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 March 31, 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.)
One Post Road, Fairfield, CT 06430
(Address of principal executive offices)
(203) 254-3900
(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 May 13, 1999: 18,022,537
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS AS OF
MARCH 31, 1999 AND DECEMBER 31, 1998
(in thousands except share data)
March 31, December 31,
1999 1998
(unaudited)
ASSETS
Current assets:
Cash, including short-term investments
of $12,383 in 1999,and $17,547 in 1998 $ 12,913 $ 18,482
Trade receivables, less allowance for
doubtful accounts 3,229 1,988
Inventories 4,551 2,810
Net assets of discontinued operations 1,141 1,518
Other 673 481
Total current assets 22,507 25,279
Property, plant and equipment:
Land 234 234
Buildings 2,377 2,377
Machinery and equipment 3,531 2,656
Less - accumulated depreciation (1,795) (1,661)
4,347 3,606
Goodwill 21,790 9,781
Other assets 1,291 1,262
$ 49,935 $ 39,928
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 147 $ 147
Trade accounts payable 2,900 1,331
Accrued liabilities 4,161 4,384
Total current liabilities 7,208 5,862
Long-term debt 956 991
Other non-current liabilities 7,730 7,780
Total liabilities 15,894 14,633
Redeemable shares 2,232 3,378
Shareholders' equity:
Common shares, $0.10 par value,
Authorized, 40,000,000 shares
Issued - 21,672,305 shares in 1999 and
20,300,954 in 1998 2,167 2,030
Additional paid-in capital 83,994 67,091
Accumulated deficit (45,004) (38,891)
Common shares held in treasury, at cost (8,207) (8,207)
Unearned compensation (1,141) (106)
Total shareholders' equity 31,809 21,917
$49,935 $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 MONTHS ENDED MARCH 31, 1999 AND 1998
(in thousands except share data)
(unaudited)
1999 1998
Net sales $ 5,196 $ 4,165
Cost of sales 3,410 2,685
Gross margin 1,786 1,480
Operating expenses:
General and administrative 1,985 1,173
Sales and marketing 1,180 199
Product development 661 176
In-process research and development 2,919 -
Goodwill amortization 673 13
7,418 1,561
Income (loss) from operations (5,632) (81)
Other income (expenses):
Interest income 154 146
Interest expense (95) (86)
Cost of pensions - nonoperating (235) (227)
Other (expense) income 47 93
(129) (74)
Income (loss) from continuing operations (5,761) (155)
Income (loss) from discontinued operations (352) 77
Net income (loss) $(6,113) $ (78)
Basic earnings (loss) per common share:
Continuing operations $(.33) $(.01)
Discontinued operations (.02) -
$(.35) $(.01)
Weighted average shares outstanding 17,508,390 13,011,597
The accompanying notes to the consolidated financial statements are an
integral part of these statements.<PAGE>
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(in thousands except share data)
(unaudited)
Common Shares Additional Accumu- Common Unearned Share-
Shares Paid-in lated Treasury Compen- holders'
Issued Amount Capital Deficit Shares sation 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 269,950 27 387 - - - 414
Common shares
issued for busi-
ness acqui-
sitions 1,096,401 110 13,946 - - - 14,056
Issuance of
restricted
shares and
grant of
stock options 5,000 - 1,424 - - (1,424) -
Amortization of
unearned
compensation - - - - - 389 389
Market adjustment
to redeemable
shares - - 1,146 - - - 1,146
Net loss - - - (6,113) - - (6,113)
Balance
March
31, 1999 21,672,305 $2,167 $83,994 $(45,004) $(8,207)$(1,141) $31,809
(1) Represents common shares held in treasury of 3,660,268 at March 31, 1999
and December 31, 1998.
