UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-33002

L-1 IDENTITY SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		02-0807887 (I.R.S. Employer Identification No.)
177 Broad Street, 12th Floor, Stamford, CT (Address of principal executive offices)		06901 (Zip Code)

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

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

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 232.405 of this chapter during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files. þ Yes o 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ		Accelerated Filer o		Non-Accelerated Filer o		Smaller Reporting Company o
		(Do not check if a smaller reporting company)

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

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

		Outstanding at
Class		November 1, 2010
Common stock, $.001 par value		93,534,981

 

 

L-1 IDENTITY SOLUTIONS, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2010

INDEX

				Page
PART I — FINANCIAL INFORMATION
Item 1 —		Unaudited Condensed Consolidated Financial Statements			3
		Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009			3
		Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009			4
		Condensed Consolidated Statements of Changes in Equity for the nine months ended September 30, 2010 and the year ended December 31, 2009			5
		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009			6
		Notes to Condensed Consolidated Financial Statements			7
Item 2 —		Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3 —		Quantitative and Qualitative Disclosures about Market Risk			40
Item 4 —		Controls and Procedures			41
PART II — OTHER INFORMATION					42
Item 1 —		Legal Proceedings			42
Item 1A-		Risk Factors			44
Item 2 —		Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 3 —		Defaults Upon Senior Securities			48
Item 4 —		[Removed and Reserved]			48
Item 5 —		Other Information			48
Item 6 —		Exhibits			48
SIGNATURES					49
EXHIBIT INDEX					50
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART 1 — FINANCIAL INFORMATION

ITEM 1 — UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

L-1 IDENTITY SOLUTIONS, INC.

Condensed Consolidated Balance Sheets
(in thousands)
(Unaudited)

		September 30,				December 31,
		2010				2009
Assets
Current assets:
Cash and cash equivalents		$	9,026			$	6,624
Accounts receivable, net			89,596				116,353
Inventory, net			34,978				29,384
Deferred tax asset, net			9,788				11,514
Other current assets			7,651				9,249
Assets held for sale			262,640				—
Total current assets			413,679				173,124
Property and equipment, net			122,098				115,500
Goodwill			700,768				889,814
Intangible assets, net			61,773				102,375
Deferred tax assets, net			47,864				26,733
Other assets, net			15,385				16,279
Total assets		$	1,361,567			$	1,323,825
Liabilities and Equity
Current liabilities:
Accounts payable and accrued expenses		$	88,033			$	110,089
Current portion of deferred revenue			19,129				19,890
Current maturities of long-term debt			268,262				27,062
Other current liabilities			7,275				6,680
Liabilities related to assets held for sale			37,001				—
Total current liabilities			419,700				163,721
Deferred revenue, net of current portion			4,927				6,676
Long-term debt, net of current maturities			199,804				419,304
Other long-term liabilities			4,643				3,663
Total liabilities			629,074				593,364
Equity:
Common stock, $0.001 par value; 125,000,000 shares authorized; 93,682,240 and 91,745,135 shares issued at September 30, 2010 and December 31, 2009, respectively			94				92
Additional paid-in capital			1,454,535				1,432,898
Accumulated deficit			(646,881	)			(627,449	)
Pre-paid forward contract			(69,808	)			(69,808	)
Treasury stock, 384,690 and 368,843 shares of common stock, at cost at September 30, 2010 and December 31, 2009, respectively			(6,316	)			(6,173	)
Accumulated other comprehensive income			570				622
Noncontrolling interest			299				279
Total equity			732,493				730,461
Total liabilities and equity		$	1,361,567			$	1,323,825

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

L-1 IDENTITY SOLUTIONS, INC.

Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Revenues		$	121,012			$	119,233			$	323,609			$	330,136
Cost of revenues:
Cost of revenues			82,299				78,480				227,743				225,526
Amortization of acquired intangible assets			1,334				1,260				3,894				4,094
Total cost of revenues			83,633				79,740				231,637				229,620
Gross profit			37,379				39,493				91,972				100,516
Operating expenses:
Sales and marketing			9,344				10,476				27,698				29,839
Research and development			6,262				6,114				16,787				17,679
General and administrative			16,658				14,571				42,650				42,363
Asset impairment charge			2,915				—				2,915
Strategic alternative transactions and acquisition related costs			6,063				27				7,971				506
Total operating expenses			41,242				31,188				98,021				90,387
Operating income (loss)			(3,863	)			8,305				(6,049	)			10,129
Financing costs:
Contractual interest			(2,515	)			(1,797	)			(7,108	)			(5,674	)
Other financing costs			(1,865	)			(1,871	)			(5,475	)			(5,191	)
Other expense, net			(226	)			(92	)			(404	)			(47	)
(Loss) income before income taxes and discontinued operations			(8,469	)			4,545				(19,036	)			(783	)
(Provision) benefit for income taxes			1,899				(1,506	)			4,078				(168	)
Net (loss) income from continuing operations, net of income taxes			(6,570	)			3,039				(14,958	)			(951	)
Net loss from discontinued operations, net of income taxes			(2,605	)			(1,667	)			(4,454	)			(2,707	)
Net (loss) income			(9,175	)			1,372				(19,412	)			(3,658	)
Net loss (income) attributable to noncontrolling interest			9				—				(20	)			—
Net income (loss) attributable to L-1’s shareholders		$	(9,166	)		$	1,372			$	(19,432	)		$	(3,658	)
Basic net (loss) income per share:
Continued operations		$	(0.07	)		$	0.04			$	(0.17	)		$	(0.01	)
Discontinued operations		$	(0.03	)		$	(0.02	)		$	(0.05	)		$	(0.03	)
Attributable to L-1’s shareholders		$	(0.10	)		$	0.02			$	(0.22	)		$	(0.04	)
Diluted net (loss) income per share:
Continued operations		$	(0.07	)		$	0.04			$	(0.17	)		$	(0.01	)
Discontinued operations		$	(0.03	)		$	(0.02	)		$	(0.05	)		$	(0.03	)
Attributable to L-1’s shareholders		$	(0.10	)		$	0.02			$	(0.22	)		$	(0.04	)
Weighted average common shares outstanding:
Basic			87,971				85,901				87,491				85,301
Diluted			87,971				86,007				87,491				85,301

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

L-1 IDENTITY SOLUTIONS, INC.

Condensed Consolidated Statements of Changes in Equity
(In thousands)
(Unaudited)

																		Pre-paid
																		Forward
						Series A												Contract To								Accumulated
						Convertible				Additional								Purchase								Other				Non-
		Common				Preferred				Paid-in				Accumulated				Common				Treasury				Comprehensive				Controlling
		Stock				Stock				Capital				Deficit				Stock				Stock				Income (Loss)				Interest				Total
Balance, January 1, 2009		$	87			$	15,107			$	1,393,763			$	(623,251	)		$	(69,808	)		$	(6,161	)		$	(1,257	)		$	—			$	708,480
Reclassification of noncontrolling interest			—				—				—				—				—				—				—				84				84
Exercise of employee stock options			—				—				87				—				—				—				—				—				87
Common stock issued for directors’ fees			—				—				208				—				—				—				—				—				208
Common stock issued under employee stock purchase plan			1				—				3,351				—				—				—				—				—				3,352
Deferred tax charge of stock options exercised			—				—				(845	)			—				—				—				—				—				(845	)
Retirement plan contribution settled in common stock			2				—				8,468				—				—				—				—				—				8,470
Stock-based compensation expense			1				—				12,941				—				—				—				—				—				12,942
Conversion of Series A convertible preferred stock			1				(15,107	)			15,106				—				—				—				—				—				—
Foreign currency translation gain			—				—				—				—				—				—				1,391				—				1,391
Unrealized gain of financial instruments, net of tax			—				—				—				—				—				—				488				—				488
Net income (loss)			—				—				—				(4,198	)			—				—				—				195				(4,003	)
Other			—				—				(181	)			—				—				(12	)			—				—				(193	)
Balance, December 31, 2009		$	92			$	—			$	1,432,898			$	(627,449	)		$	(69,808	)		$	(6,173	)		$	622			$	279			$	730,461
Exercise of employee stock options			—				—				766				—				—				—				—				—				766
Common stock issued for directors’ fees			—				—				900				—				—				—				—				—				900
Common stock issued under employee stock purchase plan			—				—				2,542				—				—				—				—				—				2,542
Retirement plan contributions settled in common stock			2				—				9,026				—				—				—				—				—				9,028
Stock-based compensation expense			—				—				8,403				—				—				—				—				—				8,403
Foreign currency translation loss			—				—				—				—				—				—				(295	)			—				(295	)
Unrealized gain of financial instruments, net of tax			—				—				—				—				—				—				243				—				243
Net income (loss)			—				—				—				(19,432	)			—				—				—				20				(19,412	)
Other			—				—				—				—				—				(143	)			—				—				(143	)
Balance, September 30, 2010		$	94			$	—			$	1,454,535			$	(646,881	)		$	(69,808	)		$	(6,316	)		$	570			$	299			$	732,493

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

L-1 IDENTITY SOLUTIONS, INC.

Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)

		Nine Months Ended
		September 30,				September 30,
		2010				2009
Cash Flow from Operating Activities:
Net loss		$	(19,412	)		$	(3,658	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			31,350				27,411
Stock-based compensation costs			18,008				16,225
Benefit for non-cash income taxes			(6,318	)			(1,428	)
Amortization of deferred financing costs and debt discount			9,049				10,354
Asset impairments charge			2,915				—
Other non-cash items			(69	)			—
Change in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable			(7,377	)			(21,571	)
Inventory			(4,911	)			4,137
Other assets			323				6,435
Accounts payable, accrued expenses and other liabilities			6,625				17,614
Deferred revenue			(2,532	)			(7,773	)
Net cash provided by operating activities			27,651				47,746
Cash Flow from Investing Activities:
Acquisitions			(3,771	)			(3,228	)
Capital expenditures			(32,558	)			(38,423	)
Additions to intangible assets			(4,822	)			(6,151	)
Increase in restricted cash			(1,043	)			(67	)
Net cash used in investing activities			(42,194	)			(47,869	)
Cash Flow from Financing Activities:
Borrowings under revolving credit agreement			61,158				—
Principal payments on borrowings under revolving credit agreement and other debt			(31,691	)			(631	)
Principal payments on term loan			(13,052	)			(9,843	)
Debt and equity issuance costs			(2,410	)			(822	)
Proceeds from issuance of common stock to employees			1,999				1,770
Proceeds from exercise of stock options by employees			766				51
Net cash provided by (used in) financing activities			16,770				(9,475	)
Effect of exchange rate changes on cash and cash equivalents			175				200
Net increase (decrease) in cash and cash equivalents			2,402				(9,398	)
Cash and cash equivalents, beginning of year			6,624				20,449
Cash and cash equivalents, end of period		$	9,026			$	11,051
Supplemental Cash Flow Information:
Cash paid for interest		$	21,231			$	19,657
Cash paid for income taxes		$	283			$	1,015

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

L-1 IDENTITY SOLUTIONS, INC.

Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. DESCRIPTION OF BUSINESS

Operations

     L-1 Identity Solutions, Inc. and its subsidiaries (“L-1” or the “Company”) provide solutions and services that protect and secure personal identities and assets and allow international governments, federal and state agencies, law enforcement and commercial businesses to guard the public against terrorism, crime and identity theft.

     In January 2010, L-1 announced that one of its strategic goals and objectives for 2010 was to explore strategic alternatives to enhance shareholder value. Subsequently, on September 19, 2010, the Company entered into an agreement (the “Merger Agreement”) with Safran SA (“Safran”) and Laser Acquisition Sub Inc. (“Merger Sub”), a wholly owned subsidiary of Safran, pursuant to which, subject to the terms and conditions set forth in the Merger Agreement, the Company is to be acquired by Safran in a merger transaction providing for shareholders to receive $12.00 per share in cash, for an aggregate enterprise value of approximately $1.6 billion, inclusive of outstanding debt. See Note 3 to our consolidated financial statements for additional information. Completion of the merger remains subject to certain conditions, including, among others, (i) the disposition of our SpecTal/McClendon and Advanced Concepts businesses as described below; (ii) approval of the merger transaction by our shareholders; (iii) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”); (iv) termination or expiration of the Committee on Foreign Investment in the United States (“CFIUS”) review period pursuant to the Exon-Florio Provision of the Defense Production Act of 1950; (v) completion of the novation, termination or expiration of certain contracts; (vi) no Company Material Adverse Effect (as defined in the Merger Agreement) having occurred since the date of the Merger Agreement; (vii) subject to certain materiality exceptions, the accuracy of the representations and warranties made by the Company and Safran and compliance by the Company and Safran with their respective obligations under the Merger Agreement; (viii) no law or government order prohibiting the merger; and (ix) other customary conditions.

     Also on September 19, 2010, the Company entered in a definitive agreement (the “BAE Purchase Agreement”) to sell SpecTal/McClendon and Advanced Concepts (the “Intel Business”) to BAE Systems Information Solutions, Inc. (“BAE”) (a subsidiary of BAE Systems, Inc. the U.S. affiliate of BAE Systems plc) for a purchase price of $295.8 million in cash (and approximately $7.2 million in assumed obligations), the net proceeds of which (as defined in the credit agreement) will be used to repay outstanding debt under the Company’s credit agreement. Completion of the sale remains subject to certain conditions, including, among others, (i) the expiration or termination of the applicable waiting periods under the HSR Act; (ii) termination or expiration of the CFIUS review period; (iii) no Business Material Adverse Effect (as defined in the BAE Purchase Agreement) having occurred since the date of the BAE Purchase Agreement; (iv) subject to certain materiality exceptions, the accuracy of the representations and warranties made by the Company and BAE and compliance by the Company and BAE with their respective obligations under the BAE Purchase Agreement; (v) the completion of certain actions in respect of organizational conflict of interest provisions under certain contracts of the Intel Business; (vi) no law or judgment prohibiting the sale and (vii) other customary conditions. The purchase price is subject to adjustment based upon the working capital of the Intel Business at closing.

     The accompanying financial statements reflect the impact of the sale of the Intel Business and approximately $11.2 million of costs incurred related to exploration of strategic alternatives in respect of the nine months ended September 30, 2010, of which $3.3 million is attributable to the Intel Business.

     The operating results related to the Intel Business have been reflected as discontinued operations for all periods presented. Unless otherwise noted, revenues and expenses in these Notes to Condensed Consolidated Financial Statements exclude amounts attributable to discontinued operations. The assets and liabilities have been included in assets held for sale and liabilities related to assets held for sale at September 30, 2010.

     The Company operates in two reportable segments: Solutions and Services. The Solutions segment includes Secure Credentialing and Biometrics/Enterprise Access. Secure Credentialing solutions span the entire secure credentialing lifecycle, from testing through issuance and inspection. This includes driver’s licenses, national IDs, ePassports and other forms of government-issued proof of identity credentials. Biometric solutions capture, manage and move biometric data for positive, rapid ID and tracking of persons of interest. Biometrics solutions also encompass access control readers that enable businesses and governments to secure facilities and restricted areas by preventing unauthorized entry.

     Prior to September 19, 2010, the Services segment included Enrollment Services, SpecTal/McClendon and Advanced Concepts. Enrollment Services performs fingerprint-based background checks necessary for federal and state licensed employment in the banking, finance, insurance, healthcare, legal, real estate, education and other industries. SpecTal/McClendon and Advanced Concepts provide services to the national security and intelligence community, including information technology, engineering and analytics, and intelligence. As a result of accounting for SpecTal/McClendon and Advanced Concepts as discontinued operations, subsequent to September 19, 2010, the Services segment consists of the Enrollment Services operating segment and all prior period segment data have been revised accordingly.

     Customers, depending on their needs, may order solutions that include hardware, equipment, consumables, software products or services or combine hardware products, consumables, equipment, software products and services to create multiple element arrangements.

Reorganization

     On May 16, 2007, the Company adopted a new holding company organizational structure to facilitate the issuance of its convertible senior notes (the “Convertible Notes” or “Notes”) and the structuring of acquisitions. Pursuant to the reorganization, L-1 Identity Solutions, Inc. became the sole shareholder of its predecessor, L-1 Identity Solutions Operating Company (“L-1 Operating”, previously also known as L-1 Identity Solutions, Inc.).

     The Company has no operations other than those carried through its investment in L-1 Operating and the financing operations related to the issuance of the Convertible Notes. A summary balance sheet of the Company (Parent Company only) is set forth below (in thousands):

		September 30,				December 31,
		2010				2009
Assets:
Deferred financing costs		$	1,693			$	2,506
Investment in L-1 Operating			903,656				894,988
		$	905,349			$	897,494
Liabilities and equity:
Accrued interest		$	2,466			$	825
Deferred tax liability			5,200				5,200
Convertible debt			165,190				161,008
			172,856				167,033
Equity			732,493				730,461
		$	905,349			$	897,494

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation

     The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments that in the opinion of management are necessary for a fair presentation of the financial statements for the interim periods. The unaudited condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements, and in accordance with SEC rules, omit or condense certain information and footnote disclosures. Results for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the full year. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K filed on February 26, 2010. The condensed consolidated financial statements include the accounts of L-1 and its wholly-owned subsidiaries, after elimination of material inter-company transactions and balances.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant assumptions and estimates relate to the allocation of the purchase price of the acquired businesses, assessing the impairment of goodwill, other intangible assets and property and equipment, revenue recognition, estimating the useful life of long-lived assets, inventory valuation allowance, provision for bad debts, income taxes, litigation and valuation of and accounting for financial instruments, including Convertible Notes, interest rate protection agreements, foreign currency contracts, warrants and stock options. Actual results could differ materially from those estimates.

Revenue Recognition

     The Company derives its revenue from sales of solutions that include hardware components, consumables and software components and related maintenance, technical support, training and installation services integral to sales of hardware and software. The Company also derives revenues from sales of fingerprint based background check enrollment services and government security and information technologies services. A customer, depending on its needs, may order solutions that include hardware, equipment, consumables, software products or services or combine these products and services to create a multiple element arrangement. The Company’s revenue recognition policies are described in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K filed on February 26, 2010. There have been no material changes to such policies.

Stock-Based Compensation

     L-1 uses the Black-Scholes valuation model to estimate the fair value of option awards. The following weighted average assumptions were utilized in the valuation of stock options in 2010 and 2009:

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Expected common stock price volatility			55.0	%			60.6	%			56.2	%			59.3	%
Risk free interest rate			2.4	%			3.9	%			3.3	%			3.9	%
Expected life of options		6.3 Years				6.3 Years				6.3 Years				6.3 Years
Expected annual dividends			—				—				—				—

     The expected volatility rate is based on the historical volatility of the Company’s common stock. The expected life of options are calculated pursuant to the relevant guidance from Staff Accounting Bulletin No. 107. The Company estimates forfeitures based on historical rates. The risk free interest rate is based on the applicable treasury security whose term approximates the expected life of the options. The Company updates these assumptions on at least an annual basis and on an interim basis if significant changes to the assumptions are determined to be necessary.

