-----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, JxOPShcbmwS0k/VIeJ3YhGw4ZefEFko2EJv7Bbje/v4lBCG7gB1OtpMPD6bmGpQV e6TSQdTO4aaNApgxWA4a/w== 0000950134-98-008062.txt : 19981014 0000950134-98-008062.hdr.sgml : 19981014 ACCESSION NUMBER: 0000950134-98-008062 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19981013 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: 10KSB SEC ACT: SEC FILE NUMBER: 001-11900 FILM NUMBER: 98724695 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 10KSB 1 FORM 10-KSB FOR FISCAL YEAR END JUNE 30, 1998 1 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-KSB /X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Fee Paid). / / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required). For Fiscal Year Ended June 30, 1998 Commission File Number: 1-11900 INTEGRATED SECURITY SYSTEMS, INC. -------------------------------- (Exact Name of Small Business Issuer as Specified in its Charter) Delaware 75-2422983 ---------------- ------------------------ (State of Incorporation) (I.R.S. Employer Identification No.) 8200 SPRINGWOOD DRIVE, SUITE 230, IRVING, TEXAS 75063 (972) 444-8280 (Address including zip code, area code and telephone number of Registrant's executive offices.) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered - ------------------- ----------------------------------------- Common stock, $.01 par value Boston Stock Exchange Nasdaq
Securities registered pursuant to Section 12(g) of the Act: None Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. / / Issuer's revenues for its most recent fiscal year: $11,092,307 As of September 23, 1998, 8,475,808 shares of the Registrant's common stock were outstanding and 1,450,000 warrants were outstanding. State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within the past 60 days: as of September 23, 1998, $7,950,308. This amount was computed by reference to the average close price of Registrant's common stock. 2 TABLE OF CONTENTS
Item No. Page - ------- ---- Part I ------ 1. Description of Business 3-6 2. Description of Properties 6-7 3. Legal Proceedings 7 Part II ------- 5. Market for Company's Common Equity and Related Stockholder Matters 7-9 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-14 7. Financial Statements 15-40 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 41 Part III -------- 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act 41 10. Executive Compensation 41 11. Security Ownership of Certain Beneficial Owners and Management 41 12. Certain Relationships and Related Transactions 41 Part IV ------- 13. Exhibits, Lists and Reports on Form 8-K 41-46
2 3 PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL Integrated Security Systems, Inc. ('ISSI' or 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 manufactures pneumatic tube carriers for financial and healthcare transport systems and fabricates modular buildings for financial institutions. 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. 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 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. 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. References to fiscal 1998 refer to the twelve months ended June 30, 1998. 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. 3 4 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 hydraulic gate operators and aluminum gate panels which it sells to distributors and directly to national accounts. 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 orders range from $1,000 to $12,000 with delivery times ranging from less than a week to several weeks depending upon whether the order is for standard products or requires custom design work. Perimeter security products are also integrated into Intelli-Site systems and resold as a subsystem by Innovative Security Technologies, Inc. ('IST') to its clients. RAILROAD: B&B ELECTROMATIC, INC. ('B&B') B&B manufactures railroad crossing safety barriers and warning gates. The warning gates are similar to those commonly seen at railroad grade crossings. The model VT-6802 safety barrier is a recently developed and tested product. It is a moveable positive-resistance barrier gate which eliminates collisions at highway-railroad crossings by preventing intrusions onto the railroad right-of-way. The premiere installation of the new safety barrier is scheduled for completion in early November 1998 at a Wisconsin and Southern Railroad Company grade crossing in Madison, Wisconsin. 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 expand its sales activities to include leveraged channel distribution as well as its own direct sales force. IST's strategy is to exploit industry outsourcing trends by promoting sales of its proprietary Intelli-Site integrated turnkey system to end users through multiple distribution channels. 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 subsystem (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 within its industry with these features. 4 5 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. Costs for custom-designed systems may be $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. On October 2, 1998, Innovative Security Technologies, Inc. was renamed Intelli-Site, Inc. PNEUMATIC CARRIERS: GOLSTON COMPANY, INC. ('GCI') GCI's primary business is the design, manufacture and marketing of pneumatic tube carriers for use in financial institutions and hospitals through its plastic injection molding operations. GCI also manufactures and markets modular buildings for financial institutions for use during new branch construction or existing facility remodeling. WARRANTY The Company has two-year and 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 $2.6 million at September 30, 1998. The Company expects that the majority of this backlog will be filled during fiscal 1999 and the first quarter of fiscal 2000. INTELLECTUAL PROPERTY On March 16, 1993, the Company entered into an agreement with COMTRAC Corporation ('CTC') that granted 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 EFT 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. 5 6 Also on March 16, 1993, the Company entered into an agreement with DesignTech, Inc. ('DTI') that granted 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 was to pay DTI a royalty of 1% of the Company's total gross revenues derived from products using the licensed technology. The royalty was to decline to 0.25% for cumulative gross revenues exceeding $20,000,000. No royalties were paid under this agreement that terminated March 16, 1998. PRODUCT DESIGN AND DEVELOPMENT There are currently two employees of the Company and one contracted consultant dedicated to research, development and product engineering. During fiscal 1996, 1997 and 1998, the Company spent approximately $152,239, $34,138 and $246,443 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 a standard product system, the design of a custom system, or multiple side-by-side systems, to meet their requirements. System integrators bid these design contracts not only for the design effort but also to place themselves in a most favored position to become the prime contractor during the implementation phase. During the design phase, system integrators survey the market for components of the specified system and define how they can be integrated together. Finally, if awarded the implementation phase, the system integrator acts as a prime contractor and subcontracts the component suppliers, and supervises the integration. Depending on the contract, the Company will either become a subcontractor for the majority of the systems or bid the project as a vertically integrated system integrator and prime contractor. By combining both the first and second phase into a proposal from a single vendor, the Company eliminates several third party profit tiers and can reduce the time and overall costs to the customer. The Company faces intense competition in the security industry. Certain of the Company's competitors are large, well-financed and established companies that have greater name recognition and resources for research and development, manufacturing and marketing than the Company has and, therefore, may be better able than the Company to compete for a share of the market. EMPLOYEES As of June 30, 1998, the Company employed 106 people, all in full-time positions. None of the Company's employees are subject to collective bargaining agreements. The Company believes that relations with its employees are good. ITEM 2. DESCRIPTION OF PROPERTIES B&B owns its manufacturing and office facility in Norwood, Louisiana. This facility consists of approximately 26,000 square feet of manufacturing and office space on five acres of land. GCI owns its manufacturing and office facility in Sanger, Texas. This facility consists of approximately 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, 2000, with monthly rent of $9,561, plus the costs of utilities, property taxes, insurance, repair/maintenance expenses and common area utilities. 6 7 The Company believes that the properties, equipment, fixtures and other assets of the Company located within the Company's facilities are adequately insured against loss, that suitable alternative facilities are readily available if the lease agreements described above are not renewed, and that its existing facilities are adequate to meet current requirements. ITEM 3. LEGAL PROCEEDINGS GCI, a wholly owned subsidiary of the Company, is a party to a lawsuit filed in the 211th Judicial District Court of Denton County, Texas on September 13, 1996, entitled S. WEBB GOLSTON AND GOLSTON COMPANY V. EVELYN SHAW, CAUSE NO. 96-30642-211. In this suit, a former employee of GCI has alleged sexual harassment, sexual discrimination, wrongful discharge, and intentional infliction of emotional distress, breach of contract, and violations of the Equal Pay Act against GCI and the former owner of GCI. Plaintiff sought 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. Pursuant to the terms of the acquisition agreement, the former owner has elected 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. In September 1998, summary judgement was granted for defendants with regard to the sexual harassment, intentional infliction of emotional distress, and breach of contract claims. As a result, all potential claims for punitive damages have been dismissed. To date, no information has become available that causes the Company to believe there is any potential liability which is not fully covered by the indemnification agreement with the former owner. PART II ITEM 5. MARKET FOR COMPANY'S COMMON STOCK 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.' As of June 30, 1998, there were 8,475,808 shares of Common Stock outstanding and 1,450,000 warrants outstanding entitling holders to purchase 3,842,500 shares of Common Stock. The shares of Common Stock are held of record by approximately 87 holders and the warrants are held of record by approximately 50 holders. The following table sets forth, for the periods indicated, the high and low bid quotations for the Common Stock on the Nasdaq Small Cap Market. Trading prices for the Common Stock 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. 7 8 Common Stock
$ High $ Low ------ ----- Fiscal 1998 First Quarter 3 1 1/4 Second Quarter 2 1/4 1 Third Quarter 1 5/16 19/32 Fourth Quarter 1 25/32 9/16 Fiscal 1997 First Quarter 3 1/2 1 3/16 Second Quarter 2 3/16 1 1/4 Fiscal 1996 First Quarter 2 13/16 5/8 Second Quarter 5 7/8 2 1/16 Third Quarter 3 1/2 1 13/16 Fourth Quarter 3 5/8 2 3/8
On October 1, 1998, the last reported sales prices for the Common Stock as reported on the Nasdaq Small Cap Market was $.94. The following table specifies securities sold by the Registrant within the past three years and not registered under the Securities Act of 1933. All such sales were carried out in reliance on the exemption from registration contained in Section 4(2) of the Securities Act of 1933. In relying on such exemption, the Registrant relied upon written representations of the persons acquiring the Registrant's shares that they were acquiring the shares for investment purposes only and not for resale, and that they had received adequate opportunity to obtain information, and had reviewed such information, regarding the Registrant. Certificates representing the shares issued to these persons contained a legend restricting transfer thereof absent registration under the Securities Act or the availability of an exemption therefrom.
