UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

Commission File Number 001-33002

 

L-1 IDENTITY SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)

 

 

(203) 504-1100

Registrant’s telephone number, including area code

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

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

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

 

 

L-1 IDENTITY SOLUTIONS, INC.

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2008

 

 

INDEX

 

 

 

L-1 IDENTITY SOLUTIONS, INC.

Condensed Consolidated Balance Sheets

(in thousands)

(Unaudited)

 

 

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

L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Statements of Operations

 

 

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

L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Statements of Changes in Shareholders’ Equity

 

 

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

L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)

 

 

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

L-1 IDENTITY SOLUTIONS, INC.
Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

L-1 Identity Solutions, Inc. and its subsidiaries (“L-1” or the “Company”) provide identity solutions and services that enable governments, law enforcement agencies and businesses to enhance security, reduce identity theft and protect personal privacy. L-1’s identity solutions are specifically designed for the identification of people and include secure credentialing, biometrics capture and access devices, automated document authentication, automated biometric identification systems, and biometrically-enabled background checks, as well as systems design, development, integration and support services. These identity solutions enable L-1’s customers to manage the entire life cycle of an individual’s identity for a variety of applications including civil identification, criminal identification, commercial, border management, military, antiterrorism and national security. L-1 also provides comprehensive consulting, training, security, technology development, and information technology solutions to the U.S. intelligence community.

 

The Company’s identity solutions combine products and related services, consisting of hardware, components, consumables and software, as well as maintenance, consulting and training services integral to sales of hardware and software. The Company also provides fingerprinting enrollment services and government consulting, training, security, technology development and information technology services. A customer, depending on its needs, may order solutions that include hardware, equipment, consumables, software products or services or combine hardware products, consumables, equipment, software products and services to create a multiple element arrangement.

 

The Company operates in two reportable segments: the Identity Solutions segment and the Services segment. The Identity Solutions segment provides biometric and identity solutions to federal, state and local government agencies, foreign governments and commercial entities. The Services segment provides fingerprinting enrollment services to federal and state governments and commercial enterprises, as well as comprehensive consulting, training, security, technology development and information technology services to the U.S. intelligence community.

 

Reorganization

 

On May 16, 2007, the Company adopted a new holding company organizational structure in order to facilitate its convertible senior notes (the “Convertible Notes” or “Notes”) offering and the structuring of acquisitions. Pursuant to the reorganization, L-1 Identity Solutions, Inc. became the sole shareholder of its predecessor, L-1 Identity Solutions Operating Company (“L-1 Operating Company”, previously also known as L-1 Identity Solutions, Inc.). The reorganization has been accounted for as a reorganization of entities under common control and the historical consolidated financial statements of the predecessor entity represent the consolidated financial statements of the Company. The reorganization did not impact the historical carrying amounts of the assets and liabilities of the Company or its historical results of operations and cash flows.

 

The Company has no operations other than those carried through its investment in L-1 Operating Company and the financing operations related to the issuance of the Convertible Notes. At June 30, 2008, its assets consist of its investment in L-1 Operating Company of $1,296.9 million and deferred financing costs of $4.8 million. Its liabilities consist of Convertible Notes of $175.0 million and accrued interest of $0.8 million.

 

Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments that in the opinion of management are necessary for a fair presentation of the financial statements for the interim periods. The unaudited condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements, and in accordance with SEC rules, omit or condense certain information and footnote disclosures. Results for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the full year. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

The accompanying condensed consolidated financial statements include the accounts of L-1 and its subsidiaries, all of which are wholly owned. All material intercompany transactions and balances have been eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant assumptions and estimates relate to the allocation of the purchase price of the acquired businesses, assessing the impairment of goodwill, other intangible assets and property and equipment, revenue recognition, income taxes, litigation and valuation of and accounting for financial instruments, including convertible notes, warrants and stock options. Actual results could differ materially from those estimates.

 

Revenue Recognition

 

The Company derives its revenue from solutions that include products and services, as well as sales of stand alone services, hardware, components, consumables and software. Solutions revenue includes revenues from maintenance, consulting and training services related to sales of hardware and software solutions. Services revenue includes fingerprinting enrollment services and government consulting, security and information technologies services. A customer, depending on its needs, may order hardware, equipment, consumables, software products or services or combine hardware products, consumables, equipment, software products and services to create a multiple element arrangement. The Company’s revenue recognition policies are described in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. There have been no material changes to such policies.

 

Stock-Based Compensation

 

On January 1, 2006, L-1 adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, which requires share-based payment transactions to be accounted for using a fair value-based method and the recognition of the related expense in the results of operations. L-1 uses the Black-Scholes valuation method to estimate the fair value of option awards. The compensation expense related to share-based payments is recognized over the vesting period for awards granted after January 1, 2006 and over the remaining service period for the unvested portion of awards granted prior to January 1, 2006.

Determining the appropriate valuation method and related assumptions requires judgment, including estimating common stock price volatility, forfeiture rates and expected terms. The following weighted average assumptions were utilized in the valuation of stock options in 2008 (excluding the Bioscrypt assumed stock options) and 2007:

 

 

The expected volatility rate is based on the historical volatility of the Company’s common stock. In the second quarter of 2007, the Company reviewed the historical volatility of its common stock and began using a weighted average method that more accurately reflects volatility. The expected life of options are calculated pursuant to the guidance from Staff Accounting Bulletin No. 107. The Company estimated forfeitures are based on historical rates. The risk free interest rate is based on the applicable treasury security whose term approximates the expected life of the options. The Company updates these assumptions on at least an annual basis and on an interim basis if significant changes to the assumptions are determined to be necessary.

 

Stock-based compensation expense was $3.5 million and $2.5 million for the three months ended June 30, 2008 and 2007, respectively, and includes $0.1 million related to restricted stock for both periods and $0.4 million and $0.1 million of retirement contributions paid in common stock, respectively. Stock-based compensation expense for the six months ended June 30, 2008 and 2007 was $6.6 million and $5.2 million, respectively, and includes $0.1 million and $0.2 million of restricted stock, respectively, and $0.5 million and $0.1 million, respectively, of retirement contributions paid in common stock. The Company did not capitalize any stock compensation costs during any of the periods presented. The following tables presents stock-based compensation expense included in the condensed consolidated statements of operations (in thousands):

 

 

Computation of Net Income (Loss) per Share

 

The Company computes basic and diluted net income (loss) per share in accordance with SFAS No. 128, “Earnings per Share.” Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is based upon the weighted average number of diluted common and common equivalent shares outstanding during the period.

