-----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, B8c5F4pEymfJpcSQ3mjuM8/qWkcmTZHJdb/pW6aUUVXwBh8cbw+/vxOqT0Tqf48b c0pKsx/yiZRgEsouNUaCFA== 0001158957-05-000045.txt : 20050408 0001158957-05-000045.hdr.sgml : 20050408 20050408124017 ACCESSION NUMBER: 0001158957-05-000045 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 20050408 DATE AS OF CHANGE: 20050408 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: SB-2/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-122849 FILM NUMBER: 05740866 BUSINESS ADDRESS: STREET 1: 8200 SPRINGWOOD DR STE 230 CITY: IRVING STATE: TX ZIP: 75063 BUSINESS PHONE: 9724448280 MAIL ADDRESS: STREET 1: 8200 SPRINGWOOD DR SUITE 230 CITY: IRVING STATE: TX ZIP: 75063 SB-2/A 1 formsb2a040805.txt INTEGRATED SECURITY SYSTEMS SB-2/A As filed with the Securities and Exchange Commission on April 8, 2005 Registration No. 333-122849 ________________________________________________________________________________ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- AMENDMENT NO. 1 TO Form SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------- INTEGRATED SECURITY SYSTEMS, INC. ----------------------------------------------------------- (Name of small business issuer as specified in its charter) Delaware 3669 75-2422983 ---------------------------- ------------------------- ------------------- (State or other jurisdiction (Primary Standard (I.R.S. Employer of incorporation or Industrial Classification Identification No.) organization) Code Number) 8200 Springwood Drive, Suite 230 Irving, Texas 75063 (972) 444-8280 ------------------------------------------------------------- (Address and telephone number of principal executive offices) ---------------- Copies of communications to: C.A. Rundell, Jr. David H. Oden, Esq. Chief Executive Officer Haynes and Boone, LLP 8200 Springwood Drive, Suite 230 2505 N. Plano Road, Suite 4000 Irving, Texas 75063 Richardson, Texas 75082 (972) 444-8280 (972) 739-6929 Telecopy: (972) 401-2500 Telecopy: (972) 692-9029 -------------------------------------- (Name, address and telephone number of agent for service) ---------------- Approximate date of commencement of proposed sale to public: From time to time after the effectiveness of this registration statement, as determined by the selling stockholder. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box. |X| If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. | | ___________________________ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. | | ___________________________ If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. | | ___________________________ Pursuant to Rule 416 of the Securities Act, this registration statement shall cover shares of common stock issued as a result of, among other events, stock splits, stock dividends and similar events which result in such selling stockholder holding additional shares of common stock or having the right to receive additional shares of common stock. If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. | | PROSPECTUS 85,307,479 Shares INTEGRATED SECURITY SERVICES, INC. Common Stock This prospectus covers the resale of a total of 85,307,479 shares of our common stock, par value $0.01 per share, being offered solely by the selling stockholders. Of the shares covered by this prospectus: o up to 12,086,821 shares are issuable to certain of the selling stockholders upon the conversion of convertible promissory notes; o up to 1,522,154 shares are issuable to certain of the selling stockholders upon exercise of warrants; o up to 190,000 shares are issuable to certain of the selling stockholders upon the conversion of our Series A preferred stock; o up to 706,250 shares are issuable to certain of the selling stockholders upon the conversion of our Series D preferred stock; and o up to 70,802,254 shares are currently held by the selling stockholders. We will not receive any proceeds from sales of shares by the selling stockholders. However, assuming that all of the warrants held by the selling stockholders are exercised for cash, we will realize proceeds of approximately $575,838. Our common stock is quoted on the OTC Bulletin Board, under the symbol "IZZI.OB". There is currently only a limited trading market in our common stock, and we do not know whether an active trading market will develop. On April 7, 2005, the last reported sale price for the common stock was $0.34 per share. --------------------------------- Investing in our common stock involves a high degree of risk. See the section entitled "Risk Factors," beginning on page 6. --------------------------------- NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this prospectus is April 11, 2005. TABLE OF CONTENTS PAGE Forward Looking Statements................................................1 Prospectus Summary........................................................2 Risk Factors..............................................................6 Use of Proceeds..........................................................13 Price Range of Common Stock..............................................13 Management's Discussion and Analysis or Plan of Operation................15 Business.................................................................24 Description of Property..................................................28 Legal Proceedings........................................................28 Management...............................................................29 Executive Compensation...................................................32 Certain Relationships and Related Transactions...........................34 Principal Stockholders...................................................36 Description of Securities................................................38 Selling Stockholders.....................................................42 Plan of Distribution.....................................................47 Shares Eligible for Future Sale..........................................49 Changes in Registrant's Certifying Accountant............................51 Experts..................................................................52 Legal Matters............................................................52 Additional Information...................................................52 Index to Financial Statements.......................................F Pages ------------------------------------------------------------------------ You should rely only on information contained in this document or to which we have referred you. Neither we nor the selling stockholders have authorized anyone to provide you with different or additional information. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document. You should not assume that the information in the prospectus, or incorporated herein by reference, or in any prospectus supplement is accurate as of any date other than the date on the front of those documents. ------------------------------------------------------------------------ FORWARD LOOKING STATEMENTS We caution readers that certain important factors may affect our actual results and could cause these results to differ materially from any forward-looking statements that we make in this prospectus. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements. This prospectus contains statements that constitute "forward-looking statements." These forward-looking statements can be identified by the use of predictive, future-tense or forward-looking terminology, such as "believes," "anticipates," "expects," "estimates," "plans," "may," "will," or similar terms. These statements appear in a number of places in this prospectus and include statements regarding our intent, belief or current expectations with respect to many things. Some of these things are: o trends affecting our financial condition or results of operations; o our business and growth strategies; o our technology; and o our financing plans. We caution readers that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties. In fact, actual results most likely will differ materially from those projected in the forward-looking statements as a result of various factors. Some factors that could adversely affect actual results and performance include: o meeting anticipated development schedules of our new products; o future national or regional economic and competitive conditions; o changes in relationships with our customers; o casualty to or other disruption of our production facility and equipment; o delays and disruptions in the shipment of our products; o ability to meet our stated business goals; o our future requirements for additional capital funding; o the failure of our technology and products to perform as specified; o the discontinuation of growth in the use of our products and services; o the enactment of new adverse government regulations; and o the development of better technology and products by others. You should carefully consider and evaluate all of these factors. In addition, we do not undertake to update forward-looking statements after we file this report with the Securities and Exchange Commission, which we will sometimes refer to in this prospectus as the "SEC," even if new information, future events or other circumstances have made them incorrect or misleading. 1 PROSPECTUS SUMMARY This summary highlights selected information contained elsewhere in this prospectus. We urge you to read this entire prospectus carefully, including "Risk Factors" on page 6 and our financial statements and the notes to those financial statements contained elsewhere in this prospectus. The Company We were formed in December 1991 as a Delaware corporation and became a publicly traded company in April 1993. We design, develop, manufacture, distribute and service security and traffic control products used in the commercial, industrial and government sectors. We conduct our operations through three wholly-owned subsidiaries: B&B ARMR Corporation, DoorTek Corporation and Intelli-Site, Inc. On September 5, 2003, we acquired all of the issued and outstanding shares of common stock of ARMR Services Corporation (which was later renamed B&B ARMR Corporation) in a merger transaction involving one of our wholly-owned subsidiaries. ARMR Services Corporation is a manufacturing company that engineers and manufactures high security anti-terrorist crash rated barriers, parking control equipment and other security systems for business and government use. By acquiring ARMR Services Corporation, we have significantly enhanced our services, product offerings and growth opportunities. On December 15, 2004, we acquired all of the issued and outstanding shares of common stock of DoorTek Corporation. DoorTek is a manufacturer of access control systems and other physical security system products. By acquiring DoorTek, we have significantly enhanced our services, product offerings and growth opportunities. We maintain our principal executive offices at 8200 Springwood Drive, Suite 230, Irving, Texas 75063; telephone (972) 444-8280. B&B ARMR Corporation B&B ARMR Corporation, one of our manufacturing subsidiaries, designs, manufactures and sells anti-terrorist crash barriers, warning and crash gates, HOV lane changers, navigational lighting, and perimeter security gates and operators. B&B ARMR Corporation has a customer network that includes distributors, engineering and architectural firms and local, state and federal government agencies, military, institutional and other critical infrastructure clients. DoorTek Corporation DoorTek Corporation, another of our manufacturing subsidiaries, manufactures and sells card access control and corrections security hardware and software products. DoorTek's sales and distribution channels are categorized as either dealer/distributor or direct sales to end-users. DoorTek also sells card access control cards, readers and ancillary devices. Intelli-Site, Inc. Intelli-Site, Inc., our software development subsidiary, designs and develops our Intelli-Site(R) computer software which is used for automated security systems and facility controls systems integration. This software allows a customer to decouple the selection of software from hardware so that a customer can mix and match different hardware from various manufacturers, into a single, integrated system. More specifically, Intelli-Site(R) allows customers to integrate a wide variety of devices such as access control, closed circuit television, badge systems, fire alarm systems, lighting control and heating, ventilation and air conditioning systems. The open system design provided by Intelli-Site(R) provides a solution and a control interface that is tailored to unique customer requirements. 2 Current Status We have incurred significant nonrecurring expenses concerning the integration of B&B ARMR Corporation. In addition, we have experienced unanticipated delays in the sale of our Intelli-Site(R) software product and have not met the anticipated sales levels for this product. During fiscal 2003 and 2004, and in each fiscal year since our inception, we have experienced significant losses from operations. In fact, the audit report of Grant Thornton LLP, our independent registered public accounting firm for our consolidated financial statements for the year ended June 30, 2004, has stated that losses from our operations raise substantial doubt about our ability to continue as a going concern. 3 The Offering Common Stock Offered by the Company.... None. Common Stock Offered by the Selling Stockholders........................ 85,307,479 shares, including up to 12,086,821 shares issuable upon the conversion of convertible promissory notes, up to 1,522,154 shares issuable upon exercise of warrants, up to 190,000 shares issuable upon the conversion of our Series A preferred stock, up to 706,250 shares issuable upon the conversion of our Series D preferred stock and up to 70,802,254 shares currently held by certain of the selling stockholders. Common Stock Outstanding Prior to this Offering.. 85,056,612 shares. Outstanding After this Offering..... 99,561,837 shares, including up to 85,307,479 shares of common stock covered by this prospectus. Common Stock Reserved in Connection with this Offering....... 14,505,225 shares, including 12,086,821 shares issuable upon the conversion of convertible promissory notes, 1,522,154 shares issuable upon exercise of warrants, 190,000 shares issuable upon the conversion of our Series A preferred stock and 706,250 shares issuable upon the conversion of our Series D preferred stock. Risk Factors We urge you to read the "Risk Factors" section beginning on page 6 of this prospectus so that you understand the risks associated with an investment in our common stock. 4 Summary Financial Data The summary financial data set forth below with respect to our consolidated statements of operations and cash flows for the six month periods ended December 31, 2003 and 2004 and each of the two fiscal years for the periods ended June 30, 2003 and 2004, are derived from, and should be read in conjunction with, our audited and unaudited consolidated financial statements and the notes thereto included elsewhere in this prospectus. Six Months Ended December 31, Years Ended June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Operations Data Selling, general and administrative $ 2,354,182 $ 1,617,306 $ 4,012,615 $ 2,458,407 Impairment of software development costs -- -- -- 224,900 Research and development 251,748 326,513 653,591 401,104 Interest and financing costs 360,505 664,272 1,431,126 541,324 Depreciation of property and equipment 109,694 79,665 166,038 134,954 Net loss $(1,111,623) $ (922,027) $(3,671,462) $(1,952,038) =========== =========== =========== =========== Six Months Ended December 31, Years Ended June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Cash Flows Data Net cash used in operations $(2,799,190) $ (300,381) $(2,442,069) $ (889,974) Net cash used in investing activities (292,653) (844,481) (898,850) (64,627) Net cash from financing activities 4,341,971 1,268,269 3,336,529 1,102,721 Net increase (decrease) in cash and equivalents $ 1,250,128 $ 123,407 $ (4,390) $ 148,120 =========== =========== =========== =========== At December 31, At June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Balance Sheet Data Cash and cash equivalents $ 1,422,816 $ 300,485 $ 172,688 $ 177,078 Total current assets 6,233,874 3,630,066 3,424,525 1,423,481 Property and equipment, net 608,597 629,719 681,168 481,608 Total assets 10,972,348 8,734,403 7,712,811 1,920,100 Total current liabilities 6,504,788 6,295,009 4,584,522 1,422,520 Total long-term liabilities 5,090,690 599,281 2,956,341 1,919,409 Preferred stock subject to redemption -- -- -- 7,945,052 Stockholders' equity (deficiency) $ (623,130) $ 1,840,113 $ 171,948 $(8,916,881)
5 RISK FACTORS There are many risks that may affect your investment in our common stock, including those described below. You should carefully consider these risk factors together with all of the other information. If any of these or other risks actually occur, our business, financial condition and operating results, as well as the trading price or value of our securities could be materially adversely affected and you may lose all or part of your investment. Risks Relating to Our Business We have a history of operating losses and we anticipate losses and negative cash flow for the foreseeable future. Unless we are able to generate profits and positive cash flow, we may not be able to continue our business. We incurred a net loss of $1,111,623 and negative cash flow from operations of $2,799,190 during the six months ended December 31, 2004, and a net loss of $922,027 and negative cash flow from operations of $300,381 during the six months ended December 31, 2003. We incurred a net loss of $3,671,462 and negative cash flow from operations of $2,442,069 during the year ended June 30, 2004, and a net loss of $1,952,038 and negative cash flow from operations of $889,974 during the year ended June 30, 2003. We expect net losses and negative cash flow from operations to continue for the foreseeable future and to increase significantly from current levels as we increase expenditures for: o sales and marketing; o technology; o infrastructure research and development; o the interest charges and expenses related to previous equity and debt financings; and o general business enhancement. With increased on-going operating expenses, we will need to generate significant revenues to achieve profitability. Consequently, we may never achieve profitability. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. If we are unable to achieve or sustain profitability in the future, we may be unable to continue our operations. Our independent registered public accounting firm has expressed substantial doubt about our ability to continue operating as a going concern. Our independent registered public accounting firm included an explanatory paragraph in their audit opinion for our consolidated financial statements for the year ended June 30, 2004. The paragraph states that our recurring losses from operations and resulting continued dependence on access to external financing raise substantial doubts about our ability to continue as a going concern. In addition, the factors leading to and the existence of the explanatory paragraph may adversely affect our relationship with our customers and suppliers and have an adverse effect on our ability to obtain financing. 6 Our independent registered public accounting firm has communicated a reportable condition regarding our system of internal controls. Our independent registered public accounting firm has communicated to our audit committee a reportable condition regarding our system of internal controls. They noted a reportable condition with respect to the inadequacy of staffing levels in our financial reporting function that could result in our inability to meet our financial reporting objectives. We will require additional capital to proceed with our long-term business plan. If we are unable to obtain additional capital in future years, we may be unable to proceed with our long-term business plan and we may be forced to limit or curtail our future operations. We will require additional working capital to proceed with our long-term business plan. Our working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business during the period and payment terms with our customers. There can be no assurance that adequate levels of additional financing, whether through equity financing, debt financing or other sources, will be available, or will be available when needed or on terms favorable to us. Additional financings could result in significant dilution to our existing stockholders or the issuance of securities with superior rights to our current outstanding securities. In addition, we may grant registration rights to investors purchasing future equity or debt securities. If we are unable to raise additional financing, we may be unable to grow or to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis, if at all. In addition, a lack of additional financing could force us to substantially curtail or cease operations. The loss of any of our key personnel or our failure to attract qualified management would likely have an adverse effect on our business. Our future success depends, to a significant extent, on the continued services of our key personnel. Our loss of any of these key personnel most likely would have an adverse effect on our business. At present, we have written employment agreements with these personnel but we do not have key man life insurance on them. In addition, competition for personnel throughout the industry is intense and we may be unable to retain our current key employees or attract, integrate or retain other highly qualified personnel in the future. If we do not succeed in retaining our current key employees or in attracting and motivating new personnel, our business could be materially adversely affected. The demand for our Intelli-Site(R) software product will be a significant determinant in our ability to increase sales and meet our business projections. Our marketing strategy includes the sale Intelli-Site(R), a sophisticated integrated security systems software product. We believe that the sale of our Intelli-Site(R) software product will result in higher sales and gross margins. To date, sales of this software have been limited and there can be no assurance that the market will accept the Intelli-Site(R) software product, or that we will be able to successfully market our integrated security system. Our limited ability to protect our intellectual property may adversely affect our ability to compete. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. A successful challenge to our ownership of our technology could materially damage our business prospects. Our technologies may infringe upon the proprietary rights of others. Licenses required by us from others may not be available on commercially reasonable terms, if at all. Any issued patent may be challenged and invalidated. Patents may not issue from any of our pending applications. Any claims allowed from existing or pending patents may not be of sufficient scope or strength to provide significant protection for our products. Patents may not be issued in all countries where our products can be sold so as to provide meaningful protection or any commercial advantage to us. Our competitors may also be able to design around our patents. Our competitors may assert that our technologies or products infringe on their patents or proprietary rights. Problems with patents or other rights could increase the cost of our products or delay or preclude our new product development and commercialization. If infringement claims against us are deemed valid, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our current or future patent and/or technology license positions or to defend against infringement claims. 7 The business environment is highly competitive and, if we do not compete effectively, we may experience material adverse effects on our operations. The market for our products and services is intensely competitive and we expect competition to increase in the future. We compete with large and small companies that provide products and services that are similar to many of our products and services. Our competitors may develop new products and services in the future that are perceived as more effective and/or cost efficient than our products and services. Some of our competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical and marketing resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products than we will. In addition, our competitors may have established or may establish financial or strategic relationships among themselves, with existing or potential customers, resellers or other third parties and rapidly acquire significant market share. If we cannot compete effectively, we may experience future price reductions, reduced gross margins and loss of market share, any of which will materially adversely affect our business, operating results and financial condition. Our operating results may prove unpredictable and may fluctuate significantly. Our operating results are likely to fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. Factors which may cause operating results to fluctuate significantly include the following: o new technology or products introduced by us or by our competitors; o the timing and uncertainty of sales cycles; o our success in marketing and market acceptance of our products and services by our existing customers and by new customers; o a decrease in the level of spending for security-related products and services by our existing and potential customers; and o general economic conditions, as well as economic conditions specific to users of our products and services. Our operating results may be volatile and difficult to predict. As such, future operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock may fall significantly. 8 Undetected software errors or failures found in our Intelli-Site(R) Software product may result in a loss of or a delay in market acceptance of Intelli-Site(R) which could materially adversely affect our operating results. Errors or defects in our Intelli-Site(R) software product may result in loss of revenues or delay in market acceptance and could materially adversely affect our business, operating results and financial condition. Applications such as ours may contain errors or defects, sometimes called "bugs," particularly when first introduced or when new versions or enhancements are released. Despite our testing, current versions, new versions or enhancements of Intelli-Site(R) may still have defects and errors after commencement of commercial operation. As a result of "bugs" in our software, customers may experience data loss, data corruption or other business disruption, which could subject us to potential liability. Seasonality affects our operating results. The vast majority of our revenues comes from products used primarily in outdoor construction, which is negatively affected by cold weather. We typically experience a decline in sales and operating results during the quarter ended March 31 due to weather conditions. Risks Relating to Our Common Stock and This Offering ---------------------------------------------------- Our common stock price may be volatile. The trading prices for equity securities in the stock market in general have been subject to wide fluctuations that may be unrelated to the operating performance of the particular company affected by such fluctuations. Consequently, broad market fluctuations may have an adverse effect on the trading price of our common stock. Other factors that may contribute to the volatility of the trading price of our common stock include, among others: o our quarterly results of operations; o financial predictions concerning security products companies and companies competing in our market in general, and concerning us in particular; o public announcements of technical innovations relating to our business, new products or technology by us or our competitors, or acquisitions or strategic alliances by us or our competitors; o public reports concerning our products or technology or those of our competitors; and o the operating and stock price performance of other companies that investors may deem comparable to us. There is a limited market for our common stock. If a substantial and sustained market for our common stock does not develop, our stockholders' ability to sell their shares may be materially and adversely affected. Our common stock is tradable in the over-the-counter market and is quoted on the OTC Bulletin Board. Many institutional and other investors refuse to invest in stocks that are traded at levels below the Nasdaq Small Cap Market which could make our efforts to raise capital more difficult. OTC Bulletin Board stocks are often lightly traded or not traded at all on any given day. We cannot predict whether a more active market for our common stock will develop in the future. In the absence of an active trading market: 9 o investors may have difficulty buying and selling our common stock or obtaining market quotations; o market visibility for our common stock may be limited; and o a lack of visibility for our common stock may have a depressive effect on the market price for our common stock. Shares issuable upon the exercise of options, warrants and convertible promissory notes or under anti-dilution provisions in certain agreements could dilute stock holdings and adversely affect our stock price. We have issued options and warrants to acquire common stock to our employees and certain other persons at various prices, some of which are, or may in the future have, exercise prices at or below the market price of our stock. As of February 11, 2005, we have outstanding options and warrants to purchase a total of 11,679,720 shares of our common stock. Of these options and warrants, 8,207,945 have exercise prices above the recent market price of $0.39 per share (as of February 11, 2005), and 3,471,775 have exercise prices at or below this recent market price. If exercised, these options and warrants will cause immediate and possibly substantial dilution to our stockholders. Our existing stock option plans have an aggregate of 1,044,398 shares remaining for issuance as of February 11, 2005. Future options issued under the plans may have further dilutive effects. The conversion of our convertible promissory notes will cause substantial dilution to our stockholders. The holders of our convertible promissory notes have the option of converting outstanding principal, plus accrued interest thereon, into shares of our common stock, some of which are, or may in the future, have exercise prices at or below the market price of our stock. As of February 11, 2005, we have outstanding convertible promissory notes totaling $4,618,000 to purchase a total of 12,086,842 shares of our common stock. Of these convertible promissory notes, $500,000 to purchase a total of 1,250,000 shares of our common stock, have exercise prices above the recent market price of $0.39 per share (as of February 11, 2005), and $4,118,000 to purchase a total of 10,836,742 shares of our common stock, have exercise pries at or below this recent market price. If converted, these convertible promissory notes will cause immediate and possibly substantial dilution to our stockholders. Issuance of shares pursuant to the exercise of options, warrants, anti-dilution provisions, or the conversion of promissory notes, could lead to subsequent sales of the shares in the public market, which could depress the market price of our stock by creating an excess in supply of shares for sale. Issuance of these shares and sale of these shares in the public market could also impair our ability to raise capital by selling equity securities. A large number of shares will be eligible for future sale and may depress our stock price. As of February 11, 2005, we had outstanding 85,056,612 shares of common stock. A large number of these shares are restricted securities that are eligible for sale under Rule 144 at various times. No prediction can be made as to the effect, if any, that sales of shares of common stock or the availability of such shares for sale will have on the market prices prevailing from time to time. Nevertheless, the possibility that substantial amounts of our common stock may be sold in the public market may adversely affect prevailing market prices for the common stock and could impair our ability to raise capital through the sale of our equity securities. We do not intend to pay dividends in the near future. Our board of directors determines whether to pay dividends on our issued and outstanding shares. The declaration of dividends will depend upon our future earnings, our capital requirements, our financial condition and other relevant factors. Our board does not intend to declare any dividends on our shares for the foreseeable future. 10 Our common stock is currently deemed to be a "penny stock." As a result, trading of our shares may be subject to special requirements that could impede our stockholders' ability to resell their shares. Our common stock is a "penny stock" as that term is defined in Rule 3a51-1 of the Securities and Exchange Commission because it is selling at a price below five dollars per share. In the future, if we are unable to list our common stock on NASDAQ or a national securities exchange, or the per share sale price is not at least $5.00, our common stock may continue to be deemed to be a "penny stock". Penny stocks are stocks: o with a price of less than five dollars per share; o that are not traded on a recognized national exchange; o whose prices are not quoted on the NASDAQ automated quotation system; or o of issuers with net tangible assets less than o $2,000,000 if the issuer has been in continuous operation for at least three years; or o $5,000,000 if in continuous operation for less than three years; or o of issuers with average revenues of less than $6,000,000 for the last three years. Section 15(g) of the Securities Exchange Act of 1934, as amended, and SEC Rule 15g-2, require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor's account. Moreover, SEC Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer: o to obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; o to determine reasonably, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; o to provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination under the previous bullet point; and o to receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor's financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them. Our current and former executive officers, directors and major stockholders own a significant percentage of our voting stock. As a result, they exercise significant control over our business affairs and policy. As of February 11, 2005, our current and former executive officers, directors and holders of 5% or more of our outstanding common stock together beneficially owned approximately 84.1% of the outstanding common stock if they exercised all of the warrants and convertible promissory notes held by them. These stockholders are able to significantly influence all matters requiring approval by stockholders, including the election of directors and the approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying, deterring or preventing a change in control and may make some transactions more difficult or impossible to complete without the support of these stockholders. 11 Provisions in our charter documents and Delaware law could prevent, delay or impede a change in control of us and may reduce the market price of our common stock. Provisions of our certificate of incorporation and bylaws, including those allowing our board of directors to offer preferred stock without stockholder approval and to issue preferred stock with rights more favorable than our common stock, could have the effect of discouraging, delaying or preventing a merger or acquisition that a stockholder may consider favorable. We are also subject to the anti-takeover laws of Delaware which may discourage, delay or prevent someone from acquiring or merging with us, and which may adversely affect the market price of our common stock. Please see "Description of Securities--Anti-Takeover Provisions" for more information concerning anti-takeover provisions. 12 USE OF PROCEEDS The selling stockholders will receive all of the proceeds of the sale of shares of our common stock pursuant to this prospectus. We will not receive any proceeds from the sale of shares by the selling stockholders. We will, however, receive approximately $575,838 if all of the warrants issued to the selling stockholders are exercised for cash, and we intend to use any such proceeds for general working capital purposes. PRICE RANGE OF COMMON STOCK The principal U.S. market in which our common stock is traded is the over-the-counter market. There is only one class of shares of our common stock. Our common stock is quoted on the OTC Bulletin Board under the symbol "IZZI.OB". The following table sets forth the range of high and low bid quotes of our common stock per quarter for the past two fiscal years as reported by the OTC Bulletin Board. These quotes reflect inter-dealer prices without retail mark-up, markdown or commission and may not necessarily represent actual transactions. The trading market in our common stock may at times be illiquid due to exceedingly low volume. BID ------------------ Quarter Ending High Low -------------------------------------- ------- ------- Fiscal 2005 Second Quarter........................ $ 0.46 $ 0.31 First Quarter......................... 0.51 0.36 Fiscal 2004 Fourth Quarter........................ $ 0.81 $ 0.43 Third Quarter......................... 0.68 0.34 Second Quarter........................ 0.37 0.26 First Quarter......................... 0.45 0.15 Fiscal 2003 Fourth Quarter........................ 0.23 0.14 Third Quarter......................... 0.24 0.13 Second Quarter........................ 0.27 0.19 First Quarter......................... 0.41 0.28 On April 7, 2005, the closing price of our common stock was $0.34 per share. 13 Holders As of February 11, 2005, there were o 85,056,612 shares of our common stock outstanding, o 3,650,043 warrants outstanding entitling holders thereof to purchaser 6,031,118 shares of common stock, and o 5,648,602 stock options outstanding entitling the holders thereof to purchase 5,648,602 shares of common stock. The shares of common stock are held of record by approximately 179 holders, the warrants are held of record by approximately 51 holders and the options are held of record by approximately 45 holders, including those brokerage firms and/or clearing houses holding our common stock for their clientele, with each such brokerage house and/or clearing house being considered as one holder. Dividend Policy We have never declared or paid any dividends on our common stock and currently intend to retain all future earnings, if any, for the operation and development of our business and to repay our outstanding debt. We do not intend to pay any dividends on the common stock in the foreseeable future. Equity Compensation Plan Information The following table provides information about securities that have been issued or are issuable under equity compensation plans as of June 30, 2004: ---------------------------------------------------------------------------------------------------------------- | Number of Securities | Weighted Average | Number of Securities | to be Issued upon | Exercise Price of | Remaining Available Plan Category | Exercise of | Outstanding | For Future Issuance | Outstanding Options, | Options, Warrants | Under Equity | Warrants and Rights | And Rights | Compensation Plans -----------------------------------|--------------------------|-----------------------|------------------------- Equity compensation plans | | | approved by security holders | | | -----------------------------------|--------------------------|-----------------------|------------------------- 1993 Stock Option Plan | 52,562 | $ 2.03 | 447,437 -----------------------------------|--------------------------|-----------------------|------------------------- 1997 Omnibus Stock Plan | 4,496,040 | $ 0.44 | 2,196,961 -----------------------------------|--------------------------|-----------------------|------------------------- Equity compensation plans not | | | approved by security holders (1) | 50,000 | $ 0.80 | None -----------------------------------|--------------------------|-----------------------|------------------------- TOTAL | 4,598,602 | $ 0.46 | 2,644,128 ----------------------------------------------------------------------------------------------------------------
(1) These options are vested or will vest in two years and have a ten year life. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Selected Financial Data The selected financial data set forth below with respect to our consolidated statements of operations and cash flows for the six month periods ended December 31, 2004 and 2003 and each of the two fiscal years in the periods ended June 30, 2004 and 2003, are derived from our audited and unaudited consolidated financial statements included in this prospectus. The following selected financial data should be read in conjunction with our consolidated financial statements and the notes thereto. Six Months Ended December 31, Years Ended June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Operations Data Selling, general and administrative $ 2,354,182 $ 1,617,306 $ 4,012,615 $ 2,458,407 Impairment of software development costs -- -- -- 224,900 Research and development 251,748 326,513 653,591 401,104 Interest and financing costs 360,505 664,272 1,431,126 541,324 Depreciation of property and equipment 109,694 79,665 166,038 134,954 Net loss $(1,111,623) $ (922,027) $(3,671,462) $(1,952,038) =========== =========== =========== =========== Six Months Ended December 31, Years Ended June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Cash Flows Data Net cash used in operations $(2,799,190) $ (300,381) $(2,442,069) $ (889,974) Net cash used in investing activities (292,653) (844,481) (898,850) (64,627) Net cash from financing activities 4,341,971 1,268,269 3,336,529 1,102,721 Net increase (decrease) in cash and equivalents $ 1,250,128 $ 123,407 $ (4,390) $ 148,120 =========== =========== =========== =========== At December 31, At June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Balance Sheet Data Cash and cash equivalents $ 1,422,816 $ 300,485 $ 172,688 $ 177,078 Total current assets 6,233,874 3,630,066 3,424,525 1,423,481 Property and equipment, net 608,597 629,719 681,168 481,608 Total assets 10,972,348 8,734,403 7,712,811 1,920,100 Total current liabilities 6,504,788 6,295,009 4,584,522 1,422,520 Total long-term liabilities 5,090,690 599,281 2,956,341 1,919,409 Preferred stock subject to redemption -- -- -- 7,945,052 Stockholders' equity (deficiency) $ (623,130) $ 1,840,113 $ 171,948 $(8,916,881)
15 General The audit report of Grant Thornton LLP, our independent registered public accounting firm for our consolidated financial statements for the fiscal year ended June 30, 2004, states that in fiscal 2004 and 2003, we suffered significant losses from our operations. The audit report further states that these matters raise substantial doubt about our ability to continue as a going concern. Critical Accounting Policies The preparation of our financial statements in conformity with generally accepted accounting principles in the United States requires us to: o make estimates and assumptions that affect the reported amounts of assets and liabilities; and o disclose contingent assets and liabilities We must report this information as of the date of the financial statements and we must report the amounts of revenues and expenses during the reporting period. In applying these accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties. Generally, the actual results or outcomes are different than the estimated or assumed amounts. These differences are usually minor and are included in our consolidated financial statements as soon as they are known. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results may differ materially from those estimates. Based on an assessment of our accounting policies, and the underlying judgments and uncertainties affecting the application of those policies, we believe that our consolidated financial statements fairly present in all material respects the financial condition, results of operations and cash flows of our company as of, and for, the periods presented in this prospectus. However, we do not suggest that other general risk factors, such as those discussed elsewhere in this prospectus as well as changes in our growth objectives or performance could not adversely impact our consolidated financial position, results of operations and cash flows in future periods. Significant Accounting Policies Software Development Costs Software development costs that are deemed to be recoverable are capitalized and amortized over the greater of the revenue method or the straight-line method over five years. At December 31, 2004 and 2003, software development costs had not been capitalized because of uncertainty regarding their recoverability. Accounts Receivable The majority of our accounts receivable are due from customers in the anti-terrorist crash barrier, perimeter security and road and bridge industries. Credit is extended based on evaluation of a customers' financial condition and credit history and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. We determine our allowances by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history with the customer, the customer's current ability to pay its obligations, and the condition of the general economy and the industry as a whole. We will write-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. 16 Inventories Inventories are carried at the lower of average cost or market. Inventory reserves are specifically identified by both item usage and overall management estimation. Income Taxes We account for income taxes using the liability method. 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. Goodwill Goodwill represents the excess of the purchase price over the fair value of net assets acquired. On an annual basis, we compare the fair value of our reporting units with their carrying values. If the carrying value of a reporting unit exceeds its fair value, we would recognize an impairment equal to the excess of the carrying value of the operating unit's goodwill over the fair value of its goodwill. The fair value of reporting units is estimated using the discounted present value of estimated future cash flows. Product Warranties We have one-year, two-year and five-year limited warranties on products that we manufacture. We provide for repair or replacement of components and/or products that contain defects of material or workmanship. When we use other manufacturers' components, the warranties of the other manufacturers are passed to the dealers and end users. To date, the cost of servicing and replacement of defective products has not been material. We record a liability for an estimate of costs that it expects to incur under its warranties when product revenue is recognized. Factors affecting our warranty liability include the number of units sold and historical and anticipated rates of claims and costs per claim. We periodically assesses the adequacy of our warranty liability based on changes in these factors. Results of Operations Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003 Sales. Our total sales decreased by $0.2 million, or 7%, to $3.1 million during the quarter ended December 31, 2004 from $3.3 million during the quarter ended December 31, 2003. This decrease is due to an overall reduction in sales volume at our B&B ARMR subsidiary. Gross Margin. Gross profit decreased by approximately $0.4 million during the quarter ended December 31, 2004, or 40%, compared to with the same the same quarter a year ago due to a less favorable product mix at our B&B ARMR subsidiary. 17 Selling, General and Administrative. Selling, general and administrative expenses increased by approximately $0.3 million or 27% during the quarter ended December 31, 2004 compared to the quarter ended December 31, 2003. This increase is primarily due to an increase in the professional staffing levels at our B&B ARMR subsidiary. Research and Product Development. Research and product development expenses decreased by approximately 2% during the quarter ended December 31, 2004 compared to the quarter ended December 31, 2003. This decrease is primarily due to a reduction in research and product development expenditures company-wide, which we expect will continue at these lower levels through fiscal 2005. Interest Expense. Interest expense decreased by approximately $0.2 million during the quarter ended December 31, 2004 compared to the quarter ended December 31, 2003. This decrease is due to the company no longer accreting to interest expense the value of warrants issued in conjunction with securing additional debt during the quarter ended December 31, 2003. This approximately $0.3 million decrease was offset by an increase of approximately $0.1 million of interest on additional debt that was obtained to meet working capital needs during the quarter ended December 31, 2004, coupled with our placement of $3.8 million in subordinated 10% convertible promissory notes (see Note 10 to the Company's Consolidated Financial Statements in Item 1 above). Six Months Ended December 31, 2004 Compared to Six Months Ended December 31, 2003 Sales. Our total sales increased by $1.4 million, or 28%, to $6.5 million during the six months ended December 31, 2004 from $5.1 million during the six months ended December 31, 2003. This increase is due to the inclusion of the sales of ARMR Services Corporation as a result of the merger of ARMR Services Corporation with the Company's B&B Electromatic, Inc. subsidiary into B&B ARMR Corporation in September 2003. Gross Margin. Gross profit increased by $0.2 million, or 11%, to $1.9 million during the six months ending December 31, 2004 from $1.7 million during the six months ending December 31, 2003 due to higher sales volume at our B&B ARMR subsidiary. Gross margin decreased to 30% from 35% for the same period due to a less favorable product mix at our B&B ARMR subsidiary. Selling, General and Administrative. Selling, general and administrative expenses increased by approximately $0.8 million or 12% during the six months ended December 31, 2004 compared to the six months ended December 31, 2003. This increase is primarily due to the inclusion of ARMR Services Corporation as a result of the merger with B&B Electromatic, Inc., as well as an increase in warranty costs at our B&B ARMR subsidiary due to the increased level of sales. Research and Product Development. Research and product development expenses decreased by approximately 1% during the six months ended December 31, 2004 compared to the six months ended December 31, 2003. This decrease is primarily due to a reduction in research and product development expenditures company-wide, which we expect will continue at these lower levels through fiscal 2005. Interest Expense. Interest expense decreased by $0.3 million during the six months ended December 31, 2004 compared to the six months ended December 31, 2003. This decrease is due to the company no longer accreting to interest expense the value of warrants issued in conjunction with securing additional debt during the quarter ended December 31, 2003. This approximately $0.5 million decrease was offset by an increase of approximately $0.2 million of interest on additional debt that was obtained to meet working capital needs during the quarter ending December 31, 2004, coupled with our placement of $4,118,000 in subordinated 10% convertible promissory notes (see Note 10 to the Company's Consolidated Financial Statements in Item 1 above). 18 Liquidity and Capital Resources Our cash position increased by $1.2 million during the six months ended December 31, 2004. At December 31, 2004, we had $1.4 million in cash and cash equivalents and had approximately $1.2 million outstanding under its asset based lending facility. The asset based lending facility, which is secured by accounts receivable and inventory, permits us to borrow up to $3.0 million, subject to availability under its borrowing base. This facility is discussed further in Note 9 to the Company's Consolidated Financial Statements in Item 1 above. For the six months ended December 31, 2004, our operating activities used $2.8 million of cash compared to $0.3 million of cash used in operations during the six months ended December 31, 2003, primarily due to our net loss and the increased levels of accounts receivable and inventories. We used $37,125 for the purchase of property and equipment during the six months ended December 31, 2004, compared to $0.1 million for the six months ended December 31, 2003. We anticipate capital expenditures to increase through the remainder of fiscal 2005, commensurate with increased sales. We also used $0.3 million in cash related to the acquisition of two businesses, consisting of $146,000 related to earn-out agreements executed as a part of the B&B ARMR merger transaction and $139,000 related to the purchase of DoorTek Corporation. During the six months ended December 31, 2004, we financed our operations with cash flows from borrowings of $4.5 million compared to $1.6 million during the six months ended December 31, 2003. The borrowings during the first six months of fiscal 2005 consisted of an additional $4.2 million from the issuance of subordinated 10% convertible promissory notes. See Note 10 to the Company's consolidated financial statements for a detail description of this transaction. We also borrowed an additional $0.2 million under our asset based credit facility. We made payments of $156,708 on debt and other liabilities during the six months ended December 31, 2004, compared to payments of $371,354 on debt and other liabilities during the six months ended December 31, 2003. The cash that we received from the placement of $4.2 million in subordinated 10% convertible promissory notes and availability under our asset based credit facility will be utilized to support Company-wide operations. Our working capital requirements will depend upon many factors, including future sales of our products, our operating results, the status of competitive products, and actual profits compared to our business plan. We are currently experiencing declining liquidity, which makes it difficult for us to meet our current cash requirements and may jeopardize our ability to continue as a going concern. Our auditor issued a going concern modification in their auditors' report for the fiscal year ended June 30, 2004. We intend to address our liquidity problems by controlling costs, seeking additional funding and maintaining focus on revenues and collections. In the foreseeable future, we will need to obtain additional financing either through equity placement or additional debt. There can be no assurance that we will be able to secure such financing. If our liquidity does not improve by the end of fiscal 2005, we may have to seek a merger partner, limit our operations or seek protection under the federal bankruptcy laws. Any of the foregoing options may be on terms that are unfavorable to us or disadvantageous to the our stockholders. 19 Principal payments required under long-term debt outstanding at December 31, 2004 are as follows: Year Ending June 30, ------------------------ 2005 $ 1,662,963 2006 2,869,072 2007 20,810 2008 2,477 2009 4,618,000 ----------- $ 9,173,322 Our backlog is calculated as the aggregate sales prices of firm orders received from customers less revenue recognized. At January 31, 2005, the Company's backlog was approximately $4.9 million. The Company expects that it will fill the majority of this backlog by March 31, 2006. Briar Capital Credit Facility On November 10, 2004, B&B ARMR Corporation entered into a loan agreement with Briar Capital, L.P. for a $3,000,000 discretionary demand asset based lending credit facility. Under the terms of the loan agreement, working capital advances are made available to the B&B ARMR Corporation based on the value of its accounts receivable and inventory. Although payable on demand, the loan agreement has a stated 3-year term. In connection with the loan agreement, B&B ARMR Corporation issued a revolving promissory note, dated November 10, 2004 to Briar Capital, L.P. in the principal amount of $3,000,000. The note has an annual interest rate of two percent above the prime rate but in no event will interest exceed the maximum nonusurious interest rate allowable under applicable law. Year Ended June 30, 2004 Compared to Year Ended June 30, 2003 Sales. Sales for the current fiscal year increased by approximately 96% or $4.8 million to $9.8 million in fiscal year 2004 from $5.0 million in fiscal 2003. This increase is primarily due to the acquisition of ARMR Services Corporation in September 2003. Gross Margin. Gross margin increased by $0.8 million; however, gross margin as a percentage of sales decreased to 26% in fiscal year 2004 from 36% for fiscal year 2003. The decrease in gross margin as a percentage of sales is principally due to the introduction of several new products and the related inherent manufacturing issues regarding new product introduction, as well as the consolidation of the manufacturing facilities in Norwood, Louisiana. Selling, General and Administrative. Selling, general and administrative expenses increased by 61% or $1.6 million during fiscal 2004 to $4.2 million from $2.6 million for fiscal year 2003 due primarily to the acquisition of ARMR Services Corporation and the relocation and consolidation of our manufacturing operations related to the B&B ARMR Corporation subsidiary. Software Development Costs. Software development costs of approximately $225,000 were determined to be impaired during fiscal 2003. This adjustment was due to the uncertainty of the recoverability of the costs related to the earlier version 3.5 of Intelli-Site(R), which became impaired when reasonable assurance concerning the recovery of these costs could not be ascertained. Research and Product Development. Research and development expenses increased 63% or approximately $250,000 during fiscal period 2004 due to the development and testing of several new products at the B&B ARMR Corporation subsidiary. Interest Expense. Interest expense increased by approximately $0.9 million to $1.4 million during fiscal 2004 as compared to $0.5 million during fiscal 2003. This increase is primarily due to nonrecurring and non-cash interest charges incurred that were associated with securing additional financing during fiscal year 2004. 20 Liquidity and Capital Resources Our cash position decreased $4,390 during fiscal year 2004. At June 30, 2004, we had $172,688 in cash and cash equivalents and $850,622 outstanding under our accounts receivable factoring facility, which was in place at such time. This accounts receivable factoring facility is explained in greater detail below in this section. For the fiscal year ended June 30, 2004, our operating activities used $2,267,652 of cash compared to $889,974 cash used during the fiscal year ended June 30, 2003, an increase of $1,377,678. This $1,377,678 increase in cash used in operating activities in fiscal 2004 is primarily due to the increase in net loss offset in part by the effect of the level of investment in working capital and the effects of the ARMR Services Corporation acquisition. We used $266,626 for the purchase of property and equipment during fiscal 2004 compared to $64,627 for the previous fiscal 2003 period. This increase is due to an increase in the amount of overall capital expenditures at B&B ARMR Corporation. We do not have any material commitments to purchase property and equipment in fiscal 2005. We do not have any material funding requirements for software and other products under development. Maturities and Commitments The following table presents certain of our obligations and commitments to make future payments, excluding interest payments, under contracts and contingent commitments as of June 30, 2004. Debt Leases Total ----------- ----------- ----------- 2005 $ 1,845,949 $ 233,429 $ 2,079,378 2006 2,437,137 59,135 2,496,272 2007 16,727 27,134 43,861 2008 2,477 -- 2,477 2009 500,000 -- 500,000 ----------- ----------- ----------- $ 4,802,290 $ 319,698 $ 5,121,988 =========== =========== =========== Issuances of Convertible Promissory Notes and Promissory Notes in Fiscal 2004 In exchange for a $500,000 cash investment, on September 5, 2003, we issued a convertible promissory note to BFS US Special Opportunities Trust PLC, which we will sometimes refer to as "BFS," a public limited company registered in England and Wales. The convertible promissory note is in the original principal amount of $500,000 and has an annual interest rate of 7% and is payable in monthly installments on the first day of each month. The convertible promissory note, plus interest, is due on September 5, 2008. The convertible promissory note is convertible at the option of BFS into our common stock at a conversion price of $0.40 per share. We have the right to call the convertible promissory note if the market price of our common stock rises above $0.60 per share for a period of 60 days. 21 In exchange for a $100,000 cash investment, on September 26, 2003, we issued a promissory note to C. A. Rundell, Jr., Chairman and Chief Executive Officer of the Company. The promissory note is in the original principal amount of $100,000 and has an annual interest rate of 7%. The promissory note, plus accrued interest, was due on April 1, 2004. The due date of this note was extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. In exchange for a total $400,000 cash investment, on October 1, 2003, we issued a promissory note to each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. Each of the two promissory notes is in the original principal amount of $200,000 and has an annual interest rate of 7%. The promissory notes, plus accrued interest, were due on April 1, 2004. The due date of these notes was extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. Issuances of Convertible Promissory Notes in Fiscal 2005 On November 30, 2004, we entered into a loan agreement with several investors of the company's subordinated 10% convertible promissory notes. Each of the investors purchasing these notes was an accredited investor. Pursuant to the terms of the loan agreement: (1) the company was authorized to sell to the investors an aggregate principal amount of up to $6,000,000 in notes and (2) the notes may be sold by the company to the investors in multiple closing so long as the final closing is consummated no later than the fifteenth day following the initial closing. As of the close of the sale, we sold an aggregate principal amount of $4,118,000 of the notes. Each note sold by the company to each investor: o is subordinated to certain other indebtedness of the company; o is due and payable on November 30, 2009; o provides interest to the holder thereof at a rate of 10% per annum; and o is convertible into the company's common stock, par value $0.01 per share, at the conversion rate of $0.38 per share of common stock. In exchange for an aggregate of $150,000 cash, on July 28, 2004, we issued a promissory note to C. A. Rundell, Jr. The original promissory note was in the principal amount of $150,000, had an annual interest rate of 9% which was due at maturity and was secured by a specific invoice of B&B ARMR Corporation issued to Horne Engineering. The promissory note, plus accrued interest, was due on October 28, 2004. In November of 2004, this note was exchanged for a $150,000 subordinated 10% convertible promissory note as a part of our placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes. In exchange for a $1,000,000 cash investment, on August 5, 2004, we issued a convertible promissory note to BFS. The original convertible promissory note was in the principal amount of $1,000,000 and had an annual interest rate of 10% and was payable in monthly installments on the first day of each month. The original convertible promissory note, plus interest, was due on August 5, 2009. The convertible promissory note was convertible at the option of BFS into our common stock at a conversion price of $0.38 per share. We had the right to call the convertible promissory note if the market price of our common stock rose above $0.60 per share for a period of 60 days. This convertible promissory note was subsequently refinanced as a part of our placement of placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes in November 2004. 22 Effects of Inflation We believe that the relatively moderate rate of inflation over the past few years has not had a significant impact on our sales or operating results. Seasonality Historically we have experienced seasonality in our business due to fluctuations in the weather. We typically experiences a decline in sales and operating results during the quarter ended March 31 due to winter weather conditions. Environmental Matters We believe that we are currently in material 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. Additional Debt Service Obligations During the fiscal year ended June 30, 2004, we financed our operations with long-term borrowings of $2,338,117. We made payments of $938,153 on debt in the fiscal year ended June 30, 2004. As discussed in this prospectus in the section entitled "Description of Property," we have a mortgage on B&B ARMR Corporation's facility. At December 31, 2004, the principal amount of the mortgage was $503,943. The interest rate is 10.5% and the amortization provisions are standard. The mortgage matured on February 8, 2004 and was refinanced with a new maturity date of February 26, 2006. All other terms and conditions of the original mortgage remained the same. 23 BUSINESS General We were formed in December 1991 as a Delaware corporation and became publicly traded in April 1993. We design, develop, manufacture, distribute and service security and traffic control products used in the commercial, industrial and government sectors through three wholly-owned subsidiaries, B&B ARMR Corporation, DoorTek Corporation and Intelli-Site, Inc. On September 5, 2003, we acquired all of the issued and outstanding shares of common stock of ARMR Services Corporation. ARMR Services Corporation, which has been renamed B&B ARMR Corporation, is a manufacturing company that engineers and manufactures high security anti-terrorist crash rated barriers, parking control equipment and other security systems for business and government use. By acquiring B&B ARMR, we have significantly enhanced our service, product offerings and growth opportunities. As a part of the consideration that we paid for ARMR Services Corporation, we issued 10,000,000 shares of our common stock to B&B ARMR's former stockholders. On December 15, 2004, we acquired all of the issued and outstanding shares of common stock of DoorTek Corporation. DoorTek is a manufacturer of access control systems and other physical security system products. By acquiring DoorTek, we have significantly enhanced our services, product offerings and growth opportunities. B&B ARMR Corporation B&B ARMR designs, manufactures and sells anti-terrorist crash barriers, bollards, wedges and gates, warning and crash gates, gate panels, soft-stop gates, high occupancy vehicle lane changers, navigational lighting, and perimeter security gates and operators. A 24/7 service and maintenance group is based in Washington, DC, servicing and maintaining a wide range of internally and competitor's manufactured products for federal and government organizations. These products compete primarily in the homeland security, perimeter security and road and bridge construction and refurbishment markets. These products are used for: o anti-terrorist crash barriers used to prevent malevolent use of vehicles; o 24/7 service and maintenance for competitors and internally manufactured products; o operators and gates used in perimeter security; o navigational lights used primarily with waterways; o tow-able barriers for event and temporary closures; o gating and barricading movable bridges; o locking down sections of roads under construction; o gates for reversible lane changer systems; and o HOV control gates, typically soft-stop. B&B ARMR sells its products through integrators, contractors, electrical sub-contractors and distributors. B&B ARMR maintains Governmental Services Administration, or GSA, schedule agreements for three product families, and license agreements both in North America and internationally. In certain instances, sales are made directly to end-users. New Business In the last two fiscal years, B&B ARMR has experienced a substantial increase in the sales of its anti-terrorism and crash-rated products not only with the new product range from ARMR, but also with the established products of B&B Electromatic, Inc. Sales also have increased within the fairly stable road and bridge sector. New and increased interest in soft-stop technology has developed, as well as an increase in the overseas business. 