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IMAGEWARE SYSTEMS INC - 10-K/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion should be read in conjunction with our consolidated
financial statements and the related notes and other financial information
appearing elsewhere in this Form 10-K. Readers are also urged to carefully
review and consider the various disclosures made by us which attempt to advise
interested parties of the factors which affect our business, including (without
limitation) the disclosures made under the captions "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Risk Factors,"
and in the audited consolidated financial statements and related notes included
in this Annual Report on Form 10-K.
Recent Developments
New Software as a Service Business Model.
With the advent of cloud based computing, the proliferation of mobile devices
which allow for mobile transactions across wide geographical areas, the
emergence of inexpensive and reliable biometric capture devices and the need to
secure access to data, product and services, the Company believes that the
market for multi-biometric solutions will expand to encompass significant
deployments of biometric systems in the commercial and consumer markets. The
Company therefore intends to leverage the strength of its existing government
clients who have deployed the Company's products for large populations, as well
as its foundational patent portfolio in the field of multi-modal biometrics and
the fusion of multiple biometric algorithms, to address the commercial and
consumer market. As part of its marketing plan, the Company will offer new
versions of its product suite on a Software as a Service ("SaaS") model during
2012. This new business model, which is intended to supplement the Company's
existing business model, will allow new commercial and consumer clients to
verify identity in order to access data, products or services from mobile and
desktop devices.
Additional Intellectual Property.
The Company is a pioneer in inventing the technology of using multi-biometrics
on a seamless and integrated platform, in addition to "fusing" multiple
biometrics into a common or fused score for greater reliability in
authenticating identity. The Company believes it has the foundational patents on
the use of multiple biometrics and fusing on such a platform and continues to be
an IP leader in the space. It is the Company's belief that this intellectual
property leadership will create a sustainable competitive advantage. In addition
to its eight issued U.S. and foreign patents, the Company recently filed three
new patent applications surrounding new "Anonymous Matching" technologies. These
technologies will allow biometric matching for identity verification while
protecting the privacy of an individual. It is the Company's belief that such
technology will be critical to providing biometric management solutions for the
consumer market where privacy protection has been a historical issue and barrier
to biometric adoption.
Consummation of Financing.
On December 20, 2011, the Company consummated an equity financing resulting in
gross proceeds of $10.0 million ("Qualified Financing"), including the $750,000
of promissory notes converted into the Qualified Financing. In connection with
the Qualified Financing, the Company issued 20.0 million shares of its common
stock (the "Shares"), and warrants to purchase 12,207,500 shares of its common
stock exercisable for $0.50 per share ("Warrants"). The Warrants expire five
years from the date of grant. As a result of the Qualified Financing, the
Company's Series C 8% Convertible Preferred Stock ("Series C Preferred") and
Series D 8% Convertible Preferred Stock ("Series D Preferred") was automatically
converted into 11,768,525 shares of common stock. In addition, in connection
with the Qualified Financing, (i) the anti-dilution provision contained in
certain of the Company's existing warrants were amended resulting in such
warrants no longer qualifying as derivative liabilities; and (ii) a significant
investor ("Investor") exchanged $4.5 million principal amount of convertible
promissory notes of the Company ("Exchanged Notes"), and accrued but unpaid
interest on the Exchanged Notes and on an additional $2.25 million in promissory
notes, into 9,774,559 shares of the Company's common stock ("Exchange Shares").
The Investor also agreed to convert $750,000 principal amount of additional
promissory notes held by the Investor and invest the proceeds into the Qualified
Financing. The Company is obligated to file a registration statement with the
Securities and Exchange Commission on or before February 20, 2012 to register
for resale the Shares and the common stock issuable upon exercise of the
Warrants.
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The net proceeds from the Qualified Financing, approximately $9.2 million, will
be used for (i) the customization of identity management products for enterprise
and consumer applications; (ii) further development of intellectual property;
(iii) development of SaaS capabilities for existing products; (iv) the payment
of $1.5 million principal amount of convertible promissory notes; and (v) for
working capital and general corporate purposes.
Overview
The Company is a pioneer and leader in the emerging market for biometrically
enabled software-based identity management solutions. Using those human
characteristics that are unique to us all, the Company creates software that
provides a highly reliable indication of a person's identity. Our "flagship"
product is our patented IWS Biometric Engine®. Scalable for small city business
or worldwide deployment, our Biometric Engine is a multi-biometric software
platform that is hardware and algorithm independent, enabling the enrollment and
management of unlimited population sizes. It allows a user to utilize one or
more biometrics on a seamlessly integrated platform. Our products are used to
manage and issue secure credentials, including national IDs, passports, driver
licenses and access control credentials. Our products also provide law
enforcement with integrated mug shot, fingerprint LiveScan and investigative
capabilities. We also provide comprehensive authentication security software
using biometrics to secure physical and logical access to facilities or computer
networks or Internet sites. Biometric technology is now an integral part of all
markets we address and all of our products are integrated into the IWS Biometric
Engine.
While we have historically marketed our products to the government market at the
federal, state and local levels, the emergence of cloud based computing - a
mobile market that demands increased security and interoperable systems, and the
proven success of our products in the government market, will enable us to
enlarge our target market focus to include the emerging consumer and
non-government enterprise marketplace.
Our biometric technology is a core software component of an organization's
security infrastructure and includes a multi-biometric identity management
solution for enrolling, managing, identifying and verifying the identities of
people by the physical characteristics of the human body. We develop, sell and
support various identity management capabilities within government (federal,
state and local), law enforcement, commercial enterprises, and transportation
and aviation markets for identification and verification purposes. Our IWS
Biometric Engine is a patented biometric identity management software platform
for multi-biometric enrollment, management and authentication, managing
population databases of virtually unlimited sizes. It is hardware agnostic and
can utilize different types of biometric algorithms. It allows different types
of biometrics to be operated at the same time on a seamlessly integrated
platform. It is also offered as a Software Development Kit (SDK) based search
engine, enabling developers and system integrators to implement a biometric
solution or integrate biometric capabilities into existing applications without
having to derive biometric functionality from pre-existing applications. The
IWS Biometric Engine combined with our secure credential platform, IWS EPI
Builder, provides a comprehensive, integrated biometric and secure credential
solution that can be leveraged for high-end applications such as passports,
driver licenses, national IDs, and other secure documents.
Our law enforcement solutions enable agencies to quickly capture, archive,
search, retrieve, and share digital images, fingerprints and other biometrics as
well as criminal history records on a stand-alone, networked, wireless or
Web-based platform. We develop, sell and support a suite of modular software
products used by law enforcement and public safety agencies to create and manage
criminal history records and to investigate crime. Our IWS Law Enforcement
solution consists of five software modules: Capture and Investigative modules,
which provide a criminal booking system with related databases as well as the
ability to create and print mug photo/SMT image lineups and electronic mugbooks;
a Facial Recognition module, which uses biometric facial recognition to identify
suspects; a Web module, which provides access to centrally stored records over
the Internet in a connected or wireless fashion; and a LiveScan module, which
incorporates LiveScan capabilities into IWS Law Enforcement providing integrated
fingerprint and palm print biometric management for civil and law enforcement
use. The IWS Biometric Engine is also available to our law enforcement clients
and allows them to capture and search using other biometrics such as iris or
DNA.
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Our secure credential solutions empower customers to create secure and smart
digital identification documents with complete ID systems. We develop, sell and
support software and design systems which utilize digital imaging and biometrics
in the production of photo identification cards, credentials and identification
systems. Our products in this market consist of IWS EPI Suite and IWS EPI
Builder (SDK). These products allow for the production of digital
identification cards and related databases and records and can be used by, among
others, schools, airports, hospitals, corporations or governments. We have
added the ability to incorporate multiple biometrics into the ID systems with
the integration of IWS Biometric Engine to our secure credential product line.
Our enterprise authentication software includes the IWS Desktop Security
product which is a comprehensive authentication management infrastructure
solution providing added layers of security to workstations, networks and
systems through advanced encryption and authentication technologies. IWS Desktop
Security is optimized to enhance network security and usability, and uses
multi-factor authentication methods to protect access, verify identity and help
secure the computing environment without sacrificing ease-of-use features such
as quick login. Additionally, IWS Desktop Security provides an easy integration
with various smart card-based credentials including the Common Access Card
(CAC), Homeland Security Presidential Directive 12 (HSPD-12), Personal Identity
Verification (PIV) credential, and Transportation Worker Identification
Credential (TWIC) with an organization's access control process. IWS Desktop
Security provides the crucial end-point component of a Logical Access Control
System (LACS), and when combined with a Physical Access Control System (PACS),
organizations benefit from a complete door to desktop access control and
security model.
CRITICAL ACCOUNTING ESTIMATES
The discussion and analysis of our consolidated financial condition and results
of operations are based on our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America, or U.S. GAAP. The preparation of these consolidated
financial statements in accordance with U.S. GAAP requires us to utilize
accounting policies and make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingencies as
of the date of the consolidated financial statements and the reported amounts of
revenue and expenses during a fiscal period. The SEC considers an accounting
policy to be critical if it is important to a company's financial condition and
results of operations, and if it requires significant judgment and estimates on
the part of management in its application.
Significant estimates include the allowance for doubtful accounts receivable,
calculation of the Company's tax provision, inventory obsolescence reserve,
deferred tax asset valuation allowances, accounting for loss contingencies,
recoverability of goodwill and acquired intangible assets and amortization
periods, assumptions used in the Black-Scholes model to calculate the fair value
of share based payments, assumptions used in the application of fair value
methodologies to calculate the fair value of derivative liabilities and revenue
and cost of revenues recognized under the percentage of completion method.
The following are our critical accounting policies because we believe they are
both important to the portrayal of our financial condition and results of
operations and require critical management judgments and estimates about matters
that are uncertain. If actual results or events differ materially from those
contemplated by us in making these estimates, our reported financial condition
and results of operations for future periods could be materially affected. For a
detailed discussion on the application of these and other accounting policies,
see Note 2 in the Notes to the Consolidated Financial Statements in Item 8 of
this Annual Report on Form 10-K, beginning on page F-13.
Revenue Recognition. Our revenue recognition policy is significant because our
revenue is a key component of our consolidated results of operations. We
recognize revenue from the following major revenue sources:
? Long-term fixed-price contracts involving significant customization
? Fixed-price contracts involving minimal customization;
? Software licensing;
? Sales of computer hardware and identification media; and
? Post contract customer support (PCS)
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The Company's revenue recognition policies are consistent with U.S. GAAP
including ASC 985-605, "Software Revenue Recognition", ASC 605-35 "Revenue
Recognition, Construction-Type and Production-Type Contracts", "Securities and
Exchange Commission Staff Accounting Bulletin 104, and ASC 605-25 "Revenue
Recognition, Multiple Element Arrangements". Accordingly, the Company recognizes
revenue when all of the following criteria are met: persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
fee is fixed or determinable, and collectability is reasonably assured.
