Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

COMMISSION FILE NUMBER: 000-29440

 

 

IDENTIVE GROUP, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

 

DELAWARE   77-0444317

(STATE OR OTHER JURISDICTION OF

INCORPORATION OR ORGANIZATION)

 

(I.R.S. EMPLOYER

IDENTIFICATION NUMBER)

1900 Carnegie Avenue, Building B

Santa Ana, California 92705

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)

(949) 250-8888

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

N/A

(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No    ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No    x

At November 1, 2012, 60,169,453 shares of common stock were outstanding, excluding 618,400 shares held in treasury.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  
PART I. FINANCIAL INFORMATION   

Item 1.

 

Financial Statements

     3   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     27   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     42   

Item 4.

 

Controls and Procedures

     42   
PART II. OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     43   

Item 1A.

 

Risk Factors

     43   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     61   

Item 3.

 

Defaults Upon Senior Securities

     61   

Item 4.

 

Mine Safety Disclosures

     61   

Item 5.

 

Other Information

     61   

Item 6.

 

Exhibits

     61   
SIGNATURES      62   
EXHIBIT INDEX      63   

 

2


Table of Contents

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(unaudited)

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2012     2011     2012     2011  

Net revenues:

        

Products

   $ 18,663      $ 23,175      $ 55,053      $ 63,950   

Services

     4,282        3,577        12,954        10,834   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     22,945        26,752        68,007        74,784   

Cost of revenues:

        

Products

     10,761        13,078        32,516        38,179   

Services

     2,464        1,844        7,433        5,181   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenues

     13,225        14,922        39,949        43,360   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     9,720        11,830        28,058        31,424   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development

     2,019        2,286        6,894        4,823   

Selling and marketing

     5,440        6,198        18,978        17,432   

General and administrative

     4,603        5,984        14,537        16,958   

Impairment of long-lived assets

     870        —          24,785        —     

Impairment of goodwill

     4,979        —          26,429        —     

Restructuring

     —          —          278        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,911        14,468        91,901        39,213   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (8,191     (2,638     (63,843     (7,789

Re-measurement of contingent consideration

     —          (388     5,657        (254

Other income (expense)

     23        25        (135     255   

Interest expense, net

     (379     (242     (1,023     (805

Foreign currency losses, net

     (29     (622     (108     (398
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes and noncontrolling interest

     (8,576     (3,865     (59,452     (8,991

Income taxes (provision) benefit

     (15     (54     (89     1,550   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net loss

     (8,591     (3,919     (59,541     (7,441

Less: Loss attributable to noncontrolling interest

     678        233        3,524        336   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Identive Group, Inc.

   $ (7,913   $ (3,686   $ (56,017   $ (7,105
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share attributable to Identive Group, Inc.

   $ (0.13   $ (0.06   $ (0.94   $ (0.14
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares used to compute basic and diluted loss per share

     60,033        57,579        59,441        52,478   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

3


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(unaudited)

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2012     2011     2012     2011  

Consolidated net loss

     (8,591     (3,919     (59,541     (7,441

Other comprehensive income (loss), net tax of nil:

        

Foreign currency translation adjustments

     236        (45     (332     2,712   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

     (8,355     (3,964     (59,873     (4,729

Comprehensive loss attributable to noncontrolling interest

     599        131        3,683        377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Identive Group, Inc.

   $ (7,756   $ (3,833   $ (56,190   $ (4,352
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

4


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(unaudited)

 

     September 30,     December 31,  
     2012     2011(A)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 6,291      $ 17,239   

Restricted cash

     2,017        —     

Accounts receivable, net of allowances of $604 and $268 as of September 30, 2012 and December 31, 2011, respectively

     13,377        13,578   

Inventories

     10,814        9,263   

Prepaid expenses and other current assets

     4,397        2,426   
  

 

 

   

 

 

 

Total current assets

     36,896        42,506   

Property and equipment, net

     7,464        6,699   

Goodwill

     44,544        58,404   

Intangible assets, net

     12,309        36,001   

Other assets

     539        501   
  

 

 

   

 

 

 

Total assets

   $ 101,752      $ 144,111   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 15,344      $ 11,941   

Liability to related party

     1,557        1,076   

Liability for consumer cards

     5,600        —     

Financial liabilities

     1, 983        884   

Deferred revenue

     3,050        2,085   

Accrued compensation and related benefits

     3,613        3,527   

Other accrued expenses and liabilities

     7,995        6,249   
  

 

 

   

 

 

 

Total current liabilities

     39,142        25,762   

Long-term earn-out liability

     —          5,663   

Long-term liability to related party

     6,997        7,303   

Long-term financial liabilities

     3,899        1,189   

Deferred tax liability

     6,851        6,094   

Other long term liability

     916        629   
  

 

 

   

 

 

 

Total liabilities

     57,805        46,640   

Commitments and contingencies (see Note 16)

     —          —     

Equity:

    

Identive Group, Inc. stockholders’ equity:

    

Preferred stock, $0.001 par value; 10,000 shares authorized; none issued and outstanding

     —          —     

Common stock, $0.001 par value; 130,000 shares authorized; 60,788 and 58,309 shares issued and outstanding as of September 30, 2012 and December 31, 2011, respectively

     61        58   

Additional paid-in capital

     337,502        331,758   

Treasury stock, 618 shares as of September 30, 2012 and December 31, 2011

     (2,777     (2,777

Accumulated deficit

     (291,415     (235,398

Accumulated other comprehensive income

     1,865        2,038   
  

 

 

   

 

 

 

Total Identive Group, Inc. stockholders’ equity

     45,236        95,679   

Noncontrolling interest

     (1,289     1,792   
  

 

 

   

 

 

 

Total equity

   $ 43,947        97,471   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 101,752      $ 144,111   
  

 

 

   

 

 

 

 

(A) The condensed consolidated balance sheet has been derived from the audited consolidated financial statements at December 31, 2011 but does not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

See notes to condensed consolidated financial statements.

 

5


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

Year Ended December 31, 2011 and Nine Months Ended September 30, 2012

(unaudited)

 

     Identive Group, Inc. Stockholders              
     Common Stock     

Additional

Paid-in

   

Treasury

   

Accumulated

   

Accumulative
Other

Comprehensive

   

Noncontrolling

   

Total

 
(In thousands)    Shares      Amount      Capital     Stock     Deficit     Income     Interest     Equity  

Balances, December 31, 2010

     48,276       $ 48       $ 306,203      $ (2,777   $ (225,896   $ 323      $ 1,903      $ 79,804   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss:

                  

Net loss

     —           —           —          —          (9,502     —          (468     (9,970

Foreign currency translation adjustment, net tax of nil

     —           —           —          —          —          1,715        (103     1,612   
                  

 

 

 

Comprehensive loss

     —           —           —          —          —          —          —          (8,358
                  

 

 

 

Issuance of common stock in connection with capital raise, net of issuance costs

     7,843         8         18,204        —          —          —          —          18,212   

Issuance of common stock in connection with idOnDemand acquisition

     996         1         3,023        —          —          —          —          3,024   

Noncontrolling interest in connection with idOnDemand acquisition

     —           —           —          —          —          —          468        468   

Issuance of common stock in connection with earn-out agreements

     137         —           316        —          —          —          —          316   

Issuance of common shares to acquire additional noncontrolling interest in a subsidiary

     3         —           8        —          —          —          (8     —     

Issuance of common stock in connection with stock bonus and incentive plans

     567         1         1,461        —          —          —          —          1,462   

Shares issued to board members as incentive/board fees

     60         —           166        —          —          —          —          166   

Issuance of common stock upon exercise of warrants

     406         —           1,075        —          —          —          —          1,075   

Issuance of common stock upon exercise of options

     21         —           57        —          —          —          —          57   

Stock options grants in connection with stock bonus and incentive plans

     —           —           672        —          —          —          —          672   

Stock-based compensation expense for stock options

     —           —           439        —          —          —          —          439   

Stock-based compensation expense for ESPP

     —           —           134        —          —          —          —          134   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, December 31, 2011

     58,309       $ 58       $ 331,758      $ (2,777   $ (235,398   $ 2,038      $ 1,792      $ 97,471   

Comprehensive loss:

                  

Net loss

     —           —           —          —          (56,017     —          (3,524     (59,541

Foreign currency translation adjustment, net tax of nil

     —           —           —          —          —          (173     (159     (332
                  

 

 

 

Comprehensive loss

     —           —           —          —          —          —          —          (59,873
                  

 

 

 

Issuance of common stock in connection with payment solution acquisition

     1,358         1         3,040        —          —          —          —          3,041   

Noncontrolling interest in connection with payment solution acquisition

     —           —           —          —          —          —          2,131        2,131   

Issuance of common shares to acquire additional noncontrolling interest in payment solution

     548         1         1,167        —          —          —          (1,168     —     

Acquisition of noncontrolling interest in idOnDemand

     —           —           (139     —          —          —          (361     (500

Issuance of common stock in connection with earn-out agreement

     57         —           128        —          —          —          —          128   

Issuance of common stock in connection with ESPP

     298         1         340        —          —          —          —          341   

Issuance of common stock in connection with stock bonus and incentive plans

     148         —           324        —          —          —          —          324   

Stock options grants in connection with stock bonus and incentive plans

     —           —           99        —          —          —          —          99   

Shares issued to board members as incentive/board fee

     70         —           64        —          —          —          —          64   

Stock-based compensation expense for stock options

     —           —           578        —          —          —          —          578   

Stock-based compensation expense for ESPP

     —           —           143        —          —          —          —          143   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, September 30, 2012

     60,788       $ 61       $ 337,502      $ (2,777   $ (291,415   $ 1,865      $ (1,289   $ 43,947   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

6


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

     Nine Months Ended  
     September 30,  
     2012     2011  

Cash flows from operating activities:

    

Net loss

   $ (59,541   $ (7,441

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     4,575        4,013   

Impairment of goodwill and long-lived assets

     51,214        —     

Stock-based compensation expense

     884        831   

Re-measurement of contingent consideration

     (5,657     254   

Deferred income taxes

     (12     (2,666

Accretion of interest to related party liability

     559        563   

Interest on financial liabilities

     374        176   

Loss on disposal of fixed assets

     15        55   

Changes in operating assets and liabilities:

    

Accounts receivable

     574        1,224   

Inventories

     (1,539     1,337   

Other assets

     (1,578     (303

Income taxes receivable

     (20     (40

Accounts payable

     2,427        (2,950

Liability to related party

     (807     (780

Accrued expenses

     549        (685

Deferred revenue

     995        514   

Income taxes payable

     77        369   
  

 

 

   

 

 

 

Net cash used in operating activities

     (6,911     (5,529
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Capital expenditures

     (1,709     (897

Restricted cash deposited for capital expenditure

     (696     —     

Net cash acquired (paid) from (for) acquisitions

     572        (5,154

Net cash paid for acquisition of noncontrolling interest

     (500     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (2,333     (6,051
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from capital raise net of issuance costs

     —          18,211   

Proceeds from issuance of common stock under employee stock purchase plan

     341        —     

Proceeds from issuance of common stock upon stock options and warrants exercised

     —          1,132   

Restricted cash related to factoring arrangement

     (1,321     —     

Payment for financial liabilities

     (1,347     (1,462

Changes in bank line of credit, net

     120        —     
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (2,207     17,881   
  

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     503        620   
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (10,948     6,921   
  

 

 

   

 

 

 

Cash and cash equivalents at beginning of period

     17,239        10,799   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 6,291      $ 17,720   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    
    

 

 

 

Common stock issued in connection with business combinations

   $ 3,041      $ 3,024   
  

 

 

   

 

 

 

Common stock issued in connection with acquiring noncontrolling interest

   $ 1,168      $ 8   
  

 

 

   

 

 

 

Common stock issued in connection with contingent consideration

   $ 128      $ 316   
  

 

 

   

 

 

 

Common stock issued in connection with stock bonus and incentive plans

   $ 324      $ 1,434   
  

 

 

   

 

 

 

Stock option grants issued in connection with stock bonus and incentive plans

   $ 99      $ 610   
  

 

 

   

 

 

 

Fair value of contingent consideration in connection with business combinations

   $ —        $ 5,060   
  

 

 

   

 

 

 

Cash paid for interest expense

   $ 1,023      $ 739   
  

 

 

   

 

 

 

Property and equipment subject to accounts payable

   $ 148      $ —     
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

7


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Identive Group, Inc. (“Identive” or “the Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments, including normal recurring adjustments, considered necessary for a fair presentation of Company’s unaudited condensed consolidated financial statements have been included. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 or any future period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The preparation of unaudited condensed consolidated financial statements necessarily requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the condensed consolidated balance sheet dates and the reported amounts of revenues and expenses for the periods presented.

On May 2, 2011, the Company acquired approximately 95.8% of the outstanding shares of idOnDemand, Inc. (“idOnDemand”), a privately-held provider of identity management services based in California. In January 2012, the Company acquired the remaining noncontrolling interest and idOnDemand became a 100%-owned subsidiary. The results for the acquired idOnDemand business are included in the Company’s condensed consolidated statements of operations since May 2, 2011. On July 18, 2011, Multicard AG, a subsidiary of the Company, acquired all of the outstanding shares of polyright SA (“polyright”), a provider of integrated ID solutions for the Swiss education and healthcare markets. The results for the acquired polyright business are included in the Company’s condensed consolidated statements of operations since July 18, 2011. On January 30, 2012, through its majority-owned subsidiary Bluehill ID AG, the Company acquired approximately 58.8% of the outstanding shares of payment solution AG, a German-based provider of integrated cashless payment solutions for sports stadiums, arenas, theme parks and other venues for leisure and entertainment throughout Europe (“payment solution”). In April 2012, the Company acquired additional noncontrolling interest and increased its ownership to approximately 82.5% of the outstanding shares of payment solution. The results for the acquired payment solution business are included in the Company’s condensed consolidated statements of operations since January 30, 2012. As a result of the timing of these acquisitions, the Company’s operating results for the periods presented are not directly comparable.

Reclassifications

Certain reclassifications have been made to prior period amounts to conform to current period presentation. In the condensed consolidated statements of operations, amounts related to re-measurement of contingent consideration was included in general and administrative as part of operating expenses in previous periods, which are now disclosed separately as non-operating income/loss. In addition, net revenues are split into products and services revenues beginning in the current period and as a result, prior period revenues have also been reclassified to conform to current period presentation.

2. Summary of Significant Accounting Policies

Recent Accounting Pronouncements

In July 2012, The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2012-02, Intangibles—Goodwill and Other, Accounting Standards Codification (“ASC”) Topic 350, Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”). ASU 2012-02 amends the guidance in ASC 350-30. The intent of this ASU is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by permitting an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis to determine whether it is necessary to perform the quantitative impairment test in accordance with ASC 350-30. Previous guidance in ASC Topic 350-30 required an entity to test indefinite-lived intangible assets for impairment, on at least an annual basis, by comparing the fair value of the asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess. The amendments in the ASU provides an entity the option not to calculate the fair value of an indefinite-lived intangible asset annually if the entity determines that it is not more likely than not that the asset is impaired. The guidance is effective for annual and interim impairment tests performed for fiscal year beginning after September 15, 2012. Early adoption is permitted. The Company will adopt the provisions of ASU 2012-02 during the fourth fiscal quarter of 2012. The adoption of ASU 2012-02 will not have any significant impact as the Company does not have any indefinite-lived intangible assets.

 

8


Table of Contents

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income, ASC Topic 220, Presentation of Comprehensive Income (“ASU 2011-05”), which requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity.

In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05 (“ASU 2011-12”). ASU 2011-12 indefinitely defers certain provisions of ASU 2011-05, including the requirement to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. ASU 2011-12 does not change the primary provisions of ASU 2011-05, which eliminate the option to present the components of other comprehensive income as part of the statement of equity. Both ASU 2011-12 and ASU 2011-05 are effective in the first quarter of fiscal year 2012 and should be applied retrospectively. The Company’s adoption of ASU 2011-05 in the first quarter of fiscal year 2012 had no impact on its condensed consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards, ASU Topic 820, Fair Value Measurement (“ASU 2011-04”), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. ASU 2011-04 is effective in the first quarter of fiscal year 2012. The Company’s adoption of ASU 2011-04 in the first quarter of fiscal year 2012 had no significant impact on its condensed consolidated results of operations or financial condition.

3. Acquisitions

Acquisition of payment solution AG

On January 30, 2012 (“payment solution acquisition date”), through its majority-owned subsidiary Bluehill ID AG, the Company acquired approximately 58.8% of the outstanding shares of payment solution AG, a company organized under the laws of Germany (“payment solution”). The acquisition was made pursuant to the terms and conditions contained in Share Exchange Agreements, each dated January 30, 2012, and entered into individually with 18 selling shareholders of payment solution (the “Selling Shareholders”) in Germany and Switzerland. In exchange for the shares of payment solution, the Company issued an aggregate of 1,357,758 shares, or approximately 2.4% of its outstanding common stock, to the Selling Shareholders, having a value of approximately $3.0 million. Mountain Partners AG, a significant stockholder of the Company, was a Selling Shareholder and held approximately 10.0% of payment solution. Daniel Wenzel, a director of the Company, is an affiliate of Mountain Partners AG. On April 2, 2012, the Company acquired additional noncontrolling interest and increased its ownership to approximately 82.5% of the outstanding shares of payment solution. In exchange for the additional shares of payment solution, the Company issued 548,114 shares of its common stock to the Selling Shareholder, having a value of approximately $1.2 million. The shares were issued to qualified investors outside the United States in reliance on the exemption provided by Regulation S under the U.S. Securities Act of 1933 from the registration requirements of such Act, as well as comparable exemptions under applicable foreign securities laws.

payment solution is a German-based provider of integrated cashless payment solutions for sports stadiums, arenas, theme parks and other venues for leisure and entertainment throughout Europe, and serves a number of professional football stadiums under an operator contract model. payment solution’s systems enable consumers at sporting and similar events to make quick, cashless payments for food, beverages and merchandise using contactless smart cards.

 

9


Table of Contents

The payment solution acquisition is accounted for under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations (“ASC 805”). Under the acquisition method of accounting, the total purchase consideration, assets acquired and the liabilities assumed are measured at fair value as of the date of acquisition when control is obtained. The fair value of the consideration transferred and the assets acquired and liabilities assumed was determined by the Company and in doing so relied in part upon a third-party valuation report to measure the purchase consideration, identifiable intangible assets acquired and fair value of loss contracts. During the third fiscal quarter of 2012, the Company continued to finalize the measurement of identifiable acquired assets and assumed liabilities and as a result, the amounts of such assets and liabilities and the resulting goodwill and deferred income tax have changed as compared to the provisionally reported amounts in the Quarterly Report on Form 10-Q for the quarter ended March 31, 2012. However, the Company is still in the process of finalizing the fair value of the liability for consumer cards and certain other liabilities. As the Company finalizes these valuation assumptions, the provisional measurements of identifiable assets and liabilities, and the resulting goodwill and deferred income taxes are subject to change, and the final purchase price accounting could be different from the amounts presented herein. The following table summarizes the fair value of total consideration transferred for payment solution controlling and noncontrolling interests, the total estimated fair value of net identifiable liabilities acquired at the payment solution acquisition date and the resulting goodwill recorded (in thousands):

 

Fair value of common stock

   $ 3,041   
  

 

 

 

Fair value of total consideration transferred

     3,041   

Fair value of noncontrolling interest

     2,131   
  

 

 

 

Fair value of controlling and noncontrolling interest

     5,172   

Fair value of net identifiable liabilities acquired

     7,786   
  

 

 

 

Goodwill

   $ 12,958   
  

 

 

 

The fair value of the shares of the Company’s common stock issued in connection with the acquisition was determined using the closing market price of the Company’s common stock as of the payment solution acquisition date of $2.24 per share. The acquisition-date fair value of the noncontrolling interest is derived by determining the fair value of the acquired business as a whole and then subtracting the consideration transferred by the Company for its controlling interest in payment solution.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the payment solution acquisition date. The estimated fair value of the identifiable assets acquired and liabilities assumed in the acquisition is based on management’s best estimates.

