IMAGEWARE SYSTEMS INC - Quarter Report: 2008 June (Form 10-Q)
UNITED STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
(Mark
One)
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x
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QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For
the quarterly period ended June 30, 2008
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o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
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For
the transition period
from to
Commission
file number 001-15757
IMAGEWARE
SYSTEMS, INC.
(Exact
Name of Registrant as Specified in Its Charter)
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Delaware
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33-0224167
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(State
or Other Jurisdiction of Incorporation or
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(IRS
Employer Identification No.)
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Organization)
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10883
Thornmint Road
San
Diego, CA 92127
(Address
of Principal Executive Offices)
(858)
673-8600
(Registrant’s
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
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Large
accelerated filer o
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Accelerated
filer o
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Non-accelerated
filer x
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Smaller
reporting company o
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(Do
not check if a smaller reporting company)
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Indicate
by check mark whether the registrant is a shell company (as
defined in Rule 12b-12 of the Exchange Act). Yes o No x
The
number of shares of Common Stock, with $0.01 par value, outstanding
on September 12, 2008
was
18,143,259.
IMAGEWARE
SYSTEMS, INC. INDEX
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PART I.
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FINANCIAL
INFORMATION
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3
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ITEM
1.
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FINANCIAL
STATEMENTS
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3
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Condensed
Consolidated Balance Sheets as of June 30, 2008 (unaudited) and
December 31, 2007
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3
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||||
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Condensed
Consolidated Statements of Operations for the three and six months ended
June 30, 2008 and 2007 (unaudited)
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4
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Condensed
Consolidated Statements of Cash Flows for the six months ended
June 30, 2008 and 2007 (unaudited)
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5
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Condensed
Consolidated Statements of Comprehensive Loss for the three and six months
ended June 30, 2008 and 2007 (unaudited)
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6
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Notes
to unaudited Condensed Consolidated Financial Statements
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7
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ITEM
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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17
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ITEM
3.
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Quantitative
and Qualitative Disclosures About Market
Risk
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29
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ITEM
4.
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Controls
and
Procedures
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29
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PART II.
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OTHER
INFORMATION
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29
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ITEM
1A.
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Risk
Factors
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29
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ITEM
6.
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Exhibits
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32
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SIGNATURES
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33
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2
IMAGEWARE
SYSTEMS, INC.
(In
Thousands, except share and per share data)
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June 30,
2008
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December 31,
2007
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|||||||
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(Unaudited)
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||||||||
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ASSETS
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||||||||
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Current
Assets:
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||||||||
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Cash
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$ | 216 | $ | 1,044 | ||||
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Accounts
receivable, net of allowance for doubtful accounts of $0 (unaudited) and
$0 at June 30, 2008 and December 31, 2007,
respectively
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490 | 425 | ||||||
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Inventory
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183 | 130 | ||||||
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Other
current assets
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451 | 441 | ||||||
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Total
Current Assets
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1,340 | 2,040 | ||||||
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Property
and equipment, net
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233 | 288 | ||||||
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Other
assets
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24 | 24 | ||||||
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Pension
assets
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760 | 694 | ||||||
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Intangible
assets, net of accumulated amortization
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2,164 | 2,437 | ||||||
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Goodwill
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3,416 | 4,452 | ||||||
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Total
Assets
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$ | 7,937 | $ | 9,935 | ||||
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LIABILITIES
AND SHAREHOLDERS’ EQUITY
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||||||||
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Current
Liabilities:
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||||||||
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Accounts
payable
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$ | 2,244 | $ | 1,415 | ||||
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Deferred
revenue
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1,193 | 1,011 | ||||||
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Billings
in excess of costs and estimated earnings on uncompleted
contracts
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531 | — | ||||||
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Accrued
expenses
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1,379 | 1,341 | ||||||
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Acquisition
related obligation
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1,060 | 1,502 | ||||||
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Total
Current Liabilities
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6,407 | 5,269 | ||||||
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Pension
obligation
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1,204 | 1,139 | ||||||
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Total
Liabilities
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7,611 | 6,408 | ||||||
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Shareholders’
equity:
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||||||||
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Preferred
stock, authorized 4,000,000 shares:
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||||||||
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Series B
convertible redeemable preferred stock, $0.01 par value; designated
750,000 shares, 389,400 shares issued, and 239,400 shares outstanding
at June 30, 2008 and December 31, 2007; liquidation
preference $599 at June 30, 2008 and
December 31, 2007
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2 | 2 | ||||||
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Series C
convertible non-redeemable preferred stock, $0.01 par value; designated
3,500 shares, 2,500 shares issued, and 2,200 shares outstanding at
June 30, 2008 and December 31, 2007; liquidation preference
$2,200 at June 30, 2008 and December 31, 2007
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— | — | ||||||
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Series D
convertible non-redeemable preferred stock, $0.01 par value; designated
2,000 shares, 1,500 shares issued, and 1,388 shares outstanding at
June 30, 2008 and December 31, 2007; liquidation preference
$1,388 at June 30, 2008 and December 31, 2007
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— | — | ||||||
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Common
stock, $.01 par value, 50,000,000 shares authorized; 18,136,439
(unaudited) and 17,797,826 shares issued at June 30, 2008 and
December 31, 2007, respectively, and 18,129,735 (unaudited) and
17,791,122 shares outstanding at June 30, 2008 and December 31,
2007, respectively
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180 | 177 | ||||||
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Additional
paid in capital
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81,151 | 79,294 | ||||||
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Treasury
stock, at cost - 6,704 shares
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(64 | ) | (64 | ) | ||||
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Accumulated
other comprehensive (loss) income
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(44 | ) | 7 | |||||
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Accumulated
deficit
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(80,899 | ) | (75,889 | ) | ||||
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Total
Shareholders’ equity
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326 | 3,527 | ||||||
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Total
Liabilities and Shareholders’ Equity
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$ | 7,937 | $ | 9,935 | ||||
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
3
IMAGEWARE
SYSTEMS, INC.
(in
thousands, except share and per share amounts)
(unaudited)
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Three Months Ended
June 30,
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Six Months Ended
June 30,
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|||||||||||||||
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2008
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2007
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2008
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2007
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Revenues:
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Product
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$ | 1,020 | $ | 1,157 | $ | 1,797 | $ | 1,866 | ||||||||
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Maintenance
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647 | 621 | 1,253 | 1,247 | ||||||||||||
| 1,667 | 1,778 | 3,050 | 3,113 | |||||||||||||
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Cost
of revenues:
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Product
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270 | 296 | 409 | 482 | ||||||||||||
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Maintenance
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289 | 296 | 604 | 590 | ||||||||||||
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Gross
profit
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1,108 | 1,186 | 2,037 | 2,041 | ||||||||||||
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Operating
expenses:
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General
& administrative
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944 | 957 | 2,045 | 2,100 | ||||||||||||
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Sales
and marketing
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548 | 674 | 1,214 | 1,367 | ||||||||||||
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Research
& development
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731 | 803 | 1,628 | 1,989 | ||||||||||||
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Depreciation
and amortization
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194 | 79 | 395 | 139 | ||||||||||||
| 2,417 | 2,513 | 5,282 | 5,595 | |||||||||||||
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Loss
from operations
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(1,309 | ) | (1,327 | ) | (3,245 | ) | (3,554 | ) | ||||||||
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Interest
expense (income), net
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— | (5 | ) | (5 | ) | 238 | ||||||||||
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Other
expense (income), net
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(15 | ) | 82 | (43 | ) | 44 | ||||||||||
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Loss
from continuing operations before income taxes
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(1,294 | ) | (1,404 | ) | (3,197 | ) | (3,836 | ) | ||||||||
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Income
tax expense (benefit)
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— | — | — | — | ||||||||||||
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Loss
from continuing operations
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(1,294 | ) | (1,404 | ) | (3,197 | ) | (3,836 | ) | ||||||||
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Discontinued
operations:
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||||||||||||||||
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Gain
(loss) from operations of discontinued Digital Photography
component
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7 | 11 | 7 | 11 | ||||||||||||
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Income
tax benefit (expense)
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— | — | — | — | ||||||||||||
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Gain
(loss) on discontinued operations
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7 | 11 | 7 | 11 | ||||||||||||
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Net
loss
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(1,287 | ) | (1,393 | ) | (3,190 | ) | (3,825 | ) | ||||||||
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Preferred
dividends
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(84 | ) | (88 | ) | (1,963 | ) | (503 | ) | ||||||||
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Net
loss available to common shareholders
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$ | (1,371 | ) | $ | (1,481 | ) | $ | (5,153 | ) | $ | (4,328 | ) | ||||
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Basic
and diluted loss per common share - see note 2
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Loss
from continuing operations
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$ | (0.07 | ) | $ | (0.09 | ) | $ | (0.18 | ) | $ | (0.27 | ) | ||||
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Discontinued
operations
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— | — | — | — | ||||||||||||
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Preferred
dividends
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(0.01 | ) | (0.01 | ) | (0.11 | ) | (0.04 | ) | ||||||||
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Basic
and diluted loss per share available to common
shareholders
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$ | (0.08 | ) | $ | (0.10 | ) | $ | (0.29 | ) | $ | (0.31 | ) | ||||
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Weighted-average
shares (basic and diluted)
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18,087,528 | 14,669,170 | 17,962,113 | 14,218,699 | ||||||||||||
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
4
IMAGEWARE
SYSTEMS, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN
THOUSANDS)
|
Six Months Ended
June 30,
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||||||||
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2008
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2007
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Cash
flows from operating activities
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||||||||
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Net
loss
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$ | (3,190 | ) | $ | (3,825 | ) | ||
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Adjustments
to reconcile net loss to net cash used in operating
activities
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||||||||
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Depreciation
and amortization
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395 | 139 | ||||||
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Provision
for losses in investment in equity securities
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— | 85 | ||||||
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Reduction
in inventory obsolescence reserve
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— | (32 | ) | |||||
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Non
cash interest and amortization of debt discount and debt issuance
costs
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— | 229 | ||||||
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Stock
based compensation
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178 | 356 | ||||||
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Provision
for losses on accounts receivable
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— | 25 | ||||||
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Change
in assets and liabilities
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Accounts
receivable, net
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(65 | ) | 654 | |||||
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Inventory
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(53 | ) | (149 | ) | ||||
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Other
current assets
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(10 | ) | (59 | ) | ||||
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Pension
assets
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(65 | ) | (23 | ) | ||||
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Accounts
payable
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828 | 617 | ||||||
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Accrued
expenses
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165 | 304 | ||||||
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Deferred
revenue
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182 | (48 | ) | |||||
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Billings
in excess of costs and estimated earnings on uncompleted
contracts
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531 | — | ||||||
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Pension
obligation
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65 | 38 | ||||||
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Total
adjustments
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2,151 | 2,136 | ||||||
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Net
cash used in operating activities
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(1,039 | ) | (1,689 | ) | ||||
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Cash
flows from investing activities
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||||||||
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Purchase
of property and equipment
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(68 | ) | (56 | ) | ||||
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Acquisition
of business, net of cash acquired
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(187 | ) | — | |||||
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Net
cash used in investing activities
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(255 | ) | (56 | ) | ||||
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Cash
flows from financing activities
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||||||||
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Repayment
of notes payable
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— | (1,310 | ) | |||||
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Proceeds
from issuance of preferred stock, net of issuance costs
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— | 1,327 | ||||||
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Other
financing issuance costs
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— | (54 | ) | |||||
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Dividends
paid
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(25 | ) | (25 | ) | ||||
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Proceeds
from exercised stock purchase warrants
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542 | 1,121 | ||||||
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Net
cash provided by financing activities
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517 | 1,059 | ||||||
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Effect
of exchange rate changes on cash
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(51 | ) | (25 | ) | ||||
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Net
increase (decrease) in cash
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(828 | ) | (711 | ) | ||||
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Cash
at beginning of period
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1,044 | 939 | ||||||
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Cash
at end of period
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$ | 216 | $ | 228 | ||||
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Supplemental
disclosure of cash flow information:
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||||||||
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Cash
paid for interest
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$ | — | $ | 46 | ||||
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Summary
of non-cash investing and financing activities:
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||||||||
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Beneficial
conversion feature of series C and D preferred stock
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$ | 1,794 | $ | 344 | ||||
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Conversion
of preferred stock to common
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$ | — | $ | 2 | ||||
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
5
IMAGEWARE
SYSTEMS, INC
CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN
THOUSANDS)
|
Three Months Ended
June 30,
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Six Months Ended
June 30,
|
|||||||||||||||
|
2008
|
2007
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2008
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2007
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|||||||||||||
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Net
loss
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$ | (1,287 | ) | $ | (1,393 | ) | $ | (3,190 | ) | $ | (3,825 | ) | ||||
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Foreign
currency translation adjustment
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(12 | ) | (15 | ) | (51 | ) | (25 | ) | ||||||||
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Comprehensive
loss
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$ | (1,299 | ) | $ | (1,408 | ) | $ | (3,241 | ) | $ | (3,850 | ) | ||||
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
6
IMAGEWARE
SYSTEMS, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1. DESCRIPTION OF BUSINESS AND OPERATIONS
ImageWare
Systems, Inc. (the “Company” or “ImageWare”) is a leader in the emerging
market for software-based identity management solutions, providing biometric,
secure credential, law enforcement and enterprise authorization. Our
“flagship” product is the IWS Biometric Engine. Scalable for small city
business or worldwide deployment, our biometric engine is a multi-biometric
platform that is hardware and algorithm independent, enabling the enrollment and
management of unlimited population sizes. Our identification products are
used to manage and issue secure credentials, including national IDs, passports,
driver licenses, smart cards and access control credentials. Our law enforcement
products provide law enforcement with integrated mug shot, fingerprint LiveScan
and investigative capabilities. We also provide comprehensive authentication
security software, as well as real-time voice recognition, multilingual speech
translation and voice analytics technologies. Biometric technology is now
an integral part of all markets we address, and all of our products are
integrated into the Biometric Engine Platform. Elements of the IWS
Biometric Engine can be used as investigative tools for law enforcement
utilizing multiple biometrics and forensic data elements, and to enhance
security and authenticity of public and private sector credentials.
