SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-KSB/A

Amendment No. 1

ý		ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

		For the fiscal year ended December 31, 2003.

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

For the transition period to .

Commission File Number

IMAGEWARE SYSTEMS, INC.

(Name of Small Business Issuer in Its Charter)

California		33-0224167
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.

10883 Thornmint Road, San Diego, California		92127
(Address of Principal Executive Offices)		(Zip Code)

(858) 673-8600
(Issuer’s Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Exchange Act:

Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, $0.01 par value Warrants to Purchase Common Stock		American Stock Exchange American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

Check if no disclosure of delinquent filers in response to Item 405 of Regulation S-B is contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. ý

The issuer’s revenues for the fiscal year ended December 31, 2003 were $16,267,541.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the issuer, based on the closing sales price of the issuer’s Common Stock on March 19, 2004 as reported on the American Stock Exchange was approximately $38,678,831. Excluded from this computation were 272,002 shares of Common Stock held by all current executive officers and directors and 1,848,637 shares held by each person who is known by the registrant to own 5% or more of the outstanding Common Stock. Share ownership information of certain persons known by the issuer to own greater than 5% of the outstanding Common Stock for purposes of the preceding calculation is based solely on information on Schedule 13G filed with the Commission and is as of March 19, 2004. Exclusion of shares held by any person or entity should not be construed to indicate that such person possesses the power, directly or indirectly, to direct or cause the direction of the management or the policies of the Registrant.

The number of shares of Common Stock outstanding as of March 19, 2004 was 11,790,347.

DOCUMENTS INCORPORATED BY REFERENCE

Certain Exhibits filed with the Registrant’s Registration Statement on Form SB-2 (333-93131), Registration Statement on Form S-3 (333-64192), Form 10-KSB for the Years Ended December 31, 2000 and December 31, 2001, Form 10-QSB for each of the quarters ended March 31, 2001, June 30, 2001, September 30, 2001, March 31, 2002, and June 30, 2002, and Forms 8-K as filed with the Commission on August 13, 2001 and on May 24, 2002 are incorporated by reference into Part III of this Form 10-KSB.

Transitional Small Business Disclosure Format (check one):Yes o No ý

EXPLANATORY NOTE

This Amendment No. 1 to ImageWare Systems, Inc.’s Annual Report on Form 10-KSB for the year ended December 31, 2003 is being filed to add the conformed signature of PricewaterhouseCoopers LLP to the Independent Accountants Report. The conformed signature was inadvertently omitted from the Independent Accountants Report filed with the original Annual Report on Form 10-KSB filed on March 30, 2004. There have been no changes to the balance of the Form 10-KSB from the original filing.

ITEM 7. Financial Statements.

INDEPENDENT AUDITORS’ REPORT

TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF IMAGEWARE SYSTEMS, INC.:

We have audited the accompanying consolidated balance sheet of ImageWare Systems, Inc. as of December 31, 2003 and the related consolidated statements of operations, stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidate financial statements referred to above present fairly, in all material respects, the consolidated financial position of the ImageWare Systems, Inc. as of December 31, 2003 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles in the United States.

/s/Stonefield Josephson, Inc.
STONEFIELD JOSEPHSON, INC.
Certified Public Accountants
Santa Monica, California
March 26, 2004

REPORT OF INDEPENDENT ACCOUNTANTS

To Board of Directors and Shareholders’ of

ImageWare Systems, Inc.

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of ImageWare Systems, Inc. and its subsidiaries (the “Company”) at December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/PricewaterhouseCoopers LLP
PRICEWATERHOUSE COOPERS LLP
San Diego, California
March 30, 2004

IMAGEWARE SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

	December 31, 2003			December 31, 2002
ASSETS

Current Assets:
Cash	$	578,093		$	214,937
Restricted cash and cash equivalents	155,215			60,000
Accounts receivable, net of allowance for doubtful accounts of $483,254 and $410,000 at December 31, 2003 and 2002, respectively	1,449,968			3,294,932
Inventories, net	804,526			1,882,082
Other current assets	204,065			422,382
Total Current Assets	3,191,867			5,874,333

Property and equipment, net	634,966			1,040,915
Other assets	571,199			743,826
Intangible assets, net	1,120,675			1,561,545
Goodwill	5,297,627			5,297,627
Total Assets	$	10,816,334		$	14,518,246

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities:
Accounts payable	$	1,052,862		$	3,232,735
Deferred revenue	847,690			976,046
Accrued expenses	1,067,379			1,501,046
Accrued expenses - related parties	—			46,597
Accrued interest	103,057			197,780
Notes & advances payable to bank and third parties	181,976			785,741
Notes payable to related parties	59,000			218,369
Total Current Liabilities	3,311,964			6,958,314

Convertible notes payable, net of discount	—			1,252,311
Warrant liability	3,460,120			—
Pension obligation	732,485			406,121
Total Liabilities	7,504,569			8,616,745

Shareholders’ equity
Preferred stock, $.01 par value, authorized 4,000,000 shares Series B convertible redeemable preferred stock, designated 750,000 shares, 389,400 shares issued, and 249,400 and 269,400 shares outstanding at December 31, 2003 and 2002 respectively, liquidation preference $623,500 and $673,500 at December 31, 2003 and December 31, 2002	2,494			2,694
Common stock, $.01 par value, 50,000,000 shares authorized, 9,930,037 shares issued, 9,923,333 and 5,481,311 shares outstanding at December 31, 2003 and 2002, respectively	98,051			53,712

Additional paid in capital	49,221,700			41,272,370
Treasury stock, at cost - 6,704 shares	(63,688		)	(63,688		)
Shareholder note receivable	(150,000		)	(150,000		)
Accumulated other comprehensive income	265,470			112,881
Accumulated deficit	(46,062,262		)	(35,326,469		)
Total shareholders’ equity	3,311,765			5,901,500

Total Liabilities and Shareholders’ Equity	$	10,816,334		$	14,518,246

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

IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

	TWELVE MONTHS ENDED December 31,
	2003			2002

Revenues:
Product	$	13,470,629		$	15,115,766
Maintenance	2,762,829			3,139,927
	16,233,458			18,255,693
Cost of revenues:
Product	6,180,726			7,060,131
Maintenance	1,201,710			1,236,316

Gross profit	8,851,022			9,959,246

Operating expenses:
General & administrative	6,106,438			6,911,228
Sales and marketing	3,820,595			4,204,613
Research & development	1,920,696			2,078,777
Depreciation and amortization	924,257			894,400
	12,771,986			14,089,018

Loss from operations	(3,920,964		)	(4,129,772		)

Interest expense, net	6,960,140			652,392

Other income, net	(207,046		)	(53,575		)

Loss before income taxes	(10,674,058		)	(4,728,589		)

Income tax expense	61,735			120,341

Net loss	$	(10,735,793	)	$	(4,848,930	)

Basic and diluted loss per common share - see note 2	$	(1.81	)	$	(0.90	)
Weighted-average shares (basic and diluted)	5,953,801			5,483,973

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

IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

	TWELVE MONTHS ENDED DECEMBER 31,
	2003			2002

Net loss	$	(10,735,793	)	$	(4,848,930	)
Other comprehensive income:
Foreign currency translation adjustment	152,589			149,533
Comprehensive loss	$	(10,583,204	)	$	(4,699,397	)

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

IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	TWELVE MONTHS ENDED December 31,
	2003			2002

Cash flows from operating activities
Net loss	$	(10,735,793	)	$	(4,848,930	)
Adjustments to reconcile net loss to net cash used by operating activities
Depreciation and amortization	924,257			894,400
Non cash interest and amortization of debt discount and debt issuance costs	6,136,480			442,822
Issuance of commson stock for professional services	48,000			—
Other non-cash charges	268,317			—
Change in assets and liabilities
Accounts receivable	1,756,784			1,246,549
Inventories	897,418			(931,879		)
Other current assets	218,320			568,401
Other assets	(94,922		)	(2,986		)
Accounts payable	(2,096,017		)	313,772
Accrued expenses	(433,670		)	(85,291		)
Accrued expenses - related parties	(2,722		)	—
Accrued interest	(59,378		)	155,323
Deferred revenue	(128,356		)	(17,134		)
Pension obligation	326,364			196,552

