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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
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 0-29794
PUBLICARD, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-0991870
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
620 FIFTH AVENUE, 7TH FLOOR, NEW YORK, NY 10020
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (212) 651-3102
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Number of shares of Common Stock outstanding as of November 7, 2003: 24,565,902
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---- ----
(unaudited)
ASSETS
Current assets:
Cash, including short-term investments of $1,376 and $1,138 in 2003 and 2002, respectively $ 1,391 $ 1,290
Trade receivables, less allowance for doubtful accounts of $107 and $103 in 2003 and
2002, respectively 1,420 853
Inventories 581 885
Prepaid insurance and other 165 375
---------- ----------
Total current assets 3,557 3,403
---------- ----------
Equipment and leasehold improvements, net 215 379
Goodwill and intangibles 832 862
Other assets 3,295 3,295
---------- ----------
$ 7,899 $ 7,939
========== ==========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Trade accounts payable and overdraft $ 1,555 $ 1,269
Accrued liabilities 4,360 2,682
---------- ----------
Total current liabilities 5,915 3,951
Other non-current liabilities 3,656 4,990
---------- ----------
Total liabilities 9,571 8,941
---------- ----------
Commitments and contingencies (Note 6)
Shareholders' deficit:
Class A Preferred Stock, Second Series, no par value: 1,000 shares authorized; 615 and 765
issued and outstanding as of September 30, 2003 and December 31, 2002, respectively 3,075 3,825
Common shares, $0.10 par value: 40,000,000 shares authorized; 24,565,902 and 24,190,902
shares issued and outstanding as of September 30, 2003 and December 31, 2002, respectively 2,457 2,419
Additional paid-in capital 107,881 107,169
Accumulated deficit (112,702) (112,024)
Other comprehensive loss (2,383) (2,391)
---------- ----------
Total shareholders' deficit (1,672) (1,002)
---------- ----------
$ 7,899 $ 7,939
========== ==========
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these statements.
1
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Sales $ 1,417 $ 1,298 $ 4,023 $ 3,513
Cost of sales 645 648 1,876 1,804
------------ ------------ ------------ ------------
Gross margin 772 650 2,147 1,709
------------ ------------ ------------ ------------
Operating expenses:
General and administrative 676 811 2,067 2,505
Sales and marketing 415 467 1,420 1,366
Product development 169 145 414 392
Amortization of intangibles 10 144 30 432
------------ ------------ ------------ ------------
1,270 1,567 3,931 4,695
------------ ------------ ------------ ------------
Loss from operations (498) (917) (1,784) (2,986)
------------ ------------ ------------ ------------
Other income (expenses):
Interest income 3 40 10 69
Interest expense (3) (18) (8) (39)
Cost of pensions - non-operating (255) (225) (697) (649)
Insurance recoveries (2) -- 1,705 --
Write-down of minority investment -- (2,068) -- (2,068)
Other income (expenses), net 6 (221) 96 (232)
------------ ------------ ------------ ------------
(251) (2,492) 1,106 (2,919)
------------ ------------ ------------ ------------
Net loss from continuing operations (749) (3,409) (678) (5,905)
Discontinued operations -- 1,066 -- 1,066
------------ ------------ ------------ ------------
Net loss $ (749) $ (2,343) $ (678) $ (4,839)
============ ============ ============ ============
Basic and diluted earnings (loss) per common share:
Continuing operations $ (.03) $ (.14) $ (.03) $ (.24)
Discontinued operations -- .04 -- .04
------------ ------------ ------------ ------------
$ (.03) $ (.10) $ (.03) $ (.20)
============ ============ ============ ============
Weighted average common shares outstanding 24,534,652 24,190,902 24,428,402 24,175,902
============ ============ ============ ============
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these statements.
2
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(IN THOUSANDS EXCEPT SHARE DATA)
(UNAUDITED)
Common Shares Other Total
Class A ------------- Additional Comprehen- Share-
Preferred Shares Paid-in Accumulated sive holders'
Stock Issued Amount Capital Deficit Loss Deficit
----- ------ ------ ------- ------- ---- -------
Balance - January 1, 2003 $ 3,825 24,190,902 $ 2,419 $ 107,169 $ (112,024) $ (2,391) $ (1,002)
Conversion of preferred stock (750) 375,000 38 712 -- -- --
Comprehensive income:
Net loss -- -- -- -- (678) -- (678)
Foreign currency translation
adjustment -- -- -- -- -- 8 8
---------- ---------- ---------- ---------- ---------- ---------- ----------
Comprehensive income (670)
----------
Balance - September 30, 2003 $ 3,075 24,565,902 $ 2,457 $ 107,881 $ (112,702) $ (2,383) $ (1,672)
========== ========== ========== ========== ========== ========== ==========
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of this statement.
3
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(IN THOUSANDS)
(UNAUDITED)
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (678) $(4,839)
Adjustments to reconcile net loss to net cash used
in operating activities:
Insurance recoveries (1,705) --
Non-cash gain from discontinued operations -- (1,066)
Write-down of minority investment -- 2,068
Amortization of intangibles 30 432
Depreciation and amortization 118 166
Loss on disposal of fixed assets 46 --
Changes in assets and liabilities:
Trade receivables (544) (14)
Inventories 319 (88)
Prepaid insurance and other current assets 211 529
Other assets -- 170
Trade accounts payable 265 (65)
Accrued liabilities 1,663 419
Other non-current liabilities (1,358) (449)
------- -------
Net cash used in operating activities (1,633) (2,737)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (11) (24)
Proceeds from insurance recoveries 1,705 --
Proceeds from discontinued operations 24 89
Other 16 15
------- -------
Net cash provided by investing activities 1,734 80
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES -- --
------- -------
Effect of exchange rate changes on cash and cash equivalents -- 5
------- -------
Net increase (decrease) in cash 101 (2,652)
Cash - beginning of period 1,290 4,479
------- -------
Cash - end of period $ 1,391 $ 1,827
======= =======
Cash paid for income taxes $ -- $ --
======= =======
Cash paid for interest $ 8 $ 59
======= =======
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these statements.
4
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF THE BUSINESS
PubliCARD, Inc. ("PubliCARD" or the "Company") was incorporated in the
Commonwealth of Pennsylvania in 1913. PubliCARD entered the smart card industry
in early 1998, and began to develop solutions for the conditional access,
security, payment system and data storage needs of industries utilizing smart
card technology. In 1998 and 1999, the Company made a series of acquisitions to
enhance its position in the smart card industry. In March 2000, PubliCARD's
Board of Directors (the "Board"), together with its management team, determined
to integrate its operations and focus on deploying smart card solutions which
facilitate secure access and transactions. To effect this new business strategy,
in March 2000, the Board adopted a plan of disposition pursuant to which the
Company divested its non-core operations.
In July 2001, after evaluating the timing of potential future revenues,
PubliCARD's Board decided to shift the Company's strategic focus. While the
Board remained confident in the long-term prospects of the smart card business,
the timing of public sector and corporate initiatives in wide-scale, broadband
environments utilizing the Company's smart card reader and chip products had
become more uncertain. Given the lengthened time horizon, the Board did not
believe it would be prudent to continue to invest the Company's current
resources in the ongoing development and marketing of these technologies.
Accordingly, the Board determined that shareholders' interests would be best
served by pursuing strategic alliances with one or more companies that have the
resources to capitalize more fully on the Company's smart card reader and
chip-related technologies. In connection with this shift in the Company's
strategic focus, workforce reductions and other measures were implemented to
achieve cost savings.
At present, PubliCARD's sole operating activities are conducted through
its Infineer Ltd. subsidiary ("Infineer"), which designs smart card solutions
for educational and corporate sites. The Company's future plans revolve around a
potential acquisition strategy that would focus on businesses in areas outside
the high technology sector while continuing to support the expansion of the
Infineer business. However, the Company will not be able to implement such plans
unless it is successful in obtaining funding, as to which no assurance can be
given.
LIQUIDITY AND GOING CONCERN CONSIDERATIONS
These unaudited condensed consolidated financial statements contemplate
the realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has incurred operating losses, a substantial
decline in working capital and negative cash flow from operations for the years
2002, 2001 and 2000 and the nine months ended September 30, 2003. The Company
has also experienced a substantial reduction in its cash and short term
investments, which declined from $17.0 million at December 31, 2000 to $1.4
million at September 30, 2003. The Company also had a working capital deficit of
$2.4 million and an accumulated deficit of $112.7 million at September 30, 2003.
If the distress termination of the Company's defined benefit pension plan
for which the Company has applied is completed (see Note 5), for which no
assurance can be given, the Company's 2003 funding requirements to the plan
could be eliminated, in which case management believes that existing cash and
short-term investments may be sufficient to meet the Company's operating and
capital requirements at the currently anticipated levels through December 31,
2003. However, additional capital will be necessary in order to operate beyond
December 2003 and to fund the current business plan and other obligations. While
the Company is actively considering various funding alternatives, the Company
has not secured or entered into any arrangements to obtain additional funds.
There can be no assurance that the Company will be able to eliminate the 2003
funding requirements for the defined benefit pension plan or be able to obtain
additional funding on acceptable terms or at all. If the Company cannot raise
additional capital to continue its present level of operations it may not be
able to meet its obligations, take advantage of future acquisition opportunities
or further develop or enhance its product offering, any of which could have a
material adverse
5
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
effect on its business and results of operations and could lead the Company to
seek bankruptcy protection. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The unaudited consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty. The independent auditors' report on the Company's
Consolidated Financial Statements for the year ended December 31, 2002 contained
an emphasis paragraph concerning substantial doubt about the Company's ability
to continue as a going concern.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of PubliCARD
and its wholly-owned subsidiaries. All intercompany transactions are eliminated
in consolidation.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements reflect all
normal and recurring adjustments that are, in the opinion of management,
necessary to present fairly the financial position of the Company and its
subsidiary companies as of September 30, 2003 and the results of their
operations and cash flows for the three and nine months ended September 30,
2003. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles in the United States of America have been omitted. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002, as amended.
