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Imageware Systems Inc – ‘424B1’ on 3/31/00

On: Friday, 3/31/00 · As of: 4/3/00 · Accession #: 912057-0-15759 · File #: 333-93131

  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 4/03/00  Imageware Systems Inc             424B1       3/31/00    1:220K                                   Merrill Corp/FA

Prospectus — Rule 424(b)(1)
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 424B1       Prospectus                                            71    336K

Document Table of Contents

Page	(sequential)	\|	(alphabetic)	Top
			Alternative Formats (Word, et al.) Available Information Business Capitalization Certain Transactions Common stock Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1999 Consolidated Statements of Operations for the Years Ended December 31, 1998 and 1999 Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended December 31, 1998 and 1999 Current assets Description of Securities Dilution Dividend Policy Experts Index to Consolidated Financial Statements Intangible assets Intellectual Property Legal Matters LIABILITIES AND SHAREHOLDERS' DEFICIT Current liabilities Management Management's Discussion and Analysis of Financial Condition and Results of Operations Net loss Notes to Consolidated Financial Statements Operating, general and administrative expenses Paul J. Devermann Preferred Stock Property and equipment Prospectus Summary Public warrants Report of Independent Accountants Research and Development Risk Factors Sales and Marketing Sales and marketing expenses Security Ownership of Certain Beneficial Owners and Management Selected Financial Information Series B Shares Eligible for Future Sale S. James Miller, Jr Underwriting Use of proceeds Wayne G. Wetherell
1	1st Page - Filing Submission
3	Prospectus Summary
6	Risk Factors
10	Use of proceeds
12	Dividend Policy
13	Capitalization
14	Dilution
15	Selected Financial Information
16	Management's Discussion and Analysis of Financial Condition and Results of Operations
18	Operating, general and administrative expenses
19	Sales and marketing expenses
"	Research and Development
"	Net loss
22	Business
27	Sales and Marketing
30	Intellectual Property
33	Management
"	S. James Miller, Jr
36	Wayne G. Wetherell
37	Paul J. Devermann
"	Certain Transactions
40	Security Ownership of Certain Beneficial Owners and Management
41	Description of Securities
"	Common stock
"	Preferred Stock
42	Public warrants
45	Shares Eligible for Future Sale
48	Underwriting
51	Legal Matters
"	Experts
"	Available Information
52	Index to Consolidated Financial Statements
53	Report of Independent Accountants
54	Current assets
"	LIABILITIES AND SHAREHOLDERS' DEFICIT Current liabilities
55	Consolidated Statements of Operations for the Years Ended December 31, 1998 and 1999
56	Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended December 31, 1998 and 1999
"	Series B
57	Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1999
58	Notes to Consolidated Financial Statements
"	Property and equipment
59	Intangible assets

424B1 1st Page of 71 TOC ↑Top Previous Next ↓Bottom Just 1st
1,875,000 UNITS

[LOGO]

This is an initial public offering of units by ImageWare Systems, Inc. Each
unit consists of one share of common stock and one redeemable public warrant to
purchase one share of common stock. The initial public offering price will be
$8.00 per unit. Prior to this offering, there has been no public market for our
securities. Our units, common stock and public warrants have been approved for
trading on The American Stock Exchange under the symbols "IW.U," "IW" and
"IW.WS," subject to official notice of issuance.

The common stock and warrants will trade only as a unit for at least
30 days following this offering. Paulson Investment Company, Inc. will then
determine when the units separate, after which the common stock and the public
warrants will trade separately.

INVESTING IN THESE UNITS INVOLVES SIGNIFICANT RISKS AND IMMEDIATE
SUBSTANTIAL DILUTION. SEE "RISK FACTORS" BEGINNING ON PAGE 4.

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PER UNIT TOTAL
-------- -----------

Initial public offering price............................... $ 8.00 $15,000,000
Underwriting discounts and commissions...................... $ 0.58 $ 1,087,500
Proceeds to ImageWare Systems, Inc.......................... $ 7.42 $13,912,500

THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE
NOT APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS
IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.

The underwriters will purchase the units on a firm commitment basis. We have
granted Paulson Investment Company, Inc. the option for a period of 45 days to
purchase up to an additional 281,250 units to cover over-allotments.

PAULSON INVESTMENT COMPANY, INC.

I-BANKERS SECURITIES, INC.

The date of this prospectus is March 30, 2000.

424B1 2nd Page of 71 TOC 1st Previous Next ↓Bottom Just 2nd
[artwork]

WE HAVE THE FOLLOWING REGISTERED TRADEMARKS:
IMAGEWARE-REGISTERED TRADEMARK-, C.R.I.M.E.S.-REGISTERED TRADEMARK-, SUSPECT
ID-REGISTERED TRADEMARK-, VEHICLE ID-REGISTERED TRADEMARK-, IMAGE
WIZARD-REGISTERED TRADEMARK-, PEOPLE POSTCARDS-REGISTERED TRADEMARK- AND
MORPHWIZARD-REGISTERED TRADEMARK-. WE ALSO HAVE THE FOLLOWING UNREGISTERED
TRADEMARKS: CRIME CAPTURE SYSTEM-REGISTERED TRADEMARK-, FACE ID-TM-, CRIME
LAB-TM-, CRIME WEB-TM-, FACE INVESTIGATE-TM- AND FORCE FIELD 2000-TM-.

424B1 3rd Page of 71 TOC 1st Previous Next ↓Bottom Just 3rd
PROSPECTUS SUMMARY
OUR COMPANY

We develop, sell and support a suite of modular software products that is
used by law enforcement and public safety agencies to manage criminal history
records. Our software systems and associated hardware allow our customers to
quickly capture, archive, search, retrieve and share digital photographs and
criminal history records. Our products are currently being used by government
agencies such as the New York City Police Department, the Los Angeles County
Sheriff's Department, the Arizona Department of Public Safety, the Montreal
Police Department and law enforcement agencies in Minneapolis, Portland,
Seattle, Indianapolis and Orlando.

The National Institute of Justice estimated in 1998 that there were
approximately 60 million criminal history records and that this number is
increasing by more than 20 million per year. Police, sheriffs, FBI officials,
airport police and many others all have a need to quickly access criminal
records to identify criminal suspects and offenders by visual descriptions. Many
law enforcement booking systems are still merely an inefficient file of paper
records which cannot be accessed quickly or from a remote location. In many
places, witnesses still flip through books of photographs to try to identify a
suspect. In light of these inefficiencies and the large number of criminal
records, many agencies are turning to new technologies to increase their ability
to quickly access these records to identify, locate and arrest criminal
suspects.

To take advantage of the growing law enforcement market for digital imaging
technology, we have developed a suite of modular software products known as the
Crime Reduction, Image Management and Enhancement System, or "C.R.I.M.E.S." The
C.R.I.M.E.S. system consists of the following software modules, which may also
be purchased individually: The Crime Capture System, Face ID, Suspect ID, Crime
Lab and Vehicle ID. To date, our products have been used by more than 450
customers.

THIS OFFERING

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Securities offered........................... 1,875,000 units. Each unit consists of one
share of common stock and one public warrant
to purchase an additional share of common
stock.

The common stock and public warrants will
trade only as a unit for at least 30 days
following this offering. Paulson Investment
Company, Inc. will then determine when the
units separate, after which the common stock
and the public warrants will trade
separately.

Public warrants.............................. The public warrants included in the units
will be exercisable commencing 30 days after
the offering. During the first year after the
offering, the exercise price of a public
warrant will be 120% of the initial public
offering price of the units. Commencing one
year after the offering, the exercise price
will be 150% of the initial public offering
price of the units. The public warrants
expire five years after completion of the
offering.

424B1 4th Page of 71 TOC 1st Previous Next ↓Bottom Just 4th
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We have the right, commencing six months
after the closing of the offering, to redeem
the public warrants at a redemption price of
$0.25 per public warrant. If the average
closing bid price of the common stock equals
or exceeds 200% of the initial public
offering price of the units for ten
consecutive trading days, we may give notice
of redemption on the next day and redeem the
public warrants 30 days later.

Common stock outstanding after this 3,036,802 shares
offering...................................

Use of proceeds.............................. Repayment of debt, sales and marketing,
research and development and working capital.

Proposed American Stock Exchange symbols

Common stock............................... IW

Units offered in this offering............. IW.U

Public warrants included in the units...... IW.WS

The number of shares of common stock outstanding after this offering is
based on 1,161,802 shares outstanding as of February 29, 2000. This number
assumes no exercise of the over-allotment option and does not include an
aggregate of 2,969,152 shares of common stock that may become outstanding as
follows:

- approximately 88,314 shares of common stock issuable upon voluntary
conversion of all of the outstanding shares of Series B preferred stock
plus accrued but unpaid dividends thereon;

- 276,611 shares of common stock issuable upon exercise of stock options
outstanding as of February 29, 2000, with a weighted average exercise
price of $6.37;

- 328,662 shares of common stock issuable upon exercise of warrants
outstanding as of February 29, 2000, with a weighted average exercise
price of $9.34;

- 37,887 shares of common stock issuable upon conversion of convertible
notes outstanding as of February 29, 2000;

- 1,875,000 shares of common stock issuable upon exercise of the public
warrants; and

- 362,678 shares of common stock issuable upon exercise of the
representatives' warrants and the public warrants underlying the
representatives' warrants.

HISTORICAL INFORMATION REGARDING OUR SECURITIES HAS BEEN ADJUSTED TO REFLECT
A 5.275-TO-1 REVERSE STOCK SPLIT EFFECTED ON NOVEMBER 29, 1999. EXCEPT AS
OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF
THE OVER-ALLOTMENT OPTION OR THE REPRESENTATIVES' WARRANTS. REFERENCES TO "US,"
THE "COMPANY" OR "IMAGEWARE" INCLUDE IMAGEWARE SYSTEMS, INC. AND OUR
WHOLLY-OWNED SUBSIDIARY, XIMAGE CORPORATION, UNLESS OTHERWISE INDICATED.

424B1 5th Page of 71 TOC 1st Previous Next ↓Bottom Just 5th
SUMMARY CONSOLIDATED FINANCIAL INFORMATION

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YEARS ENDED DECEMBER 31,
-------------------------
1998 1999
----------- -----------

STATEMENT OF OPERATIONS DATA:
Revenues
Product................................................... $ 2,708,856 $ 4,276,201
Maintenance............................................... 1,307,286 1,404,709
License and other......................................... 220,175 210,567
----------- -----------
4,236,317 5,891,477
Cost of Revenues
Product................................................... 1,354,920 1,896,916
Maintenance............................................... 1,065,740 862,816
----------- -----------
Gross margin................................................ 1,815,657 3,131,745
----------- -----------
Operating, general and administrative expenses.............. 2,265,312 2,531,079
Sales and marketing expenses................................ 960,246 1,024,224
Research and development expenses........................... 831,034 1,150,914
Depreciation and amortization............................... 988,838 1,096,484
----------- -----------
5,045,430 5,802,701
----------- -----------
Loss from operations...................................... (3,229,773) (2,670,956)
----------- -----------
Interest expense, net....................................... 204,287 363,638
----------- -----------
Loss before income taxes.................................. (3,434,060) (3,034,594)
----------- -----------
Provision for income taxes.................................. -- --
----------- -----------
Net loss.................................................. $(3,434,060) $(3,034,594)
=========== ===========
Net loss per common share................................... $ (4.08) $ (3.07)
=========== ===========
Basic and diluted weighted average shares................... 861,875 1,016,399
=========== ===========

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DECEMBER 31, 1999
-------------------------
ACTUAL AS ADJUSTED
----------- -----------

BALANCE SHEET DATA:
Cash........................................................ $ 156,063 $ 7,273,863
Net intangible assets....................................... 2,346,557 2,346,557
Total assets................................................ 5,909,587 13,027,387
Total current liabilities................................... 7,655,440 3,320,480
Notes payable, net of current portion....................... 924,542 --
Total liabilities........................................... 8,579,982 3,320,480
Total shareholders' equity (deficit)........................ (2,670,395) 9,706,907

The as adjusted balance sheet data reflects:

(1) the receipt of $12,706,300 as the estimated net proceeds from the sale of
1,875,000 units offered by us in this offering at an initial public offering
price of $8.00 per unit, after deducting underwriting discounts and
commissions and estimated offering expenses; and

(2) the planned use of the net proceeds of the offering.