UNDERWRITING TITLE AND AMOUNT OF CONSIDERATION DISCOUNTS OR DATE SOLD SECURITIES PURCHASER RECEIVED COMMISSIONS PAID - --------- ------------------- --------- ------------- ----------- September-November Promissory Notes and warrants Accredited bridge An aggregate of 1994 to purchase 211,800 shares of financial investors $1,059,000 Common Stock October 1995- Warrants to purchase 105,677 A group of 9 investors Extension of loan March 1996 shares of Common Stock terms December 1995 45,000 shares of Common Stock Managerial Resources, Financial advisory and warrants to purchase 28,000 Inc. and Steffany Lea services shares of Common Stock Martin January 1996 34,168 Series B Convertible A group of 11 Conversion of an Preferred Stock and warrants to accredited investors aggregate of $683,000 purchase 136,669 shares of primarily consisting of owed by the Company Common Stock officers and directors January 1996 Warrants to purchase 13,201 Philip R. Thomas Consulting services shares of Common Stock March 1996 Warrants to purchase 326,000 Bathgate McColley Investment banking shares of Common Stock Capital Group LLC fees March 1996 Warrant to purchase 100,000 ComVest Partners Placement Agent fee shares of Common Stock
8 9
March 1996 15,000 shares of Common Stock Louis A. Davis Shares of TCSI March 1996 15,000 shares of Common Stock Henry E. McGuffee Shares of TCSI March 1996 15,000 shares of Common Stock Michael A. Richmond Shares of TCSI March 1996 800,000 Shares of Common Stock Seabeach & Co. $800,000 $40,000 and warrants to purchase 320,000 shares of Common Stock March-May 1996 47,968 Series A Convertible A group of 38 $640,000 $78,000 Preferred Stock and warrants to accredited investors purchase 381,344 shares of Common Stock June 1996 12,500 Series C Convertible A group of 5 investors $250,000 Preferred Stock and warrants to including an officer purchase 187,500 shares of and director Common Stock July-September 1996 Warrant to purchase 70,000 I.S.T. Partners, Ltd. R&D Partnership shares of Common Stock December 31, 1996 Convertible Debentures (9%) Renaissance Capital Fund $4,600,000 December 31, 1996 600,000 shares of Common Stock ProFutures Special $600,000 $60,000 Equity Fund
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. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL 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 fabricates 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 Group, a private investment fund. During fiscal 1997, the Company recorded additional acquisition costs and non-compete agreements of $691,745. In October 1998, the Company sold the modular building portion of this business for $2.8 million, comprised of cash and $680,000 in notes. A portion of the cash proceeds will be used to retire debt. 9 10 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. References to fiscal 1998 refer to the twelve months ended June 30, 1998. 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. GOING CONCERN MATTERS The Company has suffered recurring losses from operations and its dependence on obtaining financing or additional equity capital raises substantial doubt about its ability to continue as a going concern. The financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustment that might result from the outcome of this uncertainty. Historically the Company's manufacturing subsidiaries have generated positive returns. During fiscal 1998, one of the manufacturing facilities experienced a business downturn, resulting in a loss for fiscal 1998 that is not expected to be repeated in future periods. The Company anticipates that it will continue to experience losses from the launching of the Intelli-Site product, but these losses should begin to lessen as revenues are recognized from sales. 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 funded the sales, engineering and order fulfillment expenses of IST to the extent of available funds. 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, 1998, 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. RESULTS OF OPERATIONS YEAR ENDED JUNE 30, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1996 SALES. The Company's sales increased by $2 million (23%) from $9 million during the twelve months ended December 31, 1996 to $11 million during the twelve months ended June 30, 1998. The increase was primarily attributable to the inclusion of GCI, acquired on December 31, 1996, for the twelve months ended June 30, 1998, with no equivalent revenue during the comparable 1996 period. Also contributing to the increase were sales at TCSI and IST during the twelve months ended June 30, 1998, resulting from contracts and increased business. For the twelve months ended June 30, 1998, approximately 83% of the Company's revenues were generated from the sale of products manufactured by the Company compared to 78% for the comparable twelve month period during 1996. 10 11 COST OF SALES AND GROSS MARGIN. Gross margin as a percent of sales decreased to 39% from 43% for the twelve months ended June 30, 1998 and December 31, 1996, respectively. The majority of the decrease was due to a less favorable product mix at B&B compared to the 1996 year. The TCSI subsidiary also contributed to the lower gross margin due to the completion of a large job with lower than normal margins. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses increased to $6.4 million during the twelve months ended June 30, 1998 from $3.8 million during the comparable 1996 period. The increase was attributable to the Company absorbing all of the sales and marketing expenses of IST during the 1998 period and the inclusion of GCI expenses during the twelve months ended June 30, 1998. RESEARCH AND DEVELOPMENT. Research and development expenses increased from $152,239 in fiscal 1996 to $246,433 in fiscal 1998. This increase was due to additional development of the Company's Intelli-Site products and increased testing and design of new products at B&B. INTEREST EXPENSE. Interest expense increased to $863,768 during the twelve months ended June 30, 1998 from $260,471 during the comparable 1996 period due to the financing related to the acquisition of GCI and the addition of a revolving credit facility put into place at GCI. GAIN ON SALE OF ASSETS. The Company recorded a $20,677 gain on the sale of assets during the twelve months ended June 30, 1998, 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 an anticipated trend toward Company operating results of 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 and railroad products; (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. The Company also anticipates a gain on the October, 1998 sale of a business unit of GCI (MPA Systems). This, 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 profitability. Notwithstanding the above positive factors, the Company has adopted a conservative posture by providing a valuation reserve of 94% of the deferred tax asset as of June 30, 1998. 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. 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. 11 12 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 1996 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 $108,611 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 Intelli-Site, as well as the addition of GCI. These factors, coupled with the current growth of the security industry, were considered positive factors in this assessment. Since the net operating loss carry forward does not begin to expire until 2007, the Company anticipates that all recognized carry forward benefits will be fully utilized before this expiration date arrives. As there are no significant temporary differences in the Company's tax calculation, realization will be primarily achieved by increased profitability. The Company anticipates that its move to profitability 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 91% 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. 12 13 LIQUIDITY AND CAPITAL RESOURCES The Company's cash position decreased by $1,270,074 during the fiscal year ended June 30, 1998. The Company used $1,531,971 of cash for operations during this period. Also, during the fiscal year ended June 30, 1998, the Company financed its continuing operations from long-term borrowings of $1,423,197, warrant exercises of $248,775 and operations. The Company used $494,519 to pay principal on indebtedness. Historically, the Company's manufacturing subsidiaries have generated positive cash flow from operations. This positive cash flow, in conjunction with the existing financing facilities, should position the Company to cover its working capital needs for all subsidiaries except IST. Development of distribution channels for Intelli-Site will continue, with a significant portion of future investments being utilized to launch Intelli-Site through the PSA Security Network. PSA, formed in 1974, is a member-owned cooperative of independent security and communications systems integrators and dealers, with over 114 member companies throughout the United States, Canada, Mexico, Latin America and England, that design, install and service electronic security systems and products. PSA members provide products from over 200 manufacturers, selecting the equipment that best meets a specific client's needs. PSA's products and services are marketed by over 475 salesmen, supported by over 1,200 technicians, from over 175 office locations. Training and pre-sales support of the PSA channel and other channels will require sizable expenditures by the Company in time and dollars before significant revenues are realized. To finance these activities, the Company anticipates that it will need to raise additional funds in the upcoming fiscal year through debt, equity or the divestiture of certain assets or a combination of such. CAPITAL EXPENDITURES During the year ended June 30, 1998, the Company acquired $1,004,459 of property and equipment from long-term borrowings and operations and received proceeds of $88,903 from the sale of property during the period. The Company does not anticipate any significant capital expenditures during fiscal 1999. EFFECTS OF INFLATION The Company believes that the relatively moderate rate of inflation over the past few years has not had a significant impact on the Company's sales or operating results. SEASONALITY Historically the Company has experienced seasonality in its business due to fluctuations in the weather. The Company typically experiences a decline in sales and operating results during the quarter ended March 31 due to winter weather conditions. ENVIRONMENTAL MATTERS The Company believes that it is currently 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. 13 14 YEAR 2000 The Year 2000 issue concerns the ability of computer software programs, including the logic contained within embedded chips, to correctly identify and process date-sensitive calculations across and beyond the Year 2000 dateline. This concern is largely a result of programming practices that use a two-digit field to represent the year without other program logic to identify the century. Accordingly, such software may process a year field of '00' as the year 1900 instead of the year 2000. If not identified and replaced or corrected, systems using such software, including systems used by the Company's major customers and supplies, could fail or produce erroneous results such that materially adverse financial results and/or results of operations could occur. The Company believes the products and systems it manufactures to be unaffected by the Year 2000 issue. The Company currently utilizes third-party equipment and software that may be affected by the Year 2000 issue and has begun to assess and address its critical business information and production system regarding the Year 2000 issue for both Information Technology ('IT') and non-IT systems. For IT systems, the Company is continuing the normal replacement of its financial business systems which it expects to complete by June 30, 1999. The replacement projects were scheduled without regard to Year 2000 concerns, but will also address the Year 2000 issue. The implementation of the new business systems, through planned normal business upgrades, is not expected to have a material impact on the Company's financial statements arising from the Year 2000 issue. Based upon the information currently available from the Company's assessment of non-IT systems, the Company does not believe that the costs associated with these Year 2000 activities will have a material adverse effect on the Company's consolidated results of operations or financial position. Internal and external costs specifically associated with Year 2000 issues will be charged to expense as incurred. All such costs are, and will be, funded through cash flows from operations. The Company plans to contact its critical suppliers, major customers and governmental agencies to assess their status for Year 2000 readiness. The ability of such third parties to effectively address Year 2000 issues is outside of the Company's control, and there can be no assurance that the failure of any third party with which the Company transacts business to adequately address the Year 2000 issue will not have a material adverse effect on the Company's financial results and/or results of operation. The Company is in the process of developing contingency plans to allow continuation of mission-critical business processes to moderate the impact of any Year 2000 issues not adequately addressed by the Company or any material third-party to the Company. These efforts, when completed, are expected to allow the Company to define the most reasonably likely worst case scenario, currently uncertain, resulting from Year 2000 issues. Although the Company does not expect Year 2000 issues to have a material impact on its financial results or operations, there can be no assurance that there will be no disruptions or that the Company will not incur significant costs to avoid such disruptions. This information contains 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: operations may not improve as projected, new products may not be accepted by the marketplace as anticipated, or new products may take longer to develop than anticipated. 14 15 INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- ITEM 7. FINANCIAL STATEMENTS Report of Independent Accountants 16 Consolidated Balance Sheets as of June 30, 1998 and 1997 17 Consolidated Statements of Operations for the years ended June 30, 1998 and December 31, 1996 and for the six months ended June 30, 1997 and 1996 18 Consolidated Statements of Stockholders' Equity for the years ended June 30, 1998 and December 31, 1996 and for the six months ended June 30, 1997 19 Consolidated Statements of Cash Flows for the year ended June 30, 1998 and December 31, 1996 and for the six months ended June 30, 1997 20 Notes to Consolidated Financial Statements 21-40
15 16 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 cash flows and of changes in stockholders' equity present fairly, in all material respects, the financial position of Integrated Security Systems, Inc. and its subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for the twelve months ended June 30, 1998 and December 31, 1996 and the six months ended June 30, 1997, 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. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 13 to the financial statements, the Company has suffered recurring losses from operations and the Company's dependence on obtaining debt financing or additional equity capital raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 13. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. PRICEWATERHOUSECOOPERS LLP Dallas, Texas August 26, 1998, except as to Notes 6 and 14 which are as of October 12, 1998 16 17 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS
June 30, -------- 1998 1997 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 311,117 $ 1,581,191 Accounts receivable, net of allowance for doubtful accounts of $45,159, and $54,733, respectively 2,204,005 2,457,596 Inventories 926,442 867,898 Restricted cash 107,039 54,928 Other current assets 192,987 312,234 ---------- ----------- Total current assets 3,741,590 5,273,847 Property and equipment, net 5,610,622 5,278,689 Intangible assets, net 2,055,117 2,283,970 Capitalized software development costs, net 318,453 493,350 Deferred income taxes 205,384 205,384 Other assets 19,642 18,295 ----------- ----------- Total assets $11,950,808 $13,553,535 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,002,375 $ 690,712 Accrued liabilities 675,616 672,340 Deferred revenue 159,945 116,028 Current portion of long-term debt and other liabilities 1,564,617 495,737 ----------- ----------- Total current liabilities 3,402,553 1,974,817 Long-term debt and other liabilities 7,490,753 7,630,956 Commitments and contingencies -- -- Stockholders' equity: Convertible preferred stock, $.01 par value, 750,000 shares authorized; 10,250 and 17,250 shares, respectively, issued and outstanding (liquidation preference of $205,000) 102 172 Common stock, $.01 par value, 30,000,000 shares authorized; 8,525,808 and 7,955,212 shares, respectively, issued; and 8,475,808 and 7,905,212 shares, respectively, outstanding 85,258 79,552 Additional paid in capital 10,822,802 10,523,546 Accumulated deficit (9,731,910) (6,536,758) Treasury stock, 50,000 shares (118,750) (118,750) ----------- ----------- Total stockholders' equity 1,057,502 3,947,762 ----------- ----------- Total liabilities and stockholders' equity $11,950,808 $13,553,535 =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. 17 18 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Months Ended For the Year Ended June 30, ------------------ ------------------------------ June 30, 1998 December 31, 1996 1997 1996 ------------- ----------------- ------------ ------------ (Unaudited) Sales $ 11,092,307 $ 9,054,145 $ 6,470,842 $ 4,225,419 Cost of sales 6,765,462 5,184,321 3,772,714 2,617,433 ------------ ------------ ------------ ------------ Gross margin 4,326,845 3,869,824 2,698,128 1,607,986 Operating expenses: Selling, general and administrative 6,407,039 3,776,798 2,643,134 1,809,271 Research and product development 246,433 152,239 34,138 108,611 ------------ ------------ ------------ ------------ 6,653,472 3,929,037 2,677,272 1,917,882 ------------ ------------ ------------ ------------ Income (loss) from operations (2,326,627) (59,213) 20,856 (309,896) Other income (expense): Interest income 35,321 7,748 15,900 5,805 Interest expense (863,768) (260,471) (389,540) (174,215) Gain on sale of assets 20,677 -- 23,408 -- Other (54,113) 389 6,132 5,686 ------------ ------------ ------------ ------------ Loss from continuing operations (3,188,510) (311,547) (323,244) (472,620) (Provision) benefit for income taxes (6,642) 11,991 (7,013) 14,326 ------------ ------------ ------------ ------------ Loss from continuing operations (3,195,152) (299,556) (330,257) (458,294) Discontinued operations: Loss from discontinued operations -- -- -- -- Gain on disposal of discontinued operations -- 22,789 -- 22,789 ------------ ------------ ------------ ------------ Income from discontinued operations -- 22,789 -- 22,789 ------------ ------------ ------------ ------------ Net loss $ (3,195,152) $ (276,767) $ (330,257) $ (435,505) ============ ============ ============ ============ Weighted average common shares outstanding 8,197,392 5,122,878 7,188,764 7,615,087 ------------ ------------ ------------ ------------ Basic and diluted net loss per share: Continuing operations $ (0.39) $ (0.05) $ (0.05) $ (0.06) ============ ============ ============ ============ Discontinued operations -- -- -- -- ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 18 19 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Convertible Additional Preferred Stock Common Stock Paid In Accumulated Treasury Shares Amount Shares Amount Capital Deficit Stock ------------ ------------ ------------ ------------ ------------ ------------ ------------ 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) Preferred stock conversion (7,000) (70) 175,000 1,750 (1,680) Warrant issuance 13,333 Warrant exercise 367,263 3,672 245,103 Common stock issuance 28,333 284 42,500 Net loss (3,195,152) ------------ ------------ ------------ ------------ ------------ ------------ ------------ Balance at June 30, 1998 10,250 $ 102 8,525,808 $ 85,258 $ 10,822,802 $ (9,731,910) $ (118,750) ============ ============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 19 20 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year For the Six Months For the Year Ended Ended Ended June 30, June 30, December 31, ------------ --------------- ----------------- 1998 1997 1996 ------------ --------------- ----------------- Cash flows from operating activities: Net loss $ (3,195,152) $ (330,257) $ (276,767) Adjustments to reconcile net loss to net cash (used) provided by operating activities: Depreciation 599,370 277,476 189,042 Amortization 399,640 206,360 358,295 Bad debt expense 15,801 -- 18,976 Provision for warranty reserve 184,785 69,300 188,344 Provision for inventory reserve 22,681 -- 4,601 Deferred revenue 43,917 (93,268) 56,348 Gain on sale of assets (20,919) (23,408) -- Other non-cash expenses (income) 23,397 163,610 (173,281) Net change in assets and liabilities from discontinued operations -- (29,821) (184,100) Changes in operating assets and liabilities, net of effects from acquisition of Golston Company, Inc.: Accounts receivable 237,790 153,567 (543,992) Inventories (81,224) 214,586 81,006 Restricted cash (52,111) (46,696) 149,619 Other assets 117,900 (189,744) (109,045) Accounts payable 311,663 (190,509) (344,141) Accrued liabilities (139,509) (276,391) (605,766) ------------ ----------- ----------- Net cash used by operating activities (1,531,971) (95,195) (1,190,861) ------------ ----------- ----------- Cash flows from investing activities: Purchase of property and equipment (1,004,459) (149,549) (96,983) Sale of property and equipment 88,903 135,953 5,000 Intangible assets -- -- (71,951) Acquisition of Golston Company, Inc. -- -- (4,851,406) ------------ ----------- ----------- Net cash used by investing activities (915,556) (13,596) (5,015,340) ------------ ----------- ----------- Cash flows from financing activities: Issuance of convertible preferred stock, net -- -- 687,406 Issuance of common stock and warrant exercises, net 248,775 70,875 1,863,487 Payments of debt and other liabilities (494,519) (193,277) (1,459,051) Proceeds from debt and other liabilities 1,423,197 816,291 6,012,545 Loan origination fees -- (101,798) (9,950) ------------ ----------- ----------- Net cash provided by financing activities 1,177,453 592,091 7,094,437 ------------ ----------- ----------- Increase (decrease) in cash and cash equivalents (1,270,074) 483,300 888,236 Cash and cash equivalents at beginning of period 1,581,191 1,097,891 209,655 ------------ ----------- ----------- Cash and cash equivalents at end of period $ 311,117 $ 1,581,191 $ 1,097,891 ====+======= =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. 20 21 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 integrates 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'). 2. SIGNIFICANT ACCOUNTING POLICIES Consolidation The consolidated financial statements include the Company and its wholly owned subsidiaries, B&B, IST, TCSI and GCI. 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. References to fiscal 1998 refer to the twelve months ended June 30, 1998. Cash and Cash Equivalents Cash is comprised of highly liquid instruments with maturities of three months or less. At June 30, 1998, restricted cash of $107,039 was related to a factoring arrangement (see Note 6). At June 30, 1997, restricted cash of $54,928 was related to a letter of credit obtained to secure a surety bond. 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 straight-line and accelerated methods. Estimated useful lives range from 3 to 31 years. Depreciation expense includes amortization of assets recorded as capital leases. 21 22 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Property and equipment at June 30, 1998 includes $28,662 of manufacturing equipment subject to capital leases. Intangible Assets and Amortization Goodwill, of $1,818,385 at June 30, 1998, 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 year ended June 30, 1998 was $126,588. Amortization expense for goodwill for the six months ended June 30, 1997 was $52,883 and for the year ended December 31, 1996 was $26,797. Loan origination fees, of $107,615 at June 30, 1998, 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 year ended June 30, 1998 was $20,917. Amortization expense for the six months ended June 30, 1997 was $6,329 and for the year ended December 31, 1996 was $0. 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 year ended June 30, 1998 was $81,656 and $26,803, respectively. 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. 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 ('SFAS') 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. Valuation allowances are recorded when it is more likely than not that a tax benefit will not be realized prior to the expiration of the carryforward periods. 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 markets. No single customer accounted for 10% or more of revenues during the year ended June 30, 1998, the six months ended June 30, 1997 or the year ended December 31, 1996. 22 23 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Software Development Costs The Company accounts for software development costs pursuant to SFAS 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 year ended June 30, 1998 was $127,381. 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, 1998 was $318,453. Accumulated amortization at June 30, 1997 and December 31, 1996 was $191,072 and $127,381, respectively. 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 was being amortized over a period of five years from the acquisition date. Amortization expense for the year ended June 30, 1998 was $47,516. For the six months ended June 30, 1997 and for the year ended December 31, 1996, $34,464 and $68,930 was recorded as amortization expense, respectively. At June 30, 1998, this license and distribution agreement was fully amortized. Accumulated amortization was $202,484 at June 30, 1997 and $168,020 at December 31, 1996. 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, long-term debt and other liabilities approximate the fair values of such financial instruments. Net Loss Per Share In February 1997, the Financial Accounting Standards Board ('FASB')issued SFAS 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. 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. At June 30, 1998, there were 8,609,538 potentially dilutive common shares which were not included in weighted average shares outstanding because to do so would have been antidilutive. 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. 23 24 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Statements of Cash Flows Supplemental cash flow information for the year ended June 30, 1998, the six months ended June 30, 1997 and the year ended December 31, 1996:
1998 1997 1996 Cash paid for interest expense $863,769 $344,540 $153,428 Cash paid for income taxes $ 42,473 $ 10,000 $ 51,866
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. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade accounts receivable. The Company follows the practice of filing statutory liens on construction projects where collection problems are anticipated. The liens serve as collateral for trade receivables. The Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk attendant in its business. New Accounting Pronouncements Accounting for Derivative Instruments and Hedging Activities. In June 1998, the Financial Accounting Standards Board ('FASB') issued SFAS No. 133, 'Accounting for Derivative Instruments and Hedging Activities.' SFAS No. 133 establishes a new model for accounting for derivatives and hedging activities and supercedes and amends a number of existing standards. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999, but earlier adoption is permitted. Upon initial application, all derivatives are required to be recognized in the statement of financial position as either assets or liabilities and measured at fair value. Recognition of changes in fair value depends on whether the derivative is designated and qualifies as a hedge, and the type of hedging relationship that exists. The Company does not currently, nor does it expect to, hold any derivative instruments or participate in any hedging activities. 24 25 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Comprehensive Income. In June 1997, the FASB issued SFAS No. 130, 'Reporting Comprehensive Income.' SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. The Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Statement is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company adopted SFAS No. 130 in 1998 and it had no impact on the Company's financial position or results of operations. Segment Reporting. In June 1997, the FASB issued SFAS No. 131, 'Disclosures About Segments of an Enterprise and Related Information.' SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. In general, such information must be reported for externally in the same manner used for internal management purposes. SFAS No. 131 is effective for financial statements issued for periods beginning after December 15, 1997,. In the initial year of adoption, comparative information for earlier years must be restated. Since SFAS No. 131 only requires disclosure of certain information, its adoption will not affect the Company's financial position or results of operations. Unaudited Interim Financial Information The interim financial information for the six months ended June 30, 1996 has been prepared from the unaudited financial records of the Company and in the opinion of management reflects all adjustments, consisting only of normal recurring items, necessary for a fair presentation of the financial position and results of operations and of cash flows for the interim period. Reclassification Certain reclassifications of prior year amounts have been made to conform to the fiscal 1998 presentation. 25 26 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 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 funded the sales, engineering and order fulfillment expenses of IST to the extent of available funds. 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, 1998, the partnership had not received any return on its investment. 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, a vertically integrated manufacturer of specialty products for the financial and health care industries with approximate revenues of $3.9 million. 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 and had an original conversion price of $1.05 per share. On April 15, 1998, these debentures were repriced at $.55 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, for the year ended December 31, 1996 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. 26 27 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, --------------------------------- 1998 1997 ---------- ----------- Inventories: Raw materials $ 356,468 $ 506,539 Work-in-process 404,517 313,940 Finished goods 165,457 47,419 ---------- ----------- $ 926,442 $ 867,898 ========== =========== Property and equipment: Land $ 944,689 $ 939,264 Building 1,242,250 1,177,168 Rental units 2,604,694 2,234,089 Leasehold improvements 48,768 48,769 Office furniture and equipment 905,303 767,416 Manufacturing equipment 3,298,850 3,048,288 Vehicles 39,919 39,919 Construction 153,425 153,425 ---------- ----------- 9,237,898 8,408,338 Less: accumulated depreciation (3,627,276) (3,129,649) ---------- ----------- $5,610,622 $ 5,278,689 ========== ===========
27 28 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 6. LONG-TERM DEBT AND OTHER LIABILITIES Long-term debt and other liabilities consists of the following:
June 30, ------- 1998 1997 ---- ---- 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 was convertible into ISSI's common stock based upon $1.05 per share. As of April 15, 1998, the outstanding balance of the note can be converted into ISSI's common stock based upon $0.55 per share. At June 30, 1997, the Company was not in compliance with the Debt Service Coverage financial standard under this agreement. At June 30, 1998, the Company is not in compliance with the Current Ratio, Minimum Tangible Net Worth, Debt to Equity and Debt Service Coverage financial standards under this agreement. The Company has obtained waivers related to these non-compliances. $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. 1,267,331 1,434,609 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 1998); secured by first mortgage on real estate and equipment; personally guaranteed by an officer. 774,117 834,904 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, 1998 and 1997); secured by certain assets of the Company; guaranteed by ISSI. At June 30, 1998, the Company is not in compliance with the Net Worth financial standard under this agreement. The Company has obtained a waiver related to this non-compliance. This note was paid in full in October 1998. 589,767 744,767 Term note payable to an unrelated third party; interest at Citibank's Base Rate plus 2% (10.5% at June 30, 1998 and 1997) due in monthly installments through April 2002; no principal installments were due until May 1998; secured by equipment. At June 30, 1998, the Company is not in compliance with the Net Worth financial standard under this agreement. The Company has obtained a waiver related to this non-compliance. This note was paid in full in October 1998. 569,835 30,422 Revolving credit facility in the amount of $500,000 with an unrelated third party; no principal payment requirements and interest due monthly at Citibank's Base Rate plus 1.75% based on the average daily borrowings during the prior month (10.25% at June 30, 1998); a fee equal to 1/2% of the line of credit facility is due annually; secured by eligible accounts receivable and limited by 85% of eligible accounts receivable. At June 30, 1998, the Company is not in compliance with the Net Worth financial standard under this agreement. The Company has obtained a waiver related to this non-compliance. This note was paid in full in October 1998. 344,535 -- Non-compete agreements to prior owners of GCI; due in equal monthly installments of $8,166 plus interest at 10% through January 2002. 342,953 440,940