EARNINGS (LOSS) PER COMMON SHARE
Basic net income (loss) per common share is based on net income (loss)
divided by the weighted average number of common shares outstanding during each
period. Diluted net income (loss) per common share assumes issuance of the net
incremental shares from stock options, warrants and convertible preferred stock
at the later of the beginning of the year or date of issuance. For the three and
nine months ended September 30, 2003 and 2002, diluted net income (loss) per
share was the same as basic net income (loss) per share since the effect of
stock options, warrants and convertible preferred stock were antidilutive.
REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE.
Revenue from product sales and technology and software license fees is
recorded upon shipment if a signed contract exists, the fee is fixed and
determinable, the collection of the resulting receivable is probable and the
Company has no obligation to install the product or solution. If the Company is
responsible for installation, revenue from product sales and license fees is
recognized upon client acceptance or "go live" date. Revenue from maintenance
and support fees is recognized ratably over the contract period. Provisions are
recorded for estimated warranty repairs and returns at the time the products are
shipped. Should changes in conditions cause management to determine that revenue
recognition criteria are not met for certain future transactions, revenue
recognized for any reporting period could be adversely affected.
The Company performs ongoing credit evaluations of its customers and
adjusts credit limits based upon payment history and the customer's credit
worthiness. The Company continually monitors collections and payments from its
customers and maintains a provision for estimated credit losses based upon
historical experience and any specific customer collection issues that it has
identified. While such credit losses have historically been within management's
expectations and the provisions established, there is no assurance that the
Company will continue to experience the same credit loss rates as in the past.
INVENTORIES
Inventories are stated at lower of cost (first-in, first-out method) or
market. The Company periodically evaluates the need to record adjustments for
impairment of inventory. Inventory in excess of the Company's estimated usage
requirements is written down to its estimated net realizable value. Inherent in
the estimates of net realizable value are management's estimates related to the
Company's production schedules, customer demand, possible alternative uses and
the ultimate realization of potentially excess
6
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
inventory. Inventories as of September 30, 2003 and December 31, 2002 consisted
of the following (in thousands):
2003 2002
---- ----
Raw materials and work-in-process $ 262 $ 175
Finished goods 319 710
----- -----
$ 581 $ 885
===== =====
STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation cost using the
intrinsic value method of accounting prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). The
Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123") and Statement of Financial Accounting Standards No. 148, "Accounting
for Stock-Based Compensation -- Transition and Disclosure" ("SFAS No. 148").
At September 30, 2003, the Company had four fixed stock-based compensation
plans. The exercise price of each option granted pursuant to these plans is
equal to the market price of the Company's common stock on the date of grant.
Accordingly, pursuant to APB No. 25, no compensation cost has been recognized
for such grants. Had compensation cost been determined based on the fair value
at the grant dates for such awards consistent with the method prescribed by SFAS
No. 123, the Company's net loss and loss per share for the three and nine months
ended September 30, 2003 and 2002 would have been as follows (in thousands
except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss, as reported $ (749) $ (2,343) $ (678) $ (4,839)
Deduct: Total stock-based compensation expense
determined under fair value based method (122) (43) (367) (129)
-------- -------- -------- --------
Pro forma net loss $ (871) $ (2,386) $ (1,045) $ (4,968)
======== ======== ======== ========
Basic and diluted loss per share:
As reported $ (.03) $ (.10) $ (.03) $ (.20)
======== ======== ======== ========
Pro forma $ (.04) $ (.10) $ (.04) $ (.21)
======== ======== ======== ========
The weighted-average fair value of each stock option included in the
preceding pro forma amounts was estimated using the Black-Scholes option-pricing
model and is amortized over the vesting period of the underlying options.
USE OF ESTIMATES
The preparation of these financial statements required the use of certain
estimates by management in determining the Company's assets, liabilities,
revenues and expenses. Certain of our accounting policies require the
application of significant judgment by management in selecting the appropriate
assumptions for calculating financial estimates. By their nature, these
judgments are subject to an inherent degree of uncertainty. The Company
considers certain accounting policies related to revenue recognition, estimates
of reserves for receivables and inventories, valuation of investments, goodwill
and intangibles and pension accounting to be critical policies due to the
estimation processes involved. While all available information has been
considered, actual amounts could differ from those reported.
7
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires
that costs associated with an exit or disposal plan be recognized when incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.
146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002. The statement is effective beginning January 1, 2003,
and did not have a material impact on the Company's Consolidated Financial
Statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". The interpretation addresses the
disclosures to be made by a guarantor in its financial statements about its
obligations under guarantee. In addition, it also clarifies the requirements
related to the recognition of a liability by a guarantor at the inception of a
guarantee for the obligations the guarantor has undertaken in issuing that
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions became effective
December 15, 2002 and did not have a material impact on the Company's
Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148. SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The provisions of SFAS No. 148 are effective for
fiscal years and interim periods ending after December 15, 2002. SFAS No. 148
did not require the Company to change to the fair value based method of
accounting for stock-based compensation. The Company has elected to continue to
apply APB No. 25 and related interpretations in accounting for stock options,
and the disclosures required by SFAS Nos. 123 and 148 are included in Note 1
herein.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities". The interpretation requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the company that has controlling
financial interest. It also provides the framework for determining whether a
variable interest entity should be consolidated based on voting interest or
significant financial support provided to it. This Company is required to adopt
the provisions of this interpretation on October 1, 2003. The Company does not
have any variable interest entities, and accordingly, the adoption of this
interpretation is not expected to have a material impact on the Company's
Consolidated Financial Statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative as discussed in SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". In addition, it
clarifies when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. SFAS No. 149 amends certain other
existing pronouncements. SFAS No. 149 is effective on a prospective basis for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of this statement did
not have a material impact on the Company's Consolidated Financial Statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS No. 150"). SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or
8
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
an asset in some circumstances). Many of those instruments were previously
classified as equity. This statement will become effective for financial
instruments entered into or modified after May 31, 2003, and otherwise shall be
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of this statement did not have a material impact on the
Company's Consolidated Financial Statements.
NOTE 2 - GOODWILL AND INTANGIBLES
Goodwill is the excess of the purchase price and related costs over the
value assigned to the net tangible and intangible assets relating to the
November 1999 acquisition of Infineer. Through December 31, 2001, goodwill had
been amortized over a five year life. Effective January 1, 2002, the Company
adopted FASB Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"). In accordance with the guidelines of
this statement, goodwill and indefinite lived intangible assets are no longer
amortized but will be assessed for impairment on at least an annual basis. SFAS
No. 142 also requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives and reviewed for
impairment. The Company performed an initial review for impairment of goodwill
as of January 1, 2002 and determined that no impairment existed at that date.
The Company determined the fair value of its sole reporting unit primarily using
two approaches: a market approach technique and a discounted cash flow valuation
technique. The market approach relied primarily on the implied fair value using
a multiple of revenues for several entities with comparable operations and
economic characteristics. Significant assumptions used in the discounted cash
valuation included estimates of future cash flows, future short-term and
long-term growth rates and estimated cost of capital for purposes of arriving at
a discount factor.
The Company performed its annual goodwill impairment test in the fourth
quarter of 2002 and determined that goodwill had been impaired. The Company
determined the fair value primarily using two approaches: a market approach
technique and a discounted cash flow valuation technique. The market approach
relied primarily on the implied fair value using a multiple of revenues for an
entity with comparable operations and economic characteristics. Significant
assumptions used in the discounted cash valuation included estimates of future
cash flows, future short-term and long-term growth rates and estimated cost of
capital for purposes of arriving at a discount factor. Based on comparing the
values derived from the two techniques to the carrying value of the reporting
unit, the Company recorded a goodwill impairment loss of $364,000 in the fourth
quarter of 2002. The Company attributed the impairment loss to the value of a
comparable entity that was sold in a transaction in late 2002, the significant
2002 operating loss for the reporting unit and lower forecasted revenue growth
due to a continued overall decline in technology spending and a shortage of
capital available to invest in the reporting unit. On an ongoing basis, the
Company expects to perform its annual impairment test during the fourth quarter
absent any interim impairment indicators. The carrying value of goodwill as of
September 30, 2003 and December 31, 2002 was $782,000.
Intangible assets consist of completed technology identified as of the
Infineer acquisition date and are amortized over a five-year life. Long-lived
assets and certain identifiable intangible assets to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of such assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement of
any impairment loss for long-lived assets and certain identifiable intangible
assets that management expects to hold and use is based on the net realizable of
the asset. In the fourth quarter of 2002, the Company determined that its
intangible assets had been impaired and recorded an impairment loss of $1.0
million. The Company attributed the impairment loss to the significant 2002
operating loss for the reporting unit and lower forecasted revenue growth due to
a continued overall decline in technology spending and a shortage of capital
available to invest in the reporting unit.
9
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The gross carrying amount and accumulated amortization of intangible
assets at September 30, 2003 and December 31, 2002 was as the following (in
thousands):
2003 2002
---- ----
Gross carrying amount $ 1,881 $ 1,881
Accumulated amortization (1,831) (1,801)
------- -------
$ 50 $ 80
======= =======
Amortization of intangibles for the nine months ended September 30, 2003
and 2002 was $30,000 and $432,000, respectively. The estimated amortization
expense for intangibles is $10,000 for the remaining three months of 2003 and
$40,000 for year ending December 31, 2004.
NOTE 3 - INVESTMENTS
In December 2000, the Company acquired an ownership interest in TecSec,
Incorporated, a Virginia corporation ("TecSec"), for $5.1 million. TecSec
develops and markets encryption products and solutions, which are designed to
enable the next generation information security for the enterprise,
multi-enterprise e-business and other markets. The TecSec investment, amounting
to a 5% ownership interest on a fully diluted basis, has been accounted for at
cost. The Company has certain anti-dilutive rights whereby its ownership
interest may be increased following contributions of additional third-party
capital. The Company believed that the investment in TecSec had been impaired
and a charge of $2.1 million was recorded in the third quarter of 2002. The
Company attributed the impairment to a general decline in valuations of
technology entities, the difficulties in raising capital and TecSec's recurring
operating losses. TecSec is currently evaluating alternative sources of
financing to meet ongoing capital and operating needs. If TecSec is not
successful in executing its business plan or in obtaining sufficient capital on
acceptable terms or at all, the Company's investment in TecSec could be further
impaired and subject to an additional significant write-down.