Assets acquired and liabilities assumed as of January 30, 2012 (in thousands):

 

Cash and cash equivalents

   $ 572   

Accounts receivable

     303   

Inventory

     34   

Property and equipment

     1,955   

Other current assets

     287   

Accounts payable

     (1,746

Liabilities to related party

     (432

Liability for unclaimed consumer cards

     (5,800

Financial liabilities

     (5,239

Other accrued expenses and liabilities

     (654

Unfavorable contracts subject to amortization

     (538

Intangible assets subject to amortization

  

Customer relationships

     1,323   

Developed technology

     2,023   

Trade names

     542   

Contract backlog

     344   

Deferred tax liabilities in connection with acquired intangible assets

     (760
  

 

 

 

Fair value of payment solution net identifable liabilities acquired

   $ (7,786
  

 

 

 

 

10


Table of Contents

Intangible assets of approximately $4.2 million consist primarily of customer relationships, developed technology, trade names and contract backlog. Customer relationships relate to payment solution’s ability to sell existing, in-process and future versions of its products to its existing customers. Developed technology relates to payment solution’s technology that currently generates revenue. Trade names represent future value to be derived associated with the use of existing trade names. Contract backlog represents future revenue to be derived from confirmed contracts. Customer relationships, developed technology and contract backlog were valued using the Multiperiod Excess Earnings Method (MPEEM) and the Profit Split methodology based on discounted cash flows (“DCF”). Trade names were valued using the relief from royalty method based on DCF. Unfavorable contracts of approximately $0.5 million consist of one unfavorable loan contract with a shareholder and various unfavorable equipment financing contracts with a shareholder. Unfavorable loan contract relates to a contract to purchase equipment and finance working capital requirements with an interest rate above the current market rate and unfavorable equipment financing contracts relate to equipment financing with interest rates that were above current market rates. Both unfavorable loan and equipment financing contracts are measured using a differential cash flow method. A discount rate of 14% was used to value developed technology, trade names, unfavorable loan contracts and unfavorable equipment financing contracts; a discount rate of 16% was used to value customer relationships; and a discount rate of 10% was used to value contract backlog. The discount rate used in the present value calculation was derived from a weighted average cost of capital (“WACC”) analysis, adjusted to reflect additional risks related to each asset’s characteristics. The intangible assets and unfavorable contracts are subject to amortization and the Company expects to amortize these intangible assets and unfavorable contracts over their expected useful lives of approximately four to ten years.

Of the total purchase consideration, $13.0 million was recognized as goodwill, which represents the excess of the purchase consideration of an acquired business over the fair value of the underlying net assets acquired and liabilities assumed. The goodwill arising from the payment solution acquisition is assigned to the Company’s Identity Management reportable segment in accordance with ASC 350, Intangibles – Goodwill and Other (“ASC 350”). None of the goodwill recorded as part of the payment solution acquisition will be deductible for income tax purposes. As noted in Note 9 below, the Company performed an interim goodwill and long-lived assets impairment analysis in accordance with its critical accounting policy and recorded an impairment charge in its condensed consolidated financial statements. Refer to Note 9, Goodwill and Intangible Assets, for further information.

The Company recognized $0.2 million of acquisition-related costs that were expensed in the nine months ended September 30, 2012. These costs are included as part of general and administrative costs in the condensed consolidated statement of operations.

The amounts of revenue and earnings of payment solution included in the Company’s condensed consolidated statement of operations from the payment solution acquisition date through September 30, 2012 are as follows (in thousands):

 

Revenues

   $ 3,040   

Net loss

   $ 4,628   

Acquisition of polyright SA

Multicard AG, a subsidiary of the Company, acquired all of the outstanding shares of polyright SA (“polyright”), on July 18, 2011 (“polyright acquisition date”), for a combination of cash and payment of outstanding indebtedness in the aggregate amount of CHF 2.55 million (or approximately $3.1 million). The sellers may receive aggregate potential earn-out payments (“contingent consideration”) payable in shares of the Company’s common stock over the 30-month period following the closing of the acquisition, subject to achievement of specific financial and sales performance targets over such period. The number of such shares, if any, issued under the earn-out will be based on the average share price during the month preceding the date of announcement of the Company’s annual results, and will be subject to a two-year lockup.

The fair value of the consideration transferred, which included contingent consideration, was determined to be $3.4 million at the polyright acquisition date. The fair value of the contingent consideration was classified as liability in accordance with ASC Topic 480, Distinguishing Liabilities from Equity (“ASC 480”). As of June 30, 2012, there were significant reductions in the forecast for payment solution and the $0.3 million in contingent consideration for the earn-out liability recognized as of the acquisition date was determined to be no longer a reasonable estimate based on the revised forecasts. As a result of the revised forecast, the earn-out liability was reduced to $0.1 million in accordance with ASC 480 as of June 30, 2012. The re-measurement of contingent consideration is reflected as a credit in the condensed consolidated statements of operations. Refer to Note 4, Fair Value Measurements, for further information. During the three months ended September 30, 2012, the Company settled the earn-out liability by issuing 56,834 shares of common stock to the sellers of polyright. As of September 30, 2012, the earn-out liability was zero and there is no future expectation of earn-out payment.

 

11


Table of Contents

Acquisition of idOnDemand, Inc.

The Company completed the acquisition of idOnDemand, Inc. (“idOnDemand”) on May 2, 2011 (the “idOnDemand acquisition date”), pursuant to a Stock Purchase Agreement dated April 29, 2011 between the Company and certain shareholders (the “Selling Shareholders”) of idOnDemand, under which the Company acquired approximately 95.8% of the shares of idOnDemand in exchange for cash and shares of the Company’s common stock. In addition, Selling Shareholders may receive potential earn-out payments (“contingent consideration”) over a period of three years and eight months from the idOnDemand acquisition date, payable in shares of the Company’s common stock and subject to achievement of specific financial and sales performance targets. Any shares issued in connection with the earn-out will be subject to a 12-month lock-up from date of issuance. In January 2012, the Company acquired the remaining noncontrolling interest and idOnDemand became a 100%-owned subsidiary.

The fair value of controlling and noncontrolling interests, including contingent consideration, was determined to be $10.6 million at the idOnDemand acquisition date. The fair value of the contingent consideration is classified as a liability in accordance with ASC 480. As of June 30, 2012, there were significant reductions in the forecast for idOnDemand and the contingent consideration was determined to be no longer payable due to reduced forecasts. As a result, the earn-out liability of $5.5 million was reduced to zero and there is no future expectation of an earn-out payment in accordance with ASC 480. The re-measurement of contingent consideration is reflected as a credit in the condensed consolidated statements of operations. Refer to Note 4, Fair Value Measurements, for further information.

Pro forma financial information

The results for the acquired payment solution, polyright and idOnDemand businesses are included in the Company’s condensed consolidated statements of operations since their respective acquisition dates. As a result of the timing of these acquisitions, the Company’s condensed consolidated results for the periods presented are not directly comparable. The unaudited pro forma financial information in the table below summarizes the results of operations of the combined entity, as though the acquisitions had occurred as of the beginning of the comparable prior annual reporting period. The pro forma financial information is presented for informational purposes only and is not intended to represent or be indicative of the results of operations that would have been achieved if the payment solution, polyright and idOnDemand acquisitions had been completed as of the date indicated, and should not be taken as representative of the Company’s future consolidated results of operations or financial condition. Preparation of the pro forma financial information for all periods presented required management to make certain judgments and estimates to determine the pro forma adjustments such as purchase accounting adjustments, which include, among others, amortization charges from acquired intangible assets, and income tax effects.

Pro forma results of operations for the three and nine months ended September 30, 2012 and 2011 are as follows (in thousands):

 

     Three Months Ended     Nine Months Ended  
     September 30,     September 30,  
     2012     2011     2012     2011  

Revenues

   $ 22,945      $ 28,989      $ 68,380      $ 82,222   

Net loss attributable to Identive Group, Inc.

     (7,913     (3,799     (56,162     (10,542

4. Fair Value Measurements

The Company determines the fair values of its assets and liabilities based on a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value: ASC Topic 820 — Fair Value Measurement (“ASC 820”):

 

   

Level 1 – Quoted prices (unadjusted) for identical assets and liabilities in active markets;

 

   

Level 2 – Inputs other than quoted prices in active markets for identical assets and liabilities that are observable either directly or indirectly; and

 

   

Level 3 – Unobservable inputs.

 

 

12


Table of Contents

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities that are measured and recognized at fair value on a recurring basis have been classified under the appropriate level of the fair value hierarchy as of September 30, 2012 and December 31, 2011 and are as follows (in thousands):

 

     September 30, 2012      December 31, 2011  
     Level 1      Level 2      Level 3      Total      Level 1      Level 2      Level 3      Total  

Assets:

                       

Money market fund deposits

   $ 7       $ —         $ —         $ 7       $ 1,506       $ —         $ —         $ 1,506   

Liabilities:

                       

Contingent consideration

   $ —         $ —         $ —         $ —         $ —         $ —         $ 5,765       $ 5,765   

Money market fund deposits are included in cash and cash equivalents in the Company’s condensed consolidated balance sheets.

Below is the summary of contingent consideration by acquisition (in thousands):

 

     September 2012      December 2011  
     Maximum
amount
payable
     Amount
paid
    Expense
(income)
recognized for
changes in
fair value
    Amount
outstanding
     Maximum
amount
payable
     Amount
paid
     Expense
(income)
recognized for
changes in
fair value
    Amount
outstanding
 

Contingent consideration:

                    

RockWest

   $ —         $ —        $ —        $ —         $ 960       $ 281       $ (238   $ —     

idOnDemand

     21,000         —          (5,463     —           21,000         —           706        5,463   

polyright

     737         (108     (194     —           737         —           42        302   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 21,737       $ (108   $ (5,657   $ —         $ 22,697       $ 281       $ 510      $ 5,765   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

As discussed in Note 3 above, under the terms of their respective acquisition agreements, the sellers of polyright and idOnDemand are eligible to receive limited earn-out payments (“contingent consideration”) in the form of shares of common stock subject to certain lock-up periods. The fair value of the contingent consideration is based on achieving certain revenue and profit targets as defined under the applicable acquisition agreement. These contingent payments are probability weighted and are discounted to reflect the restriction on the resale or transfer of such shares. The valuation of the contingent consideration is classified as a Level 3 measurement because it is based on significant unobservable inputs and involves management judgment and assumptions about achieving revenue and profit targets and discount rates. The unobservable inputs used in the measurement of contingent consideration are highly sensitive to fluctuations and any changes in the inputs or the probability weightage thereof could significantly change the measured value of the contingent considerations at each reporting period. The fair value of the contingent consideration is classified as liability and is remeasured each reporting period in accordance with ASC 480. As of June 30, 2012, there were significant changes in the range of outcomes for the contingent consideration recognized as of the respective acquisition dates for polyright and idOnDemand and it was determined that there is no future expectation of earn-out payments, except for $0.1 million related to polyright. As a result, the total earn-out liability of $5.8 million related to the two acquisitions was reduced to $0.1 million in accordance with ASC 480. During the three months ended September 30, 2012, the Company settled the polyright earn-out liability by issuing 56,834 shares of common stock to the sellers of polyright. The contingent consideration of $5.8 million as of December 31, 2011 shown above includes $0.3 million related to the polyright acquisition, of which $0.1 million is included in other accrued expenses and liabilities, and $0.2 million is included in long-term earn-out liability in the condensed consolidated balance sheet. The remaining $5.5 million is related to the idOnDemand acquisition and is shown as long-term earn-out liability in the condensed consolidated balance sheet. The re-measurement of contingent consideration is reflected as a credit in the condensed consolidated statements of operations. During the three months ended September 30, 2012, there were no significant changes in the range of outcomes for the contingent consideration for polyright and idOnDemand and earn-out liability remains zero as of September 30, 2012. Amounts shown in the table above for RockWest refer to contingent consideration related to the acquisition of RockWest Technology Group in April 2010.

 

13


Table of Contents

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

As of September 30, 2012 and December 31, 2011, there were no assets or liabilities that are measured and recognized at fair value on a non-recurring basis.

5. Stockholders’ Equity of Identive Group, Inc.

Preferred Stock

The Company is authorized to issue 10,000,000 shares of preferred stock, 40,000 of which have been designated as Series A Participating Preferred Stock, par value $0.001 per share. No shares of the Company’s preferred stock, including the Series A Participating Preferred Stock, were outstanding as of September 30, 2012. Upon the affirmative vote of a majority of the Board of Directors, without stockholder approval or further action, Board of Directors may from time to time direct the issuance of shares of preferred stock in series and may, at the time of issuance, determine the rights, preferences and limitations of each series, including voting rights, dividend rights and redemption and liquidation preferences. Such issuances of preferred stock could adversely affect the holders of shares of the Company’s common stock.

Public Offering

In May 2011, the Company issued 7,843,137 shares of common stock at a price of $2.55 per share in an underwritten public offering, for a net consideration of approximately $18.2 million after incurring approximately $0.4 million in underwriting discounts and commissions and issuance costs related to the offering.

2011 Employee Stock Purchase Plan

In June 2011, Identive’s stockholders approved the 2011 Employee Stock Purchase Plan (the “ESPP” or “Plan”) and 2.0 million shares of common stock are reserved for issuance over the term of the ESPP, which is ten years. In addition, on the first day of each fiscal year commencing with fiscal year 2012, the aggregate number of shares reserved for issuance under the ESPP is automatically increased by a number equal to the lowest of (i) 750,000 shares, (ii) two percent of all shares outstanding at the end of the previous year, or (iii) an amount determined by the Board. If any option granted under the ESPP expires or terminates for any reason without having been exercised in full, the unpurchased shares subject to that option will again be available for issuance under the ESPP. Under the ESPP, eligible employees may purchase shares of common stock at 85% of the lesser of the fair market value of the Company’s common stock at the beginning of or end of the applicable offering period and each offering period lasts for six months. The first six-month exercise period under the ESPP commenced on July 1, 2011. The plan contains an automatic reset feature under which if the fair market value of a share of common stock on any exercise date (except the final scheduled exercise date of any offering period) is lower than the fair market value of a share of common stock on the first trading day of the offering period in progress, then the offering period in progress shall end immediately following the close of trading on such exercise date, and a new offering period shall begin on the next subsequent January 1 or July 1, as applicable, and shall extend for a 24-month period ending on December 31 or June 30, as applicable. Subsequent offering periods shall commence on January 1 or July 1, as applicable, immediately following the end of the previous offering period and shall extend for a 24-month period ending on December 31 or June 30, as applicable. As of June 30, 2012 and December 31, 2011, the plan automatically reset and a new offering period began on July 1, 2012 and January 1, 2012, respectively. There were 204,370 and 298,241 shares of common stock issued under the ESPP during the three and nine months ended September 30, 2012, respectively. The following table illustrates the stock-based compensation expense resulting from the ESPP included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 (in thousands):

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
     2012      2011      2012      2011  

Cost of revenue

   $ 14       $ 14       $ 28       $ 14   

Research and development

     11         19         27         19   

Selling and marketing

     26         27         50         27   

General and administrative

     16         24         38         24   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 67       $ 84       $ 143       $ 84   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

14


Table of Contents

As of September 30, 2012, there was $0.4 million of total unrecognized compensation cost related to the ESPP that is expected to be recognized on a straight-line basis over the remaining vesting periods.

Stock-Based Compensation Plans

The Company has various stock-based compensation plans to attract, motivate, retain and reward employees, directors and consultants by providing its Board of Directors (the “Board”) or a committee thereof the discretion to award equity incentives to these persons. The Company’s stock-based compensation plans, the majority of which are stockholder approved, consist of the Director Option Plan, 1997 Stock Option Plan, 2000 Stock Option Plan, 2007 Stock Option Plan (“the 2007 Plan”), the Bluehill ID AG Executive Bonus Plan and Share Option Plan (the “Bluehill Plans”), the 2010 Bonus and Incentive Plan (the “2010 Plan”), and the 2011 Incentive Compensation Plan (the “2011 Plan”).

Stock Bonus and Incentive Plans

In connection with its acquisition of Bluehill ID AG in January 2010, the Company assumed the Bluehill Plans, pursuant to which options to purchase 2.0 million shares of the Company’s common stock may be granted to executives, key employees and other service providers, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), based upon the achievement of certain performance targets or other terms and conditions as determined by the administrator of the plans. No grants have been made under these plans since the date of assumption.

In June 2010, Identive’s stockholders approved the 2010 Plan, under which cash and equity-based awards may be granted to executive officers, including the CEO and CFO, and other key employees (“Participants”) of the Company and its subsidiaries and members of the Company’s Board, as designated from time to time by the Compensation Committee of the Board. An aggregate of 3.0 million shares of the Company’s common stock was reserved for issuance under the 2010 Plan as equity-based awards, including shares, nonqualified stock options, restricted stock or deferred stock awards. These awards provide the executives and employees with the opportunity to earn shares of common stock depending on the extent to which certain performance goals are met. For services rendered, the executives are eligible to receive an incentive bonus in cash and shares of the Company’s common stock with certain lock-up periods. In addition, the executives and employees are eligible to receive a grant of non-qualified stock options in an amount equal to 20% of the number of U.S. dollars in the participant’s base salary. The Compensation Committee may make incentive awards based on such terms, conditions and criteria as it considers appropriate, including awards that are subject to the achievement of certain performance criteria. Stock awards are generally fully vested at the time of grant, but subject to a 24-month lock-up from the date of grant. Because the award of share-based payments described above represents an obligation to issue a variable number of Company’s shares determined on the basis of a monetary value derived solely on variations in an operating performance measure (and not on the basis of variations in the fair value of the entity’s equity shares), the award is considered a share-based liability in accordance with ASC 480 and is remeasured to fair value each reporting period. While the Company will maintain its current 2010 Plan for making performance-based awards to Participants, all future equity awards granted under the 2010 Plan will be issued pursuant to the 2011 Plan (described below). As of September 30, 2012, a total of 0.9 million shares have been issued pursuant to the 2011 Plan.

On June 6, 2011, Identive’s stockholders approved the 2011 Plan, which is administered by the Compensation Committee of the Company’s Board of Directors. The 2011 Plan provides that stock options, stock units, restricted shares, and stock appreciation rights may be granted to officers, directors, employees, consultants, and other persons who provide services to the Company or any related entity. The 2011 Plan serves as a successor plan to the Company’s 2007 Plan. The Company reserved 4.0 million shares of common stock plus any remaining common stock available for delivery under the 2007 Plan and the 2010 Plan as of June 6, 2011. In aggregate, as of June 6, 2011, 8.6 million shares were available for future grants under the 2011 Plan, including shares rolled over from 2007 Plan and 2010 Plan. From June 6, 2011 through September 30, 2012, a total of 2.2 million options have been granted pursuant to the 2011 Plan.

 

15


Table of Contents

Stock-Based Compensation Expense (Stock Bonus and Incentive Plans)

The following table illustrates the stock-based compensation expense resulting from stock bonus and incentive plans included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 (in thousands):

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
     2012     2011      2012      2011  

Cost of revenue

   $ —        $ 1       $ 1       $ 3   

Research and development

     5        2         14         31   

Selling and marketing

     (7     8         35         175   

General and administrative

     237        61         113         296   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 235      $ 72       $ 163       $ 505   
  

 

 

   

 

 

    

 

 

    

 

 

 

As of September 30, 2012 and 2011, $0.1 million and $0.4 million, respectively, were accrued for share and stock option bonuses and included in accrued compensation and related benefits in the condensed consolidated balance sheets.