424B1 6th Page of 71 TOC 1st Previous Next ↓Bottom Just 6th
RISK FACTORS

THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION CONTAINED IN THIS
PROSPECTUS BEFORE PURCHASING ANY UNITS. THE FOLLOWING RISKS COULD MATERIALLY
HARM OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION AND COULD RESULT IN
A DECREASE IN THE TRADING PRICE OF OUR UNITS, COMMON STOCK OR PUBLIC WARRANTS OR
IN A COMPLETE LOSS OF YOUR INVESTMENT.

RISKS RELATED TO OUR BUSINESS

WE HAVE A HISTORY OF SIGNIFICANT RECURRING LOSSES TOTALLING APPROXIMATELY
$19,300,000 AND EXPECT TO INCUR LOSSES IN THE FUTURE.

As of December 31, 1999, we had an accumulated deficit of $19,285,627 and a
shareholder's deficit of $2,670,395, and we expect to incur losses in the
future. We expect to continue to incur significant sales and marketing, research
and development, and general and administrative expenses. As a result, we will
need to generate significant revenues to achieve profitability and may never
achieve profitability.

WE SUBSTANTIALLY DEPEND ON SALES OF OUR CRIME CAPTURE SYSTEM.

We derived approximately 89% of our product revenue in 1999 from sales of
our booking products. A decrease in the price of or demand for the Crime Capture
System, or its failure to achieve broad market acceptance, would significantly
harm our business, financial condition and operating results.

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

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

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

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

424B1 7th Page of 71 TOC 1st Previous Next ↓Bottom Just 7th
MOST OF OUR CUSTOMERS ARE GOVERNMENT AGENCIES THAT ARE SUBJECT TO UNIQUE
POLITICAL AND BUDGETARY CONSTRAINTS AND HAVE SPECIAL CONTRACTING REQUIREMENTS
WHICH MAY AFFECT OUR ABILITY TO OBTAIN NEW GOVERNMENT CUSTOMERS.

Most of our customers are government agencies. These agencies often do not
set their own budgets and therefore have little control over the amount of money
they can spend. In addition, these agencies experience political pressure that
may dictate the manner in which they spend money. Due to political and budgetary
processes and other scheduling delays that may frequently occur relating to the
contract or bidding process, some government agency orders may be canceled or
substantially delayed, and the receipt of revenues or payments may be
substantially delayed. In addition, future sales to government agencies will
depend on our ability to meet government contracting requirements, certain of
which may be onerous or impossible to meet, resulting in our inability to obtain
a particular contract. Common requirements in government contracts include
bonding requirements, provisions permitting the purchasing agency to modify or
terminate at will the contract without penalty, provisions requiring us to
remain liable to the agency for unlimited losses relating to year 2000
malfunctions, and provisions permitting the agency to perform investigations or
audits of our business practices.

OUR PRODUCTS HAVE NOT YET ACHIEVED BROAD MARKET ACCEPTANCE, AND OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS MAY BE ADVERSELY AFFECTED IF WE ARE
UNABLE TO ACHIEVE SUCH ACCEPTANCE.

We intend to offer our products to a broader segment of the law enforcement
and public safety markets as well as the security market. The failure of our
products to achieve broad acceptance among law enforcement officials and
security personnel would have a negative effect on our business, financial
condition and operating results. We have not yet had significant sales in any
markets. The acceptance of our products and systems may be adversely affected by
their relatively high cost and the reluctance of agencies or corporations to
adopt new technology.

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

We believe our future success depends in part on our ability to develop and
market our technology for applications other than booking systems for the law
enforcement market. If we fail in these goals, our business strategy and ability
to generate revenues and cash flow would be significantly impaired. We
anticipate our technology may be developed to create digital databases of facial
images and picture identification cards for employees of large corporations. We
also intend to develop software to fully integrate our products with the
Internet. While we intend to expend significant resources to develop new
technology, the development of new technology cannot be predicted and we cannot
guarantee we will succeed in these goals.

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

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

424B1 8th Page of 71 TOC 1st Previous Next ↓Bottom Just 8th
WE RELY ON A LICENSE OF TECHNOLOGY FROM VISIONICS, INC., AND THIS LICENSE MAY BE
TERMINATED IN THE FUTURE.

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

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

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

We license certain elements of our trademarks, trade dress, copyright and
other intellectual property to third-parties. We attempt to ensure that our
rights in our trade names and the quality of third party uses of our names are
maintained by these third parties. However, these third parties may take actions
that could significantly impair the value of our intellectual property and our
reputation and goodwill. We also license our technology to Atlus Co., Ltd. Atlus
has the right to sublicense our technology and to use our technology to compete
with us. If Atlus chooses to use our technology to compete with us, our
business, financial condition and operating results could be significantly
harmed.

In addition, international intellectual property laws differ from country to
country. Any foreign rights we have in our technology are limited by what has
been afforded to us under the applicable foreign intellectual property laws.
Also, under the laws of certain foreign jurisdictions, in order to have
recognizable intellectual property rights, we may be required to file
applications with various foreign agencies or officials to register our
intellectual property. Although we do have a patent application pending in
Japan, we do not currently have corresponding foreign registrations pending or
issued for all our technology. Accordingly, our ability to operate and exploit
our technology overseas could be significantly hindered.

UNDETECTED YEAR 2000 PROBLEMS COULD ADVERSELY AFFECT OUR OPERATIONS.

There may be undetected Year 2000 problems with our internal systems, our
products or our customers' computer systems. In the event any of our products
are not Year 2000 compliant, we may be liable to certain customers for breach of
our Year 2000 representations and warranties that appear in many of our customer
agreements, which could have a material adverse effect on our business, results
of operations and financial condition. The Force Field 2000 product, which we
acquired in our acquisition of XImage Corporation, was found not to be Year 2000
compliant. Consequently, we created a Year 2000 compliance update to the Force
Field 2000 software, which has been installed on all of our customers' systems.
As of February 29, 2000, we were not aware of any Year 2000 compliance problems
with our products.

In addition, we acquire off-the-shelf products from third parties, such as
computer hardware. We use these products in the internal operations of our
business and we provide these products to

424B1 9th Page of 71 TOC 1st Previous Next ↓Bottom Just 9th
customers in conjunction with our software products. Further, government
agencies and other of our customers may use computer systems and products that
are not Year 2000 compliant and which may disrupt the performance of our
products. The failure of any of these products or systems to be Year 2000
compliant could significantly disrupt our business and impair our ability to
generate revenues and cash flows. As of February 29, 2000, only one customer
reported to us any problem with its own computer system that affected the
performance of our products. The problem has been corrected.

RISKS RELATED TO THIS OFFERING

YOU WILL SUFFER IMMEDIATE DILUTION OF APPROXIMATELY 68% OF YOUR INVESTMENT AND
MAY EXPERIENCE FURTHER DILUTION IN THE FUTURE.

We anticipate that the initial public offering price of the units will be
substantially higher than the net tangible book value per share of our common
stock after this offering. As a result, you will incur immediate dilution of
approximately $5.47, or 68%, in net tangible book value for each share of our
common stock included in the units you purchase. You will be subject to further
dilution upon the exercise of outstanding options and warrants and conversion of
our Series B preferred stock.

FUTURE SALES OF OUR COMMON STOCK BY OUR EXISTING SHAREHOLDERS COULD DECREASE THE
TRADING PRICE OF OUR COMMON STOCK AND CAUSE US TO EXPEND SIGNIFICANT RESOURCES
TO REGISTER SUCH STOCK.

Sales of a large number of shares of our common stock in the public markets
after this offering, or the potential for such sales, could decrease the trading
price of our common stock and could impair our ability to raise capital through
future sales of our common stock. Upon completion of this offering, there will
be 3,036,802 shares of our common stock outstanding. The 1,875,000 shares of
common stock sold in this offering and the 1,875,000 shares of common stock
reserved for issuance upon exercise of the public warrants sold in this offering
are all freely tradeable without restrictions or further registration under the
Securities Act of 1933, unless such shares are purchased by our "affiliates," as
that term is defined in the Securities Act of 1933.

An additional 2,969,152 shares of common stock are either currently
outstanding or may become outstanding upon exercise or conversion of options,
warrants or convertible securities currently outstanding or sold in this
offering. All of these shares may be sold in the future subject to compliance
with securities laws and various lock-up agreements to which certain of these
shares are subject. The lock-up agreements prohibit the sale in the public
market of certain shares for either six months or one year following the
completion of this offering.

Moreover, although substantially all of the holders of registration rights
have waived such registration rights, for at least six months following the
completion of this offering, holders of securities convertible or exercisable,
as of February 29, 2000, into 63,864 shares of common stock may have rights
under certain circumstances to require us to register the shares within the next
12 months. If such holders exercise such registration rights, we could be
required to expend considerable resources to register such shares, and sales of
these shares in the public market could decrease the trading price of our common
stock and impair our ability to raise capital.

SOME OF THE STATEMENTS MADE IN THIS PROSPECTUS DISCUSS FUTURE EVENTS AND
DEVELOPMENTS, INCLUDING OUR FUTURE BUSINESS STRATEGY AND OUR ABILITY TO GENERATE
REVENUE, INCOME AND CASH FLOW. IN SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING
STATEMENTS BY TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "EXPECTS," "PLANS,"
"ANTICIPATES," "BELIEVES," "ESTIMATES," "PREDICTS," "POTENTIAL," "CONTINUE,"
"OUR FUTURE SUCCESS DEPENDS," "SEEK TO CONTINUE" OR THE NEGATIVE OF THESE TERMS
OR OTHER COMPARABLE TERMINOLOGY. THESE STATEMENTS ARE ONLY PREDICTIONS. ACTUAL
EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN EVALUATING THESE STATEMENTS, YOU
SHOULD SPECIFICALLY CONSIDER VARIOUS FACTORS, INCLUDING THE RISKS OUTLINED UNDER
"RISK FACTORS." THESE FACTORS MAY CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY
FROM ANY FORWARD-LOOKING STATEMENT. ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS
REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE
FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOREOVER,
NEITHER WE NOR ANY OTHER PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY AND
COMPLETENESS OF THESE STATEMENTS. WE ARE UNDER NO DUTY TO UPDATE ANY OF THE
FORWARD-LOOKING STATEMENTS AFTER THE DATE OF THIS PROSPECTUS TO CONFORM THESE
STATEMENTS TO ACTUAL RESULTS.

