SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT UNDER 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.
(Exact name of the 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
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
--- ---
Number of shares outstanding of the issuer's Common Stock:
Class Outstanding at September 30, 2003
Common Stock, $.001 par value 9,054,868
Intelli-Check, Inc.
INDEX
Part I Financial Information
Page
----
Item 1. Financial Statements
Balance Sheets - September 30, 2003 (Unaudited)
and December 31, 2002 1
Statements of Operations for the three and nine months ended
September 30, 2003 (Unaudited) and September 30, 2002 (Unaudited) 2
Statements of Cash Flows for the nine months ended September 30, 2003
(Unaudited) and September 30, 2002 (Unaudited) 3
Statements of Stockholders' Equity for the nine months ended
September 30, 2003 (Unaudited) 4
Notes to Financial Statements 5-9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 15
Item 4. Controls and Procedures 15
Part II Other Information
Item 1. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
Exhibits
31. CEO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 19
31. CFO Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 20
32. CEO & CFO Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 21
Intelli-Check, Inc.
Balance Sheets
ASSETS
September 30, December 31,
2003 2002
------------ ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 1,438,509 $ 1,910,579
Certificate of deposit, restricted 1,006,548 --
Accounts receivable 238,444 93,530
Inventory 824,075 1,802,839
Other current assets 177,894 273,770
------------ ------------
Total current assets 3,685,470 4,080,718
CERTIFICATE OF DEPOSIT 275,295 273,317
PROPERTY AND EQUIPMENT, net 237,953 324,112
ACQUIRED SOFTWARE, net 50,556 211,806
GOODWILL 181,447 181,447
PATENT COSTS, net 238,308 260,215
DEFERRED REGISTRATION COSTS 300,000 --
OTHER INTANGIBLES, net 22,674 83,299
------------ ------------
Total assets $ 4,991,703 $ 5,414,914
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 510,514 $ 298,635
Accrued expenses 845,072 771,405
Litigation settlement payable 921,700 --
Deferred revenue 259,998 357,059
Current portion of capital lease obligations 2,860 19,572
------------ ------------
Total current liabilities 2,540,144 1,446,671
CAPITAL LEASE OBLIGATIONS -- 427
OTHER LIABILITIES 117,568 94,565
SERIES A 8% CONVERTIBLE REDEEMABLE PREFERRED STOCK,
Net of beneficial conversion feature, warrants issued and
issuance costs - $.01 par value; 1,000,000 shares authorized;
30,000 shares issued and outstanding 1,807,916 --
------------ ------------
Total liabilities 4,465,628 1,541,663
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock - $.001 par value; 20,000,000 shares Authorized;
9,054,868 and 8,875,302 shares issued and outstanding, respectively 9,054 8,874
Additional paid-in capital 25,524,086 22,399,029
Deferred compensation (418,335) (348,476)
Accumulated deficit (24,588,730) (18,186,176)
------------ ------------
Total stockholders' equity 526,075 3,873,251
------------ ------------
Total liabilities and stockholders' equity $ 4,991,703 $ 5,414,914
============ ============
See accompanying notes to financial statements
1
Intelli-Check, Inc.
Statements of Operations
(Unaudited)
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
REVENUE $ 345,685 $ 231,819 $ 950,012 $ 773,553
COST OF REVENUE (102,025) (105,630) (343,248) (352,342)
INVENTORY WRITEDOWN -- -- (800,000) --
----------- ----------- ----------- -----------
Gross profit(loss) 243,660 126,189 (193,236) 421,211
----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling 297,162 314,573 977,012 1,190,850
General and administrative 681,252 760,486 2,105,922 2,675,750
Research and development 306,680 285,578 928,241 911,073
----------- ----------- ----------- -----------
Total operating expenses 1,285,094 1,360,637 4,011,175 4,777,673
----------- ----------- ----------- -----------
Loss from operations (1,041,434) (1,234,448) (4,204,411) (4,356,462)
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSES):
Interest income 5,877 11,688 21,499 43,943
Interest expense (42,283) (1,134) (43,437) (4,004)
Interest expense on shares subject
to mandatory redemption (126,252) -- (126,252) --
Other (Note 5) -- -- (921,730) 336,344
----------- ----------- ----------- -----------
(162,658) 10,554 (1,069,920) 376,283
Net loss $(1,204,092) $(1,223,894) $(5,274,331) $(3,980,179)
=========== =========== =========== ===========
PER SHARE INFORMATION:
Net loss per common share -
Net loss $(1,204,092) $(1,223,894) $(5,274,331) $(3,980,179)
Accretion of convertible
redeemable preferred stock costs -- -- 65,758 --
Dividend on convertible
redeemable preferred stock -- -- 62,465 --
----------- ----------- ----------- -----------
Net loss attributable to common
shareholders $(1,204,092) $(1,223,894) $(5,402,554) $(3,980,179)
=========== =========== =========== ===========
Basic and diluted $ (.13) $ (.14) $ (.60) $ (.46)
Common shares used in computing
per share amounts -
Basic and diluted 8,984,216 8,791,488 8,930,276 8,640,541
See accompanying notes to financial statements
2
Intelli-Check, Inc.
