FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________
(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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-29794
PUBLICARD, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-0991870
(State of incorporation) (I.R.S. Employer Identification No.)
75 Kings Highway Cutoff, Fairfield, CT 06430
(Address of principal executive offices)
(203) 368-6800
(Registrant's telephone number, including area code)
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 .
Number of shares of Common Stock outstanding as of October 31, 1999:
21,747,309
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS AS OF
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(in thousands except share data)
September 30, December31,
1999 1998
(unaudited)
ASSETS
Current assets:
Cash, including short-term investments of
$5,301 in 1999 and $17,547 in 1998 $ 5,890 $ 18,482
Trade receivables, less allowance for doubtful
accounts 4,955 1,988
Inventories 4,686 2,810
Net assets of discontinued operations - 1,518
Other 471 481
Total current assets 16,002 25,279
Property, plant and equipment:
Land 234 234
Buildings 2,403 2,377
Machinery and equipment 4,051 2,656
Less - accumulated depreciation (2,121) (1,661)
4,567 3,606
Goodwill 20,760 9,781
Other assets 1,138 1,262
$42,467 $39,928
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 147 $ 147
Trade accounts payable 2,723 1,331
Accrued liabilities 6,009 4,384
Total current liabilities 8,879 5,862
Long-term debt 883 991
Other non-current liabilities 6,861 7,780
Total liabilities 16,623 14,633
Redeemable shares - 3,378
Shareholders' equity:
Common shares, $0.10 par value,
Authorized, 40,000,000 shares
Issued - 22,137,814 shares in 1999
and 20,300,954 in 1998 2,214 2,030
Additional paid-in capital 86,351 67,091
Accumulated deficit (53,835) (38,891)
Common shares held in treasury, at cost (8,350) (8,207)
Unearned compensation (536) (106)
Total shareholders' equity 25,844 21,917
$42,467 $39,928
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
<PAGE>
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(in thousands except share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
Net sales $8,176 $4,303 $19,647 $12,587
Cost of sales 5,475 2,957 12,704 8,437
Gross margin 2,701 1,346 6,943 4,150
Operating expenses:
General and administrative 2,190 1,182 6,167 3,526
Sales and marketing 1,662 187 4,359 609
Product development 894 168 2,327 483
In-process research and development - - 2,919 -
Goodwill amortization 1,145 14 2,876 44
5,891 1,551 18,648 4,662
Income (loss) from operations (3,190) (205) (11,705) (512)
Other income (expenses):
Interest income 82 130 345 410
Interest expense (67) (73) (232) (233)
Cost of pensions - nonoperating (166) (202) (586) (641)
Other expense (147) (348) (222) (818)
(298) (493) (695) (1,282)
Income (loss) from continuing
operations (3,488) (698) (12,400) (1,794)
Discontinued operations:
Income (loss) from discontinued
operations - (31) (444) 150
Loss on disposition of discontinued
operations - - (2,100) -
Net income (loss) $(3,488) $(729)$(14,944) (1,644)
Basic earnings (loss) per common share:
Continuing operations $(.19) $(.05) $ (.69) $(.14)
Discontinued operations - - (.14) .01
$ (.19) $(.05) $ (.83) $(.13)
Weighted average shares
outstanding 18,389,708 13,291,602 18,004,778 13,124,601
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(in thousands except share data)
(unaudited)
Common Shares Additional Common Share-
Shares Paid-in Accumulated Treasury Unearned holder
Issued Amount Capital Deficit Shares Compensation Equity
Balance December 31, 1998
20,300,954 $2,030 $67,091 $(38,891) $ (8,207) $(106) $21,917
Common shares issued under
stock options plans
511,322 51 764 - (143) - 672
Common shares issued for
business acquisitions
1,121,401 112 14,219 - - - 14,331
Issuance of restricted
shares and grant of
stock options
5,000 1 1,422 - - (1,423) -
Amortization of unearned
compensation
- - - - - 993 993
Market adjustment to
redeemable shares
- - 846 - - - 846
Reclassification of
redeemable shares
199,137 20 2,009 - - - 2,029
Net loss
- - - (14,944) - - (14,944)
Balance
September 30, 1999
22,137,814 $2,214 $86,351 $(53,835) $(8,350) $(536) $25,844
(1) Represents common shares held in treasury of 3,678,005 and 3,660,268
as of September 30, 1999 and December 31, 1998, respectively.
The accompanying notes to the consolidated financial statements are an integral
part of this statement.
<PAGE>
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(in thousands)
(unaudited)
1999 1998
Cash flows from operating activities:
Net income (loss) from continuing operations $ (12,400) $ (1,794)
Adjustments to reconcile loss to net cash used
in continuing operations:
In-process research and development 2,919 -
Amortization of goodwill 2,876 44
Amortization of unearned compensation 993 -
Depreciation 460 296
Changes in operating assets and liabilities,
excluding effect of acquisitions:
Trade receivables (2,419) (21)
Inventories (543) (233)
Other current assets 78 381
Other assets 140 (14)
Trade accounts payable 117 223
Accrued liabilities 507 109
Other non-current liabilities (937) (1,099)
Net cash used in continuing operations (8,209) (2,108)
Net income (loss) from discontinued operations (2,544) 150
Loss on disposition of discontinued operations 2,100 -
Changes in net assets of discontinued operations (434) (409)
Net cash used in discontinued operations (878) (259)
Net cash used in operating activities (9,087) (2,367)
Cash flows from investing activities:
Payments for businesses acquired (2,734) (664)
Capital expenditures (832) (197)
Net cash used in investing activities (3,566) (861)
Cash flows from financing activities:
Repayments of term loans and notes payable (108) (99)
Proceeds from the issuance of common shares 672 600
Purchase of redeemable shares (503) -
Purchase of treasury stock - (326)
Net cash provided by financing activities 61 175
Net decrease in cash (12,592) (3,053)
Cash - beginning of period 18,482 13,077
Cash - end of period $ 5,890 $ 10,024
Supplemental disclosures of cash flow information:
Cash paid for interest $ 282 $ 310
Non-cash investing activity:
Businesses acquired for common stock 14,331 -
Non-cash financing activity:
Stock option exercises 143 -
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
<PAGE>
Note 1 - BASIS OF PRESENTATION
Description of the business
PubliCARD, Inc. ("PubliCARD" or the "Company") was incorporated in the
Commonwealth of Pennsylvania in 1913. The Company was known as Publicker
Industries Inc. until 1998, when its name was changed to PubliCARD, Inc.
The Company operates in two segments: technology products and coin products.
In its technology business, the Company develops smart cards, smart card
readers, smart card value transfer stations, operating systems for smart
cards and smart card-related application software. The Company's smart card
products are used predominantly for conditional access and security systems,
payment systems, loyalty programs and data storage systems. The Company's
smart card products are used in many industries, including the Internet,
information technology, pay television, transportation, commercial laundry
and retail (including electronic commerce). The Company also develops and
manufactures Portable Computer Memory Card International Association ("PCMCIA")
products, hard disk duplicators and digital camera flash film readers, which
are sold to original equipment manufacturers, value-added resellers,
value-added distributors and end users. In its coin products business, the
Company, through its wholly-owned subsidiary, Greenwald Industries, Inc.
