-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JUXbdvEbKMIbnTBTOj+GUnI9va1rEi3idY7lrvTYitWtoQLfIV8ZTtJY4mNJYltK c6TKKyqPo26ouTqYyOmLVQ== 0000950134-97-006397.txt : 19970826 0000950134-97-006397.hdr.sgml : 19970826 ACCESSION NUMBER: 0000950134-97-006397 CONFORMED SUBMISSION TYPE: 424B1 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19970825 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SECURITY SYSTEMS INC CENTRAL INDEX KEY: 0000741114 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 752422983 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 424B1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-33805 FILM NUMBER: 97669267 BUSINESS ADDRESS: STREET 1: 8200 SPRINGWOOD DR STE 230 CITY: IRVING STATE: TX ZIP: 75063 BUSINESS PHONE: 2144448280 MAIL ADDRESS: STREET 1: 8200 SPRINGWOOD DR SUITE 230 STREET 2: 8200 SPRINGWOOD DR SUITE 230 CITY: IRVING STATE: TX ZIP: 75063 424B1 1 PRELIMINARY PROSPECTUS 1 Filed Pursuant to Rule 424(b)(1) Registration No. 333-33805 4,980,952 SHARES INTEGRATED SECURITY ============================== ISSI ============================== SYSTEMS, INC. COMMON STOCK This Prospectus relates to the sale of 4,980,952 shares of Common Stock, $.01 par value (the "Common Stock"), of Integrated Security Systems, Inc. (the "Company"), all of which are being sold by certain selling stockholders (the "Selling Stockholders"). The Company will not receive any proceeds from the sale of the shares offered hereby. See "Principal and Selling Stockholders," "Plan of Distribution," and "Description of Securities." The Common Stock and warrants to purchase Common Stock (the "IPO Warrants") are quoted on the Nasdaq Small Cap Market under the symbol "IZZI" and "IZZW," respectively, and on the Boston Stock Exchange under the symbol "ISI" and "ISIW," respectively. On August 20, 1997, the last reported sale prices for the Common Stock and IPO Warrants as reported on the Nasdaq Small Cap Market were $1 7/8 and $1 1/32, respectively. THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK AND SHOULD BE CONSIDERED ONLY BY PERSONS WHO CAN AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" ON PAGE 4. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS PROSPECTUS IS AUGUST 21, 1997. 2 TABLE OF CONTENTS
PAGE ---- Prospectus Summary......................................................3 The Offering............................................................3 Risk Factors............................................................4 Capitalization..........................................................6 Pro Forma Consolidated Statement of Operations..........................7 Market for Company's Common Stock.......................................8 Dividend Policy.........................................................8 Principal and Selling Stockholders......................................9 Management's Discussion and Analysis of Financial Condition and Results of Operations...................................10 Business...............................................................14 Management.............................................................18 Certain Transactions...................................................21 Description of Securities..............................................21 Plan of Distribution...................................................23 Legal Matters..........................................................24 Experts................................................................24 Additional Information.................................................24 Index to Financial Statements.........................................F-1
2 3 PROSPECTUS SUMMARY THE COMPANY 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. 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 OFFERING Common Stock offered by the Selling Stockholders:.............. 4,980,952 shares of Common Stock (2) Common Stock Outstanding: Prior to this Offering........ 7,905,212 shares (1) After this Offering........... 12,286,164 shares (1)(2)
Boston Symbols Nasdaq Symbols Exchange - ------- -------------- -------- Common Stock IZZI ISI IPO Warrants IZZIW ISIW
- -------------------- (1) Does not include 500,000 shares of Common Stock reserved for issuance pursuant to the Company's Stock Option Plan. (2) Of the shares of Common Stock being offered by the Selling Stockholders, 600,000 shares are currently outstanding. The remaining 4,380,952 shares are issuable upon the conversion of currently outstanding convertible debentures. 3 4 RISK FACTORS An investment in the Common Stock involves a high degree of risk and should not be made by persons who cannot afford the loss of their entire investment. Accordingly, prospective investors should carefully consider the following factors, in addition to the other information concerning the Company and its business contained in this Prospectus before purchasing the securities offered hereby. Note: Effective January 1, 1997, the Company changed its fiscal year end from December 31 to June 30. References to fiscal years 1996 and earlier refer to the twelve months ended December 31 of such year. References to fiscal 1997 refer to the six month transition period ended June 30, 1997. CONTINUING LOSSES Certain of the Company's subsidiaries have reported consolidated losses of $276,767 in 1996, $2,864,219 in 1995, $372,568 in 1994, $1,670,059 in 1993 and $1,352,133 in 1992. For fiscal 1997, the Company had a consolidated net loss of $330,257. The Company did not experience a negative cash flow in fiscal 1997, and in the fiscal years 1996 and 1993, but experienced negative cash flow of $155,850 in 1995, $298,713 in 1994, and $50,916 in 1992. The subsidiary which contributed the majority of losses in past years was discontinued in 1995. However, the Company's Innovative Security Technologies, Inc. ("IST") subsidiary continues to operate at a loss and, under existing loan covenants, the other subsidiaries of the Company are limited in the amount of financial support they can provide IST. Therefore, in order to continue operations of this subsidiary, its losses will have to be reduced or eliminated or the Company will be required to raise additional working capital that is available to IST. If neither of these can be accomplished, the operations of IST may have to be discontinued or sold. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." FUTURE CAPITAL NEEDS The Company believes additional working capital and term financing will be required to fund growth plans at all of the Company's major business units. The amount required will depend on many factors, including cash flow from operations and the ability to market its products successfully. There can be no assurance that the Company will be able to obtain additional financing, or that financing will be available on terms that will be acceptable to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." LACK OF MARKET ACCEPTANCE OF INTELLI-SITE The Company's marketing strategy includes the sale of sophisticated integrated security systems, such as the Company's Intelli-Site(R), which the Company believes will result in higher sales and gross margins. To date, sales of these systems have been limited and there can be no assurance that the market will accept the Company's Intelli-Site products, or that the Company will be able to successfully market its integrated security systems. ACQUISITION RISKS The Company's strategy includes increasing its market penetration by starting new, or acquiring existing, businesses to develop, manufacture or sell products that enhance the safety and security of people and assets. The Company has not reached any agreement or understanding with any acquisition candidate, nor have any acquisition discussions reached the point where an acquisition is probable. There can be no assurance that any new businesses can be acquired or operated profitably. In addition, the Company's ability to execute this strategy will depend on a number of factors, including its ability to hire, train and retain an adequate number of experienced management and sales employees, and to secure adequate financing, none of which are assured. 4 5 SEASONALITY -- IMPACT ON QUARTERLY RESULTS Because the Company sells some products which are used primarily in outdoor construction, which is affected by weather, the Company's revenues during the quarters ending September and December have historically represented approximately 61% of the annual revenues of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Seasonality." DEPENDENCE UPON KEY PERSONNEL The Company's success depends, to a significant extent, upon the efforts and abilities of a number of key employees. The loss of services of one or more of these employees, especially the Company's Chairman of the Board, President and Chief Executive Officer, Gerald K. Beckmann, could have a material adverse effect on the business of the Company. The Company believes that its future success will also depend in part upon its ability to attract, retain, and motivate qualified personnel. Competition for such personnel is intense. There can be no assurance that the Company will be successful in attracting and retaining such personnel. See "Management." DEPENDENCE UPON COMPLETION OF PRODUCT DEVELOPMENT The Company's ability to compete successfully in the integrated security systems market is dependent upon its ability to develop and produce products that are technologically comparable to those of its competitors. Development by others of new or improved products or technologies may make the Company's products or proposed products obsolete or less competitive. In order to fulfill its marketing strategy, the Company will be required to devote substantial effort and financial resources to enhance its existing products and to develop new products which meet a wide range of evolving user needs and achieve market acceptance. There can be no assurance that the Company will succeed in developing and marketing such products or that the Company will be able to respond effectively to technological changes, emerging industry standards, or new product introductions by others. COMPETITION The markets for the Company's products are extremely competitive. Many of the Company's competitors have greater market recognition and greater financial, technical, marketing and human resources than the Company. There can be no assurance that the Company will be able to compete successfully against existing companies or new entrants to the marketplace. Furthermore, the development by competitors of new or improved products or technologies may render the Company's products or proposed products obsolete or less competitive. See "Business-Competition." 5 6 CAPITALIZATION The following table sets forth the capitalization of the Company on June 30, 1997.
Current Portion of Long-Term Debt $ 522,550 Long-Term Debt and Other Liabilities 7,723,558 ------------ Total Debt 8,246,108 Stockholders' Equity Convertible Preferred Stock, $.01 par value, 750,000 shares authorized; 17,250 shares issued and outstanding at June 30, 1997 172 Common Stock, $.01 par value, 30,000,000 shares authorized; 7,955,212 and 7,905,212 shares, respectively, issued and outstanding at June 30, 1997 79,552 Additional Paid In Capital 10,523,546 Treasury Stock; 50,000 shares (118,750) Accumulated Deficit (6,536,758) ------------ Total Stockholders' Equity 3,947,762 ------------ Total Capitalization $ 12,193,870 ============
6 7 PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1996 (UNAUDITED) ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) On December 31, 1996, the Company acquired all the outstanding capital stock of Golston Company, Inc. ("GCI"). The pro forma consolidated statement of operations for the year ended December 31, 1996 is presented as if the Company had acquired GCI on January 1, 1996, and gives effect to the related financing. The pro forma consolidated statement of operations should be read in conjunction with the financial statements of the Company and GCI, including the related footnotes thereto, appearing elsewhere in this Prospectus. The pro forma information is not necessarily indicative of the results that would have been reported had such events actually occurred on January 1, 1996, nor is it indicative of the Company's future results. The pro forma information also does not reflect either the issuance of shares in connection with the conversion or exercise of any of the Company's outstanding convertible preferred stock, warrants, or convertible debentures.
