U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-QSB/A

Amendment No. 1

x                              QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

o                                 TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT

For the Transition Period from              to

Commission file number 1-13463

BIO-KEY INTERNATIONAL, INC.

(Exact Name of Small Business Issuer as Specified in Its Charter)

DELAWARE

41-1741861

(State or Other Jurisdiction of
Incorporation of Organization)

(IRS Employer
Identification Number)

 

3349 HIGHWAY 138, BUILDING D, SUITE B, WALL, NJ  07719

(Address of Principal Executive Offices)

(732) 359-1100

(Issuer’s Telephone Number)

Check whether the 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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes 
x   No o

APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS

Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court.
Yes 
o   No o

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate by check mark whether the registrant is a shell company (as defined by rule 12b-2 of the Exchange Act).
Yes 
o   No x

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: There were 48,447,762 issued and outstanding shares of the registrant’s common stock, par value $.0001 per share, as of May 22, 2006.

Transitional Small Business Disclosure Format (check one): Yes o   No x

 




 

BIO-KEY INTERNATIONAL, INC.

EXPLANATORY NOTE

This Amendment on Form 10-QSB/A constitutes Amendment No. 1 to the registrant’s Quarterly Report on Form 10-QSB for the period ended March 31, 2006, which was filed with the Securities and Exchange Commission on May 22, 2006 (the “Original Report”). The purpose of this Amendment No. 1 is to amend and restate previously issued financial statements in accordance with Note 16 to the financial statements contained herein, to provide further clarification under Part I—Item 3 (Controls and Procedures) and provide further clarification under Part II—Item 3 (Defaults Upon Senior Securities). Except as amended hereby, this Form 10-QSB/A does not amend, update or change any other information contained in the Original Report.

INDEX

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

 

 

 

 

 

Item 1

 

 

Consolidated Financial Statements

 

3

 

 

 

 

 

Balance sheets as of March 31, 2006 (unaudited and restated) and December 31, 2005 (restated)

 

4

 

 

 

 

 

Statements of operations for the three months ended March 31, 2006 and 2005 (unaudited and restated)

 

5

 

 

 

 

 

Statements of cash flows for the three months ended March 31, 2006 and 2005 (unaudited and restated)

 

6

 

 

 

 

 

Notes to consolidated financial statements

 

7

 

Item 2

 

 

Management’s Discussion and Analysis

 

26

 

Item 3

 

 

Controls and Procedures

 

33

 

 

 

 

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

 

 

 

 

 

Item 3

 

 

Defaults Upon Senior Securities

 

34

 

Item 4

 

 

Submission of Matters to a Vote of Security Holders

 

35

 

Item 5

 

 

Other Information

 

35

 

Item 6

 

 

Exhibits

 

35

 

 




 

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

3




 

BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

 

 

March 31,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(Unaudited)

 

(Restated)

 

 

 

(Restated)

 

 

 

ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

1,594,641

 

$

1,422,827

 

Receivables

 

 

 

 

 

Billed, less allowance for doubtful receivables of $179,999 and $160,000, respectively

 

3,188,486

 

1,635,371

 

Unbilled

 

133,663

 

201,942

 

Costs and earnings in excess of billings on uncompleted contracts

 

3,066,290

 

4,321,392

 

Inventory

 

10,494

 

8,760

 

Prepaid expenses

 

139,705

 

137,000

 

Total current assets

 

8,133,279

 

7,727,292

 

Equipment and leasehold improvements, net

 

496,944

 

548,267

 

Deposits

 

1,362,902

 

1,828,560

 

Intangible assets, net

 

3,095,926

 

3,301,823

 

Deferred financing costs, net

 

167,693

 

1,562,338

 

Goodwill

 

11,389,654

 

11,389,654

 

Total non-current assets

 

16,513,119

 

18,630,642

 

TOTAL ASSETS

 

$

24,646,398

 

$

26,357,934

 

LIABILITIES:

 

 

 

 

 

Current maturities of long-term obligations and related obligations, net of discount

 

$

6,075,751

 

$

6,584,437

 

Accounts payable

 

1,151,611

 

833,608

 

Billings in excess of costs and earnings on uncompleted contracts

 

42,554

 

32,385

 

Accrued liabilities

 

5,881,266

 

5,520,515

 

Deferred rent

 

457,046

 

443,603

 

Deferred revenue

 

4,264,645

 

3,264,283

 

Total current liabilities

 

17,872,873

 

16,678,831

 

Warrants

 

1,618,341

 

1,483,511

 

Mandatorily redeemable preferred stock derivatives

 

280,674

 

 

Deferred rent

 

748,424

 

867,850

 

Deferred revenue

 

1,209,108

 

1,163,738

 

Total non-current liabilities

 

3,856,547

 

3,515,099

 

TOTAL LIABILITIES

 

21,729,420

 

20,193,930

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Mandatorily redeemable preferred stock, net of discounts

 

651,240

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Preferred stock — authorized, 5,000,000 shares (liquidation preference of $100 per share) Series A 7% Convertible; issued and outstanding 35,557 and 44,557 shares of $.0001 par value, respectively 

 

3

 

4

 

Common stock — authorized, 170,000,000 and 85,000,000 shares, respectively; issued and outstanding; 48,036,984 and 46,306,589 shares of $.0001 par value, respectively

 

4,803

 

4,632

 

Additional paid-in capital

 

48,944,638

 

48,921,316

 

Accumulated deficit

 

(46,683,706

)

(42,761,948

)

TOTAL STOCKHOLDERS’ EQUITY

 

2,265,738

 

6,164,004

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

24,646,398

 

$

26,357,934

 

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

4




 

BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and Restated)

 

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

Services

 

$

2,246,911

 

$

3,059,854

 

License fees and other

 

902,280

 

879,737

 

 

 

3,149,191

 

3,939,591

 

Costs and other expenses

 

 

 

 

 

Services

 

673,503

 

835,565

 

Cost of license fees and other

 

81,484

 

327,857

 

Selling, general and admiistrative

 

2,576,821

 

2,846,623

 

Research, development and engineering

 

1,654,638

 

2,075,070

 

 

 

4,986,446

 

6,085,115

 

Operating loss

 

(1,837,255

)

(2,145,524

)

Other income (deductions)

 

 

 

 

 

Interest income

 

 

26,062

 

Interest expense

 

(2,066,525

)

(834,916

)

Derivative and warrant fair market value adjustments

 

2,444,693

 

3,576,881

 

Loss on sale of marketable securities

 

 

(20,000

)

Loss on extinguishment of debt

 

(2,322,018

)

 

Other income (expense)

 

(15,176

)

 

Total other income (deductions)

 

(1,959,026

)

2,748,027

 

NET INCOME (LOSS)

 

$

(3,796,281

)

$

602,503

 

 

 

 

 

 

 

Earnings (Loss) Per Share:

 

 

 

 

 

Basic

 

$

(0.08

)

$

0.01

 

Diluted

 

$

(0.08

)

$

(0.03

)

 

 

 

 

 

 

Weighted Average Shares Outstanding:

 

 

 

 

 

Basic

 

47,026,773

 

42,662,253

 

Diluted

 

47,026,773

 

48,754,992

 

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

5




 

BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and Restated)

 

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

CASH FLOW FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net Income (Loss)

 

$

(3,796,281

)

$

602,503

 

Adjustments to reconcile net income (loss) to cash used in operating activities:

 

 

 

 

 

Derivative and warrant fair value adjustments

 

(2,444,693

)

(3,576,881

)

Loss on extinguishment of debt

 

2,322,018

 

 

Depreciation

 

65,044

 

58,590

 

Amortization

 

 

 

 

 

Intangible assets

 

215,880

 

215,682

 

Deferred financing costs

 

91,211

 

57,865

 

Discounts on convertible debt related to warrants and beneficial conversion features     

 

895,474

 

412,648

 

Allowance for doubtful receivables

 

19,998

 

19,790

 

Deferred rent

 

(105,986

)

(94,057

)

Options and warrants issued for services and other

 

120,567

 

 

Loss on sale of investment

 

 

20,000

 

Change in assets and liabilities:

 

 

 

 

 

Accounts receivable trade

 

(1,504,834

)

(655,593

)

Costs and earnings in excess of billings on uncompleted contracts

 

1,255,102

 

92,235

 

Inventory

 

(1,734

)

 

Prepaid expenses and other

 

(2,705

)

(18,195

)

Deposits

 

465,657

 

502,943

 

Accounts payable

 

318,003

 

(238,721

)

Billings in excess of costs and earnings on uncompleted contracts

 

10,169

 

1,054,043

 

Accrued liabilities

 

