SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended September 30, 2004 or

o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

IDENTIX INCORPORATED

Registrant’s telephone number, including area code: (952) 932-0888

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).YES x     NO o

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

88,497,113 shares of Common Stock
as of October 31, 2004

IDENTIX INCORPORATED

INDEX

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IDENTIX INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(Unaudited)

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

3

IDENTIX INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)

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

4

IDENTIX INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

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

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IDENTIX INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

The accompanying condensed consolidated financial statements and related notes are unaudited. However, in the opinion of management, all adjustments (consisting only of normal recurring adjustments, unless otherwise noted), which are necessary for a fair presentation of the financial position and results of operations for the interim periods presented, have been included. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2004 included in the Identix Incorporated Form 10-K. Identix Incorporated is hereinafter referred to as “Identix” or the “Company”. The results of operations for the three months ended September 30, 2004 are not necessarily indicative of results to be expected for the entire fiscal year, which ends on June 30, 2005.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts therein. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, goodwill and other intangible asset impairments, inventory allowances, warranty costs, revenue recognition as well as loss contingencies and restructurings. Actual results could differ from these estimates.

2. Revenue Recognition Policy

Significant management judgments and estimates are made in connection with the revenues recognized in any accounting period. The Company must assess whether the fee associated with a revenue transaction is fixed or determinable and whether or not collection is probable. Material differences could result in the amount and timing of revenues for any period if management were to make different judgments or utilize different estimates.

Certain of the Company’s equipment sales such as its TouchPrint Live Scan Systems generally require installation subsequent to shipment and transfer of title. The Company recognizes revenue on such sales in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”. Revenue related to equipment sales that require installation is deferred until installation is complete and customer acceptance has been obtained. Revenue related to product sales that require no installation such as the Company’s TP3000A and TP3100A products as well as printers and other peripheral devices including DFR-300, DFR-200 and FingerScan V20 are recognized in accordance with the terms of the sale, generally upon shipment by the Company, provided no significant obligations remain and collection of the receivable is deemed reasonably assured. Revenues from sales of products via authorized representatives, dealers, distributors or other third party sales channels are recognized at the time the risks and rewards have transferred.

The Company adopted Emerging Issues Task Force Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables,”(“EITF 00-21”) effective April 1, 2003. Under EITF 00-21, a company must determine whether any or all of the deliverables of a multiple deliverable agreement can be separated from one another. If separation is possible, revenue is recognized for each deliverable (based on objective and reliable evidence of the fair value) as the applicable revenue recognition criteria are achieved for that specific deliverable. Alternatively, if separation is not possible, revenue recognition may need to be spread evenly over the performance of all deliverables, or deferred until all elements of the arrangement have been delivered to the customer.

The Company also sells several stand-alone software products including ABIS systems, BioLogon and software developer kits. Revenue is recognized on software products in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended. The Company recognizes revenue on software products when persuasive evidence of an arrangement exists, delivery has occurred, the vendor’s fee is fixed or determinable and vendor-specific objective evidence (“VSOE”) exists to allocate the total fee to all undelivered elements of the arrangement and collection is deemed reasonably assured. VSOE is established based upon either sales of the element (e.g. maintenance, training or consulting) in individual transactions, or, in certain cases for maintenance, based upon substantive renewal rates. In cases where the Company does not have VSOE for all delivered elements in the transaction (e.g., for licenses), the fees from these multiple-element agreements are allocated using the residual value method. Maintenance revenue is deferred and recognized rateably over the life of the service period of the related agreement.

Revenues related to Identix Identification Services (“IIS”) (See Note 5), which was acquired in February 2004, are recognized as services are performed.

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3. Stock Based Compensation

The Company accounts for its employee and director stock option plans and employee stock purchase plans in accordance with provisions of the Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”. The Company accounts for stock options issued to non-employees in accordance with the provisions of SFAS 123 and Emerging Issues Task Force (“EITF”) 96-18 “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services”. As permitted by SFAS No. 123, “Accounting for Stock Based Compensation”, the Company continues to measure employee compensation cost for its stock option plans using the intrinsic value method of accounting.

Had compensation cost for the Company’s employee stock plans been recognized based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS No. 123, as amended by SFAS No. 148, the Company’s net loss and net loss per share would have been as follows:

4. Discontinued Operations

On February 13, 2004, the Company consummated the sale of Identix Public Sector (IPS) to Alion Science and Technology Corporation (Alion). These operations for the three months ended September 30, 2003 are presented in the Company’s Consolidated Statements of Operations as discontinued operations. Under the terms of the agreement, upon closing Alion paid the Company $8,850,000 million in cash. The terms of the sale include the potential for additional future payments to the Company of up to $500,000 pending satisfaction of certain conditions. The terms of the sale also include an obligation on the part of the Company to indemnify Alion against liabilities, including for breaches of representations and warranties made by the Company in the sales agreement, for an amount not to exceed $2,125,000.

The following table represents the summarized results for the discontinued operations for the three months ended September 30, 2003:

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5. Acquisition

On February 23, 2004, the Company acquired the remaining 50% ownership of Sylvan Identix Fingerprint Centers (“SIFC”) from Sylvan Learning Centers. SIFC is now known as Identix Identification Services (IIS). The Company had previously held a 50% interest in this joint venture and accounted for its investment under the equity method of accounting. The complete results of operations of IIS have been included in the Company’s consolidated statement of operations since February 23, 2004. IIS provides services to corporations and government agencies capturing fingerprints and transmitting the data for applicant background checks. IIS maintains a network of Identix live scan systems at processing centers across the country where certified technicians process applicants. In consideration for Sylvan’s 50% interest in the joint venture, Identix paid Sylvan $875,000 in cash and paid acquisition costs of $50,000. At the date of acquisition, Identix had a negative investment in the joint venture of $235,000. The purchase price was allocated to other intangible assets of $840,000, goodwill of $268,000 and net liabilities of $418,000.

6. Cash and Credit Facilities

The Company financed its operations during the three months ended September 30, 2004 primarily from cash provided by its working capital. As of September 30, 2004, the Company’s principal sources of liquidity consisted of $42,928,000 of working capital including $43,817,000 in cash and cash equivalents and short-term marketable securities.

The Company’s existing line of credit was entered into on May 30, 2003. This line of credit provides for up to the lesser of $15,000,000 or the cash collateral base or the borrowing base. Borrowings under the line of credit are collateralized by substantially all of the assets of the Company and bear interest at the bank’s prime rate of interest, which was 4.75% at September 30, 2004. The line of credit expires on October 1, 2005. Until the Company generates positive net income before income taxes for two consecutive fiscal quarters, the Company will be required to deposit with the lender an amount equal to the sum of the aggregate outstanding principal amount of all prior advances plus any portion of the line of credit reserved to support unexpired letters of credit plus the amount of the requested advance before an advance will be given. In addition, all advances must be used for working capital. At September 30, 2004, there were no amounts outstanding under this line of credit.

The line of credit agreement contains financial, operating and reporting covenants. At September 30, 2004, the Company was in compliance with all covenants.

7. Inventories

Inventories are stated at the lower of standard cost (which approximates actual cost determined on a first-in, first-out method) or market and consisted of the following:

During the three months ended September 30, 2004 and 2003, the Company recorded provisions for excess and obsolete inventory items in the amount of $214,000 and $248,000, respectively.