PRO FORMA PRO FORMA COMPANY GCI ADJUSTMENTS CONSOLIDATED ------------ ------------ ------------ ------------ Sales $ 9,054 $ 4,294 $ 13,348 Cost of Sales 5,184 1,535 432(1) 7,151 ------------ ------------ ------------ ------------ Gross Margin 3,870 2,759 (432) 6,197 Operating Expenses 3,929 2,077 (890)(2) 5,116 Income (Loss) from Operations (59) 682 458 1,081 Other Expense (252) (37) (552)(3) (841) ------------ ------------ ------------ ------------ Income (Loss) from Continuing Operations Before Tax (311) 645 (94) 240 Income Tax 12 (234) 234(4) 12 Discontinued Operations 23 -- -- 23 ------------ ------------ ------------ ------------ Net Income (Loss) $ (276) $ 411 $ 140 $ 275 ============ ============ ============ ============ Weighted Average Shares of Common Stock Outstanding 5,122,878 5,847,191 Net Income (Loss) Per Share Continued Operations $ (0.05) $ 0.05 Discontinued Operations 0.00 0.00 ------------ ------------ Total $ (0.05) $ 0.05 ============ ============
NOTES TO PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS The following describes the assumptions used in determining the pro forma adjustments set forth above: (1) Adjustment to depreciation of manufacturing fixed assets arising from the GCI acquisition is based on useful lives varying from 3-7 years. (2) Adjustment to depreciation of fixed assets arising from the GCI acquisition is based on useful lives of 5 years, plus goodwill amortization; net of the effect of employees terminated as of December 31, 1996 with consolidation of the businesses. (3) Interest related to $6.1 million of indebtedness incurred by the Company in connection with the acquisition, with an interest rate of 9% per annum. (4) Adjustment from utilization of parent company losses to offset federal income taxes. 7 8 MARKET FOR COMPANY'S COMMON STOCK The Company's Common Stock is traded on the Automated Quotation System of the National Association of Securities Dealers, Inc. ("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 June 30, 1997, there were 7,905,212 shares of Common Stock outstanding and 1,450,000 IPO Warrants outstanding entitling holders to purchase 3,045,000 shares of Common Stock. 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.
COMMON STOCK WARRANTS ------------------------------------------------------- $ HIGH $ LOW $ HIGH $ LOW ------------------------------------------------------- FISCAL 1997 First Quarter 3 1/2 1 3/16 1 5/8 15/16 Second Quarter 2 3/16 1 1/4 1 5/16 11/16 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
On August 20, 1997, the last reported sales prices for the Common Stock and the IPO Warrants as reported on the Nasdaq Small Cap Market were $1 7/8 and $1 1/32, respectively. DIVIDEND POLICY 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. 8 9 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth the number and percentage of outstanding shares of each class of the Company's capital stock beneficially owned as of June 30, 1997 by (i) each director and named executive officer of the Company, (ii) all officers and directors of the Company as a group, (iii) all persons who are known by the Company to be beneficial owners of 5% or more of any class of capital stock of the Company, and (iv) each Selling Stockholder. Unless otherwise noted, each of the persons listed below has sole voting and investment power with respect to the shares indicated as beneficially owned by such person. With regard to shares of Common Stock, this table assumes that the persons set forth below have fully converted all their shares of convertible preferred stock into shares of Common Stock and fully exercised all their warrants to purchase Common Stock and converted their convertible debentures. For a description of the Company's convertible preferred stock, see "Description of Securities."
SHARES OF STOCK OWNED PRIOR TO OFFERING ----------------------------------------------------------------------------- NO. OF SHARES NO. OF SHARES OF NO OF SHARES OF OF COMMON % OF SERIES A % OF SERIES C % OF NAME OF BENEFICIAL OWNER STOCK CLASS PREFERRED STOCK CLASS PREFERRED STOCK CLASS - ------------------------------------ ------------- ------ ---------------- ----- --------------- ----- Frank R. Marlow(1) 73,856 * -- -- -- -- Gerald K. Beckmann(1) 868,929 11% -- -- 3,500 100% H.J. Meyers, Inc.(2) 609,000 8% -- -- -- -- Holly J. Burlage(1) 13,128 * -- -- -- -- James E. Jack (1) -- -- -- -- -- -- James W. Casey(1) 157,873 2% -- -- -- -- Philip J. Hempleman 224,000 3% 8,000 58% -- -- Philip R. Thomas(1) 1,625,126 20% -- -- -- -- ProFutures Bridge Capital Fund LP 475,000 6% -- -- -- -- ProFutures Special Equities Fund LP 125,000 2% -- -- -- -- Renaissance Capital Growth & Income 2,190,476 27% -- -- -- -- Fund, III, Inc. Renaissance US Growth & Income Trust 2,190,476 27% -- -- -- -- PLC Robert M. Galecke(1) -- -- -- -- -- -- Seabeach & Co. 1,120,000 8% -- -- -- -- All Officers and Directors as a Group 1,113,786 14% -- -- 3,500 100% (7 Persons)
SHARES OF COMMON STOCK OWNED AFTER OFFERING ------------------------------ SHARES OF COMMON NO. OF SHARES OF NAME OF BENEFICIAL OWNER STOCK TO BE SOLD COMMON STOCK % OF CLASS - ------------------------------------ ---------------- ------------------ ---------- Frank R. Marlow(1) -- 73,856 * Gerald K. Beckmann(1) -- 973,929 11% H.J. Meyers, Inc.(2) -- 609,000 8% Holly J. Burlage(1) -- 13,128 * James E. Jack (1) -- -- -- James W. Casey(1) -- 157,873 2% Philip J. Hempleman -- 224,000 3% Philip R. Thomas(1) -- 1,625,126 20% ProFutures Bridge Capital Fund LP 475,000 -- -- ProFutures Special Equities Fund LP 125,000 -- -- Renaissance Capital Growth & Income 2,190,476 -- -- Fund, III, Inc. Renaissance US Growth & Income Trust 2,190,476 -- -- PLC Robert M. Galecke(1) -- -- -- Seabeach & Co. -- 1,120,000 8% All Officers and Directors as a Group -- 1,218,786 14% (7 Persons)
- ------------ * Less than 1%. (1) The address for this person is 8200 Springwood Drive, Suite 230, Irving, Texas 75063. (2) This amount includes warrants to purchase Common Stock. Such warrants may be held in the name of officers and directors of H.J. Meyers, Inc. 9 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Incorporated 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. 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. On 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 manufactures modular buildings for 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 real estate and facilities occupied by GCI were also acquired for an additional $1.5 million in cash. The Company funded this acquisition through the private placement of $4.6 million of convertible debentures to Renaissance Capital Fund, a private investment fund. 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. During fiscal 1997, the Company recorded additional acquisition costs and non-compete agreements of $691,745. Effective January 1, 1997, the Company changed its fiscal year end from December 31 to June 30. References to fiscal years 1996 and earlier refer to the twelve months ended December 31 of such year. References to fiscal 1997 refer to the six month transition period ended June 30, 1997. 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 Company is a Delaware corporation. 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 fund the sales, engineering and order fulfillment expenses of IST In exchange, the Partnership will receive, as compensation from IST, 85% of the revenue generated from IST's Intelli-Site sales until the Partnership has achieved at least a 150% return on its investment. After such time, the Partnership will dissolve. 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 June 30, 1997, the Partnership had not received any return on its investment. Also, during the year ended December 31, 1996, the Company received $250,000 from the Partnership related to the Partnership's purchase of sales leads and prospects. 10 11 EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share." This statement establishes a new methodology for reporting earnings per share for interim financial information and annual financial statements with periods ending after December 15, 1997. For the six months ended June 30, 1997 and the twelve months ended December 31, 1996, the pro forma basic and diluted loss per share amounts calculated assuming adoption of this statement would be the same as the loss per share presented on the consolidated statements of operations. RESULTS OF OPERATIONS Six Months Ended June 30, 1997 Compared to Six Months Ended June 30, 1996 Sales. The Company's sales increased by $2.3 million (55%) from $4.2 million during the six months ended June 30, 1996 to $6.5 million during the six months ended June 30, 1997. The increase was primarily attributable to the inclusion of GCI, acquired on December 31, 1996, for the six months ended June 30, 1997, with no equivalent revenue during the comparable 1996 period. Also contributing to the increase were sales at TCSI and IST during the six months ended June 30, 1997, due to larger contracts and increased business. For the six months ended June 30, 1997, approximately 74% of the Company's revenues were generated from the sale of products manufactured by the Company compared to 78% for the comparable six month period during 1996. Cost of Sales and Gross Margin. Gross margin as a percent of sales increased to 42% from 38% for the six months ended June 30, 1997 and 1996, respectively. This increase was primarily due to a favorable change in the Company's product mix compared to the prior year. With the inclusion of GCI results during the six months ended June 30, 1997, the Company experienced higher sales of products manufactured by the Company, which have higher gross margins. The Company also incurred $63,691 in software cost amortization during each of the 1997 and 1998 periods. Selling, General and Administrative. Selling, general and administrative expenses increased to $2.7 million during the six months ended June 30, 1997 from $1.8 million during the comparable 1996 period. The increase was primarily attributable to the inclusion of GCI expenses during the six months ended June 30, 1997. Research and Development. Research and development expenses decreased from $152,239 in fiscal 1996 to $34,138 in fiscal 1997. This decrease was due primarily to the completion of the initial development of Intelli-Site. Interest Expense. Interest expense increased to $389,540 during the six months ended June 30, 1997 from $174,215 during the comparable 1996 period due to the financing related to the acquisition of GCI. Gain on sale of assets. The Company recorded a $23,408 gain on the sale of assets during the six months ended June 30, 1997, primarily from the sale of modular buildings at GCI. 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. This positive trend will continue to be boosted by the sales of IntelliSite, 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 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 GCI; and (iii) cost control - continued cost control at all subsidiaries. 11 12 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 June 30, 1997. 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, 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 Margin. Gross margin 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. 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. 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 12 13 profitability 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 GCI; 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. LIQUIDITY AND CAPITAL RESOURCES The Company's cash position increased by $483,300 during the six months ended June 30, 1997. The Company used $95,195 of cash for operations during this period. During the six months ended June 30, 1997, the Company financed its continuing operations from operating cash flow, long-term borrowings of $816,291, and the private placement of its securities in the amount of $70,875. The Company used a total of $193,277 to pay principal and interest on indebtedness and to secure financing. The Company has a factoring facility with Union Planters Bank, Baton Rouge, Louisiana, pursuant to which it may factor accounts receivable (with recourse) and receive a total of up to $1.4 million in credit. This factoring facility expires August 15, 1997 and has an adjustable factoring fee of 3% of the total amount borrowed. As of June 30, 1997, the Company had no outstanding balance under this factoring facility. On April 11, 1997, GCI entered into a $1.95 million financing arrangement with Finova Capital Corporation, of which $775,000 was borrowed at the closing. The balance of the arrangement consists of $675,000 in additional borrowing potential and a $500,000 revolving line of credit. The initial $775,000 is due in 60 monthly principal and interest payments beginning May 1, 1997. The additional borrowing may take place over the next six to twelve months for fixed asset additions, with principal and interest payments due over 48 months beginning May 1, 1998. Interest on the term borrowings is at prime plus 2%, currently 10.5%. Although there are no principal payment requirements on the line of credit, interest is due monthly at the prime rate plus 1.75% based on the average daily borrowings during the prior month. To date, GCI has not drawn against the line of credit. The financing arrangement is guaranteed by the Company and is secured by certain tangible and intangible assets of GCI. 