("Greenwald Industries"), designs and manufactures coin meter systems used
in the commercial laundry appliance industry.
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, 1999 and the results of their
operations and cash flows for the three and nine months ended September 30,
1999 and 1998. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted. These financial
statements should be read in conjunction with the financial statements and
notes thereto included in the Company's Form 10-K for the year ended
December 31, 1998, as amended.
Earnings (loss) per common share
Basic net income (loss) per common share is based on net income 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 warrants at the later of the
beginning of the year or date of issuance. Diluted net income (loss) per
share was not computed for 1999 and 1998 as the effect of stock options and
warrants were antidilutive.
Note 2 - INVENTORIES
Inventories at September 30, 1999, and December 31, 1998, consisted of
the following (in thousands):
September 30, December 31,
1999 1998
Raw materials and supplies $ 3,082 $ 1,756
Work in process 939 214
Finished goods 665 840
$ 4,686 $ 2,810
Note 3 - ACQUISITIONS
In February 1998, the Company purchased, through a joint venture
arrangement in Greenwald Intellicard, Inc., ("Greenwald Intellicard"), the
assets and intellectual property of Intellicard Systems, Ltd. Greenwald
Intellicard develops, manufactures and markets smart card systems for the
commercial laundry appliance and other industries. The initial cash
investment in Greenwald Intellicard, all of which was provided by the
Company, was $314,000. The Company had two fixed price options aggregating
$400,000 plus 33,000 shares of common stock to increase its ownership to
100%. The Company exercised the first option on February 17, 1999 thereby
increasing its ownership interest in Greenwald Intellicard
to 65% and intends to exercise the second option which is exercisable
beginning February 1, 2000. Since the Company has funded all of Greenwald
Intellicard's operations and losses, it intends to exercise the purchase
options, its venture partner has limited financial resources and it has
significant managerial and financial influence, the operations of Greenwald
Intellicard have been consolidated with the Company's since inception of the
joint venture.
On November 24, 1998, the Company acquired 100% of the common stock of
Tritheim Technologies, Inc. ("Tritheim"), a Florida company that develops
conditional access and security products for software, computers and the
electronic information and digital video broadcast industries. The
aggregate purchase price was approximately $10.4 million and included the
issuance of 1,495,037 shares of common stock and options to purchase a total
of 333,270 shares of common stock. On February 11, 1999, the Company
acquired 100% of the common stock of Amazing! Smart Card Technologies, Inc.
("Amazing"), a California company that develops smart card solutions and
smart cards for the Internet and loyalty programs. The aggregate purchase
price was approximately $5.9 million and included the issuance of 350,000
shares of common stock and options to purchase a total of 457,503 shares of
common stock. On February 22, 1999, the Company also acquired 100% of the
common stock of Greystone Peripherals, Inc. ("Greystone"), a California
company that develops PCMCIA products, digital camera flash film readers and
hard disk duplicators. The aggregate purchase price was approximately $9.1
million and included the issuance of 746,401 shares of common stock and
options to purchase a total of 132,388 shares of common stock. The amount
and components of the estimated purchase price along with the preliminary
allocation of the estimated purchase price are as follows (in thousands):
Tritheim Amazing Greystone
Purchase price:
Value of common stock and stock
options $ 9,743 $ 5,327 $ 8,729
Acquisition expenses 695 597 414
$10,438 $ 5,924 $ 9,143
Allocation of purchase price:
Net assets (liabilities) of acquired
businesses $ (713) $(1,371) $ 306
In-process research and development 2,800 1,509 1,410
Goodwill 8,351 5,786 7,427
$10,438 $ 5,924 $ 9,143
The assets and liabilities of Tritheim, Amazing and Greystone were
recorded at their estimated fair values as of the respective acquisition
dates and are subject to adjustment when additional information concerning
asset and liability valuations and acquisition related expenses is
finalized. The aggregate fair value of research and development efforts that
had not reached technological feasibility and had no alternative future uses
was determined by appraisal to be $2.8 million, $1.5 million and $1.4
million for Tritheim, Amazing and Greystone, respectively, and was expensed
at the respective acquisition dates. Goodwill represents the excess of the
purchase price over the fair value of identifiable tangible assets acquired
and is amortized using the straight-line method over its estimated life of
five years.
The acquisitions of Tritheim, Amazing and Greystone have been accounted
for under the purchase method of accounting and, accordingly, their results
are included in the consolidated financial statements of the Company since
the respective acquisition dates. The following summarized unaudited pro
forma financial information for the nine months ended September 30, 1999 and
1998, assumes that the acquisitions had occurred as of January 1 of each
period (in thousands except per share data):
1999 1998
Net sales $ 20,308 $ 17,496
Net loss from continuing operations (13,216) (13,729)
Net loss per share from continuing operations (.73) (.88)
The summarized pro forma information for the nine months ended
September 30, 1999 and 1998 reflects charges of $2.9 million and $5.7
million, respectively, to expense in-process research and development
relating to the acquired businesses. The pro forma information is not
necessarily indicative of the results that would have been reported had such
acquisitions actually occurred on the dates specified, nor is it intended to
project the Company's results of operations or financial position for any
future period or date.
On June 30, 1999, the Company announced that it executed a letter of
intent to acquire all of the assets of Absec Ltd., a designer, manufacturer
and distributor of cost recovery and cashless payment and control systems.
Consummation of the acquisition is subject to, among other things,
negotiation and execution of a mutually satisfactory definitive acquisition
agreement and satisfaction or waiver of the conditions that may be specified
in that agreement.
Note 4 - REDEEMABLE SHARES
The Company was required to register 241,266 shares of Company common
stock issued as a portion of the merger consideration in the Tritheim
acquisition under a shelf registration statement under the Securities Act of
1933, as amended. If the shelf registration statement was not effective by
May 24, 1999, the holders of these shares were entitled, for a specified
period of time, to cause the Company to repurchase their shares for a cash
purchase price equal to the fair market value of the shares on the date of
repurchase. As such, these shares have been reflected in the accompanying
consolidated balance sheet as of December 31, 1998, under the caption
"Redeemable shares" and subsequent adjustments to the value of the
redemption obligation were charged or credited to additional paid-in
capital.
On July 21, 1999, a registration statement covering the registration of
these shares, to the extent not previously redeemed, was declared effective
by the Securities and Exchange Commission. Prior to that date, holders
caused the Company to repurchase 42,129 shares for $503,000. Upon
registration of the shares the repurchase right has terminated.
Note 5 - BUSINESS SEGMENT INFORMATION
The Company manages its business segments based on the nature of
products sold. The Company's reportable segments are comprised of coin
products and technology products. Each operating segment provides products
as further described in Note 1. The accounting policies of the various
segments are the same as those described in Note 1 to the Company's Form 10-
K for the year ended December 31, 1998. The Company evaluates the
performance of its segments based on segment operating income. Operating
income for each segment includes sales and marketing expenses, product
development expenses and non-corporate general and administrative expenses
and marketing expenses. Costs excluded from segment operating income
primarily consists of corporate expenses as well as certain non-recurring
charges such as purchased in-process research and development. Corporate
expenses are comprised principally of general and administrative expenses
and marketing expenses which are separately managed. Segment assets exclude
corporate assets. Corporate assets include cash and short-term investments
and net assets of discontinued operations.
