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EX-31.2 - CERTIFICATION OF THE CFO PURSUANT TO SECTION 302 - Digital Systems, Inc.dex312.htm
EX-10.1 - LEASE AGREEMENT BETWEEN MERITEX AND ICOP DATED APRIL 7. 2010 - Digital Systems, Inc.dex101.htm
EX-31.1 - CERTIFICATION OF THE CEO PURSUANT TO SECTION 302 - Digital Systems, Inc.dex311.htm
EX-32.1 - CERTIFICATION OF THE CEO PURSUANT TO SECTION 906 - Digital Systems, Inc.dex321.htm
EX-32.2 - CERTIFICATION OF THE CFO PURSUANT TO SECTION 906 - Digital Systems, Inc.dex322.htm
Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

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

For the quarterly period ended March 31, 2010

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
   SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-32560

 

 

ICOP Digital, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Colorado   84-1493152

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

16801 W. 116th Street, Lenexa, Kansas 66219

(Address of principal executive offices)

(913) 338-5550

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨   Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company x

Indicate by check mark whether the registration is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The issuer had 27,196,855 shares of its common stock issued and outstanding as of April 30, 2010, the latest practicable date before the filing of this report.

 

 

 


Table of Contents

ICOP DIGITAL, INC.

FORM 10-Q

FOR THE FISCAL QUARTER ENDED MARCH 31, 2010

TABLE OF CONTENTS

 

PART I

      FINANCIAL INFORMATION    3
   Item 1.    Financial Statements    3
   Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    11
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk    14
   Item 4T.    Controls and Procedures    14

PART II

      OTHER INFORMATION    15
   Item 1.    Legal Proceedings    15
   Item 1A.    Risk Factors    15
   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    15
   Item 3.    Defaults Upon Senior Securities    15
   Item 4.    [Removed and Reserved]    15
   Item 5.    Other Information    15
   Item 6.    Exhibits    15

 

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ICOP DIGITAL, INC.

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

ICOP DIGITAL, INC.

Condensed Balance Sheets (Unaudited)

 

     March 31,
2010
    December 31,
2009
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 1,448,067      $ 1,171,943   

Accounts receivable, net of allowances of $100,457 at March 31, 2010 and
December 31, 2009

     1,272,137        2,009,591   

Inventory, at lower of cost or market

     1,751,586        2,094,168   

Prepaid Expenses

     148,188        98,351   

Other Assets

     1,799,639        1,759,004   
                

Total current assets

     6,419,617        7,133,057   

Property and equipment, net of accumulated depreciation $1,499,308 and $1,411,988 at
March 31, 2010 and December 31, 2009, respectively

     1,376,445        1,463,765   

Other assets:

    

Deferred patent costs

     100,753        95,906   

Investment, at cost

     25,000        25,000   

Security deposit

     20,758        18,258   
                

Total other assets

     146,511        139,164   
                

Total assets

   $ 7,942,573      $ 8,735,986   
                

Liabilities and Shareholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 239,331      $ 370,998   

Accrued liabilities

     492,814        476,761   

Notes payable

     479,985        629,985   

Due to factor

     542,223        686,965   

Unearned revenue—current portion

     262,949        233,175   
                

Total current liabilities

     2,017,302        2,397,884   

Other liabilities:

    

Unearned revenue—long term portion

     338,266        420,009   

Shareholders’ equity:

    

Preferred stock, no par value; 5,000,000 shares authorized, no shares issued and outstanding at March 31, 2010 and December 31, 2009

     —          —     

Common stock, no par value; 50,000,000 shares authorized, 27,196,855 and 23,602,944 issued and outstanding at March 31, 2010 and December 31, 2009, respectively

     37,896,201        36,469,313   

Accumulated other comprehensive income

     3,465        3,465   

Retained deficit

     (32,312,661     (30,554,685
                

Total shareholders’ equity

     5,587,005        5,918,093   
                

Total liabilities and shareholders’ equity

   $ 7,942,573      $ 8,735,986   
                

See accompanying notes to condensed financial statements.

