10QSB

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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB

(Mark One)

/x/	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
/ /	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from                to               

Commission file number 333-93131

IMAGEWARE SYSTEMS, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)

California	33-0224167
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

10883 Thornmint Road
San Diego, CA 92127
(Address of Principal Executive Offices)

(858) 673-8600
(Issuer's Telephone Number, Including Area Code)

    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 / /

    State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of August 10, 2001 the number of outstanding shares of the Registrant's common stock, par value $.01, was 5,557,557. Transitional Small Business Disclosure Format (check one)

Yes / /    No /x/

IMAGEWARE SYSTEMS, INC.
INDEX

		Page No.
PART I    FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED)
	Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000	3
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2001 and 2000	4
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000	5
	Condensed Consolidated Statements of Comprehensive Income	6
	Notes to Condensed Consolidated Financial Statements	7
ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12
PART II    OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	21
ITEM 2.	CHANGES IN SECURITIES AND USE OF PROCEEDS	21
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	21
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	21
ITEM 5.	OTHER INFORMATION	21
ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K	22
SIGNATURES

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PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

IMAGEWARE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

				June 30, 2001			December 31, 2000
				(Unaudited)
ASSETS
Current Assets:
	Cash			$	709		$	6,900
	Restricted cash and cash equivalents				1,058			530
	Accounts receivable, net				3,552			2,944
	Inventory				962			286
	Other assets				1,139			182
			Total Current Assets		7,420			10,842
Property and equipment, net					862			535
Intangible assets, net of accumulated amortization					6,851			1,628
			Total Assets	$	15,133		$	13,005
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Accounts payable			$	1,046		$	791
	Deferred revenue				775			611
	Accrued expenses				1,765			751
	Accrued expenses—related parties				139			321
	Accrued interest				142			299
	Notes & advances payable to bank and 3rd parties				435			132
	Notes payable to related parties				216			210
			Total Current Liabilities		4,518			3,115
			Total Liabilities		4,518			3,115
Shareholders' equity (deficit):
	Preferred stock, $.01 par value, authorized 4,000,000 shares
		Series B convertible redeemable preferred stock, designated 750,000 shares, 389,400 shares issued,and 334,400 shares outstanding, liquidation preference $836,000			3			3
	Common stock, $.01 par value, 50,000,000 shares authorized, 4,848,958 shares issued and outstanding				47			41
	Additional paid in capital				38,330			34,668
	Unearned stock-based compensation				(63	)		(63	)
	Treasury stock, at cost—6,704 shares				(64	)		(64	)
Shareholder note receivable					(150	)		(150	)
Accumulated other comprehensive loss					(68	)		—
Accumulated deficit					(27,420	)		(24,545	)
			Total shareholders' equity		10,615			9,890
			Total Shareholders' Equity and Liabilities	$	15,133		$	13,005

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IMAGEWARE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)

		THREE MONTHS ENDED JUNE 30,						SIX MONTHS ENDED JUNE 30,
		2001			2000			2001			2000
					Restated—See Note 3						Restated—See Note 3
Revenues:
	Product	$	2,948		$	2,311		$	5,262		$	4,481
	Maintenance		591			411			1,038			701
			3,539			2,722			6,300			5,182
Cost of revenues:
	Product		1,209			454			2,129			1,266
	Maintenance		307			312			591			619
Gross profit			2,023			1,956			3,580			3,297
Operating expenses:
	General & administrative		1,788			944			3,004			1,772
	Sales and marketing		1,044			493			1,606			1,049
	Research & development		590			394			1,048			816
	Depreciation and amortization		642			252			915			496
			4,064			2,083			6,573			4,133
Loss from operations			(2,041	)		(127	)		(2,993	)		(836	)
Interest (income) expense, net			(2	)		(67	)		(71	)		1,010
Other (income) expense, net			(6	)		213			(6	)		363
Loss before income taxes and extraordinary items			(2,033	)		(273	)		(2,916	)		(2,209	)
Income tax benefit			(40	)		—			(40	)		—
Loss before income taxes and extraordinary items			(1,993	)		(273	)		(2,876	)		(2,209	)
Extraordinary items:
	Gain on debt extinguishments net of income taxes of $0		—			—			—			(622	)
Net loss		$	(1,993	)	$	(273	)	$	(2,876	)	$	(1,587	)
Basic and diluted loss per common share before income taxes and extraordinary item—see note 2		$	(0.42	)	$	(0.08	)	$	(0.65	)	$	(0.80	)
Extraordinary item			—			—			—			0.22
Net loss per common share		$	(0.42	)	$	(0.08	)	$	(0.65	)	$	(0.58	)
Basic and diluted common shares			4,855,662			3,845,989			4,532,347			2,823,346

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IMAGEWARE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001
(AMOUNTS IN THOUSANDS)
(UNAUDITED)

					Six Months Ended June 30,
					2001			2000
Cash flows from operating activities
	Net loss				$	(2,876	)	$	(1,585	)
	Adjustments to reconcile net loss to net cash used by operating activities
		Depreciation and amortization				902			496
		Stock-based compensation				35			128
		Deferred revenue				103			(206	)
		Change in assets and liabilities
			Restricted cash and cash equivalents			(529	)		—
			Accounts receivable, net			313			(793	)
			Inventory			113			95
			Other assets			144			(470	)
			Accounts payable			(533	)		(1,182	)
			Accrued expenses			(268	)		(527	)
			Deferred compensation			—			(294	)
			Accrued interest			(157	)		(138	)
				Total adjustments		123			(2,891	)
				Net cash used by operating activities		(2,753	)		(4,476	)
Cash flows from investing activities
	Purchase of property and equipment					(122	)		(65	)
	Acquisition of business, net of cash acquired					(2,992	)
	Payment on advances from related stockholders					(14	)
	Purchase of other long-term assets					—
				Net cash used by investing activities		(3,128	)		(65	)
Cash flows from financing activities
	Proceeds from issuance of notes payable					—			101
	Repayment of notes payable					(310	)		(3,488	)
	Proceeds from issuance of stock, net of issuance costs								15,579
	Repurchase of common stock								(64	)
	Dividends paid								(181	)
				Net cash (used in) provided by financing activities		(310	)		11,947
				Net (decrease) increase in cash		(6,191	)		7,406
Cash at beginning of period						6,900			159
				Cash at end of period	$	709		$	7,565

The accompanying notes are an integral part of these condensed consolidated financial statements.

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IMAGEWARE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)

		THREE MONTHS ENDED JUNE 30,						SIX MONTHS ENDED JUNE 30,
		2001			2000			2001			2000
		(in thousands)						(in thousands)
Net income (loss)		$	(1,993	)	$	(273	)	$	(2,876	)	$	(1,587	)
Other comprehensive income (loss):
	Foreign currency translation adjustment		68			—			68			—
Comprehensive income (loss)		$	(1,925	)	$	(273	)	$	(2,808	)	$	(1,587	)

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IMAGEWARE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

    The preparation of financial statements in conformity 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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

    The accompanying condensed consolidated unaudited financial statements of ImageWare Systems, Inc. ("ImageWare" or the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements and should be read in conjunction with the consolidated financial statements for the year ended December 31, 2000 and notes thereto included in the Company's Form 10-KSB dated April 2, 2001. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting only of adjustments of a normal recurring nature, necessary for a fair presentation of the Company's financial position as of June 30, 2001, and its results of operations and its cash flows for the periods presented. These condensed consolidated unaudited financial statements are not necessarily indicative of the results to be expected for the entire year.

    Certain reclassifications have been made to the prior period balances in order to conform to the current period presentation.

NOTE 2. NET LOSS PER COMMON SHARE

    Basic loss per common share is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares outstanding during the period, adjusted to include, if dilutive, common stock equivalents consisting of convertible preferred stock, stock options and warrants, calculated using the treasury stock method. During the periods ended June 30, 2001 and 2000, the Company has excluded all convertible preferred stock and outstanding stock options and warrants from the calculation of diluted loss per share, as their effect would have been antidilutive due to the Company's net loss.

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    The following table sets forth the computation of basic and diluted loss per share for the three and six month periods ended June 30, 2001 and 2000 (amounts in thousands except share and per share amounts):

		THREE MONTHS ENDED JUNE 30,						SIX MONTHS ENDED JUNE 30,
		2001			2000 Restated— See Note 3			2001			2000 Restated— See Note 3
Numerator
	Loss before income taxes and extraordinary item	$	(2,033	)	$	(273	)	$	(2,916	)	$	(2,209	)
	Less Series B preferred dividends		(18	)		(21	)		(37	)		(41	)
	Loss available to common shareholders before extraordinary item	$	(2,051	)	$	(294	)	$	(2,953	)	$	(2,250	)
	Extraordinary item—see note 6		—			—			—			622
	Net loss available to common shareholders before income taxes	$	(2,051	)	$	(294	)	$	(2,953	)	$	(1,628	)
	Income tax benefit		40			—			40			—
	Net loss available to common shareholders	$	(2,011	)	$	(294	)	$	(2,913	)	$	(1,628	)
Denominator
	Weighted-average shares outstanding		4,855,662			3,845,989			4,532,347			2,823,346
	Basic and diluted loss per share before extraordinary item		(0.42	)		(0.08	)		(0.65	)		(0.80	)
	Extraordinary item		—			—			—			0.22
	Net loss per common share		(0.42	)		(0.08	)		(0.65	)		(0.58	)

NOTE 3. BUSINESS COMBINATIONS AND ACQUISITION OF ASSETS

    On August 22, 2000, the Company consummated a merger with Imaging Technology Corporation ("ITC") by acquiring all of the outstanding common stock of ITC in exchange for newly issued common stock of ImageWare Systems Inc. whereby ITC became a wholly-owned subsidiary of the Company. The transaction was accounted for as a pooling of interests and, accordingly the accompanying condensed consolidated financial statements have been restated to include the accounts and operations for all periods presented.

    On September 29, 2000, the Company completed the purchase of Goddard Technology Corporation ("Goddard"), a privately held developer of software identification badging systems, by acquiring substantially all of its assets for shares of common stock of the Company and the assumption of certain liabilities for a total purchase price of $600,000. The acquisition was accounted for using the purchase method of accounting and, accordingly, Goddard's results of operations have been included in the consolidated financial statements since the date of acquisition.

    On March 30, 2001, the Company completed the purchase of substantially all the assets of G & A Imaging Ltd. ("G & A"), a privately held developer of software and software systems for digital identification documents for a total purchase price of $2.9 million in cash and the issuance of 665,000 shares of the Company's common stock. The acquisition was accounted for using the purchase method of accounting and, accordingly, G & A's results of operations have been included in the consolidated financial statements since the date of acquisition.

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    The following table presents the allocation of the acquisition cost for the G & A Imaging, Ltd. acquisition, including professional fees and other related acquisition costs, to the assets acquired and liabilities assumed:

Accounts receivable	$	919,000
Inventories		789,000
Other current assets		1,075,000
Property, plant and equipment, net		325,000
Other intangibles		—
Goodwill		6,031,000
Total assets	$	9,139,000
Amounts payable to banks and long-term debt due within one year	$	(789,000	)
Other current liabilites		(1,722,000	)
Long-term obligations, net of current portion		(71,000	)
Total liabilites	$	(2,582,000	)
Total acquisition cost	$	6,557,000

    The allocation of the purchase price is based on preliminary data and could change when final valuation information is obtained.

    The following (unaudited) pro forma consolidated results of operations for the six months ended June 30, 2001 and 2000 have been prepared as if the acquisition of Goddard and G & A had occurred at January 1, 2000:

	Six Months Ended June 30,
	2001			2000
Sales	$	7,582,000		$	10,122,000
Net income (loss)		(3,489,000	)		(2,902,000	)
Net income (loss) per share—basic		(0.73	)		(0.84	)

    The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

NOTE 4. INVENTORY

    Components of inventory are as follows (in thousands):

	As of
	June 30, 2001		December 31, 2000
Raw materials	$	—	$	—
Work in process		—		—
Finished goods		962		286
	$	962	$	286

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NOTE 5. SEGMENT INFORMATION

    Prior to its acquisition of G & A Imaging, Ltd., the Company operated in one business segment. With its acquisition of G & A Imaging, Ltd., the Company is now comprised of two reportable segments: Law Enforcement and Identification. The Law Enforcement segment develops, sells and supports a suite of modular software products and designs systems used by law enforcement and public safety agencies to manage criminal history records and investigate crime. The Identification segment develops, sells and supports software and designs systems which utilize digital imaging in the production of photo identification cards, documents and identification badging systems.

    There are no intersegment transactions.

    The table below summarizes information about reportable segments for the three and six months ended June 30, 2001 and 2000:

		THREE MONTHS ENDED JUNE 30,						SIX MONTHS ENDED JUNE 30,
		2001			2000			2001			2000
		(in thousands)						(in thousands)
Net Revenue:
	Law Enforcement	$	1,167		$	2,068		$	2,214		$	3,800
	Identification		2,372			654			4,086			1,382
Total consolidated net sales			3,539			2,722			6,300			5,182
Operating loss:
	Law Enforcement		(733	)		169			(1,569	)		(389	)
	Identification		(1,308	)		(296	)		(1,424	)		(447	)
Other unallocated amounts:
	Interest expense (income)		(2	)		(67	)		(71	)		1,010
	Other expense (income)		(6	)		213			(6	)		363
Loss before income taxes and extraordinary items		$	(2,033	)	$	(273	)	$	(2,916	)	$	(2,209	)

	June 30, 2001		December 31, 2000
	(in thousands)
Total Assets by Segment:
Law Enforcement	$	3,087	$	10,500
Identification		1,467		1,410
Total assets for reportable segments		4,554		11,910
Corporate		10,579		1,095
Total consolidated assets	$	15,133	$	13,005

NOTE 6. EXTRAORDINARY ITEM

    In November 1999, the Company issued a convertible promissory note of $1,250,000 at an interest rate of 10%, due the earlier of February 16, 2001 or five days following the closing of an IPO, to an individual affiliated with Atlus Co. (which beneficially owned approximately 31% of our common shares outstanding at the date of note issuance). Under the terms of the note, the principal amount was fixed in Japanese yen and was to be repaid in U.S. dollars at a fixed (104.55 Japanese yen per U.S. dollar) conversion rate established on the date of issuance. If the principal and interest was not paid prior to April 1, 2000, the note became convertible to common stock at $1.00 per share. In conjunction with the note, the Company issued the individual a warrant to purchase 125,000 shares of common stock for

10

$6.00 per share. The Company recorded the note at an amount, net of a discount, equal to the fair value allocated to the warrants issued of approximately $361,000.

    The Company recorded a charge of $889,000 for the beneficial conversion feature embedded in this debt instrument. The value of the beneficial conversion feature was measured using its intrinsic value, i.e., the excess of the aggregate fair value of the common stock into which the debt was convertible over the proceeds allocated to the security. The intrinsic value of the beneficial conversion feature of approximately $10 million exceeded the proceeds allocated to the debt of approximately $889,000; therefore, the Company limited recognition of the beneficial conversion feature to the approximately $889,000 of proceeds allocated to the debt. The Company accreted the entire amount of the beneficial conversion feature as interest expense over the period from the date of issuance, November 10, 1999, to the date the note became immediately convertible, April 1, 2000.

    On April 5, 2000, the Company used a portion of the proceeds from its initial public offering to extinguish this outstanding debt. The difference between the debt payment amount of $1,250,000 and the carrying amount of the debt of approximately $628,000 was recorded as an extraordinary gain of $622,000.

NOTE 7. RECENTLY ISSUED ACCOUNTING STANDARDS

    In June, 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," which supercedes Accounting Principles Board Opinion ("APB") No. 16 "Business Combinations," and SFAS No. 138, "Accounting for Preacquisition Contingencies of Purchased Enterprises," and requires all business combinations initiated after June 30, 2001 to be accounted for as purchases. The Company adopted SFAS No. 141 as required on July 1, 2001. The adoption of did not have a material impact on the Company's financial position or results of operations.

    In June, 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which supercedes APB No. 17, "Intangible Assets," and requires that all goodwill and intangible assets with indefinite lives no longer be amortized but reviewed at least annually for impairment. The Company will adopt SFAS No. 142 when required to do so on January 1, 2002. The adoption of SFAS No. 142 is expected to reduce the Company's amortization expense before income taxes, however, the total impact of the adoption of this pronouncement is currently being evaluated by the Company. The Company has not assessed the impact of any impairment under the new test prescribed by the standard.

NOTE 8. SUBSEQUENT EVENTS

    On August 10, 2001, the Company closed its acquisition of Castleworks LLC, a Nevada limited liability company ("Castleworks"), and E-Focus West LLC, a Nevada limited liability company ("E-Focus"), from Castle Holdings LLC, a Nevada limited liability company ("Castle Holdings"). The transaction was consummated pursuant to the Membership Interest Purchase Agreement dated as of August 10, 2001 (the "Purchase Agreement") between ImageWare and Castle Holdings. As a result of this transaction, Castleworks and E-Focus became wholly owned subsidiaries of ImageWare.

    The purchase price consisted of the issuance of 600,000 shares of ImageWare common stock and $100,000 in cash. An additional 100,000 shares of ImageWare common stock were issued and delivered at closing to the escrow agent as contingent shares, to be paid to Castle Holdings if the closing price of ImageWare's common stock shall fail to be equal to or greater than six dollars and fifty cents ($6.50) for at least any ten trading days during a period of one year from the date of the Purchase Agreement.

