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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (Fee Paid).
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (No Fee Required).
For Fiscal Year Ended December 31, 1996
Commission File Number: 1-11900
INTEGRATED SECURITY SYSTEMS, INC.
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(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 75-2422983
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(State of Incorporation) (I.R.S. Employer Identification No.)
8200 SPRINGWOOD DRIVE, SUITE 230, IRVING, TEXAS 75063 (972) 444-8280
(Address including zip code, area code and telephone number of
Registrant's executive offices.)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
- ---------------------------- -------------------------------------------
Common stock, $.01 par value Boston Stock Exchange
Warrants for common stock Nasdaq
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 Securities 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 [ X ] No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of 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. [ ]
Issuer's revenues for its most recent fiscal year: $9,054,145
As of March 14, 1997, 6,908,842 shares of the Registrant's common stock were
outstanding and 3,349,500 warrants were outstanding.
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days: As of March 1, 1997, $17,686,636. This amount was computed by reference
to the average of the bid and asked prices of registrant's common stock.
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TABLE OF CONTENTS
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Item No. Page
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Part I
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1. Description of Business 3-4
2. Description of Properties 5
3. Legal Proceedings 6
Part II
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5. Market for Company's Common Equity and Related Stockholder Matters 6
6. Management's Discussion and Analysis of Financial Condition
and Results of Operations 8-12
7. Financial Statements 12-32
8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 33
Part III
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9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act. 33
10. Executive Compensation 33
11. Security Ownership of Certain Beneficial Owners and Management 33
12. Certain Relationships and Related Transactions 33
Part IV
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13. Exhibits, Lists and Reports on Form 8-K 34-41
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
The Company designs, develops, manufactures, sells and services
commercial and industrial security and traffic control products including
warning gates, crash barriers, lane changers, navigational and airport
lighting, and electronically-controlled security gates. The Company also
develops and markets "intelligent" or programmable security systems that
integrate multiple security devices and subsystems for governmental, commercial
and industrial facilities. Applications for these systems include perimeter
security for airports, access control for commercial office buildings, and
video surveillance for warehouses. By integrating different commercially
available security products such as automatic gates, access control panels,
video cameras, switchers, recorders, and badge identification systems, the
Company provides turnkey security solutions that perform automated user-defined
security functions.
At present, a customer with multiple security needs such as perimeter
security, access control or video surveillance typically must design, develop
and integrate each security function internally or utilize several outside
vendors. By combining multiple security functions into an integrated system or
network, the Company allows customers to reduce costs and human error while
increasing the level of security for asset protection and personnel safety.
The Company also has exclusive licenses for certain video and electronic funds
transfer ("EFT") technologies. The licensed video technology can be used in
CCTV security applications and the licensed EFT software can be used in systems
which integrate, for example, parking garages and retail operations. By
integrating EFT (credit cards, debit cards, check verification, etc.) into
security systems, the Company can provide users, such as universities, with a
single card solution to students and faculty for identification, dormitory and
parking access, cafeteria purchases and automatic teller machine withdrawals.
Because of increasing crime rates, increased emphasis on corporate
security, and end user demands for more automated security products, the
Company believes that the industry trend will continue toward more
sophisticated, outsourced systems that offer the ability to automate several
security functions simultaneously. As a result, the Company has developed a
PC-based facility management system called Intelli-Site(R) that integrates all
security functions across an entire enterprise including remote sites.
The Company distributes its products and services through direct
sales, dealer/distributor factory-direct purchasing networks, consultants and
other system integrators.
CORE BUSINESS PRODUCTS
Road and Bridge: B&B Electromatic, Inc. ("B&B")
B&B, the Company's manufacturing subsidiary in operation since 1925,
designs, manufactures, and markets warning gates, crash barriers
(anti-terrorist or traffic control), lane changers, navigational lighting,
airport lighting and perimeter security gates and operators. Road and bridge
products are usually custom-designed and are sold through B&B's direct sales
channel. Customer contracts have a wide range of value from $5,000 to over
$500,000 with contract fulfillment ranging from several months to one or more
years.
B&B plans to continue to leverage its long-term reputation for high
quality designs and its broad network of architectural firms that prefer and
specify B&B products on new projects into increased revenues during the
rebuilding of the federal and state road and bridge infrastructures. In
addition, the Company will continue to incorporate B&B's road and bridge
reputation into its more recently established perimeter security core business.
Perimeter Security: B&B Electromatic, Inc. ("B&B")
B&B manufactures gate operators and aluminum gate panels which it
sells to dealers and distributors. Gate panels are movable portions of an
enclosure used for pedestrian and vehicular site access and egress. Gate
operators are automated mechanisms designed to open and close gate panels under
electronic control. B&B perimeter security products average between $1,000 and
$8,000 per order with delivery times ranging from less
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than a week to several weeks depending upon whether the item is custom-built or
a standard product. Perimeter security products are also integrated into
Intelli-Site systems and resold as a subsystem by IST to its clients.
Electronic Security Systems: Tri-Coastal Systems, Inc. ("TCSI")
TCSI designs, sells, installs and services electronic security systems
primarily for commercial and industrial buildings using standard
"off-the-shelf" subsystems from various manufacturers. TCSI will often provide
the subsystem components for an IST integrated system sale. In addition, TCSI
provides maintenance services and monitoring services for both its own and
IST's end users.
Integrated Systems: Innovative Security Technologies, Inc. ("IST")
IST designs, develops and markets fully integrated turnkey facility
management systems. Since its inception in 1993, IST has been developing and
testing a proprietary hardware and software product called Intelli-Site, a
user-defined, PC-based systems integration platform. IST is developing a
direct sales channel to provide total security and other facility management
functions (i.e., HVAC, EFT payment systems, parking systems, etc.) to customers
not serviced by dealers or, for various reasons including the unavailability of
turnkey products and services, choose not to use dealers. IST's strategy is to
exploit industry outsourcing trends by directly marketing and servicing its
proprietary Intelli-Site integrated turnkey system to end users and to other
system integrators.
The two industry-unique features of Intelli-Site are its ability to
integrate any vendor's security devices or sub-system (vendor independency) and
its ability to have the system's automated functionality be defined by the end
user at any time, within minutes, without programming (dynamic functionality).
The Company knows of no other product with these features.
Intelli-Site is a standard product that competes against
custom-designed systems. Since Intelli-Site is a standard product, it offers a
significant price advantage over custom-developed systems by eliminating
software development costs and reducing the time to delivery. Custom-designed
systems may cost $500,000 and can run as high as $10 million or more.
Intelli-Site systems cost much less than a custom-designed system with
approximately the same level of integration. However, custom system functions
cannot be changed by the user without paying for, and waiting for, another
custom development cycle. Intelli-Site systems, depending on the configuration
and number of integrated devices, can be sold for as little as $50,000 to over
$1 million and are user definable. The Company believes that 137,000 U.S.
companies have budgeted between $50,000 and $600,000 for security purposes.
Intelli-Site, because of the price discontinuity between standard products and
custom products, can penetrate these companies with little or no competition
from custom-design system integrators.
Having completed its customer on-site testing, IST received its first
commercial sales orders in 1995 to a major Texas semiconductor facility and an
Arizona copper mining facility.
Bank and Hospital Products. Golston Company, Inc. ("GCI")
GCI provides a variety of proprietary products and services to banks
and hospitals and designs and produces molds for injection molding companies.
Bank and hospital proprietary products include carriers for pneumatic systems,
office signage, and coin storage products. Services provided by GCI include
the provision of temporary modular bank facilities and disaster recovery
planning.
WARRANTY
The Company has two-year or five-year warranties on products it
manufactures. The Company provides for replacement of components and products
that contain manufacturing defects. When the Company uses other manufacturer's
components, the warranties of the other manufacturers are passed to the dealers
and end users. To date, the servicing and replacement of defective components
and products have not been material.
BACKLOG
The Company's backlog, calculated as the aggregate sales prices of
firm orders received from customers less revenue recognized, was approximately
$3.4 million at December 31, 1996. The Company expects that the majority of
this backlog will be filled during 1997.
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INTELLECTUAL PROPERTY
The Company has applied for U.S. registration of "ISSI" as a trademark
and a service mark. The Company has also applied for U.S. registration of the
trademark "Intelli-Gate."
On March 16, 1993, the Company entered into an agreement with COMTRAC
Corporation ("CTC") that grants to the Company a non-exclusive, worldwide,
irrevocable, paid-up license to use CTC's proprietary transaction processing
systems, applications and communications software and related hardware for use
in security-related systems and systems integrating security and electronic
funds transfer functions, all of which are components of the Intelli-Site
integration platform. The license was exclusive until March 16, 1996. The
Company paid $250,000 for this license.
Also on March 16, 1993, the Company entered into an agreement with
DesignTech, Inc. ("DTI") that grants the Company a non-exclusive, worldwide
license to use DTI's proprietary interactive Digital Video Interface system
technology for security-related functions, which may constitute a part of the
Intelli-Site system platform. Under the agreement, for a period of five years,
the Company pays DTI a royalty of 1% of the Company's total gross revenues
derived from products using the licensed technology. The royalty declines to
0.25% for cumulative gross revenues exceeding $20,000,000. To date, no
royalties have been paid.
PRODUCT DESIGN AND DEVELOPMENT
There are currently three employees of the Company dedicated to
research, development and product engineering. During fiscal 1996 and 1995,
the Company spent approximately $152,239 and $292,000 on research and
development.
COMPETITION
Many large system integration consultants and engineering firms
compete directly with the Company for large security contracts. Large, complex
projects usually receive bids for the design of a custom system, or multiple
side-by-side systems, to meet their requirements. System integrators bid
these design contracts not only for the design effort but also to place
themselves in a most favored position to become the prime contractor during the
implementation phase. During the design phase, system integrators survey the
market for components of the specified system and define how they can be
integrated together. Finally, if awarded the implementation phase, the system
integrator acts as a prime contractor and subcontracts the component suppliers,
and supervises the integration.
