FORM 10K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[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, 2002
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.
(Name of small business issuer as specified in its charter)
Delaware 11-3234779
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
246 Crossways Park West, Woodbury, New York 11797
(address of principal executive offices) (Zip Code)
Issuer's Telephone number, including area code: (516) 992-1900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-----------------------------
(Title of Class)
Check whether Issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the Issuer was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
Check if disclosure of delinquent filers pursuant to item 405 of Regulation S-B
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.
State the aggregate market value of the voting stock held by non-affiliates of
the Issuer: $ 51,010,700 (based upon the closing price of Issuer's Common Stock,
$.001 par value, as of March 26, 2003).
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 8,875,302
- ----------------------------- ---------
(Title of Class) (No. of Shares Outstanding
at March 26, 2003)
DOCUMENTS INCORPORATED BY REFERENCE: NONE
PART I
Item (a) Business
--------
(a) General Development of Business. We were originally incorporated in the
state of New York in 1994. In August 1999, we reincorporated in Delaware.
During the period from September 1996 until September 1999, we sold our
securities in private placements exempt from registration under the Securities
Act of 1933, as amended.
In November 1999, we sold, in an initial public offering, 1,000,000 shares
of common stock at an initial offering price of $7.50 per share. The net
proceeds that we received from the public offering amounted to approximately
$5,915,000.
In December 1999, the underwriter of the initial public offering exercised
its over-allotment option to purchase 150,000 common shares from us for $7.50
per share. The net proceeds received by us amounted to approximately $992,000.
In fiscal year 2000, options to acquire 66,000 shares of common stock and
warrants to acquire 1,115,084 shares were exercised. The net proceeds received
by us from these transactions was $3,426,374.
In fiscal year 2001, options to acquire 166,500 shares of common stock,
warrants to acquire 378,084 shares of common stock and rights to acquire 180,198
shares of common stock were exercised. The net proceeds received by us from
these transactions was $3,231,174.
In fiscal year 2002, options to acquire 273,700 shares of common stock,
warrants to acquire 1,250 shares of common stock and rights to acquire 107,396
shares of common stock were exercised. The net proceeds received by us from
these transactions was $1,742,466.
Recent Developments
-------------------
In March 2001, we declared a dividend distribution of one non-transferable
right to purchase one share of our common stock for every ten outstanding shares
of common stock continuously held from the record date to the date of exercise.
The rights were also distributed to holders of vested stock options and warrants
and were originally due to expire on October 4, 2002. At that time, we extended
the expiration date until April 4, 2003 and we further extended the expiration
date until December 31, 2003.
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold 30,000
shares of our Series A 8% Convertible Preferred Stock, par value $.01 per share
for $3,000,000 before expenses to Gryphon Master Fund, L.P. Each preferred share
entitles the holder to receive dividends of 8% per annum and is convertible into
15.1515 shares of our common stock. Additionally, each share of Preferred Stock
will receive one (1) 5 year warrant to purchase 3.787875 shares of common stock
at a price of $6.78. The total amount of shares that may be issued upon
conversion and the exercising of the warrants are 454,545 and 113,636 shares,
respectively. Dividend payments of $120,000 are due semi-annually in cash
beginning September 30, 2003. In connection with this financing, we paid agent
fees of $150,000, plus legal fees estimated to be approximately $55,000. Shares
of Preferred Stock will be 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
Shares 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 any 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.
In addition, we entered into a Registration Rights Agreement with respect
to the common stock underlying the Preferred Shares and the warrants pursuant to
which we will file a registration statement for the common stock no later than
30 days from the closing date of the sale of the preferred shares.
(b) Business of Issuer
(1) Principal Products
------------------
Our company was formed to develop, manufacture and market an advanced
document verification system to enable a user to detect altered, tampered or
fake IDs to:
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(i) reduce check cashing, credit card and other types of fraud such as
identity theft, the fastest growing crime in America, which principally
utilizes fake driver licenses as proof of identity;
(ii) increase security and deter terrorism at airports, shipping ports,
rail and bus terminals, military installations, high profile buildings and
other sites where security is a concern;
(iii) determine the customer's age and validity of the ID to detect and
prevent the use of fraudulent identification for the purchase of alcohol,
tobacco and other age-restricted products and to reduce the risk to the
retailer of substantial monetary fines, criminal penalties and license
revocation for the sale of age-restricted products to minors.
Our advanced document verification software, which we have licensed to
third parties and is contained in our ID- Check unit (terminal) reads in one
swipe or scan the encoded data contained on U.S. and Canadian driver licenses,
state issued identification cards and military IDs that 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).
Our terminal or licensed software helps merchants prevent economic loss
resulting from identity theft, which is the fastest growing crime in America.
The availability of high-tech fake ID's exposes retailers to many forms of fraud
utilizing fake ID's, which our unit has the capability of helping to detect.
The terminal or the licensed software are effective tools to enhance
security and deter terrorism at airports and other sites where security is
increasing. The terminals have been installed in over a dozen major airports to
verify the identity of employees and prevent access to secure areas. One major
airport recently reordered terminals. Since the tragic events of September 11,
2001, there has been increased interest in our technology to control access and
to help deter the threat of terrorism.
Additionally, 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 ID of potential customers to determine that they are of legal age to
purchase these products. These laws impose stringent penalties for violations.
In addition, many states and local governments have set up undercover "sting"
operations to detect violations.
The product we have designed and developed, the IDC-1400 is based on our
patented ID-Check technology. ID-Check provides businesses with a reliable,
simple and cost-effective way to reduce economic loss supported by fake or
altered driver licenses and to verify age and reduce the risk of severe
penalties for non-compliance with laws pertaining to age restricted products.
Effective July 9, 2003, our manufacturer will discontinue manufacturing the
IDC-1400 terminal and has introduced a new model to replace the existing
IDC-1400. We are in discussions with our manufacturer as well as other
manufacturers to select a new platform to run our patented software.
On December 18, 2001, we acquired substantially all the assets of The
IDentiScan Company, LLC, a provider of age verification terminals. The
IDentiScan products are targeted to the age verification market and they have
broadened our product line to better penetrate that market. IDentiScan has been
selected to be the exclusive provider of age verification terminals to Sunoco,
Inc.
Our new product, IDN-DLL, is a software application designed to supplement
our existing products by replicating the features of ID-Check using a customer's
existing hardware (or with minimal additional hardware components) included in
Point-Of-Sale (POS) terminals for multi-lane retailers such as grocery and
mass-retail stores. Currently, we have five (5) license agreements executed with
third parties for integration and sub-licensing of this application.
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. In addition to its primary function, the driver license is
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used to verify identity for social services, firearm sales, check cashing,
credit card use and other applications. There are approximately 228,000,000
driver licenses in circulation in the U.S. and Canada. Our technology can read
the data encoded on all licenses that comply with the AAMVA/ANSI/ISO standards,
which we believe is over 175,000,000 of those issued at the current time.
Currently, forty-six States, the District of Columbia, and seven Canadian
Provinces encode their licenses. The number of readable licenses will continue
to grow as the remaining four States and six 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 American Association of Motor Vehicle Administrators (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 all of these types of government identification.
The use of false identification
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:
(i) committing identity theft;
(ii) improperly boarding airplanes;
(iii) committing credit card, debit card and check cashing fraud;
(iv) unlawfully obtaining welfare or other government benefits;
(v) committing refund fraud,
(vi) committing pharmacy fraud, including false narcotic prescriptions,
(vii) gaining entrance to high profile buildings and sensitive
infrastructures, such as nuclear facilities;
(viii) illegally purchasing firearms;
(ix) purchasing age restricted products such as alcohol and tobacco while
under age;
(x) committing employee fraud, including employee theft and payroll
theft;
(xi) engaging in medical fraud.
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, what is needed is a document verification system
which can accurately read the electronically stored information. 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.
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Underage Use of Alcohol and Tobacco Products and the Need for Age Verification
Overview
Underage access to age-restricted products, like alcohol and tobacco,
remains a major societal problem.
(i) According to Connecticut Clearinghouse, approximately 10.6 million or
51.2% of high school students in the United States of America drink
alcoholic beverages at least once weekly, with 86% purchasing the
alcohol themselves;
(ii) The Office of Drug Control Policy reported that approximately 9.5
million drinkers of alcoholic beverages in 1996 were between the ages
of 12 and 20, according to the U.S. Department of Justice Office of
Juvenile Justice and Delinquency Prevention;
(iii)The Insurance Institute for Highway Safety has said that, in 1997,
26% of 16-20 year-olds fatally injured in motor vehicle crashes had
high blood alcohol concentrations;
(iv) According to the Journal of Adolescent Health, approximately 3,000
minors begin smoking regularly every day;
(v) Join Together Online's Fact Finder reports that underage youths can
purchase cigarettes successfully 70%- 80% of the time over the counter
and 90%-100% of the time through vending machines; and
(vi) Join Together also reports that each year merchants illegally sell
minors 947 million packs of cigarettes and 26 million containers of
chewing tobacco worth $1.26 billion;
(vii)A study by the National Center on Addiction and Substance Abuse at
Columbia University (CASA) found that 5 million high schoolers binge
drink at least once a week. It was also stated in the report that
children under 21 drink 25% of the alcohol consumed in the U.S.
To combat this problem, most states have enacted laws which provide for
substantial penalties for businesses that sell tobacco and alcohol to minors.
Regulation of retailers of tobacco products
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 appears
to be under the age of 27.
Regulation of retailers of alcoholic beverages
The retailer of alcoholic products who sells 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 under 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.
ID-Check Solution and Benefits
We believe the ID-Check solution is 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 to read, decode and process 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.
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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 can communicate with
personal computers, which could enhance the functionality of the terminals 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:
(i) is valid;
(ii) has been altered or tampered with;
(iii) has expired; and
(iv) 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:
(i) respond to the user by displaying the results in words on the
terminal's screen;
(ii) save information that is permissible by law to the terminal's own
memory;
(iii)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
(iv) 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 Q-Link or C-Link software, which
simplifies record keeping by downloading comprehensive ID-Check
due diligence data into a PC. This provides a merchant with
secure back-up files that include individual and cumulative
transaction records, where permitted by law.
(2) 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, participation in
trade shows, through resellers and OEM agreements. We had formulated our initial
marketing plan with the intention of having distributors sell sufficient
terminals per month to generate enough revenue to keep us at break even or
slightly profitable while its direct sales force concentrated on large accounts
where we knew the sales cycle was quite long and extended. We have recently
signed agreements to market our products through well known public interest and
trade associations in an effort to upgrade our distributor network. We have
entered into a marketing agreement with Mothers Against Drunk Driving (MADD) to
market our products for age-verification to sellers of alcoholic beverages. We
also signed an agreement with the American Association of Airport Executives
(AAAE), the most prominent aviation trade group in the world, to market our
document verification technology to the Aviation Industry. We are actively
pursuing additional well known organizations to expand our distributor channels.
We generate revenues from the sale or lease of ID-Check and IDentiScan
terminals, the sale of software upgrades, the sale of software maintenance and
hardware warranty programs, the sale of C-Link software and from the licensing
of our patented software to third parties.
Our patented ID-Check software is installed in a self-contained terminal
similar to those commonly used as credit card terminals, which we market to the
government, airlines, airports, high profile buildings and sensitive
infrastructure, mass merchandisers, grocery, convenience store and pharmacy
chains, casinos, banks and resellers of age restricted products. The ID-Check
unit has a suggested retail price of approximately $2,500, which includes our
Q-Link software and upgrades for the first year after purchase. We have
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developed a comprehensive marketing plan to build customer awareness and develop
brand recognition in target markets. We promote the advantages and ease of use
of the ID-Check terminal through:
(i) endorsement by nationally known public interest groups and trade
associations;
(ii) trade publications;
(iii) trade shows;
(iv) conventions and seminars;
(v) direct mail; and
(vi) our website.
As we gain market acceptance of the ID-Check terminal, we intend to develop
and market other related software applications.
Distribution strategy
In October 1999, we hired a vice president of sales. In December 2000, we
hired a director of corporate sales. In January 2002, we hired a director of
sales for the Southern Region of the U.S. In June 2002, we hired a director of
sales for the Western Region of the U.S.
Our initial target markets
Our initial target markets for the ID-Check terminal are:
(i) airports, airlines, bus, port and rail terminals;
(ii) banks and credit unions;
(iii) credit card issuers;
(iv) mass merchandisers;
(v) convenience stores;
(vi) grocery and pharmacy chains;
(vii) casinos;
(viii) bars and night clubs; and
(ix) resellers of age restricted products.
Some of the reasons why we have targeted these markets are:
(a) The Airlines are required by FAA regulations to verify the identity of
passengers over 18 years of age. The form of identification is usually
a valid driver license or other form of legally acceptable picture
identifica- tion in order to board any airliner domestically; and
(b) Banks are facing increased losses from fraudulent transactions
involving identity theft and additionally are required to verify the
identity of new accounts under provisions of the Patriot Act.
(c) Mass merchandisers and credit card issuers, who are facing huge
economic losses through the use of fraudulent credit cards and stolen
or forged checks, could use our technology to verify that the customer
who pays by check or credit card and presents a driver license as
proof of identity to support a transaction has presented a valid one
prior to processing the transaction.
Distributors and independent sales organizations
Management estimates there are thousands of businesses referred to as
distributors or independent sales organizations (ISO's), which specialize in
marketing equipment to "mom and pop" establishments. We believe that this is the
most cost effective way of reaching the smaller retailers. As such, we will
continue to actively enter into sales agreements with distributors and ISO's to
distribute our product. We have changed the requirements to become a reseller to
be more selective and are in the process of revamping our distributor network to
provide for a more knowledgeable and effective reseller.
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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. The 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 P.C. are included in the purchase price of the ID-Check unit
for the first year after purchase. We have begun to sell upgrade packages for
the period commencing after the first year of purchase. Because each terminal
has a unique serial number, the upgrade will only work with that terminal,
making unauthorized copying valueless. We have also developed a secure way of
delivering upgrades through the Internet.
C-Link Software
We have developed our C-Link software, which was introduced to the
marketplace in 2001 and is continually being enhanced with new features. C-Link,
when used in conjunction with our ID-check terminal, has the ability to collect
transaction information read and stored by the ID-Check terminal,
instantaneously display it in real time for enhanced security purposes and save
it to a PC hard drive for permanent storage. Once saved, the information can be
utilized to prevent potential economic loss to the user and can also be used to
easily search, analyze and generate demographics, statistics and mailing lists
for existing customers where permitted by law. It has the ability to build and
maintain watch lists, detect a recurring entry and signal the user when an alert
is triggered.
Additional Target Customers
In addition to the target markets prior stated, others that could benefit
by using the ID-Check terminal to prevent fraudulent transactions supported by
the use of a fake driver license as proof of identity or for access control
include:
(i) car rental agencies;
(ii) hotels and motels;
(iii) stadiums and arenas;
(iv) check cashing services;
(v) oil refineries and nuclear facilities;
(vi) court houses; and
(vii) law enforcement agencies.
Products in Development
We have developed prototypes of the following products:
MAVE In 1998, we built two prototypes of a hand-held portable version of
our ID-Check terminal specifically designed for law enforcement. We have
trademarked this product as MAVE for Mobile Age Verification and Enforcement. We
are currently testing other Windows based handheld products that could operate
our software for applications in the hospitality industry as well as other
industries.
IDN-DCD In 2002, we built several prototypes of a data capture device
containing a customized imager/scanner and a three track magnetic stripe reader
that are capable of reading all encoded data on encoded driver licenses so that
our IDN-DLL can be utilized with the customer's computer system.
(3) Competition
-----------
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 Legal Age, Card Com and ID Logix 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. Some of these
products are based on types of equipment which have limited functionality. Those
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units that cannot read barcodes are at a significant disadvantage because 31
States and two Canadian Provinces currently utilize barcodes to encode their
driver licenses in addition to all U.S. military ID's and uniformed services
cards. This number is expected to continue to increase within the next year
based upon current available information. In addition, some of these other
products cannot connect to a PC or use a printer. We also believe that some of
these products may infringe on our patent. We recently instituted a lawsuit
claiming patent infringement against CardCom.
There are also products being marketed which are essentially electronic
calendars designed to assist the retailer in calculating the age of the person
presenting a driver license. These devices, however, cannot determine whether a
driver license is valid or has been altered.
A very small number of laminate verifiers are currently used to determine
the validity of the laminate on a driver license. However, laminate verifiers
are fragile, not reliable and we believe can only be used in New York State.