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
biometric identity management platform for multi-biometric enrollment,
management and authentication, managing population databases of virtually
unlimited sizes. 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. It can
also be utilized within our law enforcement systems to incorporate any number of
various multiple biometrics into one system.
We
recently added next generation voice recognition, multilingual speech
translation and voice analytics capabilities to our suite of biometric identity
management solutions, enabling users to facilitate and improve communication
across major language groups globally. The ImageWare Mediator products are
offered standalone or integrated with our Biometric Engine platform providing an
advanced multilingual communications capability. Government, intelligence,
defense, public safety and border control customers are able to realize language
translation and voice recognition capabilities whereby an English-speaking user
can understand and be understood in numerous languages including Spanish,
German, French, Korean, Arabic and Polish, among others. ImageWare Mediator
products support speech to speech translation, multilingual collaboration,
conversational environments, which are represented for both voice and text and
include biometric functionality for speaker identification and voice
analytics.
Our law
enforcement solutions enable agencies to quickly capture, archive, search,
retrieve, and share digital images, fingerprints and 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 six software modules: a
Capture and Investigative module, which provides a criminal booking system and
related database; a Facial Recognition module, which uses biometric facial
recognition to identify suspects; a Suspect ID module, which facilitates the
creation of full-color, photo-realistic suspect composites; a wireless module,
which provides access to centrally stored records over the Internet in a
connected or wireless fashion; a PDA add-on module, which enables access to
centrally stored records while in the field on a handheld Pocket PC compatible
device combined with central repository services which allows for inter-agency
data sharing on a local, regional, and/or national level; 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.
Our
Secure Credential ID 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 in the
production of photo identification cards and credentials and identification
systems. Our products in this market consist of IWS EPI Suite, IWS EPI Builder
(SDK), Identifier for Windows and ID Card Maker. 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 recently added the ability to incorporate multiple
biometrics into the ID systems we offer with the addition of our new IWS
Biometric Engine to our product line.
7
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.
Basis
of Presentation
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those
estimates.
The
accompanying condensed consolidated balance sheet as of December 31, 2007
has been derived from the Company’s audited balance sheet included in the
2007 Annual Report on Form 10-K and the condensed consolidated unaudited
financial statements of ImageWare have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission (“SEC”)
regarding interim financial reporting. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for annual financial statements and should be read in conjunction
with the consolidated financial statements for the year ended December 31,
2007, and notes thereto included in the Company’s Annual Report on
Form 10-K, filed with the SEC on April 15, 2008, as amended on
April 29, 2008. In the opinion of management, the accompanying condensed
consolidated financial statements contain all adjustments, consisting only of
adjustments of a normal recurring nature, necessary for a fair presentation of
the Company’s financial position as of June 30, 2008, and its results of
operations for the periods presented. These condensed consolidated unaudited
financial statements for the period ended June 30, 2008 are not necessarily
indicative of the results to be expected for the entire year.
Going
Concern
As
reflected in the accompanying condensed consolidated financial statements, the
Company has continuing losses, negative working capital and negative cash flows
from operations. These matters raise substantial doubt about the Company’s
ability to continue as a going concern.
New
financing will be required to fund working capital and operations should the
Company be unable to generate positive cash flow from operations in the near
future. The Company is exploring the possible sale of equity securities and/or
debt financing. However, there can be no assurance that additional financing
will be available. In the event financing is not available in the time frame
required, the Company will be forced to sell certain of its assets or license
its technologies to others. These actions, while necessary for the continuance
of operations during a time of cash constraints and a shortage of working
capital, could adversely affect the Company’s business.
On
April 25, 2008, the Company received a letter from the American Stock
Exchange (“AMEX”) advising that a Listing Qualifications Panel of the AMEX
Committee on Securities (the “Panel”) had affirmed the determination of the
staff of the Listing Qualifications Department of AMEX (the “Staff”) to delist
the Company’s common stock from AMEX as a result of the Company’s failure to
comply with: (A) Section 1003(a)(ii) of the AMEX
Company Guide (the “Company Guide”), because the Company has shareholders’
equity of less than $4 million and has sustained losses from continuing
operations and net losses in three out of four of the Company’s most recent
fiscal years; and (B) Section 1003(a)(iii) of the Company Guide,
because the Company has shareholders’ equity of less than $6 million and has
sustained losses from continuing operations and net losses in five of the
Company’s most recent fiscal years.
On
May 5, 2008 the Company’s common stock was delisted from
AMEX. The Company’s common stock is currently trading on the
Over-The-Counter-Bulletin Board (“OTCBB”) under the ticker symbol
“IWSY”.
8
However,
the delisting could adversely affect the public price of the Company’s common
stock and limit the Company’s stockholders’ ability to dispose of, or to obtain
accurate quotations as to the prices of, the Company’s common stock. Moreover,
the Company’s ability to obtain financing on favorable terms, or at all, may be
adversely affected by the delisting because certain institutional investors that
have policies against investments in companies that are not traded on a national
securities exchange and other investors may refrain from purchasing the
Company’s common stock because of the delisting. The Company’s
ability to obtain financing may also be more limited in numerous states because
the Company will no longer benefit from state exemptions from registration which
are dependent upon the listing of the Company’s common stock on
AMEX.
In view
of the matters described in the preceding paragraphs, recoverability of a major
portion of the recorded asset amounts shown in the accompanying condensed
consolidated balance sheets is dependent upon continued operations of the
Company, which, in turn, is dependent upon the Company’s ability to continue to
raise capital and generate positive cash flows from operations. The condensed
consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts and
classifications of liabilities that might be necessary should the Company be
unable to continue its existence.
The
Company operates in markets that are emerging and highly competitive. There is
no assurance that the Company will operate at a profit in the
future.
Recently
Issued Accounting Standards
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157,
Fair
Value Measurements (SFAS No. 157).
SFAS No. 157 replaces the different definitions of fair value in the
accounting literature with a single definition. It defines fair value as the
price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date.
SFAS No. 157 is effective for fair-value measurements already required
or permitted by other standards for financial statements issued for fiscal years
beginning after November 15, 2007 and interim periods within those fiscal
years, with earlier adoption encouraged. The FASB has deferred the
implementation of SFAS 157 by one year for certain non-financial assets and
liabilities until fiscal years beginning after November 15, 2008. We are
currently in the process of determining the impact, if any, of adopting the
provisions of SFAS No. 157 on our results of operations or financial
position as it relates to other non-financial assets and
liabilities.
In December 2007, the FASB issued SFAS No. 141(R), “Business
Combinations” and SFAS No. 160, “Non-controlling Interests in Consolidated
Financial Statements”. The standards are intended to improve, simplify, and
converge internationally the accounting for business combinations and the
reporting of non-controlling interests in consolidated financial statements.
SFAS No. 141(R) requires the acquiring entity in a business
combination to recognize all (and only) the assets acquired and liabilities
assumed in the transaction; establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed; and
requires the acquirer to disclose to investors and other users all of the
information they need to evaluate and understand the nature and financial effect
of the business combination. SFAS No. 141(R) is effective for fiscal
years, and interim periods within those fiscal years, beginning on or after
December 15, 2008. SFAS No. 141(R) applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after
December 15, 2008. Earlier adoption is prohibited. The Company is currently
evaluating the impact of this standard on its consolidated financial
statements.
SFAS
No. 160 is designed to improve the relevance, comparability, and
transparency of financial information provided to investors by requiring all
entities to report non-controlling (minority) interests in subsidiaries in the
same way–as equity in the consolidated financial statements. Moreover, SFAS
No. 160 eliminates the diversity that currently exists in accounting for
transactions between an entity and non-controlling interests by requiring they
be treated as equity transactions. SFAS No. 160 is effective for fiscal
years, and interim periods within those fiscal years, beginning on or after
December 15, 2008. Earlier adoption is prohibited. In addition, SFAS
No. 160 shall be applied prospectively as of the beginning of the fiscal
year in which it is initially applied, except for the presentation and
disclosure requirements. The presentation and disclosure requirements shall be
applied retrospectively for all periods presented. We do not have an outstanding
non-controlling interest in one or more subsidiaries and therefore, SFAS
No. 160 is not applicable to us at this time.
In
December 2007, the FASB ratified the consensus reached by the EITF on Issue
No. 07-1 (“EITF 07-1”), Accounting for Collaborative
Arrangements. EITF 07-1 is effective for the Company beginning
January 1, 2009 and will be applied retrospectively to all prior periods
presented for all collaborative arrangements existing as of the effective date.
EITF 07-1 defines collaborative arrangements and establishes reporting
requirements for transactions between participants in a collaborative
arrangement and between participants in the arrangement and third parties. The
Company is assessing the impact of adoption of EITF 07-1 on its financial
position and results of operations.
9
In
March 2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities (“FAS 161”), which is effective
January 1, 2009. FAS 161 requires enhanced disclosures about derivative
instruments and hedging activities to allow for a better understanding of their
effects on an entity’s financial position, financial performance, and cash
flows. Among other things, FAS 161 requires disclosure of the fair values of
derivative instruments and associated gains and losses in a tabular format.
Since FAS 161 requires only additional disclosures about the Company’s
derivatives and hedging activities, the adoption of FAS 161 will not affect the
Company’s financial position or results of operations.
In
April 2008, the FASB issued Staff Position FSP FAS 142-3, “Determination of
the Useful Life of Intangible Assets” (“FSP FAS 142-3”). The FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, “Goodwill and Other Intangible Assets”. The intent of the FSP is
to improve the consistency between the useful life of a recognized intangible
asset under SFAS No. 142 and the period of expected cash flows used to
measure the fair value of the asset under other accounting principles generally
accepted in the United States of America. The FSP is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. Early adoption is prohibited. The
guidance for determining the useful life of a recognized intangible asset shall
be applied prospectively to intangible assets acquired after the effective date.
