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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File No.: 001-15465
Intelli-Check, Inc.
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(Name of small business issuer as specified in its charter)
Delaware 11-3234779
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
246 Crossways Park West, Woodbury, New York 11797
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(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (516) 992-1900
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.001 par value
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(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: None
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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _____
Indicated by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes No X
--- ---
State the aggregate market value of the voting and non-voting stock held by
non-affiliates of the Issuer: $61,118,303 (based upon the closing price of
Issuer's Common Stock, $.001 par value, as of the last business day of the
Issuer's most recently completed second fiscal quarter (June 30, 2004).
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date.
Common Stock, $.001 Par Value 10,754,240
- ----------------------------- ----------
(Title of Class) (No. of Shares Outstanding at March 25, 2005)
DOCUMENTS INCORPORATED BY REFERENCE: NONE
TABLE OF CONTENTS
Part I
1. Business 3
2. Description of Property 13
3. Legal Proceedings 13
4. Submission of Matters to a Vote of Security Holders 14
Part II
5. Market for Common Equity and Related Stockholder Matters 15
6. Selected Financial Data 16
7. Management's Discussion and Analysis 16
7A. Quantitative and Qualitative Disclosures About Market Risks 23
8. Financial Statements and Supplementary Data 23
9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure 23
9A. Controls and Procedures 23
9B. Other Information 23
Part III
10. Directors and Executive Officers 24
11. Executive Compensation 27
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 29
13. Certain Relationships and Related Transactions 31
14. Principal Accountant and Fees 31
15. Exhibits and Financial Statement Schedules 32
2
Item 1. Business
Overview
We were originally incorporated in the state of New York in 1994. In
August 1999, we reincorporated in Delaware. We have developed and are currently
marketing an advanced document verification system as part of our identity
management solutions to enable a user to detect altered and tampered
identification cards and to address problems such as:
o Commercial Fraud - which may lead to economic losses to merchants
from check cashing, debit and credit card and other types of fraud
such as identity theft which principally utilizes fraudulent
identification cards as proof of identity;
o Unauthorized Access - by verifying identification, our systems and
software are designed to increase security and deter terrorism at
airports, shipping ports, rail and bus terminals, military
installations, high profile buildings and infrastructure where
security is a concern;
o Underage Access to Age Restricted Products and Services - by
verifying identification, our systems and software are designed to
determine the customer's age and validity of the identification card
to detect and prevent the use of fraudulent identification for the
purchase of alcohol, tobacco and other age-restricted products and
services and to reduce the risk to the retailer of substantial
monetary fines, criminal penalties and the potential for license
revocation for the sale of age-restricted products to minors; and
o Inefficiencies Associated With Manual Data Entry - by reading
encoded data contained in the bar code and magnetic stripe of an
identification card with a quick swipe or scan of the card, where
permitted by law, customers are capable of accurately and
instantaneously inputting information into forms, applications and
the like without the errors associated with manual data entry.
Our Products and Services
ID-Check(TM) technology
Our patented ID-Check(TM) technology is our advanced document verification
software. ID-Check is contained in our software products, and is capable of
reading and verifying in one swipe or scan the encoded data contained on U.S.
and Canadian driver licenses, state issued identification cards and military IDs
that, in most cases, comply with the standards of the American Association of
Motor Vehicle Administrators (AAMVA), the American National Standards Institute
(ANSI) and the International Standards Organization (ISO).
C-Link(R) software
Our C-Link(R) software, which is our networkable data management software,
works in conjunction with the ID-Check terminal where permitted by law. It
allows the user to instantly view data for further verification and archives it
into a personal computer. C-Link(R) can be used on a stand alone personal
computer or network environment. It contains features such as alerts, watch
lists, and recurring entry.
ID-Check SDK
Our software product, ID-Check SDK, formerly called IDN-DLL, is designed
for software developers that wish to incorporate ID-Check technology into their
applications, contains our proprietary technology, as well as a device
controller, and is capable of reading the smart chip contained in the military
common access card, or CAC. We currently have six license agreements executed
with third parties for integration and sub-licensing of our software
applications.
IDC-1400
The original product we designed and developed, the IDC-1400, is based on
our ID-Check(TM) technology. Effective as of July 2003, our manufacturer
discontinued manufacturing the IDC-1400 terminal. However, we are offering this
product for sale until current inventory is sold and we have replaced it with
new software solutions compatible with new data collection modules, or DCM's
that are capable of operating on multiple hardware platforms.
3
New Products and Services
ID-Check(R) PC and ID-Check(R) PDA
Two new software solutions, ID-Check(R) PC and ID-Check(R) PDA, are
designed to replicate the features of ID-Check and to be platform-independent
and compatible with stationary and mobile hardware applications. ID-Check(R) PC
is designed to read the smart chip contained in the CAC. The ID-Check(R) PC
solution and the ID-Check(R) PDA solution were introduced to the market in 2004
and are commercially available today.
ID-Traveler
ID-Traveler is a software solution that can electronically compare two
forms of government issued ID's instantaneously and determine whether the common
fields match (i.e. name, address, date of birth, etc.). Should the fields match,
the information is highlighted in one color. If the fields do not produce a
match, the information is highlighted in a different color. Two forms of
identification that are frequently used include driver's licenses, state issued
ID cards, military ID's, passports, borders crossing cards, visas, etc.
ID-Prove
ID-Prove is a software solution that is intended to add additional layers
to IDN's identity management suite of products. ID-Prove, when prompted, will
provide an end user of IDN's software with a variable number of "out of wallet"
questions about that individual. These questions will ensure that the individual
in question is truly who they claim to be. Currently, the ID-Prove product is
integrated into our ID-Traveler product as well as available for IDN partners to
integrate directly into their product offering.
New version of C-Link(R)
The newest version of C-Link(R) contains all of the features of the
current C-Link(R). It is now capable of functioning with either our IDC-1400
terminals or our data collection module (DCM), and is designed to read the smart
chip contained on the military CAC.
Data Collection Module
ID-Check(R) PC, ID-Check(R) PDA and the next version of C-Link(R) are all
designed for use with our new data collection module, or DCM, a compact,
self-contained two-dimensional bar code and magnetic stripe reader. The DCM
enables our new software applications to be used on a variety of commercially
available data processing devices, including PDAs, Tablets, Laptops, Desktops
and Point-of-Sale Computers. As a result of these new product introductions, we
believe that our target markets will enjoy pricing efficiencies and more
flexible and versatile technology options, thereby negating the need to replace
the IDC-1400 platform.
Upgrade Capability
Our software requires periodic updates as states and provinces that did
not previously conform to AAMVA standards begin to store electronically readable
information on their driver licenses and as states and provinces adjust or
modify the format of their electronically stored information. Our technology,
which can be used to instantly upgrade the terminal by simply scanning an
encrypted upgrade card through the ID-Check terminal or downloading it from our
website through a personal computer, is included in the purchase price of the
ID-Check terminal and our ID-Check(R) PC and ID-Check(R) PDA software solutions,
for the first year after purchase. We sell upgrade packages for the period
commencing after the first year of purchase. Each upgrade package is designed to
work only with a specific terminal, which is identified by a unique serial
number. We have developed a secure way of delivering upgrades through the
Internet for our IDC-1400 terminals.
4
Background on Identification Documentation
Driver license
The driver license is the most widely used form of government issued photo
identification. We believe the driver license has become a de facto
identification card. The introduction of more comprehensive ID legislation,
which has already been passed by the House of Representatives, and should it
become law, would officially designate the driver license as the national ID. In
addition to its primary function, the driver license is used to verify identity
for social services, firearm sales, check cashing, credit card use and other
applications. There are approximately 228 million driver licenses in circulation
in the U.S. and Canada. Our technology can read the data encoded on all licenses
that in most cases comply with the AAMVA/ANSI/ISO standards, which we believe is
over 200 million of those issued at the current time. Currently, forty-nine
states, the District of Columbia, and eight Canadian Provinces encode their
licenses. We believe that the number of readable licenses will continue to grow
as the remaining states and five Canadian Provinces that have not yet encoded
their license begin to encode and jurisdictions that have recently begun to
encode complete their rotations.
Non-driver identification card
Although many people do not have a driver license, many jurisdictions that
use AAMVA compliant driver licenses offer other identification cards that may
contain encoded information. These identification cards, as well as military
ID's, are fundamentally identical to driver licenses. Because driver licenses
are the most widely used form of legally acceptable government documentation, we
will refer to all these types of legally acceptable governmental identification
documents as "driver licenses." Our ID-Check software is equally capable of
performing its function with these types of government identification.
Regulation of Retailers of Tobacco Products and Alcoholic Beverages
In an effort to combat the problems of underage drinking and smoking, the
federal government and many states and Canadian provinces have enacted laws
requiring businesses that sell age-restricted products to verify the IDs of
potential customers to determine that they are of legal age to purchase these
products. These laws impose stringent penalties for violations. For example, new
federal regulations have been enacted that place a greater burden on retailers
to prevent the sale of tobacco products to minors. Clerks are required to check
the photo ID of anyone trying to purchase tobacco products who appear to be
under the age of 27, and the retailer of alcoholic products who sell to an
underage person could face potential fines, suspension of its license and the
potential outright revocation of its license to sell alcoholic beverages.
Additionally, in states where enacted, dram shop laws allow a person who is
injured by any obviously intoxicated person to file a claim for relief for fault
against any person who knowingly sells alcoholic beverages to a person less than
21 years of age. As a result of law enforcement efforts and regulatory
penalties, we believe retailers that sell alcohol and tobacco, such as liquor
stores, bars and convenience stores, are facing increasing pressure to
accurately verify the age of their customers.
Current Challenges Associated with Verifying Identification Documents
The high-tech revolution has created a major problem for those who rely on
identification documents. In an age where scanners, computers and color printers
are commonplace, fake ID's of the highest quality are easily obtainable from a
number of locations including college campuses and from thousands of sites on
the Internet. These fakes appear so real, even law enforcement agencies have
encountered difficulty distinguishing them from legally issued documents.
Additionally, these high-tech devices have the ability to easily alter properly
issued ID's. Therefore, anyone can gain access to a false identity that gives
them the ability, in a commercial transaction, to present fake and stolen credit
cards or checks that are supported by false identification. Additionally,
starting with only a fraudulent driver license, an individual may be able to
create multiple identities, commit fraud, buy age restricted products such as
alcohol and tobacco while underage, evade law enforcement and engage in other
criminal activities, such as:
o committing identity theft; o gaining entrance to high
profile buildings and
o improperly boarding sensitive infrastructures,
airplanes; such as nuclear facilities;
o committing credit card, o illegally purchasing
debit card and check firearms;
cashing fraud;
o purchasing age restricted
o unlawfully obtaining products such as alcohol
welfare or other government and tobacco while under age;
benefits;
o committing employee fraud,
o committing refund fraud, including employee theft
and payroll theft; and
o committing pharmacy fraud,
including false narcotic o engaging in medical fraud.
prescriptions,
Given the ease with which identification can be falsified, simply looking
at a driver license may not be sufficient to verify age or identity and
determine whether or not it is fraudulent. Since merchants are facing
significant economic losses due to these frauds, we believe that a document
verification system which can accurately read the electronically stored
information is needed. We possess a patented software application technology
that provides an analysis of all the data contained on these documents by
reading and comparing the information encoded on the tracks of the magnetic
stripe or bar code on the driver license against known standards.
5
ID-Check Solutions and Benefits
We believe that ID-Check and our family of software solutions contain the
most advanced, reliable and effective technology, which provides users with an
easy, reliable, and cost-effective method of document and age verification. We
have received encoding formats from most jurisdictions that conform to AAMVA
standards. This information, combined with our patented technology, enables the
ID Check software as well as our ID-Check(R) PC and ID-Check(R) PDA software to
read, decode, process and verify the information electronically stored on driver
licenses. As jurisdictions and AAMVA change their documents and guidelines, we
believe our software, together with our programmable terminal, can be adapted to
these changes.
ID Check terminals do not require a connection to a central database to
operate, thus negating privacy concerns. Our terminals have the ability to
operate add-on peripherals such as printers, bar code scanners, fingerprint
readers and other devices. Additionally, our terminals and our new software
solutions utilizing our DCM can communicate with personal computers, which could
enhance the functionality of these products and potentially create the
opportunity for sales of other software products by us.
The ID Check process is quick, simple and easy to use. After matching the
(driver license) photograph to the person presenting the document for
identification, the user simply swipes the driver license through the ID-Check
terminal if the card has a magnetic stripe or scans it if it has a bar code. The
terminal quickly determines if the document:
o is valid;
o has been altered or tampered with;
o has expired; and
o has a date of birth equal to or greater than the legal age to
purchase age restricted products, such as alcohol and tobacco, in
the retailer's location.
Then, the terminal will automatically:
o respond to the user by displaying the results in words on the
terminal's screen;
o save information that is permissible by law to the terminal's own
memory;
o print a record of the transaction including the results on a roll of
paper similar to that used in cash registers, if an optional printer
has been installed; and
o send the results to a personal computer which has Microsoft Windows
95/98/ME/NT/2000/XP ("PC") for permanent storage when used in
conjunction with our software, which simplifies record keeping by
downloading comprehensive ID-Check due diligence data into a
personal computer, where permitted by law. This provides a merchant
with secure back-up files that include individual and cumulative
transaction records.
Strategy
Our objective is to be a leading provider of identity management
solutions, which include our identity verification technology systems and
software in the age verification, commercial fraud protection and access control
markets. Key elements of our strategy are as follows:
Expand Marketing Relationships with Trade Associations and Public Interest
Groups. We are marketing our systems and software to members of The American
Association of Airport Executives (AAAE), the largest professional organization
for airports in the world, Credit Union National Association (CUNA), the premier
trade association for credit unions, and Mothers Against Drunk Driving (MADD),
one of the highest profile public interest groups. We intend to continue to
expand our relationships with trade associations and public interest groups that
can help expand our customer base.
Develop Additional Strategic Alliances with Providers of Security
Solutions. We have entered into strategic alliances with Bioscrypt Inc., Identix
Corporation, Ultra-Scan Inc., Cross-Match Technologies, Si-Vault biometric
companies; Lenel Systems International, a provider of integrated security
solutions; and Northrop Grumman and Anteon, integrators in the defense industry,
to utilize our systems and software as the proposed or potential enrollment
application for their technologies and to jointly market these security
applications. We believe these relationships will broaden our marketing reach
through their sales efforts and we intend to develop additional strategic
alliances with additional providers of security solutions.
6
Strengthen Sales and Marketing Efforts. We intend to capitalize on the
growth in demand for age and document verification by continuing to market and
support our systems and software. Our sales and marketing departments were
recently re-organized by target market rather than geographic area to provide
focus and create experts in each area.
Enter into Additional Licensing Agreements. We intend to continue to
license our software for use with a customer's system. We are currently
licensing our IDN-SDK and C-Link(R) software products for Windows and Windows CE
platforms and intend to similarly license our ID-Check(R) PC and ID-Check(R) PDA
software solutions. Our software is intended to be used with a compatible
hardware device. We have entered into thirteen (13) licensing agreements to
date.
Protect Intellectual Property. We intend to strongly protect our
intellectual property portfolio in order to preserve value and obtain favorable
settlements where warranted. For example, in February 2003, we filed suit
against CardCom, Inc. d/b/a CardCom Technology, Inc. claiming that CardCom had
infringed one of our patents. Subsequently, we entered into a patent licensing
agreement with CardCom effective March 2003 which provides for a non-exclusive
three year license in connection with the manufacture, use and sale of CardCom's
age verification products in the United States and Canada. We also have filed a
patent infringement lawsuit against Tricom Card Technologies, Inc. in July 2003,
which is currently being litigated.
Our Revenue Sources
We derive our revenue from the following sources:
o Sales of our systems by our own direct sales force and marketing
partners;
o Royalties and licensing fees from licensing our patented technology
to third parties;
o Revenue sharing and marketing arrangements through strategic
alliances and partnerships; and
o Sale of software upgrades and extended maintenance programs.
Our Target Markets
The use of false identification cards, primarily driver licenses and
non-driver identification cards, to engage in commercial fraud, to gain access
to unauthorized areas and to gain entry to, or purchase products from,
establishments that sell age-restricted items, is prevalent. Given the ease with
which identification can be falsified, we believe that simply looking at a
driver's license may not be sufficient to verify age or identity and determine
whether or not such an identification card is fraudulent. Since merchants are
facing significant economic losses due to these frauds, we believe that what
they need is a document verification system, which can accurately read the
electronically stored information. We target the markets that would most benefit
from our systems and software. Those target markets include:
Commercial fraud protection
o Banks and other financial o Casino cage operations
institutions o Mass merchandisers and
o Credit unions retailers
o Credit card issuers o Hospitals, medical
o Check cashing services facilities and health
o Pharmacies plans
o Auto dealerships and rental o Lodging Industry
car agencies
Access control
o Airports and airlines o Oil refineries and storage
o Departments of Motor facilities
Vehicles o Military establishments
o Prisons o College Campuses
o Law enforcement agencies o Department of Homeland
o Notable buildings Security
o Court houses o Bus, rail and port
o Nuclear facilities facilities
Age verification market
o Bars and night clubs o Casinos and gaming
o Convenience stores establishments
o Grocery chains o Sellers of sexually explicit
o Restaurants material
o Stadiums and arenas o Firearm dealers
7
Current Customers
We have generated revenues from our customers from the sale of systems,
licensing of software and sale of software upgrades. The following
representative customers are using our systems and software for commercial fraud
protection:
o Certegy Check Services, Inc. o Comerica Bank
o MGM Grand o The Cooperative Bank
o Caesar's Palace o Mohegan Sun Resort Casino
o Foxwoods Resorts and Casino
The following representative customers are using our systems and software
for access control:
o JFK Airport in New York, o New York, Vermont and
O'Hare International Airport Delaware Department of
in Chicago and Reagan Motor Vehicles
National Airport in o Port Authority of New York
Washington DC and New Jersey
o American Stock Exchange o United States Supreme Court
o Fort Sam Houston and Fort
Hood
The following representative customers are using our systems and software
for age verification:
o Integrated Solutions o Darden Restaurants
International LLC o Houston's Restaurants
o Sunoco o Anton Airfoods, Inc.
o Exxon/Mobil franchisees
Marketing and Distribution
Our objective has been to become the leading developer and distributor of
document and age verification products. To date, our marketing efforts have been
through direct sales by our sales and marketing personnel, through resellers and
license agreements. We are marketing our age verification products through
direct marketing approaches such as targeted mailings, web seminars, a small
number of select trade shows and well known public interest and trade
associations, such as the Credit Unions of North America (CUNA), the American
Association of Airport Executives (AAAE) and Mothers Against Drunk Driving
(MADD).
We generate revenues from the sale or lease of ID-Check terminals, the
sale of C-Link(R) software, the sale and licensing of our patented software to
third parties, annual jurisdictional upgrades and from our software and hardware
warranty programs. We also expect to generate revenues from various new software
solutions.
Our patented ID-Check software is Microsoft Gold Certified and can run on
a variety of Windows and Windows CE platforms in addition to devices such as
credit card terminals. We plan to market our newly introduced ID-Check(R) PC and
ID-Check(R) PDA solutions to the government, airlines, airports, high profile
buildings or infrastructure, mass merchandisers, grocery, convenience and
pharmacy chains, casinos and banks. The ID-Check reader known as the DCM (data
capture module) has a "bundled with software" suggested retail price of
approximately $1,299. Our self-contained or stand alone offering, the model
1400, has a suggested retail price of approximately $1,995 which includes our
C-Link software and upgrades for the first year after purchase.
We have developed a comprehensive marketing plan to build customer
awareness and develop brand recognition in our target markets. We promote the
advantages and ease of use of our products through:
o Endorsements by nationally o Direct mail;
known public interest groups o Web seminars, as well as our
and trade associations; own website;
o Trade publications; o Various conventions and
o Trade shows; industry specific seminars.
As we gain market acceptance for our ID-Check technology, we intend to
develop and market other related software applications.
We further intend to add qualified "value added" remarketers that are
capable of reaching smaller customers. We believe this represents the most
cost-effective way to reach numerous "mom and pop" establishments in North
America involved in the sale of age restricted products. Furthermore, in order
to broaden our sales "reach" into existing and new markets, we will continue to
enter into selective agreements with proven application solution providers,
system integrators, resellers and independent sales representatives. Basically,
we are in the process of revamping our entire distribution network to provide us
with greater effectiveness.
8
Competition
We compete in a market that is relatively new, intensely competitive, and
rapidly changing. Unless a device can read, decode and analyze all of the
information legally permitted to be analyzed which is electronically stored on a
driver license, the user may not obtain accurate and reliable confirmation that
a driver license is valid and has not been altered or tampered with. We are
aware of several companies, including Card Com, Tri Com Technologies, Positive
Access, ID Logix and Legal Age that are currently offering products that
electronically read and calculate age from a driver license. We have tested and
compared some of these products to ID-Check and believe that our product is
superior in quality and functionality. We believe that units unable to read bar
codes are at a significant disadvantage because forty-three (43) states and five
(5) Canadian provinces currently utilize bar codes to encode their driver
licenses, as well as all U.S. military ID's and uniformed services cards. In
addition, some of these other products cannot connect to a personal computer or
use a printer.
