U.S. SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

FORM 10-KSBý Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2004

Commission File Number 1-13463

BIO-KEY INTERNATIONAL, INC.(Name of small business issuer in its charter)

|DELAWARE(State or other jurisdiction of
Incorporation or organization) |  | 41-1741861(IRS Employer Identification Number)
|---------------------------------------------------------------------- |  | ----------------------------------------------

3349 HIGHWAY 138, BUILDING D, SUITE B, WALL, NJ 07719(Address of Principal Executive Offices) (Zip Code)

(732) 359-1100Issuer's telephone number, including area code.

Securities registered pursuant to Section 12(b) of the Act:

|Title of Each ClassCommon Stock, $0.01 par value per share |  | Name of Exchange on which RegisteredNone
|---------------------------------------------------------- |  | ----------------------------------------

Securities registered under Section 12(g) of the Exchange ActNone

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

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will
be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment
to this form 10-KSB. o

State issuer's revenues for its most recent fiscal year: $5,558,231

The
aggregate market value of the voting common equity held by non-affiliates of the registrant based on the closing sale price of the registrant' common stock as reported on
the OTC Bulletin Board on March 1, 2005 was $50,497,343. The information provided shall in no way be construed as an admission that any person whose holdings are excluded from the figure is an
affiliate or that any person whose holdings are included in the figure is not an affiliate, and any such admission is hereby disclaimed. The information provided is solely for the record keeping
purposes of the Securities and Exchange Commission.

As
of March 1, 2005, 43,266,032 shares of the registrant's common stock were outstanding.

Transitional
Small Business Disclosure Formats (check one):

Yes o    No ý

DOCUMENTS INCORPORATED BY REFERENCE

None.



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PART I

PRIVATE SECURITIES LITIGATION REFORM ACT

The information contained in this Annual Report on Form 10-KSB and in other public statements by the Company and Company officers include or
may contain certain forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933 and Section 21E of the U.S. Securities Exchange of 1934. All
statements other than statements of historical facts contained in this Annual Report on Form 10-KSB, including statements regarding our future financial position, business strategy
and plans and objectives of management for future operations, are forward-looking statements. The words "anticipate," "believe," "estimate," "will," "may," "future," "plan," "intend" and "expect" and
similar expressions generally identify forward-looking statements. Although we believe our plans, intentions and expectations reflected in the forward-looking statements are reasonable, we cannot be
sure they will be achieved. Actual results may differ materially from the forward-looking statements contained herein due to a number of factors. Many of these factors are set forth under the caption
"Risk Factors" in Item I of this Annual Report and other filings with the Securities and Exchange Commission. These factors are not intended to
represent a complete list of the general or specific factors that may affect us. It should be recognized that other factors, including general economic factors and business strategies, may be
significant, presently or in the future. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or
otherwise.

ITEM 1. DESCRIPTION OF BUSINESS

BIO-key International, Inc., a Delaware corporation ("The Company," "BIO-key," "we," or "us), founded in 1993, delivers advanced
finger based biometric identification and security solutions and information services to law enforcement, fire service, and emergency medical service agencies as well as other government and private
sector customers. BIO-key's mobile wireless technology provides first responders with critical, reliable, real-time data and images from local, state, and national databases.
More than 2,500 police, fire, and emergency services departments in North America currently use
BIO-key solutions, making the Company a leading supplier of mobile and wireless solutions for public safety.

Effective
January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key"), reincorporated as the Company. The reincorporation
was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement"), whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to
reincorporate in the State of Delaware (the "Reincorporation"). As a result of the Reincorporation, the legal domicile of the Company is now Delaware.

Pursuant
to the Merger Agreement, at the effective time of the Reincorporation: (i) each outstanding share of Common Stock of Old BIO-key, $0.01 par value per share,
was automatically converted into one share of Common Stock, $0.0001 par value per share, of the Company; (ii) each outstanding share of Series C 7% Convertible Preferred Stock of Old
BIO-key, $0.01 par value per share, was automatically converted into one share of Series A 7% Convertible Preferred Stock, $0.0001 par value per share, of the Company, with such
Series A 7% Convertible Preferred Stock containing substantially identical terms and conditions as the Series C 7% Convertible Preferred Stock of Old BIO-key;
(iii) each option to purchase shares of Old BIO-key's Common Stock granted by Old BIO-key under any warrant, stock option plan or similar plan of Old BIO-key
outstanding immediately before the Reincorporation was, by virtue of the Merger Agreement and without any action on the part of the holder thereof, converted into and become an option to purchase,
upon the same terms and conditions, the same number of shares of the Company's Common Stock at an exercise price per share equal to the exercise price per share thereunder immediately before the
Reincorporation; and (iv) each

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warrant,
option or stock option plan of Old BIO-key was assumed by, and continues to be, a warrant, option or plan of the Company. Accordingly, as a result of the Reincorporation, the
shareholders of Old BIO-key became shareholders of the Company, and Old BIO-key has been merged out of existence by operation of law. Each certificate representing shares of
capital stock of Old BIO-key outstanding immediately before the Reincorporation, is deemed from and after the Reincorporation for all corporate purposes to represent the same number of
shares of capital stock of the Company.

Product Lines

BIO-key has four major product linesbiometrics, handheld mobile software/devices, mobile information software and records management
software for fire service/EMS agencies. These lines are described below and a list of products in each line is noted.

Biometrics

BIO-key's finger identification algorithmvector segment technology (VST) is the technology behind its full suite of
biometric products that include:



The
Company's biometric identification technology improves both the accuracy and speed of finger-based biometrics. The Company's proprietary biometric technology scans a fingerprint and
identifies a person, typically within a few seconds or less, in databases of a million people or more, without using any other identifying dataa key differentiator for BIO-key
since other biometric solutions may also require traditional token/card identification. The company believes its fingerprint identification technology has a broad range of possible information
security and access control applications, including:



Handheld Mobile Software/Devices

On March 30, 2004, BIO-key acquired Public Safety Group, Inc. (PSG), a privately held company that is a leader in wireless solutions for
law enforcement and public safety markets. PSG's primary technology is PocketCop. In addition to PocketCop, BIO-key also offers PocketBlue handheld
solution that provides mobile officers, such as detectives who are not typically in their vehicles, a hand-held, scaled down version of its mobile information software solution,
PacketCluster.

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Following
are description of both products:

PocketCOPPocketCop is a software solution that provides police officers and other security
personnel instantaneous access to important criminal, civil and private database information in a wireless environment. PocketCop is a handheld application that allows law enforcement
officers to access state and federal databases over the wireless network for PalmOS, Windows CE, and PocketPC. Using a portable wireless handheld device and the PocketCop application
software, an authorized user can access suspect information such as wanted status, warrant status, vehicle registration and driver license status. PocketCop technology has been deployed
in numerous police departments in the United States, including the deployment for the Massachusetts State Police.

PocketBluePocketBlue is driven by the growing demand to get mission-critical information to the officer in the
field, and serves as a logical and essential extension to the core PacketCluster system. Law enforcement personnel with duty assignments outside of a vehicle require the same quick, secure, and
confidential access to criminal history information as their in-vehicle counterparts. PocketBlue meets that need with a wireless handheld solution available on a variety of platforms.
PocketBlue features include:



Mobile Information Software for Police, Fire, and Emergency Medical Service ("EMS") Agencies

On September 30, 2004, BIO-key completed a transaction with Aether Systems, Inc. to purchase its Mobil Government Division ("Mobile
Government" or "AMG"), a leading provider of wireless data solutions for use by public safety organizations, primarily state, local police, fire and rescue, and emergency medical services
organizations. The PacketCluster mobile information software is integrated with 50 separate State/NCIC databases, as well as other state, local and federal databases. Its open architecture and its
published Application Programming Interface (API) make it easy to interface with a wide range of information sources. PacketCluster products deliver real-time information in seconds,
freeing dispatchers to handle more pressing emergencies. The PacketCluster suite of products includes:



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BIO-key
also provides a number of optional features designed to augment the core products. These include:



Records Management Software for Fire Service/EMS Agencies

In addition to law enforcement/fire service mobile data solutions, BIO-key offers its Sunpro fire service/EMS records management software,
FireRMS, that helps large and small agencies manage operations, track incidents, and support fire prevention initiatives. FireRMS Mobile provides wireless query and messaging solutions
that extend computer aided dispatch, fire records, and other in-house data sources to a mobile environment and provide mission-critical information to emergency response personnel where
and when they need it.



BIO-key
also offers the following Fire/EMS Partner solutions:



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Current Business Plan

BIO-key's current business plan is to:



Current Market

Biometrics

BIO-key actively markets and sells its biometric technology to biometric system integrators and resellers who are focused on the security and logical
access markets. A number of BIO-key's customers have begun to deploy its technology on a run-time basis, which is generating recurring revenues.

Public Safety

BIO-key's public safety offerings are sold directly to counties, cities, or towns across North America and to Computer Aided Dispatch/Records
Management System application providers and system integrators who include BIO-key's mobile data and fire records management software as part of their overall deliverables for their
customers. Most often, public safety offerings for small sized cities or towns are provided by BIO-key authorized resellers.

BIO-key
is a leading supplier of mobile data solutions for police and fire service agencies using laptop computers as well as applications for handheld mobile delivery on
different devices, including Blackberries, PDAs, Smartphones, and tablet notebook computers located in police vehicles. BIO-key handheld offerings are particularly suited for specialty
units and investigators that work remotely and do not have access to a conventional office desktop computer or a laptop computer.

In
the law enforcement market, BIO-key serves the full range of law enforcement agencies via its direct sales force, and addresses the needs of smaller agencies through its
authorized resellers. By bringing both PSG and AMG products into BIO-key, the company offers a full range of device-independent functionality. BIO-key can serve both public
carrier infrastructure and private radio infrastructure markets, and also offers mixed deployments of private radio and public carrier infrastructures.Law enforcement officials have real-time access to the data they need including wants and warrants and Department of Motor Vehicle information. BIO-key also offers
report-writing products for field officers to use for data capture and reporting.

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In the Fire Records Management market, mature products and vendors are moving up market for new opportunities, while new players are entering the market. One area of expected growth in
the Fire Records Management market is Emergency Medical Service (EMS) data collection and reporting. Recent statistics released by the National Fire Department indicate that in 2004, 58% of all calls
to fire service agencies were EMS-related. Leading drivers for a fire records management system include state reporting, the automatic export of data to billing systems, and efficient
field data collection using mobile solutions.

Potential Market

Biometrics

Concerns relating to Homeland Security and the ever-increasing occurrences of identity theft in the commercial marketplace have amplified the need for
positive identification of individuals, and increased interest in biometrics. BIO-key believes its biometric technology provides a most reliable, convenient, and cost effective method for
confirming the identity of persons in local or remote locations relative to existing traditional methods.

Fingerprint
based biometric solutions currently compete with more traditional security methods such as keys, cards, personal identification numbers and security personnel as well as
other forms of biometric technologies including voice, face, iris and hand geometry. The proliferation of electronic business-to-business and
business-to-consumer transactions continues to grow rapidly. Such transactions are subject to fraud resulting from unauthorized individuals gaining access to confidential
information.

Biometric
technology is becoming an acceptable approach to physical and logical security. Acceptance of biometrics as an alternative to traditional security methods depends upon a number
of factors including:



Public Safety Agencies

Public safety is a large and important market. The ability to quickly and accurately collect data from a variety of database sources and formats and deliver this
information to first responders represents a new paradigm for bringing real time intelligence to security officers deployed in the field. With BIO-key's acquisition of PSG and AMG, the
Company believes there is a substantial market opportunity to integrate our VST and WEB-key biometric technologies with our leading public safety solutions for police, fire and EMS to
protect access to the information.

BIO-key
markets and sells its wireless data solutions primarily to local, county, state, university, and federal law enforcement and fire service/EMS agencies throughout the
United Sates. BIO-key maintains an established, loyal public safety customer base and expects continued growth in this market, particularly in light of heightened security concerns.

During
fiscal year 2005, the company is consolidating its PSG and AMG products under one complete BIO-key public safety product suite. In addition, BIO-key is
expanding its biometric offerings to its public safety customer base, so they can take advantage of the BIO-key biometric solutions. This will enable customers to provide secure access to
both logical (PCs, LANs and data access) and physical (building and access to secure areas such as evidence rooms and IT facilities) areas.

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Competition

The markets for BIO-key products and technologies are developing; they are characterized by intense competition and rapid technological change. No
assurance can be given that our competitors will not develop new or enhanced technologies that will offer superior price, performance, or features, or render BIO-key products or
technologies obsolete.

Biometrics

In addition to companies that provide existing commonplace methods of restricting access to facilities and logical access points such as pass cards, PIN numbers,
passwords, locks and keys, there are numerous companies involved in the development, manufacturing and marketing of fingerprint biometrics products to commercial, government, law enforcement, and
prison markets. These companies include, but are not limited to, Cogent, NEC, Printrak International, IDENTIX, Sagem Morpho, and Bioscript.

The
most recent automated fingerprint identification product sales in the market have been deployed for government and law enforcement applications, typically at more cost than
BIO-key's products and licensing arrangements. Although most companies that target consumer application markets have completed development of their biometric products, such technologies
have not been widely accepted in the commercial markets to date. Most companies competing for commercial opportunities are in the business of selling scanning devices and tie their algorithm to a
specific device. BIO-key has created a "device independent" algorithm that provides flexibility in choosing the correct device and optical or tactile sense to fit the application served.

BIO-key
has found that commercial markets have been slow to widely purchase biometrics as a viable alternative to their current security methods. As a result, the primary
competition for biometric technology consists of traditional security methods such as passwords, PINs, cards, and tokens.

With
respect to competing biometrics technologies, each has its strength and weaknesses and none has emerged as a market leader:



The
market for biometric technology is evolving. Computer breaches, identity theft, phishing and other events in the recent past are driving a large-scale shift to biometric deployments.
In addition, companies such as IBM, Dell, Gateway, MPC, Samsung, and HP have all introduced computers with integrated finger scanning devices to complement the conventional username/password technique
since it is highly susceptible to hackers and security breaches.

Public Safety

The public safety market comprises agencies at all government levels, with a range of users, from a few to many hundreds. BIO-key competitors in the
mobile data market include Computer Aided Dispatch/Records Management companies such as Printrak, InfoCop, and Motorola. Each has comprehensive CAD and/or RMS offerings and has augmented those with
their own mobile data and field reporting solutions. While these solutions may not be as functionally rich as the BIO-key suite of products, they are sometimes less expensive. They also
provide a complete solution from one vendor.

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Fire Service/EMS

The fire records management market includes a large number of RMS vendors including Firehouse, FDM, and ETI. These and other competing companies represent a wide
range of organizations, from large integration companies, to small garage companies, and offer products similar in scope to BIO-key's FireRMS. The functionality and price of these products
also encompass wide ranges of features and costs.

Marketing and Distribution

BIO-key's marketing and distribution efforts comprise the following major initiatives:



Following
are the specific marketing/sales programs in place:



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Interoperability

The events of September 11, 2001 and the subsequent focus on Homeland Security have heightened the need to secure data dissemination throughout and between
government agencies, as well as to automate the positive identification of personnel. BIO-key's finger identification
technology coupled with the rich encryption functionality of its wireless data solutions form solutions to address these issues. Recently, BIO-key was awarded a contract to ensure the
secure access, transmission, and retrieval of critical government and public sector information. BIO-key also is working with the National Sheriff's Association and the Pegasus Research
Foundation to provide biometric authentication for secure sharing of critical data to sheriffs' offices and first responders across the country. BIO-key expects the initial roll out of 220
sheriffs' offices will continue to grow.

Licensing

BIO-key targets both Internet infrastructure companies and large portal providers as possible licensees for its WEB-key solution. On the
Internet infrastructure side, BIO-key seeks to partner with Internet server manufacturers, providers of database and data warehouse engine software, horizontally positioned application
engines, firewall solution providers, and peripheral equipment manufacturers. On the portal side, BIO-key is targeting financial service providers such as credit and debit card
authorization and issuing institutions, Internet retailers, business-to-business application service providers (ASPs), and corporate intranets. In the past two years,
BIO-key has undertaken a WEB-key and VST direct selling effort, and entered into license agreements with OEMs and system integrators to develop applications for
distribution to their respective customers.

BIO-key
is also addressing the security needs of application providers in the following vertical markets:



Intellectual Property Rights

We believe that our intellectual property is important to our biometric, mobile solutions and information management segments:

PatentsOur
biometrics segment uses patent pending technology and trade secrets developed or acquired by us. We have a number of U.S. and foreign patent applications in
process related to this intellectual property.

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TrademarksWe
have registered our trademarks "PacketCluster","PacketCluster Patrol", "PacketWriter", "PacketBlue", "SunPro" and the design mark for "Ceurulean" with the U.S.
Patent and Trademark Office. We have also applied for trademarks for "BIO-key", "SACman", "SACcat", "SACremote", "True User Identification", "WEB-key", "PocketCop" and
"Cerulean".

Copyrights
and trade secretsWe take measures to ensure copyright and license protection for our software releases prior to distribution. When possible, the software is
licensed in an attempt to ensure that only licensed and activated software functions to its full potential. We also take measures to protect the confidentiality of our trade secrets.

Research and Development

During fiscal years ended December 31, 2003 and 2004, BIO-key spent approximately $1,037,000 and $2,980,000, respectively, on research and
development for its biometric solutions. BIO-key's limited customer base during that time did not directly bear these costs, which were principally funded through outside sources of equity
and debt financing.

Although
BIO-key believes that its identification technology is one of the most advanced and discriminating fingerprint technologies available today, the markets in which
BIO-key compete are characterized by rapid technological change and evolving standards. In order to maintain its position in the market, BIO-key will continue to upgrade and
refine its existing technologies.

During
2005, BIO-key's research and development effort will be focused on the continued evolution of its client-server-based authentication solution (WEB-key),
furthering the VST algorithm, and standards based efforts like the BioAPI. The company has achieved its goal of enabling the identification of individuals with a single finger scan to a population of
one million prints on a standard Oracle platform in less than five seconds. The BIO-key information server will be refined, and more sophisticated server functionality and interoperability
will be added.

In
2005, BIO-key is introducing additional mobile applications for the FireRMS Building Inspections module to eliminate redundant data entry for occupancy inspection,
providing timely updates to critical information and immediate notification of code violations to the Occupancy Management module.

Government Regulations

BIO-key is not currently subject to direct regulation by any government agency, other than regulations generally applicable to businesses or related
to specific project requirements. In the event of any international sales, the company would be subject to various domestic and foreign laws regulating such exports and export activities.

Environmental Regulations

As of the date of this report, BIO-key has not incurred any material expenses relating to our compliance with federal, state, or local environmental
laws and does not expect to incur any material expenses in the foreseeable future.

Employees and Consultants

BIO-key currently employs one hundred fifteen (115) individuals on a full-time basis: sixty-eight (68) in engineering,
research and development; thirteen (13) in finance and administration; and thirty-four (34) in sales and marketing. BIO-key also uses the services of three
(3) consultants who provide engineering and technical services, and one (1) consultant who provides financial consulting services.

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RISK FACTORS

The following material risk factors, among others, may affect the Company's financial condition and results of
operations.

Business and Financial Risks

Based on our lack of significant revenue since inception and recurring losses from operations, our auditors have included an explanatory paragraph in their
opinion as to the substantial doubt about our ability to continue as a going concern.

Due to, among other factors, our history of losses and limited revenue, our independent auditors have included an explanatory paragraph in their opinion for the
year ended December 31, 2004 as to the substantial doubt about our ability to continue as a going concern. Our financial statements have been prepared in accordance with accounting principals
generally accepted in the United States, which contemplate that we will continue to operate as a going concern. Our financial statements do not contain any adjustments that might result if we are
unable to continue as a going concern.

Since our formation, we have historically generated minimal revenue and have sustained substantial operating losses.

As of December 31, 2004, we had negative working capital of approximately $3,016,000, and an accumulated deficit of approximately $35,111,000. Since our
inception, we have focused almost exclusively on developing our core technologies and, until the fourth quarter of 2004 have not generated any significant revenue. In order to increase revenue, we
have developed a direct sales force and anticipate the need to retain additional sales, marketing and technical support personnel and may need to incur substantial expenses. We cannot assure you that
we will be able to secure these necessary
resources, that a significant market for our technologies will develop or that we will be able to achieve our targeted revenue.

Our biometric technology has yet to gain widespread market acceptance and we do not know how large of a market will develop for our technology.

Biometric technology has received only limited market acceptance, particularly in the private sector. Our technology represents a novel security solution and we
have not yet generated significant sales. Although recent security concerns relating to identification of individuals has increased interest in biometrics generally, it remains an undeveloped,
evolving market. Biometric based solutions compete with more traditional security methods including keys, cards, personal identification numbers and security personnel. Acceptance of biometrics as an
alternative to such traditional methods depends upon a number of factors including:



For
these reasons, we are uncertain whether our biometric technology will gain widespread acceptance in any commercial markets or that demand will be sufficient to create a market large enough to
produce significant revenue or earnings. Our future success depends, in part, upon business customers adopting biometrics generally, and our solution specifically.

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Biometric technology is a new approach to Internet security which must be accepted in order for our Web-key solution to generate
significant revenue.

Our Web-key authentication initiative represents a new approach to Internet security which has been adopted on a limited basis by
companies which distribute goods, content or software applications over the Internet. The implementation of our WEB-Key solution requires the distribution and use of a finger
scanning device and integration of database and server side software. Although we believe our solution provides a higher level of security for information transmitted over the Internet than existing
traditional methods, unless business and consumer markets embrace the use of a scanning device and believe the benefits of increased accuracy outweigh implementation costs, our solution will not gain
market acceptance.

Our software products may contain defects which will make it more difficult for us to establish and maintain customers.

Although we have completed the development of our core biometric technology, it has only been used by a limited number of business customers. Despite extensive
testing during development, our software may contain undetected design faults and software errors, or "bugs" that are discovered only after it has been installed and used by a greater number of
customers. Any such default or error in new or existing software or applications could cause delays in delivering our technology or require design modifications. These could adversely affect our
competitive position and cause us to lose potential customers or opportunities. Since our technologies are intended to be utilized to secure physical and electronic access, the effect of any such bugs
or delays will likely have a detrimental impact on us. In addition, given that biometric technology generally, and our biometric technology specifically, has yet to gain widespread acceptance in the
market, any delays would likely have a more detrimental impact on our business than if we were a more established company.

While
we have commenced a significant sales and marketing effort, we have only begun to develop a significant distribution channel and may not have the resources or ability to sustain
these efforts or generate any meaningful sales.

In order to generate revenue, we are dependent upon independent original equipment manufacturers, system integrators and application developers, which we do not
control. As a result, it may be more difficult to generate sales.

We market our technology through licensing arrangements with:



As
a technology licensing company, our success will depend upon the ability of these manufacturers and developers to effectively integrate our technology into products and services which
they market and sell. We have no control over these licensees and can not assure you that they have the financial, marketing or technical resources to successfully develop and distribute products or
applications acceptable to end users or generate any meaningful revenue for us. These third parties may also offer the products of our competitors to end users.

We derive nearly all of our revenue from government contracts, which are often non-standard, involve competitive bidding, may be subject to
cancellation with or without penalty and may produce volatility in earnings and revenue.

Most of our business involves providing products and services under contracts with U.S. federal, state and local government agencies. Obtaining contracts from
government agencies is challenging, and

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government
contracts often include provisions that are not standard in private commercial transactions. For example, government contracts may:



Securing
government contracts can be a protracted process involving competitive bidding. In many cases, unsuccessful bidders may challenge contract awards, which can lead to increased
costs, delays and possible loss of the contract for the winning bidder.

We face intense competition and may not have the financial and human resources necessary to keep up with rapid technological changes, which may result in our
technology becoming obsolete.