(4) Supplier
--------
We had engaged Hand Held Products, Inc. (HHP) formerly known as Welch
Allyn, Inc., a leading privately-held manufacturer of medical equipment and
barcode readers and scanners, to provide a programmable terminal to operate our
patented ID-Check software. We have placed orders for 7,000 terminals of which
we have received 4,000, which contain a three-track magnetic reader and a
scanner/imager, which is an advanced form of barcode scanner. We have paid
$600,000 as a deposit to secure the purchase of the remaining units. HHP
informed us that effective July 9, 2003, they have discontinued manufacturing
this model and we are in discussions with them and other manufacturers as to
which platform we will select to run our patented software. The current terminal
is fully capable of running our patented software since it utilizes a state-of-
the-art imager/scanner and magnetic stripe reader. However, we have reserved the
$600,000 deposit because we have not yet determined whether we will purchase the
remaining units or select a new hardware platform to run our patented
technology.
If we are unable to secure a manufacturer for our terminal on satisfactory
terms to us, there may be an adverse effect on our results of operations.
However, as a result of our licensing of our technology, such effect could be
reduced as we would be less dependent on our supplier for sales.
In connection with the acquisition of certain assets of the IDentiScan
Company, LLC, we have also engaged another manufacturer, Accu-Time Systems, Inc.
to provide for the manufacturing of our IDentiScan line of products.
(5) Intellectual Property
---------------------
In January 1999, we were issued a patent on our ID-Check software
technology. In October 2002, we received from the U.S. Patent Office the
issuance of our continuation patent No. 6,462,416 B1. We have also been granted
multiple copyrights in the United States, which are effective in Canada and
other major industrial countries. The patent covers a specific process relating
to ID-Check, including age verification from a driver license. In addition, the
copyright protection covers software source codes and supporting graphics
relating to the operation of ID-Check and other software products. We have also
received several trademarks relating to our company, its product names, and
logos.
Upon the acquisition of the assets of IDentiScan, we received sole
ownership rights to intellectual property relating to age verification
technology. Specifically, Intelli-Check acquired ownership of U.S. Patent Nos.
6,523,741 and 6,148,091and its Canadian counterpart, Canadian Patent. No.
2,242,205. These patents are entitled "Apparatus for Controlling the Rental and
Sale of Age-Controlled Merchandise and for Controlling Access to Age-Controlled
Services." In addition, Intelli-Check also acquired all right, title and
interest to any and all patents resulting from pending U.K. patent application
No. 103275.4 relating to the foregoing patented technology as well as sole
rights to IDentiScan's trademarks, copyrights and trade secrets.
We also rely on proprietary knowledge and employ various methods, including
confidentiality agreements, to protect our software codes, concepts, ideas and
documentation of our proprietary technology.
Under an agreement with Mr. Kevin Messina, our former Senior Executive V.P.
and Chief Technology Officer, 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.
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(6) Employees
---------
As of March 26, 2003, we had twenty-five full-time employees and one
part-time employee, including four who are engaged in executive management,
thirteen in information technology, six in sales and marketing and three
administrative staff. We believe our relations with our employees are generally
good and we have no collective bargaining agreements with any labor unions.
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 2-year lease in
Connecticut to operate our IDentiScan division, which expires March 31, 2004.
Payments under these leases were $80,538 for 2000, $210,882 for 2001, $242,083
for 2002, and will be $2,113,236 for the remaining years of the leases.
Item 3. Legal Proceedings
-----------------
We are presently involved in three lawsuits.
A lawsuit was filed as a class action on October 18, 2001 on behalf of
short-sellers of our stock, who allegedly suffered losses because of the rise in
the price of our stock, in the United States District Court for New Jersey. The
class action suit was amended in November 2001 and is now an individual action.
The complaint alleges violations of the Securities and Exchange Act of 1934. On
July 26, 2002, we filed a motion to dismiss the lawsuit. Our motion to dismiss
has been fully briefed by both sides and is awaiting the Court's decision. The
Company believes the suit is without merit.
A demand for arbitration was brought by Early Bird Capital Inc. in January
2002, seeking issuance of warrants with registration rights pursuant to the
terms of a Financial Advisory and Investment Banking Agreement dated as of
August 20, 2000. The arbitration took place in December 2002 and January 2003,
and both sides have completed presenting their cases. Early Bird Capital has
demanded a monetary judgment in the amount of $968,000, which, if awarded, would
have a material adverse effect on us. We believe we have presented a meritorious
defense; however, there can be no assurance that we will prevail.
On February 19, 2003, we filed a summons and complaint upon CardCom
Technology, Inc. for its infringement on our patent. Under Federal rules, absent
an extension of time, the CardCom answer is due on or before April 1, 2003.
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.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
During the fourth quarter of our fiscal year ended December 31, 2002 there
were no matters submitted to a vote of security holders.
10
PART II
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.
2001 Low High
---- --- ----
First Quarter $3.70 $11.625
Second Quarter $4.50 $10.60
Third Quarter $7.40 $14.75
Fourth Quarter $10.20 $19.45
2002
----
First Quarter $11.30 $18.19
Second Quarter $4.85 $15.75
Third Quarter $2.10 $5.90
Fourth Quarter $2.90 $9.87
2003
----
January $6.35 $8.44
February $5.80 $7.66
(b) Number of Holders of Common Stock. The number of holders of record of
our Common Stock on March 26, 2003 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, 2002. 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. In November 1999, we completed
our initial public offering from which we received net proceeds of approximately
$5,915,000. In December 1999 the underwriters of our initial public offering
exercised the over allotment option to purchase an additional 150,000 shares of
our common stock from which we received net proceeds of $992,000. After
repayment of the Notes we issued in August and September 1999, we invested
approximately $5,000,000 in short term financial instruments and used
approximately $607,000 to make additional deposits on terminals and for general
working capital purposes.
In addition, we sold the following unregistered securities in reliance on
the exemption provided by Section 4(2) and Regulation 506 of the Securities Act
as transactions not involving a public offering:
In September 1996, we sold a total of 87,500 shares of our common stock for
$175,000. Paul Cohen and Eric Cohen, the father and uncle of our co-founder,
Todd Cohen, purchased 62,500 shares and 15,000 shares, respectively. Gregg
Messina, the brother of our co-founder, Kevin Messina, purchased 10,000 shares.
In connection with the issuance, (i) each shareholder represented to us that, by
virtue of his investment acumen, business experience or independent financial
and tax advice, he had the capability of evaluating the risks and merits in
investing in the shares, (ii) each shareholder represented that the shares
acquired cannot be sold without registration under the Securities Act, except in
reliance upon an exemption therefrom and (iii) we did not engage in any general
solicitation or advertisement for the issuance. The shareholders further
represented their intention to acquire the securities for investment only and
not with a view to the distribution thereof. Appropriate legends were affixed to
11
the stock certificates issued in such transactions. Each shareholder had
adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
In October 1996, we issued a total of 41,385 shares of our common stock to
satisfy loans in the aggregate amount of $82,770. Paul Cohen, the father of our
co-founder, Todd Cohen, accepted 28,885 shares in repayment of $57,770 of
indebtedness and William Glasgow, who has been, since September 1996, employed
by us and is currently Vice President of our Product, Management and Operations
Department, accepted 12,500 shares in repayment of $25,000 of indebtedness. Also
in October 1996, we issued a total of 22,500 shares of our common stock in
repayment of $45,000 owed to our former attorneys, Post & Heymann LLP. In
connection with the issuance, (i) each shareholder represented to us that, by
virtue of his investment acumen, business experience or independent financial
and tax advice, he had the capability of evaluating the risks and merits in
investing in the shares, (ii) each shareholder represented that the shares
acquired cannot be sold without registration under the Securities Act, except in
reliance upon an exemption therefrom and (iii) the registrant did not engage in
any general solicitation or advertisement for the issuance. The shareholders
further represented their intention to acquire the securities for investment
only and not with a view to the distribution thereof. Appropriate legends were
affixed to the stock certificates issued in such transactions. Each shareholder
had adequate access to sufficient information about the Company to make an
informed investment decision. The issuance and sale of these securities were
made in reliance on the exemption provided by Section 4(2) of the Securities
Act, as a transaction not involving any public offering. The issuance and sale
of these securities were made in reliance on the exemption provided by Section
4(2) of the Securities Act, as a transaction not involving any public offering.
In December 1996 and January 1997, Frank Mandelbaum, our chief executive
officer, made loans totaling $142,000 with interest at 10% with maturity in 90
days. He subsequently extended the notes on several occasions. In November 1997,
as part of the private placement discussed below, we issued to Mr. Mandelbaum
71,000 shares of our common stock and warrants to purchase 71,000 shares of our
common stock at an exercise price of $3.00 per share in exchange for Mr.
Mandelbaum's forgiveness of his loan to us of $142,000. Mr. Mandelbaum is an
accredited investor, as that term is defined in Regulation D promulgated under
the Securities Act. The securities issued to Mr. Mandelbaum contain a legend
stating that the securities acquired cannot be sold without registration under
the Securities Act, except in reliance upon an exemption therefrom. As the chief
executive officer, Mr. Mandelbaum had adequate access to sufficient information
about us to make an informed investment decision. The Company did not engage in
any general solicitation or advertisement for the issuance. The issuance and
sale of these securities were made in reliance on the exemption provided by
Section 4(2) of the Securities Act, as a transaction not involving any public
offering.
In January 1997, we entered into a Note Purchase Agreement with the New
York State Science and Technology Foundation, which became The Empire State
Development Corporation on February 1, 2000, pursuant to which we issued a
Convertible Promissory Note in the amount of $250,000. The Foundation also
agreed to invest an additional $250,000 through the purchase of 125,000 shares
of Series A convertible preferred stock based upon our raising a certain amount
of additional capital. The note bore interest at 8% per annum. In January 1998,
we exercised our right to redeem the convertible promissory note held by the
Foundation for 125,000 shares of Series A convertible preferred stock. In
addition, the Foundation purchased an additional 125,000 shares of Series A
convertible stock for $250,000. In July 1999, the Foundation exercised its
conversion rights and received 250,000 shares of common stock in exchange for
its preferred stock.
The Empire State Development Corporation formerly known as the New York
State Science and Technology Foundation subscribed to 100,000 units for $200,000
in the private placement of September 1998, discussed below, which units
consisted of one share of common stock and one warrant to acquire an additional
share at $3.00 per share. In April 1999, we adjusted the exercise price of
warrants issued to the Foundation from $3.00 to $2.00 if exercised within 30
days of the adjustment. In May 1999, the Foundation exercised such warrant and
we issued 100,000 shares of our common stock and a new warrant to purchase
100,000 shares of our common stock at an exercise price of $3.00, which was
exercised in February 2001.
In connection with the issuance of securities to the New York State Science
and Technology Foundation now known as the Empire State Development Corporation,
(i) the Foundation represented to us that it and/or its officers or employees
were experienced in evaluating and investing in newly-organized, high-technology
companies such as Intelli- Check, (ii) the Foundation represented that the
shares acquired cannot be sold without registration under the Securities Act,
12
except in reliance upon an exemption therefrom and (iii) we did not engage in
any general solicitation or advertisement for the issuance. Appropriate legends
were affixed to the stock certificates issued in such transactions. The
Foundation had adequate access to sufficient information about us to make an
informed investment decision. The issuance and sale of these securities were
made in reliance on the exemption provided by Section 4(2) of the Securities
Act, as a transaction not involving any public offering.
In February 1997, we issued 12,000 shares of our common stock to
Blanchfield King Kober, our former accountants, in payment of accounting fees
totaling $24,000. In June 1999, we issued an additional 9,000 shares of our
common stock to Blanchfield King Kober in payment of accounting fees totaling
$36,000. We believe that these accountants have such knowledge and experience in
financial and business matters that they were capable of evaluating the merits
and risks of the investment. The shares issued to the shareholders contain a
legend stating that the shares acquired cannot be sold without registration
under the Securities Act, except in reliance upon an exemption therefrom.
Because of their relationship with us, the shareholders had adequate access to
sufficient information about us to make an informed investment decision. We did
not engage in any general solicitation or advertisement for the issuance. The
issuance and sale of these securities were made in reliance on the exemption
provided by Section 4(2) of the Securities Act, as a transaction not involving
any public offering.
In May 1997 and June 1997, we sold 315,000 units to 8 purchasers, which
units consisted of one share of common stock and one warrant to acquire an
additional share at $3.00 per share originally set to expire in June 1999 in a
private placement with respect to which Jesup & Lamont Securities Corp. acted as
placement agent. The placement agent received a commission of $45,500 and a
non-accountable expense allowance of $20,000 in connection with the private
placement. Net proceeds to us were $550,849. Of the amount raised, $75,000
represented payment from one of our directors for 37,500 units. Our company also
issued to the placement agent non-redeemable warrants to purchase 7,500 units
for $2.25 per unit, which includes one share of common stock and an attached
warrant to purchase an additional share of common stock at $3.00 per share. In
connection with the issuance, (i) each shareholder represented to us that he was
either an accredited investor, as that term is defined in Regulation D
promulgated under the Securities Act, and/or that he and such other persons as
he found it necessary or advisable to consult, have sufficient knowledge and
experience in business and financial matters to evaluate the risks of the
investment and to make an informed investment decision with respect thereto,
(ii) each shareholder represented that the securities acquired cannot be sold
without registration under the Securities Act, except in reliance upon an
exemption therefrom and (iii) we did not engage in any general solicitation or
advertisement for the issuance. The shareholders further represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends were affixed to the stock
certificates and warrants issued in such transactions. Each shareholder had
adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
In November 1997, we sold in a private placement a total of 558,500 units
to 15 purchasers, which units consisted of one share of common stock and one
warrant to acquire an additional share at $3.00 per share originally set to
expire in November 1999. Our company received net proceeds of $1,117,000 from
this offering. In connection with the issuance, (i) each shareholder represented
to us that he was either an accredited investor, as that term is defined in
Regulation D promulgated under the Securities Act, and/or that he and such other
persons as he found it necessary or advisable to consult, have sufficient
knowledge and experience in business and financial matters to evaluate the risks
of the investment and to make an informed investment decision with respect
thereto, (ii) each shareholder represented that the securities acquired cannot
be sold without registration under the Securities Act, except in reliance upon
an exemption therefrom and (iii) we did not engage in any general solicitation
or advertisement for the issuance. The shareholders further represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends were affixed to the stock
certificates and warrants issued in such transactions. Each shareholder had
adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
In July 1998, we commenced a private placement of 500,000 units at $6.00
per unit. These units consisted of two shares of common stock at $3.00 per share
and one warrant to acquire an additional share at $5.00 per share expiring two
years from the date of the closing. In connection with this offering, we sold
31,000 units and received proceeds of $186,000. Due to market conditions
prevailing at that time for raising capital, we rescinded the offering and all
the subscribers agreed to re-subscribe under the terms of the September 1998
offering.
13
In September 1998, we commenced a private placement of 1,000,000 units at
$2.00 per unit. These units consisted of one share of common stock and one
warrant to acquire an additional share at $3.00 per share. The offering was
extended to January 17, 1999. We sold 273,000 units to 4 purchasers and received
$546,000 as a result of the offering, of which $30,000 was received in January
1999. In connection with the issuance, (i) each shareholder represented to us
that he was either an accredited investor, as that term is defined in Regulation
D promulgated under the Securities Act, and/or that he and such other persons as
he found it necessary or advisable to consult, have sufficient knowledge and
experience in business and financial matters to evaluate the risks of the
investment and to make an informed investment decision with respect thereto,
(ii) each shareholder represented that the securities acquired cannot be sold
without registration under the Securities Act, except in reliance upon an
exemption therefrom and (iii) we did not engage in any general solicitation or
advertisement for the issuance. The shareholders further represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends were affixed to the stock
certificates and warrants issued in such transactions. Each shareholder had
adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
In February 1999, we extended the expiration date for the warrants issued
in May 1997, June 1997 and November 1997 until June 30, 2000.
In March 1999, we commenced a private placement and sold 259,600 units to
17 purchasers at $2.00 per unit. These units consisted of one share of common
stock and one warrant to acquire an additional share at $3.00 per share. We
received $489,200 as a result of the offering prior to June 30, 1999 and $30,000
in August, 1999. In connection with the issuance, (i) each shareholder
represented to us that he was either an accredited investor, as that term is
defined in Regulation D promulgated under the Securities Act, and/or that he and
such other persons as he found it necessary or advisable to consult, have
sufficient knowledge and experience in business and financial matters to
evaluate the risks of the investment and to make an informed investment decision
with respect thereto, (ii) each shareholder represented that the securities
acquired cannot be sold without registration under the Securities Act, except in
reliance upon an exemption therefrom and (iii) we did not engage in any general
solicitation or advertisement for the issuance. The shareholders further
represented their intention to acquire the securities for investment only and
not with a view to the distribution thereof. Appropriate legends were affixed to
the stock certificates and warrants issued in such transactions. Each
shareholder had adequate access to sufficient information about us to make an
informed investment decision. The issuance and sale of these securities were
made in reliance on the exemption provided by Section 4(2) of the Securities
Act, as a transaction not involving any public offering.
