S-1 1 ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on August 3, 2007

Registration No. 333-            

 


SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


FORM S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933

 


ICx Technologies, Inc.

(Exact name of Registrant as specified in its charter)

 


 

Delaware   3826   77-0619113

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

1350 I Street, NW

Suite 670

Washington, DC 20005

(202) 536-5699

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 


Daniel T. Mongan

Vice President, General Counsel and Secretary

ICx Technologies, Inc.

1350 I Street, NW

Suite 670

Washington, DC 20005

(202) 536-5699

Fax (202) 659-5690

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:

 

Michael J. Danaher, Esq.

Wilson Sonsini Goodrich & Rosati

Professional Corporation

650 Page Mill Road

Palo Alto, CA 94304

(650) 493-9300

Fax (650) 493-6811

 

Kirk A. Davenport II, Esq.

Latham & Watkins LLP

885 Third Avenue

New York, NY 10022

(212) 906-1200

 


Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

CALCULATION OF REGISTRATION FEE

 


Title of each class of securities to be registered   Proposed maximum aggregate
offering price(1)
  Amount of
registration fee

Common Stock, $0.001 par value per share

  $ 184,000,000   $ 5,650

 

(1) Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended. Includes shares that may be purchased by the underwriters to cover over-allotments, if any.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a) may determine.

 



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The information contained in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

PROSPECTUS

Subject to completion, dated August 3, 2007

            Shares

LOGO

ICx Technologies, Inc.

 


We are offering              shares of our common stock in this initial public offering. No public market currently exists for our common stock.

We intend to apply to have our common stock listed for trading on The NASDAQ Global Market under the symbol “ICXT.” We anticipate that the initial public offering price will be between $             and $             per share.

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 11.

 

     Per share    Total
Initial public offering price    $                 $             
Underwriting discounts and commissions    $                 $             
Proceeds to ICx (before expenses)    $                 $             
     

We have granted the underwriters a 30-day option to purchase up to an additional              shares on the same terms and conditions as set forth above if the underwriters sell more than              shares of common stock in this offering.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Lehman Brothers, on behalf of the underwriters, expects to deliver the shares on or about                     , 2007.

 


LEHMAN BROTHERS

 

GOLDMAN, SACHS & CO.

JPMORGAN

 

MORGAN KEEGAN & COMPANY, INC.

NEEDHAM & COMPANY, LLC

                    , 2007


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   11

Special Note Regarding Forward-Looking Statements

   25

Use of Proceeds

   26

Dividend Policy

   26

Capitalization

   27

Dilution

   28

Selected Consolidated Financial Data

   30

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32

Business

   65

Management

   86
     Page

Compensation Discussion and Analysis

   94

Certain Relationships and Related Party Transactions

   109

Principal Stockholders

   112

Description Of Capital Stock

   114

Shares Eligible for Future Sale

   116

Material U.S. Federal Tax Considerations For Non-U.S. Holders Of Common Stock

   118

Underwriting

   121

Legal Matters

   126

Experts

   126

Where You Can Find Additional Information

   128

Index to Financial Statements

   F-1

 


ABOUT THIS PROSPECTUS

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by or on behalf of us or any information to which we have referred you. We have not, and the underwriters have not, authorized anyone to provide you with different information. We are not making an offer to sell or seeking an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus and any free writing prospectus is accurate as of their respective dates only. Our business, financial condition, results of operations and prospects may have changed since that date.

We use the marks AirSentinel®, bagSPEC™, barrelSPEC™, BioCapture®, BioBadge™, CAD-Kit™, Callisto™, Cameleon™, cdsSPEC™, Cerberus™, DefendIR™, dsciSPEC™, Fido®, Griffin™, ICx™, IdentiFINDER™, IdentifIR™, Illuminator™, Interceptor™, MarkIR™, MDAS™, Oasys™, Orion™, PaxPointTM, PulsIR, SAFgate™, SensiQ™, SensorChip™, SentiSPEC™, SkyWatch™, SmartGate™, Spreeta™, StarWatch™, STS™, VisionIR™, VisionSense™ and webMATE™ and the ICx logo in connection with the sale or license of our products and technology. We have registered or applied for registration of selected marks and the ICx logo in the United States and other countries around the world. This prospectus also refers to the products or services of other companies by the trademarks and trade names used and owned by those companies.

Until                     , 2007 (25 days after the commencement of this offering) all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. Although we believe this summary is materially complete, you should read this entire prospectus carefully, including the matters set forth under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements and the notes thereto and the financial statements and notes thereto for each our subsidiaries appearing elsewhere in this prospectus, before making an investment decision. Unless the context requires otherwise, references in this prospectus to “ICx,” “we,” “us,” and “our” refer to ICx Technologies, Inc. and its subsidiaries on a consolidated basis.

ICx Technologies, Inc.

Overview

We are a leading developer, manufacturer, marketer and integrator of advanced sensing technologies, products and solutions. Our first and for now principal market is homeland security. Our high precision, proprietary technologies provide a strong foundation upon which we have built a comprehensive line of products that detect, identify and prevent a broad range of critical security threats. Through our proven ability to develop and convert next generation technologies into unique, commercially successful products, we are able to offer a wide range of high quality, compact detection and surveillance products that we believe are more sensitive, more accurate and more cost-effective than conventional products. Our business is organized into three divisions—Detection, Surveillance and Solutions—through which we develop, manufacture and market complete solutions that proactively address some of the most sophisticated and severe security threats facing the world today.

We believe our ability to understand the nature of sophisticated security threats, the technological potential of security solutions and the complex procurement processes of both government and private sector customers differentiates us from other companies in the market. We have developed what we believe is the most comprehensive line of products and integration capabilities for the homeland security market available through a single company. Our revenue grew 187% from 2005 to 2006, primarily as a result of acquisitions in 2005, and grew 38% in the first three months of 2007 as compared to the same period in 2006.

We have achieved and intend to expand our leadership position in the homeland security market by developing innovative technologies. More than half of our approximately 750 employees are highly skilled technologists. From the beginning of 2004 through March 31, 2007, we and the companies we have acquired have invested approximately $37 million of internal funds in research and development and in addition have received approximately $109 million under contracts to conduct research and development for programs we believe will advance our technology and products and strengthen our leadership position in the homeland security market. Through these directed resources, we believe we have developed best-in-class technology and products. For example, our explosives detection systems use amplifying fluorescence polymer technology to detect trace levels of explosives with a level of precision that is in excess of 1,000 times more sensitive than currently deployed systems. We believe we have developed the most stable and accurate gamma and neutron radiation detection systems available in the market today with immediate isotope identification that allows our systems to differentiate between benign and potentially threatening radiation sources. We also have developed new approaches to identify and amplify DNA fragments for more precise and reliable identification of biological agents.

Building on our technological expertise, we have successfully commercialized and marketed a portfolio of products and solutions that we believe are more sensitive, accurate, compact and affordable than those of our competitors. For example, we build the most sensitive portable explosive detector, the smallest spectroscopic radiation detector and the most accurate mobile solutions for perimeter surveillance available in the market

 

 

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today. We will continue converting our innovative technology pipeline into new growth platforms, enabling us to pursue new market opportunities.

We sell our products and services both directly through a global sales force and indirectly through leading industry participants with whom we have developed strategic alliances and partnerships. Due to the breadth and diverse nature of our product offerings and technology portfolio, as well as our ability to deliver solutions for a comprehensive range of critical security applications, the future success of our business is not dependent upon a single product, technology, customer or government program.

Our direct customers include federal agencies, such as the U.S. Department of Homeland Security, U.S. Customs & Border Protection (Border Patrol) and the Transportation Security Administration, as well as various state and local governments and agencies, including the New York Police Department and the Port of Long Beach. We also sell our products, components and sub-systems to leading integrators in the security and defense industries who either resell our products or integrate them into comprehensive security installations for their end customers. The value-added-resellers and system integrators that we sell products to include The Boeing Company, Honeywell International, Inc., Northrop Grumman Corp., Raytheon Company, SAIC, Inc. and Thermo Fisher Scientific Inc. We sell to military customers such as the U.S. Department of Defense (DoD), the U.S. Air Force, the U.S. Marines and the U.S. Army. Additionally, we are expanding our addressable markets by selling to private sector customers such as Federal Express Corporation, The Walt Disney Company and two international airports serving the city of Houston, Texas and surrounding communities.

Industry Overview

The proliferation of global security threats has reached unprecedented levels. These threats not only jeopardize innocent lives, but also have the potential to inflict severe damage upon the global economy. Both the government and private sectors are preparing to address increasingly sophisticated types of terrorist attacks, including chemical, biological, radiological, nuclear and explosive threats, as well as other major security risks and natural disasters. As a result, the homeland security market has grown from approximately $33 billion in 2004 to approximately $55 billion in 2006, and is expected to grow 21% annually to $140 billion by 2011. Because of the importance of security to the global economy, we believe the homeland security market is less exposed to economic downturns and will continue to grow rapidly over the next decade.

The U.S. military is facing challenges adapting to a new style of asymmetric warfare that requires tactics similar to those used in the homeland security market. An increasingly large amount of the DoD budget is expected to shift in fiscal year 2007 toward advanced technologies that better equip U.S. military forces to face such threats. We have identified $20 billion in the $450 billion fiscal year 2007 DoD budget that is associated with the types of programs we can address. We expect such spending to increase in future years as the full extent of the new threats become more apparent and the DoD works through the aftermath of the current conflicts.

The demand for new security products and technologies also extends to the $145 billion private sector, a rapidly growing market in which many large commercial organizations have made detection, access control and advanced video surveillance a focal point for their security initiatives. Private sector organizations are expected to spend approximately $30 billion on these technologies in 2007.

In addition, we believe our technologies will have utility in a wide range of applications outside the homeland security and military markets. Historically, advanced technologies developed for security and military applications have later been found to have applications in other commercial markets, such as biological research and energy, and have led to the creation of entirely new markets. We believe our technologies may in the future be used in products and solutions for markets that surpass the size of the markets we currently serve.

 

 

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Market Opportunity

Conventional security products typically are not portable, are either not sensitive enough or generate too many false positives, are difficult to network, or are too expensive for many users to buy and operate. In addition, due to the fragmented nature of the market, many market participants have either focused on manufacturing specific products or acted as integrators who network the products of other companies without having a detailed understanding of the capabilities of these products. As a result, customers are demanding single-source providers in order to allow them to streamline their procurement processes and isolate accountability with fewer vendors.

We provide an expansive portfolio of technology products and solutions that address many of the specific demands of our customers. Our products not only address the shortcomings of conventional products, but also interact in a manner that facilitates the interchange of critical security information. We believe that our ability to network advanced sensors into highly effective, integrated solutions will enable us to capture market share and deliver our customers high-value solutions that warrant premium pricing. We believe our ability to understand the nature of sophisticated security threats, the technological potential of security solutions and the complex procurement processes of both government and private sector customers differentiates us from other companies in the market. By leveraging our unique technical expertise, we develop, produce and market what we believe are the most advanced sensor and surveillance products available in the homeland security market today. We believe we will be able to apply our technological expertise in security to develop new products in non-security markets.

Our Competitive Strengths

We develop, manufacture, market and integrate products and solutions that detect, identify and prevent a broad range of critical security threats. We believe the following competitive strengths will continue to enhance our leadership position in the homeland security market and the broader security industry.

Leading proprietary technologies.    We are a leading innovator developing high precision, proprietary security technologies that are more accurate, compact and less susceptible to false positives than most conventional technologies. More than half of our approximately 750 employees are highly skilled technologists. From the beginning of 2004 through March 31, 2007, we and companies we have acquired have invested approximately $37 million in research and development and have received approximately $109 million under contracts to conduct research and development for programs we believe will advance our technology and products and strengthen our leadership position in the homeland security market. Our emphasis on innovation has resulted in over 50 issued patents, over 25 pending patents and over 40 licensed patents and patent applications. We also have strong connections with leading research laboratories and universities which foster innovation and advance our technology leadership.

Proven ability to develop, market and commercialize products.    We have been successful in utilizing our advanced technologies to develop commercially viable products and solutions. We have received and expect to continue to receive substantial government funding to carry out our research and product development. Since 2005, we have quadrupled the size of our product line through acquisitions and individual development from 10 to 40 products. We also understand and are able to successfully navigate the complex security procurement processes of our customers. The growth in sales of our products demonstrates our commercial success.

Broad and diversified product portfolio.    Leveraging our unique technical expertise, we develop, produce and market what we believe are the most advanced products and solutions that detect, identify and prevent a broad range of critical security threats. We believe that our solutions are more sensitive, accurate, compact and affordable than those of our competitors. Due to our diverse product portfolio and our ability to provide solutions for a wide range of critical security applications, the future success of our business is not dependent on a single product, technology, customer or government program.

 

 

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Ability to deliver comprehensive integrated solutions to key customers.    Our ability to integrate our technology and products into comprehensive, reliable and affordable solutions provides our customers a single source to help address a broad range of critical security threats. We have developed our products in a manner that facilitates interoperability and functional efficiency and also accommodates third-party hardware and software. Our ability to understand the nature of complex security threats, our breadth of product offerings and broad integration capabilities allows us to deliver and implement effective solutions to meet our customers’ needs.

Experienced management team.    Our management team and advisory board has a mix of government and private sector experience across different geographies, industries and functions. Our team promotes entrepreneurial creativity and emphasizes the importance of attracting, developing and retaining the most highly-qualified personnel in our industry. Since our inception, our management team has acquired and integrated 15 diverse companies that have enhanced our capabilities and technology leadership.

Our Growth Strategy

Our objective is to strengthen our position as a leading provider of technologies, products and solutions that detect, identify and prevent a broad range of critical security threats for the homeland security and military markets and to expand on that leadership position by developing products for other markets. As part of our growth strategy, we seek to:

Strengthen our technological leadership.    We intend to continue to develop and acquire next generation technologies to strengthen our technological leadership position. We will continue to work closely with our customers and partners and will seek further government development funding. We will also invest a substantial amount of our own funds in research and development to further enhance our technology leadership position.

Enhance and extend our product line.    We plan to introduce new models of our current products with enhancements to the capabilities of those products in order to address our customers’ evolving needs. We will continue converting our innovative technologies in our research and development pipeline into new products and platforms to pursue new market opportunities.

Provide integrated solutions.    We intend to continue to provide integrated, single-source solutions that prevent a broad range of critical security threats. We believe that significant opportunities exist for companies that understand the nature of complex security threats and meet customers’ needs by developing and delivering effective solutions that respond to those threats and make it easier to capture data from advanced, multifunctional products through integrated networked command platforms.

Scale our distribution channels.    We intend to continue to build and strengthen our direct sales force and expand our indirect channels to extend our geographic reach and market penetration. We have hired key personnel from companies such as FLIR Systems Inc., General Electric Company, Johnson Controls, Inc., Smiths Detection and Thermo Fisher Scientific Inc., as well as from government agencies including the DoD, the U.S. Air Force and the Executive Office of the White House. In addition, in 2007, we significantly expanded our network of sales representatives to market our products to private sector customers and state and local governments and agencies.

Expand into non-security markets.    While in the near-term we intend to continue to focus primarily on products and solutions for the homeland security and military markets, we have developed technologies that are being used in non-security applications, such as chemical sensors for pesticide detection and thermal cameras used to inspect brakes on commercial trucks. We believe our technologies have utility in a wide variety of non-security applications and we intend to continue to explore applications for our technologies in markets that are not related to security. We believe this will allow us to leverage our existing intellectual property and infrastructure to expand our addressable markets and further accelerate our growth.

 

 

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Grow through complementary acquisitions.    We aim to grow our business, relationships and product offerings by acquiring select companies and assets that enhance our technology leadership, broaden our product offerings or expand our customer relationships. We maintain a highly disciplined approach in our pursuit of acquisitions and their integration, including a rigorous assessment of technological strengths, growth prospects, synergy potential, management strengths and the intrinsic value of potential targets. Since our inception, we have acquired and integrated 15 companies.

Summary Risks

There are numerous risks and uncertainties that may affect our financial and operating performance and our growth. You should carefully consider all of the risks discussed in “Risk Factors,” which begins on page 11, before investing in our common stock. These risks include the following:

 

   

our limited operating history, the nature of our business and the development of the markets we serve;

 

   

our reliance on sales to the U.S. government that could be affected by changes in federal funding levels;

 

   

our reliance on sales to prime contractors, systems integrators and original equipment manufacturers;

 

   

the highly competitive nature of the homeland security market, and the adverse consequences if we are unable to compete effectively;

 

   

risks related to our ability to innovate successfully and quickly; and

 

   

operational risks that cannot be adequately covered by insurance or indemnity.

Corporate Information

We were incorporated in Delaware in 2003. Our principal executive offices are located at 1350 I Street, NW, Suite 670, Washington, DC 20005 and our telephone number is (202) 536-5699. Our website is located at www.icxt.com. Information on our website should not be considered part of this prospectus.

 

 

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The Offering

 

Common stock offered by us

            shares

 

Common stock to be outstanding after the offering

            shares

 

Use of proceeds

We will receive net proceeds from this offering of approximately $            million, based on an initial public offering price of $            per share, the midpoint of the range set forth on the cover of this prospectus, which we will use for general corporate purposes, including working capital, the expansion of our sales and marketing organizations, acceleration of our research and development efforts, the expansion of our manufacturing capabilities, purchases of capital equipment and potential acquisitions of businesses, products and technologies that we believe are complementary to our business. We have no definitive agreements with respect to future acquisitions and have no commitments with respect to the net proceeds of this offering. See “Use of Proceeds.”

 

Proposed NASDAQ Global Market symbol

“ICXT”

The number of shares of common stock to be outstanding after this offering is based on shares of common stock outstanding as of March 31, 2007, and includes            shares that we will issue upon conversion to common stock of all of our outstanding shares of preferred stock, effective immediately prior to completion of this offering. The number of shares of common stock to be outstanding after this offering excludes the following shares:

 

   

            shares issuable upon exercise of stock options outstanding as of March 31, 2007, which have a weighted average exercise price of $            per share;

 

   

            shares of unvested restricted stock awards and restricted stock units as of March 31, 2007; and

 

   

            additional shares reserved as of March 31, 2007, for future issuance under our stock-based compensation plans.

Unless otherwise stated, all information contained in this prospectus:

 

   

gives effect to a                 -for-                 stock split with respect to our common stock, effected on                    , 2007;

 

   

gives effect to the conversion into common stock of all of our outstanding preferred stock;

 

   

gives effect to amendments to our certificate of incorporation and bylaws that will become effective upon completion of this offering;

 

   

assumes no exercise of the option to purchase                     additional shares of common stock granted to the underwriters; and

 

   

assumes an initial public offering price of $             per share, the mid-point of the price range set forth on the cover page of this prospectus.

 

 

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Summary Consolidated Financial Information

The following tables summarize the financial data of our business. You should read this information along with our discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and accompanying notes included elsewhere in this prospectus. The summary consolidated statement of operations data for each of the three years in the period ended December 31, 2006 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary consolidated statement of operations data for the three months ended March 31, 2007 and 2006, and the actual summary consolidated balance sheet data as of March 31, 2007, have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. Our unaudited summary consolidated financial data as of March 31, 2007 and for the three months ended March 31, 2007 and 2006 have been prepared on the same basis as the annual consolidated financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of this data in all material respects. We have completed a number of acquisitions over the last three fiscal years, each of which was accounted for as a purchase transaction, which may affect year-over-year comparisons of our consolidated summary financial data. For a more detailed description of such acquisitions, see note 4, “Business Combinations and Related Intangibles,” in the notes to our consolidated financial statements contained elsewhere in this prospectus. Accordingly, in addition to our actual financial information, we have also included pro forma operating results for 2006 and 2005, prepared as if our 2005 business acquisitions had been consummated as of the beginning of 2004. The pro forma financial information is for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the businesses been acquired at that time, nor are they intended to be a projection of future results.

 

 

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     Three Months Ended
March 31,
    Year Ended
December 31,
 
     2007     2006     2006     2005     2004  
     (in thousands, except per share data)  
     (unaudited)                    

Consolidated Statement of Operations Data:

          

Products

          

Revenue

   $ 16,397     $ 12,505     $ 59,341     $ 20,439     $ 929  

Cost of revenue

     8,833       6,799       31,329       11,203       1,086  

Gross profit

     7,564       5,706       28,012       9,236       (157 )

Contract research and development and services

          

Revenue

     7,777       6,115       25,694       10,436       2,128  

Cost of revenue

     5,202       4,084       15,840       6,135       1,276  

Gross profit

     2,575       2,031       9,854       4,301       852  

Maintenance, service and other

          

Revenue

     2,786       911       5,125       525       —    

Cost of revenue

     1,467       516       2,843       253       —    

Gross profit

     1,319       395       2,282       272       —    

Operating expenses:

          

Research and development

     4,622       3,455       14,501       7,257       1,969  

Selling, general and administrative

     13,572       11,200       55,424       14,789       2,171  

Goodwill impairment loss

     —         —         66,043       —         —    

Depreciation and amortization

     3,469       4,683       17,236       5,289       825  

Loss in equity method investees

     —         —         —         839       487  

Total operating expenses

     21,663       19,338       153,204       28,174       5,452  

Loss from operations

     (10,205 )     (11,206 )     (113,056 )     (14,365 )     (4,757 )

Interest income

     61       116       371       126       21  

Interest expense

     (90 )     (99 )     (372 )     (145 )     (1 )

Other, net

     76       176       1,039       541       1,074  

Loss before income taxes

     (10,158 )     (11,013 )     (112,018 )     (13,843 )     (3,663 )

Provision for (benefit from) income taxes

     75       (70 )     (296 )     (1,943 )     —    

Net loss from continuing operations

     (10,233 )     (10,943 )     (111,722 )     (11,900 )     (3,663 )

Discontinued operations, net(1)

     780       (1,922 )     (15,766 )     (2,852 )     (1,386 )

Net loss

     (9,453 )     (12,865 )     (127,488 )     (14,752 )     (5,049 )

Accretion on redeemable convertible preferred stock

     2,461       2,283       9,480       5,562       —    

Net income attributable to common stockholders

   $ (11,914 )   $ (15,148 )   $ (136,968 )   $ (20,314 )   $ (5,049 )

Basic and diluted earnings per share attributable to common stockholders

   $       $       $       $      

Basic and diluted weighted average shares outstanding

          

(1) In August 2006, we realized a $3.1 million gain on the sale of substantially all of the assets of a non-strategic operation owned by Nomadics, Inc. that was acquired in August 2005. In December 2006, we adopted a plan for the sale of three companies that did not align with our overall strategic plans. In February, March and April 2007, we sold Nuvonyx Europe, Harbinger Technologies Group, Inc. and Nuvonyx, Inc., respectively, pursuant to this plan. Loss from discontinued operations was $18.9 million in 2006, which includes a $13.1 million impairment loss to write-down the carrying amounts of two of the discontinued companies to their estimated fair values less costs associated with the sale of the companies.

 

 

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     As of March 31,    As of December 31,
     2007     2006    2006     2005    2004
     (in thousands, except per share data)
     (unaudited)                

Consolidated Balance Sheet Data:

            

Cash and cash equivalents

   $ 14,314     $ 11,679    $ 7,236     $ 23,354    $ 1,493

Working capital

     32,913       21,575      27,312       24,072      1,100

Total assets

     174,177       254,856      184,248       267,469      17,377

Long-term debt

     396       947      449       508      —  

Redeemable convertible preferred stock

     204,400       157,214      197,732       151,831      —  

Stockholders’ equity (deficit)

   $ (63,045 )   $ 64,849    $ (51,507 )   $ 77,811    $ 11,758

 

 

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We have completed a number of acquisitions over the last three fiscal years, each of which was accounted for as a purchase transaction, which may affect year-over-year comparisons of our consolidated summary financial data. Accordingly, in addition to our actual financial information, we have also included pro forma operating results for 2005 and 2004, prepared as if our 2005 business acquisitions had been consummated as of the beginning of 2004. The pro forma financial information is for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the businesses been acquired at that time, nor are they intended to be indicative of future results. For a more detailed description of such acquisitions, see note 4, “Business Combinations and Related Intangibles”, in the notes of our consolidated financial statements contained elsewhere in this prospectus.

 

     Year Ended December 31,  
     2006     2005     2004  
     (in thousands, except per share data)  
     (actual)     (pro forma)  
           (unaudited)  

Consolidated Statement of Operations Data:

      

Products

      

Revenue

   $ 59,341     $ 46,528     $ 45,681  

Cost of revenue

     31,329       24,810       28,608  

Gross profit

     28,012       21,718       17,073  

Contract research and development and services

      

Revenue

     25,694       28,961       46,224  

Cost of revenue

     15,840       20,144       30,897  

Gross profit

     9,854       8,817       15,327  

Maintenance, service and other

      

Revenue

     5,125       2,438       2,013  

Cost of revenue

     2,843       1,310       825  

Gross profit

     2,282       1,128       1,188  

Operating expenses:

      

Research and development

     14,501       9,119       8,548  

Selling, general and administrative

     55,424       34,142       25,113  

Goodwill impairment loss

     66,043       —         —    

Depreciation and amortization

     17,236       14,425       18,626  

Total operating expenses

     153,204       57,686       52,287  

Loss from operations

     (113,056 )     (26,024 )     (18,699 )

Interest income

     371       157       47  

Interest expense

     (372 )     (1,174 )     (1,023 )

Other, net

     1,039       766       (32 )

Loss before income taxes

     (112,018 )     (26,275 )     (19,708 )

Provision for (benefit from) income taxes

     (296 )     (1,943 )     1,384  

Net loss from continuing operations

     (111,722 )     (24,332 )     (21,092 )

Discontinued operations, net(1)

     (15,766 )     (4,824 )     (6,524 )

Net loss

     (127,488 )     (29,156 )     (27,616 )

Accretion on redeemable convertible preferred stock

     9,480       5,562       —    

Net income attributable to common stockholders

   $ (136,968 )   $ (34,718 )   $ (27,616 )

Basic and diluted earnings per share attributable to common stockholders

   $       $      

Basic and diluted weighted average shares outstanding

      

(1) In August 2006, we realized a $3.1 million gain on the sale of substantially all of the assets of a non-strategic operation owned by Nomadics, Inc. that was acquired in August 2005. In December 2006, we adopted a plan for the sale of three companies that did not align with our overall strategic plans. In February, March and April 2007, we sold Nuvonyx Europe, Harbinger Technologies Group, Inc. and Nuvonyx, Inc., respectively, pursuant to this plan. Loss from discontinued operations was $18.9 million in 2006, which includes a $13.1 million impairment loss to write-down the carrying amounts of two of the discontinued companies to their estimated fair values less costs associated with the sale of the companies.

 

 

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RISK FACTORS

Any investment in shares of our common stock involves a high degree of risk. You should consider carefully the following information about these risks, together with all of the other information contained in this prospectus, before making an investment in our common stock. If any of the following risks actually occur, our business, financial condition or results of operations could be adversely affected. Any adverse effect on our business, financial condition or results of operations could result in a decline in the trading price of our common stock and the loss of part or all of your investment.

Risks Related to Our Operations and Corporate Structure

Our future performance may be difficult to predict due to our limited operating history and the nature of our business.

Our limited operating history makes it difficult to predict our future performance. We were incorporated in 2003 and commenced operations as a holding company in 2004. However, most of our business is based on acquisitions that we have completed since June 2005. We have had a limited period of time to integrate and manage our business, which increases the possibility that we will encounter new or unexpected difficulties in our future operations or fail to achieve expected benefits from these acquisitions. We may also have difficulty forecasting our future results because our business is affected by fluctuations in demand for our products, including fluctuations caused by new security threats, new products introduced by our competitors and customer order cancellations. If we underestimate demand and build too little inventory, we could lose sales opportunities and disappoint customers. If we overestimate demand and build too much inventory, we could consume working capital unnecessarily and experience inventory write-offs.

Our business depends on the development of markets for detection and surveillance products and solutions.

Our products and services are designed to address the markets for detection, surveillance and integrated solutions. Our products and services are targeted to both governmental and the private sector. These markets and the types of products and services sold in these markets are emerging. Our ability to grow will depend in part on the rate at which markets for our products develop and on our ability to adapt to emerging demands in these markets. In particular, our business depends on our ability to offer a broader range of products and services to meet demand for integrated solutions. In addition, geopolitical developments, terrorist attacks and government mandates may cause sharp fluctuations in the demand for our products.

A substantial portion of our future sales will depend on the success of products that we have introduced recently. It is too early to predict how commercially successful these products may be. Some of them define new market categories with no historical record of demand and in which demand may develop slowly. Some of our new products are still undergoing trials, or have too short of a history of operation in the field to establish evidence that they meet long-term customer needs. This may slow the adoption of these products by security conscious customers that demand proof of long term reliability. Some of our products could encounter unanticipated problems in deployment and use, or when attempts are made to integrate them into existing systems and operations. Our ability to maintain or grow our revenues will be significantly limited if our new products fail to gain market acceptance.

A substantial portion of our revenues depends on sales to the U.S. government and could be affected by changes in federal funding levels.

Agencies and departments of the U.S. government account for a substantial portion of our revenues from product sales and substantially all of our revenues from research and development contracts. We are counting on significant revenues from U.S. government contracts for the foreseeable future. U.S. government programs are limited by budgetary constraints and are subject to uncertain future funding levels that could result in the

 

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termination of programs. A decline in security-related government spending, or a shift away from programs that we address, could hurt our sales, put pressure on our prices and reduce our revenues and margins.

