**U.S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

**(Mark One)**

 
| ý |   | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|--------|--------|---------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31, 2004**

 
| o |   | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  EXCHANGE ACT** |
|---|--------|---------------------------------------------------------------------------|

 

**For the transition periodfrom         to         **

 

**Commission file number 001-15757**

 

**IMAGEWARE SYSTEMS, INC.**

(Exact Name of Small Business Issuer as Specified in Its Charter)

 
| **California**                                                  |   | **33-0224167**                    |
|-----------------------------------------------------------------|--------|-----------------------------------|
| (State or Other Jurisdiction of Incorporation or  Organization) |   | (IRS Employer Identification No.) |

 

**10883 Thornmint RoadSan Diego, CA 92127**

(Address of Principal Executive Offices)

 

**(858) 673-8600**(Issuer’s TelephoneNumber, Including Area Code)

 

Checkwhether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.Yes ý  No o

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date: As of May 12, 2004, the number ofoutstanding shares of the Registrant’s common stock, par value $.01, was11,832,668.

 

TransitionalSmall Business Disclosure Format (check one) Yes o  No ý

 

 

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**IMAGEWARE SYSTEMS, INC. INDEX**

 
| PART I.    | FINANCIAL INFORMATION |
|------------|-----------------------|
|       | ITEM 1.               | FINANCIAL STATEMENTS (UNAUDITED) |
|       |                  | Condensed Consolidated  Balance Sheet as of March 31, 2004 |
|       |                  | Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2004 and 2003 |
|       |                  | Condensed Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and  2003 |
|       |                  | Condensed Consolidated  Statements of Comprehensive Income (Loss) for the three months ended  March 31, 2004 and 2003 |
|       |                  | Notes to Condensed Consolidated  Financial Statements |
|       | ITEM 2.               | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |
|       | ITEM 3.               | Controls and Procedures |
|       |                  |   |
| PART II.   | OTHER INFORMATION     |
|       | ITEM 5.               | Other Information |
|       | ITEM 6.               | EXHIBITS AND REPORTS ON FORM 8-K |
|       |                  |   |
| SIGNATURES |

 

2

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**PART I**

### **FINANCIALINFORMATION**

### ** **

**ITEM 1****. FINANCIAL STATEMENTS(UNAUDITED)**

 

**IMAGEWARE SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEET**

**ASSETS**

**(IN THOUSANDS)**

**(UNAUDITED)**

 
|                                                                                                                                                                                                                                                                             |   | **March 31,  2004** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                                                                                                                                                                                                                             |   |                     |   |
| Current Assets:                                                                                                                                                                                                                                                                  |   |                     |   |
| Cash                                                                                                                                                                                                                                                                             |   | $                        | 4,748  |   |
| Restricted cash and cash equivalents                                                                                                                                                                                                                                             |   | 155                      |   |
| Accounts receivable, net                                                                                                                                                                                                                                                         |   | 1,515                    |   |
| Inventory                                                                                                                                                                                                                                                                        |   | 561                      |   |
| Other current assets                                                                                                                                                                                                                                                             |   | 663                      |   |
| Total Current Assets                                                                                                                                                                                                                                                             |   | 7,642                    |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| Property and equipment, net                                                                                                                                                                                                                                                      |   | 570                      |   |
| Other assets                                                                                                                                                                                                                                                                     |   | 564                      |   |
| Intangible assets, net of accumulated  amortization                                                                                                                                                                                                                              |   | 1,025                    |   |
| Goodwill                                                                                                                                                                                                                                                                         |   | 5,298                    |   |
| **Total Assets**                                                                                                                                                                                                                                                                 |   | $                        | 15,099 |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                    |   |                     |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| Current Liabilities:                                                                                                                                                                                                                                                             |   |                     |   |
| Accounts payable                                                                                                                                                                                                                                                                 |   | $                        | 712    |   |
| Deferred revenue                                                                                                                                                                                                                                                                 |   | 869                      |   |
| Accrued expenses                                                                                                                                                                                                                                                                 |   | 1,197                    |   |
| Accrued interest                                                                                                                                                                                                                                                                 |   | 47                       |   |
| Notes & advances payable to third  parties                                                                                                                                                                                                                                   |   | 166                      |   |
| Notes payable to related parties                                                                                                                                                                                                                                                 |   | 14                       |   |
| Total Current Liabilities                                                                                                                                                                                                                                                        |   | 3,005                    |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| Warrant liability                                                                                                                                                                                                                                                                |   | 5,406                    |   |
| Pension obligation                                                                                                                                                                                                                                                               |   | 752                      |   |
| Total Liabilities                                                                                                                                                                                                                                                                |   | 9,163                    |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| Shareholders’ equity:                                                                                                                                                                                                                                                       |   |                     |   |
| Preferred stock, $.01 par value, authorized  4,000,000 shares Series B convertible redeemable preferred stock, designated  750,000 shares, 389,400 shares issued, and 249,400 shares outstanding at  March 31, 2004, liquidation preference $623,500 at March 31, 2004 |   | 2                        |   |
| Common stock, $.01 par value, 50,000,000  shares authorized, 11,806,552 shares issued and 11,799,848 shares outstanding  at March 31, 2004                                                                                                                                  |   | 117                      |   |
| Additional paid in capital                                                                                                                                                                                                                                                       |   | 54,380                   |   |
| Treasury stock, at cost - 6,704 shares                                                                                                                                                                                                                                           |   | (64                      | )      |
| Shareholder note receivable                                                                                                                                                                                                                                                      |   | (150                     | )      |
| Accumulated other comprehensive income                                                                                                                                                                                                                                           |   | 177                      |   |
| Accumulated deficit                                                                                                                                                                                                                                                              |   | (48,526                  | )      |
| Total shareholders’ equity                                                                                                                                                                                                                                                  |   | 5,936                    |   |
|                                                                                                                                                                                                                                                                             |   |                     |   |
| **Total Liabilities and Shareholders’ Equity**                                                                                                                                                                                                                              |   | $                        | 15,099 |   |

 

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

 

3

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**IMAGEWARE SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(IN THOUSANDS, EXCEPT SHARE AND PER SHAREAMOUNTS)**

**(UNAUDITED)**

 
|                                                    |   | **THREE  MONTHS ENDED  March 31,** |   |
|---------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                    |   | **2004**                                |   | **2003** |   |
|                                                    |   |                                    |   |   |   |
| **Revenues:**                                           |   |                                    |   |   |   |
| Product                                                 |   | $                                       | 1,880  |   | $ | 2,634 |   |
| Maintenance                                             |   | 484                                     |   | 798 |   |
|                                                    |   | 2,364                                   |   | 3,432 |   |
|                                                    |   |                                    |   |   |   |
| **Cost of revenues:**                                   |   |                                    |   |   |   |
| Product                                                 |   | 502                                     |   | 1,238 |   |
| Maintenance                                             |   | 248                                     |   | 355 |   |
| Gross profit                                            |   | 1,614                                   |   | 1,839 |   |
|                                                    |   |                                    |   |   |   |
| **Operating expenses:**                                 |   |                                    |   |   |   |
| General & administrative                            |   | 1,142                                   |   | 1,442 |   |
| Sales and marketing                                     |   | 682                                     |   | 1,089 |   |
| Research & development                              |   | 633                                     |   | 494 |   |
| Depreciation and amortization                           |   | 191                                     |   | 235 |   |
|                                                    |   | 2,648                                   |   | 3,260 |   |
|                                                    |   |                                    |   |   |   |
| Loss from operations                                    |   | (1,034                                  | )      | (1,421 | ) |
|                                                    |   |                                    |   |   |   |
| Interest (income) expense, net                          |   | 1,291                                   |   | 361 |   |
|                                                    |   |                                    |   |   |   |
| Other (income) expense, net                             |   | (20                                     | )      | (81 | ) |
|                                                    |   |                                    |   |   |   |
| Loss before income taxes                                |   | (2,305                                  | )      | (1,701 | ) |
|                                                    |   |                                    |   |   |   |
| Income tax expense (benefit)                            |   | —                                  |   | — |   |
|                                                    |   |                                    |   |   |   |
| Net loss                                                |   | $                                       | (2,305 | ) | $ | (1,701 | ) |
|                                                    |   |                                    |   |   |   |
| Basic and diluted (loss) per common share -  see note 2 |   | $                                       | (0.21  | ) | $ | (0.31 | ) |
| Weighted-average shares (basic and diluted)             |   | 11,210,019                              |   | 5,481,311 |   |

 

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

 

4

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**IMAGEWARE SYSTEMS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(IN THOUSANDS)**

