10QSB 1 form10qsb033105.txt INTEGRATED SECURITY SYSTEMS, INC. 10QSB UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________ Form 10-QSB _______________ |X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2005. | | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________. Commission file number 1-11900 Integrated Security Systems, Inc. ----------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) Delaware 75-2422983 ------------------------ --------------------------------- (State of incorporation) (IRS Employer Identification No.) 8200 Springwood Drive, Suite 230, Irving, Texas 75063 ----------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (972) 444-8280 --------------------------- (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of April 30, 2005, 85,496,120 shares of the Registrant's common stock were outstanding. Transitional Small Business Disclosure Format: Yes [ ] No [X] INTEGRATED SECURITY SYSTEMS, INC. INDEX Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets at March 31, 2005 (unaudited) and June 30, 2004 3 Consolidated Statements of Operations (unaudited) for the three and nine months ended March 31, 2005 and 2004 4 Consolidated Statements of Cash Flows (unaudited) for the nine months ended March 31, 2005 and 2004 5 Notes to Financial Statements 6 Item 2. Management's Discussion and Analysis or Plan of Operation 12 Item 3. Controls and Procedures 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16 Item 3. Defaults Upon Senior Securities 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Item 5. Other Information 16 Item 6. Exhibits 16 SIGNATURES 17 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements.
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Balance Sheets March 31, June 30, 2005 2004 ------------ ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 604,758 $ 172,688 Accounts receivable, net of allowance for doubtful accounts of $100,007 and $109,527, respectively 3,180,877 1,904,285 Inventories 2,029,705 1,272,532 Other current assets 97,184 75,020 ------------ ------------ Total current assets 5,912,524 3,424,525 Property and equipment, net 678,626 681,168 Goodwill 3,761,194 3,547,162 Other assets 455,767 59,956 ------------ ------------ Total assets $ 10,808,111 $ 7,712,811 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable $ 2,428,978 $ 2,029,963 Accrued liabilities 599,990 708,610 Current portion of long-term debt 4,289,313 1,845,949 ------------ ------------ Total current liabilities $ 7,318,849 $ 4,584,522 ------------ ------------ Long-term debt 5,116,264 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; 85,496,120 and 84,298,984 shares issued, respectively 854,961 842,990 Additional paid in capital 32,083,661 31,627,086 Accumulated deficit (34,447,314) (32,180,386) Treasury stock, at cost - 50,000 common shares (118,750) (118,750) ------------ ------------ Total stockholders' equity (deficit) (1,627,002) 171,948 ------------ ------------ Total liabilities and stockholders' equity (deficit) $ 10,808,111 $ 7,712,811 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 3
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Statements of Operations (Unaudited) For the Three Months Ended For the Nine Months Ended March 31, March 31, ---------------------------- ---------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Sales $ 3,534,718 $ 2,779,102 $ 10,065,562 $ 7,866,881 Cost of sales 2,767,775 1,885,019 7,334,115 5,233,121 ------------ ------------ ------------ ------------ Gross margin 766,943 894,083 2,731,447 2,633,760 ------------ ------------ ------------ ------------ Operating expenses: Selling, general and administrative 1,561,207 1,353,553 4,022,734 3,025,194 Research and product development 124,288 138,193 376,027 463,986 ------------ ------------ ------------ ------------ 1,685,495 1,491,746 4,398,761 3,489,180 ------------ ------------ ------------ ------------ Loss from operations (918,552) (597,663) (1,667,314) (855,420) Interest expense (236,752) (420,847) (599,604) (1,085,122) ------------ ------------ ------------ ------------ Net loss (1,155,304) (1,018,510) (2,266,918) (1,940,542) Preferred dividends (40,500) (40,950) (123,300) (123,750) ------------ ------------ ------------ ------------ Net loss allocable to common stockholders $ (1,195,804) $ (1,059,460) $ (2,390,218) $ (2,064,292) ============ ============ ============ ============ Weighted average common shares outstanding - basic and diluted 85,308,916 74,440,513 84,752,964 59,511,069 ============ ============ ============ ============ Net loss per share - basic and diluted $ (0.01) $ (0.01) $ (0.03) $ (0.03) ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 4