We have experienced and expect to continue to experience increased
competition in the age verification market, and have experienced limited
competition from companies in the document verification market. If any of our
competitors were to become the industry standard or were to enter into or expand
relationships with significantly larger companies through mergers, acquisitions
or otherwise, our business and operating results could be seriously harmed. In
addition, potential competitors could bundle their products or incorporate
functionality into existing products in a manner that discourages users from
purchasing our products.
Manufacturing
In January 2004, we entered into a two year product supply agreement for
the purchase of input devices. Under the terms, these devices, which were
private labeled, are programmed to work in conjunction with our ID-Check(TM)
technology.
Intellectual Property
In January 1999, the U.S. Patent and Trademark Office granted us a patent
on our ID-Check software technology. In October 2002, we were granted another
patent relating to our document authentication and age verification technology.
At present, we have other patent applications pending in the U.S. Patent and
Trademark Office. These patents cover commercially important aspects of our
capabilities relating to the authentication of a document, such as a driver's
license, along with the verification of the age of an individual associated with
that document. Upon our acquisition of the assets of IDentiScan, we also
received equitable ownership and sole ownership rights to intellectual property,
including other patents and patent applications relating to age verification
technology. We currently hold four (4) U.S. patents, two (2) Canadian patents
and one (1) United Kingdom patent. We have been notified by the U.S. Patent
Office of the issuance of another patent.
We have also been granted multiple copyrights in the United States, which
are effective in Canada and in other major industrial countries. In addition,
the copyright protection covers software source codes and supporting graphics
relating to the operation of ID-Check and other software products. We also have
several trademarks relating to our company, its product names and logos.
In connection with the sales or licensing of our intellectual property, we
have entered into an agreement with Mr. Kevin Messina, our former Senior
Executive V.P. and Chief Technology Officer, under which we will pay royalties
equal to 0.005% of gross sales from $2,000,000 to $52,000,000 and 0.0025% of
gross sales, in excess of $52,000,000. Cumulatively, as of December 31, 2004,
total fees payable under this agreement amounted to $148.
Employees
As of March 1, 2005, we had nineteen full-time employees. Four are engaged
in executive management, seven in information technology, six in sales and
marketing and two in administration. We believe our relations with our employees
are generally good and we have no collective bargaining agreements with any
labor unions.
9
RISK FACTORS
Risks Related to Our Business and Industry
We have incurred losses since inception and losses may continue, which could
result in a decline in the value of our securities and a loss of your
investment.
We sustained net losses of $6,450,943 and $6,922,931 for the fiscal years
ended December 31, 2003 and December 31, 2004, respectively. We expect to incur
additional expenditures in line with the sales growth of our business. We cannot
assure you that we will achieve operating profits in the near future.
We may be unable to meet our future capital requirements.
Our capital requirements have been and will continue to be significant. In
the event that we do not generate meaningful revenue, we would need to raise
additional capital. If we are unable to raise additional capital, we plan to
implement cost saving measures to sustain business activities on a reduced
level. Unplanned acquisition and development opportunities and other
contingencies may arise, which could require us to raise additional capital. If
we raise additional capital through the sale of equity, including preferred
stock, or convertible debt securities, the percentage ownership of our then
existing stockholders will be diluted.
We currently do not have a credit facility or any commitments for
additional financing. We cannot be certain that additional financing, should it
be needed, will be available when and to the extent required. If adequate funds
are not available on acceptable terms, we may be unable to fund our expansion,
develop or enhance our products, or respond to competitive pressures. Such
limitation could have a material adverse effect on our business, financial
condition and results of operations.
We may not be able to keep up with rapid technological change. Advances in
hardware technology before we sell our existing inventory could cause us to take
an adjustment against inventory.
Our market is characterized by frequent new product announcements and
rapid advancements in hardware technology. Significant technological change
could render our existing technology obsolete. If we are unable to successfully
respond to these developments, or do not respond in a cost-effective way, our
business, financial condition and results of operations will be materially
adversely affected. Furthermore, our inventory consists primarily of ID-Check
System terminals that run our patented software on the IDC-1400 hardware
platform. We periodically evaluate the current market value of our inventory,
taking into account any technological obsolescence that may occur due to
advances in hardware technology and the acceptance of the product in the
marketplace. We determined that an inventory reserve of $990,000 was an
appropriate adjustment to our results of operations for the year ended December
31, 2003 and an additional reserve of $357,332 was made for the year ended
December 31, 2004. Should we determine in a future period that an adjustment to
market value of the inventory is necessary, we would record such adjustment at
that time, which would not have a material adverse effect on our results of
operations.
Our proprietary software relies on reference data provided by government and
quasi-government agencies. If these governmental and quasi-government agencies
were to stop sharing data with us, the utility of our proprietary software would
be diminished in those jurisdictions and our business would be damaged.
Currently, forty-nine (49) states, eight (8) Canadian provinces and the
District of Columbia, which conform to the guidelines established by certain
organizations responsible for implementing industry standards, cooperate with us
by providing sample identification cards so that we may modify the ID-Check
System terminal and other software products to read and analyze the encoded
information found on such jurisdiction's identification cards. We cannot assure
you that each of these jurisdictions will continue to cooperate with us. In the
event that one or more of these jurisdictions do not continue to provide this
reference data, the utility of our proprietary software may be diminished in
those jurisdictions.
Future government regulation restricting the capture of information
electronically stored on identification cards could adversely affect our
business.
Our proprietary software products are designed to read and capture
information from identification cards. Currently, those customers located in New
Hampshire, North Carolina and Texas are legally restricted from using this
information for their own use without customer consent. Because issues of
personal privacy continue to be a major topic of public policy debate, it is
possible that in the future additional customers in these and other
jurisdictions may be restricted from capturing this information. Therefore, the
implementation of unfavorable regulations or unfavorable interpretations of
existing regulations by courts or regulatory bodies could require us to incur
significant compliance costs, cause the development of the affected markets to
become impractical and otherwise adversely affect our business, financial
condition and results of operations.
10
Our refocused business strategy exposes us to long sales and implementation
cycles for our products.
Our target customers in the commercial fraud protection, access control
and age verification markets include large retailers and government agencies,
which typically require longer sales and implementation cycles for our products
than do our potential customer base solely interested in age verification, such
as restaurant, bar and convenience store operators. The longer sales and
implementation cycles for larger retail companies continue to have an adverse
impact on the timing of realizing our revenues. In addition, budgetary
constraints and economic slowdowns may also continue to delay purchasing
decisions by these prospective customers. These initiatives have costs
associated with them, and we cannot assure you that they ultimately will prove
successful or result in, an increase to, our revenues or profitability.
In addition, the loss or significant reduction in government spending by
government entities could materially limit our ability to obtain government
contracts. These limitations, if significant, could also have a material adverse
effect on our business, financial condition and results of operations. In
addition, we will need to develop additional strategic relationships with large
government contractors in order to successfully compete for government
contracts. Our inability to develop these strategic relationships may limit our
ability to implement our business strategy.
The market for our systems and software is evolving and its growth is uncertain.
Demand and market acceptance for recently introduced and existing systems
and software and sales from such systems and software, are subject to a high
level of uncertainty and risk. Our business may suffer if the market develops
more slowly than anticipated and does not sustain market acceptance.
Failure to manage our operations if they expand could impair our future growth.
If we are able to expand our operations, particularly through multiple
sales to large retailers and government agencies in the document verification
market, the expansion will place significant strain on our management, financial
controls, operating systems, personnel and other resources. Our ability to
manage future growth, should it occur, will depend to a large extent upon
several factors, including our ability to do the following:
o build and train our sales force;
o establish and maintain relationships with distributors;
o develop customer support systems;
o develop expanded internal management and financial controls adequate
to keep pace with growth in personnel and sales, if they occur; and
o manage the use of third-party manufacturers and suppliers.
If we are able to grow our business but do not manage our growth successfully,
we may experience increased operating expenses, loss of customers, distributors
or suppliers and declining or slowed growth of revenues.
We are subject to risks associated with product failure and technological flaws.
Products as complex as those offered by us may contain undetected errors
or result in failures when first introduced or when new versions are released.
Despite vigorous product testing efforts and testing by current and potential
customers, it is possible that errors will be found in a new product or
enhancement after commencement of commercial shipments. The occurrence of
product defects or errors could result in adverse publicity, delay in product
introduction, diversion of resources to remedy defects, loss of, or a delay in
market acceptance, claims by customers against us, or could cause us to incur
additional costs, any of which could adversely affect our business.
11
Our failure to protect our proprietary technology may impair our competitive
position.
We continue to allocate significant resources to develop new and
innovative technologies which we utilize in our products and systems. We
consider such allocation to be fundamental to our continued success as such
success depends, to a significant degree, upon our ability to provide products
and systems that provide superior functionality and performance compared to
those of our competitors. Accordingly, we must protect our technology from
unauthorized use. This is done by processes aimed at identifying and seeking
appropriate protection for newly developed intellectual property, i.e., patents,
trade secrets, copyrights and trademarks, as well as policies aimed at
identifying unauthorized use of such property in the marketplace. These
processes include:
o contractual arrangements providing for non-disclosure of proprietary
information;
o maintaining and enforcing issued patents and filing patent
applications on innovative solutions to commercially important
problems;
o protecting our trade secrets;
o protecting our copyrights and trademarks by registration and other
appropriate means,
o establishing internal processes for identifying and appropriately
protecting new and innovative technologies; and
o establishing practices for identifying unauthorized use of our
intellectual property.
While we actively protect our intellectual property, it does not follow
that others will not intentionally or innocently use such intellectual property.
Accordingly, at times we may be required to bring legal proceedings to preclude
such unauthorized use. We are mindful that such measures can be costly and time
consuming and undertake such measures only as a last resort.
These policies and practices with respect to our intellectual property
rights do not prevent our competitors from independently developing products
similar or superior to our products and technologies. It merely protects our
property rights created as a result of our allocating significant portions of
our technical and monetary resources. Further, an inability or failure to
protect this property could have a material adverse effect on our future
business and financial condition.
If our future products incorporate technologies that infringe the proprietary
rights of third parties, and we do not secure licenses from them, we could be
liable for substantial damages.
We are not aware that our current products infringe the intellectual
property rights of any third parties. We also are not aware of any third party
intellectual property rights that may hamper our ability to provide future
products and services. However, we recognize that the development of our
services or products may require that we acquire intellectual property licenses
from third parties so as to avoid infringement of those parties' intellectual
property rights. These licenses may not be available at all or may only be
available on terms that are not commercially reasonable. We recognize that third
parties could make infringement claims against us which, whether or not they are
upheld, could have a negative impact on our business and financial condition,
by:
o consuming substantial time and financial resources;
o diverting the attention of management from growing our business and
managing operations; and
o disrupting product sales and shipments.
If any third party prevails in an action against us for infringement of
its proprietary rights, we could be required to pay damages and either enter
into costly licensing arrangements or redesign our products so as to exclude any
infringing use. As a result, we would incur substantial costs, delays in product
development, sales and shipments, our revenues may decline substantially and we
may not be able to achieve the minimum, necessary growth for our continued
success.
Failure to attract and retain management and other personnel may damage our
operations and financial results and cause our stock price to decline.
We depend to a significant degree on the skills, experience and efforts of
our executive officers and other key management, technical, finance, sales and
other personnel. Our failure to attract, integrate, motivate and retain existing
or additional personnel could disrupt or otherwise harm our operations and
financial results. Although we have employment agreements with each of Frank
Mandelbaum, our Chairman and Chief Executive Officer, and Edwin Winiarz, our
Senior Vice President - Treasurer and Chief Financial Officer, securing their
employment until December 31, 2005 and December 31, 2006, respectively, we do
not carry key man life insurance policies covering any employees. The loss of
services of certain of our key employees, an inability to attract or retain
qualified personnel in the future, or delays in hiring additional personnel
could delay the development of our business and could have a material adverse
effect on our business, financial condition, and results of operations.
12
Changes in accounting standards or our accounting policy relating to stock-based
compensation may negatively affect our operating results.
We currently are not required to record stock-based compensation charges
if the employee's stock option exercise price equals or exceeds the deemed fair
value of our common stock at the date of grant and the award has not been
modified. However, several companies have recently elected to change their
accounting policies and begun to record the fair value of stock options as an
expense. However, during December 2004, the Financial Accounting Standards Board
("FASB") issued SFAS No. 123 (revised 2004) requiring that the compensation cost
relating to share based payment transactions be recognized in financial
statements. This will require a change in our accounting policy and the amount
of our operating expenses could increase and our operating results could be
adversely affected.
Our share price may be volatile and could decline substantially
The market price of our common stock, like the price of shares of
technology companies generally, has been and may continue to be volatile. From
January 1, 2002 to March 25, 2005, the closing bid price of our common stock has
varied from a high of $19.45 to a low of $2.10 per share, as reported on the
American Stock Exchange. Many factors may cause the market price for our common
stock to decline, including:
o shortfalls in revenues, cash flows or continued losses from
operations;
o conversions of preferred stock into common stock; delays in
development or roll-out of any of our products;
o announcements by one or more competitors of new product acquisitions
or technological innovations; and
o unfavorable outcomes from outstanding litigation.
In addition, the stock market experiences extreme fluctuations in price
and volume that particularly affect the market price of shares of emerging
technology companies, such as ours. These price and volume fluctuations are
often unrelated or disproportionate to the operating performance of the affected
companies. Because of this volatility, we may fail to meet the expectations of
our shareholders or of securities analysts and our stock price could decline as
a result. Declines in our stock price for any reason, as well as broad-based
market fluctuations or fluctuations related to our financial results or other
developments, may adversely affect your ability to sell your shares at a price
equal to or above the price at which you purchased them. Decreases in the price
of our common stock may also lead to de-listing of our common stock.
Risks Related to Arthur Andersen LLP
The absence of Arthur Andersen LLP's consent to the use of its opinion may limit
the remedies available to stockholders.
Our inability to obtain Arthur Andersen LLP's consent to the use of its
opinion for our financial statements for the 2001 year and the absence of a
signed opinion may limit the remedies available to you since your claims against
Arthur Andersen LLP under the Securities Act of 1933, as amended, based on these
financial statements may be limited. Moreover, even if claims against Arthur
Andersen LLP are permitted, Arthur Andersen LLP may not have the financial
resources to satisfy any judgment. In addition, notwithstanding that we have not
filed the written consent of Arthur Andersen, LLP, our directors and officers
may still be able to establish a due diligence defense to any claim relating to
those financial statements on the basis that they were made on the authority of
our expert which could limit your ability to assert a claim against them.
Item 2. Description of Property
Our executive offices are currently located in Woodbury, New York, where
we occupy approximately 9,700 square feet of leased space pursuant to a lease
expiring on December 31, 2010. In March 2002, we signed a two year lease in
Connecticut to operate our IDentiScan division, which expired on March 1, 2004.
Payments under these leases were $242,083 for 2002, $252,386 for 2003, $243,577
for 2004 and will be $1,594,104 for the remaining years of the leases.
Item 3. Legal Proceedings
On August 1, 2003, we filed a summons and complaint against Tricom Card
Technologies, Inc. alleging infringement on our patent and seeking injunctive
and monetary relief. On October 23, 2003, we amended our complaint to include
infringement on an additional patent. On May 18, 2004, we filed a Second Amended
Complaint alleging infringement and inducement to infringe against certain
principals of Tricom in their personal capacities, as well as alleging in the
alternative false advertising claims under the Lanham Act against all the
defendants. These principals have moved to dismiss the claims against them, and
Tricom has moved to dismiss the false advertising claims. The Company has
opposed the motions. We filed the proposed Joint Pretrial Order on November 19,
2004, which has not yet been executed and a conference is scheduled for April 1,
2005.
13
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of our fiscal year ended December 31, 2004 there
were no matters submitted to a vote of security holders.
14
PART III
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) Our common stock is traded on the American Stock Exchange under the
symbol "IDN." The following table indicates high and low sales quotations for
the periods indicated based upon information supplied by AMEX.
Low High
--- ----
2003
First Quarter $ 6.35 $ 8.44
Second Quarter $ 5.80 $ 7.66
Third Quarter $ 6.70 $11.85
Fourth Quarter $ 6.30 $ 7.32
2004
First Quarter $ 3.90 $ 8.00
Second Quarter $ 4.40 $ 7.50
Third Quarter $ 4.60 $ 6.25
Fourth Quarter $ 3.91 $ 5.72
2005
January 1 - March 25, 2005* $ 4.36 $ 6.95
* Portion of first fiscal quarter of 2005.
(b) Number of Holders of Common Stock. The number of holders of record of
our Common Stock on March 25, 2005 was 67, which does not include individual
participants in security position listings.
(c) Dividends. There were no cash dividends or other cash distributions
made by us during the fiscal year ended December 31, 2004. Future dividend
policy will be determined by our Board of Directors based on our earnings,
financial condition, capital requirements and other then existing conditions. It
is anticipated that cash dividends will not be paid to the holders of our common
stock in the foreseeable future.
(d) Recent Sales of Unregistered Securities
On January 21, 2004, we entered into a one year agreement with Alexandros
Partners LLC, an accredited investor, to act as consultants in advising us in
financial and investor relation matters. We agreed to pay a consulting fee of
$50,000 payable in 12 equal monthly installments. In addition, we issued a
warrant granting the right to purchase 100,000 shares of our common stock at a
purchase price of $7.54 per share, which vested ratably over the 12 month
period. A principal of Alexandros Partners LLC is currently a member of our
Board of Directors. No sales commissions were paid in connection with this
transaction. The warrant to purchase shares of the Company's common stock issued
to Alexandros Partners was issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended.
On December 7, 2004, we entered into a one year agreement with a
consulting firm, an accredited investor, to help with our investor relations
activities. We agreed to pay a consulting fee of $100,000 payable in 12 monthly
installments. In addition, we issued 11,500 restricted shares of our common
stock at a market price of $4.25 per share. No sales commissions were paid in
connection with this transaction. The shares of the Company's common stock
issued to the consultant were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as amended.
On December 8, 2004, we issued 1,500 shares of our common stock to our
Chief Financial Officer for 50% of its then market value under the terms of his
employment agreement, which expired on December 31, 2004. We received proceeds
of $3,188 and recorded $3,188 as additional compensation for the period ended
December 31, 2004. No sales commissions were paid in connection with this
transaction. The shares of the Company's common stock issued to our Chief
Financial Officer were issued in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act of 1933, as amended.
15
(e) Repurchases of Equity Securities
In March 2001, our Board of Directors authorized, subject to certain
business and market conditions, the purchase of up to $1,000,000 of our common
stock. As of December 31, 2004, we cumulatively purchased 40,200 shares totaling
approximately $222,000 and subsequently retired these shares. None of these
shares were purchased during the fourth quarter of 2004. We may purchase
additional shares when warranted by certain conditions.
Item 6. Selected Financial Data
The following selected financial data presented under the captions
"Statement of Operations Data" and "Balance Sheet Data" as of the end of each of
the five years ended December 31, 2004, are derived from the financial
statements of Intelli-Check, Inc. The financial statements for fiscal years
ended December 31, 2000 through December 31, 2001 were audited by Arthur
Andersen LLP, independent public accountants; the financial statements for the
fiscal years ended December 31, 2002 and 2003 were audited by Grant Thornton,
LLP independent certified public accountants and the financial statements for
the fiscal year ended December 31, 2004 were audited by Amper, Politziner &
Mattia, P.C. The selected financial data should be read in conjunction with the
financial statements as of December 31, 2004 and 2003 and for each of the three
years in the period ended December 31, 2004, the accompanying notes and the
report of independent registered public accounting firms thereon, which are
included elsewhere in this Form 10-K.
Years Ended December 31,
--------------------------------------------------------
2000 2001 2002 2003 2004
-------- -------- -------- -------- --------
(In thousands)
Statement of Operations Data:
Revenue $ 343 $ 886 $ 1,139 $ 1,236 $ 1,119
Loss from operations (3,379) (4,090) (5,936) (5,537) (7,017)
Net Loss (3,133) (3,963) (5,550) (6,451) (6,923)
Net loss per common share - basic and
diluted (0.47) (0.52) (0.64) (0.74) (0.79)
Common shares used in computing per share
amounts - basic and diluted 6,648 7,911 8,686 9,218 10,225
As of December 31,
--------------------------------------------------------
2000 2001 2002 2003 2004
-------- -------- -------- -------- --------
(In thousands)
Balance sheet data:
Cash and cash equivalents 4,092 4,061 1,911 3,307 1,750
Working capital 5,920 5,303 2,634 8,350 3,629
Total assets 7,940 8,423 5,415 10,732 5,615
Stockholders equity 6,633 7,030 3,873 6,901 868
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Intelli-Check was formed in 1994 to address a growing need for a reliable
document and age verification system that could be used to detect fraudulent
driver licenses and other widely accepted forms of government-issued
identification documents. Since then, our technology has been further developed
for application in the commercial fraud protection, access control and
governmental security markets. Additionally, it is currently being used to
address inefficiencies and inaccuracies associated with manual data entry. The
core of Intelli-Check's product offerings is our proprietary software technology
that verifies the authenticity of driver licenses, state issued non-driver and
military identification cards used as proof of identity. Our patented
ID-Check(R) software technology instantly reads, analyzes, and verifies the
encoded data in magnetic stripes and barcodes on government-issue IDs from
approximately 60 jurisdictions in the U.S. and Canada to determine if the
content and format is valid. We have served as the national testing laboratory
for the American Association of Motor Vehicle Administrators (AAMVA) since 1999
and have access to all the currently encoded driver license formats. After the
tragic events that occurred on September 11, 2001, we believe there has been a
significant increase in awareness of our software technology to help improve
security across many industries, including airlines, rail transportation and
high profile buildings and infrastructure, which we believe should enhance
future demand for our technology. We have also begun to market to various
government and state agencies, which have long sales cycles including extended
test periods. Since inception, we have incurred significant losses and negative
cash flow from operating activities and, as of December 31, 2004, we had an
accumulated deficit of $35,671,379. We will continue to fund operating and
capital expenditures from proceeds that we received from sales of our equity
securities. In view of the rapidly evolving nature of our business and our
limited operating history, we believe that period-to-period comparisons of
revenues and operating results are not necessarily meaningful and should not be
relied upon as indications of future performance.
