##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q
 (Mark one)  For the quarterly period ended March 31, 2004 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: 1-9641 IDENTIX INCORPORATED 
  Delaware
    
    94-2842496(State or other jurisdiction of
    
    (IRS Employer Identification No.)incorporation of organization)5600 Rowland Road, Minnetonka, Minnesota
    
    55343(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (952) 932-0888 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 requirement for the past 90 days. YES [X] NO [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X] NO [   ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date: 88,208,078 shares of Common Stock
as of April 30, 2004 1




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IDENTIX INCORPORATED INDEX PART I
    
    FINANCIAL INFORMATIONItem 1
    
    Unaudited Financial StatementsCondensed Consolidated Balance Sheets  March 31, 2004 and June 30, 2003
    
    
    3Condensed Consolidated Statements of Operations - Three and nine months ended March 31, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows  Nine months ended March 31, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4
    
    Controls and Procedures
    
    
    27PART II
    
    OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    27Item 2
    
    Changes in Securities, Use of Proceeds and Purchase of Equity Securities
    
    
    27Item 6
    
    Exhibits and Reports on Form 8-K
    
    
    28Signature
    
    
    
    
    29IPS Stock Purchase AgreementLLC Membership Interest Transfer AgreementCEO CertificationCFO Certification906 Certifications
  2




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IDENTIX INCORPORATED 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 March 31,
    
    June 30,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    35,926,000
    
    
    $
    34,712,000Marketable
securities - short-term
    
    
    9,457,000
    
    
    
    8,991,000Accounts receivable, net
    
    
    11,489,000
    
    
    
    21,434,000Inventories
    
    
    8,208,000
    
    
    
    9,920,000Prepaid expenses and other assets
    
    
    935,000
    
    
    
    1,677,000Total current assets
    
    
    66,015,000
    
    
    
    76,734,000Marketable
securities - long-term
    
    
    
    
    
    
    505,000Property and equipment, net
    
    
    2,687,000
    
    
    
    4,157,000Goodwill
    
    
    141,256,000
    
    
    
    140,945,000Acquired intangible assets, net
    
    
    19,863,000
    
    
    
    19,854,000Other assets
    
    
    1,904,000
    
    
    
    3,075,000Total assets
    
    $
    231,725,000
    
    
    $
    245,270,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,721,000
    
    
    $
    8,025,000Accrued compensation
    
    
    3,995,000
    
    
    
    3,593,000Other accrued liabilities
    
    
    4,337,000
    
    
    
    4,522,000Deferred revenue
    
    
    8,339,000
    
    
    
    7,197,000Total current liabilities
    
    
    21,392,000
    
    
    
    23,337,000Deferred revenue
    
    
    45,000
    
    
    
    419,000Other liabilities
    
    
    6,620,000
    
    
    
    10,250,000Total liabilities
    
    
    28,057,000
    
    
    
    34,006,000Stockholders equity:Convertible preferred stock, $0.01 par value;
2,000,000 shares authorized; 0 and 234,558 shares issued and
outstanding, respectively
    
    
    
    
    
    
    3,702,000Common stock, $0.01 par value; 200,000,000 shares authorized
87,473,130 and 85,944,951 shares issued and outstanding,
respectively
    
    
    875,000
    
    
    
    859,000Additional paid-in capital
    
    
    545,437,000
    
    
    
    536,173,000Accumulated deficit
    
    
    (342,399,000
    )
    
    
    (328,651,000
    )Deferred stock-based compensation
    
    
    (100,000
    )
    
    
    (663,000
    )Accumulated other comprehensive loss
    
    
    (145,000
    )
    
    
    (156,000
    )Total stockholders equity
    
    
    203,668,000
    
    
    
    211,264,000Total liabilities and stockholders equity
    
    $
    231,725,000
    
    
    $
    245,270,000
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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IDENTIX INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    14,491,000
    
    
    $
    12,239,000
    
    
    $
    39,014,000
    
    
    $
    39,005,000Cost and expenses:Cost of revenues
    
    
    11,514,000
    
    
    
    7,354,000
    
    
    
    26,912,000
    
    
    
    26,272,000Research, development and engineering
    
    
    2,184,000
    
    
    
    2,613,000
    
    
    
    7,207,000
    
    
    
    8,407,000Marketing and selling
    
    
    2,746,000
    
    
    
    3,032,000
    
    
    
    8,238,000
    
    
    
    9,570,000General and administrative
    
    
    3,166,000
    
    
    
    3,761,000
    
    
    
    9,880,000
    
    
    
    10,542,000Amortization of acquired intangible assets
    
    
    1,419,000
    
    
    
    1,346,000
    
    
    
    4,176,000
    
    
    
    4,006,000Special Charges
    
    
    2,115,000
    
    
    
    977,000
    
    
    
    2,115,000
    
    
    
    5,698,000Total costs and expenses
    
    
    23,144,000
    
    
    
    19,083,000
    
    
    
    58,528,000
    
    
    
    64,495,000Loss from operations
    
    
    (8,653,000
    )
    
    
    (6,844,000
    )
    
    
    (19,514,000
    )
    
    
    (25,490,000
    )Interest and other income, net
    
    
    304,000
    
    
    
    378,000
    
    
    
    978,000
    
    
    
    1,404,000Interest expense
    
    
    (4,000
    )
    
    
    (7,000
    )
    
    
    (7,000
    )
    
    
    (10,000
    )Equity interest in loss of joint venture
    
    
    (55,000
    )
    
    
    (148,000
    )
    
    
    (302,000
    )
    
    
    (196,000
    )Loss from continuing operations before income taxes
    
    
    (8,408,000
    )
    
    
    (6,621,000
    )
    
    
    (18,845,000
    )
    
    
    (24,292,000
    )Provision for income taxes
    
    
    (9,000
    )
    
    
    (146,000
    )
    
    
    (28,000
    )
    
    
    (159,000
    )Loss from continuing operations
    
    
    (8,417,000
    )
    
    
    (6,767,000
    )
    
    
    (18,873,000
    )
    
    
    (24,451,000
    )Discontinued operations:Income (loss) from discontinued operations
    
    
    (1,050,000
    )
    
    
    257,000
    
    
    
    (809,000
    )
    
    
    (3,810,000
    )Gain on sale of IPS
    
    
    5,934,000
    
    
    
    
    
    
    
    5,934,000
    
    
    
    Income (loss) from discontinued operations
    
    
    4,884,000
    
    
    
    257,000
    
    
    
    5,125,000
    
    
    
    (3,810,000
    )Net loss
    
    $
    (3,533,000
    )
    
    $
    (6,510,000
    )
    
    $
    (13,748,000
    )
    
    $
    (28,261,000
    )Basic and diluted net loss per share from continuing
operations
    
    $
    (0.10
    )
    
    $
    (0.08
    )
    
    $
    (0.22
    )
    
    $
    (0.29
    )Basic and diluted net income (loss) per share from discontinued
operations
    
    $
    0.06
    
    
    $
    0.00
    
    
    $
    0.06
    
    
    $
    (0.04
    )Basic and diluted net loss per share
    
    $
    (0.04
    )
    
    $
    (0.08
    )
    
    $
    (0.16
    )
    
    $
    (0.33
    )Weighted average common shares used in basic
and diluted loss per share computation
    
    
    86,645,000
    
    
    
    85,393,000
    
    
    
    86,267,000
    
    
    
    85,103,000
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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IDENTIX INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Nine Months Ended March 31,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (13,748,000
    )
    
    $
    (28,261,000
    )Adjustments to reconcile net loss to net cash used in operating
activities:Gain on sale of discontinued operations
    
    
    (5,934,000
    )
    
    
    Depreciation and amortization
    
    
    6,065,000
    
    
    
    6,244,000Equity interest in loss of joint venture
    
    
    302,000
    
    
    
    196,000Realized gain on sales of marketable securities
    
    
    (24,000
    )
    
    
    (208,000
    )Stock-based compensation expense
    
    
    558,000
    
    
    
    1,391,000Amortization of premiums on marketable securities
    
    
    
    
    
    
    92,000Bad debt (recoveries) expense
    
    
    (625,000
    )
    
    
    921,000Inventory obsolescence provision
    
    
    3,315,000
    
    
    
    2,158,000Non-cash special charges
    
    
    1,610,000
    
    
    
    789,000Changes in assets and liabilities excluding impact of sale of IPS
and acquisitions:Accounts receivable
    
    
    4,754,000
    
    
    
    (607,000
    )Inventories
    
    
    (2,155,000
    )
    
    
    (1,123,000
    )Prepaid expenses and other assets
    
    
    1,038,000
    
    
    
    117,000Accounts payable
    
    
    (2,834,000
    )
    
    
    (3,302,000
    )Accrued compensation
    
    
    669,000
    
    
    
    (1,361,000
    )Other accrued liabilities
    
    
    (2,854,000
    )
    
    
    1,797,000Deferred revenue
    
    
    1,394,000
    
    
    
    (488,000
    )Net cash used in operating activities
    
    
    (8,469,000
    )
    
    
    (21,645,000
    )Cash flows from investing activities:Proceeds from sale of IPS, net of transaction costs
    
    
    7,808,000
    
    
    
    Cash paid in acquisition, net of cash acquired
    
    
    1,264,000
    
    
    
    Net proceeds from the sales of marketable securities
    
    
    15,007,000
    
    
    
    22,127,000Purchases of marketable securities
    
    
    (14,943,000
    )
    
    
    (21,168,000
    )Additions of intangibles and other assets
    
    
    
    
    
    
    (931,000
    )Capital expenditures
    
    
    (863,000
    )
    
    
    (500,000
    )Net cash provided by (used in) investing activities
    
    
    8,273,000
    
    
    
    (472,000
    )Cash flows from financing activities:Proceeds from sales of common stock
    
    
    1,410,000
    
    
    
    1,705,000Net cash provided by financing activities
    
    
    1,410,000
    
    
    
    1,705,000Net increase (decrease) in cash and cash equivalents
    
    
    1,214,000
    
    
    
    (20,412,000
    )Cash and cash equivalents at period beginning
    
    
    34,712,000
    
    
    
    53,346,000Cash and cash equivalents at period end
    
    $
    35,926,000
    
    
    $
    32,934,000Non Cash Activities:Stock issued
for acquisition of technology
    
    $
    3,423,000
    
    
    $
    Conversion of preferred stock to common stock
    
    $
    3,702,000
    
    
    $
    
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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IDENTIX INCORPORATED 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1.
    