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 the financing arrangement described in the preceding paragraph, 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 1998. During the six months ended June 30, 1997, the Company acquired $149,549 of property and equipment and received proceeds of $135,953 from the sale of property during the period. 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. 13 14 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 quarter ended March 31 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. 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. Custom 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. 14 15 B&B plans to continue to leverage its long term reputation of 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 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. IST continues to develop 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. In 1993, IST began developing and testing a proprietary hardware and software product called Intelli-Site, a user-defined, PC-based systems integration platform. 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. Pneumatic Carriers: Golston Company, Inc. ("GCI") GCI manufactures and sells a variety of products, primarily to the retail banking and health care industries and, through its plastic injection molding operations, is a provider of carriers used in pneumatic tube systems in both drive-up banking and hospital environments. GCI also manufactures and markets modular buildings for financial institutions for use during new branch construction or existing facility remodeling. 15 16 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 million at June 30, 1997. The Company expects that the majority of this backlog will be filled during the second half of 1997 and the first half of 1998. 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 1995 and 1996, and the first six months of 1997, the Company spent approximately $292,000, $152,239, and $34,138, respectively, on research and development, primarily related to the development of Intelli-Site. 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 16 17 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 June 30, 1997, the Company employed 89 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. 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 36,000 square feet of manufacturing and office space on 6.4 acres of land. The Company occupies 13,038 square feet of office and warehouse space in Irving, Texas, under a lease expiring on December 31, 1997, with monthly rent of $6,790, plus the costs of utilities, property taxes, insurance, repair/maintenance expenses and common area utilities. 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. 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. 17 18 MANAGEMENT DIRECTORS, OFFICERS AND KEY EMPLOYEES The directors, officers and key employees of the Company are as follows:
Name Position ---- -------- Gerald K. Beckmann............... Director, Chairman of the Board, President and Chief Executive Officer Holly J. Burlage................. Vice President, Secretary and Treasurer James W. Casey................... Director, Vice President and Assistant Secretary Richard P. Shortz................ Vice President of IST Robert M. Galecke (1)............ Director Tony C. Lisotta.................. Vice President of IST Frank R. Marlow (1)(2)........... Director James E. Jack (1) (2)............ Director
- --------------- (1) Member of the Audit Committee (2) Member of the Compensation and Stock Option Committee Each director is elected for a period of one year and serves until his successor is duly elected by the stockholders. Officers are elected by and serve at the discretion of the Board of Directors. Set forth below are descriptions of the backgrounds of the directors, officers and key employees of the Company. GERALD K. BECKMANN, 54, Director, Chairman, President and Chief Executive Officer, has served as a director and Chief Technical Officer of the Company since its inception in 1991 and Chairman of the Board of Directors since February 1993. On May 1, 1995, Mr. Beckmann became President and Chief Executive Officer of the Company. From 1991 to 1994 Mr. Beckmann was President and Chief Operating Officer of Thomas Group Holding Company, a private investment company. In 1985, Mr. Beckmann joined Thomas Group, Inc., a publicly-held management consulting firm, and currently serves as a director. Mr. Beckmann also serves as a director on the board of CTC Holdings, an electronic funds transfer systems supplier. Mr. Beckmann is also an advisor to the board of directors of Financial Data Systems, Inc., a banking software developer. Mr. Beckmann is also a manager in Celerity Partners, L.L.C., the general partner of Celerity Partners I, L.P., an acquisition limited partnership. From 1981 to 1984 Mr. Beckmann served as Chairman and Chief Executive Officer of Threshold Technology, Inc., a publicly-held voice recognition company. From 1989 to 1992, Mr. Beckmann was director of PROTECH, Inc., a publicly-held automatic test equipment supplier and a director of DesignTech, Inc., a digital video system designer. Mr. Beckmann has also served as past President of COMTRAC Corporation and BehaviorTech, Inc., a computer-based training company as well as past Chairman of Integrated Multimedia Solutions, Inc., BehaviorTech's parent company. Mr. Beckmann also held various other management positions in sales, marketing, engineering and general management at Exxon, RCA, IBM and Honeywell. Mr. Beckmann holds a B.S.E.E. from Virginia Polytechnic Institute and University. HOLLY J. BURLAGE, 33, Vice President, Secretary and Treasurer, joined the Company in February 1994 as Accounting Manager, became Controller in 1995, and became Vice President, Secretary and Treasurer in May 1997. Prior to joining the Company, Ms. Burlage was Controller of Signature Home Care Group, Inc., a home health care company, from 1993 to 1994, and Controller and Chief Accounting Officer of National Heritage, Inc., a publicly-traded long-term care company, from 1989 to 1993. Ms. Burlage holds a B.B.A. from Baylor University. JAMES W. CASEY, 55, Director, Vice President and Assistant Secretary, is currently President of GCI and CEO of B&B. Mr. Casey served as General Manager of B&B, the Company's manufacturing subsidiary, from April 1994 to May 1995, and became Director and Vice President of the Company on May 1, 1995. From May 1995 to May 1997 Mr. Casey also served as the Company's Chief Financial Officer. Prior to joining the Company, Mr. Casey was President and Chief Executive Officer of PROTECH, Inc., a publicly-held automatic test equipment manufacturer from 1990 to 1993 and President and Chief Operating 18 19 Officer of CJC Holdings, Inc., a custom jewelry manufacturer from 1989 to 1990. Mr. Casey holds a B.B.A. from Iona College and an M.S. from the State University of New York. ROBERT M. GALECKE, 55, Director, is Vice President for Finance and Administration for the University of Dallas. Prior to that he was a principal in the corporate consulting firm of Pate, Winters & Stone, Inc. from 1993 to May 1996. He also served as Executive Vice President, Chief Operating Officer and Chief Financial Officer of Southmark Corporation, a financial services insurance and real estate holding company, from 1986 to 1992. From 1989 to 1995, Mr. Galecke served as Chairman of the Board, President and Chief Executive Officer of National Heritage, Inc., one of the nation's largest nursing home management companies with annual revenues exceeding $50 million. Mr. Galecke was also Chairman of the Board, President and Chief Executive Officer of USTrails, Inc., which owns and operates 66 campground and full service resorts with total assets of $160 million and annual revenues exceeding $80 million. Mr. Galecke continues to serve as a director of USTrails Inc. and Thousand Trails Inc. Mr. Galecke received a graduate degree from the School of Banking at the University of Wisconsin, Madison, Wisconsin, and a BS in Economics from the University of Wisconsin Stevens Point. TONY C. LISOTTA, 55, Vice President and General Manager of IST, a subsidiary of the Company, joined the Company in October 1993. Mr. Lisotta has over 14 years of sales and management experience with IBM. Mr. Lisotta previously served as Senior Vice President for Fults Associates, Inc., a commercial real estate firm from 1988 to 1992, and Executive Vice President for The Consolidated Companies, a surety bond company from 1992 to 1993. Mr. Lisotta holds a B.B.A. from Lamar University. FRANK R. MARLOW, 57, Director, has been a director of the Company since May 1995. Mr. Marlow served as Vice President, Sales and Marketing for the Company from October 1993 to February 1995. Mr. Marlow has been a vice president of Hogan Systems, a publicly-traded company, since March of 1995. Previously, Mr. Marlow was with IBM, Docutel Corporation, UCCEL Corporation and Syntelligence Corporation in executive sales and training positions. RICHARD P. SHORTZ, 42, Vice President, Engineering, IST, joined the Company in May 1994 and is responsible for Intelli-Site software development. Prior to IST, Mr. Shortz was a Software Developer for Thomas Group, Inc. from 1988 to 1994. Mr. Shortz holds a B.S.C.S. from the University of Maryland. JAMES E. JACK, 55, Director, is currently retired. From 1991 to 1996 Mr. Jack was Director, Senior Executive Vice President and Chief Financial Officer of Associates First Capital Corporation, a publicly traded consumer and commercial finance organization. Prior to that, Mr. Jack was Director, Executive Vice President and Chief Financial Officer from 1981 to 1993 of the same company. Mr. Jack received a graduate degree from the Southern Methodist University School of Business and a BBA from the University of Notre Dame. SUMMARY COMPENSATION TABLE The following table sets forth the total compensation paid or accrued by the Company for services rendered during the fiscal years ended December 31, 1996, 1995, and 1994 to the Company's Chief Executive Officer and the four other most highly compensated executive officers whose total cash compensation for the fiscal year ended December 31, 1996 exceed $100,000 (the "named executive officers").
ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS ---------------------------------- ----------------------------------------------- OTHER ANNUAL RESTRICTED STOCK OPTION/ NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS SARS - ----------------------------- ---- --------- --------- ------------ ---------------- --------- Gerald K. Beckmann 1996 $ 281,875 --- --- --- --- Chairman, CEO & President 1995 $ 114,583 --- --- $ 68,750(4) $ 14,473 1994 --- --- --- --- --- James W. Casey 1996 $ 94,163 $ 6,812 --- --- $ 50,000 Vice President & CFO 1995 $ 115,145 $ 7,750 --- $ 33,333(4) $ 23,395 1994 $ 94,125 $ 17,125 --- --- $ 34,333 Ferdinand A. Hauslein, Jr.(1) 1996 $ 228,471 --- --- --- --- former CEO & President 1995 $ 233,333 --- $ 32,845(3) --- $ 20,000 1994 $ 154,167 $ 56,250 --- $ 4,284(2) $ 16,271 Tony C. Lisotta 1996 $ 120,892 --- --- --- --- Vice President, IST 1995 $ 116,000 $ 2,850 --- $ 3,550(4) $ 10,150 1994 $ 111,500 $ 16,900 --- --- $ 8,627 Richard P. Shortz 1996 $ 123,166 $ 8,400 --- --- $ 15,120 Vice President, IST 1995 $ 96,000 $ 3,000 --- $ 18,600(4) $ 2,880 1994 $ 64,000 --- --- --- $ 12,000
- -------------------- (1) No longer employed by the Company. (2) Mr. Hauslein holds 2,448 shares of restricted common stock valued at $8,874 at December 31, 1996. (3) Outplacement services. (4) Convertible preferred stock issued for forgiveness of deferred salary amounts. 19 20 No other executive officer's salary and bonus exceed $100,000 during any of the indicated periods. No other executive had any form of long-term incentive plan compensation arrangement with the Company during any of the indicated periods. STOCK OPTION GRANTS The following table provides information concerning the grant of stock options during the year ended December 31, 1996 to the named executive officers:
NUMBER OF SECURITIES % OF TOTAL OPTIONS UNDERLYING OPTIONS GRANTED TO EMPLOYEES EXERCISE EXPIRATION GRANTED(1) IN FISCAL YEAR PRICE DATE -------------------- -------------------- -------- ---------- Gerald K. Beckmann -- -- -- -- James W. Casey 50,000 27% $ .81 11/3/03 Tony C. Lisotta -- -- -- -- Richard P. Shortz 15,120 8% $1.96 8/1/06
- -------------------- (1) The options for all listed vest with respect to 25% of the shares issuable thereunder six months after the date of grant and with respect to cumulative increments of 25% of the shares issuable thereunder on each anniversary of the date of grant. OPTION EXERCISES AND HOLDINGS The following table provides information related to the number of shares received upon exercise of options, the aggregate dollar value realized upon exercise, and the number and value of options held by the named executive officers of the Company at December 31, 1996.