In May 1999, we issued 10,000 shares of our common stock to Allan Binder in
exchange for the termination of a royalty agreement. Mr. Binder is an attorney
and served as a consultant. Because of his relationship with us, Mr. Binder had
adequate access to sufficient information about us to make an informed
investment decision. We believe that Mr. Binder had such knowledge and
experience in financial and business matters that he was capable of evaluating
the merits and risks of the investment. The shares issued to Mr. Binder contain
a legend stating that the shares acquired cannot be sold without registration
under the Securities Act, except in reliance upon an exemption therefrom. We did
not engage in any general solicitation or advertisement for the issuance. The
issuance and sale of these securities were made in reliance on the exemption
provided by Section 4(2) of the Securities Act, as a transaction not involving
any public offering.
In May 1999, we issued to Frank Mandelbaum 75,000 shares of our common
stock and warrants to purchase 75,000 shares at an exercise price of $3.00 per
share, which was exercised in October 2001 and we issued to Kevin Messina 5,063
shares of our common stock and warrants to purchase 5,063 shares at an exercise
price of $3.00 per share, which expired in October 2001. These issuances reduced
Mr. Mandelbaum's deferred compensation by $150,000 and Mr. Messina's deferred
compensation by $10,126. In addition, we issued to Mr. Messina 69,937 shares of
our common stock and warrants to purchase 69,937 shares of our common stock at
an exercise price of $3.00 per share in exchange for the termination of Mr.
Messina's reversion rights for certain software. These warrants expired in
October 2001. In June 1999, all remaining deferred compensation and interest due
to Mr. Mandelbaum, Mr. Messina and Todd Cohen was eliminated by the issuance of
options to purchase 375,000, 207,000 and 110,000 shares, respectively, of our
common stock. Mr. Mandelbaum's deferred compensation was reduced by
approximately $380,000, Mr. Messina's deferred compensation was reduced by
approximately $210,000 and Mr. Cohen's deferred compensation was reduced by
approximately $110,000. Mr. Mandelbaum is an accredited investor, as that term
is defined in Regulation D promulgated under the Securities Act. In addition, we
believe that each of these members of senior management had such knowledge and
experience in financial and business matters that they were capable of
evaluating the merits and risks of the investment. The securities issued to the
shareholders contain a legend stating that the warrants, options and underlying
14
shares cannot be sold without registration under the Securities Act, except in
reliance upon an exemption therefrom. As members of senior management, Messrs.
Mandelbaum, Messina and Cohen had adequate access to sufficient information
about the Company to make an informed investment decision. We did not engage in
any general solicitation or advertisement for the issuance. The issuance and
sale of these securities were made in reliance on the exemption provided by
Section 4(2) of the Securities Act, as a transaction not involving any public
offering.
In June 1999, we agreed to terminate the supplier agreement we had with
Hazeltine (formerly Marconi Aerospace Systems, Inc.), for which we issued 75,000
shares of our common stock to Hazeltine in payment of outstanding invoices
totaling $220,000, and we received all units of ID-Check which had been
manufactured, all samples, designs, drawings, software, molds and any other item
related to ID-Check. In connection with the issuance, (i) the shareholder
represented to us that it was an accredited investor, as that term is defined in
Regulation D promulgated under the Securities Act, and that it had sufficient
knowledge and experience in business and financial matters to evaluate the risks
of the investment and to make an informed investment decision with respect
thereto, (ii) the shareholder represented that the securities acquired cannot be
sold without registration under the Securities Act, except in reliance upon an
exemption therefrom and (iii) we did not engage in any general solicitation or
advertisement for the issuance. The shareholder further represented its
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends were affixed to the stock
certificates issued in such transaction. The shareholder had adequate access to
sufficient information about us to make an informed investment decision. The
issuance and sale of these securities were made in reliance on the exemption
provided by Section 4(2) of the Securities Act, as a transaction not involving
any public offering.
In August and September 1999 we placed $1,200,000 of secured promissory
notes with interest at 10%. These notes have warrants attached to purchase 2,500
shares for each principal amount of $50,000 at $3.00 per share expiring in
August 2002 of securities by us and can be redeemed by us at $.01 per warrant at
any time that our stock has a public market price of $6.00 per share for 20
consecutive days. The notes mature on the sooner of July 31, 2000 or the date
that we receive gross proceeds from a public offering of our securities of
$6,000,000. In connection with the issuance, (i) each noteholder represented to
us that he was either an accredited investor, as that term is defined in
Regulation D promulgated under the Securities Act, and/or that he and such other
persons as he found it necessary or advisable to consult, have sufficient
knowledge and experience in business and financial matters to evaluate the risks
of the investment and to make an informed investment decision with respect
thereto, (ii) each noteholder represented that the notes, warrants and
underlying shares cannot be sold without registration under the Securities Act,
except in reliance upon an exemption therefrom and (iii) we did not engage in
any general solicitation or advertisement for the issuance. The noteholders
further represented their intention to acquire the securities for investment
only and not with a view to the distribution thereof. Appropriate legends were
affixed to the notes and warrants issued in such transactions. Each noteholder
had adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering.
In December 2000, we granted 25,000 stock options to Korey Kay & Partners
Inc., our advertising firm, for services to be performed, of which all are
exercisable at $10.00. In December 2000, 3,599 of these stock options vested for
services performed which services were valued at $14,398. During 2001, 210
additional stock options vested for services performed which services were
valued at $842. We do not expect to utilize their services in the future and the
remaining unvested stock options were expired as of December 31, 2002. The stock
options were issued pursuant to our 1998 Stock Option Plan in reliance on the
exemption provided by Section 4(2) of the Securities Act, as a transaction not
involving any public offering. The agreement for the option grant contains
restrictions on transfer of the options by the Optionee. The shares underlying
the options are registered pursuant to an effective Form S-8 registration
statement. We believe that Korey Kay, as the Company's advertising firm, had
such knowledge and experience, in financial and business matters, that it was
capable of evaluating the merits and risks of an investment and adequate access
to sufficient information about us to make an informed investment decision.
During 2000, we received $3,223,874 from the exercise of 1,115,084 warrants
previously issued. Except for the underwriter warrants, all of the warrant
holders received these warrants from their participation in our private
placement of stock and debt financing prior to its initial public offering. In
connection with the issuance, (i) each warrantholder represented to us that, by
virtue of his investment acumen, business experience or independent financial
15
and tax advice, he had the capability of evaluating the risks and merits in
investing in the shares, (ii) each warrantholder represented that the shares
acquired cannot be sold without registration under the Securities Act, except in
reliance upon an exemption therefrom and (iii) we did not engage in any general
solicitation or advertisement for the issuance. The warrantholders further
represented their intention to acquire the securities for investment only and
not with a view to the distribution thereof. Appropriate legends were affixed to
the stock certificates issued in such transactions. Each warrantholder had
adequate access to sufficient information about us to make an informed
investment decision. The issuance and sale of these securities were made in
reliance on the exemption provided by Section 4(2) of the Securities Act, as a
transaction not involving any public offering. Of these warrants, 71,000 were
exercised by an Executive Officer of Intelli-Check and 37,500 warrants were
exercised by a Director of Intelli-Check. Each of the Executive Officer and
Director who exercised their warrants is an accredited investor as that term is
defined in Regulation D promulgated under the Securities Act. In addition, we
believe that each of these persons had such knowledge and experience in
financial and business matters that they were capable of evaluating the merits
and risks of the investment. The securities issued to the shareholders contain a
legend stating that the warrants and underlying shares cannot be sold without
registration under the Securities Act, except in reliance upon an exemption
therefrom. As a member of senior management and a director of Intelli-Check,
such persons had adequate access to sufficient information about us to make an
informed investment decision. We did not engage in any general solicitation or
advertisement for the issuance. The issuance and sale of these securities were
made in reliance on the exemption provided by Section 4(2) of the Securities
Act, as a transaction not involving any public offering. In addition, the
underwriters of our initial public offering exercised 90,000 warrants. We
believe that the underwriter had such knowledge and experience in financial and
business matters that it was capable of evaluating the merits and risks of the
investment. We did not engage in any general solicitation or advertisement for
the issuance. The underwriter had adequate access to sufficient information
about us to make an informed investment decision. The issuance and sale of these
securities were made in reliance on the exemption provided by Section 4(2) of
the Securities Act, as a transaction not involving any public offer.
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 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. On October 1, 2002, the company extended the expiration date until April
4, 2003 and further extended them until December 31, 2003. If certain conditions
are met, we have the right to redeem the outstanding rights for $.01 per right.
As of March 26, 2003, these conditions were not met. We have reserved 970,076
shares of common stock for future issuance under this rights offering. As of
December 31, 2002, 287,594 of these rights were exercised and we received
$2,444,549 before expenses.
In March 2001, we extended the expiration date of its warrants that were
due to expire on various dates through June 30, 2001, until September 30, 2001.
In September 2001, we further extended the expiration of these warrants until
October 31, 2001. During 2001, we received $1,058,175 from the exercise of
352,725 remaining warrants. Of these warrants, 75,000 were exercised by an
Executive Officer of Intelli-Check. In addition, 36,250 warrants were converted
into 25,329 shares of our common stock utilizing the cashless exercise
provision. During 2002, we received $3,750 from the exercise of 1,250 warrants.
As of December 31, 2002, there remained underwriter warrants outstanding to
purchase 10,000 shares of the Company's common stock at an exercise price of
$8.40.
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. During 2001, we purchased 10,000 shares totaling approximately $53,000
and subsequently retired these shares. During 2002, we purchased an additional
10,000 shares totaling approximately $70,000 and subsequently retired these
shares.
During 2001, we received $775,150 from the exercise of 166,500 stock
options. During 2002, we also received $825,850 from the exercise of 273,700
stock options.
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold
30,000 shares of our Series A 8% Convertible Preferred Stock, par value $.01 per
share for $3,000,000 before expenses to Gryphon Master Fund, L.P. Each preferred
share entitles the holder to receive dividends of 8% per annum and is
convertible into 15.1515 shares of our common stock. Additionally, each share of
Preferred Stock will receive one (1) five year warrant to purchase 3.787875
shares of common stock at a price of $6.78. The total amount of shares that may
be issued upon conversion and the exercising of the warrants are 454,545 and
16
113,636 shares, respectively. The Company must redeem all of the Preferred S
tock outstanding on the fifth anniversary of the closing date at a redemption
price, in cash, equal to the purchase price of the Preferred Stock.
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 years in the five years ended December 31, 2002, are derived from the
financial statements of Intelli-Check, Inc. The financial statements for fiscal
years ended December 31, 1998 through December 31, 2001 were audited by Arthur
Andersen LLP, independent public accountants and the financial statements for
the fiscal year ended December 31, 2002 have been audited by Grant Thornton, LLP
independent certified public accountants. The selected financial data should be
read in conjunction with the financial statements as of December 31, 2002, the
accompanying notes and the report of independent public accountants thereon,
which are included elsewhere in this Form 10-K.
Years Ended December 31,
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(In thousands)
Statement of Operations Data:
Revenue $ 86 $ 29 $ 343 $ 886 $ 1,139
Loss from operations (1,442) (2,263) (3,379) (4,090) (5,936)
Net Loss (1,504) (2,299) (3,133) (3,963) (5,550)
Net loss per common share - basic and diluted (0.36) (0.45) (0.47) (0.52) (0.64)
Common shares used in computing per
share amounts - basic and diluted 4,208 5,080 6,648 7,911 8,686
As of December 31
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(In thousands)
Balance sheet data:
Cash and cash equivalents 160 6,381 4,092 4,061 1,911
Working capital (deficit) (925) 6,038 5,920 5,303 2,634
Total assets 451 7,208 7,940 8,423 5,415
Stockholders equity (deficit) (658) 6,325 6,633 7,030 3,873
Item 7. Management's Discussion and Analysis of Financial Condition and Results
------------------------------------------------------------------------
of Operations
-------------
(a) Overview
Our company was formed in 1994 to address a growing need for a reliable
document and age verification system to detect fraudulent driver licenses and
other widely accepted forms of government-issued identification documents. Our
sales through September 30, 2000 had been minimal since through 1998 we had
previously produced only a limited pre- production run of our product for
testing and market acceptance. In late 1999, we received a limited number of
ID-Check terminals, which were then available for sale. Shortly thereafter,
these terminals were returned to the manufacturer to be upgraded to contain an
advanced imager/scanner, which allows our software to currently read the
encoding on over 50 jurisdictions as opposed to 32 jurisdictions on the original
scanner. During the fourth quarter of 2000, we experienced a material increase
in sales as a result of product availability and establishing marketing and
distributor agreements with resellers. During 2001 and 2002, sales were limited
due to the refocus of our marketing efforts towards the larger customers in the
retail market, in which the sales cycle normally requires an extended time frame
involving multiple meetings, presentations and a test period, which has been
further extended by the rapid slowing of the economy, whereby decisions for
capital expenditures have been delayed. However, after the tragic events that
occurred on September 11, 2001, there has been a significant increase in
awareness and demand for our technology to help improve security across many
industries, including airlines, high profile buildings and facilities. Since
inception, we have incurred significant losses and negative cash flow from
operating activities, and as of December 31, 2002 we had an accumulated deficit
of $18,186,176. We will continue to fund operating and capital expenditures from
proceeds that we received from our initial public offering ("IPO") and our
recent issuance of convertible preferred stock as well as the exercise of
17
warrants, options and rights. 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.
Our initial marketing focus was targeted towards retailers of
age-restricted products such as alcohol and tobacco. Because of our products
enhanced ability to verify the validity of military ID's, driver licenses and
state issued ID cards, containing either magnetic stripes or bar codes that
conform to AAMVA/ANSI/ISO standards, we have refocused our marketing efforts to
address the markets being affected by the cost to industry of "Identity Theft"
and the need for enhanced security. As a result of our ID-Check product having
the ability to verify the encoded formats of the documents described above, we
have already sold our ID-Check unit to some of the largest companies in the
gaming industry, a state port authority, military establishments, airports,
nuclear power plants, high profile buildings and have completed successful tests
of our technology in one of the largest mass merchandisers in the United States
and a large quasi-government department. We currently have our product in tests
with some large public companies. In addition, we have recently signed
agreements with some high profile organizations which will promote the use of
our technology and our products, such as Mothers Against Drunk Driving (MADD)
and the American Association of Airport Executives (AAAE).
(b) Results of Operations
Comparison of the year ended December 31, 2002 to the year ended December
31, 2001.
The Company sells its product directly through its sales force and through
distributors. Revenue from direct sales of the Company's product is recognized
upon shipment to the customer. The Company's product requires continuing service
or post contract customer support and performance by the Company, and
accordingly a portion of the revenue based on its fair value is deferred 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 to distributors, 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.
Revenues increased $252,679 from $885,908 for the year ended December 31,
2001 to $1,138,587 recorded for the year ended December 31, 2002. Revenues for
the period ended December 31, 2002 consisted of revenues from distributors of
$464,463 and revenues from direct sales to customers of $674,124. Sales, which
represent shipments of products and contracted services, increased 34% from
$989,692 to $1,326,829 for the years ended December 31, 2001 and 2002,
respectively, primarily as a result of the inclusion of IDentiScan, which
continues to focus on the age verification market. The refocus of our marketing
efforts for Intelli-Check's patented technology to the document verification and
access control markets, which consists of the larger retailers and government
agencies, in which the sales cycle requires an extended time frame involving
multiple meetings, presentations and a test period, continues to impact our
sales. In addition, during 2001 and continuing in 2002, the sales cycle has been
further extended by the rapid slowing of the economy, resulting in decisions for
capital expenditures being delayed. Certain tests, recent marketing agreements
and legislative efforts from the government to enhance security are expected to
result in increased sales opportunities.
Operating expenses, which consist of selling, general and administrative
and research and development expenses, increased 46.2% from $4,497,322 for the
year ended December 31, 2001 to $6,573,129 for the year ended December 31, 2002.