 

The basic and diluted net income (loss) per share calculation is computed based on the weighted average number of shares of common stock outstanding during the period. The impact of approximately 5.3 million and 5.4 million common equivalent shares for the three and six month periods ended June 30, 2008, respectively, and the impact of approximately 4.8 million and 4.7 million

common equivalent shares for the three and six month period ended June 30, 2007, respectively, were not reflected in the net income (loss) per share calculations as their effect would be anti-dilutive.

 

The Company calculates the effect of the Convertible Notes for the three and six month periods ended June 30, 2008 and 2007 on diluted earnings per share utilizing the “if converted” method. For the three and six month periods ended June 30, 2008 and 2007, the effect was antidilutive. Accordingly, approximately 5.5 million shares of weighted average common stock issuable at conversion have been excluded from the determination of weighted average diluted shares outstanding.

 

In connection with the issuance of the Convertible Notes, the Company entered into a pre-paid forward contract with Bear Stearns for a payment of $69.8 million to purchase 3.5 million shares of the Company’s common stock at a price of $20.00 per share. Pursuant to SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, the number of shares to be delivered under the contract is used to reduce weighted average basic and diluted shares outstanding for income (loss) per share purposes.

 

Basic and diluted net income (loss) per share calculations for the three and six month periods ended June 30, 2008 and 2007 are as follows (in thousands, except per share data):

 

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157, as amended, defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. With respect to financial assets and liabilities, SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. However, in February 2008, the FASB determined that an entity need not apply this standard to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis until 2009. Accordingly, the Company’s adoption of this standard on January 1, 2008, is limited to financial assets and liabilities and did not have a material effect on the Company’s financial condition or results of operations. The Company is still in the process of evaluating the impact of this standard with respect to its effect on nonfinancial assets and liabilities and has not yet determined the impact that it will have on the consolidated financial statements upon full adoption.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure certain financial assets and liabilities at fair value. SFAS No. 159 is effective for years beginning after November 15, 2007. The Company has not adopted the fair value option method permitted by SFAS No. 159.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-on Amendment of ARB No. 51. SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary. SFAS No. 160 is effective for

financial statements issued for fiscal years beginning after December 15, 2008, and interim statements within those fiscal years. Among other things, SFAS No. 160 requires noncontrolling interest to be included as a component of shareholders’ equity. The Company does not currently have any material noncontrolling interests.

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) establishes standards for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS No. 141(R) also provides guidance for recognizing and measuring the goodwill acquired in the business combination and for information to disclose. Among other things, SFAS No. 141(R) requires that securities issued to be valued as of the acquisition date, transaction costs incurred in connection with an acquisition be expensed, except acquiree costs that meet the criteria of SFAS No. 146, contingent consideration be recognized at fair value as of the date of acquisition with subsequent changes reflected in income, and in process research and development be capitalized as an intangible asset. The provisions of SFAS No. 141(R) are applicable to business combinations consummated on or after December 15, 2008. Early application is prohibited. The provision of SFAS No. 141(R) will have a significant impact in the accounting for future business combinations.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 provides guidance about the location and amounts of derivative instruments disclosed in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under SFAS No. 133, Derivatives Implementation; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. SFAS No. 161 requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. SFAS No. 161 is effective for financial statements issued after November 15, 2008. The Company is evaluating the impact of this standard on its consolidated financial statements.

 

In May 2008, the FASB issued FASB Staff Position (“FSP”) No. APB 14-1, that significantly impacts the accounting for the Convertible Notes. The FSP requires that convertible debt be separated into debt and equity components at issuance. The value assigned to the Convertible Notes is the estimated fair value, as of the issuance date, of a similar bond without the conversion feature. The difference between the Convertible Notes cash proceeds and its assigned value would be recorded as a debt discount and amortized to interest expense over the life of the Convertible Notes. Although the FSP will have no impact on the actual past or future cash flows from the Convertible Notes, it will result in recording a significant amount of non-cash interest expense as the debt discount is amortized. The FSP is effective for years beginning after December 31, 2008 and will require retrospective application. Early application is prohibited.

 

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of “Present Fairly in Conformity with Generally Accepted Accounting Principles”. SFAS No. 162 is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are presented in conformity with accounting principles generally accepted in the United States of America. The Company has not completed its evaluation of the effects, if any, that SFAS No. 162 may have, but does not expect that adoption of this standard will have a material impact on its consolidated financial statements.

 

Stock Options

 

The following table summarizes the stock option activity from January 1, 2008 through June 30, 2008:

 

 

 

 

The aggregate unearned compensation cost of unvested options outstanding as of June 30, 2008 was $28.0 million and will be amortized over a weighted average period of 2.6 years. The total intrinsic value of options exercised during the three and six months ended June 30, 2008 was $0.4 million and $0.5 million, respectively. The intrinsic value is calculated as the difference between the market value of the Company’s common stock and the exercise price of options.

 

On May 7, 2008, the Company’s shareholders approved the L-1 Identity Solutions, Inc. 2008 Long-Term Incentive Plan, under which 2 million shares will be available for awards to employees, consultants and directors. Shares remaining available for issuance under the Company’s 2005 Long-Term Incentive Plan will be carried over to, and available for future awards under, the Company’s 2008 Long-Term Incentive Plan.

 

 

The provision for income taxes for 2008 is based on the consolidated annual estimated effective tax rate for 2008 of 43.0%. The income tax provision for the three and six months ended June 30, 2007 includes approximately $1.2 million and $2.3 million, respectively, which represent the aggregate increase in the deferred tax asset resulting from losses incurred for income tax purposes and a full valuation allowance against such deferred tax asset. Pursuant to SFAS No. 109, such provision was recorded for the amortization of tax deductible goodwill, for which the period of reversal of the related temporary difference is indefinite; the related deferred tax liability cannot be used to offset the deferred tax asset in determining the valuation allowance. The remaining income tax provision for 2007 periods comprises foreign and state income tax expense.

 

 

Aston Capital Partners, L.P. (“Aston”), an affiliate of L-1 Investment Partners LLC and Lau Technologies (“Lau”), an affiliate of Mr. Denis K. Berube, a member of the board of directors of the Company, own approximately 9.8%, and 2.7%, respectively, of L-1’s outstanding common stock. Mr. Robert LaPenta, Mr. James DePalma, Mr. Joseph Paresi and Ms. Doni Fordyce, each executive officers of the Company, directly and indirectly hold all the beneficial ownership in L-1 Investment Partners LLC and Aston Capital Partners GP LLC, the investment manager and general partner of Aston. Mr. LaPenta is also the Chairman of the Board of Directors and Chief Executive Officer and

President of the Company. Mr. DePalma is also the Chief Financial Officer and Treasurer of the Company.