    Castleworks and E-Focus develop software for electronic or digital imaging for photographic purposes.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

    This Quarterly Report on Form 10-QSB contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. All forward-looking statements included in this report are based on information available to us as of the date hereof and we assume no obligation to update any forward-looking statements. Forward-looking statements involve known or unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include but are not limited to: fluctuations in our operating results; continued new product introductions and market acceptance of our new products; new product introductions by competitors; risks associated with our dependence on a small number of large sales to customers with political purchasing constraints; risks related to our lengthy sales cycle; our reliance on third party systems integrators and on third party technology licenses; technological changes in the digital imaging industry; uncertainties regarding intellectual property rights; risks related to our acquisition strategies and the integration of acquired companies; and the other factors including, but not limited to, the items discussed under "Risk Factors" contained in this Quarterly Report.

    The following discussion of the financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements included elsewhere within this quarterly report. Fluctuations in annual and quarterly results may occur as a result of factors affecting demand for the Company's products such as the timing of new product introductions by us and by our competitors and our customers' political and budgetary constraints. Due to such fluctuations, historical results and percentage relationships are not necessarily indicative of the operating results for any future period.

OVERVIEW

    We develop, sell and support a suite of modular software products used by law enforcement and public safety agencies to manage criminal history records and to investigate crime. Our software systems and associated hardware enable our customers to quickly capture, archive, search, retrieve and share digital photographs and criminal history records. We also develop, sell and support software and design systems which utilize digital imaging in the production of photo identification cards, documents and identification badging systems.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2001 AND 2000.

    REVENUES.  Product revenues increased 28% from $2,311,000 for the three months ended June 30, 2000 to $2,948,000 for the corresponding period in 2001. The increase reflected $1,218,000 in identification systems and software sales from the acquisition of the assets of G & A Imaging, Ltd. ("G & A"). Exclusive of the G & A acquisition, sales of identification systems and software increased $396,000 for the three months ended June 30, 2001 as compared to the corresponding period in 2000. Revenues related to law enforcement products decreased $977,000 for the three months ended June 30, 2001 as compared to the corresponding period in 2000 as sales of law enforcement systems continued to lag behind prior year levels. Our backlog of product orders as of June 30, 2001 was approximately $846,000.

    Maintenance revenues increased 44% from $411,000 for the three months ended June 30, 2000 to $591,000 for the corresponding period in 2001. This increase is due both to the expansion of our installed base in the law enforcement market and the acquisition of G & A Imaging.

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    COST OF REVENUES.  Cost of products and maintenance increased 98% from $766,000 for the three months ended June 30, 2000 to $1,516,000 for the corresponding period in 2001. This increase reflects the acquisition of G & A. Cost of revenues for G & A were $584,000 for the three months ended June 30, 2001. As a percentage of sales, cost of products and maintenance increased from 28% for the three months ended June 30, 2000 to 43% for the corresponding period in 2001.

    Cost of product revenues increased 166% from $454,000, or 20% of product revenues, for the three months ended June 30, 2000 to $1,209,000, or 41% of product revenues, for the corresponding period in 2001. This increase in the cost of product revenues includes the acquisition of G & A. Cost of product revenues for G & A were $522,000 for the three months ended June 30, 2001. Exclusive of the G & A acquisition, cost of product revenues for the Identification segment increased $275,000 from the three months ended June 30, 2000 to the corresponding period in 2001. Cost of product revenues related to the Law Enforcement segment decreased $42,000 from $312,000, or 18% of product revenues for the three months ended June 30, 2000 to $270,000, or 37% of product revenues for the corresponding period in 2001. The increase in cost of product revenues related to the Law Enforcement segment as a percentage of revenue from 18% to 37% for the three months ended June 30, 2000 and 2001 respectively is due to an uncharacteristically high mix of software only revenues for the three month period ended June 30, 2000. Costs of products can vary as a percentage of product revenue from quarter to quarter depending upon product mix and the hardware content included in systems installed during a given period.

    Costs of maintenance revenues decreased 2% from $312,000, or 76% of maintenance revenues, for the three months ended June 30, 2000 to $307,000, or 52% of maintenance revenues, for the corresponding period in 2001. This decrease in costs of maintenance revenues as a percentage of maintenance revenues is due to lower costs incurred in maintaining upgraded Crime Capture Systems installations as opposed to pre-conversion UNIX-based systems combined with a larger revenue base to absorb fixed maintenance costs.

    GROSS MARGINS.  Total gross margins increased from $1,956,000, or 72% of revenues, for the three month period ended June 30, 2000 to $2,023,000, or 57% of revenues, for the corresponding period in 2001. Gross margins related to product sales decreased from $1,857,000, or 80% of product revenues, to $1,739,000 or 59% of product revenues, for the corresponding period in 2001. Gross margins related to law enforcement product sales decreased $935,000, from $1,400,000 for the three months ended June 30, 2000 to $465,000 for the corresponding period in 2001. This decrease was due to both a decline in revenues for the three months ended June 30, 2001 as compared to the comparable period in 2000 and an uncharacteristically high software only product mix for the three month period ended June 30, 2000.

    Gross margins for the Identification products segment increased $817,000, from $457,000 for the three months ended June 30, 2000 to $1,274,000 for the comparable period in 2001. The increase is due to the acquisition of G & A. Product gross margins related to G & A for the three months ended June 30, 2001 were $696,000. As a percentage of Identification segment revenues, gross margins decreased from 75% for the three months ended June 30, 2000 to 57% for the comparable period in 2001 due primarily to the acquisition of G & A and its product mix.

    Gross margins related to maintenance revenues increased $185,000 from $99,000 for the three months ended June 30, 2000 to $284,000 for the corresponding period in 2001. Of this increase, $138,000 was related to the Law Enforcement segment and was due primarily to lower costs incurred in maintaining upgraded Crimes Capture Systems installations as opposed to pre-conversion UNIX-based systems.

    GENERAL AND ADMINISTRATIVE EXPENSES.  General and administrative expenses are comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and

13

communication costs are also included with general and administrative expenses. Such expenses increased $844,000 or 89%, from $944,000 for the three months ended June 30, 2000 to $1,788,000 for the corresponding period in 2001. The increase includes $354,000 in general and administrative expense from the acquired infrastructure of G & A. Exclusive of the G & A acquisition, general and operating expenses increased $490,000 during the three months ended June 30, 2001 over the corresponding period in 2000. This increase was due primarily to higher legal, consulting and professional and increased headcount.

    SALES AND MARKETING.  Sales and marketing expenses consist primarily of the salaries, commissions, other incentive compensation, employee benefits and travel expenses of our sales force. Such expenses increased $551,000 or 112%, from $493,000 for the three months ended June 30, 2000 to $1,044,000 for the corresponding period in 2001. The increase includes $552,000 in sales and marketing from the acquired sales and marketing force of G & A. Exclusive of the G & A acquisition, sales and marketing expenses approximated $492,000 for the three month periods ended June 30, 2000 and 2001. Sales and marketing expenses related to the Law Enforcement segment were $301,000 and $309,000 for the three months ended June 30, 2000 and 2001, respectively, as reduced commissions in 2001 were offset by changes in sales management. Exclusive of G & A, sales and marketing expenses of the Identification segment decreased $9,000, from $192,000 for the three months ended June 30, 2000 to $183,000 for the corresponding period in 2001.

    RESEARCH AND DEVELOPMENT.  Research and development costs consist primarily of salaries, employee benefits and outside contractors for new product development, product enhancements and custom integration work. Such expenses increased $196,000 or 50% from $394,000 for the three months ended June 30, 2000 to $590,000 for the corresponding period in 2001. The increase includes $287,000 in research and development expenses from the acquisition of G & A. Exclusive of the G & A acquisition, research and development expenses decreased $91,000. The decrease reflects lower research and development expenses of $96,000 in the Law Enforcement group due to a decrease in headcount and reduced contract programming expenses.

    INTEREST EXPENSE, NET.  For the three months ended June 30, 2000, we recognized interest income of $103,000 and interest expense of $36,000. For the three months ended June 30, 2001, we recognized interest income of $25,000 and interest expense of $23,000. Interest income in the three months ended June 30, 2001 decreased due to lower cash and cash equivalents held in interest bearing accounts, resulting from the use of cash to fund our net loss and acquisition of G & A. Interest expense decreased due to the paydown of interest bearing obligations which commenced in the second quarter of 2000 upon receipt of our initial public offering proceeds on April 5, 2000.

SIX MONTHS ENDED JUNE 30, 2001 AND 2000

    REVENUES.  Product revenues increased 17% from $4,481,000 for the six months ended June 30, 2000 to $5,262,000 for the corresponding period in 2001. The increase includes $1,218,000 in identification systems and software sales from the acquisition of G & A. Exclusive of the G & A acquisition, sales of identification systems and software increased $1,309,000 due primarily to strong international sales of identification systems and the effect of our acquisition of the assets of Goddard Technology Corporation which occurred September 30, 2000. Revenues related to law enforcement products decreased $1,747,000 for the six months ended June 30, 2001 as sales of law enforcement systems continued to lag behind prior year levels.

    Maintenance revenues increased 48% from $701,000 for the six months ended June 30, 2000 to $1,038,000 for the corresponding period in 2001. This increase includes $181,000 in customer service revenue from the G & A acquisition combined with the expansion of our installed base in the law enforcement market.

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    COST OF REVENUES.  Cost of products and maintenance increased 44% from $1,885,000 for the six months ended June 30, 2000 to $2,720,000 for the corresponding period in 2001. This increase includes the acquisition of G & A. Cost of revenues for G & A were $584,000 for the six months ended June 30, 2001. As a percentage of sales, cost of products and maintenance increased from 36% for the six months ended June 30, 2000 to 43% for the corresponding period in 2001 due to the acquisition of G & A which has a lower software only product mix due to significant sales of identification card media.

    Cost of product revenues increased 68% from $1,266,000, or 28% of product revenues, for the six months ended June 30, 2000 to $2,129,000, or 40% of product revenues, for the corresponding period in 2001. This increase in cost of product revenues includes the acquisition of G & A. The six month period ending June 30, 2000 includes cost of product revenues for G & A of $522,000 since the date of acquisition, March 30, 2001. Cost of product revenues related to the Law Enforcement segment decreased $295,000 from $868,000, or 27% of product revenues for the six months ended June 30, 2000 to $573,000, or 40% of product revenues for the corresponding period in 2001. The increase in cost of product revenues as a percentage of revenue from 27% to 40% for the six months ended June 30, 2000 and 2001, respectively, is due to an uncharacteristically high mix of software only revenues for the three month period ended June 30, 2000. Costs of products can vary as a percentage of product revenue from quarter to quarter depending upon product mix and the hardware content included in systems installed during a given period.

    Costs of maintenance revenues decreased 5% from $619,000, or 88% of maintenance revenues, for the six months ended June 30, 2000 to $591,000, or 57% of maintenance revenues, for the corresponding period in 2001.

    GROSS MARGINS.  Total gross margins increased from $3,297,000, or 64% of revenues for the six month period ended June 30, 2000 to $3,580,000, or 57% of revenues, for the corresponding period in 2001. Gross margins related to product sales for the six months ending June 30, 2000 increased from $3,215,000, or 72% of revenues, to $3,133,000 or 60% of revenues, for the corresponding period in 2001. Gross margins related to law enforcement product sales decreased $1,451,000, from $2,304,000 for the six months ended June 30, 2000 to $853,000 for the corresponding period in 2001. This decrease was due to both a decline in revenues for the six months ended June 30, 2001 as compared to the comparable period in 2000 and an uncharacteristically high software only product mix for the three month period ended June 30, 2000.

    Gross margins for the Identification products segment increased $1,370,000, from $911,000 for the six months ended June 30, 2000 to $2,280,000 for the comparable period in 2001. The increase is due both to the acquisition of G & A on March 30, 2001 and strong international sales of identification systems. Product gross margins related to G & A were $696,000 from the date of acquisition through June 30, 2001.

    Gross margins related to maintenance revenues increased $365,000 from $82,000 for the six months ended June 30, 2000 to $447,000 for the corresponding period in 2001. Of this increase, $249,000 was related to the Law Enforcement segment and was due primarily to lower costs incurred in maintaining upgraded Crimes Capture Systems installations as opposed to pre-conversion UNIX-based systems.

    GENERAL AND ADMINISTRATIVE EXPENSES.  General and administrative expenses are comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and communication costs are also included with general and administrative expenses. General and administrative expenses increased $1,232,000 or 70%, from $1,772,000 for the six months ended June 30, 2000 to $3,004,000 for the corresponding period in 2001. The increase includes $354,000 in general and administrative expense from the acquired infrastructure of G & A. Exclusive of the G & A

15

acquisition, general and operating expenses increased $878,000 during the six months ended June 30, 2001. This increase was due primarily to higher legal, consulting and professional fees related to our becoming a public entity, and increased headcount.

    SALES AND MARKETING.  Sales and marketing expenses consist primarily of the salaries, commissions, other incentive compensation, employee benefits and travel expenses of our sales force. Such expenses increased $557,000 or 53%, from $1,049,000 for the six months ended June 30, 2000 to $1,606,000 for the corresponding period in 2001. The increase includes $552,000 in sales and marketing from the acquired sales and marketing force of G & A. Exclusive of the G & A acquisition, sales and marketing expenses approximated $1,049,000 for the six month periods ended June 30, 2000 and $1,054,000 for the corresponding period in 2001. Sales and marketing expenses related to the Law Enforcement segment were $702,000 and $579,000 for the six months ended June 30, 2000 and 2001, respectively, as we incurred reduced commissions in 2001 as a result of lower revenues. Sales and marketing expenses of the Identification segment increased $128,000 (exclusive of the G & A acquisition), from $347,000 for the six months ended June 30, 2000 to $475,000 for the corresponding period in 2001.

    RESEARCH AND DEVELOPMENT.  Research and development costs consist primarily of salaries, employee benefits and outside contractors for new product development, product enhancements and custom integration work. Such expenses increased $232,000 or 28% from $816,000 for the six months ended June 30, 2000 to $1,048,000 for the corresponding period in 2001. The increase includes $287,000 in research and development expenses from the acquisition of G & A. Exclusive of the G & A acquisition, research and development expenses decreased $55,000. The decrease reflects lower research and development expenses of $212,000 in the Law Enforcement group due to a decrease in headcount and reduced contract programming expenses.

    INTEREST EXPENSE, NET.  For the six months ended June 30, 2000, we recognized interest income of $104,000 and interest expense of $1,114,000. For the six months ended June 30, 2001, we recognized interest income of $109,000 and interest expense of $38,000. Interest expense for the six month period ended June 30, 2000 includes $889,000 which relates to the accretion of a beneficial conversion feature embedded in our convertible promissory note issued in November 1999. Exclusive of this charge, interest expense decreased by $187,000 due to the paydown of interest bearing obligations which commenced in the second quarter of 2000 upon receipt of our initial public offering proceeds, such proceeds received on April 5, 2000.

    EXTRAORDINARY ITEM.  In November 1999, we issued a convertible promissory note of $1,250,000 at an interest rate of 10%, due the earlier of February 16, 2001 or five days following the closing of an IPO, to an individual affiliated with Atlus Co. (which beneficially owned approximately 31% of our common shares outstanding at the date of note issuance). Under the terms of the note, the principal amount was fixed in Japanese yen and was to be repaid in U.S. dollars at a fixed (104.55 Japanese yen per U.S. dollar) conversion rate established on the date of issuance. If the principal and interest was not paid prior to April 1, 2000, the note became convertible to common stock at $1.00 per share. In conjunction with the note, we issued the individual a warrant to purchase 125,000 shares of common stock for $6.00 per share. We recorded the note at an amount, net of a discount, equal to the fair value allocated to the warrants issued of approximately $361,000.

    We recorded a charge of $889,000 for the beneficial conversion feature embedded in this debt instrument. The value of the beneficial conversion feature was measured using its intrinsic value, i.e., the excess of the aggregate fair value of the common stock into which the debt was convertible over the proceeds allocated to the security. The intrinsic value of the beneficial conversion feature of approximately $10 million exceeded the proceeds allocated to the debt of approximately $889,000; therefore we limited recognition of the beneficial conversion feature to the approximately $889,000 of proceeds allocated to the debt. We accreted the entire amount of the beneficial conversion feature as

16

interest expense over the period from the date of issuance, November 10, 1999, to the date the note became immediately convertible, April 1, 2000.

    On April 5, 2000, we used a portion of the proceeds from its initial public offering to extinguish this outstanding debt. The difference between the debt payment amount of $1,250,000 and the carrying amount of the debt of approximately $628,000 was recorded as an extraordinary gain of $622,000.

    LIQUIDITY AND CAPITAL RESOURCES.  Since inception, we have funded operations primarily from proceeds from the sale of stock and borrowings from individuals and financial institutions. On March 31, 2000, we completed an IPO of 1,875,000 units (units consist of one share of common stock and a warrant to purchase one share of common stock) at $8.00 per unit. Net proceeds aggregated approximately $13.5 million. The IPO proceeds were received on April 5, 2000. On May 2, 2000 we received approximately $2.0 million in additional net proceeds from the exercise of the over allotment option by the underwriter to sell an additional 281,250 units. During the six month period ended June 30, 2000, we received proceeds of $1.7 million from the exercise of 176,673 warrants and 1,896 options. During the six month period ended June 30, 2001, we received no proceeds from the issuance of stock or exercise of warrants or options.

    As of June 30, 2001 we had total current assets of $7.4 million and total current liabilities of $4.5 million, or working capital of $2.9 million.