24 During fiscal year 2004, several new products were designed, tested and released by B&B ARMR, such as: o A portable/tow-able anti-terrorist crash barrier, Model 850 (a number of these products have been manufactured and shipped); o A new anti-terrorist bollard product, Model B-40; and o Two new products in the XL product line of hydraulic gate operators, LXL and PXL, both tested to UL325 class 1, 2, 3 and 4 specifications. These new operators offer a wider range of products, enabling us to be more competitive. The LXL has seen high volume sales in part due to reduced need for technical assistance. The 24/7 service and maintenance group has seen an increasing volume of requests for its services, operating in and around Washington, DC, where there is a large concentration of customers. This group offers front line maintenance of our own and our competitor's products as well as third party products, frequently on an annual contract basis. DoorTek Corporation DoorTek Corporation is a manufacturer of card access control and corrections security hardware and software products. DoorTek's product offerings fall into two broad categories: The DT2001 access control product line, and the DoorTek Corrections Electronics product line. These two product lines may be sold separately or as part of a complete, integrated, corrections electronics control package. Additionally, DoorTek supports a thriving business in card access control devices, readers, and ancillary devices. The DT2001 access control system was designed from the ground up to provide a powerful, user friendly operations and administration platform within an advanced, networked environment. A key component of the DT2001 system is the advanced NP200 node processor that provides high-speed distributed processing for all user transactions and can operate independent of the host control network without degradation in performance. The system is completely scalable, supporting anywhere from two access control portals up to thousands of portals, input/output points and other security-related devices. DoorTek has also adopted a specially-branded and enhanced version of the Intelli-Site(R) software product that provides the DT2001 system with the ability to integrate with a broad range of security products, including closed circuit television, badge systems, fire alarm systems, lighting control and heating, ventilation and air conditioning systems. DoorTek Corrections Electronics products include stand-alone door control with optional interlock capabilities, a line of net-workable door/gate controllers that can be integrated into any cell control system, a similar line of corrections audio control products that can route intercom audio throughout a facility, and a complete line of cable interface devices that facilitate interconnection wiring in the field. DoorTek enjoys a strong existing installation base from which a regular flow of retrofit and upgrade business is derived. Many DoorTek systems have been installed and have been online continuously for more than 10 years. An example is the DoorTek access control system installed, and still in full operation after 14 years, at the CARA laboratory at the USNSF station at McMurdo Sound, Antarctica. 25 Intelli-Site, Inc. Our Intelli-Site(R) software product, designed and developed by Intelli-Site, Inc., allows automated security and facility controls system integration. This software allows a customer to decouple the selection of software from hardware, so that a customer can mix and match different hardware, from various manufacturers, into a single, integrated system. The open system design provided by Intelli-Site(R) provides a solution that is tailored to unique customer requirements. More specifically, Intelli-Site(R) allows customers to integrate a wide variety of devices from various manufacturers, such as access control, closed circuit television, badge systems, fire alarm systems, lighting control and heating, ventilation and air conditioning systems. In addition to providing centralized control, Intelli-Site(R) users can tailor the interface for ease of operation based on their unique functional requirements. No two companies, facilities or workgroups are identical, so each has different security requirements. Intelli-Site(R), while a standard product, allows users to define the following aspects of a security system: o Configuration - what is to be integrated; o Graphical User Interface (GUI) - how the operator controls the system; o Functionality - what the system does; and o Databases - what and how data is stored. In the past, only a custom-designed system could provide this level of user-specific features. Other standard software products either cannot be tailored or attempt to provide limited "customization" through a fixed set of user options. With Intelli-Site(R), user-defined restrictions are limited only by the capabilities of the integrated devices. Product Design and Development As of December 31, 2004, we have four employees dedicated to research, development and product engineering. We spent $653,591 and $626,004 during fiscal 2004 and 2003, respectively, related to the continual development and enhancement of the Intelli-Site(R) software product as well as the development of several new product lines in the anti-terrorist crash barrier and perimeter security divisions at B&B ARMR. Competition B&B ARMR Corporation B&B ARMR's competition can be divided into four categories: Anti-terrorism, hydraulic gate operators, road and bridge and 24/7 service and maintenance. Anti-terrorism competition has, we believe, increased over fiscal year 2004 as the market has grown worldwide. B&B ARMR is not as large as the two main competitors (Delta Scientific and Nasatka Barriers) in the marketplace, but B&B ARMR is growing in this market sector and is using its years of engineering experience in this area to help secure that growth. In the hydraulic gate operator business, B&B ARMR has one main competitor (Hy Security) and its new product lines offer a growth platform to increase market share in the future. B&B ARMR has one principle competitor (Roadyway) in the road and bridge business, and has continually maintained its market share. B&B ARMR has a unique position within the 24/7 service and maintenance business; however, we believe others may enter this market. 26 DoorTek Corporation DoorTek's competitors include manufacturers of card access control and detention control equipment. Card access control manufacturers tend to compete on terms of scalability and within vertical markets. In terms of scalability, most manufacturers concentrate on the small to mid sized installation (up to 32 doors). There are relatively few players in the large installation market (32 to 256 doors) and even fewer in the "enterprise" market (more than 256 doors). DoorTek's technology allows it to participate at any level, but its offerings are largely concentrated in the small to mid range. Increasingly, DoorTek has been successful in the corrections and detention markets at the mid range. DoorTek's longevity of more than 25 years in the business and its large existing installation base provides it with some advantage in the retrofit and upgrade markets. Intelli-Site, Inc. Many companies across the industry use the term "integrated security system" to describe their products and services. In fact, an integrated security system can range from very limited fixed function systems "integrating" as few as two sub-systems to feature-rich, real-time sophisticated software systems, including custom coded integrated solutions. Differences in functionality, performance, and price among integrated security systems vary greatly. Intelli-Site(R) has the capability to compete across the entire spectrum of integrated security systems, but currently has less than a 1% share of this market. Consequently, Intelli-Site(R) has a diverse set of competitors, depending on the complexity of the integration effort. Intelli-Site(R)'s competitors generally fall into one of three categories: Access control manufacturers, "pure" integrated systems platforms and custom software developers. Through our three subsidiaries, we face intense competition in the security industry. Some of our competitors are large, well-financed and established companies that have greater name recognition and resources for research and development, manufacturing and marketing than us. These competitors may be better able to compete for market share. Employees As of December 31, 2004, the Company employed 101 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. 27 DESCRIPTION OF PROPERTY Our principal executive offices are located at 8200 Springwood, Suite 230, Irving, Texas 75063, where we occupy 5,566 square feet of office space. The lease for the Irving facility expires on December 31, 2006. The monthly rent of this lease is $4,406, plus the costs of utilities, property taxes, insurance, repair and maintenance expenses and common area utilities. B&B ARMR Corporation maintains its principal location at 14113 Main Street, Norwood, Louisiana 70761, where it occupies approximately 26,000 square feet of manufacturing and office space on five acres of land. We have purchased this property subject to a mortgage agreement with the Highlands Bank. At December 31, 2004, the principal amount of the mortgage was $503,943 and we make a monthly payment in the amount of $10,561 on the mortgage. The interest rate payable on the mortgage is 10.5% per year and the amortization provisions are standard for a property of this nature. The mortgage matured on February 8, 2004 and was refinanced with a new maturity date of February 26, 2006. All other terms and conditions of the original mortgage remained the same. B&B ARMR Corporation also occupies manufacturing and office space located at 9045, 9047 and 9063 Jerry's Circle, Manassas, Virginia 20110, having an aggregate office space of 16,650 square feet. The monthly amount of rent for these properties is $12,080 and the lease for these properties expires in May 2005. DoorTek Corporation maintains its principal location at 9107 Marbach Road, Suite 230, San Antonio, Texas 78245, where it occupies 2,105 square feet of office space. The monthly amount of rent for this property is $1,717 and the lease is on a month-to-month basis. We believe that the Texas, Louisiana and Virginia properties are in good condition and that the properties, equipment, fixtures and other assets located within each of our facilities are in good condition, are adequately insured against loss and that suitable alternative facilities are readily available if the lease and mortgage agreements described above are not renewed. Additionally, we believe that our existing facilities are suitable and adequate to meet our current requirements. We do not make investments in: o real estate o interests in real estate o real estate mortgages; or o securities of or interests in entities engaged in real estate investment activities. LEGAL PROCEEDINGS We are subject to certain legal actions and claims arising in the ordinary course of our business and which we consider to be routine litigation incidental to our business. Although our management recognizes the uncertainties of litigation, based upon the dollar amounts involved, the nature and our management's understanding of the facts and circumstances which give rise to such actions and claims, our management believes that such litigation and claims will be resolved without material effect on our financial position, results of operations or cash flows. 28 MANAGEMENT The following table sets forth information regarding our directors and executive officers as of December 31, 2004: Company Officers and Directors Name Age Position ------------------------ --- -------------------------------------------- C.A. Rundell, Jr. 72 Director, Chairman of the Board of Directors and Chief Executive Officer Peter Beare 47 Director and President William D. Breedlove 64 Director Russell Cleveland 65 Director Robert M. Galecke 62 Director Frank R. Marlow 66 Director Paul Roland 47 Director Richard B. Powell 40 Vice President, Chief Accounting Officer, and Secretary C. A. RUNDELL, JR. has been a Director since March 1999 and has served as Chief Executive Officer since August 2000. Mr. Rundell is also Chairman of the Board of Directors of both Intelli-Site, Inc. and DoorTek Corporation. Since 1988, Mr. Rundell has owned and operated Rundell Enterprises, a sole proprietorship engaged in providing acquisition and financial services to business enterprises. From October 1996 until December 1998, Mr. Rundell served as the Chief Executive Officer of Tyler Corporation. From April 1989 until July 2000, Mr. Rundell served as a director and the Chairman of the Board of NCI Building Systems, Inc. Mr. Rundell currently serves as a director of Renaissance US Growth Investment Trust, PLC. He is also a director of Tandy Brands Accessories, Inc., a designer, manufacturer and marketer of men's, women's and children's fashion accessories. Mr. Rundell earned an M.B.A. with Distinction from Harvard University and a B.S. in Chemical Engineering from The University of Texas at Austin. PETER BEARE has been a Director since June 2002. Mr. Beare is currently the Chairman of the Board of Directors of B&B ARMR Corporation. Mr. Beare was the President and Chief Operating Officer of Ultrak, Inc. from July 2000 until March 2002 and was the Vice President - Technology of Ultrak from May 2000 to July 2000. From April 1994 to May 2000, he was employed by Baxall Ltd. in the United Kingdom (UK), a subsidiary of Upperpoint, in various capacities, including Managing Director, and later joined the main board of Upperpoint as Technology Director. Prior to Baxall, Ltd., Mr. Beare was a consultant to various companies in the communications and audio industries. From 1986 to 1990, Mr. Beare was the founder and Director of Camteq, Ltd. in the UK. WILLIAM D. BREEDLOVE has been a Director since May 2001. Mr. Breedlove has served as President of HBW Investments, Inc., a private investment firm, since August 1996. Mr. Breedlove has held senior management positions in commercial and merchant banking for over 30 years. Prior to HBW's formation in 1996, Mr. Breedlove was chairman, managing director and co-founder of Breedlove Wesneski & Co., a private merchant banking firm. From 1984 to 1989, Mr. Breedlove also served as president and director of Equus Capital Corporation, the corporate general partner of three public and private limited partnerships operating as management leveraged buyout funds. Mr. Breedlove's experience also includes 22 years at First National Bank in Dallas, the last three years of which he served as chairman and chief executive officer of the lead bank and vice chairman of InterFirst Corporation. Mr. Breedlove currently serves as a director of NCI Building Systems, Inc., and five private companies. He has previously served as director of several other publicly-held companies, including InterFirst Corporation, Texas Oil and Gas Corporation, Dillard's Department Stores, Local Financial Corporation, and Cronus Industries, Inc. Mr. Breedlove received his B.B.A. degree in finance and banking from the University of Texas at Austin. 29 RUSSELL CLEVELAND has been a Director since February 2001. Mr. Cleveland is the President, Chief Executive Officer, sole Director and the majority shareholder of Renn Capital Group, Inc. He has served as President, Chief Executive Officer and director of Renaissance Capital Growth & Income Fund III, Inc. since its inception in 1994. Mr. Cleveland is a Chartered Financial Analyst with more than 41 years experience as a specialist in investments for smaller capitalization companies. Mr. Cleveland has also served as President of the Dallas Association of Investment Analysts. He serves on the Boards of Directors of Renaissance US Investment Trust PLC, BFS US Special Opportunities Trust PLC, CaminoSoft Corp., Cover-All Technologies, Inc. and Digital Recorders, Inc., and is the chairman of Tutogen Medical, Inc. Mr. Cleveland is a graduate of the Wharton School of Commerce and Finance of the University of Pennsylvania. ROBERT M. GALECKE has been a Director since May 1996. Mr. Galecke is currently Senior Vice President of Finance and Administration for the University of Dallas. Prior to that, from 1993 to May 1996, he was a principal in the corporate consulting firm of Pate, Winters & Stone, Inc. From 1986 until 1992, he served as Executive Vice President, Chief Operating Officer and Chief Financial Officer of Southmark Corporation, a financial services insurance and real estate holding company. From 1989 to 1995, Mr. Galecke served as Chairman of the board, President and Chief Executive Officer of National Heritage, Inc. Mr. Galecke received a graduate degree from the School of Banking at the University of Wisconsin, Madison, and a B.S. in Economics from the University of Wisconsin at Stevens Point. FRANK R. MARLOW has been a Director since May 1995. Mr. Marlow served as Vice President, Sales and Marketing from October 1993 to February 1995. Mr. Marlow has been Vice President of Sales, Western Region, for ACI, a publicly traded company headquartered in Omaha, Nebraska since March 2003. ACI sells electronic payments engines to banks, credit card companies, large payment processors and merchant processors with over 600 customers around the world. In addition, Mr. Marlow is currently a Senior Partner with SMI Consulting, a sales and marketing consulting firm. Mr. Marlow was Vice President of Sales for Cofiniti, formerly Money Star, a technology company based in Austin, Texas from 1998 until 2001. From 1995 until 1998, Mr. Marlow was Vice President of Hogan Systems, a publicly traded company subsequently purchased by Computer Sciences Corp. Previously, Mr. Marlow served in various executive sales and training positions at IBM, Docutel Corporation, UCCEL Corporation and Syntelligence Corporation. PAUL ROLAND has been a Director since September 2003. Mr. Roland was appointed President of B&B ARMR Corporation in September 2003 and was Vice President of ARMR Services Corporation until September 2003. Mr. Roland was a founder of ARMR Services Corporation in 1998 and prior to that time served as a Vice President of a competitor in the vehicle barrier business. From 1986 until 1998, Mr. Roland was responsible for the formation of the federal sales and service office in Washington, DC. Mr. Roland worked as an engineer supporting the missions of the United States Department of State from 1984 through 1986. RICHARD B. POWELL, is currently the Vice President, Chief Accounting Officer and Secretary. Mr. Powell joined our company in April 1998 as Corporate Controller, became Vice President, Chief Accounting Officer in April 2001, and Secretary in May 2001. Prior to joining our company, Mr. Powell was the Accounting Manager at Medical City Dallas Hospital from 1995 to 1998, Accounting Manager of HealthCor, Inc., a home health care company, from 1993 to 1995 and Accounting Supervisor of Signature Home Care Group, Inc., a home health care company, from 1989 to 1993. Mr. Powell holds a B.S. in Accounting from McNeese State University. 30 Company's Subsidiaries Officers Name Age Position -------------------------- --- ------------------------------------------- Theodore "Ted" Wlasowski 50 Chief Executive Officer of B&B ARMR Corporation Robert "Kent" Mansfield 42 Vice President, Chief Operating Officer and Chief Financial Officer of B&B ARMR Corporation Robert "Bob" Gardner 70 President of DoorTek Corporation G.M. "John" Ulibarri 46 President and Chief Executive Officer of Intelli-Site, Inc. THEODORE "TED" WLASOWSKI is the Chief Executive Officer of B&B ARMR Corporation. Mr. Wlasowski joined the company in January 2004 and became the chief executive officer of B&B ARMR in October 2004. Prior to joining our company, from 2001 to 2004, Mr. Wlasowski served as Chief Executive Officer, President and Chief Operating Officer of Isotag. From 1998 to 2000, Mr. Wlasowski served as Executive Vice President and COO of Ultrak, Inc. Mr. Wlasowski graduated Magna Cum Lade from Seton Hall University in 1976 with a B.S. in Business Administration. ROBERT "KENT" MANSFIELD is the Vice President, Chief Operating Officer and Chief Financial Officer of B&B ARMR Corporation. Mr. Mansfield joined our company in January 2005. Prior to joining our company, from 1995 to 2004 Mr. Mansfield has held various other positions as CFO, COO and other executive level positions in both private and public companies. Mr. Mansfield received a B.B.A. in Finance from Texas Tech University in 1994. ROBERT "BOB" GARDNER is the President of DoorTek Corporation. Mr. Gardner joined our company in December 2004, when we acquire DoorTek. Mr. Gardner has served as the President of DoorTek since 1998. Prior to his employment at DoorTek, Mr. Gardner held senior management and sales positions with EO-Integrated Systems, Xetron Corporation, Kidde Automated Systems and Dukane Automated Systems, Inc. G.M. "JOHN" ULIBARRI, is the President and Chief Executive Officer of Intelli-Site, Inc. Mr. Ulibarri joined our company in April 2001 as Vice President of Engineering and Operations, was promoted to Executive Vice President in December of 2002, and President in January of 2004. Prior to joining our company, Mr. Ulibarri served in various senior management and engineering positions with major security and communications systems integration concerns throughout the US. Mr. Ulibarri holds a B.S. in Computer Engineering from the University of New Mexico. The SEC has adopted rules to implement certain requirements of the Sarbanes-Oxley Act of 2002 pertaining to audit committees. One of the rules adopted by the SEC requires a company to disclose whether it has an "audit committee financial expert" serving on its audit committee. Based on its review of the criteria of an audit committee financial expert under the rules adopted by the SEC, our board of directors has determined that Mr. Galecke is an "audit committee financial expert," as that term is defined in Item 401(e) of Regulation S-B promulgated by the Securities and Exchange Commission. 31 EXECUTIVE COMPENSATION Summary Compensation Table The following table shows the compensation of the Chief Executive Officers and the executive officers of the company and its subsidiaries whose compensation exceeded $100,000 for the fiscal years ended June 30, 2004, 2003 and 2002. Long-Term Annual Compensation Compensation Award ----------------------------------------- ------------------------ Securities Other Restricted Underlying Annual Stock Options/ Name and Principal Position Year Salary Bonus Compensation Awards SARs ----------------------------- ---- -------- ----- ------------ ---------- ---------- C. A. Rundell, Jr. 2004 $ 50,000 -- -- 28,433 300,000 Chairman of the Board and 2003 50,000 -- -- 41,753 23,298 Chief Executive Officer 2002 24,000 -- -- -- 596,518 Peter Beare 2004 $185,500 -- -- -- 450,000 Chief Executive Officer 2003 22,250 -- -- -- 100,000 B&B ARMR Corporation (1) Paul Roland 2004 $104,500 -- -- -- -- President B&B ARMR Corporation (2) Scott Rosenbloom 2004 $104,500 -- -- -- -- Executive Vice-President B&B ARMR Corporation (2) Jack G. Caldwell 2004 $ 13,375 -- -- -- -- President 2003 160,500 -- -- -- -- B&B Electromatic, Inc. (3) 2002 160,000 -- -- -- -- Lars H. Halverson 2004 $ -- -- -- -- -- President 2003 -- -- -- -- -- Intelli-Site, Inc. (4) 2002 70,417 -- -- -- 100,000 --------------------
(1) Began employment on May 19, 2003. (2) Began employment on September 5, 2003. (3) Resigned as of July 31, 2003. (4) Began employment on January 16, 2001 and resigned as of January 15, 2002. No other executive officer's salary and bonus exceeded $100,000 annually and no executive had any form of long-term incentive plan compensation arrangement with the company during the fiscal years ended June 30, 2004, 2003 and 2002. 32 Stock Option Grants The following table provides information concerning the grant of stock options during the twelve months ended June 30, 2004 to the named executive officers: Number of % of Total Options/SARs Securities Underlying Granted To Employees Exercise Expiration Name Options/SARs Granted In Fiscal Year Price Date ---------------------- --------------------- ----------------------- ----------- ---------- C. A. Rundell, Jr. (1) 300,000 18.83% $ 0.45 09/05/13 Peter Beare (1) 250,000 15.69% $ 0.45 09/05/13 Peter Beare (1) 200,000 12.55% $ 0.30 12/05/13 ----------------------
(1) The vesting schedule for these options is: 25% six months from the grant date and 25% each year thereafter. Option Exercises and Holdings The following table provides information related to the number of shares received upon exercise of options, the aggregate dollar value realized upon exercise, and the number and value of options held by the named executive officers of the company at June 30, 2004. Number of Securities Value of Unexercised Underlying Unexercised In-The-Money Options/SARs Options/SARs At At Fiscal Year End Fiscal Year End ---------------------------- ---------------------------- For the 12 Months Ended 06/30/04 Exercisable Unexercisable Exercisable Unexercisable -------------------------------- ----------- ------------- ----------- ------------- C. A. Rundell, Jr. 870,927 362,500 $ 232,232 $ 59,125 Peter Beare 162,500 387,500 43,000 86,000 Gerald K. Beckmann 314,473 -- -- --
Employment Agreements As a part of the acquisition of ARMR Services Corporation on September 5, 2003, we entered into employment agreements with Paul Roland and Scott Rosenbloom, the former executive officers of ARMR Services Corporation. The employee agreements are for a period of three (3) years at a base salary of $125,000 per year. As a part of Mr. Roland's employment agreement, Mr. Roland was granted a seat on our board of directors. Director Compensation Currently, directors are compensated by either restricted stock awards or incentive stock options, at the choice of the individual director, in an amount equivalent to $10,500 annually for serving on the board in addition to $1,250 for each committee on which they serve. All directors are reimbursed for their out-of-pocket expenses incurred in connection with their attendance at board meetings. 33 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The following table summarizes the promissory notes that we issued during fiscal year ended 2003. Each of the recipients of these notes were, and continue to be, holders of greater than five percent of our common stock. These notes are not convertible and accrue interest at a rate of 8% per year. The form of each of these non-convertible promissory notes is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2003. As a part of each of the transactions detailed in the table below, we issued stock purchase warrants. Each of the stock purchase warrants entitles the holder to purchase from the us, at any time, and in whole or in part, shares of our common stock, as indicated in the table below, for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. ---------------------------------------------------------------------------------------------------------------- | | | | Number of | Date of | Amount of | Maturity | Stock Entity | Promissory | Promissory | Date (1) | Purchase | Note | Note | | Warrants ------------------------------------------------|------------------|------------|------------------|------------ Renaissance Capital Growth & Income Fund, III |September 5, 2002 | $ 75,000 |September 5, 2003 | 375,000 ------------------------------------------------|------------------|------------|------------------|------------ Renaissance US Growth Investment Trust PLC |September 5, 2002 | 75,000 |September 5, 2003 | 375,000 ------------------------------------------------|------------------|------------|------------------|------------ BFS US Special Opportunities Trust PLC |March 11, 2003 | 250,000 |March 11, 2004 | 1,250,000 ------------------------------------------------|------------------|------------|------------------|------------ Renaissance Capital Growth & Income Fund, III |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|------------------|------------|------------------|------------ Renaissance US Growth Investment Trust PLC |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|------------------|------------|------------------|------------ BFS US Special Opportunities Trust PLC |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|------------------|------------|------------------|------------ Renaissance US Growth Investment Trust PLC |May 30, 2003 | 200,000 |May 30, 2004 | 1,000,000 ------------------------------------------------|------------------|------------|------------------|------------ BFS US Special Opportunities Trust PLC |May 30, 2003 | 200,000 |May 30, 2004 | 1,000,000 ------------------------------------------------|------------------|------------|------------------|------------ Renaissance Capital Growth & Income Fund, III |June 18, 2003 | 100,000 |June 18, 2004 | 500,000 ----------------------------------------------------------------------------------------------------------------
------------------- (1) The maturity date on all these promissory notes was extended until September 30, 2004. In exchange for an aggregate of $100,000 cash investment received on January 13, 2003, we issued a promissory note to The Rundell Foundation. C. A. Rundell, Jr., our Chairman and Chief Executive Officer, is a Trustee of The Rundell Foundation. The promissory note is in the original principal amount of $100,000 and has an annual interest rate of 9% that is due on the first day of each month. The promissory note, plus interest, was originally due on January 13, 2004. This maturity date was extended until September 30, 2004. The form of this non-convertible promissory note is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2004. As a part of the cash investment, on January 13, 2003, we issued a stock purchase warrant to The Rundell Foundation. The stock purchase warrant entitles The Rundell Foundation to purchase from us, at any time, and in whole or in part, 500,000 fully paid and non-assessable shares of our common stock for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. In exchange for a $500,000 cash investment, on September 5, 2003, we issued a convertible promissory note to BFS, which owns greater than five percent of our common stock. The convertible promissory note is in the original principal amount of $500,000 and has an annual interest rate of 7% and is payable in monthly installments on the first day of each month. The convertible promissory note, plus interest, is due on September 5, 2008. The convertible promissory note is convertible at the option of BFS into shares of our common stock at a conversion price of $0.40 per share. We have the right to call the convertible promissory note if the market price of our common stock rises above $0.60 per share for a period of 60 days. 34 In exchange for a $100,000 cash investment, on September 26, 2003, we issued a promissory note to C. A. Rundell, Jr., our Chairman and Chief Executive Officer. The promissory note is in the original principal amount of $100,000 and has an annual interest rate of 7%. The promissory note, plus accrued interest, was due on April 1, 2004. The due date of this note was extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. As a part of this financing, we also issued a stock purchase warrant to Mr. Rundell, Jr. The stock purchase warrant entitles Mr. Rundell to purchase 125,000 fully paid and non-assessable shares of our common stock for $0.40 per share. In exchange for a total $400,000 cash investment, on October 1, 2003, we issued a promissory note to each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC, which collectively own greater than five percent of our common stock. Each of the two promissory notes is in the original principal amount of $200,000 and has an annual interest rate of 7%. The promissory notes, plus accrued interest, were due on April 1, 2004. The due date of these notes was extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. As a part of this financing, we issued a stock purchase warrant to each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. Each of the two stock purchase warrants entitles each of the Renaissance entities to purchase 250,000 fully paid and non-assessable shares of our common stock for $0.40 per share. During the fiscal year ended June 30, 2004, Mr. Rundell, our Chairman and Chief Executive Officer, issued a personal letter of credit, supported by a certificate of deposit, in the amount of $70,000 in order to meet the bonding requirements of a specific construction project of B&B ARMR Corporation. The interest rate on this transaction was 6% per year. The letter of credit and related certificate of deposit was subsequently refinanced and restructured as a line of credit in the amount of $450,000 supported by municipal bonds held individually by Mr. Rundell. We agreed to compensate Mr. Rundell at the rate of 2.5% per annum for the amount of the line of credit used by us to service bonding and meet working capital needs. As of December 31, 2004, the amount of credit extended by Mr. Rundell to service the Company's bonding needs is $95,000. Through December 31, 2004, we received an additional $330,000 under this line of credit to support working capital needs. These arrangements were approved by our board of directors. In exchange for an aggregate of $150,000 cash, on July 28, 2004, we issued a promissory note to C. A. Rundell, Jr. The original promissory note was in the principal amount of $150,000, had an annual interest rate of 9% which was due at maturity and was secured by a specific invoice of B&B ARMR Corporation issued to Horne Engineering. The promissory note, plus accrued interest, was due on October 28, 2004. In November of 2004, this note was exchanged for a $150,000 subordinated 10% convertible promissory note as a part of our placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes. In exchange for a $1,000,000 cash investment, on August 5, 2004, we issued a convertible promissory note to BFS. The original convertible promissory note was in the principal amount of $1,000,000 and had an annual interest rate of 10% and was payable in monthly installments on the first day of each month. The original convertible promissory note, plus interest, was due on August 5, 2009. The convertible promissory note was convertible at the option of BFS into our common stock at a conversion price of $0.38 per share. We had the right to call the convertible promissory note if the market price of our common stock rose above $0.60 per share for a period of 60 days. This convertible promissory note was subsequently refinanced as a part of our placement of placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes in November 2004. 35 PRINCIPAL STOCKHOLDERS The following table sets forth the number and percentage of outstanding shares of common stock and other classes of our equity securities entitled to vote on all matters submitted to a vote by holders of common stock, beneficially owned as of February 11, 2005 by (a) each director and named executive officer of the company, (b) all persons who are known by the company to be beneficial owners of 5% or more of the company's outstanding common stock and (c) all officers and directors of the company as a group. Unless otherwise noted, each of the persons listed below has sole voting and investment power with respect to the shares indicated as beneficially owned by such person. The company's common stock and Series D preferred stock are its only classes of voting securities. All of the Series D preferred stock is convertible into shares of common stock at any time. The holder of each share of Series D preferred stock is entitled to one vote for each share of common stock into which such share of Series D preferred stock could then be converted. Presently, the holder of each share of Series D preferred stock is entitled to 25 votes. For purposes of the beneficial ownership calculations below, the Series D preferred stock is included in this table on an "as converted" basis. Number of Shares Beneficially Percent Name of Beneficial Owner Owned (1) of Class (1) ------------------------------------------------------------------- ---------------- ------------ Renaissance Capital Growth & Income Fund III, Inc. (2) 27,631,591 32.7% Renaissance US Growth Investment Trust PLC (3) 27,204,166 32.2% BFS US Special Opportunities Trust PLC (4) 8,225,460 9.7% Russell Cleveland (5)(6)(7) 63,147,590 74.6% C. A. Rundell, Jr. (5)(6)(8) 5,893,163 7.0% Mary Roland (5)(6) 5,000,000 5.9% The Rosenbloom Trust (5) 5,000,000 5.9% William D. Breedlove (5)(6)(9) 570,927 0.7% Peter Beare (5)(6)(10) 375,000 0.4% Frank R. Marlow (5)(6)(11) 362,213 0.4% Robert M. Galecke (5)(6)(12) 287,038 0.3% Richard B. Powell (5)(6)(13) 203,200 0.2% G.M. "John" Ulibarri (5)(6)(14) 175,000 0.2% Theodore Wlazowski (5)(6)(15) 57,500 0.1% Robert "Bob" Gardner (5)(6) 114,286 0.1% All current directors and executive officers as a group (10 persons) 71,185,917 84.1%
--------------------- (1) Pursuant to the rules of the Securities and Exchange Commission, shares of common stock which an individual or group has a right to acquire within 60 days pursuant to the exercise of options or warrants are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. (2) Includes 19,648 shares of common stock issuable upon the exercise of outstanding options excercisable within 60 days; 375,000 shares of common stock issuable upon the exercise of warrants within 60 days; and 187,500 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. The address for this company is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. (3) Includes 19,229 shares of common stock issuable upon the exercise of outstanding options excercisable within 60 days; 375,000 shares of common stock issuable upon the exercise of warrants within 60 days; and 187,500 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. The address for this company is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. 36 (4) Includes 5,197,368 shares of common stock issuable upon the exercise of outstanding convertible promissory notes within 60 days. The address for this company is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. (5) The address for this person is 8200 Springwood Drive, Suite 230, Irving, TX 75063. (6) Mr. Rundell is a director, chairman of the board and chief executive officer of the company. Messrs. Beare, Breedlove, Cleveland, Marlow, and Galecke are directors of the company. Mr. Beare became the president of the company effective October 22, 2004. Ms. Roland is the spouse of Mr. Paul Roland, who became director of the company on September 5, 2003. Mr. Ulibarri became the president and chief executive officer of Intelli-Site, Inc., effective January 1, 2004. Mr. Powell is vice president, chief accounting officer and secretary of the company. Mr. Wlazowski became chief executive officer of B&B ARMR Corporation, effective October 22, 2004. Mr. Gardner retained his position as President of DoorTek Corporation upon the company's acquisition of DoorTek on December 15, 2004. (7) Includes 80,616 shares of common stock issuable upon the exercise of outstanding options excercisable within 60 days; 750,000 shares of common stock issuable upon the exercise of warrants within 60 days; and 375,000 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. The address for this person is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. (8) Includes 1,008,427 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days; 966,672 shares of common stock issuable upon the exercise of warrants within 60 days; and 331,250 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. (9) Includes 184,872 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days and 45,677 shares of common stock issuable upon the exercise of warrants within 60 days. (10) Includes 275,000 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days. (11) Includes 182,296 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days; 20,833 shares of common stock issuable upon the exercise of warrants within 60 days; and 31,250 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. (12) Includes 182,296 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days; 8,333 shares of common stock issuable upon the exercise of warrants within 60 days; and 12,500 shares of common stock issuable upon the conversion of Series D preferred stock within 60 days. (13) Includes 203,200 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days. (14) Includes 175,000 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days. (15) Includes 57,500 shares of common stock issuable upon the exercise of outstanding options exercisable within 60 days. 37 DESCRIPTION OF SECURITIES General The following discussion summarizes our capital stock and describes certain provisions of our certificate of incorporation and bylaws. The information in this section is a summary only and is qualified by reference to our certificate of incorporation and our bylaws, which have been filed as exhibits to this registration statement, of which this prospectus forms a part. Our authorized capital stock consists of 150,750,000 shares of common stock, par value $.01 per share, and 750,000 shares of preferred stock, par value $.01 per share. As of February 11, 2005, we had 85,056,612 shares of common stock and 100,750 shares of preferred stock issued and outstanding. Common Stock The holders of our common stock are entitled to dividends, if any, as our board of directors may declare from time to time from legally available funds, subject to the preferential rights of the holders of any shares of our preferred stock currently issued and outstanding or that we may issue in the future. Except as otherwise required by law, the holders of our common stock are entitled to one vote per share on any matter to be voted upon by stockholders. Our bylaws require that a majority of our issued and outstanding shares need be represented, in person or by proxy, to constitute a quorum and to transact business at a stockholders' meeting. Under the Delaware General Corporation Law, cumulative voting for directors will be denied unless such provision is specifically set forth in a corporation's certificate of incorporation. We have not included a provision in our certificate of incorporation providing for cumulative voting for the election of directors. Accordingly, directors will be elected by a plurality of the shares voting once a quorum is present. No holder of any shares of common stock has a preemptive right to subscribe for any of our securities, nor are any common shares subject to redemption or convertible into other securities. Upon our voluntary or involuntary liquidation, distribution or sale of assets, dissolution or winding up of our affairs, the holders of our common stock are entitled to share, on a pro rata basis, all assets remaining after payment to creditors and subject to prior distribution rights, if any, on shares of preferred stock currently issued and outstanding or that we may issue in the future. All of the outstanding shares of common stock are fully paid and non-assessable. Common Stock Purchase Warrants There are currently outstanding warrants to purchase an aggregate of 6,031,118 shares of common stock at exercise prices ranging from $0.20 to $1.00 per share. We issued these warrants in connection with previous equity private placements and also in consideration for services rendered. Additionally, in connection with our initial public offering in 1993, we issued warrants to purchase shares of our common stock. As of February 11, 2004, warrants to purchase 6,031,118 shares of our common stock remain outstanding. Common Stock Options There are currently outstanding options to purchase an aggregate of 5,648,602 shares of common stock, at exercise prices ranging from $0.125 to $2.375 per share. Our 1993 Stock Option Plan provides for grants of options for up to 500,000 shares of common stock. Under the plan, options must be granted with an exercise price not less than the fair market value on the date of issue. Our 1997 Omnibus Stock Plan provides for the granting of 7,500,000 incentive stock options, non-statutory stock options, stock appreciation rights, awards of stock and stock purchase opportunities to its our directors, employees and consultants. Under the 1997 Omnibus Stock Plan, incentive stock options may only be granted to our employees or directors. Option exercise prices, in general, are equal to the market price at date of grant. Shares under grant generally become exercisable over three years and expire after ten years. 38 Preferred Stock Our certificate of incorporation and bylaws authorize the issuance of up to 750,000 shares of "blank check" preferred stock with such rights and preferences as our board of directors, without further shareholder approval, may determine from time to time. Of these authorized preferred shares, we have designated: o 9,500 shares as Series A $20 Convertible Preferred Stock, o 40,000 shares as Series B $20 Convertible Preferred Stock, o 12,500 as Series C $20 Convertible Preferred Stock, o 150,000 shares as Series D $20 Convertible Preferred Stock, o 150,000 shares as Series E $20 Convertible Preferred Stock, o 80,000 shares as Series F Cumulative Convertible Preferred Stock, and o 300,000 shares of Series G Cumulative Convertible Preferred Stock. As of February 11, 2005, there were no shares of Series B, Series C, Series E, Series F or Series G preferred stock outstanding and we have no intention of issuing any shares of any of these classes of preferred stock now or in the future. With respect to the Series B preferred stock and Series C preferred stock, we have filed certificates of elimination for each of such series and, as a result, these series no longer exist. All preferred stock ranks senior to common stock as to payment of dividends and distributions of assets. As of February 11, 2004, we had 9,500 shares of Series A preferred stock outstanding. Holders of the Series A preferred stock 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 stock may, at the company's option, be converted into 20 shares of common stock at any time after (1) 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 (2) the shares of common stock to be received on conversion have been registered or otherwise qualified for sale under applicable securities laws. The holders of the Series A preferred stock have the right to convert each share into 20 shares of common stock at any time. Upon any liquidation, dissolution, or winding up of the company, the holders of the Series A preferred stock are entitled to receive $20 per share before the holders of common stock are entitled to receive any distribution. As of February 11, 2004, we had 91,250 shares of Series D preferred stock outstanding. Holders of the Series D preferred stock are entitled to receive dividends at the annual rate of 9% per share paid quarterly in cash. Since June 30, 2001, the holders of the Series D preferred stock have been offered the option to receive the quarterly dividend in the common stock of the company. The holders who elected this option have received the restricted stock based on a 25% discount from the market price on a 20 day average based on the 10 days before and the 10 days after the dividend due date. The holders of the Series D preferred stock have voting rights of one vote for each share of common stock into which the preferred stock is convertible. Beginning on November 15, 2004 we may redeem the Series D preferred stock upon not less than 30 days' notice, in whole or in part, plus all accrued but unpaid dividends. After notice and prior to the expiration of the 30-day notice period, holders of the Series D preferred stock will have the option to convert the Series D preferred stock into common stock prior to the redemption. Each share of the Series D preferred stock may, at the company's option beginning on November 15, 2000, be converted into 25 shares of common stock at any time after (1) the closing bid price of the common stock exceeds $2.00 for at least 20 trading days during any 30 trading day period, and (2) the company has sustained positive earnings per share of common stock for the two previous quarters. The holders of the Series D preferred stock have the right to convert each share into 25 shares of common stock at any time. The holders of the Series D preferred stock are entitled to receive $20 per share before the holders of common stock are entitled to receive any distribution. 39 Anti-Takeover Provisions A number of provisions of the Delaware General Corporation Law and our certificate of incorporation and bylaws may have the effect of discouraging, delaying or preventing takeovers or changes of control or management of our company. For example, under our certificate of incorporation, our board of directors may issue preferred stock and set the voting rights, conversion rights, preferences, and other terms of the preferred stock. Such a provision could be used by our board of directors to discourage takeover attempts not first approved by our board of directors, including takeovers which may be considered by some stockholders to be in their best interests. Also, our certificate of incorporation and bylaws provide that whenever a vote of our stockholders is required or permitted to be taken to authorize or approve any action, such action may be taken without a stockholders' meeting, without prior notice, and without a vote, only if a consent in writing, setting forth the action to be taken, is signed by all of the holders of our voting shares. No action may be taken without a meeting unless such action is unanimously approved by our stockholders. We are subject to Section 203 of the Delaware General Corporation Law, which we refer to as Section 203. In general, Section 203 prevents a person who owns 15% or more of our outstanding voting stock, an "interested stockholder," from engaging in some business combinations with us for three years following the time that that person becomes an interested stockholder unless one of the following occurs: o the board of directors either approves the business combination or the transaction in which the person became an interested stockholder before that person became an interested stockholder; o upon consummation of the transaction which resulted in the person becoming an interested stockholder, the interested stockholder owned at least 85% of our voting stock outstanding at the time the transaction commenced, excluding stock held by: o directors who are also officers of our company; and o employee stock plans that do not provide employees with the right to determine confidentiality whether shares held subject to the plan will be tendered in a tender or exchange offer; or o at or subsequent to the time that the transaction in which the person became an interested stockholder, the business combination is: o approved by the board of directors; and o authorized at a meeting of stockholders by the affirmative vote of the holders of at least two-thirds of our outstanding voting stock which is not owned by the interest stockholder. For purposes of Section 203, the term "business combinations" includes mergers, consolidations, asset sales or other transactions that result in a financial benefit to the interested stockholder and transactions that would increase the interested stockholder's proportionate share ownership of our company. Under some circumstances, Section 203 makes it more difficult for an interested stockholder to effect various business combinations with us for a period of three years after the stockholder becomes an interested stockholder. Although our stockholders have the right to exclude us from the restrictions imposed by Section 203, they have not done so. Section 203 may encourage companies interested in acquiring us to negotiate in advance with the board of directors, because the requirement stated above regarding stockholder approval would be avoided if a majority of the directors approves, prior to the time the party became an interested stockholder, either the business combination or the transaction which results in the stockholder becoming an interested stockholder. 40 These types of provisions and restrictions could likely discourage or make more difficult a merger, tender offer, proxy contest or other takeover attempt, even if they might be favorable to the interests of our stockholders, and could potentially depress the market price of our common stock. Limitation of Liability and Indemnification of Officers and Directors Section 145 of the Delaware General Corporation Law provides, in summary, that directors and officers of Delaware corporations are entitled, under certain circumstances, to be indemnified against all expenses and liabilities (including attorneys' fees) incurred by them as a result of suits brought against them in their capacity as a director or officer, if they acted in good faith and in a manner they reasonably believed to be in or not opposed to our best interests, and, with respect to any criminal action or proceeding, if they had no reasonable cause to believe their conduct was unlawful; provided that no indemnification may be made against expenses in respect of any claim, issue or matter as to which they shall have been adjudged to be liable to us, unless and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, they are fairly and reasonably entitled to indemnity for such expenses which the court shall deem proper. Any such indemnification may be made by us only as authorized in each specific case upon a determination by the stockholders, disinterested directors or independent legal counsel that indemnification is proper because the indemnitee has met the applicable standard of conduct. Our certificate of incorporation and by-laws provide that we will indemnify our directors and officers to the fullest extent permitted by law and that no director shall be liable for monetary damages to us or our stockholders for any breach of fiduciary duty, except for liability: o for any breach of the director's duty of loyalty to us or our stockholders, o for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, o under Section 174 of the Delaware General Corporation Law, or o for any transaction from which the director derived an improper personal benefit. Insofar as indemnification for the liabilities arising under Securities Act of 1933 may be permitted to our directors, officers or persons controlling our company pursuant to the provisions described above, we have been informed that in the opinion of SEC, such indemnification is against public policy as expressed in the Securities Act of 1933 and is therefore unenforceable. Transfer Agent The name of our transfer agent is American Stock Transfer & Trust Company and its offices are located at 6201 15th Avenue, Brooklyn, NY 11219. 41 SELLING STOCKHOLDERS This prospectus covers offers and sales of our common stock from time to time by each of the selling stockholders set forth below. Each of the selling stockholders acquired, or will acquire upon the exercise or conversion of our debt or equity securities, their shares of common stock pursuant to a private placement by us of our equity securities, warrants or convertible promissory notes. Each of the selling stockholders currently holds or has the right to acquire one or more of the following: o shares of our common stock, o shares of our common stock issuable upon the conversion of convertible promissory notes, o shares of our common stock issuable upon the conversion of our Series A preferred stock or Series D preferred stock, and o shares of our common stock issuable upon the exercise of warrants. Pursuant to Rule 416 of the Securities Act, the selling stockholders may also offer and sell shares of common stock issued as a result of, among other events, stock splits, stock dividends and similar events which result in such selling stockholder holding additional shares of common stock or having the right to receive additional shares of common stock. Shares of Common Stock Issuable Upon the Conversion of Convertible Promissory Notes On November 30, 2004, we entered into a Loan Agreement with several purchasers of our Subordinated 10% Convertible Promissory Notes. Pursuant to the terms of the Loan Agreement, we were authorized to sell an aggregate principal amount of up to $6,000,000 in convertible promissory notes. The Loan Agreement contains various representations, warranties and covenants of the parties customary for such a transaction. We have agreed to indemnify the purchasers of the notes against various liabilities, including certain liabilities that may arise under the Securities Act of 1933. Each note sold that we sold: o is subordinated to certain of other of our indebtedness, o is due and payable on November 30, 2009, o provides interest to the holder of the note at a rate of 10% per annum, and o is convertible into our common stock at the conversion rate of $0.38 per share of common stock. On December 15, 2004, pursuant to the terms of the Loan Agreement, we completed the private placement of an aggregate principal amount of $4,118,000 of convertible promissory notes to 40 accredited investors. Since each note is convertible into the shares of our common stock at the conversion rate of $0.38 per share, in the aggregate, the notes are convertible into a total of 10,836,842 shares of our common stock. We agreed with each purchaser of the notes that we would register the shares common stock that may be issued to such purchaser upon the conversion of the notes. We agreed to register the shares of common stock pursuant to the terms and provisions of a Registration Rights Agreement, dated November 30, 2004, that we entered into with each of the purchasers of the notes. This prospectus covers each of the shares of common stock that may issued to a purchaser of the notes upon conversion of the notes. 42 Pursuant to the terms of the Registration Rights Agreement and subject to certain other provisions contained therein, if we fail to timely meet certain of our obligations under the Registration Rights Agreement, then, in addition to any other rights the holder or holders of the notes may have pursuant to the Registration Rights Agreement or under applicable law: (i) on each such date when we have failed to timely perform, we will have to pay to each holder an amount in cash, as partial liquidated damages and not as a penalty, equal to 1.0% of the aggregate purchase price paid by such holder pursuant to the Loan Agreement for any registrable securities then held by such holder; and (ii) on each monthly anniversary of each such event date (if the applicable event shall not have been cured by such date) until the applicable event is cured, we will pay to each holder an amount in cash, as partial liquidated damages and not as a penalty, equal to 1.0% of the aggregate purchase price paid by such holder pursuant to the Loan Agreement for any registrable securities then held by such holder. Our sales of the notes described above and our issuance of the shares of common stock issuable upon the conversion of such notes were (and will be upon conversion) exempt from the registration requirements of Section 5 of the Securities Act of 1933 pursuant to Section 4(2) of the Securities Act of 1933, and pursuant to Rule 506 of Regulation D of the Securities Act of 1933. A Rule 506 exemption was available (and will be available) for these sales because we sold notes and issued common stock only to accredited investors; we did not solicit or advertise the sales; a restrictive legend was placed on each certificate issued describing the restrictions against resale; and a Form D was filed with the SEC and in each state where the purchasers of the notes reside. In connection with this transaction, we agreed to pay to the finder, Roth Capital Group, a convertible promissory note in the principal amount of $168,000 and warrants exercisable at $0.38 per share, to purchase 276,316 shares of common stock, which are covered by this prospectus. Additional Registration Rights On several occasions during the last six years, we have issued and sold to various purchasers: o shares of our common stock, o shares of our common stock issuable upon the conversion of convertible promissory notes, o shares of our common stock issuable upon the conversion of our Series A Preferred Stock or Series D Preferred Stock, and o shares of our common stock issuable upon the exercise of warrants. Each of such sales were exempt from the registration requirements of Section 5 of the Securities Act of 1933 pursuant to Section 4(2) of the Securities Act, and pursuant to Rule 506 of Regulation D of the Securities Act of 1933. A Rule 506 exemption was available for these sales because we sold or issued such securities only to accredited investors; we did not solicit or advertise the sales; a restrictive legend was placed on each certificate or instrument issued describing the restrictions against resale; and a Form D was filed with the SEC and in each state where the purchasers of such securities reside. In connection with certain of these sales and issuances of our securities, we agreed to register such the shares of common stock that we sold, the shares of common stock that may be issued upon the conversion of convertible promissory notes or preferred securities that we sold or the shares of common stock that may be issued upon the exercise of the warrants that we sold. We agreed to register such shares of common stock pursuant to the terms and provisions of the registration rights agreements set forth below. o Registration Rights Agreement, dated as of February 22, 1999, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. 43 o Registration Rights Agreement, dated as of October 20, 2000, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. o Registration Rights Agreement, dated as of September 27, 2001, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. o Registration Rights Agreement, dated as of November 9, 2001, among the Company and C.A. Rundell, Jr. o Registration Rights Agreement, dated as of March 11, 2003, among the Company and BFS US Special Opportunities Trust PLC a public limited company registered in England and Wales. o Registration Rights Agreement, dated as of September 5, 2003, among the Company, Mary Roland and Ann Rosenbloom. o Registration Rights provided to holders of the Company's Series A Preferred Stock, as set forth in the Certificate of Designation, Preferences and Rights of Series A $20 Convertible Preferred Stock. This prospectus covers each of the shares of common stock that we have sold and each of the shares of common stock that may issued to a holder of warrants, a purchaser of our promissory notes or a purchaser of our preferred securities upon the conversion or exercise of the warrants, promissory notes or preferred securities, respectively. Selling Stockholders Table The following table sets forth: o the name of each selling stockholder; o the number or shares of common stock beneficially owned by each selling stockholder as of the date of this prospectus, giving effect to the conversion of the selling stockholders' convertible securities and exercise of warrants into shares of common stock; o the number of shares of common stock being offered by each selling stockholder; o the number of shares of common stock represented by convertible promissory notes; o the number of shares of common stock represented by preferred stock; o the number of shares of common stock represented by exercisable warrants; o the number of shares of common stock to be owned by the selling stockholder after the offering; and o the percent of the class of common stock to be owned after the offering. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities and includes any securities which the person has the right to acquire within 60 days of the date of this prospectus through the conversion or exercise of options, warrants, promissory notes and any other security or other right. Solely for purposes of the selling stockholder table below, we have disregarded the restriction described above and determined beneficial ownership based on the rules of the SEC. The information below is as of February 11, 2005 and has been furnished by the respective selling stockholders. 44 The table below was prepared based on information supplied to us by the selling stockholders. We may amend or supplement this prospectus from time to time to update the disclosure set forth in the table. Because the selling stockholders identified in the table may sell some or all of the shares owned by them which are included in this prospectus, and because there are currently no agreements, arrangements or understandings with respect to the sale of any of the shares, no estimate can be given as to the number of shares available for resale hereby that will be held by the selling stockholders upon termination of the offering made hereby. We have therefore assumed, for the purposes of the following table, that the selling stockholders will sell all of the shares owned by them that are being offered hereby. None of the selling stockholders has held any position or office or had any material relationship with us or any of our affiliates in the last three years, other than as described in this prospectus. ---------------------------------------------------------------------------------------------------------------------- | | | |Shares |Shares | | | | |Shares |Offered |Offered | | | | |Offered |from |from | | | | |from |Conversion |Conversion | | | | |Exercise |of |of | | Percent |Shares |Shares |of |Promissory |Preferred |Shares | of Common |Beneficially |Offered |Warrants |Notes |Stock |Beneficially| State |Owned |Pursuant |Pursuant |Pursuant |Pursuant |Owned | Owned |Before the |to this |to this |to this |to this |After | After Selling Stockholder |Offering |Prospectus |Prospectus |Prospectus |Prospectus |Offering | Offering ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Renaissance US Growth & |27,631,591 |27,611,943 |250,000 | |187,500 |27,631,591 | 27.8% Income Trust, III | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Renaissance US Growth |27,204,166 |27,184,937 |250,000 | |187,500 |27,204,166 | 27.3% Investment Trust PLC | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- BFS US Special |8,225,460 |8,225,460 | |5,197,368 | |8,225,460 | 8.3% Opportunities Trust PLC | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Mary Roland |5,000,000 |5,000,000 | | | |5,000,000 | 5.0% ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Rosenbloom Trust |5,000,000 |5,000,000 | | | |5,000,000 | 5.0% ---------------------------|-------------|------------|------------|------------|------------|------------|----------- C.A. Rundell, Jr. |5,893,163 |3,469,190 |745,838 |394,736 |81,250 |5,893,163 | 5.9% ---------------------------|-------------|------------|------------|------------|------------|------------|----------- The Rundell Foundation |3,120,564 |1,560,282 | | |250,000 |3,120,564 | 3.1% ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Lagunitas Partners, LP |921,052 |921,052 | |921,052 | |921,052 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Roth Capital Partners |718,421 |718,421 |276,316 |442,105 | |718,421 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Cordillera Fund, LP |526,315 |526,315 | |526,315 | |526,315 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Katharine Bard Dickson & |394,736 |394,736 | |394,736 | |394,736 | * Mark A. Dickson, Joint | | | | | | | Tenants | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Ralph A. Bard, Sr. Trust |315,789 |315,789 | |315,789 | |315,789 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Leonard M. Herman Trust |263,157 |263,157 | |263,157 | |263,157 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Dale F. Snavely |263,157 |263,157 | |263,157 | |263,157 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Gruber & McBaine |263,157 |263,157 | |263,157 | |263,157 | * International | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Jon D. and Linda W. Gruber |263,157 |263,157 | |263,157 | |263,157 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- The Rundell Family |500,000 |250,000 | | | |500,000 | * Limited Partnership | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Bourquin Family Trust |210,526 |210,526 | |210,526 | |210,526 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Philip J. Hempleman |160,000 |160,000 | | |160,000 |160,000 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Ralph A. L. Bogan, Jr. |157,894 |157,894 | |157,894 | |157,894 | * Trust | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Sidney N. Herman |157,894 |157,894 | |157,894 | |157,894 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Susan W. McMillan Trust |157,894 |157,894 | |157,894 | |157,894 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Anne R. Brown Irrevocable |131,578 |131,578 | |131,578 | |131,578 | * Trust | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Timothy B. Johnson |131,578 |131,578 | |131,578 | |131,578 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Gary R. Fairhead |131,578 |131,578 | |131,578 | |131,578 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- J. Patterson McBaine |131,578 |131,578 | |131,578 | |131,578 | * ----------------------------------------------------------------------------------------------------------------------
45 ---------------------------------------------------------------------------------------------------------------------- | | | |Shares |Shares | | | | |Shares |Offered |Offered | | | | |Offered |from |from | | | | |from |Conversion |Conversion | | | | |Exercise |of |of | | Percent |Shares |Shares |of |Promissory |Preferred |Shares | of Common |Beneficially |Offered |Warrants |Notes |Stock |Beneficially| State |Owned |Pursuant |Pursuant |Pursuant |Pursuant |Owned | Owned |Before the |to this |to this |to this |to this |After | After Selling Stockholder |Offering(1) |Prospectus |Prospectus |Prospectus |Prospectus |Offering | Offering ---------------------------|-------------|------------|------------|------------|------------|------------|----------- John Bard Manulis |105,263 |105,263 | |105,263 | |105,263 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Anne H. Ross |105,263 |105,263 | |105,263 | |105,263 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Robert S. Steinbaum |105,263 |105,263 | |105,263 | |105,263 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Laurie Manulis Harmon |105,263 |105,263 | |105,263 | |105,263 | * Trust of 1996 | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Carol Clark Coolidge 1997 |78,947 |78,947 | |78,947 | |78,947 | * Trust | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- William G. Escamilla |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Suzanne R. Davis |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Laura K. Reibling Trust |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Balie M. Ross |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- M. Edward Sellers and |78,947 |78,947 | |78,947 | |78,947 | * Suzan D. Boyd, Joint | | | | | | | Tenants | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Timothy B. Johnson C/F |78,947 |78,947 | |78,947 | |78,947 | * Alexis B. Johnson | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Henry J. Underwood |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Joseph H. Ballway, Jr. |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Joanne G. Bloom |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Leland D. Boddy |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Henry O. Flynn |78,947 |78,947 | |78,947 | |78,947 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Henry J. Underwood |65,789 |65,789 | |65,789 | |65,789 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Patrick T. Underwood |65,789 |65,789 | |65,789 | |65,789 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Henry J. Underwood C/F |65,789 |65,789 | |65,789 | |65,789 | * Lucy H. Underwood | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Bard Micro-Cap Value |65,789 |65,789 | |65,789 | |65,789 | * Fund, L.P. | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Renaissance Capital |44,634 |44,634 | | | |44,634 | * Group, Inc. | | | | | | | ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Wayne Hamersly |20,000 |20,000 | | |20,000 |20,000 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Donald A. Dole |10,000 |10,000 | | |10,000 |10,000 | * ---------------------------|-------------|------------|------------|------------|------------|------------|----------- Total |89,580,611 |85,307,479 |1,522,154 |12,086,821 |896,250 |89,580,611 | ---------------------------------------------------------------------------------------------------------------------- * designates < 1%
