BIO KEY INTERNATIONAL INC
Form POS AM
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As filed with the Securities and Exchange Commission on November 6, 2006
Registration No. 333-115037
POST-EFFECTIVE AMENDMENT NO. 6
FORM SB-2
THE SECURITIES ACT OF 1933
BIO-key International, Inc.
(State of incorporation) 3577
(Primary Standard Industrial
Classification Code Number) 41-1741861
3349 Highway 138, Building D, Suite B, Wall, NJ 07719, (732) 359-1100
(Address and telephone number of registrant's principal executive offices)
Michael W. DePasquale
BIO-key International, Inc., 3349 Highway 138, Building D, Suite B, Wall, NJ 07719, (732) 359-1100
(Name, address and telephone number of agent for service)
Copy to:
Charles J. Johnson, Esq.
Choate, Hall & Stewart LLP
Two International Place
Approximate date of commencement of proposed sale to public: From time to time after this registration statement becomes effective.
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, or the Securities Act, check the following box. ý
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o
Calculation of Registration Fee
Title of each class of
securities to be registered
Number of units to
be registered(1)
Proposed maximum
aggregate offering
price per unit(2)
Amount of
registration fee(3)
Common Stock, $.0001 par value per share 2,422,108 shares(4) $1.95 $4,723,111 $598
Common Stock, $.0001 par value per share 8,888,928 shares(5) $1.95 $17,333,410 $2,196
Common Stock, $.0001 par value per share, issuable upon exercise of warrants 4,444,464 shares(6) $1.95 $8,666,705 $1,098
Pursuant to Rule 416 under the Securities Act, this registration statement also covers an indeterminate number of additional shares of the registrant's common stock as may be issuable upon any stock split, stock dividend or similar transaction.
Estimated pursuant to Rule 457(c) under the Securities Act solely for the purpose of calculating the registration fee, based upon the average of the high and low sale prices of the registrant's common stock as reported on the OTC Bulletin Board on April 28, 2004, a date within five days of the original filing date of this registration statement.
Registration fee has been previously paid.
Shares of the registrant's common stock issued in connection with an agreement and plan of merger dated as of March 30, 2004.
Shares of the registrant's common stock issued pursuant to a securities purchase agreement dated as of March 31, 2004.
Shares of the registrant's common stock issuable upon the exercise of warrants issued pursuant to a securities purchase agreement dated as of March 31, 2004.
The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission acting pursuant to said Section 8(a), may determine.
POS-AM No. 333-115037
Subject to completion, dated November 6, 2006
15,755,500 Shares
We are registering up to 15,755,500 shares of our common stock for offer or sale by the selling security holders named in this prospectus. Of the shares being registered, 11,311,036 shares have been issued to the selling security holders and 4,444,464 shares are issuable upon exercise of warrants issued to the selling security holders. Of the 11,311,036 shares that have been issued to the selling security holders, 2,416,108 shares are being held in escrow and may not be offered or sold by the selling security holders until such escrow is released. The selling security holders may offer or sell all or a portion of their shares publicly or through private transactions at prevailing market prices or at negotiated prices. We will not receive any proceeds from the shares being registered for offer and sale by the selling security holders.
Investing in our common stock involves a high degree of risk.
See "Risk Factors" beginning on page 4.
Our common stock is traded on the OTC Bulletin Board under the symbol "BKYI". The last reported sale price of our common stock on November 1, 2006 was $0.48 per share.
In addition to the shares being registered for offer or sale by the selling security holders under this prospectus, the registrant is also concurrently conducting three other separate offerings under additional prospectuses. Specifically, a separate offering of up to 11,723,152 shares is being concurrently conducted by the registrant by means of a prospectus dated as of December 28, 2004 (as amended), another separate offering of up to 11,777,191 shares is being concurrently conducted by the registrant by means of a prospectus dated as of July 24, 2006 and another separate offering of up to 25,164,046 shares is being concurrently conducted by the registrant by means of a preliminary prospectus dated as of October 24, 2006.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
PROSPECTUS SUMMARY 1
MARKET FOR OUR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
DESCRIPTION OF THE BUSINESS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
DESCRIPTION OF SECURITIES
ACQUISITION OF PUBLIC SAFETY GROUP, INC.
PRIVATE PLACEMENT TRANSACTION
SELLING SECURITY HOLDERS
PLAN OF DISTRIBUTION
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
WHERE YOU CAN FIND ADDITIONAL INFORMATION
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information that is different. This prospectus may only be used where it is legal to sell these securities. The information in this prospectus may only be accurate on the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Applicable rules of the Securities and Exchange Commission may require us to update this prospectus in the future.
PROSPECTUS SUMMARY
Effective January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key") and the original registrant under this Registration Statement, reincorporated as BIO-key International, Inc., a Delaware corporation (the "Company," "BIO-key," "we" or "us"). The reincorporation was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement"), whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to reincorporate in the State of Delaware (the "Reincorporation"). As a result of the Reincorporation, the legal domicile of the registrant is now Delaware.
Pursuant to the Merger Agreement, at the effective time of the Reincorporation: (i) each outstanding share of Common Stock of Old BIO-key, $0.01 par value per share, was automatically converted into one share of Common Stock, $0.0001 par value per share, of the Company; (ii) each outstanding share of Series C 7% Convertible Preferred Stock of Old BIO-key, $0.01 par value per share, was automatically converted into one share of Series A 7% Convertible Preferred Stock, $0.0001 par value per share, of the Company, with such Series A 7% Convertible Preferred Stock containing substantially identical terms and conditions as the Series C 7% Convertible Preferred Stock of Old BIO-key; (iii) each option to purchase shares of Old BIO-key's Common Stock granted by Old BIO-key under any warrant, stock option plan or similar plan of Old BIO-key outstanding immediately before the Reincorporation was, by virtue of the Merger Agreement and without any action on the part of the holder thereof, converted into and become an option to purchase, upon the same terms and conditions, the same number of shares of the Company's Common Stock at an exercise price per share equal to the exercise price per share thereunder immediately before the Reincorporation; and (iv) each warrant, option or stock option plan of Old BIO-key was assumed by, and continues to be, a warrant, option or plan of the Company. Accordingly, as a result of the Reincorporation, the shareholders of Old BIO-key became shareholders of the Company, and Old BIO-key has been merged out of existence by operation of law. Each certificate representing shares of capital stock of Old BIO-key outstanding immediately before the Reincorporation will, from and after the Reincorporation, be deemed for all corporate purposes to represent the same number of shares of capital stock of the Company.
In accordance with Rule 414(d) under the Securities Act, the Company, as successor issuer to Old BIO-key, has expressly adopted this Registration Statement as its own for all purposes under the Securities Act and the Securities Exchange Act of 1934. The Registration Statement shall hereafter be deemed to relate to that number of shares of the Company's Common Stock to which this Registration Statement originally related.
About BIO-key International, Inc.
BIO-key International, Inc., a Delaware corporation (the "Company," "BIO-key," "we," or "us), was founded in 1993 to develop and market proprietary biometric technology and software solutions. Biometric technology is the science of analyzing specific human characteristics which are unique to each individual in order to identify a specific person from a broader population.
On March 30, 2004, BIO-key acquired Public Safety Group, Inc. (PSG), a privately held company that is a leader in wireless solutions for law enforcement and public safety markets. PSG's primary technology is PocketCop™, a handheld solution that provides mobile officers, such as detectives who are not typically in their vehicles, a hand-held mobile information software solution.
On September 30, 2004, BIO-key completed a transaction with Aether Systems, Inc. to purchase its Mobile Government Division ("Mobile Government" or "AMG"), a leading provider of wireless data solutions for use by public safety organizations, primarily state, local police, fire and rescue and emergency medical services organizations. The PacketCluster mobile information software is integrated with 50 separate State/NCIC databases, as well as other state, local and federal databases. Its open
architecture and its published Application Programming Interface (API) make it easy to interface with a wide range of information sources. PacketCluster products deliver real-time information in seconds, freeing dispatchers to handle more pressing emergencies.
Effective January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key"), reincorporated in the State of Delware. The reincorporation was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement") whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to reincorporate in the State of Delaware (the "Reincorporation"). As a result of the Reincorporation, the legal domicile of the Company is now Delaware.
Pursuant to the Merger Agreement, at the effective time of the Reincorporation: (i) each outstanding share of Common Stock of Old BIO-key, $0.01 par value per share, was automatically converted into one share of Common Stock, $0.0001 par value per share, of the Company; (ii) each outstanding share of Series C 7% Convertible Preferred Stock of Old BIO-key, $0.01 par value per share, was automatically converted into one share of Series A 7% Convertible Preferred Stock, $0.0001 par value per share, of the Company, with such Series A 7% Convertible Preferred Stock containing substantially identical terms and conditions as the Series C 7% Convertible Preferred Stock of Old BIO-key; (iii) each option to purchase shares of Old BIO-key's Common Stock granted by Old BIO-key under any warrant, stock option plan or similar plan of Old BIO-key outstanding immediately before the Reincorporation was, by virtue of the Merger Agreement and without any action on the part of the holder thereof, converted into and become an option to purchase, upon the same terms and conditions, the same number of shares of the Company's Common Stock at an exercise price per share equal to the exercise price per share thereunder immediately before the Reincorporation; and (iv) each warrant, option or stock option plan of Old BIO-key was assumed by, and continues to be, a warrant, option or plan of the Company. Accordingly, as a result of the Reincorporation, the shareholders of Old BIO-key became shareholders of the Company, and Old BIO-key has been merged out of existence by operation of law. Each certificate representing shares of capital stock of Old BIO-key outstanding immediately before the Reincorporation, is deemed from and after the Reincorporation for all corporate purposes to represent the same number of shares of capital stock of the Company.
As a result of these recent mergers, and as discussed in Note M to the Consolidated Financial Statements included in this prospectus, we have organized the Company into three reporting segments: Law Enforcement, Fire Safety and Biometrics. During 2005, the Company continued to integrate the products, operations and technologies acquired from Public Safety Group, Inc. and Aether Systems, Inc.
We have evolved from a development stage company to a revenue generating company, but we have sustained substantial losses to date. 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) provide working capital. Due to, among other factors, our history of losses and limited revenue, our independent auditors have included an explanatory paragraph in their opinion for the year ended December 31, 2005 as to the substantial doubt about our ability to continue as a going concern. Our long-term viability and growth will depend upon the successful commercialization of our technologies and our ability to obtain adequate financing. To the extent that we require such additional financing, 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.
Our principal executive offices are located at 3349 Highway 138, Building D, Suite B, Wall, NJ 07719 and our telephone number is (732) 359-1100.
About the Offering
This prospectus covers the public sale of up to 15,755,500 shares of our common stock to be sold by the selling security holders identified herein. Of this amount, 2,422,108 shares were issued to certain of the selling security holders in connection with our acquisition on March 30, 2004 of PSG, a privately-held company providing wireless solutions for law enforcement and public safety markets. This acquisition was accomplished through the exchange of 2,416,108 shares of our common stock, in addition to cash and our assumption of certain indebtedness of PSG, for all of the outstanding capital stock of PSG. We also issued 6,000 shares of our common stock in connection with this acquisition to Harward Investments, Inc. ("Harward") pursuant to an arrangement involving the discharge of certain prior debt obligations of PSG to Harward. Following the acquisition, PSG became a wholly-owned subsidiary of the Company.
The 2,416,108 shares of our common stock issued to the former PSG shareholders (the "Merger Shares") are subject to escrow provisions contained in the agreement and plan of merger and a related escrow agreement, which provide for periodic releases of such shares from escrow. One-twelfth (1/12) of the Merger Shares (the "Initial Shares") will be released from the escrow upon the effectiveness of this registration statement to Harward and the former shareholders of PSG. Specifically, Harward will receive an amount of Initial Shares that is equal to $110,000 divided by the closing price of our common stock as reported by the OTC Bulletin Board on such date, and the balance of the Initial Shares will be concurrently released to the former shareholders of PSG. An additional one-twelfth (1/12) of the Merger Shares will be released from the escrow to the former shareholders of PSG on each of June 30, 2004, September 30, 2004 and December 31, 2004. The remaining eight-twelfths (8/12) of the Merger Shares (the "Remaining Shares") will be released from the escrow to the former shareholders of PSG according to the following distribution schedule determined by the license, service and maintenance fee revenue achieved by the Company's Public Safety Division during fiscal year 2004: (i) in the event that such qualifying revenue is less than $2 million, one-twelfth (1/12) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006, December 31, 2006, March 31, 2007, June 30, 2007, September 30, 2007 and December 31, 2007; (ii) in the event that such qualifying revenue is equal to or greater than $2 million, one-eighth (1/8) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006; and (iii) in the event that such qualifying revenue is equal to or greater than $6 million, one-sixth (1/6) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006 and June 30, 2006.
8,888,928 shares of our common stock covered by this prospectus were issued on March 31, 2004 in a private placement transaction to certain institutional and accredited investors pursuant to a securities purchase agreement by and among the Company and such investors. The remaining 4,444,464 shares of our common stock covered by this prospectus are issuable upon the exercise of warrants issued to the investors pursuant to such securities purchase agreement. The aggregate purchase price paid by the investors for the securities issued in such private placement was approximately $12,000,000.
An investment in our common stock involves a high degree of risk. You should carefully consider the following information about certain of the risks of investing in our common stock, together with other information contained in this prospectus, before you decide to purchase our common stock.
Business and Financial Risks
Based on our lack of significant revenue since inception and recurring losses from operations, our auditors have included an explanatory paragraph in their opinion as to the substantial doubt about our ability to continue as a going concern.
Due to, among other factors, our history of losses (excluding gains from valuation changes in embedded derivatives) and limited revenue, our independent auditors have included an explanatory paragraph in their opinion for the year ended December 31, 2005 as to the substantial doubt about our ability to continue as a going concern. Our financial statements have been prepared in accordance with accounting principals generally accepted in the United States, which contemplate that we will continue to operate as a going concern. Our financial statements do not contain any adjustments that might result if we are unable to continue as a going concern.
Since our formation, we have historically generated minimal revenue and have sustained substantial operating losses.
As of June 30, 2006, we had negative working capital of approximately $11,268,000 and an accumulated deficit of approximately $47,757,000. Since our inception, we have focused almost exclusively on developing our core technologies and, until the fourth quarter of 2004 have not generated any significant revenue. In order to increase revenue, we have developed a direct sales force and anticipate the need to retain additional sales, marketing and technical support personnel and may need to incur substantial expenses. We cannot assure you that we will be able to secure these necessary resources, that a significant market for our technologies will develop or that we will be able to achieve our targeted revenue.
We have identified material weaknesses in our internal control over financial reporting and have failed to maintain an effective system of disclosure controls and procedures. If we are unable to successfully address such material weaknesses or if we continue to maintain an ineffective system of disclosure controls and procedures, our financial statements may not accurately reflect the financial condition of the Company, current and potential future investors may not be able to rely upon our financial statements and those investors may lose confidence in our financial reporting; this would harm our business and the trading price of our common stock.
After a review of our March 31, 2005, June 30, 2005, September 30, 2005, March 31, 2006 and June 30, 2006 quarterly operating results, as well as our 2005 annual operating results, conducted pursuant to Rules 13a-15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), our Chief Executive Officers and Chief Financial Officer ("CFO") have determined that, as of each such date, our disclosure controls and procedures were not effective to provide reasonable assurance that information that we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission rules and forms. Our management reached this conclusion after identifying our system to capture disclosure items, our internal process of review for account reconciliations, our documentation of internal controls and our internal process for preparing our annual report on Form 10-KSB for the fiscal year ended December 31, 2005 as being inadequate to provide such assistance.
In order to ensure that the Company adequately addresses all existing internal control issues, the Company initiated follow-up discussions with its former auditors to better determine what constituted these material weaknesses. During these discussions, the auditors and the Company identified the following weaknesses in the Company's internal controls: an inadequate system to capture disclosure items, an inadequate internal process of review for account reconciliations, an inadequate documentation of internal controls and an inadequate internal process around drafting of periodic filings with the Securities and Exchange Commission.
Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. We have in the past discovered, as described above, and may in the future discover, areas of our disclosure and internal controls that need improvement. We are in the process of addressing these issues to ensure that our internal control over financial reporting and disclosure controls and procedures are improved so as to provide reasonable assurance that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange rules and forms. If, however, we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed.
We cannot be certain that our efforts to improve the material weaknesses in our internal control over financial reporting and the ineffectiveness of our disclosure controls and procedures will be successful or that we will be able to maintain adequate controls over our financial processes and reporting in the future. We will need to commit substantial resources, including substantial time from our management team's accounting personnel and from external consultants, to implement and integrate into our organization improved disclosure controls and additional procedures generally and to improve systems to report financial information on a timely basis. Any failure or delay to develop or maintain effective controls, or difficulties encountered in their implementation or in other effective improvement of our internal and disclosure controls could materially harm our operating results or cause us to fail to meet our reporting obligations. If we are unable to adequately establish or improve our internal controls over financial reporting or if we continue to maintain an ineffective system of disclosure controls and procedures, our financial statements may not accurately reflect the financial condition of the Company, and current and potential future investors may not be able to rely upon our financial statements. Additionally, our external auditors may not be able to issue an unqualified opinion on the effectiveness of our internal controls. Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely have a significant negative effect on the trading price of our securities.
Our biometric technology has yet to gain widespread market acceptance and we do not know how large of a market will develop for our technology.
Biometric technology has received only limited market acceptance, particularly in the private sector. Our technology represents a novel security solution and we have not yet generated significant sales. Although recent security concerns relating to identification of individuals has increased interest in biometrics generally, it remains an undeveloped, evolving market. Biometric based solutions compete with more traditional security methods including keys, cards, personal identification numbers and security personnel. Acceptance of biometrics as an alternative to such traditional methods depends upon a number of factors including:
the reliability of biometric solutions;
public perception regarding privacy concerns;
costs involved in adopting and integrating biometric solutions.
For these reasons, we are uncertain whether our biometric technology will gain widespread acceptance in any commercial markets or that demand will be sufficient to create a market large enough to produce significant revenue or earnings. Our future success depends, in part, upon business customers adopting biometrics generally, and our solution specifically.
Biometric technology is a new approach to Internet security which must be accepted in order for our WEB-key® solution to generate significant revenue.
Our WEB-key® authentication initiative represents a new approach to Internet security which has been adopted on a limited basis by companies which distribute goods, content or software applications over the Internet. The implementation of our WEB-key® solution requires the distribution and use of a finger scanning device and integration of database and server side software. Although we believe our solutions provides a higher level of security for information transmitted over the Internet than existing traditional methods, unless business and consumer markets embrace the use of a scanning device and believe the benefits of increased accuracy outweigh implementation costs, our solution will not gain market acceptance.
Our software products may contain defects which will make it more difficult for us to establish and maintain customers.
Although we have completed the development of our core biometric technology, it has only been used by a limited number of business customers. Despite extensive testing during development, our software may contain undetected design faults and software errors, or "bugs" that are discovered only after it has been installed and used by a greater number of customers. Any such default or error in new or existing software or applications could cause delays in delivering our technology or require design modifications. These could adversely affect our competitive position and cause us to lose potential customers or opportunities. Since our technologies are intended to be utilized to secure physical and electronic access, the effect of any such bugs or delays will likely have a detrimental impact on us. In addition, given that biometric technology generally, and our biometric technology specifically, has yet to gain widespread acceptance in the market, any delays would likely have a more detrimental impact on our business than if we were a more established company.
While we have commenced a significant sales and marketing effort, we have only begun to develop a significant distribution channel and may not have the resources or ability to sustain these efforts or generate any meaningful sales.
In order to generate revenue from our biometric products, we are dependent upon independent original equipment manufacturers, system integrators and application developers, which we do not control. As a result, it may be more difficult to generate sales.
We market our technology through licensing arrangements with:
Original equipment manufacturers, system integrators and application developers which develop and market products and applications which can then be sold to end users;
Companies which distribute goods, services or software applications over the Internet.
As a technology licensing company, our success will depend upon the ability of these manufacturers and developers to effectively integrate our technology into products and services which they market and sell. We have no control over these licensees and cannot assure you that they have the financial, marketing or technical resources to successfully develop and distribute products or applications acceptable to end users or generate any meaningful revenue for us. These third parties may also offer the products of our competitors to end users.
We derive nearly all of our revenue from government contracts, which are often non-standard, involve competitive bidding, may be subject to cancellation with or without penalty and may produce volatility in earnings and revenue.
Most of our business involves providing products and services under contracts with U.S. federal, state and local government agencies. Obtaining contracts from government agencies is challenging, and government contracts often include provisions that are not standard in private commercial transactions. For example, government contracts may:
include provisions that allow the government agency to terminate the contract without penalty under some circumstances;
be subject to purchasing decisions of agencies that are subject to political influence;
contain onerous procurement procedures; and
be subject to cancellation if government funding becomes unavailable.
Securing government contracts can be a protracted process involving competitive bidding. In many cases, unsuccessful bidders may challenge contract awards, which can lead to increased costs, delays and possible loss of the contract for the winning bidder.
We face intense competition and may not have the financial and human resources necessary to keep up with rapid technological changes, which may result in our technology becoming obsolete.
The Internet, facility access control and information security markets are subject to rapid technological change and intense competition. We compete with both established biometric companies and a significant number of startup enterprises as well as providers of more traditional methods of access control. Most of our competitors have substantially greater financial and marketing resources than we do and may independently develop superior technologies, which may result in our technology becoming less competitive or obsolete. We may not be able to keep pace with this change. If we are unable to develop new applications or enhance our existing technology in a timely manner in response to technological changes, we will be unable to compete in our chosen markets. In addition, if one or more other biometric technologies such as voice, face, iris, hand geometry or blood vessel recognition are widely adopted, it would significantly reduce the potential market for our fingerprint identification technology.
We depend on key employees and members of our management team, including our Chairman of the Board and Co-Chief Executive Officer, in order to achieve our goals. We cannot assure you that we will be able to retain or attract such persons.
A loss of our current Chairman of the Board of Directors or Chief Executive Officer could severely and negatively impact our operations. We have an employment contract with Michael W. DePasquale, our Chief Executive Officer, through March 28, 2008. Although the contract does not prevent him from resigning, it does contain confidentiality and non-compete clauses which are intended to prevent him from working for a competitor within one year after leaving our Company. Our success depends on our ability to attract, train and retain employees with expertise in developing, marketing and selling software solutions. In order to successfully market our technology, we will need to retain additional engineering, technical support and marketing personnel. The market for such persons remains highly competitive and our limited financial resources will make it more difficult for us to recruit and retain qualified persons.
We cannot assure you that the limited intellectual property protection for our core technology provides a meaningful competitive advantage or barrier to entry against our competitors.
Our success and ability to compete is dependent in part upon proprietary rights to our technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets and technical measures to protect our propriety rights. We have filed a patent application relating to both the optic technology and biometrics solution components of our technology wherein several claims have been allowed. In May 2005, the U.S. Patent Office issued us a patent for our Vector Segment fingerprint technology (VST), BIO-key's core biometric analysis and identification technology. We cannot assure you that any additional patents will be issued, or that, if issued, we will have the resources to protect any patent from infringement. Although we believe our technology does not currently infringe upon patents held by others, we cannot assure you that such infringements do not exist or will not exist in the future, particularly as the number of products and competitors in the biometric industry segment grows.
We may need to obtain additional financing to execute our business plan, which may not be available. If we are unable to raise additional capital or generate significant revenue, we may not be able to continue operations.
Since our inception, we have not generated any significant revenue (other than revenue from acquired businesses) and have experienced substantial losses, including approximately $12,828,000 during 2005, excluding the impact related to embedded derivative and warrant fair value adjustments. In March 2004, we completed a private placement equity offering that resulted in approximately $12,000,000 in gross proceeds to the Company and a private placement convertible debt offering in September 2004 that resulted in approximately $10,000,000 in gross proceeds to the Company (a portion of which was used to finance the acquisition of Aether Mobile Government). In June 2005, we raised approximately $5,000,000 in gross proceeds through a private placement convertible debt offering, in January 2006 we received approximately $1,000,000 in another private placement convertible debt offering, and in August 2006 we raised approximately $2,000,000 in gross proceeds through a private issuance of equity securities, of which $1,500,000 was received in cash, and $500,000 was paid in declared and unpaid dividends. To the extent that we will require additional capital to support our operations, expand our marketing and sales efforts and to execute our business plan to substantially increase revenue, we may need to obtain additional financing through the issuance of debt or equity securities. Our long-term viability and growth will depend upon the successful commercialization of our technologies and our ability to obtain adequate financing. We have not and cannot assure you that we will ever be able to secure any such financing on terms acceptable to us. If we cannot obtain such financing or generate such revenues, we may not be able to execute our business plan or continue operations.
We may not be able to successfully complete the integration of PSG and AMG into our operations.
The integration of PSG and AMG into our operations involves a number of risks, including:
difficulty integrating operations and personnel;
diversion of management attention;
potential disruption of ongoing business;
inability to retain key personnel;
inability to successfully incorporate the acquired products and services into our product and service offerings and to develop new products and services; and
impairment of relationships with employees, customers or vendors.
Failure to overcome these risks or any other problems encountered in connection with the acquisitions of PSG and AMG could slow our growth or lower the quality of our services, which could reduce customer demand. The result could be a material adverse effect on our financial position and results of operations.
We may not achieve profitability with respect to the law enforcement and public safety components of our business if we are unable to maintain, improve and develop the wireless data services we offer.
We believe that our future business prospects depend in part on our ability to maintain and improve our current services and to develop new ones on a timely basis. Our services will have to achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements. As a result of the complexities inherent in our service offerings, major new wireless data services and service enhancements require long development and testing periods. We may experience difficulties that could delay or prevent the successful development, introduction or marketing of new services and service enhancements. Additionally, our new services and service enhancements may not achieve market acceptance. If we cannot effectively develop and improve services we may not be able to recover our fixed costs or otherwise become profitable.
