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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2007.

OR

[ ]  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 001-33002

L-1 IDENTITY SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)


Delaware 02-08087887
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
177 Broad Street, 12th Floor, Stamford, CT 06901
(Address of principal executive offices) (Zip Code)

(203) 504-1100
Registrant’s telephone number, including area code

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

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    [X]                Non-Accelerated Filer    [ ]

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

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


Class Outstanding at
August 2, 2007
Common stock, $.001 par value 74,934,131



L-1 IDENTITY SOLUTIONS, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2007

INDEX


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PART 1 — FINANCIAL INFORMATION

ITEM 1 — UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Balance Sheets
(in thousands)
(Unaudited)


  June 30,
2007
December 31,
2006
Assets    
Current assets:    
Cash and cash equivalents $ 6,086 4,993
Accounts receivable, net 69,832 61,513
Inventory 14,785 10,967
Other current assets 3,690 4,529
Total current assets 94,393 82,002
Property and equipment, net 20,985 19,928
Goodwill 974,417 951,443
Intangible assets, net 161,702 170,098
Other assets, net 11,188 3,754
Total assets $ 1,262,685 $ 1,227,225
Liabilities and Shareholders’ Equity    
Current liabilities:    
Accounts payable and accrued expenses $ 61,181 $ 54,807
Current portion of deferred revenue 9,978 10,331
Other current liabilities 3,535 5,206
Total current liabilities 74,694 70,344
Deferred tax liability 6,471 4,394
Deferred revenue, net of current portion 3,838 3,734
Long-term debt 175,000 80,000
Other long-term liabilities 830 1,668
Total liabilities 260,833 160,140
Shareholders’ equity 1,001,852 1,067,085
Total liabilities and shareholders’ equity $ 1,262,685 $ 1,227,225

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

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L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)


  Three months ended Six months ended
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
Revenues $ 90,099 $ 24,868 $ 160,106 $ 48,306
Cost of revenues:        
Cost of revenues 55,856 15,703 102,033 30,778
Amortization of purchased intangible assets 6,492 2,021 12,965 3,889
Total cost of revenues 62,348 17,724 114,998 34,667
Gross profit 27,751 7,144 45,108 13,639
Operating expenses:        
Sales and marketing 7,444 2,840 12,904 5,336
Research and development 4,551 1,863 9,212 3,546
General and administrative 12,946 3,643 26,027 8,117
Amortization of purchased intangible assets 700 141 868 258
Total operating expenses 25,641 8,487 49,011 17,257
Operating income (loss) 2,110 (1,343 )  (3,903 )  (3,618 ) 
Interest income 99 496 166 1,166
Interest expense (2,271 )  (43 )  (4,043 )  (49 ) 
Other income, net 73 11 47 28
Income (loss) before income taxes 11 (879 )  (7,733 )  (2,473 ) 
Provision for income taxes (1,208 )  (751 )  (2,295 )  (1,315 ) 
Net loss $ (1,197 )  $ (1,630 )  $ (10,028 )  $ (3,788 ) 
Basic and diluted net loss per share $ (0.02 )  $ (0.06 )  $ (0.14 )  $ (0.13 ) 
Weighted average basic and diluted common shares outstanding 71,257 29,076 71,895 29,042

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

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L-1 IDENTITY SOLUTIONS, INC.
Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Loss
(In thousands)
Unaudited)


  Common
Stock
Additional
Paid-in
Capital
Accumulated
Deficit
Pre-paid
Forward
Contract
To Purchase
Common
Stock
Other
Comprehensive
Gain (Loss)
Total
Balance, January 1, 2006 $ 29 $ 333,456 $ (56,427 )  $ $ (2,398 )  $ 274,660
Exercise of employee stock options 1 7,180 7,181
Common stock issued for directors’ fees 288 288
Common stock issued under employee stock purchase plan 53 53
Common stock issued for acquisition, net of issuing costs 43 769,931 769,974
Fair value of vested stock options and warrants assumed for acquisition 35,103 35,103
Retirement plan contributions paid in common stock 288 288
Stock-based compensation expense 7,492 7,492
Foreign currency translation adjustment 3,083 3,083
Net loss (31,037 )  (31,037 ) 
Comprehensive Loss            
Balance, December 31, 2006 73 1,153,791 (87,464 )  685 1,067,085
Exercise of employee stock options 1 7,521 7,522
Common stock issued for directors’ fees 272 272
Common stock issued under employee stock purchase plan 1,119 1,119
Retirement plan contributions paid in common stock 148       148
Pre-paid forward contract (69,808 )  (69,808 ) 
Stock-based compensation expense 4,352 4,352
Foreign currency translation adjustment 1,190 1,190
Net loss     (10,028 )      (10,028 ) 
Comprehensive Loss            
Balance, June 30, 2007 $ 74 $ 1,167,203 $ (97,492 )  $ (69,808 )  $ 1,875 $ 1,001,852