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 THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(in thousands)
(unaudited)
1999 1998
Cash flows from operating activities:
Net income (loss) from continuing operations $ (5,761) $ (155)
Adjustments to reconcile loss to net cash
used in continuing operations:
In-process research and development 2,919 -
Amortization of goodwill 673 13
Amortization of unearned compensation 389 -
Depreciation 134 96
Changes in operating assets and liabilities,
excluding effect of acquisitions:
Trade receivables (693) 63
Inventories (338) 48
Other current assets (124) 337
Other assets (13) 129
Trade accounts payable 294 103
Accrued liabilities (1,218) (559)
Other non-current liabilities (68) (76)
Net cash used in continuing operations (3,806) (1)
Net income (loss) from discontinued operations (352) 77
Changes in net assets of discontinued operations 377 (443)
Net cash provided by (used in) discontinued
operations 25 (366)
Net cash used in operating activities (3,781) (367)
Cash flows from investing activities:
Payments for businesses acquired (1,915) (299)
Proceeds from sale of discontinued operations - 5
Capital expenditures (252) (97)
Net cash used in investing activities (2,167) (391)
Cash flows from financing activities:
Repayments of term loans and notes payable (35) (32)
Proceeds from the issuance of common shares 414 -
Purchase of treasury stock - (306)
Net cash provided by (used in)
financing activities 379 (338)
Net decrease in cash (5,569) (1,096)
Cash - beginning of period 18,482 13,077
Cash - end of period $12,913 $11,981
Supplemental disclosures of cash flow information:
Cash paid for interest $ 46 30
Noncash investing activity:
Businesses acquired for common stock 14,056 -
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, theCompany 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
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"), is the leading designer and manufacturer of 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 March 31, 1999 and the results of their operations
and cash flows for the three months ended March 31, 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.
In March 1999, the Company's board of directors adopted a plan to
dispose of its engineering services subsidiary, Orr-Schelen-Mayeron &
Associates, Inc. ("OSM"), by year end. No significant gain or loss is expected
on the disposition. The results of operations for the three months ended
March 31, 1998 have been restated to reflect OSM as a discontinued operation.
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
(17,508,390 in 1999 and 13,011,597 in 1998). 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 March 31, 1999, and December 31, 1998, consisted of the
following (in thousands):
March 31, December 31,
1999 1998
Raw materials and supplies $ 2,786 $ 1,756
Work in process 379 214
Finished goods 1,386 840
$ 4,551 $ 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 has 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 $10.2 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 $5.7 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 $9.0 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 467 406 293
$10,210 $5,733 $9,022
Allocation of purchase price:
Net assets (liabilities) of
acquired businesses $(713) $(1,187) $401
In-process research and development 2,800 1,509 1,410
Goodwill 8,123 5,411 7,211
$10,210 $5,733 $9,022
The assets and liabilities of Tritheim, Amazing and Greystone were
recorded at their fair values as of the respective acquisition dates. 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 Company is 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 is not effective by
May 24, 1999, the holders of these shares are 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 under the caption "Redeemable shares". Subsequent
adjustments to the value of the redemption obligation have been charged or
credited to additional paid-in capital.
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 three months ended March 31, 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 $5,857 $5,740
Net loss from continuing operations (6,557) (7,873)
Net loss per share from continuing operations (.36) (.50)
The summarized pro forma information for the three months ended
March 31, 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.
Note 4 - 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.
Segment information as of and for the three months ended March 31, 1999 and
1998 are as follows (in thousands):
1999 1998
Net sales to unaffiliated customers:
Coin products $3,895 $4,088
Technology products 1,301 77
$5,196 $4,165
Income (loss) from operations:(1)
Coin products $ 715 $ 751
Technology products (1,533) (40)
Corporate and other (2) (4,814) (792)
$(5,632) $ (81)
Identifiable assets:
Coin products $9,795 $10,386
Technology products 24,353 547
Corporate and other 15,787 14,941
$49,935 $25,874
Depreciation and amortization expense:
Coin products $ 90 $ 87
Technology products 694 2
Corporate and other 412 20
$1,196 $ 109
Capital expenditures:
Coin products $ 182 $ 96
Technology products 52 1
Corporate and other 18 -
$ 252 $ 97
(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, $360,000 relating to the corporate sales and
marketing group established in early 1999 and $389,000 of amortization
expense relating to several stock awards and stock option grants.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 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 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, is a leading designer and manufacturer of 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 software, 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.
Discontinued Operation
In March 1999, PubliCARD's board of directors adopted a plan to
dispose of its engineering services subsidiary, OSM, by year end. No
significant gain or loss is expected on the disposition.
Presentation
The results of operations for the three months ended March 31, 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 months ended March 31,
1999 and 1998.