The Internet, facility access control and information security markets are subject to rapid technological change and intense competition. We compete with both
established biometric companies and a significant number of startup enterprises as well as providers of more traditional methods of access control. Most of our competitors have substantially greater
financial and marketing resources than we do and may independently develop superior technologies, which may result in our technology becoming less competitive or obsolete. We may not be able to keep
pace with this change. If we are unable to develop new applications or enhance our existing technology in a timely manner in response to technological changes, we will be unable to compete in our
chosen markets. In addition, if one or more other biometric technologies such as voice, face, iris, hand geometry or blood vessel recognition is widely adopted, it would significantly reduce the
potential market for our fingerprint identification technology.

We depend on our Chairman of the Board and Chief Executive Officer and need additional marketing and technical personnel to successfully market our technology. We
cannot assure you that we will be able to retain or attract such persons.

A loss of our current Chairman of the Board of Directors or Chief Executive Officer could severely and negatively impact our operations. We have had an employment
contract with Michael W. DePasquale, our Chief Executive Officer through January 3, 2005. Although the contract does not prevent him from resigning, it does contain confidentiality and
non-compete clauses which are intended to prevent him from working for a competitor within one year after leaving our Company. We continue to retain additional employees with expertise in
developing, marketing and selling software solutions. In order to successfully market our technology, we will need to retain additional engineering, technical support and marketing personnel. The
market for such persons remains highly competitive and our limited financial resources will make it more difficult for us to recruit and retain qualified persons.

We can not assure you that the limited intellectual property protection for our core technology provides a meaningful competitive advantage or barrier to entry
against our competitors.

Our success and ability to compete is dependent in part upon proprietary rights to our technology. We rely primarily on a combination of patent, copyright and
trademark laws, trade secrets and technical measures to protect our propriety rights. We have filed a patent application relating to both the optic technology and biometrics solution components of our
technology wherein several claims have been allowed. More recently, we filed a patent application with respect to our VST (Vector Segment Technology), the core algorithm of our biometric
identification solution. We can not assure you that any patents will be issued, or that, if issued, that we will have the resources to protect any patent from

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infringement.
Although we believe our technology does not currently infringe upon patents held by others, we can not assure you that such infringements do not exist or will not exist in the future,
particularly as the number of products and competitors in the biometric industry segment grows.

We may need to obtain additional financing to execute our business plan, which may not be available. If we are unable to raise additional capital or generate
significant revenue, we may not be able to continue operations.

Since our inception, we have not generated any significant revenue (other than revenue from acquired businesses) and have experienced substantial losses,
including approximately $7,237,000 during 2004. In March 2004, we completed a private placement equity offering that resulted in approximately $12,000,000 in gross proceeds to the Company and a
private placement convertible debt offering in September 2004 that resulted in approximately $10,000,000 in gross proceeds to the Company (a portion of which was used to finance the acquisition
of Aether Mobile Government). To the extent that we will require additional capital to support our operations, expand our marketing and sales efforts and to execute our business plan to substantially
increase revenue, we may need to obtain additional financing through the issuance of debt or equity securities. Our long-term viability and growth will depend upon the successful commercialization of
our technologies and our ability to obtain adequate financing. We have not and cannot assure you that we will ever be able to secure any such financing on terms acceptable to us. If we cannot obtain
such financing or generate such revenues, we may not be able to execute our business plan or continue operations.

We may not be able to successfully integrate recent acquisitions into our operations.

The integration of PSG and AMG into our operations involves a number of risks, including:



Failure
to overcome these risks or any other problems encountered in connection with the acquisitions of PSG and AMG could slow our growth or lower the quality of our services, which
could reduce customer demand. The result could be a material adverse effect on our financial position and results of operations.

We may not achieve profitability with respect to the law enforcement and public safety components of our business if we are unable to maintain, improve and
develop the wireless data services we offer.

We believe that our future business prospects depend in part on our ability to maintain and improve our current services and to develop new ones on a timely
basis. Our services will have to achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements. As a result of the complexities inherent in our
service offerings, major new wireless data services and service enhancements require long development and testing periods. We may experience difficulties that could delay or prevent the successful
development, introduction or marketing of new services and service enhancements. Additionally, our new services and service enhancements may not achieve market acceptance. If we cannot effectively
develop and improve services we may not be able to recover our fixed costs or otherwise become profitable.

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Our law enforcement and public safety division depends upon wireless networks owned and controlled by others.

If we do not have continued access to sufficient capacity on reliable networks, we may be unable to deliver services and our sales could decrease. Our ability to
grow and achieve profitability partly depends on our ability to buy sufficient capacity on the networks of wireless carriers such as Verizon Wireless, Bell South Corporation, Metrocall, Motient and
AT&T Wireless and on the reliability and security of their systems. All of our services are delivered using airtime purchased from third parties. We depend on these companies to provide uninterrupted
and bug free service and would not be able to satisfy our customers' needs if they failed to provide the required capacity or needed level of service. In addition, our expenses would increase and our
profitability could be materially adversely affected if wireless carriers were to increase the prices of their services. Our existing agreements with the wireless carriers generally have
one-year terms. Some of these wireless carriers are, or could become, our competitors and if they compete with us they may refuse to provide us with their services.

New laws and regulations that impact our law enforcement and public safety division could increase our costs or reduce our opportunities to earn revenue.

We are not currently subject to direct regulation by the Federal Communications Commission or any other governmental agency, other than regulations applicable to
businesses in general. However, in the future, we may become subject to regulation by the FCC or another regulatory agency. In addition, the wireless carriers who supply us airtime and certain of our
hardware suppliers are subject to regulation by the FCC and regulations that affect them could increase our costs or reduce our ability to continue selling and supporting our services.

If we fail to adequately manage our resources, it could have a severe negative impact on our financial results or stock price.

We could be subject to fluctuations in technology spending by existing and potential customers. Accordingly, we will have to actively manage expenses in a rapidly
changing economic environment. This could require reducing costs during economic downturns and selectively growing in periods of economic expansion. If we do not properly manage our resources in
response to these conditions, our results of operations could be negatively impacted.

We granted a blanket security interest in all of our assets to the holders of our secured debt. If we are unable to make our required monthly payments on such
debt, or any other event of default occurs, it could have a material adverse effect on our business and operations, and the debt holders may foreclose on our assets.

As part of our recent secured convertible debt financing transactions, we granted to Laurus Master Fund, Ltd. and another holder of such secured debt a
blanket security interest in all of our assets, including assets of our subsidiary. See the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this
report. In the event we default in payment on such debt, or any other event of default occurs under the relevant financing documents, and the default is not cured, 120% of the outstanding principal
amount of the secured notes, plus accrued interest and fees will accelerate and be due and payable in full. See the "Long Term Obligations" footnote to this report for a list of such potential events
of default.

The
cash required to pay such accelerated amounts on the secured notes following an event of default would most likely come out of our working capital. As we rely on our working capital
for our day to day operations, such a default could have a material adverse effect on our business, operating results, or financial condition to such extent that we are forced to restructure, file for
bankruptcy, sell assets or cease operations. In addition, upon an event of default, the holder of the secured debt could

16

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foreclose
on our assets or exercise any other remedies available to them. If our assets were foreclosed upon, we were forced to file for bankruptcy or cease operations, stockholders may not receive
any proceeds from disposition of our assets and may lose their entire investment in our stock.

Our obligations under our recently issued debt securities may adversely affect our ability to enter into potential significant transactions with other parties.

As a result of our recent debt financing transactions with Laurus Master Fund, Ltd., the Shaar Fund, Ltd. and other institutional and accredited
investors, we incurred significant repayment obligations, and we agreed to certain restrictive covenants. In particular, for so long as 25% of the aggregate principal amount of the convertible term
notes remains outstanding, we will need the consent of the holders of such notes before we can take certain actions, including the following:



Accordingly,
unless we obtain the noteholders' consent, we may not be able to enter into certain transactions. In addition, in connection with any potential significant transaction (such
as a merger, sale of substantially all our assets, joint venture, or similar transaction), it is likely that we would have to pay off such debt obligations and have the applicable security interests
released. Although we have the right at any time to prepay our debt obligations, we can only do so upon payment of 110% of the then principal balance, plus all other amounts owing under the notes. See
the "Long Term Obligations" footnote of this report. Based on an aggregate principal balance of $7.9 million at April 6, 2005, a complete prepayment would require a cash payment of
approximately $8.6 million. These provisions could have the practical effect of increasing the costs of any potential significant transaction, and restrict our ability to enter into any such
transaction.

Our obligations to the holders of our outstanding preferred stock may further affect our ability to enter into potential significant transactions with other
parties.

We will need to obtain the consent of the holders of a majority of the then outstanding shares of our convertible preferred stock before we can take certain
actions, including the following:



Accordingly,
unless we obtain such consent, we may not be able to enter into certain transactions.

Risks Related To Our Common Stock

We have issued a substantial number of securities that are convertible into shares of our common stock which will result in substantial
dilution to the ownership interests of our existing shareholders.

As
of March 1, 2005, approximately 35,728,127 shares of our common stock were reserved for issuance upon exercise or conversion of the following securities:



17

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The
exercise or conversion of these securities will result in a significant increase in the number of outstanding shares and substantially dilute the ownership interests of our existing
shareholders.

A substantial number of our convertible securities are convertible into shares of common stock at a conversion price of $.75 per share. Most of these shares are
eligible for public resale. The trading price of our common stock and our ability to raise additional financing may be adversely effected by the influx into the market of such a substantial number of
shares.

Our outstanding convertible preferred stock and cumulative dividends in arrears are convertible into 7,557,615 shares of common stock as of March 1, 2005
at a per share conversion price of $.75 which is substantially less than the current trading price of our shares. Although many of the shares issuable upon conversion of our convertible securities are
eligible for public resale under Securities Exchange Commission Rule 144, we have agreed to file a registration statement to cover the public resale of all of these shares. This
significant increase in the number of shares available for public sale may have a negative impact on the trading price of our shares and substantially dilute the ownership interests of our existing
shareholders. In the event that our stock trades below $.75 per share, in order to raise additional financing we would likely be required to issue additional shares of common stock or securities
convertible into common stock at a purchase or conversion price, as applicable, of less than $.75 per share. Any issuance of shares at a purchase price of less than $.75 per share would reduce the
conversion price of our Convertible Preferred Shares to such lower price. This would require us to issue additional shares upon conversion of our Series C Shares and further dilute the
ownership interests of our existing shareholders. To the extent these factors are viewed negatively by the market, it may provide an incentive for persons to execute short sales of our common stock
that could adversely affect the trading price of our common stock.

Applicable SEC Rules governing the trading of "penny stocks" limits the trading and liquidity of our common stock, which may affect the trading price of our
common stock.

Our common stock currently trades on the OTC Bulletin Board. Since our common stock continues to trade below $5.00 per share, our common stock is considered a
"penny stock" and is subject to SEC rules and regulations, which impose limitations upon the manner in which our shares can be publicly traded. These regulations require the delivery, prior to any
transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the associated risks. Under these regulations, certain brokers who recommend such securities to
persons other than established customers or certain accredited investors must make a special written suitability determination regarding such a purchaser and receive such purchaser's written agreement
to a transaction prior to sale. These regulations have the effect of limiting the trading activity of our common stock and reducing the liquidity of an investment in our common stock.

We do not intend to pay dividends in the foreseeable future.

We have never declared or paid a dividend on our common stock. In addition, the terms of our outstanding Convertible Preferred Shares preclude us from declaring
or paying a dividend on our common stock unless a dividend is also declared or paid, as applicable, on our Convertible Preferred Shares. We intend to retain earnings, if any, for use in the operation
and expansion of our business and, therefore, do not anticipate paying any dividends on our common stock in the foreseeable future.

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The trading price of our common stock may be volatile.

The trading price of our shares has from time to time fluctuated widely and in the future may be subject to similar fluctuations. The trading price may be
affected by a number of factors including the risk factors set forth in this Report as well as our operating results, financial condition, announcements of innovations or new products by us or our
competitors, general conditions in the biometrics and access control industries, and other events or factors. Although we believe that approximately 15 registered broker dealers currently make a
market in our common stock, we can not assure you that any of these firms will continue to serve as market makers or have the financial capability to stabilize or support our common stock. A reduction
in the number of market makers or the financial capability of any of these market makers could also result in a decrease in the trading volume of and price of our shares. In recent years broad stock
market indices, in general, and the securities of technology companies, in particular, have experienced substantial price fluctuations. Such broad market fluctuations may adversely affect the
future-trading price of our common stock.

ITEM 2. DESCRIPTION OF PROPERTY

We do not own any real estate. We conduct operations from leased premises in Marlborough, Massachusetts (38,000 square feet), Eagan, Minnesota (6,800 square
feet), Wall, New Jersey (2,180 square feet) and Winter Park, Florida (900 square feet). We believe that our current facilities are adequate for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

Prior to our acquisition of PSG in March 2004, PSG had been named as a defendant in a civil action initiated in the Superior Court Department in Hampden
County, Commonwealth of Massachusetts by The Vince Group, Inc. ("TVG"). The case has since been removed to the United States District Court for the District of Massachusetts at the request of
the Parties. The complaint claims that PSG is obligated to pay a percentage of certain of its revenues to TVG in consideration for a strategic business introduction allegedly made by an agent of TVG.
PSG has denied the allegations and filed an answer in the litigation, and as of the date of this report the outcome of the litigation is pending. The claim is for an unspecified amount including
actual damages, interest, and attorney's fees. Management believes the claim is without merit and will settle out of court for an amount, which will not have a material adverse affect on our business,
financial condition or operating results.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders in the fourth quarter of 2004.

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PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock currently trades on the OTC Bulletin Board under the symbol "BKYI". The following table sets forth the range of high and low bid prices per share
of our common stock for each of the calendar quarters identified below as reported by the OTC Bulletin Board. These quotations represent inter-dealer prices, without retail mark-up,
markdown or commission, and may not represent actual transactions.

2004:

High

LowQuarter ended December 31, 2004

$
1.61

$
0.74Quarter ended September 30, 2004


1.43


0.60Quarter ended June 30, 2004


3.00


1.26Quarter ended March 31, 2004


1.85


1.03


2003:

High

LowQuarter ended December 31, 2003

$
1.40

$
0.53Quarter ended September 30, 2003


0.59


0.38Quarter ended June 30, 2003


0.64


0.30Quarter ended March 31, 2003


0.73


0.35


The
last price of our common stock as reported on the OTC Bulletin Board on March 1, 2005 was $1.34 per share.

Holders

As of March 1, 2005, the number of stockholders of record of our common stock was 190. Based on broker inquiry conducted in connection with the
distribution of proxy solicitation materials in connection with the Company's special meeting of shareholders in 2004, we believe that there are approximately 4,466 beneficial owners of our common
stock.

Dividends

We have not paid any cash dividends to date, and have no intention of paying any cash dividends on our common stock in the foreseeable future. The terms of our
outstanding Convertible Preferred Stock preclude us from declaring or paying a dividend on our common stock unless a dividend is also declared or paid, as applicable, on our Convertible Preferred
Stock. The declaration and payment of dividends is also subject to the discretion of our Board of Directors and certain limitations imposed under the Delaware General Corporation Law. The timing,
amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors.

Recent Sales Of Unregistered Securities.

(a)   Between
December 11, 2003 and March 2, 2004, the Company issued an aggregate of 4,120,345 shares of common stock upon conversion of $2,538,938 principal
amount and $551,321 of accrued interest due under our Secured Convertible Note dated November 26, 2001. The shares were issued in a private placement transaction exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereunder without payment of underwriting discounts or commission to any person.

(b)   On
March 3, 2004, the Company issued 65,000 shares of series C convertible preferred stock to The Shaar Fund Ltd. in exchange for the cancellation
of $5,736,232 principal amount of outstanding convertible promissory notes and $763,768 of accrued interest due thereunder. The series C convertible

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preferred
are convertible at the option of the holder into common stock at a conversion price of $.75 per share, subject to certain anti-dilution adjustments. The securities were issued to
one accredited investor in a private placement transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereunder, without payment of underwriting
discounts or commissions to any person.

(c)   On
March 30, 2004, the Company issued 5,257 shares of series C convertible preferred stock to The Shaar Fund Ltd. in exchange for the cancellation
of all of our issued and outstanding shares of series B preferred stock. The series C convertible preferred are convertible at the option of the holder into common stock at a conversion
price of $.75 per share, subject to certain anti-dilution adjustments. The securities were issued to one accredited investor in a private placement transaction exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereunder, without payment of underwriting discounts or commissions to any person.

(d)   On
March 30, 2004, the Company issued 18,275 shares of series C convertible preferred stock to The Shaar Fund Ltd. in exchange for the cancellation
of $1,777,500 principal amount of outstanding convertible promissory notes and $49,963 of accrued interest due thereunder. The series C convertible preferred are convertible at the option of
the holder into common stock at a conversion price of $.75 per share, subject to certain anti-dilution adjustments. The securities were issued to one accredited investor in a private
placement transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereunder, without payment of underwriting discounts or commissions to any
person.

(e)   On
March 30, 2004, the Company issued an aggregate of 2,422,108 shares of common stock to ten (10) individuals and Harward Investments, Inc. in
connection with the Company's acquisition of Public Safety Group, Inc. These securities were issued in a private placement transaction exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind and without payment of underwriting discounts or
commissions to any person.

(f)    On
March 31, 2004, the Company issued an aggregate of 8,888,928 shares of common stock and warrants to purchase 4,444,464 shares of common stock to
forty-nine (49) accredited investors for aggregate gross proceeds of approximately $12,000,000 in cash. These securities were issued in a private placement transaction exempt from
the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind and without
payment of underwriting discounts or commissions to any person.

(g)   On
April 29, 2004, the Company issued 3,750 shares of series C convertible preferred stock to Thomas J. Colatosti in exchange for the cancellation of
$375,000 principal amount of outstanding convertible promissory notes. The series C convertible preferred are convertible at the option of the holder into common stock at a conversion price of
$.75 per share, subject to certain anti-dilution adjustments. The securities were issued to one accredited investor in a private placement transaction exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereunder, without payment of underwriting discounts or commissions to any person.

(h)   In
a cashless exchange in July 2004, the Company issued 251,000 shares of common stock in exchange for the cancellation of warrants valued at $96,183. The
securities were issued to one accredited investor in a private placement transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereunder, without
payment of underwriting discounts or commissions to any person.

(i)    In
July 2004, the Company provided an employee of the Company a seven-year option to purchase 75,000 shares of the Company's common stock at an
exercise price of $1.35 per share. The option vests in three annual installments commencing July 1, 2005. The securities were issued to one accredited investor in a private placement
transaction exempt from the registration requirements of the

21

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Securities
Act pursuant to Section 4(2) thereunder, without payment of underwriting discounts or commissions to any person.

(j)    In
July 2004, the Company issued five-year warrants to purchase an aggregate of 150,000 shares of common stock at an exercise price of $0.97 per share
to certain consultants. The warrants shall vest as follows: 50,000 shares immediately, 75,000 shares on July 15, 2005 and 25,000 shares on July 15, 2006. These securities were issued in
a private placement transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or
general solicitation of any kind and without payment of underwriting discounts or commissions to any person.

(k)   On
September 29, 2004, the Company issued secured convertible term notes in the aggregate principal amount of $5,050,000 and warrants to purchase 1,122,222 shares
of common stock at an exercise price of $1.35 per share to Laurus Master Fund, Ltd. and other institutional and accredited investors. These securities were issued in a private placement
transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation
of any kind and without payment of underwriting discounts or commissions to any person.

(l)    On
September 29, 2004, the Company issued secured convertible term notes in the aggregate principal amount of $4,950,000 and warrants to purchase 1,099,997 shares
of common stock at an exercise price of $1.35 per share to The Shaar Fund Ltd. and other institutional and accredited investors. These securities were issued in a private placement transaction
exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind
and without payment of underwriting discounts or commissions to any person.

(m)  In
September 2004, the Company issued an employee a stock option to purchase 200,000 shares of the Company's common stock at an exercise price of $1.05 per share.
The option has a term of seven (7) years and vests in three equal annual installments commencing on September 15, 2005. These securities were issued in a private placement transaction
exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind
and without payment of underwriting discounts or commissions to any person.

(n)   In
September 2004, the Company issued consultants warrants to purchase 620,667 shares of the Company's common stock at an exercise price of $1.55 per share. The
warrants have a term of five (5) years and vest immediately. These securities were issued in a private placement transaction exempt from the registration requirements of the Securities Act
pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind and without payment of underwriting discounts or commissions to
any person.

(o)   In
October 2004, the Company issued an employee a stock option to purchase 300,000 shares of the Company's common stock at an exercise price of $1.11 per share.
The option has a term of seven (7) years and vests in three equal annual installments commencing on October 4, 2005. These securities were issued in a private placement transaction
exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation of any kind
and without payment of underwriting discounts or commissions to any person.

(p)   In
October 2004, the Company issued a director, Richard E. Gaddy, a stock option to purchase 50,000 shares of the Company's common stock at an exercise price of
$1.03 per share. The option has a term of seven (7) years and vests in two equal annual installments commencing on October 12, 2005. These securities were issued in a private placement
transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the

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Company
without engaging in any advertising or general solicitation of any kind and without payment of underwriting discounts or commissions to any person.

(q)   In
December 2004 the Company issued a director, John Schoenherr, a stock option to purchase 50,000 shares of the Company's common stock at an exercise price of
$1.39 per share. The option has a term of seven (7) years and vests in two equal annual installments commencing on December 27, 2005. These securities were issued in a private placement
transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof directly by the Company without engaging in any advertising or general solicitation
of any kind and without payment of underwriting discounts or commissions to any person.

Convertible Preferred Stock

In March 2004, we designated 100,000 shares of preferred stock as Series C Convertible Preferred Stock (the "Convertible Preferred Shares"), of
which 62,182 are issued and outstanding. When the Company reincorporated in Delaware, the Convertible Preferred Shares were renamed as Series A Convertible Preferred Stock. The following
describes the material provisions of the Convertible Preferred Shares which are more fully set forth in the Certificate of Designation on file with the Delaware Secretary of State.

The
Convertible Preferred Shares accrue a cumulative annual dividend of 7% on the $100 face amount of such shares payable June 15 and December 15 each year in shares of
common stock. In the event of a liquidation, dissolution or winding up of the Company, the Convertible Preferred Shares have a liquidation preference of $100 per share (plus all accrued and unpaid
dividends thereon) prior to any payment or distribution to holders of our common stock. The Convertible Preferred Shares are convertible into common stock at a conversion price of $.75 per share. The
conversion price is subject to proportional adjustment in the event of stock splits, stock dividends or reclassifications. Subject to certain exceptions, in the event we issue additional shares of
common stock at a purchase price less than the conversion price of the Convertible Preferred Shares, the conversion price shall be lowered to such lesser price. In the event that the average closing
bid price of our common stock is less than $1.00 per share for thirty (30) consecutive trading days at any time after March 3, 2007, we will be required to redeem the Convertible
Preferred Shares by payment of $100 per share plus all accrued and unpaid dividends due thereon.

We
are required to obtain the consent of the holders of a majority of the Convertible Preferred Shares in order to, among other things, issue any shares of preferred stock that are equal
to or have a preference over the Convertible Preferred Shares or issue any shares of preferred stock, rights, options, warrants, or any other securities convertible into common stock of the Company,
other than those issued to employees of the Company in the ordinary course of their employment or to consultants or other persons providing services to the Company so long as such issuances do not
exceed 500,000 shares of common stock. We are also required to obtain such consent in order to, among other things, complete a sale or other disposition of any material assets, complete an acquisition
of a material amount of assets, engage in a merger, reorganization or consolidation, or incur or guaranty any indebtedness in excess of $50,000.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Report contain forward-looking statements that
involve risks and uncertainties. All forward-looking statements included in this Report are based on information available to us on the date hereof, and we assume no obligation to update any such
forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth in the
section captioned "RISK FACTORS" in Item 1

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and
elsewhere in this Report. The following should be read in conjunction with our audited financial statements included elsewhere herein.