28 29 Business Manager factoring facility with a bank to factor accounts receivable with recourse. This factoring facility, which expired on June 30, 1998, had an adjustable factoring fee of 3.4%, and had a maximum borrowing amount of $400,000. 298,170 -- Borrowings on line of credit with a bank; interest payable monthly is at Wall Street prime plus 1% (9.5% at June 30, 1998); secured by accounts receivable, inventories, furniture, fixtures, equipment. 240,000 -- 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. 23,905 30,598 Term note payable to a bank; due in monthly principal and interest installments of $497 through April 1999; interest at 9%; secured by equipment. 4,757 10,453 ---------- ---------- 9,055,370 8,126,693 Less current portion (1,564,617) (495,737) ---------- ---------- $7,490,753 $7,630,956 ========== ==========
29 30 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Payments required under long-term debt and other liabilities outstanding at June 30, 1998 are as follows:
1999 $1,564,617 2000 1,002,786 2001 1,259,705 2002 1,179,990 2003 917,709 Thereafter 3,130,563 ---------- $9,055,370 ==========
7. INCOME TAXES The income tax provision (benefit) is comprised of the following:
For the For the For the Year Ended Six Months Ended Year Ended June 30, June 30, December 31, ---------- ---------------- ----------- 1998 1997 1996 ---------- ---------------- ------------ Current: Federal $ -- $ -- $ -- State 6,642 7,013 (11,991) ---------- ------ -------- $ 6,642 $7,013 $(11,991) ---------- ------ -------- Deferred: Federal $ -- $ -- $ -- State -- -- -- ---------- ------ -------- -- $ -- $ -- ========== ====== ======== Tax expense (benefit) $ 6,642 $7,013 $(11,991) ========== ====== ========
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: 30 31 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
June 30, June 30, December 31, 1998 1997 1996 -------- -------- ----------- Federal statutory benefit rate (34.0%) (34.0%) (34.0%) State income tax provision, net of federal tax benefit 0.2% 2.0% (4.0%) Net operating loss not benefited 33.0% 32.0% 24.0% Non-deductible amortization and other 1.0% 2.0% 10.0% ------ ----- ----- 0.2% 2.0% (4.0%) ====== ===== =====
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, June 30, 1998 1997 ------------ ---------- Amortization -- $ (188,372) Depreciation -- (1,994) ------------ ---------- Gross deferred tax liability -- (190,366) ------------ ---------- Amortization $ 75,525 -- Non-compete covenant 33,315 14,711 Depreciation 24,164 -- Warranty reserve 27,925 37,830 Bad debt reserve 15,354 40,131 Net operating loss carryforward 3,071,981 2,278,571 ------------ ---------- Gross deferred tax asset 3,248,264 2,371,243 ------------ ---------- Net deferred tax asset 3,248,264 2,180,877 Valuation allowance (3,042,880) (1,975,493) ------------ ---------- Net deferred tax asset $ 205,384 $ 205,384 ============ ==========
31 32 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Should a cumulative change in ownership of more than 50% occur within a three-year period, there could be an annual limitation on the use of the net operating loss carryforward. The Company has unused net operating loss carryforwards of $9 million at June 30, 1998. These carryforwards begin to expire in the year 2007. The Company increased the valuation allowance each year because presently it is more likely than not that a tax benefit will not be realized prior to expiration of the carryforward periods, 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 has two capital leases. Future minimum payments for fiscal years subsequent to June 30, 1998 under capital leases and non-cancelable operating leases are as follows:
Capital Leases Operating Leases -------------- ---------------- 1999 $ 12,165 $ 163,653 2000 8,204 158,934 2001 8,293 87,044 2002 0 15,002 2003 0 2,887 ---------- ----------- Total minimum payment $ 28,662 $ 427,520 ========== ===========
Rent expense for operating leases was $163,972 for the year ended June 30, 1998. For the fiscal years ended June 30, 1997 and December 31, 1996, rent expense for operating leases was $46,360 and $103,253, respectively. Contingencies The Company is subject to certain legal actions and claims arising in the ordinary course of business. Management recognizes the uncertainties of litigation; however, based upon the nature 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. 32 33 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 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 was amortized over five years from the acquisition date. The balance was fully amortized at June 30, 1998. At June 30, 1997, the unamortized balance was $47,516. 10. 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 years ended June 30, 1998 and December 31, 1996, or during the six months ended June 30, 1997 and 1996. 11. STOCK OPTIONS AND WARRANTS Stock Options SFAS No. 123 'Accounting for Stock-Based Compensation' ('SFAS 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 as of on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the periods ended June 30, 1998 and 1997: no dividend yield, expected volatility of approximately 87% and 84%, respectively, risk-free interest rates of approximately 5.9% and 6.5% respectively, and expected lives of approximately five 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): 33 34 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
For the For the Six Months For the Year Ended Ended Year Ended June 30, 1998 June 30, 1997 December 31, 1996 ----------------- ----------------- ----------------- As Pro As Pro As Pro reported forma reported forma reported forma -------- ------- -------- ------ -------- ----- Net Loss $ (3,195) $(3,259) $ (330) $ (368) $ (277) $(308) Loss per Common Share $ (.39) $ (.40) $ (.05) $ (.05) $ (.05) $(.05)
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts as SFAS 123 does not apply to awards prior to 1995 and because 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. 34 35 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 For the Year Ended Ended For the Year Ended June 30, 1998 June 30, 1997 December 31, 1996 --------------------- ------------------ ------------------ Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price Shares Price ------ -------- ------ -------- ------ -------- Outstanding at beginning of period 928 $ 1.98 874 $ 2.01 738 $ 2.21 Granted 467 1.32 75 1.63 188 1.22 Forfeited (59) 1.28 (21) 2.02 (52) 1.95 ------ -------- ------ -------- ------ -------- Outstanding at end of period 1,336 $ 1.78 928 $ 1.98 874 $ 2.01 ====== ======== ====== ======== ====== ======== Exercisable at end of period 884 $ 2.00 721 $ 2.11 663 $ 2.18 Weighted-average fair value of options granted during the period $ 1.00 $ 1.14 $ 1.06
The following table summarizes information about the fixed-price stock options outstanding at June 30, 1998 (share amounts in thousands):
Options Outstanding Options Exercisable ---------------------------------- ------------------------------------ Weighted Range of Shares Average Weighted Shares Weighted Exercise Outstanding Remaining Average Exercisable Average Prices at 6/30/98 Contractual Life Exercise Price at 6/30/98 Exercise Price - -------- ----------- ---------------- -------------- ----------- --------------- $0.687-1.50 514 8.6 Years $1.19 189 $1.20 $1.563-2.50 811 6.7 Years 2.14 687 2.21 $2.719-3.53 11 8.1 Years 2.74 8 2.73 ------- ------- ----- ------- 1,336 $1.78 884 $2.00
35 36 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Warrants On April 20, 1993, in connection with the Company's initial public offering, the Company issued 1,450,000 Redeemable Common Stock Purchase Warrants. Each warrant entitles the holder to purchase one share of common stock at a price of $5.40 per share during the first 30 months, and $6.75 per share during the second 30 months. The warrants are subject to redemption by the Company at $0.25 per warrant upon 30 days prior written notice with the consent of the underwriter, Thomas James Associates, Inc. ('Underwriter'). 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 were then 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 were entitled to purchase 2.1 shares of common stock per warrant held. On April 15, 1998, these warrants were repriced again to $2.55 under the same obligation and the holders are entitled to purchase 2.65 shares of common stock per warrant held. These warrants expired April 19, 1998, but were exchanged for warrants expiring April 19, 1999 (the 'Exchange Warrants'). The Company may delay the issuance of shares of Common Stock issuable upon exercise of the Exchange Warrants because the registration of the Common Stock has not been amended and updated by the Company. If any shares of Common Stock were issued, those shares would not be eligible for public trading until such time as the Company amends and updates the registration. 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 consisted of a share of common stock and a warrant to purchase an additional share of common stock. Management believed that the exercise price of the warrant at the date of grant approximated market value of the underlying common stock. This warrant was exercisable over a period of four years commencing April 20, 1994. By the time these warrants expired on April 20, 1998, these warrants had been reprised to $3.17 for the purchase of 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. No value was assigned to these warrants as management believed such value to be insignificant at the time of issuance. As of June 30, 1997, 33,000 warrants issued remained outstanding. These warrants expired on April 19, 1998. 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 and 1998, 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. 36 37 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 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 assigned to these warrants of $40,000 was expensed in 1996 and $45,000 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. During fiscal year ended June 30, 1998, the Company issued warrants in consideration for obtaining a debt covenant waiver for a period of one year. These warrants permit the holder to purchase 25,000 shares of common stock at an exercise price of $1.75 and expire in 2002. During the same period, the Company issued warrants for legal fees to purchase 22,222 shares of common stock at an exercise price of $1.65. These warrants expire in 2001. 37 38 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 For the Year Ended Ended For the Year Ended June 30, 1998 June 30, 1997 December 31, 1996 ------------------ ------------------ ------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ --------- ------ --------- ------ --------- Outstanding at beginning of period 5,107 $ 3.07 4,253 $ 3.03 2,218 $ 3.38 Granted 47 1.70 66 1.63 1,590 1.05 Exercised (517) .96 (82) .60 (599) .87 Forfeited (642) 1.00 0 0.00 0 0.00 Repriced 798 2.55 870 3.14 1,044 4.04 ------- ------ ------- ------ ------- ------ Outstanding at end of period 4,793 $ 2.30 5,107 $ 3.07 4,253 $ 3.03 ======= ====== ======= ====== ======= ====== Exercisable at end of period 4,660 $ 2.30 5,008 $ 3.08 4,199 $ 3.03 ------ ------ ------ Weighted-average fair value of warrants granted during the period $ 1.05 $ .93 $ 1.57
The following table summarizes information about the warrants outstanding at June 30, 1998 (share amounts in thousands):
Warrants Outstanding Warrants Exercisable -------------------------------------------------- ------------------------------ Weighted Range of Shares Average Weighted Shares Weighted Exercise Outstanding Remaining Average Exercisable Average Prices at 6/30/98 Contractual Life Exercise Price at 6/30/98 Exercise Price -------- ----------- ---------------- -------------- ----------- -------------- $.01-1.00 565 1.8 Years $ .94 565 $ .94 $1.06-2.00 269 2.6 Years 1.53 235 1.51 $2.40-2.55 3,959 1.6 Years 2.55 3,860 2.55 ----- ----- ----- 4,793 $2.30 4,660 $2.30
38 39 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 12. 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 10,250 shares of its Series A $20 Convertible Preferred Stock (the 'Series A Preferred'). Holders of the Series A Preferred are not entitled to receive any dividends, and have no voting rights, unless otherwise required pursuant to Delaware law. Each share of the Series A Preferred may, at the option of the Company, be converted into 20 shares of Common Stock at any time after (i) the closing bid price of the Common Stock is at least $2.00 for at least 20 trading days during any 30 trading day period, and (ii) the shares of Common Stock to be received on conversion have been registered or otherwise qualified for sale under applicable securities laws. In addition, the holders of the Series A Preferred have the right to convert each share into 20 shares of Common Stock at any time. The number of shares of Common Stock into which the Series A Preferred is convertible will be proportionately adjusted in the event of a stock dividend, stock split, or reverse stock split. Upon any liquidation, dissolution, or winding up of the Company, the holders of the Series A Preferred are entitled to receive $20 per share before the holders of Common Stock are entitled to receive any distribution and the Series A Preferred ranks pari passu with Series B and Series C Preferred except with respect to the security interest granted to Series B Preferred (see Series B description below). SERIES B $20 CONVERTIBLE PREFERRED STOCK. The Company has issued 34,166 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 has issued 12,500 shares of its Series C $20 Convertible Preferred Stock (the 'Series C Preferred'). Holders of the Series C Preferred have no voting rights, unless otherwise required by Delaware law. Each share of the Series C Preferred may, at the option of the Company or the holder, be converted into 30 shares of Common Stock. The Company has no right to redeem the Series C Preferred. The Series C Preferred is also subject to the conversion adjustments, and is entitled to receive a liquidation preference, identical to the Series A Preferred. As of June 30, 1998, all Series C have been converted to Common Stock. 39 40 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 13. GOING CONCERN MATTERS The Company has suffered recurring losses from operations and its dependence on obtaining financing or additional equity capital raises substantial doubt about its ability to continue as a going concern. The financial statements have been prepared assuming that the Company will continue as a going concern and do not include any adjustment that might result from the outcome of this uncertainty. Historically the Company's manufacturing subsidiaries have generated positive returns. During fiscal 1998, one of the manufacturing facilities experienced a business downturn, resulting in a loss for fiscal 1998 that is not expected to be repeated in future periods. The Company anticipates that it will continue to experience losses from the launching of the Intelli-Site product, but these losses should begin to lessen as revenues are recognized from sales. 14. SUBSEQUENT EVENTS On October 1, 1998, the Company sold a business unit of GCI (MPA Systems) to a private investment group for $2.8 million comprised of cash and $680,000 in notes. The sale of the MPA Systems business unit of GCI involves the divestiture of a fleet of 52 modular buildings leased primarily to banks and financial institutions for short-term facility requirements and disaster recovery performance contracts to provide temporary banking facilities in the event of a natural disaster. Approximately $1.5 million of the cash proceeds will be used to retire a secured credit facility. 