    Net cash used in operating activities was $2,753,000 for the six month period ended June 30, 2001 as compared to $4,476,000 for the corresponding period in 2000.   We used cash to fund the net loss for the six months ended June 30, 2000, of $1,585,000 and $2,876,000 for the corresponding period in 2001. For the six months ended June 30, 2000, we used cash of $1,168,000 to fund increases in current assets and $2,347,000 for decreases in current liabilities (excluding debt). We generated cash of $624,000 from non cash expenses (depreciation, amortization and non cash compensation) during the six months ending June 30, 2000. For the six months ended June 30, 2001, we generated cash of $41,000 from decreases in current assets and intangible assets and used cash of $855,000 from decreases in current liabilities and deferred revenues (excluding debt), offset by $937,000 of non cash expenses (depreciation, amortization and non cash compensation).

    Net cash used by investing activities was $65,000 and $3,128,000 for the six months ended June 30, 2000 and 2001, respectively. We used cash to fund the acquisition of G & A of $2,992,000. We also used cash to fund capital expenditures of computer equipment and software, furniture and fixtures and leasehold improvements of approximately $122,000 for the six months ended June 30, 2001. The level of equipment purchases resulted primarily from continued growth of the business and replacement of older equipment.

    Net cash generated by financing activities was $11,947,000 for the six months ended June 30, 2000. Net cash generated for the six months ending June 30, 2000 was primarily from net proceeds of $15,579,000 from our IPO, completed March 31, 2000 with receipt of proceeds on April 5, 2000 and May 2, 2000, and the issuance of short term notes payable of $101,000 offset by repayment of loans of $3,488,000, dividends paid on our Series B Preferred Stock of $181,000 and the repurchase of our common stock of $64,000. For the six months ended June 30, 2001, we used cash of $310,000 for the repayment of loans.

    We believe that the funds held in cash and cash equivalents and funds provided by operations will be sufficient to finance our working capital requirements for at least the next twelve months. If we are unable to implement our business plan, we may be required to secure additional funding or institute cost reduction plans.

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RISK FACTORS

WE HAVE A HISTORY OF SIGNIFICANT RECURRING LOSSES TOTALLING APPROXIMATELY $27.4 MILLION AND WE EXPECT TO INCUR LOSSES IN THE FUTURE.

    As of June 30, 2001, we had an accumulated deficit of $27.4 million and we expect to incur losses in the future. We may need to raise capital to cover these losses, and financing may not be available to us on favorable terms. We expect to continue to incur significant sales and marketing, research and development, and general and administrative expenses. As a result, we will need to generate significant revenues to achieve profitability and may never achieve profitability.

WE DEPEND UPON A SMALL NUMBER OF LARGE SYSTEM SALES COSTING FROM $300,000 TO $600,000 AND WE MAY FAIL TO ACHIEVE ONE OR MORE LARGE SYSTEM SALES IN THE FUTURE.

    In the past three years we have derived a substantial portion of our revenues from a small number of sales of large, relatively expensive systems, typically ranging in price from $300,000 to $600,000. As a result, if we fail to receive orders for these large systems in a given sales cycle on a consistent basis, our business could be significantly harmed. Further, our quarterly results are difficult to predict because we cannot predict in which quarter, if any, large system sales will occur in a given year. As a result, we believe that quarter-to-quarter comparisons of our results of operations are not a good indication of our future performance. In some future quarters our operating results may be below the expectations of securities analysts and investors, in which case the market price of our common stock may decrease significantly.

OUR LENGTHY SALES CYCLE MAY CAUSE US TO EXPEND SIGNIFICANT RESOURCES FOR AS LONG AS ONE YEAR IN ANTICIPATION OF A SALE, YET WE STILL MAY FAIL TO COMPLETE THE SALE.

    When considering the purchase of a large computerized booking or identification system, a government agency may take as long as a year to evaluate different systems and obtain approval for the purchase. If we fail to complete a sale, we will have expended significant resources and received no revenue in return. Generally, agencies consider a wide range of issues before committing to purchase our products, including product benefits, ability to operate with their current systems, product reliability and their own budget constraints. While potential customers are evaluating our products and before they place an order with us, we may incur substantial selling costs and expend significant management effort to accomplish a sale.

A SIGNIFICANT NUMBER OF OUR CUSTOMERS ARE GOVERNMENT AGENCIES THAT ARE SUBJECT TO UNIQUE POLITICAL AND BUDGETARY CONSTRAINTS AND HAVE SPECIAL CONTRACTING REQUIREMENTS WHICH MAY AFFECT OUR ABILITY TO OBTAIN NEW GOVERNMENT CUSTOMERS.

    A significant number of our customers are government agencies. These agencies often do not set their own budgets and therefore have little control over the amount of money they can spend. In addition, these agencies experience political pressure that may dictate the manner in which they spend money. Due to political and budgetary processes and other scheduling delays that may frequently occur relating to the contract or bidding process, some government agency orders may be canceled or substantially delayed, and the receipt of revenues or payments may be substantially delayed. In addition, future sales to government agencies will depend on our ability to meet government contracting requirements, certain of which may be onerous or impossible to meet, resulting in our inability to obtain a particular contract. Common requirements in government contracts include bonding requirements, provisions permitting the purchasing agency to modify or terminate at will the

18

contract without penalty, and provisions permitting the agency to perform investigations or audits of our business practices.

WE MAY FAIL TO CREATE NEW APPLICATIONS FOR OUR PRODUCTS AND ENTER NEW MARKETS, WHICH MAY AFFECT OUR FUTURE SUCCESS.

    We believe our future success depends in part on our ability to develop and market our technology for applications other than booking systems for the law enforcement market. If we fail in these goals, our business strategy and ability to generate revenues and cash flow would be significantly impaired. We intend to expend significant resources to develop new technology, but the successful development of new technology cannot be predicted and we cannot guarantee we will succeed in these goals.

WE OCCASIONALLY RELY ON SYSTEMS INTEGRATORS TO MANAGE OUR LARGE PROJECTS AND, IF THESE COMPANIES DO NOT PERFORM ADEQUATELY, WE MAY LOSE BUSINESS.

    We are occasionally a subcontractor to systems integrators who manage large projects incorporating our systems, particularly in foreign countries. We cannot control these companies, and they may decide not to promote our products, or they may price their services in such a way as to make it unprofitable for us to continue our relationship with them. Further, they may fail to perform under agreements with their customers, in which case we might lose sales to these customers. If we lose our relationships with these companies, our business may suffer.

WE RELY ON A LICENSE OF TECHNOLOGY FROM VISIONICS, INC., AND THIS LICENSE MAY BE TERMINATED IN THE FUTURE.

    We depend on a licensing arrangement with Visionics for technology related to the search engine used in our systems. Our present licensing arrangement with Visionics expires in October 2001. If Visionics becomes unable or unwilling to continue to license us this technology or renew the terms of this license, we will have to identify or develop acceptable alternative sources of this technology, which could take up to nine months or longer. Any significant interruption in our ability to identify and contract with alternative providers of similar technology or to develop our own search engine would result in delivery delays, which could harm our customer relationships and our business and reputation.

WE DO NOT HAVE U.S. OR FOREIGN PATENT PROTECTION FOR SEVERAL OF OUR PRODUCTS, AND A COMPETITOR MAY BE ABLE TO REPLICATE OUR TECHNOLOGY.

    Our business is based in large part on our technology, and our success depends in part on our ability and efforts to protect our intellectual property rights. If we do not adequately protect our intellectual property, our business will be seriously harmed. We do not have patent protection for several of our products, including the Crime Capture System. Our Crime Capture System is based upon proprietary technology. Some of the technology used in our Suspect ID, Crime Lab and Vehicle ID products is protected by patents, copyrights and various trade secret protections afforded to us by law.

    We license certain elements of our trademarks, trade dress, copyright and other intellectual property to third parties. We attempt to ensure that our rights in our trade names and the quality of third party uses of our names are maintained by these third parties. However, these third parties may take actions that could significantly impair the value of our intellectual property and our reputation and goodwill.

    In addition, international intellectual property laws differ from country to country. Any foreign rights we have in our technology are limited by what has been afforded to us under the applicable foreign intellectual property laws. Also, under the laws of certain foreign jurisdictions, in order to have recognizable intellectual property rights, we may be required to file applications with various foreign

19

agencies or officials to register our intellectual property. Accordingly, our ability to operate and exploit our technology overseas could be significantly hindered.

WE RECENTLY HAVE ACQUIRED SEVERAL BUSINESSES AND FACE RISKS ASSOCIATED WITH INTEGRATING THESE BUSINESSES AND POTENTIAL FUTURE BUSINESSES THAT WE MAY ACQUIRE.

    We recently completed the acquisitions of Imaging Technology Corporation ("ITC"), Goddard Technology Corporation, G &A Imaging, Ltd. ("G & A"), Castleworks LLC and E-Focus West LLC. We are in the process of integrating these businesses. We plan to continue to review potential acquisition candidates, and our business and our strategy includes building our business through acquisitions. However, acceptable acquisition candidates may not be available in the future or may not be available on terms and conditions acceptable to us.

    Acquisitions involve numerous risks, including among others, difficulties and expenses incurred in the consummation of acquisitions and assimilation of the operations, personnel and services and products of the acquired companies. Additional risks associated with acquisitions include the difficulties of operating new businesses, the diversion of management's attention from other business concerns and the potential loss of key employees of the acquired company. If we do not successfully integrate the businesses we recently acquired or any businesses we may acquire in the future, our business will suffer.

WE OPERATE IN FOREIGN COUNTRIES AND ARE EXPOSED TO RISKS ASSOCIATED WITH FOREIGN POLITICAL, ECONOMIC AND LEGAL ENVIRONMENTS AND WITH FOREIGN CURRENCY EXCHANGE RATES.

    With our acquisition of G & A, we have significant foreign operations and are accordingly exposed to risks, including among others, risks associated with foreign political, economic and legal environments and with foreign currency exchange rates. Our results may be adversely affected by, among other things, changes in government policies with respect to laws and regulations, anti-inflation measures, currency conversions, remittance abroad and rates and methods of taxation.

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PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

    Not applicable.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(a)

Not applicable



(b)

Not applicable



(c)

On March 30, 2001, we issued 665,000 shares of our common stock pursuant to our acquisition of substantially all of the assets of G & A. Such issuance was exempt from registration under Regulation S of the Securities Act, as all purchasers were outside of the United States and were not U.S. Persons as defined in Regulation S.

ITEM 3. DEFAULTS ON SENIOR SECURITIES

    Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    The following matters were submitted to a vote of the shareholders of ImageWare Systems, Inc. at the Annual Meeting of Shareholders held on May 17, 2001.

a)

The following members were elected to and as the Board of Directors to serve for the ensuing year and until their successors are elected:

Nominee	Shares Voted For	Shares Withheld
S. James Miller, Jr.	2,895,926	281,451
John Callan	2,895,926	281,451
Patrick J. Downs	2,895,926	281,451
Jack Holleran	2,895,926	281,451
Yukuo Takenaka	2,895,926	281,451

b)

Our shareholders voted upon a proposal to amend our Amended and Restated 1999 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance under such plan by 800,000 as follows: 1,039,346 in favor, 341,490 against, 22,799 in abstention and 1,773,742 broker not voted. Under the provisions of our bylaws which require a majority of a quorum to approve shareholder actions, our shareholders did not approve this increase to our plan.



c)

A proposal to ratify the selection of PricewaterhouseCoopers LLP as our independent auditors for our fiscal year ending December 31, 2001 was approved by the following vote: 2,853,434 in favor, 112,157 against, and 211,786 abstentions.

ITEM 5. OTHER INFORMATION

    Not applicable.

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

Exhibit Number	Description
2.1	Agreement of Merger and Plan of Reorganization dated July 6, 2000, among the Company, Imaging Technology Corporation and ITC Acquisition Corporation (4)
2.2	First Amendment to the Agreement of Merger and Plan of Reorganization dated August 11, 2000 (4)
2.3	Plan and Agreement of Reorganization between Goddard Technology Corporation and Imaging Technology Corporation dated as of Septemeber 13, 2000 (5)
2.4	Asset Purchase Agreement dated March 8, 2001, among the Company, I.W. Systems Canada Company, G&A Imaging Ltd. and R&G Imaging Ltd. (5)
2.5	First Amendment to Asset Purchase Agreement dated March 29, 2001 (5)
2.6	Membership Interest Purchase Agreement between the Company and Castle Holdings LLC dated August 10, 2001(8)
3.1	Amended and Restated Articles of Incorporation of ImageWare Systems, Inc.(1)
3.2	Bylaws of ImageWare Systems, Inc.(1)
4.1	Form of Common Stock Certificate (1)
4.2	Reference is made to pages 1-5 and 12-15 of Exhibit 3.2 (1)
4.3	Form of Public Warrant (1)
4.4	Form of Representatives' Warrant (2)
4.5	Form of Warrant and Unit Agreement (3)
4.6	Convertible Promissory Note in favor of Naoya Harano dated November 10, 1999 (2)
4.7	Stock Purchase Warrant in favor of Naoya Harano dated November 10, 1999 (3)
4.8	Form of Warrant (Former XImage Shareholders) (1)
4.9	Form of Warrant (Former XImage Officers, Noteholders and Other Investors) (1)
4.10	Form of Warrant (Officers and Directors) (1)
4.11	Warrant to Purchase Common Stock in favor of Imperial Bank (1)
10.1	Employment Agreement with S. James Miller dated January 1, 1996, as amended September 2000 (7)
10.2	Employment Agreement with Wayne G. Wetherell dated April 1, 1997, as amended March 1, 1999 (1)
10.3	Employment Agreement with Paul J. Devermann dated July 20, 1997, as amended March 1, 1999 (1)
10.4	Employment Agreement with William Ibbetson dated November 15, 2000 (5)
10.5	Employment Agreement with Lori Rodriguez dated April 15, 2001 (6)
10.6	Employment Agreement with Ian Fraser dated March 30, 2001 (6)
10.7	Form of Indemnity Agreement entered into by the registrant with its directors and executive officers (1)

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10.8	Consulting Agreement with John Callen dated November 14, 2000 (5)
10.9	Consultant Agreement with T. Bing Byington dated August 10, 2001.
10.10	1994 Employee Stock Option Plan (1)
10.11	1994 Nonqualified Stock Option Plan (1)
10.12	1999 Stock Option Plan(1)
10.13	Lease between Thormint I and the Company dated June 9, 1998 (1)
10.14	Sublease between Castleworks LLC and Paine and Associates dated September 28, 1999.
10.15	Lease between RDL Holding, LTD and Imaging Technology Corporation dated July 1, 2000 (5)
10.16	Commercial Lease between I.W. Systems Canada Company and 3840743 Canada, Inc. dated April 12, 2001 (7)
10.17	Commercial Lease between BOS GmbH & Co. KG and Digital Imaging International GmbH dated June 20, 2001.
10.18	License Agreement with Atlus Co., Ltd. dated March 7, 1997 (1)
10.19	Value Added Reseller Agreement with Visionics Corporation dated October 7, 1998 (1)
10.20	Teaming Agreement with PRC Inc. dated November 5, 1998 (1)
10.21	Software License and Services Subcontract with PRC Inc. dated June 29, 1999 (1)
10.22	Agreement with State Procurement Office of Arizona dated January 14, 1999 (1)

(1)

Incorporated by reference to the Company's Registration Statement for Small Business Issuers, Form SB-2 as filed with the SEC on December 20, 1999 (No. 333-93131).

(2)

Incorporated by reference to the Company's Amended Registration Statement for Small Business Issuers, Form SB-2/A as filed with the SEC on February 8, 2000.

(3)

Incorporated by reference to the Company's Amended Registration Statement for Small Business Issuers, Form SB-2/A as filed with the SEC on March 15, 2000.

(4)

Incorporated by reference to the Company's Current Report, Form 8-K as filed with the SEC on September 7, 2000.

(5)

Incorporated by reference to the Company's Annual Report, Form 10-KSB as filed with the SEC on April 2, 2001.

(6)

Incorporated by reference to the Company's Quarterly Report, Form 10QSB as filed with the SEC on May 15, 2001.

(7)

Incorporated by reference to the Company's Registration Statement for Small Business Issuers, Form SB-2 as filed with the SEC on June 29, 2001.

(8)

Incorporated by reference to the Company's Current Report, Form 8-K, as filed with the SEC on August 13, 2001.

23

(b)

Reports on Form 8-K.

    During the three months ended June 30, 2001, we filed one report on Form 8-K and one report on Form 8-K/A.

    We filed a report on Form 8-K on April 16, 2001 to report the Asset Purchase Agreement to acquire substantially all of the assets of G & A.

    We filed a report on Form 8-K/A on June 15, 2001 to file financial statements of G & A and our associated pro forma financial statements by amending Item 7 of the Current Report on Form 8-K filed by the Company on April 16, 2001.

    No other reports on Form 8-K or 8-K/A were filed during the three months ended June 30, 2001.

24

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.

