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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, 2004
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.)
ONE ROCKEFELLER PLAZA, 14TH 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 12, 2004: 24,690,902
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2004 2003
--------- ---------
(unaudited)
ASSETS
Current assets:
Cash, including short-term investments of $2,102 and $3,501 in 2004
and 2003, respectively $ 2,342 $ 3,580
Trade receivables, less allowance for doubtful accounts of $89 and $115
in 2004 and 2003, respectively 1,136 1,133
Inventories 589 635
Prepaid insurance and other 561 440
--------- ---------
Total current assets 4,628 5,788
--------- ---------
Equipment and leasehold improvements, net 146 191
Goodwill and intangibles 792 822
Other assets 446 598
--------- ---------
$ 6,012 $ 7,399
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Trade accounts payable and overdraft $ 1,213 $ 1,569
Accrued liabilities 1,539 5,206
--------- ---------
Total current liabilities 2,752 6,775
Note payable 7,501 --
Other non-current liabilities 410 3,552
--------- ---------
Total liabilities 10,663 10,327
--------- ---------
Commitments and contingencies (Note 4)
Shareholders' deficit:
Class A Preferred Stock, Second Series, no par value: 1,000 shares authorized; 565
shares issued and outstanding as of September 30, 2004 and December 31, 2003 2,825 2,825
Common shares, $0.10 par value: 40,000,000 shares authorized; 24,690,902
shares issued and outstanding as of September 30, 2004 and December 31, 2003 2,469 2,469
Additional paid-in capital 108,119 108,119
Accumulated deficit (117,985) (113,617)
Other comprehensive loss (79) (2,724)
--------- ---------
Total shareholders' deficit (4,651) (2,928)
--------- ---------
$ 6,012 $ 7,399
========= =========
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, 2004 AND 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues $ 1,260 $ 1,417 $ 3,116 $ 4,023
Cost of revenues 530 645 1,416 1,876
------------ ------------ ------------ ------------
Gross margin 730 772 1,700 2,147
------------ ------------ ------------ ------------
Operating expenses:
General and administrative 568 676 1,840 2,067
Sales and marketing 365 415 1,190 1,420
Product development 173 169 522 414
Amortization of intangibles 10 10 30 30
------------ ------------ ------------ ------------
1,116 1,270 3,582 3,931
------------ ------------ ------------ ------------
Loss from operations (386) (498) (1,882) (1,784)
------------ ------------ ------------ ------------
Other income (expenses):
Interest income 6 3 18 10
Interest expense (6) (3) (16) (8)
Cost of pensions - non-operating (132) (255) (396) (697)
Loss on pension settlement (2,739) -- (2,739) --
Gain on insurance recoveries 170 (2) 647 1,705
Other income (expenses), net 5 6 -- 96
------------ ------------ ------------ ------------
(2,696) (251) (2,486) 1,106
------------ ------------ ------------ ------------
Net loss $ (3,082) $ (749) $ (4,368) $ (678)
============ ============ ============ ============
Basic and diluted loss per common share $ (.12) $ (.03) $ (.18) $ (.03)
============ ============ ============ ============
Basic and diluted weighted average 24,690,902 24,534,652 24,690,902 24,428,402
common shares outstanding ============ ============ ============ ============
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, 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
Other Total
Class A Common Shares Additional Comprehen- Share-
Preferred Shares Paid-in Accumulated sive holders'
Stock Issued Amount Capital Deficit Loss Deficit
------- ---------- ------ -------- --------- ------- -------
Balance - January 1, 2004 $ 2,825 24,690,902 $2,469 $108,119 $(113,617) $(2,724) $(2,928)
Comprehensive income (loss):
Net loss -- -- -- -- (4,368) -- (4,368)
Pension settlement -- -- -- -- -- 2,649 2,649
Foreign currency translation
adjustment -- -- -- -- -- (4) (4)
------- ---------- ------ -------- --------- ------- -------
Comprehensive loss (1,723)
-------
Balance - September 30, 2004 $ 2,825 24,690,902 $2,469 $108,119 $(117,985) $ (79) $(4,651)
======= ========== ====== ======== ========= ======= =======
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 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(IN THOUSANDS)
(UNAUDITED)
2004 2003
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,368) $ (678)
Adjustments to reconcile net loss to net cash used
in operating activities:
Loss on pension settlement 2,739 --
Gain on insurance recoveries (647) (1,705)
Loss on disposal of fixed assets -- 46
Amortization of intangibles 30 30
Depreciation and amortization 94 118
Changes in assets and liabilities:
Trade receivables 44 (544)
Inventories 69 319
Prepaid insurance and other current assets 230 211
Trade accounts payable and overdraft (271) 265
Accrued liabilities 1,029 1,663
Other non-current liabilities (675) (1,358)
------- -------
Net cash used in operating activities (1,726) (1,633)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (49) (11)
Proceeds from insurance recoveries 531 1,705
Other 5 40
------- -------
Net cash provided by investing activities 487 1,734
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES -- --
------- -------
Effect of exchange rate changes on cash and cash equivalents 1 --
------- -------
Net (decrease) increase in cash (1,238) 101
Cash - beginning of period 3,580 1,290
------- -------
Cash - end of period $ 2,342 $ 1,391
======= =======
Cash paid for interest $ 16 $ 8
======= =======
The accompanying notes to the 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 AND LIQUIDITY AND GOING
CONCERN CONSIDERATIONS
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 a number of years.