Depending on the contract, the Company will either become a
subcontractor for the majority of the systems or bid the project as a
vertically integrated system integrator and prime contractor. By combining
both the first and second phase into a proposal from a single vendor, the
Company eliminates several third party profit tiers and can reduce the time and
overall costs to the customer.
The Company faces intense competition in the security industry.
Certain of the Company's competitors are large, well-financed and established
companies that have greater name recognition and resources for research and
development, manufacturing and marketing than the Company has and, therefore,
may be better able than the Company to compete for a share of the market.
EMPLOYEES
As of December 31, 1996, the Company employed 113 people, all in
full-time positions. None of the Company's employees is subject to collective
bargaining agreements. The Company believes that relations with its employees
are good.
ITEM 2. DESCRIPTION OF PROPERTIES
B&B owns its manufacturing and office facility in Norwood, Louisiana.
This facility consists of approximately 26,000 square feet of manufacturing and
office space on five acres of land. GCI owns its manufacturing and office
facility in Sanger, Texas. This facility consists of approximately 30,000
square feet of manufacturing and office space on 6.4 acres of land. The
Company occupies 13,038 square feet of office and
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warehouse space in Irving, Texas, under a lease expiring on October 6, 1997,
with monthly rent of $6,790, plus the costs of utilities, property taxes,
insurance, repair/maintenance expenses and common area utilities. The Company
also occupies 1,200 square feet of office and warehouse space in Baltimore,
Maryland, under a lease expiring on May 31, 1997, with a monthly rent of $660
plus all utilities and property taxes. The Company sublets a portion of the
Baltimore facility to a distributor of perimeter security products.
The Company believes that the properties, equipment, fixtures and
other assets of the Company located within the Company's facilities are
adequately insured against loss, that suitable alternative facilities are
readily available if the lease agreements described above are not renewed, and
that its existing facilities are adequate to meet current requirements.
ITEM 3. LEGAL PROCEEDINGS
GCI, a wholly owned subsidiary of the Company, is a party to a lawsuit
filed in the 211th Judicial District Court of Denton County, Texas on September
13, 1996, entitled S. Webb Golston and Golston Company v. Evelyn Shaw, cause
no. 96-30642-211. In this suit, a former employee of GCI has alleged sexual
harassment, wrongful discharge and intentional infliction of emotional distress
against GCI and the former owner of GCI, requesting unspecified actual and
punitive damages. The alleged events giving rise to these claims occurred
prior to the Company's acquisition of GCI on December 31, 1996. Under the
acquisition agreement, the former owner agreed to indemnify GCI against any
damages that GCI may incur as a result of these claims. The former owner has
elected, pursuant to the terms of the acquisition agreement, to undertake the
defense of these claims and has retained counsel to defend both himself and
GCI. GCI has retained separate counsel in this matter to oversee prosecution
of the defense of the claims. The lawsuit is in the early stages of discovery.
To date, no information has become available that causes the Company to believe
there is any potential liability which is not fully covered by the
indemnification agreement with the former owner.
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq Small Cap Market
("Nasdaq") under the symbol "IZZI" and on the Boston Stock Exchange under the
symbol "ISI." The IPO Warrants are traded on the Nasdaq Small Cap Market under
the symbol "IZZIW" and on the Boston Stock Exchange under the symbol "ISIW."
As of December 31, 1996, there were 6,908,842 shares of Common Stock and
2,320,000 Warrants outstanding. The shares of Common Stock are held of record
by approximately 75 holders and the Warrants are held of record by
approximately 54 holders. The following table sets forth, for the periods
indicated, the high and low bid quotations for the IPO Warrants and the Common
Stock on the Nasdaq Small Cap Market. Trading prices for the Common Stock and
the IPO Warrants on the Boston Stock Exchange are substantially similar to the
prices set forth below for the Nasdaq Small Cap Market. These over-the-counter
market quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. The trading
market in the Company's securities may at times be relatively illiquid due to
low volume.
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Common Stock Warrants
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$ High $ Low $ High $ Low
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FISCAL 1996
First Quarter 2 13/16 5/8 7/8 1/16
Second Quarter 5 7/8 2 1/16 1 3/8 5/16
Third Quarter 3 1/2 1 13/16 1 11/16
Fourth Quarter 3 5/8 2 3/8 1 5/16 3/4
FISCAL 1995
First Quarter 2 1/2 1 5/8 11/16 3/8
Second Quarter 2 5/8 1 5/8 5/16
Third Quarter 3 1 7/8 7/8 9/16
Fourth Quarter 2 3/8 3/8 9/16 1/16
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The following table specifies securities sold by the Registrant within
the past three years and not registered under the Securities Act of 1933. All
such sales were carried out in reliance on the exemption from registration
contained in Section 4(2) of the Securities Act of 1933. In relying on such
exemption, the Registrant relied upon written representations of the persons
acquiring the Registrant's shares that they were acquiring the shares for
investment purposes only and not for resale, and that they had received
adequate opportunity to obtain information, and had reviewed such information,
regarding the Registrant. Certificates representing the shares issued to these
persons contained a legend restricting transfer thereof absent registration
under the Securities Act or the availability of an exemption therefrom.
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CONSIDERATION UNDERWRITING
DATE SOLD TITLE AND AMOUNT OF SECURITIES PURCHASER RECEIVED DISCOUNTS OF
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October 1993 Warrants to purchase 80,000 The Equity Group, Inc. Investor relation
shares of Common Stock services
September- Promissory Notes and warrants Accredited bridge financial An aggregate of
November 1994 to purchase 211,800 shares of investors $1,059,000
Common Stock
October 1995- Warrants to purchase 105,677 A group of 9 investors Extension of loan
March 1996 shares of Common Stock terms
December 1995 45,000 shares of Common Stock Managerial Resources, Inc. Financial advisory
and warrants to purchase 28,000 and Steffany Lea Martin services
January 1996 34,168 Series B Convertible A group of 11 accredited Conversion of an
Preferred Stock and warrants to investors primarily aggregate of $683,000
purchase 136,669 shares of owed by the Company
Common Stock
January 1996 Warrants to purchase 13,201 Phillip R. Thomas Consulting services
shares of Common Stock
March 1996 Warrants to purchase 326,000 Bathgate McColley Capital Investment banking
shares of Common Stock Group LLC fees
March 1996 Warrant to purchase 100,000 ComVest Partners Placement Agent fee
shares of Common Stock
March 1996 15,000 shares of Common Stock Louis A. Davis Shares of Tri-Coastal
Systems, Inc.
March 1996 15,000 shares of Common Stock Henry E. McGuffee Shares of Tri-Coastal
Shares, Inc.
March 1996 15,000 shares of Common Stock Michael A. Richmond Shares of Tri-Coastal
Shares, Inc.
March 1996 800,000 Shares of Common Seabeach & Co. $800,000 $40,000
Stock and warrants to purchase
320,000 shares of Common Stock
March-May 1996 47,965 Series A Convertible A group of 38 accredited $640,000 $78,000
Preferred Stock and warrants to investors
purchase 381,344 shares of
Common Stock
June 1996 12,500 Series C Convertible A group of 5 investors $250,000
Preferred Stock and warrants to including an officer and
purchase 187,500 shares of a director
Common Stock
July-September Warrant to purchase 70,000 I.S.T. Partner, Ltd. R&D Partnership
1996 shares of Common Stock
December 31, Convertible Debentures (9%) Renaissance Capital Fund $4,6000,000
1996
December 31, 600,000 shares of Common ProFutures Special Equity $600,000 $60,000
1996 Stock Fund
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Dividends have not been declared on the Common Stock and it is not
anticipated that dividends will be paid in the near future because any funds
available will most likely be reinvested in the Company's business and used to
repay outstanding debt.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Incorporated in Delaware on December 19, 1991, the Company is a
holding company that conducts its operations principally through four
wholly-owned subsidiaries: B&B Electromatic, Inc. ("B&B"), Golston Company,
Inc. ("GCI"), Innovative Security Technologies, Inc. ("IST"), and Tri-Coastal
Systems, Inc. ("TCSI").
On January 1, 1992, the Company acquired B&B from an affiliate in a
transaction which was accounted for similar to a pooling of interests. B&B
designs, manufactures, and distributes commercial and industrial security
products, and traffic control gates, barriers and lighting for the road and
bridge industry. B&B has been in operation since 1925. On March 16, 1993, the
Company organized IST, which is a retail seller of security products and
microprocessor-based systems to large customers. On August 23, 1993, the
Company announced the development of its PC-based security network,
Intelli-Site(R), that integrates multiple security functions into a centralized
management system for single and/or multiple site locations. IST is
responsible for the sales and marketing of this product. The first beta site
installations for this product were completed during the fourth quarter of 1994
and the first quarter of 1995. On September 18, 1995, the Company purchased
substantially all of the assets and liabilities of TCSI. TCSI sells and
installs security and safety systems to end users.
Effective January 1, 1992, the Company purchased all of the
outstanding stock of Automatic Access Controls, Inc. ("AAC"), an independent
distributor of commercial and industrial security products. The Company
discontinued the operations of AAC during 1995. Accordingly, AAC is reported
as a discontinued operation for all periods presented.
On December 31, 1996, the Company acquired all the outstanding stock
of GCI. GCI's primary business is the design, manufacture, and marketing of
pneumatic tube carriers for use in financial institutions and hospitals. In
addition, GCI leases modular buildings to financial institutions. The purchase
price was approximately $4.8 million in a combination of cash and seller notes,
and the assumption of an additional $650,000 in existing debt. The Company
funded this acquisition through the private placement to an institutional
investor of $4.6 million of convertible debentures. The debentures have a
maturity of seven years and, until converted, carry an annual interest rate of
9%. No principal payments are due for the first three years and the debentures
may be exchanged for the Company's common stock at a conversion price of $1.05
per share. To complete the funding, an additional $660,000 of Common Stock was
privately placed at $1.10 per share.
The Company's executive offices are located at 8200 Springwood Drive,
Suite 230, Irving, Texas 75063. The Company's telephone number is (972)
444-8280.