16
Our ID-Check's unique technology provides the ability to verify the
validity of military ID's, driver licenses and state issued non-driver ID cards
that contain magnetic stripes, bar codes and SMART chips that conform to
AAMVA/ANSI/ISO standards, which enables us to target three distinct markets. The
original target market was focused on resellers of age-restricted products, such
as alcohol and tobacco, where the proliferation of high-tech fake IDs expose
merchants to fines and penalties for the inadvertent sale of these products to
underage purchasers. We now also target commercial fraud, which includes
identity theft and our technology is designed to help prevent losses from these
frauds. We believe that the tragic events that occurred on September 11, 2001
have created increased awareness of our technology in security applications
involving access control. As a result of its applicability in these markets, we
have sold our products to some of the largest companies in the gaming industry,
a state port authority, military establishments, airports, nuclear power plants
and high profile buildings and have successfully completed tests of our
technology in one of the largest mass merchandisers in the United States. We
currently are testing our products with some large public companies. We have
entered into strategic alliances with several biometric companies; Lenel Systems
International, a provider of integrated security solutions; and Northrop Grumman
and Anteon, integrators in the defense industry, to utilize our systems and
software as the proposed or potential enrollment application for their
technologies and to jointly market these security applications. In addition, we
have executed agreements with some high profile organizations to promote the use
of our technology and our products. We believe these relationships have
broadened our marketing reach through their sales efforts and we intend to
develop additional strategic alliances with additional high profile
organizations and providers of security solutions.
We have developed additional software products that utilize our patented
software technology. Our latest products include ID-Traveler and ID-Prove. ID
Traveler electronically verifies and matches two forms of government issued ID's
instantaneously while the ID Prove product offering provides "out of wallet"
questions to assist in proving a users claimed identity. Additional software
solutions include ID-Check(R) PC and ID-Check(R) PDA, which replicate the
features of ID-Check. These products are designed to be platform-independent and
compatible with both stationary and mobile hardware applications. Another new
application is the next version of C-Link(R), the company's net workable data
management software. Additionally, ID-Check(R) PC and the next release of C-Link
are designed to read the smart chip contained on the military Common Access Card
(CAC). These products are all designed for use with Intelli-Check's new DCM, a
compact, self-contained two-dimensional bar code and magnetic stripe reader. The
DCM enables the new software applications to be used on a variety of
commercially available data processing devices, including PDAs, Tablets,
Laptops, Desktops and Point-of-Sale Computers, therefore negating the need to
replace the IDC-1400 platform. Our C-Link(R) software product, which runs on a
personal computer and was created to work in conjunction with the ID-Check unit
allows a user to instantly view the encoded data for further verification, to
analyze the data and to generate various reports where permitted by law. To
date, we have entered into thirteen (13) licensing agreements and are in
discussions with additional companies to license our software to be utilized
within other existing systems. The revenue received from such licensing
agreements has not been significant through the period ended December 31, 2004.
Critical Accounting Policies and the Use of Estimates
The preparation of our 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 amounts reported in
our financial statements and accompanying notes. Actual results could differ
materially from those estimates.
We believe that there are several accounting policies that are critical to
understanding our historical and future performance, as these policies affect
the reported amounts of revenue and the more significant areas involving
management's judgments and estimates. These significant accounting policies
relate to revenue recognition, valuation of inventory and commitments and
contingencies. These policies and our procedures related to these policies are
described in detail below.
REVENUE RECOGNITION
We sell our products directly through our sales force and through
distributors. Revenue from direct sales of our product is recognized when
shipped to the customer and title has passed. Our products require continuing
service or post contract customer support and performance by us; accordingly, a
portion of the revenue pertaining to the service and support is deferred based
on its fair value and recognized ratably over the period in which the future
service, support and performance are provided, which is generally one year.
Currently, with respect to sales of certain of our products, we do not have
enough experience to identify the fair value of each element and the full amount
of the revenue and related gross margin is deferred and recognized ratably over
the one-year period in which the future service, support and performance are
provided.
17
In addition, we recognize sales from licensing of our patented software to
customers. Our licensed software requires continuing service or post contract
customer support and performance by us; accordingly, a portion of the revenue is
deferred based on its fair value and recognized ratably over the period in which
the future service, support and performance are provided, which is generally one
year.
During the second quarter of fiscal 2003, we began receiving royalties
from licensing our technology, which are recognized as revenues in the period
they are earned.
INVENTORY VALUATION
Our inventory consists primarily of our ID-Check terminals that run our
patented software and input devices purchased in 2004. We acquired such
inventory in December 1999 and, shortly thereafter; it was returned to the
manufacturer for upgrade and became available for sale in the fourth quarter of
2000. We periodically evaluate the current market value of our inventory, taking
into account any technological obsolescence that may occur due to changes in
hardware technology and the acceptance of the product in the marketplace. Based
on ongoing evaluation of our inventory, we recorded an inventory write down of
$990,000 during 2003 and an additional write down of $357,332 during 2004.
Should we determine in a future period that an adjustment to market value of the
inventory is necessary, we would record such adjustment at that time, which
could have a material adverse effect on our results of operations. The
manufacturer discontinued the production of the ID-Check terminals in 2003. The
ID-Check terminal is fully capable of running our patented software as it
utilizes a high quality imager/scanner and magnetic stripe reader and is
currently being marketed for sale.
The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting
principles, with no need for management's judgment in their application. There
are also areas in which management's judgment in selecting any available
alternative would not produce a materially different result.
STOCK-BASED COMPENSATION
Options, warrants and stock awards issued to non-employees and consultants
are recorded at their fair value as determined in accordance with Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," and EITF No. 96-18, "Accounting for Equity Instrument That are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services" and recognized as expense over the related vesting period.
DEFERRED INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and net operating loss carryforwards. Deferred tax assets
and liabilities are measured using expected tax rates in effect for the year in
which those temporary differences are expected to be recovered or settled. We
have recorded a full valuation allowance for our net deferred tax assets as of
December 31, 2004, due to the uncertainty of the realizability of those assets.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See footnote 2 of financial statements attached hereto following beginning
on Page F-1
Results of Operations
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2004 TO THE YEAR ENDED DECEMBER 31,
2003.
REVENUE. Revenue decreased $116,262 from $1,235,611 for the year ended
December 31, 2003 to $1,119,349 for the year ended December 31, 2004. Revenues
for the period ended December 31, 2004 consisted of revenue from distributors of
$314,166, revenues from direct sales to customers of $738,070 and royalty income
of $67,113. Sales, which represent shipments of products and contracted
services, increased 22.3% from $1,172,056 for the year ended December 31, 2003
to $1,433,381 for the year ended December 31, 2004. Sales growth has been
limited due to our change in marketing focus from smaller customers to large
commercial customers and government agencies which require an extended sales
cycle. We believe that the time frame of the sales cycle associated with the
refocus of our marketing efforts will continue to impact our sales. We are
optimistic that sales opportunities should increase as a result of certain of
our recent marketing tests and agreements, our introduction of additional
products this year, as well as legislative efforts to enhance security and deal
with the problem of under-age access to alcoholic products.
18
GROSS PROFIT. Gross profit, excluding an inventory write down of $357,332
for 2004 and $990,000 for 2003, would have decreased by $55,814 from $781,579
for the year ended December 31, 2003 to $725,765 for the year ended December 31,
2004. Our gross profit excluding the inventory write downs for 2004 and 2003 as
a percentage of revenues would have increased to 64.8% in the year ended
December 31, 2004 from 63.3% for the year ended December 31, 2003. Our gross
profit percentage was positively impacted by an increase in revenues from
licensing our patented technology at higher gross margins.
OPERATING EXPENSES. Operating expenses, which consist of selling, general
and administrative and research and development expenses, increased 38.6% from
$5,328,742 for the year ended December 31, 2003 to $7,385,394 for the year ended
December 31, 2004. Selling expenses, which consist primarily of salaries and
related costs for marketing, decreased 13.0% from $1,352,274 for the year ended
December 31, 2003 to $1,176,911 for the year ended December 31, 2004 primarily
due to decreased travel and convention expenses of approximately $81,000 and a
reduction of non-recurring expenses of $94,000 from the hiring of professional
consultants. General and administrative expenses, which consist primarily of
salaries and related costs for general corporate functions, including executive,
accounting, facilities and fees for legal and professional services, increased
111% from $2,386,088 for the year ended December 31, 2003 to $5,032,207 for the
year ended December 31, 2004, primarily as a result of an increase in non-cash
expenses from the extension of stock options totaling $1,347,000 and an increase
in legal fees of approximately $1,630,000 primarily relating to patent
infringement litigation, which were partially offset by a decrease in
depreciation and amortization expense of approximately $323,000 as a result of
the write-off of intangible assets relating to the IDentiScan acquisition in
2003. Research and development expenses, which consist primarily of salaries and
related costs for the development of our products, decreased 4.1% from
$1,226,725 for the year ended December 31, 2003 to $1,176,276 for the year ended
December 31, 2004 primarily as a result of a decrease in employee salaries and
related expenses of approximately $75,000. During the fourth quarter of 2003, we
determined that as a result of discontinuing the selling of IDentiScan products,
certain of our intangible assets with a remaining book value of $363,655 should
be written off. No charges of a similar nature occurred in 2004. We believe that
we will require additional investments in development and operating
infrastructure as the Company grows. Therefore, we expect that expenses will
continue to incrementally increase in line with increases in the growth of the
business as we may increase expenditures for advertising, brand promotion,
public relations and other marketing activities. Research and development
expenses may also increase as we complete and introduce additional products
based upon our patented ID-Check technology.
INTEREST EXPENSE. We did not incur interest expense for the year ended
December 31, 2004 compared to the interest expense of $43,487 in the year ended
December 31, 2003, which resulted primarily from interest accrued in 2003 on an
arbitration decision awarding Early Bird Capital settlement on their demand.
INTEREST INCOME. Interest income increased from $51,437 for the year ended
December 31, 2003 to $94,030 for the year ended December 31, 2004, which is a
result of a higher average annual balance in our cash and cash equivalents,
marketable securities and short term investments available for investment during
this period resulting from additional cash received from the successful
completion of our secondary offering in October 2003.
INCOME TAXES. We have incurred net losses to date and, therefore, we have
paid nominal income taxes.
NET LOSS. As a result of the factors noted above, our net loss increased
from $6,450,943 which included $2,314,627 of non-cash expenses for the year
ended December 31, 2003 to $6,922,931 for the year ended December 31, 2004,
which included $2,231,544 of non-cash expenses.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2003 TO THE YEAR ENDED DECEMBER 31,
2002.
REVENUE. Revenue increased $97,024 from $1,138,587 for the year ended
December 31, 2002 to $1,235,611 for the year ended December 31, 2003. Revenues
for the period ended December 31, 2003 consisted of revenue from distributors of
$290,022, revenues from direct sales to customers of $880,423 and royalty income
of $65,165. Sales, which represent shipments of products and contracted
services, decreased 11.7% from $1,326,829 for the year ended December 31, 2002
to $1,172,056 for the year ended December 31, 2003. This slow growth is
primarily as a result of our change in focus to market to large commercial
customers and government agencies which require an extended sales cycle rather
than to smaller customers. This refocus of our marketing efforts will continue
to impact our sales as a result of the extended time frame associated with these
sales cycles. We believe that based upon the results of certain of our recent
marketing tests, recent marketing agreements, the introduction of additional
products in 2004 as well as legislative efforts to enhance security, these
events should result in increased sales opportunities.
19
GROSS PROFIT. Gross profit, excluding an inventory write down of $990,000,
would have increased by $144,421 from $637,158 for the year ended December 31,
2002 to $781,579 for the year ended December 31, 2003. Our gross profit
excluding the inventory write down of $990,000 as a percentage of revenues would
have increased to 63.3% in the year ended December 31, 2003 from 56% for the
year ended December 31, 2002. Our gross profit percentage was positively
impacted by an increase in revenues from licensing our patented technology at
higher gross margins.
OPERATING EXPENSES. Operating expenses, which consist of selling, general
and administrative and research and development expenses, decreased 18.9% from
$6,573,129 for the year ended December 31, 2002 to $5,328,742 for the year ended
December 31, 2003. Selling expenses, which consist primarily of salaries and
related costs for marketing, decreased 5.9% from $1,437,509 for the year ended
December 31, 2002 to $1,352,274 for the year ended December 31, 2003 primarily
due to a reduction of non-recurring expenses of approximately $123,000 from the
hiring of professional consultants to promote our product and a reduction in
sales demonstration equipment expenses of approximately $19,000, which was
partially offset by an increase in salaries and employee costs of approximately
$34,000 and marketing expenses of approximately $13,000. General and
administrative expenses, which consist primarily of salaries and related costs
for general corporate functions, including executive, accounting, facilities and
fees for legal and professional services, decreased 28.9% from $3,355,549 for
the year ended December 31, 2002 to $2,386,088 for the year ended December 31,
2003, primarily as a result of a reduction of non-recurring fees of
approximately $355,000 incurred in the prior year for the hiring of consultants
primarily relating to the recognized non-cash expense of the granting of options
to this group in the prior year, a decrease of salaries and related expenses of
approximately $12,000, a decrease in miscellaneous and office related expenses
of approximately $36,000 and a decrease in legal and accounting fees of
approximately $568,000 primarily related to the reversal of legal accruals
resulting from the settlement of prior litigation matters, which was partially
offset by an increase in insurance costs of approximately $20,000. Research and
development expenses, which consist primarily of salaries and related costs for
the development of our products, increased 4% from $1,180,071 for the year ended
December 31, 2002 to $1,226,725 for the year ended December 31, 2003 primarily
as a result of additional expenses incurred in the development of our new
products. During the fourth quarter of 2003, we determined that as a result of
discontinuing the selling of IDentiScan products, certain of our intangible
assets with a remaining book value of $363,655 should be written off. During the
fourth quarter of 2002, we recorded a reserve on inventory deposit of $600,000,
which represents the deposit we paid the manufacturer on an open purchase order,
which we subsequently decided to cancel. We believe that we will require
additional investments in development and operating infrastructure as the
Company grows. Therefore, we expect that expenses will continue to incrementally
increase in line with increases in the growth of the business as we may increase
expenditures for advertising, brand promotion, public relations and other
marketing activities. Research and development expenses may also increase as we
complete and introduce additional products based upon our patented ID-Check
technology.
INTEREST EXPENSE. Interest expense increased from $4,878 for the year
ended December 31, 2002 to $43,487 for the year ended December 31, 2003
primarily as a result of interest incurred on the Early Bird award granted on
April 8, 2003.
INTEREST INCOME. Interest income decreased from $53,871 for the year ended
December 31, 2002 to $51,437 for the year ended December 31, 2003, which
primarily resulted from a decrease in our cash and cash equivalents available
for investment through the third quarter of 2003 and lower interest rates
available on our investments which was partially offset by the additional
interest income on the cash received from the successful completion of our
secondary offering in October 2003.
OTHER EXPENSES. Other expenses for the year ended December 31, 2003
totaling $921,730 is a result of a non- recurring charge from an arbitration
decision in favor of Early Bird Capital as a settlement on their demand.
INCOME TAXES. We have incurred net losses to date and, therefore, we have
paid nominal income taxes.
NET LOSS. As a result of the factors noted above, our net loss increased
from $5,550,234, which included $1,773,131 of non-cash expenses for the year
ended December 31, 2002 to $6,450,943 for the year ended December 31, 2003,
which included $2,314,627 of non-cash expenses, accounting for 60.1% of the
increase in our net loss.
20
Liquidity and Capital Resources
Prior to our initial public offering in November 1999, we financed our
operations primarily through several private placements of equity and debt
securities. We used the net proceeds of these financings for the primary purpose
of funding working capital and general corporate purposes and for the purchase
of hardware terminals. As a result of our IPO and the underwriters exercise of
their over allotment option, we received approximately $6,907,000 in net
proceeds after deducting underwriters commissions and offering expenses. During
2000, we received $3,426,374 from the issuance of common stock from the exercise
of warrants and stock options. During 2001 and 2002, we received $3,231,174 and
$1,742,466, respectively, from the issuance of common stock from the exercise of
warrants, stock options and rights. During 2003, we received net proceeds before
legal expenses of $2,850,000, from the issuance of convertible preferred stock
and we received net proceeds of approximately $7,906,000 from our secondary
public offering of 1,100,000 shares of common stock. We funded the purchase of
hardware terminals for resale and working capital primarily from these proceeds.
On November 2, 2004, we entered into an exclusive agreement with an investment
banking firm for the purpose of investigating the opportunities in raising
additional capital for us. There can be no assurances that we will be successful
in raising additional capital on acceptable terms.
Cash used in operating activities for the year ended December 31, 2004 of
$3,773,646 was primarily attributable to the net loss of $6,922,931, a decrease
in litigation settlement payable of $921,700 resulting from the payout of the
legal award matter with Early Bird Capital recorded in 2003 and an increase in
accounts receivable of $288,946 resulting from credit sales made towards the end
of the year, which was offset primarily by an increase in certificates of
deposit, restricted of $1,283,118 resulting primarily from the payout of the
legal award, an increase in accounts payable and accrued expenses of $667,086
primarily from legal accruals resulting from the patent litigation, an inventory
reserve of $357,332, depreciation and amortization of $111,743, recognition of
non cash stock based compensation expense resulting primarily from the extension
of stock options of $1,350,187 and amortization of deferred compensation of
$363,407 from the granting of stock options to consultants. Cash used in
operating activities for the year ended December 31, 2003 of $4,612,915 was
primarily attributable to the net loss of $6,450,943, an increase in
certificates of deposit, restricted of $1,009,801 resulting from the award in
the legal matter with Early Bird Capital, an increase in accounts receivable of
$155,636 resulting from credit sales made towards the end of the year, a
decrease in accounts payable and accrued expenses of $464,354 primarily from the
reversal of legal accruals resulting from the settlement of prior litigation
matters, which was offset primarily by a decrease of inventory of $259,130 and
an inventory reserve of $990,000, an increase in litigation settlement payable
of $921,700 resulting from the legal award recorded in the first quarter of
2003, depreciation and amortization of $436,778, write off of intangible assets
of $363,655 and amortization of deferred compensation of $357,194 from the
granting of stock options to consultants. Cash used in investing activities was
$2,125,151 for the year ended December 31, 2004 and resulted primarily from the
net result of the investment in and sales of marketable securities and short
term investments of $2,147,592. Cash used in investing activities was $4,860,740
for the year ended December 31, 2003 and consisted of purchases of marketable
securities and short term investments of $4,856,388 using cash received from our
secondary offering. Cash provided by financing activities was $91,989 for the
year ended December 31, 2004 and was primarily related to proceeds of $431,167
from the issuance of common stock from the exercise of stock options, which was
partially offset by the payment of dividends to preferred stock holders of
$240,000. Cash provided by financing activities was $10,870,067 for the year
ended December 31, 2003 and was primarily related to the issuance of 1,100,000
shares of our common stock in connection with our secondary public offering, the
issuance of our Series A 8% Convertible Redeemable Preferred Stock and the
exercise of stock options.
During 2004, we received net proceeds of $427,979 from the exercise of
142,700 options. During 2003, we received net proceeds of $679,611 from the
exercise of 175,209 options. As of December 31, 2004, there remained warrants
outstanding to purchase 110,000 and 100,000 shares of the Company's common stock
at an exercise price of $8.80 and $7.54, respectively.