IMAGEWARE SYSTEMS, INC.
By:	/s/ Wayne Wetherell
	Wayne Wetherell, Chief Financial Officer

25

EXHIBIT INDEX

Exhibit
10.9	Consultant Agreement with T. Bing Byington dated August 10, 2001
10.14	Sublease between Castleworks LLC and Paine and Associates dated September 28, 1999
10.17	Commercial Lease between BOS GmbH & Co. KG and Digital Imaging International GmbH dated June 20, 2001

QuickLinks

IMAGEWARE SYSTEMS, INC. INDEX
PART I FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

IMAGEWARE SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
IMAGEWARE SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)
IMAGEWARE SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 2001 (AMOUNTS IN THOUSANDS) (UNAUDITED)
IMAGEWARE SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)
IMAGEWARE SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

RISK FACTORS
PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS ON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

SIGNATURES
EXHIBIT INDEX

EX-10.9

                                                                    Exhibit 10.9


                                                  Consultant Name: Bing Byington
                               Effective Date: ________, 2001 ("Effective Date")

                              CONSULTANT AGREEMENT

THIS AGREEMENT is made by and between IMAGEWARE SYSTEMS, INC., and its
successors or assignees ("Client") and the undersigned BING BYINGTON (the
"Consultant").

                                    RECITALS

A.       Pursuant to a Membership Interest Purchase Agreement dated as of even
         date herewith by and between ImageWare Systems, Inc. and Castle
         Holdings LLC, Castle Holdings LLC is selling all of the outstanding
         membership interests of its subsidiaries Castleworks, LLC and E-Focus
         West LLC (collectively, the "Acquired Companies") to ImageWare Systems,
         Inc. (the "Transaction").

B.       As Consultant is the sole member and equity holder of TDI Castles LLC,
         which is a member and equity holder of membership interest in Castle
         Holdings LLC, Consultant has a beneficial financial interest in the
         closing of the Transaction.

C.       In connection with the Transaction, and to enable ImageWare Systems,
         Inc. to secure more fully the benefits of such Transaction, ImageWare
         Systems, Inc. has required as a condition to the consummation of such
         Transaction, that Consultant enter into this Agreement; and Consultant
         is entering into this Agreement and terminating his Employment
         Agreement with Castleworks, LLC dated January 31, 1999 and waiving all
         rights to severance thereunder in order to induce ImageWare Systems,
         Inc. to consummate the Transaction.

                                    AGREEMENT

NOW, THEREFORE, in consideration of the foregoing and to induce ImageWare
Systems, Inc. to consummate the Transaction, and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged,
Consultant hereby agrees as follows:

1.       ENGAGEMENT OF SERVICES. Consultant shall render such services as Client
may from time to time request in his area of experience and expertise with the
Acquired Companies for up to forty (40) hours per month during the Term (as
defined below) of this Agreement. Consultant shall, to the best of his ability,
render the services requested by the Client in a professional manner using such
skills and resources as Consultant deems appropriate.

2.       TERM OF THE AGREEMENT. This Agreement will commence on the Effective
Date and will continue in effect for a period of six (6) months ("Term"). The
Term of this Agreement may be extended by mutual consent of the parties in
writing.

3.       COMPENSATION. Client will pay Consultant a monthly fee in the amount of
$3,000 for services rendered under this Agreement. Upon termination of this
Agreement for any reason, Consultant will be paid fees and expenses on a
proportional basis for work which is then in


                                       1.



progress, to and including the effective date of such termination. Consultant
shall only receive reimbursement for business expenses that are approved in
advance by Client.

4.       INDEPENDENT CONSULTANT RELATIONSHIP. Consultant's relationship with
Client will be that of an independent consultant and nothing in this Agreement
should be construed to create a partnership, joint venture, or employer-employee
relationship. Consultant is not the agent of Client and is not authorized to
make any representation, contract, or commitment on behalf of Client. Consultant
will not be entitled to any of the benefits which Client may make available to
its employees, such as group insurance, profit-sharing or retirement benefits.
Consultant will be solely responsible for all tax returns and payments required
to be filed with or made to any federal, state or local tax authority with
respect to Consultant's performance of services and receipt of fees under this
Agreement. Client will regularly report amounts paid to Consultant by filing
Form 1099-MISC with the Internal Revenue Service as required by law. Because
Consultant is an independent consultant, Client will not withhold or make
payments for social security; make unemployment insurance or disability
insurance contributions; or obtain worker's compensation insurance on
Consultant's behalf. Consultant agrees to accept exclusive liability for
complying with all applicable state and federal laws governing self-employed
individuals, including obligations such as payment of taxes, social security,
disability and other contributions based on fees paid to Consultant. Consultant
hereby agrees to indemnify and defend Client against any and all such taxes or
contributions, including penalties and interest. Consultant is free to enter any
contract to provide services to other business entities, except any contract
which would induce Consultant to violate this Agreement or the noncompetition
agreement to which Consultant is a party in connection with the Transaction.

5.       TRADE SECRETS - INTELLECTUAL PROPERTY RIGHTS. Consultant agrees during
the Term of this Agreement and thereafter that he will take all steps reasonably
necessary to hold Client's Proprietary Information (as defined below) in trust
and confidence, will not use such Proprietary Information in any manner or for
any purpose not expressly set forth in this Agreement, and will not disclose
such Proprietary Information to any third party without first obtaining Client's
express written consent on a case-by-case basis. By way of illustration but not
limitation "Proprietary Information" includes (a) trade secrets, inventions,
mask works, ideas, processes, formulas, source and object codes, data, programs,
other works of authorship, know-how, improvements, discoveries, developments,
designs and techniques (hereinafter collectively referred to as "Inventions");
and (b) information regarding plans for research, development, new products,
marketing and selling, business plans, budgets and unpublished financial
statements, licenses, prices and costs, suppliers and customers; and (c)
information regarding the skills and compensation of employees of Client.
Notwithstanding the other provisions of this Agreement, nothing received by
Consultant will be considered to be Client's Proprietary Information if (1) it
has been published or is otherwise readily available to the public other than by
a breach of this Agreement; (2) it has been rightfully received by Consultant
from a third party without confidential limitations; or (3) it has been
independently developed for Consultant by personnel or agents having no access
to Client's Proprietary Information and has not been acquired by Client in the
Transaction.

6.       NO CONFLICT OF INTEREST. Consultant agrees during the term of this
Agreement not to accept work or enter into a contract or accept an obligation,
inconsistent or incompatible with Consultant's obligations under this Agreement
or the scope of services rendered for Client.


                                       2.



Consultant warrants that to the best of his knowledge, there is no other
existing contract or duty on Consultant's part inconsistent with this Agreement.
Consultant further agrees not to disclose to Client, or bring onto Client's
premises, or induce Client to use any confidential information that belongs to
anyone other than Client or Consultant.

7.       GOVERNING LAW. This Agreement will be governed and construed in
accordance with the laws of the State of California as applied to transactions
taking place wholly within California between California residents. Consultant
and Client each hereby expressly consent to the personal jurisdiction of the
state and federal courts located in San Diego County, California for any lawsuit
filed there arising from or related to this Agreement.

8.       SEVERABILITY. In case any one or more of the provisions contained in
this Agreement shall, for any reason, be held to be invalid, illegal or
unenforceable in any respect, such invalidity, illegality or unenforceability
shall not affect the other provisions of this Agreement, and this Agreement
shall be construed as if such invalid, illegal or unenforceable provision had
never been contained herein. If moreover, any one or more of the provisions
contained in this Agreement shall for any reason be held to be excessively broad
as to duration, geographical scope, activity or subject, it shall be construed
by limiting and reducing it, so as to be enforceable to the extent compatible
with the applicable law as it shall then appear.

9.       INJUNCTIVE RELIEF. A breach of any of the promises or agreements
contained in Section 5 of this Agreement may result in irreparable and
continuing damage to Client for which there may be no adequate remedy at law,
and Client is therefore entitled to seek injunctive relief as well as such other
and further relief as may be appropriate.

10.      ENTIRE AGREEMENT; WAIVER OF SEVERANCE. This Agreement is the final,
complete and exclusive agreement of the parties with respect to the subject
matter hereof and supersedes and merges all prior discussions between us
including, but not limited to, Consultant's Employment Agreement with
Castleworks, LLC dated January 31, 1999 (the "Former Employment Agreement").
Consultant hereby terminates any employment Consultant may have with Castleworks
LLC or E-Focus West LLC and accepts this Agreement with ImageWare. By accepting
this Agreement, Consultant hereby terminates any employment agreements or
arrangements with Castleworks LLC or E-Focus West LLC, including, without
limitation, the Former Employment Agreement, and accepts this Agreement as the
sole embodiment of his consulting terms with ImageWare. In connection with the
termination of Consultant's employment with Castleworks LLC, Consultant hereby
expressly waives all rights to notice of termination or termination payments of
any kind whatsoever (except for Consultant's right to accrued wages), including,
without limitation, all rights to severance payments under Section 6.2 of the
Former Employment Agreement. No modification of or amendment to this Agreement,
nor any waiver of any rights under this Agreement, will be effective unless in
writing and signed by the party to be charged. The terms of this Agreement will
govern all services undertaken by Consultant for Client.

                 [THIS PORTION OF PAGE INTENTIONALLY LEFT BLANK]


                                       3.



         IN WITNESS WHEREOF, the parties have caused this Independent Consultant
Services Agreement to be executed by their duly authorized representative.

CLIENT:

IMAGEWARE SYSTEMS, INC.

By: /s/ S. James Miller, Jr.
   --------------------------------------

Print Name:     S. James Miller, Jr.
            -----------------------------

Title:
      -----------------------------------


CONSULTANT:


    /s/ Bing Byington
- -----------------------------------------
BING BYINGTON


                                       4.

EX-10.14

CB          SUBLEASE                                              Exhibit 10.14
COMMERCIAL  CB RICHARD ELLIS, INC.
            BROKERAGE AND MANAGEMENT
            LICENSED REAL ESTATE BROKER


1.  PARTIES.
    This Sublease, dated September 28, 1999, is made between  Paine &
    Associates ("Sublessor"), and Castleworks, LLC ("Sublessee").

2.  MASTER LEASE.
    Sublessor is the lessee under written lease dated November 10, 1994
    wherein Curci-England Co.("Lessor") leased to Sublessor the real property
    located in the City of Costa Mesa County of Orange, State of California
    described as 535 Anton, Fourth Floor ("Master Premises").  Said lease has
    been amended by the following amendments Amendment to Lease and Parking
    License Agreement dated February 16, 1996; said lease and amendments are
    herein collectively referred to as the "Master Lease" and are attached
    hereto as Exhibit "A."

3.  PREMISES.
    Sublessor hereby subleases to Sublessee on the terms and conditions set
    forth in this Sublease the following portion of the Master Premises
    ("Premises"): Suite 400, containing 4,489 rentable square feet

4.  WARRANTY BY SUBLESSOR.
    Sublessor warrants and represents to Sublessee that the Master Lease has
    not been amended or modified except as expressly set forth herein, that
    Sublessor is not now, and as of the commencement of the Term hereof will
    not be, in default or breach of any of the provisions of the Master Lease,
    and that Sublessor has no knowledge of any claim by Lessor that Sublessor
    is in default or breach of any of the provisions of the Master Lease.

5.  TERM.
    The Term of this Sublease shall commence on November 15, 1999
    ("Commencement Date"), or when Lessor consents to this Sublease (if such
    consent is required under the Master Lease), whichever shall last occur,
    and end on May 15, 2002, ("Termination Date"), unless otherwise sooner
    terminated in accordance with the provisions of this Sublease.  In the
    event the Term commences on a date other than the Commencement Date,
    Sublessor and Sublessee shall execute a memorandum setting forth the
    actual date of commencement of the Term.  Possession of the Premises
    ("Possession") shall be delivered to Sublessee on the commencement of the
    Term.  If for any reason Sublessor does not deliver Possession to
    Sublessee on the commencement of the Term, Sublessor shall not be subject
    to any liability for such failure, the Termination Date shall not be
    extended by the delay, and the validity of this Sublease shall not be
    impaired.  Notwithstanding the foregoing, if Sublessor has not delivered
    Possession to Sublessee within thirty (30) days after the Commencement
    Date, then at any time thereafter and before delivery of Possession,
    Sublessee may give written notice to Sublessor of Sublessee's intention
    to cancel this Sublease.  Said notice shall set forth an effective date
    for such cancellation which shall be at least ten (10) days after
    delivery of said notice to Sublessor.  If Sublessor delivers Possession
    to Sublessee on or before such effective date, this Sublease shall remain
    in full force and effect.  If Sublessor fails to deliver Possession to
    Sublessee on or before such effective date, this Sublease shall be
    cancelled, in which case all consideration previously paid by Sublessee
    to Sublessor on account of this Sublease shall be returned to Sublessee,
    this Sublease shall thereafter be of no further force or effect, and
    Sublessor shall have no further liability to Sublessee on account of such
    delay or cancellation.  If Sublessor permits Sublessee to take Possession
    prior to the commencement of the Term, such early Possession shall not
    advance the Termination Date and shall be subject to the provisions of
    this Sublease, including without limitation the payment of rent.  In no
    event shall any such delays be caused by subleasing to any other entity
    or the space being returned to Landlord.

6.  RENT.
    6.1 MINIMUM RENT. Sublessee shall pay to Sublessor as minimum rent,
        without deduction, setoff, notice, or demand, at 535 Anton, Suite
        450, Costa Mesa, California or at such other place as Sublessor shall
        designate from time to time by notice to Sublessee, the sum of Eight
        Thousand Three Hundred Four and 65/100 Dollars ($8,304.65) per month,
        in advance on the first day of each month of the Term. Sublessee
        shall pay to Sublessor upon execution of this Sublease the sum of
        Eight Thousand Three Hundred Four and 65/100 Dollars ($8,304.65) as
        rent for the first month.  If the Term begins or ends on a day other
        than the first or last day of a month, the rent for the partial
        months shall be prorated on a per diem basis.  Additional provisions:
        Rent shall increase annually by five cents ($0.05) per square foot
        per month,  Full Service Gross.

    6.2 OPERATING COSTS. If the Master Lease requires Sublessor to pay to
        Lessor all, or a portion of the expenses of operating the building
        and/or project of which the Premises are a part ("Operating Costs"),
        including but not limited to taxes, utilities, or insurance, then
        Sublessee shall pay to Sublessor as additional rent Twenty-two and 6/10
        percent (22.6%) of the amounts payable by Sublessor for Operating
        Costs incurred during the Term. Such



        additional rent shall be payable as paid when Operating Costs are
        payable by Sublessor to Lessor.  If the Master Lease provides for the
        payment by Sublessor of Operating Costs on the basis of an estimate
        thereof, then as and when adjustments between estimated and actual
        Operating Costs are made under the Master Lease, the obligations of
        Sublessor and Sublessee hereunder shall be adjusted in a like manner;
        and if any such adjustment shall occur after the expiration or earlier
        termination of the Term, then the obligations of Sublessor and
        Sublessee under this Subsection 6.2 shall survive such expiration or
        termination. Sublessor shall, upon request by Sublessee, furnish
        Sublessee with copies of all statements submitted by Lessor of actual
        or estimated Operating Costs during the Term, 2000 Base Year.

7.  SECURITY DEPOSIT.
    Sublessee shall deposit with Sublessor upon execution of this Sublease the
    sum of Eight Thousand Seven Hundred Fifty-Three and 55/100 Dollars
    ($8,753.55) as security for Sublessee's faithful performance of Sublessee's
    obligations hereunder ("Security Deposit").  If Sublessee fails to pay rent
    or other charges when due under this Sublease, or fails to perform any of
    its other obligations hereunder [ILLEGIBLE] hereunder and unpaid, for the
    payment of any other sum for which Sublessor may become obligated by reason
    of Sublessee's default or breach, or for any loss or damage sustained by
    Sublessor as a result of Sublessee's default or breach.  If Sublessor so
    uses any portion of the Security Deposit, Sublessee shall, within ten (10)
    days after written demand by Sublessor, restore the Security Deposit to the
    full amount originally deposited, and Sublessee's failure to do so shall
    constitute a default under this Sublease.  Sublessor shall not be required
    to keep the Security Deposit separate from its general accounts, and shall
    have no obligation or liability for payment of interest on the Security
    Deposit.  In the event Sublessor assigns its interest in this Sublease,
    Sublessor shall deliver to its assignee so much of the Security Deposit as
    is then held by Sublessor.  Within ten (10) days after the Term has
    expired, or Sublessee has vacated the Premises, or any final adjustment
    pursuant to Subsection 6.2 hereof has been made, whichever shall last
    occur, and  provided Sublessee is not then in default of any of its
    obligations hereunder, the Security Deposit, or so much thereof as had not
    theretofore been applied by Sublessor, shall be returned to Sublessee or to
    the last assignee, if any, of Sublessee's interest hereunder.

8.  USE OF PREMISES.
    The Premises shall be used and occupied only for general office use -
    computer software + hardware integration, and for no other use or purpose.

9.  ASSIGNMENT AND SUBLETTING.
    Sublessee shall not assign this Sublease or further sublet all or any
    part of the Premises without the prior written consent of Sublessor (and
    the consent of Lessor, if such is required under the terms of the Master
    Lease).

10. OTHER PROVISIONS OF SUBLEASE.
    All applicable terms and conditions of the Master Lease are incorporated
    into and made a part of this Sublease as if Sublessor were the lessor
    thereunder, Sublessee the lessee thereunder, and the Premises the Master
    Premises, except for the following: .  Sublessee assumes and agrees to
    perform the lessee's obligations under the Master Lease during the Term
    to the extent that such obligations are applicable to the Premises,
    except that the obligation to pay rent to Lessor under the Master Lease
    shall be considered performed by Sublessee to the extent and in the
    amount rent is paid to Sublessor in accordance with Section 6 of this
    Sublease. Sublessee shall not commit or suffer any act or omission that
    will violate any of the provisions of the Master Lease.  Sublessor shall
    exercise due diligence in attempting to cause Lessor to peform its
    obligations under the Master Lease for the benefit of Sublessee. If the
    Master Lease terminates, this Sublease shall terminate and the parties
    shall be relieved of any further liability or obligation under this
    Sublease, provided however, that if the Master Lease terminates as a
    result of a default or breach by Sublessor or Sublessee under this
    Sublease and/or the Master Lease, then the defaulting party shall be
    liable to the nondefaulting party for the damage suffered as a result of
    such termination.  Notwithstanding the foregoing, if the Master Lease
    gives Sublessor any right to terminate the Master Lease in the event of
    the partial or total damage, destruction, or condemnation of the Master
    Premises or the building or project of which the Master Premises are a
    part, the exercise of such right by Sublessor shall not constitute a
    default or breach hereunder.