Computation of Net Income (Loss) per Share

     Basic net income (loss) per share is calculated by using the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is based upon the weighted average number of diluted shares outstanding during the period.

     The weighted average number of shares of common stock outstanding during 2009, includes 1.1 million shares issuable pursuant to the Series A Convertible Preferred Stock before their conversion into common stock. Restricted share awards are included in the calculation of weighted average shares outstanding beginning on the date of vesting. The impact of approximately 1.9 million and 1.5 million of common equivalent shares for the three and nine month periods ended September 30, 2010, respectively, and the impact of 1.1 million and 0.5 million common equivalent shares for three and nine month periods ended September 30, 2009, respectively, were not reflected in the net income (loss) attributable to L-1’s shareholders per share as their effect would be anti-dilutive.

     The Company calculates the effect of the Convertible Notes on diluted net income (loss) attributable to L-1’s shareholders per share utilizing the “as if converted” method since the Company has the right to issue shares of common stock to settle the entire obligation upon conversion. For the three and nine month periods ended September 30, 2010 and 2009, the effect was anti-dilutive. Accordingly, approximately 5.5 million shares of weighted average common stock issuable at conversion have been excluded from the determination of weighted average diluted shares outstanding.

     In connection with the issuance of the Convertible Notes, the Company entered into a pre-paid forward contract with Bear Stearns (now JP Morgan Chase) for a payment of $69.8 million to purchase 3.5 million shares of the Company’s common stock at a price of $20.00 per share for delivery in 2012. The number of shares to be delivered under the contract is used to reduce weighted average basic and diluted shares outstanding for net income (loss) per share purposes.

Adoption of New Accounting Standards

     Effective January 1, 2010, the Company adopted the following accounting standards:

     In June 2009, the FASB issued the standard, “Amendments to FASB Interpretation No. 46(R)”. The standard changes the criteria to determine how an investee for a company is insufficiently capitalized or is not controlled through voting (or similar rights) and therefore should be consolidated. The adoption of this standard did not have a material impact on the financial statements for any of the periods presented.

     In January 2010, the FASB issued the standard, “Fair Value Measurements and Disclosures — Improving Disclosures about Fair Value Measurements”. The adoption of this standard did not have a material impact on the financial statements for any of the periods presented.

Recently Issued Accounting Standards

     In October 2009, the FASB issued the standard, “Multiple Element Arrangements”, which modifies accounting for multiple element arrangements by requiring that the separation of the arrangements be based on estimated selling prices based on entity specific assumptions rather than fair value, eliminating the residual method of allocation and requiring additional disclosures related to such arrangements. The standard is effective prospectively for arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company has not yet evaluated the impact the adoption of the standard will have on its consolidated financial statements.

     Also in October 2009, the FASB issued the standard, “Certain Revenue Arrangements That Include Software Elements”, which amends software revenue recognition guidance to eliminate from its scope tangible products containing software components that function together to deliver the tangible product’s essential functionality and to provide guidance on how to allocate arrangement consideration to deliverables in an arrangement that contain both tangible products and software. The standard is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company has not yet evaluated the impact the adoption of the standard will have on its consolidated financial statements.

On September 19, 2010, the Company has entered into an agreement to be acquired by Safran, in a merger transaction providing for L-1 shareholders to receive $12.00 per share in cash, for an aggregate enterprise value of approximately $1.6 billion, inclusive of outstanding debt. The Safran merger is conditioned on, among other things, the consummation of the BAE transaction described below.

Also on September 19, 2010, BAE agreed to acquire the stock and membership interests of the entities comprising the L-1 intelligence services businesses for a purchase price of approximately $295.8 million in cash and approximately $7.2 million of assumed obligations. These businesses include SpecTal, LLC, Advanced Concepts, Inc., and McClendon, LLC. The BAE transaction remains subject, among other conditions, to certain U.S. regulatory clearances, and is expected to close in the fourth quarter of 2010. The Company is required to use the net cash proceeds (as defined in the Company’s credit agreement) from the closing of the BAE transaction to repay a substantial portion of the Company’s indebtedness under its credit facility. The purchase price is subject to adjustment based on the Intel Business working capital at closing. It is expected that the sale of the intelligence services businesses will result in a gain which will be recorded upon consummation of the sale.

The Safran and BAE transactions are not subject to financing. The closing of the Safran merger is conditioned on the closing of the BAE transaction; however, the closing of the BAE transaction is not conditioned on the closing of the Safran merger.

The major classes of assets and liabilities that are included as part of the intelligence services business (and presented as held for sale at September 30, 2010) are included in the table below. The December 31, 2009 amounts have not been reclassified as assets held for sale. (in thousands)

		September 30,				December 31,
		2010				2009
Assets
Cash		$	—			$	370
Accounts receivable, net			34,335				40,319
Other current assets			1,446				2,291
Property and equipment, net			382				458
Goodwill and intangible assets, net			226,353				229,383
Other assets			124				124
Total current assets held for sale		$	262,640			$	272,945
Liabilities
Accounts payable and accrued expenses		$	22,680			$	23,250
Other current liabilities			894				34
Deferred tax liability			13,422				14,016
Other liabilities			5				44
Total current liabilities held for sale		$	37,001			$	37,344

The Company expects to recognize a gain on the sale of the Intel Business ranging from $40.0 million to $50.0 million pre-tax, depending on the net assets of the business at the date of closing.

A summary of the results of operations of the discontinued operations follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Revenues		$	54,877			$	53,305			$	164,610			$	160,644
Cost of sales			38,956				37,803				117,148				113,795
Operating expenses			10,727				9,780				32,923				30,190
Operating income			5,194				5,722				14,539				16,659
Interest expense			6,169				8,013				17,956				20,851
Strategic alternative transaction costs			3,328				—				3,328				—
Other income (expense)			26				(65	)			51				(111	)
Loss before income taxes			(4,277	)			(2,356	)			(6,694	)			(4,303	)
Benefit for income taxes			1,672				689				2,240				1,596
Net loss from discontinued operations		$	(2,605	)		$	(1,667	)		$	(4,454	)		$	(2,707	)

Effective on September 19, 2010, the Company ceased recording depreciation and amortization of long-lived assets related to the discontinued operations. Included in discontinued operations is interest expense related to the estimated debt that is required to be repaid from the net proceeds of the sale of the business in accordance with the terms of our credit agreement. Interest has been allocated to discontinued operations based on the ratio that the estimated debt to be repaid bears to the total average debt outstanding during the period. Strategic alternative transaction costs attributed in discontinued operations represent costs incurred in connection with the sale of the Intel Business.

4. ADDITIONAL FINANCIAL INFORMATION

Inventory, net

     Inventory comprised the following as of September 30, 2010 and December 31, 2009, net of write downs of $2.7 million and $3.2 million, respectively (in thousands):

		September 30,				December 31,
		2010				2009
Purchased parts and materials		$	25,359			$	23,107
Work in progress			3,213				615
Inventoried contract costs			3,113				3,193
Finished goods			3,293				2,469
Total Inventory		$	34,978			$	29,384

Approximately $1.5 million and $2.1 million of inventory at September 30, 2010 and December 31, 2009, respectively, were held at customer sites.

Property and Equipment, net (in thousands):

		September 30,				December 31,
		2010				2009
System assets		$	139,111			$	92,753
Computer and office equipment			11,909				9,147
Machinery and equipment			22,965				23,107
Construction in progress			25,899				53,436
Leasehold improvements			8,032				7,652
Other — including tooling and demo equipment			4,596				4,234
			212,512				190,329
Less, accumulated depreciation			90,414				74,829
Property and equipment, net		$	122,098			$	115,500

At September 30, 2010, property and equipment of $0.4 million, net of accumulated depreciation of $0.9 million was included in assets held for sale in the accompanying balance sheet.

Capital expenditures for the nine months ended September 30, 2010 and 2009 aggregated $32.6 million and $38.4 million, respectively, and include capitalized interest for the three and nine months ended September 30, 2010 and 2009 of $0.4 million and $1.5 million and $0.4 million and $1.0 million, respectively. These expenditures are principally related to the Solutions segment.

Depreciation expense on property and equipment for the three and nine months ended September 30, 2010 and 2009 was $7.5 million and $20.5 million and $5.6 million and $17.1 million. Approximately, $0.1 million and $0.2 million and $0.1 million and $0.2 million of depreciation expense for the three and nine months ended September 30, 2010 and 2009, respectively, has been included in discontinued operations.

During the third quarter of 2010, the Company and the operator of the restarted Registered Traveler program were unable to negotiate mutually acceptable terms related to the Company’s participation in the program. Accordingly, the Company determined that the assets designated for the program were impaired and recorded an impairment of $2.9 million.

