SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
|ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the Fiscal Year Ended December 31, 2006
|TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the Transition Period from to .
Commission File Number 000-21559
L-1 IDENTITY SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (203)-504-1100
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.001 par value
Indicate by a check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by a check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No
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. Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference into Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by a check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated filer’’ and ‘‘large accelerated filer’’ in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer Accelerated Filer Non-Accelerated Filer
Indicate by a check mark whether the Registrant is a shell company (as defined in Rule 12b-2). Yes No
The aggregate market value of the voting stock held by nonaffiliates of the registrant as of March 14, 2007, was approximately $936.1 million.
As of March 14, 2007, the registrant had 72,577,549 shares of Common Stock outstanding.
L-1 IDENTITY SOLUTIONS, INC.
TABLE OF CONTENTS
L-1 Identity Solutions, Inc. (‘‘L-1’’), a Delaware corporation, was formerly known as Viisage Technology, Inc. (‘‘Viisage’’). Upon completion of Viisage’s merger with Identix Incorporated (‘‘Identix’’) in August 2006, Viisage changed its name to ‘‘L-1 Identity Solutions, Inc.’’ Our principal executive offices are located at 177 Broad Street, Stamford, CT 06901, Tel. (203) 504-1100. When we refer to ‘‘we’’, ‘‘our’’ and ‘‘Viisage’’ in this Annual Report on Form 10-K, we mean L-1 Identity Solutions, Inc. (‘‘L-1’’) as well as all of our consolidated subsidiaries, unless the context otherwise requires.
We are the trusted provider of technology, products, systems and solutions that protect and secure personal identities and assets. Together, our growing portfolio of companies deliver a full range of offerings targeted to manage human identity. These offerings are the cornerstone for building convenient and secure identification (‘‘ID’’) solutions. L-1 companies have a 20-year history of serving domestic and international governments, law enforcement and border management agencies, military branches and commercial businesses.
Because of threats to national security and significant economic loss resulting from identity-based fraud and theft, the market is requiring a more secure and tamper-proof means of validating a claimed identity as well as issuing credentials that grant privileges for travel, physical and logical access to facilities and networks, and performing financial transactions. We believe that the best means available today is through an end-to-end, integrated multi-biometric (finger, face, iris) recognition solution.
Through our corporate research center and ongoing development efforts, we remain at the forefront of the latest advances in multi-modal (finger, face and iris) biometric recognition, imaging and document authentication technology. When used together to form an end-to-end solution, the modular products, services and solutions from L-1 stand apart as a comprehensive approach to protecting and securing identities. We are not aware of any other company that competes with us directly on the basis of an integrated and multi-modal identity solution, covering the entire identity lifecycle from proofing to issuance. As a complement to our R&D efforts, our strategy includes the continuing evaluation of potential acquisitions of technologies and companies participating in the biometric industry.
Our products and services offer proven reliability and scalability and are deployed in some of the most demanding applications and environments around the world. With our solutions, states can better protect their citizens against identity theft and decrease the incidence of fraudulent ID cards, including drivers’ licenses. Additionally, with our solutions credentialing standards for government and corporate employees are more robust, borders, airports, seaports and other critical infrastructure are better managed and law enforcement and military personnel gain powerful tools to solve more crimes and identify terrorist suspects. In addition, our solutions help customers respond to critical federal legislation and international mandates aimed at fighting global terrorism and crime.
We provide products and services through a global network of partners, such as leading system integrators, defense prime contractors and original equipment manufacturers (‘‘OEMs’’), serving a broad range of markets including government, law enforcement agencies, military, finance, gaming, commercial business and healthcare. Customers in each of these markets have their own specific needs, and we work with them to provide tailored solutions.
The markets for identity protection solutions are large and continue to develop. 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 cycle. Our objective is to meet those growing needs by continuing to broaden our product and solution offerings, leveraging our
existing customer base to provide additional products and services, expanding our customer base both domestically and internationally, and augmenting our competitive position through strategic acquisitions. As an expanding company, we believe that one of our greatest challenges is choosing the right markets and best opportunities to pursue that will enable us to successfully grow our business.
Recent Acquisitions and Financing Activities
Understanding the growth potential that the identity solutions market represents, L-1 sought to close the gap between the need (a better method of securing and protecting personal identities) and the ability for current industry participants to provide it due to a lack of professional management, infrastructure and capital resources. The intent was to use Viisage as the platform upon which to build an end-to-end identity solution provider to integrate multi-modal technologies into products and services to serve the need for biometric technologies by local, state, federal and international agencies.
In December 2005, we issued and sold to Aston Capital Partners, L.P. (‘‘Aston’’), approximately 7.6 million shares of Viisage common stock resulting in gross proceeds to us of $100 million. Aston is an investment fund managed by an entity controlled by certain of our current senior executives. Under the investment agreement with Aston, $85 million of the proceeds was used to finance acquisitions subject to approval by Viisage’s board of directors.
In December 2005, we acquired Integrated Biometric Technology LLC (‘‘IBT’’), a leader in providing fingerprinting products, services and solutions to government, civil, and commercial customers that require criminal background checks and screening. Also in December 2005, we acquired the AutoTest division of Openshaw Media Group, a provider of automated web-based applicant testing technologies for state departments of motor vehicles and other credential issuing agencies.
In February 2006, we acquired SecuriMetrics Inc. (‘‘SecuriMetrics’’) which develops, customizes and sells biometric solutions using principally iris recognition technology, typically consisting of biometrics capture devices bundled with proprietary software, as well as sales of devices and software.
In August 2006, we acquired Iridian Technologies, Inc. (‘‘Iridian’’) which owns and licenses an extensive portfolio of intellectual property related to iris recognition technology.
Also in August 2006, we merged with Identix, a provider of fingerprint, facial and skin biometric technologies, and related system components as well as fingerprinting services, that individually and collectively empower the identification of individuals and are critical to biometric capture and knowledge discovery in large scale identification management problems. The fingerprint services business of Identix has been integrated into the business of IBT.
In October 2006, we acquired SpecTal LLC, (‘‘SpecTal’’) which provides comprehensive security and intelligence solutions primarily to the U.S. government agencies.
Also in October 2006, we entered in a revolving credit agreement pursuant to which we can borrow up to $150 million, with the potential of up to $50.0 million of additional borrowings.
In February 2007, we acquired ComnetiX Inc., a Canadian company providing biometric identification and authentication technologies and solutions to private and public sector customers creating an important presence for us in the Canadian market and adding a highly-complementary base of customers to our portfolio, particularly within the law enforcement community.
All acquired companies continue to deliver their individual branded products and services to customers. Additionally, the companies come together to provide integrated solution sets for a variety of customers across federal, civil, criminal and commercial markets, and to border management agencies.
Segment and Geographic Information
We operate in two reportable segments, the Identity Solutions Segment and the Services Segment. The Identity Solutions Segment comprises the operations of our historical Viisage business, our
Identix business (excluding the fingerprint services business), and our SecuriMetrics and Iridian businesses. Our Services Segment consists of our fingerprint services operations and our government security and consulting operations. (See Note 11 to the Consolidated Financial Statements included in the Annual Report on Form 10-K for additional information.)
The ability to confirm an individual’s identity is playing an increasingly important role in national and international security, personal privacy and commerce. Government-issued credentials serve as the primary means for confirming the physical identity of an individual.
The effectiveness, however, of these credentials can be impaired because they can be counterfeited or altered, issued under false pretenses and are rarely linked to an identity database. Failure to provide adequate identification protection can lead to breaches of security and identity theft, the consequences of which can range from national security threats and loss of life to significant economic loss. Within this context, we believe that there is increasing pressure on governments and businesses to accelerate the adoption of advanced technology identity solutions.
To address these issues, government-issued identity credentials such as passports and drivers’ licenses increasingly are incorporating more sophisticated security features. For example, pigment ink printing, security laminates, holograms, ultra violet printing, micro printing, security fonts, half tone portraits, physical or digital watermarks and 2D barcodes have become common security features for passports and drivers’ licenses. Smart technologies are also expected to play a significant role in securing these credentials.
In addition to upgrading their security features, we believe that monitoring authorities at places like border entry points will increasingly embrace the use of automated document authentication technology to confirm the authenticity of presented credentials. Issuing authorities are increasingly incorporating biometrics to verify personal identities and deter fraud. Biometrics is a means of identifying a person using biological features unique to that individual. Biometric identifiers include facial images, fingerprints, iris scans, retinal scans, voice data and hand geometry.
While identity credentials are becoming more secure, the ability to obtain them under false pretenses continues to be a major weakness of the credential issuing process. As a result, issuing authorities are now focusing on improving their ability to verify the identity of a person requesting an identification credential prior to issuing that credential. As part of this effort, many authorities also have recognized the need to have secure and accurate audit trails of the issuance process and supporting documents for each credential.
Finally, as secure identity credentials, automated document authentication and biometrics become more prevalent, we believe the additional security generated by cross-checking the credential to a readily accessible identity database will grow in importance. This capability allows a higher level of identity assurance and real-time privilege management. With recent events surrounding the security of these source databases, we expect the standards for collecting and handling identity data to become more rigorous.
Internationally many countries have established or are establishing national identification and/or passport programs to help ensure that only qualified citizens are able to avail themselves of the benefits to which a country’s citizens are entitled, and many of these systems are expected to utilize biometric technologies. Some of these programs and potential programs are also aimed at helping to secure a country’s borders by tracking entry and exit of both citizens and visitors. The United States established legislation requiring biometric identifiers to be included in the passports of current Visa Waiver countries (countries where citizens are not required to obtain a Visa prior to entering the U.S.). We offer a range of solutions, products and technologies that can be utilized in national identification, and/or passport and border crossing programs to enroll and verify citizens and visitors for receipt of benefit purposes and/or to add biometric identifiers to national identification and/or passport programs. Accordingly we believe that international markets provide an opportunity for revenue growth.
Market Drivers and Trends
We believe the global market for advanced technology identity solutions is growing rapidly and is driven by the following key trends:
|•||Government-initiated security programs. We believe that the U.S. Federal Government and government agencies will continue to be key drivers for the growth and development of the market for advanced technology identity solutions by increasingly recommending, and in some cases mandating, the use of secure authentication as a key component of identity verification through such programs as:|
|•||the U.S. Visitor and Immigrant Status Indicator Technology program (‘‘U.S. VISIT’’), which uses biometric data as part of new screening procedures for non-U.S. citizens entering the United States;|
|•||the Transportation Workers Identification Credential (‘‘TWIC’’), which is a credentialing program that may eventually cover an estimated 12 million national transportation workers;|
|•||the U.S. Department of State’s planned introduction of ‘‘contactless chips’’ in passports, which are electronic chips that hold the bearer’s biographic and photographic data;|
|•||the Transportation Security Administration’s (‘‘TSA’’) Hazardous Material Threat Assessment Program (‘‘HAZMAT’’), mandating fingerprinting and security threat assessment of commercial truck drivers applying for, renewing or transferring the hazardous materials endorsement (‘‘HME’’) on their state-issued commercial drivers licenses (‘‘CDL’’);|
|•||the TSA’s Registered Traveler Program (‘‘RT’’) under which the TSA will conduct a security assessment to determine eligibility of an individual for an expedited screening process at TSA security checkpoints. RT participants provide both fingerprint and iris biometrics, allowing either biometric to be used for positive identity verification at the airport;|
|•||Homeland Security Presidential Directive 12 (‘‘HSPD-12’’), which mandates that a common identification card be utilized by all Federal government employees and contractors. In 2004, the U.S. Federal Government issued the Federal Information Processing Standard for Personal Identity Verification of Federal Employees and Contractors as part of HSPD-12. HSPD-12 includes a requirement for document authentication in connection with the issuance of secure credentials to federal government employees; and|
|•||The REAL ID Act, signed into law in May 2005, which mandates authentication of a person’s identity before they are issued a driver’s license.|
|•||Development of industry standards and requirements. Several organizations responsible for standards in a number of our markets have implemented requirements for the use of face recognition biometrics. For example, in May 2003, the International Civil Aviation Organization, which sets recommended travel document standards for its member states, selected face recognition as the biometric to be used in passport documentation. Moreover, in February 2003, the National Institute for Standards and Testing, which is part of the U.S. Department of Commerce, recommended that a dual system of fingerprint and face recognition technology be used to verify the identities of visa holders at points of entry in the United States.|
|•||Growing use of biometrics. Governments are increasingly mandating biometrics as an integral component of identity solutions. Global biometric revenue is projected to grow significantly driven by large-scale government programs and dynamic private-sector initiatives. Fingerprint is expected to have the largest share followed by face recognition and iris recognition.|
|•||Increasing demand for background screening. Demand is growing from civil, state, federal and commercial fronts for background screening for applicants seeking a new job or individuals who provide services that require their identity to be vetted.|
|•||Rising cost of identity theft and financial fraud. The growing direct and indirect cost of identity theft and financial fraud is increasing the pressure on businesses and individuals to accelerate the adoption of advanced technology identity solutions. Identity theft is the nation’s fastest growing crime.|
|•||Convergence of physical and logical security systems. We believe that there is a growing need for governments and businesses to provide a highly secure, unified system for user authentication to access both physical assets, such as buildings, and digital assets, such as computer networks. For example, the U.S. Department of Defense’s, or DoD, Common Access Card Smart Card program provides identity verification for approximately four million DoD employees and military personnel to enable access to military property and DoD computer networks. We believe that this program represents the model for identity protection solutions that will be implemented by governments and businesses in the future.|
Our Identity Solutions Offerings
Our identity solutions are intended to provide our customers with the products and services necessary to achieve the particular objective or address a specific need. An individual solution may include hardware, equipment, consumables, software, right to additional software products, when and if available, related hardware maintenance, software maintenance, hardware repair or replacement, technical support services, training, installation and consulting services under a single arrangement. Our identity solutions incorporate modular components and services, including the following:
Multi-Biometric Capture and Live Scan Systems — Provides high quality images for multi-biometric recognition in the industry. We estimate that more than 10,000 systems are deployed worldwide for criminal and applicant processing, border management and enrollment into civil ID programs.