 

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ICOP DIGITAL, INC.

Condensed Statements of Operations (Unaudited)

 

     Three Months Ended
March 31,
 
     2010     2009  

Sales, net of returns and allowances

   $ 1,909,432      $ 2,248,533   

Cost of sales

     1,124,759        1,162,370   
                

Gross profit

     784,673        1,086,163   

Operating expenses:

    

Selling, general and administrative

     2,304,773        1,824,404   

Research and development

     173,576        216,979   
                

Total operating expenses

     2,478,349        2,041,383   
                

Operating loss

     (1,693,676     (955,220

Other income (expense):

    

Gain on derecognition of liabilities

     —          52,765   

Loss on disposal of property and equipment

     —          (4,170

Interest income

     19        —     

Interest expense

     (66,974     (37,035

Other income

     2,655        654   
                

Loss before income taxes

     (1,757,976     (943,006

Income tax provision

     —          —     
                

Net Loss

   $ (1,757,976   $ (943,006
                

Basic and diluted net loss per share

   $ (0.07   $ (0.13
                

Basic and diluted weighted average common shares outstanding

     25,818,179        7,299,175   

See accompanying notes to condensed financial statements.

 

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ICOP DIGITAL, INC.

Condensed Statement of Changes in Shareholders’ Equity (Unaudited)

 

    

 

Preferred Stock

   Common Stock    Accumulated
Other
Comprehensive

(Loss) Income
   Retained
Deficit
    Total  
     Shares    Amount    Shares    Amount        

Balance at December 31, 2009

   —      $ —      23,602,944    $ 36,469,313    $ 3,465    $ (30,554,685   $ 5,918,093   
                                               

Stock issued under employee stock purchase plan

   —        —      33,911      12,547           12,547   

Stock issued in exchange for services

   —        —      60,000      25,200           25,200   

Stock options issued in exchange for services

   —        —           220,088           220,088   

Registered Direct Offering—net of offering costs $201,023

         3,500,000      1,169,053           1,169,053   

Comprehensive income:

                   

Unrealized effect of the change in foreign currency exchange rates

   —        —              —          —     

Net loss

   —        —                 (1,757,976     (1,757,976
                         

Total comprehensive loss

                      (1,757,976
                                               

Balance at March 31, 2010

   —      $ —      27,196,855    $ 37,896,201    $ 3,465    $ (32,312,661   $ 5,587,005   
                                               

See accompanying notes to condensed financial statements

 

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ICOP DIGITAL, INC.

Condensed Statements of Cash Flows (Unaudited)

 

     Three Months Ended
March 31,
 
     2010     2009  

Cash flows from operating activities:

    

Net loss

   $ (1,757,976   $ (943,006

Adjustments to reconcile net loss to net cash used by operating activities:

    

Depreciation

     87,349        154,136   

Stock-based compensation expense

     245,288        48,528   

Gain on derecognition of liabilities

       (52,765

Loss on disposal of property and equipment

     —          4,170   

Changes in operating assets/liabilities:

    

Accounts Receivable

     737,454        634,099   

Inventory

     342,582        1,011,160   

Prepaids and other

     (90,472     (253,838

Accounts payable

     (131,667     (162,389

Accrued liabilities

     26,058        23,751   
                

Net cash provided (used) in operating activities

     (541,384     463,846   
                

Cash flows from investing activities:

    

Purchases of property and equipment

     —          (11,759

Proceed from the sale of property and equipment

     —          9,000   

Deferred patent costs

     (4,876     —     

Deposits

     (2,500     —     
                

Net cash used in investing activities

     (7,376     (2,759
                

Cash flows from financing activities:

    

Proceeds from factoring and line of credit

     2,400,000        2,310,459   

Payments on factoring and line of credit

     (2,606,716     (2,187,822

Payments on note payable

     (150,000     (150,000

Proceeds from the issuance of common stock

     1,354,097        16,870   

Payment of offering costs

     (172,497     —     
                

Net cash (used) provided in financing activities

     824,884        (10,493
                

Effect of currency exchange rate changes on cash

     —          1,326   
                

Net change in cash

     276,124        451,920   

Cash, beginning of period

     1,171,943        99,192   
                

Cash, end of period

   $ 1,448,067      $ 551,112   
                

Supplemental disclosure of cash flow information:

    

Interest paid

   $ 66,974      $ 37,035   
                

Non-cash investing and financing transactions

    

Transfer of inventory for internal use

   $ —        $ 33,948   
                

Offering costs from Placement Agent warrants

   $ 28,526     
                

See accompanying notes to condensed financial statements.