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

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


  Six Months Ended
  June 30,
2007
June 30,
2006
Cash Flow from Operating Activities:    
Net loss $ (10,028 )  $ (3,788 ) 
Adjustments to reconcile net loss to net cash provided by operating activities:    
Depreciation and amortization 18,419 8,511
Stock-based compensation expense 5,093 1,411
Retirement plan contributions paid in common stock 148
Deferred income taxes 2,207 1,016
Amortization of deferred financing costs 417
Changes in operating assets and liabilities, net of effects of acquisitions:    
Accounts receivable (5,544 )  (962 ) 
Inventory (3,029 )  (543 ) 
Other assets (144 )  (586 ) 
Accounts payable, accrued expenses and other liabilities 426 (1,299 ) 
Deferred revenue (2,728 )  982
Net cash provided by operating activities 5,237 4,742
Cash Flow from Investing Activities:    
Cash paid for acquisitions, net of cash acquired (25,349 )  (30,567 ) 
Capital expenditures (5,965 )  (3,463 ) 
Other assets 179 (563 ) 
Net cash used in investing activities (31,135 )  (34,593 ) 
Cash Flow from Financing Activities    
Net repayments under revolving credit agreement (80,000 ) 
Principal payments on long-term debt (623 )  (88 ) 
Proceeds from senior convertible notes 175,000
Payment of pre-paid forward contract (69,808 ) 
Financing costs (5,965 ) 
Proceeds from issuance of common stock 8,319 1,226
Net cash provided by financing activities 26,923 1,138
Effect of exchange rate changes on cash and cash equivalents 68 (32 ) 
Net increase (decrease) in cash and cash equivalents 1,093 (28,745 ) 
Cash and cash equivalents, beginning of period 4,993 72,385
Cash and cash equivalents, end of period $ 6,086 $ 43,640
Supplemental Cash Flow Information:    
Cash paid for interest $ 2,550 $ 48
Cash paid for income taxes $ 176 $ 332

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

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

1.    DESCRIPTION OF BUSINESS

L-1 Identity Solutions, Inc. and its subsidiaries (‘‘L-1’’ or the ‘‘Company’’) provide a full range of identity protection and security solutions that enable governments, law enforcement agencies and businesses to enhance security, reduce identity theft and protect personal privacy. L-1’s identity solutions are specifically designed for the identification of people and include secure credentialing, biometrics, 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 L-1’s customers to manage the entire life cycle of an individual’s identity for a variety of applications including civil identification, criminal identification and border management and security. L-1 also provides comprehensive security solutions to the U.S. Government.

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

The Company has developed and acquired complementary technologies and businesses that allow it to offer a full range of secure credentialing and biometric solutions, including facial, fingerprint and iris recognition solutions and technologies, as well as security solutions to customers.

Reorganization

On May 16, 2007, the Company adopted a new holding company organizational structure in accordance with Section 251(g) of the Delaware General Corporation Law (the ‘‘DGCL’’) in order to facilitate its announced convertible senior notes (the ‘‘Convertible Notes’’ or ‘‘Notes’’) offering and in order to facilitate the structuring of potential future acquisitions. Pursuant to the reorganization, L-1 Identity Solutions, Inc. became the sole shareholder of its predecessor, L-1 Identity Solutions Operating Company (‘‘L-1 Operating Company’’, previously known as L-1 Identity Solutions, Inc.) The reorganization has been accounted for as a reorganization of entities under common control and the historical consolidated financial statements of the predecessor entity represent the consolidated financial statements of the Company. The reorganization did not impact the historical carrying amounts of the assets and liabilities of the Company or its historical results of operations and cash flows.