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold
30,000 shares of our Series A 8% Convertible Redeemable Preferred Stock, par
value $.01 per share, for $3,000,000 before expenses to Gryphon Master Fund,
L.P. Each share of Preferred Stock entitled the holder to receive dividends of
8% per annum and is currently convertible into 15.1515 shares of our common
stock for a total of 454,545 shares of common stock. Additionally, the investors
were issued five year warrants to purchase 113,636 shares of common stock at an
exercise price of $6.78. Dividend payments of $120,000 in cash are due
semi-annually beginning September 30, 2003 and, accordingly, we paid $122,958 on
September 30, 2003. In connection with this financing, we paid agent fees of
$150,000 and issued warrants and options to purchase 8,854 shares of common
stock at a price of $6.78. Shares of Preferred Stock are convertible at the
option of Gryphon Master Fund, L.P. at any time prior to redemption. We may
redeem any or all of the Preferred Stock at any time after one year from the
closing date at a cash redemption price of $100 per share, providing the volume
weighted average price of our Common Stock for 20 out of 30 consecutive trading
days exceeds $13.20 per share. We must redeem all of the Preferred Stock
outstanding on the fifth anniversary of the closing date at a redemption price,
in cash, equal to the purchase price of the Preferred Stock. A registration
statement covering the common stock issuable upon conversion of the preferred
stock and exercise of the warrants was declared effective in June 2003. On
February 25, 2005, Gryphon converted the 30,000 shares of Series A 8%
Convertible Redeemable Preferred Stock into 454,545 shares of common stock. We
paid dividends through February 25, 2005.
21
In March 2001, we declared a dividend distribution of one non-transferable
right to purchase one share of our common stock for every 10 outstanding shares
of common stock continuously held from the record date to the date of exercise,
as well as common stock underlying vested stock options and warrants, held of
record on March 30, 2001, at an exercise price of $8.50. The rights were due to
expire on October 4, 2002, which was one year after the effective date of the
registration statement related to the shares of common stock underlying the
rights. We first extended the expiration date until April 4, 2003; we then
extended the rights until December 31, 2003; we further extended the expiration
date to June 30, 2004; and subsequently extended the expiration date to June 30,
2005. We have the right to redeem the outstanding rights for $.01 per right
under certain conditions, which were not met as of March 25, 2005. We reserved
970,076 shares of common stock for future issuance under this rights offering.
Cumulatively, as of December 31, 2004, we received $2,482,009 before expenses
from the exercise of 292,001 of these rights.
In March 2001, our Board of Directors authorized, subject to certain
business and market conditions, the purchase of up to $1,000,000 of our common
stock. As of December 31, 2004, we cumulatively purchased 40,200 shares totaling
approximately $222,000 and subsequently retired these shares. None of these
shares were purchased during the fourth quarter of 2004. We may purchase
additional shares when warranted by certain conditions.
During 2004, the Company's cash expense burn rate, which does not include
dividend payments made on our Preferred Stock, was approximately $430,000 per
month and we expect that it will not materially change for 2005. We currently
anticipate that our available cash in hand and marketable securities and cash
resources from expected revenues from the sale of the units in inventory and the
licensing of our technology will be sufficient to meet our anticipated working
capital and capital expenditure requirements for at least the next twelve
months. These requirements are expected to include the purchase of inventory,
product development, sales and marketing, working capital requirements and other
general corporate purposes. We may need to raise additional funds, however, to
respond to business contingencies which may include the need to fund more rapid
expansion, fund additional marketing expenditures, develop new markets for our
ID-Check technology, enhance our operating infrastructure, respond to
competitive pressures, or acquire complementary businesses or necessary
technologies.
We are currently involved in certain legal proceedings as discussed in the
"Commitments and Contingencies" note in the Notes to the Financial Statements
filed in our form 10-K for the year ended December 31, 2004. We do not believe
these legal proceedings will have a material adverse effect on our financial
position, results of operations or cash flows.
As of December 31, 2004, we had a net operating loss carry forward of
approximately $27 million, which expires beginning in the year 2013. The
issuance of equity securities in the future, together with our earlier
financings and our IPO, could result in an ownership change and could limit our
use of our prior net operating losses. If we achieve profitable operations, any
significant limitation on the utilization of our net operating losses would have
the effect of increasing our tax liability and reducing net income and available
cash reserves. We are unable to determine the availability of these
net-operating losses since this availability is dependent upon profitable
operations, which we have not achieved in prior periods; therefore we have
recorded a full valuation allowance for the benefit from the net-operating
losses.
Contractual Obligations
The table below presents our contractual obligations and commitments at
December 31, 2004:
Payments Due by Period
Less than
Contractual Obligations Total One Year 1-3 years 4-5 years After 5 years
- --------------------------------- ---------- ---------- ---------- ---------- -------------
Operating Leases $1,609,943 $ 247,552 $ 786,277 $ 576,114 --
Consulting contracts 138,000 138,000 -- -- --
Employment contracts 574,172 412,086 162,086 -- --
---------- ---------- ---------- ---------- -------------
Total Contractual Cash Obligation $2,322,115 $ 797,638 $ 948,363 $ 576,114 --
Off-Balance Sheet Arrangements
We have never entered into any off-balance sheet financing arrangements
and have never established any special purpose entities. We have not guaranteed
any debt or commitments of other entities or entered into any options on
non-financial assets.
22
Forward Looking Statements
The foregoing contains certain forward-looking statements. Due to the fact
that our business is characterized by rapidly changing technology, high capital
requirements and an influx of new companies trying to respond to enhanced
security needs as a result of current events, actual results and outcomes may
differ materially from any such forward looking statements and, in general are
difficult to forecast.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
None
Item 8. Financial Statements and Supplementary Data
Financial statements are attached hereto following beginning on Page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On April 21, 2004, the Company dismissed its independent auditors, Grant
Thornton LLP ("Grant Thornton"), and engaged Amper, Politziner & Mattia P.C.
("Amper") as its new independent registered public accounting firm. The change
in auditors became effective immediately. This determination followed the
Company's decision to seek proposals from independent accountants to audit the
financial statements of the Company, and was approved by the Company's Board of
Directors upon the recommendation and approval of its Audit Committee. The audit
reports of Grant Thornton on the Company's financial statements for the years
ended December 31, 2003 and 2002 did not contain any adverse opinion or
disclaimer of opinion, nor were they qualified or modified as to uncertainty,
audit scope or accounting principles. During our fiscal years ended December 31,
2003 and 2002, and through the date of Grant Thornton's dismissal on April 21,
2004, there were no disagreements between the Company and Grant Thornton on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to Grant
Thornton's satisfaction, would have caused Grant Thornton to make reference to
the subject matter of the disagreement in connection with its reports.
Item 9A. Controls and Procedures
We maintain disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) that are designed (i) to collect the information
we are required to disclose in the reports we file with the SEC, and (ii) to
process, summarize and disclose this information within the time periods
specified in the rules of the SEC. Under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures. Such evaluation was
conducted as of the end of the period covered by this report. Based on such
evaluation, our Chief Executive and Chief Financial Officer have concluded that
these procedures are effective.
Additionally, there were no significant changes in our internal controls
or in other factors that could significantly affect these controls subsequent to
the end of the period covered by this report. We have not identified any
significant deficiencies or material weaknesses in our internal controls, and
therefore there were no corrective actions taken.
Compliance with Section 404 of the Sarbanes-Oxley Act of 2002
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (the Act),
beginning with our Annual Report on Form 10-K for the fiscal year ending
December 31, 2006, we will be required to furnish a report by our management on
our internal control over financial reporting. This report will contain, among
other matters, an assessment of the effectiveness of our internal control over
financial reporting as of the end of our fiscal year, including a statement as
to whether or not our internal control over financial reporting is effective.
This assessment must include disclosure of any material weaknesses in our
internal control over financial reporting identified by management. If we
identify one or more material weaknesses in our internal control over financial
reporting, we will be unable to assert our internal control over financial
reporting is effective. This report will also contain a statement that our
independent registered public accountants have issued an attestation report on
management's assessment of such internal controls and conclusion on the
operating effectiveness of those controls.
Management acknowledges its responsibility for internal controls over
financial reporting and seeks to continually improve those controls. In order to
achieve compliance with Section 404 of the Act within the prescribed period, we
are currently performing the system and process documentation and evaluation
needed to comply with Section 404, which is both costly and challenging. We
believe our process, which will begin in 2005 and continue in 2006 for
documenting, evaluating and monitoring our internal control over financial
reporting is consistent with the objectives of Section 404 of the Act.
Item 9B. Other Information
None
23
PART IV
Item 10. Directors and Executive Officers of the Company
As of March 30, 2005, the Company's directors and executive officers were
as follows:
Position With the Company
Name And Principal Occupation Held Office Since
- --------------------- -------------------------------------------------- -----------------
Frank Mandelbaum Chairman, Chief Executive Officer and Director 1996
Edwin Winiarz Senior Executive Vice President, Treasurer, Chief 1999
Financial Officer and Director
Russell T. Embry Senior Vice President and Chief Technology Officer 2001
Todd Liebman Senior Vice President, Marketing and Operations 2004
Ashok Rao Vice Chairman, Director 2004
John N. Hatsopoulos Director 2003
Arthur L. Money Director 2003
Charles McQuinn Director 1999
Thomas Prendergast Director 2004
Jeffrey Levy Director 1999
Evelyn Berezin Director 1999
Frank Mandelbaum, age 71, has served as our Chairman of the Board and
Chief Executive Officer since July 1, 1996. He also served as Chief Financial
Officer until September 1999. From January 1995 through May 1997, Mr. Mandelbaum
served as a consultant providing strategic and financial advice to Pharmerica,
Inc. (formerly Capstone Pharmacy Services, Inc.), a publicly held company. Prior
to January 1995, Mr. Mandelbaum was Chairman of the Board, Chief Executive
Officer and Chief Financial Officer of Pharmerica, Inc. From July 1994 through
December 1995, Mr. Mandelbaum served as Director and Chairman of the Audit and
Compensation Committees of Medical Technology Systems, Inc., also a publicly
held company. From November 1991 through January 1995, Mr. Mandelbaum served as
Director of the Council of Nursing Home Suppliers, a Washington, D.C. based
lobbying organization. From 1974 to date, Mr. Mandelbaum has been Chairman of
the Board and President of J.R.D. Sales, Inc., a privately held financial
consulting company. As required by his employment agreement, Mr. Mandelbaum
devotes substantially all his business time and attention to our business.
Edwin Winiarz, age 47, was elected Senior Executive Vice President in July
2000 and a director in August 1999 and became Executive Vice President,
Treasurer and Chief Financial Officer on September 7, 1999. From July 1994 until
August 1999, Mr. Winiarz was Treasurer and Chief Financial Officer of Triangle
Service Inc., a privately held national service company. From November 1990
through July 1994, Mr. Winiarz served as Vice President Finance/Controller of
Pharmerica, Inc. (formerly Capstone Pharmacy Services, Inc.). From March 1986
until November 1990, Mr. Winiarz was a manager with the accounting firm of
Laventhal & Horwath. Mr. Winiarz is a certified public accountant and holds an
MBA in management information systems from Pace University.
Russell T. Embry, age 41, was elected Senior Vice President and Chief
Technology Officer in July 2001 and was Vice President, Information Technology,
since July 1999. From January 1998 to July 1999, Mr. Embry was Lead Software
Engineer with RTS Wireless. From April 1995 to January 1998, he served as
Principal Engineer at GEC-Marconi Hazeltine Corporation. From August 1994
through April 1995, he was a staff software engineer at Periphonics Corporation.
From September 1989 to August 1994, Mr. Embry served as Senior Software Engineer
at MESC/Nav-Com. From July 1985 through September 1989, he was a software
engineer at Grumman Aerospace. Mr. Embry holds a B.S. in Computer Science from
Stony Brook and an M.S. in Computer Science from Polytechnic University,
Farmingdale.
24
Todd Liebman, age 31, joined Intelli-Check, Inc. in December 2004 as its
Senior Vice President of Marketing and Operations. Prior to joining
Intelli-Check, Mr. Liebman served as President of Quick Kiosk, a Kinetics
Company, LLC (QK), a self-service solution provider focused on the quick serve
restaurant market industry. In September 2004 Mr. Liebman completed the sale of
QK to NCR Corporation (NYSE:NCR). Prior to founding QK, Mr. Liebman served as
Director of Business Development of Trex Communications Corporation (TrexCom), a
telecommunications start-up focused on satellite communications systems and
multi-media interactive response systems, which was sold to L-3 Communications,
Inc. in February 2000. TrexCom grew from a complete start-up and losing money in
1997 to $50 million in revenues and profitable in less than two years. Prior to
joining Trex Communications, Mr. Liebman was Associate Director, Business
Development for Thermo Electron Corporation (NYSE:TMO), a $4 billion
conglomerate and parent company of Trex Communications. From 1996 to 1997, he
worked as a Management Consultant at EMI Strategic Marketing, a strategic
consulting firm. Mr. Liebman received his Bachelor's of Science in Management
from Tulane University's A.B. Freeman School of Business. Mr. Liebman has also
participated in an Executive Education program at the University of
Pennsylvania's Wharton School of Business.
Ashok Rao, age 55, was appointed a director in December 2004 and Vice
Chairman in January 2005. Mr. Rao is currently an angel investor in numerous
high-tech start-ups as well as the producer of a major motion picture scheduled
for worldwide release in April 2005. Mr. Rao was CEO of Prime Wave
Communications, a broadband wireless access technology subsidiary of L3 from
2000 to 2003. Previously, he was the founder and chief executive officer of Trex
Communications ("TrexCom"), a Thermo Electron satellite communications business,
which reached annual revenues of $60 million in the second year. He was
instrumental in the sale of TrexCom to L3 in 2000. Mr. Rao holds a bachelor's
degree in mechanical engineering from the Indian Institute of Technology, New
Delhi, a master's degree in systems engineering from Marquette University, and a
diploma in Financial Management from the London School of Economics. Mr. Rao is
also a trustee of numerous charitable organizations.
John N. Hatsopoulos, age 71, was elected a director in December 2003. Mr.
Hatsopoulos is currently the chief executive officer of American Distributed
Generation Inc. He is the co-founder of Thermo Electron Corporation (NYSE:TMO)
and the retired president and vice chairman of its Board of Directors. Mr.
Hatsopoulos is also managing partner of Glen Rose Capital LLC, a leverage buyout
investment fund, and managing partner of Alexandros Partners LLC, a financial
advisory firm. Prior to his role at American Distributed Generation, which
provides a range of products and services in support of the emerging market for
on-site generation of electricity, heating and cooling at commercial,
institutional and light industrial facilities, Mr. Hatsopoulos held a wide
variety of positions at Thermo Electron Corporation. Over more than four
decades, Mr. Hatsopoulos served, among other positions, as vice president of
corporate strategy, handling acquisitions, financial and investor relations and
corporate investments, chief financial officer and, at retirement, president and
vice chairman of the Board of Directors. Mr. Hatsopoulos graduated from Athens
College in Athens, Greece in 1953. He holds a B.S. in history and mathematics
from Northeastern University, together with Honorary Doctorates in Business
Administration from Boston College and Northeastern University. He served on the
Board of Directors of the American Stock Exchange from 1994 through 2000. He is
currently a member of the Board of Directors of TEI BioSciences Inc. and a
"Member of the Corporation" for Northeastern University.
Arthur L. Money, age 65, was elected a director in February 2003. Mr.
Money was confirmed by the Senate and served as the Assistant Secretary of
Defense for Command, Control, Communications and Intelligence from 1999 to 2001
and was also the Chief Information Officer for the Department of Defense from
1998 until 2001. Prior to that he served as the Senior Civilian Official, Office
of the Assistant Secretary of Defense, from 1998 to 1999 and was earlier
confirmed by the Senate as Assistant Secretary of the Air Force for Research,
Development and Acquisition and served as Chief Information Officer, from 1996
to 1998. Mr. Money currently serves as a member of the advisory board of several
corporations including the Boeing Company (NYSE: BA). He also serves on the
Board of Directors of numerous companies including Silicon Graphics, Inc. (NYSE:
SGI) and CACI International (NYSE: CAI) and has been recognized for his vision,
leadership and commitment to excellence in systems and process re-engineering.
Mr. Money, who holds a Master of Science Degree in Mechanical Engineering from
the University of Santa Clara (Calif.) and a Bachelor of Science Degree in
Mechanical Engineering from San Jose (Calif.) State University also currently
serves on several U.S. Government Boards and Panels such as NIMA Advisory Board,
Defense Science Board, US Air Force AC2ISR Center Advisory Board and the US Navy
"DSAP" Special Advisory Panel. Prior to his government service, he had a
distinguished business career having served as President of ESL Inc., a
subsidiary of TRW, Inc., from 1990 to 1994 prior to its consolidation with its
Avionics and Surveillance Group when he became Vice President and Deputy General
Manager of the Group.
25
Charles McQuinn, age 64, was elected a director in August 1999. He has
been, since 1997, an independent product development/marketing consultant to
Internet based companies. Mr. McQuinn has also served as CEO of The McQuinn
Group, Inc., a system integration and institutional marketing company, from
November 1998 to the present. From 1995 to 1997, Mr. McQuinn was President of
DTN West, a fixed income price quote company with products for banks and
governments. From 1990 to 1995, Mr. McQuinn was President of Bonneville Market
Information, an equities price quote company with products for traders and
brokers. From 1985 to 1990, Mr. McQuinn was President of Bonneville
Telecommunications Company, a satellite video and data company. Prior to 1985,
he held various product development/marketing/management positions with
Burroughs Corporation. Mr. McQuinn holds a BS in marketing from Ball State
University and an MBA in management from Central Michigan University.
Thomas A. Prendergast, age 71, was elected a director in March 2004. Mr.
Prendergast is currently an investment and management consultant. He presently
serves as chairman of the board for The Steel Corporation of Texas, Texzona
Industries, Inc. and Scot Holding, Inc. and as director for Double Eagle
Petroleum, Inc. Throughout his career, Mr. Prendergast has served as a member of
the board of directors for more than seventeen publicly traded companies across
a broad range of industries. He has worked with companies in special situations,
including the initial public offering of Farah Manufacturing, where he was
executive vice president for ten years. He has been involved in a number of
turnaround situations and various high-profile transactions, including the sale
of Market Guide, Inc. to Multex, the global provider of institutional research
products, which has since been integrated into Reuters Products & Services. Mr.
Prendergast was the founding member and President of the Board of Trustees of El
Paso Community College from 1962 to 1982. He is a certified public accountant
and holds a Bachelor of Science degree from Fordham University.
Jeffrey Levy, age 62, was elected a director in December 1999. He has
been, since February 1977, President and Chief Executive Officer of LeaseLinc,
Inc., a third-party equipment leasing company and lease brokerage company. Prior
to 1977, Mr. Levy served as President and Chief Executive Officer of American
Land Cycle, Inc. and Goose Creek Land Cycle, LLC, arboreal waste recycling
companies. During that time he also served as Chief Operating Officer of ICC
Technologies, Inc. and AWK Consulting Engineers, Inc. Mr. Levy has had a
distinguished career as a member of the United States Air Force from which he
retired as a colonel in 1988. He serves as a board member of the Northern
Virginia Chapter of Mothers Against Drunk Driving, the Washington Regional
Alcohol Program, the Zero Tolerance Coalition and the National Drunk and Drugged
Driving Prevention Month Coalition and is a member of the Virginia Attorney
General's Task Force on Drinking by College Students and MADD's National
Commission on Underage Drinking. Mr. Levy holds a BS in International Relations
from the United States Air Force Academy, a graduate degree in Economics from
the University of Stockholm and an MBA from Marymount University.
Evelyn Berezin, age 79, was elected a director in August 1999. She has
been, since October 1987, an independent management consultant to technology
based companies. From July 1980 to September 1987, Ms. Berezin was President of
Greenhouse Management Company, a venture capital fund dedicated to investment in
early-phase high-technology companies. Ms. Berezin holds an AB in Physics from
New York University and has held an Atomic Energy Commission Fellowship. Ms.
Berezin has served on the boards of a number of public companies including
Bionova Corp., Cigna Corp., Datapoint Corp., Koppers Company, Inc. and Genetic
Systems Inc., as well as more than fourteen private technology-based companies.
She also serves on the boards of Sion Energy Inc. and BioPhotonics Corp. Ms.
Berezin holds honorary doctorates from Adelphi University and Eastern Michigan
University and is on the Board of the Stony Brook Foundation of Stony Brook
University and Brookhaven Science Associates, the manager of Brookhaven
Laboratories.
Audit Committee of the Board of Directors
The board of directors has established a separately designated stand alone
Audit Committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act, which is currently comprised of Mr. Prendergast, chairman, Mr.
McQuinn and Ms. Berezin. They are all considered "independent" under Section
121(A) of the listing standards of the American Stock Exchange. The audit
committee recommends to the board of directors the annual engagement of a firm
of independent accountants and reviews with the independent accountants the
scope and results of audits, our internal accounting controls and audit
practices and professional services rendered to us by our independent
accountants.
The Board of Directors has determined that we have at least one audit
committee financial expert serving on our audit committee. Mr. Prendergast, who
is a certified public accountant and holds a Bachelor of Science degree from
Fordham University, is an "audit committee financial expert" and is an
independent member of the board of directors.