    Basis of Presentation
  These accompanying condensed consolidated financial statements and related
notes are unaudited. However, in the opinion of management, all adjustments
(consisting only of normal recurring adjustments, unless otherwise noted),
which are necessary for a fair presentation of the financial position and
results of operations for the interim periods presented, have been included.
These condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes
thereto for the fiscal year ended June 30, 2003 included in the Identix
Incorporated Form 10-K. Identix Incorporated is hereinafter referred to as
Identix or the Company. The results of operations for the three and nine
months ended March 31, 2004 are not necessarily indicative of results to be
expected for the entire fiscal year, which ends on June 30, 2004.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
therein. Estimates are used for, but not limited to, the accounting for the
allowance for doubtful accounts and sales returns, goodwill and other
intangible asset impairments, inventory allowances, warranty costs, revenue
recognition as well as loss contingencies and restructurings. Actual results
could differ from these estimates.On February 13, 2004, the Company closed on its sale of its wholly owned
subsidiary Identix Public Sector (IPS). The results of operations for this
subsidiary are included in the discontinued operations section of the
statements of operations for all periods presented. The balance sheet as of
March 31, 2004, excludes all assets and liabilities, which were sold as part
of this transaction. Unless otherwise noted, disclosures of revenues and
expenses in the Notes to Condensed Consolidated Financial Statements refer to
continuing operations only. 2.
    
    Revenue Recognition Policy
  The Company recognizes revenues in accordance with the provisions of the
Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104,
Revenue Recognition, which superceded SAB No. 101, and of the American
Institute of Certified Public Accountants Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9, as well
as Technical Practice Aids issued from time to time by the American Institute
of Certified Public Accountants.The Company adopted Emerging Issues Task Force Issue No. 00-21 Accounting
for Revenue Arrangements with Multiple Deliverables,(EITF 00-21) effective
April 1, 2003. There was no cumulative effect of a change in accounting
policy upon the adoption of EITF 00-21. Under EITF 00-21, a company must
determine whether any or all of the deliverables of a multiple deliverable
agreement can be separated from one another. If separation is possible,
revenue is recognized for each deliverable (based on objective and reliable
evidence of the fair value) as the applicable revenue recognition criteria
are achieved for that specific deliverable. Alternatively, if separation is
not possible, revenue recognition may need to be spread evenly over the
performance of all deliverables, or deferred until all elements of the
arrangement have been delivered to the customer.The Companys biometric system revenue is derived from the sale of equipment
and software, as well as maintenance contracts related to the Companys
product lines. Certain of the Companys equipment sales such as its Live
Scan Systems generally require installation and training subsequent to
shipment and transfer of title. Revenue related to equipment sales that
require installation is deferred until installation is complete and customer
acceptance has been obtained. Revenue related to sales that require no
installation such as printers and other peripheral devices as well as certain
security products including DFR-2080, DFR-300, DFR-200 and FingerScan V20 are
recognized in accordance with the terms of the sale, generally upon shipment
by the Company, provided no significant obligations remain and collection of
the receivable is deemed reasonably assured. Revenues from sales of products
via authorized representatives, dealers, distributors or other third party
sales channels are recognized at the time the risks and rewards have
transferred. The Company was audited by the Defense Contract Audit Agency
for the period from July 1, 1997 to June 30, 2000 and the results of the
audit did not have a material effect on the Companys financial position or
results of operations for these periods. The Company is currently undergoing
a General Services Administration pre-award audit for the renewal of a GSA
Multiple Award Schedule contract. While the Company believes that the results of such audit
will have no material effect on the results of operation, any material
adverse findings or adjustments arising out of such audit may have a material
adverse effect on our business, financial condition and results of
operations. 6




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The Company also sells several stand-alone software products including
BioLogon®, BioEngine® and Faceit® software developer kits. The Company
recognizes revenue on software products when persuasive evidence of an
arrangement exists, delivery has occurred, the vendors fee is fixed or
determinable and vendor-specific objective evidence (VSOE) of fair value
exists to allocate the total fee to all undelivered elements of the
arrangement and collection is determined to be probable. VSOE is established
based upon either sales of the element (e.g. maintenance, training or
consulting) in individual transactions, or, in certain cases for maintenance,
based upon substantive renewal rates. In cases where the Company does not
have VSOE for all delivered elements in the transaction (e.g., for licenses),
the fees from these multiple-element agreements are allocated using the
residual value method. Maintenance revenue is deferred and recognized
rateably over the life of the service period of the related agreement.Revenues related to IIS which was acquired in February 2004 (see Note 5) are
recognized as services are performed. 3.
    
    Stock Based Compensation
  The Company accounts for its employee and director stock option plans and
employee stock purchase plans in accordance with provisions of the Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees. The Company accounts for stock options issued to non-employees
in accordance with the provisions of SFAS 123 and Emerging Issues Task Force
(EITF) 96-18 Accounting for Equity Instruments that are Issued to Other
Than Employees for Acquiring or in Conjunction with Selling Goods or
Services. As permitted by SFAS No. 123, Accounting for Stock Based
Compensation, the Company continues to measure employee compensation cost
for its stock option plans using the intrinsic value method of accounting.Had compensation cost for the Companys employee stock plans been recognized
based upon the estimated fair value on the grant date under the fair value
methodology prescribed by SFAS No. 123, as amended by SFAS No. 148, the
Companys net loss and net loss per share would have been as follows: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Net loss as reported
    
    $
    (3,533,000
    )
    
    $
    (6,510,000
    )
    
    $
    (13,748,000
    )
    
    $
    (28,261,000
    )Add: Stock based compensation
expense included in reported
net loss, net of related tax
effects
    
    
    145,000
    
    
    
    459,000
    
    
    
    558,000
    
    
    
    1,391,000Deduct: Total stock based compensation
expense determined under fair value
based method for all awards, net
of cancellations and related tax effects
    
    
    574,000
    
    
    
    (2,022,000
    )
    
    
    (2,732,000
    )
    
    
    (6,343,000
    )Proforma net loss
    
    $
    (2,814,000
    )
    
    $
    (8,073,000
    )
    
    $
    (15,922,000
    )
    
    $
    (33,213,000
    )Net loss per share:As reported
    
    $
    (0.04
    )
    
    $
    (0.08
    )
    
    $
    (0.16
    )
    
    $
    (0.33
    )Proforma
    
    $
    (0.03
    )
    
    $
    (0.09
    )
    
    $
    (0.18
    )
    
    $
    (0.39
    )
 4.
    
    Discontinued Operations
  On February 13, 2004, the Company consummated the sale of Identix Public
Sector (IPS) to Alion Science and Technology Corporation (Alion). In the
third quarter of 2004, the Company recognized income from discontinued
operations of $4,884,000 of which $5,934,000 is attributable to the gain on
the sale of IPS and $1,050,000 is attributable to a loss on discontinued
operations. These operations are presented in the Companys Consolidated
Statements of Operations as discontinued operations. Under the terms of the
agreement, upon closing Alion paid the Company
$8,850,000 million in cash. This amount is shown as proceeds from sale of
IPS, net of transaction costs, in the Consolidated Statement of Cash Flows
for the nine months ended March 31, 2004. In addition, the Company is
entitled to payments totaling approximately $1,700,000 during the next
several months. The terms of the sale 7




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include the
potential for additional future payments to the Company of up to $500,000
pending satisfaction of certain conditions. The terms of the sale also
include an obligation on the part of the Company to indemnify Alion against
liabilities, including for breaches of representations and warranties made by
the Company in the sales agreement, for an amount not to exceed $2,125,000.The following table represents the summarized results for the discontinued
operations: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004*
    
    2003
    
    2004*
    
    2003Revenue
    
    $
    3,302,000
    
    
    $
    9,566,000
    
    
    $
    20,078,000
    
    
    $
    30,378,000Cost of sales
    
    
    2,564,000
    
    
    
    8,635,000
    
    
    
    17,550,000
    
    
    
    26,794,000Operating Expenses
    
    
    1,788,000
    
    
    
    674,000
    
    
    
    3,337,000
    
    
    
    7,394,000Net Income
    
    $
    (1,050,000
    )
    
    $
    257,000
    
    
    $
    (809,000
    )
    
    $
    (3,810,000
    )
  *
    
    These periods represent activity through February 13, 2004 as the
disposition of IPS was consummated on that day. 5.
    
    Acquisitions
  On February 23, 2004, the Company acquired the remaining 50% ownership of
Sylvan Identix Fingerprint Centers, LLC (SIFC) from Sylvan Learning Centers,
Inc. (Sylvan). SIFC is now known as Identix Identification services (IIS).
The Company had previously held a 50% interest in this joint venture and
accounted for its investment under the equity method of accounting. The
complete results of operations of IIS have been included in the Companys
consolidated statement of operations since February 23, 2004. IIS provides
services to corporations and government agencies whereby IIS captures
fingerprints and transmits the data for applicant background checks. IIS
maintains a network of Identix livescan systems at processing centers across
the country where certified technicians process applicants. In consideration
for Sylvans 50% interest in the joint venture, Identix paid Sylvan $875,000
in cash. The purchase price was allocated primarily to net current assets
and other intangible assets, with the remainder allocated to goodwill. The
proforma impact of the IIS acquisition was not significant to the results of
the Company for the nine months ended March 31, 2004.On March 10, 2004, the Company acquired certain technology from Delean Vision
Worldwide Inc. (Delean). This transaction was accounted for as a purchase of
assets. The technology acquired was biometric recognition algorithms known
as skin texture analysis (STA) that allows a unique characteristic of the
skin structure known as a skinprint to be used to identify individuals. In
exchange for the technology and intellectual property rights, the Company
issued to Delean 675,000 shares of Identix common stock with a value of
$3,423,000. The purchase price was allocated to intangible assets. The
Company also issued Delean a warrant with contingent future vesting rights to
purchase up to 800,000 shares of Identix common stock at $4.70 per share.
The warrant expires in March 2014 and vests based upon the successful
issuance of certain patents with the US government related to the technology
acquired from Delean. The fair value of any warrants which vest will be
recorded at the time of vesting. 6.
    
    Cash and Credit Facilities
  The Company financed its operations during the nine months ended March 31,
2004 primarily from cash provided by its working capital. As of March 31,
2004, the Companys principal sources of liquidity consisted of
$44,623,000
of working capital including $45,383,000 in cash and cash equivalents and
short-term marketable securities.The Companys existing line of credit (the Identix Line of Credit) was
entered into on May 30, 2003. This line of credit provides for up to the
lesser of $15,000,000 or the cash collateral base or the borrowing base.
Borrowings under the Identix Line of Credit are collateralized by
substantially all of the assets of the Company and bear interest at the
banks prime rate of interest, which was 4.00% at March 31, 2004. The
Identix Line of Credit expires on October 30, 2004. Until the Company
establishes a net income before income taxes for two consecutive fiscal
quarters, the Company will be required to deposit with the lender an amount
equal to the sum of the aggregate outstanding principal amount of all prior
advances plus any portion of the line of credit reserved to support unexpired
letters of credit plus the amount of the requested advance before an advance
will be given. In addition, all advances must be used for working capital.
At March 31, 2004, there were no amounts outstanding under this line of credit.The Identix Line of Credit agreement contains financial, operating and
reporting covenants. At March 31, 2004, the Company was in compliance with
all covenants. 8




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7.
    
    Inventories
  Inventories are stated at the lower of standard cost (which approximates
actual cost determined on a first-in, first-out method) or market and
consisted of the following: March 31,
    
    June 30,2004
    
    2003Purchased parts and materials
    
    $
    2,152,000
    
    
    $
    3,351,000Work-in-process
    
    
    4,912,000
    
    
    
    4,893,000Finished goods, including spares
    
    
    1,144,000
    
    
    
    1,676,000$
    8,208,000
    
    
    $
    9,920,000
  During the nine months ended March 31, 2004 and 2003, the Company recorded
provisions for excess and obsolete inventory items in the amount of
$3,315,000 and $2,158,000, respectively. 8.
    