Statements of Cash Flows
(Unaudited)
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(5,274,331) $(3,980,179)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 331,871 339,305
Noncash stock based compensation expense 29,000 --
Amortization of deferred compensation 272,032 683,566
Writedown of inventory 800,000 --
Changes in assets and liabilities -
Non cash interest expense on shares subject to mandatory redemption 65,759 --
Increase in certificates of deposit, restricted (1,008,526) (3,782)
(Increase) decrease in accounts receivable (144,914) (78,304)
Decrease in inventory 178,764 258,808
Decrease (increase) in other current assets 95,876 (464,421)
Increase in accounts payable and accrued expenses 73,546 23,927
Increase in litigation settlement payable 921,700 --
(Decrease) increase in deferred revenue (97,061) 194,136
Increase in other liabilities 23,003 --
----------- -----------
Net cash used in operating activities (3,733,281) (3,026,944)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,931) (35,187)
----------- -----------
Net cash used in investing activities (1,931) (35,187)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 716,646 1,589,226
Net proceeds from issuance of convertible redeemable
preferred stock 2,714,100 --
Payment of registration costs for secondary offering (88,000) --
Payment of dividend to preferred stock holder (62,465) --
Repayment of capital lease obligation (17,139) (16,592)
Treasury stock purchased -- (70,054)
----------- -----------
Net cash provided by financing activities 3,263,142 1,502,580
----------- -----------
(Decrease) in cash (472,070) (1,559,551)
CASH AND CASH EQUIVALENTS, beginning of period 1,910,579 4,061,235
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 1,438,509 $ 2,501,684
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for interest $ 1,437 $ 4,004
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
ACTIVITIES:
Beneficial conversion feature and warrants issued in connection
with issuance of convertible redeemable preferred stock $ 1,037,700 $ --
=========== ===========
Accretion of convertible redeemable preferred stock cost $ 65,758 $ --
=========== ===========
See accompanying notes to financial statements
3
Intelli-Check, Inc.
Statement of Stockholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2003
Additional
Common Stock Paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
--------- --------- ------------ --------- ------------ -----------
BALANCE, January 1, 2003 8,875,302 $ 8,874 $ 22,399,029 $(348,476) $(18,186,176) $ 3,873,251
Effect on extension of expiring options 29,000 29,000
Exercise of stock options 175,209 175 679,436 -- -- 679,611
Exercise of rights 4,357 5 37,030 -- -- 37,035
Effect on extension of expiring rights dividend -- -- 1,000,000 -- (1,000,000) --
Warrants issued in connection with the issuance
of convertible redeemable preferred stock -- -- 497,700 -- -- 497,700
Beneficial conversion feature embedded in
convertible redeemable preferred stock issued -- -- 540,000 -- -- 540,000
Amortization of deferred compensation -- -- -- 272,032 -- 272,032
Dividend on convertible redeemable preferred
stock -- -- -- -- (62,465) (62,465)
Recognition of deferred compensation -- -- 232,112 (232,112) -- --
Accretion of convertible redeemable preferred
stock -- -- -- -- (65,758) (65,758)
Valuation adjustment of deferred compensation -- -- 109,779 (109,779) -- --
Net loss -- -- -- -- (5,274,331) (5,274,331)
--------- --------- ------------ --------- ------------ -----------
BALANCE, September 30, 2003 9,054,868 $ 9,054 $ 25,524,086 $(418,335) $(24,588,730) $ 526,075
========= ========= ============ ========= ============ ===========
See accompanying notes to financial statements
4
Intelli-Check, Inc.
Notes to Financial Statements
(Unaudited)
Note 1. Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and notes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, the unaudited interim financial statements
furnished herein include all adjustments necessary for a fair presentation of
the Company's financial position at September 30, 2003 and the results of its
operations for the nine months and three months ended September 30, 2003 and
2002, stockholders' equity for the nine months ended September 30, 2003 and cash
flows for the nine months ended September 30, 2003 and 2002. All such
adjustments are of a normal and recurring nature. Interim financial statements
are prepared on a basis consistent with the Company's annual financial
statements. Results of operations for the nine month period ending September 30,
2003 are not necessarily indicative of the operating results that may be
expected for the year ending December 31, 2003.
The balance sheet as of December 31, 2002 has been derived from the
audited financial statements at that date but does not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements.
For further information, refer to the financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
The Company anticipates that its current available cash on hand,
including the proceeds received from its secondary offering consummated
subsequent to the end of the three month period ended September 30, 2003, cash
resources from expected revenues from the sale of the units in inventory and
licensing of its technology will be sufficient to meet its anticipated working
capital and capital expenditure requirements for at least the next eighteen
months. These requirements are expected to include the purchase of additional
inventory to run its patented software, product development, sales and
marketing, working capital requirements and other general corporate purposes.
Should sales of its products fall below expectations during the next 18 months,
the Company would be required to raise additional capital to fund its
operations. Should the Company need to raise additional capital, there can be no
assurances that the Company will be successful in raising capital. In addition,
the Company may need to raise additional funds to respond to business
contingencies which may include the need to fund more rapid expansion, fund
additional marketing expenditures, develop new markets for its ID-Check
technology, enhance our operating infrastructure, respond to competitive
pressures, or acquire complementary businesses or necessary technologies.
Recently Issued Accounting Standards
In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after September 30, 2003 except for the provisions that were cleared by
the FASB in prior pronouncements. The Company believes that the adoption of SFAS
No. 149 will not have a material effect on its financial position and results of
operations.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 ("SFAS No. 150"), "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement is effective for financial instruments entered into
on or before May 31, 2003 and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The Company adopted SFAS No.
150 July 1, 2003, and has classified
5
the Series A 8% convertible redeemable preferred stock as a liability.
Accordingly, the preferred dividend and accretion of the preferred stock
recorded subsequent to July 1, 2003 are recorded as interest expense.
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 its financial statements and accompanying notes. Actual results
could differ materially from those estimates.
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; accordingly, a portion of the revenue pertaining to the service and
support is deferred based on its fair value and recognized ratably over the
period in which the future service, support and performance are provided, which
is generally one year. Currently, with respect to sales 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.
In addition, the Company recognizes sales from licensing of its
patented software to customers. The Company's licensed software requires
continuing service or post contract customer support and performance by the
Company; accordingly, a portion of the revenue is deferred based on its fair
value and recognized ratably over the period in which the future service,
support and performance are provided, which is generally one year.
