U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended JUNE 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the Transition Period from _________ to __________
Commission file number 1-13463
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BIO-KEY INTERNATIONAL, INC.
---------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
MINNESOTA 41-1741861
--------- ----------
(State or Other Jurisdiction of (IRS Employer
Incorporation of Organization) Identification Number)
1285 CORPORATE CENTER DRIVE
SUITE # 175, EAGAN, MN 55121
----------------------------
(Address of Principal Executive Offices)
(651) 687-0414
--------------
(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 [ ]
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 [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: There were 38,430,829
issued and outstanding shares of the registrant's common stock, par value $.01
per share, as of August 12, 2004.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
BIO-KEY INTERNATIONAL, INC.
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
-----------------------------
Item 1 - Consolidated Financial Statements
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Balance sheets as of December 31, 2003, and June 30, 2004
----------------------------------------------------------------------
(unaudited) 1
-----------
Statements of operations for the three and six months ended
-----------------------------------------------------------
June 30, 2004 and 2003 (unaudited) 2
----------------------------------
Statements of cash flows for the six months ended June 30, 2004 and 2003
-------------------------------------------------------------------------
(unaudited) 3
-----------
Notes to consolidated financial statements 4
------------------------------------------
Item 2 - Management's Discussion and Analysis 14
---------------------------------------------
Item 3 - Controls and Procedures 22
--------------------------------
PART II. OTHER INFORMATION
--------------------------
22
Item 2 - Change in Securities and Small Business
------------------------------------------------
Item 6 - Exhibits and Reports on Form 8-K. 23
-----------------------------------------
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BIO-key International, Inc.
and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31, June 30,
2003 2004
------------ ------------
ASSETS (Unaudited)
CURRENT ASSETS
Cash and cash equivalents $ 1,012,790 $ 3,837,147
Receivables
Trade, less allowance for doubtful accounts
of $2,000 and $6,000, respectively 409,803 1,188,560
Subscription -- 50,000
Advances to shareholders and other -- 154,515
Inventory 65,857 36,910
Prepaid expenses 165,929 71,697
------------ ------------
Total current assets 1,654,379 5,338,829
EQUIPMENT AND FURNITURE AND FIXTURES - at cost,
less accumulated depreciation 60,157 127,536
OTHER ASSETS
Intangible assets - net of amortization -- 4,593,692
Marketable debt securities -- 5,887,500
Other 150,206 115,377
------------ ------------
$ 1,864,742 $ 16,062,934
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Advances from shareholders $ 34,030 $ 22,944
Accounts payable 351,742 550,973
Accrued liabilities 173,736 292,944
Deferred revenue 10,000 226,235
------------ ------------
Total current liabilities 569,508 1,093,096
LONG-TERM OBLIGATIONS 10,431,223 --
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock - authorized, 5,000,000 shares
of $.01 par value (liquidation preference of
$100 per share):
Series B 9% Convertible;
issued and outstanding, 4,180 as of December 31,2003 42 --
Series C 7% Convertible; issued and outstanding,
75,682 shares as of June 30, 2004 -- 757
Common stock - authorized, 60,000,000 shares
of $.01 par value; issued and outstanding, 21,222,889
and 38,430,829 shares, respectively 212,229 384,308
Additional contributed capital 18,327,992 44,559,202
Deficit (27,676,252) (29,974,429)
------------ ------------
(9,135,989) 14,969,838
------------ ------------
$ 1,864,742 $ 16,062,934
============ ============
See accompanying notes to financial statements.
1
BIO-key International, Inc.
and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months Six months
ended June 30, ended June 30,
----------------------------- ---------------------------
2003 2004 2003 2004
------------ ------------- ------------ ------------
Revenues
Product sales $ 5,305 $ 111,118 $ 6,830 $ 120,048
Licensing fees 5,000 304,557 30,000 579,713
Technical support
and other services 2,715 103,439 3,694 131,239
------------ ------------ ------------ ------------
13,020 519,114 40,524 831,000
Costs and other expenses
Cost of product sales 3,304 94,889 5,697 100,667
Selling, general
and administrative 468,947 1,346,442 1,037,447 2,167,395
Research, development
and engineering 253,770 351,814 474,876 614,575
------------ ------------ ------------ ------------
726,021 1,793,145 1,518,020 2,882,637
------------ ------------ ------------ ------------
Operating loss (713,001) (1,274,031) (1,477,496) (2,051,637)
Other income (deductions)
Interest expense (302,910) (852) (594,255) (137,472)
Sundry 426 14,175 980 16,523
------------ ------------ ------------ ------------
(302,484) 13,323 (593,275) (120,949)
------------ ------------ ------------ ------------
NET LOSS $ (1,015,485) $ (1,260,708) $ (2,070,771) $ (2,172,586)
============ ============ ============ ============
Basic and diluted loss to common stockholders
Net loss $ (1,015,485) $ (1,260,708) $ (2,070,771) $ (2,172,586)
Convertible preferred stock dividends
and accretion -- (153,150) -- (153,150)
------------ ------------ ------------ ------------
Loss applicable to common stockholders $ (1,015,485) $ (1,413,858) $ (2,070,771) $ (2,325,736)
============ ============ ============ ============
Basic and diluted loss per common share
Net loss $ (.07) $ (.03) $ (.14) $ (.07)
Convertible preferred stock dividends
and accretion -- (.01) -- (.01)
------------ ------------ ------------ ------------
Loss applicable per common share $ (.07) $ (.04) $ (.14) $ (.08)
============ ============ ============ ============
Weighted average number of
common shares outstanding 14,886,809 37,693,849 14,632,108 30,769,548
============ ============ ============ ============
See accompanying notes to financial statements
2
BIO-key International, Inc.
and Subsidiary
STATEMENTS OF CASH FLOWS
(Unaudited)
Six months
ended June 30,
-------------------------------
2003 2004
------------ ------------
Cash flows from operating activities
Net loss $ (2,070,771) $ (2,172,586)
Adjustments to reconcile
net loss to net cash used
in operating activities:
Depreciation -- 17,015
Amortization
Intangible assets -- 108,329
Discounts on convertible
debt related to warrants and
beneficial conversion features 277,092 --
Allowance for bad debts -- 4,000
Options and warrants issued for
services and other 156,000 --
Change in assets and liabilities:
Accounts receivable 60,570 (664,478)
Inventory -- 28,947
Prepaid expenses and other (42,633) 155,351
Accounts payable (22,310) (114,080)
Accrued liabilities 335,145 254,508
Deferred revenue -- 75,747
------------ ------------
Net cash used in operations (1,306,907) (2,307,247)
Cash flows from investing activities
Capital expenditures -- (79,089)
Investments -- (5,887,500)
Acquisition -- (498,937)
Subscription -- (50,000)
Other (8,075) (25,739)
------------ ------------
Net cash used in
investing activities (8,075) (6,541,265)
Cash flows from financing activities
Issuance of convertible debentures 1,553,000 1,000,000
Repayment of long-term notes -- (400,000)
Net advances from shareholders -- (44,246)
Sale of common stock -- 11,248,803
Repurchase of warrants -- (100,000)
Other -- (31,688)
------------ ------------
Net cash provided by
financing activities 1,553,000 11,672,869
------------ ------------
Net increase in cash and
cash equivalents 238,018 2,824,357
Cash and cash equivalents,
beginning of period 16,748 1,012,790
------------ ------------
Cash and cash equivalents,
end of period $ 254,766 $ 3,837,147
============ ============
See accompanying notes to financial statements.