For the nine months ended September 30, 1999 and 1998, the Company had
export sales of approximately $2,831,000 and $802,000, respectively. Such
sales were principally made into Canada and Europe. Segment information as
of and for the nine months ended September 30, 1999 and 1998 are as follows
(in thousands):
1999 1998
Net sales to unaffiliated customers:
Coin products $ 11,290 $ 11,771
Technology products 8,357 816
$ 19,647 $ 12,587
Income (loss) from operations:(1)
Coin products $ 2,202 $ 2,099
Technology products (5,573) (266)
Corporate and other (2) (8,334) (2,345)
$ (11,705) $ (512)
Identifiable Assets:
Coin products $ 9,771 $ 9,373
Technology products 25,188 711
Corporate and other 7,508 13,615
$ 42,467 $ 23,699
Depreciation and Amortization Expense:
Coin products $ 259 $ 270
Technology products 3,006 11
Corporate and other 1,064 59
$ 4,329 $ 340
Capital expenditures:
Coin products $ 313 $ 163
Technology products 389 20
Corporate and other 130 14
$ 832 $ 197
(1)Before interest income, interest expense and items of a nonoperating nature.
(2) The 1999 loss from operations for Corporate and other includes a charge
of $2.9 million to expense in-process research and development associated
with the Amazing and Greystone acquisitions, $1.0 million relating to the
corporate sales and marketing group established in early 1999 and $993,000
of amortization expense relating to several stock awards and stock option
grants.
Note 6 - DISCONTINUED OPERATIONS
In March 1999, the Company's board of directors adopted a plan to
dispose of its engineering services subsidiary, Orr-Schelen-Mayeron and
Associates, Inc. ("OSM"). During the second quarter of 1999, the Company
revised its estimates of expected sales proceeds and operating results
through the expected disposition date and recorded a loss provision of $2.1
million. The majority of the loss provision covers the writeoff of OSM's
goodwill. The loss on disposition was based on estimates of the proceeds
expected to be realized on the sale or liquidation of OSM. The Company
expects that the operations of OSM will be substantially concluded by
December 31, 1999. The amounts the Company will ultimately realize could
differ materially from the amounts assumed in arriving at the charge
recorded.
OSM's sales for the nine months ended September 30, 1999 and 1998 were
$5.1 million and $7.0 million, respectively. The results of operations for
the three and nine months ended September 30, 1998, have been restated to
reflect OSM as a discontinued operation.
Note 7 - SUBSEQUENT EVENTS
On October 6, 1999, the Company completed a private placement of
3,269,500 shares of common stock resulting in net proceeds of $19.3 million.
The securities were sold to institutional investors and other accredited
investors in the U.S. and Europe.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Management's Discussion and Analysis of Financial Condition and Results
of Operations and other sections of this Form 10-Q contain forward-looking
statements, including (without limitation) statements concerning possible or
assumed future results of operations of PubliCARD preceded by, followed by
or that include the words "believes," "expects," "anticipates," "estimates,"
"intends," "plans" or similar expressions. For those statements, we claim
the protection of the safe harbor for forward-looking statements contained
in the U.S. Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance.
They involve risks, uncertainties and assumptions. You should understand
that 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 entered the smart card industry in early 1998 by acquiring
the first of several technology businesses that currently offer and are
continuing to develop solutions for the conditional access and security,
payment system and data storage needs of a number of growth industries. In
its technology business, PubliCARD designs, develops, manufactures and
markets smart card-based hardware and smart card-enabled software for a
growing variety of applications for industries in the United States and
worldwide.
PubliCARD develops smart cards, smart card readers, smart card value
transfer stations, operating systems for smart cards and smart card-related
application software. PubliCARD's smart card products are used
predominantly for conditional access and security systems, payment systems,
loyalty programs and data storage systems. PubliCARD's smart card products
are used in many industries, including the Internet, information technology,
pay television, transportation, commercial laundry and retail (including
electronic commerce).
PubliCARD also develops and manufactures PCMCIA products, hard disk
duplicators and digital camera flash film readers which are sold to original
equipment manufacturers, value-added resellers, value-added distributors and
end users. In its coin products business, PubliCARD, through Greenwald
Industries, designs and manufacturers coin meter systems used in the
commercial laundry appliance industry.
Recent Acquisitions
Beginning in 1998, PubliCARD entered the smart card industry by
acquiring several technology businesses that currently offer and are
continuing to develop solutions for the conditional access and security,
payment system and data storage needs of a number of growth industries.
PubliCARD intends to continue acquiring businesses that broaden its
technology and product base and strengthen its presence in its channels of
distribution.
In February 1998, PubliCARD acquired, through a joint venture
arrangement in Greenwald Intellicard, the assets and intellectual property
of Intellicard Systems. Greenwald Intellicard provides smart cards, smart
card readers, value transfer stations, card management software and machine
interface boards for the commercial laundry appliance and other industries.
PubliCARD currently owns 65% of Greenwald Intellicard, and has an option
that becomes exercisable in February 2000 to acquire the remaining 35%.
In November 1998, PubliCARD acquired Tritheim, which develops
conditional access and security products for soft-ware, computers and the
electronic information and digital video broadcasting industries. Through
Tritheim, PubliCARD provides smart card readers, writers and chip sets, and
has developed software and application specific integrated circuits
("ASICs") for television set-top boxes, secure electronic commerce, Internet
security, computer security and software copy protection.
In February 1999, PubliCARD acquired Amazing, a developer of consumer
smart card solutions for the Internet, such as web filtering software, which
permits parents to limit their children's access to websites at public
institutions, libraries and schools by defining each child's use profile on
a smart card. Amazing also offers loyalty programs, which reward customers
for their continuing patronage. In addition, Amazing manufactures
customized smart cards for customers requiring rapid turnaround and smaller
volumes.
In February 1999, PubliCARD also acquired Greystone, a developer of
PCMCIA products, hard disk duplicators and digital camera flash film
readers.
On June 30, 1999, the Company announced that it executed a letter of
intent to acquire all of the assets of Absec Ltd., a designer, manufacturer
and distributor of cost recovery and cashless payment and control systems.
Consummation of the acquisition is subject to, among other things,
negotiation and execution of a mutually satisfactory definitive acquisition
agreement and satisfaction or waiver of the conditions that may be specified
in that agreement.
Greenwald Intellicard was acquired for cash; the other companies were
acquired for shares of PubliCARD common stock. PubliCARD typically
amortizes goodwill associated with the acquisition of technology companies
over five years.
