10KSB/A 1 d84523a2e10ksba.txt AMENDMENT NO. 2 TO FORM 10-K - FISCAL END 6/30/00 1 U.S. SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 ---------- FORM 10-KSB/A ---------- [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended June 30, 2000 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 1-11900 ---------- INTEGRATED SECURITY SYSTEMS, INC. ---------------------------------------------- (Name of Small Business Issuer in its Charter) Delaware 75-2422983 -------- ---------- (State of Incorporation) (I.R.S. Employer Identification No.) 8200 SPRINGWOOD DRIVE, SUITE 230, IRVING, TX 75063 (972) 444-8280 (Address including zip code, area code and telephone number of Registrant's principal executive offices.) ---------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title of Each Class ---------------------------- Common stock, $.01 par value Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] Issuer's revenues for its most recent fiscal year: $6,561,359 As of September 30, 2000, 10,572,545 shares of the Registrant's common stock and 1,340,505 warrants, entitling holders to purchase 3,552,338 shares of common stock, were outstanding. On September 30, 2000, the aggregate market value of the voting common equity held by non-affiliates of the registrant was approximately $5,150,521. This amount was calculated by reducing the total number of shares of the registrant's common stock outstanding on September 30, 2000 by the total number of shares of common stock held by officers and directors, and stockholders owning in excess of 5% of the registrant's common stock, and multiplying the remainder by the close price of the registrant's common stock on September 30, 2000, as reported on the over-the-counter market. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] Documents Incorporated by Reference: None. -------------------------------------------------------------------------------- Page 1 of 47 2 TABLE OF CONTENTS
Item No. Page -------- ---- PART I 1. Description of Business......................................................................................3 2. Description of Property......................................................................................7 3. Legal Proceedings............................................................................................8 4. Submission of Matters to a Vote of Security Holders..........................................................8 PART II 5. Market for Common Equity and Related Stockholder Matters.....................................................9 6. Management's Discussion and Analysis or Plan of Operation...................................................10 7. Financial Statements........................................................................................15 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................33 PART III 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act......................................................................34 10. Executive Compensation......................................................................................34 11. Security Ownership of Certain Beneficial Owners and Management..............................................34 12. Certain Relationships and Related Transactions..............................................................34 13. Exhibits and Reports on Form 8-K............................................................................34
-------------------------------------------------------------------------------- Page 2 of 47 3 PART I FORWARD LOOKING STATEMENTS This annual report on Form 10-KSB includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can be identified by the use of forward-looking terminology such as "may," "believe," "expect," "intend," "plan," "seek," "anticipate," "estimate," or "continue" or the negative of those words or other variations or comparable terminology. All statements other than statements of historical fact included in this annual report on Form 10-KSB, including the statements under "Item 1. Description of Business" and "Item 6. Management's Discussion and Analysis or Plan of Operation" and located elsewhere in this annual report on Form 10-KSB regarding the financial position and liquidity of the Company are forward-looking statements. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors regarding forward-looking statements, including certain risks and uncertainties that could cause actual results to differ materially from the Company's expectations, are disclosed in this annual report on Form 10-KSB. The Company does not undertake any obligation to publicly revise its forward-looking statements to reflect events or circumstances that arise after the date of this quarterly report on Form 10-QSB. Important factors that could cause actual results to differ materially from those in the forward-looking statements in this annual report on Form 10-KSB include changes from anticipated levels of operations, customer acceptance of existing and new products, anticipated development schedules of new products, anticipated levels of sales, future national or regional economic and competitive conditions, changes in relationships with customers, access to capital, casualty to or other disruption of the Company's production facility and equipment, delays and disruptions in the shipment of the Company's products, government regulations and the ability of the Company to meet its stated business goals. ITEM 1. DESCRIPTION OF BUSINESS GENERAL The Company designs, develops, manufactures, distributes and services security and traffic control products used in the commercial, industrial and government sectors through two wholly owned subsidiaries, B&B Electromatic, Inc. and Intelli-Site, Inc. B&B's products are used in thousands of locations across the country. The Company has experienced unanticipated delays in the completion of its Intelli-Site(R) software product and has not met the anticipated sales levels for this product. In addition, the audit report of Grant Thornton LLP, the Company's independent auditors, states that the Company has suffered recurring losses from operations, has an excess of liabilities over assets, and is in default of certain debt covenants. The audit report further states that these matters raise substantial doubt about the Company's ability to continue as a going concern. INTELLI-SITE, INC. Computer software that allows automated integration enables a customer to decouple the selection of software from hardware, so that a customer can mix and match different hardware, from various manufacturers, into a single, integrated security system. Within the security industry, it is generally accepted that automated integration of products improves productivity, response time and accuracy. Automated integration of products also reduces loss, which in turn reduces insurance premiums. Intelli-Site, Inc. develops software that provides automated integration for the security industry. This software, named Intelli-Site(R), allows automatic integration that can break the stranglehold that proprietary system providers have on customers. Intelli-Site(R) can integrate products, such as hardware and devices, from different vendors, to provide a tailored solution to unique customer requirements. -------------------------------------------------------------------------------- Page 3 of 47 4 More specifically, Intelli-Site(R) allows customers to integrate a wide variety of devices from various manufacturers, such as access control, closed circuit television, badge systems, fire alarm systems, lighting control and heating, ventilation and air conditioning systems. In addition to providing centralized control, Intelli-Site(R) users can tailor the interface for ease of operation based on their unique functional requirements. Since Intelli-Site(R) is device non-specific, customers can integrate currently installed equipment, even if purchased from different manufacturers. For example, an access control system and a closed circuit television system from different hardware manufacturers may already exist within a facility, but due to the proprietary nature of both systems, they cannot communicate with each other. Unless the two systems can communicate, a "forced door" alarm on the access control system cannot initiate a video recording of the event. A proprietary integrated system would require replacement of one or both of the existing systems with equipment compatible to that of the proprietary system. However, assuming device drivers are available, Intelli-Site(R) can integrate existing systems to avoid expensive equipment retrofits, time delays and single vendor dependencies. The software can also be tailored to a manufacturer's proprietary specifications to be marketed as an added feature to their existing product line. No two companies, facilities or workgroups are identical, so each has different security requirements. Intelli-Site(R), while a standard product, allows users to define the following aspects of a security system: o its configuration--what is to be integrated; o its graphical user interface--how the operator controls the system; o its functionality--what the system does; and o its databases--what and how data is stored. In the past, only a custom-designed system could provide this level of user-specific features. Other standard software products either cannot be tailored or attempt to provide limited "customization" through a fixed set of user options. With Intelli-Site(R), user-defined restrictions are limited to the capabilities of the integrated devices. B&B ELECTROMATIC, INC. B&B Electromatic, Inc., the Company's manufacturing subsidiary, designs, manufactures and distributes warning gates, crash barriers, such as railroad, anti-terrorist and traffic control barriers, lane changers, airport and navigational lighting, and perimeter security gates and operators. B&B has been in operation since 1925, and enjoys a long-term reputation of high quality designs with its broad customer network of engineering and architectural firms. Core Business B&B's core products are gates and barriers, perimeter security and navigational lighting. These products compete primarily in the road and bridge construction, refurbishment and perimeter security markets. These products are used for: o gating and barricading movable bridges; o locking down sections of roads under construction; o gates for reversible lane changer systems; o gates to secure railroad crossings; -------------------------------------------------------------------------------- Page 4 of 47 5 o operators and gates used in perimeter security; and o navigational lights used primarily with waterways. B&B typically sells its products through electrical sub-contractors or through distributors. B&B's XL automatic gate operator product line, called the XL Series, includes hydraulic sliding gate operators with two pair of infrared beams and an audible alarm. This gate operator is called a "hydraulic" sliding gate operator because it is operated by the resistance when a small quantity of liquid is forced through a small opening. In addition, the XL Series incorporates a new solid-state controller, called the PK2K, which monitors and controls the correct installation and functioning of safety devices. The PK2K will not allow the operator to function if there is incorrect wiring or a malfunction that could cause injury or property damage. The XL Series has been successfully tested and is in compliance with the Underwriters Laboratories Inc. new safety standard that is named UL325. The XL Series is also now listed by a Nationally Recognized Testing Laboratory. Meeting the new UL325 safety standard, like all of the Underwriters Laboratories standards, is voluntary. However, many governmental and private sector corporations will only purchase products that meet Underwriters Laboratories standards and that are listed by a Nationally Recognized Testing Laboratory. B&B's XL Series of gate operators are the first operators of its kind to meet the new Underwriters Laboratories 325 safety standards. The XL Series is listed by Intertek Testing Services with the Electronic Testing Laboratory trademark. The XL Series of gate operators meets the primary and secondary entrapment protection requirements of Underwriters Laboratories 325 with two pair of infrared beams and an audible alarm. Fewer movable bridges are being constructed. As a result, B&B is seeking broader applications of its movable gates and barriers. Highway lane changers, road construction gates and barriers, seismic gates and perimeter security gates are all growing market opportunities for B&B. New Business B&B has developed a railroad safety barrier gate that is targeted for highway railroad crossings with high accident incident rates, blind curves, high frequency of hazardous rail transport, whistle-ban zones, multiple track crossings and high-speed rail corridors. In November 1998, after two years of development and testing, the Federal Highway Administration accepted B&B's patented safety barrier gate. B&B has an eighteen-year patent on this safety barrier gate, expiring in September 2018. This patent is significant because B&B's railroad safety barrier gate is the only product of its kind presently on the market. In August 2000, the Federal Railroad Administration determined that the safety barrier gate is in compliance with their fail-safe requirement. The Federal Highway Administration only accepts safety barrier gates designed to improve safety at highway railroad crossings without the necessity of grade separations, such as bridges or underpasses. Federal funding of approximately $160 million per year is available for upgrading the safety of the more than 262,000 existing highway railroad crossings. Additional federal and state funding is available for highway railroad crossings on high-speed rail corridors which have mandated upgrade requirements. B&B anticipates that the available market for its railroad safety barrier gate will increase by tenfold. Penetration into this market, however, may require a relatively long sales cycle due to federal funding approvals. WARRANTIES The Company has one-year, two-year and five-year warranties on products it manufactures, depending on whether the product is an existing product or a new product. If the product is new, then the term of the warranty is based on competition and industry trends. If the product is already in existence, then the term of the warranty is based on that particular type of product. The Company provides for replacement of components and products that contain manufacturing defects. When the Company uses other manufacturers' components, the warranties -------------------------------------------------------------------------------- Page 5 of 47 6 of the other manufacturers are passed to the dealers and end users. To date, the servicing and replacement of defective software components and products have not been material. BACKLOG The Company's backlog is calculated as the aggregate sales prices of firm orders received from customers less revenue recognized. At September 30, 2000, the Company's backlog was approximately $1.6 million. The Company expects that it will fill the majority of this backlog by December 31, 2001. PRODUCT DESIGN AND DEVELOPMENT As of September 30, 2000, the Company has six employees dedicated to research, development and product engineering. During fiscal year 1999, the Company spent approximately $378,365 on research and development, primarily related to the development and enhancement of Intelli-Site(R). During fiscal year 2000, the Company spent approximately $386,899 on research and development, also primarily related to the development and enhancement of Intelli-Site(R). COMPETITION Intelli-Site, Inc. Many companies across the industry use the term "integrated security system" to describe their products and services. In fact, an integrated security system can range very limited fixed function systems "integrating" as few as two sub-systems to feature-rich, real-time sophisticated software systems, including custom coded integrated solutions. Differences in functionality, performance, and price among integrated security systems vary greatly. Intelli-Site NT has the capability to compete across the entire spectrum of integrated security systems. Consequently, Intelli-Site NT has a diverse set of competitors, depending on the complexity of the integration effort. Intelli-Site NT's competitors generally fall into one of three categories: (a) access control manufacturers, (b) "pure" integrated systems platforms and (c) custom software developers. Access Control Manufacturers Access control integration is the integration of access control systems with other security devices and sub-systems. Access control manufacturers produce integrated security systems that range in