During the second quarter of fiscal 2003, the Company began receiving
royalties from licensing its technology, which are recognized as revenues in the
period it is earned.
Inventory Valuation
The Company's inventory consists primarily of its ID-Check terminals
that run our patented software. The Company acquired such inventory in December
1999 and, shortly thereafter, it was returned to the manufacturer for upgrade
and became available for sale in the fourth quarter of 2000. 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 its current inventory, with margin, over a period of time. The
Company had reserved during the fourth quarter of 2002 its previously paid
deposit of $600,000 towards the purchase of units that would have been available
to be purchased had the outstanding purchase order not terminated with our
manufacturer. The current terminal is fully capable of running the Company's
patented software as it utilizes a state-of-the-art imager/scanner and magnetic
stripe reader. However, since the Company's policy is to periodically evaluate
the market value of the inventory, it was determined that an inventory reserve
of $800,000 should be taken, which has impacted the Company's results of
operations during the nine month period ended September 30, 2003. The Company is
evaluating various options that may be utilized in the future to fill
requirements for a hardware platform that could run its patented software.
Stock-Based Compensation
At September 30, 2003, the Company maintains stock based compensation
plans, which are described more fully in Note 7 to the Financial Statements
included in the Company's 2002 Annual Report on Form 10-K. 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 Goods or Services". All transactions in which goods or
services are the consideration received for the issuance of equity
6
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 employee stock based compensation:
---------------------------------------------------------------------------------------------------------------------
Three months ended Three months ended Nine months ended Nine months ended
September 30, 2003 September 30, 2002 September 30, 2003 September 30, 2002
------------------ ------------------ ------------------ ------------------
Net loss, as reported ($1,204,092) ($1,223,894) ($5,402,554) ($3,980,179)
---------------------------------------------------------------------------------------------------------------------
Add:
Total stock based employee compensation
expense determined under fair value
Based method for all awards 1,850,142 294,316 2,414,512 1,928,532
----------- ----------- ----------- -----------
Net loss, pro forma ($3,054,234) ($1,518,210) ($7,817,066) ($5,908,711)
---------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share, as
reported ($ 0.13) ($ 0.14) ($ 0.61) ($ 0.46)
---------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share, pro
forma ($ 0.34) ($ 0.17) ($ 0.88) ($ 0.68)
---------------------------------------------------------------------------------------------------------------------
Reclassifications
Certain prior period amounts have been reclassified to conform to the
current period presentation.
Note 2. Net Loss Per Common Share
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
periods ended September 30, 2003 and 2002 does not include the impact of stock
options, warrants and convertible preferred stock 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 September 30, 2003
and 2002 had been exercised or converted, as the case may be.
2003 2002
--------- ---------
Stock options 1,953,874 1,560,190
Warrants 128,061 10,000
Convertible redeemable preferred stock 454,545 --
--------- ---------
Total 2,536,480 1,570,190
--------- ---------
Note 3. Convertible Redeemable Preferred Stock
On March 27, 2003, pursuant to a Securities Purchase Agreement, the
Company sold 30,000 shares of our Series A 8% Convertible Redeemable Preferred
Stock, par value $.01 per share, for $3,000,000 before expenses to Gryphon
Master Fund, L.P. Each share of Preferred Stock entitled the holder to receive
dividends of 8% per annum and is currently convertible into 15.1515 shares of
our common stock. Additionally, each investor received one (1) five year warrant
to purchase 3.787875 shares of common stock at an exercise price of $6.78 with
each share of Preferred Stock purchased. The total amount of shares that may be
issued upon conversion of the Preferred Stock and exercise of the warrants are
454,545 and 113,636, respectively. Dividend payments of $120,000 in cash are due
semi-annually beginning September 30, 2003 and, accordingly, the Company paid
$122,958 on September 30, 2003. In connection with this financing, the Company
paid agent fees of $150,000 and issued warrants and optio gdns to purchase 8,854
shares of common stock at a price of $6.78. The Company also paid legal fees of
approximately $127,000. The Company recorded the relative fair value of the
warrants issued in connection with this transaction of $497,700 against the
amount of the Convertible Redeemable Preferred Stock as of March 27, 2003, which
was calculated using the Black-Scholes valuation method, as well as $540,000 of
beneficial conversion feature in accordance with EITF 00-27 and such amounts are
being accreted along with issuance cost of $285,900 over the five
7
year period until the mandatory redemption date of the Preferred Stock, the
fifth anniversary of closing. The Company recorded accretion of $131,517 for the
period ended September 30, 2003. Shares of Preferred Stock are convertible at
the option of Gryphon Master Fund, L.P at any time prior to redemption. The
Company may redeem any or all of the Preferred Stock at any time after one year
from the closing date at a cash redemption price of $100 per share, providing
the volume weighted average price of the Company's Common Stock for 20 out of 30
consecutive trading days exceeds $13.20 per share. 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.
Note 4. Rights Extension
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 that were 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, 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 in March 2003 until December 31, 2003. The Company recorded the fair
value of the additional rights extension of $1,000,000 during the quarter ended
March 31, 2003 using the Black-Scholes valuation method and recorded an increase
in additional paid-in-capital and a reduction in accumulated deficit. On
November 5, 2003 the Board of Directors elected to extend the expiration date of
these rights to June 30, 2004.
Note 5. Legal Matters
A class action lawsuit was filed 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 the Company's stock, in the United States District
Court for New Jersey. The class action suit was amended in November 2001 and
became an individual action. On July 26, 2002, the Company filed a motion to
dismiss the lawsuit. On July 30, 2003, the court granted the Company's motion to
dismiss the lawsuit. However, it did allow the Plaintiff to replead some of the
claims. The Plaintiff has filed an amended complaint pertaining to certain of
the pleadings.