3
BIO-key International, Inc.
and Subsidiary
NOTES TO FINANCIAL STATEMENTS
December 31, 2003, and June 30, 2004
(Unaudited)
1. Unaudited Statements
The accompanying unaudited interim consolidated financial statements
include the accounts of BIO-key International, Inc. and their 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. 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
interim consolidated financial statements are 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, 2003.
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
accumulated losses during the last two years and through the second
quarter of 2004 of approximately ($10,019,000) of which approximately
($2,173,000) was incurred during 2004. As of June 30, 2004
stockholders' equity was approximately $14,970,000.
On March 31, 2004 substantial doubt about the Company's ability to
continue as a going concern was alleviated when 8,888,928 shares of the
Company's common stock were sold for approximately $12,000,000 in gross
proceeds.
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 paragraph removed substantial doubt
about the Company's ability to continue as a going concern.
4
3. Loss per Common Share
Basic loss per share is calculated by dividing the net loss
attributable to common stockholders by the number of weighted average
common shares outstanding. Diluted earnings per share are calculated by
dividing the net loss attributable to common stockholders by the
weighted average common shares, and when dilutive, by including
options, warrants and convertible securities outstanding using the
treasury stock method. There was no difference between basic and
diluted loss per share for all periods presented, because the impact of
including options, warrants and convertible securities would be
antidilutive.
4. Marketable Debt Securities
Debt and equity securities designated as available-for-sale, whose fair
values are readily determinable, are carried at fair value with
unrealized gains or losses included as a component of accumulated other
comprehensive income, net of applicable taxes. Debt and equity
securities classified as trading securities are carried at fair value
with unrealized gains or losses included in income. Debt securities
that are expected to be held-to-maturity are carried at amortized cost.
Individual securities classified as either available-for-sale or
held-to-maturity are reduced to net realizable value by a charge to
income for other than temporary declines in fair value. Realized gains
and losses are determined on the average cost method and are reflected
in income. As of June 30, 2004, the Company's investments are all
classified as held-to-maturity securities and are carried at amortized
cost of $5,887,500. The fair market value of these investments as of
June 30, 2004 were $5,734,710, resulting in unrealized losses of
$152,790.
5. Acquisition of Public Safety Group, Inc.
On March 30, 2004, we acquired all of the outstanding capital stock of
Public Safety Group, Inc. (PSG), a privately-held leader in wireless
solutions for law enforcement and public safety markets based in Winter
Park, Florida. The acquisition was completed pursuant to the terms of
an Agreement and Plan of Merger (the Merger Agreement) by and among the
Company, BIO-Key Acquisition Corp., a wholly-owned subsidiary of the
Company, PSG and all of the shareholders of PSG. As a result of this
transaction PSG became a wholly-owned subsidiary of the Company and now
constitutes a division of our business specializing in the law
enforcement and public safety markets (the Public Safety Division). The
business combination will be accounted for using the purchase method.
Pursuant to the Merger Agreement, we purchased all of the outstanding
capital stock of PSG from the former shareholders of PSG in exchange
for an aggregate of 2,416,108 shares of our common stock issued to the
former shareholders of PSG, 6,000 shares of our common stock issued to
Harward Investments, Inc. (Harward) pursuant to an arrangement
involving the discharge of certain outstanding debt obligations of PSG
to Harward as of March 30, 2004, $500,000 in cash, and our assumption
of $600,000 in aggregate net liabilities of PSG. The Merger Agreement
provides that any liability or obligation of PSG in Excess of such
$600,000 limitation, whether arising before or after the effective date
of the merger, will be solely the responsibility of the former
shareholders of PSG. Additional earnout consideration, determined as a
proportion of revenues attained by the Public Safety Division over
fiscal years 2004 and 2005, may be paid to the former shareholders of
PSG. The Company will make payments of such additional consideration on
the last day of the month following each month in which the Public
Safety Division achieves specified revenue milestones during fiscal
years 2004 and 2005. Such payments will be made in cash, unless the
aggregate amount of earnout consideration exceeds sixty percent (60%)
of the aggregate consideration paid by the Company in the merger
transaction. Any such excess amounts will be paid in shares of our
common stock priced as of two (2) days prior to the date on which any
earnout payment becomes due. In connection with this acquisition, three
former employees of PSG, who were also shareholders of PSG, entered
into two-year employment agreements with the Company to serve within
the Public Safety Division.
5
The 2,416,108 shares issued to the PSG shareholders (the Merger Shares)
are subject to escrow provisions contained in the Merger Agreement and
a related escrow agreement, which provide for periodic releases of the
shares from escrow on a schedule determined by the revenues achieved by
the Public Safety Division during fiscal years 2004 and 2005. The
owners of such escrowed shares, however, will continue to enjoy all the
rights and privileges attributable to the shares, including, without
limitation, the right to vote and receive dividends. The principal
terms of the escrow arrangement are as follows:
o One-twelfth (1/12) of the Merger Shares are held in escrow for
the purpose of securing certain prior obligations of PSG to
Harward and will be released upon the effectiveness of this
registration statement to the shareholders of PSG and Harward.
o The remaining eleven-twelfths (11/12) of the Merger Shares
will be released to the former shareholders of PSG at
quarterly intervals, on a distribution schedule determined by
the revenues achieved by the Public Safety Division during
2004. According to the distribution schedule, all of the
Merger Shares will be released as early as June 30, 2006 but
no later than December 31, 2007.
o Of the remaining eleven-twelfths (11/12) of the Merger Shares,
those shares owned by former employees of PSG who became our
employees by virtue of the merger transaction are subject to
repurchase by us under certain circumstances involving the
termination of such employee's employment. Shares remaining in
escrow may also be used to fund identification obligations of
the former PSG shareholders pursuant to the Merger Agreement.
6
A summary of the estimated fair value of the net assets acquired and
liabilities assumed, pertaining to the purchased entity is as follows:
Current assets $ 133,369
Goodwill 2,535,445
Copyrighted software 1,181,429
Marketing agreements 605,340
Trademarks 379,807
Other assets 5,857
-----------
Total assets acquired 4,841,247
Current liabilities (332,307)
Long-term liabilities (400,000)
-----------
Purchase Price $ 4,108,940
===========
The Company acquired all of the issued and outstanding capital stock of
PSG, effective March 30, 2004. The following pro forma financial data,
unaudited, reflects revenue, loss from continuing operations, net loss
and loss applicable per common share of the Company for the three month
periods ended June 30, 2004 and 2003, and six month periods ended June
30, 2003 and 2004 as though the transaction occurred as of January 1,
2003 and 2004.
Three months ended Six months ended
June 30, June 30,
-------------------------- --------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
Revenue $ 271,968 $ 519,114 $ 596,079 $ 1,015,096
Loss from continued operations (836,466) (1,260,708) (1,811,409) (2,187,257)
Net Loss (836,466) (1,260,708) (1,811,409) (2,187,257)
Loss applicable per
common share $ (0.06) $ (0.03) $ (0.12) $ (0.07)
6. Prepaid Expenses
December 31, June 30,
2003 2004
-------- --------
Consulting fees $ 90,000 $ --
Insurance 42,181 63,482
Other 33,748 8,215
-------- --------
$165,929 $ 71,697
======== ========
7
In October 2003, the Company entered into a twelve-month consulting
agreement with a financial advisory services company. The terms of the
consulting agreement required $108,000 to be paid in fees over the term
of the agreement. The consulting fees were charged to operations during
the first quarter of 2004 as the consulting services were provided.