capability from the control of panel inputs and outputs to the integration of access control systems with other security devices and sub-systems, most commonly closed circuit television. Access Control and Security Systems Integration magazine, in its annual buyers guide, lists approximately 200 companies that provide software for access control integration representing approximately 81% of the market. Access control manufacturers provide closed, proprietary systems for integration of their hardware. Only a few manufacturers offer complete integrated systems. Vendor-proprietary systems tend to be expensive and lock the customer into one supplier. With vendor-proprietary systems, the end user can only add new features or integrate new technologies if the access control manufacturer supplies them. Access control manufactures' integrated product solutions prevent systems integrators and end users from integrating the products and/or technologies that best meet the end-user requirements. "Pure" Integrated Systems Platforms "Pure" integrated system providers, such as Intelli-Site, offer integration platforms that are non-proprietary and able to integrate across any device or sub-system. Integrated system providers can integrate products, such as hardware or devices, across the industry from different vendors. The Company has identified three third-party providers that supply software that competes with Intelli-Site NT. These competitors are LARES Technology, Inc., Lenel Systems International, Inc., and Integral Technologies, Inc. It is estimated that in 1998, "pure" integrated systems platform products accounted for less than 2% of the $170 million software systems -------------------------------------------------------------------------------- Page 6 of 47 7 integration market. Software system integration is the integration of various types of systems utilizing software technology. The software systems integration market includes access control manufacturers, "pure" integrated system platforms and custom software developers. The software systems integration market is a segment of the $3.4 billion systems integration market. The systems integration market encompasses all industries that integrate any type of system by utilizing various means and processes. None of the identified competitors has established itself as a clear market leader. Custom Software Developers Custom software solutions for integrated security typically target large systems with complex user integration requirements between multiple sub-systems. A number of system developers and large systems integrators provide custom software solutions. An estimated 17%, and declining, of end users use custom-developed solutions. However, the Company believes many of these end users would consider using a non-proprietary, tailored, user-definable standard platform if one were available. Today, of the estimated 1,000 system integrators in the market, only a small fraction is capable of developing custom software applications. Open, user-definable systems such as Intelli-Site NT would allow many of these integrators to bid competitively on large, integrated security system jobs that have traditionally required custom-developed software solutions. The Company faces intense competition in the security industry. Some of the Company's competitors are large, well-financed and established companies that have greater name recognition and resources for research and development, manufacturing and marketing than that of the Company. These competitors may be better able to compete for market share. B&B Electromatic, Inc. The competitors of B&B Electromatic, Inc.'s road and bridge products are relatively the same size as B&B. The customers of these competitors are concentrated in only certain geographical regions. In contrast, B&B's customers are located throughout the United States. B&B has a far more extensive design specification network than its competitors, mostly because B&B has been in existence in this market niche since 1925. Only one other manufacturer of horizontal sliding gates powered by a hydraulic operator mechanism competes with B&B's high-end perimeter security products. B&B does not compete in the lower end perimeter security products market. The competition for the railroad safety barrier market appears to be non-existent, because B&B is the only company that manufactures this type of railroad safety barrier product at the present time. B&B has two competitors in the general market of warning gates, crash barriers, such as railroad, anti-terrorist and traffic control barriers, lane changers, and seismic gates. B&B has two competitors in the airport and navigational lighting market. EMPLOYEES As of June 30, 2000, the Company employed 65 people, all in full-time positions. None of the Company's employees are subject to collective bargaining agreements. The Company believes that relations with its employees are good. ITEM 2. DESCRIPTION OF PROPERTY B&B Electromatic, Inc. own its manufacturing and office facility in Norwood, Louisiana. This facility consists of approximately 26,000 square feet of manufacturing and office space on five acres of land. The Company has a mortgage on this property. The Company refinanced the mortgage in 1999 for a cash contribution of approximately $100,000. These funds were used for operations and capital improvements at B&B. At September 30, 2000, the principal amount of the mortgage was $734,894. The interest rate is 10% and the amortization provisions are standard. There are no prepayment provisions and the mortgage matures on September 14, 2001. The balance due on the maturity date is $673,296. -------------------------------------------------------------------------------- Page 7 of 47 8 The Company occupies 13,038 square feet of office and warehouse space in Irving, Texas. The lease for the Irving facility expires on December 31, 2001. The monthly rent of this lease is $14,815, plus the costs of utilities, property taxes, insurance, repair and maintenance expenses and common area utilities. The Company believes that the properties, equipment, fixtures and other assets of the Company located within the Company's facilities are adequately insured against loss, that suitable alternative facilities are readily available if the lease agreements described above are not renewed, and that its existing facilities are adequate to meet current requirements. ITEM 3. LEGAL PROCEEDINGS The Company is subject to certain legal actions and claims arising in the ordinary course of the Company's business. Although management recognizes the uncertainties of litigation, based upon the dollar amount involved, the nature and management's understanding of the facts and circumstances which give rise to such actions and claims, management believes that such litigation and claims will be resolved without material effect on the Company's financial position, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. -------------------------------------------------------------------------------- Page 8 of 47 9 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's preferred stock is not publicly traded. The Company's Common Stock is quoted on the Over-the-Counter Bulletin Board under the symbol "IZZI." The Company's Common Stock was quoted on the Nasdaq Small Cap Market under the symbol "IZZI" until March 23, 1999. On March 24, 1999, Nasdaq delisted the Company's Common Stock for failing to meet the minimum net tangible asset base of $2.0 million and for failing to meet the minimum trading price threshold of $1.0 per share. The following table sets forth, for the periods indicated, the high and low bid quotations for the Common Stock on the Nasdaq Small Cap Market and the Nasdaq Over-the-Counter Bulletin Board Market. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. The trading market in the Company's securities may at times be moderately illiquid due to low volume.
Common Stock ------------------------------------------- $ High $ Low ----------------- ---------------- Fiscal 2000 First Quarter 11/16 19/32 Second Quarter 3/4 7/16 Third Quarter 9/16 15/32 Fourth Quarter 23/32 13/32 Fiscal 1999 First Quarter 1 9/32 21/32 Second Quarter 1 17/32 Third Quarter 1 1/2 15/32 Fourth Quarter 1 5/32 9/16
On September 15, 2000, the last reported sales prices for the Common Stock as reported on the Over-the-Counter Bulletin Board was $0.53. HOLDERS As of September 30, 2000, there were 10,572,545 shares of Common Stock outstanding and 1,340,505 warrants outstanding entitling holders to purchase 3,552,338 shares of Common Stock. The shares of Common Stock are held of record by approximately 139 holders and the warrants are held of record by approximately 21 holders, including those brokerage firms and/or clearing houses holding the Company's Common Stock for their clientele, with each such brokerage house and/or clearing house being considered as one holder. DIVIDEND POLICY The Company has never declared or paid any dividends on the Company's Common Stock. The Company currently intends to retain future earnings, if any, for the operation and development of the Company's business and to repay outstanding debt. The Company does not intend to pay any dividends on the Common Stock in the foreseeable future. -------------------------------------------------------------------------------- Page 9 of 47 10 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION GENERAL The Company's executive offices are located at 8200 Springwood Drive, Suite 230, Irving, Texas 75063. The Company's telephone number is (972) 444-8280. The Company is a Delaware corporation. The following is a brief summary of the recent history of the Company and its subsidiaries. This summary identifies why the Company is in its current financial position and what led to the changes in the Company's financial position. The summary also includes information about why the Company has experienced unanticipated delays in the completion of its Intelli-Site(R) software product and why the Company has not met the anticipated sales levels for this product. During the spring of 1999, the Company's operating cash deficit was increasing as a result of lower revenues and higher than budgeted development costs. Management made a decision to refocus the Company on two of its subsidiaries, B&B Electromatic, Inc. and Intelli-Site, Inc., and to sell its other subsidiaries, Golston Company, Inc. and Tri-Coastal Systems, Inc. Intelli-Site, Inc. manufactures the Intelli-Site(R) software product and B&B Electromatic, Inc. manufactures traffic control and safety systems as well as safety barriers for highway railroad crossings. In May 1999, the Company sold Golston for $3.2 million in cash and a $100,000 promissory note. In August 1999, the Company sold Tri-Coastal Systems to Notification Systems, Inc. for a $66,000 promissory note. These two dispositions were consistent with the Company's previously announced respositioning strategy to focus on Intelli-Site, Inc. and B&B Electromatic, Inc. When the Company decided in the spring of 1999 to shift its focus, management assumed that the development of its Intelli-Site(R) software product was complete. However, due to unanticipated delays in the completion of the product, the Company did not meet the anticipated sales levels for the product and the Company once again experienced operating cash shortfalls. In the fall of 1999, the Company successfully raised $1.8 million through a private placement. In late 1999, the anticipation by customers of a new requirement scheduled to become effective in the spring of 2000 concerning the UL325 listing for gate operators caused B&B Electromatic to experience a significant downturn in perimeter security sales. B&B received compliance listing in July 2000. B&B also experienced a much lower sales volume than anticipated for the new railroad barrier product. The audit report of Grant Thornton LLP, the Company's independent auditors, states that the Company has suffered recurring losses from operations, has an excess of liabilities over assets, and is in default of certain debt covenants. The audit report further states that these matters raise substantial doubt about the Company's ability to continue as a going concern. The Company cannot predict any material trends, events or uncertainties that may affect the Company, its subsidiaries, their businesses and financial condition. RESULTS OF OPERATIONS Year Ended June 30, 2000 Compared to Year Ended June 30, 1999 Sales. The Company's total sales increased by $0.7 million, or 12.6%, during the fiscal year ended June 30, 2000, from $5.8 million in fiscal 1999. This increase is the result of increased Intelli-Site(R) software sales of approximately $0.3 million and increased end-user system installations of approximately $0.6 million by the Company's Intelli-Site, Inc. subsidiary. Intelli-Site, Inc.'s sales increase was offset by a slight decrease of $0.2 million in overall sales at the Company's B&B Electromatic Inc. subsidiary. For the twelve months ended June 30, 2000, approximately 82% of the Company's revenues were generated from the sale of products manufactured by the Company compared to 95% for the twelve months ended June 30, 1999. -------------------------------------------------------------------------------- Page 10 of 47 11 Cost of Sales. Cost of sales as a percentage of sales remained comparable at 67% for the fiscal year ended June 30, 2000 and at 66% for the fiscal year ended June 30, 1999. For the twelve months ended June 30, 2000, approximately 73% of the Company's cost of sales were related to the products manufactured by the Company, compared to 91% for the twelve months ended June 30, 1999. This decrease in the percentage of cost of sales related to manufactured products is due to a decrease in sales at B&B Electronic, Inc., a manufacturing subsidiary of the Company, coupled with an increase in sales at Intelli-Site, Inc., a software development subsidiary of the Company that is not a manufacturer Gross Margin. Gross margin as a percent of sales remained comparable at 33% for the fiscal year ended June 30, 2000 and at 34% for the fiscal year ended June 30, 1999. Selling, General and Administrative. Selling, general and administrative expenses decreased by 24% or by $1.4 million during the fiscal 2000 period. Approximately $0.5 million of the decrease during the current year is due to decreases in recruiting and relocation expenses at the Intelli-Site, Inc. subsidiary. The additional decrease is attributable to a one-time charge in fiscal 1999 of $0.9 million for the dissolution of the partnership that was originally formed to fund marketing and sales of the Intelli-Site(R) software product. Research and Development. Research and product development expenses remained comparable for the fiscal years ended June 30, 2000 and 1999. Interest Expense. During fiscal 2000, interest expense decreased by approximately $60,000. This decrease is primarily due to securing additional financing during the fiscal 1999 period. LIQUIDITY AND CAPITAL RESOURCES Cash Position The Company's cash position decreased $151,477 during the fiscal year 2000. At June 30, 2000, the Company had $99,636 in cash and cash equivalents and $408,166 outstanding under its accounts receivable factoring facility. This accounts receivable factoring facility is explained in greater detail below in this section. Continuing Operating Activities For the fiscal year ended June 30, 2000, the Company's continuing operating activities used $2,546,753 of cash compared to $3,505,922 of cash used during the fiscal year ended June 30, 1999, a difference of $959,169. This $959,169 decrease in cash used in continuing operating activities in fiscal 2000 is primarily due to the Company's reduced losses of $2,515,414 in fiscal 2000. However, this $2,515,414 amount of reduced losses in fiscal 2000 is offset in part by the payment in fiscal 1999 of expenses with the issuance of shares of the Company's Common Stock and warrants. The market value of these shares of Common Stock and of the warrants was approximately $1,469,922. Default under Convertible Debentures In the fall of 1998, the Company required additional funding as a result of continuing operating losses. Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC loaned the Company $600,000 in exchange for promissory notes at 9% interest due and payable in February 1999. These notes were refinanced as demand notes on February 22, 1999 with all other terms and conditions remaining the same as the original notes. In December 1996, the Company entered into a convertible debenture financing with each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC to finance the purchase of Golston Company, Inc. The Company issued a $2.3 million convertible debenture to each of the two Renaissance entities, for an aggregate of $4.6 million of convertible debentures. The Renaissance convertible debentures have an annual interest rate of 9% of outstanding principal balance. The debentures, plus interest, are due on December 1, 2003. The debentures are secured by equity, assets and futures contracts. The debentures are convertible into shares of the Company's Common Stock at an initial conversion price of $1.05 per share. On March 26, 1998, as a result of the Company's failure to achieve required financial milestones for the quarter ended December 31, 1997, the conversion rate on the Renaissance convertible debentures was reduced to $0.549, the average closing price of the Company's Common Stock for the 20-day period beginning on the date of the public announcement of its financial results for the quarter ended December 31, 1997. Monthly principal installments were to commence in December 1999 through maturity. These principal payments have not yet begun. The Company is in default of the covenants for the $4.6 million of convertible debentures issued to Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. At September 30, 2000, the principal amount of these convertible debentures in default was $4.6 million, of which $398,555 is currently outstanding. The Company has not received notice of default and is currently in negotiations to restructure this debt, but no agreement has yet been reached. The Company currently has no other source of repayment and -------------------------------------------------------------------------------- Page 11 of 47 12 there can be no assurance that these renegotiations will be successful. Accordingly, the debentures are classified as short-term debt on the financial statements. Accounts Receivable Factoring Facility On March 3, 2000, the Company replaced its existing accounts receivable factoring facility with an Account Transfer Agreement with Evergreen Funding Corporation to factor accounts receivable with recourse. Under the terms of this factoring facility, the Company sells its accounts receivable to Evergreen Funding Corporation, a factoring company. Evergreen Funding Corporation then acts as the principal in collecting those accounts receivable. The Company sells the receivables with recourse, which means that Evergreen Funding Corporation can turn to the Company if the accounts receivable prove to be not collectable. The Company's factoring facility also allows the Company to borrow money from Evergreen Funding Corporation in anticipation of the Company's expected sales. Borrowing money from the factoring company allows the Company to build up its inventory before a peak selling period. This accounts receivable factoring facility expires September 3, 2001, and can be extended at the discretion of the Company. The Company may sell its eligible accounts receivable at an advance rate of 80%, less an adjustable factoring fee, or service charge, of 1.5% to 2.0% of the amount of accounts receivable sold. The factor has recourse to the 20% residual of aggregate accounts receivable purchased and outstanding. The factor may require the Company to repurchase all or any portion of the accounts receivable unpaid following 90 days after its due date. The interest rate charged is equal to the prime rate charged by Chase Bank of Texas, N.A. plus 2% per annum. The monthly minimum borrowing amount is $200,000 and the maximum monthly borrowing amount is $800,000, subject to availability under the Company's borrowing base. This facility is secured by the accounts receivable and inventory of the Company's B&B Electromatic, Inc. subsidiary and is guaranteed by the Company and Intelli-Site, Inc. The Company believes borrowing under this accounts receivable factoring facility, combined with results from operations, will be sufficient to finance future cash requirements at B&B Electromatic, Inc. for the fiscal year ended June 30, 2001. The cash that the Company receives from the accounts receivable factoring facility is also used to support Company-wide operations. Additional Debt Service Obligations During the twelve months ended June 30, 2000, the Company financed its operations with cash flows from long-term borrowings of $1,538,806 and received $1,688,021 in cash from the sale of preferred stock. The Company made payments of $613,786 on debt and other liabilities. In October and November 1999, the Company raised $1.855 million through a private placement of 92,750 shares of preferred stock. In consideration for the 1.855 million, the Company received $1,688,021 in cash, converted $87,402 of other liabilities into preferred stock and paid $79,577 in fees associated with the preferred stock placement. The preferred stock provides for dividends of 9% per annum and is convertible into common stock at a rate of 25 common shares for each preferred share. Each investor in the private placement also received a warrant to purchase 16 2/3 shares of common stock for each share of preferred stock purchased. The warrant exercise price is $1.00 per share and the warrants expire in October 2004. As of December 31, 1996, pursuant to the terms of a convertible loan agreement, Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC loaned the Company $4.6 million in convertible debentures at an interest rate of 9% per year. The monthly interest payments are $4,438. The debentures are convertible into shares of Common Stock at a rate of $0.549 per share. Since February 22, 1999, each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC has made six loans to the Company evidenced by promissory notes. Each of the twelve promissory notes accrues interest at a rate of 9% per year. The monthly interest payments are $3,975. On April 12, 2000, C. A. Rundell, Jr., currently Chairman of the board of directors and Chief Executive Officer of the Company, loaned the Company $200,000 as evidenced by a promissory note. In addition, on June 28, -------------------------------------------------------------------------------- Page 12 of 47 13 2000, The Rundell Foundation, a non-profit corporation, loaned the Company $100,000 as evidenced by a promissory note. Both of these promissory notes accrue interest at a rate of 9% a year and are due and payable on demand. The monthly interest payments are $2,250. Mr. Rundell is President, a director and trustee of The Rundell Foundation. As discussed in "Item 2. Description of Property" above, the Company has a mortgage on B&B Electromatic, Inc.'s facility. At September 30, 2000, the principal amount of the mortgage was $734,894. The interest rate is 10% and the amortization provisions are standard. There are no prepayment provisions and the mortgage matures on September 14, 2001. The balance due on the maturity date is $673,296. The Company does not have any material commitments to purchase property and equipment in fiscal 2000. The Company does not have any material funding requirements for software and other products under development. Summary of Material Terms of Convertible Debentures In December 1996, the Company entered into a convertible debenture financing with each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC to finance the purchase of Golston Company, Inc. The Company issued a $2.3 million convertible debenture to each of the two Renaissance entities, for an aggregate of $4.6 million of convertible debentures. The Renaissance convertible debentures have an annual interest rate of 9% of outstanding principal balance. The debentures, plus interest, are due on December 1, 2003. The debentures are secured by equity, assets and future contracts. The debentures are convertible at the option of the holders at any time into shares of the Company's Common Stock at an initial conversion price of $1.05 per share. Pursuant to the debenture, if the Company did not meet specified financial milestones in 1997, the conversion price would be decreased one time to an amount equal to 75% of the average closing price of the Company's Common Stock for the 20-day period beginning on the date of the public announcement of its financial results for the quarter ended December 31, 1997. On March 26, 1998, as a result of the Company's failure to achieve the required financial milestones for the quarter ended December 31, 1997, the conversion rate on the Renaissance convertible debentures was reduced to $0.549. The conversion price will be adjusted again: o If the Company issues any shares of Common Stock for a consideration per share that is less than the current conversion price,then in each such case,the conversion price will be reduced to a new conversion price equal to the consideration per share received by the Company for the additional shares of Common Stock and the number of shares issuable to the Renaissance entities will be proportionately increased. o If the Company issues shares of Common Stock for consideration, part or all of which is cash, then the amount of the cash consideration will be deemed to be the amount of the cash received by the Company for those shares, after subtracting certain fees and expenses incurred in connection with the sale. o If the Company's securities are reclassified into shares of Common Stock, then the shares of Common Stock issued in such reclassification will be deemed to have been issued for a consideration other than cash. o If issued and outstanding shares of Common Stock are subdivided or split up into a greater number of shares of Common Stock, then the conversion price will be proportionately decreased. If issued and outstanding shares of Common Stock are combined into a smaller number of shares of Common Stock, then the conversion price will be proportionately increased. The conversion price will not be affected by: o The issuance of Common Stock upon the conversion of any of the debentures; o The issuance of Common Stock upon the exercise of any warrants or stock purchase options issued and outstanding as of the date of the debentures; -------------------------------------------------------------------------------- Page 13 of 47 14 o The issuance of Common Stock pursuant to the exercise of authorized or outstanding options under any currently existing incentive stock option plan; o The issuance of Common Stock pursuant to the conversion of preferred stock currently outstanding at its current conversion price; and o The issuance of the first 700,000 shares of Common Stock sold or issued for less than the conversion price. Mandatory Principal Installments. If the debentures are not sooner redeemed or converted, then the Company is required to pay to the Renaissance entities, commencing on December 11, 1999, and the first day of each successive month before maturity, mandatory principal redemption installments in the amount of $10.00 for each $1,000,000 of the then remaining principal amount of the debentures. The Company has not made any of these payments and as a result is technically in default of the debentures. At maturity, the Company is required to make a final installment of all of the remaining unpaid principal amount plus all unpaid interest and other charges due. Mandatory Redemption in the Event of Certain Changes. If the Common Stock is not listed for exchange on the NASDAQ National Market, the New York Stock Exchange, the American Stock Exchange, or quoted on the NASDAQ Small Cap System, or any person acquires more than 50% of the Common Stock, then the debentures will, at the option of the Renaissance entities after 30 days notice to the Company, be redeemed at the greater of (a) the market value of the debentures or (b) at a certain percentage of par, depending on the date. Since March 24, 1999, the Common Stock has not been listed on any referenced exchange. As of September 30, 2000, the Company has not received notice from the holder of an election to cause mandatory redemption. Redemption at the option of the Company. On any interest payment date, and after prior irrevocable notice, the outstanding principal amount of the debentures is redeemable, in whole, at 120% of par if: o The closing bid price for the Common Stock averages at least $4.00 per share for the 21 consecutive trading days; o The $4.00 bid price is supported by a minimum of 30 times fully diluted net earnings per share of Common Stock in the aggregate for the last four consecutive fiscal quarters preceding the date of irrevocable notice; o The average, over 20 days, of the daily trading volume shall be no less than 10,000 shares; and o The Company shall have filed a registration statement covering the shares of Common Stock issuable upon conversion of the debentures. Adjustment for Mergers. If (a) the Company distributes to all Common Stock holders indebtedness of the Company or assets, excluding cash dividends or distributions from retained earnings, or other rights to purchase securities or assets, or (b) there is a capital reorganization or reclassification of the Company's Common Stock, then the debentures will be converted into the kind and amount of securities, cash and other property which the Renaissance entities would have been entitled to receive if the holder owned the Common Stock issuable upon conversion of the debentures immediately before the occurrence of the event. Events of Default. "Event of Default" includes: o the failure to pay, not later than 10 days after the due date, any interest or principal of the debenture; o any representation or warranty under the loan agreement or loan documents is untrue in any material respect as of the date made; o default in the performance of any covenant under the loan agreement, security agreement, pledge agreement or other loan documents, after the expiration of a 30 day cure period; o default in the payment of any Material Indebtedness (as defined in the debenture); o any of the loan documents cease to be enforceable or become inoperative; o bankruptcy events; o any final judgment for the payment of money in excess of $250,000 is rendered against the Company and not satisfied or discharged at least 10 days before assets could be sold to pay the judgment; o the failure of the Company to deliver shares of Common Stock upon conversion of the debenture; or o the failure to submit Renaissance's nominee, if any, for election to the Company's board for any reason other than good cause. Remedies upon Default. Upon the occurrence of an Event of Default, the holder may: o declare all principal and interest due and payable; o reduce any claim to judgment; or o pursue and enforce the holder's rights and remedies. In addition, the Company must pay all costs and expenses reasonably incurred by the holder in connection with preserving its rights. Rights under Convertible Loan Agreement. The convertible debentures were issued pursuant to the Convertible Loan Agreement dated as of December 31, 1996 among the Company, its subsidiaries and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. This loan agreement includes representations, warranties and covenants of the Company customary for a loan agreement. The loan agreement includes the same events of default as are specified in the convertible debentures. Pursuant to the loan agreement, the Renaissance parties may designate a nominee to the Company's board of directors, subject to the Company's written approval, which may not be unreasonably withheld. If the Renaissance parties do not request a board designee, then the Renaissance parties may have a representative attend board meetings. Registration Rights. The holders of convertible debentures have registration rights under the loan agreement. The holders have registration rights under the Convertible Loan Agreement dated December 31, 1996 with the Renaissance parties. The holders of at least 50% of the registrable securities then outstanding may demand that the Company file a registration statement and use its best efforts to register the securities within 150 days of the registration request. The holders also have piggyback registration rights. The registration rights terminate on the earlier to occur of June 30, 2006 or after the holders have demanded two registrations. Summary of Material Terms of Promissory Notes From February 22, 1999 to June 30, 2000, each of Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC has made three loans to the Company evidenced by promissory notes. Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC -------------------------------------------------------------------------------- Page 14 of 47 15 made their loans to the Company on the same day, from February 22, 1999 through May 5, 2000. These dates and amounts of these six promissory notes are outlined in the table below. In addition, on April 20, 2000, the Company issued a $200,000 promissory note to C. A. Rundell, Jr. The two promissory notes issued on February 22, 1999, and the Company's five other promissory notes are not convertible and were not renewed or extended. The promissory notes accrue interest at a rate of 9% per year.