Multi-Biometric ABIS Systems — Supports finger, face and iris on a single platform. This biometric matching engine is used to eliminate duplicates and aliases in the U.S. State Department’s visa issuance system.
Mobile Identification Systems — Uses finger, face and iris biometrics for identifying subjects in the field. Our rugged and portable iris devices are deployed by the U.S. Department of Defense for overseas missions in Iraq, Bosnia, Afghanistan and other harsh combat zones.
Facial Screening Systems — Alerts customs and passport control agents when an individual on a watchlist attempts to enter the country.
Information Security Software Solutions — Protects against unauthorized access to computers and networks. Our solutions are widely used by financial and health-care organizations around the world.
High-Quality Card Production Systems — Provides long-lasting, tamper-proof capabilities. Each year, we estimate that we enroll and produce more than [35 million individual credentials], such as U.S. passports and drivers’ licenses, at more than [3,000] locations.
Document Authentication and Credentialing Systems — Encompasses proofing, vetting, enrollment, biometrics, identity database management, card production and authentication components required to establish the authenticity of IDs in a large-scale secure credentialing program.
Fingerprinting Service Centers — Handles processing for employment and licensee applicants. We maintain the largest enrollment network in the country and process nearly one million applicants annually.
Government and Security Consulting Services — Provides key expert assistance in counterterrorism, counterintelligence, homeland security, vulnerability assessments and operational support.
Our solutions are designed to meet the ID needs of our customers. They combine industry-leading face, finger and iris recognition biometric technologies with state-of-the-art credentialing and document authentication capabilities and a range of outsourcing services to successfully meet all aspects of managing identity. L-1 maintains focused offerings for the U.S. federal; border management; criminal, civil and commercial customers.
Our U.S. Federal Solutions
We seek to provide efficient and reliable products and services to help improve the security of nations and to protect their citizens, both at home and abroad. We have provided our solutions to all levels of government including every major U.S. government department and most U.S. military branches. We offer a comprehensive array of solutions that make it easier to implement civilian and criminal identification systems, border security programs and data protection measures. Our solutions respond to the federal identity needs set forth by various initiatives, and programs such as:
|•||Homeland Security Presidential Directive 12 — Requires a common identification credential with Personal Identity Verification (PIV) for federal employees and contractors. L-1 provides end-to-end capabilities for identity proofing as well as modular, customizable components and outsourcing services to ensure fast and easy compliance. Our offerings are GSA and NIST certified.|
|•||Transportation Workers Identification Card — A program mandating a standardized secure credential containing biometric data for all transportation workers to enter into any secure area of a port.|
|•||U.S. DoD Common Access Card — The standard identification credential for active duty military personnel, selected reserve personnel, civilian employees, and eligible contractor personnel.|
|•||Western Hemisphere Travel Initiative (WHTI) — Requires all citizens of the U.S., Canada, British Overseas Territory of Bermuda and Mexico to have a passport or other accepted secure document to enter or re-enter the U.S.|
|•||Registered Traveler Program — A nationwide private sector program designed to accelerate the screening process at participating airports for passengers who voluntarily choose to enroll by providing biometric fingerprint and/or iris data.|
|•||US-VISIT Program (U.S. Visitor and Immigrant Status Indicator Technology) — An automated entry/exit tracking program that requires foreign visitors to submit biometric information upon arrival and departure to and from the U.S.|
|•||HAZPRINT — Requires focused background checks, including fingerprint-based biometric criminal history checks, for all commercial drivers who apply for, renew or transfer an endorsement to transport hazardous materials, including explosives.|
We also provide solutions for:
|•||Department of Defense (DoD) / Intelligence Agencies — We help the DoD and Intelligence communities in the fight against terrorism across the globe by providing technology for insurgent registration, combatant identification, watchlist ID, credentialing and high security access control. Off the field, our solutions help agencies process background checks of military personnel faster in order to provide them with secure credentials and verify their identity for the purposes of issuing benefits or accessing secure facilities and networks.|
|•||Passport and Visa Issuance and Production — We supply and integrate the technologies, software, hardware, consumables and services to help with the identity enrollment, de-duplication and production of safer and more secure passports and other travel documents.|
Our Border Management Solutions
Securing and managing national borders is a balancing act. Border control must offer efficiency and convenience for travelers, but also maintain the highest levels of safety and security to protect
national interests. We provide both. Our solutions offer a faster and more convenient process for travelers to pass through borders. They also empower border control officers to perform real-time searches against known watchlists and to scan more types of documents faster than ever before, helping to ensure that unwanted individuals do not enter the country.
L-1’s capabilities also enable the process of border management and control to happen seamlessly and with the same level of protection and security regardless of location, whether at a highly populated and wired checkpoint or a remote location connected wirelessly. We estimate that our biometric technologies and document authentication readers have been tested or deployed by border control agencies all over the world. Our companies have deployed more than 10,000 live scan systems, including for the U.S. Department of Homeland Security, for use at the nation’s border crossings. We believe we are the only U.S. company able to offer multi-biometric end-to-end solutions for fixed as well as mobile environments.
Our solutions include:
|•||Frequent Traveler Solutions that speed processing times and ensure high-quality biometric capture every time for maximum verification accuracy and convenience for travelers.|
|•||Watchlist Screening Solutions that seamlessly integrate into the immigration process to provide more accurate, real-time notification of possible matches against watchlists.|
|•||Document Authentication Solutions that automate the reading and authentication of e-passport documents with contactless smart chips, as well as existing passports, driver’s licenses and other ID cards.|
|•||Mobile ID Solutions that allow for highly accurate and fast identification of individuals seeking to pass through borders at remote sites, land and sea crossings.|
Our Criminal Solutions
Law enforcement agencies across the U.S. and internationally rely on us to provide solutions that help identify suspects and criminals faster and more accurately. With the power to scan millions of criminal records in seconds, and provide officers in the field with critical identity information in minutes, we are paving the way for a new era in identification for law enforcement agencies. Our companies have more than 20 years of experience serving the needs of law enforcement agencies. We are known for innovation and setting new standards for the industry that lead the way in greater efficiencies for law enforcement agencies.
Our solutions include:
|•||Enrollment Solutions — a broad range of enrollment capabilities to integrate personal data with biometric information and credentialing products. The core of L-1 key capabilites, incorporating fingerprint/handprint, facial, iris biometrics with document printing and authentication.|
|•||Next Generation Multi-Biometric ABIS (Automated Biometric Identification System) — incorporates finger, face and iris recognition in a single platform to improve the speed and accuracy of criminal identification. Our solution is designed for maximum flexibility in the workflow for lower risk and greater return on investment.|
|•||Booking Systems — help quickly identify known criminals at the booking process by capturing the highest quality biometric data, check watchlists and build online photo lineups — even when a picture or composite sketch is the only available information.|
|•||Mobile ID Solutions — offer immediate and highly accurate identity information on suspects to officers in the field. Our mobile ID systems support multiple biometrics, providing officers in the field with accurate identity information in minutes while saving time, enhancing officer safety and minimizing false arrests.|
|•||Investigation Systems — analyze finger and facial information found at crime scenes, leading to more IDs, regardless of the quality of the data found at the crime scene.|
|•||Inmate ID Solutions — help establish proper identification at critical steps in the incarceration process to streamline inmate booking and release.|
Our Civil Solutions
Producing valid and secure civil identity documents necessitates a wide range of requirements and each step of the process represents the potential for error and fraud that can compromise documents. We provide agencies, such as state departments of motor vehicles, with large-scale secure credentialing systems. We also maintain one of the largest anti-fraud visa issuance systems with the U.S. Department of State.
Our solutions include:
|•||Enrollment Systems — help to ensure the integrity of the ID with high quality biometric data capture, document authentication, and demographic data capture for integration with identity databases and human resources management software.|
|•||Multi-Biometric ABIS (Automated Biometric Identification System) — uses finger, face and iris to help prevent fraud in the issuance of secure documents, aids in the speedy identification of criminals and helps deter terrorists from obtaining ID documents or crossing borders.|
|•||Card Production and Document Authentication Systems — produce long-lasting, tamper-proof credentials.|
|•||Verification Solutions — are used to verify identities before credentials are issued and received.|
|•||Driver’s License Solutions — offer the latest in end-to-end processes for creating a consolidated verification of an identity claimed by an applicant. This is done through the integration of client and back-end software, services, document reader hardware, biometric technology and internal and external database queries.|
Our Commercial Solutions
Protection of a business’s valuable information and physical assets from identity theft, fraud and other security risks in today’s high-tech operating environments demands a sophisticated security platform. Regulatory mandates that require proof of requisite steps taken to protect critical personal information is adding to the pressure. We offer the latest innovation in biometric technologies to vet an identity before an individual is hired or granted access to a company’s data and physical assets. With it, we help companies better protect themselves from theft facilitated by a false or stolen identity.
We provide solutions to:
|•||Financial Services Firms — We help maintain the integrity of client records for new accounts, manage the background check process for prospective employees, and control access to secure facilities and online accounts.|
|•||Healthcare Organizations Companies — We preserve patient privacy and confidentiality of records by using biometrics to ensure that only authorized individuals have access to sensitive patient information. Our information security software helps healthcare organizations comply with the requirements set forth by the Health Insurance Portability and Accountability Act (HIPAA).|
|•||Casino and Gaming — We provide faster and more accurate background checks on prospective employees and offer improved biometric-based surveillance to identify known card counters and cheaters.|
Our Services Offerings
The fingerprinting services experts at L-1 provide an accurate and quick means to process applicant data required in federal and state licensing programs. As a result, we can help get the
identity information needed for agencies and organizations to make a hiring or licensing decision more quickly and accurately than ever before. Prospective licensee and employee fingerprints are captured quickly in a friendly, professional environment by one of our certified fingerprint technicians. The prints are taken using state-of-the-art live scan equipment that captures fingerprints without the use of ink and submits them electronically. As a result, our customers can receive criminal history results in days. Faster results mean licensing, or putting employees to work, more quickly and with peace of mind.
Our fingerprinting services include:
|•||Live Scan Fingerprinting — Applicants can call and schedule an appointment at a convenient location. Upon arrival, fingerprints are captured and submitted electronically the same day. Results are typically returned within 2-3 days.|
|•||Card Scan Fingerprinting — This service allows applicants to capture fingerprints with ink and mail the cards to us. We convert the ink cards to an electronic format and submit the fingerprint records to the appropriate channeling agency within one business day. Results are typically returned within 2-3 days.|
|•||Onsite Fingerprinting — This service brings our live scan systems directly to the customer’s location, helping fulfill short-term fingerprinting needs due to a large fingerprinting backlog, hiring surge or opening of new locations.|
Our Government and Security Consulting Services
Our government and security consulting services encompass the most pressing and sensitive areas of security and intelligence concerns facing the U.S. today. This includes counterterrorism, homeland defense, due diligence, information sharing and analysis, physical, technical and personal security, personnel surety, behavioral science, counterintelligence, vulnerability assessment, imagery analysis, forensic accounting, surveillance and surveillance detection, crisis management, computer forensics and operational support.
Our consulting personnel represent a qualified, experienced and diversified group of professionals. Our team includes all-source regional, functional, and technical analysts; field operations officers; trainers; software engineers; program managers; specialized government consultants; and operational support professionals. These individuals are veterans of the U.S. intelligence agencies, U.S. investigating agencies and the uniformed military services. Our multi-lingual professionals speak 20 languages, including Arabic, Farsi, Chinese, Korean, German, Thai, Russian, Serbo-Croatian, Greek, and the Romance languages, and are experts in Middle East, Asian and Eastern European countries. Many are senior intelligence community leaders and recipients of numerous awards and commendations for their accomplishments and career services.
Clients served include:
|•||Intelligence Community — L-1’s group of experienced reports officers work at various locations across the intelligence community and overseas, building intelligence reporting programs and helping to train and mentor the next generation of reports officers. We have an established program for developing well-rounded reports officers, for assisting with reports tasks where staffing shortages are critical, and for providing training and mentoring without adding to the demands of government officers.|
|•||Federal, State and Local Government Agencies — L-1 professionals offer expert consulting based on extensive operational experience. We provide a wide range of analytical, linguistic, technical, and other support to intelligence, defense, and law enforcement agencies. Our proven and cleared personnel can augment and/or provide specialized training.|
|•||Private Sector — Based on extensive experience, L-1 can conduct an ‘‘eye of the attacker’’ evaluation, identifying security vulnerabilities from an adversarial perspective, a distinctive and proven approach to measuring and mitigating risk whether from internal or external threats.|
Our Products and Technologies
We deliver solutions by leveraging our products and services capabilities. We offer biometric, secure credentialing and documents authentication products and technologies that are sold as part of a solution set, or standalone. Our products and solutions may include one or more of the following components: hardware, software, consumables, equipment, maintenance, systems and consulting services.
Our biometric products and technologies include multi-biometric AFIS, Live Scan booking, facial screening, fingerprint readers and scanners, iris recognition products, mobile ID, inmate ID, access control, BioLogon® Software and ID tools / SDKs. Specific products are outlined below.
ABIS System is the scalable, standards-based and easy to integrate platform designed to help integrators and end users manage today’s criminal and civil ID challenges. Unlike closed end-to-end systems that are too risky and too expensive to develop and maintain, the ABIS System is an innovative back-end platform that helps minimize intervention in ID processes. The latest generation of Identix BioEngine fingerprint technology incorporates new and more accurate high-speed filters for fingerprint identification in increasingly larger populations and tests conducted by the US government place BioEngine in the top tier of fingerprint technologies.