    Special Charges
  Special charges (such as restructuring and acquisition related charges)
result from unique facts and circumstances that likely will not recur with
similar materiality or impact on continuing operations. Special charges
consisted of the following for the periods presented: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Reduction in force costs
    
    $
    250,000
    
    
    $
    
    
    
    $
    250,000
    
    
    $
    Employment agreement obligations
    
    
    506,000
    
    
    
    
    
    
    
    506,000
    
    
    
    SIFC acquisition related
    
    
    749,000
    
    
    
    
    
    
    
    749,000
    
    
    
    Visionics merger related
    
    
    610,000
    
    
    
    977,000
    
    
    
    610,000
    
    
    
    5,698,000$
    2,115,000
    
    
    $
    977,000
    
    
    $
    2,115,000
    
    
    $
    5,698,000
  In June 2002, the Company merged with Visionics and in connection with the
merger recorded special charges of $18,798,000 related to the merger for the
termination of 110 employees, and the closure of its facilities in Dublin and
Los Gatos California. During the year ended June 30, 2003, the Company
recorded additional restructuring and other merger related charges of
$10,206,000, including a loss of $186,000 on the sublease portion of its
Dublin facility. In conjunction with the restructuring related charges
recorded, the Company made certain estimates regarding future sublease income
that have a significant impact on its anticipated cash obligations and
restructuring reserves. Although the Company believes that the lease
commitment estimates are appropriate in the circumstances, future changes in
real estate markets could impact the ultimate amount of cash paid to resolve
these obligations. The following is a summary of the charges incurred and
payments made from the time of the merger through June 30, 2003: Activity during the period June 25, 2002 to June 30, 2003Cash Paymentsthrough June 30,
    
    Liability as ofTotal Charges
    
    Non-Cash Charges
    
    2003
    
    June 30, 2003Severance and benefits
    
    $
    8,376,000
    
    
    $
    900,000
    
    
    $
    6,862,000
    
    
    $
    614,000Disposal of fixed assets
    
    
    1,664,000
    
    
    
    1,664,000
    
    
    
    
    
    
    
    Lease exit costs
    
    
    15,280,000
    
    
    
    388,000
    
    
    
    2,741,000
    
    
    
    12,151,000Internal merger costs & other
    
    
    3,684,000
    
    
    
    
    
    
    
    3,653,000
    
    
    
    31,000Total
    
    $
    29,004,000
    
    
    $
    2,952,000
    
    
    $
    13,256,000
    
    
    $
    12,796,000
  Fiscal 2004During the three months ended March 31, 2004, the Company incurred
approximately $2,115,000 in special charges. These charges consisted of
$749,000 for the value of shares of Company common stock issued to certain
former Sylvan 9




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Identix Fingerprint Center (SIFC) employees in connection with
the acquisition of 100% of SIFC, $506,000 related to payments made under the
former Chairman of the Boards employment agreement related to his retirement
in February 2004, $610,000 related to an increase in the reserve on the
sublease of the Companys Northern California facilities and $250,000 related
to a reduction in force in February 2004. The additional sublease reserve
and the reduction in force expenses are reflected in the restructuring
schedule below.The following table represents a summary of restructuring and other merger
related charges between June 30, 2003 and March 31, 2004: For the Nine months ended March 31, 2004LiabilitiesSatisfied in
    
    
    
    
    
    RestructuringRestructuring Liability
    
    
    
    
    
    Connection with IPS
    
    
    
    
    
    Liability as ofas of June 30, 2003
    
    Additions
    
    Disposition
    
    Cash Payments
    
    March 31, 2004Severance and benefits
    
    $
    614,000
    
    
    $
    250,000
    
    
    $
    
    
    
    $
    498,000
    
    
    $
    366,000Lease exit costs
    
    
    12,151,000
    
    
    
    610,000
    
    
    
    2,267,000
    
    
    
    2,261,000
    
    
    
    8,233,000Internal merger costs and other
    
    
    31,000
    
    
    
    
    
    
    
    
    
    
    
    31,000
    
    
    

    Total
    
    $
    12,796,000
    
    
    $
    860,000
    
    
    $
    2,267,000
    
    
    $
    2,790,000
    
    
    $
    8,599,000
  The additional severance and benefits expense of $250,000 recorded in the
quarter ending March 31, 2004 is the result of a reduction in force where the
Company eliminated 6% of the Companys workforce. The increase of lease exit
costs by $610,000 reflects an updated assessment by management of what the
Company will recover under the current conditions of the Northern California
real estate market. The restructuring liability is classified in the
consolidated balance sheet based on the anticipated timing of the respective
payment. As of March 31, 2004, $6,198,000 of the above restructuring
liability is classified as long-term. Management currently believes that of
the $366,000 accrued for severance and benefits, $255,000 will be paid over
the next twelve months with the remaining balance being paid through 2013
with the lease exit costs being paid over the remaining term of the leases.
The leases expire at various dates through 2011.Fiscal 2003During the three and nine months ended March 31, 2003, the Company recorded
special charges related to the merger totaling $1,272,000 and $9,577,000,

respectively. For the three months ended March 31, 2003 these costs
consisted of $489,000 in relocation costs for Identix employees and
facilities, $176,000 associated with the disposal of fixed assets, $476,000
increase in the reserve related to lease exit costs and $131,000 related to
employees with extended terminations to assist in the integration. Such
costs were expensed as incurred. For the nine months ended March 31, 2003,
these costs consisted of $2,530,000 in relocation costs, $370,000 associated
with the disposal of fixed assets, $4,541,000 related to lease exit costs and
$2,136,000 related to employees with extended terminations to assist in the
integration. Such costs were expensed as incurred. For the three months
ended March 31, 2003, $295,000 and $3,879,000 of special charges related to
the merger are included in income (loss) from discontinued operations in the
Companys Consolidated Statement of Operations.In conjunction with the restructuring related charges recorded, the Company
made certain estimates regarding future sublease income that have a
significant impact on its anticipated cash obligations and restructuring
reserves. Although the Company believes that the lease commitment estimates
are appropriate in the circumstances, future changes in real estate markets
could impact the ultimate amount of cash paid to resolve these obligations. 9.
    
    Earnings Per Share
  Basic earnings per share are computed by dividing net income (loss) by the
weighted average number of common shares outstanding during the period.
Diluted earnings per share gives effect to all dilutive potential
common shares outstanding during the period, including convertible preferred stock
as well as stock options and warrants, using the treasury stock method.Options and warrants to purchase 8,578,000 and 9,475,000 shares of common
stock were outstanding at March 31, 2004 and 2003, respectively, but were not
included in the computation of diluted net loss per share as their effect was
anti-dilutive. Also 234,558 shares of convertible preferred stock were
outstanding at March 31, 2003. Such shares of preferred stock are
convertible into 234,558 shares of the Companys common stock, but were not
included in the computation of
diluted net loss per share as their effect was anti-dilutive. The
convertible preferred stock was converted to common stock 10




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during the three
months ended March 31, 2004. 10.
    
    Comprehensive Loss
  Comprehensive loss for the three and nine months ended March 31, 2004, was
$3,531,000 and $13,737,000 compared to a loss of $6,498,000 and $28,261,000
for the same periods in the prior fiscal year. Accumulated other
comprehensive loss for the Company consisted of unrealized gain (loss) on
available-for-sale marketable securities and cumulative translation
adjustments. 11.
    
    Reportable Segment Data
  The Companys reportable segments are strategic business groups that offer
different products and services and include inter-segment revenues, corporate
allocations and administrative expenses. Due to the disposition of IPS and
the acquisition of 100% ownership of Identix Identification Services
(formerly SIFC), the business segments of Identix have correspondingly been
changed from previously reported periods to reflect this activity. Revenues
are attributed to the reportable segment that is responsible for generating
the revenue and the direct and indirect costs incurred are similarly
assigned. Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Total revenues:Biometric systems
    
    $
    12,922,000
    
    
    $
    10,708,000
    
    
    $
    36,197,000
    
    
    $
    35,921,000Other
    
    
    1,569,000
    
    
    
    1,531,000
    
    
    
    2,817,000
    
    
    
    3,084,000$
    14,491,000
    
    
    $
    12,239,000
    
    
    $
    39,014,000
    
    
    $
    39,005,000Income (Loss) from operations:Biometric systems
    
    $
    (8,752,000
    )
    
    $
    (6,939,000
    )
    
    $
    (19,369,000
    )
    
    $
    (25,708,000
    )Other
    
    
    99,000
    
    
    
    95,000
    
    
    
    (145,000
    )
    
    
    218,000$
    (8,653,000
    )
    
    $
    (6,844,000
    )
    
    $
    (19,514,000
    )
    
    $
    (25,490,000
    )March 31,
    
    June 30,2004
    
    2003Identifiable assets:Biometric systems
    
    $
    226,315,000
    
    
    $
    235,719,000*Other
    
    
    5,410,000
    
    
    
    9,551,000$
    231,725,000
    
    
    $
    245,270,000
 * Includes identifiable assets of
discontinued operations for the period ended June 30, 2003.12.
    
    Foreign Operations Data
  In geographical reporting, revenues are attributed to the geographical
location of the sales and service organizations: For the Three Months Ended March 31,
    
    For the Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Total revenues:North America
    
    $
    11,674,000
    
    
    $
    11,338,000
    
    
    $
    34,109,000
    
    
    $
    36,075,000International
    
    
    2,817,000
    
    
    
    901,000
    
    
    
    4,905,000
    
    
    
    2,930,000$
    14,491,000
    
    
    $
    12,239,000
    
    
    $
    39,014,000
    
    
    $
    39,005,000
 March 31,
    
    June 30,2004
    
    2003Identifiable assets:North America
    
    $
    230,870,000
    
    
    $
    244,115,000International
    
    
    855,000
    
    
    
    1,155,000$
    231,725,000
    
    
    $
    245,270,000
 11




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13.
    