40 41 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no disagreements concerning any matter of accounting principle or financial statements disclosure between the Company and its independent accountants. PART III Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. The information required by this item is incorporated by reference to disclosure in the Company's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report ('Proxy Statement'). ITEM 10. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the Proxy Statement. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the Proxy Statement. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the Proxy Statement. PART IV ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K (a) Exhibits. *3.1 Amended and Restated Certificate of Incorporation of the Company. 3.11 Amendment to Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.11 to the Company's Form 10-KSB for the year ended December 31, 1994). *3.2 Amended and Restated Bylaws of the Company. *4.1 Specimen certificate for common stock of the Company. *4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant. *4.3 Warrant Agreement among the Company, American Stock Transfer & Trust Company, and Thomas James Associates, Inc. *4.4 Underwriter's Warrant. **4.5 Certificate of Designation for Series A $20 Convertible Preferred Stock. 41 42 **4.6 Certificate of Designation for Series B $20 Convertible Preferred Stock. **4.7 Certificate of Designation for Series C $20 Convertible Preferred Stock. **10.1 Integrated Security Systems, Inc. 1993 Stock Option Plan dated September 7, 1993, as amended on December 30, 1994. *10.2 Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. *10.3 Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. *10.13 Form of Indemnification Agreement by and between the Company and the Company's officers and directors. *10.14 Commercial Lease dated August 6, 1984, by and among Philip R. Thomas, Wayne L. Thomas and Thomas Group Service Company, predecessor to B&B, for land, building and equipment. *10.20 Lease Agreement dated March 25, 1992 and April 6, 1992, by and among the Company, Trammell Crow Company No. 90 and Petula Associates Limited for property located in Dallas, Texas. *10.23 Lease Agreement commencing June 1, 1992 by and between Kelso Joint Venture and AAC, for property located in Baltimore, Maryland. *10.37 License and Distribution Agreement dated March 16, 1993, by and among COMTRAC Corporation, Thomas Group Holding Company and the Company relating to analog technology for transaction processing systems. *10.38 License and Distribution Agreement dated March 16, 1993, by and between DesignTech Incorporated and the Company relating to interactive digital video interface system technology. *10.49 Amendment to Integrated Security System, Inc. 1993 Stock Option Plan. *10.51 Note relating to the $900,000 Bridge Financing (incorporated by reference from similarly numbered exhibits filed with the Company's Form 10-KSB for the year ended December 31, 1995). *10.52 Standard Form of Common Stock Purchase Warrant (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.53 Subscription Agreement dated December 28, 1995 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.54 Factoring Agreement from Sunburst Bank for B&B receivables (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.55 Corporate Consulting Agreement, dated March 3, 1986, by and between the Company and Bathgate McColley Capital Group LLC for consulting services (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 42 43 10.56 Form of Promissory Notes dated March 11, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.57 Engagement letter dated March 26, 1996, from Bathgate McColley Capital Group LLC to the Company proposing private placement offering (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.58 Form of Subscription Agreement for Series A Convertible Preferred Stock executed on March 27, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.59 Subscription Agreement for Common Stock executed March 28, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.60 Form of Warrant Agreement for purchase of common stock executed March 29, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.61 Placement Agent Agreement dated April 16, 1996, by and between the Company and Bathgate McColley Capital Group LLC confirming private placement offering (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.62 Form of Amendment to Promissory Notes dated April 22, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). **10.63 Stock Purchase Agreement, dated November 7, 1996, between the Company and S. Webb Golston. **10.64 Subscription Agreement, dated December 31, 1996, between the Company and ProFutures Special Equity Fund, L.P. **10.65 Convertible Loan Agreement, dated December 31, 1996, between the Company (and its subsidiaries) and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. **10.66 Management Agreement, dated August 29, 1996, between the Company and I.S.T. Partners, Ltd. **10.67 Marketing and Development Agreement, dated July 29, 1996, between the Company, IST, and I.S.T. Partners, Ltd. **10.68 Employment Agreement, dated January 2, 1997, between Gerald K. Beckmann and the Company. **10.69 Employment Agreement, dated January 2, 1997, between James W. Casey and the Company. **10.70 Real Estate Purchase Agreement, dated September 5, 1996, between the Company and Golston Family Partners, Ltd. ***10.71 Asset Purchase Agreement, dated October 1, 1998, between the Company and MPA Systems, Inc. ***11.1 Computation of earnings per share. ***21.1 Subsidiaries of the Company. 43 44 ***23.1 Consent of PricewaterhouseCoopers LLP. ***27.1 Financial Data Schedule - ----------- * Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW) and incorporated herein by reference. ** Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 333-5023) and incorporated herein by reference. *** Filed herewith. (b) Reports filed on Form 8-K. None. 44 45 SIGNATURES In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Integrated Security Systems, Inc. --------------------------------- (Registrant) Date: October 13, 1998 /s/ GERALD K. BECKMANN ---------------- --------------------------------- Gerald K. Beckmann Director, Chairman of the Board, President and Chief Executive Officer
45 46 SIGNATURES In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Integrated Security Systems, Inc. --------------------------------- (Registrant) Date: October 13, 1998 /s/ GERALD K. BECKMANN ---------------- --------------------------------- Gerald K. Beckmann Director, Chairman of the Board, President and Chief Executive Officer Date: October 13, 1998 /s/ HOLLY J. BURLAGE ---------------- --------------------------------- Holly J. Burlage Vice President, Principal Financial Officer, Principal Accounting Officer, Secretary and Treasurer Date: October 13, 1998 /s/ ROBERT M. GALECKE ---------------- --------------------------------- Robert M. Galecke Director Date: October 13, 1998 /s/ JAMES E. JACK ---------------- --------------------------------- James E. Jack Director Date: October 13, 1998 /s/ FRANK R. MARLOW ---------------- --------------------------------- Frank R. Marlow Director
46 47 EXHIBIT INDEX
Exhibit Number Description - ------ ----------- *3.1 Amended and Restated Certificate of Incorporation of the Company. 3.11 Amendment to Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.11 to the Company's Form 10-KSB for the year ended December 31, 1994). *3.2 Amended and Restated Bylaws of the Company. *4.1 Specimen certificate for common stock of the Company. *4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant. *4.3 Warrant Agreement among the Company, American Stock Transfer & Trust Company, and Thomas James Associates, Inc. *4.4 Underwriter's Warrant. **4.5 Certificate of Designation for Series A $20 Convertible Preferred Stock.
48 **4.6 Certificate of Designation for Series B $20 Convertible Preferred Stock. **4.7 Certificate of Designation for Series C $20 Convertible Preferred Stock. **10.1 Integrated Security Systems, Inc. 1993 Stock Option Plan dated September 7, 1993, as amended on December 30, 1994. *10.2 Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. *10.3 Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. *10.13 Form of Indemnification Agreement by and between the Company and the Company's officers and directors. *10.14 Commercial Lease dated August 6, 1984, by and among Philip R. Thomas, Wayne L. Thomas and Thomas Group Service Company, predecessor to B&B, for land, building and equipment. *10.20 Lease Agreement dated March 25, 1992 and April 6, 1992, by and among the Company, Trammell Crow Company No. 90 and Petula Associates Limited for property located in Dallas, Texas. *10.23 Lease Agreement commencing June 1, 1992 by and between Kelso Joint Venture and AAC, for property located in Baltimore, Maryland. *10.37 License and Distribution Agreement dated March 16, 1993, by and among COMTRAC Corporation, Thomas Group Holding Company and the Company relating to analog technology for transaction processing systems. *10.38 License and Distribution Agreement dated March 16, 1993, by and between DesignTech Incorporated and the Company relating to interactive digital video interface system technology. *10.49 Amendment to Integrated Security System, Inc. 1993 Stock Option Plan. *10.51 Note relating to the $900,000 Bridge Financing (incorporated by reference from similarly numbered exhibits filed with the Company's Form 10-KSB for the year ended December 31, 1995). *10.52 Standard Form of Common Stock Purchase Warrant (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.53 Subscription Agreement dated December 28, 1995 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.54 Factoring Agreement from Sunburst Bank for B&B receivables (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-KSB for the year ended December 31, 1995). 10.55 Corporate Consulting Agreement, dated March 3, 1986, by and between the Company and Bathgate McColley Capital Group LLC for consulting services (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996).
49 10.56 Form of Promissory Notes dated March 11, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.57 Engagement letter dated March 26, 1996, from Bathgate McColley Capital Group LLC to the Company proposing private placement offering (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.58 Form of Subscription Agreement for Series A Convertible Preferred Stock executed on March 27, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.59 Subscription Agreement for Common Stock executed March 28, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.60 Form of Warrant Agreement for purchase of common stock executed March 29, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.61 Placement Agent Agreement dated April 16, 1996, by and between the Company and Bathgate McColley Capital Group LLC confirming private placement offering (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). 10.62 Form of Amendment to Promissory Notes dated April 22, 1996 (incorporated by reference from the similarly numbered exhibit filed with the Company's Form 10-QSB for the quarter ended March 31, 1996). **10.63 Stock Purchase Agreement, dated November 7, 1996, between the Company and S. Webb Golston. **10.64 Subscription Agreement, dated December 31, 1996, between the Company and ProFutures Special Equity Fund, L.P. **10.65 Convertible Loan Agreement, dated December 31, 1996, between the Company (and its subsidiaries) and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. **10.66 Management Agreement, dated August 29, 1996, between the Company and I.S.T. Partners, Ltd. **10.67 Marketing and Development Agreement, dated July 29, 1996, between the Company, IST, and I.S.T. Partners, Ltd. **10.68 Employment Agreement, dated January 2, 1997, between Gerald K. Beckmann and the Company. **10.69 Employment Agreement, dated January 2, 1997, between James W. Casey and the Company. **10.70 Real Estate Purchase Agreement, dated September 5, 1996, between the Company and Golston Family Partners, Ltd. ***10.71 Asset Purchase Agreement, dated October 1, 1998, between the Company and MPA Systems, Inc. ***11.1 Computation of earnings per share. ***21.1 Subsidiaries of the Company.
50 ***23.1 Consent of PricewaterhouseCoopers LLP. ***27.1 Financial Data Schedule
- ----------- * Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW) and incorporated herein by reference. ** Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 333-5023) and incorporated herein by reference. *** Filed herewith. (b) Reports filed on Form 8-K. None. EX-10.71 2 ASSET PURCHASE AGREEMENT / MPA 1 Exhibit 10.71 ASSET PURCHASE AGREEMENT This ASSET PURCHASE AGREEMENT (the 'Agreement') is made as of September 30, 1998, by and among MPA SYSTEMS, INC., a Texas corporation ('Purchaser'), GOLSTON COMPANY D/B/A MPA SYSTEMS, a Texas corporation (the 'Company'), and INTEGRATED SECURITY SYSTEMS, INC., a Delaware corporation, the sole shareholder of the Company (the 'Parent'). WHEREAS, the Company desires to sell to Purchaser, and Purchaser desires to purchase from the Company, certain of the assets of the Company which it uses in the business known as 'MPA Systems' (hereinafter referred to as the 'Business') on the terms and conditions herein set forth; NOW, THEREFORE, Purchaser, the Company and the Parent covenant and agree as follows: 1. TRANSFER OF ASSETS (a) On the terms and subject to the conditions stated in this Agreement, the Company agrees to sell, convey, transfer, assign and deliver to Purchaser at the Closing (as hereinafter defined), and Purchaser agrees to purchase, good and marketable title to all of the assets used directly and predominantly in the Company's Business, whether tangible or intangible, real, personal or mixed, including, without limitation the following: (i) the modular units more fully described in SCHEDULE 1(a)(i) attached hereto; (ii) the furniture and fixtures more fully described in SCHEDULE 1(a)(ii) attached hereto; (iii) the equipment as more fully described in SCHEDULE 1(a)(iii) attached hereto; (iv) the contractual rights in all leases of modular units in effect on the date of Closing (the 'Leases') as more fully described in SCHEDULE 1(a)(iv) attached hereto (but only to the extent such rights are assignable by the Company); (v) all other assets used predominantly in the Business including any trademarks, patents, patent applications, trade secrets, inventions, copyrights, service marks, trade names ('MPA Systems' and 'MPA' and all others associated with the Business), associated goodwill, supplies, customer and supplier lists, sales data, telephone numbers, contracts, service contracts, warranties, computer hardware and software, promotional materials, market studies, licenses and permits, copies of accounts and records, and all goodwill, proprietary rights and interests and all intangible property of the Business wherever located, as the same shall exist on the Closing Date (as hereinafter defined); (such assets are collectively hereinafter referred to as the 'Transferred Assets'); provided, however, that the Transferred Assets shall not include any accounts or notes receivable or any cash or cash equivalents on hand on the Closing Date (as hereinafter defined), or deposits on the Leases, all assets of the Company used predominantly in the Company's plastic inspection business, the existing non-compete agreements between the Company and S. Webb Golston and affiliates, and insurance policies (all such assets are collectively referred to as 'Excluded Assets'). 