7. Equipment and Furniture and Fixtures
December 31, June 30,
2003 2004
------------ --------
Equipment $ 66,543 $138,151
Furniture and fixtures 36,550 45,628
Other -- 3,708
-------- --------
103,093 187,487
Less accumulated depreciation 42,936 59,951
-------- --------
$ 60,157 $127,536
======== ========
8. Other Assets
December 31, June 30,
2003 2004
----------- ----------
Copyrighted software $ -- $1,181,429
Marketing agreements -- 605,340
Trademarks -- 379,807
-------- ----------
-- 2,166,576
Less accumulated amortization -- 108,329
-------- ----------
-- 2,058,247
Goodwill -- 2,535,445
-------- ----------
$ -- $4,593,692
======== ==========
8
Deferred Offering Costs
-----------------------
In March 2002, the Company engaged an investment banking firm to advise
the Company regarding raising additional capital through the potential
future issuance of the Company's equity, debt or convertible
securities. The Company paid a nonrefundable retainer fee of $50,000,
out of pocket expenses of $14,900 and granted a four year warrant to
purchase 25,000 shares of the Company's common stock at an exercise
price of $1.00 per share. The estimated value of the warrant is
$17,000. These deferred costs were charged to operations in the quarter
ended March 31, 2004, when this engagement terminated.
Impairment of Goodwill
----------------------
The Company has adopted SFAS No. 142. In accordance with the adoption
of this standard, the Company has not amortized goodwill. As required
under SFAS No. 142, the Company performed an assessment of the carrying
value of goodwill using a number of criteria, including the value of
the overall enterprise, and as of June 30, 2004, 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.
9. Accrued Liabilities
December 31, June 30,
2003 2004
------------ --------
Compensation $167,859 $219,401
Payroll taxes -- 61,742
Other 5,877 11,801
-------- --------
$173,776 $292,944
======== ========
10. Note Payable
Pursuant to the Merger Agreement, the Company assumed a maximum of
$600,000 in aggregate net liabilities of PSG, which included a note
payable of $400,000. This note was subsequently paid off in April 2004.
11. Long-term Obligations
Between January 4, 2004, and March 29, 2004 as part of the Company's
January 2003 amended funding transaction with an investor group (the
Investor), the Investor has provided additional financing of $1,000,000
(the Funding Agreement) in incremental monthly installments.
9
On March 30, 2004 the Company issued 18,275 shares of series C
convertible preferred stock to the Investor in exchange for the
cancellation of $1,770,500 principal amount of outstanding convertible
promissory notes and $49,963 of accrued interest due thereunder.
12. Stockholders Equity
Common Stock
------------
On March 31, 2004, the Company entered into a securities purchase
agreement with certain institutional and accredited investors pursuant
to which the Company issued and sold an aggregate of 8,888,928 shares
of common stock and warrants to purchase an aggregate of 4,444,464
shares of common stock. The investors paid an aggregate purchase price
of $1.35 for each share of common stock and warrant to purchase 0.5 of
a share of common stock, resulting in gross proceeds of approximately
$12,000,000. In connection with the securities purchase agreement, the
Investor paid for a portion of their purchased stock and warrants by
canceling $347,500 of outstanding debt. The remaining aggregate
proceeds of $11,248,803, net of offering costs totaling $403,700, were
held in escrow until April 2004. During March 2004, additional out of
pocket offering costs of $14,397 were accrued by the Company.
The Warrants may be exercised at any time prior to the Fifth
anniversary of the effective date of this registration statement at an
exercise price of $1.755 per share. Each Warrant contains anti-dilution
protection, which provides that if at any time on or prior to March 31,
2005, we issue any of our common stock or rights, options, warrants or
other securities or debt bearing a right to acquire our common stock at
a price less than the then-applicable exercise price of such Warrant,
such exercise price will be automatically reduced to such lower price.
Fifty percent (50%) of any unexercised portions of the Warrants are
callable by the Company if the volume weighted average trading price
per share of our common stock exceeds $4.3875 per share for ten (10)
consecutive trading days and the Warrants have not been exercised after
forty-five (45) days' prior notice from the Company.
Under the Purchase Agreement, in the event that (i) this registration
statement is not filed on or prior to April 30, 2004 or declared
effective on or prior to July 14, 2004, (ii) after the effectiveness of
this registration statement, an investor is not permitted to sell its
securities hereunder (or any subsequent registration statement filed in
replacement hereof) for any reason for five (5) or more trading days
(whether or not consecutive), (iii) after the effectiveness of this
registration statement, any securities covered hereunder are not listed
on an eligible tgrading market or (iv) our common stock is not listed
or quoted, or is suspended from trading, on an eligible trading market
for a period of three (3) trading days (whether or not consecutive),
the Company will be required to pay a cash amount to the investors
equal to one percent (1%) of the aggregate purchase price paid by the
investors pursuant to the Purchase Agreement for the first month that
such event occurs and one percent (1%) for each month thereafter in
which such event remains uncured, in each case prorated for any partial
month. If the Company fails to make any such payment in a timely
manner, such payment shall bear interest at the rate of one percent
(1%) per month (prorated for partial months) until paid in full.
10
Series B Convertible Preferred Stock Dividends
----------------------------------------------
On March 30, 2004 the Investor converted the remaining 4,180 shares of
Series B 9% convertible preferred stock and $107,693 of dividends and
accrued interest thereon into 5,257 share of the Company's series C
preferred stock. All of the Company's series C preferred stock is
convertible into shares of the Company's common stock.
Series C Convertible Preferred Stock Dividends
----------------------------------------------
The Company's series C preferred stock accrues dividends at 7% payable
semi-annually on June 15 and December 15 and on such date that the
preferred stockholder elects to convert preferred stock to common
stock. As of June 30, 2004 approximately $135,000 cumulative dividends
had been earned on the Series C preferred stock. All of the Company's
series C preferred stock is convertible into shares of the Company's
common stock.
Options and Warrants
--------------------
The following summarizes option and warrant activity since December 31,
2003:
Number of Shares
---------------------------------------------------------------------
1996 1999 Non-
Plan Plan Plan Warrants Total
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2003 487,380 1,176,669 3,268,000 5,394,682 10,326,731
Granted -- -- 75,000 4,444,464 4,519,464
Cancelled/Expired (5,000) -- -- (25,000) (30,000)
----------- ----------- ----------- ----------- -----------
Balance, March 31, 2004 482,380 1,176,669 3,343,000 9,814,146 14,816,195
Granted -- -- 235,000 -- 235,000
Cancelled/Expired -- -- -- (531,250) (531,250)
Exercised -- -- -- (400,000) (400,000)
----------- ----------- ----------- ----------- -----------
Balance, June 30, 2004 482,380 1,176,669 3,578,000 8,882,896 14,119,945
=========== =========== =========== =========== ===========
Available for future grants,
June 30, 2004 174,620 629,588 -- -- 804,208
=========== =========== =========== =========== ===========
11
Proforma Compensation Disclosure
--------------------------------
In December 2002, the Financial Accounting Standards Board (FASB)
issued SFASB No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. SFAS No. 148 amends SFAS No.
123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary charge to the fair value based
method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 requires expanded and more prominent disclosure
in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the
method on reported results.