The holding company organizational structure was affected pursuant to an Agreement and Plan of Reorganization (the ‘‘Merger Agreement’’) among L-1 Operating Company, the Company and L-1 Merger Co., a Delaware corporation and wholly owned subsidiary of the Company (‘‘Merger Co.’’). The Merger Agreement provided for the merger of Merger Co. with and into L-1 Operating Company, with L-1 Operating Company surviving as a wholly owned subsidiary of the Company (the ‘‘Merger’’). The Merger was consummated on May 16, 2007.

By virtue of the Merger, all of the outstanding capital stock of L-1 Operating Company was converted, on a share for share basis, into capital stock of the Company. As a result, each former shareholder of L-1 Operating Company became the owner of an identical number of shares of common stock of the Company. Additionally, each outstanding stock option and warrant to purchase shares of common stock of L-1 Operating Company was automatically converted into a stock option or warrant to purchase, upon the same terms and conditions, an identical number of shares of the Company’s common stock. The conversion of the shares of common stock in the Merger occurred without an exchange of certificates. Accordingly, certificates formerly representing shares of

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outstanding common stock of L-1 Operating Company are deemed to represent the same number of shares of common stock of the Company. Upon consummation of the Merger, the Company’s common stock was deemed to be registered under Section 12(b) of the Securities Act of 1934, as amended, pursuant to Rule 12g-3(a) promulgated thereunder. For purposes of Rule 12g-3(a), the Company is the successor issuer to L-1 Operating Company. Pursuant to Section 251(g) of the DGCL, the provisions of the certificate of incorporation and bylaws of the Company are substantially identical to those of L-1 Operating Company prior to the Merger. The authorized capital stock of the Company, the designations, rights, powers and preferences of such capital stock and the qualifications, limitations and restrictions thereof are also substantially identical to those of the capital stock of L-1 Operating Company prior to the Merger. The directors of the Company are the same individuals who were directors of L-1 Operating Company prior to the Merger. The executive officers of the Company and L-1 Operating Company are the same.

In connection with the consummation of the Merger, the Company entered into an Assignment and Assumption Agreement with L-1 Operating Company. Pursuant to the terms of the Assignment and Assumption Agreement the Company assumed L-1 Operating Company’s obligations under (i) certain plans, arrangements and agreements of L-1 Operating Company and its subsidiaries relating to stock options, employment or compensation, and (ii) certain other agreements. The other liabilities of L-1 Operating Company, including contingent liabilities, were not assumed by the Company in the Merger and therefore continue to be the obligations of L-1 Operating Company, and the assets of L-1 Operating Company were not transferred to the Company and therefore continue to be assets of L-1 Operating Company.

The Company has no operations other than those carried through its investment in L-1 Operating Company, except the financing operations related to the issuance of the convertible notes, and substantially all of its assets consist of its investment in L-1 Operating Company. At June 30, 2007, the Company’s investment in L-1 Operating Company approximated $1,171.9 million.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments that in the opinion of management are necessary for a fair presentation of the financial statements for the interim periods. The unaudited condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (‘‘SEC’’) for interim financial statements, and in accordance with SEC rules, omit or condense certain information and footnote disclosures. Results for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

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

Use of Estimates

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

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Revenue Recognition

The Company derives its revenue from solutions that include products and services, as well as sales of stand alone services, hardware, components, consumables and software. Identity Solutions revenue includes revenues from maintenance, consulting and training services related to sales of hardware and software solutions. Services revenue includes fingerprinting services and government consulting services. A customer, depending on its needs, may order hardware, equipment, consumables or software products or services or combine hardware products, consumables, equipment, software products and services to create a multiple element arrangement. The Company’s revenue recognition policies are described in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Stock-Based Compensation

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

Determining the appropriate valuation method and related assumptions requires judgment, including estimating common stock price volatility, forfeiture rates and expected terms. The following weighted average assumptions were utilized in the valuation of stock options in 2007 and 2006:


  Three Months Ended Six Months Ended
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
Expected common stock price volatility 61 %  110 %  65 %  110 % 
Risk free interest rate 4.3 %  4.3 %  4.3 %  4.3 % 
Expected life of options 6.3 Years 6.3 Years 6.3 Years 6.3 Years
Expected annual dividends

The expected volatility rate is based on the historical volatility of the Company’s common stock. In the second quarter of 2007, the Company reviewed the historical volatility of its common stock and used a weighted average method that more accurately reflects volatility. The expected life of options is based on the average life of 6.3 years pursuant to the guidance from Staff Accounting Bulletin No. 107. The Company estimated forfeitures when recognizing compensation expense based on historical rates. The risk free interest rate is based on the 7 year treasury security as it approximates the 6.3 years of expected life of the options. The Company updates these assumptions on at least an annual basis and on an interim basis if significant changes to the assumptions are warranted.

