10-K 1 d446485d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

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

For the fiscal year ended December 31, 2012

OR

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

For the transition period from                      to                     

COMMISSION FILE NUMBER 0-29440

 

 

IDENTIVE GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

DELAWARE   77-0444317
(State or other jurisdiction of   (I.R.S. Employer
Incorporation or organization)   Identification Number)
1900-B Carnegie Avenue, Santa Ana, California   92705
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code:

(949) 250-8888

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value, and associated Preferred Share Purchase Rights

(Title of Class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  þ

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements or any amendment to this Form 10-K.  ¨

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

 

Large accelerated filer  ¨   Accelerated filer  ¨   Non-accelerated filer  þ   Smaller Reporting Company    ¨
    (do not check if smaller reporting company)  

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

Based on the closing sale price of the Registrant’s Common Stock on the NASDAQ National Market System on June 30, 2012, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of Common Stock held by non-affiliates of the Registrant was $44,528,700.

At March 12, 2013, the registrant had outstanding 60,259,580 shares of Common Stock, excluding 618,400 shares held in treasury.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Designated portions of the Company’s Proxy Statement and Notice of Annual Meeting to be filed within 120 days after the Registrant’s fiscal year end of December 31, 2012 are incorporated by reference into Part II, Item 5 and Part III of this Report.

 

 

 


Table of Contents

Identive Group, Inc.

Form 10-K

For the Fiscal Year Ended December 31, 2012

TABLE OF CONTENTS

 

     Page  
PART I   
Item 1  

Business

     1   
Item 1A  

Risk Factors

     14   
Item 1B  

Unresolved Staff Comments

     35   
Item 2  

Properties

     36   
Item 3  

Legal Proceedings

     36   
Item 4  

Mine Safety Disclosures

     36   
PART II   
Item 5  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     37   
Item 6  

Selected Financial Data

     40   
Item 7  

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

     41   
Item 7A  

Quantitative and Qualitative Disclosures About Market Risk

     65   
Item 8  

Financial Statements and Supplementary Data

     67   
Item 9  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     118   
Item 9A  

Controls and Procedures

     118   
Item 9B  

Other Information

     120   
PART III   
Item 10  

Directors, Executive Officers and Corporate Governance

     121   
Item 11  

Executive Compensation

     121   
Item 12  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     121   
Item 13  

Certain Relationships and Related Transactions, and Director Independence

     121   
Item 14  

Principal Accountant Fees and Services

     121   
PART IV   
Item 15  

Exhibits and Financial Statement Schedule

     122   
Signatures      123   


Table of Contents

Identive Group and the Identive logo are trademarks of Identive Group, Inc., registered in many jurisdictions worldwide. Certain product and service brands are also trademarks or registered trademarks of Identive, including Cashless Betalen, CHIPDRIVE, HIRSCH, idOnDemand, JustPay, Multicard, payment solution, polypurse, Smartag, SmartCore, Tagtrail and Velocity. Other product and brand names not belonging to Identive that appear in this document may be trademarks or registered trademarks of their respective owners.

Statement Regarding Forward Looking Statements

This Annual Report on Form 10-K, including the documents incorporated by reference in this Annual Report, contains forward-looking statements for purposes of the safe harbor provisions under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. For example, statements, other than statements of historical facts regarding our strategy, future operations and growth, financial position, projected results, estimated revenues or losses, projected costs, prospects, plans, market trends, competition and objectives of management constitute forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “will,” “believe,” “could,” “should,” “would,” “may,” “anticipate,” “intend,” “plan,” “estimate,” “expect,” “project” or the negative of these terms or other similar expressions. Although we believe that our expectations reflected in or suggested by the forward-looking statements that we make in this Annual Report on Form 10-K are reasonable, we cannot guarantee future results, performance or achievements. You should not place undue reliance on these forward-looking statements. All forward-looking statements speak only as of the date of this Annual Report on Form 10-K. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our expectations change, whether as a result of new information, future events or otherwise. We also caution you that such forward-looking statements are subject to risks, uncertainties and other factors, not all of which are known to us or within our control, and that actual events or results may differ materially from those indicated by these forward-looking statements. We disclose some of the factors that could cause our actual results to differ materially from our expectations in the “Customers,” “Research and Development,” “Competition,” “Proprietary Information and Technology,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and elsewhere in this Annual Report on Form 10-K. These cautionary statements qualify all of the forward-looking statements included in this Annual Report on Form 10-K that are attributable to us or persons acting on our behalf.

PART I

 

ITEM 1. BUSINESS

Overview of the Company

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. Through internal development and targeted acquisitions, we have built a platform of foundational identification technologies, including smart card-based security encryption technology and radio frequency identification (“RFID”) contactless communication technology. We leverage our expertise in these core identification technologies 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 and software products, integrated systems and services to address the global markets for 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 payment sectors. Our business model is principally focused on strong technology-driven organic growth based on both established markets and emerging opportunities for Secure ID.

 

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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 also use HIRSCH™ and idOnDemand™ as product sub-brands, Multicard™ as our brand for regional ID Solutions offerings in select markets, and payment solution™ 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™.

Sales from our Identity Management segment accounted for approximately 57% of our total revenue in 2012, 55% of our total revenue in 2011 and 56% of our total revenue in 2010. Sales from our ID Products segment accounted for approximately 43% of our total revenue in 2012, 45% of our total revenue in 2011 and 44% of our total revenue in 2010. Additional information about our results for the last three years for these segments is provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K. See Note 12 of Notes to Consolidated Financial Statements in Item 8 below for further details about revenue and assets by region.

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.

Industry Background

We operate in the market for secure identification, or Secure ID solutions, which depend upon the use of electronic identity credentials that enable organizations to manage access to facilities, digital assets and other resources. In addition to identifying the holder, electronic credentials are used to authorize the granting of rights

 

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and privileges, for example to gain access to a building or network, to access funds from a bank account or digital wallet, or to access information or services, such as tax records or healthcare data.

Electronic identity credentials most commonly take the form of tickets, cards or tokens and also are beginning to be embedded within mobile phones. Electronic tickets frequently are used to gain entry to public transportation, amusement parks and ski areas, and utilize radio frequency identification, or RFID technology, which automatically identifies and verifies each ticket via a wireless radio connection. Common card-type credentials include chip-based cards known as smart cards that can be securely encrypted with data such as a unique identity code and information about specific rights for one or more applications; the card must then be read in order to authenticate the holder before access or other privileges are granted. Smart cards commonly are used for building and/or network access, drivers’ licenses, national IDs, employee IDs, student IDs and bank cards. The identification codes and data associated with electronic credentials also may be incorporated into tokens such as a key fob, or embedded within a personal digital device such as a smartphone.

Electronic identity credentials require a corresponding infrastructure of readers, software and systems with which to interact and process the data they hold. This infrastructure includes readers or terminals, as well as software- and hardware-based application management systems such as those that control physical and network access or those that process payment transactions.

In addition, because each electronic identity credential identifies a specific individual or object and may be linked to the granting of specific privileges, for many applications it is critical that credentials are issued and managed in a secure and systematic manner. Therefore, credential issuance and management often is closely controlled and may involve compliance with various specifications and standards of issuing organizations, such as government agencies, banks, universities or corporations.

Depending upon the environment in which electronic identity credentials are used, the identification of people and the granting of defined privileges may require relatively little security, or may be subject to a significant amount of regulatory compliance. Below are some of the features that characterize the primary ID market environments in which electronic credentials are used:

 

   

Consumer ID: The use of RFID-based electronic credentials for consumer applications such as transit or ski ticketing speeds the process of processing ticket holders, thereby providing convenience for users and cost savings for service providers. Colleges and universities also issue electronic identity cards to their students to manage access and rights for dormitories, classrooms, the library, parking and campus networks. Equipping smartphones with a type of close-range RFID technology known as near field communication, or NFC, provides phones with the ability to interact with RFID readers to transmit ticket details, identity credentials and other information. Smartphones and other personal electronic devices now enjoy widespread popularity, and therefore provide an ideal mobile platform for storing electronic identity credentials for a variety of consumer applications, including transit or event ticketing, merchant loyalty programs, merchandise coupons, banking and payment.

 

   

Employee ID: Employers routinely issue identity credentials, often in the form of cards or tokens, to their employees in order to enable visual identification and to grant access to buildings, computer networks and other resources. In the United States, government agencies used highly secure, smart card-based credentials that are designed to be interoperable between agencies and comply with numerous regulations concerning their security and mode of use. Common to the enterprise and government environments is the need to safeguard their personnel and protect their physical and digital assets from theft or misuse. Identity management programs that use secure electronic credentials are the foundation security in the Employee ID environment.

 

   

Citizen ID: Government-issued electronic ID cards help protect citizens against identity theft and enable users to digitally sign documents and interact with government agencies online, reducing administrative costs and increasing efficiency for both users and administrators. Many countries around

 

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the world have adopted electronic passports, which incorporate an embedded smart chip that stores identifying information such as a photograph and fingerprint and which can be read by an RFID reader. Several countries also have adopted or are in the process of implementing electronic national ID cards based on smart card technology. These include Bahrain, Belgium, Finland, Italy, The Netherlands, Germany, Oman, Portugal, Qatar, Saudi Arabia, Spain, Sweden and the UAE. In many cases, these electronic national ID cards can be used by citizens not only to access government services but also to conduct private online business in a secure fashion.

 

   

Asset ID: RFID technology is often employed to track and protect high value assets such as pharmaceutical products, medical devices, library media and animals (pets or livestock). Identification “credentials” in the form of tags are used to identify each asset. The RFID tags contain a chip and an antenna for transmitting data to a reader.

The need for identity management solutions based on smart card and RFID technologies continues to grow, to address the evolving Consumer ID, Employee ID, Citizen ID and Asset ID markets.

Identive’s Strategy

Our mission is to be 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 broad range of offerings enables us to address all of the primary Secure ID markets: Consumer ID, Employee ID, Citizen ID and Asset ID. Each of these ID markets is influenced by its own set of drivers, such as convenience, security, regulatory compliance or cost savings. But all share the need for both products and complete solutions that allow people to gain access to the facilities, networks, information, systems and services they need – while ensuring that the physical facilities and digital assets of the organizations they interact with are protected.

Our business model centers on technology-driven organic growth using our existing capabilities, complemented by disciplined acquisitive activity. We pursue investments and acquisitions with a focus on increasing our scale, reinforcing our market position in targeted areas and fully leveraging our strengths and opportunities to enter new markets, as well as driving consolidation in the rapidly growing, yet fragmented markets for identification-based technologies.

We believe the market for Secure ID solutions offers significant opportunities for growth, both in terms of the continued use of core identification technologies and the emergence of newer technologies that are being harnessed for Secure ID applications. We believe the following technologies and trends are among the most important to drive opportunities for our business:

Increasing Use of Smart Card-based Credentials — A smart card is a credit card-sized plastic card with a built-in microcontroller or secure memory chip that allows the card to store large amounts of data, carry out on-card functions such as encryption and mutual authentication, and interact intelligently with a smart card reader. The self-contained processing and memory capabilities of smart cards makes them resistant to attack as they do not need to depend upon potentially vulnerable external resources. Because of this, smart cards are often used in applications that require a high level of security protection and authentication and increasingly are being used as identity credentials: by government agencies for Citizen ID and Employee ID programs, by educational institutions and enterprises for Employee ID programs, and for secure Consumer ID applications such as cashless payment. Traditional “contact” smart cards connect to a reader with direct physical electronic contact while “contactless” smart cards require only close proximity to a reader to connect via a radio frequency interface. In addition to traditional card formats, smart card technology is also incorporated into keyfobs, subscriber identity modules (SIMs) used in GSM mobile phones, and USB-based tokens.

 

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The market research firm Eurosmart reported in November 2012 that more than 7.0 billion smart cards shipped globally in 2012 and forecasts that 7.7 billion smart cards will ship in 2013, an expected growth rate of 10%. Major drivers of this growth include strong growth in the use of smart cards for banking applications as well as the ongoing roll-out of government card programs including national ID, electronic health cards and electronic drivers’ licenses. In its October 2012 report, ABI Research points to government programs using smart cards and predicts revenue from electronic national ID programs will more than double from $3.5 billion in 2012 to $7.6 billion in 2017. Also contributing to the growth of smart card technology is a pronounced trend towards embedding smart card secure elements within mobile phones, according to Eurosmart. Embedded smart card functionality enables mobile devices to act as secure credentials for a variety of applications, including NFC and cloud computing.

Identive is a leading global supplier of contact and contactless smart card reader technology for secure authentication, including readers for logical/cyber access, national ID, eGovernment and eHealth applications. Our capabilities also include patent-pending processes for manufacturing advanced smart card technology within a card’s inner layers, under our Smartcore brand. In addition, we have significant experience in deploying smart card-based systems that leverage multiple applications on a single card, such as physical access, logical access and payment. We believe that the continued growth in demand for smart card technology provides ongoing and new opportunities for our products and services.

Expanding Market for RFID Technology — Radio frequency identification, or RFID, is a wireless, short-range communications technology that uses radio waves to automatically identify people or objects. An RFID system consists of a reader and a transponder, or tag, which includes an integrated circuit (IC) or chip containing the information to be transmitted, and an antenna for receiving and transmitting the signal, both of which are affixed to a thin substrate called an inlay. Primarily because of the convenience it offers users, RFID is rapidly emerging as the replacement for traditional identification devices, such as those utilizing simple barcodes or magnetic stripes. RFID is also being incorporated into contactless smart cards, which in many applications are replacing contact smart cards that require insertion into a reader. In its July 2012 report, IDTechEx estimates the value of the overall RFID market in 2012 to be $7.67 billion, up 18% from $6.51 billion in 2011 and likely to continue to grow well in part due to high levels of government spending in RFID worldwide for applications ranging from non-stop road tolling and library tagging to national ID cards and passports. RFID increasingly is being used for Citizen ID applications such as national ID; Consumer ID applications such as transit and event ticketing, mobile payment and banking; Employee ID applications such as student IDs, employee IDs and physical and network access control; and Asset ID applications such as tracking of library media or pharmaceuticals.