26
Section 16(a) Beneficial Ownership Reporting Compliance
The Securities and Exchange Commission has adopted rules relating to the
filing of ownership reports under Section 16 (a) of the Securities Exchange Act
of 1934. One such rule requires disclosure of filings, which under the
Commission's rules, are not deemed to be timely. During the review of Forms 3,
it was determined that Mr. Prendergast failed to file a timely report concerning
the grant of 7,500 stock options on April 1, 2004 due to his not having EDGAR
access codes; however, such failure was remedied by the reporting of this
transaction on April 7, 2004. It was also determined that Mr. Rao failed to file
a timely report concerning the grant of 75,000 stock options on December 3, 2004
due to his not having EDGAR access codes; however, such failure was remedied by
the reporting of this transaction on December 14, 2004. It was further
determined that Mr. Liebman failed to file a timely report concerning the grant
of 175,000 stock options on December 10, 2004 due to his not having EDGAR access
codes; however, such failure was remedied by the reporting of this transaction
on December 17, 2004. During the review of Forms 4, it was determined that Mr.
Hatsopoulos failed to file a timely report concerning the purchase of 1,000
shares of common stock on January 12, 2004 and the grant of 2,500 stock options
on May 10, 2004; however, such failures were remedied by the reporting of these
transactions on January 15, 2004 and May 20, 2004, respectively. It was also
determined that Mr. Levy failed to file a timely report regarding the purchase
of 500 shares on common stock on December 1, 2004; however, such failure was
remedied by the reporting of this transaction on December 7, 2004. All other
transactions were reported in a timely fashion.
Code of Ethics
On March 22, 2004, we adopted a code of ethics that applies to our Chief
Executive Officer and Chief Financial Officer, and other persons who perform
similar functions. A copy of our Code of Ethics is incorporated by reference as
an exhibit to this Annual Report on Form 10-K. Our Code of Ethics is intended to
be a codification of the business and ethical principles which guide us, and to
deter wrongdoing, to promote honest and ethical conduct, to avoid conflicts of
interest, and to foster full, fair, accurate, timely and understandable
disclosures, compliance with applicable governmental laws, rules and
regulations, the prompt internal reporting of violations and accountability for
adherence to this Code. Item 11. Executive Compensation
The following table sets forth compensation paid to executive officers
whose compensation was in excess of $100,000 for any of the three fiscal years
ended December 31, 2004. No other executive officers received total salary and
bonus compensation in excess of $100,000 during any of such fiscal years.
SUMMARY COMPENSATION TABLE
Annual Long-Term
Compensation Compensation
------------ ------------
Securities
Underlying
Name and Principal Position Year Salary($) Options/SARS (#)
- --------------------------- ---- --------- ----------------
Frank Mandelbaum 2004 250,000 75,000
Chairman and 2003 250,000 100,000
Chief Executive Officer 2002 250,000 350,000
Edwin Winiarz 2004 151,318 65,000
Senior Executive Vice President 2003 141,750 30,000
Chief Financial Officer 2002 135,000 --
Russell T. Embry 2004 152,063 10,000
Senior Vice President 2003 150,000 12,500
Chief Technology Officer 2002 150,000 12,500
Ralph Thomas 2004 103,855 --
Former Senior Vice President Sales 2003 11,060 50,000
W. Robert Holloway 2004 -- --
Former Senior Vice President 2003 108,728 --
Sales 2002 115,000 --
27
Option Grants
The following table summarizes options granted during the year ended
December 31, 2004 to the named executive officers:
- ---------------------------------------------------------------------------------------------------------
Individual Grants
- ---------------------------------------------------------------------------------------------------------
Number of
Securities % of Total
Name Underlying Options Granted Potential Realizable Value
Options to Employees In Exercise Expiration Assumed Annual Rates of
Granted 2004 Fiscal Year Price Date Appreciation for Option (1)
- ---------------------------------------------------------------------------------------------------------
5% 10%
---------------------------
Russell T. Embry 5,000 1.3% $4.37 12/03/09 $ 6,037 $ 13,340
Russell T. Embry 5,000 1.3% $4.37 06/03/10 $ 6,037 $ 13,340
Frank Mandelbaum 25,000 6.6% $4.37 01/01/15 $ 30,184 $ 66,698
Frank Mandelbaum 25,000 6.6% $4.37 01/01/16 $ 30,184 $ 66,698
Frank Mandelbaum 25,000 6.6% $4.37 01/01/17 $ 30,184 $ 66,698
Todd Liebman 25,000 6.6% $4.57 12/10/09 $ 31,565 $ 69,751
Todd Liebman 25,000 6.6% $4.57 12/10/10 $ 31,565 $ 69,751
Todd Liebman 25,000 6.6% $4.57 12/10/11 $ 31,565 $ 69,751
Todd Liebman 100,000 26.5% $4.57 12/10/14 $126,261 $279,003
Edwin Winiarz 15,000 4.0% $5.25 07/08/14 $ 21,757 $ 48,078
Edwin Winiarz 25,000 6.6% $4.37 01/01/15 $ 30,184 $ 66,698
Edwin Winiarz 25,000 6.6% $4.37 01/01/16 $ 30,184 $ 66,698
- ---------------------------------------------------------------------------------------------------------
(1) The amounts shown as potential realizable value represent hypothetical
gains that could be achieved for the respective options if exercised at the end
of the option term. The 5% and 10% assumed annual rates of compounded stock
price appreciation are mandated by rules of the Securities and Exchange
Commission and do not represent our estimate or projection of our future common
stock prices. These amounts represent certain assumed rates of appreciation in
the value of our common stock from the fair market value on the date of grant.
Actual gains, if any, on stock option exercises are dependent on the future
performance of the common stock and overall stock market conditions. The amounts
reflected in the table may not necessarily be achieved.
Aggregated Option Exercises and Fiscal Year-End Option Value Table
The following table summarizes unexercised options granted through the
year-end December 31, 2004 to the named executive officers:
- ---------------------------------------------------------------------------------------------------------------------
Aggregate Value of Unexercised
No. of Shares Dollar Value No. of Securities In-the-Money
Name Received Upon Received Upon Underlying Unexercised Options At Fiscal
Exercise Exercise Options / Warrants Year End 12/31/04
- ---------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------
Frank Mandelbaum
Chairman & CEO 0 0 900,000 75,000 $ 675,000 $ 9,750
Edwin Winiarz Senior
Executive VP & CFO 0 0 165,000 50,000 0 $ 6,500
Russell T. Embry Senior
VP & CTO 0 0 82,500 5,000 $ 9,150 $ 650
Todd Liebman, Senior
VP Marketing &
Operations 0 0 25,000 150,000 0 0
- ---------------------------------------------------------------------------------------------------------------------
28
Compensation of Directors
Non-employee directors receive a fee of $500 for attending board meetings
and $250 for attendance at such meetings telephonically. They also receive a fee
of $300 for each committee meeting held on a date other than that of a board
meeting and are reimbursed for expenses incurred in connection with the
performance of their respective duties as directors. Through December 2002,
non-employee directors received 15,000 options for each full year of service on
the Company's board of directors. In July 2003, the board increased the amount
of options granted to non-employee directors for each full year of service to
25,000 options. In addition, non-employee directors who are members of a
committee are entitled to receive grants of stock options for each year served.
The chairperson of the audit committee receives options to purchase 7,500 shares
of our common stock and audit committee members receive options to purchase
3,000 shares of our common stock. Of the remaining committees, each chairperson
receives options to purchase 2,500 shares of our common stock, while a committee
member receives options to purchase 1,500 shares of our common stock. These
options are immediately exercisable during the committee members' term and
expire ten years from date of grant.
On January 11, 2005, we issued options to purchase 60,000 shares of our
common stock, at a price of $4.55, to our Vice Chairman, Ashok Rao, as
compensation for providing us with advice in certain strategic and operational
aspects of the business. Of these options, 10,000 vested immediately and the
balance vest upon meeting certain goals.
Employment Contracts, Termination of Employment and Change-in-Control
Arrangements
On November 9, 2004, we entered into a new one-year employment contract
with our Chairman and Chief Executive Officer, Frank Mandelbaum, effective
January 1, 2005. The agreement provides for an annual base salary of $250,000.
In addition, we granted to Mr. Mandelbaum an option to purchase 75,000 shares of
common stock at an exercise price of $4.37 per share, of which 25,000 options
became exercisable on January 1, 2005; 25,000 options shall become exercisable
on January 1, 2006 and the remaining 25,000 options shall become exercisable on
January 1, 2007.
If there shall occur a change of control, as defined in the employment
agreement, the employee may terminate his employment at any time and be entitled
to receive a payment equal to 2.99 times his average annual compensation,
including bonuses, during the three years preceding the date of termination,
payable in cash to the extent of three months salary and the balance in shares
of our common stock based on a valuation of $2.00 per share.
On November 9, 2004, we entered into a new employment agreement with our
Senior Executive Vice President and Chief Financial Officer, Edwin Winiarz,
effective January 1, 2005. The agreement, which expires December 31, 2006,
provides for a fixed base annual salary of $162,086. In addition, we granted to
Mr. Winiarz an option to purchase 50,000 shares of common stock at an exercise
price of $4.37 per share, of which 25,000 options became exercisable on January
1, 2005 and the remaining 25,000 options shall become exercisable on January 1,
2006.
Each of the employment agreements requires the executive to devote
substantially all his time and efforts to our business and contains
non-competition and nondisclosure covenants of the officer for the term of his
employment and for a period of two years thereafter. Each employment agreement
provides that we may terminate the agreement for cause.
Compensation Committee Interlocks and Insider Participation
The board of directors has established a compensation committee which is
currently comprised of Mr. Levy, chairman, Mr. Hatsopoulos, Mr. Money and Mr.
Rao. No member of the Compensation Committee has a relationship that would
constitute an interlocking relationship with Executive Officers or Directors of
the Company or another entity.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth, as of March 1, 2005 certain information
regarding beneficial ownership of Intelli-Check's common stock by each person
who is known by us to beneficially own more than 5% of our common stock. The
table also identifies the stock ownership of each of our directors, each of our
officers, and all directors and officers as a group. Except as otherwise
indicated, the stockholders listed in the table have sole voting and investment
powers with respect to the shares indicated.
Unless otherwise indicated, the address for each of the named individuals
is c/o Intelli-Check, Inc., 246 Crossways Park West, Woodbury, NY 11797-2015.
29
Shares of common stock which an individual or group has a right to acquire
within 60 days pursuant to the exercise or conversion of options, warrants or
other similar convertible or derivative securities are deemed to be outstanding
for the purpose of computing the percentage ownership of such individual or
group, but are not deemed to be outstanding for the purpose of computing the
percentage ownership of any other person shown in the table.
The applicable percentage of ownership is based on 10,290,418 shares
outstanding as of March 1, 2005.
Name Shares Beneficially Owned Percent
- -----------------------------------------------------------------------------
Frank Mandelbaum (1) 1,603,505 14.17
Edwin Winiarz (2) 192,000 1.83
Todd Liebman (3) 25,000 *
Russell T. Embry (4) 86,500 *
Evelyn Berezin (5) 136,400 1.31
Charles McQuinn (6) 145,600 1.40
Jeffrey Levy (7) 113,380 1.09
Arthur L. Money (8) 78,000 *
John Hatsopoulos (9) 72,600 *
Thomas Prendergast (10) 70,000 *
Ashok Rao (11) 38,000 *
Empire State Development formerly
New York State Science and
Technology Foundation (12) 605,000 5.85
All Executive Officers & Directors as
a group (11 persons) 2,560,985 23.41
* Indicates beneficial ownership of less than one percent of the total
outstanding common stock.
(1) Includes 1,024,928 shares issuable upon exercise of stock options
exercisable within 60 days. Does not include 12,100 shares and 1,190
rights held by Mr. Mandelbaum's wife, for which Mr. Mandelbaum disclaims
beneficial ownership
(2) Includes 192,000 shares issuable upon exercise of stock options
exercisable within 60 days.
(3) Includes 25,000 shares issuable upon exercise of stock options exercisable
within 60 days.
(4) Includes 86,500 shares issuable upon exercise of stock options exercisable
within 60 days.
(5) Includes 127,900 shares issuable upon exercise of stock options
exercisable within 60 days.
(6) Includes 130,600 shares issuable upon exercise of stock options
exercisable within 60 days.
(7) Includes 110,980 shares issuable upon exercise of stock options
exercisable within 60 days.
(8) Includes 77,800 shares issuable upon exercise of stock options exercisable
within 60 days.
(9) Includes 56,500 shares issuable upon exercise of stock options exercisable
within 60 days.
(10) Includes 40,000 shares issuable upon exercise of stock options exercisable
within 60 days.
(11) Includes 38,000 shares issuable upon exercise of stock options exercisable
within 60 days.
(12) Frances A. Walton, the Chief Financial Officer exercises voting and
dispositive power over the shares. The address is 633 Third Avenue, New
York, NY 10017
30
Equity Compensation Plan Information
Number of Securities Weighted average
to be issued upon exercise price of Number of securities remaining
exercise of outstanding available for future issuance under
outstanding options, options, warrants equity compensation plans (excluding
Plan Category warrants and rights and rights securities reflected in column a)
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved 1,953,049 $7.03 774,842
by security holders
- ------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not 824,425 $7.30 None
approved by security holders
- ------------------------------------------------------------------------------------------------------------------------------
Total 2,777,474 $7.11 774,842
- ------------------------------------------------------------------------------------------------------------------------------
From time to time the Board of Directors of the Company approves the grant
of non-plan options to officers and employees of, or consultants to, the
Company. The shares of common stock listed under equity compensation plans not
approved by stockholders in the above table consist of shares of common stock
issuable pursuant to such options. The vesting schedule of the options varies,
with some vesting immediately and some vesting upon the completion of certain
performance objectives. The non-plan options currently outstanding have been
granted to eleven (11) persons. These options have a weighted average exercise
price per share equal to $7.30 and options to purchase 687,500 shares of common
stock are currently exercisable.
Item 13. Certain Relationships and Related Transactions
On January 1, 2005, we renewed our agreement with Alexandros Partners LLC
to act as consultants in advising us in financial and investor relation matters.
We agreed to pay a consulting fee of $50,000 payable in 12 equal monthly
installments. The agreement terminates on December 31, 2005. Mr. John
Hatsopoulos, a principal of Alexandros Partners LLC, is currently a member of
our Board of Directors. This transaction was approved by all of the independent
directors of our Board of Directors.
Item 14. Principal Accountant Fees and Services
During fiscal years ended December 31, 2003 until April 21, 2004, our
principal independent auditor was Grant Thornton LLP. Thereafter, our principal
independent auditor was Amper, Politziner & Mattia, P.C. The services of each
were provided in the following categories and amount:
AUDIT FEES
The aggregate fees billed by Grant Thornton LLP for professional services
rendered for the audit of the Company's annual financial statements for the
fiscal years ended December 31, 2003, for the reviews of the financial
statements included in the Company's Quarterly Reports on Form 10-Q for fiscal
year 2003 and for services performed in connection with the Company's Forms S-2
and S-3 registration statements filed in 2003, were $252,660. We were billed
$10,000 by Grant Thornton LLP for fees relating to the transition to Amper,
Politziner and Mattia, P.C. as our auditors during 2004.
The aggregate fees billed by Amper, Politziner and Mattia, P.C. for
professional services rendered for the audit of the Company's annual financial
statements for the fiscal year ended December 31, 2004 and for the reviews of
the financial statements included in the Company's Quarterly Reports on Form
10-Q for fiscal year 2004 amounted to $78,400.
AUDIT RELATED FEES
Other than the fees described under the caption "Audit Fees" above, Grant
Thornton LLP did not bill any fees for services rendered to us during fiscal
year 2003 for assurance and related services in connection with the audit or
review of our financial statements. Amper, Politziner and Mattia, P.C. did not
bill any fees for services rendered to us during fiscal year 2004 for assurance
and related services in connection with the audit or review of our financial
statements.
31
TAX FEES
There were no tax fees billed by Grant Thornton LLP during fiscal year
2003. Amper, Politziner and Mattia, P.C. has not billed us for tax fees for
fiscal 2004, but they did perform tax related services for us which we estimate
to be approximately $3,000.
ALL OTHER FEES
There were no fees billed by Grant Thornton LLP for other professional
services rendered during the fiscal year ended December 31, 2003.
There were no fees billed by Amper, Politziner and Mattia, P.C. for other
professional services rendered during the fiscal year ended December 31, 2004.
PRE-APPROVAL OF SERVICES
The Audit Committee pre-approves all services, including both audit and
non-audit services, provided by our independent accountants. For audit services,
each year the independent auditor provides the Audit Committee with an
engagement letter outlining the scope of proposed audit services to be performed
during the year, which must be formally accepted by the Committee before the
audit commences. The independent auditor also submits an audit services fee
proposal, which also must be approved by the Committee before the audit
commences. Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
Balance Sheets as of December 31, 2003 and 2004
Statements of Operations for the years ended December 31, 2002,
2003 and 2004
Statements of Stockholders' Equity for the years ended December 31,
2002, 2003 and 2004
Statements of Cash Flows for the years ended December 31, 2002,
2003 and 2004
(2) Schedule II - Valuation and Qualifying Accounts
(b) Exhibits
Exhibit No. Description
- ----------- -----------
1 Form of Underwriting Agreement (1)
3.1 Certificate of Incorporation of the Company (1)
3.2 By-laws of the Company (1)
3.3 Certificate of Designation of Preferred Stock of Intelli-Check,
Inc. (7)
4.1 Specimen Stock Certificate (2)
4.2 Form of Underwriters' Warrant Agreement (1)
4.3 Warrant to Gryphon Master Fund LLP (7)
4.4 Form of Underwriters Warrant Agreement including form of
Warrant Certificate(8)
10.1 1998 Stock Option Plan (1) *
10.5 Agreement of Lease between the Company and Industrial and
Research Associates, dated as of October 15, 2000 (5)
10.6 1999 Stock Option Plan (1) *
10.7 Development and Supply Agreement between the Company and Welch
Allyn Data Collection Inc. dated July 9, 1999 (1)
10.9 Employment Agreement between the Company and W. Robert
Holloway, dated October 25, 1999 (1) *
10.10 Agreement between the Company and Kevin Messina, individually
and d/b/a K.M. Software Development, dated as of
May 3, 1999 (1) *
10.11 Memorandum of Understanding between AAMVAnet, Inc. and Intelli
-Check, Inc. effective November 15, 2000 (5)
10.12 2001 Stock Option Plan (4)
10.15 Memorandum of Understanding between AAMVAnet, Inc. and
Intelli-Check, Inc. effective January 29, 2002 (5)
10.16 Securities Purchase Agreement between Intelli-Check, Inc. and
Gryphon Master Fund dated March 27, 2003. (7)
32
10.17 Registration Rights Agreement between Intelli-Check, Inc. and
Gryphon Master Fund dated March 27, 2003. (7)
10.18 Employment Agreement between Frank Mandelbaum and the Company,
dated as of December 15, 2004* (6)
10.19 Employment Agreement between Edwin Winiarz and the dated as of
December 15, 2004* (6)
14.1 Code of Business Conduct and (7)
21 List of Subsidiaries (1)
31.1 Certification of Chief Executive pursuant to Section 302 of The
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section
302 of The Sarbanes-Oxley Act of 2002 32 Certification of Chief
Executive Officer and Chief Financial pursuant to Section 906
of The Sarbanes-Oxley Act of 2002
- ----------
*Denotes a management contract or compensatory plan, contract or arrangement.
(1) Incorporated by reference to Registration Statement on Form SB-2 (File No.
333-87797) filed September 24, 1999.
(2) Incorporated by reference to Amendment No. 1 to the Registration Statement
filed November 1, 1999.
(3) Incorporated by reference to Amendment No. 2 to the Registration Statement
filed November 15, 1999.
(4) Incorporated by reference to Registrant's Proxy Statement on Schedule 14A
filed May 31, 2001.
(5) Incorporated by reference to Registrant's Annual Report on Form 10-K filed
March 29, 2001.
(6) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed on December 16, 2004.
(7) Incorporated by reference to Registrant's Annual Report of Form 10-K filed
March 31, 2003.
(8) Incorporated by reference to Registration Statement on Form S-2 (File No.
333-108043) filed September 30, 2003.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant had duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 2005 INTELLI-CHECK, INC.
By: /s/ Frank Mandelbaum
--------------------
Frank Mandelbaum
Chairman, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: March 30, 2005 INTELLI-CHECK, INC.
By: /s/ Frank Mandelbaum
--------------------
Frank Mandelbaum
Chairman, Chief Executive Officer
and Director
Date: March 30, 2005 /s/ Edwin Winiarz
------------------
Edwin Winiarz
Senior Executive Vice President, Treasurer and
Chief Financial Officer
Date: March 30, 2005 /s/ Ashok Rao
--------------
Ashok Rao, Vice Chairman and Director
Date: March 30, 2005 /s/ Evelyn Berezin
-------------------
Evelyn Berezin, Director
Date: March 30, 2005 /s/ John Hatsopoulos
John Hatsopoulos, Director
Date: March 30, 2005 /s/ Jeffrey Levy
-----------------
Jeffrey Levy, Director
Date: March 30, 2005 /s/ Charles McQuinn
--------------------
Charles McQuinn, Director
Date: March 30, 2005 /s/ Arthur L. Money
--------------------
Arthur L. Money, Director
Date: March 30, 2005 /s/ Thomas Prendergast
-----------------------
Thomas Prendergast, Director
INDEX
Page
----
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS F-1 - F-2
FINANCIAL STATEMENTS:
Balance Sheets as of December 31, 2003 and 2004 F-3
Statements of Operations for the Years Ended December 31, 2002,
2003 and 2004 F-4
Statements of Stockholders' Equity for the Years Ended
December 31, 2002, 2003 and 2004 F-5
Statements of Cash Flows for the Years Ended December 31, 2002,
2003 and 2004 F-6
NOTES TO FINANCIAL STATEMENTS F-7 - F-20
Schedule II - Valuation and Qualifying Accounts F-21
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Intelli-Check, Inc.