Selling expenses, which consist primarily of salaries and related costs for
marketing, increased 51.2% from $950,774 for the year ended December 31, 2001 to
$1,437,509 for the year ended December 31, 2002 primarily due to increased
salary costs, commissions and related expenses from hiring additional sales
personnel totaling approximately $224,000, increased travel and convention
expenses of approximately $112,000, increased advertising and marketing expenses
of approximately $31,000 and hiring professional consultants to promote our
product totaling approximately $103,000. 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, increased 43.9% from $2,332,150 for the year ended
December 31, 2001 to $3,355,549 for the year ended December 31, 2002, primarily
as a result of increased salary costs and related expenses from salary increases
and the hiring of additional personnel relating to the acquisition of the
IDentiScan assets in December 2001 of approximately $131,000, increased fees for
investment relations consultants of approximately $705,000 primarily relating to
the recognized non-cash expense of the granting of options to this group, which
was 78% of this increase, increases in depreciation and amortization expenses of
approximately $325,000 from additional purchases of equipment and acquired
intangible assets from the acquisition of IDentiScan, increases in insurance
costs of approximately $27,000 due to increases in premiums and higher rent
expense of approximately $34,000 due to rent escalations and additional space
from the acquisition of IDentiScan partially offset by lower legal costs of
approximately $131,000 due to the settling of certain lawsuits. Research and
development expenses, which consist primarily of salaries and related costs for
the development of our products, amounted to $1,214,398 for the year ended
December 31, 2001 compared to $1,180,071 for the year ended December 31, 2002,
has not materially changed. During the 4th quarter of 2002, we recorded a
reserve on inventory deposit of $600,000, which represents the deposit we paid
18
the manufacturer on an open purchase order due to the uncertainty of whether or
not we will complete the order to purchase additional units from our
manufacturer or to fulfill future orders from a new platform once it is
selected. As the Company experiences sales growth, we expect that we will incur
additional operating expenses to support this growth. Research and development
expenses may increase as we integrate additional products and technologies with
our patented ID-Check technology.
Interest expense decreased from $8,336 for the year ended December 31, 2001
to $4,878 for the year ended December 31, 2002 as we have paid down certain
capital leases which had higher interest rates.
Interest income decreased from $135,860 for the year ended December 31,
2001 to $53,871 for the year ended December 31, 2002, which is a result of a
decrease in our cash and cash equivalents available for investment and lower
interest rates in effect during this period.
Other income for the year ended December 31, 2002 totaling $336,344
resulted from a settlement of certain obligations under a Master Licensing
agreement between the Company and Sensormatic Electronics Corporation, which was
due to expire on March 31, 2002. We received $412,000 and incurred $75,656 in
refurbishment costs for previously customized terminals during the quarter ended
March 31, 2002.
We have incurred net losses to date; therefore we have paid nominal income
taxes.
As a result of the factors noted above, our net loss increased from
$3,962,931, which included $327,727 of non-cash expenses for the year ended
December 31, 2001 to $5,550,234 for the year ended December 31, 2002, which
included $1,773,131 of non-cash expenses, accounting for 91% of the increase in
our net loss.
Comparison of the year ended December 31, 2001 to the year ended December
31, 2000.
The Company sells its product directly through its sales force and through
distributors. Revenue from direct sales of the Company's product is recognized
upon shipment to the customer. The Company's product requires continuing service
or post contract customer support and performance by the Company, and
accordingly a portion of the revenue based on its fair value is deferred 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 to distributors, 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.
Revenues increased by $542,929 from $342,979 recorded for the year ended
December 31, 2000 to $885,908 recorded for the year ended December 31, 2001.
Revenues from distributors totaled $721,930 and revenues from direct customers
totaled $163,978. Revenues for the year ended December 31, 2000 included initial
sales of a limited number of ID-Check terminals prior to the return of our
inventory of these terminals to the manufacturer for upgrading. Sales of our
enhanced product began in the later part of the third quarter of 2000 and
primarily consisted of the initial order under the marketing agreement with
Sensormatic Electronics Corporation. Sales of approximately $585,000 for the
year ended December 31, 2001 were limited by the refocus of our marketing
efforts towards the larger customers within the retail market, in which the
sales cycle normally requires an extended time frame involving multiple
meetings, presentations and a test period, which has been further extended by
the rapid slowing of the economy, resulting in decisions for capital
expenditures being delayed. In addition, the roll-out of Sensormatic's sales and
marketing initiatives, which were to begin in April 2001 never materialized.
Since Sensormatic has met all its obligations under the original agreement,
which was modified in January 2002, the agreement, which was scheduled to expire
on March 31, 2002, was, by mutual consent, not renewed. We have also begun to
market to various government and state agencies, which have long sales cycles
including extended test periods.
Operating expenses, which consist of selling, general and administrative
and research and development expenses, increased 27.6% from $3,523,357 for the
year ended December 31, 2000 to $4,497,322 for the year ended December 31, 2001.
Selling expenses, which consist primarily of salaries and related costs for
marketing, increased 6.8% from $890,453 for the year ended December 31, 2000 to
$950,774 for the year ended December 31, 2001 primarily due to increases in
expenses attributable to the hiring of a Director of Corporate sales totaling
approximately $100,000, increased travel expenses of approximately $67,000 and
hiring professional consultants to promote our product totaling approximately
$229,000 offset by the reduction of advertising expenses totaling $293,000.
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, increased 46.6% from
$1,590,896 for the year ended December 31, 2000 to $2,332,150 for the year ended
19
December 31, 2001, primarily as a result of an increase in rent expense of
approximately $99,000 as we moved to a larger facility and increased
professional fees for accounting and investment relations counsel of
approximately $169,000, increased legal fees of approximately $244,000,
resulting from the defense of our patent and other law suits, increases in
depreciation expenses from additional purchases of equipment of approximately
$28,000, increases in insurance costs of $27,000 and refurbishment costs on
inventory of $100,000. Research and development expenses, which consist
primarily of salaries and related costs for the development of our products,
increased 16.5% from $1,042,008 for the year ended December 31, 2000 to
$1,214,398 for the year ended December 31, 2001. This increase is primarily
attributable to net increases in salaries and related expenses and hiring
additional programmers totaling $188,000. We expect that expenses will continue
to increase in line with increases in the sales and growth of the business as we
may increase expenditures for advertising, brand promotion, public relations and
other marketing activities. We expect that we will incur incremental general and
administrative expenses as we grow the business in line with the sales growth of
the business. Research and development expenses may also increase as we complete
and introduce additional products based upon our patented ID-Check technology.
Interest expense decreased from $14,863 for the year ended December 31,
2000 to $8,336 for the year ended December 31, 2001 as we have paid down certain
capital leases which had higher interest rates than those currently prevailing.
Interest income decreased from $261,181 for the year ended December 31,
2000 to $135,860 for the year ended December 31, 2001, which is a result of a
decrease in our cash and cash equivalents available for investment and lower
interest rates in effect during this period.
We have incurred net losses to date; therefore, we have paid nominal taxes.
As a result of the factors noted above, our net loss increased from
$3,132,772 for the year ended December 31, 2000 to $3,962,931 for the year ended
December 31, 2001.
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 the Company's 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 the Company's procedures related to these
policies, are described in detail below.
A. Revenue Recognition
We sell our products directly through our sales force and through
distributors. Revenue from direct sales of our product is recognized upon
shipment to the customer. Our product requires continuing service or post
contract customer support and performance by us, and 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. Currently, with respect to sales to distributors and
sales of our IDentiScan 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.
During the third quarter of fiscal 2002, we began recognizing sales from
the licensing of our technology to customers. Our licensing products require
continuing service or post contract customer support and performance by us, and
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.
20
B. Inventory Valuation
Our inventory consists primarily of its ID-Check terminals that run our
patented software. The inventory was originally received December 1999. 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. Even though we have had limited
sales to date, we believe that a sufficient market exists to sell (with margin)
the current inventory as well as the remaining units required to be purchased
from our manufacturer for which we have paid a deposit of $600,000. The current
terminal, for which this deposit was paid, is fully capable of running our
patented software as it utilizes a state-of-the-art imager/scanner and magnetic
stripe reader. However, since our policy is to periodically evaluate the market
value of the inventory, should we determine in a future period that an
adjustment is necessary, we would record such adjustment at that time, which
could have a material effect on our results of operations. We are in discussions
with our current manufacturer as well as other manufacturers to select a new
platform to run our patented software. However, during the fourth quarter of
2002, we reserved 100% of this deposit due to the uncertainty of whether or not
we will place the order to purchase the additional units from the manufacturer
under the open purchase order or purchase units to fulfill future orders from a
new platform once it is selected.
C. Commitments and Contingencies
We are currently involved in certain legal proceedings as discussed in the
"Commitments and Contingencies" note in the Notes to the Financial Statements.
We do not believe these legal proceedings will have a material adverse effect on
our financial position, results of operations or cash flows. However, were an
unfavorable ruling to occur, there exists the possibility of a material impact
on the operating results of that period.
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. See our audited
financial statements and notes thereto which begin on page F-1 of this Annual
Report on Form 10-K which contain accounting policies and other disclosures
required by generally accepted accounting principles.
(c) Quarterly Results and Seasonality
The following table sets forth unaudited financial data for each of
Intelli-Check's last eight fiscal quarters.
Year Ended December 31, 2001 Year Ended December 31, 2002
---------------------------- ----------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter(2)
------- ------- ------- ------- ------- ------- ------- ----------
(Dollars in thousands)
Income Statement Data:
Revenues $ 205 $ 270 $ 280 $ 131 $ 254 $ 287 $ 232 $ 366
Gross profit 87 129 126 65 124 171 126 216
Loss from operations (930) (920) (937) (1,303) (1,772) (1,346) (1,234) (1,584)
Net loss (879) (883) (913) (1,288) (1,424) (1,332) (1,224) (1,570)
Net loss per share attributable to
Common shareholders:
Basic and diluted (0.12) (0.11) (0.12) (0.16)(1) (0.17) (0.15) (0.14) (0.18)
(1) Basic earnings per share for fiscal 2001 in total exceeds by $0.01 the
sum of the applicable amount for each of the quarters of fiscal 2001 due to
the impact of stock issuances on the weighted average number of shares
outstanding.
(2) During the fourth quarter, a reserve on inventory deposit of $600,000
was recorded.
We have not experienced seasonality in our sales volume or operating expenses.
21
(d) Liquidity and Capital Resources
Prior to our IPO, which became effective on November 18, 1999, we financed
our operations primarily through several private placements of stock and debt
financings. 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. In March 2003, we received net proceeds
before legal expenses of $2,850,000, from the issuance of Convertible Preferred
Stock. We funded the purchase of hardware terminals for resale and working
capital primarily from these proceeds. We will continue to use these proceeds to
fund working capital.
Cash used in operating activities for the year ended December 31, 2002 of
$3,771,132 resulted primarily from the net loss of $5,550,234 and an increase in
other current assets of $502,890 primarily resulting from a $400,000 deposit for
future purchases of inventory, which was partially offset by a decrease in
inventory of $365,849, amortization of deferred compensation of $713,051,
depreciation and amortization of $451,581, a reserve on inventory deposit of
$600,000 and an increase of deferred revenue of $197,347. Cash used in operating
activities for the year ended December 31, 2001 of $2,966,437 resulted primarily
from the net loss of $3,962,931, a net decrease in deferred revenues of $344,381
which was partially offset by an increase in accounts payable and accrued
expenses of $426,651, a decrease in inventory of $367,650, and a net decrease in
other current assets of $164,758 primarily consisting of the related deferred
costs of revenues and increased by deposits of $200,000 for future purchases of
inventory. The increase in accounts payable and accrued expenses for 2001 was
attributable to certain large invoices received toward the end of 2001. Cash
used in investing activities was $29,187 for the year ended December 31, 2002
and $193,824 for the year ended December 31, 2001. Net cash used in investing
activities for both periods consisted primarily of capital expenditures for
computer equipment and furniture and fixtures. Cash provided by financing
activities was $1,649,663 for the year ended December 31, 2002 and $3,129,807
for the year ended December 31, 2001 and was primarily related to the exercise
of outstanding warrants, stock options and rights.
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 extended the expiration date until April 4, 2003 and further extended
the rights until December 31, 2003. We have the right to redeem the outstanding
rights for $.01 per right under certain conditions, which were not met as of
March 26, 2003. We have reserved 970,076 shares of common stock for future
issuance under this rights offering. As of December 31, 2002, we received
$2,444,549 before expenses from the exercise of 287,594 of these rights.
During the year ended December 31, 2002, we received net proceeds of
$829,600 from the exercise of 1,250 warrants and 273,700 options. As of December
31, 2002, there remained warrants outstanding to purchase 10,000 shares of the
Company's common stock as an exercise price of $8.40.
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, 2002, we purchased 20,000 shares totaling
approximately $123,000 and subsequently retired these shares. We do not expect
to purchase additional shares unless certain conditions warrant it.
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold
30,000 shares of our Series A 8% Convertible Preferred Stock, par value $.01 per
share for $3,000,000 before expenses to Gryphon Master Fund, L.P. Each preferred
share entitles the holder to receive dividends of 8% per annum and is
convertible into 15.1515 shares of our common stock. Additionally, each share of
Preferred Stock will receive one (1) five year warrant to purchase 3.787875
shares of common stock at a price of $6.78. The total amount of shares that may
22
be issued upon conversion and the exercising of the warrants are 454,545 and
113,636 shares, respectively. The Company 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.
Our operating expenses for 2003 are projected to be approximately
$5,900,000 compared to the reported expenses of approximately $6.6 million for
2002, which included non-cash expenses of approximately $1.8 million. The
projected decrease is primarily related to the reduction of the non-cash
expenses relating to the reserve on inventory deposit recorded in 2002. For
2002, the Company's cash expense burn rate was approximately $400,000 per month
and we expect that it will not materially change for 2003, except for potential
dividend payment due under the March 2003 financing. We currently anticipate
that our available cash in hand, cash resources from expected revenues from the
sale of the units in inventory, cash resources collected from the issuance of
Convertible Preferred Stock combined with the expected exercise of the options
by our option holders 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.
23
Below is a table, which presents our contractual obligations and commitments at
December 31, 2002:
Payments Due by Period
- -----------------------------------------------------------------------------------------------------------
Contractual Obligations Total Less than 1-3 years 4-5 years After 5 years
One Year
- -----------------------------------------------------------------------------------------------------------
Capital Lease Obligations $19,999 $19,572 $427 -- --
- -----------------------------------------------------------------------------------------------------------
Operating Leases 2,123,329 255,617 741,800 $540,886 $585,026
- -----------------------------------------------------------------------------------------------------------
Purchase commitments (1) 0 -- -- -- --
- -----------------------------------------------------------------------------------------------------------
Employment contracts 839,000 463,800 375,200 -- --
- -----------------------------------------------------------------------------------------------------------
Total Contractual Cash Obligation $2,992,420 $746,458 $1,120,050 $540,886 $585,026
- -----------------------------------------------------------------------------------------------------------
(1) We paid the manufacturer $600,000 through April 1, 2002, as an advance
inventory deposit towards the open purchase order of approximately 2,850
ID-Check units.
(e) Net Operating Loss Carry Forwards
As of December 31, 2002, we had a net operating loss carry forward of
approximately $16,000,000, 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, thus 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.
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
--------------------
Financial Statements are attached hereto following page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
-----------------------------------------------------------------------
Financial Disclosure
--------------------
Grant Thornton LLP has been selected as our independent public accountants
for the current year and examined our financial statements for the year ended
December 31, 2002. On June 6, 2002, Arthur Andersen LLP was dismissed and Grant
Thornton was engaged as our principal independent public accountants. The
decision to change accountants was approved by the Board of Directors upon the
recommendation of the Audit Committee. The reports of Arthur Andersen LLP for
the years ended December 31, 2000 and 2001 did not contain any adverse opinion
or disclaimer of opinion, nor were they qualified as to uncertainty, audit scope
or accounting principles. During our fiscal years ended December 31, 2000 and
2001 and the subsequent interim period through June 6, 2002, there were no
disagreements with Arthur Andersen LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures,
which disagreements, if not resolved to the satisfaction of Arthur Andersen LLP,
would have caused them to make reference thereto in their reports on the
financial statements for those years.
24
PART III
Item 10. Directors and Executive Officers of the Company
-----------------------------------------------
As of March 26, 2003, the Company's directors and executive officers were
as follows:
Position With the Company
Name and Age And Principal Occupation Held Office Since
- ----------------------- ------------------------- -----------------
Frank Mandelbaum, 69 Chairman, Chief Executive Officer and Director 1996
Edwin Winiarz, 45 Senior Executive Vice President, Treasurer, Chief 1999
Financial Officer and Director
W. Robert Holloway, 63 Senior Executive Vice President, Sales 1999
Russell T. Embry, 39 Senior Vice President and Chief Technology Officer 2001
Evelyn Berezin, 77 Director 1999
Charles McQuinn, 62 Director 1999
Jeffrey Levy, 61 Director 1999
Howard Davis, 47 Director 2000
Arthur L. Money, 63 Director 2003
Business Experience
Frank Mandelbaum 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 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 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
25
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.
W. Robert Holloway was elected Senior Executive Vice President in July 2000
and was Vice President, Sales from October 1999 to July 2000. From April 1999 to
October 1999, Mr. Holloway was Director of Sales for The IdentiScan Company LLC.
In February and March 1999, Mr. Holloway worked as an independent consultant.
From August 1996 to January 1999, Mr. Holloway was Global Sales Manager for
Welch Allyn, Inc. From October 1994 to July 1996, Mr. Holloway was Vice
President and Sales Manager of Bowne & Company of New York. Mr. Holloway holds
an AB in economics from Columbia University and an MBA in finance from Boston
University.