Stock Option Plans

The Company’s stock options plans are generally time-based and expire seven to ten years from the date of grant. Vesting varies, with some options vesting 25% each year over four years; some vesting 1/12th per month over one year; some vesting 100% after one year; some vesting monthly over four years; and some vesting 1/12th per month, commencing four years from the date of grant. The Director Option Plan and 1997 Stock Option Plan each expired in March 2007. The 2000 Stock Option Plan expired in December 2010 and as noted above, the 2007 Plan was discontinued in June 2011 in connection with the approval of the 2011 Plan. As a result, options will no longer be granted under any of these plans.

As of September 30, 2012, an aggregate of approximately 0.2 million granted options were outstanding under the Director Option Plan and the 1997 Stock Option Plan, 0.3 million granted options were outstanding under the 2000 Stock Option Plan, 1.1 million granted options were outstanding under the 2007 Plan, and 2.2 million granted options were outstanding under the 2011 Plan. These outstanding options remain exercisable in accordance with the terms of the original grant agreements under the respective plans.

A summary of the activity under the Company’s stock-based compensation plans for the nine months ended September 30, 2012 and for the year ended December 31, 2011 is as follows:

 

           Stock Options      Stock Awards  
     Shares
Available for
Grant
    Number
Outstanding
    Average
Exercise Price
per share
     Average
Intrinsic
Value
     Remaining
Contractual
Life (in years)
     Number
Granted
     Fair Value  

Balance at December 31, 2010

     7,542,277        1,810,188      $ 3.56       $ 128,300         4.66         
  

 

 

   

 

 

      

 

 

          

Authorized

     4,000,000                   

Granted

     (1,447,980     820,716        2.53               627,264       $ 1,627,969   

Cancelled or Expired

     20,035        (343,081     7.27               

Exercised

       (21,001     2.36               
  

 

 

   

 

 

               

Balance at December 31, 2011

     10,114,332        2,266,822        2.86       $ 49,298         5.90         
  

 

 

   

 

 

      

 

 

          

Granted

     (2,103,699     1,886,109        1.14               217,590       $ 304,655   

Cancelled or Expired

     63,749        (376,740     3.02               
  

 

 

   

 

 

               

Balance at September 30, 2012

     8,074,382        3,776,191        1.98       $ 102,000         7.5         
  

 

 

   

 

 

      

 

 

          

Vested or expected to vest at September 30, 2012

  

    3,515,554      $ 2.05       $ 74,704         7.35         
    

 

 

      

 

 

    

 

 

       

 

16


Table of Contents

The following table summarizes information about options outstanding as of September 30, 2012:

 

     Options Outstanding      Options Exercisable  

Range of Exercise Prices

   Number
Outstanding
     Weighted
Average
Remaining
Contractual
Life (Years)
     Weighted
Average
Exercise
Price
     Weighted
Average
Number
     Exercise
Exercisable
Price
 

$ 0.72 - $ 1.05

     704,000         9.91       $ 0.77         25,000       $ 1.05   

$ 1.06 - $ 1.20

     943,533         9.67         1.20         235,885         1.20   

$ 1.21 - $ 2.42

     959,398         6.29         2.24         652,755         2.26   

$ 2.43 - $ 3.12

     799,312         6.13         2.77         767,449         2.77   

$ 3.13 - $ 8.34

     369,948         3.46         3.92         369,948         3.92   
  

 

 

          

 

 

    

$ 0.72 - $ 8.34

     3,776,191         7.50       $ 1.98         2,051,037       $ 2.61   
  

 

 

          

 

 

    

The weighted-average grant date fair value per option for options granted during the three and nine months ended September 30, 2012 was $0.72 and $1.14, respectively. The weighted-average grant date fair value per option for options granted during the three and nine months ended September 30, 2011 was $2.31 and $2.57, respectively. During the three and nine months ended September 30, 2012, no options were exercised. During the three and nine months ended September 30, 2011, zero and 21,001 options, respectively, were exercised. Cash proceeds from the exercise of stock options were zero and $56,591 during the three and nine months ended September 30, 2011, respectively.

Stock-Based Compensation Expense (Stock Options)

The following table illustrates the stock-based compensation expense resulting from stock options included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 (in thousands):

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
     2012      2011      2012      2011  

Cost of revenue

   $ 3       $ 3       $ 8       $ 11   

Research and development

     16         8         36         73   

Selling and marketing

     114         51         246         168   

General and administrative

     157         32         288         (10
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock-based compensation expense before income taxes

     290         94         578         242   

Income tax benefit

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock-based compensation expense after income taxes

   $ 290       $ 94       $ 578       $ 242   
  

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2012, there was $1.1 million of unrecognized stock-based compensation expense, net of estimated forfeitures related to non-vested options, that is expected to be recognized over a weighted-average period of 2.15 years.

Common Stock Reserved for Future Issuance

As of September 30, 2012, the Company has reserved an aggregate of approximately 13.5 million shares of its common stock for future issuance under its various equity incentive plans, of which approximately 6.0 million shares are reserved for future grants under the 2011 Plan and 2010 Plan, approximately 3.8 million shares are reserved for future issuance pursuant to outstanding options under all stock options and incentive plans, 1.7 million shares are reserved for future issuance under the ESPP and approximately 2.0 million shares are reserved for future issuance under the Bluehill Plans.

As of September 30, 2012, the Company has reserved an aggregate of approximately 3.3 million shares of common stock for future issuance in connection with its acquisition of Bluehill ID AG, consisting of approximately 2.0 million shares for the outstanding options assumed at the closing of the Bluehill ID AG acquisition and approximately 1.3 million shares for the noncontrolling shareholders of Bluehill ID AG.

As of September 30, 2012, the Company has reserved an aggregate of approximately 8.6 million shares of common stock for future issuance pursuant to outstanding warrants, consisting of approximately 3.7 million shares pursuant to outstanding warrants in connection with its November 2010 private placement and approximately 4.9 million shares pursuant to outstanding warrants in connection with its April 2009 acquisition of Hirsch Electronics Corporation (“Hirsch”).

 

17


Table of Contents

6. Net Loss per Common Share Attributable to Identive Group, Inc.

Basic and diluted net loss per share is based upon the weighted average number of common shares outstanding during the period. For the three and nine months ended September 30, 2012 and 2011, common stock equivalents consisting of outstanding stock options and warrants were excluded from the calculation of diluted loss per share because these securities were anti-dilutive due to the net loss in the respective period. For the nine months ended September 30, 2012 and 2011, the total number of shares excluded from diluted loss per share relating to these securities was 600,000 and 2,120,060 respectively.

7. Inventories

The Company’s inventories are stated at the lower of cost or market. Inventories consist of (in thousands):

 

     September 30,
2012
     December 31,
2011
 

Raw materials

   $ 4,749       $ 4,243   

Work-in-process

     729         160   

Finished goods

     5,336         4,860   
  

 

 

    

 

 

 

Total

   $ 10,814       $ 9,263   
  

 

 

    

 

 

 

8. Property and Equipment

Property and equipment, net consists of (in thousands):

 

     September 30,
2012
    December 31,
2011
 

Land, building and leasehold improvements

   $ 2,258      $ 2,277   

Furniture, fixtures and office equipment

     4,977        5,755   

Plant and machinery

     8,300        5,255   

Purchased software

     1,333        1,299   
  

 

 

   

 

 

 

Total

     16,868        14,586   

Accumulated depreciation

     (9,404     (7,887
  

 

 

   

 

 

 

Property and equipment, net

   $ 7,464      $ 6,699   
  

 

 

   

 

 

 

During the three months ended June 30, 2012, the Company allocated an impairment loss related to long-lived assets to property and equipment that should have been allocated to intangible assets. This was corrected during the three months ended September 30, 2012 and the property and equipment balances shown in the table above have been restated to the net book values prior to the allocation of impairment loss to these assets.

The Company recorded depreciation expense, including amortization expense on capitalized leased assets, of approximately $0.6 million and $1.7 million during the three and nine months ended September 30, 2012, respectively. The net increase of $1.5 million in accumulated depreciation is due to depreciation expense of $1.7 million recorded during the period and $0.1 million for the change in foreign exchange rates between the balance sheet dates, offset by the reduction in accumulated depreciation of $0.3 million related to fixed assets disposed of during the nine months ended September 30, 2012.

9. Goodwill and Intangible Assets

Goodwill

The following table presents goodwill and changes in the carrying amount of goodwill for each of the Company’s business segments as of September 30, 2012, and December 31, 2011 (in thousands):

 

     Total     Identity
Management
    ID Products  

Balance at December 31, 2010

   $ 47,126      $ 37,955      $ 9,171   

Goodwill acquired during the period

     10,518        10,518        —     

Goodwill measurement period adjustment

     118        —          118   

Currency translation adjustment

     642        365        277   
  

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

     58,404        48,838        9,566   

Goodwill acquired during the period

     12,958        12,958        —     

Goodwill impaired during the period

     (26,429     (18,057     (8,372

Currency translation adjustment

     (389     (406     17   
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 44,544      $ 43,333      $ 1,211   
  

 

 

   

 

 

   

 

 

 

 

18


Table of Contents

During the nine months ended September 30, 2012, the Company recorded goodwill of $13.0 million in connection with its acquisition of payment solution. During the year ended December 31, 2011, the Company recorded goodwill of $10.5 million in connection with its acquisition of idOnDemand and polyright. Of the total goodwill, a certain amount of goodwill is designated in a currency other than United States Dollars and is adjusted at each reporting period for the change in foreign exchange rates between the balance sheet dates. In accordance with its accounting policy and ASC 350, the Company tests its goodwill and any other intangibles with indefinite lives annually for impairment and assesses whether there are any indicators of impairment on an interim basis. The Company had performed its annual impairment test for all reporting units on December 1, 2011 in accordance with its accounting policy and concluded that there was no impairment to goodwill during the year ended December 31, 2011.

Beginning in May 2012, the Company experienced a significant decline in its stock price, resulting in the Company’s market capitalization falling significantly below its net book value. In addition, during the second quarter of 2012, the Company’s demand outlook deteriorated due to macroeconomic uncertainty and associated softness in the demand for the Company’s offerings. As a result, the Company reduced its forecasted revenue, gross margin and operating profit for future periods. These factors are considered indicators of potential impairment under the Company’s critical accounting policy, and as a result, the Company performed an interim goodwill impairment analysis as part of its quarterly close as of June 30, 2012. The interim impairment of goodwill was primarily triggered due to decline in the Company’s market capitalization that occurred after the filing of its 2012 first fiscal quarter Form 10-Q and, to a lesser extent, a decrease in the forecasted future cash flows used in the income approach. Prior to its goodwill impairment test, the Company first tested its long-lived assets for impairment and adjusted the carrying value of each asset group to its fair value and recorded the associated impairment charge in its condensed consolidated statements of operations. The Company then performed its analysis of goodwill impairment using a two-step method as required by ASC 350. The first step of the impairment test compared the fair value of each reporting unit to its carrying value, including the goodwill related to the respective reporting units. At the time the impairment test was performed, the Company determined that it had six reporting units consisting of Hirsch, Multicard, payment solution and idOnDemand, which are the four components of the Identity Management segment, and ID Infrastructure and Transponders, which are the two components of the ID Products segment. The Company calculated the fair value of the reporting units using a combination of the market and income approaches and in doing so relied in part upon an independent third-party valuation report. The market approach estimates the fair value of a business based on a comparison of the Company to comparable firms in similar lines of business that are publicly traded or which are part of a public or private transaction. The income approach requires estimates of expected revenue, gross margin and operating expenses in order to discount the sum of future cash flows using each particular reporting unit’s weighted average cost of capital. The Company’s growth estimates were based on historical data and internal estimates developed as part of its long-term planning process. The Company tested the reasonableness of the inputs and outcomes of its discounted cash flow analysis by comparing these items to available market data. Based on the results of step one of the goodwill impairment analysis, it was determined that the Company’s net adjusted carrying value exceeded its estimated fair value for the idOnDemand, Transponder and Multicard reporting units. As a result, the Company proceeded to the second step of the impairment test for these three reporting units to determine the implied fair value of goodwill and compare it to the carrying amount of that goodwill to determine impairment loss.

During the second step of the goodwill impairment review, management estimated the fair value of the Company’s tangible and intangible net assets, and in doing so relied in part upon an independent third-party valuation report. Identified intangible assets were valued specifically for each reporting unit tested. The difference between the estimated fair value of each reporting unit and the sum of the fair value of the identified net assets results in the implied value of goodwill. Based on the results of step two of the goodwill impairment analysis, the Company concluded that the carrying value of goodwill for the idOnDemand, Transponder and Multicard reporting units was impaired. Due to the length of time necessary to measure impairment of goodwill, step two of the goodwill impairment analysis was not completed prior to the time of the filing of the Company’s second quarter Form 10-Q and the Company reported a preliminary impairment charge of $21.4 million in the quarter ended June 30, 2012. Step two of the goodwill impairment analysis was subsequently completed during the 2012 third quarter and resulted in an additional goodwill impairment charge of approximately $5.0 million being recorded during the three months ended September 30, 2012. Total goodwill impairment during the nine months ended September 30, 2012 was $26.4 million and is included in the Company’s condensed consolidated statements of operations. Future impairment indicators, including further declines in the Company’s market capitalization or changes in forecasted future cash flows, could require additional impairment charges. There was no goodwill impairment during the three and nine months of September 30, 2011.

 

19


Table of Contents

Intangible Assets

The following table summarizes the gross carrying amount and accumulated amortization for the intangible assets resulting from acquisitions (in thousands):

 

     Order
Backlog
    Trade
Secrets
    Patents     Existing
Technology
    Customer
Relationship
    Trade
Name
    Total  

Cost:

              

Amortization period

     0.25 - 1 year        1 -2 years        12 years        6 -15 years        4 -15 years       
 
 
1 - 10
years and
Indefinite
  
  
  
    Total   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2010

   $ 724      $ —        $ —        $ 5,462      $ 22,742      $ 9,221      $ 38,149   

Acquired as a part of idOnDemand acquisition

     17        300        790        2,700        390        60        4,257   

Acquired as a part of polyright acquisition

     246        —          —          —          1,290        —          1,536   

Currency translation adjustment

     (39     —          —          8        373        86        428   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

   $ 948      $ 300      $ 790      $ 8,170      $ 24,795      $ 9,367      $ 44,370   

Acquired as a part of payment solution acquisition

     344        —          —          2,023        1,322        542        4,231   

Impairment of intangible assets

     (1,018     (300     (790     (5,489     (15,210     (9,294     (32,101

Currency translation adjustment

     (4     —          —          (104     (183     (45     (336
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 270          $ 4,600      $ 10,724      $ 570      $ 16,164   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accumulated Amortization

              

Balance at December 31, 2010

     (718     —          —          (595     (2,970     (1     (4,284

Amortization expense

     (235     (120     (44     (715     (2,946     (37     (4,097

Currency translation adjustment

     5        —          —          15        (8     —          12   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

   $ (948   $ (120   $ (44   $ (1,295   $ (5,924   $ (38   $ (8,369

Amortization expense

     (53     (90     (32     (619     (1,860     (190     (2,844

Impairment of intangible assets

     959        210        77        865        5,118        87        7,316   

Currency translation adjustment

     (8     —          (1     1        52        (2     42   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ (50   $ —        $ —        $ (1,048   $ (2,614   $ (143   $ (3,855
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Intangible Assets, net at September 30, 2012

   $ 220      $ —        $ —        $ 3,552      $ 8,110      $ 427      $ 12,309   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Intangible Assets, net at December 31, 2011

   $ —        $ 180      $ 746      $ 6,875      $ 18,871      $ 9,329      $ 36,001   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

During the nine months ended September 30, 2012, the Company recorded intangible assets of $4.2 million in connection with its acquisition of payment solution as described in Note 3 above. Of the total intangible assets, certain acquired intangible assets are designated in a currency other than United States Dollars and are adjusted each reporting period for the change in foreign exchange rates between the balance sheet dates.

As noted above, beginning in May 2012, the Company experienced a significant decline in its stock price and during the 2012 second quarter experienced deterioration in its demand outlook as a result of macroeconomic uncertainty. Consequently, the Company performed an interim goodwill impairment analysis as of June 30, 2012. In conjunction with its goodwill impairment test, the Company also performed an impairment analysis for intangible assets in accordance with its accounting policy for reviewing long-lived assets for impairment. Management determined the estimated undiscounted cash flows and the fair value of the identified intangible assets to measure the impairment loss and in doing so relied in part upon an independent third-party valuation report. The impairment analysis for intangible assets indicated that some of the identified intangible assets are not recoverable as the sum of its estimated future undiscounted cash flows were below the asset’s carrying value. Accordingly, the Company estimated the fair value of these identified intangible assets using a discounted cash flow analysis to measure the impairment loss. The discounted cash flow analysis requires estimates for expected performance such as revenue, gross margin and operating expenses, in order to discount the sum of future independent cash flows using discount rates which were determined based on an analysis of each individual identified intangible asset group and consideration of the aggregate business of the Company. The discount rates used in the present value calculations were in the range of 16% to 20%, except for one asset group where it was 50%. The discount rates were derived from a weighted average cost of capital (“WACC”) analysis, adjusted to reflect additional risks related to each asset’s characteristics. The Company tested the reasonableness of the inputs and outcomes of its discounted cash flow analysis by comparing these items to available market data. As a result of this analysis, the Company concluded that certain of its intangible assets were impaired and recorded an impairment charge of $24.8 million, of which $23.9 million was recorded in the second quarter and $0.9 million was recorded in the third quarter of 2012, which is included as part of operating expenses in the condensed consolidated statements of operations. Based on this analysis, the Company expects to recover the remaining balance of identified intangible assets of $12.3 million.

 

20


Table of Contents

Intangible assets of $36.0 million as of December 31, 2011 include intangible assets of $9.3 million that are not subject to amortization. The Company had performed its annual impairment test for intangible assets with indefinite useful lives in accordance with its accounting policy as of December 1, 2011 and concluded that there was no impairment to unamortizable intangible assets during the year ended December 31, 2011. As of June 30, 2012, the Company evaluated the reasonableness of useful lives of its indefinite-lived intangible assets and determined that these assets’ useful lives are no longer indefinite. As a result, the Company began amortizing these assets over their useful lives. Intangible assets subject to amortization are amortized over their useful lives as shown in the table above. The impairment charge of $24.8 million above includes $8.7 million related to intangible assets which were classified as indefinite-lived intangible assets as of December 31, 2011.

The following table illustrates the amortization expense included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Cost of revenue

   $ 91       $ 378       $ 794       $ 724   

Selling and marketing

     333         818         2,050         2,208   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 424       $ 1,196       $ 2,844       $ 2,932   
  

 

 

    

 

 

    

 

 

    

 

 

 

The estimated future amortization expense of purchased intangible assets with definite lives for the next five years is as follows (in thousands):

 

September 30, 2012:

      

2012 (remaining three months)

   $ 434   

2013

     1,453   

2014

     1,074   

2015

     1,042   

2016

     997   

2017 and thereafter

     7,309   
  

 

 

 

Total

   $ 12,309   
  

 

 

 

10. Related-Party Transactions

Prior to the acquisition of Hirsch by the Company, effective November 1994, Hirsch had entered into a settlement agreement (the “1994 Settlement Agreement”) with two limited partnerships: Secure Keyboards, Ltd. (“Secure Keyboards”) and Secure Networks, Ltd. (“Secure Networks”). Secure Keyboards and Secure Networks were related to Hirsch through certain common shareholders and limited partners, including Hirsch’s then President Lawrence Midland, who is now a Senior Vice President and a director of the Company. Following the acquisition of Hirsch, Mr. Midland continues to own 30% of Secure Keyboards and 9% of Secure Networks.

