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 June 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 July 31, 1999:
18,349,809
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS AS OF
JUNE 30, 1999 AND DECEMBER 31, 1998
(in thousands except share data)
June 30, December 31,
1999 1998
(unaudited)
ASSETS
Current assets:
Cash, including short-term investments of $7,796 in
1999 and $17,547 in 1998 $ 9,217 $ 18,482
Trade receivables, less allowance for doubtful accounts 2,725 1,988
Inventories 4,550 2,810
Net assets of discontinued operations - 1,518
Other 507 481
Total current assets 16,999 25,279
Property, plant and equipment:
Land 234 234
Buildings 2,402 2,377
Machinery and equipment 3,840 2,656
Less - accumulated depreciation (1,955) (1,661)
4,521 3,606
Goodwill 21,905 9,781
Other assets 1,252 1,262
$ 44,677 $ 39,928
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 147 $ 147
Trade accounts payable 2,309 1,331
Accrued liabilities 5,698 4,384
Total current liabilities 8,154 5,862
Long-term debt 919 991
Other non-current liabilities 6,736 7,780
Total liabilities 15,809 14,633
Redeemable shares 2,029 3,378
Shareholders' equity:
Common shares, $0.10 par value,
Authorized, 40,000,000 shares
Issued - 21,783,272 shares in 1999 and
20,300,954 in 1998 2,178 2,030
Additional paid-in capital 84,098 67,091
Accumulated deficit (50,346) (38,891)
Common shares held in treasury, at cost (8,252) (8,207)
Unearned compensation (839) (106)
Total shareholders' equity 26,839 21,917
$ 44,677 $ 39,928
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(in thousands except share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
Net sales $ 6,276 $ 4,120 $ 11,472 $ 8,285
Cost of sales 3,819 2,797 7,229 5,482
Gross margin 2,457 1,323 4,243 2,803
Operating expenses:
General and administrative 1,993 1,171 3,978 2,344
Sales and marketing 1,517 222 2,697 421
Product development 772 139 1,433 315
In-process research and development - - 2,919 -
Goodwill amortization 1,058 16 1,731 29
5,340 1,548 12,758 3,109
Income (loss) from operations (2,883) (225) (8,515) (306)
Other income (expenses):
Interest income 109 133 263 279
Interest expense (70) (74) (165) (160)
Cost of pensions - nonoperating (185) (212) (420) (439)
Other expense (121) (563) (74) (470)
(267) (716) (396) (790)
Income (loss) from continuing
operations (3,150) (941) (8,911) (1,096)
Discontinued operations:
Income (loss) from discontinued
operations (92) 104 (444) 181
Loss on disposition of discontinued
operations (2,100) - (2,100) -
Net income (loss) $ (5,342) $ (837) $(11,455) $ (915)
Basic earnings (loss) per
common share:
Continuing operations $ (.17) $ (.07) $ (.50) $ (.08)
Discontinued operations (.12) .01 (.14) .01
$ (.29) $ (.06) $ (.64) $ (.07)
Weighted average shares
outstanding 18,250,274 13,056,105 17,825,907 13,053,030
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 SIX MONTHS ENDED JUNE 30, 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-Dec.
31, 1998 20,300,954 $2,030 $67,091 $(38,891) $(8,207) $(106) $21,917
Common shares
issued under
stock options
plans 355,917 36 519 - (45) - 510
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 - 1,423 - - (1,423) -
Amortization
of unearned
compensation - - - - - 690 690
Market adjustment
to redeemable
shares - - 846 - - - 846
Net loss - - - (11,455) - - (11,455)
Balance
June 30,
1999 21,783,272 $2,178 $84,098 $(50,346) $(8,252) $(839) $26,839
(1) Represents common shares held in treasury of 3,665,005 and 3,660,268
as of June 30, 1999 and December 31, 1998, respectively.
The accompanying notes to the consolidated financial statements are an
integral part of this statement.
PUBLICARD, INC.
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(in thousands)
(unaudited)
1999 1998
Cash flows from operating activities:
Net income (loss) from continuing operations $(8,911) $(1,096)
Adjustments to reconcile loss to net cash used in
continuing operations:
In-process research and development 2,919 -
Amortization of goodwill 1,731 29
Amortization of unearned compensation 690 -
Depreciation 294 196
Changes in operating assets and liabilities,
excluding effect of acquisitions:
Trade receivables (189) 173
Inventories (407) 33
Other current assets 42 332
Other assets 26 (16)
Trade accounts payable (297) 227
Accrued liabilities (553) (243)
Other non-current liabilities (1,062) (1,007)
Net cash used in continuing operations(5,717) (1,372)
Net income (loss) from discontinued operations (2,544) 181
Loss on disposition of discontinued operations 2,100 -
Changes in net assets of discontinued operations 315 (221)
Net cash used in discontinued operations (129) (40)
Net cash used in operating activities (5,846) (1,412)
Cash flows from investing activities:
Payments for businesses acquired (2,734) (314)
Capital expenditures (620) (139)
Net cash used in investing activities (3,354) (453)
Cash flows from financing activities:
Repayments of term loans and notes payable (72) (65)
Proceeds from the issuance of common shares 510 600
Purchase of redeemable shares (503) -
Purchase of treasury stock - (320)
Net cash (used in) provided by financing
activities (65) 215
Net decrease in cash (9,265) (1,650)
Cash - beginning of period 18,482 13,077
Cash - end of period $9,217 $11,427
Supplemental disclosures of cash flow information:
Cash paid for interest $ 252 $ 281
Non-cash investing activity:
Businesses acquired for common stock 14,331 -
Non-cash financing activity:
Stock option exercises 45 -
The accompanying notes to the consolidated financial statements are an
integral part of these statements.