The Company has not adopted a method under SFAS No. 148 to expense
stock options but rather continues to apply the recognition and
measurement provisions of APB Opinion No.25, Accounting for Stock
issued to Employees, and related interpretations in accounting for
those plans. No stock-based employee compensation expense for options
is reflected in net income for the fiscal periods presented as all
options granted under those plans had an exercise price equal to or
lower than the market price of the underlying common stock at the date
of grant.
If compensation expense for the stock options granted had been
determined based on the fair value at the grant dates consistent with
the method of SFAS No. 123, the Company's proforma net loss and
proforma loss per share would have been as follows:
Three Months Ended June 30, Six Months Ended June 30,
2003 2004 2003 2004
----------- ------------ ------------ ------------
Net loss
As reported (1,015,485) (1,260,708) (2,070,771) (2,172,586)
Proforma (1,049,235) (1,327,708) (2,138,271) (2,306,586)
Loss applicable to common
Stockholders
As reported (1,015,485) (1,413,858) (2,070,771) (2,325,736)
Proforma (1,049,235) (1,480,858) (2,138,271) (2,459,736)
Basic and diluted loss per
common share
As reported (.07) (.04) (.14) (.08)
Proforma (.07) (.04) (.15) (.08)
13. Legal Proceedings
In June 2003, PSG, our recently-acquired subsidiary, was named as a
defendant in a civil action initiated in the Superior Court Department
in Hampden County, Commonwealth of Massachusetts by The Vince Group,
Inc. ("TVG"). The case has since been removed to the United States
District Court for the District of Massachusetts at the request of the
Parties. The complaint claims that PSG is obligated to pay a percentage
of certain of its revenues to TVG in consideration for a strategic
12
business introduction allegedly made by an agent of TVG. PSG has denied
the allegations and filed an answer in the litigation, and as of the
date of this report the outcome of the litigation is pending. The claim
is for an unspecified amount including actual damages, interest, and
attorney's fees. Management believes that the claim is without merit
and will be settled out of court for an amount that will not have a
material adverse affect on our business, financial condition or
operating results.
14. Events Occurring Subsequent to June 30, 2004
In a cashless exchange in July 2004, the Company issued 251,000 shares
of common stock in exchange for the cancellation of warrants valued at
$96,183.
In July 2004, the Company provided an employee of the Company a
seven-year option to purchase 75,000 shares of the Company's common
stock at an exercise price of $1.35 per share. The option vests in
three annual installments commencing July 1, 2005.
In July 2004, the Company issued five-year warrants to purchase an
aggregate of 150,000 shares of common stock at an exercise price of
$.97 per share to certain consultants. The warrants shall vest as
follows: 50,000 shares immediately, 75,000 shares on July 15, 2005 and
25,000 shares on July 15, 2006.
On August 16, 2004, the Company entered into a definitive agreement
with Aether Systems, Inc. ("Aether") to purchase its Mobile Government
Division for $10 million in cash. It is anticipated that $4.5 million
in net working capital will be included in the assets and liabilities
being conveyed, and that the acquisition will be financed using the
Company's existing cash resources and new debt. In addition to the cash
purchase price, the Company will either replace or secure the release
of up to $10.75 million of credit support arrangements that Aether
currently has in place for its Mobile Government Division. Aether has
agreed to accept a subordinated, secured note from the Company for up
to $8 million of this credit support if the Company cannot arrange to
replace or release all of it by closing. The closing is expected to
occur on or about September 30, 2004, and is subject to customary
closing conditions.
15. Supplementary Disclosures of Cash Flow Information
Six Months
Ended June 30,
-------------------------------
2003 2004
------------- -----------
Cash paid for:
Interest $ -- $ 1,857
Noncash Financing Activities:
Conversion of convertible
debentures, bridge notes, and
accrued interest into common
stock -- 2,864,293
Issuance of Series C preferred
stock in exchange for Series
B preferred stock and
cumulative dividends in
arrears, thereon -- 525,668
Issuance of Series C preferred stock
in exchange for debt -- 8,702,463
Issuance of common stock in exchange for warrants -- 3,039
Issuance of common stock in exchange for
Series A, Series B and Series C preferred
stock and cumulative dividends in arrears
thereon 54,914 22,372
Issuance of common stock in
conjunction with the PSG acquisition -- 3,608,940
13
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 within the meaning of Section 27A of the U.S.
Securities Act of 1933 and Section 21E of the U.S. Securities Exchange of 1934.
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 Registration Statement on Form SB-2 and 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 consolidated
financial statements of the Company included elsewhere herein.
We develop and market proprietary fingerprint identification biometric
technology and software solutions. 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 license or
other form of possession or knowledge based identification. This advanced
BIO-key(TM) 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.
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 fingerprint biometric technology available. During the past two years,
our focus has shifted to marketing and selling this technology. We have built a
direct sales force of professionals with substantial experience in selling
technology solutions to government and corporate customers. We expect to
continue to add additional qualified personnel during the remainder of 2004.
During 2003 and the first two quarters of 2004, we entered into a
number of licensing and development agreements. Certain of these arrangements
have resulted in our technology being used in commercial applications on a run
time basis and we are beginning to generate recurring revenue. We will continue
14
to focus a substantial amount of resources on our sales and marketing efforts
and expect revenues to increase during 2004. Our primary objective in 2004 is to
generate revenue and increase the recognition, use and acceptance of our
technology in the market. To accomplish this, all sales efforts are focused on
moving evaluation and development relationships to run time license arrangements
as quickly as possible. We continue to see increases in qualified leads
resulting in evaluation licenses and run time licenses. Our biggest challenge is
obtaining human resources to pursue and follow up on opportunities available to
us.
Although recent security concerns relating to the identification of
individuals has increased interest in biometrics generally, it has yet to gain
widespread commercial acceptance. We continue to see increasing acceptance of
biometric technology and believe the market for our technology is large enough
for us to become a successful revenue generating company. Continued concerns
regarding security and increased corporate spending on technology are key
external conditions which may affect our ability to execute our business plan.
On March 30, 2004, we acquired all of the outstanding capital stock of
Public Safety Group, Inc. ("PSG"), a privately-held provider of wireless
solutions for law enforcement and public safety markets based in Winter Park,
Florida. PSG's primary technology is a software solution that provides police
officers and other security personnel instantaneous access to criminal, civil
and private database information in a wireless environment. PocketCop(C) is a
handheld application that allows law enforcement officers to access state and
federal databases over the wireless network for PalmOS, Windows CE and PocketPC.
With the use of a portable wireless handheld device and PocketCop(C) application
software, an authorized user can access suspect information.
We market and sell our PocketCop(C) solution primarily to state and
local law enforcement agencies throughout the United Sates. We are establishing
a strong customer base and expect continued growth in this division particularly
in the current environment of heightened security concerns. We believe there is
a substantial market opportunity to integrate our VST(TM) and WEB-key(TM)
biometric technologies with the PSG mobile solution. The integration will
provide us with the ability to offer a unique wireless solution and the
opportunity to provide a meaningful upgrade to all existing customers of PSG. We
expect to complete the integration of these technologies during the third
quarter of 2004. In that regard we recently entered into an agreement comprised
of an asset purchase of the Aether Mobil Government Division contingent upon
completion subject to a number of standard closing conditions.
As more fully described in our Proxy Statement filed with the
Securities and Exchange Commission, we are actively pursuing strategic
acquisitions that are expected to be accretive to operating results. To enable
us to respond rapidly to acquisition opportunities, and to meet other future
needs that could arise, we are seeking shareholder approval to raise the number
of shares we are authorized to issue from 60 million to 85 million.