Certain disclosure requirements shall be applied prospectively to all intangible
assets recognized as of, and subsequent to, the effective date. The Company is
assessing the impact of adoption of FSP FAS 142-3 on its financial position and
results of operations.
In
May 2008, the FASB issued FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles. The new standard is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with U.S. generally accepted accounting principles
(GAAP) for nongovernmental entities.
In
May 2008, the FASB issued FASB Staff Position (FSP) No. APB 14-1,
Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including
Partial Cash Settlement) (“FSP APB 14-1”). FSP APB 14-1
clarifies that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12
of APB Opinion No. 14, Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants. Additionally, this FSP
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. This FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early adoption is not permitted. We do not have an
outstanding convertible debt instruments therefore FSP No. APB 14-1 is not
applicable to us at this time.
In June
2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities,” (FSP
EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards
that contain nonforfeitable rights to dividends or dividend equivalents (whether
paid or unpaid) are participating securities and shall be included in the
computation of earnings per share pursuant to the two-class method. FSP EITF
03-6-1 becomes effective for the Company on January 1, 2009. The Company is
assessing the impact of adoption of FSP No EITF 03-6-1 on its financial position
and results of operations.
Reclassifications
Certain
reclassifications have been made to the prior period balances in order to
conform to the current period presentation.
NOTE
2. NET LOSS PER COMMON SHARE
Basic
loss per common share is calculated by dividing net loss available to common
shareholders for the period by the weighted-average number of common shares
outstanding during the period. Diluted earnings per common share is calculated
by dividing net loss available to common shareholders for the period by the
weighted-average number of common shares outstanding during the period, adjusted
to include, if dilutive, potential dilutive shares consisting of convertible
preferred stock, stock options and warrants, calculated using the treasury stock
method. During the three and six month periods ended June 30, 2008 and
2007, the Company has excluded the following securities from the calculation of
diluted loss per
share, as their effect would have been antidilutive due to the Company’s net
loss:
10
|
Potential Dilutive Securities:
|
Number of
Common Shares
Convertible into at
June 30, 2008
|
Number of
Common Shares
Convertible into at
June 30, 2007
|
||||||
|
Convertible
preferred stock
|
3,633,384 | 2,301,524 | ||||||
|
Stock
options
|
2,103,517 | 1,662,293 | ||||||
|
Warrants
|
6,721,389 | 4,747,362 | ||||||
The table
below presents the computation of basic and diluted earnings (loss) per
share:
|
Three Months Ended
June 30,
|
Six Months Ended
June 30,
|
|||||||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||||||
|
Numerator
for basic and diluted earnings per share:
|
||||||||||||||||
|
Net
income (loss) from continuing operations
|
$ | (1,294 | ) | $ | (1,404 | ) | $ | (3,197 | ) | $ | (3,836 | ) | ||||
|
Preferred
dividends
|
(84 | ) | (88 | ) | (1,963 | ) | (503 | ) | ||||||||
|
Net
loss from continuing operations available to common
shareholders
|
$ | (1,378 | ) | $ | (1,492 | ) | $ | (5,160 | ) | $ | (4,339 | ) | ||||
|
Net
income (loss) from discontinued operations
|
7 | 11 | 7 | 11 | ||||||||||||
|
Net
loss available to common shareholders
|
(1,371 | ) | (1,481 | ) | (5,153 | ) | (4,328 | ) | ||||||||
|
Denominator
for basic and diluted earnings per share — weighted-average shares
outstanding
|
18,087,528 | 14,669,170 | 17,962,113 | 14,218,699 | ||||||||||||
|
Basic
and diluted income (loss) per share:
|
||||||||||||||||
|
Continuing
operations
|
$ | (0.07 | ) | $ | (0.09 | ) | $ | (0.18 | ) | $ | (0.27 | ) | ||||
|
Discontinued
operations
|
— | — | — | — | ||||||||||||
|
Preferred
dividends
|
(0.01 | ) | (0.01 | ) | (0.11 | ) | (0.04 | ) | ||||||||
|
Net
loss available to common shareholders
|
$ | (0.08 | ) | $ | (0.10 | ) | $ | (0.29 | ) | $ | (0.31 | ) | ||||
As more
fully explained in Note 7 to these condensed consolidated financial statements,
preferred stock dividends for the six months ended June 30, 2008 contains
approximately $1,794,000 in preferred dividends attributable to an embedded
beneficial conversion feature recognized in conjunction with the issuance of
common stock pursuant to the Company’s warrant financing transaction consummated
in March 2008. Preferred dividends for the six months ended June 30,
2007 contains approximately $344,000 in preferred stock dividends attributable
to an embedded beneficial conversion feature recognized in conjunction with the
March 2007 issuance of the Company’s Series D Preferred
Stock.
NOTE 3. FAIR VALUE ACCOUNTING
In September 2006, the Financial Accounting Standards
Board (“FASB”) issued FASB Statement No. 157, “Fair Value Measurements”
(“FAS 157”). FAS 157 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 FAS 157 were adopted
January 1, 2008. In February 2008, the FASB staff issued Staff Position
No. 157-2 “Effective Date of FASB Statement No. 157” (“FSP FAS
157-2”). FSP FAS 157-2 delayed the effective date of FAS 157 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 FSP FAS 157-2 are effective for the Company’s
fiscal year beginning January 1, 2009.
11
FAS 157 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
|
Quoted prices in markets that are not active, or
inputs that are observable, either directly or indirectly, for
substantially the full term of the asset or
liability;
|
|
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).
|
The following table sets forth the Company’s financial
assets and liabilities measured at fair value by level within the fair value
hierarchy. As required by FAS 157, assets and liabilities are classified in
their entirety based on the lowest level of input that is significant to the
fair value measurement.
|
Fair Value at June 30,
2008
|
||||||||||||||||
|
($ in thousands)
|
Total
|
Level 1
|
Level 2
|
Level 3
|
||||||||||||
|
Assets:
|
||||||||||||||||
|
Pension assets
|
$ | 760 | $ | 760 | $ | — | $ | — | ||||||||
|
Totals
|
$ | 760 | $ | 760 | $ | — | $ | — | ||||||||
|
Liabilities:
|
||||||||||||||||
|
None
|
$ | — | $ | — | $ | — | $ | — | ||||||||
The Company’s Pension assets are classified within Level
1 of the fair value hierarchy because they are valued using quoted market
prices. The Pension assets that are valued based on quoted market prices in
active markets are primarily debt and equity securities.
The Company had no financial assets or liabilities
which were being measured at Level 2 or 3.
In February 2007, the FASB issued FASB Statement
No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities” (“FAS 159”). FAS 159 permits entities to choose to measure many
financial instruments and certain other items at fair value, with the objective
of improving financial reporting by mitigating volatility in reported earnings
caused by measuring related assets and liabilities differently without having to
apply complex hedge accounting provisions. The provisions of FAS 159 were
adopted January 1, 2008. The Company did not elect the Fair Value Option
for any of its financial assets or liabilities, and therefore, the adoption of
FAS 159 had no impact on the Company’s consolidated financial position, results
of operations or cash flows.
NOTE
4. INVENTORY
Inventories
at June 30, 2008 were comprised of work in process of $71,000 representing
direct labor costs on in-process projects and finished goods of $112,000 net of
reserves for obsolete and slow-moving items of $19,000. Inventories
at December 31, 2007 were comprised of work in process of $29,000 representing
direct labor costs on in-process projects and finished goods of $101,000 net of
reserves for obsolete and slow-moving items of $16,000. Appropriate
consideration is given to obsolescence, excessive levels, deterioration, and
other factors in evaluating net realizable value and required reserve
levels.
NOTE
5. ACQUISITION
In
December 2007, the Company entered into an agreement for the purchase of
certain assets of Sol Logic, Inc. (“Sol Logic”) pursuant to an Asset
Purchase Agreement (the “Asset Purchase Agreement”). The assets acquired
include certain customer contracts, software licenses and intellectual property
(collectively, the “Acquired Assets”). As a result of this asset
acquisition, the Company expects to integrate real-time voice recognition,
multiple language translation and voice analytic capabilities into its biometric
offerings. The Asset Purchase Agreement contains customary representations and
warranties on behalf of Sol Logic.
12
In
consideration for the acquisition of the Acquired Assets, the Company:
(1) issued to Sol Logic on December 19, 2007 (the “Closing”) 935,089
shares of restricted common stock of the Company (the “Initial Shares”), and
(2) on June 19, 2008 (the “Additional Issuance Date”) will issue to
Sol Logic that number of shares of restricted common stock (the “Additional
Shares” and collectively with the Initial Shares, the “Shares”) equal to the
quotient obtained by dividing $1,502,000 by the greater of (A) $1.633 and
(B) the volume weighted average closing price of the Company’s common stock
over the 20 trading-day period ending on June 18, 2008, as reported on the
Over-the-Counter Bullet Board (“OTCBB”). Fifty percent of the Initial
Shares and ten percent of the Additional Shares will be held in escrow until the
one-year anniversary of the Closing. The Company recorded the obligation to
issue the required number of shares on the Additional Issuance Date as a current
liability in the accompanying Condensed Consolidated Balance Sheet as of
December 31, 2007 under the caption “Acquisition related
obligation”.
On
March 28, 2008, the Company entered into Amendment No. 1 to Asset
Purchase Agreement (the “Purchase Agreement Amendment”) to amend the Purchase
Agreement. The Purchase Agreement Amendment provides that in consideration
for the Acquired Assets, the Company shall issue to Sol Logic an aggregate of
677,940 shares of restricted Common Stock (the “Initial Shares”). Of these
shares, 467,545 were issued to Sol Logic on December 19, 2007, the date of
the Purchase Agreement. The remaining 210,395 shares were issued to Sol Logic
upon execution of the Purchase Agreement Amendment. In conjunction with
these issuances, the Company simultaneously rescinded the issuance of 257,149
common shares originally placed into escrow on December 19,
2007.
In the
event the Company’s revenues on certain specified products set forth in the
Purchase Agreement Amendment either equal or exceed $3,000,000 for the six-month
period commencing on March 6, 2008 and ending on September 6, 2008 or
equal or exceed $5,000,000 for the eighteen-month period commencing on
March 6, 2008 and ending on September 6, 2009, the Company will be
obligated to issue that number of additional shares of Common Stock (the
“Additional Shares” and together with the Initial Shares, the “Shares”) obtained
by dividing $1,921,924 by the greater of $1.10 or the volume weighted average
closing price of the Company’s common stock over the 20 trading-day period
immediately prior to the date the Additional Shares are issued, subject to the
terms of the escrow described below. Pursuant to the Purchase Agreement
Amendment, the maximum number of Additional Shares that may be issued are
1,747,204.
Concurrently
with the execution of the Purchase Agreement Amendment, the Company entered into
Amendment No. 1 to Registration Rights Agreement (the “Rights Agreement
Amendment”) to amend the Rights Agreement. Under the terms of the Rights
Agreement Amendment, the Company will register an additional 371,755 of the
Initial Shares, for a total of 677,940 shares of Common Stock, for resale by Sol
Logic.
In the
event any Additional Shares become issuable pursuant to the Purchase Agreement
Amendment, approximately 47.5% of these shares will be deposited by the Company
into an escrow account to satisfy any indemnification and reimbursement claims
of the Company and the remaining shares will be issued directly to Sol
Logic.
As a
result of recording the terms of the Purchase Agreement Amendment, the aggregate
purchase price, not including direct transaction costs of approximately $274,000
was approximately $1,019,000. The value of the 677,940 common shares issued was
determined based on the average market price of the Company’s common stock over
the 2-day period before and after the terms of the Purchase Agreement Amendment
were consummated on March 6, 2008 in accordance with EITF 99-12,
“Determination of the Measurement Date for the Market Price of Acquirer
Securities Issued in a Purchase Business Combination’. As of June 30, 2008,
the Company also incurred approximately $131,000 related to the issuance and
registration of the Company’s equity securities issued pursuant to the Sol Logic
asset purchase. Such issuance and registration costs have been recognized as a
reduction of the fair value of the Company’s common stock in accordance with
FASB Statement of Financial Accounting Standards No 141, Business Combinations”
(“FAS 141”).