We have significant expertise in the design and manufacture of RFID technology as well as a deep understanding of the security needs inherent in application areas that increasingly are employing RFID, such as Employee ID and access control. Building on a robust foundation of patented and patent-pending technologies, we specialize in combining and connecting integrated circuit chips from external suppliers with our own antenna designs to produce RFID inlays that can withstand the physical and environmental stresses in the various environments in which they are used. We also offer significant versatility in converting our inlays into finished RFID tags, labels and cards to address a range of applications, including asset tracking, transit and event ticketing, access control and secure mobile payment. In addition to RFID inlays and tags we also supply RFID tag and RFID smart card readers for a variety of applications. We believe we are very well positioned to address the growing demand for RFID products and solutions with our technology, expertise in design and manufacturing, and knowledge of the Secure ID applications market.

Use of NFC Technology to Enable Mobile Applications — An important development in the market for Secure ID is the expected rapid growth of a specific type of RFID technology known as near field communication, or NFC. NFC is a short-range connectivity technology that enables secure interactions between mobile devices, such as smartphones, and other devices, including NFC tags, readers and point-of-sale terminals. The adoption of NFC is still in an early stage, but as NFC-enabled smartphones and other mobile devices become

 

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broadly available there is expected to be a corresponding acceleration of new applications that use the devices to unlock doors, pay for purchases, store electronic tickets, log on to social media sites and much more. Building on the 100 million NFC mobile phones shipped in 2012, in a November 2012 report ABI Research predicts a significant increase in NFC-enabled mobile devices in the coming years and forecasts that 1.95 billion NFC devices will ship in 2017, including not only NFC phones but also media tablets, PC accessories and gaming consoles. To support emerging NFC applications, an infrastructure of NFC tags and readers also must be deployed. Consumer ID applications for which NFC is expected to be widely used include mobile payment, access control, ticketing, advertising and data sharing, as well as many others.

Identive has expertise in designing, manufacturing and applying NFC technology. We currently are one of the top NFC suppliers in the global marketplace and offer a wide range of NFC inlays, tags and readers, as well as NFC development kits that allow developers to create their own applications using NFC technology.

Mobile payment is one of the most exciting applications for NFC-enabled devices. ABI Research predicts that the total value spend of NFC mobile payments will rise from $4 billion in 2012 to $191 billion in 2017, breaking the $100 billion mark in 2016. While NFC makes it possible for people to use their smartphones to purchase items or services in the same way they would use a credit or debit card, the availability of such systems is expected to expand well beyond the large “open-loop” payment networks such as Visa and Mastercard. We have experience and know-how in developing and providing both prepaid (stored value) and credit-based NFC payment solutions, and have deployed such systems for retailers, fuel companies and stadium operators. We also have extensive experience in deploying our own software-based payment solutions, including Cashless Betalen™, which we developed to enable a secure digital wallet program for the Dutch financial institution, Rabobank, and polypurse™, which is a multi-function credential management and cashless payment platform for the Swiss education market.

Outside payment, we believe the opportunity for NFC technology is potentially even larger as it allows people to use the powerful mobile platforms they already carry with them – their smartphones – to consolidate all of their various ID credentials electronically and to interact with NFC posters, tags and readers to pick up information, connect with social media applications and simplify activities such as redeeming merchant coupons and loyalty awards or unlocking doors. For example, ABI Research predicts that 26% of all NFC phones will house a contactless transportation ticketing application by 2017, and research firm MforMobile predicts that once NFC is fully adopted, 65% of NFC transactions will not be related to straightforward payments but rather to value-added services such as access control and loyalty programs. In addition, we believe the NFC-enabled smartphone is an attractive platform for advertisers, as NFC provides a convenient way to deliver targeted, engaging multi-media content directly to consumers’ mobile phones, where it can be stored, shared and acted upon even after the original exposure. Our primary focus in the NFC area is on consumer-facing applications including advertising, marketing and social networking.

In November 2012 we launched Tagtrail, a mobile services delivery platform that allows advertisers, retailers and other organizations to deliver dynamic, personalized content and services to users’ mobile devices via NFC tags. Tagtrail uses cloud-based computing and analytics technology that allows campaign owners to target different content to individual users via the same NFC tag, using information about the smartphone and user interacting with the tag, as well as other criteria such as location of the tag and time of day. Tagtrail also includes a mobile application that users can download to share information with the platform that enables a more personalized and enjoyable experience when they tap an NFC tag connected to Tagtrail. To accommodate the fact that both NFC and non-NFC devices are widely used currently, Tagtrail also works with the phone-readable bar codes known as QR codes.

We believe our strength in both RFID and smart card technologies, our consumer-facing payment capabilities and our company-wide focus on NFC put us in a strong position to take advantage of the varied emerging opportunities for NFC technology in the Secure ID market.

 

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Trend Towards Converged Access — Within the Secure ID market, there is a pronounced trend towards the integration, or convergence of systems that provide physical access to buildings and logical access to PCs, IT/cyber networks or electronic logon systems. Traditionally, organizations have had disparate systems and policies in place for physical and logical access. This can result in gaps in security as breaches can occur due to the inability of the different systems to communicate. Increasingly, organizations are modifying their existing security systems or implementing new systems that combine the management and administration of both physical and logical access control. The goal of such converged systems is to provide integrated, policy-based logical and physical access as well as network provisioning throughout a user’s lifecycle. The shift towards converged access is particularly prevalent in the U.S. Government market, as Homeland Security Presidential Directive (“HSPD”)-12, Federal Information Processing Standards (“FIPS”) 201 and other policies mandate that personal identification verification cards utilizing secure contactless interface technologies be issued to all personnel, across federal agencies, both to provide secure authentication of employees and to provide secure access to facilities and computer networks. The goal behind these mandates is to increase the security of personnel and assets through the use of converged access control systems. Many state and local government agencies are modeling their own identity management programs for law enforcement and other first responders on the federal credential standards.

We are a leading provider of smart card readers for logical access applications and of physical access control systems, and our HIRSCH Velocity™ software is one of the most highly regarded security and identity management platforms in the market. We have been a trusted supplier of both physical and logical access solutions to the U.S. Government for many years and have been deeply involved in the development of new standards designed to address the convergence of physical and logical access systems. Our offerings include identity-based integrated security systems that provide converged physical and logical access control. To further strengthen our ability to address the need for converged systems, in early 2012 we formed a dedicated Converged Access group within our Identification Products division that is focused on developing a new range of converged readers and secure credentials that work across a large number of proprietary, legacy and standards-based technologies. These converged access products build and expand on our expertise in smart card reader technology and on innovative credential recognition technology acquired through our acquisition of idOnDemand in 2011. During 2012 we also expanded our capabilities beyond smart card readers to develop and manufacture secure identity credentials. We believe we are well positioned to benefit from the trend towards convergence as the federal government, state and local agencies as well as corporate organizations invest in the migration towards new integrated systems based on the federal identity credential guidelines.

Acquisition History

To strengthen and expand our capabilities in the Secure ID market, from time to time we acquire other companies that we believe can provide us with important technology, market coverage or other benefits. During the last three years, we have acquired the following companies:

 

   

On January 4, 2010, we acquired Bluehill ID AG, a publicly-held RFID technology and ID solutions company based in Switzerland.

 

   

On April 14, 2010, we acquired RockWest Technology Group, a privately-held provider of identification and security solutions based in Denver, Colorado.

 

   

On November 19, 2010 we acquired Smartag, a Singapore-based manufacturer of high frequency (“HF”) and ultra high frequency (“UHF”) RFID inlays and inlay-based solutions.

 

   

On May 2, 2011, we acquired approximately 95.8% of the outstanding shares of idOnDemand, a privately-held provider of cloud-based credential management solutions based in Pleasanton, California. We acquired the remaining shares of idOnDemand in January 2012.

 

   

On July 18, 2011, we acquired polyright SA, a privately-held provider of identity management platforms and open-ended rights and services management solutions for higher education, healthcare and industry, based in Switzerland.

 

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On January 30, 2012, 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. In April 2012, we acquired additional non-controlling interest and increased our ownership to approximately 82.5% of the outstanding shares of payment solution.

We believe our robust technology portfolio, our expertise in key identification technologies and our broad selection of products, software, systems and services for secure identification applications position Identive as the signature company in Secure ID.

Our Offerings and Brands

Currently, we address the primary ID markets for secure identification solutions with the products, systems and services described below.

Identification Products

RFID and NFC Transponder Products — Our Transponder products include RFID inlays and inlay-based cards, labels, tags and stickers, including NFC inlays and tags, as well as other radio frequency (“RF”) and IC components. We manufacture our Transponder products at state of the art facilities in Sauerlach, Germany and Singapore, and we market and sell our Transponder products from these facilities as well as from operations in the U.S., Canada, Hong Kong and Tokyo. Our inlays and converted inlay products are used in a diverse range of applications, including transport and event ticketing, asset tracking, secure mobile payments and numerous NFC-based ID applications. The majority of our Transponder products are RFID inlays, which, along with our NFC products, are sold under the Identive brand. We sell our Transponder products primarily under the Identive brand and also utilize some product specific brands including SmartCore and Smartag.

ID Infrastructure Products — Our ID Infrastructure products include a broad range of contact, contactless and mobile smart card readers and terminals as well as digital identity and transaction platforms that are utilized around the world to enable logical and physical access, security and identification applications, transaction systems, and eHealth- and eGovernment programs. Our ID infrastructure products are designed at our research and development center in India and manufacturing is outsourced. We serve our global ID Infrastructure customer base from operational headquarters in Germany and sales offices in the U.S., Hong Kong and Tokyo. The majority of our ID Infrastructure products are sold under the Identive brand. We also offer a range of smart card-based security, productivity and time recording solutions for small and medium-size businesses under our retail CHIPDRIVE brand.

Identity Management & Cloud Solutions

Physical Access Control and Identity-based Integrated Security Systems — We market and sell enterprise-class physical access control and identity-based integrated security systems for Employee ID in the government and enterprise under our HIRSCH brand. Our HIRSCH security systems integrate access control, video surveillance, intrusion detection, building management and other network-based systems using a wide range of credentials, including digital certificates, smart cards, RFID cards and biometrics in order to successfully secure facilities, digital assets and electronic transactions. We design and support our HIRSCH systems from our facility in Santa Ana, California.

Identity as a Service — Under our idOnDemand brand, we market and sell cloud-based credential management services that allow organizations to quickly, easily and cost effectively grant trusted access for employees, customers and partners to information and assets such as IT systems, remote access, data encryption, secure email, building access and mobile authentication. We deliver our credential management solutions using standards-based technology and a Software as a Service, or SaaS, model.

 

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Customized ID Solutions

We offer customized integration services that enable a diverse range of Consumer and Citizen ID applications, including credential issuance and personalization, “smart city” and e-Government service provisioning, multi-application campus ID solutions, and cashless payments. Through our local ID solutions operations in Australia, Germany, The Netherlands, Switzerland and the U.S., we work with customers in the government, education, healthcare, corporate, financial and retail markets to design, build, install and support integrated ID solutions.

To address the need for payment applications, we offer a variety of secure, customized ID solutions for mobile payment, loyalty and hospitality for stadiums, sports clubs, restaurants, universities, retailers, festivals and other environments. Our Cashless Betalen system is a cashless payment application used with the digital wallet offered by Rabobank, one of Holland’s leading banks. Our payment solutions for European stadiums and other event venues speed concession and merchandise purchases for visitors and increase profits for merchants and venue owners. Our payment systems for university campuses in Switzerland integrate payment with other ID functions to create all-in-one ID credentials for payment, building access, library checkout, locker or bike rental. We offer closed-loop payment systems for fuel stations in Holland and Australia. We also work with our customers to create custom payment solutions that utilize our extensive expertise and technology portfolio to meet the unique requirements of each organization.

Mobility and NFC Solutions

Augmenting and leveraging our NFC inlays, tags and readers, in November 2012 we launched Tagtrail, a cloud-based mobile services platform that allows advertisers, retailers and other organizations to deliver dynamic, personalized content and services to users’ mobile devices via NFC and QR codes. Tagtrail is offered as a complete solution that includes cloud-based content delivery and analytics services, NFC or QR code tags and a mobile user app. The mobile app allows users to store, organize and revisit the personalized content received from NFC tags so it can be re-lived and shared later. Tagtrail also supports an online community forum that allows current and potential users to ask questions, get support and share feedback with each other and with Identive to enhance their mobile NFC experience and help drive future Tagtrail improvements.

Customers

We sell to customers worldwide in a diverse range of markets, including government, enterprise, consumer, education, healthcare and transportation. Sales to our top ten customers accounted for approximately 24% of total revenue in 2012, 25% of total revenue in 2011 and 24% of total revenue in 2010. No customer accounted for more than 10% of the Company’s total revenue in 2012, 2011 or 2010. A significant amount of our revenue comes from sales of products and systems to various entities of the U.S. federal government sector. A significant amount of our federal government sales are made through our OEM partners and indirect sales network or are priced using published General Service Administration schedules. We cannot guarantee that any reductions in U.S. Government budgets will not impact our sales to these government entities or that the terms of existing contracts will not be subject to renegotiation.