 

The Company has consulting agreements with Mr. Berube and his spouse, Ms. Joanna Lau, under which each receives annual compensation of $0.1 million. Each agreement terminates on the earlier of January 10, 2012 or commencement of full time employment elsewhere. During the three months and six months ended June 30, 2008 and 2007, $0.1 million and $0.1 million, and $0.1 million, $0.1 million, respectively, was paid in the aggregate to Mr. Berube and Ms. Lau in connection with the agreements.

 

Under the terms of a 2002 acquisition agreement of Lau Security Systems, the Company is obligated to pay Lau a royalty of 3.1% on certain of its face recognition revenues through June 30, 2014, up to a maximum of $27.5 million. Royalty expense included in cost of revenues was approximately $0.1 million and $0.1 million for the three months and six months ended June 30, 2008 and $0.1 million and $0.1 million for the three and six months ended June 30, 2007, respectively.

 

In connection with the merger with Identix, Aston and L-1 agreed in principle that the Company may, subject to approval of the Company’s board of directors, purchase AFIX Technologies, Inc., a portfolio company of Aston, which provides fingerprint and palmprint identification software to local law enforcement agencies, at fair market value to be determined by an independent appraiser retained by the Company’s board of directors.

 

In connection with the relocation of the corporate headquarters of the Company in the third quarter of 2006 to the offices of L-1 Investment Partners LLC in Stamford, Connecticut, the Company entered into a sublease with L-1 Investment Partners LLC under which the Company will reimburse L-1 Investment Partners LLC for the rent and other costs payable by the Company, which is estimated at $0.7 million annually. For the three months and six months ended June 30, 2008 and 2007, the Company incurred costs of $0.2 million and $0.4 million and $0.2 million and $0.4 million, respectively.

 

In connection with the merger with Identix, the Company entered into an agreement with Bear Stearns Companies, Inc. (“Bear Stearns”) pursuant to which Bear Stearns would provide financial advisory services related to the merger through August 2008. The spouse of Ms. Fordyce, Executive Vice President, Corporate Communications was an executive and senior investment banker at Bear Stearns involved with the engagement and a former employee of Bear Stearns has a personal investment in Aston. Pursuant to the letter agreement, Bear Stearns received $2.5 million upon the closing of the merger, plus expense reimbursement, as well as exclusive rights to act as underwriter, placement agent and/or financial advisor to the Company with respect to certain financings and other corporate transactions until August 2008. The Company waived any claims it may have against Bear Stearns with respect to any actual or potential conflicts of interest that may arise with respect to these relationships in the context of the Bear Stearns engagement.

 

Bear Stearns is party to the revolving credit agreement under which it was paid $0.2 million and $0.5 million in interest for the three months and six months ended June 30, 2008 and $0.2 million and $0.6 million for the three months and six months ended June 30, 2007, respectively. Bear Stearns share of borrowings outstanding at June 30, 2008 approximated $20.5 million. In addition, Bear Stearns was an initial purchaser of the Convertible Notes issued on May 17, 2007 for which it received an aggregate discount of $4.8 million. Also on May 17, 2007, the Company entered in a pre-paid forward contract with Bear Stearns to purchase approximately 3.5 million shares of the Company’s common stock for $69.8 million to be delivered in May 2012.

 

Bear Stearns acted as the broker for the purchase of 362,000 shares of the Company’s common stock in January 2008 and received a commission of 2 cents per share.

 

The Company has employment and non-competition agreements with all of its executive officers. Such agreements provide for employment and related compensation and restrict the individuals from competing with the Company. The agreements also provide for the grant of stock options under the Company’s stock option plans and for severance upon termination under circumstances defined in such agreements.

As a condition to the closing of the Identix merger, the Company and L-1 Investment Partners LLC entered into a Termination and Noncompete Agreement which, among other things, (1) terminated all arrangements whereby L-1 Investment Partners LLC and its affiliates provided financial, advisory, administrative or other services to the Company or its affiliates, and (2) prohibits L-1 Investment Partners LLC and its affiliates from engaging or assisting any person that competes directly or indirectly with the Company in the business of biometric, credentialing and ID management business anywhere in the United States or anywhere else in the world where the Company does business, or plans to do business or is actively evaluating doing business during the restricted period; provided however that the foregoing does not restrict L-1 Investment Partners LLC and its affiliates from retaining its investment in and advising AFIX Technologies, Inc. The restricted period runs co-terminously with the term of Mr. LaPenta’s employment agreement with the Company, dated as of August 29, 2006, and for a twelve month period following the expiration of the term of Mr. LaPenta’s employment agreement. On April 23, 2007, the Company entered into an employee arrangement with Mr. Robert LaPenta, Jr., the son of the Company’s Chief Executive Officer, to serve as Vice President, M&A/Corporate Development.

 

In connection with the acquisition of Integrated Biometric Technology, Inc. (“IBT”) in December 2005, the Company issued warrants to purchase 440,000 shares of common stock with an exercise price of $13.75 per share to L-1 Investment Partners LLC, of which 280,000 are currently exercisable and 160,000 will become exercisable if IBT achieves a specified level of operating performance.

 

In December 2005, Aston completed a $100 million investment in and became the beneficial owner of more than 5% of L-1’s outstanding common stock. In accordance with the terms of the investment agreement, L-1 issued to Aston warrants to purchase an aggregate of 1,600,000 shares of L-1’s common stock at an exercise price of $13.75 per share, which are fully exercisable and expire in December 2008.

 

On June 29, 2008, the Company entered into an amended and restated agreement to acquire the Secure ID business of Digimarc Corporation (“Digimarc”) in a cash transaction valued at approximately $310.0 million pursuant to a tender offer commenced on July 3, 2008. The acquisition is expected to be funded with borrowings under an amended and restated credit facility and proceeds from the issuance of $120.0 million of equity to private investors, including up to $35.0 million from Mr. Robert V. LaPenta, the Company’s Chairman, President and Chief Executive Officer. Digimarc’s stockholders will also receive shares in a new company bearing the Digimarc name and holding Digimarc’s digital watermarking business as well as the cash of Digimarc. The Company’s obligation to pay for shares in the tender offer remains subject to customary closing conditions and the spin-off of Digimarc’s digital watermarking business or the transfer of such business to a trust pending the effectiveness of a registration statement filed with the Securities and Exchange Commission, and is expected to close in the second half of 2008.

 

 

SFAS No. 131, Disclosures about Segments of a Business Enterprise and Related Information, establishes standards for reporting information regarding reportable and operating segments. Operating segments are defined as components of a company which the chief operating decision maker evaluates regularly in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company operates in two reportable segments, the Identity Solutions segment and the Services segment. The Identity Solutions segment provides solutions that enable governments, law enforcement agencies, and commercial businesses to enhance security, reduce identity theft, and protect personal privacy utilizing secure credential provisioning and authentication systems, biometric technology and the creation, enhancement and/or utilization of identity databases. The Services segment provides fingerprinting enrollment services to government, civil, and commercial customers, as well as comprehensive government consulting, training, network

security, technology development, and information technology solutions to the U.S. intelligence community.