INTEGRATED SECURITY SYSTEMS, INC. Consolidated Statements of Cash Flows (Unaudited) For the Nine Months Ended March 31, -------------------------- 2005 2004 ----------- ----------- Cash flows from operating activities: Net loss $(2,266,918) $(1,940,542) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation 154,725 142,399 Amortization 44,364 -- Provision for bad debt 4,749 39,500 Provision for warranty reserve 250,000 105,000 Provision for inventory reserve -- 1,000 Amortization of debt discount -- 578,627 Expenses paid with stock, warrants and options 362,940 249,834 Changes in operating assets and liabilities, net of effects of acquisition: Accounts receivable (1,140,176) (739,125) Inventories (633,411) (198,586) Other assets (462,339) 16,228 Accounts payable 339,330 588,623 Accrued liabilities (359,753) 240,113 ----------- ----------- Net cash used in operating activities (3,706,489) (916,929) ----------- ----------- Cash flows from investing activities: Purchase of property and equipment (152,186) (193,102) Purchase of business, net of cash acquired (302,231) (737,130) ----------- ----------- Net cash used in investing activities (454,417) (930,232) ----------- ----------- Cash flows from financing activities: Employee stock option exercise 18,750 48,125 Warrant exercise -- 120,000 Payments on debt and other liabilities (198,061) (411,838) Proceeds from notes payable and long-term debt 4,772,287 2,003,077 ----------- ----------- Net cash provided by financing activities 4,592,976 1,759,364 ----------- ----------- Increase (decrease) in cash and cash equivalents 432,070 (87,797) Cash and cash equivalents at beginning of period 172,688 177,078 ----------- ----------- Cash and cash equivalents at end of period $ 604,758 $ 89,281 =========== =========== Supplemental disclosure of noncash financing activities Conversion preferred stock -- $ 7,495,052 Issuance of company common stock in payment of preferred stock dividends -- $ 1,094,680
The accompanying notes are an integral part of the consolidated financial statements. 5 INTEGRATED SECURITY SYSTEMS, INC. Notes to Consolidated Financial Statements (Unaudited) Nine Months Ended March 31, 2005 and 2004 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 ("FASB") 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 fiscal years beginning after December 15, 2005 and the Company will begin recognizing option expense July 1, 2006. 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 Nine Months Ended March 31, March 31, -------------------------- -------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- Net loss, as reported $(1,155,304) $(1,018,510) $(2,266,918) $(1,940,542) Deduct: Total stock-based employee compensation expense determined under fair value based method (94,697) (60,015) (284,091) (395,629) ----------- ----------- ----------- ----------- Pro forma net loss $(1,250,001) $(1,078,525) $(2,551,009) $(2,336,171) =========== =========== =========== =========== Earnings per share: Basic and Diluted-as reported $ (0.01) $ (0.01) $ (0.03) $ (0.03) =========== =========== =========== =========== Basic and Diluted-pro forma $ (0.01) $ (0.01) $ (0.03) $ (0.03) =========== =========== =========== ===========
6 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 2005 and 2004, respectively: no dividend yield, expected lives of three and five years with expected volatility and risk-free interest rates as outlined in the following table: For the Three Months Ended For the Nine Months Ended March 31, March 31, -------------------------- -------------------------- 2005 2004 2005 2004 ----------- ----------- ----------- ----------- Expected volatility 107.55% 108.04% 107.78% 108.28% Risk-free interest rate 3.70% 3.20% 3.42% 3.29%
