31, 1999. The primary components of interest and other
income are interest earned on cash, cash equivalents and short-term investments,
gains or losses on the disposal of property and equipment and gains or losses on
foreign exchange. The most significant component of these items, for the year
ended December 31, 2000, was interest earned on cash, cash equivalents, and
short-term investments, which was approximately $1.4 million compared to
approximately $0.6 million for the year ended December 31, 1999. This increase
in interest income is due to a full year of interest earned on the proceeds from
our initial public offering, or IPO, in October 1999, less net proceeds
primarily used for acquisitions.
Interest Expense
Interest expense is incurred on the bank line of credit in Japan and
the United Kingdom. We also incurred interest expense on VST's line of credit
until it was paid in full on March 31, 2000. Interest expense for the year ended
December 31, 2000 remained consistent at approximately $0.1 million compared to
the year ended December 31, 1999.
Income Tax Expense (Benefit)
We are subject to tax in the United States, Japan, Switzerland and the
United Kingdom. These jurisdictions have different marginal tax rates. For the
year ended December 31, 2000, income tax benefit totaled approximately $4.1
million. This amount consisted of income tax benefits of approximately $5.5
million primarily resulting from amortization expense on certain intangible
assets related to the VST and Impleo acquisitions partially offset by
approximately $1.4 million of expense. Due to the treatment of the identifiable
intangible assets under Statement of Financial Accounting Standard No. 109,
Accounting for Income Taxes, we have a net deferred tax liability of
approximately $8.3 million. Based on our limited operating history and the
cumulative losses from the most recent three years, a valuation allowance is
provided to reduce deferred tax assets to the amount that will more likely than
not be realized. As of December 31, 2000 we had a net operating loss carry
forward of approximately $3.5 million for U.S. federal income tax purposes and
approximately $1.5 million for United Kingdom income tax purposes.
28
Comparison of Years Ended December 31, 1999 and 1998
Revenues
Total product revenues were approximately $37.3 million for the year
ended December 31, 1999 compared to approximately $15.0 million for the year
ended December 31, 1998. This increase was primarily attributable to higher
sales of our FlashPath for SmartMedia product, which we commercially introduced
in mid-1998, and, to a lesser extent, sales of our newest product, FlashPath for
the Sony Memory Stick, which we commercially introduced in the fourth quarter of
1999. Our product revenues from the sale of FlashPath increased to $36.4 million
for the year ended December 31, 1999 from $13.8 million for the year ended
December 31, 1998. This increase was partially offset by a decrease in our
Smarty sales to approximately $836,000 for the year ended December 31, 1999 from
$1.3 million for the year ended December 31, 1998. As a result of the growth of
our FlashPath revenues and the decrease in Smarty sales, Smarty revenues
represented less than 3% of product revenues for the year ended December 31,
1999 compared to approximately 9% in the year ended December 31, 1998.
Fiscal year 1999 was the first year that we had revenues from our
research and development efforts. During 1999, we entered into agreements with a
technology company for the development of new products. Upon acceptance of the
products by the customer in the fourth quarter of 1999, we recognized
approximately $2.6 million in revenue.
Our license fee and royalty revenue from the sale of our SafeBoot
product increased to $470,000 for the year ended December 31, 1999 as compared
to $284,000 for the year ended December 31, 1998.
Cost of Revenues
Cost of revenues increased to approximately $24.8 million for the year
ended December 31, 1999 compared to approximately $12.6 million for the year
ended December 31, 1998. These increases in cost were due primarily to the
increase in sales of our FlashPath product.
Gross Profit
Our gross profit for the year ended December 31, 1999 increased to
approximately $15.5 million or 38% of total revenue, compared to approximately
$2.7 million or 18% of revenue for the year ended December 31, 1998. The
increase in our gross profit and gross profit as a percentage of revenues was
primarily the result of revenue growth and improved margins on our FlashPath
product. The improved FlashPath product margins achieved in 1999 were related to
our efforts to reduce our cost per unit and a favorable mix associated with
higher shipments to customers other than our largest OEMs. Another contributor
to our improved gross profit in 1999 was our research and development revenue.
Without the research and development revenue, our gross profit would have been
approximately 35% of total revenue.
Research and Development Expenses
Our research and development expenses increased to approximately $5.9
million for the year ended December 31, 1999 compared to approximately $2.1
million for the year ended December 31, 1998. The increase was attributable to
the hiring of additional technical personnel,
29
including salaries and related payroll expenses, costs incurred in conjunction
with a research and development contract and the outsourcing of product
development.
All of these expenses were to support our development of enhanced
versions of our FlashPath for SmartMedia product, as well as our development of
FlashPath products designed to work with the Sony Memory Stick and the SanDisk
MultiMediaCard.
Sales and Marketing Expenses
Sales and marketing expenses increased by less than $0.1 million to
approximately $1.6 million for the year ended December 31, 1999 compared to the
year ended December 31, 1998. The change from year to year reflects various
additional costs incurred in 1998 in connection with the introduction of the
FlashPath for SmartMedia product including salaries and payroll related expenses
associated with the opening of our Tokyo, Japan office in March 1998.
General and Administrative Expenses
General and administrative expenses increased to approximately $6.3
million in the year ended December 31, 1999 compared to approximately $4.6
million in 1998. The increase in expenses was primarily due to increases in
professional services, legal fees and personnel related costs including
salaries, bonuses and relocation expenses.
Interest and Other Income/Interest Expense
The significant component of interest and other income was interest
earned on the proceeds from our IPO in October 1999. The average outstanding
balance on the line of credit in Japan remained consistent between 1999 and
1998, therefore, interest expense remained consistent between years.
Income Tax Expense (Benefit)
For the year ended December 31, 1999, we provided for Japanese
withholding tax of approximately $0.6 million on royalty income from Japan. We
also provided for Japanese income tax of approximately $0.8 million due to
income earned in Japan.
Liquidity and Capital Resources
Cash and cash equivalents decreased to approximately $12.8 million at
December 31, 2000 from approximately $19.1 million at December 31, 1999. The
decrease resulted primarily from approximately $6.4 million and $0.4 million
used in financing activities and investing activities, respectively, offset in
part by approximately $1.0 million provided by operating activities. In addition
to cash and cash equivalents, we have approximately $6.0 million in short-term
investments and approximately $1.7 million in restricted cash of which a portion
was used as collateral for our line of credit in Japan.
30
Net cash provided by operating activities was approximately $1.0
million for the year ended December 31, 2000 compared to cash used in operations
of approximately $0.2 million and $6.0 million for the years ended December 31,
1999 and 1998. Net cash provided by operating activities during 2000 reflected a
net loss of approximately $24.2 million offset by approximately $27.3 million in
depreciation and amortization along with approximately $10.9 million in
provisions for uncollectible accounts, sales returns and other credits and
inventory obsolescence. In addition, there were decreases in notes receivable of
approximately $6.3 million and an increase in deferred research and development
contract revenue of approximately $0.4 million. These amounts were partially
offset by increases in accounts receivable of approximately $1.1 million,
inventory of approximately $7.4 million, prepaid and other current assets of
approximately $1.6 million and decreases in accounts payable of approximately
$3.4 million, income taxes payable of approximately $1.7 million and deferred
income taxes of approximately $4.4 million.
Net cash used in investing activities was approximately $0.4 million
for the year ended December 31, 2000 compared to approximately $30.2 million and
$2.1 million for the years ended December 31, 1999 and 1998. The most
significant use of cash in 2000 was approximately $19.0 million in connection
with the acquisitions of VST, Impleo, and substantially all of the intellectual
property of El Gato. This amount was offset by proceeds from the sale of
short-term investments, net of purchases, of approximately $20.7 million. Cash
was also used for capital expenditures of approximately $1.5 million, primarily
for the acquisition of development and production equipment, net of disposals.
Net cash used in financing activities was approximately $6.4 million
for the year ended December 31, 2000 compared to cash provided by financing
activities of approximately $46.6 and $10.4 million for the years ended December
31, 1999 and 1998. This was attributable to approximately $2.9 million in net
repayments under our line of credit with a Japanese bank and approximately $4.3
million used to repay the outstanding balance under VST's line of credit, which
was terminated. These amounts were partially offset by proceeds from the
exercise of stock options and employee share purchases.
During 1998 and 1999, we financed our operations and repaid loans
outstanding through short-term borrowings and the sale of equity securities in
private placements with several strategic investors. The main contributor to the
cash provided in 1999 was the net proceeds of approximately $39.1 million from
the sale of 3,450,000 shares of common stock in our IPO in October 1999. During
2000, we financed our operations, acquisitions and repaid loans outstanding with
a portion of the proceeds from our IPO.
We maintain a line of credit in the United States under which we may
borrow up to $10.0 million subject to a borrowing base agreement, which includes
not more than 80% of specified accounts receivable. Any amounts borrowed under
this line of credit bear interest at 2% over the 30-day LIBOR rate and are
secured by substantially all of our assets. As of December 31, 2000, we had not
borrowed against this line of credit. This line of credit expires in April 2001,
at which time we plan to renew it.
As of December 31, 2000, our Japanese subsidiary had a line of credit
with a maximum borrowing capacity of approximately $2.6 million, which was
secured by accounts receivable of
31
specified trade customers and a time deposit. The outstanding balance under the
line of credit was approximately $1.7 million as of December 31, 2000 compared
to approximately $2.0 million at December 31, 1999. This line of credit was
renewed in January 2001. The maximum borrowing capacity was decreased to
approximately $1.3 million. The line of credit is secured by accounts receivable
of specified trade customers and a time deposit and expires in February 2002.
The interest rate on borrowings under the credit facility is 1.5% per year.
Our Japanese subsidiary also discounts certain short-term promissory
notes received from certain trade customers with a bank in Japan. The subsidiary
had no outstanding borrowings collateralized by promissory notes as of December
31, 2000. At December 31, 1999, the subsidiary had approximately $2.9 million of
bank borrowings collateralized by promissory notes.
As of December 31, 2000, our UK subsidiary had a line of credit with a
maximum borrowing capacity of approximately $0.7 million. The credit facility
expires in April 2001. The interest rate on borrowings under the credit facility
is 5.5% per year. The outstanding balance under the line of credit as of
December 31, 2000 was approximately $0.2 million.
We believe our cash and cash equivalents, short-term investments,
credit facility and the remaining net proceeds of our IPO, will be sufficient to
meet our working capital and anticipated capital expenditure needs for at least
the next 12 months. We may need to raise additional capital if we expand more
rapidly than currently planned, to develop and market new or enhanced products
and/or services, to respond to competitive pressures or to acquire complementary
products, businesses or technologies. The capital, if needed, may not be
available or may not be available on terms acceptable to us.
Factors That May Affect Future Results of Operations
Our business, results of operations and financial condition could be
adversely affected by a number of factors, including the following. In addition,
the following factors could cause our actual results to differ materially from
those projected in our forward-looking statements, whether made in this Form
10-K, our annual or quarterly reports to shareholders, future press releases,
SEC filings or orally, whether in presentations, responses to questions or
otherwise. See "Forward-Looking Statements."
We have incurred net losses and cannot guarantee that we will be profitable in
the future.
Except for the third and fourth quarters of 1999, we have incurred net
losses on a quarterly basis since inception. We had net income of approximately
$1.0 million during 1999. We had a net loss of approximately $24.2 million
during 2000, primarily as a result of $19.2 million in amortization of goodwill
and other intangible assets from the VST and Impleo acquisitions, net of tax. In
addition, as of December 31, 2000, we had an accumulated deficit of
approximately $46.0 million. In light of our loss history and the amortization
of goodwill and other intangible assets from the VST and Impleo acquisitions, we
cannot assure you that we will be profitable in the future.
We have a limited operating history on which to base an investment decision.
We were incorporated in March 1997, commenced operations in January
1998, and our predecessor corporation only conducted limited operations. As a
result of our limited operating
32
history, we have limited financial data that can be used in evaluating our
business and prospects and in projecting future operating results.
We may not be able to sell sufficient quantities of our products to sustain a
viable business if the market for digital connectivity products does not
continue to develop or if a competing technology displaces these products.
Our current FlashPath products and other flash media readers are
designed to provide connectivity between personal computers and digital
appliances that use flash memory cards. The flash memory market is in the early
stage of development and is still evolving. Our current dependence on sales of
FlashPath exposes us to a substantial risk of loss in the event that the flash
memory market does not develop or if a competing technology replaces flash
memory cards. If a competing memory storage device replaces or takes significant
market share from the flash memory cards which our digital connectivity products
support, we will not be able to sell our products in quantities sufficient to
grow our business.
We may not be able to sell sufficient quantities of our digital connectivity
products to sustain our current business if a single standard for flash memory
cards emerges.
We believe that demand for our flash memory connectivity products is
driven, to a large extent, by the absence of a single standard for flash memory
cards. There are currently five major flash memory cards, none of which has
emerged as the industry standard. Should one of these cards or a new technology
emerge as an industry standard, flash memory card readers could be built into
PCs, eliminating the need for our current flash memory connectivity products.
A reduction in the use of the 3.5-inch floppy disk drive by consumers and
manufacturers is contributing to the slow growth in sales of our FlashPath
products.
Our current FlashPath products only work in conjunction with the
standard 3.5-inch floppy disk drive. While the 3.5-inch floppy disk drive is
found today in most PCs, a number of newer PC models, such as the Apple iMac and
the Apple G4 desktop, do not have this device and new industry standards may
emerge that render the 3.5-inch floppy disk drive obsolete. Advances in input
devices such as CD-ROM and removable data storage disk drives, such as Zip
drives, are reducing the need for the 3.5-inch floppy diskette, which is
contributing to the slow growth in sales of our FlashPath products. In the
future, we will have to rely on our other products and develop new products that
use a different interface between personal computers and digital appliances.
Since our FlashPath products work only in conjunction with the 3.5-inch floppy
disk drive, advances in flash memory cards may make these products less
competitive because of the increased time needed to transfer data using the
3.5-inch floppy disk drive.
Consumer acceptance of our FlashPath products will depend upon their
ability to quickly transfer information from flash memory cards to PCs. However,
the time needed to transfer information using a 3.5-inch disk drive increases as
more data is transferred. As more memory is condensed on to flash memory cards,
the time necessary to transfer all of the data from a single card will increase.