 

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ICOP DIGITAL, INC.

Notes to Condensed Financial Statements (Unaudited)

Note 1: Basis of Presentation

The condensed balance sheet at December 31, 2009 has been derived from financial statements audited by Cordovano and Honeck, LLP as indicated by its report included by the Form 10-K. The accompanying unaudited financial statements at March 31, 2010 have been prepared from the records of the Company, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of March 31, 2010, the results of operations for the three months ended March 31, 2010 and 2009, and cash flows for the three months ended March 31, 2010 and 2009. These financial statements should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s annual report on Form 10-K for the year ended December 31, 2009.

There is no provision for dividends for the quarter to which this quarterly report relates.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The results of operations for the three- month period ended March 31, 2010 are not necessarily indicative of the results to be expected for the full year ending December 31, 2010.

Note 2: Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

ICOP Digital, Inc. (the “Company”) was incorporated in April 1998 in Colorado as Bail Corporation. The Company changed its name to Vista Exploration Corporation in August 2001, and to its current name, ICOP Digital, Inc. in November 2004. The Company is engaged in the design, development and marketing of surveillance equipment and systems for use in the public safety, military, and homeland security markets. The Company’s offices are located in Lenexa, Kansas.

Note 3: Inventory

Inventories are valued at the lower of cost or market. We take physical counts of inventories quarterly, and review the provision for potential losses from obsolete, excess or slow-moving inventories. The components of inventory, as of March 31, 2010 and December 31, 2009 are as follows:

 

     March 31,
2010
   December 31,
2009
     (unaudited)     

Raw materials

   $ 305,765    $ 126,064

Work in process

     78,813      101,548

Finished Goods

     1,367,008      1,866,556
             
   $ 1,751,586    $ 2,094,168
             

 

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ICOP DIGITAL, INC.

Notes to Condensed Financial Statements (Unaudited)—(Continued)

Note 4: Other Current Assets

The components of other current assets, as of March 31, 2010 and December 31, 2009 are as follows:

 

     March 31,
2010
   December 31,
2009
     (unaudited)     

Deposits on inventory purchases

   $ 1,628,659    $ 1,585,495

Inventory for parts

     169,534      172,127

Other

     1,446      1,382
             
   $ 1,799,639    $ 1,759,004
             

Note 5: Property and Equipment, net

The components of property and equipment, net of accumulated depreciation, as of March 31, 2010 and December 31, 2009 are as follows:

 

     March 31,
2010
    December 31,
2009
 
     (unaudited)        