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 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"), 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 June 30, 1999 and the results of their operations
and cash flows for the three and six months ended June 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 June 30, 1999, and December 31, 1998, consisted of the
following (in thousands):
June 30, December 31,
1999 1998
Raw materials and supplies $ 3,379 $ 1,756
Work in process 208 214
Finished goods 963 840
$ 4,550 $ 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 six months
ended June 30, 1999 and 1998, assumes that the acquisitions had occurred
as of January 1 of each period (in thousands except per share data):
Six months ended
June 30,
1999 1998
Net sales $ 12,133 $ 11,388
Net loss from continuing operations (9,727) (11,292)
Net loss per share from continuing operations (.52) (.72)
The summarized pro forma information for the six months ended June
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 and June 30, 1999, 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 six months ended June 30, 1999 and 1998, the Company had
export sales of approximately $1.7 million and $802,000, respectively.
Such sales were principally made into Canada and Europe. Segment
information as of and for the six months ended June 30, 1999 and 1998
are as follows (in thousands):
1999 1998
Net sales to unaffiliated customers:
Coin products $ 7,589 $ 7,973
Technology products 3,883 312
$ 11,472 $ 8,285
Income (loss) from operations:(1)
Coin products $ 1,507 $ 1,408
Technology products (3,525) (140)
Corporate and other (2) (6,497) (1,574)
$ (8,515) $ (306)
Identifiable Assets:
Coin products $ 9,559 $ 8,206
Technology products 24,686 521
Corporate and other 10,432 15,485
$ 44,677 $ 24,212
Depreciation and Amortization Expense:
Coin products $ 175 $ 180
Technology products 1,803 5
Corporate and other 737 40
$ 2,715 $ 225
Capital expenditures:
Coin products $ 278 $ 130
Technology products 230 7
Corporate and other 112 2
$ 620 $ 139
(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, $676,000
relating to the corporate sales and marketing group established in early
1999 and $690,000 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"). The Company has been seeking buyers and
expects to sell OSM by December 31, 1999. 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 of OSM
was based on estimates of the proceeds expected to be realized on the
sale. 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 six months ended June 30, 1999 and 1998
were $3.7 million and $4.8 million, respectively. The results of
operations for the three and six months ended June 30, 1998, have been
restated to reflect OSM as a discontinued operation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 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 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.
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 liabil-
ities of acquired businesses were recorded at their fair estimated values
as of the respective acquisition dates and are subject to adjustment when
additional information concerning asset and liability valuations 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 June
30, 1999, three of the 16 projects were complete and estimated costs to
complete the remaining projects aggregate approximately $525,000. 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. The Company has
been seeking buyers and expects to sell OSM by December 31, 1999. 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
of OSM was based on estimates of the proceeds expected to be realized on the
sale. 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 six months ended
June 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 six
months ended June 30, 1999 and 1998.
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
Net sales:
Coin products . . . . . . . 59% 94% 66% 96%
Technology products . . . . 41 6 34 4
Total net sales. . . . . .100 100 100 100
Gross margin:
Coin products (1) . . . . . .38 33 36 35
Technology products (2) . . .41 13 38 11
Total gross margin . . . . 39 32 37 34
Operating expenses:
General and administrative. .32 28 35 28
Sales and marketing . . . . .24 5 24 5
Product development . . . . .12 3 12 4
In-process research and
development . . . . . . . - - 25 -
Goodwill amortization . . . .17 1 15 -
Total operating expenses ..85 38 111 38
Income (loss) from operations. . . . (46) (5) (74) (4)
Other income (expense), net. . . . . . (4) (17) (3) (10)
Income (loss) from continuing
operations . . . . . . . . . . (50) (23) (78) (13)
_____________________
(1) Expressed as a percentage of coin products segment sales.
(2) Expressed as a percentage of technology products segment sales.