371,553

 

776,864

 

Deferred revenue

 

1,045,733

 

350,922

 

Net cash used in operating activities

 

(659,824

)

(419,362

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Capital expenditures

 

(13,720

)

(73,348

)

Expenditures for patents

 

(9,983

)

 

Proceeds from sale of marketable debt securities

 

 

980,000

 

Proceeds from sale of trademark

 

 

50,000

 

Net cash provided by (used in) investing activities

 

(23,703

)

956,652

 

CASH FLOW FROM FINANCING ACTIVITIES:

 

 

 

 

 

Repayment of advance from stockholder

 

 

(12,753

)

Issuance of long-term obligations

 

988,000

 

 

Repayment of long-term obligations

 

(79,859

)

(738,346

)

Exercise of warrants

 

 

528,164

 

Financing costs

 

(52,800

)

 

Net refund of offering costs

 

 

100,000

 

Net cash provided by (used in) financing activities

 

855,341

 

(122,935

)

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

171,814

 

414,355

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,422,827

 

956,230

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,594,641

 

$

1,370,585

 

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

6




BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006 (Unaudited and Restated) and December 31, 2005 (Restated)

1.             BASIS OF PRESENTATION

The accompanying unaudited interim consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly owned subsidiary (collectively, the “Company”) and are stated in conformity with accounting principles generally accepted in the United States, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. Significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all necessary adjustments, consisting only of those of a recurring nature, and disclosures to present fairly the financial position and the results of its operations and cash flows for the periods presented. It is suggested that these uanaudited interim consolidated financial statements should be read in conjunction with the financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2005, as amended (the “Form 10-KSB”).

Reclassifications

Certain amounts in the 2005 consolidated financial statements have been reclassified to conform to the 2006 presentation. These reclassifications had no effect on the previously reported net loss or stockholders’ equity.

2.             LIQUIDITY AND CAPITAL RESOURCE MATTERS

Broad commercial acceptance of the Company’s technology is critical to the Company’s success and ability to generate revenues. The Company has only recently begun to generate significant revenues, has suffered recurring losses from operations and has a working capital deficit.

The Company is in need of additional capital. The Company is currently considering various alternatives related to raising additional capital including new funding from other sources. No assurance can be given that any form of additional financing will be available on terms acceptable to the Company, that adequate financing will be obtained to meet its needs, or that such financing would not be dilutive to existing shareholders.

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which contemplate continuation of the Company as a going concern. The matters described in the preceding paragraphs raise substantial doubt about the Company’s ability to continue as a going concern. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon the Company’s ability to obtain additional financing, meet its financing requirements on a continuing basis, and succeed in its future operations. The accompanying financial statements do not include any adjustments that may result from the uncertainty regarding the Company’s ability to continue as a going concern.

7




3.             STOCK BASED COMPENSATION

Effect of Adoption of SFAS 123R, Share-Based Payment

Prior to January 1, 2006, the Company’s employee stock compensation plans were accounted for in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations. Under this method, no compensation expense was recognized as long as the exercise price equaled or exceeded the market price of the underlying stock on the date of the grant. The Company elected the disclosure-only alternative permitted under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148”), for fixed stock-based awards to employees.

On December 31, 2005, the Company accelerated the vesting of certain of the outstanding options to purchase shares of the Company’s common stock with option exercise prices greater than the fair market value of the Company’s common stock on such date. The acceleration applies to all such options outstanding as of December 31, 2005 under the Company’s 1996 Stock Option Plan, 1999 Stock Option Plan and 2004 Stock Option Plan, except for options held by the Company’s executive officers subject to Section 16(b) of the Securities Exchange Act of 1934, as amended, and the members of the Company’s Board of Directors. Options to purchase up to 897,614 shares of the Company’s common stock, or 14% of the total shares of the Company’s common stock subject to outstanding options, with a weighted average exercise price of approximately $1.09 and varying remaining vesting schedules, are subject to this acceleration and became immediately vested and exercisable as of December 31, 2005. The number of shares, exercise prices and other term of the options subject to the acceleration remain unchanged.

As of January 1, 2006, the Company adopted SFAS 123R using the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for options in footnote disclosures required under SFAS 123, as amended by SFAS 148, and requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of our common stock price over the expected term and the number of individuals that will ultimately not complete their vesting requirements (“forfeitures”). Changes in these subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized as an expense in the consolidated statements of operations. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, are likely to change our valuation assumptions used to value employee stock-based awards granted in future periods. The values derived from using the Black-Scholes model are recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires significant judgment. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates. Prior periods have not been restated to incorporate the stock-based compensation charge. The compensation expense recognized during the quarter ended March 31, 2006 in connection with the adoption of SFAS 123R increased the company’s net loss by $120,567. As the Company uses the full valuation allowance with respect to deferred taxes, the adoption of SFAS123R had no impact on deferred taxes.

8




Valuation Assumptions for Stock Options

For the quarter ended March 31, 2006, 1,798,000 stock options were granted. The fair value of each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

Risk free interest rate

 

4.53-4.73%

 

4.00-4.18%

 

Expected life of options (in years)

 

4.4

 

7

 

Expected dividends

 

0

 

0

 

Volatility of stock price

 

127

%

133

%

 

Expected volatilities are based on historical volatilities of our common stock; the expected life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and our historical exercise patterns; and the risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option.

Fair Value Disclosures — Prior to SFAS 123R Adoption

 

Three Months Ended

 

 

 

March 31, 2005

 

 

 

(Restated)

 

Net income:

 

 

 

As reported

 

602,503

 

Fair value-based expense, net of tax

 

(211,000

)

Pro forma

 

391,503

 

 

 

 

 

Net income (loss) per common share:

 

 

 

Basic

 

 

 

As reported

 

0.01

 

Pro forma

 

0.01

 

Diluted

 

 

 

As reported

 

(0.03

)

Pro forma

 

(0.03

)

 

Stock Option Activity

The following table summarizes stock option activity for the quarter ended March 31, 2006:

Number of Options

 

 

1996 Plan

 

1999 Plan

 

2004 Plan

 

Non Plan

 

Total

 

Range of
exercise
price

 

Weighted
average
exercise
price

 

Balance, as of December 31, 2005

 

150,000

 

1,062,125

 

2,052,860

 

3,082,850

 

6,347,835

 

0.19-6.42 

 

0.92

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Granted

 

 

 

748,000

 

1,050,000

 

1,798,000

 

0.67-.75

 

0.72

 

Exercised

 

 

 

 

 

 

 

 

 

 

Expired or cancelled

 

 

 

(42,610

)

(14,850

)

(57,460

)

0.93-1.17

 

1.04

 

Balance, as of March 31, 2006

 

150,000

 

1,062,125

 

2,758,250

 

4,118,000

 

8,088,375

 

0.19-6.42

 

0.87

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for future grants March 31, 2006

 

 

647,132

 

1,241,750

 

 

1,888,882

 

 

 

 

 

 

9




 

The options outstanding and exercisable at March 31, 2006 were in the following exercise price ranges:

Options Outstanding

 

Options Exercisable

 

Range of exercise prices

 

Number
of shares

 

Weighted
average
exercise
price

 

Weighted
average
remaining
life
(in years)

 

Aggregate
Intrinsic
Value

 

Number of
shares

 

Weighted
average
exercise
price

 

Aggregate
Intrinsic
Value

 

$0.19

 

60,000

 

$

0.19

 

2.40

 

$

27,600

 

60,000

 

$

0.19

 

$

27,600

 

.29-.40

 

837,456

 

0.33

 

2.22

 

271,187

 

834,751

 

0.33

 

270,375

 

.46-.69

 

2,556,000

 

0.58

 

6.23

 

189,850

 

1,324,165

 

0.53

 

162,950

 

.75-1.11

 

2,823,419

 

0.95

 

5.78

 

 

1,493,418

 

1.07

 

 

1.17-1.62

 

1,763,500

 

1.30

 

5.34

 

 

1,330,162

 

1.30

 

 

6.42

 

48,000

 

6.42

 

1.87

 

 

48,000

 

6.42

 

 

.19-6.42

 

8,088,375

 

 

 

 

 

$

488,637

 

5,090,496

 

 

 

$

460,925

 

 

The weighted average remaining contractual life of options exercisable at March 31, 2006 was 3.97 years.

The aggregate intrinsic value in the table above represents the total intrinsic value, based on the Company’s closing stock price of $0.65 as of March 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of March 31, 2006 was 2,118,916.