On February 19, 2003, the Company filed a summons and complaint upon
CardCom Technology, Inc. alleging infringement on its patent. During September
2003, the Company settled this case with CardCom Technology, Inc. The Company
granted CardCom a three year royalty license to use certain of the Company's
patents in connection with the manufacture, use and sale of CardCom's age
verification products in the United States and Canada. It also provides that
CardCom will pay royalties of approximately 10% on its net sales. For the period
ended September 30, 2003, the Company received $42,105 in royalty fees pursuant
to this agreement.
On April 9, 2003, the Company received notification from the American
Arbitration Association that it had awarded Early Bird Capital $921,730 on the
settlement of their demand. The Company had filed with the New York State
Supreme Court an application for setting aside the confirmation of the award. On
October 14, 2003, the court confirmed the award with interest at a rate of 9%
per annum beginning April 9, 2003. The Company recorded a charge of $921,730 in
its Statements of Operations for the three month period ending March 31, 2003.
The Company secured a one year letter of credit for the full amount of the
charge along with interest totaling $1,004,686 until April 9, 2004 in the form
of a certificate of deposit. The Company is planning to appeal the award and
examining other options available to it. If the Company is unsuccessful in its
appeal, interest would accrue until the appeal process is completed.
On August 1, 2003, the Company filed a summons and complaint against
Tricom Card Technologies, Inc. alleging infringement on its patent seeking
injunctive and monetary relief. On October 23, 2003, the Company amended its
complaint to include infringement on an additional patent. Tricom filed its
responsive pleading on November 12, 2003. The parties are currently engaged in
discovery.
Note 6. Secondary Offering
On October 8, 2003, the Company successfully consummated its secondary
offering of 1,100,000 shares of common stock at $8.00 per share and received
proceeds net of underwriting discounts and commissions and before other offering
expenses of approximately $7,906,000. In connection with this offering, the
Company granted to its underwriter an option to purchase up to an additional
165,000 shares of its common stock at $8.00 per share less underwriter discounts
and commissions for the purpose of covering over-allotments, if any, which
expires on November 16, 2003. In addition, the Company sold to the underwriter
110,000 warrants for a price of $110 to purchase 110,000 shares of its common
stock at a price of $9.60 per share. The warrants become exercisable on the
8
first anniversary of the offering and expire four years from such date. Through
September 30, 2003, the Company incurred deferred registration costs aggregating
approximately $300,000, which will be offset against equity raised in October
2003.
Note 7. Subsequent Event
On November 12, 2003, Howard Davis resigned from the Board of
Directors. The Company agreed to extend the expiration date of his options to
November 11, 2004, which originally were due to expire on February 10, 2004.
Item 2. 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 allowed our software to 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 through the quarter ended September
30, 2003, sales were limited due to the refocus of our marketing efforts towards
larger customers in the retail market, in which the sales cycle normally
requires an extended time frame to allow for multiple meetings, presentations
and a test period. We believe that this sales cycle has been further extended by
the downturn in the economy, whereby decisions for capital expenditures have
been delayed. However, after the tragic events that occurred on September 11,
2001, we believe there has been a significant increase in awareness to help
improve security across many industries, including airlines, rail transportation
and high profile buildings and facilities, which should enhance demand for our
technology. We have also begun to market to various government and state
agencies, which have long sales cycles including extended test periods. Since
inception, we have incurred significant losses and negative cash flow from
operating activities and, as of September 30, 2003, we had an accumulated
deficit of approximately $24,600,000. We will continue to fund operating and
capital expenditures from proceeds that we received from our recent financing
and our secondary offering. 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 ID-Check's unique ability to verify the validity of military ID's,
driver licenses and state issued non-driver ID cards that contain magnetic
stripes or bar codes that conform to AAMVA/ANSI/ISO standards, enables us to
target three distinct markets. The original target market was focused on
resellers of age-restricted products, such as alcohol and tobacco, where the
proliferation of high-tech fake IDs expose merchants to fines and penalties for
the inadvertent sale of these products to underage purchasers. Commercial Fraud,
which includes identity theft, has additionally exposed industry to economic
losses through various frauds that utilize fake IDs to support these
transactions. Our technology is designed to help prevent losses from these
frauds. We believe that the tragic events that occurred on September 11, 2001
have created increased awareness of our technology in security applications
involving access control. As a result of its applicability in these markets, we
have sold our products to some of the largest companies in the gaming industry,
a state port authority, military establishments, airports, nuclear power plants
and high profile buildings and have successfully completed tests of our
technology in one of the largest mass merchandisers in the United States and a
large quasi-government department. We currently are testing our products with
some large public companies and in several locations in a large population
State. We have entered into strategic alliances with Bioscrypt Inc., Identix
Corporation and Ultra-Scan Inc., biometric companies; E-Certify, an information
security company; Lenel Systems International, a provider of integrated security
solutions; and Northrop Grumman Mission Systems, an integrator in the defense
industry, to utilize our systems and software as the proposed or potential
enrollment application for their technologies and to jointly market these
security applications. In addition, we have recently signed agreements with some
high profile organizations to promote the use of our technology and our
products, such as Credit Union National Association (CUNA), Mothers Against
Drunk Driving (MADD) and the American Association of Airport Executives (AAAE).
We believe these relationships have broadened our marketing reach through their
sales efforts and we intend to develop additional strategic alliances with
additional high profile organizations and providers of security solutions.
9
We have developed additional software products that utilize our
patented software technology. Our C-Link(R) software product, which runs on a
personal computer and was created to work in conjunction with the ID-Check unit
allows a user to instantly view the encoded data for further verification, to
analyze the data and to generate various reports where permitted by law. We have
also developed software containing our patented technology 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. To date, we have entered
into six licensing agreements and are in discussions with additional companies
to license our software to be utilized within other existing systems. The
revenue received from such licensing agreements has not been significant through
the period ended September 30, 2003.