    Indemnification Arrangements and Product Warranties
  As part of the Visionics acquisition in June 2002, the Company undertook, and
assumed from Visionics, obligations to indemnify the officers and directors
of the acquired company for certain events or occurrences while the officer
or director served in such capacity. The maximum potential amount of future
payments the Company could be required to make under this indemnification
obligation is unlimited; however, the Company purchased a directors and
officers insurance policy to cover former directors and officers of
Visionics that provides coverage until June 25, 2007 and may enable Identix
to recover a portion of any future amounts paid. Assuming the applicability
of the coverage and the willingness of the insurer to assume coverage and
subject to certain retention, loss limits and other policy provisions and
except as provided below, the Company believes the estimated fair value of
the indemnification obligations to Visionics directors and officers is not
material. However, no assurances can be given that the covering insurers will
not attempt to dispute the validity, applicability or amount of coverage
without expensive and time-consuming litigation against the insurers. As of
October 30, 2003, the Company also entered into indemnification agreements
with its then current directors and executive officers. The maximum
potential amount of future payments the Company could be required to make
under these indemnification obligations is unlimited; however, the Company
purchased certain directors and officers insurance policies, effective
August 19, 2003 and September 21, 2003, respectively, to cover its directors
and officers, and such policies may enable Identix to recover a portion of
any covered claims under the agreements. Assuming the applicability of the
coverage and the willingness of the insurer to assume coverage and subject to
certain retention, loss limits and other policy provisions, the Company
believes the estimated fair value of the indemnification obligations to its
directors and officers is not material. However, no assurances can be given
that the covering insurers will not attempt to dispute the validity,
applicability or amount of coverage without expensive and time-consuming
litigation against the insurers.The terms of the sale of IPS, include an obligation on the part of the
Company to indemnify Alion against liabilities, including for breaches of
representations and warranties made by the Company in the sales agreement,
for an amount not to exceed $2,125,000.From time to time, the Company agrees to indemnify its customers against
liability if the Companys products infringe a third partys intellectual
property rights. As of March 31, 2004, the Company was not subject to any
pending litigation alleging that the Companys products infringe the
intellectual property rights of any third parties.The Company offers a warranty on various products and services. The Company
estimates the costs that may be incurred under its warranties and records a
liability in the amount of such costs at the time the product is sold.
Factors that affect the Companys warranty liability include the number of
units sold, historical and anticipated rates of warranty claims and cost per
claim. The Company periodically assesses the adequacy of its recorded
warranty liabilities and adjusts the amounts as necessary. The amount of the
reserve recorded is equal to the costs to repair or otherwise satisfy the
claim. The following table presents changes in the Companys warranty
liability during the first nine months of fiscal 2004: Balance at July 1, 2003
    
    $
    374,000Warranty Expense
    
    
    1,044,000Closed Warranty Claims
    
    
    (738,000
    )Balance at March 31, 2004
    
    $
    680,000
 14.
    
    Legal Matters
  Discussion of legal matters is cross-referenced to this
Form 10-Q, Part II, Item 1, Legal Proceedings, and should be
considered an integral part of the Consolidated Financial Statements
and Notes. 12




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 
  Item 2.The statements in this report on Form 10-Q that relate to future plans, events,
or performance are forward-looking statements. Actual results, events and
performance may differ materially due to a variety of factors including the
factors described under Risk Factors below. The Company undertakes no
obligation to publicly update these forward-looking statements to reflect
events or circumstances that occur after the date hereof or to reflect the
occurrence of unanticipated events.OVERVIEWIdentix Incorporated (Identix or the Company) provides a broad range of
fingerprint and facial recognition technology offerings that empower the
identification of individuals who wish to gain access to information or
facilities, conduct transactions and obtain identifications. Additionally, the
Companys products and solution offerings can help identify those who
perpetrate fraud and otherwise pose a threat to public safety. Identix
products serve a broad range of industries and market segments  most notably,
government, law enforcement, aviation, financial, healthcare and corporate
enterprise. A world leader in multi-biometric technology, Identix believes it
has more fingerprint and facial biometric installations worldwide than any
other company.The third quarter of fiscal year 2004 was a quarter marked by significant
positive and strategic change at Identix. The significant events that occurred
were the disposition of Identix wholly owned subsidiary Identix Public Sector
(IPS), the acquisition of technology from Delean Vision Worldwide, Inc., the
acquisition of 100% ownership of Sylvan Identix Fingerprint Centers, LLC now
renamed Identix Identification Services (IIS), and the streamlining of Identix
operations with a reduction in force plan that reduced its total workforce by
six percent. The Company believes these actions allow Identix to fully focus
on it core biometric business while enhancing its biometric technology,
expanding access to the commercial and civil markets while at the same time,
streamlining its operations.On February 13, 2004, the Company consummated the sale of Identix Public Sector
(IPS) to Alion Science and Technology Corporation (Alion). In the third quarter
of 2004, the Company recognized income from discontinued operations of
$4,884,000 of which $5,934,000 is attributable to the gain on the sale of IPS
and $1,050,000 is attributable to a loss on discontinued operations. These
operations are presented in the Companys Consolidated Statements of Operations
as discontinued operations. Under the terms of the agreement, upon closing
Alion paid the Company $8,850,000 million in cash. This amount is shown as
proceeds from sale of businesses, net of transaction costs, in the Consolidated
Statement of Cash Flows for the nine months ended March 31, 2004. In addition,
the Company is entitled to payments totaling approximately $1,700,000 during
the next several months. The terms of the sale include the
potential for additional future payments to the Company of up to $500,000
pending satisfaction of certain conditions. The terms of the sale also include
an obligation on the part of the Company to indemnify Alion against
liabilities, including for breaches of representations and warranties made by
the Company in the sales agreement, for an amount not to exceed $2,125,000.On February 23, 2004, the Company acquired the remaining 50% ownership of
Sylvan Identix fingerprint Centers, LLC now known as Identix Identification
services (IIS). IIS provides services to corporations and government agencies
whereby IIS captures fingerprints and transmits the data for applicant
background checks. IIS maintains a network of Identix livescan systems at
processing centers across the country where certified technicians process
applicants. In consideration for the remaining 50% interest in the joint
venture, Identix paid Sylvan Learning Centers, Inc. $875,000 in cash. The
proforma impact of the IIS acquisition was not significant to the results of
the Company for the nine months ended March 31, 2004.On February 26, 2004, the Company announced that it had streamlined its
operations with a reduction in force of approximately 30 full time equivalent
job positions, or approximately six percent of its workforce. The Company
recognized approximately $250,000 in expense related to reduction in force
severance costs.Identix acquired certain technology from Delean Vision Worldwide Inc. (Delean)
on March 10, 2004. The technology acquired was biometric recognition
algorithms known as skin texture analysis (STA) that allows a unique
characteristic of the skin structure known as a skinprint to be used to
identify individuals. In exchange for the technology and intellectual property
rights of Delean, the Company issued 675,000 shares of Identix common stock and
a warrant with contingent future vesting rights in favor of Delean to purchase
up to 800,000 shares of Identix common stock at $4.70 per share. The warrant
vests upon the successful issuance of certain patents with the US government
related to the technology acquired from Delean. The fair value of any warrants
which vest will be recorded at the time of vesting. 13




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On June 25, 2002, the Company completed its merger with Visionics Corporation
(Visionics), a leading provider of biometric technologies and identification
information systems. The Visionics results of operations have been included in
the Companys consolidated financial statements since the date of acquisition.
In connection with this stock-for-stock merger transaction, each outstanding
share of Visionics common stock was exchanged for 1.3436 shares of the
Companys common stock, resulting in the issuance of an aggregate of 39,422,000
shares of the Companys common stock for all outstanding shares of Visionics
common stock. In addition, all options and warrants to purchase shares of
Visionics common stock outstanding immediately prior to the consummation of
the merger were converted into options and warrants to purchase 3,860,000
shares of the Companys common stock. The total purchase price was
$334,818,000.CRITICAL ACCOUNTING POLICIESThe preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates that affect
the amounts reported in the Consolidated Financial Statements and accompanying
notes. Note 1 to the Consolidated Financial Statements in the Companys Annual
Report on Form 10-K for the fiscal year ended June 30, 2003 describes the
significant accounting policies and methods used in the preparation of the
Consolidated Financial Statements. Estimates are used for, but not limited to,
the accounting for the allowance for doubtful accounts and sales returns,
goodwill and other intangible asset impairments, inventory allowances, warranty
costs, revenue recognition as well as loss contingencies and restructurings.
Actual results could differ materially from these estimates. Managements
Discussion and Analysis of Financial Condition and Results of Operations in the
Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2003
describes the critical accounting policies that are impacted significantly by
judgments, assumptions and estimates used in the preparation of the
Consolidated Financial Statements. At March 31, 2004, the Companys critical
accounting policies and estimates continue to include revenue recognition,
allowance for doubtful accounts and sales returns, goodwill impairments,
inventory allowances, warranty costs and loss contingencies and restructurings.
The Companys annual impairment analysis was performed during the fourth
quarter of fiscal year 2003 and resulted in an impairment charge to goodwill of
$154,799,000.RESULTS OF OPERATIONSRevenues, Cost of Revenues and Gross MarginsRevenues for the three and nine months ended March 31, 2004 were $14,491,000
and $39,014,000 compared to $12,239,000 and $39,005,000 for the same periods in
the prior fiscal year. The vast majority of the Companys revenues relate to
its biometric systems segment. The Company had one customer, an agency of the
U.S. Government that accounted for 7% of the total revenue for the three and
nine months ended March 31, 2004, compared to 9% and 8% for the same periods in
the prior fiscal year. The 18% increase in revenue when comparing the third
quarter of fiscal year 2003 to the third quarter of fiscal year 2004 is
primarily the result of a large live scan order that was recognized as revenue
during the three months ended March 31, 2004. In addition, the Company
recognized revenue from several large professional service contracts that were
in place in the three months ended March 31, 2004 that were not present in the
same period in the prior fiscal year. Results for the three months ended March
31, 2004 include $728,000 of revenue generated by IIS. The Company acquired
IIS on February 23, 2004. The complete results of IIS have been included in the
Companys consolidated statement of operations since February 23, 2004.The Company is currently undergoing a General Services Administration pre-award
audit for the renewal of a GSA Multiple Award Schedule contract. While the
Company believes that the results of such audit will have no material effect on
the results of operation, any material adverse findings or adjustments arising
out of such audit may have a material adverse effect on our business, financial
condition and results of operations.International sales accounted for $2,817,000 and $4,905,000 or 19% and 13% of
the Companys revenues for the three and nine months ended March 31, 2004,
respectively, compared to $901,000 and $2,930,000 or 7% and 8% of the Companys
biometric system revenues for the same periods in the prior fiscal year. The
increase for both periods from fiscal year 2003 to fiscal year 2004 are
primarily the result of two large international orders occurring during the
three months ending March 31, 2004, one for the Companys livescan systems and
the other for contracted custom development work. In addition, during the
fiscal year 2004 to date there was increased revenue from smaller but more
numerous international orders that contributed to the increase seen above.
Identix is actively pursuing business in the international biometric market.
The Companys international sales are predominately denominated in U.S.
dollars, and the Company actively monitors its foreign currency exchange
exposure and, if significant, will take action to reduce foreign exchange risk.
To date, the Company has not entered into any hedging transactions. 14