We recognize revenue and profit as work progresses on long-term, fixed-price
contracts involving significant amount of hardware and software customization
using the percentage of completion method based on costs incurred to date
compared to total estimated costs at completion. Revenue from contracts for
which we cannot reliably estimate total costs or there are not significant
amounts of customization are recognized upon completion. Determining when a
contract should be accounted for using the percentage of completion method
involves judgment. Critical items that are considered in this process are the
degree of customization and related labor hours necessary to complete the
required work as well as ongoing estimates of the future labor hours needed to
complete the contract. We also generate non-recurring revenue from the licensing
of our software. Software license revenue is recognized upon the execution of a
license agreement, upon deliverance, fees are fixed and determinable,
collectability is probable and when all other significant obligations have been
fulfilled. We also generate revenue from the sale of computer hardware and
identification media. Revenue for these items is recognized upon delivery of
these products to the customer. Our revenue from periodic maintenance agreements
is generally recognized ratably over the respective maintenance periods provided
no significant obligations remain and collectability of the related receivable
is probable.
For a detailed discussion on the application of these and other accounting
policies, see Note 2 in the Notes to the Consolidated Financial Statements
beginning on page F-9.
Allowance for Doubtful Accounts. We provide an allowance for our accounts
receivable for estimated losses that may result from our customers' inability to
pay. We determine the amount of allowance by analyzing historical losses,
customer concentrations, customer creditworthiness, current economic trends, the
age of the accounts receivable balances, and changes in our customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. Our
accounts receivable balance was $239,000, net of allowance for doubtful accounts
of $5,000 at December 31, 2010. Our accounts receivable balance was $627,000,
net of allowance for doubtful accounts of $15,000 at December 31, 2009.
Valuation of Goodwill, Other Intangible and Long-Lived Assets. The Company
accounts for its intangible assets under the provisions of ASC 350, "Intangibles
- Goodwill and Other". In accordance with ASC 350, intangible assets with a
definite life are analyzed for impairment under ASC 360-10-05 and intangible
assets with an indefinite life are analyzed for impairment under ASC 360. In
accordance with ASC 350, goodwill, or the excess of cost over fair value of net
assets acquired, is no longer amortized but is tested for impairment using a
fair value approach at the "reporting unit" level. A reporting unit is the
operating segment, or a business one level below that operating segment
(referred to as a component) if discrete financial information is prepared and
regularly reviewed by management at the component level. The Company's reporting
unit is at the entity level. The Company recognizes an impairment charge for any
amount by which the carrying amount of a reporting unit's goodwill exceeds its
fair value. The Company uses fair value methodologies to establish fair values.
We assess impairment of goodwill and identifiable intangible assets whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important which could trigger an impairment
review include the following:
• Significant underperformance relative to historical or expected future
operating results;
• Significant changes in the manner of our use of the acquired assets or the
strategy of our overall business; and
• Significant negative industry or economic trends.
The Company annually, or more frequently if events or circumstances indicate a
need, tests the carrying amount of goodwill for impairment. The Company performs
its annual impairment test in the fourth quarter of each year. A two-step
impairment test is used to first identify potential goodwill impairment and then
measure the amount of goodwill impairment loss, if any. These tests were
conducted by determining and comparing the fair value, employing the market
approach, of the Company's reporting units to the carrying value of the
reporting unit. In 2006, the Company determined that its only reporting unit is
Identity Management. Based on the results of these impairment tests, the Company
determined that its goodwill assets were not impaired as of December 31, 2010
and 2009.
The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate their net book value may not be recoverable.
When such factors and circumstances exist, the Company compares the projected
undiscounted future cash flows associated with the related asset or group of
assets over their estimated useful lives against their respective carrying
amount. Impairment, if any, is based on the excess of the carrying amount over
the fair value, based on market value when available, or discounted expected
cash flows, of those assets and is recorded in the period in which the
determination is made. The Company's management currently believes there is no
impairment of its long-lived assets. There can be no assurance, however, that
market conditions will not change or demand for the Company's products under
development will continue. Either of these could result in future impairment of
long-lived assets.
There are many management assumptions and estimates underlying the determination
of an impairment loss, and estimates using different, but reasonable,
assumptions could produce significantly different results. Significant
assumptions include estimates of future levels of revenues and operating
expenses. Therefore, the timing and recognition of impairment losses by us in
the future, if any, may be highly dependent upon our estimates and assumptions.
There can be no assurance that goodwill impairment will not occur in the future.
Goodwill and other net intangible assets amounted to approximately $3,494,000 at
December 31, 2010.
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Stock-Based Compensation. At December 31, 2010, the Company had two
stock-based compensation plans for employees and nonemployee directors, which
authorize the granting of various equity-based incentives including stock
options and restricted stock.
The Company estimates the fair value of its stock options using a Black-Scholes
option-pricing model, consistent with the provisions of ASC No. 718,
Compensation - Stock Compensation. The fair value of stock options granted is
recognized to expense over the requisite service period. Stock-based
compensation expense for all share-based payment awards is recognized using the
straight-line single-option method. Stock-based compensation expense is reported
in selling, general and expenses based upon the departments to which
substantially all of the associated employees report and credited to additional
paid-in-capital. Stock-based compensation expense related to equity options was
approximately $243,000 and $246,000 for the twelve month ended December 31, 2010
and 2009, respectively.
ASC 718 requires the use of a valuation model to calculate the fair value of
stock-based awards. For the years ended December 31, 2010 and 2009, the Company
has elected to use the Black-Scholes option-pricing model, which incorporates
various assumptions including volatility, expected life, and interest rates. The
Company is required to make various assumptions in the application of the
Black-Scholes option-pricing model. The Company has determined that the best
measure of expected volatility is based on the historical weekly volatility of
the Company's common stock. Historical volatility factors utilized in the
Company's Black-Scholes computations range from 64% to 119%. The Company has
elected to estimate the expected life of an award based upon the SEC approved
"simplified method" noted under the provisions of Staff Accounting Bulletin
No. 110. The expected term used by the Company as computed by this method range
from 5.5 years to 6.1 years. The difference between the actual historical
expected life and the simplified method was immaterial. The interest rate used
is the risk free interest rate and is based upon U. S. Treasury rates
appropriate for the expected term. Interest rates used in the Company's
Black-Scholes calculations range from 4.1% to 4.6%. Dividend yield is zero as
the Company does not expect to declare any dividends on the Company's common
shares in the foreseeable future.
In addition to the key assumptions used in the Black-Scholes model, the
estimated forfeiture rate at the time of valuation is a critical assumption. The
Company has estimated an annualized forfeiture rate of approximately 10% for
corporate officers, 4% for members of the Board of Directors and 6% for all
other employees. The Company reviews the expected forfeiture rate annually to
determine if that percent is still reasonable based on historical experience.
Income Taxes. The Company accounts for income taxes in accordance with ASC
740, Accounting for Income Taxes, (ASC 740). Deferred income taxes are
recognized for the tax consequences related to temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes and
the amounts used for tax purposes at each year-end, based on enacted tax laws
and statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. A valuation allowance is established when
necessary based on the weight of available evidence, if it is considered more
likely than not that all or some portion of the deferred tax assets will not be
realized. Income tax expense is the sum of current income tax plus the change in
deferred tax assets and liabilities.
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ASC 740-10 requires a company to first determine whether it is
more-likely-than-not (defined as a likelihood of more than fifty percent) that a
tax position will be sustained based on its technical merits as of the reporting
date, assuming that taxing authorities will examine the position and have full
knowledge of all relevant information. A tax position that meets this
more-likely-than-not threshold is then measured and recognized at the largest
amount of benefit that is greater than fifty percent likely to be realized upon
effective settlement with a taxing authority.
We recognize and measure uncertain tax positions in accordance with U.S.GAAP,
pursuant to which we only recognize the tax benefit from an uncertain tax
position if it is more likely than not that the tax position will be sustained
on examination by the taxing authorities, based on the technical merits of the
position. Any tax benefits recognized in the financial statements from such
positions are then measured based on the largest benefit that has a greater than
50 percent likelihood of being realized upon ultimate settlement. We report a
liability for unrecognized tax benefits resulting from uncertain tax positions
taken or expected to be taken in a tax return. U.S. GAAP further requires that a
change in judgment related to the expected ultimate resolution of uncertain tax
positions be recognized in earnings in the quarter of such change. We recognize
interest and penalties, if any, related to unrecognized tax benefits in income
tax expense.
We file annual income tax returns in multiple taxing jurisdictions around the
world. A number of years may elapse before an uncertain tax position is audited
and finally resolved. While it is often difficult to predict the final outcome
or the timing of resolution of any particular uncertain tax position, we believe
that our analysis of income tax reserves reflects the most likely outcome. We
adjust these reserves, if any, as well as the related interest, in light of
changing facts and circumstances. Settlement of any particular position could
require the use of cash.
In June 2010, the Company was notified that the Canada Revenue Agency ("CRA")
has proposed certain significant adjustments to the Company's transfer pricing
tax position for the years 2001 through 2008. Management evaluated those
proposed adjustments and in July 2010 filed a formal notice of appeal. In 2011,
the Company was notified that certain significant portions of the Company's
appeal had been accepted by the CRA. As a result of appeal, the Company has
recorded a tax provision of approximately $126,000 and $0 for the years ended
2010 and 2009, respectively.
Significant judgment is required in evaluating the Company's uncertain tax
positions and determining the Company's provision for income taxes. No assurance
can be given that the final tax outcome of these matters will not be different
from that which is reflected in the Company's historical income tax provisions
and accruals. The Company adjusts these items in light of changing facts and
circumstances. To the extent that the final tax outcome of these matters is
different than the amounts recorded, such differences will impact the provision
for income taxes in the period in which such determination is made.
Fair-Value Measurements. The Company accounts for fair value measurements in
accordance with ASC Topic No. 820, Fair Value Measurements and Disclosures, (ASC
820) which defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles, and expands disclosures about fair
value measurements. The provisions of ASC 820 were adopted on January 1, 2008.
In February 2008, ASC 820-10 delayed the effective date of fair value
measurement and disclosure for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). The provisions of ASC
820-10 were effective for the Company's fiscal year beginning January 1, 2009.
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ASC 820 establishes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements). The three levels of the fair value hierarchy
under FAS 157 are described below:
Level 1 Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities.
Level 2 Level 2 applies to assets or liabilities for which there are inputs
other than quoted prices included within Level 1 that areobservable
for the asset or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets or
liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derivedprincipally
from, or corroborated by, observable market data.
Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by
little or no market activity).
Assessing the significance of a particular input to the fair value measurement
requires judgment, considering factors specific to the asset or
liability. Determining whether a fair value measurement is based on Level 1,
Level 2, or Level 3 inputs is important because certain disclosures are
applicable only to those fair value measurements that use Level 3 inputs. The
use of Level 3 inputs may include information derived through extrapolation or
interpolation which involves management assumptions.
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash
flow, market or foreign currency risks.
The Company reviews the terms of the common and preferred stock, warrants
and convertible debt it issues to determine whether there are embedded
derivative instruments, including embedded conversion options, which are
required to be bifurcated and accounted for separately as derivative financial
instruments. In circumstances where the host instrument contains more than one
embedded derivative instrument, including the conversion option, that is
required to be bifurcated, the bifurcated derivative instruments are accounted
for as a single, compound derivative instrument.
Bifurcated embedded derivatives are initially recorded at fair value and
are then revalued at each reporting date with changes in the fair value reported
as non-operating income or expense. When the equity or convertible debt
instruments contain embedded derivative instruments that are to be bifurcated
and accounted for as liabilities, the total proceeds received are first
allocated to the fair value of all the bifurcated derivative instruments. The
remaining proceeds, if any, are then allocated to the host instruments
themselves, usually resulting in those instruments being recorded at a discount
from their face value.
