[March 19, 2013] IDENTIVE GROUP, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the audited consolidated financial statements and notes thereto included in Item 8 of this Annual Report on Form 10-K. We also urge readers to review and consider our disclosures describing various factors that could affect our business, including the disclosures under the headings "Risk Factors" in this Annual Report on Form 10-K. Overview Identive Group, Inc. ("Identive," the "Company", "we" and "us") provides secure identification ("Secure ID") solutions that allow people to gain access to buildings, networks, information, systems and services - while ensuring that the physical facilities and digital assets of the organizations they interact with are protected. We leverage core identification technologies, including smart card-based security encryption and radio frequency identification ("RFID") contactless communication, to offer a comprehensive range of Secure ID products, systems and services that help to manage the identification and granting of defined privileges to people: as consumers, employees, students or citizens. Our offerings include hardware products, software and integrated systems as well as services to address Secure ID applications including identity management, physical and logical/cyber access control, customized ID solutions and a host of RFID and near field communication ("NFC") -enabled applications. We serve a global customer base in the government, enterprise, consumer, education, healthcare and transportation sectors. Our business 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, implement and manage integrated solutions, systems and services in diverse markets that enable the secure management of credentials used for the identification of people and the granting of rights and privileges based on defined policies. Our Identity Management offerings include: integrated physical and logical (i.e., PC, network or cyber) access control and security systems and cloud-based credential management systems, which we refer to collectively as our Identity Management & Cloud Solutions; customized ID Solutions that include multi-function IDs, cashless and mobile payment systems and other solutions; and our Tagtrail NFC content management platform. Our Identity Management end-customers operate in the government, education, enterprise and commercial markets and can be found in multiple vertical market segments including public services administration, law enforcement, healthcare, banking, industrial, retail and critical infrastructure. Our Identity Management solutions primarily are offered under the Identive brand. We use HIRSCH and idOnDemand as product sub brands, Multicard as our brand for regional ID solutions offerings in select markets, and payment solutions and JustPay for our payment offerings in the sports stadium and festival markets. • In our ID Products segment we design and manufacture both standard and highly specialized smart card technology-based products and components (which we refer to as ID Infrastructure products) and RFID products and components, including NFC offerings (which we refer to as Transponder products), which are used in the government, enterprise and consumer markets for a number of identity-related applications, including logical access, physical access, eHealth, eGovernment, electronic ID, mobile payment, loyalty schemes, mobile advertising, and transportation and event ticketing. Our ID Infrastructure offerings include readers and terminals based on both contact and contactless smart card technology as well as readers for RFID and NFC applications, all of which are sold under the Identive brand. Our Transponder products include RFID and NFC inlays and inlay-based tags, labels, stickers and cards. Collectively, we refer to our ID Infrastructure and Transponder offerings as Identification Products, which we sell under the Identive brand and under some product specific brands, including ChipDrive, SmartCore and Smartag. 41 -------------------------------------------------------------------------------- Table of Contents We primarily conduct our own sales and marketing activities in each of the markets in which we compete, utilizing our 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. We sell our Identification Products directly to end users and utilizing indirect sales channels that may include OEMs, dealers, systems integrators, value added resellers, resellers or Internet sales. We sell our Identity Management & Cloud Solutions directly to end users and through a channel of systems integrators, dealers and value added local partners. We sell and deliver our customized ID Solutions primarily through a direct sales effort. We sell our Tagtrail mobile content delivery service directly to end customers and through channel partners such as mobile service operators. We also maintain an online marketplace for our NFC products at www.IdentiveNFC.com. Our corporate headquarters are located in Santa Ana, California and our European and operational headquarters are located in Ismaning, Germany, where our financial reporting process is performed. 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. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to product returns, customer incentives, bad debts, inventories, asset impairment, pension plans, contingent consideration, deferred tax assets, accrued warranty reserves, restructuring costs, contingencies and litigation. 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. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies, among others, contain our more significant judgments and estimates used in the preparation of our consolidated financial statements. • Revenue - 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 our credit checks and their 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 42 -------------------------------------------------------------------------------- Table of Contents 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, that 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 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 significant impact and revenues from such software products will continue to be recognized under the guidance of ASC 985-605. 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 its 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 offerings contain a significant element of proprietary technology and provide substantially unique 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, typically we are not able to determine TPE for such products. Therefore ESP is often 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 it represents a separate unit of accounting in accordance with the provisions of ASU 2009-13. Certain sales arrangements of our hardware products are bundled with professional services and maintenance contracts, and in some cases with software products. 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. Professional services include security system integration, system migration and database conversion services, among others. The revenue from professional services contracts is recognized upon completion of such services and upon acceptance 43 -------------------------------------------------------------------------------- Table of Contents 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 revenue arrangements associated with our payment solution business, which was acquired in January 2012, we facilitate cashless payments by providing an integrated payment system ("system") for sports stadiums, arenas, theme parks and other venues for leisure and entertainment ("recreational facilities") throughout Europe, including multi-functional customer cards based on RFID contactless chip technology ("smart cards" or "cards") and comprehensive payment management software. The system is designed to ensure the seamless interaction of all relevant components such as ticketing, access, point-of-sale, parking, and other services. In addition to the smart cards and software, the system consists of readers and communication infrastructure, all supplied and implemented by Identive. The system enables consumers at recreational facilities to make quick, cashless payments for food, beverages and merchandise. Customers are provided the option of purchasing a turnkey solution or entering into a multi-year contract under which we operate and maintain responsibility for the system over a set period, in return for sharing in the revenue generated. The revenue on a turnkey solution is recognized in accordance with ASU 2009-13. We evaluate each deliverable in the arrangement to determine whether it represents a separate unit of accounting. Revenue is then recognized on each deliverable when the product has been delivered or the service has been completed, and upon acceptance of the product or service by the customer, if applicable. Under multi-year contracts, we are entitled to various cash processing fees and revenue share commissions according to the terms of each specific contract. Under certain of the multi-year contracts we also are entitled to card breakage income as described below. Revenue from cash processing fees and revenue share commissions from events is recognized after an event has taken place, the payment services have been provided, and the event revenue has been agreed with the relevant parties. Where commissions depend on thresholds measured over more than one event, revenue is not recognized until all conditions are met, and collectability is reasonably assured. Smart cards are used by consumers to make purchases at the recreational facilities and they pay an initial deposit fee to obtain 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. 