Total adjustments	7,760,875			2,780,529

Net cash used by operating activities	(2,974,918		)	(2,068,401		)

Cash flows from investing activities
Purchase of property and equipment	(135,964		)	(354,661		)
Restricted cash and cash equivalents	(95,215		)	—
Payment on advances from related stockholders	(203,243		)	(161,360		)
Sale of property and equipment	58,526			—

Net cash used by investing activities	(375,896		)	(516,021		)

Cash flows from financing activities
Proceeds from issuance of notes payable with warrants	4,856,000			2,500,000
Proceeds from issuance of common stock, net of issuance costs	6,203,080			—
Repayment of convertible notes payable	(6,777,996		)	(20,934		)
Debt issuance costs	(554,078		)	(383,885		)
Proceeds from (repayment of) bank line of credit	(165,625		)	165,625
Proceeds from exercise of options and warrants	—			1,247

Net cash provided by financing activities	3,561,381			2,262,053
Effect of exchange rate changes on cash	152,589			149,533
Net increase (decrease) in cash	363,156			(172,836		)

Cash at beginning of period	214,937			387,773

Cash at end of period	$	578,093		$	214,937

Supplemental disclosure of cash flow information:
Cash paid for interest	$	651,955		$	—
Summary of non-cash investing and financing activities:
Conversion of trade accounts payable to notes payable	$	98,661		$	—
Conversion of convertible notes and accrued interest to common stock	$	632,001		$	—
Conversion of preferred stock to common stock	$	200		$	350

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

ImageWare Systems, Inc.

Consolidated Statements of Shareholders’ Equity

for the Years Ended December 31, 2003 and 2002

	Series B Convertible, Redeemable Preferred					Common Stock			Treasury Stock						Additional Paid-In Capital			Unearned Stock Based Compensation		Share- holder Note Receivable			Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit				Total
	Shares		Amount			Shares	Amount		Shares		Amount
Balance at December 31, 2001	304,400		$	3,044		5,488,015	$	53,631	(6,704	)	$	(63,688		)	$	40,196,952		$	—	$	(150,000	)	$	(36,652	)	$	(30,477,539		)	$	9,525,748

Preferred Stock conversion to common stock	(35,000	)	(350		)	7,663	77		—		—				273			—		—			—			—				—

Issuance of common stock pursuant to option and warrant exercise for cash	—		—			416	4		—		—				1,243			—		—			—			—				1,247

Warrants issued in conjunction with convertible debt	—		—			—	—		—		—				536,951			—		—			—			—				536,951

Beneficial conversion feature of convertible debt	—		—			—	—		—		—				536,951			—		—			—			—				536,951

Accumulated other comprehensive loss	—		—			—	—		—		—				—			—		—			149,533			—				149,533
Net loss	—		—			—	—		—		—				—			—		—			—			(4,848,930			)	(4,848,930			)

Balance at December 31, 2002	269,400		2,694			5,496,094	53,712		(6,704	)	(63,688			)	41,272,370			—		(150,000		)	112,881			(35,326,469			)	5,901,500

Preferred Stock conversion to common stock	(20,000	)	(200		)	4,804	48		—		—				152			—		—			—			—				—

Issuance of common stock for cash, net of issuance costs	—		—			4,069,484	40,695		—		—				6,162,385			—		—			—			—				6,203,080

Conversion of convertible notes payable and accrued unpaid interest into common stock						334,392	3,344								632,001															635,345

Issuance of common stock for professional services						25,263	252								47,748															48,000

Warrants issued in conjunction with convertible debt and common stock	—		—			—	—		—		—				(990,530		)	—		—			—			—				(990,530			)

Beneficial conversion feature of convertible debt	—		—			—	—		—		—				3,088,417			—		—			—			—				3,088,417

Reacquisition value of beneficial conversion feature															(1,100,737		)													(1,100,737			)

Induced conversion expense of convertible debt															109,894															109,894

Foreign currency translation adjustment	—		—			—	—		—		—				—			—		—			152,589			—				152,589
Net loss	—		—			—	—		—		—				—			—		—						(10,735,793			)	(10,735,793			)

Balance at December 31, 2003	249,400		$	2,494		9,930,037	$	98,051	(6,704	)	$		(63,688	)	$	49,221,700		$	—	$	(150,000	)	$	265,470		$		(46,062,262	)	$		3,311,765

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

IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003 AND 2002

1. DESCRIPTION OF BUSINESS AND OPERATIONS

ImageWare Systems, Inc. (the “Company”), formerly known as ImageWare Software, Inc., was incorporated in the State of California on February 6, 1987. The Company utilizes digital imaging technology to provide stand alone, networked and web-based software solutions for secure credentials, biometrics, law enforcement and professional photography.

ImageWare’s law enforcement solutions which enable agencies to quickly capture, archive, search, retrieve, and share digital photographs and criminal history records on a stand alone, networked, wireless or web-based platform. ImageWare develops, sells and supports a suite of modular software products used by law enforcement and public safety agencies to create and manage criminal history records and to investigate crime. Our C.R.I.M.E.S. system consists of eight software modules: Crime Capture System (consisting of the Capture Module and the Retrieval Module), which provides a criminal booking system and related database; Face ID, which uses biometric facial recognition to identify suspects; Suspect ID, which facilitates the creation of full-color, photo-realistic suspect composites; Crime Lab, which allows officers to enhance and edit digital images; and Vehicle ID, which helps officers identify motor vehicles stolen or involved in a crime. In addition, we offer Crime Web, which provides access to centrally stored records over the Internet in a connected or wireless fashion, Pocket CCS which enables access to centrally stored records while in the field on a handheld Pocket PC compatible device, and central repository services which allows for inter-agency data sharing on a local, regional, and/or national level. We recently added a new module to CCS which incorporates fingerprint livescan capabilities into CCS for real-time capture of single to ten prints and palm to further improve the booking, investigative and identification procedures.

ImageWare’s ID solutions empower customers to create secure and smart digital identification documents with complete ID systems. We develop, sell and support software and design systems which utilize digital imaging in the production of photo identification cards and credentials and identification systems. Our sales in the digital identification market were developed through our acquisitions of ITC, Goddard and G & A (discussed below). Our products in this market consist of EpiSuite, EpiWeb, EpiWeb Enterprise, EpiBuilder (SDK), Identifier for Windows, ID Card Maker, Winbadge NT and Winbadge Aviation. These products allow for the production of digital identification cards and related databases and records and can be used by, among others, schools, airports, hospitals, corporations or governments. We have recently added the ability to incorporate multiple biometrics into the ID systems we offer with the addition of our new Omni Biometric Engine to our product line.

ImageWare’s Digital Photography (“PDI”) product line consists of a suite of software for the professional photography market. The software allows professional photographers to digitally capture images, manipulate them to create a custom package or layout, then store the images with an associated database. They can then print the digital images themselves or send them via the Internet or CD to a professional lab for processing. Our products include PC Pro, PC Event, PDI School Days+, PDI Studio, PDI Pro Lab and PDI Green Screen. Our customers use the software products in a wide variety of ways including retail studio environments, on-location event photography and “picture day” at schools and day care centers. Our software products are sold through a dealer network and directly to major accounts. The PDI group also operates an e-commerce service, Picturemore.com, used by professional photographers to allow their customers to order re-prints and various service items. Our sales in the digital photography market were developed as a result of our acquisition of Castleworks and E-Focus West in August, 2001.

Going Concern

As reflected in the accompanying consolidated financial statements, the Company has losses and negative cash flows from operations and negative working capital. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which, in turn, is dependent upon the Company’s ability to continue to raise capital and generate positive cash flows from operations. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue its existence.

Subsequent to year end, the Company has completed a private placement in which the Company raised gross proceeds of approximately $6.6 million. The Company believes that its current cash balances will satisfy its projected working capital and capital requirements for at least the next twelve months. See Note 16 for further details.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expense during the reporting period. Significant estimates include allowance for doubtful accounts receivable, deferred tax asset valuation allowances, accounting for loss contingencies, and recoverability of goodwill and acquired intangible assets. Actual results could differ from estimates.