The aggregate purchase price paid in the Tritheim, Amazing and
Greystone acquisitions amounted to approximately $25.5 million and included
the issuance of 2,591,438 shares of common stock and options to purchase a
total of 923,161 shares of common stock. The assets and liabilities of
acquired businesses were recorded at their estimated fair values as of the
respective acquisition dates are subject to adjustment when additional
information concerning asset and liability valuations and acquisition
related expenses is finalized. The aggregate fair value of research and
development efforts that had not reached technological feasibility and had
no alternative future uses was determined by appraisal to be $2.8 million,
$1.5 million and $1.4 million for Tritheim, Amazing and Greystone,
respectively, and was expensed at the respective acquisition dates. Tritheim,
Amazing and Greystone had 16 projects in various states of completion ranging
from 8% to 82% complete at the time of the acquisitions, including a smart
card-enabled software product that enables a personal computer to encrypt
and decrypt computer files and e-mail and secures personal computer access,
ASICs to incorporate multiple chip set functionality into a single integrated
circuit board, an enhanced smart card operating system, smart card data
access technology, several hard disk duplicator projects to enhance duplication
speeds or add various software options and expansion of interface capability
of digital flash film reader products. As of September 30, 1999, five of
the 16 projects were complete and estimated costs to complete the remaining
projects aggregate approximately $350,000. PubliCARD expects to complete
development of the remaining in-process projects at various dates in 1999
and the first quarter of 2000.
PubliCARD determined the value assigned to in-process technology by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the percentage of completion of
each project, estimating the resulting net cash flows from such projects and
discounting the net cash flows back to their present values. The discount
rate includes a factor that takes into account the uncertainty surrounding
the successful development of the purchased in-process technology. PubliCARD
used the following assumptions, among others, to estimate discounted net
cash flows:
The projected revenues were based on management's estimates of total
market size, penetration rate and life expectancy for each particular
product. For the majority of products, revenue was expected to cease beyond
2002 as other new products were expected to enter the market. Revenues for
three in-process products were expected to peak in 2003 and decline rapidly
in 2004-2006.
The projected cost of sales, sales and marketing expenses, general and
administrative expenses and income taxes were estimated by management
based on expected and historical operating characteristics.
A risk-adjusted discount rate was used to discount the net cash flows
back to their present value. The discount rate for a specific project
incorporated the likelihood of success of each product based on the
estimated percentage completed as of the date of the acquisition. The
discount rates used to value in-process technology ranged from 23% to
45%.
Management believes that the assumptions used in the valuation of the
purchased in-process research and development reasonably estimate the future
benefits attributable to the purchased in-process technology. However, no
assurance can be given that commercial or technological viability of these
projects will be achieved or that actual results will not deviate from those
assumptions in future periods.
Discontinued Operation
In March 1999, the Company's board of directors adopted a plan to
dispose of its engineering services subsidiary, OSM. During the second
quarter of 1999, the Company revised its estimates of expected sales proceeds
and operating results through the expected disposition date and recorded a
loss provision of $2.1 million. The majority of the loss provision covers
the writeoff of OSM's goodwill. The loss on disposition was based on
estimates of the proceeds expected to be realized on the sale or liquidation
of OSM. The Company expects that the operations of OSM will be substantially
concluded by December 31, 1999. The amounts the Company will ultimately
realize could differ materially from the amounts assumed in arriving at the
charge recorded.
Presentation
The results of operations for the three and nine months ended September
30, 1998 have been restated to reflect OSM as a discontinued operation. In
addition, the results of operations for Amazing and Greystone have been
reflected in the 1999 financial statements from the respective acquisition
dates thereof.
Results of Operations
The following table presents, as a percentage of sales, selected
consolidated statements of income data for the three and nine months ended
September 30, 1999 and 1998.
Three Months Ended Nine Months Ended
September 30, September 30,
. . . . . . . . . . . . .1999 1998 1999 1998
Net sales:
Coin products . . . . . . . 45% 88% 57% 94%
Technology products . . . . 55 12 43 6
Total net sales. . . . . . 100 100 100 100
Gross margin:
Coin products (1) . . . . . . 34 33 36 34
Technology products (2) . . . 32 15 35 13
Total gross margin . . . . .33 31 35 33
Operating expenses:
General and administrative. . .27 27 31 28
Sales and marketing . . . . . 20 4 22 5
Product development . . . . . 11 4 12 4
In-process research and
development. . . . . . . - - 15 -
Goodwill amortization . . . . 14 - 15 -
Total operating expenses . . 72 36 95 37
Income (loss) from operations. . . . (39) (5) (60) (4)
Other income (expense), net. . . . . . . (4) (11) (4) (10)
Income (loss) from continuing
operations . . . . . . . . . . (43) (16) (63) (14)
_____________________
(1) Expressed as a percentage of coin products segment sales.
(2) Expressed as a percentage of technology products segment sales.
Three Months Ended September 30, 1999 Compared to the Three Months Ended
September 30, 1998
Net sales. Consolidated net sales increased by 90% to $8.2 million for
the third quarter of 1999 compared to $4.3 million for the third quarter of
1998. Sales for the coin products segment decreased by 3% to $3.7 million
in 1999 from $3.8 million in 1998. Coin products are principally sold to
the commercial laundry industry which is experiencing a migration of
equipment from electro-mechanical to electronic and smart card based. Sales
for the technology products segment were $4.5 million for the third quarter
of 1999 compared to $505,000 in the third quarter of 1998. The increase in
third quarter sales for the technology products segment is due to revenues
from the companies acquired during late 1998 and the first quarter of 1999.
Coin products accounted for 45% of sales for the third quarter of 1999. The
percentage is expected to decline in the future as sales of technology
products increase.
Gross margin. Gross margin as a percentage of sales was 33% in the
third quarter of 1999 compared to 31% in the third quarter of 1998. Gross
margin for the coin products segment increased to 34% in 1999 from 33% in
1998. Gross margin for the technology products segment was 32% in 1999
compared to 15% in 1998. The improvement in gross margin is mainly
attributable to higher margins on products sold by the recently acquired
companies, particularly disk duplicator products, and an improvement in
smart card commercial laundry product margins due to lower manufacturing
costs.
Operating expenses. General and administrative expenses were $2.2
million for the third quarter of 1999 compared to $1.2 million in the third
quarter of 1998. The increase was due principally to $641,000 of general
and administrative expenses from the companies acquired during late 1998 and
the first quarter of 1999.
Sales and marketing expenses were $1.7 million in the third quarter of
1999 compared to $187,000 in the third quarter of 1998. The increase was
primarily due to $758,000 of expenses from the companies acquired during
late 1998 and the first quarter of 1999 and $647,000 of expenses associated
with the corporate sales and marketing group established in early 1999. A
portion of the corporate sales and marketing function expenses amounting to
$281,000 related to amortization expense in connection with a stock option
grant.
Product development expenses include expenses associated with the
development of new products and enhancements to existing products. Product
development expenses amounted to $894,000 in the third quarter of 1999
compared to $168,000 in the third quarter of 1998. Product development
expenses increased in 1999 primarily due to increased engineering headcount
and development costs from the companies acquired during late 1998 and the
first quarter of 1999. The Company believes that a significant level of
development expenditures are required in order to enable it to quickly
introduce new products that incorporate the latest technological advances
and to develop and maintain close relationships with key suppliers of
components and technologies. The Company's future success will depend upon
its ability to develop and to introduce new products on a timely basis that
keep pace with technological developments and emerging industry standards
and address the increasingly sophisticated needs of its customers.