Our law enforcement and public safety division depends upon wireless networks owned and controlled by others.
If we do not have continued access to sufficient capacity on reliable networks, we may be unable to deliver services and our sales could decrease. Our ability to grow and achieve profitability partly depends on our ability to buy sufficient capacity on the networks of wireless carriers such as Verizon Wireless, Bell South Corporation, Metrocall, Motient and AT&T Wireless and on the reliability and security of their systems. All of our services are delivered using airtime purchased from third parties. We depend on these companies to provide uninterrupted and bug free service and would not be able to satisfy our customers' needs if they failed to provide the required capacity or needed level of service. In addition, our expenses would increase and our profitability could be materially adversely affected if wireless carriers were to increase the prices of their services. Our existing agreements with the wireless carriers generally have one-year terms. Some of these wireless carriers are, or could become, our competitors and if they compete with us they may refuse to provide us with their services.
New laws and regulations that impact our law enforcement and public safety division could increase our costs or reduce our opportunities to earn revenue.
We are not currently subject to direct regulation by the Federal Communications Commission or any other governmental agency, other than regulations applicable to businesses in general. However, in the future, we may become subject to regulation by the FCC or another regulatory agency. In addition, the wireless carriers who supply us airtime and certain of our hardware suppliers are subject to regulation by the FCC and regulations that affect them could increase our costs or reduce our ability to continue selling and supporting our services.
If we fail to adequately manage our resources, it could have a severe negative impact on our financial results or stock price.
We could be subject to fluctuations in technology spending by existing and potential customers. Accordingly, we will have to actively manage expenses in a rapidly changing economic environment. This could require reducing costs during economic downturns and selectively growing in periods of economic expansion. If we do not properly manage our resources in response to these conditions, our results of operations could be negatively impacted.
We granted a blanket security interest in all of our assets to the holders of our secured debt. If we are unable to make our required monthly payments on such debt, or any other event of default occurs, it could have a material adverse effect on our business and operations, and the debt holders may foreclose on our assets.
As part of our secured convertible debt financing transactions, we granted to Laurus Master Fund, Ltd. and another holder of such secured debt a blanket security interest in all of our assets, including assets of our subsidiary. See the "Management's Discussion and Analysis or Plan of Operation" section of this report. In the event we default in payment on such debt, or any other event of default occurs under the relevant financing documents, and the default is not cured, 120% of the outstanding principal amount of the secured notes, plus accrued interest and fees will accelerate and be due and payable in full. See the "Long Term Obligations" footnote to this prospectus for a list of such potential events of default.
The cash required to pay such accelerated amounts on the secured notes following an event of default would most likely come out of our working capital. As we rely on our working capital for our day to day operations, such a default could have a material adverse effect on our business, operating results, or financial condition to such extent that we are forced to restructure, file for bankruptcy, sell assets or cease operations. In addition, upon an event of default, the holder of the secured debt could foreclose on our assets or exercise any other remedies available to them. If our assets were foreclosed upon, we were forced to file for bankruptcy or cease operations; stockholders may not receive any proceeds from disposition of our assets and may lose their entire investment in our stock.
Our obligations under our debt securities may adversely affect our ability to enter into potential significant transactions with other parties.
As a result of our debt financing transactions with Laurus Master Fund, Ltd., the Shaar Fund, Ltd. and other institutional and accredited investors, we incurred significant repayment obligations, and we agreed to certain restrictive covenants. In particular, for so long as 25% of the aggregate principal amount of the convertible term notes remains outstanding, we will need the consent of the holders of such notes before we can take certain actions, including the following:
pay any dividends;
merge, effect a material reorganization, liquidate or dissolve;
materially change the scope of our business; or
create, incur or assume any debt (other than certain trade debt, equipment financings and debt for the purchase of assets in the ordinary course of business).
Accordingly, unless we obtain the noteholders' consent, we may not be able to enter into certain transactions. In addition, in connection with any potential significant transaction (such as a merger, sale of substantially all our assets, joint venture, or similar transaction), it is likely that we would have to pay off such debt obligations and have the applicable security interests released. Although we have the right at any time to prepay our debt obligations, we can only do so upon payment of either 110% or 120% of the then principal balance, plus all other amounts owing under the notes. See the "Long Term Obligations" footnote of this prospectus. Based on an aggregate principal balance of $4.8 million at August 10, 2006, a complete prepayment would require a cash payment of approximately $5.3 million. These provisions could have the practical effect of increasing the costs of any potential significant transaction, and restrict our ability to enter into any such transaction.
Our obligations to the holders of our outstanding preferred stock may further affect our ability to enter into potential significant transactions with other parties.
We will need to obtain the consent of the holders of a majority of the then outstanding shares of our convertible preferred stock before we can take certain actions, including the following:
a sale or other disposition of any material assets;
an acquisition of a material amount of assets;
engaging in a merger, reorganization or consolidation; or
incur or guaranty any indebtedness in excess of $50,000.
Accordingly, unless we obtain such consent, we may not be able to enter into certain transactions.
Risks Related To Our Common Stock
We have issued a substantial number of securities that are convertible into shares of our common stock which will result in substantial dilution to the ownership interests of our existing shareholders.
As of August 10, 2006, approximately 56,179,800 shares of our common stock were reserved for issuance upon exercise or conversion of the following securities (at conversion prices applicable as at August 10, 2006):
9,636,400 shares upon conversion of outstanding convertible term notes;
22,224,400 shares upon exercise of outstanding stock options and warrants;
2,031,000 shares upon exercise of options available for future grant under our existing option plans; and
22,288,000 shares or more upon conversion of our outstanding shares of Convertible Preferred Stock and cumulative dividends in arrears.
The exercise or conversion of these securities will result in a significant increase in the number of outstanding shares and substantially dilute the ownership interests of our existing shareholders.
A substantial number of our convertible securities are convertible into shares of common stock at a conversion price of $.50 per share. Most of these shares are eligible for public resale. The trading price of our common stock and our ability to raise additional financing may be adversely affected by the influx into the market of such a substantial number of shares.
Our outstanding Series A Convertible Preferred Stock and cumulative dividends in arrears are convertible into 8,299,424 shares of common stock as of August 10, 2006 at a per share conversion price of $.50. Although many of the shares issuable upon conversion of our Series A Convertible Preferred Stock are eligible for public resale under Securities Exchange Commission Rule 144, we agreed to file a registration statement to cover the public resale of all of these shares. This significant increase in the number of shares available for public sale may have a negative impact on the trading price of our shares and substantially dilute the ownership interests of our existing shareholders. In the event that our stock trades below $.50 per share, in order to raise additional financing we would likely be required to issue additional shares of common stock or securities convertible into common stock at a purchase or conversion price, as applicable, of less than $.50 per share. Any issuance of shares at a purchase price of less than $.50 per share would reduce the conversion price of our Series A Convertible Preferred Shares to such lower price. This would require us to issue additional shares upon conversion of our Series A Shares and further dilute the ownership interests of our existing shareholders. To the extent these factors are viewed negatively by the market, it may provide an
incentive for persons to execute short sales of our common stock that could adversely affect the trading price of our common stock.
In January 2006, the Company issued Convertible Term Notes in the aggregate principal amount of $1,000,000 to certain investors. The Convertible Notes subsequently converted into 1,000,000 shares of Series B Convertible Preferred Stock of the Company, which shares and cumulative dividends are convertible into shares of the Common Stock of the Company at a fixed conversion of $0.50 per share for an aggregate amount of 2,147,945 shares as at August 10, 2006. Although many of the shares issuable upon conversion of our Series B Convertible Preferred Stock are eligible for public resale under Securities Exchange Commission Rule 144, we agreed to file a registration statement to cover the public resale of all of these shares. This significant increase in the number of shares available for public sale may have a negative impact on the trading price of our shares and substantially dilute the ownership interests of our existing shareholders. In the event that our stock trades below $.50 per share, in order to raise additional financing we would likely be required to issue additional shares of common stock or securities convertible into common stock at a purchase or conversion price, as applicable, of less than $.50 per share. Any issuance of shares at a purchase price of less than $.50 per share would reduce the conversion price of our Series B Convertible Preferred Shares to such lower price. This would require us to issue additional shares upon conversion of our Series B Shares and further dilute the ownership interests of our existing shareholders. To the extent these factors are viewed negatively by the market, it may provide an incentive for persons to execute short sales of our common stock that could adversely affect the trading price of our common stock.
In August 2006, certain subordinated term notes were exchanged for shares of Series C Convertible Preferred Stock of the Company, which shares and cumulative dividends are convertible into shares of the Common Stock of the Company at an initial fixed conversion of $0.50 per share for an aggregate amount of 11,840,640 shares as at August 10, 2006. Although many of the shares issuable upon conversion of our Series C Convertible Preferred Stock are eligible for public resale under Securities Exchange Commission Rule 144, we agreed to file a registration statement to cover the public resale of all of these shares. This significant increase in the number of shares available for public sale may have a negative impact on the trading price of our shares and substantially dilute the ownership interests of our existing shareholders. In the event that our stock trades below $.50 per share, in order to raise additional financing we would likely be required to issue additional shares of common stock or securities convertible into common stock at a purchase or conversion price, as applicable, of less than $.50 per share. Any issuance of shares at a purchase price of less than $.50 per share would reduce the conversion price of our Series C Convertible Preferred Shares to such lower price. This would require us to issue additional shares upon conversion of our Series C Shares and further dilute the ownership interests of our existing shareholders. To the extent these factors are viewed negatively by the market, it may provide an incentive for persons to execute short sales of our common stock that could adversely affect the trading price of our common stock.
Applicable SEC Rules governing the trading of "penny stocks" limits the trading and liquidity of our common stock, which may affect the trading price of our common stock.
Our common stock currently trades on the OTC Bulletin Board. Since our common stock continues to trade below $5.00 per share, our common stock is considered a "penny stock" and is subject to SEC rules and regulations, which impose limitations upon the manner in which our shares can be publicly traded. These regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser's written agreement to a transaction prior to
sale. These regulations have the effect of limiting the trading activity of our common stock and reducing the liquidity of an investment in our common stock.
We do not intend to pay dividends in the foreseeable future.
We have never declared or paid a dividend on our common stock. In addition, the terms of our outstanding Convertible Preferred Shares preclude us from declaring or paying a dividend on our common stock unless a dividend is also declared or paid, as applicable, on our Convertible Preferred Shares. We intend to retain earnings, if any, for use in the operation and expansion of our business and, therefore, do not anticipate paying any dividends on our common stock in the foreseeable future.
The trading price of our common stock may be volatile.
The trading price of our shares has from time to time fluctuated widely and in the future may be subject to similar fluctuations. The trading price may be affected by a number of factors including the risk factors set forth in this prospectus as well as our operating results, financial condition, announcements of innovations or new products by us or our competitors, general conditions in the biometrics and access control industries, and other events or factors. Although we believe that approximately 15 registered broker dealers currently make a market in our common stock, we can not assure you that any of these firms will continue to serve as market makers or have the financial capability to stabilize or support our common stock. A reduction in the number of market makers or the financial capability of any of these market makers could also result in a decrease in the trading volume of and price of our shares. In recent years broad stock market indices, in general, and the securities of technology companies, in particular, have experienced substantial price fluctuations. Such broad market fluctuations may adversely affect the future-trading price of our common stock.
Selling security holders intend to sell their shares of common stock in the market, which sales may cause our stock price to decline.
The selling stockholders named in this prospectus intend to sell in the public market 15,755,500 shares of our common stock being registered in that offering. That means that up to 15,755,500 shares may be sold pursuant to this registration statement. Such sales may cause our stock price to decline. Our officers and directors and those shareholders who are significant shareholders as defined by the Securities and Exchange Commission will continue to be subject to the provisions of various insider trading and Rule 144 regulations.
All statements other than statements of historical facts contained in this prospectus, 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 due to a number of factors. Many of these factors are set forth in the "RISK FACTORS" section of this prospectus. Actual results may differ materially from the forward-looking statements contained in this prospectus. 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.
The shares are being registered hereunder for resale by the selling security holders. We will not receive any proceeds from the sale of the shares by the selling security holders. We will receive the proceeds from the exercise price of certain warrants held by certain of the selling security holders to the extent such warrants are exercised. We expect to use the proceeds of any such sales for general working capital purposes.
MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Our common stock currently trades on the OTC Bulletin Board under the symbol "BKYI". The following table sets forth the range of high and low bid prices per share of our common stock for each of the calendar quarters identified below as reported by the OTC Bulletin Board. These quotations represent inter-dealer prices, without retail mark-up, markdown or commission, and may not represent actual transactions.
Quarter ended September 30, 2006 $ 0.49 $ 0.39
Quarter ended June 30, 2006 0.67 0.40
Quarter ended March 31, 2006 0.94 0.58
Quarter ended December 31, 2005 $ 0.81 $ 0.50
Quarter ended September 30, 2005 1.21 0.74
The last price of our common stock as reported on the OTC Bulletin Board on November 1, 2006 was $0.48 per share.
As of September 5, 2006, the number of stockholders of record of our common stock was 192. Based on broker inquiry conducted in connection with the distribution of proxy solicitation materials in connection with the Company's special meeting of shareholders in February 2006, we believe that there are approximately 4,816 beneficial owners of our common stock.
We have not paid any cash dividends on our common stock to date, and have no intention of paying any cash dividends on our common stock in the foreseeable future. The terms of our outstanding Convertible Preferred Stock preclude us from declaring or paying a dividend on our common stock unless a dividend is also declared or paid, as applicable, on our Convertible Preferred Stock. The declaration and payment of dividends on our common stock is also subject to the discretion of our Board of Directors and certain limitations imposed under the Delaware General Corporation Law. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors.
This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this prospectus contain forward-looking statements that involve risks and uncertainties. All forward-looking statements included in this prospectus are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth in the section captioned "RISK FACTORS" and elsewhere in this prospectus. The following should be read in conjunction with our audited financial statements included elsewhere herein.
The following Management's Discussion and Analysis or Plan of Operation ("MD&A") is intended to help you understand BIO-key International (the "Company," "we," "us" or "our"). MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes. The results included in this MD&A have been restated. Our MD&A includes the following sections:
OVERVIEW provides a description of our business, the major items that affected our business, and how we analyze our business. It then provides an analysis of our overall 2005 performance and a description of the significant events impacting 2005 and thereafter.
RESULTS OF OPERATIONS provides an analysis of the consolidated and segment results of operations for 2005 compared to 2004 and 2004 compared to 2003. It also includes an analysis of the consolidated and segment results of operations for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005.
LIQUIDITY AND CAPITAL RESOURCES provides an overview of our cash flows, financing, contractual obligations and embedded derivatives activities.
RESTATEMENT provides a description and reconciliation of the restatement. For additional information, see Item 8, Financial Statements and Supplementary Data, Note B, Restatement of Previously Issued Financial Statements.
CRITICAL ACCOUNTING POLICIES provides a discussion of our accounting policies that require critical judgment, assumptions and estimates.
OTHER MATTERS provides a discussion of our significant non-operational items which impact our financial statements, such as the SEC comment letter.
RECENT ACCOUNTING STANDARDS by reference to Note 1 to the Consolidated Financial Statements provides a description of accounting standards which we have not yet been required to implement and may be applicable to our operations, as well as those significant accounting standards which were adopted during 2005.
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 beyond 2006.
On March 30, 2004, we acquired all of the outstanding capital stock of Public Safety Group, Inc., a privately-held provider of wireless solutions for law enforcement and public safety markets based in Winter Park, Florida, in exchange for an aggregate of 2,422,108 shares of our common stock, $500,000 in cash, and our assumption of $600,000 in aggregate net liabilities of PSG. The acquisition was completed pursuant to the terms of an agreement and plan of merger 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.
On September 30, 2004, we completed our acquisition of the Mobile Government Division from Aether Systems Inc. Pursuant to the Asset Purchase Agreement dated as of August 16, 2004 by and among the Company, Aether, Cerulean Technology, Inc. and SunPro, Inc., the Company paid Aether a purchase price of $10,000,000 in cash, subject to post-closing adjustments to reflect changes in Aether Mobile Government's working capital and cash flows since June 30, 2004. Post-closing working capital adjustments resulted in an additional payment by the Company of $341,878 in December 2004. In connection with this acquisition, the Company issued a subordinated secured promissory note to Aether in the face amount of $6,884,588 (the "Aether Note"). 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 acquisition. The Company's obligations under the Aether Note are secured by a security interest granted to Aether in all or substantially all of the Company's assets, subordinate to the security interest described in the "Long-Term Obligations" footnote to this annual report.
Aether Mobile Government provides wireless data solutions for use by public safety organizations, primarily state and local police, fire and rescue and emergency medical services organizations that enable such organizations to access law enforcement databases to validate identities and obtain suspect information. Its public safety solutions are integrated into fifty (50) different state databases, as well as local and federal databases, and its products deliver real-time information in seconds, without the need for human dispatchers or other resources.
YEARS ENDED DECEMBER 31, 2005 AS COMPARED TO DECEMBER 31, 2004 AND DECEMBER 31, 2004 AS COMPARED TO DECEMBER 31, 2003
During 2005, the Company continued to integrate the products, operations and technology of the Mobile Government business, acquired from Aether Systems in September 2004, in an effort to leverage new business opportunities. Our financial objective is to increase revenue, manage expenses and attain profitability. While total expenses have increased in dollars, they have declined as a
percentage of revenue in 2005 and 2004. 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 in 2006 as the General Managers develop their organizations. A detailed analysis of each segment can be found below.
Consolidated Results of Operations
Three Year % trend
Years ended December 31,
(Restated)
Services 76 % 59 % 5 %
License fees and other 24 % 41 % 95 %
100 % 100 % 100 %
Costs and other expenses
Cost of license fees and other 7 % 16 % 41 %
Selling, general and administrative 83 % 124 % 975 %
Research, development and engineering 48 % 52 % 481 %
158 % 213 % 1498 %
Operating loss -58 % -113 % -1398 %
Other income (deductions)
Total other income (deductions) -32 % -77 % -486 %
NET INCOME (LOSS) -26 % -190 % -1884 %
As discussed in Note M to the Consolidated Financial Statements, we have three reporting segments: Law Enforcement, Fire Safety and Biometrics. The Law Enforcement and Fire Safety segments were purchased during 2004. As noted earlier, 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 have been estimated.
The Company evaluates performance and allocates resources 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 the segments revenues. 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.
$ Chg
Restated
Service $ 7,886,000 $ 2,562,136 $ — $ 5,323,863 208 % $ 2,562,136 n/a
License & other 2,638,938 1,920,642 — 718,297 37 % 1,920,642 n/a
10,524,938 4,482,778 — 6,042,160 135 % 4,482,778 n/a
Service 2,814,616 693,967 — 2,120,649 306 % 693,967 n/a
License & other 406,470 187,229 — 219,241 117 % 187,229 n/a
3,221,086 881,196 — 2,339,890 266 % 881,196 n/a
Service 161,033 95,303 10,694 65,730 69 % 84,609 791 %
License & other 319,038 261,674 204,787 57,364 22 % 56,887 28 %
480,071 356,977 215,481 123,094 34 % 141,496 66 %
Total Revenue $ 14,226,095 $ 5,720,951 $ 215,481 $ 8,505,144 149 % $ 5,505,470 2555 %
Service $ 2,260,845 $ 902,794 $ — $ 1,358,051 150 % $ 902,794 n/a
License & other 679,170 686,806 — (7,636 ) -1 % 686,806 n/a
2,940,015 1,589,600 — 1,350,415 85 % 1,589,600 n/a
Service 602,317 253,913 — 348,404 137 % 253,913 n/a
License & other 165,074 96,081 — 68,993 72 % 96,081 n/a
767,391 349,994 — 417,397 119 % 349,994 n/a
Service 42,980 17,617 1,694 25,363 144 % 15,923 940 %
License & other 93,247 107,009 87,387 (13,762 ) 13 % 19,622 22 %
136,227 124,626 89,081 11,601 9 % 35,545 40 %
Total COGS $ 3,843,633 $ 2,064,220 $ 89,081 $ 1,779,413 86 % $ 1,975,139 2217 %
The increase in these revenue components from 2004 is primarily attributable to the fact that the business was acquired in the third quarter of 2004. Therefore 2004 represents only one quarter of revenue, whereas 2005 reflects four quarters of revenue. The increase was partially offset with a reduction of revenues related to long-term project work, which during 2005 has diminished as a result of the Company focusing the business to more of a licensing model.
The increase in these revenue components from 2004 is primarily attributable to the fact that the business was acquired in the third quarter of 2004. Therefore 2004 represents only one quarter of revenue, whereas 2005 reflects four quarters of revenue. This was compounded by a general increase in overall revenue that can be attributed to a strengthened market presence through concerted efforts toward penetrating new markets by actively pursuing and marketing our Fire Safety products. Additionally revenue growth can be also attributable to functionality that was added across the entire
Fire Safety product suite as well as the release of new FireRMS mobile product which was released in the middle of 2005.
During 2004 and 2005 Biometric segment continues to show strong revenue growth year over year. This is reflective of continued market acceptance of the product and strategic channel relationships that have been developed. Additionally, the product has been a proven solution in the educational industry as well has shown continued commercial integration and acceptance of the product.
Costs of goods sold
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty. The slight decrease in cost is primarily driven by the sales mix and is solely dependent specifically on what products were sold.
Service costs increased primarily because of personnel related costs that have increased over the prior year primarily from the inclusion of a full year of costs as compared to only one quarter in 2004. This was offset by reductions related to a reduced concentration of project related revenues which are heavily burdened with labor costs, both employees and contracted labor. As significant project revenues declined after the first two quarters of 2005, this reduction offset the increase that would have occurred related to maintaining a full twelve months of expense.
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty. The slight increase in cost is primarily driven by the sales volume in addition to product mix. These costs are solely dependent specifically on what products were sold.
Services costs have increased over the prior year primarily from the inclusion of a full year of costs as compared to only one quarter as well as contractors and related costs that have been incurred related to project and service related revenues. There was a significant growth in service revenues for which additional outside contractors were used in providing some of those services.
License and other costs are primarily related to the hardware costs related to sales of biometric fingerprint readers. The change in cost of goods sold is directly attributable to the product mix between types of readers sold and the volume of readers sold. During 2004 and 2003 the volume attributable to readers remained fairly constant whereas in 2005 volume decreased resulting in a reduction of related product cost.
Service cost has increased during 2005 related primarily to a higher percentage of revenue requiring software customization and integration costs as compared to 2004 and 2003.
Selling, general and administrative
Law Enforcement $ 7,471,524 $ 3,047,247 $ — $ 4,424,277 145 % $ 3,047,247 n/a
Fire Safety 2,802,220 783,948 — 2,018,272 257 % 783,948 n/a
Biometrics 1,550,865 3,283,093 2,099,922 (1,732,228 ) -53 % 1,183,171 56 %
Total $ 11,824,609 $ 7,114,288 $ 2,099,922 $ 4,710,321 66 % $ 5,014,366 238 %
SG&A costs increased during the year as a result of 2005 representing a full 12 months worth of expenses as compared to 2004 which included only 3 months of expenses of the Law and Fire segments. As noted above, these costs are allocated based on the Segment's percentage of revenue. Changes in SG&A costs between business segments are the result of the change in their respective percentage of BIO-key's total revenue.
During 2004 the increase in SG&A was primarily attributable to the acquisition of Mobile Government. The additional costs incurred were the result of legal and audit costs surrounding both the acquisition of Mobile Government as well as Public Safety Group. Additionally, the increase was due to an increased workforce in sales and administration functions as well as the associated overhead which results from fully loaded labor charges associated with supporting larger operations. This increase was offset slightly by the elimination of non essential functions done in order to align the business with its revised model of focusing sales through channel partners and creating a model focused on licensing as oppose to integration projects.
Research, development and engineering
Fire Safety 1,207,263 337,310 — 869,953 258 % 337,310 n/a
Biometrics 1,707,507 1,333,568 1,037,330 373,939 28 % 296,238 29 %
Total $ 6,846,035 $ 2,979,904 $ 1,037,330 $ 3,866,131 130 % $ 1,942,574 187 %
R&D costs have increased over 2004 primarily related to the acquisition of Mobile Government in Q3 of 2004. During 2005 the Company spent significant R&D resources in sustaining engineering related to the large customer base as well as developing new version releases that incorporated these changes. While remaining focused on achieving these operational objectives the Company also undertook cost reduction initiatives which resulted in an approximately 25-30% reduction of the fourth quarter 2004 run rate for R&D costs in the Law Enforcement segment.
R&D costs have increased over 2004 primarily related to the acquisition of Mobile Government in Q3 of 2004. Additionally, subsequent to the acquisition, the company had several engineering initiatives in the Fire segment. As noted above a number of product enhancements were made to functionality across the entire software suite in addition to focused development of the new FireRMS mobile solution delivered to the market mid 2005. While remaining focused on achieving these product
objectives, in conjunction with the Company wide cost reduction initiatives, Fire Safety was able to realize an approximate reduction of 10% the fourth quarter 2004 run rate for R&D costs.
R&D costs have increased sequentially from 2003 to 2005. This is representative of the increased spending to enhance the interoperability and functionality of the software. The company continues to spend in R&D to enhance the products usability in different markets as well as to develop the product for integration with products from BIO-key's other segments. During 2005, BIO-key released IdentityMatch, a product which integrates BIO-key's advanced biometric offerings with BIO-key's mobile data and fire records management solutions. BIO-key continues to develop further integration of its Biometric software solutions in other products with in Company as well as partnering with other solutions in the marketplace. Additionally, in May of 2005 the Company was awarded a patent for its award-winning leadership Vector Segment fingerprint technology or "Image Identification System."