We rely in part on original equipment manufacturers (OEMs), and distribution partners to sell some of our products, and we may be adversely affected if those parties do not actively promote our products or pursue installations that use our products.

A significant portion of our revenue comes from sales to partners, including OEMs, systems integrators, distributors and resellers. Some of these relationships have not been formalized in a detailed contract and may be subject to termination at any time. Even where these relationships are formalized in a detailed contract, the agreements can often be terminated with little or no notice and subject to periodic amendment. We cannot control the amount and timing of resources that our partners devote to activities on their behalf. We intend to continue to seek strategic relationships to distribute, license and sell certain of our products. However, we may not be able to negotiate acceptable relationships in the future and cannot predict whether current or future relationships will be successful.

A substantial portion of our revenues depends on sales to prime contractors and system integrators.

We rely on a substantial portion of our revenues on contracts in which we act as a subcontractor to other contractors, typically prime contractors and system integrators who sell directly to government agencies or private customers. For the fiscal years ended December 31, 2006 and 2005, and the three-month period ended March 31, 2007, we derived approximately 31%, 17% and 41%, respectively, of our revenues from these contracts. We expect to continue to depend on these relationships for a significant portion of our revenues in the foreseeable future. Our sales will suffer if these contractors and system integrators fail to compete successfully against their competitors, if government agencies cut relevant spending, or if these contractors and system integrators purchase products from our competitors, or develop competing products of their own, or reduce their purchases from us for other reasons. Our ability to sell to customers who prefer to work with large system integrators will depend on our ability to develop and maintain strong relationships with the large system integrators. Furthermore, when our existing subcontracts expire, our subcontracting revenues may decline because prime contractors and system integrators will no longer be able to fulfill targets for small-business purchases by buying products from us or our subsidiaries.

If we do not successfully expand our direct sales and service organizations and partnering arrangements, we may not be able to increase our sales or adequately support our customers.

We sell substantially all of our services and license substantially all of our products through our direct sales organization. Our future success depends on substantially increasing the size and scope of our direct sales force and partnering arrangements, both domestically and internationally. We will face intense competition for personnel and we cannot guarantee that we will be able to attract, assimilate or retain additional qualified sales personnel on a timely basis. Moreover, given the large-scale deployment required by some of our customers, we will need to hire and retain a number of highly-trained customer service and support personnel. We cannot guarantee that we will be able to increase the size of our customer service and support organization on a timely basis to provide the high quality of support required by our customers. Failure to add additional sales and customer service representatives could result in our inability to increase sales and support our customers.

The lengthy sales cycles of our products may cause our revenues to fluctuate substantially.

Customers evaluating our products must often make very difficult choices about product capabilities and costs. Many of our customers buy our products to implement or enhance large security projects. Our larger customers take longer to evaluate our products and place new orders. For these and other reasons, our products have long sales cycles. Sales are often delayed or cancelled for reasons that we cannot control. Delays and cancellations could significantly affect revenues reported for any given financial quarter.

 

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We compete against companies that have longer operating histories, more established products and greater resources.

We face substantial competition in the advanced security technology industry. Many companies are actively developing and marketing detection, surveillance and systems and software products that compete against our products, or may soon do so. Our competitors include very large and experienced enterprises, including BAE Systems, plc, Canberra Industries, Inc., DRS Technologies, Inc., FLIR Systems Inc., General Electric Company, Goodrich Corporation, Honeywell International, Inc., L-3 Communications Holdings, Inc., RAE Systems, Inc., SAIC, Inc., Smiths Industries, Ltd. and United Technologies Corporation. Our competitors also include many smaller companies, including companies established to pursue new and emerging technologies.

Our competitors may successfully develop technologies that outperform our technologies, respond better to customer requirements, cost less or otherwise gain greater market acceptance. Many of our competitors have longer operating histories, greater financial, engineering, manufacturing, sales and marketing resources, greater name recognition, a larger base of customers and longer standing customer relationships than we have. Our larger competitors may be able to better manage large or complex contracts, maintain a broader geographic presence, compete more effectively on price, or provide a greater level of customer support. Our smaller competitors typically focus on fewer products than we do, and they are often well entrenched in their chosen markets. Any of these competitors may be able to respond more quickly to new technology, market developments or pursue new sales opportunities more effectively that we can.

Our ability to compete depends on our ability to innovate successfully and quickly.

We may lose our competitive position if we fail to innovate and develop new products quickly. Advanced security technologies are evolving rapidly, product life cycles are short and technologies can become obsolete. Our ability to compete will depend on our ability to design, develop, manufacture, assemble, test, market, sell and support new products and enhancements quickly and cost effectively. Our business will depend on how well we respond to evolving government and industry standards, and changing customer requirements. The lack of standardization in our industry may impede market acceptance of innovative products that we successfully develop. If, for any of these or other reasons, any of our technologies fail to gain acceptance in the market, we will not recoup our development costs, and we will have to attempt to develop new technologies and products. We cannot assure that we can do so successfully, cost effectively or quickly enough.

Some of our customers and operations are located outside of the United States, which subjects us to additional international risks.

We conduct some of our business with and through companies located outside the United States. We have manufacturing facilities in several foreign countries including Germany and Canada. As a result of our international operations and sales, we face a number of challenges, including:

 

   

increased complexity and costs of managing and staffing international operations;

 

   

compliance with foreign technical standards;

 

   

compliance with domestic and foreign laws and regulations, including import and export control laws, tariffs and other barriers;

 

   

timing and availability of import and export licenses;

 

   

longer and more difficult collection of receivables;

 

   

limited protection of our intellectual property and limited ability to enforce legal rights and remedies;

 

   

unanticipated changes in foreign and domestic legal and regulatory requirements, including tax regulations; and

 

   

foreign currency exchange fluctuations relating to our international operating activities.

 

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Because we anticipate that we will continue to depend on companies operating in various countries around the world for a significant part of our revenues and growth, these risks and issues that we cannot anticipate could adversely affect our ability to conduct business outside of the United States and our results of operations.

Our business has inherent operational risks that cannot be adequately covered by insurance or indemnity, and our products and technologies may not qualify for protection under the SAFETY Act.

We may face unanticipated risks of legal liability for damages caused by the actual or alleged failure of technologies or services that we supply. Our products may be deployed in response to an emergency or terrorist attack, which may increase our exposure to third-party claims. Many of our technologies are unproven. We may face liabilities related to these products. While we have attempted to secure appropriate insurance coverage at appropriate cost, it is impossible to insure against all risks that inhere in our industry, nor can we assure you that our insurers will pay a particular claim, or that we will be able to maintain coverage at reasonable rates in the future. Substantial claims resulting from an accident in excess or not otherwise covered by indemnity or insurance could harm our financial condition and operating results. Our insurance policies also contain deductibles, limitations and exclusions which increase our costs in the event of a claim.

Under the “SAFETY Act” provisions of The Homeland Security Act of 2002, the federal government provides liability limitations and the “government contractor” defense applies if the Department of Homeland Security “designates” or “certifies” technologies or products as “qualified anti-terrorism technologies,” and if certain other conditions apply. We may seek to qualify some or all of our products and technologies under the SAFETY Act’s provisions in order to obtain such liability protections, but there is no guarantee that the U.S. Department of Homeland Security will designate or certify our products and technologies as a qualified anti-terrorism technology. Our Fido Portable Explosives Detector has been designated as a qualified anti-terrorism technology, but our other products have been sold without such qualification, and we may continue to sell our products and technologies without such qualification. To the extent we do so, we will not be entitled to the benefit of the SAFETY Act’s cap on tort liability or U.S. government indemnification. Any indemnification that the U.S. government may provide may not cover certain potential claims.

We have incurred operating losses since our inception and as a result we may not achieve or sustain profitability.

We have incurred significant operating losses since our inception. We had consolidated operating losses of approximately $14.8 million in 2005, $127.5 million in 2006 and $9.5 in the three months ended March 31, 2007. As of March 31, 2007, we had an accumulated deficit of $157.1 million. We expect to incur significant additional expenses for the expansion and integration of our businesses, including expenditures for sales, marketing and manufacturing. As a public company, we also expect to incur significant accounting, legal and other expenses that we did not incur as a private company. We also expect to incur additional expenses to expand our research and development programs, and in developing new products and services we may obtain through acquisitions. As a result, we may continue to incur losses for the foreseeable future.

Because of the numerous risks and uncertainties associated with our business, we are unable to predict when or if we will achieve profitability. If our revenues do not increase, or if our expenses increase at a greater rate than our revenues, we will not become profitable. Even if we do become profitable, we may not be able to sustain or increase our profitability on a quarterly or annual basis.

A number of other factors may cause our consolidated operating results to fluctuate on a quarterly or annual basis, which may make it difficult to predict our future operating results.

We expect our consolidated revenues and expenses to fluctuate, making it difficult to predict our future operating results. Factors that could cause our operating results to fluctuate include:

 

   

demand in the markets that we serve;

 

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our ability to define, design and release new products that meet customer needs, and to do so quickly and cost effectively;

 

   

market acceptance of new and enhanced versions of our products;

 

   

the forecasting, scheduling, rescheduling or cancellation of orders by our customers;

 

   

the timing, performance and pricing of new product introductions by our competitors;

 

   

variations in the performance of our businesses;

 

   

the timing and availability of adequate manufacturing capacity from our manufacturing suppliers;

 

   

our ability to forecast demand in the markets that we serve;

 

   

the mix of products that we sell;

 

   

the length of our sales cycles;

 

   

the lack of backlog of orders for our products;

 

   

liquidity and cash flow of our distributors and end-market customers;

 

   

the timing of our acquisitions;

 

   

general economic conditions in the countries where we operate or our products are used; and

 

   

changes in accounting principles or practices, exchange rates, interest rates, tax rates and tax withholding.

Any of the above factors, many of which are beyond our control, could significantly harm our business and results of operations. The results of a prior quarter or annual period should not be relied upon as an indicator of future operating performance.

We may have difficulty scaling production to large volumes. If we are unable to meet demand or efficiently increase production, customers may turn to products offered by competitors and our operating results could be harmed.

We could have substantial difficulty dealing with rapid growth. If demand for our products increases rapidly, we will need to expand internal production capacity or implement additional outsourcing. Success in developing, manufacturing and supporting products manufactured in small volumes does not guarantee comparable success in operations conducted on a larger scale. Modifying our facilities to increase production capacity may delay delivery of our products. Manufacturing efficiencies, yields and product quality may decline as production volumes increase. In addition, component costs, overhead and other production costs may rise. If we are unable to meet the demand of our customers and deliver products quickly and cost effectively, customers may turn to our competitors. The costs associated with implementing new manufacturing technologies, methods and processes, including the purchase of new equipment, and any resulting delays, inefficiencies and loss of sales, could harm our results of operations.

We purchase certain component parts from a limited number of third-party suppliers, and are therefore subject to limitations in supply which could result in delays of product shipments and damage our business and operating results.

We currently purchase component parts used in the manufacture of our products from a limited number of third-party suppliers and currently rely on a single source of supply in some cases, including for certain semiconductor components. We depend on these suppliers to meet our needs. Moreover, we depend on the quality of the products supplied to us over which we have limited control. From time to time in the future, we may encounter shortages and delays or transportation problems in obtaining components or if there are defects in

 

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the components we purchase, there will be interruptions in the manufacture of our products and we might not be able to supply products in a timely manner or with the quality required by our customers, and our revenues and customer relationships could be harmed.

Our ability to operate and grow our business effectively will depend on retaining key employees and management, and hiring skilled and experienced personnel. If we lose the services of any key personnel or are unable to hire additional personnel, our business could be harmed.

Our success has been highly dependent on the experience, relationships and technical knowledge of our key senior management and technical employees. Our future will depend on our ability to retain their services. The loss of key employees could harm development and sales of our products, slow our growth and otherwise harm our business.

Our ability to operate and grow our business also depends on our ability to attract, retain and motivate highly skilled scientists, engineers and other technical personnel. We face intense competition for the services of such employees. The nature of our business also makes it difficult for us to hire employees who are not citizens or permanent residents of the United States.

If we fail to retain and motivate our current employees, or fail to attract new employees with comparable skills, we will be unable to enhance existing products and develop new ones, and our business will suffer. Hiring difficulties may also force us to incur higher than anticipated costs in recruiting, relocating and compensating employees who have the skills we need, and these increased costs may hurt our margins and limit our ability to make necessary hires.

Several of our officers may have divided responsibilities which could divert management time and create potential conflicts of interest.

Our chief executive officer, Hans Kobler, serves on the investment advisory committee of Digital Power Capital, LLC, which is indirectly our largest stockholder and an affiliate of Wexford VI Advisors LLC, and has an interest in the profits earned on certain Wexford investments, including Wexford’s investment in us. Some of our other executives may serve on outside boards from time to time, as well. These divided responsibilities divert management time from our business and could create potential conflicts of interest. See “Certain Relationships and Related Party Transactions.”

Wexford Capital, LLC and its affiliates, our principal stockholders, will beneficially own and control a significant amount of our common stock, giving them substantial influence over our corporate transactions and other matters. Their interests may conflict with yours, and the concentration of ownership of our common stock will limit your influence and the influence of our other stockholders.

Upon completion of this offering, Wexford and its affiliates will beneficially own and control approximately     % of our outstanding common stock. As a result, Wexford will continue to be able to exercise control over matters requiring stockholder approval, including the election of directors, changes to our charter documents, mergers, corporate control contests and other significant corporate transactions. As long as this concentration of ownership persists, it is unlikely that any other holder or group of holders of our common stock will be able to affect the way we are managed or the direction of our business. The interests of Wexford could conflict with the interests of our other stockholders. This concentration of ownership could also discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, or could otherwise delay or prevent a change in control transaction or other business combination, which could in turn have an adverse effect on the market price of our common stock. See “Certain Relationships and Related Party Transactions.”

We may divest assets to reflect changes in our strategy.

From time to time, we have divested businesses and assets which we have determined no longer fit our strategy. For example, we sold one business in 2006 and three of our businesses in 2007. We may undertake

 

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divestiture transactions when we believe there is a financial or strategic benefit to us in doing so. Such divestitures, should they occur, may result in losses. There may also be costs and liabilities that we incur or retain in connection with these divestitures. We may be unable to successfully divest non-strategic assets and, if we incorrectly evaluate the strategic fit and valuation of divested businesses or assets, we may forego opportunities that would otherwise have benefited our business.

Our strategy for future acquisitions may be costly to implement and difficult to manage.

We intend to continue to grow our business through acquisitions of additional companies. Successful execution of our acquisition strategy will depend on many factors including locating suitable companies, negotiating acceptable terms, successfully consummating the acquisitions and obtaining required financing on acceptable terms. We may incorrectly assess new businesses or technologies that we do acquire, fail to realize anticipated benefits from these acquisitions or fail to exploit anticipated opportunities. Since December 31, 2006, we have sold three previously acquired companies that no longer aligned with our strategic plan. In addition, we may face difficulties retaining qualified personnel, managing relationships with customers and integrating newly acquired businesses and operations into our existing infrastructure. We also may enter markets in which we have limited or no prior experience or incur future impairment charges and other charges which could adversely affect our results of operations.

As part of our acquisition strategy, we intend to evaluate transactions that are large in relation to our current size. One or more such transactions, should it occur, may entail risks that are currently unforeseen. A large acquisition or similar transaction could entail fundamental changes to the nature of our business and assets, and could result in changes in our strategic direction that may ultimately prove unsuccessful.

Our acquisition strategy may require more capital and result in more expenses than we anticipate, including greater than anticipated acquisition purchase prices and operating and other acquisition-related expenses. There also may be costs and liabilities that we fail or are unable to discover in the course of performing due diligence investigations on each company or business that we have already acquired or may acquire in the future. If acquisition purchase prices, liabilities and transaction costs exceed our estimates, we may need to raise more capital by incurring debt or issuing more stock, which may significantly reduce the equity interests of our stockholders.

We may have difficulty integrating our businesses.

Our company was formed by acquiring a number of geographically and technologically diverse businesses, and we continue to seek to selectively acquire companies or assets that we believe will complement or extend our existing businesses. Integrating our acquisitions is a difficult, complex, time-consuming and expensive process that has placed, and will continue to place, significant demands on our management and financial resources. We have encountered, and may encounter in the future, risks associated with the integration of our acquired businesses, such as:

 

   

difficulty coordinating geographically dispersed operations, workforces and corporate cultures;

 

   

difficulty integrating our operational, financial and management information systems, internal controls and reporting systems as we seek to establish uniform standards, controls, procedures and policies across our company;

 

   

increased operating expenses resulting from management, transaction and other costs associated with our acquisition and integration activities;

 

   

exposure to unknown liabilities of acquired companies or assets;

 

   

diversion of our management’s attention from other business matters;

 

   

loss of key employees, suppliers and customers of our acquired businesses;

 

   

potential conflicts between business cultures;

 

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disruption of ongoing business;

 

   

failure to maximize our financial and strategic position by the successful incorporation of acquired technology; and

 

   

failure to realize the potential of acquired technologies, complete product development, or properly obtain or secure appropriate protection of intellectual property rights.

In addition, the companies we have acquired have historically operated independently and have had only limited opportunity to collaborate with each other. Part of our business strategy is to allow each company to maintain a high degree of operational autonomy while integrating certain management, administrative and sales functions. Accordingly, we may have difficulty integrating businesses that operate independently from one another into our corporate structure. If we fail to successfully integrate our businesses, we may not be able to achieve operating economies or synergies that help reduce expenses or increase revenues, and we may not be able to broaden our product offering in a timely manner to remain competitive.

If we fail to maintain an accurate system of internal controls, we may not be able to accurately report our financial results, which could adversely affect our stock price.

Compliance with the Sarbanes-Oxley Act of 2002 and related requirements will be costly and will place a burden on our management. At the time we complete this offering, we will have only limited experience operating with the internal controls and procedures required of a public company. We are in the process of documenting, reviewing and where appropriate improving our internal controls and procedures in anticipation of being a public company and eventually being subject to Section 404 of the Sarbanes-Oxley Act of 2002, which will require management assessments of the effectiveness of our internal control over financial reporting. Management will be required to conduct an annual evaluation of our internal control over financial reporting and include a management report on our internal control over financial reporting, along with a report by our independent registered public accounting firm addressing these assessments, beginning with our Annual Report on Form 10-K for the year ended December 31, 2008. We cannot assure you that measures we have taken, or future measures we may take, will enable us to provide accurate and timely financial reports, particularly if we are unable to hire additional personnel in our accounting and financial department, or if we lose personnel in this area. Any failure to maintain an effective system of internal controls, or any other problems with our financial systems or internal controls, could result in delays or inaccuracies in reporting financial information or failure to comply with SEC reporting and other regulatory requirements, any of which could adversely affect our business and stock price.

Our ability to use net operating losses to offset future taxable income may be subject to certain limitations.

In general, under Section 382 of the Internal Revenue Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating losses (NOLs) to offset future taxable income. We may have undergone an ownership change in the past in connection with issuances of our stock in financings and acquisitions. The existing NOLs of some of our subsidiaries currently will be subject to limitations arising from ownership changes prior to their acquisition by us. Furthermore, our ability to utilize NOLs of companies that we may acquire in the future may be subject to limitations. If we undergo an ownership change after this public offering, our ability to utilize NOLs could be further limited by Section 382 of the Internal Revenue Code.

We may not realize the full amount of revenues reflected in our backlog, which could harm our operations and significantly reduce our future revenues.

There can be no assurances that our backlog estimates will result in actual revenues in any particular fiscal period because our clients may modify or terminate projects and contracts and may decide not to exercise contract options. Our backlog represents sales value of firm orders for products and services not yet delivered and, for long term executed contractual arrangements (contracts, subcontracts, and customer commitments), the

 

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estimated future sales value of estimated product shipments, transactions processed and services to be provided over the term of the contractual arrangements, including renewal options expected to be exercised. For contracts with indefinite quantities backlog reflects estimated quantities based on current activity levels. Our backlog includes estimates of revenues the receipt of which require future government appropriation, option exercise by our clients and/or is subject to contract modification or termination. At March 31, 2007, our backlog approximated $47 million, $43 million of which is estimated to be realized in the following twelve months. These estimates are based on our experience under such contracts and similar contracts, and we believe such estimates to be reasonable. However, we believe that the receipt of revenues reflected in our backlog estimate for the following twelve months will generally be more certain than our backlog estimate for periods thereafter. If we do not realize a substantial amount of our backlog, our operations could be harmed and our future revenues could be significantly reduced.

Our success and competitive position depend significantly on our ability to obtain and protect intellectual property. Failure to protect our intellectual property rights would impair our ability to compete effectively and defend ourselves from any third party claims that we are infringing others’ intellectual property rights.

We rely on a combination of patents, copyrights, trademarks, service marks, trade secrets, confidentiality provisions and licensing arrangements to establish and protect our intellectual property. For example, we have entered into confidentiality agreements with our employees, consultants and business partners and have controlled access to, and distribution of, our documentation and other proprietary information. We intend to continue filing patent applications to protect most of the new processes and technologies that we develop. However, we anticipate that patent protection will not be available for some of these processes or technologies. Failure to protect our intellectual property could affect our ability to secure additional contracts or preserve market advantages when we commercialize our products.

Our efforts to protect our intellectual property rights may not:

 

   

prevent challenges to, or the invalidation or circumvention of, our existing intellectual property rights;

 

   

prevent our competitors from independently developing similar products, duplicating our products or designing around any patents that may be issued to us;

 

   

provide adequate protection for our intellectual property rights;

 

   

prevent disputes with third parties regarding ownership of our intellectual property rights;

 

   

prevent disclosure of our trade secrets and know-how to third parties or their release into the public domain; or

 

   

result in valid patents, including international patents, from any of our pending applications.

Others may attempt to copy or otherwise obtain and use our proprietary technologies without our consent. Monitoring the unauthorized use of our technologies is difficult. There is a significant risk that our customers or their end-user customers may attempt to copy or otherwise obtain and use our proprietary technologies without our consent.

We may find it necessary to litigate against others, including our customers, to protect our intellectual property and to challenge the validity and scope of the proprietary rights asserted by others, and we could face counterclaims. Legal disputes with customers could substantially harm our relationships and sales. Litigation is inherently uncertain, and an adverse outcome could subject us to significant liability for damages or invalidate our proprietary rights. The complexity of the technology involved and inherent uncertainty and cost of intellectual property litigation increases our risks.

Third parties may claim that we are infringing on their intellectual property rights, and we may already be infringing without knowing it. We may face additional liability when we agree to indemnify our customers

 

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against third party infringement. If a third party establishes that we are infringing its intellectual property rights, or that our intellectual property rights are invalid, we may be forced to change our products, services, or manufacturing processes, and such changes may be expensive or impractical. We may then be forced to seek royalty or license agreements. If we are unable to agree on acceptable terms we may be required to discontinue products or halt other aspects of our operations. We may also be liable for significant damages. Even if intellectual property claims brought against us are without merit, the litigation may be costly and time consuming, and may divert our management and key personnel from operating our business.

The U.S. government’s right to use technology developed by us limits our intellectual property rights.

We seek to protect the competitive benefits we derive from our patents, proprietary information and other intellectual property. However, we do not have the right to prohibit the U.S. government from using certain technologies developed by us or to prohibit third party companies, including our competitors, from using those technologies in providing products and services to the U.S. government. The U.S. government has the right to royalty-free use of technologies that we have developed under U.S. government contracts. We are free to commercially exploit those government-funded technologies and may assert our intellectual property rights to seek to block other non-government users thereof, but we cannot assure you that we could successfully do so.

Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States.

Our subsidiaries have not consistently sought patent protection or registered our trademarks outside the United States, which may impair our ability to use or protect our technology and brand in foreign jurisdictions. The laws of some foreign countries, including countries in which we have sold and will continue to sell our products, protect proprietary rights less broadly than do the laws of the United States. Many U.S. companies have encountered substantial problems in protecting their proprietary rights in such countries, and there is a risk that we will encounter similar problems. If our competitors in these countries copy our technology without our permission, our sales and operations will be harmed.

Our business is subject to environmental regulation that could result in compliance costs. Any violations or liability under environmental laws could harm our business.

We are subject to environmental and safety laws and regulations governing the use, storage and disposal of hazardous substances or wastes and imposing liability for the cleanup of contamination from these substances. We cannot completely eliminate the risk of contamination or injury from these substances or wastes, and, in the event of such an incident, we could be held liable for any damages that result. In addition, we may be required to incur significant additional costs to comply with environmental laws and regulations in the future.

Risks Associated with Government Contracts and Regulation

The U.S. government may terminate or modify its existing contracts with us or with government contractors for which we are a subcontractor.

We must comply with and are affected by laws and regulations relating to the formation, administration and performance of U.S. government contracts and subcontracts thereunder, which affect how we do business as a contractor or subcontractor to U.S. government customers and which may impose additional expenses on our business.

There are inherent risks in contracting with the U.S. government. The U.S. government can typically terminate, reduce orders under or otherwise modify any of its contracts with us for its convenience (i.e., without cause) whether or not we have failed to perform under the terms of the applicable contract. In such case, the

 

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government would not be required to pay us for the lost profits for the unperformed work. A termination arising out of our default could expose us to liability and harm our ability to compete for future contracts and orders. In addition to unfavorable termination provisions, our U.S. government contracts and related regulations contain provisions that allow the U.S. government to unilaterally suspend us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations, reduce the value of existing contracts, issue modifications to a contract and control and potentially prohibit the export of our services and associated materials. U.S. government contracts may also be terminated if Congress fails to provide funds for the contract.

Our business is subject to laws and regulations that are more restrictive because we are a contractor and subcontractor to the U.S. government.

As a contractor and subcontractor to the U.S. government, we are subject to various laws and regulations that are more restrictive than those applicable to non-government contractors, including the Federal Acquisition Regulation and its supplements, which comprehensively regulate the formation, administration and performance of U.S. government contracts, and the Truth in Negotiations Act and various other laws, which require certain certifications and disclosures. These laws and regulations, among other things:

 

   

require that we obtain and maintain material governmental authorizations and approvals to conduct our business as it is currently conducted;

 

   

require certification and disclosure of cost and pricing data in connection with certain contract negotiations;

 

   

impose rules that define allowable and unallowable costs and otherwise govern our right to reimbursement under certain cost-based U.S. government contracts;

 

   

restrict the use and dissemination of information classified for national security purposes and the export of certain products and technical data; and

 

   

impose requirements relating to ethics and business practices, which carry penalties for noncompliance ranging from monetary fines and damages to loss of the ability to do business with the U.S. government as a prime contractor or subcontractor.

In addition, we are subject to industrial security regulations of the U.S. Department of Defense and other federal agencies that are designed to safeguard against unauthorized access by foreigners and others to classified and other sensitive information. If we were to come under foreign ownership, control or influence, our U.S. government customers could terminate, or decide not to renew, our contracts, and such a situation could also impair our ability to obtain new contracts and subcontracts. The government may also change its procurement practices or adopt new contracting rules and regulations that could be costly to satisfy or that could impair our ability to obtain new contracts.

We may not be able to receive or retain the necessary licenses or authorizations required for us to export our products and we may incur regulatory penalties for past compliance failings of our acquired companies.

We must obtain a license from the U.S. government before we may export certain products or technologies from the United States. We cannot be certain that we will obtain any licenses required to export our products to foreign customers or receive authorization from the U.S. government for sales to foreign governments. For example, export control delays precluded the delivery of approximately $2 million in orders for our radar products in 2006. Failure to receive required licenses or authorizations in a timely manner or at all will limit our ability to export our products and could reduce our revenues.

Any seizure or delay in shipment of our products for failure to obtain a required export license could harm our financial condition and results of operations. Export control laws may also inhibit the free interchange of technical discussions among our employees. Absent license authorization from the appropriate agency, technologies related to our military or dual-use products cannot be discussed with our foreign national employees

 

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who are not permanent residents, nor with our foreign subsidiaries. Licensing requirements may delay product development and other engineering or sales activities. In addition, many of our subsidiaries had not adopted formal export compliance programs prior to being acquired by us. For example, two of our subsidiaries engaged in research and development activities that involved the sharing of technical information with foreign national employees related to the development of explosives detectors and nerve gas sensors. This early development work occurred without license approvals and prior to our acquisition of these companies. These subsidiaries have now identified possible gaps in compliance, have made voluntary disclosures to the U.S. Department of State, and have adopted compliance measures to address compliance deficiencies.

Export control agencies are authorized to impose monetary penalties or even to suspend export privileges. While such actions have not been taken against our company to date, such risks exist in this highly regulated field, and we cannot entirely eliminate the possibility that such agency action may occur in the future.

We are subject to audits by the U.S. government which could adversely affect our business.

U.S. government agencies routinely audit and investigate government contractors to monitor performance, cost allocations, cost accounting and compliance with applicable laws, regulations and standards. Since some of our contracts are cost plus a fixed fee, the U.S. government has the right to audit our costs even after job completion and after we have booked the corresponding revenue. The U.S. government also may review the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allowed or improperly allocated to a specific contract will not be reimbursed, and any such costs that have already been reimbursed must be refunded. While we intend to implement uniform procurement and compliance programs for all of our business, we may be subject to more risks from these audits until we are able to implement such a program effectively. Notwithstanding current compliance, we may be responsible for the lack of compliance, if any, in the past by the companies we have acquired or acquire in the future.

Responding to governmental audits, inquiries, or investigations may involve significant expense and divert the attention of our management. If a government review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, damages, fines and suspension or debarment from doing business with U.S. government agencies. In addition, our reputation could be seriously harmed by allegations of impropriety, even if unfounded.