Goodwill amortization increased to $1.1 million for the third quarter
of 1999 from $14,000 in the third quarter of 1998. The increase in goodwill
amortization results principally from the Tritheim, Amazing and Greystone
acquisitions. The Company amortizes goodwill associated with the technology
products companies principally over five years and the coin products company
over 40 years.
Other income and expense. Other expense, net was $298,000 in the
third quarter of 1999 compared to $493,000 in the third quarter of 1998.
Other expense includes pension costs related to discontinued product lines
and related plant closing in prior years of $166,000 in 1999 and $202,000 in
1998. Other expense in 1998 also included a charge of $343,000 associated
with the termination of a letter of intent to acquire five businesses.
Nine Months Ended September 30, 1999 Compared to the Nine Months Ended
September 30, 1998
Net sales. Consolidated net sales increased by 56% to $19.6 million
for the nine months ended September 30, 1999 compared to $12.6 million for
1998. Sales for the coin products segment decreased by 4% to $11.3 million
in 1999 from $11.8 million in 1998. Sales for the technology products
segment were $8.4 million for the nine months ended September 30, 1999
compared to $816,000 in 1998. The increase in sales for the technology
products segment is due to revenues from the companies acquired during late
1998 and the first quarter of 1999.
Gross margin. Gross margin as a percentage of sales was 35% for the
nine months ended September 30, 1999 compared to 33% for 1998. Gross margin
for the coin products segment increased slightly to 36% in 1999 from 34% in
1998. Gross margin for the technology products segment was 35% in 1999
compared to 13% in 1998. The improvement in gross margin is mainly
attributable to higher margins on products sold by the recently acquired
companies.
Operating expenses. General and administrative expenses were $6.2
million for the nine months ended September 30, 1999 compared to $3.5
million in 1998. The increase was due principally to $1.5 million of
general and administrative expenses from the companies acquired during late
1998 and the first quarter of 1999 and $150,000 of amortization expense
relating to several stock awards and stock option grants. The remaining
increase in general and administrative expenses was due to an increase in
corporate activities to support the business expansion.
Sales and marketing expenses were $4.4 million for the nine months
ended September 30, 1999 compared to $609,000 for 1998. The increase was
primarily due to $1.8 million of expenses from the companies acquired during
late 1998 and the first quarter of 1999 and $1.9 million of expenses
associated with the corporate sales and marketing group established in early
1999. A portion of the corporate sales and marketing function expenses
amounting to $844,000 related to amortization expense in connection with a
stock option grant.
Product development expenses amounted to $2.3 million for the nine
months ended September 30, 1999 compared to $483,000 for 1998. Product
development expenses increased in 1999 primarily due to increased
engineering headcount and development costs from the companies acquired
during late 1998 and the first quarter of 1999.
Goodwill amortization increased to $2.9 million for the nine months
ended September 30, 1999 from $44,000 in 1998. The increase in goodwill
amortization results principally from the Tritheim, Amazing and Greystone
acquisitions.
Other income and expense. Other expense, net decreased to $695,000 for
the nine months ended September 30, 1999 from $1.3 million in 1998. Interest
income and interest expense were comparable between the two periods.
Pension costs related to discontinued product lines and related plant
closing in prior years decreased to $586,000 in 1999 from $641,000 in 1998.
Other expense in 1998 included the $906,000 of acquisition termination
costs.
Liquidity
During the nine months ended September 30, 1999, cash, including
short-term investments, decreased by $12.6 million to $5.9 million as of
September 30, 1999. Operating activities used cash of $9.1 million and
consisted principally of the loss from continuing operations of $12.4
million and an increase in working capital offset by the non-cash charges of
$7.2 million for acquired in-process research and development associated
with the acquisitions of Amazing and Greystone, amortization of goodwill and
unearned compensation on stock awards and option grants and depreciation.
Investing activities used cash of $3.6 million and consisted of cash paid,
including debt assumed and immediately repaid, in connection with the
acquisitions of Amazing and Greystone of $2.7 million and capital
expenditures of $832,000. Financing activities provided cash of $61,000 and
consisted principally of the proceeds from the exercise of options to
purchase common stock of $672,000 offset by the repurchase of redeemable
shares of $503,000 and repayment of debt of $108,000.
During the nine months ended September 30, 1999, the Company's capital
expenditures totaled $832,000. The Company anticipates that its level of
capital expenditures in 1999 will be significantly greater than those in
1998 principally due to the expected expenditure requirements of the
recently acquired businesses.
The Company anticipates that it will be able to fund its capital
expenditures during 1999 with its available cash resources as well as
through capital equipment financing.
The Company has experienced negative cash flow from operating
activities in the past, and expects to experience negative cash flow in 1999
and 2000. Uses of cash subsequent to September 30, 1999, include the
following:
The Company expects that its technology businesses will require
ongoing funding to support the expansion of sales and marketing, new
product development, working capital growth and capital expenditures.
An important element of the Company's growth strategy has been and
continues to be the acquisition of businesses that complement, enhance
or geographically expand the Company's existing business segments,
product lines or channels of distribution. As mentioned above, the
Company has signed a letter of intent to acquire Absec Ltd.
Completion of this acquisition and future acquisition activities will
require the expenditure of funds.
In April 1996, a Consent Decree (the "Consent Decree") among the
Company, the United States Environmental Protection Agency and the
Pennsylvania Department of Environmental Protection ("PADEP") was
entered by the court which resolved all of the United States' and
PADEP's claims against the Company for recovery of costs incurred in
responding to releases of hazardous substances at a facility
previously owned and operated by the Company. Pursuant to the Consent
Decree, the Company will pay a total of $14.4 million plus interest to
the United States and Commonwealth of Pennsylvania. Through September
30, 1999, the Company has made principal payments aggregating $11.8
million. Further payments totaling $2.8 million, including interest,
will be made to the United States and Commonwealth of Pennsylvania in
the amounts of $1.1 million due April 2000, $861,667 due April 2001
and $822,502 due April 2002.
The Company sponsors a defined benefit pension plan which was frozen
in 1993. As of December 31, 1998, the actuarial present value of
accrued liabilities exceeded the plan assets by approximately $6.0
million. The annual contribution to the plan is expected to be
approximately $1.0 million in 1999 and beyond.
The Company will have to utilize its current capital resources and
external sources of funding to satisfy its needs. Although the Company has
generated funds to meet its capital requirements in the past and expects to
be able to generate funds to meet its obligations and other needs enumerated
above, there can be no assurance that such funds will be available when
required.
On October 6, 1999, the Company completed a private placement of
3,269,500 shares of common stock resulting in net proceeds of $19.3 million.
The securities were sold to institutional investors and other accredited
investors in the U.S. and Europe.