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Stock-based compensation expense was $2.5 million and $0.8 million for the three months ended June 30, 2007 and 2006, respectively, and includes $0.1 million related to restricted stock for both periods. Stock-based compensation expense was $5.1 million and $1.4 million for the six months ended June 30, 2007 and 2006, respectively, and includes $0.2 million and $47,000, respectively, related to restricted stock. The Company recognized the full cost impact of the awards issued under its equity incentive plans in the condensed consolidated statements of operations for the three months and six months ended June 30, 2007 and 2006 and did not capitalize any such costs. The following tables presents stock-based compensation expense included in the condensed consolidated statements of operations (in thousands):


  Three Months Ended Six Months Ended
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
Cost of revenues $ 209 $ 84 $ 352 $ 169
Research and development 260 130 485 227
Sales and marketing 492 187 897 358
General and administrative 1,553 351 3,359 657
  $ 2,514 $ 752 $ 5,093 $ 1,411

In addition during the six months ended June 30, 2007, the Company issued common stock of approximately $0.1million as contributions to a retirement plan.

Computation of Net Loss per Share

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

The basic and diluted net loss per share calculation is computed based on the weighted average number of shares of common stock outstanding during the period. The impact of approximately 4.8 million and 4.7 million common equivalent shares for the three and six month periods ended June 30, 2007, respectively, and the impact of approximately 4.4 million of common stock equivalent shares for both the three and six months periods ended June 2006, respectively, were not reflected in the dilutive net loss per share calculations as their effect would be anti-dilutive.

The Company calculates the effect of the Convertible Notes    for the three and six months period ended June 30, 2007 on diluted earnings per share utilizing the ‘‘if converted’’ method since the Company has the right to issue shares of common stock to settle the entire obligation upon conversion. For the three and six months periods ended June 30, 2007, the effect was antidilutive. Accordingly, approximately 5.5 million shares of weighted average common stock issuable at conversion have been excluded from the determination of weighted average diluted shares outstanding.

In connection with the issuance of the Convertible Notes, the Company entered into a pre-paid forward contract with Bear Stearns pursuant which for a payment of $69.8 million to purchase 3,490,400 shares of the Company’s common stock at a price of $20.00 per share. Pursuant to SFAS No. 150, the number of shares to be delivered under the contract is used to reduce basic and weighted average diluted shares outstanding for earnings per share purposes.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (‘‘FASB’’) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which is effective for fiscal years beginning after December 15, 2006. The interpretation provides that a tax position is recognized if the enterprise determines that it is more likely than not that a tax position

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will be sustained based on the technical merits of the position, on the presumption that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods and transition. The adoption of Interpretation No. 48 on January 1, 2007 did not have a material impact on the consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, which for the Company will be as of the beginning of 2008. The Company is in the process of evaluating the impact that the adoption of SFAS No. 157 will have on its consolidated financial statements.

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

3.    STOCK OPTIONS

Stock Options

The following table summarizes the stock option activity from January 1, 2007 through June 30, 2007:


  Stock
Options
Weighted
Average
Exercise
Price
Weighted
Average
Remaining
Life
(Years)
Aggregate
Intrinsic
Value
Outstanding at January 1, 2007 6,370,051 $ 12.96    
Granted 1,641,481 18.41    
Exercised (732,936 )  10.30    
Canceled/expired/forfeited (133,904 )  21.55    
Outstanding at June 30, 2007 7,144,692 $ 14.62 7.43 $ 46,456,789
Vested or expected to vest at June 30, 2007(1) 5,401,387 $ 11.05 7.43 $ 35,121,332
Exercisable at June 30, 2007 3,434,351 $ 12.38 5.41 $ 31,080,312
(1) Options expected to vest are determined by applying the pre-vesting forfeiture rate assumptions to total outstanding options.