OVERVIEW

We develop and market proprietary fingerprint identification biometric technology and software solutions. We also deliver advanced identification solutions and
information services to law enforcement departments, public safety agencies and other government and private sector customers. Our mobile wireless technology provides first responders with critical,
reliable, real-time data and images from local, state and national databases.

We
pioneered the development of automated, finger identification technology that can be used without the aid of non-automated methods of identification such as a personal
identification, password, token, smart card, ID card, credit card, passport, drivers license or other form of possession or knowledge based identification. This advanced
BIO-key identification technology improves both the accuracy and speed of finger-based biometrics and is the only finger identification algorithm that has been certified by
the International Computer Security Association (ICSA).

Since
our inception in 1993, we have spent substantial time and effort in completing the development of what we believe is the most discriminating and effective finger biometric
technology available. During the past two years, our focus has shifted to marketing and selling this technology and completing strategic acquisitions that can help us leverage our capability to
deliver identification solutions. We have built a direct sale force of professionals with substantial experience in selling technology solutions to government and corporate customers. We expect to
continue to add additional qualified personnel in 2005.

On
March 30, 2004, we acquired all of the outstanding capital stock of Public Safety Group, Inc., a privately-held provider of wireless solutions for law
enforcement and public safety markets based in Winter Park, Florida, in exchange for an aggregate of 2,422,108 shares of our common stock, $500,000 in cash, and our assumption of $600,000 in aggregate
net liabilities of PSG. The acquisition was completed pursuant to the terms of an agreement and plan of merger by and among the Company, BIO-Key Acquisition Corp., a wholly-owned
subsidiary of the Company, PSG and all of the shareholders of PSG. As a result of this transaction, PSG became a wholly-owned subsidiary of the Company.

On
March 31, 2004, we completed a private placement equity offering that resulted in approximately $12,000,000 in gross proceeds to the Company.

As
more fully described in Proxy Statement filed on July 21, 2004 with the Securities and Exchange Commission, we are actively pursuing strategic acquisitions that are expected to
be accretive to operating results. To enable us to respond rapidly to acquisition opportunities, and to meet other future needs that could arise, we have obtained shareholder approval to raise the
number of shares of common stock that we are authorized to issue from 60 million to 85 million. In that regard, on September 30, 2004, we completed our acquisition of the Mobile
Government Division from Aether Systems Inc. Pursuant to the Asset Purchase Agreement dated as of August 16, 2004 by and among the Company, Aether, Cerulean Technology, Inc. and
SunPro, Inc., the Company paid Aether a purchase price of $10,000,000 in cash, subject to post-closing adjustments to reflect changes in Aether Mobile Government's working capital
and cash flows since June 30, 2004. Postclosing working capital adjustments resulted in an additional payment by the Company of $341,878 in December 2004. In connection with
this acquisition, the Company issued a subordinated secured promissory note to Aether in the face amount of $6,884,588 (the "Aether Note"). The Aether Note evidences a contingent reimbursement
obligation of the Company to Aether and a surety fee payable by the Company to Aether, in each case with respect to a letter of credit maintained by Aether for the Company's benefit in connection with
the acquisition. The Company's obligations under the Aether Note are secured by a security interest granted to Aether in all or substantially all of the Company's assets, subordinate to the security
interest described in the "Long-Term Obligations" footnote to this report.

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Aether Mobile Government provides wireless data solutions for use by public safety organizations, primarily state and local police, fire and rescue and emergency medical services
organizations, that enable such organizations to access law enforcement databases to validate identities and obtain suspect information. Its public safety solutions are integrated into fifty
(50) different state databases, as well as local and federal databases, and its products deliver real-time information in seconds, without the need for human dispatchers or other
resources.

On
September 29, 2004, we entered into a securities purchase agreement with certain institutional and accredited investors. Under this agreement, the Company issued secured
convertible term notes in the aggregate principal amount of $5,050,000, convertible into common stock of the Company in certain circumstances at $1.35 per share, and issued warrants to purchase an
aggregate of 1,122,222 shares of our common stock at an exercise price of $1.55 per share. The Company's obligations under these financing documents are secured by a security interest in all or
substantially all of the Company's assets. Also on September 29, 2004, we entered into a separate securities purchase agreement with existing shareholders of the Company and other accredited
investors. Under this agreement, the Company issued unsecured convertible term notes in the aggregate principal amount of $4,950,000, convertible into common stock of the Company in certain
circumstances at $1.35 per share, and issued warrants to purchase an aggregate of 1,099,997 shares of our common stock at an exercise price of $1.55 per share. The proceeds from each of these
transactions were used in part to finance a portion of the Company's acquisition of Aether Mobile Government and will be used in part for working capital purposes.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2004 AS COMPARED TO YEAR ENDED DECEMBER 31, 2003

Revenues

License fees and other, which principally includes software license fees and hardware sales, were approximately $2,207,000 during 2004 as compared to
approximately $513,000 during 2003. Service, which includes maintenance, technical support and other professional services, was approximately $3,351,000 during 2004 as compared to approximately
$11,000 in 2003. The revenue increases in each case are attributed to the additional revenue from acquired businesses in 2004, particularly the revenue generated from AMG in the fourth quarter.

During
the fourth quarter of 2004, the Company conducted a review of its contracts with certain development stage companies and decided to reduce previously recorded revenue from those
customers until payment is received. These adjustments totaled approximately $300,000.

Costs and Other Expenses

Cost of license fees and other were approximately $890,000 in 2004 as compared with approximately $87,000 in 2003. These costs consist primarily of third party
royalties and third party hardware incurred in conjunction with the AMG license revenue.

Cost
of services was approximately $1,174,000 in 2004 as compared to $1,694 in 2003. These costs consist primarily of personnel expenses related to the cost of maintenance,
customization, consulting and support.

Selling, general and administrative expenses.Selling, general and administrative expenses increased to approximately
$7,096,000 in 2004 from approximately $2,118,000 in 2003. Approximately $3,217,000 of this increase is due to expenses associated directly with acquired businesses and approximately $1,761,000 is
attributed to the Company's additional 2004 spending to enhance its sales and marketing capabilities.

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Research and Development.Research and development expenses increased to approximately $2,980,000 in 2004 from approximately
$1,037,000 in 2003. Approximately $1,558,000 of this increase is due to expenses associated directly with acquired businesses and approximately $385,000 is attributed to the Company's additional 2004
spending for research and development.

Interest Expense.Interest expense decreased by about $443,000 to approximately $667,000 in 2004. The decrease in 2004
interest expense resulted from the Company having a lower average balance of outstanding debt in 2004. During 2004, the Company had $10 million in debt outstanding during the first and fourth
quarters only. In 2003 the Company had approximately $10 million in debt outstanding for the entire year. The 2004 interest expense includes $120,000 primarily in non-cash
amortization of warrants issued in connection with the Company's September 29, 2004 issuance of $10 million of convertible notes.

YEAR ENDED DECEMBER 31, 2003 AS COMPARED TO YEAR ENDED DECEMBER 31, 2002:

Revenues

We generated license and other revenues of approximately $513,000 during 2003 as compared to approximately $135,000 during 2002 and service revenue of
approximately $11,000 during 2003 as compared to approximately $21,000 in 2002.

Costs and Other Expenses

Selling, general and administrative expenses.Selling, general and administrative expenses increased approximately $192,000
to approximately $2,118,000 during 2003 as compared to approximately $1,926,000 in 2002. Of the increase, approximately $182,000 was related to increased sales and marketing activity, approximately
$137,000 was related to an increase in general administrative costs, approximately $266,000 was related to an increase in costs for administrative personnel, and approximately $76,000 was related to
an increase in professional services. These amounts were offset by a decrease in marketing consulting costs of approximately $469,000 in 2003.

Research and Development.Research, development and engineering expenses decreased approximately $47,000 to approximately
$1,037,000 in 2003 as compared to approximately $1,084,000 in 2002. Of the decrease, approximately $58,000 was related to a decrease in general development expense, and approximately $44,000 was
related to a decrease for services of outside programming sub-contractors. This was offset by an approximate $55,000 increase in personnel costs.
Having completed the development of our core technology, research and development expenses in 2004 will consist of enhancing existing software and reacting to customer feedback.

Interest Expense.Interest expense decreased approximately $53,000 to approximately $1,110,000 in 2003 as compared to
approximately $1,163,000 in 2002. The decrease was due to a net decrease during 2003 of the amortization of discounts applicable to convertible debt issued during 2001 arising from the warrants issued
with such convertible debt and the beneficial conversion features of such debt. During 2003 we converted $6.5 million of long term debt and accrued interest into convertible preferred stock.

Net Operating Loss Carryforwards

As of December 31, 2004, we had federal net operating loss carryforwards of approximately $32,501,000. The carryforwards expire between 2011 and 2024. Such
net operating carryforwards are limited in the future in the event of a change in ownership of the Company as defined in the Internal Revenue Code.

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LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities during 2004 was approximately $5,645,000 and was principally due to cash operating losses. The operating losses were
primarily funded by the excess of proceeds from the sale of common stock, secured convertible notes, and cash on hand at December 31, 2003 over cash used to acquire PSG and AMG and to provide
security deposits to support leases and performance contracts.

Net
cash used in investing activities in 2004 was approximately $15,130,000, which included, among other things, payments for acquisitions of $10,931,000, security deposits of $2,761,000
and net purchases of marketable securities of approximately $967,000.

Net
cash provided by financing activities in 2004 was approximately $20,718,000, which included proceeds from the issuance of common stock of approximately $11,249,000 and net issuance
of long term obligations of $10,165,000. Payments in connection with financing activities approximated $698,000.

Working
capital, was negative by approximately $3,016,000 at December 31, 2004, representing a decline of approximately $5,101,000 from the prior year. Capital expenditures were
approximately $275,000 in 2004.

Since
January 7, 1993 (date of inception), our capital needs have been principally met through proceeds from the sale of equity and debt securities. We do not currently maintain a
line of credit or term loan with any commercial bank or other financial institution.

On
October 31, 2003, we entered into an amendment to the January 27, 2003 note purchase agreement with The Shaar Fund Ltd. ("Investor") to provide up to $2,500,000
of additional financing pursuant to the terms of a secured promissory note (the "Secured Note"). Of this amount, $600,000 was advanced at closing and $1,900,000 was funded between December 3,
2003 and March 29, 2004. The Secured Note was due October 1, 2005, secured by substantially all of our assets including our intellectual property, accrued interest at the rate of 7% per
annum payable on maturity, and may be prepaid without penalty. The principal amount and accrued interest was convertible at the option of the Investor into either shares of our common stock at a
conversion price of $.75 per share or shares of our Convertible Preferred Shares at a conversion price of $100 per share. The Secured Note also provided that in the event we completed a private
placement of our equity securities resulting in gross proceeds in excess of $5,000,000 on or before June 30, 2004, some or all of the principal and accrued interest shall, at the option of the
Investor, be either converted into such equity securities at a conversion price equal to the sale price of such securities or repaid in cash. Upon the closing of our private placement equity offering
in 2003, the Investor elected to convert $347,500 of the principal amount of the Secured Note into shares of our common stock and warrants to purchase shares of our common stock, each issued to the
Investor in connection with such private placement.

Pursuant
to a recapitalization transaction completed on March 3, 2004, all existing promissory notes payable to the Investor, other than the Secured Note, together with all
accrued and unpaid interest due thereon (approximately $6,500,000) were cancelled and converted into 65,000 Convertible Preferred Shares. Convertible Preferred Shares are convertible into common stock
at a conversion price of $.75 per share. In the event that the average closing bid price of our common stock is less than $1.00 per share for thirty (30) consecutive days at any time after
March 3, 2007, we will be required to redeem the Convertible Preferred Shares at a redemption price of $100 per share plus all accrued and unpaid dividends due thereon. In connection with the
recapitalization transaction, the Investor sold $375,000 of the principal amount of the Secured Note to Thomas J. Colatosti, our Chairman of the Board of Directors.

On
March 30, 2004, the Investor elected to convert $1,827,463 of principal and accrued interest due under the Secured Note into 18,275 Convertible Preferred Shares. Also on
March 30, 2004, the

27

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Investor
elected to exchange all of the issued and outstanding shares of our series B preferred stock and accrued and unpaid dividends thereon and all accrued and unpaid interest on such
dividends into 5,257 additional Convertible Preferred Shares. On April 29, 2004, Mr. Colatosti elected to convert $375,000 of the principal amount of the Secured Note into 3,750
Convertible Preferred Shares. As a result of these conversions, as of the date of this report, we have no outstanding indebtedness other than as described in the Long Term Obligations footnote of this
annual report and current liabilities.

Between
April 7, 2004 and June 21, 2004, we issued an aggregate of 2,237,198 shares of common stock upon conversion of 16,600 shares of the Company's Series C 7%
Convertible Preferred Stock and $17,898 of dividends due thereon to the Shaar Fund.

On
March 31, 2004, we entered into a securities purchase agreement with certain institutional and accredited investors pursuant to which we issued and sold an aggregate of
8,888,928 shares of our common stock and warrants (the "Warrants") to purchase an aggregate of 4,444,464 shares of our common stock. The investors paid an aggregate purchase price of $1.35 for each
share of common stock and Warrant to purchase 0.5 of a share of common stock, resulting in gross proceeds to of approximately $12,000,000.

On
March 30, 2004, we completed the acquisition of PSG in exchange for an aggregate of 2,416,108 shares of our common stock, $500,000 in cash, and our assumption of $600,000 in
net liabilities of PSG. Any liability or obligation of PSG in excess of such $600,000 limitation shall remain the liability or obligation of the former shareholders of PSG. In connection with this
acquisition, we also issued 6,000 shares of our common stock to Harward Investments, Inc. ("Harward") pursuant to an arrangement involving the discharge of certain outstanding debt obligations
of PSG to Harward as of March 30, 2004.

Additional
earnout consideration, determined as a proportion of qualified revenues, as defined, attained by the acquired business during fiscal years 2004 and 2005, may be paid to the
former shareholders of PSG. During 2004, the PSG earnout was $43,635. During 2005, earnout consideration, if any, will be paid at the following rates: Ten percent (10%) of all 2005 Qualifying Revenue
equal to or greater than $7 million but less than $10 million; and Twenty percent (20%) of all 2005 Qualifying Revenue equal to or greater than $10 million. "Qualifying Revenue"
means all license, services and maintenance fees recognized by the Company, which are generated by the Products, as defined (or any improvements thereto) in the public sector division of the Company,
plus any revenues generated by the Products through other divisions or subsidiaries of the Company, as determined in accordance with generally accepted accounting principles. We will make payments of
such additional consideration on the last day of the month following each month in which the acquired business achieves specified revenue milestones during fiscal years 2004 and 2005. Such payments
will be made in cash, unless the aggregate amount of earnout consideration exceeds sixty percent (60%) of the aggregate consideration
we paid in the merger transaction. Any such excess amounts will be paid in shares of our common stock priced as of two (2) days prior to the date on which any earnout payment becomes due.

On
September 30, 2004, we completed our acquisition of Aether Mobil Government. Pursuant to the Asset Purchase Agreement dated as of August 16, 2004 by and among the
Company, Aether, Cerulean Technology, Inc. and SunPro, Inc., the Company paid Aether a purchase price of $10,000,000 in cash, subject to post-closing adjustments to reflect
changes in Aether Mobile Government's working capital since June 30, 2004. In connection with this acquisition, the Company issued a Subordinated Secured Promissory Note to Aether in the face
amount of $6,884,588 (the "Aether Note"). The Aether Note evidences a contingent reimbursement obligation of the Company to Aether and a surety fee payable by the Company to Aether, in each case with
respect to a letter of credit maintained by Aether for the Company's benefit in connection with the acquisition. The Company's obligations under the Aether Note are secured by a security interest
granted to Aether in all or substantially all of the

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Company's
assets, subordinate to the security interest described in the "Long-Term Obligations" footnote of this report below.

On
September 29, 2004, we entered into a Securities Purchase Agreement (the "Senior Purchase Agreement") with Laurus Master Fund, Ltd. ("Laurus") and certain other
institutional and accredited investors (together with Laurus, the "Senior Investors"). Under the Senior Purchase Agreement, the Company issued secured convertible term notes (the "Senior Convertible
Notes") in the aggregate principal amount of $5,050,000, convertible into common stock of the Company in certain circumstances at $1.35 per share, and issued warrants (the "Senior Warrants") to
purchase an aggregate of 1,122,222 shares of our common stock at an exercise price of $1.55 per share. The proceeds from this transaction were used to finance in part the Company's acquisition of
Aether Mobile Government. The Company's obligations under the Senior Purchase Agreement, the Senior Convertible Notes and the Senior Warrants are secured by a security interest in all or substantially
all of the Company's assets.

Also
on September 29, 2004, we entered into a Securities Purchase Agreement (the "Subordinated Purchase Agreement") with the Investor and other existing shareholders of the
Company and accredited investors (collectively, the "Subordinated Investors"). Under the Subordinated Purchase Agreement, the Company issued unsecured convertible term notes (the "Subordinated
Convertible Notes") in the aggregate principal amount of $4,950,000, convertible into common stock of the Company in certain circumstances at $1.35 per share, and issued warrants (the "Subordinated
Warrants") to purchase an aggregate of 1,099,997 shares of our common stock at an exercise price of $1.55 per share. The proceeds from this transaction were used in part to finance a portion of the
Company's acquisition of Aether Mobile Government and will be used in part for working capital purposes. Please see the Long Term Obligations footnote to this annual report for a more complete
description of the transactions consummated in connection with the Senior Purchase Agreement and the Subordinated Purchase Agreement.

Our
future liquidity and capital requirements will depend upon numerous factors, including:



As
of April 6, 2005, we had cash resources of approximately $1.1 million and $7.9 million of convertible debt as described in the "Long-Term Obligations"
footnote of this report below. We currently require approximately $1.8 million per month to conduct our operations. During the fourth quarter of 2004, we generated approximately
$4.4 million of revenue and expect to continue to generate increasing revenue from existing and new relationships during 2005.

We
may need to obtain additional funding to (i) conduct the sales, marketing and technical support necessary to execute our plan to substantially grow operations, increase revenue
and serve a significant customer base; and (ii) provide working capital. Due to, among other factors, our history of losses and limited revenue, our independent auditors have included an
explanatory paragraph in their opinion for the year ended December 31, 2004 as to the substantial doubt about our ability to continue as a going concern. Our long-term viability and growth will
depend upon the successful commercialization of our technologies and our ability to obtain adequate financing. To the extent that we require such additional financing, no assurance can be given that
any form of additional financing will be available on terms acceptable to us, that adequate financing will be obtained to meet our needs,

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or
that such financing would not be dilutive to existing stockholders. If available financing is insufficient or unavailable or we fail to continue to generate meaningful revenue, we may be required
to further reduce operating expenses, delay the expansion of operations, or be unable to pursue merger or acquisition candidates.

CRITICAL ACCOUNTING POLICIES



Revenue recognition.Revenues from software licensing are recognized in accordance with Statement of Position (SOP)
No. 97-2, Software Revenue Recognition, as amended by SOP No. 98-9. Accordingly, revenue from software licensing is recognized when all of the following criteria
are met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable.

The
Company intends to enter into arrangements with end users for items which may include software license fees, usage fees and services or various combinations thereof. For each
arrangement, revenues will be recognized when evidence of an agreement has been documented, the fees are fixed or determinable, collection of fees is probable, delivery of the product has occurred and
no other significant obligations remain.

Multiple-Element
Arrangements: For multiple-element arrangements, each element of the arrangement will be analyzed and the Company will allocate a portion of the total fee under the
arrangement to the elements using vendor specific objective evidence of fair value of the element, regardless of any separate prices stated within the contract for each element. Vendor specific
objective evidence is based on the price the customer is required to pay when the element is sold separately (i.e., software license fees charged when consulting or other services are not provided,
hourly rates charged for consulting services when sold separately from a software license or usage fees). If vendor specific objective evidence of fair value does not exist for any undelivered
elements, all revenue is deferred and recognized ratably over the service period if the undelivered element is services, or until sufficient objective evidence of fair value exists or all elements
have been delivered.

License Revenues:Amounts allocated to license revenues are recognized at the time of delivery of the software and all other
revenue recognition criteria discussed above have been met.

Revenue
from licensing software which requires significant customization and modification is recognized using the percentage of completion method, based on the hours of effort incurred
by the company in relation to the total estimated hours to complete. In instances where third party hardware, software or services form a significant portion of a customer's contract, the
company recognizes revenue for the element of software customization by the percentage of completion method described above. Third party hardware, software, and services are recognized upon shipment
or acceptance as appropriate. If the company makes different judgments or utilizes different estimates of the total amount of work expected to be required to customize or modify the software, the
timing and revenue recognition, from period to period, and the margins on the project in the reporting period, may differ materially from amounts reported. Revenues earned but not yet billed are shown
as an asset in Costs and Earnings in Excess of Billings in the balance sheet. Billings in excess of cost and earnings are reflected as a liability in the balance sheet. Anticipated contract losses are
recognized as soon as they become known and are estimable.

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Service Revenues:Revenues from services are comprised of maintenance, consulting and implementation services. Maintenance
revenues include providing for unspecified when-and-if available product updates and customer telephone support services and are recognized ratably over the term of the service
period. Consulting services are generally sold on a time-and-materials basis and include a range of services including installation of software and assisting in the design of
interfaces to allow the software to operate in customized environments. Services are generally separable from other elements under the arrangement since performance of the services are not essential
to the functionality of any other element of the transaction and are described in the contract such that the total price of the arrangement would be expected to vary as the result of the inclusion or
exclusion of the services. Revenues from services are generally recognized as the services are performed.

Usage Fees:Usage fees are charged on certain applications based on the customer's volume of use. Usage revenue is recognized
based on the actual level of activity used by the customer or, in the case of fixed-fee arrangements, ratably over the arranged time period.

The
Company provides customers, free of charge or at a minimal cost, testing kits which potential licensing customers may use to test compatibility/acceptance of the Company's technology
with the customer's intended applications.

Accounts Receivable.Accounts receivable billed and unbilled are carried at original invoice amount less an estimate made for
doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables
and considering a customer's financial condition, credit history, and current economic conditions. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable
previously written off are recorded when received.

Accounting for Acquisitions.We have completed our acquisitions of PSG and AMG. These acquisitions have been accounted for
under the purchase method of accounting, which has resulted in recording significant goodwill and other intangible asset balances. The purchase prices have been allocated to assets acquired and
liabilities assumed at their estimated fair values on the date of the acquisitions, as determined by management, and by appraisals with respect to identifiable intangible assets. Our accounting for
these acquisitions involves significant judgments and estimates regarding fair values of acquired intangible assets, which are based on projections of future revenues and cash flows, assumptions
regarding discount factors, royalty rates, tax rates, amortization methodologies and related useful lives. The developed technology (software), copyrighted software, marketing agreements, customer
relationships and trademarks were valued using the income approach and are being amortized on a straight line basis over their estimated useful lives, which range from 5 to 7 years.

Valuation of Long-Lived Tangible and Intangible Assets and Goodwill.Our long-lived tangible assets
are fixed assets. As a result of our acquisitions, we have significant long-lived intangible assets and goodwill, which are susceptible to valuation adjustments as a result changes in
various factors or conditions. The intangible assets are developed technology (software), copyrighted software, marketing agreements, customer relationships and trademarks which are amortized over
their estimated useful lives on a straight line basis. Goodwill is not amortized.

We
assess the potential impairment of intangible assets and fixed assets whenever changes in circumstances indicate the carrying value may not be recoverable. Some indicators of
impairment include; significant underperformance relative to historical or projected future operating results, significant changes in the manner of or use of the acquired assets or the strategy for
our overall business, significant negative industry or economic trends, significant decline in our stock price for a sustained period and a decline in our market capitalization below net book value.