The weighted average fair value of options, as determined under SFAS No. 123R and SFAS 123, granted during the three months ended March 31, 2006 and March 31, 2005 was $0.56 and $1.17 per share, respectively. The total intrinsic value of options exercised during the three-month period ended March 31, 2006 and March 31, 2005 was zero and $115,427, respectively. The aggregate intrinsic value of options vested during the 3 months ended March 31, 2006 was $0.

As of March 31, 2006 future compensation cost related to nonvested stock options is approximately $1,052,000 and will be recognized over an estimated weighted average period of approximately 4.0 years.

4.             EARNINGS PER SHARE COMMON STOCK “EPS”

The Company’s basic EPS is calculated using net income (loss) and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible notes and preferred stock.

10




The reconciliation of the numerators and denominators of the basic and diluted EPS calculations was as follows for both of the following three month periods ended March 31:

 

2006

 

2005

 

 

 

(Restated)

 

(Restated)

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(3,796,281

)

$

602,503

 

 

 

 

 

 

 

Dividends accumulated on cumulative preferred stock

 

(113,226

)

(95,658

)

Income (loss) available to common stockholders (basic eps)

 

(3,909,507

)

506,845

 

 

 

 

 

 

 

Adjustment for interest expense and debt conversion features

 

 

(2,141,436

)

Loss as adjusted (diluted EPS)

 

$

(3,909,507

)

$

(1,634,591

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted-average shares used to compute basic EPS

 

47,026,773

 

42,662,253

 

Effect of dilutive securities:

 

 

 

 

 

Convertible notes

 

 

6,092,739

 

Weighted-average shares used to compute diluted EPS

 

47,026,773

 

48,754,992

 

 

 

 

 

 

 

Earnings (loss) per share

 

 

 

 

 

Basic

 

$

(0.08

)

$

0.01

 

Diluted

 

$

(0.08

)

$

(0.03

)

 

The following table summarizes the potential weighted average shares of common stock that were excluded from the diluted per share calculation, because the effect of including these potential shares was antidilutive.

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Preferred Stock

 

5,703,302

 

6,889,452

 

Convertible Debt

 

12,844,568

 

 

Stock Options

 

841,487

 

1,498,564

 

Warrants

 

25,707

 

1,228,224

 

 

 

 

 

 

 

Potentially dilutive securities

 

19,415,064

 

9,616,240

 

 

Items excluded from the diluted per share calculation because the exercise price was greater than the average market price of the common shares:

 

For The Three Month’s Ended March 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Stock options

 

4,864,741

 

1,070,250

 

Warrants

 

9,982,252

 

2,222,219

 

 

 

 

 

 

 

Total

 

14,846,993

 

3,292,469

 

 

11




5.             EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements at March 31, 2006 and December 31, 2005 consisted of the following:

 

March 31,

 

December 31,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Equipment

 

$

466,405

 

$

458,847

 

Furniture and fixtures

 

179,350

 

179,349

 

Software

 

104,414

 

104,414

 

Leasehold improvements

 

177,117

 

170,955

 

 

 

927,286

 

913,565

 

 

 

 

 

 

 

Less accumulated depreciation and amortization

 

(430,342

)

(365,298

)

 

 

 

 

 

 

Total

 

$

496,944

 

$

548,267

 

 

6.             GOODWILL AND OTHER INTANGIBLE ASSETS

The Company’s goodwill resulted from the acquisition of Public Safety Group, Inc. and certain assets and assumed liabilities of the Mobile Government Division of Aether Systems, Inc. in 2004. As provided by SFAS No. 142, the Company has elected to perform the annual assessment of the carrying value of all goodwill as of September 30th of each year using a number of criteria, including the value of the overall enterprise. As of March 31, 2006, the Company believes no material impairment exists. Future impairment charges from existing operations or other acquisitions, if any, will be reflected as an operating expense in the statement of operations. As of December 31, 2005 and March 31, 2006, goodwill totaled $11,389,653.

Other intangible assets as of March 31, 2006 and December 31, 2005 consisted of the following:

 

March 31,

 

December 31,

 

 

 

2006

 

2005

 

Copyrighted software

 

$

1,181,429

 

$

1,181,429

 

Customer relationships

 

1,009,000

 

1,009,000

 

Trademarks

 

807,872

 

807,872

 

Developed technology

 

710,000

 

710,000

 

Marketing agreements

 

605,340

 

605,340

 

Patents and patents pending

 

293,762

 

283,779

 

 

 

4,607,403

 

4,597,420

 

 

 

 

 

 

 

Less: accumulated amortization

 

(1,511,477

)

(1,295,597

)

 

 

 

 

 

 

Total

 

$

3,095,926

 

$

3,301,823

 

 

Aggregate amortization expense for the three months ended March 31, 2006 and 2005, was $215,880 and $215,682, respectively.

7.             DEFERRED FINANCING COSTS

Deferred financing costs are amortized based upon the lives of the respective debt obligations. The gross carrying amount of deferred financing costs at March 31, 2006 and December 31, 2005 was $190,300 and $1,763,238 respectively, and accumulated amortization was $22,607 and $200,900, respectively. Amortization of deferred financing costs is included in interest expense and was $91,201 and $57,865 for the three months ended March 31, 2006 and 2005, respectively.

12




 

8.             CONVERTIBLE DEBT FINANCING

Long-term obligations consisted of the following as of:

 

March 31,
2006

 

December 31,
2005

 

2004

 

 

 

 

 

Convertible term notes

 

$

5,842,448

 

$

5,992,304

 

Discount

 

(4,235,999

)

(2,134,340

)

FMV of embedded derivatives

 

1,694,557

 

421,317

 

FMV of warrants

 

797,881

 

828,095

 

2005

 

 

 

 

 

Convertible term notes

 

5,284,723

 

5,284,723

 

Discount

 

(4,529,696

)

(3,569,793

)

FMV of embedded derivatives

 

2,019,718

 

590,226

 

FMV of warrants

 

596,393

 

655,416

 

2006

 

 

 

 

 

FMV of warrants

 

224,067

 

 

 

 

7,694,092

 

8,067,948

 

 

 

 

 

 

 

Less current portion

 

6,075,751

 

6,584,437

 

 

 

 

 

 

 

Total

 

$

1,618,341

 

$

1,483,511

 

 

2004 and 2005 Senior Notes Amendment and Waiver

Effective as of January 23, 2006, BIO-key International, Inc. (the “Company”) entered into an Amendment and Waiver (the “Secured Notes Amendment and Waiver”) with Laurus in connection with the Secured Convertible Notes (the “Secured Notes”) currently held by Laurus.

Under the Secured Notes Amendment and Waiver, the Secured Notes issued by the Company to Laurus on September 29, 2004 in the aggregate principal amount of $5,000,000 (the “September 2004 Note”) and on June 7, 2005 in the aggregate principal amount of $2,000,000 (the “June 2005 Note”) were amended as follows: (i) the maturity date of the September 2004 Note was extended to January 1, 2008, (ii) the maturity date of the June 2005 Note was extended to December 1, 2008, and (iii) the fixed conversion price under each of the Secured Notes was reset from $1.35 to $0.85 per share. In addition, the exercise price of all warrants to purchase Common Stock of the Company held by Laurus was reset to $1.00 per share.

The Company also issued 150,000 shares (the “Newly Issued Shares”) of the Company’s Common Stock to Laurus in connection with the Secured Notes Amendment and Waiver. The Company granted Laurus registration rights with respect to these shares. In connection with the issuance of the Newly Issued Shares, Laurus agreed to waive the provisions of the Secured Notes regarding any adjustment of the fixed conversion price that would otherwise be triggered as a result of the issuance of the Newly Issued Shares and certain other securities which have a conversion price of $0.70 per share.

2004 and 2005 Subordinated Notes

Effective as of January 23, 2006, the Company also entered into an Amendment and Waiver (the “Subordinated Notes Amendment and Waiver”) with certain holders (“the “Subordinated Note Holders”) of its Subordinated Convertible Promissory Notes (the “Subordinated Notes”).

Under the Subordinated Notes Amendment and Waiver, the Subordinated Notes issued by the Company on September 29, 2004 in the aggregate principal amount of $5,288,221 (the “September 2004 Notes”) and on May 31, 2005 in the aggregate principal amount of $3,244,723 (the “May 2005 Notes”) were amended as follows: (i) the maturity dates were extended from September 29, 2007 and May 31, 2008, respectively, to

13




 

January 1, 2009; (ii) the interest rate was fixed at fifteen percent (15%); (iii) all principal amounts are due at the maturity date and shall be paid in shares of Common Stock priced at $0.70 per share if the average closing price of the Common Stock for the thirty (30) trading days immediately preceding the maturity date is greater than $1.10; (iv) interest shall be paid, at the Company’s election, in cash or shares of Common Stock, with the Common Stock priced at the average closing price of the Common Stock for the ten (10) trading days immediately preceding the repayment date; and (v) the currently applicable fixed conversion price was amended to $0.70 per share. In addition, the exercise price of all warrants to purchase Common Stock held by the Subordinated Note Holders that currently have an exercise price greater than $1.00 per share was reset to $1.00 per share.