Note 3 - Reclassification 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. March 31, -------------------------- 2005 2004 ----------- ----------- Accounts receivable: Trade receivables $ 3,280,884 $ 2,451,020 Less: allowance for doubtful receivables (100,007) (117,814) ----------- ----------- $ 3,180,877 $ 2,333,206 =========== =========== Allowance for doubtful receivables: Beginning Balance $ 109,527 $ 64,183 Bad debt expense 2,249 39,500 Accounts written-off (11,769) (39,430) ARMR Services Corporation merger -- 53,561 ----------- ----------- Ending Balance $ 100,007 $ 117,814 =========== =========== 7 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: March 31, ---------------------- 2005 2004 --------- --------- Liability, beginning of year $ 94,157 $ 135,471 Expense for new warranties issued 250,000 105,000 Warranty Claims (327,570) (118,346) --------- --------- Liability, end of period $ 16,587 $ 122,125 ========= ========= Note 6 - Preferred Stock Dividend Arrearage At March 31, 2005, the Company had dividends in arrears in the amount of $369,413 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 91,250 369,413 ----------- ----------- 100,750 $ 369,413 =========== =========== Note 7 - Net Loss Per Share The Company computes basic loss per common share using the weighted average number of common shares. At March 31, 2005 and 2004, there were 5,310,955 and 15,798,721 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 March 31, 2005 and 2004, the Company had approximately 111,457,616 and 98,457,978 shares, respectively, of common stock and common stock equivalents outstanding, which comprises all of the Company's outstanding equity instruments. 8 Note 8 - Subsequent Event Financing In exchange for an aggregate of $525,000 cash investment received on May 6, 2005, Integrated Security Systems, Inc. issued a promissory note to each of Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. Frost National Bank FBO Renaissance US Growth Investment Trust PLC and Frost National Bank FBO BFS US Special Opportunities Trust PLC on May 5, 2005. Each of the three promissory notes is in the original principal amount of $175,000 and has an annual interest rate of 8%. The promissory notes, plus interest, are due on November 11, 2007. Interest is payable in monthly installments on the first day of each month. As a part of this transaction, on May 5, 2005, Integrated Security Systems, Inc. issued a stock purchase warrant to each of Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. Frost National Bank FBO Renaissance US Growth Investment Trust PLC and Frost National Bank BFO BFS US Special Opportunities Trust PLC. Each of the three stock purchase warrants entitles the Renaissance entities to purchase from the Company 514,706 fully paid and non-assessable shares of Common Stock, $0.01 par value, of the Company for $0.34 per share. In exchange for an aggregate of $200,000 cash investment received on May 6, 2005, Integrated Security Systems, Inc. issued a promissory note to C. A. Rundell, Jr., Chairman and Chief Executive Officer of the Company, on May 4, 2005. The promissory note is in the original principal amount of $200,000 and has an annual interest rate of 8%. The promissory note, plus interest, is due on November 11, 2007. Interest is payable in monthly installments on the first day of each month. As a part of this transaction, on May 4, 2005 Integrated Security Systems, Inc. issued a stock purchase warrant to C. A. Rundell, Jr., Chairman and Chief Executive Officer of the Company. The stock purchase warrant entitles Mr. Rundell to purchase from the Company 588,235 fully paid and non-assessable shares of Common Stock, $0.01 par value, of the Company for $0.34 per share. 9 Note 9 - Debt As of March 31, 2005, 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................................. 1,415,294 -- 1,415,294 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, 2006........................ 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................... 76,091 408,758 484,849 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 notes at $0.60 per share (based on certain restrictions)............................... -- 4,118,000 4,118,000 Other....................................... 67,928 89,506 157,434 ---------- ---------- ---------- $4,289,313 $5,116,264 $9,405,577 ========== ========== ==========
Note 10 - Joint Venture Agreement On March 4, 2005, the Company entered into a joint venture agreement with Causey Lyon Enterprises, Inc. d/b/a Roadway Manufacturing ("CLE") in order to consolidate the two companies' core competencies in the city, state, and federal road & bridge market. Going forward, the joint venture entity ("B&B Roadway") will administrate, sell, manufacture and distribute all products relating to only the road and bridge industry, including product lines specifically designed for that market. B&B Roadway is 65% owned by B&B ARMR Corporation ("B&B ARMR"), a wholly owned subsidiary of the Company, and 35% owned by CLE. CLE provides manufacturing services and general sales & administration management to the joint venture and is the general manager of the day-to-day operations. The joint venture was primarily funded by a $100,000 line of credit from B&B ARMR at 6% interest with a repayment term of approximately 18 months. In addition, a $400,000 line of credit is available to B&B Roadway from a third party asset based lender on a secured basis. The $100,000 credit facility is subordinate to the Company's third party asset based lender's credit facility. 