On March 31, 2004, we completed a private placement equity offering
that resulted in approximately $12,000,000 in gross proceeds. Based on available
cash resources, and projected revenue, we believe our existing financial
resources will now be sufficient to sustain operations for at least the next
twenty-four (24) months. Our long-term viability and growth will depend upon the
successful commercialization of our technologies and our ability to continue to
obtain adequate financing, among other matters, as to which there can be no
assurances.
15
RESULTS OF OPERATIONS
ON MARCH 30, 2004, WE COMPLETED THE ACQUISITION OF PSG WHICH NOW
OPERATES AS OUR LAW ENFORCEMENT AND PUBLIC SAFETY DIVISION. THE DISCUSSION BELOW
REGARDING OUR RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30,
2004 REFLECTS THE COMBINED OPERATIONS OF OUR HISTORIC BIOMETRIC TECHNOLOGY
LICENSING BUSINESS AND OUR NEW PUBLIC SAFETY DIVISION, WHEREAS THE CORRESPONDING
PERIODS IN 2003 INCLUDE ONLY THE OPERATIONS OF OUR HISTORIC BIOMETRIC BUSINESS.
IN ORDER TO PRESENT THE FOLLOWING DISCUSSION IN A MANNER TO PROVIDE A MORE
MEANINGFUL COMPARISON BETWEEN THE TWO PERIODS, WHERE POSSIBLE, WE HAVE
QUANTIFIED THE MATERIAL CHANGES IN OUR RESULTS OF OPERATIONS WHICH ARE
ATTRIBUTABLE TO THE OPERATIONS OF EACH OF OUR BUSINESSES.
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004 AS COMPARED TO THREE MONTHS AND
SIX MONTHS ENDED JUNE 30, 2003
REVENUE
We generated revenue of approximately $519,000 during the three month
period ended June 30, 2004 as compared to approximately $13,000 during the
corresponding period in 2003. Of this amount, approximately $128,000 was
generated by our biometric technology business, representing an approximate
$115,000 increase over the corresponding period in 2003. This increase was due
to an increased number of licensing arrangements, some of which have moved from
evaluation to recurring run time licenses. PSG, our law enforcement and public
safety division which we acquired on March 30, 2004, accounted for approximately
$391,000 of the remaining revenue during the three month period ended June 30,
2004.
We generated revenue of approximately $831,000 during the six month
period ended June 30, 2004 as compared to approximately $41,000 during the
corresponding period in 2003. Of this amount, approximately $253,000 was
generated by our biometric technology business, representing an approximate
$212,000 increase over the corresponding period in 2003. This increase was due
to an increased number of licensing arrangements, some of which have moved from
evaluation to recurring run time licenses. Our law enforcement and public safety
division accounted for approximately $578,000 of the remaining revenue during
the six month period ended June 30, 2004.
Consolidated revenue during the six month period ended June 30, 2004
consisted of approximately $580,000 from license fees, approximately $120,000
from product sales and approximately $131,000 from technical support services.
We expect to continue to generate a majority of our revenue form license fees
and the balance from technical support and product sales. As our evaluation
customers move to run time licensing arrangements, we expect technical support
fees to comprise a larger percentage of our consolidated revenue and provide
increased recurring monthly revenue. We continue to expand our sales and
marketing departments and expect to continue to add customers and increase
revenue during 2004 in both our biometric and public safety divisions. We expect
the majority of our consolidated revenue through the remainder of 2004 to
continue to be generated by our public safety division.
COSTS AND OTHER EXPENSES
COST OF PRODUCTS AND SERVICES SOLD. Cost of products and services sold
were approximately $95,000 during the three month period ended June 30, 2004 as
compared to approximately $3,000 during the corresponding period in 2003. Of
16
this amount, approximately $31,000 was attributed to sales by our biometric
technology business, representing an approximate $28,000 increase from the
corresponding period. Approximately $64,000 of the remaining cost of products
sold, was attributed to our law enforcement and public safety division. As our
revenue and customer base continues to grow, we expect these costs to continue
to increase. Most initial sales by our law enforcement and public safety
division involve the sale of a PDA, and most initial sales by our biometrics
business involve the sale of a scanner. We expect cost of products on a
consolidated basis to continue to increase and be split approximately equally
between our public safety and biometric technology businesses. Although we
generate a margin on such sales, our future earnings, if any, will depend
primarily upon licensing and technical support fees.
Cost of products and services sold were approximately $101,000 during
the six month period ended June 30, 2004 as compared to approximately $6,000
during the corresponding period in 2003. Of this amount, approximately $37,000
was attributed to sales by our biometric technology business, representing an
approximate $31,000 increase from the corresponding period. Approximately
$64,000 of the remaining cost of products sold, was attributed to our law
enforcement and public safety division.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased approximately $877,000 to approximately
$1,346,000 during the three months ended June 30, 2004 as compared to
approximately $469,000 during the corresponding period in 2003. Of this amount,
approximately $878,000 was incurred by our biometric technology business,
representing approximately a $409,000 increase over the corresponding period in
2003. Approximately $468,000 of the remaining selling, general and
administrative expenses were incurred by our law enforcement and public safety
division.
Of the approximately $877,000 increase in selling, general and
administrative expenses during the three months ended June 30, 2004,
approximately $312,000 was related to increased sales and marketing activity,
approximately $169,000 was related to an increase in general administrative
costs, approximately $106,000 was related to an increase in costs for
administrative personnel, and approximately $290,000 was related to an increase
in professional services incurred in connection with additional SEC filings and
the audit of PSG. Although we continue to closely monitor expenses, we retained
5 additional employees in connection with our recent acquisition of PSG, and
have expanded both our direct sales force, marketing and technology support
departments. We expect continued increases in these functions during 2004 as we
continue to focus on generating additional revenue and supporting our growing
customer base. Accordingly, we expect selling, general and administrative
expenses to continue to increase during 2004.
Selling, general and administrative expenses increased approximately
$1,130,000 to approximately $2,167,000 during the six months ended June 30, 2004
as compared to approximately $1,037,000 for the corresponding period in 2003. Of
this amount, approximately $1,699,000 was incurred by our biometric technology
business, representing an approximate $662,000 increase over the corresponding
period in 2003. The remaining increase approximately $468,000 was incurred by
our law enforcement and public safety division.
17
Of the approximate $1,130,000 increase in selling, general and
administrative expenses during the six months period ended June 30, 2004,
approximately $257,000 was due to an increase in sales and marketing costs as we
continue to focus substantial resources to generating revenue, approximately
$141,000 was due to an increase in executive personnel costs, approximately
$356,000 was due to an increase in general administrative costs and
approximately $376,000 was related to an increase in professional services
incurred in connection with additional SEC filings and the audit of PSG.
RESEARCH AND DEVELOPMENT. Research, development and engineering
expenses increased approximately $98,000 to approximately $352,000 during the
three months ended June 30, 2004 as compared to approximately $254,000 during
the corresponding period in 2003. Of this amount, approximately $276,000 was
incurred by our biometric technology business, representing an approximate
$22,000 increase over the corresponding period in 2003. The remaining increase
of approximately $76,000 was incurred by our law enforcement and public safety
division. Of the approximate $98,000 increase in research, development and
engineering expenses approximately $60,000 was related to an increase in general
development expense, and approximately $38,000 related to a increase in
personnel costs. Having completed the development of our core technology,
research and development expenses in 2004 will consist of enhancing existing
software and reacting to customer feedback. We expect research and development
costs to stabilize during 2004 and be incurred primarily by our biometrics
business.