**(UNAUDITED)**

 
|                                                                        |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                        |   | **2004**                                |   | **2003** |   |
|                                                                        |   |                                    |   |   |   |
| **Cash flows from operating  activities**                                   |   |                                    |   |   |   |
| Net loss                                                                    |   | $                                       | (2,305 | ) | $ | (1,701 | ) |
| Adjustments to reconcile  net loss to net cash used by operating activities |   |                                    |   |   |   |
| Depreciation and  amortization                                              |   | 191                                     |   | 238 |   |
| Non cash interest                                                           |   | 865                                     |   | 223 |   |
| Change in assets and  liabilities                                           |   |                                    |   |   |   |
| Accounts receivable, net                                                    |   | (64                                     | )      | 1,444 |   |
| Inventory                                                                   |   | 243                                     |   | (21 | ) |
| Other current assets                                                        |   | (459                                    | )      | (17 | ) |
| Intangible and other  assets                                                |   | 7                                       |   | (23 | ) |
| Accounts payable                                                            |   | (341                                    | )      | (527 | ) |
| Accrued expenses                                                            |   | 130                                     |   | (16 | ) |
| Accrued interest                                                            |   | (56                                     | )      | 130 |   |
| Deferred revenue                                                            |   | 22                                      |   | (9 | ) |
| Pension obligation                                                          |   | 18                                      |   | 20 |   |
| Total adjustments                                                           |   | 556                                     |   | 1,442 |   |
| Net cash used by  operating activities                                      |   | (1,749                                  | )      | (259 | ) |
|                                                                        |   |                                    |   |   |   |
| **Cash  flows from investing activities**                                   |   |                                    |   |   |   |
| Purchase of property and  equipment                                         |   | (30                                     | )      | (76 | ) |
| Payment on advances from  related stockholders                              |   | (45                                     | )      | (8 | ) |
| Net cash used by  investing activities                                      |   | (75                                     | )      | (84 | ) |
|                                                                        |   |                                    |   |   |   |
| **Cash  flows from financing activities**                                   |   |                                    |   |   |   |
| Proceeds from issuance  of notes payable                                    |   | —                                  |   | 600 |   |
| Repayment of notes  payable                                                 |   | (16                                     | )      | — |   |
| Debt issuance costs                                                         |   | —                                  |   | (218 | ) |
| Proceeds from issuance  of common stock, net of issuance costs              |   | 6,083                                   |   | — |   |
| Proceeds from exercised  stock options                                      |   | 174                                     |   | — |   |
| Dividends paid                                                              |   | (159                                    | )      |   |   |
| Proceeds from bank line  of credit                                          |   | —                                  |   | 142 |   |
|                                                                        |   |                                    |   |   |   |
| Net cash provided (used)  by financing activities                           |   | 6,082                                   |   | 524 |   |
| Effect of exchange rate  changes on cash                                    |   | (88                                     | )      | 32 |   |
| Net increase (decrease)  in cash                                            |   | 4,170                                   |   | 213 |   |
|                                                                        |   |                                    |   |   |   |
| Cash at beginning of  period                                                |   | 578                                     |   | 215 |   |
|                                                                        |   |                                    |   |   |   |
| Cash at end of period                                                       |   | $                                       | 4,748  |   | $ | 428 |   |

 

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

 

5

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**IMAGEWARE SYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

**(IN THOUSANDS)**

**(UNAUDITED)**

 
|                                     |   | **THREE  MONTHS ENDED  MARCH 31,** |   |
|------------------------------------------|--------|-----------------------------------------|--------|
|                                     |   | **2004**                                |   | **2003** |   |
|                                     |   |                                    |   |   |   |
| Net loss                                 |   | $                                       | (2,305 | ) | $ | (1,701 | ) |
| Other comprehensive  income (loss):      |   |                                    |   |   |   |
| Foreign currency  translation adjustment |   | (88                                     | )      | 32 |   |
| Comprehensive loss                       |   | $                                       | (2,393 | ) | $ | (1,669 | ) |

 

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

 

6

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**IMAGEWARE SYSTEMS, INC.**

 

**NOTES****TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 1.  DESCRIPTIONOF BUSINESS AND OPERATIONS**

 

ImageWare Systems, Inc. (“we,” “our” or the “Company”), formerlyknown as ImageWare Software, Inc., was incorporated in the State ofCalifornia on February 6, 1987. The Company utilizes digital imagingtechnology to provide stand alone, networked and web-based software solutionsfor secure credentials, biometrics, law enforcement and professionalphotography.

 

ImageWare’s law enforcement solutions enable agencies to quicklycapture, archive, search, retrieve, and share digital photographs and criminalhistory records on a stand alone, networked, wireless or web-based platform.ImageWare develops, sells and supports a suite of modular software productsused by law enforcement and public safety agencies to create and managecriminal history records and to investigate crime. Our C.R.I.M.E.S. systemconsists of eight software modules: Crime Capture System (consisting of theCapture Module and the Retrieval Module), which provides a criminal bookingsystem and related database; Face ID, which uses biometric facial recognitionto identify suspects; Suspect ID, which facilitates the creation of full-color,photo-realistic suspect composites; Crime Lab, which allows officers to enhanceand edit digital images; and Vehicle ID, which helps officers identify motorvehicles stolen or involved in a crime. In addition, we offer Crime Web, whichprovides access to centrally stored records over the Internet in a connected orwireless fashion, Pocket CCS which enables access to centrally stored recordswhile in the field on a handheld Pocket PC compatible device, and centralrepository services which allows for inter-agency data sharing on a local,regional, and/or national level.  Werecently added a new module to CCS which incorporates fingerprint livescancapabilities into CCS for real-time capture of single to ten prints and palm tofurther improve the booking, investigative and identification procedures.

 

ImageWare’s ID solutions empower customers to create secure and smartdigital identification documents with complete ID systems. We develop, sell andsupport software and design systems which utilize digital imaging in theproduction of photo identification cards and credentials and identificationsystems. Our sales in the digital identification market were developed throughour acquisitions of ITC, Goddard and G & A (discussed below). Ourproducts in this market consist of EpiSuite, EpiWeb, EpiWeb Enterprise,EpiBuilder (SDK), Identifier for Windows, ID Card Maker, Winbadge NT andWinbadge Aviation. These products allow for the production of digitalidentification cards and related databases and records and can be used by,among others, schools, airports, hospitals, corporations or governments.  We have recently added the ability to incorporatemultiple biometrics into the ID systems we offer with the addition of our newOmni Biometric Engine to our product line.

 

ImageWare’s Digital Photography (“PDI”) product line consists of asuite of software for the professional photography market. The software allowsprofessional photographers to digitally capture images, manipulate them tocreate a custom package or layout, then store the images with an associateddatabase. They can then print the digital images themselves or send them viathe Internet or CD to a professional lab for processing. Our products includePC Pro, PC Event, PDI School Days+, PDI Studio, PDI Pro Lab and PDI GreenScreen. Our customers use the software products in a wide variety of waysincluding retail studio environments, on-location event photography and “pictureday” at schools and day care centers. Our software products are sold through adealer network and directly to major accounts. The PDI group also operates ane-commerce service, Picturemore.com, used by professional photographers toallow their customers to order re-prints and various service items. Our salesin the digital photography market were developed as a result of our acquisitionof Castleworks and E-Focus West in August, 2001.

 

*Liquidity and Capital Resources*

 

Asreflected in the accompanying condensed consolidated financial statements, theCompany has losses and negative cash flows from operations.  The condensed consolidated financialstatements included in this report have been prepared assuming that the Companywill continue as a going concern.

 

In view of the matters described in the preceding paragraph,recoverability of a major portion of the recorded asset amounts shown in theaccompanying condensed consolidated balance sheet is dependent upon continuedoperations of the Company, which, in turn, is dependent upon the Company’sability to continue to raise capital and generate positive cash flows fromoperations.  The condensed consolidatedfinancial statements do not include any adjustments relating to therecoverability and classification of recorded asset amounts or amounts andclassifications of liabilities that might be necessary should the Company beunable to continue its existence.

 

TheCompany operates in markets that are emerging and highly competitive. There isno assurance that the Company will operate at a profit in the future.

 

*Basis of Presentation*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from those estimates.

 

7

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Theaccompanying condensed consolidated unaudited financial statements ofImageWare  have been prepared pursuantto the rules and regulations of the Securities and Exchange Commission (“SEC”)regarding interim financial reporting. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for annual financial statements and should be read in conjunctionwith the consolidated financial statements for the year ended December 31,2003 and notes thereto included in the Company’s Annual Report on Form 10-KSB,filed with the SEC on March 30, 2004. In the opinion of management, theaccompanying condensed consolidated financial statements contain alladjustments, consisting only of adjustments of a normal recurring nature,necessary for a fair presentation of the Company’s financial position as ofMarch 31, 2004, and its results of operations for the periods presented.These condensed consolidated unaudited financial statements are not necessarilyindicative of the results to be expected for the entire year.