NUMBER OF VALUE OF UNEXERCISED UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS AT FISCAL YEAR END AT FISCAL YEAR END ---------------------------------- ------------------------------------- EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------- -------------- ------------- ------------- Gerald K. Beckmann 177,237 -- $ 200,296 $ 9,046 James W. Casey 63,281 44,448 135,903 121,141 Ferdinand A. Hauslein, Jr. 184,212 -- 230,890 -- Tony C. Lisotta 46,545 7,232 69,509 12,626 Richard P. Shortz 10,440 19,560 $ 19,845 $ 34,383
20 21 DIRECTOR COMPENSATION Directors who have served as directors for at least six months prior to the calculation of an award are eligible to receive grants of options under the Stock Option Plan. Awards are made pursuant to a formula that is based on the Company's net income per share. All directors are reimbursed for their out-of-pocket expenses incurred in connection with their attendance at Board meetings. The Company entered into a five-year employment agreement (January 1994 through October 1999) with Mr. Ferdinand A. Hauslein, Jr. that provided him with an annual salary of $200,000. Mr. Hauslein resigned on May 1, 1995. Mr. Hauslein's employment agreement provided that he was eligible for an annual cash bonus of up to 50% of his base salary. Pursuant to the terms of that employment agreement, upon the termination of his employment, the Company was obligated to pay Mr. Hauslein $100,000, 12 months of severance pay at his then-current salary, a $50,000 allowance for outplacement services, a three-month consulting agreement and accelerated vesting of all outstanding options granted to Mr. Hauslein. In addition, the Company changed the beneficiary of the key-man life insurance from the Company to Mr. Hauslein. CERTAIN TRANSACTIONS During 1995, Mr. Philip R. Thomas, the Company's founder and principal stockholder, loaned the Company $40,000 which was secured by certain receivables. On December 29, 1995, Mr. Thomas converted this loan into 2,000 Series B $20 Convertible Preferred Stock. Also on December 29, 1995, Mr. Beckmann, Mr. James W. Casey (a director and executive officer of the Company), Mr. Tony C. Lisotta (Vice President of IST), Mr. Richard P. Shortz (Vice President of IST), Ms. Holly J. Burlage (Vice President of the Company), and Mr. Frank R. Marlow (a director of the Company), converted unpaid compensation totaling $138,451 into 6,922 Series B $20 Convertible Preferred Stock. During 1995 and 1996, Mr. Beckmann loaned the Company approximately $400,000. As of December 31, 1996, no loans were outstanding. On March 11, 1996, Mr. Beckmann loaned the Company $100,000 as part of a $250,000 bridge loan. These bridge loans were converted in June 1996 into $20 Series C Preferred Stock convertible to 30 shares of Common Stock and Warrants to purchase 15 shares of Common Stock at $1.00 per share. These warrants expire five years from date of issue. During the second and third quarters of 1996, Mr. Beckmann loaned the Company $90,000 and Mr. Casey loaned the Company $75,000. Both of these loans have been repaid. In 1996, Mr. Beckmann guaranteed loans to the Company in the aggregate amount of $1,050,000. The Company believes that the terms of the foregoing transactions were on terms no less favorable to the Company than could be obtained from unaffiliated third parties. DESCRIPTION OF SECURITIES The authorized capital stock of the Company consists of 30,000,000 shares of Common Stock, $.01 par value per share, 7,905,212 of which are outstanding, and 750,000 shares of Convertible Preferred Stock, $.01 par value per share, issuable in series. As of the date hereof, there are 13,750 shares of Series A $20 Convertible Preferred Stock outstanding, and 3,500 shares of Series C $20 Convertible Preferred Stock Outstanding. The following statements are brief summaries of certain provisions relating to the Company's capital stock. COMMON STOCK Holders of Common Stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders. There is no cumulative voting with respect to the election of Directors, with the result that the holders of more than 50% of the shares voted in the election of Directors can elect all of the Directors. Holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors of the Company out of funds legally available therefor. Upon the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to receive ratably the net assets of the Company after payment of all debts and liabilities and liquidation preferences 21 22 of outstanding shares of Preferred Stock. Holders of Common Stock have no preemptive, subscription, redemption or conversion rights. PREFERRED STOCK General. The Company's Board of Directors may, without further action by the Company's stockholders, from time to time issue preferred stock in series and may, at the time of issuance, determine the rights, preferences and limitations of each series. Satisfaction of any dividend preferences of outstanding Preferred Stock would reduce the amount of funds available for the payment of dividends on Common Stock. Also, holders of Preferred Stock would normally be entitled to receive a preference payment in the event of any liquidation, dissolution, or winding-up of the Company before any payment is made to the holders of Common Stock. In addition, under certain circumstances, the issuance of Preferred Stock may render more difficult or tend to discourage a merger, tender offer or proxy contest, or the removal of incumbent management. Series A $20 Convertible Preferred Stock. The Company currently has outstanding 13,750 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 the Series C Preferred Stock. Series C $20 Convertible Preferred Stock. The Company has issued 3,500 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. WARRANTS AND OPTIONS The IPO Warrants. In connection with the Company's initial public offering ("IPO"), the Company issued warrants which currently permit the holders to purchase 3,045,000 shares of Common Stock (the "IPO Warrants"). Each IPO Warrant entitles the holder to purchase 2.1 shares of Common Stock at $3.17 per share. The IPO Warrants may be exercised at any time prior to April 20, 1998. The Warrants are subject to redemption at $.25 per Warrant on 30 days' written notice with the prior written consent of the underwriter for the IPO. The exercise price and the number of shares of Common Stock purchasable upon the exercise of the IPO Warrants are subject to adjustment upon the occurrence of certain events, including stock dividends, stock splits, combinations or reclassifications of the Common Stock, or sale by the Company of shares of its Common Stock at a price below the then-applicable exercise price of the IPO Warrants. Underwriter's Warrant. In connection with the IPO, the Company issued to H.J. Meyers, Inc. (successor to Thomas James Associates Inc.) the Underwriter's Warrant to purchase 304,500 Units, each Unit consisting of one share of Common Stock and one Warrant. The Underwriter's Warrant is exercisable until April 20, 1998, at an exercise price of $3.00 per Unit. The Underwriter's Warrant contains anti-dilution provisions providing for appropriate adjustment upon certain events, including any combination, recapitalization, reclassification, stock dividend, stock split or sale by the Company or shares of its Common Stock at a price below the then applicable exercise price of the Underwriter's Warrant. 22 23 Other Warrants. The Company has issued additional warrants to purchase 1,771,500 shares of Common Stock in connection with certain other financings and to certain other persons who provided services to the Company. The exercise prices of these warrants range from $.01 to $4.15. Stock Options. The Company has issued options to employees and consultants to purchase an aggregate of 928,530 shares of Common Stock under the Company's 1993 Stock Option Plan and outside of such Plan. DELAWARE LAW; CERTIFICATE OF INCORPORATION AND BYLAW PROVISIONS Certain provisions of Delaware law and the Company's Certificate of Incorporation and Bylaws could make more difficult the acquisition of the Company by means of a tender offer, a proxy contest or otherwise and the removal of incumbent officers and directors. The Company's Certificate of Incorporation contains a provision prohibiting stockholder action by less than unanimous written consent, which would otherwise be permitted by Delaware law. The Company's Bylaws contain a provision which requires that a stockholder may nominate a person for election as a director only if written notice of such stockholder's intent to make such nomination has been given to the Secretary of the Company not later than 60 days prior to an annual meeting and not later than ten days after the date on which notice of a special meeting was first sent to stockholders. The notice must set forth, among other things, a description of all arrangements or understandings between the nominating stockholder and the nominee and such other information regarding the nominee as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated by the Board of Directors of the Company. These provisions are expected to discourage certain types of coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of the Company to first negotiate with the Company. The Company believes that the benefits of increased protection of the Company's potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure the Company outweigh the disadvantages of discouraging such proposals because, among other things, negotiation of such proposals could results in an improvement of their terms. The Company is subject to the provisions of Section 203 of the Delaware General Corporation Law. In general, this statute prohibits a publicly held Delaware corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date that the person became an interested stockholder unless (with certain exceptions) the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a "business combination" includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the stockholder. Generally, an "interested stockholder" is a person who, together with affiliates and associates, owns (or within three years prior, did own) 15% or more of the corporation's voting stock. LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS The Company's Certificate of Incorporation and Bylaws provide broadly for indemnification of the officers and directors of the Company. In addition, the Certificate of Incorporation provides that, to the fullest extent permitted by Delaware law, no director shall be personally liable to the Company or its stockholders for monetary damages for any breach of fiduciary duty by such director in his or her capacity as a director. PLAN OF DISTRIBUTION The Common Stock offered hereby may be sold directly by each Selling Stockholder or indirectly through agents, dealers or underwriters from time to time in one or more transactions on the Nasdaq Small Cap Market, the Boston Stock Exchange or such exchanges on which the Common Stock is then listed, or in privately negotiated transactions at prices related to such market prices, at negotiated prices or at fixed prices. The Selling Stockholders will bear all discounts and commissions paid to broker-dealers in connection with the sale of their Common Stock. Other offering expenses will be borne by the Company. The Company will not receive any proceeds from the sales of Common Stock by the Selling Stockholders. 23 24 LEGAL MATTERS The validity of the securities offered hereby will be passed upon for the Company by Haynes and Boone, L.L.P., Dallas, Texas. EXPERTS The Company's financial statements as of June 30, 1997 and December 31, 1996 and 1995 and for the six month period ended June 30, 1997 and for each of the two years in the period ended December 31, 1996 included in this Prospectus, and GCI's financial statements as of June 30, 1996 and 1995 and for each of the two years in the period ended June 30, 1996 included in this Prospectus, have been so included in reliance on the reports of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. ADDITIONAL INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"), Nasdaq and the Boston Stock Exchange. The Registration Statement, the exhibits and schedules forming a part thereof, and the reports, proxy statements, and other information filed with the Commission in accordance with the Exchange Act can be inspected and copied at the public reference facilities maintained by the Commission at Judiciary Plaza, Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of the Commission at 7 World Trade Center, New York, New York 10048 and at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material also may be obtained at prescribed rates from the Public Reference Section of the Commission, 450 fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. Such material may also be accessed electronically by means of the Commission's World Wide Web site on the Internet at http://www.sec.gov. The address for Nasdaq is 1735 K Street NW., Washington, D.C. 20006-1500, and the address for the Boston Stock Exchange is One Boston Place, Boston, Massachusetts 02108. The Company has filed with the Commission a Registration Statement on Form SB-2 (herein, together with all amendments and exhibits, referred to as the Registration Statement) under the Securities Act of 1933 with respect to the securities offered hereby. As permitted by the rules and regulations of the Commission, this Prospectus omits certain information, exhibits and undertakings contained in the Registration Statement. For further information with respect to the Company and the securities offered hereby, reference is made to the Registration Statement, each such statement being qualified in all respects by such reference. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete, and in each instance reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. 24 25 INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Integrated Security Systems, Inc. Report of Independent Accountants.............................................F-2 Integrated Security Systems, Inc. Consolidated Balance Sheets as of June 30, 1997 and December 31, 1996 and 1995..................................F-3 Integrated Security Systems, Inc. Consolidated Statements of Operations for the six months ended June 30, 1997 and for the years ended December 31, 1996 and 1995..............................................................F-4 Integrated Security Systems, Inc. Consolidated Statements of Stockholders' Equity for the six months ended June 30, 1997 and for the years ended December 31, 1996 and 1995.......................F-5 Integrated Security Systems, Inc. Consolidated Statements of Cash Flows for the six months ended June 30, 1997 and for the years ended December 31, 1996 and 1995.......................F-6 Integrated Security Systems, Inc. Notes to Consolidated Financial Statements...............................................................F-7 - F-22 Golston Company, Inc. Report of Independent Accountants........................................................F-23 Golston Company, Inc. Balance Sheets as of June 30, 1996 and 1995..............................................F-24 Golston Company, Inc. Statements of Operations for the years ended June 30, 1996 and 1995.....................................................................F-25 Golston Company, Inc. Statements of Stockholders' Equity for the years ended June 30, 1996 and 1995.....................................................................F-26 Golston Company, Inc. Statements of Cash Flows for the years ended June 30, 1996 and 1995.....................................................................F-27 Golston Company, Inc. Notes to Financial Statements.....................................................F-28 - F-33 Golston Company, Inc. Consolidated Statement of Operations for the six months ended December 31, 1996.....................................................................F-34
F-1 26 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 subsidiaries (the "Company") at June 30, 1997 and December 31, 1996 and 1995, and the results of their operations and their cash flows for the six month period ended June 30, 1997 and the years ended December 31, 1996 and 1995 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 August 8, 1997 F-2 27 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS
June 30, December 31, December 31, 1997 1996 1995 ------------ ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 1,581,191 $ 1,097,891 $ 209,655 Accounts receivable, net of allowance for doubtful accounts of $54,733, $65,687 and $54,555, 2,457,596 2,629,909 1,761,701 respectively Inventories 867,898 1,086,985 854,888 Restricted cash 54,928 8,232 157,851 Other current assets 312,234 193,960 15,831 Net assets from discontinued operations -- 25,760 76,807 ------------ ------------ ----------- Total current assets 5,273,847 5,042,737 3,076,733 Property and equipment, net 5,278,689 5,502,284 1,068,123 Intangible assets, net 2,283,970 1,598,632 136,116 Capitalized software development costs, net 493,350 591,505 787,816 Deferred income taxes 205,384 205,384 205,384 Other assets 18,295 31,325 33,333 ------------ ------------ ----------- Total assets $ 13,553,535 $ 12,971,867 $ 5,307,505 ============ ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 690,712 $ 881,221 $ 1,308,650 Accrued liabilities 672,340 691,208 1,041,567 Deferred revenue 116,028 209,296 152,948 Notes payable -- 8,080 950,947 Notes payable to related parties -- 7,110 29,437 Current portion of long-term debt and other liabilities 495,737 213,975 96,451 Net liabilities from discontinued operations -- 49,252 332,866 ------------ ------------ ----------- Total current liabilities 1,974,817 2,060,142 3,912,866 ------------ ------------ ----------- Long-term debt and other liabilities 7,630,956 6,784,582 213,899 Stockholders' equity: Preferred stock, $.01 par value, 750,000 shares authorized; 17,250, 59,168 and 34,166 shares, respectively, issued and outstanding 172 591 342 Common stock, $.01 par value, 30,000,000 shares authorized; 7,955,212, 6,958,842 and 3,730,738 shares, respectively, issued; and 7,905,212, 6,908,842 and 3,680,738 shares, respectively, outstanding 79,552 69,588 37,307 Additional paid in capital 10,523,546 10,382,215 7,191,575 Accumulated deficit (6,536,758) (6,206,501) (5,929,734) Treasury stock, 50,000 shares (118,750) (118,750) (118,750) ------------ ------------ ----------- Total stockholders' equity 3,947,762 4,127,143 1,180,740 ------------ ------------ ----------- Total liabilities and stockholders' equity $ 13,553,535 $ 12,971,867 $ 5,307,505 ============ ============ ===========
The accompanying notes are an integral part of the consolidated financial statements. F-3 28 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended For the Year Ended June 30, December 31, ---------------------------- ---------------------------- 1997 1996 1996 1995 ----------- ----------- ----------- ----------- Unaudited Sales $ 6,470,842 $ 4,225,419 $ 9,054,145 $ 7,622,219 Cost of sales 3,772,714 2,617,433 5,184,321 4,200,723 ----------- ----------- ----------- ----------- Gross margin 2,698,128 1,607,986 3,869,824 3,421,496 Operating expenses: Selling, general and administrative 2,643,134 1,809,271 3,776,798 4,634,963 Research and product development 34,138 108,611 152,239 46,199 ----------- ----------- ----------- ----------- 2,677,272 1,917,882 3,929,037 4,681,162 ----------- ----------- ----------- ----------- Income (loss) from operations 20,856 (309,896) (59,213) (1,259,666) Other income (expense): Interest income 15,900 5,805 7,748 14,957 Interest expense (389,540) (174,215) (260,471) (343,012) Gain on sale of assets 23,408 -- -- -- Other 6,132 5,686 389 209 ----------- ----------- ----------- ----------- Loss from continuing operations before income taxes (323,244) (472,620) (311,547) (1,587,512) (Provision) benefit for income taxes (7,013) 14,326 11,991 (62,102) ----------- ----------- ----------- ----------- Loss from continuing operations (330,257) (458,294) (299,556) (1,649,614) Discontinued operations: Loss from discontinued operations -- -- -- (720,043) Gain (loss) on disposal of discontinued operations -- 22,789 22,789 (494,562) ----------- ----------- ----------- ----------- Income (loss) from discontinued operations -- 22,789 22,789 (1,214,605) ----------- ----------- ----------- ----------- Net loss $ (330,257) $ (435,505) $ (276,767) $(2,864,219) =========== =========== =========== =========== Weighted average common and common equivalent shares outstanding 7,188,764 7,615,087 5,122,878 4,014,108 Net loss per share: Continuing operations $ (0.05) $ (0.06) $ (0.05) $ (.41) Discontinued operations -- -- -- (.30) ----------- ----------- ----------- ----------- Total $ (0.05) $ (0.06) $ (0.05) $ (.71) =========== =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-4 29 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Additional Stockholder Preferred Common Paid In Accumulated Receivable, Treasury Shares Amount Shares Amount Capital Deficit Net Stock ---------- ----------- ----------- ---------- ------------ ----------- ----------- --------- 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) Preferred stock conversion (41,918) (419) 928,370 9,284 (8,864) Warrant issuance 80,000 Warrant exercise 68,000 680 70,195 Net loss (330,257) ---------- ----------- ----------- ---------- ------------ ----------- ----------- --------- Balance at June 30, 1997 17,250 $ 172 7,955,212 $ 79,552 $ 10,523,546 $(6,536,758) $ -- $(118,750) ========== =========== =========== ========== ============ =========== =========== =========
The accompanying notes are an integral part of the consolidated financial statements. F-5 30 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED FOR THE YEAR ENDED JUNE 30, DECEMBER 31, ------------------------ ---------------------------- 1997 1996 1995 ------------------------ ------- ----------- Cash flows from operating activities: Net loss $ (330,257) $ (276,767) $(2,864,219) Adjustments to reconcile net loss to net cash (used) provided by operating activities: Depreciation 277,476 189,042 175,428 Amortization 206,360 358,295 345,533 Bad debt expense -- 18,976 17,096 Provision for warranty reserve 69,300 188,344 137,700 Provision for inventory reserve -- 4,601 17,909 Deferred revenue (93,268) 56,348 152,948 Gain on sale of assets (23,408) -- -- Other non-cash expenses (income) 163,610 (173,281) 24,521 Net change in assets and liabilities from discontinued operations (29,821) (184,100) 1,018,324 Changes in operating assets and liabilities, net of effects from acquisition of Golston Company, Inc.: Accounts receivable 153,567 (543,992) 459,212 Inventories 214,586 81,006 (112,328) Restricted cash (46,696) 149,619 (157,851) Other assets (189,744) (109,045) 227,939 Accounts payable (190,509) (344,141) 806,872 Accrued liabilities (276,391) (605,766) 471,762 ----------- ----------- ----------- Net cash (used) provided by operating activities (95,195) (1,190,861) 720,846 ----------- ----------- ----------- Cash flows from investing activities: Purchase of property and equipment (149,549) (96,983) (52,416) Sale of property and equipment 135,953 5,000 -- Intangible assets -- (71,951) -- Capitalized software costs -- -- (245,799) Acquisition of Golston Company, Inc. -- (4,851,406) -- ----------- ----------- ----------- Net cash used by investing activities (13,596) (5,015,340) (298,215) ----------- ----------- ----------- Cash flows from financing activities: Issuance of preferred stock, net -- 687,406 -- Payments on line of credit -- -- (847,317) Issuance of common stock, net 70,875 1,863,487 143,738 Payments on debt and other liabilities (193,277) (1,459,051) (151,373) Proceeds from notes payable and long-term debt 816,291 6,012,545 278,417 Loan origination fees (101,798) (9,950) (1,946) ----------- ----------- ----------- Net cash provided (used) by financing activities 592,091 7,094,437 (578,481) ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents 483,300 888,236 (155,850) Cash and cash equivalents at beginning of period 1,097,891 209,655 365,505 =========== =========== =========== Cash and cash equivalents at end of period $ 1,581,191 $ 1,097,891 $ 209,655 =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-6 31 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"). The operations of Automatic Access Controls, Inc. ("AAC"), a 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. CHANGE IN FISCAL YEAR Effective January 1, 1997, the Company changed its fiscal year end from December 31 to June 30. References to fiscal years 1996 and earlier refer to the twelve months ended December 31 of such year. References to fiscal 1997 refer to the six month transition period ended June 30, 1997. CASH AND CASH EQUIVALENTS Cash is comprised of highly liquid instruments with maturities of three months or less. At June 30, 1997, restricted cash of $54,928 was related to a letter of credit obtained to secure a surety bond. 