We have audited the accompanying balance sheet of Intelli-Check, Inc. as of
December 31, 2003, and the related statements of operations, stockholders'
equity and cash flows for each of the two years in the period ended December 31,
2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Intelli-Check, Inc. as of
December 31, 2003, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The accompanying schedule II for the
years ended December 31, 2003 and 2002 is presented for purposes of additional
analysis and is not a required part of the basic financial statements. Such
information has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, is fairly stated in all
material respects in relation to the basic financial statements taken as a
whole.
/s/ Grant Thornton LLP
- ----------------------
New York, New York
March 5, 2004
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Intelli-Check, Inc.
We have audited the accompanying balance sheet of Intelli-Check, Inc. as of
December 31, 2004 and the related statements of operations, stockholders' equity
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States.) Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statements presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Intelli-Check, Inc. as of December 31, 2004
and the results of its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.
We have also audited the financial statement schedule listed in the index at
item 15(a)(2), schedule II for the year ended December 31, 2004. In our opinion,
such financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/Amper, Politziner & Mattia, P.C.
- -----------------------------------
New York, New York
March 4, 2005
F-2
INTELLI-CHECK, INC.
BALANCE SHEETS
DECEMBER 31, 2003 and 2004
ASSETS
2003 2004
---- ----
CURRENT ASSETS:
Cash and cash equivalents $ 3,306,991 $ 1,750,485
Certificate of deposit, restricted (Note 10) 1,007,310 --
Marketable securities and short-term investments 4,856,388 2,708,796
Accounts receivable, net of allowance of $20,000 for 2004 249,166 454,112
Inventory 553,709 211,163
Other current assets 217,387 314,466
-------------- --------------
Total current assets 10,190,951 5,439,022
CERTIFICATE OF DEPOSIT (Note 10) 275,808 --
PROPERTY AND EQUIPMENT, net (Note 3) 210,407 132,905
PATENT COSTS, net (Notes 4 and 9) 48,798 42,589
OTHER INTANGIBLES, net (Notes 4 and 9) 5,590 --
-------------- --------------
Total assets $ 10,731,554 $ 5,614,516
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 183,712 $ 759,218
Accrued expenses (Note 5) 482,464 574,043
Litigation settlement payable (Note 10) 921,700 --
Deferred revenue 252,705 476,387
Current portion of capital lease obligations (Note 10) 427 --
-------------- --------------
Total current liabilities 1,841,008 1,809,648
-------------- --------------
OTHER LIABILITIES 114,898 97,266
-------------- --------------
Total liabilities 1,955,906 1,906,914
-------------- --------------
COMMITMENTS AND CONTINGENCIES (Note 10)
SERIES A 8% CONVERTIBLE REDEEMABLE PREFERRED STOCK,
net of beneficial conversion feature, warrants issued and issuance
costs - $.01 par value; 1,000,000 shares authorized; 30,000 shares
issued and outstanding - liquidation preference of $3,000,000 (Note 7) 1,874,940 2,839,278
-------------- --------------
STOCKHOLDERS' EQUITY:
Common stock - $.001 par value; 20,000,000 shares authorized; 10,154,918 and
10,290,418 shares issued and outstanding as of 2003 and 2004, respectively 10,154 10,290
Deferred compensation (377,967) (126,469)
Additional paid-in capital 34,287,631 36,655,882
Accumulated deficit (27,019,110) (35,671,379)
-------------- --------------
Total stockholders' equity 6,900,708 868,324
-------------- --------------
Total liabilities and stockholders' equity $ 10,731,554 $ 5,614,516
============== ==============
The accompanying notes are an integral part of these statements.
F-3
INTELLI-CHECK, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
2002 2003 2004
---- ---- ----
REVENUE $ 1,138,587 $ 1,235,611 $ 1,119,349
COST OF REVENUE (501,429) (454,032) (393,584)
INVENTORY WRITEDOWN (Note 2) -- (990,000) (357,332)
-------------- -------------- --------------
Gross profit (loss) 637,158 (208,421) 368,433
-------------- -------------- --------------
OPERATING EXPENSES:
Selling 1,437,509 1,352,274 1,176,911
General and administrative 3,355,549 2,386,088 5,032,207
Research and development 1,180,071 1,226,725 1,176,276
Write off of intangible assets (Notes 2 and 9) -- 363,655 --
Reserve on inventory deposit (Notes 2 and 10) 600,000 -- --
-------------- -------------- --------------
Total operating expenses 6,573,129 5,328,742 7,385,394
-------------- -------------- --------------
Loss from operations (5,935,971) (5,537,163) (7,016,961)
-------------- -------------- --------------
OTHER INCOME (EXPENSE):
Interest income 53,871 51,437 94,030
Interest expense (4,878) (43,487) --
Other income (expense) (Note 10) 336,744 (921,730) --
-------------- -------------- --------------
385,737 (913,780) (94,030)
-------------- -------------- --------------
Net loss (5,550,234) (6,450,943) (6,922,931)
Accretion of convertible redeemable preferred stock costs -- (198,540) (964,338)
Dividend on convertible redeemable preferred stock -- (183,451) (240,000)
-------------- -------------- --------------
Net loss attributable to common stockholders $ (5,550,234) $ (6,832,934) $ (8,127,269)
============== ============== ==============
PER SHARE INFORMATION:
Net loss per common share -
Basic and diluted $ (0.64) $ (0.74) $ (0.79)
============== ============== ==============
Weighted average common shares used in computing
per share amounts -
Basic and diluted 8,685,656 9,217,856 10,224,730
============== ============== ==============
The accompanying notes are an integral part of these statements.
F-4
INTELLI-CHECK, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
Common Stock Additional
--------------------- Paid-in Deferred
Shares Amount Capital Compensation
---------- ------- ----------- -----------
BALANCE, December 31, 2001 8,470,762 $ 8,470 $19,331,004 $ (189,000)
Exercise of warrants 1,250 1 3,749 --
Exercise of options 273,700 274 825,576 --
Effect on extension of expiration of options -- -- 8,500 --
Effect on extension of expiration of rights dividend -- -- 515,000 --
Issuance of common stock for exercise of rights 107,396 107 912,759 --
Purchase and retirement of common stock (10,000) (10) (70,054) --
Issuance of additional common stock for prior year's acquisition
of certain assets 32,194 32 (32) --
Recognition of deferred compensation -- -- 1,469,327 (1,469,327)
Amortization of deferred compensation -- -- -- 713,051
Valuation adjustment of deferred compensation -- -- (596,800) 596,800
Net loss -- -- -- --
---------- ------- ----------- -----------
BALANCE, December 31, 2002 8,875,302 8,874 22,399,029 (348,476)
Effect on extension of expiring options -- -- 167,000 --
Exercise of stock options 175,209 175 679,436 --
Exercise of rights 4,407 5 37,455 --
Issuance of common stock in connection with secondary offering 1,100,000 1,100 7,580,326
Effect on extension of expiring rights dividend -- -- 2,000,000 --
Warrants issued in connection with the issuance of
convertible redeemable preferred stock -- -- 497,700 --
Beneficial conversion feature embedded in
convertible redeemable preferred stock issued 540,000 --
Amortization of deferred compensation -- -- -- 357,194
Dividend on convertible redeemable preferred stock -- -- -- --
Recognition of deferred compensation -- -- 319,904 (319,904)
Accretion of convertible redeemable preferred stock --
Valuation adjustment of deferred compensation -- -- 66,781 (66,781)
Net loss -- -- -- --
---------- ------- ----------- -----------
BALANCE, December 31, 2003 10,154,918 10,154 34,287,631 (377,967)
Effect on extension of expiring options -- -- 1,347,000 --
Exercise of stock options 142,700 143 427,836 --
Issuance of common stock under employment agreement 1,500 2 6,373 --
Effect on extension of expiring rights dividend -- -- 525,000 --
Purchase and retirement of common stock (20,200) (20) (98,731) --
Issuance of common stock for services rendered 11,500 11 48,864 --
Amortization of deferred compensation -- -- -- 363,407
Dividend on convertible redeemable preferred stock -- -- -- --
Recognition of deferred compensation -- -- 542,648 (542,648)
Accretion of convertible redeemable preferred stock -- -- -- --
Valuation adjustment of deferred compensation -- -- (430,739) 430,739
Net loss -- -- -- --
---------- ------- ----------- -----------
BALANCE, December 31, 2004 10,290,418 $10,290 $36,655,882 $ (126,469)
========== ======= =========== ===========
Accumulated
Deficit Total
------------ -----------
BALANCE, December 31, 2001 $(12,120,942) $ 7,029,532
Exercise of warrants -- 3,750
Exercise of options -- 825,850
Effect on extension of expiration of options -- 8,500
Effect on extension of expiration of rights dividend (515,000) --
Issuance of common stock for exercise of rights -- 912,866
Purchase and retirement of common stock -- (70,064)
Issuance of additional common stock for prior year's acquisition
of certain assets -- --
Recognition of deferred compensation -- --
Amortization of deferred compensation -- 713,051
Valuation adjustment of deferred compensation -- --
Net loss (5,550,234) (5,550,234)
------------ -----------
BALANCE, December 31, 2002 (18,186,176) 3,873,251
Effect on extension of expiring options -- 167,000
Exercise of stock options -- 679,611
Exercise of rights -- 37,460
Issuance of common stock in connection with secondary offering 7,581,426
Effect on extension of expiring rights dividend (2,000,000) --
Warrants issued in connection with the issuance of
convertible redeemable preferred stock -- 497,700
Beneficial conversion feature embedded in
convertible redeemable preferred stock issued -- 540,000
Amortization of deferred compensation -- 357,194
Dividend on convertible redeemable preferred stock (183,451) (183,451)
Recognition of deferred compensation -- --
Accretion of convertible redeemable preferred stock (198,540) (198,540)
Valuation adjustment of deferred compensation -- --
Net loss (6,450,943) (6,450,943)
------------ -----------
BALANCE, December 31, 2003 (27,019,110) 6,900,708
Effect on extension of expiring options -- 1,347,000
Exercise of stock options -- 427,979
Issuance of common stock under employment agreement -- 6,375
Effect on extension of expiring rights dividend (525,000) --
Purchase and retirement of common stock -- (98,751)
Issuance of common stock for services rendered -- 48,875
Amortization of deferred compensation -- 363,407
Dividend on convertible redeemable preferred stock (240,000) (240,000)
Recognition of deferred compensation -- --
Accretion of convertible redeemable preferred stock (964,338) (964,338)
Valuation adjustment of deferred compensation -- --
Net loss (6,922,931) (6,922,931)
------------ -----------
BALANCE, December 31, 2004 $(35,671,379) $ 868,324
============ ===========
The accompanying notes are an integral part of these statements.
F-5
INTELLI-CHECK, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
2002 2003 2004
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,550,234) $ (6,450,943) $ (6,922,931)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization 451,580 436,778 111,743
Write off of intangible assets -- 363,655 --
Non cash stock based compensation expense 8,500 167,000 1,350,187
Issuance of common stock for services rendered -- -- 48,875
Amortization of deferred compensation 713,051 357,194 363,407
Writedown of inventory -- 990,000 357,332
Reserve on inventory deposit 600,000 -- --
Changes in assets and liabilities-
(Increase) decrease in certificates of deposit, restricted (4,823) (1,009,801) 1,283,118
(Increase) in accounts receivable (67,994) (155,636) (288,946)
Decrease (increase) in inventory 365,849 259,130 (14,786)
(Increase) decrease (increase) in other current assets (502,890) 56,383 (97,081)
Increase (decrease) increase in accounts payable and accrued expenses 18,482 (464,354) 667,086
Increase (decrease) in litigation settlement payable -- 921,700 (921,700)
Increase (decrease) increase in deferred revenue 197,347 (84,021) 290,050
------------ ------------ ------------
Net cash used in operating activities (3,771,132) (4,612,915) (3,773,646)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (29,187) (4,352) (22,441)
Investment in marketable securities and short-term investments -- (4,856,388) (10,294,803)
Sales of marketable securities and short-term investments -- -- 12,442,395
------------ ------------ ------------
Net cash (used in) provided by investing activities (29,187) (4,860,740) 2,125,151
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 1,742,466 717,071 431,167
Net proceeds from issuance of common stock from secondary offering -- 7,581,426 --
Net proceeds from issuance of convertible redeemable preferred stock -- 2,714,100 --
Payment of dividend to preferred stockholders -- (122,958) (240,000)
Repayment of capital lease obligations (22,739) (19,572) (427)
Treasury stock purchased (70,064) -- (98,751)
------------ ------------ ------------
Net cash provided by financing activities 1,649,663 10,870,067 91,989
------------ ------------ ------------
Net (decrease) increase (decrease) in cash and cash equivalents (2,150,656) 1,396,412 (1,556,506)
CASH AND CASH EQUIVALENTS, beginning of year 4,061,235 1,910,579 3,306,991
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of year $ 1,910,579 $ 3,306,991 $ 1,750,485
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 4,878 $ 1,487 $ --
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:
Stock options issued for services rendered $ 1,469,327 $ 319,904 $ 542,648
Beneficial conversion feature and warrants issued in connection
with issuance of convertible redeemable preferred stock -- 1,037,700 --
Accretion of convertible redeemable preferred stock cost -- 198,540 964,338
The accompanying notes are an integral part of these statements.
F-6
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND LIQUIDITY
Business
Intelli-Check ("the Company" or "we") was formed in 1994 to address a growing
need for a reliable document and age verification system that could be used to
detect fraudulent driver licenses and other widely accepted forms of
government-issued identification documents. Since then, our technology has been
further developed for application in the commercial fraud protection, access
control and governmental security markets. Additionally, it is currently being
used to address inefficiencies and inaccuracies associated with manual data
entry. The core of Intelli-Check's product offerings is our proprietary software
technology that verifies the authenticity of driver licenses, state issued
non-driver and military identification cards used as proof of identity. Our
patented ID-Check(R) software technology instantly reads, analyzes, and verifies
the encoded data in magnetic stripes and barcodes on government-issue IDs from
approximately 60 jurisdictions in the U.S. and Canada to determine if the
content and format is valid. We have served as the national testing laboratory
for the American Association of Motor Vehicle Administrators (AAMVA) since 1999
and have access to all the currently encoded driver license formats.
Our patented ID-Check(TM) software technology provides the ability to verify the
validity of driver licenses, state issued non-driver ID cards and military ID's
that contain magnetic stripes or bar codes, which in most cases conform to
AAMVA/ANSI/ISO standards. The ID-Check software is contained in our platforms
and some of our other software products. Our C-Link(R) software product, which
runs on a personal computer was created to work in conjunction with the ID-Check
unit, allows a user to instantly view the encoded data for further verification,
analyze the data and generate various reports where permitted by law.
We recently announced two new products, ID-Traveler(TM) and ID-Prove(TM), which
provide "in-person proofing" to meet the credentialing requirements of
Presidential Directive HSPD-12, a policy for a Common Identification Standard
for Federal Employees and Contractors and help in Patriot Act compliance. All of
our new innovations and product roll-outs are designed for use with our new data
capture module (DCM), a compact, self-contained two-dimensional bar code and
magnetic stripe reader, which enables the new software technology applications
to be used on a variety of commercially available data processing devices,
including PDAs, Tablets, Laptops, Desktops and Point-of-Sale Computers.
Liquidity
Since inception, the Company has incurred significant losses and negative cash
flow from operating activities, and as of December 31, 2004 we had an
accumulated deficit of $35,671,379. The Company anticipates that its current
available cash on hand and marketable securities and cash resources from
expected revenues from the sale of the units in inventory and the licensing of
its technology will be sufficient to meet its anticipated working capital and
capital expenditure requirements for at least the next twelve months. These
requirements are expected to include the purchase of inventory, product
development, sales and marketing expenses, working capital requirements and
other general corporate purposes. The Company may need to raise additional funds
to respond to business contingencies which may include the need to fund more
rapid expansion, fund additional marketing expenditures, develop new markets for
its ID-Check technology, enhance its operating infrastructure, respond to
competitive pressures, or acquire complementary businesses or necessary
technologies.
2. SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
Cash and cash equivalents include cash and highly liquid investments with
original maturities of three months or less when purchased. As of December 31,
2003 and 2004, cash equivalents included money market funds, commercial paper
and other liquid short-term debt instruments (with maturities at date of
purchase of three months or less) of $3,280,691 and $1,723,810, respectively.
Marketable Securities
The Company has classified its marketable securities as held-to-maturity as the
Company has the intent and ability to hold these securities to maturity. The
securities are carried at amortized cost using the specific identification
method. Interest income is recorded using an effective interest rate, with the
associated premium or discount amortized to interest income. All of the
Company's marketable securities have maturities of less than 1 year with a
weighted average interest rate of 1.97%. The carrying value of the marketable
securities as of December 31, 2003 and 2004 approximated the fair market value.
F-7
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Inventory
Inventory is stated at the lower of cost or market and cost is determined using
the first-in, first-out method. Inventory is primarily comprised of finished
goods.
Inventory Valuation
The Company's inventory consists primarily of its ID-Check terminals that run
its patented software and input devices purchased during 2004. The Company
acquired its ID-Check terminals in December 1999 and, shortly thereafter, was
returned to the manufacturer for upgrade and became available for sale in the
fourth quarter of 2000. The Company periodically evaluates the current market
value of its inventory, taking into account any technological obsolescence that
may occur due to changes in hardware technology and the acceptance of the
product in the marketplace. Based on the ongoing evaluation of the Company's
inventory, the Company recorded an inventory write down of $990,000 during 2003
and an additional write down of $357,332 during 2004. Should the Company
determine in a future period that an adjustment to market value of the inventory
is necessary, an adjustment would be recorded at that time, which would not have
a material adverse effect on the Company's results of operations. The
manufacturer discontinued the production of the ID-Check terminals in 2003. The
ID-Check terminal is fully capable of running the Company's patented software as
it utilizes a high quality imager/scanner and magnetic stripe reader and is
currently being marketed for sale.
Long-Lived Assets and Impairment of Long-Lived Assets
The Company's long-lived assets include property and equipment, acquired
software, patents, goodwill and other intangibles.
As of January 1, 2002, the Company has adopted SFAS No. 142 "Goodwill and Other
Intangible Assets". Under SFAS No. 142, goodwill and intangible assets with
indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). Pursuant to the
adoption of SFAS No. 142, the Company has evaluated its goodwill and other
intangibles to identify additional separately identifiable intangibles; no
adjustment was warranted. Intangible assets that will continue to be classified
as goodwill will no longer be amortized. This provision had no material impact
on the Company's financial position and results of operations. At December 31,
2003, the Company performed an impairment test of its goodwill and determined
that there was an impairment of the recorded goodwill, which resulted from the
Company's decision to discontinue the selling of its IDentiScan products. As a
result, the Company wrote off the original recorded value of goodwill totaling
$181,447 as of December 31, 2003, which affected the results of operations for
the period then ended.
As of January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets" which supersedes SFAS No. 121,
"Accounting for the Impairment or Disposal of Long-lived Assets to be Disposed
Of". SFAS No. 144 requires that identifiable intangible assets that are not
deemed to have indefinite lives will be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amounts of the assets may
be impaired. Furthermore, these assets are evaluated for continuing value and
proper useful lives by comparison to undiscounted expected future cash flow
projections. The Company has determined that as a result of discontinuing the
selling of its IDentiScan products, certain of its intangible assets, including
patent costs, with a remaining book value of $182,208 has been impaired and was
written off as of December 31, 2003, which affected the results of operations
for the period then ended.
Property and Equipment
Property and equipment are recorded at cost and are depreciated over their
estimated useful lives ranging from two to ten-years using the straight-line
basis. Equipment held under capital leases and leasehold improvements are
amortized utilizing the straight-line method over the lesser of the term of the
lease or estimated useful life of the asset.
Intangible Assets
Patent costs, primarily consisting of legal costs and allocated costs are being
amortized over a period of 17 years using the straight-line method. Acquired
Software was amortized over a period of 2 years using the straight-line method.
Other intangibles, consisting of a covenant not to compete and copyrights were
amortized over a period of 2 and 3 years, respectively using the straight-line
method. As discussed above and in Note 9, certain of these intangible assets
were written off as of December 31, 2003.
F-8
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Costs of Computer Software Developed or Obtained for Internal Use
The Company accounts for certain software costs under Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"), which provides guidance for determining whether
computer software is internal-use software and guidance on accounting for the
proceeds of computer software originally developed or obtained for internal use
and then subsequently sold to the public. It also provides guidance on
capitalization of the costs incurred for computer software developed or obtained
for internal use.