 

*Stock-Based Compensation*

 

Stock-based compensation to employees has been recognized as thedifference between the per share fair value of the underlying stock and thestock option exercise price at the initial grant date.  The cost of stock options granted forservices, other than those issued to employees, are recorded at the fair valueof the stock option.

 

Had compensation cost for the Company’s stock option plan beendetermined based on the fair value at the grant date for awards consistent withthe provisions of Statement of Financial Accounting Standards. (“SFAS”) No.123, Accounting for Stock-Based Compensation, the Company’s net losses wouldhave been increased to the pro forma amount indicated below for the threemonths ended March 31, 2004 and 2003:

 
|                                                             |   | **THREE  MONTHS ENDED  MARCH 31,** |   |
|------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                             |   | **2004**                                |   | **2003** | ** ** |
| Net Loss:                                                        |   |                                    |   |   |   |
| As reported                                                      |   | $                                       | (2,305 | ) | $ | (1,701 | ) |
| Current period expense calculated under APB  25                  |   |                                    | — |   |   | — |   |
| Stock based employee compensation under  fair value based method |   | (82                                     | )      | (146 | ) |
| Pro forma net loss                                               |   | $                                       | (2,387 | ) | $ | (1,847 | ) |
|                                                             |   |                                    |   |   |   |
| Basic loss per common share:                                     |   |                                    |   |   |   |
| As reported                                                      |   | $                                       | (0.21  | ) | $ | (0.31 | ) |
| Pro forma                                                        |   | $                                       | (0.21  | ) | $ | (0.34 | ) |

 

On March 30, 2004, the Company entered into a stock exchange agreementwith certain employees whereby the employees would receive 255,792 shares ofrestricted stock in exchange for 426,321 options previously granted undervarious stock option plans.  Under theterms of the agreement, the employees will receive three shares of restrictedstock for each five options exchanged. The restricted stock will vest over three years on a quarterly basis andwill fully vest upon either a change in control, the sale of the Company, ortermination of employment unless such termination is for cause.

 

In accordance with Financial Accounting Standards Board InterpretationNo. 44 — Accounting for Certain Transactions Involving Stock Compensation (“FIN44”), the Company will recognize stock-based compensation expense ratably overthe vesting period of the restricted stock in an amount of approximately$82,000 per quarter.  Such compensationexpense was $0 for the three months ended March 31, 2004 due to thecommencement of the vesting period on March 30, 2004.

 

The differential between the number of shares underlying the optionsexchanged of 426,321 and the number of restricted shares issued of 255,792 aresubject to variable accounting treatment under the provisions of FIN 44 shouldany option grants be awarded to the participants of this stock exchangeagreement for a six month period beginning March 30, 2004.

 

8

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Certainreclassifications have been made to the prior period balances in order toconform to the current period presentation.

 

**NOTE 2.  NET LOSS PERCOMMON SHARE**

 

Basic loss per common share is calculated by dividing net lossavailable to common shareholders for the period by the weighted-average number of common shares outstandingduring the period. Diluted earnings per common share is calculated by dividingnet loss available to common shareholders for the period by theweighted-average number of common shares outstanding during the period, adjustedto include, if dilutive, potential dilutive shares consisting of convertiblepreferred stock, stock options, convertible notes payable and warrants,calculated using the treasury stock method. During the periods endedMarch 31, 2004 and 2003, the Company has excluded the following securitiesfrom the calculation of diluted loss per share, as their effect would have beenantidilutive due to the Company’s net loss:

 
| **Potential Dilutive Securities:** |   | **Number of  Common Shares  Convertible into at  March 31, 2004** |   | **Number of  Common Shares  Convertible into at  March 31, 2003** |   |
|------------------------------------|--------|------------------------------------------------------------------------|--------|------------------------------------------------------------------------|--------|
|                               |   |                                                                   |   |                                                                   |   |
| Convertible preferred stock        |   | 61,033                                                                 |   | 61,574                                                                 |   |
| Stock options                      |   | 870,424                                                                |   | 778,989                                                                |   |
| Convertible notes payable          |   | —                                                                 |   | 1,368,421                                                              |   |
| Warrants                           |   | 6,334,997                                                              |   | 2,865,227                                                              |   |

 

Thefollowing table sets forth the computation of basic and diluted loss per sharefor the three month periods ended March 31, 2004 and 2003 (amounts inthousands except share and per share amounts):

 
|                                      |   | **THREE  MONTHS ENDED  MARCH 31,** |   |
|-------------------------------------------|--------|-----------------------------------------|--------|
|                                      |   | **2004**                                |   | **2003** |   |
| Numerator                                 |   |                                    |   |   |   |
| Net loss                                  |   | $                                       | (2,305 | ) | $ | (1,701 | ) |
| Less Series B preferred dividends         |   | (15                                     | )      | (15 | ) |
| Net loss available to common shareholders |   | $                                       | (2,320 | ) | $ | (1,716 | ) |
|                                      |   |                                    |   |   |   |
| Denominator                               |   |                                    |   |   |   |
| Weighted-average shares outstanding       |   | 11,210,019                              |   | 5,481,311 |   |
|                                      |   |                                    |   |   |   |
| Basic and diluted loss per share          |   | $                                       | (0.21  | ) | $ | (0.31 | ) |

 

9

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**NOTE 3.  SEGMENTINFORMATION**

 

The Company is comprised of three reportable segments: Law Enforcement,Identification and Digital Photography. The Law Enforcement segment develops,sells and supports a suite of modular software products and designs systemsused by law enforcement and public safety agencies to manage criminal historyrecords and investigate crime. The Identification segment develops, sells andsupports software and designs systems which utilize digital imaging in theproduction of photo identification cards, documents and identification badgingsystems. The Digital Photography segment develops digital imaging software forphotographic purposes.

 

Corporate assets are comprised primarily of cash and other assetsproviding benefits to all business segments.

 

There are no significant intersegment transactions.

 

The table below summarizes information about reportable segments forthe three months ended March 31, 2004 and 2003:

 
|                         |   | **THREE  MONTHS ENDED  March 31,** |     |
|------------------------------|--------|-----------------------------------------|----------|
|                         |   | **2004**                                |     | **2003** |   |
|                         |   | **(in  thousands)**                     |     |
| Net Revenue:                 |   |                                    | * * |   | * * |
| Law Enforcement              |   | $                                       | 1,213    |   | $ | 791 |   |
| Identification               |   | 996                                     |     | 2,380 |   |
| Digital Photography          |   | 155                                     |     | 261 |   |
| Total consolidated net sales |   | $                                       | 2,364    |   | $ | 3,432 |   |
|                         |   |                                    |     |   |   |
| Operating profit (loss):     |   |                                    |     |   |   |
| Law Enforcement              |   | $                                       | 162      |   | $ | (180 | ) |
| Identification               |   | (969                                    | )        | (1,099 | ) |
| Digital Photography          |   | (227                                    | )        | (142 | ) |
|                         |   |                                    |     |   |   |
| Other unallocated amounts:   |   |                                    |     |   |   |
| Interest expense (income)    |   | 1,291                                   |     | 361 |   |
| Other expense (income)       |   | (20                                     | )        | (81 | ) |
|                         |   |                                    |     |   |   |
| Income (loss) before taxes   |   | $                                       | (2,305   | ) | $ | (1,701 | ) |

 
|                                 |   | **March 31,  2004** |   |
|--------------------------------------|--------|--------------------------|--------|
|                                 |   | **(in thousands)**       |   |
| Total Assets by Segment:             |   |                     |   |
|                                 |   |                     |   |
| Law Enforcement                      |   | $                        | 305    |   |
| Identification                       |   | 8,366                    |   |
| Digital Photography                  |   | 1,531                    |   |
| Total assets for reportable segments |   | 10,202                   |   |
| Corporate                            |   | 4,897                    |   |
| Total consolidated assets            |   | $                        | 15,099 |   |

 

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**NOTE 4. WARRANT LIABILITY**

 