424B1 10th Page of 71 TOC 1st Previous Next ↓Bottom Just 10th
USE OF PROCEEDS

We estimate that the gross proceeds from the sale of the 1,875,000 units
that we are selling in this offering will be $15,000,000, or $17,250,000 if
Paulson Investment Company, Inc. exercises its over-allotment option in full. We
estimate that the net proceeds from the offering will be approximately
$12,706,300, or $14,749,109 if Paulson Investment Company, Inc. exercises its
over-allotment option in full. These estimates are based on a public offering
price of $8.00 per unit. The estimates net proceeds of $12,706,300 represents
gross proceeds of $15,000,000 less the following commissions, fees and expenses
related to the offering:

- $1,087,500 underwriters' discount;

- $300,000 Paulson Investment Company, Inc.'s expense allowance;

- $59,906 in registration fees, NASD fees and listing fees of The American
Stock Exchange;

- $200,000 in accounting fees and expenses;

- $300,000 in legal fees and expenses;

- $65,000 in legal fees and other expenses related to state securities law
compliance;

- $170,000 in printing fees and expenses;

- $85,000 for directors and officers insurance;

- $1,250 in transfer agent fees and expenses; and

- $25,044 in miscellaneous expenses.

We expect to allocate the net proceeds of the offering as follows:

[Enlarge/Download Table]

APPROXIMATE AMOUNT APPROXIMATE PERCENTAGE
OF NET PROCEEDS OF NET PROCEEDS
------------------ ----------------------

Repayment of Debt...................................... $ 3,088,500 24%
Accrued Liabilities and Dividends...................... 2,500,000 19%
Accounts Receivable and Inventories.................... 2,250,000 18%
Sales and Marketing.................................... 1,500,000 12%
Research and Development............................... 1,500,000 12%
Working Capital and General Corporate Purposes......... 1,867,800 15%
----------- ---
TOTAL:............................................... $12,706,300 100%

Repayment of debt includes debt incurred and debt assumed with respect to
the XImage acquisition and the subsequent consolidation of the ImageWare and
XImage operations. Also included is debt incurred to provide working capital to
enable the company to maintain operations and fulfill customer orders over the
last two years.

The debt we intend to repay includes:

- short term notes in the aggregate amount of $1,050,000 at an interest rate
of prime plus 2%;

- short term notes in the aggregate amount of $258,500 at an interest rate
of 10%;

- a $1,250,000 short term note at an interest rate of 10%, payable to the
president of Atlus Co., Ltd., a Japanese corporation which beneficially
owns approximately 31% of our common stock;

- a $500,000 short term note at a variable interest rate, initially 9%; and

- a $30,000 short term note at an interest rate of prime.

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Payment of accrued liabilities and dividends includes miscellaneous accrued
expenses and payments of approximately:

- $375,525 in past legal fees incurred in connection with private
placements, litigation, our acquisition of XImage Corporation and
protection of intellectual property;

- $294,300 in deferred compensation and accrued interest assumed in
connection with our acquisition of XImage Corporation;

- $548,774 in past due payroll and sales taxes;

- $126,920 in royalty obligations;

- $387,244 in accumulated interest on debt;

- $191,137 of accumulated but unpaid dividends on our Series B preferred
stock as of February 29, 2000; and

- $576,100 for accounts payable.

Approximately $2,250,000 of the net proceeds from the offering will be used
to invest in accounts receivable and inventories as a result of our anticipated
sales growth.

Approximately $1,500,000 will be used for sales and marketing related to the
hiring of additional field personnel and the development and implementation of
strategies to expand into the private security market and international markets
for our products. We plan to increase the amount of time our sales force spends
calling on prospective customers and increase our participation in state and
regional trade shows. We also plan to update our collateral sales material and
place targeted advertising in relevant trade publications.

Approximately $1,500,000 will be used for research and development related
to the development of the wireless and Internet capabilities of our products,
the development of our "real time" facial recognition applications and the
continuing enhancement of the technical performance of our products. We are in
the process of increasing our research and development staff by approximately
40%. In order to meet our planned 2000 releases of the CrimeWeb products and
real time facial recognition products.

Pending such uses of the proceeds from the offering, we intend to invest the
net proceeds in interest-bearing, investment grade securities.

The foregoing discussion is merely an estimate based on our current business
plan. Our actual expenditures may vary depending upon circumstances not yet
known, such as the time actually required to reach a positive cash flow, or to
successfully expand the market for our products.

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DIVIDEND POLICY

We have never declared or paid any cash dividends on our shares of common
stock and do not anticipate paying any cash dividends on our shares of common
stock in the foreseeable future. Currently, we intend to retain any future
earnings for use in the operation and expansion of our business. Any future
decision to pay cash dividends will be at the discretion of our board of
directors and will be dependent upon our financial condition, results of
operations, capital requirements and other factors our board of directors may
deem relevant.

Pursuant to the terms of our Series B preferred stock, we are obligated to
pay cumulative cash dividends from legally available funds at the annual rate of
$0.2125 per share, payable in two semi-annual installments of $0.10625 each. As
of February 29, 2000, accumulated but unpaid dividends payable on the Series B
preferred stock were approximately $191,137. We intend to use a portion of the
proceeds of this offering to pay these dividends.

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 1999:

- on an actual basis;

- as adjusted to give effect to:

(1) the sale of 1,875,000 units in this offering at an initial public
offering price of $8.00 per unit; and

(2) the planned use of the net proceeds of the offering.

This table should be read in conjunction with our financial statements
included elsewhere in this prospectus.

[Enlarge/Download Table]

DECEMBER 31, 1999
-----------------------------
ACTUAL AS ADJUSTED(1)
------------ --------------

LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities......................................... $ 7,655,440 $ 3,320,480
Notes payable to related parties, net of current portion.... 924,542 0
------------ ------------
Total liabilities....................................... $ 8,579,982 $ 3,320,480
------------ ------------
Shareholders' deficit
Preferred stock, $.01 par value, authorized 4,000,000
shares: Series B convertible redeeemable preferred
stock, designated 750,000 shares, 389,400 shares issued
and outstanding, $973,500 liquidation preference........ 3,894 3,894
Common stock, $.01 par value, 50,000,000 shares
authorized, 1,161,802 and 3,036,802 shares issued and
outstanding............................................. 11,618 30,368
Additional paid-in capital................................ 16,599,720 29,287,270
Accumulated deficit....................................... (19,285,627) (19,614,625)
------------ ------------
Total shareholders' equity (deficit).................... $ (2,670,395) $ 9,706,907
------------ ------------
Total liabilities and shareholders' equity (deficit).... $ 5,909,587 $ 13,027,387

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

(1) The use of proceeds reflected on the as adjusted balance sheet includes
repayment of debt, which was recorded net of an unamortized discount of
approximately $329,000.

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DILUTION

If you invest in our units, your interest will be diluted to the extent of
the difference between the public offering price per share of our common stock
and the as adjusted net tangible book value per share of our common stock after
this offering. For purposes of the dilution computation and the following
tables, we have allocated the full purchase price of a unit to the share of
common stock included in the unit and nothing to the warrant included in the
unit. Net tangible book value per share represents the amount of our total
tangible assets reduced by the amount of our total liabilities, divided by the
total number of shares of common stock outstanding. Dilution in net tangible
book value per share represents the difference between the amount per share paid
by the purchasers of our units in this offering and the net tangible book value
per share of our common stock immediately afterwards.

As of December 31, 1999, our net tangible book value was $(5,016,952), or
$(4.32) per share of common stock. Without taking into effect any changes in the
net tangible book value after December 31, 1999, other than to give effect to
the sale of 1,875,000 units in the offering at the initial public offering price
of $8.00 per unit and the application of the net proceeds of the offering, the
net tangible book value of ImageWare as of December 31, 1999 would have been
$7,689,348, or $2.53 per share. This represents an immediate increase of $6.85
per share of common stock to existing shareholders and an immediate dilution of
$5.47, or 68%, per share of common stock to the new investors who purchase units
in the offering. The following table illustrates this per share dilution:

[Download Table]

Assumed initial public offering price....................... $8.00
Net tangible book value per share before the offering..... $(4.32)
Increase in net tangible book value per share attributable
to new investors........................................ 6.85
As adjusted net tangible book value per share after the
offering.................................................. 2.53
Dilution in tangible book value per share to new
shareholders.............................................. $5.47

If the over-allotment option is exercised in full, dilution per share to new
shareholders would be $5.07 per share of common stock.

The following table summarizes as of December 31, 1999 the differences
between the existing shareholders and the new shareholders with respect to the
number of shares of common stock included in the units purchased, the total
consideration paid, and the average price per share paid:

[Enlarge/Download Table]

SHARES PURCHASED TOTAL CONSIDERATION
-------------------- ---------------------- AVERAGE
NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE
--------- -------- ----------- -------- ---------------

Existing shareholders... 1,161,802 38% $15,641,732 51% $13.46
New shareholders........ 1,875,000 62% 15,000,000 49% 8.00
--------- --- ----------- --- ------
Total............. 3,036,802 100% $30,641,732 100% $10.09
========= === =========== === ======

The above computations assume no exercise of outstanding options or warrants
to purchase common stock, the over-allotment option, the public warrants
included in units sold in the offering or the representatives' warrants. New
investors will be subject to further dilution upon the exercise of outstanding
options and warrants and conversion of our Series B preferred stock.

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SELECTED FINANCIAL INFORMATION

The statement of operations data for the years ended December 31, 1998 and
1999 and the balance sheet data at December 31, 1998 and 1999 are derived from
financial statements of the company, which have been audited by
PricewaterhouseCoopers LLP, independent accountants. Historical results are not
necessarily indicative of the results to be expected in the future, and the
results of interim periods are not necessarily indicative of results for the
entire year.

[Enlarge/Download Table]

YEARS ENDED DECEMBER 31,
-------------------------
1998 1999
----------- -----------

STATEMENT OF OPERATIONS DATA:
Revenues
Product................................................... $ 2,708,856 $ 4,276,201
Maintenance............................................... 1,307,286 1,404,709
License and other......................................... 220,175 210,567
----------- -----------
4,236,317 5,891,477
Cost of Revenues
Product................................................... 1,354,920 1,896,916
Maintenance............................................... 1,065,740 862,816
----------- -----------
Gross margin................................................ 1,815,657 3,131,745
----------- -----------
Operating, general and administrative expenses.............. 2,265,312 2,531,079
Sales and marketing expenses................................ 960,246 1,024,224
Research and development expenses........................... 831,034 1,150,914
Depreciation and amortization............................... 988,838 1,096,484
----------- -----------
5,045,430 5,802,701
----------- -----------
Loss from operations...................................... (3,229,773) (2,670,956)
----------- -----------
Interest expense, net....................................... 204,287 363,638
----------- -----------
Loss before income taxes.................................. (3,434,060) (3,034,594)
----------- -----------
Provision for income taxes.................................. -- --
----------- -----------
Net loss.................................................. (3,434,060) $(3,034,594)
=========== ===========
Net loss per common share................................... $ (4.08) $ (3.07)
=========== ===========
Basic and diluted weighted average shares................... 861,875 1,016,399
=========== ===========

[Enlarge/Download Table]

DECEMBER 31, 1998 DECEMBER 31, 1999
----------------- -----------------

BALANCE SHEET DATA:
Cash........................................................ $ 45,793 $ 156,063
Net intangible assets....................................... 2,836,740 2,346,557
Total assets................................................ 4,384,005 5,909,587
Total current liabilities................................... 4,356,198 7,655,440
Notes payable, net of current portion....................... 1,473,172 924,542
Total liabilities........................................... 5,829,370 8,579,982
Total shareholders' deficit................................. (1,445,365) (2,670,395)

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND
RELATED NOTES TO THE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS.
THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT RELATE TO FUTURE EVENTS
OR OUR FUTURE FINANCIAL PERFORMANCE AND INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR OR OUR INDUSTRY'S ACTUAL
RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS TO BE MATERIALLY
DIFFERENT FROM ANY FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY THESE FORWARD-LOOKING STATEMENTS. THESE
RISKS AND OTHER FACTORS INCLUDE, AMONG OTHER THINGS, THOSE LISTED UNDER "RISK
FACTORS" AND ELSEWHERE IN THIS PROSPECTUS.