Land

   $ 1,000,259      $ 1,000,259   

Equipment

     1,162,991        1,162,991   

Vehicles

     235,976        235,976   

Furniture

     285,737        285,737   

Leasehold improvements

     190,790        190,790   
                
     2,875,753        2,875,753   

Less: accumulated depreciation

     (1,499,308     (1,411,988
                
   $ 1,376,445      $ 1,463,765   
                

Note 6: Debt Obligations

On November 10, 2008, we entered into a purchasing agreement (the “Purchasing Agreement”) with a financing company (the “Purchaser”) for a term of 18 months under which we agreed to sell all of our accounts receivable at a discount of 0.75% (“Purchasing Fee”) from the face value of each invoice for every 30 days the invoice is outstanding. We are obligated to sell all of our receivables to the Purchaser, but the Purchaser is not obligated to purchase any receivables or to advance against them. The Purchaser may, in its sole discretion, advance up to 85% of the eligible accounts receivable outstanding for a maximum borrowing of $5,000,000. The interest rate on any outstanding advances to us will be 2.5% plus the greater of LIBOR plus 2.75% or the prime rate as published by The Wall Street Journal. In no event shall LIBOR be less than 3%. We are required to sell the Purchaser $2,400,000 in invoices each calendar quarter or pay the minimum Purchasing Fee for any shortfall. We are required to maintain a $2,500,000 tangible net worth at all times during the term of the Purchasing Agreement (the “Net Worth Covenant”). The Purchasing Agreement may be renewed annually after the initial 18-month term unless either party elects not to renew, or it may be terminated by the Purchaser at any time without cause on 60 days’ notice to us. On March 31, 2010, the balance outstanding under the Purchasing Agreement was $542,223 and the Company was in compliance with the Net Worth Covenant.

Under the Purchasing Agreement, the Purchaser may, in its sole discretion, advance us up to 50% of eligible inventory, not to exceed the lesser of (i) 40% of the outstanding advances under the accounts receivable financing or (ii) $750,000. The interest rate on any outstanding advances on inventory to us will be 3.5% plus the greater of LIBOR plus 2.75% or the prime rate as published by The Wall Street Journal. In no event shall LIBOR be less than 3%. The financing facility is secured by a security interest in essentially all of our assets.

 

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ICOP DIGITAL, INC.

Notes to Condensed Financial Statements (Unaudited)—(Continued)

 

On March 3, 2010, we renewed our $780,000 loan agreement with the Bank of Blue Valley by paying the principal down by $150,000 and entering into a one-year note for $479,985 in principal amount. The principal bears interest at 8%, payable monthly. The Company executed the loan agreement in order to purchase land on which the Company may use to construct a new corporate headquarters after its current lease expires. The loan is principally secured by the purchased land.

Note 7: Unearned Revenue

Deferred Warranty Revenue

The Company provides extended warranties to protect against defects in equipment for periods ranging from one to four years. The revenues related to extended warranties are recognized over the life of the extended warranty, which begins upon the expiration of the manufacturer’s warranty, while the product warranty costs are expensed as incurred. The Company records estimated warranty costs that may be incurred above those associated with the deferred warranty revenues as an unfulfilled warranty liability. A summary of changes in deferred warranty revenue, which is included in both current liabilities and other liabilities, is as follows:

 

     March 31,
2010
    December 31,
2009
 
     (unaudited)        

Unearned revenue, beginning balance

   $ 652,144      $ 466,983   

Revenue deferred for new extended warranties sold

     43,854        382,533   

Revenue recognized

     (94,783     (196,228

Unfulfilled warranty liability

     —          (104
                

Unearned revenue at the end of period

   $ 601,215      $ 653,184   
                

Current portion

   $ 262,949      $ 233,175   

Non-current portion

     338,266        420,009   
                

Unearned revenue at the end of period

   $ 601,215      $ 653,184   
                

Note 8: Shareholders’ Equity

Registered Direct Offering

On February 3, 2010, the Company completed a registered direct offering (the “Financing Transaction”) of 3,500,000 shares of our common stock, Series 1 warrants to purchase up to 3,500,000 shares of common stock (the “Series 1 Warrants”) and Series 2 warrants to purchase up to 1,232,580 shares of common stock (the “Series 2 Warrants”). The initial exercise price of the Series 1 Warrants is $0.42 per share, and they are exercisable beginning six months and one day after the date of issuance until February 3, 2015. The initial exercise price of the Series 2 Warrants is $0.3833 per share, and they expire on May 4, 2010. The Series 1 Warrants and Series 2 Warrants together constitute the “Warrants.” Subject to certain customary exceptions, in the event of an issuance or deemed issuance by us of common stock (or securities convertible into common stock) at a per share price less than the then applicable Warrant exercise price (a “Dilutive Event”), then the Warrant exercise price will be reduced to that new issuance price; provided, however, that the adjusted exercise price will not be below $0.42 or $0.3833, as the case may be, without prior stockholder approval (as required by NASDAQ Marketplace Rule 5635). The Company paid Chardan Capital Markets, LLC (the “Placement Agent”) an aggregate fee of 7.0% of the gross proceeds from the Financing Transaction. The Placement Agent also received a five-year warrant (the “Placement Agent Warrant”) to purchase (i) a number of shares equal to 3.0% of the shares sold to the investors and (ii) warrants (substantially similar to a Series 1 Warrant) to purchase a number of shares equal to 3.0% of the number of shares underlying the Warrants sold to the investors (subject to reduction in number as necessary to comply with the compensation limit pursuant to applicable guidelines of the Financial Industry Regulatory Authority). The placement agent agreement requires us to indemnify the Placement Agent and certain of its affiliates against certain liabilities, including liabilities under the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended, or to contribute to payments the Placement Agent may be required to make because of any of those liabilities.