LatentExaminer works with the latent finger lifts that are often very challenging, even for the most experienced latent examiner. Extensive edit and customization tools are available to assist in latent fingerprint identification. Once captured, the latent can be automatically or manually processed to optimize clarity for search submissions to the ABIS System, the backbone of our Multi-Biometric AFIS.
FaceExaminer helps analyze, search, and identify faces of wanted subjects taken from Closed Circuit TV cameras and surveillance tapes. As a front-end module to the Identix Multi-Biometric AFIS system, the FaceExaminer is a powerful tool for enhancing the effectiveness and performance of face recognition environments, where the quality of the images is poor or the person may not be facing the camera directly.
TenprintExaminer is a multi-purpose tenprint image processing application capable of running on any Windows-based desktop computer. It provides extensive tools to analyze and manipulate tenprint images to enhance AFIS performance and maximize identification search rates. After a search, the TenprintExaminer provides extensive functionality to analyze and compare results.
TenprintVerifier/FaceVerifier are web-based, AFIS post-processing tools to assist in verification of transaction search results. Once a transaction has been completed, the verifier applications can display search results in a queue for display and review in more detail. The queue of face, fingerprint, or other multi-modal search transactions can be searched based on your business process and policy requirements.
Workflow Manager from Identix offers unprecedented flexibility, giving the power to customize the AFIS to an agency’s specific needs. The multi-biometric framework provides a single platform for finger, face and full hand biometrics for both criminal and civil environments, making it highly flexible.
Live Scan Booking
Live Scan Booking provides multi-biometric capture solutions for maximum background check results and downstream matching performance. This includes the following products:
|•||Multi-Biometric Capture Station|
|•||TouchPrint™ Enhanced Definition 3000 Live Scan Series|
|•||TouchPrint™ Enhanced Definition 4100 Slap & Roll Live Scan|
|•||TouchPrint™ Live Scan Series Peripherals|
FaceIt Argus is a real-time facial screening system that captures faces in live video stream from high resolution cameras, searches them against predefined watch lists, and generates alarms whenever a match is found. It enhances the efficiency of security and law enforcement personnel by providing a list of possible matches for human verification, so that the operator spends valuable time focusing on the persons of interest rather than the public at large.
Fingerprint Readers and Scanners
Forensic Quality Readers (DFR® 2080 & DFR® 2100/2130) are designed for large-scale enrollment and verification applications, these readers consistently capture high quality 500 ppi images for more accurate matching and faster processing. As a result, they help increase security with better authentication.
Commercial Readers (BioTouch® 500 USB) are designed for information security applications, these fast, durable, accurate and low-cost readers can help streamline the authentication process.
HIIDE (Hand-held Interagency Identity Detection Equipment) is a full function, multimodal (iris, finger, face) identification device for use in a variety of applications including battlefield detainee identification, corrections facilities, law enforcement, transportation workers identity, border control and healthcare.
PIER (Portable Iris Enrollment and Recognition) is a full function, hand-held iris recognition device used in detention facilities throughout the U.S. for inmate identification and by the U.S. Government in support of the War on Terror, national security and homeland defense.
RDT4 is a solution that employs a modular handheld device that links to any pre-configured, supported PDA, taking advantage of today’s smart-phone technology, and through a centrally located workflow manager can interface with various databases simultaneously, including the Identix ABIS® System. It combines this flexibility with forensic quality, autocapture fingerprint reader, the camera on the PDA, and a card reader module to scan documentation, such as a driver’s license, to ensure more accurate IDs and time and cost savings for officers in the field.
Offender ID (Iris) is an advanced secure identity management system incorporating state-of-the-art biometric technologies into an inmate identification system. Critical processes such as booking and release can now be securely executed with iris identification technology providing accurate inmate identification.
FacePASS is a face recognition-enabled access control and security product used to conduct one-to-one verification of an individual’s identity to authenticate that the holder of an ID document or token is the authorized user. The system carries out a real-time comparison between a live face and a stored reference image to confirm the identity of that person and grant respective rights and privileges while guaranteeing maximum reliability, security and efficiency. The system works fully automated, 24 hours a day without any user intervention and thus requires virtually no system administration after the installation.
BioLogon® is a multi-factor authentication solution which uses fingerprint biometrics to authenticate the identity of the person seeking access and to protect computers and networks from unauthorized entry. It is used by healthcare institutions in the United States and by banks across the world to manage privacy and secure assets.
ID Tools / SDKs
ID Tools / SDKs combine proven, cutting edge technology with simple developer tools to create high performance solutions. They create innovative, high-performance biometric solutions and help deliver top performing solutions, interoperable and standards-compliant applications and faster turnaround with easy integration tools.
Our secure credentialing products, technologies and systems encompass proofing/vetting, enrollment, biometrics, identity database management, card production and document authentication systems. The products offered include:
iA-Passport® processes travel and identity documents quickly and securely, working with iA-Authenticate®. The database is designed to recognize and automatically compare multiple, unique security features in each individual document type, as the unique database includes forensic information on passports, visas, U.S. Immigration cards, and national IDs.
Digital Image Workstations (ImageCAM™) provides standardized image capture for identity applications before enrollment and processing of finished driver’s license(s) and identification cards. The system is unique to the driver’s license industry with state-of-the-art digital image capture systems and workstation equipment for capturing, storing and electronically transferring cardholders’ digitized images and demographic information.
The Toppan CP400 Printer is designed to produce secure smart cards and help prevent counterfeiting. Personalization data is reversed printed into a transfer film that is that is fused to the surface of the card using heat and pressure, and the unique indirect-transfer pigment ink technologies provide unique advantages in both quality and counterfeiting protection over dye-sublimation methods. The non-fading ink technology ensures outstanding durability against light and chemical reactions that cause images to fade.
Viisage PROOF™ integrates client and back-end software, automated document authentication reader hardware and biometric technology, as well as internal and external database queries, to create a consolidated system for the verification of an applicant’s identity. Viisage PROOF evaluates aggregated information on identification documents and the most commonly used breeder documents as well as a variety of additional data points, such as social security number and address verification, to produce a proofing confidence score that aids the credential issuing agency in the final decision about whether or not the candidate is allowed to proceed to the next phase of the identity solutions process or whether additional interviewing is required. This product is based on proprietary data analytics algorithms.
AutoTest™ is a web-based testing engine for the delivery and administration of randomized identity and domain knowledge tests. This system provides additional intelligence of a person’s claimed identity prior to receiving a driver’s license or other secure identity credential. Testing is conducted through departments of motor vehicles and automated web-based and kiosk applications.
AutoTest Scheduler™ is a web-based application can be used to automate the scheduling of knowledge and/or road tests for driver licensing. It also can be deployed over the Internet as a self-service application for customers to make appointments.
Our documents authentication products, technologies and systems provide customers with invaluable tools for recognizing fraudulent identity documents and potential threats of all types. The products include:
iA-Authenticate® is a combined hardware and software solution designed to automatically authenticate documents, such as passports, visas, immigration cards, drivers’ licenses, and military ID cards that individuals use as proof of their identity. The product helps governments secure their borders and businesses to reduce identity fraud by authenticating identity credentials through a process of scanning, image processing and data analysis.
ID-Suite™ offers detection of forged and altered state & government-issued ID cards in a variety of industries through software and services that provide additional layers of security to the iA-thenticate product line’s authentication engine, as well as adding authentication capabilities for North American ID cards, such as driver’s licenses, and adds magnetic stripe and barcode reading capabilities. The Suite includes:
|•||iA-License™ — Comprehensive electronic database of North American ID templates for automated authentication of driver’s licenses, military IDs and other identity documents.|
|•||DL-Alert® — Reads, interprets, and verifies the content, sequence, and format of information encoded in the magnetic stripe and/or bar code of commonly used identity documents such as driver’s licenses, state ID cards and military IDs.|
|•||iA-Verify™ — Provides an additional security layer by applying sophisticated database queries to validate the issuance and biographic data read from driver’s licenses, passports and other ID documents.|
iA-thenticate® SmartChip is a combined hardware and software product designed to quickly and accurately read electronic passports used by travelers. It automatically reads and authenticates e-passport documents that contain contact-less SmartChips in just a few seconds.
ID-GUARD™ automatically scans document images and barcode/magnetic strip information and searches for and authenticates document security features using multiple light and angle sources. ID-GUARD® fits into small areas for use at service counters, office desks and is easily mounted for in-vehicle use. It is intuitive and works similarly to most office scanners and card swipe readers
Over 90% of our sales are to federal, state, local and foreign governments and government agencies. Contracts with governments and agencies generally allow the customer to terminate the contract for convenience of or for failure of the government to appropriate funds. For the year ended December 31, 2006 the U.S. Department of State accounted for 13% of L-1’s revenue and the Transportation Security Administration accounted for 10% of L-1’s revenue.
Historically, we have experienced minimal customer turnover. We believe this is a result of our strong product portfolio and emphasis on customer service and support. The following is a representative list of our customer base:
Sales and Marketing
We market our products and identity solutions through a direct sales force, strategic partnerships and alliances. Our direct sales force is responsible for marketing and selling our entire identity solutions portfolio. We have a worldwide sales force responsible for delivering customer solutions to the North American market, Europe, the Middle East and Asia Pacific. In addition, we have established a dedicated U.S. Federal sales team in Washington, D.C. responsible for marketing and selling to U.S. government agencies such as the Department of Homeland Security, the Department of State, the DoD and others. We also have a dedicated product sales team responsible for driving product sales to our worldwide customer base. We have a dedicated sales and services team operating from locations in Germany, the United Kingdom and Switzerland, strengthening our coverage and access to the international markets for our products and identity solutions. As of December 31, 2006, we employed 74 people in our sales and marketing organization.
We continue to seek to develop strategic partnerships and distribution channels to broaden our coverage and increase the size of our market worldwide. We have established original equipment manufacturer, or OEM, distribution agreements with partners to leverage our technologies. We have established channels of distribution for our document authentication products to open new markets outside of the U.S. Additionally, we work with systems integrators, solution providers and service organizations to deliver identity solutions in combination with their core capabilities to expand our access to such organizations’ existing relationships, marketing resources and credibility in new markets. Local agents are also utilized to expand our international access to identity solutions opportunities around the world.
Our sales strategy is organized around specific markets: federal, state and local, international and commercial. Each sales organization is supported by a full range of functional groups, which design, engineer, manufacture, market, fulfill and support our market-specific products and offerings. Each of our sales organizations is further supported by a professional service group, which customizes solutions for each market, and a field service group to ensure ongoing performance of our systems at customer sites throughout the world.
Sales and marketing costs were $14.4 million, $7.8 million and $6.9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Research and Product Development
We focus our product development efforts on critical components for advanced technology identity solutions. These include proprietary software that addresses image capture, image processing, enhancement of face recognition, iris recognition, information retrieval from identity databases, document authentication, and the accuracy of searching and matching algorithms within the very large databases. We believe our next generation fingerprint, facial, and iris recognition technology developments will be more reliable and cost effective than current commercialized technology, as well as provide additional functionality, including the storage of fingerprint and/or facial and iris templates on smart cards and similar storage devices. In addition, we focus on expanding our capabilities in solutions for the civil identification, criminal identification and border management markets. As of December 31, 2006, we employed 152 people in our research and development organization.
We benefit from research and development activities conducted by the manufacturers of the components integrated into our systems such as cameras, database software and computers. Moreover, many of our customers, including the U.S. government, provide direct funding to us to assist us in our research and development efforts on their behalf.
For the years ended December 31, 2006, 2005 and 2004, our customers provided research and development funding of $0.9 million, $1.6 million and $1.8 million, respectively. For the years ended December 31, 2006, 2005 and 2004, we had time and materials contracts with the U.S. Government to formulate and design possible product or process alternatives for biometrics technology. We recorded revenue of approximately $0.5 million, $1.0 million and $1.0 million related to these contracts during 2006, 2005 and 2004, respectively. The remaining funded research of approximately $0.4 million, $0.6 million and $0.8 million for the years ended December 31, 2006, 2005, and 2004 respectively, represents funded research and development activities that meet the requirements of SFAS No. 2. The funding associated with these contracts is recorded as a reduction of operating expenses offset when received.
For the years ended December 31, 2006, 2005 and 2004, research and development expense was $11.6 million, $4.6 million, and $3.8 million, respectively. These amounts do not include spending for projects under research and development contracts, for which the related costs are recorded as cost of revenues.
We rely on patent, copyright, trademark and trade secrets and contract law to establish and maintain our proprietary rights in our technology products and manufacturing processes. The success of our business will depend in part on our proprietary technology and protection of that technology. While our intellectual property rights are important to our success, we believe that neither our business as a whole nor any segment of our business is materially dependent on any particular patent, trademark, license or other intellectual property right.
We have a portfolio of 128 U.S. and foreign patents. In addition, we have 95 U.S. and foreign patent applications in process for biometrics and document authentication technologies. While the duration of our patents varies, we believe that the duration of our patents is adequate relative to the expected lives of our products.
We have filed applications to register the trademarks of ‘‘L-1’’ and ‘‘L-1 Identity Solutions’’, and both applications have been approved for publication by the U.S. Patent and Office. We have a broad portfolio of other vital registered and pending trademarks in the U.S. and foreign jurisdictions.