11. ATTORNEYS' FEES.
    If Sublessor, Sublessee, or Broker shall commence an action against the
    other arising out of or in connection with this Sublease, the prevailing
    party shall be entitled to recover its costs of suit and reasonable
    attorney's fees.

12. AGENCY DISCLOSURE:
    Sublessor and Sublessee each warrant that they have dealt with no other
    real estate broker in connection with this transaction except: CB RICHARD
    ELLIS, INC., who represents Sublessor and Grubb & Ellis, who represents
    Sublessee.  In the event that CB RICHARD ELLIS, INC. represents both
    Sublessor and Sublessee, Sublessor and Sublessee hereby confirm that they
    were timely advised of the dual representation and that they consent to the
    same, and that they do not expect said broker to disclose to either of them
    the confidential information of the other party.

13. COMMISSION.
    Upon execution of this Sublease, and consent thereto by Lessor (if such
    consent is required under the terms of the Master Lease), Sublessor shall
    pay Broker a real estate brokerage commission in accordance with
    Sublessor's contract with Broker for the subleasing of the Premises, if
    any, and otherwise in the amount of per separate agreement Dollars ($ ),
    for services rendered in effecting this Sublease.  Broker is hereby made a
    third party beneficiary of this Sublease for the purpose of enforcing its
    right to said commission.

14. NOTICES.
    All notices and demands which may or are to be required or permitted to
    be given by either party on the other hereunder shall be in writing.  All
    notices and demands by the Sublessor to Sublessee shall be sent by United
    States Mail, postage prepaid, addressed to the Sublessee at the Premises,
    and to the address hereinbelow, or to such other place as Sublesssee may
    from



     time to time designate in a notice to the Sublessor. All notices and
     demands by the Sublessee to Sublessor shall be sent by United States
     Mail, postage prepaid, addressed to the Sublessor at the address set
     forth herein, and to such other person or place as the Sublessor may
     from time to time designate in a notice to the Sublessee.

     To Sublessor:   535 Anton, Suite 450, Costa Mesa, California
                  --------------------------------------------------------

     To Sublessee:   535 Anton, Suite 400, Costa Mesa, California
                  --------------------------------------------------------

15.  CONSENT BY LESSOR.
     THIS SUBLEASE SHALL BE OF NO FORCE OR EFFECT UNLESS CONSENTED TO BY
     LESSOR WITHIN 10 DAYS AFTER EXECUTION HEREOF, IF SUCH CONSENT IS REQUIRED
     UNDER THE TERMS OF THE MASTER LEASE.

16.  COMPLIANCE.
     The parties hereto agree to comply with all applicable federal, state
     and local laws, regulations, codes, ordinances and administrative orders
     having jurisdiction over the parties, property or the subject matter of
     this Agreement, including, but not limited to, the 1964 Civil Rights Act
     and all amendments thereto, the Foreign Investment in Real Property Tax
     Act, the Comprehensive Environmental Response Compensation and Liability
     Act, and The Americans With Disabilities Act.

Please see 17. and 18. below

Sublessor: Paine & Associates              Sublessee:   Castleworks, LLC
          --------------------------                 --------------------------

By:    /s/   David M. Paine                By:    /s/    John Olson
   ---------------------------------          ---------------------------------

Title:       President                     Title:        C.E.O.
      ------------------------------             ------------------------------

By:                                        By:    /s/    Jerry Krant
   ---------------------------------          ---------------------------------

Title:                                     Title:        MEMBER
      ------------------------------             ------------------------------

Date:                                      Date:         10/25/99
     -------------------------------            -------------------------------


                         LESSOR'S CONSENT TO SUBLEASE

The undersigned ("Lessor"), lessor under the Master Lease, hereby consents to
the foregoing Sublease without waiver of any restriction in the Master Lease
concerning further assignment or subletting. Lessor certifies that, as of the
date of Lessor's execution hereof, Sublessor is not in default or breach of
any of the provisions of the Master Lease, and that the Master Lease has not
been amended or modified except as expressly set forth in the foregoing
Sublease.


Lessor:       Curci-England Co.
       -----------------------------

By:
   ---------------------------------

Title:
      ------------------------------

By:
   ---------------------------------

Title:
      ------------------------------

Date:
     -------------------------------


- --------------------------------------------------------------------------------
  CONSULT YOUR ADVISORS - This document has been prepared for approval by
  your attorney. No representation or recommendation is made by Broker as to
  the legal sufficiency or tax consequences of this document or the transaction
  to which it relates. These are questions for your attorney.

  In any real estate transaction, it is recommended that you consult with a
  professional, such as a civil engineer, industrial hygienist or other person,
  with experience in evaluating the condition of the property, including the
  possible presence of asbestos, hazardous materials and underground storage
  tanks.
- --------------------------------------------------------------------------------

17.  PARKING.

     Sublessor shall provide Sublessee four (4) parking spaces per 1,000
     usable square feet, free of charge up to May 17, 2001. Thereafter, parking
     shall be available at a cost of $25.00 per stall per month for the balance
     of the Term. Sublessee shall be subject to a one-time fee of $15.00 per
     parking card.

18.  TENANT IMPROVEMENTS.
     Sublessor shall grant Sublessee a concession package of $13,232.
     $10,000 shall be allocated to Tenant Improvements, and $3,232 shall
     offset the commission shortfall from a market fee.

19.  BASE YEAR.

     Sublessor shall grant Sublessee a 2000 base year for calculating
     operating expenses.



                                LEASE GUARANTY

THIS LEASE GUARANTY ("Guaranty") is made by John Olson, Jerry Krant and Bing
Byington, as individuals ("Guarantor") in favor of Paine & Associates Inc., a
California corporation ("Sublessor") in connection with that certain Sublease
dated as of September 28, 1999 (the "Agreement") pursuant to which Sublessor
and Castle Works LLC, a California Limited Liability Corporation ("Sublessee")
are to enter into that certain Office Sublease dated as of September 28, 1999
("Sublease"), concerning certain premises (the "Premises") located at Suite
400 of the building at 535 Anton Boulevard, Costa Mesa, California (the
"Building"). As a material inducement to and in consideration of Sublessor
entering into the Sublease, Sublessor having indicated that it would not
enter into the Sublease without the execution of this Guaranty, Guarantor
does hereby covenant and agree with Sublessor as follows:

1.   The Sublease is hereby incorporated into this Guaranty and made a part
     hereof by this reference and is referred to herein as the "Sublease".

2.   Guarantor hereby unconditionally and irrevocably guarantees, as a
     primary obligor and not as a surety, and promises to perform and be
     liable for, any and all obligations and liabilities of Sublessee under
     the Sublease, including, without limitation the payment of rent and
     all other sums now or hereafter becoming due or payable under the Sublease
     and the full timely performance of all other covenants, obligations and
     duties to be performed by Sublessee under the Sublease. Guarantor's
     obligations under this Guaranty are continuing and unconditional.

3.   A separate action be brought or prosecuted against Guarantor whether
     or not can action is brought or prosecuted against any other Guarantor or
     Sublessee. If Sublessee defaults under the Sublease, Sublessor may proceed
     immediately against Guarantor or Sublessee, or both, or Sublessor may
     enforce against Guarantor or Sublessee, or both, any rights that it has
     under the Sublease or against Guarantor pursuant to this Guaranty. If the
     Sublease terminates, Sublessor may enforce any remaining rights thereunder
     against Guarantor without giving prior notice to Sublessee or Guarantor,
     and without making any demand on either of them. This Guaranty shall not be
     affected by Sublessor's failure to delay in enforcing any of its rights
     hereunder or under this Sublease.

4.   Guarantor hereby waives notice or the giving of its consent to any
     extensions, amendments or modifications which may hereafter be made to the
     terms of the Sublease, and this Guaranty shall guarantee the performance
     of the Sublease as extended, amended or modified, or as the same may be
     assigned from time to time. Guarantor waives the right to require Sublessor
     to (i) proceed against Sublessee, (ii) proceed against or exhaust any
     security that Sublessor holds from Sublessee, or (iii) pursue any remedy in
     Sublessor's power. Guarantor waives any defense by reason of any disability
     of Sublessee, any statute of limitations and any other defense based on any
     termination of Sublessee's liability under the Sublease for any cause.
     Until all of Sublessee's obligations to Sublessor have been discharged in
     full, Guarantor shall have no right of subrogation against Sublessee.

5.   Guarantor waives its right to enforce any remedies that Sublessor now
     has, or later may have, against Sublessee. Guarantor waives any right to
     participate in any security now or later held by Sublessor. Guarantor
     waives all presentments, demands for performance, notices of
     non-performance, protests, notice of protests, notices of dishonor and
     notices of acceptance of this Guaranty, and waives all notices of
     existence, creation, or incurring of new or additional obligations from
     Sublessee to Sublessor. Without limiting the generality of the waivers
     contained in this Guaranty, Guarantor hereby expressly waives any and all
     benefits arising under California Civil Code Sections 2809, 2810, 2819,
     2845, 2848, 2849 and 2850.

6.   If Sublessor disposes of its interest in the Sublease, "Sublessor" as
     used in Guaranty, shall mean Sublessor's successors-in-interest and
     assigns. If Sublessor is required to enforce Guarantor's obligations by
     legal proceedings, Guarantor shall pay to Sublessor all costs incurred,
     including, without limitation, Sublessor's reasonable attorney's fees and
     all costs and other expenses incurred in any collection or attempted
     collection or in any negotiations relative to the obligations hereby
     guaranteed, or in enforcing this Guaranty against the undersigned,
     individually and jointly.

7.   This Guaranty will continue unchanged by any bankruptcy, reorganization
     or insolvency of Sublessee or any successor or assignee thereof or by
     any disaffirmance or abandonment by a trustee of Sublessee.



                                   EXHIBIT B

8.   Guarantor's obligations under this Guaranty may not be assigned and shall
     be binding upon Guarantor's heirs and successors. This Guaranty may not
     be modified or amended in any way without the express written consent of
     Sublessor. If any provision of this Guaranty shall be invalid or
     unenforceable, the remainder of this Guaranty shall not be affected
     thereby and shall otherwise remain valid and enforceable. This Guaranty
     shall be governed by the laws of, and may be enforced in the courts of,
     the State of California.

9.   The use of the singular herein shall include the plural. The obligation
     of two or more parties shall be joint and several. The terms and provisions
     of this Guarantee shall be binding upon and inure to the benefit of the
     respective successors and assigns of the parties herein named.

10.  Any married person who executed this Guarantee thereby obligates his or
     her separate property as well as his or her share of the community property
     for the performance of this Guarantee.

THE UNDERSIGNED HAS READ AND UNDERSTANDS THE TERMS II: THIS GUARANTY,
INCLUDING, WIHTOUT LIMITATION, THE WAIVERS CONTAINED IN THIS GUARANTY.

Executed on this 4th day of October, 1999.

Address of Guarantor:


                                         By:        /s/ John Olson
- ------------------------------------        -----------------------------------
                                                        John Olson
- ------------------------------------

- ------------------------------------




                                         By:        /s/ Jerry Krant
- ------------------------------------        -----------------------------------
                                                        Jerry Krant
- ------------------------------------

- ------------------------------------




                                         By:
- ------------------------------------        -----------------------------------

- ------------------------------------

- ------------------------------------


                                     B-2



                           FIRST AMENDMENT TO SUBLEASE

   This First Amendment ("First Amendment") is made between Castle Works LLC
("Sublessee") and Paine & Associates, Inc. ("Sublessor") in connection with
that certain Sublease dated September 28, 1999 (the "Agreement") pursuant to
which Sublessor and Sublessee have entered into that certain office sublease
dated September 28, 1999 ("Sublease") concerning certain premises (the
"Premises") located at Suite 400 of the building at 535 Alton Boulevard,
Costa Mesa, California (the "Building"). Sublessee does hereby covenant and
agree with Sublessor as follows:

1. The Sublease is hereby incorporated into this First Amendment and a part
   hereof by this reference and is referred to herein as the Sublease.

2. ADDITIONAL SPACE TERM AND COMMENCEMENT DATE. The term for Sublessee's
   subleasing of the Additional Space shall commence on November 15, 1999
   ("Additional Space Commencement Date") and shall be coterminous with
   Sublessee's leasing of the Original Premises, expiring on May 15, 2002.

3. RENT. Commencing as of Additional Space Commencement Date and for the
   duration of the Additional Space Term, Sublessee shall pay Monthly Base Rent
   for the Additional Space in accordance with the following schedule:

           Months               Monthly Base Rent
           ----------           -----------------
           *-12                    $9,353.60
           13-24                   $9,606.40
           25-5/15/02              $9,859.20

           *Additional Space Commencement Date

5. TENANT IMPROVEMENTS. Sublessee, at Sublessee's sole cost and expense,
   shall install two (2) doors labeled Door #1 and Door #2 on Exhibit "C"
   attached hereto and incorporated as part of the Sublease.

   If as a result of Sublessee desired Tenant Improvements, Sublessor or
   Master Lessor is required for any reason (i.e. governmental codes, ADA
   requirements, Fire Life Safety etc.) to upgrade portions of Sublessor's or
   Sublessee's Premises, Sublessee shall at Sublessee's sole cost pay for the
   expense of said required upgrades. See Exhibit "A" attached
   (Section 1134B).

6. ADDITIONAL SECURITY DEPOSIT. Upon execution of this Amendment, Sublessee
   shall deposit with Sublessor an additional $1,105.65 worth of Security
   Deposit (for a total Security Deposit of $9,859.20), which shall be held by
   Sublessor pursuant to Paragraph 7 of the Sublease as additional security for
   the performance of Sublessee's obligations under the Sublease as amended
   hereby.

7. BROKER. Real estate brokers specified in Paragraph 12 of the Sublease
   shall be paid a commission on Additional Space per the listing agreement
   between CB Richard Ellis and Sublessor.

AGREED TO:

SUBLESSEE: CASTLE WORKS LLC                 SUBLESSOR: PAINE & ASSOCIATES, INC.

By: /s/ John Olson  /s/ Jerry Krant         By:  /s/  David M. Paine
   ----------------------------------          --------------------------------

Title:         CEO                          Title:    President
      -------------------------------             -----------------------------

Date:     11/15/99                          Date:     11/15/99
      -------------------------------             -----------------------------




                              CONSENT TO SUBLEASE

     THIS CONSENT TO SUBLEASE (this "AGREEMENT") is made as of November 2,
1999, by and among BRE/South Coast, L.L.C., a Delaware limited liability
company ("LANDLORD"), Paine & Associates, a California corporation,
("TENANT"), and Castleworks, LLC, a California limited liability company
("SUBTENANT").

                                   RECITALS

     A.     Reference is hereby made to that certain Office Lease, dated
November 10, 1994, by and between Landlord and Tenant, and any amendments
thereto (collectively, the "LEASE"), for space on the 4th floor (the
"PREMISES") in that certain office building located at 535 Anton Boulevard,
Costa Mesa, California (the "BUILDING").

     B.     Pursuant to the terms of ARTICLE 28 of the Lease, Tenant has
requested Landlord's consent to that certain Sublease, dated SEPTEMBER 28,
1999, by and between Tenant and Subtenant (the "SUBLEASE"), with respect to a
subletting by Subtenant of a portion of the Premises, as more particularly
described in the Sublease (the "SUBLEASED PREMISES"). A copy of the Sublease
is attached hereto as EXHIBIT A. Landlord is willing to consent to the
Sublease on the terms and conditions contained herein.

     C.     All defined terms not otherwise expressly defined herein shall
have the respective meanings given in the Lease.

                                  AGREEMENT

     NOW THEREFORE, in consideration of the mutual covenants contained
herein, the sufficiency of which is hereby acknowledged, the parties hereto
agree as follows.

     1.     LANDLORD'S CONSENT.  Landlord hereby consents to the Sublease;
provided however, notwithstanding anything contained in the Sublease to the
contrary, such consent is granted by Landlord only upon the terms and
conditions set forth in this Agreement. The Sublease is subject and
subordinate to the Lease. Landlord shall not be bound by any of the terms,
covenants, conditions, provisions or agreements of the Sublease.

     2.     NON-RELEASE OF TENANT; FURTHER TRANSFERS.  Neither the Sublease
nor this consent thereto shall release or discharge Tenant from any
liability, whether past, present or future, under the Lease or alter the
primary liability of Tenant to pay the rent and perform and comply with all
of the obligations of Tenant to be performed under the Lease (including the
payment of all bills rendered by Landlord for charges incurred by Subtenant
for services and materials supplied to the Subleased Premises). Neither the
Sublease nor this consent thereto shall be construed as a waiver of
Landlord's right to consent to any further subleasing either by Tenant or by
Subtenant or to any assignment by Tenant of the Lease or assignment by
Subtenant of the Sublease, or as a consent to any portion of the Subleased
Premises being used or occupied by any other party. Landlord may consent to
subsequent subleasing and assignments of the Lease or the Sublease or any
amendments or modifications thereto without notifying Tenant nor anyone else
liable under the Lease and without obtaining their consent. No such action by
Landlord shall relieve such persons from any liability to Landlord or
otherwise with regard to the Subleased Premises.