Other income and expense
Interest expense $ (4,521,344 ) $ (1,415,535 ) $ (1,909,788 ) $ (3,105,809 ) 219 % $ 494,253 26 %
Ineterest income 35,958 66,824 — (30,866 ) -46 % 66,824 n/a
Gain on sale of marketable securities (20,000 ) 33,125 — (53,125 ) -160 % 33,125 n/a
Derivative and warrant fair value adjustments 9,154,951 (3,008,419 ) 857,545 12,163,370 -404 % (3,865,964 ) -451 %
Other income (expense) (34,767 ) (88,425 ) 4,145 53,658 -61 % (92,570 ) -2,233 %
$ 4,614,798 $ (4,412,430 ) $ (1,048,098 ) $ 9,027,228 -205 % $ (3,364,332 ) 321 %
For the year ended December 31, 2005, consolidated interest expense increased $3,105,809 or 219% as compared to 2004, which was attributable to the increase in long term debt from issuance of the 2004 and 2005 Senior and Subordinated notes. For the year ended December 31, 2004, consolidated interest expense increased $494,253 or 26% from 2003.
For the year ended December 31, 2005, consolidated interest income decreased $30,866 or 46% as compared to 2004, which was attributable to the average amount of cash held on hand in interest bearing accounts. For the year ended December 31, 2004, consolidated interest income increased $66,824 as compared to 2003, which was attributable to deposits held in interest bearing accounts in 2004. No deposits were held in interest bearing accounts in 2003.
For the year ended December 31, 2005, derivative and warrant fair value adjustments increased $12,163,370 or 404% as compared to 2004, which was attributable to changes in the fair market value of embedded derivatives and detachable warrants issued with convertible debt. The fair value of the derivatives will fluctuate based on; our stock price at particular points in time, the debt conversion price, the volatility of our stock price over a period of time, changes in the value of the risk free interest rate, and the time to maturity of the outstanding debt at different points in time. The major factor contributing to this change was due to the decline in the market price of our stock from $1.60 as of December 31, 2004 to $.69 as of December 31, 2005. For the year ended December 31, 2004, derivative and warrant fair value adjustments decreased $3,865,964 or 451% as compared to 2003, which was also attributable to changes in the fair value of embedded derivatives and detachable warrants issued with convertible debt. The major factor contributing to the large fluctuation in the fair
value was due to the net increase in the market price of our stock from $1.03 as of September 29, 2004 to $1.60 as of December 31, 2004.
THREE AND SIX MONTHS ENDED JUNE 30, 2006 AS COMPARED TO JUNE 30, 2005
Consolidated Results of Operations—Percent Trend
Services 76 % 75 %
License fees and other 24 % 25 %
100 % 100 %
Cost of license fees and other 3 % 6 %
Selling, general and administrative 73 % 85 %
Research, development and engineering 41 % 45 %
Operating loss -35 % -64 %
Total other income (deductions) 7 % 23 %
NET LOSS -28 % -41 %
The Law Enforcement and Fire Safety segments were purchased during 2004. 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.
The Company evaluates performance and allocates resources 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 the segments revenues and other factors. 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.
$ Change
Service $ 2,380,970 $ 2,086,719 $ 294,251 14 %
License & other 494,618 746,814 (252,196 ) -34 %
2,875,588 2,833,533 42,055 1 %
Service 523,063 657,188 (134,125 ) -20 %
License & other 275,597 86,067 189,530 220 %
798,660 743,255 55,405 7 %
Service 19,996 17,979 2,017 11 %
License & other 138,527 90,785 47,742 53 %
158,523 108,764 49,759 46 %
Total Revenue $ 3,832,771 $ 3,685,552 $ 147,219 4 %
Service $ 416,113 $ 825,916 $ (409,803 ) -50 %
License & other 101,946 157,634 (55,688 ) -35 %
518,059 983,550 (465,491 ) -47 %
Service 254,901 200,880 54,021 27 %
License & other 2,589 27,240 (24,651 ) -90 %
Service 7,205 7,330 (125 ) -2 %
License & other 27,040 20,512 6,528 32 %
34,245 27,842 6,403 23 %
Total COGS $ 809,794 $ 1,239,512 $ (429,718 ) -35 %
The revenue for this segment in 2006 includes $635,000 of service revenue from a long-term project that the Company had participated in as a subcontractor. The revenue was deferred until evidence of full acceptance by the end user was received by the Company. That increase was offset by a reduction in revenue from other longer-term project work that was included in 2005 as the Company moves to more of a licensing-based model.
The overall revenue for this segment increased 7% over the same quarter in the prior year. However, the mix between service and license revenue continued to reflect the Company's efforts to move to more of a licensing-based model.
The Biometric segment continued to show revenue growth. As the Biometric market continues to grow, the Company expects to see increased revenue in this segment.
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty and is primarily driven by the sales mix and is solely dependent specifically on what products were sold.
Due to the change in focus from long-term project revenue to licensing agreements, cost of good sold in total for the segment decreased from 2005 as labor costs, for both employees' and consultants are eliminated as projects are completed.
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty. These costs are solely dependent specifically on what products were sold.
Overall costs of goods sold for the segment were higher in 2006 due to increased sales volume in the period.
License and other costs are primarily related to the hardware costs related to sales of biometric fingerprint readers. The change in cost of goods sold is directly attributable to the product mix between types of readers sold and the volume of readers sold.
Law Enforcement $ 1,326,876 $ 1,974,866 $ (647,990 ) -33 %
Fire Safety 816,346 740,681 75,665 10 %
Biometrics 646,714 409,924 236,790 58 %
Total $ 2,789,936 $ 3,125,471 $ (335,535 ) -11 %
As discussed previously, the Company restructured its operations into three business segments: Biometrics, Law Enforcement and Fire Safety in the fourth quarter of 2005. For 2005, SG&A costs were allocated to the segments based on several factors including management's estimates and percentage of revenue. For 2006, sales expenses are a direct cost to the segment and G&A costs are allocated between business segments on fixed percentages that were established by management during the budgeting process.
The overall decline in total SG&A costs for the quarter ended June 30, 2006 as compared to 2005 are primarily attributable to the continued focus by management on cost reduction initiatives taken during the fourth quarter of 2005 after the acquisitions of Public Safety Group and Aether Mobile Government were completed. Management believes the appropriate resources are in place to support its strategic goals but also continues to analyze the expense structure and continues to explore ways to further reduce costs. During the quarter ended June 30, 2006, these reductions have been partially offset by additional costs related to reporting and compliance that the Company has experienced due to the restatements of our previously filed financial statements.
Law Enforcement $ 945,234 $ 1,039,072 $ (93,838 ) -9 %
Fire Safety 310,693 319,091 (8,398 ) -3 %
Biometrics 326,507 312,308 14,199 5 %
Total $ 1,582,434 $ 1,670,471 $ (88,037 ) -5 %
Law Enforcement and Fire Safety
R&D costs have decreased in the second quarter of 2006 as compared to 2005 primarily related to the staff and cost structure reductions undertaken to move the Company toward the break-even point while still supporting sales growth.
R&D costs in this segment have increased slightly over the second quarter of 2006 as compared to 2005 as the Company continues to develop further integration of its Biometric software solutions in other products with in Company as well as partnering with other solutions in the marketplace.
Interest income $ — $ 2,988 $ (2,988 ) -100 %
Interest expense (2,262,632 ) (552,093 ) (1,710,539 ) 310 %
Derivative and warrant fair value adjustments 2,556,159 1,373,367 1,182,792 86 %
Other income (expense) (17,118 ) (532 ) (16,586 ) 3,118 %
Total $ 276,409 $ 823,730 $ (547,321 ) -66 %
For the quarter ended June 30, 2006, consolidated interest expense increased $1,710,539 or 310% as compared to the same quarter in 2005. The increase was attributable to increases in long term debt, related discount and other debt related instruments. Interest expense includes actual cash paid for interest as well non-cash charges for amortization of debt discounts, and interest expense on the letter of credit arrangement, as well as deferred rent obligations. The increase in interest expense during 2006 was primarily related to the default interest provisions and the liquidating damages provisions with respect to the convertible debt instruments.
For the quarters ended June 30, 2006 and 2005, derivative and warrant fair value adjustments increased, which was attributable to changes in the fair market value of embedded derivatives and detachable warrants issued with convertible debt, including the additional derivatives recorded as a result of the May, June and July 2005 and January 2006 debt tranches. The changes represent non-cash income and expenses charges to the statement of operations. The fair value of the derivatives will fluctuate based on; our stock price on the valuation date, the debt conversion price, the volatility of our stock price over a period of time, changes in the value of the risk free interest rate, and the time to maturity of the outstanding debt at different points in time.
SIX MONTHS ENDED JUNE 30, 2006 AS COMPARED TO JUNE 30, 2005
Total other income (deductions) -24 % 47 %
The Company evaluates performance and allocates resources 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 the segments revenues and other factors. 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.
Service $ 3,979,530 $ 4,439,496 $ (459,966 ) -10 %
License & other 920,682 1,464,547 (543,865 ) -37 %
4,900,212 5,904,043 (1,003,831 ) -17 %
Service 1,154,795 1,319,416 (164,621 ) -12 %
License & other 348,997 191,934 157,063 82 %
1,503,792 1,511,350 (7,558 ) -1 %
Service 36,613 62,828 (26,215 ) -42 %
License & other 541,344 146,922 394,422 268 %
577,957 209,750 368,207 176 %
Total Revenue $ 6,981,961 $ 7,625,143 $ (643,182 ) -8 %
Service $ 862,271 $ 1,501,389 $ (639,118 ) -43 %
997,305 1,910,274 (912,969 ) -48 %
Service 471,810 347,709 124,101 36 %
License & other 40,148 82,810 (42,662 ) -52 %
Service 18,010 20,594 (2,584 ) -13 %
License & other 37,877 41,547 (3,670 ) -9 %
55,887 62,141 (6,254 ) -10 %
Total COGS $ 1,565,150 $ 2,402,934 $ (837,784 ) -35 %
The revenue for this segment decreased slightly over the same quarter in the prior year. Although revenue decreased, the mix between service and license revenue continued to reflect the Company's efforts to move to more of a licensing-based model.
The Biometric segment continued to show strong revenue growth in the first six months of 2006. The growth in 2006 is primarily attributable to a large license order in Q1 2006 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.
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty. The decrease in cost is primarily driven by the sales mix and is solely dependent specifically on what products were sold.
Due to the change in focus from long-term project revenue to licensing agreements, cost of good sold also decreased as labor costs, both employees' costs are reduced and consultants are eliminated as projects are completed.
License and other costs are attributable primarily to revenues derived from product sales for which we are required to pay a royalty. The slight decrease in cost is primarily driven by the sales volume in addition to product mix. These costs are solely dependent specifically on what products were sold.
Services costs have increased over the same period in the prior year, as this segment represents a higher percentage of overall revenue to the Company.
Law Enforcement $ 2,591,725 $ 3,773,541 $ (1,181,816 ) -31 %
Fire Safety 1,558,780 1,415,280 143,500 10 %
Biometrics 1,215,885 783,273 432,612 55 %
The overall decline in total SG&A costs for the six months ended June 30, 2006 as compared to the same period in 2005 are primarily attributable to the cost reduction initiatives taken during the fourth quarter of 2005 after the acquisitions of Public Safety Group and Aether Mobile Government were completed. Management believes the appropriate resources are in place to support its strategic goals but also continues to analyze the expense structure and continues to explore ways to further reduce costs.
Fire Safety 611,249 715,468 (104,219 ) -15 %
Biometrics 653,230 700,260 (47,030 ) -7 %
R&D costs have decreased for the six months ended June 30 of 2006 as compared to 2005 primarily related to the staff and cost structure reductions undertaken to move the Company toward the break-even point while still supporting sales growth.
R&D costs have decreased for the six months ended June 30 of 2006 as compared to 2005, however the reduction in costs was due to higher costs in 2005 and not related to any significant staff reductions or other cost savings initiatives. The Company continues to develop further integration of its Biometric software solutions in other products with in Company as well as partnering with other solutions in the marketplace.
Interest income $ — $ 29,050 $ (29,050 ) -100 %
Interest expense (4,329,156 ) (1,387,009 ) (2,942,147 ) 212 %
Loss on extinguishment of debt (2,322,016 ) — (2,322,016 ) — %
Derivative and warrant fair value adjustments 5,000,852 4,950,248 50,604 1 %
Total $ (1,682,614 ) $ 3,571,757 $ (5,254,371 ) -147 %
For the second quarter ended June 30, 2006, consolidated interest expense increased $2,942,147 or 212% as compared to the same quarter in 2005. The increase was attributable to increases in long term debt, related discount and other debt related instruments. Interest expense includes actual cash paid for interest as well non-cash charges for amortization of debt discounts, and interest expense on the letter of credit arrangement, as well as deferred rent obligations. The increase in interest expense during 2006 was primarily related to the default interest provisions and the liquidating damages provisions with respect to the convertible debt instruments.
For the six months ended June 30, 2006 and 2005, derivative and warrant fair value adjustments increased, which was attributable to changes in the fair market value of embedded derivatives and detachable warrants issued with convertible debt, including the additional derivatives recorded as a result of the May, June and July 2005 and January 2006 debt tranches. The changes represent non-cash income and expenses charges to the statement of operations. The fair value of the derivatives will fluctuate based on; our stock price on the valuation date, the debt conversion price, the volatility of our stock price over a period of time, changes in the value of the risk free interest rate, and the time to maturity of the outstanding debt at different points in time.
OPERATING ACTIVITIES OVERVIEW
The net cash used in operating activities during 2005 was $4,513,497, as compared to $5,644,759 and $2,857,145 in 2004 and 2003, respectively. Some of the major drivers of this change are discussed in more detail below.
The Company's income statement includes four non-cash items which made the most significant contributions to the net cash used in operating activities in 2004 and 2005.
The Company issued notes in 2004 and 2005 which contained embedded derivatives. In 2004, the company recorded a loss of approximately $3,008,419 related to the increase in value of the derivatives. The increase in value was caused by the increase in the value of the underlying BIO-key stock. In 2005, the company recorded a gain of approximately $9,154,951 related to the decrease in value of the derivatives. The decrease in value is the result of the decline in value of the underlying BIO-key stock.
A debt discount was recorded when the notes were initially recorded to reflect the FMV of derivatives and warrants related to the debt. The discount is amortized ratably into earnings over
the life of the related debt. In 2004 and 2005, the company recorded non-cash interest expense related to the amortization of the debt discount of approximately $757,318 and $2,097,973, respectively.
The Company recorded a $55,150 and $664,043 charge in 2004 and 2005, respectively, for the non-cash expense of issuing options and warrants to non employees for services.
Finally, the Company recorded $550,421 and $1,509,880 in 2004 and 2005, respectively, for the non-cash expense related to the amortization of intangibles assets.
For the year ended December 31, 2005, the Company reported positive cash flows related to a decrease in costs and earnings in excess of billings on uncompleted contracts of $2,468,770. Costs and earnings in excess of billings on uncompleted contracts represent services which have been performed on long term contracts but have not been invoiced at year end due to milestones contained within the contracts. In 2005, the Company was able to bill the customer due to the fact that the milestones have been reached.
The Company experienced positive cash flows of $1,029,404 in 2005 due to increased accrued liabilities related to interest on the 2005 debt as well as contract related costs not being invoiced by vendors. In 2004, the Company experienced positive cash flows of $955,050 related to interest on the 2004 debt as well as liabilities assumed through acquisitions.
The Company also experienced a positive cash flow from an increase of $1,191,958 in deferred revenue from 2004 to 2005 due to customers who had purchased and paid for maintenance agreements which the company had to earn typically over a one year period.
The overall major drivers in operating cash flow are the current operating costs which are greater than the current revenues. The company has experienced improvements related to the ratio of operating expenses to revenues and expects this trend to continue to improve until such time as the Company is able to generate sustained profitability.
Net cash used in operations during the six months ended June 30, 2006 was approximately $1,905,000 compared to approximately $3,752,000 during the six months ended June 30, 2005. Some of the major drivers of this change are discussed in more detail below.
The Company reported positive cash flows related to a decrease in costs and earnings in excess of billings on uncompleted contracts of approximately $2,493,000. Costs and earnings in excess of billings on uncompleted contracts represent services which have been performed on long term contracts but have not been invoiced due to milestones contained within the contracts. In the six months ended June 30, 2006, the Company was able to bill more customers due to the fact that certain milestones had been reached.
Positive cash flows were reported from an increase in accounts payable of approximately $1,296,000 due to subcontractors' costs on uncompleted projects that were invoiced during the second quarter, moving from accrued liabilities to accounts payable. That decline in accrued liabilities was offset by an increase in accrued interest of approximately $1,292,000 primarily related to the default interest provisions and the liquidating damages provisions with respect to the Company's convertible debt instruments.
The following non-cash items that are reflected in the Company's statement of operations are used to reconcile the net loss to the net cash used in operating activities during the six months ended June 30, 2006:
The Company issued notes in 2004, 2005 and 2006 that contained embedded derivatives. In the six months ended June 30, 2006, the Company recorded a gain of approximately $5,000,000 related to the decrease in value of these derivatives. The decrease in value was caused by the decline in the value of the underlying BIO-key stock.
A debt discount was recorded when the notes were initially recorded to reflect the FMV of derivatives and warrants related to the debt. The discount is amortized ratably into earnings over the life of the related debt. In the six months ended June 30, 2006, the Company recorded non-cash interest expense related to the amortization of the debt discount of approximately $1,932,000.
The Company recorded a non-operating loss on extinguishment of debt of $2,322,016. 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.
Net cash used in investing activities for the six months ended June 30, 2006 was approximately $907,000, largely a result of the return of deposits related to long-term contracts. This compares to net cash provided by investing activities of approximately $1,389,000 for the corresponding period in 2005. The 2005 amount consisted of approximately $980,000 from sale of marketable securities and $50,000 in proceeds from the sale of a trademark.
Net cash provided by financing activities during the six months ended June 30, 2006 was approximately $859,000 compared to net cash provided by financing activities of approximately $3,380,000 in the corresponding period in 2005. The 2006 amount included debt proceeds of $988,000 offset by $85,000 of debt repayments and $53,000 for costs to issue the new debt. The 2005 amount included debt proceeds of approximately $4,515,000, proceeds from warrants and option exercises of approximately $539,000, offset by debt repayments of approximately $1,405,000.
Working capital deficit at June 30, 2006 was approximately $11,268,000 as compared to a deficit of approximately $8,952,000 at December 31, 2005.
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 expect any material capital expenditures during the next twelve months.
We do not currently maintain a line of credit or term loan with any commercial bank or other financial institution.
FINANCING ACTIVITIES OVERVIEW
2005 Senior and Subordinated Term Notes
On June 8, 2005, we entered into a Securities Purchase Agreement (the "Senior Purchase Agreement") with an institutional investor. Under the Senior Purchase Agreement, the Company issued a Secured Convertible Term Note (the "Senior Convertible Note") in the aggregate principal amount of $2,000,000, convertible into Common Stock of the Company in certain circumstances at $0.85 per share, and issued a warrant (the "Senior Warrant") to purchase an aggregate of 444,444 shares of the Common Stock at a per share exercise price of $1.00. The aggregate consideration received by the Company, net of all fees and expenses, for the Senior Convertible Note and the Senior Warrant was
approximately $1,841,000. The proceeds from this transaction are to be used for working capital purposes. The Company's obligations under the Senior Purchase Agreement and the Senior Convertible Notes are secured by a security interest in all or substantially all of the Company's assets.
Under the terms of the Senior Convertible Note, we are required to make monthly payments of accrued interest only beginning on July 1, 2005. In addition, the Senior Convertible Note provides for monthly payments of principal in equal 1/32 increments thereof, plus accrued interest, commencing October 1, 2005.
We entered into a Securities Purchase Agreement, effective as of May 31, 2005, (the "Subordinated Purchase Agreement") with existing shareholders of the Company and other accredited investors (collectively, the "Subordinated Investors"). Under the Subordinated Purchase Agreement, the Company issued Convertible Term Notes (the "Subordinated Convertible Notes") in the aggregate principal amount of $2,794,723, respectively convertible into Common Stock of the Company in certain circumstances at $0.70 per share, and issued warrants (the "Subordinated Warrants") to purchase an aggregate of 828,066 shares of the Common Stock at a per share exercise price of $1.00. The aggregate consideration received by the Company, net of all fees and expenses, for such Subordinated Convertible Notes and Subordinated Warrants was approximately $2,411,000. The proceeds from this transaction are to be used for working capital purposes. The Subordinated Convertible Notes were issued at a purchase price equal to $900 for each $1,000 of principal amount of the Note.
Certain Subordinated Investors purchased additional Subordinated Convertible Notes in the aggregate principal amount of $450,000 and received additional Subordinated Warrants to purchase an aggregate of 133,333 shares of Common Stock at a per share exercise price of $1.00. The aggregate consideration received by the Company net of all fees and expenses for such Subordinated Convertible Notes and Subordinated Warrants was $404,500, which was paid by the Subordinated Investors on July 8, 2005.
Under the terms of the Subordinated Convertible Notes, we are required to make quarterly payments of accrued interest only beginning on September 1, 2005. In addition, the Subordinated Convertible Notes provide for quarterly payments of principal in equal increments thereof, plus accrued interest, commencing September 1, 2006 through May 31, 2008, which payments may be made in shares of common stock at the option of each note holder.
2005 Amendment and Waivers
The Company entered into an Amendment and Waiver with Laurus, dated as of August 31, 2005, pursuant to which the Company was permitted to defer the payment of the monthly principal amounts due and payable for the months of September, October, November and December 2005 under both (a) the Secured Convertible Term Note in the original principal amount of $5,000,000 issued by the Company to Laurus on September 29, 2004 (the "September 2004 Note"), and (b) the Secured Convertible Term Note in the original principal amount of $2,000,000 issued by the Company to Laurus on June 8, 2005 (the "June 2005 Note"), such aggregate deferred principal amounts being equal to $625,000 and $187,500, respectively. The deferred principal amount under the September 2004 Note is now due on September 29, 2007, the maturity date of that note, and will be paid at the same time the final payments due with respect to that note upon maturity. The deferred principal amount under the June 2005 Note is now due on June 7, 2008, the maturity date of that note, and will be paid at the same time the final payments due with respect to that note upon maturity. The Company will remain obligated to pay all monthly interest amounts under these notes as they are currently due.
The Company also entered into Amendment and Waivers, dated as of August 31, 2005, pursuant to which certain Subordinated Investors allowed the Company to defer the payment of the monthly principal amounts due and payable for the months of September, October, November and December 2005 under the Convertible Term Notes in the aggregate original principal amount of
$2,800,000 issued by the Company to the Subordinated Investors on September 29, 2004 (the "Subordinated Notes"), such aggregate deferred principal amount being equal to $350,004. The deferred principal amount under each Subordinated Note is now due on September 29, 2007, the maturity date of each such note, and will be paid at the same time the final payments due with respect to each such note upon maturity. The Company will remain obligated to pay all monthly interest amounts under these notes as they are currently due.
The Company entered into an Amendment No. 1 to its Subordinated Secured Promissory Note, dated as of January 23, 2006, with Aether Systems, Inc. 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 was amended to increase such aggregate maximum principal amount to $7,884,588.
The Company entered into a Securities Purchase Agreement, effective as of January 23, 2006, with The Shaar Fund, Ltd., Longview Fund, L.P. and Longview Special Finance. Under the Securities Purchase Agreement, the Company issued to the Purchasers Convertible Term 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.
Effective as of January 23, 2006, BIO-key International, Inc. entered into an Amendment and Waiver with Laurus Master Fund Ltd. in connection with the Secured Convertible 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 and on June 8, 2008 in the aggregate principal amount of $2,000,000 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.
Effective as of January 23, 2006, the Company also entered into an Amendment and Waiver with certain holders of its Subordinated Convertible Promissory 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 and on May 31, 2005 in the aggregate principal amount of $3,244,723 were amended as 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. In connection with this financing, we also reduced the conversion price of the Series A convertible Preferred shares held by the Shaar Fund Ltd. to $0.70 per share.
Effective as of August 10, 2006, the Company also entered into an Amendment and Waiver with Laurus in connection with the holder of its Secured Convertible Notes currently held by Laurus. Under the Amendment and Waiver, the September 2004 Note and June 2005 Note were amended as follows: (i) the principal amounts due and payable under the 2004 Note and the 2005 Note for the months of August and September 2006, respectively, shall be paid in shares of the Company's Common Stock priced at $0.50 per share; and (ii) the principal amount due and payable under the 2004 Note for the months of October, November and December 2006 is deferred until January 1, 2008, the final maturity date of the 2004 Note, and the principal amount due and payable under the 2005 Note for the months of October, November and December 2006 is deferred until December 1, 2008, the final maturity date of the 2005 Note. Pursuant to this Amendment and Waiver, the Company issued 150,000 shares of its common stock to Laurus as consideration for the principal payment deferral. In connection with this financing, the Company reduced the conversion price under each of the September 2004 Note and June 2005 Note to $0.50 per share.
Effective as of August 10, 2006, the Company also entered into a Securities Exchange Agreement with certain holders of its Subordinated Convertible Promissory Notes. Under the Securities Exchange Agreement, certain Subordinated Notes issued by the Company on September 29, 2004 in the aggregate principal amount of $5,288,221 and on May 31, 2005 in the aggregate principal amount of $3,244,723 were amended as follows: (i) the aggregate principal amount outstanding under the Notes, plus accrued and unpaid interest, and liquidated damages were exchanged for shares of Series C Convertible Preferred Stock; and (ii) in addition, the exercise price of all warrants held by Subordinated Note Holders dated May 31, 2005 and January 23, 2006, to purchase Common Stock of the Company was reset to $0.50 per share. In connection with this financing, the Company also reduced the conversion price of the Series A and Series B Convertible Preferred shares to $0.50 per share.