Statement
of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142") requires goodwill to be tested for impairment using a
twostep process. The first step

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compares
the fair value of the reporting unit with the unit's carrying amount, including goodwill. When the carrying amount of the reporting unit is greater than the unit's implied fair value, the
unit's goodwill may be impaired, and the second step must be completed to measure the amount of impairment charge, if any. In this step, if the carrying amount is greater than the reporting unit's
implied fair value, the carrying amount must be written down to its implied fair value. We operate in two reporting units; PSG and AMG. Goodwill is required to be tested for impairment at least
annually, or more frequently when events and circumstances indicate that recorded goodwill might be impaired. We performed the goodwill assessment of PSG during the fourth quarter of 2004 and
determined there was no impairment. As provided by SFAS No. 142, the Company has elected to perform the annual assessment of the carrying value of all goodwill as of August 1 each year.
Factors we consider to be indicators of impairment include; significant underperformance relative to historical or projected future operating results, significant negative industry or economic trends,
significant decline in our stock price for a sustained period and a decline in our market capitalization below net book value.

RECENT ACCOUNTING PRONOUNCEMENTS.

In December 2004, the FASB issued SFAS No. 123 (revised 2004),Share-Based Payment(SFAS 123R) . This statement replaces SFAS No. 123 and supersedesAPB Opinion No. 25, Accounting for Stock Issued to Employees.
SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair value. The
pro-forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. For the Company, SFAS 123R is effective for
periods beginning after December 15, 2005. We plan to adopt SFAS 123R on January 1, 2006 using the modified prospective application method described in the statement. Under the
modified prospective application method, we will apply the standard to new awards and to awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost
for the unvested portion of awards outstanding as of the required effective date will be recognized as compensation expense as the requisite service is rendered after the required effective date. We
are evaluating the impact of adopting SFAS 123R and expect that we will record substantial non-cash stock compensation expenses. The adoption of SFAS 123R is not expected to
have a significant effect on cash flows but is expected to have a significant adverse effect on our results of operations. The future impact of the adoption of SFAS 123R cannot be predicted at
this time because it will depend upon the levels of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods, the impact would have approximated the impact
of SFAS 123 as described in the disclosure of pro forma net loss attributable to common stockholders included in the Stockholders' Equity footnote.

ITEM 7. FINANCIAL STATEMENTS

See Financial Statements appearing at pages 44-79 of this Report.

ITEM 8A. CONTROLS AND PROCEDURES

An evaluation of the effectiveness of our "disclosure controls and procedures" (as such term is defined in Rules 13a-15(e) or
15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") was carried out by us under the supervision and with the participation of our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"). Based upon that evaluation, our CEO and CFO concluded that, as of the end of the period covered by this Annual Report, our disclosure controls and
procedures were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commission rules and forms. There has been no change in our internal control over financial reporting identified in connection
with that evaluation that occurred during our most recent fiscal quarter that

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has
materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The following sets forth certain information about each director and executive officer of the Company.

|NAME                  |  | AGE |  | POSITIONS HELD                                    
|--------------------- |  | --- |  | --------------------------------------------------
|Thomas J. Colatosti   |  | 57  |  | Chairman of the Board of Directors                
|Michael W. DePasquale |  | 50  |  | Chief Executive Officer and Director              
|Richard E. Gaddy      |  | 60  |  | Director                                          
|Jeffrey J. May        |  | 45  |  | Director                                          
|Charles P. Romeo(a)   |  | 63  |  | Director                                          
|John Schoenherr       |  | 52  |  | Director                                          
|Randy Fodero          |  | 46  |  | Senior Vice President of Sales and Marketing      
|Kenneth S. Souza      |  | 50  |  | Senior Vice President and Chief Technology Officer

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The
following is a brief summary of the business experience of each of the above-named individuals:

THOMAS J. COLATOSTIhas served as a Director of the Company since September 2002 and as Chairman of the Board since January 3,
2003. Mr. Colatosti currently serves as the Chief Executive Officer of American Security Ventures, a Lexington, Massachusetts based consulting firm he founded which specializes in providing
strategic management consulting services to emerging and developing companies in the homeland security industry. From 1997 through June 2002, Mr. Colatosti served as the Chief Executive
Officer of Viisage Technology, Inc., a publicly traded biometric technology company focusing on biometric face-recognition technology and delivering highly secure identification
documents and systems. Between 1995 and 1997, Mr. Colatosti served as President and Chief Executive Officer of CIS Corporation, a higher education industry leader that designed and implemented
integrated and flexible systems solutions to manage entire university administrative operations. Prior to CIS, Mr. Colatosti had a 20-year career with Digital Equipment Corporation.
His most recent responsibility was Vice President and General Manager, Northeast Area, where he was responsible for a business unit with annual revenues of more than $1.2 billion and 3,000
people. Mr. Colatosti is an active industry security spokesperson testifying before Congressional Committees and advising the White House and other Federal security agencies on homeland
security issues. Mr. Colatosti earned a Bachelor of Science degree in Management and Finance as well as a Masters degree in Business Administration from Suffolk University.

MICHAEL W. DEPASQUALEhas served as the Chief Executive Officer and a Director of the Company since January 3, 2003.
Mr. DePasquale brings more than 20 years of executive management, sales and marketing experience to the Company. Prior to joining the Company, Mr. DePasquale served as the
President and Chief Executive Officer of Prism eSolutions, Inc., a Pennsylvania based provider of professional consulting services and online solutions for ISO-9001/14000
certification for customers in manufacturing, healthcare and government markets, since February 2001. From December 1999 through December 2000, Mr. DePasquale served as
Group Vice President for WRC Media, a New York based distributor of supplemental education products and software. From January 1996 until

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December 1999,
Mr. DePasquale served as Senior Vice President of Jostens Learning Corp., a California based provider of multi media curriculum. Prior to Jostes, Mr. DePasquale
held sales and marketing management positions with McGraw-Hill and Digital Equipment Corporation. Mr. DePasquale earned a Bachelor of Science degree from the New Jersey Institute of
Technology.

JEFFREY J. MAYhas served as a Director of the Company since October 29, 2001. Since 1997, Mr. May has served as the
President of Gideons Point Capital, a Tonka Bay Minnesota based financial consulting firm and angel investor focusing on assisting and investing in start-up technology companies. In 1983,
Mr. May co-founded Advantek, Inc., a manufacturer of equipment and materials which facilitate the automatic handling of semi-conductors and other electrical
components which was sold in 1993. Mr. May continued to serve as a director and Vice-President of Operations of Advantek until 1997, at which time it had over 600 employees and
sales in excess of $100 million. Mr. May earned a Bachelor of Science degree in Electrical Engineering from the University of Minnesota in 1983.

RICHARD E. GADDYhas served as a Director of the Company since October 12, 2004. Mr. Gaddy has a been a Vice President of
Unisys Corporation for over five years and he currently serves as Vice President, Public Sector South. Mr. Gaddy is a 33-year veteran of the computer and information technology
industry. His career with Unisys includes a number of sales and business management positions.

CHARLES P. ROMEOhas served as a director of the Company since February 28, 2005 and from January 29, 2003 to
April 19, 2004. From April 2004 until February 2005, he served as Vice President of Sales, Public Safety Division of the Company. From September 2002 until
April 2004 Mr. Romeo has served as the President and Chief Executive Officer of FreedomBridge Technologies, Inc., a Rhode Island based consulting firm to technology companies in
the homeland security industry specializing in implementing direct and channel selling programs, strategic alliances and partnerships in the law enforcement market. Prior to founding FreeedomBridge,
Mr. Romeo had a 33 year sales and marketing management career with Digital Equipment Corporation, Compaq Computer Corporation and Hewlett Packard. During his career, Mr. Romeo
served as Vice President of Service Sales for a $500 million business unit, and Director of Public Sector Sales, a $275 million division of Hewlett Packard. Mr. Romeo authored The Sales Manager's Troubleshooter,Prentice Hall 1998, which was named as one of the "top 10 must reads" by Sales and Marketing Magazine.
Mr. Romeo earned a Bachelor of Science
degree in Mathematics and Economics from the University of Massachusetts and an Executive MBA from Babson College.

JOHN SCHOENHERRhas served as a Director of the Company since December 30, 2004. Mr. Schoenherr serves as Vice President of
Corporate Performance Management for Oracle Corporation, and has served as an Oracle Vice President for over five years. Mr. Schoenherr has over 25 years of experience in the area of
business intelligence. His career includes a number of product development and management positions.

RANDY FODEROhas served as the Vice President of Sales and Marketing since July 18, 2003 and as a member of the Company's sales
organization since March 2003. Mr. Fodero brings more than 20 years of successful executive and sales management experience to the Company. Prior to joining the Company,
Mr. Fodero served as director of Global Accounts from Veritas Software from February 2002 until January 2003. Between 1999 and February 2002, Mr. Fodero served in
executive sales capacities with both companies in the enterprise software industry, including Agile Software. From 1998 to 1999, Mr. Fodero served as Regional Vice President of Sales for Memco
Software, a leading provider of information security software to Fortune 1000 companies, where he was instrumental in increasing sales and enhancing shareholder value in connection with the sale of
Memco to Platinum Technology. From 1990 through 1998, Mr. Fodero served as Vice President of Sales of AT&T CommVault Systems, where he grew sales from startup to over $36 million and
participated in a management buyout.

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KENNETH S. SOUZAhas served as Senior Vice President and Chief Technology Officer of the Company since October 4, 2004. Prior to
joining the Company, Mr. Souza was Vice President of Industry Solutions for EMC Corporation. Prior to joining EMC, he was Vice President for e-Commerce Enterprise Systems Solutions
for Compaq Computer Corporation. His 25-year technology and market career includes serving in a number of executive positions with Digital Equipment Corporation including Vice President
Worldwide Solutions Services and Training, and Director of Workstations Marketing. In the early 1980's, Mr. Souza held technical sales management positions with Hewlett Packard and Burroughs.
Mr. Souza also held executive positions with a venture funded MRP software company.

Directors' Terms of Office

Mr. May was initially elected to serve as a director in 2001, and was re-elected in 2004. Mr. Colatosti was initially elected to serve
as a director in 2002, and was re-elected in 2004. Mr. DePasquale was initially elected as a director in 2003, and was re-elected in 2004. Mr. Gaddy and
Mr. Schoenherr were each initially elected as a director in 2004. Mr. Romeo was initially elected as a director in 2005. Each such director was elected to serve until the Company's next
annual meeting or until his successor is duly elected and qualified in accordance with the By-laws of the Company.

Board of Directors and Audit Committee Financial Expert

All directors hold office until the next annual meeting of shareholders and the election and qualification of their successors. Officers are elected annually by
the Board of Directors and serve at the discretion of the Board.

The
Audit Committee is comprised of Richard E. Gaddy and Jeffrey J. May, who may not qualify as "financial experts" under the rule adopted by the Securities and Exchange Commission.
However, the Board believes that each Audit Committee member has sufficient knowledge in financial and auditing matters to serve on the Audit Committee. Additionally, the Audit Committee has the
ability on its own to retain independent accountants or consultants whenever it deems appropriate.

Directors Compensation

Directors who are also officers of the Company receive no additional compensation for serving on the Board of Directors, other than reimbursement of reasonable
expenses incurred in attending meetings. The Company's 1996 stock incentive plan provides for the grant of options to purchase 50,000 shares of common stock to each non-employee director
upon first being elected or appointed to the Board of Directors. The Company's current policy is to issue options to purchase 50,000 shares of common stock to each non-employee director on
an annual basis.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the U.S. Securities and Exchange Act of 1934, as amended (the "Exchange Act"), requires the Company's officers and directors and persons
who own more than ten percent (10%) of the Company's Common Stock to file with the Securities and Exchange Commission ("SEC") initial reports of ownership and reports of changes in ownership of the
Company's Common Stock. Such officers, directors and ten percent (10%) stockholders are also required by applicable SEC rules to furnish the Company with copies of all forms filed with the SEC
pursuant to Section 16(a) of the Exchange Act. Based solely on its review of the copies of such forms received by it, or written representations from such persons that no other reports were
required for such persons, the Company believes that during the fiscal year ended December 31, 2004, all Section 16(a) filing requirements applicable to the Company's officers, directors
and ten percent (10%) stockholders were satisfied in a timely fashion except that Mr. Schoenherr did not timely file Form 3 and Form 4 in connection with his

35

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acquisition
of options to purchase 50,000 shares of the Company's common stock upon his appointment to the board of directors.

Code of Ethics

We have adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or
persons performing similar functions. Our Code of Ethics is designed to deter wrongdoing and promote: (i) honest and ethical conduct, including the ethical handling of actual or apparent
conflicts of interest between personal and professional relationships; (ii) full, fair, accurate, timely and understandable disclosure in reports and documents that we file with, or submit to,
the SEC and in our other public communications; (iii) compliance with applicable governmental laws, rules and regulations; (iv) the prompt internal reporting of violations of the code to
an appropriate person or persons identified in the code; and (v) accountability for adherence to the code.

ITEM 10. EXECUTIVE COMPENSATION

The following table sets forth a summary of the compensation paid to or accrued by our chief executive officer and all of our other executive officers as of
December 31, 2004 (the "named executive officers") for each of the fiscal years ended December 31, 2002, 2003 and 2004:

SUMMARY COMPENSATION TABLE

|                                                                       |  |           |  |                 |  |               |  |          |  |     |  | Long Term Compensation
|---------------------------------------------------------------------- |  | --------- |  | --------------- |  | ------------- |  | -------- |  | --- |  | ----------------------
|
|
|
|
|Michael W. DePasquale (1)Chief Executive Officer                       |  | 2004
2003 |  | 210,000
148,943 |  | 35,000
25,000 |  | 
      |  | 
 |  | 
1,080,000           
|Randy Fodero (2)Senior Vice President Sales and Marketing              |  | 2004
2003 |  | 150,000
111,837 |  | 
10,000      |  | 47,674
 |  | 
 |  | 
600,000             
|Kenneth S. Souza (3)Senior Vice President and Chief Technology Officer |  | 2004
2003 |  | 50,000
        |  | 19,000
      |  | 
      |  | 
 |  | 300,000
             

---

36

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OPTION GRANTS IN YEAR ENDED DECEMBER 31, 2004

The following table sets forth all options granted during the year ended December 31, 2004 to each of the named executive officers.

|Name             |  | Number of
Securities
Underlying
Options Granted |  | Percent of Total
Options Granted to
Employees in
Fiscal Year |   | Exercise
Price
$/Share |      | Expiration
Date
|---------------- |  | ----------------------------------------------- |  | ------------------------------------------------------------ | - | ---------------------- | ---- | ---------------
|Kenneth S. Souza |  | 300,000                                         |  | 11.2                                                         | % | $                      | 1.05 |                

Options
vested in three (3) annual installments commencing September 15, 2005.

AGGREGATED OPTION EXERCISES IN THE YEAR ENDED
DECEMBER 31, 2004 AND FISCAL YEAR-END OPTION VALUE

The following table sets forth for each named executive officer, information regarding stock options exercised by such officer during the year ended
December 31, 2004, together with the number and value of stock options held at December 31, 2004, each on an aggregated basis.

|Name                  |  | Number Of
Shares
Acquired On
Exercise |  | Value
Realized |  | Number Of
Unexercised
Options At Fiscal
Year-End
Exercisable/
Unexercisable(#) |  | Value Of
Unexercised
In-The-Money
Options At Fiscal
Year-End
Exercisable/
Unexercisable($)(1)
|--------------------- |  | ------------------------------------- |  | -------------- |  | ------------------------------------------------------------------------------ |  | ---------------------------------------------------------------------------------------------
|Michael W. DePasquale |  |                                      |  |               |  | 757,500/322,500                                                                |  | 597,875/83,850                                                                               
|Randy Fodero          |  |                                      |  |               |  | 190,909/409,091                                                                |  | 227,182/207,818                                                                              
|Kenneth S. Souza      |  |                                       |  |                |  | 0/300,000                                                                      |  | 0/159,000                                                                                    

---

Employment Agreements

MICHAEL W. DEPASQUALE.On January 3, 2003, the Company entered into a two-year employment agreement with
Michael W. DePasquale to serve as the Chief Executive Officer of the Company at an annual base salary of $150,000 subject to adjustment by the Board of Directors. The employment agreement also
provides for an annual bonus of options to purchase up to 500,000 shares of Company common stock payable at the discretion of the Board of Directors. The base salary was adjusted to $216,000 for 2004.
The quarterly performance bonus benchmarks for 2004 were also adjusted to provide for payment of the $37,500 quarterly bonus upon achieving gross revenue of: $500,000, $750,000, $1,000,000 and
$1,250,000 during the first, second, third and fourth calendar quarters of 2004, respectively. Additional performance bonuses of $50,000 upon achieving annual gross revenue of at least $4,000,000 and
$50,000 upon the Company reporting operating profit during 2004 were also included for 2004.

The
employment agreement contains standard and customary confidentiality, non-solicitation and "work made for hire" provisions as well as a covenant not to compete which
prohibits Mr. DePasquale from doing business with any current or prospective customer of the Company or engaging in a business competitive with that of the Company during the term of his
employment and for the one year period thereafter. The agreement may be terminated by the Company at any time with or without cause. In the event of termination without cause, Mr. DePasquale
shall continue to be paid his then current base salary for the greater of six months from the date of such termination or the number of months remaining until the end of the term of the employment
agreement.

37

---



KENNETH S. SOUZA.In connection with his appointment as Senior Vice President and Chief Technology Officer of the Company on
October 4, 2004, we entered into a one (1) year employment agreement with Kenneth S. Souza. The employment agreement provides for an annual base salary of $200,000 and a performance
bonus in the amount of up to $76,000 payable upon achievement of certain performance criteria. Unless notice of non-renewal is provided to Mr. Souza at
least two months prior to the end of the term, the employment agreement automatically renews for successive one year terms. In the event that Mr. Souza is terminated without cause,
Mr. Souza will receive severance payment equal to his base salary for the greater of 6 months and that number of months remaining until the end of the term. The employment agreement
contains standard and customary confidentiality, non-compete and work made for hire provisions.

Upon
execution of the employment agreement, we issued to Mr. Souza a stock option to purchase 300,000 shares of our common stock at an exercise price of $1.11 per share, the last
sale price of our common stock as reported on the OTC Bulletin Board on the date of grant. The option has a term of seven (7) years and vests in three equal annual installments commencing on
October 4, 2005. Upon completion of one (1) year of service, Mr. Souza shall be eligible to receive a stock option to purchase up to an additional 300,000 shares of Company stock
based upon his performance as determined by the Company in its sole discretion.

Change in Control Provisions

The Company's 1996 Stock Option Plan (as amended to date, the "1996 Plan"), 1999 Stock Option Plan and 2004 Stock Incentive Plan (the "1999 Plan" and together
with the 1996 Plan and 2004 Plan, the "Plans") provide for the acceleration of the vesting of unvested options upon a "Change in Control" of the Company. A Change in Control is defined in the Plans to
include (i) a sale or transfer of substantially all of the Company's assets; (ii) the dissolution or liquidation of the Company; (iii) a merger or consolidation to which the
Company is a party and after which the prior shareholders of the Company hold less than 50% of the combined voting power of the surviving corporation's outstanding securities; (iv) the
incumbent directors cease to constitute at least a majority of the Board of Directors; or (v) a change in control of the Company which would otherwise be reportable under Section 13 or
15(d) of the Exchange Act.

In
the event of a "Change In Control" each Plan provides for the immediate vesting of all options issued thereunder. The 1999 Plan provides for the Company to deliver written notice to
each optionee under the 1999 Plan fifteen (15) days prior to the occurrence of a Change In Control during which all options issued under the 1999 Plan may be exercised. Thereafter, all options
issued under the 1999 Plan which are neither assumed or substituted in connection with such transaction, automatically expire unless otherwise determined by the Board. The 1996 Plan provides for all
options to remain exercisable for the remainder of their respective terms and permits the Company to make a cash payment to any or all optionees equal to the difference between the exercise price of
any or all such options and the fair market value of the Company's common stock immediately prior to the Change In Control. The 2004 Plan enables the Board to provide that all outstanding options be
assumed, or equivalent options be substituted by the acquiring or succeeding corporation upon the occurrence of a "Reorganization Event" as defined. If such Reorganization Event also constitutes a
Change in Control, then such assumed or substituted options shall be immediately exercisable in full. If the acquiring or succeeding corporation does not agree to assume, or substitute for such
options, then the Board, upon written notice to the Participants, may provide that all unexercised options become exercisable in full as of a specified time prior to the Reorganization Event and
terminate prior to the consummation of the Reorganization Event. Alternatively, if under the terms and conditions of the Reorganization Event, holders of common stock will receive a cash payment for
their shares, then the Board may provide that
all Participants receive a cash payment equal to the difference between the Acquisition Price and the Option Price multiplied by the number of options held by such Participants.

38

---





Options issued to executive officers outside of the Plans contain change in control provisions substantially similar to those contained in the 1999 Plan.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth, as of March 1, 2005, information with respect to the securities holdings of all persons which the Company, pursuant to
filings with the Securities and Exchange Commission, has reason to believe may be deemed the beneficial owners of more than five percent (5%) of the Company's outstanding common stock. The following
table also sets forth, as of such date, the beneficial ownership of the Company's common stock by all officers and directors, individually and as a group. Unless otherwise indicated, the address of
each person listed below is c/o BIO-key International, Inc., 3349 Highway 138, Building D, Suite B, Wall, NJ 07719

|Name and Address of Beneficial Owner               |  | Amount and Nature
of Beneficial
Ownership(1) |     | Percentage of
Class(1) |  
|-------------------------------------------------- |  | -------------------------------------------- | --- | ---------------------- | -
|Thomas J. Colatosti                                |  | 1,055,000                                    | (2) | 2.4                    | %
|Michael W. DePasquale                              |  | 1,100,000                                    | (3) | 2.5                    | %
|Francis J. Cusick                                  |  |                                             | (4) | *                      |  
|Richard E. Gaddy                                   |  |                                             | (5) | *                      |  
|Jeffrey May                                        |  | 250,000                                      | (6) | *                      |  
|Charles P. Romeo                                   |  | 216,660                                      | (7) | *                      |  
|John Schoenherr                                    |  |                                             | (5) | *                      |  
|Randy Fodero                                       |  | 338,676                                      | (8) | *                      |  
|Kenneth S. Souza                                   |  |                                             | (9) | *                      |  
|Kingdon Capital Management, LLC                    |  | 2,621,112                                    |     | 6.1                    | %
|152 West 57th Street
50th Floor
New York, NY 10019 |  |                                              |     |                        |  
|All officers and directors as a group (9) persons  |  | 2,760,336                                    |     | 6.8                    | %

---

39

---



The
following table sets forth, as of December 31, 2004, information with respect to securities authorized for issuance under equity compensation plans.

EQUITY COMPENSATION PLAN INFORMATION

|                                                           |       | Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a) |           | Weighted-average
exercise price of outstanding options, warrants and rights
(b) |        | Number of securities
remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
|---------------------------------------------------------- | ----- | ----------------------------------------------------------------------------------------------- | --------- | ------------------------------------------------------------------------------- | ------ | -----------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders     |       | 231,380                                                                                         |           | $                                                                               | 0.6045 |                                                                                                                                                
|Equity compensation plans not approved by security holders |       | 7,294,669                                                                                       |           | $                                                                               | 0.9506 |                                                                                                                                                
|                                                           | Total |                                                                                                 | 7,526,049 |                                                                                 | $      | 0.9399                                                                                                                                         

The
Company's 1999 Stock Option Plan (the "1999 Plan") was adopted by the Board of Directors of the Company on or about August 31, 1999. The material terms of the 1999 Plan are
summarized below.

The
1999 Plan is currently administered by the Board of Directors of the Company (the "Plan Administrator"). The Plan Administrator is authorized to construe the 1999 Plan and any option
issued under the 1999 Plan, select the persons to whom options may be granted, and determine the number of shares to be covered by any option, the exercise price, vesting schedule and other material
terms of such option.