Sales and Marketing

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/or end customers, provide technical advice and support with respect to products, systems and services, and manage relationships with customers, distributors and/or OEMs. We sell the majority of our Identification Products directly to end-users and utilize indirect sales channels including OEMs, dealers, systems integrators, value added resellers, resellers and 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 idOnDemand cloud-based credential

 

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management solution primarily utilizing a direct selling model. We sell our Tagtrail mobile content delivery service directly to end customers and through channel partners such as mobile service operators. We maintain an online marketplace for our NFC products at www.IdentiveNFC.com. In support of our sales efforts, we participate in trade shows and conduct sales training courses, targeted marketing programs and advertising, and ongoing customer and third-party communications programs.

Competition

The market for secure identification products, systems and solutions is competitive and characterized by rapidly changing technology, as well as fragmentation of solutions providers. We believe that competition in this market is likely to intensify as a result of an ongoing increase in demand for RFID technology, converged access control systems, credential issuance and management, cashless payment solutions, NFC applications and other identification-based solutions.

We face a range of competition for our products, systems and solutions. In our ID Products segment, competition for our smart card readers and other products primarily comes from several well-established companies, including Gemalto NV and HID Global (a division of ASSA ABLOY AB), as well as from a number of smaller suppliers in Asia. Competition for our RFID inlays and inlay-based products comes from a small number of organizations that understand the specialized processes and have the capital equipment required to serve the transponder market. Competitors in this market include SMARTRAC NV, which in the last few years has acquired former competitors UPM RFID and KSW Microtec, as well as a number of inlay conversion companies in Asia. In the market for NFC tags, readers and other solutions, we face competition from traditional smart card reader and RFID technology providers, including Gemalto and ASSA ABLOY for NFC readers, and SMARTRAC and other inlay converters for NFC tags.

In our Identity Management segment, enterprise-class physical access control and identity-based integrated security systems are available from multiple suppliers. In this market we primarily compete with AMAG Technology (a division of G4S plc), Lenel Systems International (a division of United Technologies Corp.), Software House (a division of Tyco International Ltd.) and Honeywell International Inc. In the market for ID systems integration and credential issuance, we compete primarily with system integrators that focus on providing card-based identity systems. These integrators vary by market and geography and include large international firms as well as local suppliers focused on serving specific countries or regions. Competition for our credential management systems includes HID Global in the physical access sector, but in the logical access sector competition centers around whether or not the customer chooses to deploy a traditional in-house system assisted by vendors such as ActivIdentity (a division of ASSA ABLOY) and Intercede Group plc, or adopt a cloud-based model, which we have pioneered with our idOnDemand service. For our Tagtrail mobile services platform, competition is nascent as both large companies and start-ups begin to develop solutions for NFC-based mobile service delivery.

We also experience indirect competition from certain of our customers who currently offer alternative approaches or are expected to introduce competitive products in the future. We may in the future face competition from these and other parties that develop secure identification and RFID products based upon approaches similar to or different from those employed by us. In addition, the market for secure identification and RFID products may ultimately be dominated by approaches other than the approach marketed by us. We believe that the principal competitive factors affecting the market for our products, systems and solutions include:

 

   

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

 

   

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

 

   

technical features;

 

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the ability of suppliers to effectively integrate multiple products and systems in order to address customer requirements including full system capabilities, cost of ownership and ease of use;

 

   

quality and reliability;

 

   

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

 

   

ease of use;

 

   

strength of sales and distribution channels; and

 

   

price and total cost of system ownership.

While we believe that we compete favorably within our market environment, our ability to continue to successfully compete is subject to a variety of factors, as further discussed in “Risk Factors.”

Seasonality

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 typically are subject to U.S. Government budget cycles and are generally highest in the third quarter of each year. Sales of our smart card readers and chips for government programs are impacted by testing and compliance schedules of government bodies as well as roll-out schedules for application deployments, both of which contribute to variability in demand from quarter to quarter. Further, 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 Transponder products also tend to be marginally stronger in the second half of the year.

Backlog

We typically do not maintain a significant level of backlog and revenue in any quarter significantly depends on contracts entered into or orders booked and shipped in that quarter. The majority of our sales are made primarily pursuant to purchase orders for current delivery or agreements covering purchases over a period of time. While our customer contracts generally do not require fixed long-term purchase commitments, from time to time we do enter into customer contracts where delivery of products, systems or services is ongoing or is scheduled over multiple quarters or years. In view of our order and shipment patterns, and because of the possibility of customer changes in delivery schedules or cancellation of orders, we do not believe that such agreements provide meaningful backlog figures or are necessarily indicative of actual sales for any succeeding period.

Research and Development

We have made substantial investments in research and development (“R&D”), particularly in the areas of our Tagtrail mobile services platform, software systems for payment, our idOnDemand cloud-based Identity as a Service offering, RFID and NFC inlays and related technology, smart card-based physical and network access devices, and physical access controllers, readers and security management software. We will continue to invest in R&D that advances key areas of our business. To ensure the effective use of R&D resources within each of our product and solutions areas and to facilitate sharing of technologies and expertise across the organization, we have an Executive Vice President of Technology and Product Management that oversees the application of resources. Within each product and solutions area and as needed between these areas, our engineering design teams work cross-functionally with marketing managers, applications engineers and customers to develop

 

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products, product enhancements, software and systems to meet customer and market requirements. We also strive to develop and maintain close relationships with key suppliers of components and technologies in order to be able to quickly introduce new offerings that incorporate the latest technological advances.

We focus the bulk of our R&D activities on the development of products and solutions for new and emerging market opportunities. R&D expenses were approximately $8.7 million in 2012, $7.0 million in 2011 and $4.7 million in 2010, and we capitaqlized approximately $0.5 million of expense related to development of our cloud-based identity management solutions. The majority of our R&D activities for smart card reader products and technologies occurs in India; the majority of R&D activities for our Identity as a Service and physical access control systems occurs in California; the majority of R&D for our Tagtrail NFC solutions platform occurs in France, Holland and the UK; the majority of R&D activities for our RFID inlays and inlay-based products occurs in Germany and Singapore; and the majority of R&D activities for our card and payment software systems occurs in The Netherlands, Germany and Switzerland.

Proprietary Technology and Intellectual Property

Our success depends significantly upon our proprietary technology. We currently rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights, which afford only limited protection. Although we often seek to protect our proprietary technology through patents, it is possible that no new patents will be issued, that our proprietary products or technologies are not patentable, and that any issued patent will fail to provide us with any competitive advantages.

There has been a great deal of litigation in the technology industry regarding intellectual property rights and from time to time we may be required to use litigation to protect our proprietary technology. This may result in our incurring substantial costs and there is no assurance that we would be successful in any such litigation. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to use our proprietary information and software without authorization. In addition, the laws of some foreign countries do not protect proprietary and intellectual property rights to the same extent as do the laws of the U.S. Because many of our products are sold and a substantial portion of our business is conducted outside the U.S., our exposure to intellectual property risks may be higher. Our means of protecting our proprietary and intellectual property rights may not be adequate. There is a risk that our competitors will independently develop similar technology, duplicate our products or design around our patents or other intellectual property rights. If we are unsuccessful in protecting our intellectual property or our products or technologies are duplicated by others, our business could be harmed.

In addition, we have from time to time received claims that we are infringing upon third parties’ intellectual property rights. Future disputes with third parties may arise and these disputes may not be resolved on terms acceptable to us. As the number of products and competitors in our target markets grow, the likelihood of infringement claims also increases. Any claims or litigation may be time-consuming and costly, divert management resources, cause product shipment delays, or require us to redesign our products, accept product returns or to write off inventory. Any of these events could have a material effect on our business and operating results.

We are expanding our portfolio of more than 30 patent families (designs, patents, utility models, patents pending and exclusive licenses) in individual or regional filings, covering products, electrical and mechanical designs, software system and methods and manufacturing process ideas for our various businesses. In 2012 we made 15 filings in RFID tags, converged access readers and systems, smart card manufacturing methods, authentication and cloud based systems, and NFC offerings, and have submitted seven additional patent applications to date in 2013. Additionally, we leverage our own ASIC designs for smart card interface in some of our reader devices. However, none of our patents are currently material to our business.

 

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Manufacturing and Sources of Supply

We utilize a combination of our own manufacturing facilities and the services of contract manufacturers in various countries around the world to manufacture our products and components. Our physical access keypads, controllers and software are manufactured primarily in California, using locally sourced components. The majority of our smart card reader products and components are manufactured in Singapore and China and are certified to the ISO 9001:2000 quality manufacturing standard, and our remaining smart card readers and components are manufactured in Germany and India. Our RFID inlays and inlay-based products such as labels and tags are manufactured and assembled by our own internal manufacturing teams in Singapore using locally sourced components and in Sauerlach, Germany using components sourced both locally and in Asia.

To meet increasing customer demand for RFID inlays and finished transponder products such as tags, labels and cards, during 2010 we doubled our transponder manufacturing capacity with the addition of new manufacturing equipment and lines in Germany and during 2012 we again increased our existing capacity with the addition of new equipment at our facility in Singapore, focused on the production of converted tags, tickets and labels. During 2012 we also set up a new manufacturing capability for our Smartcore™ card manufacturing products in Sauerlach, Germany and added NFC tag personalization and customization capabilities in the U.S. and Switzerland.

We have implemented formal quality control programs to satisfy customer requirements for high quality and reliable products. To ensure that products manufactured by third parties are consistent with internal standards, our quality control programs include management of all key aspects of the production process, including establishing product specifications, selecting the components to be used to produce products, selecting the suppliers of these components and negotiating the prices for certain of these components. In addition, we may work with suppliers to improve process control and product design.

We believe that our success will depend in large part on our ability to provide quality products and services while ensuring the highest level of security for our products during the manufacturing process. In the event any of our contract manufacturers are unable or unwilling to continue to manufacture our products, we may have to rely on other current manufacturing sources or identify and qualify new contract manufacturers. Any significant delay in our ability to obtain adequate supplies of our products from current or alternative sources would harm our business and operating results.

For the majority of our product manufacturing, we utilize a global sourcing strategy that serve all business solutions areas within the company, which allows us to achieve economies of scale and uniform quality standards for our products, and to support gross margins.

On an ongoing basis, we analyze the need to add alternative sources for both our products and components. For example, we currently utilize the foundry services of external suppliers to produce our ASICs for smart cards readers and inlays, and we use chips and antenna components from third-party suppliers in our RFID inlays and contactless smart card readers. Wherever possible, we have added additional sources of supply for components. However, a risk remains that we may be adversely impacted by an inadequate supply of components, price increases, late deliveries or poor component quality. In addition, some of the basic components used in our reader products, such as semiconductors, may at any time be in great demand. This could result in components not being available to us in a timely manner or at all, particularly if larger companies have ordered more significant volumes of those components, or in higher prices being charged for components.

Employees

As of December 31, 2012, we had 429 full-time employees, of which 91 were in research and development, 123 were in sales and marketing, 74 were in general and administrative and 141 were in manufacturing and related functions. We are not subject to any collective bargaining agreements and, to our knowledge, none of our

 

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employees are currently represented by a labor union. To date, we have experienced no work stoppages and believe that our employee relations are generally good.

Foreign Operations; Properties

We operate globally, with corporate headquarters in Santa Ana, California and European operational headquarters in Ismaning, Germany. We also maintain leased facilities in Australia, Canada, Germany, Hong Kong, India, Japan, The Netherlands, Singapore, Switzerland and the U.S. We consider these properties adequate for our business needs.

Legal Proceedings

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

We are not currently nor in the past twelve months have we been a party to any pending legal, governmental or arbitration proceeding, nor is, or was in the past twelve months our property the subject of any pending legal, governmental or arbitration proceeding, that is not in the ordinary course of business or otherwise material to the financial condition of our business nor are we aware that such proceedings are threatened.

Availability of SEC Filings

We make available through our website our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports free of charge as soon as reasonably practicable after we electronically file such reports with the Securities and Exchange Commission (“SEC”). Our Internet address is www.identive-group.com. The content on our website is not, nor should be deemed to be, incorporated by reference into this Annual Report on Form 10-K. Additionally, documents filed by us with the SEC may be read and copied at the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. Our filings with the SEC are also available to the public through the SEC’s website at www.sec.gov.

 

ITEM 1A. RISK FACTORS

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

Business and Strategic Risks

Uncertain economic conditions, particularly in Europe, may adversely affect overall demand and profitability in our business.

In recent times global economies have been impacted by disruptive financial events, economic uncertainty and continuing concerns about the economic stability of certain countries in the Economic and Monetary Union (“EMU” or “Euro Zone”). In particular, certain countries in Europe are working through a debt crisis that has led

 

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to an economic slowdown, or in some cases, a recession. If macroeconomic conditions deteriorate further or spread to additional countries in the region, it could adversely affect our results of operations and financial condition. The possibility that one or more member countries could leave the Euro Zone or that the currency union could break apart could raise legal, practical and procedural issues between the Company and our European customers, which comprise approximately one-third of our revenues. The continuation or deterioration of current global market conditions, including economic instability and uncertainty in Europe, could be accompanied by decreased demand for our customers’ products and solutions and weakness in our customers’ businesses that could result in decreased demand for our products and solutions. In addition, some of our customers may require substantial financing in order to fund their operations and make purchases from us, and volatility in the capital and credit markets may limit the availability of such financing for our customers. The inability of these customers to obtain sufficient credit to finance purchases of our products and meet their payment obligations to us, or possible insolvencies of our customers, could result in decreased customer demand, an impaired ability for us to collect on outstanding accounts receivable, significant delays in accounts receivable payments, and significant write-offs of accounts receivable, each of which could adversely impact our financial results.

We are exposed to credit risk on our accounts receivables.

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

Continuing weakness in global markets may adversely impact our suppliers.