NOTE 4 - SEGMENT DATA
The Company's sole operating activities involve the deployment of smart
card solutions for educational and corporate sites. As such, the Company reports
as a single segment. Sales by geographical areas for the three and nine months
ended September 30, 2003 and 2002 are as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
United States $ 258 $ 380 $ 812 $ 800
Europe 1,062 897 2,915 2,645
Rest of world 97 21 296 68
------- ------- ------- -------
$ 1,417 $ 1,298 $ 4,023 $ 3,513
======= ======= ======= =======
The Company has operations in the United States and United Kingdom.
Identifiable assets by country as of September 30, 2003 and December 31, 2002
are as follows (in thousands):
2003 2002
---- ----
United States $ 4,874 $ 4,842
United Kingdom 2,193 2,235
------- -------
$ 7,067 $ 7,077
======= =======
10
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - UNDERFUNDED PENSION PLAN
The Company sponsors a defined benefit pension plan (the "Plan") that was
frozen in 1993. As of December 31, 2002, the actuarial present value of accrued
liabilities exceeded the plan assets by approximately $6.1 million (determined
on an ongoing basis). The assets of the Plan are managed by an outside trustee
and invested primarily in equity and fixed income securities. PubliCARD common
stock represented less than 1% of plan assets as of December 31, 2002. For 2003,
the minimum required contributions are approximately $1.4 million.
In January 2003, the Company filed a notice with the Pension Benefit
Guaranty Corporation ("PBGC") seeking a "distress termination" of the Plan. If
the PBGC determines that the Company meets one of the tests for such a
termination, the Plan will terminate and the PBGC will become responsible for
meeting future retirement obligations of participants (within certain
limitations). The Company would be liable to the PBGC for the amount of the
unfunded guaranteed benefit obligation. The Company believes that on a
termination basis, the Plan's liabilities could exceed the value of its assets
by in excess of $7.0 million. In addition, the Company did not make the required
contributions that were due to the Plan through October 15, 2003 which aggregate
approximately $1.4 million. The Company has initiated discussions with the PBGC
concerning the termination of the Plan and its obligation to the PBGC if the
Plan is terminated (including the timing of its repayment obligation). It is not
possible to predict the outcome of such discussions.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
LEGAL
On May 28, 2002, a lawsuit was filed against the Company in the Superior
Court of the State of California, in the County of Los Angeles by Leonard M.
Ross and affiliated entities alleging, among other things, misrepresentation and
securities fraud. The lawsuit names the Company and four of its current and
former executive officers and directors as the defendants. The plaintiffs seek
monetary and punitive damages for alleged actions made by the defendants in
order to induce the plaintiff to purchase, hold or refrain from selling
PubliCARD common stock. The plaintiffs allege that the defendants made a series
of material misrepresentations, misleading statements, omissions and
concealments, specifically and directly to the plaintiffs concerning the nature,
existence and status of contracts with certain purchasers, the nature and
existence of investments in the Company by third parties, the nature and
existence of business relationships and investments by the Company. The Company
believes it has meritorious defenses to the allegations and intends to defend
vigorously.
In November 2002, the Company and the individual defendants served with
the action filed a demurrer seeking the dismissal of six of the plaintiffs' nine
purported causes of action. In January 2003, the court ruled in favor of the
demurrer and dismissed the entire complaint. The plaintiffs were granted the
right to replead and subsequently filed an amended complaint in February 2003.
The Company and individual defendants filed a second demurrer in March 2003. In
June 2003, the court ruled in favor of the demurrer and dismissed, without leave
to amend, six of the eleven purported causes of action in the amended complaint.
The lawsuit is in the early stages. Preliminary discovery has just commenced and
no trial date has been set. Consequently, at this time it is not reasonably
possible to estimate the damages, or range of damages, if any, that the Company
might incur in connection with this action. However, if the outcome of this
lawsuit is unfavorable to the Company, it could have a material adverse effect
on the Company's operations, cash flow and financial position.
The Company incurred approximately $200,000 in defense costs in 2002. No
additional costs have been incurred in 2003. Notice of the commencement of this
action has been given to the Company's
11
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
directors and officers liability insurance carriers. The Company's directors and
officers liability insurance carriers are funding the additional costs of
defending this action, subject to the carriers' reservation of rights.
Various other legal proceedings are pending against the Company. The
Company considers all such other proceedings to be ordinary litigation incident
to the character of its businesses. Certain claims are covered by liability
insurance. The Company believes that the resolution of those claims to the
extent not covered by insurance will not, individually or in the aggregate, have
a material adverse effect on the financial position or results of operations of
the Company.
INSURANCE RECOVERIES
In February and March 2003, the Company entered into two binding
settlements with various historical insurers that resolve certain claims
(including certain future claims) under policies of insurance issued to the
Company by those insurers. As a result of the settlements, after allowance for
associated expenses and offsetting adjustments, the Company received net
proceeds of approximately $1.0 million in February 2003 and an additional
$682,000 in April 2003. The Company recognized a non-recurring gain from these
settlements of $1.7 million in the first quarter of 2003. See Note 9 for a
discussion regarding an additional insurance settlement reached subsequent to
September 30, 2003.
LEASES
The Company leases certain office space, vehicles and office equipment
under operating leases that expire over the next six years. Minimum payments for
operating leases having initial or remaining non-cancelable terms in excess of
one year are $91,000 for the remainder of 2003, $239,000 in 2004, $99,000 in
2005, $65,000 in 2006, $61,000 in 2007 and $41,000 thereafter.
NOTE 7 - COMPREHENSIVE LOSS
Comprehensive loss for the Company includes foreign currency translation
adjustments, as well as the net loss reported in the Company's Condensed
Consolidated Statements of Operations. Comprehensive loss for the three and nine
months ended September 30, 2003 and 2002 was as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss $ (749) $ (2,343) $ (678) $ (4,839)
Foreign currency translation adjustments -- 13 8 67
-------- -------- -------- --------
Comprehensive loss $ (749) $ (2,330) $ (670) $ (4,772)
======== ======== ======== ========
NOTE 8 - PREFERRED STOCK
In February 2003 and July 2003, 100 shares and 50 shares of Class A
Preferred Stock were converted into 250,000 shares and 125,000 shares,
respectively, of PubliCARD's common stock.
NOTE 9 - SUBSEQUENT EVENTS
In October 2003, the Company entered into an additional binding settlement
with another insurance group that resolves all claims under historic general
liability policies of insurance issued to the Company. As a result of this
settlement, after allowance for associated expenses and offsetting adjustments,
the Company expects to receive net proceeds of approximately $2.9 million, of
which approximately $2.4 million is expected to be received by November 20,
2003, subject to closing conditions. The balance of the settlement proceeds will
be held in escrow for up to three years.
12
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company is also in discussions with other insurance markets regarding
the status of certain policies of insurance. It cannot be determined whether any
additional amounts may be recovered from these other insurers nor can the timing
of any such additional recoveries be determined.
In October 2003, the Company also sold a parcel of land in Louisiana
resulting in net proceeds of approximately $370,000. The Company expects to
recognize a non-recurring gain aggregating approximately $3.2 million in the
fourth quarter of 2003 relating to the additional insurance settlement and land
sale.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" and other sections of this Form 10-Q contain forward-looking
statements, including (without limitation) statements concerning possible or
assumed future results of operations of PubliCARD preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates,"
"intends," "plans" or similar expressions. For those statements, we claim the
protection of the safe harbor for forward-looking statements contained in the
U.S. Private Securities Litigation Reform Act of 1995. Forward-looking
statements are not guarantees of future performance. They involve risks,
uncertainties and assumptions. You should understand that the possible
consequences of such statements made under "Factors That May Affect Future
Results" and elsewhere in this document could affect our future results and
could cause those results to differ materially from those expressed in such
forward-looking statements.
OVERVIEW
PubliCARD was incorporated in the Commonwealth of Pennsylvania in 1913.
PubliCARD entered the smart card industry in early 1998, and began to develop
solutions for the conditional access, security, payment system and data storage
needs of industries utilizing smart card technology. In 1998 and 1999, the
Company made a series of acquisitions to enhance its position in the smart card
industry. In March 2000, PubliCARD's Board, together with its management team,
determined to integrate its operations and focus on deploying smart card
solutions which facilitate secure access and transactions. To effect this new
business strategy, in March 2000, the Board adopted a plan of disposition
pursuant to which the Company divested its non-core operations.
In July 2001, after evaluating the timing of potential future revenues,
PubliCARD's Board decided to shift the Company's strategic focus. While the
Board remained confident in the long-term prospects of the smart card business,
the timing of public sector and corporate initiatives in wide-scale, broadband
environments utilizing the Company's smart card reader and chip products had
become more uncertain. Given the lengthened time horizon, the Board did not
believe it would be prudent to continue to invest the Company's current
resources in the ongoing development and marketing of these technologies.
Accordingly, the Board determined that shareholders' interests would be best
served by pursuing strategic alliances with one or more companies that have the
resources to capitalize more fully on the Company's smart card reader and
chip-related technologies. In connection with this shift in the Company's
strategic focus, workforce reductions and other measures were implemented to
achieve cost savings.
At present, PubliCARD's sole operating activities are conducted through
its Infineer subsidiary, which designs smart card platform solutions for
educational and corporate sites. The Company's future plans revolve around a
potential acquisition strategy that would focus on businesses in areas outside
the high technology sector while continuing to support the expansion of the
Infineer business. However, the Company will not be able to implement such plans
unless it is successful in obtaining additional funding, as to which no
assurance can be given.
PubliCARD's financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
Unaudited Consolidated Financial Statements, the Company has incurred operating
losses, has a working capital deficiency and requires additional capital to meet
its obligations and accomplish the Company's business plan, which raises
substantial doubt about its ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
Company's failure to obtain funding or inability to continue as a going concern.
14
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2002
SALES. Revenues are generated from product sales, technology and software
license fees, installation and maintenance contracts. Consolidated net sales
increased to $1.4 million in 2003 compared to $1.3 million for 2002 driven by a
6% increase from foreign currency changes. Excluding the impact of foreign
currency changes, sales increased by 3% due principally to a higher level of
direct sales and service revenues in the United Kingdom.