The discount from the face value of the convertible debt, together with the
stated interest on the instrument, is amortized over the life of the instrument
through periodic charges to interest expense, using the effective interest
method.
RESULTS OF OPERATIONS
This management's discussion and analysis of financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and related notes contained elsewhere in this Annual Report.
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Comparison of Results for Fiscal Years Ended December 31, 2010 and 2009
Product Revenues.
Years Ended December 31,
Net Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 1,882 $ 2,307 $ (425) (18) %
Percentage of total net product %
revenue 59 67 %
Hardware and consumables $ 381 $ 230 $ 151 66 %
Percentage of total net product %
revenue 12 7 %
Services $ 929 $ 893 $ 36 4 %
Percentage of total net product %
revenue 29 26 %
Total net product revenues $ 3,192 $ 3,430 $ (238) (7) %
Software and royalty revenues decreased 18% or $425,000 during the year ended
December 31, 2010 as compared to the corresponding period in 2009. The decrease
is due primarily to lower sales of our boxed identity management software sold
through our distribution channel of approximately $270,000 combined with lower
law enforcement project-oriented revenues of approximately $166,000.
Revenues from the sale of hardware and consumables increased 66% or $151,000
during the year ended December 31, 2010 as compared to the corresponding period
in 2009. The increase reflects higher levels of hardware and consumables
generated from project solutions.
Services revenues are comprised primarily of software integration services,
system installation services and customer training. Such revenues increased
approximately $36,000 during the year ended December 31, 2010 as compared to the
corresponding period in 2009 due to higher service revenues being generated from
software integration of our Biometric Engine and PIV products into project
solutions. We expect service revenues to continue to be a significant component
of our revenues through our implementation of large-scale high-end
installations.
We believe that the period-to-period fluctuations of identity management
software revenue in project-oriented solutions are largely due to the timing of
government procurement with respect to the various programs we are
pursuing. Based on management's current visibility into the timing of potential
government procurements, and while no assurances can be given, we believe that
we will see a significant increase in government procurement and implementations
with respect to identity management initiatives; however, we cannot predict the
timing of such initiatives.
Maintenance Revenues.
Years Ended December 31,
Net Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Maintenance Revenues $ 2,619 $ 2,599 $ 20 1 %
The increase in maintenance revenues reflects higher maintenance revenues from
of our Identification Products of approximately $58,000 during the year ended
December 31, 2010 as compared to the comparable period of 2009, offset by a
decrease in law enforcement maintenance revenues of approximately $38,000. The
increase in maintenance revenues from our Identification products is due to our
expanding installed base of this product suite. The decrease in maintenance
revenues from our law enforcement products reflects the expiration of certain
maintenance contracts. While no assurances can be given, we expect maintenance
revenues to increase in 2011 due to the expansion of our installed base
resulting from the completion of significant project-oriented work during the
2011 fiscal year.
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We anticipate the growth of our maintenance revenues through the retention of
existing customers combined with the expansion of installed base combined
resulting from the completion of project-oriented work, however, we cannot
predict the timing of this anticipated growth.
Cost of Product Revenues.
Years Ended December 31,
Cost of Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 266 $ 310 $ (44) (14) %
Percentage of software and
royalty product revenue 14 % 13 %
Hardware and consumables $ 289 $ 228 $ 61 27 %
Percentage of hardware and
consumables product revenue 76 % 99 %
Services $ 504 $ 627 $ (123) (20) %
Percentage of services product
revenue 54 % 70 %
Total cost of product revenues $ 1,059 $ 1,165 $
(106) (9) %
Percentage of total product
revenues 33 % 34 %
The cost of software and royalty product revenue decreased 14% or $44,000 during
the year ended December 31, 2010 as compared to the corresponding period in
2009. This decrease is reflective of lower software and royalty product revenues
of approximately $425,000 during the year ended December 31, 2010 as compared to
the corresponding period in 2009. Costs of products can vary as a percentage of
product revenue from period to period depending upon the level of software
customization and third party software license content included in product sales
during a given period.
The increase in the cost of product revenues for our hardware and consumable
sales of $61,000 for the year ended December 31, 2010 as compared to the
corresponding period in 2009 reflects the increase in hardware and consumable
revenues of approximately $151,000 for the year ended December 31, 2010 as
compared to the comparable period in 2009.
Costs of service revenues decreased $123,000 for the year ended December 31,
2010 as compared to the corresponding period in 2009. This decrease is due
primarily to the year ended December 31, 2009 containing integration costs of
our identity management products into project solutions in excess of revenues
generated on certain contracts.
Cost of Maintenance Revenues.
Years Ended
December 31,
Cost of Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance cost of revenues $ 938 $ 814 $ 124 15 %
Percentage of total maintenance revenues 36 % 31 %
Costs of maintenance revenues as a percentage of maintenance revenues increased
to 36% during the year ended December 31, 2010 from 31% for the corresponding
period in 2009. This increase is due primarily to higher identification labor
costs incurred to perform maintenance requirements on completed large-scale
identity management projects.
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Product Gross Profit.
Years Ended
December 31,
Product Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 1,616 $ 1,997 $ (381) (19) %
Percentage of software and 86 % 87 %
royalty product revenue
Hardware and consumables $ 92 $ 2 $ 90 4,500 %
Percentage of hardware and 24 % 1 %
consumables product revenue
Services $ 425 $ 266 $ 159 60 %
Percentage of services product 46 % 30 %
revenue
Total product gross profit $ 2,133 $ 2,265 $ (132) (6) %
Percentage of total product 67 % 66 %
revenues
Software and royalty gross profit decreased by 19% or approximately $381,000 for
the year ended December 31, 2010 from the corresponding period in 2009. The
decrease is principally due to lower software and royalty product revenues of
approximately $425,000 in the 2010 period. Costs of software products can vary
as a percentage of product revenue from quarter to quarter depending upon
product mix and third party software licenses included in software solutions.
Hardware and consumable gross profit increased approximately $90,000 due
primarily to higher hardware and consumable revenues of $151,000 during the year
ended December 31, 2010 as compared to the corresponding period in 2009.
The increase in services gross profit is comprised of higher service revenues of
approximately $36,000 during the year ended December 31, 2010 as compared to the
corresponding period in 2009, combined with lower cost of service revenues of
approximately $123,000 during the year ended December 31, 2010 as compared to
the corresponding period in 2009. The decrease in the cost of service revenues
of $123,000 is due primarily to the 2009-year containing integration costs of
our identity management products into project solutions in excess of revenues
generated on certain contracts.
Maintenance Gross Profit.
Years Ended
December 31,
Maintenance Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 1,681 $ 1,785 $ (104) (6) %
Percentage of total maintenance revenues 64 % 69 %
Gross margins related to maintenance revenues decreased despite higher
maintenance revenues of approximately $20,000 due to higher maintenance cost of
revenues of approximately $124,000. This increase in costs is due primarily to
higher labor costs incurred to perform maintenance requirements on completed
large-scale identity management projects.
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Operating Expenses.
Years Ended
December 31,
Operating Expenses 2010 2009 $ Change % Change
(dollars in thousands)
General and administrative $ 2,546 $ 2,433 $ 113 5 %
Percentage of total net revenue 44 % 40 %
Sales and marketing
$ 1,528 $ 1,705 $ (177) (10) %
Percentage of total net revenue 26 % 28 %
Research and development $ 2,531 $ 2,367 $ 164
7 %
Percentage of total net revenue 44 % 39 %
Depreciation and amortization $ 50 $ 98 $ (48)
(49) %
Percentage of total net revenue 1 % 2 %
General and Administrative Expenses. General and administrative expenses are
comprised primarily of salaries and other employee-related costs for executive,
financial, and other infrastructure personnel. General legal, accounting and
consulting services, insurance, occupancy and communication costs are also
included with general and administrative expenses. The increase of $113,000 is
comprised of the following major components:
· Increase in stock-based compensation expense of approximately $14,000 due to
an increase in the issuance of stock options and restricted stock grants in
2010.
· Increase in professional services of approximately $317,000.
· Decrease in occupancy and insurance related expenses of approximately $61,000.
· Decrease in compensation and related fringe benefits of approximately $197,000
due to lower headcounts and the implementation of mandatory furlough days to
reduce costs.
· Increase in licenses, dues, miscellaneous financing charges and travel of
approximately $40,000.
We are continuing to focus our efforts on achieving additional future operating
efficiencies by reviewing and improving upon existing business processes and
evaluating our cost structure. We believe these efforts will allow us to
gradually decrease our level of general and administrative expenses expressed as
a percentage of total revenues.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of
the salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales force. Selling and marketing expenses decreased in
2010 by approximately $177,000. Major components of this change are:
· Decrease in salaries and personnel costs of approximately $48,000 due to
reductions in headcount and the implementation of mandatory furlough days to
reduce costs.
· Decrease in stock-based compensation expense of approximately $20,000.
· Increase in costs of $48,000 related to our Mexico City sales office.
· Decrease in professional services of approximately $157,000.
We anticipate that the level of expenses incurred for sales and marketing during
the year ended December 31, 2011 will increase as we pursue large project
solution opportunities.
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Research and Development Expenses. Research and development costs consist
primarily of salaries, employee benefits and outside contractors for new product
development, product enhancements and custom integration work.
Research and development expenses were approximately $2,531,000 and $2,367,000
during the years ended December 31, 2010 and 2009, respectively. Such expenses
increased 7% or approximately $164,000 for the year ended December 31, 2010 as
compared to the corresponding period in 2009. The increase reflects personnel
increases in the United States partially offset by personnel decreases in Canada
resulting in a net increase in salaries and employee benefit expense of
approximately $235,000. Stock compensation expense increased by approximately
$3,000. These increases were offset by decreases in facilities related expenses
of $47,000. Travel expenditures decreased by $16,000 and contractor expenses
decreased by $11,000.
Our level of expenditures in research and development reflects our belief that
to maintain our competitive position in markets characterized by rapid rates of
technological advancement, we must continue to invest significant resources in
new systems and software as well as continue to enhance existing products.
Depreciation and Amortization. During the year ended December 31, 2010,
depreciation and amortization expense decreased 49% or $48,000 as compared to
the corresponding period in 2009. This decrease reflects the limitations placed
on acquiring new equipment in 2010 and 2009.
Interest Expense, Net. For the year ended December 31, 2010, we recognized
interest income of $0 and interest expense of $1,123,000. For the year ended
December 31, 2009, we recognized interest income of $0 and interest expense of
$743,000.
Interest expense for the year ended December 31, 2010 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $370,000.
· Accretion of note discount and debt issuance costs to interest expense of
approximately $674,000.
· Other interest expense of approximately $79,000.
Interest expense for the year ended December 31, 2009 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $115,000.
· Accretion of note discount and debt issuance costs to interest expense of
approximately $363,000.
· Amortization of deferred financing fees to interest expense of approximately
$26,000.
· Interest expense of approximately $175,000 related to liquidated damages
accrued pursuant to a registration payment arrangement.
· Fair value of warrants issued to related party convertible note holders in
consideration for wavier of default of approximately $51,000.
· Other interest expense of approximately $12,000
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Financing Expense. For the year ended December 31, 2010, we recognized financing
expenses of $0 as compared to $1,373,000 for the corresponding period in 2009.