Evelyn Berezin 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.
Howard Davis was appointed a non-voting advisor to the Board in December
1999 and elected a director in March 2000. He has been, since 1997, Executive
Vice President of GunnAllen Financial Inc., where he is the executive
responsible for the investment banking and finance division. From 1990 to 1997
Mr. Davis was President and Chief Executive Officer of Kensington Securities,
Inc. In 1997, Kensington and GunnAllen joined together. Mr. Davis has also
served as President of Wentworth Securities, Inc. from 1988 to 1990 and prior to
that as President of Numero Uno Franchise Corporation. He has attended the
University of Southern California, California State University, Northridge and
Kent State University where he majored in Finance and Accounting.
Jeffrey Levy 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. 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.
Charles McQuinn 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 was with Burroughs Corporation in
various product development/marketing/management positions. Mr. McQuinn holds a
BS in marketing from Ball State University and an MBA in management from Central
Michigan University.
Arthur L. Money 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. He prior 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 was their Chief Information Officer, from 1996 to 1998. Mr.
26
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.
Directors serve for staggered terms of 3 years and hold office until the
next annual meeting, following the conclusion of their term, of stockholders and
the election and qualification of their successors. Executive officers are
elected by and serve at the discretion of the board of directors.
Board Committees
The board of directors has established a compensation committee which is
currently comprised of Mr. Levy, chairman, Mr. Davis and Mr. Money. The
compensation committee reviews and determines the compensation for all officers
and directors of our company and reviews general policy matters relating to the
compensation and benefits of all employees. The compensation committee also
administers the stock option plans.
The board of directors has established an audit committee which is
currently comprised of Mr. Davis, chairman, Mr. McQuinn and Ms. Berezin. 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 established a corporate governance committee,
which is comprised of Mr. McQuinn, chairman, Ms. Berezin and Mr. Levy. The
corporate governance committee reviews our internal policies and procedures and
by-laws and acts as our nominating committee for the Board of Directors.
The technology oversight committee was eliminated in July 2002. The
technology oversight committee assisted management in planning future
development of products and services within the framework of consumer,
regulatory and competitive environments. This committee also monitored actions
taken to protect our intellectual property and recommended appropriate actions
in furtherance of that protection.
Compliance with Section 16(a) of the Exchange Act
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, it was
determined that although Paul Cohen did not file timely his sales of shares
during the month of September, such failure was remedied by the reporting of
those sales in October and all other transactions were timely filed thereafter.
27
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, 2002. No other executive officers received total salary and
bonus compensation in excess of $100,000 during any of such fiscal years.
SUMMARY COMPENSATION TABLE
Annual Long-Term
Compensation Compensation
Securities
Underlying
Name and Principal Position Year(s) *Salary ($) Options/SARS (#)
- --------------------------- ------ ----------- ----------------
Frank Mandelbaum 2002 225,000 350,000
Chairman & CEO 2001 204,808
2000 150,000 --
Edwin Winiarz 2002 135,000
Senior Executive Vice President 2001 128,333 75,000
Chief Financial Officer 2000 125,000 25,000
W. Robert Holloway 2002 115,000
Senior Executive Vice President 2001 115,000
Sales 2000 115,000 --
Russell T. Embry 2002 150,000 12,500
Senior Vice President 2001 133,750 --
Chief Technology Officer 2000 104,052 25,000
Kevin Messina 2001 52,500
Former Senior Executive Vice President 2000 150,000 --
Former Chief Technology Officer
*Salaries include all deferred salaries paid and accrued.
The options shown above were granted under the 1998, 1999 and 2001 Stock
Option Plans as well as outside these plans and are exercisable as follows: (1)
for Frank Mandelbaum at $12.10 per share; (2) for Edwin Winiarz 25,000 options
at an exercise price of $10.75 and 75,000 options at an exercise price of $8.04
exercisable on September 7, 2006 and (3) Russell T. Embry 25,000 options at an
exercise price of $8.75 and 12,500 options at an exercise price of $3.82. All
options expire five years after the date of vesting.
Messrs. Mandelbaum and Messina had Employment Agreements expiring December
31, 2001, which provided for base annual salaries of $225,000, subject to
specified conditions. Because of our limited resources, Messrs. Mandelbaum and
Messina had from time to time agreed to defer the receipt of substantial
portions of their salaries. In May 1999, Mr. Mandelbaum's deferred salary was
reduced by $150,000 by the issuance to him of 75,000 shares of our common stock
and warrants entitling him to purchase an additional 75,000 shares of our common
stock at a price of $3.00 per share at any time prior to May 3, 2001. In May
1999, Mr. Messina's deferred salary was reduced by $10,126 through the issuance
to him of 5,063 shares of our common stock and warrants to purchase 5,063 shares
of our common stock at a purchase price of $3.00 per share at any time prior to
May 3, 2001. As of June 30, 1999, Mr. Mandelbaum's deferred salary was
approximately $375,000 and Mr. Messina's deferred salary was approximately
$200,000. In June 1999, Mr. Messina received, in lieu of all deferred salary,
28
options to purchase 207,000 shares of common stock at an exercise price of $3.00
per share which were exercised in 2002. Also in June 1999, Mr. Mandelbaum
received, in lieu of all deferred salary, options to purchase 375,000 shares of
common stock at an exercise price of $3.00 per share.
Mr. Kevin Messina resigned as Senior Executive Vice President and Chief
Technology Officer in May 2001.
All the options granted in exchange for deferred salary expire five years
after the date of grant.
The following table summarizes options granted during the year ended
December 31, 2002 to the named executive officers:
Potential Realizable Value
Individual Grants At
- ---------------------------------------------------------------------------------------------------------------------
Number of % of Total Options Assumed Annual Rates of
Stock Price
Securities Granted To Appreciation for Option Term
Underlying Options Employees In Exercise Expiration
- ---------------------------------------------------------------------------------------------------------------------
2002
Name Granted Fiscal Year Price Date 5% 10%
- ---------------------------------------------------------------------------------------------------------------------
Russell T. Embry 12,500 3.1% $ 3.82 10/31/07 $13,192 $29,152
- ---------------------------------------------------------------------------------------------------------------------
Frank Mandelbaum 350,000 80.1% $ 12.10 02/01/07 $1,170,052 $2,585,510
- ---------------------------------------------------------------------------------------------------------------------
The following table summarizes unexercised options granted through the
year-end December 31, 2002 to the named executive officers:
Aggregate Value Of Unexercised
No. of Shares Dollar Value No. of Securities In-the-Money
Received Upon Received Upon Underlying Unexercised Options At Fiscal
Name Exercise Exercise Options / Warrants Year End 12/31/02
- ---------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
Frank Mandelbaum
Chairman & CEO 700,000 150,000 $1,950,000
- ---------------------------------------------------------------------------------------------------------------------
Ed Winiarz
Senior Executive VP
CFO 60,000 75,000 $66,500
- ---------------------------------------------------------------------------------------------------------------------
W. Robert Holloway
Senior Executive VP
Sales 20,000 30,000
- ---------------------------------------------------------------------------------------------------------------------
Russell T. Embry
Senior VP & CTO 76,500 6,250 $19,250 $19,250
- ---------------------------------------------------------------------------------------------------------------------
Pursuant to their employment agreements, Messrs. Mandelbaum and Messina
each received a grant in August 1999 of options to purchase 75,000 shares of our
common stock at a purchase price of $3.00 per share. Mr. Mandelbaum has options
to purchase 50,000 shares of common stock, which are currently exercisable.
Options to purchase 25,000 shares of our common stock became exercisable on
January 1, 2002. The options expire five years from the date of grant. Kevin
Messina exercised 50,000 options on October 5, 2001 and options to purchase
25,000 shares for Mr. Messina expired as a result of his resignation. During the
years ended December 31, 2001 and December 31, 2002, we granted employees other
than the executive officers named above options to purchase 32,750 shares and
150,500 shares respectively, of common stock under the 1998, 1999 and 2001 Stock
Option Plans and non plan.
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
29
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.
Compensation of Non-Employee 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. In August 1999,
non-employee directors, Messrs. Paul Cohen and McQuinn and Ms. Berezin, each
received a grant of a non- qualified stock option to purchase an aggregate of
45,000 shares of our common stock upon their election as a director at an
exercise price of $3.00 per share. Of these options, 15,000 were immediately
exercisable and an additional 15,000 became exercisable in July 2000 and the
remaining 15,000 became exercisable in July 2001. On December 13, 1999, Mr. Levy
and Mr. Davis were each granted non-qualified options to purchase 15,000 shares
of our common stock at an exercise price of $11.625, the fair market value on
the date of grant. These options were immediately exercisable. In addition, in
July 2000 they were each granted non-qualified options to purchase an aggregate
of 30,000 shares of our common stock for serving as a director at an exercise
price of $8.25 per share. Of these options, 15,000 were immediately exercisable
and 15,000 were exercisable in July 2001. In July 2001, Mr. Davis was granted
non-qualified options to purchase 15,000 shares of our common stock at an
exercise price of $10.15 exercisable on the date of our next annual meeting. In
addition, Mr. McQuinn was granted non-qualified options to purchase 30,000
shares of our common stock at an exercise price of $10.15. Of these options,
15,000 are exercisable in 2002 and the balance are exercisable in 2003 on the
date of our annual meeting during these years. In July 2002, Ms. Berezin and Mr.
Cohen were granted non-qualified options to purchase 45,000 shares of our common
stock for serving as a director at an exercise price of $2.80 per share. Of
these options, 15,000 were immediately exercisable with an additional 15,000
becoming exercisable on each of the next two anniversaries of the date of grant
provided that they remain as Directors.
During 2001, Mr. Davis exercised 15,000 of his options and earned
compensation of $138,300, Mr. McQuinn exercised 1,000 of his options and earned
compensation of $6,800 and Ms. Berezin exercised 500 of her options and earned
compensation of $3,938. During 2002, Mr. Davis exercised 200 of his options and
earned compensation of $2,320. Options granted to non-employee directors are
exercisable only during the non-employee director's term and automatically
expire on the date his or her service terminates. Mr. Paul Cohen had previously
been granted options to purchase 30,000 shares of common stock exercisable at
$3.00 per share. Mr. Cohen also received an option to purchase 50,000 shares of
common stock exercisable at $3.00 per share in connection with a one-year
consulting agreement dated November 1, 1997 which was exercised during 2002. As
a result of Mr. Paul Cohen's resignation on February 3, 2003, all of his
remaining vested options expire 90 days from his resignation.
During 2003, Mr. Arthur Money was appointed to the Board of Directors and
was granted non-qualified options to purchase 45,000 shares of our common stock
for serving as a director at an exercise price of $6.40 per share. Of these
options, 15,000 were immediately exercisable with an additional 15,000 becoming
exercisable on each of the next two of our annual meetings provided that they
remain as Directors. Mr. Money also received an option to purchase 1,500 shares
of common stock exercisable at $6.22 per share in connection with his
appointment to the compensation committee on March 17, 2003. Prior to becoming a
Director, he received on November 7, 2001an option to purchase 10,000 shares of
common stock exercisable at $15.13 in connection with providing certain
consulting services. In addition, on March 17, 2003, Mr. Levy received options
to purchase 1,000 shares of common stock exercisable at $6.40 per share for
being appointed the Chairman of the compensation committee.
In addition, non-employee directors who are members of a committee are
entitled to receive grants of stock options for each year served. Each
chairperson of a committee 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. In March 2000, July 2000, July 2001 and July 2002 the
following non-qualified options were granted to committee chairpersons:
Name Committee Number of Options
- ---- --------- -----------------
March 2000 July 2000 July 2001 July 2002
---------- --------- --------- ---------
Ms. Berezin Audit 2,500 2,500 2,500 2,500
Mr. McQuinn Corporate Governance 2,500 2,500 2,500 2,500
Mr. Levy Technology Oversight 2,500 2,500 2,500 -----
Mr. Davis Compensation 2,500 2,500 2,500
30
The following non-qualified options were granted to committee members:
Name Committee(s) Number of Options
- ---- ----------- -----------------
March 2000 July 2000 July 2001 July 2002
---------- --------- --------- ---------
Mr. Cohen Compensation, Audit 3,000 1,500 1,500 1,500
Ms. Berezin Corporate Governance,
Technology Oversight 3,000 3,000 3,000 1,500
Mr. McQuinn Audit, Technology
Oversight 3,000 3,000 3,000 1,500
Mr. Levy Corporate Governance,
Compensation 3,000 3,000 3,000
Mr. Davis Audit 1,500 1,500 1,500 1,500
These options are exercisable at $12.125 for options granted in March 2000,
$8.75 for options granted in July 2000, $10.15 for options granted in July 2001
and $2.80 for options granted in July 2002, the fair market value on the date of
grant, are immediately exercisable during the committee members term and expire
five years from date of grant.
Employment Contracts, Termination of Employment and Change-in-Control
- --------------------------------------------------------------------------------
Arrangements
- ------------
Effective January 1, 1999, Mr. Mandelbaum and Mr. Messina each entered into
a three-year employment agreement with Intelli-Check. Each of the agreements
provided for a base salary of $225,000. However, until such time as we received
payment for gross sales of at least $1,000,000, which occurred in April 2001,
the salaries were capped at $150,000. The agreements also provided for the
payment of a bonus if our sales exceed $2,000,000 in the previous year. The
bonus would have been in the amount of $50,000 plus 1% of the amount of sales in
excess of $2,000,000 in each year. In addition, for each fiscal year ending
during the term of the employment agreements, we were obligated to grant to each
of the executives an option to purchase the greater of 25,000 shares of our
common stock at fair market value on the date of grant or 10,000 shares of our
common stock at fair market value on the date of grant for each full $250,000 by
which pre-tax profits for each year exceeded pre-tax profits for the prior
fiscal year. However, we were not required to grant options to purchase more
than 150,000 shares of our common stock with respect to any one fiscal year.
During the terms of their agreements, no bonuses were earned.
On May 7, 2001, our board of directors accepted the resignation of Kevin
Messina. Accordingly, all of the obligations under the employment agreement,
including the payment of salary and incentives, ceased as of this date.
On February 1, 2002, we entered into a new three-year employment contract
with its Chairman and Chief Executive Officer, effective January 1, 2002. The
agreement provides for an annual base salary of $250,000. In addition, we
granted to the Chairman and Chief Executive Officer an option to purchase
350,000 shares of common stock, of which 125,000 options are immediately
exercisable at $12.10 per share and 225,000 options become exercisable at a rate
of 75,000 per year on December 31, 2002, 2003 and 2004.
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. Included within the
definition of change of control is the first day on which a majority of the
directors of the company do not consist of individuals recommended by Mr.
Mandelbaum and one outside director.
We had entered into a two-year employment agreement with Mr. Winiarz, which
became effective on September 7, 1999. The agreement provided for a base salary
of $125,000. In addition, we granted Mr. Winiarz an option to purchase 50,000
shares of common stock, of which 30,000 options were immediately exercisable at
$5.00 per share and 20,000 options became exercisable on September 7, 2000 at
$5.00 per share.
31
On September 7, 2001, we renewed the employment agreement with Mr. Winiarz.
The agreement, which expires December 31, 2004, provides for a base salary of
$135,000 with annual increases of 5% per annum. In addition, we granted 75,000
stock options at an exercise price of $8.04 vesting on September 7, 2006 with
earlier vesting incentives.
We entered into a two-year employment agreement with Mr. Holloway, which
became effective on October 25, 1999. The agreement provides for a base salary
of $115,000. In addition, we granted Mr. Holloway an option to purchase 50,000
shares of common stock at $7.50 per share, of which 20,000 shares are
immediately exercisable and 5,000 shares become exercisable for each 10,000
sales of ID-Check products sold that exceed 10,000. The maximum options that can
be earned in any calendar year may not exceed 100,000. Any options earned above
the initial 50,000 options will be at fair market value on the date of grant.
Upon the expiration of this agreement, we renewed the agreement for an
additional two years under the same terms and conditions.
Under the terms of the agreements, each of the executives has the right to
receive his compensation in the form of shares of common stock valued at 50% of
the closing bid price of our shares of common stock as of the date of the
employee's election, which is to be made at the beginning of each quarter. In
addition, 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.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
----------------------------------------------------------------------
Related Stockholder Matters
---------------------------
Equity Compensation Plan Information
Number of Securities Weighted average
to be issued upon exercise price of Number of securities remaining available
exercise of outstanding for future issuance under equity
outstanding options, options, warrants compensation plans (excluding securities
Plan Category warrants and rights and rights reflected in column a)
(a) (b) (c)
- ---------------------------- ----------------------- --------------------- -------------------------------------------
- ---------------------------- ----------------------- --------------------- -------------------------------------------
Equity compensation plans
approved by security
holders 1,318,866 $7.96 281,934
- ---------------------------- ----------------------- --------------------- -------------------------------------------
Equity compensation plans
not approved by security
holders 1,015,000 $7.59 -0-
- ---------------------------- ----------------------- --------------------- -------------------------------------------
Total
- ---------------------------- ----------------------- --------------------- -------------------------------------------
The following table sets forth, as of December 31, 2002 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.