The Company entered into (i) a Securities Purchase Agreement (the "Trellus Securities Purchase Agreement"), dated as of August 10, 2006, with Trellus Partners, L.P. ("Trellus") and (ii) a Securities Purchase Agreement (the "Shaar Securities Purchase Agreement"), dated as of August 10, 2006, with Shaar. Under the Trellus Securities Purchase Agreement, the Company (i) issued and sold 3,000,000 shares of its Common Stock (the "Trellus Shares") to Trellus, at a purchase price of $0.50 per share, for an aggregate purchase price of $1,500,000 and (ii) issued a warrant to Trellus (the "Trellus Warrant") to purchase up to an aggregate of 400,000 shares of the Company's Common Stock at an exercise price of $0.75 per share.
Under the Shaar Securities Purchase Agreement, the Company agreed to (i) issue and sell 1,000,000 shares of its Common Stock (the "Shaar Shares") to Shaar, at a purchase price of $0.50 per share, for an aggregate purchase price of $500,000 to be paid by exchanging Shaar's rights in an aggregate amount of $500,000 in declared and unpaid dividends on the Shares of Series A Convertible Preferred Stock currently held by Shaar; and (ii) issue a warrant to Shaar (the "Shaar Warrant") to purchase up to an aggregate of 133,333 shares of the Company's Common Stock at an exercise price of $0.75 per share.
Liquidity outlook
At June 30, 2006 our total of cash and cash equivalents was $1,284,123 as compared to $1,422,827 at December 31, 2005. As discussed above, the Company has financed itself through access to the capital markets by issuing debt securities, Convertible Preferred Stock and common stock.
As discussed above, subsequent to June 30, 2006, the Company entered into securities purchase agreements to issue and sell 4,000,000 shares of its common stock to several investors at a price of $0.50 per share for an aggregate purchase price of $2,000,000 of which $1,500,000 was received in cash, and $500,000 was paid in declared and unpaid dividends.
Also, as discussed above, subsequent to June 30, 2006, the Company entered into a securities exchange agreement under which approximately $5,000,000 of subordinated convertible debt plus accrued interest was exchanged for the Company's Series C Convertible Preferred Stock.
We currently require approximately $1,700,000 per month to conduct our operations. During the first half of 2006, we generated approximately $6,982,000 of revenue and expect to increase quarterly revenue in 2006.
The Company has undertaken strategic steps to position itself to realize positive cash flows from operations in the future by increasing revenues and better managing expenses. These steps include the acquisition of two enterprises in 2004. Although the acquisitions inherently produced a greater demand for cash than we would have liked, we are confident that many of the initial costs are isolated in nature and will not be recurring year after year. The Company has also taken strategic steps to downsize the workforce in areas that we felt were either non-essential or not in line with where we wanted the Company to develop in the near future. The Company has also recently experienced additional costs associated with various compliance related activities.
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) provide working capital. Due to several factors, including our history of losses and limited revenue, our former independent auditors have included an explanatory paragraph in opinions that they have previously issued related to our annual financial statements as to the substantial doubt about our ability to continue as a going concern. Our long-term viability and growth will depend upon the successful commercialization of our technologies and our ability to obtain adequate financing. To the extent that we require such additional financing, 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, be unable to pursue merger or acquisition candidates, or continue as a going concern.
We have various contractual obligations impacting our liquidity. The following represents some of our contractual obligations as of December 31, 2005:
Non-cancelable operating leases $ 3,427,000 $ 1,260,000 $ 1,278,000 $ 866,000 $ 23,000
Senior secured convertible term notes 5,599,999 1,524,211 3,048,421 1,027,367 —
Subordinated unsecured convertible term notes 5,677,028 18,750 14,063 — 5,644,215
Total $ 14,704,027 $ 2,802,961 $ 4,340,484 $ 1,893,367 $ 5,667,215
The Company does not own any real estate but conducts operations from four leased premises. These non-cancelable operating leases expire a various dates through 2009. In addition to base rent, the Company pays for property taxes, maintenance, insurance and other occupancy expenses according to the terms of the individual leases.
RESTATEMENT
In the process of reviewing our registration statement for the securities issued in our June 2005 financing, the staff of the Securities and Exchange Commission ("SEC") raised questions with regard to our convertible term notes suggesting that we consider EITF 00-19 "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" to evaluate whether there were any embedded derivative instruments and if so, whether they should be accounted for as an equity or liability classification. The SEC staff suggested that we review the methodology used in the valuations of the embedded derivative instruments and also review whether warrants issued with our 2004 financing should be accounted for as an equity or liability classification. The SEC staff also commented that the Company should review the convertible notes issued in fiscal 2003 and 2004. The SEC staff also asked us to review adjustments to revenue made in the fourth quarter of 2004. The SEC staff raised the question of whether the transactions had a material impact on previously filed Exchange Act reports and would be better characterized as restatements. Further, the Company recalculated the convertible preferred stock dividends and accretion including the accrued but unpaid dividends in accordance with FAS 128—Earnings per Share.
There were several items that were identified as requiring restatement, these items were:
The Company reviewed contracts and purchase agreements related to certain non-governmental customers and identified specific contracts for which the initial accounting inflated annual and quarterly revenues and earnings in violation of generally accepted accounting principles ("GAAP"). These practices were primarily the result of recognizing revenue on transactions with customers that were not creditworthy and recognizing revenue when the earnings process had not been completed. The revenue and related cost has been adjusted on the income statement as well as the related balance sheet accounts.
Accounting for Convertible Financing Arrangements
The Company reviewed the initial accounting for the 7% Convertible Notes issued in 2003, the Senior and Subordinated Convertible Term Notes issued in 2004 and the Senior and Subordinated Convertible Term Notes issued in 2005. During the review the company identified that EITF 00-19 should be applied to evaluate whether any embedded derivative instruments qualify as equity instruments or as liabilities. As such certain embedded derivatives were identified that met the conditions set forth under paragraph 12 of SFAS No. 133. These embedded derivative instruments have been evaluated using EITF 00-19 paragraphs 12 to 32 and determined that these instruments would not be classified as components of stockholders equity. The instruments have been deemed liabilities, and as such will be subject to SFAS 133 and should be recorded at fair value. Features that have been evaluated and determined to require such treatment include:
The principal conversion option
The monthly payments conversion option
The interest rate adjustment provisions.
Additionally, it was identified that certain other components of the related financings were also incorrectly accounted for. This includes the warrants issued with the above financing and the costs incurred by Company in obtaining the above financings. The correction of prior errors affected the subsequent accounting for debt conversions to equity as well as the amortization of related discounts and deferred finance charges associated with the above financings.
Accounting for Warrants Related to the Companies 2004 Debt Financing
Based on certain registration rights provisions it was determined that the warrants issued with the 2004 Debt Financing would require continued classification as a liability and revalued every quarter. The Company previously classified the warrants as equity upon the registration rights agreement becoming effective during the fourth quarter of 2004.
Valuations of Embedded Derivatives
The initial valuation methodology overstated the value of the conversion option derivatives. The company's review of the valuations of the embedded derivatives determined that the valuation of the principal conversion option and the monthly payments conversion option shared certain components that resulted in a double counting of the embedded derivative valuation. As such the company has adjusted its valuations of these embedded derivatives.
Additional Derivative (Default Provision)
The company also reviewed the default provisions set forth in the debt instruments and determined that an additional embedded derivative existed that required bifurcation from the host contract and would need to be revalued on a quarterly basis.
The Company reviewed the earnout calculations performed in the prior year for the PSG acquisition and identified an error in the calculation. As a result the Company has restated the prior year's impact relating to this error. At December 31, 2004 the Company had accrued $43,635 for the earnout provision. The corrected calculation resulted in no accrual being required, and as such the related accrual and goodwill balances have been reduced by $43,635.
Management believes the scope and process of its internal review of previously reported financial information was sufficient to identify issues of a material nature that could affect our Consolidated Financial Statements and all dates and periods presented herein have been restated to fairly present the results of our operations.
The errors in our previously reported financial information, and the failure to prevent them or detect them in our financial reporting process, were largely attributable to weak internal controls, an inadequate staff of competent accounting personnel with an appropriate level of knowledge of GAAP and to errors in the valuations of the previously identified embedded derivatives.
As a result of our review and communications with the SEC, we determined that a restatement of previously reported financial information was required. Our previously reported financial information should no longer be relied upon. Accordingly, we have restated our previously reported financial information for the years ended December 31, 2003 and 2004 and our previously reported unaudited financial statements for the first, second and third quarters of 2003, 2004 and 2005 (the "restatement"). The restatement covers a number of separate matters, each of which is described above.
For the quarterly impact of the restatement and the restated financial results for the first, second and third quarters of 2003, 2004 and 2005 see Note X, Results by Quarter in the Notes to the Financial Statements on Page F-7.
The following tables summarize the impact of all of these adjustments on previously reported revenue and assets, liabilities, and stockholders' equity (deficit) for the years ended December 31, 2005, 2004 and 2003.
Impact of Adjustments on Revenue
For the Years Ended December 31,
As previously reported $ 14,226,095 $ 5,558,231 $ 524,101
Revenue recognition 162,720 (308,620 )
As restated $ 14,226,095 $ 5,720,951 $ 215,481
Impact of Adjustments on Consolidated
Balance Sheet Accounts
Stockholders'
(Deficit)
As previously reported $ 26,357,934 $ 17,050,206 $ 9,307,728
Revenue recognition and related SG&A expense — — —
Debt financing — 3,143,724 (3,143,724 )
Total Adjustments — 3,143,724 (3,143,724 )
As restated $ 26,357,934 $ 20,193,930 $ 6,164,004
Impact of Adjustments on Consolidated Balance Sheet Accounts
As previously reported $ 30,844,681 $ 20,223,283 $ 10,621,398 $ 1,864,742 $ 11,000,731 $ (9,135,989 )
Revenue recognition and related SG&A expense (122,090 ) 23,810 (145,900 ) (308,620 ) (18,200 ) (290,420 )
Debt financing 816,501 4,742,344 (3,925,843 ) — (57,543 ) 57,543
Total Adjustments 694,411 4,766,154 (4,071,743 ) (308,620 ) (75,743 ) (232,877 )
As restated $ 31,539,092 $ 24,989,437 $ 6,549,655 $ 1,556,122 $ 10,924,988 $ (9,368,866 )
The following tables present the effect of the restatement adjustments on the consolidated Statement of Operations for the years ended December 31, 2005, 2004 and 2003.
Year Ended December 31, 2005
As Previously
Services $ 10,861,649 $ — $ 10,861,649
License fees and other 3,364,446 — 3,364,446
14,226,095 — 14,226,095
Services 2,906,142 — 2,906,142
Cost of license fees and other 937,491 — 937,491
Selling, general and administrative 11,824,609 — 11,824,609
Research, development and engineering 6,846,035 — 6,846,035
Operating loss (8,288,182 ) — (8,288,182 )
Interest income 35,958 — 35,958
Interest expense (6,548,130 ) 2,026,786 (4,521,344 )
Derivative and warrant fair value adjustments 15,213,186 (6,058,235 ) 9,154,951
Loss on sale of marketable securities (20,000 ) — (20,000 )
Other expense (34,767 ) — (34,767 )
Total other income (deductions) 8,646,247 (4,031,449 ) 4,614,798
NET INCOME (LOSS) $ 358,065 $ (4,031,449 ) $ (3,673,384 )
Basic Loss per Share:
Net loss $ 358,065 $ (4,031,449 ) $ (3,673,384 )
Convertible preferred stock dividends and accretion
Net Income (Loss) attributable to common shareholders $ 44,548 $ (4,031,449 ) $ (3,986,901 )
Weighted average common shares outstanding 44,787,807 44,787,807 44,787,807
Basic Loss per Share $ 0.00 $ (0.09 ) $ (0.09 )
Diluted Loss per Share:
Effect of Dilutive Securities: Convertible Debentures
(8,795,834
Net loss attributable to common shareholders and assumed conversions
Weighted average shares outstanding 44,787,807 — 44,787,807
Diluted weighted average common shares and common equivalents outstanding
Diluted Loss per Share $ (0.17 ) $ 0.05 $ (0.12 )
Services $ 3,351,406 $ — $ 3,351,406
License fees and other 2,206,825 162,720 2,369,545
5,558,231 162,720 5,720,951
Selling, general and administrative 7,096,088 18,200 7,114,288
12,140,212 18,200 12,158,412
Operating loss (6,581,981 ) 144,520 (6,437,461 )
Interest expense (667,008 ) (748,527 ) (1,415,535 )
Derivative and warrant fair value adjustments — (3,008,419 ) (3,008,419 )
Total other income (deductions) (655,484 ) (3,756,946 ) (4,412,430 )
NET LOSS $ (7,237,465 ) $ (3,612,426 ) $ (10,849,891 )
Net Loss attributable to common shareholders $ (7,651,705 ) $ (3,583,541 ) $ (11,235,246 )
Basic Loss per Share $ (0.22 ) $ (0.10 ) $ (0.32 )
(11,235,246
Weighted average shares outstanding 34,806,201 34,806,201 34,806,201
Diluted Loss per Share $ (0.22 ) $ (0.10 ) $ (0.32 )
Services $ 10,694 $ — $ 10,694
License fees and other 513,407 (308,620 ) 204,787
524,101 (308,620 ) 215,481
Cost of services 1,694 — 1,694
Cost of license fees and other 87,387 — 87,387
Selling, general and administrative 2,118,122 (18,200 ) 2,099,922
3,244,533 (18,200 ) 3,226,333
Operating loss (2,720,432 ) (290,420 ) (3,010,852 )
Interest expense (1,109,786 ) (800,002 ) (1,909,788 )
Derivative and warrant fair value adjustments — 857,545 857,545
Other income 4,145 — 4,145
Total other income (deductions) (1,105,641 ) 57,543 (1,048,098 )
NET LOSS $ (3,826,073 ) $ (232,877 ) $ (4,058,950 )
Net loss attributable to common shareholders
Basic Loss per Share
Net loss attributable to common shareholders $ (3,962,828 ) $ (232,877 ) $ (4,195,705 )
Effect of Dilutive Securities: Convertible Debentures — — —
Net loss attributable to common shareholders and assumed conversions $ (3,962,828 ) $ (232,877 ) $ (4,195,705 )
Diluted weighted average common shares and common equivalents outstanding 17,543,586 17,543,586 17,543,586
The following tables present the effect of the restatement adjustments on the Consolidated Balance Sheet as of December 31, 2005, 2004 and 2003.
As Restated
Cash and cash equivalents $ 1,422,827 $ — $ 1,422,827
Billed less allowance for doubtful receivables as of $160,000 1,635,371 — 1,635,371
Unbilled 201,942 — 201,942
Costs and earnings in excess of billings on uncompleted contracts 4,321,392 — 4,321,392
Inventory 8,760 — 8,760
Prepaid expenses 137,000 — 137,000
Total current assets 7,727,292 7,727,292
Equipment and leasehold improvements, net 548,267 — 548,267
Deposits 1,828,560 — 1,828,560
Intangible assets—less accumulated amortization 3,301,823 — 3,301,823
Deferred financing costs, net 1,562,338 — 1,562,338
Goodwill 11,389,654 — 11,389,654
Total non-current assets 18,630,642 — 18,630,642
TOTAL ASSETS $ 26,357,934 $ — $ 26,357,934
Current maturities of long-term obligations $ 4,924,224 $ 3,143,724 $ 8,067,948
Accounts payable 833,608 — 833,608
Billing in excess of costs and earnings on uncompleted contracts 32,385 — 32,385
Accrued liabilities 5,520,515 — 5,520,515
Deferred rent 443,603 — 443,603
Deferred revenue 3,264,283 — 3,264,283
Total current liabilities 15,018,618 3,143,724 18,162,342
Long-term obligations, net of discount and current maturities — — —
Total non-current liabilities 2,031,588 — 2,031,588
TOTAL LIABILITIES 17,050,206 3,143,724 20,193,930
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock-authorized, 5,000,000 shares (liquidation preference of $100 per share) Series A 7% Convertible; issued and outstanding, 44,557 shares of $.0001 par value 4 — 4
Common stock-authorized, 85,000,000 shares, 46,306,589 issued and outstanding of $.0001 par value 4,632 — 4,632
Additional paid-in capital 51,529,332 (2,608,016 ) 48,921,316
Accumulated deficit (42,226,240 ) (535,708 ) (42,761,948 )
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 9,307,728 (3,143,724 ) 6,164,004
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 26,357,934 $ — $ 26,357,934
Cash and cash equivalents $ 956,230 $ — $ 956,230
Marketable debt securities 1,000,000 — 1,000,000
Billed less allowance for doubtful receivables as of $422,393 1,698,144 (90,090 ) 1,608,054
Due from selling stockholders and other 60,793 (32,000 ) 28,793
Inventory 29,599 — 29,599
Total current assets 10,461,022 (122,090 ) 10,338,932
Costs and earnings in excess of billings on uncompleted contracts 657,000 — 657,000
Intangible assets—less accumulated amortization 4,177,279 (77,982 ) 4,099,297
Deferred financing costs, net — 938,118 938,118
Goodwill 12,067,248 (43,635 ) 12,023,613
Total non-current assets 20,383,659 816,501 21,200,160
TOTAL ASSETS $ 30,844,681 $ 694,411 $ 31,539,092
Current maturities of long-term obligations $ 3,255,182 $ (192,460 ) $ 3,062,722
Advances from stockholders 12,753 — 12,753
Accounts payable 1,325,282 23,810 1,349,092
Billing in excess of costs and earnings on uncompleted contracts 760,807 — 760,807
Accrued liabilities 4,639,619 (43,635 ) 4,595,984
Total current liabilities 13,553,675 (212,285 ) 13,341,390
Long-term obligations, net of discount and current maturities 5,286,951 4,978,439 10,265,390
Deferred rent 1,311,454 — 1,311,454
Deferred revenue 71,203 — 71,203
Total non-current liabilities 6,669,608 4,978,439 11,648,047
Preferred stock-authorized, 5,000,000 shares (liquidation preference of $100 per share) Series C 7% Convertible; issued and outstanding, 62,182 shares of $.01 par value 623 — 623
Common stock-authorized, 85,000,000 shares, 40,680,691 issued and outstanding of $.01 par value 406,808 — 406,808
Additional paid-in capital 45,325,172 (226,441 ) 45,098,731
Accumulated deficit (35,111,205 ) (3,845,302 ) (38,956,507 )
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 10,621,398 (4,071,743 ) 6,549,655
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 30,844,681 $ 694,411 $ 31,539,092
Receivables billed 409,803 (308,620 ) 101,183
Total current assets 1,654,379 (308,620 ) 1,345,759
Equipment and leasehold improvements, net 60,157 — 60,157
Intangible assets—less accumulated amortization 68,306 — 68,306
Deferred financing costs, net 81,900 — 81,900
Total non-current assets 210,363 — 210,363
TOTAL ASSETS $ 1,864,742 $ (308,620 ) $ 1,556,122
LIABILITIES:
Advances from stockholders $ 34,030 $ — $ 34,030
Accrued liabilities 173,736 (18,200 ) 155,536
Total current liabilities 569,508 (18,200 ) 551,308
Long-term obligations, net of discount and current maturities 10,431,223 (57,543 ) 10,373,680
Total non-current liabilities 10,431,223 (57,543 ) 10,373,680
TOTAL LIABILITIES 11,000,731 (75,743 ) 10,924,988
Preferred stock-authorized, 5,000,000 shares (liquidation preference of $100 per share) Series B 9% Convertible; issued and outstanding, 4,180 shares of $.01 par value 42 — 42
Common stock-authorized, 85,000,000 shares, issued and outstanding 21,222,990 of $.01 par value 212,229 — 212,229
Additional paid-in capital 18,327,992 — 18,327,992
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (9,135,989 ) (232,877 ) (9,368,866 )
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 1,864,742 $ (308,620 ) $ 1,556,122
1. Basis of Consolidation
The accompanying 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. Intercompany accounts and transactions have been eliminated in consolidation.
2. Revenue Recognition
Revenues from software licensing are recognized in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9. Accordingly, revenue from software licensing is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable.
The Company intends to enter into arrangements with end users for items which may include software license fees, usage fees and services or various combinations thereof. For each arrangement, revenues will be recognized when evidence of an agreement has been documented, the fees are fixed or determinable, collection of fees is probable, delivery of the product has occurred and no other significant obligations remain.
Multiple-Element Arrangements: For multiple-element arrangements, each element of the arrangement will be analyzed and the Company will allocate a portion of the total fee under the arrangement to the elements using vendor specific objective evidence of fair value of the element, regardless of any separate prices stated within the contract for each element. Vendor specific objective evidence is based on the price the customer is required to pay when the element is sold separately (i.e., software license fees charged when consulting or other services are not provided, hourly rates charged for consulting services when sold separately from a software license or usage fees). If vendor specific objective evidence of fair value does not exist for any undelivered elements, all revenue is deferred and recognized ratably over the service period if the undelivered element is services, or until sufficient objective evidence of fair value exists or all elements have been delivered.
License Revenues: Amounts allocated to license revenues are recognized at the time of delivery of the software and all other revenue recognition criteria discussed above have been met.
Revenue from licensing software, which requires significant customization and modification, is recognized using the percentage of completion method, based on the hours of effort incurred by the company in relation to the total estimated hours to complete. In instances where third party hardware, software or services form a significant portion of a customer's contract, the company recognizes revenue for the element of software customization by the percentage of completion method described above. Third party hardware, software, and services are recognized upon shipment or acceptance as appropriate. If the company makes different judgments or utilizes different estimates of the total amount of work expected to be required to customize or modify the software, the timing and revenue recognition, from period to period, and the margins on the project in the reporting period, may differ materially from amounts reported. Revenues earned but not yet billed are shown as an asset in Costs and Earnings in Excess of Billings in the balance sheet. Billings in excess of cost and earnings are reflected as a liability in the balance sheet. Anticipated contract losses are recognized as soon as they become known and are estimable.
Service Revenues: Revenues from services are comprised of maintenance and consulting and implementation services. Maintenance revenues include providing for unspecified when-and-if available product updates and customer telephone support services, and are recognized ratably over the term of
the service period. Consulting services are generally sold on a time-and-materials basis and include a range of services including installation of software and assisting in the design of interfaces to allow the software to operate in customized environments. Services are generally separable from other elements under the arrangement since performance of the services are not essential to the functionality of any other element of the transaction and are described in the contract such that the total price of the arrangement would be expected to vary as the result of the inclusion or exclusion of the services. Revenues from services are generally recognized as the services are performed.
Usage Fees: Usage fees are charged on certain applications based on the customer's volume of use. Usage revenue is recognized based on the actual level of activity used by the customer or, in the case of fixed-fee arrangements, ratably over the arranged time period.
The Company provides customers, free of charge or at a minimal cost, testing kits which potential licensing customers may use to test compatibility/acceptance of the Company's technology with the customer's intended applications.
3. Accounting for Acquisitions
We have completed our acquisitions of PSG and AMG. These acquisitions have been accounted for under the purchase method of accounting, which has resulted in recording significant goodwill and other intangible asset balances. The purchase prices have been allocated to assets acquired and liabilities assumed at their estimated fair values on the date of the acquisitions, as determined by management, and by appraisals with respect to identifiable intangible assets. Our accounting for these acquisitions involves significant judgments and estimates regarding fair values of acquired intangible assets, which are based on projections of future revenues and cash flows, assumptions regarding discount factors, royalty rates, tax rates, amortization methodologies and related useful lives. The developed technology (software), copyrighted software, marketing agreements, customer relationships and trademarks were valued using the income approach and are being amortized on a straight line basis over their estimated useful lives, which range from 5 to 7 years.
4. Marketable Debt Securities
The Company accounts for marketable securities pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). SFAS 115 requires classification of debt and equity securities in three categories: trading securities, available-for-sale securities and held-to-maturity securities. Debt and equity securities classified as trading securities are carried at fair value with unrealized gains or losses included in income. 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 securities that are expected to be held-to-maturity are carried at amortized cost. On December 31, 2004, the Company's investments were all classified as available-for-sale. In January 2005 the Company sold these investments and did not purchase any additional Marketable Debt Securities as of December 31, 2005.
5. Derivative and Warrant financial instruments
In connection with the sale of debt or equity instruments, we may sell options or warrants to purchase our common stock. In certain circumstances, these options or warrants may be classified as derivative liabilities, rather than as equity. Additionally, the debt or equity instruments may contain embedded derivative instruments, such as conversion options, which in certain circumstances may be required to be bifurcated from the associated host instrument and accounted for separately as a derivative instrument asset or liability.
The identification of, and accounting for, derivative instruments is complex. Our derivative instrument liability is re-valued at the end of each reporting period, with changes in the fair value of the derivative liability recorded as charges or credits to income, in the period in which the changes occur. For options, warrants and bifurcated conversion options that are accounted for as derivative instrument liabilities, we determine the fair value of these instruments using the Black-Scholes option pricing model. That model requires assumptions related to the remaining term of the instruments and risk-free rates of return, our current common stock price and expected dividend yield, and the expected volatility of our common stock price over the life of the option. The identification of, and accounting for, derivative instruments and the assumptions used to value them can significantly affect our financial statements.
6. Goodwill and Intangible Assets
Goodwill represents the excess of costs of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets., which requires the Company to test goodwill for impairment annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, rather than amortize. Accordingly, the Company has not amortized goodwill. 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 December 31, 2005, the Company believes that no material impairment exists. Future impairment charges from previous or future acquisitions, if any, will be reflected as an operating expense in the statement of operations.
7. Deferred Revenue
Deferred revenue includes customer advances and amounts that have been billed per the contractual terms but have not been recognized as revenue. The majority of these amounts are related to maintenance contracts for which the revenue is recognized ratably over the applicable term, which generally is 12 months from the date the customer accepts the products.
8. Research and Development Expenditures
Research and development expenses include costs directly attributable to the conduct of research and development programs primarily related to the development of our software products and improving the efficiency and capabilities of our existing software. Such costs include salaries, payroll taxes, employee benefit costs, materials, supplies, depreciation on research equipment, services provided by outside contractors, and the allocable portions of facility costs, such as rent, utilities, insurance, repairs and maintenance, depreciation and general support services. All costs associated with research and development is expensed as incurred.