The following table presents depreciation and amortization expense excluding amortization of acquisition related intangible assets, but including amortization of other intangible assets, as reflected in continuing operations (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Cost of revenues		$	7,525			$	5,652			$	20,590			$	16,847
Sales and marketing			88				76				272				212
Research and development			175				110				438				317
General and administrative			991				884				2,972				2,477
		$	8,779			$	6,722			$	24,272			$	19,853

Goodwill (in thousands):

The following summarizes the activity in goodwill for the nine months ended September 30, 2010:

		Solutions				Services				Total
Balance, January 1, 2010		$	626,499			$	263,315			$	889,814
Reclassification to assets held for sale			—				(188,589	)			(188,589	)
Currency translation adjustments			(587	)			130				(457	)
Balance, September 30, 2010		$	625,912			$	74,856			$	700,768

As of September 30, 2010, approximately $149.0 million of goodwill was deductible for income tax purposes, of which $101.0 million is included in assets held for sale. Goodwill reflects accumulated impairment charges of approximately $430.0 million as a result of the charge recorded in 2008, principally related to the Solutions segment.

Intangible Assets, net (in thousands):

Intangible assets, net comprise the following as of September 30, 2010 and December 31, 2009:

		September 30, 2010								December 31, 2009
						Accumulated								Accumulated
		Cost				Amortization				Cost				Amortization
Acquisition related intangibles assets:
Completed technology		$	16,407			$	(6,931	)		$	14,425			$	(4,853	)
Core technology			340				(130	)			340				(79	)
Trade names, trademarks and other			1,176				(688	)			7,263				(2,269	)
Customer contracts and relationships			56,163				(21,404	)			104,063				(31,382	)
			74,086				(29,153	)			126,091				(38,583	)
Other intangible assets			26,934				(10,094	)			23,591				(8,724	)
		$	101,020			$	(39,247	)		$	149,682			$	(47,307	)

At September 30, 2010, intangible assets of $37.8 million, net of accumulated amortization of $16.4 million was included in assets held for sale in the accompanying balance sheet. As of September 30, 2010, approximately $60.3 million of intangible assets, net were deductible for income tax purposes, of which $27.7 million are included in assets held for sale.

Amortization of acquisition related intangible assets for the three and nine months ended September 30, 2010 and 2009, was $1.3 million and $3.9 million and $1.3 million and $4.1 million, respectively. Other intangible asset amortization excluding acquisition related amortization was $1.3 million and $3.8 million and $1.1 million and $2.7 million for the three and nine months ended September 30, 2010 and 2009, respectively. Approximately, $0.8 million and $3.0 million of amortization of acquisition related intangible assets for the three and nine months ended September 30, 2010 and $1.1 million and $3.3 million for the three and nine months ended September 30, 2009, respectively, are included in discontinued operations.

The following summarizes amortization of acquisition related intangible assets included in the continuing operations (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Cost of revenues		$	1,334			$	1,260			$	3,894			$	4,094

Amortization of acquisition related intangible assets used in continuing operations for the current and subsequent four years and thereafter is as follows: $1.3 million, $4.9 million, $4.2 million, $3.8 million, $2.0 million, and $28.7 million, respectively.

Financial Instruments

The carrying amounts of accounts receivable, net, accounts payable and accrued expenses and other current liabilities approximate their fair values due to the short term maturities. The carrying amount of borrowings under the revolving credit agreement approximates fair value since the long-term debt bears interest at variable rates. The fair value of the Convertible Notes and Term Loan is based on market transaction prices. The fair value of interest rate protection agreements and foreign currency forward contracts are determined based on the estimated amounts that such contracts could be settled with the counterparty at the balance sheet date, taking into account current interest rates, future expectations of interest rates, and L-1’s current credit worthiness. The recorded and estimated fair values are as follows for September 30, 2010 (in thousands):

		Assets (Liabilities)
		Recorded				At
		amount at				Fair Value
		September 30,				September 30,
		2010				2010
Accounts Receivable		$	89,596			$	89,596
Accounts Payable and Accrued Expenses, Excluding Interest Rate Protection Agreements and Foreign Currency Forward Contracts			(86,361	)			(86,361	)
Other Current Liabilities			(7,275	)			(7,275	)
Term Loans			(266,655	)			(269,355	)
Revolving Credit Facility			(35,000	)			(35,000	)
Convertible Notes			(165,190	)			(174,781	)
Other Debt			(1,222	)			(1,122	)
Derivatives:
Foreign Currency Forward Contracts (included in accounts payable and accrued expenses)			(4	)			(4	)
Interest Rate Protection Agreements (included in accounts payable and accrued expenses)			(1,668	)			(1,668	)

Derivatives

The Company is exposed to interest rate risk and foreign exchange risks that in part are managed by using derivative financial instruments. These derivatives include foreign currency forward contracts related to risks associated with foreign operations and interest protection agreements related to risks associated to variable rate borrowings. The Company does not use derivatives for trading purposes and at September 30, 2010, has no derivatives that are designated as fair value hedges.

Derivatives are recorded at their estimated fair values based upon Level 2 inputs. Derivatives designated and effective as cash flow hedges are reported as a component of other comprehensive income and reclassified to earnings in the same periods in which the hedged transactions impact earnings. Gains and losses related to derivatives not meeting the requirements of hedge accounting and the portion of derivatives related to hedge ineffectiveness are recognized in current earnings.

At September 30, 2010, the Company had outstanding foreign currency forward contracts denominated in Japanese Yen aggregating $0.6 million. At December 31, 2009, the Company had outstanding foreign currency contracts denominated in Japanese Yen aggregating $1.8 million.

The following summarizes certain information regarding the Company’s derivative financial instruments (in thousands):

						Fair Value at
		Balance Sheet Caption				September 30, 2010				December 31, 2009
Interest rate protection agreements		Accounts Payable/Accrued Expenses				$	(1,668	)		$	(1,896	)

The following summarizes certain information regarding the Company’s derivatives which have been designated and are effective as cash flow hedges (in thousands):

						Gain (loss) reclassified from
						OCI to Income Statement
		Recognized				Three Months				Three Months				Nine Months				Nine Months
		In OCI at				Ended				Ended				Ended				Ended
		September 30, 2010				September 30, 2010				September 30, 2009				September 30, 2010				September 30, 2009
Interest rate protection agreements		$	(578	)		$	(133	)		$	(133	)		$	(400	)		$	(356	)
Foreign currency contracts			—				—			$	4				—			$	37

The following summarizes certain information regarding the Company’s derivatives that are not designated or are not effective as hedges (in thousands):

						Amounts of Gain (Loss) Recognized in Income
						Statement
						Three Months				Three Months				Nine Months				Nine Months
		Income Statement				Ended				Ended				Ended				Ended
		Caption				September 30, 2010				September 30, 2009				September 30, 2010				September 30, 2009
Interest rate protection agreements		Interest Expense				$	99			$	(750	)		$	228			$	(518	)
Foreign currency forward contracts		Other Expense, net				$	(39	)			—			$	(85	)			—

Products and Services Revenues:

The following provides details of the products and services revenues included in continuing operations for the three and nine months ended September 30, 2010 and 2009 (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Services:
U.S. Federal government services		$	6,539			$	8,103			$	19,938			$	27,441
State and local government services			24,900				22,654				69,006				57,085
Total Services			31,439				30,757				88,944				84,526
Solutions:
State and local government solutions			33,497				30,622				91,585				88,992
Hardware and consumables			18,297				31,492				58,661				86,411
Software, licensing fees and other			29,198				17,618				58,282				45,671
Maintenance			8,581				8,744				26,137				24,536
Total Solutions			89,573				88,476				234,665				245,610
Total Revenues		$	121,012			$	119,233			$	323,609			$	330,136

     Services revenues included in continuing operations represent revenues from enrollment services contracts for which the Company is compensated based on volume of enrollments performed. Solutions revenues comprise revenues from the delivery of consumables and equipment, as well as hardware, software and systems that include related services, primarily maintenance, bundled with the related product deliverables. Because the product functionality is the primary deliverable for the customer, we have included the total revenues from these arrangements in solutions revenues. Solutions revenues also include revenues related to driver’s license production contracts for which we provide systems and maintenance, produce the licenses and are compensated in one all inclusive price per license as the licenses are produced.

Comprehensive Income (Loss) (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Net income (loss)		$	(9,175	)		$	1,372			$	(19,412	)		$	(3,658	)
Changes in accumulated comprehensive income (loss)			1,611				963				(52	)			1,769
Comprehensive income (loss)		$	(7,564	)		$	2,335			$	(19,464	)		$	(1,889	)

     Aston Capital Partners, L.P. (“Aston”), an affiliate of L-1 Investment Partners LLC, owns approximately 8.2 percent of L-1’s outstanding common stock. Mr. Robert LaPenta, Mr. James DePalma, Mr. Joseph Paresi and Ms. Doni Fordyce, each executive officers of the Company, directly and indirectly hold all the beneficial ownership in L-1 Investment Partners LLC and Aston Capital Partners GP LLC, the investment manager and general partner of Aston. Mr. LaPenta is also the Chairman of the Board of Directors and Chief Executive Officer and President of the Company. Mr. DePalma is also the Chief Financial Officer and Treasurer of the Company.

     Contemporaneously with the execution of the Merger Agreement described above, on September 19, 2010, Mr. LaPenta, Chairman, President and Chief Executive Officer of the Company, and Aston, entered into a voting and support agreement with Safran and Merger Sub. Pursuant to the voting and support agreement, Mr. LaPenta and Aston agreed, among other things, to vote their shares of our common stock in favor of the adoption of the Merger Agreement and approval of the merger, unless the Company’s board of directors changes its recommendation of the merger to shareholders (in which case, Mr. LaPenta and Aston may vote for or against the merger).