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. F-7 32 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- INTANGIBLE ASSETS AND AMORTIZATION Goodwill, of $1,818,385 at June 30, 1997, resulted from the acquisitions of TCSI and GCI and is amortized using the straight-line method over periods of ten and twenty years, respectively. Amortization expense for goodwill for the six months ended June 30, 1997 was $52,883. Amortization expense for goodwill for the years ended December 31, 1996 and 1995 was $26,797 and $1,144, respectively. Loan origination fees, of $111,725 at June 30, 1997, were incurred to secure financing. These fees are being amortized using the straight-line method over a period of five years. Amortization expense for the six months ended June 30, 1997 was $6,329. Amortization expense for the years ended December 31, 1996 and 1995 was $0 and $156,319, respectively. Non-compete agreements were executed in conjunction with the GCI acquisition. These are being amortized using the straight-line method over a period of five years. Amortization expense and interest expense for the six months ended June 30, 1997 was $48,993 and $13,406, respectively. There was no amortization expense or interest expense related to such agreements during the years ended December 31, 1996 and 1995. 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". 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 either the time of shipment or by percentage of completion for installations of security systems. 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 during the six months ended June 30, 1997 or the years ended December 31, 1996 and 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". The Company began amortizing its capitalized software costs in 1996 using the straight-line method over a period of five years. Amortization expense for the six months ended June 30, 1997 and the year ended December 31, 1996 was $63,691 and $127,381, respectively. Accumulated amortization at June 30, 1997 and December 31, 1996 was $191,072 and $127,381, respectively. F-8 33 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 six months ended June 30, 1997, $34,464 was recorded as amortization expense. Amortization expense for the years ended December 31, 1996 and 1995 was $68,930 and $57,426, respectively. Accumulated amortization was $202,484 at June 30, 1997 and $168,020 and $99,090, respectively, at December 31, 1996 and 1995. 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 period is computed using the weighted average number of common and common equivalent shares outstanding during the respective periods. In February 1997, the Financial Accounting Standards Board issued Statement of Financing Accounting Standards No. 128, "Earnings Per Share." This statement establishes a new methodology for reporting earnings per share for interim financial information and annual financial statements issued with periods ending after December 15, 1997. For the six months ended June 30, 1997 and the years ended December 31, 1996 and 1995, the pro forma basic and diluted loss per share amounts calculated assuming adoption of this statement would have been the same as the loss per share amounts presented on the consolidated statements of operations. 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. STATEMENTS OF CASH FLOWS Supplemental cash flow information for the six months ended June 30, 1997 and the years ended December 31, 1996 and 1995:
1997 1996 1995 ---- ---- ---- Cash paid for interest expense $344,540 $153,428 $295,469 Cash paid for income taxes $ 10,000 $ 51,866 $ 63,615
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. F-9 34 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- RECLASSIFICATION Certain reclassifications of prior year amounts have been made to conform to the fiscal 1997 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 will receive, as compensation from IST, 85% of the revenue generated from IST's Intelli-Site sales until the partnership has achieved at least a 150% return on its investment. After such time, the partnership will dissolve. 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 June 30, 1997, the partnership had not received any return on its investment. Also, during the year ended December 31, 1996, the Company received $250,000 from the partnership related to the partnership's purchase of sales leads and prospects. 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 was recorded as goodwill, and is being amortized using the straight-line method over a period of 20 years. During the six months ended June 30, 1997, intangible assets related to this acquisition increased by $691,745 to $2,011,373 related to additional acquisition costs and non-compete agreements. 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, which is being amortized using the straight-line method over a period of ten years. F-10 35 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 5. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS The composition of certain balance sheet accounts is as follows:
June 30, December 31, December 31, 1997 1996 1995 ----------- ----------- ----------- Inventories: Raw materials $ 506,539 $ 714,106 $ 586,237 Work-in-process 313,940 267,015 223,052 Finished goods 47,419 105,864 45,599 ----------- ----------- ----------- $ 867,898 $ 1,086,985 $ 854,888 =========== =========== =========== Property and Equipment: Land $ 939,264 $ 905,264 $ 5,264 Building 1,177,168 1,177,168 577,168 Rental Units 2,234,089 2,311,033 -- Leasehold improvements 48,769 48,769 48,769 Office furniture and equipment 767,416 855,002 575,257 Manufacturing equipment 3,048,288 2,952,930 533,167 Vehicles 39,919 48,503 68,304 Construction 153,425 153,425 153,425 ----------- ----------- ----------- 8,408,338 8,452,094 1,961,354 Less: accumulated depreciation (3,129,649) (2,949,810) (893,231) ----------- ----------- ----------- $ 5,278,689 $ 5,502,284 $ 1,068,123 =========== =========== ===========
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 August 15, 1997, has an adjustable factoring fee of 3%, and has a maximum borrowing amount of $1.4 million. At June 30, 1997, $0 of this facility was utilized. At December 31, 1996 and 1995, respectively, $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. On April 11, 1997, the Company secured a $500,000 revolving line of credit facility from an unrelated third party. There are no principal payment requirements on the line of credit; however, interest is due monthly at Citibank's prime rate plus 1.75% based on the average daily borrowings during the prior month. In addition, a fee equal to 1/2% of the line of credit facility is due annually. As of June 30, 1997, the Company had not drawn against this line of credit. F-11 36 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTES PAYABLE Notes payable consists of the following:
June 30, December 31, December 31, 1997 1996 1995 -------- ------------ ------------ 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 to a bank due on June 24, 1996; interest at 11%; secured by second mortgage on real estate -- -- 150,000 Notes 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 to unrelated individual investor; no interest; due in one lump sum payment in January 1997 -- 8,080 -- Note payable, due on April 1, 1996; interest at 3.3% -- -- 7,016 ------ -------- -------- $ -- $ 8,080 $950,947 ====== ======== ========
NOTES PAYABLE TO RELATED PARTIES Notes payable to related parties consists of the following:
June 30, December 31, December 31, 1997 1996 1995 --------- ------- ------- Notes payable to an employee; due in monthly principal and interest installments of $2,412 through March 1997; $ -- $ 7,110 $25,437 interest at 10.53% Note payable to an officer; due upon demand; no interest -- -- 4,000 --------- ------- ------- ======= $ -- $ 7,110 $29,437 ========= ======= =======
F-12 37 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- LONG-TERM DEBT AND OTHER LIABILITIES Long-term debt and other liabilities consists of the following:
June 30, 1997 December 31, 1996 December 31, 1995 ---------------- -------------------- -------------------- Convertible note payable to unrelated funds; 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 ISSI and all subsidiaries. The outstanding balance of the note can be converted into ISSI's common stock based upon $1.05 per share. At June 30, 1997, the Company is not in compliance with the Debt Service Coverage financial standard under this agreement. The Company has obtained a waiver related to this non-compliance $ 4,600,000 $ 4,600,000 $ -- 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 1,434,609 1,500,000 -- Term note payable to a bank; due in monthly principal and interest installments of $12,000 through November 2000; interest at the lender's prime rate less 1% (10% at June 30, 1997 and December 31, 1996); secured by first mortgage on real estate and equipment; personally guaranteed by an officer 834,904 864,865 -- Term note payable to an unrelated third party; due in monthly principal installments of $12,917 plus interest through April 2002; interest at Citibank's Base Rate plus 2% (10.5% at June 30, 1997); secured by certain assets of the Company; guaranteed by ISSI 744,767 -- -- Non-compete agreements to prior owners of GCI; due in equal monthly installments of $8,166 plus interest at 10% through January 2002 440,940 -- -- 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); guaranteed by principal stockholder -- -- 234,365
F-13 38 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------
June 30, 1997 December 31, 1996 December 31, 1995 ------------- ----------------- ----------------- 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 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 30,598 33,692 -- Term note payable to an unrelated third party; interest at Citibank's Base Rate plus 2% (10.5% at June 30, 1997) due in monthly installments through April 2002; no principal installments due until May 1998; secured by equipment 30,422 -- -- Term note payable to a bank; due in monthly principal and interest installments of $497 through April 1999; interest at 9%; secured by equipment 10,453 -- -- 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 ---------- -------------- ------------ 8,126,693 6,998,557 310,350 Less current portion (495,737) (213,975) (96,451) ---------- -------------- ------------ Long-term portion $7,630,956 $ 6,784,582 $ 213,899 ========== ============== ============
F-14 39 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Payments required under long-term debt and other liabilities outstanding at June 30, 1997 are as follows: 1998 $ 495,737 1999 572,301 2000 1,098,431 2001 1,663,537 2002 972,806 Thereafter 3,323,881 ------------ $ 8,126,693 ============
7. INCOME TAXES The income tax provision (benefit) is comprised of the following:
For the For the For the Six Months Ended Year Ended Year Ended June 30, December 31, December 31, 1997 1996 1995 -------- -------- ------- Current: Federal $ -- $ -- $ -- State 7,013 (11,991) 62,102 -------- -------- ------- $ 7,013 $(11,991) $62,102 -------- -------- ------- Deferred: Federal $ -- $ -- $ -- State -- -- -- -------- -------- ------- -- -- -- ======== ======== ======= Tax expense (benefit) $ 7,013 $(11,991) $62,102 ======== ======== =======
A reconciliation of the income tax provision and the amount computed by applying the federal statutory benefit rate to loss before income taxes are as follows:
June 30, December 31, December 31, 1997 1996 1995 -------- ------------ ------------ Federal statutory benefit rate (34%) (34%) (34%) State income tax provision, net of federal tax benefit 2% (4%) 4% Installment sale gain -- -- 2% Net operating loss not benefited 32% 24% 31% Non-deductible amortization and other 2% 10% 1% === === === 2% (4%) 4% === === ===
F-15 40 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 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: June 30, 1997 December 31, 1996 December 31, 1995 ------------- ----------------- ----------------- Amortization $ (188,372) $ (213,196) $ (39,915) Depreciation (1,994) (964) -- ----------- ----------- ----------- Gross deferred tax liability (190,366) (214,160) (39,915) ----------- ----------- ----------- Non-compete covenant 14,711 -- -- Litigation reserve -- 6,047 57,120 Depreciation -- -- 3,343 Warranty reserve 37,830 31,609 24,733 Bad debt reserve 40,131 43,855 49,970 Net operating loss carryforward 2,278,571 2,205,531 1,895,091 ----------- ----------- ----------- Gross deferred tax asset 2,371,243 2,287,042 2,030,257 ----------- ----------- ----------- Net deferred tax asset 2,180,877 2,072,882 1,990,342 Valuation allowance (1,975,493) (1,867,498) (1,784,958) ----------- ----------- ----------- Net deferred tax asset $ 205,384 $ 205,384 $ 205,384 =========== =========== ===========