2 (b) Purchaser shall not assume or be responsible for any liabilities, liens, claims, obligations or encumbrances, contingent or otherwise, except for those specifically set forth on SCHEDULE 1(b) hereto (the 'Assumed Liabilities'), and the Transferred Assets shall be sold and conveyed to Purchaser free and clear of all liabilities, liens, claims, obligations and encumbrances except for the liens created by this transaction. Without limiting the generality of the foregoing, in no event shall Purchaser assume or be responsible for: (i) any federal, state or local income, sales, property, franchise, use or other tax relating to the Transferred Assets and arising prior to the Closing (as hereinafter defined) or resulting from the ownership or operation of the Transferred Assets by the Company prior to the Closing Date (as hereafter defined); (ii) any liabilities, obligations or costs (including, without limitation, attorneys' fees) resulting from any claim or lawsuit or other proceeding relating to the Transferred Assets and (i) pending at the Closing Date (as hereinafter defined) or (ii) based upon events, transactions or circumstances occurring or existing prior to the Closing Date (as hereinafter defined); or (iii) except as contemplated by SECTIONS 7 or 11 of this Agreement, any attorneys', accountants', brokers' or finders' fees or other expenses of the Company or the Parent incurred in connection with this Agreement or any transaction contemplated herein. (c) In furtherance of the foregoing, the Company and the Parent expressly release, and agree to cause any affiliate or related party or any corporation, partnership or other entity controlled by them or any of their affiliates or related parties to release any claims relating to any of the foregoing liabilities, liens, claims, obligations or encumbrances that they or such persons might have against Purchaser or the Transferred Assets, other than pursuant to this Agreement or the transactions contemplated hereby. (d) The Company and the Parent covenant and agree that, at the time of the Closing, the Company will be current in all payments and other obligations required to be made or performed by the Company under the contracts, purchase orders and other agreements which are included in the Transferred Assets or the Assumed Liabilities or which are otherwise transferred to and/or assumed by Purchaser hereunder or pursuant hereto. (e) Purchaser and the Company have agreed upon the allocation of the consideration paid by Purchaser to the Company (including the assumption of the Liabilities) among the Transferred Assets and have set forth the allocation of such consideration and the tax basis of the Transferred Assets for federal income tax purposes in writing, and such allocation is presented on SCHEDULES 1(a)(i)-(iv). Such allocation was made in accordance with the applicable rules under SECTION 1060 of the Internal Revenue Code of 1986, as amended ('Code') and is binding upon Purchaser and the Company for all purposes (including financial accounting purposes, financial and regulatory reporting purposes and tax purposes). Purchaser and the Company also each agree to file appropriate documents with the IRS under Treasury Regulation SECTION 1.1060-1T(h)(3) reflecting the foregoing. 2. PURCHASE PRICE (a) The Total Purchase Price (herein so called) payable to the Company for the Transferred Assets shall be $2,800,000. (b) The Purchase Price shall be payable on the closing date as follows: 3 (i) the delivery of an unsecured promissory note made by Purchaser and payable to Company in the amount of $300,000 bearing interest on the unpaid balance at the rate of 10% per annum (the '$300,000 Promissory Note') with payment terms and form substantially similar to the form attached hereto as EXHIBIT 2(b)(i). (ii) the Purchaser's assumption of the Assumed Liabilities on SCHEDULE 1(b). (iii) the delivery of an unsecured promissory note made by Purchaser and payable to Company in the amount of no more than $400,000, bearing interest on the unpaid balance at the rate of 12.5% per annum (the '$400,000 Promissory Note') with payment terms and form substantially similar to the form attached hereto as EXHIBIT 2(b)(ii). (iv) cash, delivered by wire transfer, in an amount equal to the Total Purchase Price less the amount of the Assumed Liabilities, less the amount of the $300,000 Promissory Note and less 95% of the $400,000 Promissory Note. 3. THE CLOSING (a) The Closing of the transactions contemplated by this Agreement shall be deemed effective as of 12:01 a.m., October 1, 1998. The closing shall occur at the offices of Haynes and Boone, LLP, Attorneys at Law, Dallas, TX (the 'Closing') The term 'Closing Date' refers to September 30, 1998. (b) At Closing, the Company and the Parent will deliver to Purchaser: (i) the Bill of Sale, Assignment of Leases and Assignment of Contracts (substantially in the forms attached hereto as EXHIBITS 3(b)(i)-l, 3(b)(i)-2 and 3(b)(i)-3, respectively) and such other good and sufficient instruments of conveyance, assignment and transfer, in form and substance satisfactory to Purchaser's counsel, as shall be effective to vest in Purchaser good and marketable title to the Transferred Assets and take such actions as shall be effective to put Purchaser in possession of such Transferred Assets; (ii) evidence of any approvals of applications to public authorities, and any approvals of any private persons the granting of which is necessary for the consummation of the transactions contemplated hereby, or for the preventing of any termination of any material right, privilege, license or agreement of, or any material loss or disadvantage to, Purchaser upon consummation of the transactions contemplated hereby; (iii) evidence of the release of all liens and encumbrances with respect to the Transferred Assets; (iv) the records of the Company concerning the Business (excluding Company financial statements and reports and corporate minute books and stock records); (v) a certificate of good standing from the Texas Comptroller of Public Accounts; (vi) certified resolutions of the Board of Directors and Shareholders of the Company authorizing the transactions contemplated by this Agreement; (vii) such other documents, undertakings, agreements and instruments, in form and substance acceptable to Purchaser's counsel, as may otherwise be required by Purchaser to consummate the transactions contemplated hereby. 4 (c) At Closing, Purchaser will deliver, or cause to be delivered, to the Company: (i) the cash portion of the Total Purchase Price in wire-transferred funds; (ii) the $300,000 Promissory Note and the $400,000 Promissory Note; (iii) the Stock Option Agreement, an option agreement granted by Purchaser to the Company for the purchase of 4,633 shares of the Company's Common Stock at an exercise price equal to $7.78 per share, expiring on December 31, 2003; (iv) certified resolutions of Purchaser's Board of Directors authorizing the transactions contemplated by this Agreement; (v) a release by James W. Casey; and (vi) such other documents, undertakings, agreements and instruments, in form and substance acceptable to the Company's counsel as may otherwise be required by the Company and the Parent to consummate the transactions contemplated hereby. (d) At Closing, Purchaser and the Company shall execute a lease agreement between them in a form substantially similar to Exhibit 3(d). 4. REPRESENTATIONS AND WARRANTIES OF PURCHASER Purchaser represents and warrants to the Company and the Parent as follows: (a) Purchaser is a corporation duly organized, validly existing and in good standing under the laws of the State of Texas. (b) Purchaser has all requisite corporate power and authority to enter into this Agreement and all other agreements and documents required to be executed and delivered by Purchaser. The execution, delivery and performance of this Agreement and all other agreements and documents required to be delivered by Purchaser pursuant to this Agreement have been duly authorized by all necessary action (corporate or otherwise) by Purchaser, and this Agreement and the other agreements and documents required to be delivered by the Company pursuant to this Agreement, have been duly executed and delivered and are legal, valid and binding agreements of Purchaser, enforceable in accordance with their respective terms. (c) Neither the execution or delivery of this Agreement, nor the consummation of any of the transactions contemplated hereby or thereby, will result in the breach or violation of any term or provision, or constitute a default under, any charter provision, bylaw, agreement, mortgage, deed of trust, note, bond, license, lease, indenture, instrument, order, writ, injunction, decree, statute, rule or regulation to which Purchaser is a party or which is otherwise applicable to Purchaser. (d) No court decision restrains or prohibits the consummation of the transactions contemplated hereby, and no litigation is pending seeking to restrain or prohibit or seeking damages with respect to the consummation of the transactions contemplated hereby. 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE PARENT The Company and the Parent, jointly and severally, represent and warrant to Purchaser as follows: 5 (a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Texas. The Parent is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company and the Parent each has full corporate power to own its properties and conduct its business. The Company is a wholly-owned subsidiary of the Parent. (b) The Company and the Parent each have all the requisite corporate power and authority, and the legal right, to enter into this Agreement and all other agreements and documents required to be executed and delivered by them. The execution, delivery and performance of this Agreement, and all other agreements and documents required to be delivered by the Company or the Parent pursuant to this Agreement, have been duly authorized by all necessary action (corporate or otherwise) by the Company and the Parent, and this Agreement and the other agreements and documents required to be delivered by the Company and the Parent pursuant to this Agreement, have been duly executed and delivered and are legal, valid and binding agreements of the Company and the Parent, enforceable in accordance with their respective terms. (c) Upon execution and delivery, the Bill of Sale, Assignment of Leases and the Assignment of Contracts (upon receipt of all applicable lessee and other third party consents) will be sufficient to and will convey to Purchaser good and marketable title to all of the Transferred Assets free and clear of all liens, claims and encumbrances of any kind (including liens, claims and encumbrances relating to income, franchise, use, sales, employee income tax withholding, social security, unemployment and sales taxes), except as set forth on SCHEDULE 5(c). (d) Upon receipt of all applicable lessee and other third party consents, neither the execution or delivery of this Agreement, the Bill of Sale or the Assignment of Leases or other instruments or conveyance, assignment and transfer, nor the consummation of any of the transactions contemplated hereby or thereby, will result in the breach or violation of any term or provision of, or constitute a default under, or result in any loss to, or the creation of a lien on, any of the Transferred Assets, under any charter provision, bylaw, agreement, mortgage, deed of trust, note, bond, license, statute, law, rule or regulation, to which the Company or the Parent is a party or which is otherwise applicable to either of them or any of the Transferred Assets. (e) All financial statements concerning the Business previously provided to Purchaser have been prepared from the books and records of the Company, which accurately and fairly reflect the transactions and dispositions of the assets and the incurrence of liabilities of the Company, are complete and correct and reasonably present the financial position of the Business at the respective dates indicated. (f) Since the date of the last financial statements provided to Purchaser, and except as set forth on SCHEDULE 5(f), the Company has operated its businesses in the ordinary course, and there has not been: (i) any material adverse change in the condition (financial or otherwise), results of operations, business, prospects, assets or liabilities (contingent or otherwise) of the Company; (ii) any material theft, damage, or material operating or other loss (whether or not covered by insurance) suffered by the Company; (iii) any material change in the promotion, marketing, standard terms in the Leases, sales or other policies relating to or affecting the business of the Company or any changes in management, accounting or operations; 6 (iv) any sale of material assets used in the business which have not been replaced with assets of substantially similar utility and remaining life. (g) As of the date hereof, proper and accurate reports to taxing authorities have been timely filed by the Company (or extensions for filing granted) with respect to the Transferred Assets and Business for all periods in which such were due. Except as noted in paragraph 12(a), all taxes have been paid or adequate provisions made therefor. Except as noted in paragraph 12(a), there is not in force any extension of the date on which any tax return was or is due to be filed by or with respect to the Transferred Assets or Business or any waiver or agreement for the extension of time for the payment of any tax which would result in the delay of payment of taxes due in the periods up to Closing to periods after Closing. There are no tax liens upon any of the Transferred Assets, other than for current taxes not yet due. (h) Other than as set forth on SCHEDULE 5(h) hereto, neither the Company nor the Parent beneficially owns, directly or indirectly, a controlling interest in any corporation, partnership firm or association which is a competitor, customer, supplier or lessor of the Business. For purposes of this SECTION 5(h), the term 'control' shall mean the ownership of not less than five percent of the voting stock, in the case of a corporation, or not less than five percent of the voting interest, in the case of a partnership, firm or association, or otherwise the power or authority to manage, direct, service or administer the affairs of any person. (i) Except as set forth in SCHEDULE 5(i) hereto, the Company has good and marketable title to the Transferred Assets (including any patents, patent rights, copyrights, trade names, trademarks, service marks and other names and marks used in connection with the Company's operations), which assets are free and clear of all liens, pledges, charges, claims, encumbrances, proscriptions, restrictions, conditions, covenants and easements of any kind. Except as set forth on SCHEDULE 5(i), no liens, mortgages or financing statements have been filed under the Uniform Commercial Code or other similar statute on the Transferred Assets, nor has the Company signed any security agreement or similar agreement authorizing any secured party thereunder to file any such lien, mortgage or financing statement regarding the Transferred Assets. (j) Except as disclosed on SCHEDULE 5(j), substantially all modular units subject to Leases or in the Company's inventory are merchantable for lease in the ordinary course of the Company's business. The Transferred Assets include all of the Company's modular units relating to the Company's business. (k) Except as set forth on SCHEDULE 5(k): (i) except with respect to the Evelyn Shaw matter, there are currently no pending, and neither the Company nor the Parent is aware of any threatened lawsuits, mediations, arbitrations, or administrative proceedings against the Company to which the Business or any of the Transferred Assets may be or are subject; (ii) except with respect to a threatened IRS audit, neither the Company nor the Parent is aware of any investigation or review threatened by any governmental entity with respect to the Business or relating to the Transferred Assets; (iii) the Company is in compliance in all material respects with all laws and regulations with respect to, and is not subject to any currently existing order, writ, injunction or decree relating to the operations of the Business or the Transferred Assets; and 7 (iv) no court decision restrains or prohibits the consummation of the transactions contemplated hereby, and no litigation is pending seeking to restrain or prohibit or seek damages with respect to the consummation of the transactions contemplated hereby. (l) SCHEDULE 5(l) hereto contains a true and correct list or brief description of: (i) all current or pending contracts, commitments and leases (of real or personal property) written or otherwise, between the Company and any party related to the Business, and all trade names, trademarks, assumed name (fictitious name) filings and service marks used by the Company and related to the Business; (ii) all agreements related to the Business (other than those relating to trade accounts payable or receivable) pursuant to which the Company is obligated to pay or will receive in the future more than $5,000.00 annually; and (iii) all agreements or arrangements with competitors of the Company or which restrict the Company's ability to compete in the Business. The Company has delivered or made available to Purchaser, complete and current copies of all written agreements, documents, arrangements, commitments and Leases (together with all amendments thereto) referred to above or listed on SCHEDULE 5(l), indicating by notation whether, to the Company's best knowledge and belief, the consent of any person is required for the consummation of transactions contemplated hereby, or for the preventing of the termination of any material right, privilege, license or agreement of, or any loss to Purchaser upon consummation of the transactions contemplated hereby. All such written agreements, documents and Leases and, to the knowledge of the Company and the Parent, all other arrangements and commitments are in full force and effect. (m) The Company has in all material respects (except as set forth on SCHEDULE 5(m)) performed all obligations to be performed by it under all contracts, Leases, agreements and commitments to which it is a party, and, to the best knowledge of the Company and Parent, there is not under any such contract, Lease, agreement or commitment any existing default or event of default or event which, with notice or lapse of time or both, would constitute a default. (n) Neither the Company nor the Parent makes any representation with regard to the operating condition or repair of the Transferred Assets, and understands that Purchaser is purchasing the Transferred Assets based upon Purchaser's previous inspection of the Transferred Assets, and the Transferred Assets are being sold to Purchaser 'as is.' (o) To the best knowledge and belief of the Company and Parent, no toxic chemicals, hazardous wastes, radioactive wastes, hazardous constituents, non-hazardous industrial solid waste, or wastes classified by the Texas Natural Resources Conservation Commission in 30 Tex. Admin. Code 335.505-335.507 as Class 1, Class 2, or Class 3 wastes, have been deposited or disposed of in or on the modular units. To the best knowledge and belief of the Company and Parent, asbestos or similar materials which may create a potential health hazard have not been used in the construction of, or in the manufacture of the modular units. (p) The Transferred Assets are all of the properties, assets and rights (except for the Company's accounts receivable, cash and Excluded Assets) which are currently being used by the Company in the conduct of the Business. (q) The records of the Business for all periods, fairly set forth the transactions to which the Company is a party or by which its properties are bound, are accurate and complete and have been maintained consistent with good business practices. 