Our business may increasingly depend upon obtaining and maintaining required security clearances.

We may bid for U.S. government contracts that require our employees to maintain various levels of security clearances and require us or our subsidiaries to maintain certain facility security clearances in compliance with DoD and other government requirements. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If our employees are unable to obtain or retain security clearances, or if our employees who hold security clearances stop working for us, we may face delays in fulfilling contracts, or be unable to fulfill or secure new contracts, with any customer involved in classified work. Any breach of security for which we are responsible could seriously harm our business, damage our reputation and make us ineligible to work on any classified programs.

Cost over-runs on our contracts could subject us to losses or adversely affect our future business.

Certain of our contracts with the U.S. government are subject to fixed prices, in which we receive a fixed price irrespective of the actual costs we incur. Consequently, any costs in excess of the fixed price are ordinarily absorbed by us. Under time-and-materials contracts, we are paid for labor at negotiated hourly billing rates and for certain expenses. Under cost reimbursement contracts, which are subject to a contract-ceiling amount, we are

 

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reimbursed for allowable and allocable costs and ordinarily paid a fee, which may be fixed or performance based. We may not be able to obtain reimbursement for any costs that exceed the contract limits or are not allowable or allocable under the provisions of the contract or applicable regulations. Under each type of contract our financial condition and operating results could be affected materially and adversely if we fail to anticipate technical problems, estimate costs accurately or control costs we incur in performing under the contract. Cost over-runs also may adversely affect our ability to sustain existing programs and obtain future contract awards.

Risks Related to Our Common Stock

There is no guarantee that an active and liquid public market will develop for our common stock.

Prior to this offering, there has not been a public market for our common stock. A liquid trading market for our common stock may not develop. The initial public offering price will be determined in negotiations between the representatives of the underwriters and us and may not be indicative of prices that will prevail in the market. We cannot assure you that you will be able to sell your shares at or above the initial public offering price.

After this offering, the price of our common stock may be volatile and we cannot assure you that the price of our shares will not decline.

The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:

 

   

political, military and security developments in the United States and worldwide;

 

   

the development of fundamentally new detection, surveillance, active denial and systems and software technologies;

 

   

general and industry-specific economic conditions;

 

   

changes in financial estimates or recommendations by securities analysts;

 

   

sales of our common stock or other actions by investors with significant shareholdings; and

 

   

general market conditions.

The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock.

In the past, stockholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention and resources and harm our business.

Purchasers of shares of our common stock in this offering will experience immediate and substantial dilution in net tangible book value.

The initial public offering price of our common stock is higher than the net tangible book value per share of our outstanding common stock. This is referred to as dilution. If you purchase common stock in the offering, you will incur immediate and substantial dilution in the net tangible book value per share from the price you pay for our common stock. If the holders of outstanding stock options and warrants exercise those securities, you will incur additional dilution. See “Dilution.”

 

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Future sales of our common stock by our stockholders could depress the price of our common stock.

Sales of a large number of shares of our common stock in the public market, or the availability of a large number of shares for sale, could adversely affect the market price of our common stock and could impair our ability to raise funds in subsequent stock offerings. Upon completion of this offering, we will have shares of common stock outstanding and our amended and restated certificate of incorporation will authorize us to issue              shares of common stock. Substantially all of our current stockholders will be subject to agreements with the underwriters that restrict their ability to transfer their stock for 180 days after the date of this prospectus. Lehman Brothers Inc., on behalf of the underwriters, may in its sole discretion and at any time waive the restrictions on transfer in these agreements during this period. After these agreements expire, approximately             these shares will be eligible for sale in the public market subject to the volume and other restrictions under Rules 144 and 701 under the Securities Act. As of March 31, 2007, we had options to purchase a total of              shares outstanding, of which              were vested, and an additional              were available for grant under our stock based compensation plans. In addition, as of March 31, 2007, we had a total of              shares of unvested restricted stock awards and restricted stock units. See “Shares Eligible for Future Sale.”

We currently do not intend to pay dividends on our common stock, and as a result, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We do not expect to pay any cash dividends on our common stock in the foreseeable future. For more information, see “Dividend Policy.” As a result, your only opportunity to achieve a return on your investment in us will be if the market price of our common stock appreciates and you sell your shares at a profit. The market price for our common stock after this offering may never exceed the price that you pay for our common stock in this offering.

Our organizational documents and Delaware law have anti-takeover provisions that could delay or prevent a change in control of our company.

In addition to Wexford Capital LLC’s and its affiliates’ ownership of a majority of our common stock after this offering, our certificate of incorporation and by-laws and Delaware law contain provisions that could delay or prevent a change in control of our company that stockholders may consider favorable. These provisions include the following:

 

   

the ability of our Board of Directors to issue, without stockholder approval, up to              shares of preferred stock with terms set by the Board of Directors, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;

 

   

the prohibition of cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; and

 

   

requirements for advance notice of nominations for election to the Board of Directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

These provisions in our organizational documents and under Delaware law could allow our Board of Directors to affect your rights as a stockholder by making it more difficult for stockholders to replace board members and could discourage takeover attempts. Because our Board of Directors is responsible for appointing members of our management team, these provisions could in turn affect any attempt to replace the current management team. In addition, these provisions could deprive our stockholders of opportunities to realize a premium on their shares of common stock.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus, including the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains forward-looking statements. These statements relate to future events or our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance and achievements to be materially different from the future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” and similar expressions, whether in the negative or affirmative. These statements are only predictions and may be inaccurate. Actual events or results may differ materially and you should not place undue reliance on these forward-looking statements. In evaluating these statements, you should specifically consider a number of important factors, including the risks outlined under “Risk Factors” and in other parts of this prospectus. These factors may cause our actual results to differ materially from any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, investments or strategic alliances we may make. Except as may be required by the federal securities laws, we are under no duty to update any of the forward-looking statements after the date of this prospectus.

This prospectus contains statistical data that we obtained from industry publications and reports. These publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we believe the publications are reliable, we have not independently verified their data.

 

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USE OF PROCEEDS

We estimate that the net proceeds from the sale of the shares of common stock in this offering will be approximately $            million, assuming an initial public offering price of $            per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We have granted the underwriters an option exercisable for 30 days after the date of this prospectus, to purchase, from time to time, in whole or in part, up to an aggregate of             shares at the initial public offering price less underwriting discounts and commissions. This option may be exercised if the underwriters sell more than             shares in connection with this offering. To the extent that the underwriters exercise this option in full, we estimate that the net proceeds to us from such exercise will be approximately $             million. A $1.00 increase (decrease) in the assumed initial offering price of $             per share would increase (decrease) the net proceeds of this offering by $             million, assuming the sale of              million shares of our common stock and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use our net proceeds for general corporate purposes, including working capital, the expansion of our sales and marketing organizations, acceleration of our research and development efforts, expansion of our manufacturing capabilities and purchases of capital equipment. We anticipate we will also use a portion of the proceeds in acquisitions of businesses, products and technologies that are complementary to our business. Although we have from time to time evaluated possible acquisitions, we currently have no definitive commitments or agreements to make any acquisitions, and we cannot assure you that we will make any acquisitions in the future. Until we use the net proceeds from this offering, we intend to invest the funds in United States government securities and other short-term, investment-grade, interest-bearing instruments or high-grade corporate notes. Management will have significant flexibility in applying the net proceeds from this offering.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock and we do not currently intend to pay any cash dividends on our common stock. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our common stock will be at the discretion of our Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions.

 

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CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2007:

 

   

on an actual basis;

 

   

on an as adjusted basis (i) to give effect to the conversion into common stock of all of our outstanding shares of preferred stock into            shares of common stock upon the completion of this offering; and (ii) to give effect to the our issuance and sale of              shares of common stock in this offering at an assumed initial public offering price of $            per share (the mid-point of the price range set forth on the cover page of this prospectus) and our receipt of the net proceeds of the shares of common stock we are offering, as described under “Use of Proceeds.”

You should read the following table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Description of Capital Stock” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

     As of March 31, 2007
     Actual     As
Adjusted
     (in thousands)

Long-term debt

   $ 396     $  

Series A convertible redeemable preferred stock, $.001 par value: 41,000,000 shares authorized, actual;            shares issued and outstanding, actual; no shares issued or outstanding as adjusted and pro forma as adjusted

     204,400    

Stockholders’ equity:

    

Common stock, $0.001 par value: 120,000,000 shares authorized, actual;                      shares authorized, pro forma; shares issued and outstanding, actual;            shares issued and outstanding, as adjusted;            shares issued and outstanding, pro forma as adjusted

     20    

Additional paid-in capital

     92,822    

Accumulated other comprehensive income

     1,192    

Accumulated deficit

     (157,079 )  

Stockholders’ (deficit) equity

     (63,045 )  
              

Total capitalization

   $ 141,751     $             
              

Each $1.00 increase or decrease in the assumed initial public offering price per share would increase or decrease, as applicable, the amount of additional paid-in capital, stockholders’ equity and total capitalization by approximately $             million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions payable by us.

 

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DILUTION

Our pro forma net tangible book value on March 31, 2007 was approximately $44.4 million, or $0.78 per share. “Pro forma net tangible book value” is total assets minus the sum of liabilities and intangible assets. “Pro forma net tangible book value per share” is pro forma net tangible book value divided by the total number of shares of our common stock outstanding on a pro forma basis giving effect to the conversion to common stock of our outstanding preferred stock.

After giving effect to adjustments relating to the offering, our pro forma as adjusted net tangible book value on March 31, 2007 would have been $            million, or $            per share. The adjustments made to determine pro forma as adjusted net tangible book value per share consist of:

 

   

an increase in total assets to reflect the net proceeds to us of the offering as described under “Use of Proceeds;” and

 

   

the addition of the number of shares offered by us in this prospectus to the number of shares outstanding.

The following table illustrates the increase in pro forma net tangible book value of $            per share and the dilution (the difference between the offering price per share and net tangible book value per share) to new investors:

 

Assumed public offering price per share         $            

Pro forma net tangible book value per share as of March 31, 2007

   $                

Increase in pro forma net tangible book value per share attributable to the offering

     

Pro forma as adjusted net tangible book value per share as of March 31, 2007 after giving effect to the offering

     

Dilution per share to new investors in the offering

      $             

A $1.00 increase (decrease) in the assumed offering price would increase (decrease): (1) our net tangible book value after giving effect to this offering by $             million; (2) the net tangible book value per common share after giving effect to this offering by $            ; and (3) the dilution per common share to investors in this offering by $            , in each case, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

The following table shows the difference between existing stockholders and new investors with respect to the number of shares purchased from us, the total consideration paid and the average price paid per share. The table assumes the initial public offering price will be $              per share.

 

     Shares Purchased     Total Consideration    

Average Price
Per Share

      Number    Percent     Amount    Percent    

Existing stockholders

           %   $                      %   $             

New public investors

          
                          

Total

      100.0 %   $      100.0 %  
                          

A $1.00 increase (decrease) in the assumed offering price would increase (decrease) total consideration paid by new investors and the total average price per share by $             million and $            , respectively, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

The preceding tables are based on our shares outstanding at March 31, 2007, and assume no exercise of any outstanding stock options or vesting of restricted stock awards or restricted stock units after that date. At

 

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March 31, 2007, there were outstanding options to purchase a total of              shares of our common stock at a weighted average exercise price of $            per share. To the extent any of these options are exercised, there will be further dilution to new investors. The preceding tables also do not reflect as outstanding approximately             shares of our common stock subject to stock options and restricted stock awards that we intend to issue prior to the closing of this offering pursuant to our 2007 Equity Incentive Plan. No sale or (with certain exceptions for estate planning purposes) other disposition of the shares subject to these awards will be permitted prior to the fifth anniversary of the date of grant. The exercise price of the options to be granted prior to the closing of this offering pursuant to the 2007 Equity Incentive Plan will be equal to the initial public offering price. If all options outstanding at March 31, 2007 had been exercised as of that date:

 

   

our pro forma net tangible book value, giving effect to those transactions, would be $            per share, and the dilution per share to new investors in the offering would be $            per share; and

 

   

the average price per share paid by all existing stockholders for their shares, giving effect to those transactions, would be $            , and existing stockholders would own     % of our outstanding shares and would have paid     % of the total consideration paid for all our outstanding shares.

If all the foregoing options, including the additional options to be granted immediately prior to the closing of this offering, assuming an initial public offering price of $             per share, the midpoint of the price range on the cover of this prospectus, had been exercised and the anticipated restricted stock awards referred to above had been granted, each as of March 31, 2007:

 

   

our pro forma net tangible book value, giving effect to those transactions, would be $            per share, and the dilution per share to new investors in the offering would be $            per share; and

 

   

the average price per share paid by all existing stockholders for their shares, giving effect to those transactions, would be $            , and existing stockholders would own     % of our outstanding shares and would have paid     % of the total consideration paid for all our outstanding shares.

A $1.00 increase (decrease) in the assumed offering price would increase (decrease) (i) pro forma net tangible book value per share and dilution per share to new investors by $             and $            , respectively, and (ii) the average price per share paid by all existing stockholders for their shares by $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus.

We derived the consolidated statement of operations data for the years ended December 31, 2006, 2005 and 2004 and the consolidated balance sheet data as of December 31, 2004, 2005 and 2006 from our audited consolidated financial statements, which were audited by Grant Thornton LLP, an independent registered public accounting firm, and which appear elsewhere in this prospectus. The consolidated statement of operations data for the three months ended March 31, 2007 and 2006, and the consolidated balance sheet data as of March 31, 2007, are derived from our unaudited consolidated financial statements appearing elsewhere in this prospectus and include all necessary adjustments, consisting only of normal recurring adjustments, that we consider necessary for the fair presentation of this data. We have completed a number of acquisitions over the last three fiscal years, each of which was accounted for as a purchase transaction, which may affect year-over-year comparisons of our consolidated summary financial data. See a description of such acquisitions fully described in note 4, “Business Combinations and Related Intangibles” in the notes to our consolidated financial statements.

 

     Three Months Ended
March 31,
    Year Ended
December 31,
 
           2007                 2006           2006     2005     2004  
     (in thousands, except per share data)  
     (unaudited)                    

Consolidated Statement of Operations Data:

          

Products

          

Revenue

   $ 16,397     $ 12,505     $ 59,341     $ 20,439     $   929  

Cost of revenue

     8,833       6,799       31,329       11,203       1,086  

Gross profit

     7,564       5,706       28,012       9,236       (157 )

Contract research and development and services

          

Revenue

     7,777       6,115       25,694       10,436       2,128  

Cost of revenue

     5,202       4,084       15,840       6,135       1,276  

Gross profit

     2,575       2,031       9,854       4,301       852  

Maintenance, service and other

          

Revenue

     2,786       911       5,125       525       —    

Cost of revenue

     1,467       516       2,843       253       —    

Gross profit

     1,319       395       2,282       272       —    

Operating expenses:

          

Research and development

     4,622       3,455       14,501       4,957       1,969  

Sales and marketing

     4,723       3,566       17,679       3,524       859  

General and administrative

     8,849       7,634       37,745       11,265       1,312  

Goodwill impairment loss

     —         —         66,043       —         —    

Depreciation and amortization

     3,469       4,683       17,236       5,289       825  

Acquired in-process R&D

     —         —         —         2,300       —    

Other

     —         —         —         839       487  

Total operating expenses

     21,663       19,338       153,204       28,174       5,452  

Loss from operations

     (10,205 )     (11,206 )     (113,056 )     (14,365 )     (4,757 )

Interest income

     61       116       371       126       21  

Interest expense

     (90 )     (99 )     (372 )     (145 )     (1 )

 

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     Three Months Ended
March 31,
    Year Ended
December 31,
 
           2007                 2006           2006     2005     2004  
     (in thousands, except per share data)  
     (unaudited)                    

Other, net

     76       176       1,039       541       1,074  

Loss before income taxes

     (10,158 )     (11,013 )     (112,018 )     (13,843 )     (3,663 )

Provision for (benefit from) income taxes

     75       (70 )     (296 )     (1,943 )     —    

Net loss from continuing operations

     (10,233 )     (10,943 )     (111,722 )     (11,900 )     (3,663 )

Discontinued operations, net(1)

     780       (1,922 )     (15,766 )     (2,852 )     (1,386 )

Net loss

     (9,453 )     (12,865 )     (127,488 )     (14,752 )     (5,049 )

Accretion on redeemable convertible preferred stock

     2,461       2,283       9,480       5,562       —    

Net income attributable to common stockholders

   $ (11,914 )   $ (15,148 )   $ (136,968 )   $ (20,314 )   $ (5,049 )

Basic and diluted earnings per share

   $       $       $       $       $    

Basic and diluted weighted average shares outstanding

          

 

     As of March 31,    As of December 31,
     2007     2006    2006     2005    2004
     (in thousands, except per share data)
     (unaudited)                

Consolidated Balance Sheet Data:

            

Cash and cash equivalents

   $ 14,314     $ 11,679    $ 7,236     $ 23,354    $ 1,493

Working capital

     32,913       21,575      27,312       24,072      1,100

Total assets

     174,177       254,856      184,248       267,469      17,377

Long-term debt

     396       947      449       508      —  

Redeemable convertible preferred stock

     204,400       157,214      197,732       151,831      —  

Stockholders’ equity (deficit)

   $ (63,045 )   $ 64,849    $ (51,507 )   $ 77,811    $ 11,758

(1) In August 2006, we realized a $3.1 million gain on the sale of substantially all of the assets of a non-strategic operation owned by Nomadics, Inc., that was acquired in August 2005. In December 2006, we adopted a plan for the sale of three companies that did not align with our overall strategic plans. In February, March and April 2007, we sold Nuvonyx Europe, Harbinger Technologies Group, Inc. and Nuvonyx, Inc., respectively, pursuant to this plan. Loss from discontinued operations was $18.9 million in 2006, which includes a $13.1 million impairment loss to write-down the carrying amounts of two of the discontinued companies to their estimated fair values less costs associated with the sale of the companies.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this prospectus statement. This discussion contains forward-looking statements that involve risk and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to these differences include, but are not limited to those identified below, and those discussed in the section entitled “Risk Factors” included elsewhere in this prospectus.

Overview

We are a leading developer, manufacturer, marketer and integrator of advanced sensor and surveillance technologies, products and solutions. Our first and currently our principal market is homeland security. We were incorporated in 2003, and our business was primarily formed through the acquisition of 18 companies. As more fully described below, we sold the non-stretegic operations of one of our companies in 2006 and three companies in 2007.

We operate our business in three reportable segments: Detection, Surveillance and Solutions. Our Detection segment develops products and conducts research and development in the areas of chemical, biological, radiation, nuclear and explosives detection. Our Surveillance segment provides products and services for perimeter security and wide area surveillance. Our Solutions segment integrates our technologies and products to provide single source solutions that address a broad range of customer specific security and surveillance needs.

Our direct customers include federal agencies such as the U.S. Department of Homeland Security, U.S. Customs & Border Protection (Border Patrol) and the Transportation Security Administration, as well as various state and local governments and agencies, including the New York Police Department and the Port of Long Beach. We also provide products, components and sub-systems to leading integrators in the security and defense industries who either resell our products or integrate them into comprehensive security installations for their end customers. The value-added-resellers and system integrators that we sell products to include The Boeing Company, Honeywell International, Inc., Northrop Grumman Corp., Raytheon Company, SAIC, Inc. and Thermo Fisher Scientific Inc. We also sell to military customers such as the U.S. Department of Defense, the U.S. Air Force, the U.S. Marines and the U.S. Army. We have also begun to expand our addressable markets by selling to private sector customers such as Federal Express Corporation, The Walt Disney Company and two international airports serving the city of Houston, Texas and surrounding communities. Due to the breadth and diverse nature of our product and technology portfolio and our ability to deliver solutions for a comprehensive range of critical security applications, the future success of our business is not dependent upon a single product, technology, customer or government program.

Our objective is to grow our business organically and through the acquisition of complementary companies. To achieve this objective, we plan to:

 

   

continue to develop and acquire next generation technologies to strengthen our technological leadership position;

 

   

continue converting our innovative technologies in our research and development pipeline into new products and platforms to pursue new market opportunities;

 

   

continue to provide integrated, single-source solutions that prevent a broad range of critical security threats;

 

   

continue to build and strengthen our direct sales force and expand our indirect channels to extend our geographic reach and market penetration;

 

   

leverage our existing intellectual property and infrastructure to expand our addressable markets and further accelerate our growth; and

 

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grow our business, relationships and product offerings by acquiring select companies and assets that enhance our technology leadership, broaden our product offerings or expand our customer relationships.

Business Acquisitions

We were incorporated in 2003, and our business was primarily formed through the acquisitions of 18 companies beginning in 2003. In 2007, we sold three of these companies. The following table includes information about our acquisitions.

 

Businesses Acquired(1)

  

Acquisition Dates

Detection Segment

  

GHC Technologies, Inc.

  

December 2006

target systemelectronic, GmbH

  

November 2005

Target Instruments, Inc.

  

November 2005

MesoSystems Technology, Inc.

  

November 2005

Griffin Analytical Technologies, Inc.

  

November 2005

Agentase, LLC

  

September 2005

Nomadics, Inc.

  

August 2005

Surveillance Segment

  

Sensor Technologies & Systems, Inc.

  

December 2005

IonOptics, Inc.(2)

  

October 2005 and January 2004

New Heights Manufacturing, Inc.

  

August 2005

Digital Infrared Imaging, Inc.

  

August 2005

Amphitech(3)

  

July 2005 and November 2003

Solutions Segment

  

Security 2000, Inc.

  

November 2006

360 Surveillance, Inc./PBA Engineering Ltd./Chilkoot Designs Ltd./Peter Boudreau Associates Ltd./Davidson Technologies (360/PBA)

  




December 2005

DAQ Electronics, Inc.

  

April 2005


(1) In February, March and April 2007, we sold Nuvonyx Europe, Harbinger Technologies Group, Inc. and Nuvonyx, Inc., respectively.
(2) We acquired a portion of this company in 2004 and the remainder in 2005.
(3) We acquired a portion of this company in 2003 and the remainder in 2005.

In connection with these business acquisitions, we acquired approximately $59 million in amortizable intangible assets, which primarily include our core technology, customer relationships and firm contracts. The estimated lives of these intangible assets range from four to 10 years for core technology, one to five years for customer relationships and one year for firm contracts.

Key Business Metrics

We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of our sales and marketing efforts, accelerate product development and measure operational effectiveness.

Product Revenue.    We were incorporated in 2003, and our business was formed through the acquisition of 18 companies. Many of these businesses were in the early stages of transitioning advanced technologies into products, integrating solutions and developing marketing and sales strategies. Beginning in 2005, we began to

 

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develop a more comprehensive sales and marketing structure to support our business segments. A key measure of our success is product revenue growth. Because our financial statements present the results of operations of acquired businesses from the date of acquisition, we monitor revenue growth by comparing current periods against pro forma results of operations as if we had acquired the businesses as of the beginning of the prior comparable periods.

Product Gross Profit.    Our goal is to grow product gross profit to increase the profitability of our business. Because of the emerging stage of many of our products, gross profit has been inconsistent and unpredictable. Key factors affecting our gross profit are volume pricing, warranty costs, product mix, economies of scale and the ability to absorb fixed costs. Our ability to effectively monitor and manage these factors is important in attaining business profitability.

Research and Development.    Our primary source of research and development funds is through direct contracts with the U.S. government and subcontracts with other commercial entities that contract with the U.S. government. We refer to this externally funded research and development as contract research and development. We also invest in research and development activities using our own internal funds in an effort to accelerate new and enhanced product offerings and to expand our technological leadership. We refer to this internally funded research and development as internal research and development. One of our key objectives is to expand our market share by continuing to convert advanced technologies into products and single source integrated solutions. Accordingly, we intend to continue our research and development activities through both contract research and development and internal research and development programs to advance our technologies and release new products and provide integrated solutions.

Description of Certain Factors Affecting our Revenue, Gross Profit and Operating Expenses

Product Revenue and Gross Profit.    In our Detection segment, we primarily derive product revenue through the sale of our Fido explosive detectors, IdentiFINDER and Interceptor radiation detectors, AirSentinel bioaerosol sensors and our Griffin gas chromatography/mass spectrometry line of products. In our Surveillance segment, we primarily derive product revenue from the sale of our Cerberus and SkyWatch towers, our thermal imaging cameras, including DefendIR and Orion, our STS line of radar products and our infrared sensors product—MarkIR. In our Solutions segment, we primarily derive product revenue from the sale of our Cameleon advanced camera control systems, Cameleon ITS transportation management software, StarWatch security command and control software and Callisto, a non-security related product for process management of diverse supervisory control and data acquisition (SCADA) applications.

Our gross profit on product sales is primarily impacted by the relative mix of higher and lower margin products, the efficiency and scale of our manufacturing operations, the relative mix of direct sales to end customers and sales through original equipment manufacturers and other resellers, and the relative mix of products that are manufactured by us and those that are manufactured by third parties. We typically earn a higher gross profit on products that we sell directly to end customers and on products that we manufacture ourselves. Because of the emerging stage of many of our products and our plans for new product introductions, we anticipate that our gross profit may continue to be impacted in the future by fixed overhead costs related to the expansion of our manufacturing capacity. As a result of these factors, our product gross profit has been inconsistent and may continue to be inconsistent for the foreseeable future.

Contract Research and Development Revenue and Gross Profit.    We earn contract research and development revenue by performing research and development primarily under contracts that we enter into directly with the U.S. government or as subcontractors to other commercial entities that contract with the U.S. government. Most of our research and development contracts are either based on our cost plus a fixed fee which is subject to a dollar cap, or are fixed price. We account for earnings under long-term contracts using the percentage-of-completion method of accounting. See “Critical Accounting Policies—Revenue RecognitionContract Research and Development and Service.”

 

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Gross profit on contract research and development revenue is primarily impacted by the mix of contract type and the estimates inherent in recognizing revenue using the percentage-of-completion method of accounting. Our fee, or profit, under cost plus fixed fee contracts is based on a percentage of contract spending and is subject to a cap. On a fixed price contract, we are generally only required to incur the costs necessary to complete the contract. The degree of accuracy in determining the costs to complete our deliverables may impact gross profit under both contract types.

Maintenance, Service and Other Revenue and Gross Profit.    We derive maintenance, service and other revenue, in all of our segments, from training, installation and warranty contracts. Additionally, in our Solutions segment we derive revenue from project management and technology integration services. Most of our project management and integration service contracts are for a fixed price and revenue is recognized under the percentage of completion method. Revenue from training and installation contracts is recognized upon completion of services. Revenue under product maintenance and extended warranty contracts is generally recognized over the requisite service period. See “Critical Accounting Policies— Revenue RecognitionMaintenance, Service and Other Revenue.”

Gross profit under fixed price project management and integration service contracts is primarily impacted by the degree of accuracy in estimating the costs to complete our deliverables under those contracts. Because our product training, installation, maintenance and warranty contracts are generally based on standard services, we have historically recognized higher margins on those services than on our project management and integration services.

General and Administrative Expenses.    General and administrative expenses represent the costs and expenses of managing and supporting our operations. We increased our general administrative expenses in 2006 and 2007 through the use of consultants and other professionals to complete certain accounting and legal functions. We also increased general and administrative expenses by hiring additional executive officers and advisors and in connection with our expansion into additional facilities. Following the completion of this offering, we believe that our general and administrative expenses will increase further in connection with becoming a public company. This increase will consist of legal and accounting fees and additional expenses related to compliance with the Sarbanes-Oxley Act of 2002 and other regulations. Such increase also will result from accounting support services, filing annual and quarterly reports with the Securities and Exchange Commission (SEC), investor relations, directors’ fees, directors’ and officers’ insurance and registrar and transfer agent fees. As a result, we believe that our general and administrative expenses for 2008 will significantly increase and that these increased expenses may affect the comparability of our financial statements with periods leading up to the completion of this offering. Beginning in 2009, and in the longer term, we expect our general and administrative expenses to decrease as a percentage of revenue.

Selling and Marketing Expenses.    In 2006, we increased our spending on sales, marketing and other related business development matters to support our early stage products and emerging technologies and to support anticipated future growth in our business. We anticipate our sales and marketing expense will continue to increase in future periods in connection with new product introductions and the overall expansion of our business.

Research and Development.    In addition to external funding we receive and record as revenue from the U.S. government and other commercial entities for contract research and development activities, we also invest in research and development activities using our own internal funds in an effort to provide additional means for accelerating the development of new and enhanced product offerings and to expand our technological leadership. The costs of our internally funded research and development are included in our operating expenses. In 2006, we increased our spending on internally funded research and development activities and the integration of products and technologies among our reportable segments. One of our key objectives is to expand our market share by continuing to convert advanced technologies into products and single source integrated solutions. Accordingly, we anticipate our research and development expense will increase in future periods.

 

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Results of Operations

Results of Operations Presentation

We present results of operations that have been derived from our financial statements, which were prepared in accordance with accounting principles generally accepted in the United States of America and that include the results of operations from companies we have acquired beginning on the dates of their respective acquisitions. We refer to these results of operations as our Actual results of operations. We also have presented supplemental financial information that includes results of operations of businesses we have acquired in 2004 and 2005 as though we had acquired those businesses at the beginning of 2004. We refer to these results of operations as our Pro Forma results of operations. We have included our Pro Forma results of operations as supplemental information that is not necessarily indicative of the results of operations that actually would have been achieved had we actually acquired these companies at the beginning of 2004, nor are the Pro Forma results of operations intended to be indicative of future results. The companies we acquired in 2006 are not included in the Pro Forma results of operations because they were not significant to our consolidated financial statements.