     3.     RELATIONSHIP WITH LANDLORD.  Tenant hereby assigns and
transfers to Landlord Tenant's interest in the Sublease and all rentals and
income arising therefrom, subject to the terms of this SECTION 3. Landlord,
by consenting to the Sublease agrees that until a default shall occur in the
performance of Tenant's obligations under the Lease, Tenant may receive,
collect and enjoy the rents accruing under the Sublease. In the event Tenant
shall default in the performance of its obligations to Landlord under
SECTION 21.1 of the Lease (whether or not Landlord terminates the Lease),
Landlord may, in connection with SECTION 22.1 of the Lease, at its option by
notice to Tenant, either (i) terminate the Sublease, (ii) elect to receive and
collect, directly from Subtenant, all rent and any other sums owing and to be
owed under the Sublease, as further set forth in SECTION 3.1, below, or (iii)
elect to succeed to Tenant's interest in the Sublease and cause Subtenant to
attorn to Landlord, as further set forth in SECTION 3.2, below.

            3.1     LANDLORD'S ELECTION TO RECEIVE RENTS.  Landlord shall
not, by reason of the Sublease, nor by reason of the collection of rents or
any other sums from the Subtenant pursuant to SECTION 3(ii), above, be deemed
liable to Subtenant for any failure of Tenant to perform and comply with any
obligation of Tenant, and Tenant hereby irrevocably authorizes and directs
Subtenant, upon receipt of any written notice from Landlord stating that a
default exists in the performance of Tenant's obligations under the Lease, to
pay to Landlord the rents and any other sums due and to become due under the
Sublease. Tenant agrees that Subtenant shall have the right to rely upon any
such statement and request from Landlord, and that Subtenant shall pay any
such rents and any other sums to Landlord without any obligation or right to
inquire as to whether such default exists and notwithstanding any notice from
or claim from Tenant to the contrary. Tenant shall not have any right or
claim against Subtenant for any such rents or any other sums so paid by
Subtenant to Landlord. Landlord shall credit Tenant with any rent received by
Landlord under such assignment but the acceptance of any payment on account
of rent from Subtenant as the result of any such default shall in no manner
whatsoever be deemed an attornment by Landlord to Subtenant or by Subtenant
to Landlord, be deemed a waiver by Landlord of any provision of the Lease or
serve to  release Tenant from any liability under the terms, covenants,
conditions, provisions or agreements under the Lease. Notwithstanding the
foregoing, any other payment of rent from Subtenant directly to Landlord,
regardless of the circumstances or reasons therefor, shall in no manner
whatsoever be deemed an attornment by Subtenant to Landlord in the absence of
a specific written agreement signed by Landlord to such an effect.

            3.2     LANDLORD'S ELECTION OF TENANT'S ATTORNMENT.  In the event
Landlord elects, at its option, to cause Subtenant to attorn to Landlord
pursuant to SECTION 3(iii), above, Landlord shall undertake the obligations
of Tenant under the Sublease from the time of the exercise of the option, but
Landlord shall not (i) be liable for any prepayment of more than one month's
rent or any security deposit paid by Subtenant, (ii) be liable for any
previous act or omission of Tenant under the Lease or for any other defaults
of Tenant under the Sublease, (iii) be subject to any defenses or offsets
previously accrued which Subtenant may have against Tenant, or (iv) be bound
by any changes or modifications made to the Sublease without the written
consent of Landlord.

     4.     TENANT IMPROVEMENTS.  Tenant and Landlord hereby agree to amend
SECTION 6 of the Second Amendment to Office Lease and Parking License
Agreement by and between Landlord and Tenant and dated July 27, 1997 (the
"SECOND AMENDMENT"). The "$47,628.00" Allowance referenced in the Second
Amendment shall be deleted and inserted in its place shall be the following:
"Thirteen Thousand, Two Hundred and Thirty Two Dollars ($13,232.00)".


                                     -2-


With respect to said Allowance, in no event shall Landlord be responsible for
paying more than $13,232.00 toward any costs associated with the subleasing
or improvement of said Sublease Premises. Tenant hereby forfeits all rights
to the original Allowance noted in SECTION 6, amounting to $47,628.00. Tenant
may attribute up to $13,232.00 Dollars of the new Allowance toward the
payment of leasing commissions in connection with subleasing the Sublease
Premises.

     5.     GENERAL PROVISIONS.

            5.1     CONSIDERATION FOR SUBLEASE.  Tenant and Subtenant
represent and warrant that there are no additional payments of rent or any
other consideration of any type payable by Subtenant to Tenant with regard to
the Subleased Premises other than as disclosed in the Sublease.

            5.2     BROKERAGE COMMISSION.  Tenant and Subtenant covenant and
agree that under no circumstances shall Landlord be liable for any brokerage
commission or other charge or expense in connection with the Sublease and
Tenant and Subtenant agree to protect, defend, indemnify and hold Landlord
harmless from the same and from any cost or expense (including but not
limited to attorneys' fees) incurred by Landlord in resisting any claim for
any such brokerage commission.

            5.3     RECAPTURE.  This consent shall in no manner be construed
as limiting Landlord's ability to exercise its rights to recapture any
portion of the Premises, as set forth in SECTION 28.3 of the Lease, in the
event of a proposed future sublease or assignment of such portion of the
Premises.

            5.4     GOVERNING LAW.  The terms and provisions of this
Agreement shall be construed in accordance with and governed by the laws of
the State of California.

            5.5     BINDING EFFECT.  This Agreement shall be binding upon and
inure to the benefit of the parties hereto, their heirs, successors and
assigns. As used herein, the singular number includes the plural and the
masculine gender includes the feminine and neuter.

            5.6     CAPTIONS.  The paragraph captions utilized herein are in
no way intended to interpret or limit the terms and conditions hereof;
rather, they are intended for purposes of convenience only.

            5.7     SEVERABILITY.  If any term, provision or condition
contained in this Agreement shall, to any extent, be invalid or
unenforceable, the remainder of this Agreement, or the application of such
term, provision or condition to persons or circumstances other than those
with respect to which it is invalid or unenforceable, shall not be affected
thereby, and each and every other term, provision and condition of this
Agreement shall be valid and enforceable to the fullest extent possible
permitted by law.

            5.8     ATTORNEYS' FEES.  If either party commences litigation
against the other for the specific performance of this Agreement, for damages
for the breach hereof or otherwise for enforcement of any remedy hereunder,
the parties hereto agree to and hereby do waive any right to a trial by jury
and, in the event of any such commencement of litigation, the prevailing party


                                      -3-



shall be entitled to recover from the other party such costs and reasonable
attorneys' fees as may have been incurred.

     IN WITNESS WHEREOF, the parties have executed this Consent to Sublease
Agreement as of the day and year first above written.

                                       "LANDLORD":

                                       BRE/SOUTH COAST L.L.C.,
                                       a Delaware limited liability company

                                       By: /s/ [ILLEGIBLE]
                                          --------------------------------------
                                          Its: Vice President
                                              ----------------------------------

                                       By:
                                          --------------------------------------
                                          Its:
                                              ----------------------------------

                                       "TENANT":
                                       PAINE & ASSOCIATES
                                       a California corporation

                                       By: /s/ David M. Paine
                                          --------------------------------------
                                          Its: President
                                              ----------------------------------

                                       By:
                                          --------------------------------------
                                          Its:
                                              ----------------------------------

                                       "SUBTENANT":

                                       CASTLEWORKS, LLC.,
                                       a California limited liability company

                                       By: /s/ John Olson
                                          --------------------------------------
                                          Its: Manager
                                              ----------------------------------

                                       By: /s/ Jerry Krant
                                          --------------------------------------
                                          Its: CEO
                                              ----------------------------------


                                       -4-


                                   EXHIBIT A

                                  THE SUBLEASE


                               EXHIBIT A - Page 1




                        SECOND AMENDMENT TO OFFICE LEASE
                         AND PARKING LICENSE AGREEMENT

         THIS SECOND AMENDMENT TO OFFICE LEASE AND PARKING LICENSE AGREEMENT
("Amendment") is made and entered into as of July 27, 1997, by and between
CURCI-ENGLAND CO. L.P., a California limited partnership ("Landlord"),
successor-in-interest to Curci England Co. ("Curci"), and PAINE & ASSOCIATES,
INC., a California corporation ("Tenant").


                                    RECITALS:

         A. Curci and Tenant entered into that certain Office Lease dated as
of November 10, 1994, which was amended by that certain Amendment to Lease
and Parking License Agreement dated February 16, 1996 ("First Amendment")
between Landlord and Tenant (as amended, the "Lease"), concerning certain
premises (the "Premises") located at Suite 450 of the building at 535 Anton
Boulevard [1B], Costa Mesa, California (the "Building"), and more
particularly described in the Lease, a copy of which is attached hereto as
EXHIBIT A.

         B. Concurrently with the execution of the Lease, Landlord and Tenant
entered into that certain Parking License Agreement pertaining to Tenant's
parking rights at the Building (the "Parking Agreement"), a copy of which is
attached hereto as EXHIBIT B.

         C. Landlord and Tenant desire to expand the Premises to include an
additional approximately 4,489 rentable square feet of area on the fourth
floor of the Building, to extend the Term of the Lease and to otherwise
modify the Lease and the Parking Agreement as set forth in this Amendment,
which modifications shall be deemed effective as of the "New Commencement
Date" referenced in Paragraph 2 below.

                               AGREEMENT:

         NOW, THEREFORE, in consideration of the mutual covenants and
agreements herein contained and for other good and valuable consideration,
the receipt and sufficiency of which are hereby acknowledged, Landlord and
Tenant hereby amend the Lease and the Parking Agreement and agree as follows:

         1. INCORPORATION; DEFINED TERMS. The Lease and the Parking Agreement
are hereby incorporated into this Amendment by this reference. All
capitalized terms used and not otherwise defined in this Amendment, but
defined in the Lease or in the Parking Agreement, shall have the same meaning
in this Amendment as in the Lease or the Parking Agreement, as the case may
be.

         2. EXPANSION OF PREMISES. Tenant has exercised Tenant's First Right
to Lease the First Offer Space described in Paragraph 9 of the First
Amendment. Effective as of the date hereof, Landlord hereby leases to Tenant
and Tenant hereby leases from Landlord, the additional premises located
contiguous to the Premises, containing approximately 4,489 rentable square
feet as shown on. EXHIBIT C attached hereto (the "First Offer Space"), upon and
subject to all of the terms and conditions of the Lease as amended by this
Amendment. EXHIBIT C attached hereto showing the original Premises, the
Additional Space added pursuant to the First Amendment ("Additional Space")
and the First Offer Space shall replace EXHIBIT A to the Lease as the
description of the Premises. From and after the "New Commencement Date"
referenced in Paragraph 3 below, the Premises, the Additional Space and the
First Offer Space shall be referred to as Suites 400 and 450 of the Building
and all references in the Lease and in the Parking Agreement to the "Premises",
as amended by this Amendment, shall mean and refer to Suites 400 and 450 of
the Building which shall include the original Premises, the Additional Space
and the First Offer Space. References herein to the First Offer Space shall
mean the First Offer Space shown on EXHIBIT C attached hereto and references
herein to the "Existing Premises" shall mean only Suite 450 of the Building
as shown in the Lease consisting of the original Premises and the Additional
Space.

         3. NEW COMMENCEMENT DATE. Tenant's leasing of the First Offer Space
shall commence as of the date hereof, however, Tenant's obligation to pay
rent with respect to the First Offer Space shall commence July 27, 1997 (the
"New Commencement Date")

         4. EXTENSION OF LEASE TERM. Effective as of the date hereof, the
Term of the Lease as to both the Existing Premises and the First Offer Space
shall be extended to expire on May 16, 2002 (herein, the "Extended Term").

         5. SUBSTITUTION OF FUNDAMENTAL LEASE PROVISIONS. Effective as of the
New Commencement Date, the Fundamental Lease Provisions which (a) the parties
desire to amend or (b) are affected by the addition of the First Offer Space
to the Existing Premises and the extension of the Lease Term, shall be
modified to read as follows:

         1.1 Premises:   Project: South Coast Metro Center
                         Building: 535 Anton Boulevard [1B]
                         Suites: 400 and 450      Floor: 4th
                         City: Costa Mesa         County: Orange
                         State: California

         1.2 Floor Area: Rentable Area: 19,838 square feet
                         Usable Area: 17,541 square feet

         1.3 Term:       Approximately Fifty-Seven (57) months
                         New Commencement Date: July 27, 1997
                         New Expiration Date: May 16, 2002.

         1.4 Basic Rent:       Period            Rent Per Month
                               ------            --------------

             Suite 450     8/1/97-5/16/01         $23,023.50
                           5/17/01-5/16/02        $26,860.75

             Suite 400     7/27/97-5/16/01        $7,631.30*
                           5/17/01-5/16/02        $7,855.75

         *The first month's rent for the First Offer Space shall be due and
          payable upon Tenant's execution of this Amendment.

         1.5 Expenses: As to both the Existing Premises and the First Offer
Space, Tenant shall pay Tenant's Share of all Expenses that exceed Landlord's
Base Year Costs together with other items of Expense as set forth in
Article 6. Tenant's Share as to the original Premises consisting of 9,557
rentable square feet is 3.94%. The Base Year for purposes of determining
Tenant's Share of Expenses for the original Premises shall remain calendar
year 1994. Tenant's Share as to the Additional Space consisting of 5,792
rentable square feet shall be 2.37%. The Base Year for purposes of
determining Tenant's Share of Expenses for the Additional Space shall remain
calendar year 1996. Tenant's Share as to the First Offer Space consisting of
4,489 rentable square feet shall be 1.83%. The Base Year for purposes of
determining Tenant's Share of Expenses for the First Offer Space shall be
calendar year 1997. Expenses shall be grossed up to reflect a minimum
occupancy of ninety five percent (95%) as provided in the Lease.

         1.6 After-Hours Charges: Fixed for the Extended Term at the rates set
forth in Section 1.6 of the Lease.

         1.8 Security Deposit: Upon execution of this Amendment, Tenant shall
pay to Landlord the sum of $7,855.75 to be held by Landlord in accordance
with Article 9 of the Lease as additional security deposit together with the
$26,535.00 presently held by Landlord as a security deposit for the Original
Premises (for a total security deposit of $34,390.75).


                                       -2-


           1.9  Landlord's Address for Notices:   Curci-England Co., L.P.
                                                  c/o Lakeside Realty
                                                  535 Anton Boulevard, Suite 150
                                                  Costa Mesa, California  92626

           1.10 Tenant's Address for Notices: From and after the New
Commencement Date: 535 Anton Boulevard, Suite 450, Costa Mesa, California
92626; prior to the New Commencement Date, as set forth in Section 1.10 of
the Lease.

           1.11 Brokers: CB Commercial Real Estate Group, Inc. and Lakeside
Realty as to the leasing of the First Offer Space.

           1.12 Guarantee: The performance of Tenant's obligations under the
Lease as amended by this Amendment shall be guaranteed by David M. Paine and
Patricia Paine, pursuant to a Lease Guaranty in the form attached hereto as
EXHIBIT E to be executed by the Guarantors prior to Landlord's execution of
this Amendment. Such Lease Guaranty shall supplement the existing Guarantee of
Lease executed by the Guarantors as a condition to Landlord's execution of the
Lease.

           6.   CONDITION OF FIRST OFFER SPACE. During the first twenty-four
(24) months of the Extended Term, the First Offer Space will be occupied by
the existing occupant. The Falcor Group, Inc. d/b/a ARTEX ("Artex") pursuant
to a sublease agreement between Tenant and Artex which must be negotiated and
executed by such parties on or before July 27, 1997 as a condition to
Landlord's obligations under this Amendment. Consequently, Tenant hereby
accepts possession of the First Offer Space in its current as-is condition,
and acknowledges and agrees that Landlord shall have no obligation whatsoever
to improve the First Offer Space while Artex is in possession of the First
Offer Space. Upon the vacation of the First Offer Space by Artex, Landlord
shall provide Tenant with a tenant improvement allowance of $47,628.00 (the
"Allowance"), in accordance with the Work Letter Agreement attached hereto as
EXHIBIT D (the "Work Letter"). The Allowance shall be used by Tenant to
improve the First Offer Space as provided in the Work Letter. Tenant shall
use Landlord's contractor to construct the Tenant improvements as provided in
the Work Letter.

           7.   AMENDMENT TO PARKING AGREEMENT. Commencing upon the New
Commencement Date, Tenant, as Licensee under the Parking Agreement, shall be
entitled to use an additional eighteen (18) unassigned parking spaces for its
employees for a total of seventy-seven (77) unassigned parking spaces upon
and subject to all terms and conditions of the Parking Agreement, except that
throughout the Extended Term of the Lease, Tenant shall pay a monthly fee of
$25.00 per stall per month for the eighteen (18) additional parking spaces in
addition to Tenant's Share of Expenses which are attributable to parking in
excess of such Expenses for the Base Year. Tenant shall not be charged for
any parking access cards except for the costs to replace lost or stolen
cards. Visitor parking is available on a non-exclusive, first-come-first
served basis. Tenant may purchase validations for its visitors from the
parking operator.