THE IPO AND SUBSEQUENT SECURITIES ISSUANCES
The Company completed its initial public offering (the "IPO") in April
1993. In connection with the IPO, the Company issued to the public units (the
"Units") with each Unit consisting of one share of Common Stock and one IPO
Warrant. At the time of the IPO, each IPO Warrant was exercisable for one
share of Common Stock. In connection with the IPO, the Company issued the
Underwriter's Warrant to Thomas James Associates, Inc. (which firm was
subsequently acquired by H.J. Meyers, Inc.), the lead underwriter of the IPO.
The Underwriter's Warrant was initially exercisable for an aggregate of 145,000
Units, at an exercise price of $6.30 per Unit.
The IPO Warrants and the Underwriter's Warrant provide that the
exercise price and number of shares of Common Stock purchasable upon exercise
are subject to adjustment upon the occurrence of certain events, including the
sale by the Company of shares of Common Stock (or securities exercisable for,
or convertible into, shares of Common Stock) at a price below the
then-applicable exercise price of the IPO Warrants or the Underwriter's
Warrant. As a result of the Company's issuance of warrants, options, and
convertible preferred stock after the IPO, the exercise prices for the IPO
Warrants and the Underwriter's Warrant were adjusted, effective January 15,
1997. After giving effect to the adjustments, the IPO Warrants may now be
exercised for 2.1 shares of Common Stock (for a total of 3,045,000 shares of
Common Stock) at an exercise price of $3.17 per share,
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and the Underwriter's Warrant may now be exercised for a total of 304,500 Units
(relating to 609,000 shares of Common Stock) at an exercise price of $3.00 per
Unit. Prior to such adjustment, the exercise price of the IPO Warrants was
$6.75.
During the period from 1994 through 1996, the Company (i) granted
non-qualified compensatory options to purchase Common Stock to its current and
former employees, (ii) issued Common Stock in connection with acquisitions, and
(iii) issued convertible preferred stock, Common Stock, and warrants to
purchase Common Stock in connection with financing transactions, the settlement
of litigation, and to pay for consulting services. All such securities were
issued in private placements exempt from registration under applicable
securities laws. Such securities (totaling an aggregate of 5,052,678 shares of
Common Stock, upon full exercise or conversion).
R&D PARTNERSHIP
Effective September 1, 1996, the Company entered into an agreement
with I.S.T. Partners, Ltd., an unaffiliated limited partnership, whereby the
partnership will make an initial payment of $250,000 to the Company and
since has funded the sales, engineering, and order fulfillment expenses of the
Company's IST subsidiary. In exchange, the partnership receives, as
compensation from IST, 85% of the revenue generated from the sales of the
Company's Intelli-Site products until such time as the partnership has achieved
a return of at least 150% on its investment. The Company retains full
ownership of all other rights to the Intelli-Site product, and also retains the
responsibility for managing IST's business activities, including customer
relationships. As of December 31, 1996, the Company had received $250,000 from
the partnership, which was recorded as income in the quarter ended September
30, 1996, for the initial sale of sales leads and prospects, and the Company
also received $200,000 during the fourth quarter of 1996 as reimbursement for
development and sales costs.
RESULTS OF OPERATIONS
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Sales. The Company experienced a $1.4 million (19%) increase in sales
from 1995 to 1996 from $7.6 million to $9 million. This increase was primarily
attributable to the inclusion of TCSI, acquired in September 1995, for the
entire year of 1996. The Company experienced a 5% increase in road and bridge
and perimeter security sales during 1996; however, over $1 million of
anticipated fourth quarter shipments were delayed by customer requests due to
late construction projects and revised specifications. Also contributing to
the increase in sales for 1996 was the sale of the Company's Intelli-Site
software sales leads and prospects for $250,000 to a limited partnership
chartered to fund the acceleration of marketing and sales efforts.
For the year ended December 31, 1996, approximately 78% of the
Company's revenues were generated from the sale of products manufactured by the
Company compared to 94% for 1995.
Cost of Sales and Gross Profit. Gross profit as a percent of sales
decreased to 43% in 1996 from 45% in 1995. This decrease was primarily due to
a less favorable product mix compared with the prior year. During 1996, the
Company experienced higher sales of perimeter security products which have
lower gross margins compared to road and bridge products. Also during 1996, in
accordance with FAS 86, the Company began to amortize capitalized software
development costs related to Intelli-Site as the product was brought to market.
Amortization expense of $127,381 was recognized in 1996.
Selling, General and Administrative. Selling, general and
administrative expenses decreased from $4.6 million in 1995 to $3.8 million in
1996. The majority of this decrease was due to one-time expenses in 1995 of
approximately $1 million for severance obligations to a former officer and the
write-off of $511,000 in acquisition fees relating to a discontinued
acquisition candidate. The decrease was offset by a 16% increase in expenses
at B&B and the inclusion of expenses at TCSI for the entire year of 1996
compared to four months in 1995.
Research and Development. Research and development expenses increased
from $46,199 in 1995 to $152,239 in 1996. This increase was due to the
inclusion of expenses at IST related to the development of Intelli-Site
partially offset by reimbursement of development costs from the limited
partnership chartered to fund the development and sales of the Intelli-Site
product. Prior to 1996, the Company capitalized software development costs
related to Intelli-Site in accordance with FAS 86.
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Interest Income. Interest income in 1996 decreased to $7,748 from
$14,957 in 1995. During the first quarter of 1995, the Company earned interest
on a $350,000 certificate of deposit placed with a bank as collateral to secure
a line of credit. The certificate of deposit and accumulated interest were
released on April 11, 1995.
Interest Expense. Interest expense for 1996 decreased from $343,012
in 1995 to $260,471 in 1996. This decrease was primarily due to the repayment
of certain short-term notes.
Discontinued Operations. The discontinued operations reflect the
operations of AAC. AAC's operations were discontinued during the second
quarter of 1995. During 1996, the Company has recorded a gain on disposal of
discontinued operations in the amount of $22,789 related to the settlement of
certain liabilities.
Income Taxes. In assessing the likelihood of realization of the
deferred tax asset, the Company primarily considered the trend of the Company's
operating results toward profitability. The Company anticipates a positive
trend to continue in 1997. This positive trend will continue to be boosted by
the sales of Intelli-Site, as well as the addition of GCI. These factors,
coupled with the current growth of the security industry, were considered
positive factors in this assessment. Since the net operating loss carry
forward does not begin to expire until 2007, the Company anticipates that all
recognized carry forward benefits will be fully utilized before this expiration
date arrives. As there are no significant temporary differences in the
Company's tax calculation, realization will be primarily achieved by increased
profitability. The Company anticipates that its move to profitability in 1997
and beyond will be dependent on its success in three areas: (i) sales -
continued increases in sales at all subsidiaries plus a positive response to
the Intelli-Site product; (ii) profit margins - continued focus on increasing
margins at IST, while maintaining the current margins at B&B; and (iii) cost
control - continued cost control at all subsidiaries.
Notwithstanding the above positive factors, the Company has adopted a
conservative posture by providing a valuation reserve of 90% of the deferred
tax asset as of December 31, 1996. Further recognition of the asset will be
dependent on the Company attaining profitability targets that have been
established. The realizability of the net deferred tax asset has been (and
will continue to be) reviewed on a quarterly basis. The income tax benefit for
1996 consists of state income taxes for the Company's subsidiary, B&B.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Sales. The Company experienced a $247,000 (3%) increase in sales from
1994 to 1995 from $7.4 million to $7.6 million, respectively. This increase is
primarily attributable to increased sales at B&B, net of the discontinuance of
the AAC operations. During the fourth quarter of 1995 sales increased to $3.5
million compared to $1.9 million for the comparable 1994 quarter. Record sales
at B&B accounted for this 84% increase over prior year.
For the period ended December 31, 1995, approximately 94% of the
Company's revenues were generated from the sale of products manufactured by the
Company compared to 82% for 1994.
Cost of Sales and Gross Profit. Gross profit as a percent of sales
decreased to 45% in 1995 from 53% in 1994. This decrease was due to a less
favorable product mix from the prior year. During 1994, the Company
experienced higher sales of road and bridge products compared to perimeter
security products which have higher gross margins. Also during 1995 obsolete
inventory totaling $125,000 was written off.
Selling, General and Administrative. Selling, general and
administrative expenses increased from $2.8 million for the 1994 12-month
period to $4.6 million for the comparable 1995 period. The majority of this
increase is due to one-time expenses of approximately $1 million for severance
obligations to a former officer and for the write-off of acquisition fees. The
remaining increase is caused by non-recurring expenses associated with employee
terminations, legal fees associated with litigation dating from 1994 and
amortization expense of origination fees for 1994 loans.
During 1995, the Company received notice from a target company that
was the subject of acquisition efforts that the target company no longer wished
to continue discussions. Although the Company continues to pursue an
acquisition strategy with other candidates in similar or complementary
industries, $511,000 of costs and fees previously incurred in connection with
this acquisition target and deferred at the time of being incurred, were
charged to operations in the quarter ended September 30, 1995.
Page 10 of 41
<PAGE> 11
Interest Expense. Interest expense increased $192,000 for the
12-month period from $151,000 in 1994 to $343,000 in 1995. This increase is
primarily attributable to interest on bridge financing that was entered into
during the third and fourth quarters of 1994, amortization of debt discount
pertaining to the aforementioned bridge financing and higher interest costs for
the accounts receivable financing facility.
Discontinued Operations. The operations of the AAC subsidiary are
reflected as discontinued operations for all periods. During the second
quarter of 1995, the decision was made to discontinue the operations of this
subsidiary. The Company recorded a reserve of $425,000 during the second
quarter of 1995 for inventory and asset disposition, as well as office closings
and staff reductions. During the third and fourth quarters of 1995, the
Company reversed $65,000 of this accrual as actual costs became more
determinable.