In July 2009 and ending in early August 2009, we undertook a series warrant
financing whereby we received cash proceeds of approximately $1,370,000 from the
exercise of 2,401,075 warrants. The warrants were originally issued in various
previous private placement financings. In conjunction with this financing, we
issued to such warrant holders a total of 2,401,075 additional warrants:
2,135,795 five year warrants with an exercise price of $0.50 and 265,280 five
year warrants with an exercise price of $1.00 to incentivize the warrants
holders to exercise their warrants. Additionally, we agreed to reprice 200,000
warrants from an existing exercise price of $1.67 to $0.50 to incentivize this
warrant holder to exercise. We recorded the issuance of the additional warrants
as a financing expense equal to the fair value of the warrants issued using the
Black-Scholes option-pricing model. We recorded the repricing of the warrants as
a modification equal to the difference in fair value immediately before and
after the modification using the Black Scholes option-pricing model. The
issuance of the additional warrants and the repricing of the warrants resulted
in financing expense of approximately $1,373,000 during the year ended December
31, 2009.
Change in Fair Value of Derivative Liabilities. For the year ended December 31,
2010, we recognized a non-cash expense of $738,000 compared to $6,327,000 for
the corresponding period in 2009 due to implementation of ASC 815 effective
January 1, 2009. Such expense is related to the change in fair value of the
Company's Derivative Liabilities. The Derivative Liabilities were revalued using
available market information and commonly accepted fair value methodologies.
Change in Fair Value of Financing Obligation. For the year ended 2010, we
recognized non-cash income of $551,000 compared to non-cash expense of
$1,335,000 for the corresponding period of 2009 related to the change in fair
value of the Company's financing obligation. For the year ended 2010, such
income is related to the change in fair value of the Company's variable
component of the financing obligation of approximately $695,000 offset by the
accretion of the fixed component of the financing obligation of approximately
$144,000. For the year December 31, 2009, such expense is related to the change
in fair value of the Company's variable component of the financing obligation of
approximately $1,079,000 and the accretion of the fixed component of the
financing obligation of approximately $256,000. The variable component of the
financing obligation was revalued using available market information and
commonly accepted valuation methodologies.
Other Expense (Income), Net. For the year ended December 31, 2010, we recognized
other income of $330,000 and other expense of $2,000. For the year ended
December 31, 2009, we recognized other income of $473,000 and other expense of
$28,000. Other income for the year ended December 31, 2010 is comprised of
approximately $280,000 from the reduction of previously accrued liquidated
damages due to the expiration of the statue of limitations; $10,000 for the
application of forfeiture account balances of the Company's 401(k) plan against
the accrued employer match; $5,000 from the reduction of the allowance for
doubtful accounts; $10,000 from the write-off of certain long-outstanding trade
accounts payable; and $25,000 in income on previously derecognized accounts
receivables offset by $2,000 in losses on the disposal of certain fixed assets.
Other income for the year ended December 31, 2009 is comprised of approximately
$454,000 from the negotiated settlement of certain trade accounts payable at
amounts less than their carrying value, $13,000 in reductions to the allowance
for doubtful accounts, $6,000 in insurance reimbursements offset by other
expense of $28,000 related to adjustments to previously established exit
activity reserved related to the closure of our German sales office.
Income Tax Expense. During the year ended December 31, 2010, we recorded a
provision for income taxes of $126,000 as compared to $0 during the year ended
December 31, 2009.
During the year ended December 31, 2010, our provision for income taxes of
$126,000 related to taxes on income generated in certain foreign jurisdictions.
We have incurred consolidated pre-tax losses during the years ended
December 31, 2010 and 2009, and have incurred operating losses in all periods
prior to 2009. Management has determined that it is more likely than not that a
tax benefit from such losses will not be realized. Accordingly, we did not
record a benefit for income taxes for these periods.
Liquidity and Capital Resources
As of December 31, 2010, we had total current assets of $411,000 and total
current liabilities of $4,407,000, or negative working capital of $3,996,000. At
December 31, 2010 and 2009, we had available cash of $103,000 and $342,000,
respectively.
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Operating Activities
Net cash used in operating activities was $2,070,000 during the year ended
December 31, 2010 as compared to $2,874,000 for the corresponding period in
2009. We used cash to fund net losses of $2,720,000, excluding non-cash expenses
(depreciation, amortization, change in fair value of additional financing
obligation and derivative liabilities, amortization of debt discount,
stock-based compensation, loss on debt modification and financing expense
incurred from the issuance of derivative instruments) of $2,329,000 for the year
ended December 31, 2010. We used cash to fund net losses of $1,830,000,
excluding non-cash expenses (depreciation, amortization, change in fair value of
additional financing obligation and derivative liabilities, amortization of debt
discount, stock-based compensation, loss on debt modification and financing
expense incurred from the issuance of derivative instruments) of $10,806,000 for
the year ended December 31, 2009. For the year ended December 31, 2010 we
generated cash of $617,000 through reductions in current assets and generated
cash of $34,000 through increases in current liabilities (excluding debt). For
the year ended December 31, 2009, we used cash of $222,000 from increases in
current assets and used cash of $822,000 through decreases in current
liabilities (excluding debt).
Investing Activities
For the years ended December 31, 2010 and 2009, we used cash of $13,000 and
$16,000, respectively, to fund capital expenditures of computer equipment and
software and furniture and fixtures. The level of equipment purchases resulted
primarily from continued growth of the business and replacement of older
equipment.
Financing Activities
Net cash provided by financing activities was $1,820,000 for the year ended
December 31, 2010. We generated cash of $5,750,000 from our issuance of
convertible notes payable with warrants. We also generated cash of $500,000 from
our issuance of common stock pursuant to warrant exercises. In 2010, we used
cash of $4,430,000 for the repayment of our secured notes payable. Net cash
provided by financing activities was $3,191,000 for the year ended December 31,
2009. We generated cash of $2,325,000 from our issuance of secured notes
payable. We also generated cash of $1,370,000 from our issuance of common stock
pursuant to warrant exercises. In 2009, we used cash of $350,000 to repay notes
a portion of our secured notes payable and incurred financing related expenses
of $154,000.
Factors That May Affect Future Financial Condition and Liquidity
Currently our cash commitments include normal recurring trade payables, expense
accruals, minimum royalty obligations, debt and operating and capital leases,
all of which are currently expected to be funded through existing working
capital. Aside from these recurring operating expenses, we expect to incur
approximately $100,000 in capital expenditures in fiscal 2011.
During the first three quarters of fiscal 2011, we were faced with limited funds
for operations. As a result, we took measures to reduce our operating costs. As
a result of the consummation of the Qualified Financing in December 2011 we
believe that our current cash and cash equivalents will be sufficient to meet
our working capital and capital expenditure requirements for at least the next
12 months from the date of the filing of this Annual Report and that we will
have sufficient liquidity to fund our business and meet our contractual
obligations over a period beyond the next 12 months. However, we may be required
to obtain additional financing in order to fund our continued operations. Due to
the tightening of the credit markets, general economic conditions, our SEC
filing delinquencies and other economic and business factors, this financing may
not be available to us on acceptable terms or at all. Although we cannot
accurately anticipate the effect of inflation or foreign exchange markets on our
operations, we do not believe these external economic forces have had, or are
likely in the foreseeable future to have, a material impact on our results of
operations.
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Off-Balance Sheet Arrangements
At December 31, 2010, we did not have any relationships with unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance, special purpose or variable interest entities, which would
have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes. In addition, we
did not engage in trading activities involving non-exchange traded contracts. As
a result, we are not exposed to any financing, liquidity, market or credit risk
that could arise if we had engaged in such relationships. We do not have
relationships and transactions with persons or entities that derive benefits
from their non-independent relationship with us or our related parties except as
disclosed elsewhere in this Annual Report.
Quarter-Over-Quarter Comparisons
The following tables set forth condensed unaudited statement of operations for
each of the six quarters beginning January 1, 2009 and ended September 30, 2010.
The following quarterly information is intended to supplement our discussion and
analysis of the results of operations provided above and should be read in
conjunction with such discussion and our audited financial statements and the
notes included elsewhere in this Annual Report.
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IMAGEWARE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
Quarter Ended
March June Sept. March June Sept.
31 30 30 31 30 30
2009 2009 2009 2010 2010 2010
Revenues:
Product $ 675 $ 999 $ 241 $ 1,360 $ 511 $ 769
Maintenance 638 646 659 668 640 653
1,313 1,645 900 2,028 1,151 1,422Cost of revenues:
Product 284 317 167 528 144 249
Maintenance 209 199 201 247 254 198
Gross profit 820 1,129 532 1,253 753 975
Operating expenses:
General and
administrative 609 595 555 697 680 512
Sales and marketing 429 451 376 392 381 385
Research and
development 587 553 582 697 666 576
Depreciation and
amortization 33 30 19 14 12 13
1,658 1,629 1,532 1,800 1,739 1,486
Loss from operations (838 ) (500 ) (1,000 ) (547 ) (986 ) (511 )
Interest expense, net 102 180 212 242 334 60
Change in fair value
of financing
obligation 152 450 438 229 (744 ) (38 )
Change in fair value
of derivative
liabilities (748 ) 5,179 756 477 (4,154 ) (506 )
Loss on debt
modification - 750 - - - 1,100Financing expense - - 1,371 - - -
Other income, net (11 ) (11 ) (124 ) (17 ) (284 ) (12 )
Income (loss) from
operations before
income taxes (333 ) (7,048 ) (3,653 ) (1,478) 3,862 (1,115 )
Income tax expense - - - - 197 2
Income (loss) from
operations (333 ) (7,048 ) (3,653 ) (1,478 ) 3,665 (1,117 )
Net income (loss) $ (333 ) $ (7,048 ) $ (3,653 ) $ (1,478 ) $ 3,665 $ (1,117 )
Preferred dividends
(99 ) (100 ) (101 ) (99 (98 ) (99 )
Net income (loss)
available to common
shareholders $ (432 ) $ (7,148 ) $ (3,754 ) $ (1,577 ) $ 3,567 $ (1,216 )
Basic and diluted
income (loss) per
common share - see
note 2
Income (loss) from
operations $ (0.02 ) $ (0.39 ) $ (0.18 ) $ (0.07 ) $ 0.16 $ (0.05 )
Preferred dividends - (0.01 ) (0.01 ) - - -
Basic and diluted
income (loss) per
common shareavailable
to common
shareholders $ (0.02 ) $ (0.40 ) $ (0.19 ) $ (0.07 ) $ 0.16 (1) $ (0.05 )
(1) For the quarter ended June 30, 2010, amount presented is only basic loss per
share.
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Table of Contents
Restatement of Financial Statements for the Three Months Ended March 31, 2009
The Company has restated its previously issued consolidated financial statements
as of and for the three months ended March 31, 2009 to reflect the Company's
adoption of ASC 815 which significantly changes how the Company accounts for
derivative liabilities and related gains and losses from the change in fair
value of these derivative liabilities.
Beginning January 1, 2009, the Company is required to account for the embedded
derivative related to the conversion feature in its Series C Preferred and
Series D Preferred and certain warrants as derivative liabilities (collectively
the "Derivative Liabilities"). The Company is required to mark to market at the
end of each reporting period the value of the Derivative Liabilities. The
Company revalues these Derivative Liabilities at the end of each reporting
period by using available market information and commonly accepted valuation
methodologies. The periodic change in value of the Derivative Liabilities is
recorded as either non-cash derivative income (if the value of the embedded
derivative and warrants decrease) or as non-cash derivative expense (if the
value of the embedded derivative and warrants increase). Although the values of
the embedded derivative and warrants are affected by interest rates, the
remaining contractual conversion period and the Company's stock volatility, the
primary cause of the change in the values of will be the value of the Company's
common stock. If the stock price goes up, the value of these derivatives will
generally increase and if the stock price goes down the value of these
derivatives will generally decrease.