46 PLAN OF DISTRIBUTION The selling stockholders and any of their pledgees, donees, transferees, assignees and successors-in-interest may, from time to time, sell any or all of their shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The selling stockholders may use any one or more of the following methods when selling shares: o ordinary brokerage transactions and transactions in which the broker-dealer solicits investors; o block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; o purchases by a broker-dealer as principal and resale by the broker-dealer for its account; o an exchange distribution in accordance with the rules of the applicable exchange; o privately negotiated transactions; o to cover short sales made after the date that this registration statement is declared effective by the SEC; o broker-dealers may agree with the selling stockholders to sell a specified number of such shares at a stipulated price per share; o a combination of any such methods of sale; and o any other method permitted pursuant to applicable law. The selling stockholders may also sell shares under Rule 144 under the Securities Act of 1933, if available, rather than under this prospectus. Broker-dealers engaged by the selling stockholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the selling stockholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The selling stockholders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved. The selling stockholders may from time to time pledge or grant a security interest in some or all of the shares owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell shares of common stock from time to time under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act of 1933 amending the list of selling stockholders to include the pledgee, transferee or other successors in interest as selling stockholders under this prospectus. Upon our receiving notification in writing by a selling stockholder that any material arrangement has been entered into with a broker-dealer for the sale of common stock through a block trade, special offering, exchange distribution or secondary distribution or a purchase by a broker or dealer, a supplement to this prospectus will be filed, if required, pursuant to Rule 424(b) under the Securities Act of 1933, disclosing (i) the name of each such selling stockholder and of the participating broker-dealer(s), (ii) the number of shares involved, (iii) the price at which such the shares of common stock were sold, (iv) the commissions paid or discounts or concessions allowed to such broker-dealer(s), where applicable, (v) that such broker-dealer(s) did not conduct any investigation to verify the information set out or incorporated by reference in this prospectus, and (vi) other facts material to the transaction. In addition, upon our receiving notification in writing by a selling stockholder that a donee or pledgee intends to sell more than 500 shares of common stock, a supplement to this prospectus will be filed if then required in accordance with applicable securities law. 47 The selling stockholders also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus. The selling stockholders and any broker-dealers or agents that are involved in selling the shares may be deemed to be "underwriters" within the meaning of the Securities Act of 1933 in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act of 1933. Discounts, concessions, commissions and similar selling expenses, if any, that can be attributed to the sale of shares will be paid by the selling stockholder and/or the purchasers. Each selling stockholder has represented and warranted to us that it acquired the shares subject to this registration statement in the ordinary course of such selling stockholder's business and, at the time of its purchase of such securities such selling stockholder had no agreements or understandings, directly or indirectly, with any person to distribute any such shares of common stock. We have advised each selling stockholder that it may not use shares registered under this registration statement to cover short sales of common stock made prior to the date on which this registration statement shall have been declared effective by the SEC. If a selling stockholder uses this prospectus for any sale of the common stock, it will be subject to the prospectus delivery requirements of the Securities Act of 1933. The selling stockholders will be responsible to comply with the applicable provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the rules and regulations thereunder promulgated, including, without limitation, Regulation M, as applicable to such selling stockholders in connection with resales of their respective shares under this registration statement. We are required to pay all fees and expenses incident to the registration of the shares, but we will not receive any proceeds from the sale of the common stock. We have agreed to indemnify the selling stockholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act of 1933. 48 SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of common stock (including shares issued upon the exercise of outstanding warrants and options) in the public market after this offering could cause the market price of our common stock to decline. Those sales also might make it more difficult for us to sell equity-related securities in the future or might reduce the price at which we could sell any equity-related securities. At the date of this prospectus, we have outstanding approximately 85,056,612 shares of common stock. Of the shares of common stock outstanding at the date of this prospectus, a large majority of such shares will be freely tradable without restriction or further registration under the Securities Act of 1933, except that any shares held by our "affiliates," as that term is defined in Rule 144 under the Securities Act of 1933, generally may be sold only in compliance with the limitations of Rule 144 described below. Except as set forth below, a much smaller portion of our outstanding shares of common stock will be "restricted" securities as that term is defined in Rule 144. The "restricted" securities may not be resold unless they are registered under the Securities Act of 1933 or are sold pursuant to an available exemption from registration, including Rule 144 under the Securities Act. The restricted shares will be eligible for resale at various times upon the expiration of applicable holding periods. Restricted securities may be sold in the public market only if they qualify for an exemption from registration under Rule 144, including Rule 144(k), or Rule 701 under the Securities Act of 1933. In addition, up to 14,505,225 shares covered by this prospectus, when issued, will be freely tradable upon the effectiveness of the Registration Statement of which this prospectus forms a part, and up to 85,307,479 shares, including 70,802,254 shares that are currently outstanding will be freely tradable upon the effectiveness of the Registration Statement. Rule 144 In general, under Rule 144 as currently in effect, a person who has beneficially owned shares of our common stock for at least one year is entitled to sell within any three-month period a number of shares that does not exceed the greater of: o 1% of the number of shares of common stock then outstanding, which is approximately 850,561 shares at the time of this prospectus, or o the average weekly trading volume of our common stock during the four calendar weeks preceding the date on which notice of the sale is filed with the SEC. Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and to the availability of current public information about us. Rule 144(k) UnderRule 144(k), a person who is not one of our affiliates at any time during the three months preceding a sale and who has beneficially owned the shares proposed to be sold for at least two years is entitled to sell the shares under Rule 144(k) without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Outstanding Options, Warrants and Convertible Debentures 49 Shares of common stock issuable upon the exercise or conversion of the following options, warrants, preferred stock and convertible promissory notes will be restricted securities and may be resold by their holders only when covered by an effective registration under the Securities Act of 1933, or under an available exemption from registration: o up to 12,086,821 shares are issuable to the selling stockholders upon the conversion of convertible promissory notes; o up to 1,522,154 shares are issuable to the selling stockholders upon exercise of warrants; o up to 190,000 shares are issuable to the selling stockholders upon the conversion of our Series A preferred stock; and o up to 706,250 shares are issuable to the selling stockholders upon the conversion of our Series D preferred stock. 50 CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT On January 12, 2005, Grant Thornton LLP notified us that it will decline to stand for re-election as our independent registered public accounting firm. Effective at the earlier of February 15, 2005, the date we anticipate filing our Form 10-QSB for the quarter ended December 31, 2004 with the SEC, or the appointment of a new independent registered public accounting firm by the audit committee of our board of directors, Grant Thornton will no longer be our independent registered public accounting firm of record. Our audit committee has commenced an immediate search for a new independent registered public accountant, including requesting proposals from other accounting firms. Grant Thornton performed audits of our consolidated financial statements for the fiscal years ended June 30, 2004 and 2003. Grant Thornton's reports did not contain an adverse opinion or disclaimer of opinion, but were modified to include an explanatory paragraph related to uncertainties about our ability to continue as a going concern. During the fiscal years ended June 30, 2004 and 2003 and through December 31, 2004 (i) there have been no disagreements with Grant Thornton on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreement(s), if not resolved to Grant Thornton's satisfaction, would have caused Grant Thornton to make reference to the subject matter of the disagreement(s) in connection with its reports for such year, and (ii) there were no "reportable events" as such term is defined in Item 304(a)(1)(v) of Regulation S-K. However, as reported in our Form 10-KSB for the fiscal year ended June 30, 2004, Grant Thornton has communicated to our audit committee a reportable condition regarding our system of internal controls. They noted a reportable condition with respect to the inadequacy of staffing levels in our financial reporting function that could result in our inability to meet financial reporting objectives. We and the audit committee are in the process of taking the steps necessary to correct this identified reportable condition. 51 EXPERTS Our consolidated financial statements as of June 30, 2004 and 2003, and for the fiscal years then ended, have been audited by Grant Thornton LLP, independent registered public accountants, and are given upon such firm's authority as an expert in auditing and accounting. LEGAL MATTERS Our legal counsel, Haynes and Boone, LLP, will pass upon the validity of the common stock being offered by this prospectus and will provide counsel with respect to other legal matters concerning the registration and offering of the common stock. ADDITIONAL INFORMATION We have filed a registration statement on Form SB-2 with the SEC. This prospectus, which forms a part of that registration statement, does not contain all of the information included in the registration statement and the exhibits and schedules thereto as permitted by the rules and regulations of the SEC. For further information with respect to us and the shares of our common stock offered hereby, please refer to the registration statement, including its exhibits and schedules. Statements contained in this prospectus as to the contents of any contract or other document referred to herein are not necessarily complete and, where the contract or other document is an exhibit to the registration statement, each such statement is qualified in all respects by the provisions of such exhibit, to which reference is hereby made. We file annual, quarterly and current reports and other information with the SEC. You may read and review a copy of any document we file at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. Our SEC filings are also available to the public from the SEC's web site at www.sec.gov. If you would like a copy of this registration statement, our annual report including audited financial statements or any of our other SEC filings, please submit your request to Integrated Security Systems, Inc., 8200 Springwood Drive, Suite 230, Irving, Texas 75063, or call (972) 444-8280. 52 INDEX TO FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm................F-1 Consolidated Balance Sheets as at June 30, 2003 and 2004...............F-2 Consolidated Statements of Operations for the years ended June 30, 2004 and 2003.................................................F-3 Consolidated Statements of Changes in Stockholders' Equity (Deficiency) and Comprehensive Loss for the years ended June 30, 2004 and 2003.................................................F-4 Consolidated Statements of Cash Flows for the years ended June 30, 2004 and 2003.................................................F-5 Notes to Consolidated Financial Statements.............................F-6 Consolidated Condensed Balance Sheets (unaudited) as at December 31, 2004 and December 31, 2003...............................F-21 Consolidated Condensed Statements of Operations (unaudited) for the six months ended December 31, 2004 and 2003...................F-22 Consolidated Condensed Statements of Cash Flows (unaudited) for the six months ended December 31, 2004 and 2003...................F-23 Notes to Consolidated Condensed Financial Statements (unaudited)......F-24 F REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders of Integrated Security Systems, Inc. We have audited the accompanying consolidated balance sheets of Integrated Security Systems, Inc. as of June 30, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the years then ended. 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 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Integrated Security Systems, Inc. as of June 30, 2004 and 2003, and the consolidated results of its operations and its consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, in fiscal 2004 and 2003, the Company suffered significant losses from operations. These matters raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ GRANT THORNTON LLP Dallas, Texas September 24, 2004 F-1
INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS June 30, ---------------------------- 2004 2003 ------------ ------------ ASSETS Current assets: Cash and cash equivalents.............................. $ 172,688 $ 177,078 Accounts receivable, net of allowance for doubtful accounts of $109,527 and $64,183, respectively............................ 1,904,285 545,337 Inventories............................................ 1,272,532 630,995 Other current assets................................... 75,020 70,071 ------------ ------------ Total current assets................................. 3,424,525 1,423,481 Property and equipment, net............................ 681,168 481,608 Goodwill............................................... 3,547,162 -- Other assets........................................... 59,956 15,011 ------------ ------------ Total assets......................................... $ 7,712,811 $ 1,920,100 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable - trade............................... $ 2,029,963 $ 538,190 Accrued liabilities.................................... 708,610 510,000 Current portion of long-term debt...................... 1,845,949 374,330 ------------ ------------ Total current liabilities............................ 4,584,522 1,422,520 Long-term debt............................................ 2,956,341 1,919,409 Preferred stock subject to redemption..................... -- 7,495,052 Stockholders' deficit: Convertible preferred stock, $.01 par value, 750,000 shares authorized; 100,750 issued and outstanding (liquidation value of $2,015,000)........ 1,008 1,613 Common stock, $.01 par value, 150,000,000 shares authorized; 84,298,984 and 12,881,110 shares, respectively, issued......................... 842,990 128,811 Additional paid in capital............................. 31,627,086 18,434,838 Accumulated deficit.................................... (32,180,386) (27,363,393) Treasury stock, at cost - 50,000 common shares......... (118,750) (118,750) ------------ ------------ Total stockholders' equity (deficit)................... 171,948 (8,916,881) ------------ ------------ Total liabilities and stockholders' equity (deficit). $ 7,712,811 $ 1,920,100 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-2 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended June 30, ---------------------------- 2004 2003 ------------ ------------ Sales ........................................... $ 9,827,461 $ 5,029,147 Cost of sales ................................... 7,235,553 3,220,496 ------------ ------------ Gross margin .................................... 2,591,908 1,808,651 Operating expenses: Selling, general and administrative .......... 4,178,653 2,593,361 Impairment of software development costs ..... -- 224,900 Research and product development ............. 653,591 401,104 ------------ ------------ 4,832,244 3,219,365 ------------ ------------ Loss from operations ............................ (2,240,336) (1,410,714) Other income (expense): Interest expense ............................. (1,431,126) (541,324) ------------ ------------ Net loss ........................................ (3,671,462) (1,952,038) Preferred dividend requirement .................. (164,250) (614,034) ------------ ------------ Net loss allocable to common stockholders ....... $ (3,835,712) $ (2,566,072) ============ ============ Weighted average common shares outstanding ...... 64,340,010 12,310,903 ============ ============ Basic and diluted loss per share ................ $ (0.06) $ (0.21) ============ ============ The accompanying notes are an integral part of the consolidated financial statements. F-3
INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) Convertible Preferred Stock Common Stock Additional ------------------- ----------------------- Paid In Accumulated Treasury Shares Amount Shares Amount Capital Deficit Stock Total -------- -------- ---------- ---------- ------------ ------------ --------- ----------- Balance at July 1, 2003.. 161,345 $ 1,613 11,834,589 $ 118,346 $ 17,234,734 $(25,335,103) $(118,750) $(8,099,160) Common stock issuance.... 666,918 6,669 158,466 165,135 Warrant issuance......... 172,494 172,494 Stock option exercise.... 33,000 330 3,795 4,125 Preferred stock dividends 346,603 3,466 72,786 (76,252) -- Debt discount............ 792,563 792,563 Net loss................. (1,952,038) (1,952,038) -------- -------- ---------- ---------- ------------ ------------ --------- ----------- Balance at June 30, 2003. 161,345 1,613 12,881,110 128,811 18,434,838 (27,363,393) (118,750) (8,916,881) Preferred stock conversion.............. (60,595) (605) 45,049,751 450,497 7,045,161 7,495,053 Preferred stock dividend conversion.............. 5,219,149 52,192 991,639 (1,043,831) -- Common stock issuance.... 760,812 7,608 226,815 234,423 Warrant exercise......... 9,250,000 92,500 1,757,500 1,850,000 Stock option exercise.... 509,000 5,090 81,475 86,565 Preferred stock dividends 629,162 6,292 95,408 (101,700) -- Debt discount............ 244,250 244,250 Purchase of business..... 10,000,000 100,000 2,750,000 2,850,000 Net loss................. (3,671,462) (3,671,462) -------- -------- ---------- ---------- ------------ ------------ --------- ----------- Balance at June 30, 2004. 100,750 $ 1,008 84,298,984 $ 842,990 $ 31,627,086 $(32,180,386) $(118,750) $ 171,948 ======== ======== ========== ========== ============ ============= ========= ===========
The accompanying notes are an integral part of the consolidated financial statements. F-4
INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended June 30, -------------------------- 2004 2003 ----------- ----------- Cash flows from operating activities: Net loss ............................................. $(3,671,462) $(1,952,038) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation ....................................... 166,308 134,954 Provision/(credit) for bad debt .................... 61,726 (30,000) Provision for warranty reserve ..................... 185,270 182,500 Provision for inventory reserve .................... 163,333 -- Amortization of debt discount and beneficial conversion feature ............................... 911,802 297,505 Expenses paid with stock, warrants and options ..... 234,423 165,136 Changes in operating assets and liabilities, net of effects of acquisition: Accounts receivable ............................. (543,204) 520,496 Inventories ..................................... (457,189) 79,705 Other assets .................................... (30,794) 8,098 Accounts payable - trade ........................ 1,086,418 (145,956) Accrued liabilities ............................. (548,700) (150,374) ----------- ----------- Net cash used in operating activities ....... (2,442,069) (889,974) ----------- ----------- Cash flows from investing activities: Purchase of property and equipment ................... (266,626) (64,627) Purchase of business, net of cash acquired ........... (632,224) -- ----------- ----------- Net cash used in investing activities ....... (898,850) (64,627) ----------- ----------- Cash flows from financing activities: Employee stock option exercise ....................... 86,565 4,125 Warrant exercise ..................................... 1,850,000 -- Payments of debt ..................................... (938,153) (328,684) Proceeds from debt ................................... 2,338,117 1,427,280 ----------- ----------- Net cash provided by financing activities ... 3,336,529 1,102,721 ----------- ----------- Increase (decrease) in cash and cash equivalents ........ (4,390) 148,120 Cash and cash equivalents at beginning of year .......... 177,078 28,958 ----------- ----------- Cash and cash equivalents at end of year ................ $ 172,688 $ 177,078 =========== =========== Supplemental disclosure: Noncash activities Issuance of common stock in payment of preferred stock dividends .................................... $ 101,700 $ 76,252
The accompanying notes are an integral part of the consolidated financial statements. F-5 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 1. ORGANIZATION AND DESCRIPTION OF BUSINESS Integrated Security Systems, Inc. was formed in December 1991. The Company has two wholly-owned subsidiaries: B&B ARMR Corporation, an anti-terrorist crash barrier and gate engineering and manufacturing facility; and Intelli-Site, Inc., a developer and retail seller of PC-based control systems which integrate discrete security devices. Both of the Company's subsidiaries have domestic and international installations and customers. 2. SIGNIFICANT ACCOUNTING POLICIES Consolidation The consolidated financial statements include the Company and its subsidiaries: B&B ARMR Corporation and Intelli-Site, Inc. All significant intercompany transactions and balances have been eliminated. Cash and Cash Equivalents Cash and cash equivalents are comprised of highly-liquid instruments with original maturities of three months or less. Accounts Receivable The majority of the Company's accounts receivable are due from companies in the anti-terrorist crash barrier, perimeter security and road and bridge industries. Credit is extended based on evaluation of a customers' financial condition and credit history and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Inventories Inventories are carried at the lower of average cost or market. Inventory reserves are specifically identified by both item usage and overall management estimation. Property and Equipment and Depreciation Property and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the assets using straight-line and accelerated methods. Leased property and equipment under capital leases are amortized on the straight-line method over the lesser of the life of the asset or the remaining term of the lease. Estimated useful lives range from 3 to 7 years. F-6 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- Income Taxes The Company accounts for income taxes using the liability method. 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. Revenue Recognition The Company recognizes revenue from sales at the time of shipment. The Company's accounts receivable are generated from a large number of customers in the security integration, construction contractor and electrical subcontractor and governmental markets. No single customer accounted for 10% or more of revenues during the years ended June 30, 2004 or 2003. Software Development Costs Software development costs that are deemed to be recoverable are capitalized and amortized over the greater of the revenue method or the straight-line method over five years. At June 30, 2004 and 2003, software development costs had not been capitalized because of uncertainty regarding their recoverability. Fair Value of Financial Instruments The carrying values of the Company's cash and cash equivalents, accounts receivable and current portion of term notes payable approximate fair value due to their relatively short-term maturity. The carrying value of the accounts receivable factoring facility and long-term debt approximates fair value because it bears a prevailing market rate of interest. The fair value of the remaining debt instruments is undeterminable due to their related party nature. Goodwill Goodwill represents the excess of the purchase price over the fair value of net assets acquired. On an annual basis, the Company compares the fair value of its reporting units with their carrying values. If the carrying value of a reporting unit exceeds its fair value, the Company would recognize an impairment equal to the excess of the carrying value of the operating unit's goodwill over the fair value of its goodwill. The fair value of reporting units is estimated using the discounted present value of estimated future cash flows. Valuation of Long-Lived Assets The Company periodically reviews the net realizable value of its long-lived assets whenever events and circumstances indicate an impairment may have occurred. In the event the Company determines that the carrying value of long-lived assets is in excess of estimated gross future cash flows for those assets, the Company will write-down the value of the assets to a level commensurate with a discounted cash flow analysis of the estimated future cash flows. F-7 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- Product Warranties The Company has one-year, two-year and five-year limited warranties on products it manufactures. The Company provides for repair or replacement of components and/or products that contain defects of material or workmanship. When the Company uses other manufacturers' components, the warranties of the other manufacturers are passed to the dealers and end users. To date, the servicing and replacement of defective software components and products have not been material. The Company records a liability for an estimate of costs that it expects to incur under its warranties when product revenue is recognized. Factors affecting the Company's warranty liability include the number of units sold and historical and anticipated rates of claims and costs per claim. The Company periodically assesses the adequacy of its warranty liability based on changes in these factors. The changes in the Company's product warranty liability are as follows: June 30, ----------------------- 2004 2003 --------- --------- Liability, beginning of year $ 135,471 $ 97,095 Expense for new warranties issued 185,270 182,500 Warranty claims (226,584) (144,124) --------- --------- Liability, end of period $ 94,157 $ 135,471 ========= ========= Net Loss Per Share The Company computes basic loss per common share using the weighted average number of common shares outstanding. At June 30, 2004 and 2003, there were 7,970,318 and 3,606,252 shares of in-the-money potentially dilutive common shares, respectively, outstanding, which were not included in weighted average shares outstanding because their effect is antidilutive due to the Company's reported net loss. At June 30, 2004 and 2003, the Company had approximately 99,919,466 and 82,066,333 shares of common stock and common stock equivalents outstanding, which comprises all of the Company's outstanding equity instruments. As discussed in Note 10, all outstanding shares of the Series F and Series G Preferred Stock, along with all accrued and unpaid dividends, were converted into common shares during the first quarter of fiscal 2004. These conversions increased to number of common shares outstanding by 50,268,900 shares. Also, as discussed in Note 12, 10,000,000 common shares were issued in September 2003 in a merger transaction. Per share amounts for fiscal 2004 reflect these additional common shares outstanding. Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual amounts could differ from these estimates. F-8 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- Statements of Cash Flows Supplemental cash flow information for fiscal years 2004 and 2003: June 30, ------------------------ 2004 2003 ---------- ---------- Interest paid $ 284,907 $ 113,312 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 Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk attendant in its business. Stock-based Compensation The Company accounts for stock-based compensation to employees using the intrinsic value method. Accordingly, compensation cost for stock options to employees is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock. If the Company recognized compensation expense as permitted under Statement of Financial Accounting Standards No. 123 ("SFAS 123"), based on the fair value at the grant dates, the Company's pro forma net loss and net loss per share would have been as follows: For the Year Ended --------------------------- 2004 2003 ----------- ----------- Net loss, as reported $(3,671,462) $(1,952,038) Add: Stock-based employee compensation expense determined under the intrinsic value method included in reported net loss -- -- Deduct: Stock-based employee compensation expense determined under the fair value method (222,415) (177,217) ----------- ----------- Pro forma net loss $(3,893,877) $(2,129,255) =========== =========== Earnings per share: Basic and Diluted - as reported $ (0.06) $ (0.21) =========== =========== Basic and Diluted - pro forma $ (0.06) $ (0.22) =========== =========== The fair value of these options was estimated at the date of grant using the Black-Sholes option pricing model with the following weighted average assumptions used for grants in fiscal 2004 and 2003, respectively: no dividend yield, expected volatility of 108% and 105%; risk-free interest rates of 3.31% and 2.58% and expected lives of five years. F-9 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 3. LIQUIDITY The Company has experienced significant losses during fiscal 2004 and 2003. Management anticipates positive performance in the first part of fiscal 2005. However, in order to meet working capital needs, the Company will need to receive additional financing either through the sale of assets, equity placement and/or additional debt. Failure to receive such financing could jeopardize the Company's ability to continue as a going concern. Subsequent to June 30, 2004, the Company generated additional capital of $1,000,000 (as more fully described in Note 13) from the issuance of a convertible promissory note. In addition, the Company is involved in continuing discussions regarding additional sources of capital. The Company believes that it will be able to fund any further operating losses through the issuance of new equity securities or debt instruments. 4. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS The composition of certain balance sheet accounts is as follows: June 30, -------------------------- 2004 2003 ----------- ----------- Accounts receivable: Trade receivables $ 2,013,812 $ 609,520 Less: allowance for doubtful receivables (109,527) (64,183) ---------- ----------- $ 1,904,285 $ 545,337 =========== =========== Allowance for doubtful receivables: Beginning Balance $ 64,183 $ 100,692 Bad debt expense (reversal) 61,726 (30,000) Accounts written-off (16,382) (6,509) ----------- ----------- Ending Balance $ 109,527 $ 64,183 =========== =========== Inventories: Raw materials $ 785,782 $ 444,718 Work-in-process 393,420 186,277 Finished goods 93,330 -- ----------- ----------- $ 1,272,532 $ 630,995 =========== =========== Property and equipment: Land $ 40,164 $ 40,164 Building 613,469 586,449 Leasehold improvements 86,766 48,769 Office furniture and equipment 608,247 485,634 Manufacturing equipment 676,637 545,043 Vehicles 76,844 51,164 ----------- ----------- 2,102,127 1,757,223 Less: accumulated depreciation (1,420,959) (1,275,615) ----------- ----------- $ 681,168 $ 481,608 =========== =========== F-10 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 5. DEBT June 30, ------------------------- 2004 2003 ----------- ----------- Accounts receivable factoring facility with a finance company to factor accounts receivable with recourse. This accounts receivable factoring facility has an adjustable factoring fee of 1.5%-2.0%, a minimum and maximum borrowing of $400,000 and $1,800,000, respectively, per month; interest at the prime rate of Chase Bank of Texas, N. A. (4.25% as of June 30, 2004) plus 2%; agreement expires March 2005 and may be terminated by either party with 30 days written notice after expiration.......................... $ 850,622 $ 307,008 Term note payable to a bank; due in monthly principal and interest installments of $10,500; interest at 10.5% and 10% at June 30, 2004 and 2003, respectively; secured by first mortgage on real estate and equipment; maturity date of February 26, 2006................................... 540,660 614,975 Notes payable to stockholders; interest at 8% due in monthly installments of $11,333; principal and accrued unpaid interest due September 30, 2005................................................ 1,700,000 1,700,000 Convertible note payable to stockholder; interest at 7% due in monthly installments of $2,917; principal and accrued unpaid interest due September 5, 2008; convertible at the option of the shareholder at $0.40 per share; Company may call the note at $0.60 per share (based on certain restrictions)............................... 500,000 -- Notes payable to stockholders; interest at 7% due in monthly installments of $2,333; principal and accrued unpaid interest due October 1, 2005......... 400,000 -- Note payable to bank and secured by a letter of credit in the amount of $500,000 from Chief Executive Officer; interest at the prime rate of Bank One, N.A. (4.25% as of June 30, 2004); principal and accrued unpaid interest due January 26, 2005............................................ 310,000 -- Note payable to stockholder; interest at 9% due in monthly installments of $750; principal and accrued unpaid interest due September 30, 2005...... 100,000 100,000 Notes payable to Chief Executive Officer; interest at 8% due in monthly installments of $667; principal and accrued unpaid interest due September 30, 2005.................................. 100,000 100,000 Note payable to Chief Executive Officer; interest at 7% due in monthly installments of $583; principal and accrued unpaid interest due October 1, 2005............................................. 100,000 -- Note payable to bank; interest at 8% due in quarterly installments of $2,000; principal and accrued unpaid interest was due August 28,2003...... 90,073 100,073 Discount related to stock purchase warrants......... -- (667,552) Other............................................... 110,935 39,235 ----------- ----------- 4,802,290 2,293,739 Less current portion................................ (1,845,949) (374,330) ----------- ----------- $ 2,956,341 $ 1,919,409 =========== =========== F-11 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- Principal payments required under long-term debt outstanding at June 30, 2004 are as follows: Year Ending June 30, ------------------------- 2005 $ 1,845,949 2006 2,437,137 2007 16,727 2008 2,477 2009 500,000 ----------- $ 4,802,290 6. INCOME TAXES A reconciliation of the income tax provision and the amount computed by applying the federal statutory benefit rate to loss before income taxes follows: For the Years Ended ------------------------------ June 30, 2004 June 30, 2003 ------------- ------------- Federal statutory benefit rate (34.0)% (34.0)% Valuation allowance 34.0% 34.0% ------------- ------------- --% --% ============= ============= Deferred tax assets (liabilities) are comprised of the following at: June 30, 2004 June 30, 2003 ------------- ------------- Deferred tax assets Inventory reserve $ 38,000 $ 29,000 Accounts receivable 37,000 22,000 Net operating loss carryforward 7,585,000 7,105,000 Contributions carryover 2,000 2,000 Other 76,000 57,000 ------------- ------------- Gross deferred tax asset 7,738,000 7,215,000 Deferred tax liabilities Property and equipment (5,000) (12,000) ------------- ------------- Net deferred tax asset 7,733,000 7,203,000 Valuation allowance (7,733,000) (7,203,000) ------------- ------------- Net deferred tax asset $ -- $ -- ============= ============= The Company has unused net operating loss carryforwards of approximately $22.3 million at June 30, 2004. The carryforwards expire from 2007 through 2021. The annual use of these carryforwards is substantially limited as a result of changes in ownership of the Company's common stock. The Company has recorded a valuation allowance to the extent it is more likely than not that a tax benefit will not be realized prior to expiration of the carryforward periods. F-12 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 7. COMMITMENTS AND 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, results of operations or cash flows. Operating Leases The Company leases facilities under leases accounted for as operating leases. Rent expense for operating leases was $251,741 and $121,936 for the years ended June 30, 2004 and 2003, respectively. Future minimum payments for fiscal years subsequent to June 30, 2004 under these leases are as follows: 2005 $ 233,429 2006 59,135 2007 27,134 ----------- $ 319,698 Capital Leases The Company leases certain equipment under leases accounted for as capital leases, with the resulting liability recorded as a component of both current and long-term debt, in the accompanying consolidated balance sheet. Future minimum payments for fiscal years subsequent to June 30, 2004 under these leases are as follows: 2005 $ 51,930 2006 31,803 2007 8,537 2008 2,608 ---------- 94,878 Less amount representing interest (12,172) ---------- $ 82,706 ========== The following is a summary of the assets under capital leases at June 30, 2004: Production and office equipment $ 144,648 Less accumulated depreciation (58,850) ---------- $ 85,798 8. 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 and the Company may at its option make discretionary contributions. Vesting on the Company's contributions occurs over a five-year period. The Company made contributions of $11,773 and $14,105 during fiscal 2004 and 2003, respectively. F-13 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 9. STOCK OPTIONS, WARRANTS AND COMMON STOCK ISSUANCES Stock Options The Company's 1993 Stock Option Plan provides for grants of options for up to 500,000 shares of common stock. Under the plan, options must be granted with an exercise price not less than the fair market value on the date of grant. The Company's 1997 Omnibus Stock Plan provides for the granting of 7,500,000 incentive stock options, non-statutory stock options, stock appreciation rights, awards of stock and stock purchase opportunities to its directors, employees and consultants. Under the plan, incentive stock options may only be granted to employees or directors of the Company. Option exercise prices, in general, are equal to the market price at date of grant. Shares under grant generally become exercisable over three years and expire after ten years. Changes for the two years ending June 30, 2004, with respect to options outstanding, is detailed in the following table:
For the Year Ended For the Year Ended June 30, 2004 June 30, 2003 ---------------------- ---------------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price --------- --------- --------- --------- Outstanding at beginning of period 4,026,378 $ 0.53 4,117,393 $ 0.59 Issued 1,593,149 0.37 412,703 0.23 Exercised (509,000) 0.17 (33,000) 0.13 Expired (511,925) 1.00 (470,718) 0.89 --------- --------- --------- --------- Outstanding at end of period 4,598,602 $ 0.46 4,026,378 $ 0.53 ========= ========= ========= ========= Exercisable at end of period 3,133,602 $ 0.51 3,232,552 $ 0.59 ========= ========= ========= ========= Weighted-average fair value of options granted during the period $ 0.37 $ 0.16
Information about stock options outstanding at June 30, 2004 is summarized as follows: Options Outstanding Options Exercisable ----------------------------------- ---------------------- Weighted Weighted Weighted Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Of Shares Life Price Of Shares Price ----------- --------- --------- --------- --------- --------- $0.125-0.21 832,977 5.6 Years $ 0.15 782,977 $ 0.14 $ 0.27-0.39 1,838,799 7.0 Years 0.32 1,148,798 0.33 $ 0.40-0.49 1,047,636 8.3 Years 0.44 322,636 0.45 $0.531-1.00 529,136 4.0 Years 0.77 529,136 0.77 $ 1.38-1.96 316,396 3.0 Years 1.48 316,396 1.48 $ 2.00-2.37 33,659 0.9 Years 2.16 33,659 2.16 --------- --------- --------- --------- --------- 4,598,602 6.4 Years $ 0.46 3,133,602 $ 0.51 ========= ========= F-14 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- Warrants In connection with short-term debt financings, the Company issued warrants to purchase 625,000 shares of common stock in fiscal 2004 and warrants to purchase 6,500,000 shares of common stock in fiscal 2003. The warrants provide for the purchase of common stock at $0.40 and $0.20 per share, respectively, are exercisable at date of issuance and expire five years from date of issuance. The Company valued the warrants using the Black-Scholes model, which resulted in a cumulative total fair value of $1,146,807 for both fiscal years 2004 and 2003. The Company amortized $849,302 and $297,505 of this amount as interest expense in fiscal 2004 and fiscal 2003, respectively. Additional information with respect to warrants outstanding at June 30, 2004 and changes for the two years then ended are as follows:
For the Year Ended For the Year Ended June 30, 2004 June 30, 2003 ------------------------ ------------------------ Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ---------- ---------- ---------- ---------- Outstanding at beginning of period 17,637,845 $ 0.85 11,162,845 $ 1.22 Issued 625,000 0.40 6,500,000 0.20 Exercised (9,250,000) 0.20 -- -- Expired (1,712,215) 0.61 (25,000) 1.75 ---------- ---------- ---------- ---------- Outstanding at end of period 7,300,630 $ 0.85 17,637,845 $ 0.85 ========== ========== ========== ========== Exercisable at end of period 7,300,630 $ 0.85 17,637,845 $ 0.85 ========== ========== ========== ==========
Common Stock Issuances The Company issued common stock in the following non-cash transactions:
For the Year Ended For the Year Ended June 30, 2004 June 30, 2003 ----------------------- ----------------------- Number Number of shares Fair value of shares Fair value --------- ---------- --------- ---------- Payment of interest 612,149 $ 169,065 378,512 $ 116,898 Employee and director bonuses 140,118 61,398 288,406 48,238 Consultants 8,545 3,960 --------- ---------- --------- ---------- -- -- 760,812 234,423 666,918 165,136 Payment of dividends on Series D Preferred Stock 629,162 101,700 346,603 76,252 --------- ---------- --------- ---------- 1,389,974 $ 336,123 1,013,521 $ 241,388 ========= ========== ========= ==========
The shares issued in these transactions are subject to restrictions on sale. F-15 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 10. CONVERTIBLE PREFERRED STOCK At June 30, 2004 and 2003, convertible preferred stock, $0.01 par value per share, consisted of the following:
For the Year Ended June 30, 2004 For the Year Ended June 30, 2003 ----------------------------------------- ----------------------------------------- Shares Liquidation Shares Liquidation Outstanding Par Value Value Outstanding Par Value Value ----------- ----------- ----------- ----------- ----------- ----------- Series A $20 9,500 $ 95 $ 190,000 9,500 $ 95 $ 190,000 Series D $20 91,250 913 1,825,000 91,250 913 1,825,000 Series F $25 -- -- -- 60,595 605 1,514,875 ----------- ----------- ----------- ----------- ----------- ----------- 100,750 $ 1,008 $ 2,015,000 161,345 $ 1,613 $ 3,529,875 =========== =========== =========== =========== =========== =========== Convertible Preferred Stock Subject to redemption Series G $25 -- $ -- $ -- 299,802 $ 2,998 $ 7,495,052 =========== =========== =========== =========== =========== ===========
Series A $20 Convertible Preferred Stock. At June 30, 2004, the Company had 9,500 shares of its Series A $20 Convertible Preferred Stock (the "Series A Preferred") outstanding. 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. The holders of the Series A Preferred have the right to convert each share into 20 shares of common stock at any time. 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. Series D $20 Convertible Preferred Stock. At June 30, 2004 the Company had 91,250 shares of its Series D $20 Convertible Preferred Stock (the "Series D Preferred") outstanding. Holders of the Series D Preferred are entitled to receive dividends at the annual rate of 9% per share paid quarterly in cash. Since June 30, 2001, the holders of the Series D Preferred have been offered the option to receive the quarterly dividend in the common stock of the Company. The holders who elected this option have received the restricted stock based on a 25% discount from the market price on a 20 day average based on the 10 days before and the 10 days after the dividend due date. The holders of the Series D Preferred have voting rights of one vote for each share of common stock into which the Preferred Stock is convertible. Beginning on November 15, 2004 the Company may redeem the Series D Preferred upon not less than 30 days' notice, in whole or in part, plus all accrued but unpaid dividends. After notice and prior to the expiration of the 30-day notice period, holders of the Series D Preferred will have the option to convert the Series D Preferred into common stock prior to the redemption. Each share of the Series D Preferred may, at the option of the Company beginning on November 15, 2000, be converted into 25 shares of common stock at any time after (i) the closing bid price of the common stock exceeds $2.00 for at least 20 trading days during any 30 trading day period, and (ii) the Company has sustained positive earnings per share of common stock for the two previous quarters. The holders of the Series D Preferred have the right to convert each share into 25 shares of common stock at any time. The holders of the Series D Preferred are entitled to receive $20 per share before the holders of common stock are entitled to receive any distribution. Each holder also received a stock purchase warrant to purchase 16.67 shares of common stock at $1.00 per share for each share of Series D Preferred purchased. These warrants expire on October 10, 2004. At June 30, 2004, dividends in arrears on the Series D preferred stock totaled approximately $246,113. F-16 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- During August and September 2003, all of the holders of the Company's Series F and Series G preferred stock converted all of these shares at a rate of 125 shares of common stock for each share of the preferred stock and all of the related accrued dividends at a rate of $0.20 into the Company's $0.01 par value common stock. These conversions are detailed in the following tables. Convertible Preferred Stock -------------------------------------------------------------- Preferred Stock Number of Number of Series Preferred Shares Common Shares ------------------- ------------------ ----------------- Series F 60,595 7,574,501 Series G 299,802 37,475,250 Convertible Preferred Stock Accrued Dividends -------------------------------------------------------------- Preferred Stock Amount of Number of Series Accrued Dividends Common Shares ------------------- ------------------ ----------------- Series F $ 175,350 876,748 Series G 868,480 4,342,401 F-17 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 11. SEGMENT REPORTING The Company has two business segments: B&B ARMR Corporation and Intelli-Site, Inc. These segments are differentiated by the products they produce and the customers they service as follows: B&B ARMR Corporation. This segment consists of road and bridge perimeter security and railroad physical security products such as warning gates, crash barriers, lane changers, navigational lighting, airport lighting and hydraulic gates and operators, and aluminum gate panels. Intelli-Site, Inc. This segment consists of the development and marketing of programmable security systems that integrate multiple security devices and subsystems for governmental, commercial and industrial facilities utilizing the Intelli-Site(R) software product through systems integrators and original equipment manufacturers to end users. The Company's underlying accounting records are maintained on a legal entity basis for government and public reporting requirements. Segment disclosures are on a performance basis consistent with internal management reporting. The Company evaluates performance based on income (loss) from operations before income tax and other income and expense. The corporate column includes corporate overhead-related items. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 2). The following table provides financial data by segment for the fiscal years ended June 30, 2004 and 2003.
B&B ARMR Intelli-Site, Corporation Inc. Corporate Total ------------ ------------ ------------ ------------ 2004 Sales $ 9,540,703 $ 286,758 $ -- $ 9,827,461 Loss from operations (1,479,540) (382,332) (378,464) (2,240,336) Interest expense 284,906 -- 1,146,220 1,431,126 Total assets 7,566,077 75,477 71,257 7,712,811 Depreciation and amortization expense 144,384 19,197 2,727 166,308 Capital additions 256,417 10,209 -- 266,626 2003 Sales $ 4,859,601 $ 169,546 $ -- $ 5,029,147 Loss from operations (379,445) (695,764) (335,505) (1,410,714) Interest expense 76,414 -- 464,910 541,324 Total assets 1,720,138 51,754 148,208 1,920,100 Depreciation and amortization expense 96,019 36,178 2,757 134,954 Capital additions 64,627 -- -- 64,627
F-18 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 12. MERGER On September 5, 2003, the Company acquired, in a merger transaction, all of the issued and outstanding shares of common stock of ARMR Services Corporation ("ARMR"), a manufacturing company that engineers and manufactures high security crash rated barriers, parking control equipment and other security systems for business and government use. The Company entered into this merger transaction seeing it as an opportunistic acquisition that would allow it to expand its product offering and customer base in conjunction with the Company's strategic growth plans. In exchange for all the outstanding shares of ARMR, the Company issued 10 million shares of the Company's $0.01 par value common stock. The common stock issued in this transaction was valued at approximately $2.85 million. The Company also paid the sellers $500,000 in cash, which had been obtained in September 2003 through the issuance of a $500,000 convertible promissory note. In addition, the Company and the sellers executed an earn-out agreement for maximum additional payments of approximately $2.2 million based on sales over the next three years. Any additional consideration will increase the recorded goodwill. The acquisition and merger of ARMR was accounted for using the purchase method of accounting. As such, the assets and liabilities of ARMR were recorded at their estimated fair value and the results of operations have been included in the Company's consolidated results of operations from the date of acquisition. An assessment of the other identifiable intangible assets related to this acquisition transaction yielded no assignment of value thereto. Therefore, the purchase price in excess of the estimated fair value of the net assets acquired has been allocated to goodwill, which is not deductible for federal income tax purposes. The table below summarizes the current allocation of the purchase price based on the estimated fair values of the assets acquired: Estimated Values ---------------- Cash and cash equivalents $ 93,000 Accounts receivable 877,000 Inventory 348,000 Property and equipment 99,000 Other assets 19,000 Accounts payable (630,000) Accrued liabilities (562,000) Current and long-term debt (441,000) Goodwill 3,547,000 ---------------- Purchase price $ 3,350,000 ================ The following unaudited pro forma consolidated statements of operations have been prepared as if the acquisition discussed above had occurred at the beginning of each period presented. For the Years Ended June 30, ---------------------------- 2004 2003 ------------ ------------ Sales $ 10,513,388 $ 10,657,049 Net loss allocable to common stockholders $ (4,013,492) $ (2,490,064) Net loss per share allocable to common Stockholders, basic and diluted $ (0.06) $ (0.11) Weighted average shares outstanding, basic and diluted 66,143,288 22,310,903 F-19 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------- 13. SUBSEQUENT EVENTS In exchange for an aggregate of $1,000,000 cash investment, the Company issued a convertible promissory note to BFS US Special Opportunities Trust PLC ("BFS"), a public limited company registered in England and Wales, on August 5, 2004. The convertible promissory note is in the original principal amount of $1,000,000 and has an annual interest rate of 10% and is payable in monthly installments on the first day of each month. The convertible promissory note, plus interest, is due on August 5, 2009. The convertible promissory note is convertible at the option of BFS into the common stock of the Company at a conversion price of $0.38 per share. The Company has the right to call the convertible promissory note if the market price of the commons stock of the Company is above $0.60 per share for period of 60 days. The Company's board of directors ratified this transaction on August 20, 2004. In addition to the above transaction, the board of directors of the Company also ratified an Amended and Restated Pledge Agreement and an Amended and Restated Security Agreement, both of which are between the Company and Renaissance Capital Growth & Income Fund III, Renaissance US Growth Investment Trust PLC, BFS US Special Opportunities Trust PLC, and Renaissance Capital Group, Inc. F-20
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Balance Sheets December 31, June 30, 2004 2004 ------------ ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 1,422,816 $ 172,688 Accounts receivable, net of allowance for doubtful accounts of $98,964 and $109,527, respectively 2,531,081 1,904,285 Inventories 2,130,352 1,272,532 Other current assets 149,625 75,020 ------------ ------------ Total current assets 6,233,874 3,424,525 Property and equipment, net 608,597 681,168 Goodwill 3,714,491 3,547,162 Other assets 415,386 59,956 ------------ ------------ Total assets $ 10,972,348 $ 7,712,811 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable $ 1,890,778 $ 2,029,963 Accrued liabilities 531,378 708,610 Current portion of long-term debt 4,082,632 1,845,949 ------------ ------------ Total current liabilities 6,504,788 $ 4,584,522 ------------ ------------ Long-term debt 5,090,690 2,956,341 Stockholders' equity (deficit): Preferred stock, $.01 par value, 750,000 shares authorized; 100,750 shares issued and outstanding (liquidation value of $2,015,000) 1,008 1,008 Common stock, $.01 par value, 150,000,000 shares authorized; 84,906,612 and 84,298,984 shares issued, 849,066 842,990 respectively Additional paid in capital 31,938,512 31,627,086 Accumulated deficit (33,292,966) (32,180,386) Treasury stock, at cost - 50,000 common shares (118,750) (118,750) ------------ ------------ Total stockholders' equity (deficit) (623,130) 171,948 ------------ ------------ Total liabilities and stockholders' equity (deficit) $ 10,972,348 $ 7,712,811 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-21
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Statements of Operations (Unaudited) For the Three Months Ended For the Six Months Ended December 31, December 31, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Sales $ 3,134,131 $ 3,367,883 $ 6,530,845 $ 5,087,780 Cost of sales 2,468,066 2,263,003 4,566,339 3,322,051 ------------ ------------ ------------ ------------ Gross profit 666,065 1,104,880 1,964,506 1,765,729 ------------ ------------ ------------ ------------ Operating expenses: Selling, general and administrative 1,286,365 1,012,037 2,463,876 1,696,971 Research and product development 128,445 187,557 251,748 326,513 ------------ ------------ ------------ ------------ 1,414,810 1,199,594 2,715,624 2,023,484 ------------ ------------ ------------ ------------ Loss from operations (748,745) (94,714) (751,118) (257,755) Interest expense (212,004) (411,587) (360,505) (664,272) ------------ ------------ ------------ ------------ Net loss (960,749) (506,301) (1,111,623) (922,027) Preferred dividends (41,400) (41,400) (82,800) (82,800) ------------ ------------ ------------ ------------ Net loss allocable to common stockholders $ (1,002,149) $ (547,701) $ (1,194,423) $ (1,004,827) ============ ============ ============ ============ Weighted average common shares outstanding - basic and diluted 84,663,078 73,595,757 84,481,031 52,127,485 ============ ============ ============ ============ Net loss per share - basic and diluted $ (0.01) $ (0.01) $ (0.01) $ (0.02) ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-22
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Statements of Cash Flows (Unaudited) For the Six Months Ended December 31, --------------------------- 2004 2003 ----------- ----------- Cash flows from operating activities: Net loss $(1,111,623) $ (922,027) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 109,694 79,665 Amortization 11,266 -- Provision for bad debt 4,749 15,500 Provision for warranty reserve 160,000 30,000 Provision for inventory reserve -- 1,000 Amortization of debt discount -- 300,032 Expenses paid with stock, warrants and options 229,690 237,047 Changes in operating assets and liabilities, net of effects of acquisition: Accounts receivable (490,380) (808,874) Inventories (734,058) 115,568 Other assets (441,301) 29,329 Accounts payable (198,870) 582,590 Accrued liabilities (337,357) 39,789 ----------- ----------- Net cash used in operating activities (2,799,190) (300,381) ----------- ----------- Cash flows from investing activities: Purchase of property and equipment (37,125) (111,347) Purchase of businesses, net of cash acquired (255,528) (733,134) ----------- ----------- Net cash used in investing activities (292,653) (844,481) ----------- ----------- Cash flows from financing activities: Employee stock option exercise -- 48,125 Payments on debt and other liabilities (156,708) (371,354) Proceeds from notes payable and long-term debt 4,498,679 1,591,498 ----------- ----------- Net cash provided by financing activities 4,341,971 1,268,269 ----------- ----------- Increase in cash and cash equivalents 1,250,128 123,407 Cash and cash equivalents at beginning of period 172,688 177,078 ----------- ----------- Cash and cash equivalents at end of period $ 1,422,816 $ 300,485 =========== =========== Supplemental disclosure of noncash financing activities: Conversion preferred stock $ -- $ 7,495,052 Issuance of company common stock in payment of preferred stock dividends $ -- $ 1,043,830
The accompanying notes are an integral part of the consolidated financial statements. F-23 INTEGRATED SECURITY SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended December 31, 2004 and 2003 Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments (all of which are normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim period are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2005. The accompanying financial statements include the accounts of Integrated Security Systems, Inc. (the "Company") and all of its subsidiaries, with all significant intercompany accounts and transactions eliminated. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's fiscal 2004 Annual Report on Form 10-KSB filed on October 13, 2004 with the Securities and Exchange Commission. Note 2 - Stock Options The Company accounts for stock-based compensation to employees using the intrinsic value method. Accordingly, compensation cost for stock options granted to employees is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock. In December 2004, the Financial Accounting Standards Board issued a revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123R"). SFAS No. 123R supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" and requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, and recognize that cost over the vesting period. SFAS No. 123R is effective for the first interim or annual period beginning after June 15, 2005 and the Company will begin recognizing option expense July 1, 2005. The following table illustrates the effect on net loss and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation:
For the Three Months Ended For the Six Months Ended December 31, December 31, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Net loss, as reported $ (960,749) $ (506,301) $(1,111,623) $ (922,027) Deduct: Total stock-based employee compensation expense determined under fair value based method (56,135) (144,638) (112,271) (335,614) ----------- ----------- ----------- ----------- Pro forma net loss $(1,016,884) $ (650,939) $(1,223,894) $(1,257,641) =========== =========== =========== =========== Earnings per share: Basic and Diluted-as reported $ (0.01) $ (0.01) $ (0.01) $ (0.02) =========== =========== =========== =========== Basic and Diluted-pro forma $ (0.01) $ (0.01) $ (0.01) $ (0.03) =========== =========== =========== ===========
F-24 The fair value of these options was estimated at the date of grant using the Black-Sholes option pricing model with the following weighted average assumptions used for grants in fiscal 2004 and 2003, respectively: no dividend yield, expected lives of three and five years, respectively, with expected volatility and risk-free interest rates as outlined in the following table:
For the Three Months Ended For the Six Months Ended December 31, December 31, -------------------------- -------------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- Expected volatility 107.85% 108.34% 107.85% 108.31% Risk-free interest rate 3.33% 3.31% 3.33% 3.30%
Note 3 - Reclassifications Certain reclassifications of prior year amounts have been made to conform to the current period presentation. Note 4 - Accounts Receivable The majority of the Company's accounts receivable are due from companies in the perimeter security and road and bridge industries. Credit is extended based on evaluation of a customer's financial condition and credit history and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company's previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. December 31, --------------------------- 2004 2003 ----------- ----------- Accounts receivable: Trade receivables $ 2,630,045 $ 2,531,372 Less: allowance for doubtful receivables (98,964) (104,417) ----------- ----------- $ 2,531,081 $ 2,426,955 =========== =========== For the Six Months Ended December 31, --------------------------- 2004 2003 ----------- ----------- Allowance for doubtful receivables: Beginning Balance $ 109,527 $ 64,183 Bad debt expense 4,749 15,500 Accounts written-off (15,312) (28,827) ARMR Services Corporation merger -- 53,561 ----------- ----------- Ending Balance $ 98,964 $ 104,417 =========== =========== F-25 Note 5 - Product Warranties The Company offers one-year, two-year and five-year warranties on products it manufactures. The length of the warranty is dictated by competition. The Company provides for repair or replacement of components and/or products that contain defects of material or workmanship. When the Company uses other manufacturers' components, the warranties of the other manufacturers are passed to the dealers and end users. The Company records a liability for an estimate of costs that it expects to incur under its basic limited warranty when product revenue is recognized. Factors affecting the Company's warranty liability include the number of units sold and historical and anticipated rates of claims and costs per claim. The Company periodically assesses the adequacy of its warranty liability based on changes in these factors. The changes in the Company's product warranty liability are as follows: December 31, ----------------------- 2004 2003 --------- --------- Liability, beginning of year $ 94,157 $ 135,471 Expense for new warranties issued 160,000 30,000 Warranty Claims (218,291) (55,853) --------- --------- Liability, end of period $ 35,866 $ 109,618 ========= ========= Note 6 - Preferred Stock Dividend Arrearage At December 31, 2004, the Company had dividends in arrears in the amount of $328,913 related to its outstanding Series A and Series D preferred stock, which consists of the following: ------------------------------ Shares Dividends Outstanding In Arrears ------------------------------ Series A $20 9,500 $ -- Series D $20 91,250 328,513 ------------------------------ 100,750 $ 328,513 ============================== Note 7 - Net Loss Per Share The Company computes basic loss per common share using the weighted average number of common shares. At December 31, 2004 and 2003, there were 18,915,450 and 15,094,125 shares, respectively, of in-the-money potentially dilutive common shares outstanding, which were not included in weighted average shares outstanding because their effect is antidilutive due to the Company's reported net loss. At December 31, 2004 and 2003, the Company had approximately 110,294,424 and 100,288,021 shares, respectively, of common stock and common stock equivalents outstanding, which comprises all of the Company's outstanding equity instruments. Note 8 - Financing The Company received a $500,000 cash investment on October 27, 2004 from BFS US Special Opportunities Trust PLC ("BFS"). This investment by BFS was included as a part of the Company's placement of subordinated 10% convertible promissory notes on November 30, 2004 (see Note 10 - Financing Agreement - Placement of Subordinated 10% Convertible Promissory Notes). F-26 Note 9 - Financing Arrangement - Asset Based Lending Facility On November 10, 2004, the Company's wholly-owned subsidiary, B&B ARMR Corporation ("B&B ARMR"), entered into a loan agreement with Briar Capital L.P. ("Briar") to provide a $3,000,000 discretionary demand asset based lending facility. Under the terms of the loan agreement, working capital advances are made available to B&B ARMR based on the value of its accounts receivable and inventory. Although payable on demand, the loan agreement has a stated three (3) year term. In connection with the loan agreement, B&B ARMR issued a revolving promissory note dated November 10, 2004 to Briar in the principal amount of $3,000,000. The note has an annual interest rate of two percent above the prime rate, but in no event will interest exceed the maximum nonusurious interest rate allowable under applicable law. In connection with the loan agreement between B&B ARMR and Briar, the Company, B&B ARMR, and Intelli-Site, Inc. ("Intelli-Site"), another wholly-owned subsidiary of the Company, also entered into a subordination agreement, dated November 10, 2004, with Briar, Renaissance Capital Growth & Income Fund III, Inc. ("RENN III"), Renaissance US Growth Investment Trust PLC ("RUSGIT"), and BFS (together with RENN III and RUSGIT, collectively, the "Subordinated Lenders"). Pursuant to the terms of the subordination agreement, the Subordinated Lenders agreed to subordinate their indebtedness, liens and other obligations to Briar's indebtedness, liens and other obligations. Also in connection with the loan agreement between B&B ARMR and Briar, the Company and Intelli-Site unconditionally guaranteed the obligations of B&B ARMR pursuant to the terms of separately executed guaranty agreements, dated November 10, 2004. The Company's and Intelli-Site's guaranty obligations to Briar are secured by a first priority security interest in the Company's and Intelli-Site's personal property pursuant to the terms of a guarantor security agreement, dated November 10, 2004. Note 10 - Financing Agreement - Placement of Subordinated 10% Convertible Promissory Notes On November 30, 2004, the Company entered into a Loan Agreement ("Loan Agreement") with several purchasers (the "Investors") of the Company's Subordinated 10% Convertible Promissory Notes (individually, a "Note" and collectively the "Notes"). The Company issued $4,118,000 in Notes to the Investors and others (as payment of fees) who effected the placement of the Notes. Each of the Investors is an accredited investor. Pursuant to the terms of the Loan Agreement: (i) the Company was authorized to sell to the Investors an aggregate principal amount of up to $6,000,000 in Notes and (ii) the Notes could have been sold by the Company to the Investors in multiple closings so long as the final closing was consummated no later than the fifteenth day following the initial closing. Each Note sold by the Company to each Investor: (i) is subordinated to certain other indebtedness of the Company, (ii) is due and payable on November 30, 2009, (iii) provides interest to the holder thereof at a rate of 10% per annum and (iv) is convertible into the Company's Common Stock, par value $0.01 per share, at the conversion rate of $0.38 per share of Common Stock. Each share of Common Stock that the Investor receives as a result of the conversion of the Notes shall be registered with the Securities and Exchange Commission. As a part of this transaction, BFS exchanged a promissory note in the amount of $1,000,000, originally issued on August 5, 2004, as a part of the placement of the Notes. In addition, BFS included an investment made in the Company on October 27, 2004 (see Note 8 - Financing) as a part of this placement. F-27 Also included with this placement of the Notes, C. A. Rundell, Jr., Chairman and Chief Executive Officer of the Company, exchanged a $150,000 promissory note with an annual interest rate of 9%, originally issued on July 28, 2004 to B&B ARMR for a $150,000 Note. The Company paid fees in this transaction to Roth Capital Partners, LLC ("Roth") in the form of a Note in the amount of $168,000 with the same general terms and conditions as the other participants in the transaction discussed above. As further consideration, the Company also issued a stock purchase warrant dated November 30, 2004 with a five year life and an exercise price of $0.38 per share to Roth for the purchase of 276,316 common shares of the Company's $0.01 par value common stock. Note 11 - Debt As of December 31, 2004, the Company's current and long-term debt consisted of the following:
Current Long-term Total ---------- ---------- ---------- Notes payable to stockholders; interest at 8% due in monthly installments of $11,333; principal and accrued unpaid interest due September 30, 2005................. $2,400,000 $ -- $2,400,000 Asset based lending facility with a financing company. The loan with the asset based lending facility is a demand loan, but has a three-year term expiring November 10, 2007; interest at 2% above the prime rate; secured by accounts receivable and inventory of B&B ARMR Corporation....................................... 1,201,330 -- 1,201,330 Convertible note payable to stockholder; interest at 7% due in monthly installments of $2,917; principal and accrued unpaid interest due September 5, 2008; convertible at the option of the shareholder at $0.40 per share; Company may call the note at $0.60 per share (based on certain restrictions)........................ -- 500,000 500,000 Note payable to bank and secured by a letter of credit in the amount of $500,000 from Chief Executive Officer; interest at the prime rate of Bank One, N.A. (4.25% as of June 30, 2004); principal and accrued unpaid interest due January 26, 2005........................ 330,000 -- 330,000 Term note payable to a bank; due in monthly principal and interest installments of $10,500; interest at 10.5% and 10% at June 30, 2004 and 2003, respectively; secured by first mortgage on real estate and equipment; maturity date of February 26, 2006................... 76,091 427,852 503,943 Convertible notes payable; interest at 10% due in semi-annual installments of $205,900; principal and accrued unpaid interest due November 30, 2009; convertible at the option of the shareholder at $0.38 per share; Company may call the note at $0.60 per share (based on certain restrictions)........................ -- 4,118,000 4,118,000 Other.................................................. 75,211 44,838 120,049 ---------- ---------- ---------- $4,082,632 $5,090,690 $9,173,322 ========== ========== ==========
F-28 Note 12 - Acquisition On December 15, 2004, the Company acquired all of the issued and outstanding shares of Common Stock of DoorTek Corporation ("DoorTek"), a manufacturer of access control systems and other physical security system products. In exchange for all of the outstanding shares of DoorTek, the Company issued 228,572 shares of its $0.01 par value Common Stock, which has been preliminarily valued at approximately $87,000. The Company also paid $120,000 in cash to DoorTek's former stockholders. In addition, the Company and the sellers executed an earn-out agreement for maximum additional payments of approximately $100,000 based on net profits over the next two years. Any additional consideration will increase the recorded goodwill. The Company entered into this acquisition seeing it as an opportunity to significantly enhance its services, allow it to expand its product offering and customer base in conjunction with the Company's strategic growth plans. The acquisition of DoorTek was accounted for using the purchase method of accounting. As such, the assets and liabilities of DoorTek were recorded at their estimated fair value and the results of operations have been included in the Company's consolidated results of operations from the date of acquisition. To date, the purchase price paid in excess of the estimated fair value of the net assets acquired has been allocated to goodwill, which is not deductible for federal income tax purposes. A preliminary assessment of the other identifiable intangible assets related to this acquisition transaction yielded no assignment of value thereto. The Company is in the process of finalizing the allocation of the purchase price to the assets acquired. Any adjustment resulting form this allocation will reduce the amount of goodwill and any required amortization will be recorded. It is expected this allocation will be competed by the end of fiscal 2005. The table below summarizes the current allocation of the purchase price based on the estimated fair values of the assets acquired and liabilities assumed: Estimated Values --------- Cash and cash equivalents $ 29,000 Accounts receivable 141,000 Inventories 124,000 Accounts payable (60,000) Accrued liabilities (1,000) Long-term debt (29,000) Goodwill 22,000 --------- Purchase price $ 226,000 ========= The following unaudited pro forma consolidated statement of operations information has been prepared as if the acquisition discussed above had occurred at the beginning of each period presented. F-29
For the Three Months Ended For the Six Months Ended December 31, December 31, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Sales $ 3,281,491 $ 3,547,083 $ 6,955,808 $ 5,400,948 Net loss allocable to common stockholders $ (993,591) $ (565,246) $ (1,164,861) $ (1,029,348) Net loss per share allocable To common stockholders, basic and diluted $ (0.01) $ (0.01) $ (0.01) $ (0.02) Weighted average shares outstanding, basic and diluted 84,849,414 73,824,329 84,574,199 52,356,057
Note 13 - Business Segments Information for the Company's reportable segments for the three and six months ended December 31, 2004 and 2003 is as follows:
For the Three Months Ended For the Six Months Ended December 31, December 31, -------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Sales B&B ARMR Corporation $ 2,942,566 $ 3,293,548 $ 6,123,051 $ 4,921,534 Intelli-Site, Inc. 160,111 74,335 376,340 166,246 DoorTek Corporation (1) 31,454 -- 31,454 -- ----------- ----------- ----------- ----------- $ 3,134,131 $ 3,367,883 $ 6,530,845 $ 5,087,780 =========== =========== =========== =========== Income (loss) from operations B&B ARMR Corporation $ (590,214) $ 74,113 $ (598,244) $ 84,747 Intelli-Site, Inc. (46,644) (89,325) (35,467) (184,027) DoorTek Corporation (1) 1,010 -- 1,010 -- Corporate (112,897) (79,502) (118,417) (158,475) ----------- ----------- ----------- ----------- $ (748,745) $ (94,714) $ (751,118) $ (257,755) =========== =========== =========== ===========
(1) Includes only data since acquisition date. F-30 85,307,479 Shares Common Stock INTEGRATED SECURITY SYSTEMS, INC. ----------------------- Prospectus ----------------------- April 11, 2005 PART II Item 24. Indemnification of Directors and Officers Our certificate of incorporation and by-laws provide that we will indemnify our directors and officers to the fullest extent permitted by Delaware law and that no director shall be liable for monetary damages to us or our stockholders for any breach of fiduciary duty, except for liability: o for any breach of the director's duty of loyalty to us or our stockholders, o for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, o under Section 174 of the Delaware General Corporation Law, or o for any transaction from which the director derived an improper personal benefit. Our authority to indemnify our directors and officers is governed by the provisions of Section 145 of the Delaware General Corporation Law, as follows: (a) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the person's conduct was unlawful. (b) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. II-1 (c) To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. (d) Any indemnification under subsections (a) and (b) of this section (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances because the person has met the applicable standard of conduct set forth in subsections (a) and (b) of this section. Such determination shall be made, with respect to a person who is a director or officer at the time of such determination, (1) by a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (2) by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or (3) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (4) by the stockholders. (e) Expenses (including attorneys' fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corporation as authorized in this section. Such expenses (including attorneys' fees) incurred by former directors and officers or other employees and agents may be so paid upon such terms and conditions, if any, as the corporation deems appropriate. (f) The indemnification and advancement of expenses provided by, or granted pursuant to, the other subsections of this section shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office. (g) A corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such person and incurred by such person in any such capacity, or arising out of such person's status as such, whether or not the corporation would have the power to indemnify such person against such liability under this section. (h) For purposes of this section, references to "the corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under this section with respect to the resulting or surviving corporation as such person would have with respect to such constituent corporation if its separate existence had continued. II-2 (i) For purposes of this section, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to any employee benefit plan; and references to "serving at the request of the corporation" shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner such person reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the corporation" as referred to in this section. (j) The indemnification and advancement of expenses provided by, or granted pursuant to, this section shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. (k) The Court of Chancery is hereby vested with exclusive jurisdiction to hear and determine all actions for advancement of expenses or indemnification brought under this section or under any bylaw, agreement, vote of the stockholders or disinterested directors, or otherwise. The Court of Chancery may summarily determine a corporation's obligation to advance expenses (including attorneys' fees). II-3 Item 25. Other Expenses of Issuance and Distribution. The estimated expenses payable by the Company in the connection with the distribution of the securities being registered are as follows: SEC Registration and Filing Fees................................. $ 3,888 Federal Taxes.................................................... $ 0 State Taxes and Registration Fees................................ $ 0 Legal Fees and Expenses.......................................... $100,000 Accounting Fees and Expenses..................................... $ 20,000 Financial Printing............................................... $ 500 Trustee and Transfer Agent Fees.................................. $ 500 Miscellaneous.................................................... $ 500 -------- TOTAL.................................................. $125,388 All of these expenses, except for the SEC registration and filing fees and the federal and state taxes, represent estimates only. We will pay all of the expenses of the offering. II-4 Item 26. Recent Sales of Unregistered Securities During fiscal years 2002, 2003, 2004 and the first part of fiscal 2005, we issued unregistered convertible promissory notes, stock purchase warrants, preferred stock and common stock in connection with the transactions described below. The issuances of the promissory notes, stock purchase warrants, preferred stock and common stock were exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof, as transactions not involving a public offering, and an appropriate restrictive legend was affixed to the securities. Issuances of Convertible Promissory Notes and Promissory Notes in Fiscal 2005 In exchange for an aggregate of $150,000 cash, on July 28, 2004, we issued a promissory note to C. A. Rundell, Jr. The original promissory note was in the principal amount of $150,000, had an annual interest rate of 9% which was due at maturity and was secured by a specific invoice of B&B ARMR Corporation issued to Horne Engineering. The promissory note, plus accrued interest, was due on October 28, 2004. In November of 2004, this note was exchanged for a $150,000 subordinated 10% convertible promissory note as a part of our placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes. In exchange for a $1,000,000 cash investment, on August 5, 2004, we issued a convertible promissory note to BFS. The original convertible promissory note was in the principal amount of $1,000,000 and had an annual interest rate of 10% and was payable in monthly installments on the first day of each month. The original convertible promissory note, plus interest, was due on August 5, 2009. The convertible promissory note was convertible at the option of BFS into our common stock at a conversion price of $0.38 per share. We had the right to call the convertible promissory note if the market price of our common stock rose above $0.60 per share for a period of 60 days. This convertible promissory note was subsequently refinanced as a part of our placement of placement of $4,118,000 of subordinated 10% subordinated convertible promissory notes in November 2004. On November 30, 2004, we entered into a loan agreement with several investors of the company's subordinated 10% convertible promissory notes. Each of the investors purchasing these notes was an accredited investor. Pursuant to the terms of the loan agreement: (1) the company was authorized to sell to the investors an aggregate principal amount of up to $6,000,000 in notes and (2) the notes may be sold by the company to the investors in multiple closing so long as the final closing is consummated no later than the fifteenth day following the initial closing. As of the close of the sale, we sold an aggregate principal amount of $4,118,000 of the notes. Each note sold by the company to each investor: o is subordinated to certain other indebtedness of the company; o is due and payable on November 30, 2009; o provides interest to the holder thereof at a rate of 10% per annum; and o is convertible into the company's common stock, par value $0.01 per share, at the conversion rate of $0.38 per share of common stock. Asset Based Credit Facility On November 10, 2004, B&B ARMR Corporation entered into a loan agreement with Briar Capital, L.P. for a $3,000,000 discretionary demand asset based lending credit facility. Under the terms of the loan agreement, working capital advances are made available to the B&B ARMR Corporation based on the value of its accounts receivable and inventory. Although payable on demand, the loan agreement has a stated 3-year term. In connection with the loan agreement, the B&B ARMR Corporation issued a revolving promissory note, dated November 10, 2004 to Briar Capital, L.P. in the principal amount of $3,000,000. The note has an annual interest rate of two percent above the prime rate but in no event will interest exceed the maximum nonusurious interest rate allowable under applicable law. II-5 Issuances of Convertible Promissory Notes and Promissory Notes in Fiscal 2004 In exchange for a $500,000 cash investment, on September 5, 2003, we issued a convertible promissory note to BFS. The convertible promissory note is in the original principal amount of $500,000, has an annual interest rate of 7%, and is payable in monthly installments on the first day of each month. The convertible promissory note, plus interest, is due on September 5, 2008. The convertible promissory note is convertible at the option of BFS into the common stock of the company at a conversion price of $0.40 per share. We have the right to call the convertible promissory note if the market price of our common stock rises above $0.60 per share for a period of 60 days. In exchange for a $100,000 cash investment, on September 26, 2003, we issued a promissory note to C. A. Rundell, Jr., Chairman and Chief Executive Officer. The promissory note is in the original principal amount of $100,000 and has an annual interest rate of 7%. The promissory note, plus accrued interest, was due on April 1, 2004. The due date of this note was extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. The note is not convertible into capital stock of the company. As a part of this financing, on September 26, 2003, we issued a stock purchase warrant to C. A. Rundell, Jr., Chairman and Chief Executive Officer. The stock purchase warrant entitles Mr. Rundell to purchase from the company 125,000 fully paid and non-assessable shares of our common stock for $0.40 per share. In exchange for a $400,000 cash investment, on October 1, 2003, we issued a promissory note to each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. Each of the two promissory notes is in the original principal amount of $200,000 and has an annual interest rate of 7%. The promissory notes, plus accrued interest, were due on April 1, 2004. The due date of these notes were extended until October 1, 2005. Interest is payable in monthly installments on the first day of each month. The notes are not convertible into our capital stock. As a part of this financing, on October 1, 2003, we issued a stock purchase warrant to each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. Each of the two stock purchase warrants entitles the Renaissance entities to purchase from the company 250,000 fully paid and non-assessable shares of our common stock for $0.40 per share. ARMR Services Corporation Acquisition On September 5, 2003, we acquired all of the issued and outstanding shares of common stock of ARMR Services Corporation. As a part of the consideration paid by the company, we issued 10,000,000 shares of this $0.01 par value common stock. The issuance of the 10,000,000 shares of the company's common stock made in connection with the acquisition of ARMR was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof, as a transaction not involving a public offering, and an appropriate restrictive legend was affixed to the securities. Issuances of Promissory Notes in Fiscal 2003 The following table summarizes the promissory notes that we issued during fiscal year ended 2003. These notes are not convertible and accrue interest at a rate of 8% per year. The form of each of these non-convertible promissory notes is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2003. As a part of each of the transactions detailed in the table below, we issued stock purchase warrants. Each of the stock purchase warrants entitles the holder to purchase from the us, at any time, and in whole or in part, shares of our common stock, as indicated in the table below, for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. II-6 ------------------------------------------------------------------------------------------------------------------- | | | | Number of | Date of | Amount of | Maturity | Stock Entity | Promissory | Promissory | Date (1) | Purchase | Note | Note | | Warrants ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance Capital Growth & Income Fund, III |September 5, 2002 | $ 75,000 |September 5, 2003 | 375,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance US Growth Investment Trust PLC |September 5, 2002 | 75,000 |September 5, 2003 | 375,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ BFS US Special Opportunities Trust PLC |March 11, 2003 | 250,000 |March 11, 2004 | 1,250,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance Capital Growth & Income Fund, III |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance US Growth Investment Trust PLC |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ BFS US Special Opportunities Trust PLC |April 23, 2003 | 100,000 |April 23, 2004 | 500,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance US Growth Investment Trust PLC |May 30, 2003 | 200,000 |May 30, 2004 | 1,000,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ BFS US Special Opportunities Trust PLC |May 30, 2003 | 200,000 |May 30, 2004 | 1,000,000 ------------------------------------------------|-------------------|-------------|-------------------|------------ Renaissance Capital Growth & Income Fund, III |June 18, 2003 | 100,000 |June 18, 2004 | 500,000 -------------------------------------------------------------------------------------------------------------------
------------------- (1) The maturity date on all these promissory notes was extended until September 30, 2004. In addition, in exchange for an aggregate of $100,000 cash investment received on January 13, 2003, we issued a promissory note to The Rundell Foundation. C. A. Rundell, Jr., is a Trustee of The Rundell Foundation. The promissory note is in the original principal amount of $100,000 and has an annual interest rate of 9% that is due on the first day of each month. The promissory note, plus interest, was originally due on January 13, 2004. This maturity date was extended until September 30, 2004. The form of this non-convertible promissory note is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2004. As a part of the cash investment, on January 13, 2003, we issued a stock purchase warrant to The Rundell Foundation. The stock purchase warrant entitles The Rundell Foundation to purchase from us, at any time, and in whole or in part, 500,000 fully paid and non-assessable shares of our common stock for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. Issuances of Promissory Notes in Fiscal 2002 The following table summarizes the promissory notes that we issued to Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC (known together as "Renaissance") from September 2001 through January 2002. These notes are not convertible and accrue interest at a rate of 8% per year. The form of each of these non-convertible promissory notes is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2002. As a part of each of the transactions detailed in the table below, we issued stock purchase warrants to each of the Renaissance entities. Each of the stock purchase warrants entitles each of the Renaissance entities to purchase from us, at any time, and in whole or in part, shares of our common stock, as indicated in the table below, for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. II-7 Number of Stock Amount of Promissory Purchase Warrants Notes Issued to Each of the Issued to Each of the Date Renaissance Entities ($) Maturity Date (1) Renaissance Entities ------------------ --------------------------- ----------------- --------------------- September 28, 2001 75,000 January 26, 2002 375,000 October 12, 2001 25,000 February 9, 2002 125,000 October 29, 2001 25,000 February 23, 2002 125,000 November 9, 2001 25,000 March 9, 2002 125,000 November 16, 2001 25,000 March 16, 2002 125,000 December 29, 2001 25,000 April 26, 2002 125,000 January 14, 2002 50,000 May 13, 2002 250,000
------------------ (1) The maturity date was extended until September 5, 2003. The following table summarizes the promissory notes that we issued to C. A. Rundell, Jr., in November 2001. These notes are not convertible and accrue interest at a rate of 8% per year. The form of each of these non-convertible promissory notes is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2002. As a part of each of the transactions detailed in the table below, we issued stock purchase warrants to Mr. Rundell. Each of the stock purchase warrants entitles Mr. Rundell to purchase from us, at any time, and in whole or in part, shares of our common stock, as indicated in the table below, for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. Number of Stock Date Amount of Promissory Notes ($) Maturity Date (1) Purchase Warrants ----------------- ------------------------------ ----------------- ----------------- November 9, 2001 50,000 March 9, 2002 125,000 November 16, 1001 50,000 March 16, 2002 250,000
----------------- (1) The maturity date was extended until September 5, 2003. In addition, in exchange for an aggregate of $50,000 cash investment received on February 27, 2002, we issued a promissory note to The Rundell Family Partnership. C. A. Rundell, Jr., is the Managing Partner of The Rundell Family Partnership. The promissory note is in the original principal amount of $50,000 and has an annual interest rate of 8% that is due on the first day of each month. The promissory note, plus interest, was due on June 26, 2002 or upon the sale of the VT 6802 railroad barrier technology, whichever occurred first. This note, plus all accrued interest, was paid in full on March 21, 2002, the approximate date of the sale of the Company's VT 6802 railroad barrier technology. The form of each of these non-convertible promissory notes is filed with the SEC as an exhibit to our Form 10-KSB for the year ended June 30, 2002. As a part of the cash investment, on February 27, 2002, we issued a stock purchase warrant to The Rundell Family Partnership. The stock purchase warrant entitles The Rundell Family Partnership to purchase from us, at any time, and in whole or in part, 250,000 fully paid and non-assessable shares of common stock for $0.20 per share. The number of shares of common stock purchasable upon exercise of a warrant is subject to adjustment in the event of any dividends, distributions, reclassifications, or capital reorganizations. The holder of the warrant is also entitled to certain registration rights. II-8 Issuances of Preferred Stock in Fiscal 2002 On July 27, 2001, we received $100,000 in cash from each of the Renaissance entities in exchange for 3,000 shares of the Company's Series G cumulative convertible preferred stock and 1,000 shares of its Series F cumulative convertible preferred stock to each of the Renaissance entities. These shares of Series F and Series G cumulative convertible preferred stock have since been fully converted into shares of our common stock. II-9 Item 27. Exhibits 2.1 Agreement and Plan of Merger, by and among the Company, ARMR Services Corporation, ISSI Merger Sub, Inc. and the Officers and Shareholders of ARMR Corporation, dated September 5, 2003. (14) 3.1+ Amended and Restated Certificate of Incorporation of the Company, as amended to date. 3.2 Amended and Restated Bylaws of the Company. (1) 4.1 Specimen certificate for Common Stock of the Company. (1) 4.2 Registration Rights Agreement, dated as of February 22, 1999, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (6) 4.3 Registration Rights Agreement, dated as of October 20, 2000, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (6) 4.4 Registration Rights Agreement, dated as of September 27, 2001, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (11) 4.5 Registration Rights Agreement, dates as of November 9, 2001, by and between the Company and C.A. Rundell, Jr. (9) 4.6 Registration Rights Agreement, dated as of March 11, 2003, among the Company and BFS US Special Opportunities Trust PLC, a public limited company registered in England and Wales. (13) 4.7+ Registration Rights Agreement, dated as of September 5, 2003, by and among the Company and Mary Roland and Ann Rosenbloom. 4.8 Certificate of Designation, Preferences and Rights of Series A $20 Convertible Preferred Stock. (2) 4.9 Registration Rights Agreement, dated November 30, 2004, by and among Integrated Security Systems, Inc. and those certain Investors set forth on the signature page to the registration Rights Agreement. (21) 5.1+ Opinion of Haynes and Boone, LLP. 10.1* Integrated Security Systems, Inc. 1993 Stock Option Plan, dated September 7, 1993, as amended on December 30, 1994. (1) 10.2* Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. (1) II-10 10.3* Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. (1) 10.4* Integrated Security Systems, Inc. 1997 Long-Term Incentive Plan. (10) 10.5* Form of Indemnification Agreement by and between the Company and the Company's officers and directors. (1) 10.6+ Lease Agreement, dated November 7, 2003, between TPLP Office Park Properties and the Company for property located in Irving, TX. 10.7 Form of Warrant Agreement for purchase of Common Stock, executed March 29, 1996. (3) 10.8 Form of Convertible Promissory Note. (8) 10.9 Form of Non-Convertible Promissory Note. (8) 10.10 Form of Stock Purchase Warrant. (12) 10.11 Promissory Note, dated October 1, 2003, payable to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. in the amount of $200,000. (15) 10.12 Promissory Note, dated October 1, 2003, payable to Frost National Bank FBO Renaissance US Growth Investment Trust PLC in the amount of $200,000. (15) 10.13 Stock Purchase Warrant, dated October 1, 2003, issued to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. (15) 10.14 Stock Purchase Warrant, dated October 1, 2003, issued to Frost National Bank FBO Renaissance US Growth Investment Trust PLC. (15) 10.15 Convertible Promissory Note, dated September 5, 2003, payable to BFS US Special Opportunities Trust PLC in the amount of $500,000. (16) 10.16 Promissory Note, dated September 26, 2003, payable to C. A. Rundell, Jr. in the amount of $100,000. (17) 10.17 Stock Purchase Warrant, dated September 26, 2003, issued to C. A. Rundell, Jr. (17) 10.18 Promissory Note, dated July 28, 2004, payable to C. A. Rundell, Jr. in the amount of $150,000. (20) 10.19 Promissory Note, dated August 5, 2004, payable to BFS US Special Opportunities Trust PLC in the amount of $1,000,000. (18) 10.20 Amended and Restated Pledge Agreement, dated August 5, 2004, between the Company, Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) II-11 10.21 Amended and Restated Security Agreement, dated August 5, 2004, between the Company, B&B ARMR Corporation, Intelli-Site, Inc., Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) 10.22 Letter Agreement by the Company, B&B ARMR Corporation and Intelli-Site, Inc. in favor of, and agreed to and accepted on August 20, 2004 by, Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) 10.23 Loan Agreement, dated November 10, 2004, among B&B ARMR Corporation, Integrated Security Systems, Inc., Intelli-Site, Inc. and Briar Capital, L.P. (19) 10.24 Revolving Promissory Note, dated November 10, 2004, issued by B&B ARMR Corporation to Briar Capital, L.P. (19) 10.25 Subordination Agreement, dated November 10, 2004, among B&B ARMR Corporation, Integrated Security Systems, Inc., Intelli-Site, Inc., Briar Capital, L.P., Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., and BFS US Special Opportunities Trust PLC. (20) 10.26 Subordination Agreement, dated November 10, 2004, among B&B ARMR Corporation, C. A. Rundell, Jr. and Briar Capital, L.P. (19) 10.27 Guaranty Agreement, dated November 10, 2004, by Integrated Security Systems, Inc. in favor of Briar Capital, L.P. (19) 10.28 Guarantor Security Agreement, dated November 10, 2004, by Integrated Security Systems, Inc. in favor of Briar Capital, L.P. (19) 10.29 Guaranty Agreement, dated November 10, 2004, by Intelli-Site, Inc. in favor of Briar Capital, L.P. (19) 10.30 Guarantor Security Agreement, dated November 10, 2004, by Intelli-Site, Inc. in favor of Briar Capital, L.P. (19) 10.31 Loan Agreement, dated November 30, 2004, by and among Integrated Security Systems, Inc. and those certain Investors set forth on the signature page to the Loan Agreement. (21) 10.32 Form of Subordinated 10% Convertible Promissory Note due November 30, 2009, issued by the Company to each of the Investors set forth on the signature page to the Loan Agreement. (21) 16.1 Letter of Grant Thornton LLP on Change in Certifying Accountant. (22) 21.1+ Subsidiaries of the Company. 23.1+ Consent of Grant Thornton LLP. II-12 __________ (1) Incorporated by reference to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW). (2) Incorporated by reference to the Company's Registration Statement on Form SB-2 (No. 333-5023). (3) Incorporated by reference to the Company's Form 10-QSB for the quarter ended March 31, 1996, accession number 0000950134-96-002226, SEC file number 001-11900, film number 96567733. (4) Incorporated by reference to the Company's Form 8-K filed on June 14, 1999, accession number 0000950134-99-005489, SEC file number 001-11900, film number 99646148. (5) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 1999, accession number 0000950134-99-010485, SEC file number 001-11900, film number 99761099. (6) Incorporated by reference to the Company's Form 10-KSB/A (Amendment No. 2) for the year ended June 30, 2000. (7) Incorporated by reference to the Company's proxy statement on Schedule 14A filed March 16, 2001. (8) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 2001. (9) Incorporated by reference to the Company's Form 8-K filed on November 13, 2001. (10) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 333-76558). (11) Incorporated by reference to the Company's Form 8-K filed on October 15, 2002. (12) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 2002. (13) Incorporated by reference to the Company's Form 8-K filed on March 25, 2003. (14) Incorporated by reference to the Company's Form 8-K filed on September 22, 2003. (15) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000198. (16) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000194. (17) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000196. (18) Incorporated by reference to the Company's Form 8-K filed on August 31, 2004. (19) Incorporated by reference to the Company's Form 8-K filed on November 16, 2004. (20) Incorporated by reference to the Company's Form 10-QSB for the quarter ended September 30, 2004. (21) Incorporated by reference to the Company's Form 8-K filed on December 3, 2004. (22) Incorporated by reference to the Company's Form 8-K filed on January 18, 2005. + Filed herewith. * Indicates management contract or compensatory plan or arrangement. II-13 Item 28. Undertakings The undersigned hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the company pursuant to the foregoing provisions, or otherwise, the company has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the company of expenses incurred or paid by a director, officer or controlling person of the company in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. II-14 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of filing on Form SB-2 and authorized this registration statement to be signed on its behalf by the undersigned, in the city of Irving, Texas, on this 8th day of April, 2005. INTEGRATED SECURITY SYSTEMS, INC. By: /s/ C.A. Rundell, Jr. ---------------------------------- C.A. Rundell, Jr. Director, Chairman of the Board, and Chief Executive Officer (Principal Executive and Financial Officer) In accordance with the requirements of the Securities Act of 1933, this registration statement was signed by the following persons in the capacities and on the dates indicated: Date: April 8, 2005 /s/ C. A. RUNDELL, JR. ---------------------------------- C. A. Rundell, Jr. Director, Chairman of the Board, and Chief Executive Officer (Principal Executive and Financial Officer) Date: April 8, 2005 /s/ RICHARD B. POWELL ---------------------------------- Richard B. Powell Vice President, Chief Accounting Officer, Secretary (Principal Accounting Officer) Date: April 8, 2005 /s/ PETER BEARE ---------------------------------- Peter Beare, Director Date: April 8, 2005 /s/ WILLIAM D. BREEDLOVE ---------------------------------- William D. Breedlove Director Date: April 8, 2005 /s/ RUSSELL CLEVELAND ---------------------------------- Russell Cleveland Director Date: April 8, 2005 /s/ ROBERT M. GALECKE ---------------------------------- Robert M. Galecke Director Date: April 8, 2005 /s/ FRANK R. MARLOW ---------------------------------- Frank R. Marlow Director Date: April 8, 2005 /s/ PAUL ROLAND ---------------------------------- Paul Roland Director II-15 EXHIBIT INDEX Exhibit No. Document Description ------------- ------------------------------------------------------------- 2.1 Agreement and Plan of Merger, by and among the Company, ARMR Services Corporation, ISSI Merger Sub, Inc. and the Officers and Shareholders of ARMR Corporation, dated September 5, 2003. (14) 3.1+ Amended and Restated Certificate of Incorporation of the Company, as amended to date. 3.2 Amended and Restated Bylaws of the Company. (1) 4.1 Specimen certificate for Common Stock of the Company. (1) 4.2 Registration Rights Agreement, dated as of February 22, 1999, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (6) 4.3 Registration Rights Agreement, dated as of October 20, 2000, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (6) 4.4 Registration Rights Agreement, dated as of September 27, 2001, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth Investment Trust PLC. (11) 4.5 Registration Rights Agreement, dates as of November 9, 2001, by and between the Company and C.A. Rundell, Jr. (9) 4.6 Registration Rights Agreement, dated as of March 11, 2003, among the Company and BFS US Special Opportunities Trust PLC, a public limited company registered in England and Wales. (13) 4.7+ Registration Rights Agreement, dated as of September 5, 2003, by and among the Company and Mary Roland and Ann Rosenbloom. 4.8 Certificate of Designation, Preferences and Rights of Series A $20 Convertible Preferred Stock. (2) 4.9 Registration Rights Agreement, dated November 30, 2004, by and among Integrated Security Systems, Inc. and those certain Investors set forth on the signature page to the registration Rights Agreement. (21) 5.1+ Opinion of Haynes and Boone, LLP. 10.1* Integrated Security Systems, Inc. 1993 Stock Option Plan, dated September 7, 1993, as amended on December 30, 1994. (1) 10.2* Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. (1) II-16 10.3* Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. (1) 10.4* Integrated Security Systems, Inc. 1997 Long-Term Incentive Plan. (10) 10.5* Form of Indemnification Agreement by and between the Company and the Company's officers and directors. (1) 10.6+ Lease Agreement, dated November 7, 2003, between TPLP Office Park Properties and the Company for property located in Irving, TX. 10.7 Form of Warrant Agreement for purchase of Common Stock, executed March 29, 1996. (3) 10.8 Form of Convertible Promissory Note. (8) 10.9 Form of Non-Convertible Promissory Note. (8) 10.10 Form of Stock Purchase Warrant. (12) 10.11 Promissory Note, dated October 1, 2003, payable to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. in the amount of $200,000. (15) 10.12 Promissory Note, dated October 1, 2003, payable to Frost National Bank FBO Renaissance US Growth Investment Trust PLC in the amount of $200,000. (15) 10.13 Stock Purchase Warrant, dated October 1, 2003, issued to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. (15) 10.14 Stock Purchase Warrant, dated October 1, 2003, issued to Frost National Bank FBO Renaissance US Growth Investment Trust PLC. (15) 10.15 Convertible Promissory Note, dated September 5, 2003, payable to BFS US Special Opportunities Trust PLC in the amount of $500,000. (16) 10.16 Promissory Note, dated September 26, 2003, payable to C. A. Rundell, Jr. in the amount of $100,000. (17) 10.17 Stock Purchase Warrant, dated September 26, 2003, issued to C. A. Rundell, Jr. (17) 10.18 Promissory Note, dated July 28, 2004, payable to C. A. Rundell, Jr. in the amount of $150,000. (20) 10.19 Promissory Note, dated August 5, 2004, payable to BFS US Special Opportunities Trust PLC in the amount of $1,000,000. (18) 10.20 Amended and Restated Pledge Agreement, dated August 5, 2004, between the Company, Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) II-17 10.21 Amended and Restated Security Agreement, dated August 5, 2004, between the Company, B&B ARMR Corporation, Intelli-Site, Inc., Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) 10.22 Letter Agreement by the Company, B&B ARMR Corporation and Intelli-Site, Inc. in favor of, and agreed to and accepted on August 20, 2004 by, Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., BFS US Special Opportunities Trust PLC and Renaissance Capital Group, Inc. (18) 10.23 Loan Agreement, dated November 10, 2004, among B&B ARMR Corporation, Integrated Security Systems, Inc., Intelli-Site, Inc. and Briar Capital, L.P. (19) 10.24 Revolving Promissory Note, dated November 10, 2004, issued by B&B ARMR Corporation to Briar Capital, L.P. (19) 10.25 Subordination Agreement, dated November 10, 2004, among B&B ARMR Corporation, Integrated Security Systems, Inc., Intelli-Site, Inc., Briar Capital, L.P., Renaissance US Growth Investment Trust PLC, Renaissance Capital Growth & Income Fund III, Inc., and BFS US Special Opportunities Trust PLC. (20) 10.26 Subordination Agreement, dated November 10, 2004, among B&B ARMR Corporation, C. A. Rundell, Jr. and Briar Capital, L.P. (19) 10.27 Guaranty Agreement, dated November 10, 2004, by Integrated Security Systems, Inc. in favor of Briar Capital, L.P. (19) 10.28 Guarantor Security Agreement, dated November 10, 2004, by Integrated Security Systems, Inc. in favor of Briar Capital, L.P. (19) 10.29 Guaranty Agreement, dated November 10, 2004, by Intelli-Site, Inc. in favor of Briar Capital, L.P. (19) 10.30 Guarantor Security Agreement, dated November 10, 2004, by Intelli-Site, Inc. in favor of Briar Capital, L.P. (19) 10.31 Loan Agreement, dated November 30, 2004, by and among Integrated Security Systems, Inc. and those certain Investors set forth on the signature page to the Loan Agreement. (21) 10.32 Form of Subordinated 10% Convertible Promissory Note due November 30, 2009, issued by the Company to each of the Investors set forth on the signature page to the Loan Agreement. (21) 16.1 Letter of Grant Thornton LLP on Change in Certifying Accountant. (22) 21.1+ Subsidiaries of the Company. 23.1+ Consent of Grant Thornton LLP. II-18 __________ (1) Incorporated by reference to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW). (2) Incorporated by reference to the Company's Registration Statement on Form SB-2 (No. 333-5023). (3) Incorporated by reference to the Company's Form 10-QSB for the quarter ended March 31, 1996, accession number 0000950134-96-002226, SEC file number 001-11900, film number 96567733. (4) Incorporated by reference to the Company's Form 8-K filed on June 14, 1999, accession number 0000950134-99-005489, SEC file number 001-11900, film number 99646148. (5) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 1999, accession number 0000950134-99-010485, SEC file number 001-11900, film number 99761099. (6) Incorporated by reference to the Company's Form 10-KSB/A (Amendment No. 2) for the year ended June 30, 2000. (7) Incorporated by reference to the Company's proxy statement on Schedule 14A filed March 16, 2001. (8) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 2001. (9) Incorporated by reference to the Company's Form 8-K filed on November 13, 2001. (10) Incorporated by reference to the Company's Registration Statement on Form S-8 (No. 333-76558). (11) Incorporated by reference to the Company's Form 8-K filed on October 15, 2002. (12) Incorporated by reference to the Company's Form 10-KSB for the year ended June 30, 2002. (13) Incorporated by reference to the Company's Form 8-K filed on March 25, 2003. (14) Incorporated by reference to the Company's Form 8-K filed on September 22, 2003. (15) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000198. (16) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000194. (17) Incorporated by reference to the Company's Form 8-K filed on October 3, 2003, accession number 0001158957-03-000196. (18) Incorporated by reference to the Company's Form 8-K filed on August 31, 2004. (19) Incorporated by reference to the Company's Form 8-K filed on November 16, 2004. (20) Incorporated by reference to the Company's Form 10-QSB for the quarter ended September 30, 2004. (21) Incorporated by reference to the Company's Form 8-K filed on December 3, 2004. (22) Incorporated by reference to the Company's Form 8-K filed on January 18, 2005. + Filed herewith. * Indicates management contract or compensatory plan or arrangement. II-19 EX-3.(I) 2 exhibit3-1sb2a040805.txt EXHIBIT 3.1 AMENDED CERTIFICATE OF INC. Exhibit 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF INTEGRATED SECURITY SYSTEMS, INC. The undersigned, Ferdinand A. Hauslein and William S. Leftwich, certify that they are the President and Secretary, respectively, of Integrated Security Systems, Inc., a corporation organized and existing under the laws of the State of Delaware (the "Corporation"), and do hereby further certify as follows: (1) The name of the corporation is Integrated Security Systems, Inc. (2) The name under which the Corporation was originally incorporated was "Integrated Security Systems, Inc." and the original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on December 18, 1991. (3) This Amended and Restated Certificate of Incorporation was duly adopted in accordance with the provisions of Sections 242 and 245 of the General Corporation Law of the State of Delaware. (4) This Amended and Restated Certificate of Incorporation restates and integrates previous provisions and also amends the provisions of the Corporation's Certificate of Incorporation. (5) The text of the Amended and Restated Certificate of Incorporation of the Corporation, as amended hereby, is restated to read in its entirety, as follows: First: The name of the Corporation is Integrated Security Systems, Inc. Second: The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street in the City of Wilmington, County of New Castle. The name and address of its registered agent is The Corporation Trust Company, Corporation Trust Center, 1209 Orange Street, Wilmington, Delaware 19801. Third: The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of the State of Delaware. Fourth: The total number of shares of stock which the Corporation shall have authority to issue is 150,750,000 shares, of which 150,000,000 shares shall be Common Stock, par value $0.01 per share ("Common Stock") and 750,000 shares shall be Preferred Stock, par value $0.01 per share ("Preferred Stock"). Fifth: From time to time the Corporation may issue its authorized shares for such consideration per share (with respect to shares having a par value, not less than the par value thereof), either in money or money's worth of property or services, and for such other consideration, whether greater or less, now or from time to time hereafter permitted by law, as may be fixed by the Board of Directors, and all shares so issued shall be fully paid and nonassessable. No holder of any shares of any class shall as such holder have any preemptive right to subscribe for or purchase any other shares or securities of any class, whether now or hereafter authorized, which any time may be offered for sale or sold by the Corporation. The Corporation may issue Preferred Stock from time to time in one or more series as the Board of Directors may establish by the adoption of a resolution or resolutions relating thereto, each series to have such voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, as shall be stated and expressed in the resolution of resolutions providing for the issue of such series adopted by the Board of Directors pursuant to authority to do so, which authority is hereby granted to the Board of Directors. Sixth: Any action required by the General Corporation Law of the State of Delaware to be taken at any annual or special meeting of stockholders, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, shall be signed by all the stockholders entitled to vote with respect to the subject matter thereof, and such consent shall have the same force and effect as a unanimous vote of the stockholders. No action may be taken by such written consent upon less than unanimous consent of all stockholders entitled to vote thereof. Seventh: In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized: (1) To make, alter or repeal the bylaws of the Corporation; (2) To authorize and cause to be executed mortgages and liens upon the real and personal property of the Corporation; (3) To set apart out of any of the funds of the Corporation available for dividends a reserve or reserves for any proper purpose and to abolish any such reserve in the manner in which it was created; (4) By a majority of the whole Board of Directors, to designate one or more committees, each committee to consist of two or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution or in the bylaws of the Corporation, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation and may authorize the seal of the Corporation to be affixed to all papers which may require it; provided, however, the bylaws may provide that in the absence or disqualification of any member of such committee or committees the member or members thereof present at any meeting and not disqualified from voting whether or not he or they constitute a quorum, may unanimously appoint another member or the Board of Directors to act at the meeting in the place of any such absent or disqualified member; and (5) When and as authorized by the affirmative vote of the holders of a majority of the stock issued and outstanding having voting power given at a stockholders' meeting duly called upon such notice as is required by statute, or when authorized by the written consent of the holders of a majority of the voting stock issued and outstanding, to sell, lease or exchange all or substantially all of the property and assets of the Corporation, including its goodwill and its corporate franchises, upon such terms and conditions and for such consideration, which may consist in whole or in part of money or property including securities of any other corporation or corporations, as the Board of Directors shall deem expedient and for the best interests of the Corporation. 2 Eighth: Whenever a compromise or arrangement is proposed between this Corporation and is creditors or any class of them and/or between this Corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this Corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this Corporation under the provisions of section 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this Corporation under the provisions of section 279 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this Corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this Corporation, as the case may be, and also on this Corporation. Ninth: Meetings of stockholders may be held within or without the State of Delaware, as the bylaws may provide. The books of the Corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in the bylaws of the Corporation. Elections of directors need not be by written ballot unless the bylaws of the Corporation shall so provide. Tenth: The Corporation is to have perpetual existence. Eleventh: The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation. Twelfth: No director of the Corporation shall be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law hereafter is amended to authorize the further elimination or limitation of the liability of directors, then the liability of a director of the Corporation, in addition to the limitation on personal liability provided herein, shall be limited to the fullest extent permitted by the amended Delaware General Corporation Law. Any repeal or modification of this Section by the stockholders of the Corporation shall be prospective only and shall not adversely affect any limitation on the personal liability of a director of the Corporation existing at the time of such repeal or modification. Thirteenth: Notwithstanding any other provisions of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, the affirmative vote of the holders of at least two-thirds (2/3) of the outstanding shares of each class of capital stock of the Corporation then entitled to vote thereon shall be required to amend, alter, or repeal any one or more of Articles SIXTH, SEVENTH, TWELFTH and THIRTEENTH of this Certificates of Incorporation. 3 IN WITNESS WHEREOF, Integrated Security Systems, Inc. has caused its corporate seal to be hereunto affixed and this Amended and Restated Certificate of Incorporation to be signed by Ferdinand A. Hauslein, Jr., its President, and attested by William S. Leftwich, its Secretary on April 15, 1993. INTEGRATED SECURITY SYSTEMS, INC. By: /s/ Ferdinand A. Hauslein, Jr. ------------------------------ Ferdinand A. Hauslein, Jr. President [SEAL] ATTEST: /s/ William S. Leftwich ------------------------------ William S. Leftwich, Secretary 4 CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS OF SERIES A $20 CONVERTIBLE PREFERRED STOCK of INTEGRATED SECURITY SYSTEMS, INC. Pursuant to Section 151 of the General Corporation Law of the State of Delaware The undersigned, President of Integrated Security Systems, Inc., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), in accordance with the provisions of Section 103 thereof DOES HEREBY CERTIFY: That pursuant to the authority conferred upon the Board of Directors by the Certificate of Incorporation of the Corporation, the said Board of Directors on March 4, 1996, adopted the following resolutions creating a series of shares of Preferred Stock, par value $.01 per share, designated as Series A $20 Convertible Preferred Stock: RESOLVED, that, pursuant to the authority vested in the Board of Directors of the Corporation in accordance with the provisions of its Certificate of Incorporation, a series of Preferred Stock of the Corporation be, and it hereby is, created, and that the designations and amounts thereof and the voting powers, preferences and relative, participating, optional and other special rights of the shares of such series, and the qualifications, limitations or restrictions thereof are as follows: Section 1. Designation and Amount. The shares of such series shall be designated as "Series A $20 Convertible Preferred Stock" and the number of shares constituting such series shall be 75,000. Section 2. Dividends. The Series A $20 Convertible Preferred Stock shall not be entitled to any dividends. Section 3. Voting. The holders of shares of Series A $20 Convertible Preferred Stock shall have no voting rights. Section 4. Conversion. (A) Each share of Series A $20 Convertible Preferred Stock may be converted at the option of the Board of Directors of the Corporation, as a whole or in part, at any time after the occurrence of both events described in paragraph (B) of this Section 4 into twenty (20) times the "Adjustment Number" of shares of Common Stock, par value $.01, of the Corporation ("Common Stock"). The initial Adjustment Number shall be one (1), and shall be subject to adjustment from time to time as provided in paragraph (D) of this Section 4. Upon the action by the Board of Directors authorizing the conversion of Series A $20 Convertible Preferred Stock, the Corporation shall send notice of such conversion to each holder of Series A $20 Convertible Preferred Stock whose shares are to be so converted. (B) The Corporation shall not have the conversion right described in paragraph (A) of this Section 4 until such time as (i) the closing bid price of the Common Stock, as quoted on NASDAQ, is at least equal to $2.00 for at least twenty (20) consecutive or nonconsecutive trading days during any thirty (30) consecutive trading day period preceding the date of the action by the Board of Directors ordering conversion, and (ii) the shares of Common Stock that will be received upon such conversion have been registered or otherwise qualified for sale under applicable federal and state securities laws. 5 (C) Each share of Series A $20 Convertible Preferred Stock shall be convertible, at the option of the holder thereof, by written notice to the Corporation, into twenty (20) times the Adjustment Number of shares of Common Stock, subject to adjustment as provided in paragraph (D) of this Section 4. Before any holder of Series A $20 Convertible Preferred Stock shall be entitled to convert the same into shares of Common Stock, he shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation. (D) In the event the Corporation shall at any time after the date of issuance of the Series A $20 Convertible Preferred Stock (i) declare any dividend on the Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the number of shares of Common Stock into which holders of shares of Series A $20 Convertible Preferred Stock were entitled to convert their shares or into which the Corporation could convert their shares pursuant to paragraph (C) or paragraph (A), respectively, of this Section 4 immediately prior to such event shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event (such fraction, the "Adjustment Number"). Section 5. Registration Rights. Within twelve (12) months of issue, the Corporation will file, and use its best efforts to have declared effective, one (1) registration statement pursuant to the Securities Act of 1933, as amended, registering resales of the shares of Common Stock into which the Series A $20 Convertible Preferred Stock may be converted (the "Registrable Stock"). This registration right is subject to any and all registration rights granted and outstanding as of the date hereof. Such resales need not be underwritten. No such registration shall be required if all of the Registrable Stock may be sold pursuant to Rule 144 or any successor rule. At least thirty (30) days prior to the filing of such registration statement, the Corporation will notify all registered holders of the Series A $20 Convertible Preferred Stock (or the Registrable Stock, if the Series A $20 Convertible Preferred Stock has been converted under the provisions of Section 4) by first class mail at their last known addresses as such shall appear on the stock transfer books of the Corporation of the Corporation's intention to file, and each registered holder shall have fifteen (15) days from the date the notice was mailed to the holders to notify the Corporation in writing stating what portion of the Registrable Stock such holder desires to have covered by such registration statement. Any notice which is mailed in the manner herein provided shall be conclusively presumed to have been duly given when mailed whether or not the holder receives the notice. If the registered holder fails to so notify the Corporation, then the Corporation shall have no further obligation to register such shares. Any registered holder of the Series A $20 Convertible Preferred Stock (or the Registrable Stock, if the Series A $20 Convertible Preferred Stock has been exercised) shall cooperate with the Corporation in the registration of the shares, and shall deliver such agreements as are customary or appropriate to facilitate the registration of such shares, including, but not limited to, the execution of an underwriting agreement with the underwriters, if any, selected by the Corporation. If requested by the Corporation and an underwriter of Common Stock of the Corporation, a holder shall not sell or otherwise transfer or dispose of any Common Stock or Series A $20 Convertible Preferred Stock of the Corporation held by such holder (other than those included in the registration statement) during the 180-day period following the effective date of a registration statement of the Corporation filed under the Securities Act of 1933, as amended. 6 Section 6. Expenses. For purposes of this Section 6, "Registration Expenses" shall mean any and all expenses, except Selling Expenses as defined below, incurred by the Corporation in complying with Section 5, including without limitation, (a) all Securities and Exchange Commission and stock exchange or National Association of Securities Dealers registration and filing fees, (b) all fees and expenses of complying with securities or blue sky laws (including reasonable fees and disbursements of counsel for the underwriters in connection with blue sky qualifications of the registered securities), (c) all printing, messenger and delivery expenses, (d) the fees and disbursements of counsel for the Corporation and of its independent public accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance and (e) any reasonable fees and expenses of any special experts retained in connection with the registration, but excluding underwriting discounts and commissions and transfer taxes, if any. "Selling Expenses" shall mean all underwriting discounts selling commissions and stock transfer taxes applicable to the Registrable Stock registered by the holders and, except as set forth in the definition of Registration Expenses, all reasonable fees and disbursements of one (1) counsel for the holders whose Registrable Stock is included in such registration as chosen by a simple majority of such holders. All Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to Section 5 shall be borne by the Corporation. All Selling Expenses relating to Registrable Stock registered on behalf of the holders whose Registrable Stock is included in any registration, qualification or compliance pursuant to Section 5 shall be borne by the holders pro rata based on the number of shares of Registrable Stock to be registered. Section 7. Reacquired Shares. Any shares of Series A $20 Convertible Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein. Section 8. Liquidation, Dissolution or Winding Up. (A) Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A $20 Convertible Preferred Stock unless, prior thereto, the holders of shares of Series A $20 Convertible Preferred Stock shall have received $20.00 per share (the "Liquidation Preference"). Following the payment of the full amount of the Liquidation Preference, no additional distributions shall be made to the holders of shares of Series A $20 Convertible Preferred Stock. (B) In the event, however, that there are not sufficient assets available to permit payment in full of the Liquidation Preference and the liquidation preferences of all other series of Preferred Stock, if any, which rank on a parity with the Series A $20 Convertible Preferred Stock, then such remaining assets shall be distributed ratably to the holders of such parity shares in proportion to their respective liquidation preferences. 7 Section 9. Consolidation, Merger, etc. In the event the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or other securities, cash or any other property, then in any such event the shares of Series A $20 Convertible Preferred Stock shall at the same time be similarly exchanged or changed in an amount per share (subject to the provision for adjustment hereinafter set forth) equal to twenty (20) times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time after the issuance of the Series A $20 Convertible Preferred Stock (i) declare any dividend on the Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A $20 Convertible Preferred Stock shall be adjusted by multiplying such amount by the Adjustment Number. The consolidation, merger, combination or other transaction of the Corporation with one or more other corporations shall not constitute a liquidation, dissolution or winding up of the Corporation within the meaning of paragraph (A) of Section 8. Section 10. Ranking. The Series A $20 Convertible Preferred Stock shall rank junior to all other series of the Corporation's Preferred Stock as to the distribution of assets, unless the terms of any such series shall provide otherwise. IN WITNESS WHEREOF, I have executed and subscribed this Certificate and do affirm the foregoing as true as of the day of March 4, 1996. /S/ Gerald K. Beckmann ------------------------- Name: Gerald K. Beckmann Title: President 8 CERTIFICATE OF DECREASE OF SERIES A $20 CONVERTIBLE PREFERRED STOCK OF INTEGRATED SECURITY SYSTEMS, INC. (Pursuant to Section 151(g) of the Delaware General Corporation Law) The undersigned hereby certifies that, by unanimous written consent of the Board of Directors of Integrated Security Systems, Inc., a Delaware corporation (the "Corporation"), effective as of March 13, 2001, the Board of Directors of the Corporation adopted a resolution retiring 65,500 shares of a previously-established series of the preferred stock of the Corporation, par value $0.01 per share, which series was designated "Series A $20 Convertible Preferred Stock" pursuant to a Certificate of Designation filed with the Delaware Secretary of State on April 2, 1996, and providing that the shares so retired shall resume the status of authorized but unissued shares of Preferred Stock, par value $0.01 per share, thereby decreasing the number of shares of preferred stock of the Corporation that are designated as Series A $20 Convertible Preferred Stock from 75,000 to 9,500. In witness whereof the Corporation has caused this Certificate to be signed by its duly authorized officer this 14th day of March, 2001. INTEGRATED SECURITY SYSTEMS, INC. By: /S/ C.A. RUNDELL, JR. -------------------------------- Name: C.A. Rundell, Jr. Title: Chief Executive Officer CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS OF SERIES D $20 CONVERTIBLE PREFERRED STOCK of INTEGRATED SECURITY SYSTEMS, INC. Pursuant to Section 151 of the General Corporation Law of the State of Delaware The undersigned, President of Integrated Security Systems, Inc., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), in accordance with the provisions of Section 103 thereof DOES HEREBY CERTIFY: That pursuant to the authority conferred upon the Board of Directors by the Certificate of Incorporation of the Corporation, the said Board of Directors on August 13, 1999, adopted the following resolutions creating a series of shares of Preferred Stock, par value $.01 per share, designated as Series D $20 Convertible Preferred Stock: RESOLVED, that, pursuant to the authority vested in the Board of Directors of the Corporation in accordance with the provisions of its Certificate of Incorporation, a series of Preferred Stock of the Corporation be, and it hereby is, created, and that the designations and amounts thereof and the voting powers, preferences and relative, participating, optional and other special rights of the shares of such series, and the qualifications, limitations or restrictions thereof are as follows: Section 1. Designation and Amount. The shares of such series shall be designated as "Series D $20 Convertible Preferred Stock" and the number of shares constituting such series shall be 150,000. Section 2. Dividends. The holders of Series D $20 Convertible Preferred Stock shall be entitled to receive, out of the funds of the Corporation legally available therefor (and the Board of Directors shall declare such dividends to the extent funds are legally available therefor), a cash dividend at the rate of $1.80 per annum per share, and no more. Dividends on each share of Series D shall be cumulative from the date of original issue of such share. Such dividends shall be paid in four equal quarterly installments on each December 31, March 31, June 30 and September 30 (the "Dividend Payment Dates"), beginning with December 31, 1999. Dividends on account of arrears may be declared and paid at any time, without reference to any Dividend Payment Date. Each dividend shall be paid to the holders of record of shares of Series D $20 Convertible Preferred Stock as they appear on the stock register of the Corporation on such record date, not exceeding 30 days preceding the payment date thereof, as may be fixed by the Board of Directors of the Corporation. So long as any share of Series D $20 Convertible Preferred Stock remains outstanding, no dividend whatever shall be paid or declared and no distribution shall be made on shares of the Common Stock or any junior stock (that is, stock ranking junior to the Series D $20 Convertible Preferred Stock either as to dividends or upon liquidation, dissolution or winding up), other than a dividend payable solely in junior stock, and no shares of junior stock shall be purchased, redeemed or otherwise acquired for consideration by the Corporation, directly or indirectly (other than as a result of a reclassification of junior stock, or the exchange or conversion of one share of junior stock, in each case, for or into another share of junior stock, and other than through the use of the proceeds of a substantially contemporaneous sale of other shares of junior stock), unless all accrued dividends on all outstanding shares of Series D $20 Convertible Preferred Stock for all past quarterly dividend periods shall have been paid and the full dividend thereon for the then current quarterly dividend period shall have been paid or declared and set apart for payment. Subject to the foregoing, and not otherwise, such dividends (payable in cash, stock or otherwise) as may be determined by the Board of Directors may be declared and paid on any junior stock from time to time out of any funds legally available therefor, and the shares of Series D $20 Convertible Preferred Stock shall not be entitled to participate therein. Section 3. Voting. The holder of each share of Series D $20 Convertible Preferred Stock shall have the right to one vote for each share of Common Stock, par value $.01, of the Corporation ("Common Stock"), into which such share of Series D $20 Convertible Preferred Stock could then be converted, and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled to notice of any meeting of the holders of Common Stock, in accordance with the bylaws of the Corporation, and shall be entitled to vote, together with holders of Common Stock, with respect to any question upon which holders of Common Stock have the right to vote, including without limitation, the election of directors by holders of the Common Stock. Fractional votes shall not be permitted and any fractional voting rights available to any holder of Series D $20 Convertible Preferred Stock on an as-converted basis (after aggregating all shares of Common Stock into which shares of Series D $20 Convertible Preferred Stock held by such holder could be converted) shall be rounded down to the nearest whole number. Section 4. Conversion. (1) Beginning on November 15, 2000, each share of Series D $20 Convertible Preferred Stock (and all or any portion of all such shares) may be converted at the option of the Board of Directors of the Corporation at any time, subject to the occurrence of both events described in paragraph (B) of this Section 4, into the number of shares of Common Stock as is determined by dividing the Liquidation Amount (defined below) by the Conversion Price (defined below). The initial Conversion Price shall be $.80, and shall be subject to adjustment from time to time as provided in paragraph (D) of this Section 4. Upon the action by the Board of Directors authorizing the conversion of shares of Series D $20 Convertible Preferred Stock, the Corporation shall send notice of such conversion to each holder of Series D $20 Convertible Preferred Stock whose shares are to be so converted. (2) The Corporation shall not have the conversion right described in paragraph (A) of this Section 4 until such time as (i) the closing bid price for the Common Stock, as quoted on NASDAQ, for twenty (20) consecutive trading days exceeds 2.5 times the Conversion Price in effect on such trading days and (ii) the Corporation has had basic earnings per share of Common Stock of greater than $0 for each of the two complete fiscal quarters immediately preceding such conversion. (3) Each share of Series D $20 Convertible Preferred Stock shall be convertible, at the option of the holder thereof, as a whole or in part, at any time and from time to time, by written notice to the Corporation, into the number of shares of Common Stock as is determined by dividing the Liquidation Amount by the Conversion Price then in effect. Before any holder of Series D $20 Convertible Preferred Stock shall be entitled to convert the same into shares of Common Stock, he shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation. (4) In the event the Corporation shall at any time after the date of issuance of the Series D $20 Convertible Preferred Stock (i) declare any dividend on the Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Conversion Price in effect immediately prior to such event shall be adjusted by multiplying such Conversion Price by a fraction the numerator of which is the number of shares of Common Stock that were outstanding immediately prior to such event and the denominator of which is the number of shares of Common Stock outstanding immediately after such event. 