2004 and 2005 Senior and Subordinated Notes

The Senior Notes’ contain features that are considered embedded derivative financial instruments:  Principal’s conversion option:  The Notes are convertible at the Holder’s option at any time at the fixed conversion price of $0.85 per share; Monthly Payments Conversion Option:  Holders have the option to convert the Notes’ monthly payment at a $0.85 per share conversion price if the common stock price is higher than 110% of the conversion price ($0.935), as long as the amount converted is not higher than 25% of trading volume for the last 22 trading days. If the Notes’ monthly payments are not converted, the payments will be paid in cash at 102% of such amount; Interest Rate Adjustment provision:  For every 25% increase in common stock value above $0.85 per share, the interest will be reduced by 2%. The interest rate may never be reduced below 0%; Default provision: In the event of default under the terms set forth above, the Senior Lenders will be entitled to specified remedies, including remedies under the Uniform Commercial Code. These features have been bifurcated and recorded on the Company’s balance sheet at their fair value.

The Subordinated Notes also include features that are considered embedded derivative financial instruments:  Principal’s conversion option:  The Notes are convertible at the Holder’s option at any time at the fixed conversion price of $0.70 per share; Monthly Payments Conversion Option:  Holders have the option to convert the Notes’ monthly payment at a $0.70 per share conversion price if the common stock price is higher than 110% of the conversion price ($0.77), as long as the amount converted is not higher than 25% of trading volume for the last 22 trading days. If the Notes’ monthly payments are not converted, the payments will be paid in cash at 102% of such amount; Default provision: In the event of default under the terms set forth above, the unpaid principal balance on the Subordinated Convertible Notes, plus accrued interest, shall, at the note holder’s option, become immediately due and the Subordinated Investors shall be entitled to payment of additional default interest at the rate of 2.0% per annum on all amounts due under the Subordinated Convertible Notes.

The accounting treatment of the derivatives and warrants requires that the Company record the derivatives and the warrant at their relative fair value as of the inception date of the agreement, and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives and warrants is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives and warrants is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. As of December 31, 2005 and March 31, 2006, respectively, the derivatives were valued at $1,011,543 and $3,714,275. Conversion related derivatives were valued using the Binomial Option Pricing Model with the following assumptions: dividend yield of 0%; annual volatility of 87% to 141%; and risk free annual interest rate of 2.89% to 4.8% as well as probability analysis related to trading volume restrictions. The remaining derivatives were valued using other binomial models and measuring the impact of the derivative on the expected interest payment amount over the life of the Note. The Warrants issued with the 2004 and 2005 debt financings classified as liabilities were valued at $1,394,274 and $1,483,511, as of March 31, 2006 and December 31, 2005 respectively, using the Black Scholes Option Pricing model with the following assumptions: dividend yield of 0%; annual volatility of 91%-99% and risk-free interest rate of 4.8%, and dividend yield of 0%; annual volatility of 98% to 111%% and risk-free interest rate of 4.4%, respectively. Both the derivatives and warrants were classified as long-term liabilities.

14




 

At the time of issuance, the initial relative fair value assigned to the embedded derivatives was $3,714,589 and $2,031,414 for the 2004 and 2005 notes, respectively. The initial relative fair value assigned to the warrants was $1,912,639 and $1,233,153 for the 2004 and 2005 notes, respectively.

Both the derivatives and the warrants were recorded as discounts to the Notes and are being amortized to interest expense over the expected term of the debt, using the effective interest method. At March 31, 2006, the unamortized discount on the Notes was $4,235,999 and $4,529,696 for 2004 and 2005 notes, respectively. The effective interest rate on the Notes for the periods ended March 31, 2006 and December 31, 2005 ranged between 72% and 136% based on the frequency of principal payments as well as actual payments made. At December 31, 2005, the unamortized discount on the Notes was $2,134,340 and $3,569,793 for 2004 and 2005 notes, respectively.

2006 Notes

The Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”), effective as of January 23,2006, with The Shaar Fund, Ltd., Longview Fund, L.P. and Longview Special Finance (collectively, the “Purchasers”).

Under the Securities Purchase Agreement, the Company issued to the Purchasers Convertible Term Notes (the “Convertible Notes”) in the aggregate principal amount of $1,000,000, bearing interest at 15% per annum. The Convertible Notes converted into shares of the Series B Preferred Stock of the Company on February 23, 2006, which shares are convertible into shares of the Common Stock of the Company at an initial fixed conversion price of $0.70 per share.

In connection with the Purchasers’ purchase of the Notes, the Company also issued warrants to the Purchasers (the “Warrants”) to purchase up to an aggregate of 500,000 shares of the Company’s Common Stock (subject to adjustment as set forth therein) at a per share exercise price of $1.00 per share. The proceeds from this transaction will be used for general working capital purposes. The Warrants were classified as liabilities and were valued at $224,067 as of March 31, 2006, using the Black Scholes Option Pricing model with the following assumptions: dividend yield of 0%; annual volatility of 98.5% and risk-free interest rate of 4.5%. The initial relative fair value assigned to the Warrants was $308,376.

The Convertible Term Notes contain features that are considered embedded derivative financial instruments:  Principal’s conversion option:  The Convertible Term Note is convertible at the Holder’s option at any time at the fixed conversion price of $0.70 per share; Quarterly Payments Conversion Option:  Holders have the option to convert the Note’s quarterly interest payment at a $0.70 per share conversion. These features have been bifurcated and recorded on the Company’s balance sheet at their fair value.

The accounting treatment of the derivatives and warrants requires that the Company record the derivatives and the warrant at their relative fair value as of the inception date of the agreement, and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives and warrants is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives and warrants is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. Conversion related derivatives were valued using the Binomial Option Pricing Model with the following assumptions: dividend yield of 15%; annual volatility of 43%; and risk free annual interest rate of 4.83% as well as probability analysis related to trading volume restrictions. Both the derivatives and warrants were classified as long-term liabilities. At the time of issuance, the initial relative fair value assigned to the embedded derivatives was $679,624 for the Convertible Term Notes. At the time of conversion to Preferred Stock, the derivatives were valued at $563,069.

The Company entered into an Amendment No. 1 to Subordinated Secured Promissory Note, dated as of January 23, 2006 (the “Aether Note Amendment”), with Aether Systems, Inc. (“Aether”). Pursuant to the Aether Note Amendment, the Subordinated Secured Promissory Note issued by the Company to Aether on September 30,2004 in the aggregate maximum principal amount of $6,884,588 (the “Aether Note”), was amended to increase such aggregate maximum principal amount to $7,884,588. The Aether Note evidences

15




 

a contingent reimbursement obligation of the Company to Aether and a surety fee payable by the Company to Aether, in each case with respect to a letter of credit maintained by Aether for the Company’s benefit in connection with the Company’s acquisition of the Mobile Government Division of Aether on September 30, 2004. The Company’s obligations under the Aether Note remain secured by a security interest granted to Aether in all or substantially all of the Company’s assets subordinated to the security interest of Laurus pursuant to the Secured Notes.

Default on 2004 and 2005 Notes

With respect to the convertible notes issued in 2004 and 2005, the Company is required to make interest payments or issue registered shares in lieu of interest payments on a monthly basis. In January 2006, the Company failed to make timely payment of interest due. This failure to make payments is considered an event of default of the subordinated notes, which then triggered a cross-default of the senior notes. Upon default, the interest rates on all the 2004 and 2005 notes increase and all debt becomes current.

Total accrued interest for all of the Company’s convertible debt as of March 31, 2006 amounted to $493,928.

Additionally, because the registration statement related to the 2005 convertible notes was not declared effective by April 30, 2006, the Company was required to pay liquidating damages per the registration rights agreement with the 2005 subordinated note holders May 30, 2006. The Company has not yet made this payment nor has that registration statement been declared effective. As of March 31, 2006 accrued liquidated damages totaled $630,000.