Backlog represents sales value of firm orders for products and services not yet delivered and, for long term executed contractual arrangements (contracts, subcontracts, and customer commitments),
the estimated future sales value of estimated product shipments, transactions processed and services to be provided over the term of the contractual arrangements, including renewal options expected to be exercised. For contracts with indefinite quantities backlog reflects estimated quanities based on current activity levels. Backlog will not necessarily result in future revenue because firm orders may be cancelled, options and renewals may not be exercised by the customers, the quantities ordered, the volume of transaction processed or services to be provided may be less than estimated. Backlog includes deferred revenues. Contractual arrangements could be cancelled by our customers without penalty for lack of performance. Contracts terminated by our customers for convenience generally would result in recovery of actual costs incurred and profit, if any, on work performed through the date of cancellation.
At December 31, 2006 backlog, determined as described above, approximated $523 million, of which $250 million is estimated to be realized in the following twelve months. At December 31, 2005 backlog was approximately $141 million.
The market for our solutions and related products and services is extremely competitive and we expect this competitive environment to intensify as the market for our products continues to grow and mature. We compete on the basis of the following factors: technology, service and support, product quality, price, reliability, capability to work with large criminal history networks and flexibility in accommodating customer technical and business needs. We believe our ability to provide multi modal identity solutions incorporating finger, face and iris technologies, together with search and matching software to work with a large database differentiates us from our competitors. We are not aware of any company that competes with us directly on the basis of multi-modal identity solutions that cover the full identity life cycle.
Substantially all of our sales to new customers have been the result of competitive bidding for contracts pursuant to public sector procurement rules. In some cases, we may be competing with an entity that has a pre-existing relationship with a potential customer, which could put us at a significant competitive disadvantage. In other cases, however, we have pre-existing relationships with customers, which give us an advantage relative to our competitors for that customer.
The markets for our products and solutions are characterized by rapid technological change as a result of technical developments exploited by competitors, the changing technical needs of the customers, and frequent introductions of new features. We expect competition to increase as other companies introduce products that are more price competitive, that may have increased performance or functionality, or that incorporate technological advances not yet developed or implemented by us. In order to compete effectively in this environment, we must continually develop and market new and enhanced products at competitive prices, and have the resources to invest in significant research and development activities.
A significant number of established and startup companies are developing and marketing solutions and related software and hardware for fingerprint, face, iris and other biometric security applications that could compete directly with our products. Some of these companies are developing semiconductor or optically based contact fingerprint image capture devices. Other companies are developing and marketing other methods of biometric identification such as retinal blood vessel, signature recognition, hand geometry and voice. If one or more of these approaches were widely adopted, it would significantly reduce the potential market for our products.
We face competition from a number of competitors who are actively engaged in developing and marketing biometrics or other security products, including AuthenTec, Inc., AssureTec Systems, Inc., Bundesdrukerei, Canadian Bank Note Company, Limited, Cogent Systems, Inc., Cognitec Systems Corporation, CrossMatch Technologies, Digimarc ID Systems LLC, Imageware Systems, NEC Corporation, Precise Biometrics AB, Rochford Thompson, SafLink Corporation, Sagem Inc., Sagem Morpho Inc., Secugen Corporation and 3M-AiT.
SpecTal competes with a number of large and small providers of security consulting services. SpecTal believes its competitive advantage is the strong relationships with its customers and the quality and qualification of the workforce.
We engineer and design the hardware products we sell and develop the software embedded in the products. However, we limit our manufacturing activities to the assembly, repair, and testing of proprietary sub-assemblies. Our hardware is fabricated by highly automated, contract manufacturing partners. We believe this will permit rapid expansion of production capacity to meet any significant increase in product demand and minimize the cost associated with the expansion of our manufacturing capabilities. We believe that the cost of material and fabricated subassemblies will decline if manufacturing volumes increase. Quality control audits are performed as part of the manufacturing process.
We currently use certain components and sub-assemblies which are purchased from sole source suppliers. The partial or complete loss of supplies available from sole source or limited sources of supply or the delay in receiving supplies from these sources could result in delays in manufacturing and shipping products to customers and require the incurrence of development and other costs to establish alternative sources of supply. While we attempt to maintain inventory on sole sourced components, it may take us several months to locate alternative supplies if required, or redesign our products to accommodate components from different suppliers.
Our business is not subject to seasonal fluctuations.
Our capital requirements consist of capital expenditures for new secure credentialing contracts and working capital needs. We expect to meet our requirements from operating cash flows, bank borrowings and proceeds from stock option exercises. We expect to fund our acquisitions from cash flows from operations and with issuance of debt and other securities.
In October 2006, we entered into an Amended and Restated Credit Agreement the (‘‘Agreement’’) by and among the Company, Bank of America N.A. (the ‘‘Bank’’), Bear Stearns Companies Inc., 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 we are 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. As of December 31, 2006, the outstanding debt balance was $80.0 million.
Amounts borrowed under the Agreement bear interest for any interest period (as defined by the Agreement) at the British Bankers Association LIBOR Rate, plus a margin of 1.75% (subject to adjustment to 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. We also have the option to borrow at a fluctuating rate per annum equal to the higher of (a) the Federal Funds Rate plus ½ 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 we have not borrowed all available amounts under the facility, we must pay a commitment fee of 0.375 per annum on such unutilized amounts.
Environmental Protection Regulations
We believe that our compliance with federal, state and local environmental regulations will not have a material adverse effect on our financial position or results of operations.
As of December 31, 2006, we had 1,047 full time employees. None of our employees are covered by collective bargaining agreements. We believe that our relations with our employees are good.
Our executive officers are appointed by our Board of Directors and serve until their successors have been duly appointed and qualified.
Robert V. LaPenta, 61, has served as the Chairman of the Board since December 2005, President and Chief Executive Officer of L-1 since August 2006. Mr. LaPenta is the founder and Chief Executive Officer of L-1 Investment Partners, LLC, a private investment management firm. From April 1997 to April 2005, Mr. LaPenta served as President, Chief Financial Officer and a Director of L-3 Communications Holdings, Inc., which he co-founded in April 1997. From April 1996, when Loral Corporation was acquired by Lockheed Martin Corporation, until April 1997, Mr. LaPenta was a Vice President of Lockheed Martin and was Vice President and Chief Financial Officer of Lockheed Martin’s Command, Control, Communications and Intelligence and Systems Integration Sector. Prior to the April 1996 acquisition of Loral, he was Loral’s Senior Vice President and Controller, a position he held since 1981. He joined Loral in 1972 and was named Vice President and Controller of its largest division in 1974. He became Corporate Controller in 1978 and was named Vice President in 1979. Mr. LaPenta is on the Board of Trustees of Iona College, the board of trustees of The American College of Greece and the board of directors of Core Software Technologies and the board of directors of Leap Wireless International, Inc.
Dr. Joseph Atick, 43, joined L-1 in August 2006 as Executive Vice President and Chief Strategic Officer effective with the merger of Identix with L-1. Prior to that, he served as President & Chief Officer of Identix since June of 2002. Prior to that, he had co-founded one of the original facial recognition companies, Visionics Corporation. Over the years, Dr. Atick co-founded and managed several companies focused on technology transfer and development, and has served as a technical advisor to many high-tech enterprises and organizations, including NATO. He had also led the Computational Neuroscience Laboratory at Rockefeller University and the Neural Cybernetics Group at the Institute for Advanced Study in Princeton, New Jersey. Dr. Atick holds a Ph.D. in Mathematical Physics from Stanford University.
James DePalma, 55, joined L-1 as Executive Vice President, Chief Financial Officer and Treasurer effective with the merger of Identix with L-1. He brings three decades of operational and finance experience in the defense and technology industries to his role within the company. Prior to joining L-1, Mr. DePalma was a founding partner of L-1 Investment Partners. Prior to the formation of L-1 Investment Partners, Mr. DePalma served as a consultant to L-3 Communications Holdings, Inc. and was chief executive officer of Core Software Technology, a leading software provider to the intelligence community and an equity investment of L-3 Communications Holdings, Inc.
Doni Fordyce, 47, joined L-l as Executive Vice President of Corporate Communications effective with the merger of Identix with L-1. In August 2006 she was a founding partner of L-1 Investment Partners and brings two decades of senior executive and investment management experience to the company, serving most recently as chief executive officer, president and chief operation officer of Bear Stearns Asset Management (BSAM) Inc. Prior to that Ms. Fordyce was vice president of Goldman Sachs Inc. from 1986 to 1996 where she was one of the founders of the asset management business. She has also worked in IT solutions consulting, specializing networking, data management and printing for investment banks and financial institutions.
Mark S. Molina, 47, joined L-1 in August 2006 as Executive Vice President, Chief Legal Officer and Secretary in August 2006 effective with the merger of Identix with L-1. Prior to joining L-1, he was Executive Vice President, Chief Legal Officer and Secretary at Identix, which he joined as Vice President and General Counsel in 1999. Mr. Molina is a business and technology lawyer with over 20 years experience structuring and negotiating mergers, acquisition, dispositions, joint ventures, technology licenses, financings and investments. He has considerable experience with public offerings and private placements as well as SEC reporting compliance and obligations of publicly traded companies.
Joseph Paresi, 52, joined L-1 in August 2006 as Executive Vice President and Chief Marketing Officer effective with the merger of Identix with L-1. He was a founding partner of L-1 Investment
Partners LLC. Mr. Paresi brings three decades of executive management, product development, and design engineering experience in the technology and defense industries to his role with the company. Prior to joining L-1 Investment Partners, he served as corporate vice president of product development for L-3 Communications and as president of L-3 security & Detection Systems from 1997 to 2005.
Vincent A. D’Angelo, 63, joined L-1 as Senior Vice President of Finance in August 2006 effective with the merger of Identix with L-1. Prior to that, he was a consultant for L-1 Investment Partners. Prior to that, Mr. D’Angelo was a senior audit partner with PricewaterhouseCoopers for more than 35 years where he was involved in all facets of the business, including client service, management, operations, governance, SEC filings, and mergers and acquisitions.
There are no family relationships among any of our executive officers and directors.
Financial Information about Foreign and Domestic Operations and Export Sales
For the years ended December 31, 2006, 2005 and 2004, export sales were approximately $14.6 million, $6.0 million, and $2.4 million, respectively. Foreign operations and export sales may increase in relative and absolute terms in the future due to our increased focus on markets outside the United States. See note 11 to consolidated financial statements for additional information.
L-1’s Internet Website
We maintain a corporate website with the address www.L1id.com. We are not including the information contained in our website, or incorporating it by reference into, this Annual Report on Form 10-K. We make available, free of charge through our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission.
Item 1A. Risk Factors
This Annual Report on Form 10-K contains or incorporates a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management’s beliefs and assumptions. Any statements contained herein (including without limitation statements to the effect that we or our management ‘‘believe’’, ‘‘expect’’, ‘‘anticipate’’, ‘‘plan’’ and similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included in this report. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties, including those not presently known to us or that we currently deem immaterial, may also impair our business. We expressly disclaim any obligation to update any forward-looking statements, except as may be required by law.
Risks Related to Our Business
We have a history of operating losses.
We have a history of operating losses. Our business operations began in 1993 and, except for 1996 and 2000, have resulted in net losses in each year, including a net loss of $31.0 million in 2006. At December 31, 2006, we had an accumulated deficit of approximately $87.5 million. We will continue to invest in the development of our secure credential and biometric technologies, as well as related security consulting services. Although we were profitable in the fourth quarter of 2006, we cannot provide any assurance that we will achieve profitability on an annual basis in the future.
We derive over 90% 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.
More than 90% of our business involves providing solutions, and services under contracts with U.S. federal, state, local and foreign 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;|
|•||include bonding requirements;|
|•||contain onerous procurement procedures; and|
|•||be subject to cancellation or reduction if government funding becomes unavailable or is cut back.|
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. Protests, and similar delays, regarding any future government contracts of a material nature that may be awarded to us could result in materially adverse revenue volatility, making management of inventory levels, cash flows and profitability inherently difficult. Outright loss of any material government contract through the protest process or otherwise, could have a material adverse effect on our financial results and stock price.
Similar to federal government contracts, state and local government agency contracts may be contingent upon availability of matching funds from federal, state or local entities. State and local law enforcement and other government agencies are subject to political, budgetary, purchasing and delivery constraints which may result in quarterly and annual revenue and operating results that may be irregular and difficult to predict. Such revenue volatility makes management of inventory levels, cash flows and profitability inherently difficult. In addition, if we are successful in winning such procurements, there may be unevenness in shipping schedules, as well as potential delays and changes in the timing of deliveries and recognition of revenue, or cancellation of such procurements.
In addition, government contracts may specify performance criteria that must be satisfied before the customer accepts the products and services. Collection of accounts receivable may be dependent on meeting customer requirements, which may be unpredictable, subject to change by the customer, and not fully understood by us at the time of acceptance of the order, and may require the incurrence of unexpected costs. These costs are accounted for as required but may be uncompensated and could negatively affect profit margins and our liquidity.
We may not realize the full amount of revenues reflected in our backlog, which could harm our operations and significantly reduce our future revenues.
There can be no assurances that our backlog estimates will result in actual revenues in any particular fiscal period because our clients may modify or terminate projects and contracts and may decide not to exercise contract options. Our backlog represents sales value of firm orders for products and services not yet delivered and, for long term executed contractual arrangements (contracts, subcontracts, and customers commitments), the estimated future sales value of estimated product shipments, transactions processed and services to be provided over the term of the contractual arrangements, including renewal options expected to be exercised. For contracts with indefinite quantities backlog reflects estimated quanitites based on current actitity levels. Our backlog includes estimates of revenues the receipt of which require future government appropriation, option exercise by our clients and/or is subject to contract modification or termination. At December 31, 2006, our backlog approximated $523.3 million, $250.5 million of which is estimated to be realized in the following twelve months. These estimates are based on our experience under such contracts and
similar contracts, and we believe such estimates to be reasonable. However, we believe that the receipt of revenues reflected in our backlog estimate for the following twelve months will generally be more certain than our backlog estimate for periods thereafter. If we do not realize a substantial amount of our backlog, our operations could be harmed and our future revenues could be significantly reduced.