2 (5) In connection with the conversion of any shares of the Series D $20 Convertible Preferred Stock, no fractional shares of Common Stock shall be issued. Any fractional shares of Common Stock to which a holder of Series D $20 Convertible Preferred Stock would otherwise be entitled (after aggregating all shares of Common Stock which such holder would receive upon such conversion) shall be rounded down to the nearest whole number. Section 5. Reacquired Shares. Any shares of Series D $20 Convertible Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of preferred stock and may be reissued as part of a new series of preferred stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein. Section 6. Redemption. At any time on or after November 15, 2004, the Corporation, at the option of the Board of Directors, may redeem shares of Series D $20 Convertible Preferred Stock, at any time and from time to time, in whole or in part, upon notice given as hereinafter specified, at the Liquidation Amount per share in effect on the redemption date. Notice of every redemption of shares of Series D $20 Convertible Preferred Stock shall be mailed by first class mail, postage prepaid, addressed to the holders of record of the shares to be redeemed at their respective last addresses as they shall appear on the books of the Corporation. Such mailing shall be at least 30 days and no more than 60 days prior to the date fixed for redemption. Any notice which is mailed in the manner herein provided shall be conclusively presumed to have been duly given, whether or not the stockholder receives such notice, and failure duly to give such notice by mail, or any defect in such notice, to any holder of shares of Series D $20 Convertible Preferred Stock designated for redemption shall not affect the validity of the proceedings for the redemption of any other shares of Series D $20 Convertible Preferred Stock. The giving of such notice will not prohibit the conversion of the Series D $20 Convertible Preferred Stock by any holder in accordance with paragraph (C) of Section 4. In case of redemption of only a part of the shares of Series D $20 Convertible Preferred Stock at the time outstanding, the redemption may be either pro rata or by lot. The Board of Directors shall have full power and authority, subject to the provisions herein contained, to prescribe the terms and conditions upon which shares of Series D $20 Convertible Preferred Stock shall be redeemed from time to time. If notice of redemption shall have been duly given, and if on or before the redemption date specified therein all funds necessary for such redemption shall have been set aside by the Corporation, separate and apart from its other funds, in trust for the benefit of the holders of the shares called for redemption, so as to be and continue to be available therefor, then, notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, on and after such redemption date, all shares so called for redemption shall no longer be deemed outstanding and all rights with respect to such shares shall forthwith on such redemption date cease and terminate, except only the right of the holders thereof to receive the amount payable on redemption thereof, without interest. 3 Any funds so set aside or deposited by the Corporation which shall not be required for such redemption because of the exercise of any right of conversion by the holder thereof pursuant to paragraph (C) of Section 4 subsequent to the date of such deposit shall be released or repaid to the Corporation forthwith. Any funds so set aside or deposited, as the case may be, and unclaimed at the end of three years from such redemption date shall, to the extent permitted by law, be released or repaid to the Corporation, after which time the holders of the shares so called for redemption shall look only to the Corporation for payment thereof. Section 7. Liquidation, Dissolution or Winding Up. (1) Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series D $20 Convertible Preferred Stock unless, prior thereto, the holders of shares of Series D $20 Convertible Preferred Stock shall have received the Liquidation Amount with respect to such shares. "Liquidation Amount" with respect to any share of Series D $20 Convertible Preferred Stock on any date shall mean the sum of (i) $20 and (ii) the amount of any accrued and unpaid dividends with respect to such share on such date. Following the payment of the full amount of the Liquidation Amount, no additional distributions shall be made to the holders of shares of Series D $20 Convertible Preferred Stock. (2) In the event that there are not sufficient assets available to permit payment in full of the Liquidation Amount and the liquidation preferences of all other series of preferred stock of the Corporation, if any, which rank on a parity with the Series D $20 Convertible Preferred Stock, then such remaining assets shall be distributed ratably to the holders of the Series D $20 Convertible Preferred Stock and the holders of such parity shares in proportion to their respective liquidation preferences. Section 8. Consolidation, Merger, etc. In the event the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or other securities, cash or any other property, then in any such event each share of Series D $20 Convertible Preferred Stock shall at the same time be similarly exchanged or changed into the aggregate amount of stock, securities, cash and/or any other property, as the case may be, as a holder of Series D $20 Convertible Preferred Stock would have received in such consolidation, merger, combination or other transaction in exchange for the shares of Common Stock issuable upon conversion of one share of Series D $20 Convertible Preferred Stock had the holder converted such share of Series D $20 Convertible Preferred Stock into shares of Common Stock immediately prior to such consolidation, merger, combination or other transaction, at the Conversion Price then in effect. The consolidation, merger, combination or other transaction of the Corporation with one or more other corporations shall not constitute a liquidation, dissolution or winding up of the Corporation within the meaning of paragraph (A) of Section 7. Section 9. Ranking. The Series D $20 Convertible Preferred Stock shall rank on a parity with the Corporation's Series A $20 Convertible Preferred Stock, and with all other series of the Corporation's preferred stock as to the distribution of assets, unless the terms of any such series shall provide otherwise. IN WITNESS WHEREOF, I have executed and subscribed this Certificate and do affirm the foregoing as true as of October 8, 1999. /S/ Gerald K. Beckmann ---------------------- Gerald K. Beckmann President 4 CERTIFICATE OF AMENDMENT OF CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS OF SERIES D $20 CONVERTIBLE PREFERRED STOCK OF INTEGRATED SECURITY SYSTEMS, INC. Integrated Security Systems, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that: FIRST: The name of the Corporation is Integrated Security Systems, Inc. SECOND: The Board of Directors of the Corporation, by the unanimous written consent of its members, adopted a resolution proposing and declaring advisable that the liquidation amount set forth in the Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock of the Corporation should be modified by adopting the following amendment to the Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock of the Corporation: Paragraph (1) of Section 7 shall be amended in its entirety as follows: "(1) Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series D $20 Convertible Preferred Stock unless, prior thereto, the holders of shares of Series D $20 Convertible Preferred Stock shall have received the Liquidation Amount with respect to such shares. Until (a) all of the shares of Series F Cumulative Convertible Preferred Stock and Series G Cumulative Convertible Preferred Stock have been converted and/or redeemed, or (b) all of the holders of shares of Series F Cumulative Convertible Preferred Stock and Series G Cumulative Convertible Preferred Stock have received dividends and/or other distributions with respect to the Series F preferred stock and Series G preferred stock in an aggregate amount equal to the Liquidation Preference for such shares as set forth in this Restated Certificate of Incorporation. "Liquidation Amount" with respect to any share of Series D $20 Convertible Preferred Stock shall mean $0.01. After all of the shares of Series F Cumulative Convertible Preferred Stock and Series G Cumulative Convertible Preferred Stock have been converted or redeemed, or after all of the holders of shares of Series F Cumulative Convertible Preferred Stock and Series G Cumulative Convertible Preferred Stock have received dividends and/or other distributions with respect to the Series F preferred stock and Series G preferred stock in an aggregate amount equal to the Liquidation Preference for such shares as set forth in this Restated Certificate of Incorporation, "Liquidation Amount" with respect to any share of Series D $20 Convertible Preferred Stock shall mean the sum of (i) $20 and (ii) the amount of any accrued and unpaid dividends with respect to such share on such date. Following the payment of the full amount of the Liquidation Amount, no additional distributions shall be made to the holders of shares of Series D $20 Convertible Preferred Stock." THIRD: The resolution adopted by the Board of Directors has been duly adopted by (a) the affirmative vote of the holders of a majority of the shares of Common Stock outstanding and entitled to vote on the record date and Series D preferred stock, voting together as a class, and (b) the affirmative vote of the holders of the Series D preferred stock, voting separately as a class, in accordance with the provisions of the General Corporation Law of the State of Delaware. [The remainder of this page has been intentionally left blank; signature page to follow.] 2 IN WITNESS WHEREOF, Integrated Security Systems, Inc. has caused this certificate to be signed by its Chief Executive Officer as of May 10, 2001. INTEGRATED SECURITY SYSTEMS, INC. By: /S/ C.A. RUNDELL, JR. ----------------------- C.A. Rundell, Jr. Chief Executive Officer 3 CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS OF SERIES E $20 CONVERTIBLE PREFERRED STOCK of INTEGRATED SECURITY SYSTEMS, INC. Pursuant to Section 151 of the General Corporation Law of the State of Delaware The undersigned, President of Integrated Security Systems, Inc., a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), in accordance with the provisions of Section 103 thereof DOES HEREBY CERTIFY: That pursuant to the authority conferred upon the Board of Directors by the Certificate of Incorporation of the Corporation, the said Board of Directors on July 21, 2000, adopted the following resolutions creating a series of shares of Preferred Stock, par value $.01 per share, designated as Series E $20 Convertible Preferred Stock: RESOLVED, that, pursuant to the authority vested in the Board of Directors of the Corporation in accordance with the provisions of its Certificate of Incorporation, a series of Preferred Stock of the Corporation be, and it hereby is, created, and that the designations and amounts thereof and the voting powers, preferences and relative, participating, optional and other special rights of the shares of such series, and the qualifications, limitations or restrictions thereof are as follows: Section 1. Designation and Amount. The shares of such series shall be designated as "Series E $20 Convertible Preferred Stock" and the number of shares constituting such series shall be 150,000. Section 2. Dividends. The holders of Series E $20 Convertible Preferred Stock shall be entitled to receive, out of the funds of the Corporation legally available therefor (and the Board of Directors shall declare such dividends to the extent funds are legally available therefor), a cash dividend at the rate of $1.80 per annum per share, and no more. Dividends on each share of Series E shall be cumulative from the date of original issue of such share. Such dividends shall be paid in four equal quarterly installments on each December 31, March 31, June 30 and September 30 (the "Dividend Payment Dates"), beginning with December 31, 1999. Dividends on account of arrears may be declared and paid at any time, without reference to any Dividend Payment Date. Each dividend shall be paid to the holders of record of shares of Series E $20 Convertible Preferred Stock as they appear on the stock register of the Corporation on such record date, not exceeding 30 days preceding the payment date thereof, as may be fixed by the Board of Directors of the Corporation. So long as any share of Series E $20 Convertible Preferred Stock remains outstanding, no dividend whatever shall be paid or declared and no distribution shall be made on shares of the Common Stock or any junior stock (that is, stock ranking junior to the Series E $20 Convertible Preferred Stock either as to dividends or upon liquidation, dissolution or winding up), other than a dividend payable solely in junior stock, and no shares of junior stock shall be purchased, redeemed or otherwise acquired for consideration by the Corporation, directly or indirectly (other than as a result of a reclassification of junior stock, or the exchange or conversion of one share of junior stock, in each case, for or into another share of junior stock, and other than through the use of the proceeds of a substantially contemporaneous sale of other shares of junior stock), unless all accrued dividends on all outstanding shares of Series E $20 Convertible Preferred Stock for all past quarterly dividend periods shall have been paid and the full dividend thereon for the then current quarterly dividend period shall have been paid or declared and set apart for payment. Subject to the foregoing, and not otherwise, such dividends (payable in cash, stock or otherwise) as may be determined by the Board of Directors may be declared and paid on any junior stock from time to time out of any funds legally available therefor, and the shares of Series E $20 Convertible Preferred Stock shall not be entitled to participate therein. Section 3. Voting. The holder of each share of Series E $20 Convertible Preferred Stock shall have the right to one vote for each share of Common Stock, par value $.01, of the Corporation ("Common Stock"), into which such share of Series E $20 Convertible Preferred Stock could then be converted, and with respect to such vote, such holder shall have full voting rights and powers equal to the voting rights and powers of the holders of Common Stock, and shall be entitled to notice of any meeting of the holders of Common Stock, in accordance with the bylaws of the Corporation, and shall be entitled to vote, together with holders of Common Stock, with respect to any question upon which holders of Common Stock have the right to vote, including without limitation, the election of directors by holders of the Common Stock. Fractional votes shall not be permitted and any fractional voting rights available to any holder of Series E $20 Convertible Preferred Stock on an as-converted basis (after aggregating all shares of Common Stock into which shares of Series E $20 Convertible Preferred Stock held by such holder could be converted) shall be rounded down to the nearest whole number. Section 4. Conversion. Beginning on November 15, 2000, each share of Series E $20 Convertible Preferred Stock (and all or any portion of all such shares) may be converted at the option of the Board of Directors of the Corporation at any time, subject to the occurrence of both events described in paragraph (B) of this Section 4, into the number of shares of Common Stock as is determined by dividing the Liquidation Amount (defined below) by the Conversion Price (defined below). The initial Conversion Price shall be $.80, and shall be subject to adjustment from time to time as provided in paragraph (D) of this Section 4. Upon the action by the Board of Directors authorizing the conversion of shares of Series E $20 Convertible Preferred Stock, the Corporation shall send notice of such conversion to each holder of Series E $20 Convertible Preferred Stock whose shares are to be so converted. The Corporation shall not have the conversion right described in paragraph (A) of this Section 4 until such time as (i) the closing bid price for the Common Stock, as quoted on NASDAQ, for twenty (20) consecutive trading days exceeds 2.5 times the Conversion Price in effect on such trading days and (ii) the Corporation has had basic earnings per share of Common Stock of greater than $0 for each of the two complete fiscal quarters immediately preceding such conversion. Each share of Series E $20 Convertible Preferred Stock shall be convertible, at the option of the holder thereof, as a whole or in part, at any time and from time to time, by written notice to the Corporation, into the number of shares of Common Stock as is determined by dividing the Liquidation Amount by the Conversion Price then in effect. Before any holder of Series E $20 Convertible Preferred Stock shall be entitled to convert the same into shares of Common Stock, he shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation. In the event the Corporation shall at any time after the date of issuance of the Series E $20 Convertible Preferred Stock (i) declare any dividend on the Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Conversion Price in effect immediately prior to such event shall be adjusted by multiplying such Conversion Price by a fraction the numerator of which is the number of shares of Common Stock that were outstanding immediately prior to such event and the denominator of which is the number of shares of Common Stock outstanding immediately after such event. 2 In connection with the conversion of any shares of the Series E $20 Convertible Preferred Stock, no fractional shares of Common Stock shall be issued. Any fractional shares of Common Stock to which a holder of Series E $20 Convertible Preferred Stock would otherwise be entitled (after aggregating all shares of Common Stock which such holder would receive upon such conversion) shall be rounded down to the nearest whole number. Section 5. Reacquired Shares. Any shares of Series E $20 Convertible Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of preferred stock and may be reissued as part of a new series of preferred stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein. Section 6. Redemption. At any time on or after November 15, 2004, the Corporation, at the option of the Board of Directors, may redeem shares of Series E $20 Convertible Preferred Stock, at any time and from time to time, in whole or in part, upon notice given as hereinafter specified, at the Liquidation Amount per share in effect on the redemption date. Notice of every redemption of shares of Series E $20 Convertible Preferred Stock shall be mailed by first class mail, postage prepaid, addressed to the holders of record of the shares to be redeemed at their respective last addresses as they shall appear on the books of the Corporation. Such mailing shall be at least 30 days and no more than 60 days prior to the date fixed for redemption. Any notice which is mailed in the manner herein provided shall be conclusively presumed to have been duly given, whether or not the stockholder receives such notice, and failure duly to give such notice by mail, or any defect in such notice, to any holder of shares of Series E $20 Convertible Preferred Stock designated for redemption shall not affect the validity of the proceedings for the redemption of any other shares of Series E $20 Convertible Preferred Stock. The giving of such notice will not prohibit the conversion of the Series E $20 Convertible Preferred Stock by any holder in accordance with paragraph (C) of Section 4. In case of redemption of only a part of the shares of Series E $20 Convertible Preferred Stock at the time outstanding, the redemption may be either pro rata or by lot. The Board of Directors shall have full power and authority, subject to the provisions herein contained, to prescribe the terms and conditions upon which shares of Series E $20 Convertible Preferred Stock shall be redeemed from time to time. If notice of redemption shall have been duly given, and if on or before the redemption date specified therein all funds necessary for such redemption shall have been set aside by the Corporation, separate and apart from its other funds, in trust for the benefit of the holders of the shares called for redemption, so as to be and continue to be available therefor, then, notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, on and after such redemption date, all shares so called for redemption shall no longer be deemed outstanding and all rights with respect to such shares shall forthwith on such redemption date cease and terminate, except only the right of the holders thereof to receive the amount payable on redemption thereof, without interest. Any funds so set aside or deposited by the Corporation which shall not be required for such redemption because of the exercise of any right of conversion by the holder thereof pursuant to paragraph (C) of Section 4 subsequent to the date of such deposit shall be released or repaid to the Corporation forthwith. Any funds so set aside or deposited, as the case may be, and unclaimed at the end of three years from such redemption date shall, to the extent permitted by law, be released or repaid to the Corporation, after which time the holders of the shares so called for redemption shall look only to the Corporation for payment thereof. 3 Section 7. Liquidation, Dissolution or Winding Up. Upon any liquidation (voluntary or otherwise), dissolution or winding up of the Corporation, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series E $20 Convertible Preferred Stock unless, prior thereto, the holders of shares of Series E $20 Convertible Preferred Stock shall have received the Liquidation Amount with respect to such shares. "Liquidation Amount" with respect to any share of Series E $20 Convertible Preferred Stock on any date shall mean the sum of (i) $20 and (ii) the amount of any accrued and unpaid dividends with respect to such share on such date. Following the payment of the full amount of the Liquidation Amount, no additional distributions shall be made to the holders of shares of Series E $20 Convertible Preferred Stock. In the event that there are not sufficient assets available to permit payment in full of the Liquidation Amount and the liquidation preferences of all other series of preferred stock of the Corporation, if any, which rank on a parity with the Series E $20 Convertible Preferred Stock, then such remaining assets shall be distributed ratably to the holders of the Series E $20 Convertible Preferred Stock and the holders of such parity shares in proportion to their respective liquidation preferences. Section 8. Consolidation, Merger, etc. In the event the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or other securities, cash or any other property, then in any such event each share of Series E $20 Convertible Preferred Stock shall at the same time be similarly exchanged or changed into the aggregate amount of stock, securities, cash and/or any other property, as the case may be, as a holder of Series E $20 Convertible Preferred Stock would have received in such consolidation, merger, combination or other transaction in exchange for the shares of Common Stock issuable upon conversion of one share of Series E $20 Convertible Preferred Stock had the holder converted such share of Series E $20 Convertible Preferred Stock into shares of Common Stock immediately prior to such consolidation, merger, combination or other transaction, at the Conversion Price then in effect. The consolidation, merger, combination or other transaction of the Corporation with one or more other corporations shall not constitute a liquidation, dissolution or winding up of the Corporation within the meaning of paragraph (A) of Section 7. Section 9. Ranking. The Series E $20 Convertible Preferred Stock shall rank on a parity with the Corporation's Series A $20 Convertible Preferred Stock, and with all other series of the Corporation's preferred stock as to the distribution of assets, unless the terms of any such series shall provide otherwise. IN WITNESS WHEREOF, I have executed and subscribed this Certificate and do affirm the foregoing as true as of July 21, 2000. /S/ Gerald K. Beckmann ---------------------- Gerald K. Beckmann President 4 INTEGRATED SECURITY SYSTEMS, INC. --------------------------- Certificate of Designation and Preferences of Series F Cumulative Convertible Preferred Stock --------------------------- Dated as of May 10, 2001 INTEGRATED SECURITY SYSTEMS, INC. --------------------- Certificate of Designation and Preferences of Series F Cumulative Convertible Preferred Stock ---------------------- Integrated Security Systems, Inc., a Delaware corporation, having its principal office in Dallas, Texas (the "Corporation"), hereby certifies to the Secretary of State of the State of Delaware that: Pursuant to authority expressly vested in the Board of Directors of the Corporation by the Certificate of Incorporation of the Corporation (the "Certificate of Incorporation"), the Board of Directors has duly adopted resolutions authorizing the creation and issuance of up to Eighty Thousand (80,000) shares of Series F Cumulative Convertible Preferred Stock, $.01 par value, with a liquidation preference of Twenty-Five Dollars ($25.00) per share, and determining the preferences, rights, powers, limitations, qualifications and restrictions, as follows: Section 1. Number of Shares and Designation. This series of Preferred Stock, $.01 par value, shall be designated as Series F Cumulative Convertible Preferred Stock (the "Series F Preferred Stock"), and the number of shares which shall constitute such series shall be 80,000 shares. Section 2. Definitions. For purposes of the Series F Preferred Stock, the following terms shall have the meanings indicated below: "Act" shall mean the Securities Act of 1933, as amended. "Affiliate" of a person means a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified. "Board of Directors" shall mean the Board of Directors of the Corporation or any committee authorized by such Board of Directors to perform any of its responsibilities with respect to the Series F Preferred Stock. "Business Day" shall mean any day other than a Saturday, Sunday or a day on which state or federally chartered banking institutions in New York, New York are not required to be open. "Common Stock" shall mean the common stock, $.01 par value, of the Corporation or such shares of the Corporation's capital stock into which such Common Stock shall be reclassified. "Current Market Price" of publicly traded shares of Common Stock or any other class or series of capital stock or other security of the Corporation or of any similar security of any other issuer for any day shall mean the last reported sale price, regular way on such day, or, if no sale takes place on such day, the reported closing bid price, regular way on such day, in either case as reported on the NASDAQ National Market of the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") or, if not quoted on NASDAQ, on the principal national securities exchange on which such security is listed or admitted for trading or, if such security is not listed or admitted for trading on a national securities exchange or quoted on the NASDAQ National Market, the closing bid price on such day as reported on the NASDAQ SmallCap Market, or, if the bid price for such security on such day shall not have been reported on the NASDAQ SmallCap Market, the bid price on such day as reported on the OTC Electronic Bulletin Board or, if the bid price for such security on such day shall not have been reported on the OTC Electronic Bulletin Board, the price on such day, furnished by any NYSE member firm regularly making a market in such security selected for such purpose by the Chief Executive Officer or the Board of Directors or if any class or series of securities are not publicly traded, the fair value of the shares of such class as determined reasonably and in good faith by the Board of Directors of the Corporation or other issuer. "Dividend Payment Date" shall mean, with respect to each Dividend Period, the last day of March, June, September and December, in each year, commencing on March 31, 2001; provided, however, that if any Dividend Payment Date falls on any day other than a Business Day, the dividend payment due on such Dividend Payment Date shall be paid on the Business Day immediately following such Dividend Payment Date. "Dividend Periods" shall mean quarterly dividend periods commencing on January 1, April 1, July 1 and October 1 of each year and ending on and including the day preceding the first day of the next succeeding Dividend Period (other than the initial Dividend Period, which shall commence on the Issue Date and end on and include the day immediately preceding the Dividend Payment Date which immediately follows the Issue Date.) "Fair Market Value" on any date shall mean the average of the daily Current Market Price of a share of Common Stock during five (5) consecutive Trading Days ending on the day before such date. "Funds Available for Distribution" shall mean funds from operations (net income, computed in accordance with generally accepted accounting principles, excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization) minus non-revenue generated capital expenditures and debt principal amortization, as determined by the Board of Directors on a basis consistent with the policies and practices adopted by the Corporation for reporting publicly its results of operations and financial condition. "Issue Date" shall mean the date upon which shares of Series F Preferred Stock are issued. "Junior Stock" shall have the mean any class or series of capital stock of the Corporation which is junior to the Series F Preferred Stock as to the payment of dividends or as to the distribution of assets upon liquidation, dissolution or winding up of if the holders of Series F Preferred Stock shall be entitled to receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in preference or priority to the holders of shares of such class or series. "NYSE" shall mean the New York Stock Exchange. "Parity Stock" shall mean any class or series of capital stock of the Corporation on a parity with the Series F Preferred Stock or any other capital stock designated as Parity Stock as to the payment of dividends or as to the distribution of assets upon liquidation, dissolution or winding up, whether or not the dividend rates, dividend payment dates or redemption or liquidation prices per share thereof be different from those of the Series F Preferred Stock, if the holders of such class of stock or series and the Series F Preferred Stock shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in proportion to their respective amounts of accrued and unpaid dividends per share or liquidation preferences, without preference or priority of one over the other, including, without limitation, the Series G Preferred Stock. 2 "Permitted Common Stock Cash Distributions" means cash dividends and cash distributions paid on Common Stock after December 31, 2000 not in excess of the sum of the Corporation's cumulative undistributed net earnings at December 31, 2000, plus the cumulative amount of Funds Available for Distribution after December 31, 2000, minus the cumulative amount of dividends accumulated, accrued or paid on the Series F Preferred Stock or any other class of Preferred Stock after January 1, 2001. "Person" shall mean any individual, partnership, corporation or other entity and shall include the successor (by merger or otherwise) of such entity. "Senior Stock" shall mean any class or series of capital stock of the Corporation which is prior or senior to the Series F Preferred Stock, as to the payment of dividends and as to distribution of assets upon liquidation, dissolution or winding up, if the holders of such class or series shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in preference or priority to the holders of Series F Preferred Stock. "Series F Preferred Stock" shall have the meaning set forth in Section 1 hereof. "Series G Preferred Stock" shall have the meaning set forth in Section 5(d)(v) hereof. "Set apart for payment" shall be deemed to include, without any action other than the following, the recording by the Corporation in its accounting ledgers of any accounting or bookkeeping entry which indicates, pursuant to a declaration of dividends or other distribution by the Board of Directors, the allocation of funds to be so paid on any series or class of capital stock of the Corporation; provided, however, that if any funds for any class or series of Junior Stock or any class or series of Parity Stock are placed in a separate account of the Corporation or delivered to a disbursing, paying or other similar agent, then "set apart for payment" with respect to the Series F Preferred Stock shall mean placing such funds in a separate account or delivering such funds to a disbursing, paying or other similar agent. "Trading Day," as to any securities, shall mean any day on which such securities are traded on the NYSE or, if such securities are not listed or admitted for trading on the NYSE, on the principal national securities exchange on which such securities are listed or admitted or, if such securities are not listed or admitted for trading on any national securities exchange, on the NASDAQ National Market or, if such securities are not quoted on the NASDAQ National Market, in the securities market in which such securities are traded. Section 3. Dividends. (a) The holders of Series F Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available for that purpose, cumulative dividends payable in cash in an amount per share of Series F Preferred Stock equal to $1.25 per annum. Such dividends shall be cumulative from the Issue Date, whether or not in any Dividend Period or Periods such dividends shall be declared or there shall be funds of the Corporation legally available for the payment of such dividends, and shall be payable quarterly on the Dividend Payment Dates, commencing on the ninth Dividend Payment Date after the Issue Date. Each such dividend shall be payable to the holders of record of the Series F Preferred Stock, as they appear on the stock records of the Corporation at the close of business on a record date which shall be not more than sixty (60) days prior to the applicable Dividend Payment Date. Accumulated, accrued and unpaid dividends for any past Dividend Periods may be declared and paid at any time, without reference to any regular Dividend Payment Date, to holders of record on such date, which date shall not precede by more than forty-five (45) days the payment date thereof, as may be fixed by the Board of Directors. The amount of accumulated, accrued and unpaid dividends on any share of Series F Preferred Stock, or fraction thereof, at any date shall be the amount of any dividends thereon calculated at the applicable rate to and including such date, whether or not earned or declared, which have not been paid in cash. 3 (b) The amount of dividends payable per share of Series F Preferred Stock for each Dividend Period shall be computed by dividing the annual dividend by four (4). The amount of dividends payable per share of Series F Preferred Stock for the initial Dividend Period, or any other period shorter or longer than a full Dividend Period, shall be computed ratably on the basis of twelve (12) 30-day months and a 360-day year. Holders of Series F Preferred Stock shall not be entitled to any dividends, whether payable in cash, property or stock, in excess of cumulative dividends, as herein provided on the Series F Preferred Stock. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments on the Series F Preferred Stock that may be in arrears. (c) So long as any of the shares of Series F Preferred Stock are outstanding, no dividends, except as described in the immediately following sentence, shall be declared or paid or set apart for payment by the Corporation, or other distribution of cash or other property declared or made directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates with respect to any class or series of Parity Stock for any period, unless dividends equal to the full amount of accumulated, accrued and unpaid dividends have been or contemporaneously are declared and paid or declared and a sum sufficient for the payment thereof have been or contemporaneously are set apart for such payment on the Series F Preferred Stock for all Dividend Periods terminating on or prior to the Dividend Payment Date with respect to such class or series of Parity Stock. When dividends are not paid in full or a sum sufficient for such payment is not set apart, as aforesaid, all dividends declared upon the Series F Preferred Stock and all dividends declared upon any other class or series of Parity Stock shall be declared ratably in proportion to the respective amounts of dividends accumulated, accrued and unpaid on the Series F Preferred Stock and accumulated, accrued and unpaid on such Parity Stock. (d) So long as any of the shares of Series F Preferred Stock are outstanding, no dividends (other than dividends or distributions paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, Junior Stock) shall be declared or paid or set apart for payment by the Corporation, or other distribution of cash or other property declared or made directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates with respect to any shares of Junior Stock, nor shall any shares of Junior Stock be redeemed, purchased or otherwise acquired (other than a redemption, purchase or other acquisition of Common Stock made for purposes of an employee incentive or benefit plan of the Corporation or any subsidiary) for any consideration (or any moneys be paid to or made available for a sinking-fund for the redemption of any shares of any such stock) directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates (except by conversion into or exchange for Junior Stock), nor shall any other cash or other property otherwise be paid or distributed to or for the benefit of any holder of shares of Junior Stock in respect thereof, directly or indirectly, by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates, unless in each case (i) the full cumulative dividends (including all accumulated, accrued and unpaid dividends) on all outstanding shares of Series F Preferred Stock and any other Parity Stock of the Corporation shall have been paid or such dividends have been declared and set apart for payment for all past Dividend Periods with respect to the Series F Preferred Stock and all past Dividend Periods with respect to such Parity Stock, and (ii) sufficient funds shall have been paid or set apart for the payment of the full dividend for the current Dividend Period with respect to the Series F Preferred Stock and the current Dividend Period with respect to such Parity Stock. 4 Section 4. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, before any payment or distribution of the assets of the Corporation (whether capital or surplus) shall be made to or set apart for the holders of Junior Stock, the holders of shares of Series F Preferred Stock shall be entitled to receive Twenty-Five Dollars ($25.00) per share of Series F Preferred Stock, plus an amount equal to all dividends (whether or not earned or declared) accumulated, accrued and unpaid thereon to the date of final distribution to such holders. Until the holders of the Series F Preferred Stock have been paid the liquidation preference in full, no payment will be made to any holder of Junior Stock upon the liquidation, dissolution or winding up of the Corporation. If, upon any liquidation, dissolution or winding up of the Corporation, the assets of the Corporation, or proceeds thereof, distributable among the holders of Series F Preferred Stock shall be insufficient to pay in full the preferential amount aforesaid and liquidating payments on any other shares of any class or series of Parity Stock, then such assets, or the proceeds thereof, shall be distributed among the holders of Series F Preferred Stock and any such other Parity Stock ratably in the same proportion as the respective amounts that would be payable on such Series F Preferred Stock and any such other Parity Stock if all amounts payable thereon were paid in full. (b) Subject to the rights of the holders of any shares of Parity Stock, upon any liquidation, dissolution or winding up of the Corporation, after payment shall have been made in full to the holders of Series F Preferred Stock and any Parity Stock, as provided in this Section 4, any other series or class or classes of Junior Stock shall, subject to the respective terms thereof, be entitled to receive any and all assets remaining to be paid or distributed, and the holders of the Series F Preferred Stock and any Parity Stock shall not be entitled to share therein. (c) For purposes of this Section 4, a merger, consolidation, sale of voting control or sale of all or substantially all of the assets of the Corporation in which the holders of Common Stock of the Corporation immediately before such event do not own a majority of the outstanding shares or voting power of the surviving corporation shall be deemed to be a liquidation and dissolution of the Corporation. Section 5. Conversion Rights. The holders of shares of Series F Preferred Stock shall have the right, at their option, to convert such shares into shares of Common Stock of the Corporation at any time on and subject to the following terms and conditions: (a) The shares of Series F Preferred Stock shall be convertible at the office of the transfer agent for the Common Stock or the principal executive office of the Corporation, into fully paid and non-assessable shares (calculated as to each conversion to the nearest 1/100th of a share) of Common Stock of the Corporation, at the conversion price, determined as hereinafter provided, in effect at the time of conversion, each share of Series F Preferred Stock being taken at $25.00 for the purpose of such conversion. The price at which shares of Common Stock shall be delivered upon conversion (the "Conversion Price") shall initially be $.20 per share of Common Stock, and the number of shares initially issuable upon conversion of each share of Series F Preferred Stock is 125. The conversion price shall be adjusted in certain instances as provided below. (b) In order to convert shares of Series F Preferred Stock into Common Stock, the holder thereof shall surrender at the office or offices herein above mentioned the certificate or certificates therefor, duly endorsed or assigned to the Corporation or in blank, and give written notice to the Corporation at said office or offices that such holder elects to convert such shares. Shares of Series F Preferred Stock surrendered for conversion during the period from the close of business on any record date for the payment of a dividend on the shares of Series F Preferred Stock to the opening of business on the date for payment of such dividend shall be accompanied by a payment of an amount equal to the dividend declared and payable on such dividend payment date on the shares of Series F Preferred Stock being surrendered for conversion. Except as provided in the preceding sentence, no payment or adjustment shall be made upon any conversion on account of any unpaid or accrued dividends on the shares of Series F Preferred Stock surrendered for conversion or on account of any dividends on the Common Stock issued upon conversion. 5 Shares of Series F Preferred Stock shall be deemed to have been converted immediately prior to the close of business on the day of the surrender of the certificates for such shares for conversion in accordance with the foregoing provisions, and the person or persons entitled to receive the Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Stock at such time. As promptly as practicable on or after the conversion date, the Corporation shall issue and shall deliver at such office a certificate or certificates for the number of full shares of Common Stock issuable upon such conversion, together with payment in lieu of any fraction of a share, as hereinafter provided, to the person or persons entitled to receive the same. In case shares of Series F Preferred Stock are called for redemption, the right to convert such shares shall cease and terminate at the close of business on the date fixed for redemption, unless default shall be made in payment of the redemption price. (c) No fractional shares of Common Stock shall be issued upon conversion of shares of Series F Preferred Stock, but, instead of any fraction of a share which would otherwise be issuable, the Corporation shall pay a cash adjustment in respect of such fraction in an amount equal to the same fraction of the Closing Price (as hereinafter defined) on the date on which the certificate or certificates for such shares were duly surrendered for conversion, or, if such date is not a Trading Day (as hereinafter defined), on the next Trading Day. (d) The Conversion Price shall be adjusted from time to time as follows: (i) Adjustment for Issuance of Shares at Less Than the Conversion Price. If at any time after the date of the first issuance of Series F Preferred Stock, the Corporation shall issue any shares of Common Stock, Convertible Securities (as hereinafter defined), Rights (as hereinafter defined) or Related Rights (as hereinafter defined; any such shares, Convertible Securities, Rights or Related Rights, "Securities") without consideration or for a consideration per share or unit less than the Conversion Price in effect immediately prior to the issuance of such Securities, then the Conversion Price in effect immediately prior to each such issuance shall forthwith be reduced to the quotient obtained by dividing: (A) an amount equal to the sum of (1) the total number of shares of Common Stock outstanding immediately prior to such issuance (including for this purpose the number of shares of Common Stock into which the shares of Series F Preferred Stock outstanding immediately prior to such issuance are convertible on the date of such issuance in accordance with Subsection 5(a) (without regard to Subsection 5(c)), without giving effect to such issuance) multiplied by the Conversion Price in effect immediately prior to such issuance, and (2) the amount of consideration, if any, received by the Corporation upon such issuance, by (B) the total number of shares of Common Stock (1) outstanding immediately after such issuance (including the number of shares of Common Stock into which the shares of Series F Preferred Stock outstanding immediately prior to such issuance are convertible on the date of such issuance in accordance with Subsection 5(a) (without regard to Subsection 5(c)), without giving effect to such issuance) or (2) into or for which any such newly issued Convertible Securities are then convertible or exchangeable or (3) issuable upon the exercise of any such Rights or Related Rights). 6 (C) For the purpose of this Subsection 5(d), the following definitions and procedures shall be applicable: (1) In the case of the issuance of options, warrants or other rights to purchase or otherwise acquire Common Stock, whether or not at the time exercisable ("Rights"), the total number of shares of Common Stock issuable upon exercise of such Rights shall be deemed to have been issued at the time such Rights are issued, for a consideration equal to the sum of the consideration, if any, received by the Corporation upon the issuance of such rights and the minimum purchase or exercise price payable upon the exercise of such Rights for the Common Stock to be issued upon the exercise thereof. (2) In the case of the issuance of any class or series of stock or any bonds, debentures, notes or other securities or obligations convertible into or exchangeable for Common Stock, whether or not then convertible or exchangeable ("Convertible Securities"), or options, warrants or other rights to purchase or otherwise acquire Convertible Securities ("Related Rights"), the total number of shares of Common Stock issuable upon the conversion or exchange of such Convertible Securities or exercise of such Related Rights shall be deemed to have been issued at the time such Convertible Securities or Related Rights are issued, for a consideration equal to the sum of (I) the consideration, if any, received by the Corporation upon issuance of such Convertible Securities or Related Rights (excluding any cash received on account of accrued interest or dividends) and (II) (A) in the case of Convertible Securities, the minimum additional consideration, if any, to be received by the Corporation upon the conversion or exchange of such Convertible Securities or (B) in the case of Related Rights, the sum of (x) the minimum purchase or exercise price payable upon the exercise of such Related Rights for Convertible Securities and (y) the minimum additional consideration, if any, to be received by the Corporation upon the conversion or exchange of the Convertible Securities issued upon the exercise of such Related Rights. (3) On any change in the number of shares of Common Stock issuable upon the exercise of Rights or Related Rights or upon the conversion or exchange of Convertible Securities or on any change in the minimum purchase or exercise price of Rights, Related Rights or Convertible Securities, including, but not limited to, a change resulting from the anti-dilution provisions of such Rights, Related Rights or Convertible Securities, the Conversion Price to the extent in any way affected by such Rights, Related Rights or Convertible Securities shall forthwith be readjusted to be thereafter the Conversion Price that would have been obtained had the adjustment which was made upon the issuance of such Rights, Related Rights or Convertible Securities been made after giving effect to such change. No further adjustment shall be made in respect of such change upon the actual issuance of Common Stock or any payment of consideration upon the exercise of any such Rights or Related Rights or the conversion or exchange of such Convertible Securities. (4) On the expiration or cancellation of any such Rights, Related Rights or Convertible Securities, if the Conversion Price shall have been adjusted upon the issuance thereof, the Conversion Price shall forthwith be readjusted to such Conversion Price as would have been obtained had the adjustment made upon the issuance of such Rights, Related Rights or Convertible Securities been made upon the basis of the issuance of only the number of shares of Common Stock actually issued upon the exercise of such Rights or Related Rights or the conversion or exchange of such Convertible Securities. (ii) Sale of Shares. In case of the issuance of Securities for a consideration part or all of which shall be cash, the amount of the cash consideration therefor shall be deemed to be the gross amount of the cash paid to Corporation for such shares, before deducting any underwriting compensation or discount in the sale, underwriting or purchase thereof by underwriters or dealers or others performing similar services or for any expenses incurred in connection therewith. In case of the issuance of any Securities for a consideration part or all of which shall be other than cash, the amount of the consideration therefor, other than cash, shall be deemed to be the then fair market value of the property received. (iii) Reclassification of Shares. In case of the reclassification of securities into shares of Common Stock, the shares of Common Stock issued in such reclassification shall be deemed to have been issued for a consideration other than cash. Securities issued by way of dividend or other distribution on any class of stock of Corporation shall be deemed to have been issued without consideration. (iv) Stock Dividends, Stock Splits, Subdivisions or Combinations. In the event of a stock dividend, stock split or subdivision of shares of Common Stock into a greater number of shares, the Conversion Price shall be proportionately decreased, and in the event of a combination of shares of Common Stock into a smaller number of shares, the Conversion Price shall be proportionately increased, such increase or decrease, as the case may be, becoming effective at the record date. (v) Exceptions. The adjustments provided in Subsection 5(d)(i) shall not apply to any (A) Common Stock issued upon the conversion of any of the Series F Preferred Stock or the Series G Cumulative Convertible Preferred Stock, $.01 par value (the "Series G Preferred Stock"); (B) Common Stock issued upon exercise of any outstanding warrants; (C) Common Stock issued upon exercise of outstanding employee stock options; and (D) up to 1,500,000 shares of Common Stock issuable upon exercise of employee stock options to be granted subsequent to the date hereof. (vi) Adjustment for Mergers and Consolidations. (A) In the event of distribution to all Common Stock holders of any stock, indebtedness of the Corporation or assets (excluding cash dividends or distributions from retained earnings) or other rights to purchase securities or assets, then, after such event, the shares of Series F Preferred Stock will be convertible into the kind and amount of securities, cash and other property which the holder of the shares of Series F Preferred Stock would have been entitled to receive if the holder owned the Common Stock issuable upon conversion of the shares of Series F Preferred Stock immediately prior to the occurrence of such event. 7 (B) In case of any capital reorganization, reclassification of the stock of the Corporation (other than a change in par value or as a result of a stock dividend, subdivision, split up or combination of shares), the shares of Series F Preferred Stock shall be convertible into the kind and number of shares of stock or other securities or property of the Corporation to which the holder of the shares of Series F Preferred Stock would have been entitled to receive if the holder owned the Common Stock issuable upon conversion of the shares of Series F Preferred Stock immediately prior to the occurrence of such event. The provisions of the immediately foregoing sentence shall similarly apply to successive reorganizations, reclassifications, consolidations, exchanges, leases, transfers or other dispositions or other share exchanges. (C) The term "Fair Market Value," as used herein, is the value ascribed to consideration other than cash as determined by the Board of Directors of the Corporation in good faith, which determination shall be final, conclusive and binding. If the Board of Directors shall be unable to agree as to such fair market value, then the issue of fair market value shall be submitted to arbitration under and pursuant to the rules and regulations of the American Arbitration Association, and the decision of the arbitrators shall be final, conclusive and binding, and a final judgment may be entered thereon; provided, however, that such arbitration shall be limited to determination of the fair market value of assets tendered in consideration for the issue of Common Stock. (e) Whenever the conversion price is adjusted as herein provided: (i) The Corporation shall compute the adjusted conversion price in accordance with this Section 5 and shall cause to be prepared a certificate signed by the Corporation's treasurer setting forth the adjusted conversion price and showing in reasonable detail the fact upon which such adjustment is based; and (ii) A notice stating that the conversion price has been adjusted and setting forth the adjusted conversion price shall, as soon as practicable, be mailed to the holders of record of outstanding shares of Series F Preferred Stock. (f) In case: (i) The Corporation shall declare a dividend or other distribution on its Common Stock payable otherwise than in cash out of retained earnings; (ii) The Corporation shall authorize the issuance to the holders of its Common Stock of rights or warrants entitling them to subscribe for or purchase any shares of capital stock of any class or any other subscription rights or warrants; or (iii) Of any reclassification of the capital stock of the Corporation (other than a subdivision or combination of its outstanding shares of Common Stock), or of any consolidation or merger to which the Corporation is a party and for which approval of any stockholders of the Corporation is required, or of the sale, transfer or other disposition of all or substantially all of the assets of the Corporation; or (iv) Of the voluntary or involuntary liquidation, dissolution or winding up of the Corporation; 8 then the Corporation shall cause to be mailed to the holders of record of the outstanding shares of Series F Preferred Stock, at least 20 days (or 10 days in any case specified in clause (i) or (ii) above) prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date as of which the holders of record of Common Stock to be entitled to such dividend, distribution, rights or warrants are to be determined, or (y) the date on which such reclassification, consolidation, merger, sale, transfer, disposition, liquidation, dissolution or winding up is expected to become effective, and the date as of which it is expected that holders of record of Common Stock shall be entitled to exchange their shares for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, disposition, liquidation, dissolution or winding up, or the vote on any action authorizing such. (g) The Corporation shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, for the purpose of issuance upon conversion of shares of Series F Preferred Stock, the full number of shares of Common Stock then deliverable upon the conversion of all shares of Series F Preferred Stock then outstanding. (h) The Corporation will pay any and all taxes that may be payable in respect of the issuance of delivery of shares of Common Stock on conversion of shares of Series F Preferred Stock pursuant thereto. The Corporation shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of shares of Common Stock in a name other than that in which the shares of Series F Preferred Stock so converted were registered, and no such issuance or delivery shall be made unless and until the person requesting such issuance has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid. (i) The certificate of any independent firm of public accountants of nationally recognized standing selected by the Board of Directors shall be presumptive evidence of the correctness of any computation made under this Section 5. Section 6. Series F Preferred Stock To Be Retired. All shares of Series F Preferred Stock which shall have been issued and reacquired in any manner by the Corporation shall be restored to the status of authorized, but unissued shares of Preferred Stock, without designation as to series. The Corporation may also retire any unissued shares of Series F Preferred Stock, and such shares shall then be restored to the status of authorized but unissued shares of Preferred Stock, without designation as to series. Section 7. Ranking. No class or series of capital stock of the Corporation shall rank senior to the Series F Preferred Stock, and the Series G Preferred Stock shall be Parity Stock. Section 8. Voting. (a) The holders of Series F Preferred Stock shall be entitled to a number of votes equal to the number of shares of Common Stock into which the shares of Series F Preferred Stock are convertible on the record date of the determination of stockholders entitled to receive notice of and to vote on any matter submitted to a vote of stockholders of the Corporation. The holders of Series F Preferred Stock will vote together with holders of the Common Stock, the Series G Preferred Stock and any other class of equity securities which may vote with the holders of Common Stock as a single class on all matters upon which stockholders are entitled to vote, including the election of directors, except as specifically provided herein or as otherwise required by law. 9 (b) The affirmative vote or consent of the holders of 80% of the votes entitled to be cast by holders of the Series F Preferred Stock then outstanding, voting as a single class, in person or by proxy, either in writing without a meeting or by vote at any meeting called for the purpose, will be required in order to amend the Certificate of Incorporation or Bylaws to affect materially and adversely the rights, preferences or voting power of the holders of the Series F Preferred Stock. The affirmative vote or consent of the holders of 80% of the votes entitled to be cast by holders of the Series F Preferred Stock and Series G Preferred Stock then outstanding, voting as a single class, in person or by proxy, either in writing without a meeting or by vote at any meeting called for the purpose, will be required in order to authorize, create or increase the authorized amount of any class of Senior Stock or Parity Stock (other than the Series G Preferred Stock or securities to evidence bank debt or asset securitizations) or the merger, consolidation or sale of assets (other than in the ordinary course) of the Corporation, including the capital stock of its subsidiaries. However, the Corporation may create classes or series of Junior Stock or increase the authorized number of shares of Junior Stock, without the consent of any holder of Series F Preferred Stock. (c) The holders of shares of Series F Preferred Stock and Series G Preferred Stock shall be entitled to designate or elect two (2) directors to serve on the Board of Directors, by the vote of a plurality of the votes cast by the holders of the Series F Preferred Stock and Series G Preferred Stock, voting together as a single class, at an annual meeting of stockholders or special meeting held in place thereof, or at a special meeting of the holders of the Series F Preferred Stock and Series G Preferred Stock called from time to time for the election of directors. If the Board of Directors fails to appoint the two designees of the holders of the Series F Preferred Stock and Series G Preferred Stock, as herein above provided, the Secretary of the Corporation shall, upon the written request of any holder of Series F Preferred Stock and Series G Preferred Stock (addressed to the Secretary at the principal office of the Corporation), call a special meeting of the holders of the Series F Preferred Stock and Series G Preferred Stock for the election of the two (2) directors to be elected by them as herein provided, such call to be made by notice similar to that provided in the Bylaws of the Corporation for a special meeting of the stockholders or as required by law. If any such special meeting required to be called, as above provided, shall not be called by the Secretary within twenty (20) days after receipt of any such request, then any holder of Series F Preferred Stock and Series G Preferred Stock may call such meeting, upon the notice above provided, and for that purpose shall have access to the stock books of the Corporation. The directors elected at any such special meeting shall hold office until the next annual meeting of the stockholders or special meeting held in lieu thereof if such office shall not have previously terminated as above provided. If any vacancy shall occur among the directors elected by the holders of the Series F Preferred Stock and Series G Preferred Stock, a successor shall be elected by the Board of Directors, upon the nomination of the then remaining directors elected by the holders of the Series F Preferred Stock and Series G Preferred Stock or the successors of such remaining directors, to serve until the next annual meeting of the stockholders or special meeting held in place thereof if such office shall not have previously terminated as above provided. So long as any shares of Series F Preferred Stock and Series G Preferred Stock are outstanding, the number of directors of the Corporation shall at all times be such that the exercise by the holders of shares of Series F Preferred Stock and Series G Preferred Stock of the right to designate or elect directors under the circumstance provided in this Section 8(c) will not contravene any provisions of the Corporation's Certificate of Incorporation or Bylaws. Section 9. Redemption. The Series F Preferred Stock shall not be redeemable. Section 10. Record Holders. The Corporation may deem and treat the record holder of any share of Series F Preferred Stock as the true and lawful owner thereof for all purposes, and neither the Corporation nor the Transfer Agent shall be affected by any notice to the contrary. 