Capitalized Software Development Costs
SFAS No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased
or Otherwise Marketed," specifies that costs incurred internally in creating a
computer software product shall be charged to expense when incurred as research
and development until technological feasibility has been established for the
product. Software production costs for computer software that is to be used as
an integral part of a product or process shall not be capitalized until both (a)
technological feasibility has been established for the software and (b) all
research and development activities for the other components of the product or
process have been completed. The Company has not capitalized any software costs
for the years ended December 31, 2002, 2003 and 2004.
Revenue Recognition
The Company sells its products directly through its sales force and through
distributors. Revenue from direct sales of the Company's product is recognized
upon shipment to the customer and title has passed. The Company's products
require continuing service or post contract customer support and performance by
the Company; accordingly, a portion of the revenue pertaining to the service and
support is deferred based on its fair value and recognized ratably over the
period in which the future service, support and performance are provided, which
is generally one year. Currently, with respect to sales of certain of its
products, the Company does not have enough experience to identify the fair value
of each element and the full amount of the revenue and related gross margin is
deferred and recognized ratably over the one-year period in which the future
service, support and performance are provided.
In addition, the Company recognizes sales from licensing of its patented
software to customers. The Company's licensed software requires continuing
service or post contract customer support and performance by the Company;
accordingly, a portion of the revenue is deferred based on its fair value and
recognized ratably over the period in which the future service, support and
performance are provided, which is generally one year.
During the second quarter of fiscal 2003, the Company began receiving royalties
from licensing its technology, which are recognized as revenues in the period
they are earned.
The Company has adopted EITF 00-21, "Revenue Arrangements with Multiple
Deliverables" as of fiscal year ended December 31, 2003. Revenue arrangements
were allocated to the separate units of accounting based on their relative fair
values and revenue is recognized in accordance with its policy as stated above.
The impact of adopting EITF 00-21 on the financial statements was immaterial.
Research and Development Costs
Research and development costs are charged to expense as incurred.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes." Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and net operating loss carryforwards. Deferred tax assets
and liabilities are measured using expected tax rates in effect for the year in
which those temporary differences are expected to be recovered or settled. The
Company has recorded a full valuation allowance for its net deferred tax assets
as of December 31, 2004, due to the uncertainty of the realizability of those
assets.
F-9
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Fair Value of Financial Instruments
The Company adheres to the provisions of SFAS No. 107, "Disclosures about Fair
Value of Financial Instruments." This pronouncement requires that the Company
calculate the fair value of financial instruments and include this additional
information in the notes to financial statements when the fair value is
different than the book value of those financial instruments. The Company's
financial instruments include cash and cash equivalents, certificate of
deposits, marketable securities, accounts receivable and accounts payable. At
December 31, 2003 and 2004, the carrying value of the Company's financial
instruments approximated fair value, due to their short-term nature.
Business Concentrations and Credit Risk
Financial instruments, which subject the Company to concentrations of credit
risk, consist primarily of cash, cash equivalents and marketable securities. The
Company maintains cash between two financial institutions. The marketable
securities consist of short term investment grade corporate bonds. The Company
performs periodic evaluations of the relative credit standing of these
institutions.
The Company's sales to date have been limited due to the refocus of its
marketing efforts and introduction of new products to a number of clients which
are concentrated in the United States of America and the long sales cycle to
government entities. The Company performs ongoing credit evaluations, generally
does not require collateral, and establishes an allowance for doubtful accounts
based upon factors surrounding the credit risk of customers, historical trends
and other information.
The Company had one supplier for the production of its ID-Check 1400 product and
one supplier for the production of its IDentiScan products. The agreements with
these suppliers have terminated. The Company has modified its software to
operate in windows based systems and can integrate with different hardware
platforms that are readily available in the marketplace. The Company does not
maintain a manufacturing facility of its own and is not dependent on maintaining
its production relationships due to the flexibility of its software to run on
multiple existing platforms.
Net Loss Attributable to Common Shareholders
The Company computes net loss per common share in accordance with SFAS No. 128,
"Earnings Per Share". Under the provisions of SFAS No. 128, basic net loss per
common share ("Basic EPS") is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted net loss per common share
("Diluted EPS") is computed by dividing net loss by the weighted average number
of common shares and dilutive common share equivalents then outstanding. SFAS
No. 128 requires the presentation of both Basic EPS and Diluted EPS on the face
of the statements of operations. Diluted EPS for the years ended December 31,
2002, 2003 and 2004, does not include the impact of stock options and warrants
then outstanding, as the effect of their inclusion would be antidilutive.
The following table summarizes the equivalent number of common shares assuming
the related securities that were outstanding as of December 31, 2002, 2003 and
2004 had been converted:
2002 2003 2004
---- ---- ----
Stock options 2,333,866 2,701,124 2,777,474
Convertible redeemable preferred stock 454,545 454,545
Warrants 10,000 233,636 323,636
--------- --------- ---------
Total 2,343,866 3,389,305 3,555,655
========= ========= =========
Stock-Based Compensation
At December 31, 2004, the Company has stock based compensation plans, which are
described more fully in Note 8. As permitted by the SFAS No. 123, "Accounting
for Stock Based Compensation", the Company accounts for stock-based compensation
arrangements with employees in accordance with provisions of Accounting
Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued to
Employees". Compensation expense for stock options issued to employees is based
on the difference on the date of grant, between the fair value of the Company's
stock and the exercise price of the option. No stock based employee compensation
cost is reflected in net loss, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock at the
date of grant. The Company accounts for equity instruments issued to
non-employees in accordance with the provisions of SFAS No. 123 and Emerging
Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction With
Selling Goods or Services". All transactions in which goods or services are the
consideration received for the issuance of equity instruments are accounted for
based on the fair value of the consideration received or the fair value of the
equity instrument issued, whichever is more reliably measurable.
F-10
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
In accordance with SFAS No. 148 "Accounting for Stock Based
Compensation-Transition and disclosure", the following table illustrates the
effect on net loss and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to employees stock based compensation:
Years Ended
December 31, 2002 December 31, 2003 December 31, 2004
----------------- ----------------- -----------------
Net loss attributable to common stockholders,
as reported $ (5,550,234) $ (6,832,934) $ (8,127,269)
Add:
Total stock based employee compensation
expense determined under fair value based
method for all awards (2,196,369) (2,970,686) (2,107,593)
---------------- ---------------- ----------------
Net loss, pro forma $ (7,746,603) $ (9,803,620) $ (10,234,862)
Basic and diluted loss per share, as reported $ (0.64) $ (0.74) $ (0.79)
Basic and diluted loss per share, pro forma $ (0.89) $ (1.06) $ (1.00)
Comprehensive Loss
The Company's comprehensive net loss is equal to its net loss for the years
ended December 31, 2002, 2003 and 2004.
Segment Information
The Company adheres to the provisions of SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." This statement establishes
standards for the way public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in financial
statements issued to shareholders. Management has determined that it does not
have any separately reportable business segments.
Use of Estimates
The preparation of the Company's 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 amounts
reported in the Company's financial statements and accompanying notes. Actual
results could differ materially from those estimates.
Recently Issued Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN No. 46), which addresses consolidation by
business enterprises of variable interest entities ("VIEs"). FIN No. 46 is
applicable immediately for VIEs created after January 31, 2003 and are effective
for reporting periods ending after December 15, 2003, for VIEs created prior to
February 1, 2003. In December 2003, the FASB published a revision to FIN 46
("FIN 46R") to clarify some of the provisions of the interpretation and to defer
the effective date of implementation for certain entities. Under the guidance of
FIN 46R, public companies that have interests in VIE's that are commonly
referred to as special purpose entities are required to apply the provisions of
FIN 46R for periods ending after December 15, 2003. A public company that does
not have any interests in special purpose entities but does have a variable
interest in a VIE created before February 1, 2003, must apply the provisions of
FIN 46R by the end of the first interim or annual reporting period ending after
March 15, 2004. The Company adopted FIN 46R during the quarter ended March 31,
2004. The adoption of FIN 46 had no impact on the financial condition or results
of operations since the Company does not have investments in VIE's.
F-11
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123 (revised 2004) ("123R"), "Share-Based Payment." Statement 123(R) will
provide investors and other users of financial statements with more complete and
neutral financial information by requiring that the compensation cost relating
to share based payment transactions be recognized in financial statements. That
cost will be measured based on the fair value of the equity or liability
instruments issued. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights and employee share purchase
plans. SFAS No. 123(R) replaces SFAS No. 123, "Accounting for Stock Based
Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees." SFAS No. 123, as originally issued in 1995, established as
preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, that Statement permitted entities the
option of continuing to apply the guidance in APB Opinion No. 25, as long as the
footnotes to financial statements disclosed what net income would have been had
the preferable fair-value based method been used. Public entities (other than
those filing as small business issuers) will be required to apply SFAS No.
123(R) as of the first interim or annual reporting period that begins after June
15, 2005. We are in the process of evaluating whether the adoption of SFAS No.
123(R) will have a significant impact on our overall results of operations or
financial position.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an Amendment
of ARB No. 43," Chapter 4 ("SFAS No. 151"). The amendments made by SFAS No. 151
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and require the allocation of fixed production overheads to inventory based on
the normal capacity of the production facilities. SFAS No. 151 will become
effective beginning in fiscal 2006. The adoption of this Statement will not have
a significant impact on our financial condition or results of operations.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmonetary Assets"
an amendment of APB Opinion No. 29, "Accounting for Nonmonetary Transactions."
The amendments made by SFAS No. 153 are based on the principle that exchanges on
nonmonetary assets should be measured based on the fair value of the assets
exchanged. Further, the amendments eliminate the narrow exception for
nonmonetary exchanges of similar productive assets and replace it with a broader
exception for exchanges of nonmonetary assets that do not have commercial
substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring
in fiscal periods beginning after June 15, 2005. Earlier application is
permitted for nonmonetary asset exchanges occurring in fiscal periods after the
date of issuance. The provisions of SFAS No. 153 shall be applied prospectively.
The adoption of this Statement will not have a significant impact on our
financial condition or results of operations.
3. PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following as of December 31, 2003
and 2004:
2003 2004
---- ----
Computer equipment $ 485,989 $ 515,982
Furniture and fixtures 155,589 152,252
Leasehold improvements 143,253 143,253
Office equipment 47,552 43,338
--------- ---------
832,383 854,825
Less - Accumulated depreciation and amortization (621,976) (721,920)
--------- ---------
$ 210,407 $ 132,905
========= =========
Depreciation expense for the years ended December 31, 2002, 2003 and 2004
amounted to $126,537, $118,057 and $99,944, respectively.
4. INTANGIBLE ASSETS
The following summarize the carrying amounts of intangible assets and related
amortization:
As of December 31, 2003 As of December 31, 2004
----------------------------- -----------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Amortized intangible assets
Patents 105,661 56,863 105,661 63,072
Copyrights 17,500 11,910 17,500 17,500
-------------- ------------ -------------- ------------
Total $ 123,161 $ 68,773 $ 123,161 $ 80,572
============== ============ ============== ============
F-12
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Amortization expense for years ended December 31, 2002, 2003, and 2004 were
$325,043, $318,724 and $11,799, respectively.
As of December 31, 2004, estimated amortization expense for each of the
succeeding five years is $6,215.
5. ACCRUED EXPENSES
Accrued expenses are comprised of the following as of December 31, 2003 and
2004:
2003 2004
---- ----
Professional fees $184,876 $302,360
Payroll 128,783 131,661
Rent 23,943 20,523
Other 144,862 119,499
-------- --------
$482,464 $574,043
======== ========
6. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets for federal and state income taxes as of
December 31, 2003 and 2004 are as follows:
2003 2004
---- ----
Deferred tax assets, net:
Net operating loss carryforwards $ 8,904,550 $ 10,682,000
Depreciation (20,000) (20,000)
Reserves 636,000 779,000
Less- Valuation allowance (9,520,550) (11,441,000)
------------ ------------
Deferred tax assets, net $ -- $ --
============ ============
Realization of deferred tax assets is dependent upon future earnings, if any.
The Company has recorded a full valuation allowance against its deferred tax
assets since management believes that it is more likely than not that these
assets will not be realized in the near future.
As of December 31, 2004 the Company had net operating loss carryforwards (NOL's)
for federal income tax purposes of approximately $27 million. There can be no
assurance that the Company will realize the benefit of the NOL's. The federal
NOL's are available to offset future taxable income and expire from 2018 through
2024 if not utilized. Under Section 382 of the Internal Revenue Code, these
NOL's may be limited due to ownership changes.
The effective tax rate for the years ended December 31, 2002, 2003 and 2004 is
different from the tax benefit that would result from applying the statutory tax
rates mainly due to the additional valuation allowance that has been recognized.
7. SERIES A 8% CONVERTIBLE REDEEMABLE PREFERRED STOCK
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold 30,000
shares of our Series A 8% Convertible Redeemable Preferred Stock, par value $.01
per share, for $3,000,000 before expenses to Gryphon Master Fund, L.P. Each
share of Preferred Stock entitles the holder to receive dividends of 8% per
annum and was convertible into 15.1515 shares of our common stock. Additionally,
each investor received one (1) five year warrant to purchase 3.787875 shares of
common stock at an exercise price of $6.78 with each share of Preferred Stock
purchased. The total amount of shares that may be issued upon conversion of the
Preferred Stock and exercise of the warrants are 454,545 and 113,636,
respectively. Dividend payments of $120,000 in cash are due semi-annually
beginning September 30, 2003 and, accordingly, the Company paid $122,958 on
September 30, 2003. In connection with this financing, we paid agent fees of
$150,000 and issued warrants and options to purchase 8,854 shares of our common
stock at a price of $6.78. We also paid professional fees of approximately
$136,000. We recorded the relative fair value of all the warrants issued in
connection with this transaction of $497,700 against the amount of the
Convertible Redeemable Preferred Stock as of March 27, 2003, which was
calculated using the Black-Scholes valuation method, as well as $540,000 of
beneficial conversion feature in accordance with EITF 00-27 and such amounts
were being accreted along with issuance cost of $285,900 over the five year
period until the mandatory redemption date of the Preferred Stock, the fifth
anniversary of closing. We recorded dividend and accretion of $381,991 for 2003,
and dividends of $240,000 for 2004. On February 25, 2005, Gryphon Master Fund,
L.P. converted the Company's Preferred Stock into 454,545 shares of the
Company's common stock at a conversion price of $6.60 per share. A final
dividend payment of $97,315 was paid for the period up to the date of
conversion. Additionally, as a result of this conversion, the period we used in
estimating the accretion of all of the costs associated with the issuance of the
Preferred Stock changed from 5 years to 1.9166 years. Accordingly, the accretion
was increased in the fourth quarter of 2004 by $669,618 and amounted to $964,338
for the year ended December 31, 2004. The effect of this change in accounting
estimate in 2004 was a reduction in equity. A registration statement covering
the common stock issued upon conversion of the preferred stock and issuable upon
the exercise of the warrants was declared effective on June 24, 2003.
F-13
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
8. STOCKHOLDERS' EQUITY
Series A Convertible Preferred Stock
In January 1997, the Board of Directors authorized the creation of a class of
Series A Convertible Preferred Stock with a par value of $.01. The Series A
Convertible Preferred Stock is convertible into an equal number of common shares
at the holder's option, subject to adjustment for anti-dilution. The holders of
Series A Convertible Preferred Stock are entitled to receive dividends as and if
declared by the Board of Directors. In the event of liquidation or dissolution
of the Company, the holders of Series A Convertible Preferred Stock are entitled
to receive all accrued dividends, if applicable, plus the liquidation price of
$1.00 per share. As of December 31, 2003 and 2004, there were no outstanding
shares of Series A Convertible Preferred Stock.
Secondary Offering
On October 8, 2003, the Company successfully consummated its secondary offering
of 1,100,000 shares of common stock at $8.00 per share and received proceeds net
of underwriting discounts and commissions and before other offering expenses of
approximately $7,906,000. Offering expenses totaled $324,574 and were fully paid
as of December 31, 2003. In connection with this offering, the Company granted
to its underwriter an option to purchase up to an additional 165,000 shares of
its common stock at $8.00 per share less underwriter discounts and commissions
for the purpose of covering over-allotments, which expired on November 16, 2003.
In addition, the Company sold to the underwriter 110,000 warrants for a price of
$110 to purchase 110,000 shares of its common stock at a price of $9.60 per
share and expire on October 8, 2008.
Common Stock, Warrants and Rights
In March 2001, the Company declared a dividend distribution of one
non-transferable right to purchase one share of the Company's common stock for
every 10 outstanding shares of common stock continuous held from the record date
to the date of exercise, as well as common stock underlying vested stock options
and warrants, held of record on March 30, 2001, at an exercise price of $8.50.
The rights were due to expire on October 4, 2002, which was one year after the
effective date of the registration statement related to the shares of common
stock underlying the rights. We extended the expiration date until April 4,
2003, further extended the rights until December 31, 2003, June 30, 2004, and,
finally, extended the expiration date again to June 30, 2005. Under certain
conditions, the Company has the right to redeem the outstanding rights for $.01
per right. Such conditions were not met as of March 25, 2005. The Company
reserved 970,076 shares of common stock for future issuance under this rights
offering. The Company has recorded the fair value of the rights of $1,082,000 as
a dividend during the quarter ended March 31, 2001, which was calculated using
the Black-Scholes valuation method and recorded as an increase in additional
paid-in capital and a reduction in accumulated deficit. The Company also
recorded the fair value of the additional rights extensions of $515,000,
$2,000,000 and $525,000 during the years ended December 31, 2002, 2003 and 2004,
respectively, using the Black-Scholes valuation method and recorded an increase
in additional paid-in-capital and a reduction in accumulated deficit. As of
December 31, 2004, 292,001 of these rights were exercised and the Company
received cumulatively $2,482,009 before expenses of $133,834.
In March 2001, the Board of Directors authorized, subject to certain business
and market conditions, the purchase of up to $1,000,000 of our common stock. As
of December 31, 2004, the Company cumulatively purchased 40,200 shares of the
Company's common stock for approximately $222,000 and subsequently retired those
shares.
All warrants have been issued with an exercise price that is equal to or above
the fair market value of the Company's common stock on the date of grant.
F-14
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Stock Options
In order to retain and attract qualified personnel necessary for the success of
the Company, the Company adopted a Stock Option Plan (the "1998 Stock Option
Plan") covering up to 400,000 of the Company's common shares, pursuant to which
officers, directors, key employees and consultants to the Company are eligible
to receive incentive stock options and nonqualified stock options. The
Compensation Committee of the Board of Directors administers the 1998 Stock
Option Plan and determines the terms and conditions of options granted,
including the exercise price. The 1998 Stock Option Plan provides that all stock
options will expire within ten years of the date of grant. Incentive stock
options granted under the 1998 Stock Option Plan must be granted at an exercise
price that is not less than the fair market value per share at the date of grant
and the exercise price must not be less than 110% of the fair market value per
share at the date of grant for grants to persons owning more than 10% of the
voting stock of the Company. The 1998 Stock Option Plan also entitles
nonemployee directors to receive grants of non-qualified stock options as
approved by the Board of Directors.
In August 1999, the Company adopted the 1999 Stock Option Plan (the "1999 Stock
Option Plan") covering up to 1,000,000 of the Company's common shares, pursuant
to which officers, directors, key employees and consultants to the Company are
eligible to receive incentive stock options and nonqualified stock options. The
Compensation Committee of the Board of Directors administers the 1999 Stock
Option Plan and determines the terms and conditions of options granted,
including the exercise price. The 1999 Stock Option Plan provides that all stock
options will expire within ten years of the date of grant. Incentive stock
options granted under the 1999 Stock Option Plan must be granted at an exercise
price that is not less than the fair market value per share at the date of grant
and the exercise price must not be less than 110% of the fair market value per
share at the date of grant for grants to persons owning more than 10% of the
voting stock of the Company. The 1999 Stock Option Plan also entitles
nonemployee directors to receive grants of non-qualified stock options as
approved by the Board of Directors.
At the Company's Annual Meeting held on July 11, 2001, the stockholders approved
the 2001 Stock Option Plan covering up to 500,000 of the Company's common
shares, pursuant to which the officers, directors, key employees and consultants
to the Company are eligible to receive incentive stock options and nonqualified
stock options. The Compensation Committee of the Board of Directors administers
the 2001 Stock Option Plan and determines the terms and conditions of options
granted, including the exercise price. The 2001 Stock Option Plan provides that
all stock options will expire within ten years of the date of grant. Incentive
stock options granted under the 2001 Stock Option Plan must be granted at an
exercise price that is not less than the fair market value per share at the date
of the grant and the exercise price must not be less than 110% of the fair
market value per share at the date of the grant for grants to persons owning
more than 15% of the voting stock of the Company. The 2001 Stock Option Plan
also entitles non-employee directors to receive grants on non-qualified stock
options as approved by the Board of Directors.