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

Our markets are highly competitive and technology is rapidly evolving.

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

the ability to commercialize custom solutions for common customer requests.

 

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

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

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

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

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

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

Our future success will depend upon our ability to enhance our current products and solutions and to develop and introduce new offerings with clearly differentiated benefits that address the increasingly sophisticated needs of our customers and that keep pace with technological developments, new competitive product offerings and emerging industry standards. In addition, in cases where we are selected to supply products

 

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or solutions based on features or capabilities that are still under development, we must be able to complete our design, delivery and implementation process on a timely basis, or risk losing current and any future revenue from those offerings. In developing our offerings, we must collaborate closely with our customers, suppliers and other strategic partners to ensure that critical development, marketing and distribution projects proceed in a coordinated manner. Also, this collaboration is important because these relationships increase our exposure to information necessary to anticipate trends and plan product development. If any of our current relationships terminate or otherwise deteriorate, or if we are unable to enter into future alliances that provide us with comparable insight into market trends, our product development and marketing efforts may be adversely affected, and we could lose sales. We expect that our product development efforts will continue to require substantial investments and we may not have sufficient resources to make the necessary investments.

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

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

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

In order to remain competitive and rapidly adapt to changing conditions in our industry, we may require additional investments in research and development. As noted in the “Liquidity and Capital Resources” section of Part II, Item 7, if we fail to realize our current plan anticipating increased revenues and improved profit margins for at least the next twelve months, we may be required to curtail investments in research and development activities. If we are required to reduce our investment in research and development, we may be unable to compete effectively with newer products and technologies, and our financial results would be adversely affected.

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

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

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

 

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the size of the market that may develop. The demand and market acceptance for our offerings, as is common for new technologies, is subject to high levels of uncertainty and risk and may be influenced by various factors, including, but not limited to, the following:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

general economic conditions, for example economic uncertainty.

Acquisitions and strategic investments expose us to significant risks.

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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diversion of management resources;

 

   

failure to realize anticipated benefits of the acquisition;

 

   

costly fees for legal and transaction-related services; and

 

   

the unanticipated assumption of liabilities.

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

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

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

In October 2012, we entered into a Loan and Security Agreement with Hercules Technology Growth Capital, Inc. The loan agreement includes provisions that place limitations on a number of our activities, including our ability to incur additional debt, create liens on our assets or make guarantees, make certain investments or loans, pay dividends or dispose of or sell assets or enter into a merger or similar transaction. The loan agreement also contains financial covenants that require the Company to achieve certain levels of financial performance as measured periodically in terms of our EBITDA, revenues and current ratio. If an event of default in such covenants occurs and is continuing, the lender may, among other things, accelerate the loan and seize collateral or take other actions of a secured creditor. If the loan is accelerated, we could face a substantial liquidity problem and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness. Such alternative measures may not be available or successful. Also, our loan covenants may limit our ability to dispose of material assets or operations or to restructure or refinance our indebtedness. Even if we are able to restructure or refinance our indebtedness, the economic terms may not be favorable to us. All of the foregoing could have serious consequences to our financial condition and results of operations. Our ability to generate cash to meet scheduled payments with respect to our debt depends on our financial and operating performance, which in turn, is subject to prevailing economic and competitive conditions and the other factors discussed in this “Risk Factors” section. If our cash flow and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness as noted above. Such alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations.

If we are not able to secure additional financing when needed, our business could be adversely affected.

We may seek or need to raise additional funds for general corporate and commercial purposes or for acquisitions. Our ability to obtain financing depends on our historical and expected future operating and financial performance, and is also subject to prevailing economic conditions and to financial, business and other factors beyond our control. If we are unable to secure additional financing when desired, our ability to fund our business operations, make capital expenditures, pursue additional expansion or acquisition opportunities, or make another discretionary use of cash could be limited, and this could adversely impact our financial results. There can be no assurance that additional capital will be available to us on favorable terms or at all. The sale of additional debt or equity securities may cause dilution to existing stockholders.

 

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

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

Operational Risks

There are doubts about our ability to continue as a going concern. If we fail to generate revenue as forecast, improve our margins, realize savings from our cost reduction activities or are unable to obtain additional capital necessary to fund our operations, our financial results, financial condition and our ability to continue as a going concern will be adversely affected.

As discussed in “Liquidity and Capital Resources” in Item 7 of this report, as of December 31, 2012, we have a total accumulated deficit of approximately $286.0 million, and during the year ended December 31, 2012, we sustained a consolidated net loss of $53.6 million, of which $51.9 million related to impairment of goodwill and long-lived assets. These factors, among others, including the recent effects of the U.S. Government “sequester” and related budget uncertainty on a substantial part of our business, have raised significant doubt about our ability to operate as a going concern. 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 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.

Our consolidated financial statements have been prepared assuming that we will continue as a going concern. We have historically incurred operating losses and negative cash flows from operating activities, and we expect to continue to incur losses for the foreseeable future. Based on our current plans, we believe our current capital resources, including cash, cash equivalents, anticipated cash flow from operating activities, savings from cost reduction activities and available borrowings, should be sufficient to fund our operating expenses and capital requirements through the next twelve months.

However, there can be no assurance that we will be successful with our plans or that our future results of operations will improve. If revenue trends do not improve, our available liquidity from cash flows from operations will be adversely affected. We may need to resort to contingency plans, including further cost reductions or disposals of non-strategic activities. We may also need to raise additional debt or equity financing through public or private offerings over the next 12 months, including in the near term. There can be no assurance that we will be able to improve cash flows from operations, or that we will be able to access additional capital if and when required or on acceptable terms to us. Therefore, there can be no guarantee that our existing and anticipated capital resources will be adequate to meet our liquidity requirements. If we are unable to address our liquidity challenges, then our financial results and financial condition would be adversely affected.

We have incurred and may in the future incur significant costs associated with acquisitions, which reduces the amount of capital available to fund our business.

We have incurred, and in the future may continue to incur, significant costs associated with acquisitions. These costs may include investment banking fees, legal fees, accounting fees, printing and mailing of stockholder

 

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materials, integration, earn-outs, restructuring charges, and other costs, as well as past and possible future outlays of cash to support the business until its synergies are realized and sustainable. We may also incur costs related to potential future acquisitions, including expenditures on acquisition opportunities that do not result in completed transactions. As a result, the capital available to fund our activities has been and may in the future be further reduced. If we are unsuccessful in securing expected synergies from our acquisitions within a reasonable time period, then we will likely require additional cash to fund our operations.

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

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

During the second quarter of 2012, because of a significant decline in our stock price and revised forecasts regarding revenue, gross margin and operating profit, we undertook an interim review for potential impairment of our goodwill, intangible assets and other long-lived assets in connection with the second quarter close and recorded a goodwill impairment charge of $27.1 million in our consolidated statement 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. We will continue to monitor relevant market and economic conditions that could result in impairment, including a sustained drop in the market price of our common stock, increased competition or loss of market share, product innovation or obsolescence, or a decline of our business related to acquired companies. It is possible that conditions could deteriorate due to these factors, resulting in the need to adjust our estimates or to take additional impairment charges in the future. As a result, our operating results and stockholders’ equity could be materially and adversely affected.

We may experience quarterly fluctuations in our operating results due to a number of factors which make our future results difficult to predict and could cause our operating results to fall below any guidance we might issue or the expectations of public market analysts and investors.

Our quarterly and annual operating results have varied greatly in the past and will likely vary greatly in the future depending upon a number of factors, many of which are beyond our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. If our revenue or operating results fall below any guidance we may provide to the market or below the expectations of investors or securities analysts, the price of our common stock could decline.

In addition to other risk factors listed in this “Risk Factors” section, factors that may affect our quarterly operating results, business and financial condition include the following:

 

   

business and economic conditions overall and in our markets;

 

   

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

 

   

the recent effects of the U.S. Government “sequester” and related budget uncertainty on certain parts of our business;

 

   

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

 

   

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

 

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the absence of significant backlog in our business;

 

   

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

 

   

competition;

 

   

new product announcements or introductions;

 

   

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

 

   

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

 

   

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

 

   

technological changes in the markets for our products and solutions;

 

   

the rate of adoption of industry-wide standards;

 

   

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

 

   

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

 

   

strategic acquisitions, sales and dispositions;

 

   

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

 

   

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

 

   

loss of key personnel; and

 

   

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

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

Based upon all of the factors described above, we have a limited ability to forecast with certainty the amount and mix of future revenues and expenses, and it is possible that at some time our operating results will fall below our estimates or any guidance we may provide to the market or the expectations of public market analysts and investors.

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

In our Identity Management segment, sales tend to be relatively linear (regularly spaced throughout the quarter), as orders are tied to projects with relatively predictable timelines. In our ID Products segment, we sell our smart card readers primarily through a channel of distributors who place orders on an ongoing basis depending on their customers’ requirements. As a result, the size and timing of these orders can vary from quarter to quarter. This makes it difficult to predict revenues both in our smart card reader business, and for the company overall. In addition, the increasing use of RFID technology in the marketplace is resulting in larger program deployments of Transponder products and components. Accordingly, changes in ordering patterns, including delays or reductions in orders from our Transponder customers also can have a significant effect on our business. Across both our segments, the timing of closing larger orders increases the risk of quarter-to-quarter fluctuation in revenues. If orders forecasted for a specific group of customers for a particular quarter are not realized or revenues are not otherwise recognized in that quarter, our operating results for that quarter could be

 

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materially adversely affected. In addition, from time to time, we may experience unexpected increases or decreases in demand for our products resulting from fluctuations in our customers’ budgets, purchasing patterns or deployment schedules. These occurrences are not always predictable and can have a significant impact on our results in the period in which they occur.

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

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

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

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

Our business could be adversely affected by reductions or delays in the purchase of our products or services for government security programs in the United States and other countries.

We derive a substantial portion of our revenues from indirect sales to U.S. federal, state and local governments and government agencies, as well as from subcontracts under federal government prime contracts. Large government programs are an important market for our business, as higher security systems employing smart cards, RFID or other access control technologies are increasingly used to enable applications ranging from authorizing building and network access for federal employees to paying taxes online, to citizen identification, to receiving health care. We believe that the success and growth of our business will continue to be influenced by our successful procurement of government business either directly or through our indirect sales channels. Accordingly, changes in government purchasing policies or government budgetary constraints could directly affect our financial performance. Sales to government agencies and customers primarily serving the U.S. Government, including further sales pursuant to existing contracts, may be adversely affected by factors outside our control, such as the “sequestration” or other Congressional actions in addressing budget concerns, current economic uncertainty, downgrading of U.S. Government debt, the political climate in the U.S. focusing on cutting or limiting budgets and their effect on government budgets, limits on federal borrowing capacity, changes in procurement policies, budgetary considerations including Congressional delays in completing appropriation bills, domestic crises, international developments such as the downgrading of European debt, delays in developing technology standards related to government security programs, the adoption of new laws or regulations or changes to existing laws or regulations pertaining to electronic security, and changes in political or

 

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social attitudes with respect to security or electronic identification issues. In addition, our efforts to obtain new business may be hindered as budgetary or economic factors distract the attention of governments or impair the ability of governments to hear or act upon our value proposition due to reduced personnel or turnover. These same factors may also jeopardize our renewal or rebid opportunities on existing contracts. If current market and economic conditions persist or deteriorate, we may experience adverse impacts on our business, results of operations, cash flows, and financial condition. If agencies and departments of the United States or other governments were to stop, reduce or delay their use and purchases of our products and services, our revenue and operating results would be adversely affected.

Moreover, government orders are frequently awarded only after a formal competitive bidding process, which typically is protracted and dependent upon necessary funds being available to the public agency. We may not be awarded orders for which we bid directly and our dealers may not be successful in their bids that would utilize our offerings. In some cases, unsuccessful bidders for government agency orders are provided the opportunity to formally protest certain order awards through various agency, administrative and judicial channels. The protest process may substantially delay a successful bidder’s award or result in cancellation of the order entirely. Furthermore, local government agency awards may be contingent upon availability of matching funds from federal or state entities and law enforcement and other government agencies are subject to political, budgetary, purchasing and delivery constraints. Any of these factors can make it difficult to predict our quarterly and annual revenues and operating results.

Additionally, we anticipate that an increasingly significant portion of our future revenues will come from government programs outside the U.S., such as national electronic identity, eGovernment, eHealth and others applications. We currently supply smart card readers, RFID stickers and credential management solutions for various government programs in Europe and Asia and are actively targeting additional programs in these areas as well as in Latin America. However, the timing of government smart card programs is not always certain and delays in program implementation are common. The delay of government projects in any country for any reason could negatively impact our sales.

The actions of the U.S. Government, the Federal Reserve and the U.S. Treasury may materially and adversely affect our business.

The U.S. Government, the Federal Reserve, the U.S. Treasury and other governmental and regulatory bodies have taken and continue to take various actions to address the recent financial crisis. There can be no assurance that such actions will have a beneficial impact on the U.S. economy. Additionally, the U.S. Congress and/or various states and local legislatures may enact additional legislation or regulatory action designed to address the current economic climate or for other purposes, which could have a material adverse effect on our ability to continue to execute our business strategies. To the extent the market does not respond favorably to these initiatives or they do not function as intended, they may not have a positive impact on our business.

Our U.S. Government business is dependent upon receipt of certain governmental approvals or certifications, and failure to receive such approvals or certifications could have a material adverse effect on our sales in those market segments for which such approvals or certifications are customary or required.