9. Earnings Per Share Common Stock
Earnings per share of common stock-basic is computed by dividing Net Income applicable to common stockholders by the weighted-average number of common shares outstanding for the period. Earnings per share of common stock-assuming dilution reflects the maximum potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and would then share in the net income of the company. See note U. "Earnings Per Share of Common Stock," for additional information.
10. Income Taxes
The provision for, or benefit from, income taxes includes deferred taxes resulting from the temporary differences in income for financial and tax purposes using the liability method. Such temporary differences result primarily from the differences in the carrying value of assets and liabilities. Future realization of deferred income tax assets requires sufficient taxable income within the carry back, carry forward period available under tax law. The Company evaluates, on a quarterly basis whether, based on all available evidence, if it is probable that the deferred income tax assets are realizable. Valuation allowances are established when it is more likely than not that the tax benefit of the deferred tax asset will not be realized. The evaluation, as prescribed by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," includes the consideration of all available evidence, both positive and negative, regarding historical operating results including recent years with reported losses, the estimated timing of future reversals of existing taxable temporary differences, estimated future taxable income exclusive of reversing temporary differences and carryforwards, and potential tax planning strategies which may be employed to prevent an operating loss or tax credit carry forward from expiring unused. Because of the Companies historical performance and estimated future taxable income a full valuation allowance has been established.
11. Accounting for 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. Accordingly, financial statement amounts for the prior periods presented have not been restated to reflect the fair value method of expensing share-based compensation.
Under this application, we are required to record compensation cost for all share-based payments granted after the date of adoption based on the grant date fair value estimated in accordance with the provisions of SFAS 123R and for the unvested portion of all share-based payments previously granted that remain outstanding which were based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. The majority of our share-based compensation arrangements vest over either a three or four year vesting schedule. The Company expenses its share-based compensation under the ratable method, which treats each vesting tranche as if it were an individual grant.
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 option term"), the estimated volatility of our common stock price over the option's expected term, the risk-free interest rate over the option's expected term, and the Company's expected annual dividend yield. 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 number of individuals that will ultimately not complete their vesting requirements). 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. The compensation expense recognized in connection with the adoption of SFAS 123R increased the Company's net loss by $169,352 with no effect per share for the
three months ended June 30, 2006 and increased the Company's net loss for the six months ended June 30, 2006 by $289,919. 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 SFAS 123R had no impact on deferred taxes.
12. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses during the reporting period, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
Estimates and assumptions which, in the opinion of management are used in accounting for, among other things, long-term contracts, allowances for uncollectible receivables, recoverability of goodwill and other long-lived assets, depreciation and amortization, valuation of deferred income taxes, convertible notes and related preferred stock, and stock options, discounts, embedded derivatives, and warrants outstanding.
RECENT ACCOUNTING STANDARDS
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 will be effective beginning Q1 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.
On September 30, 2004, BIO-key completed a transaction with Aether Systems, Inc. to purchase its Mobile Government Division ("Mobile Government" or "AMG"), a leading provider of wireless data solutions for use by public safety organizations, primarily state, local police, fire and rescue and emergency medical services organizations. The PacketCluster mobile information software is integrated with 50 separate State/NCIC databases, as well as other state, local and federal databases. Its open architecture and its published Application Programming Interface (API) make it easy to interface with a wide range of information sources. PacketCluster products deliver real-time information in seconds, freeing dispatchers to handle more pressing emergencies.
BIO-key® operates in three major segments—biometrics, law enforcement and fire safety. These segments are described below and a list of products in each line is noted.
BIO-key's finger identification algorithm—Vector Segment Technology (VST™) is the core intellectual property behind its full suite of biometric products that include:
Vector Segment Technology SDK (VST)—BIO-key's biometric development kit that provides developers the ability to take advantage of a highly accurate, device interoperable algorithm. VST is available as a low level SDK for incorporation into many complex application systems. VST runs in Windows, Linux or Solaris systems.
True User Identification®—BIO-key's biometric identification solution that offers large scale one to many user lookup with nothing but a single fingerprint. This solution leverages the power of Oracle for large scale solutions in the millions of users, or uses smaller databases for more modest applications to 100,000 users.
WEB-key®—BIO-key's biometric platform that offers an enhanced level of security by securing the user's authentication with trusted communications and simple use. WEB-key runs on Windows or Linux systems.
Biometric Service Provider™—BIO-key provides support for the BioAPI (a standards based solution meeting worldwide needs, see www.bioapi.org for details) for a compliant interface to applications using biometrics for verification and identification. BIO-key enhances the traditional use of the BioAPI by adding support for CE devices, supporting identification calls and also providing a single user interface for multiple fingerprint readers.
ID Director™—BIO-key's solution for single sign on integration with Computer Associates SiteMinder, Oracle's Fusion Middleware SSO, and other solutions, utilizing the power and security of WEB-key. This solution provides a simple to implement, custom authentication scheme for companies looking to enhance authentication and add a level of security and audit through re-authentication of a user at the transaction level.
The Company's biometric identification technology improves both the accuracy and speed of finger-based biometrics. The Company's proprietary biometric technology scans a fingerprint and identifies a person, typically within a few seconds or less, in databases of a million people or more. BIO-key can accomplish this without using any other identifying data—a key differentiator for BIO-key since other biometric solutions may also require traditional token/card identification. BIO-key's core technology supports user enrollment on over 40 different commercially available readers and in turn can offer compatibility among those readers through a single fingerprint template. We have also added INCITS 378-2004 support to our software development kits which makes our products compatible with all of the Registered Traveler projects, PIV initiatives, and FIXS consortium solutions. We believe our fingerprint identification technology has a broad range of possible information security and access control applications, including:
Securing Internet sites and electronic transactions
Securing access to logical networks and applications
Securing access to buildings and restricted areas
Providing fast, accurate member identification services
Securing mobile devices such as cell phones and PDA's
Preventing identity theft with positive identification and false alias validation
MobileCop™—A complete wireless query and messaging application that puts the power of mobile and wireless technology to work for agencies of every size, MobileCop™ sets the standard for mobile law enforcement. Providing real-time retrieval of motor vehicle, warrant and criminal history information, powerful mobile integration capabilities, and an intuitive user interface, MobileCop delivers the most in performance and it's easy to see why over 1,200 law enforcement agencies around the country have deployed MobileCop for fast and secure access to critical information in the field.
PocketCop®—PocketCop® is a software solution that provides police officers and other security personnel instantaneous access to important criminal, civil, and private database information in a wireless environment. PocketCop® is a handheld application that allows law enforcement officers to access state and federal databases over the wireless network for Palm OS, Windows CE, and Pocket PC. Using a portable wireless handheld device and the PocketCop® application software, an authorized user can access suspect information such as wanted status, warrant status, vehicle registration and driver license status. PocketCop® technology has been deployed in numerous police departments in the United States, including the deployment for the Massachusetts State Police.
IdentityMatch™—a web-based system that allows law enforcement agencies to capture and store fingerprints online and to identify subjects by matching their fingerprint against those stored in the database, securely and in real time. Fingerprints can be captured using a live scan device from existing 10-print cards or through a wide variety of inexpensive commercially available fingerprint readers. This is an AFIS companion, not a replacement, product designed to maximize the value of fingerprint data and also to provide a new level of safety for the law enforcement personnel.
BIO-key also provides a number of optional features designed to augment the core Law Enforcement products. These include:
Field Interview Tracker™—enables personnel to capture field contact information. The data is stored in a searchable database where it can be located quickly. Police agencies can create online contact forms that meet their specific needs and multiple agencies can share information while using their own forms and procedures.
TStop™—was developed to enable law enforcement agencies to comply with state mandated and voluntary traffic stop reporting. Law enforcement personnel can capture the required information on their mobile computer and transmit it to the server where it is stored and can generate reports.
State Crash Report—enables personnel to use their mobile computer to collect data needed for their state's crash report. This data can be wirelessly transmitted to a server so a supervisor can review and approve it. Once complete the report can be printed in the state's format. Only selected states are supported.
Multiple Application Programming Interface (API)—allows an agency to have multiple ports to the server to accommodate disparate interfaces. These multiple API ports are in addition to the one port that is inherent in the server as well as the State/NCIC interface.
Incident Command—using FieldSoft's PDonScene, this solution is used by both patrol and tactical teams, such as a SWAT, to manage people and resources at the scene of an incident or
at a central location such as an emergency operations center. It can also be used for general event management.
InfoServer™—BIO-key's solution for an agency's central messaging switch for application software service, State/NCIC interfaces, Computer Aided Dispatch (CAD) and Records Management Software (RMS) interfaces, data sharing and other applications.
In addition to law enforcement/fire service mobile data solutions, BIO-key offers its Sunpro fire service/EMS records management software, FireRMS™, that helps large and small agencies manage operations, track incidents and support fire prevention initiatives. FireRMS Mobile provides wireless query and messaging solutions that extend computer aided dispatch, fire records, and other in-house data sources to a mobile environment and provide mission-critical information to emergency response personnel where and when they need it.
PacketCluster® Rescue™ —BIO-key's mobile information solution for fire and EMS, runs off the same server as MobileCop™. It provides much of MobileCop™ functionality without the State/NCIC interface not required by fire service and EMS. Rescue provides mission-critical data such as HAZMAT information and building plans that fire service officers need to know while at a fire scene.
FireRMS Records Management Software—this NFIRS 5.0-compliant fire records system helps manage operations, track incidents and support fire prevention initiatives. It is designed to speed data entry and reduce completion time for front-line personnel.
CAD Interfaces—CAD interfaces provide a connection between BIO-key records and all major CAD systems with the most comprehensive real time integration. Incident reports are opened as soon as CAD dispatches a call. Incidents are current and ready to complete when the crew returns to the station, streamlining and improving the accuracy of incident reporting.
RMS Interfaces—RMS interfaces provide a mechanism to integrate patient care reports collected in the field with the NIBRS report. Patient data is populated in the appropriate fields, eliminating redundant data entry.
Other Interfaces—BIO-key provides interfaces to other third party solutions including EMS billing, EMS county/state interfaces, professional staffing solutions and others.
BIO-key also offers the following Fire/EMS Partner solutions:
EMS Field Data Collection—Regist*r Express from MedDataSolutions enables EMS field data collection for efficient collection of patient data where it is generated.
Geographic Data Analysis—FireView™ from the Omega Group allows Fire and EMS agencies to analyze their deployment strategies.
Personnel Staffing—Telestaff™ from PDSI automates and manages complex Fire/RMS agency staffing needs and is integrated with FireRMS's Personnel and Roster modules.
Incident Command Module—FDonScene™ by FieldSoft provides incident management, responder accountability, and tactical survey or preplan browser software solutions. FDonScene interfaces with PacketCluster Rescue to support incident management-en route or on scene.
Current Business Plan
BIO-key's current business plan is to:
License its core technology "VST" and True User Identification® to original equipment manufacturers, systems integrators, and application developers who develop products and applications that utilize its biometric finger matching solutions.
License WEB-key®, the Company's security centric web-based biometric authentication solution.
Provide for "device independent" finger identification matching for virtually any application by using the latest advances in scanning technology.
License its wireless software solutions for the public safety market directly to counties, cities and towns across North America as well as through systems integrators and resellers.
Leverage its FireRMS suite of products for the growing Emergency Medical Service data collection and reporting market.
Integrate its core technology competencies to leverage new business opportunities and develop new markets for its innovative products.
BIO-key's InfoServer™, MobileCop™ and PocketCop® Law Enforcement products are the leading wireless mobile data communications client/server solution, implemented in more than 1,200 agencies nationwide. Providing immediate access to mission-critical data and enabling in-field reporting, BIO-key software keeps officers on the street, improving their productivity and enhances officer safety. BIO-key solutions are able to run across any and all wireless infrastructures and integrate with virtually all computer-aided dispatch (CAD) and records management systems. This makes us a proven leader in multi-agency cooperation and interoperability, which are absolutely critical in times of large-scale natural and terrorist threats.
Growth potential—BIO-key's large base of more than 1,200 law enforcement agencies continues to be a strength that helps leverage additional sales from both existing customers and new customers. A key opportunity is the growing awareness of the need for multi-agency interoperability. In these situations, BIO-key offers:
BIO-key's LE products can run on any and all wireless infrastructures. BIO-key also has proven success implementing seamless roaming across multiple infrastructures for multi-agency consortiums.
BIO-key's open architecture.
BIO-key has experience in large, complex and multi-agency implementations such as Hamilton County, Ohio, Sheriff's Office and Pennsylvania State Police.
These capabilities position BIO-key well to work with leading CAD vendors, even with vendors that have mobile data solutions but do not have the depth of interoperability capability that BIO-key offers.
An additional growth area is the introduction of BIO-key's finger-based biometric identification to law enforcement. In addition to now offering biometric login to our traditional InfoServer™ product, we have introduced the IdentityMatch™ fingerprint identification solution, which lets law enforcement personnel capture fingerprints in the field and, using BIO-key's patented Vector Segment Technology®, then analyzes and categorizes fingerprints the same way a fingerprint expert would—only faster. IdentityMatch™ also enables multiple law enforcement agencies to share fingerprint data with other agencies. This powerful tool, built on BIO-key's understanding of law enforcement requirements and its fingerprint technology, present opportunities for the law enforcement business segment in the coming year.
BIO-key's FireRMS fire records management software is a flexible solution available for Fire Service and EMS agencies. It is a comprehensive collection of modules that manage a range of activities from daily scheduling to vehicle maintenance. FireRMS streamlines data collection across all areas of department operations, and integrates with other department systems to provide a seamless solution for data access, whether in the station or on the scene of an incident. In addition to helping first responders efficiently deliver traditional fire safety and services and respond to massive emergency situations, it enables adherence to NFIRS, NEMSIS, HIPAA, and ISO requirements. The solutions also bring the station into the field with mobile data communications solutions, and most recently, FireRMS Mobile, which brings the capabilities of FireRMS to first responders where and when they most need to report and access critical information.
Growth potential—a growth opportunity for the fire business segment is in the mobile market with the RMS mobile products. BIO-key's FireRMS Mobile solutions extend the power of our FireRMS product to the field. Inspectors, for example, can now perform occupancy inspections over a wireless or synched connection using a pen tablet. This approach eliminates redundant data entry, and provides immediate updates of critical information and notification of violations. Likewise, EMS workers can collect critical patient data and relay the data to medical personnel. This new mobile approach to fire and EMS data collection and access offers great potential among both new and existing FireRMS customers.
Finger-based Biometric Identification
Finally, BIO-key is a leader in finger-based biometric identification. In partnerships with OEMs, integrators, and solution providers, we provide biometric software solutions to private and public sector customers. BIO-key's patented vector segment technology is the foundation for these solutions.
BIO-key's WEB-key® is a cost-effective, easy-to-deploy, fingerprint-based strong authentication system. This unique solution allows users to positively identify themselves to any application with the simple scan of their finger. This capability is a significant improvement in both convenience and security over other alternatives and provides companies with a cost-effective solution to thwart phishing attacks and comply with government regulations and legislation such as FFIEC compliance, HIPAA, Sarbanes-Oxley, and the Electronic Signatures Act. BIO-key couples these capabilities with device interoperability and system flexibility and scalability. BIO-key enables the use of about 40 different fingerprint sensor technologies to enroll and identify employees, customers or business partners. Most recently, BIO-key integrated its biometric capabilities with its public safety mission with the introduction of IdentityMatch™, a real-time, in-station solution that allows law enforcement professionals to capture fingerprints from a suspect or captured from a crime scene and compare them to fingerprints. BIO-key has also formed relationships with providers of biometric logon software like IdentiPHI, Softex, and Computer Associates to provide enterprise-ready SingleSignOn systems to many large companies in the US and abroad. Also, BIO-key has integrated to a pure physical access solution in NextGenID, which has been deployed at BIO-key facilities.
Growth potential—As the provider of the core technology, BIO-key's greatest growth potential for this market is as a partner with companies that offer cutting-edge applications that address growing concerns particularly about identity theft and terrorism.
For example, BIO-key has implemented programs that will enable biometric access. These include a national pilot with a large fitness center chain to provide finger-based membership and access to its locations around the country; with IdentiPHI to provide strong network based authentication on BIO-key technology; and with the Pegasus Program to authenticate users accessing a nationwide information-sharing system designed by and for the nation's sheriffs. These represent the kind of partnership-based opportunities BIO-key may see in the finger- based biometric market.
In parallel, BIO-key is both strengthening security and improving user and system administrator convenience by integrating biometric log-in, as well as two-factor authentication, with its law enforcement and fire safety products. This is a true differentiator to potential new customers, and creates add-on opportunities with existing customers.
The markets for BIO-key products and technologies are developing and are characterized by intense competition and rapid technological change. No assurance can be given that our competitors will not develop new or enhanced technologies that will offer superior price, performance, or features, or render BIO-key products or technologies obsolete.
In addition to companies that provide existing commonplace methods of restricting access to facilities and logical access points such as pass cards, PIN numbers, passwords, locks and keys, there are numerous companies involved in the development, manufacturing and marketing of fingerprint biometrics products to commercial, government, law enforcement and prison markets. These companies include, but are not limited to, Cogent, NEC, IDENTIX, Sagem-Morpho, and Bioscrypt.
The most recent automated fingerprint identification product sales in the market have been deployed for government and law enforcement applications, typically at more cost than BIO-key's products and licensing arrangements. Although most companies that target consumer application markets have completed development of their biometric products, such technologies have not been widely accepted in the commercial markets to date. Most companies competing for commercial opportunities are in the business of selling scanning devices and tie their algorithm to a specific device. BIO-key has created a "device independent" algorithm that provides flexibility in choosing the correct device and optical or tactile sense to fit the application served.
BIO-key has found that commercial markets have been slow to widely purchase biometrics as a viable alternative to their current security methods. As a result, the primary competition for biometric technology consists of traditional security methods such as passwords, PINs, cards, and tokens.
With respect to competing biometrics technologies, each has its strength and weaknesses and none has emerged as a market leader:
Fingerprint identification is generally viewed as inexpensive and non-intrusive.
Iris scanning is viewed as accurate, but can be expensive and inconvenient to use.
Facial recognition has recently received substantial attention; however, it can have accuracy limitations and be highly dependent on ambient lighting conditions, angle of view and other factors.
The market for biometric technology is evolving. Computer breaches, identity theft, phishing and other events in the recent past are driving a large-scale shift to biometric deployments. In addition, companies such as IBM, Dell, Gateway, MPC, Samsung and HP have all introduced computers with integrated finger scanning devices to complement the conventional username/password technique since it is highly susceptible to hackers and security breaches. BIO-key supports these integrated devices for broader enterprise level security solutions.
The public safety market comprises agencies at all government levels, with a range of users, from a few to many hundreds. BIO-key competitors in the mobile data market include Computer Aided Dispatch/Records Management companies such as Printrak, InfoCop and Motorola. Each has comprehensive CAD and/or RMS offerings and has augmented those with their own mobile data and field reporting solutions. While these solutions may not be as functionally rich as the BIO-key suite of products, they are sometimes less expensive. They also provide a complete solution from one vendor.
The fire records management market includes a large number of RMS vendors including Firehouse, FDM and ETI. These and other competing companies represent a wide range of organizations, from large integration companies, to small garage companies, and offer products similar in scope to BIO-key's FireRMS. The functionality and price of these products also encompass wide ranges of features and costs.
BIO-key's marketing and distribution efforts comprise the following major initiatives:
During the past year, BIO-key has strengthened its alliance with Oracle and has been recognized as a Certified Partner in the Oracle Partner Network. BIO-key supports the Oracle e-business suite of applications and provides the biometric enabler for the Oracle Single Sign on product. As an Oracle development partner, BIO-key provides the underlying database used for true user identification and on demand alias checking. As a development partner, BIO-key participates in Oracle Trade Shows such as Oracle Open World and Oracle Apps World.
BIO-key has strategic alliances with technology leaders including Oracle, Netegrity, Hewlett Packard, Dell, Verizon, Sprint/Nextel, Cingular and others.
BIO-key is also promoting biometric technology and its offerings through industry trade shows, public speaking engagements, press activities and partner marketing programs
BIO-key is directing licensing efforts to original equipment manufacturers, application developers and system integrators.
BIO-key is building a reseller, integrator and partner network as well as a direct sales team.
Following are the specific marketing/sales programs in place:
Direct Selling Efforts—BIO-key now has a base of area sales directors who are responsible for both the law enforcement and fire safety markets. This team of sales professionals brings extensive experience in technical solution and relationship-based selling. They are supported by a pre-sales team that includes system engineering and proposal management and a post-sales program management, implementation and training professionals. Included in this team are individuals who are themselves former police officers and firefighters.
BIO-key's direct sales force also includes area sales directors for the OEM and Federal Government markets, each of whom brings not only extensive sales experience but also expertise in emerging biometric technologies. The BIO-key sales force is rounded out by Inside Sales, which is responsible for maintaining and supporting our existing install base, acting as a front-line support for any inquiries on our product line, and facilitating activities that make the field team more productive.
Conferences and Trade Shows—BIO-key attends and actively participates in various product-related conferences and trade shows in the technology and security industries to generate market awareness of biometric and wireless mobile data technology generally and our offerings specifically. BIO-key's public safety software often is featured at our business partners' booths at these events, showcasing the interoperability of the two products.
Strategic Alliance—BIO-key's strategic alliances and reseller agreements with other vendors play a significant role in our overall sales efforts. In the past year, BIO-key has initiated and bolstered numerous important and promising long-term relationships. Just a few examples include:
BIO-key is partnering with Cingular, the largest wireless carrier in the country, to first responders in a seven-county Tennessee consortium of fire, police and EMS agencies in access to mission critical information using MobileCOP solution in conjunction with Cingular's nationwide* EDGE wireless data network.
The Omega Group continues to provide FireView software mapping tools that help review existing deployment policies and develop new strategies, to complement BIO-key's range of solutions for Fire/EMS agencies.
BIO-key now resells solutions from ThreatScreen that provide an exposure-diagnostic/identification, data collection, and reporting tool to first responders so they can quickly assess victims to determine chemical, biological, or nuclear agent exposure.
Silex Technology America, Inc., which develops fingerprint reader products designed to support a variety of secure computing options, utilizes BIO-key's VST and WEB-key technology.
Strategic Marketing Alliance—BIO-key has established a strategic marketing alliance with Hewlett Packard to provide BIO-key handheld technology for the Massachusetts State Police.
Reseller Relationships—BIO-key has established reseller relationships with companies that resell BIO-key public safety software.
BIO-key targets both Internet infrastructure companies and large portal providers as possible licensees for its WEB-key® solution. On the Internet infrastructure side, BIO-key seeks to partner with Internet server manufacturers, providers of database and data warehouse engine software, horizontally positioned application engines, firewall solution providers and peripheral equipment manufacturers. On the portal side, BIO-key is targeting financial service providers such as credit and debit card authorization and issuing institutions, Internet retailers, business-to-business application service providers (ASPs) and corporate intranets. In the past three years, BIO-key has undertaken a WEB-key® and VST direct selling effort, and entered into license agreements with OEMs and system integrators to develop applications for distribution to their respective customers.
BIO-key is also addressing the security needs of application providers in the following vertical markets:
Government—Using BIO-key's technology, Northup Grumman deployed an application within the Department of Defense to cross-credential visitors and contractors to certain military bases.
Education—Educational Biometric Technologies, Lunch Byte Systems and Identimetrics have incorporated BIO-key technology to enable school children to pay for school lunch programs and checkout library books using their fingerprints. VST technology enables schools to enroll these children and reduces the administrative costs of managing passwords and collecting payments.
Commerce—ChoicePoint has implemented a check cashing solution using BIO-key's VST technology to reduce fraud and identity theft.
Patient Records and Information Management—HBOC, one of the largest healthcare patient records and information management companies, has integrated BIO-key technology into their portal and has deployed their solution in a pilot for the Baptist Hospital System.
Financial—BIO-key is working with several companies focusing on financial applications such as point of sale systems and employee trusted identification cards, as well as customer facing applications over the Internet. BIO-key has also begun work with several financial institutions to incorporate its technology for secure access to money transfers for institutional customers.
We believe that our intellectual property is important to our biometric, law enforcement and fire information management segments:
Patents—our biometrics segment uses patented technology and trade secrets developed or acquired by us. In May 2005, the U.S. Patent Office issued us a patent for our Vector Segment fingerprint technology (VST), BIO-key's core biometric analysis and identification technology. Additionally, we have a number of U.S. and foreign patent applications in process related to this intellectual property.
Trademarks—We have registered our trademarks (BIO-key", "SACman", "SACcat", "SACremote", "True User Identification", "WEB-key", "PacketCluster", "PacketCluster Patrol", "PacketWriter", "PacketBlue", "SunPro") and the design mark for "Ceurulean" with the U.S. Patent and Trademark Office. We have also applied for trademarks for "PocketCop" and "Cerulean".
Copyrights and trade secrets—We take measures to ensure copyright and license protection for our software releases prior to distribution. When possible, the software is licensed in an attempt to ensure that only licensed and activated software functions to its full potential. We also take measures to protect the confidentiality of our trade secrets.
Our research and development efforts are concentrated on enhancing the functionality, reliability and integration of our current products as well as developing new and innovative products for the biometrics, law enforcement and fire markets. Although BIO-key believes that its identification technology is one of the most advanced and discriminating fingerprint technologies available today, the markets in which BIO-key compete are characterized by rapid technological change and evolving standards. In order to maintain its position in the market, BIO-key will continue to upgrade and refine its existing technologies.
In 2005, BIO-key announced the launch of IdentityMatch, our fingerprint identification system. IdentityMatch offers a tool for agencies to store and search fingerprints and the associated demographic data, the ability to compare new prints with those previously captured as a low-cost AFIS
alternative or to be used for a wide variety of routine identification transactions not supported by AFIS. IdentityMatch™ is currently being tested by a number of customers.