 

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ICOP DIGITAL, INC.

Notes to Condensed Financial Statements (Unaudited)—(Continued)

 

Sale of Common Stock

During the first quarter 2010, the Company received proceeds of $10,665 in connection with employees purchasing 33,911 shares of its common stock under the Company’s Employee Stock Purchase Plan.

Awards of Restricted Common Stock and Stock Options

The Company has granted to employees, consultants and directors shares of restricted common stock and options to purchase shares of the Company’s common stock which vest in 2007 and future years. Stock-based compensation expense related to these awards of $220,088 and $48,528 has been recorded in the three month period ended March 31, 2010 and 2009, respectively.

Note 9: Income Taxes

The Company accounts for income taxes under the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records a valuation allowance, if necessary, to reduce deferred tax assets to an amount it believes is more likely than not to be realized.

The Company incurred net operating losses during the periods shown on the condensed financial statements resulting in a deferred tax asset, all of which was fully reserved; therefore, the net benefit and expense resulted in $0 income taxes. The recognition of these net operating loss carry-forwards depends on the ability of the Company to generate taxable income in the future.

Certain U.S. Federal returns from inception and following are not closed by relevant statutes of limitation due to unused net operating losses reported on those returns.

The Company’s policy is to record estimated interest and penalties related to the underpayment of income taxes as income tax expense in the statements of operations. There has been no interest or penalties recognized in the condensed financial statements.

Note 10: Contingencies

On July 11, 2008, the Company was served with a summons and a complaint in which the Company and TriSquare Communications, Inc., a Missouri corporation (“TriSquare”), were named as defendants (a total of eleven defendants were named in this lawsuit) in a patent infringement action commenced by L-3 Communications Mobile-Vision, Inc., a New Jersey corporation (“L-3”). According to the complaint, which was filed in the United States District Court for the District of New Jersey, and with the United States International Trade Commission (ITC), the wireless microphone and related base station that TriSquare and its affiliates manufacture and import, and the Company incorporates into and sells as components of its ICOP Model 20/20-W product, infringe upon a patent held by L-3 covering a wireless microphone for use with an in-car video system.

In the ITC investigation L-3 failed to provide any expert opinion regarding infringement and did not produce any witnesses to testify on its behalf. On January 29, 2009, Mobile-Vision moved to withdraw its complaint with the ITC, and the ITC administrative law judge granted the motion.

On November 5, 2009, L-3 and the Company agreed to settlement terms in a mediation hearing. On February 22, 2010, the Company announced it had resolved all pending litigation with L-3 and that litigation between the parties had been dismissed with prejudice.

 

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Forward Looking Statements

This report contains forward-looking statements, as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are subject to material known and unknown risks and uncertainties. These forward-looking statements include information about possible or assumed financial results of our business, financial condition, liquidity, results of operations, plans and objectives. In some cases, you may identify forward-looking statements by words such as “may,” “should,” “plan,” “intend,” “potential,” “continue,” “believe,” “expect,” “predict,” “anticipate,” and “estimate,” the negative of these words or other comparable words. These statements are only predictions and expressions of belief. You should not place undue reliance on these forward-looking statements. These forward-looking statements are qualified by their terms and/or important factors, many of which are outside our control, and involve a number of risks, uncertainties and contingencies that could cause actual results and events to differ materially from the statements made. Such factors include, among other things, the risks and uncertainties described in “Forward-Looking Statements” in our annual report on Form 10-K for the year ended December 31, 2009, which is on file with the U.S. Securities and Exchange Commission. Readers are strongly encouraged to consider these factors when evaluating forward-looking statements.