AMOUNT OF PROMISSORY NOTES AMOUNT OF PROMISSORY ISSUED TO RENAISSANCE CAPITAL NOTES ISSUED TO RENAISSANCE US DATE GROWTH & INCOME FUND III, INC.($) GROWTH & INCOME TRUST PLC($) ---- --------------------------------- ------------------------------ February 22, 1999 $ 375,000(1) $ 225,000(1) August 12, 1999 115,000(2) 115,000(2) May 5, 2000 150,000 150,000
---------- (1) This is a convertible promissory note, with an initial conversion price of $0.549 per share. This promissory note was amended on May 5, 2000. (2) This promissory note was renewed and extended on May 5, 2000. The following is a summary of the material terms of the promissory notes. Interest. Interest will accrue interest on the unpaid principal balance due under the notes at an annual rate equal to 9%. Interest accrues from the date of the note until it is paid in full. For the convertible promissory notes only, interest is due and payable monthly on the first date of each month. Limitation of Interest. All agreements of the Company and the payee are expressly limited so that in no contingency or event will the amount contracted for, charged, received, paid or agreed to be paid to the holder of the note exceed the maximum amount permissible under applicable usury laws. Payment of Notes. The principal balance of and all accrued unpaid interest will be due and payable on demand. The notes may be prepaid in whole or in part at any time, at the option of the maker, without premium or penalty. Two of the seven issued promissory notes are silent regarding prepayment of the note: (a) the $375,000 convertible promissory note dated February 22, 1999, issuable to Renaissance Capital Growth & Income Fund III, Inc. and (b) the $200,000 note dated April 12, 2000, issuable to Mr. Rundell. Upon the default in payment of the notes, the payee may pursue any and all remedies to which payee may be entitled. Security of Agreements. The $200,000 note dated April 12, 2000, issuable to Mr. Rundell is secured by the accounts receivable of Intelli-Site, Inc. The other six promissory notes issued by the Company through June 30, 2000 are secured by (a) the Security Agreement, dated as of October 2, 1998, among the Company, B&B Electromatic, Inc., Golston Company, Inc., Innovative Security Technologies, Inc. (now named Intelli-Site, Inc.) and Tri-Coastal Systems, Inc. and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC, and (b) the Stock Pledge Agreement, dated as of December 31, 1996, as amended, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. Conversion. Of the seven promissory notes issued between February 22, 1999 and May 5, 2000, only the two promissory notes issued on February 22, 1999 are convertible into shares of Common Stock. The conversion rate is $0.549 per share. The convertible notes may be converted at the option of the payee in its sole and absolute discretion, in whole or in part, and at any time or from time to time, into fully paid and nonassessable shares of Common Stock. If the Company issues Common Stock for consideration per share less than the conversion rate, then the conversion rate will be reduced to that lower price. This does not apply to Common Stock issued upon (a) the conversion of a promissory note, (b) the exercise of any outstanding warrants, options or convertible debt instruments, or (c) the exercise of outstanding employee stock options. Adjustment for Mergers, Sales and Consolidations. For the Company's convertible promissory notes -------------------------------------------------------------------------------- Page 15 of 47 16 only, if there is a consolidation or merger of the Company with or into, or the sale of substantially all of the properties and assets of the Company, to any person and, in connection with such transaction, consideration is payable to holders of Common Stock in cash, securities or other property, then the payee will have the right to purchase the kind of receivable in connection with the transaction by a holder of the same number of shares of Common Stock as were exercisable by the payee immediately prior to the transaction. In addition, if there is such a transaction, or in the event of the dissolution, liquidation or winding up of the Company, then the payee will be entitled to receive distributions on the date of such event on an equal basis with holders of Common Stock as if the note had been converted immediately prior to such event, less the conversion price. Registration Rights. For the Company's convertible promissory notes only, the shares of Common Stock issued upon conversion of the notes will be restricted from transfer by the payee, unless the shares are duly registered for sale pursuant to the Securities Act of 1933 or the transfer is exempt from registration. Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC have rights regarding the registration of shares of Common Stock issued upon the conversion of the notes under the terms of the Registration Rights Agreement between the Company and the two Renaissance entities, dated February 22, 1999. Dividends. For the Company's convertible promissory notes only, shares of Common Stock issued as a dividend or other distribution on any class of capital stock of the Company will be deemed to have been issued without consideration. Stock Splits/Subdivisions. For the Company's convertible promissory notes only, if there is a stock split or subdivision of shares of Common Stock into a greater number of shares, the conversion price will be proportionately decreased. If there is a combination of shares of Common Stock into a smaller number of shares, the conversion price will be proportionately increased. Any increase or decrease will be effective at the record date. Property and Equipment The Company used $110,298 for the purchase of property and equipment during fiscal 2000 compared to $266,192 for the previous fiscal 1999 period. The purchases in fiscal 1999 of a new computer system for approximately $30,000 at B&B Electromatic, Inc. and a trade show booth for approximately $90,000 at Intelli-Site, Inc. accounted for the majority of this variance. Additional Sources of Financing The Company's liabilities are currently in excess of its assets and the Company has experienced significant losses during fiscal 1999 and 2000. Management expects losses to continue through the majority of fiscal 2001. In order to meet working capital needs, the Company will need to receive additional financing either through the sale of assets of the Company or its subsidiaries, equity placement and/or additional debt. Failure to receive financing could jeopardize the Company's ability to continue to operate. The Company is seeking stockholder approval of a proposed financial restructuring of the Company's debt. Under the terms of this financial restructuring, the Company will obtain approximately $1.0 million in cash from Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC in exchange for the issuance of promissory notes and new series of preferred stock of the Company. The Company anticipates that it will receive a portion of this $1.0 million in funding before the 2001 Annual Meeting of Stockholders. The Company will receive the full amount of this $1.0 million in funding before June 30, 2001. The cash that the Company receives from the accounts receivable factoring facility is utilized to support Company-wide operations. As discussed in more detail in the Company's proxy statement for the 2001 Annual Meeting of Stockholders, the Company's board of directors determined that the proposed financial restructuring is the best alternative to attempt to preserve stockholder value and to obtain additional funding. If the Company's stockholders do not approve the proposed financial restructuring or if the financial restructuring is not completed, then at the present time and the foreseeable future, it seems unlikely that the Company will be able to obtain additional financing either through the sale of assets of the Company or its subsidiaries, equity placement and/or additional debt. -------------------------------------------------------------------------------- Page 16 of 47 17 BACKLOG The Company's backlog is calculated as the aggregate sales prices of firm orders received from customers less revenue recognized. At September 30, 2000, the Company's backlog was approximately $1.6 million. The Company expects that it will fill the majority of this backlog by December 31, 2001. CAPITAL EXPENDITURES During the year ended June 30, 1999, the Company acquired $110,298 of property and equipment with both short-term and long-term borrowings. The Company does not anticipate any significant capital expenditures during fiscal 2001. EFFECTS OF INFLATION The Company believes that the relatively moderate rate of inflation over the past few years has not had a significant impact on the Company's sales or operating results. SEASONALITY Historically the Company has experienced seasonality in its business due to fluctuations in the weather. The Company typically experiences a decline in sales and operating results during the quarter ended March 31 due to winter weather conditions. ENVIRONMENTAL MATTERS The Company believes that it is currently in compliance with all applicable environmental regulations. Compliance with these regulations has not had, and is not anticipated to have, any material impact upon the Company's capital expenditures, earnings or competitive position. -------------------------------------------------------------------------------- Page 17 of 47 18 INTEGRATED SECURITY SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ITEM 7. FINANCIAL STATEMENTS
Page ---- Report of Independent Accountants..................................................................................16 Consolidated Balance Sheets as of June 30, 2000 and 1999...........................................................17 Consolidated Statements of Operations for the years ended June 30, 2000 and 1999...................................18 Consolidated Statements of Stockholders' Equity for the years ended June 30, 2000 and 1999.........................19 Consolidated Statements of Cash Flows for the years ended June 30, 2000 and 1999...................................20 Notes to Consolidated Financial Statements......................................................................21-33
-------------------------------------------------------------------------------- Page 18 of 47 19 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and the Stockholders of Integrated Security Systems, Inc. We have audited the accompanying consolidated balance sheets of Integrated Security Systems, Inc. as of June 30, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Integrated Security Systems, Inc. as of June 30, 2000 and 1999, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has suffered recurring losses from operations, has an excess of liabilities over assets, and is in default of certain debt covenants. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ GRANT THORNTON LLP Dallas, Texas August 4, 2000 -------------------------------------------------------------------------------- Page 19 of 47 20 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS
June 30, ---------------------------- 2000 1999 ------------ ------------ ASSETS Current assets: Cash and cash equivalents ........................................................ $ 99,636 $ 251,113 Accounts receivable, net of allowance for doubtful accounts of $58,847 and $54,383, respectively ......................... 1,201,491 1,381,879 Inventories ...................................................................... 585,486 529,198 Notes receivable, net of $60,000 discount in 1999 ................................ 28,546 340,000 Unbilled revenue ................................................................. 252,567 -- Other current assets ............................................................. 112,718 156,165 Assets of discontinued operations ................................................ -- 626,220 ------------ ------------ Total current assets ........................................................... 2,280,444 3,284,575 Property and equipment, net ...................................................... 921,695 1,019,993 Capitalized software development costs, net ...................................... 113,713 332,802 Deferred income taxes ............................................................ -- 205,384 Other assets ..................................................................... 16,898 74,653 ------------ ------------ Total assets ................................................................... $ 3,332,750 $ 4,917,407 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable - trade ......................................................... $ 582,717 $ 625,964 Accrued liabilities .............................................................. 440,072 1,004,253 Current portion of long-term debt ................................................ 6,135,260 1,330,566 Liabilities of discontinued operations ........................................... -- 249,654 ------------ ------------ Total current liabilities ...................................................... 7,158,049 3,210,437 Long-term debt ...................................................................... 728,331 4,608,003 Stockholders' deficit: Convertible preferred stock, $.01 par value, 750,000 shares authorized; 102,250 and 10,250, shares respectively issued and outstanding (liquidation value of $2,045,000 and $205,000, respectively) ................................ 1,023 102 Common stock, $.01 par value, 35,000,000 shares authorized; 10,564,145 and 10,513,993 shares, respectively, issued; and 10,514,145 and 10,463,993 shares, respectively, outstanding ...................................................... 105,641 105,140 Additional paid in capital ....................................................... 14,502,963 12,704,653 Accumulated deficit .............................................................. (19,044,507) (15,592,178) Treasury stock, at cost - 50,000 shares .......................................... (118,750) (118,750) ------------ ------------ Total stockholders' deficit ...................................................... (4,553,630) (2,901,033) ------------ ------------ Total liabilities and stockholders' deficit .................................... $ 3,332,750 $ 4,917,407 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. -------------------------------------------------------------------------------- Page 20 of 47 21 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended June 30, ---------------------------- 2000 1999 ------------ ------------ Sales ...................................................... $ 6,561,359 $ 5,828,247 Cost of sales .............................................. 4,369,262 3,836,319 ------------ ------------ Gross margin ............................................... 2,192,097 1,991,928 Operating expenses: Selling, general and administrative ..................... 4,589,922 6,038,120 Research and product development ........................ 386,899 378,365 ------------ ------------ 4,976,821 6,416,485 ------------ ------------ Loss from operations ....................................... (2,784,724) (4,424,557) Other income (expense): Interest income ......................................... 33,690 45,448 Interest expense ........................................ (645,684) (705,352) Other ................................................... -- (59,482) ------------ ------------ Loss from continuing operations before income taxes ........ (3,396,718) (5,143,943) Deferred income tax benefit ................................ 51,856 -- ------------ ------------ Net loss from continuing operations after income taxes ..... (3,344,862) (5,143,943) Discontinued operations: Gain from operations .................................... -- 21,837 Loss on disposal ........................................ -- (738,170) ------------ ------------ Loss from discontinued operations .......................... -- (716,333) ------------ ------------ Net loss ................................................... (3,344,862) (5,860,276) Preferred dividends ........................................ (107,467) -- ------------ ------------ Net loss allocable to common stockholders .................. $ (3,452,329) $ (5,860,276) ============ ============ Weighted average common shares outstanding ................. 10,508,510 9,168,124 Basic and diluted loss per share: Continuing operations ................................... $ (0.33) $ (0.56) Discontinued operations ................................. $ -- $ (0.08) ------------ ------------ Total ...................................................... $ (0.33) $ (0.64) ============ ============