The foregoing contains certain forward-looking statements. Due to the
fact that we could face intense competition in a business characterized by
rapidly changing technology and high capital requirements, actual results and
outcomes may differ materially from any such forward looking statements and, in
general, are difficult to forecast.
Critical Accounting Policies and the Use of Estimates
The preparation of our financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in our financial statements and accompanying notes. Actual results
could differ materially from those estimates.
We believe that there are several accounting policies that are critical
to understanding our historical and future performance, as these policies affect
the reported amounts of revenue and the more significant areas involving
management's judgments and estimates. These significant accounting policies
relate to revenue recognition, valuation of inventory and commitments and
contingencies. These policies and our procedures related to these policies are
described in detail below.
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; accordingly, a portion of the
revenue pertaining to the service and support is deferred based on its fair
value and recognized ratably over the period in which the future service,
support and performance are provided, which is generally one year. Currently,
with respect to sales to distributors and sales of our IDentiScan products, we
do not have enough experience to identify the fair value of each element.
Therefore, the full amount of revenue and related gross margin is deferred and
recognized ratably over the one-year period in which the future service, support
and performance will be 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; accordingly, a portion of the revenue is deferred based on its fair value
and recognized ratably over the period in which the future service, support and
performance are provided, which is generally one year.
During the second quarter of fiscal 2003, we began receiving royalties
from licensing our technology. We will recognize these payments as revenues in
the period it is earned.
B. Inventory Valuation
Our inventory consists primarily of our ID-Check terminals that run our
patented software. We acquired such inventory in December 1999 and, shortly
thereafter, it was returned to the manufacturer for upgrade and became available
for sale in the fourth quarter of 2000. We periodically evaluate the current
market value of our inventory, taking into account any technological
obsolescence that may occur due to changes in hardware technology and the
acceptance of the product in the marketplace. Even though we have had limited
sales to date, we believe that a sufficient market exists to sell the current
inventory ,with margin, over a period of time. We have reserved during the
fourth quarter of 2002 our previously paid deposit of $600,000 towards the
purchase of units that would have been available to be purchased had the
outstanding purchase order not terminated with our manufacturer. The current
terminal 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, we
determined that an inventory reserve of $800,000 should be taken, which has our
results of
10
operations during the nine month period ended September 30, 2003. We are
evaluating various options that may be utilized in the future to fill
requirements for a hardware platform that could run our patented software.
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 filed in our form 10-K for the year ended December 31, 2002. Other
than as described in footnote 5 above, we do not believe these legal proceedings
will have a material adverse effect on our financial position, results of
operations or cash flows.
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.
(b) Results of Operations
Comparison of the nine months ended September 30, 2003 to the nine
months ended September 30, 2002.
Revenues increased $176,459 from $773,553 for the nine months ended
September 30, 2002 to $950,012 for the nine months ended September 30, 2003.
Revenues for the period ended September 30, 2003 consisted of revenues from
distributors of $234,191, revenues from direct sales to customers of $673,715
and royalty payments of $42,106. Shipments of products and contracted services
amounted to $885,371 and $989,692 for the periods ended September 30, 2003 and
2002, respectively. The refocus of our marketing efforts to larger retailers and
government agencies continues to impact our sales as a result of the extended
time frame associated with these sales cycles. In addition, during 2001, 2002
and continuing in 2003, the sales cycle has been further extended by the
economic downturn in the economy delaying capital expenditures decisions. We
believe that based upon the results of certain of our recent marketing tests and
recent marketing agreements as well as legislative efforts to enhance security,
these events should result in increased sales opportunities.
Gross profit, excluding an inventory writedown of $800,000 in the
second quarter of 2003, would have increased by $185,553 from $421,211 for the
nine months ended September 30, 2002 to $606,764 for the nine months ended
September 30, 2003. Our gross profit excluding the inventory writedown of
$800,000 in the second quarter of 2003 as a percentage of revenues would have
increased to 63.9% in the nine months ended September 30, 2003 from 54.5% for
the nine months ended September 30, 2002. Our gross profit percentage was
positively impacted by an increase in revenues from licensing our patented
technology at higher gross margins.
Operating expenses, which consist of selling, general and
administrative and research and development expenses, decreased 16.0% from
$4,777,673 for the nine months ended September 30, 2002 to $4,011,175 for the
nine months ended September 30, 2003. Selling expenses, which consist primarily
of salaries and related costs for marketing, decreased 18.0% from $1,190,850 for
the nine months ended September 30, 2002 to $977,012 for the nine months ended
September 30, 2003 primarily due to decreased travel and convention expenses of
approximately $61,000 and a reduction of non-recurring expenses of $203,000 from
the hiring of professional consultants during the nine months ended September
30, 2002 to promote our product, which was partially offset by an increase in
salaries and employee costs of approximately $15,000 and advertising expenses of
approximately $18,000 during the nine months ended September 30, 2003. General
and administrative expenses, which consist primarily of salaries and related
costs for general corporate functions, including executive, accounting,
facilities and fees for legal and professional services, decreased 21.3% from
$2,675,750 for the nine months ended September 30, 2002 to $2,105,922 for the
nine months ended September 30, 2003 primarily as a result of a reduction of
non-recurring fees of approximately $415,000 incurred in the prior year for the
hiring of consultants primarily relating to the recognized non-cash expense of
the granting of options to this group in the prior year, a decrease of salaries
and related expenses of approximately $14,000, a decrease in miscellaneous and
office related expenses of approximately $39,000 and a decrease in legal and
accounting fees of approximately $112,000, which was partially offset by an
increase in insurance costs of approximately $23,000. Research and development
expenses, which consist primarily of salaries and related costs for the
development of our products, amounted to $911,073 for the nine months ended
September 30, 2002 compared to $928,241 for the nine months ended September 30,
2003, which has not materially changed. We believe that we will require
additional investments in development and operating infrastructure as the
Company grows. Therefore, we expect that expenses will continue to incrementally
increase in line with increases in the growth of the business as we may increase
expenditures for advertising, brand promotion, public relations and other
marketing activities. We expect that we will incur incremental general and
11
administrative expenses as the business grows. Research and development expenses
may also increase as we complete and introduce additional products based upon
our patented ID-Check technology.