The
1999 Plan provides for the issuance of options to purchase up to 2,000,000 shares of common stock to officers, employees, directors and consultants of the Company at exercise prices
not less than 85% of the last sale price of the Company's common stock as reported on the OTC Bulletin Board on the date of grant. Options have terms of not more than 10 years from the date of
grant, are subject to vesting as determined by the Plan Administrator and are not transferable without the permission of the Company except by will or the laws of descent and distribution or pursuant
to a domestic relations order. Options terminate three (3) months after termination of employment or other association with the Company or one (1) year after termination due to
disability, death or retirement. In the event that termination of employment or association is for a cause, as that term is defined in the 1999 Plan, options terminate immediately upon such
termination. The Plan Administrator has the discretion to extend options for up to three years from the date of termination or disassociation with the Company.

The
1999 Plan provides for the immediate vesting of all options in the event of a "Change In Control" of the Company. In the event of a Change In Control, the Company is required to
deliver written notice to each optionee under the 1999 Plan fifteen (15) days prior to the occurrence of a

40

---



Change
in Control, during which time all options issued under 1999 Plan may be exercised. Thereafter, all options issued under the 1999 Plan which are neither assumed or substituted in connection with
such transaction, automatically expire, unless otherwise determined by the Board. Under the 1999 Plan, a "Change In Control" is defined to include (i) a sale or transfer of substantially all of
the Company's assets; (ii) the dissolution or liquidation of the Company; (iii) a merger or consolidation to which the Company is a party and after which the prior shareholders of the
Company hold less than 50% of the combined voting power of the surviving corporation's outstanding securities; (iv) the incumbent directors cease to constitute at least a majority of the Board
of Directors; or (v) a change in control of the Company which would otherwise be reportable under Section 13 or 15(d) of the Exchange Act.

As
of December 31, 2004, there were outstanding options under the 1999 Plan to purchase 1,176,669 shares of common stock, and options to purchase an aggregate of 629,588 shares
were available for future grants.

On
October 12, 2004,the Board of Directors of the Company approved the 2004 Stock Option Plan (the 2004 Plan). The 2004 Plan has not yet been presented to stockholders for
approval and thus incentive stock options are not available under this plan. Under the terms of this plan, 4,000,000 shares of common stock are reserved for issuance to employees, officers, directors,
and consultants of the Company at exercise prices which may not be below 85% of fair market value. The term of stock options granted may not exceed ten years. Options issued under the 2004 Plan vest
pursuant to the terms of stock option agreements with the recipients. In the event of a change in control, as defined, all options outstanding vest immediately. The 2004 Plan terminates in
October 2014.

As
of December 31, 2004, there were outstanding options under the 2004 Plan to purchase 1,960,000 shares of common stock, and options to purchase an aggregate of 2,040,000 shares
were available for future grants.

In
addition to options issued under the 1999 and 2004 Plans, the Company has issued options and warrants to employees, officers, directors and consultants to purchase an aggregate of
7,884,047 shares of common stock. The terms of these options are substantially similar to the provisions of the 1999 Plan and options issued thereunder.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Employment Arrangements

The Company has entered into employment agreements with Michael W. DePasquale and Kenneth S. Souza. See"EXECUTIVE
COMPENSATIONEmployment Agreements."

Options Granted to Executive Officers and Directors

During 2002, the Company issued options to purchase 200,000 shares of common stock to Thomas J. Colatosti upon his appointment as a director of the
Company. During 2003 and 2004, the Company issued options to purchase an aggregate of 2,180,000 and 400,000 shares, respectively of common stock to its officers and directors. The options were issued
at exercise prices equal to the last sales price of the Company's common stock as reported on the OTC Bulletin Board on the date of grant, have terms of three (3) to seven (7) years, and
vest over a one to three year period.

Consulting Arrangement with Thomas J. Colatosti

In connection with his appointment to the Board of Directors in September 2002, the Company entered into a consulting arrangement with Thomas J. Colatosti.
Under the arrangement, the Company paid Mr. Colatosti $4,000 per month through December 2003 and issued him options to purchase 150,000 shares of common stock at an exercise price of
$.33 per share, the closing price of the Company's common stock on the date of grant. In December 2003, a committee of independent

41

---



directors
renewed this arrangement through December 31, 2004. The committee also issued options to Mr. Colatosti to purchase 150,000 shares of common stock at an exercise price of $1.32
per share, the closing price of the Company's common stock on the date of grant, for serving as Chairman. Effective November 1, 2004, Mr. Colatosti's monthly consulting fee was increased
to $14,500. Mr. Colatosti has substantial experience in the biometric industry and in addition to his role as the Chairman of the Board of Directors of the Company, provides extensive service
to the Company in the areas of strategic planning and corporate finance.

In
March 2004, Mr. Colatosti entered into a three year consulting arrangement with the Shaar Fund Ltd., a principal creditor of the Company. Under the terms of the
arrangement, The Shaar Fund transferred $375,000 principal amount of our secured convertible notes due October 1, 2005 to Mr. Colatosti. On April 28, 2004 the Company issued 3,750
shares of the Company's series C 7% convertible preferred stock to Mr. Colatosti in conversion of the $375,000 secured convertible note.

ITEM 13. EXHIBITS

(a)   The
following documents are filed as part of this Report. Portions of Item 13 are submitted as separate sections of this Report:





42

---







ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES

The following table presents fees for professional audit services by Divine, Scherzer & Brody, Ltd for the audit of the Company's annual financial
statements for 2003 and 2002, and fees billed for other services rendered by Divine, Scherzer & Brody, Ltd.

2004

2003Audit Fees:

$
213,175

$
95,622Audit-Related Fees:





Tax Fees:


3,356


1,846All Other Fees:





Total Fees

$
216,531

$
97,468


Audit Feesconsist of fees billed for professional services rendered for the audit of our financial statements and review of the interim
financial statements included in quarterly reports and services that are normally provided by Divine, Scherzer & Brody, Ltd in connection with statutory and regulatory
filings or engagements. Audit fees also include fees for services provided in connection with business acquisitions and registration of securities.

Audit-Related Feesconsist of fees billed for assurance and related services that are reasonably related to the performance of the audit
or review of the Company's consolidated financial statements and are not reported under "Audit Fees."

Tax Feesconsists of fees billed for professional services for tax compliance, tax advice and tax planning. These services include
assistance regarding federal and state tax compliance, tax audit defense, customs and duties, and mergers and acquisitions.

Audit Committee Pre-Approval Procedures

The Audit Committee of our Board of Directors, which consists of Richard E. Gaddy and Jeffrey J. May, serves as our audit committee. Our Board of
Directors approves the engagement of our independent auditors to render audit and non-audit services before they are engaged. All of the services performed by Divine, Scherzer &
Brody, Ltd for us were pre-approved by our the Audit Committee.

43

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ITEM 7FINANCIAL STATEMENTS

The following financial statements of BIO-key International, Inc. are included herein at the indicated page numbers:

|                                                                                         |  | Page No.
|---------------------------------------------------------------------------------------- |  | --------
|Report of Independent Certified Public Accountants                                       |  | 45      
|Balance Sheets at December 31, 2004 and 2003                                             |  | 46      
|Statements of OperationsYears ended December 31, 2004, 2003 and 2002                    |  | 48      
|Statement of Stockholders' Equity (Deficit)Years ended December 31, 2004, 2003 and 2002 |  | 49      
|Statements of Cash FlowsYears ended December 31, 2004, 2003 and 2002                    |  | 50      
|Notes to the Financial StatementsDecember 31, 2004, 2003 and 2002                       |  | 51      

44

---





Report of Independent Certified Public Accountants

Board
of Directors and Stockholders
BIO-key International, Inc.

We
have audited the accompanying consolidated balance sheets of BIO-key International, Inc. and Subsidiary as of December 31, 2004 and 2003, and the related
statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the three year period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of BIO-key International, Inc. and
Subsidiary as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the three year period ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States.

The
accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which contemplate continuation of the Company
as a going concern. However, as discussed in Note A to the financial statements, the Company has only recently begun to generate significant revenues, has suffered recurring losses from
operations and has a working capital deficit. These aforementioned issues, among others, raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do
not include any adjustments that might result from this uncertainty. Management's plans in regard to these matters are also discussed in Note A.

/s/
Divine, Scherzer & Brody, Ltd.

Minneapolis,
Minnesota
April 7, 2005

45

---





BIO-key International, Inc. and Subsidiary        BALANCE SHEETS

ASSETS

|                                                                            |                                                                   | December 31,                                                                        
|--------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------------------------------------------------------------------------------------
|
|CURRENT ASSETS                                                              |                                                                   |                                                                                     
|                                                                            | Cash and cash equivalents                                         |                                                                                     
|                                                                            | Marketable debt securities                                        |                                                                                     
|                                                                            | Receivables                                                       |                                                                                     
|                                                                            |                                                                   | Billed, less allowance for doubtful receivables of $422,393 and $2,000, respectively
|                                                                            |                                                                   | Unbilled                                                                            
|                                                                            | Due from selling stockholders and other                           |                                                                                     
|                                                                            | Costs and earnings in excess of billings on uncompleted contracts |                                                                                     
|                                                                            | Inventory                                                         |                                                                                     
|                                                                            | Prepaid expenses                                                  |                                                                                     
|                                                                            |                                                                   |                                                                                     
|                                                                            |                                                                   | Total current assets                                                                
|EQUIPMENT AND LEASEHOLD IMPROVEMENTSAT COST, less accumulated depreciation |                                                                   |                                                                                     
|OTHER ASSETS                                                                |                                                                   |                                                                                     
|                                                                            | Costs and earnings in excess of billings on uncompleted contracts |                                                                                     
|                                                                            | Deposits                                                          |                                                                                     
|                                                                            | Deferred offering costs                                           |                                                                                     
|                                                                            | Intangible assetsless accumulated amortization                   |                                                                                     
|                                                                            | Goodwill                                                          |                                                                                     
|                                                                            |                                                                   |                                                                                     
|                                                                            |                                                                   |                                                                                     
|                                                                            |                                                                   |                                                                                     
|                                                                            |                                                                   | $                                                                                   
|                                                                            |                                                                   |                                                                                     

46

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LIABILITIES
AND STOCKHOLDERS' EQUITY (DEFICIT)

|                                                             |                                                                                                                                     | December 31,                                                                           |           
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ----------
|
|CURRENT LIABILITIES                                          |                                                                                                                                     |                                                                                        |           
|                                                             | Current maturities of long-term obligations                                                                                         |                                                                                        | $         
|                                                             | Advances from stockholders                                                                                                          |                                                                                        |           
|                                                             | Accounts payable                                                                                                                    |                                                                                        |           
|                                                             | Billings in excess of costs and earnings on uncompleted contracts                                                                   |                                                                                        |           
|                                                             | Accrued liabilities                                                                                                                 |                                                                                        |           
|                                                             | Deferred rent                                                                                                                       |                                                                                        |           
|                                                             | Deferred revenue                                                                                                                    |                                                                                        |           
|                                                             |                                                                                                                                     |                                                                                        |           
|                                                             |                                                                                                                                     | Total current liabilities                                                              |           
|LONG-TERM OBLIGATIONS, less discounts and current maturities |                                                                                                                                     |                                                                                        | 5,286,951 
|DEFERRED RENT                                                |                                                                                                                                     |                                                                                        | 1,311,454 
|DEFERRED REVENUE                                             |                                                                                                                                     |                                                                                        | 71,203    
|COMMITMENTS AND CONTINGENCIES                                |                                                                                                                                     |                                                                                        |           
|STOCKHOLDERS' EQUITY (DEFICIT)                               |                                                                                                                                     |                                                                                        |           
|                                                             | Preferred stockauthorized, 5,000,000 shares of $.01 par value (liquidation preference of $100 per share)                           |                                                                                        |           
|                                                             |                                                                                                                                     | Series B 9% Convertible; issued and outstanding, 4,180 shares as of December 31, 2003  |           
|                                                             |                                                                                                                                     | Series C 7% Convertible; issued and outstanding, 62,182 shares as of December 31, 2004 |           
|                                                             | Common stockauthorized, 85,000,000 shares of $.01 par value; issued and outstanding 40,680,691 and 21,222,889 shares, respectively |                                                                                        |           
|                                                             | Additional contributed capital                                                                                                      |                                                                                        |           
|                                                             | Accumulated deficit                                                                                                                 |                                                                                        |           
|                                                             |                                                                                                                                     |                                                                                        |           
|                                                             |                                                                                                                                     |                                                                                        | 10,621,398
|                                                             |                                                                                                                                     |                                                                                        |           
|                                                             |                                                                                                                                     | $                                                                                      | 30,844,681
|                                                             |                                                                                                                                     |                                                                                        |           

The
accompanying notes are an integral part of these statements.

47

---





BIO-key International, Inc. and Subsidiary        STATEMENTS OF OPERATIONS

|                                              |                                                     | Years ended December 31, |           
|--------------------------------------------- | --------------------------------------------------- | ------------------------ | ----------
|
|Revenues                                      |                                                     |                          |           
|                                              | Services                                            |                          | $         
|                                              | License fees and other                              |                          |           
|                                              |                                                     |                          |           
|                                              |                                                     |                          | 5,558,231 
|Costs and other expenses                      |                                                     |                          |           
|                                              | Cost of services                                    |                          |           
|                                              | Cost of license fees and other                      |                          |           
|                                              | Selling, general and administrative                 |                          |           
|                                              | Research, development and engineering               |                          |           
|                                              |                                                     |                          |           
|                                              |                                                     |                          | 12,140,212
|                                              |                                                     |                          |           
|                                              |                                                     | Operating loss           |           
|Other income (deductions)                     |                                                     |                          |           
|                                              | Interest income                                     |                          |           
|                                              | Interest expense                                    |                          |           
|                                              | Other expense                                       |                          |           
|                                              |                                                     |                          |           
|                                              |                                                     |                          | (655,484  
|                                              |                                                     |                          |           
|                                              |                                                     | NET LOSS                 |           
|                                              |                                                     |                          |           
|Basic and diluted loss to common stockholders |                                                     |                          |           
|                                              | Net loss                                            |                          | $         
|                                              | Convertible preferred stock dividends and accretion |                          |           
|                                              |                                                     |                          |           
|                                              | Loss applicable to common stockholders              |                          | $         
|                                              |                                                     |                          |           
|Basic and diluted loss per common share       |                                                     |                          |           
|                                              | Net loss                                            |                          | $         
|                                              | Convertible preferred stock dividend and accretion  |                          |           
|                                              |                                                     |                          |           
|                                              | Loss applicable per common share                    |                          | $         
|                                              |                                                     |                          |           
|Weighted average number of shares             |                                                     |                          | 34,727,969
|                                              |                                                     |                          |           

The
accompanying notes are an integral part of these statements.

48

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BIO-key International, Inc. and Subsidiary
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)

|                                                                                                      |  | Series B 9% Convertible
Preferred Stock |   | Series C 7% Convertible
Preferred Stock |      |   |         |   |   |      |   |            |  |   |        
|----------------------------------------------------------------------------------------------------- |  | --------------------------------------- | - | --------------------------------------- | ---- | - | ------- | - | - | ---- | - | ---------- |  | - | -------
|
|
|
|Balance as of December 31, 2001                                                                       |  | 21,430                                  |   | $                                       | 214  |   |        |   | $ |     |   | 12,528,469 |  | $ | 125,285
|Conversion of series B preferred stock and cumulative dividends in arrears into common stock          |  | (3,000                                  | ) |                                         | (30  | ) |        |   |   |     |   | 1,045,739  |  |   | 10,457 
|Conversion of note and accrued interest into common stock                                             |  |                                        |   |                                         |     |   |        |   |   |     |   | 803,198    |  |   | 8,032  
|Options and warrants issued for services and other                                                    |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Net loss                                                                                              |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|                                                                                                      |  |                                         |   |                                         |      |   |         |   |   |      |   |            |  |   |        
|Balance as of December 31, 2002                                                                       |  | 18,430                                  |   |                                         | 184  |   |        |   |   |     |   | 14,377,406 |  |   | 143,774
|Conversion of series B preferred stock and cumulative dividends in arrears into common stock          |  | (14,250                                 | ) |                                         | (142 | ) |        |   |   |     |   | 4,239,206  |  |   | 42,392 
|Conversion of note, debenture and accrued interest into common stock                                  |  |                                        |   |                                         |     |   |        |   |   |     |   | 2,097,953  |  |   | 20,980 
|Exercise of options into common stock                                                                 |  |                                        |   |                                         |     |   |        |   |   |     |   | 308,324    |  |   | 3,083  
|Options and warrants issued for services and other                                                    |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Common stock issued in exchange for services and other                                                |  |                                        |   |                                         |     |   |        |   |   |     |   | 200,000    |  |   | 2,000  
|Net loss                                                                                              |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|                                                                                                      |  |                                         |   |                                         |      |   |         |   |   |      |   |            |  |   |        
|Balance as of December 31, 2003                                                                       |  | 4,180                                   |   |                                         | 42   |   |        |   |   |     |   | 21,222,889 |  |   | 212,229
|Issuance of series C preferred stock for Series B preferred stock and cumulative dividends in arrears |  | (4,180                                  | ) |                                         | (42  | ) | 5,257   |   |   | 52   |   |           |  |   |       
|Issuance of series C preferred stock in exchange for debt                                             |  |                                        |   |                                         |     |   | 83,275  |   |   | 833  |   |           |  |   |       
|Sale in March 2004 of common stock and warrants at $1.35 per unit, less offering costs of $580,996    |  |                                        |   |                                         |     |   |        |   |   |     |   | 8,888,928  |  |   | 88,889 
|Issuance of common stock in conjunction with PSG acquisition                                          |  |                                        |   |                                         |     |   |        |   |   |     |   | 2,422,108  |  |   | 24,221 
|Conversion of debentures, bridge notes, convertible notes and accrued interest into common stock      |  |                                        |   |                                         |     |   |        |   |   |     |   | 3,455,724  |  |   | 34,558 
|Conversion of series C preferred stock and cumulative dividends in arrears into common stock          |  |                                        |   |                                         |     |   | (30,100 | ) |   | (301 | ) | 4,133,060  |  |   | 41,331 
|Issuance of series C preferred stock in exchange for note payable to officer                          |  |                                        |   |                                         |     |   | 3,750   |   |   | 38   |   |           |  |   |       
|Exercise of options and warrants into common stock                                                    |  |                                        |   |                                         |     |   |        |   |   |     |   | 557,982    |  |   | 5,579  
|Repurchase warrants                                                                                   |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Options and warrants issued for services and other                                                    |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Issuance of warrants in conjunction with convertible notes offering                                   |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Discount on senior and subordinated convertible notes                                                 |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|Net loss                                                                                              |  |                                        |   |                                         |     |   |        |   |   |     |   |           |  |   |       
|                                                                                                      |  |                                         |   |                                         |      |   |         |   |   |      |   |            |  |   |        
|Balance as of December 31, 2004                                                                       |  |                                        |   | $                                       |     |   | 62,182  |   | $ | 622  |   | 40,680,691 |  | $ | 406,807
|                                                                                                      |  |                                         |   |                                         |      |   |         |   |   |      |   |            |  |   |        

The accompanying notes are an integral part of this statement.

49

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BIO-key International, Inc. and Subsidiary        STATEMENTS OF CASH FLOWS

|                                             |                                                                             | Years ended December 31, |                                                   
|-------------------------------------------- | --------------------------------------------------------------------------- | ------------------------ | --------------------------------------------------
|
|Cash flows from operating activities         |                                                                             |                          |                                                   
|                                             | Net loss                                                                    |                          | $                                                 
|                                             | Adjustments to reconcile net loss to net cash used in operating activities: |                          |                                                   
|                                             |                                                                             |                          | Depreciation                                      
|                                             |                                                                             |                          | Amortization                                      
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          | Allowance for doubtful receivables                
|                                             |                                                                             |                          | Gain on sale of marketable debt securities        
|                                             |                                                                             |                          | Write down of investment                          
|                                             |                                                                             |                          | Non-cash interest                                 
|                                             |                                                                             |                          | Deferred rent                                     
|                                             |                                                                             |                          | Options and warrants issued for services and other
|                                             |                                                                             |                          | Common stock issued for services and other        
|                                             |                                                                             |                          | Change in assets and liabilities:                 
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|Cash flows from investing activities         |                                                                             |                          |                                                   
|                                             | Acquisition of PSG                                                          |                          |                                                   
|                                             | Acquisition of AMG                                                          |                          |                                                   
|                                             | Capital expenditures                                                        |                          |                                                   
|                                             | Purchases of marketable debt securities                                     |                          |                                                   
|                                             | Proceeds from sale of marketable debt securities                            |                          |                                                   
|                                             | Deposits                                                                    |                          |                                                   
|                                             | Patents pending                                                             |                          |                                                   
|                                             | Other                                                                       |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|Cash flows from financing activities         |                                                                             |                          |                                                   
|                                             | Net advance from (to) stockholders                                          |                          |                                                   
|                                             | Issuance of convertible bridge notes                                        |                          |                                                   
|                                             | Issuance of long-term obligations                                           |                          |                                                   
|                                             | Repayment of long term obligations                                          |                          |                                                   
|                                             | Financing costs                                                             |                          |                                                   
|                                             | Sale of common stock                                                        |                          |                                                   
|                                             | Exercise of warrants                                                        |                          |                                                   
|                                             | Repurchase of warrants and other                                            |                          |                                                   
|                                             | Offering costs                                                              |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|                                             |                                                                             |                          |                                                   
|Cash and cash equivalents, beginning of year |                                                                             |                          | 1,012,790                                         
|                                             |                                                                             |                          |                                                   
|Cash and cash equivalents, end of year       |                                                                             | $                        | 956,230                                           
|                                             |                                                                             |                          |                                                   

The accompanying notes are an integral part of these statements

50

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BIO-key International, Inc. and Subsidiary        NOTES TO THE FINANCIAL STATEMENTS        December 31, 2004, 2003 and 2002

NOTE ATHE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Change in Name of Company and State of Incorporation

In February 2002, the Company's shareholders approved the change in the Company's name from SAC Technologies, Inc. to BIO-key
International, Inc.

Effective
January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key"), reincorporated as BIO-key
International, Inc., a Delaware corporation (the "Company," "BIO-key",). The reincorporation was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement"),
whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to reincorporate in the State of Delaware (the "Reincorporation"). As a result of the
Reincorporation, the legal domicile of the registrant is now Delaware.

Nature of Business

The Company, founded in 1993, made two strategic acquisitions in 2004. The Company acquired Public Safety Group Inc.("PSG") in March, 2004, and the Mobile
Government division of Aether Systems, Inc. ("AMG" or "Mobile Government") in September, 2004. The Company is now focused on delivering advanced finger based biometric identification and
security solutions and information services to law enforcement, fire service and emergence medical service agencies as well as other government and private sector customers. The Company's mobile
wireless technology provides first responders throughout North America with critical, reliable, real-time data and images from local, state and national databases.

Basis of Presentation

Broad commercial acceptance of the Company's technology is critical to the Company's success and ability to generate revenues. As a result of two acquisitions,
the Company's only significant revenues to date have come during the fourth quarter of 2004. The Company has accumulated losses during the past three years of approximately $15,084,000, of which
approximately $7,237,000 was incurred during 2004. As of December 31, 2004, there was a working capital deficit of approximately $3,016,000.

The
Company is in need of substantial additional capital. The Company is currently considering various alternatives in addition to improving its operating results. These include the
continued funding from two investment groups and new funding from other sources. No assurance can be given that the Company's operating results will improve, that any form of additional funding will
be available on terms acceptable to the Company, that adequate funding will be obtained to meet its needs, or that such funding would not be dilutive to existing stockholders.

