7. Goodwill and Intangible Assets

Goodwill

The following table presents goodwill and changes in the carrying amount of goodwill for each of the Company’s business segments as of September 30, 2013, and December 31, 2012 (in thousands):

	Total			Identity Management			ID Products
Balance at December 31, 2011	$	59,044		$	49,478		$	9,566
Goodwill acquired during the period		12,958			12,958			—
Goodwill measurement period adjustment		297			297			—
Goodwill impairment during the period		(27,084	)		(18,712	)		(8,372	)
Currency translation adjustment		55			16			39
Balance at December 31, 2012		45,270			44,037			1,233
Goodwill impairment during the period		(22,622	)		(22,622	)		—
Currency translation adjustment		75			61			14
Balance at September 30, 2013	$	22,723		$	21,476		$	1,247

The gross amount of goodwill as of September 30, 2013 and December 31, 2012 was $72.4 million and $72.4 million, respectively and accumulated goodwill impairment was $49.7 million and $27.1 million, respectively. During the year ended December 31, 2012, the Company recorded goodwill of $13.0 million in connection with its acquisition of payment solution. In addition, the Company also adjusted goodwill by $0.3 million in connection with its acquisition of payment solution as a measurement period adjustment during the year ended December 31, 2012. Of the total goodwill, a certain amount of goodwill is designated in a currency other than U.S. Dollars and is adjusted at each reporting period for the change in foreign exchange rates between the balance sheet dates.

In accordance with its accounting policy and ASC 350, the Company tests its goodwill and any other intangibles with indefinite lives annually for impairment and assesses whether there are any indicators of impairment on an interim basis. The Company performs interim goodwill impairment reviews between its annual reviews if certain events and circumstances have occurred, including a deterioration in general economic conditions, an increased competitive environment, a change in management, key personnel, strategy or customers, negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods. The Company believes the methodology that it uses to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides it with a reasonable basis to determine whether impairment has occurred. However, many of the factors employed in determining whether its goodwill is impaired are outside of its control and it is reasonably likely that assumptions and estimates will change in future periods. These changes could result in future impairments.

The Company performed its annual impairment test for all reporting units on December 1, 2012 and concluded that there was no impairment to goodwill during the year ended December 31, 2012, other than the impairment identified in its interim assessment during the second quarter of 2012, as described below. As further described below, based on interim assessment performed during the three months ended September 30, 2013, some of the impairment indicators noted above were identified and a preliminary impairment charge to goodwill was recorded in its condensed consolidated statements of operations during the three and nine months ended September 30, 2013.

The Company calculates the fair value of its reporting units using a combination of the market and income approaches and in doing so relies in part upon an independent third-party valuation report. Prior to its goodwill impairment test, the Company first tests its long-lived assets for impairment and adjusts the carrying value of each asset group to its fair value and records the associated impairment charge in its condensed consolidated statements of operations. The Company then performs its analysis of goodwill impairment using a two-step method as required by ASC 350. The first step of the impairment test compares the fair value of each reporting unit to its carrying value, including the goodwill related to the respective reporting units. The market approach of fair value calculation estimates the fair value of a business based on a comparison of the Company to comparable firms in similar lines of business that are publicly traded or which are part of a public or private transaction. The income approach requires estimates of expected revenue, gross margin and operating expenses in order to discount the sum of future cash flows using each particular reporting unit’s weighted average cost of capital. The Company’s growth estimates are based on historical data and internal estimates developed as part of its long-term planning process. The Company tests the reasonableness of the inputs and outcomes of its discounted cash flow analysis by comparing these items to available market data. The second step of the impairment test compares the implied fair value of goodwill to the carrying value of goodwill. 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 level of goodwill impairment, if any. During the second step, management estimates the fair value of the Company’s tangible and intangible net assets. Intangible assets are identified and valued for each reporting unit for which second step is performed. The difference between the estimated fair value of each reporting unit and the sum of the fair value of the identified net assets results in the implied value of goodwill. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized equal to that excess. Both in 2013 and 2012, when the impairment test was performed, the Company had six reporting units. These reporting units include Hirsch, ID Solutions, payment solution and idOnDemand, which are the four components of the Identity Management segment, and ID Infrastructure and Transponders, which are the two components of the ID Products segment.