In conjunction with the Company’s issuance ofsecured convertible promissory notes in June 2003 (the “Notes”), the Companyagreed to register with the Securities and Exchange Commission the shares ofcommon stock underlying the warrants issued in connection with the Notes.  In conjunction with the Company’s issuanceof common stock in separate private placement transactions in November 2003 andJanuary 2004, the Company agreed to register with the Securities and ExchangeCommission the shares of common stock underlying the warrants issued as part ofthe private placement transactions.  Inaccordance with the Financial Accounting Standards Board Emerging Issue TaskForce 00-19, the Company has recorded a long-term liability for the allocatedvalue of the warrants.  Accordingly, theCompany is accounting for the liability under fair value accounting.  The following table sets forth the changesin fair value and the resulting interest income or expense of this liability asdetermined under fair value accounting:

 
|                                                                                                         |   | **Warrant  Liability in Conjunction with warrants issued with Notes** |   | **Interest  Expense (Income) from revaluation of  Warrants issued with Notes** |   | **Warrant  Liability in Conjunction with warrants issued with November 2003 Private  Placement** |   | **Interest  Expense (Income) from revaluation of Warrants issued with November 2003  Private Placement** |   | **Warrant  Liability in Conjunction with warrants issued with January 2004 Private  Placement** |   | **Interest  Expense (Income) from revaluation of Warrants issued with January 2004  Private Placement** |   | **Total** |   |
|--------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|--------|-----------|--------|
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| (INTHOUSANDS)                                                                                                |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| Warrant liability at December 31, 2003                                                                  |   | $                                                                     | 2,046  |                                                                           |   |                                                                                                  | $      | 1,414                                                                                                         |   |                                                                                                 |   | $                                                                                                            | — |      |   |   | $ | 3,460 |   |
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| Warrant liability at date of inception of                                                                    |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| warrants issued in January 2004 private                                                                 |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| placement of securities                                                                                      |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   | $                                                                                                    | 1,080  |                                                                                                         |   |      | $      | 1,080 |   |
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| Change in fair value of warrant liability                                                                    |   | $                                                                     | 669    |                                                                           | $      | 669                                                                                                   |   | $                                                                                                             | 309    |                                                                                                 | $      | 309                                                                                                          |   | $         | (113   | ) | $ | (113 | ) | $ | 865 |   |
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| Warrant liability at March 31, 2004                                                                     |   | $                                                                     | 2,715  |                                                                           |   |                                                                                                  | $      | 1,723                                                                                                         |   |                                                                                                 |   | $                                                                                                            | 967    |      |   |   | $ | 5,405 |   |
|                                                                                                         |   |                                                                  |   |                                                                           |   |                                                                                                  |   |                                                                                                          |   |                                                                                                 |   |                                                                                                         |   |      |   |
| Interest Expense (Income) from revaluation of  warrant liability for three months ended March 31, 2004. |   |                                                                  |   | $                                                                              | 669    |                                                                                                  |   |                                                                                                          | $      | 309                                                                                                  |   |                                                                                                         |   | $         | (113   | ) | $ | 865 |   |

 

# **NOTE 5. COMMON STOCK**

 

On January 29, 2004, the Company completed a private placement,which involved the sale of units consisting of one share of common stock and awarrant to purchase 0.20 shares of common stock.  Each unit was priced at $3.65. The warrants, which are first exercisable six-months after the closingdate, have a five-year term and an exercise price of $5.48 per share.  As a result of this transaction, the Companyissued an aggregate of approximately 1,818,000 new shares of common stock andwarrants to purchase up to approximately 364,000 shares of common stock.  In connection with this transaction, theCompany also issued to certain placement agents warrants to purchase anadditional 199,000 shares of common stock. The Company raised approximately $6.6 million from the privateplacement.

 

# **NOTE 6. SUBSEQUENT EVENTS**

 

During April 2004, the Company issued 3,750 shares of common stockpursuant to stock option exercises and issued 29,070 shares of common stockpursuant to warrant exercises.

 

 

11

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**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.**

 

ThisQuarterly Report on Form 10-QSB contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, and Section 21Eof the Securities Exchange Act of 1934. All forward-looking statements includedin this report are based on information available to us as of the date hereofand we assume no obligation to update any forward-looking statements.Forward-looking statements involve known or unknown risks, uncertainties andother factors, which may cause our actual results, performance or achievements,or industry results to be materially different from any future results,performance or achievements expressed or implied by such forward-lookingstatements. Factors that could cause or contribute to such differences includebut are not limited to those items discussed under “Risk Factors” and elsewherein this Quarterly Report.

 

Thefollowing discussion of the financial condition and results of operations shouldbe read in conjunction with the condensed consolidated financial statementsincluded elsewhere within this quarterly report. Fluctuations in annual andquarterly results may occur as a result of factors affecting demand for theCompany’s products such as the timing of new product introductions by us and byour competitors and our customers’ political and budgetary constraints. Due tosuch fluctuations, historical results and percentage relationships are notnecessarily indicative of the operating results for any future period.

 

**OVERVIEW**

 

ImageWareSystems, Inc. utilizes its imaging technology to develop software used tocreate booking and investigative software, smart and secure identificationsystems and documents, and software for professional photographers. Oursoftware systems and associated hardware enable our customers to quicklycapture, archive, search, retrieve and share digital photographs and associatedtext records.

 

**RESULTS OF OPERATIONS**

 

***THREE MONTHS ENDED MARCH 31, 2004 AND2003.***

 
| **Net Product Revenues**                |   | **THREE  MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|-----------------------------------------|--------|------------------------------------------|--------|----------|--------|--------|------------|
| **(dollars in thousands)**              |   | **2004**                                 |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                    |   |                                     |   |     |   |   |       |   |   |
| **Product revenues:**                   |   |                                     |   |     |   |   |       |   |   |
| Law Enforcement                         |   | $                                        | 781    |     | $      | 204    |       | $ | 577 |   | 283 | % |
| Percentage of total net product revenue |   | 42                                       | %      | 8        | %      |   |       |   |   |
| Identification                          |   | $                                        | 945    |     | $      | 2,169  |       | $ | (1,224 | ) | -56 | % |
| Percentage of total net product revenue |   | 50                                       | %      | 82       | %      |   |       |   |   |
| Digital Photography                     |   | $                                        | 154    |     | $      | 261    |       | $ | (107 | ) | -41 | % |
| Percentage of total net product revenue |   | 8                                        | %      | 10       | %      |   |       |   |   |
| Total net product revenues              |   | $                                        | 1,880  |     | $      | 2,634  |       | $ | (754 | ) | -29 | % |

 

Productrevenues decreased 29% from $2,634,000 for the three months endedMarch 31, 2003 to $1,880,000 for the corresponding period in 2004.Revenues related to law enforcement systems and software increased $577,000 forthe three months ended March 31, 2004 as compared to the correspondingperiod in 2003.  This increase is dueprimarily to revenues from our implementation of a browser-based, investigativelaw enforcement system for the New South Wales Police Department.  We believe that the increase in terrorismhas created heightened interest in the ability of law enforcement and othergovernment agencies to be able to efficiently retrieve, analyze and shareinformation from their respective criminal databases.  We anticipate that these factors will continue to increase theoverall demand for the Company’s law enforcement products, however, we cannotpredict the timing of the shift in demand.

 

Identificationproduct revenues decreased 56% from $2,169,000 for the three months endedMarch 31, 2003 to $944,000 for the corresponding period in 2004.  Domestically, Identification revenuesdecreased approximately $506,000.  Thisdecrease in revenue is reflective of a decrease in project-oriented work and adecrease in boxed software sold through distribution channels.  In mid 2003, we established a masterdistributor to handle our domestic sales of our EPI line of boxedsoftware.  The master distributor model hasnot produced the results we anticipated and we have terminated that arrangementeffective June of this year and will implement a plan to re-establish directsales to our distribution channel. Internationally, our Identification revenues decreased approximately$718,000.   This decrease is reflectiveof procurement problems relating to our primary identification card printer andrelated print media consumables, which caused significant delays in our abilityto ship identification printers and related media.  We have addressed these procurement issues with the supplier ofthese products and have begun to receive shipments.  We do not anticipate any such interruptions in the future.  We continue to be of the opinion thatgovernment agencies and private entities will react to heightened securityconcerns resulting from acts of terrorism by re-evaluating and upgrading theirability to positively identify and track their

 

12

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employees,consultants and visitors. We anticipate that these factors will increaseoverall demand for the Company’s identification products, however, we cannotpredict the timing of the shift in demand.

 

13

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DigitalPhotography product revenues decreased 41% from $261,000 for the three monthsended March 31, 2003 to $154,000 for the corresponding period in2004.  This decrease is due to adecrease in custom contract programming during the first quarter of 2004.

 

Ourbacklog of product orders as of March 31, 2004 was approximately $888,000.

 
| **Maintenance Revenues**                    |   | **THREE MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|---------------------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|------------|
| **(dollars in thousands)**                  |   | **2004**                                |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                        |   |                                    |   |     |   |   |       |   |   |
| **Maintenance  revenues:**                  |   |                                    |   |     |   |   |       |   |   |
| Law Enforcement                             |   | $                                       | 432    |     | $      | 587    |       | $ | (155 | ) | -26 | % |
| Percentage of total net maintenance revenue |   | 74                                      | %      | 74       | %      |   |       |   |   |
| Identification                              |   | $                                       | 52     |     | $      | 211    |       | $ | (159 | ) | -75 | % |
| Percentage of total net maintenance revenue |   | 26                                      | %      | 26       | %      |   |       |   |   |
| Digital Photography                         |   | $                                       | — |     | $      | — |       | $ | — |   | N/A |   |
| Percentage of total net maintenance revenue |   | 0                                       | %      | 0        | %      |   |       |   |   |
| Total net maintenance revenues              |   | $                                       | 484    |     | $      | 798    |       | $ | (314 | ) | -39 | % |

 

Maintenancerevenues decreased 39% from $798,000 for the three months ended March 31,2003 to $484,000 for the corresponding period in 2004. Law enforcementmaintenance revenues decreased 26% or $155,000 for the three months endedMarch 31, 2004 from $587,000 for the three months ended March 31,2003 to $432,000 for the corresponding period in 2004. This decrease is dueprimarily to the expiration of the New York City Police Department service andmaintenance contract during the third quarter of 2003.