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 decrease in the card balance. Revenues from unredeemed balances on cards are estimated and recognized when the likelihood of the card being redeemed by the customer is remote ("card breakage income"), based on an aging of card balances and historical evidence of redemption rates. We determine the likelihood of redemption to be remote for cards due to, among other things, long periods of inactivity and change in customer behavior as part of the normal accounting processes performed each reporting period. Based on historical information, including the historical redemption patterns experienced by payment solution during its pre-acquisition period, we determine the likelihood of a card remaining unredeemed 12 months after the card is issued and recognize breakage income accordingly. Card breakage income is included in revenue in the Company's consolidated statements of operations. • Inventories - Inventories are stated at the lower of cost, using FIFO, average cost or standard cost, as applicable, or market value. We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. We regularly review inventory quantities on hand and record an estimated provision for excess inventory, technical obsolescence and inability to sell based primarily on our historical sales and expectations for future use. Actual demand and market conditions may be different from those projected by our management. This could have a material effect on our operating results and financial position. If we were to make different judgments or utilize different estimates, the amount and timing of our write- 44 -------------------------------------------------------------------------------- Table of Contents down of inventories could be materially different. Once we have written down inventory below cost, we do not subsequently write it up. • Income Taxes - Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management's best assessment of estimated current and future taxes to be paid. We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, for all material jurisdictions, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and incorporate assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income (loss). As of December 31, 2012, we have federal and state income tax net operating loss (NOL) carryforwards of $54.7 million and $34.3 million, which will expire at various dates starting 2013. Such NOL carryforwards expire as follows (in thousands): Years Amounts 2013 - 2018 $ 21,592 2019 - 2024 39,500 2025 - 2030 12,517 2031 - 2036 15,341 Total $ 88,950 We believe that it is more likely than not that the benefit from the state NOL carryforwards will not be realized. In recognition of this risk, we have provided a full valuation allowance on the deferred tax assets relating to these state NOL carryforwards. If our assumptions change and we determine we will be able to realize these NOLs, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets as of December 31, 2012, will be accounted for as a reduction of income tax expense. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. ASC 740 states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. We (1) record unrecognized tax benefits as liabilities in accordance with ASC 740 and (2) adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available. We believe that none of the unrecognized tax benefits, excluding the associated interest and penalties, which are insignificant, may be recognized by the end of 2013. With the exception of one insignificant subsidiary for which we have recorded a deferred tax liability, we consider the earnings of other non-U.S. subsidiaries to be indefinitely invested outside the United States on the basis of estimates that 45 -------------------------------------------------------------------------------- Table of Contents future domestic cash generation will be sufficient to meet future domestic cash needs and our specific plans for reinvestment of those subsidiary earnings. We have not recorded a deferred tax liability of approximately $0.7 million related to the U.S. federal and state income taxes and foreign withholding taxes on approximately $2.0 million of undistributed earnings of these other foreign subsidiaries indefinitely invested outside the United States. Should we decide to repatriate the foreign earnings, we would need to adjust our income tax provision in the period we determined that the earnings will no longer be indefinitely invested outside the United States. • Goodwill - Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. Goodwill is not subject to amortization but is subject to annual assessment, at a minimum, for impairment in accordance with ASC Topic 350, Intangibles - Goodwill and Other ("ASC 350"). We evaluate goodwill, at a minimum, on an annual basis and whenever events and changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment of goodwill is tested at the reporting unit level, which is one level below its operating segment level. The reporting units are identified in accordance with ASC 350-20-35-33 through 35-46. We first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, it is determined it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit, including goodwill. If the carrying value of the reporting unit exceeds the fair value, goodwill is considered impaired and a second step is performed to measure the amount of the impairment loss, if any. Under this second step, the implied fair value of goodwill value is determined, in the same manner as the amount of goodwill recognized in a business combination, to assess the level of goodwill impairment, if any. The implied fair value of goodwill as determined above is compared to the carrying value of goodwill. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized equal to that excess (i.e., write goodwill down to the implied fair value of goodwill amount). We determine the fair value of the reporting units using the income, or discounted cash flows, approach ("DCF model") and verify the reasonableness of such fair value calculations of the reporting units using the market approach, which utilizes comparable companies' data. The completion of the DCF model requires that we make a number of significant assumptions to produce an estimate of future cash flows. These assumptions include, but are not limited to, projections of future revenue, gross profit rates, working capital requirements, and discount rates. In determining an appropriate discount rate for each reporting unit we make assumptions about the estimated cost of capital and relevant risks, as appropriate. The projections that we use in our DCF model are updated at least annually and will change over time based on the historical performance and changing business conditions for each of our reporting units. The determination of whether goodwill is impaired involves a significant level of judgment in these assumptions, and changes in our business strategy, government regulations, or economic or market conditions could significantly impact these judgments. Prior to January 1, 2012, our reporting units were the Hirsch, ID Solutions (formerly known as Multicard), and idOnDemand businesses in the Identity Management segment, and the ID Infrastructure and Transponders businesses in the ID Products segment. As discussed in Note 2 of Notes to Consolidated Financial Statements in Item 8 below, we recorded goodwill of $13.3 million in connection with our acquisition of payment solution during the year ended December 31, 2012. The goodwill acquired as a result of the acquisition of payment solution was assigned to payment solution, a newly-created reporting unit, which was included in the Identity Management segment. 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 and recorded a goodwill 46-------------------------------------------------------------------------------- Table of Contents impairment charge of $27.1 million in our consolidated statements of operations for the year ended December 31, 2012. As of December 31, 2012, of the remaining goodwill of $45.3 million after the impairment charge, $21.9 million was allocated to the Hirsch reporting unit, $8.4 million to the ID Solutions reporting unit, $13.3 million to the payment solution reporting unit, $0.5 million to the idOnDemand reporting unit and $1.2 million to the ID Infrastructure reporting unit. The Company´s annual impairment test as of December 1, 2012 indicated that the estimated fair value for all the reporting units substantially exceeded the carrying value. Additionally, as part of the annual goodwill impairment test we compared our total market capitalization with the aggregate estimated fair value of our reporting units to ensure significant differences are understood. As of the December 1, 2012 annual impairment test, the aggregate fair value of the reporting units as determined by management exceeded the Company´s market capitalization by an amount that in management´s judgment reflects a reasonable control premium. There was no impairment existed as of December 1, 2011. Future impairment indicators, including further declines in the Company's market capitalization or changes in forecasted future cash flows, could require additional impairment charges. • Intangible and Long-lived Assets - We evaluate our long-lived assets and certain identifiable amortizable intangible assets for impairment in accordance with ASC Topic 360, Property, Plant and Equipment ("ASC 360") whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by an asset group. If such asset groups are considered to be impaired (i.e., if the sum of its estimated future undiscounted cash flows used to test for recoverability is less than its carrying value), the impairment loss to be recognized is measured by the amount by which the carrying amount of the asset group exceeds the fair value of the asset groups. Intangible assets with definite lives are amortized using the straight-line method over the estimated useful lives of the related assets. For intangible assets, where we have determined that these have an indefinite useful life, no amortization is recognized until its useful life is determined to be no longer indefinite. We evaluate indefinite useful life intangible assets, if any, for impairment at a minimum on an annual basis and whenever events and changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with ASC 350. We perform the impairment test of the indefinite-lived intangible assets by calculating the fair value of such intangible assets and comparing the fair value of the intangible assets with the carrying amount. If the carrying amount of such intangible assets exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. There are no intangible assets with indefinite lives as of December 31, 2012. The Company´s annual impairment test as of December 1, 2011 indicated no impairment. • Stock-based Compensation - We recognize stock-based compensation expense for all share-based payment awards in accordance with ASC Topic 718, Compensation - Stock Compensation ("ASC 718"). Stock-based compensation expense for expected-to-vest awards is valued under the single-option approach and amortized on a straight-line basis, net of estimated forfeitures. We utilize the Black-Scholes-Merton option-pricing model in order to determine the fair value of stock-based awards. The Black-Scholes-Merton model requires various highly subjective assumptions including volatility, expected option life, and risk-free interest rate. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates. These estimates involve inherent uncertainties and the application of management's judgment. If factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and recognize expense only for those expected-to-vest shares. If our actual forfeiture rate is materially different from our estimate, our recorded stock-based compensation expense could be different. • Defined Benefit Plans - We have several insurance-based pension arrangements in Switzerland covering Multicard AG, Identive Service AG and polyright SA employees, whereby a certain fixed amount of contribution is required from both employees and employer. We assumed sponsorship of two statutory pension plans as part of the BlueHill ID acquisition on January 4, 2010, and another 47 -------------------------------------------------------------------------------- Table of Contents statutory pension plan as part of the polyright SA acquisition on July 18, 2011. We record pension costs and benefit obligations related to our defined benefit plans based on actuarial valuations. These valuations reflect key assumptions determined by management, including the discount rate and expected long-term rate of return on plan assets. The expected long-term rate of return assumption considers the asset mix of the plans' portfolios, past performance of these assets, the anticipated future economic environment and long-term performance of individual asset classes, and other factors. Material changes in pension costs and in benefit obligations may occur in the future due to experience different than assumed and changes in these assumptions. Future benefit obligations and annual pension costs could be impacted by changes in the discount rate, changes in the expected long-term rate of return, changes in the level of contributions to the plans and other factors. We measure defined benefit plan assets and obligation in accordance with ASC Topic 715, Compensation - Retirement Benefits ("ASC 715"). As of December 31, 2012, we recorded an accrued pension liability of $1.5 million and pension expense of $0.6 million for fiscal 2012. Recent Accounting Pronouncements In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02'). The updated accounting standard is an amendment to ASU 2011-12, which requires companies to present information about reclassifications out of accumulated other comprehensive income in a single note or on the face of the financial statements. The updated standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012, with early adoption permitted. The Company will adopt this standard in the first quarter of 2013 and does not expect the adoption will have a material impact on its consolidated results of operations or financial condition. In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other, 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 adopted the Provisions of ASU 2012-02 during the fourth fiscal quarter of 2012. The adoption of ASU 2012-02 did not have any significant impact as the Company currently has no indefinite-lived intangible assets. 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 $3.0 million, to 18 selling shareholders of payment solution. 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%. 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 are subject to applicable restrictions on transfer. payment solution's operating results have been included in our consolidated results from the date of acquisition. We are in the process of completing the integration of payment solution into our existing operations in Germany. 48-------------------------------------------------------------------------------- Table of Contents 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 the operations of our existing ID Solutions business 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. 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 from ActivIdentity Corporation 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 operations under our Identity Management & Cloud Solutions division. Certain products and technology from idOnDemand have been transferred to our Identification Products operations, leaving the focus in Identity Management & Cloud Solutions on our software, integrated systems and Software as a Service (SaaS) offerings. On November 19, 2010, we acquired FCI Smartag Pte. Ltd. ("Smartag"), a Singapore-based manufacturer of high frequency ("HF") and ultra high frequency ("UHF") radio frequency identification ("RFID") inlays and inlay-based solutions and a subsidiary of FCI Asia Pte. Ltd., FCI SA and FCI Connectors Singapore Pte. Ltd. (collectively, "FCI"). The acquisition was pursuant to a Share Purchase Agreement dated October 29, 2010, under which we paid FCI approximately $3.2 million, consisting of a one-time payment at the close of the transaction of approximately $1.0 million and a debt note for approximately $2.2 million. The debt note carries an interest rate of 6% per year and is payable within 30 months from the closing date. Smartag's operating results have been included in our consolidated results since the date of acquisition. Following the acquisition, Smartag was integrated into our Identification Products operations. On April 14, 2010, we acquired RockWest Technology Group LLC, a privately-held provider of identification and security solutions based in Denver, Colorado ("RockWest"), pursuant to the Share Purchase Agreement dated March 30, 2010 and amended on April 9, 2010, under which we issued an aggregate of 2.6 million shares of our common stock. RockWest's operating results have been included in our consolidated results since the date of acquisition. Following the acquisition, RockWest became the core of our ID Solutions business in the U.S. 49 -------------------------------------------------------------------------------- Table of Contents On January 4, 2010, we acquired Bluehill ID, pursuant to the Business Combination Agreement dated as of September 20, 2009, as amended, under which we made an offer to the Bluehill ID shareholders to acquire all of the Bluehill ID shares and issued 0.52 new shares of Identive common stock for every one share of Bluehill ID tendered. A total of 29,422,714, or approximately 92% of Bluehill ID shares outstanding were tendered in the offer and exchanged for a total of 15,299,797 new shares of Identive common stock. Bluehill ID's operating results have been included in our consolidated results since the date of acquisition. Following the acquisition, Bluehill ID's ACiG Technology, Syscan ID and TagStar Systems businesses were integrated into what are now our Identification Products operations and Bluehill ID's multi-location Multicard businesses have been brought under our ID Solutions operations. Recent Trends and Strategies for Growth Identive is focused on building the world's signature company in Secure ID, and our goal is to build a lasting business of scale and technology to both enable and capitalize on the growth of established identity management applications and the adoption of NFC, converged access and other emerging trends. To accomplish this, we have built significant expertise in core identification technologies, including smart card-based security and radio frequency identification (RFID). We work to leverage this expertise to create a comprehensive range of offerings that span the value chain of Secure ID, from products to fully integrated systems, as well as services. Our business strategy is focused on technology-driven organic growth based on both established markets and emerging opportunities for Secure ID. We work to enhance our ability to address our market opportunities and extend our product and solutions offerings through ongoing research and development programs. For example, during 2012 we completed a significant, multi-year update to our access control software and hardware platforms, made additional enhancements to our software systems for cashless payment systems and continued to develop and extend our smart card reader offerings. 