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Gross margin on revenues was 20% and 31% for the three and nine months ended
March 31, 2004 and 40% and 33% for the same periods of the prior fiscal year. The decrease in gross margin for the
three and nine months ended March 31, 2004, is primarily the result of a
provision for excess and obsolete inventory for $2,600,000 that occurred in the
three months ended March 31, 2004. The majority of this adjustment was to
reserve for inventory items that will be used to support products that the
Company no longer manufactures but the Company is still obligated to provide
services. For the nine months ended March 31, 2004 and 2003 the provisions for
excess and obsolete inventory were $3,315,000 and $2,158,000 respectively. The
Company expects gross margins to fluctuate in future periods due to changes in
the product mix, the costs of components and the competition in the industry.Research, Development and EngineeringResearch, development and engineering expenses were $2,184,000 and $7,207,000
or 15% and 18% of revenues for the three and nine months ended March
31, 2004 compared to $2,613,000 and $8,407,000 or 21% and 22% of product
revenues for the same periods in the prior fiscal year. The decrease of
$1,200,000 in research and development expense in the nine month
period in fiscal year 2004 from the
nine month period in fiscal year 2003, is the result of several development
projects ongoing in fiscal year 2003 that were completed before the start of
fiscal year 2004. In addition, there has been a concerted effort by the
Company to decrease its reliance on its principle subcontractor for research
and development, which has resulted in an additional reduction of research and
development expense year over year.Marketing and SellingMarketing and selling expenses were $2,746,000 and $8,238,000
or 19% and 21% of
total revenues for the three and nine months ended March 31, 2004, compared to
$3,032,000 and $9,570,000 or 25% of total revenues for the both periods in the
prior fiscal year. The decrease in marketing and selling expenses for the nine
months ended March 31, 2004 as expressed in dollars, was driven primarily by a
significant reduction in bad debt expense for the first and second quarters of
fiscal year 2004. The reduction of bad debt expense totaling $625,000 in the
nine months ended March 31, 2004 was due to the cash collections
of several large accounts receivable which had been in dispute for more than
one year and had been previously fully reserved consistent with Company policy.General and AdministrativeGeneral and administrative expenses were $3,166,000 and $9,880,000 for the
three and nine months ended March 31, 2004, compared to $3,761,000 and
$10,542,000 for the same periods in the prior fiscal year. The decrease in
general and administrative expense for the three and nine months ended March
31, 2004 was due primarily to the vacancy of two senior level finance
positions, and a decrease in stock-based compensation expense of $413,000 and
$833,000 when comparing the three and nine months ended March 31, 2004 to the
same periods in the prior fiscal year. The decrease in the stock-based
compensation expense is driven by a continued decline in the number of unvested
options from period to period which originally generated the deferred
compensation. These decreases on a year to date basis, were partially offset
by certain professional services and increased insurance costs.Amortization of Acquired Intangible AssetsThe amortization expense is primarily related to acquired intangible assets
such as developed technology, and patents. The amortization expense related to
acquired intangible assets was $1,419,000 and $4,176,000 for the three and nine
months ended March 31, 2004 compared to $1,346,000 and $4,006,000 for the same
periods in the prior fiscal year. 15




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##### Table of Contents



Special ChargesSpecial charges (such as restructuring and acquisition related charges) result
from unique facts and circumstances that likely will not recur with similar
materiality or impact on continuing operations. Special charges consisted of
the following for the periods presented: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Reduction in force costs
    
    $
    250,000
    
    
    $
    
    
    
    $
    250,000
    
    
    $
    Employment agreement obligations
    
    
    506,000
    
    
    
    
    
    
    
    506,000
    
    
    
    SIFC acquisition related
    
    
    749,000
    
    
    
    
    
    
    
    749,000
    
    
    
    Visionics merger related
    
    
    610,000
    
    
    
    977,000
    
    
    
    610,000
    
    
    
    5,698,000$
    2,115,000
    
    
    $
    977,000
    
    
    $
    2,115,000
    
    
    $
    5,698,000
 In June 2002, the Company merged with Visionics and in connection with the
merger recorded special charges of $18,798,000 related to the merger for the
termination of 110 employees, and the closure of its facilities in Dublin and
Los Gatos California. During the year ended June 30, 2003, the Company
recorded additional restructuring and other merger related charges of
$10,206,000, including a loss of $186,000 on the sublease portion of its Dublin
facility. In conjunction with the restructuring related charges recorded, the
Company made certain estimates regarding future sublease income that have a
significant impact on its anticipated cash obligations and restructuring
reserves. Although the Company believes that the lease commitment estimates
are appropriate in the circumstances, future changes in real estate markets
could impact the ultimate amount of cash paid to resolve these obligations.
The following is a summary of the charges incurred and payments made from the
time of the merger through June 30, 2003: Activity during the period June 25, 2002 to June 30, 2003Cash Paymentsthrough June 30,
    
    Liability as ofTotal Charges
    
    Non-Cash Charges
    
    2003
    
    June 30, 2003Severance and benefits
    
    $
    8,376,000
    
    
    $
    900,000
    
    
    $
    6,862,000
    
    
    $
    614,000Disposal of fixed assets
    
    
    1,664,000
    
    
    
    1,664,000
    
    
    
    
    
    
    
    Lease exit costs
    
    
    15,280,000
    
    
    
    388,000
    
    
    
    2,741,000
    
    
    
    12,151,000Internal merger costs & other
    
    
    3,684,000
    
    
    
    
    
    
    
    3,653,000
    
    
    
    31,000Total
    
    $
    29,004,000
    
    
    $
    2,952,000
    
    
    $
    13,256,000
    
    
    $
    12,796,000
 Fiscal 2004 During the three months ended March 31, 2004, the Company incurred
approximately $2,115,000 in special charges. These charges consisted of
$749,000 for the value of shares of Company common stock issued to certain
former Sylvan Identix Fingerprint Center (SIFC) employees in connection with
the acquisition of 100% of SIFC, $506,000 related to payments made under the
former Chairman of the Boards employment agreement related to his retirement
in February 2004, $610,000 related to an increase in the reserve on the
sublease of the Companys Northern California facilities and $250,000 related
to a reduction in force in February 2004. The additional sublease reserve and
the reduction in force expenses are reflected in the restructuring schedule
below. 16




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##### Table of Contents



The following table represents a summary of restructuring and other merger
related charges between June 30, 2003 and March 31, 2004: For the Nine months ended March 31, 2004LiabilitiesSatisfied in
    
    
    
    
    
    RestructuringRestructuring Liability
    
    
    
    
    
    Connection with IPS
    
    
    
    
    
    Liability as ofas of June 30, 2003
    
    Additions
    
    Disposition
    
    Cash Payments
    
    March 31, 2004Severance and benefits
    
    $
    614,000
    
    
    $
    250,000
    
    
    $
    
    
    
    $
    498,000
    
    
    $
    366,000Lease exit costs
    
    
    12,151,000
    
    
    
    610,000
    
    
    
    2,267,000
    
    
    
    2,261,000
    
    
    
    8,233,000Internal merger costs and other
    
    
    31,000
    
    
    
    
    
    
    
    
    
    
    
    31,000
    
    
    
    Total
    
    $
    12,796,000
    
    
    $
    860,000
    
    
    $
    2,267,000
    
    
    $
    2,790,000
    
    
    $
    8,599,000
 The additional severance and benefits expense of $250,000 recorded in the
quarter ending March 31, 2004 is the result of a reduction in force where the
Company eliminated 6% of the Companys workforce. The increase of lease exit
costs by $610,000 reflects an updated assessment by management of what the
Company will recover under the current conditions of the Northern California
real estate market. The restructuring liability is classified in the
consolidated balance sheet based on the anticipated timing of the respective
payment. As of March 31, 2004, $6,198,000 of the above restructuring liability
is classified as long-term. Management currently believes that of the $366,000
accrued for severance and benefits, $255,000 will be paid over the next twelve
months with the remaining balance being paid through 2013 with the lease exit
costs being paid over the remaining term of the leases. The leases expire at
various dates through 2011. Fiscal 2003 During the three and nine months ended March 31, 2003, the Company recorded
special charges related to the merger totaling $1,272,000 and $9,577,000,
respectively. For the three months ended March 31, 2003 these costs consisted
of $489,000 in relocation costs for Identix employees and facilities, $176,000
associated with the disposal of fixed assets, $476,000 increase in the reserve
related to lease exit costs and $131,000 related to employees with extended
terminations to assist in the integration. Such costs were expensed as
incurred. For the nine months ended March 31, 2003, these costs consisted of
$2,530,000 in relocation costs, $370,000 associated with the disposal of fixed
assets, $4,541,000 related to lease exit costs and $2,136,000 related to
employees with extended terminations to assist in the integration. Such costs
were expensed as incurred. For the three months ended March 31, 2003, $295,000
and $3,879,000 of special charges related to the merger are included in income
(loss) from discontinued operations in the Companys Consolidated Statement of
Operations. In conjunction with the restructuring related charges recorded, the Company
made certain estimates regarding future sublease income that have a significant
impact on its anticipated cash obligations and restructuring reserves.
Although the Company believes that the lease commitment estimates are
appropriate in the circumstances, future changes in real estate markets could
impact the ultimate amount of cash paid to resolve these obligations. Interest and Other Income, net For the three and nine months ended March 31, 2004, interest and other income,
net were $304,000 and $978,000 respectively, compared to $378,000 and
$1,404,000 for the same periods in the prior fiscal year. The decrease is
primarily the result of lower cash balances in the first six months of fiscal
year 2004 and realized gains on investments of $208,000 that occurred in the
first nine months of fiscal year 2003 that did not occur in fiscal year 2004. Interest Expense Interest expense was $7,000 for the nine months ended March 31, 2004, compared
to $10,000 for the same period in the prior fiscal year. There have been no
borrowings under the Companys line of credit during the nine months ended
March 31, 2004. Interest expense is comprised primarily of interest costs
associated with the Companys leased vehicles in the United Kingdom as well as
interest connected to leased equipment in the U.S. Provision for Income Taxes The Company recorded a provision for income tax expense of $9,000 and $28,000
for the three and nine months ended March 17




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##### Table of Contents



31, 2004 and a provision of $146,000
and $159,000 for the same periods in prior fiscal year. The tax amounts
recorded for both fiscal years are related to state income taxes. Equity Interest in Loss of Joint Venture The equity interest in loss of the joint venture represents the Companys 50%
share of the results of Sylvan Identix Fingerprint Centers, LLC (SIFC) through
February 23, 2004 when Identix acquired the remaining 50% interest in SIFC.
For the three and nine months ended March 31, 2004, the Companys equity
interest in the joint venture loss was $55,000 and $302,000. For the same
periods in the prior fiscal year the Companys equity interest in the joint
venture loss was $148,000 and $196,000. Discontinued Operations On February 13, 2004, the Company consummated the sale of Identix Public Sector
(IPS) to Alion Science and Technology Corporation (Alion). In the third quarter
of 2004, the Company recognized income from discontinued operations of
$4,884,000
of which $5,934,000 is attributable to the gain on the sale of IPS and
$1,050,000 is attributable to a loss on discontinued operations. These
operations are presented in the Companys Consolidated Statements of Operations
as discontinued operations. Under the terms of the agreement, upon closing
Alion paid the Company $8,850,000 million in cash. This amount is shown as
proceeds from sale of businesses, net of transaction costs, in the Consolidated
Statement of Cash Flows for the nine months ended March 31, 2004. In addition,
the Company is entitled to payments totaling approximately $1,700,000 during
the next several months. The terms of the sale include the
potential for additional future payments to the Company of up to $500,000
pending satisfaction of certain conditions. During the three months ended
March 31, 2004 and 2003, the Company recorded a loss from discontinued
operations of $1,050,000 and income from discontinuing operations of $257,000,
respectively. The Company recorded a loss of $809,000 and $3,810,000 from
discontinuing operations during nine months ended March 31, 2004 and 2003
respectively. The historical consolidated results, including results from the
prior periods in fiscal year 2004 and 2003 have been restated to reflect the
divestiture of IPS. The following table represents the summarized results for the discontinued
operations: Three Months Ended March 31,
    