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.
32
The applicable percentage of ownership is based on 8,875,302 shares outstanding
as of December 31, 2002.
- ---------------------------------------------------------------------------------------------
Name Shares Beneficially Owned Percent
- ---------------------------------------------------------------------------------------------
Frank Mandelbaum 1,327,400 13.72
- ---------------------------------------------------------------------------------------------
Edwin Winiarz 63,500 *
- ---------------------------------------------------------------------------------------------
W. Robert Holloway 24,200 *
- ---------------------------------------------------------------------------------------------
Russell T. Embry 71,250 *
- ---------------------------------------------------------------------------------------------
Paul Cohen 171,200 1.91
- ---------------------------------------------------------------------------------------------
Evelyn Berezin 84,550 *
- ---------------------------------------------------------------------------------------------
Charles McQuinn 84,600 *
- ---------------------------------------------------------------------------------------------
Jeffrey Levy 68,250 *
- ---------------------------------------------------------------------------------------------
Howard Davis 64,800 *
- ---------------------------------------------------------------------------------------------
Todd Cohen 940,800 10.37
- ---------------------------------------------------------------------------------------------
Empire State Development***, formerly New York
State Science and Technology Foundation 605,000 6.42
- ---------------------------------------------------------------------------------------------
All Executive Officers & Directors as a group (10 persons) 1,959,750 20.67
- ---------------------------------------------------------------------------------------------
* Indicates beneficial ownership of less than one percent of the total outstanding common stock.
** The person who exercises the voting power is the CFO who, at the present time, is Frances A. Walton.
The amounts shown for Mr. Mandelbaum do not include 24,900 shares and 2,490
rights held by Mr. Mandelbaum's wife, for which Mr. Mandelbaum disclaims
beneficial ownership.
The amounts shown for Mr. Paul Cohen do not include 50,500 shares and 5,050
rights held by Mr. Cohen's wife and daughter, for which Mr. Cohen disclaims
beneficial ownership.
Mr. Todd Cohen's address is P.O. Box 20054, Huntington Station, New York
11746.
Due to recent legislation, all assets of the New York State Small Business
Technology Investment Fund, which were located in the New York State Science and
Technology Foundation, were transferred to The Urban Development Corporation
d/b/a Empire State Development. The Commissioner of Empire State Development is
Charles A. Gargano. The members of the Board of Directors are Charles A.
Gargano, J. Patrick Barrett, Charles E. Dorkey, III, David Feinberg, Anthony
Gioia, Deborah Weight and Elizabeth McCaul. The address for that fund is 633
Third Avenue, New York, NY 10017.
The amounts shown in the table above for the following persons include the
right to acquire the number of shares shown pursuant to currently exercisable
stock options, and/or warrants and/or rights at the exercise price shown:
Name Number of Shares Exercise Price
- --------------------------------------------------------------------------------------------------
Frank Mandelbaum 500,000 $3.00
200,000 $12.10
102,100 $8.50
- --------------------------------------------------------------------------------------------------
Edwin Winiarz 35,000 $5.00
25,000 $10.75
3,500 $8.50
- --------------------------------------------------------------------------------------------------
Russell T. Embry 20,000 $7.50
20,000 $11.625
25,000 $8.75
5,250 $8.50
6,250 $3.82
- --------------------------------------------------------------------------------------------------
33
- --------------------------------------------------------------------------------------------------
Name Number of Shares Exercise Price
- --------------------------------------------------------------------------------------------------
W. Robert Holloway 20,000 $7.50
2,200 $8.50
- --------------------------------------------------------------------------------------------------
Paul Cohen 60,000 $3.00
3,000 $12.125
1,500 $8.75
1,500 $10.15
11,200 $8.50
16,500 $2.80
- --------------------------------------------------------------------------------------------------
Evelyn Berezin 44,500 $3.00
5,500 $12.125
5,500 $8.75
5,500 $10.15
4,050 $8.50
19,000 $2.80
- --------------------------------------------------------------------------------------------------
Charles McQuinn 44,000 $3.00
5,500 $12.125
5,500 $8.75
5,500 $10.15
4,100 $8.50
4,000 $2.80
- --------------------------------------------------------------------------------------------------
Jeffrey Levy 15,000 $11.625
2,500 $12.125
1,500 $8.00
35,500 $8.75
5,500 $10.15
3,950 $8.50
- --------------------------------------------------------------------------------------------------
Howard Davis 15,000 $11.625
2,500 $8.000
1,500 $12.125
14,800 $8.75
18,000 $10.15
3,800 $8.50
4,000 $2.80
- --------------------------------------------------------------------------------------------------
Arthur L. Money 10,000 $15.13
15,000 $6.40
- --------------------------------------------------------------------------------------------------
Todd Cohen 110,000 $3.00
86,000 $8.50
- --------------------------------------------------------------------------------------------------
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
In October 1994, Messrs. Todd Cohen and Kevin Messina co-founded
Intelli-Check and each purchased 975,000 shares of common stock for $975. In
April 1998, Mr. Todd Cohen resigned as an officer of our company for personal
reasons and in August 1999, he completed his term as a director. In May 2001,
Mr. Messina resigned as an officer of our company to pursue other opportunities
and in July 2001, he completed his term as a director.
In June 1996, Mr. Messina's company, K.M. Software, assigned two copyrights
covering certain software employed by ID-Check and a patent application covering
the ID-Check technology to Intelli-Check for an agreement to pay $98,151 plus
interest. The agreement also gave K.M. Software, or its successor, the right to
reclaim the rights to the copyrights and the patent under certain specified
conditions. In May 1999, the prior agreement was superseded and in exchange Mr.
Messina received 69,937 shares of our common stock and warrants to purchase
69,937 shares of our common stock, at $3.00 per share, exercisable at any time
prior to May 3, 2001. The May 1999 agreement provides for the payment by
34
Intelli-Check of 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. Also, in May
1999, Mr. Messina's deferred salary was reduced by $10,126 through the issuance
to him of 5,063 shares of our common stock and warrants to purchase 5,063 shares
of our common stock at a purchase price of $3.00 per share at any time prior to
May 3, 2001. In June 1999, the balance of Mr. Messina's deferred salary was
reduced to zero by the issuance of options to purchase 207,000 shares of our
common stock at a purchase price of $3.00 per share at any time prior to June
30, 2004.
In June 1996, Frank Mandelbaum, Intelli-Check's Chief Executive Officer and
Chairman of the Board of Directors, purchased 950,000 shares of common stock for
$50,000. From time to time since then, Mr. Mandelbaum loaned money to
Intelli-Check totaling $142,000. In November 1997, Mr. Mandelbaum converted his
outstanding loans into 71,000 shares of our common stock and warrants to
purchase 71,000 shares of our common stock at $3.00 per share, which he
exercised on December 31, 2000. In May 1999, Mr. Mandelbaum's deferred salary
was reduced by $150,000 through the issuance to him of 75,000 shares of our
common stock and warrants to purchase 75,000 shares of our common stock at a
purchase price of $3.00 per share, which were exercised in October 2001. In June
1999, Mr. Mandelbaum's deferred salary was reduced to zero by the issuance of
options to purchase 375,000 shares of our common stock at an exercise price of
$3.00 per share at any time prior to June 30, 2004.
In March 1997, one of our directors, Paul Cohen purchased 37,500 units
consisting of one share of common stock and one warrant to purchase an
additional share at $3.00 per share in connection with one of our private
placements, for $75,000. He exercised the warrants in December 2000 and we
received net proceeds of $112,500. In November 1997, Mr. Cohen received an
option to purchase 50,000 shares of common stock exercisable at $3.00 per share
in connection with a one-year consulting agreement which was exercised in
November 2002 and we received $150,000. Also in November 1997, Mr. Cohen's wife
purchased 25,000 units consisting of one share of common stock and one warrant
to purchase an additional share of common stock for $3.00 in connection with one
of our private placements for $50,000. Mrs. Cohen exercised the warrant in
December 2000 and we received net proceeds of $75,000. In August 1999, Mr. Cohen
purchased one unit in connection with our last private placement. The unit
consisted of a promissory note having a principal amount of $50,000, which bore
interest at the annual rate of 10% and a warrant to purchase 2,500 shares of our
common stock for $3.00 per share which expired during 2002. The principal was
repaid by us to Mr. Cohen in November 1999.
In June 1999, all deferred compensation due to Todd Cohen, our former
President and director, was eliminated by the issuance of options to purchase
110,000 shares of common stock at an exercise price of $3.00 per share at any
time prior to June 30, 2004.
Item 14. Controls and Procedures
-----------------------
Internal Controls.
-----------------
We maintain a system of internal controls designed to provide reasonable
assurance that: (i) transactions are executed in accordance with management's
general or specific authorization; (ii) transactions are recorded as necessary
to permit preparation of financial statements in conformity with generally
accepted accounting principles, and to maintain accountability for assets; (iii)
access to assets is permitted only in accordance with management's general or
specific authorization; and (iv) the recorded accountability for assets is
compared with the existing assets at reasonable intervals and appropriate action
is taken with respect to any differences.
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 the our internal
controls and procedures. Such evaluation was conducted within the 90 days prior
to the date of filing of this report. There have been no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of such evaluation.
Disclosure Controls and Procedures
----------------------------------
We maintain disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) 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
35
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 within the 90
days prior to the date of filing of this report. Based on such evaluation, our
Chief Executive and Chief Financial Officer have concluded that these procedures
are effective.
Item 15. Principal Accountant Fees and Services
--------------------------------------
During fiscal year ended December 31, 2001 until September 6, 2002, our
principal independent auditor was Arthur Andersen LLP. Thereafter, our principal
independent auditor was Grant Thornton LLP. The services of each were provided
in the following category and amount:
Arthur Andersen LLP Grant Thornton LLP
2001 2002 2001 2002
---- ---- ---- ----
Audit Fees: $63,500 $4,500 Audit Fee: 0 $56,000
Other Services: $22,420 0 Other Services: 0 0
PART IV
Item 16. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits. See index of exhibits annexed hereto.
--------
(b) Reports on Form 8-K.
-------------------
On September 6, 2002, the Company filed a report on Form 8-K to disclose
Changes in Registrant's Certified Public Accountants from Arthur Andersen LLP to
Grant Thornton LLP.
36
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.
4.1 Specimen Stock Certificate (2)
4.2 Form of Underwriters' Warrant Agreement (1)
4.3 Warrant to Gryphon Master Fund LLP
10.1 1998 Stock Option Plan (1) *
10.2 Employment Agreement between Frank Mandelbaum and the Company, dated as of
January 1, 1999 (1) *
10.3 Employment Agreement between Kevin Messina and the Company, dated as of
January 1, 1999 (1)*
10.4 Employment Agreement between Edwin Winiarz and the Company, dated as of
July 21, 1999 (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)
10.8 Agreement between the Company and Northern Leasing Systems Inc., dated as
of August 13, 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)
10.13 Employment Agreement between Edwin Winiarz and the Company, dated as of
September 7, 2001*
10.14 Employment Agreement between Frank Mandelbaum and the Company, dated as of
February 1, 2002* (6)
10.15 Memorandum of Understanding between AAMVAnet, Inc. and Intelli-Check, Inc.
effective January 29, 2002 (6)
10.16 Securities Purchase Agreement between Intelli-Check, Inc. and Gryphon
Master Fund dated March 27, 2003.
10.17 Registration Rights Agreement between Intelli-Check, Inc. and Gryphon
Master Fund dated March 27, 2003.
21 List of Subsidiaries (1)
23 Consent of Grant Thornton LLP
99.1 Certifications of Chief Executive Officer
99.2 Certifications of Chief Financial Officer
- -------------------------------------------------------------
* 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 to Registrant's Annual Report on Form 10-K
filed March 29, 2002.
37
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 27, 2003 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 27, 2003 /s/ Frank Mandelbaum
------------------------
Frank Mandelbaum
Chairman, Chief Executive Officer and Director
Date: March 27, 2003 /s/ Edwin Winiarz
------------------------
Edwin Winiarz
Senior Executive Vice President, Treasurer and
Chief Financial Officer
Date: March 27, 2003 /s/ Evelyn Berezin
------------------------
Evelyn Berezin, Director
Date: March 27, 2003 /s/ Howard Davis
------------------------
Howard Davis, Director
Date: March 27, 2003
------------------------
Jeffrey Levy, Director
Date: March 27, 2003 /s/ Charles McQuinn
------------------------
Charles McQuinn, Director
Date: March 27, 2003 /s/ Arthur L. Money
------------------------
Arthur L. Money, Director
INDEX
Page
REPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1 - F-2
FINANCIAL STATEMENTS:
Balance Sheets as of December 31, 2001 and 2002 F-3
Statements of Operations for the Years Ended December 31, 2000,
2001 and 2002 F-4
Statements of Stockholders' Equity for the Years Ended December
31, 2000, 2001 and 2002 F-5
Statements of Cash Flows for the Years Ended December 31, 2000,
2001 and 2002 F-6
NOTES TO FINANCIAL STATEMENTS F-7 - F-19
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
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, 2002, 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 these financial statements based on our audit. The financial
statements of Intelli-Check, Inc. as of December 31, 2001 and for the years
ended December 31, 2001 and 2000 were audited by other auditors who have ceased
operations and whose report dated March 6, 2002, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Intelli-Check, Inc. as of
December 31, 2002, 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.
New York, New York
March 3, 2003
(except with respect to the matters
discussed in Note 10, as to which the date is
March 27, 2003)
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Intelli-Check, Inc.:
We have audited the accompanying balance sheets of Intelli-Check, Inc. (a
Delaware corporation) as of December 31, 2001 and 2000, and the related
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. 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 auditing standards generally accepted
in the 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 statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to the above present fairly,
in all material respects, the financial position of Intelli-Check, Inc. as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001 in conformity
with accounting principles generally accepted in the United States.
/s/Arthur Andersen LLP
New York, New York
March 6, 2002
This Report of Independent Certified Public Accountants is a copy of a
previously issued Arthur Andersen LLP ("Andersen") report and has not been
reissued by Andersen. The inclusion of this previously issued Andersen report is
pursuant to the "Temporary Final Rule and Final Rule; Requirements for Arthur
Andersen LLP Auditing Clients," issued by the U.S. Securities and Exchange
Commission in March 2002. Note that this previously issued Andersen report
includes references to certain fiscal years, which are not required to be
presented in the accompanying financial statements as of and for the fiscal year
ended December 31, 2002.
F-2
INTELLI-CHECK, INC.
BALANCE SHEETS
DECEMBER 31, 2001 and 2002
ASSETS
------
2001 2002
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 4,061,235 $ 1,910,579
Accounts receivable 25,536 93,530
Inventory 2,168,688 1,802,839
Other current assets 370,880 273,770
------------ ------------
Total current assets 6,626,339 4,080,718
CERTIFICATE OF DEPOSIT, restricted (Note 9) 268,494 273,317
PROPERTY AND EQUIPMENT, net (Note 3) 466,576 324,112
ACQUIRED SOFTWARE, net (Notes 4 and 8) 426,806 211,806
GOODWILL (Notes 4 and 8) 181,447 181,447
PATENT COSTS, net (Notes 4 and 8) 289,425 260,215
OTHER INTANGIBLES, net (Notes 4 and 8) 164,132 83,299
------------ ------------
Total assets $ 8,423,219 $ 5,414,914
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 254,171 $ 298,635
Accrued expenses (Note 5) 842,501 771,405
Current portion of deferred revenue 200,953 357,059
Current portion of capital lease obligations (Note 9) 25,421 19,572
------------ ------------
Total current liabilities 1,323,046 1,446,671
------------ ------------
CAPITAL LEASE OBLIGATIONS (Note 9) 17,317 427
------------ ------------
DEFERRED REVENUE AND OTHER LIABILITIES 53,324 94,565
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY:
Series A Convertible Preferred Stock - $.01 par value; 1,000,000 shares
authorized; 0 shares issued and outstanding - -
Common stock - $.001 par value; 20,000,000 shares authorized; 8,470,762 and
8,875,302 shares issued and outstanding as of 2001 and 2002, respectively 8,470 8,874
Deferred compensation (189,000) (348,476)
Additional paid-in capital 19,331,004 22,399,029
Accumulated deficit (12,120,942) (18,186,176)
------------ ------------
Total stockholders' equity 7,029,532 3,873,251
------------ ------------
Total liabilities and stockholders' equity $ 8,423,219 $ 5,414,914
============ ============
The accompanying notes are an integral part of these statements.