Factors That May Affect Future Results
WE HAVE A HISTORY OF OPERATING LOSSES AND NEGATIVE CASH FLOW, AND WE
HAVE ONGOING FUNDING OBLIGATIONS. 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
1999 and 2000. We incurred losses from continuing operations in 1996, 1997,
1998 and the nine months ended September 30, 1999 of approximately $3.5
million, $1.9 million, $6.1 million and $12.4 million, respectively. In
addition, we experienced negative cash flow from continuing operating
activities of $11.4 million, $3.0 million, $3.1 million and $8.2 million in
1996, 1997, 1998 and the nine months ended September 30, 1999, respectively.
We have been and may continue to be obligated to assume or extinguish
obligations of the companies we recently acquired. We expect that these
acquired companies will require ongoing funding to support the expansion of
their sales and marketing efforts, new product development, working capital
growth and capital expenditures.
We also have continuing obligations to fund payments due under the
Consent Decree and an underfunded pension plan. As of September 30, 1999,
we were required to make future aggregate payments of $2.8 million through
April 2002 in connection with the Consent Decree. Consistent with the
general practices of environmental enforcement agencies, the Consent Decree
does not eliminate our potential liability for remediation of contamination
that had not been known at the time of the settlement. The Company sponsors
a defined benefit pension plan which was frozen in 1993. In addition to
the cash contribution of approximately $1.0 million we expect to make to the
plan in 1999, we are obligated to make continued contributions to the plan
in accordance with the rules and regulations prescribed by the Employee
Retirement Income Security Act of 1974. Future contribution levels depend
in large measure on the mortality rate of plan participants and the
investment return on the plan assets.
WE HAVE LIMITED EXPERIENCE IN THE SMART CARD MARKET. We acquired our
first smart card company in February 1998, and in September 1998, our board
of directors decided to significantly expand our presence in the smart card
industry. We are therefore subject to the risks inherent in establishing a
new business enterprise.
THE MARKET FOR SMART CARD PRODUCTS IS NOT WELL DEVELOPED AND MAY NOT
GROW. Existing demand for smart card products in the United States is not
large enough for all the companies seeking to engage in the smart card
business to succeed. Current participants in the smart card business rely
upon anticipated growth in demand, which may not occur. The success of the
smart card industry depends on the ability of market participants, including
the Company, to convince governmental authorities, commercial enterprises
and other potential system sponsors to adopt a smart card system in lieu of
existing or alternative systems such as magnetic stripe card and paper-based
systems. Smart card-based systems may not prove economically feasible for
some potential system sponsors. For example, municipal transit authorities
and colleges and universities, many of which use magnetic stripe card
systems, may resist the introduction of smart card products. Moreover, a
portion of the sales of smart card products will depend upon emerging
communications and commerce networks, such as the Internet. We cannot
assure you that there will be significant market opportunities for smart
card systems in the United States or that the acceptance of smart card
systems in other countries will be sustained.
THE MARKET'S ACCEPTANCE OF OUR PRODUCTS IS UNCERTAIN. Demand for, and
market acceptance of, our products is 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 also 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 smart card technology generally, and our products
specifically, will not be chosen to replace existing technology or will not
otherwise achieve market acceptance. With respect to our digital camera
products, the market for digital photography is still in the early stages of
development and there has not yet been broad acceptance of our products
developed for that market.
OUR FUTURE PROFITABILITY DEPENDS LARGELY UPON PRODUCTS THAT HAVE NOT
YET PRODUCED ANY REVENUES. Certain of the technology companies we have
recently acquired have products which we believe are viable, but which have
not yet generated any material sales. Our future revenues and earnings
depend in large part on the success of these products.
OUR GROWTH STRATEGY FOCUSES ON ACQUISITIONS WHICH MAY INVOLVE RISKS.
An important element of our growth strategy has been and continues to be the
acquisition of businesses that complement, enhance or geographically expand
our existing business segments, product lines or channels of distribution.
The companies we have acquired have no prior history of operating as a
combined enterprise and have experienced net losses prior to being acquired
by us.
In February 1998, we acquired, through a joint venture arrangement in
Greenwald Intellicard, Inc., the assets and intellectual property of
Intellicard Systems, Ltd. We currently own 65% of Greenwald Intellicard and
have an option that becomes exercisable in 2000 to acquire the remaining
interest. In November 1998, we acquired Tritheim Technologies, Inc. In
February 1999, we acquired Amazing! Smart Card Technologies, Inc. and
Greystone Peripherals, Inc.
Our recently completed acquisitions, and our acquisition strategy
generally, present a number of significant risks and uncertainties,
including the risks that:
we will not be able to retain the employees or business
relationships of acquired companies;
we will fail to realize any anticipated synergies or other cost
reduction objectives expected from the acquisitions;
we will not be able to integrate the operations, products,
personnel and facilities of any acquired company;
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;
the companies we acquire will fail to achieve or sustain
profitability;
we will incur or assume liabilities, including liabilities that
are unknown or not fully known to us at the time of an
acquisition; and
we will enter markets in which we have no prior experience.
Additional 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 financing required for future 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.
WE DEPEND ON A RELATIVELY SMALL NUMBER OF CUSTOMERS FOR A MAJORITY OF
OUR REVENUES. We rely on a limited number of customers in the coin products
segment of our business. We expect to continue to depend upon a relatively
small number of customers for a majority of the revenues in our coin
products segment.
We generally do not enter into long-term supply commitments with our
technology and coin products businesses customers. Instead, we bid on a
project basis and have supply contracts in place for each project.
Significant reductions in sales to any of our largest customers would have a
material adverse effect on our company. 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 liquidity and results
of operations.
WE DEPEND ON A RELATIVELY SMALL NUMBER OF SUPPLIERS IN OUR COIN
PRODUCTS SEGMENT. We purchase mechanical coin chutes using our patented
designs and proprietary tooling exclusively from one supplier in Taiwan.
Our reliance on sole source suppliers involves several risks, including a
potential inability to obtain an adequate supply of required components,
price increases, late deliveries and poor component quality. We cannot
assure you that we will be able to obtain our full requirements of such
components in the future, that prices of such components will not increase
and that problems with respect to quality and timely delivery will not
occur. Disruption or termination of the supply of these components could
delay shipments of our products, have a material adverse effect on our
business and operations and damage our relationships with our customers and
our reputation.
WE DEPEND ON THIRD PARTY MANUFACTURERS WHO ARE OUTSIDE OF OUR CONTROL.
We outsource manufacturing needs of a significant portion of our technology
products to third party contract manufacturers. Outsourcing of
manufacturing involves risks with respect to quality assurance, cost and the
absence of close engineering support. In addition, financial, operational
or supply problems encountered by the third party manufacturers we use or
may use in the future, their subcontractors or their suppliers could result
in our inability to obtain timely delivery, if at all, of finished products.
Any such difficulties, now or in the future, would adversely affect our
financial results.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH
TECHNOLOGICAL CHANGES AND INTRODUCE NEW PRODUCTS IN A TIMELY MANNER. The
smart card industry is subject to rapid technological change. Because new
product development commitments must be made well in advance of actual
sales, new product decisions must anticipate future demand as well as the
speed and direction of technological change. Our ability to remain
competitive will depend upon our ability to develop in a timely and cost
effective manner new and enhanced products at competitive prices. New
product introductions or enhancements by our competitors could cause a
decline in sales or loss of market acceptance of our existing products and
lower profit margins.