GROSS MARGIN. Cost of sales consists primarily of material, personnel
costs and overhead. Gross margin, as a percentage of net sales, was 54% in 2003
and 50% in 2002. The gross margin was favorably impacted by a higher percentage
of sales derived from service revenues.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of personnel and travel costs, public relations, trade shows and
marketing materials. Sales and marketing expenses were $415,000 in 2003 compared
to $467,000 in 2002. The decrease is mainly due to a reduction in salaries
caused by lower headcount and an elimination of a sales office.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses include costs
associated with the development of new products and enhancements to existing
products. Product development expenses consist primarily of personnel and travel
costs and contract engineering services. Product development expenses amounted
to $169,000 in 2003 compared to $145,000 in 2002.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of personnel and related costs for general corporate
functions, including finance and accounting, human resources, risk management
and legal. General and administrative expenses were $676,000 in 2003 compared to
$811,000 in 2002. The decrease is mainly due to a reduction in salaries and
employee business expenses associated with lower headcount.
AMORTIZATION OF INTANGIBLES. In accordance with SFAS No. 142, effective
January 1, 2002, goodwill is no longer amortized. Goodwill and other intangibles
will be subject to an annual review for impairment or earlier if circumstances
or events indicate that impairment has occurred. This may result in future
write-downs or the write-off of such assets. Amortization of intangibles relates
to the continuing amortization of definite life intangibles. Amortization
expense decreased from $144,000 in 2002 to $10,000 in 2003 as a result of an
impairment loss of $1.0 million recognized in the fourth quarter of 2002.
OTHER INCOME AND EXPENSE. Cost of pensions, which represents amounts
related to discontinued product lines and related plant closings in prior years,
principally relates to pension expense associated with the Company's frozen
defined benefit pension plan. In addition, for the third quarter of 2002, other
expense includes a $2.1 million charge for an impairment of the Company's
minority investment in TecSec and a $200,000 charge in connection with the
defense of a shareholder lawsuit.
INCOME FROM DISCONTINUED OPERATIONS. In September 2002, the Company
reached an agreement pursuant to which an escrow relating to the June 2000 sale
of the Company's Greenwald Industries, Inc. subsidiary was terminated and net
proceeds of approximately $1.3 million were disbursed to the Company. Pursuant
to the escrow termination agreement, the buyer acknowledged that there were no
indemnification claims outstanding under the applicable asset purchase
agreement. A gain of $1.1 million was recognized in the third quarter of 2002,
principally relating to reserves reversed upon the resolution of the escrow
account.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
SALES. Consolidated net sales increased to $4.0 million in 2003 compared
to $3.5 million for 2002 driven by an 11% increase from foreign currency
15
changes. Excluding the impact of foreign currency changes, sales in 2003
increased by 4% and benefited from several one-time custom development projects,
an increase in export distributor sales principally in Australia and an increase
in United Kingdom service revenue.
GROSS MARGIN. Gross margin, as a percentage of net sales, was 53% in 2003
compared to 49% in 2002. The gross margin improvement resulted from higher
margins generated by revenues from certain custom development projects and
license fees and increased service revenue in the United Kingdom.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $1.4
million in both 2003 and 2002.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses amounted to
$414,000 in 2003 compared to $392,000 in 2002.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
for the nine months ended September 30, 2003 decreased to $2.1 million from $2.5
million for 2002. The decrease is mainly due to corporate cost containment
initiatives and headcount reductions.
AMORTIZATION OF GOODWILL AND INTANGIBLES. Amortization expense decreased
from $432,000 in 2002 to $30,000 in 2003 as a result of an impairment loss of
$1.0 million recognized in the fourth quarter of 2002.
OTHER INCOME AND EXPENSE. Cost of pensions, which represents amounts
related to discontinued product lines and related plant closings in prior years,
principally relates to pension expense associated with the Company's frozen
defined benefit pension plan.
In February and March 2003, the Company entered into two binding
settlements with various historical insurers that resolve certain claims
(including certain future claims) under policies of insurance issued to the
Company by those insurers. As a result of the settlements, after allowance for
associated expenses and offsetting adjustments, the Company received net
proceeds of approximately $1.0 million in February 2003 and an additional
$682,000 in April 2003. The Company recognized a non-recurring gain from these
settlements of $1.7 million in the first quarter of 2003. In addition, for 2002,
other expense includes a $2.1 million charge for an impairment of the Company's
minority investment in TecSec and a $200,000 charge in connection with the
defense of a shareholder lawsuit.
INCOME FROM DISCONTINUED OPERATIONS. In September 2002, the Company
reached an agreement pursuant to which an escrow relating to the June 2000 sale
of the Company's Greenwald Industries, Inc. subsidiary was terminated and net
proceeds of approximately $1.3 million were disbursed to the Company. Pursuant
to the escrow termination agreement, the buyer acknowledged that there were no
indemnification claims outstanding under the applicable asset purchase
agreement. A gain of $1.1 million was recognized in the third quarter of 2002,
principally relating to reserves reversed upon the resolution of the escrow
account.
LIQUIDITY
The Company has financed its operations over the last three years
primarily through the sale of capital stock, the sale of non-core businesses and
insurance recoveries. During the nine months ended September 30, 2003, cash,
including short-term investments, increased by $101,000 to $1.4 million as of
September 30, 2003. Subsequent to September 30, 2003, the Company sold a parcel
of unused land and expects to receive additional proceeds from an insurance
settlement that will result in aggregate net proceeds of approximately $3.2
million in cash.
Operating activities utilized cash of $1.6 million in 2003 and principally
consisted of the net loss of $678,000 plus a gain on insurance recoveries of
$1.7 million offset by depreciation and amortization of $148,000 and a reduction
in assets and liabilities of $556,000.
16
Investing activities provided cash of $1.7 million in 2003 and consisted
principally of $1.7 million of proceeds received from insurance recoveries.
The Company has experienced negative cash flow from operating activities
in the past and expects to experience negative cash flow in 2003 and beyond. In
addition to funding operating and capital requirements and corporate overhead,
future uses of cash include the following:
- The Company sponsors a defined benefit pension plan, which was
frozen in 1993. As of December 31, 2002, the actuarial present value
of accrued liabilities exceeded the plan assets by approximately
$6.1 million (determined on an ongoing basis). The required
contribution to the plan is approximately $1.4 million in 2003.
Absent some action by the Company, the annual contribution
requirements beyond 2003 would continue to be significant. In view
of its financial condition, in January 2003, the Company filed a
notice with the PBGC seeking a "distress termination" of the Plan.
If the PBGC determines that the Company meets one of the tests for
such a termination, the Plan will terminate and the PBGC will become
responsible for meeting future retirement obligations to
participants (within certain limitations). The Company would be
liable to the PBGC for the amount of the unfunded guaranteed benefit
obligation. The Company believes that on a termination basis, the
Plan's liabilities could exceed the value of its assets by in excess
of $7.0 million. In addition, the Company did not make the required
contributions that were due to the Plan through October 15, 2003
which aggregate approximately $1.4 million. The Company has
initiated discussions with the PBGC concerning the termination of
the Plan and its repayment obligation to the PBGC if the Plan is
terminated (including the timing of its repayment obligation). It is
not possible to predict the outcome of such discussions.
- The Company and certain current and former officers are defendants
in a lawsuit alleging, among other things, misrepresentation and
securities fraud. The Company believes that it has meritorious
defenses to the allegations and intends to defend itself vigorously.
The cost of defending against this action could be significant, and
if the Company is not successful in defending itself, the Company
may be required to pay the plaintiff's damages, which could have a
material adverse effect on the Company's business and operations.
- The Company leases certain office space, vehicles and office
equipment under operating leases that expire over the next six
years. Minimum payments for operating leases having initial or
remaining non-cancelable terms in excess of one year are $91,000 for
the remainder of 2003, $239,000 in 2004, $99,000 in 2005, $65,000 in
2006, $61,000 in 2007 and $41,000 thereafter.
The Company will need to raise additional capital that may not be
available to it. If the distress termination of the Company's defined benefit
pension plan for which the Company has applied is completed (see Note 5 to the
Notes to Unaudited Condensed Consolidated Financial Statements), the Company's
2003 funding requirements to the plan could be eliminated, in which case
management believes that existing cash and short-term investments may be
sufficient to meet the Company's operating and capital requirements at the
currently anticipated levels through December 31, 2003. However, additional
capital will be necessary in order to operate beyond December 2003 and to fund
the current business plan and other obligations. While the Company is actively
considering various funding alternatives, it has not secured or entered into any
arrangements to obtain additional capital. There can be no assurance that the
Company will be able to eliminate the 2003 funding requirements for the defined
benefit pension plan or be able to obtain additional funding on acceptable terms
or at all. If the Company cannot raise additional capital to continue its
present level of operations, it may not be able to meet its obligations, take
advantage of future acquisition opportunities or further develop or enhance its
product offering, any of which could have a material adverse effect on its
business and results of operations.
The Company currently has no capacity for commercial debt financing.
Should such capacity become available it may be adversely affected in the future
by factors such as higher interest rates, inability to borrow without
collateral, and continued operating losses. Borrowings may also involve
covenants limiting
17
or restricting its operations or future opportunities.
As a result of a failure to meet certain continuing listing requirements
of the Nasdaq National Market ("National Market"), the Company transferred the
listing of its common stock to the Nasdaq SmallCap Market ("SmallCap Market")
effective May 2, 2002. On March 19, 2003, the Company received a Nasdaq Staff
Determination letter indicating that the Company failed to comply with the
minimum bid price requirement for continued listing on the SmallCap Market and
that the Company's common stock was therefore subject to delisting. The Board of
the Company decided not to appeal the delisting determination. Effective March
28, 2003, the Company's common stock no longer traded on the Nasdaq SmallCap
Market. On March 28, 2003 the Company's common stock began trading on the OTC
Bulletin Board. As a result of the delisting, the liquidity of the common stock
may be adversely affected. This could impair the Company's ability to raise
capital in the future. If additional capital is raised through the issuance of
equity securities, the Company's stockholders' percentage ownership of the
common stock will be reduced and stockholders may experience dilution in net
book value per share, or the new equity securities may have rights, preferences
or privileges senior to those of its common stockholders.