Income Taxes. In assessing the likelihood of realization of the
deferred tax asset, the Company primarily considered the trend of the Company's
operating results toward profitability. The 1995 operating results, net of
non-recurring expenses, were in line with 1994. The Company anticipates a
positive trend to develop in 1996 since all non-recurring amounts have been
recognized in 1995, except for an anticipated seasonal loss in the first
quarter of 1996. This positive trend will be boosted by the sales roll-out of
Intelli-Site. These factors, coupled with the current growth of the security
industry, were considered positive factors in this assessment. Since the net
operating loss carry forward does not begin to expire until 2007, the Company
anticipates that all recognized carry forward benefits will be fully utilized
before this expiration date arrives. As there are no significant temporary
differences in the Company's tax calculation, realization will be primarily
achieved by increased profitability. The Company anticipates that its move to
profitability in 1996 and beyond will be dependent on its success in three
areas: (i) sales - continued increases in sales at all subsidiaries plus a
positive response to the Intelli-Site product; (ii) profit margins - continued
focus on increasing margins at IST, while maintaining the current margins at
B&B; and (iii) cost control - continued cost control at all subsidiaries.
Notwithstanding the above positive factors, the Company has adopted a
conservative posture by providing a valuation reserve of 88% of the deferred
tax asset as of December 31, 1995. Further recognition of the asset will be
dependent on the Company attaining profitability targets that have been
established. The realizability of the net deferred tax asset has been (and
will continue to be) reviewed on a quarterly basis. The provision for income
taxes for 1995 consists of state income taxes for the Company's subsidiary,
B&B.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position increased by $888,236 during 1996. The
Company used $1,190,861 for operations during 1996 compared to $720,846
provided by operations during 1995. Discontinued operations used $184,100 of
cash during 1996 compared to providing $1,018,324 in 1995.
During 1996, the Company financed its continuing operations from
operating cash flow, short-term borrowings in the approximate amount of
$512,000, and the private placement of its securities in the approximate amount
of $687,000. During 1996, the Company used a total of approximately $1,459,000
to pay principal on indebtedness. For a description of the
financing for the GCI acquisition, see the subheading "General" above.
The Company has a factoring facility with a financial institution
pursuant to which it may factor accounts receivable and receive a total of up
to $1,400,000 in credit. As of December 31, 1996, the Company had a balance of
$36,413 outstanding under this factoring facility.
On April 25, 1996, the Company obtained a $900,000 term loan facility
with a lending institution. The loan is due in eleven monthly payments of
$12,000 beginning June 1, 1996, and one final payment sufficient to pay the
balance. Interest on the loan is floating at the lending institution's base
lending rate (which was 10% at December 31, 1996) minus 1%. The loan is
secured by all real estate and equipment at B&B and is personally guaranteed by
an officer of the Company, with certain personal assets of such officer pledged
as collateral. Approximately $450,000 of the proceeds of this loan were used
to repay existing mortgages and notes payable at B&B, and the remaining was
used to repay a portion of Company notes due April 29, 1996.
Page 11 of 41
<PAGE> 12
Historically, GCI has generated positive cash flow from operations.
The Company anticipates this trend to continue. This positive cash flow, in
conjunction with the existing factoring facility and an asset-based loan that
the Company is currently negotiating, should position the Company to cover its
working capital needs. As the Company continues to operate, additional
financing will be necessary to fund growth plans at all of the Company's major
business units.
The information contained in the previous paragraph includes certain
forward-looking statements. It is important to note that the Company's actual
results could differ materially from those projected by such forward-looking
statements. Important factors that could cause actual results to differ
materially from those projected in the forward-looking statements include, but
are not limited to, the following: anticipated seasonal changes may not occur
or operations may not improve as projected.
CAPITAL EXPENDITURES
The Company has no commitments for capital expenditures during 1997.
The Company acquired approximately $96,983 and $52,416 of machinery and
equipment in 1996 and 1995, respectively, principally for its B&B manufacturing
facility.
In 1994, the Company began capitalizing software development costs in
accordance with FAS 86 "Accounting for the Costs of Computer Software to be
Sold, Leased, or Otherwise Marketed." As of December 31, 1995, the amount
capitalized was $636,906. The Company completed its first sale of the
Intelli-Site system in March 1996 and began amortizing these costs in 1996 on a
straight-line basis over five years, the expected life of the product.
EFFECTS OF INFLATION
The Company believes that the relatively moderate rate of inflation
over the past few years has not had a significant impact on the Company's sales
or operating results.
SEASONALITY
Historically the Company has experienced seasonality in its business
due to fluctuations in the weather. The Company typically experiences a
decline in sales and operating results and expects to incur a loss during the
first quarter of the year due to winter weather conditions.
ENVIRONMENTAL MATTERS
The Company believes that it is in compliance with all applicable
environmental regulations. Compliance with these regulations has not had, and
is not anticipated to have, any material impact upon the Company's capital
expenditures, earnings or competitive position.
Page 12 of 41
<PAGE> 13
INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 7. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants 13
Consolidated Balance Sheets as of December 31, 1996 and 1995 14
Consolidated Statements of Operations for the years
ended December 31, 1996 and 1995 15
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 1996 and 1995 16
Consolidated Statements of Cash Flows for the
years ended December 31, 1996 and 1995 17
Notes to Consolidated Financial Statements 18-31
</TABLE>
All financial statement schedules are omitted since they are not
required, are not applicable, or the information required is
included in the Consolidated Financial Statements or the Notes thereto.
Page 13 of 41
<PAGE> 14
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
the Stockholders of Integrated Security Systems, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
Integrated Security Systems, Inc., and its subsidiaries (the "Company") at
December 31, 1996 and 1995 and the results of their operations and their cash
flows for the years then ended in conformity with generally accepted accounting
principles. 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 audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards 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 audits provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
Dallas, Texas
February 18, 1997
Page 14 of 41
<PAGE> 15
INTEGRATED SECURITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
----------------------------
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash $ 1,097,891 $ 209,655
Accounts receivable, net of allowance for doubtful accounts
of $65,687 and $54,558, respectively 2,629,909 1,761,701
Inventories 1,086,985 854,888
Restricted cash 8,232 157,851
Other current assets 193,960 15,831
Net assets of discontinued operations 25,760 76,807
------------ ------------
Total current assets 5,042,737 3,076,733
Property and equipment, net 5,502,284 1,068,123
Intangible assets, net 1,598,632 136,116
Capitalized software development costs, net 591,505 787,816
Deferred income taxes 205,384 205,384
Other assets 31,325 33,333
------------ ------------
Total assets $ 12,971,867 $ 5,307,505
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 881,221 $ 1,308,650
Accrued liabilities 691,208 1,041,567
Deferred revenue 209,296 152,948
Notes payable 8,080 950,947
Notes payable to related parties 7,110 29,437
Current portion of long-term debt 213,975 96,451
Net liabilities of discontinued operations 49,252 332,866
------------ ------------
Total current liabilities 2,060,142 3,912,866
------------ ------------
Long-term debt 6,784,582 213,899
Stockholders' equity:
Convertible preferred stock, $0.01 par value, 750,000 shares
authorized, 59,168 and 34,166, respectively, shares issued
and outstanding 591 342
Common stock, $0.01 par value, 18,000,000 shares authorized,
6,958,842 and 3,730,738, respectively, shares issued and
6,908,842 and 3,680,738, respectively, shares outstanding 69,588 37,307
Additional paid-in-capital 10,382,215 7,191,575
Accumulated deficit (6,206,501) (5,929,734)
Treasury stock, 50,000 shares (118,750) (118,750)
------------ ------------
Total stockholders' equity 4,127,143 1,180,740
------------ ------------
Total liabilities and stockholders' equity $ 12,971,867 $ 5,307,505
============ ============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
Page 15 of 41
<PAGE> 16
INTEGRATED SECURITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended
December 31,
---------------------------
1996 1995
------------ ------------
<S> <C> <C>
Sales $ 9,054,145 $ 7,622,219
Cost of sales 5,184,321 4,200,723
------------ ------------
Gross margin 3,869,824 3,421,496
------------ ------------
Operating expenses:
Selling, general and administrative 3,776,798 4,634,963
Research and product development 152,239 46,199
------------ ------------
3,929,037 4,681,162
------------ ------------
Loss from operations (59,213) (1,259,666)
Other income (expense):
Interest income 7,748 14,957
Interest expense (260,471) (343,012)
Other 389 209
------------ ------------
Loss from continuing operations before income taxes (311,547) (1,587,512)
Benefit (provision) for income taxes 11,991 (62,102)
Loss from continuing operations (299,556) (1,649,614)
------------ ------------
Discontinued operations:
Loss from discontinued operations -- (720,043)
Gain (loss) on disposal of discontinued operations 22,789 (494,562)
------------ ------------
Income (loss) from discontinued operations 22,789 (1,214,605)
------------ ------------
Net loss $ (276,767) $ (2,864,219)
============ ============
Weighted average common and common
equivalent shares outstanding 5,122,878 4,014,108
Net loss per share:
Continuing operations $ (0.05) $ (.41)
Discontinued operations -- (.30)
------------ ------------
Total $ (0.05) $ (.71)
============ ============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
Page 16 of 41
<PAGE> 17
INTEGRATED SECURITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL STOCKHOLDER
PREFERRED COMMON PAID IN ACCUMULATED RECEIVABLE, TREASURY
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT NET STOCK
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ -- $ -- 3,519,290 $ 35,192 $ 6,047,883 $ (3,065,515) $ (144,062) $ --
Preferred stock issuance 34,166 342 683,011
Shares issued to officer 2,448 25 4,259
Warrant issuance 102,557
Warrant exercise 138,000 1,380 112,808
Common stock issuance 71,000 710 179,165
Stockholder settlement 61,892 144,062 (118,750)
Net loss (2,864,219)
-----------------------------------------------------------------------------------------------------
Balance at December 31, 1995 34,166 $ 342 3,730,738 $ 37,307 $ 7,191,575 $ (5,929,734) $ -- $ (118,750)
Preferred stock issuance 60,168 601 1,050,169
Preferred stock conversion (35,166) (352) 1,039,919 10,399 (10,047)
Warrant issuance 82,471
Warrant exercise 599,230 5,992 513,497
Common stock issuance 1,588,955 15,890 1,554,550
Net loss (276,767)
-----------------------------------------------------------------------------------------------------
Balance at December 31, 1996 59,168 $ 591 6,958,842 $ 69,588 $ 10,382,215 $ (6,206,501) $ -- $ (118,750)
=====================================================================================================
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
Page 17 of 41
<PAGE> 18
INTEGRATED SECURITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended
December 31,
----------------------------
1996 1995
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (276,767) $ (2,864,219)
Adjustments to reconcile net loss to net cash (used) provided
by operating activities:
Depreciation 189,042 175,428
Amortization 358,295 345,533
Bad debt expense 18,976 17,096
Provision for warranty reserve 188,344 137,700
Provision for inventory reserve 4,601 17,909
Non-cash (income) expenses (173,281) 24,521
Net change in assets and liabilities from
discontinued operations (184,100) 1,018,324
Changes in operating assets and liabilities,
net of effects from acquisition of Golston Company:
Accounts receivable (543,992) 459,212
Inventories 81,006 (112,328)
Restricted cash 149,619 (157,851)
Other assets (109,045) 227,939
Accounts payable (344,141) 806,872
Accrued liabilities (605,766) 471,762
Deferred revenue 56,348 152,948
------------ ------------
Net cash (used) provided by operating activities (1,190,861) 720,846
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (96,983) (52,416)
Sale of property and equipment 5,000 --
Intangible assets (71,951) --
Capitalized software costs -- (245,799)
Acquisition of Golston Company (4,851,406) --
------------ ------------
Net cash used by investing activities (5,015,340) (298,215)
------------ ------------
Cash flows from financing activities:
Issuance of preferred stock, net 687,406 --
Issuance of common stock, net 1,863,487 143,738
Payments on line of credit -- (847,317)
Payments on notes payable and long-term debt (1,459,051) (151,373)
Proceeds from notes payable and long-term debt 6,012,545 278,417
Other (9,950) (1,946)
------------ ------------
Net cash provided (used) by financing activities 7,094,437 (578,481)
------------ ------------
Increase (decrease) in cash 888,236 (155,850)
Cash at beginning of year 209,655 365,505
------------ ------------
Cash at end of year $ 1,097,891 $ 209,655
============ ============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
Page 18 of 41
<PAGE> 19
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Integrated Security Systems, Inc. ("ISSI" or the "Company") was formed in
December 1991 to leverage highway traffic control and security core
businesses into turnkey security solutions for "middle market" commercial
and industrial businesses. The middle market is defined as commercial,
industrial and institutional companies or government agencies which
budget $50,000 to $600,000 annually to meet their security needs. the
two types of security targeted by ISSI are asset protection and personal
safety.