The Company's Series C Preferred and Series D Preferred and certain warrants
contain anti-dilution provisions which results in these instruments no longer
being deemed to be indexed to the Company's own stock. As a result of the
restatement, amounts previously classified in equity were reclassified to
liabilities as of January 1, 2009. For each subsequent reporting quarter, the
value of the Derivative Liabilities was revalued using available market
information and commonly accepted valuation methodologies. The cumulative effect
of the adoption of ASC 815 as of January 1, 2009 was a decrease in additional
paid in capital of $5,836,000, a decrease in accumulated deficit of $1,709,000
and an increase in Derivative Liabilities of $4,127,000. The resulting impact of
this accounting change as of and for the three months ended March 31, 2009 is an
increase in note discount of $288,000, a decrease in the Company's net loss
available to common shareholders of $715,000, a decrease in additional paid-in
capital of $241,000, a decrease in accumulated deficit of $715,000 and a
decrease in Derivative Liabilities of $186,000.
The revisions relate to non-operating and non-cash items as of and for the three
months ended March 31, 2009. ASC 815 did not impact the Company's consolidated
financial statements for periods ended December 31, 2008 or earlier.
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Table of Contents
The following table summarizes the effect of the restated adjustments on amounts
previously reported as of, and for the quarter ended March 31 2009 (in
thousands, except share and per share amounts):
As Previously As
($ in thousands) Reported Adjustments Restated
Total assets $ 5,340 $ - $ 5,340
Total current liabilities $ 5,111 $ - $ 5,111
Secured note payable, net of discount 485 (321 ) (2) 316
119 (5)
33 (4)
Additional financing obligation, net of
discount 440 (119 ) (5) 321
Derivative liabilities - 4,127 (1) 3,941
562 (2)
(748 ) (3)
Pension obligation 1,073 - 1,073
Total liabilities 7,109 3,653 10,762
Stockholders' equity
Preferred stock, authorized 4,000,000
shares:
Series B convertible redeemable
preferred stock 2 - 2
Series C convertible non-redeemable
preferred stock - - -
Series D convertible non-redeemable
preferred stock - - -
Common stock 180 - 180
Additional paid in capital 86,316 (5,836 ) (1) 80,239
(241 ) (2)
Treasury Stock (64 ) (64 )
Accumulated other comprehensive income 46 46
Accumulated deficit (88,249 ) 748 (3) (85,824 )
(33 ) (4)
1,709 (1)
Total Shareholders' deficit (1,769 ) (3,653 ) (5,422 )
Total Liabilities and Shareholders'
Deficit $ 5,340 $ - $ 5,340
The effect of the restatement adjustments on the consolidated statement of operations for the three months ended
March 31, 2009 is set forth in the following table:
As Previously As
($ in thousands) Reported Adjustments Restated
Loss from operations $ (838 ) $ - $ (838 )
Interest expense, net 131 29 (4)(6) 102
Change in fair value of financing
obligation 90 62 (6) 152
Other income, net (11 ) - (11 )
Change in fair value of derivative
liabilities - (748 ) (3) (748 )
Net loss (1,048 ) 715 (333 )
Preferred dividends (99 ) - (99 )
Beneficial conversion feature on
preferred stocks - - -
Net loss available to common
shareholders $ (1,147 ) $ 715 $ (432 )
Basic and diluted loss per common share
Continuing operations $ (0.06 ) $ 0.04 $ (0.02 )
Preferred dividends - - -
Basic and diluted loss per common share $ (0.06 ) $ 0.04 $ (0.02 )
(1) to record the cumulative-effect adjustment to the opening balance of
retained earnings to reclassify the fair value of the derivatives as a liability
(2) to record the fair value of warrants issued February 12, 2009 as a
derivative liability
(3) to record the change in fair value of derivative liabilities
(4) to record the change in interest expense resulting from changes to note
discount and related amortization caused by revaluation of warrants issued with
debt
(5) to record change in discount on additional financing obligation
(6) to record reclassification of accretion of minimum portion of additional
financing obligation
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Restatement of Financial Statements for the Three Months Ended June 30, 2009
The Company has restated its previously issued consolidated financial statements
as of and for the three months ended June 30, 2009 to reflect the Company's
adoption of ASC 815 which significantly changes how the Company accounts for
Derivative Liabilities and related gains and losses from the change in fair
value of these Derivative Liabilities.
Beginning January 1, 2009, the Company is required to account for the embedded
derivative related to the conversion feature in its Series C Preferred and
Series D Preferred and certain warrants as Derivative Liabilities. The Company
is required to mark to market at the end of each reporting period the value of
the Derivative Liabilities. The Company revalues these Derivative Liabilities at
the end of each reporting period by using available market information and
commonly accepted valuation methodologies. The periodic change in value of the
Derivative Liabilities is recorded as either non-cash derivative income (if the
value of the embedded derivative and warrants decrease) or as non-cash
derivative expense (if the value of the embedded derivative and warrants
increase). Although the values of the embedded derivative and warrants are
affected by interest rates, the remaining contractual conversion period and the
Company's stock volatility, the primary cause of the change in the values of
will be the value of the Company's common stock. If the stock price goes up, the
value of these derivatives will generally increase and if the stock price goes
down the value of these derivatives will generally decrease.
The Company's Series C Preferred and Series D Preferred and certain warrants
contain anti-dilution provisions which results in these instruments no longer
being deemed to be indexed to the Company's own stock. As a result of the
restatement, amounts previously classified in equity were reclassified to
liabilities as of January 1, 2009. For each subsequent reporting quarter, the
value of the Derivative Liabilities was revalued using available market
information and commonly accepted valuation methodologies. The cumulative effect
of the adoption of ASC 815 as of January 1, 2009 was a decrease in additional
paid in capital of $5,836,000, a decrease in accumulated deficit of $1,709,000
and an increase in Derivative Liabilities of $4,127,000. The resulting impact of
this accounting change as of and for the three months ended June 30, 2009 is a
decrease in discount on secured notes payable and additional financing
obligation of $9,000, an increase in the Company's net loss available to common
shareholders of $5,589,000, a decrease in additional paid-in capital of
$554,000, an increase in accumulated deficit of $4,874,000 and an increase in
Derivative Liabilities of 5,419,000.
The revisions relate to non-operating and non-cash items as of and for the three
months ended June 30, 2009. ASC 815 did not impact the Company's consolidated
financial statements for periods ending December 31, 2008 or earlier.
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The following table summarizes the effect of the restated adjustments on amounts
previously reported as of, and for the quarter ended June 30, 2009 (in
thousands, except share and per share amounts):
As Previously As
($ in thousands) Reported Adjustments Restated
Total assets $ 5,400 $ - $ 5,400
Secured note payable, net of discount 818 (437 ) (2) 933
106 (4)
36 (6)
410 (5)
Additional financing obligation, net of
discount 877 (106 ) (4) 771
Other current liabilities 5,337 - 5337
Total current liabilities $ 7,032 $ 9 $ 7,041
Derivative liabilities - 4,127 (1) 9,547
989 (2)
4,430 (3)
Pension obligation 1,117 - 1,117
Total liabilities 8,149 9,556 17,705
Stockholders' equity
Preferred stock, authorized 4,000,000
shares:
Series B convertible redeemable preferred
stock 2 - 2
Series C convertible non-redeemable
preferred stock - - -
Series D convertible non-redeemable
preferred stock - - -
Common stock 180 - 180
Additional paid in capital 86,833 (5,836 ) (1) 80,441
(554 ) (2)
Treasury Stock (64 ) (64 )
Accumulated other comprehensive income 9 9
Accumulated deficit (89,709 ) (4,430 ) (3) (92,873 )
(410 ) (5)
(34 ) (6)
1,709 (1)
Total Shareholders' deficit (2,749 ) (9,556 ) (12,303 )
Total Liabilities and Shareholders' Equity
(Deficit) $ 5,400 $ - $ 5,400
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The effect of the restatement adjustments on the consolidated statement of
operations for the three months ended June 30, 2009 is set forth in the
following table:
As Previously As
($ in thousands) Reported Adjustments Restated
Loss from operations $ (500 ) $ - $ (500 )
Interest expense, net 233 (53 ) 180
Change in fair value of financing
obligation 397 53 450
Loss on debt modification 340 410 (5) 750
Other income, net (11 ) - (11 )
Change in fair value of derivative
liabilities - 5,179 (3) 5,179
Net loss (1,459 ) (5,589 ) (7,048 )
Preferred dividends (100 ) - (100 )
Net loss available to common
shareholders $ (1,559 ) $ (5,589 ) $ (7,148 )
Basic and diluted loss per common share
Continuing operations $ (0.08 ) $ (0.31 ) $ (0.39 )
Preferred dividends (0.01 ) - (0.01 )
Basic and diluted loss per common share $ (0.09 ) $ (0.31 )
$ (0.40 )
(1) to record the cumulative-effect adjustment to the opening balance of
retained earnings to reclassify the fair value of the Derivatives as a liability
(2) to record the fair value of 2009 warrant issuances as a derivative liability
(3) to record the change in fair value of derivative liabilities
(4) to record change in discount on additional financing obligation
(5) to record the change in the loss on loan modification
(6) to record the change in interest expense resulting from changes to note
discount and related amortization caused by revaluation of warrants issued with
debt
(7) to record reclassification of accretion of minimum portion of additional
financing obligation
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Comparison of Results for the Periods Ended March 31, 2010 and March 31, 2009
Product Revenues.
Three Months Ended
March 31,
Net Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 827 $ 390 $ 437 112 %
Percentage of total net product revenue 61 % 58 %
Hardware and consumables $ 224 $ 60 $ 164 273 %
Percentage of total net product revenue 16 % 9 %
Services $ 309 $ 225 $ 84 37 %
Percentage of total net product revenue 23 % 33 %
Total net product revenues $ 1,360 $ 6755 $ 685 101 %
Software and royalty revenues increased 112% or $437,000 during the three months
ended March 31, 2010 as compared to the corresponding period in 2009. The
increase is due to higher sales of our Biometric Engine software solutions of
approximately $462,000, higher royalties and license revenues of approximately
$4,000 and higher project-oriented revenues of our law enforcement software
solutions of approximately $24,000, offset by lower sales of our boxed identity
management software sold through our distribution channel of approximately
$53,000.
Revenues from the sale of hardware and consumables increased 273% or
approximately $164,000 during the three months ended March 31, 2010 as compared
to the corresponding period in 2009. The increase reflects higher revenues from
project solutions containing hardware and consumable components.
Services revenues are comprised primarily of software integration services,
system installation services and customer training. Such revenues increased
approximately $84,000 during the three months ended March 31, 2010 as compared
to the corresponding period in 2009 due primarily to higher revenues being
generated from our identity management and law enforcement project solutions.
Maintenance Revenues.
Three Months Ended
March 31,
Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Maintenance revenues $ 668 $ 638 $ 30 5 %
The increase in maintenance revenues reflects higher maintenance revenues of
approximately $9,000 generated from our law enforcement products combined with
higher maintenance revenues of approximately $21,000 generated from our identity
management product suite.