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 $2.3
million at September 30, 2004. The Company also had a shareholders' deficit of
$4.7 million at September 30, 2004.
The Company sponsored a defined benefit pension plan (the "Plan") that was
frozen in 1993. In January 2003, the Company filed a notice with the Pension
Benefit Guaranty Corporation (the "PBGC") seeking a "distress termination" of
the Plan. In September 2004, the PBGC proceeded to terminate the Plan and was
appointed as the Plan's trustee. See Note 3 for further information on the Plan
termination. As a result of the Plan termination, the Company's 2003 and 2004
funding requirements due to the Plan amounting to $3.4 million through September
15, 2004 were eliminated. As such, 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 September 30,
2005. However, additional capital will be necessary in order to operate beyond
September 30, 2005 and to fund the current business plan and other obligations.
While the Company is 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 obtain additional funding
on acceptable terms or at all. If the Company cannot raise additional capital to
continue its present level of operations it is not likely to be able to meet its
obligations, take advantage of future acquisition opportunities or further
develop or enhance its product offering, any of which would have a material
adverse effect on its business and results of operations and is likely to lead
the Company to seek bankruptcy protection. These conditions raise
5
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
substantial doubt about the Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. The independent auditors' reports
on the Company's Consolidated Financial Statements for the years ended December
31, 2003 and 2002 contained emphasis paragraphs 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, 2004 and the results of their
operations and cash flows for the three and nine months ended September 30,
2004. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted 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, 2003.
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 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, 2004 and 2003, diluted net income (loss) per share
was the same as basic net income (loss) per share since the effect of stock
options 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
deferred and recognized upon client acceptance or "go live" date. Maintenance
and support fees are deferred and recognized as revenue 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,
6
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
possible alternative uses and the ultimate realization of potentially excess
inventory. Inventories as of September 30, 2004 and December 31, 2003 consisted
of the following (in thousands):
2004 2003
---- ----
Raw materials and work-in-process $388 $486
Finished goods 201 149
---- ----
$589 $635
==== ====
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 Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") 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 determines 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 relies 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 performs its annual goodwill
impairment test during the fourth quarter absent any interim impairment
indicators. The carrying value of goodwill as of September 30, 2004 and December
31, 2003 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. The gross carrying amount and accumulated amortization of intangible
assets at September 30, 2004 and December 31, 2003 was as follows (in
thousands):
2004 2003
------- -------
Gross carrying amount $ 1,881 $ 1,881
Accumulated amortization (1,871) (1,841)
------- -------
$ 10 $ 40
======= =======
Amortization of intangibles was $30,000 for both the nine months ended
September 30, 2004 and 2003. The estimated annual amortization expense for
intangibles is $40,000 for 2004.
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").
7
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
At September 30, 2004, 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) income and (loss) income per share for the
three and nine months ended September 30, 2004 and 2003 would have been as
follows (in thousands except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------- ----- ------- -------
Net loss, as reported $(3,082) $(749) $(4,368) $ (678)
Deduct: Total stock-based compensation expense
determined under fair value based method (35) (122) (95) (367)
------- ----- ------- -------
Pro forma net loss $(3,117) $(871) $(4,463) $(1,045)
======= ===== ======= =======
Basic and diluted loss per share:
As reported $ (.12) $(.03) $ (.18) $ (.03)
======= ===== ======= =======
Pro forma $ (.13) $(.04) $ (.18) $ (.04)
======= ===== ======= =======
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 the Company's 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 and valuation of goodwill and
intangibles to be critical policies due to the estimation processes involved.
While all available information has been considered, actual amounts could differ
from those reported.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The carrying amount of financial instruments, including cash and short-term
investments, accounts receivable, accounts payable and accrued liabilities,
approximates fair value. The fair value of long-term debt is estimated based on
current rates which could be offered to the Company for debt of the same
remaining maturity. The estimated fair value of the Company's long term debt as
of September 30, 2004 was as follows (in thousands):
CARRYING FAIR
AMOUNT VALUE
------- -----
Long-term debt $ 7,501 $ 943
Financial instruments that subject the Company to concentrations of credit
risk consist primarily of cash and short-term investments and accounts
receivable. The Company maintains all of its cash and short-term investments
with high-credit quality financial institutions. The Company's customer base
consists of businesses principally in Europe (with a concentration in the United
Kingdom) and the United States. For the year ended December 31, 2003, no one
customer accounted for more than 10% of revenues. For the nine months ended
September 30, 2004, one customer accounted for 10% of revenues. Amounts due from
this customer represented approximately 25% of the accounts receivable balance
as of September 30, 2004.