OVERVIEW

ImageWare Systems, Inc. was founded in February 1987 as a photo novelty
company. From 1987 through 1994, the company's business consisted of building
and operating unmanned photo booths which sold postcards with digitally captured
images of customers combined with various background and foreground scenes. In
November 1994, a group of employees and outside investors acquired a controlling
interest in the company from its founders, discontinued the photo booth business
and redirected the company toward the development of image-based software
products for the law enforcement community. Through the date of the acquisition,
the founders had invested approximately $7.6 million into the company,
represented by stock and paid in capital, and the company had an accumulated
deficit of approximately $8.5 million.

Since the acquisition, we have devoted substantially all of our resources to
designing, developing, producing and marketing image-based software products for
law enforcement agencies. At December 31, 1999, we had raised additional equity
capital of approximately $9.0 million, bringing our total equity capital raised
since inception to approximately $16.6 million. From the date of the acquisition
through December 31, 1999, we accumulated an additional deficit of approximately
$10.8 million, bringing the total accumulated deficit since inception to
approximately $19.3 million. As a result of this accumulated deficit and other
factors, our independent auditors have qualified their report on our audited
financials for fiscal 1999.

In 1995 and 1996, we worked with law enforcement agencies to identify their
needs and develop the initial modules for our C.R.I.M.E.S. suite of products and
the integrated system in which they would operate. Our first three modules,
Suspect ID, Crime Lab, and Vehicle ID, were introduced during this period. In
1997, we completed the development of Face ID and the Crime Capture System,
which, when included in our C.R.I.M.E.S. suite, gave us a sufficient breadth of
products to begin marketing entire systems in addition to individual modules.

Cash generated from sales of the initial three modules in 1997 and 1998 was
limited due to their relatively low selling prices which ranged from $600 to
$5,000 per unit. The introduction of the Crime Capture System and Face ID in
late 1997 gave us the ability to sell systems with prices ranging from $25,000
to one million dollars or more per system. With this fully integrated, modular
suite of products, we were able to differentiate ourselves in the market from
competitors offering non-integrated products. Both the Crime Capture System and
Face ID create the potential for significant add-on sales, following the
installation of an initial system, through the sale of additional modules to
both the agency purchasing the system and other agencies that desire to access
that system. In addition, we expect a significant and growing stream of revenue
from the sale of customer support services, which are generally priced at
approximately 12-18% of the price paid for installed hardware and software. As
our installed base grows, we anticipate this revenue stream will grow.

In 1997, recognizing that we would be shifting to sales of systems rather
than individual modules, and recognizing that the sales cycle for sales to
government agencies is relatively long, we established a

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national sales force and implemented a top-down sales plan to market our
products first to the largest agencies and then to smaller agencies. We
attempted to develop contacts and relationships at the federal, state and large
county/municipality levels during 1997 to lay the groundwork for larger systems
orders. Our first significant system order was received from the Arizona
Department of Public Safety in January 1998.

In January 1998, we also acquired all of the outstanding stock of XImage
Corporation for a combination of approximately $2.1 million in cash and warrants
to purchase 61,611 shares of our common stock. XImage Corporation, based in San
Jose, California, was founded in 1987 and designed and marketed mug shot systems
to the law enforcement community. This acquisition enabled us to gain a
significant foothold in the digital mug shot market with a customer base which
included the New York City Police Department and law enforcement agencies in
Minneapolis, Portland, Seattle, Indianapolis, Orlando and Montreal. We
consolidated XImage Corporation's operations into our San Diego offices during
the second and third quarters of 1998.

BACKLOG

Although our backlog as of December 31, 1999 was approximately $2.7 million
compared to $1.6 million as of December 31, 1998, we believe that such backlog
is the result, in part, of our inability to timely deliver orders due to lack of
working capital. After receiving the proceeds of this offering, we expect to be
able to ship most outstanding orders within three to four months and to ship
orders thereafter in a timely and orderly fashion. As a result, our present
backlog may not be indicative of our backlog in future periods.

REVENUE RECOGNITION

We recognize revenue from periodic license and maintenance agreements
ratably over the respective period covered thereunder. Our revenue from software
installation and implementation and from contract services is generally
recognized as the services are performed using the percentage of completion
method based on costs incurred to date compared to total estimated costs at
completion. Amounts received under contracts in advance of performance are
recorded as deferred revenue and generally recognized within one year from
receipt. Revenue from contract services for which we cannot reliably estimate
total costs are recognized upon completion.

COST OF REVENUES

Our principal product costs include:

- Hardware costs when a product is purchased as a "turnkey" system. The
majority of our system sales include equipment, which generally equates to
between 15% and 50% of the sales price. As our installed base grows and
add-on retrieval seats and investigative modules are purchased for use on
existing personal computers, we anticipate that hardware sales as a
percentage of revenue may decrease and gross margins may increase as
orders include a greater proportion of software and services.

- Third party software licensing fees for search engine technology
incorporated into our software. The amount of these fees depends on the
number of images in the customer's database.

- Costs of personnel, travel, and overhead associated with custom
integration work, hardware/software configuration, site preparation,
installation, and training.

Our principal maintenance costs to deliver customer support services include
personnel, communications and overhead costs associated with maintaining a
7-day, 24-hour customer support desk and in-house and remote field service
personnel. These costs represent significant fixed costs. These costs are not,
however, anticipated to grow as fast as customer service revenues.

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RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1998 AND 1999

REVENUES. Product revenues increased 58% from $2.7 million for the year
ended December 31, 1998 to $4.3 million for the corresponding period in 1999.
The increase reflected the further purchases of the Crime Capture System, with
purchases by state and local agencies in Arizona to tie into the state-wide
system purchased and implemented by the Arizona Department of Public Safety in
1998. The increase also reflects system upgrades by most of our UNIX-based
customers who adopted our Windows-based Crime Capture System in 1999. Our
backlog of product orders increased significantly from approximately
$1.6 million at December 31, 1998 to $2.7 million at December 31, 1999,
indicating further acceptance of our products. Our booking products represented
approximately 89% of our product revenues in 1999.

Customer service revenues increased 7% from $1.3 million for the year ended
December 31, 1998 to $1.4 million for the corresponding period in 1999. In 1999,
we offered our UNIX-based customers incentives to upgrade to the Windows-based
Crime Capture System. As part of the incentives, the customers received reduced
maintenance fees in 1999. The price reductions were justified based upon the
need to consolidate the number of versions of systems we would have to support
and to avoid the cost of bringing the older installations into Y2K compliance.
We do not expect to offer similar price reductions in the future and expect
customer service revenues to increase along with our expanded installed base.

COST OF PRODUCTS AND MAINTENANCE. Cost of products and maintenance
increased 14% from $2.4 million, or 57% of revenue, for the year ended
December 31, 1998 to $2.8 million, for the corresponding period in 1999. Cost of
products and maintenance decreased as a percent of revenue from 57% in 1998 to
47% in 1999 primarily as a result of higher than normal costs for maintenance in
the second and third quarters of 1998 as we merged the maintenance functions of
ImageWare and XImage. Maintenance costs decreased 19% from $1.1 million or 82%
of maintenance revenue in 1998 to $863,000 or 61% of maintenance revenue in
1999. In addition, the shift in product mix from the UNIX based XImage booking
products in prior years to primarily NT based products with inherently lower
hardware costs caused product costs of sales to decrease from 50% as a percent
of product revenues in 1998 to 44% in 1999. Cost of products can vary as a
percentage of revenue from quarter to quarter depending upon product mix and the
hardware content included in systems installed during a given period.

The royalties received in 1998 and 1999 were from a patent license agreement
with Panasonic for a product which does not compete with any of ImageWare's
current or contemplated products. Panasonic has stopped using the technology and
is not expected to pay further royalties.

GROSS MARGINS Total gross margins increased from $1.8 million, or 43% of
revenues, for the year ended 1998 to $3.1 million, or 53% of revenues, for the
corresponding period in 1999. Gross margins related to product sales increased
from $1.4 million, or 50% of revenues, to $2.4 million, or 56% of revenues,
during the same periods. Gross margins related to maintenance revenues increased
from $241,546, or 18% of revenues, to $541,893, or 39% of revenues, during the
same period.

OPERATING, GENERAL AND ADMINISTRATIVE EXPENSES. Operating, general and
administrative expenses increased 12% from $2.3 million for the year ended
December 31, 1998 to $2.5 million for the corresponding period in 1999.
Approximately $387,000 of the increase was related to one-time, non-recurring
costs associated with an evaluation of our products for Year 2000 compliance and
the related work performed to bring them into compliance. An independent company
performed the Year 2000 work under contract.

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SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 4%
from $960,000 for the year ended December 31, 1998 to $1 million for the
corresponding period in 1999. We were unable to significantly accelerate our
sales effort in 1999 due to a lack of resources which limited our ability to
keep our sales force on the road and fully utilize trade publication advertising
and trade shows.

RESEARCH AND DEVELOPMENT. Research and development expenses increased 38%
from $831,000 for the year ended December 31, 1998 to $1.2 million for the
corresponding period in 1999. The cost increase for research and development
reflects an increase in personnel to accelerate new product development and
respond to customer requests for product enhancements and custom integration
work.

INTEREST EXPENSE. Interest expense increased 78% from $204,000 for the year
ended December 31, 1998 to $364,000 for the same period in 1999. The increase
reflects the cost of additional debt that the company issued to fund the
consolidation of XImage and ImageWare and to fund operations in 1999.

NET LOSS. The net loss decreased 12% from $3.4 million for the year ended
December 31, 1998 to $3.0 million for the corresponding period in 1999. Gross
profits from the sale of products and maintenance services for the year
increased $1.3 million from 1998 to 1999. Research and development expenses for
the year increased $320,000 from 1998 to 1999 due to increased personnel costs
in the more recent year. Operating, general and administrative expenses for the
year increased $266,000 from 1998 to 1999, due to a $387,000 one-time charge in
1999 for Year 2000 offset by higher administrative costs in 1998 due to the
consolidation of XImage.

LIQUIDITY AND CAPITAL RESOURCES

LIQUIDITY. We had negative working capital of $3.1 million at December 31,
1998 compared to $4.3 million at December 31, 1999. Cash used by operating
activities totaled $1.9 million for both years ended December 31, 1998 and 1999.

For the year ended December 31, 1999, cash was principally used to fund
$3.0 million in losses offset by non-cash charges of $423,000 for compensation
and fees paid with stock and $1.1 million in depreciation and amortization. Also
contributing to the cash used by operations was a $2.1 million increase in
current assets, primarily related to a $2.0 million increase in accounts
receivable. The increases in current assets were due to a significant level of
installation activity in the fourth quarter of 1999. Additional sources of
working capital in 1999 were the extension of payment terms by the Company on
$594,000 in accounts payable, an increase in accrued expenses and interest of
$1.1 million and an increase in short-term debt of $1.7 million resulting in an
increase in current liabilities of $3.3 million. These increases resulted from
our increased volume of business and our inability to meet the terms of our
obligations during the year. At the end of 1999, accounts receivable attributed
to three major customers collectively represented 55% of total accounts
receivable. Such concentration of credit risk is normal in our business.

