Bushido Equity Analysis LLC Intelli-Check (AMEX: IDN)
12 August 2003
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Summary: Our overall opinion for the near, intermediate, and long term performance of IDN shares is negative. IDN produces a device which reads bar codes found on the back of identification cards. Numerous competitors sell similar or superior products at lower prices. During its nearly 10 years of existence IDN has never shown a profit and its sales have been insignificant, yet IDN has enriched its managers and other insiders by creating and selling shares to outside investors. IDN does so through the frequent issuance of press releases which imply that the company's future prospects are bright. IDN focuses its operations on creating alliances and agreements with other organizations and individuals in order to provide material for its press releases, and none of the alliances or agreements have ever resulted in any but token sales. IDN has an extensive network of brokers and agents who assist it in selling its shares to the public and maintaining its stock price. In our opinion, IDN is a stock promotion scheme intended for the sale of stock rather than sale of a profitable product. In our experience and research in modern stock markets, we have never seen a company with these attributes which has ended well for outside investors.
1. IDN's product reads the information contained in bar codes found on on the back of identification cards such as drivers' licenses. The IDN product is similar in design and construction to the bar code readers which are found at supermarket checkout counters. IDN also sells, separately, the software which operates its bar code reading device. IDN was founded in 1994 with the initial stated purpose of selling its devices to merchants interested in preventing the use of fraudulent identification in the purchase of alcohol, tobacco, and other age-restricted items, to reduce liability to retailers, and to reduce check cashing, credit card and other types of fraud. IDN listed its shares on the American Stock Exchange through an initial public offering (IPO) in 1999.
2. In the aftermath of the September 2001 terrorist attacks, IDN began to sell itself to investors as a company whose product had anti-terrorist security applications. IDN was one of many companies which took advantage of the terrorist threat to reinvent themselves in the security field, with the implication that they were poised to profit from massive increases in anti-terror spending by government and commercial organizations.
3. IDN has never shown a profit nor had a profitable quarter during its nearly 10 years of existence and its sales have been insignificant. From its founding in 1994 to its IPO in 1999, its total sales were nearly zero, and during the first six months of 1999, leading up to the IPO, its sales were zero. IDN's IPO occurred during a bubble period in financial markets, when in response to rabid demand for stocks, many companies went public without a prior record of sales and earnings; we believe it unlikely that a similar IPO could find investors today. IDN has held an abnormally high price to sales ratio of more than 80 during much of its history. Few other companies have had a market value which is as high compared to its low sales for such a long period of time. Its already low sales have in fact recently declined sequentially, from $365,000 during the fourth quarter of 2002 to $264,000 during the first quarter of 2003.
4. IDN raises the money necessary to stay in business by creating and selling new shares. Shares outstanding have increased from 4.4 million as of 1 January 1999 to nearly 9 million as of 31 March 2003. Thus, a share of IDN in March 2003 represented less than half of what it represented in January 1999 in terms of ownership of the company.
5. In order to convince investors to buy its stock, IDN has actively issued press releases which imply that the company's future prospects are bright. For sources of press release material, IDN has followed three main themes: IDN creates alliances and agreements with other organizations which imply that these alliances and agreements will result in significant future sales; IDN sells token amounts of its products to other organizations and businesses and then announces the successful sales of these products, the implication of which is that greater sales will follow; and IDN obtains endorsements for its product from other organizations and individuals, which imply that the product is of high quality and will result in future sales.
6. IDN has announced alliances with or endorsements from organizations including SISCO (on two separate occasions of which we are aware, brokers pitching IDN shares implied that SISCO, a small private company, was Cisco, the multi-billion dollar technology company), Imaging Automation, the American Stock Exchange (which praised the IDN bar code reader as "an exceptional weapon"), ICTS (on 4 October 2002, IDN issued a press release announcing its alliance with ICTS; on 23 May 2003 the chairman and one director of ICTS were arrested in Israel on suspicion of securities fraud), Mothers Against Drunk Driving (MADD), Darden Restaurants, the American Association of Airport Executives (AAAE), the Credit Union National Association (CUNA), Integrated Solutions, CardCom, Northrop Grumman, Lenel, E-Certify, and, in early August 2003, the US Supreme Court. In addition IDN has issued numerous press releases detailing individual sales of between one and three of its products to various buyers. Although the credibility of the above names varies from very high to very low, the one thing all have in common is that none resulted in any but token sales. In conference calls with the investing public, IDN managers have tended to discuss specific alliances for two or three quarters after issuance of a press release, eventually dropping discussion of old names in favor of fresher press releases.