While we are not able to quantify the amount of sales made to the U.S. Government due to the indirect nature of our selling process, we believe that orders for U.S. Government agencies represent a significant portion of our revenues. Failing to obtain certain government approvals or certifications could have a material adverse effect in those environments for which such approvals or certifications are customary or required. As newer versions of existing products, or new products in development are released, they may require certifications or approvals. In addition, the U.S. Government may introduce new requirements that some existing products will be required to meet. If we fail to obtain any required approvals or certifications for our products, our business will suffer.

 

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Our business could be adversely affected by negative audits by government agencies; we could be required to reimburse the U.S. Government for costs that we have expended on government orders; and our ability to compete successfully for future orders could be materially impaired.

Government agencies in the U.S. and other countries may audit our business as part of their routine audits and investigations of government orders. As part of an audit, these agencies may review our performance on orders, cost structures and compliance with applicable laws, regulations and standards. These agencies may also review the adequacy of, and our compliance with, our own internal control systems and policies, including our purchasing, property, estimating, compensation and management information systems. If any of our costs are found to be improperly allocated to a specific order, the costs may not be reimbursed and any costs already reimbursed for such order may have to be refunded. An audit could materially affect our business’ competitive position and result in a material adjustment to our financial results or statements of operations. If a government agency audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of orders, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with the federal government. In addition, our business could suffer serious harm to its reputation if allegations of impropriety were made against us.

While our business has never had a negative audit by a governmental agency, we cannot assure you that one will not occur. If we were suspended or barred from supplying solutions to the federal government generally, or if our reputation or relationships with our distribution channel or government agencies were impaired, or if the government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our revenues and prospects would be materially harmed.

A significant portion of our sales is made through an indirect sales channel, and the loss of dealers, systems integrators, resellers, or other channel partners could result in decreased revenue.

We currently use an indirect sales channel that includes dealers, systems integrators, value added resellers and resellers to sell a significant portion of our products and solutions, primarily into markets or customers where the channel partner may have closer relationships or greater access than we do. Some of these channel partners also sell our competitors’ products, and if they favor our competitors’ products for any reason, they may fail to market our products as effectively or to devote resources necessary to provide effective sales, which would cause our sales to suffer. Indirect selling arrangements are intended to benefit both us and the channel partner, and may be long- or short-term relationships, depending on market conditions, competition in the marketplace and other factors. If we are unable to maintain effective indirect sales channels, there could be a reduction in the amount of product we are able to sell, and our revenues could decrease.

Our business could suffer if our third-party manufacturers cannot meet production requirements.

Many of our products are manufactured outside the U.S. by contract manufacturers. Our reliance on foreign manufacturing poses a number of risks, including, but not limited to:

 

   

difficulties in staffing;

 

   

currency fluctuations;

 

   

potentially adverse tax consequences;

 

   

unexpected changes in regulatory requirements;

 

   

tariffs and other trade barriers;

 

   

export controls;

 

   

political and economic instability;

 

   

lack of control over the manufacturing process and ultimately over the quality of our products;

 

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late delivery of our products, whether because of limited access to our product components, transportation delays and interruptions, difficulties in staffing, or disruptions such as natural disasters;

 

   

capacity limitations of our manufacturers, particularly in the context of new large contracts for our products, whether because our manufacturers lack the required capacity or are unwilling to produce the quantities we desire; and

 

   

obsolescence of our hardware products at the end of the manufacturing cycle.

The use of contract manufacturing requires us to exercise strong planning and management in order to ensure that our products are manufactured on schedule, to correct specifications and to a high standard of quality. If any of our contract manufacturers cannot meet our production requirements, we may be required to rely on other contract manufacturing sources or identify and qualify new contract manufacturers. We may be unable to identify or qualify new contract manufacturers in a timely manner or at all or with reasonable terms and these new manufacturers may not allocate sufficient capacity to us in order to meet our requirements. Any significant delay in our ability to obtain adequate supplies of our products from our current or alternative manufacturers would materially and adversely affect our business and operating results. In addition, if we are not successful at managing the contract manufacturing process, the quality of our products could be jeopardized or inventories could be too low or too high, which could result in damage to our reputation with our customers and in the marketplace, as well as possible write-offs of excess inventory.

We have a limited number of suppliers of key components, and may experience difficulties in obtaining components for which there is significant demand.

We rely upon a limited number of suppliers for some key components of our products. For example, we currently utilize the foundry services of external suppliers to produce our ASICs for smart cards readers and inlays, and we use chips and antenna components from third-party suppliers in our contactless smart card readers. Our reliance on a limited number of suppliers may expose us to various risks including, without limitation, an inadequate supply of components, price increases, late deliveries and poor component quality. In addition, some of the basic components used in our reader products, such as semiconductors, may at any time be in great demand. This could result in components not being available to us in a timely manner or at all, particularly if larger companies have ordered more significant volumes of those components, or in higher prices being charged for components. Disruption or termination of the supply of components or software used in our products could delay shipments of our products. These delays could have a material adverse effect on our business and operating results and could also damage relationships with current and prospective customers.

We are required to comply with regulations regarding the use of “conflict minerals”, and the difficulty of tracking the source of materials used in our products and components exposes us to risks that could adversely affect our business.

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires us to track and disclose the source of certain metals used in manufacturing which may stem from minerals (so called “conflict minerals”) which originate in the Democratic Republic of the Congo or adjoining regions. These metals, which include tantalum, tin, gold and tungsten, are central to the technology industry and may be present in some of our products as component parts. In most cases no acceptable alternative material exists which has the necessary properties. It may not be possible to determine the source of the metals by analysis; instead, a good faith description of the source of the intermediate components and raw materials must be obtained. The components which incorporate those metals may originate from many sources and we purchase components such as ASICs from manufacturers who may have a long and difficult process to trace the supply chain. As the price of these materials varies, producers of the metal intermediates can be expected to change the mix of sources used, and components and assemblies which we buy may have a mix of sources as their origin. We are required by SEC rules to carry out a diligent effort to determine and disclose the source of these materials in our products, with the first report due May 31, 2014. There can be no assurance we can obtain this information from intermediate

 

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producers who are unwilling or unable to provide this information or further identify their sources of supply or to notify us if these sources change. We will incur additional costs in order to comply with the SEC rules. In addition, our sourcing, supply and pricing of component parts may be adversely affected. We may face reputational challenges if we are unable to verify the sources of our materials as “conflict-free”.

Cybersecurity breaches in systems we sell or maintain could result in the disclosure of sensitive government information or private personal information that could result in the loss of clients and negative publicity.

Many of the systems we sell manage private personal information and protect information involved in sensitive government functions. A cybersecurity breach in one of these systems could cause serious harm to our business as a result of negative publicity and could prevent us from having further access to such systems or other similarly sensitive areas for other governmental clients.

As part of our technical support services, we agree, from time to time, to possess all or a portion of the security system database of our customers. This service is subject to a number of risks. For example, despite our security measures our systems may be vulnerable to cyber attacks by hackers, physical break-ins and service disruptions that could lead to interruptions, delays or loss of data. If any such compromise of our security were to occur, it could be very expensive to correct, could damage our reputation and could discourage potential customers from using our services. Although we have not experienced attempted cyber or physical attacks, we may experience such attempts in the future. Our systems may also be affected by outages, delays and other difficulties. Our insurance coverage may be insufficient to cover losses and liabilities that may result from such events.

Failure to properly manage the implementation of customer projects in our business may result in costs or claims against us, and our financial results could be adversely affected.

In our business, deployments of our solutions often involve large-scale projects. The quality of our performance on such projects depends in large part upon our ability to manage relationships with our customers and to effectively manage the implementation of our solutions in such projects and to deploy appropriate resources, including our own project managers and third-party subcontractors, in a timely manner. Any defects or errors or failures to meet clients’ expectations could result in damage to our reputation or even claims for substantial monetary damages against us. In addition, we sometimes provide guarantees to customers that we will complete a project by a scheduled date or that our solutions will achieve defined performance standards. If our solutions experience a performance problem, we may not be able to recover the additional costs we incur in our remedial efforts, which could materially impair profit derived from a particular project. Moreover, a portion of our revenues are derived from fixed price contracts.

Our products may have defects, which could damage our reputation, decrease market acceptance of our products, cause us to lose customers and revenue and result in costly litigation or liability.

Products such as our smart card readers, access control panels and RFID inlays may contain defects for many reasons, including defective design or manufacture, defective material or software inoperability issues. Often, these defects are not detected until after the products have been shipped. If any of our products contain defects or perceived defects or have reliability, quality or compatibility problems or perceived problems, our reputation might be damaged significantly, we could experience a delay in market acceptance of the affected product or products and we might be unable to retain existing customers or attract new customers. In addition, these defects could interrupt or delay sales. In the event of an actual or perceived defect or other problem, we may need to invest significant capital, technical, managerial and other resources to investigate and correct the potential defect or problem and potentially divert these resources from other development efforts. If we are unable to provide a solution to the potential defect or problem that is acceptable to our customers, we may be required to incur substantial product recall, repair and replacement and even litigation costs. These costs could have a material adverse effect on our business and operating results.

 

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

In addition, because our customers rely on our smart card readers to prevent unauthorized access to PCs, networks or facilities, a malfunction of or design defect in our products (or even a perceived defect) could result in legal or warranty claims against us for damages resulting from security breaches. If such claims are adversely decided against us, the potential liability could be substantial and have a material adverse effect on our business and operating results. Furthermore, the possible publicity associated with any such claim, whether or not decided against us, could adversely affect our reputation. In addition, a well-publicized security breach involving smart card-based or other security systems could adversely affect the market’s perception of products like ours in general, or our products in particular, regardless of whether the breach is actual or attributable to our products. Any of the foregoing events could cause demand for our products to decline, which would cause our business and operating results to suffer.

Our global operations require significant financial, managerial and administrative resources and our results could be adversely affected if we are unable to manage them efficiently.

Our business model includes the management of separate product lines that address disparate market opportunities that are geographically dispersed. While there is some shared technology across our products, each product line requires significant research and development efforts to address the evolving needs of our customers and markets. To support our development and sales efforts, we maintain company offices and/or business operations in several locations around the world, including Australia, Canada, Germany, Hong Kong, India, Japan, The Netherlands, Singapore, Switzerland and the U.S. We also maintain manufacturing facilities in Germany, Singapore and California and manage contract manufacturers in multiple countries, including China and Singapore. Managing our various development, sales, administrative and manufacturing operations places a significant burden on our financial systems and has contributed to a level of operational spending that is disproportionately high compared to our current revenue levels.

Operating in diverse geographic locations also imposes significant burdens on our managerial resources. In particular, our management must:

 

   

divert a significant amount of time and energy to manage employees and contractors in different geographic areas and time zones, who are from diverse cultural backgrounds and who speak different languages;

 

   

travel between our different company offices;

 

   

maintain sufficient internal financial controls in multiple geographic locations that may have different control environments;

 

   

manage different product lines for different markets;

 

   

manage our supply and distribution channels across different countries and business practices; and

 

   

coordinate these efforts to produce an integrated business effort, focus and vision.

Any failure to effectively manage our operations globally could have a material adverse effect on our business and operating results.

 

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We conduct a significant portion of our operations outside the U.S. economic, political, regulatory and other risks associated with international sales and operations could have an adverse effect on our results of operation.

We conduct a substantial portion of our business in Europe and Asia. Approximately 48% of our revenue in 2012 and 57% of our revenue in 2011 was derived from customers located outside the U.S.

Because a significant number of our principal customers are located in other countries, we anticipate that international sales will continue to account for a substantial portion of our revenues. As a result, a significant portion of our sales and operations may continue to be subject to risks associated with foreign operations, any of which could impact our sales and/or our operational performance. These risks include, but are not limited to:

 

   

changes in foreign currency exchange rates;

 

   

changes in a specific country’s or region’s political or economic conditions and stability, particularly in emerging markets;

 

   

unexpected changes in foreign laws and regulatory requirements;

 

   

export controls;

 

   

potentially adverse tax consequences;

 

   

longer accounts receivable collection cycles;

 

   

difficulty in managing widespread sales and manufacturing operations; and

 

   

less effective protection of intellectual property.

Fluctuations in the valuation of foreign currencies could impact costs and/or revenues we disclose in U.S. dollars, and could result in foreign currency losses.

A significant portion of our business is conducted in foreign currencies, principally the Euro. Fluctuations in the value of foreign currencies relative to the U.S. Dollar will continue to cause currency exchange gains and losses. If a significant portion of operating expenses are incurred in a foreign currency such as the Euro, and revenues are generated in U.S. Dollars, exchange rate fluctuations might have a positive or negative net financial impact on these transactions, depending on whether the U.S. Dollar devalues or revalues compared to the Euro. In addition, the valuation of current assets and liabilities that are denominated in a currency other than the functional currency can result in currency exchange gains and losses. For example, when one of our subsidiaries uses the Euro as the functional currency, and this subsidiary has a receivable in U.S. Dollars, a devaluation of the U.S. Dollar against the Euro of 10% would result in a foreign exchange loss of the reporting entity of 10% of the value of the underlying U.S. Dollar receivable. We cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results. The effect of currency exchange rate changes may increase or decrease our costs and/or revenues in any given quarter, and we may experience currency losses in the future. To date, we have not adopted a hedging program to protect against risks associated with foreign currency fluctuations.

Personnel Risks

Our key personnel and directors are critical to our business, and such key personnel may not remain with us in the future.

We depend on the continued employment of our senior executive officers and other key management and technical personnel. If any of our key personnel were to leave and not be replaced with sufficiently qualified and experienced personnel, our business could be adversely affected.

We also believe that our future success will depend in large part on our ability to attract and retain highly qualified technical and management personnel. However, competition for such personnel is intense. We may not be able to retain our key technical and management employees or to attract, assimilate or retain other highly qualified technical and management personnel in the future.