If the Company's liquidity does not improve, it may be unable to continue
as a going concern and could seek bankruptcy protection. Such an event may
result in the Company's common and preferred stock being negatively affected or
becoming worthless. The auditors' report on the Company's Consolidated Financial
Statements for the year ended December 31, 2002 contains an emphasis paragraph
concerning substantial doubt about the Company's ability to continue as a going
concern.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are more fully described in
the Notes to the Company's Unaudited Condensed Consolidated Financial
Statements. Certain accounting policies require the application of significant
judgment by management in selecting the appropriate assumptions for calculating
financial estimates. By their nature, these judgments are subject to an inherent
degree of uncertainty. The Company considers certain accounting policies related
to revenue recognition, estimates of reserves for receivables and inventories,
valuation of investments and goodwill and intangibles and pension accounting to
be critical policies due to the estimation processes involved.
REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE. Revenue from product sales
and technology and software license fees is recorded upon shipment if a signed
contract exists, the fee is fixed and determinable, the collection of the
resulting receivable is probable and the Company has no obligation to install
the product or solution. If the Company is responsible for installation, revenue
from product sales and license fees is recognized upon client acceptance or "go
live" date. Revenue from maintenance and support fees is recognized ratably over
the contract period. Provisions are recorded for estimated warranty repairs and
returns at the time the products are shipped. Should changes in conditions cause
management to determine that revenue recognition criteria are not met for
certain future transactions, revenue recognized for any reporting period could
be adversely affected.
The Company performs ongoing credit evaluations of its customers and
adjusts credit limits based upon payment history and the customer's credit
worthiness. The Company continually monitors collections and payments from its
customers and maintains a provision for estimated credit losses based upon
historical experience and any specific customer collection issues that it has
identified. While such credit losses have historically been within management's
expectations and the provisions established, there is no assurance that the
Company will continue to experience the same credit loss rates as in the past.
INVENTORIES. Inventories are stated at lower of cost (first-in, first-out
method) or market. The Company periodically evaluates the need to record
adjustments for impairment of inventory. Inventory in excess of the Company's
estimated usage requirements is written down to its estimated net realizable
value. Inherent in the estimates of net realizable value are management's
estimates related to the Company's production schedules, customer demand,
possible alternative uses and the ultimate realization of potentially
18
excess inventory. A decrease in future demand for current products could result
in an increase in the amount of excess inventories on hand.
VALUATION OF INVESTMENTS. The Company periodically assesses the carrying
value of its minority-owned investments for impairment. This assessment is based
upon a review of operations and indications of continued viability, such as
subsequent rounds of financing. As discussed in Note 3 to the Unaudited
Consolidated Financial Statements, during 2002 the Company made a determination
that its minority-owned investments in TecSec was impaired. While management
believes that the adjusted carrying value of its investment in TecSec is fairly
stated, future circumstances could affect the valuation.
IMPAIRMENT OF GOODWILL AND INTANGIBLES. Effective January 1, 2002, the
Company adopted SFAS No. 142. In accordance with the guidelines of this
statement, goodwill and indefinite lived intangible assets are no longer
amortized but will be assessed for impairment on at least an annual basis. SFAS
No. 142 also requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives and reviewed for
impairment. The Company performed an initial review for impairment of goodwill
as of January 1, 2002 and determined that no impairment existed at that date.
The Company determined the fair value of its sole reporting unit primarily using
two approaches: a market approach technique and a discounted cash flow valuation
technique. The market approach relied primarily on the implied fair value using
a multiple of revenues for several entities with comparable operations and
economic characteristics. Significant assumptions used in the discounted cash
valuation included estimates of future cash flows, future short-term and
long-term growth rates and estimated cost of capital for purposes of arriving at
a discount factor.
The Company performed its annual goodwill impairment test in the fourth
quarter of 2002 and determined that goodwill had been impaired. The Company
determined the fair value primarily using two approaches: a market approach
technique and a discounted cash flow valuation technique. The market approach
relied primarily on the implied fair value using a multiple of revenues for an
entity with comparable operations and economic characteristics. Significant
assumptions used in the discounted cash valuation included estimates of future
cash flows, future short-term and long-term growth rates and estimated cost of
capital for purposes of arriving at a discount factor. Based on comparing the
values derived from the two techniques to the carrying value of the reporting
unit, the Company recorded a goodwill impairment loss of $364,000 in the fourth
quarter of 2002. The Company attributed the impairment loss to the value of a
comparable entity that was sold in a transaction in late 2002, the significant
2002 operating loss for the reporting unit and lower forecasted revenue growth
due to a continued overall decline in technology spending and a shortage of
capital available to invest in the reporting unit. On an ongoing basis, the
Company expects to perform its annual impairment test during the fourth quarter
absent any interim impairment indicators.
Long-lived assets and certain identifiable intangible assets to be held
and used are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Determination of recoverability is based on an estimate of undiscounted future
cash flows resulting from the use of the asset and its eventual disposition.
Measurement of any impairment loss for long-lived assets and certain
identifiable intangible assets that management expects to hold and use is based
on the net realizable of the asset. In the fourth quarter of 2002, the Company
determined that its intangible assets had been impaired and recorded an
impairment loss of $1.0 million. The Company attributed the impairment loss to
the significant 2002 operating loss for the reporting unit and lower forecasted
revenue growth due to a continued overall decline in technology spending and a
shortage of capital available to invest in the reporting unit.
PENSION OBLIGATIONS. The determination of obligations and expense for
pension benefits is dependent on the selection of certain assumptions used by
actuaries in calculating such amounts. These assumptions include, among others,
the discount rate and the expected rate of return on plan assets. Actual results
that differ from assumptions are accumulated and amortized over future periods
and, therefore, generally affect the recognized expense and recorded obligation
in such future periods. While management believes that
19
the assumptions are appropriate, differences in actual experience or significant
changes in assumptions may materially affect the pension obligation and future
expense.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities".
SFAS No. 146 supersedes Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146
requires that costs associated with an exit or disposal plan be recognized when
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The statement is effective beginning January
1, 2003, and did not have a material impact on the Company's Consolidated
Financial Statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". The interpretation addresses the
disclosures to be made by a guarantor in its financial statements about its
obligations under guarantee. In addition, it also clarifies the requirements
related to the recognition of a liability by a guarantor at the inception of a
guarantee for the obligations the guarantor has undertaken in issuing that
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions became effective
December 15, 2002 and did not have a material impact on the Company's
Consolidated Financial Statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The provisions of SFAS No. 148 are effective for
fiscal years and interim periods ending after December 15, 2002. SFAS No. 148
did not require the Company to change to the fair value based method of
accounting for stock-based compensation. The Company has elected to continue to
apply APB No. 25 and related interpretations in accounting for stock options,
and the disclosures required by SFAS Nos. 123 and 148 are included in Note 1 to
the Unaudited Consolidated Financial Statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities". The interpretation requires that the assets,
liabilities and results of the activity of variable interest entities be
consolidated into the financial statements of the company that has controlling
financial interest. It also provides the framework for determining whether a
variable interest entity should be consolidated based on voting interest or
significant financial support provided to it. This Company is required to adopt
the provisions of this interpretation on October 1, 2003. The Company does not
have any variable interest entities, and accordingly, the adoption of this
interpretation is not expected to have a material impact on the Company's
Consolidated Financial Statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities". SFAS No. 149 clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative as discussed in SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". In addition, it clarifies when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 amends certain other existing
pronouncements. SFAS No. 149 is effective on a prospective basis for contracts
entered into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The adoption of this statement did not have a
material impact on the Company's Consolidated Financial Statements.
20
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. This statement will become effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
shall be effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of this statement did not have a material impact on
the Company's Consolidated Financial Statements.
FACTORS THAT MAY AFFECT FUTURE RESULTS
WE HAVE A HISTORY OF OPERATING LOSSES AND NEGATIVE CASH FLOW, WE HAVE
ONGOING FUNDING OBLIGATIONS AND WE NEED TO RAISE ADDITIONAL CAPITAL THAT MAY NOT
BE AVAILABLE TO US, ALL OF WHICH COULD LEAD US TO SEEK BANKRUPTCY PROTECTION. We
have incurred losses and experienced negative cash flow from operating
activities in the past, and we expect to incur losses and experience negative
cash flow from operating activities in the foreseeable future. We incurred
losses from continuing operations in 2000, 2001 and 2002 and the nine months
ended September 30, 2003 of approximately $19.7 million, $17.2 million, $8.3
million and $678,000 respectively. In addition, we experienced negative cash
flow from operating activities of $22.0 million, $12.7 million, $5.1 million and
$1.6 million in 2000, 2001, 2002 and the nine months ended September 30, 2003,
respectively, and have a working capital deficit of $2.4 million as of
September 30, 2003.
We sponsor a defined benefit pension plan which was frozen in 1993. As of
December 31, 2002, the present value of the accrued liabilities of our plan
exceeded its' assets by approximately $6.1 million. (determined on an ongoing
basis) The required contribution to the Plan is approximately $1.4 million for
2003 and if the Plan is continued, we will be obligated to make continued
contributions in future years which, absent some action by us, we expect that
the annual contribution requirements beyond 2003 will continue to be
significant. Future contribution levels depend in large measure on the mortality
rate of plan participants, the discount rate required, and the expected return
on the plan assets. In April 2002, we failed to make the required quarterly
contribution to the Plan due April 15, 2002, in the amount of $253,000. We made
this contribution on June 11, 2002 and quarterly contributions of $253,000 were
made on a timely basis in July 2002 and October 2002. In view of our financial
condition, in January 2003, we filed a notice with the PBGC seeking a "distress
termination" of the Plan and did not make the contributions due to the Plan
through October 15, 2003 which aggregate approximately $1.4 million. If the PBGC
determines that we meet one of the tests for such termination, the Plan will
terminate and the PBGC will become responsible for meeting future retirement
obligations to participants (within certain limitations). We would be liable to
the PBGC for the amount of the unfunded benefit obligation. We believe that, on
a termination basis, the Plan's liabilities could exceed the value of its assets
by in excess of $7.0 million. We have initiated discussions with the PBGC
concerning the termination of the Plan and our repayment obligation to the PBGC
if the Plan is terminated (including the timing of our repayment obligation). It
is not possible to predict the outcome of such discussions.