8
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
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 guarantees. 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. The adoption of the recognition and measurement provisions
did not have a material impact on the Company's Consolidated Financial
Statements.
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). In December 2003, the
FASB issued FIN No. 46 (Revised) ("FIN 46-R") to address certain FIN 46
implementation issues. This interpretation clarifies the application of
Accounting Research Bulletin ("ARB") No. 51, "Consolidated Financial Statements"
for companies that have interests in entities that are Variable Interest
Entities ("VIE") as defined under FIN 46. According to this interpretation, if a
company has an interest in a VIE and is at risk for a majority of the VIEs
expected losses or receives a majority of the VIE's expected gains, it must
consolidate the VIE. FIN 46-R also requires additional disclosures by primary
beneficiaries and other significant variable interest holders. For entities
acquired or created before February 1, 2003, this interpretation is effective no
later than the end of the first interim or reporting period ending after March
15, 2004, except for those VIE's that are considered to be special purpose
entities, for which the effective date is no later than the end of the first
interim or annual reporting period ending after December 15, 2003. For all
entities that were acquired subsequent to January 31, 2003, this interpretation
is effective as of the first interim or annual period ending after December 31,
2003. The adoption of the provisions of this interpretation did not have a
material effect 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 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.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ("SFAS No. 132
revised") that improves financial statement disclosures for defined benefit
plans. The change replaces existing SFAS No. 132 disclosure requirements for
pensions and other postretirement benefits and revises employers' disclosures
about pension plans and other postretirement benefit plans. It does not change
the measurement of recognition of those plans required by SFAS No. 87,
"Employers' Accounting for Pensions", or SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits." SFAS No. 132 revised retains the disclosure requirements
9
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
contained in the original SFAS No. 132, but requires additional disclosures
about the plan assets, obligations, cash flows, and net periodic benefit cost of
defined benefit pension plans and other defined benefit postretirement plans.
SFAS No. 132 revised is effective for annual and interim periods with fiscal
years ending after December 15, 2003. The Company adopted the revised disclosure
provisions.
In December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition", which supersedes SAB
No. 101, "Revenue Recognition in Financial Statements". SAB No. 104 rescinds
accounting guidance in SAB No. 101 related to multiple-element arrangements, as
this guidance has been superseded as a result of the issuance of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." The adoption
of SAB No. 104 did not have a material impact on the Company's Consolidated
Financial Statements.
NOTE 2 - 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, 2004 and 2003 are as follows (in thousands):
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30 SEPTEMBER 30,
------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
United States $ 197 $ 258 $ 368 $ 812
Europe 1,043 1,062 2,568 2,915
Rest of world 20 97 180 296
------ ------ ------ ------
$1,260 $1,417 $3,116 $4,023
====== ====== ====== ======
The Company has operations in the United States and United Kingdom.
Identifiable tangible assets by country as of September 30, 2004 and December
31, 2003 are as follows (in thousands):
2004 2003
------- -------
United States $ 3,375 $ 4,542
United Kingdom 1,845 2,035
------- -------
$ 5,220 $ 6,577
======= =======
NOTE 3 - UNDERFUNDED PENSION PLAN
The Company sponsored a defined benefit pension plan that was frozen in
1993. In January 2003, the Company filed a notice with the PBGC seeking a
"distress termination" of the Plan. Pursuant to the Agreement for Appointment of
Trustee and Termination of Plan between the PBGC and the Company, effective
September 30, 2004, the PBGC proceeded to terminate the Plan and was appointed
as the Plan's trustee. As a result, the PBGC has assumed responsibility for
paying the obligations to Plan participants. Under the terms of the Settlement
Agreement, effective September 23, 2004, between the PBGC and the Company (the
"Settlement Agreement"), the Company is liable to the PBGC for the unfunded
guaranteed benefit payable by the PBGC to Plan participants in the amount of
$7.5 million. The Company satisfied this liability by issuing a non-interest
bearing note (the "Note"), dated September 23, 2004, payable to the PBGC with a
face amount of $7.5 million. A loss on the termination of the Plan of $2.7
million was recorded in the third quarter of 2004.
Pursuant to the Security Agreement and Pledge Agreement, both dated
September 23, 2004, the Note is secured by (a) all presently owned or hereafter
acquired real or personal property and rights to property of the Company and (b)
the common and preferred stock of Infineer and TecSec Incorporated ("TecSec")
owned by the
10
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Company. Infineer is a wholly-owned subsidiary of the Company. The Company has
an approximately 5% ownership interest in TecSec, on a fully diluted basis.
The Note matures on September 23, 2011. The first payment will be equal to
$1.0 million and will become due 30 days after the Company has received a total
of $4.0 million in Net Recoveries (as defined below). Thereafter, on each
anniversary of the first payment, the Company is required to pay the PBGC an
amount equal to 25% of the Net Recoveries in excess of $4.0 million (less the
sum of all prior payments made in accordance with this sentence in prior years).