Our success in developing, introducing and selling new and enhanced
products depends upon a variety of factors, including:
product selections;
timely and efficient completion of product design and
development;
timely and efficient implementation of manufacturing processes;
effective sales, service and marketing;
price; and
product performance in the field.
Our ability to develop new products also depends upon the success of
our research and development efforts. Our research and development
expenditures, on a pro forma basis for 1998, were $1.7 million, and are
planned to increase substantially in the near term. We cannot assure you
that these expenditures will lead to the development of viable products. We
may need to devote substantially more resources to our research and
development efforts in the future.
THE DEMAND FOR THE MECHANICAL COIN METER SYSTEMS THAT WE MANUFACTURE IS
DECLINING. We design and manufacture mechanical coin meter systems used
primarily in the commercial laundry appliance industry. Sales of mechanical
coin meter systems accounted for approximately 93% and 57% of our revenues
in 1998 and for the nine months ended September 30, 1999, respectively. Our
sales of mechanical coin meter systems were $15.5 million, $17.0 million,
$15.4 million and $11.3 million in 1996, 1997, 1998 and the nine months
ended September 30, 1999, respectively. We expect the demand for the coin
handling equipment that we manufacture to decline as advances are made
towards the development of equipment utilizing electronic, smart card or
other technologies.
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 believe that competition is likely to
intensify.
We believe that the principal competitive factors affecting the smart
card market are:
the extent to which products support industry standards and are
capable of being operated or integrated with other products;
technical features and level of security;
strength of distribution channels;
price;
product reputation, reliability, quality, performance and
customer support;
product features such as adaptability, functionality and ease of
use; and
competitor reputation, positioning and resources.
We cannot assure you that competitive pressures will not have a
material adverse effect on our business and operating results. Many of our
current and potential competitors have longer operating histories in the
smart card industry 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 business segments. Increased competition
would likely result in price reductions, reduced margins and loss of market
share, any of which would have a material adverse effect on our business and
operating results.
We compete with Gemplus and Schlumberger Technologies among others, in
the manufacture and sale of smart cards. Competitors for our smart card
readers and writers include SCM Microsystems, Gemplus, Utimaco, Towitoko
Electronics and Philips Electronics. In the future, we may also experience
competition from IBM and Microsoft. We compete with Schlumberger
Technologies, ESD and Set-O-Matic for our commercial laundry smart card
products. Our competitors in the disk duplication market include
Intelligent Computer Systems, CSC, Wytron, Symantec Corp and MicroHouse.
Competitors in the digital flash camera market include SanDisk and SCM
Microsystems. We compete with SCM Microsystems and Actiontec Corporation
in PCMCIA products.
We also compete with original equipment manufacturers, peripheral
equipment manufacturers and others that have greater resources than our
company.
We believe that the principal competitive factors affecting our coin
products business are:
quality of product;
delivery times;
ease of use;
marketing and customer service; and
price.
In the coin products segment of our business, we compete with ESD,
Set-O-Matic and Monarch, as well as alternative technologies including
electronic systems and smart card products. We also experience indirect
competition from certain of our customers that currently offer alternative
products or are expected to introduce competitive products in the future.
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 that can
represent major investments for customers. We rely on 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 for production volumes. 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 September 30, 1999, we had net operating loss
carryforwards totaling approximately $85 million for federal income tax
purposes, approximately $6.0 million of which will expire at the end of
1999, $12.0 million of which will expire at the end of 2000, $9.0 million of
which will expire at the end of 2001 and $25.0 million of which will expire
at the end of 2002. We do not expect to earn any significant taxable income
prior to 2001, and may not do so until later. A federal net operating loss
can generally be carried back two or three 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," the corporation'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 intend to issue a substantial number of shares of our
common stock in connection with future acquisitions, private placements
and/or public offerings. In addition, the exercise of outstanding warrants
and 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 common stock could result in an "ownership change." If we were
to experience such an "ownership change," we estimate that we would not be
able to use a substantial amount of our available federal net operating
losses to reduce our taxable income.
The extent of the actual future use of our federal net operating losses
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 actually use any of
our federal net operating losses 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 currently have a number of patent applications pending. 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 are determined to infringe upon the
rights of others, we could be required to cease using the technology and
stop selling the products if we are unable to obtain licenses to use the
technology. We may not be able to obtain a license in a timely manner on
acceptable terms or at all. Any of these events would have a material
adverse effect on our financial condition and results of operations.
Patent disputes are common in technology-related industries. We cannot
assure you that we will have the financial resources to enforce or defend a
patent infringement or proprietary rights action. As the number of products
and competitors in our target markets grows, the likelihood of infringement
claims also increases. Any claims or litigation may be time-consuming and
costly, cause product shipment delays or require us to redesign our products
or require us to 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 to as great an extent 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.
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 computer networks, personal
computers, computer files, cellular telephones, digital video broadcasting,
websites 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 would have a material adverse effect on our
business and operating results.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN MANAGEMENT, TECHNICAL AND
OTHER KEY PERSONNEL. Our future success depends on our ability to attract
and retain management, technical and other key personnel at the corporate
level and at each of our subsidiaries. We cannot assure you that we will be
able to do so.
Our ability to execute our acquisition and growth plan depends upon the
continued services of Harry I. Freund, Chairman, Jay S. Goldsmith, Vice
Chairman, Jan-Erik Rottinghuis, newly appointed President and Chief Executive
Officer and Richard Phillimore, Executive Vice President/Smart Card Business.
Our ability to execute our strategic plan could be materially adversely
affected should the services of any of these individuals cease to be available
to us. None of these employees is subject to an agreement not to compete
with us in the event his services are terminated. We cannot guarantee that
we will be able to attract and retain our key personnel in the future.
Failure to attract or retain key personnel could have a material adverse
effect on our operations.
YEAR 2000 COMPLIANCE ISSUES COULD NEGATIVELY IMPACT OUR BUSINESS.
Year 2000 Issue
The Year 2000 issue concerns the potential exposures that our company
and other companies have because certain computer systems, computer chips
and hardware use two digits, rather than four, to define the applicable
year. On January 1, 2000, these systems and programs may recognize the date
as January 1, 1900 and may process data incorrectly or stop processing data
altogether.
Status of Remediation
Our assessment of the impact of the Year 2000 issue focuses on three
functional areas:
information technology, which includes computer systems and
related application software;
embedded chips, which are hidden internal components of many
non-computer devices and equipment as well as our own products;
and
business partners, which include suppliers, vendors, third party
manufacturers and customers.