1999 1998
Net sales:
Coin products . . . . . . . . . . . . . 75% 98%
Technology products . . . . . . . . . . 25 2
Total net sales. . . . . . . . . . 100 100
Gross margin:
Coin products (1) . . . . . . . . . . . 35 36
Technology products (2) . . . . . . . . 33 4
Total gross margin . . . . . . . . 34 36
Operating expenses:
General and administrative. . . . . . . 38 28
Sales and marketing . . . . . . . . . . 23 5
Product development . . . . . . . . . . 13 4
In-process research and development . . 56 -
Goodwill amortization . . . . . . . . . 13 -
Total operating expenses . . . . . 143 37
Income (loss) from operations. . . . . . . .(108) (2)
Other income (expense), net . . . . . . . . (2) (2)
Income (loss) from continuing operations . .(111) (4)
_____________________
(1) Expressed as a percentage of coin products segment sales.
(2) Expressed as a percentage of technology products segment sales.
Three Months Ended March 31, 1999 Compared to the Three Months Ended
March 31, 1998
Net sales. Consolidated net sales increased by 25% to $5.2 million for the
first quarter of 1999 compared to $4.2 million for the first quarter of
1998. Sales for the coin products segment decreased by 5% to $3.9 million
in 1999 from $4.1 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 $1.3 million for the first quarter of 1999,
compared to $77,000 in the first quarter of 1998. The increase in first
quarter revenues for the technology products segment is due to revenues from
the companies acquired during 1998 and the first quarter of 1999. Coin
products accounted for 75% of consolidated sales for the first quarter of
1999. The percentage is expected to decline significantly in the future
as sales of technology products increase.
Gross margin. Gross margin as a percentage of sales was 34% in the
first quarter of 1999 compared to 36% in the first quarter of 1998. Gross
margin for the coin products segment decreased slightly to 35% in 1999 from 36%
in 1998. Gross margin for the technology products segment was 33% in 1999
compared to 4% 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 $2.0
million for the first quarter of 1999 compared to $1.2 million in the first
quarter of 1998. The increase was due principally to $405,000 of general and
administrative expenses from the companies acquired during 1998 and the first
quarter of 1999, an increase in acquisition search activities and $107,000 of
amortization expense relating to several stock awards and stock option
grants.
Sales and marketing expenses were $1.2 million in the first quarter of
1999 compared to $199,000 in the first quarter of 1998. The increase was
primarily due to $370,000 of expenses from the companies acquired during 1998
and the first quarter of 1999 and $642,000 of expenses associated the
corporate sales and marketing group established in early 1999. A portion
of the corporate sales and marketing function expenses amounting to $282,000
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 $661,000 in the first quarter of 1999
compared to $176,000 in the first quarter of 1998. Product development
expenses increased in 1999 primarily due to increased engineering headcount
and development costs from the companies acquired during 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.
Upon consummation of the Amazing and Greystone acquisitions in February
1999, the Company immediately expensed $2.9 million representing purchased
in-process research and development projects that had not yet reached
technological feasibility and had no alternative future use. Amazing and
Greystone had 15 projects in various states of completion ranging from 8% to
76% complete at the time of the acquisitions including 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. Estimated costs to complete these projects aggregate approximately
$1 million and such costs are expected to be incurred in 1999. The Company
expects to complete development of the in-process projects at various dates in
1999.
The value assigned to in-process technology was determined 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. The
following assumptions were used, 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. Revenue was expected to cease beyond 2002 as other new products
were expected to enter the market.
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 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 estimated 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.
Goodwill amortization increased to $673,000 for the first quarter of
1999 from $13,000 in the first 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 increased to $129,000 in
the first quarter of 1999 from $74,000 in the first quarter of 1998. Interest
income and interest expense were comparable between the two periods. Other
expense includes pension costs related to discontinued product lines and
related plant closing in prior years of $235, 000 in 1999 and $227,000 in
1998.
Liquidity
During the three months ended March 31, 1999, cash, including
short-term investments, decreased by $5.6 million to $12.9 million.
Operating activities used cash of $3.8 million and consisted principally of
the loss from continuing operations of $5.8 million and an increase in
working capital offset by the non-cash charges of $4.1 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 $2.2 million and consisted of cash paid, including debt
assumed and immediately repaid, in connection with the acquisitions of
Amazing and Greystone of $1.9 million and capital expenditures of $252,000.