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 an unused net operating loss carryforward of $6.7 million at June 30, 1997. At December 31, 1996 and 1995, the Company had unused net operating loss carryforwards of $6.5 million and $5.6 million, respectively. These carryforwards begin to expire in the year 2007. The Company increased the valuation allowance each year 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. 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 fiscal years subsequent to June 30, 1997 under capital and non-cancelable operating leases are as follows:
Operating Leases ---------------- 1998 $40,352 1999 12,331 2000 7,133 2001 -- 2002 -- ------- Total minimum payments $59,816 =======
Rent expense for operating leases was $46,360 for the six months ended June 30, 1997. For the years ended December 31, 1996 and 1995, rent expense for operating leases was $103,253 and $85,836, respectively. Under a five year license agreement dated March 16, 1993, the Company has committed to pay DesignTech, Inc. a royalty of 1% of revenues derived from products using the licensed technology. To date, no royalties have been paid. F-16 41 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 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 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. The unamortized balance was $47,516 at June 30, 1997. At December 31, 1996 and 1995, the unamortized balance was $81,980 and $150,910, respectively. 10. DISCONTINUED OPERATIONS During the second quarter of 1995, the Company adopted a plan to discontinue the operations of AAC. 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. At June 30, 1997, current assets and current liabilities related to this action were not material. Current assets and current liabilities totaled $25,760 and $49,252, respectively, at December 31, 1996 and $76,807 and $332,866, respectively, at December 31, 1995. Where appropriate, the financial statements reflect the operating results and balance sheet items of the discontinued operations separately from continuing operations. Prior years have been restated. Operating results for the discontinued operations were:
For the For the Six Months Ended Year Ended June 30, December 31, -------- ---------------- 1997 1996 1995 -------- ----- ------ ($ in thousands) Operating Revenue -- -- $ 1,389 Loss from Operations -- -- $ (720) Loss Per Share -- -- $ (.30)
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 during the six months ended June 30, 1997 or the years ended December 31, 1996 and 1995. F-17 42 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 12. STOCK OPTIONS AND WARRANTS STOCK OPTIONS Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("FAS 123") was implemented in January 1996. As permitted by FAS 123, ISSI retained its prior method of accounting for stock compensation. As required by FAS 123, 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 during the six months ended June 30, 1997: no dividend yield, expected volatility of approximately 84%, risk-free interest rates of approximately 6.5%, and expected lives of approximately 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):
For the Six Months Ended For the Year Ended For the Year Ended June 30, 1997 December 31, 1996 December 31, 1995 ------------------------ ------------------ --------------------- As Pro As Pro As Pro reported forma reported forma reported forma ---------- -------- ------- -------- --------- --------- Net Loss $ (330) $ (368) $ (276) $ (307) $ (2,864) $ (2,874) Loss per Common Share $ (.05) $ (.05) $ (.05) $ (.05) $ (.71) $ (.71)
The effects of applying FAS 123 in this pro forma disclosure are not indicative of future amounts as FAS 123 does not apply to awards prior to 1995 and as additional awards are anticipated in future years. 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 1993 Stock Option 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. In May 1997, the Company established the 1997 Omnibus Stock Plan (the "Omnibus Plan") which provides for the grant of incentive stock options ("ISO's") within the meaning of the Internal Revenue Code, non-statutory stock options ("NSO's"), stock appreciation rights ("SAR's"), awards of stock ("Awards") and stock purchase opportunities ("Purchase Rights") to directors, employees and consultants of the Company and its present and future subsidiaries. The Omnibus Plan will remain in effect until May 1, 2007, subject to the Board's right to terminate it earlier. Under the Omnibus Plan, ISO's may only be granted to employees or directors of the Company; NSO's, SAR's, Awards and Purchase Rights may be granted to any director, employee or consultant of the Company. Recipients of ISO's, Awards and Purchase Rights are selected by the Compensation Committee. F-18 43 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- A summary of stock option transactions is as follows (share amounts in thousands):
For the Six Months Ended For the Year Ended For the Year Ended June 30, 1997 December 31, 1996 December 31, 1995 ------------------------ ------------------ ------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- -------- --------- -------- ------ ---------- Outstanding at beginning of period 874 $ 2.01 738 $ 2.21 687 $ 2.20 Granted 75 1.63 188 1.22 115 2.07 Forfeited (21) 2.02 (52) 1.95 (64) 1.90 --- -------- --- -------- --- -------- Outstanding at end of period 928 $ 1.98 874 $ 2.01 738 $ 2.21 === ======== === ======== === ======== Exercisable at end of period 721 $ 2.11 663 $ 2.18 556 $ 2.26 Weighted-average fair value of options granted during the period $ 1.14 $ 1.06 $ 1.40
The following table summarizes information about the fixed-price stock options outstanding at June 30, 1997 (share amounts in thousands):
Options Outstanding Options Exercisable ----------------------------------------- --------------------------------- Range of Shares Weighted-Average Weighted- Shares Weighted- Exercise Outstanding Remaining Average Exercisable Average Prices at 6/30/97 Contractual Life Exercise Price At 6/30/97 Exercise Price -------------- -------------- --------------------- ------------------ -------------- ----------------- $0.687-1.50 206 8.8 years $1.11 85 $1.05 $1.563-2.50 711 7.6 years 2.22 631 2.25 $2.719-3.53 11 9.6 years 2.74 5 2.72 -------------- -------------- 928 $1.98 721 $2.11 ============== ==============
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 underwriter, Thomas James Associates, Inc. ("Underwriter"). As of June 30, 1997, 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 of the underlying common stock. On June 17, 1996, the Company repriced these warrants to $4.15 due to obligations under the original warrant agreement. The holders are also now entitled to purchase 1.6 shares of common stock per warrant held. Again, on January 15, 1997, these warrants were repriced to $3.17 under the same obligation and the holders are now entitled to purchase 2.1 shares of common stock per warrant held. F-19 44 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Also, in connection with the initial public offering, the Company issued a warrant to the Underwriter 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 of the underlying common stock. 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 per warrant held. 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 per warrant held. 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 June 30, 1997, 33,000 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 June 30, 1997, 108,800 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 $13,201 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. 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. The Company issued warrants to purchase 111,000 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, and 2002. Value was assigned to these warrants totaling $40,000 which was expensed in 1996 and $45,000 which was expensed in 1997. During 1997, the Company issued warrants for consulting and director fees to purchase 21,334 shares of common stock at an exercise price of $.01. Value was assigned to these warrants totaling $35,000 and was expensed in 1997. F-20 45 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- A summary of warrant transactions is as follows (share amounts in thousands):
For the Six Months Ended For the Year Ended For the Year Ended June 30, 1997 December 31, 1996 December 31, 1995 ----------------------------- ------------------------ ------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------- -------------- --------- ----------- ---------- ----------- Outstanding at beginning of period 4,253 $3.03 2,218 $3.38 2,296 $3.32 Granted 66 1.63 1,590 1.05 60 .13 Exercised (68) .60 (599) .87 (138) 1.01 Repriced 870 3.14 1,044 4.04 -- -- ----------- --------- ---------- Outstanding at end of period 5,121 $3.07 4,253 $3.03 2,218 $3.38 =========== ========= ========== Exercisable at end of period 5,008 $3.08 4,199 $3.03 2,218 $3.38 Weighted-average fair value of warrants granted during the period $.93 $1.57 $.76
The following table summarizes information about the warrants outstanding at June 30, 1997 (share amounts in thousands):
Warrants Outstanding Warrants Exercisable ----------------------------------------- ------------------------------- Range of Shares Weighted-Average Weighted- Shares Weighted- Exercise Outstanding Remaining Average Exercisable Average Prices at 6/30/97 Contractual Life Exercise Price at 6/30/97 Exercise Price -------------- -------------- --------------------- ------------------ -------------- ----------------- $ .01-1.00 1,114 3.0 years $ .95 1,114 $ .95 $1.06-2.00 222 2.87 years 1.49 222 1.49 $2.40-4.15 3,785 2.0 years 3.78 3,672 3.82 ------------ ---------- 5,121 $3.07 5,008 $3.08 ============ ==========
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 13,750 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 F-21 46 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 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 34,166 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 currently has outstanding 3,500 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. F-22 47 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Golston Company, Inc. In our opinion, the accompanying balance sheets and the related statements of operations and stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Golston Company, Inc. at June 30, 1996 and 1995, and the results of its operations and its 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 September 30, 1996 F-23 48 GOLSTON COMPANY, INC. BALANCE SHEETS
June 30, --------------------------- 1996 1995 ------------ ---------- ASSETS Current assets: Cash and cash equivalents $ 124,901 $ 255,302 Accounts receivable 481,045 357,070 Interest receivable from related party 42,329 -- Inventories 409,839 508,724 Other current assets 61,216 36,306 ---------- ---------- Total current assets 1,119,330 1,157,402 Property and equipment, net 2,048,720 1,836,652 Intangible assets, net 3,833 4,500 Note receivable from related party 671,824 -- Other assets 150 1,560 ---------- ---------- Total assets $3,843,857 $3,000,114 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 45,090 $ 8,908 Accrued liabilities 169,576 208,630 Deferred revenue 135,515 144,267 Current portion of long-term debt 170,624 120,084 ---------- ---------- Total current liabilities 520,805 481,889 ---------- ---------- Long term liabilities: Deferred tax liability 148,504 112,923 Long-term debt 594,857 464,965 ---------- ---------- Total long term liabilities 743,361 577,888 ---------- ---------- Stockholders' equity: Common stock, $1.00 par value, 100,000 shares authorized, 1,000 shares issued and outstanding 1,000 1,000 Retained earnings 2,578,691 1,939,337 ---------- ---------- Total stockholders' equity 2,579,691 1,940,337 ---------- ---------- Total liabilities and stockholders' equity $3,843,857 $3,000,114 ========== ==========
The accompanying notes are an integral part of the financial statements. F-24 49 GOLSTON COMPANY, INC. STATEMENTS OF OPERATIONS
For the Year Ended June 30, ------------------------------ 1996 1995 ------------ ------------ Sales and revenues: Product sales $ 2,203,029 $ 2,074,110 Service revenues 1,688,313 1,492,776 ----------- ----------- 3,891,342 3,566,886 ----------- ----------- Cost of sales and revenues: Product sales 879,572 793,752 Service revenues 666,618 559,161 ----------- ----------- 1,546,190 1,352,913 ----------- ----------- Gross margin 2,345,152 2,213,973 ----------- ----------- Operating expenses: Selling, general and administrative 1,290,244 1,254,421 ----------- ----------- 1,290,244 1,254,421 ----------- ----------- Income from operations 1,054,908 959,552 Other income (expense): Interest income from related party 42,329 -- Interest income 1,997 1,506 Interest expense (86,922) (79,635) Other (23,765) (46,559) ----------- ----------- Income before income taxes 988,547 834,864 Provision for income taxes (349,193) (298,120) ----------- ----------- Net income $ 639,354 $ 536,744 =========== ===========