8. Special Charges

Special charges (such as restructuring and acquisition related charges) result from unique facts and circumstances that likely will not recur with similar materiality or impact on continuing operations. In June 2002, the Company merged with Visionics and in connection with the merger recorded special charges of $18,798,000 for the termination of 110 employees, and the closure of its facilities in Dublin and Los Gatos California.

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The following is a summary of the charges incurred and payments made from the time of the merger through June 30, 2004:

Fiscal 2005

During the three months ended September 30, 2004, the Company incurred $451,000 in special charges related to a reduction in the estimated amount of lease recoveries the Company can expect related to its Los Gatos facilities. The following table represents a summary of special charges between June 30, 2004 and September 30, 2004:

* The portion of the lease exit costs of $4,854,000 that relates to payments to be made more than one year from September 30, 2004 is classified in the consolidated balance sheet as a long-term liability as part of other liabilities.

Fiscal 2004

The following table represents a summary of special charges for the three months ended September 30, 2003:

9. Earnings Per Share

Basic earnings per share are computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to all dilutive potential common shares outstanding during the period, including convertible preferred stock as well as stock options and warrants, using the treasury stock method.

Options and warrants to purchase 7,172,696 and 9,021,068 shares of common stock were outstanding at September 30, 2004 and 2003, respectively, but were not included in the computation of diluted net loss per share as their effect was anti-dilutive. Also 234,558 shares of convertible preferred stock was outstanding at September 30, 2003. Such shares of

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preferred stock were convertible into 234,558 shares of the Company’s common stock, but were not included in the computation of diluted net loss per share as their effect was anti-dilutive. The convertible preferred stock was converted to common stock during the third quarter of fiscal year 2004.

10. Comprehensive Loss

Comprehensive loss for the three months ended September 30, 2004, was $4,833,000 compared to a loss of $4,651,000 for the same period in the prior fiscal year. Accumulated other comprehensive loss for the Company consisted of unrealized gain (loss) on available-for-sale marketable securities and cumulative translation adjustments.

11. Reportable Segment Data

The Company’s reportable segments are strategic business groups that offer different products and services and include inter-segment revenues, corporate allocations and administrative expenses. Due to the disposition of IPS and the acquisition of 100% ownership of IIS, the business segments of Identix have correspondingly been changed from previously reported periods to reflect this activity. Revenues are attributed to the reportable segment that is responsible for generating the revenue and the direct and indirect costs incurred are similarly assigned.

*Revenue related to IIS is included in the Company’s consolidated revenues from the date of acquisition on February 23, 2004 (see Note 5)

12. Foreign Operations Data

In geographical reporting, revenues are attributed to the geographical location of the sales and service organizations:

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13. Indemnification Arrangements and Product Warranties

As part of the Visionics acquisition in June 2002, the Company undertook, and assumed from Visionics, obligations to indemnify the officers and directors of the acquired company for certain events or occurrences while the officer or director served in such capacity. The maximum potential amount of future payments the Company could be required to make under this indemnification obligation is unlimited; however, the Company purchased a directors’ and officers’ insurance policy to cover former directors and officers of Visionics that provides coverage until June 25, 2007 and may enable Identix to recover a portion of any future amounts paid. Assuming the applicability of the coverage and the willingness of the insurer to assume coverage and subject to certain retention, loss limits and other policy provisions and except as provided below, the Company believes the estimated fair value of the indemnification obligations to Visionics’ directors and officers is not material. However, no assurances can be given that the covering insurers will not attempt to dispute the validity, applicability or amount of coverage without expensive and time-consuming litigation against the insurers. As of November 4, 2004, the Company holds indemnification agreements with its current directors and executive officers. The maximum potential amount of future payments the Company could be required to make under these indemnification obligations is unlimited; however, the Company purchased certain directors’ and officers’ insurance policies, effective August 19, 2004, respectively, to cover its directors and officers, and such policies may enable Identix to recover a portion of any covered claims under the agreements. Assuming the applicability of the coverage and the willingness of the insurer to assume coverage and subject to certain retention, loss limits and other policy provisions, the Company believes the estimated fair value of the indemnification obligations to its directors and officers is not material. However, no assurances can be given that the covering insurers will not attempt to dispute the validity, applicability or amount of coverage without expensive and time-consuming litigation against the insurers.

The terms of the sale of IPS, include an obligation on the part of the Company to indemnify Alion against liabilities, including for breaches of representations and warranties made by the Company in the sales agreement, for an amount not to exceed $2,125,000. This indemnification expires two years after the sale of IPS in February 2006.

From time to time, the Company agrees to indemnify its customers against liability if the Company’s products infringe a third party’s intellectual property rights. As of September 30, 2004, the Company was not subject to any pending litigation alleging that the Company’s products infringe the intellectual property rights of any third parties.

The Company offers a 90-day and one year warranty on various products and services. The majority of the warranty liability that the Company has recorded is due to the one-year warranties. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the product is sold. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. The following table presents changes in the Company’s warranty liability during the three months ended September 2004:

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14. Legal Matters

On February 5, 2003, Roger Benson, an individual, filed a lawsuit seeking unspecified damages against the Company, Digital Biometrics, Inc. (“DBI”), and Visionics Corporation in California Superior Court, alleging that in 1998 he was issued a duplicate electronic fingerprint number that was also held by a convicted felon. He alleges that the fingerprint number was generated by a live scan system manufactured by DBI and operated by a Sheriff’s office in the State of Oregon. The lawsuit also alleges injuries from a 43-day incarceration after the plaintiff’s identity was allegedly mistaken for that of the felon because of the duplicate fingerprint number. The complaint alleges liability under strict product liability, failure to warn, breach of implied warranty, negligence, and unfair business practices, among other theories of liability. On December 2, 2003, the court granted the Company’s motion for judgment on the pleadings, dismissing all of the plaintiff’s causes of action and granting leave to amend. The plaintiff filed amended complaints on January 14, 2004, and January 30, 2004. Additional individual plaintiffs were added to the amended complaint and the State of Oregon and the State of California, among others, were added as defendants. On May 11, 2004, the Court denied the Company’s motion to dismiss. While discovery in the case is continuing, based on currently available information, the Company believes that the issuance of any duplicate fingerprint numbers was not the result of any design, manufacturing or product defect or malfunction, or any other error, omission or fault on the part the Company or affiliated defendants. The Company intends to vigorously defend this lawsuit.

On July 22, 2004, the Company was served with a class action complaint naming Miguel Espinoza as a purported class action plaintiff. Mr. Espinoza is also one of the individual plaintiffs added to the Benson litigation via the January 2004 amended complaints in that litigation. Mr. Espinoza claims that he was denied a liquor license for his business in Oregon on August 1, 2002 because he was misidentified as a convicted felon. He alleges the misidentification was a result of duplicate fingerprint identification number also held by a convicted felon, and that the duplicate number was generated by a live scan system manufactured by DBI and operated by a Sheriff’s office in the State of Oregon. The complaint alleges liability under strict product liability, failure to warn, breach of implied warranty, negligence, product misrepresentation and 42 U.S.C §1983 among other theories of liability. While the case is in its early stages, based on currently available information, the Company believes that the issuance of any duplicate fingerprint numbers was not the result of any design, manufacturing or product defect or malfunction, or any other error, omission or fault on the part the Company or affiliated defendants. The Company intends to vigorously defend this lawsuit.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Item 2.

The statements in this report on Form 10-Q that relate to future plans, events, or performance are forward-looking statements. Actual results, events and performance may differ materially due to a variety of factors including the factors described under “Risk Factors” below. The Company undertakes no obligation to publicly update these forward-looking statements to reflect events or circumstances that occur after the date hereof or to reflect the occurrence of unanticipated events.