The accompanying notes are an integral part of the consolidated financial statements. -------------------------------------------------------------------------------- Page 21 of 47 22 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Convertible Preferred Stock Common Stock Additional -------------------------- -------------------------- Paid In Accumulated Treasury Shares Amount Shares Amount Capital Deficit Stock ------------ ------------ ------------ ------------ ------------ ------------ ------------ Balance at July 1, 1998 ...... 10,250 $ 102 8,525,808 $ 85,258 $ 10,822,802 $ (9,731,902) $ (118,750) Common stock issuance ........ 1,200,000 12,000 768,000 Warrant issuance ............. 689,929 Warrant exercise ............. 1,668 17 Debenture conversion ......... 786,517 7,865 423,933 Net loss ..................... (5,860,276) ------------ ------------ ------------ ------------ ------------ ------------ ------------ Balance at June 30, 1999 ..... 10,250 102 10,513,993 105,140 12,704,653 (15,592,178) (118,750) Preferred stock issuance ..... 92,750 928 1,774,638 Preferred stock conversion ... (750) (7) 15,000 150 (143) Preferred dividends paid ..... (107,467) Common stock issuance ........ 35,152 352 23,815 Net loss ..................... (3,344,862) ------------ ------------ ------------ ------------ ------------ ------------ ------------ Balance at June 30, 2000 ..... 102,250 $ 1,023 10,564,145 $ 105,641 $ 14,502,963 $(19,044,507) $ (118,750) ============ ============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. -------------------------------------------------------------------------------- Page 22 of 47 23 INTEGRATED SECURITY SYSTEMS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
For the Years Ended June 30, ---------------------------- 2000 1999 ------------ ------------ Cash flows from operating activities: Net loss ................................................ $ (3,344,862) $ (5,860,276) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operations ..................... -- 716,333 Depreciation .......................................... 208,596 202,872 Amortization .......................................... 219,089 227,638 Provision for bad debt ................................ 36,946 20,060 Provision for warranty reserve ........................ 55,000 113,352 Provision for inventory reserve ....................... 1,359 -- Unbilled revenue ...................................... (189,976) (70,091) Expenses paid with common stock and warrants .......... 111,712 1,469,922 Changes in operating assets and liabilities: Accounts receivable ................................. 171,988 (108,558) Inventories ......................................... (57,647) (81,831) Notes receivable .................................... 311,454 (338,544) Deferred income taxes ............................... 205,384 -- Other assets ........................................ 38,612 51,990 Accounts payable .................................... (43,247) 180,835 Accrued liabilities ................................. (271,161) (29,624) ------------ ------------ Cash used in continuing operations ................ (2,546,753) (3,505,922) Cash provided by discontinued operations .......... -- 3,445,964 ------------ ------------ Net cash used in operating activities ........... (2,546,753) (59,958) ------------ ------------ Cash flows from investing activities: Purchase of property and equipment ...................... (110,298) (266,192) Purchase of software technology ......................... -- (200,090) ------------ ------------ Net cash used in investing activities ........... (110,298) (466,282) ------------ ------------ Cash flows from financing activities: Issuance of preferred stock ............................. 1,688,021 -- Dividends on preferred stock ............................ (107,467) -- Issuance of common stock ................................ -- 17 Payments of long-term debt and other liabilities ........ (613,786) (1,833,671) Proceeds from notes payable and long-term debt .......... 1,538,806 2,561,260 ------------ ------------ Net cash provided by financing activities ....... 2,505,574 727,606 ------------ ------------ Increase (decrease) in cash and cash equivalents ........... (151,477) 201,366 Cash and cash equivalents at beginning of period ........... 251,113 49,747 ------------ ------------ Cash and cash equivalents at end of period ................. $ 99,636 $ 251,113 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. -------------------------------------------------------------------------------- Page 23 of 47 24 1. ORGANIZATION AND DESCRIPTION OF BUSINESS Integrated Security Systems, Inc. was formed in December 1991. The Company consists of two wholly-owned subsidiaries: Intelli-Site, Inc., a developer and retail seller of PC-based control systems which integrate discrete security devices; and B&B Electromatic, Inc., a gate and barrier engineering and manufacturing facility. Golston Company, Inc. and Tri-Coastal Systems, Inc. are reflected as discontinued operations in the financial statements as a result of the sale of Golston in May 1999 and the sale of Tri-Coastal Systems in August 1999. 2. SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The consolidated financial statements include the Company and its subsidiaries: B&B Electromatic, Inc. and Intelli-Site, Inc.. All significant intercompany transactions and balances have been eliminated. CASH AND CASH EQUIVALENTS Cash is comprised of highly liquid instruments with original maturities of three months or less. INVENTORIES Inventories are carried at the lower of cost or market using the first-in, first-out method. PROPERTY AND EQUIPMENT AND DEPRECIATION Property and equipment are recorded at cost. Depreciation is provided over the estimated useful lives of the assets using straight-line and accelerated methods. Leased property and equipment under capital leases are amortized on the straight-line method over the lesser of the life of the asset or the remaining term of the lease. Estimated useful lives range from 3 to 31 years. INCOME TAXES The Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". Under the liability method, deferred taxes are provided for tax effects of differences in the basis of assets and liabilities arising from differing treatments for financial reporting and income tax purposes using currently enacted tax rates. Valuation allowances are recorded when it is more likely than not that a tax benefit will not be realized prior to the expiration of the carryforward periods. REVENUE RECOGNITION AND ACCOUNTS RECEIVABLE The Company recognizes revenue from sales at either the time of shipment or by percentage of completion for installations of security systems. The Company's accounts receivable are generated from a large number of customers in the traffic and security products markets. No single customer accounted for 10% or more of revenues during the years ended June 30, 2000 or 1999. UNBILLED REVENUE The Company recognizes revenue on system installation contracts as services are performed, which results in unbilled or unearned revenues based on billing provisions in the contract. This variance due to timing is accounted for as unbilled revenue. -------------------------------------------------------------------------------- Page 24 of 47 25 SOFTWARE DEVELOPMENT COSTS The Company accounts for software development costs pursuant to SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Capitalized costs are amortized over the greater of the revenue method or the straight-line method over five years. Amortization expense for the years ended June 30, 2000 and 1999 was $219,089 and $227,638, respectively. Accumulated amortization at June 30, 2000 was $723,283 and at June 30, 1999 was $504,194. The Company expenses all other research and product development costs as they are incurred. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values of the Company's accounts receivable, notes receivable, accounts payable, long-term debt and other liabilities approximate the fair values of such financial instruments. NET LOSS PER SHARE The Company computes basic loss per common share using the weighted average number of common shares. Dilutive net loss per common share is not presented as all common equivalent shares would have been antidilutive. At June 30, 2000 and 1999, there were 12,503,022 and 9,664,010 potentially dilutive common shares, which were not included in weighted average shares outstanding because their effect is antidilutive. ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual amounts could differ from these estimates. STATEMENTS OF CASH FLOWS Supplemental cash flow information for the years ended June 30, 1999 and 1998:
2000 1999 -------- -------- Interest paid $411,421 $284,805 Income tax refunds received $257,240 $ --
CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade accounts receivable. The Company follows the practice of filing statutory liens on construction projects where collection problems are anticipated. The liens serve as collateral for trade receivables. The Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk attendant in its business. NEW ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The Company will adopt SAB 101 in the fiscal year ending June 30, 2001. SAB 101 is not expected to have a significant effect on the Company's consolidated results of operations or financial position. -------------------------------------------------------------------------------- Page 25 of 47 26 STOCK-BASED COMPENSATION The Company accounts for stock-based compensation to employees using the intrinsic value method. Accordingly, compensation cost for stock options to employees is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock. 3. LIQUIDITY The Company is in default of the covenants for the convertible debentures issued to Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. The Company has not received notice of default and is currently in negotiations to restructure this debt, but no agreement has yet been reached. The Company currently has no other source of repayment and there can be no assurance that these renegotiations will be successful. Accordingly, the debentures are classified as short-term debt on the financial statements. The Company's liabilities are currently in excess of its assets and the Company has experienced significant losses during fiscal 1999 and 2000. Management expects losses to continue through the majority of fiscal 2001. In order to meet working capital needs, the Company will need to receive additional financing either through the sale of assets, equity placement and/or additional debt. Failure to receive such financing could jeopardize the Company's ability to continue to operate. The Company is seeking stockholder approval of a proposed financial restructuring of the Company's debt. Under the terms of this financial restructuring, the Company will obtain approximately $1.0 million in cash from Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC in exchange for the issuance of promissory notes and new series of preferred stock of the Company. The Company anticipates that it will receive a portion of this $1.0 million in funding before the 2001 Annual Meeting of Stockholders. The Company will receive the full amount of this $1.0 million in funding before June 30, 2001. The cash that the Company receives from the accounts receivable factoring facility is utilized to support Company-wide operations. As discussed in more detail in the Company's proxy statement for the 2001 Annual Meeting of Stockholders, the Company's board of directors determined that the proposed financial restructuring is the best alternative to attempt to preserve stockholder value and to obtain additional funding. If the Company's stockholders do not approve the proposed financial restructuring or if the financial restructuring is not completed, then at the present time and the foreseeable future, it seems unlikely that the Company will be able to obtain additional financing either through the sale of assets of the Company or its subsidiaries, equity placement and/or additional debt. 4. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS The composition of certain balance sheet accounts is as follows:
June 30, ---------------------------- 2000 1999 ------------ ------------ Inventories: Raw materials $ 383,092 $ 422,770 Work-in-process 188,391 105,763 Finished goods 14,003 665 ------------ ------------ $ 585,486 $ 529,198 ============ ============ Property and equipment: Land $ 40,164 $ 40,164 Building 586,449 586,449 Leasehold improvements 48,769 48,769 Office furniture and equipment 1,070,258 990,088 Manufacturing equipment 626,122 595,994 Vehicles 63,875 63,875 Construction 153,425 153,425 ------------ ------------ 2,589,062 2,478,764 Less: accumulated depreciation (1,667,367) (1,458,771) ------------ ------------ $ 921,695 $ 1,019,993 ============ ============
-------------------------------------------------------------------------------- Page 26 of 47 27 5. DEBT Debt:
June 30, ---------------------------------------- 2000 1999 ----------------- ----------------- Convertible debentures to venture capital funds; interest at 9% of outstanding principal balance due in monthly installments through December 2003; monthly principal installments of $10 per $1,000 of the then remaining principal amount of the debenture beginning in December 1999 through maturity; secured by equity, assets and future contracts. The outstanding balance of the note can be converted into the Company's common stock at $0.549 per share. At June 30, 1999 and 2000, the Company was not in compliance with the Current Ratio, Minimum Tangible Net Worth, Debt to Equity and Debt Service Coverage financial standards under this agreement. ............................................... $ 4,168,202 $ 4,168,202 Term note payable to a bank; due in monthly principal and interest installments of $12,000 through November 2000; interest at the lender's prime rate less 1% (10% at June 30, 1999 and 2000); this note was refinanced in September 1999; secured by first mortgage on real estate and equipment; personally guaranteed by a former officer............................................................ 752,084 704,258 Convertible notes payable to venture capital funds; interest at 9% due in monthly installments of $4,438; principal and accrued unpaid interest due upon demand. The outstanding balance of the note can be converted into the Company's common stock at $0.549 per share............................................... 600,000 600,000 Accounts receivable factoring facility with a finance company to factor accounts receivable with recourse. This accounts receivable factoring facility has an adjustable factoring fee of 1.5%-2.0%, a minimum and maximum borrowing of $200,000 and $800,000, respectively, per month; interest at the prime rate of Chase Bank of Texas, N. A. plus 2% and expires on September 3, 2001............ 408,166 -- Notes payable to venture capital funds; interest at 9% due in monthly installments of $3,975; principal and accrued unpaid interest due upon demand.. 530,000 -- Notes payable to individual and foundation; interest at 9% due in monthly installments of $2,250; secured by accounts receivable; principal and accrued unpaid interest due upon demand................................................ 300,000 -- Cash accelerator agreement with a bank; interest at prime plus 3%; paid in full in fiscal 2000............................................................ -- 325,460 Other term notes payable to unrelated third parties............................ 105,139 140,649 ----------------- ----------------- 6,863,591 5,938,569 Less current portion........................................................... (6,135,260) (1,330,566) ----------------- ----------------- $ 728,331 $ 4,608,003 ================= =================