Fair Value of Financial Instruments:

For certain of the Company’s financial instruments, including accounts receivable, accounts payable, accrued expenses and deferred revenues the carrying amounts approximate fair value due to their relatively short maturities.

Property and equipment

Property and equipment, consisting of furniture and equipment, are stated at cost and are being depreciated on a straight-line basis over the estimated useful lives of the assets, which range from three to five years. Maintenance and repairs are charged to expense as incurred. Major renewals or improvements are capitalized. When assets are sold or abandoned, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized.

Goodwill:

Goodwill arising from the acquisition of G & A Imaging and Castleworks and E-Focus was first attributed to developed technology, trademarks and tradenames, patents, agreements not-to-compete and customer relationship based upon their estimated fair value at the date of acquisition. These intangible assets are being amortized over their estimated useful lives, which range from 3-15 years. Goodwill acquired will be reviewed for impairment pursuant to SFAS No. 142.

The Company accounts for its intangible assets under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets”. In accordance with SFAS No. 142, intangible assets with a definite life are accounted for impairment under SFAS No. 144 and intangible assets with indefinite life are accounted for impairment under SFAS No. 142. In accordance with SFAS No. 142, goodwill, or the excess of cost over fair value of net assets acquired, is no longer amortized but is tested for impairment using a fair value approach at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (referred to as a component) if discrete financial information is prepared and regularly reviewed by management at the component level. The Company recognizes an impairment charge for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its fair value. The Company uses discounted cash flows to establish fair values. When available and as appropriate, comparative market multiples to corroborate discounted cash flow results is used. When a business within a reporting unit is disposed of, goodwill is allocated to the gain or loss on disposition using the relative fair value methodology.

The Company did not record any goodwill impairment charges for the years ended December 31, 2003 and 2002.

Intangible and Long-lived assets

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairment of Disposal of Long-Lived Assets”, which supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, and the accounting and reporting provision of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”, for the disposal of a segment of a business. This statement also amends ARB No. 51, “Consolidated Financial Statements”, to eliminate the exception to consolidation for a subsidiary for which control is likely to be impaired. SFAS No. 144 requires that long-lived assets to be disposed of by sale, including those of discontinued operations, be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS No. 144 broadens the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 also establishes a “primary-asset” approach to determine the cash flow estimation period for a group of assets and liabilities that represents the unit of accounting for a long-lived asset to be held and used. At December 31, 2003 and 2002, there was no impairment of the Company’s intangible or long-lived assets.

Concentration of credit risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company places its cash with high quality financial institutions and at times may exceed the FDIC $100,000 insurance limit. Sales are typically made on credit and the Company generally does not require collateral. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains an allowance for doubtful accounts. Accounts receivable are presented net of an allowance for doubtful accounts of $483,254 and $410,147 and at December 31, 2003 and 2002, respectively.

In 2003, there were no customers who accounted for more than 10% of the Company’s revenues. In 2002, one customer accounted for 18% of the Company’s revenues.

As of December 31, 2003, there were no customers who accounted for more than 10% of total accounts receivable. At December 31, 2002, one customer accounted for 25% of total accounts receivable.

Stock-based compensation

Stock-based compensation to employees has been recognized as the difference between the per share fair value of the underlying stock and the stock option exercise at the initial grant date. The cost of stock options granted for services, other than those issued to employees, are recorded at the fair value of the stock option.

SFAS No. 123, “Accounting for Stock-Based Compensation,” establishes and encourages the use of the fair value based method of accounting for stock-based compensation arrangements under which compensation cost is determined using the fair value of stock-based compensation determined as of the date of grant and is recognized over the periods in which the related services are rendered. The statement also permits companies to elect to continue using the current intrinsic value accounting method specified in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for stock-based compensation. The Company has elected to use the intrinsic value based method and has disclosed the pro forma effect of using the fair value based method to account for its stock-based compensation issued to employees. For options granted to employees where the exercise price is less than the fair value of the stock at the date of grant, the Company recognizes an expense in accordance with APB 25. For non-employee stock based compensation the Company recognizes an expense in accordance with SFAS No. 123 and values the equity securities based on the fair value of the security on the date of grant. For stock-based awards the value is based on the market value for the stock on the date of grant. Stock option awards are valued using the Black-Scholes option-pricing model.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes method with the following assumptions: risk free interest rate ranging from 4.00% to 6.32%; dividend yield of 0% for each of the years 2003 and 2002; volatility factor of the expected market price of the Company’s common stock of 65% for 2003 and 2002; and an expected life of the options of 5 years for 2003 and 2002. The volatility of the Company’s common stock underlying the options was not considered for options granted up to March 31, 2000 because the Company’s stock was not publicly traded.

If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards under the Stock Option Plan consistent with the methodology prescribed by SFAS No. 123, the Company’s net loss and loss per share would have been increased to the pro forma amounts indicated below for the years ended December 31, 2003 and 2002:

	2003			2002
NET LOSS:
As reported	$	(10,735,793	)	$	(4,848,930	)
Stock based compensation included in net loss	—			—
Stock based employee compensation under fair value based method	(527,374		)	(918,555		)
Pro forma net loss	$	(11,263,168	)	$	(5,767,485	)
Basic loss per common share:
As reported	$	(1.81	)	$	(0.90	)
Pro forma	(1.90		)	(1.06		)

Income taxes

Current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is computed for the expected future impact of differences between the financial reporting and tax bases of assets and liabilities and for the expected future tax benefit to be derived from tax credits and loss carryforwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Foreign currency translation

The financial position and results of operations of the Company’s foreign subsidiaries are measured using the foreign subsidiary’s local currency as the functional currency. Revenues and expenses of such subsidiaries have been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of shareholders’ equity, unless there is a sale or complete liquidation of the underlying foreign investments. The Company translates

foreign currencies of its German, Canadian and Singapore subsidiaries. The cumulative translation adjustment account, which is part of accumulated other comprehensive income, increased $153,000 for the twelve months ended December 31, 2003 and $150,000 for the twelve months ended 2002.

Comprehensive Income

Comprehensive income consists of net gains and losses affecting shareholders’ equity that, under generally accepted accounting principles, are excluded from net income (loss). For the Company, the only item is the cumulative translation adjustment.

Revenue recognition

The Company recognizes revenue and profit as work progresses on long-term, fixed-price contracts involving significant amount of hardware and software customization using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Revenue from contracts for which we cannot reliably estimate total costs or there are not significant amounts of customization are recognized upon completion. Our revenue from periodic maintenance agreements is generally recognized ratably over the respective maintenance periods provided no significant obligations remain and collectibility of the related receivable is probable. The Company also generates non-recurring revenue from the licensing of its software. Software license revenue is recognized upon the execution of a license agreement, upon deliverance, fees are fixed and determinable, collectibility is probable and when all other significant obligations have been fulfilled. The Company also generates revenue from the sale of identification card media and other software. Revenue for these items is recognized upon delivery of these products to the customer. The Company also generates revenue from the sale of professional digital photography software. Revenue for these items is recognized upon delivery of these products to the customer.

Capitalized software development costs

Software development costs incurred prior to the establishment of technological feasibility are charged to research and development expense as incurred. Technological feasibility is established upon completion of a working model. Software development costs incurred subsequent to the time a product’s technological feasibility has been established, through the time the product is available for general release to customers, are capitalized, if material. To date, the Company has not capitalized any software costs as the period between achieving technological feasibility and the general availability of the related products has been short and software development costs qualifying for capitalization have been insignificant.