The aggregate unearned compensation cost of unvested options outstanding as of June 30, 2007 was $30.7 million and will be amortized over a weighted average period of 3.3 years. The total intrinsic value of options exercised during the three and six months ended June 30, 2007 was $4.6 million and $6.1 million, respectively. The intrinsic value is calculated as the difference between the market value of the Company’s common stock and the exercise price of options.

The recognition of a tax benefit related to the exercise of stock options and subsequent sale of the underlying stock is being deferred per SFAS No. 123(R) and will be recognized when net operating loss carryforwards are fully utilized. In May 2007, the Company’s shareholders approved an increase from 2 million to 4 million available issuance of common stock for share based awards issued under the 2005 long-term incentive plan.

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4.    INCOME TAXES

The income tax provision for the three and six months ended June 30, 2007 and 2006 includes approximately $1.1 million and $0.5 million, and $2.1 million and $1.0 million, respectively, which represent the aggregate increase of a deferred tax asset resulting from losses incurred during the periods, a full valuation allowance against such deferred tax asset and an additional provision. Pursuant to SFAS No. 109, such additional provision was recorded for the amortization of tax deductible goodwill, for which the period of reversal of the related temporary difference is indefinite; the related deferred tax liability cannot be used to offset the deferred tax asset in determining the valuation allowance. The remaining income tax provision comprises foreign and state income tax expense.

The Company is subject to income tax examinations by U.S. Federal and other jurisdictions for tax years ended subsequent to December 31, 2002. The condensed consolidated financial statements do not include any provision for interest or penalties. In the event interest and penalties are incurred, the Company may make an election to account for interest expense and penalties related for income tax issues as income tax expense.

5.    RELATED PARTY TRANSACTIONS

Aston Capital Partners, L.P. (‘‘Aston’’), an affiliate of L-1 Investment Partners LLC, Lau Technologies (‘‘Lau’’), an affiliate of Mr. Denis K. Berube, a member of the board of directors of the Company, and Mr. Buddy Beck, also a member of the board of directors of the Company beneficially own approximately 10.9%, 3.5% and 1.9%, respectively, of L-1’s outstanding common stock. Mr. Robert V. LaPenta, Mr. James DePalma, Mr. Joseph Paresi and Ms. Doni Fordyce, each executive officers of the Company, directly and indirectly hold all the beneficial ownership in L-1 Investment Partners LLC and Aston Capital Partners GP LLC, the investment manager and general partner of Aston Capital Partners, L.P., respectively. Mr. LaPenta is the Chairman of the board of directors, Chief Executive Officer and President of the Company. Mr. DePalma is the Chief Financial Officer and Treasurer of the Company.

The Company has consulting agreements with Mr. Berube and his spouse, Ms. Joanna Lau, under which each receives annual compensation of $0.1 million. Each agreement terminates on the earlier of July 10, 2012 or commencement of full time employment elsewhere. As of June 30, 2007, approximately $0.1 million represents the outstanding balance owed to them as no payments were made in 2007, and for the three and six months ended June 30, 2006, approximately $0.1 million was paid in the aggregate to Mr. Berube and Ms. Lau under the consulting agreements.

Under the terms of a 2002 acquisition agreement of Lau Security Systems, the Company is obligated to pay Lau a royalty of 3.1% on certain of its face recognition revenues through June 30, 2014, up to maximum royalties of $27.5 million. Royalty expense included in cost of revenues was approximately $12,000 and $36,000 for the three months and six months ended June 30, 2007, respectively, and $6,000 and $39,000 for the three months and six months ended June 30, 2006, respectively.

In connection with a consulting agreement which terminated in April 2006, Mr. Beck received annual compensation of $0.3 million. For the three months and six months ended June 30, 2006, Mr. Beck was paid $50,000 and $0.1 million, respectively, for these services. At June 30, 2007, there was no outstanding balance owed to Mr. Beck.

In connection with the merger with Identix Incorporated (‘‘Identix’’) and the acquisition of SecuriMetrics, Inc. (‘‘SecuriMetrics’’) in 2006, the Company paid L-1 Investment Partners LLC a one time fee of $2.5 million for professional services related to these acquisitions. Approximately $2.0 million and $0.5 million of this fee has been included in the cost of the acquisition of Identix and SecuriMetrics, respectively.

In connection with the merger with Identix, Aston and the Company agreed in principle that the Company may, subject to approval of the Company’s board of directors, purchase AFIX Technologies, Inc., a portfolio company of Aston, which provides fingerprint and palmprint identification software to

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local law enforcement agencies, at fair market value to be determined by an independent appraiser retained by the Company’s board of directors.