 

21


Table of Contents

On April 8, 2009, Secure Keyboards, Secure Networks and Hirsch amended and restated the 1994 Settlement Agreement to replace the royalty-based payment arrangement under the 1994 Settlement Agreement with a new, definitive installment payment schedule with contractual payments to be made in future periods through 2020 (the "2009 Settlement Agreement"). Prior to the acquisition of Hirsch by the Company, the Company was not a party to the 2009 Settlement Agreement. The Company has, however, provided Secure Keyboards and Secure Networks with a limited guarantee of Hirsch’s payment obligations under the 2009 Settlement Agreement (the "Guarantee"). The 2009 Settlement Agreement and the Guarantee became effective upon the acquisition of Hirsch on April 30, 2009. Hirsch’s annual payment to Secure Keyboards and Secure Networks in any given year under the 2009 Settlement Agreement is subject to increase based on the percentage increase in the Consumer Price Index during the prior calendar year.

The final payment to Secure Networks was due on January 30, 2012 and the final payment to Secure Keyboards is due on January 30, 2021. Hirsch’s payment obligations under the 2009 Settlement Agreement will continue through the calendar year period ending December 31, 2020, unless Hirsch elects at any time on or after January 1, 2012 to earlier satisfy its obligations by making a lump-sum payment to Secure Keyboards.

The Company recognized $0.2 million and $0.6 million of expense during the three and nine months ended September 30, 2012, respectively, and $0.2 million and $0.6 million of expense during the three and nine months ended September 30, 2011, respectively, in its condensed consolidated statements of operations for the interest accreted on the discounted liability amount.

The payment amounts for related-party liability in connection with the Hirsch acquisition for the next five years are as follows (in thousands):

 

September 30, 2012:

      

2012 (remaining three months)

   $ 272   

2013

     1,131   

2014

     1,187   

2015

     1,247   

2016

     1,309   

2017 and thereafter

     6,453   

Present value discount factor

     (3,486
  

 

 

 

Total

   $ 8,113   
  

 

 

 

In connection with its acquisition of payment solution, through its majority-owned subsidiary Bluehill ID AG, the Company assumed an unsecured loan payable to Mountain Partners AG, a significant shareholder of the Company. At the inception of the loan agreement, an amount of €250,000 was provided for working capital needs. An amount of €327,000, or approximately $0.4 million, was outstanding as of the payment solution acquisition date of January 30, 2012. The loan carries an interest rate of 8% per year. There are no specific payment terms and the amount outstanding under the loan agreement, including accrued interest, is due to be paid upon demand by Mountain Partners AG. The Company recorded interest expense on the loan of $6,200 and $17,200 during the three and nine months ended September 30, 2012, respectively. As of September 30, 2012, approximately $0.4 million was outstanding under the loan, which is shown as a current liability on the condensed consolidated balance sheet.

 

22


Table of Contents

11. Financial Liabilities

Financial liabilities consist of (in thousands):

 

     September 30,      December 31,  
     2012      2011  

Current liability:

     

Equipment financing liabilities

   $ 754       $ —     

Bank loan

     419         —     

Debt note

     626         829   

Mortgage loan payable to bank

     55         55   

Bank line of credit

     129         —     
  

 

 

    

 

 

 

Total current liability

   $ 1,983       $ 884   
  

 

 

    

 

 

 

Non-current liability:

     

Equipment financing liabilities

   $ 1,836       $ —     

Bank loan

     1,339         —     

Debt note

     —           423   

Mortgage loan payable to bank

     724         766   
  

 

 

    

 

 

 

Total non-current liability

   $ 3,899       $ 1,189   
  

 

 

    

 

 

 

Total

   $ 5,882       $ 2,073   
  

 

 

    

 

 

 

In connection with its acquisition of payment solution, through its majority-owned subsidiary Bluehill ID AG the Company acquired obligations for equipment financing liabilities, a bank loan and a revolving line of credit payable to a bank.

The equipment financing liabilities are partially secured by payment solution’s systems installed in the stadiums to which they relate and will mature in 2014. Amounts outstanding under the equipment finance obligations accrue interest in the range of 8.6% to 18.6%, and interest is payable quarterly. payment solution is obligated to pay a quarterly sum of approximately $0.2 million in principal and interest during 2012. The repayments increase to approximately $0.3 million per quarter in 2013, with a final payment of approximately $0.8 million in October 2014. The Company recorded interest expense on the equipment financing obligations of approximately $0.1 million and $0.3 million during the three and nine months ended September 30, 2012, respectively.

The bank loan is secured by some of payment solution’s tangible assets installed in the various stadiums and will mature in 2017. Amounts outstanding under the bank loan accrue interest at 11.15% and interest is payable quarterly. payment solution is obligated to pay a quarterly sum of approximately $0.1 million in principal and interest over the life of the loan. The Company recorded interest expense on the bank loan of approximately $50,000 and $0.1 million during the three and nine months ended September 30, 2012, respectively.

The revolving line of credit is guaranteed by a former executive of payment solution up to a limit of approximately $0.1 million. The advances on the revolving line of credit accrue interest at a base rate of 6.85%, payable quarterly. Any advances over the limit will accrue interest at 13.9%. The revolving line of credit is ongoing with no specific end date. The Company recorded interest expense on the line of credit of approximately $3,000 and $9,000 during the three and nine months ended September 30, 2012, respectively.

In connection with its acquisition of Smartag Pte., Ltd. (“Smartag”) in November 2010, the Company issued a debt note with a face value of $2.2 million to FCI Asia Pte. Ltd. The debt note carries an interest rate of 6.0% per year, compounded daily and is payable within 30 months from the closing date. The Company is obligated to pay the principal and accrued interest on a quarterly basis beginning February 19, 2011. The Company may at any time prepay the principal amount of this debt note, in whole or in part, together with accrued interest thereon, without penalty. The discount for prepayment shall be 10% on any remaining amount outstanding under the debt note. The debt note is secured by the grant of first-priority security interest in over all the shares and assets of Smartag. The Company recorded interest expense on the debt note of $11,000 and $43,000 during the three and nine months ended September 30, 2012, respectively. The Company recorded interest expense on the debt note of $24,000 and $0.1 million during the three and nine months ended September 30, 2011, respectively.

 

23


Table of Contents

In connection with its acquisition of Bluehill ID AG in January 2010, the Company acquired an obligation for a mortgage loan and a related revolving line of credit payable to a bank. The mortgage loan and the revolving line of credit are related to one of the wholly-owned subsidiaries of Bluehill ID AG and are secured by the land and building to which it relates as well as total inventory, machinery, stock, products and raw materials of the subsidiary. Amounts outstanding under the mortgage loan accrue interest at 5.50%, and interest is payable monthly. The mortgage loan will mature in 2026. The Company is obligated to pay a monthly amount of approximately $4,400 over the life of the mortgage loan towards the principal amount in addition to monthly interest payments. The total amount that can be advanced under the line of credit is approximately $0.1 million. The advances on the revolving line of credit accrue interest at a base rate determined by the bank plus 2%, payable quarterly. Any advances over the limit will accrue interest at 10.75%. The revolving line of credit is ongoing with no specific end date. The Company recorded interest expense on the mortgage loan and line of credit of approximately $11,000 and $40,000 during the three and nine months ended September 30, 2012, respectively. The Company recorded interest expense on the mortgage loan and line of credit of approximately $21,000 and $0.1 million during the three and nine months ended September 30, 2011, respectively. As of September 30, 2012 and December 31, 2011, outstanding balances under the revolving line of credit were zero.

12. Accounts Receivable Factoring

On November 30, 2010, the Company’s Hirsch subsidiary entered into an account purchase agreement (“factoring arrangement”) with a third-party bank (the “factor”) whereby Hirsch may sell certain accounts receivable to the factor in return for cash advances. Under the terms of this agreement, the factor makes advances to Hirsch based on 90% of the gross receivable amount, up to $8.0 million. The factor imposes a financing fee equal to the greater of 7% per annum or the sum of LIBOR plus 6% per annum of the receivables sold. Based on this arrangement, Hirsch is liable to the factor if the accounts receivable are not collected or are past due over 90 days. Prior to September 2012, Hirsch did not utilize the factoring arrangement. During the three and nine months ended September 30, 2012, Hirsch factored approximately $1.5 million of its gross receivables for a cash consideration of approximately $1.3 million. Subsequent to the quarter ended September 30, 2012, on October 30, 2012, Hirsch terminated the factoring arrangement and, as a result, it is obliged to repurchase the accounts receivable sold in its entirety from the factor. As a result, the factoring arrangement is accounted for as secured borrowing in accordance with ASC 860-30. As of September 30, 2012, the Company recorded $1.3 million accounts payable to the factor under the factoring arrangement which is included in other accrued expenses and liabilities, and $1.5 million accounts receivable pledged to the factor, which is included in accounts receivable in the condensed consolidated balance sheet. The financing fee related to the factoring incurred as of September 30, 2012 was insignificant.

13. Restricted Cash

As of September 30, 2012, the Company has a restricted cash balance of approximately $2.0 million, of which $0.7 million is related to payment amounts deposited in an escrow account for purchase of equipment in a subsidiary and $1.3 million is related to amounts payable to the factor as described in Note 12 above.

14. Segment Reporting, Geographic Information and Major Customers

ASC Topic 280 — Segment Reporting (“ASC 280”) establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operating decisions and assessing financial performance. An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenue and incur expenses and about which separate financial information is available. The Company’s chief operating decision makers (“CODM”) are considered to be its CEO and CFO.

The Company operates in two business segments that reflect its current organizational structure and focus on providing secure identification solutions. The Company’s reportable segments are “Identity Management Solutions & Services” (“Identity Management”) and “Identification Products & Components” (“ID Products”).

 

   

In the Identity Management segment the Company designs, supplies and manages solutions, systems and services that enable the secure management of credentials in diverse markets. These credentials are used for the identification of people and the granting of rights and privileges based on defined policies. The Company’s Identity Management offerings include integrated physical and logical (i.e., PC, network or cyber) access systems, integrated ID solutions, cashless payment solutions and cloud-based credential management systems, all of which are designed to enable organizations to enhance security and better meet compliance and regulatory requirements while providing the benefits of ease of use and convenience. The Company sells its Identity Management solutions under the Identive, Hirsch Identive, polyright, payment solution and idOnDemand brands. The Company’s Identity Management end customers operate in the government, education, enterprise and commercial markets and can be found in multiple vertical market segments including payment, healthcare, banking, industrial, retail and critical infrastructure. Business units in the Identity Management segment include Hirsch Identive, idOnDemand and Multicard (which includes payment solution) and these business units were aggregated based on similar economic characteristics and products offerings as well as type of customers.

 

24


Table of Contents
   

In the ID Products segment the Company designs and manufactures both standard and highly specialized radio frequency identification (“RFID”) and smart card technology-based products and components, including near field communication (“NFC”) products and components, that are used in the government, enterprise and consumer markets for a number of identity-based and related applications, including logical access, physical access, eHealth, eGovernment, citizen ID, mobile payments, loyalty schemes, and transportation and event ticketing. The Company’s ID Infrastructure products include i) readers and terminals based on both contact and contactless smart card technology and ii) RFID transponders, which consist of RFID inlays and inlay-based tags, labels, stickers and cards, including NFC inlays and tags. ID Products are sold primarily under the Identive brand. The ID Products segment includes the results of the Company’s ID Infrastructure and Transponder business units.

The CODM reviews financial information and business performance at the Identity Management and ID Products reportable segment. The Company evaluates the performance of its segments at the revenue and gross margin level. The CODM does not review operating expenses or asset information for purposes of assessing performance or allocating resources.

Summary information by segment is as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Identity Management:

        

Revenues from external customers

   $ 13,833      $ 15,148      $ 40,721      $ 42,248   

Intersegment revenue

     1        (2     20        314   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Identity Management revenue

     13,834        15,146        40,741        42,562   

Elimination of intersegment revenues

     (1     2        (20     (314
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 13,833      $ 15,148      $ 40,721      $ 42,248   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

   $ 6,872      $ 6,816      $ 19,053      $ 18,971   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit %

     50     45     47     45

ID Products:

        

Revenues from external customers

   $ 9,112      $ 11,604      $ 27,286      $ 32,536   

Intersegment revenue

     106        1,991        414        5,699   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total ID Products revenue

     9,218        13,595        27,700        38,235   

Elimination of intersegment revenues

     (106     (1,991     (414     (5,699
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 9,112      $ 11,604      $ 27,286      $ 32,536   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

   $ 2,848      $ 5,014      $ 9,005      $ 12,453   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit %

     31     43     33     38

Total:

        

Net revenue

   $ 22,945      $ 26,752      $ 68,007      $ 74,784   

Gross profit

   $ 9,720      $ 11,830      $ 28,058      $ 31,424   

Gross profit %

     42     44     41     42

 

25


Table of Contents

Geographic net revenue is based on selling location. Information regarding net revenue by geographic region is as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Net Revenues:

        

Americas

   $ 13,014      $ 11,673      $ 35,839      $ 33,465   

Europe

     6,653        11,943        22,027        30,587   

Asia-Pacific

     3,278        3,136        10,141        10,732   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 22,945      $ 26,752      $ 68,007      $ 74,784   
  

 

 

   

 

 

   

 

 

   

 

 

 

% of net Revenues:

        

Americas

     57     43     53     45

Europe

     29     45     32     41

Asia-Pacific

     14     12     15     14
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

No customers exceeded 10% of total revenue during the three and nine months ended September 30, 2012 or 2011. No customer represented 10% of the Company’s accounts receivable balance at September 30, 2012 or December 31, 2011.

The Company tracks assets by physical location. Long-lived assets by geographic location are as follows (in thousands):

 

     September 30,
2012
     December 31,
2011
 

Property and equipment, net:

     

Americas

   $ 647       $ 656   

Europe

     5,017         3,970   

Asia-Pacific

     1,800         2,073   
  

 

 

    

 

 

 

Total

   $ 7,464       $ 6,699   
  

 

 

    

 

 

 

15. Restructuring

In 2012, the Company implemented a restructuring plan (the “2012 Restructuring Plan”) in an effort to align its business operations with the current market and macroeconomic conditions. The 2012 Restructuring Plan included a worldwide workforce reduction and restructuring of certain business functions. The Company incurred restructuring charges of $0.3 million related to payment for severance charges associated with the 2012 Restructuring Plan during the nine months ended September 30, 2012.

16. Commitments

The Company leases its facilities, certain equipment, and automobiles under non-cancelable operating lease agreements. Those lease agreements existing as of September 30, 2012 expire at various dates during the next five years.

The Company recognized rent expense of $0.6 million and $1.7 million for the three and nine months ended September 30, 2012, respectively, and recognized rent expense of $0.4 million and $1.6 million for the three and nine months ended September 30, 2011, respectively, in its condensed consolidated statements of operations.

Purchases for inventories are highly dependent upon forecasts of customer demand. Due to the uncertainty in demand from its customers, the Company may have to change, reschedule, or cancel purchases or purchase orders from its suppliers. These changes may lead to vendor cancellation charges on these purchases or contractual commitments. The following table summarizes the Company’s principal contractual obligations as of September 30, 2012 (in thousands):

 

26


Table of Contents
     Operating
Leases
     Purchase
Commitments
     Other
Contractual
Obligations
     Total  

2012 (remaining three months)

   $ 969       $ 10,757       $ 637       $ 12,363   

2013

     1,849         1,219         64         3,132   

2014

     799         —           4         803   

2015

     256         —           —           256   

2016 and thereafter

     185         —           25         210   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,058       $ 11,976       $ 730       $ 16,764   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company provides warranties on certain product sales, which range from 12 to 24 months, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company currently establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior 12 months’ sales activities. If actual return rates and/or repair and replacement costs differ significantly from the Company’s estimates, adjustments to recognize additional cost of sales may be required in future periods. Historically the warranty accrual and the expense amounts have been immaterial.

17. Subsequent Events

On October 30, 2012, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Hercules Technology Growth Capital, Inc. (the “Lender”). The Loan Agreement provides for a term loan in aggregate principal amount of up to $10.0 million with an initial drawdown of $7.5 million and, provided certain financial and other requirements are met, an additional $10.0 million in loan advances, all upon the terms and conditions set forth in the Loan Agreement.

The initial drawdown of $7.5 million is reflected in the Secured Term Promissory Note dated October 30, 2012 (the “Note”). The loan agreement provides that, subject to the terms and conditions contained therein (including compliance with certain financial covenants), beginning October 1, 2013 and continuing until December 31, 2013 the company may request an additional advance in an aggregate amount up to $2.5 million. After full drawdown of the $10.0 million term loan, the company has the opportunity to secure additional advances up to a further $10.0 million subject to compliance with certain conditions and covenants as set out in the Loan Agreement or as may be otherwise required by the Lender. The Note matures on November 1, 2015 and bears interest at a rate of the greater of (i) the prime rate plus 7.75% and (ii) 11.00%. Interest on the Note is payable monthly beginning on November 1, 2012, and the principal balance is payable in 30 equal monthly installments beginning on May 1, 2013. In connection with the initial advance, the Company paid a $150,000 facility charge to the Lender, of which 50% will be credited to the Company if all advances under the Loan Agreement are repaid on but not before maturity. The Company may prepay outstanding amounts under the Note, subject to certain prepayment charges as set out in the Loan Agreement. The Company will also pay additional fees to the Lender in the aggregate of $1,000,000, payable in three equal annual installments beginning on October 30, 2013. The entire amounts of these fees are immediately due and payable if the Company prepays all of its obligations under the Loan Agreement or if the Lender declares all obligations due and payable after an event of default thereunder.

The obligations of the Company under the Loan Agreement and the Note are secured by substantially all assets of the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements for purposes of the safe harbor provisions under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements, other than statements of historical facts, include statements on our ability to execute our growth strategy, expand our business, leverage our opportunities, enter new markets, capitalize on the growth in our industries, develop and improve new technology, and similar statements regarding our strategy, future operations, financial position, projected results, estimated revenues or losses, projected costs, prospects, plans, market trends, competition and objectives of management. In some cases, you can identify forward-looking statements by terms such as “will,” “believe,” “could,” “should,” “would,” “may,” “anticipate,” “intend,” “plan,” “estimate,” “expect,” “project” or the negative of these terms or other similar expressions. Although we believe that our expectations reflected in or suggested by the forward-looking statements that we make in this Quarterly Report on Form 10-Q are reasonable, we cannot guarantee future results, performance or achievements. You should not place undue reliance on these forward-looking statements. All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our expectations change, whether as a result of new information, future events or otherwise.

 

27


Table of Contents

We also caution you that such forward-looking statements are subject to risks, uncertainties and other factors, not all of which are known to us or within our control, and that actual events or results may differ materially from those indicated by these forward-looking statements. Such factors include our ability to successfully integrate strategic businesses that we acquire, our ability to reduce costs associated with strategic acquisitions, our ability to anticipate product demand, our ability to obtain supplies for products in a timely manner, and our ability to retain key personnel, as well as those additional factors listed in the “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011. These cautionary statements qualify all of the forward-looking statements included in this Quarterly Report on Form 10-Q that are attributable to us or persons acting on our behalf.