We and certain current and former officers are defendants in a lawsuit
alleging, among other things, misrepresentation and securities fraud. We believe
that we have meritorious defenses to the allegations and intend to defend
ourselves vigorously. The cost of defending against this action could be
significant, and if we are not successful in defending our self, we may be
required to pay the plaintiffs damages, which could have a material adverse
effect on our business and operations. See "We are unable to predict the extent
to which the resolution of lawsuits pending against us could adversely affect
our business". In addition, we have future non-cancelable operating lease
obligations for office space, vehicles and office equipment aggregating
$576,000.
We will need to raise additional capital that may not be available to us.
If the distress termination of the Plan for which we have applied is completed,
our 2003 funding requirements discussed above could be eliminated, in which
case, we believe that existing cash and short-term investments may be sufficient
to
21
meet our operating and capital requirements at the currently anticipated level
through December 31, 2003. However, additional capital will be necessary in
order to operate beyond December 2003 and to fund the current business plan and
other obligations. While we are actively considering various funding
alternatives, no arrangement to obtain additional funding has been secured or
entered into. There can be no assurance that we will be able to eliminate the
2003 funding requirements for the Plan or be able to obtain additional funding,
on acceptable terms or at all. If we cannot raise additional capital to continue
at our present level of operations we may not be able to meet our obligations,
take advantage of future acquisition opportunities or further develop or enhance
our product offering, any of which could have a material adverse effect on our
business and results of operations and could lead us to seek bankruptcy
protection. The auditors' reports on our Consolidated Financial Statements for
the years ended December 31, 2001 and 2002 contained an emphasis paragraph
concerning substantial doubt about our ability to continue as a going concern.
We currently have no capacity for commercial debt financing. Should such
capacity become available to us, we may be adversely affected in the future by
factors such as higher interest rates, inability to borrow without collateral,
and continued operating losses. Borrowings may also involve covenants limiting
or restricting our operations or future opportunities.
OUR STOCK HAS BEEN DELISTED FROM THE NASDAQ SYSTEM. On February 14, 2002,
we received a notice from The Nasdaq Stock Market ("Nasdaq") that our common
stock had failed to maintain a minimum closing bid price of $1.00 over the last
30 consecutive trading days as required by National Market rules. We received a
second notice on February 27, 2002, that our common stock also failed to
maintain a market value of public float of $5 million.
In accordance with the Nasdaq rules, we were required to regain compliance
with the National Market minimum bid price requirement and with the market value
of public float requirement by May 2002. Since our common stock continued to
trade significantly below $1.00, in April 2002, we filed an application to
transfer the listing of our common stock to the SmallCap Market. The application
was approved and our common stock listing was transferred to the SmallCap Market
effective May 2, 2002. The SmallCap Market also has a minimum bid price
requirement of $1.00. We qualified for an extended grace period to comply with
the SmallCap Market's $1.00 minimum bid price requirement, which extended the
delisting determination by Nasdaq until February 10, 2003.
On March 19, 2003, we received a Nasdaq Staff Determination letter
indicating that we failed to comply with the minimum bid price requirement for
continued listing on the SmallCap Market and that our common stock was therefore
subject to delisting. Our Board decided not to appeal the delisting
determination. Effective March 28, 2003, our common stock no longer traded on
the SmallCap Market. On March 28, 2003, our common stock began trading on the
OTC Bulletin Board.
As a result of the delisting, the liquidity of our common stock may be
materially adversely affected. This could impair our ability to raise capital in
the future. There can be no assurance that we will be able to obtain additional
funding, on acceptable terms or at all. If we cannot raise additional capital to
continue at our present level of operations we may not be able to meet our
obligations, take advantage of future acquisition opportunities or further
develop or enhance our product offering, any of which could have a material
adverse effect on our business and results of operations and could lead us to
seek bankruptcy protection.
WE ARE UNABLE TO PREDICT THE EXTENT TO WHICH THE RESOLUTION OF LAWSUITS
PENDING AGAINST US COULD ADVERSELY AFFECT OUR BUSINESS. On May 28, 2002, a
lawsuit was filed against us in the Superior Court of the State of California,
in the County of Los Angeles by Leonard M. Ross and affiliated entities
alleging, among other things misrepresentation and securities fraud. The lawsuit
names four of our current and former executive officers and directors and us as
the defendants. The plaintiffs seek monetary and punitive damages for alleged
actions made by the defendants in order to induce the plaintiff to purchase,
hold or refrain from selling our common stock. The plaintiffs allege that the
defendants made a series of material
22
misrepresentations, misleading statements, omissions and concealments,
specifically and directly to the plaintiffs concerning the nature, existence and
status of contracts with certain purchasers, the nature and existence of
investments in us by third parties, the nature and existence of business
relationships and investments by us. We believe we have meritorious defenses to
the allegations and intend to defend vigorously.
In November 2002, we and the individual defendants served with the action
filed a demurrer seeking the dismissal of six of the plaintiffs' nine purported
causes of action. In January 2003, the court ruled in favor of the demurrer and
dismissed the entire complaint. The plaintiffs were granted the right to replead
and subsequently filed an amended complaint in February 2003. We and the
individual defendants filed a second demurrer in March 2003. In June 2003, the
court ruled in favor of the demurrer and dismissed, without leave to amend, six
of the eleven purported causes of action in the amended complaint. The lawsuit
is in the early stages. Preliminary discovery has just commenced and no trial
date has been set. Consequently, at this time it is not reasonably possible to
estimate the damages, or range of damages, if any, that we might incur in
connection with this action. However, if the outcome of this lawsuit is
unfavorable to us, it could have a material adverse effect on our operations,
cash flow and financial position.
We incurred approximately $200,000 in defense costs in 2002. No additional
costs have been incurred in 2003. Notice of the commencement of this action has
been given to our directors and officers liability insurance carriers. Our
directors and officers liability insurance carriers are funding the additional
costs of defending this action, subject to the carriers' reservation of rights.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS. An important element of our
new strategic plan involves the acquisition of businesses in areas outside the
technology sectors in which we have recently been engaged, so as to diversify
our asset base. However, we will only be able to engage in future acquisitions
if we are successful in obtaining additional funding, as to which no assurance
can be given. Acquisitions would require us to invest financial resources and
may have a dilutive effect on our earnings or book value per share of common
stock. We cannot assure you that we will consummate any acquisitions in the
future, that any financing required for such acquisitions will be available on
acceptable terms or at all, or that any past or future acquisitions will not
materially adversely affect our results of operations and financial condition.
Our acquisition strategy generally presents a number of significant risks
and uncertainties, including the risks that:
- we will not be able to retain the employees or business
relationships of the acquired company;
- we will fail to realize any synergies or other cost reduction
objectives expected from the acquisition;
- we will not be able to integrate the operations, products, personnel
and facilities of acquired companies;
- management's attention will be diverted to pursuing acquisition
opportunities and integrating acquired products, technologies or
companies and will be distracted from performing its regular
responsibilities;
- we will incur or assume liabilities, including liabilities that are
unknown or not fully known to us at the time of the acquisition; and
- we will enter markets in which we have no direct prior experience.
We cannot assure you that any of the foregoing will not materialize, which
could have an adverse effect on our results of operations and financial
condition.
OUR TECSEC INVESTMENT MAY BE IMPAIRED OR SUBJECT TO A SIGNIFICANT
WRITE-DOWN IN THE FUTURE. As of September 30, 2003, after recording an
impairment charge of $2.1 million in the third quarter of 2002, the
23
carrying value of our investment in TecSec, a privately held company, was $3.0
million. This investment has been accounted for at cost and could be subject to
write-down in future periods if it is determined that the investment is
permanently impaired and not recoverable. TecSec is currently evaluating
alternative sources of financing to meet ongoing capital and operating needs. If
TecSec is not successful in executing its business plan or in obtaining
sufficient capital on acceptable terms or at all, our investment in TecSec could
be further impaired and subject to an additional significant write-down.
THE MARKET'S ACCEPTANCE OF OUR PRODUCTS IS UNCERTAIN. Demand for, and
market acceptance of, our software solutions and products are subject to a high
level of uncertainty due to rapidly changing technology, new product
introductions and changes in customer requirements and preferences. The success
of our products or any future products depends upon our ability to enhance our
existing products and to develop and introduce new products and technologies to
meet customer requirements. We face the risk that our current and future
products will not achieve market acceptance.
Our future revenues and earnings depend in large part on the success of
these products, and if the benefits are not perceived sufficient or if
alternative technologies are more widely accepted, the demand for our solutions
may not grow and our business and operating results would be materially and
adversely affected.
WE DEPEND ON A RELATIVELY SMALL NUMBER OF CUSTOMERS FOR A MAJORITY OF OUR
REVENUES. We rely on a limited number of customers in our business. We expect to
continue to depend upon a relatively small number of customers for a majority of
the revenues in our business. For the nine months ended September 30, 2003, no
one customer represented more than 10% of our sales. Amounts due from one
customer represented approximately 11% of the accounts receivable balance as of
September 30, 2003. For the year ended December 31, 2002, one customer
represented approximately 10% of our sales. Amounts due from this customer
represented approximately 12% of the accounts receivable balance as of December
31, 2002.
We generally do not enter into long-term supply commitments with our
customers. Instead, we bid on a project basis. Significant reductions in sales
to any of our largest customers would have a material adverse effect on our
business. In addition, we generate significant accounts receivable and inventory
balances in connection with providing products to our customers. A customer's
inability to pay for our products could have a material adverse effect on our
results of operations.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH TECHNOLOGICAL
CHANGES AND INTRODUCE NEW PRODUCTS IN A TIMELY MANNER. The rate of technological
change currently affecting the smart card market is particularly rapid compared
to other industries. Our ability to anticipate these trends and adapt to new
technologies is critical to our success. Because new product development
commitments must be made well in advance of actual sales, new product decisions
must anticipate future demand as well as the speed and direction of
technological change. Our ability to remain competitive will depend upon our
ability to develop in a timely and cost effective manner new and enhanced
products at competitive prices. New product introductions or enhancements by our
competitors could cause a decline in sales or loss of market acceptance of our
existing products and lower profit margins.