     In December 2005, Aston completed a $100 million investment and became the beneficial owner of L-1’s common stock. The investment agreement provides Aston with a right of first refusal to purchase a pro rata of new securities issued by L-1, subject to specified terms.

     On August 5, 2008, Mr. Robert LaPenta purchased 750,000 shares of L-1 common stock and 15,107 shares of Series A Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred Stock”) which in accordance with its terms was converted to 1,310,992 shares of common stock in 2009.

     In connection with the merger with Identix, Aston and L-1 agreed in principle that the Company may, subject to approval of the Company’s Board of Directors, purchase AFIX Technologies, Inc. (“AFIX”) a portfolio company of Aston, which provides fingerprint and palmprint identification software to local law enforcement agencies, at fair market value to be determined by an independent appraiser retained by the Company’s Board of Directors. A committee of the Board of Directors was appointed to evaluate a potential transaction. In March 2009, L-1 concluded that due to a variety of factors, it was not advisable to pursue the transaction with AFIX at that point in time. Receivables from AFIX at September 30, 2010 and 2009 were $0.2 million and $0.1 million, respectively. Sales to AFIX for the three and nine month period ended September 30, 2010 were less than $0.1 million and $0.2 million, respectively, and less than $0.1 million and $0.1 million for the same period in the prior year.

     In connection with the relocation of the corporate headquarters of the Company in the third quarter of 2006 to the offices of L-1 Investment Partners LLC in Stamford, Connecticut, the Company entered into a sublease with L-1 Investment Partners LLC under which the Company reimburses L-1 Investment Partners LLC for the rent and other costs payable by the Company. On June 29, 2009, the sublease was extended until March 2015. For the three and nine months ended September 30, 2010, the Company incurred costs of $0.2 million and $0.5 million, respectively, and $0.2 million and $0.6 million for the same period in the prior year, related to the sublease agreement.

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

     As a condition to the closing of the 2006 merger between the Company and Identix Incorporated (“Identix”), the Company and L-1 Investment Partners LLC entered into a Termination and Noncompete Agreement which, among other things, (1) terminated all arrangements whereby L-1 Investment Partners LLC and its affiliates provided financial, advisory, administrative or other services to the Company or its affiliates, and (2) prohibits L-1 Investment Partners LLC and its affiliates from engaging or assisting any person that competes directly or indirectly with the Company in the business of biometric, credentialing and ID management business anywhere in the United States or anywhere else in the world where the Company does business, or plans to do business or is actively evaluating doing business during the restricted period; provided however that the foregoing does not restrict L-1 Investment Partners LLC and its affiliates from retaining its investment in and advising AFIX Technologies, Inc. The restricted period runs co-terminously with the term of Mr. LaPenta’s employment agreement with the Company, dated as of August 29, 2006, and for a twelve month period following the expiration of the term of Mr. LaPenta’s employment agreement. On April 23, 2007, the Company entered into an employee arrangement with Mr. Robert LaPenta, Jr., the son of the Company’s Chief Executive Officer, to serve as Vice President, M&A/Corporate Development.

     The Company has consulting agreements with Mr. Denis K. Berube, a former member of the Company’s Board of Directors, and his spouse, Ms. Joanna Lau, under which each receives annual compensation of $0.1 million. Each agreement terminates on the earlier of January 10, 2012, or commencement of full time employment elsewhere. Under the terms of a 2002 acquisition agreement with Lau Security Systems, an affiliate of Mr. Berube and Ms. Lau, the Company is obligated to pay Lau a royalty on certain of its face recognition revenues through June 30, 2014, up to a maximum of $27.5 million. The estimated royalty costs incurred for the three and nine months ended September 30, 2010 amounted to approximately less than $0.1 million and $0.1 million, respectively, and less than $0.1 million for the same periods in the prior year.

     On February 26 and February 28, 2010, the Company entered into an engagement letter with each of Goldman Sachs & Co. (“Goldman”) and Stone Key Partners LLC and Hudson Partners Securities LLC (“Stone Key”), pursuant to which they are acting as financial advisors to the Company in connection with the Company’s exploration of strategic alternatives to enhance shareholder value. Both Goldman and Stone Key were selected after a competitive evaluation process involving multiple prospective advisors. In connection with their respective engagements, Goldman and Stone Key are entitled to receive customary fees from the Company. These fees, a substantial portion of which are payable in the event a transaction or transactions are consummated, would be allocated approximately 58% to Goldman and 42% to Stone Key. The aggregate transaction fee payable to the advisors would be 1.2% of the transaction value of which 15% was earned upon the delivery of the fairness opinions and the signing of a definitive transaction agreements, which occurred on September 19, 2010. Accordingly, the Company recorded aggregate liabilities for transaction fees and expenses of $3.0 million of which $1.3 million is due to Stone Key. The remainder would be earned upon closing of the Safran and BAE transactions. In addition, Stone Key would be entitled to a reduced fee if the Company receives a “break up” fee or similar payment in connection with the termination of a signed transaction agreement. Similar features apply to the Goldman engagement fee structure and the Company believes such arrangements are customary. Upon successful completion of the merger transaction with Safran described above, the Company will pay Stone Key and Goldman estimated aggregate transaction fees of $18.9 million of which $7.9 million is payable to Stone Key.

     Michael J. Urfirer, is a co-owner and co-founder of Stone Key’s parent company, is Co-Chairman and Co-CEO of Stone Key, and is also the husband of Doni L. Fordyce, our Executive Vice President of Corporate Communications. Mr. Urfirer has confirmed to the Company that he has no specific interest in any fees paid to Stone Key attributable to his status as co-owner of Stone Key and its affiliates or otherwise. He will not receive any commission, direct participation or similar payment in connection with Stone Key’s receipt of any fees. In his capacity as an employee of Stone Key’s parent company, Stone Key Group LLC (SKG), Mr. Urfirer receives a salary from SKG which is not based on fees. In addition, in his capacity as the holder of an interest in SKG, Mr. Urfirer is entitled to a percentage of SKG’s profits. The profits interest in SKG held by Mr. Urfirer is not a fixed percentage and will vary based on the revenues and expenses of SKG, the operation of payment priorities in SKG’s LLC Agreement and potential future dilution. Under certain scenarios, Mr. Urfirer’s interest in SKG’s 2010 profits could be equal to but will in no event exceed 50% and therefore, Mr. Urfirer’s share of the fee could approximate $4.0 million, before considering related operating costs and expenses.

     Mr. Urfirer and Stone Key’s other Co-Chairman and Co-CEO hold personal investments in Aston Capital Partners, L.P. as minority limited partners. Certain of our executive officers, including Mr. LaPenta, Mr. DePalma, Mr. Paresi and Ms. Fordyce, control Aston Capital Partners, L.P. through their ownership interest in the general partner.

6. LONG-TERM DEBT AND FINANCING ARRANGEMENTS

     Long-term debt consists of the following (in thousands):

		September 30,				December 31,
		2010				2009
$175.0 million aggregate principal amount 3.75 percent Convertible Senior Notes due May 15, 2027		$	175,000			$	175,000
Borrowings under revolving credit agreement			35,000				4,868
Borrowings under term loan			269,005				282,056
Capital leases and other			1,222				1,611
			480,227				463,535
Less: Unamortized discount on convertible notes			9,811				13,991
Less: Unamortized original issue discount on term loan			2,350				3,178
Less: Current portion of long-term debt			268,262				27,062
		$	199,804			$	419,304

     Pursuant to the terms of the Credit Agreement, as amended, as described below, the Company is required to use the Net Cash Proceeds (as defined) from the sale the Intel Business to BAE to reduce amounts borrowed under the Credit Agreement first in reduction to the Term Loans and next in reduction of revolving loans. The estimated Net Cash Proceeds, as defined, approximate $270.0 million which exceeds the aggregate principal amounts of the Term Loans as of September 30, 2010. Because the related assets held for sale and corresponding liabilities are included in current assets and liabilities the total amount outstanding under the Term Loans, of $269.0 million, net of original discount and $1.0 million of borrowings under the revolving credit facility has been included in current liabilities. The related deferred financing costs are included in other assets. It is expected that upon this mandatory prepayment of the Term Loans, the Company will record a loss on the settlement of the debt.

     Excluding the effect of the mandatory prepayment described above, scheduled principal payments on long-term debt and financing arrangements for the subsequent four years are as follows: $43.6 million, $34.0 million, $402.5 million and $0.1 million. The Convertible Notes’ final maturity date is 2027, but the holders have the right to require the Company to repurchase the Notes at par in 2012. The repayment schedule assumes that it will be repaid in 2012. The Term Loan’s final maturity date is 2013, but must be repaid prior to the repayment of the Convertible Notes. Accordingly, the repayment schedules reflect the repayment in 2012.

     Credit Agreement

     On August 5, 2008, L-1 entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”), among L-1 Identity Operating, L-1, Bank of America, N.A., Wachovia Bank, National Association, Banc of America Securities LLC and Wachovia Capital Markets LLC, Royal Bank of Canada, Societe Generale and TD Bank, N.A. to amend and restate the Amended and Restated Credit Agreement, by and among L-1, Bank of America, N.A. (“Administrative Agent”), Bear Stearns Corporate Lending, Inc., Bear Stearns & Co., Inc., Banc of America Securities LLC, Wachovia Bank, N.A. and Credit Suisse, Cayman Islands Branch. The Credit Agreement provides for a senior secured term loan facility in an aggregate principal amount of up to $300.0 million, with a term of five years, and a senior secured revolving credit facility in an aggregate principal amount of up to $135.0 million. The proceeds of the senior secured facilities were used to (i) fund, in part, the purchase price paid, and fees and expenses incurred, in connection with L-1’s acquisition of Digimarc Corporation after giving effect to the spin-off of its digital watermarking business (“Old Digimarc”), (ii) repay borrowings under L-1’s existing revolving credit facility and (iii) provide ongoing working capital and fund other general corporate purposes of L-1. As of September 30, 2010, the Company has approximately $92.0 million available under its revolving credit facility, subject to continuing compliance with the covenants contained in the agreement.