 

The Company measures segment performance primarily based on revenues and operating income (loss) and Adjusted EBITDA. The segment information for 2007 has been reclassified to reflect the integration of ComnetiX’s products business into the Identity Solutions segment and its fingerprinting services business into the Services segment. The effects of the reclassification were not material to the segment information. Operating results by segment, including allocation of corporate expenses, for the three months and six months ended June 30, 2008 and 2007 were as follows (in thousands):

 

 

 

Corporate assets consist mainly of cash and cash equivalents, deferred financing costs and deferred tax assets. Revenues by market are as follows for the three and six months ended June 30, 2008 and 2007 (in thousands):

 

The Company’s operations outside the United States include wholly-owned subsidiaries in Bochum, Germany, Oakville, Canada and Markham, Canada. Revenues are attributed to each region based on the location of the customer. The following is a summary of revenues and total assets by geographic region (in thousands):

 

 

For the three month and six month periods ended June 30, 2008, two Federal Government agencies accounted for 30% and 30% of consolidated revenues, respectively. For the three month and six month periods ended June 30, 2007, two Federal Government agencies accounted for 32% and 30% of consolidated revenues, respectively. As of June 30, 2008, the Company had an accounts receivable balance of approximately $15.3 million from one Federal Government agency which was the only customer that had a balance of greater than 10% of consolidated accounts receivable. As of June 30, 2007, two Federal Government agencies were the only customers that had a balance of greater than 10% of consolidated accounts receivable, which was approximately $20.9 million.

 

 

2008 Acquisitions

 

Digimarc

 

On June 29, 2008, the Company entered into an amended and restated merger agreement with Digimarc. The agreement contemplates the Company’s acquisition of Digimarc, consisting solely of its secure ID business, following the spin-off of its digital watermarking business. Pursuant to the amended and restated merger agreement on July 3, 2008, the Company commenced a tender offer for all outstanding shares of Digimarc for $12.25 per share. Digimarc and L-1 also agreed that if the aggregate price paid to Digimarc stockholders for 100% of the issued and outstanding capital stock of Digimarc exceeds $310.0 million, then the new company holding Digimarc’s digital watermarking business will pay L-1 a cash amount equal to the excess at the closing of the merger. Conversely, if the aggregate price paid is less than $310.0 million, then Digimarc, as a wholly-owned subsidiary of L-1, will pay the new company a cash amount equal to the shortfall at the closing of the merger. The tender offer and acquisition transaction is expected to be funded with proceeds from borrowings under an amended and restated credit facility and proceeds from the issuance of $120.0 million of equity to private investors, including up to $35.0 million from Mr. Robert V. LaPenta, the Company’s Chairman, President and Chief Executive Officer. Digimarc stockholders will also receive shares in the new company that will hold Digimarc’s digital watermarking business and the cash of Digimarc.

 

The results of operations of all consummated acquisitions described below have been included in the condensed consolidated financial statements from their respective dates of acquisition.

 

Bioscrypt

 

On March 5, 2008, the Company acquired Bioscrypt Inc. (“Bioscrypt”), a provider of enterprise access control solutions headquartered in Markham, Canada. Under the terms of the definitive agreement, the Company issued approximately 2.5 million shares. Certain shareholders of Bioscrypt have exercised their dissenting shareholder rights under Canadian law and will receive cash. In addition the Company assumed all Bioscrypt stock options outstanding at the effective date of the acquisition (approximately 252,656 options). The Company has valued the assumed Bioscrypt stock options consistent with our valuation methodology of stock options issued by the Company. Bioscrypt is included in the Identity Solutions segment.

The aggregate purchase price of Bioscrypt was approximately $36.9 million, including an estimated $1.7 million of liabilities to dissenting shareholders and direct acquisition costs, and stock options valued at $1.4 million. The Company acquired Bioscrypt for its leadership position in Biometric physical access control, its global customer base, its offerings that complement the Company’s existing offerings and expected cost and revenue synergies. Preliminarily, the purchase price has been allocated as follows (in thousands):

 

 

The purchase price allocation of Bioscrypt is preliminary. The final allocation will be based on final analyses of identifiable intangible assets, contingent liabilities and income taxes, among other things, and will be finalized after the data necessary to complete the analyses of fair value of assets and liabilities is obtained and evaluated. Differences between the preliminary and final allocation could have a material impact on the consolidated results of operations. None of the goodwill is deductible for income tax purposes.

 

2007 Acquisitions

 

McClendon

 

On July 13, 2007, the Company acquired McClendon Corporation (“McClendon”). The Company purchased all of the issued and outstanding shares of common stock of McClendon from a newly-formed holding company for a purchase price of $33.0 million in cash and $33.0 million (approximately 1.6 million shares) of the Company’s common stock for a total consideration of $66.0 million, plus a $1.0 million adjustment based on McClendon’s closing working capital. The number of shares issued were determined based on an average for a specified period prior to closing. The Company acquired McClendon for the suite of technical and professional services it provides to the intelligence and military communities and a customer base which complements the Company’s portfolio. McClendon is included in the Services segment.

 

The aggregate purchase price of McClendon was approximately $68.8 million, including a working capital adjustment of $1.0 million and $1.8 million of direct acquisition costs. Substantially all of the cash portion of the purchase price was funded by borrowings under the revolving credit facility. Preliminarily, the purchase price has been allocated as follows (in thousands):

 

The purchase price allocation of McClendon is preliminary. The final allocation will be based on final analyses of identifiable intangible assets, contingent liabilities and income taxes, among other things, and will be finalized after the data necessary to compare the analyses of fair value of assets and liabilities is obtained and analyzed. Differences between preliminary and final allocations are not expected to have a material impact on the consolidated results of operations. None of the goodwill is deductible for income tax purposes.

 

ACI

 

On July 27, 2007, the Company acquired Advanced Concepts, Inc., (“ACI”), pursuant to which the Company acquired of all of the issued and outstanding shares of common stock of ACI from a newly-formed holding company for a purchase price of $71.5 million in cash, plus a $0.5 million adjustment based on ACI’s closing working capital. In addition, pursuant to the Stock Purchase Agreement, if ACI achieves certain financial targets in 2008, the Company will make additional payments of a maximum amount of $3.0 million. The Company acquired ACI for its access to a customer base within the U.S. government and its complementary service offerings, consisting of information and network security solutions and system engineering and development capabilities to the U.S. intelligence and military communities. ACI is included in the Services segment.