Interest income decreased from $43,943 for the nine months ended
September 30, 2002 to $21,499 for the nine months ended September 30, 2003,
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.
Interest expense increased from $4,004 for the nine months ended
September 30, 2002 to $43,437 for the nine months ended September 30, 2003
resulting primarily from interest accrued on an arbitration decision awarding
Early Bird Capital settlement on their demand.
Interest expense on shares subject to mandatory redemption amounted to
$126, 252 for the three months ended September 30, 2003 resulting from the sale
of 30,000 shares of our Series A 8% Convertible Redeemable Preferred Stock on
March 27, 2003 and recorded as a result of FAS #150, which we adopted as of July
1, 2003.
Other expenses for the nine months ended September 30, 2003 totaling
$921,730 is as a result of a non- recurring charge from an arbitration decision
awarding Early Bird Capital settlement on their demand. Other income for the
nine months ended September 30, 2002 totaling $336,344 resulted from a
settlement of certain obligations under a Master Licensing agreement between us
and Sensormatic Electronics Corporation, which expired on March 31, 2002. We
received $412,000 and incurred $75,656 in refurbishment costs for previously
customized terminals.
As a result of the factors noted above, our net loss increased from
$3,980,179 for the nine months ended September 30, 2002 to $5,274,331for the
nine months ended September 30, 2003.
Comparison of the three months ended September 30, 2003 to the three
months ended September 30, 2002.
Revenues increased by $113,866 from $231,819 for the three months ended
September 30, 2002 to $345,685 for the three months ended September 30, 2003.
Revenues for the period ended September 30, 2003 consisted of revenues from
distributors of $64,216, revenues from direct sales to customers of $264,594 and
royalty payments of $16,877. Shipments of products and contracted services
amounted to $327,579 and $256,000 for the periods ended September 30, 2003 and
2002, respectively. The refocus of our marketing efforts to larger retailers and
government agencies continues to impact our sales as a result of the extended
time frame associated with these sales cycles. In addition, during 2001, 2002
and continuing in 2003, the sales cycle has been further extended by the
downturn in the economy which, we believe, has delayed capital expenditure
decisions. We believe that based upon the results of certain of our recent
marketing tests and agreements as well as legislative efforts to enhance
security, these events should result in increased sales opportunities.
Gross profit increased by $117,471 from $126,189 for the three months
ended September 30, 2002 to $243,660 for the three months ended September 30,
2003. Our gross profit as a percentage of revenues amounted to 70.5% in the
three months ended September 30, 2003 compared to 54.4% for the three months
ended September 30, 2002. Our gross profit percentage was positively impacted by
an increase in revenues from licensing our patented technology at higher gross
margins.
Operating expenses, which consist of selling, general and administrative
and research and development expenses, decreased 5.6% from $1,360,637 for the
three months ended September 30, 2002 to $1,285,094 for the three months ended
September 30, 2003. Selling expenses, which consist primarily of salaries and
related costs for marketing, decreased 5.5% from $314,573 for the three months
ended September 30, 2002 to $297,162 for the three months ended September 30,
2003 primarily due to a reduction in non-recurring fees of approximately $7,000
incurred in the prior year from the hiring of professional consultants to
promote our product and a decrease in travel and convention expense of
approximately $10,000. General and administrative expenses, which consist
primarily of salaries and related costs for general corporate functions,
including executive, accounting, facilities and fees for legal and professional
services decreased 10.4% from $760,486 for the three months ended September 30,
2002 to $681,252 for the three months ended September 30, 2003 primarily as a
result of a reduction of non-recurring fees of approximately $17,000 incurred in
the prior year for the hiring of consultants primarily relating to the
recognized non-cash expense of the granting of options to this group in the
prior year, a decrease in miscellaneous and office related expenses of
approximately $26,000, a decrease in depreciation and amortization expense of
approximately $30,000 and a decrease in legal and accounting fees of
approximately $56,000, which was partially offset by an increase in insurance
costs of approximately $8,000. Research and development expenses, which consist
primarily of salaries and related costs for the development and testing of our
products, increased 7.4% from $285,578 for the three months ended September 30,
2002 to $306,680 for the three months ended September 30, 2003 primarily
12
relating to an increase in salaries and related employee expenses of
approximately $22,000. Research and development expenses may continue to
increase as we complete and introduce additional products based upon our
patented ID-Check technology. We believe that we will require additional
investments in development and operating infrastructure as the Company grows.
Therefore, we expect that expenses will continue to incrementally increase in
line with increases in the growth of the business as we may increase
expenditures for advertising, brand promotion, public relations and other
marketing activities.
Interest income decreased from $11,688 for the three months ended
September 30, 2002 to $5,877 for the three months ended September 30, 2003,
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.
Interest expense increased from $1,134 for the three months ended
September 30, 2002 to $42,283 for the three months ended September 30, 2003
resulting primarily from interest accrued on an arbitration decision awarding
Early Bird Capital settlement on their demand.
Interest expense on shares subject to mandatory redemption amounted to
$126, 252 for the three months ended September 30, 2003 resulting the sale of
30,000 shares of our Series A 8% Convertible Redeemable Preferred Stock on March
27, 2003 and recorded as a result of FAS #150, which we adopted as of July 1,
2003.