The
accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which contemplate continuation of the Company
as a going concern. The matters described in the preceding paragraphs raise substantial doubt about the Company's ability to continue as a going concern. Recoverability of a major portion of the
recorded asset amounts shown in the accompanying balance sheet is dependent upon the Company's ability to obtain additional funding, meet its funding requirements on a continuing basis, and succeed in
its future operations. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue in existence.

51

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Summary of Significant Accounting Policies

A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:

The accompanying consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly owned subsidiary (collectively, the
Company) and are stated in conformity with accounting principles generally accepted in the United States, pursuant to the rules and regulations of the Securities and Exchange Commission. Intercompany
accounts and transactions have been eliminated in consolidation.

Revenues from software licensing are recognized in accordance with Statement of Position (SOP) No. 97-2, Software Revenue Recognition, as
amended by SOP No. 98-9. Accordingly, revenue from software licensing is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collectibility is probable.

The
Company intends to enter into arrangements with end users for items which may include software license fees, usage fees and services or various combinations thereof. For each
arrangement, revenues will be recognized when evidence of an agreement has been documented, the fees are fixed or determinable, collection of fees is probable, delivery of the product has occurred and
no other significant obligations remain.

Multiple-Element
Arrangements: For multiple-element arrangements, each element of the arrangement will be analyzed and the Company will allocate a portion of the total fee under the
arrangement to the elements using vendor specific objective evidence of fair value of the element, regardless of any separate prices stated within the contract for each element. Vendor specific
objective evidence is based on the price the customer is required to pay when the element is sold separately (i.e., software license fees charged when consulting or other services are not provided,
hourly rates charged for consulting services when sold separately from a software license or usage fees). If vendor specific objective evidence of fair value does not exist for any undelivered
elements, all revenue is deferred and
recognized ratably over the service period if the undelivered element is services, or until sufficient objective evidence of fair value exists or all elements have been delivered.

License
Revenues: Amounts allocated to license revenues are recognized at the time of delivery of the software and all other revenue recognition criteria discussed above have been met.

Revenue
from licensing software, which requires significant customization and modification is recognized using the percentage of completion method, based on the hours of effort incurred
by the company in relation to the total estimated hours to complete. In instances where third party hardware, software or services form a significant portion of a customer's contract, the
company recognizes revenue for the element of software customization by the percentage of completion method described above. Third party hardware, software, and services are recognized upon shipment
or acceptance as appropriate. If the company makes different judgments or utilizes different estimates of the total amount of work expected to be required to customize or modify the software, the
timing and revenue recognition, from period to period, and the margins on the project in the reporting period, may differ materially from amounts reported. Revenues earned but not yet billed are shown
as an asset in Costs and Earnings in Excess of Billings in the balance sheet. Billings in excess of cost and earnings are

52

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reflected
as a liability in the balance sheet. Anticipated contract losses are recognized as soon as they become known and are estimable.

Service
Revenues: Revenues from services are comprised of maintenance and consulting and implementation services. Maintenance revenues include providing for unspecified
when-and-if available product updates and customer telephone support services, and are recognized ratably over the term of the service period. Consulting services are generally
sold on a time-and-materials basis and include a range of services including installation of software and assisting in the design of interfaces to allow the software to operate
in customized environments. Services are generally separable from other elements under the arrangement since performance of the services are not essential to the functionality of any other element of
the transaction and are described in the contract such that the total price of the arrangement would be expected to vary as the result of the inclusion or exclusion of the services. Revenues from
services are generally recognized as the services are performed.

Usage
Fees: Usage fees are charged on certain applications based on the customer's volume of use. Usage revenue is recognized based on the actual level of activity used by the customer
or, in the case of fixed-fee arrangements, ratably over the arranged time period.

The
Company provides customers, free of charge or at a minimal cost, testing kits which potential licensing customers may use to test compatibility/acceptance of the Company's technology
with the customer's intended applications.

Cash equivalents consist of certificates of deposit and all other liquid investments with original maturities of three months or less. The Company maintains its
cash balances in a financial institution in Nevada. These balances are insured by the Federal Deposit Insurance Corporation up to $100,000.

Accounts receivable billed and unbilled are carried at original amount less an estimate made for doubtful receivables based on a review of all outstanding amounts
on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer's financial condition, credit
history, and current economic conditions. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received.

Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over the estimated service lives, principally using
straight-line methods. Leasehold improvements are amortized over the shorter of the life of the improvement or the lease term, using the straight-line method. Intangible assets
are amortized on the straight-line method over their expected useful lives.

53

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The
estimated useful lives used to compute depreciation and amortization for financial reporting purposes are as follows:

Equipment and leasehold improvementsEquipment

3-5 yearsFurniture and fixtures

3-5 yearsSoftware

3 yearsLeasehold improvements

4-5 yearsIntangible assetsCopyrighted software

5 yearsCustomer relationships

5 yearsTrademarks

5 yearsDeveloped technology

5 yearsMarketing agreements

5 yearsFinancing fees

3 years


Patent
costs are capitalized until patents are awarded. Upon award, such costs are amortized over their respective lives. If a patent is denied, all costs are charged to operations in
that year. At December 31, 2004 all patent costs relate to patents pending.

Financing
fees related to the issuance of long-term obligations are capitalized and amortized to interest expense over the lives of the related debt.

The
estimated aggregate amortization expense of intangible assets for the five years following December 31, 2004 is approximately as follows:

Year ending December 31,2005

$
892,0002006


892,0002007


882,0002008


863,0002009


430,000


The Company accounts for marketable securities pursuant to Statement of Financial Accounting Standards No. 115"Accounting for
Certain Investments in Debt and Equity Securities ("SFAS 115"). SFAS 115 requires classification of debt and equity securities in three categories: trading securities,
availablefor-sale securities and held-to-maturity securities. Debt and equity securities classified as trading securities are carried at fair value
with unrealized gains or losses included in income. Debt and equity securities designated as available-for-sale, whose fair values are readily determinable, are carried at fair
value with unrealized gains or losses included as a component of accumulated other comprehensive income, net of applicable taxes. Debt securities that are expected to be
held-to-maturity are carried at amortized cost. As of September 30, 2004, the Company's investments were all classified as non-current
held-to-maturity securities. During January 2005, the Company sold these investments, resulting in a transfer from held-to-maturities to available-for-sale securities as of
December 31, 2004. These securities are carried in current assets at amortized cost of $1,000,000, which approximated fair value as of December 31, 2004.

54

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Goodwill represents the excess of costs over the fair value of assets of businesses acquired. The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 142, Goodwill and Other Intangible Assets. In accordance with SFAS No. 142, goodwill and intangible assets acquired in a purchase business combination and determined to have
an indefinite useful life are not amortized, but instead tested for impairment at least annually. Accordingly, the Company has not amortized goodwill. As provided by SFAS No. 142, the Company
has elected to perform the annual assessment of the carrying value of all goodwill as of August 1 each year using a number of criteria, including the value of the overall enterprise. As of
December 31, 2004, the Company believes no material impairment exists. Future impairment charges from previous or future acquisitions, if any, will be reflected as an operating expense in the
statement of operations.

The Company has adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In accordance with SFAS No. 144,
long-lived assets subject to depreciation and amortization, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The
Company's long-lived assets consist primarily of its equipment and leasehold improvements and its intangible assets. Upon indication of possible impairment, the Company evaluates the
recovery of held-for-use long-lived assets by measuring the carrying value of the assets against the related estimated undiscounted future cash flows. When an
evaluation indicates that the future undiscounted cash flows are not sufficient to recover the carrying value of the asset, the asset is adjusted to its estimated fair value. The following
circumstances would be considered important and could lead to an impairment review; significant changes in the manner of our using the asset, negative industry or economic trends and underperformance
relative to projected operating results.

The Company expenses the costs of advertising as incurred. Advertising expenses for the years ended December 31, 2004, 2003, and 2002, were approximately
$146,000, $18,000, and $6,000, respectively.

All costs related to development of new products are charged to expense as incurred. Such costs are required to be expensed until technological feasibility and
proven marketability of the product are established.

55

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Basic and diluted loss per common share for all periods presented is computed using the weighted average number of common shares outstanding. Basic weighted
average shares outstanding include only outstanding common shares. Shares reserved for outstanding stock options and warrants, and convertible notes and preferred stock are not considered because the
impact of the incremental shares is antidilutive.

The Company provides for income taxes based on income reported for financial reporting purposes. Certain charges to earnings differ as to timing from those
deducted for tax purposes; these relate primarily to net operating loss carryforwards. The tax effect of these differences is recorded as deferred income taxes.

In December 2002, the Financial Accounting Standards Board (FASB) issued SFASB No. 148, Accounting for Stock-Based Compensation-Transition and
Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary charge to the fair value based method
of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires expanded and more prominent disclosure in both annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method on reported results.

The
Company has not adopted a method under SFAS No. 148 to expense stock options but rather continues to apply the recognition and measurement provisions of APB Opinion No.25,
Accounting for Stock issued to Employees, and related interpretations in accounting for those plans. No stock-based
employee compensation expense for options is reflected in net loss for the fiscal periods presented as all employee options granted under those plans had an exercise price equal to the market value of
the underlying common stock at the date of grant. A pro forma effect table is presented in the Pro Forma Compensation Disclosure section of the Stock-Based Compensation footnote, which assumes the
fair value recognition provisions of SFAS No. 123 would have been adopted for all options granted.

In
the future, if employees exercise certain nonstatutory stock options, the Company may realize a tax benefit equal to the tax effect on the difference between the strike price of the
option and the fair market value of the stock on the day of exercise. Tax benefits realized, if any, by the Company will be credited to additional contributed capital. Similar accounting treatment is
also given to any tax benefits the Company may realize arising from employees making disqualifying dispositions of incentive stock options.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses during the reporting period, and
disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Estimates are used in accounting for, among other things, long-term contracts, allowances
for uncollectible receivables, recoverability of goodwill and other long-lived assets, depreciation and amortization, valuation of deferred income taxes, conversion features of convertible
notes and preferred stock, and stock options and warrants outstanding.

In December 2004, the FASB issued SFAS No. 123 (revised 2004),Share-Based Payment(SFAS 123R). This statement replaces SFAS No. 123 and supersedesAPB Opinion No. 25, Accounting

56

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for Stock Issued to Employees. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial
statements based on their fair value. The pro-forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. For the
Company, SFAS 123R is effective for periods beginning after December 15, 2005. We plan to adopt SFAS 123R on January 1, 2006 using the modified prospective application
method described in the statement. Under the modified prospective application method, we will apply the standard to new awards and to awards modified, repurchased, or cancelled after the required
effective date. Additionally, compensation cost for the unvested portion of awards outstanding as of the required effective date will be recognized as compensation expense as the requisite service is
rendered after the required effective date. We are evaluating the impact of adopting SFAS 123R and expect that we will record substantial non-cash stock compensation expenses. The
adoption of SFAS 123R is not expected to have a significant effect on our cash flows but is expected to have a significant adverse effect on our results of operations. The future impact of the
adoption of SFAS 123R cannot be predicted at this time because it will depend upon the levels of share-based payments granted in the future. However, had we adopted SFAS 123R in prior
periods, the impact would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss attributable to common stockholders included in the Stock-Based
Compensation footnote.

NOTE BACQUISITIONS

Acquisition of Public Safety Group, Inc.

On March 30, 2004, we acquired all of the outstanding capital stock of Public Safety Group, Inc. (PSG), a privately-held leader in
wireless solutions for law enforcement and public safety markets based in Winter Park, Florida. The acquisition was completed pursuant to the terms of an Agreement and Plan of Merger (the Merger
Agreement) by and among the Company, BIO-Key Acquisition Corp., a wholly-owned subsidiary of the Company, PSG and all of the shareholders of PSG. As a result of this transaction PSG became
a wholly-owned subsidiary of the Company and now constitutes a division of our business specializing in the law enforcement and public safety markets (the Public Safety Division). The business
combination was accounted for using the purchase method.

Pursuant
to the Merger Agreement, we purchased all of the outstanding capital stock of PSG from the former shareholders of PSG in exchange for an aggregate of 2,416,108 shares of our
common stock issued to the former shareholders of PSG, 6,000 shares of our common stock issued to Harward Investments, Inc. (Harward) pursuant to an arrangement involving the discharge of
certain outstanding debt obligations of PSG to Harward as of March 30, 2004, $500,000 in cash, and our assumption of $600,000 in aggregate net liabilities of PSG. The Merger Agreement provides
any liability or obligation of PSG in excess of such $600,000 limitation, whether arising before or after the effective date of the merger, will be solely the responsibility of the former shareholders
of PSG. Additional earnout consideration, determined as a proportion of revenues attained by the Public Safety Division over fiscal years 2004 and 2005, may be paid to the former shareholders of PSG.
The Company will make payments of such additional consideration on the last day of the month following each month in which the Public Safety Division achieves specified revenue milestones during
fiscal years 2004 and 2005. Such payments will be made in cash, unless the aggregate amount of earnout consideration exceeds sixty percent (60%) of the aggregate consideration paid by the Company in
the merger transaction. Any such excess amounts will be paid in shares of our common stock priced as of two (2) days prior to the date on which any earnout payment becomes due. The earnout for
2004 was $43,635 and has been recorded as an increase in goodwill. In connection with this acquisition, three former employees of PSG, who were also shareholders of PSG, entered into
two-year employment agreements with the Company to serve within the Public Safety Division.

The
2,416,108 shares issued to the PSG shareholders (the Merger Shares) are subject to escrow provisions contained in the Merger Agreement and a related escrow agreement, which provide
for

57

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periodic
releases of the shares from escrow on a schedule determined by the revenues achieved by the Public Safety Division during fiscal years 2004 and 2005. The owners of such escrowed shares,
however, will continue to enjoy all the rights and privileges attributable to the shares, including, without limitation, the right to vote and receive dividends. The principal terms of the escrow
arrangement are as follows:



Through
February 1, 2005, 761,628 Merger Shares have been released from escrow under the Merger Agreement.

A
summary of the estimated fair value of the net assets acquired and liabilities assumed, pertaining to PSG, is as follows:

Current assets

$
133,369Goodwill


2,535,445Copyrighted software


1,181,429Marketing agreements


605,340Trademarks


379,807Other assets


5,857Total assets acquired


4,841,247Current liabilities


(332,307
)Long-term obligations


(400,000
)Purchase price

$
4,108,940


Acquisition of Mobile Government

On September 30, 2004, we acquired certain assets and assumed certain liabilities of the Mobile Government division of Aether Systems, Inc (Aether). The
aggregate purchase price of the acquisition was $12,198,171, which includes a $311,537 post closing reduction in deferred rent and a working capital adjustment payment of $341,878 made to Aether
during December 2004.

58

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A
summary of the adjusted estimated fair value of the net assets acquired and liabilities assumed, is as follows:

Current assets

$
9,706,935Goodwill


9,666,527Developed technology


710,000Customer relationships


1,009,000Trademarks


428,065Fixed assets


381,358Total assets acquired


21,901,885Current liabilities assumed


(9,703,714
)Total purchase price

$
12,198,171


The
components of the adjusted purchase price are as follows:

Cash paid

$
10,341,878Deferred rent as a result of a sub-lease with Aether


1,766,293Acquisition costs


90,000Total purchase price

$
12,198,171


In
connection with this acquisition, the Company issued a subordinated secured promissory note to Aether in the face amount of $6,884,588 (the "Aether Note"). The Aether Note evidences a
contingent reimbursement obligation of the Company to Aether and a surety fee payable by the Company to Aether, in each case with respect to a letter of credit maintained by Aether for the Company's
benefit in connection with the acquisition. The Company's obligations under the Aether Note are secured by a security interest granted to Aether in all or substantially all of the Company's assets,
subordinate to the security interest described in the Long-Term Obligations footnote.

In
conjunction with the acquisition of the Mobile Government division, the company was required to place approximately $2,750,000 in escrow as of September 30, 2004, for the
following:

$1,000,000
in escrow deposit supporting a $6,884,588 subordinated secured promissory note issued to Aether to secure performance obligations assumed under a contract with Hamilton
County, Ohio. The obligation is expected to extend for one year after final acceptance of the system by the customer. Acceptance is expected to occur in 2006.

$1,000,000
in escrow available to Lockheed Martin in the event of non-payment of liabilities for work performed on a contract with the Pennsylvania State Police. The escrow
is available to Lockheed Martin until conditional acceptance of certain defined milestones, which is expected in 2005. In March 2005, $500,000 of the escrow was returned to the Company upon
successful completion of a project milestone.

$750,000
in escrow which is available to the landlord of a subleased facility in the event the company defaults on a lease. The funds will not be available for use by the company until
the termination of the lease in August 2008.

Liquidated Damages

The Company may have to pay liquidated damages to customers in certain circumstance, including instances where its sub-contractors do not perform on
time. In addition, the Company sometimes indemnifies certain of its customers against damages, if any, they might incur as a result of a claim brought against them related to third party software
imbedded in the Company's products.

59

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The
Company's most significant exposure to liquidated and other damages is with its two largest uncompleted contracts with the Pennsylvania State Police (PSP) and Hamilton County, Ohio
(Hamilton). The PSP and Hamilton contracts limit the Company's liability for damage to approximately $7,000,000 and $10,000,000, respectively. The Company's management believes both contracts will be
completed within contract terms including defined specification for performance, and accordingly, payments of damages under the contracts are not likely. However, the projects are not complete and
there can be no assurances damages will not be incurred in the future. If damages are incurred there can be no assurance that any amounts required to be paid will not be material to the financial
statements.

Warranty Reserve

In some instances the Company may make commitments to provide additional products or services to customers beyond those obligations specified in the contract or
those provided in standard maintenance agreements or ordinary upgrades. These commitments usually arise in complex customer installations and are granted to help ensure customer satisfaction. There
was no accrued warranty liability as of December 31, 2004.

Summary of Operations

A summary of the aggregate operating results of the two acquired businesses for the years ended December 31, 2003 and 2002 are as follow:

2003

2002Revenues

$
21,833,661

$
20,739,962Costs and other expenses


25,072,263


35,849,423Operating loss


(3,238,602
)

(15,109,461
)Other income (deductions)


(13,142
)

(35,177
)Loss before income tax benefit and cumulative effect of change in accounting principle


(3,251,744
)

(15,144,638
)Income tax benefit





618,000Loss before cumulative effect of change in accounting principle


(3,251,744
)

(14,526,638
)Cumulative effect of change in accounting principle relating to adoption of SFAS No. 142





(32,037,000
)Net loss

$
(3,251,744
)
$
(46,563,638
)


Pro Forma Information

The following unaudited financial data reflects revenue, loss from continuing operations, net loss and loss applicable per common share of the Company for the
years ended December 31, 2004 and 2003 as though the PSG and Mobile Government transactions had occurred as of January 1, 2003.

Years ended December 31,2004

2003Revenue

$
19,251,001

$
22,357,762Loss from continuing operations

$
(11,817,800
)
$
(5,873,834
)Net loss

$
(11,817,800
)
$
(5,873,834
)Loss applicable per common share

$
(0.32
)
$
(0.30
)


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NOTE CCONCENTRATION OF RISK

Financial instruments and long-term contracts, which potentially subject the Company to risk, primarily consist of receivables and costs and earnings
in excess of billings on uncompleted contracts. The company extends credit to customers on an unsecured basis in the normal course of business. The company's policy is to perform an analysis of the
recoverability of its accounts receivable and costs and earnings in excess of billings on uncompleted contracts at the end of each reporting period and to establish allowances where appropriate. The
company analyses historical bad debts and contract losses, customer concentrations, and customer credit-worthiness when evaluating the adequacy of the allowances. As of December 31, 2004, two
customers accounted for approximately 26% of the company's outstanding accounts receivable balance and one customer accounted for approximately 86% of the costs and earnings in excess of billings on
uncompleted contracts. For the year ended December 31, 2004, one customer accounted for approximately 21% of the Company's revenue.

NOTE DCOSTS AND EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS

The components of uncompleted contracts consisted of the following as of December 31, 2004:

Costs and earnings incurred on uncompleted contracts

$
20,610,050Less billings to date


(14,421,254
)$
6,188,796Costs and earnings in excess of billings on uncompleted contracts

$
6,949,603Billings in excess of costs and earnings on uncompleted contracts


(760,807
)$
6,188,796


NOTE EPREPAID EXPENSES

Prepaid expenses consisted of the following as of December 31:

2004

2003Consulting fees

$


$
90,000Payment in lieu of bid bonds


76,897


Insurance and other


113,130


75,929$
190,027

$
165,929


In
October 2003, the Company entered into a twelve-month consulting agreement with a financial advisory services company. The terms of the consulting agreement required $108,000
to be paid in fees over the term of the agreement. The consulting fees were amortized to expense over the term of the agreement, which expired October 31, 2004.

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NOTE FEQUIPMENT AND LEASEHOLD IMPROVEMENTS

Equipment and leasehold improvements consisted of the following as of December 31:

2004

2003Equipment

$
348,298

$
66,543Furniture and fixtures


162,593


36,550Software


88,302


Leasehold improvements


165,756


764,949


103,093Less accumulated depreciation and amortization


120,848


42,936$
644,101

$
60,157


NOTE GOTHER ASSETS

Intangible Assets

Intangible assets consisted of the following as of December 31:

2004

2003Copyrighted software

$
1,181,429

$
Customer relationships


1,009,000


Trademarks


807,872


Developed technology


710,000


Marketing agreements


605,340


Patents pending


217,994


68,307Financing fees and other


84,840


4,616,475


68,307Less accumulated amortization


439,196


$
4,177,279

$
68,307


Goodwill

Mobile GovernmentInitial allocation

$
9,636,186Recalculation of deferred rent


(311,537
)Working capital purchase price adjustment


341,878Allocation adjustment


(303,156
)9,363,371Public Safety Group, Inc.Initial allocation


2,535,445Allocation adjustment


124,797Contingent purchase price adjustment


43,6352,703,877Total goodwill

$
12,067,248


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Deferred Offering Costs

In March 2002, the Company engaged an investment banking firm to advise the Company regarding raising additional capital through the potential future
issuance of the Company's equity, debt or convertible securities. The firm received a nonrefundable retainer fee of $50,000, out of pocket costs of
$14,900 and has been granted a warrant to purchase 25,000 shares of the Company's common stock at an exercise price of $1.00 per share through March 22, 2006. The estimated value of the warrant
is $17,000. These deferred costs were charged to operations in 2004 when this engagement terminated.

Deposits

Deposits consisted of the following as of December 31, 2004:

Contract performance deposit with Lockheed Martin

$
1,000,000Deposit securing a promissory note with Aether


1,000,000Lease deposit with Aether


750,000Other


11,134$
2,761,134


NOTE HACCRUED LIABILITIES

Accrued liabilities consisted of the following as of December 31:

2004

2003Contract costs not yet invoiced by vendors

$
3,301,442

$
Compensation


634,894


167,859Royalties


254,055


Interest


227,680


Other


221,548


5,877$
4,639,619

$
173,736


NOTE INOTE PAYABLE

Pursuant to the PSG Merger Agreement, dated March 30, 2004, the Company assumed a maximum of $600,000 in aggregate net liabilities of PSG, which included a
note payable of $400,000. This note was satisfied in April 2004.