Three Months Ended June 30, 1999 Compared to the Three Months Ended June
30, 1998
Net sales. Consolidated net sales increased by 52% to $6.3
million for the second quarter of 1999 compared to $4.1 million for the
second quarter of 1998. Sales for the coin products segment decreased
by 5% to $3.7 million in 1999 from $3.9 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 $2.6 million for the second quarter of 1999 compared to
$233,000 in the second quarter of 1998. The increase in second 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 59% of sales for the second 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 39% in
the second quarter of 1999 compared to 32% in the second quarter of
1998. Gross margin for the coin products segment increased to 38% in
1999 from 33% in 1998 principally due to manufacturing productivity
improvements. Gross margin for the technology products segment was 41%
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, 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 $2.0
million for the second quarter of 1999 compared to $1.2 million in the
second quarter of 1998. The increase was due principally to $526,000 of
general and administrative expenses from the companies acquired during
late 1998 and the first quarter of 1999.
Sales and marketing expenses were $1.5 million in the second
quarter of 1999 compared to $222,000 in the second quarter of 1998. The
increase was primarily due to $687,000 of expenses from the companies
acquired during late 1998 and the first quarter of 1999 and $596,000 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 $772,000 in the second quarter
of 1999 compared to $139,000 in the second 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 second
quarter of 1999 from $16,000 in the second 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 $267,000 in the
second quarter of 1999 compared to $716,000 in the second quarter of
1998. Other expense includes pension costs related to discontinued
product lines and related plant closing in prior years of $185,000 in
1999 and $212,000 in 1998. Other expense in 1998 also included a
charge of $563,000 associated with the termination of a letter of intent
to acquire five businesses.
Six Months Ended June 30, 1999 Compared to the Six Months Ended June 30,
1998
Net sales. Consolidated net sales increased by 38% to $11.5
million for the six months ended June 30, 1999 compared to $8.3 million
for 1998. Sales for the coin products segment decreased by 5% to $7.6
million in 1999 from $8.0 million in 1998. Sales for the technology
products segment were $3.9 million for the six months ended June 30,
1999 compared to $312,000 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 37% for
the six months ended June 30, 1999 compared to 34% for 1998. Gross
margin for the coin products segment increased slightly to 36% in 1999
from 35% in 1998. Gross margin for the technology products segment was
38% in 1999 compared to 11% 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 $4.0
million for the six months ended June 30, 1999 compared to $2.3 million
in 1998. The increase was due principally to $860,000 of general and
administrative expenses from the companies acquired during late 1998 and
the first quarter of 1999 and $128,000 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 $2.7 million for the six months
ended June 30, 1999 compared to $421,000 for 1998. The increase was
primarily due to $1.0 million of expenses from the companies acquired
during late 1998 and the first quarter of 1999 and $1.2 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 $563,000 related to
amortization expense in connection with a stock option grant.
Product development expenses amounted to $1.4 million for the six
months ended June 30, 1999 compared to $315,000 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 $1.7 million for the six
months ended June 30, 1999 from $29,000 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
$396,000 for the six months ended June 30, 1999 from $790,000 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 $420,000 in 1999 from
$439,000 in 1998. Other expense in 1998 included the $563,000 of
acquisition termination costs.
Liquidity
During the six months ended June 30, 1999, cash, including
short-term investments, decreased by $9.3 million to $9.2 million as of
June 30, 1999. Operating activities used cash of $5.8 million and
consisted principally of the loss from continuing operations of $8.9
million and an increase in working capital offset by the non-cash
charges of $5.6 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 $3.4 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 $620,000. Financing activities used
cash of $65,000 and consisted principally of the proceeds from the
exercise of options to purchase common stock of $510,000 offset by the
repurchase of redeemable shares of $503,000.
During the six months ended June 30, 1999, the Company's capital
expenditures totaled $620,000. 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 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.
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 June 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 June 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.
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 six months ended June
30, 1999 of approximately $3.5 million, $1.9 million, $6.1 million and
$8.9 million, respectively. In addition, we experienced negative cash
flow from continuing operating activities of $11.4 million, $3.0
million, $3.1 million and $5.7 million in 1996, 1997, 1998 and the six
months ended June 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 June 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 66% of our revenues in 1998 and for the six months
ended June 30, 1999, respectively. Our sales of mechanical coin meter
systems were $15.5 million, $17.0 million, $15.4 million and $7.6
million in 1996, 1997, 1998 and the six months ended June 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, Lexmar and SCM Microsystems.
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 Lexmar 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 June 30, 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 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, 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.
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 of our products 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
used for certain critical functions such as order entry, inventory management
and accounting, which we expect to remediate during the third quarter of
1999. In addition, we have identified certain older generation personal
computers, file servers, embedded chips and telephone systems 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 June 30, 1999, short-term
investments (principally treasury bills) were $7.8 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.
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:
Form 8-K/A dated April 27, 1999 containing the financial
statements and pro forma information relating to the February 11,
1999 acquisition of Amazing! Smart Card Technologies, Inc.
Form 8-K dated May 6, 1999, containing the financial statements
and pro forma information relating to the February 22, 1999
acquisition of Greystone Peripherals, Inc.
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: August 13, 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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