In order to provide turnkey security solutions to the middle market,
several key operating components and technologies have been vertically
integrated into the Company. To date, ISSI created internally, or
acquired, a gate and barrier engineering and manufacturing facility, B&B
Electromatic, Inc. ("B&B"), a developer and retail seller of PC-based
control systems which integrate discrete security devices, Innovative
Security Technologies, Inc. ("IST"), an installation and service company,
Tri-Coastal Systems, Inc. ("TCSI"), and a manufacturer of specialty
products for the financial and health care industries, Golston Company,
Inc. ("GCI"). ISSI also has a subsidiary that was a distributor of
commercial and industrial perimeter security products, Automatic Access
Controls, Inc. ("AAC"). The operations of this subsidiary were
discontinued during 1995.
2. SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the company and its
wholly-owned subsidiaries, B&B, IST, TCSI, GCI AND AAC. All significant
intercompany transactions and balances have been eliminated.
CASH
Cash is comprised of highly liquid instruments with maturities of three
months or less. At December 31, 1996 and 1995, restricted cash of $8,232
and $157,851, respectively, was recorded related to a factoring
arrangement (see Note 6).
INVENTORIES
Inventories are primarily carried at the lower of cost or market using
the first-in, first-out method.
PROPERTY AND EQUIPMENT AND DEPRECIATION
Property and equipment are recorded at cost. Depreciation is computed
over the estimated useful lives of the assets using the straight-line and
accelerated methods. Estimated useful lives range from 3 to 31 years.
Depreciation expense includes amortization of assets recorded as capital
leases.
INTANGIBLE ASSETS AND AMORTIZATION
Goodwill resulted from the acquisitions and is amortized using the
straight-line method over a period of ten years.
Amortization expense for goodwill for the years ended December 31, 1996
and 1995, respectively, was $26,797 and $1,144.
Page 19 of 41
<PAGE> 20
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
It is the Company's policy to periodically review the net realizable
value of its intangible assets, including goodwill, through an
assessment of the estimated future cash flows related to such assets.
Each business unit to which these intangible assets relate is reviewed
to determine whether future cash flows over the remaining estimated
useful life of the assets provide for recovery of the carrying value of
the assets. If assets are being carried at amounts in excess of
estimated gross future cash flows, then the assets are adjusted for
impairment to a level commensurate with a discounted cash flow analysis
of the underlying assets.
INCOME TAXES
The Company accounts for income taxes using the liability method in
accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("FAS 109"). Under the liability method,
deferred taxes are provided for tax effects of differences in the basis
of assets and liabilities arising from differing treatments for
financial reporting and income tax purposes using currently enacted tax
rates.
REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE
The Company recognizes revenue from sales at the time of shipment. The
Company's accounts receivable are generated from a large number of
customers in the traffic and security products market. No single
customer accounted for 10% or more of revenues in the years ended
December 31, 1996 or 1995.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs pursuant to
Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed"
("FAS 86"). As of December 31, 1995, $636,906 in software development
costs qualified for capitalization pursuant to FAS 86. The Company began
amortizing its capitalized software costs in 1996 using the
straight-line method over a period of five years. $127,381 in
amortization expense was recorded in 1996.
During 1993, the Company entered into a license and distribution
agreement for certain proprietary technology. In connection with this
agreement (see Note 9), the Company paid $250,000 to an affiliate
controlled by the Company's former parent for the right to use the
technology, which is being amortized over a period of five years from
the acquisition date. For the years ended December 31, 1996 and 1995,
$68,930 and $57,426, respectively, was recorded as amortization expense.
Accumulated amortization at December 31, 1996 and 1995 was $168,020 and
$99,090, respectively.
The Company expenses all other research and product development costs as
they are incurred.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of the Company's accounts receivable, notes
receivable, accounts payable, note payable and other debt instruments
approximate the fair values of such financial instruments.
NET LOSS PER SHARE
Net loss per common share for each year is computed using the weighted
average number of common and common equivalent shares outstanding during
the respective years.
Page 20 of 41
<PAGE> 21
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the period. Actual amounts could differ from these estimates.
STATEMENT OF CASH FLOWS
Supplemental cash flow information for the year ended December 31:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Cash paid for interest expense $153,428 $295,469
Cash paid for income taxes $ 51,866 $ 63,615
</TABLE>
During 1995, accounts payable to unrelated parties of $139,141 and notes
and accrued liabilities to related parties of $469,212 were converted by
the Company's creditors into convertible preferred stock. During 1996,
notes to unrelated parties of $304,051 and related parties of $100,000
were converted by the Company's creditors into convertible preferred
stock and common stock.
RECLASSIFICATION
Certain reclassifications of prior year amounts have been made to
conform to the fiscal 1996 presentation.
3. I.S.T. PARTNERS, LTD.
Effective September 1, 1996, the Company entered into an agreement with
I.S.T. Partners, Ltd., an unaffiliated limited partnership, whereby the
partnership will fund the sales, engineering and order fulfillment
expenses of IST. In exchange, the partnership receives, as compensation
from IST, 85% of the revenue generated from Intelli-Site sales until a
specified investor return has been achieved. The Company retains full
ownership of Intelli-Site during the agreement period and retains
responsibility for managing IST's business activities, including
customer relationships. As of December 31, 1996, $250,000 had been
received by the Company and recorded as income in the quarter ended
September 30, 1996 for the initial sale of the sales leads and
prospects.
Page 21 of 41
<PAGE> 22
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
4. ACQUISITIONS
On December 31, 1996, the Company acquired GCI with approximate revenues
of $3.9 million, a vertically integrated manufacturer of specialty
products for the financial and health care industries. This acquisition
has been accounted for as a purchase. ISSI purchased 100% of GCI stock
for approximately $4.8 million of combined cash and seller notes and
assumed approximately $650,000 in debt. The real estate and facilities
occupied by GCI were also acquired for an additional $1.5 million in
cash. To fund the transactions, $4.6 million of convertible debentures
were placed. The debentures have a maturity of seven years, and, until
converted, carry an annual interest rate of nine percent. No principal
payments are due on the debentures during the first three years. The
debentures may be exchanged for ISSI Common Stock at a conversion price
of $1.05 per share. To complete the funding, an additional $660,000 of
ISSI Common Stock was privately placed on December 31, 1996 at $1.10 per
share. The excess of the purchase price over the fair value of the
assets acquired of $1,319,628 has been recorded as goodwill. If the
acquisition of GCI had been effective as of January 1, 1996, pro forma
net sales would have amounted to approximately $13.3 million and pro
forma net income from continuing operations would have been
approximately $252,000.
In September 1995, the Company acquired substantially all of the assets
and liabilities of TCSI, an unrelated company, in exchange for the
Company's common stock valued at $156,375. The excess of the purchase
price over the fair value of the assets acquired of $296,945 was
recorded as goodwill. If the acquisition of TCSI had been effective as
of January 1, 1995, pro forma net sales would have amounted to
approximately $8.6 million and pro forma net loss from continuing
operations would have been approximately $1.6 million.
5. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS
The composition of certain balance sheet accounts is as follows at
December 31:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Inventories:
Raw materials $ 714,106 $ 586,237
Work-in-process 267,015 223,052
Finished goods 105,864 45,599
----------- -----------
$ 1,086,985 $ 854,888
=========== ===========
Property and Equipment:
Land $ 905,264 $ 5,264
Building 1,177,168 577,168
Rental Units 2,311,033 --
Leasehold improvements 48,769 48,769
Office furniture and equipment 855,002 575,257
Manufacturing equipment 2,952,930 533,167
Vehicles 48,503 68,304
Construction 153,425 153,425
----------- -----------
8,452,094 1,961,354
Less: accumulated depreciation (2,949,810) (893,231)
----------- -----------
$ 5,502,284 $ 1,068,123
=========== ===========
</TABLE>
Page 22 of 41
<PAGE> 23
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
6. NOTES PAYABLE AND LONG-TERM DEBT
On April 11, 1995, the Company entered into a Business Manager factoring
facility with a bank to factor accounts receivable with recourse. This
factoring facility expires April 15, 1997, has an adjustable factoring
fee which ranged from 3.13% to 3% during 1996, and a maximum borrowing
amount of $1,400,000. As of December 31, 1996 and 1995, $36,413 and
$1,103,275 was utilized, $8,232 and $157,851 of restricted cash was
held, and $36,413 and $1,103,275 of factored accounts receivable were
subject to recourse.
NOTES PAYABLE
Notes payable consists of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Bridge loans payable to unrelated individual investors;
interest at 16%; due April 30, 1996, net of debt discount
of $0 and $46,766, respectively -- $ 736,285
Note payable due in monthly principal installments of
various amounts until paid in full by June 1996, net of
debt discount of $0 and $6,000, respectively; no
interest; personally guaranteed by an officer -- 57,646
Note payable, interest at 3.3%, due on April 1, 1996 -- 7,016
Note payable to a bank due on June 24, 1996; interest at
11%; secured by second mortgage on real estate -- 150,000
Note payable to unrelated individual investor; no
interest; due in one lump sum payment in January 1997 $ 8,080 --
------- ---------
$ 8,080 $ 950,947
======= =========
</TABLE>
Page 23 of 41
<PAGE> 24
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
LONG-TERM DEBT
Long-term debt consists of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
-------- ---------
<S> <C> <C>
Term note payable to a bank; due in monthly principal and interest
installments of $3,720 through August 2002; interest at the lender's
prime plus .5% (10.75% at December 31, 1995 and 10.25% at December 31,
1994); guaranteed by principal stockholder -- $ 234,365
Note payable to a bank due in monthly principal and interest
installments of $4,060 through March 1997 when the balance is due;
interest at 9.75% secured by equipment and accounts receivable -- 53,265
Note payable due in monthly principal and interest installments of $576
through May 1997 when the balance is due; interest at 8.75%;
secured by equipment -- 9,188
Note payable due in monthly principal and interest installments of $366
through August 1997 when the balance is due; interest at 11%;
secured by equipment -- 6,243
Note payable due in monthly principal and interest installments of $477
through May 1997 when the balance is due; interest at 11%; secured
by equipment -- 7,289
Term note payable to a bank; due in monthly principal and interest
installments of $793 through May 2001; interest
at 10.2503%; secured by equipment 33,692 --
Term note payable to a bank; due in monthly principal and interest
installments of $12,000 through April 1998 and one balloon payment in
May 1998; interest at the lender's prime less 1% (10% at December 31,
1996); secured by first mortgage on real estate, equipment and certain
personal assets of an officer; personally guaranteed by 864,865 --
an officer
Term note payable to an unrelated third party due in monthly
principal and interest installments of $24,134 through January
2004; interest at 9%; secured by equipment 1,500,000 --
Convertible note payable to an unrelated fund; interest at 9% due in
monthly installments of $34,500 through December 2003; no principal
installments due until December 1999; secured by equity, assets and
future contracts; guaranteed by all subsidiaries of ISSI 4,600,000 --
----------- -----------
6,998,557 310,350
Less current portion (213,975) (96,451)
----------- -----------
Long-term portion $ 6,784,582 $ 213,899
=========== ===========
</TABLE>
Page 24 of 41
<PAGE> 25
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTES PAYABLE TO RELATED PARTIES
Notes payable consists of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
---------- ---------
<S> <C> <C>
Notes payable to executive officers and members of Board
of Directors; non-interest bearing; due on demand $ -- $ 4,000
Note payable to an employee; due in monthly principal and
interest installments of $2,412 through March 1997;
interest at 10.53% 7,110 25,437
---------- ---------
$ 7,110 $ 29,437
Less: current portion (7,110) (29,437)
---------- ---------
Long-term portion $ -- $ --
========== =========
</TABLE>
Payments required under all notes payable and long-term debt outstanding
at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997 $ 229,124
1998 986,433
1999 245,154
2000 769,943
2001 784,806
Thereafter 3,998,286
==========
$7,013,746
==========
</TABLE>
7. INCOME TAXES
The income tax provision (benefit) is comprised of the following:
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Current:
Federal $ -- $ --
State (11,991) 62,102
-------- --------
$(11,991) $ 62,102
-------- --------
Deferred:
Federal $ -- $ --
State -- --
-------- --------
-- --
-------- --------
Tax expense (benefit) $(11,991) $ 62,102
======== ========
</TABLE>
Page 25 of 41
<PAGE> 26
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
A reconciliation of the income tax provision and the amount computed by
applying the federal statutory benefit rate to loss before income taxes
is as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Federal statutory benefit rate (34%) (34%)
State income tax (benefit) provision,
net of federal tax benefit (4%) 4%
Installment sale gain -- 2%
Net operating loss not benefited 24% 31%
Non-deductible expenses and other 10% 1%
---- ----
(4%) 4%
==== ====
</TABLE>
Deferred tax assets are subject to a valuation allowance if their
realization is less likely than not. Deferred tax assets (liabilities)
are comprised of the following at December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Amortization $ (213,196) $ (39,915)
Depreciation (964) --
----------- -----------
Gross deferred tax liability (214,160) (39,915)
----------- -----------
Litigation reserve 6,047 57,120
Depreciation -- 3,343
Warranty reserve 31,609 24,733
Bad debt reserve 43,855 49,970
Net operating loss carryforward 2,205,531 1,895,091
----------- -----------
Gross deferred tax asset 2,287,042 2,030,257
----------- -----------
Net deferred tax asset 2,073,846 1,990,342
Valuation allowance (1,868,462) (1,784,958)
----------- -----------
Net deferred tax asset $ 205,384 $ 205,384
=========== ===========
</TABLE>
Should a cumulative change in ownership of more than 50% occur within a
three year period, there could be an annual limitation on the use of the
net operating loss carryforward. The Company has unused net operating
loss carryforwards of $6.5 million and $5.6 million at December 31, 1996
and 1995, respectively, that begin to expire in the year 2007. The
Company increased the valuation allowance because it does not expect to
realize the benefit of net operating losses, except to the extent of the
$205,384 deferred tax asset, in the foreseeable future.
Page 26 of 41
<PAGE> 27
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
8. COMMITMENTS AND CONTINGENCIES
The Company leases facilities and equipment under leases accounted for
as operating leases. The Company currently does not have any capital
leases. Future minimum payments for years subsequent to December 31,
1996 under capital and non-cancelable operating leases are as follows:
<TABLE>
<CAPTION>
Operating Leases
----------------
<S> <C>
1997 $ 115,340
1998 5,256
1999 5,256
2000 --
2001 --
----------
Total minimum payments $ 125,852
==========
</TABLE>
Rent expense for operating leases was $103,253 and $85,836 for the years
ended December 31, 1996 and 1995, respectively.
CONTINGENCIES
The Company is subject to certain legal actions and claims arising in
the ordinary course of business. Management recognizes the uncertainties
of litigation; however, based upon the nature of and management's
understanding of the facts and circumstances which give rise to such
actions and claims, management believes that such litigation and claims
will be resolved without material effect on the Company's financial
position or results of operations.
9. RELATED PARTY TRANSACTIONS
SOFTWARE LICENSE
During 1993, the Company entered into a license and distribution
agreement for certain proprietary technology to be utilized as the basis
for the Intelli-Site products. This license was purchased for $250,000
from COMTRAC, a company controlled at that time by ISSI's largest
stockholder. This license is being amortized over five years from the
acquisition date.
10. DISCONTINUED OPERATIONS
During the second quarter of 1995, the Company adopted a plan to
discontinue the operations of the wholesale distribution subsidiary,
Automatic Access Controls, Inc. ("AAC"). The operations of this
subsidiary were discontinued during July 1995. Provisions totaling
$560,000 were recorded for estimated losses during the phase-out period,
and for writedown of assets to net realizable value. During the fourth
quarter of 1995, this provision was decreased by $65,000 due to better
receipts than anticipated on certain assets. Current assets and current
liabilities related to this action totaled $25,760 and $76,807,
respectively, at December 31, 1996 and $49,252 and $332,866,
respectively, at December 31, 1995. These assets and liabilities consist
of accounts receivable and a note payable.
Page 27 of 41<EN>
<PAGE> 28
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
Where appropriate, the financial statements reflect the operating
results and balance sheet items of the discontinued operations
separately from continuing operations. Prior years have been restated.
Operating results for the discontinued operations were:
<TABLE>
<CAPTION>
For the Period Ended
December 31,
--------------------
1996 1995
-------- -------
($ in thousands)
<S> <C> <C>
Operating Revenue -- $ 1,389
Loss from Operations -- $ (720)
Loss Per Share -- $ (.30)
</TABLE>
11. BENEFIT PLANS
The Company has established a 401(k) savings and profit sharing plan.
Participants include all employees who have completed six months of
service and are at least 21 years of age. Employees can contribute up to
15% of compensation. Vesting on the Company's contribution occurs over a
five-year period. The Company made no contributions in 1996 and 1995.
12. STOCK OPTIONS AND WARRANTS
Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" was implemented in January 1996. As permitted
by the Standard, ISSI retained its prior method of accounting for stock
compensation. As required by the Standard, the following information
represents pro forma net income (loss) and earnings (loss) per share as
if the Company had accounted for its employee stock options under the
fair value method prescribed by the Standard.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 1996 and 1995, respectively; no
dividend yield, expected volatility of approximately 80% and 55%,
risk-free interest rates of approximately 6.5% and 7%, and expected
lives of ten years.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
pro forma information for the Company follows in thousands (except per
share amounts):
<TABLE>
<CAPTION>
1996 1995
--------------------------- --------------------------
As reported Pro forma As reported Pro forma
----------- ------------ ----------- ---------
<S> <C> <C> <C> <C>
Net Income (Loss) $ (276) $ (307) $ (2,864) $ (2,874)
Income (Loss) per Common Share $ (.05) $ (.05) $ (.71) $ (.71)
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are
not indicative of future amounts as SFAS No. 123 does not apply to
awards prior to 1995 and additional awards are anticipated in future
years.