           Effective May 17, 2001, Tenant shall pay a monthly fee of $25.00
per stall per month for all of Tenant's seventy-seven (77) unreserved parking
spaces.

           8.  OPTION TO EXTEND. Tenant's Option to Extend contained in
Section 43 of the Lease shall remain in full force and effect as to the
combined  Existing Premises and the First Offer Space such that Tenant may
extend the Term of the Lease for an additional five (5) year period beyond
the Extended Term in accordance with the provisions of Section 43.

           9.   INAPPLICABLE PROVISIONS. Section 44 of the original Lease and
Paragraph 9 of the First Amendment are hereby deleted as inapplicable to the
Lease, as amended hereby.


                                     -3-


           10.  MISCELLANEOUS.

                (a)  EFFECT OF AMENDMENT. Except to the extent the Lease and
the Parking Agreement are modified by this Amendment, the remaining terms and
provisions of the Lease and the Parking Agreement shall remain unmodified and
in full force and effect. In the event of conflict between the terms of the
Lease or the terms of the Parking Agreement and the terms of this Amendment,
the terms of this Amendment shall prevail.

                (b)  ENTIRE AGREEMENT. This Amendment embodies the entire
understanding between Landlord and Tenant with respect to its subject matter
and can be changed only by an instrument in writing signed by Landlord and
Tenant.

                (c)  COUNTERPARTS. This Amendment may be executed in
counterparts, each of which shall be deemed an original, but all of which,
together, shall constitute one in the same Amendment.

                (d)  CORPORATE AND PARTNERSHIP AUTHORITY. If Tenant is a
corporation or partnership, or is comprised of either or both of them, each
individual executing this Amendment for the corporation or partnership
represents that he or she is duly authorized to execute and deliver this
Amendment for the corporation or partnership and that this Amendment is
binding upon the corporation or partnership in accordance with its terms.

                (e)  ATTORNEYS' FEES. The provisions of the Lease respecting
payment of attorneys' fees shall also apply to this Amendment.

           IN WITNESS WHEREOF, the parties have executed this Amendment as
of the date and year first set forth above.

         LANDLORD:           CURCI-ENGLAND CO. L.P.,
                             a California limited partnership

                             By:  Copley Investors Limited Partnership,
                                  a Delaware limited partnership,
                                  its general partner

                                   3By:  Copley Management Partnership,
                                         a Massachusetts general partnership,
                                         its general partner

                                         By:  AEW Advisors, Inc.
                                              a Massachusetts corporation,
                                              its managing general partner

                                              By: /s/[ILLEGIBLE]
                                                 -------------------
                                                 Its: Managing Director



         "TENANT"            PAINE & ASSOCIATES, INC.,
                             a California corporation

                             By: /s/ David M. Paine
                                ------------------------------------------
                                David M. Paine
                                President

                             By: /s/ David M. Paine
                                ------------------------------------------
                                David M. Paine
                                Secretary


                                     -4-




              AMENDMENT TO LEASE AND PARKING LICENSE AGREEMENT

         THIS AMENDMENT TO LEASE AND PARKING LICENSE AGREEMENT ("Amendment") is
made and entered into as of February 16th, 1996, by and between CURCI-ENGLAND
CO. L.P., a California limited partnership ("Landlord"), and PAINE & ASSOCIATES,
INC., a California corporation ("Tenant").

                                  RECITALS:

         A. Landlord and Tenant entered into that certain Office Lease dated as
of November 10, 1994 (as amended, the "Lease"), concerning certain premises (the
"Premises") located at Suites 420 and 450 of the building at 535 Anton Boulevard
[1B], Costa Mesa, California (the "Building"), and more particularly described
in the Lease, a copy of which is attached hereto as EXHIBIT A.

         B. Concurrently with the execution of the Lease, Landlord and Tenant
entered into that certain Parking License Agreement pertaining to Tenant's
parking rights at the Building (the "Parking Agreement"), a copy of which is
attached hereto as EXHIBIT B.

         C. Landlord and Tenant desire to expand the Premises to include an
additional approximately 5,792 rentable square feet of area on the fourth floor
of the Building, to extend the Term of the Lease and to otherwise modify the
Lease and the Parking Agreement as set forth in this Amendment, which
modifications shall be deemed effective as of the "New Commencement Date"
referenced in Paragraph 2 below.


                                   AGREEMENT:


         NOW, THEREFORE, in consideration of the mutual covenants and agreements
herein contained and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, Landlord and Tenant hereby amend
the Lease and the Parking Agreement and agree as follows:

         1. INCORPORATION; DEFINED TERMS. The Lease and the Parking Agreement
are hereby incorporated into this Amendment by this reference. All capitalized
terms used and not otherwise defined in this Amendment, but defined in the Lease
or in the Parking Agreement, shall have the same meaning in this Amendment as in
the Lease or the Parking Agreement, as the case may be.

         2. EXPANSION OF PREMISES. Effective as of the date hereof, Landlord
hereby leases to Tenant and Tenant hereby leases from Landlord, the additional
premises located contiguous to the Premises, containing approximately 5,792
rentable square feet as shown on EXHIBIT C attached hereto (the "Additional
Space"), upon and subject to all of the terms and conditions of the Lease as
amended by this Amendment. EXHIBIT C attached hereto showing both the original
Premises and the Additional Space shall replace EXHIBIT A to the Lease as the
Description of the Premises. From and after the "New Commencement Date"
referenced in Paragraph 3 below, the Premises and the Additional Space shall be
referred to together as Suite 450 of the Building and all references in the
Lease and in the Parking Agreement to the "Premises," as amended by this
Amendment shall mean and refer to Suite 450 of the Building which shall include
both the original Premises and the Additional Space. References herein to the
Additional Space shall mean the Additional Space shown on EXHIBIT C attached
hereto and references herein to the "Original Premises" shall mean only Suites
420 and 450 of the Building as shown in the Lease.

         3. NEW COMMENCEMENT DATE. Tenant's leasing of the Additional Space
shall commence as of the date hereof, however, Tenant's obligation to pay rent
with respect to the Additional Space shall commence upon the date (the "New
Commencement Date") which is the earlier to occur of (i) the date Landlord has
substantially completed the Tenant Improvements substantially in accordance with
the Final Plans as described in EXHIBIT D attached hereto, or (ii) the date
Tenant takes occupancy of the Additional Space and commences to conduct business
therefrom. The parties anticipate that the New Commencement Date will occur on
or before April 1, 1996.


                                   EXHIBIT "A" TO
        SECOND AMENDMENT TO OFFICE LEASE AND PARKING LICENSE AGREEMENT



         4. EXTENSION OF LEASE TERM. Effective as of the date hereof, the Term
of the Lease as to both the Original Premises and the Additional Space shall be
extended to expire on the date which is one day prior to the date which is five
(5) years after the New Commencement Date (herein, the "Extended Term").

         5. SUBSTITUTION OF FUNDAMENTAL LEASE PROVISIONS. Effective as of the
New Commencement Date, the Fundamental Lease Provisions which are affected by
the addition of the Additional Space to the Premises and the extension of the
Lease Term shall be modified to read as follows:

         1.1 Premises:    Project: South Coast Metro Center
                          Building: 535 Anton Boulevard [1B]
                          Suite: 450   Floor: 4th
                          City: Costa Mesa   County: Orange
                          State: California

         1.2 Floor Area:  Rentable Area: 15,349 square feet
                          Usable Area: 13,572 square feet

         1.3 Term:        Five (5) years
                          New Commencement Date: Determined as provided in
                               Paragraph 3 above. Estimated New
                               Commencement Date - April 1, 1996.
                          New Expiration Date:  Five (5) years after New
                               Commencement Date. Estimated New Expiration
                               Date: March 31, 2001.

         1.4 Basic Rent:  Months       Rent Per Month
                          ------       --------------
                          1 - 60       $23,023.50 FSG*
                                       * Full Service Gross

         1.5 Expenses: As to both the Original Premises and the Additional
Space, Tenant shall pay Tenant's Share of all Expenses that exceed Landlord's
Base Year Costs together with other items of Expense as set forth in Article 6.
Tenant's Share as to the Original Premises is 3.94%. The Base Year for purposes
of determining Tenant's Share of Expenses for the Original Premises shall remain
calendar year 1994. Tenant's Share as to the Additional Space shall be 2.367%.
The Base Year for purposes of determining Tenant's Share of Expenses for the
Additional Space shall be calendar year 1996. Expenses shall be grossed up to
reflect a minimum occupancy of ninety five percent (95%) as provided in the
Lease.

         1.6 After-Hours Charges: Fixed for the Extended Term at the rates set
forth in Section 1.6 of the Lease.

         1.7 Prepaid Rent: None.

         1.8 Security Deposit: Upon execution of this Amendment, Tenant shall
pay to Landlord the sum of $8,688.30 to be held by Landlord in accordance with
Article 9 of the Lease as additional security deposit together with the
$17,846.70 presently held by Landlord as a security deposit for the Original
Premises (for a total security deposit of $26,535.00).

         1.10 Tenant's Address for Notices: From and after the New Commencement
Date: 535 Anton Boulevard, Suite 450, Costa Mesa, California 92696; prior to the
New Commencement Date, as set forth in Section 1.10 of the Lease.

         1.11 Brokers: Grubb & Ellis; Commission payable based upon Agreement
dated March 9, 1994 and letter dated October 3, 1995.

         1.12 Guarantee: The performance of Tenant's obligations under the Lease
as amended by this Amendment shall be guaranteed by David M. Paine and Patricia
Paine, pursuant to a Lease Guaranty in the form attached hereto as EXHIBIT E to
be executed by the Guarantors prior to Landlord's execution of this Amendment.
Such Lease Guaranty shall supplement the existing Guarantee of Lease executed by
the Guarantors as a condition to Landlord's execution of the Lease.

         6. CONDITION OF ADDITIONAL SPACE. Landlord shall provide Tenant with a
tenant improvement allowance of $78,550.00, plus $34,450 - $113,000
(collectively the "Allowance"), in accordance with the Work Letter Agreement
attached hereto as EXHIBIT D (the


                                       -2-


"Work Letter") The Allowance shall be used by Tenant to improve the Additional
Space as provided in the Work Letter. Tenant shall use Landlord's contractor to
construct the Tenant Improvements as provided in the Work Letter.

         7. AMENDMENT TO PARKING AGREEMENT. Commencing upon the New Commencement
Date, Tenant, as Licensee under the Parking Agreement, shall be entitled to use
an additional twenty three (23) unassigned parking spaces for its employees for
a total of fifty nine (59) unassigned parking spaces upon and subject to all
terms and conditions of the Parking Agreement, except that throughout the five
(5) year Extended Term of the Lease, Tenant shall not be obligated to pay any
monthly fee for any such parking spaces other than Tenant's Share of Expenses
which are attributable to parking in excess of such Expenses for the Base Year.
Tenant shall not be charged for any parking access cards except for the costs to
replace lost or stolen cards. Visitor parking is available on a non-exclusive,
first come - first served basis. Tenant may purchase validations for its
visitors from the parking operator.

         8. OPTION TO EXTEND. Tenant's Option to Extend contained in Section 43
of the Lease shall remain in full force and effect such that Tenant may extend
the Term of the Lease for an additional five (5) year period beyond the Extended
Term in accordance with the provisions of Section 43.

         9. RIGHT TO LEASE ADDITIONAL SPACE.

              (a) Subject to the terms of this Paragraph 9, through the
remainder of the Extended Term, Tenant shall have a continuing first right to
lease ("Tenant's First Right to Lease") the balance of space located contiguous
to the Premises on the fourth floor of the Building within the area depicted on
EXHIBIT C attached hereto (the "First Offer Space") to the extent such space
becomes available for lease to third parties after the expiration of any
existing lease for such space during the Lease Term, including the expiration of
all renewal or extension options, and after the existing tenant or occupant
vacates such space. The First Offer Space contains approximately 4,489 rentable
square feet of space. Tenant's First Right to Lease is subject and subordinate
to the rights of all other existing tenants of the Building with prior expansion
or lease rights relative to such First Offer Space. Without limiting the
foregoing, Landlord advises Tenant that the First Offer Space has been leased to
another tenant for a term which is presently scheduled to expire as of July 31,
1997.

              (b) From time to time during the Lease Term, as and when the First
Offer Space shall become available to lease, Landlord will give Tenant written
notice of the availability of the First Offer Space and the date the existing
tenant or occupant, if any, is expected to vacate such space ("Landlord's
Availability Notice"). Landlord agrees to deliver the first Landlord's
Availability Notice to Tenant as to the existing tenant in the First Offer Space
on or before February 1, 1997. Landlord's Availability Notice will contain the
basic economic terms, including, but not limited to, Landlord's determination of
the Monthly Base Rent, tenant improvement allowance, if any, and all other
economic terms and conditions (collectively, the "Economic Terms"), upon which
Landlord is willing to lease the First Offer Space desired by Tenant, either to
Tenant or to a third party. Such Economic Terms will represent Landlord's
reasonable determination of the fair market rental rate for such First Offer
Space. Such fair market rental rate will mean the annual amount per rentable
square foot, projected during the relevant period, that a willing, comparable,
non-equity tenant (excluding sublease and assignment transactions) would pay,
and a willing, comparable landlord of a comparable Class "A" quality office
building located in the South Coast Plaza/John Wayne Airport area would accept,
at arm's length (what Landlord is accepting in current transactions for the
Building and in the building at 575 Anton Boulevard may be considered), for
space of comparable size and quality as the leased area at issue taking into
account the age, quality and layout of the existing improvements in the leased
area at issue and taking into account items that professional real estate
brokers customarily consider, including, but not limited to, rental rates,
office space availability, tenant size, tenant improvement allowances, operating
expenses and allowance, parking charges, free rent, reduced rent, free parking,
reduced parking, and any other lease concessions, if any, then being charged or
granted by Landlord or the lessors of such similar office buildings. The fair
market rental rate will be an effective rate, not specifically including, but
accounting for, the appropriate economic concessions described above.

              (c) Within five (5) business days after receipt of Landlord's
Availability Notice, Tenant must give Landlord written notice pursuant to
which Tenant


                                       -3-


     shall elect to either: (i) lease such First Offer Space upon such Economic
     Terms and the same non-Economic Terms as set forth in the Lease with
     respect to the Premises; (ii) refuse to lease such First Offer Space,
     specifying that such refusal is not based upon the Economic Terms, but upon
     Tenant's lack of need for such First Offer Space, in which event Landlord
     may at any time within one hundred eighty (180) days thereafter lease such
     First Offer Space to any party upon any terms Landlord deems appropriate;
     or (iii) refuse to lease the First Offer Space, specifying that such
     refusal is based upon the Economic Terms, in which event Tenant will also
     specify revised Economic Terms upon which Tenant is willing to lease such
     First Offer Space (provided that Tenant may not specify a different lease
     term for the First Offer Space). Tenant's failure to timely choose either
     clause (i), clause (ii) or clause (iii) above will be deemed to be Tenant's
     choice of clause (ii) above.

                (d)     If Tenant gives Landlord notice pursuant to clause
     (c)(iii) above, Landlord may elect, within five (5) days following receipt
     of such notice from Tenant, either to: (i) lease such First Offer Space to
     Tenant upon such revised Economic Terms proposed by Tenant, and the same
     other non-Economic Terms as set forth in this Lease; or (ii) lease the
     First Offer Space at any time within one hundred eighty (180) days
     thereafter to any third party upon terms which are not substantially more
     favorable to said party than the Economic Terms originally proposed by
     Tenant. Landlord's failure to timely choose either clause (i) or clause
     (ii) above will be deemed to be Landlord's choice of clause (ii) above.

                (e)     If Tenant chooses (or is deemed to have chosen) clause
     (c)(ii) above, or if Landlord chooses (or is deemed to have chosen) clause
     (d)(ii) above, and within one hundred eighty (180) days following such
     election or deemed election Landlord does not enter into a binding written
     lease for the First Offer Space with a third party upon terms permitted
     under clause (c)(ii) or (d)(ii) above, as the case may be, Tenant's Right
     of First Offer shall be reinstated and the parties shall again follow the
     procedures set forth in this Paragraph 9 as to the First Offer Space. If
     Landlord enters into a binding written lease for the First Offer Space
     within one hundred eighty (180) days following the applicable election
     by Landlord or Tenant, Tenant's First Right to Lease and First Offer shall
     again arise only if and when the First Offer Space shall again become
     available for lease as provided in this Paragraph 9. If Tenant exercises
     its Right to Lease as provided herein, the parties will promptly
     thereafter execute an amendment to the Lease to include the First Offer
     Space in the Premises and to document the lease terms thereof.

                (f)     As provided above, Tenant's Right to Lease is subject to
     all expansion and extension rights and other rights to lease, as
     applicable, which Landlord has granted to other tenants prior to the date
     of this Amendment. Thus, Landlord's Availablility Notice will be delivered
     to Tenant only after Landlord has appropriately notified and received
     negative responses from all other tenants with rights in the First Offer
     Space superior to Tenant's rights.

                (g)     Tenant's Right to Lease the First Offer Space is
     personal to the original Tenant executing this Lease and may be
     exercised only by the original Tenant executing this Lease while occupying
     the entire Premises and without the intent of thereafter assigning this
     Lease or subletting the Premises and may not be exercised or be assigned,
     voluntarily or involuntarily, by any person or entity other than the
     original Tenant executing this Lease. Tenant's Right to Lease the First
     Offer Space is not assignable separate and apart from this Lease, nor may
     such right be separated from this Lease in any manner, either by
     reservation or otherwise.