     On July 9, 2009, L-1 entered into an amendment to the Credit Agreement pursuant to which the term loans under the Credit Agreement have been split into two tranches: the Tranche B-1 Term Loan and the Tranche B-2 Term Loan. The Tranche B-1 Term Loan, with an aggregate principal amount of approximately $136.5 million at September 30, 2010, requires annual principal payments (payable quarterly) of 10 percent of the original principal amount through September 30, 2010, 20 percent of the original principal amount through September 30, 2012, and thereafter increasing over the duration of the Credit Agreement. The Tranche B-2 Term Loan, with an aggregate principal amount of approximately $132.5 million at September 30, 2010, requires annual principal payments (also payable quarterly) of 1 percent of the related original principal amounts over the remaining term of the Credit Agreement. There were $35.0 million of borrowings and $8.0 million of letters of credit that were outstanding under the revolving credit facility, respectively, at September 30, 2010.

     Under the terms of the amended senior secured credit facility, the Company has the option to borrow at LIBOR (subject to a floor of 3 percent) plus 2.75 percent to 5.0 percent per annum or at prime (subject to a floor of 2 percent) plus 1.75 percent to 4.0 percent per annum. L-1 is required to pay a fee of 0.5 percent on the unused portion of the revolving credit facility. All obligations of L-1 Operating under the Credit Agreement are guaranteed on a senior secured basis by L-1 and by each of L-1’s existing and subsequently acquired or organized direct or indirect wholly-owned subsidiaries (subject to certain exceptions). At September 30, 2010, the interest rates were 6.75 percent for Tranche B-1 Term Loans, 7.25 percent for Tranche B-2 Term Loans and 6.0 percent for borrowings under the revolving credit facility.

     L-1 is required to maintain the following financial covenants under the Credit Agreement:

	•		Consolidated Debt Service Coverage Ratio. As of the end of any fiscal quarter, the ratio of Consolidated EBITDA (as defined in the Credit Agreement) of L-1 Operating and its consolidated subsidiaries for the period of four consecutive fiscal quarters ending on or immediately prior to such date to the sum of (i) Consolidated Interest Charges (as defined in the Credit Agreement) of L-1 Operating and its consolidated subsidiaries paid or payable in cash during the period of four consecutive fiscal quarters ended on or immediately prior to such date, plus (ii) Consolidated Debt Amortization (as defined in the Credit Agreement) of L-1 Operating and its consolidated subsidiaries as of such date, shall not be less than 2.25:1.00, subject to the amendment described below.
	•		Consolidated Leverage Ratio. As of the end of any fiscal quarter, the ratio of L-1 Operating’s Consolidated Funded Indebtedness (as defined in the Credit Agreement, which excludes standby letters of credit issued in connection with performance bonds) as of such date to its Consolidated EBITDA (as defined in the Credit Agreement) for the period of four consecutive fiscal quarters ended on or immediately prior to such date, may not be more than: (i) 3.25:1.00 from the Closing Date (as defined in the Credit Agreement) to and including March 31, 2010, (ii) 3.00:1.00 from March 31, 2010 to March 30, 2011, and (iii) 2.75:1.00 at the end of each fiscal quarter thereafter, which has been amended as described below.

     On August 30, 2010, L-1 entered into an amendment and consent (the “Third Amendment”) to the Second Amended and Restated Credit Agreement dated as of August 5, 2008, among L-1 Identity Solutions Operating Company, the Company, Bank of America, N.A., the Lenders party thereto, Wachovia Bank, National Association, Banc of America Securities LLC and Wachovia Capital Markets LLC (as amended, the “Credit Agreement”). The Third Amendment extends the time period during which previously modified financial covenants will apply under the Credit Agreement, subject to the Company entering into definitive agreements providing for the sale of all or substantially all of the assets and operations of the Company and its subsidiaries in connection with its strategic alternatives review by September 30, 2010, which the Company executed on September 19, 2010. The Third Amendment provides that the minimum Consolidated Debt Service Coverage Ratio of 1.65 to 1.00 will remain in effect for the third fiscal quarter of 2010 and the period through and including March 30, 2011, after which the minimum Consolidated Debt Service Coverage Ratio shall return to 2.25 to 1.00 for each fiscal quarter thereafter, and the maximum Consolidated Leverage Ratio of 3.85 to 1.00 remain in effect for the third fiscal quarter of 2010 and the period through and including March 30, 2011, after which the maximum Consolidated Leverage Ratio shall return to 2.75 to 1.00 for each fiscal quarter thereafter. At September 30, 2010 the Company’s Consolidated Debt Service Coverage Ratio was 2.00:1.00 and the Consolidated Leverage Ratio was 3.25:1.00; accordingly the Company was in compliance with the modified financial covenants.

     Under the terms of the Credit Agreement, as amended, L-1 Operating may incur, assume or guarantee unsecured subordinated indebtedness in an amount up to $200.0 million, provided that no default or event of default shall have occurred or would occur as a result of the incurrence of such subordinated debt and the borrower and its subsidiaries are in pro forma compliance, after giving effect to the incurrence of such subordinated debt, with each of the covenants in the Credit Agreement, including, without limitation, the financial covenants described above.

     Pursuant to the terms of the Credit Agreement, as amended, L-1 may incur, assume or guarantee any amount of unsecured subordinated indebtedness, provided, that no default or event of default shall have occurred or would occur as a result of the incurrence of such subordinated debt and the pro forma Consolidated Leverage Ratio (as defined in the Credit Agreement) of L-1 and its subsidiaries after giving effect to the incurrence of such subordinated debt shall be less than 4.75:1.00. The Credit Agreement limits the ability of L-1 to (i) pay dividends or other distributions or repurchase capital stock, (ii) create, incur, assume or suffer to exist any indebtedness, (iii) create, incur, assume or suffer to exist liens upon any of its property, assets or revenues, (iv) sell, transfer, license, lease or otherwise dispose of any property, (v) make or become legally obligated to make capital expenditures above certain thresholds, subject to certain permitted adjustments, (vi) make investments, including acquisitions, and (vii) enter into transactions with affiliates. These covenants are subject to a number of exceptions and qualifications. The Credit Agreement provides for customary events of default which include (subject in certain cases to grace and cure periods), among others: nonpayment, breach of covenants or other agreements in the Credit Agreement or the other Loan Documents (as defined in the Credit Agreement), payment defaults or acceleration of other indebtedness, failure to pay certain judgments, inability to pay debts as they become due and certain events of bankruptcy, insolvency or reorganization.

     If an event of default, including a change in control, occurs (as defined in the Credit Agreement), the Administrative Agent may, with the consent of the Required Lenders declare all outstanding indebtedness including accrued and unpaid interest under the Credit Agreement to be due and payable.

     In October 2008, the Company entered into an interest rate protection agreement to reduce its exposure to the variable interest rate payments on its term loan. The interest rate protection agreement has a notional amount of $62.5 million, and expires in November, 2011. Under the term of the agreement, the Company pays the counterparty a fixed rate of 4.1 percent and receives variable interest based on three-month LIBOR (subject to a floor of 3.0 percent). In May 2009, the Company entered into two additional interest rate protection agreements with notional amounts of $50.0 million each pursuant to which the Company pays a fixed rate of 1.4 percent and receives three month LIBOR. The counterparties to the agreements are highly rated financial institutions. In the unlikely event that the counterparties fail to meet the terms of the interest rate swap agreement, the Company’s exposure is limited to the interest rate differential on the notional amount at each quarterly settlement period over the life of the agreements. L-1 does not anticipate non-performance by the counterparties.

Convertible Senior Notes

     On May 17, 2007, the Company issued $175.0 million of Convertible Notes with a conversion feature which allows the Company the option to settle the debt either in shares of common stock or to settle the principal amount in cash and the conversion spread in cash or common stock. The proceeds of the Convertible Notes offering, net of deferred financing costs amounted to $168.7 million. The embedded conversion feature has not been deemed a derivative since the conversion feature is indexed to the Company’s stock and would be classified as equity.

     The Notes are governed by an indenture, dated May 17, 2007 (the “Indenture”), between the Company and The Bank of New York, as trustee. The Notes will be convertible only under certain circumstances, as described below. If, at the time of conversion, the daily volume-weighted average price per share for a 25 trading day period calculated in accordance with the Indenture (as defined in greater detail in the Indenture, “VWAP”) of the Company’s common stock is less than or equal to $32.00 per share, which is referred to as the base conversion price, the Notes will be convertible into 31.25 shares of common stock of the Company per $1,000 principal amount of the Notes, subject to adjustment upon the occurrence of certain events. If, at the time of conversion, the VWAP of the shares of common stock of the Company exceeds the base conversion price of $32.00 per share, the conversion rate will be determined pursuant to a formula resulting in holders’ receipt of up to an additional 14 shares of common stock per $1,000 principal amount of the Notes, subject to adjustment upon the occurrence of certain events and determined as set forth in the Indenture.