The accompanying notes are an integral part of the financial statements. F-25 50 GOLSTON COMPANY, INC. STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK RETAINED SHARES AMOUNT EARNINGS TOTAL --------- ----------- ------------ ------------ Balances at June 30, 1994 1,000 $ 1,000 $1,402,593 $1,403,593 Net income 536,744 536,744 ------- -------- ---------- ---------- Balances at June 30, 1995 1,000 $ 1,000 $1,939,337 $1,940,337 Net income 639,354 639,354 ------- -------- ---------- ---------- Balances at June 30, 1996 1,000 $ 1,000 $2,578,691 $2,579,691 ======= ======== ========== ==========
The accompanying notes are an integral part of the financial statements. F-26 51 GOLSTON COMPANY, INC. STATEMENTS OF CASH FLOWS
For the Year Ended June 30, -------------------------- 1996 1995 ----------- --------- Cash flows from operating activities: Net income $ 639,354 $ 536,744 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 214,047 175,130 Amortization 667 667 Deferred income taxes 35,581 7,445 Changes in operating assets and liabilities: Accounts receivable (123,975) (32,638) Inventories 98,885 (45,470) Other assets (23,500) (3,855) Accounts payable 36,182 (54,687) Accrued liabilities (39,054) (86,651) Deferred revenue (8,752) 37,430 ----------- --------- Net cash provided by operating activities 829,435 534,115 ----------- --------- Cash flows from investing activities: Purchase of property and equipment (426,115) (206,941) Loan to related party (671,824) -- Interest receivable from related party (42,329) -- ----------- --------- Net cash used by investing activities (1,140,268) (206,941) ----------- --------- Cash flows from financing activities: Payments on notes payable and long-term debt (169,608) -- Proceeds from notes payable and long-term debt 350,040 (201,423) ----------- --------- Net cash provided (used) by financing activities 180,432 (201,423) ----------- --------- Increase (decrease) in cash and cash equivalents (130,401) 125,751 Cash and cash equivalents at beginning of year 255,302 129,551 ----------- --------- Cash and cash equivalents at end of year $ 124,901 $ 255,302 =========== =========
The accompanying notes are an integral part of the financial statements. F-27 52 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 1. ORGANIZATION AND DESCRIPTION OF BUSINESS Golston Company, Inc. ("Golston" or the "Company") was founded in 1976 and incorporated as a Texas corporation in 1979. Its primary business has been to design, manufacture, and supply pneumatic tube carriers to the financial industry for use in the retail drive-up banking centers for commercial banks, savings and loans, and credit unions. More recently, the Company has expanded its pneumatic tube carrier business to the medical services industry, supplying a proprietary line of carriers to hospitals and other medical facilities. The Company distributes its products through sales to original equipment manufacturers of pneumatic carrier systems, to dealers and distributors, and, through telemarketing, directly to end-users. The Company's sales are primarily to the banking and hospital industries. Sales are dependent on customer orders and requests. 2. SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS Cash and cash equivalents is comprised of highly liquid instruments with maturities of three months or less. 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 financial and medical services industries. Based on management's analysis of accounts receivable, including consideration of the Company's historical collection experience, no allowance for doubtful accounts is necessary at June 30, 1996 or 1995. During 1996 and 1995, respectively, a single customer accounted for greater than 10% of the Company's revenues ($600,000 and $650,000). The Company records deferred revenue related to a service to provide the use of temporary facilities in the event of a disaster by the retail banking industry. Revenues related to these services is recognized ratably over the term of the agreement. INVENTORIES Inventories consist of the costs of raw materials, work-in-process and finished goods and are carried at the lower of cost using the first-in, first-out method or market. Labor and overhead costs are allocated to work-in-process and finished goods inventories based on total labor and overhead costs divided by the number of units produced. OTHER ASSETS Other assets consist of certain prepaid expenses and the cash value of a life insurance policy for an officer of the Company. The cash value of the policy was $35,822 and $32,618 at June 30, 1996 and 1995, respectively. 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 method. Estimated useful lives range from 3 to 20 years. F-28 53 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- INTANGIBLE ASSETS AND AMORTIZATION Goodwill resulting from the acquisition of MPA Systems ("MPA") in 1987 is amortized using the straight-line method over a period of fifteen years. Goodwill amortization for the years ended June 30, 1996 and 1995, was $667 and $667, respectively. Accumulated amortization at June 30, 1996 and 1995 was $6,167 and $5,500, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values of the Company's accounts receivable, notes receivable, accounts payable, and long-term debt approximate the fair values of such financial instruments. 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 June 30:
1996 1995 ---- ---- Cash paid for interest expense $ 86,922 $ 70,728 Cash paid for income taxes $391,013 $311,904
F-29 54 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 3. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS The composition of certain balance sheet accounts is as follows at June 30:
1996 1995 ----------- ----------- Inventories: Raw materials $ 40,046 $ 94,686 Work-in-process 250,491 253,156 Finished goods 119,302 160,882 ----------- ----------- $ 409,839 $ 508,724 =========== =========== Property and Equipment: Building and leasehold $ 509,273 $ 509,273 Automotive 5,477 14,060 Machinery and equipment 1,198,166 1,166,459 Office equipment 112,060 109,676 MPA Equipment and fixtures 62,686 48,823 MPA Units 1,320,275 917,067 MPA Unit in construction -- 16,590 Molds in progress 3,769 3,642 ----------- ----------- 3,211,706 2,785,590 Less: accumulated depreciation (1,162,986) (948,938) ----------- ----------- $ 2,048,720 $ 1,836,652 =========== =========== Accrued liabilities: Federal income taxes payable $ 91,218 $ 154,407 Accrued compensation 42,342 12,185 Customer damage deposits 23,060 24,145 Other 12,956 17,893 ----------- ----------- $ 169,576 $ 208,630 =========== ===========
55 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 4. LONG-TERM DEBT Long-term debt consists of the following at June 30:
1996 1995 --------------- --------------- Term note payable to a bank; due in monthly principal and interest installments of $7,397 through February 2000; interest at 10.24% at June 30, 1996 and 1995; secured by equipment; guaranteed by principal stockholder $ 207,364 $ 269,429 Term note payable to a bank; due in monthly principal and interest installments of $1,945 through April 1999; interest at 11.31% at June 30, 1996 and 1995; secured by equipment; guaranteed by principal stockholder 58,301 74,066 Term note payable to a bank; due in monthly principal and interest installments of $1,673 through October 2002; interest at the lender's prime rate plus 1% (10.25% at June 30, 1996); secured by buildings; guaranteed by principal stockholder 93,259 -- Term note payable to a bank; due in monthly principal and interest installments of $1,673 through October 2002; interest at the lender's prime rate plus 1% (10.25% at June 30, 1996); secured by buildings; guaranteed by principal stockholder 93,259 -- Term note payable to a bank; due in monthly principal and interest installments of $1,669 through November 2002; interest at the lender's prime rate plus 1% (10.25% at June 30, 1996); secured by buildings and accounts receivables; guaranteed by principal stockholder 92,843 -- Term note payable to a bank; due in monthly principal and interest installments of $7,448 through July 1998; interest at the lender's prime rate plus .5% (10.5% at June 30, 1996 and 9.87 % at June 30, 1995); secured by buildings; guaranteed by principal stockholder 171,204 241,554 Term note payable to a bank; due in monthly principal and interest installments of $825 through April 2003; interest at the lender's prime rate plus 1% (10.25% at June 30, 1996); secured by buildings; guaranteed by principal stockholder 49,251 -- --------------- --------------- 765,481 589,049 Less current portion (170,624) (120,084) --------------- --------------- Long-term portion $ 594,857 $ 464,965 =============== ===============
F-31 56 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Payments required under all long-term debt outstanding at June 30, 1996 are as follows:
Fiscal years ended June 30: 1997 $ 170,624 1998 209,206 1999 141,279 2000 101,213 2001 57,478 Thereafter 85,681 -------------- $ 765,481 ==============
5. INCOME TAXES The income tax provision is comprised of the following:
1996 1995 -------- -------- Current: Federal $295,218 $290,675 State 18,394 -- -------- -------- $313,612 $290,675 -------- -------- Deferred: Federal $ 35,581 $ 7,445 State -- -- -------- -------- 35,581 7,445 -------- -------- Tax expense $349,193 $298,120 ======== ========
A reconciliation of the income tax provision and the amount computed by applying the federal statutory tax rate to income before income taxes is as follows:
1996 1995 --------- -------- Tax expense at federal statutory rate $ 345,991 $292,202 State income tax provision, net of federal tax benefit 12,140 -- Permanent differences 4,037 1,380 Other (12,975) 4,538 --------- -------- $ 349,193 $298,120 ========= ========
F-32 57 GOLSTON COMPANY, INC. NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- 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 June 30, 1996 and 1995:
1996 1995 --------- --------- Gross deferred tax liability - Depreciation $(226,472) $(173,166) --------- --------- Inventory 21,693 11,193 Deferred income 46,075 49,050 Bonus Accrual 10,200 -- --------- --------- Gross deferred tax asset 77,968 60,243 Valuation allowance -- -- --------- --------- Net deferred tax liability $(148,504) $(112,923) ========= =========
6. CONTINGENCIES An officer of the Company has alleged that the Company has breached an oral agreement to sell the Company to the officer and has asserted a claim for emotional distress. The Company is disputing these claims. Management believes that the maximum loss contingency is immaterial. 7. RELATED PARTY TRANSACTIONS During the fiscal year ended June 30, 1996, a note receivable in the amount of $671,824 resulted from a transaction between the Company and Golston Family Partners Ltd. for the purpose of Golston Family Partners Ltd. purchasing the MPA Modular, L.L.C. manufacturing business. The Company's shareholder and President owns an interest in Golston Family Partners Ltd. and MPA Modular, L.L.C. Accrued interest receivable of $42,329 is recorded at June 30, 1996. The note bears interest at 10.25% and is scheduled for repayment, including accrued interest, upon the sale of Golston. The note is unsecured. 8. PENDING SALE OF COMPANY The Company's Board of Directors has approved the sale of the Company to Integrated Security Systems, Inc. ("ISSI") effective October 24, 1996. ISSI is purchasing all of the stock of the Company and the real estate and property currently leased by the Company from Golston Family Partners Ltd. These financial statements do not reflect any adjustments arising from this pending acquisition. F-33 58 GOLSTON COMPANY, INC. CONSOLIDATED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 1996 ($ IN THOUSANDS) (UNAUDITED) Sales $ 2,084 Cost of sales 902 ------------ Gross margin 1,181 Operating expenses: Selling, general and administrative 726 ------------ Income from operations 455 Other income (expense) (2) ------------ Income before income taxes 453 Income tax provision (150) ------------ Net income $ 303 ============
Note: These financial statements have been prepared on a consistent basis with the June 30, 1996 and June 30, 1995 financial statements. F-34 -----END PRIVACY-ENHANCED MESSAGE-----