 

Identificationmaintenance revenues decreased 75% or $159,000 for the three months endedMarch 31, 2004 from $211,000 for the three months ended March 31,2004 to $52,000 for the corresponding period in 2003. This decrease is dueprimarily to the shift in our strategy in late 2003 to outsource internationalservice and maintenance for hardware. This shift has enabled the Company to reduce costs and focus itsresources on expanding our international sales effort of DigitalIdentification, Biometric, Law Enforcement and Digital Photography solutions.

 
| **Cost of Product Revenues:**                      |   | **THREE  MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|----------------------------------------------------|--------|------------------------------------------|--------|----------|--------|--------|------------|
| **(dollars in thousands)**                         |   | **2004**                                 |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                               |   |                                     |   |     |   |   |       |   |   |
| **Cost of Product  Revenues:**                     |   |                                     |   |     |   |   |       |   |   |
| Law Enforcement                                    |   | $                                        | 183    |     | $      | 165    |       | $ | 18 |   | 11 | % |
| Percentage of Law Enforcement product  revenue     |   | 23                                       | %      | 81       | %      |   |       |   |   |
| Identification                                     |   | $                                        | 303    |     | $      | 1,057  |       | $ | (754 | ) | -71 | % |
| Percentage of Identification product  revenue      |   | 32                                       | %      | 49       | %      |   |       |   |   |
| Digital Photography                                |   | $                                        | 16     |     | $      | 16     |       | $ | 0 |   | 0 | % |
| Percentage of Digital Photography product  revenue |   | 10                                       | %      | 6        | %      |   |       |   |   |
| Total net product revenues                         |   | $                                        | 502    |     | $      | 1,238  |       | $ | (736 | ) | -59 | % |
| Percentage of total product revenues               |   | 27                                       | %      | 47       | %      |   |       |   |   |

 

14

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Costof product revenues as a percentage of product revenues decreased from 47% forthe three month period ended March 31, 2003 to 27% of product revenues forthe corresponding period in 2004. This decrease is due primarily to product mixwith a greater percentage of product revenues being from software. Cost ofproduct revenues for our Law Enforcement segment increased 11%, or $18,000 from$165,000 or 81% of Law Enforcement product revenues for the three months endedMarch 31, 2003 to $183,000, or 23% of product revenues for the correspondingperiod in 2004.  This decrease, as apercentage of product revenues is due primarily to the larger revenue base toabsorb fixed product costs and product mix with a higher percentage of softwaresales.  Costs of products also can varyas a percentage of product revenue from period to period depending upon productmix and the hardware content, print media consumable content and softwarecontent included in systems installed during a given period.

 

Costof product revenues related to our Identification segment decreased 71% or$754,000 from $1,057,000 or 49% of Identification product revenues for thethree months ended March 31, 2003 to $303,000 or 32% of Identificationproduct revenues for the corresponding period in 2004.  The decrease is reflective of loweridentification revenues both domestically and internationally.

 
|                                                   |   | **THREE  MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|--------------------------------------------------------|--------|------------------------------------------|--------|----------|--------|--------|------------|
| **Maintenance cost of revenues**                       |   | **2004**                                 |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                                   |   |                                     |   |     |   |   |       |   |   |
| **Maintenance cost of  revenues:**                     |   |                                     |   |     |   |   |       |   |   |
| Law Enforcement                                        |   | $                                        | 196    |     | $      | 223    |       | $ | (27 | ) | -12 | % |
| Percentage of Law Enforcement maintenance  revenue     |   | 45                                       | %      | 38       | %      |   |       |   |   |
| Identification                                         |   | $                                        | 52     |     | $      | 132    |       | $ | (80 | ) | -60 | % |
| Percentage of Identification maintenance  revenue      |   | 101                                      | %      | 63       | %      |   |       |   |   |
| Digital Photography                                    |   | $                                        | — |     | $      | — |       | $ | — |   | N/A |   |
| Percentage of Digital Photography  maintenance revenue |   |                                     | %      |     | %      |   |       |   |   |
| Total net maintenance revenues                         |   | $                                        | 248    |     | $      | 355    |       | $ | (107 | ) | -30 | % |
| Percentage of total maintenance revenues               |   | 51                                       | %      | 44       | %      |   |       |   |   |

 

Costsof maintenance revenues decreased 30% from $355,000, or 44% of maintenancerevenues, for the three months ended March 31, 2003 to $248,000, or 51% ofmaintenance revenues, for the corresponding period in 2004. Cost of maintenancerevenues in Law Enforcement decreased 12%, from $223,000 or 38% of maintenancerevenues for the three months ended March 31, 2003 to $196,000 or 45% ofmaintenance revenues for the corresponding period in 2003. This dollar decreasein costs of maintenance revenues is reflective of reduced costs due to theexpiration of the New York City Police Department service and maintenancecontract in the third quarter of 2003 offset by costs necessary to service ourexpanding installed base. Identification maintenance cost of revenues decreased$80,000 largely due to the shift in strategy to outsource hardware service andmaintenance in late 2003.

15

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|                                               |   | **THREE  MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|----------------------------------------------------|--------|------------------------------------------|--------|----------|--------|--------|------------|
| **Product gross profit (dollars in  thousands)**   |   | **2004**                                 |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                               |   |                                     |   |     |   |   |       |   |   |
| **Product gross  profit**                          |   |                                     |   |     |   |   |       |   |   |
| Law Enforcement                                    |   | $                                        | 598    |     | $      | 39     |       | $ | 559 |   | 1434 | % |
| Percentage of Law Enforcement product  revenue     |   | 77                                       | %      | 19       | %      |   |       |   |   |
| Identification                                     |   | $                                        | 641    |     | $      | 1,112  |       | $ | (471 | ) | -42 | % |
| Percentage of Identification product  revenue      |   | 68                                       | %      | 51       | %      |   |       |   |   |
| Digital Photography                                |   | $                                        | 139    |     | $      | 246    |       | $ | (107 | ) | -44 | % |
| Percentage of Digital Photography product  revenue |   | 90                                       | %      | 94       | %      |   |       |   |   |
| Total net product revenues                         |   | $                                        | 1,378  |     | $      | 1,397  |       | $ | (19 | ) | -1 | % |
| Percentage of total product revenues               |   | 73                                       | %      | 53       | %      |   |       |   |   |

 

Totalproduct gross margin as a percentage of product revenues increased from 53% forthe three month period ended March  31, 2003 to 73% of product revenuesfor the corresponding period in 2004. The overall increase is primarily due toa higher percentage of total revenues coming from the sales of software.

 

LawEnforcement gross profit as a percentage of Law Enforcement product revenueincreased from 19% for the three months ended March 31, 2003 to 77% forthe corresponding period of 2004. This increase is due primarily to our productmix containing higher percentages of software than the comparable period in2003, as well as a higher revenue base to absorb fixed product costs.  Costs of products can vary as a percentageof product revenue from quarter to quarter depending upon product mix and hardwarecontent and print media consumable content included in systems installed duringa given period.

 

Identification gross profit as a percentageof Identification product revenue increased from 51% for the three months endedMarch 31, 2003 to 68% of Identification product revenues for the correspondingperiod in 2004.  This increase is dueprimarily to our product mix containing higher percentages of software than thecomparable period in 2003.  The shift inproduct mix is a result of lower sales in the period of hardware andconsumables due to procurement problems experienced during the first quarter of2004.