-------------------------------------------------------------------------------- Page 27 of 47 28 Due to financial covenant defaults, the entire balance of the convertible debentures has been included in current maturities. Payments required under long-term debt and other liabilities outstanding at June 30, 2000 are as follows: 2001 $6,135,260 2002 724,805 2003 3,526 2004 -- 2005 -- Thereafter -- ---------- $6,863,591 ==========
6. INCOME TAXES A reconciliation of the income tax provision and the amount computed by applying the federal statutory benefit rate to loss before income taxes are as follows:
For the Years Ended ------------------------------ June 30, 2000 June 30, 1999 ------------- ------------- Federal statutory benefit rate (34.0)% (34.0)% Tax gain on sale of Golston Company, Inc. --% 22.6% Net operating carryforwards lost on sale of Golston --% 5.3% Increase in valuation allowance 38.6% 4.5% Other (2.6)% 1.6% ------------ ------------ 2.0% --% ============ ============
Deferred tax assets (liabilities) are comprised of the following at:
June 30, 2000 June 30, 1999 ------------- ------------- Deferred tax assets Amortization -- 69,000 Warranty reserve 25,000 29,000 Accounts receivable 20,000 17,000 Net operating loss carryforward 4,640,000 3,489,000 ------------- ------------- Gross deferred tax asset 4,685,000 3,604,000 Deferred tax liabilities Property and equipment (96,000) (122,000) ------------- ------------- Net deferred tax asset 4,589,000 3,482,000 Valuation allowance (4,589,000) (3,276,616) ------------- ------------- Net deferred tax asset $ -- $ 205,384 ============= =============
The tax benefit of net operating loss carryforwards at June 30, 1999 has been reduced by $1,441,000 from the amount previously reported, upon final determination of the tax effect of the sale of Golston Company, Inc. in fiscal 1999. The Company has unused net operating loss carryforwards of approximately $13.6 million at June 30, 2000. These carryforwards expire beginning in 2007 through 2020. The Company has recorded a valuation allowance each year to the extent it is more likely than not that a tax benefit will not be realized prior to expiration of the carryforward periods. -------------------------------------------------------------------------------- Page 28 of 47 29 7. COMMITMENTS AND CONTINGENCIES The Company leases facilities and equipment under leases accounted for as operating leases. Future minimum payments for fiscal years subsequent to June 30, 2000 under these leases, which expire in 2001, are approximately $96,073. Rent expense for operating leases was $163,959 and $146,269 for the years ended June 30, 2000 and 1999, respectively. CONTINGENCIES The Company is subject to certain legal actions and claims arising in the ordinary course of business. Management recognizes the uncertainties of litigation; however, based upon the nature and management's understanding of the facts and circumstances which give rise to such actions and claims, management believes that such litigation and claims will be resolved without material effect on the Company's financial position, results of operations or cash flows. 8. BENEFIT PLANS The Company has established a 401(k) savings and profit sharing plan. Participants include all employees who have completed six months of service and are at least 21 years of age. Employees can contribute up to 15% of compensation and the Company may at its option make discretionary contributions. Vesting on the Company's contribution occurs over a five-year period. The Company made no contributions during the years ended June 30, 2000 and 1999. 9. STOCK OPTIONS AND WARRANTS The Company's 1993 Stock Option Plan provides for grants of options for up to 500,000 shares of common stock. Under the plan, options must be granted with an exercise price not less than the fair market value on the date of grant. The Company's 1997 Omnibus Stock Plan provides for the granting of incentive stock options, non-statutory stock options, stock appreciation rights, awards of stock and stock purchase opportunities to its directors, employees and consultants. Under the plan, incentive stock options may only be granted to employees or directors of the Company. Option exercise prices are equal to the market price at date of grant. Shares under grant generally become exercisable over three years and expire after ten years. If the Company recognized compensation expense as permitted under Statement of Financial Accounting Standards No. 123 ("SFAS 123"), based on the fair value at the grant dates, the Company's pro forma net loss and net loss per share would have been as follows (net loss amounts in thousands):
For the Year Ended For the Year Ended June 30, 2000 June 30, 1999 -------------------------------------- -------------------------------------- As reported Pro forma As reported Pro forma ----------------- ----------------- ----------------- ----------------- Net Loss $ (3,345) $ (3,521) $ (5,860) $ (5,979) Loss per Common Share $ (.33) $ (.35) $ (.64) $ (.65)
-------------------------------------------------------------------------------- Page 29 of 47 30 The fair value of these options was estimated at the date of grant using the Black-Sholes option pricing model with the following weighted average assumptions: For the period ending June 30, 2000, expected volatility of 100-110%; risk-free interest rates of approximately 6.2-6.9%; no dividend yield; and expected lives of five years. For the period ending June 30, 1999, expected volatility of 37-45%; risk-free interest rates of 4.5-5.4%; no dividend yield; and expected lives of five years. The pro forma net loss and net loss per share may not be indicative of future amounts because the disclosures do not reflect compensation expense for options granted prior to fiscal 1995. Additional information with respect to options outstanding at June 30, 2000 and changes for the two years then ended is as follows (share amounts in thousands):
For the Year Ended For the Year Ended June 30, 2000 June 30, 1999 ------------------------------------ ------------------------------------ Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price ---------------- ---------------- ---------------- ---------------- Outstanding at beginning of period 2,162 $ 1.40 1,336 $ 1.78 Granted 452 .58 933 .86 Forfeited (397) 1.12 (107) 1.42 ---------------- ---------------- ---------------- ---------------- Outstanding at end of period 2,217 $ 1.29 2,162 $ 1.40 ================ ================ ================ ================ Exercisable at end of period 1,499 $ 1.54 1,242 $ 1.71 ================ ================ ================ ================ Weighted-average fair value of options granted during the period $ .51 $ .54
Information about stock options outstanding at June 30, 2000 is summarized as follows:
Options Outstanding Options Exercisable ------------------------------------------------------ -------------------------------- Range of Shares Weighted Average Weighted Shares Weighted Exercise Outstanding Remaining Average Exercisable Average Prices at 6/30/00 Contractual Life Exercise Price at 6/30/00 Exercise Price -------- ------------- ---------------- -------------- ----------- -------------- $0.01-1.00 1,194 8.4 Years $ .73 564 $ .80 $1.1875-2.00 573 6.3 Years 1.55 485 1.58 $2.0938-2.50 450 2.9 Years 2.43 450 2.43 ----- ------ ----- ----- 2,217 $ 1.29 1,499 $1.54
-------------------------------------------------------------------------------- Page 30 of 47 31 WARRANTS During fiscal 1999, the Company issued warrants to purchase 100,000 shares of its common stock at $0.01 per share. These warrants were issued as compensation for certain investor relations representation and expire in 2003. Also in fiscal 1999, in conjunction with financing transactions, the Company issued warrants to purchase 437,500 shares of its common stock for $0.80 per share and warrants to purchase 1,274,715 shares of its common stock for $0.549 per share, both of which expire in 2004, and, in association with the acquisition of the royalty arrangements, warrants to purchase 480,000 shares of its common stock for $2.00 per share which expire in 2009. During fiscal 2000, the company issued warrants to purchase 1,545,833 shares of its common stock at $1.00 per share. These warrants were issued in connection with the Company's Series D Convertible Preferred Stock placement completed in October and November 1999. Additional information with respect to warrants outstanding at June 30, 2000 and changes for the two years then ended are as follows (share amounts in thousands):
For the Year Ended For the Year Ended June 30, 2000 June 30, 1999 ------------------------------------ ------------------------------------ Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price ---------------- ---------------- ---------------- ---------------- Outstanding at beginning of period 6,977 $ 1.84 4,793 $ 3.30 Granted 1,546 1.00 2,292 .86 Exercised -- -- (2) .01 Forfeited (18) 2.40 (106) 1.00 ---------------- ---------------- ---------------- ---------------- Outstanding at end of period 8,505 $ 1.69 6,977 $ 1.84 ================ ================ ================ ================ Exercisable at end of period 8,505 $ 1.69 6,977 $ 1.84 ================ ================ ================ ================ Weighted-average fair value of warrants granted during the period $ .28 $ .36
-------------------------------------------------------------------------------- Page 31 of 47 32 Information about warrants outstanding at June 30, 2000 is summarized as follows:
Warrants Outstanding Warrants Exercisable ------------------------------------------------------ ------------------------------- Shares Weighted Average Weighted Shares Weighted Range Outstanding Remaining Average Exercisable Average of Exercise Prices at 6/30/00 Contractual Life Exercise Price at 6/30/00 Exercise Price ------------------ ----------- ---------------- -------------- ----------- -------------- $.01-1.00 3,965 4.4 Years $ .80 3,965 $ .80 $1.06-2.00 610 7.7 Years 1.96 610 1.96 $2.40-2.55 3,930 .8 Years 2.55 3,930 2.55 ----- ------- ----- ------- 8,505 $ 1.69 8,505 $ 1.69
10. CONVERTIBLE PREFERRED STOCK The Company's outstanding preferred stock consists of 750,000 authorized shares of $.01 par value convertible preferred stock. Series A $20 Convertible Preferred Stock. At June 30, 2000, the Company had 9,500 shares of its Series A $20 Convertible Preferred Stock (the "Series A Preferred") outstanding. Holders of the Series A Preferred are not entitled to receive any dividends, and have no voting rights, unless otherwise required pursuant to Delaware law. Each share of the Series A Preferred may, at the option of the Company, be converted into 20 shares of Common Stock at any time after (i) the closing bid price of the Common Stock is at least $2.00 for at least 20 trading days during any 30 trading day period, and (ii) the shares of Common Stock to be received on conversion have been registered or otherwise qualified for sale under applicable securities laws. The holders of the Series A Preferred have the right to convert each share into 20 shares of Common Stock at any time. Upon any liquidation, dissolution, or winding up of the Company, the holders of the Series A Preferred are entitled to receive $20 per share before the holders of Common Stock are entitled to receive any distribution. Series D $20 Convertible Preferred Stock. At June 30, 2000 the Company had 92,750 shares of its Series D $20 Convertible Preferred Stock (the "Series D Preferred") outstanding. Holders of the Series D Preferred are entitled to receive dividends at the annual rate of 9% per share paid quarterly in cash, and have voting rights of one vote for each share of Common Stock into which the Preferred Stock is convertible. Beginning on November 15, 2004 the Company may redeem the Series D Preferred upon not less than 30 days' notice, in whole or in part, plus all accrued but unpaid dividends. After notice and prior to the expiration of the 30-day notice period, holders of the Series E Preferred will have the option to convert the Series D Preferred into Common Stock prior to the redemption. Each share of the Series D Preferred may, at the option of the Company beginning on November 15, 2000, be converted into 25 shares of Common Stock at any time after (i) the closing bid price of the Common Stock exceeds $2.00 for at least 20 trading days during any 30 trading day period, and (ii) the Company has sustained positive earnings per share of Common Stock for the two previous quarters. The holders of the Series D Preferred have the right to convert each share into 25 shares of Common Stock at any time. Upon any liquidation, dissolution, or winding up of the Company, the holders of the Series D Preferred are entitled to receive $20 per share before the holders of Common Stock are entitled to receive any distribution. Each holder also received a stock purchase warrant to purchase 16.67 shares of common stock at $1.00 per share for each share of Series D Preferred purchased. These warrants expire on October 10, 2004. -------------------------------------------------------------------------------- Page 32 of 47 33 11. SEGMENT REPORTING The Company has two business segments: B&B Electromatic, Inc. and Intelli-Site, Inc. These segments are differentiated by the products they produce and the customers they service as follows: B&B Electromatic, Inc. This segment consists of road and bridge perimeter security and railroad physical security products such as warning gates, crash barriers, lane changers, navigational lighting, airport lighting and hydraulic gates and operators, and aluminum gate panels. Intelli-Site, Inc. This segment consists of the development and marketing of programmable security systems that integrate multiple security devices and subsystems for governmental, commercial and industrial facilities utilizing the Intelli-Site(R) software product through systems integrators and original equipment manufacturers to end users. The Company's underlying accounting records are maintained on a legal entity basis for government and public reporting requirements. Segment disclosures are on a performance basis consistent with internal management reporting. The Company evaluates performance based on earnings from operations before income tax and other income and expense. The corporate column includes corporate overhead-related items. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 2). The following table provides financial data by segment for the fiscal years ended June 30, 2000 and 1999.