Comparison of First Quarters of 2007 and 2006

The following table presents selected summarized consolidated financial information for the three months ended March 31, 2007 and 2006.

 

     Three Months Ended
March 31,
 
     2007      2006  
     (dollars in thousands)  
     (unaudited)  

Product revenue

   $ 16,397      $ 12,505  

Gross profit %

     46.1%        45.6%  

Contract research and development revenue

     7,777        6,115  

Gross profit %

     33.1%        33.2%  

Maintenance, service and other revenue

     2,786        911  

Gross profit %

     47.3%        43.4%  
                 

Total revenue

   $ 26,961      $ 19,531  

Gross profit %

     42.5%        41.6%  
                 
     

Loss from continuing operations

   $ (10,233 )    $ (10,943 )

Loss from discontinued operations, net

     (1,302 )      (1,922 )

Gain on sale of discontinued operations, net

     2,082        —    
                 

Net loss

   $ (9,453 )    $ (12,865 )
                 

Product revenue and Gross Profit.    Product revenue increased $3.9 million, or 31%, to $16.4 million in the first quarter of 2007 from $12.5 million in the first quarter of 2006. Approximately 92% of this increase, or $3.6 million, resulted from increased sales of new and enhanced products in our Detection segment. Gross profit as a percentage of product revenue was relatively consistent at 46.1% and 45.6% in the first quarters of 2007 and 2006, respectively.

Contract Research and Development Revenue and Gross Profit.    Contract research and development revenue increased $1.7 million, or 27%, to $7.8 million in the first quarter of 2007 from $6.1 million in the first quarter of 2006. This increase was primarily related to additional contract research and development revenue contributed by a company we acquired in December 2006. Gross profit as a percentage of contract research and development revenue was relatively consistent at 33.1% and 33.2% in the first quarters of 2007 and 2006, respectively.

 

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Maintenance, Service and Other Revenue and Gross Profit.    Maintenance, service and other revenue increased $1.9 million, or 206%, to $2.8 million in the first quarter of 2007 from $0.9 million in the first quarter of 2006. Maintenance, service and other revenue in our Solutions segment accounted for approximately 88%, or $1.7 million, of the increase, of which 57%, or $0.9 million, was contributed by a company we acquired in October 2006 and the remaining increase related primarily to new project management and integration contracts in connection with intelligent transportation systems and video networking and surveillance. Gross profit as a percentage of maintenance, service and other revenue was 47.3% and 43.4% in the first quarters of 2007 and 2006, respectively. Gross profit increased in the first quarter of 2007 because we had a higher relative mix of standard service contracts.

Loss from Continuing Operations.    Our loss from continuing operations decreased $0.7 million, or 6%, to $10.2 million in the first quarter of 2007 from $10.9 million in the first quarter of 2006. Our $7.4 million revenue increase in the first quarter of 2007 was partially offset by increased spending on internal research and development programs, selling and marketing activities and our expansion into new facilities. We increased spending in these areas in an effort to introduce new products and to integrate our products and technologies into broader integrated solutions.

Discontinued Operations.    In December 2006, we adopted a plan for the sale of three companies. Those businesses did not align with our overall strategic plans. We completed two of the sales in the first quarter of 2007 and the third sale during the second quarter of 2007. In the first quarter of 2007, our loss from discontinued operations was $1.3 million compared to $1.9 million in the first quarter of 2006. The $0.6 million, or 32%, decrease in loss from discontinued operations primarily related to two of the businesses being sold prior to the close of the first quarter. We also realized a gain on the sale of discontinued operations of $2.1 million related to the sale of one of the businesses in the first quarter of 2007.

Net Loss.    Net loss decreased $3.4 million, or 27%, to $9.5 million in the first quarter of 2007 from $12.9 million in the first quarter of 2006 primarily due to a $2.1 million gain on the sale of discontinued operations during the first quarter of 2007. Our $7.4 million revenue increase during the first quarter of 2007 also contributed to a decrease in our net loss but was partially offset by increased spending on internal research and development projects, selling and marketing activities and our expansion into new facilities. We increased spending in these areas in an effort to introduce new products and to integrate our products and technologies into broader solutions.

 

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Comparison of 2006, 2005 and 2004

The following table presents our Actual results of operations for 2006, 2005 and 2004. This table includes the results of operations of companies we acquired as of the dates of their actual acquisitions.

 

     Year Ended December 31,  
     2006      2005      2004  
     (dollars in thousands)  
     (Actual)  

Product revenue

   $ 59,341      $ 20,439      $ 929  

Gross profit %

     47.2%        45.2%        (17.0% )

Contract research and development revenue

     25,694        10,436        2,128  

Gross profit %

     38.4%        41.2%        40.1%  

Maintenance, service and other revenues

     5,125        525        —    

Gross profit %

     44.5%        52.0%        —    
                          

Total revenue

   $ 90,160      $ 31,400      $ 3,057  

Gross profit %

     44.5%        44.0%        22.7%  
                          

Operating loss

   $ (113,056 )    $ (14,753 )    $ (4,757 )

Goodwill impairment

     66,043        —          —    

Depreciation and amortization

     17,236        5,289        825  
                          

Operating loss excluding goodwill impairment depreciation and amortization

   $ (29,777 )    $ (9,076 )    $ (3,932 )
                          

Loss from continuing operations

   $ (111,722 )    $ (11,900 )    $ (3,663 )

Loss from discontinued operations, net

     (18,903 )      (2,852 )      (1,386 )

Gain on sale of discontinued operations, net

     3,137        —          —    
                          

Net loss

   $ (127,488 )    $ (14,752 )    $ (5,049 )
                          

 

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The following table presents our Actual results of operations for 2006 and our Pro Forma results of operations for 2005 and 2004. The Pro Forma results of operations in this table include results of operations of companies we acquired during 2004 and 2005 as though we had acquired those companies at the beginning of 2004. The Pro Forma results do not include the results of operations of businesses we acquired in 2006 because those acquisitions were not material to our business.

 

     Year Ended December 31,  
     2006      2005      2004  
     (dollars in thousands)  
     (Actual)     

(Pro Forma)

(unaudited)

 

Product revenue

   $ 59,341      $ 46,528      $ 45,681  

Gross profit %

     47.2%        46.7%        37.4%  

Contract research and development revenue

     25,694        28,961        46,224  

Gross profit %

     38.4%        30.4%        33.2%  

Maintenance, service and other revenue

     5,125        2,438        2,013  

Gross profit %

     44.5%        46.2%        59.0%  
                          

Total revenue

   $ 90,160      $ 77,927      $ 93,917  

Gross profit %

     44.5%        40.6%        35.8%  
                          

Operating loss

   $ (113,056 )    $ (26,024 )    $ (18,699 )

Goodwill impairment

     66,043        —          —    

Depreciation and amortization

     17,236        14,425        18,626  
                          

Operating loss excluding goodwill impairment depreciation and amortization

   $ (29,777 )    $ (11,599 )    $ (73 )
                          

Loss from continuing operations

   $ (111,722 )    $ (24,332 )    $ (21,092 )

Loss from discontinued operations, net

     (18,903 )      (4,824 )      (6,524 )

Gain on sale of discontinued operations, net

     3,137        —          —    
                          

Net loss

   $ (127,488 )    $ (29,156 )    $ (27,616 )
                          

Product Revenue and Gross Profit.    On an Actual basis, product revenue increased $38.9 million, or 191%, to $59.3 million in 2006 from $20.4 million in 2005, and increased $19.5 million, or 2,101%, in 2005 from $0.9 million in 2004. In both periods, increases in revenue were principally related to business acquisitions that occurred in the final six months of 2005. On an Actual basis, gross profit as a percentage of product revenue was 47.2%, 45.2% and (17.0%) in 2006, 2005 and 2004, respectively. Product mix, business acquisitions and the scale and efficiency of our manufacturing operations have the most significant impact on gross profit. In 2004, warranty costs and the smaller scale of our manufacturing operations resulted in negative gross profit.

On a Pro Forma basis, product revenue increased $12.8 million, or 27.5%, to $59.3 million in 2006 from $46.5 million in 2005, and increased $0.8 million, or 2%, in 2005 from $45.7 million in 2004. The increase in 2006 is primarily due to increased product sales resulting from the introduction of new and enhanced products in our Detection segment and increases in sales of radar products in our Surveillance segment. On a Pro Forma basis, gross profit as a percentage of product revenue was 47.2%, 46.7% and 37.4% in 2006, 2005 and 2004, respectively. Increases in gross profit resulted primarily from the introduction of new higher margin products in late 2004 and 2005.

Contract Research and Development Revenue and Gross Profit.    On an Actual basis, contract research and development revenue increased $15.3 million, or 146%, to $25.7 million in 2006 from $10.4 million in 2005, and increased $8.3 million, or 390%, in 2005 from $2.1 million in 2004. In both periods, increases in contract research and development revenue were principally related to business acquisitions that primarily occurred in the last six months of 2005. Gross profit as a percentage of contract research and development revenue was 38.4%, 41.2% and 40.1% in 2006, 2005 and 2004, respectively. Contract research and development gross profit varied according to the mix of contract types and changes in estimates of the costs to complete those contracts.

 

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On a Pro Forma basis, contract research and development revenue decreased $3.3 million, or 11.3%, to $25.7 million in 2006 from $29.0 million in 2005, and decreased $17.3 million, or 37%, in 2005 from $46.2 million in 2004. In 2004 and 2005, a significant portion of our contract research and development revenue resulted from small business government programs in which some of the businesses we acquired participated. Those businesses were no longer eligible to secure contracts under the government small business program after the acquisitions in late 2005. Our inability to renew or enter into new contracts under these programs contributed to the decline in contract research and development revenue in 2006 compared to 2005. In 2004, one contract related to the development of our radar technology accounted for approximately $22.0 million, or 48%, of our total contract research and development revenue. This contract was completed in 2004 and, accordingly, our contract research and development revenue decreased in 2005 compared to 2004. Gross profit as percentage of contract research and development revenue was 38.4%, 30.4% and 33.2% in 2006, 2005 and 2004, respectively. Contract research and development gross profit varies according to the mix of contract types and changes in estimates of the costs to complete those contracts.

Maintenance, Service and Other Revenue and Gross Profit.    On an Actual basis, maintenance, service and other revenue increased $4.6 million, or 876%, to $5.1 million in 2006 from $0.5 million in 2005. The increase in revenue was principally related to business acquisitions that primarily occurred in the last six months of 2005. Gross profit as a percentage of maintenance, service and other revenue was 44.5% and 52.0% in 2006 and 2005, respectively. The decrease is primarily due to a higher percentage of revenue derived from fixed price project management and integration service contracts in 2006 compared to more standard product maintenance, training and installation contracts in 2005.

On a Pro Forma basis, maintenance, service and other revenue increased $2.7 million, or 110%, to $5.1 million from $2.4 million in 2005, and increased $0.4 million, or 21% in 2005 from $2.0 million in 2004. The increase in maintenance, service and other revenue in 2006 compared to 2005 is attributable to our securing additional fixed price contracts related to intelligent transportation solutions. In addition, revenue increased in 2006 due to revenue contributed by a business we acquired in October 2006 and growth in our video networking and surveillance service business. Gross profit as a percentage of maintenance, service and other revenue was 44.5%, 46.2% and 59.0% in 2006, 2005 and 2004, respectively. The decrease was primarily due to a higher percentage of revenue derived from fixed price project management and integration service contracts in 2006 and 2005 compared to more standard product maintenance, training and installation contracts in 2004.

Goodwill Impairment.    In 2006, the estimated fair value of certain of our reporting units was less than book value of those units resulting in goodwill impairment of $66.0 million.

Depreciation and Amortization.    On an Actual basis, approximately 91%, 84% and 89% of the depreciation and amortization of $17.2 million, $5.3 million and $0.8 million in 2006, 2005 and 2004, respectively, were comprised of amortization of our identifiable intangibles. On a Pro Forma basis, we assumed that the identifiable intangible amortization began at the beginning of 2004. Accordingly, on a Pro Forma basis, certain intangibles became fully amortized by 2005. On an Actual basis, the same intangibles did not become fully amortized until 2006. Therefore, we believe it is more meaningful to compare 2006 Actual to 2004 Pro Forma depreciation and amortization expense. Approximately 92% of the $18.6 million 2004 Pro Forma depreciation and amortization was comprised of intangible amortization.

Operating Loss Excluding Goodwill Impairment and Depreciation and Amortization.    Operating loss excluding goodwill impairment and depreciation and amortization is a non-GAAP financial measure that is derived by reducing our operating loss by goodwill impairment and depreciation and amortization. The goodwill impairment and depreciation and amortization primarily represent costs associated with our business acquisitions that do not correspond to an outlay of current and future cash flow. Accordingly, we believe operating loss excluding goodwill impairment and depreciation and amortization is a more meaningful measure of our recurring operations and an indicator of our working capital requirements.

 

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On an Actual basis, operating loss excluding goodwill impairment and depreciation and amortization increased $20.7 million, or 228%, to $29.8 million in 2006 from $9.1 million in 2005 and increased $5.1 million, or 131%, in 2005 from $3.9 million in 2004. Our business acquisitions, the majority of which occurred in the final six months of 2005, was the primary reason for the increase in both 2006 and 2005.

On a Pro Forma basis, our operating loss excluding goodwill impairment and depreciation and amortization increased $18.2 million, or 157%, to $29.8 million in 2006 from $11.6 million in 2005. Our increased revenue in 2006 was offset by increased spending on internal research and development, selling and marketing activities, our expansion into new facilities and general and administrative expenses. Operating loss excluding goodwill impairment and depreciation and amortization increased $11.5 million in 2005 from $0.07 million in 2004 primarily due to a decrease in revenue resulting from the completion of a research and development contract in our Surveillance segment in 2004.

Discontinued Operations.    In August 2006, we realized a $3.1 million gain on the sale of substantially all of the assets of a subdivision in our Detection segment. In December 2006, we adopted a plan for the sale of three businesses that did not align with our overall strategic plans. Loss from discontinued operations was $18.9 million in 2006 and included a $13.1 million impairment loss to write-down the carrying amounts of two of our discontinued businesses to their fair values less costs associated with the sale of the businesses. We completed two of the three sales in the first quarter of 2007 and the third sale during the second quarter of 2007.

Net Loss.    On an Actual basis, net loss increased $112.7 million, or 764%, to $127.5 million in 2006 from $14.8 million in 2005 and increased $9.7 million, or 192%, in 2005 from $5.0 million in 2004. The acquisition of businesses, the majority of which occurred in the final six months of 2005, was the primary reason that revenue increased in both 2006 and 2005. In addition, a goodwill impairment charge of $66.0 million and our loss from discontinued operations of $18.9 million resulted in an increased net loss in 2006.

On a Pro Forma basis, net loss increased $98.3 million, or 337%, to $127.5 million in 2006 from $29.2 in 2005 primarily due to a $66.0 million goodwill impairment loss and losses associated with our discontinued operations. Increased revenue in 2006 was offset by increased spending on internal research and development, selling and marketing activities, the expansion into new facilities and general and administrative expenses. As a result, our net loss is expected to be higher than the Pro Forma comparative periods.

Reportable Segments

We operate our business in three reportable segments: Detection, Surveillance and Solutions. Our Detection segment develops products and conducts research and development in the areas of chemical, biological, radiation, nuclear and explosives detection. Our Surveillance segment provides products and services for perimeter security and wide area surveillance. Our Solutions segment integrates our technologies and products to provide single source solutions that address a broad range of customer specific security and surveillance needs.

Detection Segment

In our Detection segment, we develop products and conduct research in the areas of chemical, biological, radiation, nuclear and explosives detection. Product revenue is primarily derived from the sale of our Fido explosive detectors, Identifinder and Interceptor radiation detectors, AirSentinel bioaerosol sensors and our Griffin gas chromatography/mass spectrometry line of products. Contract research and development revenue is primarily derived from direct contracts with the U.S. government and subcontracts with other commercial entities that contract with the U.S. government. The Detection segment was formed through the acquisition of six companies in 2005 and one company in 2006.

 

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Detection Segment Comparison of First Quarters of 2007 and 2006

The following table includes Actual financial information for the first quarters ended March 31, 2007 and 2006.

 

     Three Months Ended
March 31,
 
     2007      2006  
     (dollars in thousands)  
     (unaudited)  

Revenue and gross profit %

     

Product revenue

   $ 7,694      $ 4,101  

Gross profit %

     44.9%        55.9%  

Contract research and development revenue

     7,086        4,849  

Gross profit %

     31.3%        30.5%  

Maintenance, service and other revenue

     38        37  
                 

Total revenue

   $ 14,818      $ 8,987  

Gross profit %

     38.3%        42.1%  
                 

Operating expenses

     

General and administrative

   $ 2,683      $ 2,308  

% of revenue

     18.1%        25.7%  

Selling and marketing

     1,912        1,728  

% of revenue

     12.9%        19.2%  

Research and development

     1,903        1,094  

% of revenue

     12.8%        12.2%  

Depreciation and amortization

     1,908        2,289  
                 

Total operating expenses

   $ 8,406      $ 7,419  
                 

Operating loss

   $ (2,727 )    $ (3,633 )
                 

Product Revenue and Gross Profit.    Product revenue increased $3.6 million, or 88%, to $7.7 million in the first quarter of 2007 from $4.1 million in the first quarter of 2006 primarily resulting from the increased adoption of new and enhanced products that we have introduced beginning in 2005. Gross profit as a percentage of product sales decreased from 55.9% in the first quarter of 2006 to 44.9% in the first quarter of 2007 primarily due to a change in the mix of sales directly to end customers and sales to original equipment manufacturers in the first quarter of 2007. We typically earn lower gross profit on sales to original equipment manufacturers than on sales directly to end customers, and approximately 26% of our first quarter 2007 revenue was generated by sales through original equipment manufacturers compared to 14% in the first quarter of 2006. To a lesser extent, we experienced lower gross profit in the first quarter of 2007 compared to the first quarter of 2006 because we were required to absorb increased fixed overhead costs due to the expansion of our manufacturing capacity and increased warranty costs.

Contract Research and Development Revenue and Gross Profit.    Contract research and development revenue increased $2.3 million, or 46%, to $7.1 million in the first quarter of 2007 from $4.8 million in the first quarter of 2006. Approximately 90% of the increase, or $2.0 million, is attributable to contract research and development revenue contributed in the first quarter of 2007 by a business that we acquired in December 2006. For the first quarter of 2007 compared to 2006, our gross profit as a percentage of contract research and development was relatively flat.

General and Administrative Expenses.    General and administrative expenses increased $0.4 million, or 16%, to $2.7 million in the first quarter of 2007 from $2.3 million in the first quarter of 2006. Approximately 56% of the increase, or $0.2 million, is attributable to general and administrative expenses included in the first

 

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quarter of 2007 by a business that we acquired in December 2006. The remaining increase primarily resulted from the expansion of our operations into additional facilities. General and administrative expense as a percentage of revenue decreased to 18.1% from 25.7% in the first quarter of 2007 compared to the first quarter of 2006 primarily due to an increase in revenue in the first quarter of 2007 compared to the first quarter of 2006.

Selling and Marketing Expenses.    Selling and marketing expenses increased $0.2 million, or 11%, to $1.9 million in the first quarter of 2007 from $1.7 million in the first quarter of 2006 primarily due to the hiring of additional personnel to support the direct sales of our emerging products.

Research and Development Costs.    Research and development costs increased $0.8 million, or 74%, to $1.9 million in the first quarter of 2007 from $1.1 million in the first quarter of 2006. Approximately 65% of the increase, or $0.5 million, is due to spending on internal research and development projects intended to accelerate the release of our new and enhanced gas chromatography/mass spectrometry line of products. The remaining portion of the increase is attributable to spending on several internal research and development projects for potential applications of our technology in both security and non-security markets.

Depreciation and Amortization.    Depreciation and amortization decreased $0.4 million, or 17%, in the first quarter of 2007 compared to the first quarter of 2006 primarily due to certain customer relationships and firm contracts becoming fully amortized in 2006. Approximately 87% and 94% of the $1.9 million and $2.3 million depreciation and amortization balance in the first quarter of 2007 and 2006, respectively, was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time that the Detection businesses were acquired in 2005.

Operating Loss.    Operating loss decreased $0.9 million, or 25%, to $2.7 million in the first quarter of 2007 from $3.6 million in the first quarter of 2006. Revenue growth of $1.9 million for the comparable quarters was offset by $1.0 million in increased operating expenses related to an increase in spending on selling and marketing activities and internal research and development projects.

Detection Segment Comparison of 2006, 2005 and 2004

The following table presents our Actual results of operations for 2006, 2005 and 2004. This table includes the results of operations of companies we acquired as of the dates of their actual acquisitions.

 

     Year Ended December 31,
     2006      2005      2004
     (dollars in thousands)
     (Actual)

Revenue and gross profit %

        

Product revenue

   $ 21,538      $ 4,173      $   —  

Gross profit %

     47.8%        41.8%        —  

Contract research and development revenue

     21,698        7,146        —  

Gross profit %

     37.7%        39.2%        —  

Maintenance, service and other revenue

     (13 )      9        —  
                        

Total revenue

   $ 43,223      $ 11,328      $ —  

Gross profit %

     42.9%        40.2%        —  
                        

Operating expenses

        

Selling, general and administrative

   $ 17,605      $ 3,608      $ —  

% of revenue

     40.7%        31.9%        —  

Research and development

     4,807        467        —  

% of revenue

     11.1%        4.1%        —  

Goodwill impairment loss

     33,785        —          —  

Depreciation and amortization

     8,569        1,813        —  
                        

Total operating expenses

   $ 64,766      $ 5,888      $ —  
                        

Operating loss

   $ (46,210 )    $ (1,333 )    $ —  
                        

 

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The following table presents our Actual results of operations for 2006 and our Pro Forma results of operations for 2005 and 2004. The Pro Forma results of operations in this table include results of operations of companies we acquired during 2004 and 2005 as though we had acquired those companies at the beginning of 2004. The Pro Forma results do not include the results of operations of companies we acquired in 2006 because those acquisitions were not material to our business.

 

     Year Ended December 31,  
     2006      2005      2004  
     (dollars in thousands)  
     (Actual)     

(Pro Forma)

(unaudited)

 

Revenue and gross profit %

        

Product revenue

   $ 21,538      $ 15,898      $ 19,367  

Gross profit %

     47.8%        50.1%        35.6%  

Contract research and development revenue

     21,698        23,557        16,518  

Gross profit %

     37.7%        31.4%        38.7%  

Maintenance, service and other revenue

     (13 )      451        380  
                          

Total revenue

   $ 43,223      $ 39,906      $ 36,265  

Gross profit %

     42.9%        38.7%        37.5%  
                          

Operating expenses

        

Selling, general and administrative

   $ 17,605      $ 15,141      $ 13,568  

% of revenue

     40.7%        37.9%        37.4%  

Research and development

     4,807        1,366        1,237  

% of revenue

     11.1%        3.4%        3.4%  

Goodwill impairment loss

     33,785        —          —    

Depreciation and amortization

     8,569        7,244        8,778  
                          

Total operating expenses

   $ 64,766      $ 23,751      $ 23,583  
                          

Operating loss

   $ (46,210 )    $ (8,289 )    $ (10,000 )
                          

Product Revenue and Gross Profit.    On an Actual basis, product revenue increased $17.3 million, or 416%, to $21.5 million in 2006 from $4.2 million in 2005 primarily due to the acquisition of five businesses in our Detection segment in 2005 and the acquisition of one business in our Detection segment in 2006. On an Actual basis, gross profit as a percentage of product revenue was 47.8% and 41.8% in 2006 and 2005, respectively. Gross profit on product sales was impacted by our business acquisitions and product mix.

On a Pro Forma basis, product revenue increased $5.6 million, or 35%, to $21.5 million in 2006 from $15.9 million in 2005, and decreased $3.5 million, or 18%, in 2005 from $19.4 million in 2004. In 2005 and 2004, the majority of product revenue in our Detection segment was derived from sales of our radiation products due to the fact that other significant products were not introduced until late in 2004 and in 2005. Approximately 75% of the decrease in revenue from 2004 to 2005, or $2.6 million, resulted from a large one time order that was delivered to a customer through an original equipment manufacturer sale in 2004. In 2006, the increase in product revenue resulted primarily from the introduction of explosive detection and gas chromatography/mass spectrometry products in late 2004 and in 2005.

On a Pro Forma basis, gross profit as a percentage of product revenue was 47.8%, 50.1% and 35.6% in 2006, 2005 and 2004, respectively. Gross profit is primarily impacted by the mix of products we sell and the mix of direct and original equipment manufacturer product sales. Approximately 19%, 29% and 30% of our product revenue in 2006, 2005 and 2004, respectively, was derived from sales to one original equipment manufacturer customer. Because of the introduction of new products in late 2004 and 2005, our product revenue in 2006 and 2005 was attributable to a more diverse and higher margin product base which resulted in better absorption of the lower gross profit derived from original equipment manufacturer sales in 2004. In 2006, gross profit decreased to

 

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47.8% from 50.1% in 2005 primarily due to product mix, efficiency and scale of our manufacturing operations and increased warranty costs.

Contract Research and Development Revenue and Gross Profit.    On an Actual basis, contract research and development revenue increased $14.6 million, or 204%, to $21.7 million in 2006 from $7.1 million in 2005 primarily due to the acquisition of five companies in our Detection segment in 2005 and the acquisition of one company in our Detection segment in 2006. On an Actual basis, gross profit as a percentage of contract research and development revenue was 37.7% and 39.2% in 2006 and 2005, respectively.

On a Pro Forma basis, contract research and development revenue decreased $1.9, or 8%, to $21.7 million in 2006 from $23.6 million in 2005, and increased $7.1 million, or 43%, in 2005 from $16.5 million in 2004. The increase in contract research and development revenue in 2005 compared to 2004 is primarily due to increased government spending on defense and security related programs. In 2004 and 2005, a significant portion of our contract research and development revenue resulted from small business government programs in which some of the businesses we acquired participated. These businesses were no longer eligible to secure contracts under the government small business program after the acquisition in late 2005. Our inability to renew or enter into new contracts under these programs contributed to the decline in contract research and development revenue in 2006 compared to 2005. On a Pro Forma basis, gross profit as a percentage of contract research and development revenue was 37.7%, 31.4% and 38.7% in 2006, 2005 and 2004, respectively. Contract research and development gross profit varies according to the mix of contract types and changes in estimates of the costs to complete those contracts.

Selling, General and Administrative Expenses.    On an Actual basis, selling, general and administrative expenses increased $14.0 million, or 388%, to $17.6 million in 2006 from $3.6 million in 2005 primarily due to the acquisition of five businesses in our Detection segment in 2005 and the acquisition of one business in our Detection segment in 2006.

On a Pro Forma basis, selling, general and administrative expenses increased $2.5 million, or 16%, to $17.6 million in 2006 from $15.1 million in 2005, and increased $1.5 million, or 12%, in 2005 from $13.6 million in 2004. The increases in 2006 and 2005 were related to increased spending on hiring additional personnel, including in particular sales and marketing personnel, expanded facilities and sales and marketing activities, such as tradeshows, demo units and travel, due to the introduction of new products in the Detection segment.

Research and Development Costs.    On an Actual basis, research and development costs increased $4.3 million, or 929%, to $4.8 million in 2006 from $0.5 million in 2005 primarily resulting from the inclusion of internal research and development costs from five businesses we acquired in our Detection segment in 2005 and one business we acquired in our Detection Segment in 2006.

On a Pro Forma basis, research and development costs increased $3.4 million, or 252%, to $4.8 million in 2006 from $1.4 million in 2005, and increased $0.2 million, or 10%, in 2005 from $1.2 million in 2004. In 2006, approximately 57% of the research and development costs in the Detection segment related to spending on internal research and development projects intended to accelerate the release of new and enhanced radiation, explosive and other detection products, and the remaining portion of the increase is attributable to several internal research and development projects related to potential applications of our technology in both security and non-security markets.

Goodwill Impairment.    In 2006, our goodwill impairment was $33.8 million because the estimated fair value of our Detection reporting unit was less than its book value.

Depreciation and Amortization.    On an Actual basis, approximately 90% of the $8.6 million depreciation and amortization balance in 2006 was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time the Detection businesses were acquired in 2005.

 

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On a Pro Forma basis, we assumed that the identifiable intangible amortization began at the beginning of 2004. Accordingly, on a Pro Forma basis, certain intangibles became fully amortized by 2005. On an Actual basis, the same intangibles became fully amortized in 2006. Therefore, we believe it is more meaningful to compare 2006 Actual to 2004 Pro Forma depreciation and amortization expense. Approximately 94% of the 2004 Pro Forma balance was comprised of intangible amortization.

Operating Loss. In 2006, operating loss included a goodwill impairment loss of $33.8 million. On an Actual basis, operating loss excluding the goodwill impairment increased $11.1 million, or 854%, to $12.4 million from $1.3 million in 2005 primarily due to the acquisition of five businesses in our Detection segment in 2005 and the acquisition of one business in our Detection segment in 2006.