In
connection the Purchase Agreement Amendment, the Company has agreed to pay
additional consideration in future periods, based upon the attainment of certain
revenue levels on certain specified products. FAS 141 requires, in situations
involving a contingent consideration agreement that might result in the
recognition of an additional element of cost when the contingency is resolved,
the recognition of a purchase accounting liability in an amount equal to the
lesser of the maximum amount of contingent consideration or the excess (the
amount by which the amounts assigned to the assets acquired exceeds the cost of
the acquired entity). Accordingly, the Company has recorded a purchase
accounting liability of approximately $1,060,000 as a current liability in the
accompanying Condensed Consolidated Balance Sheet as of June 30, 2008 under
the caption “Acquisition related obligation”. When the contingency is resolved
and the consideration is issued or becomes issuable, any excess of the fair
value of the contingent consideration issued or issuable over the amount that
was recognized as a liability shall be recognized as an additional cost of the
acquisition. Any such additional cost would result in increases in goodwill. If
the amount initially recognized as a liability exceeds the fair value of the
consideration issued or issuable, that excess shall be allocated as a pro rata
reduction of the amounts assigned to the acquired assets. As of June 30,
2008, no additional consideration was due pursuant to the terms of the Purchase
Agreement Amendment.
13
The
following table presents the allocation of the acquisition cost, including
professional fees and other related acquisition costs, to the assets acquired
and liabilities assumed, based on their fair values:
|
As
recorded
per
Dec. 19 2007
Asset
Purchase
Agreement
|
As recorded
per
Mar. 6, 2008
Purchase
Agreement
Amendment
|
|||||||
|
Fixed
assets, net
|
$ | 41,805 | $ | 41,805 | ||||
|
Covenant
not to compete
|
199,760 | 199,760 | ||||||
|
Customer
base
|
93,000 | 93,000 | ||||||
|
Developed
technology
|
2,018,242 | 2,018,242 | ||||||
|
Goodwill
|
1,036,396 | — | ||||||
|
Total
assets acquired
|
$ | 3,389,203 | $ | 2,352,807 | ||||
|
Cash
and direct transaction costs
|
$ | (409,762 | ) | $ | (465,880 | ) | ||
|
Acquisition
liability
|
(1,502,000 | ) | (1,059,841 | ) | ||||
|
Common
stock
|
(9,351 | ) | (6,779 | ) | ||||
|
Additional
paid in capital
|
(1,468,090 | ) | (820,307 | ) | ||||
|
Total
consideration issued and liabilities incurred
|
$ | (3,389,203 | ) | $ | (2,352,807 | ) | ||
|
Number
of shares issued
|
935,089 | 677,940 | ||||||
The
following (unaudited) pro forma consolidated results of operations have been
prepared as if the acquisition of Sol Logic, Inc. had occurred at
January 1, 2007:
|
($ in thousands)
|
Three
Months Ended June 30, 2007
|
Six
Months Ended June 30, 2007
|
||||||
|
(unaudited)
|
(unaudited)
|
|||||||
|
Sales
|
$
|
1,863
|
$
|
3,307
|
||||
|
Net
loss available to common shareholders
|
$
|
(1,782
|
)
|
$
|
(4,905
|
)
|
||
|
Net
loss per share available to common shareholders
|
$
|
(0.12
|
)
|
$
|
(0.33
|
)
|
||
The pro
forma information is presented for informational purposes only and is not
necessarily indicative of the results of operations that actually would have
been achieved had the acquisition been consummated as of that time, nor is it
intended to be a projection of future results.
NOTE
6. CONTRACT COSTS
The Company recognizes sales and cost
of sales on long-term, fixed price contracts involving significant amounts of
customization using the percentage of completion method based on costs incurred
to date compared to total estimated costs at completion. Such amounts
are included in the accompanying Balance Sheets at June 30, 2008 and December
31, 2007 under the caption “Billings in excess of costs and estimated earnings
on uncompleted contract”.
Costs and estimated billings on
uncompleted contracts and related amounts billed as of June 30, 2008 and
December 31, 2007 are as follows:
|
($ in thousands)
|
June 30,
2008
|
December 31,
2007
|
||||||
|
Costs
incurred on uncompleted contract
|
$ | 49 | $ | — | ||||
|
Estimated
earnings
|
184 | — | ||||||
| 233 | — | |||||||
|
Less:
Billings to date
|
(764 | ) | — | |||||
|
Billings
in excess of costs and estimated earnings on uncompleted
contract
|
$ | (531 | ) | $ | — | |||
14
NOTE
7. COMMON STOCK AND WARRANTS
On
March 12, 2008, the Company received $541,666 from the exercise of
541,666 warrants to purchase shares of the
Company’s common stock, par value $0.01 per share (the “Warrant Financing”). The
warrants were originally issued in connection with a
private placement of Common Stock to certain accredited investors (the
“Investors”). The Financing was previously reported in a Current Report on
Form 8-K filed on September 26, 2007. The Company agreed to reprice
all warrants issued in the Financing, which originally had an exercise price of
$1.67 per share, to an exercise price of $1.00 per share, in consideration for
their immediate exercise (the “Warrant Repricing”) by the Investors who
participated in the Warrant Repricing or their transferees, as applicable (the
“Participating Investors”).
In
connection with the Warrant Repricing, the Company also issued to the
Participating Investors new warrants (the “Warrants”) to purchase up to an
aggregate of 270,833 shares of Common Stock with an exercise price of $1.20 per
share. The Warrants may be exercised at any time from March 12, 2008 until
March 12, 2013. In addition, if the shares of Common Stock issuable upon
exercise of the Warrants are not registered for resale with the Securities and
Exchange Commission on or before the later of September 12, 2008 or the end
of the applicable holding period for resales of securities by non-affiliates
under Rule 144 of the Securities Act, but in any event no later than
March 12, 2009, the Warrants may be exercised by the Participating
Investors by “cashless” exercise.
The
issuance of common stock and warrants pursuant to the Warrant Financing
triggered certain antidilution and exercise price reduction clauses in existing
warrant agreements. As a result of these modifications, the Company was required
to issue an additional 1,036,388 warrants and reduce the exercise price of
certain previously issued warrants. As these warrants were classified as
permanent equity, and the adjustment was related to antidilution features within
these financial instruments, this increase in warrants and reduction of exercise
price resulted in no adjustment to the financial statements.
As more fully
disclosed in Note 4 to these condensed consolidated financial statements,
in March 2008 the Company amended the Asset Purchase Agreement relating to
the purchase of certain assets of Sol Logic, Inc. As a result of amending
the Asset Purchase Agreement, the Company rescinded the issuance of 257,149
shares of common stock originally issued to Sol Logic and placed into escrow on
December 19, 2007.
In June
2008, the Company issued 54,096 shares of common stock pursuant to stock-based
compensation agreements with certain employees.
NOTE
8. PREFERRED STOCK
The
issuance of common stock and warrants pursuant to the Warrant Financing
triggered certain antidilution clauses in the Company’s Series C and
Series D Preferred Stock agreements. As a result of these antidilution
clauses, the Company was required to adjust the conversion price of the
Series C and Series D Preferred Stock from $1.50 per share to $1.00
per share. This antidilution feature will cause an additional 733,335 common
shares to be issued upon conversion of the Series C Preferred Stock into
common stock and an additional 462,669 common shares to be issued upon
conversion of the Series D Preferred Stock into common stock. In accordance
with EITF Issue 00-27, “Application of Issue No. 98-5 to Certain
Convertible Instruments”, this antidilution feature resulted in the additional
recognition of a discount attributable to an embedded beneficial conversion
feature of approximately $1,100,000 related to Series C Preferred Stock and
$694,000 related to Series D Preferred Stock. This discount was amortized
over the minimum period from the date of the conversion price adjustment to the
date at which the preferred shareholders are permitted to convert as a dividend
to the Series C and Series D Preferred Stock
shareholders.
At
June 30, 2008, the Company had cumulative undeclared dividends relating to
Series B, C and D Preferred Stock of approximately $8,000, $315,000 and
$153,000 respectively.
NOTE
9. REGISTRATION PAYMENT ARRANGEMENTS
On
September 25, 2007, the Company sold to certain accredited investors a
total of 2,016,666 shares of the Company’s common stock, par value $0.01
per share, at a purchase price of $1.50 per share for aggregate gross proceeds
of $3,025,003 (the “Common Stock Financing”). As part of the Common Stock
Financing, the Company entered into a Registration Payment Arrangement as
defined by FASB Staff Position No. EITF 00-19-2, “Accounting for
Registration Payment Arrangements” (“EITF 00-19-2”). EITF 00-19-2 specifies that
the contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement should be separately
recognized and measured in accordance with SFAS No. 5 “Accounting for
Contingencies” (“SFAS No. 5”). EITF 00-19-2 is effective for registration
payment arrangements entered into after December 21, 2006 or for the fiscal
year beginning after December 15, 2006. The Company determined that no loss
contingency related to the Common Stock Financing registration payment
arrangement was required to be recorded as of June 30,
2008.
15
As part
of the September 25, 2007 Common Stock registration payment arrangement,
the Company agreed to register the shares of common stock issued in the
financing and the shares of common stock underlying the warrants issued to the
investors in the Common Stock Financing with the SEC within certain
contractually specified time periods. The Company also agreed to use its best
efforts to keep the registration statement continuously effective until the
earlier of either the second year after the date the registration statement is
declared effective by the SEC or the date when all the common stock, including
the common stock underlying the warrants have been sold or may be sold without
volume limitations. If the Company is unable to register the shares of common
stock with the SEC or keep the registration statement continuously effective in
accordance with the Securities Purchase Agreement dated September 25, 2007,
between the Company and certain accredited investors, the Company is subject to
a liquidated damages penalty equal to 1% of the aggregate purchase price paid
for each month the registration statement is not effective, provided that such
liquidated damages shall not exceed 12% of the aggregate purchase price. The
maximum exposure at June 30, 2008 is approximately $363,000. The Company
has met the requirements of the Common Stock Financing registration payment
arrangement by filing the required registration statement with the SEC within
the time frame specified by the agreement. Company management believes that it
will be able to maintain current filing status with the SEC over the prescribed
period.
On
March 9, 2007, the Company entered into a Securities Purchase Agreement
with certain accredited investors pursuant to which the Company sold to the
investors an aggregate of 1,500 shares of the Company’s Series D 8%
Convertible Preferred Stock (the “Series D Preferred Stock”) at a stated
value of $1,000 per share for aggregate gross proceeds of $1,500,000 and issued
to the investors warrants to purchase up to an aggregate of 59,207 shares of
common stock of the Company. As part of the Series D Preferred Stock
financing, the Company entered into a Registration Payment Arrangement as
defined by FSP No. EITF 00-19-2. The Company determined that no loss
contingency related to the Series D Preferred Stock registration payment
arrangement was required to be recorded as of June 30, 2008.
As part
of the Series D Preferred Stock registration payment arrangement, the
Company agreed to register the shares of common stock the Series D
Preferred Stock is convertible into and the shares of common stock underlying
the warrants issued to the investors in the Series D Preferred Stock
financing with the SEC within certain contractually specified time periods. The
Company also agreed to use its best efforts to keep the registration statement
continuously effective until the earlier of either the fifth year after the date
the registration statement is declared effective by the SEC or the date when all
the common stock, including the common stock underlying the warrants have been
sold. If the Company is unable to register the shares of common stock with the
SEC or keep the registration statement continuously effective in accordance with
the Securities Purchase Agreement dated March 9, 2007, between the Company
and certain accredited investors, the Company is subject to a liquidated damages
penalty equal to 1% of the aggregate purchase price paid for each month the
registration statement is not effective, provided that such liquidated damages
shall not exceed 12% of the aggregate purchase price. The maximum exposure at
June 30, 2008 is approximately $180,000. The Company has met the
requirements of the Series D Preferred Stock registration payment
arrangement by filing the required registration statement with the SEC within
the time frame specified by the agreement. Company management believes that it
will be able to maintain current filing status with the SEC over the prescribed
period.