We derive a significant portion of our revenue from federal government customers, the loss of which could have an adverse effect on our revenue.
For the year ended December 31, 2006 our three largest U.S. Government customers accounted for an aggregate of 31.0% of revenues. For the year ended December 31, 2005, one customer, the U.S. Department of State, accounted for 27.5% of our revenue. For the year ended December 31, 2004, two customers, Telos Corporation (U.S. Department of Defense) and U.S. Department of State accounted for an aggregate of 31.0% of our revenue. The loss of any of our significant customers would cause revenue to decline and could have a material adverse effect on our business.
We have been named as a defendant in a putative class action lawsuit, an adverse outcome in which could have a material adverse effect on our business, financial condition and results of operations by adversely affecting our cash position.
As described below in Item 3, Legal Proceedings, in March and April 2005, eight putative class action lawsuits were filed against Viisage in the United States District Court for the District of Massachusetts. These lawsuits have been consolidated into one action under one case name: In re: Viisage Technology Securities Litigation, Civil Action No. 05-10438-MLW. The amended consolidated complaint which was filed in February 2006 alleges violations of the federal securities laws by Viisage and certain of Viisage’s then officers and directors arising out of purported misstatements and omissions in Viisage’s SEC filings related to the litigation involving the Georgia drivers’ license contract and related to Viisage’s reported material weaknesses in internal controls over financial reporting, which allegedly artificially inflated the price of Viisage’s stock during the period May 12, 2004 through March 2, 2005. In February 2007 all claims related to the Georgia driver’s license contract were dismissed. We are not able to estimate the amount of the loss allegedly suffered by members of the putative class or the amount of legal costs and internal efforts associated with defending ourselves and our officers and directors. If we are unsuccessful in defending ourselves in this litigation, this lawsuit could adversely affect our business, financial condition, results of operations and cash flows as a result of the damages that we would be required to pay. We cannot be certain that we will be successful in this litigation.
Biometric technologies have not achieved widespread commercial acceptance and our strategy of expanding our biometric business could adversely affect our business operations and financial condition.
Part of our strategy is to enhance our leadership in biometric technologies. Pursuing this strategy involves risks. For instance, to date, biometric technologies have not gained widespread commercial acceptance. Although there has been more recent activity, there is no assurance that this activity will continue. Some of the obstacles include a perceived loss of privacy and public perceptions as to the usefulness of biometric products. Whether the market for biometric technologies will expand will be dependent upon factors such as:
|•||national or international events which may affect the need for or interest in biometric products or services;|
|•||the cost, performance and reliability of the products and services and those of our competitors;|
|•||customers’ perception of the perceived benefit of biometric products and services and their satisfaction with the products and services;|
|•||public perceptions of the intrusiveness of these biometric products and services and the manner in which firms are using the information collected;|
|•||public perceptions regarding the confidentiality of private information;|
|•||proposed or enacted legislation related to privacy of information; and|
|•||marketing efforts and publicity regarding these products and services.|
We do not know when, if ever, biometric products and services will gain widespread commercial acceptance. Certain groups have publicly objected to the use of biometric products and services for some applications on civil liberties grounds and legislation has been proposed to regulate the use of biometric security products. From time to time, biometric technologies have been the focus of organizations and individuals seeking to curtail or eliminate such technologies on the grounds that they may be used to diminish personal privacy rights. If such initiatives result in restrictive legislation, the market for biometric solutions may be adversely affected. Even if biometric technologies gain wide market acceptance, our biometric products and services may not adequately address the requirements of the market and may not gain widespread commercial acceptance.
We face intense competition, which could result in lower revenues and higher research and development expenditures and could adversely affect our results of operations.
The events of September 11, 2001 and subsequent regulatory and policy changes in the U.S. and abroad have heightened interest in the use of biometric security solutions, and we expect competition in this field, which is already substantial, to intensify. Competitors are developing and marketing semiconductor or optically based direct contact fingerprint image capture devices, or retinal blood vessel, iris pattern, hand geometry, voice or various types of facial structure solutions. Among these companies are Cognitec Systems Corporation, CrossMatch Technologies, Imageware Systems, Inc., SAGEM Morpho Inc., NEC Corporation and Cogent, Inc. Our products also compete with non-biometric technologies such as certificate authorities and traditional keys, cards, surveillance systems and passwords. Widespread adoption of one or more of these technologies or approaches in the markets we intend to target could significantly reduce the potential market for our systems and products. Many of our competitors have significantly more cash and resources than we have. Our competitors may introduce products that are more price competitive, have increased performance or functionality or incorporate technological advances that we have not yet developed or implemented. To remain competitive, we must continue to develop, market and sell new and enhanced systems and products at competitive prices, which will require significant research and development expenditures. If we do not develop new and enhanced products or if we are not able to invest adequately in their research and development activities, our business, financial condition and results of operations could be severely and negatively impacted.
Unless we keep pace with changing technologies, we could lose existing customers and fail to win new customers.
In order to compete effectively in the biometrics market, we must continually design, develop and market new and enhanced products. Our future success will depend, in part, upon our ability to address the changing and sophisticated needs of the marketplace. Frequently, technical development programs in the biometric industry require assessments to be made of the future directions of technology and technology markets generally, which are inherently risky and difficult to predict. We may not be able to accurately predict which technologies our customers will support. If we fail to choose correctly among technical directions, or we fail to offer innovative products and services at competitive prices in a timely manner, customers may forego purchases of our products and services and purchase those of our competitors.
Security breaches in systems that we sell or maintain could result in the disclosure of sensitive government information or private personal information that could result in the loss of customers and negative publicity.
Many of the systems we sell manage private personal information and protect information involved in sensitive government functions. The protective security measures that we use in these systems may not prevent security breaches, and failure to prevent security breaches may disrupt our
business, damage our reputation, and expose us to litigation and liability. A party who is able to circumvent protective security measures used in these systems could misappropriate sensitive or proprietary information or cause interruptions or otherwise damage our products, services and reputation, and the property and privacy of our customers. If unintended parties obtain sensitive data and information, or create bugs or viruses or otherwise sabotage the functionality of our systems, we may receive negative publicity, incur liability to our customers or lose the confidence of our customers, any of which may cause the termination or modification of our contracts. Further, our insurance coverage may be insufficient to cover losses and liabilities that may result from such events.
In addition, we may be required to expend significant capital and other resources to protect ourselves against the threat of security breaches or to alleviate problems caused by the occurrence of any such breaches. However, protective or remedial measures may not be available at a reasonable price or at all, or may not be entirely effective if commenced.
Our reliance on external suppliers and contract manufacturers may result in disruption of our operations.
The lead-time for ordering certain of products and materials and for building many of our products can be many months. As a result, we must order products and materials based on forecasted demand. If demand for our products lags significantly behind our forecasts, we may purchase more products than we can sell, which can result in increased cash needs and write-downs of obsolete or excess inventory. In addition, if product purchases are delayed, we may lose customers and sales.
We rely on contract manufacturers to produce our hardware products under short term manufacturing arrangements. Although we believe we can find alternative sources of manufacturing our hardware, any disruption of contractual arrangements could result in delaying deliveries or in the loss our sales.
Loss of limited source suppliers may result in delays or additional expenses.
We obtain certain hardware and services, as well as software applications, from a limited group of suppliers. Our reliance on these suppliers involves significant risks, including reduced control over quality and delivery schedules. In particular, we are dependent on Toppan Printing Co. Ltd. for all of the printers and consumables for the U.S. Department of State passport contract and the U. S. Department of Defense common access card contract. Any financial instability of our suppliers could result in our having to find new suppliers. We may experience significant delays in manufacturing and deliveries of our products and services to customers if we lose our sources or if supplies and services delivered from these sources are delayed. As a result, we may be required to incur additional development, manufacturing and other costs to establish alternative sources of supply. It may take several months to locate alternative suppliers, if required, or to re-tool our products to accommodate components from different suppliers. We cannot predict if we will be able to obtain replacement components within the time frames we require at an affordable cost, or at all. Any delays resulting from suppliers failing to deliver components or obtain alternative service providers, products or services on a timely basis, in sufficient quantities and of sufficient quality or any significant increase in our costs of components from existing or alternative suppliers could have a severe negative impact on our business, financial condition and results of operations.
The market for our solutions is still developing and if the industry adopts standards or a platform different from our platform, then our competitive position would be negatively affected.
The market for identity solutions is still emerging. The evolution of this market is in a constant state of flux that may result in the development of different technologies and industry standards that are not compatible with our current products or technologies. In particular, the face recognition market lacks industry-wide standards. Several organizations, such as the International Civil Aviation Organization, which sets standards for travel documents that its member states then put into effect, and the National Institute for Standards and Testing, which is part of the U.S. Department of Commerce, have recently selected face recognition as the biometric to be used in identification
documentation. It is possible, however, that these standards may change and that any standards eventually adopted could prove disadvantageous to or incompatible with our business model and product lines.
Our plan to pursue sales in international markets may be limited by risks related to conditions in such markets.
In the year ended December 31, 2006, we derived approximately 9% of our total revenues from international sales. There is a risk that we may not be able to successfully market, sell and deliver our products in foreign countries.
Risks inherent in marketing, selling and delivering products in foreign and international markets, each of which could have a severe negative impact on our financial results and stock price, include those associated with:
|•||regional economic or political conditions;|
|•||delays in or absolute prohibitions on exporting products resulting from export restrictions for certain products and technologies, including ‘‘crime control’’ products and encryption technology;|
|•||loss of, or delays in importing products, services and intellectual property developed abroad, resulting from unstable or fluctuating social, political or governmental conditions;|
|•||fluctuations in foreign currencies and the U.S. dollar;|
|•||loss of revenue, property (including intellectual property) and equipment from expropriation, nationalization, war, insurrection, terrorism, criminal acts and other political and social risks;|
|•||the overlap of different tax structures;|
|•||seasonal reductions in business activity;|
|•||risks of increases in taxes and other government fees; and|
|•||involuntary renegotiations of contracts with foreign governments.|
We expect that we will have increased exposure to foreign currency fluctuations. As of December 31, 2006, our accumulated other comprehensive income includes foreign currency translation adjustments of $0.7 million. In addition, we have significant Japanese yen-denominated transactions with Japanese vendors supplying hardware and consumables for the delivery of certain large contracts. Fluctuations in foreign currencies, including our Japanese yen-denominated transactions could result in unexpected fluctuations to our results of operations, which could be material and adverse.
If we do not successfully expand our direct sales and services organizations and partnering arrangements, we may not be able to increase our sales or support our customers.
We sell substantially all of our services and license substantially all of our products through our direct sales organization. Our future success depends on substantially increasing the size and scope of our direct sales force and partnering arrangements, both domestically and internationally. We will face intense competition for personnel, and we cannot guarantee that we will be able to attract, assimilate or retain additional qualified sales personnel on a timely basis. Moreover, given the large-scale deployment required by some of our customers, we will need to hire and retain a number of highly trained customer service and support personnel. We cannot guarantee that we will be able to increase the size of our customer service and support organization on a timely basis to provide the high quality of support required by our customers. Failure to add additional sales and customer service representatives could result in our inability to increase sales and support our customers.
We rely in part upon original equipment manufacturers, or OEM, and distribution partners to sell our products, and we may be adversely affected if those parties do not actively promote their products or pursue installations that use their equipment.
A significant portion of our revenue comes from sales to partners including OEMs, systems integrators, distributors and resellers. Some of these relationships have not been formalized in a detailed contract, and may be subject to termination at any time. Even where these relationships are formalized in a detailed contract, the agreements can often be terminated with little or no notice and subject to periodic amendment. We cannot control the amount and timing of resources that our partners devote to activities on their behalf.
We intend to continue to seek strategic relationships to distribute, license and sell certain of our products. We, however, may not be able to negotiate acceptable relationships in the future and cannot predict whether current or future relationships will be successful.
For example, we are currently involved in a dispute with LG Electronics, Inc. and its subsidiary relating to the termination of such a relationship. As a result of this dispute, LG has alleged the invalidity of Iridian’s patents, copyrights and trade secrets. A material adverse ruling against Iridian respecting either the underlying contract claims or enforceability of Iridian’s intellectual property rights could materially adversely impact the value of the Company’s investment in Iridian and its iris recognition technology. See Item 3. ‘‘Legal Proceedings.’’
If our systems and products are not timely delivered or do not perform as promised, we could experience increased costs, lower margins, liquidated damage payment obligations and reputational harm.
We will be required to provide complex systems that will be required to operate on an ‘‘as needed’’ basis. This may in turn lead to delays or shortages in the availability of certain products, or, in some cases, the unavailability of certain products. The negative effects of any delay or failure to deliver our products could be exacerbated if the delay or failure occurs in products that provide personal security, secure sensitive computer data, authorize significant financial transactions or perform other functions where a security breach could have significant consequences. If a product launch is delayed or is the subject of an availability shortage because of problems with our ability to manufacture or assemble the product successfully on a timely basis, or if a product or service otherwise fails to meet performance criteria, we may lose revenue opportunities entirely and/or experience delays in revenue recognition associated with a product or service in addition to incurring higher operating expenses during the period required to correct the defects.
There is a risk that for unforeseen reasons we may be required to repair or replace a substantial number of products in use or to reimburse customers for products that fail to work or meet strict performance criteria. From time to time, in certain critical or complex sale or licensing transactions, we may be compelled to accept liability provisions that vary from our preferred contracting model. There is a risk that in certain contracts and circumstances we may not be successful in adequately minimizing our product and related liabilities or that the protections we negotiate will not ultimately be deemed enforceable. We carry product liability insurance, but existing coverage may not be adequate to cover potential claims. Although we will deploy back-up systems, the failure of our products to perform as promised could result in increased costs, lower margins, liquidated damage payment obligations and harm to our reputation. This could result in contract terminations and have a material adverse effect on our business and financial results.