Earnings (loss) per share

Basic earnings (loss) per common share is calculated by dividing net income (loss) available to common shareholders for the period by the weighted-average number of common shares outstanding during the period. Diluted earnings (losses) per common share is calculated by dividing net income (loss) available to common shareholders for the period by the weighted-average number of common shares outstanding during the period, increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares, if dilutive, had been issued at the beginning of the year. The dilutive effect of outstanding stock options is included in the calculation of diluted earnings (losses) per common share, if dilutive, using the treasury stock method. During the years ended December 31, 2003 and 2002, the Company has excluded the following securities from the calculation of diluted loss per share, as their effect would have been antidilutive due to the Company’s net loss:

Potential Dilutive Securities:	Number of Common Shares Convertible into at December 31, 2003	Number of Common Shares Convertible into at December 31, 2002

Convertible preferred stock	60,017	60,489
Stock options	912,895	745,068
Convertible notes payable	—	464,037
Warrants	5,772,229	2,865,227

The following table sets forth the computation of basic and diluted loss per share for the years ended December 31, 2003 and 2002:

	TWELVE MONTHS ENDED DECEMBER 31,
	2003			2002
Numerator
Net loss	$	(10,735,793	)	$	(4,848,930	)
Less Series B preferred dividends	(61,356		)	(63,764		)
Net loss available to common shareholders	$	(10,797,149	)	$	(4,912,694	)

Denominator
Weighted-average shares outstanding	5,953,801			5,483,973

Basic and diluted loss per share	$	(1.81	)	$	(0.90	)

Segment information

Prior to its acquisition of G & A, Castleworks and E-Focus, the Company operated in one business segment. With its acquisition of G & A, Castleworks and E-Focus, the Company is now comprised of three reportable segments: Law Enforcement, Identification and Digital Photography. The Law Enforcement segment develops, sells and supports a suite of modular software products and designs systems used by law enforcement and public safety agencies to manage criminal history records and investigate crime. The Identification segment develops, sells and supports software and designs systems which utilize digital imaging in the production of photo identification cards, documents and identification badging systems. The Digital Photography segment develops digital imaging software for photographic purposes.

Corporate assets are comprised primarily of cash and other assets providing benefits to all business segments.

There are no intersegment transactions.

The table below summarizes information about reportable segments for the years ended December 31, 2003 and 2002:

	Year Ended December 31,
	2003			2002
Revenues:
Law Enforcement	$	3,273,001		$	4,247,645
Identification	11,783,672			13,088,453
Digital Photography	1,176,785			919,595
Total consolidated revenues	$	16,233,458		$	18,255,693
Operating profit (loss):
Law Enforcement	$	(459,243	)	$	183,103
Identification	(3,170,974		)	(3,205,486		)
Digital Photography	(290,747		)	(1,107,389		)
Other unallocated amounts:
Interest expense (income)	6,960,140			652,392

Other expense (income)	(207,046		)	(53,575		)
Loss before taxes	$	(10,674,058	)	$	(4,728,589	)
Total Assets by Segment:
Law Enforcement	$	528,175		$	1,167,292
Identification	8,238,539			10,754,234
Digital Photography	1,502,936			1,712,032
Total assets for reportable segments	10,269,650			13,633,558
Corporate	546,684			884,688
Total consolidated assets	$	10,816,334		$	14,518,246

The Company has total assets in foreign locations as follows: $2,531,000 in Germany, $152,000 in Canada and $393,000 in Singapore. Revenues generated from the Company’s foreign locations were $6,973,000 and $7,398,000 for years ended December 31, 2003 and 2002, respectively.

New Accounting Pronouncements

In December 2003 the FASB concluded to revise certain elements of FIN 46, primarily to clarify the required accounting for interests in variable interest entities. FIN-46R replaces FIN-46, that was issued in January 2003. FIN-46R exempts certain entities from its requirements and provides for special effective dates for entities that have fully or partially applied FIN-46 as of December 24, 2003. In certain situations, entities have the option of applying or continuing to apply FIN-46 for a short period of time before applying FIN-46R. In general, for all entities that were previously considered special purpose entities, FIN 46 should be applied in periods ending after December 15, 2003. Otherwise, FIN 46 is to be applied for registrants who file under Regulation SX in periods ending after March 15, 2004, and for registrants who file under Regulation SB, in periods ending after December 15, 2004. The Company does not expect the adoption to have a material impact on the Company’s financial position or results of operations.

In April 2003, the FASB issued Statement of Financial Accounting Standard No. 149, (“SFAS 149”), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, except for the provisions that were cleared by the FASB in prior pronouncements. The adoption of this statement did not impact the Company’s consolidated financial statements.

In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150 (SFAS 150), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability because that financial instrument embodies an obligation of the issuer. The adoption of this statement did not have a significant impact on the Company’s consolidated financial statements.

In May 2003, the Emerging Issues Task Force (EITF) finalized Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” During December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 104, “Revenue Recognition,” which incorporated EITF 00-21. This issue addresses determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how arrangement consideration should be measured and allocated to the separate units of accounting. The adoption of EITF 00-21 and SAB 104 was not material to the Company’s results of operations or financial condition.

In December 2003, the FASB issued a revision to SFAS 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, which requires additional disclosures about the assets, obligations, cash flows, and periodic benefit costs of defined benefit pension plans and other defined benefit postretirement plans. Disclosure of additional information about foreign plans is not required until the Company’s next fiscal year.

Reclassifications

Certain reclassifications were made to prior years’ consolidated financial statements to conform to the current year presentation.

3. Acquisitions and Goodwill

The following disclosure presents certain information about the Company’s acquired intangible assets as of December 31, 2003 and 2002. All intangible assets are being amortized over their estimated useful lives, as indicated below, with no estimated residual values.

Acquired Intangible Assets	Amortization Period	Gross Carrying Amount		Accumulated Amortization			Net Balance
At December 31, 2003
Amortized acquired intangible assets:
Technology	5 years	$	1,160,000	$	(678,288	)	$	481,712
Trademarks and tradenames	14.5 years	630,000		(128,119		)	501,881
Customer relationship	5 years	200,000		(109,998		)	90,002
Non-compete Agreements	3 years	125,000		(101,670		)	23,330
Patents	4 years	60,000		(36,250		)	23,750
		$	2,175,000	$	(1,054,325	)	$	1,120,675
At December 31, 2002
Amortized acquired intangible assets:
Technology	5 years	$	1,160,000	$	(438,180	)	$	721,820
Trademarks and tradenames	14.5 years	630,000		(80,623		)	549,377
Customer relationship	5 years	200,000		(69,998		)	130,002
Non-compete Agreements	3 years	125,000		(61,666		)	63,334
Patents	4 years	60,000		(21,250		)	38,750
		$	2,175,000	$	(671,717	)	$	1,503,283

As a result of adopting FAS 142 on January 1, 2002, “Acquired workforce” with a net book value of $525,000 was subsumed into goodwill.

Amortization expense for the twelve months ended December 31, 2003 was approximately $383,000.

The estimated acquired intangible amortization expense for the next five fiscal years is as follows:

Fiscal Year Ended December 31,		Estimated Amortization Expense
2004		354,000
2005		253,000
2006		50,000
2007		40,000
2008		40,000

The balance of the Company’s goodwill was $5,297,627 at December 31, 2003 and 2002.

In June 2002, we completed our transitional goodwill and purchased intangibles impairment tests outlined under SFAS 142 which required the assessment of goodwill and purchased intangibles for impairment as of January 1, 2002 and in December 2002 and 2003, we completed our annual impairment tests. These tests were conducted by determining and comparing the fair value of our reporting units, as defined in SFAS 142, to the reporting unit’s carrying value as of that date. Our reporting units are Law Enforcement, Identification and Digital Photography. Based on the results of these impairment tests, we determined that our goodwill

assets and purchased intangible assets were not impaired as of January 1, 2002 or during December 2002 and December 2003. We plan to conduct our annual impairment tests in the fourth quarter of every year, unless impairment indicators exist sooner.

4. Restricted Cash

At December 31, 2003 and 2002, the Company had $155,000 and $60,000, respectively, of restricted cash and cash equivalents which serves as collateral for irrevocable standby letter of credits that provide financial assurance that the Company will fulfill its obligations under certain commitments discussed in Note 9. The cash is held in custody by the issuing bank, is restricted as to withdrawal or use, and is currently invested in time certificates of deposits. Income from these investments is paid to the Company.