OVERVIEW

Identix Incorporated (“Identix” or the “Company”) provides a broad range of fingerprint and facial recognition technology offerings that empower the identification of individuals who wish to gain access to information or facilities, conduct transactions and obtain identifications. Additionally, the Company’s products and solution offerings can help identify those who perpetrate fraud and otherwise pose a threat to public safety. Identix’ products serve a broad range of industries and markets most notably, government, law enforcement, aviation, financial, healthcare and corporate enterprise. A world leader in multi-biometric technology, Identix believes it has more fingerprint and facial biometric installations worldwide than any other company.

The first quarter of fiscal year 2005 was highlighted by the following events. The flow of orders from the federal sector was strong with announced purchase orders of more than $7,300,000 from federal customers for the Identix TouchPrint® 3000 line of 10-print and full hand live scan systems. Identix was selected by the U.S. Department of State (DoS) to supply and integrate the Company’s biometric data-mining engines (ABIS) into the DoS visa issuance programs to create the largest facial recognition project in the world for DoS visa processing. Identix experienced additional strength in the state and local government markets, with multiple high value purchase orders announced of approximately $2,100,000 for the Company’s TouchPrint 3000 line of 10-print and full hand live scan systems. International opportunities for Identix continue to grow as illustrated by the Company’s biometric fingerprint technology being selected by an unnamed country in the Arab world to assist in tracking visitors into and out of this particular country.

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CRITICAL ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004 describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, goodwill and other intangible asset impairments, inventory allowances, warranty costs, revenue recognition as well as loss contingencies and restructurings. Actual results could differ materially from these estimates. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004 describes the critical accounting policies that are affected significantly by judgments, assumptions and estimates used in the preparation of the Consolidated Financial Statements. At September 30, 2004, the Company’s critical accounting policies and estimates continue to include revenue recognition, allowance for doubtful accounts and sales returns, goodwill impairments, inventory allowances, warranty costs and loss contingencies and restructurings. The Company’s annual impairment analysis was performed during the fourth quarter of fiscal year 2004 which did not result in an impairment charge.

RESULTS OF OPERATIONS

Revenues, and Gross Margins

Total revenue for the three months ended September 30, 2004, was $16,623,000 compared to $12,467,000 for the same period in the prior fiscal year. These revenues are generated from two segments, biometric system revenue and other.

Revenue from biometric systems was $14,498,000 for the three months ended September 30, 2004, compared to $11,767,000 for the same period in the prior fiscal quarter. This increase was due to growth in the federal and international markets. The Company had one customer, the U.S. Government that accounted for 27% of the total revenue for the three months ended September 30, 2004, compared to 13% for the same period in the prior fiscal year.

Revenue from other sources is generated from the Company’s IIS and LDS subsidiaries and was $2,125,000 for the three months ended September 30, 2004, and $700,000 for the same period in the prior fiscal year. The increase was primarily due to the addition of IIS, which was acquired, in the third quarter of fiscal year 2004.

The Company is currently undergoing a General Services Administration pre-award audit for the renewal of a GSA Multiple Award Schedule contract. While the Company believes that the results of such audit will have no material effect on the results of operation, any material adverse findings or adjustments arising out of such audit may have a material adverse effect on our business, financial condition and results of operations.

International sales accounted for $1,716,000 or 10% of the Company’s revenues for the three months ended September 30, 2004, compared to $733,000 or 6% of the Company’s revenue for the same periods in the prior fiscal year. The increase in international revenue is due primarily to the Company’s continued efforts to actively pursue business in the international biometric market place. The Company’s international sales are predominately denominated in U.S. dollars, and the Company actively monitors its foreign currency exchange exposure and, if significant, will take action to reduce foreign exchange risk. To date, the Company has not entered into any hedging transactions.

Gross margin on revenue was 30% for the three months ended September 30, 2004 compared to 38% for the same period of the prior fiscal year. The decrease in gross margin was expected due to the Company’s investment in specific customer programs that the Company believes when combined with a shift in product mix will lead to significantly higher gross margins in the range of a low 40% in the second half of its fiscal year 2005. The Company expects gross margins to fluctuate in future periods due to changes in the product mix, the costs of components and the competition in the industry and the expected increase in gross margin will be conditioned in part upon an increase in the Company’s higher margin Automated Biometric Information System (ABIS) revenue during the third and fourth quarters of fiscal year 2005.

Research and Development

Research and Development expense was $2,529,000 or 15% of revenues for the three months ended September 30, 2004, compared to $2,255,000 or 18% revenues for the same period in the prior fiscal year. The increase of $274,000 in research and development expense is primarily the result of increased investment in personnel. Now and in the foreseeable future, Identix is committed to continue its focus on the investment in research and development, which is critical to developing new and innovative products intended to allow the Company to maintain a strong technological position in the industry.

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Marketing and Selling

Marketing and selling expenses were $2,662,000 or 16% of revenue for the three months ended September 30, 2004, compared to $2,737,000 or 22% of revenue for the same period in the prior fiscal year. The small decrease of $75,000 in marketing and selling expenses resulted from the Company maintaining tight control over discretionary spending.

General and Administrative

General and administrative expense was $3,089,000 or 19% of revenues for the three months ended September 30, 2004, compared to $3,549,000 or 28% of revenues for the same period in the prior fiscal year. The decrease of general and administrative expense is primarily explained by decreases in salaries, deferred compensation and director’s and officer’s liability insurance totaling $785,000. These changes resulted from a decreased headcount of highly compensated individuals, a lower unamortized deferred compensation balance which was fully amortized at September 30, 2004, and lower insurance premiums. These decreases were partially offset by increased expenses of $451,000 related to IIS, which was not present during the three months ended September 30, 2003.

Amortization of Acquired Intangible Assets

The amortization expense is primarily related to acquired intangible assets such as developed technology, and patents. The amortization expense related to acquired intangible assets was $1,284,000 for the three months ended September 30, 2004, compared to $1,382,000 for the same period in the prior fiscal year.

Special Charges

Special charges (such as restructuring and acquisition related charges) result from unique facts and circumstances that likely will not recur with similar materiality or impact on continuing operations. In June 2002, the Company merged with Visionics and in connection with the merger recorded special charges of $18,798,000 for the termination of 110 employees, and the closure of its facilities in Dublin and Los Gatos California.

The following is a summary of the charges incurred and payments made from the time of the merger through June 30, 2004:

Fiscal 2005

During the three months ended September 30, 2004, the Company incurred $451,000 in special charges related to a reduction in the estimated amount of lease recoveries the Company can expect related to its Los Gatos facilities. The following table represents a summary of special charges between June 30, 2004 and September 30, 2004:

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* The portion of the lease exit costs of $4,854,000 that relates to payments to be made more than one year from September 30, 2004 is classified in the consolidated balance sheet as a long-term liability as part of other liabilities.

Fiscal 2004

The following table represents a summary of special charges for the three months ended September 30, 2003:

Interest and Other Income, net

For the three months ended September 30, 2004, interest and other income, net was $269,000 compared to $310,000 for the same period in the prior fiscal year. Identix acquired 100% ownership of the joint venture between Sylvan and Identix in February 2004. As a result of this 100% acquisition, Identix no longer derives income from these operations that are reported as other income, rather the results are fully consolidated into Identix’ results of operation. For the three months ended September 30, 2003, the joint venture generated $82,000 which was reported as other income.