Net Recoveries, as defined in the Settlement Agreement, is the net cash proceeds
received by the Company with respect to transactions consummated after March 31,
2003 from (a) the sale of the Company's interest in Infineer and TecSec and real
property in Louisiana and (b) any recoveries from the Company's historic
insurance program. As of September 30, 2004, Net Recoveries was approximately
$3.2 million.
In the event of default by the Company under the Settlement Agreement, the
PBGC may declare the outstanding amount of the Note to be immediately due and
payable, proceed with foreclosure of the liens granted in favor of the PBGC and
exercise any other rights available under applicable law.
Cost of retirement benefits - non-operating of $396,000 and $697,000 for the
nine months ended September 30, 2004 and 2003, respectively, includes the net
periodic pension cost and other Plan related expenses. The components of the net
periodic pension cost for the nine months ended September 30, 2004 and 2003 were
as follows (in thousands):
2004 2003
--------- ---------
Interest cost $ 348 $ 398
Expected return on plan assets (87) (122)
Amortization of transition obligation - 220
Amortization of net (gain) loss 83 64
--------- ---------
Net periodic pension cost $ 344 $ 560
========= =========
The unrecognized transition obligation was zero at December 31, 2003 and,
accordingly, there was no further amortization expense related to this component
of net periodic pension cost in 2004. As a result of the termination of the
Plan, net periodic pension cost will be zero prospectively.
NOTE 4 - 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
11
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
leave to amend, six of the eleven purported causes of action in the amended
complaint. The lawsuit is in the early stages. 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 2004 and 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 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 gain from these settlements of $1.7 million in
the first quarter of 2003.
In February 2004, the Company entered into a binding agreement to assign to
a third party certain insurance claims against a group of historic insurers. In
July 2004, the assignment was supplemented to include several additional
insurers. The claims involve several historic general liability policies of
insurance issued to the Company. As a result of the assignment, after allowance
for associated expenses and offsetting adjustments, the Company received net
proceeds of approximately $477,000 in May 2004 and an additional $170,000 in
October 2004. The Company recognized a gain of $477,000 in the first quarter of
2004 and an additional gain of $170,000 in the third quarter of 2004.
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.
LEASES
The Company leases certain office space, vehicles and office equipment under
operating leases that expire over the next five years. Minimum payments for
operating leases, having initial or remaining non-cancelable terms in excess of
one year, aggregates approximately $921,000.
NOTE 5- COMPREHENSIVE LOSS
Comprehensive (loss) income for the Company includes foreign currency
translation adjustments, as well as the net (loss) income reported in the
Company's Condensed Consolidated Statements of Operations. Comprehensive (loss)
income for the three and nine months ended September 30, 2004 and 2003 was as
follows (in thousands):
12
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------- ------- ------- -------
Net loss $(3,082) $ (749) $(4,368) $ (678)
Pension termination 2,649 -- 2,649 --
Foreign currency translation adjustments (2) -- (4) 8
------- ------- ------- -------
Comprehensive loss $ (435) $ (749) $(1,723) $ (670)
======= ======= ======= =======
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 forward-looking words or phrases, including "believes," "expects,"
"anticipates," "estimates," "may," "should," "would," "could," "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 events
described under 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 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 Condensed Consolidated Financial Statements, the Company has incurred
operating losses 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, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
REVENUES. Revenues are generated from product sales, technology and software
license fees, installation and maintenance contracts. Consolidated revenues
decreased to $1.3 million in 2004 compared to $1.4 million for 2003. Foreign
currency changes had the effect of increasing revenues by 10%. Excluding the
impact of foreign currency changes, sales in 2004 decreased by 21% driven by a
decline in shipments to distribution partners located outside of the United
Kingdom.
GROSS MARGIN. Cost of revenues consists primarily of material, personnel
costs and overhead. Gross margin, as a percentage of net sales, was 58% in 2004
and 54% in 2003.
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 $365,000 in 2004 compared to
$415,000 in 2003. The 2003 results included $25,000 in employee termination
expense.
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 $173,000 in 2004 compared to $169,000 in 2003.
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 $568,000 in 2004 compared to
$676,000 in 2003. The decrease in expenses is mainly attributable to a decline
in legal, insurance and other corporate costs.
AMORTIZATION OF INTANGIBLES. In accordance with SFAS No. 142, "Goodwill and
Other Intangible Assets" ("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 was $10,000 in
both 2004 and 2003.
COST OF PENSIONS - NON-OPERATING. 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. The original unrecognized transition obligation
was fully amortized at December 31, 2003. As such, beginning in 2004 there will
be no further amortization expense related to this component of net periodic
pension cost. Cost of pensions therefore declined from $255,000 in 2003 to
$132,000 in 2004. As a result of the pension settlement (see below), cost of
pensions - non-operating will be zero prospectively.