5. Inventory

Inventories at December 31, 2003 and 2002 were comprised of finished goods of $805,000 and $1,882,000 net of reserves of $316,000 and $171,000, respectively. Inventories are stated at the lower of cost or market. Market is determined based on net realizable value. Appropriate consideration is given to obsolescence, excessive levels, deterioration, and other factors in evaluating net realizable value.

6. Property and Equipment

Property and equipment at December 31, 2003 and 2002 consists of:

	2003			2002

Equipment	$	1,649,901		$	2,141,722
Leasehold improvements	119,930			100,630
Furniture	219,685			281,490
	1,989,516			2,523,842
Less accumulated depreciation	(1,354,550		)	(1,482,927		)
	$	634,966		$	1,040,915

Total depreciation expense for the years ended December 31, 2003 and 2002 was $483,000 and $503,000, respectively.

7. Notes Payable and Line of Credit

Notes payable consist of the following:

	2003			2002
Notes payable to bank and third parties:
Short-term note payable to third party to accrue interest at 10%. Note due upon demand	$	100,000		$	100,000
Short-term note payable to third party to accrue interest at 12.5%. Note due upon demand	—			500,000
Line of credit payable to bank to accrue interest at 8.4%	—			165,625
Short-term notes payable to certain vendors	81,976			20,116
Total notes payable to bank and third parties	181,976			785,741

Notes payable to related parties:
Short-term note payable to ITC shareholder. Such note accrues interest at 10% and is due upon demand	59,000			210,125
Short-term note payable to ITC shareholder. Such note accrues interest at 10% and includes monthly payments through December 31, 2002	—			8,244
Total notes payable to related parties	59,000			218,369

Convertible notes payable, net of discount:
Senior secured convertible promissory note to accrue interest at 12.5%. Face value of note $2,000,000. Discount on note at December 31, 2002 is $747,689. Note due May 22, 2004.	—			1,252,311
Total notes payable	$	240,976		$	2,256,421
Less current portion	(240,976		)	(1,004,110		)
Long-term notes payable	$	—		$	1,252,311

In May 2002, the Company issued a senior secured promissory note for $2,000,000 at an interest rate of 12.5%, due May 22, 2004 (the “Note”). The Note initially was convertible into common shares of the Company at $4.31 per share. In conjunction with the note, the Company issued a warrant to purchase 150,000 shares of common stock at $4.74 per share. The Company recorded the note net of a discount equal to the fair value allocated to the warrants issued of approximately $537,000.

The Note also contained a beneficial conversion feature, which resulted in additional debt discount of $537,000. The beneficial conversion amount was measured using the accounting intrinsic value, i.e. the excess of the aggregate fair value of the common stock into which the debt is convertible over the proceeds allocated to the security. The Company accreted the beneficial conversion feature as interest expense over the life of the note. For the twelve months ended December 31, 2002, the Company recorded $326,212 as interest expense from the amortization of the discount related to the fair value of the warrants and from the accretion of the beneficial conversion feature.

The issuance by the Company of $600,000 in convertible subordinated promissory notes in March 2003 (described below) triggered certain anti-dilution provisions contained in the Note. This resulted in the conversion price of the Note being reduced to $1.90 per share. Similar provisions also reduced the warrant exercise price to $4.65 per share. These reductions resulted in the recognition of an additional beneficial conversion feature in the amount of $926,000 which was recorded as additional debt discount. The Company accreted this additional beneficial conversion feature as interest expense through the date of extinguishment.

In September 2002, the Company issued a secured demand promissory note for $500,000 at an interest rate of 12.5% to the holder of the Note. The note was due and payable upon demand given by the holder. The Company repaid this note in full in June 2003.

In March 2003, the Company issued to certain accredited investors convertible subordinated promissory notes (“the Subordinated Notes”). The Subordinated Notes had an aggregate principal amount of $600,000, bear an interest rate of 8.5% per annum, payable semi-annually in arrears, have a maturity date of April 15, 2005 and are convertible into shares of the Company’s common stock at a conversion price of $1.90 per share.

The Subordinated Notes contained an embedded beneficial conversion feature which resulted in debt discount of $111,000. The beneficial conversion amount was measured using the accounting intrinsic value, i.e. the excess of the aggregate fair value of the common stock into which the debt is convertible over the proceeds allocated to the security. The Company accreted the beneficial conversion feature as interest expense over the life of the note.

In November 2003, the holders of the Subordinated Notes converted the principal amount and accrued interest outstanding into 334,392 shares of the Company’s Common Stock. To induce the holders of the Subordinated Notes to convert their debt, the Company issued the holders of the Subordinated Notes warrants to purchase 66,876 shares of the Company’s common stock at $2.58 per share. The Company has recorded $110,000 as induced conversion expense based on the value of the warrants on the date of issuance. The estimated value of the warrants of $110,000 was determined using the Black-Scholes option pricing model and the following assumptions: term of 5 years, a risk free interest rate of 2.53%, a dividend yield of 0% and volatility of 85%.

In June 2003, the Company issued two senior secured convertible promissory notes for an aggregate of $4,150,000 and a third senior secured convertible note for $106,000 (collectively “the New Notes”) in lieu of payment of financing fees. The New Notes bear interest at 12.5% per annum and are due on May 22, 2005. Under the terms of the New Notes, the holders retain the right, subject to certain exceptions, to convert all or any part of the principal and accrued interest outstanding under the New Notes into shares of our Common Stock at a conversion price equal to $2.11. In conjunction with the issuance of the New Notes, the Company issued warrants to acquire 1,600,000 shares of the Company’s Common Stock at an exercise price of $2.11 per share.

In accordance with EITF 00-27, the Company first determined the fair value of the New Notes and the fair value of the detachable warrants issued in connection with these notes. The estimated value of the warrants of $2,770,000 was determined using the Black-Scholes option pricing model and the following assumptions: term of 6 years, a risk free interest rate of 2.53%, a dividend yield of 0% and volatility of 82%. The face amount of the New Notes of $4,256,000 was proportionately allocated to the New Notes and the warrants in the amount of $2,218,000 and $2,038,000, respectively. The amount allocated to the warrants of $2,038,000 was recorded as a discount on the New Notes and as additional paid-in capital. The value of the New Notes was then allocated between the New Notes and the beneficial conversion feature, which amounted to $166,000 and $2,052,000, respectively. The amount allocated to the beneficial conversion feature of $2,052,000 was recorded as a discount on the New Notes and as additional paid-in capital. The Company accreted the discounts on the New Notes as interest expense over the life of the notes.

The Company utilized a portion of the proceeds from the issuance of the New Notes to extinguish the $2,000,000 Senior Secured Convertible Note issued May 2002 and the $500,000 secured demand promissory note issued in September 2002. The Company has recorded additional interest expense of $766,757 representing the unamortized debt discount at the date of the extinguishment. The Company has also recorded additional interest expense of $225,000 representing unamortized deferred financing fees at the date of extinguishment. The Company allocated $516,000 of the reacquisition price to the beneficial conversion feature based on the intrinsic value of the conversion feature on the date of extinguishment.

In November 2003, the Company repaid the principal amount of the New Notes plus accrued interest outstanding at the date of extinguishment. The Company has recorded additional interest expense of $2,715,000 representing the unamortized debt discount at the date of the extinguishment. The Company has also recorded additional interest expense of $429,000 representing

unamortized deferred financing fees at the date of extinguishment. The Company allocated $585,000 of the reacquisition price to the beneficial conversion feature based on the intrinsic value of the conversion feature on the date of extinguishment.

A foreign subsidiary of the Company had two lines of credit with commercial banks totaling $606,000. As of December 31, 2002, the Company had utilized approximately $165,625 of this facility. Borrowings under this facility bear interest at 8.4% per annum and are collateralized by the subsidiary’s accounts receivable. During 2003, the Company repaid all outstanding borrowings under these credit facilities upon their termination.

On June 30, 2001, the Company converted accrued liabilities due to an employee into a promissory note in the amount of $269,605. The note bears interest at 10% per annum. Under the terms of the note, the Company is required to make monthly payments of $15,000 until the note is paid in full on January 14, 2003. At December 31, 2002, the balance of this note payable was $8,244. During 2003, the Company repaid the remainder of this note in full.