B&B Intelli-Site, Electromatic, Inc Inc. Corporate Total ------------------ ------------------ ------------------ ------------------ 2000 ---- Sales $ 5,363,239 $ 1,198,120 -- $ 6,561,359 Income/(loss) from operations 510,083 (1,900,298) (1,394,509) (2,784,724) Total assets 2,356,082 748,892 227,776 3,332,750 Depreciation and amortization expense 140,176 280,445 7,064 427,685 Capital additions 51,332 57,656 1,310 110,298 1999 ---- Sales $ 5,538,930 $ 289,318 $ -- $ 5,828,247 Loss from operations (71,385) (2,799,885) (1,553,287) (4,424,557) Total assets 2,720,489 727,227 1,469,691 4,917,407 Depreciation and amortization expense 143,503 236,269 50,738 430,510 Capital additions 108,690 144,039 13,463 266,192
-------------------------------------------------------------------------------- Page 33 of 47 34 12. DISCONTINUED OPERATIONS Effective October 1, 1998, the Company disposed of a portion of its Golston Company, Inc. subsidiary. In May 1999, the Company sold the remainder of Golston, which designs, manufactures and markets pneumatic tube carriers for use in financial institutions and hospitals through its plastic injection molding operations. Summarized financial information for Golston Company, Inc. is as follows:
For the Year Ended June 30, 1999 ------------------ Revenues $ 3,794,575 Income from discontinued operations 344,747 Loss on disposal (313,170)
In June 1999, the Company discontinued operations of its Tri-Coastal Systems, Inc. subsidiary, which designs, sells, installs and services electronic security systems. The Company sold Tri-Coastal Systems, Inc. on August 13, 1999. Summarized financial information for Tri-Coastal Systems, Inc. is as follows:
For the Year Ended June 30, 1999 ------------------ Revenues $ 1,423,095 Loss from discontinued operations (332,910) Loss on disposal (425,000)
The net assets of discontinued operations of Tri-Coastal Systems, Inc. at June 30, 1999 of $626,220 consist of $29,495 of cash, $159,741 of accounts receivable, $51,949 of inventories, $179,669 of other current assets, $10,601 of equipment, and $194,768 of goodwill, net of accumulated amortization. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There are no changes or disagreements required to be reported under this Item 8. -------------------------------------------------------------------------------- Page 34 of 47 35 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT C. A. RUNDELL, 67, Director and Chairman of the board of directors, has been a director of the Company since March 1999. Mr. Rundell was appointed Chief Executive Officer of the Company upon Gerald K. Beckmann's resignation as President, Chief Executive Officer and director on August 31, 2000. Mr. Rundell is also a director and Chairman of the board of NCI Building Systems, since 1988. Also since 1989, Mr. Rundell has owned and operated Rundell Enterprises, a sole proprietorship engaged in providing acquisitions and financial consulting services to various business enterprises. Mr. Rundell is a director and member of the executive committee of Tyler Technologies, Inc., a provider of information management systems and services for county governments and other enterprises. Mr. Rundell was the President and Chief Executive Officer of Tyler Technologies, Inc. from 1997 to 1998, Chairman of the board from 1996 to 1997, and temporary Chief Executive Officer from 1996 to 1997. Mr. Rundell is also a director of Renaissance US Growth & Income Trust, PLC, a director of Dain Rauscher Corporation, a holding company for a full-service regional brokerage and investment banking company and Tandy Brands Accessories, Inc., a manufacturer of accessories for men, women and boys. Mr. Rundell earned an M.B.A. with Distinction from Harvard University and a B.S. in Chemical Engineering from The University of Texas at Austin. ALAN M. ARSHT, 57, Director has been a director of the Company since 1999. Mr. Arsht has been President of Arsht & Company, Inc., a New York based investment banking firm established in 1986. From 1977 to 1986, Mr. Arsht was Senior Vice President and Managing Director of Thomson McKinnon Securities, Inc. He also served as Vice President, Corporate Finance at Wertheim & Company, Inc. and was Special Assistant to the Deputy Secretary of the U.S. Treasury Department. Mr. Arsht also held positions at the U.S. Securities and Exchange Commission. Mr. Arsht earned an M.B.A. in Finance from American University and a B.A. in History from East Texas State University. HOLLY J. BURLAGE, 37, Executive Vice President, Chief Financial Officer, Secretary and Treasurer, joined the Company in February 1994 as Accounting Manager, became Controller in 1995, became Vice President, Secretary and Treasurer in May 1997, and became Chief Financial Officer in July 1999. Prior to joining the Company, Ms. Burlage was Controller of Signature Home Care Group, Inc., a home health care company, from 1993 to 1994, and Controller and Chief Accounting Officer of National Heritage, Inc., a publicly-traded long-term care company, from 1989 to 1993. Ms. Burlage holds a B.B.A. from Baylor University. JACK G. CALDWELL, 63, President, B&B Electromatic, Inc., joined the Company in January 1998. Prior to joining the Company, Mr. Caldwell was a Results Manager for Thomas Group, Inc. from 1992 to 1998. From 1986 to 1992, Mr. Caldwell served as the European Operations Manager for E-Systems and was Director of Sales and Marketing from 1978 to 1986 for the Cooper Industries. Mr. Caldwell earned an M.B.A. and B.S. degrees from East Texas State University. ROBERT M. GALECKE, 59, Director, has been a director of the Company since May 1996. Mr. Galecke is currently Vice President of Finance and Administration for the University of Dallas. Prior to that he was a principal in the corporate consulting firm of Pate, Winters & Stone, Inc. from 1993 to May 1996. He also served as Executive Vice President, Chief Operating Officer and Chief Financial Officer of Southmark Corporation, a financial services insurance and real estate holding company, from 1986 to 1992. From 1989 to 1995, Mr. Galecke served as Chairman of the board, President and Chief Executive Officer of National Heritage, Inc. Mr. Galecke received a graduate degree from the School of Banking at the University of Wisconsin, Madison, and a B.S. in Economics from the University of Wisconsin at Stevens Point. JAMES E. JACK, 60, Director, has been a director of the Company since May 1997. Mr. Jack is currently Executive Vice President and Chief Financial Officer of Coachmen Industries, Inc. From 1996 to 1999, Mr. Jack was Director, Global Financial Services Product for TowersPerrin. From 1991 to 1996 Mr. Jack -------------------------------------------------------------------------------- Page 35 of 47 36 was Senior Executive Vice President and Chief Financial Officer of Associates First Capital Corporation, a publicly-traded consumer and commercial finance organization. Prior to that, Mr. Jack was Director, Executive Vice President and Chief Financial Officer from 1981 to 1993 of the same company. Mr. Jack received a graduate degree from the Southern Methodist University School of Business and a B.B.A. from the University of Notre Dame. JOHN P. JENKINS, 50, Director, has been a director of the Company since September 2000. Mr. Jenkins served as Chairman, Chief Executive Officer and President of TAVA Technologies, Inc., a systems integrator providing sophisticated IT solutions to manufacturing and process industries from 16 locations across the U.S. In July 1999, Real Software, a Belgian IT service and software provider, acquired TAVA. Mr. Jenkins continued as CEO and President of the U.S. operations, Real Enterprise Solutions, until June 2000. Prior to TAVA Technologies, Inc., Mr. Jenkins was President of Morgan Technical Ceramics, Inc., and Vice President and General Manager of the Structural Ceramic Division of Coors Ceramic Company, a subsidiary of Adolph Coors Company. Mr. Jenkins holds a Juris Doctor degree from the University of Denver and a B.S. degree in Mechanical Engineering from the University of Washington. FRANK R. MARLOW, 62, Director, has been a director of the Company since May 1995. Mr. Marlow served as Vice President, Sales and Marketing for the Company from October 1993 to February 1995. Mr. Marlow is currently Vice President of Sales for Conformity, formerly Money Star, a technology company based in Austin, Texas. From 1995 until 1998, Mr. Marlow was Vice President of Hogan Systems, a publicly-traded company subsequently purchased by Computer Sciences Corp. Previously, Mr. Marlow was with IBM, Docutel Corporation, UCCEL Corporation and Syntelligence Corporation in executive sales and training positions. Robert C. Pearson, 65, has been affiliated with the Company in a non-voting capacity since January 1997 and was a director from April 1999 to August 2000. Mr. Pearson is currently Senior Vice President of Renaissance Capital Group, Inc. From 1994 to 1997, Mr. Pearson was an independent financial management consultant. From 1990 to 1994, Mr. Pearson served as Chief Financial Officer and Executive Vice President of Thomas Group, Inc., a management consulting firm, where he was instrumental in moving the company from a small privately held company to a public company with over $40 million in revenue. Prior to 1990, Mr. Pearson was responsible for all administrative activities for the Superconducting Super Collider Laboratory. In addition, from 1960 to 1985, Mr. Pearson served in a variety of positions at Texas Instruments in financial planning and analysis. Mr. Pearson earned an M.B.A. from the University of Michigan and a B.S. in Business from the University of Maryland, where he was a W. A. Paton Scholar. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors, executive officers and persons who own more than ten percent of the Company's Common Stock, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Such persons are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file. Based solely upon a review of Forms 3, 4 and 5 and amendments thereto provided to the Company pursuant to Rule 16a-3(e), Messrs. Rundell, Arsht, Caldwell, Galecke, Jack, Beckmann and Marlow and Ms. Burlage had late filings during the fiscal year ending June 30, 2000. -------------------------------------------------------------------------------- Page 36 of 47 37 ITEM 10. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table shows the compensation of the Chief Executive Officer and the two executive officers of the Company whose compensation exceeded $100,000 for the fiscal years ended June 30, 2000, 1999 and 1998.
ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS ---------------------------------- -------------------------------------------- OTHER ANNUAL RESTRICTED OPTION/ NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION STOCK AWARDS SARS --------------------------- ---- ----------- -------- ------------ ------------ ---------- Gerald K. Beckmann 2000 $ 277,078 -- -- -- 100,000 Chief Executive Officer 1999 296,393 -- -- -- -- and President(1) 1998 289,425 -- -- -- 200,000 Holly J. Burlage 2000 $ 125,650 -- -- -- 40,000 Executive Vice President 1999 105,011 -- -- -- 60,000 and Chief Financial Officer 1998 90,368 $ 15,000 -- -- 17,500 Jack G. Caldwell 2000 $ 149,213 President 1999 140,510 -- -- -- 100,000 B&B Electromatic, Inc. 1998 58,333 -- -- -- 61,790
---------- (1) Resigned as of August 31, 2000. No other executive officer's salary and bonus exceeded $100,000 annually and no executive had any form of long-term incentive plan compensation arrangement with the Company during the fiscal years ended June 30, 2000, 1999 and 1998. STOCK OPTION GRANTS The following table provides information concerning the grant of stock options during the twelve months ended June 30, 2000 to the named executive officers:
NUMBER OF % OF TOTAL OPTIONS FOR THE TWELVE SECURITIES UNDERLYING GRANTED TO EMPLOYEES EXERCISE MONTHS ENDED 6/30/00 OPTIONS GRANTED(1) IN FISCAL YEAR(%) PRICE($) EXPIRATION DATE -------------------- --------------------- -------------------- -------- --------------- Gerald K. Beckmann(2) 50,000 11.1% $0.563 08/23/09 Gerald K. Beckmann(2) 50,000 11.1 0.625 06/26/10 Holly J. Burlage 20,000 4.4 0.563 08/23/09 Holly J. Burlage 20,000 4.4 0.625 06/26/10 Jack G. Caldwell 10,000 2.2 0.563 08/23/09 Jack G. Caldwell 20,000 4.4 0.625 06/26/10
---------- (1) The options for all listed vest with respect to 25% of the shares issuable thereunder six months after the date of grant and with respect to cumulative increments of 25% of the shares issuable thereunder on each anniversary of the date of grant. (2) Resigned as of August 31, 2000. -------------------------------------------------------------------------------- Page 37 of 47 38 OPTION EXERCISES AND HOLDINGS The following table provides information related to the number of shares received upon exercise of options, the aggregate dollar value realized upon exercise, and the number and value of options held by the named executive officers of the Company at June 30, 2000.
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED OPTIONS/SARS AT IN-THE-MONEY OPTIONS/SARS FISCAL YEAR END AT FISCAL YEAR END($) ---------------------------- ---------------------------- EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------- ------------- ----------- ------------- FOR THE TWELVE MONTHS ENDED 6/30/00 ----------------------------------- Gerald K. Beckmann 346,973 137,500 $ 7,031 $ 21,094 Holly J. Burlage 90,625 69,375 2,813 8,437 Jack G. Caldwell 98,843 92,947 1,406 4,219
DIRECTOR COMPENSATION Currently, directors are compensated by incentive stock options in an amount equivalent to $7,500 annually for serving on the board in addition to $1,250 for each committee on which they serve. All directors are reimbursed for their out-of-pocket expenses incurred in connection with their attendance at board meetings. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the number and percentage of outstanding shares of Common Stock beneficially owned as of September 30, 2000, by (a) each director and named executive officer of the Company, (b) all officers and directors of the Company as a group, and (c) all persons who are known by the Company to be beneficial owners of 5% or more of the Company's outstanding Common Stock. Unless otherwise noted, each of the persons listed below has sole voting and investment power with respect to the shares indicated as beneficially owned by such person. -------------------------------------------------------------------------------- Page 38 of 47 39
NUMBER OF SHARES BENEFICIALLY NAME OF BENEFICIAL OWNER OWNED(1) PERCENT(1) ------------------------------------------------------------------ ----------------- ---------- Renaissance Capital Growth & Income Fund III, Inc.(4) 5,874,295 36.7% Renaissance US Growth & Income Trust PLC(5) 5,595,388 35.8% C. A. Rundell, Jr.(2)(3)(6) 1,764,190 15.0% Phillip R. Thomas(7) 1,490,942 14.0% Gerald K. Beckmann(8) 1,063,166 9.6% Alan M. Arsht(2)(3)(9) 316,955 2.9% Frank R. Marlow(2)(3)(10) 188,911 1.8% Holly J. Burlage(2)(3)(11) 168,619 1.6% Jack Caldwell(2)(3)(12) 101,343 0.9% James E. Jack(2)(3)(13) 93,575 0.9% Robert M. Galecke(2)(3)(14) 46,081 0.4% John P. Jenkins(2)(3) -- --% All current directors and executive officers as a group (8 person) 1,500,484 14.0%