F-3
INTELLI-CHECK, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002
2000 2001 2002
---- ----
REVENUE $ 342,979 $ 885,908 $ 1,138,587
COST OF REVENUE 198,712 479,041 501,429
------------- ------------- -------------
Gross profit 144,267 406,867 637,158
------------- ------------- -------------
OPERATING EXPENSES:
Selling 890,453 950,774 1,437,509
General and administrative 1,590,896 2,332,150 3,355,549
Research and development 1,042,008 1,214,398 1,180,071
Reserve on inventory deposit (Notes 2 and 9) - - 600,000
------------- ------------- -------------
Total operating expenses 3,523,357 4,497,322 6,573,129
------------- ------------- -------------
Loss from operations (3,379,090) (4,090,455) (5,935,971)
OTHER INCOME (EXPENSE):
Interest income 261,181 135,860 53,871
Interest expense (14,863) (8,336) (4,878)
Other income (Note 9) - - 336,744
------------- ------------- -------------
246,318 127,524 385,737
------------- ------------- -------------
Net loss $ (3,132,772) $ (3,962,931) $ (5,550,234)
============= ============= =============
PER SHARE INFORMATION:
Net loss $ (3,132,772) $ (3,962,931) $ (5,550,234)
Dividend on warrant modification - (140,000) -
------------- ------------- -------------
Net loss attributable to common shareholders $ (3,132,772) $ (4,102,931) $ (5,550,234)
============= ============= =============
Net loss per common share -
Basic and diluted $ (0.47) $ (0.52) $ (0.64)
============= ============= =============
Weighted average common shares used in computing
per share amounts-
Basic and diluted 6,648,191 7,910,913 8,685,656
============= ============= =============
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, 2000, 2001 AND 2002
Additional
Common Stock Paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
------ ------ ------- ------------ ------- -----
BALANCE, December 31, 1999 6,515,152 $ 6,515 $10,121,771 $ - $(3,803,239) $6,325,047
Exercise of warrants 1,115,084 1,115 3,222,759 - - 3,223,874
Exercise of stock options 66,000 66 202,434 - - 202,500
Issuance of stock options in settlement
of accounts payable - - 14,398 - - 14,398
Net loss - - - - (3,132,772) (3,132,772)
---------- -------- ----------- ---------- ------------ -----------
BALANCE, December 31, 2000 7,696,236 $ 7,696 $13,561,362 $ - $(6,936,011) $6,633,047
Exercise of warrants 378,084 379 1,057,796 - - 1,058,175
Exercise of options 166,500 165 774,985 - - 775,150
Distributions of Rights Dividends - - 1,082,000 - (1,082,000) -
Effect on extension of expiration of
warrants - - 140,000 - (140,000) -
Issuance of common stock for exercise
of rights 180,198 180 1,397,669 - - 1,397,849
Purchase and retirement of common stock (10,000) (10) (52,590) - - (52,600)
Issuance of stock options in settlement
of accounts payable - - 842 - - 842
Issuance of common stock for the
acquisition of certain assets 59,744 60 979,940 - - 980,000
Recognition of Deferred Compensation - - 389,000 (389,000) - -
Amortization of Deferred Compensation - - - 200,000 - 200,000
Net loss - - - - (3,962,931) (3,962,931)
---------- -------- ----------- ---------- ------------ -----------
BALANCE, December 31, 2001 8,470,762 $8,470 $19,331,004 $ (189,000) $(12,120,942) $7,029,532
Exercise of warrants 1,250 1 3,749 - - 3,750
Exercise of options 273,700 274 825,576 - - 825,850
Effect on extension of expiration of
options - - 8,500 - - 8,500
Effect on extension of expiration of
rights dividend - - 515,000 - (515,000) -
Issuance of common stock for exercise of
rights 107,396 107 912,759 - - 912,866
Purchase and retirement of common stock (10,000) (10) (70,054) - - (70,064)
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 - 713,051
Valuation adjustment of Deferred Compensation - - (596,800) 596,800 - -
Net loss - - - - (5,550,234) (5,550,234)
---------- -------- ----------- ---------- ------------ -----------
BALANCE, December 31, 2002 8,875,302 $8,874 $22,399,029 $ (348,476) $(18,186,176) $3,873,251
========== ======== =========== ========== ============ ==========
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, 2000, 2001 AND 2002
2000 2001 2002
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,132,772) $ (3,962,931) $ (5,550,234)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization 90,115 126,885 451,580
Noncash expense 14,398 842 8,500
Noncash compensation - 200,000 713,051
Reserve on inventory deposit - - 600,000
Changes in assets and liabilities-
(Increase) in certificate of deposit, restricted (250,000) (18,494) (4,823)
(Increase) decrease (increase) in accounts receivable (30,475) 19,259 (67,994)
(Increase) decrease in inventory (2,349,729) 367,650 365,849
(Increase) decrease (increase) in other current assets (211,525) 164,758 (502,890)
Decrease in other assets 8,766 - -
(Decrease) Increase in accounts payable and accrued expenses (137,941) 426,651 18,482
Increase (decrease) increase in deferred revenue 545,334 (344,381) 197,347
Increase in other liabilities - 53,324 -
---------------- --------------- ----------------
Net cash used in operating activities (5,453,829) (2,966,437) (3,771,132)
---------------- --------------- ----------------
CASH FLOWS FROM INVESTING activities:
Purchases of property and equipment (223,511) (140,877) (29,187)
Cash paid for acquisition expenses - (52,947) -
---------------- --------------- ----------------
Net cash used in investing activities (223,511) (193,824) (29,187)
---------------- --------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 3,426,374 3,231,174 1,742,466
Repayment of capital lease obligations (37,893) (48,767) (22,739)
Treasury stock purchased - (52,600) (70,064)
---------------- --------------- ----------------
Net cash provided by financing activities 3,388,481 3,129,807 1,649,663
---------------- --------------- ----------------
Net decrease in cash and cash equivalents (2,288,859) (30,454) (2,150,656)
CASH AND CASH EQUIVALENTS, beginning of year 6,380,548 4,091,689 4,061,235
---------------- --------------- ----------------
CASH AND CASH EQUIVALENTS, end of year $ 4,091,689 $ 4,061,235 $ 1,910,579
================ =============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 14,863 $ 8,336 $ 4,878
================ =============== ================
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:
Stock options issued for services rendered $ - $ 389,000 $ 1,469,327
Common stock issued to purchase certain assets in acquisition - 980,000 -
Capital lease obligations incurred 54,125 - -
The accompanying notes are an integral part of these statements.
F-6
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
The accompanying notes are an integral part of these statements.
1. NATURE OF BUSINESS
------------------
Intelli-Check, Inc. (the "Company") was originally incorporated in New York in
October 1994 and later reincorporated in Delaware in December 1999 to develop,
manufacture and market an advanced document verification system to enable a
retailer to help prevent economic loss through various frauds, such as Identity
theft, which utilizes fake ID's as support for these transactions, to increase
security and deter terrorism at airports, military installations and other sites
where security is a concern and to determine whether purchasers of age
restricted products meet the minimum age requirements for the sale. This helps
reduce the risk to the retailer of substantial monetary fines, criminal
penalties and license revocation for the sale of age-restricted products to
minors.
The Company has developed and patented the innovative software technology that
is included in the advanced document verification system terminal called
"ID-Check." The ID-Check terminal, in which the Company's patented software is
loaded, was designed to offer convenient and reliable document and age
verification. ID-Check reads, analyzes and displays the encoded information
contained on driver licenses and other forms of accepted government issued
identification where permitted by law. In addition, the ID-Check terminal is
capable of being upgraded to accommodate changes made by the governmental
issuers of driver licenses and ID cards. The ID-Check terminal requires a quick
swipe or scan of the driver license or ID card by the user; displays a "valid",
"expired", "tampered" or other customized display; and creates a record where
permitted by law of transactions to protect the merchant against fraudulent
transactions, unauthorized access and as proof that the retailer has used proper
due diligence in the sale of age restricted products.
During 2001 and 2002, the Company developed additional software products that
utilize its patented software technology. C- Link runs on a personal computer
and was created to work in conjunction with the ID-Check unit that allows the
retailer to instantly view the data for further verification, analyze data and
generate various reports where permitted by law. The Company also has developed
software that can be integrated onto a Windows platform that will enable a user
of the software to perform all the functions of the ID-Check terminal.
Additionally, in December 2001, the Company acquired the assets of the
IDentiScan Company, LLC ("IDentiScan"), which has developed a product that helps
determine whether a purchaser of age restricted products meets the minimum age
requirements for sale in a less sophisticated method than the Company's ID-Check
terminal.
Since inception, the Company has incurred significant losses and negative cash
flow from operating activities, and as of December 31, 2002 we had an
accumulated deficit of $18,186,176. Subsequent to the balance sheet date, the
Company received financing totaling $3 million, see footnote 10. We currently
anticipate that our available cash in hand, cash resources from expected
revenues from the sale of the units in inventory, cash resources collected from
the Company's financing as noted above, combined with the expected exercise of
the options by our option holders will be sufficient to meet our anticipated
working capital and capital expenditure requirements for at least the next
twelve months.
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.
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. The inventory was originally received December 1999.
Shortly thereafter, it 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. Even though the Company
has had limited sales to date, it believes that a sufficient market exists to
sell with margin the current inventory as well as the remaining units required
to be purchased from its manufacturer for which the Company has paid a deposit
of $600,000. The current terminal, for which this deposit was paid, is fully
capable of running the Company's patented software since it utilizes a
F-7
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
state-of-the-art imager/scanner and magnetic stripe reader. However, since our
policy is to periodically evaluate the market value of the inventory, should the
Company determine in a future period that an adjustment is necessary, the
Company would record such adjustment at that time, which could have a material
effect on the Company's results of operations. The Company is in discussions
with its current manufacturer as well as other manufacturers to select a new
platform to run its patented software. However, as of December 31, 2002, the
Company reserved 100% of this deposit due to the uncertainty of whether or not
the Company will place the order to purchase the additional units from its
manufacturer under the open purchase order or purchase units to fulfill future
orders from a new platform once it is selected.
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 results of operations. Upon adoption of SFAS No. 142, as well
as at December 31, 2002, the Company performed an impairment test of its
goodwill and determined that no impairment of the recorded goodwill existed.
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 no impairment exists as of December
31, 2002. The adoption of SFAS No. 144 had no effect on the Company.
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 as a
result of certain assets acquired from IDentiScan (see note 8), are amortized
over a period between 10 and 17 years using the straight-line method. Acquired
Software is being amortized over a period of 2 years using the straight-line
method. Other intangibles, consisting of a covenant not to compete and
copyrights are amortized over a period of 2 and 3 years, respectively using the
straight-line method.
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
F-8
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
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, 2000, 2001 and 2002.
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. The Company's products require continuing service
or post contract customer support and performance by the Company, and
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. Currently, with respect
to sales to distributors and sales of the Company's IDentiScan 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.
During 2002, the Company recognized 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, and
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.
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, 2002, due to the uncertainty of the realizability of those
assets.
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. At December 31,
2002, the carrying value of all 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 and cash equivalents. The Company maintains cash
between two financial institutions. The Company performs periodic evaluations of
the relative credit standing of these institutions.
The Company has had limited sales due to the downturn of the economy and the
refocus of its marketing efforts to a number of clients which are concentrated
in the United States of America. 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 currently has one supplier for the production of its ID-check
products and one supplier for the production of its IDentiScan products (Note
9). The Company does not maintain a manufacturing facility of its own and,
accordingly, is dependent on maintaining its existing production relationships.
Further, should the Company's relationship with its supplier not be renewed, it
may not be able to find an alternative, comparable supplier on satisfactory
terms to the Company, and therefore, there may be an adverse effect on the
Company's results of operations. However, as a result of the Company commencing
the licensing of its technology, such effect could be reduced as the Company
would be less dependent on its manufacturer for sales.
F-9
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
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,
2000, 2001 and 2002, 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, 2000, 2001 and
2002 had been converted:
2000 2001 2002
---- ---- ----
Stock options 1,768,560 1,946,041 2,333,866
Warrants 596,475 17,500 10,000
--------------- --------------- ---------------
Total
2,365,035 1,963,541 2,343,866
=============== =============== ===============
Stock-Based Compensation
- ------------------------
At December 31, 2002, the Company has stock based compensation plans, which are
described more fully in Note 7. 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 income, 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, 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.
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:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
------------ ------------ ------------
2000 2001 2002
------------ ------------ ------------
Net loss, as reported $ (3,132,772) $ (4,102,931) $ (5,550,234)
Add:
Total stock based employee compensation expense
determined under fair value based method for all
awards (944,779) (1,402,154) (2,196,369)
------------ ------------ ------------
Net loss, pro forma $ (4,077,551) $ (5,505,085) $ (7,746,603)
Basic and diluted loss per share, as reported $ (0.47) $ (0.52) $ (0.64)
Basic and diluted loss per share, pro forma $ (0.61) $ (0.70) $ (0.89)
Comprehensive Loss
- ------------------
The Company's comprehensive net loss is equal to its net loss for the years
ended December 31, 2000, 2001 and 2002.
F-10
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
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 June 2002, the FASB issued Statement 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This statement requires entities to recognize
costs associated with exit or disposal activities when liabilities are incurred
rather than when the entity commits to an exit or disposal plan, as currently
required. Examples of costs covered by this guidance include one-time employee
termination benefits, costs to terminate contracts other than capital leases,
costs to consolidate facilities or relocate employees, and certain other exit or
disposal activities. This statement is effective for fiscal years beginning
after December 31, 2002, and will impact any exit or disposal activities the
Company initiates after that date.
In November 2002, the Emerging Issues Task Force reached a consensus opinion on
EITF 00-21, "Revenue Arrangements with Multiple Deliverables." The consensus
provides that revenue arrangements with multiple deliverables should be divided
into separate units of accounting if certain criteria are met. The consideration
for the arrangement should be allocated to the separate units of accounting
based on their relative fair values, with different provisions if the fair value
of all deliverables are not known or if the fair value is contingent on delivery
of specified items or performance conditions. Applicable revenue recognition
criteria should be considered separately for each separate unit of accounting.
EITF 00-21 is effective for revenue arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company believes that the adoption of EITF
00-21 on its financial statements will be immaterial.
In December 2002, the FASB issued Statement 148 (SFAS 148), "Accounting for
Stock-Based Compensation Transition and Disclosure: an amendment of FASB
Statement 123 (SFAS 123)", to provide alternative transition methods for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in annual financial statements
about the method of accounting for stock-based employee compensation and the pro
forma effect on reported results of applying the fair value based method for
entities that use the intrinsic value method of accounting. The pro forma effect
disclosures are also required to be prominently disclosed in interim period
financial statements. This statement is effective for financial statements for
fiscal years ending after December 15, 2002 and is effective for financial
reports containing condensed financial statements for interim periods beginning
after December 15, 2002, with earlier application permitted. The Company does
not plan a change to the fair value based method of accounting for stock-based
employee compensation and has included the disclosure requirements of SFAS 148
in the accompanying financial statements.
In November 2002, FASB Interpretation 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" (FIN 45), was issued. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002,
but has certain disclosure requirements effective for interim and annual periods
ending after December 15, 2002. The Company has not yet determined the effects
of FIN 45 on its financial statements. The Company determines that the
disclosure provisions do not have a material impact on the accompanying
financial statements.
Reclassifications
- -----------------
Certain prior year amounts have been reclassified to conform to the current year
presentation.
F-11
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
3. PROPERTY AND EQUIPMENT
----------------------
Property and equipment are comprised of the following as of December 31, 2001
and 2002:
2001 2002
---- ----
Computer equipment $ 508,044 $ 481,640
Furniture and fixtures 152,251 155,589
Leasehold improvements 143,253 143,253
Office equipment 40,412 47,552
------------ ------------
843,960 828,034
Less- Accumulated depreciation and amortization (377,384) (503,922)
------------ ------------
$ 466,576 $ 324,112
============ ============
Depreciation expense for the years ended December 31, 2000, 2001 and 2002
amounted to $83,908, $112,044, and $126,537 respectively.
4. INTANGIBLE ASSETS
-----------------
The following summarize the carrying amounts of intangible assets and related
amortization:
As of December 31, 2002
-----------------------
Gross Carrying Accumulated
Amount Amortization
-------------- ------------
Amortized intangible assets
Software $430,000 $218,194
Patents 335,661 75,446
Other
Covenant not to compete 150,000 78,125
Copy Rights 17,500 6,076
-------- --------
Total $933,161 $377,841
======== ========
Unamortized intangible assets
Goodwill $181,477 $ -
======== ========
Amortization expense for years ended December 31, 2000, 2001, and 2002 were
$6,207, $14,841 and $325,043, respectively.