 

The aggregate purchase price of ACI was approximately $73.3 million, including a working capital adjustment of $0.5 million and $1.3 million of direct acquisition costs, substantially all of which was funded by borrowings under the Company’s revolving credit facility. Preliminarily, the purchase price has been allocated as follows (in thousands):

 

 

The purchase price allocation of ACI is preliminary. The final allocation will be based on final analyses of identifiable intangible assets, contingent liabilities and income taxes, among other things, and will be finalized after the data necessary to compare the analyses of fair value of assets and liabilities is obtained and analyzed. Differences between preliminary and final allocations are not expected to have a material impact on the consolidated results of operations. Additional payments that may be made if certain financial targets are achieved will be accounted for as additional purchase price. The goodwill is deductible for income tax purposes.

 

ComnetiX

 

On February 22, 2007, the Company consummated the acquisition of ComnetiX Inc. (“ComnetiX”), for approximately $17.8 million in cash. ComnetiX offers biometric identification solutions for use in areas such as applicant screening, financial services, health care, transportation, airlines and airports, casinos and gaming, and energy and utilities. ComnetiX is also a leading applicant fingerprinting services company in Canada, with a chain of ten offices. In addition, ComnetiX has established more than 40 applicant fingerprinting services locations throughout the United States. The fingerprinting services business has been integrated with our IBT business and is included in the Services segment. The biometric identification solutions business is included in the Identity Solutions segment.

The aggregate purchase price of ComnetiX was approximately $18.9 million, including $1.1 million of direct acquisition costs, substantially all of which was funded by borrowings under the revolving credit facility. The purchase price has been allocated as follows (in thousands):

 

 

None of the goodwill is deductible for income tax purposes.

 

Pro Forma Information

 

The following gives pro forma effect to the acquisitions of Bioscrypt, ACI, McClendon and ComnetiX as if they had occurred at the beginning of each period presented (in thousands except per share amounts):

 

 

The pro forma data is presented for informational purposes only and may not necessarily be indicative of future results of operations or what the results of operations would have been had the acquisitions of Bioscrypt, ACI, McClendon and ComnetiX been consummated on the dates indicated.

 

The pro forma results of operations include direct transaction costs, severance costs and other costs incurred by the acquired companies of $3.7 million for the six months ended June 30, 2008.

 

 

Inventory (in thousands):

 

 

Approximately $2.2 million and $3.5 million of inventory were maintained at customer sites at June 30, 2008 and December 31, 2007, respectively.

Property and equipment (in thousands):

 

 

For the three months ended June 30, 2008 and 2007, depreciation and amortization expense of property and equipment was $3.1 million and $2.4 million, respectively. For the six months ended June 30, 2008 and 2007, depreciation and amortization expense of property and equipment was $6.1 million and $4.5 million, respectively.

 

Goodwill (in thousands):

 

The following summarizes the activity in goodwill for the six months ended June 30, 2008 (in thousands):

 

 

During the six months ended June 30, 2008, the Company made an earnout payment pursuant to the 2006 SpecTal purchase agreement of $1.8 million which resulted in an increase in goodwill.

 

Intangible Assets (in thousands):

 

 

Amortization of intangible assets was $7.1 million and $13.8 million for the three months and six months ended June 30, 2008, respectively. For the three months and six months ended June 30, 2007,

amortization of intangible assets was $7.0 million and $13.9 million, respectively. Amortization for the current and subsequent five years and thereafter is as follows: $14.4 million, $25.7 million, $23.7 million, $22.6 million, $21.3 million and $65.5 million.

 

Products and Services Revenues:

 

The following represents details of the products and services for revenues for the three and six months ended June 30, 2008 and 2007 (in thousands):

 

 

Comprehensive Income (Loss):

 

 

 

Long-term debt consists of the following (in thousands):

 

 

Convertible Senior Notes

 

On May 17, 2007, the Company issued $175.0 million of convertible senior notes (the “Convertible Notes” or “Notes”) with a conversion feature which allows the Company the option to settle the debt either in shares of common stock or to settle the principal amount in cash and the conversion spread in cash or common stock. The proceeds of the Convertible Notes offering, net of deferred financing costs amounted to $168.7 million. Pursuant to the provisions of SFAS No. 133, EITF 90-19 and EITF 01-06, the embedded conversion feature has not been deemed a derivative since the conversion feature is indexed to Company’s stock and would be classified as equity.

 

The Notes are governed by an indenture, dated May 17, 2007 (the “Indenture”), between the Company and The Bank of New York, as trustee. The Notes will be convertible only under certain circumstances, as described below. If, at the time of conversion, the daily volume-weighted average price per share for a 25 trading day period calculated in accordance with the Indenture (as defined in greater detail in the Indenture, “VWAP”) of the Company’s common stock is less than or equal to

$32.00 per share, which is referred to as the base conversion price, the Notes will be convertible into 31.25 shares of common stock of the Company per $1,000 principal amount of the Notes, subject to adjustment upon the occurrence of certain events. If, at the time of conversion, the VWAP of the shares of common stock of the Company exceeds the base conversion price of $32.00 per share, the conversion rate will be determined pursuant to a formula resulting in holders’ receipt of up to an additional 14 shares of common stock per $1,000 principal amount of the Notes, subject to adjustment upon the occurrence of certain events and determined as set forth in the Indenture. The Notes are convertible until the close of business on the second business day immediately preceding May 15, 2027, in multiples of $1,000 in principal amount, at the option of the holder under the following circumstances: (1) during the five business-day period after any five consecutive trading day period (the “measurement period”) in which the trading price the Note, for each day of such measurement period was less than 98% of the product of the last reported sale price of shares of common stock of the Company and the applicable conversion rate for such trading day; (2) during any fiscal quarter after June 30, 2008, if the last reported sale price of shares of common stock of the Company for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the base conversion price on the related trading day; (3) if the Company calls any or all of the Notes for redemption; and (4) upon the occurrence of specified corporate transactions described in the Indenture. Upon conversion, the Company has the right to deliver shares of common stock based upon the applicable conversion rate, or a combination of cash and shares of common stock, if any, based on a daily conversion value as described above calculated on a proportionate basis for each trading day of a 25 trading-day observation period. In the event of a fundamental change as specified in the Indenture, the Company will increase the conversion rate by a number of additional shares of common stock specified in the Indenture, or, in lieu thereof, the Company may in certain circumstances elect to adjust the conversion rate and related conversion obligation so that the Notes will become convertible into shares of the acquiring or surviving company.