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. For example, in anticipation of the launch of new smartphones that include NFC technology, we created a dedicated Mobility & NFC Solutions group that is responsible for guiding our NFC technology development and market activities. This has resulted in the release of several new NFC tags, readers and development kits that address trending NFC applications and markets. We also developed and in November 2012 launched Tagtrail, our cloud-based mobile services platform that enables delivery of dynamic, personalized content to consumers' smartphones via NFC tags. In addition, we maintain 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 continue to invest in the development of "Identity as a Service" software solutions and capabilities. During 2012 we consolidated our various Transponder and ID Infrastructure business activities into a single Identification Products organization and moved the majority of our product brands under a single market brand, Identive. We also combined our Hirsch and idOnDemand operations into a single organization focused on Identity Management & Cloud Solutions. Currently we are engaged in combining our most recent acquisitions, polyright and payment solutions, into our global ID Solutions operations. Trends in our Business Sales Trends Sales in 2012 were $94.6 million, down 8% compared with $102.7 in 2011. This decrease reflects incremental revenue of $6.2 million from idOnDemand, polyright and payment solution, offset by a decrease in 50-------------------------------------------------------------------------------- Table of Contents organic sales of $14.3 million, or 14%, of which approximately half was due to the absence of new orders for secure card readers and software for the German national ID program, for which we recorded $7.6 million in revenue in 2011. We have also seen a significant drop in revenues from European citizen ID initiatives overall as a result of European economic austerity measures. Also impacting our revenues in 2012 were project delays at several customers in the mobile device and transportation sectors, which resulted in order deferrals for RFID inlays and tags that continued through the third quarter of the year. The resumption of these projects and the receipt of new orders resulted in a significant increase in sales of RFID transponder products in the fourth quarter of the year. Additionally, we experienced stronger sales of smart card readers and identity management and access control systems to the U.S. Government market in 2012, related in part to some improvement in activity associated with previously delayed security projects with U.S. federal agencies. Sales in the Americas. Sales in the Americas were $49.0 million in 2012, accounting for 52% of total revenue and up 12% compared with $43.8 million in 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 access control systems in the Americas increased by approximately 9% in 2012 compared with 2011, primarily as a result of an increase in activity associated with previously delayed security projects with U.S. federal agencies. 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 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 access conrol systems to the U.S. Government sector were negatively impacted by budget and funding delays. While increased project activity at some federal agencies during 2012 is a positive development, the outlook for our U.S. Government business remains uncertain in the near term as federal budget priorities continue to be unresolved. 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. Sales of smart card readers and other ID Infrastructure products in the Americas increased 44% in 2012 compared with 2011, primarily 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. Americas RFID inlay and tag sales increased 26% in 2012 compared with 2011, primarily due to large NFC orders in the fourth quarter of 2012, some of which had been deferred previously. Sales in Europe and the Middle East. Sales in Europe and the Middle East (EMEA) were $31.5 million in 2012, accounting for 33% of total revenue and down 25% from $42.2 million in 2011. A primary reason for this decrease was the absence of new orders for secure card readers and software to support the German national ID program, which had contributed $7.6 million in 2011. The absence of German national ID orders also was the primary driver of a 47% decrease in sales in our European ID Solutions business in 2012. European sales of smart card readers also were 46% lower in 2012 compared with the prior year, reflecting economic austerity measures that contributed to comparative weakness in the market for European government programs including national ID, electronic health and other citizen ID programs. Additionally, European RFID inlay and tag sales were 13% lower in 2012 compared with the prior year due to softness in some of our markets during the first three quarters of the year; however order patterns improved in the 2012 fourth quarter. Market weakness in Europe in 2012 was partially offset by approximately $5.9 million of incremental revenue from polyright and payment solution. Sales in Asia/Pacific. Sales in the Asia/Pacific region were $14.1 million in 2012, accounting for 15% of total revenue and down 16% from $16.8 million in 2011. Revenue from Asia/Pacific in 2012 reflected a 5% increase in sales of our smart card reader technology, driven by higher demand for smart card chipsets for PC applications and smart card readers to support e-government and telecommunications applications in China and 51-------------------------------------------------------------------------------- Table of Contents Japan. This was offset by a 26% decline in sales of RFID inlays and tags due to order deferrals from customers in the NFC mobile device and transportation sectors, which rebounded in the fourth quarter of the year. Additionally, sales in our ID Solutions business in Australia declined 41% in 2012 due to the completion of a large customer program deployment during 2011. Looking forward, we believe demand will continue to 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 access control systems to U.S. Government agencies are subject to 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, this business is typically subject to seasonality based on governmental budget cycles, with lowest sales in the first half, and in particular the first quarter of the year, and highest sales in the second half of each year. In our global ID Solutions business, a variety of local market factors including government budget cycles and retail demand cycles typically result in stronger demand in the second half of the year. In general, sales of our RFID inlays and transponders also are marginally stronger in the second half of the year. In addition to the general seasonality of demand, overall U.S. Government expenditure has a significant impact on demand for our products due to the significant portion of our revenues that we believe comes from U.S. government agencies. Therefore, any significant reduction in U.S. Government spending could adversely impact our financial results. In that regard, our preliminary financial results for the first two months of 2013 have been adversely impacted by the recent effects of the U.S. Government "sequester" on our U.S. Government business and could cause our operating results for the first quarter of 2013 to fall below any guidance we provide to the market or below the expectations of investors or securities analysts, particularly with respect to the first quarter of 2013, which is seasonally our weakest quarter of the year. 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 expenses) decreased 4% in 2012 compared with 2011, primarily as a result of expense reductions taken under our 2012 restructuring plan as described below, an ongoing focus on reducing general and administrative spending, and the completion of various development projects. Partially offsetting these expense reductions was the addition of $3.6 million of incremental expenses from our acquired idOnDemand, polyright and payment solution businesses, which accounted for 7% of our base operating expenses in 2012. In addition, overall we maintained an increased level of investment in the development of core technology, new solutions offerings and sales and marketing capabilities to address emerging opportunities within the secure identification market that we believe hold significant long-term potential for Identive. 