     The Notes are convertible until the close of business on the second business day immediately preceding May 15, 2027, in multiples of $1,000 in principal amount, at the option of the holder under the following circumstances: (1) during the five business-day period after any five consecutive trading day period (the “measurement period”) in which the trading price the Note, for each day of such measurement period was less than 98 percent of the product of the last reported sale price of shares of common stock of the Company and the applicable conversion rate for such trading day; (2) during any fiscal quarter, if the last reported sale price of shares of common stock of the Company for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130 percent of the base conversion price on the related trading day; (3) if the Company calls any or all of the Notes for redemption; and (4) upon the occurrence of specified corporate transactions described in the Indenture. Upon conversion, the Company has the right to deliver shares of common stock based upon the applicable conversion rate, or a combination of cash and shares of common stock, if any, based on a daily conversion value as described above calculated on a proportionate basis for each trading day of a 25 trading-day observation period. In the event of a fundamental change as specified in the Indenture, the Company will increase the conversion rate by a number of additional shares of common stock specified in the Indenture, or, in lieu thereof, the Company may in certain circumstances elect to adjust the conversion rate and related conversion obligation so that the Notes will become convertible into shares of the acquiring or surviving company. In connection with the Safran merger, the Company is required to deliver a conversion price notice no later than 35 days prior to the anticipated closing date. It is expected that the conversion price will be equal to the base conversion price. The Notes will not become convertible into shares of Safran in connection with the merger.

     The Notes bear interest at a rate of 3.75 percent per year payable semiannually in arrears in cash on May 15 and November 15 of each year. The Notes will mature on May 15, 2027, unless earlier converted, redeemed or repurchased. The Company may redeem the Notes at its option, in whole or in part, on or after May 20, 2012, subject to prior notice as provided in the Indenture. The redemption price during that period will be equal to the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest. The holders can require the Company to repurchase the Notes for cash on May 15, 2012, May 15, 2017 and May 15, 2020. The embedded redemption and repurchase provisions have not been separated from the host contracts and accounted for as derivatives because such embedded derivatives are deemed to be clearly and closely related to the host contract.

     The Convertible Notes are structurally subordinated to all liabilities of L-1 Operating. Under the term of the Credit Agreement, as defined above, L-1 Operating may not make any dividend payment to the Company except to permit the Company to make scheduled interest payments on the subordinated debt up to a maximum of $10.0 million per year, and certain tax liabilities. However, subject to certain prepayment requirements under the Credit Agreement, the Company may prepay, redeem or repurchase the Convertible Notes in amounts not in excess of proceeds from the issuance of additional equity securities of the Company.

     Upon consummation of any share exchange, consolidation or merger of L-1 pursuant to which its common stock will be converted into cash, securities or other property or any sale, lease or other transfer in one transaction or a series of transactions of all or substantially all of L-1’s and L-1’s subsidiaries’ assets, taken as a whole, to any person other than one of its subsidiaries, the holders of the Convertible Notes can convert the Notes or require the Company to repurchase all outstanding debt at a purchase price equal to 100 percent of the principal amount plus accrued and unpaid interest. It is expected that the holder of the Notes will exercise their rights to require the Company to purchase the Notes upon closing of the consummation of the merger of the Company with Safran.

7. EQUITY

Warrants

     In connection with the merger with Identix, the Company assumed Identix’ obligation under a warrant which was issued in exchange for the technology and intellectual property rights acquired by Identix. The warrant was issued with contingent future vesting rights to purchase up to 378,400 shares of common stock at $9.94 per share. The fair value of the warrant at the time of vesting will be recorded as additional cost of the acquisition of Identix. The warrant vests upon successful issuance of certain patents with the U.S. government related to the technology acquired. As of September 30, 2010, 141,900 warrants were vested of which 17,738 have been exercised, and 236,500 remain unvested. Subsequently, in October 2010, an additional 109,972 warrants were exercised. The warrants expire in 2014.

Pre-paid Forward Contract

     In connection with the issuance of the Convertible Notes on May 17, 2007, the Company entered into a contract with Bear Stearns (subsequently acquired by JP Morgan Chase & Co.) to purchase 3,490,400 shares of the Company’s common stock at a purchase price of $20.00 per share. Under the agreement, Bear Stearns is required to deliver the shares to the Company in April-May 2012. At closing of the Convertible Notes, the Company settled its obligation under the pre-paid forward contract to Bear Stearns for cash of $69.8 million. The fair value of the obligation (which is equal to the cash paid) has been accounted for as a repurchase of common stock and as a reduction of equity. Under terms of the contract, any dividend payment that Bear Stearns would otherwise be entitled to on the common stock during the term of the contract would be paid to the Company. The transaction is subject to early settlement or settlement with alternative consideration in the event of certain significant corporate transactions such as a change in control (which would include the consummation of the merger with Safran).

Issuance of Equity Securities

     On August 5, 2008, pursuant to the terms and conditions of (i) the Securities Purchase Agreement, by and between L-1 and Robert V. LaPenta (the “LaPenta Agreement”), (ii) the Securities Purchase Agreement (the “Iridian Agreement”), by and between L-1 and Iridian Asset Management LLC (“Iridian”) and (iii) the LRSR LLC Agreement (together with the LaPenta Agreement and Iridian Agreement, the “Investor Agreements”), L-1 issued an aggregate of 8,083,472 shares of L-1 common stock and 15,107 shares of Series A Convertible Preferred Stock (the “Series A Preferred Stock”) for aggregate proceeds to L-1 of $119.0 million, net of related issuance costs, which were used to fund a portion of L-1’s acquisition of Old Digimarc. In accordance with its terms, the Series A Preferred Stock was converted to 1,310,992 shares of common stock in 2009.

8. STOCK OPTIONS AND RESTRICTED STOCK AWARDS

The following table summarizes the stock option activity from January 1, 2010 through September 30, 2010:

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Stock				Exercise				Life				Intrinsic
		Options				Price				(Years)				Value
Outstanding at January 1, 2010			8,091,652			$	13.56
Granted			38,500				8.09
Exercised			(207,242	)			3.70
Canceled/expired/forfeited			(704,118	)			18.99
Outstanding at September 30, 2010			7,218,792			$	13.29				5.99			$	9,875,494
Vested or expected to vest at September 30, 2010			5,637,877			$	13.29				5.99			$	7,712,761
Exercisable at September 30, 2010			5,228,456			$	14.05				5.22			$	4,616,590

Under the terms of the merger agreement with Safran SA, all options and restricted stock will vest at closing of the sale. The aggregate unearned compensation cost of unvested options outstanding as of September 30, 2010, was $10.4 million and will be amortized over a weighted average period of 2.0 years. The total intrinsic value of options exercised during the three and nine months ended September 30, 2010 was $0.9 million and $1.3 million, respectively. The intrinsic value is calculated as the difference between the market value of the Company’s common stock and the exercise price of options.

For the nine month period ending September 30, 2010, the Company awarded 419,787 shares of restricted stock to officers, directors and employees and had total outstanding restricted stock awards of 1,531,189 as of September 30, 2010. The restricted stock vests over four years and the weighted average grant date fair value was $7.40 at September 30, 2010. At September 30, 2010, approximately 1,196,000 shares are expected to vest. Unearned compensation related to restricted stock that is expected to vest approximated $6.3 million at September 30, 2010. Options and restricted stock expected to vest are determined by applying the pre-vesting forfeiture rate assumptions to total outstanding options and restricted stock.

Stock-based compensation expense was $3.8 million and $11.2 million and $3.4 million and $9.7 million for the three and nine months ended September 30, 2010 and 2009, respectively, and includes compensation expense related to restricted stock, stock options, employee purchases under the stock purchase plan, and Company retirement plan contributions settled or to be settled in common stock. The Company did not capitalize any stock compensation costs during any of the periods presented. Approximately, $2.0 million and $6.8 million of stock-based compensation expense for the three and nine months ended September 30, 2010, respectively, and $2.0 million and $6.5 million for the three and nine months ended September 30, 2009, respectively, are included in discontinued operations. The following table presents stock-based compensation expense included in continuing operations (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Cost of Revenues		$	306			$	214			$	796			$	686
Research and Development			419				402				1,233				1,369
Sales and Marketing			564				595				1,375				1,553
General and Administrative			2,552				2,157				7,836				6,121
		$	3,841			$	3,368			$	11,240			$	9,729

9. LITIGATION

Putative Shareholder Class Action Litigation

     The Company has been named as a defendant in five putative shareholder class actions filed in the Superior Court of Connecticut, Judicial District of Stamford-Norwalk at Stamford, arising out of the proposed transactions with Safran and BAE pursuant to the Merger Agreement and BAE Purchase Agreement. The actions are captioned: Michael Palma v. Robert LaPenta et al., CV-10-6006781-S (Conn. Super. Ct.), Barry P. Kranz, Jr. v. L-1 Identity Solutions et al., CV-10-6006760-S (Conn. Super. Ct.), Michael Matteo v. L-1 Identity Solutions et al., CV-10-6006759-S (Conn. Super. Ct.), Dart Seasonal Products Retirement Plan v. L-1 Identity Solutions et al., CV-10-6006835-S (Conn. Super. Ct.), and George F. Chrisman v. Robert LaPenta et al., CV-10-6006886-S (Conn. Super. Ct.) (collectively, the “Shareholder Actions”).