 

The Notes bear interest at a rate of 3.75% per year payable semiannually in arrears in cash on May 15 and November 15 of each year, beginning November 15, 2007. The Notes will mature on May 15, 2027, unless earlier converted, redeemed or repurchased. The Company may redeem the Notes at its option, in whole or in part, on or after May 20, 2012, subject to prior notice as provided in the Indenture. The redemption price during that period will be equal to the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest. The holders may require the Company to repurchase the Notes for cash on May 15, 2012, May 15, 2017 and May 15, 2020. Pursuant to the provision of SFAS Nos. 150 and 133, the embedded redemption and repurchase provisions have not been separated from the host contracts and accounted for as derivatives because such embedded derivatives are deemed to be clearly and closely related to the host contract.

 

The Convertible Notes are structurally subordinated to all liabilities of L-1 Operating Company. Under the term of the revolving credit agreement, L-1 Operating Company may not make any dividend payment to the Company except to permit the Company to make scheduled interest payments on the subordinated debt up to a maximum of $10.0 million per year and certain administrative expenses. However, the Company may prepay, redeem or repurchase the convertible notes in amounts not in excess of proceeds from the issuance of additional equity securities of the Company.

 

Revolving Credit Agreement

 

On October 19, 2006, the Company entered into an Amended and Restated Credit Agreement (the “Agreement”) by and among the Company, Bank of America, N.A. (the “Bank”), Bear Stearns, Wachovia Bank, Credit Suisse, Societe Generale and TD Bank North, to amend and restate the Credit Agreement, dated as of August 16, 2006, by and between the Company and the Bank. The Agreement provides for a revolving credit facility of up to $150.0 million, with the potential for up to $50.0 million in additional borrowings. In order to borrow under the facility, the Company is required to comply with certain covenants as more fully described below, some of which may limit the amounts borrowed or available. The Agreement provides that up to $25.0 million of the total facility amount may be used

for the issuance of letters of credit. The proceeds from the convertible note offering were used to repay the outstanding balance of the revolving credit facility. The amount available under the revolving credit facility is reduced by letters of credit of $8.1 million. At June 30, 2008, the Company had approximately $53.9 million available under the revolving credit facility. At June 30, 2008, the variable interest rates ranged from 4.0% to 4.2%.

 

Amounts borrowed under the Agreement bear interest for any interest period (as defined in the Agreement) at the British Bankers Association LIBOR Rate, plus a margin of 1.75% (subject to adjustment to a minimum margin of 1.50% and a maximum margin of 2.00% based on the Company’s indebtedness to EBITDA ratio described below), and must be repaid on or before October 19, 2011. The Company also has the option to borrow at a fluctuating rate per annum equal to the higher of (a) the Federal Funds Rate plus 1/2 of 1% and (b) the rate of interest in effect for such day as publicly announced from time to time by Bank of America as its “prime rate”, with respect to base rate loans plus the margin described above. If the Company has not borrowed all available amounts under the facility, it must pay a commitment fee of 0.375% per annum on such unutilized amounts. At June 30, 2008, debt outstanding under the Agreement amounted to $88.0 million.

 

In accordance with the Agreement, borrowings are secured by all assets of the Company and certain of its affiliates. The Company is required to maintain the following financial covenants under the Agreement:

 

 

Under the terms of the Agreement, L-1 Operating Company may incur, assume or guarantee unsecured subordinated indebtedness of up to $200.0 million and the Company may incur an additional $25.0 million of unsecured convertible subordinated indebtedness. Among other restrictions, the Agreement limits the Company’s ability to (i) pay dividends or repurchase capital stock, except with the proceeds of equity issuances or permitted subordinated debt, (ii) incur indebtedness (subject to the exceptions described above, among others), (iii) incur liens upon the collateral pledged to the Bank, (iv) sell or otherwise dispose of assets, including capital stock of subsidiaries, (v) merge, consolidate, sell or otherwise dispose of substantially all of the Company’s assets, (vi) make capital expenditures above certain thresholds, (vii) make investments, including acquisitions for cash in excess of $300.0 million in the aggregate and (viii) enter into transactions with affiliates. These covenants are subject to a number of additional exceptions and qualifications. The Agreement provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others: nonpayment, breach of covenants or other agreements in the Agreement, payment defaults or acceleration of other indebtedness, a failure to pay certain judgments and certain events of bankruptcy, insolvency or reorganization. Generally, if an event of default occurs, the Bank, with the consent of lenders holding a majority of the aggregate commitments under the facility, may declare all outstanding indebtedness under the Agreement to be due and payable. At June 30, 2008, the Company was in compliance with these covenants.

 

As of June 30, 2008, the Company has approximately $53.9 million available under its revolving credit facility and under the agreement to purchase Digimarc, the Company is required to pay $310.0 million in cash. On June 29, 2008, the Company received a commitment letter for up to $350.0 million of debt financing from Bank of America, N.A. and Wachovia Bank, N.A. which the company expects will be increased up to $435 million consisting of (1) a senior secured term loan facility in an aggregate principal amount of up to $300.0 million with a term of five years, and (2) a

senior secured revolving credit facility in an aggregate principal amount of $135.0 million. The proceeds of borrowings under the senior secured facilities will be used (a) to finance, in part, the payment of the purchase price of Digimarc, the repayment of the above referred revolving credit facility and the payment of fees and expenses incurred in connection with the acquisition of Digimarc, (b) to provide ongoing working capital and (c) for other general corporate purposes of the Company. The debt financing commitments are conditioned on the completion of the Digimarc acquisition, as well as other customary conditions, including the negotiation, execution and delivery of definitive documentation and the completion of $120.0 million of equity financings described herein. Borrowings under the senior secured credit facilities are expected to bear interest a rate equal to LIBOR (subject to a floor of 3%) plus 3.75% to 4.5% per annum. L-1 also expects to pay a fee of 0.5% on the unused portion of the revolving credit facility. The senior secured term loan facility will require quarterly principal payments beginning at 5.0% of the outstanding borrowings under the senior secured term loan facility for the initial year, increasing over the duration of the senior secured term loan facility. All obligations of L-1 Operating Company under the senior secured credit facilities are expected to be guaranteed on a senior secured basis by L-1 and by each of L-1’s existing and subsequently acquired or organized direct or indirect wholly-owned material subsidiaries (subject to certain exceptions).