 

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Likewise, as a small, publicly-traded company, we are challenged to identify, attract and retain experienced professionals with diverse skills and backgrounds who are qualified and willing to serve on our Board of Directors. The increased burden of regulatory compliance under the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act creates additional liability and exposure for directors. Financial losses in our business and lack of growth in our stock price make it difficult for us to offer attractive director compensation packages. If we are not able to attract and retain qualified board members, our ability to practice a high level of corporate governance could be impaired.

Qualified management, marketing, and sales personnel are difficult to locate, hire and train, and if we cannot attract and retain qualified personnel, it will harm the ability of our business to grow.

The success of our company depends, in part, on the continued service of key managerial, marketing and sales personnel. Competition for qualified management, technical, sales and marketing employees is intense. We cannot assure you that we will be able to attract, retain and integrate employees to develop and continue our business and successfully implement strategic acquisitions.

Risks of Financial and Capital Markets

Our stock price has been and is likely to remain volatile.

Over the past few years, the NASDAQ Stock Market and the Frankfurt Stock Exchange have experienced significant price and volume fluctuations that have particularly affected the market prices of the stocks of technology companies. Volatility in our stock price on either or both exchanges may result from a number of factors, including, among others:

 

   

low volumes of trading activity in our stock;

 

   

variations in our or our competitors’ financial and/or operational results;

 

   

the fluctuation in market value of comparable companies in any of our markets;

 

   

expected, perceived or announced relationships or transactions with third parties;

 

   

announcements of significant contract wins or losses;

 

   

comments and forecasts by securities analysts;

 

   

trading patterns of our stock on the NASDAQ Stock Market or the Frankfurt Stock Exchange;

 

   

the inclusion or removal of our stock from market indices, such as groups of technology stocks or other indices;

 

   

loss of key personnel;

 

   

announcements of technological innovations or new products by us or our competitors;

 

   

announcements of dispositions, organizational restructuring, headcount reductions, litigation or write-off of investments;

 

   

litigation developments; and

 

   

general market downturns.

In the past, companies that have experienced volatility in the market price of their stock have been the object of securities class action litigation. If we were the object of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources.

If we fail to comply with the listing requirements of The NASDAQ Global Market, the price of our common stock and our ability to access the capital markets could be negatively impacted.

Our common stock currently is listed on The NASDAQ Global Market. There are a number of continuing requirements that must be met in order for our common stock to remain listed on The NASDAQ Global Market,

 

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and the failure to meet these listing standards could result in the delisting of our common stock from NASDAQ. On August 16, 2012, we received notification from NASDAQ that the Company no longer met the requirement for continued listing under NASDAQ’s listing rules because the minimum bid price of our common stock was below $1.00 over a period of 30 consecutive trading days. On October 18, 2012, NASDAQ notified us that because the closing bid price of our common stock was above the minimum $1.00 per share price for ten consecutive trading days, we had regained compliance with the listing rules. However, should our common stock price again fall below the $1.00 minimum bid price for 30 consecutive trading days, we may fail to comply with NASDAQ listing rules and be required to take action to improve the price of our common stock, for example by seeking approval for a reverse stock split. If our common stock ceases to be listed for trading on The NASDAQ Global Market for any reason, it may harm our stock price, increase the volatility of our stock price, decrease the level of trading activity and affect our ability to access the capital markets.

You may experience dilution of your ownership interests due to the future issuance of additional shares of our stock, and future sales of shares of our common stock could have an adverse effect on our stock price.

We have issued a significant number of shares of our common stock, together with warrants to purchase shares of our common stock, in connection with a number of acquisitions in recent years. In May 2011 we issued approximately 7.8 million shares of Identive common stock in an underwritten public offering. As of December 31, 2012, warrants to purchase approximately 8.6 million shares of Identive common stock were outstanding. From time to time, in the future we also may issue additional previously authorized and unissued securities, resulting in the dilution of the ownership interests of our current stockholders. We are currently authorized to issue up to 130,000,000 shares of common stock. As of March 12, 2013, 60,259,580 shares of common stock were outstanding, excluding 618,400 shares held in treasury.

In addition, the Company maintains various incentive plans under which equity may be issued. As of December 31, 2012, an aggregate of approximately 9.5 million shares of common stock are reserved for future grants and 4.1 million shares are reserved for future issuance pursuant to outstanding equity awards under our various equity incentive plans. In addition, as of December 31, 2012, an aggregate of approximately 3.3 million shares of common stock are reserved for future issuance in connection with the Company’s acquisition of Bluehill ID AG. We may issue additional shares of our common stock or other securities that are convertible into or exercisable for shares of common stock in connection with the hiring of personnel, future acquisitions, future private placements, or future public offerings of our securities for capital raising or for other business purposes. If we issue additional securities, the aggregate percentage ownership of our existing stockholders will be reduced. In addition, any new securities that we issue may have rights senior to those of our common stock.

The issuance of additional shares of common stock or preferred stock or other securities, or the perception that such issuances could occur, may create downward pressure on the trading price of our common stock.

One of our directors indirectly holds significant amounts of our common stock and could have significant influence over the outcome of corporate actions requiring board and stockholder approval.

As of February 22, 2013, Mountain Partners AG, together with its affiliates (collectively “Mountain Partners”), had the right to vote approximately 12% of the outstanding shares of our common stock. Daniel Wenzel, a director of our Company, is a co-founder of Mountain Partners. As of February 22, 2013, the directors and officers of Identive Group collectively held approximately 8% of our common stock. Accordingly, our directors and officers could have influence over the outcome of corporate actions requiring board and stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction.

Provisions in our charter documents and Delaware law may delay or prevent the acquisition of Identive by another company, which could decrease the value of your shares.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us or enter into a material transaction with us without the consent of our

 

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Board of Directors. These provisions include a classified Board of Directors and limitations on actions by our stockholders by written consent. Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. These provisions will apply even if the offer were to be considered adequate by some of our stockholders. Because these provisions may be deemed to discourage a change of control, they may delay or prevent the acquisition of our Company, which could decrease the value of our common stock.

Legal and Regulatory Risks

Our business could be adversely affected by changes in laws or regulations pertaining to security.

The U.S. federal government, suppliers to the federal government and certain industries in the public sector currently fall, or may in the future fall, under particular regulations pertaining to security. Some of the laws, regulations, certifications or requirements that may stimulate new security systems sales include the following:

 

   

Homeland Security Presidential Directive (HSPD) 12 and Federal Information Processing Standards (FIPS) 201 produced by National Institute of Standards and Technology (NIST);

 

   

Federal Information Security Management Act (FISMA);

 

   

Transportation Security Administration’s (TSA) Transportation Worker Identification Credential (TWIC) program;

 

   

Sarbanes-Oxley Act of 2002 (also known as the Public Company Accounting Reform and Investor Protection Act);

 

   

Dodd-Frank Act;

 

   

Health Insurance Portability and Accountability Act (HIPAA);

 

   

Gramm-Leach Bliley Act of 1999 (GLBA, a.k.a., the Financial Modernization Act);

 

   

Customs-Trade Partnership Against Terrorism (C-TPAT);

 

   

Free and Secure Trade Program (FAST);

 

   

Chemical Facility Anti Terrorism Standards (CFATS); and

 

   

various codes of the Code of Federal Regulations (CFR).

Discontinuance of, changes in, or lack of adoption of laws or regulations pertaining to security could adversely affect our performance.

We are subject to extensive government regulation, and any failure to comply with applicable regulations could subject us to penalties that may restrict our ability to conduct our business.

Our business is affected by and must comply with various government regulations that impact our operating costs, profit margins and our internal organization and operations. Furthermore, our business may be audited to assure compliance with these requirements. Any failure to comply with applicable regulations, rules and approvals could result in the imposition of penalties, the loss of government orders or the removal of our products from the GSA approved list, any of which could adversely affect our business, financial condition and results of operations. Among the most significant regulations affecting our business are the following:

 

   

the Federal Acquisition Regulations, or the FAR, and agency regulations supplemental to the FAR, which comprehensively regulate the formation and administration of, and performance under government contracts;

 

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the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations;

 

   

the Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under cost-based government contracts;

 

   

the Foreign Corrupt Practices Act; and

 

   

laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data.

These regulations affect how our customers can do business with us, and, in some instances, the regulations impose added costs on our business. Any changes in applicable laws and regulations could restrict our ability to conduct our business. Any failure to comply with applicable laws and regulations could result in contract termination, price or fee reductions or suspension or debarment from contracting with the federal government generally.

If we are unable to continue to obtain U.S. Government authorization regarding the export of our products, or if current or future export laws limit or otherwise restrict our business, we could be prohibited from shipping our products to certain countries, which could cause our business, financial condition and results of operations to suffer.

In our business, we must comply with U.S. and European Union (“EU”) laws, among others, regulating the export of our products. In some cases, explicit authorization from the U.S. or an EU government is needed to export our products. The export regimes and the governing policies applicable to our business are subject to changes. We cannot be certain that such export authorizations will be available to us or for our products in the future. In some cases, we rely upon the compliance activities of our prime contractors, and we cannot be certain they have taken or will take all measures necessary to comply with applicable export laws. If we or our prime contractor partners cannot obtain required government approvals under applicable regulations, we may not be able to sell our products in certain international jurisdictions.

We face risks from future claims of third parties and litigation.

From time to time, we may be subject to claims of third parties, possibly resulting in litigation, which could include, among other things, claims regarding infringement of the intellectual property rights of third parties, product defects, employment-related claims, and claims related to acquisitions, dispositions or restructurings. Any such claims or litigation may be time-consuming and costly, divert management resources, cause product shipment delays, require us to redesign our products, require us to accept returns of products and to write off inventory, or have other adverse effects on our business. Any of the foregoing could have a material adverse effect on our results of operations and could require us to pay significant monetary damages.

We expect the likelihood of intellectual property infringement and misappropriation claims may increase as the number of products and competitors in our markets grows and as we increasingly incorporate third-party technology into our products. As a result of infringement claims, we could be required to license intellectual property from a third party or redesign our products. Licenses may not be offered when we need them or on acceptable terms. If we do obtain licenses from third parties, we may be required to pay license fees or royalty payments or we may be required to license some of our intellectual property to others in return for such licenses. If we are unable to obtain a license that is necessary for us or our third-party manufacturers to manufacture our allegedly infringing products, we could be required to suspend the manufacture of products or stop our suppliers from using processes that may infringe the rights of third parties. We may also be unsuccessful in redesigning our products. Our suppliers and customers may be subject to infringement claims based on intellectual property included in our products. We have historically agreed to indemnify our suppliers and customers for patent infringement claims relating to our products. The scope of this indemnity varies, but may, in some instances,

 

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include indemnification for damages and expenses, including attorney’s fees. We may periodically engage in litigation as a result of these indemnification obligations. Our insurance policies exclude coverage for third-party claims for patent infringement.

We may be exposed to risks of intellectual property infringement by third parties.

Our success depends significantly upon our proprietary technology. We currently rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights, which afford only limited protection. We may not be successful in protecting our proprietary technology through patents, it is possible that no new patents will be issued, that our proprietary products or technologies are not patentable or that any issued patent will fail to provide us with any competitive advantages.

There has been a great deal of litigation in the technology industry regarding intellectual property rights, and from time to time we may be required to use litigation to protect our proprietary technology. This may result in our incurring substantial costs and we may not be successful in any such litigation.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to use our proprietary information and software without authorization. In addition, the laws of some foreign countries do not protect proprietary and intellectual property rights to the same extent as do the laws of the U.S. Because many of our products are sold and a significant portion of our business is conducted outside the U.S., our exposure to intellectual property risks may be higher. Our means of protecting our proprietary and intellectual property rights may not be adequate. There is a risk that our competitors will independently develop similar technology or duplicate our products or design around patents or other intellectual property rights. If we are unsuccessful in protecting our intellectual property or our products or technologies are duplicated by others, our business could be harmed.

Changes in tax laws or the interpretation thereof, adverse tax audits and other tax matters may adversely affect our future results.

A number of factors may impact our tax position, including:

 

   

the jurisdictions in which profits are determined to be earned and taxed;

 

   

the resolution of issues arising from tax audits with various tax authorities;

 

   

changes in the valuation of our deferred tax assets and liabilities;

 

   

adjustments to estimated taxes upon finalization of various tax returns;

 

   

increases in expenses not deductible for tax purposes; and

 

   

the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes.

Any of these factors could make it more difficult for us to project or achieve expected tax results. An increase or decrease in our tax liabilities due to these or other factors could adversely affect our financial results in future periods.

We have identified material weaknesses in our internal control over financial reporting. We will continue to incur costs to remediate these weaknesses and to maintain effective internal controls over financial reporting. If we are unable to remediate these material weaknesses, and if additional weaknesses are discovered in the future, our business, results of operations and investors’ confidence in us could be materially affected.

Under Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, our management is required to make certain assessments and certifications regarding our disclosure controls and internal controls over financial reporting. We have dedicated, and expect to continue to dedicate, significant management, financial and other

 

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resources in connection with our compliance with Section 404 of the Sarbanes-Oxley Act. The process of maintaining and evaluating the effectiveness of these controls is expensive, time-consuming and requires significant attention from our management and staff. During the course of our evaluation, we may identify areas requiring improvement and may be required to design enhanced processes and controls to address issues identified through this review. This could result in significant delays and costs to us and require us to divert substantial resources, including management time from other activities.