LOSS ON PENSION SETTLEMENT. The Company sponsored a defined benefit pension
plan that was frozen in 1993. In January 2003, the Company filed a notice with
the PBGC seeking a "distress termination" of the Plan. Pursuant to the Agreement
for Appointment of Trustee and Termination of Plan between the PBGC and the
Company effective September 30, 2004, the PBGC proceeded to terminate the Plan
and was appointed as the Plan's trustee. As a result, the PBGC has assumed
responsibility for paying the obligations to Plan participants. Under the terms
of the Settlement Agreement, the Company is liable to the PBGC for the unfunded
guaranteed benefit payable by the PBGC to Plan participants in the amount of
$7.5 million. The Company satisfied this liability by issuing a non-interest
bearing Note payable to the PBGC with a face amount of $7.5 million. A loss on
the termination of the Plan of $2.7 million was recorded in the third quarter of
2004.
Pursuant to the Security Agreement and Pledge Agreement, both dated
September 23, 2004, the Note is secured by (a) all presently owned or hereafter
acquired real or personal property and rights to property of the
15
Company and (b) the common and preferred stock of Infineer and TecSec
Incorporated ("TecSec") owned by the Company. Infineer is a wholly-owned
subsidiary of the Company. The Company has an approximately 5% ownership
interest in TecSec, on a fully diluted basis.
The Note matures on September 23, 2011. The first payment will be equal to
$1.0 million and will become due 30 days after the Company has received a total
of $4.0 million in Net Recoveries (as defined below). Thereafter, on each
anniversary of the first payment, the Company is required to pay the PBGC an
amount equal to 25% of the Net Recoveries in excess of $4.0 million (less the
sum of all prior payments made in accordance with this sentence in prior years).
Net Recoveries, as defined in the Settlement Agreement, is the net cash proceeds
received by the Company with respect to transactions consummated after March 31,
2003 from (a) the sale of the Company's interest in Infineer and TecSec and real
property in Louisiana and (b) any recoveries from the Company's historic
insurance program. As of September 30, 2004, Net Recoveries was approximately
$3.2 million.
In the event of default by the Company under the Settlement Agreement, the
PBGC may declare the outstanding amount of the Note to be immediately due and
payable, proceed with foreclosure of the liens granted in favor of the PBGC and
exercise any other rights available under applicable law.
GAIN ON INSURANCE RECOVERIES. In February 2004, the Company entered into a
binding agreement to assign to a third party certain insurance claims against a
group of historic insurers. In July 2004, the assignment was supplemented to
include several additional insurers. The claims involve several historic general
liability policies of insurance issued to the Company. As a result of the
assignment, after allowance for associated expenses and offsetting adjustments,
the Company received net proceeds of approximately $477,000 in May 2004 and an
additional $170,000 in October 2004. The Company recognized a gain of $477,000
in the first quarter of 2004 and an additional gain of $170,000 in the third
quarter of 2004.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
REVENUES. Consolidated revenues decreased by 23% to $3.1 million in 2004
compared to $4.0 million for 2003. Foreign currency changes had the effect of
increasing revenues by 8%. Excluding the impact of foreign currency changes,
sales in 2004 decreased by 31%. Sales in each of the Company's three geographic
areas suffered declines versus 2003. The revenue decline in Europe, principally
in the United Kingdom, was caused by a decrease in new business booked through
catering accounts. Also, shipments to distribution partners located in the U.S.
declined by $444,000 in 2004 as compared to 2003. The 2003 revenues included
$270,000 of sales to a customer in the U.S. relating to a magnetic stripe
product that was phased-out.
GROSS MARGIN. Gross margin, as a percentage of net sales, increased slightly
to 55% in 2004 compared to 53% in 2003.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $1.2 million
in 2004 compared to $1.4 million in 2003. The decrease is primarily attributable
to a $150,000 reduction in salaries, employee business expense and employee
termination expense resulting from headcount reductions. Also, the 2004 expenses
reflect a reimbursement of $47,000 of marketing costs under a grant with a
government agency in Northern Ireland.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses amounted to
$522,000 in 2004 compared to $414,000 in 2003. The 2003 expenses included a
$73,000 reimbursement of certain development costs under a grant with a
government agency in Northern Ireland. This reimbursement coupled with a $44,000
increase in wages and third party engineering costs primarily accounted for the
increase in product development expense.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for
the nine months ended September 30, 2004 decreased to $1.8 million from $2.1
million for 2003. The decrease in expenses is mainly attributable to a decline
in legal, consulting, public reporting costs, insurance and other corporate
costs.
AMORTIZATION OF GOODWILL AND INTANGIBLES. Amortization expense associated
with definite lived intangible assets was $30,000 in both 2004 and 2003.
16
COST OF PENSIONS - NON-OPERATING. Cost of pensions declined from $697,000 in
2003 to $396,000 in 2004. The decrease is primarily attributable to the
cessation of the amortization of the transition obligation component of net
period pension expense effective December 31, 2003.
LOSS ON PENSION SETTLEMENT. A loss on the termination of the Plan of $2.7
million was recorded in the third quarter of 2004. See the discussion above for
further information.