As technological advances make it possible and feasible to produce higher
density cards, our ability to create products, which quickly transfer all of the
stored information
33
on a single card will be constrained by the inherent limitations of the 3.5-inch
disk drive. In that case, our products would be less attractive to consumers and
our sales would decline.
We may not be able to sell sufficient quantities of our personal storage systems
to sustain our future growth if PC manufacturers do not adopt IEEE 1394 as a
high-speed peripheral interface or if a competing CPU interface displaces or
prevents the widespread adoption of IEEE 1394.
A substantial portion of our business depends on the adoption of
Institute of Electrical and Electronics Engineering, or IEEE, 1394 technology by
PC manufacturers. IEEE 1394 is a high speed PC interface that is replacing Small
Computer System Interface, or SCSI, and parallel interfaces. If these
manufacturers do not include a IEEE 1394 interface on their PCs or notebook
computers, then we may not be able to sell sufficient quantities of our FireWire
personal storage systems to support our future growth. FireWire is Apple's trade
name for IEEE 1394. For example, a new, competing high speed interface, such as
Universal Serial Bus, or USB, 2.0, could be developed and emerge as an industry
standard, thus limiting the demand for our FireWire technology and related
personal storage systems.
We may not be able to sell sufficient quantities of our personal storage systems
to support our business if suppliers of our drives develop native FireWire-based
personal storage systems that do not require our FireWire conversion technology.
We embed conversion ASICs and integrated software drivers in the hard
disk drives and Zip drives we obtain from our suppliers, which enables our
FireWire-based personal storage systems to be used with FireWire-equipped
computers. We license this technology and the firmware from LSI Logic. If our
suppliers were to develop a native FireWire solution that does not require the
conversion ASICs and drivers embedded in our products, then we may not be able
to sell sufficient quantities of our FireWire personal storage systems to
support our business.
Most of our revenues are derived from only a few major products and our business
will be seriously harmed if demand for those products declines.
To date, substantially all of our revenue has been derived from the
sale of only a few major products. While our long-term strategy is to derive
revenue from multiple products, we anticipate that the sale of our FlashPath
products and our USB and FireWire storage systems will continue to represent the
most substantial portion of our revenues through at least 2001. A decline in the
price of or demand for these products as a result of competition, technological
change, the introduction of new products by us or others, a failure to
adequately manage product transitions, or for other reasons, would seriously
harm our business. During 2000, we derived approximately 43% of our product
revenues from the sale of FlashPath, 18% from the sale of our USB-based personal
storage systems, and 10% from the sale of our FireWire-based personal storage
systems.
We must develop new products and introduce them in a timely manner in order to
remain competitive.
We operate in an industry that is subject to evolving industry
standards, rapid technological changes, rapid changes in consumer demands and
the rapid introduction of new,
34
higher performance products that shorten product life cycles. To be competitive
in this demanding market, we must both continue to refine current products so
that they remain competitive, and continually design, develop and introduce, in
a timely manner, new products that meet the performance and price demands of
OEMs and consumers. These development activities will require the investment of
substantial resources before revenues are derived from product sales. Any
significant delay in releasing new products would adversely affect our
reputation, provide a competitor a first-to-market opportunity or allow a
competitor to achieve greater market share. Product development is inherently
risky because it is difficult to foresee developments in technology, coordinate
our technical personnel and strategic relationships, and identify and eliminate
design flaws. If we are unable to develop and sell new products, we will not be
able to continue our strategy of maintaining media neutrality, and our target
market will be limited. Further, we may not be able to recoup research and
development expenditures if new products are not widely commercially accepted.
We may not be able to develop or maintain the strategic relationships necessary
to provide us with the insight we need to develop commercially viable products.
We may not be able to produce commercially viable products if we are
unable to anticipate market trends and the price, performance and functionality
requirements of flash memory card, PC and digital appliance manufacturers. We
must continue to collaborate closely with our customers, our OEM manufacturers
and our other contract manufacturers to ensure that critical development
projects proceed in a coordinated manner. This collaboration is also important
because our ability to anticipate trends and plan our product development
activities depends to a significant degree upon our continued access to
information derived from these strategic relationships. We currently rely on
strategic relationships with flash memory card manufacturers, such as Sony,
SanDisk and Toshiba, PC manufacturers, such as Apple, and consumer product OEMs,
such as Olympus and FujiFilm. For example, through our co-development efforts
with Sony, we developed our FlashPath for the Sony Memory Stick and introduced a
follow-on FlashPath product for new models of Sony's Mavica digital still camera
a few months later. If we cannot maintain our relationship with these
manufacturers then we may not be able to continue to develop products that are
compatible with their flash memory cards, PCs and digital appliances. However,
collaboration is more difficult because many of these companies are located
overseas. If any of our current relationships deteriorates or is terminated, or
if we are unable to enter into future alliances that provide us with comparable
insight into market trends, we will be hindered in our ability to produce
commercially viable products. For example, we depend on our relationship with
Iomega Corporation in order to produce our Zip drive products for Apple notebook
computers. If we cannot maintain our relationship with Iomega, or if Iomega
wishes to produce these products internally, then our current market for these
products will deteriorate.
We may not be able to sustain our relationship with Apple Computer, which would
greatly hinder our ability to timely develop products, which are compatible with
Macintosh operating systems.
Historically, Apple has provided us, as an Apple developer, access to
selected product road maps, which has allowed us to timely develop and engineer
many of our current products, including our current FireWire and USB storage
systems. As a result of this collaborative
35
relationship, we have received a substantial portion of our historical revenues
from direct sales to Apple and Apple users. Moreover, we anticipate that a
significant portion of our product revenues will continue to be derived from
sales of our Apple compatible products in the near future. If Apple were to
terminate our status as an Apple developer or if there were a material
deterioration of our relationship, we would not be able to timely develop new
technologies that are compatible with Apple's product road maps and this would
have an adverse effect on our business. Moreover, we currently sell a number of
our Apple products through the Apple Web Store, where our products may be sold
separately or may be configured and ordered along with a Macintosh computer.
While we do not anticipate any change in this arrangement, Apple is not
contractually obligated to offer our products on their website.
A continued decline in the demand for Apple products would further reduce the
market for many of our products.
Our continued growth depends to a large extent on both our strategic
relationship with Apple and demand for Apple products. This dependence is due
primarily to the fact that, to date, Apple has been the principal PC
manufacturer using the FireWire interface technology on which many of our
products are based. The recent decline in demand for Apple products has
contributed to the slow growth in sales of our personal storage products in the
second half of 2000. If the decline in the demand for Apple products continues
or if Apple suffers a material change in its business, the market for many of
our products would be further negatively impacted.
Our operating results have fluctuated significantly and may fluctuate
significantly in the future, which could lead to decreases in our stock price.
Our operating results have fluctuated significantly in the past and we
expect that they will continue to fluctuate in the future. If our future
operating results materially fluctuate or are below the expectations of stock
market analysts, our stock price would likely decline. Future fluctuations may
result from a variety of factors including the following:
/bullet/ The timing and amount of orders we receive from our customers,
which may be tied to seasonal demand for the consumer products
manufactured and sold by OEMs;
/bullet/ Cancellations or delays of customer product orders, or the
loss of a significant customer;
/bullet/ Reductions in consumer demand for our customers' products in
general, such as Apple products, or for our products in
particular, such as FlashPath;
/bullet/ The timing and amount of research and development
expenditures;
/bullet/ The availability of manufacturing capacity necessary to make
our products;
/bullet/ General business conditions in the United States, Japan
and Europe, as well as general economic and political
conditions;
/bullet/ Any new product introductions, or delays in product
introductions, by us or our competitors;
36
/bullet/ Increased costs charged by our suppliers or changes in the
delivery of products to us;
/bullet/ Increased competition or reductions in the average selling
prices that we are able to charge;
/bullet/ Fluctuations in the value of foreign currencies, particularly
the Japanese yen and British Pound, against the U.S. dollar;
and
/bullet/ Changes in our product mix as well as possible seasonal demand
for our products.
As a result of these and other factors, we believe that
period-to-period comparisons of our historical results of operations are not a
good predictor of our future performance.
The stock market has experienced significant price and volume
fluctuations that have particularly affected the market prices of the stocks of
technology companies. Recently, the market price of our common stock, like that
of many technology companies, has experienced significant fluctuations. For
instance, from October 6, 1999, the date of our IPO, to February 28, 2001, the
reported last sale price for our common stock ranged from $2.19 to $65.13 per
share. On February 28, 2001, the reported last sale price of our common stock
was $3.88 per share.
The market price of our common stock also has been and is likely to
continue to be significantly affected by expectations of analysts and investors.
Reports and statements of analysts do not necessarily reflect our views. The
fact that we have in the past met or exceeded analyst or investor expectations
does not necessarily mean that we will do so in the future.
We may fail to adequately protect our intellectual property and, therefore, lose
our competitive advantage.
Our proprietary technology with respect to 3.5-inch floppy disk drive
interfaces and USB and FireWire source codes is critical to our future growth.
We rely in part on patent, trade secret, trademark and copyright law to protect
our intellectual property. However, the patents issued to us may not be adequate
to protect our proprietary rights, to deter misappropriation or to prevent an
unauthorized third party from copying our technology, designing around the
patents we own or otherwise obtaining and using our products, designs or other
information. We have, in fact, filed a complaint against one of our former
patent attorneys for improperly copying one of our patent applications and
filing a patent application without our consent naming himself as a co-inventor.
This matter was settled with no materially adverse consequences to SmartDisk. In
addition, we may not receive trademark protection for our "SmartDisk" name. We
have filed for trademark registration of the name "SmartDisk," but this has not
yet been granted. We are aware of a trademark application for the name
"SmartDisk" that was filed by another company. Our application could be denied
and we could be prohibited from using the "SmartDisk" name. In that event, we
would be required to incur substantial costs to establish new name recognition.
We also claim copyright protection for some proprietary software and
documentation. We attempt to protect our trade secrets and other proprietary
information through agreements with our customers, employees and consultants,
and through other security measures. However, despite our efforts to protect our
intellectual property, unauthorized parties may attempt to copy aspects of our
products or obtain and use information and software that we regard as
proprietary.
37
Those parties may have substantially greater financial resources than we have,
and we may not have the resources available to challenge their use of our
proprietary technology. If we fail to adequately protect our intellectual
property, it will be easier for our competitors to sell competing products.
We may face competition from Intel if it decides to utilize its competing
patent.
Intel Corporation was issued a patent in 1997 disclosing and claiming
technology substantially similar to that disclosed in one of our key patents.
The Intel patent was filed four years after our effective filing date, and we do
not believe that the Intel patent can be validly applied to any of the
technology disclosed in our patent. However, given the substantial resources
available to Intel, our financial condition could suffer if we engage in a
dispute with Intel. Our business could also be harmed if Intel's patent is
determined to be valid and Intel or any licensee of Intel decides to sue our
customers or develop and commercialize products based on its patent.
Infringement claims by third parties could result in costly litigation and
otherwise adversely impact our business.
From time to time we may receive communications from third parties
asserting that our products infringe, or may infringe, the proprietary rights of
these third parties. These claims of infringement may result in protracted and
costly litigation that could require us to pay substantial damages or have sales
of our products stopped by an injunction. Infringement claims could also cause
product shipment delays, require us to redesign our products or require us to
enter into royalty or licensing agreements, any of which could harm our
business. For example, we received communications alleging that our FlashPath
products infringed a third party's patent rights. We have met with this third
party, a non-public limited liability company, to gain a better understanding of
its claim and attempted to resolve the dispute through mediation. Such mediation
did not yield a resolution to the dispute and such party subsequently filed a
complaint in the Central District Federal Court of the State of California (See
Part I, Item 3. "Legal Proceedings"). While we believe that we do not infringe
upon this third party's patent and that such claim is wholly without merit, we
cannot guarantee that the effects or outcome of this litigation will be
favorable to SmartDisk. We also received correspondence alleging that our
SafeBoot product violated another third party's intellectual property rights. We
discussed this correspondence with counsel and concluded that our product does
not infringe upon the third party's rights. In addition, we license a portion of
the intellectual property included in our products from third parties, which may
increase our exposure to infringement actions because we rely upon those third
parties for information about the origin and ownership of the licensed
intellectual property. We may also lose our license rights with respect to the
intellectual property for which infringement is claimed. Further, if our
customers are required to obtain a license on other than commercially reasonable
terms, our business could be jeopardized.
We have indemnification obligations related to our intellectual property, which
may require us to pay damages.
Our arrangements with Fuji Photo USA, Iomega, SanDisk, Sony, Toshiba
and others require us to indemnify them for any damages they may suffer if a
third party claims that we are violating their intellectual property rights.
While, to date, we have not received indemnification
38
claims, there may be future claims. For example, Fuji Photo USA has been named
as a co-defendant in the above referenced complaint filed in the Central
District Federal Court of the State of California. SmartDisk has agreed to
indemnify Fuji Photo USA with respect to expenses or damages incurred by Fuji
Photo USA in connection with this matter. Any indemnification claim may require
us to pay substantial damages, which could negatively impact our financial
condition.
We may have particular difficulty protecting our intellectual property rights
overseas.
The laws of some foreign countries do not protect proprietary rights to
as great an extent as do the laws of the United States, and many U.S. companies
have encountered substantial infringement problems in some foreign countries.
Because many of our products are sold and a portion of our business is conducted
overseas, primarily Japan and Europe, our exposure to intellectual property
risks may be higher.
Because most of our sales are to a relatively small number of customers the loss
of any of our key customers would seriously harm our business.
Our business will be seriously harmed if we lose any of our significant
customers, particularly Apple, FujiFilm, Ingram Micro, Olympus or Sony, or
suffer a substantial reduction in or cancellation of orders from these
customers. Our current distribution strategy results, and will continue to
result, in sales to only a limited number of customers. Some of our products are
sold as stand-alone products by OEMs and, to a lesser extent, are bundled
together and sold with systems manufactured by third party OEMs. During 2000,
Ingram Micro, Sony and Apple accounted for approximately 18%, 15% and 10% of our
revenues and our top five customers collectively accounted for approximately 56%
of our revenues. Furthermore, we expect to continue to depend on sales of our
products to relatively few customers, which will continue to account for a
significant portion of our net revenues, for the foreseeable future.
Since we sell our products to a limited number of large customers, we expect
that those customers may pressure us to make price concessions, which would
reduce our future gross margins.