On a Pro Forma basis, operating loss excluding goodwill impairment increased $4.1 million, or 50%, to $12.4 million in 2006 from $8.3 million in 2005, and decreased $1.7 million, or 17%, in 2005 from $10.0 million in 2004. The Pro Forma impact of the amortization of our identifiable intangibles represents substantially all of the decline in our Pro Forma operating loss from 2004 to 2005. As more fully described above, the emerging nature of our product business requires investment in internal research and development programs and sales and marketing activities to accelerate the advancement of our technologies into new and enhanced products and to penetrate our markets. As a result, our operating loss (excluding goodwill impairment) was expected to be higher in 2006 than in the Pro Forma comparative periods.

Surveillance Segment

The Surveillance segment provides products and services for perimeter security and wide area surveillance. Product revenue is derived from the sale of our Cerberus and SkyWatch towers, our thermal imaging cameras, including DefendIR and Orion, our STS line of radar products and our infrared sensors product—MarkIR. Contract research and development revenue is primarily derived from direct contracts with the U.S. government and subcontracts with other commercial entities that contract with the U.S. government. Maintenance, service and other revenue is primarily derived from training, installation and warranty contracts. The Surveillance segment was formed through the acquisition of one company in 2003, one company in 2004 and three companies in 2005.

 

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Surveillance Segment Comparison of First Quarters of 2007 and 2006

The following table includes Actual financial information for the first quarters ended March 31, 2007 and 2006.

 

     Three Months Ended
March 31,
 
     2007      2006  
     (dollars in thousands)  
     (unaudited)  

Revenue and gross profit %

     

Product revenue

   $ 6,871      $ 6,310  

Gross profit %

     49.9%        39.0%  

Contract research and development revenue

     692        1,265  

Gross profit %

     51.1%        43.7%  

Maintenance, service and other revenue

     366        152  
                 

Total revenue

   $ 7,929      $ 7,727  

Gross profit %

     49.8%        39.1%  
                 

Operating expenses

     

General and administrative

   $ 1,663      $ 1,684  

% of revenue

     21.0%        21.8%  

Selling and marketing

     1,336        996  

% of revenue

     16.8%        12.9%  

Research and development

     2,032        1,834  

% of revenue

     25.6%        23.7%  

Depreciation and amortization

     945        1,554  
                 

Total operating expenses

   $ 5,976      $ 6,068  
                 

Operating loss

   $ (2,028 )    $ (3,045 )
                 

Product Revenue and Gross Profit.    Product revenue increased $0.6 million, or 9%, to $6.9 million in the first quarter of 2007 from $6.3 million in the first quarter of 2006. Revenue growth in our surveillance segment was limited by export control restrictions that precluded the delivery of approximately $2.0 million in firm orders for our radar products. These restrictions were removed in the third quarter of 2007, and we expect to deliver on unfulfilled orders by the end of 2007. Our limited radar product sales were offset by increased sales of our SkyWatch and Cerberus products.

Gross profit as a percentage of product revenue was 49.9% and 39.0% in the first quarters of 2007 and 2006, respectively, primarily due to the mix of revenue derived from the sales of products manufactured by us and products manufactured by third party contract manufacturers. Approximately 40% of our first quarter 2006 revenue was derived from the sales of products that were manufactured by third parties compared to 3% in the first quarter of 2007. Gross profit on products that are manufactured by third parties is typically lower than gross profit on products that we manufacture ourselves. Our gross profit was also impacted by product mix, increased fixed overhead costs related to the expansion of our manufacturing capabilities and increased warranty costs.

Contract Research and Development Revenue and Gross Profit.    Contract research and development revenue decreased $0.6 million, or 45%, to $0.7 million in the first quarter of 2007 from $1.3 million in the first quarter of 2006 primarily due to the completion of contracts in 2006. Gross profit as a percentage of contract research and development revenue was 51.1% and 43.7% in the first quarters of 2007 and 2006, respectively. The increase in gross profit in the first quarter of 2007 resulted from $0.3 in additional funding on a project that was substantially completed in 2006.

 

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General and Administrative Expenses.    General and administrative expenses were $1.7 million for the first quarters of 2007 and 2006.

Selling and Marketing Expenses.    Selling and marketing expenses increased $0.3 million, or 34%, to $1.3 million in the first quarter of 2007 from $1.0 million in the first quarter of 2006 primarily due to the hiring of additional personnel to support the direct sale of our products.

Research and Development Costs.    Research and Development costs increased $0.2 million, or 11%, to $2.0 million in the first quarter of 2007 from $1.8 million in the first quarter of 2006 primarily due to several internally funded research and development projects that relate to potential applications of our technology in both security and non-security markets.

Depreciation and Amortization.    Depreciation and amortization decreased $0.7 million, or 39%, to $0.9 million in the first quarter of 2007 from $1.6 million in the first quarter of 2006 primarily due to certain customer relationships and firm contracts that became fully amortized in 2006. Approximately 85% and 92% of depreciation and amortization in the first quarter of 2007 and 2006, respectively, was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time the Surveillance businesses were acquired in 2004 and 2005.

Operating Loss.    Operating loss decreased $1.0 million, or 33%, to $2.0 million in the first quarter of 2007 from $3.0 million in the first quarter of 2006. This decrease resulted from $0.9 million in improved gross profit that resulted primarily from a higher mix of our product revenue from internally manufactured products and a $0.09 million decrease in operating costs that resulted primarily from a decrease in intangible amortization.

Surveillance Segment Comparison of 2006, 2005 and 2004

The following table presents our Actual results of operations for 2006, 2005 and 2004. This table includes the results of operations of companies we acquired as of the dates of their actual acquisitions.

 

     Year Ended December 31,  
     2006      2005      2004  
     (dollars in thousands)  
     (Actual)  

Revenue and gross profit %

        

Product revenue

   $ 27,048      $ 10,951      $ 929  

Gross profit %

     48.4%        49.0%        (17.0% )

Contract research and development revenue

     3,996        3,290        2,128  

Gross profit %

     41.8%        45.6%        40.1%  

Maintenance, service and other revenue

     946        336        —    
                          

Total revenue

   $ 31,990      $ 14,577      $ 3,057  

Gross profit %

     47.1%        47.7%        22.7%  
                          

Operating expenses

        

Selling, general and administrative

   $ 12,636      $ 3,517      $ 2,171  

% of revenue

     39.5%        24.1%        71.0%  

Research and development

     7,455        3,596        1,969  

% of revenue

     23.3%        24.7%        64.4%  

Goodwill impairment loss

     25,021        —          —    

Depreciation and amortization

     5,631        1,557        214  
                          

Total operating expenses

   $ 50,743      $ 8,670      $ 4,354  
                          

Operating loss

   $ (35,713 )    $ (1,722 )    $ (3,659 )
                          

 

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The following table presents our Actual results of operations for 2006 and our Pro Forma results of operations for 2005 and 2004. The Pro Forma results of operations in this table include results of operations of companies we acquired during 2004 and 2005 as though we had acquired those companies at the beginning of 2004.

 

     Year Ended December 31,  
     2006      2005      2004  
     (dollars in thousands)  
     (Actual)      (Pro Forma)  
            (unaudited)  

Revenue and gross profit %

        

Product revenue

   $ 27,048      $ 20,042      $ 15,643  

Gross profit %

     48.4%        44.6%        35.2%  

Contract research and development revenue

     3,996        5,405        29,706  

Gross profit %

     41.8%        26.3%        30.1%  

Maintenance, service and other revenue

     946        437        —    
                          

Total revenue

   $ 31,990      $ 25,884      $ 45,349  

Gross profit %

     47.1%        40.9%        31.9%  
                          

Operating expenses

        

Selling, general and administrative

   $ 12,636      $ 9,126      $ 7,678  

% of revenue

     39.5%        35.3%        16.9%  

Research and development

     7,455        6,514        4,090  

% of revenue

     23.3%        25.2%        9.0%  

Goodwill impairment loss

     25,021        —          —    

Depreciation and amortization

     5,630        4,396        6,119  
                          

Total operating expenses

   $ 50,742      $ 20,036      $ 17,887  
                          

Operating loss

   $ (35,713 )    $ (9,442 )    $ (3,436 )
                          

Product Revenue and Gross Profit.    On an Actual basis, product revenue increased $16.0 million, or 147%, to $27.0 million in 2006 from $11.0 million in 2005, and increased $10.1 million, or 1,078%, in 2005 from $0.9 million in 2004 primarily due to the acquisition of one company in our Surveillance segment in 2004 and the acquisition of three companies in our Surveillance segment in 2005. On an Actual basis, gross profit as a percentage of product revenue was 48.4%, 49.0%, and (17.0)% in 2006, 2005, and 2004, respectively.

On a Pro Forma basis, product revenue increased $7.0 million, or 35%, to $27.0 million in 2006 from $20.0 million in 2005 and increased $4.4 million, or 28%, in 2005 from $15.6 million in 2004 primarily due to the introduction of our radar products in late 2004 and 2005. On a Pro Forma basis, gross profit as a percentage of product revenue was 48.4%, 44.6% and 35.2% in 2006, 2005, and 2004, respectively. On a Pro Forma basis, in 2004, our revenue was primarily derived from the sale of SkyWatch towers and cameras. Our cameras were introduced in 2004 and as a marketing strategy we sold those cameras at lower prices to penetrate our target markets, which resulted in lower gross profit in 2004. Additionally, higher than normal warranty costs on our cameras in 2004 resulted in lower gross profit. The sales of our more advanced technology radar systems in 2006 and 2005 increased prices on our cameras, and the correction of our warranty issues resulted in the improvement in our 2006 and 2005 gross profit as compared to 2004.

Contract Research and Development Revenue and Gross Profit.    On an Actual basis, contract research and development revenue increased $0.7 million, or 21%, to $4.0 million in 2006 from $3.3 million in 2005, and increased $1.2 million, or 55%, in 2005 from $2.1 million in 2004 primarily due to the acquisition of one business in our Surveillance segment in 2004 and the acquisition of three businesses in our Surveillance segment in 2005. On an Actual basis gross profit as a percentage of contract research and development revenue was 41.8%, 45.6% and 40.1% in 2006, 2005 and 2004, respectively.

 

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On a Pro Forma basis, contract research and development revenue decreased $1.4 million, or 26%, to $4.0 million in 2006 from $5.4 million in 2005, and decreased $24.3 million, or 82%, in 2005 from $29.7 million in 2004. Substantially all of our contract research and development revenue was derived from U.S. government related contracts. In the 2005 and 2004, the majority of our contract research and development revenue was related to programs for the advancement of our radar technologies. One contract that accounted for approximately 74% of our total contract research and development revenue in 2004 was completed and, accordingly, contract research and development revenue decreased in 2005 compared to 2004. We completed other radar related programs late in 2005, which accounts for the decrease in 2006 contract research and development revenue compared to 2005. In 2006, contract research and development revenue was primarily related to programs for the advancement of technology for our surveillance towers.

On a Pro Forma basis, gross profit as a percentage of contract research and development revenue was 41.8%, 26.3%, and 30.1% in 2006, 2005 and 2004, respectively. Contract research and development gross profit varies according to the mix of contract types. We earned a fixed price on most of our contract research and development contracts in 2006. We had a higher number of cost plus fixed fee contracts in 2004 and 2005, which resulted in lower gross profit. In addition, in 2004, 74% of contract research and development revenue resulted from one cost plus fixed fee contract which impacted gross profit in that year. We use the percentage of completion method for revenue recognition. The estimates inherent in our revenue recognition impact gross profit in the comparative periods.

Selling, General and Administrative Expenses.    On an Actual basis, selling, general and administrative expenses increased $9.1 million, or 259%, to $12.6 million in 2006 from $3.5 million in 2005, and increased $1.3 million, or 62%, in 2005 from $2.2 million in 2004 primarily due to the acquisition of one business in our Surveillance segment in 2004 and the acquisition of three businesses in our Surveillance segment in 2005.

On a Pro Forma basis, selling, general and administrative expenses increased $3.5 million, or 38%, to $12.6 million in 2006 from $9.1 million in 2005, and increased $1.4 million, or 19%, in 2005 from $7.7 million in 2004 primarily due to increased spending on hiring additional personnel, including in particular sales and marketing personnel, expanded facilities and sales and marketing activities for trade shows, demo units and travel, in connection with the introduction of new products in this segment.

Research and Development Costs.    On an Actual basis, research and development costs increased $3.9 million, or 107%, to $7.5 million in 2006 from $3.6 million in 2005, and increased $1.6 million, or 83%, in 2005 from $2.0 million in 2004 primarily due to the acquisition of one business in our Surveillance segment in 2004 and the acquisition of three businesses in our Surveillance segment in 2005.

On a Pro Forma basis, research and development costs increased $1.0 million, or 14%, to $7.5 million in 2006 from $6.5 million in 2005, and increased $2.4 million, or 59%, in 2005 from $4.1 million 2004. In 2006, spending on internal research and development projects related to infrared sensor accounted for approximately 90% of the increase, or $0.8 million, in research and development costs. The remaining increase is attributable to various internal research and development projects that relate to potential applications of our technology in both security and non-security markets.

Goodwill Impairment.    Our impairment was $25.0 million in 2006 because the estimated fair value of certain reporting units in the Surveillance segment was less than their book value.

Depreciation and Amortization.    Approximately 90% of the depreciation and amortization balance of $5.6 million in 2006 was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time the Surveillance businesses were acquired in 2005. On a Pro Forma basis, we assumed that the identifiable intangible amortization began at the beginning of 2004. Accordingly, certain intangibles became fully amortized on a Pro Forma basis by 2005. On an Actual basis, the same intangibles did not become fully amortized until 2006. Accordingly, we believe it is more meaningful to compare 2006 Actual to the 2004 Pro

 

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Forma depreciation and amortization. Approximately 94% of the $6.1 million depreciation and amortization in 2004 on a Pro Forma basis was comprised of intangible amortization.

Operating Loss.    On an Actual basis, excluding the goodwill impairment loss, our 2006 operating loss of $10.7 million increased $9.0 million, or 519%, from $1.7 million in 2005, and decreased $2.0 million, or 53%, in 2005 from $3.7 million in 2004 primarily due to expanded product mix resulting from the acquisition of three businesses in our Surveillance segment in 2005.

On a Pro Forma basis, operating loss excluding goodwill impairment increased $1.3 million, or 13%, to $10.7 million in 2006 from $9.4 million in 2005, and increased $6.0 million, or 175%, in 2005 from $3.4 million in 2004. Improved gross profit for the Surveillance segment was offset by higher operating costs, particularly for selling and marketing activities and internal research and development. As a result, our operating loss (excluding goodwill impairment) was expected to be higher in 2006 than in the Pro Forma comparative periods.

Solutions Segment

The Solutions segment sells products and integrates our technologies and product portfolio to provide single source solutions that address a broad range of customer specific security and surveillance needs. Product revenue is primarily derived from the sale of our Cameleon advanced camera control systems, Cameleon ITS transportation management software, StarWatch security command and control software and Callisto, a non-security related product for process management of diverse SCADA applications. Maintenance, service and other revenue is primarily derived from project management services for the integration of technologies, product training and installation, software maintenance and extended warranty contracts. The Solutions segment was formed through the acquisition of three companies in 2005 and one company in 2006.

Solutions Segment Comparison of First Quarters of 2007 and 2006

The following table includes Actual financial information for the first quarters ended March 31, 2007 and 2006.

 

     Three Months Ended
March 31,
 
     2007     2006  
     (dollars in thousands)  
     (unaudited)  

Revenue and gross profit %

    

Product revenue

   $ 1,832     $ 2,094  

Gross profit %

     36.9%       45.4%  

Maintenance, service and other revenue

     2,382       723  

Gross profit %

     48.2%       51.2%  
                

Total revenue

   $ 4,214     $ 2,817  

Gross profit %

     43.3%       46.9%  
                

Operating expenses

    

General and administrative

   $ 1,376     $ 591  

% of revenue

     32.7%       21.0%  

Selling and marketing

     735       349  

% of revenue

     17.4%       12.4%  

Research and development

     687       526  

% of revenue

     16.3%       18.7%  

Depreciation and amortization

     573       840  
                

Total operating expenses

   $ 3,371     $ 2,306  
                

Operating loss

   $ (1,541 )   $ (985 )
                

 

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Product Revenue and Gross Profit.    Product revenue decreased $0.3 million, or 13%, to $1.8 million in the first quarter of 2007 from $2.1 million in the first quarter of 2006 primarily due to a delay in approval for supplemental funding under the ICIDS military program. We believe that the supplemental funding will be approved in 2007 but we cannot guarantee that the funding will be approved or, if approved, that we will be able to manufacture and deliver the same level of products as in prior years. Gross profit as a percentage of product revenue was 36.9% and 45.4% in the first quarters of 2007 and 2006, respectively. This decrease primarily resulted from the absorption of our relatively fixed overhead costs by revenue derived from a smaller volume of product sales.

Maintenance, Service and Other Revenue and Gross Profit.    Maintenance, service and other revenue increased $1.7 million, or 230%, to $2.4 million in the first quarter of 2007 from $0.7 million in the first quarter of 2006. Approximately 57% of the increase, or $0.9 million, was attributable to maintenance, service and other revenue included in the first quarter of 2007 contributed by a business that we acquired in October 2006. The remaining increase primarily resulted from two fixed price contracts for the project management and integration of technologies for intelligent transportation systems. Gross profit on maintenance, service and other revenue varies according to the mix of contract types.

General and Administrative Expenses.    General and administrative expenses increased $0.8 million, or 133%, to $1.4 million in the first quarter of 2007 from $0.6 million in the first quarter of 2006. Approximately 54% of the increase, or $0.4 million, in the first quarter of 2007 resulted from the inclusion of general and administrative expenses from a business that we acquired in October 2006. The remaining increase primarily resulted from the hiring of additional personnel and the expansion of our operations into additional facilities.

Selling and Marketing Expenses.    Selling and marketing expenses increased $0.4 million, or 111%, to $0.7 million in the first quarter of 2007 from $0.3 million in the first quarter of 2006. Approximately 28% of the increase, or $0.1 million, in the first quarter of 2007 resulted from the inclusion of selling and marketing expenses from a business that we acquired in October 2006. The remaining increase was primarily related to the hiring of additional personnel to support the direct sale of our products and the bid and proposal process for service contracts.

Research and Development Costs.    Research and Development costs increased $0.2 million, or 31%, to $0.7 million in the first quarter of 2007 from $0.5 million in the first quarter of 2006 primarily due to several projects in connection with potential applications of our technology in both security and non-security markets.

Depreciation and Amortization.    Depreciation and amortization decreased $0.2 million, or 32%, to $0.6 million in the first quarter of 2007 from $0.8 million in the first quarter of 2006 primarily due to certain customer relationships and firm contracts becoming fully amortized in 2006. Approximately 94% and 97% of the depreciation and amortization in the first quarters of 2007 and 2006, respectively, was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time the Solutions businesses were acquired in 2005.

Operating Loss.    Operating loss increased $0.5 million, or 56%, to $1.5 million in the first quarter of 2007 from $1.0 million in the first quarter of 2006 primarily due to increased operating costs related to hiring new personnel and the expansion of our facilities.

 

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Solutions Segment Comparison of 2006, 2005 and 2004

The following table presents our Actual results of operations for 2006, 2005 and 2004. This table includes the results of operations of companies we acquired as of the dates of their actual acquisitions.

 

     Year Ended December 31,
     2006     2005     2004
     (dollars in thousands)
     (Actual)

Revenue and gross profit %

      

Product revenue

   $ 10,755     $ 5,315     $ —  

Gross profit %

     43.1%       40.0%       —  

Maintenance, service and other revenue

     4,192       180       —  

Gross profit %

     46.0%       100.0%       —  
                      

Total revenue

   $ 14,947     $ 5,495     $ —  

Gross profit %

     43.9%       42.0%       —  
                      

Operating expenses

      

Selling, general and administrative

   $ 5,823     $ 1,735     $ —  

% of revenue

     29.2%       31.6%       —  

Research and development

     2,239       3,194       —  

% of revenue

     15.0%       58.1%       —  

Goodwill impairment loss

     7,237       —         —  

Depreciation and amortization

     3,007       1,240       —  
                      

Total operating expenses

   $ 18,306     $ 6,169     $   —  
                      

Operating loss

   $ (11,743 )   $ (3,864 )   $ —  
                      

The following table presents our Actual results of operations for 2006 and our Pro Forma results of operations for 2005 and 2004. The Pro Forma results of operations in this table include results of operations of companies we acquired during 2004 and 2005 as though we had acquired those companies at the beginning of 2004. The Pro Forma results do not include the results of operations of companies we acquired in 2006 because those acquisitions were not material to our business.

 

     Year Ended December 31,  
     2006     2005     2004  
     (dollars in thousands)  
     (Actual)     (Pro Forma)  
           (unaudited)  

Revenue and gross profit %

      

Product revenue

   $ 10,755     $ 10,587     $ 10,670  

Gross profit %

     43.1%       45.5%       43.7%  

Maintenance, service and other revenue

     4,192       1,550       1,633  

Gross profit %

     46.0%       50.6%       54.5%  
                        

Total revenue

   $ 14,947     $ 12,137     $ 12,303  

Gross profit %

     43.9%       46.2%       45.1%  
                        

Operating expenses

      

Selling, general and administrative

   $ 5,823     $ 3,812     $ 3,867  

% of revenue

     39.0%       31.4%       31.4%  

Research and development

     2,239       1,240       3,221  

% of revenue

     15.0%       10.2%       26.2%  

Goodwill impairment loss

     7,237       —         —    

Depreciation and amortization

     3,007       2,241       3,118  
                        

Total operating expenses

   $ 18,306     $ 7,293     $ 10,206  
                        

Operating loss

   $ (11,743 )   $ (1,687 )   $ (4,652 )
                        

 

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Product Revenue and Gross Profit.    On an Actual basis, product revenue increased $5.5 million, or 102%, to $10.8 million in 2006 from $5.3 million in 2005 primarily due to the acquisition of three businesses in the Solutions segment in 2005 and the acquisition of one company in the Solutions segment in 2006.

On a Pro Forma basis, revenue in 2006 increased $0.2 million, or 2%, to $10.8 million in 2006 from $10.6 million in 2005, and decreased $0.1 million, or 1%, from $10.7 million in 2004. Approximately 80% of the product revenue in each of the three years is derived from SCADA related applications, a product line that historically contributed relatively consistent product revenue and gross profit due to the maturity of the product line and the stable base of customers.

Maintenance, Service and Other Revenue and Gross Profit.    On an Actual basis, maintenance, service and other revenue increased $4.0 million, or 2,229%, to $4.2 million in 2006 from $0.2 million in 2005 primarily due to the acquisition of two companies in the Solutions segment in 2005.

On a Pro Forma basis, maintenance, service and other revenue increased $2.6 million, or 171%, to $4.2 million in 2006 from $1.6 million in 2005. Maintenance, service and other revenue was relatively flat at $1.6 million in 2005 and 2004. Substantially all of the maintenance, service and other revenue in 2005 and 2004 was derived from video networking and surveillance projects for transportation and other non-security related systems. Approximately 30% of the increase, or $0.8 million, in 2006 compared to 2005 is attributable to securing additional fixed price contracts related to intelligent transportation solutions by hiring managers and engineers with existing customer relationships in the transportation market. Approximately 22% of the increase, or $0.6 million, in 2006 compared to 2005 is attributable to the integration, training, installation and extended warranty service contracts from our business acquisition in October 2006. The remaining increase is primarily derived from growth in our video networking and surveillance service business and software maintenance contracts.

Maintenance, service and other revenue gross profit was 46%, 50.6% and 54.5% in 2006, 2005 and 2004, respectively. Gross profit as a percentage of maintenance, service and other revenue varies according to the mix of contract types.

Selling, General and Administrative Expenses.    On an Actual basis, selling, general and administrative expenses increased $4.1 million, or 236%, to $5.8 million in 2006 from $1.7 million in 2005 primarily due to the acquisition of three businesses in the Solutions segment in 2005 and the acquisition of one business in the Solutions segment in 2006.

On a Pro Forma basis, selling, general and administrative expenses increased $2.0 million, or 53%, to $5.8 million in 2006 from $3.8 million in 2005, and decreased $0.1 million, or 3%, in 2005 from $3.9 million in 2004. Approximately 38% of the increase, or $0.8 million, in 2006 compared to 2005 related to the hiring of new personnel to service the transportation market and the expansion of our office space. Approximately 16% of the increase, or $0.4 million, resulted from the inclusion of selling, general and administrative expenses by a business that we acquired in 2006. The remaining increase resulted from an overall increase in spending related to sales and marketing activities to support our growth.

Research and Development Costs.    On an Actual basis, research and development costs decreased $1.0 million, or 30%, to $2.2 million in 2006 from $3.2 million in 2005. In 2005, research and development costs included $2.3 million in acquired in process research and development. Excluding the impact of the acquired in process research and development, research and development increased $1.3 million, or 144%, to $2.2 million in 2006 from $0.9 million in 2005.

On a Pro Forma basis, research and development increased $1.0 million, or 81%, to $2.2 million in 2006 from $1.2 million in 2005, and decreased $2.0 million, or 62%, in 2005 from $3.2 million in 2004 primarily due to $2.3 million in acquired in process research and development that was assumed in 2004. In 2006, approximately

 

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61% of the increase in research and development costs related to spending on internal research and development projects in connection with our Cameleon product line and the integration of that technology into surveillance applications. The remaining portion of our 2006 increased research and development costs was related to several internal research and development projects that relate to potential applications of our technology in both security and non-security markets.

Goodwill Impairment.    Our goodwill impairment was $7.2 million in 2006 because the estimated fair value of a reporting unit within the Solutions segment was less than its book value.

Depreciation and Amortization.    Approximately 96% of the depreciation and amortization of $3.0 million in 2006 was comprised of amortization of our identifiable intangibles, the majority of which was recorded at the time the Solutions businesses were acquired in 2005. On a Pro Forma basis, we assumed that the identifiable intangible amortization began at the beginning of 2004, and therefore certain intangibles became fully amortized on a Pro Forma basis by 2005. On an Actual basis, the same intangibles became fully amortized in 2006. Accordingly, we believe it is more meaningful to compare Actual 2006 to the Pro Forma 2004 depreciation and amortization. Approximately 99% of the 2004 Pro Forma depreciation and amortization of $3.1 million was comprised of intangible amortization. We are not a capital intensive business and therefore the impact of depreciation on our operating results is not material.

Operating Loss.    On an Actual basis, excluding the goodwill impairment loss, our 2006 operating loss of $4.5 million increased $0.6 million, or 17%, from $3.9 million in 2005 primarily due to the acquisition of three businesses in the Solutions segment in 2005 and the acquisition of one business in the Solutions segment in 2006.

On a Pro Forma basis, operating loss excluding goodwill impairment increased $2.8 million, or 167%, to $4.5 million in 2006 from $1.7 million in 2005, and decreased $3.0 million, or 64%, in 2005 from $4.7 million in 2004, which was primarily due to $2.3 million of acquired in process research and development being included in 2004. Increased spending on personnel and expansion of facilities specific to the transportation market, the acquisition of a business in 2006 and additional investments in selling and marketing activities and internal research and development were the primary factors that increased our operating loss in 2006 compared to 2005. Our plans to grow this segment through sales of integrated solutions will require additional spending on selling, marketing, project management and engineering personnel as well as internal research and development. As a result, our operating loss (excluding goodwill impairment) is expected to be higher than the Pro Forma comparative periods.

Reconciliation of Reportable Segment Operating Losses to the Consolidated Loss from Continuing Operations

The following tables provides a reconciliation of operating losses from reportable segments to our consolidated net loss from continuing operations for the first quarters ended March 31, 2007 and 2006 and the years ended December 31, 2006, 2005 and 2004.

 

     Three Months Ended
March 31,
    Year Ended December 31,  
     2007     2006     2006     2005     2004  
     (dollars in thousands)  
     (unaudited)                    

Reconciliation of segment operating losses to consolidated loss from continuing operations

          

Segment operating losses

   $ (6,297 )   $ (7,663 )   $ (93,667 )   $ (6,918 )   $ (3,659 )

Unallocated general and administrative expenses

     (3,866 )     (3,543 )     (19,360 )     (6,063 )     —    

Unallocated depreciation and amortization expenses

     (42 )     —         (29 )     (545 )     (611 )

Interest expense

     61       116       371       126       21  

Interest income

     (90 )     (99 )     (372 )     (145 )     (1 )

Loss in equity investees

     —         —         —         (839 )     (487 )

Other nonoperating gains (losses), net

     76       176       1,040       (98 )     112  

Minority interest in subsidiaries’ losses

     —         —         —         (639 )     (962 )

Income tax expense (benefit)

     75       (70 )     (295 )     (1,943 )     —    
                                        

Consolidated loss from continuing operations

   $ (10,233 )   $ (10,943 )   $ (111,722 )   $ (11,900 )   $ (3,663 )
                                        

 

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We began incurring significant unallocated general administrative expenses in August 2005 in an effort to begin to centralize and build an operating infrastructure to support our acquired businesses. We did not incur unallocated general administrative expenses prior to that time. As described in note 1 to our consolidated financial statements, for the year ended 2004 we presented consolidated or equity method results of certain of our 2005 business acquisitions if those businesses had previously received investment dollars from Wexford Capital LLC (Wexford). Wexford is our majority shareholder through its affiliate investments. Our unallocated general administrative expenses primarily include personnel costs for executive and senior management, corporate accounting and finance, facilities’ costs, professional fees for audit, tax, legal and other professional services, board of director and advisory board fees, travel, supplies and communication related expenses. Unallocated corporate costs included $0.1 million at March 31, 2007 and 2006 and $0.4 million and $1.2 million for the years ended December 31, 2006 and 2005, respectively, for fees paid to Wexford pursuant to an administrative services agreement.