Interest Expense

Interest expense was $6,000 for the three months ended September 30, 2004, compared to $3,000 for the same period in the prior fiscal year. There have been no borrowings under the Company’s line of credit during the three months ended September 30, 2004. Interest expense is comprised primarily of interest costs associated with the Company’s leased vehicles in the United Kingdom as well as interest connected to leased equipment in the U.S.

Provision for Income Taxes

The Company recorded a provision for income tax expense of $13,000 for the three months ended September 30, 2004 and a provision of $9,000 for the same period in prior fiscal year. The tax amounts recorded for both fiscal years are related to state income taxes.

Equity Interest in Loss of Joint Venture

The equity interest in the loss of the joint venture represents the Company’s 50% share of the results of Sylvan Identix Fingerprint Centers, LLC (SIFC) through February 23, 2004 when Identix acquired the remaining 50% interest in SIFC. For the three months ended September 30, 2004, the Company’s equity interest in the joint venture loss was $0. For the same period in the prior fiscal year the Company’s equity interest in the joint venture loss was $105,000.

Discontinued Operations

On February 13, 2004, the Company consummated the sale of Identix Public Sector (IPS) to Alion Science and Technology Corporation (Alion). The operations for the three months ended September 30, 2003 are presented in the Company’s Consolidated Statements of Operations as discontinued operations. Under the terms of the agreement, upon closing Alion paid the Company $8,850,000 million in cash. The terms of the sale include the potential for additional future payments to the Company of up to $500,000 pending satisfaction of certain conditions. The terms of the sale also include an obligation on the part of the Company to indemnify Alion against liabilities, including for breaches of representations and warranties made by the Company in the sales agreement, for an amount not to exceed $2,125,000.

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The following table represents the summarized results for the discontinued operations for the three months ended September 30, 2003:

Liquidity and Capital Resources

The Company financed its operations during the three months ended September 30, 2004, primarily from cash provided by its working capital. As of September 30, 2004, the Company’s principal sources of liquidity consisted of $42,928,000 of working capital including $43,817,000 in cash and cash equivalents and short-term marketable securities.

The Company’s existing line of credit was entered into on May 30, 2003. This line of credit provides for up to the lesser of $15,000,000 or the cash collateral base or the borrowing base. Borrowings under the line of credit are collateralized by substantially all of the assets of the Company and bear interest at the bank’s prime rate of interest, which was 4.75% at September 30, 2004. The line of credit expires on October 1, 2005. Until the Company generates positive net income before income taxes for two consecutive fiscal quarters, the Company will be required to deposit with the lender an amount equal to the sum of the aggregate outstanding principal amount of all prior advances plus any portion of the line of credit reserved to support unexpired letters of credit plus the amount of the requested advance before an advance will be given. In addition, all advances must be used for working capital. At September 30, 2004, there were no amounts outstanding under this line of credit.

The line of credit agreement contains financial, operating and reporting covenants. At September 30, 2004, the Company was in compliance with all covenants.

For the three months ended September 30, 2004, $1,556,000 of cash was used in operating activities. The cash used in operations consisted primarily of the net loss of $4,833,000; increased accounts receivable of $1,015,000 and decreased accounts payable of $738,000. These items were partially offset primarily by increases of deferred revenue of $1,448,000; decreases in inventories of $891,000; decreases in prepaid expenses and other assets of $777,000 and non-cash charges from depreciation and amortization of $1,702,000. Cash consumed in investing activities resulted primarily from the purchases of marketable securities of $5,964,000 and purchases of fixed assets of $252,000 which were partially offset by the proceeds from the sale of marketable securities of $6,000,000. Cash used in financing activities was the result of proceeds from the sale of common stock of $190,000. These items combined to create a cash usage of $1,582,000 during the three months ended September 30, 2004.

For the three months ended September 30, 2003, $1,115,000 of cash was used in operating activities. The cash used in operations consisted primarily of the net loss of $4,656,000 and a decrease in other accrued liabilities of $1,214,000. These uses were partially offset by non-cash charges from depreciation and amortization of $1,941,000 and decreased accounts receivable of $1,153,000, decreased prepaid expenses and other assets of $891,000, increased accrued compensation of $931,000 and increased deferred revenue of $749,000. Cash generated from investing activities was $575,000, which resulted primarily from the proceeds of the sales of marketable securities of $4,000,000, which were partially offset by cash used to purchase marketable securities of $2,987,000 and capital expenditures of $438,000. Cash provided by financing activities for the three months ended September 30, 2003 was due solely to proceeds from the sale of the Company’s equity securities and the exercise of employee stock options. These items combined to create a cash usage of $61,000 during the three months ended September 30, 2003.

The Company currently occupies its Minnesota headquarters under a lease that expires in March 2008, and is required to pay taxes, insurance, and maintenance as well as monthly rental payments. The Company also leases space for its corporate research and development lab in New Jersey under a lease that expires in May 2006, and is required to pay taxes, insurance, and maintenance as well as monthly rental payments. In addition, the Company leases space for its former headquarters in Los Gatos, California under a lease that expires in December of 2007; and a space in Dublin, California for its former research,

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development and engineering activities that expire in March 2006. Further, the Company leases office space for its sales force and customer support activities under operating leases, which expire at various dates through 2008. The leases contain escalation provisions requiring rental increases for increases in operating expense and real estate taxes.

Future minimum lease payments for operating leases are as follows:

Included in the above future minimum payments is $7,687,000 related to two leased facilities in Northern California that were vacated in connection with the Company’s merger with Visionics. The Company has accrued for the estimated losses on these leases at September 30, 2004 and 2003. The Company is attempting to sublease the unoccupied facilities.

While the Company believes that existing working capital will be adequate to fund the Company’s current cash requirements for at least the next twelve months, the Company may need to raise additional debt or equity financing in the future. The Company may not be able to obtain additional debt or equity financing on favorable terms that are not excessively dilutive to existing stockholders. Failure to secure additional financing in a timely manner and on favorable terms in the future could have a material adverse impact on the Company’s financial performance and stock price and require the Company to implement certain cost reduction initiatives and curtail certain of its operations.

RISK FACTORS

This report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The Company’s business, operating results, financial performance and share price may be materially adversely affected by a number of factors, including but not limited to the following risk factors, any one of which could cause actual results to vary materially from anticipated results or from those expressed in any forward-looking statements made by the Company in this quarterly report on Form 10-Q or in other reports, press releases or other statements issued from time to time. Additional factors that may cause such a difference are set forth in the Company’s Annual Report on Form 10-K.

Our business will not grow unless the market for biometric products and services expands both domestically and internationally.

Our revenues are derived from the sale of biometric products and services. Biometric products have not gained widespread commercial acceptance. We cannot accurately predict the future growth rate, if any, or the ultimate size of the biometric technology market. The expansion of the market for our products depends on a number of factors including without limitation:

	•		the cost, performance and reliability of our products and services and those of our competitors;
	•		customers’ perception of the perceived benefit of biometric products and services;
	•		public perceptions of the intrusiveness of these products and services and the manner in which firms are using the information collected;
	•		public perceptions regarding the confidentiality of private information;
	•		proposed or enacted legislation related to privacy of information;
	•		customers’ satisfaction with our products and services; and
	•		marketing efforts and publicity regarding these products and services.