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Cost of Product Revenues.
Three Months Ended
March 31,
Cost of Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 182 $ 45 $ 137 304 %
Percentage of software and
royalty product revenue 22 % 12 %
Hardware and consumables $ 193 $ 40 $ 153 383 %
Percentage of hardware and
consumables product revenue 86 % 67 %
Services $ 153 $ 199 $ (46) (23) %
Percentage of services product
revenue 50 % 88 %
Total cost of product revenues $ 528 $ 284 $
244 86 %
Percentage of total product
revenues 39 % 42 %
The cost of software and royalty product revenue increased 304% or $137,000
during the three months ended March 31, 2010 as compared to the corresponding
period in 2009 due to higher third-party software content in solutions provided
during the three months ended March 31, 2010 as compared to the corresponding
period in 2009.
The increase in the cost of hardware and consumables product revenue of $153,000
for the three months ended March 31, 2010 as compared to the corresponding
period in 2009 reflects the increase in hardware and consumable revenues of
approximately $164,000 for the three months ended March 31, 2010 as compared to
the comparable period in 2009.
Costs of service revenues decreased $46,000 for the three-month period ended
March 31, 2010 as compared to the corresponding period in 2009 despite an
increase of approximately $84,000 in service revenues. This inverse relationship
is due to the three-month period ended March 31, 2009 containing software
integration costs of our identity management products into project solutions in
excess of revenues generated on certain contracts.
Cost of Maintenance Revenues.
Three Months Ended
March 31,
Cost of Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance cost of
revenues $ 247 $ 209 $ 38 18 %
Percentage of total maintenance
revenues 37 % 33 %
Cost of maintenance revenues as a percentage of maintenance revenues increased
to 37% during the three months ended March 31, 2010 from 33% for the
corresponding period in 2009 due to higher identification labor costs incurred
to support completed identity management project solutions.
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Product Gross Profit.
Three Months Ended
March 31,
Product Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 645 $ 345 $ 300 87 %
Percentage of software and 78 % 88 %
royalty product revenue
Hardware and consumables $ 31 $ 20 $ 11 55 %
Percentage of hardware and 14 % 33 %
consumables product revenue
Services $ 156 $ 26 $ 130 500 %
Percentage of services product 50 % 12 %
revenue
Total product gross profit $ 832 $ 391 $ 441 113 %
Percentage of total product 61 % 58 %
revenues
Software and royalty gross profit increased by 87% or approximately $300,000 for
the three months ended March 31, 2010 from the corresponding period in 2009 due
to higher software and royalty product revenues of approximately $437,000 in the
2010 period, offset by increases in software and royalty cost of revenues of
approximately $137,000. Costs of software products can also vary as a percentage
of product revenue from quarter to quarter depending upon product mix and third
party software licenses included in software solutions.
Hardware and consumables gross profit increased by 55% or approximately $11,000
for the three months ended March 31, 20010 from the corresponding period in 2009
due to higher hardware and consumables product revenues of approximately
$164,000 in the 2010 period, offset by increases in hardware and consumables
cost of revenues of approximately $153,000.
Services gross profit increased approximately $130,000 for the three months
ended March 31, 2010 as compared to the corresponding period in 2009. The
increase is due primarily to a increase of $84,000 in service revenues generated
during the three month period ended March 31, 2010 as compared to the comparable
period in 2009 combined with the three month period ending March 31, 2009
containing direct labor costs in excess of revenues generated on certain
contracts.
Maintenance Gross Profit.
Three Months Ended
March 31,
Maintenance Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 421 $ 429 $
(8 ) (2) %
Percentage of total maintenance
revenues 63 % 67 %
Gross margins related to maintenance revenues decreased despite higher
maintenance revenues of approximately $30,000 due to higher maintenance cost of
revenues of approximately $38,000. The increase in maintenance revenues is due
to higher maintenance revenues generated from our identity management product
suite. The increase in maintenance cost of revenues is reflective of higher
identification labor costs incurred to support completed identity management
project solutions.
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Operating Expenses.
Three Months Ended
March 31,
Operating Expenses 2010 2009 $ Change % Change
(dollars in thousands)
General and administrative $ 697 $ 609 $ 88 14 %
Percentage of total net revenue 34 % 46 %
Sales and marketing $ 392 $ 429 $ (37 ) (9) %
Percentage of total net revenue 19 % 33 %
Research and development $ 697 $ 587 $ 110
19 %
Percentage of total net revenue 34 % 45 %
Depreciation and amortization $ 14 $ 33 $ (19 )
(58) %
Percentage of total net revenue 1 % 3 %
General and Administrative Expenses. General and administrative expenses are
comprised primarily of salaries and other employee-related costs for executive,
financial, and other infrastructure personnel. General legal, accounting and
consulting services, insurance, occupancy and communication costs are also
included with general and administrative expenses. The dollar increase of
$88,000 is comprised of the following major components:
† Increase in stock-based compensation expense of approximately $8,000 due to
the issuance of restricted stock grants in the quarter ended March 31, 2010.
· Increase in professional services of approximately $180,000.
† † Decrease in occupancy related expenses of approximately $11,000.
· Decrease in compensation and related fringe benefits of approximately $85,000
due to reductions in headcount.
· Increase in travel related expenses of approximately $7,000.
· Decrease in expenses related to our closed sales office in Germany and other
expenses of approximately $11,000.
Sales and Marketing. Sales and marketing expenses consist primarily of the
salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales, marketing and business development functions. The
dollar decrease of $37,000 is comprised of the following major components:
†† Decrease in compensation and related fringe benefits of approximately $38,000.
†† Decrease of $40,000 in expenses incurred for sales contractors and
consultants.
· Increase in occupancy related expenses of approximately $1,000.
· Decrease in travel related expenses of approximately $4,000.
· Increase of $44,000 from costs related to our Mexico City sales office opened
in June 2009.
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Research and Development. Research and development expenses consist primarily of
salaries, employee benefits and outside contractors for new product development,
product enhancements and custom integration work. Such expenses increased 19% or
$110,000 for the three months ended March 31, 2010 as compared to 2009. The
increase is comprised of the following major components:
† † Increase of $109,000 in compensation and related fringe benefits combined
with increases in contract programming expenditures of approximately $27,000.
††† Decrease in travel related expenses of approximately $6,000.
· Decrease in occupancy related expenses of approximately $20,000.
Depreciation and Amortization. During the three months ended March 31, 2010,
depreciation and amortization expense decreased 58% or $19,000 as compared to
the corresponding period in 2009. The decrease in depreciation and amortization
expense is due largely to limitations placed on acquiring new equipment in 2010.
Interest Expense (Income), Net. For the three months ended March 31, 2010, we
recognized interest income of $0 and interest expense of $242,000. For the three
months ended March 31, 2009, we recognized interest income of $0 and interest
expense of $102,000.
Interest expense for the three months ended March 31, 2010 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $64,000.
· Accretion of note discount to interest expense of approximately $162,000.
· Other interest expense of approximately $16,000.
Interest expense for the three months ended March 31, 2009 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $7,000.
· Accretion of note discount to interest expense of approximately $59,000.
· Amortization of deferred financing fees to interest expense of approximately
$16,000.
· Interest expense of approximately $20,000 related to liquidated damages
accrued pursuant to a registration payment arrangement.
Change in Fair Value of Derivative Liabilities. For the three months ended March
31, 2010, we recognized a non-cash expense of $477,000 compared to non-cash
income of $748,000 for the corresponding period of 2009 due to implementation of
ASC 815 effective January 1, 2009. Such expense is related to the change in fair
value of the Company's Derivative Liabilities. The Derivative Liabilities were
revalued using available market information and commonly accepted valuation
methodologies.
Change in Fair Value of Financing Obligation. For the three months ended March
31, 2010, we recognized non-cash expense of $229,000 compared to non-cash
expense of $152,000 for the corresponding period of 2009 related to the change
in fair value of the Company's financing obligation. For the three months ended
March 31, 2010, such expense is related to the change in fair value of the
Company's variable component of the financing obligation of approximately
$158,000 and the accretion of the fixed component of the financing obligation of
approximately $71,000. For the three months ended March 31, 2009, such expense
is related to the change in fair value of the Company's variable component of
the financing obligation of approximately $90,000 and the accretion of the fixed
component of the financing obligation of approximately $62,000. The variable
component of the financing obligation was revalued using available market
information and commonly accepted valuation methodologies.
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Other Expense (Income), Net. For the three months ended March 31, 2010, we
recognized other income of $17,000 and other expense of $0. For the three months
ended March 31, 2009, we recognized other income of $11,000 and other expense of
$0. Other income for the three months ended March 31, 2010 contains
approximately $2,000 from the negotiated settlement of certain trade accounts
payable at amounts less than their carrying value, $10,000 from the forfeiture
by certain participants of certain 401(k) plan employer match contributions and
$5,000 from collections on previously derecognized receivables. Other income for
the three months ended March 31, 2009 is comprised primarily of $6,000 in
insurance reimbursement and $5,000 from collection on previously derecognized
receivables.
Comparison of Results for the Periods Ended June 30, 2010 and June 30, 2009
Product Revenues.
Three Months Ended
June 30,
Net Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 319 $ 785 $ (466) (59) %
Percentage of total net product
revenue 62 % 79 %
Hardware and consumables $ 98 $ 25 $ 73 292 %
Percentage of total net product
revenue 19 % 3 %
Services $ 94 $ 189 $ (95) (50) %
Percentage of total net product
revenue 18 % 19 %
Total net product revenues $ 511 $ 999 $ (488) (49) %
Software and royalty revenues decreased 59% or $466,000 during the three months
ended June 30, 2010 as compared to the corresponding period in 2009. The
decrease is due primarily to lower identity management software sold into
project solutions of approximately $147,000, lower sales of our boxed identity
management software sold through our distribution channel of approximately
$122,000 and lower project-oriented revenues of our law enforcement software
solutions of approximately $237,000. These decreases were partially offset by
higher identification software royalties and license revenues of approximately
$40,000.
Revenues from the sale of hardware and consumables increased 292% or $73,000
during the three months ended June 30, 2010 as compared to the corresponding
period in 2009. The increase reflects higher revenues from consumables sold to
our law enforcement customers.
Services revenues are comprised primarily of software integration services,
system installation services and customer training. Such revenues decreased
approximately $95,000 during the three months ended June 30, 2010 as compared to
the corresponding period in 2009 due to lower revenues being generated from our
identity management and law enforcement project solutions.
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Maintenance Revenues.
Three Months Ended
June 30,
Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Maintenance revenues $ 640 $ 646 $ (6) ) (1) %
The decrease in maintenance revenues reflects lower maintenance revenues of
approximately $10,000 generated from our law enforcement products offset by
higher maintenance revenues of approximately $4,000 generated from our identity
management product suite.
Cost of Product Revenues.
Three Months
Ended
June 30,
Cost of Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 39 $ 120 $ (81) (68) %
Percentage of software and
royalty product revenue 12 % 15 %
Hardware and consumables $ 48 $ 26 $ 22 85 %
Percentage of hardware and
consumables product revenue 49 % 104 %
Services $ 57 $ 171 $ (114) (67) %
Percentage of services product
revenue 61 % 90 %
Total cost of product revenues $ 144 $ 317 $ (173) (55) %
Percentage of total product
revenues 28 % 32 %
The cost of software and royalty product revenue decreased 68% or $81,000 during
the three months ended June 30, 2010 as compared to the corresponding period in
2009 due to lower third-party software content in solutions provided during the
three month period ended June 30, 2010 as compared to the corresponding period
in 2009. The decrease also reflects the reduction in our project-oriented
revenues from our law enforcement and identity management product suites during
the three months ended June 30, 2010 as compared to the corresponding period in
2009.