2013 Interim Impairment Test

During the third quarter of fiscal 2013, the Company began a strategic review of certain under-performing business units for potential divestiture and to simplify the Company’s operations and market focus, and as a consequence revised its forecasted revenue, gross margin and operating profit for future periods. In addition, the Company noted certain other indicators of impairment, including a change in management following the appointment of a new chief executive officer, a sustained decline in its stock price, and as a result of the U.S. Federal budget sequester continued reduced performance in certain reporting units. Based on its reduced forecast and the indicators of impairment noted above, the Company performed an interim goodwill impairment analysis as part of its quarterly close as of September 30, 2013. Based on the results of step one of the goodwill impairment analysis, it was determined that the Company’s net adjusted carrying value exceeded its estimated fair value for the Hirsch, ID Solutions, payment solution and idOnDemand reporting units. As a result, the Company proceeded to the second step of the goodwill impairment test for these four reporting units to determine the implied fair value of goodwill to calculate the impairment loss, if any.

Due to the length of time necessary to measure impairment of goodwill relating to these four reporting units, the second step of the goodwill impairment analysis was not completed as of the time of the filing of this Quarterly Report on Form 10-Q and is subject to change. Based on the preliminary results of step two of the goodwill impairment analysis, the Company concluded that the carrying value of goodwill for the Hirsch, ID Solutions, payment solution and idOnDemand reporting units was impaired and recorded a preliminary impairment charge of $22.6 million in its condensed consolidated statements of operations during the three and nine months ended September 30, 2013. While goodwill impairment charges are preliminary, they represent Company’s best estimates as of the date of the filing of this Quarterly Report on Form 10-Q. The Company expects to complete its analysis during the fourth quarter of 2013 and will record any adjustments to this preliminary estimate at that time.

2012 Interim Impairment Test

During the second quarter of 2012, the Company experienced a significant decline in its stock price, resulting in the Company’s market capitalization falling significantly below its net book value, and the Company’s demand outlook deteriorated due to macroeconomic uncertainty and associated softness in demand for the Company’s offerings. These factors were considered indicators of potential impairment, and as a result, the Company performed an interim goodwill impairment analysis as part of its quarterly close as of June 30, 2012. The interim impairment of goodwill was primarily triggered due to decline in the Company’s market capitalization that occurred after the filing of its 2012 first fiscal quarter Form 10-Q and, to a lesser extent, a decrease in the forecasted future cash flows used in the income approach. Based on the results of step one of the goodwill impairment analysis, it was determined that the Company’s net adjusted carrying value exceeded its estimated fair value for the ID Solutions, idOnDemand and Transponder reporting units. As a result, the Company proceeded to the second step of the impairment test for these three reporting units to determine impairment loss, if any.

Based on the results of step two of the goodwill impairment analysis, the Company concluded that the carrying value of goodwill for the idOnDemand, Transponder and ID Solutions reporting units was impaired and recorded an impairment charge of $27.1 million in its consolidated statements of operations during the year ended December 31, 2012, of which $21.4 million was recorded during the three months ended June 30, 2012, $5.0 million was recorded during the three months ended September 30, 2012 and $0.7 million was recorded during the three months ended December 31, 2012.

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 Assets

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

	Order Backlog			Trade Secrets			Patents
Cost:
Amortization period		0.25 - 1 year			1 - 2 years			12 years			6 - 12 years			4 - 12 years			1 - 10 years
Balance at December 31, 2011	$	948		$	300		$	790		$	8,170		$	24,795		$	9,367		$	44,370
Acquired as a part of payment solution acquisition		344			—			—			2,023			1,323			542			4,232
Impairment of intangible assets		(1,018	)		(300	)		(790	)		(5,489	)		(15,210	)		(9,294	)		(32,101	)
Currency translation adjustment		3			—			—			(104	)		(176	)		(45	)		(322	)
Balance at December 31, 2012	$	277		$	—		$	—		$	4,600		$	10,732		$	570		$	16,179
Impairment of intangible assets		(277	)		—			—			—			—			—			(277	)
Currency translation adjustment		—			—			—			—			8			—			8
Balance at September 30, 2013	$	—		$	—		$	—		$	4,600		$	10,740		$	570		$	15,910
Accumulated Amortization:
Balance at December 31, 2011	$	(948	)	$	(120	)	$	(44	)	$	(1,295	)	$	(5,924	)	$	(38	)	$	(8,369	)
Amortization expense		(72	)		(90	)		(33	)		(695	)		(2,055	)		(332	)		(3,277	)
Impairment of intangible assets		959			210			77			865			5,118			87			7,316
Currency translation adjustment		(10	)		—			—			—			45			(2	)		33
Balance at December 31, 2012	$	(71	)	$	—		$	—		$	(1,125	)	$	(2,816	)	$	(285	)	$	(4,297	)
Amortization expense		(59	)		—			—			(230	)		(589	)		(285	)		(1,163	)
Impairment of intangible assets		130			—			—			—			—			—			130
Currency translation adjustment		—			—			—			—			(8	)		—			(8	)
Balance at September 30, 2013	$	—		$	—		$	—		$	(1,355	)	$	(3,413	)	$	(570	)	$	(5,338	)
Intangible Assets, net at September 30, 2013	$	—		$	—		$	—		$	3,245		$	7,327		$	—		$	10,572
Intangible Assets, net at December 31, 2012	$	206		$	—		$	—		$	3,475		$	7,916		$	285		$	11,882