    Nine Months Ended March 31,2004*
    
    2003
    
    2004*
    
    2003Revenue
    
    $
    3,302,000
    
    
    $
    9,566,000
    
    
    $
    20,078,000
    
    
    $
    30,378,000Cost of sales
    
    
    2,564,000
    
    
    
    8,635,000
    
    
    
    17,550,000
    
    
    
    26,794,000Operating Expenses
    
    
    1,788,000
    
    
    
    674,000
    
    
    
    3,337,000
    
    
    
    7,394,000Net Income
    
    $
    (1,050,000
    )
    
    $
    257,000
    
    
    $
    (809,000
    )
    
    $
    (3,810,000
    )
 * These periods represent activity through February 13, 2004 as the
disposition of IPS was consummated on that day. Liquidity and Capital Resources The Company financed its operations during the nine months ended March 31,
2004, primarily from cash provided by its working capital. As of March 31,
2004, the Companys principal sources of liquidity consisted of
$44,623,000 of
working capital including $45,383,000 in cash and cash equivalents and
short-term marketable securities. The Companys existing line of credit (the Identix Line of Credit) was
entered into on May 30, 2003. This line of credit provides for up to the
lesser of $15,000,000 or the cash collateral base or the borrowing base.
Borrowings under the Identix Line of Credit are collateralized by substantially
all of the assets of the Company and bear interest at the banks prime rate of
interest which was 4.00% at March 31, 2004. The Identix Line of Credit expires
on October 30, 2004. Until the Company establishes a net income before income
taxes for two consecutive fiscal quarters, the Company will be required to
deposit with the lender an amount equal to the sum of the aggregate outstanding
principal amount of all prior advances plus any portion of the line of credit
reserved to support unexpired letters of credit plus the amount of the
requested advance before an advance will be given. In addition, all advances
must be used for working capital. At March 31, 2004, there were no amounts
outstanding under this line of credit. The Identix Line of Credit agreement contains financial, operating and
reporting covenants. At March 31, 2004, the Company was in compliance with all
covenants. For the nine months ended March 31, 2004, $8,469,000 of was used in operating
and investing activities that was offset by the cash generated from investing
and financing activities of $8,273,000 and $1,410,000 respectively. The cash
that was generated 18




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from investing activities primarily resulted from sale of
the Companys IPS subsidiary as well the acquisition of 100% interest in SIFC
now known as Identix Identification Services (IIS). In addition, the cash
generated from financing activities resulted primarily from the exercise of
stock options. The net result of the Companys cash flow activities resulted
in $1,214,000 of cash and cash equivalents being generated. The Company used
$20,412,000 of cash and cash equivalents during the nine months ended March 31,
2003. For the nine months ended March 31, 2003, operating activities used
$21,645,000 that was partially offset by the Companys financing activities
that generated cash flows of $1,705,000. Cash provided by financing activities
for the periods presented was due solely to proceeds from the sale of the
Companys equity securities and the exercise of employee stock options. The Company currently has a commitment with a certain supplier to purchase by
December 2004, approximately $1,000,000 of parts for use in the Companys
livescan systems. Currently, the Companys anticipated cash requirements
relate primarily to funding operations and paying remaining obligations related
to restructuring and other merger related charges recorded in fiscal years 2003
and 2002. The Company currently occupies its Minnesota headquarters under a lease that
expires in March 2008, and is required to pay taxes, insurance, and maintenance
as well as monthly rental payments. In addition, the Company leases space for
its former headquarters in Los Gatos, California under a lease that expires in
December of 2007; and a space in Dublin, California for its former research,
development and engineering activities that expire in March 2006. Further, the
Company leases office space for its sales force and customer support activities
under operating leases, which expire at various dates through 2008. The leases
contain escalation provisions requiring rental increases for increases in
operating expense and real estate taxes. Future minimum lease payments for operating leases are as follows: Periods or fiscal years ending June 30:
    
    Occupied
    
    Unoccupied or Sublet
    
    Total2004
    
    $
    448,000
    
    
    $
    554,000
    
    
    $
    1,002,0002005
    
    
    1,998,000
    
    
    
    2,550,000
    
    
    
    4,548,0002006
    
    
    1,274,000
    
    
    
    2,518,000
    
    
    
    3,792,0002007
    
    
    1,056,000
    
    
    
    2,127,000
    
    
    
    3,183,0002008
    
    
    728,000
    
    
    
    1,074,000
    
    
    
    1,802,000Thereafter
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    5,504,000
    
    
    $
    8,823,000
    
    
    $
    14,327,000
 Included in the above future minimum payments is $8,823,000 related to two
leased facilities in Northern California that were vacated in connection with
the Companys merger with Visionics. The Company has accrued for the estimated
losses on these leases at March 31, 2003 and 2004. The Company is attempting
to sublease the unoccupied facilities. While the Company believes that existing working capital will be adequate to
fund the Companys current cash requirements for at least the next twelve
months, the Company may need to raise additional debt or equity financing in
the future. The Company may not be able to obtain additional debt or equity
financing on favorable terms that are not excessively dilutive to existing
stockholders. Failure to secure additional financing in a timely manner and on
favorable terms in the future could have a material adverse impact on the
Companys financial performance and stock price and require the Company to
implement certain cost reduction initiatives and curtail certain of its
operations. RISK FACTORS This report on Form 10-Q contains forward-looking statements that involve risks
and uncertainties. The Companys business, operating results, financial
performance and share price may be materially adversely affected by a number of
factors, including but not limited to the following risk factors, any one of
which could cause actual results to vary materially from anticipated results or
from those expressed in any forward-looking statements made by the Company in
this quarterly report on Form 10-Q or in other reports, press releases or other
statements issued from time to time. Additional factors that may cause such a
difference are set forth in the Companys annual report on Form 10-K. Our business will not grow unless the market for biometric solutions expands
both domestically and internationally. Our revenues are primarily derived from the sale of biometric products and
services. Biometric solutions have not gained widespread commercial acceptance.
We cannot accurately predict the future growth rate, if any, or the ultimate
size of the biometric technology market. The expansion of the market for our
products and services depends on a number of factors including without
limitation:  
    
    the cost, performance and reliability of our products and services and the products and services of our competitors; 19




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
    
    customers perception of the perceived benefit of biometric solutions;
    
    public perceptions of the intrusiveness of these solutions 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;
    
    customers satisfaction with our products and services; and
    
    marketing efforts and publicity regarding these products and services. Certain groups have publicly objected to the use of biometric products for
some applications on civil liberties grounds and legislation has been proposed
to regulate the use of biometric security products. From time to time,
biometrics 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 solutions gain wide
market acceptance, our products and services may not adequately address the
requirements of the market and may not gain wide market acceptance. We face intense competition from other biometric solution providers as well as
identification and security systems providers. A significant number of established and startup companies have developed or are
developing and marketing software and hardware for facial and/or fingerprint
biometric products and applications that currently compete or will compete
directly with our current facial and fingerprint offerings. Some of these
companies have developed or are developing and marketing semiconductor or
optically based direct contact fingerprint image capture devices, or retinal
blood vessel, iris pattern, hand geometry, voice or facial structure solutions.
If one or more of these technologies or approaches were widely adopted, it
would significantly reduce the potential market for our products. Our security
and identity related line of products and applications also compete with
non-biometric technologies such as certificate authorities, smart card security
solutions, and traditional key, card, surveillance systems and passwords. Many
competitors offering products that are competitive with our security and
identity related line of products and applications have significantly more
financial and other resources than the Company. The biometric security market
is a rapidly evolving and intensely competitive market, and we believe that
additional competitors will continue to enter the market and become significant
long-term competitors. Our facial biometric products face intense competition from a number of
competitors who are actively engaged in developing and marketing facial-based
recognition or security products, including Viisage Technology, Inc., Cognitech
and Imagis Technologies, Inc. The products designed, developed and sold under
our line of products known as our Live Scan products also face intense
competition from a number of competitors who are actively engaged in developing
and marketing similar products, including Heimann Biometric Systems GmbH, Sagem
Morpho, Inc., Printrak International, Inc., (a Motorola company), and
CrossMatch Technologies, Inc. We expect competition to increase and intensify in the near term in the
biometrics markets. Companies competing with us may introduce products that are
competitively priced, have increased performance or functionality or
incorporate technological advances not yet developed or implemented by us. Some
present and potential competitors have financial, marketing, research, and
manufacturing resources substantially greater than ours. In order to compete effectively in this environment, we must continually
design, develop and market new and enhanced products at competitive prices and
must have the resources available to invest in significant research and
development activities. The failure to do so could have a material adverse
effect on our business operations, financial results and stock price. We derive a significant
amount of revenue from government contracts, which
are often non-standard, involve competitive bidding, may be subject to
cancellation without penalty and may produce volatility in earnings and
revenue. Our performance in any one reporting period is not necessarily indicative of
sale trends or future operating or earnings performance because of our reliance
on a small number of large customers, the majority of which are government
agencies. Government contracts frequently include provisions that are not
standard in private commercial transactions. For example, government contracts
may include bonding requirements and provisions permitting the purchasing
agency to cancel the contract for convenience at any time without penalty in
certain circumstances. As public agencies, our prospective customers are also
subject to public agency contract requirements that vary from jurisdiction to
jurisdiction. Some of these requirements may be onerous or impossible to
satisfy. Additionally, public agency contracts are frequently awarded only after formal
competitive bidding processes, which are often protracted, and typically impose
provisions that permit cancellation in the event that funds are unavailable to
the public agency. In some cases, unsuccessful bidders for public agency
contracts are provided the opportunity to formally protest certain contract
awards through various agency, administrative and judicial channels. The
protest process may delay a successful bidders contract performance for a
number of weeks, months or more, or result in the cancellation of the contract
award entirely. There is a risk that we may not be awarded contracts for which

we bid or, if awarded, that substantial delays or cancellation of purchases may
follow as a result of third party protests. For example, in October 2003, the
Company announced that is had been awarded a Blanket Purchase Order (BPO)
from the Department of Homeland Security (DHS) with an estimated value of
approximately $27 million. The award was subsequently the subject of a formal
protest by one 20