Our reliance on sales to a limited number of large customers may expose
us to pressure for price concessions. Because of this reliance and because of
our dependence on OEMs as our primary distribution channel, we expect that our
OEM customers may seek price concessions from us, which would reduce our average
selling prices and our gross margins. Since we do not manufacture our own
products, we may be unable to reduce our manufacturing costs in response to
declining average per unit selling prices.
Our customers could stop purchasing our products at any time because we do not
have long-term purchase contracts with them.
No OEM or other customer is contractually obligated to purchase
products from us. As a result, our customers are free to cancel their orders or
stop ordering our products at any time. In addition, even if we are able to
demonstrate that our products are superior, OEMs may still choose not to bundle
our products with theirs or market and distribute our products on a stand-alone
basis. OEMs may also change their business strategies and manufacturing
practices, which
39
could cause them to purchase fewer of our products, find other sources for
products we currently manufacture or manufacture these products internally.
Our ability to sell our products will be limited if the OEMs' products do not
achieve market acceptance or if the OEMs do not adequately promote our products.
We depend upon our OEM customers to market certain of our products and
we do not have significant experience and resources devoted to independent
marketing efforts. Failure of the OEMs' products to achieve market acceptance,
the failure of the OEMs to bundle our products with theirs, or any other event
causing a decline in our sales to the OEMs could seriously harm our business.
Even if consumers buy OEMs' products, their ultimate decision to buy our
products depends on OEM packaging, distribution and sales efforts, which may not
be sufficient to maintain or increase sales of our products. If we cannot
achieve or maintain a sufficient consumer acceptance rate of our products
concurrent with their purchases of OEM products, our future sales to OEM
customers will be adversely affected.
A new or competing data transfer solution that achieves significant market share
or receives significant support from flash memory card or digital appliance
manufacturers would jeopardize our business.
Our products currently compete with a number of cable and non-cable
interfaces between personal computers and digital appliances, including ports,
PCMCIA slots and infrared interfaces, all of which are PC peripheral interfaces.
It is possible that one of these competing data transfer solutions, or another
existing or new technology, could achieve a significant market presence or
become supported by a number of significant flash memory card or digital
appliance manufacturers. Regardless of the relative benefits of our products, if
a competing product gains significant market share or significant support of
flash card manufacturers, this product would likely emerge as the industry
standard and thereby achieve a dominant market position that would jeopardize
our survival.
We expect to continue outsourcing key operational functions and our ability to
do so will be impaired if we are unable to maintain our strategic relationships.
We have formed strategic relationships with a number of significant
industry participants, including Apple, FujiFilm, Hitachi, Iomega, Olympus,
Rohm, SanDisk, Sony, Toshiba and Yamaichi. We depend upon these corporations to
provide technical assistance and perform key manufacturing, marketing,
distribution and other functions. For example, Yamaichi is currently one of two
manufacturers of our FlashPath products, Toshiba and Apple provide technological
assistance in the development of our products, and Olympus and FujiFilm market
our products. We expect that these and similar types of relationships will be
critical to our growth because our business model calls for the continued
outsourcing of many key operational functions and we do not currently have the
resources to perform these functions ourselves.
We must overcome geographic and cultural differences in order to maintain our
strategic relationships.
There are inherent difficulties in developing and maintaining
relationships with foreign entities. Language and cultural differences often
impair relationships, and geographical distance,
40
at times, is also an impediment. If any of our current relationships is
impaired, or if we are unable to develop additional strategic relationships in
the future, our product development costs would significantly increase and our
business would be materially and adversely affected.
A portion of our sales and expenses are geographically concentrated in Japan,
and, therefore, we could suffer from exchange rate fluctuations and economic and
political difficulties.
Approximately 37% of our revenues for 2000 were attributable to sales
to Japanese customers, and we expect that sales to Japanese customers will
continue to account for a significant portion of our total revenues for the
foreseeable future. All of our Japanese sales, as well as the related expenses,
are denominated in Japanese yen. Fluctuations in exchange rates between the yen
and the U.S. dollar, particularly with respect to Japanese transactions
denominated in a currency other than the yen, could adversely impact our
financial results. Some transactions and accounts of our Japanese and European
subsidiary are U.S. dollar denominated. Since the foreign subsidiaries'
accounting records are kept in local currency, those U.S. dollar denominated
transactions are accounted for using the local currency at the time of the
transaction. U.S. dollar denominated accounts are remeasured at the end of the
accounting period. This remeasurement results in adjustments to income. In
addition, the balance sheet accounts of our foreign subsidiaries are translated
to the U.S. dollar for financial reporting purposes and resulting adjustments
are made to stockholders equity. The value of the Japanese yen and the British
pound may deteriorate against the dollar, which would impair the value of
stockholders' investment in us. Fluctuations in the value of the Japanese yen
and the British pound against the dollar have occurred in 2000, resulting in a
foreign currency gain of approximately $348,000 and a foreign currency
translation adjustment to reduce equity for approximately $447,000. Further, we
do not currently hedge against foreign currency exposure. In the future, we
could be required to denominate our product sales in other currencies, which
would make the management of currency fluctuations more difficult and expose us
to greater currency risks.
We depend on a limited number of contract and offshore manufacturers, and it may
be difficult to find replacement manufacturers if our existing relationships are
impaired.
We contract with offshore manufacturers to produce some of our products
and our dependence on a limited number of contract manufacturers exposes us to a
variety of risks, including shortages of manufacturing capacity, reduced control
over delivery schedules, quality assurance, production yield and costs. For
example, Yamaichi and Mitsumi are the sole manufacturers of our FlashPath
products. We do not have contracts with Yamaichi or Mitsumi. If Yamaichi or
Mitsumi terminates production, or cannot meet our production requirements, we
may have to rely on other contract manufacturing sources or identify and qualify
new contract manufacturers. The lead-time required to qualify a new manufacturer
could range from approximately three to six months. Despite efforts to do so, we
may not be able to identify or qualify new contract manufacturers in a timely
manner and these new manufacturers may not allocate sufficient capacity to us in
order to meet our requirements. Any significant delay in our ability to obtain
adequate quantities of our products from our current or alternative contract
manufacturers would cause our sales to decline.
41
Toshiba introduced us to one of our manufacturers and we may not be able to
retain the services of the manufacturer if our relationship with Toshiba is
impaired.
Yamaichi, one of the manufacturers of our FlashPath products, was
introduced to us by Toshiba, which is one of our major stockholders. If our
relationship with Toshiba is impaired, we may not be able to retain the services
of Yamaichi in manufacturing our products.
Our dependence on foreign manufacturing and international sales exposes us to
difficulties often not encountered by exclusively domestic companies.
Many of our products are manufactured overseas and a significant
portion of our revenues is derived from overseas sales. Approximately 43% of our
revenues during 2000 were derived from customers located outside the United
States, primarily in Japan. Our dependence on foreign manufacturers and
international sales poses a number of risks, including:
/bullet/ Difficulties in monitoring production;
/bullet/ Transportation delays and interruptions;
/bullet/ Unexpected changes in regulatory requirements;
/bullet/ Currency exchange risks;
/bullet/ Tariffs and other trade barriers, including import and export
restrictions;
/bullet/ Difficulties in staffing and managing disparate branch
operations;
/bullet/ Political or economic instability;
/bullet/ Compliance with foreign laws;
/bullet/ Difficulties in protecting intellectual property rights in
foreign countries;
/bullet/ Exchange controls; and
/bullet/ Potential adverse tax consequences, including with respect to
repatriation of earnings.
We intend to continue manufacturing our products overseas and we
anticipate that international sales will continue to account for a significant
portion of our revenues. Therefore, we expect to be subject to the risks
outlined above for the foreseeable future.
We have a limited number of suppliers of key components and our ability to
produce finished products will be impaired if we are unable to obtain sufficient
quantities of some components.
Rohm is our sole provider of application specific integrated circuits,
or ASICs, for our FlashPath products. In our FlashPath products, the specific
function of these integrated circuits is the conversion of digital and analog
data. In addition, Iomega is a sole source supplier of Zip drives, and LSI Logic
is our primary supplier of ASICs for our FireWire products. Our dependence on a
limited number of suppliers and our lack of long-term supply contracts exposes
us to several risks, including a potential inability to obtain an adequate
supply of components,
42
price increases, late deliveries and poor component quality. Disruption or
termination of the supply of components could delay shipments of our products.
The lead-time required for orders of some of our components is as much as six
months. In addition, the lead-time required to qualify new suppliers for our
components is as much as 12 months. If we are unable to accurately predict our
component needs, or if our component supply is disrupted, we may miss market
opportunities by not being able to meet the demand for our products. This may
damage our relationships with current and prospective customers.
Our current and potential competitors have significantly greater resources than
we do, and increased competition could harm sales of our products.
Many of our current and potential competitors have significantly
greater financial, technical, marketing, purchasing and other resources than we
do. As a result, some of our competitors may be able to respond more quickly to
new or emerging technologies or standards or to changes in customer
requirements. Our competitors may also be able to devote greater resources to
the development, promotion and sale of products, and may be able 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 our prospective customers. Therefore, 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 these
factors could have a material adverse effect on our business and operating
results.
Our business may suffer if we are unable to manage our growth.
Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenues increasing from approximately $15.3 million in 1998 to
approximately $96.7 million in 2000. The growth of our business has placed a
strain on our management, operations and financial systems. In addition, the
number of employees has increased from 16 at January 1, 1998 to 125 as of
December 31, 2000. We expect to continue to increase the number of employees as
our business grows, and may expand operations to locations other than those in
which we currently operate.
Continued growth is likely to place a greater burden on our operating
and financial systems as well as our senior management and other personnel.
Existing and new members of management may not be able to improve existing
systems and controls or implement new systems and controls in response to
anticipated growth. Management of our operations in diverse locations may also
complicate the task of managing our growth.
We may not be able to integrate the business of companies we acquire and
therefore these acquisitions may not provide additional value to our
stockholders.
We continually evaluate potential acquisitions of complementary
businesses, products and technologies. We acquired VST in March 2000 and Impleo
in April 2000. We may not realize the desired benefits of these transactions or
of future transactions. In order to successfully integrate acquired companies we
must, among other things:
43
/bullet/ Continue to attract and retain key management and other
personnel;
/bullet/ Integrate the acquired products from both an engineering and
sales and marketing prospective;
/bullet/ Establish a common corporate culture; and
/bullet/ Integrate geographically distant facilities, systems and
employees.
If our management's attention to day-to-day operations is diverted to
integrating acquired companies or if problems in the integration process arise,
our business could be adversely affected and we could be required to use a
significant portion of our available cash. If an acquisition is made utilizing
our securities, a significant dilution to our stockholders and significant
acquisition related charges to earnings could occur.
Our acquisitions of VST and Impleo were dilutive and we expect that our
earnings per share will remain negative for the foreseeable future as a result
of these acquisitions. We may incur additional charges in the future resulting
from redundancies in product lines, customer lists and sales channels associated
with these acquisitions. Acquisitions may also cause us to incur or assume
additional liabilities or indebtedness, including liabilities that are unknown
or not fully known to us at the time of the acquisition, which could have an
adverse effect on us. Furthermore, we cannot assure that any products we acquire
in connection with any acquisition will gain acceptance in our markets.
Some of our products may be returned to us by our OEM customers if projected
consumer demand does not materialize, which would lead to a reduction in our
revenues.
Lack of consumer demand for our products may result in efforts by OEMs
to return products to us. While we are contractually obligated to accept
returned products from our OEMs only on a limited basis, we may determine that
it is in our best interest to accept returns in order to maintain good relations
with them. Product returns would reduce our revenues. While we have experienced
very limited product returns to date, returns may increase in the future.
We could be held liable for product defects, which could require us to pay
substantial damages and harm our reputation with our customers.
Complex products such as ours can contain errors, defects and bugs when
first introduced or as new versions are released. Delivery of products with
production defects or reliability, quality or compatibility problems could
hinder market acceptance of our products, which could damage our reputation and
harm our ability to attract and retain customers. Errors, defects or bugs could
also cause interruption, delays or a cessation of sales to our customers, and
could subject us to warranty claims from our customers. We would have to expend
significant capital and resources to remedy these problems. Errors, defects or
bugs could be discovered in our new products after we begin commercial
production of them, despite testing by us and our suppliers and customers. This
could result in additional development costs, loss of, or delays in, market
acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss of
credibility with our current and prospective customers.
44
Our executive officers and key personnel are critical to our business, and these
officers and personnel may not remain with us in the future.
We depend upon the continuing contributions of our key management,
sales and product development personnel. The loss of any of those personnel
could seriously harm us. Although some of our officers are subject to employment
agreements, we cannot be sure that we will retain their services. In addition,
we have not obtained key-person life insurance on any of our executive officers
or key employees.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. Our exposure to market risk for changes in interest
rates relates primarily to our investment portfolio. The primary objective of
our investment activities is to preserve our invested funds while at the same
time maximizing the income we receive from our investments without significantly
increasing risk. Some of the securities that we have invested in may be subject
to market risk. This means that a change in prevailing interest rates may cause
the principal amount of the investment to fluctuate. For example, if we hold a
security that was issued with a fixed interest rate at the then-prevailing rate
and the prevailing interest rate later rises, the principal amount of our
investment will probably decline in value. If market interest rates were to
increase immediately and uniformly by 10 percent from levels at December 31,
2000, this would not materially change the fair market value of our portfolio.
To minimize this risk, we maintain our portfolio of cash equivalents and
short-term investments in a variety of securities including U.S. government and
government agency notes, corporate bonds and notes and money market funds. In
general, money market funds are not subject to interest rate risk because the
interest paid on such funds fluctuates with the prevailing interest rate. Our
investment portfolio includes marketable securities with contractual maturities
of less than one year and active secondary or resale markets to ensure portfolio
liquidity.
The following table presents the amounts of our cash equivalents and
short-term investments that are subject to market risk and weighted-average
interest rates as of December 31, 2000. This table does not include money market
funds because those funds are not subject to market risk.
Aggregate Average
Fair Value Interest Rate
---------- -------------
Included in cash and cash equivalents (0-3 months) $ 4,952 6.38%
Included in short-term investments (3-9 months) 6,001 6.57%
We do not currently hold or issue derivative securities, derivative
commodity instruments or other financial instruments for trading purposes.