52-------------------------------------------------------------------------------- Table of Contents 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 access control platforms. To address the growing opportunities for NFC-enabled systems, we have developed a cloud-based NFC mobile services platform that provides NFC tag content management and 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 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 have included acceleration of the elimination of duplicate expenses at newly acquired companies, reductions in other general and administrative expenses, the consolidation of facilities, a reduction in the Company's global workforce, and nearly $0.5 million of temporary reductions in executive and management salaries and Board fees. All restructuring actions were completed in the fourth quarter of 2012. We incurred restructuring charges of $0.3 million, which mainly consisted of one-time termination benefits, in connection with our 2012 Restructuring Plan during the 12 months ended December 31, 2012. For the fourth quarter of 2012, our base operating expenses (consisting of research and development, sales and marketing, and general and administrative expenses) were 22% lower than the same quarter of the previous year as a result of cost reductions implemented under the restructuring plan and from ongoing initiatives to improve the efficiency of our business. 53-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our statements of operations as a percentage of net revenue for the periods indicated: Years Ended December 31, 2012 2011 2010 Net revenue 100.0 % 100.0 % 100.0 % Cost of revenues: Products 48.8 52.2 50.0 Services 10.5 6.1 6.0 Total cost of revenues 59.3 58.3 56.0 Gross profit 40.7 41.7 44.0 Operating expenses: Research and development 9.2 6.9 5.5 Selling and marketing 25.4 22.9 24.0 General and administrative 19.3 21.5 25.4 Impairment of long-lived assets 26.2 - - Impairment of goodwill 28.6 - - Re-measurement of contingent consideration (6.0 ) 0.5 0.3 Restructuring 0.3 - 0.4 Total operating expenses 103.0 51.8 55.6 Loss from operations (62.3 ) (10.1 ) (11.6 ) Other (expense)income (0.1 ) 0.3 0.3 Interest expense, net (1.7 ) (1.0 ) (1.0 ) Foreign currency gains (losses), net 0.3 (0.4 ) (0.3 ) Loss from continuing operations before income taxes and noncontrolling interest (63.8 ) (11.2 ) (12.6 ) Benefit for income taxes 7.2 1.3 0.3 Loss from continuing operations (56.6 ) (9.9 ) (12.3 ) Gain from discontinued operations, net of income taxes - - 0.3 Consolidated net loss (56.6 ) (9.9 ) (12.0 ) Less: Net loss attributable to noncontrolling interest 3.4 0.5 0.7 Net loss attributable to Identive Group, Inc. stockholders equity (53.2 )% (9.4 )% (11.3 )% Comparability of Results - The comparability of our operating results in the three years ended December 31, 2012 is impacted by our acquisition of RockWest on April 14, 2010, Smartag on November 19, 2010, idOnDemand on May 2, 2011, polyright on July 18, 2011 and payment solution on January 30, 2012. Results of each of these acquisitions have been included in our consolidated financial results since their respective acquisition dates. 54-------------------------------------------------------------------------------- Table of Contents Revenue Summary information about our revenue by type and by business segment for the year ended December 31, 2012, 2011 and 2010 is shown below: % Change % Change Fiscal 2012 Fiscal 2011 Fiscal 2012 to 2011 2011 to 2010 2010 (In thousands) Products: Revenues $ 77,651 (13 )% $ 89,310 20 % $ 74,610 Percentage of total revenues 82 % 87 % 88 % Services: Revenues $ 16,948 26 % $ 13,398 31 % $ 10,233 Percentage of total revenues 18 % 13 % 12 % Identity Management Segment: Revenues $ 54,149 (4 )% $ 56,473 19 % $ 47,521 Percentage of total revenues 57 % 55 % 56 % ID Products Segment: Revenues $ 40,450 (13 )% $ 46,235 24 % $ 37,322 Percentage of total revenues 43 % 45 % 44 % Total revenues $ 94,599 (8 )% $ 102,708 21 % $ 84,843 Fiscal 2012 Revenue Compared with Fiscal 2011 Revenue Total revenue in 2012 was $94.6 million, down 8% compared with $102.7 million in 2011, primarily as a result of decreased product sales in both our ID Products and Identity Management segments. Incremental revenue from acquired businesses was approximately $6.2 million and accounted for 7% of total revenue in 2012. Excluding the impact of this incremental revenue, organic revenue was 14% lower in 2012 compared with 2011. Sales within our Identity Management segment accounted for 57% of total revenue and sales within our ID Products segment accounted for 43% of revenue in 2012. Product revenue includes sales of all non-service related products, software and systems. Services revenue includes sales of payment-related services, professional consulting services and annual maintenance contracts. Services comprised a higher proportion of our revenues in 2012 compared with the prior two years, primarily as a result of the addition of new payment-related and maintenance services revenue from our acquisitions of polyright and payment solution. 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 $54.1 million in 2012, down 4% from $56.5 million in 2011. Results for the Identity Management segment included $6.2 million of incremental revenue from idOnDemand, polyright and payment solution in 2012. Excluding the impact of this incremental revenue, organic revenue was 15% lower in 2012 compared with the prior year, primarily due to the complete absence of new orders for secure card readers and software for the German national ID program within our European ID Solutions business, which had accounted for $7.6 million of sales in 2011. Additionally, sales in our ID Solutions 55 -------------------------------------------------------------------------------- Table of Contents business in Australia declined 41% in 2012 due to the completion of a large customer program deployment during 2011. These declines were partially offset by an 8% increase in sales of our access control systems in 2012, 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 ID Infrastructure products including smart card, RFID and NFC readers and terminals as well as software development kits, and Transponder products including RFID and NFC inlays and 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 we are actively working to increase sales to end customers, primarily online. Sales in this segment are subject to pricing pressure, both for our Transponder products and for our ID Infrastructure products, the market for 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 $40.5 million in 2012, down 13% from sales of $46.2 million in 2011, primarily due to lower sales of our ID Infrastructure products. ID Infrastructure revenue was 16% lower 2012 compared with the prior year as a result of decreased demand for smart card readers used in European government and citizen ID programs, partially offset by increased reader sales to the U.S. Government sector. Transponder product sales also declined by 8% in 2012. Sales of our RFID inlays and transponder products were negatively impacted by order deferrals related to large mobile device and transportation customer projects during the first three quarters of 2012. The resumption of these projects and new orders resulted in a significant increase in RFID inlay and transponder sales for the fourth quarter of 2012. Fiscal 2011 Revenue Compared with Fiscal 2010 Revenue Revenue in 2011 was $102.7 million, up 21% from $84.8 million in 2010. This increase resulted both from the addition of $10.6 million of incremental revenue from our acquisitions in 2011, as well as from organic growth of 9% from our existing business. Outside the U.S. Government sector, where we experienced a decline in sales activity in 2011 due to ongoing budget uncertainties and project delays, we achieved an organic growth rate of 17%. Sales within our Identity Management segment accounted for 55% of total revenue and sales within our ID Products segment accounted for 45% of revenue in 2011. Revenue in the Identity Management segment was $56.5 million in 2011, up 19% from $47.5 million in 2010. The increase primarily was the result of $6.2 million of incremental revenue from our acquisitions, more than half of which came from sales recognized for polyright and the remaining from sales recognized for RockWest and idOnDemand. We also recorded organic growth of 6% in the Identity Management segment in 2011, which resulted from higher sales in our ID Solutions division, partially offset by a significant reduction in sales of access control systems to the U.S. Government sector. Higher ID Solutions revenues in 2011 primarily resulted from significant orders for secure card readers and software for the German national ID program, as well as strong sales in Australia related to a government credential management program and a cashless payment card solution for a large fuel retailer, and the inclusion of incremental revenue from the acquisition of RockWest. Organic growth of our non-U.S. Government-related sales in the Identity Management segment was 17% in 2011. Revenue in our ID Products segment was $46.2 million in 2011, up 24% from $37.3 million in 2010. This increase was due both to organic growth of 12% in our Transponder business and to $4.4 million of incremental revenue from our acquired Smartag business. Sales of our RFID inlays and transponder products were driven by demand for a variety of applications, in particular transit, theme park and ski ticketing, as well as orders for more than two million NFC tags for a mobile handset manufacturer. Sales of our ID Infrastructure products grew slightly in 2011 compared with the prior year, reflecting substantial orders of eHealth terminals for the German electronic health card program, strong demand for employee ID, government and corporate programs in Europe, and increased demand from a variety of markets in Asia, partially offset by lower demand for PC/network access 56 -------------------------------------------------------------------------------- Table of Contents applications from the U.S. Government market as a result of budget uncertainties and