8 (r) SCHEDULE 5(r) lists all licenses, franchises, permits and other governmental authorizations which, to the best knowledge and belief of the Company, are necessary or are legally required to conduct the Business as conducted on the date hereof, the failure of which to obtain would have a material adverse effect on the Company's business. (s) SCHEDULE 5(s) sets forth a complete and correct list of each patent, patent application, trademark (whether or not registered), trademark application, trade name, service mark, copyright and proprietary intellectual property (including without limitation, proprietary computer software, whether in object or source form) (collectively, 'Intellectual Property') owned, used or licensed by the Company which are used in the Business and a description of whether such Intellectual Property is owned or licensed by the Company. The Company is the owner of all right, title and interest in and to the Intellectual Property, has the exclusive right to use such Intellectual Property and its current use of such Intellectual Property does not infringe the rights of any other person. Neither the Company nor the Parent is aware of any facts which would render any of the patents, trademarks or trade names listed on SCHEDULE 5(s) invalid. To the best knowledge of the Company and the Parent, no person is materially infringing the rights of the Company in any such Intellectual Property. (t) All of the schedules provided by the Company or the Parent pursuant to this Agreement are true, correct and complete in all respects, and no representation, warranty or statement made by the Company and/or the Parent in or pursuant to this Agreement (including the schedules hereto) contains or will contain any untrue statement of a material fact. 6. COVENANTS The Company and the Parent, jointly and severally, covenant and agree, from and after the Closing Date: (a) to cooperate and work in good faith with Purchaser for the orderly transfer of the Transferred Assets and the Business to Purchaser; and (b) to change and, not at any time in the future, use the corporate name 'MPA Systems, Inc. ' or any name similar thereto except in the orderly transfer of the Business to Purchase. 7. INDEMNIFICATION (a) Subject to the further terms and conditions of this SECTION 7, the Company and the Parent agree, jointly and severally, to indemnify and hold Purchaser, its directors, officers, employees, agents, affiliates, attorneys, successors and assigns (each, a 'Purchaser Party') harmless from any and all losses, damages, claims, costs (excluding incidental and consequential damages and punitive damages, or expenses (including all court costs and reasonable attorneys' fees) incurred by any Purchaser Party arising from or in connection with: (i) the material breach or inaccuracy of any representations, warranties, covenants or agreements by the Company or the Parent set forth in this Agreement or in any exhibit, schedule or document delivered pursuant hereto; (ii) any obligation or liability of the Company not expressly assumed by the Purchaser pursuant to SECTION 1(b) hereof; 9 (iii) any claims by employees of the Company (whether or not employed by the Purchaser after Closing) for severance, sick leave, medical benefits (including, without limitation, any claims arising out of or relating to the Company's violation of or failure to comply with, the provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985), or other employee benefits arising out of or relating to any period prior to Closing; (iv) any fact or occurrence causing any Purchaser Party to be or become liable for any losses, damages, claims, costs or expenses, whether fixed or contingent, matured or unmatured, known or unknown, other than the Assumed Liabilities, arising out of or relating to the Company's ownership or operation of the Transferred Assets or Business in the period prior to Closing; or (v) any claim for brokerage or finder's fees or commissions or similar payments based upon any agreement or understanding alleged to have been made by any person with Company or Parent (or any person acting on their behalf) in connection with any of the transactions contemplated by this agreement. (b) Subject to the further terms and conditions of this SECTION 7, Purchaser agrees to indemnify and hold the Company and the Parent, their directors, officers, employees, agents, affiliates, attorneys, successors and assigns (each, a 'Company Party') harmless from any and all losses, damages, claims, costs (excluding incidental and consequential damages and punitive damages or expenses (including all court costs and reasonable attorneys' fees) incurred by any Purchaser Party arising from or in connection with: (i) the material breach or inaccuracy of any representations, warranties, covenants or agreements by Purchaser set forth in this Agreement or in any exhibit, schedule or document delivered pursuant hereto (subject to the period of limitations provided in SECTION 7(e)); (ii) the Assumed Liabilities; or (iii) any claim for brokerage or finder's fees or commissions or similar payments based upon any agreement or understanding alleged to have been made by any person with the Purchaser (or any person acting on Purchaser's behalf) in connection with any of the transactions contemplated by this agreement. (c) In the event of any claim for which indemnification will be sought pursuant to subsections (a) or (b) above, the party claiming the right to indemnity (the 'Claimant') shall promptly notify (but in no case later than 30 days) the indemnifying party (the 'Indemnitor') in writing of such claim, which notice shall set forth the basis of the claim for indemnity (including, without limitation, reference to the specific representation, warranty, covenant or obligation alleged to have been breached) and a reasonable estimate of the amount thereof; provided that failure to give such notice shall not affect the Indemnitor's obligations hereunder unless such failure materially prejudices the rights of the Indemnitor with respect to any third party claim. The obligations and liabilities of the parties with respect to such claims resulting from the assertion of liability by third parties ('Claims'), shall be subject to compliance by Claimant with each of the following terms and conditions: (i) Claimant will give Indemnitor notice of any Claim asserted against or imposed upon or incurred by Claimant, and Indemnitor will undertake the defense thereof by attorneys of Indemnitor's own choosing reasonably satisfactory to Claimant, and Claimant may elect to participate in such defense; (ii) in the event that Indemnitor, within 10 days after notice of any such Claim, fails to defend, Claimant will (upon further notice to Indemnitor) have the right to undertake the defense, compromise or settlement of such Claim for the account of Indemnitor; and 10 (iii) anything in this subsection (c) notwithstanding, Indemnitor shall not, without Claimant's prior written consent, settle or compromise any Claim or consent to entry of any judgment with respect to any Claim for anything other than money and damages paid by Indemnitor. Indemnitor may, without Claimant's prior written consent, settle or compromise any Claim or consent to entry of any judgment with respect to any Claim which requires solely money damages paid by Indemnitor and which includes as an unconditional term thereof the release of Claimant and all related parties and affiliates from all liability in respect to such Claim. (d) Indemnification pursuant to this SECTION 7 shall not be the sole remedy of the Claimant, and the Claimant shall in such cases be entitled to any and all remedies, whether at law or in equity, that it would otherwise have under applicable law. (e) After Closing, any claim for indemnification hereunder that is not made in writing to the party against whom indemnification is sought within twenty-four (24) months of the Closing Date shall be deemed waived, and no person shall have any remedy under this SECTION 7 against any party for indemnification; provided, however, that such actions by Purchaser against the Company and the Parent for misrepresentations in SECTION 5(c) and 5(i) may be commenced at any time that Purchaser or the Company or the Parent (as the case may be) is subject to damages with respect thereto. (f) In computing the amount of any damages to which a party shall be entitled to indemnification hereunder, the Indemnitor shall be given the benefit of any insurance proceeds which may become available to the Claimant (net of any applicable costs in collecting such insurance and additional premiums resulting from such loss). (g) The Company and the Parent shall have no liability (for indemnification or otherwise) with respect to the matters described in SECTION 7 until the total of all damages with respect to such matters exceeds $50,000 and then only for the amount by which such damages exceed $30,000. The Company and the Parent's total liability (for indemnification or otherwise) with respect to the matters described in SECTION 7 shall not exceed $500,000. However, these limitations on liability will not apply to any breach of SECTIONS 5(c) and (i), and the Company and the Parent shall be liable for all damages with respect to such breach. 8. SELLER'S COVENANT NOT TO COMPETE (a) For a period of three (3) years following the Closing Date (the 'Effective Time'), the Company and the Parent, jointly and severally, covenant and agree that they, and each of their subsidiaries (each a 'Covenantor' and jointly, the Covenantors in this SECTION 8): (i) will not directly or indirectly, own, manage, operate, join, advise, control or otherwise engage or participate in or be connected as an officer, employee, shareholder, creditor, guarantor, partner, advisor, consultant or otherwise, with any business of the type presently or historically conducted by the Company with respect to the Business (specifically including, without limitation, any activity concerning the leasing or selling of the Transferred Assets; (ii) will keep confidential all, and will not divulge to any other party (except as required by law) any, of the private, secret or confidential information of the Business or Purchaser, including, but not limited to, private, secret and confidential information relating to such matters as the Business' or Purchaser's finances, trade secrets, proprietary rights, intellectual property, methods of operation and competition, marketing plans and strategies, equipment and operational requirements and information concerning personnel, customers and suppliers; 11 (iii) will not, either for any Covenantor's own account or for any person, firm or company, solicit, interfere with or endeavor to cause any present or future employee of Purchaser to leave his employment or induce or attempt to induce any such employee to terminate or breach his employment agreement or terminate his employment with the Purchaser; or (iv) will not influence or attempt to influence any franchisee, customer or potential customer of the Purchaser to engage in activities similar to the Business. The provisions of this SECTION 8(a) are intended to benefit and be enforceable by Purchaser, its present and future affiliates and any of their assignees. (b) In the event any Covenantor violates the provisions of this SECTION 8, the running of the time period of such provisions so violated shall be automatically suspended upon the date of such violation and shall resume on the date any such Covenantor permanently ceases such violation. (c) Notwithstanding anything set forth herein to the contrary, the remedy at law for any breach of this SECTION 8 is and will be inadequate, and in the event of a breach or threatened breach by any Covenantor of any of the provisions of this SECTION 8, Purchaser shall be entitled to an injunction restraining any such Covenantor from violating any of the provisions of this SECTION 8. Nothing herein contained shall be construed as prohibiting Purchaser from pursuing any other remedies (at law or in equity) available to it for any such breach or threatened breach, including, without limitation, the recovery of damages from any such Covenantor. (d) The agreements described in this SECTION 8 shall be deemed to consist of a series of separate covenants. Each Covenantor expressly agrees that the character, duration and geographical scope of the agreements described in this SECTION 8 are reasonable in light of the circumstances as they exist on the date upon which this Agreement is executed. However, should a determination nonetheless be made by a court of competent jurisdiction at a later date that the character, duration or geographical scope of any of the agreements described in this SECTION 8 is unreasonable in light of the circumstances as they then exist, then it is the intention and the agreement of each Covenantor and Purchaser that this Agreement shall be construed by the court in such a manner as to impose only those restrictions on the conduct of each Covenantor which are reasonable in light of the circumstances as they then exist and as are necessary to assure Purchaser of the intended benefit of this SECTION 8. If, in any judicial proceeding, a court shall refuse to enforce all of the separate covenants deemed included herein because, taken together they are more extensive than necessary to assure Purchaser of the intended benefit of this SECTION 8, it is expressly understood and agreed among the parties that those of such covenants which, if eliminated, would permit the remaining separate covenants to be enforced in such proceeding shall, for the purpose of such proceeding, be deemed eliminated from the provisions hereof. (e) Purchaser's need for the protections afforded by the foregoing provisions of this SECTION 8 outweighs the burdens and any potential hardship to each Covenantor and outweighs any injury likely to the public, and such burdens do not impose any undue hardship on any Covenantor. 