Research, development and engineering expenses increased approximately
$140,000 to approximately $615,000 during the six months ended June 30, 2004 as
compared to approximately 475,000 during the corresponding period in 2003. Of
this amount, approximately $539,000 was incurred by our biometric technology
business, representing an approximate $64,000 increase over the corresponding
period in 2003. Approximately $76,000 of the remaining increase was incurred by
our law enforcement and public safety division. Of the approximate $140,000
increase in research, development and engineering expenses approximately $35,000
was related to a increase in general development expense, and approximately
$105,000 related to a increase in personnel costs.
INTEREST EXPENSE. Interest expense was approximately $1,000 and
$137,000 during the three and six month periods ended June 30, 2004,
respectively, as compared to approximately $303,000 and $594,000 during the
corresponding periods in 2003, respectively. Substantially all of the interest
expense was incurred by our biometric technology business. The decrease in
interest expense during the three and six months ended June 30, 2004 was due to
the decrease in long-term obligations. As of the date of this report, all term
indebtedness has been converted into equity.
NET OPERATING LOSS CARRYFORWARDS. As of December 31, 2003, we had
federal and Minnesota net operating loss carryforwards of approximately
$24,504,000 and $12,406,000, respectively. The carryforwards expire between 2011
and 2023. Such net operating carryforwards will be limited due to the change in
ownership of the Company that has occurred, as defined in the Internal Revenue
Code.
18
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities during the six months ended June
30, 2004 was approximately $2,307,000 compared to approximately $1,307,000
during the six months ended June 30, 2003. The primary use of cash for both
years was to fund the net losses. Net cash used in investing activities for the
six months ended June 30, 2004 was approximately $6,541,000 compared to net cash
used in investing activities of approximately $8,000 for the corresponding
period in 2003 and consisted primarily of $5,887,500 invested in government
bonds, $498,937 invested in the acquisition of PSG, $50,000 invested in
Classifeye, and $79,089 invested in capital equipment additions. Net cash
provided by financing activities during the six months ended June 30, 2004 was
approximately $11,673,000 compared to approximately $1,553,000 in the
corresponding period in 2003 and consisted primarily of $11,249,000 from sales
of our common stock and approximately $1,000,000 from long term borrowings.
These amounts were offset approximately $400,000 for a note repayment,
approximately $100,000 for repurchasing warrants, approximately 44,000 in
repayment of advances from a shareholder, and approximately $32,000 for other
items.
Working capital increased approximately $3,161,000 during the six
months ended June 30, 2004 to approximately $4,246,000 compared to approximately
$1,085,000 as of December 31, 2003. This increase was due to an approximate
$11,249,000 increase in cash as a result of the completion of our recent private
placements of our equity securities. This amount was offset by the purchase of
approximately $5,888,000 of marketable debt securities classified as
held-to-maturity securities. Pursuant to an available credit facility, we can
access an amount equal to up to 90% of the current market value of such
marketable debt securities at a cost of funds equal to or less then the
effective interest earned on such securities.
Since January 7, 1993 (date of inception), our capital needs have been
principally met through proceeds from the sale of equity and debt securities. We
do not currently maintain a line of credit or term loan with any commercial bank
or other financial institution except as described in the immediate preceding
paragraph.
On October 31, 2003, we entered into an amendment to the January 27,
2003 note purchase agreement with the Shaar Fund Ltd. ("Investor") to provide up
to $2,500,000 of additional financing pursuant to the terms of a secured
promissory note (the "Secured Note"). Of this amount, $600,000 was advanced at
closing and $1,900,000 was funded between December 3, 2003 and March 29, 2004.
The Secured Note was due October 1, 2005, secured by substantially all of our
assets including our intellectual property, accrued interest at the rate of 7%
per annum payable on maturity, and may be prepaid without penalty. The principal
amount and accrued interest was convertible at the option of the Investor into
either shares of our common stock at a conversion price of $.75 per share or
shares of our series C preferred stock (the "Series C Shares") at a conversion
price of $100 per share. The Secured Note also provided that in the event we
completed a private placement of our equity securities resulting in gross
proceeds in excess of $5,000,000 on or before June 30, 2004, some or all of the
principal and accrued interest shall, at the option of the Investor, be either
converted into such equity securities at a conversion price equal to the sale
price of such securities or repaid in cash. Upon the closing of our recent
private placement equity offering, the Investor elected to convert $347,500 of
the principal amount of the Secured Note into shares of our common stock and
warrants to purchase shares of our common stock, each issued to the Investor in
connection with such private placement.
19
Pursuant to a recapitalization transaction completed on March 3, 2004,
all existing promissory notes payable to the Investor, other than the Secured
Note, together with all accrued and unpaid interest due thereon (approximately
$6,500,000) were cancelled and converted into 65,000 Series C Shares. Series C
Shares are convertible into common stock at a conversion price of $.75 per
share. In the event that the trading price of our common stock is less than
$1.00 per share for thirty (30) consecutive days at any time after March 3,
2007, we will be required to redeem the Series C Shares at a redemption price of
$100 per share plus all accrued and unpaid dividends due thereon. In connection
with the recapitalization transaction, the Investor transferred $375,000 of the
principal amount of the Secured Note to Thomas J. Colatosti, our Chairman of the
Board of Directors.
On March 30, 2004, the Investor elected to convert $1,827,463 of
principal and accrued interest due under the Secured Note into 18,275 Series C
Shares. Also on March 30, 2004, the Investor elected to exchange all of the
issued and outstanding shares of our series B preferred stock and accrued and
unpaid dividends thereon and all accrued and unpaid interest on such dividends
into 5,257 additional Series C Shares. On April 29, 2004, Mr. Colatosti elected
to convert $375,000 of the principal amount of the Secured Note into 3,750
Series C Shares. As a result of these conversions, as of the date of this
report, we have no outstanding indebtedness other than current liabilities.
Between April 7, 2004 and June 21, 2004, we issued an aggregate of
2,237,198 shares of common stock upon conversion of 16,600 shares of the
Company's Series C 7% Convertible Preferred Stock and $17,898 of dividends due
theron to the Shaar Fund.
On March 31, 2004, we entered into a securities purchase agreement with
certain institutional and accredited investors pursuant to which we issued and
sold an aggregate of 8,888,928 shares of our common stock and warrants (the
"Warrants") to purchase an aggregate of 4,444,464 shares of our common stock.
The investors paid an aggregate purchase price of $1.35 for each share of common
stock and Warrant to purchase 0.5 of a share of common stock, resulting in gross
proceeds to of approximately $12,000,000.
On March 30, 2004, we completed the acquisition of PSG in exchange for
an aggregate of 2,416,108 shares of our common stock, $500,000 in cash, and our
assumption of $600,000 in net liabilities of PSG. Any liability or obligation of
PSG in excess of such $600,000 limitation will be solely the responsibility of
the former shareholders of PSG. In connection with this acquisition, we also
issued 6,000 shares of our common stock to Harward Investments, Inc. ("Harward")
pursuant to an arrangement involving the discharge of certain outstanding debt
obligations of PSG to Harward as of March 30, 2004.