Foreign Exchange Risk. We conduct operations and sell products in
several different countries. Some balance sheet accounts of our U.S., Japanese
and European operations are denominated in currencies other than the respective
local currency and are remeasured to the respective local currency at the end of
the accounting period. This remeasurement results in an adjustment to income.
Additionally, the balance sheet accounts of our Japanese and European operations
are translated to U.S. dollars for financial reporting purposes and resulting
adjustments are made to stockholders' equity. The value of the respective local
currency may strengthen or weaken against the U.S. dollar, which would impact
the value of stockholders' investment in our common stock. Fluctuations in the
value of the Japanese yen and the British pound against the U.S. dollar have
occurred in 2000, resulting in a realized foreign currency gain of approximately
$348,000. In addition, during 2000 such fluctuations resulted in an unrealized
foreign currency translation loss of approximately $447,000, which is included
in accumulated other comprehensive income and shown in the equity section of our
balance sheet.
While most of the transactions of our U.S., Japanese and European
operations are denominated in the respective local currency, some transactions
are denominated in other currencies. Since the accounting records of our foreign
operations are kept in the respective local currency, any transactions
denominated in other currencies are accounted for in the respective local
currency at the time of the transaction. Upon settlement of such a transaction,
any foreign currency gain or loss results in an adjustment to income.
Our operating results may be impacted by the fluctuating exchange rates
of foreign currencies, especially the Japanese yen and the British pound, in
relation to the U.S. dollar. Most of the revenue and expense items of our
Japanese and European subsidiaries are denominated in the respective local
currency. In both regions, we believe this serves as a natural hedge against
exchange rate fluctuations because although an unfavorable change in the
45
exchange rate of the foreign currency against the U.S. dollar will result in
lower revenues when translated into U.S. dollars, operating expenses will also
be lower in these circumstances. For example, a decrease in the Japanese yen to
U.S. dollar rate of 10 percent would have resulted in a decrease in revenues of
approximately $3.0 million and a decrease in the net loss before income tax of
approximately $0.3 million. A 10 percent adverse change in the British pound
against the U.S. dollar would not have a material effect on net loss before
income taxes.
We do not currently engage in hedging activities with respect to our
foreign currency exposure; however, we continually monitor our exposure to
currency fluctuations. We have not incurred significant realized losses on
exchange transactions. If realized losses on foreign transactions were to become
significant, we would evaluate appropriate strategies, including the possible
use of foreign exchange contracts, to reduce such losses.
Intangible Asset Risk. We have a substantial amount of intangible
assets. Although at December 31, 2000 we believe our intangible assets are
recoverable, changes in the economy, the business in which we operate and our
own relative performance could change the assumptions used to evaluate
intangible asset recoverability. We continue to monitor those assumptions and
their consequent effect on the estimated recoverability of our intangible
assets.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this Form
10-K. See Item 14.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information regarding directors and executive officers required by Item
10 is incorporated by reference from the information set forth in the Company's
definitive proxy statement for its annual stockholders' meeting to be held on
May 30, 2001.
46
Item 11. Executive Compensation
The information regarding executive compensation required by Item 11 is
incorporated by reference from the information set forth in the Company's
definitive proxy statement for its annual stockholders' meeting to be held on
May 30, 2001.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information regarding security ownership of certain beneficial owners
and management required by Item 12 is incorporated by reference from the
information set forth in the Company's definitive proxy statement for its annual
stockholders' meeting to be held on May 30, 2001.
Item 13. Certain Relationships and Related Transactions
The information regarding certain relationships and related transactions
required by Item 13 is incorporated by reference from the information set forth
in the Company's definitive proxy statement for its annual stockholders' meeting
to be held on May 30, 2001.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Financial Statements
The following consolidated financial statements of SmartDisk
Corporation are filed as a part of this report:
Page
----
Report of Independent Certified Public Accountants......................50
Consolidated Financial Statements:
Balance Sheets as of December 31, 1999 and 2000.....................51
Statements of Operations
for the years ended December 31, 1998, 1999 and 2000..............52
Statements of Cash Flows
for the years ended December 31, 1998, 1999 and 2000..............53
Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1998, 1999 and 2000..............54
Notes to Consolidated Financial Statements..........................56
Selected Quarterly Financial Data (Unaudited).......................77
(a) 2. Financial Statement Schedules
The following financial statement schedule of the Company for each of the
years ended December 31, 1998, 1999 and 2000 is filed as part of this Form 10-K
and should be read in conjunction with the Consolidated Financial Statements,
and the related notes thereto, of the Company.
Page
----
Schedule II--Valuation and Qualifying Accounts...............................78
47
All other schedules are omitted since they are either not required, not
applicable or the required information is shown in the consolidated financial
statement or notes thereto.
(a) 3. Exhibits
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Securities and Exchange Commission.
Exhibit
Number Description
- ------- -----------
2.1 Agreement and Plan of Merger among SmartDisk, VST Acquisition
Corp., Inc., VST Technologies, Inc. and certain stockholders of
VST Technologies, Inc. (2.0) (2)
3.1 Certificate of Incorporation (3.1) (1)
3.2 Bylaws (3.2) (1)
10.1 1998 Employee Stock Option Plan (10.1) (1) *
10.2 1998 Directors and Consultants Stock Option Plan (10.2) (1) *
10.3 1999 Incentive Compensation Plan (10.3) (5) *
10.4 1999 Employee Stock Option Plan (10.4) (1) *
10.5 Employment Agreement with Michael S. Battaglia (10.5) (4)
10.6 Employment Agreement with Robert Protheroe (10.6) (1)
10.7 Employment Agreement with Quresh Sachee (10.7) (4)
10.8 Employment Agreement with Vincent Fedele (10.8) (6)
10.9 Employment Agreement with James M. Giarrusso (10.9) (6)
10.10 License Agreement dated May 26, 1998 between Toshiba Corporation
and SmartDisk, as amended (10.8) (1)
10.11 Operating Agreement dated May 28, 1998 between Fischer
International System Corporation and SmartDisk, as amended (10.9)
(1)
10.12 License and Distribution Agreement dated May 28, 1998 between
SmartDisk and Fischer International Systems Corporation (10.10)
(1)
10.13 Distribution Agreement dated May 28, 1998 between Fischer
International Systems Corporation (10.11) (1)
10.14 Investors' Rights Agreement dated May 22, 1998 among SmartDisk
and each of the investors a party thereto (10.12) (1)
10.15 Amendment Number One to Investors' Rights Agreement dated July
1999 among SmartDisk and each of the investors a party thereto
(10.13) (3)
10.16 Management Registration Rights Agreement dated March 6, 2000
among SmartDisk and certain former stockholders of VST
Technologies, Inc. (10.16) (6)
10.17 Non-Management Registration Rights Agreement dated March 6, 2000
among SmartDisk and certain former stockholders of VST
Technologies, Inc. (10.17) (6)
10.18 Lease Agreement dated October 4, 1993 between Arnold Industrial
Park and SmartDisk, by assignment (10.13) (1)
10.19 Development and License Agreement dated June 30, 1999 between
SmartDisk and Sony Corporation
10.20 Development and License Agreement dated December 1, 1999 between
SmartDisk and Sony Corporation (10.16) (3)
10.21 Cooperative Development Agreement dated June 30, 1999 between
SmartDisk and SanDisk Corporation (10.15) (1) +
48
Exhibit
Number Description
- ------- -----------
10.22 Form of Indemnification between the Registrant and each of its
directors and executive officers (10.16) (1)
10.23 Joint Venture Agreement dated as of February 24, 1998 by and
among Phoenix House Investments, L.L.C., Toshiba Corporation and
SmartDisk (10.17) (1)
10.24 Amendment No. 2 to License Agreement dated April 1, 1999 between
Toshiba Corporation and SmartDisk (10.20) (4)
10.25 Agreement for the exchange of the whole of the issued share
capital of Impleo Limited dated April 28, 2000 among SmartDisk
and the stockholders of Impleo Limited (10.25) (5)
10.26 Lease Agreement dated July 2, 1996 between SmartDisk Personal
Storage Systems Corporation and Nagog Development Company, as
amended.
21.1 Subsidiaries of SmartDisk
23.1 Consent of Ernst & Young LLP
- ------------
(1) Incorporated by reference to the exhibit in the preceding parentheses as
filed with SmartDisk's registration statement on Form S-1 (Registration No.
333-82793).
(2) Incorporated by reference to the exhibit in the preceding parentheses as
filed with SmartDisk's Current Report on Form 8-K on March 21, 2000 (File
No. 000-27257).
(3) Incorporated by reference to the exhibit in the preceding parentheses as
filed with SmartDisk's Annual Report on Form 10-K for the year ended
December 31, 1999 (File No. 000-27257).
(4) Incorporated by reference to the exhibit in the preceding parentheses as
filed with Amendment No. 1 to SmartDisk's Annual Report on Form 10-K/A for
the year ended December 31, 1999 (File No. 000-27257).
(5) Incorporated by reference to the exhibit in the preceding parentheses as
filed with SmartDisk's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000 (File No. 000-27257).
(6) Incorporated by reference to the exhibit in the preceding parentheses as
filed with SmartDisk's registration statement on Form S-3 (Registration No.
333-48466).
* Management Compensation Plan or Arrangement.
+ Certain information in these exhibits has been omitted pursuant to a request
for confidential treatment filed with the SEC.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by the Company during the fourth quarter
of our fiscal year ended December 31, 2000.
49
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of SmartDisk Corporation:
We have audited the accompanying consolidated balance sheets of
SmartDisk Corporation as of December 31, 1999 and 2000, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 2000. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a)2. These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial position of
SmartDisk Corporation at December 31, 1999 and 2000, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Miami, Florida
February 13, 2001
50
SMARTDISK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------
1999 2000
--------- ---------
(in thousands,
except par value)
ASSETS
Current assets:
Cash and cash equivalents $ 19,080 $ 12,833
Restricted cash 1,050 1,671
Short-term investments 26,640 6,001
Accounts receivable, net 3,866 7,176
Notes receivable 6,302 28
Inventories 1,474 15,378
Other current assets 1,353 3,262
--------- ---------
Total current assets 59,765 46,349
Property and equipment, net 2,624 3,265
Goodwill, net 56 52,110
Other intangible assets, net 827 22,988
Deposits and other assets 172 309
--------- ---------
TOTAL ASSETS $ 63,444 $ 125,021
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,330 $ 9,125
Bank line of credit and discounted notes 4,895 1,907
Income taxes payable 1,110 878
Deferred revenue 308 725
Other accrued liabilities 2,015 3,577
--------- ---------
Total current liabilities 13,658 16,212
Deferred tax liabilities -- 8,494
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value; 5,000 shares authorized; none issued -- --
Common stock, $.001 par value; 60,000 shares authorized; 16,072 issued
and 15,991 outstanding at December 31, 1999; 17,596 issued and
17,509 outstanding at December 31, 2000 16 18
Capital in excess of par value 71,246 146,388
Treasury stock, 81 shares at December 31, 1999 and 87 shares at
December 31, 2000, at cost (58) (89)
Accumulated other comprehensive income 712 315
Notes receivable from officers/employees (387) (336)
Accumulated deficit (21,743) (45,981)
--------- ---------
Total stockholders' equity 49,786 100,315
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,444 $ 125,021
========= =========
See notes to consolidated financial statements.
51
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
------------------------------------
1998 1999 2000
-------- -------- --------
(in thousands, except per share amounts)
REVENUES
Net product sales $ 15,038 $ 37,262 $ 94,318
Research and development -- 2,587 1,349
License fees and royalties 284 470 1,055
-------- -------- --------
Total revenues 15,322 40,319 96,722
COST OF REVENUES 12,600 24,820 74,039
-------- -------- --------
GROSS PROFIT 2,722 15,499 22,683
OPERATING EXPENSES
Research and development 2,107 5,869 9,174
Sales and marketing 1,566 1,608 6,568
General and administrative 4,631 6,259 12,294
Amortization of goodwill and other
acquisition related intangible assets -- -- 24,691
-------- -------- --------
Total operating expenses 8,304 13,736 52,727
-------- -------- --------
OPERATING INCOME (LOSS) (5,582) 1,763 (30,044)
Gain (loss) on foreign exchange (47) 30 348
Interest and other income 76 586 1,473
Interest expense (52) (54) (112)
-------- -------- --------
Net income (loss) before income taxes (5,605) 2,325 (28,335)
Income tax expense (benefit) (102) 1,367 (4,097)
-------- -------- --------
NET INCOME (LOSS) $ (5,503) $ 958 $(24,238)
======== ======== ========
Earnings (loss) per share - basic $ (0.68) $ 0.09 $ (1.44)
Earnings (loss) per share - diluted $ (0.68) $ 0.07 $ (1.44)
Weighted average shares used to calculate
earnings (loss) per share amounts
Basic 8,040 10,725 16,861
Diluted 8,040 13,349 16,861
See notes to consolidated financial statements.