Liquidity and Capital Resources

As of March 31, 2007, our principal sources of liquidity were cash and cash equivalents of $14.3 million and accounts receivable of $20.3 million.

Our primary sources of cash historically have been proceeds from the issuance of convertible preferred stock, customer payments for our products and services, lines of credit and short term loans and proceeds from the sale of businesses. We were incorporated in 2003 and have primarily grown our business organically and through the acquisition of eighteen companies, most of which were completed in the final six months of 2005. Many of the acquired businesses have early stage products and/or emerging products and engage in research and development activities that are funded both through external government contracts and internal resources.

During 2006 and through the first quarter of 2007, we began to increase our investment in sales, marketing and other related business development structures to support our early stage products and emerging technologies. Additionally, we increased our investment in internally funded research and development activities and the integration of products and technologies among our operating units. We also increased our general administrative expenses in 2006 through the use of consultants and other professionals to complete certain accounting and legal functions. Consequently, our cumulative net losses, which amounted to approximately $157.0 million at March 31, 2007, were expected based on the nature of our business, the early stage of our products and technologies and our ongoing research and development activities. Since our inception in 2003 and through March 31, 2007, we have received approximately $180 million in funding through the issuance of series A convertible preferred stock (Series A), contributed capital and other common equity sources, the proceeds of which have been used to fund our acquisitions and net losses. As more fully described in notes 3 and 4 to our consolidated financial statements, the majority of the funding was from Wexford affiliates.

In 2007, we plan to reduce our losses through a variety of means, including but not limited to the potential sale of certain assets, relying less on external consultants, professionals and advisors, prioritizing our internal research and development spending and increasing revenue through organic growth in product sales. In connection with such loss reduction plans, we adopted a plan in 2006 to seek a purchaser for three of our businesses (see note 10 to our consolidated financial statements). We completed the sale of two of those businesses in the first quarter of 2007 and received net cash proceeds of $8.9 million. We completed the sale of the third business in the second quarter of 2007 and received net cash proceeds of $10.9 million. We believe that we have sufficient working capital and the ability to raise additional equity to fund operations for at least the next twelve months.

We may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. Our future capital requirement will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of new product releases and the acceptance of our products in the marketplace. We may also enter into acquisition agreements for complementary businesses that would require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

 

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The following table shows our cash and cash equivalents and working capital as of March 31, 2007 and December 31, 2006 and 2005:

 

    

As of
March 31,

2007

  

As of

December 31,

        2006    2005
     (dollars in thousands)
     (unaudited)          

Cash and cash equivalents

   $ 14,314    $ 7,236    $ 23,354

Working capital

   $ 32,913    $ 27,312    $ 24,072

The following table shows our cash flows from operating, investing and financing activities for the three months ended March, 31, 2007 and 2006, and for the years ended December 31, 2006, 2005 and 2004. The 2005 and 2004 sections of the table show cash flows for our business acquisitions from the date of acquisition in those years.

 

     Three Months Ended
March 31,
    Year Ended December 31,  
     2007     2006     2006     2005     2004  
     (dollars in thousands)  
     (unaudited)                    

Summary of cash flow:

          

Cash flows used in operating activities

   $ (7,630 )   $ (14,696 )   $ (43,190 )   $ (9,998 )   $ (4,955 )

Cash flows provided by (used in) investing activities

     7,913       (1,156 )     (4,675 )     (92,181 )     (8,529 )

Cash flows provided by financing activities

     6,785       4,058       31,450       124,041       14,396  

Effect of foreign exchange rate on cash

     10       119       295       —         —    
                                        

Consolidated net change in cash and cash equivalents

   $ 7,078     $ (11,675 )   $ (16,120 )   $ 21,862     $ 912  
                                        

Cash Flows from Operating Activities.    Our cash flows from operating activities are significantly influenced by spending required to support the growth of our business in areas such as research and development, sales and marketing, facilities’ expansion and certain general and administrative costs. Our operating cash flows are also influenced by our working capital needs to support growth and fluctuations in inventory, accounts receivable, accounts payable and other current assets and liabilities. The concentration of business with the U.S. government also impacts operating cash flow, particularly for fixed price contracts in which revenue recognition under the percentage of completion method may not coincide with billing. Cash flow used in operating activities decreased $7.1 million, or 48%, to $7.6 million for the first quarter of 2007 from $14.7 million in 2006. The decrease is primarily the result of reduced net losses and an increase in customer collections. For the years ended 2006, 2005 and 2004, our net losses and the timing of customer collections had a significant influence on operating cash flows. Additionally, in 2006, the introduction of new and enhanced products and the overall growth of our business resulted in additional working capital needs to build inventory.

Cash Flows from Investing Activities.    Cash flows from investing activities primarily relate to business acquisitions and dispositions and capital expenditures. In the first quarter of 2007, cash flows from investing activities included $8.9 million of cash proceeds for the sale of two businesses offset by $1.0 million in capital expenditures. In the first quarter of 2006, cash flows used in investing activities related to $1.2 million in capital expenditures. For the years ended December 31, 2006 and 2005, cash flows used in investing activities included $4.2 million and $90.4 million, respectively, for the cash portion of our business acquisitions. In 2006, 2005 and 2004, we incurred capital expenditures of $4.8 million, $1.8 million and $0.5 million, respectively. Capital expenditures for all periods presented primarily pertain to the expansion of facilities, computer equipment and manufacturing and lab equipment. In 2004, we also invested $8.0 million of capital into companies in which we had a minority interest.

 

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Cash Flows from Financing Activities.    Cash flows from financing activities primarily relate to the issuance of our Series A, and the issuance and repayment of our lines of credit, notes payable and long-term debt. In the first quarter of 2007 and 2006, we issued $3.5 million and $3.1 million of Series A, respectively, which was used for working capital purposes. In 2006 and 2005, we issued $32.0 million and $122.1 million in Series A, respectively, which was used for business acquisitions and working capital purposes. Debt issuances, net of repayments, in the first quarter of 2007 and 2006 were $3.2 million and $0.5 million respectively. In the first quarter of 2007, our debt proceeds included a $3.0 million bridge loan from Wexford to be used for working capital purposes. The $3.0 million bridge loan from Wexford was repaid during the second quarter of 2007. For the years ended 2006 and 2005, debt repayments, net of issuances, were $1.1 million and $3.4 million, respectively. In 2005 and 2004, financing cash flows included $5.0 million and $13.8 million of cash contributions from Wexford affiliates to be used for business combinations in those years.

Contractual Obligations

The following table is a summary of our contractual obligations as of December 31, 2006:

 

     Payments Due by Period
     Total    Less than
1 Year
   1-3
Years
   3-5
Years
   More than
5 Years
     (dollars in thousands)

Contractual obligations

              

Long-term debt, including current portion

   $ 657    $ 207    $ 406    $ 44    $ —  

Operating lease obligations

     11,941      2,813      4,929      2,308      1,891

Payments due for prior business combinations

     1,022      1,022      —        —        —  
                                  

Total contractual obligations

   $ 13,620    $ 4,042    $ 5,335    $ 2,352    $ 1,891
                                  

The long-term debt excludes interest payments on each obligation. In July 2007 we entered into a new operating lease agreement for our corporate headquarters. As a result of this new lease agreement our obligations will increase in total by approximately $1.4 million over the term of the lease. Payments due for prior business combinations represent cash amounts held in escrow and a notes payable related to our 2006 business combinations.

Other Notes Payable and Lines of Credit.    At March 31, 2007, we had $0.5 million outstanding under a promissory note which bears interest at 8%. The principal is due and payable on demand and interest payments are made on a monthly basis. The note is secured by substantially all assets of one of our Surveillance businesses. We must obtain consent from the lender prior to incurring additional debt for that business. We also had $0.2 million outstanding under a promissory note which bears interest at 5% and is due and payable on demand; payments of principal and interest are made on a monthly basis. The note is unsecured and is payable to one of our minority shareholders.

In connection with one of our 2006 acquisitions, we issued a $0.3 million note payable as partial consideration. The note bore interest at 8% and was paid in full during 2007.

Certain of our businesses have operating lines of credit with banks in which borrowing is generally collateralized by and based on a percentage of certain eligible accounts receivable, inventory and/or property and equipment. Interest is based on prime or, in some cases, percentage points above prime. The aggregate maximum borrowing amount under those agreements is $3.0 million. At March 31, 2007, we had $1.9 million outstanding under those agreements.

 

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Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make assumptions and prepare estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and revenues and expenses. We base our estimates on historical experience and various other assumptions that we believe are reasonable; however, actual results may differ. See note 1 to our consolidated financial statements contained elsewhere in this prospectus for a discussion of our significant accounting policies.

Revenue RecognitionProducts.    The majority of our revenue is derived from the sale of our products. We recognize revenue from product sales at the time the product is shipped, title and risk have passed to the customer and collection from the customer is reasonably assured.

Revenue RecognitionContract Research and Development and Services.    We follow the guidelines of American Institute of Certified Public Accountants (AICPA) Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, for our contract research and development and contract service revenue. We account for sales and earnings under long-term contracts using the percentage-of-completion method of accounting. Under the percentage-of-completion method, we recognize revenue as the work progresses—either as the products are produced and delivered or as services are rendered, as applicable. We estimate profit as the difference between total estimated revenue and total estimated cost of a contract and recognize that profit over the remaining life of the contract based on either input (e.g., costs incurred) or output (e.g., units delivered) measures, as appropriate. If a revised estimate of contract profitability reveals an anticipated loss on the contract, we recognize the loss in the period it is identified.

The percentage-of-completion method of accounting involves the use of various estimating techniques to project costs at completion, and in some cases includes estimates of recoveries asserted against the customer for changes in specifications. Contract estimates involve various assumptions and projections relative to the outcome of future events over a period of several months or years, including future labor productivity and availability, the nature and complexity of the work to be performed, the cost and availability of materials, the impact of delayed performance, the availability and timing of funding from the customer and the timing of product deliveries. These estimates are based on our best judgment. A significant change in one or more of these estimates could affect the profitability of one or more of our contracts. We principally use hours of work and contract milestones to measure the progress of contract completeness. Certain contracts provide for billings and/or payments that may not coincide with revenue recognition. To the extent that customer billings or payments are in excess of revenues, we record the excess as deferred revenue. To the extent that we recognize revenue under the percentage of completion method prior to billings as defined in the contracts, we record such amounts as unbilled revenue, and we expect them to be collected within one year of recognition. Substantially all of the unbilled revenue is due from various agencies of the U.S. government.

We review our contract estimates monthly to assess revisions in contract values and estimated costs at completion and reflect changes in estimates in the current and future periods under the reallocation method.

Revenue RecognitionMaintenance, Service and Other.    Maintenance, service and other revenue is primarily derived from project management and technology integration services, product training and installation and software maintenance and extended warranty contracts. We recognize revenue from project management and integration services using the percentage of completion method described above. We recognize revenue from product training and installation services when the services are provided. We generally recognize revenue for software maintenance and extended warranty contracts on a straight-line basis over the life of the contract. We recognize software revenue under the provisions of the Accounting Standards Executive Committee’s Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition (as amended by SOP 98-9). Under the terms of

 

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SOPs 97-2 and 98-9, companies are required to defer all revenue from multiple-element software arrangements if sufficient vendor specific objective evidence does not exist for the allocation of revenue to the various elements of the arrangement. As a result, we recognize any revenue on multi-year software license agreements ratably over the life of the arrangement.

Goodwill and Identifiable Intangible Assets.    In accordance with SFAS No. 141, Business Combinations (SFAS 141), we allocate the cost of business acquisitions to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition (commonly referred to as the purchase price allocation). As part of the purchase price allocations for our business acquisitions, identifiable intangible assets are recognized as assets apart from goodwill if they arise from contractual or other legal rights, or if they are capable of being separated or divided from the acquired business and sold, transferred, licensed, rented or exchanged. However, in accordance with SFAS 141, we do not recognize any intangible assets apart from goodwill for the assembled workforces of our business acquisitions.

A significant component of the businesses we have acquired historically is the presence of advanced security products and technologies that the business has developed. The most significant identifiable intangible asset that we have separately recognized in accordance with SFAS 141 is core technologies. Our intellectual property and proprietary rights for these core technologies are typically protected through a combination of patents, copyrights, trademarks, service marks, trade secrets, confidentiality provisions and licensing arrangements. The fair value for core technologies is determined, as of the date of acquisition, using the “Relief from Royalty Method,” an approach commonly used in valuing intangible assets. The basic tenet of the “Relief from Royalty Method” is that without ownership of the subject intangible asset, the user of that intangible asset would have to make a stream of payments to the owner of the asset in return for the rights to use that asset. By acquiring the intangible asset, the user avoids these payments. The valuation of the core technologies takes into consideration the percentage of forecasted revenues directly attributable to the underlying core/developed technologies. The royalty rate was selected based on consideration of several factors including external research, industry practices and margin considerations. Also factoring into the valuations of core technologies are the estimated technological useful lives of the products that use the technologies and the present value of future cash flows. The discount rates used to determine the present value of future cash flows is based on consideration of the weighted average cost of capital and internal rates of return as well as the risk and return characteristics of the core technologies.

Customer contractual relationships also constitute a significant portion of identifiable intangible assets recognized in accordance with SFAS 141. All of our contractual relationships are established through written customer contracts (revenue arrangements). The fair value for customer contractual relationships is determined, as of the date of acquisition, based on estimates and judgments regarding expectations for the estimated future after-tax earnings and cash flows (including cash flows from working capital) arising from the follow-on sales on contract (revenue arrangement) renewals expected from customer contractual relationships over their estimated lives, including the probability of expected future contract renewals and sales, less a contributory asset charge, all of which is discounted to present value.

The value assigned to goodwill equals the amount of the purchase price of the business acquired in excess of the sum of the amounts assigned to identifiable acquired assets, both tangible and intangible, less liabilities assumed. At December 31, 2006, we had goodwill of $62.9 million and identifiable intangible assets, net of accumulated amortization, of $37.0 million.

Intangible assets are amortized over their respective estimated useful lives ranging from one to ten years. The useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to our future cash flows rather than the period of time that it would take us to internally develop an intangible asset that would provide similar benefits. The estimate of the useful lives of our intangible asset is based on an analysis of all pertinent factors, in particular:

 

   

the expected use of the asset by the entity;

 

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the expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate;

 

   

any legal, regulatory or contractual provisions that may limit the useful life;

 

   

any legal, regulatory, or contractual provisions that enable renewal or extension of the asset’s legal or contractual life without substantial cost (provided there is evidence to support renewal or extension and renewal or extension can be accomplished without material modifications of the existing terms and conditions);

 

   

the effects of obsolescence, demand, competition and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels); and

 

   

the level of regular maintenance expenditures (but not enhancements) required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a limited useful life).

If no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset, the useful life of the asset is considered to be indefinite. The term indefinite does not mean infinite. An intangible asset with a finite useful life is amortized over that useful life; an intangible asset with an indefinite useful life is not amortized. We have no intangible assets with indefinite useful lives. Under U.S. generally accepted accounting principles (GAAP), goodwill is not amortized.

We review goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, and also review goodwill annually in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 142 requires that goodwill be tested, at a minimum, annually for each reporting unit using a two-step process. A reporting unit is an operating segment, as defined in paragraph 10 of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, or a component of an operating segment. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and is reviewed. Two or more components of an operating segment may be aggregated and deemed a single reporting unit for goodwill impairment testing purposes if the components have similar economic characteristics. The first step is to identify any potential impairment by comparing the carrying value of the reporting unit to its fair value. If a potential impairment is identified, the second step is to measure the impairment loss by comparing the implied fair value of goodwill with the carrying value of goodwill of the reporting unit. The fair value of a reporting unit is estimated using a discounted cash flow valuation approach and is dependent on estimates for future sales, operating income, depreciation and amortization, income tax payments, working capital changes and capital expenditures as well as expected growth rates for cash flows and long-term interest rates, all of which are affected by economic conditions related to the industries in which we operate as well as conditions in the U.S. capital markets.

The most significant assumptions used in a discounted cash flow valuation regarding the estimated fair values of our reporting units in connection with goodwill valuation assessments are:

 

   

detailed long-range (approximating 10 years) cash flow projections for each of our reporting units;

 

   

a risk adjusted discount rate including the estimated risk-free rate of return; and

 

   

the expected long-term growth rate of our business, which approximates the expected long-term growth rate for the U.S. economy and the industries in which we operate.

The risk adjusted discount rate represents the estimated weighted average cost of capital. The weighted average cost of capital focuses on rates of return for equity and debt, and a corresponding capital structure.

 

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A decline in the estimated fair value of a reporting unit could result in a goodwill impairment and a related non-cash impairment charge against earnings, if estimated fair value for the reporting unit is less than the carrying value of the net assets of the reporting unit, including its goodwill. For the year ended December 31, 2006, we recognized a goodwill impairment loss of $66.0 million.

Stock-based Compensation.    Prior to January 1, 2006, we accounted for employee stock options using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, and had adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123(R)), and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. In accordance with APB 25, we recognized no stock-based compensation expense for options granted with an exercise price equal to or greater than the fair value of the underlying common stock on the date of grant.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method. Under the modified prospective transition method, share-based awards granted or modified on or after January 1, 2006 are recognized in compensation expense over the applicable vesting period. Also, any previously granted awards that were not fully vested as of January 1, 2006, are recognized as compensation expense over the remaining vesting period. We recognize this expense on a straight-line basis over the options’ expected terms. We estimate the grant date fair value of stock option awards under the provisions of SFAS 123(R) using the Black-Scholes option valuation model, which requires, among other inputs, an estimate of the fair value of the underlying common stock on the date of grant and the expected term of the options.

Given the absence of an active market for our common stock, we engaged independent third parties to perform valuations of our common stock for 16 separate dates in 2005 and five separate dates in 2006. We based the estimated fair value of our common stock on these independent third-party valuations. These valuations used a discounted cash flow model for 2005 and the probability weighted expected return method for 2006.

We also engaged independent third parties to calculate the Black-Scholes fair value of each option granted during the related stock valuation periods. Separate values were determined for options having pre-split exercise prices ranging from $0.08 to $5.00 in 2005 and for options having pre-split exercise prices of $5.00 per share and $7.50 per share in 2006. The independent third parties applied the resulting fair values for one share of common stock as of each of the valuation dates to our Black-Scholes option valuation model to arrive at the fair value of the related options granted during the valuation period.

For 2005 options, the independent third party calculated expected option terms of two to five years based primarily on the vesting dates. For 2006 options, the independent third party calculated expected option terms based on the “simplified” method for “plain vanilla” options contained in SEC Staff Accounting Bulletin No. 107, Valuation of Share-Based Payment Arrangements for Public Companies. The “simplified method” calculates the expected term as the average of the vesting term and the original contractual term of the options. The expected term affects the assumed rate of forfeitures. If the actual number of forfeitures differs from that estimated by management, we may be required to record adjustments to stock-based compensation expense in future periods. As our common stock has no market, the independent third parties calculated volatility using the annualized daily volatilities of similar publicly-traded entities.

For the year ended December 31, 2005, we recognized stock-based compensation expense of $1.1 million for “in the money” stock options resulting from unvested stock options assumed in connection with our business acquisitions. Our pro forma stock-based compensation expense for the year ended December 31, 2005 would have been $7.4 million had we followed the fair value provisions of SFAS 123(R). For the year ended December 31, 2006, we recognized stock-based compensation expense of $4.9 million. In future periods, stock-based compensation expense may increase as we issue additional equity-based awards to continue to attract and

 

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retain key employees. Additionally, SFAS 123(R) requires that we recognize compensation expense only for the portion of stock options that are expected to vest. As of December 31, 2006, our total unrecognized compensation expense related to stock-based awards granted to employees and non-employee directors was $5.6 million.

Income Taxes.    We use an asset and liability approach for accounting for income taxes. Deferred income taxes are recognized for the tax consequences of temporary differences and carryforwards by applying enacted tax rates applicable to future years to differences between the financial statement amounts and the tax bases of existing assets and liabilities. We establish a valuation allowance if it is probable that some portion of the deferred tax asset will not be realized. Our determination of whether a valuation allowance is appropriate requires the exercise of judgment. At December 31, 2006, we had net operating loss carryforwards available for U.S. federal and state income taxes of $69.5 million which begin to expire in 2011. The net operating loss carryforwards that we acquired in connection with our business acquisitions may also be limited by provision of the Internal Revenue Code regarding changes in ownership. We have provided a valuation allowance against net U.S. deferred tax assets and operating loss carryforwards in certain non-U.S. jurisdictions. We have recorded a valuation allowance because of the emerging nature of our business and our history of losses. We will continue to evaluate income generated in future periods in determining the reasonableness of our position. If we determine that future income is sufficient or insufficient to cause the realization of the net operating loss carryforwards within the required time, the valuation allowance will be adjusted as necessary.

Liabilities for Pending and Threatened Litigation.    We are subject to litigation, investigations, proceedings, claims or assessments and various contingent liabilities incidental to our business or assumed in connection with certain business acquisitions. In accordance with SFAS No. 5, Accounting for Contingencies, we accrue a charge for a loss contingency when we believe it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. If the loss is within a range of specified amounts, the most likely amount is accrued, and if no amount within the range represents a better estimate we accrue the minimum amount in the range. Generally, we record the loss contingency at the amount we expect to pay to resolve the contingency and the amount is generally not discounted to the present value. Amounts recoverable under insurance contracts are recorded as assets when recovery is deemed probable. Contingencies that might result in a gain are not recognized until realized. Changes to the amount of the estimated loss, or resolution of one or more contingencies could have a material impact on our results of operations, financial position and cash flows.

Recent Accounting Pronouncements

The Financial Accounting Standards Board (FASB) periodically issues new accounting standards in a continuing effort to improve standards of financial accounting and reporting. The Company has reviewed the recently issued pronouncements and concluded that the following new accounting standards are applicable to the Company.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company has not yet determined the effect on the Company’s consolidated financial statements, if any, upon adoption of SFAS 157.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value at specified election dates. Upon adoption, an entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Most of the provisions apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115, “Accounting for Certain

 

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Investments in Debt and Equity Securities,” applies to all entities with available for sale and trading securities. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact that SFAS 159 will have, if any, on its consolidated financial statements.

Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Risk.    Our international businesses generate revenue and incur expenses that are denominated in foreign currencies. These transactions could be materially affected by currency fluctuations. Our exposures are to fluctuations in exchange rates for the U.S. dollar versus the Euro and the Canadian dollar. Changes in currency exchange rates could adversely affect our consolidated results of operations or financial position. We also maintain cash balances denominated in foreign currencies. At March 31, 2007, we had $1.4 million of cash in foreign accounts. We have not hedged our exposure to changes in foreign currency exchange rates and, as a result, could incur unanticipated translation gains and losses.

Interest Rate Risk.    We had cash and cash equivalents balance of $14.3 million at March 31, 2007. We do not enter into investments for trading or speculative purposes. We do not believe that we have any material exposure to changes in the fair value of these investments as a result of changes in interest rates. Declines in interest rates, however, will reduce future income.

We had $1.9 million outstanding under line of credit agreements at March 31, 2007, which bore interest at variable rates adjusted monthly based on the prime rate plus applicable margins. Based on the amounts outstanding and the maximum amount available for borrowing, we do not believe that changes in interest rates create material exposure to our business. Increases in interest rates, however, will increase future interest expense.

Off Balance Sheet Arrangements

As of March 31, 2007, we have no off-balance sheet arrangements as defined in Item 303(a)(4) of the SEC’s Regulation S-K.

 

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BUSINESS

Company Overview

We are a leading developer, manufacturer, marketer and integrator of advanced sensing technologies, products and solutions. Our first and for now principal market is homeland security. Our high precision, proprietary technologies provide a strong foundation upon which we have built a comprehensive line of products that detect, identify and prevent a broad range of critical security threats. Through our proven ability to develop and convert next generation technologies into unique, commercially successful products, we are able to offer a wide range of high quality, compact detection and surveillance products that we believe are more sensitive, more accurate and more cost-effective than conventional products. Our business is organized into three divisions—Detection, Surveillance and Solutions—through which we develop, manufacture and market complete solutions that proactively address some of the most sophisticated and severe security threats facing the world today.

We believe our ability to understand the nature of sophisticated security threats, the technological potential of security solutions and the complex procurement processes of both government and private sector customers differentiates us from other companies in the market. We have developed what we believe is the most comprehensive line of products and integration capabilities for the homeland security market available through a single company. Our revenue grew 187% from 2005 to 2006, primarily as a result of acquisitions in 2005 and grew 38% in the first three months of 2007 as compared to the same period in 2006.

We have achieved and intend to expand our leadership position in the homeland security market by developing innovative technologies. More than half of our approximately 750 employees are highly skilled technologists. From the beginning of 2004 through March 31, 2007, we and the companies we have acquired have invested approximately $37 million of internal funds in research and development and in addition have received approximately $109 million under contracts to conduct research and development for programs we believe will advance our technology and products and strengthen our leadership position in the homeland security market. Through these directed resources, we believe we have developed best-in-class technology and products. For example, our explosives detection systems use amplifying fluorescence polymer technology to detect trace levels of explosives with a level of precision that is in excess of 1,000 times more sensitive than currently deployed systems. We believe we have developed the most stable and accurate gamma and neutron radiation detection systems available in the market today with immediate isotope identification that allows our systems to differentiate between benign and potentially threatening radiation sources. We also have developed new approaches to identify and amplify DNA fragments for more precise and reliable identification of biological agents.

Building on our technological expertise, we have successfully commercialized and marketed a portfolio of products and solutions that we believe are more sensitive, accurate, compact and affordable than those of our competitors. For example, we build the most sensitive portable explosive detector, the smallest spectroscopic radiation detector and the most accurate mobile solutions for perimeter surveillance available in the market today. We will continue converting our innovative technology pipeline into new growth platforms, enabling us to pursue new market opportunities.

We sell our products and services both directly through a global sales force and indirectly through leading industry participants with whom we have developed strategic alliances and partnerships. Due to the breadth and diverse nature of our product offerings and technology portfolio, as well as our ability to deliver solutions for a comprehensive range of critical security applications, the future success of our business is not dependent upon a single product, technology, customer or government program.

Our direct customers include federal agencies, such as the U.S. Department of Homeland Security, U.S. Customs & Border Protection (Border Patrol) and the Transportation Security Administration, as well as various state and local governments and agencies, including the New York Police Department and the Port of Long Beach. We also sell our products, components and sub-systems to leading integrators in the security and defense industries who either resell our products or integrate them into comprehensive security installations for their end

 

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customers. The value-added resellers and system integrators that we sell products to include The Boeing Company, Honeywell International, Inc., Northrop Grumman Corp., Raytheon Company, SAIC, Inc. and Thermo Fisher Scientific Inc. We sell to military customers such as the U.S. Department of Defense (DoD), the U.S. Air Force, the U.S. Marines and the U.S. Army. Additionally, we are expanding our addressable markets by selling to private sector customers such as Federal Express Corporation, The Walt Disney Company and two international airports serving the city of Houston, Texas and surrounding communities.

Industry Overview

The proliferation of global security threats has reached unprecedented levels. These threats not only jeopardize innocent lives, but also have the potential to inflict severe damage upon the global economy. Both the government and private sectors are preparing to address increasingly sophisticated types of terrorist attacks, including chemical, biological, radiological, nuclear and explosive threats, as well as other major security risks and natural disasters. As a result, the homeland security market has grown from approximately $33 billion in 2004 to approximately $55 billion in 2006, and is expected to grow 21% annually to $140 billion by 2011. Because of the importance of security to the global economy, we believe the homeland security market is less exposed to economic downturns and will continue to grow rapidly over the next decade.

The U.S. military is facing challenges adapting to a new style of asymmetric warfare that requires tactics similar to those used in the homeland security market. An increasingly large amount of the DoD budget is expected to shift in fiscal year 2007 toward advanced technologies that better equip U.S. military forces to face such threats. We have identified $20 billion in the $450 billion fiscal year 2007 DoD budget that is associated with the types of programs we can address. We expect such spending to increase in future years as the full extent of the new threats become more apparent and the DoD works through the aftermath of the current conflicts.

The demand for new security products and technologies also extends to the $145 billion private sector, a rapidly growing market in which many large commercial organizations have made detection, access control and advanced video surveillance a focal point for their security initiatives. Private sector organizations are expected to spend approximately $30 billion on these technologies in 2007.

In addition, we believe our technologies will have utility in a wide range of applications outside the homeland security and military markets. Historically, advanced technologies developed for security and military applications have later been found to have applications in other commercial markets, such as biological research and energy, and have led to the creation of entirely new markets. We believe our technologies may in the future be used in products and solutions for markets that surpass the size of the markets we currently serve.

Market Opportunity

Conventional security products typically are not portable, are either not sensitive enough or generate too many false positives, are difficult to network, or are too expensive for many users to buy and operate. In addition, due to the fragmented nature of the market, many market participants have either focused on manufacturing specific products or acted as integrators who network the products of other companies without having a detailed understanding of the capabilities of these products. As a result, customers are demanding single-source providers in order to allow them to streamline their procurement processes and isolate accountability with fewer vendors.