 

Grossmargins for the Digital Photography product segment decreased 44% or $107,000,from $246,000 or 94% of Digital Photography product revenues for the threemonths ended March 31, 2003 to $139,000, or 90% of Digital Photographyrevenues for the corresponding period in 2004. This decrease of $107,000 isreflective of our lower custom contract programming in the three months endedMarch 31, 2004 as compared to the corresponding period in 2003.

 
| **Maintenance gross profit**                           |   | **THREE  MONTHS  ENDED  MARCH 31,** |   |     |   |   |       |
|--------------------------------------------------------|--------|------------------------------------------|--------|----------|--------|--------|------------|
| **(dollars in thousands)**                             |   | **2004**                                 |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                                                   |   |                                     |   |     |   |   |       |   |   |
| **Maintenance gross****profit**                        |   |                                     |   |     |   |   |       |   |   |
| Law Enforcement                                        |   | $                                        | 236    |     | $      | 364    |       | $ | (128 | ) | -35 | % |
| Percentage of Law Enforcement maintenance  revenue     |   | 55                                       | %      | 62       | %      |   |       |   |   |
| Identification                                         |   | $                                        | (1     | )        | $      | 79     |       | $ | (80 | ) | -101 | % |
| Percentage of Identification maintenance  revenue      |   | -1                                       | %      | 37       | %      |   |       |   |   |
| Digital Photography                                    |   | $                                        | — |     | $      | — |       | $ | — |   | N/A |   |
| Percentage of Digital Photography  maintenance revenue |   | N/A                                      |   | N/A      |   |   |       |   |   |
| Total net maintenance revenues                         |   | $                                        | 235    |     | $      | 443    |       | $ | (208 | )  | -47 | % |
| Percentage of total maintenance revenues               |   | 49                                       | %      | 56       | %      |   |       |   |   |

 

Grossmargins related to maintenance revenues decreased $208,000 from $443,000, or56% of maintenance revenues for the three months ended March 31, 2003 to$235,000, or 49% of maintenance revenues for the corresponding period in 2004.This percentage decrease is due primarily to lower maintenance revenues toabsorb fixed maintenance costs.

 

16

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| **Operating expenses**          |   | **THREE  MONTHS ENDED  MARCH 31,** |   |     |   |   |       |
|---------------------------------|--------|-----------------------------------------|--------|----------|--------|--------|------------|
| **(dollars in thousands)**      |   | **2004**                                |   | **2003** |   | **$**  | **Change** |   | **%****Change** |   |
|                            |   |                                    |   |     |   |   |       |   |   |
| General & administrative    |   | $                                       | 1,142  |     | $      | 1,442  |       | $ | (300 | ) | -21 | % |
| Percentage of total net revenue |   | 48                                      | %      | 42       | %      |   |       |   |   |
| Sales and marketing             |   | $                                       | 682    |     | $      | 1,089  |       | $ | (407 | ) | -37 | % |
| Percentage of total net revenue |   | 29                                      | %      | 32       | %      |   |       |   |   |
| Research & development      |   | $                                       | 633    |     | $      | 494    |       | $ | 139 |   | 28 | % |
| Percentage of total net revenue |   | 27                                      | %      | 14       | %      |   |       |   |   |
| Depreciation and amortization   |   | $                                       | 191    |     | $      | 235    |       | $ | (44 | ) | -19 | % |
| Percentage of total net revenue |   | 8                                       | %      | 7        | %      |   |       |   |   |

 

*GENERAL AND ADMINISTRATIVE EXPENSES.* General and administrative expenses are comprised primarily of salariesand other employee-related costs for executive, financial, and otherinfrastructure personnel. General legal, accounting and consulting services,insurance, occupancy and communication costs are also included with general andadministrative expenses. Such expenses decreased 21%, or $300,000 from$1,442,000 for the three months ended March 31, 2003 to $1,142,000 for thecorresponding period in 2004.  Suchexpenses, as a percentage of total net revenues, increased from 42% for thethree months ended March 31, 2003 to 48% for the corresponding period in2004.  This percentage increase isreflective of lower total net revenues during the three months endedMarch 31, 2004 as compared to the corresponding period in 2003.  We are continuing to focus our efforts onachieving additional future operating efficiencies by reviewing and improvingupon existing business processes and evaluating our cost structure. We believethese efforts will allow us to gradually decrease our level of general andadministrative expenses expressed as a percentage of total revenues.

 

*SALES AND MARKETING.* Sales and marketing expenses consist primarily of the salaries,commissions, other incentive compensation, employee benefits and travelexpenses of our sales force. Such expenses decreased 37%, or $407,000 from $1,089,000for the three months ended March 31, 2003 to $682,000 for thecorresponding period in 2004.  Suchexpenses, as a percentage of total net revenues, decreased from 32% for thethree months ended March 31, 2003 to 29% for the corresponding period in2004.  The dollar decrease of $407,000is due primarily to reduced headcount and lower sales commissions.  The headcount reduction reflects theconsolidation in 2003 of our product lines and sales force under the directionof our San Diego office.  We anticipatethat expenses for sales and marketing will increase through 2004 as we addpersonnel and resources for large project solution sales.

 

*RESEARCH AND DEVELOPMENT.* Research and development costs consist primarily of salaries, employeebenefits and outside contractors for new product development, productenhancements and custom integration work. Such expenses increased 28% or$139,000 from $494,000  for the threemonths ended March 31, 2003 to $633,000 for the corresponding period in2004 due primarily to the accelerated development of our new OMNIBiometric product and the web enablement of our CCS product line utilizingcontract programming services in conjunction with internal research anddevelopment resources.   Our level of expenditures in research anddevelopment reflects our belief that to maintain our competitive position inmarkets characterized by rapid rates of technological advancement, we mustcontinue to invest significant resources in new systems and software as well ascontinue to enhance existing products.

 

*DEPRECIATION AND AMORTIZATION.* Depreciation and amortization decreased $44,000 from $235,000 for thethree months ended March 31, 2003 to $191,000 for the corresponding periodin 2004. This decrease is due primarily to lower amortization of intangibleassets due to such assets being fully amortized.

 

*INTEREST (INCOME) EXPENSE, NET.*  Forthe three months ended March 31, 2004, we recognized interest income of$2,000 and interest expense of $1,293,000. For the three months endedMarch 31, 2003, we recognized interest income of $1,000 and interestexpense of $362,000.  Interest expensefor the three months ended March 31, 2004 contains approximately $965,000of interest expense related to fair value accounting for our warrant liabilitydue to the registration rights agreement associated with the underlying sharesof the Company’s common stock to be issued upon conversion of thewarrants.  Interest expense for thethree months ended March 31, 2004 also contains $424,000 in liquidateddamages, which were classified as interest expense.  The liquidated damages were incurred as the Company did not meetcertain time requirements for the registration of shares of the Company’scommon stock under the registration rights agreements for the November 2003 andJanuary 2004 private placements. Interest expense for the three months ended March 31, 2003 includesapproximately of $269,000 of debt discount and deferred financing feeamortization classified as interest expense. The following table sets forth the major components of net interestexpense for the three months ended March 31, 2004 and 2003:

 

17

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|                                                                                         |   | **THREE  MONTHS ENDED  MARCH 31,** |   |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
| **Components of net interest expense  (income):**                                            |   | **2004**                                |   | **2003** |   |
| **(dollars in thousands)**                                                                   |   |                                    |   |   |   |
|                                                                                         |   |                                    |   |   |   |
| Senior secured convertible promissory note  issued May 22, 2002, interest rate 12.5% due     |   |                                    |   |   |   |
| May 22, 2004; Principal amount $2,000,000                                                    |   |                                    |   |   |   |
| Coupon interest rate expense                                                                 |   | $                                       | — |   | $ | 62 |   |
| Amortization to interest expense of note  discount related to fair value of warrants         |   |                                    |   | 67 |   |
| Amortization to interest expense of note  discount related to beneficial conversion feature  |   |                                    |   | 152 |   |
| Interest expense from amortization of  deferred financing fees                               |   |                                    |   | 48 |   |
|                                                                                         |   |                                    |   |   |   |
| Secured demand promissory note issued  September, 2002, interest rate 12.5%, due upon demand |   | —                                  |   | 16 |   |
|                                                                                         |   |                                    |   |   |   |
| Subordinated convertible promissory notes  issued                                            |   |                                    |   |   |   |
| March 2003, interest rate 8.5%, due  April 15, 2005; principal amount $600,000     |   |                                    |   |   |   |
| Coupon interest rate expense                                                                 |   |                                    |   | 1 |   |
| Amortization to interest expense of note  discount related to beneficial conversion feature  |   |                                    |   | 2 |   |
| Interest expense from amortization of  deferred financing fees                               |   |                                    |   | 1 |   |
|                                                                                         |   |                                    |   |   |   |
| Other note payable interest expense                                                          |   | 4                                       |   | 12 |   |
|                                                                                         |   |                                    |   |   |   |
| Change in warrant liability classified as  interest (income) or expense                      |   | 865                                     |   | — |   |
|                                                                                         |   |                                    |   |   |   |
| Interest expense from incurrence of  liquidated damages related to timely registration of    |   |                                    |   |   |   |
| Common stock                                                                                 |   | 424                                     |   | — |   |
|                                                                                         |   |                                    |   |   |   |
| Interest income                                                                              |   | (2                                      | )      | (0 | ) |
|                                                                                         |   |                                    |   |   |   |
| Net interest (income) expense                                                                |   | $                                       | 1,291  |   | $ | 361 |   |

 

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*LIQUIDITY AND CAPITAL RESOURCES*

 

Asof March 31, 2004, we had total current assets of $7,642,000 and totalcurrent liabilities of $3,005,000, or working capital of $4,637,000. AtMarch 31, 2004, we had available cash of $4,748,000 and $155,000 inrestricted cash securing our performance on certain software implementationcontracts.