project deferrals. Organic growth of our non-U.S. Government-related sales in the ID Products segment was 17% in 2011. Not reflected in the reported figures for our ID Products segment were intercompany shipments of secure card readers to our ID Solutions division for the German national ID program, which totaled approximately $6.4 million in 2011. Gross Profit The following table sets forth our gross profit and year-to-year change in gross profit by product segment for the fiscal years ended December 31, 2012, 2011 and 2010. The comparability of our operating results in 2012 versus prior years is impacted by various acquisitions as stated above. % Change % Change Fiscal 2012 Fiscal 2011 Fiscal 2012 to 2011 2011 to 2010 2010 (In thousands) Products: Revenues $ 77,651 $ 89,310 $ 74,610 Gross profit 31,446 (12 %) 35,649 11 % 32,152 Gross profit % 40 % 40 % 43 % Services: Revenues $ 16,948 $ 13,398 $ 10,233 Gross profit 6,990 (2 %) 7,153 37 % 5,206 Gross profit % 41 % 53 % 51 % Identity Management Segment: Revenues $ 54,149 $ 56,473 $ 47,521 Gross profit 25,176 (1 )% 25,556 2 % 25,013 Gross profit % 46 % 45 % 53 % ID Products Segment: Revenues $ 40,450 $ 46,235 $ 37,322 Gross profit 13,260 (23 )% 17,246 40 % 12,345 Gross profit % 33 % 37 % 33 % Total: Revenues $ 94,599 $ 102,708 $ 84,843 Gross profit 38,436 (10 )% 42,802 15 % 37,358 Gross profit % 41 % 42 % 44 % Gross profit for 2012 was $38.4 million, or 41% of revenue. By product segment, gross profit margin for our Identity Management segment was 46% and gross profit margin for our ID Product segment was 33% of revenue in 2012. Gross profit margin in our Identity Management segment in 2012 was positively impacted by strong margins on increased sales of access control systems and strong margins in our polyright business, and negatively impacted by weak margins in our global ID Solutions business due to lower sales in some regions. Gross profit margin in our ID Products segment in 2012 was negatively affected primarily by weaker sales of transponder products for the first three quarters of the year, which resulted in lower absorption of overhead costs in our manufacturing facilities. Gross profit for 2011 was $42.8 million, or 42% of revenue. By product segment, gross profit margin for our Identity Management segment was 45% and gross profit margin for our ID Product segment was 37% of revenue in 2011. Gross profit margin in our Identity Management segment in 2011 was negatively affected by lower sales of access control systems due to budget uncertainty and project deferrals in the U.S. Government market; an unfavorable, lower margin product mix in our ID Solutions business in Germany; and a slow sales ramp for our cloud-based credential management offering. Gross profit in our ID Products segment in 2011 was affected by favorable product mix both for smart card reader products and RFID inlays and transponders, as well as improvement in overall average selling price of RFID transponders due to the introduction of higher value NFC products for payment applications. 57-------------------------------------------------------------------------------- Table of Contents Gross profit for 2010 was $37.4 million, or 44% of revenue. By product segment, gross profit margin for our Identity Management segment was 53% and gross profit margin for our ID Products segment was 33% of revenue in 2010. During 2010, gross profit in the Identity Management segment was positively impacted by stable margins from sales of access control systems and ID Solutions in the U.S., offset by unfavorable product mix in our ID Solutions business in Europe in the first half of the year. Gross profit in our ID Products segment in 2010 was impacted by an unfavorable product mix of smart card reader products sold in the second half of the year, overall low margins from sales of RFID inlays and transponders, and a period of inefficiency related to the start up of a new RFID inlay product manufacturing line in the first quarter of 2010. 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 % Change % Change Fiscal 2012 Fiscal 2011 Fiscal 2012 to 2011 2011 to 2010 2010 (In thousands) Expenses $ 8,665 23 % $ 7,025 49 % $ 4,715 Percentage of revenue 9 % 7 % 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 2011, only eight months of results for 2011 (May - December) are included for idOnDemand, and only five months of results for 2011 (August - December) are included for polyright. Research and development expenses were $8.7 million in 2012, comprising 9.2% of revenue, and up 23% from $7.0 million, or 7% of revenue in 2011. Higher research and development expenses in 2012 reflected increased in investment in core technology as well as in new products and solutions for emerging markets. Because we consider this investment to be essential to our future success, we did not reduce research and development spending in 2012 under the corporate cost-reduction program we initiated in June. Key investment areas during 2012 included the development of cloud-based credential issuance and management solutions; the development of our Tagtrail NFC mobile services platform; software enhancements to our ID Solutions offerings, and new contactless, NFC and RFID readers and transponder products. In addition to overall higher levels of investment, research and development expenses in 2012 included $1.1 million in incremental expenses from the acquired idOnDemand and polyright businesses. Excluding the impact of these additional expenses, research and development expenses increased 9% in 2012 compared with the prior year. Research and development expenses were $7.0 million in 2011, comprising 7% of revenue and up 49% from $4.7 million, or 6% of revenue in 2010. Beginning in the third quarter of 2011, we significantly increased our investment in core technology and in new products and solutions for emerging markets, and this increased investment accounted for more than half of the increase in research and development expenses we recorded in 2011. Key investment areas included the development of cloud based credential issuance and management solutions; next generation software and controllers for our access control systems; and new contactless, NFC and RFID readers and transponder products. 2011 research and development expenses also included $1.5 million in incremental expenses from the acquired Smartag, idOnDemand and polyright businesses. 58-------------------------------------------------------------------------------- Table of Contents We expect to maintain our current level of investment in research and development in terms of absolute spending in 2013. Selling and Marketing % Change % Change Fiscal 2012 Fiscal 2011 Fiscal 2012 to 2011 2011 to 2010 2010 (In thousands) Expenses $ 23,988 2 % $ 23,563 16 % $ 20,375 Percentage of revenue 25 % 23 % 24 % 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 2011, only eight months of results for 2011 (May - December) are included for idOnDemand, and only five months of results for 2011 (August - December) are included for polyright. Sales and marketing expenses were $24.0 million in 2012, comprising 25% of revenue and up 2% from $23.6 million, or 23% of revenue in 2011. This increase was due to the addition of approximately $1.1 million of sales and marketing expenses from acquired businesses, partially offset by cost reductions initiated in June 2012 as part of our corporate cost-reduction program. Excluding the impact of additional acquired expenses, sales and marketing expense levels decreased 3% in 2012 compared with the prior year. During 2012 we invested in additional sales and marketing resources and programs to address existing and new market opportunities, including the creation of new sales teams focused on NFC solutions and converged access products, for which we expect future sales, but minimal revenues during 2012. Sales and marketing expenses were $23.6 million in 2011, or 23% of revenue, up 16% from $20.4 million, or 24% of revenue in 2010. This increase was primarily due to the addition of approximately $1.5 million of sales and marketing expenses from acquired businesses. Excluding the impact of these additional expenses, sales and marketing expense levels were nearly unchanged in 2011 compared with the prior year. Key sales and marketing initiatives in 2011 included programs and the allocation of resources to address new market opportunities, including NFC, converged physical and logical access, cloud-based solutions, and development of our sales capabilities in geographic regions including Asia and the Middle East. We expect to modestly reduce spending in sales and marketing on an absolute basis during 2013. General and Administrative % Change % Change Fiscal 2012 Fiscal 2011 Fiscal 2012 to 2011 2011 to 2010 2010 (In thousands) Expenses $ 18,218 (17 )% $ 22,066 2 % $ 21,569 Percentage of revenue 19 % 21 % 25 % 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 2011, only eight months of results for 2011 (May - December) are included for idOnDemand, and only five months of results for 2011 (August - December) are included for polyright. 