The increase in the cost of hardware and consumables product revenue of $22,000
for the three months ended June 30, 2010 as compared to the corresponding period
in 2009 reflects the increase in hardware and consumable revenues of
approximately $73,000 for the three months ended June 30, 2010 as compared to
the comparable period in 2009.
Costs of service revenues decreased $114,000 for the three-month period ended
June 30, 2010 as compared to the corresponding period in 2009. The decrease is
due primarily to a decrease of 50% or $95,000 in service revenues generated
during the three month period ended June 30, 2010 as compared to the comparable
period in 2009 combined with the three month period ended June 30, 2009
containing integration costs of our identity management products into project
solutions in excess of revenues generated on certain contracts.
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Cost of Maintenance Revenues.
Three Months Ended
June 30,
Cost of Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance cost of
revenues $ 254 $ 199 $ 55 28 %
Percentage of total maintenance
revenues 40 % 31 %
Costs of maintenance revenues as a percentage of maintenance revenues increased
to 40% during the three months ended June 30, 2010 from 31% for the
corresponding period in 2009. This increase is due primarily to higher
identification labor costs incurred to perform maintenance requirements on
completed large-scale identity management projects.
Product Gross Profit.
Three Months Ended
June 30,
Product Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 280 $ 665 $ (385 ) (58 ) %
Percentage of software and
royalty product revenue 88 % 85 %
Hardware and consumables $ 50 $ (1 ) $ 51 5100 %
Percentage of hardware and
consumables product revenue 51 % -4 %
Services $ 37 $ 18 $ 19 106 %
Percentage of services product
revenue 39 % 10 %
Total product gross profit $ 367 $ 682 $ (315 ) (46 ) %
Percentage of total product
revenues 72 % 68 %
Software and royalty gross profit decreased by 58% or approximately $385,000 for
the three months ended June 30, 2010 from the corresponding period in 2009 due
to lower software and royalty product revenues of approximately $466,000 in
2010. Costs of software products can also vary as a percentage of product
revenue from quarter to quarter depending upon product mix and third party
software licenses included in software solutions.
Hardware and consumables gross profit increased by approximately $51,000 for the
three months ended June 30, 2010 from the corresponding period in 2009 due to
higher hardware and consumables product revenues of approximately $73,000 in the
2010 period, offset by increases in hardware and consumables cost of revenues of
approximately $22,000.
Services gross profit increased approximately $19,000 for the three months ended
June 30, 2010 from the corresponding period in 2009 due to the three months
ended June 30, 2009 containing direct labor costs in excess of revenues
generated on certain contracts.
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Maintenance Gross Profit.
Three Months Ended
June 30,
Maintenance Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 386 $ 447 $
(61) (14) %
Percentage of total maintenance
revenues 60 % 69 %
Gross margins related to maintenance revenues decreased due to lower maintenance
revenues of approximately $6,000 combined with higher maintenance cost of
revenues of approximately $55,000. This increase in costs is due primarily to
higher labor costs incurred to perform maintenance requirements on completed
large-scale identity management projects.
Operating Expenses.
Three Months Ended
June 30,
Operating expenses 2010 2009 $ Change % Change
(dollars in thousands)
General and administrative $ 680 $ 595 $ 85 14 %
Percentage of total net revenue 59 % 36 %
Sales and marketing $ 381 $ 451 $ (70) (16) %
Percentage of total net revenue 33 % 27 %
Research and development $ 666 $ 553 $ 113
20 %
Percentage of total net revenue 58 % 34 %
Depreciation and amortization $ 12 $ 30 $ (18)
(60) %
Percentage of total net revenue 1 % 2 %
General and Administrative Expenses. General and administrative expenses are
comprised primarily of salaries and other employee-related costs for executive,
financial, and other infrastructure personnel. General legal, accounting and
consulting services, insurance, occupancy and communication costs are also
included with general and administrative expenses. The dollar increase of
$85,000 is comprised of the following major components:
· Increase in professional services of approximately $174,000.
· Decrease in finance related expenses of approximately $59,000.
· Decrease in occupancy and insurance related expenses of approximately $7,000.
· Decrease in compensation and related fringe benefits of approximately $31,000
due to reductions in headcount.
· Decrease in expenses related to our closed sales office in Germany of
approximately $3,000.
· Increase in stock based compensation expense of approximately $6,000 due to
the issuance of restricted stock grants in the quarter ended March 31, 2010.
· Increase in travel related expenses of approximately $5,000.
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Sales and Marketing. Sales and marketing expenses consist primarily of the
salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales, marketing and business development functions. The
decrease of $70,000 is comprised of the following major components:
††† Decrease in compensation, including stock based compensation and related
fringe benefits of approximately $42,000.
††† Decrease of $40,000 in expenses incurred for sales contractors and
consultants.
· Decrease in occupancy related expenses of approximately $4,000.
· Increase in travel related expenses of approximately $4,000.
· Increase of $12,000 from costs related to our Mexico City sales office opened
in June 2009.
Research and Development. Research and development expenses consist primarily of
salaries, employee benefits and outside contractors for new product development,
product enhancements and custom integration work. Such expenses increased 20% or
$113,000 for the three months ended June 30, 2010 as compared to 2009. The
increase is comprised of the following major components:
· Increase of $107,000 in compensation and related fringe benefits combined with
increases in contract programming expenditures of approximately $9,000.
· Decrease in occupancy and other related expenses of approximately $3,000.
Depreciation and Amortization. During the three months ended June 30, 2010,
depreciation and amortization expense decreased 60% or $18,000 as compared to
the corresponding period in 2009. The decrease in depreciation and amortization
expense reflects the limitations placed on acquiring new equipment in 2010.
Interest Expense (Income), Net. For the three months ended June 30, 2010, we
recognized interest income of $0 and interest expense of $334,000. For the three
months ended June 30, 2009, we recognized interest income of $0 and interest
expense of $180,000.
Interest expense for the three months ended June 30, 2010 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $58,000.
· Accretion of note discount to interest expense of approximately $271,000.
· Other interest expense of approximately $5,000.
Interest expense for the three months ended June 30, 2009 is comprised of the
following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $33,000.
· Accretion of note discount to interest expense of approximately $74,000.
· Amortization of deferred financing fees to interest expense of approximately
$8,000.
· Interest expense of approximately $65,000 primarily related to liquidated
damages accrued pursuant to a registration payment arrangement.
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Change in Fair Value of Derivative Liabilities. For the three months ended June
30, 2010, we recognized non-cash income of $4,154,000 compared to non-cash
expense of $5,179,000 for the corresponding period of 2009 due to implementation
of ASC 815 effective January 1, 2009. Such expense is related to the change in
fair value of the Company's Derivative Liabilities. The Derivative Liabilities
were revalued using available market information and commonly accepted valuation
methodologies.
Change in Fair Value of Financing Obligation. For the three months ended June
30, 2010, we recognized non-cash income of $744,000 compared to non-cash expense
of $450,000 for the corresponding period of 2009 related to the change in fair
value of the Company's financing obligation. For the three months ended June 30,
2010, such income is related to the change in fair value of the Company's
variable component of the financing obligation of approximately $816,000 offset
by the accretion of the fixed component of the financing obligation of
approximately $72,000. For the three months ended June 30, 2009, such expense is
related to the change in fair value of the Company's variable component of the
financing obligation of approximately $412,000 and the accretion of the fixed
component of the financing obligation of approximately $38,000. The variable
component of the financing obligation was revalued using available market
information and commonly accepted valuation methodologies.
Other Expense (Income), Net. For the three months ended June 30, 2010, we
recognized other income of $284,000 and other expense of $0. For the three
months ended June 30, 2009, we recognized other income of $11,000 and other
expense of $0. Other income for the three months ended June 30, 2010 contains
approximately $280,000 from the reduction of previously accrued liquidated
damages due to the expiration of the statue of limitations and $4,000 from
collections on previously derecognized receivables. Other income for the three
months ended June 30, 2009 is comprised primarily of $6,000 from the negotiated
settlement of certain trade accounts payable at amounts less than their carrying
value and $5,000 from collection on previously derecognized receivables.
Comparison of Results for the Periods Ended September 30, 2010 and September 30,
2009
Product Revenues.
Three Months Ended
September 30,
Net Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 370 $ 216 $ 154 71 %
Percentage of total net product
revenue 48 % 90 %
Hardware and consumables $ 21 $ 37 $ (16) (43) %
Percentage of total net product
revenue 3 % 15 %
Services $ 378 $ (12 ) $ 390 3,250 %
Percentage of total net product
revenue 49 % (5 )%
Total net product revenues $ 769 $ 241 $ 528 219 %
Software and royalty revenues increased 71% or $154,000 during the three months
ended September 30, 2010 as compared to the corresponding period in 2009. The
increase is due primarily to higher identity management software sold into
project solutions of approximately $129,000, higher sales of our boxed identity
management software sold through our distribution channel of approximately
$17,000 and higher project-oriented revenues of our law enforcement software
solutions of approximately $12,000. This was partially offset by lower royalties
and license revenues of approximately $4,000.
Revenues from the sale of hardware and consumables decreased 43% or $16,000
during the three months ended September 30, 2010 as compared to the
corresponding period in 2009. The decrease reflects the lower levels of hardware
and consumables generated from project solutions.
Services revenues are comprised primarily of software integration services,
system installation services and customer training. Such revenues increased
approximately $390,000 during the three months ended September 30, 2010 as
compared to the corresponding period in 2009 due to higher service revenues
being generated from our identity management project solutions.
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Maintenance Revenues.
Three Months Ended
September 30,
Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Maintenance revenues $ 653 $ 659 $ (6) (1) %
The decrease in maintenance revenues reflects lower maintenance revenues of
approximately $23,000 generated from our law enforcement products offset by
higher maintenance revenues of approximately $17,000 generated from our identity
management product suite.
Cost of Product Revenues.
Three Months Ended
September 30,
Cost of Product Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 36 $ 32 $ 4 13 %
Percentage of software and
royalty product revenue 10 % 15 %
Hardware and consumables $ 26 $ 42 $ (16) (38) %
Percentage of hardware and
consumables product revenue 124 % 114 %
Services $ 187 $ 93 $ 94 101 %
Percentage of services product
revenue 49 % -775 %
Total cost of product revenues $ 249 $ 167 $
82 49 %
Percentage of total product
revenues 32 % 69 %
The cost of software and royalty product revenue increased 13% or $4,000 during
the three months ended September 30, 2010 as compared to the corresponding
period in 2009 due to higher third-party software content in solutions provided
during the three month period ended September 30, 2010 as compared to the
corresponding period in 2009.
The decrease in cost of hardware and consumables product revenue of $16,000 for
the three months ended September 30, 2010 as compared to the corresponding
period in 2009 reflects the decrease in hardware and consumable revenues of
approximately $16,000 for the three months ended September 30, 2010 as compared
to the comparable period in 2009.
Costs of service revenues increased $94,000 for the three-month period ended
September 30, 2010 as compared to the corresponding period in 2009. The increase
is due primarily to an increase of $390,000 in service revenues generated during
the three month period ended September 30, 2010 as compared to the comparable
period in 2009.