Cash used by operating activities in 1998 totaled $1.9 million and was used
principally to fund $3.4 million in losses offset by non-cash charges of
$989,000 for depreciation and amortization and $522,000 for fees paid with
stock.

During 1998, we used an additional $2.1 million in cash for investing
activities to complete the acquisition of XImage.

CAPITAL RESOURCES. Prior to 1998, our primary sources of funds were
shareholder loans, private placements of stock and, to a lesser extent, cash
provided by operating activities. In 1998, we received $1.2 million in funds
from secured bank loans, in addition to $705,000 in loans from shareholders. In
1999, we received $2,500,000 in loans and $375,000 from the sale of stock.
During 1999, we repaid $700,000 in bank debt and $100,000 in shareholder debt.

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Included in loans received in 1999 was $1.25 million from the president of
Atlus Co., Ltd., with terms extending to the earlier of the completion of our
initial public offering or February 10, 2001. We have agreed to assume any
exchange rate risk in the repayment of this loan and have not entered into any
hedging transaction with respect to this potential obligation. In 1999, we also
received an additional $500,000 as a loan from the chairman of Paulson
Investment Company, Inc. with terms extending to the earliest of the demand of
our lender, the closing of our initial public offering, or April 3, 2000. We
used $500,000 of the funds provided by these 1999 financing activities to reduce
our bank debt. We used an additional $125,000 of the loan proceeds to reduce
notes payable to shareholders and pay officers for credit card debt. During
1999, we received an extension of the bank loan until March 3, 2000 and, in
2000, a verbal forebearance pending the completion of this initial public
offering. In 1999, we also received extensions on shareholder debt totaling
$803,500, subject to progressive principal payments on a monthly payment
schedule, with the balance due upon the completion of our initial public
offering.

We have not generated sufficient cash from operations to fund continued
operations or our growth plan, and will require significant additional future
funding. We anticipate that, after completion of this offering, our operating
cash flows will be sufficient to meet our liquidity needs for the foreseeable
future, based on our current expense calculations and our current and
anticipated revenue streams, including the proceeds of this offering. Our
operating and financing plans assume certain revenue projections can be met and
our overall cost structure remains stable, as to either of which there can not
be any assurance. There also can be no assurance that our working capital
objectives will be reached in the near future, if ever. In the event that
additional capital is required, we may seek to raise such capital though private
or public equity financing. There can be no assurance that such capital will be
available on favorable terms, if at all.

Based upon our order intake experience and quality of our existing pipeline
of future business, we are projecting significant growth in revenues in the
coming twelve months. We anticipate reaching profitability and positive cash
flow from operations within the next twelve months. We do not anticipate
significant increases in operating expenses associated with the increased
revenues, and we expect gross profit margins to maintain or improve over current
levels. No significant capital expenditures or investments in infrastructure are
anticipated. Anticipated operating cash flows and the proceeds from this
offering are expected to be sufficient to fund our growth for the foreseeable
future, however, there can be no assurance that the Company will achieve
sufficient cash flow or that the Company may not need additional funding in the
future.

OTHER COMMITMENTS. In connection with the outstanding Series B preferred
stock, we are obligated to pay cumulative dividends at the rate of $0.2125 per
share per year. At December 31, 1999, dividends due aggregated approximately
$177,572. Dividends accrued at February 29, 2000 were $191,137 and will be paid
from the proceeds from this offering.

We are also obligated to pay approximately $1,055,000 over the next three
years under our employment agreements, an estimated $200,000 over the next one
and one-half years under our license agreements, and approximately $1,018,000
over the next three and one-half years under our real property lease.

YEAR 2000 COMPLIANCE

With regard to our internal operations, we have relied on written
representations from our software and hardware vendors to confirm that the
versions of their products we are using are Year 2000 compliant. We have spent
between $15,000 and $25,000 on these compliance issues, and any additional costs
are not expected to be more than $15,000. As of February 29, 2000, our
compliance activities are complete and we are not aware of any Year 2000
compliance problems with our products. As of February 29, 2000, only one
customer reported to us any problem with its own computer system

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that affected the performance of our products. The problem has been corrected.
There may be undetected Year 2000 problems with our internal systems, our
products or our customers' computer sytems. As part of our contingency plan in
case our internal systems are not entirely Year 2000 compliant, we regularly
have all data backed up in a form so as to ensure no loss of information and to
enable a system migration if necessary.

With regard to software and hardware used in our products, we engaged an
independent firm to evaluate our products, identify areas of non-compliance,
develop a plan to bring the products into compliance and implement the plan to
bring all customers under maintenance contracts compliant by December 31, 1999.
The cost of such compliance activities totaled $387,000 and was funded primarily
through borrowings. The implementation of our remediation plan remained on
schedule and was completed by December 31, 1999.

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BUSINESS

INDUSTRY BACKGROUND

Police departments and other law enforcement and public safety agencies rely
on criminal history records to help fight crime. A criminal history record
includes personal information and a history of arrests, convictions and other
events, and may also include fingerprints and photographs. According to a 1989
recidivism study conducted by the U.S. Department of Justice, of the 108,580
persons released from prisons in 11 states in 1983, an estimated 62.5% were
re-arrested for a felony or serious misdemeanor within three years. Since many
crimes are committed by recidivists, the ability to quickly search criminal
history records to identify a suspect is particularly important.

Many law enforcement and public safety record-keeping systems are still
files of paper records, which cannot be searched quickly or from remote
locations. Even if paper records contain pictures of criminals, they cannot be
quickly searched based on selected criteria such as eye color, first name or
gang membership. To alleviate the inadequacies of paper records, many agencies
have moved to digital record-keeping systems. However, many of these systems are
merely a database of criminal records that can be searched by record number
only. While they reduce the need for paper files and are easier to keep secure,
they do not allow officers to search for an unknown suspect in the database
based on criteria such as height, hair color, gang membership or other factors.
Even agencies that have installed searchable databases often do not yet have
biometrics-based software that would allow them to compare a digital facial
photograph with photographs in the database in order to match an unknown suspect
with known criminals who have similar physical characteristics. "Biometrics"
refers to the method of identifying a person by measuring distinctive biological
characteristics, such as facial features or fingerprints.

In view of the inefficiencies in traditional record keeping-systems, many
agencies are turning to new technologies to increase their ability to quickly
identify, locate and arrest criminal suspects. Costs have decreased for computer
hardware, bandwidth and communications infrastructures. The ability to transmit
large quantities of data, such as digital images, has increased, as has the use
of open architecture among systems, allowing agencies to share data more
effectively. The speed and accuracy of facial recognition technology is also
increasing, as are the capabilities for the transmission of digital images. As a
result of these factors, we believe law enforcement agencies will increasingly
seek to replace outdated methods, increase the size of their digital booking
systems and look for investigative products that allow them to effectively
search and share the information captured in their systems.

Further, we believe that, as computer technology becomes more common, law
enforcement agencies will increasingly use laptop computers and wireless data
communication. These technologies will eventually allow investigators and police
officers to access their agency's database and other information from the scene
of a crime or from a patrol car.

MARKETS

THE LAW ENFORCEMENT AND PUBLIC SAFETY MARKETS

The United States law enforcement and public safety markets are composed of
federal, state and local law enforcement agencies. As of 1996, state and local
governments in the United States operated approximately 18,769 law enforcement
agencies consisting of 13,578 local police departments, 3,088 sheriffs'
departments and offices, 49 primary state law enforcement agencies, 1,316
special police agencies, and 738 county constable offices. As of 1996, the
federal market consisted of federal agencies, such as the Federal Bureau of
Investigation and the Drug Enforcement Administration, which in total employed
about 74,500 full-time employees, not including military agencies and their
personnel.

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The federal government has promoted the development and use of nationwide
criminal history record databases called the Interstate Identification Index and
the National Crime Information Center 2000, or NCIC 2000, each consisting of
national and regional databases. The Interstate Identification Index is
maintained by the FBI and includes persons arrested for felonies or serious
misdemeanors. The FBI has indicated that this Index will accept photographs in
the future. NCIC 2000 is an on-line information system dedicated to serving
criminal justice agencies. In July 1999, NCIC 2000 replaced an older system to
allow for the sharing of digital images. We anticipate that the inclusion of
digital images in these databases will increase the value of digital booking
systems and the demand for facial recognition applications.

The Violent Crime Control and Law Enforcement Act of 1994 is expected to
contribute at least $130 million in grants to support technological improvements
for law enforcement agencies and other activities to improve law enforcement
training and information systems, which could include purchases of our products
and services. The Crime Identification Technology Act of 1998 authorized funding
of up to $250 million in each of the next five years to, among other things,
support integration of state and local justice system technology. Agencies are
eligible for grants under this program based on their initiatives to develop,
oversee, plan and implement integrated information technology, including
technology of the type produced by ImageWare. This act merely authorizes this
funding and is contingent on Congress passing legislation to appropriate the
funds each year.

OTHER APPLICATIONS AND MARKETS

We believe there are emerging applications for our products within the
public safety market beyond the needs of agencies to book and identify criminal
suspects. Variations on our system can be used to track inmate populations of
correctional facilities, to monitor the location of persons on parole or
probation without the need for them to visit their parole or probation officer
in person, to monitor gun registrations and allow gun retailers and distributors
to run more accurate background checks on potential buyers, and to help
authorities locate missing children.

Our technology also has emerging applications in markets related to access
control and identification. Organizations concerned with security issues can use
our products to create picture identification cards that can be instantly
checked against a database of facial images to prevent unauthorized access to
secure areas. Potential customers in these markets include large corporations,
hospitals, universities and government agencies.

While we have not yet had significant international sales, we plan to
continue to market and sell our products internationally in the future. Some of
the challenges and risks associated with international sales include the
difficulty in protecting our intellectual property rights, longer collection
cycles, difficulty in enforcing agreements through foreign legal systems and
volatility and unpredictability in the political and economic conditions of
foreign countries. We believe we can work to successfully overcome these
challenges.

PRODUCTS AND SERVICES

We believe our integrated suite of software products significantly reduces
the inefficiencies and expands the capabilities of traditional booking systems.
Using our products, an agency can create a digital database of thousands of
criminal history records, each including a full-color facial image, text
information and images of other distinctive physical features. This database can
be quickly searched using text queries or by using our facial recognition
technology to compare the face of an unknown suspect with facial images in the
database. Our investigative software products can also be used to create, edit
and enhance digital images and to search databases of other agencies to which
the customer has access.

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We believe our products allow our customers to achieve the following
benefits:

MORE QUICKLY BOOK AND IDENTIFY SUSPECTS. Because many officers can enter
information and images directly into the booking system simultaneously from
multiple locations, an agency can reduce the time required to book a
suspect. In addition, rather than flipping through books of mugshots, an
officer and witness can use our software to quickly compare the digital
image of a suspect with thousands of facial images in the booking system.

MORE ACCURATELY CAPTURE AND IDENTIFY FACES. Officers and witnesses can
together create and edit full-color, photograph-quality images to match the
facial image as closely as possible to the description of the suspect.