Our success in developing, introducing and selling new and enhanced
products depends upon a variety of factors, including:
- product selections;
- timely and efficient completion of product design and development;
- timely and efficient implementation of manufacturing processes;
- effective sales, service and marketing;
- price; and
- product performance in the field.
Our ability to develop new products also depends upon the success of our
research and development
24
efforts. We may need to devote additional resources to our research and
development efforts in the future. We cannot assure you that funds will be
available for these expenditures or that these funds will lead to the
development of viable products.
THE HIGHLY COMPETITIVE MARKETS IN WHICH WE OPERATE COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR BUSINESS AND OPERATING RESULTS. The markets in which we
operate are intensely competitive and characterized by rapidly changing
technology. We compete against numerous companies, many of which have greater
resources than we do, and we believe that competition is likely to intensify.
We believe that the principal competitive factors affecting us are:
- the extent to which products support industry standards and are
capable of being operated or integrated with other products;
- technical features and level of security;
- strength of distribution channels;
- price;
- product reputation, reliability, quality, performance and customer
support;
- product features such as adaptability, functionality and ease of
use; and
- competitor reputation, positioning and resources.
We cannot assure you that competitive pressures will not have a material
adverse effect on our business and operating results. Many of our current and
potential competitors have longer operating histories and significantly greater
financial, technical, sales, customer support, marketing and other resources, as
well as greater name recognition and a larger installed base of their products
and technologies than our company. Additionally, there can be no assurance that
new competitors will not enter our markets. Increased competition would likely
result in price reductions, reduced margins and loss of market share, any of
which could have a material adverse effect on our business and operating
results.
Our primary competition currently comes from companies offering closed
environment solutions, including small value electronic cash systems and
database management solutions, such as Girovend, Cunninghams, Uniware, Diebold
and Schlumberger.
Many of our current and potential competitors have broader customer
relationships that could be leveraged, including relationships with many of our
customers. These companies also have more established customer support and
professional services organizations than we do. In addition, a number of
companies with significantly greater resources than we have could attempt to
increase their presence by acquiring or forming strategic alliances with our
competitors, resulting in increased competition.
OUR LONG PRODUCT SALES CYCLES SUBJECT US TO RISK. Our products fall into
two categories; those that are standardized and ready to install and use and
those that require significant development efforts to implement within the
purchasers' own systems. Those products requiring significant development
efforts tend to be newly developed technologies and software applications that
can represent major investments for customers. We are subject to potential
customers' internal review processes and systems requirements. The
implementation of some of our products involves deliveries of small quantities
for pilot programs and significant testing by the customers before firm orders
are received, or lengthy beta testing of software solutions. For these more
complex products, the sales process may take one year or longer, during which
time we may expend significant financial, technical and management resources,
without any certainty of a sale.
WE MAY BE LIMITED IN OUR USE OF OUR FEDERAL NET OPERATING LOSS
CARRYFORWARDS. As of December 31, 2002, we had federal net operating loss
carryforwards, subject to review by the Internal Revenue Service, totaling
approximately $64.0 million for federal income tax purposes. The federal net
operating loss carryforwards begin to expire in 2005. We do not expect to earn
any significant taxable income in the next several years, and may not do so
until much later, if ever. A federal net operating loss can generally be
25
carried back two, three or five years and then forward fifteen or twenty years
(depending on the year in which the loss was incurred), and used to offset
taxable income earned by a company (and thus reduce its income tax liability).
Section 382 of the Internal Revenue Code provides that when a company
undergoes an "ownership change," that company's use of its net operating losses
is limited in each subsequent year. An "ownership change" occurs when, as of any
testing date, the sum of the increases in ownership of each shareholder that
owns five percent or more of the value of a company's stock as compared to that
shareholder's lowest percentage ownership during the preceding three-year period
exceeds fifty percentage points. For purposes of this rule, certain shareholders
who own less than five percent of a company's stock are aggregated and treated
as a single five-percent shareholder. We may issue a substantial number of
shares of our stock in connection with public and private offerings,
acquisitions and other transactions in the future, although no assurance can be
given that any such offering, acquisition or other transaction will be affected.
In addition, the exercise of outstanding options to purchase shares of our
common stock may require us to issue additional shares of our common stock. The
issuance of a significant number of shares of stock could result in an
"ownership change." If we were to experience such an "ownership change," we
estimate that virtually all of our available federal net operating loss
carryforwards would be effectively unavailable to reduce our taxable income.
The extent of the actual future use of our federal net operating loss
carryforwards is subject to inherent uncertainty because it depends on the
amount of otherwise taxable income we may earn. We cannot give any assurance
that we will have sufficient taxable income in future years to use any of our
federal net operating loss carryforwards before they would otherwise expire.
OUR PROPRIETARY TECHNOLOGY IS DIFFICULT TO PROTECT AND MAY INFRINGE ON THE
INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES. Our success depends significantly
upon our proprietary technology. We rely on a combination of patent, copyright
and trademark laws, trade secrets, confidentiality agreements and contractual
provisions to protect our proprietary rights. We seek to protect our software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection. We cannot assure you that any of our
applications will be approved, that any patents will be issued, that we will
develop proprietary products or technologies that are patentable, that any
issued patent will provide us with any competitive advantages or will not be
challenged by third parties. Furthermore, we cannot assure you that the patents
of others will not have a material adverse effect on our business and operating
results.
If our technology or products is determined to infringe upon the rights of
others, and we were unable to obtain licenses to use the technology, we could be
required to cease using the technology and stop selling the products. We may not
be able to obtain a license in a timely manner on acceptable terms or at all.
Any of these events would have a material adverse effect on our financial
condition and results of operations.
Patent disputes are common in technology related industries. We cannot
assure you that we will have the financial resources to enforce or defend a
patent infringement or proprietary rights action. As the number of products and
competitors in the smart card market grows, the likelihood of infringement
claims also increases. Any claim or litigation may be time consuming and costly,
cause product shipment delays or require us to redesign our products or enter
into royalty or licensing agreements. Any of these events would have a material
adverse effect on our business and operating results. Despite our efforts to
protect our proprietary rights, unauthorized parties may attempt to copy aspects
of our products or to use our proprietary information and software. In addition,
the laws of some foreign countries do not protect proprietary and intellectual
property rights as effectively as do the laws of the United States. Our means of
protecting our proprietary and intellectual property rights may not be adequate.
There is a risk that our competitors will independently develop similar
technology, duplicate our products or design around patents or other
intellectual property rights.
We believe that establishing, maintaining and enhancing the Infineer brand
name is essential to our business. We filed an application for a United States
trademark registration and an application for service
26
mark registration of our name and logo. We are aware of third parties that use
marks or names that contain similar sounding words or variations of the "infi"
prefix. In July 2002, we received a claim from a third party challenging the use
of the Infineer name. We have reached an agreement in principle with this third
party, subject to negotiation of definitive documentation, and believe this
particular challenge should be resolved. As a result of this claim and other
challenges which may occur in the future, we may incur significant expenses, pay
substantial damages and be prevented from using the Infineer name. Use of a
similar name by third parties may also cause confusion to our clients and
confusion in the market, which could decrease the value of our brand and harm
our reputation. We cannot assure you that our business would not be adversely
affected if we are required to change our name or if confusion in the market did
occur.
THE NATURE OF OUR PRODUCTS SUBJECTS US TO PRODUCT LIABILITY RISKS. Our
customers may rely on certain of our current products and products in
development to prevent unauthorized access to digital content for financial
transactions, computer networks, and real property. A malfunction of or design
defect in certain of our products could result in tort or warranty claims.
Although we attempt to reduce the risk of exposure from such claims through
warranty disclaimers and liability limitation clauses in our sales agreements
and by maintaining product liability insurance, we cannot assure you that these
measures will be effective in limiting our liability for any damages. Any
liability for damages resulting from security breaches could be substantial and
could have a material adverse effect on our business and operating results. In
addition, a well-publicized actual or perceived security breach involving our
conditional access or security products could adversely affect the market's
perception of our products in general, regardless of whether any breach is
attributable to our products. This could result in a decline in demand for our
products, which could have a material adverse effect on our business and
operating results.
WE MAY HAVE DIFFICULTY RETAINING OR RECRUITING PROFESSIONALS FOR OUR
BUSINESS. Our future success and performance is dependent on the continued
services and performance of our senior management and other key personnel. If we
fail to meet our operating and financial objectives this may make it more
difficult to retain and reward our senior management and key personnel. The loss
of the services of any of our executive officers or other key employees could
materially adversely affect our business.
Our business requires experienced software and hardware engineers, and our
success depends on identifying, hiring, training and retaining such experienced,
knowledgeable professionals. If a significant number of our current employees or
any of our senior technical personnel resign, or for other reasons are no longer
employed by us, we may be unable to complete or retain existing projects or bid
for new projects of similar scope and revenues. In addition, former employees
may compete with us in the future.
Even if we retain our current employees, our management must continually
recruit talented professionals in order for our business to grow. Furthermore,
there is significant competition for employees with the skills required to
perform the services we offer. We cannot assure you that we will be able to
attract a sufficient number of qualified employees in the future to sustain and
grow our business, or that we will be successful in motivating and retaining the
employees we are able to attract. If we cannot attract, motivate and retain
qualified professionals, our business, financial condition and results of
operations will suffer.
OUR INTERNATIONAL OPERATIONS SUBJECT US TO RISK ASSOCIATED WITH OPERATING
IN FOREIGN MARKETS, INCLUDING FLUCTUATIONS IN CURRENCY EXCHANGE RATES, WHICH
COULD ADVERSELY AFFECT OUR OPERATIONS AND FINANCIAL CONDITION. Our operation are
currently conducted through Infineer, which is located in the United Kingdom.