Certain groups have publicly objected to the use of biometric products for some applications on civil liberties grounds and legislation has been proposed to regulate the use of biometric security products. From time to time, biometrics technologies have been the focus of organizations and individuals seeking to curtail or eliminate such technologies on the grounds that they may be used to diminish personal privacy rights. If such initiatives result in restrictive legislation, the market for biometric solutions may be adversely affected. Even if biometric solutions gain wide market acceptance, our products and services may not adequately address the requirements of the market and may not gain wide market acceptance.

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We face intense competition from other biometric solution providers as well as identification and security systems providers.

A significant number of established and startup companies have developed or are developing and marketing software and hardware for facial and/or fingerprint biometric products and applications that currently compete or will compete directly with our current facial and fingerprint offerings. Some of these companies have developed or are developing and marketing semiconductor or optically based direct contact fingerprint image capture devices, or retinal blood vessel, iris pattern, hand geometry, voice or various types of facial structure solutions. If one or more of these technologies or approaches were widely adopted, it would significantly reduce the potential market for our products. Our security and identity related line of products and applications also compete with non-biometric technologies such as certificate authorities, smart card security solutions, and traditional key, card, surveillance systems and passwords. Many competitors offering products that are competitive with our security and identity related line of products and applications have significantly more financial and other resources than the Company. The biometric security market is a rapidly evolving and intensely competitive market, and we believe that additional competitors will continue to enter the market and become significant long-term competitors.

Our facial biometric products face intense competition from a number of competitors who are actively engaged in developing and marketing facial-based recognition or security products, including Viisage Technology, Inc., Cognitec Systems GmbH and Imagis Technologies, Inc. The products designed, developed and sold under our line of products known as our “live scan” products also face intense competition from a number of competitors who are actively engaged in developing and marketing similar products, including Smiths Heimann Biometrics GmbH, Sagem Morpho, Inc., Printrak International, Inc., (a Motorola company), and CrossMatch Technologies, Inc.

We expect competition to increase and intensify in the near term in the biometrics markets. Companies competing with us may introduce products that are competitively priced, have increased performance or functionality or incorporate technological advances not yet developed or implemented by us. Some present and potential competitors have financial, marketing, research, and manufacturing resources substantially greater than ours.

In order to compete effectively in this environment, we must continually design, develop and market new and enhanced products at competitive prices and we must have the resources available to invest in significant research and development activities. The failure to do so could have a material adverse effect on our business operations, financial results and stock price.

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

Our performance in any one reporting period is not necessarily indicative of sale trends or future operating or earnings performance because of our reliance on a small number of large customers, the majority of which are government agencies. Government contracts frequently include provisions that are not standard in private commercial transactions. For example, government contracts may include bonding requirements and provisions permitting the purchasing agency to cancel the contract for convenience at any time without penalty in certain circumstances. As public agencies, our prospective customers are also subject to public agency contract requirements that vary from jurisdiction to jurisdiction. Some of these requirements may be onerous or impossible to satisfy.

Additionally, public agency contracts are frequently awarded only after formal competitive bidding processes, which are often protracted, and typically impose provisions that permit cancellation in the event that funds are unavailable to the public agency. In some cases, unsuccessful bidders for public agency contracts are provided the opportunity to formally protest certain contract awards through various agency, administrative and judicial channels. The protest process may delay a successful bidder’s contract performance for a number of weeks, months or more, or result in the cancellation of the contract award entirely. There is a risk that we may not be awarded contracts for which we bid or, if awarded, that substantial delays or cancellation of purchases may follow as a result of third party protests. For example, in October 2003, the Company announced that is had been awarded a Blanket Purchase Order (“BPO”) from the Department of Homeland Security (“DHS”) with an estimated value of approximately $27 million. The award was subsequently protested by one of our competitors who had been an unsuccessful participant in the bidding process for the BPO. Though the protest was ultimately resolved in favor of Identix, the protest resulted in substantial delays in DHS’ procurement of our technology under the BPO. Similar protests, and similar delays, regarding any future government contracts of a material nature that may be awarded to Identix could result in materially adverse revenue volatility, making management of inventory levels, cash flow and profitability or loss inherently difficult. Outright loss of any material government contract, such as the BPO award to Identix, through the protest process or otherwise, could have a material adverse effect on our financial results and stock price.

The ownership of our GSA Multiple Award IT-70 Schedule contract related to our product business was transferred to the buyer of our former wholly owned subsidiary, Identix Public Sector, Inc. (“IPS”), in February 2004. We entered into a reseller agreement with such third party concurrently with the closing of the sale of IPS, and we continue to sell our products through such reseller’s IT 70 Schedule. Such contract, now held by our reseller, is subject to future audit, and any material adverse findings or adjustments arising out of such audits may have a material adverse effect on ability to sell our products through the reseller’s contract, which could in turn materially adversely affect our business, financial condition and results of operations. Furthermore, the current IT-70 contract, which has the been the subject of two monthly extensions since its original expiration date of June 30, 2004, is currently set to expire November 22, 2004. While efforts are underway by the reseller to obtain a multi-year extension to the original contract term, the failure to obtain such extension may have a material adverse effect on ability to sell our products through the reseller’s contract, which could in turn materially adversely affect our business, financial condition and results of operations. The Company is in the process of applying for a new IT-70 Schedule contract, but there can be no assurance that we will successfully obtain such contract on a timely basis. Any failure to obtain such contract, or any significant delays we experience in obtaining such contract, could have a material adverse effect on our business operations, financial results and stock price.

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Similar to federal government contracts, state and local government agency contracts may be contingent upon availability of matching funds from federal, state or local entities. State and local law enforcement and other government agencies are subject to political, budgetary, purchasing and delivery constraints which may continue to result in quarterly and annual revenues and operating results that may be irregular and difficult to predict. Such revenue volatility makes management of inventory levels, cash flow and profitability inherently difficult. In addition, if we are successful in winning such procurements, there may be unevenness in shipping schedules, as well as potential delays and schedule changes in the timing of deliveries and recognition of revenue, or cancellation of such procurements.

For the three months ended September 30, 2004, we derived approximately 27% of our revenue directly from contracts relating to the U.S. Federal Government with the Department of Homeland Security making up 23% of sales to the Federal Government. The loss of a material government contract due to budget cuts or otherwise could have a severe negative impact on our financial results and stock price.

Our financial and operating results often vary significantly from quarter to quarter and may be negatively affected by a number of factors.

Our financial and operating results may fluctuate from quarter to quarter because of the following reasons:

	•		the lack of or delays in authorization for availability of government funds;
	•		reduced demand for products and services caused, for example, by product offerings from new competitors;
	•		the inability to timely and successfully complete (i) development of complex designs and components, (ii) new product introductions that may result in improved gross margins or the inability to manufacture in volume or install certain of our complex products.
	•		changes in the mix of products and services we or our distributors sell;
	•		cancellations, delays or contract amendments by government agency customers;
	•		protests of federal, state or local government contract awards by competitors;
	•		unforeseen legal expenses, including litigation and/or administrative protest costs;
	•		expenses related to acquisitions or mergers;
	•		impairment charges arising out of our assessments of goodwill and intangibles;
	•		other one-time financial charges; and
	•		the lack of availability or increase in cost of key components and subassemblies.
	•		competitive pricing pressures
	•		unpredictable product installation schedules

Particularly important is the need to invest in planned technical development programs to maintain and enhance our competitiveness, and to successfully develop and launch new products and services on a timely basis. Managing and improving the likelihood of success of such programs requires the development of budgets, plans and schedules for the execution of these programs and the adherence to such budgets, plans and schedules. The majority of such program costs are payroll and related staff expenses, and secondarily materials, subcontractors and promotional expenses. These costs are very difficult to adjust in response to short-term fluctuations in our revenues, compounding the difficulty of achieving profitability in the event of a revenue downturn.