SEARCH THROUGH A GREATER NUMBER OF CRIMINAL RECORDS. As agencies are able
to access not only their own booking system but the databases of other
agencies as well, they will be able to access a far greater number of
criminal records than available through traditional booking systems.

MINIMIZE TRAINING TIME AND EXPENSE. Our products are designed to be used by
persons with minimal technical backgrounds. Our software programs ask simple
questions to create full-color facial images, book a suspect or search a
booking system.

INTEGRATE OUR PRODUCTS INTO A COMPLETE SYSTEM. Our system is made up of a
suite of six fully integratable software modules. A customer may purchase
all of the modules as a complete system or each module individually. Our
booking system can also be integrated with other information systems, such
as an automated fingerprint identification system.

SCALE OUR PRODUCTS FOR USE ON A SINGLE COMPUTER OR A LARGE NETWORK. Our
products are completely scalable, so that they may be used on one computer
terminal or with a client-server network including dozens of terminals or
more.

Our C.R.I.M.E.S. system consists of six software modules, which may also be
purchased individually. The Crime Capture System (including both the Capture
Module and the Retrieval Module) is our booking system and database. Our
investigative modules are Face ID, Suspect ID, Crime Lab and Vehicle ID.

CRIME CAPTURE SYSTEM. The Crime Capture System is a Windows-based digital
booking system made up of two distinct software modules and associated hardware
such as cameras and computer hardware as needed. The Crime Capture System allows
a customer to capture and store images and other information in a database and
search and retrieve records from the database. The Crime Capture System uses
off-the-shelf hardware and is designed to comply with open industry standards so
that it can operate on an array of systems ranging from a stand-alone personal
computer to a wide area network. To avoid duplication of entries, the system can
be integrated easily with several other information storage and retrieval
systems, such as a live scan fingerprint system, a records management system or
an automated fingerprint identification system.

Our first order for the Crime Capture System occurred in January 1998. As of
December 31, 1999, the Crime Capture System is being used by 34 customers,
including the Arizona Department of Public Safety and the Los Angeles County
Sheriff's Department. Each Crime Capture System is scalable to suit each
customer's needs and can be configured to connect with systems which may already
be in place. As a result, the price of the system to the customer varies widely.
Full installations of the Crime Capture System have ranged from $25,000 for a
stand-alone system to over $1 million, and most commonly range from $150,000 to
$400,000. Gross revenues from sales of the Crime Capture System represented 80%
of our 1999 gross revenues.

CCS CAPTURE. This software module allows a user to capture and store facial
images as well as images of distinguishing features such as scars, tattoos and
other marks. Each entry contains both

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images and text information in an easy-to-view format made up of distinct
fields. As of February 29, 2000, we had installed CCS Capture at 59 sites.
Current customers of this module range from agencies that capture a few thousand
mugshots per year to those that capture over 600,000 mugshots per year. CCS
Capture will generally replace our UNIX-based booking system, ForceField 2000,
which was originally introduced by XImage Corporation in 1989 as a mugshot
capture system. While a few of our customers will continue to use ForceField
2000 for the foreseeable future, we have upgraded most current customers from
the ForceField 2000 to the Crime Capture System.

CCS RETRIEVAL. This software module allows a user to search the database
created with CCS Capture. Officers can conduct text searches in many fields,
including file number, name, alias, distinctive features like "brown eyes" or
"tattoo," and other information such as gang membership, arrests and
convictions. CCS Retrieval creates a catalogue of possible matches, allowing
officers or witnesses to save time by looking only at mugshots that closely
resemble the description of the suspect. This module can also be used to create
a line-up of similar facial images from which a witness may identify the
suspect. CCS Retrieval can be used by a law enforcement agency's satellite
offices that need to access a database created and maintained at a central
location using CCS Capture. As of February 29, 2000, we had installed CCS
Retrieval at 240 sites. When purchased separately from CCS Capture, the CCS
Retrieval module is typically priced at approximately $6,750.

FACE ID. This software module uses biometric facial recognition and
retrieval technology to help authorities identify possible suspects. Images
taken from surveillance videos, digital sketches or photographs can be searched
against a digital database of facial images to retrieve any desired number of
faces with similar characteristics. This investigative module can also be used
at the time of booking to identify persons using multiple aliases. Using
biometrics-based technology, Face ID can search through thousands of facial
images in a matter of seconds, reducing the time it would otherwise take a
witness to flip through a paper book of photographs that may or may not be
similar to the description of the suspect. Face ID then creates a selection of
possible matches ranked in order of similarity to the suspect, and a percentage
confidence level is attributed to each possible match. Face ID incorporates
search engine technology which we license from Visionics, Inc. We first
introduced Face ID in late 1997. This module is comprised of a server, which is
typically priced at $25,000 or more, and a personal computer client, which is
typically priced at approximately $15,000.

SUSPECT ID. This software module allows officers and witnesses to quickly
create full-color, photo-realistic suspect composites. The digital composites
are constructed from libraries of facial features based upon actual color
photographs of such features. Suspect ID allows officers with minimal computer
training and artistic talent to create a suspect composite by pointing and
clicking with a mouse. This module can be installed on a laptop computer and
taken into the field, allowing officers to conduct interviews and create
composites before witnesses' memories fade. For rapid identification, officers
can distribute completed composites within minutes via fax or e-mail. Suspect ID
incorporates our patented object-layering technology. We first introduced
Suspect ID in 1995. This module is typically priced at approximately $5,000.

CRIME LAB. This software module allows officers to enhance and edit digital
images. Using Crime Lab, an officer can update old images, create
non-prejudicial line-ups, remove distracting backgrounds and enhance the quality
of surveillance videos. Crime Lab incorporates our patented object-layering and
color-masking technologies. We first introduced Crime Lab in 1995. This module
is typically priced at approximately $600.

VEHICLE ID. This software module helps officers identify motor vehicles
which may have been stolen or involved in a crime. Vehicle ID's comprehensive
database includes images and text information for over 1,000 vehicle makes and
models and can be searched using many fields, including physical features and
Vehicle Identification Number. Images of vehicles similar to the suspect vehicle
can be viewed from front, rear, side or three quarter angles and can be depicted
in any color. A color

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copy of the suspect vehicle can then be produced and immediately broadcast,
printed or faxed to officers in the field. Vehicle ID incorporates our patented
object-layering technology. Vehicle ID also incorporates Vehicle Identification
Number software provided by the National Insurance Crime Bureau. We first
introduced Vehicle ID in 1996. This module is typically priced at approximately
$1,500.

MAINTENANCE AND CUSTOMER SUPPORT

We work directly with purchasers of our system to ensure that the system
they purchase will meet their unique needs. We configure and test the system
either at our facilities or on-site and conduct any customized programming
necessary to connect the system with any legacy systems already in place, such
as old booking system databases or other records management systems.

As part of our installation of a system, we train our customer's employees
in the effective use of our products. We also provide training on an ongoing
basis both on-site and at our facilities in San Diego, California. We provide
on-site hardware support to our customers, generally within 24 hours of the
customer request. Customers can use a toll free number to speak with our
technical support center, which provides software support and general assistance
24 hours a day, seven days a week. On-site customer support is coordinated by
our field personnel in New York, Minnesota, Washington and Arizona. Providing
customer support services typically provides us with annual revenue of 12% to
18% of the initial sales price of the system purchased by our customer.

SYSTEM CONFIGURATION AND FULFILLMENT

We directly employ computer programmers and also retain independent
programmers to develop our software and perform quality control. We provide
customers software which we specifically configure to operate on their existing
computer system. We can also provide customers with a complete computer hardware
system with our software already installed and configured. In either case, the
customer is provided with a complete "turn-key" system which can be used
immediately. When we provide our customers with a complete computer system
including hardware, we use "off-the-shelf" computers, cameras and other
components purchased from other companies such as IBM or Gateway 2000. Systems
are assembled and configured either at our facilities in San Diego, California,
or at the customer's location.

OUR STRATEGY

Key elements of our strategy for growth include the following:

FULLY EXPLOIT THE EXPANDING LAW ENFORCEMENT AND PUBLIC SAFETY MARKETS

We intend to use our successful installations with customers such as the
Arizona Department of Public Safety as reference accounts and to aggressively
market C.R.I.M.E.S. as a superior technological solution. The majority of our
recent and near term sales has been and will be from sales of the Crime Capture
System. Our sales effort in the near term will be to establish the Crime Capture
System as the mug shot system adopted in as many countries, states and large
county/municipalities as possible. Once we have a system installed in a region,
we intend to then sell additional systems or retrieval seats to other agencies
within the primary customer's region and in neighboring regions. In addition, we
will then market our complementary investigative modules to the customer,
including Face ID, Suspect ID, Crime Lab and Vehicle ID. As customer databases
of digital mug shots grow, we expect that the perceived value of our
investigative modules, and corresponding revenues from sales of those modules,
will also grow.

EXPAND INTO RELATED APPLICATIONS WITHIN THE LAW ENFORCEMENT AND PUBLIC SAFETY
MARKETS

Our products can provide solutions to law enforcement and public safety
agencies beyond our core application of police booking systems and related
investigative products, with minimal adaptation. The

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technology behind our C.R.I.M.E.S. product line can be used to create databases
of missing children and compare the facial image of a lost child to the images
in the database. Our system can be used to help correctional facilities track
and control inmates. Gun sellers could use our products to access available
criminal databases and help prevent the sale of guns to ineligible persons. Our
technology can be used to monitor persons on parole or probation without
requiring them to travel to their parole or probation officer. We anticipate
that a parolee or probationer will be able to have his photograph taken in a
specially designed kiosk which uses biometrics-based technology to identify the
person and inform his parole or probation officer of his location.

PENETRATE THE ACCESS CONTROL AND IDENTIFICATION MARKETS

We believe security issues are becoming increasingly important among public
agencies, corporations, hospitals, universities and similar organizations. Using
our products, an organization can create picture IDs that correspond to images
in a digital database. A security guard can stop an individual and accurately
check his identity against a database of authorized persons, and either allow or
deny access as required. Picture IDs cannot be faked in the system, and
authorized people are not delayed more than a moment. Our technology can also be
applied in other markets to facilitate activities such as voter registration,
immigration control and welfare fraud identification. Our system has been
adopted as the picture ID system for the government of Kuwait.

DEVELOP THE INTERNET AND WIRELESS CAPABILITIES OF OUR PRODUCTS

We are currently developing a new software module, called Crime Web, which
will allow users to use the Internet or secure Intranets to conduct
investigative searches of digital booking systems. Crime Web will include the
most frequently used investigative features of the Crime Capture System to allow
users to retrieve single images, conduct searches based on one or more
parameters, create digital line-ups and print retrieved records. We are also
currently developing an Internet-based version of Face ID that will allow
investigators to use the Internet to compare the digital image of an unknown
suspect with a database of images using biometrics-based technology. We believe
our Internet products will allow users to quickly access and share images via
the Internet while maintaining the security and integrity of databases, thereby
encouraging the widespread dissemination and sharing of criminal information
among law enforcement agencies. We intend to introduce Crime Web in the first
quarter of fiscal 2000.

We also intend to develop the wireless capabilities of our products. Public
safety agencies require information to be available to their agents in the
field. Vehicles are being outfitted with wireless terminals which will allow for
the receipt of more information, including color photographs and arrest records.
Additionally, public safety agencies are investigating the feasibility of
handheld devices which can operate outside of a vehicle and accompany
investigators wherever an investigation takes them. In order to facilitate the
transfer of arrest records and investigative tools to public safety employees in
the field, we plan to develop technology in cooperation with wireless
communications companies which will allow our products in the field to operate
over wireless systems.