10 IN WITNESS WHEREOF, the Corporation has caused this Certificate to be duly executed as of May 10, 2001. INTEGRATED SECURITY SYSTEMS, INC. By: /S/ C. A. RUNDELL, JR. ------------------------------------ C. A. Rundell, Jr. Chairman and Chief Executive Officer 11 INTEGRATED SECURITY SYSTEMS, INC. --------------------------- Certificate of Designation and Preferences of Series G Cumulative Convertible Preferred Stock --------------------------- Dated as of May 10, 2001 INTEGRATED SECURITY SYSTEMS, INC. --------------------- Certificate of Designation and Preferences of Series G Cumulative Convertible Preferred Stock ---------------------- Integrated Security Systems, Inc., a Delaware corporation, having its principal office in Dallas, Texas (the "Corporation"), hereby certifies to the Secretary of State of the State of Delaware that: Pursuant to authority expressly vested in the Board of Directors of the Corporation by the Certificate of Incorporation of the Corporation (the "Certificate of Incorporation"), the Board of Directors has duly adopted resolutions authorizing the creation and issuance of up to Three Hundred Thousand (300,000) shares of Series G Cumulative Convertible Preferred Stock, $.01 par value, with a liquidation preference of Twenty-Five Dollars ($25.00) per share, and determining the preferences, rights, powers, limitations, qualifications and restrictions, as follows: Section 1. Number of Shares and Designation. This series of Preferred Stock, $.01 par value, shall be designated as Series G Cumulative Convertible Preferred Stock (the "Series G Preferred Stock"), and the number of shares which shall constitute such series shall be 80,000 shares. Section 2. Definitions. For purposes of the Series G Preferred Stock, the following terms shall have the meanings indicated below: "Act" shall mean the Securities Act of 1933, as amended. "Affiliate" of a person means a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified. "Board of Directors" shall mean the Board of Directors of the Corporation or any committee authorized by such Board of Directors to perform any of its responsibilities with respect to the Series G Preferred Stock. "Business Day" shall mean any day other than a Saturday, Sunday or a day on which state or federally chartered banking institutions in New York, New York are not required to be open. "Common Stock" shall mean the common stock, $.01 par value, of the Corporation or such shares of the Corporation's capital stock into which such Common Stock shall be reclassified. "Current Market Price" of publicly traded shares of Common Stock or any other class or series of capital stock or other security of the Corporation or of any similar security of any other issuer for any day shall mean the last reported sale price, regular way on such day, or, if no sale takes place on such day, the reported closing bid price, regular way on such day, in either case as reported on the NASDAQ National Market of the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ") or, if not quoted on NASDAQ, on the principal national securities exchange on which such security is listed or admitted for trading or, if such security is not listed or admitted for trading on a national securities exchange or quoted on the NASDAQ National Market, the closing bid price on such day as reported on the NASDAQ SmallCap Market, or, if the bid price for such security on such day shall not have been reported on the NASDAQ SmallCap Market, the bid price on such day as reported on the OTC Electronic Bulletin Board or, if the bid price for such security on such day shall not have been reported on the OTC Electronic Bulletin Board, the price on such day, furnished by any NYSE member firm regularly making a market in such security selected for such purpose by the Chief Executive Officer or the Board of Directors or if any class or series of securities are not publicly traded, the fair value of the shares of such class as determined reasonably and in good faith by the Board of Directors of the Corporation or other issuer. 2 "Dividend Payment Date" shall mean, with respect to each Dividend Period, the last day of March, June, September and December, in each year, commencing on March 31, 2001; provided, however, that if any Dividend Payment Date falls on any day other than a Business Day, the dividend payment due on such Dividend Payment Date shall be paid on the Business Day immediately following such Dividend Payment Date. "Dividend Periods" shall mean quarterly dividend periods commencing on January 1, April 1, July 1 and October 1 of each year and ending on and including the day preceding the first day of the next succeeding Dividend Period (other than the initial Dividend Period, which shall commence on the Issue Date and end on and include the day immediately preceding the Dividend Payment Date which immediately follows the Issue Date.) "Fair Market Value" on any date shall mean the average of the daily Current Market Price of a share of Common Stock during five (5) consecutive Trading Days ending on the day before such date. "Funds Available for Distribution" shall mean funds from operations (net income, computed in accordance with generally accepted accounting principles, excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization) minus non-revenue generated capital expenditures and debt principal amortization, as determined by the Board of Directors on a basis consistent with the policies and practices adopted by the Corporation for reporting publicly its results of operations and financial condition. "Issue Date" shall mean the date upon which shares of Series G Preferred Stock are issued. "Junior Stock" shall have the mean any class or series of capital stock of the Corporation which is junior to the Series G Preferred Stock as to the payment of dividends or as to the distribution of assets upon liquidation, dissolution or winding up of if the holders of Series G Preferred Stock shall be entitled to receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in preference or priority to the holders of shares of such class or series. "NYSE" shall mean the New York Stock Exchange. "Parity Stock" shall mean any class or series of capital stock of the Corporation on a parity with the Series G Preferred Stock or any other capital stock designated as Parity Stock as to the payment of dividends or as to the distribution of assets upon liquidation, dissolution or winding up, whether or not the dividend rates, dividend payment dates or redemption or liquidation prices per share thereof be different from those of the Series G Preferred Stock, if the holders of such class of stock or series and the Series G Preferred Stock shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in proportion to their respective amounts of accrued and unpaid dividends per share or liquidation preferences, without preference or priority of one over the other, including, without limitation, the Series F Preferred Stock. 3 "Permitted Common Stock Cash Distributions" means cash dividends and cash distributions paid on Common Stock after December 31, 2000 not in excess of the sum of the Corporation's cumulative undistributed net earnings at December 31, 2000, plus the cumulative amount of Funds Available for Distribution after December 31, 2000, minus the cumulative amount of dividends accumulated, accrued or paid on the Series G Preferred Stock or any other class of Preferred Stock after January 1, 2001. "Person" shall mean any individual, partnership, corporation or other entity and shall include the successor (by merger or otherwise) of such entity. "Senior Stock" shall mean any class or series of capital stock of the Corporation which is prior or senior to the Series G Preferred Stock, as to the payment of dividends and as to distribution of assets upon liquidation, dissolution or winding up, if the holders of such class or series shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up in preference or priority to the holders of Series G Preferred Stock. "Series F Preferred Stock" shall have the meaning set forth in Section 5(d)(v) hereof. "Series G Preferred Stock" shall have the meaning set forth in Section 1 hereof. "Set apart for payment" shall be deemed to include, without any action other than the following, the recording by the Corporation in its accounting ledgers of any accounting or bookkeeping entry which indicates, pursuant to a declaration of dividends or other distribution by the Board of Directors, the allocation of funds to be so paid on any series or class of capital stock of the Corporation; provided, however, that if any funds for any class or series of Junior Stock or any class or series of Parity Stock are placed in a separate account of the Corporation or delivered to a disbursing, paying or other similar agent, then "set apart for payment" with respect to the Series G Preferred Stock shall mean placing such funds in a separate account or delivering such funds to a disbursing, paying or other similar agent. "Trading Day," as to any securities, shall mean any day on which such securities are traded on the NYSE or, if such securities are not listed or admitted for trading on the NYSE, on the principal national securities exchange on which such securities are listed or admitted or, if such securities are not listed or admitted for trading on any national securities exchange, on the NASDAQ National Market or, if such securities are not quoted on the NASDAQ National Market, in the securities market in which such securities are traded. Section 3. Dividends. (a) The holders of Series G Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors out of funds legally available for that purpose, cumulative dividends payable in cash in an amount per share of Series G Preferred Stock equal to $1.25 per annum. Such dividends shall be cumulative from the Issue Date, whether or not in any Dividend Period or Periods such dividends shall be declared or there shall be funds of the Corporation legally available for the payment of such dividends, and shall be payable quarterly on the Dividend Payment Dates, commencing on the eighth Dividend Payment Date after the Issue Date. Each such dividend shall be payable to the holders of record of the Series G Preferred Stock, as they appear on the stock records of the Corporation at the close of business on a record date which shall be not more than sixty (60) days prior to the applicable Dividend Payment Date. Accumulated, accrued and unpaid dividends for any past Dividend Periods may be declared and paid at any time, without reference to any regular Dividend Payment Date, to holders of record on such date, which date shall not precede by more than forty-five (45) days the payment date thereof, as may be fixed by the Board of Directors. The amount of accumulated, accrued and unpaid dividends on any share of Series G Preferred Stock, or fraction thereof, at any date shall be the amount of any dividends thereon calculated at the applicable rate to and including such date, whether or not earned or declared, which have not been paid in cash. 4 (b) The amount of dividends payable per share of Series G Preferred Stock for each Dividend Period shall be computed by dividing the annual dividend by four (4). The amount of dividends payable per share of Series G Preferred Stock for the initial Dividend Period, or any other period shorter or longer than a full Dividend Period, shall be computed ratably on the basis of twelve (12) 30-day months and a 360-day year. Holders of Series G Preferred Stock shall not be entitled to any dividends, whether payable in cash, property or stock, in excess of cumulative dividends, as herein provided on the Series G Preferred Stock. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments on the Series G Preferred Stock that may be in arrears. (c) So long as any of the shares of Series G Preferred Stock are outstanding, no dividends, except as described in the immediately following sentence, shall be declared or paid or set apart for payment by the Corporation, or other distribution of cash or other property declared or made directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates with respect to any class or series of Parity Stock for any period, unless dividends equal to the full amount of accumulated, accrued and unpaid dividends have been or contemporaneously are declared and paid or declared and a sum sufficient for the payment thereof have been or contemporaneously are set apart for such payment on the Series G Preferred Stock for all Dividend Periods terminating on or prior to the Dividend Payment Date with respect to such class or series of Parity Stock. When dividends are not paid in full or a sum sufficient for such payment is not set apart, as aforesaid, all dividends declared upon the Series G Preferred Stock and all dividends declared upon any other class or series of Parity Stock shall be declared ratably in proportion to the respective amounts of dividends accumulated, accrued and unpaid on the Series G Preferred Stock and accumulated, accrued and unpaid on such Parity Stock. (d) So long as any of the shares of Series G Preferred Stock are outstanding, no dividends (other than dividends or distributions paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, Junior Stock) shall be declared or paid or set apart for payment by the Corporation, or other distribution of cash or other property declared or made directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates with respect to any shares of Junior Stock, nor shall any shares of Junior Stock be redeemed, purchased or otherwise acquired (other than a redemption, purchase or other acquisition of Common Stock made for purposes of an employee incentive or benefit plan of the Corporation or any subsidiary) for any consideration (or any moneys be paid to or made available for a sinking-fund for the redemption of any shares of any such stock) directly or indirectly by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates (except by conversion into or exchange for Junior Stock), nor shall any other cash or other property otherwise be paid or distributed to or for the benefit of any holder of shares of Junior Stock in respect thereof, directly or indirectly, by the Corporation or any affiliate or any person acting on behalf of the Corporation or any of its affiliates, unless in each case (i) the full cumulative dividends (including all accumulated, accrued and unpaid dividends) on all outstanding shares of Series G Preferred Stock and any other Parity Stock of the Corporation shall have been paid or such dividends have been declared and set apart for payment for all past Dividend Periods with respect to the Series G Preferred Stock and all past Dividend Periods with respect to such Parity Stock, and (ii) sufficient funds shall have been paid or set apart for the payment of the full dividend for the current Dividend Period with respect to the Series G Preferred Stock and the current Dividend Period with respect to such Parity Stock. 5 Section 4. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, before any payment or distribution of the assets of the Corporation (whether capital or surplus) shall be made to or set apart for the holders of Junior Stock, the holders of shares of Series G Preferred Stock shall be entitled to receive Twenty-Five Dollars ($25.00) per share of Series G Preferred Stock, plus an amount equal to all dividends (whether or not earned or declared) accumulated, accrued and unpaid thereon to the date of final distribution to such holders. Until the holders of the Series G Preferred Stock have been paid the liquidation preference in full, no payment will be made to any holder of Junior Stock upon the liquidation, dissolution or winding up of the Corporation. If, upon any liquidation, dissolution or winding up of the Corporation, the assets of the Corporation, or proceeds thereof, distributable among the holders of Series G Preferred Stock shall be insufficient to pay in full the preferential amount aforesaid and liquidating payments on any other shares of any class or series of Parity Stock, then such assets, or the proceeds thereof, shall be distributed among the holders of Series G Preferred Stock and any such other Parity Stock ratably in the same proportion as the respective amounts that would be payable on such Series G Preferred Stock and any such other Parity Stock if all amounts payable thereon were paid in full. (b) Subject to the rights of the holders of any shares of Parity Stock, upon any liquidation, dissolution or winding up of the Corporation, after payment shall have been made in full to the holders of Series G Preferred Stock and any Parity Stock, as provided in this Section 4, any other series or class or classes of Junior Stock shall, subject to the respective terms thereof, be entitled to receive any and all assets remaining to be paid or distributed, and the holders of the Series G Preferred Stock and any Parity Stock shall not be entitled to share therein. (c) For purposes of this Section 4, a merger, consolidation, sale of voting control or sale of all or substantially all of the assets of the Corporation in which the holders of Common Stock of the Corporation immediately before such event do not own a majority of the outstanding shares or voting power of the surviving corporation shall be deemed to be a liquidation and dissolution of the Corporation. Section 5. Conversion Rights. The holders of shares of Series G Preferred Stock shall have the right, at their option, to convert such shares into shares of Common Stock of the Corporation at any time on and subject to the following terms and conditions: (a) The shares of Series G Preferred Stock shall be convertible at the office of the transfer agent for the Common Stock or the principal executive office of the Corporation, into fully paid and non-assessable shares (calculated as to each conversion to the nearest 1/100th of a share) of Common Stock of the Corporation, at the conversion price, determined as hereinafter provided, in effect at the time of conversion, each share of Series G Preferred Stock being taken at $25.00 for the purpose of such conversion. The price at which shares of Common Stock shall be delivered upon conversion (the "Conversion Price") shall initially be $.20 per share of Common Stock, and the number of shares initially issuable upon conversion of each share of Series G Preferred Stock is 125. The conversion price shall be adjusted in certain instances as provided below. (b) In order to convert shares of Series G Preferred Stock into Common Stock, the holder thereof shall surrender at the office or offices herein above mentioned the certificate or certificates therefor, duly endorsed or assigned to the Corporation or in blank, and give written notice to the Corporation at said office or offices that such holder elects to convert such shares. Shares of Series G Preferred Stock surrendered for conversion during the period from the close of business on any record date for the payment of a dividend on the shares of Series G Preferred Stock to the opening of business on the date for payment of such dividend shall be accompanied by a payment of an amount equal to the dividend declared and payable on such dividend payment date on the shares of Series G Preferred Stock being surrendered for conversion. Except as provided in the preceding sentence, no payment or adjustment shall be made upon any conversion on account of any unpaid or accrued dividends on the shares of Series G Preferred Stock surrendered for conversion or on account of any dividends on the Common Stock issued upon conversion. 6 Shares of Series G Preferred Stock shall be deemed to have been converted immediately prior to the close of business on the day of the surrender of the certificates for such shares for conversion in accordance with the foregoing provisions, and the person or persons entitled to receive the Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Stock at such time. As promptly as practicable on or after the conversion date, the Corporation shall issue and shall deliver at such office a certificate or certificates for the number of full shares of Common Stock issuable upon such conversion, together with payment in lieu of any fraction of a share, as hereinafter provided, to the person or persons entitled to receive the same. In case shares of Series G Preferred Stock are called for redemption, the right to convert such shares shall cease and terminate at the close of business on the date fixed for redemption, unless default shall be made in payment of the redemption price. (c) No fractional shares of Common Stock shall be issued upon conversion of shares of Series G Preferred Stock, but, instead of any fraction of a share which would otherwise be issuable, the Corporation shall pay a cash adjustment in respect of such fraction in an amount equal to the same fraction of the Closing Price (as hereinafter defined) on the date on which the certificate or certificates for such shares were duly surrendered for conversion, or, if such date is not a Trading Day (as hereinafter defined), on the next Trading Day. (d) The Conversion Price shall be adjusted from time to time as follows: (i) Adjustment for Issuance of Shares at Less Than the Conversion Price. If at any time after the date of the first issuance of Series G Preferred Stock, the Corporation shall issue any shares of Common Stock, Convertible Securities (as hereinafter defined), Rights (as hereinafter defined) or Related Rights (as hereinafter defined; any such shares, Convertible Securities, Rights or Related Rights, "Securities") without consideration or for a consideration per share or unit less than the Conversion Price in effect immediately prior to the issuance of such Securities, then the Conversion Price in effect immediately prior to each such issuance shall forthwith be reduced to the quotient obtained by dividing: (A) an amount equal to the sum of (1) the total number of shares of Common Stock outstanding immediately prior to such issuance (including for this purpose the number of shares of Common Stock into which the shares of Series G Preferred Stock outstanding immediately prior to such issuance are convertible on the date of such issuance in accordance with Subsection 5(a) (without regard to Subsection 5(c)), without giving effect to such issuance) multiplied by the Conversion Price in effect immediately prior to such issuance, and (2) the amount of consideration, if any, received by the Corporation upon such issuance, by (B) the total number of shares of Common Stock (1) outstanding immediately after such issuance (including the number of shares of Common Stock into which the shares of Series G Preferred Stock outstanding immediately prior to such issuance are convertible on the date of such issuance in accordance with Subsection 5(a) (without regard to Subsection 5(c)), without giving effect to such issuance) or (2) into or for which any such newly issued Convertible Securities are then convertible or exchangeable or (3) issuable upon the exercise of any such Rights or Related Rights). 7 (C) For the purpose of this Subsection 5(d), the following definitions and procedures shall be applicable: (1) In the case of the issuance of options, warrants or other rights to purchase or otherwise acquire Common Stock, whether or not at the time exercisable ("Rights"), the total number of shares of Common Stock issuable upon exercise of such Rights shall be deemed to have been issued at the time such Rights are issued, for a consideration equal to the sum of the consideration, if any, received by the Corporation upon the issuance of such rights and the minimum purchase or exercise price payable upon the exercise of such Rights for the Common Stock to be issued upon the exercise thereof. (2) In the case of the issuance of any class or series of stock or any bonds, debentures, notes or other securities or obligations convertible into or exchangeable for Common Stock, whether or not then convertible or exchangeable ("Convertible Securities"), or options, warrants or other rights to purchase or otherwise acquire Convertible Securities ("Related Rights"), the total number of shares of Common Stock issuable upon the conversion or exchange of such Convertible Securities or exercise of such Related Rights shall be deemed to have been issued at the time such Convertible Securities or Related Rights are issued, for a consideration equal to the sum of (I) the consideration, if any, received by the Corporation upon issuance of such Convertible Securities or Related Rights (excluding any cash received on account of accrued interest or dividends) and (II) (A) in the case of Convertible Securities, the minimum additional consideration, if any, to be received by the Corporation upon the conversion or exchange of such Convertible Securities or (B) in the case of Related Rights, the sum of (x) the minimum purchase or exercise price payable upon the exercise of such Related Rights for Convertible Securities and (y) the minimum additional consideration, if any, to be received by the Corporation upon the conversion or exchange of the Convertible Securities issued upon the exercise of such Related Rights. (3) On any change in the number of shares of Common Stock issuable upon the exercise of Rights or Related Rights or upon the conversion or exchange of Convertible Securities or on any change in the minimum purchase or exercise price of Rights, Related Rights or Convertible Securities, including, but not limited to, a change resulting from the anti-dilution provisions of such Rights, Related Rights or Convertible Securities, the Conversion Price to the extent in any way affected by such Rights, Related Rights or Convertible Securities shall forthwith be readjusted to be thereafter the Conversion Price that would have been obtained had the adjustment which was made upon the issuance of such Rights, Related Rights or Convertible Securities been made after giving effect to such change. No further adjustment shall be made in respect of such change upon the actual issuance of Common Stock or any payment of consideration upon the exercise of any such Rights or Related Rights or the conversion or exchange of such Convertible Securities. 8 (4) On the expiration or cancellation of any such Rights, Related Rights or Convertible Securities, if the Conversion Price shall have been adjusted upon the issuance thereof, the Conversion Price shall forthwith be readjusted to such Conversion Price as would have been obtained had the adjustment made upon the issuance of such Rights, Related Rights or Convertible Securities been made upon the basis of the issuance of only the number of shares of Common Stock actually issued upon the exercise of such Rights or Related Rights or the conversion or exchange of such Convertible Securities. (ii) Sale of Shares. In case of the issuance of Securities for a consideration part or all of which shall be cash, the amount of the cash consideration therefor shall be deemed to be the gross amount of the cash paid to Corporation for such shares, before deducting any underwriting compensation or discount in the sale, underwriting or purchase thereof by underwriters or dealers or others performing similar services or for any expenses incurred in connection therewith. In case of the issuance of any Securities for a consideration part or all of which shall be other than cash, the amount of the consideration therefor, other than cash, shall be deemed to be the then fair market value of the property received. (iii) Reclassification of Shares. In case of the reclassification of securities into shares of Common Stock, the shares of Common Stock issued in such reclassification shall be deemed to have been issued for a consideration other than cash. Securities issued by way of dividend or other distribution on any class of stock of Corporation shall be deemed to have been issued without consideration. (iv) Stock Dividends, Stock Splits, Subdivisions or Combinations. In the event of a stock dividend, stock split or subdivision of shares of Common Stock into a greater number of shares, the Conversion Price shall be proportionately decreased, and in the event of a combination of shares of Common Stock into a smaller number of shares, the Conversion Price shall be proportionately increased, such increase or decrease, as the case may be, becoming effective at the record date. (v) Exceptions. The adjustments provided in Subsection 5(d)(i) shall not apply to any (A) Common Stock issued upon the conversion of any of the Series G Preferred Stock or the Series F Cumulative Convertible Preferred Stock, $.01 par value (the " Series F Preferred Stock"); (B) Common Stock issued upon exercise of any outstanding warrants; (C) Common Stock issued upon exercise of outstanding employee stock options; and (D) up to 1,500,000 shares of Common Stock issuable upon exercise of employee stock options to be granted subsequent to the date hereof. (vi) Adjustment for Mergers and Consolidations. (A) In the event of distribution to all Common Stock holders of any stock, indebtedness of the Corporation or assets (excluding cash dividends or distributions from retained earnings) or other rights to purchase securities or assets, then, after such event, the shares of Series G Preferred Stock will be convertible into the kind and amount of securities, cash and other property which the holder of the shares of Series G Preferred Stock would have been entitled to receive if the holder owned the Common Stock issuable upon conversion of the shares of Series G Preferred Stock immediately prior to the occurrence of such event. 9 (B) In case of any capital reorganization, reclassification of the stock of the Corporation (other than a change in par value or as a result of a stock dividend, subdivision, split up or combination of shares), the shares of Series G Preferred Stock shall be convertible into the kind and number of shares of stock or other securities or property of the Corporation to which the holder of the shares of Series G Preferred Stock would have been entitled to receive if the holder owned the Common Stock issuable upon conversion of the shares of Series G Preferred Stock immediately prior to the occurrence of such event. The provisions of the immediately foregoing sentence shall similarly apply to successive reorganizations, reclassifications, consolidations, exchanges, leases, transfers or other dispositions or other share exchanges. (C) The term "Fair Market Value," as used herein, is the value ascribed to consideration other than cash as determined by the Board of Directors of the Corporation in good faith, which determination shall be final, conclusive and binding. If the Board of Directors shall be unable to agree as to such fair market value, then the issue of fair market value shall be submitted to arbitration under and pursuant to the rules and regulations of the American Arbitration Association, and the decision of the arbitrators shall be final, conclusive and binding, and a final judgment may be entered thereon; provided, however, that such arbitration shall be limited to determination of the fair market value of assets tendered in consideration for the issue of Common Stock. (e) Whenever the conversion price is adjusted as herein provided: (i) The Corporation shall compute the adjusted conversion price in accordance with this Section 5 and shall cause to be prepared a certificate signed by the Corporation's treasurer setting forth the adjusted conversion price and showing in reasonable detail the fact upon which such adjustment is based; and (ii) A notice stating that the conversion price has been adjusted and setting forth the adjusted conversion price shall, as soon as practicable, be mailed to the holders of record of outstanding shares of Series G Preferred Stock. (f) In case: (i) The Corporation shall declare a dividend or other distribution on its Common Stock payable otherwise than in cash out of retained earnings; (ii) The Corporation shall authorize the issuance to the holders of its Common Stock of rights or warrants entitling them to subscribe for or purchase any shares of capital stock of any class or any other subscription rights or warrants; or (iii) Of any reclassification of the capital stock of the Corporation (other than a subdivision or combination of its outstanding shares of Common Stock), or of any consolidation or merger to which the Corporation is a party and for which approval of any stockholders of the Corporation is required, or of the sale, transfer or other disposition of all or substantially all of the assets of the Corporation; or (iv) Of the voluntary or involuntary liquidation, dissolution or winding up of the Corporation; 10 then the Corporation shall cause to be mailed to the holders of record of the outstanding shares of Series G Preferred Stock, at least 20 days (or 10 days in any case specified in clause (i) or (ii) above) prior to the applicable record or effective date hereinafter specified, a notice stating (x) the date as of which the holders of record of Common Stock to be entitled to such dividend, distribution, rights or warrants are to be determined, or (y) the date on which such reclassification, consolidation, merger, sale, transfer, disposition, liquidation, dissolution or winding up is expected to become effective, and the date as of which it is expected that holders of record of Common Stock shall be entitled to exchange their shares for securities, cash or other property deliverable upon such reclassification, consolidation, merger, sale, transfer, disposition, liquidation, dissolution or winding up, or the vote on any action authorizing such. (g) The Corporation shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, for the purpose of issuance upon conversion of shares of Series G Preferred Stock, the full number of shares of Common Stock then deliverable upon the conversion of all shares of Series G Preferred Stock then outstanding. (h) The Corporation will pay any and all taxes that may be payable in respect of the issuance of delivery of shares of Common Stock on conversion of shares of Series G Preferred Stock pursuant thereto. The Corporation shall not, however, be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of shares of Common Stock in a name other than that in which the shares of Series G Preferred Stock so converted were registered, and no such issuance or delivery shall be made unless and until the person requesting such issuance has paid to the Corporation the amount of any such tax or has established to the satisfaction of the Corporation that such tax has been paid. (i) The certificate of any independent firm of public accountants of nationally recognized standing selected by the Board of Directors shall be presumptive evidence of the correctness of any computation made under this Section 5. Section 6. Series G Preferred Stock To Be Retired. All shares of Series G Preferred Stock which shall have been issued and reacquired in any manner by the Corporation shall be restored to the status of authorized, but unissued shares of Preferred Stock, without designation as to series. The Corporation may also retire any unissued shares of Series G Preferred Stock, and such shares shall then be restored to the status of authorized but unissued shares of Preferred Stock, without designation as to series. Section 7. Ranking. No class or series of capital stock of the Corporation shall rank senior to the Series G Preferred Stock, and the Series F Preferred Stock shall be Parity Stock. Section 8. Voting. (a) The holders of Series G Preferred Stock shall be entitled to a number of votes equal to the number of shares of Common Stock into which the shares of Series G Preferred Stock are convertible on the record date of the determination of stockholders entitled to receive notice of and to vote on any matter submitted to a vote of stockholders of the Corporation. The holders of Series G Preferred Stock will vote together with holders of the Common Stock, the Series F Preferred Stock and any other class of equity securities which may vote with the holders of Common Stock as a single class on all matters upon which stockholders are entitled to vote, including the election of directors, except as specifically provided herein or as otherwise required by law. 11 (b) The affirmative vote or consent of the holders of 80% of the votes entitled to be cast by holders of the Series G Preferred Stock then outstanding, voting as a single class, in person or by proxy, either in writing without a meeting or by vote at any meeting called for the purpose, will be required in order to amend the Certificate of Incorporation or Bylaws to affect materially and adversely the rights, preferences or voting power of the holders of the Series G Preferred Stock. The affirmative vote or consent of the holders of 80% of the votes entitled to be cast by holders of the Series G Preferred Stock and Series F Preferred Stock then outstanding, voting as a single class, in person or by proxy, either in writing without a meeting or by vote at any meeting called for the purpose, will be required in order to authorize, create or increase the authorized amount of any class of Senior Stock or Parity Stock (other than the Series F Preferred Stock or securities to evidence bank debt or asset securitizations) or the merger, consolidation or sale of assets (other than in the ordinary course) of the Corporation, including the capital stock of its subsidiaries. However, the Corporation may create classes or series of Junior Stock or increase the authorized number of shares of Junior Stock, without the consent of any holder of Series G Preferred Stock. (c) The holders of shares of Series G Preferred Stock and Series F Preferred Stock shall be entitled to designate or elect two (2) directors to serve on the Board of Directors, by the vote of a plurality of the votes cast by the holders of the Series G Preferred Stock and Series F Preferred Stock, voting together as a single class, at an annual meeting of stockholders or special meeting held in place thereof, or at a special meeting of the holders of the Series G Preferred Stock and Series F Preferred Stock called from time to time for the election of directors. If the Board of Directors fails to appoint the two designees of the holders of the Series G Preferred Stock and Series F Preferred Stock, as herein above provided, the Secretary of the Corporation shall, upon the written request of any holder of Series G Preferred Stock and Series F Preferred Stock (addressed to the Secretary at the principal office of the Corporation), call a special meeting of the holders of the Series G Preferred Stock and Series F Preferred Stock for the election of the two (2) directors to be elected by them as herein provided, such call to be made by notice similar to that provided in the Bylaws of the Corporation for a special meeting of the stockholders or as required by law. If any such special meeting required to be called, as above provided, shall not be called by the Secretary within twenty (20) days after receipt of any such request, then any holder of Series G Preferred Stock and Series F Preferred Stock may call such meeting, upon the notice above provided, and for that purpose shall have access to the stock books of the Corporation. The directors elected at any such special meeting shall hold office until the next annual meeting of the stockholders or special meeting held in lieu thereof if such office shall not have previously terminated as above provided. If any vacancy shall occur among the directors elected by the holders of the Series G Preferred Stock and Series F Preferred Stock, a successor shall be elected by the Board of Directors, upon the nomination of the then remaining directors elected by the holders of the Series G Preferred Stock and Series F Preferred Stock or the successors of such remaining directors, to serve until the next annual meeting of the stockholders or special meeting held in place thereof if such office shall not have previously terminated as above provided. So long as any shares of Series G Preferred Stock and Series F Preferred Stock are outstanding, the number of directors of the Corporation shall at all times be such that the exercise by the holders of shares of Series G Preferred Stock and Series F Preferred Stock of the right to designate or elect directors under the circumstance provided in this Section 8(c) will not contravene any provisions of the Corporation's Certificate of Incorporation or Bylaws. Section 9. Redemption. (a) The Corporation shall redeem, from any source of funds legally available therefor, shares of the Series G Preferred Stock upon the earlier of (i) the sale of B & B Electromatic, Inc., to the extent of the net proceeds to the Corporation, and/or (ii) in quarterly installments (each a "Series G Redemption Date ") of $250,000 each beginning on the second anniversary of the date the Series G Preferred Stock was originally issued (the "Original Issue Date"), $500,000 each beginning on the third anniversary of the Original Issue Date, and on the fourth anniversary of the Original Issue Date, the full amount of the remaining Series G Preferred Stock outstanding. The Corporation shall effect such redemptions on the applicable Series G Redemption Dates by paying in cash in exchange for the shares of Series G Preferred Stock to be redeemed a sum equal to $25.00 per share of Series G Preferred Stock (as adjusted for any stock dividends, combinations or splits with respect to such shares) plus, upon final redemption, any accrued and unpaid dividends from the Original Issue Date (the "Series G Redemption Price"). 12 (b) As used herein and in Section 9(c) and Section 9(d) below, the term "Redemption Date" shall refer to each "Series G Redemption Date" and the term "Redemption Price" shall refer to each "Series G Redemption Price." At least 15 but no more than 30 days prior to each Redemption Date, written notice shall be mailed, first class postage prepaid, to each holder of record (at the close of business on the business day next preceding the day on which notice is given) of the Series G Preferred Stock to be redeemed, at the address last shown on the records of the Corporation for such holder, notifying such holder of the redemption to be effected, specifying the number of shares to be redeemed from such holder, the Redemption Date, the Redemption Price, the place at which payment may be obtained and calling upon such holder to surrender to the Corporation, in the manner and at the place designated, the certificate or certificates representing the shares to be redeemed (the "Redemption Notice"). Except as provided in Section 9(b), on or after the Redemption Date, each holder of Series G Preferred Stock to be redeemed shall surrender to the Corporation the certificate or certificates representing such shares, in the manner and at the place designated in the Redemption Notice, and thereupon the Redemption Price of such shares shall be payable to the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be cancelled. In the event less than all the shares represented by any such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. (c) From and after the Redemption Date, unless there shall have been a default in payment of the Redemption Price, all rights of the holders of shares of Series G Preferred Stock designated for redemption in the Redemption Notice as holders of Series G Preferred Stock (except the right to receive the Redemption Price without interest upon surrender of their certificate or certificates) shall cease with respect to such shares, and such shares shall not thereafter be transferred on the books of the Corporation or be deemed to be outstanding for any purpose whatsoever. If the funds of the Corporation legally available for redemption of shares of Series G Preferred Stock on any Redemption Date are insufficient to redeem the total number of shares of Series G Preferred Stock to be redeemed on such date, those funds which are legally available will be used to redeem the maximum possible number of such shares ratably among the holders of such shares to be redeemed based upon their holdings of Series G Preferred Stock. The shares of Series G Preferred Stock not redeemed shall remain outstanding and entitled to all the rights and preferences proved herein. At any time thereafter when additional funds of the Corporation are legally available for the redemption of shares of Series G Preferred Stock such funds will immediately be used to redeem the balance of the shares which the Corporation has become obliged to redeem on any Redemption Date, but which it has not redeemed. (d) On or prior to each Redemption Date, the Corporation shall deposit the Redemption Price of all shares of Series G Preferred Stock designated for redemption in the Redemption Notice and not yet redeemed with a bank or trust corporation having aggregate capital and surplus in excess of $100,000,000 as a trust fund for the benefit of the respective holders of the shares designated for redemption and not yet redeemed, with irrevocable instructions and authority to the bank or trust corporation to pay the Redemption Price for such shares to their respective holders on or after the Redemption Date upon receipt of notification from the Corporation that such holder has surrendered his share certificate to the Corporation pursuant to Section 9(b) above. As of the Redemption Date, the deposit shall constitute full payment of the shares to their holders, and from and after the Redemption Date the shares so called for redemption shall be redeemed and shall be deemed to be no longer outstanding, and the holders thereof shall cease to be stockholders with respect to such shares and shall have no rights with respect thereto except the right to receive from the bank or trust corporation payment of the Redemption Price of the shares, without interest, upon surrender of their certificates therefor. Such instructions shall also provide that any moneys deposited by the Corporation pursuant to this Section 9(d) for the redemption of shares thereafter converted into shares of the Corporation's Common Stock pursuant to Section 5.2 hereof prior to the Redemption Date shall be returned to the Corporation forthwith upon such conversion. The balance of any moneys deposited by the Corporation pursuant to this Section 9(d) remaining unclaimed at the expiration of two (2) years following the Redemption Date shall thereafter be returned to the Corporation upon its request expressed in a resolution of its Board of Directors. 13 Section 10. Record Holders. The Corporation may deem and treat the record holder of any share of Series G Preferred Stock as the true and lawful owner thereof for all purposes, and neither the Corporation nor the Transfer Agent shall be affected by any notice to the contrary. [The remainder of this page has been left intentionally blank; signature pages to follow.] 14 IN WITNESS WHEREOF, the Corporation has caused this Certificate to be duly executed as of May 10, 2001. INTEGRATED SECURITY SYSTEMS, INC. By: /S/ C. A. Rundell, Jr. --------------------------- C. A. Rundell, Jr. Chairman and Chief Executive Officer 15 EX-4 3 exhibit4-7sb2021505.txt EXHIBIT 4.7 REGISTRATION RIGHTS AGREEMENT Exhibit 4.7 REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT ("Agreement"), dated as of September 5, 2003, is by and between INTEGRATED SECURITY SYSTEMS, INC., a Delaware corporation (the "Company"), and MARY ROLAND and ANN ROSENBLOOM (collectively, "Shareholders"). WITNESSETH: WHEREAS, the Company has issued to Shareholders ten million (10,000,000) shares of common stock of the Company (hereinafter referred to as the "Registrable Shares") pursuant to the Agreement and Plan of Merger dated September 5, 2003 among the Company, ISSI Merger Sub, Inc. (the "Merger Sub"), ARMR Services Corporation ("ARMR"), Paul Roland, Scott Rosenbloom, and the Shareholders (the "Merger Agreement"); WHEREAS, the Registrable Shares have not been registered under the Securities Act of 1933, as amended (the "1933 Act") and, as an inducement to Shareholders to enter into the Merger Agreement and to consummate the merger of ARMR with and into the Merger Sub (the "Merger"), the Company has agreed to grant to Shareholders certain registration rights with respect to the Registrable Shares as set forth herein. NOW, THEREFORE, in consideration of the mutual covenants contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. DEMAND REGISTRATION. (a) The Company hereby agrees to use its best efforts to register all or any portion of the Registrable Shares on one (1) occasion upon receipt of a written request from a holder (the "Holder" or "Holders") of record of the Registrable Shares that the Company file a registration statement under the 1933 Act covering the registration of at least twenty-five (25%) of the Registrable Shares then outstanding; provided, however, that the Holders hereby agree not to exercise such demand registration rights pursuant to this Section 1 for a period of one (1) year following the date hereof unless Renaissance Capital Growth & Income Fund III ("Renaissance Capital") and/or Renaissance US Growth & Income Trust PLC ("Renaissance PLC") exercise any of their respective registration rights pursuant to that certain Registration Rights Agreement among the Company, Renaissance Capital and Renaissance PLC, or any other agreement(s) granting to Renaissance Capital and/or Renaissance PLC registration rights. The Company shall, within twenty (20) days of its receipt thereof, give written notice of such request to all holders of record of Registrable Shares. The Holders of said Registrable Shares shall then have fifteen (15) days from the date of mailing of such notice by the Company to request that all or a portion of their respective Registrable Shares be included in said registration. (b) If the Holders intend to distribute the Registrable Shares covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to this Agreement, and the Company shall include such information in the written notice to the other Holders of Registrable Shares referred to in Section 1(a) above. In such event, the right of any Holder to include its Registrable Shares in such registration shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Shares in the underwriting (unless otherwise mutually agreed by the Company, the underwriter, the initiating Holder (the "Initiating Holder") and such Holder) is limited to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company as provided in Section 4(e) below) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by mutual agreement of the Company and the Initiating Holder, which agreement shall not be unreasonably withheld. Notwithstanding any other provision of this Section 1, if the underwriter advises the Initiating Holder and the Company in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holder shall so advise all Holders of Registrable Shares which would otherwise be underwritten pursuant hereto, and the number of shares of Registrable Shares that may be included in the underwriting shall be allocated on a pro rata basis among all Holders that have requested to participate in such registration. (c) Each such registration shall remain effective for a period of one hundred eighty (180) days, unless the Initiating Holder requests that such registration be terminated prior to the expiration of such period. Notwithstanding the foregoing, if the Holders elect not to sell all or any portion of the Registrable Shares pursuant to a demand registration which has become effective, such demand registration right shall nonetheless be deemed satisfied. (d) If, after a registration statement becomes effective, the Company advises the Holders that the registration statement is required to be amended under applicable federal securities laws, the Holders shall suspend any further sales of their Registrable Shares, until the Company advises them that the registration statement has been amended, but not more than thirty (30) days. The one hundred eighty (180)-day time period referred to in subsection (c) during which the registration statement must be kept current after its effective date shall be extended for an additional number of business days equal to the number of business days during which the right to sell the Registrable Shares was suspended pursuant to the preceding sentence. (e) The Company shall have the right to exclude an underwriter not reasonably acceptable to it. 2. "PIGGY-BACK" REGISTRATION. If the Company proposes to register any of its capital stock under the 1933 Act in connection with the public offering of such securities for its own account or for the account of its security Holders, other than Holders of Registrable Shares pursuant hereto (a "Piggy-Back Registration Statement"), except for (i) a registration relating solely to the sale of securities to participants in the Company's stock plans or employee benefit plans or (ii) a registration relating solely to a transaction for which Form S-4 may be used, then: (a) The Company shall give written notice of such determination to each Holder of Registrable Shares, and each such Holder shall have the right to request, by written notice given to the Company within fifteen (15) days of the date that such written notice was mailed by the Company to such Holder, that a specific number of Registrable Shares held by such Holder be included in the Piggy-Back Registration Statement (and related underwritten offering, if any); (b) If the Piggy-Back Registration Statement relates to an underwritten offering, the notice given to each Holder shall specify the name or names of the managing underwriter or underwriters for such offering. In addition, such notice shall also specify the number of securities to be registered for the account of the Company and for the account of its stockholders (other than the Holders of Registrable Shares), if any; (c) If the Piggy-Back Registration Statement relates to an underwritten offering, each Holder of Registrable Shares to be included therein must agree (i) to sell such Holder's Registrable Shares on the same basis as provided in the underwriting arrangement approved by the Company, and (ii) to timely complete and execute all questionnaires, powers of attorney, indemnities, hold-back agreements, underwriting agreements and other documents required under the terms of such underwriting arrangements or by the United States Securities and Exchange Commission (the "SEC") or by any state securities regulatory body; 2 (d) If the managing underwriter or underwriters for the underwritten offering under the Piggy-Back Registration Statement determines that inclusion of all or any portion of the Registrable Shares in such offering would materially adversely affect the ability of the underwriters for such offering to sell all of the securities requested to be included for sale in such offering at the best price obtainable therefor, the aggregate number of Registrable Shares that may be sold by the Holders shall be limited to such number of Registrable Shares, if any, that the managing underwriter or underwriters determine may be included therein without such adverse effect as provided below. If the number of securities proposed to be sold in such underwritten offering exceeds the number of securities that may be sold in such offering, there shall be included in the offering, first, up to the maximum number of securities to be sold by the Company for its own account, and second, as to the balance, if any, Registrable Shares requested to be included therein by the Holders thereof (pro rata as between such Holders and all other holders of common stock of the Company exercising Registration Rights based upon the number of shares proposed to be registered by each), or in such other proportions as the managing underwriter or underwriters for the offering may require. (e) Holders of Registrable Shares shall have the right to withdraw their Registrable Shares from the Piggy-Back Registration Statement, but if the same relates to an underwritten offering, they may only do so during the time period and on the terms agreed upon among the underwriters for such underwritten offering and the Holders of Registrable Shares; (f) The Holders will advise the Company at the time a registration becomes effective whether the Registrable Shares included in the registration will be underwritten or sold directly by the Holders; (g) All demand and piggy-back registration rights of the Holders shall terminate when all of the Registrable Shares then outstanding may be sold pursuant to Rule 144(k) promulgated under the 1933 Act ("Rule 144(k)"). 3. OBLIGATIONS OF THE COMPANY. Whenever required to effect the registration of any Registrable Shares pursuant to this Agreement, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Shares and use all reasonable efforts to cause such registration statement to become effective, and keep such registration statement effective until the sooner of all such Registrable Shares having been distributed, or until one hundred twenty (120) days have elapsed since such registration statement became effective (subject to extension of this period as provided below); (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the 1933 Act with respect to the disposition of all securities covered by such registration statement, or one hundred twenty (120) days have elapsed since such registration statement became effective (subject to the extension of this period as provided below); 3 (c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the 1933 Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Shares owned by them; (d) Use all reasonable efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders, provided that the Company shall not be required in connection therewith or as a condition thereto to qualify as a broker-dealer in any states or jurisdictions or to do business or to file a general consent to service of process in any such states or jurisdictions; (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement with the managing underwriter of such offering, in usual and customary form reasonably satisfactory to the Company and the Holders of a majority of the Registrable Shares to be included in such offering. Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement; (f) Notify each Holder of Registrable Shares covered by such registration statement, at any time when a prospectus relating thereto and covered by such registration statement is required to be delivered under the 1933 Act, of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing; and (g) In the event of the notification provided for in Section 4(f) above, the Company shall use its best efforts to prepare and file with the SEC (and to provide copies thereof to the Holders) as soon as reasonably possible an amended prospectus complying with the 1933 Act, and the period during which the prospectus referred to in the notice provided for in Section 4(f) above cannot be used and the time period prior to the use of the amended prospectus referred to in this Section 4(g) shall not be counted in the one hundred twenty (120) day period of this Section 4. 4. FURNISH INFORMATION. (a) It shall be a condition precedent to the obligations of the Company that the selling Holders shall furnish to the Company any and all information reasonably requested by the Company, its officers, directors, employees, counsel, agents or representatives, the underwriter or underwriters, if any, and the SEC or any other Governmental Authority, including, but not limited to: (i) such information regarding themselves, the Registrable Shares held by them, and the intended method of disposition of such securities, as shall be required to effect the registration of their Registrable Shares; and (ii) the identity of and compensation to be paid to any proposed underwriter or broker-dealer to be employed in connection therewith. (b) In connection with the preparation and filing of each registration statement registering Registrable Shares under the 1933 Act, the Company shall give the Holders of Registrable Shares on whose behalf such Registrable Shares are to be registered and their underwriters, if any, and their respective counsel and accountants, at such Holders' sole cost and expense (except as otherwise set forth herein), such access to copies of the Company's records and documents and such opportunities to discuss the business of the Company with its officers and the independent public accountants who have certified its financial statements as shall be reasonably necessary in the opinion of such Holders and such underwriters or their respective counsel, to conduct a reasonable investigation within the meaning of the 1933 Act. 4 5. EXPENSES OF REGISTRATION. All expenses, other than underwriting discounts and commissions applicable to the Registrable Shares sold by selling Holders, incurred in connection with the registration of the Registrable Shares pursuant to this Agreement, including, without limitation, all registration, filing and qualification fees, printer's expenses, accounting and legal fees and expenses of the Company and the reasonable legal fees of one (1) legal counsel for all Holders, shall be borne by the Company. 6. INDEMNIFICATION REGARDING REGISTRATION RIGHTS. If any Registrable Shares are included in a registration statement pursuant to this Agreement: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, the officers and directors of each Holder, any underwriter (as defined in the 1933 Act) for such Holder and each person, if any, who controls such Holder or underwriter within the meaning of the 1933 Act or the Securities Exchange Act of 1934, as amended (the "1934 Act"), against any losses, claims, damages, liabilities (joint or several) or any legal or other costs and expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action to which they may become subject under the 1933 Act, the 1934 Act or state law, insofar as such losses, claims, damages, costs, expenses or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (each a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact with respect to the Company or its securities contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements therein; (ii) the omission or alleged omission to state therein a material fact with respect to the Company or its securities required to be stated therein or necessary to make the statements therein not misleading; or (iii) any violation or alleged violation by the Company of the 1933 Act, the 1934 Act, any state securities law or any rule or regulation promulgated under the 1933 Act, the 1934 Act or any state securities law. Notwithstanding the foregoing, the indemnity agreement contained in this Section 7(a) shall not apply and the Company shall not be liable (i) in any such case for any such loss, claim, damage, costs, expenses, liability or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by any such Holder, underwriter or controlling person, (ii) for amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the prior written consent of the Company, which consent shall not be unreasonably withheld, or (iii) if the statement or omission was corrected in a subsequent preliminary or final prospectus or amendment or supplement thereto, and the Holder failed to deliver such document to the purchaser of its securities. (b) To the extent permitted by law, each Holder who participates in a registration pursuant to the terms and conditions of this Agreement shall indemnify and hold harmless the Company, each of its directors and officers who have signed the registration statement, each Person, if any, who controls the Company within the meaning of the 1933 Act, the 1934 Act, any state securities law or any rule or regulation promulgated under the 1933 Act, the 1934 Act or any state securities law, each of the Company's employees, agents, counsel and representatives, any underwriter and any other Holder selling securities in such registration statement, or any of its directors or officers, or any person who controls such Holder, against any losses, claims, damages, costs, expenses, liabilities (joint or several) to which the Company or any such director, officer, controlling person, employee, agent, representative, underwriter, or other such Holder, or director, officer or controlling person thereof, may become subject, under the 1933 Act, the 1934 Act or other federal or state law, only insofar as such losses, claims, damages, costs, expenses or liabilities or actions in respect thereto arise out of or are based upon any Violation, in each case to the extent and only to the extent that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such. Each such Holder will indemnify any legal or other expenses reasonably incurred by the Company or any such director, officer, employee, agent representative, controlling person, underwriter or other Holder, or officer, director or of any controlling person thereof, in connection with investigating or defending any such loss, claim, damage, liability or action; provided, however, that the indemnity agreement contained in this Section 7(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, costs, expenses, liability or action if such settlement is effected without the prior written consent of the Holder, which consent shall not be unreasonably withheld. 5 (c) Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 7, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party shall have the right to retain its own counsel, with the reasonable fees and expenses of such counsel to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential conflict of interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action shall not relieve the indemnifying party of its obligations under this Section 7, except to the extent that the failure results in a failure of actual notice to the indemnifying party and such indemnifying party is materially prejudiced in its ability to defend such action solely as a result of the failure to give such notice. (d) If the indemnification provided for in this Section 7 is unavailable to an indemnified party under this Section 7 in respect of any losses, claims, damages, costs, expenses, liabilities or actions referred to herein, then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, costs, expenses, liabilities or actions in such proportion as is appropriate to reflect the relative fault of the Company, on the one hand and of the Holder, on the other, in connection with the Violation that resulted in such losses, claims, damages, costs, expenses, liabilities or actions. The relative fault of the Company, on the one hand, and of the Holder, on the other, shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of the material fact or the omission to state a material fact relates to information supplied by the Company or by the Holder, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. (e) The Company, on the one hand, and the Holders, on the other, agree that it would not be just and equitable if contribution pursuant to this Section 7 were determined by a pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. The amount paid or payable by an indemnified party as a result of losses, claims, damages, costs, expenses, liabilities and actions referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any reasonable legal or other expenses incurred by such indemnified party in connection with defending any such action or claim. Notwithstanding the provisions of this Section 7, neither the Company nor the Holders shall be required to contribute any amount in excess of the amount by which the total price at which the securities were offered to the public exceeds the amount of any damages which the Company or each such Holder has otherwise been required to pay by reason of such Violation. No person guilty of fraudulent misrepresentations (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any person who is not guilty of such fraudulent misrepresentation. 6 7. REPORTS UNDER THE 1934 ACT. So long as the Company has a class of securities registered pursuant to Section 12 of the 1934 Act, with a view to making available to the Holders the benefits of Rule 144 and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, if applicable, the Company agrees to use its reasonable efforts to: (a) Make and keep public information available, as those terms are understood and defined in Rule 144, at all times; (b) File with the SEC in a timely manner all reports and other documents required of the Company under the 1933 Act and the 1934 Act; (c) Use its reasonable best efforts to include all Common Stock covered by such registration statement on NASDAQ if the Common Stock is then quoted on NASDAQ; or list all Common Stock covered by such registration statement on such securities exchange on which any of the Common Stock is then listed; or, if the Common Stock is not then quoted on NASDAQ or listed on any national securities exchange, use its best efforts to have such Common Stock covered by such registration statement quoted on NASDAQ or, at the option of the Company, listed on a national securities exchange; and (d) Furnish to any Holder, so long as the Holder owns any Registrable Shares, (i) forthwith upon request a copy of the most recent annual or quarterly report of the Company and such other SEC reports and documents so filed by the Company, and (ii) such other information (but not any opinion of counsel) as may be reasonably requested by any Holder seeking to avail himself of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. 8. ASSIGNMENT OF REGISTRATION RIGHTS. Subject to the terms and conditions of this Agreement, the right to cause the Company to register Registrable Shares pursuant to this Agreement may be assigned by Holder to any transferee or assignee of such securities; provided that said transferee or assignee is a transferee or assignee of at least ten percent (10%) of the Registrable Shares and provided that the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; and provided, further, that such assignment shall be effective only if immediately following such transfer the further disposition of such securities by the transferee or assignee is restricted under the 1933 Act; it being the intention that so long as Holder holds any Registrable Shares hereunder, either Holder or its transferee or assignee of at least ten percent may exercise the registration rights hereunder. Other than as set forth above, the parties hereto hereby agree that the registration rights hereunder shall not be transferable or assigned and any contemplated transfer or assignment in contravention of this Agreement shall be deemed null and void and of no effect whatsoever. 9. OTHER MATTERS. (a) Each Holder of Registrable Shares hereby agrees by acquisition of such Registrable Shares that, with respect to each offering of the Registrable Shares, whether each Holder is offering such Registrable Shares in an underwritten or nonunderwritten offering, such Holder will comply with Regulation M or such other or additional anti-manipulation rules then in effect until such offering has been completed, and in respect of any nonunderwritten offering, in writing will inform the Company, any other Holders who are selling shareholders, and any national securities exchange upon which the securities of the Company are listed, that the Registrable Shares have been sold and will, upon the Company's request, furnish the distribution list of the Registrable Shares. In addition, upon the request of the Company, each Holder will supply the Company with such documents and information as the Company may reasonably request with respect to the subject matter set forth and described in this Section 10. 