52
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
------------------------------------
1998 1999 2000
-------- -------- --------
(in thousands)
Cash flows from operating activities:
Net income (loss) $ (5,503) $ 958 $(24,238)
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation of property and equipment 614 1,478 2,183
Amortization of goodwill and other intangible assets 411 552 25,122
Provision for uncollectible accounts 26 93 492
Provision for sales returns and other credits -- -- 2,439
Provision for inventory obsolescence -- 87 7,964
Employee stock option expense -- 76 --
Foreign currency gain (31) (30) (348)
Deferred income tax benefit (102) (389) (4,360)
Forgiveness of note receivable -- -- 180
Loss on disposals of property and equipment -- -- 265
Loss on sale of short-term investments -- -- 20
Changes in assets and liabilities:
Accounts receivable (2,222) (1,763) (1,085)
Notes receivable (1,382) (4,921) 6,274
Inventories (1,395) 128 (7,383)
Other current assets (240) (918) (1,626)
Deposits and other assets (177) 94 (137)
Accounts payable 3,452 1,623 (3,419)
Income taxes payable -- -- (1,697)
Deferred research and development contract revenue -- 308 417
Other accrued liabilities and income taxes payable 588 2,432 (79)
-------- -------- --------
Net cash (used in) provided by operating activities (5,961) (192) 984
Cash flows from investing activities:
Purchases of property and equipment (1,020) (3,057) (1,770)
Proceeds from disposals of property and equipment -- -- 250
Cash paid for acquisitions, net of cash acquired -- -- (18,998)
Purchases of short-term investments -- (36,708) (9,117)
Sales and maturities of short-term investments -- 9,995 29,818
Purchase of intangible assets -- (405) --
Increase in restricted cash (1,050) -- (621)
-------- -------- --------
Net cash used in investing activities (2,070) (30,175) (438)
Cash flows from financing activities:
Proceeds from issuance of exchangeable note 5,000 -- --
Net borrowings (repayments) under line of credit 2,248 2,647 (7,232)
Net proceeds (repayment) of stockholder loan (3,955) -- --
Net proceeds (repayment) of loan from related parties (1,045) -- --
Proceeds from sale of redeemable common stock 4,950 -- --
Net proceeds from issuance of common stock 3,260 43,821 --
Proceeds from exercise of stock options -- -- 263
Proceeds from stock issued under ESPP -- -- 473
Proceeds from sale of stock by SDL -- 65 --
Collections on notes receivable from officers/employees -- 30 51
Purchase of treasury stock (58) (1) --
-------- -------- --------
Net cash provided by (used in) financing activities 10,400 46,562 (6,445)
Effect of exchange rate fluctuations on cash 221 (35) (348)
-------- -------- --------
Increase (decrease) in cash and cash equivalents 2,590 16,160 (6,247)
Cash and cash equivalents at beginning of period 330 2,920 19,080
-------- -------- --------
Cash and cash equivalents at end of period $ 2,920 $ 19,080 $ 12,833
======== ======== ========
Supplemental cash flow disclosures:
Issuance of common stock for business combinations $ -- $ -- $ 72,958
Conversion of stockholder loan to capital -- 648 --
Exchange of note payable plus accrued interest
for redeemable common stock 5,042 -- --
Notes receivable obtained for stock option exercise 417 -- 210
Forgiveness of note receivable -- -- 210
Issuance of common stock for intellectual property 900 300 1,240
See notes to consolidated financial statements.
53
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock Capital in
--------------------------- Excess of Comprehensive Accumulated
Shares Amount Par Value Income (Loss) Deficit
---------- ------ ---------- ------------- ------------
(in thousands)
Balance at December 31, 1997 7,748 $ 8 $ 12,375 $(17,198)
Comprehensive loss:
Net loss $ (5,503) (5,503)
Foreign currency translation 290
---------------
Comprehensive loss $ (5,213)
===============
Issuance of common stock in private placement 666 3,164
Common stock issued for trademarks 150
Common stock issued under stock option plans 700 1 512
Acquisition of SDL minority interest 33 300
Repurchase of common stock
---------- ----- --------- ------------
Balance at December 31, 1998 9,297 9 16,351 (22,701)
Comprehensive income:
Net income $ 958 958
Foreign currency translation adjustments 277
Unrealized loss on short-term investments (44)
---------------
Comprehensive income $ 1,191
===============
Issuance of common stock in public offering, net 3,453 3 39,170
Conversion of redeemable common stock 2,487 3 9,990
Issuance of common stock in private placements 650 1 4,299
Issuance of common stock under stock option plans 48 252
Issuance of common stock under employee
stock purchase plan 15 171
Issuance of common stock for license 37 300
Conversion of stockholder loan into SDL shares 76 648
Issuance of shares by SDL 9 65
Collection on notes receivable from
officers/employees
Repurchase of common stock
---------- ----- -------- ------------
Balance at December 31, 1999 16,072 16 71,246 (21,743)
Comprehensive loss:
Net loss $(24,238) (24,238)
Foreign currency translation (447)
Unrealized gain on short-term investments 50
---------------
Comprehensive loss $(24,635)
===============
Issuance of common stock under stock
option plans 161 1 472
Issuance of common stock under employee
stock purchase plan 62 473
Issuance of common stock for intellectual property 87 1,240
Acquisition of VST Technologies, Inc. 1,089 1 69,584
Acquisition of Impleo Limited 125 3,373
Collection on notes receivable from
officers/employees
Repurchase of common stock
---------- ---- -------- ------------
Balance at December 31, 2000 17,596 $ 18 $146,388 $(45,981)
========== ==== ======== ============
See notes to consolidated financial statements.
54
Notes
Accumulated Receivable
Other From
Comprehensive Officers/ Treasury
Income (Loss) Employees Stock Total
------------- ----------- -------- -----
Balance at December 31, 1997 $ 189 $ -- $ -- $ (4,626)
Comprehensive loss:
Net loss
Foreign currency translation 290
Comprehensive loss (5,213)
Issuance of common stock in private placement 3,164
Common stock issued for trademarks --
Common stock issued under stock option plans (417) 96
Acquisition of SDL minority interest 300
Repurchase of common stock (57) (57)
----- ------------ ---------- ----------
Balance at December 31, 1998 479 (417) (57) (6,336)
Comprehensive income:
Net income
Foreign currency translation adjustments 277
Unrealized loss on short-term investments (44)
Comprehensive income 1,191
Issuance of common stock in public offering, net 39,173
Conversion of redeemable common stock 9,993
Issuance of common stock in private placements 4,300
Issuance of common stock under stock option plans 252
Issuance of common stock under employee
stock purchase plan 171
Issuance of common stock for license 300
Conversion of stockholder loan into SDL shares 648
Issuance of shares by SDL 65
Collection on notes receivable from
officers/employees 30 30
Repurchase of common stock (1) (1)
----- ------------ ---------- ----------
Balance at December 31, 1999 712 (387) (58) 49,786
Comprehensive loss:
Net loss
Foreign currency translation (447)
Unrealized gain on short-term investments 50
Comprehensive loss (24,635)
Issuance of common stock under stock
option plans 473
Issuance of common stock under employee
stock purchase plan 473
Issuance of common stock for intellectual property 1,240
Acquisition of VST Technologies, Inc. 69,585
Acquisition of Impleo Limited 3,373
Collection on notes receivable from
officers/employees 51 51
Repurchase of common stock (31) (31)
----- ------------ ---------- ----------
Balance at December 31, 2000 $ 315 $ (336) $ (89) $ 100,315
===== ============ ========== ==========
See notes to consolidated financial statements.
55
SMARTDISK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000
Note 1. Business and Organization
Business
SmartDisk Corporation ("SmartDisk" or the "Company") designs, develops,
manufactures and markets digital connectivity products and personal storage
systems that enable consumers and businesses to easily access, exchange,
organize and store all types of digital content such as photographs, video,
music, voice and data among digital appliances, personal computers and the
Internet. The Company serves customers in the electronics and other consumer
markets. Principal geographic markets for the Company's products include the
United States, Japan, Europe and other world markets.
Organization
SmartDisk was incorporated in March 1997, and its predecessor,
SmartDisk Security Corporation ("SDSC") was incorporated in May 1993. SDSC was
substantially wholly-owned by Addison Fischer ("Fischer"). From 1993 to 1995,
SDSC exploited technology that it licensed under a manufacturing license
agreement with Fischer International Systems Corporation ("FISC"), another
company substantially wholly-owned by Fischer. The license agreement covered the
manufacture and sale of solid-state diskettes relating to the fields of data
security and validation and computer security and access control. The patents
underlying the licensed technology were held by SmartDiskette GmbH ("SDG"), a
German company that is wholly-owned by SmartDiskette Limited ("SDL"), an English
company that was approximately 37% owned by Fischer until May 1996. SDG licensed
these patents to SDL. SDL in turn entered into a manufacturing license agreement
with FISC that FISC subsequently assigned to SDSC. In May 1996, Fischer
increased his ownership of SDL to 87% and the accounts of SDL were adjusted as
of that date to reflect a new basis under the purchase method of accounting. In
May 1997, Fischer increased his ownership of SDL to 92%. In May 1998, Phoenix
House Investments, LLC ("Phoenix House"), an investment company substantially
owned by Fischer, acquired the remaining outstanding interests of SDL through
the issuance of common stock valued at approximately $300,000. In May 1999, the
stockholders of SDL exchanged all their shares of SDL for 515,500 shares of
common stock of SmartDisk and SDL became a wholy owned subsidiary of SmartDisk.
The merger was a combination of entities under common control and accounted for
at historical cost. The individual financial statements of SmartDisk and SDL are
combined in the accompanying financial statements from May 1996, the point in
time SDL came under common control.
In March 2000, the Company acquired VST Technologies, Inc. ("VST") to
expand the Company's product line to include USB- and Firewire-based personal
storage systems. In April 2000, the Company acquired Impleo Limited ("Impleo")
to increase the Company's access to the European market. These acquisitions were
recorded under the purchase method of accounting. See Note 3 for additional
information on these acquisitions.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions between the companies have been eliminated. The consolidated
financial statements are stated in U.S. dollars and have been prepared in
accordance with accounting principles generally accepted in the United States.
Certain Uncertainties and Risks
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash and cash equivalents,
short-term investments and trade receivables. The Company places its cash and
cash equivalents and short-term investments with major financial institutions.
56
The Company sells a significant portion of its products through
distributors and third-party resellers and, as a result, maintains individually
significant receivable balances with major customers. If the financial condition
or operations of these customers were to deteriorate, the Company's results
could be adversely affected. Credit terms to these distributors and resellers
generally range from 30 to 60 days. The Company evaluates and monitors the
credit worthiness of each customer on a case-by-case basis. Allowances are
maintained for potential credit losses.
The Company sells to original equipment manufacturers ("OEMs"),
distributors, resellers and retailers in the United States, Japan, Europe and
other world markets. However, large portions of the Company's sales are to
Japanese customers. Japanese sales as well as related expenses are denominated
in Yen and, accordingly, are subject to the risks associated with fluctuations
in exchange rates between the Yen and the US dollar. The Company does not hedge
against foreign currency exposure.
Certain raw materials used by the Company in the manufacture of its
products are available from a limited number of suppliers. The Company is
dependent on its manufacturers to allocate a sufficient portion of their
manufacturing capacity to meet the Company's needs.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Foreign Currency Translation
The functional currency of most of the Company's wholly-owned foreign
subsidiaries is the local currency. Assets and liabilities of the subsidiaries
are translated to the U.S. dollar at the current exchange rates in effect at the
balance sheet date with the resulting translation adjustments recorded directly
to a separate component of stockholders' equity. Revenue and expense accounts
are translated using average exchange rates in effect for the period in which
the items occur. Where the U.S. dollar is the functional currency or the
transactions are denominated in U.S. dollars, translation adjustments are
reflected in the gain (loss) on foreign exchange account included in the
statement of operations.
Cash, Cash Equivalents and Short-Term Investments
All highly liquid investments with an original maturity of three months
or less when purchased are considered to be cash equivalents. All cash
equivalents are carried at cost, which approximates fair value. Cash and cash
equivalents include money market funds, certificates of deposit and U.S.
government agency securities.
57
The Company has cash investment policies that limit investments to
investment grade securities. Investments held by the Company are classified as
"available-for-sale" as defined by Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and are carried at fair value based on quoted market prices. Such
investments consist of U.S. government agency securities, corporate debt
securities and asset backed securities with original maturities beyond three
months and less than twenty-four months. Realized losses represent the
difference between the proceeds received upon sale of an investment and its
amortized cost.
The Company's realized losses during the years ended December 31, 1999
and 2000 were $46,000 and $44,000, respectively. The Company had unrealized
losses, net of tax, as of December 31, 1999 of $44,000 and unrealized gains, net
of tax, as of December 31, 2000 of $6,000.
The fair value of the Company's short-term investments is as follows:
Amortized Aggregate Unrealized Unrealized
December 31, 1999 Cost Basis Fair Value Gains Losses
----------------- ---------- ---------- ---------- ----------
(in thousands)
U.S. government and government agency
securities $15,965 $15,920 $ -- $ (45)
Asset backed securities 5,991 5,984 -- (6)
Corporate bonds and notes 4,757 4,736 -- (21)
------- ------- ----- -------
Total short-term investments $26,713 $26,640 $ -- $ (72)
======= ======= ===== =======
Amortized Aggregate Unrealized Unrealized
December 31, 2000 Cost Basis Fair Value Gains Losses
----------------- ---------- ---------- ---------- ----------
(in thousands)
U.S. government and government agency
securities $ 4,990 $ 5,000 $ 10 $ --
Corporate bonds and notes 1,001 1,001 -- --
------- ------- ----- -------
Total short-term investments $ 5,991 $ 6,001 $ 10 $ --
======= ======= ===== =======
The following represents the aggregate fair values of maturities of the
Company's short-term investments:
December 31,
-------------------
1999 2000
------- -------
(in thousands)
Due in 0-12 months $ 9,996 $ 6,001
Due in 12-24 months 16,644 --
------- -------
Total $26,640 $ 6,001
======= =======
Restricted Cash
Restricted cash is mainly composed of a time deposit maintained by our
Japanese subsidiary as collateral for a line of credit.
58
Fair Value of Other Financial Instruments
The carrying value of cash and cash equivalents, restricted cash,
accounts receivable, accounts payable, other accrued liabilities and lines of
credit approximate fair value because of the short-term maturity of these
financial instruments.
Inventories
Inventories are stated at the lower of cost or market (estimated net
realizable value), with cost being determined on a first-in, first-out basis.
Property and Equipment
Property and equipment are stated at cost, less accumulated
depreciation and amortization. All major expenditures for production equipment
are capitalized and depreciated over the economic life of the asset.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, which are approximately three years for computer and
electronic equipment and software and five years for office furniture and
fixtures. Depreciation and amortization of leasehold improvements is computed
using the shorter of the remaining lease term or five years. In addition,
certain production equipment is depreciated using the units-of-production
method. The units-of-production method depreciates the property over the
estimated life cycle production quantities. The monthly depreciation cost is
calculated by using the number of pieces produced times the depreciation cost
per piece computed from the estimated total production quantity. The costs of
repairs and maintenance are charged to expense in the period when they are
incurred.
Intangible Assets
Intangible assets primarily consist of goodwill and separately
identified intangible assets recognized in connection with the Company's
acquisitions during the year. Amortization of intangible assets is provided
using the straight-line method over the assets' estimated useful lives, which
range from one to ten years.
Impairment of Long-Lived Assets
The Company's long-lived assets consist primarily of goodwill and other
intangible assets, property and equipment and other long-term assets. SmartDisk
reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Such events or circumstances include, but are not limited to, a
significant decrease in the fair value of the underlying business, a significant
decrease in the benefits realized from the acquired business, or a significant
change in the operations of the acquired business.