GAIN ON 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 gain from
these settlements of $1.7 million in the first quarter of 2003. As discussed
above, the 2004 results include a gain of $647,000 relating to the assignment to
a third party of certain insurance claims against a group of historic insurers.
LIQUIDITY
The Company has financed its operations over the last several years
primarily through funds received from the sale of a non-core businesses in 2000
and insurance recoveries in 2003 and 2004. For the nine months ended September
30, 2004, cash, including short-term investments, decreased by $1.2 million to
$2.3 million as of September 30, 2004.
Operating activities utilized cash of $1.7 million in 2004 and principally
consisted of the net loss of $4.4 million plus a gain on insurance recoveries of
$647,000 offset by a loss on the pension settlement of $2.7 million,
depreciation and amortization of $124,000 and a reduction in assets and
liabilities of $426,000.
Investing activities for the nine months ended September 30, 2004
principally consisted of cash received from insurance recoveries of $531,000
offset by capital expenditures of $49,000.
The Company has experienced negative cash flow from operating activities in
the past and expects to experience negative cash flow in 2004 and beyond. In
addition to funding operating and capital requirements and corporate overhead,
future uses of cash include the following:
o The Company sponsors a defined benefit pension plan, which was frozen in
1993. In January 2003, the Company filed a notice with the PBGC seeking
a "distress termination" of the Plan. Pursuant to the Agreement for
Appointment of Trustee and Termination of Plan between the PBGC and the
Company effective September 30, 2004, the PBGC proceeded to terminate
the Plan and was appointed as the Plan's trustee. As a result, the PBGC
has assumed responsibility for paying the obligations to Plan
participants. Under the terms of the Settlement Agreement effective
September 23, 2004 between the PBGC and the Company, the Company is
liable to the PBGC for the unfunded guaranteed benefit payable by the
PBGC to Plan participants in the amount of $7.5 million. The Company
satisfied this liability by issuing a non-interest bearing note dated
September 23, 2004 payable to the PBGC with a face amount of $7.5
million.
Pursuant to the Security Agreement and Pledge Agreement, both dated
September 23, 2004, the Note is secured by (a) all presently owned or
hereafter acquired real or personal property and rights to property of
the Company and (b) the common and preferred stock of Infineer and
TecSec owned by the Company. Infineer is a wholly-owned subsidiary of
the Company. The Company has an approximately 5% ownership interest in
TecSec, on a fully diluted basis.
The Note matures on September 23, 2011. The first payment will be equal
to $1.0 million and will become due 30 days after the Company has
received a total of $4.0 million in Net Recoveries. Thereafter, on each
anniversary of the first payment, the Company is required to pay the
PBGC an
17
amount equal to 25% of the Net Recoveries in excess of $4.0 million
(less the sum of all prior payments made in accordance with this
sentence in prior years). As of September 30, 2004, Net Recoveries was
approximately $3.2 million.
In the event of default by the Company under the Settlement Agreement,
the PBGC may declare the outstanding amount of the Note to be
immediately due and payable, proceed with foreclosure of the liens
granted in favor of the PBGC and exercise any other rights available
under applicable law.
o 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. 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.
o The Company leases certain office space, vehicles and office equipment
under operating leases that expire over the next five years. Minimum
future payments for operating leases having initial or remaining
non-cancelable terms in excess of one year aggregates approximately
$921,000.
The Company will need to raise additional capital that may not be available
to it. As a result of the Plan termination discussed above, the Company's 2003
and 2004 funding requirements due to the Plan amounting to $3.4 million through
September 15, 2004 were eliminated. As such, 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
September 30, 2005. However, additional capital will be necessary in order to
operate beyond September 30, 2005 and to fund the current business plan and
other obligations. While the Company is 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 obtain additional funding on acceptable terms or at all. If the Company
cannot raise additional capital to continue its present level of operations it
is not likely to be able to meet its obligations, take advantage of future
acquisition opportunities or further develop or enhance its product offering,
any of which would 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
or restricting its operations or future opportunities.
18
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 is likely to seek bankruptcy protection. Such an event may
result in the Company's common and preferred stock being negatively affected or
becoming worthless. The auditors' reports on the Company's Consolidated
Financial Statements for the years ended December 31, 2003 and 2002 contained an
emphasis paragraph concerning substantial doubt about the Company's ability to
continue as a going concern.
CONTRACTUAL OBLIGATIONS
The following is a summary of the Company's commitments as of September 30,
2004 (in thousands):
PAYMENTS DUE BY PERIOD
----------------------
LESS MORE
THAN 1 TO 3 3 TO 5 THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------ ------ ------ ------ ------
Operating lease obligations $ 921 $ 339 $ 500 $ 82 $ --
Other long-term liabilities:
Note payable to PBGC 7,501 -- -- -- 7,501
Other long-term obligations 410 30 312 60 8
------ ------ ------ ------ ------
Total $8,832 $ 369 $ 812 $ 142 $7,509
====== ====== ====== ====== ======
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
included herein and the Notes to the Consolidated Financial Statements included
the Company's Form 10-K for the year ended December 31, 2003. 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 and valuation
of goodwill and intangibles 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 deferred and recognized upon client
acceptance or "go live" date. Maintenance and support fees are deferred and
recognized as revenue ratably over the contract period. Provisions are recorded
for estimated warranty repairs and returns at the time the
19
products are shipped. In the event 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
inventory.