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Cost of Maintenance Revenues.
Three Months Ended
September 30,
Cost of Maintenance Revenues 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance cost of
revenues $ 198 $ 201 $ (3) (1) %
Percentage of total maintenance
revenues 30 % 31 %
Costs of maintenance revenues as a percentage of maintenance revenues decreased
to 30% during the three months ended September 30, 2010 from 31% for the
corresponding period in 2009. This decrease is due primarily to reductions in
costs incurred to perform maintenance requirements on completed law enforcement
project solutions.
Product Gross Profit.
Three Months Ended
September 30,
Product Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Software and royalties $ 334 $ 184 $ 150 ) 82 %
Percentage of software and 90 % 85 %
royalty product revenue
Hardware and consumables $ (5) $ (5) $ 0 0 %
Percentage of hardware and -24 % (14) %
consumables product revenue
Services $ 191 $ (105) $ 296 282 %
Percentage of services product 51 % (875) %
revenue
Total product gross profit $ 520 $ 74 $ 446 ) 603 %
Percentage of total product 68 % 31 %
revenues
Software and royalty gross profit increased by 82% or approximately $150,000 for
the three months ended September 30, 2010 from the corresponding period in 2009
due to higher software and royalty product revenues of approximately $154,000 in
the 2010 period, offset partially by higher software and royalty cost of
revenues of approximately $4,000. Costs of software products can also vary as a
percentage of product revenue from quarter to quarter depending upon product mix
and third party software licenses included in software solutions.
Services gross profit increased approximately $296,000 for the three months
ended September 30, 2010 from the corresponding period in 2009 due to higher
service revenues being generated from our identity management project solutions.
Maintenance Gross Profit.
Three Months Ended
September 30,
Maintenance Gross Profit 2010 2009 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 455 $ 458 $
(3 ) (1) %
Percentage of total maintenance
revenues 70 % 69 %
Gross profit related to maintenance revenues decreased approximately $3,000 due
to lower maintenance revenues.
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Operating Expenses.
Three Months Ended
September 30,
Operating Expenses 2010 2009 $ Change % Change
(dollars in thousands)
General and administrative $ 512 $ 555 $ (43 ) (8) %
Percentage of total net revenue 36 % 62 %
Sales and marketing $ 385 $ 376 $ 9 2 %
Percentage of total net revenue 27 % 42 %
Research and development $ 576 $ 582 $ (6 )
(1) %
Percentage of total net revenue 41 % 65 %
Depreciation and amortization $ 13 $ 19 $ (6 )
(32) %
Percentage of total net revenue 1 % 2 %
General and Administrative Expenses. General and administrative expenses are
comprised primarily of salaries and other employee-related costs for executive,
financial, and other infrastructure personnel. General legal, accounting and
consulting services, insurance, occupancy and communication costs are also
included with general and administrative expenses. The decrease of $43,000 is
comprised of the following major components:
· Decrease in expenses related to our closed sales office in Germany of
approximately $9,000.
· Increase in professional services of approximately $6,000.
· Decrease in insurance related expenses of approximately $3,000.
· Decrease in occupancy related expenses of approximately $18,000.
††† Decrease in compensation and related fringe benefits of approximately
$14,000 due to reductions in headcount.
· Decrease in travel related expenses of approximately $5,000.
Sales and Marketing. Sales and marketing expenses consist primarily of the
salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales, marketing and business development functions. The
increase of $9,000 is comprised of the following major components:
††† Increase in compensation and related fringe benefits of approximately $44,000
due to increases in headcount.
· Decrease of $39,000 in expenses incurred for sales contractors and
consultants.
· Decrease in occupancy related expenses of approximately $1,000.
· Decrease in travel related expenses of approximately $4,000.
††† Decrease in stock-based compensation expense of approximately $13,000.
· Increase of $22,000 from costs related to our Mexico City sales office opened
in June 2009.
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Research and Development. Research and development expenses consist primarily of
salaries, employee benefits and outside contractors for new product development,
product enhancements and custom integration work. Such expenses decreased 1% or
$6,000 for the three months ended September 30, 2010 as compared to 2009.
Depreciation and Amortization. During the three months ended September 30, 2010,
depreciation and amortization expense decreased 32% or $6,000 as compared to the
corresponding period in 2009. The decrease in depreciation and amortization
expense reflects the limitations placed on acquiring new equipment in 2010.
Interest Expense (Income), Net. For the three months ended September 30, 2010,
we recognized interest income of $0 and interest expense of $60,000. For the
three months ended September 30, 2009, we recognized interest income of $0 and
interest expense of $212,000.
Interest expense for the three months ended September 30, 2010 is comprised of
the following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $54,000.
· Other interest expense of approximately $6,000.
Interest expense for the three months ended September 30, 2009 is comprised of
the following components:
· Coupon interest on secured notes payable and convertible notes payable of
approximately $32,000.
· Accretion of note discount to interest expense of approximately $82,000.
· Fair value of warrants issued to related party convertible note holders in
consideration for wavier of default of approximately $52,000.
· Amortization of deferred financing fees to interest expense of approximately
$1,000.
· Interest expense of approximately $45,000 primarily related to liquidated
damages accrued pursuant to a registration payment arrangement.
Change in Fair Value of Derivative Liabilities. For the three months ended
September 30, 2010, we recognized non-cash income of $506,000 compared to
non-cash expense of $756,000 for the corresponding period of 2009 due to
implementation of ASC 815 effective January 1, 2009. Such expense is related to
the change in fair value of the Company's Derivative Liabilities. The Derivative
Liabilities were revalued using available market information and commonly
accepted valuation methodologies.
Change in Fair Value of Financing Obligation. For the three months ended
September 30, 2010, we recognized non-cash income of $38,000 compared to
non-cash expense of $438,000 for the corresponding period of 2009 related to the
change in fair value of the Company's financing obligation. For the three months
ended September 30, 2010, such income is related to the change in fair value of
the Company's variable component of the financing obligation. For the three
months ended September 30, 2009, such expense is related to the change in fair
value of the Company's variable component of the financing obligation of
approximately $355,000 and the accretion of the fixed component of the financing
obligation of approximately $83,000. The variable component of the financing
obligation was revalued using available market information and commonly accepted
valuation methodologies.
Other Expense (Income), Net. For the three months ended September 30, 2010, we
recognized other income of $12,000 and other expense of $0. For the three months
ended September 30, 2009, we recognized other income of $132,000 and other
expense of $8,000. Other income for the three months ended September 30, 2010
contains approximately $12,000 from collections on previously derecognized
receivables. Other income for the three months ended September 30, 2009 is
comprised primarily of $128,000 from the negotiated settlement of certain trade
accounts payable at amounts less than their carrying value and $4,000 from
collection on previously derecognized receivables. Other expense for the three
months ended September 30, 2009 is comprised of approximately $8,000 of foreign
currency transaction losses.
Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial
Accounting Standards Board, or FASB, or other standard setting bodies, which are
adopted by us as of the specified effective date. Unless otherwise discussed,
the Company's management believes that the impact of recently issued standards
that are not yet effective will not have a material impact on the Company's
consolidated financial statements upon adoption.
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FASB ASU 2010-06. In January 2010, the FASB issued FASB Accounting Standards
Update, or ASU 2010-06, which amends the disclosure requirements relating to
recurring and nonrecurring fair value measurements. New disclosures are required
about transfers into and out of the levels 1 and 2 fair value hierarchy and
separate disclosures about purchases, sales, issuances and settlements relating
to Level 3 measurements. This ASU also requires an entity to present information
about purchases, sales, issuances and settlements for significant unobservable
inputs on a gross basis rather than as a net number. This ASU was effective for
us with the reporting period beginning January 1, 2010, except for the
disclosures on the roll forward activities for Level 3 fair value measurements,
which will become effective for us with the reporting period beginning
October 1, 2011. The adoption of this ASU had no impact on the Company's
financial position and results of operations, as it only requires additional
disclosures.
FASB ASU 2010-29. In December 2010, the FASB issued FASB ASU 2010-29, which
requires an entity to disclose revenue and earnings of a combined entity as
though the business combination that occurred during the current year had
occurred as of the beginning of the comparable prior annual period only. It also
requires pro forma disclosures to include a description of the nature and amount
of the material, nonrecurring pro forma adjustments directly attributable to the
business combination included in the reported pro forma revenue and
earnings. The Company does not expect the adoption of ASU 2010-29 to have a
material impact on the Company's consolidated financial statements.
FASB ASU 2011-05. In June 2011 the FASB issued ASU No. 2011-05, Comprehensive
Income (Topic 220): Presentation of Comprehensive Income, ("ASU 2011-05"). This
new accounting standard: (1) eliminates the option to present the components of
other comprehensive income as part of the statement of changes in stockholders'
equity; (2) requires the consecutive presentation of the statement of net income
and other comprehensive income; and (3) requires an entity to present
reclassification adjustments on the face of the financial statements from other
comprehensive income to net income. This new standard does not change the items
that must be reported in other comprehensive income or when an item of other
comprehensive income must be reclassified to net income, nor does it affect how
earnings per share is calculated or presented. ASU 2011-05 is required to be
applied retrospectively and is effective for fiscal years and interim periods
within those years beginning after December 15, 2011, with early adoption
permitted. As this new standard only requires enhanced disclosure, the adoption
of ASU 2011-05 will not impact the Company's financial position or results of
operations.
FASB ASU 2011-08. In September 2011 the FASB issued ASU No. 2011-08, Goodwill
and Other (Topic 350): Testing Goodwill for Impairment, ("ASU 2011-08"). This
new accounting standard simplifies goodwill impairment tests and states that a
qualitative assessment may be performed to determine whether further impairment
testing is necessary. ASU 2011-08 is effective for annual and interim goodwill
impairment tests performed for fiscal years beginning after December 15, 2011.
The Company does not expect the adoption of ASU 2011-08 to have a material
impact on the Company's consolidated financial statements.
FASB ASU 2011-09. The FASB has issued Accounting Standards Update (ASU) No.
2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80):
Disclosures about an Employer's Participation in a Multiemployer Plan. ASU
2011-09 is intended to address concerns from various users of financial
statements on the lack of transparency about an employer's participation in a
multiemployer pension plan. Users of financial statements have requested
additional disclosure to increase awareness of the commitments and risks
involved with participating in multiemployer pension plans. The amendments in
this ASU will require additional disclosures about an employer's participation
in a multiemployer pension plan. Previously, disclosures were limited primarily
to the historical contributions made to the plans. ASU 2011-09 applies to
nongovernmental entities that participate in multiemployer plans. For public
entities, ASU 2011-09 is effective for annual periods for fiscal years ending
after December 15, 2011. For nonpublic entities, ASU 2011-09 is effective for
annual periods for fiscal years ending after December 15, 2012. Early adoption
is permissible for both public and nonpublic entities. ASU 2011-09 should be
applied retrospectively for all prior periods presented. The Company does not
expect the adoption of ASU 2011-09 to have a material impact on the Company's
consolidated financial statements.
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Impact of Inflation
The primary inflationary factor affecting our operations is labor costs and we
do not believe that inflation has materially affected earnings during the past
four years. Substantial increases in costs and expenses, particularly labor and
operating expenses, could have a significant impact on our operating results to
the extent that such increases cannot be passed along to customers and end
users.
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