59-------------------------------------------------------------------------------- Table of Contents General and administrative expenses in 2012 were $18.2 million, comprising 19% of revenue and down 17% from $22.1 million, or 21% of revenue in 2011. This decrease was primarily due to our ongoing efforts to reduce general and administrative expenses and to accelerated reductions as a result our cost-reduction program put in place in June 2012. Our 2012 general and administrative expenses included approximately $1.5 million of additional expenses from businesses acquired during the year, as well as $0.2 million of transaction expenses related to the acquisition of the remaining shares of idOnDemand and acquisition of payment solution. As mentioned below, 2011 general and administrative expenses included approximately $1.9 million of incremental expenses. Excluding the impact of these additional acquired expenses and transaction costs, general and administrative expenses decreased by $3.7 million, or 18% in 2012 compared with the prior year due to our ongoing cost reduction efforts. General and administrative expenses in 2011 were $22.1 million, or 21% of revenue, up 2% from $21.6 million, or 25% of revenue in 2010. Our 2011 general and administrative expenses include approximately $1.6 million of additional expenses from businesses acquired during the year, as well as $0.3 million of transaction expenses related to the acquisition of idOnDemand, polyright and payment solution. General and administrative expenses in 2010 included $1.3 million of transaction costs related to previous acquisitions. Excluding the impact of these additional acquired expenses and transaction costs, general and administrative expenses decreased by $0.1 million in 2011 compared with the prior year. We expect to modestly increase general and administrative spending on an absolute basis during 2013. Impairment Charges As a result of a significant decline in our stock price and changes to our forecasted revenue, gross margin and operating profit, we undertook interim goodwill impairment analyses as of June 30, 2012 and recorded a total goodwill impairment charge of $27.1 million in our consolidated statements of operations for the year ended December 31, 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 consolidated statements of operations for the year ended December 31, 2012. Please see Item 8, Financial Statements and Supplementary Data, Note 8 of Notes to Consolidated Financial Statements, Goodwill and Intangible Assets, for more detailed information. Re-measurement of Contingent Consideration For the year ended December 31, 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 re-measurement of this contingent consideration as of June 30, 2012. Please see Item 8, Financial Statements and Supplementary Data, Note 3 of Notes to Consolidated Financial Statements, Fair Value Measurements, for more detailed information. Restructuring Charges We recorded $0.3 million in restructuring costs in 2012 related to the realignment of certain business operations under our restructuring plan implemented in June 2012. We recorded $0.3 million in restructuring costs in 2010 related to the closure and consolidation of facilities as well as headcount reductions under our cost reduction program initiated in the first quarter of 2010. Please see Item 8, Financial Statements and Supplementary Data, Note 14 of Notes to Consolidated Financial Statements, Other Financial Information, for more information. 60 -------------------------------------------------------------------------------- Table of Contents Other (Expense) Income In 2012 we recorded other expense of $(0.1) million related to the loss recognized on the sale of a subsidiary. We recorded other income of $0.3 million in 2011 and 2010 related to a dividend distribution made by SCM PC-Card GmbH in which we had made an investment in 1998, and this investment 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 consists of interest accretion expense for liabilities to a related party and interest on financial liabilities, offset by interest earned on invested cash. We recorded net interest expense of $1.6 million in 2012, $1.0 million in 2011 and $0.9 million in 2010. Interest expense is higher in 2012 as compared to 2011 and 2010 due to additional interest expense recognized as a result of financial liabilities acquired in connection with our acquisition of payment solution and entering into a secured debt facility in 2012. Please see Item 8, Financial Statements and Supplementary Data, Note 10 of Notes to Consolidated Financial Statements, Financial Liabilities, for more detailed information. Interest income in 2012, 2011 and 2010 was immaterial. Foreign Currency Gains (Losses), Net We recorded foreign currency transaction gains of $0.3 million in 2012 and foreign currency transaction losses of $(0.4) million in 2011 and $(0.2) million in 2010. Changes in currency valuation in all periods presented were primarily a 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. Our foreign currency transaction losses primarily result from the valuation of current assets and liabilities denominated in a currency other than the functional currency of the respective entity in the local financial statements. Accordingly, these foreign currency losses are predominantly non-cash items. Income Taxes Our effective tax rate for fiscal years 2012, 2011, and 2010 was 11.30%, 11.62%, and 2.81%, respectively. Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income (loss) we earn in jurisdictions, which we expect to be fairly consistent in the near term. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. The following items had the most significant impact on the difference between our statutory U.S. federal income tax rate of 34% and our effective tax rate in fiscal years 2012, 2011 and 2010. 2012 - (a) A reduction of $0.9 million, or 1.43% to the statutory rate resulted from changes in valuation allowance during the year. (b) A reduction of $8.7 million, or 14.37% resulted from rate differences between U.S. and non-U.S. jurisdictions. With the exception of one subsidiary for which we have recorded a deferred tax liability, no U.S. taxes were provided with respect to undistributed earnings of other foreign subsidiaries as these earnings are intended to be indefinitely reinvested outside the United States. Significant jurisdictions causing this difference are Germany, Switzerland and Singapore. (c) A reduction of $3.8 million, or 6.34% resulted from non-cash impairment charges for goodwill that is nondeductible for tax purposes. The net effect of these changes was an income tax benefit of $6.8 million recorded in 2012. 2011 - (a) A reduction of $1.8 million, or 15.27% resulted from rate differences between U.S. and non-U.S. jurisdictions. (b) A reduction of $0.7 million, or 6.29% resulted from changes in valuation allowance during the year. The net effect of these changes was an income tax benefit of $1.3 million recorded in 2011. 2010 - (a) A reduction of $2.7 million, or 25.41% resulted from rate differences between U.S. and non-U.S. jurisdictions. (b) A reduction of $1.0 million, or 9.06% resulted from recognition of IRC Section 956 income. 61-------------------------------------------------------------------------------- Table of Contents (c) An increase of $1.0 million, or 9.89% resulted from changes in permanent reinvestment plans for a foreign subsidiary. The net effect of these changes was an income tax benefit of $0.3 million recorded in 2010. Discontinued Operations During 2003, we completed two transactions to sell our retail Digital Video and Digital Media Reader business. During 2006, we completed the sale of substantially all the assets and some of the liabilities associated with our Digital TV solutions business. Gain from discontinued operations in 2010 was mainly related to changes in estimates for lease commitments and termination of our lease agreement for premises leased in the UK and U.S. Liquidity and Capital Resources For the twelve months ended December 31, 2012, our working capital, which we have defined as current assets less current liabilities, was $(0.1) million, a decrease of approximately $16.8 million compared to $16.7 million as of December 31, 2011. The decrease in working capital reflects a $10.2 million net decrease in cash and cash equivalents and inventory, as well as a $11.9 million net increase in accounts payable, liability to related party, liability for consumer cards, financial liabilities, deferred revenue, and other accrued expenses, offset by a $4.9 million increase in accounts receivable and prepaid expenses and other current assets, and a $0.4 million decrease in accrued compensation and related benefits. Cash and cash equivalents were $7.4 million as of December 31, 2012, a decrease of approximately $9.8 million compared to $17.2 million as of December 31, 2011 as a result of cash of $12.2 million used in operations, a cash payment of approximately $0.5 million for the acquisition of the remaining outstanding shares of idOnDemand, approximately $2.8 million used for capital expenditures, $0.5 million used in software development, and $2.1 million cash payments on financial liabilities, offset by $6.9 million net proceeds received from issuance of debt, an acquired cash balance of $0.6 million from the acquisition of payment solution, a $0.3 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 $0.2 million on cash and cash equivalents. The following summarizes our cash flows for the twelve months ended December 31, 2012 and 2011 (in thousands): 12 Months Ended 12 Months Ended December 31, December 31, 2012 2011 Net cash used in operating activities from continuing operations $ (12,180 ) $ (4,645 ) Net cash provided by (used in) investing activities (2,669 ) (6,882 ) Net cash provided by financing activities 4,856 17,638 Effect of exchange rates on cash and cash equivalents 132 329 Net increase in cash and cash equivalents (9,861 ) 6,440 Cash and cash equivalents, beginning of year 17,239 10,799 Cash and cash equivalents, end of year $ 