Additional earnout consideration, determined as a proportion of
qualified revenues, as defined, attained by the acquired business during fiscal
years 2004 and 2005, may be paid to the former shareholders of PSG. During 2004,
earnout consideration, if any, will be paid at the following rates: Five percent
(5%) of all 2004 Qualifying Revenue less than $2 million, less the Accounts
Receivable Holdback; as defined; Ten percent (10%) of all 2004 Qualifying
Revenue equal to or greater than $2 million but less than $4 million; Twenty
percent (20%) of all 2004 Qualifying Revenue equal to or greater than $4 million
but less than $7 million; and Thirty percent (30%) of all 2004 Qualifying
Revenue equal to or greater than $7 million. During 2005, earnout consideration,
if any, will be paid at the following rates: Ten percent (10%) of all 2005
20
Qualifying Revenue equal to or greater than $7 million but less than $10
million; and Twenty percent (20%) of all 2005 Qualifying Revenue equal to or
greater than $10 million. We will make payments of such additional consideration
on the last day of the month following each month in which the acquired business
achieves specified revenue milestones during fiscal years 2004 and 2005. Such
payments will be made in cash, unless the aggregate amount of earnout
consideration exceeds sixty percent (60%) of the aggregate consideration we paid
in the merger transaction. Any such excess amounts will be paid in shares of our
common stock priced as of two (2) days prior to the date on which any earnout
payment becomes due.
We recently announced, our intention to actively pursue strategic
acquisitions that are expected to be accretive to operating results. We believe
that an active acquisition strategy is timely because (i) companies with
synergistic technology and/or market channels can combine to respond to the need
in the homeland security market for complete technology solutions and to create
operating efficiencies and (ii) there are many companies in the technology
sector that have over-invested in the development stage and now lack sufficient
financial resources to invest in the sales and marketing capabilities necessary
for growth. To enable us to respond rapidly to acquisition opportunities, and to
meet other future needs that could arise, we are seeking shareholder approval to
increase the number of shares we are authorized to issue from 60 million to 85
million. While some of these newly authorized shares could be used as currency
for acquisitions, we expect to raise the additional capital required for
acquisitions through the issuance of convertible instruments that would not be
immediately convertible into common stock. In that regard, we have engaged Jesup
& Lamont, an investment banking firm, to assist us in reviewing potential
acquisition candidates.
On August 16, 2004, we entered into a definitive agreement with Aether
Systems, Inc. ("Aether") to purchase its Mobile Government Division for $10
million in cash. It is anticipated that $4.5 million in net working capital will
be included in the assets and liabilities being conveyed, and that the
acquisition will be financed using the Company's existing cash resources and new
debt. In addition to the cash purchase price, the Company will either replace or
secure the release of up to $10.75 million of credit support arrangements that
Aether currently has in place for its Mobile Government Division. Aether has
agreed to accept a subordinated, secured note from the Company for up to $8
million of this credit support if the Company cannot arrange to replace or
release all of it by closing. The closing is expected to occur on or about
September 30, 2004, and is subject to customary closing conditions.
Our future liquidity and capital requirements will depend upon numerous
factors, including:
o our ability to license our technology to original equipment
manufacturers, systems integrators and application developers;
o our ability to successfully integrate PSG's technology and
customer relationships into our current business plan;
o the costs and timing of product development efforts and the
success of these efforts;
o our ability to maintain and grow quality customer base; and
o biometric technology market developments.
As of the date of this report, we had cash resources of approximately
$8,700,000 and no debt other than current liabilities. We currently require
approximately $400,000 per month to conduct our operations. During the first two
quarters of 2004, we generated approximately $831,000 of revenue and expect to
continue to generate increasing revenue from existing and new relationships
during 2004.
21
We now believe our current cash resources and anticipated cash flow
from current operations will enable us to maintain operations at current levels
for at least the next twenty-four (24) months. We may need to obtain additional
funding to (i) conduct the sales, marketing and technical support necessary to
execute our plan to substantially grow operations, increase revenue and serve a
significant customer base; and (ii) pursue our acquisition strategy. While
anticipated revenues are expected to defray operating expenses and reduce the
need for additional financing, they are not expected to be sufficient for us to
significantly expand operations. To the extent that we would require such
additional funding, no assurance can be given that any form of additional
financing will be available on terms acceptable to us, that adequate financing
will be obtained to meet our needs, or that such financing would not be dilutive
to existing stockholders. If available financing is insufficient or unavailable
or we fail to continue to generate meaningful revenue, we may be required to
further reduce operating expenses, delay the expansion of operations, or be
unable to pursue merger or acquisition candidates.
ITEM 3. CONTROLS AND PROCEDURES
An evaluation of the effectiveness of the Company's "disclosure
controls and procedures" (as such term is defined in Rules 13a-15(e) or
15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) was carried out by the Company under the supervision and with the
participation of the Company's Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"). Based upon that evaluation, the Company's CEO and CFO
concluded that, as of the end of the period covered by this quarterly report,
the Company's disclosure controls and procedures were effective to provide
reasonable assurance that information the Company is required to disclose in
reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission rules and forms. There has been no change in the Company's
internal control over financial reporting identified in connection with that
evaluation that occurred during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
SECURITIES
Between May 17 and June 21, 2004, we issued an aggregate of 611,019
shares of common stock upon conversion of 4,500 shares of the Company's Series C
7% Convertible Preferred Stock and $8,264 of dividends due thereon to the Shaar
Fund, Ltd. The shares were issued to one accredited investor in a private
placement transaction exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereunder without
payment of underwriting discounts or commissions to any person.