Page 28 of 41
<PAGE> 29
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
STOCK OPTIONS
In February 1993, the Company established a stock option plan whereby
options to purchase up to 250,000 shares of common stock may be granted
(the "1993 Stock Option Plan"). In December 1994, the shareholders of
the Company increased the number of shares of common stock which may be
granted under this plan to 500,000. The plan is administered by the
Company's Board of Directors which has the authority to establish the
terms of each option grant. Under the plan, incentive stock options must
be granted with an exercise price not less than the fair market value on
the date of grant.
A summary of stock option transactions is as follows (share amounts in
thousands):
<TABLE>
<CAPTION>
1996 1995
-------------------------- ---------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----
<S> <C> <C> <C> <C>
Outstanding at beginning of year 738 $ 2.21 687 $ 2.20
Granted 188 1.22 115 2.07
Forfeited (52) 1.95 (64) 1.90
--- ---
Outstanding at end of year 874 $ 2.01 738 $ 2.21
=== ===
Exercisable at end of year 663 $ 2.18 556 $ 2.26
Weighted-average fair value of
options granted during the year $ 1.06 $ 1.40
</TABLE>
The following table summarizes information about the fixed-price stock
options outstanding at December 31, 1996 (share amounts in thousands):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- ------------------------------
Range of Shares Weighted-Average Weighted- Shares Weighted-
Exercise Outstanding Remaining Average Exercisable Average
Prices at 12/31/96 Contractual Life Exercise Price at 12/31/96 Exercise Price
- -------------- -------------- --------------------- ------------------ -------------- --------------
<C> <C> <C> <C> <C> <C>
$0.687-1.50 159 8.7 years $ 1.02 50 $ 1.09
$1.563-2.50 705 7.5 years 2.22 609 2.26
$2.719-3.53 10 9.1 years 2.77 4 2.72
--- ---
874 2.01 663 2.18
=== ===
</TABLE>
Page 29 of 41
<PAGE> 30
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
WARRANTS
On April 20, 1993, in connection with the Company's initial public
offering, the Company issued 1,450,000 Redeemable Common Stock Purchase
Warrants. Each warrant entitles the holder to purchase one share of
common stock at a price of $5.40 per share during the first 30 months,
and $6.75 per share during the second 30 months. The warrants are
subject to redemption by the Company at $0.25 per warrant upon 30 days
prior written notice with the consent of the underwriters, Thomas James
Associates, Inc. ("Underwriters"). As of December 31, 1996, all warrants
issued remain outstanding. The warrants expire on April 20, 1998.
Management believes that the exercise price of the warrants at the date
of grant approximated market value. On June 17, 1996, the Company
repriced these warrants to $4.15 due to obligations under the original
warrant agreement. The holder is also now entitled to purchase 1.6
shares of common stock. Again, on January 15, 1997, these warrants were
repriced to $3.17 under the same obligation and the holder is now
entitled to purchase 2.1 shares of common stock
Also, in connection with the initial public offering, the Company issued
a warrant to the Underwriters for the purchase of up to 145,000 units at
a price of $6.30 per unit. A unit consists of a share of common stock
and a warrant to purchase an additional share of common stock. This
warrant is exercisable over a period of four years commencing April 20,
1994. Management believes that the exercise price of the warrant at the
date of grant approximated market value. On June 17, 1996, the Company
repriced these warrants to $3.51 due to obligations under the original
warrant agreement. The holder is also now entitled to purchase 1.6
units. Again, on January 15, 1997, these warrants were repriced to $3.17
under the same obligation. The holder is now entitled to purchase 2.1
units.
In connection with bridge financing obtained in 1993, the Company issued
warrants to purchase 246,000 shares of common stock at an exercise price
of $1.00 per share and warrants to purchase 18,000 shares of common
stock at an exercise price of $2.40. As of December 31, 1996, 51,000
warrants issued remain outstanding. The warrants expire in 1998. No
value has been assigned to warrants as management believed such value to
be insignificant at the time of issuance.
The Company issued warrants to purchase 211,800 shares of common stock
at exercise prices of $1.06, in connection with the bridge financing
obtained in 1994. As of December 31, 1996, 154,800 warrants remain
outstanding and have expiration dates in 1999. Value was assigned to
these warrants totaling $90,000 at December 31, 1994. Such value was
amortized over the one year term of the bridge loans. During 1995 and
1996, the Company issued an additional 50,376 and 37,301 warrants,
respectively, in exchange for an additional extension of the bridge
loans' due date to April 30, 1996. Value was assigned to these warrants
totaling $87,677. Such value was amortized over the five-month extension
term of the bridge loans.
During 1995, in connection with a payable to a former director, the
Company issued warrants to purchase 10,000 shares of common stock at an
exercise price of $.75 per share. Value assigned to these warrants of
$7,500 was amortized over the 5-month term of the note. In connection
with the convertible preferred stock sale completed in December 1995,
the Company issued 136,677 warrants in 1996. These warrants are
exercisable at $.67 per share and expire in 2000. The value of the
warrants was recorded as part of the convertible preferred stock
offering.
During 1996, the Company issued warrants to purchase 13,201 shares of
common stock at an exercise price of $1.18. Value assigned to these
warrants totaling $13,210 was recorded during 1996.
During 1996, the Company issued 832,844 warrants in connection with the
convertible Series A and Series C preferred stock sales. These warrants
are exercisable at $1.00 per share and expire in 2001. The value of the
warrants was recorded as part of the convertible preferred stock
offering.
Page 30 of 41
<PAGE> 31
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
During 1996, the Company issued 500,000 warrants in connection with the
sale of common stock to unrelated investors. The value of the warrants
was recorded as part of the equity sale. As of December 31, 1996,
116,000 of these warrants remain outstanding.
The Company issued warrants to purchase 70,000 shares of common stock to
investors in I.S.T. Partners, Ltd. These warrants are exercisable at
$2.40 per share and expire in 2001. Value was assigned to these warrants
totaling $40,000 and was expensed in 1996.
A summary of warrant transactions is as follows (share amounts in
thousands):
<TABLE>
<CAPTION>
1996 1995
--------------------------------- -------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
----------- ------------- ---------- ---------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 2,218 $ 3.38 2,296 $ 3.32
Granted 1,590 1.05 60 .13
Exercised (599) .87 (138) 1.01
Repriced 1,044 4.04 -- --
----- -----
Outstanding at end of year 4,253 $ 3.03 2,218 $ 3.38
===== =====
Exercisable at end of year 4,199 $ 3.03 2,218 $ 3.38
Weighted-average fair value of
options granted during the year $ 1.57 $ .76
</TABLE>
The following table summarizes information about the warrants outstanding at
December 31, 1996 (share amounts in thousands):
<TABLE>
<CAPTION>
Warrants Outstanding Warrants Exercisable
----------------------------------------- -------------------------------
Range of Shares Weighted-Average Weighted- Shares Weighted-
Exercise Outstanding Remaining Average Exercisable Average
Prices at 12/31/96 Contractual Life Exercise Price at 12/31/96 Exercise Price
------------ ----------- ---------------- --------------- ------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
$ .01-1.00 1,129 3.7 years $ .94 1,129 $ .94
$1.06-2.00 268 3.4 years 1.42 268 1.42
$2.40-4.15 2,856 2.4 years 4.00 2,802 4.03
----- -----
4,253 3.03 4,199 3.03
===== =====
</TABLE>
Page 31 of 41
<PAGE> 32
INTEGRATED SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
13. CONVERTIBLE PREFERRED STOCK
The Company's outstanding convertible preferred stock consists of
750,000 authorized shares of $.01 par value convertible preferred stock.
Series A $20 Convertible Preferred Stock. The Company currently has
outstanding 46,668 shares of its Series A $20 Convertible Preferred
Stock (the "Series A Preferred"). Holders of the Series A Preferred are
not entitled to receive any dividends, and have no voting rights, unless
otherwise required pursuant to Delaware law. Each share of the Series A
Preferred may, at the option of the Company, be converted into 20 shares
of Common Stock at any time after (i) the closing bid price of the
Common Stock is at least $2.00 for at least 20 trading days during any
30 trading day period, and (ii) the shares of Common Stock to be
received on conversion have been registered or otherwise qualified for
sale under applicable securities laws. In addition, the holders of the
Series A Preferred have the right to convert each share into 20 shares
of Common Stock at any time. The number of shares of Common Stock into
which the Series A Preferred is convertible will be proportionately
adjusted in the event of a stock dividend, stock split, or reverse stock
split. Upon any liquidation, dissolution, or winding up of the Company,
the holders of the Series A Preferred are entitled to receive $20 per
share before the holders of Common Stock are entitled to receive any
distribution and the Series A Preferred ranks pari passu with Series B
and Series C Preferred except with respect to the security interest
granted to Series B Preferred (see Series B description below).
Series B $20 Convertible Preferred Stock. The Company has issued 34,168
shares of its Series B $20 Convertible Preferred Stock (the "Series B
Preferred"). Holders of the 34,166 Series B Preferred are entitled to
receive dividends equal to $2.00 per share per annum, payable in equal
semi-annual payments. Holders of the Series B Preferred have no voting
rights, unless otherwise required by Delaware law. Each share of the
Series B Preferred may, at the option of the Company or the holder, be
converted into 29.85 shares of Common Stock, together with accrued but
unpaid dividends. The Company has the right to redeem the Series B
Preferred at any time at $22 per share, together with accrued but unpaid
dividends. The number of shares of Common Stock into which the Series B
Preferred is convertible will be proportionately adjusted in the event
of a stock dividend, stock split, or reverse stock split. Upon any
liquidation, dissolution, or winding up of the Company, the holders of
the Series B Preferred are entitled to receive $20 per share together
with accrued but unpaid dividends before the holders of any shares of
Common Stock and on a pari passu basis with Series A and C Preferreds. A
security interest in 6.8% of the Common Stock of B&B Electromatic, Inc.
has been granted to secure payment of any liquidation proceeds or
dividends to which the Series B becomes entitled. All Series B was
converted to Common Stock in June 1996.