Our results of operations may be harmed by lack of governmental funding, credit and other policies.

In many instances, the procurements of our federal, state and local customers are dependent on the availability or continued availability of federal, state or local government funds or grants and general tax funding. Such funding may not be approved or, if approved, it may not be available for the purchase of our products or solutions, and even if such funding is approved and available, such funds may be subject to termination at any time at the sole discretion of the government body providing or receiving such funds.

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We also extend substantial credit to federal, state and local governments in connection with sales of our products and services. Sales to sizeable customers requiring large and sophisticated networks of fingerprint recognition and Live Scan systems and peripheral equipment often include technical requirements which may not be fully known at the time requirements are specified by the customer. In addition, contracts may specify performance criteria that must be satisfied before the customer accepts the products and services. Collection of accounts receivable may be dependent on completion of customer requirements, which may be unpredictable, subject to change by the customer, and not fully understood by us at the time of acceptance of the order, and may involve investment of additional resources. These investments of additional resources are accrued when amounts can be estimated but may be uncompensated and negatively affect profit margins and our liquidity.

Additionally, without regard to termination of funding, government agencies both domestically and internationally may successfully assert the right to terminate business or funding relationships with us at their sole discretion without adequate or any compensation or recourse for us.

The substantial costs of our merger with Visionics Corporation, which was completed in June 2002, and the manner of accounting for the merger may affect Identix’ reported results of operations.

Approximately $30 million of costs have been incurred in connection with our merger with Visionics. These include costs associated with combining the businesses of the two companies, including integration and restructuring costs, costs associated with the consolidation of operations and the fees of financial advisors, attorneys and accountants. While the vast majority of costs associated with the merger are behind us, we may incur additional integration costs, for example, costs associated with the sublease of our former office and manufacturing space in California, and these costs may be higher than anticipated.

In connection with the Visionics merger, we recorded a substantial amount of goodwill. Generally accepted accounting principles requires that goodwill be tested for impairment at least annually and a non-cash charge to earnings must be recognized in the period any impairment of goodwill is determined. While we did not record an impairment of goodwill in fiscal year 2004, during the fourth quarter of fiscal year 2003, we recorded an impairment charge to goodwill in the amount of $154,799,000.

The market price of our common stock could decline if:

	•		our merger with Visionics ultimately proves to be unsuccessful;
	•		the combined company is unable to successfully market its products and services to both companies’ customers;
	•		the combined company does not achieve the perceived benefits of the merger as rapidly as, or to the extent, anticipated by financial or industry analysts, or such analysts do not perceive the same benefits to the merger as do we; or
	•		the effect of the merger on our financial results is not consistent with the expectations of financial or industry analysts.

The terrorist attacks of September 11, 2001, and the continuing threat of global terrorism, have increased financial expectations that may not materialize.

The September 11, 2001 terrorist attacks, and continuing concerns about global terrorism, may have created an increase in awareness for biometric security solutions generally. However, it is uncertain whether the actual level of demand for our biometric products and services will grow as a result of such increased awareness. Increased demand may not result in an actual increase in our revenues. In addition, it is uncertain which security solutions, if any, will be adopted as a result of the terrorism and whether our products will be a part of those solutions. Efforts in the war against terrorism, the war in Iraq, and the post-war reconstruction efforts in Iraq, may actually delay funding for the implementation of biometric solutions generally. Even if our products are considered or adopted as solutions to the terrorism, the level and timeliness of available funding are unclear. These factors may adversely impact us and create unpredictability in revenues and operating results.

We may need to raise additional equity or debt financing in the future.

While we believe existing working capital will be adequate to fund our operating cash requirements for at least the next 12 months, we may need to raise additional debt or equity financing in the future, which may not be available to us. Even if we are successful in raising additional financing, we may not be able to do so on terms that are not excessively dilutive to existing stockholders or less costly than existing sources of financing. Failure to secure additional financing in a timely manner and on favorable terms could have a material adverse effect on our financial performance and stock price and require us to implement certain cost reduction initiatives resulting in the curtailment of our operations.

The biometrics industry is characterized by rapid technological change and evolving industry standards, which could render existing products obsolete.

Our future success will depend upon our ability to develop and introduce a variety of new products and services and enhancements to these new product and services in order to address the changing and sophisticated needs of the marketplace. Frequently, technical development

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programs in the biometric industry require assessments to be made of the future directions of technology and technology markets generally, which are inherently risky and difficult to predict. Delays in introducing new products, services and enhancements, the failure to choose correctly among technical alternatives or the failure to offer innovative products and services at competitive prices may cause customers to forego purchases of our products and services and purchase those of our competitors.

Continued participation by us in the market for Live Scan systems that are linked to forensic quality databases under the jurisdiction of governmental agencies may require the investment of our resources in upgrading our products and technology for us to compete and to meet regulatory and statutory standards. We may not have adequate resources available to us or may not adequately keep pace with appropriate requirements in order to effectively compete in the marketplace.

Our lengthy and variable sales cycle will make it difficult to predict operating results.

Certain of our products often have a lengthy sales cycle while the customer evaluates and receives approvals for purchase. If, after expending significant funds and effort, we fail to receive an order, a negative impact on our financial results and stock price could result.

It is difficult to predict accurately the sales cycle of any large order for any of our products. If we do not ship and or install one or more large orders as forecast for a fiscal quarter, our total revenues and operating results for that quarter could be materially and adversely affected.

The substantial lead-time required for ordering parts and materials may lead to excess or insufficient inventory.

The lead-time for ordering parts and materials and building many of our products can be many months. As a result, we must order parts and materials and build our products based on forecasted demand. If demand for our products lags significantly behind our forecasts, we may produce more products than we can sell, which can result in cash flow problems and write-offs or write-downs of obsolete inventory.

We rely in part upon original equipment manufacturers (“OEM”) and distribution partners to distribute our products, and we may be adversely affected if those parties do not actively promote our products or pursue installations that use our equipment.

A significant portion of our revenue comes from sales to partners including OEMs, systems integrators, distributors and resellers. Some, but not all, of these relationships are formalized in written agreements. Even where these relationships are formalized in written agreements, the agreements are often terminable 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 our behalf.

We intend to continue to seek strategic relationships to distribute, license and sell certain of our products. We, however, may not be able to negotiate acceptable relationships in the future and cannot predict whether current or future relationships will be successful.

Loss of sole or limited source suppliers may result in delays or additional expenses.

We obtain certain hardware components and complete products, as well as software applications, from a single source or a limited group of suppliers. We do not have long-term agreements with any of our suppliers. We will experience significant delays in manufacturing and shipping of products to customers if we lose these sources or if supplies from these sources are delayed.

As a result, we may be required to incur additional development, manufacturing and other costs to establish alternative sources of supply. It may take several months to locate alternative suppliers, if required, or to re-tool our products to accommodate components from different suppliers. We cannot predict if we will be able to obtain replacement components within the time frames we require at an affordable cost, or at all. Any delays resulting from suppliers failing to deliver components or products on a timely basis in sufficient quantities and of sufficient quality or any significant increase in the price of components from existing or alternative suppliers could have a severe negative impact on our financial results and stock price.

The success of our strategic plan to pursue sales in international markets may be limited by risks related to conditions in such markets.

For the three months ended September 30, 2004 we derived approximately 10% of our product revenues from international sales. We currently have a local presence in the United Kingdom.