7 (b) Each Holder of Registrable Shares hereby agrees by acquisition of such Registrable Shares that, upon receipt of any notice from the Company of the happening of any event which makes any statement made in the registration statement, the prospectus or any document incorporated therein by reference, untrue in any material respect or which requires the making of any changes in the registration statement, the prospectus or any document incorporated therein by reference, in order to make the statements therein not misleading in any material respect, such Holder will forthwith discontinue disposition of Registrable Shares under the prospectus related to the applicable registration statement until such Holder's receipt of the copies of the supplemented or amended prospectus, or until it is advised in writing by the Company that the use of the prospectus may be resumed, and has received copies of any additional or supplemental filings which are incorporated by reference in the prospectus. 10. WAIVERS AND MODIFICATIONS. All modifications, consents, amendments or waivers (herein "Waivers") of any provision of this Agreement shall be effective only if the same shall be in writing by Shareholders and then shall be effective only in the specific instance and for the purpose for which given. No notice or demand given in any case shall constitute a waiver of the right to take other action in the same, similar or other instances without such notice or demand. No failure to exercise, and no delay in exercising, on the part of Shareholders, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right. The rights of Shareholders hereunder shall be in addition to all other rights provided by law. 11. GOVERNING LAW. This Agreement will be governed by the laws of the State of Delaware without regard to conflicts of law principles. 12. ARBITRATION. (a) Upon the demand of Shareholders or the Company (collectively the "parties"), made before the institution of any judicial proceeding or not more than sixty (60) days after service of a complaint, third party complaint, cross-claim or counterclaim or any answer thereto or any amendment to any of the above, any Dispute (as defined below) shall be resolved by binding arbitration in accordance with the terms of this arbitration clause. A "Dispute" shall include any action, dispute, claim, or controversy of any kind, whether founded in contract, tort, statutory or common law, equity, or otherwise, now existing or hereafter occurring between the parties arising out of, pertaining to or in connection with this Agreement, or any related agreements, documents, or instruments (the "Documents"). The parties understand that by this Agreement they have decided that the Disputes may be submitted to arbitration rather that being decided through litigation in court before a judge or jury and that once decided by an arbitrator the claims involved cannot later be brought, filed, or pursued in court. (b) Arbitrations conducted pursuant to this Agreement, including selection of arbitrators, shall be administered by the American Arbitration Association ("Administrator") pursuant to the Commercial Arbitration Rules of the Administrator. Arbitrations conducted pursuant to the terms hereof shall be governed by the provisions of the Federal Arbitration Act (Title 9 of the United States Code), and to the extent the foregoing are inapplicable, unenforceable or invalid, the laws of the State of Delaware. Judgment upon any award rendered hereunder may be entered in any court having jurisdiction; provided, however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. 91 or similar governing state law. Any party who fails to submit to binding arbitration following a lawful demand by the opposing party shall bear all costs and expenses, including reasonable attorneys' fees, incurred by the opposing party in compelling arbitration of any Dispute. 8 (c) No provision of, nor the exercise of any rights under, this arbitration clause shall limit the right of any party to (i) foreclose against any real or personal property collateral or other security, (ii) exercise self-help remedies (including repossession and set off rights) or (iii) obtain provisional or ancillary remedies such as injunctive relief, sequestration, attachment, replevin, garnishment, or the appointment of a receiver from a court having jurisdiction. Such rights can be exercised at any time except to the extent such action is contrary to a final award or decision in any arbitration proceeding. The institution and maintenance of an action as described above shall not constitute a waiver of the right of any party, including the plaintiff, to submit the Dispute to arbitration, nor render inapplicable the compulsory arbitration provisions hereof. Any claim or Dispute related to exercise of any self-help, auxiliary or other exercise of rights under this Section 13 shall be a Dispute hereunder. (d) Arbitrator(s) shall resolve all Disputes in accordance with the applicable substantive law of the State of Delaware. Arbitrator(s) may make an award of attorneys' fees and expenses if permitted by law or the agreement of the parties. All statutes of limitation applicable to any Dispute shall apply to any proceeding in accordance with this arbitration clause. Any arbitrator selected to act as the only arbitrator in a Dispute shall be required to be a practicing attorney with not less than five (5) years practice in commercial law in the State of Delaware. With respect to a Dispute in which the claims or amounts in controversy do not exceed five hundred thousand dollars ($500,000), a single arbitrator shall be chosen and shall resolve the Dispute. In such case the arbitrator shall have authority to render an award up to but not to exceed five hundred thousand dollars ($500,000), including all damages of any kind whatsoever, costs, fees and expenses. Submission to a single arbitrator shall be a waiver of all parties' claims to recover more than five hundred thousand dollars ($500,000). A Dispute involving claims or amounts in controversy exceeding five hundred thousand dollars ($500,000) shall be decided by a majority vote of a panel of three arbitrators ("Arbitration Panel"), one of whom must possess the qualifications to sit as a single arbitrator in a Dispute decided by one arbitrator. The arbitrator(s) shall be empowered to resolve any dispute regarding the terms of this Agreement or any Dispute or any claim that all or any part (including this provision) is void or voidable but shall have no power to change or alter the terms of this Agreement. The award of the arbitrator(s) shall be in writing and shall specify the factual and legal basis for the award. (e) To the maximum extent practicable, the Administrator, the arbitrator(s) and the parties shall take any action reasonably necessary to require that an arbitration proceeding hereunder be concluded within one hundred eighty (180) days of the filing of the Dispute with the Administrator. The arbitrator(s) shall be empowered to impose sanctions for any party's failure to proceed within the times established herein. Arbitration proceedings hereunder shall be conducted in the State of Delaware at a location determined by the Administrator. In any such proceeding, a party shall state as a counterclaim any claim which arises out of the transaction or occurrence or is in any way related to this Agreement which does not require the presence of a third party which could not be joined as a party in the proceeding. The provisions of this arbitration clause shall survive any termination, amendment or expiration of this Agreement unless the parties otherwise expressly agree in writing. Each party agrees to keep all Disputes and arbitration proceedings strictly confidential, except for disclosures of information required in the ordinary course of business of the parties or as required by applicable law or regulation. 9 13. INVALID PROVISIONS. If any provision of this Agreement is held to be illegal, invalid or unenforceable under present or future laws during the term of this Agreement, such provision shall be fully severable; this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Agreement; and the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance from this Agreement. Furthermore, in lieu of each such illegal, invalid or unenforceable provision shall be added as part of this Agreement a provision mutually agreeable to the Company and Shareholders as similar in terms to such illegal, invalid or unenforceable provision as may be possible and be legal, valid and enforceable. In the event the Company and Shareholders are unable to agree upon a provision to be added to this Agreement within a period of ten (10) business days after a provision of this Agreement is held to be illegal, invalid or unenforceable, then a provision acceptable to independent arbitrators, such to be selected in accordance with the provisions of the American Arbitration Association, as similar in terms to the illegal, invalid or unenforceable provision as is possible and be legal, valid and enforceable shall be added automatically to this Agreement. In either case, the effective date of the added provision shall be the date upon which the prior provision was held to be illegal, invalid or unenforceable. 14. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Company and Shareholders and their respective successors, assigns and legal representatives; provided, however, that the Company may not, without the prior written consent of Shareholders, assign any rights, powers, duties or obligations thereunder. 15. NO THIRD PARTY BENEFICIARY. The parties do not intend the benefits of this Agreement to inure to any third party, nor shall this Agreement be construed to make or render Shareholders liable to any materialman, supplier, contractor, subcontractor, purchaser or lessee of any property owned by the Company, or for debts or claims accruing to any such persons against the Company. Notwithstanding anything contained herein, no conduct by any or all of the parties hereto, before or after signing this Agreement, shall be construed as creating any right, claim or cause of action against Shareholders, or any of its officers, directors, agents or employees, in favor of any materialman, supplier, contractor, subcontractor, purchaser or lessee of any property owned by the Company, nor to any other person or entity other than the Company. 16. ENTIRETY. This Agreement and any other documents or instruments issued or entered into pursuant hereto and thereto contain the entire agreement between the parties and supersede all prior agreements and understandings, written or oral (if any), relating to the subject matter hereof and thereof. 17. HEADINGS. Section headings are for convenience of reference only and, except as a means of identification of reference, shall in no way affect the interpretation of this Agreement. 18. SURVIVAL. All representations and warranties made by the Company herein shall survive the Merger. 19. MULTIPLE COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. 20. NOTICES. (a) Any notices or other communications required or permitted to be given by this Agreement or any other documents and instruments referred to herein must be (i) given in writing and personally delivered, mailed by prepaid certified or registered mail or sent by overnight service, such as FedEx, or (ii) made by telex or facsimile transmission delivered or transmitted to the party to whom such notice or communication is directed, with confirmation thereupon given in writing and personally delivered or mailed by prepaid certified or registered mail. 10 (b) Any notice to be mailed, sent or personally delivered shall be mailed or delivered to the principal offices of the party to whom such notice is addressed, as that address is specified herein below. Any such notice or other communication shall be deemed to have been given (whether actually received or not) on the day it is mailed, postage prepaid, or sent by overnight service or personally delivered or, if transmitted by telex or facsimile transmission, on the day that such notice is transmitted; provided, however, that any notice by telex or facsimile transmission, received by any the Company or Shareholders after 4:00 p.m., Dallas, Texas time, at the recipient's address, on any day, shall be deemed to have been given on the next succeeding business day. Any party may change its address for purposes of this Agreement by giving notice of such change to the other parties. If to the Company to: Integrated Security Systems, Inc. 8200 Springwood Drive, Suite 230 Irving, Texas 75063 (972) 444-8280 (telephone) (972) 869-3843 (fax) with a copy to: David H. Oden, Esq. Hayes and Boone, LLP 2505 N. Plano Road Suite 4000 Richardson, Texas 75082 (972) 739-6929 (telephone) (972) 680-7551 (fax) If to Shareholders to: Mary Roland 7911 Roswell Drive Falls Church, VA 22043-3410 and Ann Rosenbloom 1326 Colvin Forest Drive Vienna, VA 22182 with a copy to: Robert A. Welp, Esq. Hogan & Hartson L.L.P. 8300 Greensboro Drive Suite 1100 McLean, VA 22203 (703) 610-6119 (telephone) (703) 610-6200 (fax) 11 Any notice delivered personally in the manner provided herein will be deemed given to the party to whom it is directed upon the party's (or its agent's) actual receipt. Any notice addressed and mailed in the manner provided here will be deemed given to the party to whom it is addressed at the close of business, local time of the recipient, on the fourth business day after the day it is placed in the mail, or, if earlier, the time of actual receipt. 12 IN WITNESS WHEREOF, the undersigned has caused this Agreement to be executed and delivered, as of the date and year first above written. COMPANY: INTEGRATED SECURITY SYSTEMS, INC. By: /S/ C. A. Rundell, Jr. ------------------------------------ C. A. Rundell, Jr. Chairman and Chief Executive Officer SHAREHOLDERS: /S/ Mary Roland ----------------------------------------- Mary Roland /S/ Ann Rosenbloom ----------------------------------------- Ann Rosenbloom 13 EX-5 4 exhibit5-1sb2a040805.txt EXHIBIT 5.1 LEGAL OPINION Exhibit 5.1 [Haynes and Boone, LLP Letterhead] April 8, 2005 Integrated Security Systems, Inc. 8200 Springwood Drive, Suite 230 Irving, Texas 75063 Ladies and Gentlemen: We have acted as special counsel to Integrated Security Systems, Inc., a Delaware corporation (the "Company"), in connection with the issuance of up to 85,307,479 shares of the Company's common stock, par value $0.01 per share (the "Common Stock"), plus an indeterminate number of additional shares of Common Stock issuable to prevent dilution resulting from stock splits, stock dividends or similar events, to be sold by the selling stockholders named in the prospectus constituting a part of the Registration Statement (defined below) (the "Shares"). The Shares, which include: (i) up to 12,086,821 shares issuable upon the conversion of convertible promissory notes, (ii) up to 1,522,154 shares issuable upon the exercise of warrants, (iii) up to 190,000 shares issuable upon the conversion of the Company's Series A Convertible Preferred Stock, (iv) up to 706,250 shares issuable upon the conversion of the Company's Series D Convertible Preferred Stock, and (v) up to 70,802,254 shares that are currently outstanding, are being registered pursuant to a Registration Statement on Form SB-2 (as amended or supplemented, the "Registration Statement") filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended (file no. 333-122849). In connection therewith, we have examined and relied upon the original, or copies certified to our satisfaction, of (i) the Amended and Restated Certificate of Incorporation of the Company, as amended; (ii) the Amended and Restated Bylaws of the Company; (iii) the minutes and records of the corporate proceedings of the Company with respect to the registration by the Company of the Shares; (iv) the Registration Statement and all exhibits thereto; and (v) such other documents and instruments as we have deemed necessary and advisable for the expression of the opinions contained herein. In making the foregoing examinations, we have assumed the genuineness of all signatures, the authenticity of all documents submitted to us as originals, the conformity to original documents of all documents submitted to us as certified or photostatic copies thereof and the authenticity of the originals of such latter documents. As to all questions of fact material to this opinion, where such facts have not been independently established, and as to the content and form of certain minutes, records, resolutions or other documents or writings of the Company, we have relied, to the extent we have deemed reasonably appropriate, upon certificates of an officer of the Company and governmental officials. Based upon and subject to the foregoing and the limitations, qualifications, exceptions and assumptions set forth herein, we are of the opinion that: 1. The currently outstanding Shares are duly authorized, validly issued, fully paid and non-assessable. 2. Upon the issuance of Shares to be issued upon the conversion of promissory notes or preferred stock, or the exercise of warrants, such Shares (when issued in accordance with the terms of such promissory notes, preferred stock or warrants) will be duly authorized, validly issued, fully paid and non-assessable. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement on Form SB-2 filed by the Company to effect the registration of the Shares under the Securities Act of 1933, as amended, and to the reference to our firm under the caption "Legal Matters" in the prospectus constituting a part of the Registration Statement. Very truly yours, /s/Haynes and Boone, LLP Haynes and Boone, LLP 2 EX-10 5 exhibit10-5sb2021505.txt EXHIBIT 10.6 LEASE AGREEMENT EXHIBIT 10.6 MODIFIED TRIPLE NET LEASE TPLP Office Park Properties ___________________________ (LESSOR) AND Integrated Security Systems, Inc. _________________________________ (LESSEE) MODIFIED TRIPLE NET LEASE TABLE OF CONTENTS Page 1. Lease Terms..........................................................1 2. Letting..............................................................2 3. Base Rent............................................................3 4. Additional Rent......................................................3 5. Late Charges.........................................................5 6. Security Deposit and Financial Reporting.............................5 7. Use of Premises; Quiet Enjoyment; Trash..............................6 8. Parking..............................................................6 9. Utilities............................................................7 10. Lessee Improvements; Lessee Alterations and Mechanic's Liens.........8 11. Repairs..............................................................9 12. Insurance...........................................................10 13. Indemnification and Waiver of Claims................................11 14. Hazardous Materials.................................................11 15. Auctions and Signs..................................................12 16. Lessor's Access.....................................................13 17. Abandonment.........................................................13 18. Damage or Destruction...............................................13 19. Transfer (Assignment/Subletting)....................................14 20. Default.............................................................15 21. Remedies of Lessor..................................................15 22. Arbitration.........................................................16 23. Surrender of Lease Not Merger.......................................16 24. Professional Fees, Costs and Expenses...............................16 25. Condemnation........................................................17 26. Rules and Regulations...............................................17 27. Estoppel Certificate................................................17 28. Sale By Lessor......................................................17 29. Notices.............................................................17 30. Waiver..............................................................18 31. Lessee's Intent; Holdover...........................................18 32. Relocation of the Premises..........................................18 33. Default by Lessor; Limitation of Liability; Real Estate Investment Trust..................................................18 34. Subordination.......................................................19 35. Force Majeure.......................................................19 36. Miscellaneous Provisions............................................19 37. Examination of Lease; Good Faith Deposits...........................20 38. Governing Law.......................................................21 39. Lessor's Lien.......................................................21 40. Special Provisions and Exhibits.....................................21 2 MODIFIED TRIPLE NET LEASE Lease Preparation Date: November 7, 2003 ----------------------------------------------------- Lessor: TPLP Office Park Properties ----------------------------------------------------- Lessee: Integrated Security Systems, Inc. ----------------------------------------------------- Guarantor: N/A ----------------------------------------------------- 1. Lease Terms 1.01 Premises: The Premises is located within the Building (as defined below) and is depicted on Exhibit "A-1". The Premises contains approximately 5,566 rentable square feet. The address of the leased Premises is: 8200 Springwood, Suite 230, Irving, Texas 75063. 1.02 Building: The Premises is located in the Building indicated on Exhibit "A-2". The Building contains approximately 28,165 rentable square feet and is part of the Project. 1.03 Project: The Project is depicted on Exhibit "A-3" and consists of all improvements on the Property, including the Building of which the Premises is a part. The Project is commonly referred to as Royal Tech - Springwood Business Park and contains approximately 56,330 rentable square feet. 1.04 Property: The Project, and all Lessor's land thereunder or appurtenant thereto as described in Exhibit "A" is the Property. 1.05 Lessee's Notice Address: Lessee's Notice Address is the address of the leased Premises as stated in Paragraph 1.01 above unless otherwise specified here:8200 Springwood, Suite 230, Irving, Texas 75063. 1.06 Lessor's Notice Address: Lessor's Notice Address is: 8200 Springwood, Suite 240, Irving, Texas 75063. 1.07 Lessee's Permitted Use: Lessee and Lessor agree that Lessee may only use the Premises for the following purpose(s): Offices for security systems consultants. 1.08 Lease Term: The Lease Term commences on January 1, 2004 and ends on December 31, 2006 (36 months, and 0 days). 1.09 Base Rent: During the original term of this Lease, Base Rent shall be paid monthly, in lawful money of the United States of America in the amounts specified below, during the applicable periods noted: Base Rent Applicable Period $4,290.46 Beginning January 1, 2004 Ending December 31, 2004 ------------- -------------------- -------------------- $4,406.42 Beginning January 1, 2005 Ending December 31, 2005 ------------- -------------------- -------------------- $4,522.38 Beginning January 1, 2006 Ending December 31, 2006 ------------- -------------------- -------------------- $ Beginning Ending ------------- -------------------- --------------------
1.10 Security Deposit: $8,431.24 payable in lawful money of the United States of America. 1.11 Lease Documentation Fee: $N/A 1.12 Initial Monthly Rent Charges: Base Rent (1.09) $4,290.46 --------- CAM (1.14) $ 783.88 --------- Real Property Taxes (1.14) $ 667.92 --------- Utility and Service Costs (1.14) $ 92.77 --------- Insurance Premiums (1.14) $ 51.02 --------- Total initial monthly payment $5,886.05 --------
1.13 Proportionate Share: Lessee's Proportionate Share of the Project, which represents the approximate Proportionate Share of the Premises to the Project is .0988 . Lessee's Proportionate Share of the Building within which it is located, which represents the approximate Proportionate Share of the Premises to the Building is .1976 . Proportionate Share may be adjusted during the Lease Term if the size of the Project, Premises or Building changes. 1.14 Operating Expense Estimate: Lessee's Operating Expense Estimate is 1,595.59. 1.15 Broker(s): N/A. 3 1.16 Additional Attachments: A-1, A-2, A-3, B, C, D. 1.17 Automatic Payments: Unless Lessor otherwise directs in writing, all payments of Base Rent and the monthly estimated payments of Lessee's Proportionate Share of Operating Expenses shall be made by automatic debit electronic payment. Lessee shall execute all such documents, provide such information, and follow such procedures as are requested by Lessor from time to time to facilitate such payments. If, by reason of insufficient funds or other reason, any such payment is not fully made and received, such event shall be deemed a failure of Lessee to make the required payment. Payment shall be deemed made by Lessee on the date funds are actually received by Lessor; provided, Lessor shall have the right to return all or any funds received within ten (10) business days of receipt, in which event the returned amount shall be deemed to have not been paid by Lessee or received by Lessor. Receipt of any funds pursuant to this Section shall not constitute a waiver by Lessor of any Default by Lessee whether or not such Default is known to Lessor. 2. Letting 2.01 Lessor leases to Lessee, and Lessee leases from Lessor, the Premises, as indicated in Paragraph 1.01 in consideration of Lessee's payment of Base Rent and other payments hereunder subject to all of the terms, covenants and conditions of this Lease and all recorded matters, laws, ordinances and governmental regulations and orders. Lessee's possession and occupancy of the Premises constitutes Lessee's acknowledgment that it has satisfied itself with respect to the overall condition of the Premises, the present and future suitability of the Premises for Lessee's intended use and the substantial completion of the improvements to the Premises, if any, which are to be constructed by Lessor pursuant to Exhibit "B." Any such improvements to be constructed by Lessor pursuant to Exhibit "B" are herein referred to as "Lessor's Work." 2.02 Lessee shall only use the Premises for Lessee's Permitted Use set forth in Paragraph 1. Lessee shall not occupy or use the Premises or any part thereof for other than Lessee's Permitted Use and not for any use or purpose which is unlawful or deemed by Lessor to be disreputable in any manner or dangerous to life, limb or property. 2.03 Unless otherwise provided herein, any statement of square footage set forth in this Lease is an approximation which Lessor and Lessee agree is reasonable for all purposes, and the Premises shall be deemed to contain the rentable square feet set forth in this Lease, regardless of minor variations in actual square footage. Lessor reserves the right to change Lessee's Proportionate Share to reflect any increase or decrease in the common area. Any use of the terms "rentable" and "usable" is for convenience only, and such descriptions represent Lessor's interpretation of such terms. If there is no Lessor's Work pursuant to Exhibit "B," or if Exhibit "B" is not attached hereto, then Lessee accepts the Premises in "AS-IS" condition and Lessor shall have no obligation to provide or pay for any repair or other work therein, except as stated in this Lease; and Lessee shall obtain and deliver to Lessor a certificate of occupancy for the Premises from the appropriate governmental authority. 2.04 Lessor will deliver, where applicable, all systems in the Premises to Lessee with existing plumbing, electrical, fire sprinkler, lighting, air conditioning, heating and mechanical, if any, in good working condition. Lessee has thirty (30) days after the Lease Term commences, or Lessee's occupancy, whichever is sooner, to notify Lessor, in writing, of any non-operative items, and Lessor will promptly rectify same at Lessor's sole cost. However, if Lessee does not give Lessor written notice of any non-operative items within this notification period, all repairs to the Premises which are Lessee's responsibility per Paragraph 11.01 of this Lease will become the obligation of Lessee at Lessee's sole cost and expense. 2.05 All Lessor's Work to be installed in the Premises pursuant to Exhibit "B," if any, shall be installed by Lessor in compliance with all then applicable codes. Subject to the foregoing, Lessee agrees to comply with all laws, codes, ordinances and other legal requirements (including covenants and restrictions) now or hereafter applicable to the Premises and agrees to cause the Premises to comply with the same, including by making any Lessee Alterations necessitated by any Lessee activity, including but not limited to: (a) any Lessee Improvements or Lessee Alterations, as defined in Paragraph 10.02 below, made or to be made by Lessee or at Lessee's direction; (b) Lessee's Permitted Use; (c) Lessee's occupancy of the Premises and/or the Property; and (d) the presence of Lessee's employees, agents, contractors, suppliers, invitees or licensees on or about the Property. 4 2.06 If for any reason Lessor cannot deliver possession of the Premises on the Commencement Date of the Lease Term, Lessor will not be subject to any liability nor will the validity of this Lease be affected in any manner. Rather, the Commencement Date shall be delayed until delivery of possession and the expiration date of the Lease Term shall be extended so that the Lease Term shall include the same number of full calendar months as set forth in Paragraph 1.08 above (plus any partial first month); provided, in the event delivery of possession is delayed by any act, omission or request of Lessee, then the Premises shall be deemed to have been delivered (and the Commencement Date shall occur) on the earlier of the actual date of delivery or the date delivery would have occurred absent the number of days of such delay attributable to Lessee and the term shall then be for such number of full calendar months (plus any partial first month). If for any reason possession of the Premises is not delivered within ninety (90) days of scheduled Commencement Date set forth in Paragraph 1.08 above, Lessor or Lessee may terminate this Lease by written notice given after such ninety (90) day period but prior to delivery of possession; provided, such ninety (90) day period shall be extended by (a) the number of days of delays attributable to Lessee, plus (b) the number of days of delays caused by events beyond the reasonable control of Lessor. Lessee shall take possession of the Premises within fifteen (15) days after Lessor notifies Lessee in writing that the Premises is ready for Lessee's occupancy. 2.07 Subject to Paragraph 10.05 and Lessor's right to retain improvements, upon termination of this Lease, Lessee agrees to return the Premises to Lessor in the same condition as received by Lessee as of the original date Lessor delivers the Premises to Lessee, normal wear and tear excepted. 2.08 If Lessee, with Lessor's prior written consent, occupies the Premises prior to the Commencement Date, Lessee's occupancy of the Premises shall be subject to all the provisions of the Lease. Early occupancy of the Premises shall not advance the expiration date of the Lease. Lessee shall not pay Base Rent during the early occupancy period but all other charges shall begin to accrue on the date of such early occupancy. Lessee shall, however, provide Lessor with evidence of insurance coverage pursuant to Paragraph 12, prior to such early occupancy. 3. Base Rent 3.01 On or before the first day of each calendar month of the Lease Term, Lessee will pay to Lessor in lawful monies of the United States of America, without deduction or offset, prior notice or demand, Base Rent at the place Lessor designates. However, the first month's Base Rent and the Security Deposit will be due and payable concurrently with Lessee's execution of this Lease. 3.02 If indicated in Exhibit "B," Base Rent includes an amortized estimation of the costs of Lessor's Work (or costs of Lessor's Work in excess of any Lessee Allowance) which, subject to the terms and conditions of this Lease, shall be paid in equal installments as part of Base Rent by Lessee over the Lease Term. Subject to the provisions of Exhibit "B," should Lessor and Lessee agree to any additional Lessor's Work not included in this estimate or if the actual cost of Lessor's Work exceeds this estimate, Lessor may increase Base Rent according to the terms and conditions outlined in Exhibit "B" to similarly amortize such additional costs. 4. Additional Rent 4.01 Unless otherwise specifically stated, any charge payable by Lessee under this Lease other than Base Rent is called "Additional Rent". Additional Rent is to be paid concurrently with and subject to the same terms and conditions of Base Rent. The term "rent" whenever used in this Lease means Base Rent, Additional Rent and/or any other monies payable by Lessee under the terms of this Lease. In the event any rent payable under this Lease commences or ends on a day other than the first day of a calendar month, the actual number of days in the prorated month will be used as the basis for the calculation. 4.02 "Operating Expenses" as used herein shall include all costs and expenses related to the operation, maintenance, and repair of the Premises, Building, Project and/or Property, or any part thereof, incurred by Lessor including but not limited to: (1) Property supplies, materials, labor, equipment, and tools; (2) Lessor-incurred Utility and Service Costs (as further described in Paragraph 4.03B below), security, janitorial, and all applicable service and maintenance agreements; (3) Property related legal, accounting, and consulting fees, costs and expenses; (4) Insurance Premiums for all policies deemed necessary by Lessor and/or its lenders, and all deductible amounts under such policies (as further described in Paragraph 4.03C below); (5) costs and expenses of operating, maintaining, and repairing common areas of the Property, including but not limited to, hallways, restrooms, conference rooms, exercise rooms, equipment and telephone rooms, driving, parking and other paved or unpaved areas (including but not limited to, resurfacing and striping), landscaped areas (including but not limited to, tree trimming), walkways, building exteriors (including but not limited to, painting and roof repairs), signs and directories, and elevators and stairways; (6) capital improvements and replacements (including all financing costs and interest charges) which are made to improve the operating efficiency of the Property; (7) capital improvements and replacements (including but not limited to, all financing costs and interest charges) required by any governmental authority or law including but not limited to, compliance required under the Americans with Disabilities Act of 1990; (8) compensation (including but not limited to, any payroll taxes, worker's compensation for employees, and customary employee benefits) of all persons, including independent contractors, who perform duties, or render services on behalf of, or in connection with the Property, or any part thereof, including but not limited to, Property operations, maintenance, repair, and rehabilitation; (9) Property management fees; (10) Real Property Taxes (as further described in Paragraph 4.03A, below), provided, however, wherever the Lessee and/or any other lessee of space within the Property has agreed in its lease or otherwise to provide any item of such services partially or entirely at its own expense, or wherever in the Lessor's judgment any such significant item of expense is not incurred with respect to or for the benefit of all of the space within the Property, in allocating the Operating Expenses pursuant to the foregoing provisions of this subsection the Lessor shall make an appropriate adjustment, as aforesaid, so as to avoid allocating to the Lessee or to such other lessee (as the case may be) those Operating Expenses covering such services already being provided by the Lessee or by such other lessee at its own expense, or to avoid allocating to all of the net rentable space within the Property those Operating Costs incurred only with respect to a portion thereof, as aforesaid. Lessor agrees that no cost or expense shall be charged more than once. All Operating Expenses other than Real Property Taxes, Utility and Service Costs, and Insurance Premiums, are herein referred to as Common Area Expenses (CAM). 5 4.03A "Real Property Taxes" as used herein shall include any fee, license, tax, late fee, levy, charge, assessment, penalty (if a result of Lessee's delinquency or negligence), or surcharge (hereinafter individually and/or collectively referred to as "Tax") imposed by any authority (including but not limited to, any federal, state, county, or local government, or any school, agricultural, lighting, drainage, or other improvement district, or public or private association) having the direct or indirect power to tax and where such Tax is imposed against the Property, or any part thereof, or Lessor in connection with its ownership or operation of the Property, including but not limited to: (1) any Tax on Lessor's right to receive, or the receipt of, rent or income from the Property, or any part thereof, or Tax against Lessor's business of leasing the Property; (2) any Tax by any authority for services or maintenance provided to the Property, or any part thereof, including but not limited to, fire protection, streets, sidewalks, and utilities; (3) any Tax on real estate or personal property levied with respect to the Property, or any part thereof, and any fixtures and equipment and other property of Lessor or the Property used in connection with the operation, maintenance or repair of the Property; (4) any Tax imposed on this transaction, or based upon a reassessment of the Property, or any part thereof, due to a change in ownership or transfer of all or part of Lessor's interest in the Property, or any part thereof and, (5) any Tax replacing, substituting for, or in addition to any Tax previously included with this definition. Real Property Taxes do not include: (1) Lessor's federal or state income, franchise, inheritance, or estate taxes; or (2) Lessee's personal property taxes (taxes charged against Lessee's trade fixtures, furnishings, equipment, or other personal property) which are the sole responsibility of Lessee, and shall be billed directly to, and paid in a timely manner by Lessee. 4.03B "Utility and Service Costs" as used herein shall include all Lessor incurred utility and service costs and expenses including, but not limited to water, electricity, gas, heating, lighting, steam sewer, waste disposal, air conditioning, heating and ventilation related to the Project. 4.03C "Insurance Premiums" as used herein shall include all insurance premiums for all policies deemed necessary by Lessor and/or its lenders, including but not limited to, worker's compensation, liability, commercial general liability, automobile, rental interruption insurance and any and all additional endorsements, casualty insurance with extended coverage, riders under or attached to such policies, and the deductibles, fees and other charges and costs associated with the maintenance of the insurance carried by Lessor hereunder. 4.04 Throughout the Lease Term, Lessee will pay as Additional Rent its Proportionate Share (of the Project and/or building, as applicable) of Operating Expenses which will be equal to each calendar year's total Operating Expenses multiplied by Lessee's Proportionate Share. In the event Lessee is only responsible for a portion of a given calendar year, Lessee's share will be based on the actual number of elapsed applicable days. All Operating Expenses will be adjusted to reflect an average Project occupancy level of ninety-five percent (95%) during any calendar year in which the Project is not at least ninety-five percent (95%) occupied. 4.05 Lessee's Proportionate Share of Operating Expenses shall be determined and paid as follows: 4.05A. Lessee's Operating Expense estimates: On or about April 1st of each calendar year, Lessor will provide Lessee with a statement of: (1) Lessee's annual share of estimated Operating Expenses for the then current calendar year; (2) Lessee's new monthly Operating Expense estimate for the then current year; and, (3) Lessee's retroactive estimate correction billing (for the period of January 1st through the date immediately prior to the commencement date of Lessee's new monthly Operating Expense estimate) for the difference between Lessee's new and previously billed monthly Operating Expense estimates for the then current year. 4.05A(1). Annual estimated share: Lessee's annual share of estimated Operating Expenses for the then current calendar year shall be determined by multiplying Lessor's estimated total Operating Expenses for the then current calendar year, by Lessee's Proportionate Share (of the Project or Building, as applicable) identified in Paragraph 1.13. 4.05A(2). Monthly Operating Expense estimate: Lessee's new monthly Operating Expense estimate for the then current calendar year shall be calculated by dividing Lessee's annual share of estimated Operating Expenses, as determined above, by 12. 4.05A(3). Retroactive estimate correction: Lessee's share of the change in Operating Expense estimates retroactive to January 1st of each year shall be determined as follows: For the then current calendar year, the total of Lessee monthly Operating Expense estimates billed prior to the commencement of Lessee's new monthly Operating Expense estimate shall be subtracted from Lessee's new monthly Operating Expense estimate multiplied by the number of elapsed months within the same period. 6 4.05B. Lessee's share of actual annual Operating Expenses: On or about April 1st of each year, Lessor will provide Lessee with a statement reflecting the total Operating Expenses for the calendar year just ended. If the total of Lessee's Operating Expense estimates billed for the calendar year just ended are less than Lessee's Proportionate Share of the actual Operating Expenses for the calendar year just ended, the statement will indicate the payment amount and date due. If Lessee has paid more than its Proportionate Share of Operating Expenses for the preceding calendar year, Lessor will credit the overpayment towards Lessee's future Operating Expense obligations. 4.06 Under this Lease, monthly Operating Expense estimates, retroactive estimate corrections, and Lessee's share of actual annual Operating Expenses are considered Additional Rent. Monthly Operating Expense estimates are due on the 1st of each month and shall commence in the month specified by Lessor. Lessee's retroactive estimate correction, and actual annual Operating Expense charges, if any, shall be due, in full, on the date(s) specified by Lessor. 4.07 Lessee will not be entitled to any reduction, refund, offset, allowance or rebate should any Real Property Taxes be retroactively reduced, credited, abated or exempted by any direct or indirect taxing authority for any prior taxation or assessment period. If Lessor fails to provide Lessee with an Operating Expense statement by April 1st of any calendar year, or elects not to bill Lessee its share of actual Operating Expenses, and/or Operating Expenses estimate(s), or estimate increase(s) for any period of time, Lessor's right to bill and collect these charges from Lessee at a later time is not waived. 4.08 Whether now in force or hereafter in force, Lessee will pay as Additional Rent its share of any duties, levies or fees resulting from any statutes or regulations, or interpretations thereof, enacted by any governing authority which pertains to Lessor's or Lessee's use, ownership, occupancy or alteration of the Premises, Project, or Property, or any part thereof. Lessee's share of such duties or fees will be based on Lessee's Proportionate Share as indicated in Paragraph 1.13, or other equitable method determined by Lessor in its sole discretion. In the event the Property, or any part thereof, shares common Operating Expenses, commonly used areas, land or other items not exclusive to the Property, Lessor shall allocate and bill Lessee its share of any costs and expenses attributable to such sharing on an equitable basis, as determined by Lessor in its sole discretion. 4.09 In the event Lessee wishes to audit any Operating Expense charge, such an audit shall be limited to an audit of the annual statement delivered under Section 4.05B above. Such audit shall be performed only if Lessee is not in Default, as defined in Paragraph 20.02 below at the time of the audit request and/or at any time during the course of the audit. Any audit shall be conducted at a time and location mutually agreed by Lessor and Lessee within sixty (60) days of receipt by Lessor of a timely written request for audit. Lessor and Lessee agree that any Lessee audit must be requested by Lessee by written notice given within six (6) months of the date that Lessor provides the applicable annual statement under Section 4.05B above, and if Lessee does not give such written notice within this period of time, Lessee's right to audit is waived, and the Operating Expenses, as billed, including all calculations used as the basis for any applicable Base Year or expense stop, shall be deemed conclusive and final for all purposes under this Lease. Any audit shall be conducted only by Lessee and the CPA then used by Lessee for the preparation of its tax returns and financial statements. Lessee shall maintain as strictly confidential, and shall cause its auditor to execute in favor of Lessor a confidentiality agreement (in form prepared by Lessor) regarding, all financial information audited, the results of any such audit, and the resolution of any disputed issues arising in connection with such audit. Lessor shall not be bound by the result of any such audit. If the parties do not agree upon the inclusion or amount of any Operating Expense charged by Lessor, the sole remedy of Lessee shall be to conduct an audit within the time specified in this Lease and, if still in disagreement with Lessor, to submit the matter to arbitration pursuant to Paragraph 22 below within thirty (30) days after completion of the audit to request an adjustment to any disputed Operating Expense item. In no event will this Lease be terminable nor shall Lessor be liable for damages based upon any disagreement regarding or adjustment of Operating Expenses. 5. Late Charges If any installment, including any partial installment, of Base Rent, Additional Rent, rent or any other rent charge payable by Lessee is not received by Lessor within five (5) days after it becomes due, Lessee shall, without the necessity of notification from Lessor, pay Lessor a late charge equal to fifty dollars ($50.00) or ten percent (10%) of the then delinquent amount, whichever is greater. Additionally, a fifty dollar ($50.00) handling fee will be paid to Lessor by Lessee for each bank returned check, and Lessee will be required to make all future payments to Lessor by money order or cashier's check. The acceptance of late charges and returned check charges by Lessor will in no way constitute a waiver of Lessee's Default with respect to any overdue amount nor prevent Lessor from exercising any of its rights or remedies resulting from such late payment. 6. Security Deposit and Financial Reporting 6.01 Upon Lessee's execution of this Lease, Lessee will deposit with Lessor an initial Security Deposit in the amount specified in Paragraph 1.10 as security for Lessee's full and faithful performance of every provision under this Lease. Lessor will not be required to keep the Security Deposit separate from its general funds and has no obligation or liability for payment of interest thereon (except when required by law). Any time the Base Rent increases during the Lease Term, Lessee will deposit additional monies with Lessor as an addition to the Security Deposit so that the total amount of the Security Deposit will at all times at a minimum bear the same proportion to the then current Base Rent as the initial Security Deposit bears to the initial Base Rent set forth in Paragraph 1.09. Such additional Security Deposit monies will be due and payable concurrently with the next payment of Base Rent, after receipt of written notice from Lessor of the need to increase this Security Deposit as required by this Paragraph. 7 6.02 In no event will Lessee have the right to apply any part of the Security Deposit to any amounts payable under the terms of this Lease nor is it a measure of Lessor's damages in event of a Default by Lessee. If Lessee fails to pay any rent due herein, or otherwise is in Default of any provision of this Lease, Lessor may, without waiver of the Default nor of any other right or remedy, use, apply or retain all or any portion of the Security Deposit for the payment of any amount due Lessor, or to compensate Lessor for any loss or damage suffered by Lessee's Default. Within five (5) days after written notification by Lessor, Lessee will pay monies to Lessor sufficient to restore the Security Deposit to the full amount required under this Lease. 6.03 Within 30 days after the expiration of the Lease or earlier surrender of the Premises, Lessor shall (a) deliver to Lessee a description and itemized statement of any deductions from the Security Deposit permitted under the Lease, and (b) return the unused portion of the Security Deposit. Lessee acknowledges and agrees that Lessor is not obligated to deliver such statement if Lessee owes rent at the date of expiration or surrender, and is not obligated to return any unused portion of the Security Deposit until Lessee gives Lessor a written statement of Lessee's forwarding address. 6.04 At any time during the Lease Term, within ten (10) days after written request from Lessor, Lessee shall deliver to Lessor such financial statements as Lessor reasonably requests regarding Lessee or any assignee, subtenant, or guarantor of Lessee. In addition, Lessee shall deliver to any lender designated by Lessor any financial statements required by such lender to facilitate the financing or refinancing of the Property. Lessee represents and warrants to Lessor that each financial statement is a true and accurate statement as of the date of such statement. Lessor shall maintain as confidential any financial statements of Lessee delivered by Lessee to Lessor under this Section 6.04 which Lessee designates as confidential; provided, financial statements which are easily obtainable from public records need not be kept confidential; and provided further, Lessor shall have the right to disclose the contents of such financial statements (a) for any business purpose, including disclosure to third parties engaged by Lessor (including but not limited to attorneys, brokers, or accountants) and to actual or potential purchasers, lenders or investors of Lessor, (b) when ordered to do so by legal authority, (c) when Lessor determines that Lessor may have a legal obligation to do so, (d) in connection with enforcement of this Lease or any guaranty, and/or (e) in connection with any dispute with Lessee or any guarantor. 7. Use of Premises; Quiet Enjoyment; Trash 7.01 The Premises will be used and occupied only for Lessee's Permitted Use, as described in Paragraph 1.07. Lessee agrees it has negotiated Lessee's Permitted Use in a fair and reasonable manner and, as so written, Lessee's Permitted Use is enforceable for all purposes under this Lease. Further, Lessee expressly waives the right to challenge the validity of Lessee's Permitted Use, including but not limited to, in connection with any Default of this Lease, mitigation of damages, and any and all Transfers under this Lease. 7.02 Lessee will comply with all conditions and covenants of this Lease, and all applicable governmental agency laws, codes, regulations, ordinances, covenants and restrictions affecting the Property or any part thereof. Lessee will not use or permit the use of the Premises, the Property or any part thereof, in a manner that is unlawful, diminishes the appearance or aesthetic quality of any part of the Property, creates waste or a nuisance, disturbs Lessor, other lessees or any neighboring property occupants, or causes damage to the Property, or any part thereof, or to any neighboring property, personal property or person. Any animals, excepting guide dogs, on or about the Property or any part thereof are expressly prohibited. 7.03 Lessor agrees that so long as Lessee performs all of its obligations under the Lease, Lessee's possession, quiet enjoyment and use of the Premises for the term of the Lease will not be disturbed by Lessor, subject only to the provisions of the Lease. 7.04 Lessee shall be responsible for providing all trash receptacles and pickup for its premises. In the event of any excessive trash in or outside Lessee's Premises, as determined by Lessor in its sole discretion, Lessor will have the right to remove such excess trash, charge all costs and expenses attributable to its removal to Lessee, and require Lessee to obtain, at its sole cost and expense, additional trash receptacles, to be placed in a location designated by Lessor for Lessee's specific use. Under no circumstances may any "Hazardous Materials," as defined in Paragraph 14 below, any materials not permitted by law, any materials improperly or illegally handled, stored, contained or released, or any materials which are not permitted by Lessor, as determined in its sole discretion, be disposed of in any trash receptacles located in or about the Property. Lessee will not cause, maintain or permit any outside storage on or about the Property without prior written consent by Lessor, which consent, if given, may be revoked at any time. In the event of any unauthorized outside storage by Lessee, Lessor will have the right, without notice, in addition to such other rights and remedies it may have, to remove any such storage and charge all direct and associated costs and expenses to Lessee. 8 8. Parking All parking will comply with the terms and conditions of this Lease and the parking rules and regulations included in Exhibit "D." Unless otherwise stated, Lessee, its employees, agents, contractors, suppliers, invitees and licensees will have a non-exclusive privilege, in conjunction with Lessor, other lessees of the Property, and such other persons as Lessor may designate, to use those parking spaces designated by Lessor for public parking. Vehicles parked in public parking areas will be no larger than full-sized passenger automobiles or pick-up trucks. Larger vehicles, if permitted in writing by Lessor, will be parked, loaded and unloaded in locations designated by Lessor. Lessor reserves the right, without notice to Lessee, to tow away at Lessee's sole cost and expense any vehicles parked in any parking area for any continuous period of 24 hours or more, or earlier if Lessor, in its sole discretion, determines such parking to be a hazard or inconvenience to other lessees or Lessor, upon prior written notice to Lessee, or violates any rules or regulations or posted notices related to parking. Lessor shall not be responsible for enforcing Lessee's parking rights against third parties. From time to time, Lessor reserves the right, upon written notice to Lessee, to change the location, the availability and nature of parking spaces, establish reasonable time limits on parking, and, on an equitable basis, assign specific spaces with or without charge to Lessee as Additional Rent. 9. Utilities 9.01 Lessor agrees to provide at its cost water and electric service connections (and gas where applicable) to the Premises and telephone service connections to the Building, but Lessee agrees to make all arrangements for and pay directly to the appropriate utility company all costs and expenses of utility services supplied to, and for the use of, Lessee in or about the Premises, including but not limited to, water, gas, heat, light, power, telephone, sewer, sprinkler charges, usage costs and expenses, service fees, connection charges, deposits and any duties or taxes for such utilities. 9.02 If for any reason, Lessor incurs any utility costs and expenses which are attributed to Lessee, as determined by Lessor, Lessee, upon notification from Lessor, shall immediately reimburse Lessor for all such costs and expenses. 9.03 In the event it is not possible for Lessee to pay directly for any utility service, the utility service may, at Lessor's discretion, be obtained in Lessor's name, and Lessee will pay Lessor, as Additional Rent, Lessor's best estimate of Lessee's share of such utility costs and expenses. Lessor's best estimate will be determined by Lessor in its sole discretion and will be subject to change as Lessor deems necessary. Periodically during the Lease Term, Lessor will compare Lessee's utility estimates to actual utility costs and expenses incurred, and bill or credit, whichever is applicable, Lessee for any difference. Lessor reserves the right to separately meter any such service not so separately metered at Lessee's sole cost and expense at any time during the Lease Term, at which time Lessee shall be directly responsible for payment of such expense directly to the utility service provider, if possible. 9.04 Lessor will not be liable or deemed in Lessor Default, nor will there be any abatement of rent, for any interruption or reduction of utilities, utility services or telecommunication services. Without limiting the foregoing, Lessor shall have no liability in the event any telecommunication service to the Premises is interrupted or in the event that any telecommunications company providing services to the Premises (whether selected by Lessor or Lessee) fails to provide such services or provides defective service. Additionally, Lessee agrees to comply with any energy conservation programs implemented by Lessor by reason of enacted laws or ordinances, or otherwise. 9.05 Lessor reserves the right, in its sole discretion, to designate, at any time, Lessee's utility equipment and service providers for any utility available for Lessee's use within the Property. 9.06 By execution of this Lease, Lessee acknowledges it has satisfied itself as to the adequacy of any Lessor owned telephone equipment, if any, and the quantity of telephone lines and service connections to the Building available for Lessee's use. Additionally prior to termination of this Lease, Lessee at its sole cost and expense, will remove all equipment, both above and below the ceiling to the phone closet where applicable, (if required by Lessor), including but not limited to, all lines, wiring and all telephone boards belonging to Lessee and restore the Premises to the same condition as before such installation. 9.07 Lessee acknowledges and agrees that the number and type of telephone lines to its Premises, and all other telephone, telecommunication or other communication equipment (specifically including any antennas, towers {microwave or otherwise} or other exterior equipment of any nature) which either utilizes telephone or telecommunications equipment or technology or in any other manner affects the ability to use telephone or communications facilities at the Premises, as presently existing and as contemplated to be installed prior to the Commencement Date as specifically provided in any Exhibit to this Lease, are fully adequate for Lessee's uses and purposes. In the event that Lessee later wishes additional telephone, telecommunication or other communication lines or equipment to be installed after the date of Lessee's execution of this Lease, no such additional lines or equipment shall be installed without first securing the prior written consent of Lessor, which will not be unreasonably withheld. Any telecommunications installation shall be subject to the following: (1) Lessor shall incur no expense whatsoever with respect to any aspect of Lessee's need for additional access or equipment, including without limitation, the costs of installation, consultants, materials, permits, service, etc. (2) Prior to the commencement of any work in or about the Building to install such additional access, lines or equipment, Lessee shall agree to abide by such conditions to installation, use and removal, as are determined by Lessor in its sole discretion. 9 (3) Lessor reasonably determines that there is sufficient space in the Building for the placement of all of the lines, access and equipment. (4) Lessee agrees to compensate Lessor the reasonable amount determined by Lessor for space used in the Building for the storage and maintenance of the equipment, if any lies outside the leased Premises, and for all costs that may be incurred by Lessor in arranging for access by the Lessee's personnel, security for Lessee's equipment, and any other such costs as Lessor may expect to incur. (5) Any other requirements Lessor may deem reasonable. The refusal of Lessor to consent to any request shall not be deemed a Lessor Default nor otherwise be grounds for any termination, claim or offset by Lessee. Lessee agrees that to the extent service by any telephone or communication equipment is interrupted, curtailed, or discontinued, Lessor shall have no obligation or liability with respect thereto and it shall be the sole obligation of Lessee at its expense to obtain substitute service, but only with Lessor's prior written permission, which shall not be unreasonably withheld. Lessor's consent under this section shall not be deemed a warranty or representation by Lessor as to the availability or suitability of the present or future telephone or communications equipment, connections, compatibility or space available for any additional equipment, lines or access. The provisions of this clause may be enforced solely by the Lessee and Lessor, and are not for the benefit of another party, specifically, without limitation, no telephone or telecommunications provider shall be deemed a third party beneficiary of the Lease. 10. Lessee Improvements; Lessee Alterations and Mechanic's Liens 10.01 Any improvements to be constructed in the Premises by Lessee prior to Lessor's initial delivery of the Premises are referred to throughout this Lease as "Lessee Improvements." All Lessee Improvements will be performed in accordance with the terms and conditions outlined in Exhibit "B" and this Section 10. 10.02 Lessor's prior written consent is required for any: (a) Lessee constructed Lessee Improvements; and (b) any alterations, utility installations, additions, or other improvements made by Lessee, at its sole cost and expense, after Lessor's initial delivery of the Premises (herein collectively referred to as Lessee Alterations). Lessor's consent will be conditioned upon its approval of: (i) Lessee's contractor(s); (ii) detailed plans and work specifications of Lessee Alterations; and (iii) certificates of insurance from Lessee's contractor(s) for commercial general liability, automobile liability and property damage insurance with limits not less than $2,000,000 / $250,000 / $500,000 respectively endorsed to show Lessor as an additional insured evidencing Lessor's requirement to be notified at least thirty (30) days in advance of any change, expiration or cancellation of any such policies along with proof of a current worker's compensation policy. In addition, Lessee must obtain all approvals and permits required by any and all governmental authorities and provide same to Lessor prior to commencement of any work, and after work commences must comply with all conditions of such approvals and permits and perform work in a prompt and expeditious manner with good and sufficient materials. Lessor also retains the right, as a condition of its consent, to require Lessee to provide Lessor with a lien and completion bond in a form acceptable to Lessor in an amount equal to one and one-half times the estimated cost of Lessee constructed Lessee Improvements and Lessee Alterations and/or require the inclusion of Lessor's non-responsibility language in all contracts in a form approved by Lessor. Lessor shall be entitled to a contract management fee of 15% of the total cost of such construction. Lessee will give Lessor a minimum of fifteen (15) days prior written notice to the commencement of any Lessee constructed Lessee Improvements and Lessee Alterations to allow Lessor sufficient time in which to post notices of non-responsibility or no liability for work then in progress in, on, or about the Premises as provided by law. Upon completion of any improvements, all alterations or additions, Lessee shall deliver to Lessor accurate, reproducible as-built plans of such construction. 10.03 Lessor's approval of any Lessee constructed Lessee Improvements and Lessee Alterations will not create any liability whatsoever on the part of Lessor. By way of example and without limitation, Lessor's approval of Lessee's plans and work specifications will not create any responsibility or liability on the part of Lessor for their sufficiency, completeness or compliance with any and all governmental laws, codes, regulations, ordinances, covenants and restrictions (including without reservation any and all provisions of the Americans with Disabilities Act of 1990 and analogous local architectural barriers removal acts applicable to the Property, or any part thereof). 10 10.04 Lessee will pay when due, all claims for services, labor and materials furnished by, or at the request of Lessee, including any claims which are secured by any mechanic's or materialmen's or other lien against the Property, or any interest therein. Lessee agrees that should any lien be posted on the Property due to work performed, materials furnished, or obligations incurred by Lessee, or its employees, agents, contractors, suppliers, invitees or licensees, Lessee will immediately notify Lessor and proceed to remove such lien. Lessee further acknowledges that it will remain liable to Lessor and indemnify Lessor for any costs and expenses or damages to Lessor or the Property or any interest therein as a result of such lien(s). If Lessee, in good faith, contests the validity of any such lien, claim or demand, Lessee will, at its sole expense, defend and protect itself, Lessor and the Property, or any part thereof. To ensure such protection of Lessor and the Property and any part thereof, Lessor may, at its sole option, require Lessee to provide Lessor with a surety bond satisfactory to Lessor in an amount deemed appropriate by Lessor which will indemnify Lessor against any liability and ensure the Property, or any part thereof, is free from the effect of such a lien or claim. In addition, Lessor may require Lessee to pay all legal fees of Lessor's attorney(s) of choice and any other associated costs and expenses should Lessor decide it is in its best interest to participate in such an action. If Lessee fails to keep the Property, or any part thereof, free from any lien or provide a Lessor approved surety bond, then, in addition to any other rights and remedies available to Lessor, Lessor may take any action necessary to discharge such a lien, including but not limited to, payment to the claimant on whose behalf the lien was filed, and regardless of the corrective action taken by Lessor, Lessee will be liable to Lessor for all costs and expenses of such action to discharge the lien, including, but not limited to, any legal fees and costs. 10.05 All Lessee Improvements and Lessee Alterations are part of the realty and belong to Lessor. As a condition of Lessor consenting to any Lessee Improvements or Lessee Alterations, Lessor reserves the right, at any time to: (i) require Lessee to pay an amount determined by Lessor to cover the costs of demolishing part or all of any Lessee Improvements or Lessee Alterations and or the cost of returning the Premises to their condition before any such work commenced (normal wear and tear excepted); or (ii) elect to make Lessee the owner of all or any specified part and, upon termination of this Lease, require Lessee to remove same at its sole cost and expense. The provisions of this Paragraph shall survive the termination of this Lease. 10.06 Lessee may, without prior written consent of Lessor, make non-structural installations within the Premises of its trade fixtures, equipment, and machinery in conformance with all applicable governing agency laws, codes, regulations, ordinances, covenants and restrictions, and they may be removed upon termination of this Lease provided the Premises are restored to its condition at the commencement of this Lease and no material damage to the Premises will occur. All such installations shall be made by a licensed and bonded contractor, approved by Lessor, with all permits obtained when required by law. 10.07 Lessor retains the right to construct or permit construction of improvements, and/or lessee alterations, for new and existing lessees and to alter any commonly used areas in or about the Property. Notwithstanding anything which may be contained in this Lease, Lessee understands this right of Lessor and agrees that such construction will not be deemed to constitute a Lessor Default of this Lease. Lessee waives any such claims which it might have arising from such construction. 