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto set forth in Part I—Item 1 of this Quarterly Report on Form 10-Q and with the audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Identive Group, Inc. (“Identive,” the “Company”, “we” or “us”) provides secure identification (“Secure ID”) solutions that combine the convenience of radio frequency identification (“RFID”) with the security of smart card technology to enable people to easily and securely interact with and manage digital devices, systems and data. Our offerings include hardware products, software, integrated systems and services to address the global markets for credential management, physical and logical/cyber access control, integrated ID solutions and a host of near field communication (“NFC”) and RFID-enabled applications for customers in the government, enterprise, consumer, education, healthcare and transportation sectors. Our growth model is principally based on strong technology-driven organic growth, supported by disciplined acquisitive expansion. Our common stock is listed on the NASDAQ Global Market in the U.S. under the symbol “INVE” and the Frankfurt Stock Exchange in Germany under the symbol “INV.”

We operate in two segments, “Identity Management Solutions & Services” (“Identity Management”) and “Identification Products & Components” (“ID Products”):

 

   

In our Identity Management segment we design, supply and manage solutions, systems and services that enable the secure management of credentials in diverse markets. These credentials are used for the identification of people and the granting of rights and privileges based on defined security policies. Our Identity Management offerings include integrated physical and logical (i.e., PC, network or cyber) access systems, integrated ID solutions, cashless payment solutions and cloud-based credential management systems, all of which are designed to enable organizations to enhance security and better meet compliance and regulatory requirements while providing the benefits of ease of use and convenience. We sell our Identity Management solutions under the Identive, Hirsch Identive, polyright, payment solution and idOnDemand brands. Our Identity Management end customers operate in the government, education, enterprise and commercial markets and can be found in multiple vertical market segments including payment, healthcare, banking, industrial, retail and critical infrastructure.

 

   

In our ID Products segment we design and manufacture both standard and highly specialized RFID and smart card technology-based products and components, including NFC products and components, that are used in the government, enterprise and consumer markets for a number of identity-based and related applications, including logical access, physical access, e-Health, e-Government, citizen ID, mobile payments, loyalty schemes, and transportation and event ticketing. Our ID Products offerings include i) readers and terminals based on both contact and contactless smart card technology and ii) RFID transponders, which consist of RFID inlays and inlay-based RFID tags, labels, stickers and cards, including NFC inlays and tags. Our ID Products are sold primarily under the Identive brand.

Each of the business areas within Identive conducts its own sales and marketing activities in the markets in which it competes, primarily utilizing its own sales and marketing organization to solicit prospective channel partners and customers, provide technical advice and support with respect to products, systems and services, and manage relationships with customers, distributors and OEMs. Increasingly, we also leverage common resources between business areas to optimize our sales and marketing efforts across multiple regions and market opportunities. The majority of our sales are made through indirect sales channels that may include dealers, systems integrators, value added resellers, resellers or Internet sales.

 

28


Table of Contents

Our corporate headquarters are located in Santa Ana, California and our European and operational headquarters are located in Ismaning, Germany. We maintain facilities in Chennai, India for research and development and in Australia, Canada, Germany, Hong Kong, Japan, The Netherlands, Singapore, Switzerland and the U.S. for local operations and sales. The Company was founded in 1990 in Munich, Germany and incorporated in 1996 under the laws of the State of Delaware.

Recent Acquisitions

On January 30, 2012, through our Bluehill ID AG subsidiary, we acquired approximately 58.8% of the outstanding shares of payment solution AG, a privately-held German company that provides cashless payment solutions for stadiums, arenas and other event venues (“payment solution”). In exchange for the shares of payment solution, we issued an aggregate of 1,357,758 shares of our common stock, which had an approximate value of €2.35 million (or approximately $3.0 million), to 18 selling shareholders of payment solution. The shares have not been, and will not be, registered under the U.S. Securities Act of 1933 and were issued in reliance upon available exemptions from the registration requirements of the Securities Act. The shares are also subject to applicable restrictions on transfer. payment solution’s operating results have been included in our consolidated results from the date of acquisition. On April 2, 2012 we acquired an additional 23.7% of the outstanding shares of payment solution, bringing our total ownership of the company to 82.5%. We are in the process of integrating payment solution into our existing ID Solutions operations in Germany.

On July 18, 2011, through our Multicard AG subsidiary we acquired polyright SA, a Swiss provider of identity management platforms and open-ended rights and services management solutions for higher education, healthcare and industry ("polyright"). The acquisition was made using a combination of cash and payment of outstanding indebtedness in the aggregate amount of CHF 2.55 million (or approximately $3.1 million). The sellers included Securitas AG, Kudelski SA and members of polyright’s management team. The sellers may receive aggregate potential earn-out payments payable in shares of our common stock, over the 30-month period following the closing of the acquisition, subject to achievement of specific financial and sales performance targets over such period. The number of shares, if any, issued under the earn-out will be based on the average share price during the month preceding the date of announcement of our annual results, and will be subject to a two-year lockup. polyright’s operating results have been included in our consolidated results since the date of acquisition. Following the acquisition, polyright was integrated into our existing ID Solutions operations in Switzerland.

On May 2, 2011, we acquired 95.8% of the shares of idOnDemand, Inc., a privately-held provider of identity management services based in Pleasanton, California (“idOnDemand”). The acquisition was pursuant to the Stock Purchase Agreement dated April 29, 2011, under which we paid the selling shareholders of idOnDemand initial consideration at closing of approximately $2.4 million in cash and 995,675 shares of our common stock. In addition, the selling shareholders may receive aggregate potential earn-out payments payable in shares of our common stock subject to achievement of specific financial and sales performance targets over a period of three years and eight months from the closing date of the acquisition. Any shares issued in connection with the earn-out will be subject to a 12-month lock-up from date of issuance. Shares issued as consideration to the selling shareholders at closing are subject to a three-year lock-up from the closing date of the acquisition. The shares have not been, and will not be, registered under the U.S. Securities Act of 1933, and were issued in reliance upon available exemptions from the registration requirements of the Securities Act. Of the total initial share consideration paid to the selling shareholders, 407,289 shares were released from lock-up six months after the closing date. Beginning on the second anniversary of the closing date, the remaining shares will be released from the lock-up in equal amounts on a monthly basis until the expiration of the lock-up period. idOnDemand’s operating results have been included in our consolidated results since the date of acquisition. On December 22, 2011, we entered into an agreement to purchase the remaining outstanding shares of idOnDemand for the sum of $500,000, pursuant to an agreement among Identive, ActivIdentity Corporation and idOnDemand. Following the completion of this share purchase on January 9, 2012, idOnDemand became a wholly-owned subsidiary of Identive. idOnDemand’s software and services activities have been closely integrated with our Hirsch Identive operations and together they comprise our Identity Management & Cloud Solutions division. Certain reader products from idOnDemand have been transferred to our ID Products segment.

Recent Trends and Strategies for Growth

Identive is focused on building the world's signature company in Secure ID by providing products, systems and services that are interoperable, easy to integrate and easy to use. Our goal is to build a lasting business of scale and technology to both enable and capitalize on the growth of the security and RFID industries. Our growth strategy is based both on technology-driven organic growth and disciplined acquisitive activity. We pursue investments and acquisitions with a focus on expanding our business, reinforcing our market position in targeted areas and fully leveraging our strengths and opportunities to enter new markets, as well as driving consolidation in the rapidly growing, yet fragmented markets for identification-based technologies.

 

29


Table of Contents

As part of our organic growth strategy, we are focused on enhancing our ability to address emerging growth markets and extending our product and solutions offerings through ongoing research and development programs. This includes a significant update to our Hirsch Identive access control software and hardware platforms and continued enhancements to our software systems for cashless payment systems. Additionally, to meet increasing customer demand for RFID inlays and finished transponder products such as tags, labels and cards, we continue to add new manufacturing and production equipment and lines at our facilities in Germany and Singapore.

In order to position the Company to participate in emerging, potentially very high-growth market opportunities, we have invested and continue to invest in new products and solutions in a number of areas. In anticipation of the launch of new smartphones that include NFC technology, we created a new dedicated group focused on NFC and mobility applications, which is responsible for guiding and coordinating our NFC product and market strategies as well as launching new cloud-based NFC services. We are investing in NFC product and service offerings, including NFC tags, readers, development kits, and a cloud-based services platform for managing content on deployed NFC tags. We also launched an online market to sell our NFC products and services at www.identiveNFC.com. To take advantage of the growing market trend towards the convergence (or integration) of physical and cyber access systems, we created a new group focused on the market for converged access products. Additionally, to meet the growing demand for cloud-based credential issuance and management, we are investing in the development of “Identity as a Service” software solutions and capabilities.

Because acquisitions have been and continue to be a component of our strategy to expand our capabilities and the scale of our business, from time to time we reorganize our operations to enhance our ability to address our market opportunities. For example, we have consolidated our various transponder, reader and firmware product businesses into a single Identification Products organization and moved the majority of our product brands under a single market brand, Identive. We have combined our Hirsch Identive and idOnDemand operations into a single organization focused on Identity Management & Cloud Solutions, and are in the process of transitioning our Hirsch Identive and idOnDemand offerings to the Identive brand. We are also engaged in combining our most recent acquisitions, polyright and payment solutions, into the operations of our ID Solutions division.

While we expect to continue to invest in those areas of our business that we perceive to be important future growth drivers, as described below in “Results of Operations” and “Liquidity and Capital Resources,” our sales for the first nine months of 2012 were negatively impacted by market factors, and we continue to incur operating losses

Goodwill and Intangibles Impairment

As described in Note 9 to the unaudited condensed consolidated financial statements included in this Quarterly Report on
Form 10-Q, because of a significant decline in the Company’s stock price and market capitalization and changes to forecasted revenue, gross margin and operating profit during the 2012 second quarter, we undertook interim goodwill impairment analyses in connection with our quarterly close as of June 30, 2012. Due to the length of time necessary to measure impairment of goodwill, our analysis was not completed as of the time of the filing of our second quarter Form 10-Q and we reported a preliminary impairment charge of $21.4 million in the second quarter ended June 30, 2012. The goodwill impairment analysis was subsequently completed during the 2012 third quarter and resulted in an additional goodwill impairment charge of approximately $5.0 million being recorded during the three months ended September 30, 2012, for a total goodwill impairment charge of $26.4 million during the nine months ended September 30, 2012.

In conjunction with our goodwill impairment test, we also tested our long-lived assets for impairment and adjusted the carrying value of each asset group to its fair value and recorded the associated impairment charge of $24.8 million in our condensed consolidated statements of operations, of which $23.9 million was recorded in the second quarter and $0.9 million was recorded in the third quarter of 2012. These charges affected our financial condition and results of operation; however, they have no impact on our day-to-day operations or liquidity and will not result in any future cash expenditures. We also expect that as a result of the impairment there will be lower non-cash charges to net earnings in future quarters, as the amount of intangible assets being amortized will be significantly reduced.

Trends in our Business

Sales Trends

Sales in the first nine months of 2012 decreased 9% to $68.0 million compared with the first nine months of 2011, reflecting a 16% decrease in organic sales, partially offset by $5.4 million of incremental revenue from idOnDemand, polyright and payment solution. In the first nine months of 2012, sales were affected by a revenue gap of approximately $6.2 million caused by the absence of new orders for secure card readers and software for the German national ID program, which had been a significant component of our revenue throughout 2011; project delays with several transponder customers in the mobile device and transportation sectors; and ongoing budget delays and constraints in the U.S. government and European government program sectors. These factors were partially offset by stronger sales of smart card readers and Hirsch Identive identity management and access control systems to the U.S. government market, related in part to limited improvement in activity associated with previously delayed security projects with some U.S. federal agencies.

 

30


Table of Contents

Sales in the Americas. Sales in the Americas were $35.8 million in the first nine months of 2012, accounting for 53% of total revenue and up 7% compared with $33.5 million in the first nine months of 2011. Sales of products and systems for employee ID programs within various U.S. government agencies comprise a significant proportion of our revenues in the Americas region, which also includes Canada and Latin America.

Sales of our Hirsch Identive access control systems in the Americas increased by approximately 3% in the first nine months of 2012 compared with the same period of 2011, primarily as a result of an increase in activity with certain U.S. federal agencies, including a $1.7 million order from the Department of Justice recorded in the 2012 second quarter. As a general trend, U.S. federal agencies continue to be subject to security improvement mandates under programs such as Homeland Security Presidential Directive-12 (“HSPD-12”) and reiterated in memoranda from the Office of Management and Budget (“OMB M-11-11”). We believe that our Hirsch Identive access control systems remain among the most attractive offerings in the market to help agencies move towards compliance with federal directives and mandates. During 2011, our sales of security systems to the U.S. Government sector were negatively impacted by budget and funding delays. While increased project activity at some federal agencies in the first nine months of 2012 is a positive development, the outlook for our U.S. Government business remains uncertain in the near term, particularly as it is uncertain how the upcoming U.S. election may affect federal spending. To offset project and budget delays in the U.S. Government market, in recent quarters we have expanded our focus on the utility and enterprise sectors as well as on further developing our opportunities in international markets.

Smart card reader sales in the Americas increased 72% in the first nine months of 2012 compared with the same period of 2011, as a result of large orders from a few U.S. government agencies and broader, seasonally driven demand from the U.S. government sector as a whole to support cybersecurity and network access projects. This was partially offset by a 22% decrease in transponder sales in the Americas as various transportation projects slowed and expected orders were delayed.

Sales in Europe and the Middle East. Sales in Europe and the Middle East (EMEA) were $22.0 million in the first nine months of 2012, accounting for 32% of total revenue and down 28% from $30.6 million for the same period of 2011. A primary reason for this decrease was the $6.2 million revenue gap caused by the absence of new orders for readers and software to support the German national ID program, which were a significant component of our sales in 2011. This contributed to a 57% decrease in sales in our European ID Solutions business in the first nine months of 2012. European sales of smart card readers also were 46% lower in the first nine months of 2012 compared with the prior year, reflecting weakness in the market for European government programs including national ID, electronic health and other programs. Additionally, European sales of transponder products were 27% lower in the first nine months of 2012 compared with the same period of the prior year due to softness in some of our markets. These factors were partially offset by approximately $5.1 million of incremental revenue from polyright and payment solution in the first nine months of 2012.

Sales in Asia/Pacific. Sales in the Asia/Pacific region were $10.1 million in the first nine months of 2012, accounting for 15% of total revenue and down 6% from $10.7 million the first nine months of 2011. The decrease was primarily due to a 36% decline in sales from our ID Solutions business in Australia, which experiences significant variability from period to period due to the timing of large program deployments for a small number of customers. Sales of transponder products also fell 18% in the first nine months of 2012 due to project delays from customers in the NFC mobile device and transportation sectors. These trends were partially offset by stronger sales of smart card reader products, including chipsets for PC applications and smart card readers to support telecommunications applications in China and Japan.

Looking forward, we believe demand will increase across our markets for products, systems and solutions that address emerging applications such as converged access control, NFC tag deployment and management, mobile payment schemes and ID programs for citizens, consumers and employees. The trends towards the convergence of cyber and physical access and the marriage of contactless payment technology with mobile devices are beginning to be realized and to drive new activity from governments, enterprises and consumer applications around the world. We believe that our unique portfolio of technology, products, solutions, systems and experience position Identive to address these emergent trends and benefit from their growth.

Seasonality and Other Factors. In our business overall, we may experience significant variations in demand for our products quarter to quarter, and overall we typically experience a stronger demand cycle in the second half of our fiscal year. Sales of our Hirsch Identive physical access control systems are subject to U.S. government budget cycles and are generally highest in the third quarter of each year. Sales of our smart card readers and chips for government programs are impacted by testing and compliance schedules of government bodies as well as roll-out schedules for application deployments, both of which contribute to variability in demand from quarter to quarter. Further, sales of these products typically are subject to seasonality based on governmental budget cycles, with lowest sales in the first half, and in particular the second quarter of the year, and highest sales in the second half of each year. In our ID Solutions division, a variety of localized market factors including government budget cycles and retail demand cycles typically result in stronger demand in the second half of the year. This pattern is also true for our payment solutions business as sales activity in the German sports market is strongest in the second half of the year. In general, sales of our global transponder products also are typically marginally stronger in the second half of the year.

 

31


Table of Contents

Operating Expense Trends

We have made and continue to make significant investments in the development of products and solutions to position the Company to benefit from the expected growth of the emerging markets for NFC, payment and cloud-based identity management, as further described below. As these markets do not yet offer significant revenue opportunities, our sales in these areas currently are relatively small and not yet able to compensate for the level of investment required to participate in these markets. In recent periods this has contributed significantly to our operational losses.

Our base operating expenses (research and development, sales and marketing, and general and administrative) increased 3% in the first nine months of 2012 compared with the same period of 2011. This increase was primarily due to a $3.5 million, or 9% increase in costs from idOnDemand, polyright and payment solution, partially offset by expense reductions taken under our 2012 restructuring plan as described below, and upon the completion of various development projects. Over the past several quarters, we have increased our investment in new solutions offerings and to develop our sales and marketing capabilities to address emerging opportunities within the secure identification market that we believe hold significant long-term potential for Identive. We have also reduced our spending on general and administrative expenses as part of an ongoing initiative to lower our operating costs.

In the area of research and development, we continue to make significant investments in technology and in specific solutions to address market opportunities with both new and existing customers. We have developed next-generation software, controllers and other products to reinforce and extend the customer base for our Hirsch Identive access control offering. To address the growing opportunities for NFC-enabled systems, we have developed a cloud-based NFC tag content management platform that provides business analytics for organizations seeking to create dynamic engagement with consumers and other groups, and we continue to invest in this platform. We also continue to invest in trusted identity solutions and capabilities for cloud-based credential issuance and management, and to enhance our cashless payment and ID software systems. On an ongoing basis, we invest in the development of new contactless readers, tokens and modules, new physical access readers to enable converged physical and logical/cyber access, and in the extension of our contactless platforms. In addition, we continue to invest in enhancing and broadening our RFID transponder inlay designs and technology in the areas of NFC, payment, tag on metal, card manufacturing and medical/pharmaceutical tracking applications. Across our business we have a significant number of new patent applications and new inventions in process. We attempt to balance our investments in new technologies, products and services with careful management of our development resources so that our increased development activities do not result in unexpected or significant changes in our overall spending on research and development.

2012 Restructuring Plan

While we remain committed to our strategy of investment in emerging markets, in June 2012, we announced a series of cost reduction measures designed to align our business operations with the current market and macroeconomic conditions. Cost reduction measures include an 11% reduction in the Company’s global workforce, acceleration of the elimination of duplicate expenses at newly acquired companies, reductions in other general and administrative expenses, the consolidation of facilities, and nearly $0.5 million of temporary reductions in executive and management salaries and Board fees. The remaining restructuring actions will be executed in the fourth quarter of 2012 and benefits are expected to accrue from 2013 onwards. These benefits will contribute to an annualized saving of $7.0 million.

Results of Operations

The comparability of our operating results in the nine months ended September 30, 2012 with the nine months ended September 30, 2011 is impacted by our acquisition of idOnDemand on May 2, 2011, polyright on July 18, 2011 and payment solution on January 30, 2012. Results of the idOnDemand, polyright and payment solution businesses have been included since their respective acquisition dates.