In
November and December of 2006, the Company entered into a Securities
Purchase Agreement with certain accredited investors to which the Company sold
to the investors an aggregate of 2,500 shares of the Company’s Series C 8%
Convertible Preferred Stock (the “Series C Preferred Stock”) at a stated
value of $1,000 per share for aggregate gross proceeds of $2,500,000 and issued
to the investors warrants to purchase up to an aggregate of 125,000 shares of
the Company’s common stock. As part of the Series C Preferred Stock
financing consummated in November and December of 2006, the Company
entered into a Registration Payment Arrangement as defined by EITF 00-19-2. EITF
00-19-2 is effective for registration payment arrangements entered into after
December 21, 2006 or for the fiscal year beginning after December 15,
2006, however early adoption is permitted for interim or annual periods for
which financial statements have not been issued. The Company adopted the
provisions of FSP EITF 00-19-2 for the annual period ending December 31,
2006. The Company determined that no loss contingency related to the
Series C Preferred Stock registration payment arrangement was required to
be recorded as of June 30, 2008.
As part
of the Series C Preferred Stock registration payment arrangement, the
Company agreed to register the shares of common stock the Series C
Preferred Stock is convertible into and the shares of common stock underlying
the warrants issued to the Series C investors with the SEC within certain
contractually specified time periods. The Company also agreed to use its best
efforts to keep the registration statement continuously effective until the
earlier of either the fifth year after the date the registration statement is
declared effective by the SEC or the date when all the common stock, including
the common stock underlying the warrants have been sold. If the Company is
unable to register the shares of common stock with the SEC or keep the
registration statement continuously effective in accordance with the Securities
Purchase Agreement dated November 14, 2006, between the Company and certain
accredited investors, the Company is subject to a liquidated damages
penalty equal to 1% of the aggregate purchase price paid for each month the
registration statement is not effective, provided that such
liquidated damages shall not exceed 12% of the aggregate purchase price. The
maximum exposure at June 30, 2008 is approximately $300,000. The Company
has met the requirements of the Series C Preferred Stock registration
payment arrangement by registering the shares of common stock with the SEC
within the time frame specified by the agreement and has kept the registration
continuously effective thereafter. Company management believes that it will be
able to maintain current filing status with the SEC over the prescribed
period.
16
NOTE 10. SUBSEQUENT EVENT
By resolution dated August
29, 2008, the Board of Directors of ImageWare Systems, Inc. (the
"Company") authorized the sale of 1,500 shares of the Company's Series D 8%
Convertible Preferred Stock (the "Series D Preferred Stock") at a stated value
of $1,000 per share for aggregate gross proceeds of $1,500,000. Commencing
on August 29, 2008 and ending on September 5, 2008 (the “Closing”), the
Company entered into a Securities Purchase Agreement with certain accredited
investors (the “Investors”) pursuant to which the Company sold to the Investors
an aggregate of 765 shares of the Company’s Series D Preferred Stock for
aggregate gross proceeds of $765,000, and issued to the Investors warrants (the
“Warrants”) to purchase up to an aggregate of 1,530,000 shares of
common stock of the Company with an exercise price of $0.50 per share (the
“Financing”). The Warrants may be exercised at any time from February 28,
2009 until February 28, 2014. In addition, the Warrants contain a “cashless
exercise” feature. At any time on or before the 15th day
following the Closing, the Company may sell up to the balance of the authorized
shares of Preferred Stock and Warrants not sold at the Closing to such persons
as may be approved by the Company.
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
This
Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All
forward-looking statements included in this report are
based on information available to us as of the date hereof and we assume no
obligation to update any forward-looking statements. Forward-looking statements
involve known or unknown risks, uncertainties and other factors, which may cause
our actual results, performance or achievements, or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Factors that could
cause or contribute to such differences include but are not limited to those
items discussed under “Risk Factors” beginning on page 29 and elsewhere in
this Quarterly Report.
The
following discussion of the financial condition and results of operations should
be read in conjunction with the condensed consolidated financial statements
included elsewhere within this Quarterly Report. Fluctuations in annual and
quarterly results may occur as a result of factors affecting demand for our
products such as the timing of new product introductions by us and by our
competitors and our customers’ political and budgetary constraints. Due to such
fluctuations, historical results and percentage relationships are not
necessarily indicative of the operating results for any future
period.
OVERVIEW
ImageWare
Systems, Inc. is a leader in the emerging market for software-based
identity management solutions, providing biometric, secure credential and law
enforcement technologies. Our “flagship” product is the IWS Biometric Engine™.
Scalable for small city business or worldwide deployment, our biometric engine
is a multi-biometric platform that is hardware and algorithm independent,
enabling the enrollment and management of unlimited population sizes. Our
identification products are used to manage and issue secure credentials
including national IDs, passports, driver licenses, smart cards and access
control credentials. Our law enforcement products provide law enforcement with
integrated mug shot, fingerprint Livescan and investigative capabilities. The
biometric technology is now an integral part of all markets we address, and all
of our products are integrated into the Biometric Engine Platform.
Elements of the biometric engine can be used as investigative tools to law
enforcement potentially utilizing multiple biometrics and forensic data
elements, and to enhance security and authenticity of public and private sector
credentials.
CRITICAL
ACCOUNTING ESTIMATES
The
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principals generally accepted in the United States of
America, or U.S. GAAP. The preparation of these 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 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. Although we believe that our judgments and estimates are
appropriate and correct, actual results may differ from those
estimates.
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.
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:
17
|
|
·
|
Long-term
fixed-price contracts involving significant
customization
|
|
|
·
|
Fixed-price
contracts involving minimal
customization
|
|
|
·
|
Software
licensing
|
|
|
·
|
Sales
of computer hardware and identification
media
|
|
|
·
|
Postcontract
customer support (PCS)
|
The
Company’s revenue recognition policies are consistent with U. S. GAAP including
Statements of Position 97-2 “Software Revenue Recognition” and 98-9
“Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions”, Securities and Exchange Commission Staff Accounting Bulletin 104
, Emerging Issues Task Force Issue 00-21 “Revenue Arrangements with Multiple
Deliverables”, and Emerging Issues Task Force Issue 03-05 “Applicability of
AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement
Containing More-Than-Incidental Software”. 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 collectibility is reasonably
assured.
We
recognize revenue and profit as work progresses on long-term, fixed-price
contracts involving significant amounts 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 which do not involve
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,
collectibility 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 collectibility of the related receivable
is probable.
Allowance
for Doubtful Accounts
Our
management must make estimates of the uncollectibility of our accounts
receivable. Management specifically analyzes accounts receivable and analyzes
historical bad debts, 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
approximately $490,000 and our allowance for doubtful accounts was approximately
$0 as of June 30, 2008.
Valuation
Of Goodwill And Other Intangible Assets
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;
|
|
|
·
|
Significant
negative industry or economic
trends;
|
When we
determine that the carrying value of goodwill and other intangible assets may
not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based upon fair value
methodologies. Goodwill and other net intangible assets amounted to
approximately $5,580,000 for as of June 30, 2008. During the three months
ended March 31, 2008 we amended the purchase agreement for the acquisition
of substantially all the assets of Sol Logic, Inc. originally consummated
December 19, 2007. As a result of this amendment, which reduced the
purchase price of the Sol Logic assets, we reversed previously recorded goodwill
from this acquisition of approximately $1,036,000.
18
In 2002,
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
Other Intangible Assets” became effective, and as a result we ceased to amortize
goodwill. In lieu of amortization, we performed an initial impairment review of
our goodwill in June, 2002 and will perform an annual impairment review
thereafter in the fourth quarter of our fiscal year.
With the
sale of our Digital Photography component in 2006, we reassessed the composition
of our operating segments and determined that we no longer operate in separate,
distinct market segments but rather operate in one market segment, such segment
being identity management. The Company’s determination was based on fundamental
changes in the Company’s business structure due to the consolidation of
operations, restructuring of the Company’s operations and management team, and
the integration of what where previously distinct, mutually exclusive
technologies. This has resulted in changes in the manner by which the Company’s
chief decision maker assesses performance and makes decisions concerning
resource allocation. As a result of our operation in one market segment, such
segment being identity management, our 2006 and 2007 goodwill impairment review
consisted of the comparison of the fair value of our identity management segment
as determined by the quoted market prices of our common stock to the carrying
amount of the segment. As the fair value exceeded the carrying value by a
substantial margin, we determined that our goodwill was not impaired. Using the
same methodologies, we determined that as of June 30, 2008 there were no
indicators of potential impairment.
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.
We
account for long-lived assets in accordance with the provisions of SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets.” This statement requires that long-lived assets and certain
identifiable intangible assets be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net undiscounted cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount which the
carrying amount of the assets exceeds the fair value of the assets. Fair value
is determined based on discounted cash flows or appraised values, depending upon
the nature of the asset. Assets to be disposed of are reported at the lower of
the carrying amount of fair value less costs to sell. During the twelve months
ended December 31, 2007 we completed the acquisition of substantially all
the assets of Sol Logic, Inc. In March 2008, we amended the purchase
price of this asset acquisition. Pursuant to this acquisition, we recorded
approximately $2,311,000 in identifiable intangible assets. The assets acquired
were a covenant not to compete valued at approximately $200,000, customer base
valued at approximately $93,000 and developed technology valued at approximately
$2,018,000. The allocation of the purchase price was based on fair value
methodologies employed by an independent valuation firm.
We
determined that as of June 30, 2008 there were no indicators of potential
impairment and accordingly we recorded no impairment losses for long-lived or
intangible assets during the six months ended June 30, 2008. 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 intangible asset impairment will not occur in the future.
Stock-Based
Compensation
Upon
adoption of SFAS 123R on January 1, 2006, we began estimating the value of
employee stock options on the date of grant using the Black-Scholes model. Prior
to the adoption of SFAS 123R, the value of each employee stock option was
estimated on the date of grant using the Black-Scholes model for the purpose of
the pro forma financial disclosure in accordance with SFAS 123. The
determination of fair value of stock-based payment awards on the date of grant
using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to the expected stock price volatility
over the term of the awards and the actual and projected employee stock option
exercise behaviors. The expected term of options granted is derived from
historical data on employee exercises and post-vesting employment termination
behavior. We calculated our expected volatility assumption required in the
Black-Scholes model based on the historical volatility of our stock. 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 10% for corporate officers, 4% for
members of the Company’s
Board of Directors and 24% for all other employees. The Company reviews the
expected forfeiture rate annually to determine if that percent is still
reasonable based on historical experience.
19
As of
January 1, 2006 we have adopted the modified prospective transition method
and its effect is included in our Condensed Consolidated Statements of
Operations for the three and six months ended June 30, 2008 and
2007.
RESULTS
OF OPERATIONS
Results
as presented do not contain the results of our Digital Photography component as
this component is classified as a discontinued operation due to the sale of the
Digital Photography product line in November 2006.
Three
Months Ended June 30, 2008 Compared to the Three Months Ended June 30,
2007.
| ` |
Three Months
Ended
June 30,
|
|||||||||||||||
|
Net Product Revenues
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 586 | $ | 798 | $ | (212 | ) | (27 | )% | |||||||
|
Percentage
of total net product revenue
|
57 | % | 69 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 97 | $ | 116 | $ | (19 | ) | (16 | )% | |||||||
|
Percentage
of total net product revenue
|
10 | % | 10 | % | ||||||||||||
|
Services
|
$ | 337 | $ | 243 | $ | 94 | 39 | % | ||||||||
|
Percentage
of total net product revenue
|
33 | % | 21 | % | ||||||||||||
|
Total
net product revenues
|
$ | 1,020 | $ | 1,157 | $ | (137 | ) | (12 | )% | |||||||
Software
and royalty revenues decreased 27% or $212,000 during the three months ended
June 30, 2008 as compared to the corresponding period in 2007. This
decrease is due to lower project-oriented revenues of our Law Enforcement
software solutions of approximately $124,000 combined with lower identification
software royalties and license revenues of approximately $154,000 and lower
sales of boxed identity management software through our distribution channel of
approximately $104,000 offset by higher sales of our identity management
software into project solutions of approximately $170,000.