 

Netcash used in operating activities was $1,749,000 for the three month periodended March 31, 2004 as compared to $259,000 for the corresponding periodin 2003. We used cash to fund net losses of $1,248,000, excluding non-cashexpenses (depreciation and amortization) of $1,057,000 for the three monthsended March 31, 2004.  We used cashto fund net losses of $1,240,000, excluding non-cash expenses (depreciation andamortization) of $461,000 for the corresponding period in 2003. For the threemonths ended March 31, 2004, we used cash of $273,000 to fund increases incurrent assets and used cash of $228,000 for reductions in current liabilitiesand deferred revenues, excluding debt. In 2003, we generated cash of $1,383,000from reductions to current assets and used cash of $402,000 from reductions incurrent liabilities and deferred revenues, excluding debt.

 

Netcash used by investing activities was $75,000 for the three months endedMarch 31, 2004 as compared to $84,000 for the corresponding period in2003. For the three months ended March 31, 2004, we used cash to fundcapital expenditures of computer equipment and software, furniture and fixturesand leasehold improvements of approximately $30,000. The level of equipmentpurchases resulted primarily from continued growth of the business andreplacement of older equipment. For the three months ended March 31, 2004,we used cash of approximately $45,000 to repay advances from relatedstockholders. For the three months ended March 31, 2003, we used cash of$76,000 to fund capital expenditures of computer equipment, software, furnitureand fixtures. We used cash of $8,000 to repay advances from relatedstockholders.

 

Netcash provided by financing activities was $6,082,000 for the three month periodended March 31, 2004 as compared to $524,000 for the corresponding period in 2003.  For the three months ended March 31, 2004, we generated cashof $6,083,000 from  our issuance ofcommon stock in a private placement.  Wealso generated cash of $174,000 from the exercise of stock options.   For the three months period endedMarch 31, 2004, we used cash of $159,000 for the payment of dividends onour Series B Preferred Stock and used cash of $16,000 for the repayment ofnotes payable.  For the three monthsended March 31, 2003, we generated cash of $600,000 from our issuance ofsubordinated convertible promissory notes payable offset by $60,000 in debtissuance costs.  We also used cash of$158,000 to fund increases in capitalized financing fees.  We also generated cash of $142,000 fromshort-term borrowings under bank line of credit agreements

 

We conduct operations in leased facilities under operating leasesexpiring at various dates through 2006. In conjunction with our performance onvarious software installation and implementation contracts, we are contingentlyliable under two irrevocable letters of credit in the aggregate amount of$155,000. The letters of credit expire in an amount of $49,000 onApril 19, 2004, with the remaining $106,000 expiring on December 26,2008.  We also have various short-termnotes payable due at various times during the next twelve months.

 

We believe that ourcurrent cash balances will satisfy our projected working capital and capitalexpenditure requirements for at least the next 12 months. Thereafter, weanticipate continuing to use cash, cash equivalents, and short-term investmentbalances to satisfy our projected working capital and capital expenditurerequirements. However, because of our concern that currently weak economicconditions may continue

 

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through 2004, if not longer, we have taken andcontinue to take steps to limit our expenses and align our cost structure toour revenues. These steps include, among other things, considering and/ortaking steps, as needed, to restructure our business, consolidating ouroperations, negotiating volume pricing with vendors, centralizing certainservices, and standardizing products. We recognize that our operating expenselevels, including research, development, engineering, selling, marketing,general and administrative expenses, depend on anticipated business activitylevels. While research, development, engineering and marketing expenses arebased on anticipated investment levels in technology development, productdevelopment and market development activities, the appropriate expense levelsin selling, general and administrative expenses are dependant on the level ofinfrastructure required to support our anticipated business volume. We reviewour business plans periodically to determine the appropriate level of such expensesbased on various business factors. In the past we have taken appropriatemeasures to control our expenses based on business circumstances. In the futurewe will continue to review our business plans from time to time and makeappropriate changes to our expense levels, as we have in the past, to reduceoperating expenses where it is advantageous to do so to improve operationalefficiencies.

 

In order to takeadvantage of opportunities, we may find it necessary to obtain additionalequity financing, debt financing, or credit facilities although we do notbelieve at this time that our long-term working capital and capitalexpenditures will be of such a nature that we would be required to take stepspresently to obtain such financings. If it were necessary to obtain additionalfinancings or credit facilities, we may not be able to do so, or if these fundsare available, they may not be available on satisfactory terms.

 

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**RISK FACTORS**

 

**WE HAVE A HISTORY OF SIGNIFICANT RECURRINGLOSSES TOTALLING APPROXIMATELY $48.5 MILLION, AND THESE LOSSES MAY CONTINUE INTHE FUTURE.**

 

As of March 31, 2004, we had an accumulated deficit of$48.5 million, and these losses may continue in the future. We may need toraise capital to cover these losses, and financing may not be available to uson favorable terms. We expect to continue to incur significant sales andmarketing, research and development, and general and administrative expenses.As a result, we will need to generate significant revenues to achieveprofitability and may never achieve profitability.

 

**THE HOLDERS OF OUR PREFERRED STOCK HAVECERTAIN RIGHTS AND PRIVILEGES THAT ARE SENIOR TO THE COMMON STOCK AND WE MAYISSUE ADDITIONAL SHARES OF PREFERRED STOCK WITHOUT SHAREHOLDER APPROVAL THATCOULD HAVE A MATERIAL ADVERSE EFFECT ON THE MARKET VALUE OF THE COMMON STOCK.**

 

Our Board of Directors has the authority to issue a total of up to4,000,000 shares of preferred stock and to fix the rights, preferences,privileges, and restrictions, including voting rights, of the preferred stock,which typically are senior to the rights of the common shareholders, withoutany further vote or action by you and the other common shareholders. Yourrights will be subject to, and may be adversely affected by, the rights of theholders of the preferred stock that have been issued, or might be issued in thefuture. Preferred stock also could have the effect of making it more difficultfor a third party to acquire a majority of the outstanding voting stock ofImageWare. This could delay, defer, or prevent a change in control.Furthermore, holders of preferred stock may have other rights, includingeconomic rights, senior to the common stock. As a result, their existence andissuance could have a material adverse effect on the market value of the commonstock. We have in the past issued, and, may from time to time in the futureissue, preferred stock for financing or other purposes with rights,preferences, or privileges senior to the common stock.

 

The provisions of our outstanding Series B Preferred Stockprohibit the payment of dividends on the common stock unless the dividends onthose preferred shares are first paid. In addition, upon a liquidation,dissolution or sale of ImageWare’s business, the holders of the Series BPreferred Stock will be entitled to receive, in preference to any distributionto the holders of common stock, initial distributions of $2.50 per share, plusall accrued but unpaid dividends.

 

Pursuant to the terms of our Series B Preferred Stock we are obligatedto pay cumulative cash dividends on shares of Series B Preferred Stock fromlegally available funds at the annual rate of $0.2125 per share, payable in twosemi-annual installments of $0.10625 each, which cumulative dividends must bepaid prior to payment of any dividend on our Common Stock.  As of March 31, 2004, the Company hadcumulative undeclared dividends of approximately $22,000.

 

**WE DEPEND UPON A SMALL NUMBER OF LARGE SYSTEMSALES RANGING FROM $300,000 TO IN EXCESS OF $1,000,000, AND WE MAY FAIL TOACHIEVE ONE OR MORE LARGE SYSTEM SALES IN THE FUTURE.**

 

In the past three years we have derived a substantial portion of ourrevenues from a small number of sales of large, relatively expensive systems,typically ranging in price from $300,000 to in excess of  $1,000,000. As a result, if we fail toreceive orders for these large systems in a given sales cycle on a consistentbasis, our business could be significantly harmed. Further, our quarterlyresults are difficult to predict because we cannot predict in which quarter, ifany, large system sales will occur in a given year. As a result, we believethat quarter-to-quarter comparisons of our results of operations are not a goodindication of our future performance. In some future quarters our operatingresults may be below the expectations of securities analysts and investors, inwhich case the market price of our common stock may decrease significantly.

 

**OURRELIANCE ON SINGLE SOURCE SUPPLIERS COULD DELAY PRODUCT SHIPMENTS.**

 

We purchaseprinters, cameras and custom consumable products (printer ribbons and cardmaterials) which we resell to our customers. There are a number of suppliers that sell these items; however, in somecases these are purchased from a single supplier due to price, quality,technology or customer requirements.  Ifwe are unable to purchase sufficient quantities of these products on acceptableterms or experience significant delays or quality issues in the delivery ofthese products and must find a new supplier of equivalent products, our new andexisting product shipments could be delayed or reduced, adversely affecting ourbusiness and operating results.