9.             FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s derivative financial instruments consist of embedded derivatives related to the Senior Secured Convertible Term Note and the Subordinated Unsecured Convertible Term Note (“Notes’’). These embedded derivatives include certain conversion features and variable interest features. The Company also issued warrants to purchase shares of the Company’s Common stock as part of the debt financing. The accounting treatment of derivatives and the warrants requires that the Company record the derivatives and the warrants as a liability at their relative fair values as of the inception date of the agreement, and at fair

16




 

value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives or the warrant is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives or warrant is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. As of December 31, 2005, the derivatives and warrants classified as liabilities were valued at $1,011,543 and $1,483,511, respectively. As of March 31, 2006, the derivatives and warrants classified as liabilities were valued at $3,714,275 and $1,618,341 respectively. Derivatives were valued at each quarter end using the Binomial Option Pricing Model with the following assumptions: dividend yield of 0%; annual volatility ranging from 141% to 87%; and risk free interest rate of 4.8% as well as probability analysis related to subsequent financing. In accordance with EITF 00-19, the derivatives are classified as long-term liabilities due to the possible monetary penalties associated with conversion features embedded within the debt instruments.

10.           ACCRUED LIABILITIES

Accrued liabilities at March 31, 2006 and December 31, 2005 consisted of the following:

 

March 31,
2006

 

December 31,
2005

 

 

 

(Restated)

 

(Restated)

 

Contract costs not yet invoiced by vendors

 

$

3,339,211

 

$

3,654,440

 

Compensation

 

589,484

 

614,934

 

Royalties

 

339,381

 

294,512

 

Interest

 

1,270,636

 

684,253

 

Other

 

342,554

 

272,376

 

 

 

 

 

 

 

Total

 

$

5,881,266

 

$

5,520,515

 

 

11.           MANDATORILY REDEEMABLE PREFERRED STOCK

The company issued 1,000,000 shares of mandatorily redeemable Series B Convertible Preferred Stock on February 23, 2006, upon the conversion of certain convertible term notes. Each share of Series B preferred stock has an Original Issue Price of $1.00 per share. The holder has the option to redeem the shares of Series B preferred stock at any time for a number of shares of the company’s common stock equal to the Original Issue Price plus accrued and unpaid dividends divided by the initial fixed conversion price of $.70 per share of Common Stock. The conversion price is subject to adjustment if common stock is issued by the company subsequent to the original issue date of the Series B preferred stock, except for other conversions, options, warrants, dividends paid in stock or pursuant to an acquisition by the company, at a price less than the conversion price. Mandatory conversion of all Series B shares will be automatic if, for the 30 trading days prior to January 1, 2009, the average closing bid price for one share of common stock is at least $1.10. The shares shall be converted at the conversion price then in effect. If the average bid price for the 30 trading days prior to January 1, 2009 per common share is less than $1.10 the company shall mandatorily redeem all remaining outstanding Series B preferred stock by paying cash equal to $1.00 per share with all accrued and unpaid dividends. The company may, at its election, redeem any or all of the remaining outstanding Series B shares in cash at a conversion price equal to $1.20 per share, together with all accrued and unpaid dividends upon giving 30 day notice. Holders of the Series B preferred stock are entitled to cumulative, prior and in preference to holders of common stock dividends equal to 15% per annum of the Original Purchase Price still outstanding, payable quarterly commencing April 1, 2006. In any liquidation of the company, each share of preferred stock is entitled to a liquidation preference in pari passu with the Series A Preferred stock before any distribution may be made on the company’s common stock. As of March 31, 2006, 1,000,000 preferred stock shares are authorized, issued and outstanding, at a par value of $0.001 and a liquidation preference of $1.00 with accumulated dividends in arrears of approximately $15,000.

The Preferred Stock contains features that are considered embedded derivative financial instruments:

17




 

Preferred Stock’s conversion option:  The Preferred Stock is convertible at the Holder’s option at any time at the fixed conversion price of $0.70 per share; Quarterly Dividends Conversion Option:  Holders have the option to convert the Stock’s quarterly dividend payment at a $0.70 per share conversion. These features have been bifurcated and recorded on the Company’s balance sheet at their fair value.

The accounting treatment of the derivatives requires that the Company record the derivatives at its relative fair value as of the inception date of the agreement, and at fair value as of each subsequent balance sheet date. Any change in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. If the fair value of the derivatives is higher at the subsequent balance sheet date, the Company will record a non-operating, non-cash charge. If the fair value of the derivatives is lower at the subsequent balance sheet date, the Company will record non-operating, non-cash income. As of March 31, 2006 the derivatives were valued at $280,674. Conversion related derivatives were valued using the Binomial Option Pricing Model with the following assumptions: dividend yield of 15%; annual volatility of 43%; and risk free annual interest rate of 4.83% as well as probability analysis related to trading volume restrictions. The derivatives were classified as long-term liabilities.

At the time of issuance, the initial relative fair value assigned to the embedded derivatives was $360,467 for the Preferred Stock.

An amount equal to the original value of the derivatives was recorded as discount to the Preferred Stock. The discount is being amortized to interest expense over the expected term of the Preferred Stock, using the effective interest method. At March 31, 2006, the unamortized discount on the Preferred Stock was $348,760.

12.           STOCKHOLDERS EQUITY

Common Stock

During the three months ended March 31, 2006, Investors converted convertible term notes in the aggregate principal amount of $70,000 and  $10,802 of accrued interest thereon into 115,431 shares of the Company’s common stock.

Convertible Preferred Stock

During the three months ended March 31, 2006, Investors converted a total of 9,000 shares of the Company’s Series A Preferred Stock and $125,475 of accrued dividends thereon into 1,464,964 shares of the Company’s $0.0001 par value common stock.

As of March 31, 2006, cumulative dividends in arrears related to the Series A preferred stock were approximately $498,000.

Warrants

The following table summarizes the warrant activity for the 3 month period ending March 31, 2006:

Balance, December 31, 2005

 

13,188,280

 

 

 

 

 

Granted

 

500,000

 

Exchanged

 

 

Exercised

 

 

Expired or cancelled

 

(25,000

)

 

 

 

 

Balance, March 31, 2006

 

13,663,280

 

 

18




 

13.           SEGMENT INFORMATION

In the fourth quarter of fiscal year 2005, the Company’s consolidated operations were divided into three segments: Law, Fire and Biometric. Prior to this segmentation of the business, management evaluated the business as one consolidated operation. For presentation and comparability purposes the allocation of costs between segments for prior periods have been estimated.

The Company evaluates performance based on revenues and operating loss. Operating loss for each segment includes selling, general and administrative expenses directly attributable to the segment in addition to those allocated as a percentage based on a number of factors including revenue and bookings. The segmentation of operating loss as noted above and detailed below reflects how management now evaluates its business. Assets for the company are commingled and are related to all operating segments. Management does not evaluate or identify the operating assets of the segments separately.

Geographically, North American sales accounted for approximately 100% of the Company’s total sales for three month periods ending March 31, 2006 and 2005.

Summarized financial information concerning our reportable segments is shown in the following table:

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

(Restated)

 

(Restated)

 

Revenue:

 

 

 

 

 

Law

 

$

2,024,625

 

$

3,070,511

 

Fire

 

705,132

 

768,095

 

Biometrics

 

419,434

 

100,986

 

Consolidated Revenue

 

3,149,191

 

3,939,592

 

Segment operating loss

 

 

 

 

 

Law

 

(730,314

)

(846,473

)

Fire

 

(584,404

)

(474,831

)

Biometrics

 

(522,537

)

(824,220

)

Total Segment Operating Loss

 

(1,837,255

)

(2,145,524

)

Reconciliation to net income (loss)

 

 

 

 

 

Interest expense

 

(2,066,525

)

(834,916

)

Interest income

 

 

26,062

 

Loss on sale of marketable securities

 

 

(20,000

)

Loss on extinguishment of debt

 

(2,322,018

)

 

Derivative and warrant fair value adjustments

 

2,444,693

 

3,576,881

 

Other expense

 

(15,176

)

 

Net income (loss)

 

$

(3,796,281

)

$

602,503

 

 

19




 

14.           SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

(Restated)

 

(Restated)

 

Cash paid for:

 

 

 

 

 

Interest

 

441,926

 

329,952

 

 

 

 

 

 

 

Noncash Financing Activities:

 

 

 

 

 

Conversion of convertible notes and related obligations, net of discount, and accrued interest into common stock

 

 

129,106

 

2,022,541

 

Issuance of mandatorily redeemable preferred stock in exchange for debt and related obligations

 

1,960,222

 

 

Issuance of common stock in conjunction with refinancing

 

127,500

 

 

Issuance of common stock in exchange for Series A preferred stock and cumulative dividends in arrears, thereon

 

 

72,188

 

Cashless exercise of options and warrants

 

 

164,075

 

Goodwill allocation adjustment

 

 

692,302

 

Origination of warrants in conjunction with debt financing

 

308,376

 

 

Conversion of preferred stock to common stock

 

125,476

 

 

Origination of embedded derivations in conjunction with debt financing

 

679,624

 

 

Origination of embedded derivatives with preferred stock

 

360,467

 

 

 

15.           EXTINGUISHMENT OF DEBT

To address certain liquidity issues, on January 23, 2006, the Company issued convertible debt, common stock and warrants in consideration for certain modifications of its outstanding 2004 and 2005 Notes. Pursuant to this activity:

Effective as of January 23, 2006, BIO-key International, Inc. (the “Company”) entered into an Amendment and Waiver (the “Secured Notes Amendment and Waiver”) with Laurus in connection with the Secured Convertible Notes (the “Secured Notes”) currently held by Laurus.