On February 23, 2003, pursuant to a settlement agreement, the Company amended the $ 210,125 note due the ITC shareholder and converted approximately $44,000 in accrued liabilities into a new promissory note. This new note bears interest at 7% per annum. Under the terms of the note, the Company is required to make monthly payments of $15,000 until the note is paid in full on April 15, 2004. At December 31, 2003, the balance of this note payable was $59,000.

In July 2003, the Company converted $99,000 in trade accounts payable into promissory notes. The notes bear interest between 6.50% to 7.50% per annum, call for monthly payments between $1,000 to $2,000 until paid in full, with payments commencing August 1, 2003.

Future maturities of notes payable as of December 31, 2003 are $240,976 due at various dates in 2004 and $0 due thereafter.

8. Warrant Liability

In conjunction with the Company’s issuance of the New Notes, the Company agreed to register with the Securities and Exchange Commission, the shares of common stock underlying the warrants issued as part of the New Notes. In conjunction with the Company’s issuance of common stock in a private placement, the Company agreed to register with the Securities and Exchange Commission, the shares of common stock underlying the warrants issued as part of the private placement. In accordance with the Financial Accounting Standards Board Emerging Issue Task Force 00-19, the Company has recorded as long-term liability for the allocated value of the warrants. Accordingly, the Company is accounting for the liability under fair value accounting. The following table sets forth the changes in fair value and the resulting interest income or expense of this liability as determined under fair value accounting:

	Warrant Liability in Conjunction with warrants issued with New Notes			Interest Expense (Income) from warrant revaluation of New Notes Warrants			Warrant Liability in Conjunction with warrants issued with Private Placement		Interest Expense (Income) from warrant revaluation of Private Placement Warrants

Warrant liability at date of inception	$	2,037,000					$	1,035,000

Change in fair value of warrant liability	$	321,000		$	321,000

Warrant liability at June 30, 2003	$	2,358,000

Change in fair value of warrant liability	$	(711,000	)	$	(711,000	)

Warrant liability at September 30, 2003	$	1,647,000

Change in fair value of warrant liability	$	399,000		$	399,000		$	379,000	$	379,000

Warrant liability at December 31, 2003	$	2,046,000		$	9,000		$	1,414,000	$	379,000

The estimated warrant liability and subsequent valuations were determined using the Black-Scholes option pricing model and the following assumptions: term of 5-6 years, a risk free interest rate of 2.53%, a dividend yield of 0% and volatility of 82% - 85%.

8. Income Taxes

The significant components of the income tax provision (benefit) are as follows:

	December 31,
	2003		2002
Current
Federal	$	—	$	—
State	—		—
Foreign	—		—

Deferred
Federal	—		—
State	—		—
Foreign	61,735		120,341

	$	61,735	$	120,341

The principal components of the Company’s deferred tax assets (liabilities) at December 31, 2003 and 2002 are as follows:

	2003			2002

Net operating loss carryforwards	$	8,586,589		$	6,961,249
Research and development credits	607,614			561,033
Intangible Assets	534,656			209,937
Reserves and accrued expenses	248,875			281,310
Other	(48,550		)	(20,000		)
	9,929,184			7,993,529
Less valuation allowance	(9,929,184		)	(7,929,042		)

Net deferred tax assets	$	—		$	64,487

A reconciliation of the provision (benefit) for income taxes to the amount computed by applying the statutory income tax rates to loss before income taxes is as follows:

	2003			2002

Amounts computed at statutory rates	$	(3,649,626	)	$	1,548,005	)
State income tax, net of federal benefit	(201,348		)	(270,445		)
Foreign tax	61,735			120,341
Non-deductible interest	1,823,746			—
Other	(13,930		)	40,053
Net change in valuation allowance	2,039,910			1,778,397

	$	60,487		$	120,341

The Company has established a valuation allowance against its deferred tax asset due to the uncertainty surrounding the realization of such asset. Management periodically evaluates the recoverability of the deferred tax asset. At such time as it is determined that is more likely than not that deferred tax assets are realizable, the valuation allowance will be reduced.

At December 31, 2003 and 2002, the Company had federal net operating loss carryforwards of approximately $23,104,000 and $18,534,000, respectively, state net operating loss carryforwards of approximately $10,022,000 and $12,534,000, respectively, which may be available to offset future taxable income for tax purposes. The federal net operating loss carryforwards expire at various dates from 2004 through 2023. The state net operating loss carryforwards expire at various dates from 2004 through 2008. In addition, the Company had foreign operating losses carryforwards of approximately $659,000 at December 31, 2003.

The Company also had federal research credit carryforwards of approximately $396,000 and $361,000 and state research credit carryforwards of approximately $212,000 and $200,000 for tax purposes at December 31, 2003 and 2002, respectively. The federal carryforwards will begin to expiring, if unused, in 2008.

The Internal Revenue Code (the “Code”) limits the availability of net operating losses and certain tax credits that arose prior to certain cumulative changes in a corporations’s ownership resulting in a change of control of the Company. The Company’s use of its net operating loss carryforwards and tax credit carryforwards will be significantly limited because the Company underwent “ownership changes” in 1991, 1995, 2000 and 2003. The effect of the existing limitation has been reflected in the above summary of the deferred tax assets.

9. Commitments and Contingencies

Employment Agreements

The Company has employment agreements with its Chief Executive Officer, Senior Vice President of Administration and Chief Financial Officer, Vice President of Research and Development, President of ImageWare Systems Law Enforcement Group, and President of ImageWare Systems Digital Photography. The Company may terminate the agreements with or without cause. Should the Company terminate the agreements without cause, the officers are entitled to compensation ranging from 12 to 36 months of salary.

Letter of Credit

As collateral for performance on various software installation and implementation contracts, the Company is contingently liable under two irrevocable standby letters of credits in an aggregate amount of approximately $155,000. The letters of credit expire in an amount of $49,000 on April 19, 2004. The second letter of credit in the amount of $106,000 expires December 26, 2008. As a

condition, the bank requires the Company to invest an equal amount in the form of certificate of deposit. As of December 31, 2003, there were no drawings against the outstanding balance.

Litigation

The Company is involved in certain legal proceedings generally incidental to its normal business activities. While the outcome of such proceedings cannot be accurately predicted, the Company does not believe the ultimate resolution of any such existing matters should have a material effect on its financial position, results of operations or cash flows.

Leases

The Company currently leases office and research and development space under operating leases which expire at various dates through December 2006.

At December 31, 2003, future minimum lease payments are as follows:

2004	$	780,000
2005	$	774,000
2006	$	830,000
2007	$	—
2008	$	—
	$	2,384,000

The Company is committed to a three year lease for office space housing its Digital Photography operations in Costa Mesa, California which is for 4,275 square feet. During 2002, the Company consolidated these operations into its corporate headquarters in San Diego, California and vacated the premises. The Company does not intend to occupy this space and is actively seeking a tenant to sub-lease this space. During 2002, the Company recorded an estimated loss on its lease commitment totaling $132,416, which is included in current accrued liabilities on the balance sheet. In determining this estimated loss for its lease commitment, the Company has been required to make various assumptions, including occupancy dates for new tenants, sub-lease rental rates, tenant improvement allowances, abandoned leasehold improvements and commission payments, that involve estimates and judgments. In formulating its assumptions, the Company took into account current and projected real estate market conditions. If the Company’s estimates and related assumptions change in the future, the Company may be required to revise this estimated loss on its lease commitment. If any revisions to its estimated loss are necessary, then an additional loss or a benefit will be recorded.

During 2003, the Company secured a tenant to sublease this space. As a result of subletting this property, the Company recorded an additional $38,000 loss on its lease commitment.

Rental expense under operating leases for the years ended December 31, 2003 and 2002 was approximately $828,000 and $1,006,000 respectively.