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
-------------------- -------------------------------------------- -----------------------------------------------
Exhibit No. Exhibit Method of Filing
-------------------- -------------------------------------------- -----------------------------------------------
2.1 Agreement and Plan of Merger dated as of Incorporated by reference to Exhibit 2.1 to
March 30, 2004 by and among BIO-key the Registrant's Current Report on Form 8-K
International, Inc., BIO-Key Acquisition dated March 30, 2004
Corp., Public Safety Group, Inc. ("PSG")
and each of the shareholders of PSG
-------------------- -------------------------------------------- -----------------------------------------------
3.1 Amended and Restated Articles of Incorporated by reference to Exhibit 3.1 to
Incorporation the Registrant's Registration Statement on
SB-2, File No. 333-16451 filed February 14,
1997 (the "Registration Statement")
-------------------- -------------------------------------------- -----------------------------------------------
3.2 Certificate of Amendment to Amended and Incorporated by reference to Exhibit 3.3 to
Restated Articles of Incorporation the Registrant's Report on Form 10-QSB for
the quarter ended March 31, 1999
-------------------- -------------------------------------------- -----------------------------------------------
3.3 Amendment to the Amended and Restated Incorporated by reference to Exhibit 3.7 to
Articles of Incorporation filed February the Registrant's Registration Statement on
28, 2002 Form SB-2 filed March 27, 2002
-------------------- -------------------------------------------- -----------------------------------------------
3.4 Certificate of Designation of Series C Incorporated by reference to Exhibit 3.6 to
Convertible Preferred Stock the Registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2003
(the "2003 10-KSB")
-------------------- -------------------------------------------- -----------------------------------------------
3.5 Amended and Restated Bylaws Incorporated by reference to Exhibit 3.2 to
the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
4.1 Specimen of Common Stock Certificate Incorporated by reference to Exhibit 4.1 to
the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
10.1 SAC Technologies, Inc. 1996 Stock Option Incorporated by reference to Exhibit 10.1 to
Plan the Registration Statement
-------------------- -------------------------------------------- -----------------------------------------------
10.2 Amendment No. 1 to the SAC Technologies, Incorporated by reference to Exhibit 10.3 to
Inc. 1996 Stock Option Plan the 1999 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.3 SAC Technologies, Inc. 1999 Stock Option Incorporated by reference to Exhibit 10.4 to
Plan the 1999 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.4 Warrant issued to The Shaar Fund Incorporated by reference to Exhibit 10.5 to
the Registrant's Current Report on Form 8-K
dated November 26, 2001 (the "November 20,
2001 8-K")
-------------------- -------------------------------------------- -----------------------------------------------
23
-------------------- -------------------------------------------- -----------------------------------------------
10.5 Option to Purchase 150,000 Shares of Incorporated by reference to Exhibit 10.9 to
Common Stock issued to Thomas J. Colatosti. the Registrants Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2003
(the "2002 10-KSB")
-------------------- -------------------------------------------- -----------------------------------------------
10.6 Non-Qualified Stock Option Agreement under Incorporated by reference to Exhibit 10.10 to
the Registrant's 1999 Stock Incentive Plan the 2002 10-KSB
to Purchase 200,000 Shares of Common Stock
issued to Thomas J. Colatosti
-------------------- -------------------------------------------- -----------------------------------------------
10.7 Employment Agreement by and between the Incorporated by reference to Exhibit 10.11 to
Registrant and Michael W. DePasquale dated the 2002 10-KSB
January 3, 2003
-------------------- -------------------------------------------- -----------------------------------------------
10.8 Option to Purchase 580,000 Shares of Incorporated by reference to Exhibit 10.12 to
Common Stock issued to Michael W. the 2002 10-KSB
DePasquale
-------------------- -------------------------------------------- -----------------------------------------------
10.9 Note Purchase Agreement dated January 27, Incorporated by reference to Exhibit 10.13 to
2003 the 2002 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.10 Secured Convertible Promissory Due June Incorporated by reference to Exhibit 10.14 to
30, 2004 the 2002 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.11 Option to Purchase 200,000 Shares of Incorporated by reference to Exhibit 10.15 to
Common Stock issued to Charles P. Romeo the 2002 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.12 Amendment No. 1 to Note Purchase Agreement Incorporated by reference to Exhibit 10.16 to
dated October 31, 2003 by and between the the 2003 10-KSB
Registrant and The Shaar Fund Ltd.
-------------------- -------------------------------------------- -----------------------------------------------
10.13 Securities Exchange Agreement dated March Incorporated by reference to Exhibit 10.17 to
3, 2004 by and between the Registrant and the 2003 10-KSB
The Shaar Fund Ltd.
-------------------- -------------------------------------------- -----------------------------------------------
10.14 Registration Rights Agreement dated March Incorporated by reference to Exhibit 10.18 to
3, 2004 by and between the Registrant and the 2003 10-KSB
The Shaar Fund Ltd.
-------------------- -------------------------------------------- -----------------------------------------------
10.15 Secured Convertible Promissory Note due Incorporated by reference to Exhibit 10.19 to
October 31, 2005 in the principal amount the 2003 10-KSB
of up to $2,125,000
-------------------- -------------------------------------------- -----------------------------------------------
10.16 Secured Convertible Promissory Note due Incorporated by reference to Exhibit 10.20 to
October 31, 2005 in the principal amount the 2003 10-KSB
of $375,000
-------------------- -------------------------------------------- -----------------------------------------------
10.17 Option to Purchase 500,000 Shares of Incorporated by reference to Exhibit 10.21 to
Common Stock issued to Michael W. the 2003 10-KSB
DePasquale
-------------------- -------------------------------------------- -----------------------------------------------
24
-------------------- -------------------------------------------- -----------------------------------------------
10.18 Option to Purchase 150,000 Shares of Incorporated by reference to Exhibit 10.22 to
Common Stock issued to Thomas J. Colatosti the 2003 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.19 Option to Purchase 50,000 Shares of Common Incorporated by reference to Exhibit 10.23 to
Stock issued to Thomas J. Colatosti the 2003 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.20 Option to Purchase 50,000 Shares of Common Incorporated by reference to Exhibit 10.24 to
Stock issued to Jeff May the 2003 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.21 Option to Purchase 50,000 Shares of Common Incorporated by reference to Exhibit 10.25 to
Stock issued to Charles Romeo the 2003 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.22 Option to Purchase 300,000 Shares of Incorporated by reference to Exhibit 10.26 to
Common Stock issued to Randy Fodero the 2003 10-KSB
-------------------- -------------------------------------------- -----------------------------------------------
10.23 Amendment Agreement dated March 30, 2004 Incorporated by reference to Exhibit 10.26 to
by and between the Registrant and The the Registrant's Registration Statement on
Shaar Fund Ltd. Form SB-2 2004 File No. 333-115037 filed
April 30, 2004 (the "2004 Registration
Statement")
-------------------- -------------------------------------------- -----------------------------------------------
10.24 Securities Purchase Agreement dated as of Incorporated by reference to Exhibit 10.1 to
March 31, 2004 (the "Securities Purchase the Registrant's current report on Form 8-K
Agreement") by and among the Registrant filed with the Securities and Exchange
and each of the Purchasers named therein. Commission on April 5, 2004 (the "April 5,
2004 8-K")
-------------------- -------------------------------------------- -----------------------------------------------
10.25 Form of Warrant issued by BIO-key Incorporated by reference to Exhibit 10.2 to
International, Inc. pursuant to the the April 5, 2004 8-K
Securities Purchase Agreement
-------------------- -------------------------------------------- -----------------------------------------------
31.1 Certificate of CEO of Registrant required Filed herewith
by Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
31.2 Certificate of CFO of Registrant required Filed herewith
by Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
32.1 Certificate of CEO of Registrant required Filed herewith
by Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
32.2 Certificate of CFO of Registrant required Filed herewith
by Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
25
(b) Current Reports on Form 8-K filed during the three month period ended
June 30, 2004:
1. On April 5, 2004, the Company filed a Current Report on Form 8-K
dated April 5, 2004, reporting under Item 5 the completion of a private
placement of equity securities.
2. On April 14, 2004, the Company filed a Current Report on Form 8-K
dated March 30, 2004, reporting under Item 2 the acquisition of Public Safety
Group, Inc. On June 14, 2004, the Company filed Amendment No. 1 to Current
Report on Form 8-K dated March 30, 2004, amending Item 7 thereof, to include the
financial statements and pro forma financial information required thereby.
26
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
BIO-KEY INTERNATIONAL, INC.
Dated: August 16, 2004 /s/ Michael W. DePasquale
-------------------------
Michael W. DePasquale
Chief Executive Officer
Dated: August 16, 2004 /s/ Gary Wendt
--------------
Gary Wendt
Chief Financial Officer
27
EXHIBIT INDEX
-------------------- -------------------------------------------- -----------------------------------------------
Exhibit No. Exhibit Method of Filing
-------------------- -------------------------------------------- -----------------------------------------------
31.1 Certificate of CEO of Registrant required Filed herewith
by Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
31.2 Certificate of CFO of Registrant required Filed herewith
by Rule 13a-14(a) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
32.1 Certificate of CEO of Registrant required Filed herewith
by Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
32.2 Certificate of CFO of Registrant required Filed herewith
by Rule 13a-14(b) under the Securities
Exchange Act of 1934, as amended
-------------------- -------------------------------------------- -----------------------------------------------
28