10 Both B&B ARMR and CLE contributed all outstanding orders not currently in production, intellectual property, patterns, molds, designs, and equipment to the joint venture. All existing orders that were currently in production or substantially underway in the manufacturing process on the effective date of the joint venture agreement will be produced independently by B&B ARMR and CLE and these transactions will be recoded on the respective books of those entities. B&B ARMR agreed to sell all remaining road and bridge related inventory to CLE as part of the joint venture transaction which will be completed in the fourth quarter of 2005. This inventory sale will be evidenced by a promissory note from CLE to the B&B ARMR at an interest rate of 6% with a repayment schedule of approximately 18 months after the inventory transfer has been completed. Note 11 - 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 of DoorTek 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 and to 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 27,000 ---------------- Purchase price $ 231,000 ================ 11 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. For the Three Months Ended For the Nine Months Ended March 31, March 31, -------------------------- ---------------------------- 2004 2005 2004 -------------------------- ------------ ------------ Sales $ 2,933,802 $ 10,490,526 $ 8,334,749 Net loss allocable to common stockholders $ (1,047,445) $ (2,237,923) $ (2,076,798) Net loss per share allocable To common stockholders, basic and diluted $ (0.01) $ (0.03) $ (0.03) Weighted average shares outstanding, basic and diluted 74,669,085 84,981,536 59,739,641
Note 12 - Business Segments Information for the Company's reportable segments for the three and nine months ended March 31, 2005 and 2004 is as follows: For the Three Months Ended For the Nine Months Ended March 31, March 31, ---------------------------- ---------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Sales B&B ARMR Corporation $ 3,237,079 $ 2,730,605 $ 9,360,130 $ 7,652,138 B&B Roadway (1) 11,530 -- 11,530 -- Intelli-Site, Inc. 97,657 48,497 473,996 214,743 DoorTek Corporation (1) 188,452 -- 219,906 -- ------------ ------------ ------------ ------------ $ 3,534,718 $ 2,779,102 $ 10,065,562 $ 7,866,881 ============ ============ ============ ============ Income (loss) from operations B&B ARMR Corporation $ (572,617) $ (463,484) $ (1,165,815) $ (307,793) B&B Roadway (1) (1,055) -- (1,055) -- Intelli-Site, Inc. (74,260) (107,205) (109,718) (291,232) DoorTek Corporation (1) 2,415 -- 3,425 -- Corporate (273,035) (26,974) (394,151) (256,395) ------------ ------------ ------------ ------------ $ (918,552) $ (597,663) $ (1,667,314) $ (855,420) ============ ============ ============ ============
(1) Includes only data since acquisition or formation date. 12 Item 2. Management's Discussion and Analysis or Plan of Operation. Forward Looking Statements This quarterly report on Form 10-QSB includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can be identified by the use of forward-looking terminology such as "may," "believe," "expect," "intend," "plan," "seek," "anticipate," "estimate," or "continue" or the negative of those words or other variations or comparable terminology. All statements other than statements of historical fact included in this quarterly report on Form 10-QSB, including the statements under "Part I. --Item 2. Management's Discussion and Analysis or Plan of Operation" and located elsewhere in this quarterly report on Form 10-QSB regarding the financial position and liquidity of the Company are forward-looking statements. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors regarding forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from the Company's expectations, are disclosed in this quarterly report on Form 10-QSB. The Company does not undertake any obligation to publicly revise its forward-looking statements to reflect events or circumstances that arise after the date of this quarterly report on Form 10-QSB. Important factors that could cause actual results to differ materially from those in the forward-looking statements in this quarterly report on Form 10-QSB include changes from anticipated levels of operations, customer acceptance of existing and new products, anticipated development schedules of new products, anticipated levels of sales, future national or regional economic and competitive conditions, changes in relationships with customers, access to capital, casualty to or other disruption of the Company's production facility and equipment, delays and disruptions in the shipment of the Company's products, government regulations and the ability of the Company to meet its stated business goals. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the Company's cautionary statements. Results of Operations Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 Sales. The Company's total sales increased by $0.8 million, or 28%, to $3.6 million during the quarter ended March 31, 2005 from $2.8 million during the quarter ended March 31, 2004. This increase is due to overall increased sales levels at the Company's B&B ARMR Corporation subsidiary ("B&B ARMR") and the inclusion of the sales of DoorTek Corporation ("DoorTek"), as a result of the acquisition of DoorTek on December 16, 2004. Gross Margin. Gross margin decreased by $0.1 million, or 14%, to $0.8 million during the quarter ended March 31, 2005 from $0.9 million during the quarter ended March 31, 2004. This decrease is due to a less favorable product mix and cost overruns on a specific customer order at B&B ARMR, but was partially offset by the inclusion of DoorTek. Selling, General and Administrative. Selling, general and administrative expenses increased by approximately $0.2 or 16% during the quarter ended March 31, 2005 compared to the quarter ended March 31, 2004. This increase is primarily due to increase in the professional staffing levels at B&B ARMR, the inclusion of DoorTek, and administrative expenses incurred at the corporate level related to the registration statement filing on April 8, 2005. 13 Research and Product Development. Research and product development expenses were comparable, with a slight decrease of approximately $14,000 or 10% during the quarter ended March 31, 2005 compared to the quarter ended March 31, 2004. Interest Expense. Interest expense decreased by approximately $200,000 during the quarter ended March 31, 2005 compared to the quarter ended March 31, 2004. This decrease is due primarily to approximately $300,000 in amortization of the value of warrants issued in conjunction with securing additional debt and the interest on debt that was obtained to meet working capital needs, coupled with additional debt financing subsequent to the quarter ending March 31, 2004. This decrease was offset by an increase of approximately $100,000 in additional interest expense related to the Company's placement of convertible promissory notes issued in November 2004. Nine Months Ended March 31, 2005 Compared to Nine Months Ended March 31, 2004 Sales. The Company's total sales increased by $2.2 million, or 28%, to $10.0 million during the nine months ended March 31, 2005 from $7.8 million during the nine months ended March 31, 2004. This increase is due to overall increased sales levels at both the Company's B&B ARMR and Intelli-Site subsidiaries, coupled with the inclusion of the sales of DoorTek, as a result of the acquisition of DoorTek on December 16, 2004. Gross Margin. Gross margin increased by $0.1 million, or 4%, to $2.7 million during the nine months ended March 31, 2005 from $2.6 million during the nine months ended March 31, 2004. This increase is primarily due to the increased sales volume at Intelli-Site, which yields a higher gross margin contribution, in addition to the inclusion of DoorTek. This increase was offset by the less favorable product mix and cost overruns on a specific customer order at B&B ARMR. Selling, General and Administrative. Selling, general and administrative expenses increased by approximately $1.0 million or 33% during the nine months ended March 31, 2005 compared to the nine months ended March 31, 2004. This increase is due to increased professional staffing levels at B&B ARMR, the inclusion of DoorTek, and administrative expenses incurred at the corporate level related to the registration statement filing on April 8, 2005. Research and Product Development. Research and product development expenses decreased by approximately $90,000 or 19% during the nine months ended March 31, 2005 compared to the nine months