10. Equity

The Company’s Articles of Incorporation were amended effective August 31, 1994 and authorize the issuance of two classes of stock to be designated “Common Stock” and “Preferred Stock,” provide that both Common and Preferred Stock shall have a par value of $.01 per share and authorize the Company to issue 50,000,000 shares of Common Stock and 4,000,000 shares of Preferred Stock. The Preferred Stock may be divided into such number of series and with the rights, preferences, privileges and restrictions as the Board of Directors may determine.

Series B Convertible, Redeemable Preferred Stock

In April 1995, the Company’s Articles of Incorporation were amended to authorize 750,000 shares of Series B Convertible Redeemable Preferred Stock (“Series B”). Each 5.275 shares of Series B are convertible into one share of the Company’s common stock. As of December 31, 2003, the Company had 249,400 shares of Series B outstanding.

The holders of Series B are entitled to cumulative preferred dividends payable at the rate of $.2125 per share per annum commencing April 30, 1996, subject to legally available funds. The Series B plus accrued but unpaid dividends are convertible at the option of the holder into shares of common stock at a conversion price equal to the original Series B issue price as adjusted to prevent

dilution. The Series B will automatically be converted into shares of common stock upon the closing of an underwritten public offering at a price per common share of not less than $31.65. If the public offering price is less than $31.65 but at least $21.10 per share, the conversion shall still be automatic upon written consent of a majority of the then outstanding shareholders of Series B.

The Series B, on an as-converted basis, have the same voting rights per share as the Company’s common shares; provided, that the Series B has a special right to elect one director if the Company defaults in the payment of any dividend to the holders of Series B. The Series B are entitled to initial distributions of $2.50 per share of Series B outstanding, upon liquidation and in preference to common shares and any other series of preferred stock plus all accrued but unpaid dividends.

Any time after December 31, 2000, the Company has the right to redeem all or some of the outstanding shares of Series B at a price equal to the original issue price, plus all accrued but unpaid dividends.

As of December 31, 2002, the Company had 269,400 shares of Series B outstanding. During 2003, 20,000 shares of Series B preferred stock were converted into 4,804 shares of common stock. At December 31, 2003 and 2002, the Company had cumulative undeclared dividends of approximately $174,000 and $146,000, respectively.

Common Stock

On November 24, 2003, the Company completed a private placement of securities, which involved the sale of units consisting of one share of common stock and a warrant to purchase 0.20 shares of common stock. Each unit was priced at $1.72. The warrants have a five-year term and an exercise price of $2.58 per share. As a result of these transactions, the company issued an aggregate of approximately 4,070,000 new shares of common stock and warrants to purchase up to approximately 814,000 shares of common stock. In connection with this transaction, the Company also issued to certain placement agents warrants to purchase an additional approximately 407,000 shares of common stock. The Company raised approximately $7.0 million for the private placement, approximately $4.5 million of which was used to retire the Company’s outstanding 12.5% convertible secured debt.

Warrants

As of December 31, 2003, warrants to purchase 5,772,229 shares of common stock at prices ranging from $2.11 to $16.46 were outstanding. All warrants are exercisable as of December 31, 2003 and expire at various dates through June 2009.

The following table summarizes warrant activity since 2001:

	Warrants		Weighted- Average Exercise Price

Balance at December 31, 2001	2,823,943		$	11.28
Granted	200,282		$	3.55
Expired / Canceled	(108,717	)	$	7.91
Exercised	—		$	—
Balance at December 31, 2002	2,915,508		$	10.87
Granted	2,887,721		$	2.32
Expired / Canceled	(31,000	)	$	6.25
Exercised	—		$	—
Balance at December 31, 2003	5,772,229		$	6.62

The following table summarized information about warrants outstanding and exercisable at December 31, 2003:

Exercise Price	Number Outstanding	Weighted—Average Remaining Life (Years)	Weighted—Average Exercise Price

$2.1100	1,600,000	5.45	$	2.1100

$2.5800	1,287,721	4.90	$	2.5800

$3.5500	200,282	3.39	$	3.5500

$6.0000	125,000	0.86	$	6.0000

$7.9125	23,065	0.29	$	7.9125

$9.6000	181,339	1.25	$	9.6000

$10.8600	176,273	1.83	$	10.8600

$12.000	2,162,389	1.26	$	12.0000

$15.000 — $16.4600	16,161	1.42	$	15.5566

	5,772,229

11. Stock Option Plans

On August 31, 1994, the directors of the Company adopted the Company’s 1994 Employee Stock Option Plan (the “1994 Plan”) and the 1994 Nonqualified Stock Option Plan (the “Nonqualified Plan”). The 1992 Stock Option Plan and options previously granted were canceled by the Board of Directors.

The 1994 Plan originally provided for officers and other key employees to receive nontransferable incentive stock options to purchase up to 170,616 shares of the Company’s common stock. The number of stock options issued and outstanding and the number of stock options remaining available for future issuance are shown in the table below. The option price per share must be at least equal to 100% of the market value of the Company’s common stock on the date of grant and the term may not exceed ten years.

The Nonqualified Plan originally provided for directors and consultants to receive nontransferable options to purchase up to 18,957 shares of the Company’s common stock. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below. The option price per share must be at least equal to 85% of the market value of the Company’s common stock on the date of grant and the term may not exceed five years.

Both the 1994 Plan and the Nonqualified Plan are administered by the Board of Directors or a Committee of the Board which determines the employees, directors or consultants which will be granted options and the terms of the options, including vesting provisions which to date has been over a three year period. Both the 1994 Plan and the Nonqualified Plan expire on August 31, 2004.

Due to a significant decline in the estimated fair value of the Company’s common stock, in February 1999, the exercise price of previously granted stock options was repriced to $5.28 per share, which was based upon the fair value of the Company’s common stock as of that date, as determined by the Company’s Board of Directors. The Company was required to record compensation expense equal to the difference between the estimated fair value of the common stock and the exercise price of the repriced options. For the years ended December 31, 2003 and 2002, the Company recorded no compensation expense as the exercise price was equal or above the estimated fair value.

On December 17, 1999, the Company’s Board of Directors adopted the ImageWare Systems, Inc. Amended and Restated 1999 Stock Option Plan (the “1999 Plan”). Under the terms of the 1999 Plan, the Company could, originally, issue up to 350,000 non-qualified or incentive stock options to purchase common stock of the Company. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below. The 1999 Plan has substantially the same terms as the 1994 Employee Stock Option Plan and the 1994 Nonqualified Stock Option Plan and expires on December 17, 2009.

On September 12, 2001, the Company’s Board of Directors approved adoption of the 2001 Equity Incentive Plan (the “2001 Plan”). Under the terms of the 2001 Plan, the Company may issue stock awards to employees, directors and consultants of the Company, and such stock awards may be given for nonstatutory stock options (options not intended to qualify as an “incentive stock option” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended), stock bonuses, and rights to acquire restricted stock. The Company originally reserved 1,000,000 shares of its common stock for issuance under the 2001 Plan. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below.

The 2001 Plan is administered by the Board of Directors or a Committee of the Board as provided in the 2001 Plan. Options granted under the 2001 Plan shall not be less than 85% of the market value of the Company’s common stock on the date of the grant, and, in some cases, may not be less than 110% of such fair market value. The term of options granted under the 2001 Plan as well as their vesting are determined by the Board and to date, options have been granted with a ten year term and vesting over a three year period. While the Board may suspend or terminate the 2001 Plan at any time, if not terminated earlier, it will terminate on the day before its tenth anniversary of the date of adoption.

Stock Option Plans
As of December 31, 2003

	Number of securities to be issued upon exercise of outstanding options	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)	(b)
1994 Plan	112,038	37,915
Nonqualified Plan	18,957	-0-
1999 Plan	312,000	37,060
2001 Plan	897,011	102,257
Total	1,340,006	177,232

The following table summarizes employee stock option activity since December 31, 2001:

	Options		Weighted- Average Exercise Price

Balance at December 31, 2001	1,310,417		$	4.56
Granted	255,508		$	3.75
Expired/canceled	(167,831	)	$	3.02
Exercised	(416	)	$	3.00

Balance at December 31, 2002	1,397,678		$	4.59
Granted	203,750		$	2.52
Expired/canceled	(261,422	)	$	3.77
Exercised	(0	)	$	0

Balance at December 31, 2003	1,340,006		$	4.44

At December 31, 2003, a total of 912,895 options were exercisable at a weighted average price of $5.03 per share. At December 31, 2002, a total of 745,068 options were exercisable at a weighted average price of $5.22 per share.