Financing activities provided cash of $379,000 and consisted principally of
the proceeds from the exercise of options to purchase common stock of $414,000.
The Company believes that its current cash balances will be sufficient
to meet its anticipated cash needs for working capital, research and
development and capital expenditures through December 31, 1999. Uses of cash
subsequent to March 31, 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.
In connection with the acquisition of Tritheim, the Company is
required to register 241,266 shares of common stock issued as a portion
of the merger consideration under a shelf registration statement under
the Securities Act of 1933. If the shelf registration
statement is not effective by May 24, 1999, the holders of these shares
are 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.
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 March 31, 1999, the Company has made principal
payments aggregating $11 million. Payments totaling $1.0 million,
including interest, were made in April 1999. 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.
During the three months ended March 31, 1999, the Company's capital
expenditures totaled $252,000. 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 has not entered into any material
commitments for acquisitions or capital expenditures and has the ability to
increase or decrease capital expenditure levels as required. 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.
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 three months ended March 31, 1999 of approximately $3.5
million, $1.9 million, $6.1 million and $5.8 million, respectively. In
addition, we experienced negative cash flow from continuing operating
activities of $11.4 million, $3.0 million, $3.1 million and $3.8 million in
1996, 1997, 1998 and the three months ended March 31, 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 April 15, 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.
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 companies;
management's attention will be diverted to pursuing acquisition
opportunities and integrating acquired products, technologies or
companies and will be distracted from performing its regular
responsibilities;
the companies we acquire may 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 75% of our revenues in
1998 and for the three months ended March 31, 1999, respectively. Our sales
of mechanical coin meter systems were $15.5 million, $17.0 million, $15.4
million and $3.9 million in 1996, 1997, 1998 and the three months ended
March 31, 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 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.
Competitors offering similar technology include, among others, SCM
Microsystems and Actiontec Corporation in PCMCIA products, and Symantec, Wytron
and Intelligent Computer Systems in the disk duplication
market. SCM Microsystems, SanDisk and Lexmark Corporation are our primary
competitors in the digital flash camera market.
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 March 31, 1999, we had federal net operating loss
carryforwards totaling approximately $80.0 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 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 certain 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 net operating losses to reduce our taxable
income.
The extent of the actual future use of our 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 net
operating losses before they would otherwise expire.
WE MAY BECOME OBLIGATED TO REPURCHASE THE SHARES OF CERTAIN OF OUR
SHAREHOLDERS. In payment of a portion of the consideration for our
acquisition of Tritheim in November 1998, we issued 241,266 shares of common
stock to certain employees and former shareholders of Tritheim. These
shareholders may require us to repurchase their shares for a cash purchase price
equal to the fair market value of the shares as of the date of repurchase if
we fail to register those shares under the Securities Act of 1933 by May 24,
1999. Our obligation to repurchase the shares will be outstanding until the
earlier of the date the shares are registered or the expiration of the holding
period under Rule 144 of the Securities Act of 1933. Since we do not expect to
register these shares by May 24, 1999, this put right will become exercisable.
If the shareholders exercise this put right, our liquidity will be adversely
affected.
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, James J. Weis, 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.
In the coin products segment of our business, we have performed an
assessment of 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 in this segment have
been identified, assessed and categorized for Year 2000 compliance. Computer
hardware and software, operating systems and utilities, desktop applications,
computer peripherals, business partners, embedded chips and plant
facilities have been included in the project scope. The products
manufactured by the coin products segment have been tested and we believe
that they are Year 2000 compliant. The only items for which Year 2000
compliance are not known are low-risk devices, such as an alarm system, which
would not materially impact normal operations if they malfunctioned. We have
identified one device that is non-compliant: the application program used for
certain critical functions such as order entry, inventory management and
accounting, which will undergo remediation during the second quarter of 1999.
In addition, certain older generation personal computers have been identified
as requiring Year 2000 software upgrades or will need to be replaced. While
we expect all systems in our coin products segment 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, there can be no assurance that the failure to ensure
Year 2000 compliance will not have a material adverse impact on our business
and operating results.