As a result of the factors noted above, our net loss decreased from
$1,223,894 for the three months ended September 30, 2002 to $1,204,092 for the
three months ended September 30, 2003.
(c) Liquidity and Capital Resources
Prior to our IPO, which became effective in November 1999, we financed
our operations primarily through several private placements of equity and debt
securities. We used the net proceeds of these financings for the primary purpose
of funding working capital and general corporate purposes and for the purchase
of hardware terminals. As a result of the net proceeds we received from 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, 2001 and 2002, we received
$8,400,014 in net proceeds from the issuance of common stock from the exercise
of warrants, rights and stock options. In March 2003, we received net proceeds
before legal expenses of $2,850,000, from the issuance of Convertible Redeemable
Preferred Stock. We funded the purchase of hardware terminals for resale and
working capital primarily from these proceeds. On October 8, 2003, we
successfully consummated a secondary public offering of 1,100,000 shares of
common stock at $8.00 per share and received proceeds net of underwriter
commissions and discounts and before other offering expenses of approximately
$7,906,000. In connection with this offering, we granted to our underwriter an
option to purchase up to an additional 165,000 shares of our common stock at
$8.00 per share less underwriter discounts and commissions for the purpose of
covering over-allotments, if any, which expires on November 16, 2003. In
addition, we sold to our underwriters 110,000 warrants for a price of $110 to
purchase 110,000 shares of our common stock at a price of $9.60 per share which
become exercisable on the first anniversary of the public offering and remain
exercisable for four years thereafter. We plan to use the net proceeds for
general corporate purchases, including purchase of equipment, product
development, sales and marketing, consultant fees and working capital.
Cash used in operating activities for the nine months ended September 30,
2003 of $3,733,281 was primarily attributable to the net loss of $5,274,331, an
increase in certificates of deposit, restricted of $1,008,526 resulting from the
award in the legal matter with Early Bird Capital and an increase in accounts
receivable of $144,914, which was offset primarily by a decrease of inventory of
$178,764 and an inventory reserve of $800,000, an increase in accounts payable
and accrued expenses of $73,546, an increase in litigation settlement payable of
$921,700 resulting from the legal award recorded in the first quarter of 2003,
depreciation and amortization of $331,871 and amortization of deferred
compensation of $272,032 from the granting of stock options to consultants. Cash
used in operating activities for the nine months ended September 30, 2002 of
$3,026,944 resulted primarily from the net loss of $3,980,179, an increase in
accounts receivable of $78,304 and an increase in other current assets of
$464,421 resulting primarily from a deposit made to our manufacturer for
additional inventory, which was primarily offset by an increase in depreciation
and amortization of $339,305 as a result of the acquisition of the assets of
IDentiScan, an increase in amortization of deferred compensation of $683,566
from the granting of stock options to consultants, a decrease in inventory of
$258,808 and an increase in deferred revenues of $194,136. Cash used in
investing activities was $1,931 for the nine months ended September 30, 2003 and
$35,187 for the nine months ended September 30, 2002. Net cash used in investing
activities consisted primarily of capital expenditures for computer equipment
and furniture and fixtures. Cash provided by financing activities was $3,263,142
for the nine months ended September 30, 2003 and $1,502,580 for the six months
ended September 30, 2002 and was primarily related to the issuance of Series A
8% Convertible Redeemable Preferred Stock and exercise of stock options for the
period
13
ended September 30, 2003 and primarily related to the exercise of outstanding
rights and stock options for the period ended September 30, 2002.
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
November 12, 2003. We had reserved 970,076 shares of common stock for future
issuance under this rights offering. As of September 30, 2003, we received
$2,481,583 before expenses from the exercise of 291,951 of these rights. On
November 5, 2003 the Board of Directors elected to extend the expiration date of
these rights to June 30, 2004.
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 2002, we purchased 20,000 shares totaling approximately $123,000
and subsequently retired these shares. We do not expect to purchase additional
shares unless warranted by certain conditions.
On March 27, 2003, pursuant to a Securities Purchase Agreement, we sold
30,000 shares of our Series A 8% Convertible Redeemable Preferred Stock, par
value $.01 per share, for $3,000,000 before expenses to Gryphon Master Fund,
L.P. Each share of Preferred Stock entitles the holder to receive dividends of
8% per annum and is currently convertible into 15.1515 shares of our common
stock. Additionally, each investor received one (1) five year warrant to
purchase 3.787875 shares of common stock at an exercise price of $6.78 with each
share of Preferred Stock purchased. The total amount of shares that may be
issued upon conversion of the Preferred Stock and exercise of the warrants are
454,545 and 113,636, respectively. Dividend payments of $120,000 in cash are due
semi-annually beginning September 30, 2003 and, accordingly, the Company paid
$122,958 on September 30, 2003. In connection with this financing, we paid agent
fees of $150,000 and issued warrants and options to purchase 8,854 shares of our
common stock at a price of $6.78. We also paid legal fees of approximately
$127,000. We recorded the relative fair value of all the warrants issued in
connection with this transaction of $497,700 against the amount of the
Convertible Redeemable Preferred Stock as of March 27, 2003, which was
calculated using the Black-Scholes valuation method, as well as $540,000 of
beneficial conversion feature in accordance with EITF 00-27 and such amounts are
being accreted along with issuance cost of $285,900 over the five year period
until the mandatory redemption date of the Preferred Stock, the fifth
anniversary of closing. We recorded accretion of $131,517 for the period ended
September 30, 2003. Shares of Preferred Stock are convertible at the option of
Gryphon Master Fund, L.P at any time prior to redemption. We may redeem any or
all of the Preferred 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.
During the nine months ended September 30, 2003, we received approximately
$680,000 from the exercise of 175,209 stock options.