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of our competitors who had been an unsuccessful participant in
the bidding process for the BPO. In response to the protest, DHS decided to
re-evaluate all responsible technical and price proposals previously submitted
in response to the Governments RFQ and Source Selection Plan for the BPO. DHS
also sought and obtained dismissal of the protest by the U.S. General
Accounting Office and issued a stop work order, meaning procurement of Identix
technology under the BPO would be held in abeyance until the re-evaluation was
completed. On March 10, 2004, DHS notified Identix that DHS had completed its
re-evaluation and re-confirmed Identix as the sole recipient of the BPO. DHS
also immediately released the stop work order. Subsequently, the same
competitor that had previously filed the original protest filed a second
protest, and in response to the second protest, the Government issued a new
stop work order, meaning procurement of technology under the BPO will be held
in abeyance until the protest is resolved. Based on all available
information, Identix continues to believe it will prevail and that its products
and services will again be proven to represent the best overall value to the
Government. However, there can be no assurance that the protest will be
resolved in Identix favor, or that any additional affirmation of the previous
BPO award to Identix will not be subject to further protest or challenge by
unsuccessful third parties. Further substantial delays in DHS procurement of
our technology under the BPO could result in adverse revenue volatility, making
management of inventory levels, cash flow and profitability inherently
difficult. Outright loss of the BPO award to Identix through the protest
process or otherwise could have a material adverse effect on our financial
results and stock price. Similarly, state and local government agency contracts may be contingent upon
availability of matching funds from federal or state entities. State and local
law enforcement and other government agencies are subject to political,
budgetary, purchasing and delivery constraints which may continue to result in
quarterly and annual revenues and operating results that may be irregular and
difficult to predict. Such revenue volatility makes management of inventory
levels, cash flow 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 schedule changes in the
timing of deliveries and recognition of revenue, or cancellation of such
procurements. As a result of the purchase
by a buyer of our wholly-owned subsidiary, Identix Public Sector,
Inc. (IPS) in February 2004, the buyer also now owns all
the public contracts of IPS, including a GSA Multiple Award IT-70
schedule contract related to our product business.
We entered
into a reseller agreement with such third party concurrently with the closing
of the sale of IPS, and we continue to sell our products through such
resellers IT 70 Schedule. Such contract , now held by our reseller, is
subject to future audit, and any material adverse findings or adjustments
arising out of such audits may have a material adverse effect on ability to
sell our products through the resellers contract, which could in turn
materially adversely affect our business, financial condition and results of
operations. Furthermore, the current IT-70 contract held by our reseller
expires June 30, 2004. While efforts are underway by the reseller to obtain
an extension to the contract term, the failure to obtain such extension may
have a material adverse effect on ability to sell our products through the
resellers contract, which could in turn materially adversely affect our
business, financial condition and results of operations. While the Company is
in the process of applying for a new IT-70 Schedule contract, there can be no
assurance that we will successfully obtain such contract on a timely basis.
Any failure to obtain such contract, or any significant delays we experience in
obtaining such contract, could have a material adverse effect on our business
operations, financial results and stock price. The General Services
Administration has recently completed its pre-award audit for the
renewal of our GSA Multiple Award Schedule contract related to our
certain of our products and services. The end result of the pre-award
audit process was favorable to Identix, with no adverse findings or
adjustments arising out of the process. The Company expects to
undergo an additional audit of this contract in the near term, and
revenue generated from this contract may be subject to future
adjustment by negotiation with representatives of the government
agencies. While we believe that the results of any future audits will
have no material effect on our financial results or business
operations, any material adverse findings or adjustments arising out
of such audits may have a material adverse effect on our business,
financial condition and results of operations. Acquisitions and dispositions of companies, assets or technologies may result
in disruptions to our business. As part of our business roadmap, we may from time to time acquire
businesses, assets or technologies relating to, or complementary to, our
current strategies or operations, and we may also divest certain businesses or
assets that we consider non-complementary to our current strategies or
operations. In March 2004, we acquired certain technology and intellectual property rights
of Delean Vision Worldwide, Inc. In February 2004, we acquired the remaining
50% percent interest in Sylvan Identix Fingerprint Centers, LLC (SIFC) that
we didnt already own. We subsequently re-named SIFC Identix Identification
Services, LLC. In February 2004, we sold our wholly owned subsidiary, Identix
Public Sector, Inc., whose business principally consisted of providing project
management and facilities engineering services to government agencies. We
acquired certain proprietary software and source code assets from a third party
in October 2002. We merged with Visionics in June 2002 and acquired Identicator
Technology, Inc. in fiscal 1999. We also acquired one company in fiscal 1998
and two companies in fiscal 1996. These and any other acquisitions, mergers and
divestitures by Identix are and will be accompanied by the risks commonly
encountered in such transactions. These risks include, among other things:  
    
    exposure to unknown liabilities of acquired companies or assets;
    
    higher than anticipated acquisition costs and expenses;
    
    effects of costs and expenses of acquiring and integrating new businesses on our operating results and financial condition;
    
    effects of consolidated revenue loss associated with dispositions of material subsidiaries or assets;
    

    effects of costs and expenses of integrating and introducing new technologies;
    
    the difficulty and expense of assimilating the operations and personnel of the companies;
    
    disruption of our ongoing business; 21




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
    
    diversion of management time and attention;
    
    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;
    
    the maintenance of uniform standards, controls, procedures and policies;
    
    loss of key employees and customers as a result of changes in management;
    
    the incurrence of amortization expenses;
    
    incurring impairment charges arising out of our assessments of goodwill and intangibles; and
    
    possible dilution to our stockholders. In addition, geographic distances may make integration of businesses or
the acquisition of assets more difficult. We may not be successful in
overcoming these risks or any other problems encountered in connection with any
mergers or acquisitions. Our financial and operating results often vary significantly from quarter to
quarter and may be negatively affected by a number of factors. Our financial and operating results may fluctuate from quarter to quarter
because of the following reasons:  
    
    the lack of availability of government funds;
    
    reduced demand for products and services caused, for example, by competitors;
    
    price reductions, new competitors, or the introduction of enhanced products or
services by us or by new or existing competitors;
    
    changes in the mix of products and services we or our distributors sell;
    
    cancellations, delays or contract amendments by government agency customers;
    
    protests of federal, state or local government contract awards by competitors;
    
    unforeseen legal expenses, including litigation and/or administrative protest costs;
    
    expenses related to acquisitions or mergers;
    
    impairment charges arising out of our assessments of goodwill and intangibles;
    
    other one-time financial charges;
    
    the lack of availability or increase in cost of key components and subassemblies; and
    
    the inability to timely and successfully complete development of complex designs and
components, or manufacture in volume and install certain of our products. Particularly important is the need to invest in planned technical development
programs to maintain and enhance our competitiveness, and to successfully
develop and launch new products and services on a timely basis. Improving the
manageability and likelihood of success of such programs requires the
development of budgets, plans and schedules for the execution of these programs
and the adherence to such budgets, plans and schedules. The majority of such
program costs are payroll and related staff expenses, and secondarily
materials, subcontractors and promotional expenses. These costs are very
difficult to adjust in response to short-term fluctuations in our revenues,
compounding the difficulty of achieving profitability in the event of a revenue
downturn. 22




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Our results of operations may be harmed by availability of governmental
funding, credit and other policies. In many instances, the procurements of our federal, state and local customers
are dependent on the availability or continued availability of federal, state
or local government funds or grants and general tax funding. Such funding may
not be approved or, if approved, it may not be available for the purchase of
our products or solutions, and even if such funding is approved and available,
such funds may be subject to termination at any time at the sole discretion of
the government body providing or receiving such funds. We also extend substantial credit to federal, state and local governments in
connection with sales of our products and services. Sales to sizeable customers
requiring large and sophisticated networks of fingerprint recognition and Live
Scan systems and peripheral equipment often include technical requirements
which may not be fully known at the time requirements are specified by the
customer. In addition, 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 completion of 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 involve
investment of additional resources. These investments of additional resources
are accrued when amounts can be estimated but may be uncompensated and
negatively affect profit margins and our liquidity. Additionally, without regard to termination of funding, government agencies
both domestically and internationally may successfully assert the right to
terminate business or funding relationships with us at their sole discretion
without adequate or any compensation or recourse for us. The substantial costs of our merger with Visionics Corporation, which was
completed in June 2002, and the manner of accounting for the merger may affect
Identix reported results of operations. Approximately $30 million of costs have been incurred in connection with our
merger with Visionics. These include costs associated with combining the
businesses of the two companies, including integration and restructuring costs,
costs associated with the consolidation of operations and the fees of financial
advisors, attorneys and accountants. While the vast majority of costs
associated with the merger are behind us, we may incur additional integration
costs, for example, costs associated with the sublease of our former office and
manufacturing space in California, and these costs may be higher than
anticipated. In connection with the Visionics merger, we recorded a substantial amount of
goodwill. Generally accepted accounting principles requires that goodwill be
tested for impairment at least annually and a non-cash charge to earnings must
be recognized n the period any impairment of goodwill is determined. During the
fourth quarter of fiscal year 2003, we recorded an impairment charge to
goodwill in the amount of $154,799,000. The market price of our common stock could decline if:  
    
    our merger with Visionics ultimately proves to be unsuccessful;
    
    the combined company is unable to successfully market its products and services to both companies customers;
    
    the combined company does not achieve the perceived benefits of the merger as rapidly as, or to the extent, anticipated by
financial or industry analysts, or such analysts do not perceive the same benefits to the merger as do we; or
    
    the effect of the merger on our financial results is not consistent with the expectations of financial or industry analysts. The terrorist attacks of September 11, 2001, and the continuing threat of
global terrorism, have increased financial expectations that may not
materialize. The September 11, 2001 terrorist attacks, and continuing concerns about global
terrorism, may have created an increase in awareness for biometric security
solutions generally. However, it is uncertain whether the actual level of
demand for our biometric products and services will grow as a result of such
increased awareness. Increased demand may not result in an actual increase in
our product or services revenues. In addition, it is uncertain which security
solutions, if any, will be adopted as a result of the terrorism and whether our
products will be a part of those solutions. Efforts in the war against
terrorism, the war in Iraq, and the post-war reconstruction efforts in Iraq,
may actually delay funding for the implementation of biometric solutions
generally. Even if our products are considered or adopted as solutions to the
terrorism, the level and timeliness of available funding are unclear. These
factors may adversely impact us and create unpredictability in revenues and
operating results. We may need to raise additional equity or debt financing in the future. While we believe existing working capital will be adequate to fund our
operating cash requirements for at least the next 12 months, we may need to
raise additional debt or equity financing in the future, which may not be
available to us even if we are successful in raising additional financing, 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 financial performance and stock price and
require us to implement certain cost reduction initiatives resulting in the
curtailment of our operations. 23