There is a risk that we may not be able to successfully market, sell and deliver our products in foreign countries, or successfully rely on supplemental offshore research and development resources.

Risks inherent in marketing, selling and delivering products in foreign and international markets, each of which could have a severe negative impact on our financial results and stock price, include those associated with:

	•		regional economic or political conditions;
	•		delays in or absolute prohibitions on exporting products resulting from export restrictions for certain products and technologies, including “crime control” products and encryption technology;

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	•		loss of, or delays in importing products, services and intellectual property developed abroad, resulting from unstable or fluctuating social, political or governmental conditions;
	•		fluctuations in foreign currencies and the U.S. dollar;
	•		loss of revenue, property (including intellectual property) and equipment from expropriation, nationalization, war, insurrection, terrorism, criminal acts and other political and social risks;
	•		the overlap of different tax structures;
	•		seasonal reductions in business activity;
	•		risks of increases in taxes and other government fees; and
	•		involuntary renegotiations of contracts with foreign governments.

In addition, foreign laws treat the protection of proprietary rights differently from laws in the United States and may not protect our proprietary rights to the same extent as U.S. laws. The failure of foreign laws or judicial systems to adequately protect our proprietary rights or intellectual property, including intellectual property developed on our behalf by foreign contractors or subcontractors may have a material adverse effect on our business, operations, financial results and stock price.

Individual stockholders owning a significant portion of our stock may have the ability to delay or prevent a change in control or adversely affect the stock price through sales in the open market.

As of June 30, 2004, the State of Wisconsin Investment Board and Kern Capital Management LLC owned approximately 8% and 4% of the Company’s outstanding common stock, respectively. As of September 30, 2004, Artemis Investment Management LLC owned approximately 4% of the Company’s outstanding common stock. The concentration of large percentages of ownership in any single stockholder, or in any series of single stockholders, may delay or prevent change in control of the Company. Additionally, the sale of a significant number of our shares in the open market by single stockholders or otherwise could adversely affect our stock price.

We may be subject to loss in market share and market acceptance as a result of manufacturing errors, delays or shortages.

Performance failure in our products may cause loss of market share, delay in or loss of market acceptance, additional warranty expense or product recall, or other contractual liabilities. The complexity of certain of our fingerprint readers makes the manufacturing and assembly process of such products, especially in volume, complex. This may in turn lead to delays or shortages in the availability of certain products, or, in some cases, the unavailability of certain products. The negative effects of any delay or failure could be exacerbated if the delay or failure occurs in products that provide personal security, secure sensitive computer data, authorize significant financial transactions or perform other functions where a security breach could have significant consequences. If a product launch is delayed or is the subject of an availability shortage because of problems with our ability to manufacture or assemble the product successfully on a timely basis, or if a product or service otherwise fails to meet performance criteria, we may lose revenue opportunities entirely and/or experience delays in revenue recognition associated with a product or service in addition to incurring higher operating expenses during the period required to correct the defects. There is a risk that for unforeseen reasons we may be required to repair or replace a substantial number of products in use or to reimburse customers for products that fail to work or meet strict performance criteria. We carry product liability insurance, but existing coverage may not be adequate to cover potential claims.

We may be subject to repair, replacement, reimbursement and liability claims as a result of products that fail to work or to meet applicable performance criteria.

There is a risk that for unforeseen reasons we may be required to repair or replace a substantial number of products in use or to reimburse customers for products that fail to work or meet strict performance criteria. We attempt to limit remedies for product failure to the repair or replacement of malfunctioning or noncompliant products or services, and also attempt to exclude or minimize exposure to product and related liabilities by including in our standard agreements warranty disclaimers and disclaimers for consequential and related damages as well as limitations on our aggregate liability. From time to time, in certain complex sale or licensing transactions, we may negotiate liability provisions that vary from such standard forms. There is a risk that our contractual provisions may not adequately minimize our product and related liabilities or that such provisions may be unenforceable. We carry product liability insurance, but existing coverage may not be adequate to cover potential claims. We maintain warranty reserves as deemed adequate by management.

Failure by us to maintain the proprietary nature of our technology, intellectual property and manufacturing processes could have a material adverse effect on our business, operating results, financial condition, stock price, and on our ability to compete effectively.

We principally rely upon patent, trademark, copyright, trade secret and contract law to establish and protect our proprietary rights. There is a risk that claims allowed on any patents or trademarks we hold may not be broad enough to protect our technology. In addition, our patents or trademarks may be challenged, invalidated or circumvented and we cannot be certain that the rights granted thereunder will provide competitive advantages to us. Moreover, any current or future issued or licensed patents, or trademarks, or currently existing or future

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developed trade secrets or know-how may not afford sufficient protection against competitors with similar technologies or processes, and the possibility exists that certain of our already issued patents or trademarks may infringe upon third party patents or trademarks or be designed around by others. In addition, there is a risk that others may independently develop proprietary technologies and processes, which are the same as, substantially equivalent or superior to ours, or become available in the market at a lower price.

There is a risk that we have infringed or in the future will infringe patents or trademarks owned by others, that we will need to acquire licenses under patents or trademarks belonging to others for technology potentially useful or necessary to us, and that licenses will not be available to us on acceptable terms, if at all.

We may have to litigate to enforce our patents or trademarks or to determine the scope and validity of other parties’ proprietary rights. Litigation could be very costly and divert management’s attention. An adverse outcome in any litigation may have a severe negative effect on our financial results and stock price. To determine the priority of inventions, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office or oppositions in foreign patent and trademark offices, which could result in substantial cost and limitations on the scope or validity of our patents or trademarks.

We also rely on trade secrets and proprietary know-how, which we seek to protect by confidentiality agreements with our employees, consultants, service providers and third parties. There is a risk that these agreements may be breached, and that the remedies available to us may not be adequate. In addition, our trade secrets and proprietary know-how may otherwise become known to or be independently discovered by others.

If we fail to adequately manage the size of our business, it could have a severe negative effect on our financial results or stock price.

Our management believes that in order to be successful we must appropriately manage the size of our business. This may mean reducing costs and overhead in certain economic periods, and selectively growing in periods of economic expansion. In addition, we will be required to implement operational, financial and management information procedures and controls that are efficient and appropriate for the size and scope of our operations. The management skills and systems currently in place may not be adequate and we may not be able to manage any significant cost reductions or effectively provide for our growth.

Acquisitions and dispositions of companies, assets or technologies may result in disruptions to our business.

As part of our business roadmap, we may from time to time acquire businesses, assets or technologies relating to, or complementary to, our current strategies or operations, and we may also divest certain businesses or assets that we consider non-complementary to our current strategies or operations.