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 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.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
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 guarantees. 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. The adoption of the recognition and measurement provisions
did not have a material impact on the Company's Consolidated Financial
Statements.
In January 2003, the FASB issued FASB FIN No. 46, "Consolidation of Variable
Interest Entities". In December 2003, the FASB issued FIN No. 46 (Revised) to
address certain FIN 46 implementation issues. This interpretation clarifies the
application of ARB No. 51, "Consolidated Financial Statements", for companies
that have interests in entities that are Variable Interest Entities as defined
under FIN 46. According to this interpretation, if a company has an interest in
a VIE and is at risk for a majority of the VIE's expected losses or receives a
majority of the VIE's expected gains, it must consolidate the VIE. FIN 46-R also
requires additional disclosures by primary beneficiaries and other significant
variable interest holders. For entities acquired or
20
created before February 1, 2003, this interpretation is effective no later than
the end of the first interim or reporting period ending after March 15, 2004,
except for those VIEs that are considered to be special purpose entities, for
which the effective date is no later than the end of the first interim or annual
reporting period ending after December 15, 2003. For all entities that were
acquired subsequent to January 31, 2003, this interpretation is effective as of
the first interim or annual period ending after December 31, 2003. The adoption
of the provisions of this interpretation did not have a material effect 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.
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.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits" that improves
financial statement disclosures for defined benefit plans. The change replaces
existing SFAS No. 132 disclosure requirements for pensions and other
postretirement benefits and revises employers' disclosures about pension plans
and other postretirement benefit plans. It does not change the measurement of
recognition of those plans required by SFAS No. 87, "Employers' Accounting for
Pensions", or SFAS No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits."
SFAS No. 132 revised retains the disclosure requirements contained in the
original SFAS No. 132, but requires additional disclosures about the plan
assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. SFAS No.
132 revised is effective for annual and interim periods with fiscal years ending
after December 15, 2003. The Company adopted the revised disclosure provisions.
In December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104, Revenue Recognition, which supersedes SAB No. 101,
Revenue Recognition in Financial Statements. SAB No. 104 rescinds accounting
guidance in SAB No. 101 related to multiple-element arrangements, as this
guidance has been superseded as a result of the issuance of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." The adoption
of SAB No. 104 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 2001, 2002, 2003 and the nine months ended
September 30, 2004 of approximately $17.2 million, $8.3 million, $1.6 million
and $4.4 million, respectively. In addition, we experienced negative cash flow
from operating activities of $12.7 million, $5.1 million, $2.2 million and $1.7
21
million in 2001, 2002, 2003 and the nine months ended September 30, 2004
respectively, and have a shareholders' deficit of $4.7 million as of September
30, 2004.
We sponsor a defined benefit pension plan which was frozen in 1993. In
January 2003, we filed a notice with the PBGC seeking a "distress termination"
of the Plan. Pursuant to the Agreement for Appointment of Trustee and
Termination of Plan between the PBGC and us effective September 30, 2004, the
PBGC proceeded to terminate the Plan and was appointed as the Plan's trustee. As
a result, the PBGC has assumed responsibility for paying the obligations to Plan
participants. Under the terms of the Settlement Agreement effective September
23, 2004 between the PBGC and us, we are liable to the PBGC for the unfunded
guaranteed benefit payable by the PBGC to Plan participants in the amount of
$7.5 million. We satisfied this liability by issuing a non-interest bearing note
dated September 23, 2004 payable to the PBGC with a face amount of $7.5 million.
Pursuant to the Security Agreement and Pledge Agreement, both dated
September 23, 2004, the Note is secured by (a) all of our presently owned or
hereafter acquired real or personal property and rights to property of and (b)
the common and preferred stock of Infineer and TecSec we own. Infineer is a
wholly-owned subsidiary of ours. We have an approximately 5% ownership interest
in TecSec, on a fully diluted basis.
The Note matures on September 23, 2011. The first payment will be equal to
$1.0 million and will become due 30 days after we have received a total of $4.0
million in Net Recoveries (as defined below). Thereafter, on each anniversary of
the first payment, we are required to pay the PBGC an amount equal to 25% of the
Net Recoveries in excess of $4.0 million (less the sum of all prior payments
made in accordance with this sentence in prior years). As of September 30, 2004,
Net Recoveries was approximately $3.2 million.
In the event of our default under the Settlement Agreement, the PBGC may
declare the outstanding amount of the Note to be immediately due and payable,
proceed with foreclosure of the liens granted in favor of the PBGC and exercise
any other rights available under applicable law.
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 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. 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 $921,000.