 

32


Table of Contents

Revenue

Beginning in the third quarter of 2012, we began to include the breakdown of our revenue by products and services. Summary information about our revenue by type and by business segment for the three and nine months ended September 30, 2012 and 2011 is shown below (in thousands):

 

     Three Months Ended
September 30,
    % change
period to
period
    Nine Months Ended
September 30,
    % change
period to
period
 
     2012     2011       2012     2011    

Products:

            

Revenues

   $ 18,663      $ 23,175        (19 %)    $ 55,053      $ 63,950        (14 %) 

% of total revenue

     81     87       81     86  

Gross profit

     7,902        10,097          22,537        25,771     

Gross profit %

     42     44       41     40  
  

 

 

   

 

 

     

 

 

   

 

 

   

Services:

            

Revenues

   $ 4,282      $ 3,577        20   $ 12,954      $ 10,834        20

% of total revenue

     19     13       19     14  

Gross profit

     1,818        1,733          5,521        5,653     

Gross profit %

     42     48       43     52  
  

 

 

   

 

 

     

 

 

   

 

 

   

Identity Management Segment:

            

Revenues

   $ 13,833      $ 15,148        (9 %)    $ 40,721      $ 42,248        (4 %) 

% of total revenue

     60     57       60     56  

Gross profit

     6,872        6,816          19,053        18,971     

Gross profit %

     50     45       47     45  
  

 

 

   

 

 

     

 

 

   

 

 

   

ID Products Segment:

            

Revenues

   $ 9,112      $ 11,604        (21 %)    $ 27,286      $ 32,536        (16 %) 

% of total revenue

     40     43       40     44  

Gross profit

     2,848        5,014          9,005        12,453     

Gross profit %

     31     43       33     38  
  

 

 

   

 

 

     

 

 

   

 

 

   

Total

            

Revenues

   $ 22,945      $ 26,752        (14 %)    $ 68,007      $ 74,784        (9 %) 

Gross profit

     9,720        11,830          28,058        31,424     

Gross profit %

     42     44       41     42  

Total revenue for the third quarter of 2012 was $22.9 million, down 14% compared with $26.8 million for the third quarter of 2011. For the first nine months of 2012, revenue was $68.0 million, down 9% compared with $74.8 million for the first nine months of 2011. Lower revenue in both the third quarter and first nine months of 2012 primarily was due to decreased product sales in both our ID Products and Identity Management segments. Incremental revenue from acquired businesses was approximately $1.1 million and accounted for 5% of total revenue in the third quarter, and was $5.4 million, accounting for 8% of total revenue in the first nine months of 2012. Excluding the impact of this incremental revenue, organic revenue was 19% lower in the third quarter and 16% lower in the first nine months of 2012 compared with the same periods of 2011.

Services revenue includes sales of payment-related services, professional consulting services and annual maintenance contracts. Services have comprised a higher proportion of our revenues in the third quarter and first nine months of 2012 compared with the same periods of the prior year, primarily as a result of the addition of new payment-related and maintenance services revenue from our acquisitions of polyright and payment solution.

 

33


Table of Contents

In our Identity Management segment we provide solutions and services that enable the secure management of credentials in diverse markets. Our Identity Management segment includes the operations of our Identity Management & Cloud Solutions division and our ID Solutions division, both of which specialize in the design and manufacturing of highly secure, integrated systems that can enhance security and better meet compliance and regulatory requirements while providing users the benefits and convenience of simple and secure solutions. The majority of sales in our Identity Management segment are made to customers in the government, education, enterprise and commercial markets and encompass vertical market segments including payment, healthcare, banking, industrial, retail and critical infrastructure. Because of the complex nature of the problems we address for our Identity Management customers, pricing pressure is not prevalent in this segment.

Revenue in our Identity Management segment was $13.8 million in the third quarter of 2012, down 9% from $15.1 million for the third quarter of 2011. For the first nine months of 2012, Identity Management revenue was $40.7 million, down 4% from $42.2 million in the first nine months of 2011. Results for the Identity Management segment included incremental revenue from idOnDemand, polyright and payment solution of $1.1 million in the third quarter and $5.4 in the first nine months of 2012. Excluding the impact of this incremental revenue, organic revenue was 16% lower in both the third quarter and first nine months of 2012 compared with the same periods of the prior year. The decrease in organic revenue primarily was due to the absence of new orders for secure IT kits for the German electronic ID program in our European ID Solutions business, which had accounted for $1.4 million of sales in the third quarter and $6.2 million of sales in the first nine months of 2011. Sales of Hirsch Identive access control systems remained stable in the third quarter and grew 6% in the first nine months of 2012 compared with the same periods of the prior year, despite continued budget and project delays from U.S. government customers.

In our ID Products segment we design and manufacture RFID products and components that are used for a number of identity-based and related applications in the government, enterprise, transportation and financial markets. Our ID Products segment includes sales of smart card and NFC readers and terminals, and RFID transponder products including RFID and NFC inlays, inlay-based cards, tags, labels and stickers. The majority of sales in our ID Products segment are made to original equipment manufacturers and system integrators, although an increasing proportion are sold directly to end customers. Sales in this segment are somewhat subject to pricing pressure, both for our transponder products and in the market for our smart card reader technology, which has been shifting away from external readers and towards lower-cost, embedded chip sets over the last several years.

Sales in our ID Products segment were $9.1 million in the third quarter of 2012, down 21% from sales of $11.6 million in the third quarter of 2011. For the first nine months of 2012, ID Products sales were $27.3 million, down 16% from $32.5 million for the first nine months of 2011. Both our smart card reader and transponder product sales were lower in the 2012 periods. Revenue from smart card readers was 16% lower in the third quarter and 11% lower in the first nine months of 2012 compared with the same periods of the prior year, as a result of decreased demand for smart card readers used in European government and citizen ID programs, partially offset by strong reader sales to the U.S. government sector. Transponder product sales fell 30% in the third quarter and 23% in the first nine months of 2012 compared with the same periods of the prior year, as a result of order delays with large mobile device and transportation customer projects. Some of these delayed projects began to move forward at the end of the third quarter.

Gross Profit

Gross profit for the third quarter of 2012 was $9.7 million, or 42% of revenue, compared with $11.8 million, or 44% of revenue in the third quarter of 2011. For the first nine months of 2012, gross profit was $28.1 million, or 41% of revenue, compared to $31.4 million, or 42% of revenue for the first nine months of 2011.

By segment, gross profit margin for our Identity Management segment was $6.9 million, or 50% of revenue in the third quarter of 2012, compared with $6.8 million, or 45% of revenue in the third quarter of 2011. For the first nine months of 2012, Identity Management gross profit margin was 47%, compared to 45% for the first nine months of 2011. Favorable product mix in our Identity Management segment in the third quarter and first nine months of 2012 resulted in improved gross product margin.

Gross profit margin for our ID Products segment was $2.8 million, or 31% of revenue for the third quarter of 2012, compared to $5.0 million, or 43% of revenue in the third quarter of 2011. For the first nine months of 2012, ID Products gross profit margin was 33%, compared to 38% for the first nine months of 2011. Gross profit margin in our ID Products segment in the third quarter and first nine months of 2012 primarily was affected by weaker sales of transponder products, which resulted in lower absorption of overhead costs in our manufacturing facilities.

 

34


Table of Contents

We expect there will be some variation in our gross profit from period to period, as our gross profit has been and will continue to be affected by a variety of factors, including, without limitation, competition, the volume of sales in any given quarter, manufacturing volumes, product configuration and mix, the availability of new products, product enhancements, software and services, risk of inventory write-downs and the cost and availability of components.

Research and Development Expenses

 

      Three months ended
September 30,
    % change
period  to

period
    Nine months ended
September 30,
    % change
period  to

period
 
(In thousands)    2012     2011       2012     2011    

Expenses

   $ 2,019      $ 2,286        (12 )%    $ 6,894      $ 4,823        43

Percentage of total revenues

     9     9       10     6  

Research and development expenses consist primarily of employee compensation and fees for the development of hardware, software and firmware products. We focus the bulk of our research and development activities on the continued development of existing products and the development of new offerings for emerging market opportunities. Due to the timing of their respective acquisitions, no results for the payment solution business are included in research and development expenses for the first nine months of 2011, only five months of results for 2011 (May—September) are included for idOnDemand, and only two months of results for 2011 (August—September) are included for polyright.

Research and development expenses in the third quarter of 2012 were $2.0 million, or 9% of revenue, compared with $2.3 million, or 9% of revenue in the third quarter of 2011, a decrease of 12% as a result of decreased spending on projects nearing completion and lower spending in line with our cost reduction plan. For the first nine months of 2012, research and development expenses were $6.9 million, representing 10% of revenue and up 43% from $4.8 million, or 6% of revenue for the first nine months of 2011. Research and development expenses included $1.1 million from idOnDemand, polyright and payment solution in the first nine months of 2012; however there were no incremental expenses from acquired companies in the third quarter of 2012. Excluding the impact of acquisitions, research and development expenses increased 21% in the first nine months of 2012 compared with the same period of 2011. Beginning in the third quarter of 2011, we significantly increased our investment in core technology and new products and solutions for emerging markets. Key investment areas include the development of credential issuance and management solutions offered as “Identity as a Service,” our cloud-based NFC tag content management platform, software enhancements in our ID Solutions offerings, and new contactless, NFC and RFID readers and transponder products.

In the next few quarters we expect similar reduced levels of investment in research and development as we benefit from the effect of our cost reduction initiatives. In the future, our research and development expenses will vary according to project demands and the markets we target.

Selling and Marketing Expenses

 

     Three months ended
September 30,
    % change
period to
    Nine months ended
September 30,
    % change
period to
 
(In thousands)    2012     2011     period     2012     2011     period  

Expenses

   $ 5,440      $ 6,198        (12 )%    $ 18,978      $ 17,432        9

Percentage of total revenues

     24     23       28     23  

Selling and marketing expenses consist primarily of employee compensation as well as tradeshow participation, advertising and other marketing and selling costs. We focus a significant proportion of our sales and marketing activities on new and emerging market opportunities. Due to the timing of their respective acquisitions, no results for the payment solution business are included in sales and marketing expenses for the first nine months of 2011, only five months of results for 2011 (May—September) are included for idOnDemand, and only two months of results for 2011 (August—September) are included for polyright.

Selling and marketing expenses in the third quarter of 2012 were $5.4 million, or 24% of revenue, compared with $6.2 million, or 23% of revenue in the third quarter of 2011, a decrease of 12%. For the first nine months of 2012, sales and marketing expenses were $19.0 million, representing 28% of revenue, an increase of 9% from $17.4 million, or 23% of revenue for the first nine months of 2011. Selling and marketing expenses included $0.1 million and $1.0 million from idOnDemand, polyright and payment solution in the third quarter and first nine months of 2012, respectively. Excluding the impact of these additional expenses, selling and marketing expenses were 15% lower in the third quarter of 2012 and 3% higher in the first nine months of 2012 compared with the same periods of 2011. Higher selling and marketing expenses in the first nine months of 2012 reflect investments in additional resources and programs to address existing and new market opportunities, including new sales teams focused on NFC solutions and converged access products, for which we expect future sales, but minimal revenues during 2012. Lower expenses in the third quarter of 2012 reflect initial results from the cost reduction program implemented in June 2012.

 

35


Table of Contents

We expect modest reductions in our investment in selling and marketing as a percentage of sales in the next quarter.

General and Administrative Expenses

 

     Three months ended
September 30,
   

% change
period to

period

    Nine months ended
September 30,
   

% change
period to

period

 
(In thousands)    2012     2011       2012     2011    

Expenses

   $ 4,603      $ 5,984        (23 )%    $ 14,537      $ 16,958        (14 )% 

Percentage of total revenues

     20     22       21     23  

General and administrative expenses consist primarily of compensation expenses for employees performing administrative functions, and professional fees arising from legal, auditing and other consulting services. Due to the timing of their respective acquisitions, no results for the payment solution business are included in general and administrative expenses for the first nine months of 2011, only five months of results for 2011 (May—September) are included for idOnDemand, and only two months of results for 2011 (August—September) are included for polyright.

In the third quarter of 2012, general and administrative expenses were $4.6 million, or 20% of revenue, compared with $6.0 million, or 22% of revenue in the third quarter of 2011, a decrease of 23%. For the first nine months of 2012, general and administrative expenses were $14.5 million, representing 21% of revenue and down 14% from $17.0 million, or 23% of revenue for the first nine months of 2011. General and administrative expenses included $0.1 million and $1.4 million from idOnDemand, polyright and payment solution in the third quarter and first nine months of 2012, respectively. Also reflected in general and administrative expenses in the first nine months of 2012 were approximately $0.2 million of transaction expenses related to the acquisition of the remaining shares of idOnDemand and acquisition of payment solution. Excluding the impact of these additional expenses and including credits of approximately $1.0 million to reverse incentive bonus accruals in the second quarter of 2012, general and administrative expenses were 25% lower in the third quarter and 18% lower in the first nine months of 2012 compared with the same periods of 2011 as a result of ongoing efforts to reduce general and administrative expenses which were accelerated with our cost reduction program put in place in the second quarter of 2012.

With reduced incentive accruals and the benefits of accelerated restructuring programs, we expect modest decreases in general and administrative expenses in absolute dollars and as a percentage of overall revenue during the remainder of 2012.

 

36


Table of Contents

Impairment Charges

During the second quarter of 2012, as a result of a significant decline in our stock price and changes to our future forecasted revenue, gross margin and operating profit, we undertook interim goodwill impairment analyses in connection with our quarterly close as of June 30, 2012. Due to the length of time necessary to measure impairment of goodwill, our analysis was not completed as of the time of the filing of our second quarter Form 10-Q and we reported a preliminary impairment charge of $21.4 million in the second quarter ended June 30, 2012, The goodwill impairment analysis was subsequently completed during the 2012 third quarter and resulted in an additional goodwill impairment charge of approximately $5.0 million being recorded during the three months ended September 30, 2012, for a total goodwill impairment charge of $26.4 million during the nine months ended September 30, 2012.

In conjunction with our goodwill impairment test, we also tested our long-lived assets for impairment and adjusted the carrying value of each asset group to its fair value and recorded the associated impairment charge of $24.8 million in our condensed consolidated statements of operations, of which $23.9 million was recorded in the second quarter and $0.9 million was recorded in the third quarter of 2012. Please see Note 9, Goodwill and Intangible Assets, for more detailed information.

Restructuring Charges

Restructuring charges of $0.3 million in the first nine months of 2012 relate to the realignment of certain business operations under our 2012 restructuring plan, implemented in June 2012.

Remeasurement of Contingent Consideration

For the first nine months of 2012, a credit of $5.7 million was recorded for reductions to the amount of performance-based earn-outs payable related to the polyright and idOnDemand acquisitions, following the remeasurement of this contingent consideration as of June 30, 2012. Please see Note 4, Fair value Measurements, for more detailed information.

Other Income (Expense)

Other income (expense) of $23,000 recorded in the third quarter of 2012 related to insurance reimbursement on lost shipments for a subsidiary, and other expense of $(0.2) million recorded in the first nine months of 2012 related to the loss recognized on the sale of a subsidiary. Other income of $25,000 recorded in the 2011 third quarter and $0.3 million recorded in the first nine months of 2011 related to a dividend distribution made by SCM PC-Card GmbH in which we had made an investment in 1998, which was written off in prior periods. The dividend distribution was made as a result of the entity’s plan to close its operations.

Interest Expense, Net

Interest expense, net of $0.4 million and $1.0 million in the third quarter and first nine months of 2012, respectively, and interest expense, net of $0.2 million and $0.8 million in the third quarter and first nine months of 2011, respectively, consists of interest accretion expense for a liability to a related party in the Hirsch business and interest paid on financial liabilities, offset by interest earned on invested cash during the respective periods.

Foreign Currency Losses, Net

Foreign currency losses were $29,000 and $0.1 million in the third quarter and first nine months of 2012, respectively. Foreign currency losses were $0.6 and $0.4 million in third quarter and first nine months of 2011, respectively. Changes in currency valuation in the periods presented mainly were the result of exchange rate movements between the U.S. dollar and the Euro, Swiss Franc, and the British pound and their impact on the valuation of intercompany transaction balances. Accordingly, they are predominantly non-cash items.

 

37


Table of Contents

Income Taxes

We recorded a provision for income taxes of $15,000 and $0.1 million for the three and nine months ended September 30, 2012, respectively, reflecting an effective tax rate of 33% for the nine months ended September 30, 2012. In addition, during the third quarter and first nine months of 2011, we recorded a net provision for income taxes of $0.1 million and a net benefit for income taxes of $1.6 million respectively, which resulted primarily from accounting treatment following the acquisition of idOnDemand. In connection with the acquisition of idOnDemand, we recorded deferred tax liabilities of $1.5 million, which were netted against the Company’s existing deferred tax assets. As a result the Company released valuation allowance of $1.5 million in the second quarter of 2011. This tax benefit was offset by estimated tax expense of $0.2 million on deemed income upon an intra-group sale of one of the Company’s subsidiaries, as the sales price was less than the fair market value of the subsidiary.

The effective tax rates for the nine-month periods ended September 30, 2012 and September 30, 2011, differ from the federal statutory rate of 34% primarily due to the benefit of earnings in foreign jurisdictions, which are subject to lower tax rates, and the ratio of taxable earnings in foreign jurisdictions to taxable earnings in the U.S.

Liquidity and Capital Resources

As of September 30, 2012, our working capital, which we have defined as current assets less current liabilities, was approximately ($2.2) million, compared to approximately $16.7 million as of December 31, 2011, a decrease of approximately $18.9 million. The decrease in working capital for the nine months ended September 30, 2012 reflects a $10.9 million decrease in cash and cash equivalents, a $0.2 million net decrease in accounts receivable, a $3.4 million increase in accounts payable, a $5.6 million additional liability for unclaimed consumer cards from the acquired payment solution business, a $1.0 million increase in deferred revenue, an aggregate $1.6 million increase in liability to related party and financial liabilities, and an aggregate $1.8 million increase in accrued compensation and other accrued expenses and liabilities, offset by a $2.0 million increase in restricted cash, a $1.6 million increase in inventories and $2.0 million increase in prepaids and other current assets.

Cash and cash equivalents were $6.3 million as of September 30, 2012, a decrease of approximately $10.9 million compared to $17.2 million as of December 31, 2011, mainly as a result of cash of $6.9 million used in operations, a cash payment of approximately $0.5 million for the acquisition of the remaining outstanding shares of idOnDemand, approximately $1.7 million used for capital expenditures, $1.3 million cash payments on financial liabilities, $1.3 million restricted cash related to a factoring arrangement, and $0.7 million restricted cash deposited for capital expenditure, offset by an acquired cash balance of $0.6 million from the acquisition of payment solution, a $0.1 million change in bank line of credit, $0.3 million cash proceeds from the issuance of common stock under our employee stock purchase plan and an exchange rate effect of $0.5 million on cash and cash equivalents. The following summarizes our cash flows for the nine months ended September 30, 2012 and 2011 (in thousands):

 

     Nine Months Ended  
     September 30,  
     2012     2011  

Cash used in operating activities from continuing operations

   $ (6,911   $ (5,529

Cash used in investing activities

     (2,333     (6,051

Cash (used in) provided by financing activities

     (2,207     17,881   

Effect of exchange rate changes on cash and cash equivalents

     503        620   
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     (10,948     6,921   

Cash and cash equivalents at beginning of period

     17,239        10,799   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 6,291      $ 17,720   
  

 

 

   

 

 

 

Significant commitments that will require the use of cash in operating activities in future periods include obligations under operating leases, liability to related party, inventory purchase commitments and other contractual agreements and financial liabilities, including bank loan, debt note, mortgage bank loan and equipment financing liabilities. At September 30, 2012, gross committed lease obligations were approximately $4.1 million, equipment financing liabilities and bank loan were approximately $4.3 million, the mortgage bank loan was approximately $0.8 million, the debt note was approximately $0.6 million, liability to related party was approximately $8.6 million and inventory purchase commitments and other purchase commitments were approximately $12.7 million. Total commitments due for the remainder of fiscal 2012 were approximately $13.1 million and commitments due thereafter were approximately $18.0 million at September 30, 2012.

The cash used in investing activities primarily reflects cash payment of approximately $0.5 million for the acquisition of the non-controlling interest in idOnDemand, approximately $1.7 million spent for capital expenditures, and $0.7 million restricted cash deposited for capital expenditure, offset by $0.6 million cash acquired from the acquisition of payment solution.