In the technology products segment of our business, the status of our
Year 2000 compliance assessment varies by subsidiary. Greystone's Year 2000
compliance program is currently in the assessment phase. To date, Greystone
has compiled an inventory of its information technology and non-information
technology systems, and is currently determining a methodology to achieve
compliance or develop contingency plans for those systems identified as
non-compliant. We believe that Greystone's products are Year 2000 ready.
However, there are two software applications that are deemed critical to
Greystone's business that have not yet been evaluated specifically for Year
2000 compliance. There can be no assurance that such software applications
or that Greystone's information technology or non-information technology
systems are or will be Year 2000 compliant. We will be materially adversely
affected if Greystone fails to be Year 2000 compliant.
We are in the early stages of assessment with respect to the Year 2000
compliance of Greenwald Intellicard, Tritheim and Amazing. We initiated
limited Year 2000 readiness efforts and have performed some due diligence
with respect to the products of these subsidiaries, but we have not performed
a comprehensive assessment of the Year 2000 compliance of their internal
systems, products, vendors or business partners. We believe that Greenwald
Intellicard's and Amazing's products are Year 2000 ready. Tritheim has
entered into agreements with two of its main suppliers in which it ensured
its business continuity into the Year 2000, but we have not yet evaluated its
Year 2000 readiness. Tritheim's failure to achieve Year 2000 compliance
could therefore have a material adverse effect on our business and financial
condition. To address the limited state of Year 2000 assessment efforts in
our technology products segment, we intend to compile an inventory of items
with possible Year 2000 implications with respect to this segment, and to
prepare, prioritize and assess an inventory of critical suppliers and
business partners. We have created a partial inventory of computer hardware
and software, which is in the process of being assessed for possible Year
2000 problems. We expect to identify and remediate non-compliant Year 2000
information technology and embedded chips by the end of 1999, but there can
be no assurance that compliance will be achieved or that the failure to
ensure Year 2000 compliance will not have a material adverse impact on our
business and financial condition. Furthermore, there can be no assurance
that use of any of our products in connection with other products that are
not Year 2000 compliant, including non-compliant hardware and software, will
not result in the inaccurate exchange of dates and result in performance
problems or system failures.
Third Party Compliance
Our Year 2000 project scope extends to assessing issues affecting
suppliers' and customers' products, services, systems and operations. We
have contacted approximately 200 suppliers and business partners in our coin
products segment with requests for Year 2000 status updates, have received
responses from approximately 40% of those contacted and are following up on
all unsatisfactory responses. In our technology products segment, We have
contacted 20 vendors and business partners, 50% of whom have responded. We
intend to prepare, prioritize and assess an inventory of additional critical
suppliers and business partners in our technology products segment and to
contact them regarding their Year 2000 status by the end of the second
quarter of 1999.
Contingency Plans
We are currently in the process of developing contingency plans for
potential Year 2000 failures. With respect to our coin products segment, we
have conducted research on the possible consequences of a broken supply chain
resulting from the Year 2000 issue and how to work around a failure. We
intend to rely on the existing disaster recovery plan in the event of a
significant impact to our coin products business resulting from the Year 2000
issue. We intend to develop, where practicable, contingency plans for all
mission critical processes by the end of 1999.
Estimated Costs
We currently estimate that the costs for Year 2000 remediation
projects for our coin products segment and for project management, inventory
and identification of non-compliant systems in our technology products
segment will be less than $250,000. For our technology products segment, our
Year 2000 assessment is in the very early stages. As such, we have not yet
determined an estimate of the costs for any Year 2000 remediation projects
that may be required for this segment. Year 2000 expenditures are financed
through cash on hand and funds generated from operations, and are capitalized
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 March 31, 1999, short-term investments
(principally treasury bills) were $12.4 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
(b) Reports on Form 8-K:
Form 8-K/A dated February 5, 1999 containing the financial
statements and pro forma information relating to the November 24,
1998 acquisition of Tritheim Technologies, Inc.
Form 8-K dated February 26, 1999 relating to the February 11,
1999 acquisition of Amazing! Smart Card Technologies, Inc.
Form 8-K dated March 8, 1999 relating to the February 22, 1999
acquisition of Greystone Peripherals, Inc.
<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: May 17, 1999 /s/ James J. Weis
James J. Weis, President and Chief
Executive Officer
/s/ Antonio L. DeLise
Antonio L. DeLise, Vice President -
Finance, Principal Financial and
Accounting Officer
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