During fiscal years ended December 31, 2004 and 2005, BIO-key spent approximately $2,980,000 and $6,846,000 respectively, on research and development. BIO-key's limited customer base during that time did not directly bear these costs, which were principally funded through outside sources of equity and debt financing.
BIO-key is not currently subject to direct regulation by any government agency, other than regulations generally applicable to businesses or related to specific project requirements. In the event of any international sales, the company would be subject to various domestic and foreign laws regulating such exports and export activities.
As of the date of this report, BIO-key has not incurred any material expenses relating to our compliance with federal, state, or local environmental laws and does not expect to incur any material expenses in the foreseeable future.
BIO-key currently employs ninety-six (96) individuals on a full-time basis: sixty (60) in engineering, customer support, research and development; fifteen (15) in finance and administration; and twenty-one (21) in sales and marketing. BIO-key also uses the services of seven (7) consultants who provide engineering and technical services.
We do not own any real estate. We conduct operations from leased premises in Marlborough, Massachusetts (38,000 square feet), Eagan, Minnesota (6,800 square feet), Wall, New Jersey (2,180 square feet) and Winter Park, Florida (900 square feet). We believe that our current facilities are adequate for the foreseeable future.
Prior to our acquisition of PSG in March 2004, PSG had been 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 was then removed to the United States District Court for the District of Massachusetts at the request of the parties. The complaint claimed that PSG was obligated to pay a percentage of certain of its revenues to TVG in consideration for a strategic business introduction allegedly made by an agent of TVG. PSG denied the allegations and filed an answer in the litigation. On April 20, 2006, the action was reported settled to the Court, and on June 20, 2006 a Stipulation of Dismssal with Prejudice was filed.
Directors and Executive Officers
The following sets forth certain information about each director and executive officer of the Company.
Thomas J. Colatosti 58 Chairman of the Board of Directors
Michael W. DePasquale 51 Chief Executive Officer and Director
Jeffrey J. May 46 Director
Charles P. Romeo(a) 64 Director
John Schoenherr 53 Director
Francis J. Cusick 51 Chief Financial Officer
Randy Fodero 47 Vice President of Sales
Kenneth S. Souza 51 General Manager, Law Enforcement and Chief Technology Officer
From April 2004 to February 2005, Mr. Romeo was employed by the Company.
The following is a brief summary of the business experience of each of the above-named individuals:
THOMAS J. COLATOSTI has served as a Director of the Company since September 2002 and as Chairman of the Board since January 3, 2003. He has served as Co-Chief Executive Officer from July 2005 to August 2006. Mr. Colatosti also currently serves as the Chief Executive Officer of American Security Ventures, a Lexington, Massachusetts based consulting firm he founded which specializes in providing strategic management consulting services to emerging and developing companies in the homeland security industry. From 1997 through June 2002, Mr. Colatosti served as the Chief Executive Officer of Viisage Technology, Inc., a publicly traded biometric technology company focusing on biometric face-recognition technology and delivering highly secure identification documents and systems. Between 1995 and 1997, Mr. Colatosti served as President and Chief Executive Officer of CIS Corporation, a higher education industry leader that designed and implemented integrated and flexible systems solutions to manage entire university administrative operations. Prior to CIS, Mr. Colatosti had a 20-year career with Digital Equipment Corporation. His most recent responsibility was Vice President and General Manager, Northeast Area, where he was responsible for a business unit with annual revenues of more than $1.2 billion and 3,000 people. Mr. Colatosti is an active industry security spokesperson testifying before Congressional Committees and advising the White House and other Federal security agencies on homeland security issues. Since August 18, 2005, Mr. Colatosti has served as a Director and Chief Financial Officer of Good Harbor Partners Acquisition Corp., a publicly-traded blank check company formed to acquire businesses in the security sectors. Mr. Colatosti earned a Bachelor of Science degree in Management and Finance as well as a Masters degree in Business Administration from Suffolk University.
MICHAEL W. DEPASQUALE has served as the Chief Executive Officer and a Director of the Company since January 3, 2003. He has served as Co-Chief Executive Officer from July 2005 to August 2006. Mr. DePasquale brings more than 20 years of executive management, sales and marketing experience to the Company. Prior to joining the Company, Mr. DePasquale served as the President and Chief Executive Officer of Prism eSolutions, Inc., a Pennsylvania based provider of professional consulting services and online solutions for ISO-9001/14000 certification for customers in manufacturing, healthcare and government markets, since February 2001. From December 1999 through December 2000, Mr. DePasquale served as Group Vice President for WRC Media, a New York based distributor of supplemental education products and software. From January 1996 until
December 1999, Mr. DePasquale served as Senior Vice President of Jostens Learning Corp., a California based provider of multi media curriculum. Prior to Jostens, Mr. DePasquale held sales and marketing management positions with McGraw-Hill and Digital Equipment Corporation. Mr. DePasquale earned a Bachelor of Science degree from the New Jersey Institute of Technology.
JEFFREY J. MAY has served as a Director of the Company since October 29, 2001. Since 1997, Mr. May has served as the President of Gideons Point Capital, a Tonka Bay Minnesota based financial consulting firm and angel investor focusing on assisting and investing in start-up technology companies. In 1983, Mr. May co-found Advantek, Inc., a manufacturer of equipment and materials which facilitate the automatic handling of semi-conductors and other electrical components which was sold in 1993. Mr. May continued to serve as a director and Vice-President of Operations of Advantek until 1997, at which time it had over 600 employees and sales in excess of $100 million. Mr. May earned a Bachelor of Science degree in Electrical Engineering from the University of Minnesota in 1983.
CHARLES P. ROMEO has served as a director of the Company since February 28, 2005 and from January 29, 2003 to April 19, 2004. From April 2004 until February 2005, he served as Vice President of Sales, Public Safety Division of the Company. From September 2002 until April 2004, Mr. Romeo has served as the President and Chief Executive Officer of FreedomBridge Technologies, Inc., a Rhode Island based consulting firm to technology companies in the homeland security industry specializing in implementing direct and channel selling programs, strategic alliances and partnerships in the law enforcement market. Prior to founding FreeedomBridge, Mr. Romeo had a 33 year sales and marketing management career with Digital Equipment Corporation, Compaq Computer Corporation and Hewlett Packard. During his career, Mr. Romeo served as Vice President of Service Sales for a $500 million business unit, and Director of Public Sector Sales, a $275 million division of Hewlett Packard. Mr. Romeo authored The Sales Manager's Troubleshooter, Prentice Hall 1998, which was named as one of the "top 10 must reads" by Sales and Marketing Magazine. Mr. Romeo earned a Bachelor of Science degree in Mathematics and Economics from the University of Massachusetts and an Executive MBA from Babson College.
JOHN SCHOENHERR has served as a Director of the Company since December 30, 2004. Mr. Schoenherr serves as Vice President of Corporate Performance Management for Oracle Corporation, and has served as an Oracle Vice President for over five years. Mr. Schoenherr has over 25 years of experience in the area of business intelligence. His career includes a number of product development and management positions.
FRANCIS J. CUSICK has served as the Chief Financial Officer of the Company since February 28, 2005. Mr. Cusick joined the Company as the Corporate Controller in September 2004. Mr. Cusick served as an independent business consultant to public and private companies in a variety of strategic and financial executive roles from March 2002 until September 2004. From January 2001 through February 2002, Mr. Cusick was Chief Financial Officer for SANgate Systems, a multi-national provider of storage hardware and software. Between November 1999 and December 2000, Mr. Cusick served as Corporate Controller for Equipe Communications Corporation and was responsible for all accounting and finance functions. Prior to Equipe, Mr. Cusick held senior financial management positions at Parametric Technology Corp., Cascade Communications Corp. and Synernetics Inc.
RANDY FODERO has served as the Vice President of Sales since February 1, 2006. From July 22, 2005 until February 1, 2006, he was a sales consultant to the Company. Between July 18, 2003 and July 22, 2005, Mr. Fodero was the Vice President of Sales and Marketing of the Company. Mr. Fodero joined the Company as a member of the sales organization in March 2003. Mr. Fodero brings more than 20 years of successful executive and sales management experience to the Company. Prior to joining the Company, Mr. Fodero served as director of Global Accounts from Veritas Software from February 2002 until January 2003. Between 1999 and February 2002, Mr. Fodero served in executive sales capacities with both companies in the enterprise software industry, including Agile Software. From
1998 to 1999, Mr. Fodero served as Regional Vice President of Sales for Memco Software, a leading provider of information security software to Fortune 1000 companies, where he was instrumental in increasing sales and enhancing shareholder value in connection with the sale of Memco to Platinum Technology. From 1990 through 1998, Mr. Fodero served as Vice President of Sales of AT&T CommVault Systems, where he grew sales from startup to over $36 million and participated in a management buyout.
KENNETH S. SOUZA has served as Chief Technology Officer of the Company since October 4, 2004 and the General Manager, Law Enforcement since October 18, 2005. Prior to joining the Company, Mr. Souza was Vice President of Industry Solutions for EMC Corporation. Prior to joining EMC, he was Vice President for e-Commerce Enterprise Systems Solutions for Compaq Computer Corporation. His 25-year technology and market career includes serving in a number of executive positions with Digital Equipment Corporation including Vice President Worldwide Solutions Services and Training, and Director of Workstations Marketing. In the early 1980's, Mr. Souza held technical sales management positions with Hewlett Packard and Burroughs. Mr. Souza also held executive positions with a venture funded MRP software company.
Directors' Terms of Office
Mr. May was initially elected to serve as a director in 2001, and was re-elected in 2004. Mr. Colatosti was initially elected to serve as a director in 2002, and was re-elected in 2004. Mr. DePasquale was initially elected as a director in 2003, and was re-elected in 2004. Mr. Schoenherr was initially elected as a director in 2004. Mr. Romeo was initially elected as a director in 2005. Each such director was elected to serve until the Company's next annual meeting or until his successor is duly elected and qualified in accordance with the By-laws of the Company.
The following table sets forth a summary of the compensation paid to or accrued by our chief executive officer and all of our other executive officers as of December 31, 2005 (the "named executive officers") for each of the fiscal years ended December 31, 2003, 2004 and 2005:
SUMMARY COMPENSATION TABLE
Long Term Compensation
Annual Compensation
Options/SARs
Salary($)
Bonus($)
Other Annual
Compensation($)
LTIP
Michael W. DePasquale(1)
Chief Executive Officer 2005
148,943 —
1,080,000 —
Francis J. Cusick(2)
Randy Fodero(3)
Kenneth S. Souza(6)
General Manager, Law
Enforcement and Chief Technology Officer
Mr. DePasquale became employed as our Chief Executive Officer on January 3, 2003.
Mr. Cusick became our Chief Financial Officer on February 28, 2005.
Mr. Fodero became Vice President of Sales on February 1, 2006. He was a sales consultant to the Company from July 22, 2005 until February 1, 2006. Between July 18, 2003 and July 22, 2005, Mr. Fodero was the Senior Vice President of Sales and Marketing of the Company.
Includes $48,176, $47,674 and $10,282 of commission income in 2005, 2004 and 2003, respectively.
These options expired unexercised on October 20, 2005.
Mr. Souza became an executive officer of the Company on October 4, 2004.
OPTION GRANTS IN YEAR ENDED DECEMBER 31, 2005
The following table sets forth all options granted during the year ended December 31, 2005 to each of the named executive officers.
Options Granted
Percent of Total
Options Granted to
Employees in
$/Share
Francis J. Cusick(1) 155,000 10.0 % $ 1.33 02/27/2012
Randy Fodero 600,000 38.7 % 0.60 11/10/2012
Options vested in three (3) annual installments commencing February 28, 2006.
Options vest 33.3% upon grant and thereafter at 22.2222% in three (3) annual installments commencing November 11, 2006.
AGGREGATED OPTION EXERCISES IN THE YEAR ENDED
DECEMBER 31, 2005 AND FISCAL YEAR-END OPTION VALUE
The following table sets forth for each named executive officer, information regarding stock options exercised by such officer during the year ended December 31, 2005, together with the number and value of stock options held at December 31, 2005, each on an aggregated basis.
Acquired On
Realized
Unexercised
Options At Fiscal
Exercisable/
Unexercisable(#)
Value Of
In-The-Money
Unexercisable($)(1)
Michael W. DePasquale — — 1,080,000 92,800/0
Francis J. Cusick — — 15,000/185,000 0/0
Randy Fodero — — 200,000/400,000 18,000/36,000
Kenneth S. Souza — — 100,000/200,000 0/0
The last sales price of the Company's Common Stock as reported on the OTC Bulletin Board on December 30, 2005 was $0.69.
Directors who are also officers of the Company receive no additional compensation for serving on the Board of Directors, other than reimbursement of reasonable expenses incurred in attending meetings. The Company's 1996 stock incentive plan provides for the grant of options to purchase 50,000 shares of common stock to each non-employee director upon first being elected or appointed to the Board of Directors. The Company's current policy is to issue options to purchase 50,000 shares of common stock to each non-employee director on an annual basis.
MICHAEL W. DEPASQUALE. On March 28, 2006, the Company entered into a two-year employment agreement with Michael W. DePasquale to serve as the Co-Chief Executive Officer of the Company at an annual base salary of $250,000 subject to adjustment by the Board of Directors as well as $1,000 per month in lieu of participating in the Company's medical plan. In addition to the Base Salary and Stock Options, a "Discretionary Bonus" may be awarded to Mr. DePasquale on the basis of merit performance on an annual basis in the sole discretion of the Board of Directors. The employment agreement also provides for the grant of options to purchase up to 400,000 shares of Company common stock payable at the discretion of the Board of Directors.
In the event that Mr. DePasquale is terminated without cause, Mr. DePasquale will receive severance payment equal to his base salary for the 6 months. The employment agreement contains standard and customary confidentiality, non-solicitation and "work made for hire" provisions as well as a covenant not to compete which prohibits Mr. DePasquale from doing business with any current or prospective customer of the Company or engaging in a business competitive with that of the Company during the term of his employment and for the one year period thereafter. The Company may terminate the agreement at any time with or without cause. In the event of termination without cause, Mr. DePasquale shall continue to be paid his then current base salary for the greater of six months from the date of such termination or the number of months remaining until the end of the term of the employment agreement.
KENNETH S. SOUZA. In connection with his appointment as Senior Vice President and Chief Technology Officer of the Company on October 4, 2004, we entered into a one (1) year employment
agreement with Kenneth S. Souza. The employment agreement provides for an annual base salary of $200,000 and a performance bonus in the amount of up to $76,000 payable upon achievement of certain performance criteria. Unless notice of non-renewal is provided to Mr. Souza at least two months prior to the end of the term, the employment agreement automatically renews for successive one year terms. In the event that Mr. Souza is terminated without cause, Mr. Souza will receive severance payment equal to his base salary for the greater of 6 months and that number of months remaining until the end of the term. The employment agreement contains standard and customary confidentiality, non-compete and work made for hire provisions.
Upon execution of the employment agreement, we issued to Mr. Souza a stock option to purchase 300,000 shares of our common stock at an exercise price of $1.11 per share, the last sale price of our common stock as reported on the OTC Bulletin Board on the date of grant. The option has a term of seven (7) years and vests in three equal annual installments commencing on October 4, 2005. Upon completion of one (1) year of service, Mr. Souza shall be eligible to receive a stock option to purchase up to an additional 300,000 shares of Company stock based upon his performance as determined by the Company in its sole discretion.
Change in Control Provisions
The Company's 1996 Stock Option Plan (as amended to date, the "1996 Plan"), 1999 Stock Option Plan and 2004 Stock Incentive Plan (the "1999 Plan" and together with the 1996 Plan and 2004 Plan, the "Plans") provide for the acceleration of the vesting of unvested options upon a "Change in Control" of the Company. A Change in Control is defined in the Plans to include (i) a sale or transfer of substantially all of the Company's assets; (ii) the dissolution or liquidation of the Company; (iii) a merger or consolidation to which the Company is a party and after which the prior shareholders of the Company hold less than 50% of the combined voting power of the surviving corporation's outstanding securities; (iv) the incumbent directors cease to constitute at least a majority of the Board of Directors; or (v) a change in control of the Company which would otherwise be reportable under Section 13 or 15(d) of the Exchange Act.
In the event of a "Change In Control" each Plan provides for the immediate vesting of all options issued thereunder. The 1999 Plan provides for the Company to deliver written notice to each optionee under the 1999 Plan fifteen (15) days prior to the occurrence of a Change In Control during which all options issued under the 1999 Plan may be exercised. Thereafter, all options issued under the 1999 Plan which are neither assumed or substituted in connection with such transaction, automatically expire unless otherwise determined by the Board. The 1996 Plan provides for all options to remain exercisable for the remainder of their respective terms and permits the Company to make a cash payment to any or all optionees equal to the difference between the exercise price of any or all such options and the fair market value of the Company's common stock immediately prior to the Change In Control. The 2004 Plan enables the Board to provide that all outstanding options be assumed, or equivalent options be substituted by the acquiring or succeeding corporation upon the occurrence of a "Reorganization Event" as defined. If such Reorganization Event also constitutes a Change in Control, then such assumed or substituted options shall be immediately exercisable in full. If the acquiring or succeeding corporation does not agree to assume, or substitute for such options, then the Board, upon written notice to the Participants, may provide that all unexercised options become exercisable in full as of a specified time prior to the Reorganization Event and terminate prior to the consummation of the Reorganization Event. Alternatively, if under the terms and conditions of the Reorganization Event, holders of common stock will receive a cash payment for their shares, then the Board may provide that all Participants receive a cash payment equal to the difference between the Acquisition Price and the Option Price multiplied by the number of options held by such Participants.
Options issued to executive officers outside of the Plans contain change in control provisions substantially similar to those contained in the 1999 Plan.
Employment Arrangements
The Company has entered into employment agreements with Michael W. DePasquale and Kenneth S. Souza. See "EXECUTIVE COMPENSATION—Employment Agreements."
Options Granted to Executive Officers and Directors
During 2002, the Company issued options to purchase 200,000 shares of common stock to Thomas J. Colatosti upon his appointment as a director of the Company. During 2003, 2004 and 2005, the Company issued options to purchase an aggregate of 2,180,000, 400,000 and 1,155,000 shares, respectively of common stock to its officers and directors. The options were issued at exercise prices equal to the last sales price of the Company's common stock as reported on the OTC Bulletin Board on the date of grant, have terms of three (3) to seven (7) years, and vest over a one to three year period.
Consulting Arrangement with Thomas J. Colatosti
In connection with his appointment to the Board of Directors in September 2002, the Company entered into a consulting arrangement with Thomas J. Colatosti. Under the arrangement, the Company paid Mr. Colatosti $4,000 per month through December 2003 and issued him options to purchase 150,000 shares of common stock at an exercise price of $0.31 per share, the closing price of the Company's common stock on the date of grant. In December 2003, a committee of independent directors renewed this arrangement through December 31, 2004. The committee also issued options to Mr. Colatosti to purchase 200,000 shares of common stock at an exercise price of $1.32 per share, the closing price of the Company's common stock on the date of grant, for serving as Chairman. Effective November 1, 2004, Mr. Colatosti's monthly consulting fee was increased to $14,500. Mr. Colatosti has substantial experience in the biometric industry and in addition to his role as the Chairman of the Board of Directors of the Company, provides extensive service to the Company in the areas of strategic planning and corporate finance.
In March 2004, Mr. Colatosti entered into a three year consulting arrangement with the Shaar Fund Ltd., a principal creditor and shareholder of the Company. Under the terms of the arrangement, The Shaar Fund transferred $375,000 principal amount of our secured convertible notes due October 1, 2005 to Mr. Colatosti. On April 28, 2004 the Company issued 3,750 shares of the Company's Series A 7% convertible preferred stock to Mr. Colatosti in conversion of the $375,000 secured convertible note.
On February 7, 2006, the Company entered into a consulting agreement with Mr. Colatosti, the current Chairman of the Board of Directors and Co-Chief Executive Officer of the Company. Pursuant to the Agreement, Mr. Colatosti will provide services to the Company and its subsidiaries and affiliates for the year ending December 31, 2006, at a rate of $14,500 per month.
The following table sets forth, as of August 10, 2006, information with respect to the securities holdings of all persons which the Company, pursuant to filings with the Securities and Exchange Commission, has reason to believe may be deemed the beneficial owners of more than five percent (5%) of the Company's outstanding common stock. The following table also sets forth, as of such date, the beneficial ownership of the Company's common stock by all officers and directors, individually and as a group. Unless otherwise indicated, the address of each person listed below is c/o BIO-key International, Inc., 3349 Highway 138, Building D, Suite B, Wall, NJ 07719.
Name and Address of Beneficial Owner
Amount and Nature
of Beneficial
Ownership(1)
Percentage of
Thomas J. Colatosti 905,000 (2) 1.7 %
Michael W. DePasquale 1,100,000 (3) 2.0 %
Francis J. Cusick 66,666 (4) *
Jeffrey May 250,000 (5) *
Charles P. Romeo 300,000 (6) *
John Schoenherr 25,000 (7) *
Randy Fodero 200,000 (8) *
Kenneth S. Souza 200,000 (9) *
Kingdon Capital Management, LLC 2,696,112 5.0 %
Trellus Management Company, LLC 8,083,500 15.0 %
All officers and directors as a group (8) persons 3,046,666 5.7 %
Less than 1%
The securities "beneficially owned" by an individual are determined in accordance with the definition of "beneficial ownership" set forth in the regulations promulgated under the Securities Exchange Act of 1934 and, accordingly, may include securities owned by or for, among others, the spouse and/or minor children of an individual and any other relative who has the same home as such individual, as well as, other securities as to which the individual has or shares voting or investment power or which each person has the right to acquire within 60 days through the exercise of options or otherwise. Beneficial ownership may be disclaimed as to certain of the securities. This table has been prepared based on 53,822,435 shares of common stock outstanding as of August 28, 2006.
Includes 550,000 shares issuable upon exercise of options and 350,000 shares issuable upon conversion of Series A Preferred Stock.
Includes 1,080,000 shares issuable upon exercise of options. Does not include 400,000 shares issuable upon exercise of options subject to vesting.
Includes 66,666 shares issuable upon exercise of options. Does not include 283,334 shares issuable upon exercise of options subject to vesting.
Consists of shares issuable upon exercise of options.
Includes 300,000 shares issuable upon exercise of options. Does not include 100,000 shares issuable upon exercise of options subject to vesting.
Includes 25,000 shares issuable upon exercise of options. Does not include 25,000 shares issuable upon exercise of options subject to vesting.
The following table sets forth, as of December 31, 2005, information with respect to securities authorized for issuance under equity compensation plans.
EQUITY COMPENSATION PLAN INFORMATION
Number of securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security
holders 150,000 $ 0.45 —
Equity compensation plans not approved by security
holders 6,197,385 $ 0.93 2,594,272
Total 6,347,835 $ 0.92 2,594,272
During 1996, the Board of Directors and stockholders of the Company adopted the 1996 Stock Option Plan (the 1996 Plan). Under the 1996 Plan, 750,000 shares of common stock are reserved for issuance to employees, officers, directors, and consultants of the Company at exercise prices which may not be below 100% of fair market value for incentive stock options and 50% for all others. The term of stock options granted may not exceed ten years. Options issued under the Plan vest pursuant to the terms of stock option agreements with the recipients. In the event of a change in control, as defined, all options outstanding vest immediately. The Plan terminated in May 2005.
The Company's 1999 Stock Option Plan (the "1999 Plan") was adopted by the Board of Directors of the Company on or about August 31, 1999. The material terms of the 1999 Plan are summarized below.
The 1999 Plan is currently administered by the Board of Directors of the Company (the "Plan Administrator"). The Plan Administrator is authorized to construe the 1999 Plan and any option issued under the 1999 Plan, select the persons to whom options may be granted, and determine the number of shares to be covered by any option, the exercise price, vesting schedule and other material terms of such option.
The 1999 Plan provides for the issuance of options to purchase up to 2,000,000 shares of common stock to officers, employees, directors and consultants of the Company at exercise prices not less than 85% of the last sale price of the Company's common stock as reported on the OTC Bulletin Board on the date of grant. Options have terms of not more than 10 years from the date of grant, are subject to vesting as determined by the Plan Administrator and are not transferable without the permission of the Company except by will or the laws of descent and distribution or pursuant to a domestic relations order. Options terminate three (3) months after termination of employment or other association with
the Company or one (1) year after termination due to disability, death or retirement. In the event that termination of employment or association is for a cause, as that term is defined in the 1999 Plan, options terminate immediately upon such termination. The Plan Administrator has the discretion to extend options for up to three years from the date of termination or disassociation with the Company.
The 1999 Plan provides for the immediate vesting of all options in the event of a "Change In Control" of the Company. In the event of a Change In Control, the Company is required to deliver written notice to each optionee under the 1999 Plan fifteen (15) days prior to the occurrence of a Change in Control, during which time all options issued under 1999 Plan may be exercised. Thereafter, all options issued under the 1999 Plan which are neither assumed or substituted in connection with such transaction, automatically expire, unless otherwise determined by the Board. Under the 1999 Plan, a "Change In Control" is defined to include (i) a sale or transfer of substantially all of the Company's assets; (ii) the dissolution or liquidation of the Company; (iii) a merger or consolidation to which the Company is a party and after which the prior shareholders of the Company hold less than 50% of the combined voting power of the surviving corporation's outstanding securities; (iv) the incumbent directors cease to constitute at least a majority of the Board of Directors; or (v) a change in control of the Company which would otherwise be reportable under Section 13 or 15(d) of the Exchange Act.
As of December 31, 2005, there were outstanding options under the 1996 Plan to purchase 150,000 shares of common stock, and no shares were available for future grants.
As of December 31, 2005, there were outstanding options under the 1999 Plan to purchase 1,062,125 shares of common stock, and options to purchase an aggregate of 647,132 shares were available for future grants.