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NOTE JLONG-TERM OBLIGATIONS

Long-term obligations consisted of the following as of December 31:

2004

2003Senior secured convertible term notes issued in 2004

$
5,149,437

$
Subordinated unsecured convertible term notes issued in 2004


4,815,000


Discounts assigned to fair values of conversion feature and warrants of above notes


(1,422,304
)

10% secured convertible note issued in 2001





3,617,92010% secured convertible notes issued in 2002





1,080,0007% convertible notes issued in 2002





750,0007% secured convertible notes issued in 2003





3,852,250Accrued interest





1,131,0538,542,133


10,431,223Less current maturities


3,255,182


$
5,286,951

$
10,431,223


Aggregate
maturities of long-term obligations for the years following December 31, 2004 are as follows:

2005

2006

2007

TotalsSenior secured convertible term notes

$
2,092,000

$
1,931,000

$
1,126,437

$
5,149,437Subordinated unsecured convertible term notes


1,655,000


1,806,000


1,354,000


4,815,000$
3,747,000

$
3,737,000

$
2,480,437

$
9,964,437


Senior Convertible Term Notes

On September 29, 2004, we entered into a Securities Purchase Agreement (the "Senior Purchase Agreement") with Laurus Master Fund, Ltd. ("Laurus")
and certain other institutional and accredited investors (together with Laurus, the "Senior Investors"). Under the Senior Purchase Agreement, the Company issued secured convertible term notes (the
"Senior Convertible Notes") in the aggregate
principal amount of $5,050,000, convertible into common stock of the Company in certain circumstances at $1.35 per share, and issued warrants (the "Senior Warrants") to purchase an aggregate of
1,122,222 shares of our common stock at an exercise price of $1.55 per share.

The
proceeds from this transaction were used in part to finance the Company's acquisition of Aether Mobile Government (the "Aether Acquisition"). The Company's obligations under the
Senior Purchase Agreement, the Senior Convertible Notes and the Senior Warrants are secured by a security interest in all or substantially all of the Company's assets.

Under
the terms of the Senior Convertible Notes, we are required to make monthly payments of accrued interest beginning on November 1, 2004. In addition, the Senior Convertible
Notes provide for monthly payments of principal in equal monthly increments of $157,813 thereof, plus accrued interest, commencing December 1, 2004. The Company made a principal payment of
$1,563 in December 2004, but was in default of the remaining principal payment (see below). The Senior Convertible Notes bear interest at an initial rate equal to the prime rate plus two
percent (2%), subject to a six percent (6%) floor. The interest rate on the Senior Convertible Notes is subject to reduction on a month-by-month

64

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basis
if specified conditions are met. In particular, if (a) we register the common stock underlying the Senior Convertible Notes and Senior Warrants on a registration statement declared
effective by the Securities and Exchange Commission and (b) our common stock is trading at a 25% or greater premium to the note conversion price, then the interest rate will be adjusted
downward by 2.0% for each incremental 25% increase over the note conversion price. Alternatively, if (x) we have not registered such common stock under an effective registration statement, but
(y) our common stock is trading at a 25% or greater premium to the note conversion price, then the interest rate will be adjusted downward by 1.0% for each incremental 25% increase over the
note conversion price. The effective interest rate as of December 31, 2004 was 7.25%.

For
any cash payments we make on the Senior Convertible Notes (e.g., any amounts due that are not converted into common stock), we are required to pay an amount equal to 102% of the
principal amount due. Accordingly, an additional principal amount of $101,000 has been included in outstanding Senior Convertible Notes and in the related discounts on long-term
obligations. In addition, we can prepay the note at any time upon payment of an amount equal to 110% of the then outstanding principal balance, plus accrued and unpaid interest.

The
Senior Investors have the option at any time to convert any or all of the outstanding principal and accrued and unpaid interest on the Senior Convertible Notes into shares of our
common stock at a conversion price of $1.35 per share. In addition, for each monthly payment under the note, the Senior Investors will be obligated to convert a portion of the monthly payment into
common stock at the applicable conversion price, so long as:



The
terms of the Senior Convertible Notes and Senior Warrants prohibit conversion of the notes or exercise of the warrants to the extent that conversion of the notes and exercise of the
warrants would result in any holder thereof, together with its affiliates, beneficially owning in excess of 4.99% of our outstanding shares of common stock. A holder may waive the 4.99% limitation
upon 75 days' prior written notice to us. Also, this limitation does not preclude the holder from converting or exercising the note or warrant and selling shares underlying the note or warrant
in stages over time where each stage does not cause the holder and its affiliates to beneficially own shares in excess of the limitation amount.

As
security for our obligations to the Senior Investors, we, along with our wholly-owned subsidiary Public Safety Group, Inc. ("PSG"), granted to the Senior Investors a blanket
security interest in all of our assets, and we entered into a stock pledge with the Senior Investors for the capital stock in PSG. If an event of default occurs under the Senior Convertible Notes or
the other related investment agreements, 120% of the unpaid principal balance on the Senior Convertible Notes, plus accrued interest and fees, shall become immediately due and the Senior Investors
shall be entitled to payment of a default interest rate of 1.5% per month on all amounts due under the Senior Convertible Notes. Such events of default include the following:



65

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As
of December 31, 2004 the Company was in default of one of its December 1 principal payments. The Company cured this default on January 5, 2005 and has received a
waiver from the Senior Investors, thus avoiding any penalties.

Upon
an event of default, the Senior Lenders will be entitled to specified remedies, including remedies under the Uniform Commercial Code.

We
have registered with the Securities and Exchange Commission for resale the shares of common stock that are issuable upon conversion of the Senior Convertible Notes and upon exercise
of the Senior Warrants. If we fail to comply with our registration obligations, the Senior Investors will be entitled to certain specified remedies, including monetary liquidated damages. In
particular, for each 30 days (or such pro rated number of days) that we are out of compliance with our registration
obligations, we will be subject to a liquidated damage assessment of 2% of the then outstanding principal amount of the Senior Convertible Notes.

Each
Senior Investor has agreed, pursuant to the Senior Purchase Agreement, that neither it nor any of its affiliates and investment partners will (and will not cause any other person or
entity, directly or indirectly, to) engage in "short sales" of our common stock for as long as any Senior Convertible Notes held by it remain outstanding. "Short sales" are contracts for the sale of
shares of stock that the seller does not own, or certificates which are not within the seller's control, so as to be available for delivery at the time when, under applicable rules, delivery must be
made.

Subordinated Convertible Term Notes

On September 29, 2004, we entered into a Securities Purchase Agreement (the "Subordinated Purchase Agreement") with The Shaar Fund, Ltd. ("Shaar")
and other existing shareholders of the Company and accredited investors (collectively, the "Subordinated Investors") for $4,950,000. Under the Subordinated Purchase Agreement, the Company issued
unsecured convertible term notes (the "Subordinated Convertible Notes") in the aggregate principal amount of $4,950,000, convertible into common stock of the Company in certain circumstances at $1.35
per share, and issued warrants (the "Subordinated Warrants") to purchase an aggregate of 1,099,997 shares of our common stock at an exercise price of $1.55 per share. The proceeds from this
transaction were used in part to finance a portion of the Aether Acquisition and will be used in part for working capital purposes.

Under
the terms of the Subordinated Convertible Notes, we are required to make monthly payments of accrued interest only beginning on November 1, 2004. In addition, the
Subordinated

66

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Convertible
Notes provide for monthly payments of principal in equal monthly increments of $154,688 thereof, plus accrued interest, commencing February 1, 2005, which payments may be made in
shares of common stock at the option of each note holder. The Subordinated Convertible Notes bear interest at an initial rate equal to the prime rate plus seven and one-half percent
(7.5%), subject to an eleven percent (11%) floor.

We
may prepay the Subordinated Convertible Notes at any time upon payment of an amount equal to 110% of the then outstanding principal balance, plus accrued and unpaid interest. Upon any
such prepayment, the Senior Convertible Notes must also be prepaid. The Subordinated Investors have the option at any time to convert any or all of the outstanding principal and accrued and unpaid
interest on the Subordinated Convertible Notes into shares of our common stock at a conversion price of $1.35 per share. During 2004, certain subordinated investors converted an aggregate principal
amount of $135,000 into 100,000 shares of the Company's common stock.

The
terms of the Subordinated Convertible Notes and Subordinated Warrants prohibit conversion of the notes or exercise of the warrants to the extent that conversion of the notes and
exercise of the warrants would result in any holder thereof, together with its affiliates, beneficially owning in excess of 4.99% of our outstanding shares of common stock. A holder may waive the
4.99% limitation upon 75 days' prior written notice to us. Also, this limitation does not preclude the holder from converting or exercising the note or warrant and selling shares underlying the
note or warrant in stages over time where each stage does not cause the holder and its affiliates to beneficially own shares in excess of the limitation amount.

If
an event of default occurs under the Subordinated Convertible Notes or the other related investment agreements, the unpaid principal balance on the Subordinated Convertible Notes,
plus accrued interest, shall, at the noteholder's option, become immediately due and the Subordinated Investors shall be entitled to payment of additional default interest at the rate of 2.0% per
month on all amounts due under the Subordinated Convertible Notes.

Such
events of default include the following:



67

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Upon
an event of default, the rights and remedies of the Subordinated Investors will be subordinate to those of the Senior Investors pursuant to a Subordination and Intercreditor
Agreement dated as of September 30, 2004 by and among Laurus, as Collateral Agent, Shaar, as Purchaser Agent, Aether Systems, Inc., PSG and the Company.

We
have registered with the Securities and Exchange Commission for resale the shares of common stock that are issuable upon conversion of the Subordinated Convertible Notes and upon
exercise of the Subordinated Warrants. If we fail to comply with our registration obligations, the Subordinated Investors will be entitled to certain specified remedies, including monetary liquidated
damages. In particular, for each 30 days (or such pro rated number of days) that we are out of compliance with our registration obligations, we will be subject to a liquidated damage assessment
of 2% of the then outstanding principal amount of the Subordinated Convertible Notes.

Each
Subordinated Investor has agreed, pursuant to the Subordinated Purchase Agreement, that neither it nor any of its affiliates and investment partners will (and will not cause any
other person or entity, directly or indirectly, to) engage in "short sales" of our common stock for as long as any Subordinated Convertible Notes held by it remain outstanding.

The
key provisions of the Company's long-term notes and debentures issued prior to 2004 are as follows:





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During
the quarter ended March 31, 2004, the Company received the final advances totaling $1,000,000, pursuant to this note agreement. In March 2004, at the request of
Shaar, the Company issued Thomas J. Colatosti, the chairman of the Board, a $375,000 note and Shaar a $2,125,000 note (collectively the Investors) in exchange for the October 31, 2003,
$2,500,000 7% Secured Convertible Promissory Note due Shaar. The terms of the notes require the principal and accrued interest at 7% to be repaid on October 1, 2005. In the event that the
Company completes a private placement of equity securities resulting in gross proceeds of at least $5,000,000 on or before June 30, 2004 the principal amount and accrued interest due under the
notes are convertible, at the option of the Investors, into the securities sold in such transaction at a conversion price equal to the sale price of such securities. Upon completion of such an equity
transaction, the Investors also have the right to request repayment of the note. The Investors may, at any time, elect to convert some or all of the notes into shares of the Company's common stock at
a conversion price of $0.75 per share or into shares of the Company's series C preferred stock at a conversion price of $100 per share.

Pursuant
to the Agreement entered into in March 2004, the Investors converted the remaining $2,352,250 of these notes into shares of the Company's series C convertible
preferred stock at the stipulated per share conversion price of $100 per share. During March 2004, Shaar, in a separate transaction, converted $1,777,500 of this note into shares of the
Company's series C convertible preferred stock at the stipulated per share conversion price of $100 per share. In March 2004, Shaar, in connection with a securities purchase agreement,
paid for a portion of their purchased stock and warrants by canceling $347,500 of this note.

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As of December 31, 2003, all existing long-term obligations were amended to provide, among other things, that all accrued interest be repaid on October 1, 2005.
In connection with the above conversions of notes during 2004, Shaar also converted all accrued interest due thereon into shares of the Company's common stock and series C convertible preferred
stock at their respective stipulated per share conversion prices of $0.75 and $100 per share.

The
conversion and exercise prices of the Company's convertible instruments, options and warrants discussed here and elsewhere were determined by individual negotiation between the
Company and the individual security holders or grantees.

Primarily
all of the Company's interest expense during 2003 and 2002 related to obligations due Shaar. During 2004, interest expense to Shaar was approximately $176,000.

NOTE KCOMMITMENTS AND CONTINGENCIES

Operating Leases

The Company does not own any real estate but conducts operations from four leased premises. These non-cancelable operating leases expire a various
dates through 2009. In addition to base rent, the Company pays for property taxes, maintenance, insurance and other occupancy expenses according to the terms of the individual leases.

In
connection with the Company's acquisition of AMG in 2004, the Company entered into a sub-lease with Aether, which requires monthly lease payments in excess of existing
market rates. Rent expense is recorded at market rate and charged on a straight- line basis through August 31, 2008, the termination date of the lease. The company has accrued a liability to
reflect the net present value of the excess of cash payments over rent expense for the remaining term of the lease.

Minimum
rental commitments of non-cancelable operating leases are approximately as follows:

Year ending December 31,2005

$
1,226,0002006


1,260,0002007


1,278,0002008


866,0002009


23,000$
4,653,000


Rental
expense was approximately $258,000, $60,000 and $63,000 during 2004, 2003 and 2002, respectively.

Employment Agreements

The Company has employment agreements with seven employees. These agreements allow the continuation of the employee's salary in the event of termination without
cause. The agreements also acknowledge the employee's eligibility to participate in the Company's bonus and option plans, the terms of which have not yet been
established.Upon completion of one year of service during 2005, one employee is eligible for options for up to 300,000 shares. As of
December 31, 2004, the aggregate commitment under these agreements is approximately $930,000.

Legal Proceeding

Prior to our acquisition of PSG in June 2003, PSG was named as a defendant in a civil action initiated in the Superior Court Department in Hampden County,
Commonwealth of Massachusetts by

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The
Vince Group, Inc. ("TVG"). The case has since been removed to the United States District Court for the District of Massachusetts at the request of the Parties. The complaint claims that PSG
is obligated to pay a percentage of certain of its revenues to TVG in consideration for a strategic business introduction allegedly made by an agent of TVG. PSG has denied the allegations and filed an
answer in the litigation, and as of the date of this report the outcome of the litigation is pending. The claim is for an unspecified amount including actual damages, interest, and attorney's fees.
Management believes the claim is without merit and will settle out of court for an amount which will not have a material adverse affect on our business, financial condition or operating results.

Royalty Reserve

From time to time, the Company licenses or sells products which may include technology obtained from third parties under a royalty agreement. These agreements
obligate the company to pay the third party a fixed fee, or in some instances, a percentage of the associated revenue. The fees are generally due and payable only when software has been installed and
accepted by the customer. Royalty expense was approximately $23,000 during 2004.

NOTE LSTOCKHOLDERS' EQUITY

Common Stock

In August 2004, the Company's shareholders approved amendments to its articles of incorporation which increased the number of authorized shares of common
stock from 60,000,000 to 85,000,000.

During
March 2004, the company entered into a securities purchase agreement with certain institutional and accredited investors pursuant to which the Company issued and sold an
aggregate of 8,888,928 shares of common stock and warrants to purchase an aggregate of 4,444,464 shares of common stock. The investors paid an aggregate purchase price of $1.35 for each share of
common stock and warrant to purchase 0.5 of a share of common stock, resulting in gross proceeds of approximately $12,000,000. In connection with the securities purchase agreement, the Investor paid
for a portion of their purchased stock and warrants by canceling $347,500 of outstanding debt.

The
Warrants issued in conjunction with the sale of common stock on March 31, 2004, may be exercised at any time prior to June 8, 2009. Each Warrant contains
anti-dilution protection through March 31, 2005, which has resulted in a reduction of the exercise price from $1.755 to $1.35 per share. Fifty percent (50%) of any unexercised
portions of the Warrants are callable by the Company if the volume weighted average trading price per share of our common stock exceeds $4.3875 per share for ten (10) consecutive trading days
and the Warrants have not been exercised after forty-five (45) days' prior notice from the Company.

Under
the Purchase Agreement, in the event that (i) an investor is not permitted to sell its securities hereunder for any reason for five (5) or more trading days (whether
or not consecutive), (ii) any securities covered hereunder are not listed on an eligible trading market or (iii) our common stock is not listed or quoted, or is suspended from trading,
on an eligible trading market for a period of three (3) trading days (whether or not consecutive), the Company will be required to pay a cash amount to the investors equal to one percent (1%)
of the aggregate purchase price paid by the investors pursuant to the Purchase Agreement for the first month that such event occurs and one percent (1%) for each month thereafter in which such event
remains uncured, in each case prorated for any partial month. If the Company fails to make any such payment in a timely manner, such payment shall bear interest at the rate of one percent (1%) per
month (prorated for partial months) until paid in full.

71

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Series B 9% Convertible Preferred Stock

The Series B Preferred Stock accrues dividends of 9% payable semi-annually on June 15, December 15, and on such date that the
preferred stockholder elects to convert preferred stock to common stock, in cash, or at the option of the Company, in additional shares of its common stock. As of December 31, 2003, cumulative
dividends in arrears were approximately $86,000. The Series B shares are redeemable at the option of the Company, so long as the Company's common stock is eligible for quotation on the OTC
Bulletin Board and the shares issuable upon conversion are subject to an effective registration statement. The Series B shares are convertible into shares of the Company's common stock at a per
share conversion price equal to the lesser of $0.75 or a 22% discount to the average closing price of the common stock during the five trading days preceding conversion. The Series B shares
have no voting rights.

During
March 2004, the Investor converted the remaining 4,180 shares of Series B 9% convertible preferred stock and $107,693 of dividends and accrued interest thereon into
5,257 shares of the Company's series C preferred stock. All of the Company's series C preferred stock is convertible into shares of the Company's common stock at a conversion price of
$.75 per share.

Series C 7% Convertible Preferred Stock

In March 2004, we designated 100,000 shares of preferred stock as Series C Convertible Preferred Stock (the "Series C Shares"), of which
62,182 are issued and outstanding at December 31, 2004. The Series C Shares accrue a cumulative annual dividend of 7% on the $100 face amount of such shares payable in shares of common
stock on June 15 and December 15 each year, and on such date that the preferred stockholder elects to convert preferred stock to common stock. As of December 31, 2004, cumulative
dividends in arrears were approximately $308,900. In the event of a liquidation, dissolution or winding up of the Company, the Series C Shares have a liquidation preference of $100 per share
plus all accrued and unpaid dividends thereon prior to any payment or distribution to holders of our common stock. The Series C Shares are convertible into common stock at a conversion price of
$.75 per share. The conversion price is subject to proportional adjustment in the event of stock splits, stock dividends or reclassifications. Subject to certain exceptions, in the event we issue
additional shares of common stock at a purchase price less than the conversion price of the Series C Shares, the conversion price shall be lowered to such lesser price. In the event that the
average closing bid price of our common stock is less than $1.00 per share for thirty (30) consecutive trading days at any time after March 3, 2007, we will be required to redeem the
Series C Shares by payment of $100 per share plus all accrued and unpaid dividends due thereon.

We
are required to obtain the consent of the holders of a majority of the Series C Shares in order to, among other things, issue any shares of preferred stock that are equal to or
have a preference over the Series C shares or issue any shares of preferred stock, rights, options, warrants, or any other securities convertible into common stock of the Company, other than
those issued to employees of the Company in the ordinary course of their employment or to consultants or other persons providing services to the Company so long as such issuances do not exceed the
conversion rights for more than 500,000 shares of common stock. We are also required to obtain such consent in order to, among other things, complete a sale or other disposition of any material
assets, complete an acquisition of a material amount of assets, engage in a merger, reorganization or consolidation, or incur or guaranty any indebtedness in excess of $50,000.

72

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Warrants

The Company has issued warrants to certain creditors, investors, investment bankers and consultants. A summary of warrant activity is as follows:

|                                              |  | Outstanding |   | Price per
share |            | Expiration
date |           | Exercisable at
December 31,
2004 |           
|--------------------------------------------- |  | ----------- | - | --------------- | ---------- | --------------- | --------- | -------------------------------- | ----------
|Balance, December 31, 2001                    |  | 5,811,898   |   |                 |            |                 |           |                                  | 5,677,898 
|Granted to consultants                        |  | 418,000     |   | $               | 0.45-$1.25 |                 | 2003-2006 |                                  | 418,000   
|Expired                                       |  | (372,216    | ) | $               | 0.84-$3.60 |                 |          |                                  | (372,216  
|                                              |  |             |   |                 |            |                 |           |                                  |           
|Balance, December 31, 2002                    |  | 5,857,682   |   |                 |            |                 |           |                                  | 5,723,682 
|Granted to consultants                        |  | 200,000     |   | $               | 0.49       |                 | 2006      |                                  | 200,000   
|Expired                                       |  | (663,000    | ) | $               | 0.86-$7.50 |                 |          |                                  | (529,000  
|                                              |  |             |   |                 |            |                 |           |                                  |           
|Balance, December 31, 2003                    |  | 5,394,682   |   |                 |            |                 |           |                                  | 5,394,682 
|Sold in connection with private placement     |  | 4,444,464   |   | $               | 1.35       |                 | 2009      |                                  | 4,444,464 
|Sold in connection with convertible notes     |  | 2,222,219   |   | $               | 1.55       |                 | 2009      |                                  | 2,222,219 
|Granted to consultants and Investment bankers |  | 1,214,667   |   | $               | 0.97-$1.35 |                 | 2009      |                                  | 1,114,667 
|Exercised                                     |  | (3,000      | ) | $               | 0.65       |                 |          |                                  | (3,000    
|Repurchased                                   |  | (567,000    | ) | $               | 0.38-$1.00 |                 |          |                                  | (567,000  
|Expired or cancelled                          |  | (561,932    | ) | $               | 0.45-$3.00 |                 |          |                                  | (561,932  
|                                              |  |             |   |                 |            |                 |           |                                  |           
|Balance, December 31, 2004                    |  | 12,144,100  |   |                 |            |                 |           |                                  | 12,044,100
|                                              |  |             |   |                 |            |                 |           |                                  |           

The
estimated fair value of the warrants granted during 2004, 2003 and 2002 was $4,297,620, $67,000 and $32,000, respectively. The estimated fair value of the 1,214,667 warrants granted
to consultants and investment bankers in 2004 was $677,471 of the $4,297,620 total for the year. The fair value of warrants is estimated as of the grant date using the Black-Scholes pricing model
utilizing the same assumptions described in the Stock-Based Compensation footnote. The estimated fair value of warrants granted for goods and services is being amortized to expense over the terms of
the consulting agreements.

NOTE MSTOCK-BASED COMPENSATION

1996 Stock Option Plan

During 1996, the Board of Directors and stockholders of the Company adopted the 1996 Stock Option Plan (the 1996 Plan). Under the 1996 Plan, 750,000 shares of
common stock are reserved for issuance to employees, officers, directors, and consultants of the Company at exercise prices which may not be below 100% of fair market value for incentive stock options
and 50% for all others. The term of stock options granted may not exceed ten years. Options issued under the Plan vest pursuant to the terms of stock option agreements with the recipients. In the
event of a change in control, as defined, all options outstanding vest immediately. The Plan terminates in May 2006.

1999 Stock Option Plan

During 1999, the Board of Directors of the Company adopted the 1999 Stock Option Plan (the 1999 Plan). The 1999 Plan was not presented to stockholders for
approval and thus incentive stock options are not available under the plan. Under the 1999 Plan, 2,000,000 shares of common stock are reserved for issuance to employees, officers, directors, and
consultants of the Company at exercise prices which may not be below 85% of fair market value. The term of nonstatutory stock options granted may not exceed ten years. Options issued under the Plan
vest pursuant to the terms of stock

73

---



option
agreements with the recipients. In the event of a change in control, as defined, all options outstanding vest immediately. The 1999 Plan terminates in August 2009.

2004 Stock Option Plan

On October 12, 2004, the Board of Directors of the Company approved the 2004 Stock Option Plan (the 2004 Plan). The 2004 Plan has not yet been presented to
stockholders for approval and thus
incentive stock options are not available under this plan. Under the terms of this plan, 4,000,000 shares of common stock are reserved for issuance to employees, officers, directors, and consultants
of the Company at exercise prices which may not be below 85% of fair market value. The term of stock options granted may not exceed ten years. Options issued under the Plan vest pursuant to the terms
of stock option agreements with the recipients. In the event of a change in control, as defined, all options outstanding vest immediately. The Plan terminates in October 2014.