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

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

Bear Stearns is party to the revolving credit agreement under which it was paid $0.2 million and $0.6 million in interest for the three and six months ended June 30, 2007, respectively, and there were no interest payments for the three and six months ended June 30, 2006. No borrowings were outstanding at June 30, 2007. In addition, Bear Stearns was an initial purchaser of the Convertible Notes issued on May 17, 2007 for which it received an aggregate discount of $4.8 million. The purchasers of the Convertible Notes, including Bear Stearns, are parties to a registration rights agreement under which the Company has agreed to file a shelf registration statement covering resales of the Convertible Notes and shares of common stock issuable upon the conversion of Convertible Notes. Also on May 17, 2007, the Company, entered in a pre-paid forward contract with Bear Stearns to purchase approximately 3.5 million shares of the Company’s common stock or 69.8 to be delivered in 5 years. Also, Bear Stearns makes a market for the Convertible Notes.

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

As a condition to the closing of the Identix Merger, the Company and L-1 Investment Partners LLC entered into a Termination and Noncompete Agreement which, among other things, (1) terminated all arrangements whereby L-1 Investment Partners LLC and its affiliates provided financial, advisory, administrative or other services to the Company or its affiliates, and (2) prohibited L-1 Investment Partners LLC and its affiliates from engaging or assisting any person that competes directly or indirectly with the Company in the business of biometric, credentialing and ID management business anywhere in the United States or anywhere else in the world where the Company does business, or plans to do business or is actively evaluating doing business during the restricted period; provided however that the foregoing does not restrict L-1 Investment Partners LLC and its affiliates from retaining its investment in and advising AFIX Technologies, Inc. The restricted period runs co-terminously with the term of Robert V. LaPenta’s employment agreement with the Company, dated as of August 29, 2006, and for a twelve (12) month period following the expiration of the term of Mr. LaPenta’s employment agreement.

In December 2005, Aston completed a $100.0 million investment in and became the beneficial owner of more than 5% of the Company’s outstanding common stock. In accordance with the terms of the investment agreement, the Company issued to Aston warrants to purchase an aggregate of

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1,600,000 shares of L-1’s common stock at an exercise price of $13.75 per share, of which 1,493,333 at June 30, 2007 are currently exercisable and 106,667 vest if gross revenues for four consecutive quarters equal or exceed $300 million.

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

On April 23, 2007, the Company entered into an employee arrangement with Mr. Robert LaPenta, Jr., the son of the Company’s Chief Executive Officer, to serve as Vice President, M&A/Corporate Development.

6.  REPORTABLE SEGMENTS, GEOGRAPHICAL INFORMATION AND CONCENTRATIONS OF RISK

SFAS No. 131, Disclosures about Segments of a Business Enterprise and Related Information, establishes standards for reporting information regarding reportable and operating segments. Operating segments are defined as components of a company which the chief operating decision maker evaluates regularly in deciding how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chief Executive Officer. Effective with the acquisition of IBT in December 2005, the Company operates in two operating segments, the Identity Solutions segment and the Services segment. The Identity Solutions segment provides solutions that enable governments, law enforcement agencies, and businesses to enhance security, reduce identity theft, and protect personal privacy utilizing secure credential provisioning and authentication systems, biometric technology and the creation, enhancement and/or utilization of identity databases. The Services segment provides fingerprinting services to government, civil, and commercial customers, as well as security consulting services to U.S. Government agencies.

The Company measures segment performance primarily based on revenues and operating income (loss) and Adjusted EBITDA. Operating results by segment for the three and six months ended June 30, 2007 and 2006 were as follows (in thousands):


  Three months ended
June 30, 2007
Six months ended
June 30, 2007
As of
June 30, 2007
  Revenues Operating
Income (Loss)
Revenues Operating
Income (Loss)
Total
Assets
Goodwill
Identity Solutions $ 53,196 $ 2,061 $ 89,499 $ (4,954 )  $ 1,026,173 $ 819,451
Services 36,903 49 70,607 1,051 211,624 154,966
Corporate 24,888
  $ 90,099 $ 2,110 $ 160,106 $ (3,903 )  $ 1,262,685 $ 974,417