Recoverability of long-lived assets is measured by comparison of the
carrying amount to future undiscounted net cash flows the assets are expected to
generate. If assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
long-lived assets exceeds its fair market value.
Software Development Costs
Development costs incurred in the research and development of new
software products and enhancements to existing software products are expensed as
incurred until technological
59
feasibility has been established, at which time certain development costs
required to attain general production release would be capitalized. To date, the
Company's software development has essentially been completed concurrent with
the establishment of technological feasibility, and, accordingly, no costs have
been capitalized.
Income Taxes
Deferred income tax assets and liabilities are determined based upon
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
Revenue Recognition
Product revenue is recognized when title and risk of loss are
transferred to customers, which is generally at the time of shipment. Title and
risk of loss is transferred when pervasive evidence of an arrangement exists,
delivery has occurred, the sales price is fixed or determinable and
collectibility is probable. Accordingly, the Company defers recognition of
revenue on shipments to certain distributors until the distributors have resold
the products. Product revenue at our Japanese subsidiary is recognized upon
acceptance by the customer. The Company records a provision for estimated
product returns at the time the related revenue is recognized on sales to
certain resellers that have rights of return. The Company also provides for
price protection and other offerings that may occur under programs the Company
has with its customers. The Company records a provision for product warranties
upon shipment. Shipping and handling costs are included in cost of goods sold.
Research and development revenue is recognized when earned based upon
achievement of contract milestones. License fees and royalties are recognized
when earned based upon terms contained in the respective contractual agreements.
Stock Based Compensation
The Company has adopted the disclosure only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. In accordance with the provisions of
SFAS No. 123, the Company applies Accounting Principles Board Opinion (APB) No.
25, Accounting for Stock Issued to Employees, and related interpretations, to
account for stock-based compensation arrangements. The Company has included the
pro forma disclosures required under SFAS No. 123 in Note 12.
Advertising
Advertising costs are charged to expense as incurred, advertising
expenses for 1998, 1999 and 2000 were $214,000, $147,000 and $2,503,000,
respectively.
60
Comprehensive Income (Loss)
Other comprehensive income (loss) refers to revenues, expenses, gains,
and losses that under accounting principles generally accepted in the United
States are included in comprehensive income (loss) but are excluded from net
income (loss) as these amounts are recorded directly as an adjustment to
stockholders' equity, net of tax. SmartDisk's other comprehensive income (loss)
is composed of unrealized gains and losses on available-for-sale securities and
foreign currency translation adjustments.
Segment Information
The Company reports segment data based on the management approach which
designates the internal reporting that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable operating segments. The Company also discloses information about
products and services and geographical areas.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as
amended, which is required to be adopted in years beginning after June 15, 2000.
SFAS No. 133, as amended, establishes accounting and reporting standards for
derivative instruments and hedging activities and will require the Company to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Because the
Company currently holds no derivative instruments and does not engage in hedging
activities, management does not anticipate that the adoption of SFAS No. 133
will have a significant effect on the financial position, results of operations
or cash flows of the Company.
Note 3. Acquisitions
On March 6, 2000, SmartDisk Corporation acquired all the outstanding
shares of VST common stock in exchange for approximately 1.1 million shares of
SmartDisk common stock and approximately $16.4 million in cash. In addition,
SmartDisk issued options to purchase a total of approximately 443,000 shares of
SmartDisk common stock in exchange for all issued and outstanding VST options.
Under the purchase method of accounting, the total purchase price was
allocated to VST's assets and liabilities based on their relative fair values as
of the date of the closing of the acquisition. The amounts and components of the
purchase price along with the allocation of the purchase price to net assets
acquired are presented below (in thousands).
Purchase Price
Cash $16,433
Fair value of common stock issued 49,793
Fair value of SmartDisk options issued 19,792
Transaction costs 2,918
-------
Total purchase price $88,936
=======
61
Net Assets Acquired
Book value of net tangible assets of VST $ 9,181
Intangible assets:
Non-compete agreements 21,300
Distributions channels 4,900
VST trade name 4,800
Patents 2,200
Workforce in place 1,000
Deferred income taxes (13,680)
Goodwill 59,235
-------
Net assets acquired $88,936
=======
The consolidated financial statements include the operating results of
VST from the date of acquisition. The following unaudited pro forma financial
information reflects the VST acquisition as if it had occurred on January 1,
1999 after giving effect to certain adjustments including amortization of
goodwill and other acquired intangible assets. The pro forma financial
information does not purport to represent what the Company's actual results of
operations would have been had the acquisition occurred as of January 1, 1999
and may not be indicative of operating results for any future periods.
Years Ended December 31,
-----------------------
1999 2000
-------- --------
(in thousands, except per share amounts)
Revenues $101,845 $102,759
Net loss $(31,058) $(30,296)
Loss per share--Basic and diluted $ (2.63) $ (1.69)
On April 21, 2000, the Company completed its acquisition of
substantially all of the intellectual property of El Gato Software LLC ("El
Gato"), a California limited liability company, for approximately $755,000 in
cash and approximately 37,000 shares of SmartDisk common stock, valued at $1.0
million. El Gato develops and markets USB and FireWire drivers, applications and
firmware support for leading personal storage systems. The purchase price of the
acquired intellectual property is being amortized over two years.
On April 28, 2000, the Company acquired all of the capital stock of
Impleo, an English corporation, for approximately $200,000 in cash and
approximately 125,000 shares of SmartDisk common stock, valued at approximately
$3.4 million. Impleo manufactures and markets digital connectivity products and
personal storage systems under the Datawise brand. Under purchase accounting,
the total purchase price was allocated to Impleo's assets and liabilities based
on their relative fair values as of the date of the closing of the acquisition.
Amounts allocated to identifiable assets and the residual goodwill are amortized
on a straight-line basis over periods not exceeding five years. Identifiable
intangible assets include trade name, workforce in place, distribution channel
and non-compete agreements. The consolidated financial statements include the
operating results of Impleo from the date of acquisition. Pro forma results of
operations have not been presented because the effect of this acquisition was
not material.
62
Note 4. Accounts and Notes Receivable
SmartDisk's accounts receivable are reported net of allowance for
doubtful accounts of approximately $140,000 and $705,000 at December 31, 1999
and 2000, respectively and sales returns and other credits of approximately
$245,000 at December 31, 2000. The Company had no allowance for sales returns
and other credits at December 31, 1999.
At December 31, 1999, the Company's Japanese subsidiary had
approximately $6.3 million of trade receivables, substantially all of which
related to sales to Asian OEMs, that were subject to extend payment term
arrangements. This is a normal business practice in Asia, particularly in Japan,
and, in these cases, credit terms generally ranged from 90-120 days. The OEMs
are required to pay for the products they order and accept from the Company,
whether or not they ultimately resell the products. All of these notes
receivable were collected in 2000 and the amount of notes receivable at December
31, 2000 was minimal.
Note 5. Inventory
Inventories consist of the following:
December 31,
------------------
1999 2000
------ -------
(in thousands)
Finished goods $1,474 $ 4,859
Raw materials -- 10,519
------ -------
Total inventories $1,474 $15,378
====== =======
Note 6. Property and Equipment
Property and equipment consists of the following:
December 31,
--------------------
1999 2000
------- -------
(in thousands)
Equipment $ 3,698 $ 5,014
Furniture and fixtures 319 603
Software 370 984
Leasehold improvements -- 84
Property and equipment, at cost 4,387 6,685
Accumulated depreciation and amortization (1,763) (3,420)
------- -------
Property and equipment, net $ 2,624 $ 3,265
======= =======
Note 7. Goodwill and Other Intangible Assets
During 1999, the Company incurred approximately $400,000 in costs for
the successful defense of the patent on its primary technology and product.
These costs have been capitalized and included in patents. These costs are being
amortized over three years, the expected future life of the patent.
On June 30, 1999, the Company issued 37,500 shares of its common stock
to SanDisk Corporation ("SanDisk") in exchange for a license to utilize certain
patented technology developed by SanDisk. The Company is amortizing the license
on a straight-line basis over the ten year term of the license. In addition, the
Company is required to pay a royalty to SanDisk on
63
net revenues from direct sales to customers other than SanDisk of products
developed by the Company utilizing this licensed technology.
Goodwill and other intangible assets consist of the following:
December 31,
-------------------
Life 1999 2000
-------- ------ --------
(in thousands)
Goodwill 5 yrs. $ 326 $ 62,730
Accumulated amortization (270) (10,620)
------ --------
Goodwill, net $ 56 $ 52,110
====== ========
Covenants not to compete 2 yrs. $ -- $ 21,450
Patents 2-3 yrs. 1,389 5,316
Distribution channel 2 yrs. -- 5,100
Tradenames 1-2 yrs. -- 4,950
Workforce in place 4 yrs. -- 1,200
Licenses 10 yrs. 301 539
------ --------
Total other intangible assets 1,690 38,555
Accumulated amortization (863) (15,567)
------ --------
Other intangible assets, net $ 827 $ 22,988
====== ========
Note 8. Bank Line of Credit
The Company maintains a line of credit in the United States under which
it may borrow up to $10.0 million subject to a borrowing base agreement, which
includes not more than 80% of specified accounts receivable. Any amounts
borrowed under this line of credit bear interest at 2% over the 30-day LIBOR
rate and are secured by substantially all of the Company's assets. This line of
credit expires in April 2001. As of December 31, 1999 and 2000, there were no
borrowings outstanding under this line of credit.
As of December 31, 2000, the Company's wholly owned Japanese subsidiary
had a line of credit with a maximum borrowing capacity of approximately $2.6
million, which was secured by accounts receivable of specified trade customers
and a time deposit. The interest rate on borrowings under the credit facility is
1.5% per year and expires in February 2002. The outstanding balance under this
line of credit was approximately $2.0 million and $1.7 million as of December
31, 1999 and 2000, respectively.
The Japanese subsidiary also discounts certain short-term promissory
notes received from certain trade customers with a bank in Japan. Bank
borrowings collateralized by promissory notes totaled approximately $2.9 million
as of December 31, 1999. The subsidiary had no outstanding borrowings
collateralized by promissory notes as of December 31, 2000.
As of December 31, 2000, the Company's wholly owned UK subsidiary had a
line of credit with a maximum borrowing capacity of approximately $0.7 million.
The interest rate on borrowings under the credit facility, which expires in
April 2001, is 5.5% per year. The
64
outstanding balance under the line of credit as of December 31, 2000 was
approximately $0.2 million.
Interest paid during the years ended December 31, 1998, 1999 and 2000
amounted to $5,000, $54,000 and $112,000, respectively.
Note 9. Commitments, Contingencies and Factors That May Affect
Future Operations
Leases
The Company leases certain office and warehouse space and office
equipment under various operating leases. Rent expense on operating leases for
the years ending December 31, 1998, 1999 and 2000 totaled approximately
$261,000, $444,000, and $1,090,000, respectively. The table below sets forth
minimum payments for the years indicated under operating leases with remaining
terms in excess of one year, at December 31, 2000 (in thousands):
2001 ............. $ 993
2002 ............. 640
2003 ............. 557
2004 ............. 185
------
Total $2,375
======
Employment Agreements
The Company has entered into employment agreements with certain of its
employees. These agreements stipulate, among other things, severance and benefit
arrangements in the event of termination. In addition, the agreements include
confidentiality provisions, invention assignment provisions, and covenants not
to compete.
Contingencies
The Company relies on a combination of patents, trademarks, copyright
and trade secret laws, confidentiality procedures and licensing arrangements to
protect its intellectual property rights. There can be no assurance that there
will not be any disputes regarding the Company's intellectual property rights.
Specifically, there can be no assurance that any patents held by the Company
will not be invalidated, that patents will be issued for any of the Company's
pending applications or that any claims allowed from existing or pending patents
will be of sufficient scope or strength or be issued in the primary countries
where the Company's products can be sold that will provide meaningful protection
or any commercial advantage to the Company. Additionally, competitors of the
Company may be able to design around the Company's patents.
On June 26, 2000, a party filed a complaint in the Central District
Federal Court of the State of California alleging SmartDisk's infringement of a
patent. On November 20, 2000, the Company prevailed in removing the venue for
such action from the State of California to the Middle District of Florida. The
Company considers this claim to be wholly without merit. Accordingly, a
contingent loss has not been accrued by the Company as of December 31, 2000.
65
Factors That May Affect Future Operations
The Company participates in a highly volatile industry that is
characterized by intense industry-wide competition for market share. Industry
participants confront aggressive pricing practices, continually changing
customer demand patterns and rapid technological developments. The Company's
operating results could be adversely affected should the Company be unable to
successfully anticipate customer demand accurately, manage its product
transitions, inventory levels and manufacturing processes efficiently,
distribute its products quickly in response to customer demands, differentiate
its products from those of its competitors or compete successfully in the
markets for its new products.
Note 10. Earnings (Loss) Per Share Data
Basic earnings (loss) per share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
year. Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding for the year
plus the dilutive effect of potential common shares using the "treasury stock"
method. Potential common shares for 1998 and 1999 include conversion of
redeemable common stock, stock options and shares of non-vested stock. Potential
common shares for 2000 include stock options and shares of non-vested stock. For
the years ended December 31, 1998 and 2000, potential common shares totaling
2,354,481 and 1,323,496, respectively, were excluded from the computation of net
loss per share because they were anti-dilutive. For the year ended December 31,
1999, potential common shares totaling 2,624,768 were included in the
computation of earnings per share due to their dilutive effect.
Earnings (loss) per share has been computed reflecting the retroactive
adjustment of outstanding shares related to the mergers of SDSC and SDL into
SmartDisk as well as the one for four reverse stock split that was effected in
August 1999.