---------- (1) Pursuant to the rules of the Securities and Exchange Commission, shares of Common Stock which an individual or group has a right to acquire within 60 days pursuant to the exercise of options or warrants are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. (2) The address for this person is 8200 Springwood Drive, Suite 230, Irving, TX 75063. (3) Mr. Rundell is a Director, Chairman of the Board and Chief Executive Officer of the Company. Mr. Arsht, Mr. Marlow, Mr. Jack, Mr. Galecke, and Mr. Jenkins are Directors of the Company. Mr. Caldwell is President of a subsidiary of the Company. Ms. Burlage is Vice President, Chief Financial Officer and Secretary of the Company. (4) Based on a 13(g) filing dated November 10, 1999, Renaissance Capital Growth & Income Fund III, Inc. is deemed the beneficial owner of 5,874,295 shares of Common Stock. The address for this company is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. (5) Based on a 13(g) filing dated November 12, 1999, Renaissance US Growth & Income Trust PLC is deemed the beneficial owner of 5,595,388 shares of Common Stock. The address for this company is 8080 N. Central Expressway, Suite 210, Dallas, TX 75206. (6) Includes 164,126 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 705,971 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 331,250 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. (7) Includes 108,418 shares of Common Stock issuable upon the exercise of warrants within 60 days. The address for Mr. Thomas is 3510 Turtle Creek Boulevard, Ph-A, Dallas, TX 75219-5542. (8) Includes 409,473 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; and 128,021 shares of Common Stock issuable upon the exercise of warrants within 60 days. The address for Mr. Beckmann is 1017 Diamond Boulevard, Southlake, TX 76092. (9) Includes 4,455 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 125,000 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 187,500 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. (10) Includes 79,879 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 35,167 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 31,250 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. -------------------------------------------------------------------------------- Page 39 of 47 40 (11) Includes 95,625 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 26,240 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 37,500 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. (12) Includes 101,343 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days. (13) Includes 21,492 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 20,833 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 31,250 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. (14) Includes 25,248 shares of Common Stock issuable upon the exercise of outstanding options exercisable within 60 days; 8,333 shares of Common Stock issuable upon the exercise of warrants within 60 days; and 12,500 shares of Common Stock issuable upon the conversion of preferred stock within 60 days. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On April 12, 2000, Mr. Rundell, Chairman of the board of directors, Chief Executive Officer and a stockholder of the Company, loaned the Company approximately $200,000, at 9% annual interest. On June 28, 2000, The Rundell Foundation, an affiliate of Mr. Rundell, loaned the Company approximately $100,000, at 9% annual interest. To date, both of the loans remain outstanding. On December 31, 1996, Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC together loaned the Company $4.6 million at a 9% annual interest rate. Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC currently are stockholders of the Company. In addition, during calendar year 1999 and through June 30, 2000, Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC loaned the Company approximately $1.13 million at a 9% annual interest rate in exchange for promissory notes. Mr. Jenkins joined the board of directors in September 2000. In addition to his board duties, Mr. Jenkins currently serves as a consultant to the Company's subsidiary, Intelli-Site, Inc., on a part-time basis at an hourly rate of $120.00. Intelli-Site did not employ Mr. Jenkins as a consultant in fiscal year 2000. Mr. Beckmann was the Company's Chief Executive Officer and President until August 2000. He is currently a director and stockholder of the Company. Mr. Beckmann became a consultant to the Company in August 2000 on a part-time basis at an hourly rate of $120.00. The Company believes that the terms of the foregoing transactions were on terms no less favorable to the Company than could be obtained from unaffiliated third parties. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. *3.1 Amended and Restated Certificate of Incorporation of the Company. *3.2 Amended and Restated Bylaws of the Company. *3.11 Amendment to Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.11 to the Company's Form 10-KSB for the year ended December 31, 1994). *4.1 Specimen certificate for common stock of the Company. *4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant. -------------------------------------------------------------------------------- Page 40 of 47 41 **4.5 Certificate of Designation for Series A $20 Convertible Preferred Stock. *******4.6 Certificate of Designation for Series D $20 Convertible Preferred Stock. *******4.7 Convertible Debenture, dated December 31, 1996, in the amount of $2.3 million, with Renaissance Capital Growth & Income Fund III, Inc. *******4.8 Convertible Debenture, dated December 31, 1996, in the amount of $2.3 million, with Renaissance US Growth & Income Trust PLC. *******4.9 Amendment to Convertible Debenture, dated March 26, 1998, in the amount of $2.3 million, with Renaissance Capital Growth & Income Fund III, Inc., originally dated December 31, 1996. *******4.10 Amendment to Convertible Debenture, dated March 26, 1998, in the amount of $2.3 million, with Renaissance US Growth & Income Trust PLC, originally dated December 31, 1996, *******4.11 Form of Convertible Promissory Note. *******4.12 Form of Non-Convertible Promissory Note. *******4.13 Security Agreement, dated as of October 2, 1998, among the Company, B&B Electromatic, Inc., Golston Company, Inc., Innovative Security Technologies, Inc. (now named Intelli-Site, Inc.) and Tri-Coastal Systems, Inc. and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.14 Stock Pledge Agreement, dated as of December 31, 1996, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.15 First Amendment to Stock Pledge Agreement, dated May 5, 2000, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.16 Registration Rights Agreement, dated as of February 22, 1999, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.17 Registration Rights Agreement, dated as of October 20, 2000 among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.18 Promissory Note, dated April 12, 2000, issued to C. A. Rundell, Jr., in the amount of $200,000. *******4.19 Promissory Note, dated June 28, 2000, issued to The Rundell Foundation, in the amount of $100,000. *******4.20 Promissory Note, dated November 17, 2000, issued to C. A. Rundell, Jr., in the amount of $50,000. -------------------------------------------------------------------------------- Page 41 of 47 42 **10.1 Integrated Security Systems, Inc. 1993 Stock Option Plan dated September 7, 1993, as amended on December 30, 1994. *10.2 Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. *10.3 Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. *10.13 Form of Indemnification Agreement by and between the Company and the Company's officers and directors. *10.20 Lease Agreement dated March 25, 1992 and April 6, 1992, by and among the Company, Trammell Crow Company No. 90 and Petula Associates Limited for property located in Dallas, Texas. *10.49 Amendment to Integrated Security System, Inc. 1993 Stock Option Plan. ***10.58 Form of Subscription Agreement for Series A Convertible Preferred Stock executed on March 27, 1996. ***10.59 Subscription Agreement for Common Stock executed March 28, 1996. ***10.60 Form of Warrant Agreement for purchase of common stock executed March 29, 1996. **10.64 Subscription Agreement, dated December 31, 1996, between the Company and ProFutures Special Equity Fund, L.P. **10.65 Convertible Loan Agreement, dated December 31, 1996, between the Company (and its subsidiaries) and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. **10.71 Asset Purchase Agreement, dated October 1, 1998, between the Company and MPA Systems, Inc. ****10.73 Asset Purchase Agreement, dated May 29, 1999 between the Company and Day's Molding & Machinery, LLC *****10.74 Purchase Agreement dated May 21, 1999 between the Company and I.S.T. Partners, Ltd. *****10.75 Stock Purchase Agreement dated August 13, 1999 between the Company and Notification Systems of America, Inc. ******10.76 Form of Subscription Agreement for Series D Convertible Preferred Stock. ******10.77 Amended and Restated Certificate of Incorporation of the Company. *******21.1 Subsidiaries of the Company. -------------------------------------------------------------------------------- Page 42 of 47 43 *******23.1 Consent of Grant Thornton LLP ---------- * Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW) and incorporated herein by reference. ** Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 333-5023) and incorporated herein by reference. *** Filed as the similarly numbered exhibit to the Company's Form 10-QSB for the quarter ended March 31, 1996 and incorporated herein by reference. **** Filed as the similarly numbered exhibit to the Company's Form 8-K filed June 14, 1999 and incorporated herein by reference. ***** Filed as the similarly numbered exhibit to the Company's Form 10-KSB for the fiscal year ended June 30, 1999 and incorporated herein by reference. ****** Filed as the similarly numbered exhibit to the Company's Form 10-QSB for the quarter ended December 31, 1999 and incorporated herein by reference. ******* Filed herewith. (b) Reports filed on Form 8-K. The Company filed a Form 8-K on August 25, 2000 to report the changes in the Company's management. -------------------------------------------------------------------------------- Page 43 of 47 44 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Integrated Security Systems, Inc. ----------------------------------------- (Registrant) Date: February 28, 2001 /s/ C. A. RUNDELL, JR. ------------------ ----------------------------------------- C. A. Rundell, Jr. Director, Chairman of the Board, and Chief Executive Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Integrated Security Systems, Inc. ----------------------------------------- (Registrant) Date: February 28, 2001 /s/ C. A. RUNDELL, JR. ------------------ ----------------------------------------- C. A. Rundell, Jr. Director, Chairman of the Board, and Chief Executive Officer Date: February 28, 2001 /s/ HOLLY J. BURLAGE ------------------ ----------------------------------------- Holly J. Burlage Executive Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) Date: February 28, 2001 /s/ ALAN M. ARSHT ------------------ ----------------------------------------- Alan M. Arsht Director Date: February 28, 2001 /s/ ROBERT M. GALECKE ------------------ ----------------------------------------- Robert M. Galecke Director Date: February 28, 2001 /s/ JAMES E. JACK ------------------ ----------------------------------------- James E. Jack Director Date: February 28, 2001 /s/ JOHN P. JENKINS ------------------ ----------------------------------------- John P. Jenkins Director Date: February 28, 2001 /s/ FRANK R. MARLOW ------------------ ----------------------------------------- Frank R. Marlowe Director -------------------------------------------------------------------------------- Page 44 of 47 45 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- *3.1 Amended and Restated Certificate of Incorporation of the Company. *3.2 Amended and Restated Bylaws of the Company. *3.11 Amendment to Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.11 to the Company's Form 10-KSB for the year ended December 31, 1994). *4.1 Specimen certificate for common stock of the Company. *4.2 Specimen certificate for Redeemable Common Stock Purchase Warrant. **4.5 Certificate of Designation for Series A $20 Convertible Preferred Stock. *******4.6 Certificate of Designation for Series D $20 Convertible Preferred Stock. *******4.7 Convertible Debenture, dated December 31, 1996, in the amount of $2.3 million, with Renaissance Capital Growth & Income Fund III, Inc. *******4.8 Convertible Debenture, dated December 31, 1996, in the amount of $2.3 million, with Renaissance US Growth & Income Trust PLC. *******4.9 Amendment to Convertible Debenture, dated March 26, 1998, in the amount of $2.3 million, with Renaissance Capital Growth & Income Fund III, Inc., originally dated December 31, 1996. *******4.10 Amendment to Convertible Debenture, dated March 26, 1998, in the amount of $2.3 million, with Renaissance US Growth & Income Trust PLC, originally dated December 31, 1996, *******4.11 Form of Convertible Promissory Note. *******4.12 Form of Non-Convertible Promissory Note. *******4.13 Security Agreement, dated as of October 2, 1998, among the Company, B&B Electromatic, Inc., Golston Company, Inc., Innovative Security Technologies, Inc. (now named Intelli-Site, Inc.) and Tri-Coastal Systems, Inc. and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.14 Stock Pledge Agreement, dated as of December 31, 1996, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.15 First Amendment to Stock Pledge Agreement, dated May 5, 2000, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.16 Registration Rights Agreement, dated as of February 22, 1999, among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.17 Registration Rights Agreement, dated as of October 20, 2000 among the Company and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. *******4.18 Promissory Note, dated April 12, 2000, issued to C. A. Rundell, Jr., in the amount of $200,000. *******4.19 Promissory Note, dated June 28, 2000, issued to The Rundell Foundation, in the amount of $100,000. *******4.20 Promissory Note, dated November 17, 2000, issued to C. A. Rundell, Jr., in the amount of $50,000.
-------------------------------------------------------------------------------- Page 45 of 47 46 **10.1 Integrated Security Systems, Inc. 1993 Stock Option Plan dated September 7, 1993, as amended on December 30, 1994. *10.2 Form of Integrated Security Systems, Inc. 1993 Incentive Stock Option Agreement. *10.3 Form of Integrated Security Systems, Inc. 1993 Non-Qualified Stock Option Agreement. *10.13 Form of Indemnification Agreement by and between the Company and the Company's officers and directors. *10.20 Lease Agreement dated March 25, 1992 and April 6, 1992, by and among the Company, Trammell Crow Company No. 90 and Petula Associates Limited for property located in Dallas, Texas. *10.49 Amendment to Integrated Security System, Inc. 1993 Stock Option Plan. ***10.58 Form of Subscription Agreement for Series A Convertible Preferred Stock executed on March 27, 1996. ***10.59 Subscription Agreement for Common Stock executed March 28, 1996. ***10.60 Form of Warrant Agreement for purchase of common stock executed March 29, 1996. **10.64 Subscription Agreement, dated December 31, 1996, between the Company and ProFutures Special Equity Fund, L.P. **10.65 Convertible Loan Agreement, dated December 31, 1996, between the Company (and its subsidiaries) and Renaissance Capital Growth & Income Fund III, Inc. and Renaissance US Growth & Income Trust PLC. **10.71 Asset Purchase Agreement, dated October 1, 1998, between the Company and MPA Systems, Inc. ****10.73 Asset Purchase Agreement, dated May 29, 1999 between the Company and Day's Molding & Machinery, LLC *****10.74 Purchase Agreement dated May 21, 1999 between the Company and I.S.T. Partners, Ltd. *****10.75 Stock Purchase Agreement dated August 13, 1999 between the Company and Notification Systems of America, Inc. ******10.76 Form of Subscription Agreement for Series D Convertible Preferred Stock. ******10.77 Amended and Restated Certificate of Incorporation of the Company. *******21.1 Subsidiaries of the Company. -------------------------------------------------------------------------------- Page 46 of 47 47
*******23.1 Consent of Grant Thornton LLP
---------- * Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 33-59870-FW) and incorporated herein by reference. ** Filed as the similarly numbered exhibit to the Company's Registration Statement on Form SB-2 (No. 333-5023) and incorporated herein by reference. *** Filed as the similarly numbered exhibit to the Company's Form 10-QSB for the quarter ended March 31, 1996 and incorporated herein by reference. **** Filed as the similarly numbered exhibit to the Company's Form 8-K filed June 14, 1999 and incorporated herein by reference. ***** Filed as the similarly numbered exhibit to the Company's Form 10-KSB for the fiscal year ended June 30, 1999 and incorporated herein by reference. ****** Filed as the similarly numbered exhibit to the Company's Form 10-QSB for the quarter ended December 31, 1999 and incorporated herein by reference. ******* Filed herewith. Page 47 of 47