We will need to raise additional capital that may not be available to us. As
a result of the Plan termination discussed above, our 2003 and 2004 funding
requirements due to the Plan amounting to $3.4 million through September 15,
2004 were eliminated. As such, we believe that existing cash and short term
investments may be sufficient to meet our operating and capital requirements at
the currently anticipated levels through September 30, 2005. However, additional
capital will be necessary in order to operate beyond September 30, 2005 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 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 the
Company's Consolidated Financial Statements for the years ended December 31,
2001, 2002 and 2003 contained an emphasis paragraph concerning substantial doubt
about the Company's 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.
22
OUR STOCK WAS 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 the Nasdaq 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 of directors 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 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. 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.
23
We incurred approximately $200,000 in defense costs in 2002. No additional
costs have been incurred in 2004 and 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
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:
o we will not be able to retain the employees or business relationships of
the acquired company;
o we will fail to realize any synergies or other cost reduction objectives
expected from the acquisition;
o we will not be able to integrate the operations, products, personnel and
facilities of acquired companies;
o 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;
o we will incur or assume liabilities, including liabilities that are
unknown or not fully known to us at the time of the acquisition; and
o 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.
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 year ended December 31, 2003, no one
customer accounted for more than 10% of our revenues. For the nine months ended
September 30, 2004, one customer accounted for 10% of revenues. Amounts due from
this customer represented approximately 25% of the accounts receivable balance
as of September 30, 2004.
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
24
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:
o product selections;
o timely and efficient completion of product design and development;
o timely and efficient implementation of manufacturing processes;
o effective sales, service and marketing;
o price; and
o product performance in the field.
Our ability to develop new products also depends upon the success of our
research and development 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:
o the extent to which products support industry standards and are capable
of being operated or integrated with other products;
o technical features and level of security;
o strength of distribution channels;
o price;
o product reputation, reliability, quality, performance and customer
support;
o product features such as adaptability, functionality and ease of use;
and
o 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 Moneybox (Girovend), MARS, 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
25
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, 2003, we had federal net operating loss
carryforwards, subject to review by the Internal Revenue Service, totaling
approximately $66.8 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 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 effected.
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 new 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.
26
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 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
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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 RISKS ASSOCIATED WITH OPERATING
IN FOREIGN MARKETS, INCLUDING FLUCTUATIONS IN CURRENCY EXCHANGE RATES, WHICH
COULD ADVERSELY AFFECT OUR OPERATIONS AND FINANCIAL CONDITION. Our operations
are located in the United Kingdom and sales to customers outside the U.S.
represented approximately 82% and 88% of total sales for the year ended December
31, 2003 and nine months ended September 30, 2004, 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:
o tariffs and other trade barriers;
o difficulties in staffing and managing foreign operations;
o currency exchange risks;
o export controls related to encryption technology;
o unexpected changes in regulatory requirements;
o changes in economic and political conditions;
o seasonal reductions in business activities in the countries where our
customers are located;
o longer payment cycles and greater difficulty in accounts receivable
collection;
o 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.
RECENTLY ENACTED AND PROPOSED REGULATORY CHANGES WILL CAUSE US TO INCUR
INCREASED COSTS. Recently enacted and proposed changes in the laws and
regulations affecting public companies, including the provisions of the
Sarbanes-Oxley Act of 2002, will increase our expenses as we evaluate the
implications of new rules and devote resources to respond to the new
requirements. In particular, we expect to incur significant additional
administrative expense as we implement Section 404 of the Sarbanes-Oxley Act,
which requires management to report on, and our independent registered public
accounting firm to attest to, our internal controls. The compliance of these new
rules could also result in continued diversion of management's time and
attention, which could prove to be disruptive to business operations. Further,
we may lose or may experience difficulty in attracting qualified directors and
officers.
There can be no assurance that we will timely complete the management
certification and auditor attestation requirements of Section 404 of
Sarbanes-Oxley Act. Possible consequences of failure to complete such actions
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include sanction or investigation by regulatory authorities, such as the
Securities and Exchange Commission. Any such action could harm our stock price
and also have a material adverse effect on our cash flow and financial position.
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.
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 would be made of approximately $738,000 to
each of Mr. Harry I. Freund and Mr. Jay S. Goldsmith. 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:
o 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);
o 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;
o our ability to effectively manage our business, including our ability to
raise capital;
o variations in our annual or quarterly financial results or those of our
competitors;
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o general economic conditions, in particular, the technology service
sector;
o expected or announced relationships with other companies;
o announcements of technological advances innovations or new products by
us or our competitors;
o patents or other proprietary rights or patent litigation; and
o 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, 2004, short-term investments
(principally U.S. Treasury bills and money-market accounts) were $2.1 million
and borrowing under the overdraft facility amounted to $344,000. 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.
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 period 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. 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 2004 and 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 13, 2004, reporting of the Registrant's results of
operations for the second quarter of 2004.
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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 12, 2004 /s/ Antonio L. DeLise
Antonio L. DeLise, President,
Chief Executive Officer, Chief Financial
Officer
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