The following table summarizes information about employee stock options outstanding and exercisable at December 31, 2003:

	Options Outstanding
		Weighted-			Options Exercisable
Exercise Price	Number Outstanding	Average Remaining Life (Years)	Weighted- Average Exercise Price		Number Exercisable	Weighted- Average Exercise Price

$ 1.97 - 2.15	178,750	9.02	$	2.02	37,016	$	2.03
$ 2.65 - 4.90	509,700	8.20	$	3.01	301,175	$	3.05
$ 5.28	112,038	0.10	$	5.28	112,038	$	5.28
$ 5.29 - 6.51	455,561	7.06	$	6.10	378,709	$	6.15
$ 8.00 -11.00	83,957	4.78	$	8.09	83,957	$	8.09

Total	1,340,006				912,895

The weighted-average grant-date fair value per share of options granted to employees during the years ended December 31, 2003 and 2002 was $1.61 and $2.59, respectively.

12. Employee Benefit Plan

During 1995, the Company adopted a defined contribution 401(k) retirement plan (the “Plan”). All employees aged 21 years and older become participants after completion of three months of employment. The Plan provides for annual contributions by the Company determined at the discretion of the Board of Directors. Participants may contribute up to 20% of their compensation.

Employees are fully vested in their share of the Company’s contributions after the completion of five years of service. The Company did not make contributions to the plan for the 2002 plan year. The company has accrued a contribution of $50,000 for the 2003 plan year.

13. Pension Plan

One of the Company’s foreign subsidiaries maintains a defined benefit pension plan that provide benefits based on length of service and final average earnings.

The following table sets forth the benefit obligation, fair value of plan assets, and the funded status of the Company’s plan; amounts recognized in the Company’s consolidated financial statements; and the assumptions used in determining the actuarial present value of the benefit obligations as of December 31:

	2003			2002
Change in projected benefit obligation:
Benefit obligation at beginning of year	$	883,483		$	588,573
Service cost	72,200			115,186
Interest cost	78,795			59,047
Actuarial gain (loss)	(66,520		)	(4,323		)
Effect of exchange rate changes	150,277			125,000
Effect of curtailment	(410,130		)
Benefits paid	—			—
Benefit obligation at end of year	708,105			883,483

Change in plan assets
Fair value of plan assets at beginning of year	235,211			163,784
Actual return of plan assets	(29,357		)	(11,104		)
Company contributions	98,740			82,531
Benefits paid	—			—
Fair value of plan assets at end of year	304,594			235,211

Unfunded status	(406,121		)	(648,272		)
Unrecognized actuarial loss (gain)	(326,364		)	242,151
Unrecognized prior service (benefit) cost	—			—
Unrecognized transition (asset) liability	—			—
Prepaid (accrued) benefit cost	$	(732,485	)	$	(406,121	)

Weighted-average assumptions as of December 31:
Discount rate	5.5		%	6.0		%
Expected return on plan assets	6.0		%	7.0		%
Rate of compensation increase	2.5		%	2.5		%

Components of net periodic benefit cost are as follows:
Service cost	72,200			115,186
Interest cost on projected benefit obligations	78,795			59,047
Expected return on plan assets	(24,006		)	(13,837		)
Amortization of prior service costs	—			—
Amortization of actuarial loss	—			5,845
Net periodic benefit costs	126,989			166,241

14. Exit Activities

The Company adopted the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 146 — Accounting for Costs Associated with Exit or Disposal Activities in the fourth fiscal quarter of the year ended December 31, 2002. The Company terminated its operating lease for 4,275 square feet of office space used to house our Digital Photography operations and moved these operations to its San Diego, California facility. In connection with this exit activity, the Company also reduced headcount. The Company has recorded a liability for the remaining lease payments under the operating lease net of estimated sublease rents of $132,000 and accrued $6,000 in severance as of December 31, 2002. These expenses are classified as part of general and administrative expenses as of December 31, 2002.

In May 2003, the Company entered into an agreement to sublet this office space. Under the terms of the sublease, the Company will receive rents of $144,000 over the term of the sublease.

The following table summarizes charges recorded and changes in the exit activities reserve during 2003:

Accrued for exit activities at December 31, 2002	$	138,000

Reductions to exit activity reserve:
Payments:
Severance	(6,000		)
Lease Obligation, net of Sublease income	(97,000		)

Addtions to exit activity reserve:
Additions to reserve based on sublease finalization	38,000

Accrued for exit activities at December 31, 2003	$	73,000

15. Related Party Transactions

RDL Holdings LTD (“RDL”) is considered to be an affiliated entity because a major shareholder of this entity is also a major shareholder of the Company.

ITC entered into a five-year operating lease for its office and research and development facilities from RDL. The Company recorded rent expense of $0 for the years ended December 31, 2003 and 2002. At December 31, 2003, $76,000 in accrued rent remained unpaid.

Prior to the consummation of the ITC merger, certain ITC shareholders advanced funds to ITC on a regular basis for general corporate and working capital purposes. Amounts owed to the shareholders for these advances at December 31, 2002 and 2001 were $208,000 and $208,000, respectively. On February 23, 2003, pursuant to a settlement agreement, the Company amended the amount due the ITC shareholder and converted an additional approximately $44,000 in accrued liabilities incurred for management services into a new promissory note. This new note bears interest at 7% per annum. Under the terms of the note, the Company is required to make monthly payments of $15,000 until the note is paid in full on April 15, 2004. At December 31, 2003, the balance of this note payable was $59,000.

The Company has a development contract with a non-employee shareholder. There were no costs incurred under the development contract for the years ended December 31, 2002 and 2001. In June 2001, the Company converted the amounts due the shareholder into a note payable of $270,000 which includes a principal balance of $170,000 and accrued but unpaid interest of $100,000. The note bears interest at 10% per annum and calls for monthly payments of $15,000 until January, 2003. In conjunction with the ITC transaction, the shareholder became an employee of the Company. At December 31, 2002, $8,244 of this note was unpaid and classified as part of notes payable to related parties. This note was paid in full in January 2003.

16. Subsequent Event

On January 29, 2004, the Company completed a private placement, which involved the sale of units consisting of one share of common stock and a warrant to purchase 0.20 shares of common stock. Each unit was priced at $3.65. The warrants, which are first exercisable six-months after the closing date, have a five-year term and an exercise price of $5.48

per share. As a result of this transaction, the Company issued an aggregate of approximately 1,818,000 new shares of common stock and warrants to purchase up to approximately 364,000 shares of common stock. In connection with this transaction, the Company also issued to certain placement agents warrants to purchase an additional 199,000 shares of common stock. The Company raised approximately $6.6 million from the private placement, and expects to use the net proceeds for working capital.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Amendment No. 1 on Form 10-KSB/A to be signed on its behalf by the undersigned thereunto duly authorized.

		CYMER, INC.


Dated: May 20, 2004	By:	/s/ Wayne G. Watherall
		Wayne G. Watherall
		Chief Financial Officer

Exhibit Index

23.1 Consent of Pricewaterhouse Coopers LLP, Independent Accountants

23.2 Consent of Stonefield Josephson, Inc., Independent Accountants

31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act

31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act

32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act

Dated: May 20, 2004

/s/ S. James Miller		/s/ Wayne Wetherell
S. James Miller, Jr.		Wayne Wetherell
Chief Executive Officer		Chief Financial Officer

/s/Stonefield Josephson, Inc.
Stonefield Josephson, Inc.
Los Angeles, CA
May 20, 2004

Dated:	May 20, 2004	/s/ S. James Miller
		S. James Miller
		Chief Executive Officer

Dated:	May 20, 2004	/s/ Wayne G. Wetherell
		Wayne G. Wetherell
		Chief Financial Officer

Stock Option Plans As of December 31, 2003

Stock Option Plans
As of December 31, 2003