 

In connection with the acquisition of Digimarc, L-1 entered into private placement securities purchase agreements, which would provide L-1 with up to $120.0 million of proceeds from the sale of its equity securities. Under the terms of the agreements, L-1 is obligated to apply all net proceeds from the sale of its securities to fund the acquisition of Digimarc. L-1 entered into agreements with two institutional investors pursuant to which L-1 agreed to sell to the investors shares of L-1 common stock. Subject to the terms and conditions set forth in the agreements, these institutional investors have committed to purchase shares of L-1 common stock for an aggregate purchase price of $85.0 million, which may be increased to $95.0 million. L-1 also entered into an agreement with Mr. Robert V. LaPenta, the Chairman and Chief Executive Officer of L-1, dated June 29, 2008, pursuant to which L-1 agreed to sell to Mr. LaPenta shares of L-1 non-voting common stock and L-1 non-voting preferred stock. Subject to the terms and conditions set forth in the agreement with Mr. LaPenta, Mr. LaPenta committed to purchase shares of L-1 common stock and L-1 preferred stock for an aggregate price of $25.0 million, which may be increased prior to closing to up to $35.0 million at the sole discretion of Mr. LaPenta.

 

Pursuant to the terms of each of the agreements, each investor, including Mr. LaPenta, had an option, exercisable following the close of business on June 30, 2008, to purchase shares of L-1 common stock for either (1) a per share price of $12.9543 (representing a 4% discount to the volume weighted-average price of a share of L-1 common stock on June 30, 2008, as reported by Bloomberg Financial Markets) or (2) a per share price of $13.19, together with a contractual price protection right to receive additional shares of L-1 common stock if the volume weighted-average price of a share of L-1 common stock as reported by Bloomberg Financial Markets for the 30 consecutive trading days ending on the last trading day prior to June 30, 2009 was less than $13.19. The investors other than Mr. LaPenta elected option (1) above, accordingly, upon consummation of the transactions contemplated by their respective agreements, they would purchase an aggregate of 6,561,528 common shares. Mr. LaPenta elected option (2) above, which entitled him to the contractual price protection right to receive additional shares of L-1 preferred stock as described above. Accordingly, upon consummation of the transaction, Mr. LaPenta would purchase 750,000 shares of L-1 non-voting common stock for $13.19 per share and 15,107 shares of L-1 non-voting preferred stock for $1,000 per share. Pursuant to the terms of the price protection right, Mr. LaPenta may receive up to 2,185 additional shares of L-1 preferred stock (assuming an aggregate purchase price of $25.0 million).

 

If any agreement is terminated, with limited exceptions, each of the institutional investors will have the option to purchase shares of L-1 common stock at a price of $12.90 per share. The option will remain exercisable for 15 business days from the date of the termination. The investors would be entitled to purchase up to an aggregate 1,098,138 shares of L-1 common stock following a termination

within 90 days from the date of the agreement, and up to 1,647,286 shares of L-1 common stock upon a later termination.

 

 

In connection with the issuance of the Convertible Notes on May 17, 2007, the Company entered into a contract with Bear Stearns to purchase 3,490,400 shares of the Company’s common stock at a purchase price of $20.00 per share. Under the agreement, Bear Stearns is required to deliver the shares to the Company in April-May 2012. The transaction is subject to early settlement or settlement with alternative consideration in the event of certain significant corporate transactions such as a change in control. At closing of the Convertible Notes, the Company settled its obligation under the pre-paid forward contract to Bear Stearns for cash of $69.8 million. As required by SFAS No. 150, the fair value of the obligation (which is equal to the cash paid) has been accounted for as a repurchase of common stock and as a reduction of shareholders’ equity. Under terms of the contract, any dividend payment that Bear Stearns would otherwise be entitled to on the common stock during the term of the contract would be paid to the Company.

 

 

In January 2004, LG Electronics USA, Inc. (“LGE USA”) and LG Electronics, Inc., (“LGE”) a Korean corporation (LGE USA and LGE, together, “LG”) filed a lawsuit against Iridian Technologies, Inc., a wholly owned subsidiary of the Company, in federal court in New Jersey seeking to cancel Iridian’s federal trademark registration for its IrisAccess trademark, and alleging that Iridian had made false statements by announcing that it had discontinued its IrisAccess line of products. At the time LG filed this lawsuit, the parties had been engaged in an ongoing negotiation regarding Iridian’s introduction of new standard pricing for its licenses. LG contended that Iridian was not entitled to impose its new standard “per user” pricing on LG pursuant to the terms of the parties’ 2000 Amended and Restated Development, Distribution and Supply agreement (the “License Agreement”). In August 2004, LG filed a demand for arbitration before the American Arbitration Association, seeking a finding that its fee for using Iridian’s iris recognition technology remained at the original “per unit” pricing structure under the License Agreement. Shortly thereafter, Iridian terminated the License Agreement due to LG’s failure to pay royalties as required under Iridian’s new standard pricing. In response, LG filed another lawsuit in New Jersey federal court, asking the court to enter a finding that Iridian’s termination of the License Agreement was improper and that LG’s continued use of Iridian’s technology did not infringe upon Iridian’s patent rights. The issues in all three cases were consolidated into one action in New Jersey federal court. Iridian vigorously denied all of LG’s claims and counterclaimed for LG’s breach of contract, infringement of Iridian’s patents and copyrights, and misappropriation of Iridian’s trade secrets. LG replied to Iridian’s counterclaims and asserted defenses that include, among other things, the alleged invalidity or unenforceability of Iridian’s patents, copyrights and trade secrets. The court subsequently allowed LG to further amend its complaint to add allegations of antitrust violations by Iridian and to assert claims against L-1 and SecuriMetrics as defendants. Iridian subsequently requested to assert additional counterclaims against LG, which request remained pending while the Court conducted mediation with all parties in an effort to reach settlement terms. On May 1, 2008, the Company settled the litigation, which resolves all historical issues and disputes among the parties and dismisses with prejudice the pending litigation in the U.S. District Court for the District of New Jersey. Concurrently with the settlement, LG entered into a new license agreement with Iridian to license Iridian’s proprietary 2pi iris recognition software, and LGE USA entered into a separate agreement to obtain certain limited telephonic assistance for a period of twelve months from Iridian and L-1. In addition, Iridian assigned to LGE its “IRISACCESS” trademark which was determined to have minimal value to the Company.

 

In the ordinary course of business, the Company is subject to various claims, demands, litigation, investigations, inquiries, proceedings, or assessments and various contingent liabilities incidental to its businesses or assumed in connection with business acquisitions. In accordance with SFAS No. 5,

Accounting for Contingencies, the Company records a liability when management believes that it is both probable that a liability has been incurred and can reasonably estimate the amount of the potential loss. The Company believes it has adequate provisions for any such matters. The Company reviews these provisions quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. However, litigation is inherently unpredictable and it is therefore possible that the consolidated financial position, results of operations or cash flows of the Company could be materially adversely affected in any particular period by the unfavorable resolution of one or more of these contingencies.