Based on our assessment to date, we believe that the current versions
of our products are Year 2000 ready. New products are being designed to be
Year 2000 ready. Although our products have undergone, or will undergo, our
usual quality testing procedures, there can be no assurance that our
products will contain all necessary date code changes. Furthermore, use of
our products in connection with other products which are not Year 2000
compliant, including non-compliant hardware, software and firmware, may
result in inaccurate exchange of dates and result in performance problems or
system failures. In addition, older product versions may not be Year 2000
ready. Any failure of our products to perform properly or at all, or any
system malfunctions associated with the onset of Year 2000, could result in
claims against us and have a material adverse affect on us.
We have conducted a process to identify and assess potential Year 2000
exposures to our business processes, infrastructure and communications.
Substantially all of the internal information systems, communications
systems, building security systems and embedded chips in areas such as
manufacturing processes have been identified, assessed and categorized for
Year 2000 compliance. We have included computer hardware and software,
operating systems and utilities, desktop applications, computer peripherals,
business partners, embedded chips and plant facilities in the project scope.
The only items for which we do not know Year 2000 compliance status are
low-risk devices, such as certain alarm systems and office equipment, which
would not materially impact normal operations if they malfunctioned, and
certain embedded chips and packaged software where the remediation is
believed to require minimal effort. We have several application programs
and operating systems which we expect to remediate during the fourth quarter
of 1999. In addition, we have identified certain older generation personal
computers, file servers,embedded chips and telephone system as requiring
Year 2000 software upgrades or replacement. While we expect all systems
to be Year 2000 compliant, we can give no assurance that compliance will
be achieved with respect to those items not currently compliant or for
which compliance is not known. In addition, we cannot assure you that the
failure to ensure Year 2000 compliance will not have a material adverse
impact on our business and operating results.
Third Party Compliance
Our Year 2000 project scope extends to identifying and assessing issues
affecting suppliers' and customers' products, services, systems and
operations. We have identified approximately 150 major suppliers and other
third parties integral to the operations of our business and have initiated
communications with those parties. To date, we have received responses from
approximately 50% of those contacted. For those suppliers or vendors deemed
to be critical or important to our business, we are following up on all
unsatisfactory responses or non-responses. We intend to arrange, to the
extent available, alternate supplier sources in the event a third party
vendor is deemed to be non-compliant or is materially impacted by Year 2000
issues. However, we cannot assure you that we will be able to identify and
resolve any significant Year 2000 problems related to third party products
or services. Any failure of these suppliers or other third parties to
resolve Year 2000 problems with their systems in a timely manner could have
a material adverse effect on our business, financial condition and results
of operations.
Contingency Plans
We are currently in the process of developing contingency plans for
potential Year 2000 failures. We intend to develop, where practicable,
contingency plans for all mission critical processes by the end of 1999.
Any failure by us to address any unforeseen Year 2000 issues could adversely
effect on our business, financial condition and results of operations.
Estimated Costs
We currently estimate that the costs for defined Year 2000 remediation
projects and for project management, inventory and identification of non-
compliant systems will be less than $250,000. We have not completed the
scope, definition and contingency plans for every identified non-compliant
system, device or third party provider nor can we assure you that we have
identified all possible Year 2000 deficiencies. Accordingly, we cannot
assure you that we will timely identify and remedy all significant Year 2000
problems, that any such remediation efforts will not involve significant
time and expense or that such problems or additional remediation
expenditures will not have a material adverse effect on our business,
financial condition and results of operations. We finance our Year 2000
expenditures through cash on hand and funds generated from operations, and
capitalize them to the extent they enhance the capabilities and useful life
of the underlying systems.
We have not assessed the specific financial impact of not being Year
2000 compliant. In connection with our acquisitions of each of Tritheim,
Amazing and Greystone, certain of the sellers gave us representations and
warranties with respect to the Year 2000 compliance of the applicable
company's information technology. Subject to certain financial limitations,
certain of the sellers are required to indemnify us for any losses we may
incur as a result of any breach of such representations and warranties.
These indemnification obligations of such sellers expire in May 2000.
However, any failure to be Year 2000 compliant could have a material adverse
effect on our business, results of operations and financial condition.
FLUCTUATIONS IN THE CURRENCY EXCHANGE RATE BETWEEN THE U.S. DOLLAR AND
THE NEW TAIWAN DOLLAR COULD HAVE AN ADVERSE EFFECT ON OUR OPERATING RESULTS.
One of our principal suppliers is located in Taiwan. Our purchases from
this supplier were approximately $2.1 million in 1998 and are expected to
continue at that level in the future. As a result, a portion of our
purchases is subject to certain risks, including tariffs and other trade
barriers, currency exchange risks and exchange controls. These factors
could have a material adverse effect on our business and operating results.
Also, as a result of our Taiwanese purchases, a portion of our supply
costs are subject to significant fluctuations based upon changes in the
exchange rate of the new Taiwan dollar in relation to the U.S. dollar. We
do not currently engage in hedging activities with respect to foreign
currency exposure. Our management will continue to monitor our exposure to
currency fluctuations and, when appropriate, may use financial hedging
techniques in the future to minimize the effect of these fluctuations.
WE ARE SUBJECT TO GOVERNMENT REGULATION. Market needs and competitive
pressures require that our products contain mathematical methods used to
protect data or establish the genuineness of data called cryptographic
algorithms, in order to protect information and cash substitutes stored in
smart cards. The U.S. and many other governments restrict the export of
products containing "strong cryptography" for reasons of national security.
In the case of the U.S., "strong cryptography" means any product exceeding
40 bits of symmetric algorithms or 512 bits of asymmetric algorithms.
Companies wishing to export products of this nature are subject to a license
requirement. Our PCDefender product uses a 448 bit symmetric key for its
privacy function, and would therefore require a license for export.
Currently, we do not export this product. However, if we decide to export
PCDefender , we could not do so without obtaining an export license.
Export, import and usage of such cryptographic algorithms are subject to a
large and changing body of regulations in the United States. Our failure to
comply with any regulations that may be enacted with respect to
cryptographic algorithms would have a material adverse effect on our
business.
Federal, state and local regulations impose various environmental
controls on the discharge of chemicals and gases which may be used in our
present or future assembly 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
our company to comply with environmental rules and regulations, including
the discharge of hazardous substances, would subject us to liabilities and
would materially adversely affect our operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk primarily through its short-term
investments. The Company's investment policy calls for investment in short-
term, low risk instruments. As of September 30, 1999, short-term
investments (principally treasury bills) were $5.3 million. Due to the
nature of these investments, any decrease in rates would not have a material
impact on the Company's financial condition and results of operations.
Foreign exchange rate risk principally relates to supply costs denominated
in the new Taiwan dollar. Such supply costs amounted to approximately $2.1
million in fiscal 1998. The Company does not currently engage in hedging
activities with respect to foreign currency exposure. The Company will
continue to monitor exposure to currency fluctuations and, when appropriate,
may use financial hedging techniques in the future to minimize the effect of
these fluctuations.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
General Litigation
Various legal proceedings are pending against the Company. The Company
considers all such 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 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K.
Exhibit 27: Financial Data Schedule (EDGAR version only)
(b) Reports on Form 8-K:
None
<PAGE>
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 9, 1999 /s/ Antonio L. DeLise
Antonio L. DeLise, Vice President -
Finance, Principal Financial and
Accounting Officer
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