As described in “Controls and Procedures” in Part II, Item 9A of this report, in connection with the audit of our financial statements as of and for the years ended December 31, 2011 and 2012, we identified material weaknesses in internal control over financial reporting. Specifically, for 2011 we determined that 1) we had an insufficient number of accounting personnel with appropriate knowledge, experience or training in U.S. GAAP to provide effective oversight and review of transactions and the preparation of financial statements, particularly at the subsidiary level, and 2) the design of controls related to revenue recognition were inadequate. For 2012, we determined that there was insufficient review and oversight of the recording of complex and non-routine transactions. We developed and substantially implemented remediation plans to address the material weaknesses identified in 2011, and we have deemed the material weakness related to revenue recognition to be remediated as of December 31, 2012. However, certain other remedial actions have not been completed or have only recently been undertaken, and our material weaknesses related to the review and oversight of complex and non-routine transactions have not been fully remediated as of December 31, 2012. While we expect to complete the implementation of remediation measures and remediate our existing material weaknesses in the first half of 2013, there can be no assurance that such remediation efforts will be successful or that our internal control over financial reporting will be effective as a result of these efforts. In addition, we may in the future identify additional internal control deficiencies that could rise to the level of a material weakness or uncover errors in financial reporting.

If we fail to remediate the material weakness and maintain an effective system of disclosure controls or internal control over financial reporting, we may not be able to rely on the integrity of our financial results, which could result in inaccurate or late reporting of our financial results and investigation by regulatory authorities. If we fail to achieve and maintain adequate internal controls the financial position of our business could be harmed; current and potential future shareholders could lose confidence in us and/or our reported financial results, which may cause a negative effect on the trading price of our common stock; and we could be exposed to litigation or regulatory proceedings, which may be costly or divert management attention.

In addition, all internal control systems, no matter how well designed and operated, can only provide reasonable assurance that the objectives of the control system are met. Because there are inherent limitations in all control systems, no evaluation of control can provide absolute assurance, that all control issues and instances of fraud, if any, within the Company have been or will be detected. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Any failure of our internal control systems to be effective could adversely affect our business.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

Our corporate headquarters are located in Santa Ana, California and we maintain European operational headquarters in Ismaning, Germany. We lease additional facilities around the world to house our engineering, sales and marketing, administrative and manufacturing functions. Additionally, we own an office building in The Netherlands which houses the software development, sales and marketing operations of our Dutch ID Solutions business. At December 31, 2012, our major facilities consisted of the following:

 

Location

 

Function

 

Square
Feet

   

Lease Expiration

 

Used by

Santa Ana, California   Corporate headquarters. Co-located with Hirsch business operations; manufacturing     34,599      January 2018   Corporate; Identity management segment
Ismaning, Germany   European operational headquarters and sales facility for ID Infrastructure business     22,000      November 2013   Corporate; both business segments
Chennai, India   Research and development     10,398      April 2013   ID Products segment
Wallisellen, Switzerland   Product development, sales and marketing for ID Solutions business in Switzerland     15,478      October 2014   Identity Management segment
Sauerlach, Germany   Transponder manufacturing     11,647      November 2013   ID Products segment
Singapore   Transponder manufacturing     16,060      May 2014   ID Products segment
Oud-Beijerland, The Netherlands   Product development, sales and marketing for ID Solutions business in The Netherlands     18,622      N/A   Identity Management segment
Los Angeles, California   Sales and marketing for ID Solutions business in the U.S.     5,160      June 2013   Identity Management segment

 

ITEM 3. LEGAL PROCEEDINGS

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

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock; Number of Holders; Dividends

Our common stock is traded on the NASDAQ Stock Market’s Global Market under the symbol “INVE” and on the Frankfurt Stock Exchange under the symbol “INV.” According to data available at March 5, 2013, we estimate we had approximately 3,600 stockholders of record and beneficial stockholders. Not represented in this figure are individual stockholders in Germany whose custodian banks do not release stockholder information to us. The following table sets forth the high and low closing prices of our common stock for the periods indicated.

 

     NASDAQ
National Market
     Prime Standard
(Quoted in Euros)
 
     High      Low      High      Low  

Fiscal 2012:

           

First Quarter

   $ 2.41       $ 1.74       1.82       1.35   

Second Quarter

   $ 2.13       $ 0.91       1.61       0.75   

Third Quarter

   $ 0.98       $ 0.66       0.80       0.52   

Fourth Quarter

   $ 1.50       $ 0.86       1.11       0.66   

Fiscal 2011:

           

First Quarter

   $ 3.20       $ 2.24       1.61       2.29   

Second Quarter

   $ 5.69       $ 2.21       3.92       1.52   

Third Quarter

   $ 2.45       $ 1.51       1.79       1.00   

Fourth Quarter

   $ 2.55       $ 1.76       1.81       1.34   

We have never declared or paid cash dividends on our common stock or other securities. We currently anticipate that we will retain all of our future earnings for use in the expansion and operation of our business and do not anticipate paying any cash dividends in the foreseeable future.

The disclosure required by Item 201(d) of Regulation S-K is included in Item 12 of this Annual Report on Form 10-K.

 

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Stock Performance Graph

The following performance graph compares the cumulative total return to holders of our common stock since December 31, 2007, to the cumulative total return over such period of the NASDAQ Composite index and the RDG Technology Index.

The performance graph assumes that $100 was invested on December 31, 2007 in our common stock and in each of the comparative indices. The performance graph further assumes that such amount was initially invested in our common stock at a price of $3.34 per share, the closing price on December 31, 2007.

Our historic stock price performance is not necessarily indicative of future stock price performance.

 

LOGO

 

Measurement Period
(Fiscal Year Covered)

   Identive
Group
     NASDAQ
Composite
     RDG
Technology
 

Dec-07

   $ 100.00       $ 100.00       $ 100.00   

Dec-08

     67.37         59.10         56.88   

Dec-09

     70.96         82.19         91.53   

Dec-10

     75.45         97.23         103.09   

Dec-11

     66.77         98.85         101.14   

Dec-12

     44.91         110.91         117.74   

 

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Recent Sales of Unregistered Securities

On January 30, 2012, through our Bluehill ID AG subsidiary, we issued an aggregate of 1,357,758 shares of our common stock, which had an approximate value of $3.0 million, acquiring 58.8% of the outstanding shares of payment solution. On April 2, 2012 we acquired an additional 23.7% of the outstanding shares of payment solution in exchange for 548,114 shares of our common stock.

In September 2012, we issued an aggregate of 56,834 shares of common stock, having an approximate value of $0.1 million, in satisfaction of a previously disclosed earn-out payment to the former owners of polyright SA under the polyright purchase agreement.

These shares were issued in reliance upon exemptions from registration provided by Section 4(2) of the Securities Act, including Regulation D and Regulation S thereunder.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

 

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ITEM 6. SELECTED FINANCIAL DATA

The comparability of our operating results for the years shown in the table below is impacted by our acquisitions of Hirsch Electronics Corporation (“Hirsch”) on April 30, 2009; Bluehill ID AG (“Bluehill ID”) on January 4, 2010; 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 these businesses have been included since their respective acquisition dates.

IDENTIVE GROUP, INC.

SELECTED CONSOLIDATED FINANCIAL DATA

 

     Years Ended December 31,  
     2012     2011(1)     2010(1)     2009     2008  
     (In thousands, except per share data)  

Consolidated Statements of Operations Data:

          

Net revenue

   $ 94,599      $ 102,708      $ 84,843      $ 41,315      $ 28,362   

Cost of revenue

     56,163        59,906        47,485        21,971        15,358   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     38,436        42,802        37,358        19,344        13,004   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Research and development

     8,665        7,025        4,715        4,253        3,118   

Selling and marketing

     23,988        23,563        20,375        12,886        7,875   

General and administrative

     18,218        22,066        21,569        16,431        11,063   

Impairment of long-lived assets

     24,785        —          —          647        —     

Impairment of goodwill

     27,084        —          —          —          —     

Re-measurement of contingent consideration

     (5,657     510        221        —          —     

Restructuring

     325        —          337        —          —     

Gain on sale of assets

     —          —          —          (1,417     (1,455
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     97,408        53,164        47,217        32,800        20,601   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (58,972     (10,362     (9,859     (13,456     (7,597

Loss and impairment on equity investments

     —          —          —          (2,244     (256

Other (expense) income

     (106     262        264        —          —     

Interest (expense) income, net

     (1,602     (1,049     (865     (487     757   

Foreign currency gains (losses), net

     288        (398     (234     76        (2,638
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes and noncontrolling interest

     (60,392     (11, 547     (10,694     (16,111     (9,734

Benefit (provision) for income taxes

     6,824        1,326        300        1,549        (752
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (53,568     (10,221     (10,394     (14,562     (10,486

Income from discontinued operations, net of income taxes

     0        0        220        383        376   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net loss

     (53,568     (10,221     (10,174     (14,179     (10,110

Less: Net loss attributable to noncontrolling interest

     3,232        468        630        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Identive Group, Inc. stockholders’ equity

   $ (50,336   $ (9,753   $ (9,544   $ (14,179   $ (10,110
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share attributable to Identive Group Inc. stockholders’ equity:

          

Loss from continuing operations

   $ (0.84   $ (0.18   $ (0.22   $ (0.66   $ (0.66

Income from discontinued operations

     —          —        $ 0.01      $ 0.02      $ 0.02   

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

     59,623        53,748        42,722        22,047        15,743   
     December 31,  
     2012     2011 (1)     2010 (1)     2009     2008  

Consolidated Balance Sheet Data:

          

Cash and cash equivalents

   $ 7,378      $ 17,239      $ 10,799      $ 4,836      $ 20,550   

Working capital(2)

     (128     16, 744        9,305        4,114        23,931   

Total assets

     104,905        144,751        126,165        64,571        41,138   

Long-term earn-out liability

     —          5,663        —          —          —     

Long-term liability to related party

     6,177        7,303        7,615        7,899        —     

Total other long-term obligations(3)

     1,905        1,807        808        456        184   

Total long-term financial liabilities

     9,795        1,189        1,790        —          —     

Total equity

     49,590        96,933        79,634        37,940        28,126   

 

(1) Certain amounts shown in the table above have changed as compared to amounts reported in prior years as noted in Item 8, Financial Statements and Supplementary Data, Note 1 of Notes to Consolidated Financial Statements, Reclassifications and Correction of Prior Period Errors, for more details.
(2) Working capital is defined as current assets less current liabilities.
(3) Other long-term obligations excludes long-term deferred tax liability.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.

 

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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

 

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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

 

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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-

 

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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

 

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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

 

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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

 

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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.

 

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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.

 

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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

 

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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

 

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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.

 

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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.

 

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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.

 

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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:

 

     Fiscal
2012
    % Change
2012
to 2011
    Fiscal
2011
    % Change
2011
to 2010
    Fiscal
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

 

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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

 

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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.

 

     Fiscal
2012
    % Change
2012
to 2011
    Fiscal
2011
    % Change
2011
to 2010
    Fiscal
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.

 

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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

 

     Fiscal
2012
    % Change
2012
to 2011
    Fiscal
2011
    % Change
2011
to 2010
    Fiscal
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.

 

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We expect to maintain our current level of investment in research and development in terms of absolute spending in 2013.

Selling and Marketing

 

     Fiscal
2012
    % Change
2012
to 2011
    Fiscal
2011
    % Change
2011
to 2010
    Fiscal
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

 

     Fiscal
2012
    % Change
2012
to 2011
    Fiscal
2011
    % Change
2011
to 2010
    Fiscal
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.

 

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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.

 

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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.

 

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(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,
2012
    December 31,
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

 

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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,

 

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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):

 

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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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.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk

We are primarily exposed to changes in currency exchange rates. Our foreign currency exposure continues to increase as we grow internationally.

Economic Exposure

We transact business in various foreign currencies and have significant international revenues, as well as costs denominated in foreign currencies. This exposes us to the risk of fluctuations in foreign currency exchange rates. Our objective is to identify material foreign currency exposures and to manage these exposures to minimize the potential effects of currency fluctuations on our reported consolidated cash flow and results of operations.

Transaction Exposure

Our exposure to foreign currency transaction gains and losses is the result of assets and liabilities, (including inter-company transactions) that are denominated in currencies other than the relevant entity’s functional currency. In certain circumstances, changes in the functional currency value of these assets and liabilities create fluctuations in our reported consolidated statements of financial position, consolidated statements of operations, and consolidated statements of cash flows. We have performed sensitivity analyses as of December 31, 2012 and 2011 using a modeling technique that evaluated the hypothetical impact of a 10% movement in the value of the U.S. dollar compared to the functional currency of the subsidiary, with all other variables held constant, to determine the incremental transaction gains or losses that would have been incurred. The foreign exchange rates

 

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used were based on market rates in effect at each of December 31, 2012 and 2011. The results of this hypothetical sensitivity analysis indicated that the impact on a hypothetical 10% movement in foreign currency exchange rates would result in increased foreign currency gains or losses of $0.2 million and $0.4 million for 2012 and 2011, respectively.

Translation Exposure

We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries and our investments in equity interests into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars results in a gain or loss which is recorded as a component of accumulated other comprehensive income in our consolidated statements of equity.

With respect to our international operations, we have remeasured accounts which are denominated in the non-functional currencies into the functional currency of the subsidiary and recorded the resulting gains (losses) within foreign currency gains (losses), net in our consolidated statements of operations for the period. We remeasure all monetary assets and liabilities at the current exchange rate at the end of the period, non-monetary assets and liabilities at historical exchange rates, and revenue and expenses at average exchange rates in effect during the period

Fixed Income Investments

We do not use derivative financial instruments in our investment portfolio. We do, however, limit our exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for our fixed income portfolios. At the present time, the maximum duration of any investment in our portfolio is limited to less than one year. The guidelines also establish credit quality standards, limits on exposure to one issue or issuer, as well as to the type of instrument. Due to the limited duration and credit risk criteria we have established, our exposure to market and credit risk is not expected to be material.