Neither we nor any other person assumes responsibility for the accuracy or completeness of these forward-looking statements. We undertake no obligation to revise, or publicly release the results of any revisions to, these forward-looking statements.

As used herein, references to “ICOP,” “we,” “us” or “the Company” mean ICOP Digital, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

For the Three Months Ended March 31, 2010 and 2009

Results of Operations

Sales

Sales for the three months ended March 31, 2010 and 2009 were $1,909,432 and $2,248,533, respectively, a decrease of $339,101 (15.1%) due to a reduction in units sold.

Cost of Sales

Cost of sales for the three months ended March 31, 2010 and 2009 were $1,124,759 and $1,162,370, respectively, a decrease of $37,611 (3.2%). The decline is in relation to the decrease in units shipped.

Gross Margin

Gross margin was 41.1% for the three months ended March 31, 2010 compared to 48.3% for the three months ended March 31, 2009. The decline is due to lower margins in 2010 for certain markets.

Operating Expenses

Operating expenses were $2,478,349 and $2,041,383 for the three months ended March 31, 2010 and 2009, respectively, an increase of $436,966 (21.4%).

Selling, General and Administrative

Selling, general and administrative expenses for the three months ended March 31, 2010 and 2009, were $2,304,773 and $1,824,404, respectively, an increase of $480,369 (26.3%). The increase is mainly due to stock based compensation, professional services and travel costs offset by the decline in research and development projects and depreciation. The increase in professional services is due primarily to legal costs regarding the L-3 litigation, which is now settled, and the NASDAQ hearing expenses associated with maintaining our NASDAQ listing, both of which are onetime events. The increase in travel costs is attributed to trade events, activities relating to a newly formed client services team and greater focus on direct sales.

 

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Research and Development

Research and development expenses for the three months ended March 31, 2010 and 2009 were $173,576 and $216,979, respectively, a decrease of $43,403 (20.0%). The decrease is the result of the completion of product development for certain products.

Stock-based Compensation Expense

Stock-based compensation expense for the three months ended March 31, 2010 and 2009 was $245,287 and $48,528 respectively, an increase of $196,759 (405.5%). The increase is due to more options granted in the first quarter of 2010 compared to the first quarter 2009.

Other Income (Expenses)

Interest Expense

Interest expense was $66,974 and $37,035 for the three months ended March 31, 2010 and 2009, respectively, an increase of $29,939 (80.8%). The increase is due to the interest and factoring fees for advances on the Purchasing Agreement.

Liquidity and Capital Resources

Working Capital

On March 31, 2010, the Company had $1,448,067 in cash, $1,272,137 in accounts receivable, $1,751,586 in inventory, $1,947,827 in prepaid expenses and other current assets and $2,017,302 in current liabilities, for a net working capital of $4,402,315.

Operating Cash Flows

Net cash used in operating activities for the three months ended March 31, 2010 was $541,384 compared to net cash provided of $463,846 for the three months ended March 31, 2009. The increase in net cash used from operations is mainly due to the decreases in inventory and accounts receivable in 2009. The increase is also attributed to a higher net loss in the 2010 three month period compared to the 2009 three month period.

Investing Activity Cash Flows

Net cash used in investing activities for the three months ended March 31, 2010 was $7,376, primarily for deferred patent and deposit expenses, compared to $2,759 for the three months ended March 31, 2009, for the sales and purchases of equipment.

Financing Activity Cash Flows

Net cash provided by financing activities was $824,884 for the three months ended March 31, 2010, primarily from the closing of registered direct offering along with proceeds and collections from the Purchasing Agreement, compared to net cash used of $10,493 for the three months ended March 31, 2009, substantially the proceeds and collections from the Purchasing Agreement.