  Three months ended
June 30, 2006
Six months ended
June 30, 2006
As of
June 30, 2006
  Revenues Operating
Income (Loss)
Revenues Operating
Income (Loss)
Total
Assets
Goodwill
Identity Solutions $ 19,872 $ (1,054 )  $ 37,723 $ (3,294 )  $ 230,736 $ 117,565
Services 4,996 (289 )  10,583 (324 )  67,683 58,710
  $ 24,868 $ (1,343 )  $ 48,306 $ (3,618 )  $ 298,419 $ 176,275

Corporate assets consist mainly of cash and cash equivalents and deferred financing costs. Effective January 1, 2007, the Company began allocating corporate costs using a three factor formula based on sales, payroll and capital assets. Prior to the merger with Identix, all corporate costs were allocated to the Identity Solutions segment.

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Revenues by market are as follows for the three and six months ended June 30, 2007 and 2006 (in thousands):


  Three months ended Six months ended
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
State and local $ 28,661 $ 11,892 $ 57,218 $ 21,652
Federal 57,883 11,511 98,188 22,514
Commercial 3,555 1,465 4,700 4,140
  $ 90,099 $ 24,868 $ 160,106 $ 48,306

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


  Three months ended Six months ended Total assets as of
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
North America $ 82,542 $ 23,225 $ 144,018 $ 44,491 $ 1,210,785 $ 268,366
Rest of the World 7,557 1,643 16,088 3,815 51,900 30,053
  $ 90,099 $ 24,868 $ 160,106 $ 48,306 $ 1,262,685 $ 298,419

The Company did not have significant international sales to individual countries for the periods presented.

For the three and six month periods ended June 30, 2007, two Federal government agencies accounted for 32% and 30% of consolidated revenues, respectively. For the three and six month period ended June 30, 2006, two Federal government agencies accounted for 35% of consolidated revenues for both periods. As of June 30, 2007, the Company had an accounts receivable balance of approximately $20.9 million from two Federal government agencies which were the only customers that had a balance of greater than 10% of consolidated accounts receivable. As of June 30, 2006, one Federal government agency was the only customer that had a balance of greater than 10% of consolidated accounts receivable, which was approximately $2.9 million.

7.    ACQUISITIONS

On July 27, 2007, the Company acquired Advanced Concepts, Inc., (‘‘ACI’’), pursuant to which the Company acquired of all of the issued and outstanding shares of common stock of ACI from a newly-formed holding company for a purchase price of $71.5 million in cash, subject to adjustment based on ACI’s closing working capital, as defined. In addition, pursuant to the Stock Purchase Agreement, if ACI achieves certain financial targets in 2007 and 2008, the Company will make additional payments of a maximum amount of $6.0 million. The acquisition was funded with borrowings under the revolving credit agreement. The Company acquired ACI for its access to a customer base within the U.S. government and its complementary service offerings, consisting of information and network security solutions and system engineering and development capabilities to the U.S. intelligence and military communities.

On July 13, 2007, the Company acquired McClendon Corporation (‘‘McClendon’’). The Company purchased all of the issued and outstanding shares of common stock of McClendon from a newly-formed holding company for a purchase price of $33.0 million in cash and $33.0 million (approximately 1.6 million shares) of the Company’s common stock. The share price was based on an average for a specified period prior to closing, for a total consideration of $66.0 million, subject to adjustment based on McClendon’s closing working capital, as defined. The cash portion of the acquisition was funded with borrowings under the revolving credit agreement. The shares of common stock were issued in a private placement without registration under the Securities Act of 1933 and the

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Company has agreed to file a shelf registration statement with respect to the resale of such shares. The Company acquired McClendon for the suite of technical and professional services it provides to the intelligence and military communities and a customer base which complements the Company’s portfolio.

On February 21, 2007, the Company acquired ComnetiX, Inc. (‘‘ComnetiX’’) which provides biometric identification and authentication technologies to private and public sector companies in Canada and the United States. The Company acquired ComnetiX because of its presence in the fingerprint services segment of the Canadian market and complementary base of customers, particularly within the law enforcement community. ComnetiX is included in the Services reporting segment. The results of operations of ComnetiX have been included in the condensed consolidated statements of operations from the date of acquisition.