                (h)     Tenant will have no right to exercise its Right to Lease
     the First Offer Space, notwithstanding any provision of the grant of option
     to the contrary, and Tenant's exercise of its Right to Lease the First
     Offer Space may be nullified by Landlord and deemed of no further force or
     effect, if (i) Tenant is in default of any monetary obligation or material
     non-monetary obligation under the terms of this Lease (or if Tenant would
     be in such default under this Lease but for the passage of time or the
     giving of notice, or both) as of Tenant's exercise of its Right to Lease
     the First Offer Space or at any time after the exercise of such right and
     prior to the commencement of Tenant's occupancy of the First Offer Space,
     or (ii) Landlord has given Tenant two (2) or more notices of default,
     whether or not such defaults are subsequently cured, during any twelve (12)
     consecutive month period of the Lease.


                                      -4-



         11.    MISCELLANEOUS.

                (a)     EFFECT OF AMENDMENT. Except to the extent the Lease and
     the Parking Agreement are modified by this Amendment, the remaining terms
     and provisions of the Lease and the Parking Agreement shall remain
     unmodified and in full force and effect. In the event of conflict between
     the terms of the Lease or the terms of the Parking Agreement and the terms
     of this Amendment, the terms of this Amendment shall prevail.

                (b)     ENTIRE AGREEMENT.  This Amendment embodies the entire
     understanding between Landlord and Tenant with respect to its subject
     matter and can be changed only by an instrument in writing signed by
     Landlord and Tenant.

                (c)     COUNTERPARTS. This Amendment may be executed in
     counterparts, each of which shall be deemed an original, but all of which,
     together, shall constitute one in the same Amendment.

                (d)     CORPORATE AND PARTENERSHIP AUTHORITY. If Tenant is a
     corporation or partnership, or is comprised of either or both of them,
     each individual executing this Amendment for the corporation or
     partnership represents that he or she is duly authorized to execute and
     deliver this Amendment for the corporation or partnership and that this
     Amendment is binding upon the corporation or partnership in accordance
     with its terms.

                (e)     ATTORNEYS' FEES. The provisions of the Lease respecting
     payment of attorneys' fees shall also apply to this Amendment.


        IN WITNESS WHEREOF, the parties have executed this Amendment as of
the date and year first set forth above.

     LANDLORD:               CURCI-ENGLAND CO. L.P.,
                             a California limited partnership

                             By:   Copley Investors Limited Partnership,
                                   a Delaware limited partnership,
                                   its general partner

                                   By:   Copley Management Partnership,
                                         a Massachusetts general
                                         partnership,
                                         its general partner

                                          By:   Copely Advisors, Inc.
                                                a Massachusetts corporation,
                                                its managing general partner

                                                By:  /s/ [ILLEGIBLE]
                                                   --------------------------
                                                   Its: /s/ [ILLEGIBLE]
                                                       ----------------------



      "TENANT"                       PAINE & ASSOCIATES, INC.,
                                     a California corporation

                                     By: /s/ David M. Paine
                                        --------------------------------------
                                        David M. Paine
                                        President


                                     By: /s/ David M. Paine
                                        --------------------------------------
                                        David M. Paine
                                        Secretary


                                      -5-



                                     LEASE

              (REFER TO LEASE DATED NOVEMBER 10, 1994 ATTACHED)





                                    EXHIBIT A





                            PARKING LICENSE AGREEMENT

      (REFER TO PARKING LICENSE AGREEMENT DATED NOVEMBER 10, 1994 ATTACHED)





                                    EXHIBIT B





                              FLOOR PLAN OF PREMISES


                                   [FLOOR PLAN]



                                    EXHIBIT C

EX-10.17

                                                                   Exhibit 10.17

- --------------------------------------------------------------------------------


                                COMMERCIAL LEASE

                                    between

THIS LEASE is made between company BOS GmbH & Co. KG, Buchenteich 3, 73773
Aichwald, Germany, legally represented by its personally liable lady's companion
of the company BOS Verwaltungsgesellschaft mbH, the latter represented by its
sole authorized representative Herrn Stefan Grein, manager.

- - herein called (LESSOR) "V",

                                      and

company Digital Imaging International GmbH, HedelfingerstraBe 80, 70327
Stuttgart, legally represented by its manager Herrn Gerd Schafer, manager

- - herein called (LESSEE) "M",

                                     PAR. 1
                                  LEASE OBJECT

1.       V leases to M the property Buchenteich 3 in 73773 Aichwald (Flst. -No.
         1267, registered in the land register of Aichschiess No. 2476, land
         registry Aichwald, district court of region Esslingen) including the
         buildings on this property in accordance with the general plan of the
         site per ADDENDUM 1 of this contract and the building specification in
         ADDENDUM 2 of this contract.

2.       Also included in the lease are the inventory items listed in ADDENDUM 3
         of this contract.

3.       M is familiar with the rent object, which corresponds to the documents
         of addenda 1, 2, and 3.


                                  Page 1 of 10



                                     PAR. 2
                              PURPOSE OF THE LEASE

1.       The purpose of the lease is to operate an IT service company.

2.       Any other use (whole or in part) requires a prior written approval by
         V, which will be denied only if there is an important reason for it.

3.       M is obligated to carry on the trade mentioned under Object of Rental
         in item 1 for the duration of the tenancy.

4.       M will procure all necessary official licenses required for the
         operation of his business at his own expense.

                                     PAR. 3
                             DURATION OF THE LEASE

1.       The tenancy commences on October 1, 2001. Its term is 5 years and it
         will terminate on September 30, 2006.

2.       M is entitled to demand an extension of this tenancy beyond the date
         mentioned in item 1 for an additional term of 3 years, i.e. to
         September 30, 2009, and still another additional extension for 2 more
         years, i.e. September 30, 2011.
         The term extension options must be submitted in writing and must reach
         V not later than 12 months before the end of the regular tenancy
         mentioned under item 1, or before the end of the extended term of the
         first option.

3.       Unless one of the contractual partners cancels the tenancy and informs
         the other partner in writing not less than 6 months before the
         respective termination date mentioned in items 1 and 2, the tenancy
         will automatically extend by a period of one year.

4.       V retains the right to cancel this tenancy without notice for an
         important reason. An important reason for cancellation is considered in
         particular if:

                  a)       M discontinues making payments, or declares
                           insolvency on account of his assets, or insolvency is
                           denied because of insufficient funds.

                  b)       M does not comply with a vital obligation of this
                           contract inspite of a written dissuasion.

         In the event of a premature termination of the tenancy for an important
         reason by M, M will be held liable for the losses incurred by V as a
         result of the premature termination of this contract.


                                  Page 2 of 10



5.       Continued use of the rent by M after termination of the tenancy
         excludes the extension of the contract in accordance with paragraph
         568 of the BGB.

                                     PAR. 4
                                      RENT

1.       The monthly rent is

         a)       in the 1. treaty year          DM 24.580,00
         b)       in the 2. and 3. treaty year   DM 28.750,00
         c)       in the 4. and 5. treaty year   DM 32.500,00

2.       In addition, M must pay the respective legal value-added taxes to the
         amounts mentioned in Item 1.

3.       The rent shall be paid at the beginning of each month and must be
         deposited in the bank account designated by V not later than on the 3rd
         workday of the month.

                                     PAR. 5
                                ADDITIONAL COSTS

1.       M will pay all costs incurring through the use of his business. These
         costs, especially electricity, water, sewer, heating, refuse
         collection, and chimneysweeper are to be paid right away. Any
         invoices sent from V will be forwarded to M for immediate attention.

2.       The following additional costs will be invoiced by V to M and shall be
         paid within 14 days after date of invoice. Property tax, fire
         insurance, and EC-insurance.

                                     PAR. 6
                                   INSURANCES

1.       M shall be obligated to get and maintain the following insurance
         coverage for both the Rent Object: and the commercial business operated
         by M:

         a)       Liability insurance

         b)       Insurance for the inventory items and merchandise inside the
                  Rent Object against fire and water damage, including drinking
                  water.

2.       Upon request by V, M shall be obligated to provide proof of the
         currently effective and



                                  Page 3 of 10



         maintained insurance under item 1.

                                     PAR. 7
                            VALUE PROTECTION CLAUSE

1.       In the event the tenancy is extended beyond September 30, 2006, V is
         entitled to start negotiations concerning an appropriate rent increase.
         This increase shall correspond to the equity and shall take into
         account any change of economic conditions, in particular any reduction
         of rents for commercial property since the time of contract closure.

         2. If the parties cannot agree on an appropriate rent increase, a
         competent referee from the local chamber of commerce shall decide as
         to what is an appropriate rent increase. Both parties subject
         themselves to the judgment of the referee as the arbitrator.

                                      PAR. 8
                              ACCOUNTING OF PAYMENTS
                           SUMMATION, RIGHT OF RETENTION

1.       Unless M declares a specific purpose on payments, V may account for
         those payments by M into open items of his choice.

2.       It is not permissible to offset demands against this contract with
         other demands than such from this contract. The right of retention can
         not be claimed because of other rights than such from this contract.

                                     PAR. 9
                       SURRENDER OF THE RENT OBJECT TO M

1.       M accepts the rent object as is and without any warranty.

2.       V does not assume any liability regarding the suitability of the rent
         object for the intended use by M and the required official permits and
         licenses.

3.       Meter readings for electricity, water, and heating oil will be read at
         the time of acceptance of the rent object.


                                  Page 4 of 10



                                    PAR. 10
                           MAINTENANCE AND ALTERATION
                     OF THE RENT OBJECT, APPEARANCE REPAIRS

1.       M will pay for all work necessary to maintain and repair the appearance
         of the rent object as well as for renewals and replacements as
         necessary during the term of the tenancy. It is also M's duty to comply
         with all expenditures, regulations and obligations arising from legal
         provisions and insurances for his commercial business. V will pay for
         the maintenance of the following parts of the building: fundaments, all
         supporting parts of the building including supporting walls and outer
         walls, floors, ceilings and the roof.

2.       If M defaults with his obligations per item 1, V is entitled to carry
         out necessary actions on account of M. In this case, M cannot claim any
         reduction in expenses or indemnity. If V defaults with his obligations
         per item 1, M is entitled to carry out necessary actions on account of
         V to ensure the rental purpose.

3.       M is entitled to furnish, at his expense, the rent object with certain
         facilities to comply with legal regulations and official ordinances.
         Any structural modifications require prior written permission by V.

                                    PAR. 11
                           TRAFFIC SECURITY LIABILITY

M assumes traffic security liability for the inside part of the entire rent
object including any outer facilities and installations that may yet to be
established by M. M also assumes the duty of clearing and strewing the
respective areas on the sidewalk and the drive way outside the property in
Winter time as is specified in the municipal by-laws. M exempts V of all demands
by a third party regarding any claims as to violation of traffic security
liability against V.

                                    PAR. 12
                                    SECURITY

1.       M will pay V the sum of DM 150.000,00 as a security to fulfill its
         obligations of this contract.

2.       After receipt, V will deposit this security with a credit institution
         at the usual interest rate based on a savings account with a 3 months
         cancellation period.


                                  Page 5 of 10



3.          V is entitled to withdraw any maturing demands from this security
            account during the term of tenancy. In this case, M is obligated
            to replenish this security account back to its original amount.
            During the duration of the tenancy, M cannot claim any summation
            of debts due with respect to the repayment demand from the
            security.

4.          After the termination of the tenancy, V must settle the security
            account and pay M the remaining sum plus all interest. The demand
            by M for repayment is due 3 months after return of the rent
            object.

5.          M is entitled to yield security through an unlimited bank
            guarantee as to M's indebtedness. If M is making use of this
            right, items 3 and 4 of this stipulation shall apply,
            respectively, except for the regulation as to interest.


                                   PAR. 13
                             SUBLETTING, SUBLEASE

1.          M is entitled to sublease at any time within the framework of the
            purpose of the lease according to paragraph 2. Outside of this
            framework, subleasing is subject to a written permission by V in
            advance, which may be denied only because of a convincing reason.

2.          M is not entitled to premature cancellation if V denies
            permission for the subleasing.


                                   PAR. 14
                           TERMINATION OF TENANCY

1.          M will return the rent object at the end of the tenancy in a
            swept clean and cleared condition. The condition must correspond
            to one of normal wear and tear.

2.          M may remove any installation, reconstructions or upgradings
            incorporated by him but then must restore to the original
            condition.

3.          M may leave any installations, reconstructions or upgradings
            incorporated by him; they will then become the property of V
            without reimbursement.


                                 Page 6 of 10



                                     PAR. 15
                                OTHER AGREEMENTS

1.          This contract may only be changed in writing.

2.          There have been no additional verbal agreements between the
            contract partners.

3.          Should M desire the right of preemption for the rent object, V is
            prepared to grant it to M. The contractual partners are aware
            that such a right of preemption requires notarization to become
            effective. The effectiveness of this tenancy shall not depend
            upon the effective agreement of a preemptive right. In the event
            M wishes to register the preemptive right, M must bear all costs
            in connection with this.

4.          If any stipulation of this contract is ineffective, the validity
            for the rest of this contract shall not be affected as a result of
            this. In that case, another stipulation shall be agreed upon
            between the contractual parties that comes as close as possible
            to the ineffective stipulation in terms of its purpose and
            commercial relevance.


AICHWALD, JUNE 20, 2001                     AICHWALD, JUNE 20, 2001
BOS GMBH & CO. KG                           Digital Imaging International GmbH
Buchenteich 3                               Hedelfingerstrasse 60
73773 Aichwald-Aichschiess                  D-70327 Stuitgart


(Signature)                                 (Signature)
- ----------------------------------          ----------------------------------
BOS GMBH & CO. KG                           DIGITAL IMAGING
                                            INTERNATIONAL GMBH


                                  Page 7 of 10



ADDENDUM 1

BAUMEISTER + OSTLER
GMBH & CO.

SPECIFICATIONS BOS - PROPERTY AND BUILDING BUCHENTEICH 3

1.          Year of construction: 1986 / was originally built as a
            manufacturing building.

2.          Reconstructions performed.

            - First reconstruction 1994/95: First and second floor (Foyer as
              office building)
            - Second reconstruction 1995/96: Basement into test and
              development rooms
            - Double reconstruction 1996/97: First floor converted into large
              office rooms
            - Fourth reconstruction 1997/98: Setup of presentation and show
              rooms in the first floor

3.          Size of property: 2480 m(2) (26,685 ft(2))

4.          TOTAL AREA OF THE BUILDING: 3484(2) (37,488(2))

5.          Floor spaces (Basement/First Floor/Second Floor):

            A) Basement:

            - Floor space (Test room, Lab,
              Research Manufacturing)              725 m(2) (7,801 ft(2))
            - Storage space                        177 m(2) (1,905 ft(2))
            - Personnel areas (dressing room,
              washing rooms, toilets, general
              areas)                                76 m(2) (818 ft(2))
            - House installations (heating room,
              compressor room, elevator vent)       67 m(2) (721 ft(2))
            - Traffic areas                         105 m(2) (1,130 ft(2))

            B) First floor:

            - Floor space: (offices, QS room,
              reception)                            817 m(z) (8,791 ft(z))
            - Presentation areas                    163 m(2) (1,754 ft(2))
            - Storage areas (EDP, Plotter)           25 m(2) (269 ft(2))
            - Personnel areas (toilets,
              cleaning room, First aid
              station)                               31 m(2) (334 ft(2))
            - House installations (Elevator
              room, elevator, venting room)          21 m(2) (266 ft(2))
            - Traffic areas                         115 m(2) (1,237 ft(2))


                                  Page 8 of 10



BAUMEISTER + OSTLER
GMBH & CO.

            C) Second floor

            - Floor space: (Offices)                736 m(2) (7,919 ft(2))
            - Storage areas (Filing, archive,
              office supplies, EDP, plotter)         65 m(2) (667 ft(2))
            - Personnel areas (Tee kitchen,
              toilets, cleaning room, lounge)        75 m(2) (807 ft(2))
            - House technology area (Technical
              room, elevator, ventilation center)    12 m(2) (129 ft(2))
            - Traffic areas                         274 m(2) (2,948 ft(2))

            6. Outer installations

            - Total area, outer installations:     1290 m(2) (13,880 ft(2))
            - Parking area (approx. 30 parking
              spaces)                               400 m(2) (4,304 ft(2))
            - Paved areas (drive ways, etc.)        600 m(2) (6,456 ft(2))
            - Planted areas                         290 m(2) (3,120 ft(2))


            WERNER SCHLECHT
            MANAGER

                                   Page 9 of 10



INVENTORY LIST TO COMMERCIAL LEASE, ADDENDUM 3

Alarm system
Motion sensor
EDP Ethernet cabling
Hubs and closet in the second floor
Empty closet in the basement
Air conditioning in the server room first and second floor
Furniture in reception room
Mounted welcome board with plugable lettering set
Company board before the entrance and at the building
Plants in the staircase (planted)
All of the available sun blinds, inside and outside
Fire extinguisher
First aid closet
Hung-up plans of the site, escape plans and safety boards
Monitoring system, camera and monitor for parking places before the building
Emergency electricity generator in the basement
Mounted wardrobes in the first and second floor
Mounted fixtures in the toilets (warm water boiler, soap dispenser, towel
dispenser)
Cafeteria Build-in kitchenette (Kuchenzeile)
Tee kitchen between meeting room and hallway
Kitchenette (Kuchenzeile) in the basement (lunch room)
Wall mounted board shelves


                                   Page 10 of 10