11. Repairs 11.01 This is a net lease. Lessee will, at all times and at its sole cost and expense, keep all parts of the Premises, interior and exterior, in good order, condition and repair, and all equipment and facilities within or serving the Premises, including but not limited to: windows, glass and plate glass, doors and office entry(s), walls and finish work, floors and floor coverings, interior of the roof, foundation, down spouts, gutters, heating and air conditioning systems, electrical systems, dock boards, truck doors, chain link gates and fences, dock bumpers, life safety-sprinkler systems, signage, speed bumps, paving, plumbing work and fixtures, termite and pest extermination, regular removal of trash and debris, snow removal, regular mowing of any grass, trimming, weed removal and general landscape maintenance, keeping the parking areas, driveways, alleys and whole of the Premises in a clean and sanitary condition. Lessee shall at its own costs and expense repaint exterior overhead doors, canopies, entries, handrails, gutters, and other exposed parts of the Building which reasonably require periodic repainting to prevent deterioration or to maintain aesthetic standards. The cost of maintenance and repair of any common party wall (any wall, divider, partition or other structure separating the premises from any adjacent premises occupied by other Lessees) shall be shared equally by Lessee and the lessee occupying the adjacent premises. Lessee shall not damage any party wall or disturb the integrity and support provided by any party wall and shall, at its sole cost and expense, promptly repair any damage or injury to any party wall caused by Lessee or its employees, agents or invitees. Lessee will keep the Premises and every part thereof in good order, condition and repair regardless of whether any portion of the Premises requiring repairs, or the means of repairing same are reasonably or readily accessible. Additionally, Lessee shall be obligated to maintain and repair the Premises whether the need for such repairs or maintenance occurs as a result of Lessee's use, any prior use, vandalism, acts of third parties, Force Majeure or the age of the Premises. The standard for comparison of condition will be the condition of the Premises as of the original date of Lessor's delivery of the Premises and failure to meet such standard shall create the need to repair. All Lessee repairs will be made by a licensed and bonded contractor, approved by Lessor, with permits and any other governmental agency approvals and requirements obtained and observed, and conform to all requirements of Paragraph 10.02 herein. Lessor's maintenance and repair obligations are limited to air-conditioning and other equipment, facilities and areas used in common with other lessees, exterior walls, foundations and exterior roofs which Lessor agrees to repair and maintain on behalf of Lessee unless such repairs are due to negligent or intentional acts of Lessee or its employees, agents, contractors, suppliers, invitees or licensees. 11.02 Lessee expressly waives the benefit of any statute or other legal right now or hereafter in effect which would otherwise afford Lessee the right to make repairs at Lessor's expense, whether by deduction of rent or otherwise, or to terminate this Lease because of Lessor's failure to keep the Property, or any part thereof in good order, condition and repair. If Lessee does not keep the Premises in good order, condition, conforming to and consistent with Lessor-specified standard colors, materials and quality, or fails to make any Lessor required maintenance or repairs, Lessor shall have the right, without waiver of Default nor of any other right or remedy, to perform such obligations of Lessee on Lessee's behalf, and Lessee will reimburse Lessor for any direct and indirect costs and expenses incurred immediately upon demand. 11 11.03 In the event the Premises constitute a portion of a multiple occupancy building, Lessor shall perform the roof, paving, and landscape maintenance, exterior painting and common sewage line plumbing which are otherwise Lessee's obligation under Paragraph 11.01 above, and Lessee shall, in lieu of the obligations set forth under Paragraph 11.01 above with respect to such items, be liable for its Proportionate Share of the Building (as defined in Paragraph 1.13 above) of the costs and expense of Building maintenance and the care for the grounds around the Building, including but not limited to, the mowing of grass, care of shrubs, general landscaping, maintenance of parking areas, driveways and alleys, roof maintenance, exterior repainting and common sewage line plumbing; provided, however, that Lessor shall have the right to require Lessee to pay such other reasonable proportion for said mowing, shrub care and general landscaping costs as may be determined by Lessor in its sole discretion, and further provided that if Lessee or any other particular lessee of the Building can be clearly identified as being responsible for obstruction or stoppage of the common sanitary sewage line, then Lessee, if Lessee is responsible, or such other responsible lessee, shall pay the entire cost thereof, upon demand, as Additional Rent. 11.04 Lessee shall, at its own cost and expense, enter into regularly scheduled preventive maintenance/service contract(s) with a maintenance contractor for servicing all heating and air conditioning systems and equipment within the Premises and shall provide Lessor with copies of all service reports. The maintenance contractor and contract must be approved by Lessor. The service contract must include all services suggested by the equipment manufacturer within the operation/maintenance manual and must become effective (and a copy thereof delivered to Lessor) within thirty (30) days of the date Lessee take possession of the Premises. Each Lease year Lessor, at its option, may inspect the HVAC system to determine that the aforementioned maintenance is being performed. If the HVAC system is not being maintained pursuant to this Section, Lessor will send notice of such lack of maintenance to Lessee and Lessee shall thereafter have thirty (30) days to perform the necessary maintenance. If Lessee fails to complete the necessary maintenance in such thirty (30) day period, Lessor shall have the right, without waiver of any other right or remedy, to perform such work at the expense of Lessee. Should the inspection demonstrate a lack of maintenance of the HVAC system, Lessee shall pay for the cost of such inspection. Thirty days before Lessee vacates the Premises, Lessor will have the HVAC equipment inspected by a qualified HVAC mechanic at Lessor's expense. If, in the opinion of the HVAC mechanic, the equipment has not been properly maintained, then Lessor may authorize necessary repairs and/or replacements to be made to the system. Such repairs will be deducted from the Lessee's Security Deposit. Lessee shall reimburse Lessor for any and all costs associated with such repairs which exceed the amount of any Security Deposit. The remainder of the Security Deposit, if any, shall be refunded to Lessee in accordance with the terms of the Lease. 12. Insurance 12.01 Except as expressly provided as Lessee's Permitted Use, or as otherwise consented to by Lessor in writing, Lessee will not do or permit anything to be done within or about the Premises or the Property which will increase the existing rate of any insurance on any portion of the Property or cause the cancellation of any insurance policy covering any portion of the Property. Lessee will not keep, use or sell, or permit anyone to keep, use or sell, anything in or about the Premises, which may be prohibited by the standard form of fire and other insurance policies. Lessee will, at its sole cost and expense, comply with any requirements of any insurer of Lessor and of Lessee. 12.02 Lessee agrees to maintain in full force and effect at all times during the Lease Term, at its sole cost and expense, for the protection of Lessee and Lessor, policies of insurance which afford the following coverage: (a) Worker's Compensation Statutory Requirements Employer's Liability Not less than $1,000,000.00 (b) Commercial General Liability Not less than $1,000,000.00 per occurrence Not less than $2,000,000.00 aggregate this location Commercial policies shall insure on an occurrence and not a claims-made basis and cover the Premises, Project and Property. The policy shall cover liability arising from premises, operations, independent contractors, products-completed operations, personal injury, advertising injury and liability assumed under an insured contract and not be excess, nor exclude pollution or employment-related practices. (c) Automobile Liability Not less than $300,000.00 combined single limit including property damage 12 (d) "All Risk" coverage including fire and extended coverage, vandalism, malicious mischief and any other perils normally covered therein. This insurance coverage must be upon the Premises and all property owned by Lessee, for which Lessee is legally liable, which Lessee is obligated to repair and restore hereunder, and/or which was installed at the expense of or at the request of Lessee, including but not limited to, any Lessee Improvements, Lessee Alterations, furniture, fixtures, equipment, installations and any other personal property of Lessee, in an amount not less than their full replacement value, and with a deductible not to exceed $1,000.00 per occurrence. All proceeds of this insurance shall only be used for the repair and replacement of property so insured, and Lessee hereby assigns to Lessor all its rights to receive any proceeds of such insurance policies attributable to any Lessee Improvements and Lessee Alterations. The limits of the insurance coverage required under this Lease will not limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance to be carried by Lessee will be primary to, and non-contributory with Lessor's insurance, and contain cross-liability endorsements and will in addition to the above coverage specifically insure Lessor against any damage or loss that may result either directly or indirectly from any default of Lessee under Paragraph 14 (Hazardous Materials) herein. Any similar insurance carried by Lessor will be considered excess insurance only. 12.03 Lessee will name Lessor (and, at Lessor's request, any Mortgagee) as an additional insured on all insurance policies required of Lessee under this Lease, other than Worker's Compensation, Employer's Liability, Automobile Liability, and Fire and Extended coverage (except on improvements or alterations to Lessees' Premises for which Lessor shall be named an additional insured). Such insurance policies carried by Lessee will permit the insured, prior to any loss, to agree with a third party to waive any claim it might have against said third party without invalidating the coverage under the insurance policy, and will release Lessor and any of its agents and employees from any claims for damage to any person, to the Property of which the Premises are a part, any existing improvements, etc., Lessee Improvements and Lessee Alterations to the Premises, and to any furniture, fixtures, equipment, installations and any other personal property of Lessee caused by or resulting from, risks which are to be insured against by Lessee under this Lease, regardless of cause. 12.04 Lessee will deliver to Lessor, (and, at Lessor's request any Mortgagee, Assignee or Receiver) simultaneously with its execution of this Lease, (and thereafter at least thirty (30) days prior to expiration, cancellation or change in any Lessor required certificates of insurance), certificates of insurance evidencing, at a minimum, the coverage specified in Paragraph 12.02. All insurance required hereunder will be with companies licensed and authorized to do business in the state in which the Property is located and holding a "General Policyholders Rating" of "A -, VII" or better, as set forth in the most current Best's Insurance Guide. 12.05 Lessor will secure and maintain insurance coverage in such limits as Lessor may deem reasonable in its sole judgment to afford Lessor adequate protection. The premiums for such coverage are "Insurance Premiums" under Section 4.03C above. 12.06 Lessor makes no representation that the insurance policies and coverage amounts specified to be carried by Lessee or Lessor under the terms of this Lease are adequate to protect Lessee. Lessee will provide, at its own expense, all insurance as Lessee deems adequate to protect its interests. 12.07 As to any insurance proceeds received by Lessor, such proceeds shall for all purposes be deemed Lessor's sole property, free from any claims of Lessee, and unless otherwise stated, available for Lessor's exclusive use as it may alone determine in the exercise of its sole discretion. 12.08 Without limiting the effect of any other waiver of or limitation on the liability of Lessor set forth herein, and except as provided in Section 13 and/or Section 14 below, neither Lessor nor Lessee shall be liable to the other party or to any insurance company (by way of subrogation or otherwise) for any loss of or damage to tangible property due to casualty regardless of negligence. 13. Indemnification and Waiver of Claims Lessee waives all claims against Lessor and its agents for any damage to any property in or about the Property, for any loss of business or income, and for injury to any persons, including death resulting therefrom, regardless of cause or time of occurrence. Lessee will indemnify, protect, defend and hold harmless Lessor and its agents from and against all claims, losses, damages, causes of action, costs, expenses and liabilities, including legal fees, arising out of, involving, or in connection with Lessee's occupancy of the Premises or presence on the Property, the conducting of Lessee's business, any Default by Lessee, and/or any act, omission or neglect of Lessee, its agents, contractors, employees, suppliers, licensees or invitees except only for any third party claim for bodily injury or death which is the direct result of the gross or intentional acts by Lessor, its agents, contractors, employees, suppliers, licensees or invitees. In the event any action or proceeding is brought against Lessor, its agents, contractors, employees, suppliers, licensees or invitees, by reason of the foregoing, Lessee, upon notice by Lessor, will defend Lessor, its agents, contractors, employees, suppliers, licensees or invitees, at Lessee's sole cost and expense, and by counsel reasonably satisfactory to Lessor. 13 14. Hazardous Materials 14.01 For purposes of this Lease, "Hazardous Materials" will mean any product, substance, chemical, material or waste whose presence, nature, quantity and/or intensity of existence, use, manufacture, disposal, transportation, spill, release or effect, either by itself or in combination with other materials expected to be on the Property, now or in the future, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Property, or any part thereof; (ii) regulated or monitored by any governmental authority; or (iii) a basis for potential liability of Lessor to any governmental authority or third party. Hazardous Materials will include, but not be limited to, solvents, petrochemical products, flammable materials, explosives, asbestos, urea formaldehyde, PCB's, chlorofluorocarbons, freon or radioactive materials. Lessee agrees to provide Lessor, prior to its occupancy of the Premises, a list of all Hazardous Materials which Lessee proposes to bring into the Premises and their locations within the Premises and methods of storage. Lessee further agrees to comply with all future requests for information by Lessor including but not limited to copies of all applicable Material Safety Data Sheets (MSDS sheets). 14.02 Lessee will not cause or permit any Hazardous Materials to be brought upon, kept, stored, discharged, released or used in, under or about any portion of the Property by itself, its agents, employees, contractors, subcontractors, licensees or invitees, without the prior written consent of Lessor, and Lessor's consent will be in its sole discretion; provided, Lessee may bring into the Premises small amounts of Hazardous Materials (such as cleaning products and copy toner) which are readily available to Lessee by unregulated retail purchase if the same are necessary in Lessee's normal business operations. As to any Hazardous Materials brought to the Premise or Property by Lessee, with or without the prior written consent of Lessor (without waiver of the requirement of prior written consent), Lessee shall: (1) use such Hazardous Material only as is reasonably necessary to Lessee's business, in small, properly labeled quantities; (2) handle, use, keep, store, and dispose of such Hazardous Material using the highest accepted industry standards and in compliance with all applicable regulatory agencies and governmental Hazardous Materials requirements; (3) maintain at all times with Lessor a copy of the most current MSDS sheet for each such Hazardous Material; and (4) comply with such other rules and requirements Lessor may from time to time impose. 14.03 As to any Hazardous Materials brought to the Premises or Property by Lessee, with or without the prior written consent of Lessor (without waiver of the requirement of prior written consent), Lessee will comply with all federal, state and local laws, ordinances, and rules and regulations relating to Hazardous Materials, including but not limited to, current rules and regulations or levels and standards as set from time to time by the Environmental Protection Agency, the U. S. Occupational Safety and Health Administration, or any other governmental agency. It is not necessary that any presence or contamination of the Premises reflect any government mandated threshold or quantity in order for Lessor to take any action under this Paragraph 14. 14.04 Upon expiration or earlier termination of this Lease, Lessee will, at Lessee's sole cost and expense, cause all Hazardous Materials brought to the Premises or the Property by Lessee, its agents, contractors, employees, suppliers, licensees or invitees, to be removed from the Property in compliance with any and all applicable Hazardous Material disposal laws. If Lessee or its agents, contractors, employees, suppliers, licensees or invitees, violates the provisions of this Paragraph 14, or performs any act or omission, or contaminates, or expands the scope of contamination of the Premises, the Property, or any part thereof, the underlying groundwater, or any property adjacent to Lessor's Property, then Lessee will promptly, at Lessee's expense, take all investigatory and/or remedial action (collectively called "Remediation") that is necessary to fully clean up, remove and dispose of such Hazardous Materials and any contamination so caused and shall do so in compliance with any applicable Hazardous Material laws and regulations. Lessee will also repair any damage to the Premises and any other affected portion(s) of the Property caused by such Hazardous Material presence, investigation and Remediation. 14.05 With respect to any Remediation of the Premises, the Property or any portion thereof, Lessee will provide Lessor with written notice of Lessee's intended Remediation, including Lessee's method, time and procedure of Remediation, and Lessor will have the right to require reasonable changes in such method, time or procedure before Lessee commences any such work. Lessee will not commence any Remediation of Hazardous Materials in any way connected with the Property, or any portion thereof, without first notifying Lessor, in writing, of Lessee's intention to do so and affording Lessor ample opportunity to appear, intervene or otherwise appropriately assert and protect Lessor's interest. 14.06 Lessee will immediately notify Lessor in writing of any governmental or regulatory action threatened, any claim, demand, or complaint made or threatened by any person against Lessee or any portion of the Property relating to damage, contribution, cost recovery compensation, or loss or injury resulting from any Hazardous Materials, and any report made to any governmental authority arising out of any Hazardous Materials on, or removed from, the Property or any portion thereof. Lessor retains the right to join and participate, as a party, in any legal actions affecting the Property or any portion thereof initiated in connection with Hazardous Materials laws. 14.07 Lessee will indemnify, protect, defend and forever hold Lessor, its agents, employees, lenders and ground lessor, if any, and the Premises, the Property, or any portion thereof, harmless from any and all damages, losses, liabilities, judgments, penalties, claims, obligations, attorneys and consultants' fees and any other costs and expenses arising out of any failure of Lessee, its agents, contractors, employees, suppliers, licensees or invitees to observe any covenants of this Paragraph 14 of this Lease. All provisions of this Paragraph 14 shall survive any termination of this Lease. 14 15. Auctions and Signs 15.01 Lessee will not conduct, nor permit to be conducted, either voluntarily or involuntarily, any auction on or about the Property, without having the express written consent of Lessor, and Lessor will not be obligated to exercise any standard of reasonableness in determining whether or not to grant such consent. Should Lessor grant such consent, Lessee will comply with any requirements of Lessor and any applicable laws governing such an auction. 15.02 Lessee will not place any Signage on or about the Property, or on any part thereof, without the prior written consent of Lessor, which Lessor may withhold in its sole discretion. All approved Lessee Signage will comply with the terms and conditions of this Lease and the sign criteria set forth in Exhibit "C" and Exhibit "D," or other criteria which Lessor may establish from time to time. 16. Lessor's Access 16.01 Lessor, its agents, contractors, consultants, servants and employees, will have the right to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times to (a) examine the Premises; (b) perform any obligation to or exercise any right or remedy of Lessor under this Lease; (c) make repairs, alterations, improvements or additions to the Premises or to other portions of the Property as Lessor deems necessary or desirable; (d) perform work necessary to comply with laws, ordinances, rules or regulations of any governing authority or insurance underwriter; (e) serve, post or keep posted any notices required or allowed under the provisions of this Lease or by law; (f) show, at reasonable times, Lessee's Premises to prospective lessees; (g) post on or about the Premises any ordinary "For Lease" signs during the last sixty (60) days of the Lease Term; and (h) perform work at Lessee's sole cost that Lessor deems necessary to prevent waste or deterioration of the Premises should Lessee fail to commence to make, and diligently pursue to completion, its required repairs. 16.02 For each of the purposes described in Paragraph 16.01 above, Lessor will at all times have and retain any necessary keys with which to unlock all doors in, upon and about the Premises, excluding Lessee's vaults and safes. Lessee will not alter any lock or install new or additional locks or bolts on any door in or about the Premises without obtaining Lessor's prior written approval and will, in each event, furnish Lessor with a new key. All access activities of Lessor will be without abatement of rent or liability on the part of Lessor. 17. Abandonment Lessee will not vacate or abandon the Premises, or cease to conduct its ordinary business operations in the Premises, or permit the Premises to remain unoccupied for any period longer than fifteen (15) consecutive days any time during the Lease Term. If Lessee abandons, vacates or surrenders the Premises, or is dispossessed by process of law, or otherwise, any personal property belonging to Lessee left in or about the Premises will, at the option of Lessor, be deemed abandoned and may be disposed of by Lessor. 18. Damage or Destruction 18.01 If the Premises is damaged or destroyed by fire or other casualty, Lessee will immediately give written notice to Lessor of the casualty and Lessor will promptly repair the damage as set forth in Paragraph 18.03 unless Lessor has the right to terminate this Lease as provided in Paragraph 18.02 and Lessor elects to so terminate. 18.02 Lessor will have the right, but not the obligation, to terminate this Lease following a casualty if any of the following occur: (i) insurance proceeds actually payable and paid to Lessor are not sufficient to pay one hundred percent (100%) of the cost to fully repair the damage; (ii) Lessor determines that the Premises cannot, with reasonable diligence, within six (6) months after Lessor obtains knowledge of the casualty, be fully repaired by Lessor or cannot be safely repaired because of the presence of hazardous factors and conditions, including but not limited to, Hazardous Materials, earthquakes, utility outages and any other similar dangers; (iii) the Premises are damaged or destroyed within the last twelve (12) months of the Lease Term; (iv) the Building within which the Premises is located is damaged or destroyed and Lessor (as determined in its sole discretion) cannot reasonably complete such repair within six (6) months of Lessor obtaining knowledge of the casualty; (v) Lessee is in Default of this Lease at the time of the casualty; (vi) Lessor would be required under Paragraph 18.04 to abate or reduce Lessee's rent for a period in excess of six (6) months if the repairs were undertaken; or (vii) the Project, or the Building in which the Premises is located, is damaged such that the cost of repair of the same would exceed 10% of the replacement cost of the same. If Lessor elects to terminate this Lease pursuant to this Paragraph 18.02, Lessor will give Lessee written notice of this election, and fifteen (15) days after Lessee's receipt of such notice, this Lease will terminate. If Lessor elects to terminate this Lease, subject to the rights of any mortgagee, Lessor will be entitled to retain all applicable Lessee insurance proceeds excepting those attributable to Lessee's furniture, fixtures, equipment, and any other personal property. 18.03 If Lessor does not have the right to elect, or fails to elect, to terminate this Lease, this Lease will remain in full force and effect, and Lessor will, within ten (10) days after receipt of all applicable insurance proceeds and monies required to fully repair 100% of the Premises, begin the process of obtaining all necessary permits and approvals, and upon receipt thereof, diligently pursue the repair through completion. The repair obligation of Lessor shall be limited to repair of the Premises, including Lessor's Work (if any), excluding any Lessee Improvements, Lessee Alterations, and any personal property and trade fixtures of Lessee. 15 18.04 If Lessor does not have the right to elect, or fails to elect, to terminate this Lease, during the period of repair, Lessee's rent will be temporarily abated or reduced in proportion to the degree to which Lessee's use of the Premises is impaired, as determined by Lessor, beginning the date Lessor obtains knowledge of the casualty and ending on the date all repairs affecting Lessee's use of the Premises are substantially completed, as determined by Lessor in its sole discretion. However, the total amount of such rent abatement or reduction shall not exceed the total amount of insurance proceeds, directly attributable to Lessee's Premises, Lessor may receive from any rental loss insurance coverage it may carry free from any claim of Lessee. Except for the abatement of rent as herein described, Lessee will not be entitled to any compensation or damages for the loss of or interference with Lessee's personal property (including but not limited to, furniture, fixtures, equipment, and installations), or existing improvements of the Premises, Lessee Improvements, Lessee Alterations or any other improvements on or about any portion of the Property, or business, or use, or access to all or any part of the Premises or the Property resulting from such damage, destruction or repair, including but not limited to, any consequential damages, opportunity costs or lost profits incurred or suffered by Lessee. In no event, however, will Lessor be responsible for any abatement of rent if Lessee, or its agents, contractors, employees, suppliers, licensees or invitees is the cause of the casualty, or any part thereof. 19. Transfer (Assignment/Subletting) 19.01 Lessee will not assign, sell, convey, sublet or otherwise transfer all or any part of Lessee's right or interest in this Lease, or allow any other person or entity to occupy or use all or any part of the Premises (collectively called "Transfer") without first obtaining the written consent of Lessor. Any Transfer without the prior written consent of Lessor shall be void. "Transfer" for purposes of this section: (i) an entity other than Lessee becoming the Tenant hereunder by merger, consolidation Without limiting the generality of the definition of "Transfer," it is agreed that each of the following shall be deemed a, or other reorganization; (ii) a transfer of any ownership interest in Lessee (unless Lessee is an entity whose stock is publicly traded) so as to result in a change in the current control of Lessee; (iii) a grant of a license, concession, or other right of occupancy of any portion of the Premises, or (iv) the use of the Premises by any party other than Lessee. Should Lessee desire a Transfer, Lessee will notify Lessor in writing of: (i) Lessee's intent to Transfer; (ii) the name of the proposed transferee; (iii) the nature of the proposed transferee's business to be conducted on the Premises; (iv) the terms and provisions of the proposed Transfer, and (v) any other information Lessor may reasonably request concerning the proposed Transfer; including but not limited to, a statement of net worth, financial statements covering a specified period of time, environmental reports and a completed environmental questionnaire supplied by Lessor. 19.02 Lessee agrees, by way of example and without limitation, that Lessor may withhold its consent to a proposed Transfer if Lessor in its reasonable judgment determines that the proposed transferee: (a) is of a character or is engaged in a business which is not in keeping with Lessor's standards for the Property, as determined solely by Lessor; (b) has a use which conflicts with a provision of this Lease or proposes an unacceptable risk to Lessor, as determined by Lessor; (c) does not meet the then current financial standards required by Lessor; (d) has been required by any prior lessor, lender or governmental authority to take a remedial action in connection with Hazardous Materials contaminating a property; (e) is unacceptable because Lessee is in Default under this Lease at the time of the request for Transfer or as of the effective date of the Transfer. Notwithstanding the foregoing, Lessee's right to a Transfer is subject to Lessor's approval of Lessee's financial condition at the time the Transfer is requested by Lessee. 19.03 In the event Lessor consents to a Transfer, the Transfer will not be effective until Lessor is in receipt of a fully executed agreement to Transfer, in a form and of substance acceptable to Lessor, and a Transfer fee of two hundred and fifty dollars ($250.00) which shall represent Lessee's minimum liability for such service. The receipt and cashing of any check by Lessor wherein such check is in a name other than that of Lessee will not constitute consent to a Transfer. Lessor also reserves the right to collect any rents due under this Lease directly from the transferee, and such direct collection will not constitute recognition of the transferee as Lessee or release Lessee or any guarantor of Lessee from any of its obligations under this Lease. Any consideration received by Lessee in excess of Lessee's Base Rent (including additional rent) as a result of a Lessor approved transfer shall be due and payable to Lessor. Upon any assignment or sublease, any rights, options or opportunities granted to Lessee hereunder to extend or renew the Lease Term, to shorten the Lease Term, or to lease additional space shall be null and void. 19.04 Lessor may, within thirty (30) days after submission of Lessee's written request for Lessor's consent to a Transfer, cancel this Lease (or, as to a subletting or assignment, cancel as to the portion of the Premises proposed to be sublet or assigned) as of the date the proposed Transfer was to be effective. If Lessor cancels this Lease as to any portion of the Premises, then this Lease shall cease for such portion of the Premises, and Lessee shall pay to Lessor all Base Rent and other amounts accrued through the cancellation date relating to the portion of the Premises covered by the proposed Transfer and all brokerage commissions paid or payable by Lessor in connection with this Lease that are allocable to such portion of the Premises. Thereafter, Lessor may lease such portion of the Premises to the prospective transferee (or to any other person) without liability to Lessee. 19.05 If Lessor has not agreed in writing to a Transfer within thirty (30) days of Lessee's request hereunder, Lessor will be deemed to have rejected Lessee's request. 19.06 In no event shall Lessee mortgage, encumber, pledge or assign for security purposes all or any part of its interest in this Lease. 16 20. Default 20.01 Lessee's performance of each of Lessee's obligations under this Lease is a condition as well as a covenant. Lessee's right to continue in possession of the Premises is conditioned upon such performance. Time is of the essence in the performance of all covenants and conditions of Lessee. 20.02 Lessee will be in Default if any of the following events occurs: (a) Lessee fails to make any payment of Base Rent, Additional Rent, or any other monetary payment required to be made by Lessee herein and Lessee does not cure such failure within three (3) days after receipt of Lessor's written notice to Lessee. (b) Lessee fails to maintain, or to provide Lessor with proof of, insurance or performance or surety bond as required under this Lease. (c) Lessee violates any provision of Paragraph 14 or of Paragraph 19 above. (d) Lessee fails to ensure that life and property are not endangered, as determined by Lessor in its sole discretion. (e) Lessee vacates the Premises without the intention to reoccupy same, or abandons the Premises as further described in Paragraph 17. (f) Lessor discovers that any financial statement of Lessee or of any guarantor of this Lease given to Lessor was materially false. (g) Lessee makes any general arrangement or assignment for the benefit of creditors, becomes a "debtor" as defined in 11 U. S. Code Section 101 or any successor statute, has substantially all it assets located at the Premises or its interest in this Lease appointed to a receiver or trustee, indicates in Lessor's reasonable opinion an inability to pay its debts or obligations as they occur, has an attachment, or execution or other judicial seizure of substantially all of its assets located at the Property or its interest in this Lease. (h) Lessee fails to observe, perform or comply with any of the non-monetary terms, covenants, conditions, provisions or rules and regulations applicable to Lessee under this Lease other than as specified above in this Section 20.02; provided, if such failure (i) is not intentional on the part of Lessee, (ii) is not the type of failure as to which Lessor shall have previously given Lessee written notice, (iii) does not constitute a default or violation under any loan or other agreement to which Lessor is a party, and (iv) is, in the sole opinion of Lessor, a curable failure, then such failure shall not be a "Default" unless Lessee does not cure such failure within ten (10) days following written notice of such failure from Lessor; and provided, if Lessor shall allow such a ten (10) day cure period, the same may be extended by Lessor, for a maximum additional period of twenty (20) days, if (x) Lessee promptly commences cure within the ten (10) day period but is not reasonably able to complete cure within the ten (10) day period, and (y) prior to the expiration of the initial ten (10) day period, Lessee provides to Lessor a written request for extension accompanied by a report of its cure efforts to date and its plan to complete cure within the requested extended period. 21. Remedies of Lessor 21.01 If Lessee fails to perform any duty or obligation of Lessee under this Lease, Lessor may at its option, without waiver of Default nor any other right or remedy, perform any such duty or obligation on Lessee's behalf. The costs and expenses of any such performance by Lessor will be immediately due and payable by Lessee upon receipt from Lessor of the reimbursement amount required. 17 21.02 Upon a Default, with or without notice or demand, and without limiting any other of Lessor's rights or remedies, Lessor may: (a) Terminate this Lease and/or terminate Lessee's right to possession of the Premises. Upon any such termination, Lessee will immediately surrender possession of the Premises to Lessor. Lessor reserves all right and remedies available to it pursuant to the terms and conditions of this Lease as well as under state law (whether by terms of this Lease or otherwise). Lessee hereby grants Lessor the full and free right to enter the Premises with or without process of law. Lessee releases Lessor of any liability for any damage resulting therefrom and waives any right to claim damage for such re-entry. Lessee also agrees that Lessor's right to re-lease or any other right given to Lessor as a consequence of Lessee's Default hereunder or by operation of law is not relinquished. On such termination, Lessor will be entitled to recover from Lessee: (i) the worth at the time of the award of the unpaid rent which had been earned at the time of the termination; (ii) the worth at the time of the award of the amount by which the unpaid rents which would have been earned after termination until the time of award exceeds the amount of such rental loss that Lessee proves could have been avoided; (iii) the worth at the time of the award of the amount by which the unpaid rents for the balance of the Lease Term after the time of award exceeds the amount of such rental loss for such period that Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the damage proximately caused by Lessee's failure to perform its obligations under this Lease or which in the ordinary course of events would likely result therefrom, including but not limited to, all costs and expenses attributable to recovering possession of the Premises, reletting expenses (including the costs and expenses of any necessary repairs, renovations and alterations to the Premises), costs of carrying the Premises (including but not limited to, Lessor's payment of real property taxes and insurance premiums), actual legal fees and associated costs and expenses, the unamortized portion of all brokerage commissions paid in connection with this Lease and all costs of Lessor's Work (amortized without interest on a straight line basis over the initial Lease Term), and reimbursement of any deferred rent or other Lease execution inducement; or (b) Continue the Lease and Lessee's right to possession and recover rent as it becomes due. Acts of maintenance or preservation, efforts to relet the Premises, removal or storage of Lessee's personal property or the appointment of a receiver to protect Lessor's interest under this Lease, will not constitute a termination of Lessee's right to possession. Lessor agrees to make reasonable efforts to mitigate its damages provided however, Lessor shall not be required to relet any or all of the Premises prior to leasing other vacant space on the Project, nor shall Lessor be required to accept a tenant of lesser financial quality than Lessee was as of the commencement date of this Lease; and/or (c) Alter or change all the door locks to the Premises, without additional notice, and refuse access (without terminating Lessee's right of possession) until delinquent Rent has been paid in full; and (d) Pursue any other remedy now or hereafter available to Lessor under the laws or judicial decisions of the state wherein the Premises are located. 21.03 In the event of bankruptcy of Lessee, or if Lessee becomes a debtor as defined under the Bankruptcy Code, Lessee assigns to Lessor all its rights, title and interest in the Premises as security for its obligations under this Lease. The expiration or termination of this Lease, and/or the termination of Lessee's right to possession, will not relieve Lessee from any liability accruing during Lessee's Lease Term or by reason of Lessee's occupancy of the Premises. Any efforts by Lessor to mitigate the damages caused by Lessee's Default of this Lease will not waive Lessor's right to recover damages. 21.04 The "worth at the time of award" referred to in 21.02(a) (i) and 21.02(a) (ii) will additionally include interest computed by allowing interest at the maximum rate allowed by law. The "worth at the time of award" referred to in 21.02(a) (iii) will be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco in effect at the time of award, plus one percent (1%). 21.05 No right or remedy conferred upon or reserved to Lessor in this Lease is intended to be exclusive of any right or remedy granted to Lessor by statute or common law, and each and every such right and remedy will be cumulative. 22. Arbitration In the event any dispute arises under a provision of this Lease which specifically requires resolution by arbitration under this Section 22, then the parties agree that in lieu of judicial proceedings, the matter shall be submitted to arbitration in accordance with the rules of the American Arbitration Association, in a venue nearest to the location of the Premises. This agreement to arbitrate shall not, however, prohibit Lessor from exercising its statutory and/or common law rights to proceed against Lessee for injunctive relief, for possession of the Premises, and/or for damages, including but not limited to any action in the nature of unlawful detainer, ejectment, or any other similar summary proceeding. If the subject matter of the arbitration includes Operating Expense calculations, Lessee shall maintain as strictly confidential all information regarding the same. 23. Surrender of Lease Not Merger Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation of this Lease, or the termination of this Lease by Lessor due to a Default by Lessee, will not work as a merger, and will, at the option of Lessor, terminate all or any subleases of the Premises or operate as an assignment to Lessor of any or all such subleases; provided, (a) Lessor shall not be liable for nor obligated to correct any failures by Lessee to have performed any obligation under any such assigned sublease, nor (b) be obligated to credit any prepaid rent or to return any security deposit paid by the sublessee to Lessee. 18 24. Professional Fees, Costs and Expenses 24.01 In the event that any party to this Lease initiates an action or proceeding to enforce the terms of this Lease or to declare the rights of a party to this Lease, the prevailing party will be entitled to all actual costs and expenses, including but not limited to, all fees and costs and expenses of appraisers, experts, accountants and attorneys, which obligations shall be deemed to have accrued as of the commencement date of such action or proceeding; attorneys fees shall include all attorneys fees incurred at and in preparation for arbitration, trial, appeal and review, including deposition attorneys fees. This attorneys fee provision shall also apply to all litigation and other proceedings in Bankruptcy Court. Should Lessor be named as a defendant in any legal action or proceeding brought against Lessee in connection with, or arising out of, Lessee's occupancy within the Property, Lessee will pay to Lessor all of Lessor's actual costs and expenses incurred, including its legal fees. Attorneys' fees will not be computed in accordance with any court fee schedule, but will be the actual amount of any fees incurred. 24.02 If Lessor utilizes the services of any attorney with regard to Lessee's occupancy or tenancy under this Lease, Lessor will be entitled to reimbursement by Lessee of its legal fees, and all other costs and expenses, whether or not a legal action is commenced by Lessor. 25. Condemnation If any portion of the Premises or any portion of the Building in which the Premises is located, or any portion of the Property which would substantially interfere with Lessor's ownership, or Lessor's or Lessee's ability to conduct business is taken for any public or quasi-public purpose by any governmental authority, including but not limited to, by exercise of the right of appropriation, inverse condemnation, condemnation or eminent domain, or sold to prevent such taking, Lessor, at its option, may terminate this Lease without recourse by Lessee. Any award for such taking or payment made under such threat of exercise of such power will be the property of Lessor, whether such award be made as compensation for diminution of value of the leasehold or for the taking of the fee, or as severance damages; however, Lessee will be entitled to any compensation, separately awarded to Lessee for Lessee's relocation expenses. If this Lease is not terminated, Lessor will promptly proceed to restore the Premises and/or any portion of the Property used in common by all lessees to substantially the same condition as prior to such taking allowing for any reasonable effects of such taking. Should a partial taking directly affect a portion of Lessee's Premises and Lessor does not exercise its right to terminate this Lease, Lessor will make an appropriate allowance to Lessee for the rent corresponding to the term during which, and to the part of the Premises which, Lessee is deprived on account of such taking and restoration. 26. Rules and Regulations Lessee agrees to abide by, keep and observe all Rules and Regulations set forth in Exhibit "D" and all additions and amendments to the same of which Lessor provides written notice to Lessee. Lessor will not be responsible to Lessee for any nonperformance by any other lessee, occupant or invitee of the Property of any said Rules and Regulations. 27. Estoppel Certificate Lessee will execute and deliver, in a form prepared by Lessor, to Lessor within ten (10) business days after written receipt of notice from Lessor, a written statement certifying: (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification); (ii) the date to which rent and any other charges are paid in advance, if any; (iii) acknowledgment that there are not, to Lessee's knowledge, any uncured Defaults on the part of Lessor, or stating the nature of any uncured Defaults; (iv) the current Base Rent amount and the amount and form of the Security Deposit on deposit with Lessor; and (v) any other information as Lessor, Lessor's agents, mortgagees and prospective purchasers may reasonably request, including but not limited to, any requested information regarding Hazardous Materials. Lessee's failure to deliver such statement within ten (10) days of its receipt of such request will be deemed as Lessee's conclusive confirmation that: (1) this Lease (including specifically the Base Rent, Additional Rent and Lease Term) is in full force and effect and without modification except as may be represented by Lessor; (2) neither Lessor nor Lessee are in Default under the Lease; and (3) not more than one (1) month's rent charges, if any, are paid in advance. 28. Sale By Lessor Upon the sale or any other conveyance by Lessor of the Property, or any portion thereof, Lessor will be relieved of all liability under any and all of its covenants and obligations contained in or derived from this Lease or arising out of any act, encumbrance, occurrence or omission occurring after the date of such conveyance. 29. Notices All communications and notices required under this Lease shall be in writing and shall be addressed to the respective address of the receiving party set forth in Paragraph 1 above. All notices to Lessee shall be given by reputable overnight courier, U. S. mail (First Class, postage prepaid), or personal delivery, and shall be deemed received three (3) days after such mailing, one business day following delivery by Lessor to such an overnight courier, or upon personal delivery. Any notice to Lessee may also be given by posting at the Premises and shall be effective upon such posting. Notices to Lessor shall be sent to Lessor by U. S. mail, postage prepaid, registered or certified mail with return receipt requested to the address indicated in Paragraph 1.06 and shall be deemed received five (5) days after such mailing. At any time during the Lease Term, Lessor or Lessee may specify a different Notice Address by providing written notification to the other. 19 30. Waiver No waiver by Lessor of a Default by Lessee of any term, covenant or condition of this Lease by Lessee, will be deemed a waiver of any other term, covenant or condition of this Lease, or of any subsequent Default of Lessee of the same or any other term, covenant or condition of this Lease, nor will any delay or omission by Lessor to seek a remedy for any Lessee Default of this Lease be deemed a waiver by Lessor of its remedies or rights with respect to such Default. Additionally, regardless of Lessor's knowledge of a Default at the time of accepting rent, the acceptance of rent by Lessor whether on account of monies or damages due Lessor, or otherwise, will not constitute a waiver by Lessor of any Default by Lessee. 31. Lessee's Intent; Holdover Unless otherwise specified in this Lease, Lessee will give Lessor, not less than ninety (90) days prior to the expiration date of this Lease Term, written notice of its intent to remain or vacate the Premises on the expiration date of this Lease. If Lessee remains in possession of all or any part of the Premises with Lessor's written consent after the expiration of the Lease Term, such possession will constitute a month-to-month tenancy, which may be terminated by either Lessor or Lessee with thirty (30) days written notice and will not constitute a renewal or extension of the Lease Term. If Lessee remains in possession after the Lease Term without Lessor's written permission, such possession will constitute a tenancy-at-will terminable upon forty-eight (48) hour notice by either Lessee or Lessor and will not constitute a renewal or extension of the Lease Term. In the event of a month-to-month tenancy or tenancy-at-will, Lessee's Base Rent will be two hundred percent (200%) of the Base Rent payable during the last month of the Lease Term, and any other sums due under this Lease will be payable in the amounts and at the times specified in this Lease and all options, rights of refusal, expansions and/or renewals shall be null and void. Such tenancy will be subject to every other term, condition and covenant contained in this Lease. 32. Relocation of the Premises Lessor may, at any time during the Lease Term, relocate Lessee to substantially comparable space within the Project. Lessor will give Lessee a written notice of its intention to relocate the Premises and Lessee will complete such relocation within the thirty (30) days after receipt of such written notice. Lessor shall pay all reasonable costs and expenses of such relocation (excluding any Lessee owned telecommunication equipment, lines, boards and wiring which Lessee must bear the cost of relocating and installing), and the terms and conditions of the Lease will remain in full force and effect except for any actual adjustments in square footage, Base Rent, or Lessee's Proportionate Share that may result from such relocation. If the space to which Lessor proposes to relocate the Lessee are not substantially the same in configuration and finishout as those of the Premises, or if the Base Rent of the new space is not substantially the same as the prior Base Rent, Lessee may so notify Lessor, and if Lessor fails to offer space satisfactory to Lessee, Lessee may terminate this Lease effective as of the thirtieth (30th) day after Lessor's initial notice. 33. Default by Lessor; Limitation of Liability; Real Estate Investment Trust 33.01 In the event Lessor fails to perform any obligation required to be performed under this Lease, Lessee will notify Lessor in writing, pursuant to the provisions of Paragraph 29, of such failure at Lessor's Notice Address as specified in Paragraph 1.06, and Lessor shall not be deemed in Lessor Default hereunder unless and until such notice is received and Lessor fails within thirty (30) days of receipt of such notice to commence to make a good faith effort to cure the failure or thereafter ceases in a diligent and prudent manner to continue to pursue such cure to completion. 33.02 The obligations of Lessor under this Lease shall be binding only on Lessor and not upon any of the individual partners, investors, trustees, directors, officers, employees, agents, shareholders, advisors or managers of Lessor in their individual capacities, and with respect to any obligations of Lessor to Lessee, Lessee's sole and exclusive remedy shall be against Lessor. 33.03 In consideration of the benefits accruing hereunder, Lessee on behalf of itself and all of its Transferees covenants and agrees that, in the event of any actual or alleged Lessor Default of this Lease, Lessee's recourse against Lessor for any monetary damages will be limited to the lesser of Lessor's interest in the Property including, subject to the prior rights of any mortgagee, Lessor's interest in the rents of the Property, or Lessor's equity interest in the Property if the Property were encumbered by debt in an amount equal to eighty percent (80%) of its value of the Property as of the initial date Lessee notifies Lessor of the actual or alleged Default, and any insurance proceeds payable to Lessor. Any action by Lessee will be limited to actual damages only and will not, under any circumstances, include future profits or consequential damages. 33.04 If Lessor is a real estate investment trust, and if Lessor in good faith determines that its status as a real estate investment trust under the applicable provisions of the Internal Revenue Code of 1986, as heretofore or hereafter amended, will be jeopardized because of any provision of this Lease, Lessor may require reasonable amendments to this Lease and Lessee shall not unreasonably withhold or delay its consent thereto, provided that such modifications do not in any way, (i) increase the obligations of Lessee under this Lease or (ii) adversely affect any rights or benefits to Lessee under this Lease. Lessor shall pay all reasonable costs incurred by Lessee, including without limitation, legal fees incurred for reviewing any such proposed modifications. 20 33.05 Lessee represents that, to its knowledge, no person or entity who is a significant indirect owner of Lessor, owns actually or constructively a 10% or more interest in Lessee. Lessee will promptly notify Lessor if it learns that any such ownership interest exists. Significant owners of Lessor at this time include Public Storage, Inc. and New York Common Retirement Fund. 34. Subordination Without the necessity of any additional document being executed by Lessee for the purposes of effecting a subordination, and at the election of Lessor or any mortgagee or any ground lessor with respect to the land of which the Premises are a part, this Lease will be subject and subordinate at all times to: (i) all ground leases or underlying leases which may now exist or hereafter be executed affecting the Property and (ii) the lien of any mortgage or deed of trust which may now exist or hereafter be executed in any amount for which the Property, ground leases or underlying leases, or Lessor's interest or estate in any of said items is specified as security. Lessor or any mortgagee or ground lessor will have the right, at its election, to subordinate or cause to be subordinated any ground lessee or underlying leases or any such liens to this Lease. If Lessor's interest in the Premises is acquired by any ground lessor or mortgagee, or in the event any proceedings are brought for the foreclosure of, or in the event of exercise of power of sale under, any mortgage or deed of trust made by Lessor covering the Premises, or in the event a conveyance in lieu of foreclosure is made for any reason, Lessee will, notwithstanding any subordination and upon the request of such successor in interest to Lessor, attorn to and become the Lessee of the successor in interest to Lessor and recognize such successor in interest as the Lessor under this Lease. Lessee acknowledges that although this Paragraph 34 is self-executing, Lessee covenants and agrees to execute and deliver, upon demand by Lessor and in the form requested by Lessor, or any other mortgagee or ground lessor, any additional documents evidencing the priority or subordination of this Lease with respect to any such ground leases or underlying leases or the lien of any such mortgage or deed of trust. 35. Force Majeure Lessor will not be deemed in Lessor Default or have liability to Lessee, nor will Lessee have any right to terminate this Lease or abate rent or assert a claim of partial or constructive eviction, because of Lessor's failure to perform any of its obligations under this Lease if the failure is due in part or in full to reasons beyond Lessor's reasonable control. Such reasons will include but not be limited to: strike, other labor trouble, fuel, labor or supply shortages, utility failure or defect, the inability to obtain any necessary governmental permit or approval (including building permits and certificates of occupancy), war, riot, mandatory or prohibitive injunction issued in connection with the enforcement of the Americans with Disabilities Act of 1990, civil insurrection, accidents, acts of God, any governmental preemption in connection with a national emergency or any other cause, whether similar or dissimilar, which is beyond the reasonable control of Lessor. If this Lease specifies a time period for performance of an obligation by Lessor, that time period will be extended by the period of any delay in Lessor's performance caused by such events as described herein. 36. Miscellaneous Provisions 36.01 Whenever the context of this Lease requires, the neuter, the masculine and the feminine gender shall include the other, and the word person shall include partnership or corporation or joint venture, and the singular shall include the plural and the plural shall include the singular. 36.02 If more than one person or entity is Lessee, the obligations imposed on each such person or entity will be joint and several. 36.03 The captions and headings of this Lease are used for the purpose of convenience only and shall not be construed to interpret, limit or extend the meaning of any part of this Lease. 36.04 This Lease contains all of the agreements and conditions made between Lessor and Lessee and may not be modified in any manner other than by a written agreement signed by both Lessor and Lessee. Any statements, promises, agreements, warranties or representations, whether oral or written, not expressly contained herein will in no way bind either Lessor or Lessee, and Lessor and Lessee expressly waive all claims for damages by reason of any statements, promises, agreements, warranties or representations, if any, not contained in this Lease. No provision of this Lease shall be deemed to have been waived by Lessor unless such waiver is in writing signed by a regional vice president or higher of Lessor or the management company, and no custom or practice which may develop between the parties during the Lease Term shall waive or diminish the Lessor's right to enforce strict performance by Lessee of any terms of the Lease. 36.05 Time is of the essence for the performance of each term, condition and covenant of this Lease. 36.06 Except as otherwise expressly noted, each payment required to be made by Lessee is in addition to and not in substitution for other payments to be made by Lessee. 21 36.07 Subject to Paragraph 19, the terms, conditions and provisions of this Lease will apply to and bind the heirs, successors, executors, administrators and assigns of Lessor and Lessee. 36.08 If any provision contained herein is determined to be invalid, illegal or unenforceable in any respect, such invalidity, illegality, or unenforceability will not affect any other provision of this Lease. 36.09 In consideration of Lessor's covenants and agreements hereunder, Lessee hereby agrees not to disclose any terms, covenants or conditions of this Lease to any non-related party other than its officers, directors, attorneys or accountants without the prior written consent of Lessor. Additionally, Lessee shall not record this Lease or any short form memorandum hereof without the prior written consent of Lessor, which Lessor may withhold in its sole discretion. 36.10 The rights and obligations of the parties under this Lease shall survive the expiration of this Lease and the termination of this Lease and/or of Lessee's right of possession. 36.11 The duties and warranties of Lessor are limited to those expressly stated in this Lease and does not and shall not include any implied duties or implied warranties, now or in the future. No representations or warranties have been made by Lessor other than those contained in this Lease. 36.12 Lessee promises and it is a condition to the continuance of this Lease that there will be no discrimination against or segregation of any person or group of persons on the basis of race, color, sex, creed, national origin or ancestry in the leasing, subleasing, transferring occupancy, tenure, or use of the Property, the Premises, or any portion thereof. 36.13 Lessor and Lessee each warrant to the other that it has not dealt with any broker or agent in connection with this Lease, other than the person(s) listed in Paragraph 1.15 above. Except for any broker(s) who shall be compensated in accordance with the provisions of a separate agreement, Lessor and Lessee each agree to indemnify the other against all costs, expenses, legal fees and other liability for commissions or other compensation claimed by any other broker or agent. 36.14 Lessee shall not permit or allow any activity in the Premises which will have an adverse effect on indoor air quality, including smoking and any remodeling activity or introduction of materials which would have such an effect. Lessor shall have the right, but not the obligation, to monitor indoor air quality within the Project. Lessee shall take such steps to protect and to improve indoor air quality as Lessor may request from time to time. Lessee acknowledges that construction (either initial construction or remodeling) by Lessor in the Premises or elsewhere in the Project, and other operations in the Project, may involve processes or materials which have adverse effects on indoor air quality; accordingly, Lessee (1) shall follow directives of Lessor and its agents related to ventilation, occupancy of the Premises, and other steps related to indoor air quality, and (2) hereby waives any claims related to such effects, including claims for damages, breach of quiet enjoyment, and/or constructive eviction. 36.15 Lessee specifically acknowledges that Lessor has no duty to provide security for any portion of the Project, including, without limitation, the Premises or the common areas, and Lessee has assumed sole responsibility and liability for the security of itself, its employees, customers and invitees and their respective property in, on or about the Project. Notwithstanding anything herein to the contrary, Lessee expressly acknowledges and agrees that to the extent Lessor elects to provide any security, Lessor is not warranting the effectiveness of any such security personnel, services, procedures or equipment and that Lessee is not relying and shall not hereafter rely on any such personnel, services, procedures or equipment. Lessor shall not be responsible or liable in any manner for failure of any such security personnel, services, procedures or equipment to prevent or control, or to apprehend anyone suspected of, personal injury or property damage in, on or around the Project. 36.16 The grant of any consent or approval required from Lessor under this Lease shall be proved only if granted in writing. Unless otherwise specified herein, any such consent or approval may be withheld in Lessor's sole discretion. Any consent may be issued subject to conditions determined by Lessor, in its sole discretion. As a condition to any consent, and without limiting the right of Lessor to impose other conditions, Lessor may require that any other party or parties with a right of consent issue such consent on terms acceptable to Lessor. Notwithstanding any other provision of this Lease, the sole and exclusive remedy of Lessee for any alleged or actual improper withholding, delaying or conditioning of any consent or approval by Lessor shall be the right to specifically enforce any right of Lessee to require issuance of such consent or approval on conditions allowed by this Lease; in no event shall Lessee have the right to terminate this Lease, to collect monetary damages, or to pursue any other remedy for any actual or alleged improper withholding, delaying or conditioning of any consent or approval, regardless of whether this Lease requires that such consent or approval not be unreasonably withheld, conditioned or delayed. 37. Examination of Lease; Good Faith Deposits Submission of this document for examination and signature by Lessee does not create a reservation or option to lease. Lessee hereby agrees that Lessor will be entitled to immediately endorse and cash any good faith check(s) forwarded by Lessee along with this document. It is further agreed that such cashing of good faith checks by Lessor will not guarantee acceptance of this document by Lessor, but, in the event Lessor does not accept or execute this document, the amount of such good faith check(s) will be refunded to Lessee. This document will become this "Lease" and be effective and binding only upon full execution by authorized representatives of both Lessee and Lessor as defined in this Lease. Thereafter, a fully executed copy of this Lease will be deemed an original for all purposes. 22 38. Governing Law This Lease is governed by and construed in accordance with the laws of the state in which the Premises are located, and venue of any legal action will be in the county where the Premises are located. 39. Lessor's Lien LESSOR HEREUNDER WILL HAVE THE BENEFIT OF, AND THE RIGHT TO, ANY AND ALL LESSOR'S LIENS PROVIDED UNDER THE LAW BY WHICH THIS LEASE IS GOVERNED. Lessor reserves (and is hereby granted) a first and superior lien and security interest (which shall be in addition to and not in lieu of the statutory Lessor's lien) on all fixtures, equipment, and personal property (tangible and intangible) not leased or financed now or hereinafter placed by Lessee in or on the Premises to secure all sums due by Lessee hereunder, which lien and security interest may be enforced by Lessor in any manner provided by law, including, without limitation, under and in accordance with the Texas Uniform Commercial Code. The provisions of this Section shall constitute a security agreement under the Texas Uniform Commercial Code, and Lessor may file, where appropriate and at Lessee's expense, all documents, including Financing Statements, required to perfect the security interest herein granted in accordance with the Texas Uniform Commercial Code. Unless otherwise provided by law and for the purpose of exercising any right pursuant to this Section, Lessor and Lessee agree that reasonable notice shall be met if such notice is given by five days' written notice, certified mail, return receipt requested, to Lessee by Lessor at the address specified herein. Any fixtures, equipment and personal property belonging to Lessee left in or about the Premises upon abandonment or vacation of the Premises, or expiration or termination of the Term of this Lease, or dispossession by process of law, or otherwise, will, at the option of Lessor, be deemed abandoned and may be used or disposed of by Lessor without liability to Lessee. 40. Special Provisions and Exhibits Special provisions of this Lease number 41 through 42 are attached hereto and made a part hereof. The following Exhibits are attached to this Lease and by this reference made a part hereof: "A-1," "A-2," "A-3," "B," "C," and "D." 23 IN WITNESS WHEREOF, Lessor and Lessee have executed this Lease as of the day and year indicated by Lessor's execution date as written below. If Lessee is a corporation, each person signing this Lease on behalf of Lessee represents and warrants that he or she has full authority to do so and that this Lease binds the corporation. Prior to the execution of this Lease, Lessee shall deliver to Lessor a certified copy of a resolution of Lessee's Board of Directors authorizing the execution of this Lease or other evidence of such authority reasonably acceptable to Lessor. If Lessee is a partnership or limited liability company, each person or entity signing this Lease for Lessee represents and warrants that he, she or it is a general partner of the partnership or limited liability company, as applicable. Lessee shall give written notice to Lessor of any general partner's or member's withdrawal or addition. Simultaneous with the delivery of Lessee's signed lease, Lessee shall deliver to Lessor a copy of Lessee's recorded statement of partnership or certificate of limited partnership or articles of organization, as applicable. THIS LEASE, WHETHER OR NOT EXECUTED BY LESSEE, IS SUBJECT TO ACCEPTANCE BY LESSOR, ACTING BY ITSELF OR BY ITS AGENT BY THE SIGNATURE ON THIS LEASE OF ITS SENIOR VICE PRESIDENT, VICE PRESIDENT, REGIONAL MANAGER OR DIRECTOR OF LEASING. LESSOR: LESSEE: TPLP Office Park Properties Integrated Security Systems, Inc. --------------------------------------- -------------------------------------- By: American Office Park Properties TPGP, a California Corporation doing business in Texas as TPGP Office Park Properties, Inc., General Partner By: /S/ Angelique Benschneider By: /S/ Richard Powell --------------------------------------- -------------------------------------- Richard Powell, Vice President, Chief Angelique Benschneider, Vice President Accounting Officer -------------------------------------- -------------------------------------- AUTHORIZED SIGNATURE / TITLE AUTHORIZED SIGNATURE / TITLE Federal Tax ID#: 95-4613916 Lessee's Information: tax id no. 17524229832 -------------------- organizational no. 000948106 ------------ state of organization Texas ---------
24 EX-21 6 exhibit21-1sb2021505.txt EXHIBIT 21.1 SUBSIDIARIES Exhibit 21.1 SUBSIDIARIES OF THE COMPANY B&B ARMR Corporation DoorTek Corporation Intelli-Site, Inc. EX-23 7 exhibit23-1sb2021505.txt EXHIBIT 23.1 CONSENT OF GRANT THORNTON LLP Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued our report dated September 24, 2004, accompanying the consolidated financial statements of Integrated Security Systems, Inc. contained in the Registration Statement and Prospectus. We consent to the use of the aforementioned reports in the Registration Statement and Prospectus, and to the use of our name as it appears under the captions "Current Status," "Management's Discussion and Analysis or Plan of Operation - General," "Changes in Registrant's Certifying Accountant," and "Experts." /s/ GRANT THORNTON LLP Dallas, Texas February 15, 2005 -----END PRIVACY-ENHANCED MESSAGE-----