Series C $20 Convertible Preferred Stock. The Company has issued 12,500
shares of its Series C $20 Convertible Preferred Stock (the "Series C
Preferred"). Holders of the Series C Preferred have no voting rights,
unless otherwise required by Delaware law. Each share of the Series C
Preferred may, at the option of the Company or the holder, be converted
into 30 shares of Common Stock. The Company has no right to redeem the
Series C Preferred. The Series C Preferred is also subject to the
conversion adjustments, and is entitled to receive a liquidation
preference, identical to the Series A Preferred.
Page 32 of 41
<PAGE> 33
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements concerning any matter of accounting
principle or financial statements disclosure between the Company and its
independent accountants.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The information required by this item is incorporated by reference to
disclosure in the Company's Proxy Statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A within 120 days after the end of
the fiscal year covered by this report ("Proxy Statement").
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to
the Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to
the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to
the Proxy Statement.
Page 33 of 41
<PAGE> 34
PART IV
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
(a) Exhibits.
Unless otherwise indicated, all exhibits are incorporated by
reference to comparable exhibits to Amendment No. 2 to the
Company's registration statement on Form SB-2 No. 33-59870-FW
filed March 11, 1997.
3.1 Amended and Restated Certificate of Incorporation of the Company.
3.11 Amendment to Restated Certificate of Incorporation of the Company.
3.2 Amended and Restated Bylaws of the Company.
4.1 Specimen certificate for common stock of the Company.
4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant.
4.3 Warrant Agreement among the Company, American Stock Transfer &
Trust Company, and Thomas James Associates, Inc.
4.4 Representative's Warrant.
10.1 Integrated Security Systems, Inc. 1993 Stock Option Plan.
10.2 Form of Integrated Security Systems, Inc. 1993 Incentive Stock
Option Agreement.
10.3 Form of Integrated Security Systems, Inc. 1993 Non-Qualified
Stock Option Agreement.
10.4 Integrated Security Systems, Inc. Non-Qualified Stock Option
Agreements with each of Robert C. Pearson, William S. Leftwich,
Ferdinand A. Hauslein, Jr., Gerald K. Beckman and Daniel Hampton.
10.20 Lease Agreement dated March 25, 1992 and April 6, 1992, by and
among the Company, Trammell Crow Company No. 90 and Petula
Associates Limited for property located in Dallas, Texas.
10.23 Lease Agreement commencing June 1, 1992 by and between Kelso
Joint Venture and AAC, for property located in Baltimore,
Maryland.
10.24 Letter dated March 15, 1993, from Mr. Philip R. Thomas to Mr.
Lynn R. Causey, President of B&B, terminating Mr. Thomas' $14,000
per month salary from B&B.
10.27 Letter dated January 1, 1993, from the Company to Ferdinand A.
Hauslein, Jr., granting Mr. Hauslein 16,794 shares of common
stock in exchange for personal guaranties.
Page 34 of 41
<PAGE> 35
10.37 License and Distribution Agreement dated March 16, 1993, by and
among COMTRAC Corporation, Thomas Group Holding Company and the
Company relating to analog technology for transaction processing
systems.
10.38 License and Distribution Agreement dated March 16, 1993, by and
between DesignTech Incorporated and the Company relating to
interactive digital video interface system technology.
10.40 Non-Disclosure Agreement between the Company and its employees.
10.42 Redeemable Common Stock Purchase Warrants (2 forms) that were
issued in connection with Bridge Financing.
10.46 Financial Consulting Agreement dated March 16, 1993, by and
between the Company and Thomas James Associates, Inc.
10.47 Merger and Acquisition Agreement by and between the Company and
Thomas James Associates, Inc.
10.48 Employment Agreement dated October 19, 1994, by and between the
Company and Ferdinand A. Hauslein.
10.49 Amendment to Integrated Security System, Inc. 1993 Stock Option
Plan.
10.50 Confidential Agreement dated February 16, 1994, by and between
the Company and Thomas Group Holding Company.
10.51 Note relating to the $900,000 Bridge Financing.
10.52 Redeemable Common Stock Purchase Warrants that were issued in
connection with the $900,000 Bridge Financing.
10.53 Subscription Agreement dated December 28, 1995.
10.54 Factoring Agreement from Sunburst Bank for B&B receivables.
10.63 Stock Purchase Agreement, dated November 7, 1996, between the
Company and S. Webb Golston.
10.64 Subscription Agreement, dated December 31, 1996, between the
Company and ProFutures Special Equity Fund, L.P.
10.65 Convertible Loan Agreement, dated December 31, 1996, between the
Company (and its subsidiaries) and Renaissance Capital Growth &
Income Fund III, Inc. and Renaissance US Growth & Income Trust
PLC.
10.66 Management Agreement, dated August 29, 1996, between the Company
and I.S.T. Partners, Ltd.
10.67 Marketing and Development Agreement, dated July 29, 1996, between
the Company, IST, and I.S.T. Partners, Ltd.
10.68 Employment Agreement, dated January 2, 1997, between Gerald K.
Beckmann and the Company.
10.69 Employment Agreement, dated January 2, 1997, between James W.
Casey and the Company.
10.70 Real Estate Purchase Agreement, dated September 5, 1996, between
the Company and Golston Family Partners, Ltd.
*11.1 Statement related to computation of per common share earnings.
*21.1 Subsidiaries of the Company.
*23.1 Consent of Price Waterhouse LLP.
* Filed herewith.
(b) Reports filed on Form 8-K.
None.
Page 35 of 41
<PAGE> 36
SIGNATURES
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
INTEGRATED SECURITY SYSTEMS, INC.
------------------------------------------
(Registrant)
Date: March 25, 1997 /s/ GERALD K. BECKMANN
----------------------- ------------------------------------------
Gerald K. Beckmann
Director, Chairman of the Board, President
and Chief Executive Officer
Page 36 of 41
<PAGE> 37
SIGNATURES
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
INTEGRATED SECURITY SYSTEMS, INC.
-------------------------------------
(Registrant)
<TABLE>
<S> <C>
Date: March 25, 1997 /s/ GERALD K. BECKMANN
--------------------------------- ----------------------------------------------------
Gerald K. Beckmann
Director, Chairman of the Board, President
and Chief Executive Officer
Date: March 25, 1997 /s/ JAMES W. CASEY
--------------------------------- ----------------------------------------------------
James W. Casey
Director, Vice President, Chief Financial Officer,
Chief Accounting Officer, Secretary and Treasurer
Date: March 25, 1997 /s/ ROBERT M. GALECKE
--------------------------------- ----------------------------------------------------
Robert M. Galecke
Director
Date: March 25, 1997 /s/ FRANK R. MARLOW
--------------------------------- ----------------------------------------------------
Frank R. Marlow
Director
</TABLE>
Page 37 of 41
<PAGE> 38
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
11.1 - Statement Related to Computation of Per Common Share Earnings
21.1 - Subsidiaries of the Company
23.1 - Consent of Price Waterhouse LLP
27 - Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 11.1
Statement related to computation of per common share earnings.
INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER COMMON SHARE
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------
1996 1995
---------------- -----------------
PRIMARY AND FULLY DILUTED:
<S> <C> <C>
Shares and share equivalents:
Weighted average number shares of common stock
outstanding during period 5,122,878 3,506,488
Add incremental shares:
Shares potentially issuable upon the assumed exercise
of the stock options, net of assumed repurchases
using the Treasury Stock Method -- 507,620
Total 5,122,878 4,014,108
Net earnings (loss) from continuing operations $ (299) $ (1,650)
Net earnings (loss) from discontinued operations 22 (1,215)
----------- -----------
Net earnings (loss) $ (277) $ (2,864)
=========== ===========
Per share continuing operations $ (.05) $ (0.41)
Per share discontinued operations -- $ (0.30)
----------- -----------
Per share $ (.05) $ (0.71)
=========== ===========
</TABLE>
<PAGE> 1
Exhibit 21.1
Subsidiaries of the Company.
B&B Electromatic, Inc.
Golston Company, Inc.
Tri-Coastal Systems, Inc.
Innovative Security Technologies, Inc.
Automatic Access Controls, Inc.
<PAGE> 1
Exhibit 23.1
Consent of Price Waterhouse LLP.
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-3 (No. 33-89218) and
in the Registration Statement on Form S-8 (No. 33-59870-S) of Integrated
Security Systems, Inc. of our report dated February 18, 1997 appearing on page
13 of this Form 10-KSB.
PRICE WATERHOUSE LLP
Dallas, Texas
February 18, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1,097,891
<SECURITIES> 0
<RECEIVABLES> 2,629,909
<ALLOWANCES> 0
<INVENTORY> 1,086,985
<CURRENT-ASSETS> 5,042,737
<PP&E> 5,502,284
<DEPRECIATION> 0
<TOTAL-ASSETS> 12,971,867
<CURRENT-LIABILITIES> 2,060,142
<BONDS> 0
0
591
<COMMON> 69,588
<OTHER-SE> 4,056,964
<TOTAL-LIABILITY-AND-EQUITY> 12,971,867
<SALES> 9,054,145
<TOTAL-REVENUES> 9,054,145
<CGS> 5,184,321
<TOTAL-COSTS> 5,184,321
<OTHER-EXPENSES> 3,929,037
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 260,471
<INCOME-PRETAX> (311,547)
<INCOME-TAX> (11,991)
<INCOME-CONTINUING> (299,556)
<DISCONTINUED> 22,789
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (276,767)
<EPS-PRIMARY> (.05)
<EPS-DILUTED> (.05)
</TABLE>