7. We learned from a conversation with the security office of the most prestigious organization listed above, the US Supreme Court, that IDN had offered to give two of its devices to the security office at a deeply discounted price. The security office accepted, enabling IDN to issue a press release on 7 August 2003 stating that the US Supreme Court had purchased its devices. The press release implies an endorsement of its product by the US Supreme Court, although the security office within the Supreme Court did not in fact offer any opinion of the IDN product. The security office does not represent a market for any significant future purchases, and we believe the only reason for IDN to have approached the Supreme Court was to create an attractive press release.
8. During 2003 IDN added both a former Clinton administration appointee named Arthur Money and a former Democratic congressman named Jim Moody to the IDN board of directors. In exchange for attaching their names to IDN, both have received options in IDN stock. The press releases issued to inform the investing public of the arrival of these two board members stressed their past federal government employment and implied that their addition to the IDN board will influence the US government to purchase IDN products. Again, the common element to information contained in these as well as other IDN press releases is that they have resulted in no significant sales of IDN's product. IDN occasionally re-issues its press releases in multiple forms. For example, IDN issued the press release announcing its sale of two bar code readers to the American Stock Exchange in five separate formats.
9. The timing of IDN press releases is often suspicious, with the stock rising noticably a day or two prior to a new press release. In a Business Week article of 19 May 2003, actually released 8 May 2003, IDN promoters Sawtooth Capital and WAB Capital advised Business Week that IDN had just signed an important contract and was likely to sign a second important contract. This information had been given to Sawtooth and WAB in their capacity as promoters of IDN, information which was not made public and which was thus in violation of SEC regulations requiring fair disclosure. (The contracts referred to are among the alliances and agreements listed above and did not result in actual sales.) (In an earlier, 24 September 2001 Business Week article following the turmoil of the September 2001 terrorist attacks, Sawtooth and Hermitage Capital recommended purchase of IDN shares for IDN's anti-terrorist profit potential. The day before the article, IDN traded at $8.60 and with publication, the next day the stock opened at $14.75, enabling IDN insiders to unload shares. Hermitage estimated sales of $30mm and earnings of 45 cents a share for 2002 which proved to be outlandish. Having been used as a tool of a stock promotion in September 2001, Business Week nevertheless revisited the IDN story with the above 19 May 2003 article.)
10. IDN's sole item of tangible value is its market capitalization, calculated as the number of shares outstanding times the price of each share, which was about $100 million in early August 2003. With cash running low during the first quarter of 2003, IDN management turned to a floorless convertible in a deal with a Bahamian entity named Gryphon Master Fund to raise additional cash. This type of financing, also knows as a "toxic convertible" or "death spiral financing", gives the lender a security which can require the company to sell however many shares are necessary until the lender is repaid. This form of financing became more frequent during the late 1990's, when managements of some companies seeking to raise cash were unable to make outright sales of stock. Nevertheless, the lower the price of the shares, the more shares which must be sold to repay the holder of the floorless convertible, which can result in the "death spiral" of infinite dilution to shareholders.
11. Upon financing the floorless convertible, Gryphon began to sell IDN shares short, and by 24 June 2003, the date the prospectus was issued, had already sold short 240,000 shares plus a derivative representing the short of an additional 65,000 shares. It is difficult to borrow IDN stock for use in short selling; stock promotion schemes typically lock up all shares which they control with brokers who have instructions not to lend the stock. Indeed, we consider the difficulty of borrowing a stock to sell short to be an important indicator in itself, that the more difficult it is for an investor to borrow a stock for short sale, the more likely it is that that stock is a promotion scheme. We believe that in order for Gryphon to sell short such a large amount of IDN stock in such a short period of time, IDN insiders must have loaned IDN shares specifically to Gryphon for this purpose. We note that as lender of last resort to IDN, Gryphon had access to complete information on IDN, information which led it to sell shares short immediately so as to cover its risk. At the same time as these events, IDN engaged in an especially active round of press release issuance in order to maintain and increase the price of IDN shares. The toxic convertible allowed IDN to obtain more cash; if the arrangement between Gryphon is closer than arms length, then the net effect is that IDN insiders were able to liquidate more shares.