We provide an expansive portfolio of technology products and solutions that address many of the specific demands of our customers. Our products not only address the shortcomings of conventional products, but also interact in a manner that facilitates the interchange of critical security information. We believe that our ability to network advanced sensors into highly effective, integrated solutions will enable us to capture market share and deliver our customers high-value solutions that warrant premium pricing. We believe our ability to understand the nature of sophisticated security threats, the technological potential of security solutions and the complex procurement processes of both government and private sector customers differentiates us from other companies

 

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in the market. By leveraging our unique technical expertise, we develop, produce and market what we believe are the most advanced sensor and surveillance products available in the homeland security market today. We believe we will be able to apply our technological expertise in security to develop new products in non-security markets.

Our Competitive Strengths

We develop, manufacture, market and integrate products and solutions that detect, identify and prevent a broad range of critical security threats. We believe the following competitive strengths will continue to enhance our leadership position in the homeland security market and the broader security industry.

Leading proprietary technologies.    We are a leading innovator developing high precision, proprietary security technologies that are more accurate, compact and less susceptible to false positives than most conventional technologies. More than half of our approximately 750 employees are highly skilled technologists. From the beginning of 2004 through March 31, 2007, we and companies we have acquired have invested approximately $37 million in research and development and have received approximately $109 million under contracts to conduct research and development for programs we believe will advance our technology and products and strengthen our leadership position in the homeland security market. Our emphasis on innovation has resulted in over 50 issued patents, over 25 pending patents and over 40 licensed patents and patent applications. We also have strong connections with leading research laboratories and universities which foster innovation and advance our technology leadership.

Proven ability to develop, market and commercialize products.    We have been successful in utilizing our advanced technologies to develop commercially viable products and solutions. We have received and expect to continue to receive substantial government funding to carry out our research and product development. Since 2005, we have quadrupled the size of our product line through acquisitions and individual development from ten to forty products. We also understand and are able to successfully navigate the complex security procurement processes of our customers. The growth in sales of our products demonstrates our commercial success.

Broad and diversified product portfolio.    Leveraging our unique technical expertise, we develop, produce and market what we believe are the most advanced products and solutions that detect, identify and prevent a broad range of critical security threats. We believe that our solutions are more sensitive, accurate, compact and affordable than those of our competitors. Due to our diverse product portfolio and our ability to provide solutions for a wide range of critical security applications, the future success of our business is not dependent on a single product, technology, customer or government program.

Ability to deliver comprehensive integrated solutions to key customers.    Our ability to integrate our technology and products into comprehensive, reliable and affordable solutions provides our customers a single source to help address a broad range of critical security threats. We have developed our products in a manner that facilitates interoperability and functional efficiency and also accommodates third-party hardware and software. Our ability to understand the nature of complex security threats, our breadth of product offerings and broad integration capabilities allows us to deliver and implement effective solutions to meet our customers’ needs.

Experienced management team.    Our management team and advisory board has a mix of government and private sector experience across different geographies, industries and functions. Our team promotes entrepreneurial creativity and emphasizes the importance of attracting, developing and retaining the most highly-qualified personnel in our industry. Since our inception, our management team has acquired and integrated 15 diverse companies that have enhanced our capabilities and technology leadership.

 

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Our Growth Strategy

Our objective is to strengthen our position as a leading provider of technologies, products and solutions that detect, identify and prevent a broad range of critical security threats for the homeland security and military markets and to expand on that leadership position by developing products for other markets. As part of our growth strategy, we seek to:

Strengthen our technological leadership.    We intend to continue to develop and acquire next generation technologies to strengthen our technological leadership position. We will continue to work closely with our customers and partners and will seek further government development funding. We will also invest a substantial amount of our own funds in research and development to further enhance our technology leadership position.

Enhance and extend our product line.    We plan to introduce new models of our current products with enhancements to the capabilities of those products in order to address our customers’ evolving needs. We will continue converting our innovative technologies in our research and development pipeline into new products and platforms to pursue new market opportunities.

Provide integrated solutions.    We intend to continue to provide integrated, single-source solutions that prevent a broad range of critical security threats. We believe that significant opportunities exist for companies that understand the nature of complex security threats and meet customers’ needs by developing and delivering effective solutions that respond to those threats and make it easier to capture data from advanced, multifunctional products through integrated networked command platforms.

Scale our distribution channels.    We intend to continue to build and strengthen our direct sales force and expand our indirect channels to extend our geographic reach and market penetration. We have hired key personnel from companies such as FLIR Systems Inc., General Electric Company, Johnson Controls, Inc., Smiths Detection and Thermo Fisher Scientific Inc., as well as from government agencies including the DoD, the U.S. Air Force and the Executive Office of the White House. In addition, in 2007, we significantly expanded our network of sales representatives to market our products to private sector customers and state and local governments and agencies.

Expand into non-security markets.    While in the near-term we intend to continue to focus primarily on products and solutions for the homeland security and military markets, we have developed technologies that are being used in non-security applications, such as chemical sensors for pesticide detection and thermal cameras used to inspect brakes on commercial trucks. We believe our technologies have utility in a wide variety of non-security applications and we intend to continue to explore applications for our technologies in markets that are not related to security. We believe this will allow us to leverage our existing intellectual property and infrastructure to expand our addressable markets and further accelerate our growth.

Grow through complementary acquisitions.    We aim to grow our business, relationships and product offerings by acquiring select companies and assets that enhance our technology leadership, broaden our product offerings or expand our customer relationships. We maintain a highly disciplined approach in our pursuit of acquisitions and their integration, including a rigorous assessment of technological strengths, growth prospects, synergy potential, management strengths and the intrinsic value of potential targets. Since our inception, we have acquired and integrated 15 companies.

Products

We develop and sell proprietary products and solutions that protect people and facilities from a broad range of critical security threats. Our detection products are designed to detect potentially dangerous materials, such as chemical, biological, radiological, nuclear and explosive agents. Our surveillance products are designed to allow more effective surveillance of wide areas, borders and pipelines. Our integrated solutions combine our products and, in some cases, the products of other providers into integrated security solutions. We sell our products and solutions primarily to government and private sector customers in the homeland security and military force

 

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protection markets. Many of our products are designed for use in the field by civilian guards, border patrol officers, coast guard personnel, soldiers, airport passenger and baggage screeners and others working on the front lines of security.

Detection Products

We offer products with advanced capabilities to detect threats in all of the critical chemical, biological, radiological, nuclear and explosive segments. Our detection products are compact, portable, affordable and simple to use compared to laboratory instruments that perform similar functions. We believe that the sensitivity, accuracy and low rate of false positives of our products underscores the technological superiority of our products relative to products designed by other companies for use in the field.

We believe our Fido suite of products, first introduced in 2004, are the world’s most sensitive portable and handheld explosive detection instruments. In tests by the Defense Advanced Research Products Agency and other government laboratories, our Fido products have demonstrated sensitivity more than 1,000 times as sensitive as currently deployed systems, which we believe is comparable to the capabilities of canines. We believe Fido is the first hand-held instrument sensitive enough to detect trace airborne vapors. Fido has been used in the field by U.S. Marines deployed in Iraq and by both the U.S. Air Force and the DoD’s Special Operations Command and is also incorporated into one of iRobot’s detection-and-disarmament autonomous robot platforms. We have recently introduced Fido PaxPoint, which extends the capabilities of Fido technology to detect certain liquids.

Our radiation detectors lead the industry in portability and specificity. We believe our pager-sized radiation sensor Interceptor is the smallest and first instrument in its class that is capable of detection and identification. Other comparably-sized units only measure the intensity of radiation present in an area and sound alarms, but do not identify the material emitting the radiation which is critical to responding to the threat. We have sold radiation detectors to a broad range of customers, including the U.S. Department of Energy’s Nuclear Emergency Search Team, the New York Police Department, the International Atomic Energy Agency (for security at the Summer Olympic Games in Greece), the U.S. Coast Guard and the United Kingdom’s Home Office Border and Immigration Agency.

Our biological security components and products are used to provide reliable, affordable, first-stage detection of airborne biological particulates, such as anthrax. Our BioCapture bio-hazard air sampler is a uniquely small and efficient collector of airborne toxins. Our AirSentinel product—a next-generation “biological smoke alarm”—was selected by the Homeland Security Advanced Research Projects Agency for that agency’s Low-Cost Bio-Aerosol Detector Systems program, and by the DoD for the Pentagon Shield program. We are also developing next generation applications in molecular biological agent detection.

We sell compact and highly sensitive chemical sensors. The DoD has performed live agent testing on all five of our chemical-warfare sensors in this family of products. The U.S. Army ranked the technology that powers these sensors as one of the “10 Greatest Inventions of 2003.” Our magic-marker-sized nerve-agent sensor performs highly sensitive chemical analyses in the field. Under two separate contracts, one with the Department of Homeland Security (Lightweight Autonomous Chemical Identification System program) and one with the U.S. Marines (Field Chemical Analysis Tool program), we are now developing ruggedized, suitcase-size version of this product.

We are also incorporating our core detection technologies in a wide variety of non-security commercial products. For example, we sell chemical sensors used for pesticide detection, hospital sanitation and laboratory measurements; radiation instruments used by hospitals, laboratories and industry; gamma spectroscopy products used for environmental monitoring and food safety; gas sensors used for industrial safety and quality control; and sensors used in the construction industry to monitor the curing of concrete.

 

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ICx Detection Products

(representative list)

 

Explosive   
Fido XT   

•     Light-weight and portable

 

•     True vapor sensing and field tested

 

•     More than 1,000 times more sensitive than conventional trace detection products

 

•     Sensitivity we believe to be comparable to the capabilities of canines (detects femtogram level concentrations)

 

•     Based on sensitive amplifying fluorescent polymer

Fido On-
Board
  

•     Ultra-light version of Fido to integrate onto robots

 

•     Integrated with robot communication protocols

 

•     Comparable to Fido XT in sensing performance

Fido   

•     High sensitivity

 

•     Similar to Fido XT in ease of use

Chemical   
CAD-Kit   

•     Portable, light-weight chemical agent detection kit

 

•     Laboratory-level sensitivity with rapid, visual indication

 

•     Senses key high-threat chemical warfare agents: nerve, blood and blister

 

•     Detects well below immediately dangerous to life or health concentrations

 

•     Very few false readings

Griffin
600
  

•     Provides continuous air monitoring for infrastructure security

 

•     Competitive with ion mobility spectrometry continuous monitoring systems

 

•     Instruments can be arrayed and run remotely with a networked system

Griffin
X-Sorber
  

•     Handheld vapor sampler for chemical warfare agents, toxic industrial compounds and pollutants

 

•     Integrated heaters make the X-Sorber the smallest thermal desorber on the market

 

•     Docks with Griffin 450 to provide on-site lab quality analysis

 

•     Saves and transfers data from sampling event—GPS, sample volume, time stamp and tube ID

Griffin
450
  

•     Mobile gas chromatograph/mass spectrometer with full laboratory level detection

 

•     Detects and identifies explosives, chemical warfare agents, chemicals and organic compounds

 

•     Includes air sampling module

 

•     Suitable for mobile, transportable and remote site applications

 

•     Sensitive to parts-per-trillion concentrations in air, soil and water

 

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SensorChip 4P   

•     Micro-electro-mechanical system (MEMS) photonic crystal that emits and absorbs extremely efficiently in narrow infrared (IR) wave bands used for gas sensing

 

•     Industry-first wafer-level packaging, hermetically sealed, sensor-on-a-chip

 

•     Wearable, compact and highly reliable

 

•     Less than one-tenth of the power consumption of standard IR detectors

Biological   
BioCapture   

•     Widely deployed portable air sampler for detection of biowarfare agents

 

•     Battery powered, modular design for ease of integration

 

•     Stand-alone or incorporated as front-end for range of bio-analytical systems

AirSentinel   

•     Biological “smoke alarm” provides continuous indoor air sampler for biowarfare agents

 

•     Integrates into building HVAC automation systems

 

•     Modular architecture for ease of system integration

 

•      Can integrate with chemical, radiological and explosive sensors

BioBadge   

•     Wearable, low-cost air sampler for detection and alert of biowarfare agents

 

•     Employs key technologies of AirSentinel

SensiQ   

•     High performance biomolecular analysis system

 

•     Semi-automated high throughput system

 

•     Targeted at drug discovery market

SensiQ Discovery   

•     Manual dual-channel biomolecular analysis system

  

 

•     Based on integrated biochip

Radiation & Nuclear Material
Interceptor   

•     Pager-sized radiation detector and identifier

 

•     Gamma/neutron identification

 

•     On-the-spot identification of specific radioactive materials

 

•      Easy operation, built-in event recording and camera

 

•      Bluetooth module

 

•      On-board memory stores up to 50 spectra

identiFINDER   

•      Laboratory-level sensitivity and accuracy in a handheld radiation detector and identifier

 

•      Gamma/neutron detection and identification

 

•      Built-in laboratory-level multi-channel analyzer

 

•      Available in underwater version

 

•      Available in version optimized for explosive ordinance disposal

 

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bagSPEC   

•     Luggage monitor for radioactive materials

 

•     Mountable on standard conveyer belt system

 

•     Two-second response time

cdsSPEC   

•     Portable non-destructive testing of closed containers for possible chemical warfare agents

 

•     Chlorine detection down to 20 grams

 

•     2 to 5 minute response time

dsciSPEC   

•     Digital scintillation spectrometer with ethernet interface

 

•     Real time, remote detection of radioactive sources

 

•     Core driver for portal applications

barrelSPEC   

•     Analyzes the contents of sealed drums

 

•     Fully automatic gamma spectroscopy system

Surveillance Products

Our surveillance products are designed to secure perimeters, such as around ports, airports, nuclear power plants, vessels and vehicles, and to monitor borders, parking lots and other public and private spaces. These products incorporate technologies we have developed to create and fuse images in the infrared, visible light, microwave and millimeter wave bands.

We have developed security cameras with unique capabilities that allow users to overlay visible and infrared images with the user controlling the relative intensity of each of the two overlaid images. Our cameras were selected by over 20 commercial nuclear facilities that deployed advanced technology solutions in 2004 in response to new security mandates issued by the Nuclear Regulatory Commission. These cameras are also being used to protect U.S. Navy bases and civilian ports, including the Port of Long Beach and Port of San Diego. These units are deployed at military bases around the world. Based on our millimeter wave band capabilities, the U.S. Navy awarded us an $8 million contract for our marine millimeter wave band surface search radar. We are also, we believe, the first company to receive certification for a civilian airborne obstacle warning millimeter wave band radar.

We have developed efficient, user-friendly interfaces that integrate our thermal/visible cameras with object-detection radars into a single product. We believe this is the first fully-integrated commercially available radar-camera system with automated radar that points a thermal/visible camera at a moving target that the radar has detected and alerts the human operator to the image of interest.

We have also pioneered the development of surveillance and deterrence towers that can be controlled remotely and allow for manned or un-manned operation. These towers provide a suite of surveillance systems for force protection and force multiplication, which provides greater security with fewer people. Our towers currently protect Border Patrol installations, police departments, prisons, transportation facilities and over 60 U.S. military facilities at home and abroad. Additionally, the U.S. Army Night Vision Lab selected us to design, build and deploy our Cerberus product—a portable, stand-alone, integrated, unmanned tower that incorporates such technologies as radar-cueing of infrared/visible cameras.

We are also incorporating our core surveillance technologies in products unrelated to security. These products include aviation and navigation radars, military targeting and tracking radars and thermal cameras used to inspect truck brakes for safety inspection.

 

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ICx Surveillance Products

(representative list)

 

Integrated surveillance platforms:
SkyWatch   

•     Trailer-transportable, manned surveillance and deterrence platform

 

•     Options include thermal camera, radar, spotlights, ballistic glass and ground sensors

 

•     Lifts from ground to 20-foot level

 

•     Generator or solar power options

 

•     Scalable, open-architecture control software

 

•     Available with integrated video motion detection and digital recording

 

•     Wireless transmission up to seven miles and integrates up to 20 towers

Cerberus   

•     Unmanned self-powered, integrated perimeter surveillance platform

 

•     Integrated sensor suite can include infrared or visible light cameras, ground surveillance radar, video motion detection and unattended ground sensors

 

•     Wireless local area network

 

•     Multiple towers can be networked to central location for complete perimeter coverage

Infrared Cameras:
Illuminator   

•     Low-light camera with High Powered Spotlight triggered on detection

 

•     Non-lethal deterrence

 

•     Radar, Video Motion Detection and Unattended Ground Sensors capability

 

DefendIR   

•     Dual Sensor (visible light and thermal) Pan and Tilt Thermal Imager

 

•     VisionSense Technology that combines the visible and thermal image into one output

 

•     Multiple configurations utilizing various lenses and detectors to optimize the field of view for the desired use

 

•     Radar, Video Motion Detection and Unattended Ground Sensors capability

 

Orion   

•     Long Range 5.5x continuous zoom lens

 

•     Cryogenically cooled detector

 

•     Integrated visible light camera VisionSense Technology

 

•     Precision pan/tilt mount with control and pointing accuracy

 

•     Radar, Video Motion Detection and Unattended Ground Sensors

VisionIR   

•     Mixed-range fixed infrared camera

 

•     Focus-free technology

 

•     Available with either 25 or 37.5 micron focal plane array

 

•     Environmentally sealed and low-maintenance

 

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Radar:
STS-350   

•     Millimeter wave band high-resolution radar for ground surveillance

 

•     High performance radar with unparalleled resolution and accuracy

 

•     360° field of view

 

•     Detects people walking up to 300 meters and crawling up to 100 meters

 

•     Rapid deployable, battery-operated versions

 

•     Network up to 24 units

 

•     Readily integrates to direct and control camera on targets

 

•     User-friendly programmable field-of-detection interface

 

•     Sophisticated built-in software for noise rejection

STS-1400   

•     Video area high-resolution millimeter wave band ground surveillance radar

 

•     360° field of view, one revolution per second and few false-positive readings

 

•     Easy to integrate with Ethernet/XML interface

STS-12000   

•     High performance radar with unparalleled resolution and accuracy

 

•     Remote detection and tracking system radar

 

•     Long-range and/or wide-area surveillance

 

•     Detect moving vehicles up to ten kilometers or people up to five kilometers

Miniature
Surface Search
Radar
  

•     High-resolution marine radar for obstacle detection and terrain mapping

 

•     Lightweight (less than ten pounds)

 

•     Efficient clutter suppression

 

•     Full integration with navigation

 

•     Ethernet interface

Oasys   

•     Certified aviation millimeter wave band radar for obstacle detection (towers, power lines)

 

•     Millimeter wave band radar sees through snow, light rain, smoke, dust, mist and most fog

 

•     Real-time integration with flight-path prediction and range/location of obstacles

Perimeter
Surveillance
Sensors:
  
MarkIR   

•     Friendly force infrared identification and long-range infrared beacon

 

•     Extremely narrow-band emissions in three to five or eight to twelve micron bands

 

•     100 times more infrared energy than LEDs

 

•     Based on our MEMS SensorChip tuned infrared chips

 

•     Not visible to standard imaging or night vision (visible only to narrow infrared cameras)

PulsIR   

•     Broadband infrared power source

 

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Solutions

We design, create and deploy security operating systems and video networking systems. In addition to providing platforms for our sensors and surveillance technologies, we offer software systems that are open, scalable and specifically designed to support or integrate with hardware and software developed by us and other companies.

Our StarWatch software security operating system aggregates inputs from widely dispersed sensors, detectors, portals and imaging systems, providing integrated networking, supervision, control and critical data management, including sophisticated access control. Starwatch was selected to protect the Pentagon and has become a standard for many DoD applications. StarWatch was also selected as one of the software platforms for the Integrated Commercial Intrusion Detection System (ICIDS) for military base security.

Our Cameleon video integration and command software networks, integrates and controls both analog and digital video cameras. The Cameleon software can interface with over 200 different devices and sensors, is used by state government agencies and is installed at military and classified facilities.

We also incorporate the technology used in our security operating systems into non-security solutions, such as supervisory and control systems used to monitor electric utility networks. Government transportation agencies also use our video networking software to monitor and control intelligent traffic systems. Our technologies are also being used in advanced signal processing and in telecommunications, including tunable filters and other components for optical signal processing.

 

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ICx Solution Products

(representative list)

 

Cameleon   

•      Operating system to fully integrate video command centers

 

•      Interfaces with cameras, monitors, video recorders and other types of devices

 

•      Interfaces with both analog and digital video

 

•      Allows easy, incremental migration from analog to digital formats

 

•      Scalable, distributed architecture allows video feeds to be collected from a large number of points and distributed to multiple users

 

•      Vendor agnostic

 

•      Supports over 550 types of equipment sold by mainstream vendors

StarWatch   

•      Suite of security system options for intelligent sensor network and access control

 

•      Scalable from small stand-alone through fully–integrated, wide-area PC-based networked systems

 

•      Supports composite access and alarm monitoring with full workstation performance

 

•      Supports closed circuit television, video badging and video verification options and biometric access controls

 

•      Supports all major communications systems

 

•      Compatible with a wide range of cameras, radars and chemical, biological, radiological and nuclear sensors

SmartGate   

•      Controls vehicular access to facilities and allows those facilities to link specific vehicles with specific individuals, each of which is uniquely identified as they enter the facility

 

•      The system controls all peripherals including gates, light trees and annunciations to the guard force

SAFgate   

•      Monitors and provides access control for vehicle traffic lanes entering military bases or comparable facilities

SmartGate C5   

•      Integrates access control, intrusion detection, video management and devices for chemical, biological, radiation, nuclear and explosives detection

Cameleon ITS   

•      Command and control software for Intelligent Transportation Systems

 

•      Scalable and flexible for large video sharing projects

 

•      Customizable off-the-shelf software for lane control, event management, signage, congestion warning, parking management, bridge and tunnel security, incident detection and management and vehicle access systems

 

•      NTCIP (National Transportation Communications for ITS Protocol) compliant camera, sign and detector control and information exchange

 

•      XML data transfer engine for integration with third party traffic management systems and advanced traveler information systems

 

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Cameleon
Tactical
  

•      Automated camera tracking of radar targets and known GPS-tracked objects

 

•      Supports manned or unmanned tactical platforms for wide area surveillance

 

•      Integrated geo-referenced maps with ability to determine coordinates of fixed assets and known GPS-tracked sources

Cameleon
Enterprise
  

•      Large scale enterprise-wide monitoring of disparate sites from one integrated interface

 

•      Interface permits “point and click” monitoring and alert response for any site on the network worldwide

Customers

We sell our products to a broad base of federal, state and local government customers, to all branches of the U.S. military, and to private sector businesses both in the United States and internationally. We sell our products directly through our internal sales force to agencies of the U.S. government, such as the U.S. Department of Homeland Security (DHS), the U.S. Department of Defense (DoD), the U.S. Department of Energy (DoE), U.S. Customs & Border Protection (Border Patrol), the U.S. Transportation Security Administration (TSA), Federal Bureau of Investigation (FBI), National Aeronautics and Space Administration (NASA), U.S. Secret Service, U.S. Coast Guard, as well as agencies of various state and local governments in the United States, such as the New York Police Department (NYPD) and the Port of Long Beach. We are also beginning to sell our products directly to private sector customers such as Federal Express Corporation, The Walt Disney Company and the international airports serving the city of Houston, Texas and its surrounding communities. For the twelve months ended December 31, 2006 and for the three months ended March 31, 2007, no single customer accounted for over 10% of our product sales.

We also provide products, components and sub-systems to value-added-resellers and system integrators in the security and defense industries who either resell our products or integrate them into comprehensive security installations for their customers. These companies include The Boeing Company, DRS Technologies, Inc., General Dynamics, Inc., General Electric Company, Honeywell International, Inc., Johnson Controls, Inc., Motorola, Inc., Northrop Grumman Corp., Raytheon Company, SAIC, Inc. and Thermo Fisher Scientific Inc. Our core technologies are also being incorporated into non-security products for industrial, environmental, medical and other applications.

The following table illustrates some representative installations for our products.

 

Customer
Installation

  

Product

  

Product Description / Deployment

U.S. Army (Iraq and Afghanistan)    Fido XT   

•      Fido XT is a field-deployable unit that can detect highly sensitive explosives on a real-time basis and has particular application in extreme battlefield conditions present in Iraq and Afghanistan

 

•      Deployed more than 500 units with squadrons of the U.S. and Iraqi armed forces

iRobot, Foster Miller, Exponents    Fido On-Board   

•      Fido On-Board is an ultra-lightweight, highly sensitive explosive sensor for robotic applications

 

•      Currently deployed on iRobot Pacbot, Forest Miller’s Talon and research platforms

 

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Customer
Installation

  

Product

  

Product Description / Deployment

NYPD / Police Departments    SkyWatch Surveillance Tower   

•      SkyWatch is a mobile crime deterrent and surveillance unit that is used to increase security and prevent crime in high risk areas and at special events

 

•      The NYPD purchased several units for crime monitoring and special events, such as the Macy’s Thanksgiving Day Parade

 

•      There are more than 14,000 police agencies in the United States

Bush and Hobby international airports (Houston)    Perimeter Security Radars   

•      STS Radars are the most accurate and precise perimeter security radars commercially available that can see through fog, rain and darkness enabling uninterrupted perimeter monitoring

 

•      Deployed over 1,300 radars at various locations, including three large commercial airports

 

•      There are more than 500 commercial airports in the United States and over 1,500 worldwide

U.S. Customs and Border Patrol    Cerberus Integrated Mobile Sensor Platform   

•      Cerberus is an advanced mobile perimeter security tower with an integrated automated radar, thermal camera and command and control center

 

•      Jointly developed with Night Vision Labs and currently installed at various locations along the southern board of the United States

 

•      Several countries including the United States, Saudi Arabia and the member states of the European Union currently seek to increase their border protection. There are 265 countries worldwide with an estimated total border length of more than 150,000 miles

National Park Service / U.S. Department of the Interior /Statue of Liberty    Advanced Sensors   

•      National monuments are regarded as primary terrorist targets due to the large amount of visitors and their national importance. They generally require perimeter protection and screening of visitors

 

•      The Statue of Liberty National Monument is one of our key pilot sites to deploy our larger product line. Visitors are being screened with our explosive and radiation detectors. We monitor the air for biological agents and protect the perimeter with our radars, cameras and command and control center

 

•      There are over 100 registered national monuments and memorials in the United States

Pentagon    Instantaneous Bioaerosol Detection System   

•      Following the 2001 anthrax attacks in the United States, many government buildings, including the Pentagon, sought to detect and defend against an attack with biological agents

 

•      We have deployed our bio detection systems at the Pentagon and have started to market to the broader commercial building market

 

•      There are over 4.8 million commercial buildings in the United States

 

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Customer
Installation

  

Product

  

Product Description / Deployment

U.S. Army    Integrated Commercial Intrusion Detection Systems   

•      ICIDS is an intrusion detection system that uses CCTV surveillance, intrusion detection sensors and equipment and pass-card enabled entry/exit portals to supervise movement of personnel in buildings

 

•      Installed by the U.S. Army and U.S. Air Force to protect their critical facilities against intrusion and security threats

 

•      The U.S. Army has approximately 185 installations

Hawaii Department of Transportation (DOT)   

Intelligent Traffic Management System

(ITMS)

  

•      ITMS is an integrated software system that can manage and deploy a complete communication, command and control system and allows for detection of security breaches, threats and natural disasters and helps respond better by managing and monitoring traffic patterns

 

•      Deployed by the Hawaii DOT in large cities that require integrated sensor networks comprising air temperature sensors, traffic lights, pop-up barriers and reversible lanes

 

•      There are approximately 100 agencies operating traffic management centers in the United States

NYPD    Video Surveillance   

•      Cameleon manages and integrates dispersed camera networks

 

•      We provided the command and control software for NYPD’s camera network installed during the 2004 Republican National Convention

 

•      The United Kingdom’s Home Office alone monitors approximately 4.2 million video surveillance cameras

Sales and Marketing

We sell our products worldwide through our direct sales force, sales representatives, value added resellers and system integrators. We sell many of our products and services to a broad range of customers in both the government and commercial sectors through our internal sales force. We recently hired sales and marketing personnel from companies in the security industry, including FLIR Systems Inc., General Electric Company, Johnson Controls, Inc., Smiths Detection and Thermo Fisher Scientific Inc., and we intend to aggressively expand our direct sales force in the future. In 2006, our direct sales represented approximately 63% of our revenue.

Some of our products are designed as components or sub-systems that are sold to value added resellers or system integrators for incorporation into their products and systems. For example, we provide firmware and electronics for thermal cameras, video-integration software for security command centers, access control software and firmware for building-wide military security systems, bio-samplers for first-responder bio-alarms, spectrum analyzers and data multiplexers for radiation portals, and laser diodes for medical lasers. The value-added-resellers and system integrators that we sell products to include The Boeing Company, DRS Technologies, Inc., General Dynamics, Inc., General Electric Company, Honeywell International, Inc., Johnson Controls, Inc., Motorola, Inc., Northrop Grumman Corp., Raytheon Company, SAIC, Inc. and Thermo Fisher Scientific Inc. In 2006, our sales through value-added-resellers and system integrators represented approximately 37% of our revenue.

We sell products through our various operating units. While some of our customers purchase products from more than one operating unit, we intend to further coordinate joint sales and marketing activities in the future. For example, we intend to market integrated platforms that combine two or more products, such as mobile surveillance towers integrated with thermal cameras, millimeter wave band radar and other products supplied by our various operating units networked together through our software solution.