Cash used in financing activities primarily reflects $1.3 million paid for financial liabilities, which consist of equipment financing liabilities, bank loan, and debt note, and $1.3 million restricted cash related to a factoring arrangement, offset by $0.3 million cash proceeds from issuance of common stock under employee stock purchase plan and $0.1 million net change in bank line of credit.

 

38


Table of Contents

We have historically incurred operating losses and negative cash flows from operating activities. As of September 30, 2012, we have total accumulated deficit of approximately $291 million. During the nine months ended September 30, 2012 and 2011, we sustained consolidated net losses of $59.5 million and $7.4 million, respectively. Our working capital reduced significantly as of September 30, 2012 compared with December 31, 2011. We expect to use a significant amount of cash in our operations over the next twelve months for our operating activities and servicing of financial liabilities, including investment in new technologies in anticipation of future significant revenues following wider adoption of these products and services. These investments are in the area of research and development and sales and marketing for solutions based on NFC, cloud-based identity management (“Identity as a Service”) and our SmartCore card manufacturing technology. Our current plan anticipates increased revenues and improved profit margins for the twelve-month period, which we expect will reduce the levels of cash required for our operating activities as compared to historical levels. In addition, we are in the process of improving our working capital, including reduction in the levels of accounts receivable and discussion with several key suppliers to further reduce the levels of inventory and improve payment terms. On October 30, 2012, the Company signed an agreement for a term loan in aggregate principal amount of up to $10.0 million and received an initial advance in the aggregate principal amount of $7.5 million. Based on our current projections and estimates, we believe our current capital resources, including existing cash, cash equivalents, anticipated cash flows from operating activities, savings from our continued cost reduction activities, and available borrowings, should be sufficient to meet our operating and capital requirements through at least the next twelve months.

Our plans may be adversely impacted if we fail to realize our assumed levels of revenues and expenses or savings from our cost reduction activities, or fail to meet required financial covenants under our loan agreement. If these events occur, we may need to delay, reduce the scope of, or eliminate one or more of our development programs or obtain funds through collaborative arrangements with others that may require us to relinquish rights to certain of our technologies, or programs that we would otherwise seek to develop or commercialize ourselves, and to reduce personnel related costs. We may resort to contingency plans to make these needed cost reductions upon determination that funds will not be available in a timely matter. These contingency plans include consolidating certain functions, including integration of newly acquired entities into the group and elimination of duplicate general and administration expenses by expanding the scope of shared services in the Americas and European regions. We may also need to raise additional funds through additional debt or equity financings. The sale of additional debt or equity securities may cause dilution to existing stockholders. There can be no assurance that we will be able to raise such funds if and when they are required. Failure to obtain future funding when needed or on acceptable terms would adversely affect our ability to fund operations.

Contractual Obligations

The following summarizes expected cash requirements for contractual obligations as of September 30, 2012 (in thousands):

 

     Total      Less than 1
Year
     1-3 Years      3-5 Years      More Than
5 Years
 

Operating leases

   $ 4,058       $ 2,356       $ 1,453       $ 249       $ —     

Equipment financing liabilities

     2,590         754         1,836         —           —     

Bank loan

     1,758         419         670         669      

Liability to related party

     8,554         1,557         2,405         2,651         1,941   

Debt note

     626         626         —           —           —     

Mortgage loan payable to bank

     779         55         110         110         504   

Purchase commitments and other obligations

   $ 12,706         12,356         325         25         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations

   $ 31,071       $ 18,123       $ 6,799       $ 3,704       $ 2,445   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company excluded of $0.9 million as it relates to uncertain tax positions from contractual obligations table because we are unable to make reasonable estimates of the period of cash settlement with the respective taxing authority. See Note 16 of Notes to condensed consolidated financial statements for more information about the contractual obligations listed in the table above.

 

39


Table of Contents

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires management to establish accounting policies that contain estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These policies relate to revenue recognition, inventory, income taxes, goodwill, long-lived assets and stock-based compensation.

We have other important accounting policies and practices; however, once adopted, these other policies either generally do not require us to make significant estimates or assumptions or otherwise only require implementation of the adopted policy and not a judgment as to the policy itself. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Despite our intention to establish accurate estimates and assumptions, actual results may differ from these estimates under different assumptions or conditions.

During the nine months ended September 30, 2012, management believes there have been no significant changes to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011, except that our revenue recognition policy was updated to include additional information concerning our revenue recognition policy with regard to multi-functional customer cards based on RFID contactless chips. Below is our current revenue recognition policy as updated to include this information:

Revenue Recognition — Revenue is recognized when all of the following criteria have been met:

 

   

Persuasive evidence of an arrangement exists. We generally rely upon sales contracts or agreements, and customer purchase orders to determine the existence of an arrangement.

 

   

Delivery has occurred. We use shipping terms and related documents, or written evidence of customer acceptance, when applicable, to verify delivery or performance.

 

   

Sales price is fixed or determinable. We assess whether the sales price is fixed or determinable based on the payment terms and whether the sales price is subject to refund or adjustment.

 

   

Collectability is reasonably assured. We assess collectability based on creditworthiness of customers as determined by credit checks and customer payment histories. We record accounts receivable net of allowance for doubtful accounts, estimated customer returns, and pricing credits.

In 2011, we adopted the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13, Revenue Recognition (Topic 605)Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). ASU 2009-13 changes the requirements for establishing separate units of accounting in a multiple element arrangement and eliminates the residual method of allocation and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of the deliverable’s estimated fair value. Concurrently with issuing ASU 2009-13, the FASB also issued ASU No. 2009-14, Software (Topic 985)Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”) which amends the scope of software revenue guidance in Accounting Standards Codification (“ASC”) Subtopic 985-605, Software-Revenue Recognition (“ASC 985-605”), to exclude tangible products containing software and non-software components that function together to deliver the product’s essential functionality. ASU 2009-14 provides that tangible products containing software components and non-software components, which function together to deliver the tangible product’s essential functionality, are no longer within the scope of the software revenue guidance in ASC 985-605 and should follow the guidance in ASU 2009-13 for multiple-element arrangements. All non-essential and standalone software components will continue to be accounted for under the guidance of ASC 985-605.

ASU 2009-13 and ASU 2009-14 are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We prospectively adopted the provisions of ASU 2009-13 and ASU 2009-14 effective January 1, 2011. Our revenue is derived primarily from sales of hardware products and services, and to a lesser extent, from the license of proprietary software products and software components in revenue arrangements that are considered standalone. As a result, ASU 2009-14 did not have any impact and revenues from such software products will continue to be recognized under the guidance of ASC 985-605. We cannot reasonably estimate the effect of adopting these standards on future financial periods as the impact will vary depending on the nature and volume of new or materially modified deals in any given period.

 

40


Table of Contents

ASU 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable in revenue arrangements. The revenue is generated from sales to direct end-users and to distributors. When a sales arrangement contains multiple elements and software and non-software components function together to deliver the tangible products' essential functionality, we allocate revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor-specific objective evidence (“VSOE”) if available, third-party evidence (“TPE”) if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available. We then recognize revenue on each deliverable in accordance with our policies for product and service revenue recognition. VSOE of selling price is based on the price charged when the element is sold separately. TPE of selling price is established by evaluating largely interchangeable competitor products or services in stand-alone sales to similarly situated customers. The best estimate of selling price is established considering multiple factors, including, but not limited to, pricing practices in different geographies and through different sales channels, gross margin objectives, internal costs, competitor pricing strategies and industry technology lifecycles. Some of our products contain a significant element of proprietary technology and our solutions offer substantially different features and functionality; as a result, the comparable pricing of products with similar functionality typically cannot be obtained. Additionally, as we are unable to reliably determine what competitors products’ selling prices are on a stand-alone basis, we are not typically able to determine TPE for such products. Therefore ESP is used for such products in the selling price hierarchy for allocating the total arrangement consideration.

We evaluate each deliverable in an arrangement to determine whether they represent separate units of accounting in accordance with the provisions of ASU 2009-13. Certain sales arrangements of our hardware products are bundled with our professional services and maintenance contracts, and in some cases with our software products. Professional services include security system integration, system migration, database conversion services and other services. In such multiple element arrangements, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. Allocation of the consideration is determined at arrangement inception on the basis of each unit’s relative selling price. We account for software sales in accordance with ASC 985-605 and hardware sales in accordance with ASU 2009-13, when all the revenue recognition criteria noted above have been met. The revenue from professional services contracts is recognized upon completion of such services and upon acceptance from the customer, if applicable. The revenue from maintenance contracts is deferred and amortized ratably over the period of the maintenance contracts. Certain sales arrangement contains hardware, software and professional service elements where professional services are essential to the functionality of the hardware and software system and a test of the functionality of the complete system is required before the customer accepts the system. As a result, hardware, software and professional service elements are accounted for as one unit of accounting and revenue from these arrangements is recognized upon completion of the project.

In certain revenue arrangements, we facilitate cashless payments by providing integrated payment system for sports stadiums, arenas, theme parks and other venues for leisure and entertainment (“recreational facilities”) throughout Europe. For these facilities, we provide multi-functional customer cards based on RFID contactless chip technology (“smart cards” or “cards”) and comprehensive management software as a part of an integrated cashless payment system (the “system”) that ensures the seamless interaction of all relevant components such as ticketing, access, point-of-sale, parking, etc. The system consists of comprehensive payment management software, smart cards, readers and communication infrastructure, all supplied and implemented by us. Our system enables consumers at sporting and similar events to make quick, cashless payments for food, beverages and merchandise. We offer our customers the option of purchasing of a turnkey solution or entering into a multi-year contract under which we continue to operate and maintain responsibility for the cashless payment system over a set period, in return for sharing in the revenue generated at various events held in the stadiums or other venues. We also provide cards which are used by the end consumers to buy food, beverages and merchandise during their visits to recreational facilities. Consumers pay a deposit fee on the cards and then may load money onto the cards to enable purchases. There may be an unredeemed balance on the cards at any given time. Revenues from unredeemed balance on cards are recognized when the likelihood of the card being redeemed by the customer is remote ("card breakage income"). Although there are expiration dates on the cards, our practice has been to honor all cards presented for payment or redemption. We do not charge any service fees that cause a decrement to card balances. While we expect to continue to honor all cards presented for payment, management may determine the likelihood of redemption to be remote for certain cards due to, among other things, long periods of inactivity. We determine our card breakage rate based upon historical redemption patterns. Based on our historical information, we make a determination of the likelihood of a card remaining unredeemed 12 months after the card is issued. At that time, we recognize breakage income for those cards for which the likelihood of redemption is deemed remote. Card breakage income is included in revenue in our condensed consolidated statements of operations.

Recent Accounting Pronouncements

See Note 2, Summary of Significant Accounting Policies, in the Notes to condensed consolidated financial statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full description of recent accounting pronouncements, including the actual and expected dates of adoption and estimated effects on our consolidated results of operations and financial condition, which is incorporated herein by reference.

 

41


Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no significant change in our exposure to market risk during the nine months ended September 30, 2012. For discussion of the Company’s exposure to market risk, refer to Item 7A, Quantitative and Qualitative Disclosures About Market Risk, contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Attached as exhibits to this report are certifications of our principal executive officer and principal financial officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and related evaluations referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

As of the end of the nine months ended September 30, 2012, we carried out an evaluation, as required in Rule 13a-15(b) under the Exchange Act, under the supervision and with the participation of members of our senior management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act.

Based on that evaluation, our principal executive officer and principal financial officer concluded that, due to the material weaknesses in our control over financial reporting disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011, our internal disclosure controls and procedures were not effective as of the end of the period covered by this report.

Based on additional analysis and other post-closing procedures designed to ensure that our consolidated financial statements will be presented in accordance with generally accepted accounting principles, management believes, notwithstanding the material weaknesses, that the consolidated financial statements included in this report fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the U.S. (GAAP).

Remediation of Material Weaknesses

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011, our management identified material weaknesses in our internal control over financial reporting as of December 31, 2011, namely that we had an insufficient number of accounting personnel with appropriate knowledge, experience or training in U.S. GAAP to provide effective oversight and review of transactions and the preparation of financial statements, particularly at the subsidiary level, and that the design of controls related to revenue recognition was inadequate.

Management developed and began implementing a remediation plan to address these material weaknesses, and remediation efforts have included the following:

 

   

Revising and distributing to all accounting personnel specific guidance on revenue recognition policies, including cut-off controls;

 

   

Appointing a U.S. GAAP Committee to prepare and implement U.S. GAAP training for all accounting personnel, including training specifically relating to revenue recognition;

 

   

Hiring additional accounting personnel at the corporate level and subsidiary levels with experience in U.S. GAAP accounting; and

 

   

Reviewing and revising, as appropriate, the Company’s internal Sarbanes-Oxley testing program and schedule.

Management has developed a timetable for the implementation of the foregoing remediation efforts and will monitor the implementation. While substantial progress has been made in implementing the remediation plan, management has not yet completed and tested all of the corrective processes and procedures identified in its remediation plan. In addition, under the direction of the Audit Committee, management will continue to review and make necessary changes to the overall design of the Company’s internal control environment, as well as to policies and procedures to improve the overall effectiveness of internal control over financial reporting. Management believes the foregoing efforts will effectively remediate the material weaknesses. However, the material weaknesses will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively, which we expect to occur in the current fiscal year.

 

42


Table of Contents

Changes in Internal Controls over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We note that management continued its remediation efforts during the third quarter of 2012 related to the above-described material weaknesses.

A control system, no matter how well designed and operated, can only provide reasonable assurances that the objectives of the control system are met. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been or will be detected.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we could be subject to claims arising in the ordinary course of business or be a defendant in lawsuits. While the outcome of such claims or other proceedings cannot be predicted with certainty, our management expects that any such liabilities, to the extent not provided for by insurance or otherwise, will not have a material effect on our financial condition, results of operations or cash flows.

Item 1A. Risk Factors

Our business and results of operations are subject to numerous risks, uncertainties and other factors that you should be aware of, some of which are described below. The risks, uncertainties and other factors described in these risk factors are not the only ones facing our company. Additional risks, uncertainties and other factors not presently known to us or that we currently deem immaterial may also impair our business operations. Any of the risks, uncertainties and other factors could have a materially adverse effect on our business, financial condition, results of operations, cash flows or product market share and could cause the trading price of our common stock to decline substantially.

Business and Strategic Risks

Continuing weakness in global economic markets may adversely impact customers and customer spending patterns.

In recent times global economies have been impacted by disruptive financial events, economic uncertainty and most recently concerns about the possible breakup of the Euro Zone. Continuing weakness or uncertainty in global economic markets may cause consumers, businesses and governments to defer purchases in response to tighter credit, decreased cash availability and low consumer confidence. Accordingly, demand for our products could fail to grow or could decrease and differ materially from our current expectations. In addition, some of our customers may require substantial financing in order to fund their operations and make purchases from us. The inability of these customers to obtain sufficient credit to finance purchases of our products and meet their payment obligations to us, or possible insolvencies of our customers, could result in decreased customer demand, an impaired ability for us to collect on outstanding accounts receivable, significant delays in accounts receivable payments, and significant write-offs of accounts receivable, each of which could adversely impact our financial results.

We are exposed to credit risk on our accounts receivables.

We are exposed to credit risk in our accounts receivable, and this risk is heightened in times of economic weakness. We distribute our products both through third-party resellers and directly to certain customers and a majority of our outstanding trade receivables are not covered by collateral or credit insurance. We may not be able to monitor and limit our exposure to credit risk on our trade and non-trade receivables, and we may not be effective in limiting credit risk and avoiding losses.

Continuing weakness in global markets may adversely impact our suppliers.

Our ability to meet customers’ demands depends, in part, on our ability to obtain timely and adequate delivery of quality materials, parts and components or products from our suppliers. Certain of our components are available only from a single source or limited sources. If certain key suppliers were to become capacity constrained or insolvent for any reason, including a weak economic environment, it could result in a reduction or interruption in supplies or a significant increase in the price of supplies, each of which would adversely impact our financial results. In addition, credit constraints at key suppliers could result in accelerated payment of accounts payable by us, impacting our cash flow.

 

43


Table of Contents

Our markets are highly competitive and technology is rapidly evolving.

The markets for our products are competitive and characterized by rapidly changing technology. Additionally, the demand for higher security environments, including rapid certification of identity authentication, has led to new standards, driving the need for new technology solutions. We believe that the principal competitive factors affecting the markets for our products and solutions include:

 

   

the extent to which products and systems must support evolving industry standards and provide interoperability;

 

   

the extent to which standards are widely adopted and product and system interoperability is required within industry segments;

 

   

the extent to which products are differentiated based on technical features, quality and reliability, ease of use, strength of distribution channels and price;

 

   

the ability of suppliers to quickly develop new products and integrated solutions to satisfy new market and customer requirements;

 

   

the total cost of ownership including installation, maintenance and expansion capability of systems; and

 

   

the ability to commercialize custom solutions for common customer requests.

We currently experience competition from a number of companies in each of our target market segments and we believe that competition in our markets is likely to intensify as a result of anticipated increased demand for secure identification products, systems and solutions. We may not be successful in competing against offerings from other companies and could lose business as a result.

We also experience indirect competition from certain of our customers who currently offer alternative products or solutions or are expected to introduce competitive offerings in the future. For example, in our ID Infrastructure business, we sell our various reader products to OEMs who incorporate our products into their offerings or who resell our products in order to provide a more complete solution to their customers. If our OEM customers develop their own products to replace ours, this would result in a loss of sales to those customers, as well as increased competition for our products in the marketplace. In addition, these OEM customers could cancel outstanding orders for our products, which could cause us to write down inventory already designated for those customers. In our Hirsch Identive business, many of our dealer channel partners act as system integrators, providing installation and service, and therefore carry competitive lines of products and systems. This is a common practice within the industry as the integrators need access to multiple lines in order to support all potential service and user requirements. Depending on the technical competence of their sales forces, comfort level of their technical staff with our systems and price pressure from customers, these integrators may choose to offer a competitive system. There is also business pressure to provide some level of sales to all vendors to maintain access to a range of products and systems.

We may, in the future, face competition from these and other parties that develop secure identification products based upon approaches similar to or different from those employed by us. In addition, the market for secure identification products and solutions may ultimately be dominated by approaches other than the approaches marketed by us.

Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing and other resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or standards and to changes in customer requirements. Our competitors may also be able to devote greater resources to the development, promotion and sale of products or solutions and may be able to deliver competitive products or solutions at a lower end user price. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products or solutions to address the needs of our prospective customers. Therefore, new competitors, or alliances among competitors, may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share.

 

44


Table of Contents

Our future success will depend on our ability to keep pace with technological change and meet the needs of our target markets and customers. If we are unable to introduce new products and solutions, we may experience a decrease in sales or lose customers.

As noted above, the markets for our products are characterized by rapidly changing technology and the need to meet market requirements and to differentiate our products and solutions through technological enhancements, and in some cases, price. Our customers’ needs change, new technologies are introduced into the market, and industry standards continue to evolve. As a result, product life cycles are often short and difficult to predict, and frequently we must develop new products quickly in order to remain competitive in light of new market requirements. Rapid changes in technology, or the adoption of new industry standards, could render our existing products obsolete and unmarketable. Changes in market requirements could render our existing solutions obsolete or could require us to expend more on research and development efforts.