The aggregate purchase price of ComnetiX was approximately $18.9 million, including $0.8 million in transaction costs, all of which was funded by borrowings under the revolving credit facility. Preliminarily, the purchase price has been allocated as follows:


Current assets $ 4,539
Other assets 491
Current liabilities (5,754 ) 
Note payable – long- term (50 ) 
Intangible assets 4,724
Goodwill 14,908
  $ 18,858

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

The following gives pro forma effect to the acquisition of ComnetiX as if it had occurred at the beginning of each period presented (in thousands except per share amounts)


  Six Months Ended Three Months Ended
  June 30,
2007
June 30,
2006
June 30,
2006
Revenues $ 161,632 $ 53,606 $ 27,668
Net loss (11,685 )  (6,888 )  (2,830 ) 
Basic and dilutive loss per share (0.16 )  (0.24 )  (0.10 ) 

The pro-forma data is presented for informational purposes only and may not necessarily be indicative of future results of operations or what the results of operations would have been had the Company acquired ComnetiX on the date indicated.

8.    ADDITIONAL FINANCIAL INFORMATION

Inventory (in thousands):


  June 30,
2007
December 31,
2006
Purchased parts and materials $ 11,479 $ 8,482
Work in progress 182 209
Finished goods 3,124 2,276
Total Inventory $ 14,785 $ 10,967

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Approximately $3.2 million of inventory was maintained at customer sites at both June 30, 2007 and December 31, 2006.

Property and equipment (in thousands):


  June 30,
2007
December 31,
2006
System assets $ 50,345 $ 48,437
Computer and office equipment 4,244 4,377
Software 2,443 1,994
Machinery and equipment 1,340 678
Leasehold improvements 882 423
Other- including tooling and demo equipment 4,717 2,595
  63,971 58,504
Less accumulated depreciation and amortization 42,986 38,576
Property and equipment, net $ 20,985 $ 19,928

For the three months ended June 30, 2007 and 2006, depreciation and amortization expense of property and equipment was $2.4 million and $2.3 million, respectively. For the six months ended June 30, 2007 and 2006, depreciation and amortization expense of property and equipment was $4.5 million and $4.3 million, respectively.

Goodwill (in thousands):

The following summarizes the activity in goodwill for the six months ended June 30, 2007 (in thousands):


  Identity
Solutions
Services Total
Balance beginning of period $ 813,435 $ 138,008 $ 951,443
ComnetiX acquisition 14,908 14,908
Additional purchase price consideration for SpecTal 1,429 1,429
Iridian acquisition purchase price allocation adjustment 6,000 6,000
Other adjustments 16 621 637
  $ 819,451 $ 154,966 $ 974,417

Intangible Assets (in thousands):


  June 30, 2007 December 31, 2006
  Cost Accumulated 
Amortization
Cost Accumulated 
Amortization
Completed technology $ 124,352 $ (17,297 )  $ 124,452 $ (7,462 ) 
Core technology 5,850 (1,448 )  5,500 (785 ) 
Trade names and trademarks 27,774 (1,418 )  25,600 (557 ) 
Customer contracts and relationships 34,196 (12,325 )  31,692 (9,785 ) 
Other 3,064 (1,046 )  2,103 (660 ) 
  $ 195,236 $ (33,534 )  $ 189,347 $ (19,249 ) 

Amortization of intangible assets was $7.0 million and $13.9 million for the three months and six months ended June 30, 2007, respectively. For the three and six month periods ended June 30, 2006, amortization of intangible assets was $2.1 million and $4.2 million, respectively. Amortization for the current and subsequent five years and thereafter is as follows: $29.0 million, $29.5 million, $25.2 million, $23.6 million, $22.3 million and $32.1 million.

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Products and Services Revenues:

The following represents details of the products and services for revenues for the three months and six months ended June 30, 2007 and 2006 (in thousands):


<
  Three months ended Six months ended
  June 30,
2007
June 30,
2006
June 30,
2007
June 30,
2006
Government consulting services $ 18,890 $ 1,377 $ 36,916 $ 2,839
Fingerprinting services 15,023 4,996 29,107 10,583
Drivers’ licenses 7,589 7,421 15,588 14,449
Software, hardware, and consumables 41,072 9,123 62,145 16,823
Maintenance and other services 7,525 1,951 16,350 3,612
Total revenues $ 90,099 $ 24,868 $ 160,106 $ 48,306
         
Comprehensive Loss:        
Net (Loss) $ (1,197