Other Sources of Capital

On November 10, 2008, we entered into a purchasing agreement (the “Purchasing Agreement”) with a financing company (the “Purchaser”) for a term of 18 months under which we agreed to sell all of our accounts receivable at a discount of 0.75% (“Purchasing Fee”) from the face value of each invoice for every 30 days the invoice is outstanding. We are obligated to sell all of our receivables to the Purchaser, but the Purchaser is not obligated to purchase any receivables or to advance against them. The Purchaser may, in its sole discretion, advance up to 85% of the eligible accounts receivable outstanding for a maximum borrowing of $5,000,000. The interest rate on any outstanding advances to us will be 2.5% plus the greater of LIBOR plus 2.75% or the prime rate as published by The Wall Street Journal. In no event shall LIBOR be less than 3%. We are required to sell the Purchaser $2,400,000 in invoices each calendar quarter or pay the minimum Purchasing Fee for any shortfall. We are required to maintain a $2,500,000 tangible net worth at all times during the term of

 

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the Purchasing Agreement (the “Net Worth Covenant”). The Purchasing Agreement may be renewed annually after the initial 18-month term unless either party elects not to renew, or it may be terminated by the Purchaser at any time without cause on 60 days’ notice to us. On March 31, 2010, the balance outstanding under the Purchasing Agreement was $542,223 and the Company was in compliance with the Net Worth Covenant.

Under the Purchasing Agreement, the Purchaser may, in its sole discretion, advance us up to 50% of eligible inventory, not to exceed the lesser of (i) 40% of the outstanding advances under the accounts receivable financing or (ii) $750,000. The interest rate on any outstanding advances on inventory to us will be 3.5% plus the greater of LIBOR plus 2.75% or the prime rate as published by The Wall Street Journal. In no event shall LIBOR be less than 3%. The financing facility is secured by a security interest in essentially all of our assets.

On February 3, 2010, we completed a registered direct offering (the “Financing Transaction”) of 3,500,000 shares of our common stock, Series 1 warrants to purchase up to 3,500,000 shares of common stock (the “Series 1 Warrants”) and Series 2 warrants to purchase up to 1,232,580 shares of common stock (the “Series 2 Warrants”). The initial exercise price of the Series 1 Warrants is $0.42 per share, and they are exercisable beginning six months and one day after the date of issuance until February 3, 2015. The initial exercise price of the Series 2 Warrants is $0.3833 per share, and they expire on May 4, 2010. The Series 1 Warrants and Series 2 Warrants together constitute the “Warrants.” Subject to certain customary exceptions, in the event of an issuance or deemed issuance by us of common stock (or securities convertible into common stock) at a per share price less than the then applicable Warrant exercise price (a “Dilutive Event”), then the Warrant exercise price will be reduced to that new issuance price; provided, however, that the adjusted exercise price will not be below $0.42 or $0.3833, as the case may be, without prior stockholder approval (as required by NASDAQ Marketplace Rule 5635). The Company paid the Chardan Capital Markets, LLC (the “Placement Agent”) an aggregate fee of 7.0% of the gross proceeds from the Financing Transaction. The Placement Agent also received a five-year warrant (the “Placement Agent Warrant”) to purchase (i) a number of shares equal to 3.0% of the shares sold to the investors and (ii) warrants (substantially similar to a Series 1 Warrant) to purchase a number of shares equal to 3.0% of the number of shares underlying the Warrants sold to the investors (subject to reduction in number as necessary to comply with the compensation limit pursuant to applicable guidelines of the Financial Industry Regulatory Authority). The placement agent agreement requires us to indemnify the Placement Agent and certain of its affiliates against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended, or to contribute to payments the Placement Agent may be required to make because of any of those liabilities.