Estimated amortization expense:
For year ended December 31, 2003 $ 318,724
For year ended December 31, 2004 $ 34,800
For year ended December 31, 2005 $ 29,209
For year ended December 31, 2006 $ 29,209
For year ended December 31, 2007 $ 29,209
5. ACCRUED EXPENSES
Accrued expenses are comprised of the following as of December 31, 2001 and
2002:
2001 2002
---- ----
Professional fees $ 474,245 $ 563,294
Payroll 97,500 120,536
Rent 30,784 27,363
Other 239,972 60,212
------------ ------------
$ 842,501 $ 771,405
============ ============
F-12
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
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, 2001 and 2002 are as follows:
2001 2002
---- ----
Deferred tax assets, net:
Net operating loss carryforwards $ 4,662,652 $ 6,502,540
Depreciation (20,000) (20,000)
Reserves 5,000 240,000
Less- Valuation allowance (4,647,652) (6,722,540)
----------- -----------
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 31,2002, the Company had net operating loss carryforwards (NOL's)
for federal income tax purposes of approximately $16 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
2022 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, 2000, 2001 and 2002 is
different from the tax benefit that would result from applying the statutory tax
rates mainly due to the valuation allowance that has been recognized.
7. 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, 2001 and 2002, there were no outstanding
shares of Series A Convertible Preferred Stock.
Common Stock, Warrants and Rights
- ---------------------------------
In February 1999, the Company extended the expiration dates for the warrants
issued on May 26, 1997 and November 30, 1997 until June 30, 2000 and further
extended the warrants to December 31, 2000. The Company did not record a charge
for the adjustment to the terms of the warrants, as the amount was immaterial.
All of the warrants were exercised prior to their expiration.
In April 1999, the Company adjusted the exercise price of a warrant to purchase
common stock of the Company issued to an investor, in a previous common stock
private placement, from $3.00 to $2.00. The adjustment was contingent upon the
investor exercising the warrants within thirty days of the adjustment. The
Company did not record a charge for the adjustment to the terms of the warrants,
as the amount was immaterial as the exercise price of the warrant was equal or
above the fair market value of the Company's common stock on the date of the
adjustment. The investor exercised this warrant in May 1999 at the adjusted
exercise price and the Company received total proceeds of $200,000. In addition,
the investor received a new warrant to purchase 100,000 shares of the Company's
common stock at an exercise price of $3.00 per share, which was exercised in
February 2001. The new warrant has been issued with an exercise price that was
equal or above the fair market value of the Company's common stock on the date
of grant.
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
F-13
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
and warrants, held of record on March 30, 2001, at an exercise price of $8.50.
The rights, which were due to expire on October 4, 2002, were extended by the
Company on October 1, 2002 until April 4, 2003 and further extended until
December 31, 2003. 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 3, 2003. 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.
As of December 31, 2002, 287,594 of these rights were exercised and the Company
received $2,444,549 before expenses of $133,834.
In March 2001, the Company extended the expiration date of its warrants that
were due to expire on various dates through June 30, 2001, until September 30,
2001. During the three months ended March 31, 2001, the Company recorded the
$85,000 difference between the fair value of the warrants prior and subsequent
to this extension as a dividend. In September 2001, the Company further extended
the expiration of these warrants until October 31, 2001 and recorded the $55,000
difference between the fair value of the warrants prior and subsequent to this
extension as a dividend during the three months ended September 30, 2001. These
dividends were calculated using the Black-Scholes valuation method and are
included in net loss attributable to common shareholders.
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, 2001, the Company purchased 10,000 shares of the Company's
common stock for approximately $53,000 and subsequently retired those shares.
During June 2002, the Company purchased 10,000 shares totaling approximately
$70,000 and subsequently retired those shares.
As discussed above, on October 1, 2002, the Company extended until April 4, 2003
all unexercised rights under its rights offering, which were due to expire on
October 4, 2002 and were further extended until December 31, 2003. Each non-
transferable right entitles the stockholder to purchase one share of common
stock at an exercise price of $8.50. The Company recorded the fair value of the
rights extension of $515,000 during the forth quarter of 2002 using the
Black-Scholes valuation method and recorded as an increase in additional
paid-in-capital and a reduction in accumulated deficit.
As of December 31, 2002, there remained warrants outstanding to purchase 10,000
shares of the Company's common stock at an exercise price of $8.40 per share.
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.
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.
F-14
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
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.
In December 2000, the Company granted an option to a third-party to purchase
25,000 shares of common stock at $10.00 per share in lieu of cash payments for
advertising services rendered. Options on 3,599 shares were immediately
exercisable and 21,401 vested as advertising services were performed. The fair
market value of each option has been estimated at $4.00 on the date of grant
using the Black-Scholes option pricing model and is revalued at each measurement
date when services are performed. The Company recorded a charge of $14,398 and
$842 in the accompanying statement of operations as of December 31, 2000 and
2001, respectively. The Company is no longer utilizing these services and the
remaining unvested shares have expired.
During the fourth quarter of 2001, the Company granted options to purchase
41,231 shares of common stock at prices ranging from $9.22 to $16.05 per share
to consultants under various agreements. During 2002, the Company granted
additional 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. 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 $389,000 as deferred compensation for these services as of December 31,
2001 and $1,469,327 as of December 31, 2002. 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 December 31, 2002 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.
During December 31, 2001 and 2002, the Company recognized amortization of
deferred compensation of $200,000 and $713,051, respectively.
Stock option activity under the 1998, 1999 and 2001 Stock Option Plans during
the periods indicated below is as follows:
Number Weighted
Of Average
Options Exercise Price
------- --------------
Outstanding at January 1, 2000 1,538,000 $ 3.72
Granted 376,560 $ 9.80
Canceled (80,000) 3.00
Exercised (66,000) 3.07
------------ ----------
Outstanding at December 31, 2000 1,768,560 4.89
Granted 381,481 11.88
Canceled (37,500) 5.17
Exercised (166,500) 4.72
------------ ----------
Outstanding at December 31, 2001 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
============ ==========
Included in the option schedule are 1,222,000 non-plan options, of which,
1,015,000 are outstanding.
F-15
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
The weighted-average remaining life of the options outstanding at December 31,
2000, 2001 and 2002 is 3.87 years, 2 years, and 3.54 years respectively, and the
weighted-average fair value of the options granted during the year ended
December 31, 2000, 2001 and 2002 is $5.14, $5.14, and $6.62 respectively.
As of December 31, 2000, 2001 and 2002, 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 2, 2 and 5 years; risk free
interest rates of 6.00%, 4.50% and 4.50%; expected volatility of 91%, 90% and
90% and a dividend yield of 0%, 0% and 0%, respectively.
As of December 31, 2002, the Company has 1,703,738 options exercisable with a
weighted average exercise price of $6.97. As of December 31, 2002, the Company
has 281,934 options available for future grant under the 1998, 1999 and 2001
Stock Option Plans.
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.
8. 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 will 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 are being
amortized on a straight-line basis of between 2-10 years, which represents the
estimated future period to be benefited.
9. 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 will be reduced after 45 months to $34,916
for the remaining lease term. The Company has invested $250,000 in a restricted
interest bearing certificate of deposit collateralizing the letter of credit. As
of December 31, 2002 the total amount in this account is $273,317.
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:
2003 $ 255,617
2004 241,832
2005 245,064
2006 254,904
2007 265,140
Thereafter 860,772
--------------
$ 2,123,329
==============
Rent expense for the years ended December 31, 2000, 2001 and 2002 amounted to
$120,050, $208,100 and $242,083, respectively.
F-16
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Capital Lease Obligations
- -------------------------
The Company leases computer equipment and office equipment under several capital
leases expiring in 2004. The asset and liability are recorded at the lower of
the present value of minimum lease payments or the fair market value of the
assets.
Future minimum payments under the lease agreements are as follows:
Year Ending December 31:
2003 $ 19,572
2004 427
-----------
Total minimum lease payments $ 19,999
===========
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, 2002, no payments were made or payable under
this agreement.
Employment Agreements
- ---------------------
On January 1, 1999, the Company entered into three-year employment contracts
with both its Chairman and Chief Executive Officer and its Senior Executive Vice
President and Chief Technology Officer. Each of the agreements provided for a
base salary of $225,000 subject to certain conditions and the payment of a bonus
if the Company's sales exceed $2,000,000 in the previous year. The bonus would
have been in the amount of $50,000 plus 1% of the amount of sales in excess of
$2,000,000 in each year. In addition, for each fiscal year ending during the
term of the employment agreements, the Company was obligated to grant to each of
the executives an option to purchase the greater of 25,000 shares of common
stock at fair market value on the date of grant or 10,000 shares of common stock
at fair market value on the date of grant for each full $250,000 by which
pre-tax profits for each year exceeds pre-tax profits for the prior fiscal year.
However, the Company was not required to grant options to purchase more than
150,000 shares of common stock with respect to any one fiscal year. During the
terms of their agreements, no bonuses were earned.
On May 7, 2001, the Board of Directors accepted the resignation of its Senior
Vice President and Chief Technical Officer. Accordingly, all of the obligations
under the employment agreement, including the payment of salaries and
incentives, ceased as of this date.
On February 1, 2002 the Company entered into a new three-year employment
contract with its Chairman and Chief Executive Officer, the agreement provides
for an annual base salary of $250,000. In addition, the Company granted the
Chairman and Chief Executive Officer an option to purchase 350,000 shares of
common stock exercisable at $12.10 per share of which 125,000 options are
immediately exercisable and 225,000 options become exercisable at a rate of
75,000 per year at December 31, 2002, 2003 and 2004.
In June 1999, the Chairman and Chief Executive Officer converted approximately
$380,000 in deferred salary and interest into 375,000 options to purchase a
share of common stock at an exercise price of $3.00, expiring in June 2004. In
addition, the Company's Senior Executive Vice President and Chief Technology
Officer converted approximately $210,000 in deferred salary and interest into
207,000 options to purchase a share of common stock at $3.00, expiring in June
2004. Furthermore, the Company's former President converted approximately
$110,000 in deferred salary and interest into 110,000 options to purchase a
share of common stock at $3.00, expiring in June 2004.
In July 1999, the Company entered into a two-year employment agreement with its
Senior Executive Vice President and Chief Financial Officer, which became
effective on September 7, 1999. The agreement provided for a base salary of
$125,000. In addition, the Company granted the Chief Financial Officer an option
to purchase 50,000 shares of common stock, of which 30,000 options were
immediately exercisable at $5.00 per share and 20,000 options became exercisable
on September 7, 2000 at $5.00 per share.
On September 7, 2001, the Company renewed the employment agreement of its Senior
Executive Vice President and Chief Financial Officer. The agreement, which
expires December 31, 2004, provides for a base salary of $135,000 with annual
F-17
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
increases of 5%. In addition, the Company granted 75,000 stock options at an
exercise price of $8.04 vesting on September 7, 2006 with earlier vesting
incentives.
Effective October 1999, the Company entered into a two-year employment agreement
with its Senior Executive Vice President of Sales. The agreement provides for a
base salary of $115,000. In addition, the Company granted the Senior Executive
Vice President of Sales an option to purchase 50,000 shares of common stock at
$7.50 per share, of which 20,000 shares are immediately exercisable and 5,000
shares become exercisable for each 10,000 sales of ID-Check products sold that
exceed 10,000. The maximum options that can be earned in any calendar year may
not exceed 100,000. Any options earned above the initial 50,000 options will be
at fair market value on the date of grant. This agreement was renewed for an
additional 2 years expiring October 2003 under the same terms and conditions.
Supplier Agreements
- -------------------
In July 1999, and amended November 1999 and July 2000, the Company entered into
a supplier agreement with Hand Held Products (HHP), formerly Welch Allyn, Inc.
The agreement specified that the Company pay approximately $188,000 for the
development of the Company's ID-check products. In addition, HHP agreed to
manufacture these products for an initial period of two years and provides for
automatic renewal periods of one year. The Company placed an initial order for a
total of 2,000 units of which 500 units were received as of December 31, 1999.
These units were subsequently returned to the manufacturer to exchange the
original scanner for a high-tech scanner, which allows the software to read the
encoding on 51 jurisdictions as opposed to 32 jurisdictions that could be read
on the original scanner. The Company received all of its product on these
orders. During July 2000, the Company placed an additional order to purchase
5,000 units and has received a portion of the units prior to December 31, 2000.
During 2001, the Company agreed to provide HHP with advance deposits totaling
$600,000 towards the fulfillment of its obligation on its purchase order. The
Company satisfied its obligation and paid $200,000 in 2001 and the remaining
$400,000 in 2002. It was further agreed that should the Company decide not to
purchase the required units under the purchase order, all of the materials
purchased by the manufacturer to secure the production of units would be shipped
to the Company and the balance of the obligation would cease. As of December 31,
2002, the Company reserved the deposit of $600,000 due to the uncertainty of
whether or not the Company will complete this purchase order and use the
materials.
In addition, HHP has notified the Company that effective July 9, 2003, it will
terminate the Development and Supply agreement dated July 9, 1999 due to the
discontinuation of manufacturing the IDC-1400 model, but will fulfill its
obligation remaining with respect to the outstanding purchase order. The Company
is in discussions with its current manufacturer as well as other manufacturers
to select a new platform to run its patented software.
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.
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 as of December 31, 2002.
Investment Banking Relationship
- -------------------------------
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. Should KPMG secure funding
from a private placement of the Company's securities, the Company will also pay
3.5% of proceeds received from such funding. In connection with financing
described in note 11 below, KPMG agreed to receive 2.0% in cash and 1% of funds
drawn in warrants. Additionally, other fees are required to be paid as a result
of any acquisition by the Company and merger of or sale of the Company.
F-18
INTELLI-CHECK, INC.
NOTES TO FINANCIAL STATEMENTS
Legal Proceedings
- -----------------
A lawsuit was filed as a class action on October 18, 2001 on behalf of
short-sellers of the Company's stock, who allegedly suffered losses because of
the rise in the price of our stock, in the United States District Court for New
Jersey. The class action suit was amended in November 2001 and is now an
individual action. The complaint alleges violations of the Securities and
Exchange Act of 1934. On July 26, 2002, the Company filed a motion to dismiss
the lawsuit. The Company's motion to dismiss has been fully briefed by both
sides and is awaiting the Court's decision. The Company believes the suit is
without merit. The Company did not accrue for any potential outcome as such
accrual can not be determined at this time.
A demand for arbitration was brought by Early Bird Capital Inc. in January 2002,
seeking issuance of warrants with registration rights pursuant to the terms of a
Financial Advisory and Investment Banking Agreement dated as of August 20, 2000.
The arbitration took place in December 2002 and January 2003, and both sides
have completed presenting their cases. Early Bird Capital has demanded a
monetary judgment in the amount of $968,000, which, if awarded, would have a
material adverse effect on the Company. The Company believes it has presented a
meritorious defense; however, there can be no assurance that we will prevail.
The Company did not accrue for any potential outcome as such accrual can not be
determined at this time.
On February 19, 2003, we filed a summons and complaint upon CardCom Technology,
Inc. for its infringement on our patent. Under Federal rules, absent an
extension of time, the CardCom answer is due on or before April 1, 2003.
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.
10. SUBSEQUENT EVENTS
-----------------
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold 30,000
shares of our Series A 8% Convertible Preferred Stock, par value $.01 per share
for $3,000,000 before expenses to Gryphon Master Fund, L.P. Each preferred share
entitles the holder to receive dividends of 8% per annum and is convertible into
15.1515 shares of our common stock. Additionally, each share of Preferred Stock
will receive one (1) 5 year warrant to purchase 3.787875 shares of common stock
at a price of $6.78. The total amount of shares that may be issued upon
conversion and the exercising of the warrants are 454,545 and 113,636 shares,
respectively. Dividend payments of $120,000 are due semi-annually in cash
beginning September 30, 2003. In connection with this financing, we paid agent
fees of $150,000, plus legal fees estimated to be approximately $55,000. Shares
of Preferred Stock will be 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
Shares 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 any 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.
On March 17, 2003 the Company further extended the expiration date of its right
offering (see Note 7) until December 31, 2003.
F-19
Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each of
the undersigned officers of Intelli-Check, Inc. (the "Company"), does hereby
certify, to such officer's knowledge, that:
The Annual Report on Form 10-K for the year ended December 31, 2002 of the
Company fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and information contained in the Form 10-K
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
/s/ Frank Mandelbaum
Dated: March 27, 2003 ___________________________________
Name: Frank Mandelbaum
Title: Chief Executive Officer
/s/ Edwin Winiarz
Dated: March 27, 2003 ___________________________________
Name: Edwin Winiarz
Title: Chief Financial Officer
The foregoing certification is being furnished solely pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350,
Chapter 63 of Title 18, United States Code) and is not being filed as part of
the Form 10-K or as a separate disclosure document.