Failure to maintain the proprietary nature of our technology, intellectual property and manufacturing processes could have a material adverse effect on our business and our ability to compete effectively.
We principally rely upon patent, trademark, copyright, trade secret and contract law to establish and protect our proprietary rights. There is a risk that claims allowed on any patents or trademarks we hold may not be broad enough to protect our technology. In addition, our patents or trademarks may be challenged, invalidated or circumvented and we cannot be certain that the rights granted there under will provide competitive advantages to us. Moreover, any current or future issued or licensed patents, or trademarks, or currently existing or future developed trade secrets or know-how may not afford sufficient protection against competitors with similar technologies or processes, and the possibility exists that certain of our already issued patents or trademarks may infringe upon third party patents or trademarks or be designed around by others. In addition, there is a risk that others
may independently develop proprietary technologies and processes, which are the same as, substantially equivalent or superior to ours, or become available in the market at a lower price.
We may have to litigate to enforce our patents or trademarks or to determine the scope and validity of other parties’ proprietary rights. Litigation could be very costly and divert management’s attention. An adverse outcome in any litigation may have a severe negative effect on our financial results and stock price. To determine the priority of inventions, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office or oppositions in foreign patent and trademark offices, which could result in substantial cost and limitations on the scope or validity of our patents or trademarks.
In addition, foreign laws treat the protection of proprietary rights differently from laws in the United States and may not protect our proprietary rights to the same extent as U.S. laws. The failure of foreign laws or judicial systems to adequately protect our proprietary rights or intellectual property, including intellectual property developed on our behalf by foreign contractors or subcontractors may have a material adverse effect on our business, operations, financial results and stock price.
Legal claims regarding infringement by us or our suppliers of third party intellectual property rights could result in substantial costs, diversion of managerial resources and harm to our reputation.
Although we believe that our products and services do not infringe currently existing and validly issued intellectual property rights of others, we might not be able to defend successfully against a third-party infringement claim. A successful infringement claim against us, our customers or our suppliers could subject us to:
|•||liability for damages and litigation costs, including attorneys’ fees;|
|•||lawsuits that prevent us from further use of the intellectual property;|
|•||having to license the intellectual property from a third party, which could include significant licensing fees;|
|•||having to develop a non-infringing alternative, which could be costly and delay projects;|
|•||having to indemnify clients with respect to losses they incurred as a result of the alleged infringement; and|
|•||having to establish alternative sources for products supplied to us by third parties, as discussed above in the risk factor regarding their dependence on limited source suppliers.|
Our failure to prevail against any third party infringement claim could have a material adverse effect on our business and financial results. Even if we are not found liable in a claim for intellectual property infringement, such a claim could result in substantial costs, diversion of resources and management attention, termination of customer contracts and harm to our reputation.
We may be unable to obtain additional capital required to fund our operations and finance our growth.
The installation of our secure credentialing systems requires capital expenditures. Moreover, our strategy includes growth of our business through acquisitions. At December 31, 2006, we had cash and cash equivalents of $5.0 million and availability under our line of credit of $67.5 million. While we believe we have adequate capital resources to meet current working capital requirements and have been successful in the past in obtaining financing for working capital, capital expenditures, and acquisitions, we expect to have ongoing capital needs as we continue to expand our business. If we require additional financing, we may be unsuccessful in raising additional financing or we may not be able to do so on terms that are not excessively dilutive to existing stockholders or less costly than existing sources of financing. Failure to secure additional financing in a timely manner and on favorable terms could have a material adverse effect on our growth strategy, financial performance and stock price and could require us to delay or abandon our development and expansion plans or to implement certain cost reduction initiatives resulting in the curtailment of our operations.
We are dependent on a small number of individuals, and if we lose key personnel upon whom we are dependent, our business will be adversely affected.
Much of our future success depends on the continued service and availability of our senior management, including our Chairman of the Board, President and Chief Executive Officer, Robert V. LaPenta, and other members of our executive team. These individuals have acquired specialized knowledge and skills with regards to advanced technology identity solutions. The loss of any of these individuals could severely harm our business. Our business is also highly dependent on our ability to retain, hire and motivate talented highly skilled personnel. Experienced personnel in the advanced technology identity solutions industry are in high demand and competition for their talents are intense. If we are unable to successfully attract, retain and motivate key personnel, our business may be severely harmed.
Certain of our stockholders have significant relationships with us, which could result in it taking actions that are not supported by unaffiliated stockholders.
In connection with the Aston investment, Aston became the largest stockholder of L-1, owning approximately 10.5% of our outstanding common stock. In addition, Lau Technologies, or (‘‘Lau’’), and Mr. Buddy Beck, beneficially own approximately 3% and 3%, respectively, of our outstanding common stock. As a result, Aston (together with its affiliate, L-1 Investment Partners LLC), Lau and Mr. Beck have an influence on matters requiring approval by our stockholders, including the election of directors and most corporate actions, such as mergers and acquisitions. In addition, we have significant relationships with each of L-1 Investment Partners LLC, Aston, Lau and Mr. Beck, including:
|•||Mr. Robert V. LaPenta, the founder and Chief Executive Officer of L-1 Investments Partners LLC, is Chairman of our board of directors and Chief Executive Officer and President;|
|•||Mr. James DePalma, Mr. Joseph Paresi and Ms. Doni Fordyce who are affiliates of L-1 Investment Partners LLC and Aston, serve as the Executive Vice President and Chief Financial Officer, Executive Vice President and Chief Marketing and Sales Officer, and Executive Vice President and of Corporate Communications, respectively;|
|•||we acquired intellectual property, contracts and distribution channels through a transaction with Lau in January 2002 under which we agreed to pay Lau a 3.1% royalty on certain of our face recognition revenues through June 30, 2014, up to a maximum of $27.5 million;|
|•||in connection with the above transaction with Lau, we entered into consulting agreements with Ms. Joanna Lau, the President of Lau, and her spouse Mr. Denis K. Berube, the Chief Operating Officer of Lau who also serves as a director on our board of directors, under which we will pay each of Ms. Lau and Mr. Berube $125,000 per year through the earlier of January 10, 2012 or the commencement of the consultants’ full-time employment elsewhere. Mr. Berube and Ms. Lau own a majority of Lau’s stock;|
|•||in connection with the acquisition of TDT in February 2004, Mr. Beck was elected a member of our board of directors and we entered into a consulting agreement with Mr. Beck under which we agreed to pay Mr. Beck $300,000 per year for two years. The consulting agreement expired on April 14, 2006.|
The concentration of large percentages of ownership in any single stockholder, or in any series of single stockholders, may delay or prevent change in control of the Company. Additionally, the sale of a significant number of our shares in the open market by single stockholders or otherwise could adversely affect our stock price.
Risks Related to Our Acquisition Strategy
Integration of Identix and other recently acquired businesses may be difficult to achieve and will consume significant financial and managerial resources, which may adversely affect operations.
We may encounter substantial difficulties, costs and delays in integrating our operations with Identix and other recently acquired companies, including SpecTal, SecuriMetrics, IBT, Iridian and ComnetiX, Inc. such as:
|•||exposure to unknown liabilities of acquired companies or assets;|
|•||higher than anticipated acquisition costs and expenses;|
|•||assumption of ongoing litigation matters that may be highly complex and involve significant time, cost and expense (such as the dispute with LG assumed with in connection with our acquisition of Iridian and described under ‘‘Item 3. Legal Proceedings.’’)|
|•||potential conflicts between business cultures;|
|•||adverse changes in business focus perceived by third-party constituencies;|
|•||disruption of our ongoing business;|
|•||potential conflicts in distribution, marketing or other important relationships;|
|•||potential constraints of management resources;|
|•||failure to maximize our financial and strategic position by the successful incorporation of acquired technology;|
|•||failure to realize the potential of acquired technologies, complete product development, or properly obtain or secure appropriate protection of intellectual property rights; and|
|•||loss of key employees and/or the diversion of management’s attention from other ongoing business concerns.|
In addition, we have offices in many locations and have moved our corporate headquarters from the Viisage facilities in Billerica, Massachusetts, to Stamford, Connecticut. Identix is headquartered in Minnetonka, Minnesota and has employees in seven locations. SpecTal is headquartered in Reston, Virginia and SecuriMetrics and Iridian are located in Martinez, California. IBT is located in Nashville, Tennessee and Springfield, Illinois and ComnetiX is headquartered in Oakville, Ontario, Canada. The geographic distance between the companies and their respective offices and operations increases the risk that the integration will not be completed successfully or in a timely and cost-effective manner. We may not be successful in overcoming these risks or any other problems encountered in connection with the integration of the companies. The simultaneous integration of these acquisitions may place additional strain on our resources and increase the risk that our business may be adversely affected by the disruption caused by the acquisitions. Our strategy contemplates acquiring additional businesses, the integration of which may consume significant financial and managerial resources, and could have a severe negative impact on our business, financial condition and results of operations.
Our acquisitions could result in future impairment charges and other charges which could adversely affect our results of operations.
At December 31, 2006, goodwill and other intangible assets are $951.4 million and $170.1 million, respectively. Because goodwill represents a residual after the purchase price is allocated to the fair value of acquired assets and liabilities, it is difficult to quantify the factors that contribute to the recorded amounts. Nevertheless, management believes that the following factors have contributed to the amount recorded:
|•||technological development capabilities and intellectual capital;|
|•||expected significant growth in revenues and profits from the expanding market in identity solutions; and|
|•||expected synergies resulting from providing multi modal product offerings to existing customer base and to new customers of the combined company.|
The recorded amounts at the purchase date for goodwill and other intangible assets are estimates at a point in time and are based on valuations and other analyses of fair value that require significant estimates and assumptions about future events, including but not limited to projections of revenues, market growth, demand, technological developments, political developments, government policies, among other factors, which are derived from information obtained from independent sources, as well
as the management of the acquired businesses and our business plans for the acquired businesses or intellectual property. If estimates and assumptions used to initially record goodwill and intangible assets do not materialize, or unanticipated adverse developments or events occur, ongoing reviews of the carrying amounts of such goodwill and intangible assets may result in impairments which will require us to record a charge in the period in which such an impairment is identified, and could have a severe negative impact on its business and financial statements.
If we do not achieve the expected benefits of the acquisitions we have made, the price of our common stock could decline.
We expect that the acquisitions of Identix and Iridian in August 2006, SpecTal in October 2006, SecuriMetrics in February 2006 and ComnetiX in February 2007, as well as the acquisitions that we have made previously will enhance our leadership in the identity solutions industry through the combination of their respective technologies. However, the combination of such technologies might not meet the demands of the marketplace. If our technologies fail to meet such demand, customer acceptance of our biometric products could decline, which would have an adverse effect on our results of operations and financial condition. Further, we expect that the additions to our product portfolio will extend our reach into our current markets and provide a critical component to our comprehensive offering for new markets in need of identity solutions. However, there can be no assurance that our current customers or customers in new markets will be receptive to these additional offerings. Further, we might not be able to market successfully our products and services to the customers of the companies we acquired. If our product offerings and services fail to meet the demands of this marketplace, our results of operations and financial condition could be adversely affected. There is also a risk that we will not achieve the anticipated benefits of the acquisitions as rapidly as, or to the extent, anticipated by financial or industry analysts, or that such analysts will not perceive the same benefits to the acquisitions as they do. If these risks materialize, our stock price could be adversely affected.
Item 1B. Unresolved Staff Comments
Item 2. Properties
We do not own any properties. The following describes our most significant leasing arrangements.
Our corporate headquarters comprises approximately 32,000 square feet of space in facilities located in Stamford, Connecticut. We sublease space from L-1 Investment Partners LLC. The sublease terminates on the earlier of the date that the Company’s chairman ceases employment with the Company or April 2010. We use this property for corporate, administrative, customer support and other general business needs. We also lease the following facilities:
|•||32,000 square feet of space in Billerica, MA which is under a lease that expires in 2008. The space houses the headquarters and operations of our Viisage division.|
|•||15,000 square feet of space in Springfield, IL which is under a lease that expires in 2010. The space houses certain operating and administrative of IBT.|
|•||80,000 square feet in Minnetonka, MN which is under a lease that expires in March 2008. The space houses the headquarters and operations of our Identix division. A portion of this space has been sublet.|
|•||10,000 square feet in Jersey City, NJ under a lease that expires in April 2007. The space houses our research and development operations. We have entered into a new lease for approximately 18,000 square feet to accommodate our research and development activities, also in Jersey City which lease expires in April 2017.|
|•||16,000 square feet in Reston, VA under a lease that expires in March 2012. The space houses the headquarters and operations of the SpecTal division.|
|•||12,000 square feet in Fairfax, VA under a lease that expires in December 2009. We have vacated this space and seeking to sublease it.|
|•||12,500 square feet of space in facilities located in Bochum, Germany. The term of this lease is indefinite, but the lease can be terminated on six months’ notice. This space is used for research and development and sales operations.|
|•||4,000 square feet of space in Arlington, Virginia. The term of this lease runs through April 2009. We use this property for our federal sales and marketing operations.|
|•||6,700 square feet of space in Nashville, Tennessee, which is used for the headquarters and operations of IBT. The term of this lease runs through July 2009.|
|•||26,000 square feet of space in Martinez, California, which houses the headquarters and operations of SecuriMetrics and Iridian. The term of this lease runs through February 2011.|
|•||8,000 square feet in Oakville, Ontario, Canada, on a month to month basis which houses the headquarters of ComnetiX. We also lease approximately 6,000 square feet in Carrollton, Georgia, under a lease that expires in August 2007, which houses ComnetiX, U.S. operations.|
While we believe that these facilities are adequate to meet our immediate needs, it may become necessary to secure additional space in the future to accommodate any future growth. We believe that such additional space will be available as needed in the future on commercially reasonable terms.