Our Capital Requirements

We have incurred significant operating losses and negative cash flow from operations since inception. We intend to utilize our financing arrangement to supplement operating cash and fund operations in the near future. However, our ability to obtain sufficient advances under our financing arrangement to meet our operating capital requirements for the foreseeable future may be dependent upon our ability to generate increased accounts receivable through higher sales volumes, which cannot be assured. We will need to become profitable in the near future through generating higher revenues or lowering operating costs, or a combination of the two, or raise additional capital or additional debt financing in order to sustain future operations. In February 2010, we completed a registered direct offering of our equity securities and were able to generate approximately $1,182,000 in net proceeds for inventory purchases and general corporate purposes. The securities were sold pursuant to a shelf registration statement that was declared effective by the Securities and Exchange Commission on October 28, 2009. Our ability to sell additional securities using the shelf registration statement may be constrained by our stock price; and unless the trading price of our stock rises significantly, we will need to find alternative methods of raising capital.

We are required to meet NASDAQ’s continued listing requirements (including a minimum bid price for our common stock of $1.00 per share) to maintain the listing of our common stock and warrants on the NASDAQ Capital Market. We have not been in compliance with the minimum bid price requirement, but we have been allowed continued listing, subject to the condition that on or before July 12, 2010, we must have evidenced a closing bid price of $1.00 or more for a minimum of ten prior consecutive trading days (or such longer period as NASDAQ may determine). We cannot provide assurance that our stock price will recover within the permitted grace period. If our common stock and other securities are delisted, the value of our stock could suffer a material decline, and it could become significantly more difficult for us to raise the capital necessary to carry out our business plan or sustain operations.

 

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In connection with the minimum bid price requirement, we are seeking shareholder approval of a proposal to permit a reverse stock split of our common stock. However, there is no guarantee that shareholder approval will be obtained or that, even if shareholder approval is obtained, implementation of a reverse stock split would satisfy the minimum bid price requirement. Further, even if our shareholders approve the proposal to permit a reverse stock split, we are contractually obligated to obtain written consent from both holders of the Series 1 Warrants and Series 2 Warrants before affecting a reverse stock split, and one of the warrant holders has communicated to us that it intends to withhold consent. Consequently, if we are unable to timely obtain the written consents, we may not implement a reverse stock split, even if shareholder approval is obtained.

We have no commitments for material capital expenditures.

Employees

We had 52 full-time employees at March 31, 2010, remaining unchanged from December 31, 2009.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required for smaller reporting companies.

 

Item 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In connection with the preparation of this Quarterly Report on Form 10-Q, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as of March 31, 2010 of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2010, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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ICOP DIGITAL, INC.

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

Note 10 to the condensed financial statements in Part I is incorporated by reference to this Item 1.

 

Item 1A. Risk Factors

Not required for smaller reporting companies.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

 

Item 3. Defaults Upon Senior Securities

Not applicable.

 

Item 4. [Removed and Reserved]

 

Item 5. Other Information

Not applicable.

 

Item 6. Exhibits

An index of exhibits begins on page 17 of this Quarterly Report.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    ICOP DIGITAL, INC.
Date: May 13, 2010     By:   /S/    DAVID C. OWEN        
     

David C. Owen

Chief Executive Officer

     

 

   
Date: May 13, 2010     By:   /S/    MICKIE R. KOSLOFSKY        
     

Mickie R. Koslofsky

Chief Financial Officer

 

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Exhibit Index

 

Exhibit No.

  

Description

Exhibit 3.1    Articles of Incorporation (incorporated by reference to Exhibit 2.1 of the Registration Statement on Form 10 filed with the Commission on September 13, 1999).
Exhibit 3.2    First Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Form 8-K filed August 16, 2001).
Exhibit 3.3    Second Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Form 8-K filed August 26, 2002).
Exhibit 3.4    Third Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.4 of the Form SB-2 registration statement filed April 4, 2005).
Exhibit 3.5    Fourth Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.5 of the Form 10-KSB filed March 22, 2007).
Exhibit 3.6    Third Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 of the Form 8-K filed December 4, 2007).
Exhibit 10.1    Lease Agreement between Meritex and ICOP dated April 7, 2010. *
Exhibit 31.1    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
Exhibit 31.2    Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
Exhibit 32.1    Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
Exhibit 32.2    Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

 

* Filed herewith

 

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