Under the Secured Notes Amendment and Waiver, the Secured Notes issued by the Company to Laurus on September 29, 2004 in the aggregate principal amount of $5,000,000 (the “September 2004 Note”) and on June 8, 2005 in the aggregate principal amount of $2,000,000 (the “June 2005 Note”) were amended as follows: (i) the maturity date of the September 2004 Note was extended to January 1, 2008, (ii) the maturity date of the June 2005 Note was extended to December 1, 2008, and (iii) the fixed conversion price under each of the Secured Notes was reset from $1.35 to $0.85 per share. In addition, the exercise price of all warrants to purchase Common Stock of the Company held by Laurus was reset to $1.00 per share.

The Company also issued 150,000 shares (the “Newly Issued Shares”) of the Company’s Common Stock to Laurus in connection with the Secured Notes Amendment and Waiver. The Company granted Laurus registration rights with respect to these shares. In connection with the issuance of the Newly Issued Shares, Laurus agreed to waive the provisions of the Secured Notes regarding any adjustment of the fixed conversion price that would otherwise be triggered as a result of the issuance of the Newly Issued Shares and certain other securities which have a conversion price of $0.70 per share.

Effective as of January 23, 2006, the Company also entered into an Amendment and Waiver (the “Subordinated Notes Amendment and Waiver”) with certain holders (“the “Subordinated Note Holders”) of its Subordinated Convertible Promissory Notes (the “Subordinated Notes”).

Under the Subordinated Notes Amendment and Waiver, the Subordinated Notes issued by the Company on September 29, 2004 and during the fourth quarter of 2004 in the aggregate principal amount of $4,950,000 (the “September 2004 Notes”) and on May 31, 2005 and during July 2005 in the aggregate principal amount of $3,244,723 (the “May 2005 Notes”) were amended as

20




 

follows: (i) the maturity dates were extended from September 29, 2007 and May 31, 2008, respectively, to January 1, 2009; (ii) the interest rate was fixed at fifteen percent (15%); (iii) all principal amounts are due at the maturity date and shall be paid in shares of Common Stock priced at $0.70 per share if the average closing price of the Common Stock for the thirty (30) trading days immediately preceding the maturity date is greater than $1.10; (iv) interest shall be paid, at the Company’s election, in cash or shares of Common Stock, with the Common Stock priced at the average closing price of the Common Stock for the ten (10) trading days immediately preceding the repayment date; and (v) the currently applicable fixed conversion price was amended to $0.70 per share. In addition, the exercise price of all warrants to purchase Common Stock held by the Subordinated Note Holders that currently have an exercise price greater than $1.00 per share was reset to $1.00 per share.

The Company also entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”), effective as of January 23,2006, with The Shaar Fund, Ltd., Longview Fund, L.P. and Longview Special Finance (collectively, the “Purchasers”).

Under the Securities Purchase Agreement, the Company issued to the Purchasers Convertible Term Notes (the “Convertible Notes”) in the aggregate principal amount of $1,000,000. The Convertible Notes converted into shares of the Series B Preferred Stock of the Company, which shares are convertible into shares of the Common Stock of the Company at an initial fixed conversion price of $0.70 per share.

In connection with the Purchasers’ purchase of the Notes, the Company also issued warrants to the Purchasers (the “Warrants”) to purchase up to an aggregate of 500,000 shares of the Company’s Common Stock (subject to adjustment as set forth therein) at a per share exercise price of $1.00 per share. The proceeds from this transaction will be used for general working capital purposes.

The Company entered into an Amendment No. 1 to Subordinated Secured Promissory Note, dated as of January 23, 2006 (the “Aether Note Amendment”), with Aether Systems, Inc. (“Aether”). Pursuant to the Aether Note Amendment, the Subordinated Secured Promissory Note issued by the Company to Aether on September 30,2004 in the aggregate maximum principal amount of $6,884,588 (the “Aether Note”),was amended to increase such aggregate maximum principal amount to $7,884,588. The Aether Note evidences a contingent reimbursement obligation of the Company to Aether and a surety fee payable by the Company to Aether, in each case with respect to a letter of credit maintained by Aether for the Company’s benefit in connection with the Company’s acquisition of the Mobile Government Division of Aether on September 30, 2004. The Company’s obligations under the Aether Note remain secured by a security interest granted to Aether in all or substantially all of the Company’s assets subordinate to the security interest of Laurus pursuant to the Secured Notes.

In accordance with the Emerging Issues Task Force of the FASB No. 96-19, Debtor’s Accounting for Modification or Exchange of Debt Terms (“EITF 96-19”), the Company recorded a non-operating loss on extinguishment of debt of $2,322,018. The loss mainly relates to the accounting for the effect of the modification of certain embedded derivatives, extinguishment of previously recorded deferred financing costs and changes in the present value of debt and warrants. In accordance with EITF 96-19, the New Notes are recorded in the Company’s balance sheet at fair value at the date of the modification.

16.           RESTATEMENT

In the process of reviewing our Form 10-QSB filed on May 22, 2006, the Securities and Exchange Commission (“SEC”) raised questions with regard to our mandatorily redeemable preferred stock. Specifically, the SEC suggested that we review the classification as permanent equity, a liability or mezzanine equity, and that the preferred stock contained derivatives that needed to be reported separately. After further review of EITF 96-19 and related guidance, the Company determined that additional items need to be expensed as part of the debt  extinguishment loss. Additionally, the Company has made several other changes.

The items identified as requiring restatement were:

21




 

Accounting for Mandatorily Redeemable Preferred Stock

After reviewing FAS 150 and EITF D-98, the Company determined that the Mandatorily Redeemable Convertible Preferred Stock should be treated as mezzanine equity, not as a long term liability. The Company has reclassified the Mandatorily Redeemable Convertible Preferred Stock accordingly, along with removing the accrued dividends from the calculation of net income and is now including them as an adjustment to net income to arrive at net income available to common stockholders used in calculating earnings per share.

Accounting for Derivatives included in Mandatorily Redeemable Preferred Stock

The Company evaluated the Mandatorily Redeemable Convertible Preferred Stock to determine the appropriate accounting for certain provisions which may constitute embedded derivative instruments. The Company addressed the following issues: (i) identification of embedded derivative instruments; (ii) determination of which embedded derivative instruments are “separable” from the underlying host contract; and, (iii) for embedded derivatives which are deemed to be separable, determination of the appropriate classification as either equity or liability/asset. The Company identified two derivatives, which are separable from the host and classified them as liabilities on the balance sheet, as discussed in Note 11 Mandatorily Redeemable Preferred Stock. With respect to these changes, the Company also had to record certain adjustments to correct the amortization of debt discount.

Additional items required to be included in the extinguishment of debt loss

Upon further review of EITF 96-19 and related guidance, the Company determined that additional items should be included in the calculation of the extinguishment of debt loss. Specifically, all deferred financing costs and bankers’ fees related to the debts that were deemed extinguished have now been included as of January 23 in loss on extinguishment of debt.

Other Changes

After a review of the Company’s interim financial statements by our independent public accountants, several other adjustments related to long-term obligations and equity were made. In addition a reclassification was made between unbilled receivables and costs and earnings in excess of billings on uncompleted contracts.

22




 

The following tables set forth for the quarter the amounts of the restatement adjustments and reconciliation from previously reported amounts to restated amounts.