12. IDN has a lengthy history of disputes with suppliers and other organizations. According to SEC filings, IDN's disputes include a termination of an agreement with a contractor named Hazeltine, which had produced the bar code readers, and settlement with a $220,000 billl outstanding with Hazeltine by payment of 75,000 shares of stock. A company called IdentiScan contested IDN's patents, which was resolved by IDN buying IdentiScan. IDN was sued by its landlord for $177,000 for non-payment of its rent in 1998. Also in 1998, IDN's CEO Frank Mandelbaum was involved in a lawsuit on behalf of plaintiffs' litigators Milberg Weiss against Pharmerica. In May 1999 IDN paid an unnamed third party 10,000 shares of IDN stock for a disputed royalty claim. Also in 1999 IDN was required to pay 9,000 shares for accounting services as claimed by a former accountant. During 2000 IDN's CEO Frank Mandelbaum was banned from at least one Atlantic City casino for failure to pay his debts within a specified period of time. In 2002 IDN's CEO Frank Mandelbaum was again involved in a lawsuit on behalf of litigators Millberg Weiss, this time against Columbia Laboratories. IDN disputed the sale by its co-founder of IDN stock, though eventually the co-founder was able to sell 435,000 shares for about $6 million during 2002. In October 2001, IDN was sued for securities fraud by a group of short sellers. On 5 August 2003, the IDN issued a press release saying that the suit had been dismissed, although the court's decision allows an amended complaint. IDN contracted with a company called Early Bird Capital to assist in raising money from investors. IDN was unhappy with Early Bird's performance and refused to pay fees to Early Bird. IDN lost an arbitration brought against it by Early Bird and during the first quarter of 2003 was ordered to pay $921,730 to Early Bird. During mid 2002, IDN's CEO Frank Mandelbaum sold IDN shares on almost a daily basis as required by the brokerage firm holding his shares, in order to fulfill a margin call created by Mandelbaum's unsuccessful speculation in other stocks. In August 2003 IDN sued Tricom Card Technologies for patent infringement.
13. During our investigation we uncovered no aspect of the IDN product which is unique. When an identification card is swiped through the device, a screen lists the information found on the bar code, and this information can be authenticated by comparing it to the information written in hard copy on the front of the identification card to see if it matches. For example, if a teenager were able to alter the birth date on the card in order to indicate that he is of legal age to purchase alcoholic beverages, he would likely be unable to alter the information in the bar code as well, and thus the bar code reader would expose the altered birth date. The IDN product does not have the ability to retain data or otherwise utilize or compile the data for use in identifying terrorists or criminals. Competitors with significant sales and earnings in the space include Symbol, Verifone, SecureTech Peripherals, Card Scanning Solutions, and at least a dozen others. All produce competitive products at significantly lower sales prices. In addition, IDN faces indirect competition from competitors who make drivers' licenses based on facial recognition and producers of watermarked drivers' licenses. Any federal government procurements would required bidding in which IDN would not be competitive.
14. IDN's inventory consists of its bar code reader devices. The inventory was purchased from a contract manufacturer in late 1999. Although the inventory is carried at a value of $1.77 million as of 31 March 2003, due to the age of the devices, the aging technology within the devices, and minimal customer interest in the devices, we believe the actual value of the inventory is considerably lower and that for accounting purposes its value should be written down to reflect its true worth.