ended March 31, 2004. This decrease is primarily due to a reduction in research and product development expenditures Company-wide, which the Company expects will continue at these lower levels through the remainder of fiscal 2005. Interest Expense. Interest expense decreased by approximately $485,000 during the nine months ended March 31, 2005 compared to the nine months ended March 31, 2004 due to approximately $725,000 in amortization of the value of warrants issued in conjunction with securing additional debt and the interest on debt that was obtained to meet working capital needs, coupled with additional debt financing subsequent to the nine months ended March 31, 2004. This decrease was offset by approximately $240,000 in additional interest expense related to the Company's placement of convertible promissory notes issued in November 2004. Liquidity and Capital Resources The Company's cash position increased by $432,070 during the nine months ended March 31, 2005. At March 31, 2005, the Company had $604,758 in cash and cash equivalents and had approximately $1.4 million outstanding under its asset based lending facility. This asset based lending facility, which is secured by accounts receivable and inventory, permits the Company to borrow up to a combined $3.0 million, subject to availability under its borrowing base. 14 For the nine months ended March 31, 2005, the Company's operating activities used $3,706,489 of cash compared to $916,929 of cash used in operations during the nine months ended March 31, 2004. The Company used $152,186 for the purchase of property and equipment during the nine months ended March 31, 2005, compared to $193,102 for the nine months ended March 31, 2004. In addition, the Company used cash of $302,231 during the nine months ended March 31, 2005, consisting of $184,000 related to earn-out agreements executed as a part of the B&B ARMR merger transaction and $118,000 related to the purchase of DoorTek Corporation. During the nine months ended March 31, 2005, the Company financed its operations with cash flows from borrowings of $4,772,287 compared to $2,003,077 during the nine months ended March 31, 2004. The borrowings from the first nine months of fiscal 2004 consisted of an additional $4.2 million from the issuance of subordinated 10% convertible promissory notes. The Company also borrowed an additional $0.5 million under the Company's asset based lending facility. The Company made payments of $198,061 on debt and other liabilities during the nine months ended March 31, 2005, compared to payments of $411,838 on debt and other liabilities during the nine months ended March 31, 2004. Principal payments required under long-term debt outstanding at March 31, 2005 are as follows: Year Ending June 30, ------------------------ 2005 $ 1,510,956 2006 3,223,098 2007 31,418 2008 13,935 2009 4,626,170 ----------- $ 9,405,577 The principal payments required for fiscal year 2005 consist of $1,415,294 under the Company's asset based lending facility which is a demand note and will expire on November 10, 2007 (see Note 9 - Debt). The Company does not anticipate full repayment of this facility during fiscal 2005. The cash that the Company received from the placement of $4.2 million in subordinated 10% convertible promissory notes in November, 2004 and the availability under its asset based lending facility will be utilized to support Company-wide operations. The Company's working capital requirements will depend upon many factors, including future sales of the Company's products, the Company's operating results, the status of competitive products, and actual profits compared to the Company's business plan. The Company is currently experiencing declining liquidity, which makes it difficult for the Company to meet its current cash requirements and may jeopardize the Company's ability to continue as a going concern. The Company's former auditor issued a going concern modification in their auditors' report for our year ended June 30, 2004. The Company intends to address its liquidity problems by controlling costs, seeking additional funding and maintaining focus on revenues and collections. At the present time and in the foreseeable future, the Company will need to obtain additional financing either through equity placement or additional debt. There can be no assurance that the Company will be able to secure such financing. If the Company's liquidity does not improve by the end of fiscal 2005, it may have to seek a merger partner, limit its operations or seek protection under the federal bankruptcy laws. Any of the foregoing options may be on terms that are unfavorable to the Company or disadvantageous to the Company's stockholders. The Company's backlog is calculated as the aggregate sales prices of firm orders received from customers less revenue recognized. At April 30, 2005, the Company's backlog was approximately $6.0 million. The Company expects that it will fill the majority of this backlog by June 30, 2006. 