Revenues
from the sale of hardware and consumables decreased 16% or approximately $19,000
during the three months ended June 30, 2008 as compared to the
corresponding period in 2007. The decrease reflects the lower 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 $94,000 during the three months ended June 30, 2008 as
compared to the corresponding period in 2007 due primarily to a higher
percentage of overall revenues being generated from project work and a decrease
in our sales of boxed products which do not typically require integration or
installation services. We expect service revenues to increase in the remainder
of 2008 through increased implementations of large-scale high-end
solutions.
We
believe that the increase in identity management software revenue in
project-oriented solutions is largely due to increases in government procurement
with respect to the various programs we are pursuing. Based on management’s
current visibility into the timing of potential government procurements, we
believe that we will see a significant increase in government procurement and
implementations with respect to identity management initiatives during the
remainder of 2008 and continuing into 2009.
We feel
that we are well positioned for participation in one or more large-scale
domestic or international projects which will enable our company to achieve
significant product revenue growth. In the past eighteen months we have
continuously retooled our identity management suite of products to meet changing
government specifications and to enable customization for large project
applications. Additionally, we reoriented our sales organization to direct our
resources and efforts toward establishing partnerships with large systems
integrators as we believe these integrators will be the ultimate choice for
awards of large-scale secure identification solutions.
Our
backlog of product orders as of June 30, 2008 was approximately $2,555,000.
At June 30, 2008, we also had maintenance and support backlog of approximately
$1,080,000 under existing maintenance agreements. Product revenue is
typically
recognized within a three to six month time period depending upon the required
degree of customization, if any and customer implementation schedules.
Historically, we have experienced a very minimal risk of order cancellation. Our
revenue from maintenance agreements is generally recognized ratably over the
respective maintenance periods provided no significant obligations remain and
collectibility of the related receivable is probable.
20
|
Three Months
Ended
June 30,
|
||||||||||||||||
|
Maintenance Revenues
|
2008
|
2007
|
$
Change
|
%
Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Maintenance
revenues
|
$ | 647 | $ | 621 | $ | 26 | 4 | % | ||||||||
The
increase in maintenance revenues reflects higher revenues generated from
identification software solutions offset by lower maintenance revenues generated
from our Desktop Security product due to the expiration of certain maintenance
contracts related to this product. We expect maintenance revenues to increase
during the remainder of 2008 due to the expansion of our installed base
resulting from the completion of significant project-oriented work during the
2008 year.
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.
|
Three Months
Ended
June 30,
|
||||||||||||||||
|
Cost of Product Revenues:
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 81 | $ | 111 | $ | (30 | ) | (27 | )% | |||||||
|
Percentage
of software and royalty product revenue
|
14 | % | 14 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 83 | $ | 118 | $ | (35 | ) | (30 | )% | |||||||
|
Percentage
of hardware and consumables product revenue
|
86 | % | 102 | % | ||||||||||||
|
Services
|
$ | 106 | $ | 67 | $ | 39 | 58 | % | ||||||||
|
Percentage
of services product revenue
|
31 | % | 28 | % | ||||||||||||
|
Total
product cost of revenues
|
$ | 270 | $ | 296 | $ | (26 | ) | (9 | )% | |||||||
|
Percentage
of total product revenues
|
26 | % | 26 | % | ||||||||||||
The cost
of software and royalty product revenue decreased 27% or $30,000 during the
three months ended June 30, 2008 as compared to the corresponding period in
2007 due to lower software and royalty revenues generated during the three
months ended June 30, 2008 as compared to the corresponding period in 2007.
In addition to changes in costs of software and royalty product revenue caused
by revenue level fluctuations, costs of products can vary as a percentage of
product revenue from period to period depending upon level of software
customization and third party software license content included in product sales
during a given period.
The
decrease in the cost of product revenues for our hardware and consumable sales
of $35,000 for the three months ended June 30, 2008 as compared to the
corresponding period in 2007 reflects the decrease in hardware and consumable
revenues for the three months ended June 30, 2008 as compared to the comparable
period in 2007 combined with lower costs incurred on hardware and consumable
procurements.
|
Three Months
Ended
June 30,
|
||||||||||||||||
|
Cost
of Maintenance Revenues
|
2008
|
2007
|
$
Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Total
maintenance cost of revenues
|
$ | 289 | $ | 296 | $ | (7 | ) | (2 | )% | |||||||
|
Percentage
of total maintenance revenues
|
45 | % | 48 | % | ||||||||||||
Cost of
maintenance revenues as a percentage of maintenance revenues decreased to 45%
during the three months ended June 30, 2008 from 48% for the corresponding
period in 2007 due primarily to higher maintenance revenues to absorb fixed
maintenance costs. The dollar decrease of $7,000 or 2% during the three months
ended June 30, 2008 as compared to the
corresponding period in 2007 reflects lower hardware costs incurred for
replacement equipment during the 2008 period.
21
|
Three Months
Ended
June
30,
|
||||||||||||||||
|
Product gross profit
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 505 | $ | 687 | $ | (182 | ) | (26 | )% | |||||||
|
Percentage
of software and royalty product revenue
|
86 | % | 86 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 14 | $ | (2 | ) | $ | 16 | 800 | % | |||||||
|
Percentage
of hardware and consumables product revenue
|
14 | % | (2 | )% | ||||||||||||
|
Services
|
$ | 231 | $ | 176 | $ | 55 | 31 | % | ||||||||
|
Percentage
of services product revenue
|
69 | % | 72 | % | ||||||||||||
|
Total
product gross profit
|
$ | 750 | $ | 861 | $ | (111 | ) | (13 | )% | |||||||
|
Percentage
of total product revenues
|
74 | % | 74 | % | ||||||||||||
Total
product gross profit decreased due to lower product revenues during the three
months ended June 30, 2008 as compared to the corresponding period in
2007.
Software
and royalty gross profit decreased by 26% or approximately $182,000 for the
three months ended June 30, 2008 from the corresponding period in 2007 due
to lower software and royalty product revenues of approximately $212,000 in the
2008 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.
Services
gross profit increased due to higher services revenues of approximately $94,000
generated through project sales for the three month period ending June 30,
2008 as compared to the corresponding period in 2007.
|
Three Months
Ended
June 30,
|
||||||||||||||||
|
Maintenance gross profit
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Total
maintenance gross profit
|
$ | 358 | $ | 325 | $ | 33 | 10 | % | ||||||||
|
Percentage
of total maintenance revenues
|
55 | % | 52 | % | ||||||||||||
Gross
margins related to maintenance revenues increased due primarily to higher
maintenance revenues to absorb fixed maintenance costs combined with lower
equipment costs incurred during the three months ended June 30, 2008 as compared
to the corresponding period in 2007.
|
Three Months
Ended
June 30,
|
||||||||||||
|
Operating expenses
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||
|
(dollars in thousands)
|
||||||||||||
|
General &
administrative
|
$
|
944
|
$
|
957
|
$
|
(13
|
)
|
(1
|
)%
|
|||
|
Percentage
of total net revenue
|
57
|
%
|
54
|
%
|
||||||||
|
Sales
and marketing
|
$
|
548
|
$
|
674
|
$
|
(126
|
)
|
(19
|
)%
|
|||
|
Percentage
of total net revenue
|
33
|
%
|
38
|
%
|
||||||||
|
Research &
development
|
$
|
731
|
$
|
803
|
$
|
(72
|
)
|
(9
|
)%
|
|||
|
Percentage
of total net revenue
|
44
|
%
|
45
|
%
|
||||||||
|
Depreciation
and amortization
|
$
|
194
|
$
|
79
|
$
|
115
|
146
|
%
|
||||
|
Percentage
of total net revenue
|
12
|
%
|
4
|
%
|
||||||||
22
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 in such expenses, as a percentage of total
net revenues, is reflective of lower net revenues during the three months ended
June 30, 2008 as compared to the corresponding period in 2007. The dollar
decrease of $13,000 is primarily comprised of the following major
components:
|
|
·
|
Decrease
in stock-based compensation expense of approximately $18,000 due to the
expiration of certain restricted stock grants combined with lower expenses
recorded pursuant to SFAS 123(R) due to the expiration of vesting
periods for certain prior year share-based payment
issuances.
|
|
|
·
|
Decrease
in insurance related expenses of approximately
$7,000.
|
|
|
·
|
Decrease in
professional services of approximately
$16,000.
|
|
|
·
|
Decrease
in office related expenses of approximately
$8,000.
|
|
|
·
|
Increase
in travel related expenses of approximately
$8,000.
|
|
|
·
|
Increase
in compensation and related fringe benefits of approximately
$28,000.
|
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. Sales
and marketing expenses consist primarily of the salaries, commissions, other
incentive compensation, employee benefits and travel expenses of our sales,
marketing, business development and product management functions. The dollar
decrease of $126,000 during the three months ended June 30, 2008 as
compared to the corresponding period in 2007 reflects headcount reductions due
to the elimination and consolidation of various sales positions combined with
reduced advertising, trade show and travel expenditures.
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 9% or
approximately $72,000 for the three months ended June 30, 2008 as compared
to the corresponding period in 2007. The decrease reflects reductions in
contract programming expenditures of approximately $211,000 offset by increases
in salaries and employee benefits of approximately $145,000. Other
major components of the overall decrease were increased expenditures of $7,000
for engineering supplies and equipment offset by lower travel and other expenses
of approximately $13,000. The reduction in contract programming reflects the
absorption of the majority of these functions by internal engineering resources.
The increase in salaries and employee benefits is due primarily to increased
headcount in the three month period ending June 30, 2008 as compared to the
corresponding prior year period needed to facilitate the transition from
contract programming to internal resources. 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 three months ended June 30, 2008, depreciation and
amortization expense increased 146% or $115,000 as compared to the corresponding
period in 2007. The increase in depreciation and amortization expense reflects
higher amortization of approximately $122,000 for certain definite long-lived
intangible assets acquired in the Company’s December 2007 purchase of
certain assets of Sol Logic, Inc. offset by reduced depreciation expense
due to fully depreciated fixed assets.
INTEREST EXPENSE (INCOME), NET.
For the three months ended June 30, 2008, we recognized interest income
of $2,000 and interest expense of $2,000. For the three months ended
June 30, 2007, we recognized interest income of $6,000 and interest expense
of $1,000.
23
Six
Months Ended June 30, 2008 Compared to the Six Months Ended June 30,
2007
Product
Revenues
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Net
Product Revenues
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 1,245 | $ | 1,409 | $ | (164 | ) | (12 | )% | |||||||
|
Percentage
of total net product revenue
|
69 | % | 76 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 117 | $ | 190 | $ | (73 | ) | (38 | )% | |||||||
|
Percentage
of total net product revenue
|
7 | % | 10 | % | ||||||||||||
|
Services
|
$ | 435 | $ | 267 | $ | 168 | 63 | % | ||||||||
|
Percentage
of total net product revenue
|
24 | % | 14 | % | ||||||||||||
|
Total
net product revenues
|
$ | 1,797 | $ | 1,866 | $ | (69 | ) | (4 | )% | |||||||
Software
and royalty revenues decreased 12% or $164,000 during the six months ended June
30, 2008 as compared to the corresponding period in 2007. The
decrease is due primarily to lower identification software royalties and license
revenues of approximately $299,000 resulting primarily from our Desktop Security
product, lower sales of our boxed identity management software through our
distribution channel of approximately $174,000 and lower Law Enforcement
project-oriented revenues of approximately $167,000 offset by higher sales of
our identification management software into project solutions of approximately
$476,000.