Sales to customer in the U.S. represented approximately 22% and 20% of total
sales for the year ended December 31, 2002 and nine months ended September 30,
2003, respectively. Because we derive a substantial portion of our business
outside the United States, we are subject to certain risks associated with
operating in foreign markets including the following:
- tariffs and other trade barriers;
- difficulties in staffing and managing foreign operations;
27
- currency exchange risks;
- export controls related to encryption technology;
- unexpected changes in regulatory requirements;
- changes in economic and political conditions;
- potentially adverse tax consequences; and o burdens of complying
with a variety of foreign laws.
Any of the foregoing could adversely impact the success of our operations.
We cannot assure you that such factors will not have a material adverse effect
on our future sales and, consequently, on our business, operating results and
financial condition. In addition, fluctuations in exchange rates could have a
material adverse effect on our business, operating results and financial
condition. To date, we have not engaged in currency hedging.
CHANGES WE MAY NEED OR BE REQUIRED TO MAKE IN OUR INSURANCE COVERAGE MAY
EXPOSE US TO INCREASED LIABILITIES AND MAY INTERFERE WITH OUR ABILITY TO RETAIN
OR ATTRACT QUALIFIED OFFICERS AND DIRECTORS. We renew or replace various
insurance policies on an annual basis, including those that cover directors and
officers liability. Given the current climate of rapidly increasing insurance
premiums and erosions of coverage, we may need or be required to reduce our
coverage and increase our deductibles in order to afford the premiums. To the
extent we reduce our coverage and increase our deductibles, our exposure and the
exposure of our directors and officers for liabilities that either become
excluded from coverage or underinsured will increase. As a result, we may lose
or may experience difficulty in attracting qualified directors and officers.
WE ARE SUBJECT TO GOVERNMENT REGULATION. Federal, state and local
regulations impose various environmental controls on the discharge of chemicals
and gases, which have been used in our past assembly processes and may be used
in future processes. Moreover, changes in such environmental rules and
regulations may require us to invest in capital equipment and implement
compliance programs in the future. Any failure by us to comply with
environmental rules and regulations, including the discharge of hazardous
substances, could subject us to liabilities and could materially adversely
affect our operations.
OUR ARTICLES OF INCORPORATION AND BY-LAWS, CERTAIN CHANGE OF CONTROL
AGREEMENTS, OUR RIGHTS PLAN AND PROVISIONS OF PENNSYLVANIA LAW COULD DETER
TAKEOVER ATTEMPTS.
Blank check preferred stock. Our board of directors has the authority to
issue preferred stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares without any further vote
or action by the holders of our common stock. The rights of the holders of any
preferred stock that may be issued in the future may adversely affect the rights
of the holders of our common stock. The issuance of preferred stock could make
it more difficult for a third party to acquire a majority of our outstanding
voting stock, thereby delaying, deferring or preventing a change of control.
Such preferred stock may have other rights, including economic rights, senior to
our common stock, and as a result, the issuance of the preferred stock could
limit the price that investors might be willing to pay in the future for shares
of our common stock and could have a material adverse effect on the market value
of our common stock.
Rights plan. Our rights plan entitles the registered holders of rights to
purchase shares of our class A preferred stock upon the occurrence of certain
events, and may have the effect of delaying, deferring or preventing a change of
control.
Change of control agreements. We are a party to change of control
agreements, which provide for payments to certain of our directors and executive
officers under certain circumstances following a change of control. Since the
change of control agreements require large cash payments to be made by any
person effecting a change of control, these agreements may discourage takeover
attempts.
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The change of control agreements provide that, if the services of any
person party to a change of control agreement are terminated within three years
following a change of control, that individual will be entitled to receive, in a
lump sum within 10 days of the termination date, a payment equal to 2.99 times
that individual's average annual compensation for the shorter of the five years
preceding the change of control and the period the individual received
compensation from us for personal services. Assuming a change of control were to
occur at the present time, payments in the following amounts would be required:
Mr. Harry I. Freund of $842,000 and Mr. Jay S. Goldsmith of $842,000. If any
such payment, either alone or together with others made in connection with the
individual's termination, is considered to be an excess parachute payment under
the Internal Revenue Code, the individual will be entitled to receive an
additional payment in an amount which, when added to the initial payment, would
result in a net benefit to the individual, after giving effect to excise taxes
imposed by Section 4999 of the Internal Revenue Code and income taxes on such
additional payment, equal to the initial payment before such additional payment
and we would not be able to deduct these initial or additional payments for
income tax purposes.
Pennsylvania law. We are a Pennsylvania corporation. Anti-takeover
provisions of Pennsylvania law could make it difficult for a third party to
acquire control of us, even if such change of control would be beneficial to our
shareholders.
OUR STOCK PRICE IS EXTREMELY VOLATILE. The stock market has recently
experienced significant price and volume fluctuations unrelated to the operating
performance of particular companies. The market price of our common stock has
been highly volatile and is likely to continue to be volatile. The future
trading price for our common stock will depend on a number of factors,
including:
- delisting of our common stock from the Nasdaq SmallCap Market
effective March 28, 2003 (see "Our stock has been delisted from the
Nasdaq System" above);
- the volume of activity for our common stock is minimal and therefore
a large number of shares placed for sale or purchase could increase
its volatility;
- our ability to effectively manage our business, including our
ability to raise capital;
- variations in our annual or quarterly financial results or those of
our competitors;
- general economic conditions, in particular, the technology service
sector;
- expected or announced relationships with other companies;
- announcements of technological advances innovations or new products
by us or our competitors;
- patents or other proprietary rights or patent litigation; and
- product liability or warranty litigation.
We cannot be certain that the market price of our common stock will not
experience significant fluctuations in the future, including fluctuations that
are adverse and unrelated to our performance.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign currency exchange rate risk
We conduct operations in the United Kingdom and sell products in several
different countries. Therefore, our operating results may be impacted by the
fluctuating exchange rates of foreign currencies, especially the British pound,
in relation to the U.S. dollar. We do not currently engage in hedging activities
with respect to our foreign currency exposure. We continually monitor our
exposure to currency fluctuations and may use financial hedging techniques when
appropriate to minimize the effect of these fluctuations. Even so, exchange rate
fluctuations may still have a material adverse effect on our business and
operating results.
Market Risk
We are exposed to market risk primarily through short-term investments and
an overdraft facility. Our investment policy calls for investment in short-term,
low risk instruments. As of September 30, 2003, short-term investments
(principally U.S. Treasury bills and money-market accounts) were $1.4 million
and borrowing under the overdraft facility amounted to $292,000. Due to the
nature of the short-term investments and the amount of the overdraft facility,
any change in rates would not have a material impact on our financial condition
or results of operations.
Investment Risk
As of September 30, 2003, the carrying value of our investment in TecSec,
a privately held company, was $3.0 million after recording an impairment change
of $2.1 million in the third quarter of 2002. This investment has been accounted
for at cost and could be subject to write-downs in future periods if it is
determined that the investment is permanently impaired and is not recoverable.
TecSec is currently evaluating alternative sources of financing to meet ongoing
capital and operating needs. If TecSec is not successful in executing its
business plan or in obtaining sufficient capital on acceptable terms or at all,
our investment could be further impaired and subject to a significant additional
write-down.
ITEM 4. CONTROLS AND PROCEDURES
With the participation of management, the Company's chief executive
officer and chief financial officer has evaluated the effectiveness of the
Company's disclosure controls and procedures as of the end of the period covered
by this report. Based upon this evaluation, the chief executive officer and
chief financial officer has concluded that, as of the end of such period, the
Company's disclosure controls and procedures are effective.
There has not been any change in the Company's internal controls over
financial reporting during the fiscal quarter to which this report relates that
has materially affected, or is reasonably likely to materially affect, the
Company's internal controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 28, 2002, a lawsuit was filed against the Company in the Superior
Court of the State of California, in the County of Los Angeles by Leonard M.
Ross and affiliated entities alleging, among other things, misrepresentation and
securities fraud. The lawsuit names the Company and four of its current and
former executive officers and directors as the defendants. The plaintiffs seek
monetary and punitive damages for alleged actions made by the defendants in
order to induce the plaintiff to purchase, hold or refrain from selling
PubliCARD common stock. The plaintiffs allege that the defendants made a series
of material misrepresentations, misleading statements, omissions and
concealments, specifically and directly to the plaintiffs concerning the nature,
existence and status of contracts with certain purchasers, the nature and
existence of investments in the Company by third parties, the nature and
existence of business relationships and investments by the Company. The Company
believes it has meritorious defenses to the allegations and intends to defend
vigorously.
In November 2002, the Company and the individual defendants served with
the action filed a demurrer seeking the dismissal of six of the plaintiffs' nine
purported causes of action. In January 2003, the court ruled in favor of the
demurrer and dismissed the entire complaint. The plaintiffs were granted the
right to replead and subsequently filed an amended complaint in February 2003.
The Company and individual defendants filed a second demurrer in March 2003. In
June 2003, the court ruled in favor of the demurrer and dismissed, without leave
to amend, six of the eleven purported causes of action in the amended complaint.
The lawsuit is in the early stages. Preliminary discovery has just commenced and
no trial date has been set. Consequently, at this time it is not reasonably
possible to estimate the damages, or range of damages, if any, that the Company
might incur in connection with this action. However, if the outcome of this
lawsuit is unfavorable to the Company, it could have a material adverse effect
on the Company's operations, cash flow and financial position.
The Company incurred approximately $200,000 in defense costs in 2002. No
additional costs have been incurred in 2003. Notice of the commencement of this
action has been given to the Company's directors and officers liability
insurance carriers. The Company's directors and officers liability insurance
carriers are funding the additional costs of defending this action, subject to
the carriers' reservation of rights.
Various other legal proceedings are pending against the Company. The
Company considers all such other proceedings to be ordinary litigation incident
to the character of its business. Certain claims are covered by liability
insurance. The Company believes that the resolution of these claims to the
extent not covered by insurance will not, individually or in the aggregate, have
a material adverse effect on the consolidated financial position or consolidated
results of operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of the Chief Executive Officer and Chief Financial Officer
filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Financial Officer
filed herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Report on Form 8-K
Form 8-K dated August 8, 2003, reporting of the Registrant's results of
operations for the second quarter of 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PUBLICARD, INC.
(Registrant)
Date: November 10, 2003 /s/ Antonio L. DeLise
Antonio L. DeLise, President,
Chief Executive Officer, Chief Financial Officer
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