On October 12, 2004, the Board of Directors of the Company approved the 2004 Stock Option Plan (the 2004 Plan). The 2004 Plan has not yet been presented to stockholders for approval and thus incentive stock options are not available under this plan. Under the terms of this plan, 4,000,000 shares of common stock are reserved for issuance to employees, officers, directors, and consultants of the Company at exercise prices which may not be below 85% of fair market value. The term of stock options granted may not exceed ten years. Options issued under the 2004 Plan vest pursuant to the terms of stock option agreements with the recipients. In the event of a change in control, as defined, all options outstanding vest immediately. The 2004 Plan terminates in October 2014.
As of December 31, 2005, there were outstanding options under the 2004 Plan to purchase 2,052,860 shares of common stock, and options to purchase an aggregate of 1,947,140 shares were available for future grants.
In addition to options issued under the 1996, 1999 and 2004 Plans, the Company has issued options to employees, officers, directors and consultants to purchase common stock under the non plan. As of December 2005, there were outstanding options under the non plan to purchase 3,082,850 shares of common stock. The terms of these options are substantially similar to the provisions of the 1999 Plan and options issued thereunder.
The Company is authorized to issue 170,000,000 shares of common stock, $.0001 par value per share, of which 53,822,435 were outstanding as of August 10, 2006.
Holders of common stock have equal rights to receive dividends when, as and if declared by the Board of Directors, out of funds legally available therefor. Holders of common stock have one vote for each share held of record and do not have cumulative voting rights.
Holders of common stock are entitled, upon liquidation of the Company, to share ratably in the net assets available for distribution, subject to the rights, if any, of holders of any preferred stock then outstanding. Shares of common stock are not redeemable and have no preemptive or similar rights. All outstanding shares of common stock are fully paid and nonassessable.
Within the limits and restrictions provided in the Company's Certificate of Incorporation, the Board of Directors has the authority, without further action by the shareholders, to issue up to 5,000,000 shares of preferred stock, $.0001 par value per share, in one or more series, and to fix, as to any such series, any dividend rate, redemption price, preference on liquidation or dissolution, sinking fund terms, conversion rights, voting rights, and any other preference or special rights and qualifications.
Series A Convertible Preferred Stock. In March 2004, we designated 100,000 shares of preferred stock as Series C Convertible Preferred Stock. In connection with the Company's reincorporation in Delaware, each share of Series C Convertible Preferred Stock was automatically converted into one share of Series A Convertible Preferred Stock (the "Series A Shares"), of which 44,557 were issued and outstanding December 31, 2005. The following describes the material provisions of the Series A Shares which are more fully set forth in the Certificate of Designation on file with the Minnesota Secretary of State.
The Series A Shares accrue a cumulative annual dividend of 7% on the $100 face amount of such shares payable June 15 and December 15 each year in shares of common stock. In the event of a liquidation, dissolution or winding up of the Company, the Series A shares have a liquidation preference of $100 per share (plus all accrued and unpaid dividends thereon) prior to any payment or distribution to holders of our common stock. The Series A Shares are convertible into common stock at a conversion price of $.70 per share. The conversion price is subject to proportional adjustment in the event of stock splits, stock dividends or reclassifications. Subject to certain exceptions, in the event we issue additional shares of common stock at a purchase price less than the conversion price of the Series A Shares, the conversion price shall be lowered to such lesser price. In the event that the average closing bid price of our common stock is less than $1.00 per share for thirty (30) consecutive trading days at any time after March 3, 2007, we will be required to redeem the Series A Shares by payment of $100 per share plus all accrued and unpaid dividends due thereon.
We are required to obtain the consent of the holders of a majority of the Series A Shares in order to, among other things, issue any shares of preferred stock that are equal to or have a preference over the Series A shares or issue any shares of preferred stock, rights, options, warrants, or any other securities convertible into common stock of the Company, other than those issued to employees of the Company in the ordinary course of their employment or to consultants or other persons providing services to the Company so long as such issuances do not exceed 500,000 shares of common stock. We are also required to obtain such consent in order to, among other things, complete a sale or other disposition of any material assets, complete an acquisition of a material amount of assets, engage in a merger, reorganization or consolidation, or incur or guaranty any indebtedness in excess of $50,000.
Series B Convertible Preferred Stock. In January 2006, the Company designated 1,000,000 shares of preferred stock as Series B Convertible Preferred Stock, all of which are issued and outstanding. The following describes the material provisions of the Series B Convertible Preferred Shares which are more fully set forth in the Certificate of Designation on file with the Delaware Secretary of State.
The Series B Convertible Preferred Shares accrue a cumulative annual dividend of 15% on the $1 face amount of such shares payable January 1, April 1, July 1 and October 1 each year in shares of common stock. In the event of a liquidation, dissolution or winding up of the Company, the Series B Convertible Preferred Shares have a liquidation preference of $1 per share (plus all accrued and unpaid dividends thereon) prior to any payment or distribution to holders of our common stock. The Series B Convertible Preferred Shares are convertible into common stock at a conversion price of $.70 per share. The conversion price is subject to proportional adjustment in the event of stock splits, stock dividends or reclassifications. Subject to certain exceptions, in the event we issue additional shares of common stock at a purchase price less than the conversion price of the Series B Convertible Preferred Shares, the conversion price shall be lowered to such lesser price.
If during the thirty (30) consecutive trading day period occurring prior to January 1, 2009, the average closing bid price for one share of Common Stock, as reported by Bloomberg, L.P. is at least $1.10, all outstanding Series B shares shall automatically be converted into Common Stock, at the then effective conversion rate. Upon conversion, all accrued or declared but unpaid dividends on the Series B shares shall be paid in shares of Common Stock. In the event that the average closing bid price of our common stock is less than $1.10 per share for thirty (30) consecutive trading days at any time after January 1, 2009, we will be required to redeem the Series A Convertible Preferred Shares by payment of $1 per share plus all accrued and unpaid dividends due thereon.
For as long as twenty-five percent (25%) of the Series B Convertible Preferred Stock are outstanding, we are required to obtain the consent of the holders of a majority of the Series B Convertible Preferred Shares in order to, among other things, issue any shares of preferred stock that are equal to or have a preference over the Series B Convertible Preferred Shares or issue any shares of preferred stock, rights, options, warrants, or any other securities convertible into common stock of the Company, other than those issued to employees of the Company in the ordinary course of their employment or to consultants or other persons providing services to the Company. We are also required to obtain such consent in order to, among other things, complete a sale or other disposition of any material assets, complete an acquisition of a material amount of assets, engage in a merger, reorganization or consolidation, or incur or guaranty any indebtedness in excess of $50,000.
Series C Convertible Preferred Stock. In August 2006, the Company designated 600,000 shares of preferred stock as Series C Convertible Preferred Stock, 592,032 of which are issued and outstanding, as of August 10, 2006. The following describes the material provisions of the Series C Convertible Preferred Shares, which are more fully set forth in the Certificate of Designation on file with the Delaware Secretary of State.
The Series C Convertible Preferred Shares accrue a cumulative annual dividend of 15% on the $10 face amount of such shares payable December 1, March 1, June 1 and September 1 each year in shares of common stock, or cash at the Company's election. In the event of a liquidation, dissolution or winding up of the Company, the Series C Convertible Preferred Shares have a liquidation preference of $10 per share (plus all accrued and unpaid dividends thereon) prior to any payment or distribution to holders of our common stock. The Series C Convertible Preferred Shares are convertible into common stock at a conversion price of $.50 per share. The conversion price is subject to proportional adjustment in the event of stock splits, stock dividends or reclassifications. Subject to certain exceptions, in the event we issue additional shares of common stock at a purchase price less than the conversion price of the Series C Convertible Preferred Shares, the conversion price shall be lowered to such lesser price.
If during the thirty (30) consecutive trading day period occurring prior to January 1, 2009, the average closing bid price for one share of Common Stock, as reported by Bloomberg, L.P. is at least $1.20, all outstanding Series C shares shall automatically be converted into Common Stock, at the then effective conversion rate. Upon conversion, all accrued or declared but unpaid dividends on the Series C shares shall be paid in shares of Common Stock.
For as long as any of the Series C Convertible Preferred Stock are outstanding, we are required to obtain the consent of the holders of the Series C Convertible Preferred Shares in order to, among other things, issue any shares of preferred stock that are equal to or have a preference over the Series C Convertible Preferred Shares or issue any shares of preferred stock, rights, options, warrants, or any other securities convertible into common stock of the Company, other than those issued to employees of the Company in the ordinary course of their employment or to consultants or other persons providing services to the Company.
The Company has never paid cash dividends on its common stock. The Board of Directors does not anticipate paying cash dividends in the foreseeable future as it intends to retain future earnings, if any, to finance the growth of the business. The payment of future dividends will depend on such factors as earnings levels, anticipated capital requirements, the operating and financial condition of the Company and other factors deemed relevant by the Board of Directors.
Anti-Takeover Provisions of the Company's Certificate of Incorporation
As described above, the Board of Directors is authorized without further stockholder action, to designate any number of series of preferred stock with such rights, preferences and designations as determined by the Board. Shares of preferred stock issued by the Board of Directors could be utilized, under certain circumstances, to make an attempt to gain control of the Company more difficult or time consuming. For example, shares of preferred stock could be issued with certain rights that might have the effect of diluting the percentage of common stock owned by a significant stockholder or issued to purchasers who might side with management in opposing a takeover bid that the Board of Directors determines is not in the best interest of the Company and its stockholders. The existence of the preferred stock may, therefore, be viewed as having possible anti-takeover effects.
The transfer agent for the Company's common stock is StockTrans, Inc., 44 West Lancaster Avenue, Ardmore, Pennsylvania 19003, (610) 649-7300.
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").
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, $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.
As a result of the acquisition, we issued a total of 2,422,108 shares of our common stock, which includes 6,000 shares 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. The 2,416,108 shares issued to the former 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 primarily by the revenue achieved by the Public Safety Division during fiscal year 2004. 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 such escrow arrangement are as follows:
One-twelfth (1/12) of the Merger Shares (the "Initial Shares") are being 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 Harward and the former shareholders of PSG. Specifically, Harward will receive an amount of Initial Shares that is equal to $110,000 divided by the closing price of our common stock as reported by the OTC Bulletin Board on such date. The balance of the Initial Shares will be concurrently released to the former shareholders of PSG.
An additional one-twelfth (1/12) of the Merger Shares will be released from the escrow to the former shareholders of PSG on each of June 30, 2004, September 30, 2004 and December 31, 2004.
The remaining eight-twelfths (8/12) of the Merger Shares (the "Remaining Shares") will be released from the escrow to the former shareholders of PSG based on a distribution schedule determined by the license, service and maintenance fee revenue achieved by the Public Safety Division during fiscal year 2004. Specifically, the Remaining Shares will be released according to the following schedule: (i) in the event that such qualifying revenue is less than $2 million, one-twelfth (1/12) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006, December 31, 2006, March 31, 2007, June 30, 2007, September 30, 2007 and December 31, 2007; (ii) in the event that such qualifying revenue is equal to or greater than $2 million, one-eighth (1/8) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006; and (iii) in the event that such qualifying revenue is equal to or greater than $6 million, one-sixth (1/6) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006 and June 30, 2006.
Of the shares remaining in escrow following the effectiveness of this registration statement, 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 indemnification obligations of the former PSG shareholders pursuant to the Merger Agreement.
This prospectus relates to the resale of 2,422,108 shares of our common stock acquired by certain of the selling security holders in connection with our acquisition of PSG. Of the shares being registered, the 2,416,108 shares being held in escrow may not be resold by such selling security holders until such shares have been released from the escrow as described above.
On March 31, 2004, we entered into a securities purchase agreement (the "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 the Company of approximately $12,000,000. Net proceeds to the Company were approximately $11,632,400, which will be used for working capital purposes. These securities were sold to accredited investors in a private placement transaction exempt from registration under the Securities Act pursuant to Rule 506 of Regulation D thereunder.
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 trading 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.
This prospectus relates to the resale of 8,888,928 shares of our common stock and the Warrants to purchase an aggregate of 4,444,464 shares of our common stock acquired by certain of the selling security holders pursuant to the Purchase Agreement.
We are registering for resale shares of our common stock issued to the selling security holders identified below. The selling security holders identified in the following table are offering for sale up to 15,755,500 shares of common stock, of which 4,444,464 shares are issuable upon exercise of warrants, issued to the selling security holders in private placement transactions. The following table sets forth:
the name of each selling security holder;
the nature of any material relationship within the past three years between any selling security holder and BIO-key or any of our affiliates based on information currently available to us;
the number of shares of our common stock beneficially owned by each selling security holder prior to this offering;
the number of shares of our common stock offered hereunder by each selling security holder; and
the number and percent of shares of our common stock beneficially owned by each selling security holder after this offering is complete. This calculation assumes that all shares are sold pursuant to this offering and that no other shares of common stock are acquired or disposed of by the selling security holder prior to the termination of this offering.
Each of the selling security holders is offering for sale with this prospectus the number of shares listed below subject to the limitations described in the section of this prospectus entitled "Plan of Distribution". Beneficial ownership is determined in accordance with the rules and regulations of the Securities and Exchange Commission. Except as indicated in the footnotes to this table and subject to applicable community property laws, each of the selling security holders named in this table has sole voting power with respect to all shares of common stock listed as beneficially owned by such selling security holders.
The applicable percentages of beneficial ownership set forth below are based on an aggregate of 53,822,435 shares of our common stock issued and outstanding on August 10, 2006.
Shares Offered
Pursuant to
this Prospectus
from Exercise
of Warrants
Shares Beneficially Owned
After Offering is Complete
Name of Selling Security Holder
Beneficially Owned
Prior to Offering(1)
this Prospectus(1)
Donald C. Nagle(2) 626,200 (3) 626,200 (3) 0 0 0
Robert Lorenz(4) 626,200 (5) 626,200 (5) 0 0 0
Ramzan Janmohamed(6) 626,200 (7) 626,200 (7) 0 0 0
Frank DiMaggio 139,211 (8) 139,211 (8) 0 0 0
Robert R. Hendry 139,211 (9) 139,211 (9) 0 0 0
Douglas C. Foreman 96,674 (10) 96,674 (10) 0 0 0
Brett Fadeley & Dwain DeVille, JTWROS 58,005 (11) 58,005 (11) 0 0 0
Dwain DeVille & Brett Fadeley, JTWROS 58,005 (12) 58,005 (12) 0 0 0
Bryan Coy 23,201 (13) 23,201 (13) 0 0 0
Paul Serluco 23,201 (14) 23,201 (14) 0 0 0
Harward Investments, Inc.(16) 6,000 (15) 6,000 (15) 0 0 0
Continuity Asian Technology Fund(17) 162,998 162,998 54,333 0 0
SAC Strategic Investment LLC(18) 571,016 571,016 190,339 0 0
Continuity Asian Technology Partners(19) 43,781 43,781 14,594 0 0
Fady A. Rizk 150,000 150,000 50,000 0 0
Kingdon Capital(20) 2,233,334 833,334 277,778 1,400,000 2.6 %
DKR Soundshore Oasis Holding Fund LTD(21) 277,779 277,779 92,593 0 0
Schottenfeld Qualified Associates, LP(22) 944,445 944,445 314,815 0 0
CSL Associates, LP(23) 166,668 166,668 55,556 0 0
The Shaar Fund, LTD(24) 1,497,224 1,497,224 499,075 0 0
STG Capital Partners (QP), LP(25) 450,000 450,000 150,000 0 0
STG Capital Fund, LTD.(26) 1,050,000 1,050,000 350,000 0 0
Iroquois Capital L.P.(27) 222,224 222,224 74,075 0 0
Vertical Ventures, LLC(28) 333,335 333,335 111,112
Minhas Sayani 111,113 111,113 37,038 0 0
Thomas J. Molumphy 66,668 66,668 22,223 0 0
Molumphy Capital Mgmt Profit Sharing Plan(29) 44,445 44,445 14,815 0 0
Etienne Des Roys 111,113 111,113 37,038 0 0
Bengt Eriksson 166,668 166,668 55,556 0 0
Gamma Opportunity Capital Partners, LP(30) 555,557 555,557 185,186 0 0
Longview Fund, LP(31) 277,779 277,779 92,593 0 0
Alpha Capital AG(32) 833,334 833,334 277,778 0 0
Truk Opportunity Fund, LLC(33) 111,113 111,113 37,038 0 0
Investor's Management Corporation(34) 277,779 277,779 92,593 0 0
Davos Partners, L.P.(35) 222,224 222,224 74,075 0 0
Albert Fried, Jr.(36) 277,779 277,779 92,593 0 0
Marc Florin IRA(37) 55,557 55,557 18,519 0 0
U.S. Bank, FBO The Tocqueville Fund(38) 787,500 787,500 262,500
Tocqueville Amerique(39) 212,501 212,501 70,834 0 0
Ronald D. Corwin & Beth Blumenthal 111,113 111,113 37,038 0 0
OTAPE Investments, LLC(40) 111,113 111,113 37,038 0 0
Omicron Master Trust(41) 298,138 298,138 75,915 0 0
Eagle & Dominion EuroAmerican Growth Fund, LP(42) 50,700 50,700 16,900 0 0
Eagle & Dominion EuroAmerican Growth Fund Limited(43) 174,300 174,300 58,100 0 0
November Group Defined Benefits Pension(44) 55,557 55,557 18,519 0 0
Mason Speed Sexton IRA Rollover(45) 55,557 55,557 18,519 0 0
Douglass Bermingham IRA(46) 45,000 45,000 15,000 0 0
Ten Pine Advisors LLC(47) 27,224 27,224 9,075 0 0
Gryphon Master Fund, L.P.(48) 277,778 277,778 92,593 0 0
Colbart Birnet, L.P.(49) 222,224 222,224 74,075 0 0
Smithfield Fiduciary LLC(50) 277,779 277,779 92,593 0 0
Eric Haber 55,557 55,557 18,519 0 0
Ann Derrey Bermingham 27,779 27,779 9,260 0 0
Larry Bursten 55,557 55,557 18,519 0 0
Michael Derrey 27,779 27,779 9,260 0 0
Zenny Trading Limited(51) 111,113 111,113 37,038 0 0
Alan Butler(52) 111,113 111,113 37,038 0 0
Ellis International Limited, Inc.(53) 111,113 111,113 37,038 0 0
Symmetry Peak, L.P(54) 194,447 194,447 64,816 0 0
Symmetry Peak Offshore, Ltd.(55) 83,333 83,333 27,778 0 0
Rockmore Investment Master Fund Ltd.(56) 35,197 35,197 35,197 0 0
Total 15,755,500 (57) 15,755,500 (57) 4,444,464 1,400,000 2.6 %
Less than one percent (1%) of the outstanding common stock.
Includes the amount of shares of common stock, if any, set forth opposite the name of each selling security holder under the column entitled "Shares Offered Pursuant to this Prospectus from Exercise of Warrants", which shares are issuable upon the exercise of warrants at an exercise price of $1.755 per share.
Mr. Nagle is currently employed by the Company as its General Manager of the Public Safety Division.
Includes up to 626,200 shares that may become available for resale by the selling security holder upon release of the escrow established pursuant to the Agreement and Plan of Merger (the "Merger Agreement") by and among the Company, BIO-Key Acquisition Corp., Public Safety Group, Inc. and the shareholders of Public Safety Group, Inc., which number of shares may be reduced in accordance with note 15 below.
Mr. Lorenz is currently employed by the Company as its Technical Director of the Public Safety Division.
Includes up to 626,200 shares that may become available for resale by the selling security holder upon release of the escrow established pursuant to the Merger Agreement, which number of shares may be reduced in accordance with note 15 below.
Mr. Janmohamed is currently employed by the Company as its Director of Business Development/Marketing of the Public Safety Division.
Includes up to 96,674 shares that may become available for resale by the selling security holder upon release of the escrow established pursuant to the Merger Agreement, which number of shares may be reduced in accordance with note 15 below.
Does not include the additional shares (the "Additional Harward Shares") issuable pursuant to the Merger Agreement to Harward Investments, Inc. ("Harward") upon the effectiveness of this registration statement, which number of shares will be equal to $110,000 divided by the closing price of our common stock as reported by the OTC Bulletin Board on such date. In order to satisfy this obligation, each of the former shareholders of PSG listed above will transfer his pro rata portion of the Additional Harward Shares to Harward upon the effectiveness of this registration statement.
This selling security holder has identified Dennis J. Harward as having voting and dispositive power with respect to these securities.
This selling security holder has identified Juwan Lee as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
Kingdon Capital beneficially owned 5.7% of our outstanding common stock prior to acquiring shares of our common stock and warrants to purchase our common stock on March 31, 2004. This selling security holder has identified Ken Hahn as having voting and dispositive power with respect to these securities.
This selling security holder has identified Barbara Burger as having voting and dispositive power with respect to these securities.
This selling security holder has identified Richard Schottenfeld as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Charles S. Lipson as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
The Shaar Fund, Ltd. has been the principal creditor and source of financing for the Company since June 1998 and currently owns 76,432 shares of our series C preferred stock in addition to the shares set forth in this table. This selling security holder has identified Hugo Van Neutegem as having voting and dispositive power with respect to these securities.
This selling security holder has identified Steven Glass as having voting and dispositive power with respect to these securities.
This selling security holder has identified Josh Silverman as having voting and dispositive power with respect to these securities. Mr. Silverman disclaims beneficial ownership of the securities held by Iroquois Capital L.P.
This selling security holder has identified Josh Silverman as having voting and dispositive power with respect to these securities. Mr. Silverman disclaims beneficial ownership of the securities held by Vertical Ventures, LLC.
This selling security holder has identified Thomas J. Molumphy as having voting and dispositive power with respect to these securities.
This selling security holder has identified Jonathan P. Knight as having voting and dispositive power with respect to these securities.
This selling security holder has identified Peter T. Benz as having voting and dispositive power with respect to these securities.
This selling security holder has identified Rainer Posch and Konrad Ackerman as having voting and dispositive power with respect to these securities.
This selling security holder has identified Michael E. Fein and Stephen E. Saltzstein, as principals of Atoll Asset Management, LLC, the managing member of this selling security holder, as having voting and dispositive power with respect to these securities. Each of Mr. Fein and Mr. Saltzstein disclaim beneficial ownership with respect to these securities.
This selling security holder has identified Richard A. Urquhart, III as having voting and dispositive power with respect to these securities.
This selling security holder has identified David P. Nolan as having voting and dispositive power with respect to these securities.
This selling security holder has identified himself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Marc Florin as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Robert W. Kleinschmidt as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Ira M. Leventhal as having voting and dispositive power with respect to these securities. Mr. Leventhal disclaims beneficial ownership of these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
Omicron Capital, L.P., a Delaware limited partnership ("Omicron Capital"), serves as investment manager to Omicron Master Trust, a trust formed under the laws of Bermuda ("Omicron"), Omicron Capital, Inc., a Delaware corporation ("OCI"), serves as general partner of Imicron Capital, and Winchester Global Trust Company Limited ("Winchester") serves as the trustee of Omicron. By reason of such relationships, Omicron Capital and OCI may be deemed to share dispositive power over the shares of our common stock owned by Omicron, and Winchester may be deemed to share voting and dispositive power of the shares of our common stock owned by Omicron. Omicron Capital, OCI and Winchester disclaim beneficial ownership of such shares of
our common stock. Omicron Capital has delegated authority from the board of directors of Winchester regarding the portfolio management decisions with respect to the shares of common stock owned by Omicron and, as of June 11, 2004, Mr. Oliver H. Morali and Mr. Bruce T. Bernstein, officers of OCI, have delegated authority from the Board of Directors of OCI regarding the portfolio management decisions of Omicron Capital with respect to the shares of common stock owned by Omicron. By reason of such delegated authority, Messrs. Morali and Bernstein may be deemed to share dispositive power over the shares of our common stock owned by Omicron. Messrs. Morali and Bernstein disclaim beneficial ownership of such shares of our common stock and neither of such persons has any legal right to maintain such delegated authority. No other person has sole or shared voting or dispositive power with respect to the shares of our common stock being offered by Omicron, as those terms are used for purposes under Regulation 13D-G of the Securities Exchange Act of 1934, as amended. Omicron and Winchester are not "affiliates" of one another, as that term is used for purposes of the Securities exchange Act of 1934, as amended, or of any other person named in this prospectus as a selling security holder. No person or "group" (as that term is used in Section 13(d) of the Securities Exchange Act of 1934, as amended, or the SEC's Regulation 13D-G) controls Omicron and Winchester.
This selling security holder has identified Eagle & Dominion Asset Management Ltd. as having voting and dispositive power with respect to these securities and Duncan Byatt as having control over Eagle & Dominion Asset Management.
This selling security holder has identified Carol Safir as having voting and dispositive power with respect to these securities.
This selling security holder has identified Mason Sexton as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Douglass Bermingham as having voting and dispositive power with respect to these securities. Mr. Bermingham disclaims beneficial ownership with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified E.B. Lyon IV as having voting and dispositive power with respect to these securities.
This selling security holder has identified Ezra Birnbaum as having voting and dispositive power with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified Highbridge Capital Management, LLC as having voting and dispositive power with respect to these securities and Glen Dubin and Henry Swieca as having control over Highbridge Capital Management, LLC. Each of Highbridge Capital Management, LLC, Mr. Dubin and Mr. Swieca disclaim beneficial ownership with respect to these securities. In addition, this selling security holder has identified itself as an affiliate of a registered broker-dealer. See "Plan of Distribution" section of this prospectus for required disclosure regarding such selling security holder's status as an affiliate of a registered broker-dealer.
This selling security holder has identified David Dennis Cuby as having voting and dispositive power with respect to these securities.
This selling security holder has identified Wilhelm Ungar as having voting and dispositive power with respect to these securities.
This selling security holder has identified Frank P. Slattery as having voting and dispositive power with respect to these securities.
Includes 35,197 shares issuable upon exercise of a warrant held by this selling security holder at an exercise price of $1.755. This selling security holder received such warrant as of April 1, 2006 by way of assignment from Omicron Master Trust. This selling security holder has identified Mr. Oliver H. Morali and Mr. Bruce T. Bernstein as having voting and dispositive power with respect to this security.