Of the total intangible assets, certain acquired intangible assets are designated in a currency other than U.S. Dollars and are adjusted each reporting period for the change in foreign exchange rates between the balance sheet dates. Each period the Company evaluates the estimated remaining useful life of purchased intangible assets and whether events or changes in circumstances warrant a revision to the remaining period of amortization and adjusts the useful life, as appropriate and amortization is prospectively adjusted over the remaining useful live. Intangible assets subject to amortization are amortized over their useful lives as shown in the table above. The Company evaluated its amortizable intangible assets for impairment at the end of each reporting periods and concluded that no indicators of impairment existed, other than the periods mentioned below.

2013 Impairment Test

As noted above, the Company began a strategic review of certain under-performing business units for potential divestiture during the third quarter of fiscal 2013. As a consequence, the Company performed an impairment analysis for intangible assets in accordance with its accounting policy for reviewing long-lived assets for impairment. As a result of this analysis, the Company identified that backlog is impaired and recorded an impairment charge in its condensed consolidated statements of operations of $0.1 million during the three and nine months ended September 30, 2013. Based on this analysis, the Company expects to recover the remaining balance of identified intangible assets of $10.6 million.

2012 Impairment Test

As noted above, the Company performed an interim goodwill impairment analysis as of June 30, 2012 and in conjunction also performed an impairment analysis for intangible assets in accordance with its accounting policy for reviewing long-lived assets for impairment. Management determined the estimated undiscounted cash flows and the fair value of the identified intangible assets to measure the impairment loss and in doing so relied in part upon an independent third-party valuation report. The impairment analysis for intangible assets indicated that some of the identified intangible assets are not recoverable as the sum of its estimated future undiscounted cash flows were below the asset’s carrying value. Accordingly, the Company estimated the fair value of these identified intangible assets using a discounted cash flow analysis to measure the impairment loss. The discounted cash flow analysis requires estimates such as expected revenue, gross margin and operating expenses, in order to discount the sum of future independent cash flows using discount rates which were determined based on an analysis of each individual identified intangible asset group and consideration of the aggregate business of the Company. The discount rates used in the present value calculations were in the range of 16% to 20%, except for one asset group where it was 50%. The discount rates were derived from a weighted average cost of capital (“WACC”) analysis, adjusted to reflect additional risks related to each asset’s characteristics. The Company tested the reasonableness of the inputs and outcomes of its discounted cash flow analysis by comparing these items to available market data.

As a result of this analysis, the Company concluded that certain of its intangible assets were impaired and recorded an impairment charge in its condensed consolidated statements of operations of $24.8 million during the year ended December 31, 2012, of which $23.9 million was recorded during the three months ended June 30, 2012 and $0.9 million was recorded during the three months ended September 30, 2012.

The following table illustrates the amortization expense included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2013 and 2012 (in thousands):

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2013		2012			2013			2012
Cost of revenue	$	96	$	91	$		289	$		794
Selling and marketing		197		333			874			2,050
Total	$	293	$	424	$		1,163	$		2,844

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

September 30, 2013:
2013 (remaining three months)	$	388
2014		1,455
2015		1,455
2016		1,455
2017		1,455
2018 and thereafter		4,364
Total	$	10,572