 

**OUR LENGTHY SALES CYCLE MAY CAUSE US TOEXPEND SIGNIFICANT RESOURCES FOR AS LONG AS ONE YEAR IN ANTICIPATION OF A SALE,YET WE STILL MAY FAIL TO COMPLETE THE SALE.**

 

When considering the purchase of a large computerized booking oridentification system, a government agency may take as long as a year toevaluate different systems and obtain approval for the purchase. If we fail tocomplete a sale, we will have expended significant resources and received norevenue in return. Generally, agencies consider a wide range of issues beforecommitting to purchase our products, including product benefits, ability tooperate with their current systems, product reliability and their own budgetaryconstraints. While potential customers are evaluating our products and beforethey place an order with us, we may incur substantial selling costs and expendsignificant management effort to accomplish a sale.

 

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**A SIGNIFICANT NUMBER OF OUR CUSTOMERS AREGOVERNMENT AGENCIES THAT ARE SUBJECT TO UNIQUE POLITICAL AND BUDGETARYCONSTRAINTS AND HAVE SPECIAL CONTRACTING REQUIREMENTS WHICH MAY AFFECT OURABILITY TO OBTAIN NEW GOVERNMENT CUSTOMERS.**

 

A significant number of our customers are government agencies. Theseagencies often do not set their own budgets and therefore have little controlover the amount of money they can spend. In addition, these agencies experiencepolitical pressure that may dictate the manner in which they spend money. Dueto political and budgetary processes and other scheduling delays that mayfrequently occur relating to the contract or bidding process, some governmentagency orders may be canceled or substantially delayed, and the receipt ofrevenues or payments may be substantially delayed. In addition, future sales togovernment agencies will depend on our ability to meet government contractingrequirements, certain of which may be onerous or impossible to meet, resultingin our inability to obtain a particular contract. Common requirements ingovernment contracts include bonding requirements, provisions permitting thepurchasing agency to modify or terminate at will the contract without penalty,and provisions permitting the agency to perform investigations or audits of ourbusiness practices.

 

**WE MAY FAIL TO CREATE NEW APPLICATIONS FOROUR PRODUCTS AND ENTER NEW MARKETS, WHICH MAY AFFECT OUR FUTURE SUCCESS.**

 

We believe our future success depends in part on our ability to developand market our technology for applications other than booking systems for thelaw enforcement market. If we fail in these goals, our business strategy andability to generate revenues and cash flow would be significantly impaired. Weintend to expend significant resources to develop new technology, but thesuccessful development of new technology cannot be predicted and we cannotguarantee we will succeed in these goals.

 

**WE OCCASIONALLY RELY ON SYSTEMS INTEGRATORSTO MANAGE OUR LARGE PROJECTS, AND IF THESE COMPANIES DO NOT PERFORM ADEQUATELY,WE MAY LOSE BUSINESS.**

 

We are occasionally a subcontractor to systems integrators who managelarge projects that incorporate our systems, particularly in foreign countries.We cannot control these companies, and they may decide not to promote ourproducts, or they may price their services in such a way as to make itunprofitable for us to continue our relationship with them. Further, they may failto perform under agreements with their customers, in which case we might losesales to these customers. If we lose our relationships with these companies,our business may suffer.

 

**WE DO NOT HAVE U.S. OR FOREIGN PATENTPROTECTION FOR OUR PRODUCTS, AND A COMPETITOR MAY BE ABLE TO REPLICATE OURTECHNOLOGY.**

 

Our business is based in large part on our technology, and our successdepends in part on our ability and efforts to protect our intellectual propertyrights. If we do not adequately protect our intellectual property throughcopyrights and various trade secret protections afforded to us by law, ourbusiness will be seriously harmed. We do not have patent protection for ourproducts.

 

We license certain elements of our trademarks, trade dress, copyrightand other intellectual property to third parties. We attempt to ensure that ourrights in our trade names and the quality of third party uses of our names aremaintained by these third parties. However, these third parties may takeactions that could significantly impair the value of our intellectual propertyand our reputation and goodwill.

 

In addition, international intellectual property laws differ fromcountry to country. Any foreign rights we have in our technology are limited bywhat has been afforded to us under the applicable foreign intellectual propertylaws. Also, under the laws of certain foreign jurisdictions, in order to haverecognizable intellectual property rights, we may be required to fileapplications with various foreign agencies or officials to register ourintellectual property. Accordingly, our ability to operate and exploit ourtechnology overseas could be significantly hindered.

 

**WE HAVE ACQUIRED SEVERAL BUSINESSES AND FACERISKS ASSOCIATED WITH INTEGRATING THESE BUSINESSES AND POTENTIAL FUTUREBUSINESSES THAT WE MAY ACQUIRE.**

 

We completed the acquisitions of several companies and we plan tocontinue to review potential acquisition candidates, and our business and ourstrategy includes building our business through acquisitions. However,acceptable acquisition candidates may not be available in the future or may notbe available on terms and conditions acceptable to us.

 

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Acquisitions involve numerous risks, including among others, difficultiesand expenses incurred in the consummation of acquisitions and assimilation ofthe operations, personnel and services and products of the acquired companies.Additional risks associated with acquisitions include the difficulties ofoperating new businesses, the diversion of management’s attention from otherbusiness concerns and the potential loss of key employees of the acquiredcompany. If we do not successfully integrate the businesses we may acquire inthe future, our business will suffer.

 

**WE OPERATE IN FOREIGN COUNTRIES AND AREEXPOSED TO RISKS ASSOCIATED WITH FOREIGN POLITICAL, ECONOMIC AND LEGALENVIRONMENTS AND WITH FOREIGN CURRENCY EXCHANGE RATES.**

 

With our acquisition of G & A, we have significant foreignoperations and are accordingly exposed to risks, including among others, risksassociated with foreign political, economic and legal environments and withforeign currency exchange rates. Our results may be adversely affected by,among other things, changes in government policies with respect to laws andregulations, anti-inflation measures, currency conversions, remittance abroadand rates and methods of taxation.

 

**ITEM 3****.  CONTROLS ANDPROCEDURES**

 

*Evaluation of disclosure controls andprocedures. *ImageWare’schief executive officer and its chief financial officer, after evaluating theeffectiveness of ImageWare’s disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2004, haveconcluded that as of such date, ImageWare’s disclosure controls and procedureswere adequate and sufficient to ensure that information required to bedisclosed by ImageWare in the reports that it files under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported within the time period specified in the Securities and ExchangeCommission’s rules and forms.

 

*Changes in internal controls. *There has been nochange in our internal control over financial reporting during the fiscalquarter ended March 31, 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II**

**ITEM 5. OTHER****INFORMATION**

 

As of May 12, 2004, JosephSchuler, the Company’s Senior Vice President of Sales and Marketing, left theCompany to pursue other personal opportunities.  Mr. Schuler is expected to continue to work with the Company as aconsultant.

 

**ITEM 6****. EXHIBITS AND REPORTS ONFORM 8-K**

 

**(a)****                                 ****EXHIBITS**

 

10.1                           Form of Securities Purchase Agreement dated January 29, 2004*

10.2                           Form of Warrant dated January 29, 2004*

10.3                           Form of Registration rights Agreement datedJanuary 29, 2004*

31.1                           Certification of Chief Executive Officerpursuant to Section 302 of the Sarbanes-Oxley Act

31.2                           Certificationof Chief Financial Officer pursuant ot Section 302 of the Sarbanes-OxleyAct

32.1                           Certification by ChiefExecutive Officer and Chief Financial Officer pursuant to Section 906 ofthe Sarbanes-Oxley Act

 

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*                 Incorporated by reference toImageWare’s Current Report, Form 8-K as filed with the Securities and ExchangeCommission on February 9, 2004.

 

**(b)****                                 ****Reports on Form 8-K**

 

During the three months ended March 31, 2004, we filed one reporton Form 8-K.  We filed a report on Form8-K on February 9, 2004 to report and disclose information concerning theissuance of shares of our common stock and warrants to purchase shares of ourcommon stock in private placement transactions that took place in November 2003and January 2004.

 

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**SIGNATURES**

 

Inaccordance with the requirements of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                | IMAGEWARE  SYSTEMS, INC. |
|---------------------|--------------------------|
|                |                     |   |
|                |                     |   |   |
| Date:  May 17, 2004 | By:                      | /s/ Wayne Wetherell |   |
|                |                     | Wayne Wetherell, Chief Financial Officer  (on behalf of the Registrant and  as Registrant’s Principal Financial and  Accounting Officer) |   |

 

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