ACQUIRE BUSINESSES THAT ENHANCE OUR STRATEGIC POSITION

We may in the future acquire businesses that will complement our growth
strategy and enhance our competitive position in our core markets and other
markets. However, we have no current plans for such acquisitions.

SALES AND MARKETING

We market and sell our products through our direct sales force and through
indirect distribution channels, including systems integrators. Our sales and
account representatives are based in Massachusetts, New Jersey, Georgia and
California.

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As of February 29, 2000, our domestic sales organization included our
director of sales, our director of major account development, our vice president
of sales and business development and five regional managers. Our director of
major account development, based in Boston, coordinates relationships with
systems integrators and other strategic partners and is responsible for U.S.
federal accounts and European sales. Other international sales are coordinated
by our vice president of sales and business development. Our sales professionals
are supported by our technical experts who are available by telephone and
conduct on-site customer presentations.

The typical sales cycle for our Crime Capture System includes a pre-sale
process to define the potential customer's needs and budget, an on-site
demonstration, and conversations between the potential customer and existing
customers. Government agencies are typically required to purchase large systems
by including a list of requirements in a Request For Proposal, known as an
"RFP", and allowing several companies to openly bid for the project by
responding to the RFP. If our response is selected, we enter into negotiations
for the contract and, if successful, ultimately receive a purchase order from
the customer. This process can take anywhere from a few months to over a year.

In addition to our direct sales force, we have developed relationships with
a number of large systems integrators who contract with government agencies for
the installation and integration of large computer and communication systems. By
acting as a subcontractor to these systems integrators, we are able to avoid the
time-consuming and often expensive task of submitting proposals to government
agencies and also gain access to large clients who might not contract directly
with small companies. In this context, we provide agencies with digital image
booking systems and our related investigative software products. As of
February 29, 2000, we were a subcontractor to the following prime contractors:

- SCIENCE APPLICATIONS INTERNATIONAL CORPORATION, for the New York City
Police Department.

- MORPHO SYSTEMES, S.A., a subsidiary of SAGEM, S.A., a French company, for
the national identification system of Kuwait.

- PRC, INC., for the Las Vegas Metropolitan Police Department.

- DIGITAL BIOMETRICS, INC., for the Los Angeles County Sheriff's Department.

We have also entered into agreements or arrangements with the following
companies to jointly bid on certain specific projects:

- HEWLETT-PACKARD SINGAPORE (SALES) PTE LTD., to jointly bid on the booking
and facial recognition system for the Singapore Police Department.

- INTELLIGENCE AND STRATEGIC PROCESSES PTY LTD., an Australian company, to
sell our booking system in Australia and New Zealand.

We also work with companies that offer complementary products, where value
is created through product integration. These teaming arrangements allow us to
both enhance our products and expand our customer base through the relationships
and contracts of our strategic partners. We have entered into agreements with
the following companies:

- POLAROID CORPORATION. In September 1999, we entered into an agreement to
jointly market centralized imaging and facial recognition technology to
law enforcement agencies in selected states where Polaroid has state
contracts for drivers' license systems.

- H.T.E., INC. In August 1999, we entered into an agreement to integrate our
Crime Capture System with the records management system and jail
management system of H.T.E., Inc.

We promote our products through trade journal advertisements, direct mail,
and attendance at industry trade shows, including those sponsored by the
International Association for Law Enforcement,

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the International Association for Identification, and the International
Association of Chiefs of Police. We also target other media through public
relations efforts, including non-industry publications, daily newspapers, local
and national news programs, and television programs related to law enforcement.
Articles regarding our products have appeared in BUSINESS WEEK, IMAGING
MAGAZINE, THE WALL STREET JOURNAL and a number of other publications.

CUSTOMERS

We have a broad range of domestic and international customers. Most of our
customers are government agencies at the federal, state and local levels in the
United States. Our products are also being used in Canada, the United Arab
Emirates, Kuwait, Mexico, Colombia, Venezuela, and the Philippines by over 450
customers, including the following:

[Download Table]

New York City Police Department Los Angeles County Sheriff's Department
Arizona Department of Public Safety King County (Seattle), Washington
Orange County, Florida Sheriff's Office U.S. Army, Navy and Air Force
Hennepin County (Minneapolis), Minnesota Montreal Police Department
Government of Kuwait Milwaukee County, Wisconsin
City of San Antonio, Texas

In addition to the major customers listed above, we also receive purchase
orders from or enter into contracts with cities or counties. We have agreed in
certain instances with the state agency, for example, the Arizona Department of
Public Safety, to provide our products and services to smaller cities within the
state at the price and on the terms offered to the state agency. When referring
to the number of our customers, we not only include the large entities such as
the Arizona Department of Public Safety, but also include the smaller cities (or
counties), such as Tempe and Scottsdale, which separately enter into contracts
with us or submit purchase orders for our products and services.

COMPETITION

Due to the fragmented nature of the law enforcement and public safety market
and the modular nature of our product suite, we face different degrees of
competition with respect to each C.R.I.M.E.S. module. We believe the principal
bases on which we compete with respect to all of our products are:

- The ability to integrate our modular products into a complete imaging and
facial recognition system.

- Our reputation as a reliable systems supplier.

- The usability and functionality of our products.

- The responsiveness, availability and reliability of customer support.

The Crime Capture System faces strong competition from other makers of
booking systems, including companies such as Printrak International, Inc. and
Digital Descriptors Systems, Inc. Other companies in this market include Identix
Corp., Dynamic Imaging, Inc. and Epic Solutions, Inc. Printrak serves over 250
customers, including the Philadelphia Police Department. Internationally, there
are a number of local companies offering booking solutions in most countries.
Most competitors' products in this niche offer basic image capture and storage
but lack the functionality of investigative products, including facial
recognition and image editing and enhancement.

We believe Face ID was the first facial recognition software produced and
sold to the law enforcement and public safety markets. As a result, we believe
it is the most widely recognized product

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in this niche, with the largest number of installations. Identix Corp. has,
through its subsidiary, developed products with facial recognition capabilities.

Suspect ID faces competition primarily from Smith and Wesson and
Faces, Inc. Some agencies continue to employ sketch artists who develop
hand-drawn composites from witness interviews. Smith and Wesson has supplied
"acetate foil overlay" products for over 30 years. This method of creating
suspect composites requires a user to overlay sheets of clear plastic with
different facial features in order to produce a full picture. This method is
still the most widely used method for creating suspect composites, but its use
has declined since the introduction of computerized composite systems.

Crime Lab faces competition primarily from off-the-shelf image editing and
enhancement programs such as Photoshop from Adobe Systems. Photoshop is a well
known application, but was not specifically designed for the law enforcement and
public safety industry. As a result, it is not customized for use by law
enforcement agencies and cannot be easily integrated with other law enforcement
investigative software products.

Vehicle ID is, to our knowledge, the only software product using digital
images of motor vehicles to help law enforcement agencies locate and identify
stolen vehicles or vehicles involved in crimes.

INTELLECTUAL PROPERTY

We rely on patents, trademarks, trade secret and copyright laws, and
confidentiality agreements to protect our intellectual property. We own two
United States patents that are important to our business strategy. Our patented
"Color Masking System" allows a user to manipulate selected colors of an image
without affecting other colors of the image. Our patented "Object Layering"
technology allows a user to save each element of an image as a separate layer so
that edits can be made to certain elements without affecting other elements or
having to re-create the entire image. Our patented object layering technology is
used in Suspect ID, Crime Lab and Vehicle ID, and our patented color masking
technology is used in Crime Lab. These patents expire in 2012 and 2013,
respectively. We have several unregistered and federally registered trademarks,
as well as trademarks for which there are pending trademark registrations with
the United States Patent & Trademark Office, including the following marks:

[Download Table]

C.R.I.M.E.S.-Registered Trademark- Crime Capture System-Registered Trademark-
Image Wizard-Registered Trademark- Crime Lab-TM-
ImageWare-Registered Trademark- Crime Web-TM-
Morphwizard-Registered Trademark- Face ID-TM-
People Postcards-Registered Trademark- Face Investigate-TM-
Suspect ID-Registered Trademark- ForceField 2000-TM-
Vehicle ID-Registered Trademark-

We license and depend on intellectual property from third parties. We
license certain facial recognition and retrieval technology from Excalibur
Technologies Corporation on a nonexclusive, worldwide basis. Under the agreement
with Excalibur, we can create our own intellectual property as a derivative of
the Excalibur technology. Our license from Excalibur with respect to certain
technology will expire on April 29, 2001, while our license with respect to
other technology expired on October 29, 1999. Under the license with Excalibur,
we are currently paying royalties at rates equal to 10% and 25% of the net sales
price of the product depending on the category of Excalibur's technology which
is incorporated into the specific product being sold.

We also license search engine technology from Viisage Technology, Inc. and
Visionics, Inc. Our license from Viisage Technology is a nonexclusive license
for the United States and expires on December 31, 2000. The royalties payable by
us under the license from Viisage are $5,000 for searches

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of up to 40,000 images and $0.17 per image beyond 40,000 images. Our license
from Visionics is on a nonexclusive, worldwide basis and expires in July 2001.
The royalties payable by us under the license are based upon the number of
images on the database and the number of clients accessing the server. As of
February 29, 2000, we were actively using the technology licensed from Visionics
in our products. We believe that, prior to expiration of the Visionics license,
we will be able to either enter into a new license agreement with Visionics,
obtain similar search engine technology from another third party or develop our
own technology.

We also license certain of our technology to third parties. For a one-time
licensing fee of $1,961,039 received in 1997, we entered into a license
agreement pursuant to which we granted Atlus Co., Ltd. an exclusive license
(except with respect to the license granted to American Photo Booth, Inc.) to
use our patents and related technology in the entertainment photo booth market
and a nonexclusive license to use our patents and related technology in other
markets. The patents licensed to Atlus relate to only two of the six modules of
our C.R.I.M.E.S. suite of products, Suspect ID and Crime Lab. The remaining four
modules of the C.R.I.M.E.S. suite of products are not based on the patents or
technology which was the subject of this license agreement. The license
agreement also required that we first offer to Atlus, at a price and at terms
acceptable to us, the right to license all new technologies which we developed
before we could license such new technology to any third party. Atlus, in turn,
could only assign or sublicense its rights under the license agreement to an
affiliate or subsidiary of Atlus.

As of June 30, 1999, we entered into a settlement agreement and release with
Atlus in which we assigned to Atlus certain patents that were previously subject
to the license agreement mentioned above. In turn, Atlus has given us perpetual,
nonexclusive licenses to such assigned patents to use for applications other
than photo booth entertainment applications. The settlement agreement modifies
the license agreement with Atlus in that those patents which were assigned to
Atlus are no longer subject to the license agreement, and Atlus is now able to
freely sublicense to third parties the patents and intellectual property which
is still subject to the license agreement.

Pursuant to a license agreement with Panasonic Computer Peripheral Company,
Panasonic has the exclusive right to use our technology for the purpose of
bundling it with its motion printers and distributing the bundled product in the
United States and Canada. As of February 29, 2000, we had received payments from
Panasonic under this agreement of approximately $277,000, and Panasonic had
informed us that they have stopped using the technology for the time being. We
also granted to American Photo Booths Inc. a non-exclusive license to make and
sell entertainment photo booths using our "Color Masking" and "Object Layering"
technology pursuant to a confidential license agreement dated as of August 28,
1999. We do not receive royalties under this license agreement. We believe
certain of our patented technology may be currently used by third parties
without licenses from us and we intend to seek to enter into license agreements
with the parties similar to our arrangement with Panasonic.