In March 2004, we acquired certain technology and intellectual property rights of Delean Vision Worldwide, Inc. In February 2004, we acquired the remaining 50% percent interest in Sylvan Identix Fingerprint Centers, LLC (“SIFC”) that we didn’t already own. We subsequently re-named SIFC to Identix Identification Services, LLC. In February 2004, we sold our wholly owned subsidiary, Identix Public Sector, Inc., whose business principally consisted of providing project management and facilities engineering services to government agencies. We acquired certain proprietary software and source code assets from a third party in October 2002. We merged with Visionics in June 2002 and acquired Identicator Technology, Inc. in fiscal 1999. We also acquired one company in fiscal 1998 and two companies in fiscal 1996. These and any other acquisitions, mergers and divestitures by Identix are and will be accompanied by the risks commonly encountered in such transactions. These risks include, among other things:

	•		exposure to unknown liabilities of acquired companies or assets;
	•		higher than anticipated acquisition costs and expenses;
	•		effects of costs and expenses of acquiring and integrating new businesses on our operating results and financial condition;
	•		effects of consolidated revenue loss associated with dispositions of material subsidiaries or assets;
	•		effects of costs and expenses of integrating and introducing new technologies;
	•		the difficulty and expense of assimilating the operations and personnel of the companies;
	•		disruption of our ongoing business;
	•		diversion of management time and attention;
	•		failure to maximize our financial and strategic position by the successful incorporation of acquired technology;
	•		failure to realize the potential of acquired technologies, complete product development, or properly obtain or secure appropriate protection of intellectual property rights;

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	•		the maintenance of uniform standards, controls, procedures and policies;
	•		loss of key employees and customers as a result of changes in management;
	•		the incurrence of amortization expenses;
	•		incurring impairment charges arising out of our assessments of goodwill and intangibles; and
	•		possible dilution to our stockholders.

In addition, geographic distances may make integration of businesses or the acquisition of assets more difficult. We may not be successful in overcoming these risks or any other problems encountered in connection with any mergers or acquisitions.

Under new regulations required by the Sarbanes-Oxley Act of 2002, an adverse opinion on internal controls could be issued by our auditors and have a negative impact on our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we establish and maintain an adequate internal control structure and procedures for financial reporting and assess on an on-going basis the design and operating effectiveness of our internal control structure and procedures for financial reporting. Our auditors are required to audit both the design and operating effectiveness of our internal controls and management’s assessment of the design and the effectiveness of its internal controls. Although no known material weaknesses exist at this time, this will be the first year that we have undergone an audit of our internal controls and procedures, and it is possible that material weaknesses could be found. If we are unable to remediate the weaknesses the auditors could be required to issue an adverse opinion on our internal controls. Because opinions on internal controls have not been required in the past, it is uncertain what impact an adverse opinion would have upon our stock price.

If we fail to attract and retain qualified senior executive and key technical personnel, our business will not be able to expand.

We are dependent on the continued availability of the services of our employees, many of whom are individually key to our future success, and the availability of new employees to implement our business plans. The market for skilled employees is highly competitive, especially for employees in technical fields. Although our compensation programs are intended to attract and retain the employees required for us to be successful, there can be no assurance that we will be able to retain the services of all our key employees or a sufficient number to execute our plans, nor can there be any assurance we will be able to continue to attract new employees as required.

Our personnel may voluntarily terminate their relationship with us at any time, and competition for qualified personnel, especially engineers, is intense. The process of locating additional personnel with the combination of skills and attributes required to carry out our strategy could be lengthy, costly and disruptive.

If we lose the services of key personnel, or fail to replace the services of key personnel who depart, we could experience a severe negative effect on our financial results and stock price. In addition, there is intense competition for highly qualified engineering and marketing personnel in the locations where we principally operate. The loss of the services of any key engineering, marketing or other personnel or our failure to attract, integrate, motivate and retain additional key employees could have a material adverse effect on our business, operating and financial results and stock price.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Interest Rate Risk. The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s cash equivalents, marketable securities and line of credit. The Company does not use derivative financial instruments. The Company’s cash equivalents are invested in money market accounts with major financial institutions. Due to the short duration and conservative nature of the Company’s cash equivalents, their carrying value approximates fair market value. The Company has performed an analysis to assess the potential effect of reasonably possible near-term changes in interest rates. The effect of such rate changes is not expected to be material to the Company’s results of operations, cash flows or financial condition.

     The Company primarily enters into debt obligations to support general corporate purposes including working capital requirements and capital expenditures. The Company is subject to fluctuating interest rates that may impact, adversely or otherwise, its results of operation or cash flows for its variable rate lines of credit and cash equivalents.

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     Foreign Currency Exchange Rate Risk. Certain of the Company’s foreign revenues, cost of revenues and marketing expenses are transacted in local currencies, primarily the British Pound. As a result, the Company’s results of operations and certain receivables and payables are subject to foreign exchange rate fluctuations. The Company does not currently hedge against foreign currency rate fluctuations. Gains and losses from such fluctuations have not been material to the Company’s consolidated results of operations or balance sheet.

Item 4. Controls and Procedures

     Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

     Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with our evaluation that occurred during our first fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     PART II OTHER INFORMATION

     Item 1. Legal Proceedings

     On February 5, 2003, Roger Benson, an individual, filed a lawsuit seeking unspecified damages against the Company, Digital Biometrics, Inc. (“DBI”), and Visionics Corporation in California Superior Court, alleging that in 1998 he was issued a duplicate electronic fingerprint number that was also held by a convicted felon. He alleges that the fingerprint number was generated by a live scan system manufactured by DBI and operated by a Sheriff’s office in the State of Oregon. The lawsuit also alleges injuries from a 43-day incarceration after the plaintiff’s identity was allegedly mistaken for that of the felon because of the duplicate fingerprint number. The complaint alleges liability under strict product liability, failure to warn, breach of implied warranty, negligence, and unfair business practices, among other theories of liability. On December 2, 2003, the court granted the Company’s motion for judgment on the pleadings, dismissing all of the plaintiff’s causes of action and granting leave to amend. The plaintiff filed amended complaints on January 14, 2004, and January 30, 2004. Additional individual plaintiffs were added to the amended complaint and the State of Oregon and the State of California, among others, were added as defendants. On May 11, 2004, the Court denied the Company’s motion to dismiss. While discovery in the case is continuing, based on currently available information, the Company believes that the issuance of any duplicate fingerprint numbers was not the result of any design, manufacturing or product defect or malfunction, or any other error, omission or fault on the part the Company or affiliated defendants. The Company intends to vigorously defend this lawsuit.

     On July 22, 2004, the Company was served with a class action complaint naming Miguel Espinoza as a purported class action plaintiff. Mr. Espinoza is also one of the individual plaintiffs added to the Benson litigation via the January 2004 amended complaints in that litigation. Mr. Espinoza claims that he was denied a liquor license for his business in Oregon on August 1, 2002 because he was misidentified as a convicted felon. He alleges the misidentification was a result of duplicate fingerprint identification number also held by a convicted felon, and that the duplicate number was generated by a live scan system manufactured by DBI and operated by a Sheriff’s office in the State of Oregon. The complaint alleges liability under strict product liability, failure to warn, breach of implied warranty, negligence, product misrepresentation and 42 U.S.C §1983 among other theories of liability. While the case is in its early stages, based on currently available information, the Company believes that the issuance of any duplicate fingerprint numbers was not the result of any design, manufacturing or product defect or malfunction, or any other error, omission or fault on the part the Company or affiliated defendants. The Company intends to vigorously defend this lawsuit.

     While it is not possible at this early stage of the proceedings to predict with precision and certainty the outcome of the actions discussed above, based on the facts and information currently available to the Company (which are subject to change based on discovery of further facts and information) the Company believes that liabilities and costs arising out of such actions will not have a material adverse impact on the Company’s consolidated financial position, results of operations or cash flows.

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Item 6. Exhibits and Reports on Form 8-K.

(a)

Exhibits

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SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, Identix Incorporated, a corporation organized and existing under the laws of the State of Delaware, has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Minnetonka, State of Minnesota, on November 9, 2004.

	IDENTIX INCORPORATED
	By:	/s/ Elissa J. Lindsoe
		Elissa J. Lindsoe
		Chief Financial Officer

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