9. PURCHASER'S COVENANT NOT TO COMPETE (a) For a period of three (3) years following the Closing Date (the 'Effective Time'), the Purchaser covenants and agrees that it and each of its, officers and directors, (whoever they may be during said three year period and individually, each a 'Covenantor' and jointly, the 'Covenantors' in this SECTION 9): 12 (i) will not directly or indirectly, own, manage, operate, join, advise, control or otherwise engage or participate in or be connected as an officer, employee, shareholder, creditor, guarantor, partner, advisor, consultant or otherwise, with any business (not including the Business subject to this Agreement) of the type presently or historically conducted by the Company specifically including, without limitation, any activity concerning the production and sale of carriers for pneumatic transport systems or the production and sale of injection molding tools (the 'Retained Business'); (ii) will keep confidential all, and will not divulge to any other party (except as required by law) any, of the private, secret or confidential information of the Company, including, but not limited to, private, secret and confidential information relating to the Retained Business such as the Retained Business' finances, trade secrets, proprietary rights, intellectual property, methods of operation and competition, marketing plans and strategies, equipment and operational requirements and information concerning personnel, customers and suppliers; (iii) will not, either for any Covenantor's own account or for any person, firm or company, solicit, interfere with or endeavor to cause any present or future employee of Company engaged in the Retained Business to leave his employment or induce or attempt to induce any such employee to terminate or breach his employment agreement or terminate his employment with the Company; or (iv) will not influence or attempt to influence any franchisee, customer or potential customer of the Company's Retained Business to engage in activities similar to the Business. The provisions of this SECTION 9(a) are intended to benefit and be enforceable by Company, its present and future affiliates and any of their assignees. (b) In the event any Covenantor violates the provisions of this SECTION 9, the running of the time period of such provisions so violated shall be automatically suspended upon the date of such violation and shall resume on the date any such Covenantor permanently ceases such violation. (c) Notwithstanding anything set forth herein to the contrary, the remedy at law for any breach of this SECTION 9 is and will be inadequate, and in the event of a breach or threatened breach by any Covenantor of any of the provisions of this SECTION 9, Company shall be entitled to an injunction restraining any such Covenantor from violating any of the provisions of this SECTION 9. Nothing herein contained shall be construed as prohibiting Company from pursuing any other remedies (at law or in equity) available to it for any such breach or threatened breach, including, without limitation, the recovery of damages from any such Covenantor. 13 (d) The agreements described in this SECTION 9 shall be deemed to consist of a series of separate covenants. Each Covenantor expressly agrees that the character, duration and geographical scope of the agreements described in this SECTION 9 are reasonable in light of the circumstances as they exist on the date upon which this Agreement is executed. However, should a determination nonetheless be made by a court of competent jurisdiction at a later date that the character, duration or geographical scope of any of the agreements described in this SECTION 9 is unreasonable in light of the circumstances as they then exist, then it is the intention and the agreement of each Covenantor and Company that this Agreement shall be construed by the court in such a manner as to impose only those restrictions on the conduct of each Covenantor which are reasonable in light of the circumstances as they then exist and as are necessary to assure Company of the intended benefit of this SECTION 9. If, in any judicial proceeding, a court shall refuse to enforce all of the separate covenants deemed included herein because, taken together they are more extensive than necessary to assure Company of the intended benefit of this SECTION 9, it is expressly understood and agreed among the parties that those of such covenants which, if eliminated, would permit the remaining separate covenants to be enforced in such proceeding shall, for the purpose of such proceeding, be deemed eliminated from the provisions hereof. (e) Company's need for the protections afforded by the foregoing provisions of this SECTION 9 outweighs the burdens and any potential hardship to each Covenantor and outweighs any injury likely to the public, and such burdens do not impose any undue hardship on any Covenantor. 10. OFFSET In addition to any rights or remedies which Purchaser may have to assert, pursue or enforce any claim against the Company or the Parent hereunder or with respect to which the Purchaser shall be entitled to indemnification under SECTION 7 hereof or which Purchaser may otherwise possess by virtue of this Agreement or at law or in equity, Purchaser shall have the absolute right, but not the obligation, to offset any amount payable to the Company by an amount equal to any and all of such claims; provided, however, that the Purchaser shall give the Company and the Parent not less than ten (10) days written notice (the 'Offset Notice') prior to effecting any offset contemplated hereby. The Company or Parent shall notify the Purchaser in writing (the 'Dispute Notice') if the Company or Seller disputes the amount or validity of such claim (such Dispute Notice shall specify each disputed item, the amount thereof and the basis on which such dispute is asserted by the Company or Parent) within 10 days after receipt of the Offset Notice. If the Company or Parent fails to so timely deliver the Dispute Notice, the Company or Parent shall be deemed to have agreed to the offset or deduction of the amount claimed by the Purchaser as a Purchaser claim and such amount may be offset and deducted by the Purchaser without being in breach of or default under this Agreement. In the event the Company or Parent timely and properly delivers the Dispute Notice, the Purchaser agrees to deposit into the registry of a court having jurisdiction over the matter or with a suitable escrow agent the amount offset that has been disputed by the Company or Parent in such Dispute Notice until such matter has been resolved by the agreement of the Parties. 14 11. MISCELLANEOUS (a) The Company, Parent and Purchaser agree to cooperate with each of the other parties to this Agreement after Closing as may be necessary to determine if any party has received income or incurred expense which is inconsistent with the goal of the Purchaser having the costs and benefits of ownership of the Transferred Assets and Business after the Closing and the Company having the costs and benefits of ownership up to and including the Closing. Should any items be identified by any party which are inconsistent therewith, the party receiving the benefit shall promptly reimburse the other party. For purposes of determining into which time period an item of income or expense properly belongs to achieve the purpose herein stated, generally accepted accounting principles shall apply. Without limiting the number or types of reimbursements which may occur under this paragraph, the Company acknowledges that ad valorem taxes applicable to the Transferred Assets for the calendar year 1998 have partially accrued but have not yet been paid and are not due until January 31, 1999. Company will reimburse Purchaser for a portion of such taxes (prorated based on the number of days in 1998 prior to and after Closing) at the time they are due. (b) This Agreement and the related documents referenced as Exhibits or SCHEDULES hereto or otherwise expressly contemplated hereby contain the entire understanding of the parties relating to the sale of the Transferred Assets by the Company to Purchaser and supersede all prior agreements and understandings, written or oral, relating to the subject matter thereof. This Agreement cannot be modified, amended except in writing signed by the party against whom enforcement is sought. (c) Each party agrees to keep confidential the specific terms hereof, except as shall be mutually agreed on or required by law but nothing in this paragraph shall prevent either party from communicating to all interested parties that a purchase of the Business has occurred. Purchaser shall not make any announcement to the public at large without the prior written consent of the Company or the Parent. (d) The Parent, the Company and Purchaser shall each bear the attorneys', accountants', finders' or other fees, costs and expenses separately incurred by the Parent and the Company on the one hand, and the Purchaser on the other, in connection with the negotiation, execution and performance of this Agreement or any of the transactions contemplated hereunder. Notwithstanding the foregoing, the Purchaser shall bear the transfer fees, sales taxes and expenses related to such fees and taxes incurred in connection with the consummation of the transactions contemplated hereby. (e) Each of the parties to this Agreement represents to the other party that it has not incurred and will not incur any liability for brokerage or finder's fees or agents' commissions in connection with this Agreement and any of the transactions contemplated hereby, or if any party has incurred any such liability, that the party incurring such liability shall be responsible for such fees and commissions. (f) In the event attorneys' fees or other costs are incurred to require performance of any of the obligations herein provided for, or to establish damages for the breach thereof, or to obtain any other appropriate relief, whether by way of prosecution or defense, the prevailing party shall be entitled to recover reasonable attorneys' fees and costs incurred therein. (g) Each party hereto agrees to execute any and all documents, and to perform such other acts, which may be necessary or expedient to further the purposes of this Agreement or in order to more effectively convey and transfer to Purchaser any of the Transferred Assets or for aiding and assisting Purchaser in collecting and reducing to possession the Transferred Assets or exercising rights with respect hereto. 15 (h) In the period after Closing, Company and Parent shall promptly refer to the Purchaser any inquiries or requests for information from past or potential customers of the Business of which they may become aware. Purchaser shall promptly refer to the Company any inquiries or requests for information from past or potential customers of the Company of which they may become aware. (i) THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS (WITHOUT GIVING EFFECT TO THE CHOICE OF LAW PROVISIONS THEREOF). ANY SUIT, ACTION OR PROCEEDING WITH RESPECT TO THIS AGREEMENT, OR ANY JUDGMENT ENTERED BY ANY COURT IN RESPECT HEREOF MAY BE BROUGHT IN THE COURTS OF THE STATE OF TEXAS, DALLAS COUNTY, OR IN THE UNITED STATES COURTS LOCATED IN THE STATE OF TEXAS, AS THE PARTY BRINGING SUCH ACTION IN ITS SOLE DISCRETION MAY ELECT AND THE PARTIES HERETO SUBMIT TO THE EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF TEXAS, COUNTY OF DALLAS, OR IN THE UNITED STATES COURTS LOCATED IN THE STATE OF TEXAS, FOR THE PURPOSE OF ANY SUCH SUIT, ACTION OR PROCEEDING. EACH PARTY WILL ADVISE THE OTHER PROMPTLY OF ANY CHANGE OF ADDRESS. EACH PARTY HERETO HEREBY FURTHER IRREVOCABLY CONSENTS TO THE SERVICE OF PROCESS IN ANY SUIT, ACTION OR PROCEEDING IN SAID COURTS BY THE MAILING THEREOF BY CERTIFIED MAIL, RETURN RECEIPT REQUESTED, POSTAGE PREPAID, TO IT AT THE ADDRESSES SET FORTH ON THE SIGNATURE PAGE HERETO. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT BROUGHT IN THE COURTS LOCATED IN THE STATE OF TEXAS, DALLAS COUNTY, OR IN THE UNITED STATES COURTS LOCATED IN THE STATE OF TEXAS, AND HEREBY FURTHER IRREVOCABLY WAIVES ANY CLAIM THAT ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. (j) This Agreement shall be binding on, and inure to the benefit of the parties hereto and on their respective heirs, legal representatives, successors and assigns. (k) In the event any provision contained herein shall be held to be invalid, illegal or unenforceable, it shall not affect any other provision hereof, and this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein, unless to do so would cause this Agreement to fail of its essential purpose. (l) After the Closing Date, for a reasonable period of time, the Company and the Parent shall furnish to Purchaser copies of any books, records and other documents of the Company which may have been retained by the Company or the Parent following the Closing which may reasonably be required by Purchaser for tax purposes or other similar valid business purposes of Purchaser and otherwise reasonably cooperate with Purchaser, to permit Purchaser to interpret and evaluate the information so furnished. Without limiting the foregoing, the Company and the Parent covenant and agree not to destroy or otherwise dispose of any books or records of the Company, including records relating to tax information and customer files, for a period of six years following the Closing Date. (m) All notices which are required or may be given pursuant to the terms of this Agreement shall be in writing and shall be sufficient in all respects if given in writing and delivered personally or sent by registered or certified mail, postage prepaid, to the addresses set forth under the signatures of the parties hereto on the last page of this Agreement, or to such other address as any party shall request of the others in writing. All notices shall be deemed to be effective upon delivery to an agent for personal delivery or upon mailing. (n) All exhibits and schedules attached hereto are incorporated herein by reference. (o) Time is of the essence. 16 (p) This Agreement may be executed in one or more counterparts for the convenience of the parties hereto, all of which together shall constitute one and the same instrument. (q) The parties hereto will hold this Agreement and the transactions contemplated hereby in strict confidence, and will not disclose this Agreement or its contents without the prior written authorization of the other party, subject to the requirements of applicable law. All covenant and agreements in this Agreement which are intended by their terms to continue after the Closing Date, shall survive the closing of this transaction. IN WITNESS WHEREOF the parties hereto have executed this Agreement on the date first stated above. Purchaser: MPA SYSTEMS, INC. By: ---------------------------- James W. Casey, President P.O. Box 838 Sanger, Texas 76266 with a copy to: Goodall, Davison & Goldsmith, L.L.P. 1250 Capital of Texas Hwy. S., Suite 2-400 Austin, TX 78746 Attn: Anthony C. Goodall the Company: GOLSTON COMPANY D/B/A MPA SYSTEMS By: ---------------------------- Gerald K. Beckmann c/o Integrated Security Systems, Inc. 8200 Springwood Drive Suite 230 Irving, Texas 75063 with a copy to: Haynes and Boone, LLP 901 Main Street, Suite 3100 Dallas, Texas 75202 Attn: David H. Oden Parent: INTEGRATED SECURITY SYSTEMS, INC. By: ----------------------------- Gerald K. Beckmann c/o Integrated Security Systems, Inc. 8200 Springwood Drive Suite 230 Irving, Texas 75063 EX-11.1 3 COMPUTATION OF EARNINGS PER SHARE 1 Exhibit 11.1 Statement related to computation of per common share earnings. INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER COMMON SHARE (Dollars in Thousands, except per share data)
For the Six Months Ended For the Year Ended June 30, ----------------------------- ------------------------ June 30, December 31, 1998 1996 1997 1996 ----------- ------------ ---------- ----------- (Unaudited) BASIC: Shares and share equivalents: Weighted average common and common equivalent shares outstanding 8,197,392 5,122,878 7,188,764 7,615,087 Net loss $ (3,195) $ (277) $ (330) $ (436) Basic and diluted net loss per share: Continuing operations $ (0.39) $ (0.05) $ (0.05) $ (0.06) =========== ============ ========== =========== Discontinued operations -- -- -- -- =========== ============ ========== ===========
EX-21.1 4 SUBSIDIARIES OF THE COMPANY 1 Exhibit 21.1 Subsidiaries of the Company. B&B Electromatic, Inc. Golston Company, Inc. Tri-Coastal Systems, Inc. Innovative Security Technologies, Inc., name changed to Intelli-Site, Inc. on October 2, 1998. EX-23.1 5 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 Exhibit 23.1 Consent of PricewaterhouseCoopers LLP CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 33-89218) and in the Registration Statement on Form S-8 (No. 33-59870-S) of Integrated Security Systems, Inc. of our report dated August 26, 1998, except as to Notes 6 and 14, which are as of October 12, 1998 appearing on page 16 of this Form 10-KSB. PRICEWATERHOUSECOOPERS LLP Dallas, Texas October 12, 1998 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 YEAR JUN-30-1998 JUL-01-1997 JUN-30-1998 311,117 0 2,204,005 0 926,442 3,741,590 5,610,622 0 11,950,808 3,402,553 0 0 102 85,258 972,142 11,950,808 11,092,307 11,092,307 6,765,462 6,765,462 6,653,472 0 863,768 (3,188,510) 6,642 (3,195,152) 0 0 0 (3,195,152) (0.39) (0.39)
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