Our future success will depend upon our ability to enhance our current products and solutions and to develop and introduce new offerings with clearly differentiated benefits that address the increasingly sophisticated needs of our customers and that keep pace with technological developments, new competitive product offerings and emerging industry standards. In addition, in cases where we are selected to supply products or solutions based on features or capabilities that are still under development, we must be able to complete our design, delivery and implementation process on a timely basis, or risk losing current and any future revenue from those offerings. In developing our offerings, we must collaborate closely with our customers, suppliers and other strategic partners to ensure that critical development, marketing and distribution projects proceed in a coordinated manner. Also, this collaboration is important because these relationships increase our exposure to information necessary to anticipate trends and plan product development. If any of our current relationships terminate or otherwise deteriorate, or if we are unable to enter into future alliances that provide us with comparable insight into market trends, our product development and marketing efforts may be adversely affected, and we could lose sales. We expect that our product development efforts will continue to require substantial investments and we may not have sufficient resources to make the necessary investments.

In some cases, we depend upon partners who provide one or more components of the overall solution for a customer in conjunction with our products. If our partners do not adapt their products and technologies to new market or distribution requirements, or if their products do not work well, then we may not be able to sell our products into certain markets.

Because we operate in markets for which industry-wide standards have not yet been fully set, it is possible that any standards eventually adopted could prove disadvantageous to or incompatible with our business model and product lines. If any of the standards supported by us do not achieve or sustain market acceptance, our business and operating results would be materially and adversely affected.

Our ability to remain competitive by quickly developing new products and technologies depends on continued investment in research and development and on our ability to generate adequate capital resources to fund such development activities. If we reduce this investment, our future financial performance could be adversely affected.

In order to remain competitive and rapidly adapt to changing conditions in our industry and position ourselves for new market opportunities, we make ongoing investments in research and development. As noted in the “Liquidity and Capital Resources” section of Part I, Item 2 of this Quarterly Report on Form 10-Q, to address liquidity issues currently facing our business we may be required to curtail investments these investments in the short term. If we are required to reduce our investment in research and development, we may be unable to compete effectively with newer products and technologies, and our financial results could be adversely affected.

Sales of our products depend on the widespread adoption of our products and on diversifying and expanding our customer base in new markets and geographic regions.

We sell our products, systems and services primarily to address emerging applications that have not yet reached a stage of mass adoption or deployment. For example, in our Multicard business, our solutions are used in various identity-based programs, such as cashless payment, “smart city” offerings and, national and regional IDs, which are applications that are not yet widely implemented. We are also focused on sales of products and solutions for the emerging near field communication (NFC) market, which is expected to grow as a result of the availability of NFC-enabled mobile phones. As NFC phones are not yet widely deployed, this market for our products is also still in an early stage. Additionally, we are investing in “cloud-based” solutions, also known as Software as a Service (“SaaS”), which are also in an early phase of adoption.

 

45


Table of Contents

Because the markets for our products and solutions are still emerging, demand for our offerings is subject to variability from period to period. There is no assurance that demand will become more predictable as additional identity-based programs, NFC applications or SaaS solutions demonstrate success. If demand for our products and solutions does not develop further and grow sufficiently, our revenue and gross profit margins could decline or fail to grow. We cannot predict the future growth rate, if any, or size or composition of the market for any of our offerings. Our target markets have not consistently grown or developed as quickly as we have expected, and we have experienced delays in the development of new products designed to take advantage of new market opportunities. Since new target markets are still evolving, it is difficult to assess the competitive environment or the size of the market that may develop. The demand and market acceptance for our offerings, as is common for new technologies, is subject to high levels of uncertainty and risk and may be influenced by various factors, including, but not limited to, the following:

 

   

our ability to demonstrate to our potential customers and partners the value and benefits of new products;

 

   

the ability of our competitors to develop and market competitive solutions for emerging applications in our target markets and our ability to win business in advance of and against such competition;

 

   

the adoption and/or continuation of industry or government regulations or policies requiring the use of products or solutions such as our smart card readers or access control solutions;

 

   

the timing of large scale security programs involving smart cards, RFID and related technology by governments, banks and enterprises;

 

   

the ability of financial institutions, corporate enterprises, the U.S. government and other governments to agree on industry specifications and to develop and deploy security applications that will drive demand for products and solutions such as ours;

 

   

the widespread availability of certain technologies, such as NFC-enabled mobile phones, required to spur demand for our products, such as our NFC tags and readers; and

 

   

general economic conditions, for example economic uncertainty.

Acquisitions and strategic investments expose us to significant risks.

A component of our ongoing business strategy is to seek to buy businesses, products and technologies that complement or augment our existing businesses, products and technologies. Acquiring and integrating acquired businesses into our business exposes us to certain risks. The combination of companies is a complex, costly and time-consuming process. As a result, we must devote significant management attention and resources to finalizing transaction terms and to integrating the diverse business practices and operations of the acquired companies. These processes may divert the attention of our executive officers and management from day-to-day operations and disrupt our business and, if implemented ineffectively, preclude realization of the full benefits expected from the transactions. Failure to meet the challenges involved in successfully integrating another company’s operations with ours or otherwise to realize any of the anticipated benefits of an acquisition could cause an interruption of, or a loss of momentum in, the activities of our combined company and could adversely affect our results of operations. In addition, the integration of acquired companies may result in unanticipated problems, expenses, liabilities, competitive responses and loss of customer relationships, may cause dilution of shareholder value, and may cause our stock price to decline.

Any future acquisition could expose us to additional significant risks, including, without limitation:

 

   

the use of our limited cash balance or potentially dilutive stock offerings to fund such acquisitions;

 

   

costs of any necessary financing, which may not be available on reasonable terms or at all;

 

   

accounting charges we might incur in connection with such acquisitions, including the future write-down or write-off of goodwill or intangible assets;

 

   

the difficulty and expense of integrating personnel, technologies, customer, supplier and distributor relationships, marketing efforts and facilities acquired through acquisitions;

 

   

integrating internal controls over financial reporting; discovering and correcting deficiencies in internal controls and other regulatory compliance, data adequacy and integrity, product quality and product liabilities;

 

   

diversion of management resources;

 

   

failure to realize anticipated the benefits of the acquisition;

 

   

costly fees for legal and transaction-related services; and

 

   

the unanticipated assumption of liabilities.

 

46


Table of Contents

Any of the foregoing could have a material adverse effect on our financial condition and results of operations. We may not be successful with any such acquisition. Acquisitions and strategic investments may also lead to substantial increases in non-current assets, including goodwill. Write-downs of these assets due to unforeseen business developments may materially and adversely impact our financial condition and results of operations.

Additionally, we have in the past acquired or made, and from time to time in the future may acquire or make, investments in companies, products and technologies that we believe are complementary to our existing businesses, products and technologies. These investments may not yield positive results.

Our loan covenants may affect our liquidity or limit our ability to incur debt, make investments, sell assets, merge or complete other significant transactions.

In October 2012, we entered into a Loan and Security Agreement with Hercules Technology Growth Capital, Inc. The loan agreement includes provisions that place limitations on a number of our activities, including our ability to incur additional debt, create liens on our assets or make guarantees, make certain investments or loans, pay dividends or dispose of or sell assets or enter into a merger or similar transaction. The loan agreement also contains financial covenants that require the Company to achieve certain levels of financial performance. A breach of any of the restrictive covenants in the loan agreement could result in a default under the loan agreement. If a default occurs, the lender may elect to declare all outstanding borrowings, together with accrued interest, to be immediately due and payable, to terminate any commitments they have to provide further borrowings, and to exercise any other rights they have under the loan agreement or applicable law.

We may not be able to maintain compliance with the financial covenants under our loan agreement, and our capital resources may not be sufficient to make required payments on our outstanding indebtedness.

Our ability to maintain compliance with the financial and other covenants under our loan agreement with Hercules Technology Growth Capital, Inc. is dependent upon our ability to continue to execute our business model and current operational plans. If an event of default in such covenants occurs and is continuing, among other things, the lender may accelerate the loan and seize collateral or take other actions of a secured creditor. If the loan is accelerated, we could face a substantial liquidity problem and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness. Such alternative measures may not be available or successful. Also, our loan covenants may limit our ability to dispose of material assets or operations or to restructure or refinance our indebtedness. Even if we are able to restructure or refinance our indebtedness, the economic terms may not be favorable to us. All of the foregoing could have serious consequences to our financial condition and results of operations. Our ability to generate cash to meet scheduled payments with respect to our debt depends on our financial and operating performance, which in turn, is subject to prevailing economic and competitive conditions and the other factors discussed in this “Risk Factors” section. If our cash flow and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness as noted above. Such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

We may not be able to secure additional financing.

We may seek or need to raise additional funds for general corporate and commercial purposes or for acquisitions. Our ability to obtain financing depends on our historical and expected future operating and financial performance, and is also subject to prevailing economic conditions and to financial, business and other factors beyond our control. If we are unable to secure additional financing when desired, our ability to fund our business operations, make capital expenditures, pursue additional expansion or acquisition opportunities, or make another discretionary use of cash could be limited, and this could adversely impact our financial results.

We currently expect that our current and anticipated capital resources and available borrowings should be sufficient to meet our operating and capital requirements at least through the next twelve months. We may, however, seek additional debt or equity financing prior to that time. There can be no assurance that additional capital will be available to us on favorable terms or at all. The sale of additional debt or equity securities may cause dilution to existing stockholders.

We may not recognize anticipated benefits from the strategic disposition or divestiture of portions of our business.

Our business strategy may also contemplate divesting portions of our business from time to time, if and when we believe we would be able to realize greater value for our stockholders in so doing. We have in the past sold, and may from time to time in the future sell, all or one or more portions of our business. Any divestiture or disposition could expose us to significant risks, including, without limitation, costly fees for legal and transaction-related services; diversion of management resources; loss of key personnel; and reduction in revenue. Further, we may be required to retain or indemnify the buyer against certain liabilities and obligations in connection with any such divestiture or disposition and we may also become subject to third-party claims arising out of such divestiture or disposition. In addition, we may not achieve the expected price in a divestiture transaction. Failure to overcome these risks could have a material adverse effect on our financial condition and results of operations.

 

47


Table of Contents

Operational Risks

If we fail to generate revenue as forecast, improve our margins, realize anticipated savings from our cost reduction activities or are unable to obtain additional capital necessary to fund our operations, our financial results and financial condition could be adversely affected.

As discussed in “Liquidity and Capital Resources” in Part I, Item 2 of this report, as of September 30, 2012, we have a total accumulated deficit of approximately $291.4 million, and during the nine months ended September 30, 2012, we sustained a consolidated net loss of $59.5 million. We have historically incurred operating losses and negative cash flows from operating activities, and we expect to continue to incur losses for the foreseeable future. Based on our current plans, we believe our current capital resources, including cash, cash equivalents, anticipated cash flow from operating activities, savings from cost reduction activities and available borrowings, will be sufficient to fund our operating expenses and capital requirements through at least the next twelve months.

However, there can be no assurance that we will be successful with our plans or that our future results of operations will improve. If our revenue trend does not improve, our available liquidity from cash flows from operations will be adversely affected. While we have put in place a restructuring plan designed to lower our operational expense base, we may not be able to realize the amount of savings anticipated. There can be no assurance that we will be able to improve cash flows from operations, or that we will be able to access additional capital, either through debt or equity financings, if and when required or on acceptable terms to us. Therefore, there can be no guarantee that our existing and anticipated capital resources will be adequate to meet our liquidity requirements. If we are unable to address our liquidity challenges, then our financial results and financial condition would be adversely affected.

We have incurred and may in the future incur significant expenses as a result of acquisitions, which reduces the amount of capital available to fund our business.

We have incurred, and in the future may continue to incur, significant expenses related to acquisitions. These expenses include investment banking fees, legal fees, accounting fees, printing and mailing of stockholder materials, integration and other costs, as well as past and possible future outlays of cash. There may also be unanticipated costs related to acquisitions on an ongoing basis, including expenditures on acquisition opportunities that do not result in completed transactions. As a result, the capital available to fund our activities has been and is expected to be further reduced. If we are unsuccessful in securing sufficient sales from established markets or in generating sufficient new revenues from emerging markets, then we would likely continue to require cash to fund our operations. The remaining cash available to us might not be adequate in subsequent years.

A material impairment in the carrying value of goodwill, intangible assets or other long-lived assets could negatively affect our consolidated operating results and net worth.

A significant portion of our assets consists of goodwill and other intangible assets relating to acquisitions. We review goodwill, other intangible assets and long-lived assets on an annual basis and whenever events and changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the carrying value of these assets exceeds the current fair value, the asset is considered impaired and is reduced to fair value, resulting in a non-cash charge to earnings during the period in which any impairment is determined.

During the second quarter of 2012, because of a significant decline in our stock price and revised forecasts regarding revenue, gross margin and operating profit, we undertook an interim review for potential impairment of our acquisition-related goodwill, intangible assets and other long-lived assets in connection with the second quarter close. Due to the length of time necessary to measure impairment of goodwill, our analysis was not completed as of the time of the filing of our second quarter Form 10-Q and we reported a preliminary impairment charge of $21.4 million in the second quarter ended June 30, 2012. The goodwill impairment analysis was subsequently completed during the 2012 third quarter and resulted in an additional goodwill impairment charge of approximately $5.0 million being recorded during the three months ended September 30, 2012, for a total goodwill impairment charge of $26.4 million during the nine months ended September 30, 2012. In conjunction with our goodwill impairment test, we also tested our long-lived assets for impairment and adjusted the carrying value of each asset group to its fair value and recorded the associated impairment charge of $24.8 million in our condensed consolidated statements of operations, of which $23.9 million was recorded in the second quarter and $0.9 million was recorded in the third quarter of 2012. We will continue to monitor relevant market and economic conditions that could result in impairment, including a sustained drop in the market price of our common stock, increased competition or loss of market share, product innovation or obsolescence, or a decline of our business related to acquired companies. It is possible that conditions could deteriorate due to these factors, resulting in the need to adjust our estimates or to take additional impairment charges in the future. As a result, our operating results and stockholders’ equity could be materially and adversely affected.

 

 

48


Table of Contents

We have a history of operating losses and negative cash flow from operations and may not achieve or maintain profitability.

We have a history of operating losses and negative cash flow from operations. If we are unable to achieve expected results, including experiencing sufficient revenue growth to generate positive future cash flow, and continue to incur losses, we may be unable to achieve or maintain profitability.

Our results may fluctuate greatly from quarter to quarter and, as a result, may not be a valid indicator of our future performance.

Our quarterly and annual operating results have varied greatly in the past and will likely vary greatly in the future depending upon a number of factors. Many of these factors are beyond our control. Our revenues, gross profit and operating results may fluctuate significantly from quarter to quarter due to, among other things:

 

   

business and economic conditions overall and in our markets;

 

   

the timing and amount of orders we receive from our customers that may be tied to annual or other budgetary cycles, seasonal demand, product plans or program roll-out schedules;

 

   

cancellations or delays of customer orders or the loss of a significant customer;

 

   

our ability to obtain an adequate supply of quality components on a timely basis;

 

   

the absence of significant backlog in our business;

 

   

our inventory levels and the inventory levels of our customers and indirect sales channels;

 

   

competition;

 

   

new product announcements or introductions;

 

   

our ability to develop, introduce, market and deliver new products and product enhancements on a timely basis, if at all;

 

   

our ability to successfully market and sell our products and solutions into new geographic or market segments;

 

   

the sales volume, product configuration and mix of offerings that we sell;

 

   

technological changes in the markets for our products and solutions;

 

   

the rate of adoption of industry-wide standards;

 

   

the rate of development of emerging market markets such as NFC-based mobile applications and cashless payment;

 

   

reductions in the average selling prices that we are able to charge due to competition or other factors;

 

   

strategic acquisitions, sales and dispositions;

 

   

fluctuations in the value of foreign currencies against the U.S. dollar;

 

   

the timing and amount of marketing and research and development expenditures;

 

   

loss of key personnel; and

 

   

costs related to events such as dispositions, organizational restructuring, headcount reductions, litigation or write-off of investments or goodwill.

Due to these and other factors, our revenues may not increase or even remain at their current levels. Because a majority of our operating expenses are fixed, a small variation in our revenues can cause significant variations in our operational results from quarter to quarter and our operating results may vary significantly in future periods. Therefore, our historical results may not be a reliable indicator of our future performance.

 

49


Table of Contents

The unpredictable purchase patterns of customers in our ID Products segment impacts our budgeting process and may adversely affect our results if orders are not placed in line with expectations.

In our Identity Management segment, sales tend to be relatively linear (regularly spaced throughout the quarter), as orders are tied to projects with relatively predictable timelines. In our ID Products segment, the largest component of revenue in any given quarter is sales of smart card reader technology. Historically, many of our smart card reader customers have tended to make a significant portion of their purchases towards the end of the quarter, in part because they believe they are able to negotiate lower prices and more favorable terms. As a result, smart card reader revenue in any quarter depends on contracts entered into or orders booked and shipped in that quarter. This makes it difficult to predict revenues both in our smart card reader business, and for the company overall. In addition, the increasing use of RFID technology in the marketplace is resulting in larger program deployments of transponder products and components. Accordingly, changes in ordering patterns, including delays or reductions in orders from our transponder customers also can have a significant effect on our business. Across both our segments, the timing of closing larger orders increases the risk of quarter-to-quarter fluctuation in revenues. If orders forecasted for a specific group of customers for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, our operating results for that quarter could be materially adversely affected. In addition, from time to time, we may experience unexpected increases or decreases in demand for our products resulting from fluctuations in our customers’ budgets, purchasing patterns or deployment schedules. These occurrences are not always predictable and can have a significant impact on our results in the period in which they occur.

If we do not accurately anticipate the correct mix of products that will be sold, we may be required to record charges related to excess inventories.

Due to the unpredictable nature of the demand for our products, we are required to place orders with our suppliers for components, finished products and services in advance of actual customer commitments to purchase these products. Significant unanticipated fluctuations in demand could result in costly excess production or inventories. In order to minimize the negative financial impact of excess production, we may be required to significantly reduce the sales price of the product to increase demand, which in turn could result in a reduction in the value of the original inventory purchase. If we were to determine that we could not utilize or sell this inventory, we may be required to write down its value, which we have done in the past. Writing down inventory or reducing product prices could adversely impact our cost of revenues and financial condition.

We may choose to take back unsold inventory from our customers.

If demand is less than anticipated, our distribution customers may ask that we accept returned products that they do not believe they can sell. We do not have a policy relating to product returns for the majority of our products. However, we may determine that it is in our best interest to accept returns in order to maintain good relations with our customers. If we were to accept product returns, we may be required to take additional inventory reserves to reflect the decreased market value of slow-selling returned inventory, even if the products are in good working order.

We are subject to a lengthy sales cycle and additional delays could result in significant fluctuations in our quarterly operating results.

In much of our business, the initial sales cycle for a new customer usually takes a minimum of six to nine months, and even in the case of established customers, it may take up to a year for us to receive approval for a given purchase from the customer. In the case of emerging market areas such as NFC and cloud-based identity management services, this cycle may be longer and less predictable, as demand from our customers’ end markets may not be predictable. During the sales cycle, we may expend substantial financial and managerial resources with no assurance that a sale will ultimately result. The length of a new customer’s sales cycle depends on a number of factors, many of which we may not be able to control. These factors include the customer’s product and technical requirements and the level of competition we face for that customer’s business. Any delays in the sales cycle for new customers could delay or reduce our receipt of new revenue and could cause us to expend more resources to obtain new customer wins. If we are unsuccessful in managing sales cycles, our business could be adversely affected.

Our business could be adversely affected by significant changes in the contracting or fiscal policies of governments and governmental entities.

We derive a substantial portion of our revenues from indirect sales to U.S. federal, state and local governments and government agencies, as well as from subcontracts under federal government prime contracts. Large government programs are an important target for our business, as higher security systems employing smart cards, RFID or other access control technologies are increasingly used to enable applications ranging from authorizing building and network access for federal employees to paying taxes online, to citizen identification, to receiving health care