At the Company's Annual Meeting held on July 10, 2003, the stockholders approved
the 2003 Stock Option Plan covering up to 500,000 of the Company's common
shares, pursuant to which the officers, directors, key employees and consultants
to the Company are eligible to receive incentive stock options and nonqualified
stock options. The Compensation Committee of the Board of Directors administers
the 2003 Stock Option Plan and determines the terms and conditions of options
granted, including the exercise price. The 2003 Stock Option Plan provides that
all stock options will expire within ten years of the date of grant. Incentive
stock options granted under the 2003 Stock Option Plan must be granted at an
exercise price that is not less than the fair market value per share at the date
of the grant and the exercise price must not be less than 110% of the fair
market value per share at the date of the grant for grants to persons owning
more than 15% of the voting stock of the Company. The 2003 Stock Option Plan
also entitles non-employee directors to receive grants on non-qualified stock
options as approved by the Board of Directors.
At the Company's Annual Meeting held on July 8, 2004, the stockholders approved
the 2004 Stock Option Plan covering up to 850,000 of the Company's common
shares, pursuant to which the officers, directors, key employees and consultants
to the Company are eligible to receive incentive stock options and nonqualified
stock options. The Compensation Committee of the Board of Directors administers
the 2004 Stock Option Plan and determines the terms and conditions of options
granted, including the exercise price. The 2004 Stock Option Plan provides that
all stock options will expire within ten years of the date of grant. Incentive
stock options granted under the 2004 Stock Option Plan must be granted at an
exercise price that is not less than the fair market value per share at the date
of the grant and the exercise price must not be less than 110% of the fair
market value per share at the date of the grant for grants to persons owning
more than 15% of the voting stock of the Company. The 2004 Stock Option Plan
also entitles non-employee directors to receive grants on non-qualified stock
options as approved by the Board of Directors.
F-15
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
During 2002, the Company granted stock options to purchase 180,176 shares of
common stock at exercise prices ranging from $3.97 to $12.10 per share to
consultants under various agreements, of which 50,000 options expired. During
2003, the Company granted additional stock options to purchase 69,425 shares of
common stock at exercise prices ranging from $6.78 to $6.97 per share to
consultants under various agreements. During 2004, the Company granted warrants
to purchase 100,000 shares of common stock at an exercise price of $7.54 per
share to consultants (see footnote 10). The fair market value of each option was
estimated on the date of grant using the Black-Scholes option pricing model.
Accordingly, we have recorded $1,469,327, $319,904 and $542,648 as deferred
compensation for these services as of December 31, 2002, 2003 and 2004,
respectively. As a result of some of the granted options having varying vesting
periods, the Company revalued certain options either as of the vesting date or
as of the balance sheet date for those options unvested using the Black Scholes
option pricing model. Accordingly, the Company recorded a reduction of the fair
value of these options totaling $596,800 for the year ended December 31, 2002,
an increase in the fair value of $66,781 for the year ended December 31, 2003
and a reduction of the fair value of $430,739 for the year ended December 31,
2004. During December 31, 2002, 2003 and 2004, the Company recognized
amortization of deferred compensation of $713,051, $357,194 and $363,407,
respectively.
Stock option activity under the 1998, 1999, 2001, 2003 and 2004 Stock Option
Plans during the periods indicated below is as follows:
Number Of Weighted Average
Options Exercise Price
--------- ----------------
Outstanding at January 1, 2002 1,946,041 $6.26
Granted 693,176 9.86
Canceled (31,651) 9.27
Exercised (273,700) 3.02
--------- -----
Outstanding at December 31, 2002 2,333,866 7.72
Granted 713,650 7.73
Canceled (171,183) 8.86
Exercised (175,209) 3.88
--------- -----
Outstanding at December 31, 2003 2,701,124 7.97
Granted 655,550 5.07
Canceled (436,500) 7.93
Exercised (142,700) 3.00
--------- -----
Outstanding at December 31, 2004 2,777,474 $7.11
========= =====
Included in the option schedule are 824,425 non-plan options, of which 699,925
are fully vested.
The weighted-average remaining life of the options outstanding at December 31,
2002, 2003 and 2004 is 3.54 years, 2.89 years and $4.42 respectively, and the
weighted-average fair value of the options granted during the year ended
December 31, 2002, 2003 and 2004 is $6.62, $5.58 and $2.97 respectively.
As of December 31, 2002, 2003 and 2004, the fair market value of each option
grant has been estimated on the date of grant using the Black-Scholes option
pricing model based upon expected option lives of 5, 5 and 5 years; risk free
interest rates of 4.50%, 4.50% and 4.0%; expected volatility of 90%, 90% and 60%
and a dividend yield of 0%, 0% and 0%, respectively.
As of December 31, 2004, the Company had 2,093,724 options exercisable with a
weighted average exercise price of $7.18. As of December 31, 2004, the Company
had 774,842 options available for future grant under the 1998, 1999, 2001, 2003
and 2004 Stock Option Plans.
On November 12, 2003, a member of the Company's Board of Directors resigned. The
Company agreed to extend the expiration date of his options to November 11,
2004, which originally were due to expire on February 10, 2004. As a result, the
Company recorded the fair value of the extension of $138,000 as a non cash
expense during the fourth quarter ended December 31, 2003, which was calculated
using the Black-Scholes valuation method.
F-16
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
On July 8, 2004, the Company's Board of Directors agreed to extend the
expiration date of the Chief Executive Officer's options to July 15, 2008, which
originally were due to expire on July 15, 2004. As a result, the Company
recorded the fair value of the extension of $1,347,000 as a non cash expense
during the second quarter ended December 31, 2004, which was calculated using
the Black-Scholes valuation method.
In the opinion of management, all stock options have been issued with an
exercise price that is equal or above the fair market value of the Company's
Common Stock on the date of grant.
9. ACQUISITION
On December 18, 2001, the Company acquired substantially all of the assets of
the IDentiScan Company, LLC, which was accounted for under the purchase method.
The aggregate purchase price totaled $1,032,947 which consisted of 59,774 of the
Company's restricted common stock valued at $980,000 based on the fair market
value at the date of acquisition and transaction costs of $52,947, plus
additional incentives upon meeting specific objectives over the next three
years. The purchase agreement provided that if after one year from closing, the
aggregate current market price of the shares issued at closing is less than
$750,000, the Company would pay additional cash or additional common stock for
the short fall. The Company computed the market value of the original 59,774
shares issued as of December 18, 2002 and it was valued at $487,457. As a
result, the Company issued an additional 32,194 shares to the owners of
IDentiScan in accordance with the Asset Purchase Agreement. The allocation of
the purchase price was $430,000 to acquired technology, $230,000 to
patents/trademarks, $181,447 to goodwill, $167,500 for other intangible assets,
and $24,000 to tangible assets. All Intangible assets except goodwill were being
amortized on a straight-line basis of between 2-10 years, which represents the
estimated future period to be benefited.
As of December 31, 2003, the Company decided to discontinue the selling of its
IDentiScan products. The Company has determined that there is no future benefit
from these intangibles related to the IDentiScan acquisition and, accordingly,
all of its intangible assets, except for $5,590 of copyrights, with a remaining
book value of $363,655, were written off as of December 31, 2003, which affected
the results of operations for the period then ended.
10. COMMITMENTS AND CONTINGENCIES
Operating Leases
During July 2000, the Company entered into a 10-year lease agreement for its new
office. The lease provides for monthly rental payments of $17,458 beginning
December 15, 2000 with immaterial annual increases. In connection with this
lease, the Company provided an irrevocable unconditional letter of credit in the
amount of $250,000 as security, which was cancelled and replaced with a cash
security payment of $34,916 for the remaining lease term.
In addition, the Company has entered into various leases for office equipment
and office space expiring through December 2010. Future minimum lease payments
under these lease agreements are as follows:
Year Ending December 31:
2005 247,552
2006 252,991
2007 261,444
2008 271,842
2009 282,660
Thereafter 293,454
----------
$1,609,943
==========
Rent expense for the years ended December 31, 2002, 2003 and 2004 amounted to
$242,083, $252,386 and $243,577, respectively.
F-17
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Capital Lease Obligations
The Company leased computer and office equipment under several capital leases
that expired in 2004. As of December 31, 2004, the Company had no outstanding
Capital Lease obligations.
Royalty and License Agreements
The Company entered into an agreement with a former officer of the Company
during 1996 to license certain software. The agreement stipulated, among other
provisions, that the officer would receive royalties equal to a percentage of
the Company's gross sales. This agreement was terminated in May 1999 and was
superceded by a new agreement which calls for payment of royalties of .005% on
gross sales from $2,000,000 to $52,000,000 and .0025% on gross sales in excess
of $52,000,000. As of December 31, 2004, total fees payable under this agreement
amounted to $148.
Employment Agreements
On November 9, 2004, the Company entered into a new one-year employment contract
with its Chairman and Chief Executive Officer, Frank Mandelbaum, effective
January 1, 2005. The agreement provides for an annual base salary of $250,000.
In addition, the Company granted to Mr. Mandelbaum an option to purchase 75,000
shares of common stock at an exercise price of $4.37 per share, of which 25,000
options became exercisable on January 1, 2005; 25,000 options shall become
exercisable on January 1, 2006 and the remaining 25,000 options shall become
exercisable on January 1, 2007.
If there shall occur a change of control, as defined in the employment
agreement, the employee may terminate his employment at any time and be entitled
to receive a payment equal to 2.99 times his average annual compensation,
including bonuses, during the three years preceding the date of termination,
payable in cash to the extent of three months salary and the balance in shares
of the Company's common stock based on a valuation of $2.00 per share.
On November 9, 2004, the Company entered into a new employment agreement with
our Senior Executive Vice President and Chief Financial Officer, Edwin Winiarz,
effective January 1, 2005. The agreement, which expires December 31, 2006,
provides for a fixed annual base salary of $162,086. In addition, the Company
granted to Mr. Winiarz an option to purchase 50,000 shares of common stock at an
exercise price of $4.37 per share, of which 25,000 options became exercisable on
January 1, 2005 and the remaining 25,000 options shall become exercisable on
January 1, 2006.
Each of the employment agreements requires the executive to devote substantially
all his time and efforts to our business and contains non-competition and
nondisclosure covenants of the officer for the term of his employment and for a
period of two years thereafter. Each employment agreement provides that we may
terminate the agreement for cause.
Supplier Agreements
In connection with the acquisition of certain assets of the IDentiScan Company,
LLC, on December 17, 2001, the Company entered into a product supply agreement
with Accu-Time Systems, Inc. ("ATS"). ATS agreed to manufacture the IDentiScan
line of products for an initial period of three (3) years and provides for
automatic renewal periods of one year. As a result of the Company discontinuing
the sale of these products, the product supply agreement was not renewed.
On January 2, 2004, the Company entered into a 2 year product supply agreement
with a manufacturer of input devices. Under the terms of the agreement, the
Company purchased the minimum required number of units during 2004. These
devices, which were private labeled, are programmed to work in conjunction with
the ID-Check technology.
Customer Agreement
Effective January 30, 2002, the Company mutually agreed with Sensormatic
Electronics Corporation not to renew its non-exclusive Master Distributor
agreement which was due to expire on March 31, 2002. The Company received
$412,000 from Sensormatic Electronics Corporation and additionally Sensormatic
agreed to return to the Company all units previously purchased and unsold in
their inventory as settlement of its obligations under the agreement. The
Company did not assign any value to these units. The Company recognized the
income, net of refurbishment costs, totaling $336,744 and it was recorded as
other income on the Company's Statements of Operations for the year ended
December 31, 2002.
F-18
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Investment Firm Relationships
Effective March 28, 2002, the Company entered into an agreement with KPMG
Corporate Finance LLC to act as an exclusive financial advisor to the Company.
The fee for such services was $100,000 of which $50,000 was paid as of March 31,
2002 and the balance paid by June 30, 2002. This amount was expensed in the
second quarter of 2002 as services were rendered. In connection with financing
described in Note 7, KPMG agreed to receive 2.0% in cash and 1% of funds drawn
in warrants. Effective January 5, 2004, the Company terminated this agreement.
On January 21, 2004, the Company entered into a one year agreement with
Alexandros Partners LLC to act as consultants in advising the Company in
financial and investor relation matters. The Company agreed to pay a consulting
fee of $50,000 payable in 12 equal monthly installments. In addition, the
Company issued a warrant granting the right to purchase 100,000 shares of the
Company's common stock at a purchase price of $7.54 per share, which vested
ratably over the 12 month period. A principal of Alexandros Partners LLC is
currently a member of the Company's Board of Directors. Effective January 1,
2005, the Company renewed its agreement with Alexandros Partners LLC for an
additional year and agreed to pay a consulting fee of $50,000 payable in 12
equal monthly installments.
On December 7, 2004, the Company entered into a one year agreement with a
consulting firm to help with our investor relations activities. The Company
agreed to pay a consulting fee of $100,000 payable in 12 monthly installments.
In addition, the Company issued 11,500 restricted shares of its common stock.
On November 2, 2004, the Company entered into an exclusive agreement with an
investment banking firm for the purpose of investigating the opportunities in
raising additional capital for the Company. There can be no assurances that the
Company will be successful in raising additional capital on acceptable terms.
Legal Proceedings
On February 19, 2003, the Company filed a summons and complaint upon CardCom
Technology, Inc. alleging infringement on its patent. During September 2003, the
Company settled this case with CardCom Technology, Inc. The Company granted
CardCom a three year royalty license to use certain of the Company's patents in
connection with the manufacture, use and sale of CardCom's age verification
products in the United States and Canada. It also provides that CardCom will pay
royalties of approximately 10% on its net sales. For the years ended December
31, 2003 and 2004, the Company received $65,165 and $67,113, respectively in
royalty fees pursuant to this agreement.
On April 9, 2003, the Company received notification from the American
Arbitration Association that it had awarded Early Bird Capital $921,730 on the
settlement of their demand. The Company had filed with the New York State
Supreme Court an application for setting aside the confirmation of the award. On
October 14, 2003, the court confirmed the award with interest at a rate of 9%
per annum beginning April 9, 2003. The Company recorded a charge of $921,730 in
its Statements of Operations for the three month period ending March 31, 2003.
The Company secured a one year letter of credit for the full amount of the
charge along with interest in the form of a certificate of deposit. On March 5,
2004, the Company paid $950,000, which included interest expense recorded in the
year ended December 31, 2003, to Early Bird Capital as full settlement in this
matter.
On August 1, 2003, the Company filed a summons and complaint against Tricom Card
Technologies, Inc. alleging infringement on its patent seeking injunctive and
monetary relief. On October 23, 2003, the Company amended its complaint to
include infringement on an additional patent. On May 18, 2004, the Company filed
a Second Amended Complaint alleging infringement and inducement to infringe
against certain principals of Tricom in their personal capacities, as well as
alleging in the alternative false advertising claims under the Lanham Act
against all the defendants. These principals have moved to dismiss the claims
against them, and Tricom has moved to dismiss the false advertising claims. The
Company has opposed the motions. The Joint Pretrial Order is due for filing on
November 19, 2004. The Company filed the proposed Joint Pretrial Order on
November 19, 2004, which has not yet been executed and a conference is scheduled
for April, 1, 2005.
We are not aware of any infringement by our products or technology on the
proprietary rights of others.
Other than as set forth above, we are not currently involved in any legal or
regulatory proceeding, or arbitration, the outcome of which is expected to have
a material adverse effect on our business.
F-19
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
11. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth unaudited financial data for each of
Intelli-Check's last eight fiscal quarters.
Year Ended December 31, 2003
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands)
Income Statement Data:
Revenues $ 264 $ 342 $ 345 $ 285
Gross profit 160 (596)(2) 243 (15)(3)
Loss from operations (1,101) (2,061) (1,042) (1,333)
Net loss (2,019)(1) (2,050) (1,078)(4) (1,304)
Net loss attributable to Common
stockholders (2,018) (2,178) (1,204) (1,433)
Net loss per share attributable to
Common stockholders:
Basic and diluted (0.23) (0.24) (0.13) (0.15)
Year Ended December 31, 2004
----------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(Dollars in thousands)
Income Statement Data:
Revenues $ 298 $ 260 $ 233 $ 328
Gross profit 195 144 (57)(5) 86(6)
Loss from operations (1,106) (2,663)(7) (1,694) (1,554)
Net loss (1,075) (2,642) (1,669) (1,537)
Net loss attributable to Common
stockholders (1,201) (2,768) (1,796) (2,362)(8)
Net loss per share attributable to
Common stockholders:
Basic and diluted (0.12) (0.27) (0.17) (0.23)
(1) During the first quarter, a litigation reserve of $921,730 was recorded.
(2) During the second quarter, an inventory reserve of $800,000 was recorded.
(3) During the fourth quarter, an additional inventory reserve of $190,000 was
recorded.
(4) Third quarter net loss was reduced by $126,000 to reflect additional
considerations which resulted in determining that adopting FASB No.150 had
no effect on our financial position and results of operations. This
adjustment had no effect on net loss attributable to common stockholders.
(5) During the third quarter, an inventory reserve of $200,000 was recorded.
(6) During the fourth quarter, an inventory reserve of $157,000 was recorded.
(7) During the second quarter, a non cash expense of $1,347,000 was recorded
for extension of options
(8) Effective in the fourth quarter, due to the conversion of the Convertible
Redeemable Preferred Stock on February 25, 2005, the amortization of the
accretion costs was increased by $669,618.
We have not experienced seasonality in our sales volume or operating
expenses.
F-20
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Schedule II - Valuation and Qualifying Accounts
Year Ended December 31, 2004, 2003 and 2002
Balance at Net Deductions Balance at
Year ended December 31, 2004 Beginning of Period Additions and Other End of Period
- -----------------------------------------------------------------------------------------------------------------
Doubtful accounts and allowances -- $ 20,000 -- $ 20,000
Deferred tax assets valuation allowance $9,520,550 1,920,450 -- 11,441,000
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Balance at Net Deductions Balance at
Year ended December 31, 2003 Beginning of Period Additions and Other End of Period
- -----------------------------------------------------------------------------------------------------------------
Doubtful accounts and allowances -- -- -- --
Deferred tax assets valuation allowance $6,722,540 $2,798,010 -- $9,520,550
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Balance at Net Deductions Balance at
Year ended December 31, 2002 Beginning of Period Additions and Other End of Period
- -----------------------------------------------------------------------------------------------------------------
Doubtful accounts and allowances -- -- -- --
Deferred tax assets valuation allowance $4,647,652 $2,074,888 -- $6,722,540
- -----------------------------------------------------------------------------------------------------------------
F-21
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
1 Form of Underwriting Agreement (1)
3.1 Certificate of Incorporation of the Company (1)
3.2 By-laws of the Company (1)
3.3 Certificate of Designation of Preferred Stock of Intelli-Check,
Inc. (7)
4.1 Specimen Stock Certificate (2)
4.2 Form of Underwriters' Warrant Agreement (1)
4.3 Warrant to Gryphon Master Fund LLP (7)
4.4 Form of Underwriters Warrant Agreement including form of Warrant
Certificate(8)
10.1 1998 Stock Option Plan (1) *
10.5 Agreement of Lease between the Company and Industrial and Research
Associates, dated as of October 15, 2000 (5)
10.6 1999 Stock Option Plan (1) *
10.7 Development and Supply Agreement between the Company and Welch
Allyn Data Collection Inc. dated July 9, 1999 (1)
10.9 Employment Agreement between the Company and W. Robert Holloway,
dated October 25, 1999 (1) *
10.10 Agreement between the Company and Kevin Messina, individually and
d/b/a K.M. Software Development, dated as of May 3, 1999 (1) *
10.11 Memorandum of Understanding between AAMVAnet, Inc. and Intelli
Check, Inc. effective November 15, 2000 (5)
10.12 2001 Stock Option Plan (4)
10.15 Memorandum of Understanding between AAMVAnet, Inc. and
Intelli-Check, Inc. effective January 29, 2002 (5)
10.16 Securities Purchase Agreement between Intelli-Check, Inc. and
Gryphon Master Fund dated March 27, 2003. (7)
10.17 Registration Rights Agreement between Intelli-Check, Inc. and
Gryphon Master Fund dated March 27, 2003. (7)
10.18 Employment Agreement between Frank Mandelbaum and the Company,
dated as of December 15, 2004* (6)
10.19 Employment Agreement between Edwin Winiarz and the Company, dated
as of December 15, 2004* (6)
14.1 Code of Business Conduct and Ethics (7)
21 List of Subsidiaries (1)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
The Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
The Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive
Officer and Chief Financial pursuant to Section 906 of The
Sarbanes-Oxley Act of 2002
- ----------
*Denotes a management contract or compensatory plan, contract or arrangement.
(1) Incorporated by reference to Registration Statement on Form SB-2 (File No.
333-87797) filed September 24, 1999.
(2) Incorporated by reference to Amendment No. 1 to the Registration Statement
filed November 1, 1999.
(3) Incorporated by reference to Amendment No. 2 to the Registration Statement
filed November 15, 1999.
(4) Incorporated by reference to Registrant's Proxy Statement on Schedule 14A
filed May 31, 2001.
(5) Incorporated by reference to Registrant's Annual Report on Form 10-K filed
March 29, 2001.
(6) Incorporated by reference from the Registrant's Current Report on Form 8-K
filed on December 16, 2004.
(7) Incorporated by reference to Registrant's Annual Report of Form 10-K filed
March 31, 2003.
(8) Incorporated by reference to Registration Statement on Form S-2 (File No.
333-108043) filed September 30, 2003.