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
Years Ended December 31,
-----------------------------------------
1998 1999 2000
-------- -------- --------
(in thousands, except per share amounts)
Numerator:
Net income (loss) $ (5,503) $ 958 $(24,238)
======== ======== ========
Denominator:
Weighted average shares outstanding 8,040 10,724 16,861
Dilutive effect of conversion of redeemable
Common stock -- 1,901 --
Dilutive effect of stock options -- 366 --
Dilutive effect of non-vested common stock -- 358 --
-------- -------- --------
Diluted shares outstanding 8,040 13,349 16,861
======== ======== ========
Basic earnings (loss) per share $ (0.68) $ 0.09 $ (1.44)
Diluted earnings (loss) per share $ (0.68) $ 0.07 $ (1.44)
66
Note 11. Stockholders' Equity (Deficit)
In connection with an agreement that was finalized in May 1998, Toshiba
Corporation received 2,487,500 shares of redeemable common stock in exchange for
$9,991,918 (consisting of $4,950,000 cash, the exchange of a $5,000,000 note and
accrued interest of $41,918).
In January and July 1999, SmartDisk sold a total of 650,000 shares of
its common stock in private transactions for gross proceeds of $4.3 million.
In August 1999, the Company completed a reverse stock split of one for
four. The consolidated financial statements and footnotes have been
retroactively restated to reflect the reverse stock split in the prior periods,
including all references in the financial statements to number of shares and per
share amounts.
In August 1999, the Company amended and restated its Certificate of
Incorporation such that the number of shares of authorized capital stock was
increased to 65,000,000 shares, consisting of 60,000,000 shares of common stock
with a par value of $0.001 per share and 5,000,000 shares of preferred stock
with a par value $0.001 per share.
On October 6, 1999, the Company completed its initial public offering
("IPO") and realized net proceeds of approximately $39.1 million from the sale
of 3,450,000 shares of common stock. Upon the successful completion of the
Company's IPO, each of the 2,487,500 outstanding shares of redeemable common
stock were converted into one share of common stock.
Note 12. Stock Based Compensation
Stock Option Plans
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS No. 123 requires use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's stock
options equals the market price of the underlying stock on the date of grant, no
compensation expense was recognized during 1998, 1999 and 2000.
The Company's 1998 Employee Stock Option Plan authorized the grant of
options to employees including members of the Company's Board of Directors who
are employees of the Company for up to 1,454,545 shares of the Company's common
stock. Options granted under the plan are fully vested after four years and all
options granted have a ten-year contractual life. This plan was terminated in
July 1999 and no additional options can be granted under this plan. Of the
1,419,727 options granted under this plan, net of cancellations, 782,777 remain
outstanding and the Company has reserved an equivalent amount of shares of
common stock for these outstanding options.
The Company's 1998 Directors and Consultants Stock Option Plan
authorized the grant of options to officers, directors, consultants and other
independent contractors (including
67
members of the Company's Board of Directors who are not employees of the
Company) for up to 250,000 shares of the Company's common stock. Options granted
under the plan are fully vested after four years and all options granted have a
ten-year contractual life. This plan was terminated in July 1999 and no
additional options can be granted under this plan. Of the 212,781 options
granted under this plan, net of cancellations, 139,593 remain outstanding and
the Company has reserved an equivalent amount of shares of common stock for
these outstanding options.
In July 1999, the Company established the 1999 Incentive Compensation
Plan (the "1999 Plan"), which provides for the issuance of stock options, stock
appreciation rights, restricted stock, deferred stock, other stock-related
awards and performance or annual incentive awards that may be settled in cash,
stock or other property (collectively, the "Awards"). Pursuant to the terms of
the 1999 Plan, the Company reserved 2,500,000 shares for issuance. During 2000,
an additional 1,000,000 shares of common stock were reserved for issuance under
the plan. Under the 1999 Plan, as amended, the total number of shares of common
stock that may be subject to the granting of Awards at any time during the term
of the 1999 Plan shall equal 3,500,000 shares, plus the number of shares with
respect to which Awards previously granted under the 1999 Plan that terminate
without being exercised, and the number of shares of common stock that are
surrendered in the payment of any Awards or any tax withholding requirements. As
of December 31, 2000, 2,990,143 options granted under the 1999 Plan were
outstanding of which 381,511 were vested. No other form of Awards have been
granted under the 1999 Plan.
During 1998, 1999 and 2000, 880,613 options granted to employees and
directors of SmartDisk with exercise prices ranging from $0.72 to $35.00 were
immediately exercisable for cash or in part by cash (minimum par value for the
shares purchased) and the balance by a five-year full recourse promissory note.
Such notes would be secured by the shares purchased (to be held in escrow with
no transfer rights pending full payment) with interest based on the coupon rate
yield of a 52-week U.S. Treasury bill immediately preceding the execution and
issuance of the promissory note, with voting rights for the underlying shares
remaining with the shareholder until default, if any, on the note. Of the
880,613 immediately exercisable options granted, 760,988 options have been
exercised and 67,250 have been cancelled as of December 31, 2000. Of the 760,988
shares of common stock issued upon exercise, 203,747 remain nonvested and 80,977
have been repurchased and are included in treasury stock in the equity section
of the balance sheet. The nonvested shares of common stock will vest in
accordance with the provisions of the original option award.
During the year ended December 31, 1999, compensation expense of
$76,500 was recognized relating to the accelerated vesting of 21,000 options,
exercisable at $0.72 per share.
68
The following table summarizes the status and activity of the Company's
stock option plans:
Weighted Number of Weighted
Number of Average Options Average
Options Exercise Price Exercisable Exercise Price
--------- -------------- ----------- --------------
Outstanding at December 31, 1997 -- $ -- -- $ --
Options granted with exercise
prices equal to fair market value 1,041,613 1.29
Options granted with exercise
prices less than fair market value 25,000 4.00
Exercised (699,863) 0.73
Canceled (750) 0.72
---------
Outstanding at December 31, 1998 366,000 2.54 2,250 0.72
Options granted with exercise
prices equal to fair market value 1,024,500 7.77
Exercised (47,875) 3.67
Canceled (205,875) 2.66
---------
Outstanding at December 31, 1999 1,136,750 7.19 44,794 2.73
Options granted with exercise
prices equal to fair market value 2,766,500 18.55
Options granted with exercise
prices less than fair market value 443,248 1.28
Exercised (160,438) 2.94
Canceled (117,985) 31.08
---------
Outstanding at December 31, 2000 4,068,075 $ 13.74 613,597 $ 4.12
=========
The 443,248 options granted with exercise prices less than fair market
value were the options exchanged as part of the VST acquisition; therefore, no
compensation expense was recognized and the value of the options was included as
part of the purchase consideration.
The following table summarizes information about stock options
outstanding at December 31, 2000:
Outstanding Options Exercisable Options
--------------------------------------------------- -------------------------------
Weighted
Average Weighted Weighted
Range of Number of Remaining Average Options Average
Exercise Prices Options Contractual Life Exercise Price Exercisable Exercise Price
- --------------- --------- ---------------- -------------- ----------- --------------
$ 0.72 - $ 1.00 273,257 8.9 years $0.88 255,759 $0.88
$ 1.61 - $ 2.70 85,693 9.2 years 1.99 85,693 1.99
$ 4.00 - $ 5.38 1,923,200 9.6 years 5.16 130,325 4.65
$ 8.00 - $14.38 734,625 8.4 years 8.28 128,855 8.41
$19.00 - $27.50 186,000 9.4 years 24.99 -- --
$30.50 - $47.25 865,300 9.1 years 40.27 12,965 34.07
--------- -------
$0.72 - $47.25 4,068,075 9.2 years $13.74 613,597 $4.12
========= =======
Employee Stock Purchase Plan
In July 1999, the Company established the 1999 Employee Stock Purchase
Plan (the "Purchase Plan"), for which 465,000 shares of the Company's common
stock have been reserved. Eligible employees may purchase a limited number of
shares of the Company's common stock at 85% of the market value at certain
plan-defined dates. For the years ended December 31, 1999 and 2000, the Company
issued 15,411 and 62,307 shares of common stock, respectively, under the
Purchase Plan. At December 31, 2000, 387,282 shares of common stock were
available for issuance under the Purchase Plan.
Pro Forma Information for Stock-Based Compensation
Pro forma information regarding net income (loss) and earnings (loss)
per share is required by SFAS No. 123, and has been determined as if the Company
had accounted for its employee stock options and employee stock purchase plan
under the fair value method of that Statement. For the
69
fair value disclosure below, compensation value is estimated for each option
grant using a Black-Scholes option-pricing model. The following weighted average
assumptions were used for option grants in fiscal 1998, 1999 and 2000: weighted
average risk-free interest rate of 5.25%, 5.75% and 5.93% in 1998, 1999 and
2000, respectively; expected dividend yield of 0% for all years; volatility
factor of the expected market price of the Company's common stock of zero for
1998 and the period in 1999 prior to the Company's IPO, 0.80 for the period in
1999 following the Company's IPO and 1.42 for 2000; and an expected life of the
options of 3 years for all years. Options issued under the Purchase Plan during
1999 were valued with a minimum value pricing model using the following
assumptions: weighted average risk-free interest rate of 5.75%; an expected
dividend yield of 0% and a life of the options of three months. Options issued
under the Purchase Plan during 2000 were valued using a Black-Scholes
option-pricing model using the following assumptions: weighted average risk-free
interest rate of 6.0%; expected dividend yield of 0%; volatility factor of the
expected market price of the Company's common stock of 1.42; and an expected
life of the options of six months.
The weighted average grant date fair value of options granted during
the years ended December 31, 1998, 1999 and 2000 with exercise prices equal to
market value was $0.84, $5.11 and $14.89, respectively. The weighted average
grant date fair value of options granted during the year ended December 31, 1998
with exercise prices less than market value was $3.40. There were no options
granted during the year ended December 31, 1999 with exercise prices less than
market value and the options issued in 2000 at exercise prices less than market
value were those exchanged as part of the VST acquisition. The weighted average
grant date fair value of the shares issued under the Purchase Plan during 1999
and 2000 was $2.11 and $12.07, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different than those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee's stock options.
For purposes of pro forma disclosures, the estimated fair value of
options is amortized to expense over the options' vesting period. The Company's
pro forma information for options granted, excluding those exchanged in the VST
acquisition, is as follows:
Years Ended December 31,
-----------------------------------------------
1998 1999 2000
------- ------ --------
(in thousands, except per share amounts)
Net income (loss):
As reported $(5,503) $ 958 $(24,238)
Pro forma $(5,621) $ 754 $(32,178)
Basic net income (loss) per share:
As reported $ (0.68) $ 0.09 $ (1.44)
Pro forma $ (0.70) $ 0.07 $ (1.91)
Diluted net income (loss) per share:
As reported $ (0.68) $ 0.07 $ (1.44)
Pro forma $ (0.70) $ 0.06 $ (1.91)
The effects of applying SFAS No. 123 on pro forma disclosures of net
income (loss) and earnings (loss) per share for fiscal 1998, 1999 and 2000 are
not likely to be representative of the
70
pro forma effects on net income (loss) and earnings (loss) per share in future
years because the number of shares to be issued under these plans is not known
and the assumptions used to determine the fair value can vary significantly.
Note 13. Employee Benefit Plans
The Company has two defined contribution plans. One of the plans was
assumed in 2000 upon the acquisition of VST (the "VST Plan"). The VST Plan is
offered to employees of the Company's wholly owned subsidiary, SmartDisk
Personal Storage Systems Corporation. All other U.S.-based employees may elect
to participate in the SmartDisk Plan. Qualified employees may elect to make pre
tax contributions into the plans for up to 15% of their annual compensation, up
to a maximum of $10,500 per year. The Company's matching contributions are
earned by the employee based on a straight line, five-year vesting schedule for
participants in the SmartDisk Plan and a straight line, three-year vesting
schedule for participants in the VST Plan. The Company may make additional
annual contributions to the plans at the discretion of the Board of Directors.
For the years ended December 31, 1998, 1999 and 2000, the Company made matching
contributions of approximately $11,000, $31,000 and $130,000, respectively, to
these plans.
Note 14. Income Taxes
The United States and foreign components of income (loss) from
continuing operations before income taxes are as follows:
Years Ended December 31,
-----------------------------------------------
1998 1999 2000
------- ------- --------
(in thousands)
United States $(4,584) $ 553 $(32,437)
Foreign (1,021) 1,772 4,102
------- ------- --------
Total $(5,605) $ 2,325 $(28,335)
======= ======= ========
The income tax benefit for 1998 and 2000 as presented in the statements
of operations relates to the reduction of the deferred income tax liability
associated with the identified intangible assets. The components of the income
tax provision (benefit) are as follows:
Years Ended December 31,
---------------------------------------------
1998 1999 2000
----- ------ -------
(in thousands)
Current:
United States $ -- $ 60 $ (225)
Foreign -- 1,696 1,528
----- ------ -------
Total current expense $ -- 1,756 1,303
Deferred:
United States (25) (50) (5,531)
Foreign (77) (339) 131
----- ------ -------
Total deferred benefit (102) (389) (5,400)
----- ------ -------
Income tax provision (benefit) $(102) $1,367 $(4,097)
===== ====== =======
The Company made income tax payments of approximately $145,000 and $1.5
million during 1999 and 2000, respectively. No income tax payments were made in
1998.
71
The significant components of the Company's deferred income taxes are
as follows:
December 31,
-----------------------
1999 2000
------- -------
(in thousands)
Deferred tax assets:
Current:
Accrued expenses $ 134 $ 135
Bad debt & inventory reserves 85 2,698
Noncurrent:
Net operating loss carryforwards 1,238 1,787
Depreciation and amortization 105 27
Foreign tax & alternative minimum tax credits 1,759 1,759
Foreign deferred tax asset -- 105
Other 347 (29)
------- -------
Deferred tax assets 3,668 6,482
Less: valuation allowance (3,417) (6,377)
------- -------
Net deferred tax assets 251 105
Deferred tax liabilities:
Acquired intangibles (56) (8,454)
------- -------
Total net deferred taxes $ 195 $(8,349)
======= =======
The reconciliation of the U.S. federal statutory income tax rate to the
effective income tax rate is:
Years Ended December 31,
------------------------------------
1998 1999 2000
------ ----- ------
Federal income tax benefit (34.00)% 34.00% (34.00)%
State taxes, net of federal benefit (3.63) 3.57 (1.93)
Foreign tax rate differential (0.13) (0.33) (3.33)
Non-deductible items 1.38 0.56 0.06
Goodwill 0.13 1.83 11.27
Change in valuation allowance 34.01 19.48 9.94
Other 0.44 (0.32) 1.71
------ ----- ------
Total (1.80)% 58.79% (16.28)%
====== ===== ======
Prior to May 1998, SDSC elected to be taxed as an S corporation under
the Internal Revenue Code. As a result, the taxable income or losses for periods
prior to May 1998 were reported by the stockholders on their individual income
tax returns. Upon the conversion from an S corporation to a C corporation, SDSC
became subject to income tax. Subsequent to the conversion from an S corporation
to a C corporation, SDSC was merged into SmartDisk, a C corporation.