We anticipate that our current available cash in hand, cash resources
from expected revenues from the sale of the units in inventory, licensing of its
technology, combined with the cash received from our secondary offering will be
sufficient to meet our anticipated working capital and capital expenditure
requirements for at least the next eighteen months. We expect to use the net
proceeds from this offering for general corporate purposes, including purchase
of equipment, product development, sales and marketing, consultant fees and
working capital. We intend to purchase equipment for transactions in which we
receive a transaction fee for the utilization of our hardware and bundling it
with our software to provide an identity verification product. A portion of the
proceeds will be used for product development, which encompasses both hardware
and software development. We anticipate using some of the proceeds for sales and
marketing and a portion of the proceeds will also be used for consultant fees
for government lobbyists. Pending our use of the net proceeds of this offering,
we intend to invest the net proceeds in short-term, investment-grade,
investment-bearing securities. Should sales of our products fall below
expectations during the next 18 months, we would be required to raise additional
capital to fund our operations. Should we need to raise additional capital,
there can be no assurances that we will be successful in raising capital. In
addition, we may need to raise additional funds to respond to business
contingencies which may include the need to fund more rapid expansion, fund
additional marketing expenditures, develop new markets for our ID-Check
technology,
14
enhance our operating infrastructure, respond to competitive pressures, or
acquire complementary businesses or necessary technologies.
Below is a table, which presents our contractual obligations and
commitments at September 30, 2003:
PAYMENTS DUE BY PERIOD
---------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1-3 YEARS 4-5 YEARS AFTER
ONE YEAR 5 YEARS
---------------------------------------------------------------------------------------------------------------
Capital Lease Obligations $ 2,860 $ 2,860 -- --
---------------------------------------------------------------------------------------------------------------
Operating Leases 1,946,304 252,778 $766,820 556,899 369,807
---------------------------------------------------------------------------------------------------------------
Employment contracts 505,000 405,000 100,000 -- --
---------- -------- -------- -------- --------
---------------------------------------------------------------------------------------------------------------
Total Contractual Cash Obligation $2,454,164 $660,638 $866,820 $556,899 $369,807
---------------------------------------------------------------------------------------------------------------
(d) Net Operating Loss Carry forwards
As of September 30, 2003, we had a net operating loss carry forward of
approximately $20,000,000, which expires in the year 2013. The issuance of
equity securities in the future, together with our recent financings and our
secondary public offering, 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
None
Item 4. 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 as to the end of the
period covered by 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
rules of the SEC. Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures. Such evaluation was conducted as to the end
of the period covered by this report. Based on such evaluation, our Chief
Executive and Chief Financial Officer have concluded that these procedures are
effective.
15
Part II Other Information
Item 1. 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 became an
individual action. On July 26, 2002, the Company filed a motion to dismiss the
lawsuit. On July 30, 2003, the court granted the Company's motion to dismiss the
lawsuit. However, it did allow the Plaintiff to replead some of the claims. The
Plaintiff filed an amended complaint pertaining to certain of the pleadings.
On February 19, 2003, we filed a summons and complaint upon CardCom
Technology, Inc. alleging infringement on its patent. During September 2003, we
settled with CardCom Technology, Inc. pursuant to which we granted CardCom a
three year royalty license to use certain of our patents in connection with the
manufacture, use and sale of CardCom's age verification products in the United
States and Canada. It also provides that CardCom will pay approximately 10%
royalties on its net sales. For the period ended September 30, 2003 we received
$42,105 in royalty fees.
On April 9, 2003, we received notification from the American Arbitration
Association that it had awarded Early Bird Capital $921,730 on the settlement of
their demand. We have filed with the New York State Supreme Court an application
for setting aside the confirmation of the award. On October 14, 2003, the court
confirmed the award with interest at a rate of 9% per annum beginning April 9,
2003. We recorded a charge of $921,730 in the Statements of Operations during
the three month period ending March 31, 2003. We secured a one year letter of
credit for the full amount of the charge along with interest totaling $1,004,686
until April 9, 2004. We are planning to appeal the award and examining other
options available to us. If we are unsuccessful in our appeal, interest would
accrue until the appeal process is completed.
On August 1, 2003, we filed a summons and complaint against Tricom Card
Technologies, Inc. alleging infringement on its patent seeking injunctive and
monetary relief. On October 23, 2003we amended our complaint to include
infringement on an additional patent. Tricom filed its responsive pleading on
November 12, 2003. The parties are currently engaged in discovery.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held on July 10, 2003.
A proposal to elect two (2) directors to serve for a three-year term was
approved by the stockholders. The nominees received the following votes:
Name Votes For Votes Withheld
Howard Davis (three-year term) 8,221,458 59,250
Jeffrey Levy (three-year term) 8,261,958 18,750
A proposal to approve the 2003 Stock Option Plan was accepted by the
stockholders. This proposal received the following votes:
For Against Abstain Not Voted
3,369,501 244,375 52,826 4,159,461
In addition, stockholders ratified the appointment of Grant Thornton LLP
as the independent public accountants for the Company for the year ended
December 31, 2003. This proposal received the following votes:
For Against Abstain
7,715,607 100,486 10,070
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Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of the Quarterly Report on
Form 10-Q:
Exhibit No. Description
----------- -----------
31. Certifications pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32. Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) On April 8, 2003, we filed a report on Form 8-K to disclose the sale of
our Series A 8% Convertible Preferred Stock.
(c) On July 2, 2003, we filed a report on Form 8-K to disclose the terms of
settlement with CardCom Technology, Inc.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date - November 13, 2003 Intelli-Check, Inc.
(Registrant)
By: /s/ Frank Mandelbaum
---------------------------------------
Frank Mandelbaum
Chairman/CEO
By: /s/ Edwin Winiarz
---------------------------------------
Edwin Winiarz
Senior Executive Vice President,
Treasurer/CFO
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