15. IDN has built a web of relationships with brokers and agents to assist it in selling its stock to the public and maintaining the price of its shares. In exchange, these brokers and agents are paid fees or given IDN stock, options, or warrants. These relationships include Early Bird Capital as noted above, Jesup & Lamont Securities Corp., which did a private placement for IDN in 1997, GunnAllen and Starr Securities, which managed IDN's IPO in 1999, Sawtooth Capital Management, where about 6.6% of IDN shares are parked, Hermitage Capital and Ladenburg Thalmann, both of which are traders and sellers of IDN stock, Stockhouse.com which has written a positive research articel on IDN in exchange for payment, Taglich Brothers which has also written positive research reports on IDN in exchange for payment, and The Wall Street Transcript which has written positive articles on IDN in exchange for payment. IDN entered into a relationship in early 2002 with KPMG to help it raise additional funds in private placements. IDN paid Linda Daschle, wife of Senator Tom Daschle, to promote IDN and to seek grants and contracts from the federal government (see Congressional Quarterly, 16 April 2002). As noted above, Gryphon Master Fund is involved in providing cash to IDN through a floorless convertible. In our experience, we have never seen an ordinary, legitimate company make use of such a web of agencies.
16. IDN's network includes a great number of relationships, some of which are with notorious stock promotion outfits, all of which have helped promote IDN's stock to the public in exchange for payment. We believe that the omission of details of IDN's promotional relationships in SEC filings is a violation of law. Specifically, the filings to not contain adequate disclosure regarding IDN's agreements with Sawtooth Capital and WAB Capital. The filings contain information about Gryphon Master Fund, but per paragraph 11 above, we do not believe the filings contain adquate information about the extent to which the deal with Gryphon is not an arm's length transaction.
17. Other political connections include IDN's claims to have close relationships with Senators Fritz Hollings (D-SC) and Senator Barbara Boxer (D-CA). IDN claims Hollings actually visited the IDN office. We do not believe there is much substance to IDN's claims of connections to these two. We believe that these elected officials are eager to support new security and anti-terrorism ideas, but once they become aware that their names are being used to further a stock promotion, they will sever contact, if they have not already done so.
18. (An oddity noted by several of those who follow the IDN story is that IDN is located near one of America's most notorious stock promotions, Research Frontiers (NASDAQ: REFR). IDN is at 246 Crossways Parkway West and REFR is at 240 Crossways Park Drive, both in Woodbury, New York. IDN and REFR are two of the nation's most systematic stock promotions in that they feature a remarkable array of similar stock promotion techniques; both have a product which seems to intuitively make sense but never produces revenue. Both issue frequent press releases on alliances and agreements which are used by collaborating associates to sell stock, the proceeds of which enrich insiders and managers. The office setups are similar and both employ roughly the same number of employees. The CEO's of both REFR and IDN are oddly similar in age, build, appearance, and demeanor. However, although the two companies must certainly know of each other, we uncovered no direct link. The earliest and most complete researcher of REFR is Asensio & Co., with analysis available at www.asensio.com.)
19. We refer readers to the Yahoo internet message board for IDN, which is unusual for an internet message board in that it contains particularly high quality analysis.
20. IDN usually reveals its SEC filings at the last possible moment, which is typical of stock promotions whose financial performance is nearly always bad. Few reputable companies have not filed by the time IDN files. We speculate that as a matter of human nature, good news comes out faster, and bad news is spread reluctantly. Also, IDN's last minute filings may reflect last minute negotiation with accountants on how to present information and judgment calls about whether the filings require "going concern" language, which are phrases indicating when a company must warn investors that it may not be able to remain in business. Its next earnings announcement is scheduled for 14 August 2003, a day before the deadline for release of earnings, and IDN has released a flurry of positive press releases in the weeks leading up to the earnings announcement.
21. Conclusion: We believe that IDN is a stock promotion scheme aimed at enriching its managers and other insiders through the sale of stock and not through the sale of products. We believe the company has no real prospects of ever making significant sales or profits as competitors sell similar products at much lower prices. The company has a lengthy history of poor financial performance. IDN has the attributes of a stock promotion in the way that it issues its press release and sells its shares, and throughout our study of modern stock markets we have never seen a company employing these methods which did not end in disappointment for outside investors. |