Includes 2,416,108 shares (the "Merger Shares") that may become available for resale by the selling security holders who are former shareholders of PSG upon release of the escrow established pursuant to the Merger Agreement. Specifically, one-twelfth (1/12) of the Merger Shares (the "Initial Shares") are being 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 Harward and the former shareholders of PSG. At that time, Harward will receive the Additional Harward Shares, as described in note 15 above, and the balance of the Initial Shares will be concurrently released to the former shareholders of PSG. An additional one-twelfth (1/12) of the Merger Shares will be released from the escrow to the former shareholders of PSG on each of June 30, 2004, September 30, 2004 and December 31, 2004. The remaining eight-twelfths (8/12) of the Merger Shares (the "Remaining Shares") will be released from the escrow to the former shareholders of PSG according to the following distribution schedule determined by the license, service and maintenance fee revenue achieved by the Company's Public Safety Division during fiscal year 2004: (i) in the event that such qualifying revenue is less than $2 million, one-twelfth (1/12) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006, December 31, 2006, March 31, 2007, June 30, 2007, September 30, 2007 and December 31, 2007; (ii) in the event that such qualifying revenue is equal to or greater than $2 million, one-eighth (1/8) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 30, 2006 and December 31, 2006; and (iii) in the event that such qualifying revenue is equal to or greater than $6 million, one-sixth (1/6) of the Remaining Shares will be released on each of March 31, 2005, June 30, 2005, September 30, 2005, December 31, 2005, March 31, 2006 and June 30, 2006.
The selling security holders may, from time to time after the registration statement which includes this prospectus becomes effective, sell any or all of their shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The selling security holders may use any one or more of the following methods when selling shares:
ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers;
block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction;
purchases by a broker-dealer as principal and resale by the broker-dealer for its account;
an exchange distribution in accordance with the rules of the applicable exchange;
privately negotiated transactions;
short sales;
broker-dealers may agree with the selling security holders to sell a specified number of such shares at a stipulated price per share;
a combination of any such methods of sale; and
any other method permitted pursuant to applicable law.
The selling security holders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus.
The selling security holders may also, after the registration statement which includes this prospectus becomes effective, engage in short sales against the box, puts and calls and other transactions in our securities or derivatives of our securities and may sell or deliver shares in connection with these trades.
Broker-dealers engaged by the selling security holders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling security holders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The selling security holders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved. Any profits on the resale of shares of common stock by a broker-dealer acting as principal might be deemed to be underwriting discounts or commissions under the Securities Act. Discounts, concessions, commissions and similar selling expenses, if any, attributable to the sale of shares will be borne by a selling security holder. The selling security holders may agree to indemnify any agent, dealer or broker-dealer that participates in transactions involving sales of the shares if liabilities are imposed on that person under the Securities Act.
The selling security holders may from time to time pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time under this prospectus after we have filed an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of selling security holders to include the pledgee, transferee or other successors in interest as selling security holders under this prospectus.
The selling security holders also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus and may sell the shares of common stock from time to time
under this prospectus after we have filed an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of selling security holders to include the pledgee, transferee or other successors in interest as selling security holders under this prospectus.
The selling security holders and any broker-dealers or agents that are involved in selling the shares of common stock may be deemed to be "underwriters" within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares of common stock purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act.
We are required to pay all fees and expenses incident to the registration of the shares of common stock. We have agreed to indemnify the selling security holders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act.
Each selling security holder that is an affiliate of a registered broker-dealer has certified to us that it purchased our securities in the ordinary course of business and that at the time of such purchase, such selling security holder had no agreements, plans or understandings, directly or indirectly, with any person to distribute such securities.
The selling security holders have advised us that they have not entered into any agreements, understandings or arrangements with any underwriters or broker-dealers regarding the sale of their shares of common stock, nor is there an underwriter or coordinating broker acting in connection with a proposed sale of shares of common stock by any selling security holder. If we are notified by any selling security holder that any material arrangement has been entered into with a broker-dealer for the sale of shares of common stock, if required, we will file a supplement to this prospectus. If the selling security holders use this prospectus for any sale of the shares of common stock, they will be subject to the prospectus delivery requirements of the Securities Act.
The anti-manipulation rules of Regulation M under the Exchange Act may apply to sales of our common stock and activities of the selling security holders. We have informed the selling security holders that, during such time as they may be engaged in a distribution of any of the shares we are registering by this registration statement, they are required to comply with Regulation M. In general, Regulation M precludes any selling security holder, any affiliated purchasers and any broker-dealer or other person who participates in a distribution from bidding for or purchasing, or attempting to induce any person to bid for or purchase, any security which is the subject of the distribution until the entire distribution is complete. Regulation M defines a "distribution" as an offering of securities that is distinguished from ordinary trading activities by the magnitude of the offering and the presence of special selling efforts and selling methods. Regulation M also defines a "distribution participant" as an underwriter, prospective underwriter, broker, dealer or other person who has agreed to participate or who is participating in a distribution.
Regulation M also prohibits any bids or purchases made in order to stabilize the price of a security in connection with the distribution of that security, except as specifically permitted by Rule 104 of Regulation M. These stabilizing transactions may cause the price of our common stock to be more than it would otherwise be in the absence of these transactions. We have informed the selling security holders that stabilizing transactions permitted by Regulation M allow bids to purchase our common stock if the stabilizing bids do not exceed a specified maximum. Regulation M specifically prohibits stabilizing that is the result of fraudulent, manipulative or deceptive practices. Selling security holders and distribution participants are required to consult with their own legal counsel to ensure compliance with Regulation M.
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES
The Company's Certificate of Incorporation limit the personal liability of the Company's officers and directors for monetary damages for breach of their fiduciary duty as directors, except for liability that cannot be eliminated under the Delaware General Corporation Law (the "DGCL"). The Company's Bylaws also provide for the Company to indemnify directors and officers to the fullest extent permitted by the DGCL.
The indemnification provisions described above would provide coverage for claims arising under the Securities Act and the Exchange Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the Company's Certificate of Incorporation, Bylaws, the DGCL, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.
Our financial statements as of December 31, 2005 and for each of the three years in the period ended December 31, 2005 included in this prospectus have been audited by DS&B, Ltd., independent certified public accountants, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission under the Exchange Act. Such reports and other information may be inspected and copied at the Securities and Exchange Commission's Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the Public Reference Room. The Securities and Exchange Commission also maintains an Internet site that contains reports, proxy statements and other information about issuers, like us, who file electronically with the Securities and Exchange Commission. The address of the Securities and Exchange Commission's web site is http://www.sec.gov.
This prospectus is part of a registration statement that we have filed with the Securities and Exchange Commission. The prospectus, which forms a part of such registration statement, and any accompanying prospectus supplement do not contain all of the information included in the registration statement. We have omitted a few parts of the registration statement according to the rules and regulations of the Securities and Exchange Commission. For further information, we refer you to the registration statement, including its exhibits and schedules. Statements contained in this prospectus and any accompanying prospectus supplement about the provisions or contents of any contract, agreement or any other document referred to are not necessarily complete. For each of these contracts, agreements or documents filed as an exhibit to the registration statement, we refer you to the actual exhibit for a more complete description of the matters involved. You should not assume that the information in this prospectus or any supplement is accurate as of any date other than the date on the front of those documents. We do not intend to distribute annual reports or audited financial statements to our shareholders. This information may be found in our filings with the Securities and Exchange Commission.
The following consolidated financial statements of BIO-key International, Inc. and Subsidiary are included herein at the indicated page numbers.
BIO-key International, Inc. and Subsidiary
Fiscal Year Ended December 31, 2005
Report of Independent Certified Public Accountants
Balance Sheet at December 31, 2005, 2004 and 2003 F-3
Statements of Operations—Years ended December 31, 2005, 2004 and 2003 F-4
Statement of Stockholders' Equity (Deficit)—Years ended December 31, 2005, 2004 and 2003 F-5
Statements of Cash Flows—Years ended December 31, 2005, 2004 and 2003 F-6
Notes to Consolidated Financial Statements—December 31, 2005, 2004 and 2003 F-7
Balance sheet as of June 30, 2006 (unaudited) and December 31, 2005 F-113
Statements of operations for the three and six months ended June 30, 2006 and 2005 (unaudited) F-114
Statements of cash flows for the six months ended June 30, 2006 and 2005 (unaudited) F-115
Notes to consolidated financial statements for the six months ended June 30 2006 F-117
Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of BIO-key International, Inc. and Subsidiary as of December 31, 2005, 2004 and 2003, and the related statements of operations, stockholders' equity (deficit) and cash flows for each of the years in the three year period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.
As described in Note B to the consolidated financial statements, the Company restated its 2005, 2004, and 2003 consolidated financial statements.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BIO-key International, Inc. and Subsidiary as of December 31, 2005, 2004 and 2003, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States.
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. However, as discussed in Note A to the financial statements, the Company has only recently begun to generate significant revenues, has suffered recurring losses from operations and has a working capital deficit. These aforementioned issues, among others, raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result front this uncertainty. Management's plans in regard to these matters are also discussed in Note A.
/s/ DS&B, Ltd.
BIO-key International, Inc and Subsidiary
Cash and cash equivalents $ 1,422,827 $ 956,230 $ 1,012,790
Marketable debt securities — 1,000,000 —
Billed, less allowance for doubtful receivables of $160,000, $422,393 and $2,000, respectively 1,635,371 1,608,054 101,183
Unbilled 201,942 310,523 —
Due from selling stockholders and other — 28,793 —
Costs and earnings in excess of billings on uncompleted contracts 4,321,392 6,292,603 —
Inventory 8,760 29,599 65,857
Prepaid expenses 137,000 113,130 165,929
Total current assets 7,727,292 10,338,932 1,345,759
Equipment and leasehold improvements, net 548,267 644,101 60,157
Costs and earnings in excess of billings on uncompleted contracts — 657,000 —
Deposits 1,828,560 2,838,031 —
Intangible assets—less accumulated amortization 3,301,823 4,099,297 68,306
Deferred financing costs, net 1,562,338 938,118 81,900
Goodwill 11,389,654 12,023,613 —
Total non-current assets 18,630,642 21,200,160 210,363
TOTAL ASSETS $ 26,357,934 $ 31,539,092 $ 1,556,122
Current maturities of long-term obligations, net of discount $ 8,067,948 $ 3,062,722 $ —
Advances from stockholders — 12,753 34,030
Accounts payable 833,608 1,349,092 351,742
Billings in excess of costs and earnings on uncompleted contracts 32,385 760,807 —
Accrued liabilities 5,520,515 4,595,984 155,536
Deferred rent 443,603 393,676 —
Deferred revenue 3,264,283 3,166,356 10,000
Total current liabilities 18,162,342 13,341,390 551,308
Long-term obligations, net of discount and current maturities — 10,265,390 10,373,680
Deferred rent 867,850 1,311,454 —
Deferred revenue 1,163,738 71,203 —
Total non-current liabilities 2,031,588 11,648,047 10,373,680
TOTAL LIABILITIES 20,193,930 24,989,437 10,924,988
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock-authorized, 5,000,000 shares (liquidation preference of $100 per share)
Series A 7% Convertible; issued and outstanding 44,557 Shares of $.0001 par value 4 — —
Series B 9% Convertible; issued and outstanding, 4,180 shares of $.01 par value — — 42
Series C 7% Convertible; issued and outstanding, 62,182 shares of $.01 par value — 623 —
Common stock-authorized, 85,000,000 shares; issued and outstanding; 46,306,589 shares of $.0001 par value in 2005 and 40,680,691 and 21,222,889 shares of $.01 par value in 2004 and 2003, respectively 4,632 406,808 212,229
Additional paid-in capital 48,921,316 45,098,731 18,327,992
Accumulated deficit (42,761,948 ) (38,956,507 ) (27,909,129 )
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 6,164,004 6,549,655 (9,368,866 )
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 26,357,934 $ 31,539,092 $ 1,556,122
The accompanying notes are an integral part of these statements.
Services $ 10,861,649 $ 3,351,406 $ 10,694
License fees and other 3,364,446 2,369,545 204,787
14,226,095 5,720,951 215,481
Services 2,906,142 1,174,324 1,694
Cost of license fees and other 937,491 889,896 87,387
Selling, general and administrative 11,824,609 7,114,288 2,099,922
Research, development and engineering 6,846,035 2,979,904 1,037,330
22,514,277 12,158,412 3,226,333
Operating loss (8,288,182 ) (6,437,461 ) (3,010,852 )
Interest income 35,958 66,824 —
Interest expense (4,521,344 ) (1,415,535 ) (1,909,788 )
Derivative and warrant fair value adjustments 9,154,951 (3,008,419 ) 857,545
Gain (Loss) on sale of marketable securities (20,000 ) 33,125 —
Other income (expense) (34,767 ) (88,425 ) 4,145
Total other income (deductions) 4,614,798 (4,412,430 ) (1,048,098 )
NET LOSS $ (3,673,384 ) $ (10,849,891 ) $ (4,058,950 )
Loss Per Share:
Basic $ (0.09 ) $ (0.32 ) $ (0.24 )
Diluted $ (0.12 ) $ (0.32 ) $ (0.24 )
Basic 44,787,807 34,806,201 17,543,586
Diluted 52,046,303 34,806,201 17,543,586
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Series A 7%
Series B 9%
Series C 7%
Balance as of December 31, 2002 — $ — 18,430 $ 184 — $ — 14,377,406 $ 143,774 $ 16,284,399 $ (23,605,404 ) $ (7,177,047 )
Conversion of series B preferred stock and cumulative dividends in arrears into common stock — — (14,250 ) (142 ) — — 4,239,206 42,392 202,525 (244,775 ) —
Coversion of note, debenture and accrued interest into common stock — — — — — — 2,097,953 20,980 1,552,486 — 1,573,466
Exercise of options into common stock — — — — — — 308,324 3,083 58,582 — 61,665
Options and warrants issued for services and other — — — — — — — — 156,000 — 156,000
Common stock issued in exchange for services and other — — — — — — 200,000 2,000 74,000 — 76,000
Net loss — — — — — — — — — (4,058,950 ) (4,058,950 )
Balance as of December 31, 2003 (Restated) — $ — 4,180 $ 42 — $ — 21,222,889 $ 212,229 $ 18,327,992 $ (27,909,129 ) $ (9,368,866 )
Issuance of series C preferred stock for Series B preferred stock and cumulative dividends in arrears — — (4,180 ) (42 ) 5,257 53 — — 107,682 (107,693 ) —
Issuance of series C preferred stock in exchange for debt — — — — 83,275 833 — — 8,326,630 — 8,327,463
Sale in March 2004 of common stock and warrants at $1.35 per unit, less offering costs of $743,895 — — — — — — 8,888,928 88,889 11,330,117 — 11,419,006
Issuance of common stock in conjunction with PSG acquisition — — — — — — 2,422,108 24,221 3,584,719 — 3,608,940
Conversion of debentures, bridge notes, convertible notes, accrued interest and related discounts and derivatives into common stock — — — — — — 3,455,725 34,558 2,462,593 — 2,497,151
Conversion of series C preferred stock and cumulative dividends in arrears into common stock — — — — (30,100 ) (301 ) 4,133,060 41,331 48,764 (89,794 ) —
Issuance of series C preferred stock in exchange for note payable to officer — — — — 3,750 38 — — 374,962 — 375,000
Exercise of options and warrants into common stock — — — — — — 557,982 5,580 92,554 — 98,134
Repurchase warrants — — — — — — — — (221,183 ) — (221,183 )
Issuance of warrants in conjunction with convertible notes offering — — — — — — — — 534,201 — 534,201
Net loss (10,849,891 ) (10,849,891 )
Balance as of December 31, 2004 (Restated) — $ — — $ — 62,182 $ 623 40,680,692 $ 406,808 $ 45,098,731 $ (38,956,507 ) $ 6,549,655
Conversion of series C preferred stock to series A preferred stock 62,182 6 — — (62,182 ) (623 ) — — 617 — —
Adjust par values to $0.0001 — — — — — — — (402,739 ) 402,739 — —
Costs incurred in conjunction with issuance of debt — — — — — — — — (56,642 ) — (56,642 )
Issuance of shares in exchange for debt payment delay — — — — — — 875,871 88 788,196 — 788,284
Conversion of debentures, bridge notes, convertible notes, accrued interest and related discounts and derivatives into common stock — — — — — — 1,575,135 158 1,179,341 — 1,179,499
Conversion of series A preferred stock and cumulative dividends in arrears into common stock (17,625 ) (2 ) — — — — 2,512,426 251 121,569 (132,057 ) (10,239 )
Exercise of options and warrants into common stock — — — — — — 662,465 66 558,722 — 558,788
Balance as of December 31, 2005 (Restated) 44,557 $ 4 — $ — — $ — 46,306,589 $ 4,632 $ 48,921,316 $ (42,761,948 ) $ 6,164,004
CASH FLOW FROM OPERATING ACTIVITIES:
Adjustments to reconcile net loss to net cash used in operating activities:
Derivative and warrant fair value adjustments (9,154,951 ) 3,008,419 (857,545 )
Depreciation 244,450 77,912 6,386
Intangible assets 1,323,601 535,799 —
Deferred financing costs 186,279 14,622 —
Discounts on convertible debt related to warrants and beneficial conversion features 2,097,973 757,318 1,215,636
Allowance for doubtful receivables 48,148 71,384 —
(Gain) Loss on sale of marketable debt securities 20,000 (33,125 ) —
Write down of investment — 50,000 —
Non-cash interest — — 1,131,053
Deferred rent (393,677 ) (91,291 ) —
Options and warrants issued for services and other 664,043 55,150 156,000
Common stock issued for services and other — — 76,000
Change in assets and liabilities:
Accounts receivable trade 345,050 1,268,791 (33,185 )
Costs and earnings in excess of billings on uncompleted contracts 2,468,770 (906,649 ) —
Inventories 20,839 36,258 (65,857 )
Prepaid expenses and other (65,227 ) 273,588 (115,032 )
Accounts payable (549,036 ) (362,505 ) (2,951 )
Billings in excess of costs and earnings on uncompleted contracts (317,737 ) 899,857 —
Accrued liabilities 1,029,404 955,050 (318,700 )
Deferred revenue 1,191,958 (1,405,446 ) 10,000
Net cash used in operating activities (4,513,497 ) (5,644,759 ) (2,857,145 )
Acquisition of PSG — (498,937 ) —
Acquisition of AMG — (10,431,878 ) —
Capital expenditures (148,616 ) (275,193 ) (66,543 )
Purchases of marketable debt securities — (5,887,500 ) —
Proceeds from sale of marketable debt securities 980,000 4,920,625 —
Deposits 1,009,471 (2,760,583 ) —
Patents and patents pending (65,786 ) (149,687 ) —
Other 50,000 (46,552 ) (28,215 )
Net cash provided by (used in) investing activities 1,825,069 (15,129,705 ) (94,758 )
CASH FLOW FROM FINANCING ACTIVITIES:
Net advance from (to) stockholders (12,753 ) (54,437 ) 34,030
Issuance of convertible bridge notes 250,000 — —
Repayment of convertible bridge notes (250,000 ) — —
Issuance of long-term obligations 4,822,250 10,601,839 3,852,250
Repayment of long term obligations (1,908,212 ) (401,563 ) —
Financing costs (248,406 ) (522,000 ) —
Sale of common stock — 11,248,803 61,665
Exercise of warrants 558,788 1,950 —
Repurchase of warrants and other — (125,000 ) —
Payment of offering costs (56,642 ) (31,688 ) —
Net cash provided by financing activities 3,155,025 20,717,904 3,947,945
NET INCREASE (DECREASE) IN CASH 466,597 (56,560 ) 996,042
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 956,230 1,012,790 16,748
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,422,827 $ 956,230 $ 1,012,790
NOTES TO THE FINANCIAL STATEMENTS
December 31, 2005, 2004 and 2003
NOTE A—THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Change in Name of Company and State of Incorporation
Effective January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key"), reincorporated as BIO-key International, Inc., a Delaware corporation (the "Company," "BIO-key"). The reincorporation was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement"); whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to reincorporate in the State of Delaware (the "Reincorporation"). As a result of the Reincorporation, the legal domicile of the registrant is now Delaware.
The Company, founded in 1993, made two strategic acquisitions in 2004. The Company acquired Public Safety Group Inc. ("PSG") in March, 2004, and the Mobile Government division of Aether Systems, Inc. ("AMG" or "Mobile Government") in September, 2004. The Company is now focused on delivering advanced finger based biometric identification and security solutions and information services to law enforcement, fire service and emergence medical service agencies as well as other government and private sector customers. The Company's mobile wireless technology provides first responders throughout North America with critical, reliable, real-time data and images from local, state and national databases.
Broad commercial acceptance of the Company's technology is critical to the Company's success and ability to generate revenues. As a result of two acquisitions, the Company's only significant revenues to date have began in the fourth quarter of 2004. The Company recorded approximately $14,226,000 in revenues in 2005. The Company has accumulated losses during 2003 and 2004 of approximately $14,909,000, of which approximately $10,850,000 was incurred during 2004. The Company reported a loss of approximately $3,673,684 in 2005. As of December 31, 2005, there was a working capital deficit of approximately $10,400,000.
The Company issued notes in 2004 as well as 2005 in amount of approximately $10,101,000 and $5,300,000, respectively. The Company is also currently considering various alternatives to improve its operating results. No assurance can be given that the Company's operating results will improve as a result of this additional funding or that such funding would not be dilutive to existing stockholders.
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 funding, meet its funding requirements on a continuing basis, and succeed in its future operations. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue in existence.
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:
Revenue from licensing software, which requires significant customization and modification, is recognized using the percentage of completion method, based on the hours of effort incurred by the company in relation to the total estimated hours to complete. In instances where third party hardware, software or services form a significant portion of a customer's contract, the company recognizes revenue for the element of software customization by the percentage of completion method described
above. Third party hardware, software, and services are recognized upon shipment or acceptance as appropriate. If the company makes different judgments or utilizes different estimates of the total amount of work expected to be required to customize or modify the software, the timing and revenue recognition, from period to period, and the margins on the project in the reporting period, may differ materially from amounts reported. Revenues earned but not yet billed are shown as an asset in Costs and Earnings in Excess of Billings in the balance sheet. Billings in excess of cost and earnings are reflected as a liability in the balance sheet. Anticipated contract losses are recognized as soon as they become known and are estimable.
Service Revenues: Revenues from services are comprised of maintenance and consulting and implementation services. Maintenance revenues include providing for unspecified when-and-if available product updates and customer telephone support services, and are recognized ratably over the term of the service period. Consulting services are generally sold on a time-and-materials basis and include a range of services including installation of software and assisting in the design of interfaces to allow the software to operate in customized environments. Services are generally separable from other elements under the arrangement since performance of the services are not essential to the functionality of any other element of the transaction and are described in the contract such that the total price of the arrangement would be expected to vary as the result of the inclusion or exclusion of the services. Revenues from services are generally recognized as the services are performed.
3. Cash and Cash Equivalents
Cash equivalents consist of certificates of deposit and all other liquid investments with original maturities of three months or less. The Company maintains its cash balances in a financial institution in Nevada. These balances are insured by the Federal Deposit Insurance Corporation up to $100,000.
4. Accounts Receivable
Accounts receivable billed and unbilled are carried at original amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer's financial condition, credit history, and current economic conditions. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received.
The Company completed the acquisitions of PSG and AMG. These acquisitions have been accounted for under the purchase method of accounting, which has resulted in recording significant goodwill and other intangible asset balances. The purchase prices have been allocated to assets acquired and liabilities assumed at their estimated fair values on the date of the acquisitions, as determined by management, and by appraisals with respect to identifiable intangible assets. Our accounting for these acquisitions involves significant judgments and estimates regarding fair values of acquired intangible assets, which are based on projections of future revenues and cash flows, assumptions regarding discount factors, royalty rates, tax rates, amortization methodologies and related useful lives. The developed technology (software), copyrighted software, marketing agreements, customer relationships and trademarks were valued using the income approach and are being amortized on a straight line basis over five years, their estimated useful lives.
6. Depreciation and Amortization
Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over the estimated service lives, principally using straight-line methods. Leasehold improvements are amortized over the shorter of the life of the improvement or the lease term, using the straight-line method. Intangible assets other than patent costs are amortized on the straight-line method over their expected useful lives. Patent costs are capitalized until patents are awarded. Upon award, such costs are amortized over their respective lives. If a patent is denied, all costs are charged to operations in that year. Deferred financing fees related to the issuance of long-term obligations are capitalized and amortized to interest expense over the lives of the related debt using the effective interest rate method.
The estimated useful lives used to compute depreciation and amortization for financial reporting purposes are as follows:
Equipment and leasehold improvements
Equipment 3-5 years
Furniture and fixtures 3-5 years
Software 3 years
Leasehold improvements life or lease term
Copyrighted software 5 years
Customer relationships 5 years
Trademarks 5 years
Developed technology 5 years
Marketing agreements 5 years
Patents life
Deferred financing fees
The estimated aggregate amortization expense of intangible assets for the five years following December 31, 2005 is approximately as follows:
Year ending December 31,
2006 $ 1,826,000
2010 $ —
The Company accounts for marketable securities pursuant to Statement of Financial Accounting Standards No. 115—"Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). SFAS 115 requires classification of debt and equity securities in three categories: trading securities, available-for-sale securities and held-to-maturity securities. Debt and equity securities classified as trading securities are carried at fair value with unrealized gains or losses included in income. 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 securities that are expected to be held-to-maturity are carried at amortized cost. On December 31, 2004, the Company's investments were all classified as available-for-sale. In January 2005, the Company sold these investments and did not purchase any additional Marketable Debt Securities as of December 31, 2005.
Goodwill represents the excess of costs of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, which requires the Company to test goodwill for impairment annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, rather than amortize. Accordingly, the Company has not amortized goodwill. As prov