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The biometrics industry is characterized by rapid technological change and
evolving industry standards, which could render existing products obsolete. Our future success will depend upon our ability to develop and introduce a
variety of new products and services and enhancements to these new product and
services in order 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. Delays in introducing new products, services and enhancements, the
failure to choose correctly among technical alternatives or the failure to
offer innovative products and services at competitive prices may cause
customers to forego purchases of our products and services and purchase those
of our competitors. Continued participation by us in the market for Live Scan systems that are
linked to forensic quality databases under the jurisdiction of governmental
agencies may require the investment of our resources in upgrading our products
and technology for us to compete and to meet regulatory and statutory
standards. We may not have adequate resources available to us or may not
adequately keep pace with appropriate requirements in order to effectively
compete in the marketplace. Our lengthy and variable sales cycle will make it difficult to predict
operating results. Certain of our products often have a lengthy sales cycle while the
customer evaluates and receives approvals for purchase. If, after expending
significant funds and effort, we fail to receive an order, a negative impact on
our financial results and stock price could result. It is difficult to predict accurately the sales cycle of any large order for
any of our products. If we do not ship and or install one or more large orders
as forecast for a fiscal quarter, our total revenues and operating results for
that quarter could be materially and adversely affected. The substantial lead-time required for ordering parts and materials may lead to
excess or insufficient inventory. The lead-time for ordering parts and materials and building many of our
products can be many months. As a result, we must order parts and materials and
build our products based on forecasted demand. If demand for our products lags
significantly behind our forecasts, we may produce more products than we can
sell, which can result in cash flow problems and write-offs or write-downs of
obsolete inventory. We rely in part upon original equipment manufacturers (OEM) and distribution
partners to distribute our products, and we may be adversely affected if those
parties do not actively promote our products or pursue installations that use
our equipment. A significant portion of our product revenue comes from sales to partners
including OEMs, systems integrators, distributors and resellers. Some, but not
all, of these relationships are formalized in written agreements. Even where
these relationships are formalized in written agreements, the agreements are
often terminable 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 our 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. Loss of sole or limited source suppliers may result in delays or additional
expenses. We obtain certain hardware components and complete products, as well as
software applications, from a single source or a limited group of suppliers. We
do not have long-term agreements with any of our suppliers. We will experience
significant delays in manufacturing and shipping of products to customers if we
lose these sources or if supplies 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 products on a timely basis in
sufficient quantities and of sufficient quality or any significant increase in
the price of components from existing or alternative suppliers could have a
severe negative impact on our financial results and stock price. The success of our strategic plan to pursue sales in international markets may
be limited by risks related to conditions in such markets. For the three and nine months ended March 31, 2004, we derived approximately
19% and 13% of our product revenues from international sales. We currently have
a local presence in the United Kingdom and the Commonwealth of Australia. There is a risk that we may not be able to successfully market, sell and
deliver our products in foreign countries, or successfully rely on supplemental
offshore research and development resources. 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; 24




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
    
    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. 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. Two stockholders own a significant portion of our stock and may delay or
prevent a change in control or adversely affect the stock price through sales
in the open market. As of March 31, 2004, the State of Wisconsin Investment Board and Kern Capital
Management LLC owned approximately 9% and 5% respectively of the Companys
outstanding common stock. The concentration of large percentages of ownership
in any single stockholder 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 a single stockholder or otherwise could adversely affect our
stock price. We may be subject to loss in market share and market acceptance as a result of
manufacturing errors, delays or shortages. Performance failure in our products or certain of our services may cause
loss of market share, delay in or loss of market acceptance, additional
warranty expense or product recall, or other contractual liabilities. The
complexity of certain of our fingerprint readers makes the manufacturing and
assembly process of such products, especially in volume, complex. 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 could be exacerbated if the delay or failure occurs in
products or services 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 or
service launch is delayed or is the subject of an availability shortage because
of problems with our ability to manufacture or assemble the product or service
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. We carry product liability insurance, but existing coverage may not
be adequate to cover potential claims. We may be subject to repair, replacement, reimbursement and liability claims as
a result of products that fail to work or to meet applicable performance
criteria. 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. We attempt to
limit remedies for product or service failure to the repair or replacement of
malfunctioning or noncompliant products or services, and also attempt to
exclude or minimize exposure to product and related liabilities by including in
our standard agreements warranty disclaimers and disclaimers for consequential
and related damages as well as limitations on our aggregate liability. From
time to time, in certain complex sale or licensing transactions, we may
negotiate liability provisions that vary from such standard forms. There is a
risk that our contractual provisions may not adequately minimize our product
and related liabilities or that such provisions may be unenforceable. We carry
product liability insurance, but existing coverage may not be adequate to cover
potential claims. We maintain warranty reserves as deemed adequate by
management. Failure by us to maintain the proprietary nature of our technology,
intellectual property and manufacturing processes could have a material adverse
effect on our business, operating results, financial condition and stock price
and on our ability to compete effectively. 25




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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 thereunder 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. There is a risk that we have infringed or in the future will infringe
patents or trademarks owned by others, that we will need to acquire licenses
under patents or trademarks belonging to others for technology potentially
useful or necessary to us, and that licenses will not be available to us on
acceptable terms, if at all. 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. We also rely on trade secrets and proprietary know-how, which we seek to
protect by confidentiality agreements with our employees, consultants, service
providers and third parties. There is a risk that these agreements may be
breached, and that the remedies available to us may not be adequate. In
addition, our trade secrets and proprietary know-how may otherwise become known
to or be independently discovered by others. If we fail to adequately manage the size of our business, it could have a
severe negative effect on our financial results or stock price. Our management believes that in order to be successful we must appropriately
manage the size of our business. This may mean reducing costs and overhead in
certain economic periods, and selectively growing in periods of economic
expansion. In addition, we will be required to implement operational, financial
and management information procedures and controls that are efficient and
appropriate for the size and scope of our operations. The management skills and
systems currently in place may not be adequate and we may not be able to manage
any significant cost reductions or effectively provide for our growth. If we fail to attract and retain qualified senior executive and key technical
personnel, our business will not be able to expand. We are dependent on the continued availability of the services of our
employees, many of whom are individually key to our future success, and the
availability of new employees to implement our business plans. The market for
skilled employees is highly competitive, especially for employees in technical
fields. Although our compensation programs are intended to attract and retain
the employees required for us to be successful, there can be
no assurance that we will be able to retain the services of all our key
employees or a sufficient number to execute our plans, nor can there be any
assurance we will be able to continue to attract new employees as required. Our personnel may voluntarily terminate their relationship with us at any time,
and competition for qualified personnel, especially engineers, is intense. The
process of locating additional personnel with the combination of skills and
attributes required to carry out our strategy could be lengthy, costly and
disruptive. If we lose the services of key personnel, or fail to replace the services of
key personnel who depart, we could experience a severe negative effect on our
financial results and stock price. In addition, there is intense competition
for highly qualified engineering and marketing personnel in the locations where
we principally operate. The loss of the services of any key engineering,
marketing or other personnel or our failure to attract, integrate, motivate and
retain additional key employees could have a material adverse effect on our
business, operating and financial results and stock price. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk.The Companys exposure to market risk for changes in
interest rates relates primarily to the Companys cash equivalents, marketable
securities and line of credit.The Company does not use derivative financial
instruments. The Companys cash equivalents are invested in money market
accounts with major financial institutions. Due to the short duration and
conservative nature of the Companys cash equivalents, their carrying value
approximates fair market value. The Company has performed an analysis to
assess the potential effect of reasonably possible near-term changes in
interest rates. The effect of such rate changes is not expected to be material
to the Companys results of operations, cash flows or financial condition. 26




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The Company primarily enters into debt obligations to support general
corporate purposes including working capital requirements and capital
expenditures. The Company is subject to fluctuating interest rates that may
impact, adversely or otherwise, its results of operation or cash flows for its
variable rate lines of credit and cash equivalents. Foreign Currency Exchange Rate Risk.Certain of the Companys foreign
revenues, cost of revenues and marketing expenses are transacted in local
currencies, primarily the British Pound. As a result, the Companys results of
operations and certain receivables and payables are subject to foreign exchange
rate fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations. Gains and losses from such fluctuations have not
been material to the Companys consolidated results of operations or balance
sheet. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures.Based on their
evaluation as of the end of the period covered by this Quarterly Report on Form
10-Q, our chief executive officer and chief financial officer have concluded
that our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms. Changes in Internal Control Over Financial Reporting.There were no
changes in our internal control over financial reporting identified in
connection with our evaluation that occurred during our second fiscal quarter
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting. 
  PART II OTHER INFORMATION 
  Item 1. Legal ProceedingsOn February 5, 2003, Roger Benson, an individual, filed a lawsuit seeking
unspecified damages against the Company, Digital Biometrics, Inc. (DBI),
and Visionics Corporation in California Superior Court, alleging that in 1998
he was issued a duplicate electronic fingerprint number that was also held by
a convicted felon. He alleges that the fingerprint number was generated by a
live scan system manufactured by DBI and operated by a Sheriffs office in
the State of Oregon. The lawsuit also alleges injuries from a 43-day
incarceration after the plaintiffs identity was allegedly mistaken for that
of the felon because of the duplicate fingerprint number. The complaint
alleges liability under strict product liability, failure to warn, breach of
implied warranty, negligence, and unfair business practices, among other
theories of liability. On December 2, 2003, the court granted the Companys
motion for judgment on the pleadings, dismissing all of the plaintiffs
causes of action and granting leave to amend. The plaintiff filed amended
complaints on January 14, 2004, and January 30, 2004. Additional individual
plaintiffs were added to the amended complaint and the State of Oregon and
the State of California, among others, were added as defendants. On May 11,
2004, the Court denied the Companys motion to dismiss. While the case is
still in early stages of discovery, based on currently available information,
the Company believes that the issuance of any duplicate fingerprint numbers
was not the result of any design, manufacturing or product defect or
malfunction, or any other error, omission or fault on the part the Company or
affiliated defendants. The Company intends to vigorously defend this
lawsuit. 
  Item 2. Changes in Securities, Use of Proceeds and Purchases of Equity
SecuritiesOn March 10, 2004, Identix acquired certain technology from Delean Vision
Worldwide Inc. (Delean) by issuing 675,000 shares of common stock and a
warrant with contingent future vesting rights in favor of Delean to purchase
up to 800,000 shares of common stock at $4.70 per share. The technology
acquired was biometric recognition algorithms known as skin texture analysis
(STA) that allows a unique characteristic of the skin structure known as a
skinprint to be used to identify individuals. The warrant vests upon the
successful issuance of certain patents with the US government related to the
technology acquired from Delean. 27




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Item 6. Exhibits and Reports on Form 8-K.  (a)
    
    Exhibits ExhibitNumber
    
    Description10.57
    
    
    IPS Stock Purchase Agreement10.58
    
    
    LLC Membership Interest Transfer Agreement10.59
    
    
    Asset Purchase Agreement (incorporated by
reference to Exhibit 4.1 to the registration statement on Form
S-3 (333-113935) filed March 25, 2004)31.1
    
    
    CEO Certification31.2
    
    
    CFO Certification32
    
    
    906 Certifications
  (b)
    
    A Form 8-K was filed on January 29, 2004, which contained
the Companys press release announcing its the financial results
for the quarter ending December 31, 2004.(c)
    
    A Form 8-K was filed on February 13, 2004, which
contained the Companys press release announcing the sale of
Identix Public Sector (IPS) a wholly owned subsidiary of Identix. 28




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Identix Incorporated, a corporation
organized and existing under the laws of the State of Delaware, has duly caused
this report to be signed on its behalf by the undersigned thereunto duly
authorized, in the City of Minnetonka, State of Minnesota, on May 17, 2004. IDENTIX INCORPORATEDBY:
    
    /s/ James H. MoarJames H. MoarChief Financial Officer
 29