 

Three Months Ended March 31, 2006 (Unaudited)

 

 

 

As previously
reported

 

Effect of
Restatement

 

As Restated

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

Services

 

$

2,246,911

 

 

$

2,246,911

 

License fees and other

 

902,280

 

 

902,280

 

 

 

3,149,191

 

 

3,149,191

 

Costs and other expenses

 

 

 

 

 

 

 

Services

 

673,503

 

 

673,503

 

Cost of license fees and other

 

81,484

 

 

81,484

 

Selling, general and administrative

 

2,576,821

 

 

2,576,821

 

Research, development and engineering

 

1,654,638

 

 

1,654,638

 

 

 

4,986,446

 

 

4,986,446

 

Operating loss

 

(1,837,255

)

 

(1,837,255

)

Other income (deductions)

 

 

 

 

 

 

 

Interest expense

 

(2,666,609

)

600,084

 

(2,066,525

)

Derivative and warrant fair market value adjustments

 

2,197,233

 

247,460

 

2,444,693

 

Loss on extinguishment of debt

 

(813,432

)

(1,508,586

)

(2,322,018

)

Dividends on mandatorily redeemable preferred stock

 

(15,205

)

15,205

 

 

Other income (expense)

 

(15,176

)

 

(15,176

)

Total other income (deductions)

 

(1,313,189

)

(645,837

)

(1,959,026

)

NET LOSS

 

$

(3,150,444

)

$

(645,837

)

$

(3,796,281

)

 

 

 

 

 

 

 

 

Basic Loss per Share:

 

 

 

 

 

 

 

Numerator

 

 

 

 

 

 

 

Net loss

 

$

(3,150,444

)

$

(645,837

)

$

(3,796,281

)

Convertible preferred stock dividends and accretion

 

(98,021

)

(15,205

)

(113,226

)

Loss attributable to common shareholders

 

$

(3,248,465

)

$

(661,042

)

$

(3,909,507

)

 

 

 

 

 

 

 

 

Denominator

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

47,026,773

 

47,026,773

 

47,026,773

 

Basic Loss per Share

 

$

(0.07

)

$

(0.01

)

$

(0.08

)

 

 

 

 

 

 

 

 

Diluted Loss per Share:

 

 

 

 

 

 

 

Numerator

 

 

 

 

 

 

 

Loss attributable to common shareholders

 

$

(3,248,465

)

$

(661,042

)

$

(3,909,507

)

 

 

 

 

 

 

 

 

Effect of Dilutive Securities: Convertible Debentures

 

 

 

 

Loss attributable to common shareholders and assumed conversions

 

$

(3,248,465

)

$

(661,042

)

$

(3,909,507

)

 

 

 

 

 

 

 

 

Denominator

 

 

 

 

 

 

 

Weighted average shares outstanding

 

47,026,773

 

47,026,773

 

47,026,773

 

 

 

 

 

 

 

 

 

Effect of Dilutive Securities: Convertible Debentures

 

 

 

 

Diluted weighted average common shares and common equivalents outstanding

 

47,026,773

 

47,026,773

 

47,026,773

 

Diluted Loss per Share

 

$

(0.07

)

$

(0.01

)

$

(0.08

)

 

23




 

 

 

March 31, 2006 Unaudited

 

 

 

As previously
reported

 

Effect of
Restatement

 

As Restated

 

 

 

 

 

 

 

 

 

ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,594,641

 

 

$

1,594,641

 

Receivables

 

 

 

 

 

 

 

Billed, less allowance for doubtful receivables of $179,999

 

3,188,486

 

 

3,188,486

 

Unbilled

 

26,806

 

106,857

 

133,663

 

Costs and earnings in excess of billings on uncompleted contracts

 

3,173,147

 

(106,857

)

3,066,290

 

Inventory

 

10,494

 

 

10,494

 

Prepaid expenses

 

139,705

 

 

139,705

 

Total current assets

 

8,133,279

 

 

8,133,279

 

Equipment and leasehold improvements, net

 

496,944

 

 

496,944

 

Deposits

 

1,362,902

 

 

1,362,902

 

Intangible assets—less accumulated amortization

 

3,095,926

 

 

3,095,926

 

Deferred financing costs , net

 

1,526,318

 

(1,358,625

)

167,693

 

Goodwill

 

11,389,654

 

 

11,389,654

 

Total non-current assets

 

17,871,744

 

(1,358,625

)

16,513,119

 

TOTAL ASSETS

 

$

26,005,023

 

$

(1,358,625

)

$

24,646,398

 

LIABILITIES:

 

 

 

 

 

 

 

Current maturities of long-term obligations and related obligations, net of discount

 

$

6,288,608

 

$

(212,857

)

$

6,075,751

 

Accounts payable

 

1,151,611

 

 

1,151,611

 

Billings in excess of costs and earnings on uncompleted contracts

 

42,554

 

 

42,554

 

Accrued liabilities

 

6,021,973

 

(140,707

)

5,881,266

 

Deferred rent

 

457,046

 

 

457,046

 

Deferred revenue

 

4,264,645

 

 

4,264,645

 

Total current liabilities

 

18,226,437

 

(353,564

)

17,872,873

 

Warrants

 

1,618,341

 

 

1,618,341

 

Mandatorily redeemable preferred stock

 

1,015,205

 

(1,015,205

)

 

Mandatorily redeemable preferred stock derivatives

 

 

280,674

 

280,674

 

Deferred rent

 

748,424

 

 

748,424

 

Deferred revenue

 

1,209,108

 

 

1,209,108

 

Total non-current liabilities

 

4,591,078

 

(734,531

)

3,856,547

 

TOTAL LIABILITIES

 

22,817,515

 

(1,088,095

)

21,729,420

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mandatorily redeemable preferred stock, net of discounts

 

 

651,240

 

651,240

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Preferred stock — authorized, 5,000,000 shares (liquidation preference of $100 per share) Series A 7% Convertible; issued and outstanding 35,557 shares of $.0001 par value

 

3

 

 

 

3

 

Common stock  — authorized, 170,000,000 shares; issued and outstanding; 48,036,984 shares of $.0001 par value

 

4,803

 

 

4,803

 

Additional paid-in capital

 

49,220,571

 

(275,933

)

48,944,638

 

Accumulated deficit

 

(46,037,869

)

(645,837

)

(46,683,706

)

TOTAL STOCKHOLDERS’ EQUITY

 

3,187,508

 

(921,770

)

2,265,738

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

26,005,023

 

$

(1,358,625

)

$

24,646,398

 

 

24




 

 

 

Three Months Ended March 31, 2006 Unaudited

 

 

 

As previously
reported

 

Effect of
Restatement

 

As Restated

 

 

 

 

 

 

 

 

 

CASH FLOW FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net Loss

 

$

(3,150,444

)

$

(645,837

)

$

(3,796,281

)

Adjustments to reconcile net loss to cash used in operating activities:

 

 

 

 

 

 

 

Derivative and warrant fair value adjustments

 

(2,197,233

)

(247,460

)

(2,444,693

)

Loss on extinguishment of debt

 

813,432

 

1,508,586

 

2,322,018

 

Depreciation

 

65,044

 

 

65,044

 

Amortization

 

 

 

 

 

 

 

Intangible assets

 

215,880

 

 

215,880

 

Deferred financing costs

 

603,005

 

(511,794

)

91,211

 

Discounts on convertible debt related to warrants and beneficial conversion features

 

1,220,202

 

(324,728

)

895,474

 

Allowance for doubtful receivables

 

19,998

 

 

19,998

 

Deferred rent

 

(105,986

)

 

(105,986

)

Dividends on mandatorily redeemable preferred stock

 

15,205

 

(15,205

)

 

Options and warrants issued for services and other

 

120,567

 

 

120,567

 

Change in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable trade

 

(1,504,834

)

 

(1,504,834

)

Costs and earnings in excess of billings on uncompleted contracts

 

1,255,102

 

 

1,255,102

 

Inventory

 

(1,734

)

 

(1,734

)

Prepaid expenses and other

 

(2,705

)

 

(2,705

)

Deposits

 

465,657

 

 

465,657

 

Accounts payable

 

318,003

 

 

318,003

 

Billings in excess of costs and earnings on uncompleted contracts

 

10,169

 

 

10,169

 

Accrued liabilities

 

137,554

 

233,999

 

371,553

 

Deferred revenue

 

1,045,733

 

 

1,045,733

 

Net cash used in operating activities

 

(657,385

)

(2,439

)

(659,824

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Capital expenditures

 

(13,720

)

 

(13,720

)

Expenditures for patents

 

(9,983

)

 

(9,983

)

Net cash used in investing activities

 

(23,703

)

 

(23,703

)

CASH FLOW FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Issuance of long-term obligations

 

1,000,000

 

(12,000

)

988,000

 

Repayment of long-term obligations

 

(82,314

)

2,455

 

(79,859

)

Issuance of common stock in conversion

 

15

 

(15

)

 

Expenditures for financing costs

 

(64,799

)

11,999

 

(52,800

)

Net cash provided by financing activities

 

852,902

 

2,439

 

855,341

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

171,814

 

 

171,814

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,422,827

 

 

1,422,827

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

1,594,641

 

$

 

$

1,594,641

 

 

25




ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

CAUTIONARY STATEMENT FOR FORWARD-LOOKING STATEMENTS

The information contained in this Report on Form 10-QSB and in other public statements by the Company and Company officers include or may contain certain forward-looking statements. All statements other than statements of historical facts contained in this Report on Form 10-QSB, including statements regarding our future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “will,” “may,” “future,” “plan,” “intend” and “expect” and similar expressions generally identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in the forward-looking statements are reasonable, we cannot be sure that they will be achieved. Actual results may differ materially from the forward-looking statements contained herein due to a number of factors. Many of these factors are set forth in the Company’s Annual Report on Form 10-KSB under the caption “Risk Factors” and other filings with the Securities and Exchange Commission. These factors are not intended to represent a complete list of the general or specific factors that may affect us. It should be recognized that other factors, including general economic factors and business strategies may be significant, presently or in the future. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

OVERVIEW

The following should be read in conjunction with the financial statements of the Company included elsewhere herein.