 

 

On August 1, 2008 the Company accepted approximately 19,767,699 shares of Digimarc common stock validly tendered and not withdrawn, pursuant to its tender offer, representing approximately 79 percent of the issued and outstanding shares of Digimarc common stock. Also the Company’s wholly owned subsidiary, Dolomite Acquisition Co., commenced a subsequent offering period to acquire all of the remaining outstanding shares of common stock of Digimarc not tendered into the offer. The subsequent offering period will expire at 5:00 p.m., New York City time, on Friday, August 8, 2008, unless otherwise extended. Following the expiration of the subsequent offering period, L-1 expects that it will acquire all of the remaining outstanding shares of Digimarc common stock through a merger. With the purchase of shares in the offer, L-1 has sufficient voting power to approve the merger without the affirmative vote of any other Digimarc stockholder. As a result of this merger, Digimarc will be come a wholly-owned subsidiary of L-1, and each outstanding share of Digimarc common stock will be cancelled and (except for shares held by L-1 or its subsidiaries or shares for which appraisal rights are properly demanded) will be converted into the right to receive the same consideration, without interest, received by holders who tendered into the Offer.

 

Introduction

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes contained in our 2007 Annual Report on Form 10-K and the condensed consolidated financial statements and the accompanying notes contained in this Quarterly Report on Form 10-Q.

 

Business Overview

 

L-1 Identity Solutions, Inc. and its subsidiaries provide identity solutions and services that enable governments, law enforcement agencies and businesses to enhance security, reduce identity theft and protect personal privacy. L-1’s identity solutions are specifically designed for the identification of people and include secure credentialing, biometrics capture and access devices, automated document authentication, automated biometric identification systems, and biometrically-enabled background checks, as well as systems design, development, integration and support services. These identity solutions enable L-1’s customers to manage the entire life cycle of an individual’s identity for a variety of applications including civil identification, criminal identification, commercial, border management, military, antiterrorism and national security. L-1 also provides comprehensive consulting, training, security, technology development, and information technology solutions to the U.S. intelligence community.

 

The Company’s identity solutions combine products and related services, consisting of hardware, components, consumables and software, as well as maintenance, consulting and training services integral to sales of hardware and software. The Company also provides fingerprinting enrollment services and government consulting, training, security, technology development and information technology services. A customer, depending on its needs, may order solutions that include hardware, equipment, consumables, software products or services or combine hardware products, consumables, equipment, software products and services to create a multiple element arrangement.

 

The market for identity protection solutions has continued to develop at a rapid pace. In particular, consumers of identity protection solutions are demanding end-to-end solutions with increased functionality that can solve their spectrum of needs across the identity life cycle. Our objective is to meet those growing needs by continuing to broaden our product and solution offerings to meet our customer needs, leveraging our existing customer base to provide additional products and services, expanding our customer base both domestically and abroad, and augmenting our competitive position through strategic acquisitions. We evaluate our business primarily through financial metrics such as revenues, operating income (loss) and earnings before interest, income taxes, depreciation and amortization, asset impairments and in-process research and development charges, and stock-based compensation expense (“Adjusted EBITDA”), as well as free cash flow.

 

Our revenues increased to $145.0 million and $260.9 for the three and six months ended June 30, 2008, respectively, from $90.1 million and $160.1 million for the three and six months ended June 30, 2007. Our net income for the three months and six months ended June 30, 2008 was $3.2 million and $1.3 million, respectively, compared to net losses of $1.2 million and $10.0 million for the three months and six months ended June 30, 2007, respectively.

 

Sources of Revenues

 

Our Secure Credentialing Division, formerly known as “Viisage”, generates revenues from the sales of biometric solutions consisting of bundled proprietary software with commercial off-the-shelf equipment and related maintenance and services, the sale of secure printing solutions and related consumables, and the design, customization and installation of secure credential issuance systems which generate revenues as the credentials are issued by the customer. The division also generates revenues

from solutions using biometric technologies of other divisions. The division is included in our Identity Solutions segment.

 

Our Biometrics division, formerly known as Identix, also included in our Identity Solutions segment, generates revenues from the sale of biometric solutions incorporating fingerprint, facial, skin and iris biometrics and system components necessary for the biometric capture and knowledge discovery. Identix offerings include Live Scan and mobile systems and services for biometric capture and identification, systems and biometric solutions that include modules and software for biometric matching and verification. Revenues are generated by sales of hardware, software and maintenance and other services.

 

Our SecuriMetrics, Inc. (“SecuriMetrics”)/Iridian Technologies, Inc. (“Iridian”) division, historically included in our Identity Solutions segment, is being integrated with the Biometric division and generates revenues through the development, customization and sale of biometrics solutions using iris technology which typically consists of proprietary multi-biometric capture devices bundled together with our proprietary software and other biometric technologies, as well as sales of licenses and software.

 

Our Bioscrypt Inc, (“Bioscrypt”) division generates revenues from the sales of biometric access control units and technologies. In addition, Bioscrypt’s VeriSoft software application is included on personal computers and its 3D facial recognition technology is used by the largest casino in the world. Bioscrypt is included in the Identity Solutions segment.

 

Our ComnetiX Inc. (“ComnetiX”) division, which was acquired on February 21, 2007, provides fingerprinting biometric authentication and identification solutions and enrollment services. In 2007, the division was included in our Services segment. Effective 2008, the company separated the biometric authentification and identification business of ComnetiX and integrated it with the Biometrics division of our Identity Solutions segment. The enrollment services business of ComnetiX is now integrated with the IBT division, included in our Services segment.

 

Our Integrated Biometric Technology, Inc. (“IBT”) division, included in our Services segment, generates revenues through the sales of enrollment and background screening products and services.

 

Our SpecTal, LLC (“SpecTal”) division, included in our Services segment, provides comprehensive security consulting services to U.S. government intelligence agencies.

 

Our McClendon LLC (“McClendon”) division, included in our Services segment, provides technical and professional services to the U.S. intelligence and military communities.

 

Our Advanced Concepts, Inc. (“ACI”) division, included in our Services segment, provides information technology and network security solutions, and system engineering and development services for the U.S. intelligence and military communities.

 

We market our solutions and services primarily to U.S. and foreign, federal, state and local government agencies and law enforcement agencies. We also are working to expand the use of our solutions in commercial markets, particularly financial services, transportation and healthcare. In a typical contract with a government entity for an identity solution, we design the system, supply and install equipment and software and integrate the solution within the entity’s existing network infrastructure and provide maintenance services. These contracts may be structured as fixed price contracts with payments made upon completion of agreed milestones or deliveries and with each milestone or delivery typically having a value specified in the contract. Alternatively, these contracts may be paid at a fixed price per credential issued as is typical in the drivers’ license market, per fingerprint delivered in the case of our fingerprinting services or on a time and material and fixed price level of effort basis for our government services.