     The plaintiffs in the Shareholder Actions generally allege the members of the L-1 Board of Directors and certain officers of the Company breached their fiduciary duties to shareholders by, among other things, allegedly failing to receive maximum value for their shares, failing to conduct an appropriate sale process and agreeing to certain terms in the proposed merger agreement with Safran that allegedly discourage competing offers from other potential bidders and/or benefit defendants. The Shareholder Actions generally allege that the Company aided and abetted these alleged breaches of fiduciary duty. Certain of the suits also allege claims against Safran, Merger Sub, BAE and BAE Systems, Inc. (the parent entity to BAE and the U.S. affiliate of BAE Systems plc) for aiding and abetting the foregoing alleged breaches of fiduciary duty. The Shareholder Actions generally seek preliminary and permanent relief, including, among other things, permission to proceed as a class action, declaratory relief declaring that defendants have breached their fiduciary duties, an injunction enjoining the transactions contemplated by the Merger Agreement and BAE Purchase Agreement, recessionary damages in the event that the Transactions are consummated, costs and attorneys’ and experts’ fees.

     The Company believes the lawsuits are without merit and intends to vigorously defend against them. As of the date of this Form 10-Q, the Company’s time to respond to the complaints has not yet expired.

Old Digimarc Litigation

     In connection with the Company’s August 2008 acquisition of Old Digimarc, which consisted of its Secure ID Business following the spin-off of its digital watermarking business, the Company assumed certain legal proceedings of Old Digimarc as described below.

     Beginning in May 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York naming approximately 300 companies, including Old Digimarc, certain officers and directors and certain underwriters of the companies’ initial public offerings as defendants. The complaints were subsequently consolidated into a single action, and a consolidated amended complaint was filed in April 2002. The amended complaint alleges, among other things, that the underwriters of Old Digimarc’s initial public offering violated securities laws by failing to disclose certain alleged compensation arrangements in Old Dig marc’s initial public offering registration statement and by engaging in manipulative practices to artificially inflate the price of Old Dig marc’s stock in the aftermarket subsequent to the initial public offering. Old Digimarc and certain of its officers and directors are named in the amended complaint pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative practices. The complaint sought unspecified damages. In July 2002, the claims against Old Digimarc under Section 10(b) were dismissed. In October 2002, the individual officer and director defendants were dismissed without prejudice pursuant to tolling agreements. Subsequent addenda to these tolling agreements extended the tolling period through August 27, 2010. In June 2004, a stipulation of partial settlement among the plaintiffs, the companies, and the officers and directors was submitted to the District Court. While the partial settlement was pending approval, the plaintiffs continued to litigate their claims against the underwriter defendants. The district court directed that the litigation proceed within a number of “focus cases” rather than in all of the 309 cases that have now been consolidated. Old Digimarc was not one of these focus cases. In October 2004, the district court certified the focus cases as class actions. The underwriter defendants appealed that ruling and, on December 5, 2006, the Court of Appeals for the Second Circuit reversed the district court’s class certification decision for the six focus cases. In light of the Second Circuit opinion, in June 2007, the district court entered an order terminating the settlement. On August 14, 2007, the plaintiffs filed their second consolidated amended class action complaints against the focus cases and on September 27, 2007, again moved for class certification. On November 12, 2007, certain of the defendants in the focus cases moved to dismiss the second consolidated amended class action complaints. The court issued an opinion and order on March 26, 2008, denying the motions to dismiss except as to Section 11 claims raised by those plaintiffs who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period. The class certification motion was withdrawn without prejudice on October 10, 2008. On April 2, 2009, a stipulation and agreement of settlement among the plaintiffs, issuer defendants (including Old Digimarc) and underwriter defendants was submitted to the Court for preliminary approval. Old Digimarc’s portion of the settlement, which is wholly immaterial, is covered entirely by insurance.

     On June 10, 2009, the Judge granted preliminary approval of the settlement, and on October 5, 2009, the Judge granted final approval of the settlement. On August 26, 2010, based on the expiration of the tolling period stated in the tolling agreements with the individual officers and directors, the plaintiffs filed a Notice of Termination of Tolling Agreement and Recommencement of Litigation against the named officers and directors. The plaintiffs stated to the Court that they do not intend to take any further action against the named officers and directors at this time. Notices of appeal of the opinion granting final approval were filed by six groups of appellants. In October 2010, four of the groups of appellants withdrew their appeals with prejudice. Briefing on the remaining two appeals is ongoing.

     On October 10, 2007, an Old Digimarc shareholder filed a lawsuit in the United States District Court for the Western District of Washington against several companies that acted as lead underwriters for the Old Digimarc initial public offering. The complaint, which also named Old Digimarc as a nominal defendant but did not assert any claims against Old Digimarc, asserted claims against the underwriters under Section 16(b) of the Securities Exchange Act of 1934. On February 28, 2008, an amended complaint was filed, with Old Digimarc still named only as a nominal defendant.

Similar complaints have been filed by this same plaintiff against a number of other issuers in connection with their initial public offerings, and the factual allegations are closely related to the allegations in the litigation pending in the United States District Court for the Southern District of New York which is described above. On March 12, 2009, after considering motions to dismiss, one filed by thirty moving issuers and the other filed by the underwriters, the judge dismissed the plaintiff’s claims on a jurisdictional and statute of limitations basis. On April 10, 2009, the plaintiff filed a notice of appeal of the dismissal. The final appellate brief was filed on November 17, 2009; and oral argument was heard by the Ninth Circuit Court of Appeals on October 5, 2010. The Company currently believes that the outcome of this litigation will not have a material adverse impact on its condensed consolidated financial position and results of operations.

Patent Litigation

     On May 12, 2010, the Company was served with a complaint in the U.S. District Court, District of Delaware, alleging patent infringement of US Patent No. 5,913,542 regarding the making, using, offering for sale and selling of ID cards, including drivers’ licenses. On August 19, 2010, the Company filed an amended answer to the complaint, which contained counterclaims for declaratory judgment against the plaintiff. Based on the preliminary nature of the proceedings, it is not possible at this stage to quantify the potential damages, exposure or liability to L-1, if any.

Other

     The Company records a liability for any claim, demand, litigation and other contingency when management believes that it is both probable that a liability has been incurred and can reasonably estimate the amount of the potential loss. Based on current information and belief, the Company believes it has adequate provisions for any such matters. The Company reviews these provisions quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. However, because of the inherent uncertainties of litigation the ultimate outcome of certain litigation cannot be accurately predicted by the Company; it is therefore possible that the consolidated financial position, results of operations or cash flows of the Company could be materially adversely affected in any particular period by the unfavorable resolution of one or more of these matters and contingencies.

10. INCOME TAXES

For the nine months ended September 30, 2010 and 2009 the tax benefit from continuing operations was $4.1 million and a provision of $0.2 million, respectively and the pre-tax loss was $19.0 million and $0.8 million, respectively. The tax benefit from discontinued operations for the nine months ended September 30, 2010 and 2009 was $2.2 million and $1.6 million, respectively. The tax benefit was allocated between continued and discontinued operations by first calculating the provision on a consolidated basis including discontinuing operations and then calculating the provision excluding the discontinued operations. The difference between the two calculations was then allocated to discontinued operations.

The tax benefit is based on an estimated annual effective tax rate applied to the cumulative year to date results for both periods. Separate annual effective tax rates were used for entities that file returns on a separate company basis and expect to report losses for the full year, which have an estimated annual effective tax rate of 0%. The remaining entities included in the condensed consolidated financial statements have estimated annual effective tax rates of 34% and 39% for the nine months ended September 30, 2010 and 2009. The provision for the nine months ended September 30, 2010 also reflects the impact of the discrete items, (including certain transactions costs associated with the sale of the Company), which are not deductible for federal income tax purposes.

In connection with the sale of the Intel Business, the Company expects to recognize a significant gain for financial and tax reporting purposes, which is estimated to result in a current tax liability of approximately $20.0 million. The tax effects of the sale will be reflected as discrete items in the period during which the sale is consummated.

11. SEGMENT REPORTING, GEOGRAPHICAL INFORMATION AND CONCENTRATIONS OF RISK

The Company’s operating segments have been aggregated in two reportable segments: Solutions and Services. The Solutions reportable segment provides solutions that enable governments, law enforcement agencies, and businesses to enhance security, reduce identity theft, and protect personal privacy utilizing secure credential provisioning and authentication systems, biometric technology and the creation, enhancement and/or utilization of identity databases.

The Services reportable segment provides finger-print based background checks enrollment services to government, civil, and commercial customers. The following segment information has been retroactively adjusted to reflect the SpecTal/McClendon and Advanced Concepts operating segments as discontinued operations effective September 19, 2010. The Company measures segment performance primarily based on revenues and operating income (loss) and Adjusted EBITDA. Operating results by segment, including allocation of corporate expenses, for the three and nine months ended September 30, 2010 and 2009 are as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Solutions:
Revenues		$	89,573			$	88,476			$	234,665			$	245,610
Operating Income (Loss)			(2,238	)			7,768				(3,015	)			8,607
Depreciation and Amortization Expense			9,142				7,274				25,310				22,043
Services:
Revenues			31,439				30,757				88,944				84,526
Operating Income (Loss)			(1,625	)			537				(3,034	)			1,522
Depreciation and Amortization Expense			971				708				2,856				1,904
Consolidated:
Revenues		$	121,012			$	119,233			$	323,609			$	330,136
Operating Income (Loss)			(3,863	)			8,305				(6,049	)			10,129
Depreciation and Amortization Expense			10,113				7,982				28,166				23,947