We develop and market proprietary fingerprint identification biometric technology and software solutions. We also deliver advanced identification solutions and information services to law enforcement departments, public safety agencies and other government and private sector customers. Our mobile wireless technology provides first responders with critical, reliable, real-time data and images from local, state and national databases.

We pioneered the development of automated, finger identification technology that can be used without the aid of non-automated methods of identification such as a personal identification, password, token, smart card, ID card, credit card, passport, driver’s license or other form of possession or knowledge based identification. This advanced BIO-key™ identification technology improves both the accuracy and speed of finger-based biometrics and is the only finger identification algorithm that has been certified by the International Computer Security Association (ICSA).

Since our inception in 1993, we have spent substantial time and effort in completing the development of what we believe is the most discriminating and effective finger biometric technology available. During the past two years, our focus has shifted to marketing and selling this technology and completing strategic acquisitions that can help us leverage our capability to deliver identification solutions. We have built a direct sale force of professionals with substantial experience in selling technology solutions to government and corporate customers. We expect to continue to add additional qualified personnel.

CRITICAL ACCOUNTING POLICIES

For detailed information on our critical accounting policies and estimates, see our financial statements and notes thereto included in this Report and in our Annual Report on Form 10-KSB, as amended, for the fiscal year ended December 31, 2005. There have been no material changes to our critical accounting policies and estimates from those disclosed in our amended 10-KSB filed on June 19, 2006.

With the adoption of SFAS 123R at the beginning of the Company’s first fiscal quarter of 2006, we added

26




“Stock-Based Compensation” as a critical accounting policy.

Stock-Based Compensation

As of January 1, 2006, the Company adopted SFAS 123R using the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for options in footnote disclosures required under SFAS 123, as amended by SFAS 148, and requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). Changes in these subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized as an expense on the consolidated statements of operations. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value employee stock-based awards granted in future periods. The values derived from using the Black-Scholes model are recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires significant judgment. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates. Prior periods have not been restated to incorporate the stock-based compensation charge. The compensation expense recognized in connection with the adoption of SFAS 123R increased the company’s net loss by $120,567 and with no effect per share. There was no impact on cash flows from operations, investment, or financing in connections with the adoptions of SFAS 123R. As the Company uses the full valuation allowance with respect to deferred taxes, the adoption of SFAS123R had no impact on deferred taxes.

There was no stock-based compensation expense related to employee stock options and employee stock purchases recognized under FAS 123R during the three months ended March 31, 2005.

RECENT ACCOUNTING PRONOUNCEMENTS

Not applicable for the current period.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2006 AS COMPARED TO THREE MONTHS ENDED MARCH 31, 2005

INTRODUCTION

In the fourth quarter of 2005, the Company restructured its operations into three business segments: Biometrics, Law Enforcement and Fire Safety. Each segment will be headed by a General Manager and organized to quickly respond to market needs as well as to drive down costs to achieve profitability. Management believes that this initiative will lead to increased opportunities throughout 2006 as the General Managers continue to develop their business units. During the first quarter of 2006 the Company continued to stay focused on its objectives of increasing revenue and managing expenses.

27




Consolidated Results of Operations - Percent Trend

 

Three Months Ended March 31,

 

 

 

2006

 

2005

 

 

 

(Restated)

 

(Restated)

 

Revenues

 

 

 

 

 

Services

 

71

%

78

%

License fees and other

 

29

%

22

%

 

 

100

%

100

%

Costs and other expenses

 

 

 

 

 

Services

 

21

%

21

%

Cost of license fees and other

 

3

%

8

%

Selling, general and administrative

 

82

%

72

%

Research, development and engineering

 

53

%

53

%

 

 

159

%

154

%

Operating loss

 

-59

%

-54

%

 

 

 

 

 

 

Other income (deductions)

 

 

 

 

 

Total other income (deductions)

 

-62

%

70

%

NET LOSS

 

-121

%

16

%

 

We have three reporting segments: Law Enforcement, Fire Safety and Biometrics. The Law Enforcement and Fire Safety segments were purchased during 2004. In the fourth quarter of 2005 the Company restructured its operations into three business segments, prior to this segmentation of the business, management evaluated the business as one consolidated operation. For presentation and comparability purposes the allocation of costs between segments for prior periods has been estimated.

28




The Company evaluates performance based on revenues and operating income (loss). Operating income (loss) for each segment includes selling, general and administrative expenses directly attributable to the segment in addition to those allocated as a percentage based on a number of factors including revenue and bookings. The segmentation of operating income as noted above and detailed below reflects how management now evaluates its business. Assets for the company are commingled and are related to all operating segments. Management does not evaluate or identify the operating assets of the segments separately.

 

Three months ended

 

 

 

 

 

 

 

March 31,

 

 

 

 

 

 

 

2006

 

2005

 

$ Change

 

% Change

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Law Enforcement

 

 

 

 

 

 

 

 

 

Service

 

$

1,598,559

 

2,352,776

 

$

(754,217

)

-32

%

License & other

 

426,066

 

717,734

 

(291,668

)

-41

%

 

 

2,024,625

 

3,070,510

 

(1,045,885

)

-34

%

Fire Safety

 

 

 

 

 

 

 

 

 

Service

 

631,732

 

662,228

 

(30,496

)

-5

%

License & other

 

73,400

 

105,867

 

(32,467

)

-31

%

 

 

705,132

 

768,095

 

(62,963

)

-8

%

Biometrics

 

 

 

 

 

 

 

 

 

Service

 

16,618

 

44,850

 

(28,232

)

-63

%

License & other

 

402,816

 

56,135

 

346,681

 

618

%

 

 

419,434

 

100,985

 

318,449

 

315

%

 

 

 

 

 

 

 

 

 

 

Total Revenue

 

$

3,149,191

 

$

3,939,590

 

$

(790,399

)

-20

%

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

 

 

 

 

 

 

 

Law Enforcement

 

 

 

 

 

 

 

 

 

Service

 

$

424,929

 

$

675,473

 

$

(250,542

)

-37

%

License & other

 

33,087

 

251,251

 

(218,163

)

-87

%

 

 

458,016

 

926,724

 

(468,705

)

-51

%

Fire Safety

 

 

 

 

 

 

 

 

 

Service

 

217,415

 

146,829

 

70,586

 

48

%

License & other

 

37,560

 

55,570

 

(18,010

)

-32

%

 

 

254,975

 

202,399

 

52,575

 

26

%

Biometrics

 

 

 

 

 

 

 

 

 

Service

 

31,159

 

13,264

 

17,895

 

135

%

License & other

 

10,837

 

21,035

 

(10,198

)

-48

%

 

 

41,996

 

34,299

 

7,697

 

22

%

 

 

 

 

 

 

 

 

 

 

Total COGS

 

$

754,987

 

$

1,163,422

 

$

(408,434

)

-35

%

 

Revenues

Law Enforcement

The decrease in revenue for this segment from 2005 was primarily attributable to a reduction in revenue from longer-term project work of approximately $762,000 as the Company moves to more of a licensing based model.

Fire Safety

The revenue for this segment decreased over the same quarter in the prior year. Although revenue

29




decreased, the company expects future growth in the segment as the market for fire safety products continues to remain strong, and the decrease is mainly attributable to timing of orders being received.

Biometrics

During the first quarter of 2006 the Biometric segment continued to show strong revenue growth. The growth in the current quarter was primarily attributable a large license order from a new customer. The Biometric business continues to gain traction and acceptance in the market place and is pursuing new customers to grow its installed customer base.

Costs of goods sold

Law Enforcement