Revenues
from the sale of hardware and consumables decreased 38% or $73,000 during the
six months ended June 30, 2008 as compared to the corresponding period in
2007. The decrease reflects lower 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 $168,000 during the six months ended June 30, 2008 as compared to
the corresponding period in 2007 due primarily to higher service revenues being
generated from software integration of our biometric engine and PIV products
into project solutions offset by a decrease in our installation of hardware
products. We expect service revenues to increase in the remainder of
2008 through increased implementations of large-scale high-end
solutions.
We
believe that the increase in identity management software revenue in
project-oriented solutions is largely due to increases in government procurement
with respect to the various programs we are pursuing. Based on management’s
current visibility into the timing of potential government procurements, we
believe that we will see a significant increase in government procurement and
implementations with respect to identity management initiatives during the
remainder of 2008 and continuing into 2009.
We feel
that we are well positioned for participation in one or more large-scale
domestic or international projects which will enable our company to achieve
significant product revenue growth. In the past eighteen months we
have continuously retooled our identity management suite of products to meet
changing government specifications and to enable customization for large project
applications. Additionally, we reoriented our sales organization to
direct our resources and efforts toward establishing partnerships with large
systems integrators as we believe these integrators will be the ultimate choice
for awards of large-scale secure identification solutions.
Maintenance
Revenues
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Maintenance
Revenues
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Maintenance
revenues
|
$ | 1,253 | $ | 1,247 | $ | 6 | — | % | ||||||||
The
increase in maintenance revenues reflects the expansion of our installed base
resulting from the completion of significant project-oriented work during the
year ended December 31, 2007 and the first three months of 2008.
24
We
anticipate continued 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
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Cost of Product Revenues:
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 186 | $ | 210 | $ | (24 | ) | (11 | )% | |||||||
|
Percentage
of software and royalty product revenue
|
15 | % | 15 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 110 | $ | 203 | $ | (93 | ) | (46 | )% | |||||||
|
Percentage
of hardware and consumables product revenue
|
94 | % | 107 | % | ||||||||||||
|
Services
|
$ | 113 | $ | 69 | $ | 44 | 64 | % | ||||||||
|
Percentage
of services product revenue
|
26 | % | 26 | % | ||||||||||||
|
Total
cost of product revenues
|
$ | 409 | $ | 482 | $ | (73 | ) | (15 | )% | |||||||
|
Percentage
of total product revenues
|
23 | % | 26 | % | ||||||||||||
The cost
of software and royalty product revenue decreased 11% or $24,000 during the six
months ended June 30, 2008 as compared to the corresponding period in 2007 due
to lower software and royalty revenues during the six months ended June 30,
2008. In addition to changes in costs of software and royalties
product revenues caused by revenue level fluctuations, costs of products can
also vary as a percentage of product revenue from period to period depending
upon level of software customization and third party software license content
included in product sales during a given period.
The
decrease in the cost of product revenues for our hardware and consumable sales
of $93,000 for the six months ended June 30, 2008 as compared to the
corresponding period in 2007 reflects the decrease in hardware and consumable
revenues for the three months ended June 30, 2008 as compared to the comparable
period in 2007 combined with lower costs incurred on hardware and consumable
procurements.
Cost of
service revenue increased $44,000 during the six months ended June 30, 2008 as
compared to the corresponding period in 2007 due to higher software integration
revenues of our Biometric Engine and PIV products into project
solutions.
Cost
of Maintenance Revenues
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Cost of
Maintenance Revenues
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Total
maintenance cost of revenues
|
$ | 604 | $ | 590 | $ | 14 | 2 | % | ||||||||
|
Percentage
of total maintenance revenues
|
48 | % | 47 | % | ||||||||||||
Cost of
maintenance revenues increased 2% or $14,000 during the six months ended June
30, 2008 as compared to the corresponding period in 2007 and reflect higher
costs needed to service our expanding installed base.
25
Product
Gross Profit
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Product gross profit
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Software
and royalties
|
$ | 1,059 | $ | 1,199 | $ | (140 | ) | (12 | )% | |||||||
|
Percentage
of software and royalty product revenue
|
85 | % | 85 | % | ||||||||||||
|
Hardware
and consumables
|
$ | 7 | $ | (13 | ) | $ | 20 | 154 | % | |||||||
|
Percentage
of hardware and consumables product revenue
|
6 | % | (7 | )% | ||||||||||||
|
Services
|
$ | 322 | $ | 198 | $ | 124 | 63 | % | ||||||||
|
Percentage
of services product revenue
|
74 | % | 74 | % | ||||||||||||
|
Total
product gross profit
|
$ | 1,388 | $ | 1,384 | $ | 4 | — | % | ||||||||
|
Percentage
of total product revenues
|
77 | % | 74 | % | ||||||||||||
Software
and royalty gross profit decreased 12% or $140,000 for the six months ended June
30, 2008 as compared to the corresponding period in 2007 due to lower software
and royalties revenues.
Hardware
and consumables gross profit increased $20,000 during the six months ended June
30, 2008 as compared to the corresponding period in 2007 due to lower costs
incurred on sales of hardware and consumables of $93,000 during the six months
ended June 30, 2008 as compared to the corresponding period in 2007. Hardware
and consumables gross profit as a percentage of hardware and consumables product
revenue increased to 6% from (7%) and reflects the 2007 period containing
expenses charged to cost of sales for restocking fees. Costs of products can
vary as a percentage of product revenue from quarter to quarter depending upon
product mix and hardware content and print media consumable content included in
systems installed during a given period.
Services
gross profit increased approximately $124,000 for the six months ended June 30,
2008 as compared to the corresponding period of 2007 due to higher project
revenues for the integration of our Biometric Engine and PIV products into
project solutions.
Maintenance
Gross Profit
|
Six Months
Ended
June 30,
|
||||||||||||||||
|
Maintenance gross profit
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
Total
maintenance gross profit
|
$ | 649 | $ | 657 | $ | (8 | ) | (1 | )% | |||||||
|
Percentage
of total maintenance revenues
|
52 | % | 53 | % | ||||||||||||
Gross
margins related to maintenance revenues decreased due primarily to higher
maintenance costs needed to service our expanding installed base.
26
Operating
Expenses
|
Six Months Ended
June 30,
|
||||||||||||||||
|
Operating expenses
|
2008
|
2007
|
$ Change
|
% Change
|
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
|
General
& administrative
|
$ | 2,045 | $ | 2,100 | $ | (55 | ) | (3 | )% | |||||||
|
Percentage
of total net revenue
|
67 | % | 67 | % | ||||||||||||
|
Sales
and marketing
|
$ | 1,214 | $ | 1,367 | $ | (153 | ) | (11 | )% | |||||||
|
Percentage
of total net revenue
|
40 | % | 44 | % | ||||||||||||
|
Research
& development
|
$ | 1,628 | $ | 1,989 | $ | (361 | ) | (18 | )% | |||||||
|
Percentage
of total net revenue
|
53 | % | 64 | % | ||||||||||||
|
Depreciation
and amortization
|
$ | 395 | $ | 139 | $ | 256 | 184 | % | ||||||||
|
Percentage
of total net revenue
|
13 | % | 4 | % | ||||||||||||
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 decrease of $55,000 is comprised of the following major
components:
|
|
·
|
Decrease
in stock-based compensation expense of approximately $92,000 due to the
expiration of certain restricted stock grants combined with lower expenses
recorded pursuant to SFAS 123(R) due to the expiration of vesting
periods for certain prior year share-based payment
issuances.
|
|
|
·
|
Decrease
in insurance related expenses of approximately
$14,000.
|
|
|
·
|
Increase in
professional services of approximately
$30,000.
|
|
|
·
|
Decrease
in office related expenses of approximately
$37,000.
|
|
|
·
|
Increase
in travel related expenses of approximately
$28,000.
|
|
|
·
|
Increase
in compensation and related fringe benefits of approximately
$30,000.
|
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. Sales and marketing expenses consist primarily of
the salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales, marketing, business development and product
management functions. The dollar decrease of $153,000 during the six
months ended June 30, 2008 as compared to the corresponding period in 2007
reflects headcount reductions due to the elimination and consolidation of
various sales positions resulting in lower personnel related expenses of
approximately $93,000, lower advertising and trade show expenses of
approximately $52,000, lower travel expenses of approximately $29,000, lower
stock-based compensation expense of approximately $17,000 and lower other office
related expenses of approximately $14,000 offset by an increase in amounts paid
to in contractor fees of approximately $52,000.
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 18% or $361,000 for the six months ended June 30, 2008 as compared to
the corresponding period in 2007. The decrease reflects reductions in
contract programming expenditures of approximately $448,000 offset by increases
in equipment and supplies of approximately $20,000 and increases in salaries and
employee benefits of approximately $67,000 due primarily to increased headcount
necessary for the continued development of our Biometric Engine, the development
of our Personal Identity Verification (PIV) solution, the web enablement of our
CCS product line, and the development of our IWS desktop security
solution. 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.
27
Depreciation
and Amortization. During the six months ended June 30, 2008,
depreciation and amortization expense increased 184% or $256,000 as compared to
the corresponding period in 2007. The increase in depreciation and
amortization expense reflects higher amortization of approximately $265,000 for
certain definite long-lived intangible assets acquired in the Company’s
December 2007 purchase of certain assets of Sol Logic, Inc. offset by
reduced depreciation expense due to fully depreciated fixed assets.
Interest Expense
(Income), net. For the six months ended June 30, 2008, we
recognized interest income of $7,000 and interest expense of $2,000. For the six
months ended June 30, 2007, we recognized interest income of $14,000 and
interest expense of $252,000. Interest expense for the six months
ended June 30, 2007 contains three components approximating $248,000
related to our secured notes payable which were paid in full in March 2007:
$19,000 of coupon interest, $213,000 in note discount amortization and $16,000
in deferred financing fee amortization classified as interest
expense.
LIQUIDITY
AND CAPITAL RESOURCES
As of
June 30, 2008, we had total current assets of $1,340,000 and total current
liabilities of $6,407,000, or negative working capital of $5,067,000. At
June 30, 2008, we had available cash of $216,000 and $132,000 in restricted
cash securing our performance on certain software implementation
contracts.
Net cash
used in operating activities was $1,039,000 for the six month period ended
June 30, 2008 as compared to $1,689,000 for the corresponding period in
2007. We used cash to fund net losses of $2,617,000, excluding non-cash expenses
(depreciation, amortization, and stock-based compensation) of $573,000 for the
six months ended June 30, 2008. We used cash to fund net losses of
$3,023,000, excluding non-cash expenses (depreciation, amortization, debt
issuance costs, debt discount, stock-based compensation and provision for losses
on accounts receivable and investment in marketable securities less reductions
in inventory obsolescence reserves) of $802,000 for the six months ended
June 30, 2007. For the six months ended June 30, 2008, we used cash of
$193,000 to fund increases in current assets and generated cash of $1,771,000
through increases in current liabilities and deferred revenues, excluding debt.
For the six months ended June 30, 2007, we generated cash of $423,000
through reductions in current assets and generated cash of $911,000 through
increases in current liabilities and deferred revenues, excluding
debt.
Net cash
used in investing activities was $255,000 for the six months ended June 30,
2008. Net cash used in investing activities was $56,000 for the six months ended
June 30, 2007. For the six months ended June 30, 2008, we used cash to
fund capital expenditures of computer equipment, software and furniture and
fixtures of approximately $68,000. This level of equipment purchases resulted
primarily from the replacement of older equipment. We also used cash of
approximately $187,000 for our acquisition of Sol Logic, Inc. For the six
months ended June 30, 2007, we used cash to fund capital expenditures of
computer equipment and software, furniture and fixtures and leasehold
improvements of approximately $56,000.