15 Item 3. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures. Based on his evaluation as of the end of the period covered by this Quarterly Report on Form 10-QSB, the Company's principal executive and principal financial officer has concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. We strive to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the requirements specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for appropriate decisions regarding required disclosure. Our former independent registered public accounting firm had 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. The Company and its audit committee has taken the steps necessary to correct this identified reportable condition. Effective January 2005, the Company hired an experienced Chief Financial Officer at the Company's B&B ARMR subsidiary. In addition, the Company has hired additional staffing within the finance and accounting department at the corporate office. (b) Changes in Internal Controls. There were no significant changes in the Company's internal control over financial reporting that occurred during the company's last completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting, other than described above. Additionally, the Company has and will continue to improve both the quality and the quantity of staffing in order to effect significant improvements in the Company's internal control structure. 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits. 10.1+ Promissory Note, dated May 5, 2005, payable to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. in the amount of $100,000. 10.2+ Stock Purchase Warrant, dated May 5, 2005, issued to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. 10.3+ Promissory Note, dated May 5, 2005, payable to Frost National Bank FBO Renaissance US Growth Investment Trust PLC in the amount of $100,000. 10.4+ Stock Purchase Warrant, dated May 5, 2005, issued to Frost National Bank FBO Renaissance US Growth Investment Trust PLC. 10.5+ Promissory Note, dated May 5, 2005, payable to HSBC Global Custody Nominee (U.K) Limited, Designation No. 896414 in the amount of $100,000. 10.6+ Stock Purchase Warrant, dated May 5, 2005, issued to HSBC Global Custody Nominee (U.K) Limited, Designation No. 896414. 10.7+ Promissory Note, Dated May 4, 2005, payable to C. A. Rundell, Jr. in the amount of $200,000. 10.8+ Stock Purchase Warrant, dated May 4, 2005 issued to C. A. Rundell, Jr. 31.1+ Officer's Certificate Pursuant to Section 302 32.1+ Officer's Certificate Pursuant to Section 906 ________________ + Filed herewith. 17 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Integrated Security Systems, Inc. (Registrant) Date: May 11, 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: May 11, 2005 /s/ RICHARD B. POWELL --------------------- Richard B. Powell Vice President, Chief Accounting Officer and Secretary (Principal Accounting Officer) 18 EXHIBIT INDEX 10.1+ Promissory Note, dated May 5, 2005, payable to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. in the amount of $100,000. 10.2+ Stock Purchase Warrant, dated May 5, 2005, issued to Frost National Bank FBO Renaissance Capital Growth & Income Fund III, Inc. 10.3+ Promissory Note, dated May 5, 2005, payable to Frost National Bank FBO Renaissance US Growth Investment Trust PLC in the amount of $100,000. 10.4+ Stock Purchase Warrant, dated May 5, 2005, issued to Frost National Bank FBO Renaissance US Growth Investment Trust PLC. 10.5+ Promissory Note, dated May 5, 2005, payable to HSBC Global Custody Nominee (U.K) Limited, Designation No. 896414 in the amount of $100,000. 10.6+ Stock Purchase Warrant, dated May 5, 2005, issued to HSBC Global Custody Nominee (U.K) Limited, Designation No. 896414. 10.7+ Promissory Note, Dated May 4, 2005, payable to C. A. Rundell, Jr. in the amount of $200,000. 10.8+ Stock Purchase Warrant, dated May 4, 2005 issued to C. A. Rundell, Jr. 31.1+ Officer's Certificate Pursuant to Section 302 32.1+ Officer's Certificate Pursuant to Section 906 ________________ + Filed herewith. 19