Item 3. Legal Proceedings
In March and April 2005, eight putative class action lawsuits were filed in the United States District Court for the District of Massachusetts against Viisage, Mr. Bernard C. Bailey, Mr. William K. Aulet (Viisage’s former Chief Financial Officer) and Mr. Denis K. Berube and other members of the Board of Directors of Viisage Technology, Inc. These lawsuits have been consolidated into one action under one case name: In re: Viisage Technology Securities Litigation, Civil Action No. 05-10438-MLW. The so-called Turnberry Group has been designated as lead plaintiff and its counsel has been designated as lead counsel. The amended consolidated complaint which was filed in February 2006 alleges violations of the federal securities laws by Viisage (now named L-1 Identity Solutions, Inc.) and certain officers and directors arising out of purported misstatements and omissions in Viisage’s SEC filings related to certain litigation involving the Georgia drivers’ license contract and related to the Viisage’s reported material weaknesses in internal controls over financial reporting, which allegedly artificially inflated the price of the Company’s stock during the period May 12, 2004 through March 2, 2005. (The Company is not able to estimate the amount of the loss allegedly suffered by members of the putative class or the amount of legal costs and internal efforts associated with defending the Company and Viisage’s then officers and directors.) The Company’s insurance carrier is currently paying defense costs of the Company and the individual defendants. In April 2006, the Company filed a motion to dismiss this case. In February 2007 the Judge dismissed all claims related to the Georgia drivers’ license contract and permitted the case to proceed on claims associated with purported internal control weaknesses over financial reporting. Based on all facts and circumstances, including available insurance policies, management believes that it is unlikely that the eventual resolution of the litigation will have a material adverse effect on the consolidated financial statements of the Company.
In April 2005, two purported shareholder derivative actions also were filed against directors, naming Viisage as a nominal defendant. The suits claim that these directors breached their fiduciary duties to its shareholders and to Viisage generally in connection with the same set of circumstances alleged in the class action lawsuit. The complaints are derivative in nature and do not seek relief from the Company. One of these actions was filed in Massachusetts Superior Court and the other was filed in the United States District Court for the District of Massachusetts. In July 2005, the state court action was dismissed with prejudice at the plaintiff’s request. An amended complaint in the federal court derivative action was filed in July 2006 in which the plaintiff added allegations regarding disclosures by Viisage’s representatives that generally appear to be intended to support her contention that she was excused from making a demand on the board of directors before filing a derivative complaint. The Company has filed a motion to dismiss the federal court action.
From time to time in the ordinary course of business, the Company is involved in disputes with third parties, including former employees of the Company. Identix is a defendant in one lawsuit filed by a former employee in the Fresno County Superior Court of California alleging, among other things, wrongful discharge. L-1 believes the claims are without merit and is vigorously defending the lawsuit. In a separate dispute, in June 2006 another former employee of Identix filed a lawsuit in the U.S. District Court for the Central District of California alleging, among other things, unlawful wage rate discrimination based on gender. Based on Identix’ motion in federal court in Minnesota, the plaintiff was enjoined from further prosecuting plaintiff’s claims in California and ordered to arbitrate the dispute in Minnesota. L-1 believes that the plaintiff’s claims are without merit and is vigorously defending the pending arbitration proceeding.
In January 2004, LG Electronics USA, Inc. and LG Electronics, Inc. (a Korean Corporation) (‘‘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 have since been consolidated into one action pending in New Jersey federal court, and are being litigated pursuant to a series of amended complaints filed by LG. Iridian vigorously denies all of LG’s claims and is counterclaiming for LG’s breach of contract, infringement of Iridian’s patents and copyrights, and misappropriation of Iridian’s trade secrets. LG has replied to Iridian’s counterclaims and has asserted defenses that include, among other things, the alleged invalidity or unenforceability of Iridian’s patents, copyrights and trade secrets. LG has also sought leave to amend its complaint to add antitrust claims against Iridian for attempted monopolization. Iridian believes that it has strong defenses to all of LG’s claims and a strong basis to pursue all of Iridian’s counterclaims, and intends to vigorously defend against LG’s claims and pursue its own counterclaims. At this time, the parties have not completed discovery and accordingly, it is not possible to predict with certainty the outcome of this litigation. However, a material adverse ruling against Iridian respecting either the underlying contract claims or enforceability of Iridian’s intellectual property rights could materially adversely impact the value of the Company’s investment in Iridian and its iris recognition technology.
In September 2006, L-1 received a notice of a claim from a former employee and consultant of Iridian alleging that Iridian owed such individual $2.0 million pursuant to a consulting agreement entered into between Iridian and the individual in 1997. In January 2007, Iridian entered into a full and final settlement and release agreement with such individual pursuant to which the individual withdrew and forever waived, released and discharged all claims. Payment to such individual under the settlement and release agreement was substantially offset by funds recovered by L-1 from the indemnification escrow account established as part of L-1’s acquisition of Iridian.
In July 2006, Identix received an ordinary course call from the Office of Export Enforcement (‘‘BIS’’) requesting copies of shipping documentation related to a prior shipment of Identix products. In the process of retrieving the documentation, Identix determined that its shipping department had incorrectly completed the relevant documentation, and Identix promptly informed BIS of the error. Identix promptly thereafter initiated an internal review of compliance with its own export compliance policies and export regulations. During the course of the internal review, additional shipping documentation discrepancies were identified. In September 2006, Identix voluntarily disclosed such
discrepancies to BIS and retained an independent consultant to supplement Identix’ internal review of export compliance. A subsequent report to BIS was made by Identix in January 2007. While monetary penalties arising out of these inadvertent discrepancies are a possible result of these discrepancies, based on information currently available, L-1 does not believe that liabilities or penalties arising out of these discrepancies will have a material adverse effect on the business, operations or financial results of L-1.
Item 4. Submission of Matters to a Vote of Security Holders
|Item 5.||Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities|
Market for Our Common Stock
Our common stock is traded on the New York Stock Exchange under the symbol ‘‘ID.’’ Prior to August 30, 2006 our common stock traded on the NASDAQ National Market under the symbol ‘‘VISG.’’ As of March 14, 2007, there were 777 holders of record of our common stock.
The quarterly high and low sales prices, as reported by the New York Stock Exchange or NASDAQ, of our common stock during 2006 and 2005 were as follows:
We paid no dividends in 2006 or 2005. We presently intend to retain our cash for use in the operation and expansion of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. In addition, we are prohibited from paying dividends pursuant to our lending arrangements.
Recent Sales of Unregistered Securities
We did not sell any unregistered securities during the year ended December 31, 2006.
Repurchases of Common Stock
We did not repurchase any shares of our common stock during the fourth quarter of 2006.
Stock Performance Chart
The following performance chart assumes an investment of $100 on December 31, 2001 and compares the change to December 31, 2006 in the market price for our common stock with the Nasdaq Composite Index, the Russell 2000 Index and a peer group identified by the Company (the ‘‘Selected Peer Group Index’’). The Selected Peer Group Index was selected to include publicly-traded companies engaging in one or more of the Company’s lines of business. The Company has historically compared its performance to that of the Russell 2000 Index. The Selected Peer Group Index was added in 2006 with the intention of replacing the Russell 2000 Index, an index that is no longer comparable due to our current market capitalization.
The Selected Peer Group Index is weighted according to the respective issuer’s stock market capitalization and is comprised of the following companies: Cogent Inc., ActivIdentity Corporation, DigiMarc Corporation, LaserCard Corporation, Bioscrypt Inc., ImageWare Systems, Inc. and Saflink Corporation.
The comparisons in the graph below are based on historical data and are not intended to forecast the possible future performance of our common stock.
Stock Performance Chart
The following chart supplements the stock performance chart presented above to show the stock performance from October 5, 2005, the day prior to the date that Aston Capital Partners LP announced its investment in L-1 through December 31, 2006 since during this period the Company underwent significant changes in operations and capital structure, including the issuance of $100 million of common stock to Aston, the merger with Identix and acquisitions of IBT, SecuriMetrics, Iridian and SpecTal, as well as significant changes in the board of directors and management.
Item 6. Selected Financial Data
The financial data set forth below should be read in conjunction with ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and our audited consolidated financial statements as of and for the years ended December 31, 2006, 2005 and 2004 and the related notes included elsewhere in this report and in our prior reports on Form 10-K. The historical results of operations are not necessarily indicative of future results.
|(1)||The results reflect the adoption of SFAS No. 123(R) on January 1, 2006.|
|(2)||The results reflect the adoption of EITF 00-21 on January 1, 2003.|
|(3)||The results reflect the use of percentage of completion based on the cost-to-cost method for state drivers’ license contracts, which was the accounting method used prior to the adoption of EITF 00-21.|
|(4)||Reflects reclassification of $1.4 million and $0.6 million of amortization of purchased technology from operating expenses to cost of sales for 2005 and 2004, respectively.|
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the accompanying notes thereto included in ‘‘Item 8. Financial Statements and Supplementary Data’’ of this report.
L-1 Identity Solutions, Inc. (‘‘L-1’’ or ‘‘the Company’’) provides identity protection solutions that enable governments, law enforcement agencies and businesses to enhance security, reduce identity theft, and protect personal privacy. Our solutions are specifically designed for the identification of people and include secure credentialing, biometrics, automated document authentication, real-time identity databases, automated testing of identity and identity information, and biometrically-enabled background checks, as well as systems design, development, integration and support services. These identity solutions enable our customers to manage the entire life cycle of an individual’s identity for a variety of applications including civil identification, criminal identification, border management, anti-terrorism, and security.
The Company also provides comprehensive security solutions to U. S. government agencies.
Our revenues increased to $164.4 million for the year ended December 31, 2006 from $66.2 million for the year ended December 31, 2005. Our net loss for the year increased to $31.0 million from $7.4 million in 2005 and includes $7.8 million of stock based compensation expense. The loss in 2006 includes $22.8 million of asset impairments, separation costs, change in control and other costs, of which $3.2 million comprises stock-based compensation charges. The results for 2006 also include amortization expense of intangible assets of $9.0 million related to businesses acquired in late 2005 and 2006
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 revenue, operating income (loss) and earnings before interest, depreciation, amortization and stock based compensation expenses (‘‘Adjusted EBITDA’’). As an expanding company, we believe that our greatest challenge is choosing the right markets and best opportunities to pursue that will enable us to successfully grow business.
Sources of Revenues
Our Viisage Division, which prior to December 15, 2005 comprised our sole business, 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.
Our Identix Incorporated (‘‘Identix’’) division generates revenues from the sale of biometric solutions incorporating fingerprint, facial and skin biometrics and system components necessary for the
biometric capture and knowledge discovery. Solution offerings include Live Scan and mobile systems and services for biometric capture and identification, and systems, modules and software for biometric matching and verification. Revenues are generated by sales of hardware, software and maintenance services.
Our SecuriMetrics, Inc. (‘‘SecuriMetrics’’) / Iridian Technologies, Inc. (‘‘Iridian’’) division generates revenues through the development, customization and sale of biometrics solutions using iris technology which typically consists of proprietary biometrics capture devices bundled together with our proprietary software, as well as sales of licenses and software.
Our Integrated Biometric Technology, Inc. (‘‘IBT’’)/Identix Identification Services, Inc. (‘‘IIS’’) division generates revenues through the sales of background screening products and services.
Our SpecTal division provides comprehensive security consulting services to U.S. government intelligence agencies.
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 security consulting services.
Since the fourth quarter of 2003 our growth of revenues is due principally to acquisitions we consummated as well as increased demand for our identity solutions related to heightened emphasis on secure credential issuance, document authentication and biometrics. We anticipate that the U.S. Department of State will continue to be one of our major customers for the foreseeable future due to the continuing increase in the number of passports issued each year. We also anticipate steadily increasing funding for major government programs such as TWIC, HSPD-12, REAL ID and e-passport. Any delay or other changes in the rollout of these programs could cause our revenues to fall short of expectations. We also expect to experience increased demand from a number of other government entities as they deploy identity solutions, particularly document authentication, at points of entry and exit, including borders, seaports and airports and in connection with national identification programs. Notwithstanding our expectations regarding demand for these solutions, the quantity and timing of orders from both U.S. and foreign government entities depends on a number of factors outside of our control, such as the level and timing of budget appropriations.
We have pursued strategic acquisitions to complement and expand our existing products, and solutions. Recent acquisitions include:
|•||Our February 2007 acquisition of ComnetiX, Inc. creates an important presence for us in the Canadian market and adding a complementary base of customers to our portfolio, particularly within the law enforcement community.|
|•||Our October 2006 acquisition of SpecTal, LLC, which provides comprehensive security and intelligence solutions, specializing in government consulting, training and technology development;|
|•||Our August 2006 merger with Identix, whose multi-biometric technology provides a broad range of fingerprint and facial recognition technology offerings, which we believe will expand and better serve our market;|
|•||Our August 2006 acquisition of Iridian, which holds the leading iris recognition technology in the industry;|
|•||Our February 2006 acquisition of SecuriMetrics, a provider of the world’s only full-function handheld iris recognition and multi-modal biometric devices, enabling us to now offer multiple and multi-modal biometric capabilities that include finger, face and iris technologies,|
|•||Our December 2005 acquisition of IBT, a provider of proprietary fingerprint technology and background screening solutions, and|
|•||Our December 2005 acquisition of the assets of the Auto Test Division of Openshaw Media Group, a provider of automated web-based applicant testing technologies for state departments of motor vehicles.|
Impact of the Acquisitions
The acquisitions have been included in the consolidated financial statements subsequent to the dates of acquisition.