At December 31, 2012 and 2011, we had $7.4 million and $17.2 million, respectively, in cash and cash equivalents and no short-term investments.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

 

     Page  

Reports of Independent Registered Public Accounting Firms

     68   

Consolidated Balance Sheets as of December 31, 2012 and 2011

     70   

Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010

     71   

Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011 and 2010

     72   

Consolidated Statements of Stockholders’ Equity for the Years Ended December  31, 2012, 2011 and 2010

     73   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010

     75   

Notes to Consolidated Financial Statements

     76   

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Identive Group, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheet of Identive Group, Inc. and Subsidiaries (the “Company”) as of December 31, 2012, and the related consolidated statement of operations and of comprehensive loss, stockholders’ equity, and cash flows for the year then ended. Our audit also included the 2012 figures presented in the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2012, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the 2012 figures presented in the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

The accompanying consolidated financial statements and related schedule have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has recurring losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Also, the financial statement schedule does not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of the uncertainty regarding the Company’s ability to continue as a going concern.

 

/s/ Müller  

/s/ Richter

Wirtschaftsprüfer   Wirtschaftsprüfer
[German Public Auditor]   [German Public Auditor]
Ernst & Young GmbH  
Wirtschaftsprüfungsgesellschaft  
Munich, Germany  
March 19, 2013  

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Identive Group, Inc.:

We have audited the accompanying consolidated balance sheet of Identive Group, Inc. and subsidiaries (the “Company”) as of December 31, 2011, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a) for each of the two years in the period ended December 31, 2011. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant accounting estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Identive Group, Inc. and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

/s/ DELOITTE & TOUCHE GMBH
    WIRTSCHAFTSPRÜFUNGSGESELLSCHAFT
Munich, Germany
March 29, 2012 (March 19, 2013 as to the effects of the restatements discussed in Note 1)

 

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IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

     December 31,  
(In thousands; except par value)    2012     2011  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 7,378      $ 17,239   

Accounts receivable, net of allowances of $401 and $268 as of December 31, 2012 and 2011, respectively

     17,261        13,578   

Inventories

     8,892        9,263   

Prepaid expenses and other current assets

     3,659        2,426   
  

 

 

   

 

 

 

Total current assets

     37,190        42,506   
  

 

 

   

 

 

 

Property and equipment, net

     8,892        6,699   

Goodwill

     45,270        59,044   

Intangible assets, net

     11,882        36,001   

Other assets

     1,671        501   
  

 

 

   

 

 

 

Total assets

   $ 104,905      $ 144,751   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 12,926      $ 11,941   

Liability to related party

     1,552        1,076   

Liability for consumer cards

     5,811        —     

Financial liabilities

     4,532        884   

Deferred revenue

     2,843        2,085   

Accrued compensation and related benefits

     3,164        3,527   

Other accrued expenses and liabilities

     6,490        6,249   
  

 

 

   

 

 

 

Total current liabilities

     37,318        25,762   
  

 

 

   

 

 

 

Long-term earn-out liability

     —          5,663   

Long-term liability to related party

     6,177        7,303   

Long-term financial liabilities

     9,795        1,189   

Deferred tax liability

     120        6,094   

Other long-term liability

     1,905        1,807   
  

 

 

   

 

 

 

Total liabilities

     55,315        47,818   
  

 

 

   

 

 

 

Commitments and contingencies (see Note 15 and 16)

     —          —     

Stockholders’ Equity:

    

Identive Group, Inc. stockholders’ equity:

    

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

     —          —     

Common stock, $0.001 par value: 130,000 shares authorized; 60,809 and 58,309 shares issued and outstanding as of December 31, 2012 and 2011, respectively

     61        58   

Additional paid-in capital

     337,811        331,758   

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

     (2,777     (2,777

Accumulated deficit

     (286,011     (235,675

Accumulated other comprehensive income

     1,379        1,777   
  

 

 

   

 

 

 

Total Identive Group, Inc. stockholders’ equity

     50,463        95,141   

Noncontrolling interest

     (873     1,792   
  

 

 

   

 

 

 

Total stockholders’ equity

     49,590        96,933   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 104, 905      $ 144,751   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Years Ended December 31,  
(In thousands, except per share data)    2012     2011     2010  

Net revenues:

      

Products

   $ 77,651      $ 89,310      $ 74,610   

Services

     16,948        13,398        10,233   
  

 

 

   

 

 

   

 

 

 

Total net revenues

     94,599        102,708        84,843   

Cost of revenues:

      

Products

     46,205        53,661        42,458   

Services

     9,958        6,245        5,027   
  

 

 

   

 

 

   

 

 

 

Total cost of revenues

     56,163        59,906        47,485   
  

 

 

   

 

 

   

 

 

 

Gross profit

     38,436        42,802        37,358   
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Research and development

     8,665        7,025        4,715   

Selling and marketing

     23,988        23,563        20,375   

General and administrative

     18,218        22,066        21,569   

Impairment of long-lived assets

     24,785        —          —     

Impairment of goodwill

     27,084        —          —     

Re-measurement of contingent consideration

     (5,657     510        221   

Restructuring

     325        —          337   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     97,408        53,164        47,217   
  

 

 

   

 

 

   

 

 

 

Loss from operations

     (58,972     (10,362     (9,859

Other (expense) income

     (106     262        264   

Interest expense, net

     (1,602     (1,049     (865

Foreign currency gain (loss), net

     288        (398     (234
  

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes and noncontrolling interest

     (60,392     (11,547     (10,694

Income tax benefit

     6,824        1,326        300   
  

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (53,568     (10,221     (10,394

Income from discontinued operations, net of income taxes

     —          —          220   
  

 

 

   

 

 

   

 

 

 

Consolidated net loss

     (53,568     (10,221     (10,174

Less: Loss attributable to noncontrolling interest

     3,232        468        630   
  

 

 

   

 

 

   

 

 

 

Net loss attributable to Identive Group, Inc. stockholders’ equity

   $ (50,336   $ (9,753   $ (9,544
  

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share attributable to Identive Group, Inc. stockholders’ equity:

      

Loss from continuing operations

   $ (0.84   $ (0.18   $ (0.22
  

 

 

   

 

 

   

 

 

 

Income from discontinued operations

   $ —        $ —        $ 0.01   
  

 

 

   

 

 

   

 

 

 

Net loss.

   $ (0.84   $ (0.18   $ (0.21
  

 

 

   

 

 

   

 

 

 

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

     59,623        53,748        42,722   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

 

     Twelve Months Ended December 31,  
     2012     2011     2010  

Consolidated net loss

   $ (53,568   $ (10,221   $ (10,174

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

      

Unrealized gain (loss) on defined benefit plans, net of tax of nil

     29        (117     (144

Foreign currency translation adjustments, net of tax of nil

     (462     1,612        (3,161
  

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income

     (433     1,495        (3,305
  

 

 

   

 

 

   

 

 

 

Consolidated comprehensive loss

     (54,001     (8,726     (13,479

Comprehensive loss attributable to noncontrolling interest .

     (3,267     (571     (955
  

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Identive Group, Inc. stockholders’ equity

   $ (50,734   $ (8,155   $ (12,524
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years Ended December 31, 2012, 2011 and 2010

 

    Identive Group, Inc. Stockholders’ Equity     Noncontrolling
Interest
    Total
Equity
 
    Common Stock     Additional
Paid-in

Capital
    Treasury
Stock
    Accumulated
Deficit
    Accumulative
Other
Comprehensive

Income
     
(In thousands)   Shares     Amount              

Balances, January 1, 2010

    25,753      $ 26      $ 253,910      $ (2,777   $ (216,378   $ 3,159      $ —        $ 37,940   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    —          —          —          —          (9,544     —          (630     (10,174

Other comprehensive loss

    —          —          —          —          —          (2,980     (325     (3,305

Issuance of common stock in connection with acquisitions

    17,900        18        38,758        —          —          —          —          38,776   

Fair value of stock options converted in connection with Bluehill ID acquisition

    —          —          3,007        —          —          —          —          3,007   

Assumption of treasury stock in connection with Bluehill ID acquisition

    —          —          —          (2,880     —          —          —          (2,880

Repurchase of treasury stock in connection with Bluehill ID acquisition

    —          —          (402     2,880        —          —          —          2,478   

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

    88        —          199        —          —          —          (199     —     

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

    106        —          185        —          —          —          —          185   

Issuance of common stock to affiliates for conversion of loan

    181        —          291        —          —          —          —          291   

Issuance of common stock in connection with private placement, net of issuance costs

    4,098        4        9,582        —          —          —          —          9,586   

Issuance of common stock for settlement of pre-acquisition liabilities

    150        —          343        —          —          —          —          343   

Noncontrolling interest in connection with Bluehill ID acquisition

    —          —          —          —          —          —          3,057        3,057   

Stock-based compensation expense

    —          —          330        —          —          —          —          330   

Balances, December 31, 2010

    48,276      $ 48      $ 306,203      $ (2,777   $ (225,922   $ 179      $ 1,903      $ 79,634   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    —          —          —          —          (9, 753     —          (468     (10,221

Other comprehensive income

    —          —          —          —          —          1,598        (103     1,495   

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

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

Issuance of common stock in connection with idOnDemand acquisition

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

Noncontrolling interest in connection with idOnDemand acquisition

    —          —          —          —          —          —          468        468   

Issuance of common stock in connection with earn-out agreements

    137        —          316        —          —          —          —          316   

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

    3        —          8        —          —          —          (8     —     

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

    648        1        1,684        —          —          —          —          1,685   

Issuance of common stock upon exercise of warrants

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

Stock options grants in connection with stock bonus and incentive plans

    —          —          672        —          —          —          —          672   

Stock-based compensation expense for stock options

    —          —          439        —          —          —          —          439   

Stock-based compensation expense for ESPP

    —          —          134        —          —          —          —          134   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years Ended December 31, 2012, 2011 and 2010

 

    Identive Group, Inc. Stockholders’ Equity     Noncontrolling
Interest
    Total
Equity
 
    Common Stock     Additional
Paid-in

Capital
    Treasury
Stock
    Accumulated
Deficit
    Accumulative
Other
Comprehensive

Income
     
(In thousands)   Shares     Amount              

Balances, December 31, 2011

    58,309      $ 58      $ 331,758      $ (2,777   $ (235,675   $ 1,777      $ 1,792      $ 96,933   

Net loss

    —          —          —          —          (50,336     —          (3,232     (53,568

Other comprehensive loss

    —          —          —          —          —          (398     (35     (433

Issuance of common stock in connection with payment solution acquisition

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

Noncontrolling interest in connection with payment solution acquisition

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

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

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

Acquisition of noncontrolling interest in idOnDemand

    —          —          (139     —          —          —          (361     (500

Issuance of common stock in connection with earn-out agreement

    57        —          128        —          —          —          —          128   

Issuance of common stock in connection with ESPP

    298        1        340        —          —          —          —          341   

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

    239        —          420        —          —          —          —          420   

Stock options grants in connection with stock bonus and incentive plans

    —          —          99        —          —          —          —          99   

Stock-based compensation expense for stock options

    —          —          816        —          —          —          —          816   

Stock-based compensation expense for ESPP

    —          —          182        —          —          —          —          182   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, December 31, 2012

    60,809      $ 61      $ 337,811      $ (2,777   $ (286,011   $ 1,379      $ (873   $ 49,590   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

74


Table of Contents

IDENTIVE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years Ended December 31,  
(In thousands)    2012     2011     2010  

Cash flows from operating activities:

      

Net loss

   $ (53,568   $ (10,221   $ (10,174

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

      

Income from discontinued operations

     —          —          (220

Impairment of goodwill and long-lived assets

     51,869        —          —     

Deferred income taxes

     (6,716     (1,983     (159

Depreciation and amortization

     5,563        5,581        4,696   

Accretion of interest to related party liability

     745        748        772   

Amortization of debt issuance costs

     93        —          —     

Interest on financial liabilities

     686        223        79   

Re-measurement of contingent consideration

     (5,657     510        221   

Stock-based compensation expense

     1,208        1,227        2,352   

Loss on disposal and abandonment of fixed assets

     74        —          —     

Pension charges

     289        136        (19

Changes in operating assets and liabilities:

      

Accounts receivable

     (3,135     2,140        (4,400

Inventories

     484        1,923        (2,053

Income taxes receivable

     93        (44     148   

Other assets

     (728     570        (371

Accounts payable

     (433     (2,112     3,307   

Liability to related party

     (1,818     (1,042     (1,081

Accrued expenses

     (1,765     (2,565     (1,971

Deferred revenue

     766        (291     1,054   

Income taxes payable

     (230     555        (539
  

 

 

   

 

 

   

 

 

 

Net cash used in operating activities from continuing operations

     (12,180     (4,645     (8,358

Net cash used in operating activities from discontinued operations

     —          —          (941
  

 

 

   

 

 

   

 

 

 

Net cash used in operating activities

     (12,180     (4,645     (9,299
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Capital expenditures

     (2,789     (1,728     (758

Capitalized software development costs

     (452     —          —     

Net cash acquired (paid) from (for) acquisitions

     572        (5,154     3,881   

Sales and maturities of short-term investments

     —          —          1,015   
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (2,669     (6,882     4,138   
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Proceeds from issuance of debt, net of issuance costs

     6,882        —          —     

Proceeds from capital raise, net of issuance costs

     —          18,212        11,532   

Proceeds from issuance of common stock under employee stock purchase plan

     341        —          —     

Proceeds from issuance of common stock upon options and warrants exercised

     —          1,133        —     

Cash paid for acquisition of noncontrolling interest

     (500     —          —     

Payments on financial liabilities

     (2,106     (1,102     (53

Changes in bank line of credit, net

     239        (605     98   
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     4,856        17,638        11,577