Non-Plan Stock Options

Periodically, the Company has granted options outside of the 1996, 1999, and 2004 Plans to various employees and consultants. In the event of change in control,
as defined, certain of the non-plan options outstanding vest immediately.

Summary of Option Information

Information summarizing option activity is as follows:

|                                               |                     | Number of Options |          |           |          |          
|---------------------------------------------- | ------------------- | ----------------- | -------- | --------- | -------- | ---------
|
|
|Balance, December 31, 2001                     |                     | 390,380           |          | 1,456,669 |          |         
|                                               | Granted             |                   |         |           | 380,000  |          
|                                               | Expired or canceled |                   |         |           |         |          
|                                               |                     |                   |          |           |          |          
|Balance, December 31, 2002                     |                     | 390,380           |          | 1,836,669 |          |         
|                                               | Granted             |                   | 130,000  |           | 150,000  |          
|                                               | Exercised           |                   |         |           | (193,743 | )        
|                                               | Expired or canceled |                   | (33,000  | )         | (616,257 | )        
|                                               |                     |                   |          |           |          |          
|Balance, December 31, 2003                     |                     | 487,380           |          | 1,176,669 |          |         
|                                               | Granted             |                   |         |           |         |          
|                                               | Exercised           |                   | (251,000 | )         |         |          
|                                               | Expired or canceled |                   | (5,000   | )         |         |          
|                                               |                     |                   |          |           |          |          
|Balance, December 31, 2004                     |                     | 231,380           |          | 1,176,669 |          | 1,960,000
|                                               |                     |                   |          |           |          |          
|Available for future grants, December 31, 2004 |                     | 174,620           |          | 629,588   |          | 2,040,000
|                                               |                     |                   |          |           |          |          

Additional information regarding outstanding options as of December 31, 2004 is as follows:

|Shares under outstanding options |  | Shares exercisable under
outstanding options
|-------------------------------- |  | --------------------------------------------
|
|$.19.50                         |  | 1,685,000                                   
|.51.97                          |  | 1,523,049                                   
|1.001.62                        |  | 4,270,000                                   
|3.006.42                        |  | 48,000                                      

74

---



The
weighted average fair value of options granted to employees and directors during 2004, 2003 and 2002 were $0.68, $0.62 and $0.17 per share, respectively. The fair value of each
option grant is estimated as of the date of the grant using the Black-Scholes option-pricing model utilizing the same assumptions presented in the proforma compensation disclosure section below.

Non-Plan
options were granted to consultants during 2004 and 2002 totaling 45,000 and 150,000 shares, respectively. The options issued in 2004 vest annually over a
three-year period commencing in July 2005. The 2002 options vested quarterly over a one-year period commencing in December 2002. The estimated fair value of these
Non-Plan options granted to consultants in 2004 and 2002 were $27,000 and $35,000, respectively.

Proforma Compensation Disclosure

In December 2002, the Financial Accounting Standards Board (FASB) issued SFASB No. 148, Accounting for Stock-Based Compensation-Transition and
Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary charge to the fair value based method
of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires expanded and more prominent disclosure in both annual and interim financial statements about the method
of accounting for stock-based employee compensation and the effect of the method on reported results.

The
Company has not adopted a method under SFAS No. 148 to expense stock options but rather continues to apply the recognition and measurement provisions of APB Opinion No.25,
Accounting for Stock issued to Employees, and related interpretations in accounting for those plans. No stock-based employee compensation expense for options is reflected in net loss for the fiscal
periods presented as all options granted under those plans had an exercise price equal to or lower than the market price of the underlying common stock at the date of grant.

If
compensation expense for the stock options granted had been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the Company's
proforma net loss and proforma loss per share would have been as follows:

Years ended December 31,2004

2003

2002Net lossAs reported

$
(7,237,465
)
$
(3,826,073
)
$
(4,019,974
)Proforma


(7,505,465
)

(3,962,073
)

(4,166,974
)Loss applicable to common stockholdersAs reported

$
(7,651,705
)
$
(3,962,828
)
$
(4,184,939
)Proforma


(7,919,705
)

(4,098,828
)

(4,331,939
)Basic and diluted loss per common shareAs reported

$
(.22
)
$
(.23
)
$
(.32
)Proforma


(.23
)

(.23
)

(.33
)


In
determining the proforma compensation cost of the options granted, the fair value of each grant was estimated on the date of grant using the Black-Scholes option pricing model. The
assumptions used to determine the fair value of each grant included the following weighted average assumptions:

2004

2003

2002Risk free interest rate

3.00
%
1.90
%
2.54
%Expected life of options (in years)

3.00

3.00

5.00Expected dividends





Volatility of stock price

90
%
120
%
154
%


75

---



NOTE NINCOME TAXES

Deferred taxes are due to income tax credits and net operating loss carryforwards, and to the temporary differences between the carrying values of certain assets
and liabilities for financial reporting and income tax purposes. Significant components of deferred taxes are as follows at December 31:

2004

2003Current asset:Accrued compensation

$
59,000

$
20,000Accounts receivable allowance


29,000


Non-current asset:Accrued interest and other


100,000


396,000Income tax credits


217,000


166,000Net operating loss carryforwards


11,796,000


9,070,000Valuation allowances


(12,201,000
)

(9,652,000
)$


$



A
valuation allowance equal to the full amount of the deferred tax assets has been recorded due to the uncertainty of realization of the deferred tax assets due to operating loss history
of the Company. The valuation allowance could be reduced or eliminated based on future earnings and future estimates of taxable income. Similarly, income tax benefits related to stock options
exercised have not been recognized in the financial statements.

The
Company has federal and state net operating loss carryforwards of approximately $32,501,000 and $14,129,000, respectively, as of December 31, 2004. These operating losses
expire between 2011 and 2024. Net operating loss carryforwards are subject to the limitations under Section 382 of the Internal Revenue Code due to changes in the equity ownership of the
Company.

NOTE OFAIR VALUES OF FINANCIAL INSTRUMENTS

The Statement of Financial Accounting Standards Board No. 107 "Disclosures about Fair Value of Financial Instruments" (SFAS 107) requires disclosure
of the estimated fair value of an entity's financial instruments. Such disclosures, which pertain to the Company's financial instruments, do not purport to represent the aggregate net fair value of
the Company. At December 31, 2004 and 2003, the carrying value of all material financial instruments, for which it is practicable to estimate the fair value, approximated fair value because of
the short maturity of those instruments.

76

---



NOTE PSUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION

|                                                          |                                                                                                                                       | Years ended December 31,
|--------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | ------------------------
|
|Cash paid for:                                            |                                                                                                                                       |                         
|                                                          | Interest                                                                                                                              |                         
|Noncash Financing Activities:                             |                                                                                                                                       |                         
|                                                          | Conversion of convertible debentures and notes, bridge notes and accrued interest into common stock                                   |                         
|                                                          | Issuance of Series C preferred stock in exchange for Series B Preferred stock and cumulative dividends in arrears, thereon            |                         
|Issuance of Series C preferred stock in exchange for debt |                                                                                                                                       |                         
|                                                          | Issuance of common stock in exchange for options and warrants                                                                         |                         
|                                                          | Issuance of common stock in conjunction with PSG acquisition                                                                          |                         
|                                                          | Issuance of common stock and warrants in exchange for services                                                                        |                         
|                                                          | Issuance of warrants in conjunction with debt offering                                                                                |                         
|                                                          | Trade receivables assumed by prior Shareholders of AMG                                                                                |                         
|                                                          | Offering costs                                                                                                                        |                         
|                                                          | Conversion of short-term notes and penalties into long-term notes                                                                     |                         
|                                                          | Issuance of common stock in exchange for Series A, Series B and Series C preferred stock and cumulative dividends in arrears, thereon |                         
|                                                          | Issuance of warrants for reduction in payables                                                                                        |                         
|                                                          | Securities transferred from held-to-maturity to available-for-sale                                                                    |                         

NOTE QPROFIT SHARING PLAN

The Company has established a savings plan under section 401(k) of the Internal Revenue Code. All employees of the Company, after completing one day of
service are eligible to enroll in the 401(k) plan. Participating employees may elect to defer a portion of their salary on a pre-tax basis up to the limits as provided by the IRS Code. The
Company is not required to match employee contributions but may do so at its discretion. The Company made no contributions during the three years ended December 31, 2004.

NOTE RRECLASSIFICATIONS

Certain amounts in the 2003 and 2002 financial statements have been reclassified to conform to the 2004 and 2003 presentation. These reclassifications had no
effect on the previously reported net loss or stockholders' equity (deficit).

NOTE SFOURTH QUARTER ADJUSTMENTS

During the fourth quarter of 2004, the Company recorded a number of adjustments to its consolidated financial statements, which individually and/or cumulatively
had a material effect on its consolidated results of operations and financial condition. These adjustments included the following:



77

---





Working capital purchase price adjustment

$
342,000Contingent purchase price adjustment


44,000Recalculation of deferred rent


(312,000
)Allocation adjustments


(178,000
)Total goodwill adjustment

$
104,000


NOTE TEVENTS OCCURRING SUBSEQUENT TO DECEMBER 31, 2004

Effective January 1, 2005, BIO-key International, Inc., a Minnesota corporation ("Old BIO-key") and the original registrant
under this Registration Statement, reincorporated as BIO-key International, Inc., a Delaware corporation (the "Company," "BIO-key," "we" or "us"). The reincorporation
was effected pursuant to an Agreement and Plan of Merger (the "Merger Agreement"), whereby Old BIO-key was merged with and into the Company, its wholly owned subsidiary, in order to
reincorporate in the State of Delaware (the "Reincorporation"). As a result of the Reincorporation, the legal domicile of the registrant is now Delaware.

Pursuant
to the Merger Agreement, at the effective time of the Reincorporation: (i) each outstanding share of Common Stock of Old BIO-key, $0.01 par value per share,
was automatically converted into one share of Common Stock, $0.0001 par value per share, of the Company; (ii) each outstanding share of Series C 7% Convertible Preferred Stock of Old
BIO-key, $0.01 par value per share, was automatically converted into one share of Series A 7% Convertible Preferred Stock, $0.0001 par value per share, of the Company, with such
Series A 7% Convertible Preferred Stock containing substantially identical terms and conditions as the Series C 7% Convertible Preferred Stock of Old BIO-key;
(iii) each option to purchase shares of Old BIO-key's Common Stock granted by Old BIO-key under any warrant, stock option plan or similar plan of Old BIO-key
outstanding immediately before the Reincorporation was, by virtue of the Merger Agreement and without any action on the part of the holder thereof, converted into and become an option to purchase,
upon the same terms and conditions, the same number of shares of the Company's Common Stock at an exercise price per share equal to the exercise price per share thereunder immediately before the
Reincorporation; and (iv) each warrant, option or stock option plan of Old BIO-key was assumed by, and continues to be, a warrant, option or plan of the Company. Accordingly, as a
result of the Reincorporation, the shareholders of Old BIO-key became shareholders of the Company, and Old BIO-key has been merged out of existence by operation of law.

Each
certificate representing shares of capital stock of Old BIO-key outstanding immediately before the Reincorporation will, from and after the Reincorporation, be deemed
for all corporate purposes to represent the same number of shares of capital stock of the Company.

Between
January 1, 2005 and April 6, 2005, the Shaar Fund converted a total of 11,000 shares of the Company's Series A Preferred Stock and $72,187 of accrued
dividends thereon into 1,562,917 shares of the Company's $0.0001 par value common stock.

Between
January 1, 2005 and April 6, 2005 Investors converted principal amount of $2,041,518 and $36,246 of accrued interest thereon into 1,536,861 shares of the Company's
$0.0001 par value common stock.

In
February 2005, the Company issued an employee a stock option to purchase 155,000 shares of the Company's common stock at an exercise price $1.33 per share. The option has a
term of seven (7) years and vests in three equal annual installments commencing on February 28, 2006.

78

---



In
March 2005, the Company issued a director an option to purchase 50,000 shares of the Company's common stock at an exercise price of $1.34 per share. The option has a term of
seven (7) years and vests in two equal annual installments commencing on March 1, 2006.

On
March 31, 2005 the Shaar Fund exercised warrants to purchase 500,000 shares of the Company's common stock for $1.00 per share, or $500,000.

79

---





SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

|                     |  | BIO-KEY INTERNATIONAL, INC.
|-------------------- |  | ---------------------------
|Date: April 14, 2005 |  | By:                        

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on the
dates indicated.

|Signature                                     |  | Title                                                 |  | Date          
|--------------------------------------------- |  | ----------------------------------------------------- |  | --------------
|                                              |  |                                                       |  |               
|/s/MICHAEL W. DEPASQUALEMichael W. DePasquale |  | Chief Executive Officer and Director                  |  | April 14, 2005
|/s/FRANCIS J. CUSICKFrancis J. Cusick         |  | Chief Financial Officer, Principal Accounting Officer |  | April 14, 2005
|/s/THOMAS J. COLATOSTIThomas J. Colatosti     |  | Chairman of the Board of Directors                    |  | April 14, 2005
|/s/RICHARD E. GADDYRichard E. Gaddy           |  | Director                                              |  | April 14, 2005
|/s/JEFFREY J. MAYJeffrey J. May               |  | Director                                              |  | April 14, 2005
|/s/CHARLES P. ROMEOCharles P. Romeo           |  | Director                                              |  | April 14, 2005
|/s/JOHN SCHOENHERRJohn Schoenherr             |  | Director                                              |  | April 14, 2005

80

---





EXHIBIT INDEX

|Exhibit No. |  | Description                                                                                                                                                                                       
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1(1)      |  | Agreement and Plan of Merger dated as of March 30, 2004 by and among BIO-key International, Inc., BIO-Key Acquisition Corp., Public Safety Group, Inc. ("PSG") and each of the shareholders of PSG
|2.2(2)      |  | Asset Purchase Agreement dated as of August 16, 2004 by and among BIO-key International, Inc., Aether Systems, Inc., Cerulean Technologies, Inc. and SunPro, Inc.                                 
|2.3(3)      |  | Agreement and Plan of Merger dated as of December 30, 2004 by and among BIO-key International, Inc., a Delaware corporation, and BIO-key International, Inc., a Minnesota corporation             
|3.1(3)      |  | Certificate of Incorporation of BIO-key International, Inc., a Delaware corporation                                                                                                               
|3.2(3)      |  | Certificate of Designation of Series A 7% Convertible Preferred Stock of BIO-key International, Inc., a Delaware corporation                                                                      
|3.3(3)      |  | By-Laws of BIO-key International, Inc., a Delaware corporation                                                                                                                                    
|4.1(4)      |  | Specimen certificates for shares of BIO-key International, Inc. common stock                                                                                                                      
|10.1(4)     |  | SAC Technologies, Inc. 1996 Stock Option Plan                                                                                                                                                     
|10.2(5)     |  | Amendment No. 1 to the SAC Technologies, Inc. 1996 Stock Option Plan                                                                                                                              
|10.3(5)     |  | SAC Technologies, Inc. 1999 Stock Option Plan                                                                                                                                                     
|10.4(6)     |  | Warrant issued to The Shaar Fund Ltd.                                                                                                                                                             
|10.5(6)     |  | Security Interest Provisions                                                                                                                                                                      
|10.6(6)     |  | Employment Agreement by and between BIO-key International, Inc. and Mira LaCous dated November 20, 2001                                                                                           
|10.7(6)     |  | Option to Purchase 140,000 Shares of Common Stock issued to Mira LaCous                                                                                                                           
|10.8(9)     |  | Option to Purchase 150,000 Shares of Common Stock issued to Thomas J. Colatosti                                                                                                                   
|10.9(9)     |  | Non-Qualified Stock Option Agreement under the registrant's 1999 Stock Incentive Plan to Purchase 200,000 Shares of Common Stock issued to Thomas J. Colatosti                                    
|10.10(9)    |  | Employment Agreement by and between BIO-key International, Inc. and Michael W. DePasquale dated January 3, 2003                                                                                   
|10.11(9)    |  | Option to Purchase 580,000 Shares of Common Stock issued to Michael W. DePasquale                                                                                                                 
|10.12(9)    |  | Note Purchase Agreement dated January 27, 2003                                                                                                                                                    
|10.13(9)    |  | Secured Convertible Promissory due June 30, 2004                                                                                                                                                  
|10.14(9)    |  | Option to Purchase 200,000 Shares of Common Stock issued to Charles P. Romeo                                                                                                                      
|10.15(7)    |  | Amendment No. 1 to Note Purchase Agreement dated October 31, 2003 by and between BIO-key International, Inc. and The Shaar Fund Ltd.                                                              
|10.16(7)    |  | Securities Exchange Agreement dated March 3, 2004 by and between BIO-key International, Inc. and The Shaar Fund Ltd.                                                                              
|10.17(7)    |  | Registration Rights Agreement dated March 3, 2004 by and between BIO-key International, Inc. and The Shaar Fund Ltd.                                                                              
|            |  |                                                                                                                                                                                                   

81

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|10.18(7)  |  | Secured Convertible Promissory Note due October 31, 2005 in the principal amount of up to $2,125,000                                                                                                                 
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.19(7)  |  | Secured Convertible Promissory Note due October 31, 2005 in the principal amount of up to $375,000                                                                                                                   
|10.20(7)  |  | Option to Purchase 500,000 Shares of Common Stock issued to Michael W. DePasquale                                                                                                                                    
|10.21(7)  |  | Option to Purchase 150,000 Shares of Common Stock issued to Thomas J. Colatosti                                                                                                                                      
|10.22(7)  |  | Option to Purchase 50,000 Shares of Common Stock issued to Thomas J. Colatosti                                                                                                                                       
|10.23(7)  |  | Option to Purchase 50,000 Shares of Common Stock issued to Jeff May                                                                                                                                                  
|10.24(7)  |  | Option to Purchase 50,000 Shares of Common Stock issued to Charles Romeo                                                                                                                                             
|10.25(7)  |  | Option to Purchase 300,000 Shares of Common Stock issued to Randy Fodero                                                                                                                                             
|10.26(10) |  | Amendment Agreement dated March 30, 2004 by and between BIO-key International, Inc. and The Shaar Fund Ltd.                                                                                                          
|10.27(11) |  | Securities Purchase Agreement dated as of March 31, 2004 (the "March Securities Purchase Agreement") by and among BIO-key International, Inc. and each of the Purchasers named therein                               
|10.28(11) |  | Form of Warrant issued by BIO-key International, Inc. pursuant to the March Securities Purchase Agreement                                                                                                            
|10.29(2)  |  | Securities Purchase Agreement dated as of September 29, 2004 (the "Laurus Securities Purchase Agreement") by and between BIO-key International, Inc., Laurus Master Fund, Ltd. and the other Purchasers party thereto
|10.30(2)  |  | Form of Secured Convertible Term Note issued by BIO-key International, Inc. pursuant to the Laurus Securities Purchase Agreement                                                                                     
|10.31(2)  |  | Form of Common Stock Purchase Warrant issued by BIO-key International, Inc. pursuant to the Laurus Securities Purchase Agreement                                                                                     
|10.32(2)  |  | Master Security Agreement dated as of September 29, 2004 by and between BIO-key International, Inc., Public Safety Group, Inc. and Laurus Master Fund, Ltd., as Collateral Agent                                     
|10.33(2)  |  | Subsidiary Guaranty dated as of September 29, 2004 made by Public Safety Group, Inc. in favor of Laurus Master Fund, Ltd. and the other Purchasers party thereto                                                     
|10.34(2)  |  | Stock Pledge Agreement dated as of September 29, 2004 by and between BIO-key International, Inc. and Laurus Master Fund, Ltd. and the other Purchasers party thereto                                                 
|10.35(2)  |  | Registration Rights Agreement dated as of September 29, 2004 by and between BIO-key International, Inc., Laurus Master Fund, Ltd. and the other Purchasers party thereto                                             
|10.36(2)  |  | Securities Purchase Agreement dated as of September 29, 2004 (the "Shaar Securities Purchase Agreement") by and between BIO-key International, Inc., The Shaar Fund, Ltd. and the other Purchasers party thereto     
|10.37(2)  |  | Form of Convertible Term Note issued by BIO-key International, Inc. pursuant to the Shaar Securities Purchase Agreement                                                                                              
|10.38(2)  |  | Form of Common Stock Purchase Warrant issued by BIO-key International, Inc. pursuant to the Shaar Securities Purchase Agreement                                                                                      
|          |  |                                                                                                                                                                                                                      

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|10.39(2)  |  | Registration Rights Agreement dated as of September 29, 2004 by and between BIO-key International, Inc., The Shaar Fund, Ltd. and the other Purchasers party thereto                                                                                          
|--------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.40(2)  |  | Intercreditor Agreement dated as of September 30, 2004 by and among Laurus Master Fund, Ltd., individually and as Collateral Agent, Aether Systems, Inc., Public Safety Group, Inc. and BIO-key International, Inc.                                           
|10.41(2)  |  | Subordination and Intercreditor Agreement dated as of September 30, 2004 by and among Laurus Master Fund, Ltd., as Collateral Agent, The Shaar Fund, Ltd., as Purchaser Agent, Aether Systems, Inc., Public Safety Group, Inc. and BIO-key
International, Inc.
|10.42(2)  |  | Subordinated Secured Promissory Note dated September 30, 2004 issued by BIO-key International, Inc. and Public Safety Group, Inc. in favor of Aether Systems, Inc.                                                                                            
|10.43(12) |  | Option to Purchase 200,000 shares of common stock issued to Harlan Plumley                                                                                                                                                                                    
|10.44(12) |  | Employment Agreement dated as of September 15, 2004 by and between BIO-key International, Inc. and Harlan Plumley                                                                                                                                             
|10.45(12) |  | Option to Purchase 300,000 shares of common stock issued to Kenneth Souza                                                                                                                                                                                     
|10.46(12) |  | Employment Agreement dated as of October 4, 2004 by and between BIO-key International, Inc. and Kenneth Souza                                                                                                                                                 
|10.47(12) |  | Option to Purchase 50,000 shares of common stock issued to Richard Gaddy                                                                                                                                                                                      
|10.48(12) |  | BIO-Key International, Inc. 2004 Stock Incentive Plan                                                                                                                                                                                                         
|10.49(12) |  | Warrant to purchase 10,000 shares of Common Stock issued to Krieger & Prager LLP on November 26, 2001                                                                                                                                                         
|10.50(12) |  | Warrant to purchase 100,000 shares of Common Stock issued to The November Group Ltd. on July 14, 2004                                                                                                                                                         
|10.51(12) |  | Warrant to purchase 230,000 shares of Common Stock issued to Jesup & Lamont Securities Corp. on March 31, 2004                                                                                                                                                
|10.52(12) |  | Warrant to purchase 105,000 shares of Common Stock issued to Douglass Bermingham on March 31, 2004                                                                                                                                                            
|10.53(12) |  | Warrant to purchase 60,000 shares of Common Stock issued to Mason Sexton on March 31, 2004                                                                                                                                                                    
|10.54(12) |  | Warrant to purchase 22,000 shares of Common Stock issued to David Moss on March 31, 2004                                                                                                                                                                      
|10.55(12) |  | Warrant to purchase 22,000 shares of Common Stock issued to Patrick Gaynes on March 31, 2004                                                                                                                                                                  
|10.56(12) |  | Warrant to purchase 5,000 shares of Common Stock issued to Tom DuHamel on March 31, 2004                                                                                                                                                                      
|21.1(12)  |  | List of subsidiaries of BIO-Key International, Inc.                                                                                                                                                                                                           
|23.1(8)   |  | Consent of Divine, Scherzer & Brody, Ltd.                                                                                                                                                                                                                     
|31.1(8)   |  | Certificate of CEO of Registrant required under Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended                                                                                                                                          
|          |  |                                                                                                                                                                                                                                                               

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|31.2(8) |  | Certificate of CFO of Registrant required under Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
|------- |  | --------------------------------------------------------------------------------------------------------------------
|32.1(8) |  | Certificate of CEO of Registrant required under Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended
|32.2(8) |  | Certificate of CFO of Registrant required under Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended

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