The Identix merger and the acquisitions of Iridian, IBT, SecuriMetrics and SpecTal, which have resulted in the consolidation of marketing resources, facilities and corporate functions of the separate entities in Stamford, Connecticut are expected to have a continuing material effect on our operations resulting from, but not limited to:
|•||Expected synergies resulting from providing a comprehensive product line to current and future customers.|
|•||Expected future growth in revenues and profits from expanded markets for identity solutions.|
|•||Enhancement of technical capabilities resulting from combining the intellectual capital of the combined entities.|
|•||Appointment of a new corporate executive team, including CEO, CFO and new head of sales and marketing.|
|•||Rationalization technology costs and research and development activities.|
|•||Realignment business divisions to complement each division’s unique capabilities and rationalizing costs.|
Reportable segments and geographic information
Prior to December 15, 2005, we operated in a single reportable segment, the Identity Solutions segment, and starting with our 2006 year, we changed the reporting of our segments to be aligned with our market opportunities and how we manage our various businesses. We currently operate in two reportable segments, the Identity Solutions segment and the Services segment. We measure segment performance based on revenues, Adjusted EBITDA and operating income (loss). Operating results by segment for the three years ended December 31, 2006 follow (in thousands):
In 2006 the Identity Solutions segment include asset impairments and merger related costs of $21.6 million and corporate costs include merger related costs of $1.1 million.
Revenue by market comprises the following for the three years ended December 31, 2006 (in thousands):
Revenues are attributed to each region based on the location of the customer. The following is a summary of revenues by geographic region for the three years ended December 31, 2006 (in thousands):
Identity Solutions revenues
The following provides details of the products and services provided as an integral part of our Identity Solutions’ revenues for the years ended December 31, 2006, 2005 and 2004 (in thousands):
These revenues were classified as follows in 2005 and 2004:
Dependence on Significant Customers
We believe that we will continue to derive a significant portion of our revenues from a limited number of large U.S. Government customers. For the year ended December 31, 2006, three Federal government agencies accounted for 31.0% of our consolidated revenues. For the year ended December 31, 2005, the U.S. Department of State accounted for 27.5% of our consolidated revenues. For the year ended December 31, 2004, the U.S. Department of State accounted for 16.0% of our consolidated revenue and Telos Corporation (U.S. Department of Defense) accounted for 15.0% of consolidated revenues. As of December 31, 2006, we had an accounts receivable balance of approximately $23.8 million from three Federal government agencies. As of December 31, 2005, the U.S. Department of State was the only customer that had a balance of greater than 10% of consolidated accounts receivable, which was approximately $4.4 million.
Consolidated Results of Operations
Comparison of 2006 to 2005
The 2006 results of operations were significantly affected by the December 2005 acquisition of IBT, the February 2006 acquisition of SecuriMetrics, the August 2006 acquisition of Iridian, the August 2006 merger with Identix and the October 2006 acquisition of SpecTal. The 2005 results are those of Viisage, which is now a division of L-1, and encompassed substantially all of the Company’s revenue and operating loss. Approximately $91.7 million and $8.2 million, respectively, of the revenues and the operating loss recorded in 2006 are related to the aforementioned acquisitions.
Approximately 19% and 44% of our revenues for the years ended December 31, 2006 and 2005 were derived from long-term contracts for the production of drivers’ licenses and credentials for which we are compensated on a fixed unit price per license or credential produced. The unit price for these
contracts is fixed throughout the term of the contract, which range from 4 – 5 years. The prices are established in competitive bid situations; in which price is one among many important criteria evaluated by the customer. Approximately 60% of the costs associated with these volume-based revenues are variable and 40% are fixed. Accordingly, margins improve as volumes increase, and margins deteriorate as volumes decrease. Moreover, any increase in the variable costs which include materials and labor will result in margin deterioration unless such increases are offset by the impact of volume increases. Historically, the Company has been able to maintain its margins because volume increases have offset cost increases over the term of the contracts. In addition, we often obtain contract extensions beyond the original terms in which case the fixed depreciation costs on the capitalized equipment and systems are spread over a longer period of time and margins improve. Accordingly, we historically have not incurred losses on these contracts. Sales and marketing and research and development costs related to these revenues are not significant.
The remaining revenues, including other revenues from the drivers’ license contracts which are not based on card production volumes, comprise 52% and 56% of the revenues for the years ended December 31, 2006 and 2005 and were derived from short term purchase orders for consumables, hardware, software, custom solutions and services. These revenues are priced at prevailing prices at the time the order is negotiated and received, and delivery occurs over a short term period. These orders are often competitively bid, although some, particularly consumables sold pursuant to driver license and credential contracts, are sole source. Although we have encountered pricing pressures in our negotiations, we do not believe that they have impacted the margins significantly. Most of our research and development and sales and marketing costs are related to generating these revenues.
Approximately 29% of our revenues in 2006 were derived from long term fingerprinting services and security consulting service contracts with the U.S. and State and Local Governments.
Revenues for the years ended December 31, 2006 and 2005 aggregate $164.4 million and $66.2 million, respectively, of which approximately $91.7 million and $0.6 million, respectively, is related to the acquisitions of IBT, SecuriMetrics, Iridian, Identix and SpecTal. Excluding the impact of the acquisitions, revenues increased by $7.1 million or 11%. Revenue increased by $2.1 million due to increased volumes of U.S. passports revenue from U.S. Department of State and increased sales to U.S. Department of Defense relating to the Common Access Card program, higher face recognition revenues of $1.4 million, increased international software sales of $0.7 million and increased revenues in our state drivers’ license business of $2.7 million.
Cost of revenues and gross margins.
Cost of revenues increased by $66.0 million for the year ended December 31, 2006, of which $63.5 million related to the acquisitions of IBT, SecuriMetrics, Identix, Iridian, and SpecTal. Consolidated gross margins in 2006 increased to 31% from 28% in 2005. Excluding the impact of the acquisitions, gross margin for the year ended December 31, 2006 was 32% compared to 28% in the prior year as a result of increased revenues and improved mix sales. Inventory adjustments and other charges had the effect of reducing gross margin by 2% in the year ended December 31, 2006. Included in the cost of revenues for the year ended December 31, 2006 was $13.9 million of amortization of purchased intangible assets of which $8.9 million related to the IBT, SecuriMetrics, Identix, SpecTal
and Iridian acquisitions. Amortization of purchased intangible assets reduced gross margins by 8% for both the years ended December 31, 2006 and 2005.
Sales and Marketing Expenses.
Sales and marketing expenses increased by approximately $6.6 million for the year ended December 31, 2006 compared to the prior year. The acquisitions of IBT, SecuriMetrics, Iridian, SpecTal and Identix accounted for approximately $5.2 million of the increase. Additional increases of $0.8 million for the year ended December 31, 2006 related to stock based compensation expense. The remaining increase is the result of investment in marketing resources offset in part by savings from the consolidation of sales and marketing activities including, salaries, related personnel expenses, commissions, travel and entertainment expenses, promotions and other marketing and sales support expenses. We expect our sales and marketing expenses to decline as a percentage of revenues in future years.
Research and Development Expenses
Research and development expenses increased by approximately $7.0 million for the year ended December 31, 2006 compared to the prior year, of which approximately $6.5 million is due to the acquisitions of IBT, SecuriMetrics, Iridian and Identix. Excluding the effects of the acquired businesses, research and development expenses in 2006 decreased by $0.3 million primarily as a result of cost reductions, offset by an increase of $0.8 million due to stock based compensation.
Research and development expenses consist primarily of salaries, stock based compensation and related personnel costs and prototype costs related to the design, development, testing and enhancement of our products. Research and development expenses reflect reimbursement of $0.4 million and $0.6 million for 2006 and 2005, respectively. We expect our research and development expenses to decline as a percentage of revenues in future years.
General and Administrative Expenses
General and administrative expense increased approximately $17.9 million for year ended December 31, 2006 compared to 2005, of which approximately $9.9 million is due to the acquisitions of IBT, SecuriMetrics, Iridian, SpecTal and Identix. Stock based compensation expense was $2.5 million for the year ended December 31, 2006. Other increases for the year ended December 31, 2006 relate to legal, professional and other costs incurred in connection with the integration of the acquired businesses, as well as additional audit and professional fees related to the growth of the Company and to remediate internal control weaknesses. We expect our general and administrative expenses to decline as a percentage of revenues in future years.
Asset Impairment and Merger Related Expenses
In connection with the Identix merger, the Company incurred significant personnel cost for severance and other contractual compensation arrangements with its former management team and Board of Directors. These personnel and other severance costs were $5.4 million. Additionally, the Company reviewed its long-term assets in light of the strategy and plans of the combined company and evaluated the carrying value of the assets that would be impacted by that strategy. This resulted in impairment and other charges of $14.6 million relating to facial recognition technology, documentation authentication technology, patents, and other long-term assets. The Company also recorded a charge for in process research and development of $2.7 million related to the Identix merger.
Amortization of Purchased Intangible Assets
Amortization of purchased intangible assets decreased as a result of impairments recorded in 2006.
Interest Income and Expense
Interest income increased compared to the same period in 2005, primarily as a result of interest income related to higher average cash balances during 2006, due to the $100.0 million investment made by L-1 Investment Partners LLC in late 2005. Interest expense increased as a result of the $105.0 million in borrowings used to purchase SpecTal in October 2006.
Other Income, Net
Other income includes realized and unrealized currency transaction gains and losses on yen-denominated purchases, as well as unrealized gains and losses forward currency contracts.
The provision for income taxes represents a deferred tax provision related to the amortization of tax deductible goodwill and state and local income tax provisions. The provision increased primarily as a result of increased amortization of the deductible goodwill resulting from the acquisitions of SpecTal, IBT and Auto Test.
The change in comprehensive loss results from of the increase in net loss incurred in 2006 of $31.0 million compared to $7.4 million is 2005, offset by foreign currency translation gains of $3.1 million in 2006 resulting from the weakening of the U.S. dollar relative to the euro, compared to a foreign currency translation loss of $2.1 million recorded in 2005.
Comparison of 2005 to 2004
Revenue decreased slightly by approximately 1.8% to $66.2 million for the year ended December 31, 2005 from $67.5 million for the year ended December 31, 2004, primarily as a result of:
|•||An increase of approximately $7.6 million of revenue related to deliveries under our contract to deliver passports to the U.S. Department of State;|
|•||An increase of approximately $5.7 million of revenue related to document authentication products and services, primarily to state government customers, which was the result of a full year of operations compared to one quarter of operations following the acquisition of Imaging Automation, Inc. (‘‘ iA’’) in 2004;|
|•||An increase of approximately $0.6 million of revenue related to our acquisition of IBT in December 2005;|
|•||A decrease of approximately $8.6 million of revenue from the U.S. Department of Defense, primarily due to a one-time sale of printing systems in 2004 for its common access card, or CAC, program of $10.6 million, partially offset by an increase in consumable purchases in 2005;|
|•||A decrease of approximately $6.0 million of revenue related to document issuance solutions to state government customers, primarily due to expired contracts in five states, partially offset by three new state contracts as well as credential volume increases in some states where we produce drivers’ licenses; and|
|•||A decrease of approximately $0.6 million related to sales of face recognition solutions.|
Cost of Revenues and Gross Profit
Gross margins increased to 28.2% or $18.7 million for the year ended December 31, 2005 compared to 27.7% or $18.7 million for the year ended December 31, 2004.
Amortization of purchased intangible assets included in cost of revenues increased from $3.6 million for the year ended December 31, 2004 to $5.0 million for the year ended December 31, 2005. This increase was primarily due to the inclusion of a full year of amortization expense in 2005 attributable to the acquisition of TDT, which closed in February 2004. For the year ended December 31, 2004, gross profit reflected $0.3 million of corporate insurance costs; such costs are reported in general and administrative expenses for the year ended December 31, 2005.
Sales and Marketing Expenses
Sales and marketing expenses increased approximately $0.9 million, to $7.8 million for the year ended December 31, 2005 from $6.9 million in for the year ended December 31, 2004. The increase is primarily due to a $0.9 million increase in payroll and other outside service costs related to the iA acquisition from 2004, which includes a full year of activity for the year ended December 31, 2005 compared to only one quarter in 2004. In addition, the Company incurred additional payroll-related costs from additional sales personnel, partially offset by reduced facility costs and reduced spending on bid and proposal activity. For the year ended December 31, 2004, sales and marketing expenses reflected $0.2 million of corporate insurance costs; such costs are reported in general and administrative expenses for the year ended December 31, 2005. As a percentage of revenues, sales and marketing expenses increased to 11.8% for the year ended December 31, 2005 from 10.3% for the year ended December 31, 2004 as a result of lower than expected revenues.
Research and Development Expenses
Research and development expenses increased by approximately $0.8 million, to $4.6 million for the year ended December 31, 2005 from $3.8 million for the year ended December 31, 2004. The increase is primarily due to a $0.9 million increase in payroll and benefit costs related to the iA acquisition from a full year of activity for the year ended December 31, 2005 compared to only one quarter in 2004. For the year ended December 31, 2004, research and development expenses reflected $0.1 million of corporate insurance costs; such costs are reported in general and administrative
expenses for the year ended December 31, 2005. Billable labor hours of research and development personnel were relatively consistent for the years ended December 31, 2005 and 2004 and are classified as cost of revenues when such billable hours result in the delivery of a product or service to a customer. Reimbursements for funded research and development are recorded as a reduction to expense, and were approximately $0.6 million and $0.8 million for 2005 and 2004, respectively. As a percentage of revenue, research and development expenses increased to 7.0% for the year ended December 31, 2005 from 5.7% for the year ended December 31, 2004.
General and Administrative Expenses