 

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We also sell our products internationally. In 2006, sales to customers located outside of the United States accounted for approximately 16% of our revenue. We intend to expand our direct sales force or engage new distributors to target international customers and to take advantage of our business and relationships through our subsidiaries in Canada and Germany. Many security technologies require export licenses before they can be exported from the United States. Obtaining those licenses can be time consuming and expensive. We intend to continue to seek export licenses for appropriate technologies and to develop additional expertise in obtaining these licenses expeditiously and efficiently. We cannot assure you, however, that we will be successful in obtaining export licenses for key technologies because the U.S. Department of State and the U.S. Department of Commerce have broad discretion to delay or prevent the exportation of security technologies. See “Business—Regulatory” and “Risk Factors—Export Controls.”

Technology

Our key technological strengths fall into four principal categories:

 

   

developing, purifying and assembling new sensing materials;

 

   

developing technologies to enable compact design of analytic instruments;

 

   

developing technologies to facilitate the sensing and projection of power at different electromagnetic wavelengths; and

 

   

software technologies for devices and networks.

Sensing materials

Our sensors use new materials with novel characteristics, such as new semiconductors, crystals, polymers, reagents and other recently developed materials. These new materials are extraordinarily sensitive. Some of the materials respond to trace exposures of specific chemical compounds, such as explosives, nerve agents, or biological proteins. Other new materials respond to low-intensity radioactive emissions or specific types of electromagnetic energy, such as specific bands of infrared light. Many of these materials did not exist a few years ago or could not be sufficiently purified or economically assembled into functional structures. These new materials are now the key starting point in our development of extremely compact sensors, imagers and detectors.

In order to transform these materials into sensors, imagers and detectors, we must ensure that these materials are precisely powered. We have sought technologies that incorporate innovative, compact and high-speed electrical circuits, amplifiers, power supplies, communications interfaces and embedded operating systems. Many of the new security threats are so diffuse, or move so quickly, that even the best conventional sensors often give off signals with significant static that can be difficult to interpret. We embed sophisticated software into our products that helps separate static from the signal.

Our core radiation sensing technology combines advanced sensors (sodium iodide, cadmium-zinc-telluride, lithium-6-fiber and helium) with sophisticated analytical engines powered by multichannel spectrum analyzers and high-speed digital signal processors. We have developed some unique approaches to the design and assembly of the basic sensing materials that improves the ability of our units to accurately distinguish between man-made and natural sources of radioactivity. One of our handheld units, for example, provides simultaneous gamma and neutron radiation detection at very low emission rates (1 microrem/hour).

Our explosive detector’s accuracy and sensitivity are derived from a unique amplifying fluorescent polymer, which we use under an exclusive license from the Massachusetts Institute of Technology. This amplifying fluorescent polymer dramatically increases the signal strength of the molecules of interest. Our Fido explosive detector, for example, has achieved detection sensitivities as low as 100 parts per quadrillion. Our various chemical detectors incorporate a number of different technologies, including enzyme-based detection, gamma spectroscopy, the same amplifying fluorescent polymer technology at the core of our explosive detectors, and gamma spectrometry adapted from our radiation detectors.

 

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Compact design

Our engineers have developed very compact, rugged products, suitable for use in the field that perform sophisticated analyses of the sort that would typically require laboratory facilities. Our various biosensors incorporate a number of different technologies, including a very small and efficient air sampler which serves as the front end for our ultraviolet fluorescence interrogation and amplifying fluorescent polymer technologies. Our AirSentinel “biological smoke alarm” uses deep-ultraviolet light-emitting diodes (LEDs) to interrogate samples. Biological proteins fluoresce under this form of deep-ultraviolet illumination. The technology is extremely compact and can be powered by a battery.

Another core detection technology allows us to incorporate biologically active proteins and enzymes within plastics and polymers. Our enzyme-in-polymer technology enables us to turn laboratory test protocols and agents into field test kits for a wide range of chemical and biological materials. We are currently completing development of a spray-on formulation using this technology that can indicate the exact location of any contamination, or confirm that decontamination efforts have succeeded.

Mass spectrometry is uniquely sensitive and accurate, and is the standard laboratory technology for detecting, differentiating and identifying trace levels of chemical compounds in complex chemical environments. All conventionally designed units, however, are much too large and cumbersome to be deployed outside of a laboratory. By contrast, our miniaturized units incorporate unique cylindrical ion trap technology developed at Purdue University, which we use under exclusive license. This technology has allowed us to build the first truly miniaturized, portable mass spectrometer capable of multiple stages of analysis. The cylindrical ion trap incorporates smaller vacuum systems and power electronics than are required in conventional systems. Software incorporated into the product provides instrument control and data analysis and allows end-users to customize operation to address specific applications.

Sensing and projecting power at different electromagnetic wavelengths

Our surveillance products sense and project power across a range of electromagnetic wavelengths to enable better surveillance and response. We believe we are a world leader in developing devices and surfaces that allow the tuning of infrared emission, absorption and transmission. Our photonic crystal technology allows precise tuning of the wavelength of infrared light emitted or absorbed by a silicon surface. Our SensorChip product implements this technology in a micro-electro-mechanical system. The SensorChip enables the single-chip gas sensors that are used to detect potentially dangerous gases, such as methane.

We believe that we have developed the first commercial ground-level surveillance radar operating in the very high frequency millimeter wave bands. Conventional radar systems operate at much lower frequencies, and are less able to discern small, slow and soft targets. Millimeter wave band radar presents very different technical challenges, requiring fundamentally different signal processing and data analysis, and optimal design of all key components, such as antennas, electrical circuitry, firmware and software. We combine these proprietary circuits with real-time operational and signal processing software. Our millimeter wave band radar technology improves image resolution by fourfold or more over conventional microwave radar, and penetrates light rain, fog, and smoke—conditions that often interfere with infrared technologies. Advanced software algorithms provide object recognition, and can control and direct visible and infrared cameras to point toward radar-identified targets.

Our infrared technology consists of the key imaging processing electronics and software to rapidly transform the latest infrared detectors into functioning products. Our pan-and-tilt, forward-looking units operate in the eight to twelve micron spectral range—the infrared band in which humans and animals radiate much of their heat—and wavelengths that readily pass through fog and dust. Our versatile software is incorporated on a modular, scalable, flexible and fully programmable electronics card set that can be used with many detectors. This card set can be readily adapted to interface with new and higher resolution detectors as they are developed by third party vendors. Our cameras can be readily customized to customer specifications.

 

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Flexible software, open interfaces, and scalable systems.

We favor open interfaces and scalability in all of our products, systems and software. We use standard communication and control protocols. We make it easy for system integrators and end-users to incorporate our products in larger systems, and easy for us to link other vendors’ products with our own. We view this as essential because many new security products are being added to legacy systems.

Our security operating systems and video network software, which collect data from large, distributed arrays of sensors and imagers, are extremely robust and stable—a core requirement of all security-related software. At the same time, these are scalable, open-architecture systems that can control and communicate with a very broad range of security hardware, wired and wireless communications networks, and support hardware (such as camera platforms, floodlights, generators, batteries, solar panels, and fuel tanks). Our objective is to make our software the industry-standard security operating system.

The software in our surveillance towers, for example, can monitor, control and integrate distributed arrays of cameras, sensors, high-intensity spotlights, fuel levels in power generators, battery levels, backup solar panels and communication systems. We integrate our infrared cameras with radar, acoustic and other sensors provided by other manufacturers. These cameras can easily link to large, integrated security systems through our Internet Protocol control and video interface. In addition, our AirSentinel product is easily connected to existing control and alarm networks in buildings. The AirSentinel’s modular architecture also makes it easy to network with chemical, radiological and explosive detectors supplied by us or other vendors.

We also embed a great deal of software directly in our products. Highly sensitive sensors and imagers require advanced algorithms and high-speed processors to separate signal from noise, and to transform large streams of raw data into readily accessible information. Our infrared cameras, for example, produce a high- resolution picture from the signal generated by a focal plane array. The software that does this incorporates a deep understanding of how focal plane arrays actually operate in thermally noisy environments. Our software skills are tied to our understanding of high-tech sensing and imaging products, on the one hand, and the practical imperatives of supervision and control on the other.

Intellectual Property

We rely on our patents, trade secret laws, contractual provisions, licenses, copyrights, trademarks and other proprietary rights to protect our intellectual property. We have over 50 issued patents, over 25 pending patents and over 40 licensed patents and patent applications. We cannot guarantee that our pending patent applications will be approved. We focus our patent efforts in the United States and, when justified by cost and strategic importance, we file corresponding foreign patent applications in foreign jurisdictions.

Much of our intellectual property resides in software, firmware, trade secrets and the technical know-how of our employees. The design of compact, efficient radars, for example, is a specialized craft, and we owe the success of our radar products in large part to the skills of our design engineers. The same principle is true for our networking and software systems.

We cannot assure you that the measures we have implemented to prevent misappropriation of our intellectual property are sufficient or will be successful. Competitors may copy our technologies or products, or obtain and use information that we consider proprietary, without our permission. Competitors may also recruit our employees who have access to our proprietary technologies. Intellectual property litigation is often extremely expensive, and the cost of enforcing our patents and other intellectual property may be burdensome or prohibitive.

Many companies and inventors in the technology markets in which we operate file patents. In addition, these companies and inventors may assert other types of intellectual property rights. In the future, others may allege that we are infringing on their intellectual property. Lawsuits stemming from such allegations could limit our sales, expose us to significant liability for damages, force us to shoulder significant litigation costs and consume management time and other resources.

 

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Research and Development

From the beginning of 2004 through March 31, 2007, we and companies we have acquired have invested approximately $37 million in research and development and have received approximately $109 million under contracts to conduct research and development for programs we believe will advance our technology and products and strengthen our leadership position in the homeland security market. Government agencies have funded much of our research and development, and a substantial amount of the basic science leading to our technologies has emerged from decades of earlier federal and university-based research and development. We anticipate earning approximately $25 million in revenue under similar contracts in 2007.

We have received funding support from a wide variety of federal agencies including the Defense Threat Reduction Agency (chemical agent detection), National Institute of Standards and Technology and the National Science Foundation (photonic crystals), DARPA and DHS (biohazard and explosive sensors), DHS and the Air Force Research Labs (high-power lasers), the Army Night Vision Labs (surveillance towers) and the Naval Air Warfare Center (millimeter-wave radar). Our participation in these and other development programs has culminated in the development of a significant number of commercial products. In general, our U.S. government contracts permit us to retain all rights in patents emerging from the funded research and development, subject to the U.S. government’s non-exclusive, non-transferable, irrevocable paid-up license to practice, or to have practiced on its behalf, throughout the world, any technology developed in the performance of such contracts. In addition, the government possesses the right to allow others to use such technology if, among other things, we fail expeditiously to bring products to market or commercialize products based on such technology.

A number of our technologies and key employees came out of the science and engineering departments of leading universities. We have maintained significant connections with leading academic personnel working in fields relevant to our technology and research and development efforts and often hire these academic personnel as consultants. We maintain offices in close proximity to these universities and contract to use their laboratory instruments and tools. We participate with these universities in major government-funded development programs.

We plan to continue to seek government research and development funding for the development of core enabling technologies. We plan to focus our own research and development spending on turning technologies into commercial products, improving product performance and integrating our technologies into multi-function products.

Manufacturing

We manufacture components and products at 12 facilities in the United States and at our facilities in Canada and Germany. We generally conduct the specialized manufacturing that is specific to our technology and core expertise, such as polymer and chemical synthesis, and perform final assembly and quality assurance testing at our own facilities. We seek to avoid any single-supplier dependence, and have identified, or are in the process of identifying, qualified alternative suppliers of critical components. We typically outsource to unaffiliated third parties mold fabrication and plastics injection molding, most circuit board manufacturing and assembly, antenna manufacturing, optics manufacturing, wiring of certain electronic systems and other more routine operations. Unaffiliated third parties also supply specific components of some of our products, such as electrical components and detectors for infrared cameras. While our customers define the performance criteria or characteristics of our products, we have established internal procedures for final test and calibration of key devices and components, and in some cases the calibration process itself is a core, proprietary technology.

Although we have sufficient manufacturing capacity for our existing operations, we expect that we will need to expand some of our manufacturing capacity as our sales increase. Our operating units plan to share manufacturing expertise and resources in the future, and consolidate some of their outsourcing contracts. We believe this will increase our manufacturing efficiency and reduce costs.

 

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Competition

Our diverse product portfolio places us in competition with a wide variety of companies in the homeland security, defense and industrial sectors. Our markets are highly competitive and dynamic. Our many competitors include both a wide variety of small companies with single-point solutions or products and a number of very large and well-established enterprises, including divisions and subsidiaries of Axis AB, BAE Systems, plc, Canberra Industries, Inc., DRS Technologies, Inc., FLIR Systems Inc., General Electric Company, Goodrich Corporation, Honeywell International, Inc., L-1 Identity Solutions Inc., L-3 Communications CE Holdings, Inc., Nice Systems Ltd., RAE Systems, Inc., SAIC, Inc., Smiths Detection and United Technologies Corporation. We do not compete with any one large competitor across the full range of our product portfolio. Many of our competitors have much greater research and development, sales and marketing, manufacturing and financial resources than we have. We expect that competition will increase as other established and emerging companies enter our markets and as new products and technologies are introduced.

We expect our markets to remain highly competitive and dynamic and to reflect rapid technological evolution and continuously evolving customer requirements. Our ability to compete successfully will depend on a number of factors including our ability to:

 

   

develop, adapt and apply new technologies to meet customer needs;

 

   

develop products that reduce costs, that are easy to deploy and that can be integrated into larger systems and networks;

 

   

establish and maintain relationships with key government customers, including government agencies and prime contractors on government projects; and

 

   

recruit and retain qualified personnel, particularly technical personnel.

Employees

As of March 31, 2007, we had 752 full-time employees, of which 606 were located in the United States, 92 were located in Canada and 54 were located in Germany. As of March 31, 2007, approximately 500 of our employees were primarily engaged in engineering, research and development and production, approximately 70 of our employees were primarily engaged in sales and marketing, and approximately 175 of our employees were primarily engaged in operations, general and administration, quality assurance and customer service. Over half of our employees have science and/or engineering backgrounds and approximately 10% of our employees hold PhD degrees.

Facilities

Our principal executive offices are located in a leased facility in Washington, DC. This facility primarily accommodates certain administrative activities, as well as sales and marketing activities. We also lease facilities around the world, including a total of 22 facilities in the Unites States, four facilities in Canada and one facility in Germany. Our facilities in the United States are located in Arizona, California, Florida, Georgia, Indiana, Massachusetts, New Jersey, New Mexico, Oklahoma, Oregon, Pennsylvania, Tennessee and Washington, DC.

We do not own any real property. We believe that our leased facilities are adequate to meet our current needs and that additional facilities are available for lease to meet future needs. Most of our facilities are easily replaceable. Several facilities contain specialized laboratory or manufacturing equipment that would require months to replace if the facility were shut down by fire or other events.

Regulatory

A number of our advanced technology products are subject to U.S. export control laws and regulations, which have certain registration, licensing and recordkeeping requirements for sales and transfers to foreign persons. These regulations include the U.S. Department of State’s International Traffic in Arms Regulations (ITAR), the U.S. Department of Commerce’s Export Administration Regulations (EAR), and the U.S.

 

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Department of Treasury’s economic sanctions regulations. Another key law in this regulatory field is the Foreign Corrupt Practices Act (FCPA). We have a compliance system to identify those products and technologies subject to certain export control regulatory restrictions and, where required, we obtain authorization from the relevant federal agency for sales to foreign buyers or for technology transfers to foreign consultants, companies, universities, investment partners or foreign national employees.

Our products are utilized by all branches of the U.S. military and by some foreign armed forces, and much of our research is funded by DoD agencies such as DARPA and DTRA. Many of the products we develop through our research and development program are characterized as “defense articles” on the ITAR’s U.S. Munitions List, and we are registered with the U.S. Department of State as both a manufacturer and exporter of such munitions items. Other products and technologies with dual-use military and commercial application, such as chemical detectors for environmental safety purposes, are controlled under the EAR’s Commerce Control List, and we have export compliance systems for determining the proper export licensing requirements for such products and technologies. Under U.S. sanctions laws, we are prohibited from exporting our products, technology or services to embargoed countries such as Cuba, Iran, Syria or Sudan, or to terrorist-supporting entities, and our compliance system is structured to address these restrictions as well. Federal law prohibits the payment of bribes or other corrupt payments to get or retain business, and we are mindful of such prohibitions on corrupt payments. Our overseas subsidiaries must abide by the applicable provisions of U.S. export control law and the related export control laws of the countries in which they are located. The U.S. export control laws and regulations place licensing restrictions on transfers of technology to our foreign subsidiaries, and export licenses or other appropriate authorizations are obtained, as appropriate, from the U.S. Department of State or the U.S. Department of Commerce, when required by law.

Compliance with U.S. export control laws and regulations is a challenge for any high technology company involved in export activities. An effective compliance program includes periodic internal auditing and monitoring of export transactions. In any acquisition, the successor company must ensure that the acquired firm is complying with the requirements of U.S. export control regulations and must see that deficiencies are promptly identified and corrected. We have such a practice and establish export compliance standards for all of our subsidiaries, while recognizing the special compliance demands necessitated by certain sensitive technologies or workforce makeup. Violations of any of the various U.S. export control laws can result in significant civil or criminal penalties, or even a denial of export privileges. We recognize that an effective compliance program can help protect the reputation and relationship of a regulated company with the federal agencies administering these laws. Each of the regulatory agencies administering these laws has a voluntary disclosure program that offers the possibility of significantly reduced penalties, if any are applicable, and we have utilized these agency disclosure procedures as part of our overall compliance policy and system of internal controls.

Under the “SAFETY Act” provisions of The Homeland Security Act of 2002, and its implementing regulations, the federal government provides certain liability limitations and a presumption that the “government contractor” defense applies if the Department of Homeland Security “designates” or “certifies” technologies or products as “qualified anti-terrorism technologies,” and if certain other conditions apply. We may seek to qualify some or all of our products and technologies under the SAFETY Act’s provisions in order to obtain such liability protections, but there is no guarantee that the Department of Homeland Security will designate or certify our products and technologies as a qualified anti-terrorism technology. To date, our Fido Portable Explosives Detector has been designated as a qualified anti-terrorism technology, but our other products have been sold without such qualification, and we may continue to sell our products and technologies without such qualification. To the extent we do so, we will not be entitled to the benefit of the SAFETY Act’s limitations on tort liability, or to any U.S. government indemnification.

Legal Proceedings

From time to time, we are involved in various routine legal proceedings. We cannot predict the outcome of these lawsuits, legal proceedings and claims with certainty. Nevertheless, we believe that the outcome of these proceedings, even if determined adversely, would not have a material adverse effect on our business, financial condition and results of operations.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth certain information with respect to our executive officers and members of our Board of Directors as of July 31, 2007:

 

Name

   Age   

Positions

Executive Officers:

     

Hans C. Kobler

   42    President and Chief Executive Officer, Director

Deborah D. Mosier

   40    Chief Financial Officer

Colin J. Cumming

   54    Chief Technology Officer, President—Detection, Director

Douglas Knight

   43    President—Solutions

Daniel L. Manitakos

   49    President—Surveillance

Kenneth P. Rapuano

   44    President—Homeland Security

Daniel T. Mongan

   43    Vice President, General Counsel and Secretary

Non-Employee Directors:

     

Mark P. Mills(3)

   55    Chairman of the Board of Directors

E. Spencer Abraham(2)(3)(4)

   55    Director

Rodney E. Slater(3)(4)

   52    Director

Joseph M. Jacobs(1)(2)

   54    Director

Robert A. Maginn, Jr.(1)(2)(4)

   50    Director

Mark L. Plaumann(1)(4)

   52    Director

(1) Member of the audit committee.
(2) Member of the compensation committee.
(3) Member of the nominating and corporate governance committee.
(4) Our Board of Directors has determined that these directors are independent pursuant to the rules of The NASDAQ Global Market.

Hans C. Kobler, President and Chief Executive Officer, Director. Hans Kobler is a co-founder and has served as our President and Chief Executive Officer and as a member of the Board of Directors since our inception. Mr. Kobler also is a founding partner of Digital Power Capital LLC, a private equity firm, and has served as its Chief Executive Officer since 2001. From 1998 to 2001, Mr. Kobler headed General Electric’s Energy Technology Investment Group, a joint effort by GE Equity and GE Structured Finance. From 1997 to 1998, Mr. Kobler served as Chief Quality Officer of GE Equity, heading its strategic investment initiative and overseeing the development of advanced underwriting methodologies. From 1992 to 1997, Mr. Kobler was a consultant with Bain & Company in its Boston, Munich and Sydney offices, where he was a member of the Buyout practice group. Mr. Kobler holds a Masters degree in Aerospace Engineering from the Technical University of Munich, an M.B.A. from the University of Texas at Austin and has attended INSEAD’s M.B.A. (SS) program.

Deborah D. Mosier, Chief Financial Officer. Debbie Mosier joined Nomadics, Inc., a wholly-owned subsidiary of ICx, as its Chief Financial Officer in 2005. She became our Chief Financial Officer in 2006. From 1995 to 2004, she served in various leadership positions, including as president, chief financial officer and a director for TMS, Inc., a publicly held technology company that developed software and provided services to enable businesses to use document imaging to solve critical business issues. From 1989 to 1996, Ms. Mosier worked in the audit practice of KPMG LLP. Ms. Mosier is a graduate of Leadership Oklahoma, holds a B.S. from Oklahoma State University and is a Certified Public Accountant.

Colin J. Cumming, Chief Technology Officer, President—Detection, Director. Colin Cumming has served as our Chief Technology Officer since 2006 and has been our President—Detection and a member of our Board of Directors since 2005. Mr. Cumming also serves as President and Chief Executive Officer of Nomadics, Inc., our wholly-owned subsidiary, a position he has held since he co-founded Nomadics in 1994. From 1985 to 1994,

 

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Mr. Cumming served as Vice President of Engineering at Frontier Engineering. Mr. Cumming received a B.S. and an M.S. in Electrical Engineering from Oklahoma State University. He has been awarded five patents and has written numerous publications on explosives detection.

Douglas Knight, President—Solutions. Doug Knight joined us as President of our Solutions division in 2007. Prior to joining us, Mr. Knight was the Vice President and General Manager for Global and Federal Accounts with Johnson Controls Security Systems, LLC (Johnson Controls). Before that, he served as a key manager in Scientech, Inc.’s security group from 2002 to 2007. Upon Scientech Inc.’s acquisition by Johnson Controls, Mr. Knight managed finance and corporate support. Prior to that, Mr. Knight was a Program Manager at RJO Enterprises where he was responsible for multiple contracts providing programmatic support to the U.S. government. Mr. Knight has a B.A. and an M.A. from the University of Maryland and a J.D. from American University Washington College of Law.

Daniel L. Manitakos, President—Surveillance. Dan Manitakos joined us in 2006 after a seventeen year tenure at FLIR Systems, Inc. (FLIR). Mr. Manitakos spent the last six years of his career at FLIR as Senior Vice President and General Manager of FLIR’s Boston Operating Division where he oversaw the security camera production business. Mr. Manitakos also served for eight years as a mechanical engineer at Compugraphic Corporation. Mr. Manitakos holds a B.S. in Mechanical Engineering from the University of Massachusetts at Lowell, an M.S. in Mechanical Engineering from Northeastern University and an Executive M.B.A. from Suffolk University.

Kenneth P. Rapuano, President—Homeland Security. Ken Rapuano joined us in 2007 following a long career in the field of national security. Prior to joining ICx, Mr. Rapuano served as the Deputy Intelligence Chief for the Other Coalition Forces Joint Special Operations Task Force in Afghanistan. From 2004 to 2006, Mr. Rapuano served as the Deputy Assistant to the President and Deputy Homeland Security Advisor in the White House. From 2001 to 2004, he served as Deputy Under Secretary for Nuclear Counterterrorism and as National Security Advisor to the Secretary, both at the Department of Energy. As a reserve member of the United States Marine Corps, he also served in Baghdad from May to October in 2003 as Deputy Chief of Operations for the Iraq Survey Group and was promoted to Chief of the Joint Interrogations and Debriefing Center. Mr. Rapuano served as an Infantry Officer in the United States Marine Corps from 1984 to 1988 and has served as a reserve officer since that time. He holds an M.A. in National Security Studies from Georgetown University, a B.A. in Political Science, with a minor in Education, from Middlebury College, and has attended the Marine Corps Air-Ground Task Force Intelligence Officer Course at the Navy and Marine Corps Intelligence School.

Daniel T. Mongan, Vice President, General Counsel and Secretary. Dan Mongan joined us as Vice President, General Counsel and Secretary in 2006. Mr. Mongan has over seventeen years of legal and strategic consulting services experience. From 1995 until 2001 and from 2004 to 2006, Mr. Mongan owned and operated a legal consulting practice that assisted W.L. Gore & Associates, Inc. and other corporate clients in mergers, acquisitions and strategic relationships. From 2001 to 2004, he worked for W.L. Gore & Associates as leader of Corporate Strategy and Corporate Development. Mr. Mongan was also an associate at Shearman & Sterling’s New York office from 1990 until 1995. He received his J.D. from the University of Pennsylvania and a B.S. in Chemical Engineering from the University of Delaware.

Mark P. Mills, Chairman of the Board of Directors. Mark Mills has served as our Chairman of the Board of Directors since 2006. From 2005 to 2006, Mr. Mills also served as our Chief Technology Officer. Mr. Mills is a co-founding partner of Digital Power Capital LLC, was a technology advisor to Banc of America Securities from 2000 to 2002 , and co-author of a technology investment newsletter, the Huber-Mills Digital Power Report from 1999 to 2003. Mr. Mills founded and ran a technology consulting business. He has served as a staff consultant to The White House Science Office (under President Reagan), and has worked with a number of the Federal Research Laboratories, the (former) Congressional Office of Technology Assessment and the U.S. Department of Energy. Mr. Mills holds several patents in fiber optics, defense and solid-state devices. Mr. Mills received his

 

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BSc Honours degree in Physics from Queen’s University, Canada, and is a member of numerous professional societies.

Secretary E. Spencer Abraham, Director. Spencer Abraham is the founder of The Abraham Group LLP, an international strategic consulting firm. Secretary Abraham served as Secretary of the Department of Energy from January 2001 until he resigned in November 2004. Prior to becoming Energy Secretary, Secretary Abraham represented Michigan in the United States Senate from 1995 to 2001 where he served on the Budget, Commerce, Science and Transportation, Judiciary and Small Business Committees. Before his election to the Senate, Secretary Abraham served as co-chairman of the National Republican Congressional Committee from 1991 to 1993. He holds a J.D. from Harvard University.

Secretary Rodney E. Slater, Director. Rodney Slater is currently a partner in the Transportation and Infrastructure group at Patton Boggs LLP. Secretary Slater served under President Clinton as the 13th Secretary of the Department of Transportation from 1997 to 2001. Before becoming Secretary, Mr. Slater was Administrator of the Federal Highway Administration from 1992 to 1997. From 1987 to 1992, he was a member of the Arkansas Sate Highway Commission where he attained the position of chairman. Secretary Slater graduated from Eastern Michigan University and earned a law degree at the University of Arkansas. Additionally, he received an Honorary Doctorate from Howard University in 1999.

Joseph M. Jacobs, Director. Joseph Jacobs has served as a member of our Board of Directors since 2003. Mr. Jacobs is the President of Wexford Capital LLC, an SEC registered investment advisor that he co-founded in 1994. From 1982 to 1994, Mr. Jacobs was employed by Bear Stearns & Co., Inc., where he attained the position of Senior Managing Director. From 1979 to 1982, he was employed as a commercial lending officer at Citibank, N.A. Mr. Jacobs has served on the boards and creditors’ committees of a number of public and private companies in which Wexford has held investments. Mr. Jacobs holds an M.B.A. from Harvard Business School and a B.S. in Economics from the Wharton School of the University of Pennsylvania.

Robert A. Maginn, Jr., Director. Bob Maginn has served as one of our Directors since 2006. He currently serves as Chief Executive Officer and Chairman of Jenzabar, Inc. (Jenzabar), a provider of software and services for higher education. Mr. Maginn joined Jenzabar’s Board of Directors in 1998 and became their Chief Executive Officer in March 2001. Prior to his tenure at Jenzabar, Mr. Maginn worked for over seventeen years at Bain & Company, where he attained the position of Senior Partner and Director. He holds an M.B.A. and an M.A. in Government from Harvard University.

Mark L. Plaumann, Director. Mark Plaumann has served as a member of our Board of Directors since 2006. He is currently a Managing Member of Greyhawke Capital Advisors LLC (Greyhawke), which he co-founded in 1998. Prior to founding Greyhawke, Mr. Plaumann was a Senior Vice President of Wexford Capital LLC, which indirectly holds over ten percent of our outstanding shares of capital stock. Mr. Plaumann was formerly a Managing Director of Alvarez & Marsal, Inc. and the President of American Healthcare Management, Inc. He also earned the position of Senior Manager at Ernst & Young LLP. Mr. Plaumann holds an M.B.A. and a B.A. in Business from University of Central Florida.

Board of Directors

Our Board of Directors currently consists of eight directors who will be elected annually at our annual meeting of stockholders. Our amended and restated bylaws permit our Board of Directors to establish by resolution the authorized number of directors. Nine directors are currently authorized.

Committees of the Board of Directors

Our Board of Directors has established an audit committee, a compensation committee and a nominating and corporate governance committee. The composition and functioning of these committees complies with the

 

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rules of the SEC and The NASDAQ Global Market that are currently applicable to us, and we intend to comply with additional requirements to the extent that they become applicable