SFAS No. 109, Accounting for Income Taxes, requires a valuation
allowance to reduce the deferred tax assets reported if, based on the weight of
the evidence, it is more likely than not that some portion or all of the
deferred tax assets will not be realized. After consideration of all the
evidence, both positive and negative, management has determined that a valuation
allowance of approximately $2,643,000, $3,417,000 and $6,377,000 at December 31,
1998, 1999 and 2000,
72
respectively, is necessary to reduce the deferred tax assets to the amount that
will more likely than not be realized. The change in valuation allowance
amounted to $1,873,000, $774,000 and $2,960,000 for December 31, 1998, 1999 and
2000, respectively.
At December 31, 1999 and 2000, the Company had United States and
foreign net operating loss carryforwards for tax purposes as follows:
December 31, 1999 December 31, 2000
-------------------- ---------------------
Jurisdiction Amount Expiration Amount Expiration
------------ ------ ---------- ------ ----------
(amounts in thousands)
United States $1,532 2018 $3,521 2018
United Kingdom 2,005 Unlimited 1,539 Unlimited
Japan -- N/A -- N/A
At December 31, 1999 and 2000, the Company had United States tax credit
carryforwards as follows:
December 31, 1999 December 31, 2000
-------------------- ---------------------
Tax Credit Amount Expiration Amount Expiration
---------- ------ ---------- ------ ----------
(amounts in thousands)
Foreign tax credit $1,700 2004 $1,700 2004
Alternative minimum tax credit 60 Unlimited 60 Unlimited
Undistributed earnings of the Company's foreign subsidiaries are
considered to be permanently invested; therefore, in accordance with SFAS No.
109, no provision for U.S. Federal and state income taxes on those earnings have
been provided. Upon distribution of those earnings in the form of dividends or
otherwise, the Company would be subject to both U.S. income tax liability
(subject to an adjustment for foreign tax credits) and withholding taxes payable
to the various foreign countries. However, unrecognized foreign tax credit
carryforwards would be available to reduce some portion of the U.S. liability.
Note 15. Segment Information
Based on its method of internal reporting, SmartDisk has two reportable
segments: digital connectivity products and personal storage systems. Digital
connectivity products primarily consist of the Company's FlashPath flash memory
card readers, which support Toshiba SmartMedia, Sony Memory Stick, and SanDisk
MultiMediaCard. Personal storage systems primarily consist of the family of
Universal Serial Bus ("USB") and FireWire-based products, which include high
performance, portable hard disk drives and floppy disk drives for desktop and
notebook PCs, as well as expansion-bay disk drives for notebook PCs.
The accounting policies for each of the segments are the same as those
described in the summary of significant accounting policies. There are no
intersegment revenues. SmartDisk does not allocate operating expenses, interest
expense and other income, net or income tax expense or benefit to these segments
for internal reporting purposes.
73
The following table presents information about the Company's operations
and assets for the two reportable segments:
Years Ended December 31,
-----------------------------
1998 1999 2000
------- ------- -------
(in thousands)
Digital connectivity products:
Revenues $15,038 $37,262 $44,486
Gross profit $ 2,438 $12,468 $14,403
Personal storage systems:
Revenues $ -- $ -- $49,832
Gross profit $ -- $ -- $ 6,196
Other:
Revenues $ 284 $ 3,057 $ 2,404
Gross profit $ 284 $ 3,031 $ 2,084
Total
Revenues $15,322 $40,319 $96,722
Gross profit $ 2,722 $15,499 $22,683
Sales to foreign markets and to significant customers as a percentage
of the Company's total revenues were as follows:
Years Ended December 31,
------------------------
Foreign markets: 1998 1999 2000
---- ---- ----
Asian and Pacific Rim 84% 81% 37%
United States 10 15 57
Europe 6 4 6
Years Ended December 31,
------------------------
Significant Customers: 1998 1999 2000
---- ---- ----
Apple --% --% 10%
FISC 14 10 --
FujiFilm 38 28 7
Ingram Micro -- -- 18
Olympus 32 27 6
Sony -- 10 15
74
The following is a summary of the carrying amounts of the Company's net
assets by geographic area in which they are located:
December 31,
------------------
1999 2000
------- -------
(in thousands)
United States $45,228 $93,785
Asian and Pacific Rim 4,360 4,723
Europe 198 1,807
The following is a summary of the Company's long-lived assets by
geographic area in which they are located:
December 31,
------------------
1999 2000
------- -------
(in thousands)
United States $ 1,807 $77,883
Asian and Pacific Rim 1,680 713
Europe 192 76
Note 16. Related Party Transactions
Material related party transactions that have been entered into by the
Company that are not disclosed otherwise in these notes are summarized below.
As outlined in Note 1, SmartDisk (including SDSC and SDL) and FISC were
under the common ownership of Fischer. Pursuant to operating agreements entered
into in 1998, FISC provides operating assistance to the Company consisting of
services, facilities and shared equipment. The Company's share of expenses for
these services is based on an internal analysis of the relative amount of time
devoted to its business by employees of FISC as well as the overhead charges
attributable to these employees. In the opinion of management, the allocations
were reasonable and represent the Company's cost of doing business. The Company
recorded operating expenses related to these agreements for the years ended
December 31, 1998, 1999 and 2000 of approximately $1.5 million, $0.3 million and
$0.2 million, respectively.
In 1998, the Company was granted a non-exclusive license agreement to
certain patents relating to the interface with Toshiba's SmartMedia cards. This
license was amended to expand the field of use in September 1998. In April 1999,
we again amended the agreement whereby Toshiba granted us a fully paid license
at which time we stopped paying royalties. Prior to this, we paid a one-half of
one percent royalty on the net sales price of our products that use the Toshiba
license. In 1998 and 1999, we paid royalty expenses pertaining to this license
of $69,000 and $26,000, respectively.
During 1998, 1999 and 2000, approximately 34%, 18% and 1%,
respectively, of the Company's sales were to related parties. In addition, the
Company procures certain engineering services from a strategic investor, which
have approximated $400,000 for 1998, 1999 and 2000.
Pursuant to a license and distribution agreement entered into in 1998
between FISC and the Company, FISC was granted the right to license and
distribute certain of the Company's products. For this right, FISC agreed to pay
75
to the Company royalties of 33.3% of net revenue derived from those product
sales. During 1998, 1999 and 2000, FISC paid royalties under this agreement of
$284,000, $470,000 and $71,000, respectively. This agreement was discontinued in
July 2000. During 2000, FISC represented SmartDisk in a transaction to license
the Company's SafeBoot product. The Company incurred expenses of approximately
$290,000 for FISC's services in connection with this transaction.
During February 1999, the Company loaned $60,000 to one of its
officers. The loan was made pursuant to a Promissory Note, bears interest at
4.71%, and is repayable in four annual installments of principal and interest.
As of December 31, 1999 and 2000, the balance outstanding on this loan was
$60,000 and $45,000, respectively.
The Company has, in conjunction with the 1998 Employee Stock Option
Plan, made loans to several of its employees to allow for the immediate exercise
of stock option grants. Each loan was made pursuant to a full recourse
Promissory Note, is secured by a pledge of the shares of stock, which the
employee has acquired, bears interest at approximately 5.5%, which is payable
quarterly, and is required to be paid in full within five years of the date of
issuance. As of December 31, 1999 and 2000, the principal amount due under these
loans was approximately $387,000 and $336,000, respectively.
In January 2000, a director of SmartDisk exercised 6,000 stock options
with an exercise price of $35.00 per option. The director executed a $210,000
full recourse promissory note with the Company as payment for these shares. The
Company repurchased these shares in November 2000 for $30,000 and the remaining
$180,000 balance on the note was forgiven and recognized as compensation
expense. The repurchased shares are included in treasury stock in the equity
section of the balance sheet.
Note 17. Research and Development Contract Revenues
During 1999, SmartDisk entered into and completed various research and
development contracts with a technology company. The contracts entitled the
Company to invoice and receive funds over the development period, some of which
were conditioned upon acceptance of certain deliverables. Through December 31,
1999, SmartDisk invoiced approximately $2.6 million for development work. All of
these revenues were recognized as income in the fourth quarter of 1999 upon the
technology company's final acceptance of the product. Approximately $1.6 million
of contract costs were charged to expense over the life of the development
periods, which ended in 1999.
As of December 31, 1999, SmartDisk had an ongoing research and
development contract. This contract entitled SmartDisk to invoice and receive
funds over the development period based upon the customer's acceptance of
certain deliverables. During 2000, SmartDisk recognized as income approximately
$1.2 million related to this development contract. Approximately $0.5 million
and $0.5 million of contract costs related to this development contract were
charged to expense as of December 31, 1999 and 2000, respectively.
76
SMARTDISK CORPORATION
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below sets forth selected unaudited financial data for each
quarter of the most recent two years:
Three Months Ended
------------------------------------------------
March 31 June 30 September 30 December 31
-------- -------- ------------ -----------
(in thousands, except per share amounts)
1999
Revenues $ 5,507 $ 8,485 $ 11,464 $ 14,863
Gross profit 836 2,885 4,496 7,282
Net income (loss) (1,966) (190) 702 2,412
Earnings (loss) per share (2)
Basic (1) $ (0.22) $ (0.02) $ 0.07 $ 0.16
Diluted (1) $ (0.22) $ (0.02) $ 0.05 $ 0.15
2000
Revenues (3) $ 17,383 $ 30,928 $ 32,708 $ 15,703
Gross profit (loss) (4) 6,053 9,448 10,046 (2,864)
Net loss (503) (4,272) (3,912) (15,551)
Loss per share (2)
Basic and diluted $ (0.03) $ (0.25) $ (0.23) $ (0.90)
- ------------
(1) Shares used in computing earnings (loss) per share reflect the retroactive
adjustment of outstanding shares related to the merger of SmartDiskette
Limited into SmartDisk, as well as the one for four reverse stock split
completed in August 1999.
(2) Earnings (loss) per share for each quarter is computed using the
weighted-average number of shares outstanding during that quarter while
earnings (loss) per share for the full year is computed using the
weighted-average number of shares outstanding during the year. Thus, the sum
of the four quarters' earnings (loss) per share may not equal the full-year
earnings (loss) per share.
(3) Revenues in the fourth quarter of 2000 reflect a decline in sales of the
Company's personal storage products. In addition, the Company is
experiencing a decrease in demand for its FlashPath products due to the
anticipated decrease in the use of the 3.5-inch floppy drive.
(4) Gross profit (loss) in the fourth quarter of 2000 reflects approximately
$5.2 million of inventory writedowns arising from the recent decrease in the
demand for the Company's personal storage products, as well as approximately
$0.5 million in inventory writedowns associated with the Company's Smarty
product due to the Company's discontinuance of that product line.
77
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
SMARTDISK CORPORATION
Year Ended December 31, 2000
- -------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- -------------------------------------------------------------------------------------------------------------------------------
Balance at Charged to Balance at
Beginning Costs Charged to End
of and Other of
Classification Period Expenses Accounts Deductions Period
- -------------------------------------------------------------------------------------------------------------------------------
(in thousands)
YEAR ENDED DECEMBER 31, 1998:
Reserves and allowances deducted
From asset accounts:
Allowance for doubtful accounts $ -- $ 34 $ -- $ -- $ 34
Valuation allowance for deferred tax asset 770 1,873 -- -- 2,643
------ ------ ------ ------ ------
$ 770 $1,907 $ -- $ -- $2,677
====== ====== ====== ====== ======
YEAR ENDED DECEMBER 31, 1999:
Reserves and allowances deducted
From asset accounts:
Allowance for doubtful accounts $ 34 $ 106 $ -- $ -- $ 140
Valuation allowance for deferred tax asset 2,643 774 -- -- 3,417
------ ------ ------ ------ ------
$2,677 $ 880 $ -- $ -- $3,557
====== ====== ====== ====== ======
YEAR ENDED DECEMBER 31, 2000:
Reserves and allowances deducted
From asset accounts:
Allowance for doubtful accounts $ 140 $ 603 $ -- $ 38 $ 705
Allowance for sales returns and other credits -- 2,439 -- 2,194 245
Valuation allowance for deferred tax asset 3,417 2,960 -- -- 6,377
------ ------ ------ ------ ------
$3,557 $6,002 $ -- $2,232 $7,327
====== ====== ====== ====== ======
78
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 29, 2001.
SmartDisk Corporation
By: /s/ Michael S. Battaglia
-------------------------------------
Michael S. Battaglia
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the date indicated.
Name Title Date
---- ----- ----
/s/ Addison M. Fischer Chairman of the Board of Directors March 29, 2001
- --------------------------------------
Addison M. Fischer
/s/ Michael S. Battaglia President, Chief Executive Officer and March 29, 2001
- -------------------------------------- Director (Principal Executive Officer)
Michael S. Battaglia
/s/ Michael R. Mattingly Chief Financial Officer (Principal Financial March 29, 2001
- -------------------------------------- and Accounting Officer)
Michael R. Mattingly
Director March 29, 2001
- --------------------------------------
D. James Bidzos
/s/ Anthony A. Ibarguen Director March 29, 2001
- --------------------------------------
Anthony A. Ibarguen
/s/ Hirotsugu Nakaiwa Director March 29, 2001
- --------------------------------------
Hirotsugu Nakaiwa
/s/ Timothy Tomlinson Director March 29, 2001
- --------------------------------------
Timothy Tomlinson
/s/ Hatim Tyabji Director March 29, 2001
- --------------------------------------
Hatim Tyabji
79
SMARTDISK CORPORATION
INDEX OF EXHIBITS
As required under Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K, the exhibits filed as part of this report are provided in
this separate section. The exhibits included in this section are as follows:
Exhibit No. Exhibit Titles
----------- --------------
10.19 Development and License Agreement dated June 30, 1999
between SmartDisk and Sony Corporation
10.26 Lease Agreement dated July 2, 1996 between SmartDisk
Personal Storage Systems Corporation and Nagog
Development Company, as amended.
21.1 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP
80