7,378 $ 17,239 Significant commitments that will require the use of cash in future periods include obligations under operating leases, liability to a related party, a secured note, an acquisition debt note, a mortgage bank loan, bank loan, equipment financing liabilities, pension plan obligations, inventory purchase commitments and other contractual agreements. Gross committed operating lease obligations are approximately $5.1 million, liability to related party is approximately $10.5 million, the equipment financing liabilities are approximately $3.1 million, the bank loan is approximately $2.2 million, the secured note is approximately $9.9 million, the acquisition debt note is approximately $0.4 million, the mortgage bank loan is approximately $1.1 million, the bank line of credit is approximately $0.3 million, pension plan obligations are $0.5 million, and inventory and other purchase 62-------------------------------------------------------------------------------- Table of Contents commitments are approximately $9.6 million at December 31, 2012. Total commitments due within one year are approximately $18.7 million and due thereafter are approximately $24.0 million at December 31, 2012. Cash used in investing activities primarily reflects approximately $3.3 million spent for capital expenditures and capitalized software development costs, offset by $0.6 million cash acquired from the acquisition of payment solution. Cash provided by financing activities primarily reflects $6.9 million net cash proceeds from issuance of debt under a secured debt facility and $0.3 million cash proceeds from issuance of common stock under our employee stock purchase plan, offset by a cash payment of approximately $0.5 million for the acquisition of the noncontrolling interest in idOnDemand, $2.1 million paid for financial liabilities, which consist of equipment financing liabilities, a bank loan and debt note, and $0.3 million net change in bank line of credit. With the exception of one insignificant subsidiary, we consider the undistributed earnings of our foreign subsidiaries, if any, as of December 31, 2012, to be indefinitely reinvested and, accordingly, no U.S. income taxes have been provided thereon. Generally most of our foreign subsidiaries have accumulated deficits and cash and cash equivalents that are held outside the United States are typically not cash generated from earnings that would be subject to tax upon repatriation if transferred to the United States. We have access to the cash held outside the United States to fund domestic operations and obligations without any material income tax consequences. As of December 31, 2012, the amount of cash included at such subsidiaries was approximately $3.6 million. We have not, nor do we anticipate the need to, repatriate funds to the United States to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements. On October 30, 2012, we entered into a Loan and Security Agreement (the "Loan Agreement") with Hercules Technology Growth Capital, Inc. 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 "Secured Note"). Our obligations under the Loan Agreement and the Secured Note are secured by substantially all of our assets. We received net proceeds of approximately $6.9 million after incurring approximately $0.6 million in issuance costs related to the Secured Note. Amongst others, the Loan Agreement requires us to maintain a certain amount of revenue, EBITDA, and current ratio on a consolidated basis ("covenants"). If any covenants are not met, the violation may constitute an event of default. Upon the occurrence and during the continuance of an event of default, the lender may, among other things, accelerate the loan and seize collateral or take other actions of a secured creditor. See Item 8, Financial Statements and Supplementary Data, Note 10 of Notes to Consolidated Financial Statements, Financial Liabilities for more information. 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. As of December 31, 2012, we have total accumulated deficit of approximately $286.0 million. During the year ended December 31, 2012, we sustained consolidated net losses of $53.6 million, of which $51.9 million related to impairment of goodwill and long-lived assets. Our working capital reduced significantly as of December 31, 2012 as compared to December 31, 2011. These factors, among others, including the recent effects of the U.S. Government "sequester" and related budget uncertainty on certain parts of our business, have raised significant doubt about our ability to continue as a going concern. 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 on NFC, SaaS and SmartCore. 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 of use. In addition, 63-------------------------------------------------------------------------------- Table of Contents 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. 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 consolidated financial statements have been prepared under the assumption that we will continue as a going concern. Such assumption contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Our continuation as a going concern is contingent upon our ability to generate revenue and cash flow to meet our obligations on a timely basis and our ability to raise financing or dispose of certain noncore assets as required. 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. For example, our preliminary financial results for the first two months of 2013 have been adversely impacted by the recent effects of the U.S. Government "sequester" on our U.S. Government business and could cause our operating results for the first quarter of 2013 to fall below any guidance we provide to the market or below the expectations of investors or securities analysts, particularly with respect to the first quarter of 2013, which is seasonally our weakest quarter of the year. If these events, like the sequester, cause a significant adverse impact on our revenues, expenses or savings from our cost reduction activities, 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 public or private offerings of additional debt or equity during the course of the year or in the near term as we may deem appropriate. The sale of additional debt or equity securities may cause dilution to existing stockholders. However, 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. Off-Balance Sheet Arrangements We have not entered into off-balance sheet arrangements, or issued guarantees to third parties. Contractual Obligations The following summarizes expected cash requirements for contractual obligations as of December 31, 2012 (in thousands): Less Than 1 1-3 3-5 More Than 5 Total Year Years Years Years Operating leases $ 5,103 $ 2,283 $ 1,907 $ 913 $ - Liability to related party 10,513 1,096 2,306 2,495 4,616 Equipment financing liabilities 3,136 1,326 1,810 - - Bank loan 2,213 643 904 666 - Secured note 9,907 3,108 6,799 - - Acquisition debt note 424 424 - - - Mortgage loan payable to bank 1,102 99 189 177 637 Bank line of credit 253 253 - - - Expected payments for pension plans 486 19 63 98 306 Purchase commitments and other obligations 9,595 9,492 78 25 - Total obligations $ 42,732 $ 18,743 $ 14,056 $ 4,374 $ 5,559 64 -------------------------------------------------------------------------------- Table of Contents The secured debt facility relates to a loan and security agreement entered into by us on October 30, 2012 with Hercules Technology Growth Capital, Inc. The acquisition debt note was issued in connection with our acquisition of Smartag in November 2010. Equipment financing liabilities and a bank loan were acquired in connection with our acquisition of payment solution in January 2012. The mortgage loan payable to bank was acquired in connection with our acquisition of Bluehill ID in January 2010. See Item 8, Financial Statements and Supplementary Data, Note 10, of Notes to Consolidated Financial Statements, Financial Liabilities for more information about the financing liabilities listed in the table above. Our liability to related party was acquired in connection with our acquisitions of Hirsch and payment solution. See Item 8, Financial Statements and Supplementary Data, Note 9 of Notes to Consolidated Financial Statements, Related-Party Transactions, for more information about this liability, which is listed in the table above. Purchases for inventories are highly dependent upon forecasts of customer demand. Due to the uncertainty in demand from our customers, we may have to change, reschedule, or cancel purchases or purchase orders from our suppliers. These changes may lead to vendor cancellation charges on these purchases or contractual commitments. See Item 8, Financial Statements and Supplementary Data, Note 16 of Notes to Consolidated Financial Statements, Commitments, for more information about the contractual obligations listed in the table above. The Company's consolidated balance sheets consist deferred tax liabilities and other long-term liability which includes gross unrecognized tax benefits, and related gross interest and penalties. As of December 31, 2012, the Company had noncurrent deferred tax liabilities of $0.1 million. In addition, as of December 31, 2012, the Company had gross unrecognized tax benefits of $0.1 million and an additional $0.1 million for gross interest and penalties classified as noncurrent liabilities. At this time, the Company is unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities; therefore, such amounts are not included in the contractual obligation table above. [ Back To TMCnet.com's Homepage ]