Net cash
provided by financing activities was $517,000 for the six month period ended
June 30, 2008 as compared to $1,059,000 for the corresponding period in
2007. For the six months ended June 30, 2008, we generated cash of $542,000
from our issuance of common stock pursuant to warrant exercises and used cash of
$25,000 for the payment of dividends on our Series B Preferred Stock. For the
six months ended June 30, 2007, we generated cash of $1,327,000 from our
issuance of preferred stock in a private placement net of direct transaction
costs of $173,000. We also generated cash of $1,121,000 from our issuance of
common stock pursuant to warrant exercises. For the six months ended
June 30, 2007, we used cash of $1,310,000 for the repayment of our secured
notes payable and used cash of $54,000 from the incurrence of financing related
expenses. We also used cash of $25,000 for the payment of dividends
on our Series B Preferred Stock.
We
conduct operations in leased facilities under operating leases expiring at
various dates through 2009. As collateral for performance on certain software
installation and implementation contracts, we are contingently liable under an
irrevocable standby letter of credit in an amount of approximately $132,000.
This letter of credit expires on December 26, 2008. As a condition to this
letter of credit, the bank requires the Company to invest an equal amount in the
form of certificate of deposit. As of June 30, 2008, there were no
drawings against the outstanding balance. This certificate of deposit is
included as a component of other current assets in the Company’s Condensed
Consolidated Balance Sheets at June 30, 2008 and December 31,
2007.
28
The
report of our independent accountants included with our Annual Report on
Form 10-K as filed with the Commission on April 15, 2008, contained an
explanatory paragraph regarding the substantial doubt of our ability to continue
as a going concern. We are seeking additional financing that we believe is
necessary to fund our working capital requirements for at least the next twelve
months in conjunction with the successful implementation of our business plan.
Our business plan includes, among other things, the monitoring and controlling
of operating expenses, collection of significant trade and other accounts
receivable, and controlling of capital expenditures. We may seek to sell
equity or debt securities, secure a bank line of credit, or consider strategic
alliances. The sale of equity or equity-related securities could result in
additional dilution to our shareholders. There can be no assurance that
additional financing, in any form, will be available at all or, if available,
will be on terms acceptable to us. On May 5, 2008 the Company’s common
stock was delisted from AMEX. The Company’s common stock is currently trading on
the Over-The-Counter-Bulletin Board (“OTCBB”) under the ticker symbol “IWSY”.
The delisting could adversely affect the public price of our common stock and
limit the Company’s stockholders’ ability to dispose of, or to obtain accurate
quotations as to the prices of the Company’s common stock. Moreover, the
Company’s ability to obtain financing on favorable terms, or at all, may be
adversely affected by the delisting because certain institutional investors that
have policies against investments in companies that are not traded on a national
securities exchange and other investors may refrain from purchasing the
Company’s common stock because of the delisting. The Company’s ability to obtain
financing may also be more limited in numerous states because the Company will
no longer benefit from state exemptions from registration which are dependent
upon the listing of the Company’s common stock on AMEX. Insufficient funds
will require us to sell certain of our assets or license or technologies to
others and if we are unable to obtain additional funding there is substantial
doubt about our ability to continue as a going concern.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign
Currency Exchange Risk
Market
risk is the potential loss arising from adverse changes in market rates and
prices, such as interest rates and foreign currency exchange rates. Changes in
foreign currency exchange rates have an impact on our results of operations. Our
exposure to adverse movements in foreign currency exchange rates is primarily
related to our subsidiaries operating expense, primarily in Canada, denominated
in the respective local currency. We currently do not enter into forward
exchange contracts to hedge exposures denominated in foreign currencies and do
not use derivative financial instruments for trading or speculative purposes.
The effect of an immediate 10% change in foreign currency exchange rates should
not have a material effect on our future operating results or cash flows;
however, a long term change in foreign currency rates would likely result in
increased technical support and engineering expenses. The vast majority of our
sales are transacted in U. S. dollars.
ITEM
4T. CONTROLS AND PROCEDURES
Conclusions
Regarding the Effectiveness of Disclosure Controls and Procedures.
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures as such term
is defined under Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended. Based on this evaluation, our principal
executive officer and principal financial officer have concluded, based upon
their evaluation as of the end of the period covered by this report, that our
disclosure controls and procedures are effective in ensuring that information
required to be disclosed in the reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and
forms.
Changes in
Internal Control Over Financial Reporting. There has been no change in
our internal control over financial reporting during the fiscal quarter ended
June 30, 2008, that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Our
results of operations and financial condition are subject to numerous risks and
uncertainties described in our Annual Report on Form 10-K for our fiscal
year ended December 31, 2007, filed on April 15, 2008 and as amended
on April 30, 2008 and incorporated herein by reference. You should
carefully consider these risk factors in conjunction with the other information
contained in this report. Should any of these risks materialize, our business,
financial condition and future prospects could be negatively impacted. As of
June 30, 2008, there have been no material changes to the disclosures made
on the above-referenced Form 10-K, as amended, except as
follows:
29
AMEX HAS DELISTED THE
COMPANY’S COMMON STOCK FROM LISTING AND REGISTRATION ON THE
EXCHANGE.
On
May 5, 2008 the Company’s common stock was delisted from AMEX. The
Company’s common stock is currently trading on the Over-The-Counter-Bulletin
Board (“OTCBB”) under the ticker symbol “IWSY”.
The
delisting could adversely affect the public price of our common stock and limit
our stockholders’ ability to dispose of, or to obtain accurate quotations as to
the prices of, our common stock. Moreover, our ability to obtain financing on
favorable terms, or at all, may be adversely affected by the delisting because
certain institutional investors that have policies against investments in
companies that are not traded on a national securities exchange and other
investors may refrain from purchasing our common stock because of the delisting.
Our ability to obtain financing may also be more limited in numerous states
because we will no longer benefit from state exemptions from registration which
are dependent upon the listing of our common stock on AMEX.
WE
HAVE A HISTORY OF SIGNIFICANT RECURRING LOSSES TOTALING APPROXIMATELY $80.9
MILLION, AND THESE LOSSES MAY CONTINUE IN THE FUTURE.
As of
June 30, 2008, we had an accumulated deficit of $80.9 million, and
these losses may continue in the future. We will need to raise capital
to cover these losses, and financing may not be available to us on
favorable terms. In the event financing is not available, in the time frame
required, we will be forced to sell certain of our assets or license our
technologies to others. We expect to continue to incur significant sales and
marketing, research and development, and general and administrative expenses. As
a result, we will need to generate significant revenues to achieve profitability
and we may never achieve profitability.
WE HAVE HAD AND CONTINUE TO HAVE NEGATIVE WORKING
CAPITAL BALANCES WHICH INCLUDE SIGNIFICANT CREDITOR BALANCES THAT ARE PAST
DUE.
As of
June 30, 2008 we had accounts payable of $2.2 million, much of which were past
due. There is no assurance that the company’s creditors will continue to
work with the company and allow us to pursue our business plan to achieve
positive working capital balances and bring our creditor accounts
current.
THE
HOLDERS OF OUR PREFERRED STOCK HAVE CERTAIN RIGHTS AND PRIVILEGES THAT ARE
SENIOR TO THE COMMON STOCK, AND WE MAY ISSUE ADDITIONAL SHARES OF PREFERRED
STOCK WITHOUT SHAREHOLDER APPROVAL THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON
THE MARKET VALUE OF THE COMMON STOCK.
Our Board
of Directors has the authority to issue a total of up to 4,000,000 shares of
preferred stock and to fix the rights, preferences, privileges, and
restrictions, including voting rights, of the preferred stock, which typically
are senior to the rights of the common stockholders, without any further vote or
action by the common stockholders. The rights of our common shareholders will be
subject to, and may be adversely affected by, the rights of the holders of the
preferred stock that have been issued, or might be issued in the future.
Preferred stock also could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of ImageWare.
This could delay, defer, or prevent a change in control.
Furthermore, holders of preferred stock may have other rights, including
economic rights, senior to the common stock. As a result, their existence and
issuance could have a material adverse effect on the market value of the common
stock. We have in the past issued and may from time to time in the future issue,
preferred stock for financing or other purposes with rights, preferences, or
privileges senior to the common stock. At June 30, 2008 we had three series
of preferred stock outstanding, Series B preferred stock, Series C 8%
convertible preferred stock and Series D 8% convertible preferred
stock.
The
provisions of our Series B Preferred Stock prohibit the payment of
dividends on the common stock unless the dividends on those preferred shares are
first paid. In addition, upon a liquidation, dissolution or sale of ImageWare’s
business, the holders of the Series B Preferred Stock will be entitled to
receive, in preference to any distribution to the holders of common stock,
initial distributions of $2.50 per share, plus all accrued but unpaid
dividends. Pursuant to the terms of our Series B Preferred Stock we
are obligated to pay cumulative cash dividends on shares of Series B
Preferred Stock from legally available funds at the annual rate of $0.2125 per
share, payable in two semi-annual installments of $0.10625 each, which
cumulative dividends must be paid prior to payment of any dividend on our common
stock. As of June 30, 2008, the Company had cumulative undeclared dividends on
the Series B Preferred Stock of approximately $8,000.
30
The
Series C Preferred Stock has a liquidation preference equal to its stated
value, plus any accrued and unpaid dividends thereon and any other fees or
liquidated damages owing thereon. The Series C Preferred Stock accrues
cumulative dividends at the rate of 8.0% of the stated value per share per
annum. At the option of the Company, the dividend payment may be made in
the form of cash, after the payment of cash dividends to the holders of
Series B Preferred Stock, or common stock issuable upon conversion of the
Series C Preferred Stock. Each share of Series C Preferred Stock
is convertible at any time at the option of the holder into a number of shares
of common stock equal to the stated value (initially $1,000 per share, subject
to adjustment), plus any accrued and unpaid dividends, divided by the conversion
price (initially $1.50 per share, subject to adjustment). Subject to certain
limitations, the conversion price per share shall be adjusted in the event of
certain subsequent
stock dividends, splits, reclassifications, dilutive issuances, rights
offerings, and reclassifications. The Series C Preferred Stock
generally does not have voting rights except as required by law, however,
certain activities may not be undertaken by the Company without the affirmative
vote of a majority of the holders of the outstanding shares of Series C
Preferred Stock. As of June 30, 2008, the Company had cumulative undeclared
dividends on the Series C Preferred Stock of approximately
$315,000.
The
Series D Preferred Stock has a liquidation preference equal to its stated
value, plus any accrued and unpaid dividends thereon and any other fees or
liquidated damages owing thereon. The Series D Preferred Stock accrues
cumulative dividends at the rate of 8.0% of the stated value per share per
annum. At the option of the Company, the dividend payment may be made in
the form of cash, after the payment of cash dividends to the holders of
Series B and Series C Preferred Stock, or common stock issuable upon
conversion of the Series D Preferred Stock. Each share of
Series D Preferred Stock is convertible at any time at the option of the
holder into a number of shares of common stock equal to the stated value
(initially $1,000 per share, subject to adjustment), plus any accrued and unpaid
dividends, divided by the conversion price (initially $1.90 per share, subject
to adjustment). Subject to certain limitations, the conversion price per share
shall be adjusted in the event of certain subsequent stock dividends, splits,
reclassifications, dilutive issuances, rights offerings, and
reclassifications. The Series D Preferred Stock generally does not
have voting rights except as required by law, however, certain activities may
not be undertaken by the Company without the affirmative vote of a majority of
the holders of the outstanding shares of Series C Preferred Stock. As of
June 30, 2008, the Company had cumulative undeclared dividends on the
Series D Preferred Stock of approximately $153,000.
31
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(a)
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EXHIBITS
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31.1
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Certification
of the Principal Executive Officer pursuant to
Rule 13a-14(a) and 15d-14(a)
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31.2
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Certification
of the Principal Financial and Accounting Officer pursuant to
Rule 13a-14(a) and 15d-14(a)
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32.1
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Certification
by the Principal Executive Officer and Principal Financial and Accounting
Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of
2002
|
32
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.
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IMAGEWARE
SYSTEMS, INC.,
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a
Delaware corporation
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Date: September
18, 2008
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By: /s/ Wayne G.
Wetherell
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Wayne
G. Wetherell
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Chief
Financial Officer
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33