RESEARCH AND DEVELOPMENT

Our research and development team is made up of 11 programmers, engineers
and other employees. We spent approximately $831,000 on research and development
in 1998 and $1,200,000 in 1999. We continually work to increase the speed and
accuracy of our existing suite of products. Our research and development efforts
will continue to focus on technology and products for the law enforcement and
public safety markets. We intend to use the proceeds of this offering to expand
our research and development efforts related to other markets as well.
Currently, our principal projects include:

- Completing the development of the Crime Web product and enabling our
existing products to allow facial images and associated data to be
accessed over the Internet or an agency's Intranet.

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- Completing the development of our "real time" facial recognition
application so that facial searches and resulting matches can be processed
within seconds of initial image capture.

- Adding wireless communications capabilities to our suite of products to
allow for the transmissions of images and text between agencies and their
officers in the field.

- Developing a standard interface template to allow for easier integration
of C.R.I.M.E.S. with the complementary applications of our strategic
partners, such as jail management and record keeping programs.

EMPLOYEES

As of February 29, 2000, we had a total of 52 full-time employees, including
ten in sales and marketing, 24 in customer support and installation, eleven in
research and development and seven in administration. Our employees are not
covered by any collective bargaining agreement, and we have never experienced a
work stoppage. We believe that our relations with our employees are good.

FACILITIES

We conduct our operations from a 16,000-square-foot facility located in San
Diego, California. The monthly rent for this facility is approximately $22,000.
This lease expires on July 31, 2003. We believe this facility will meet our
needs for the next three years and that additional space will be available on
reasonable terms upon the expiration of our current lease or in the event we
need to expand our facilities.

LEGAL PROCEEDINGS

We are not aware of any pending legal proceedings against us that,
individually or in the aggregate, would have a material adverse effect on our
business, results of operations or financial condition.

CORPORATE INFORMATION

ImageWare Systems, Inc. was incorporated in California in February 1987 as
Practically Perfect Productions, Inc. and changed its name to ImageWare
Software, Inc. in July 1992. We first focused on the law enforcement and public
safety markets in 1994 and originally introduced our C.R.I.M.E.S. system in
August 1995. We acquired XImage Corporation in January 1998. We changed our name
to ImageWare Systems, Inc. in November 1999. Our headquarters are located at
10883 Thornmint Road, San Diego, California 92127, and our telephone number is
(858) 673-8600. Our website address is WWW.IWSINC.COM. Information contained on
our website or any other website does not constitute a part of this prospectus.

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MANAGEMENT

DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES

Our directors, executive officers and key employees are as follows:

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NAME AGE POSITION
---- -------- ----------------------------------------------------

S. James Miller, Jr.................. 46 Chairman, President and Chief Executive Officer

Wayne G. Wetherell................... 47 Vice President of Finance and Chief Financial
Officer

Paul J. Devermann.................... 44 Vice President of Sales and Business Development

Patricia E. Ryan..................... 35 Director of Major Account Development

William J. Ibbetson.................. 31 Chief Technical Officer

Patrick J. Downs..................... 63 Director

John L. Holleran..................... 73 Director

Yukuo Takenaka....................... 57 Director

S. JAMES MILLER, JR. has served as our president and chief executive officer
and as a director since 1990. From 1980 to 1990, Mr. Miller was an executive
with Oak Industries, Inc., a manufacturer of components for the
telecommunications industry. While at Oak Industries, Mr. Miller served as a
director and as general counsel, corporate secretary and chairman/president of
Oak Industries' Pacific Rim subsidiaries. Mr. Miller has a J.D. from the
University of San Diego School of Law and a B.A. from the University of
California, San Diego.

WAYNE G. WETHERELL has served as our vice president of finance and chief
financial officer since 1996. From 1991 to 1996, Mr. Wetherell was the vice
president and chief financial officer of Bilstein Corporation of America, a
manufacturer and distributor of automotive parts. Mr. Wetherell holds a B.S. in
Management and a M.S. in Finance from San Diego State University.

PAUL J. DEVERMANN has served as our vice president of sales and business
development since 1997. From 1992 to 1997, Mr. Devermann was the managing
director and founding partner of Intra-International Trade and Transactions, an
international consulting and trading company which facilitates business
transactions between the U.S. and Japanese companies. He holds a B.S. degree in
Marketing from Northern Illinois University and an M.B.A. from the University of
Puget Sound.

PATRICIA E. RYAN has served as our director of major account development
since 1994. From 1992 to 1994, Ms. Ryan was an account executive of Noble
Broadcasting, Inc., where she was responsible for developing new business
through vendor and event marketing campaigns. Ms. Ryan holds a B.S. in Business
Administration and a B.A. in Economics from the University of New Hampshire.

WILLIAM J. IBBETSON joined us in 1992 as a field support technician and has
served as our chief technical officer since April 1996. Mr. Ibbetson holds a
Certification in Computer Electronics Technology from Coleman College.

PATRICK J. DOWNS was elected to the Board in August 1994. Since 1997,
Mr. Downs has been manager of Control Commerce, LLC, an Internet business. He is
a founding shareholder of NTN Communications, Inc., a interactive gaming company
whose common stock is listed on the American Stock Exchange, and served as its
chairman and chief executive officer from 1983 to 1997.

JOHN L. HOLLERAN was elected to the Board in May 1996. For the last five
years, Mr. Holleran has been self-employed as a management and investment
consultant.

YUKUO TAKENAKA was elected to the Board in April 1997. Since 1989,
Mr. Takenaka has been president of Takenaka & Company LLC, an investment firm.
Mr. Takenaka is a director of Atlus Dream Entertainment Co., Ltd., which is
majority owned by Atlus Holding, a wholly owned subsidiary of our largest
shareholder, Atlus Co., Ltd.

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We currently have four directors on our board and we intend to maintain at
least two independent directors. Each director holds office until the next
annual meeting of shareholders and until a successor is elected and qualified.

DIRECTOR COMPENSATION

In January 1998, for past services rendered as directors, we issued 2,844
shares of common stock to S. James Miller, 2,844 shares to Patrick Downs, 2,654
shares to William Guthner, 1,327 shares to John Holleran and 569 shares to Yukuo
Takenaka. Directors did not receive any other compensation in 1998. Beginning
November 1999, directors who are not also employees will receive $12,000
annually in return for their services as directors, payable in cash or our
common stock as determined by the company. We reimburse directors for travel and
other out-of-pocket expenses incurred in attending shareholder, board and
committee meetings. Directors are also entitled to receive options under the
1994 nonqualified stock option plan.

COMMITTEES OF THE BOARD OF DIRECTORS

Our board of directors has a compensation committee consisting of Mr. Downs
and Mr. Holleran and an audit committee consisting of Mr. Takenaka, Mr. Downs
and Mr. Holleran, all of whom are independent directors. The compensation
committee reviews and recommends to the board of directors the compensation and
benefits of our officers, reviews general policy matters relating to
compensation and benefits of our employees and administers the issuance of stock
options and discretionary cash bonuses to our officers, employees, directors and
consultants. The audit committee meets with management and our independent
public accountants to determine the adequacy of our internal controls and other
financial reporting matters. It is our intention to appoint only independent
directors to the audit and compensation committees.

EXECUTIVE COMPENSATION

The following table sets forth information regarding compensation awarded
to, earned by or paid to our president and chief executive officer and executive
officers whose annual compensation exceeded $100,000 in 1999 for all services
rendered to us during 1999, 1998 and 1997.

SUMMARY COMPENSATION TABLE

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LONG TERM
COMPENSATION
ANNUAL COMPENSATION ------------
------------------------------------------------ SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS(#)
--------------------------- -------- -------- -------- ------------ ------------

S. James Miller, Jr. .................. 1999 $174,310 -- $ 9,000(3) 11,000
President and Chief Executive Officer 1998 159,769 -- 9,000(3) --
1997 156,445(1) $15,000 10,320(2)(3) 9,479

Wayne G. Wetherell .................... 1999 $117,884 -- -- 7,000
Vice President of Finance and 1998 108,606 -- -- 2,844
Chief Financial Officer 1997 108,127 $ 7,500 $ 1,320(2) 18,957

Paul J. Devermann ..................... 1999 $112,593 -- -- 7,000
Vice President of Sales and 1998 101,300 $10,000 -- 2,844
Business Development 1997 99,865 -- -- 18,957

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

(1) Includes cash and common stock.

(2) Includes a 401(k) matching contribution of $1,320.

(3) Includes an auto allowance of $750 per month.

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OPTION GRANTS IN LAST FISCAL YEAR

The following table sets forth information regarding options granted to the
following executive officers during the year ended December 31, 1999.

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NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS GRANTED
UNDERLYING TO EMPLOYEES IN EXERCISE PRICE
NAME OPTIONS GRANTED FISCAL YEAR ($/SHARE) EXPIRATION DATE
---- --------------- ---------------- -------------- ---------------

S. James Miller, Jr................. 11,000 4.0% $8.00 Nov. 18, 2004

Wayne G. Wetherell.................. 7,000 2.5% 8.00 Nov. 18, 2004

Paul J. Devermann................... 7,000 2.5% 8.00 Nov. 18, 2004

FISCAL YEAR END OPTION VALUES

The following table sets forth information regarding the number and value of
unexercised options held by the following executive officers on December 31,
1999. None of these executive officers exercised options to purchase common
stock during 1999.

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NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS IN-THE-MONEY OPTIONS
AT FISCAL YEAR END(#) AT FISCAL YEAR END($)(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------

S. James Miller, Jr............................ 28,436 11,000 $77,486 $ 0

Wayne G. Wetherell............................. 14,265 14,536 38,873 20,534

Paul J. Devermann.............................. 14,265 14,536 38,873 20,534

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

(1) Based on the estimated fair value of our common stock as of December 31,
1999, determined by our board of directors to be $8.00 per share.

STOCK OPTION PLANS

We have three separate stock option plans: the 1994 employee stock option
plan, the 1994 nonqualified stock option plan, and the 1999 stock option plan.

The 1994 employee stock option plan is an incentive stock option plan which
authorizes us to issue options to purchase up to 170,616 shares of our common
stock to our officers and key employees. Under this plan, we have issued options
to purchase 165,118 shares at a weighted average exercise price of $5.275 per
share. The plan is administered by our board of directors. Subject to the
provisions of this plan, the board determines who will receive options, the
number of options granted, the manner of exercise and the exercise price of the
options. The term of the options granted under the plan may not exceed ten
years, or five years for options granted to an optionee owning more than 10% of
our common stock. No options may be granted after August 31, 2004. The exercise
price of the options granted under this plan must be equal to or greater than
the fair market value of the shares of our common stock on the date the option
is granted or, in the case of options granted to an optionee owning more than
10% of our voting stock, at a price equal to or greater than 110% of the fair
market value of our common stock on the date the option is granted.

The 1994 nonqualified stock option plan is a non-qualified stock option plan
which authorizes us to issue options to purchase up to 18,957 shares of our
common stock to our directors and consultants. Under this plan, we have issued
options to purchase 16,493 shares at an exercise price of $8.00. The plan is
administered by our board of directors. Subject to the provisions of this plan,
the board determines who will receive options, the number of options granted,
the manner of exercise and the exercise price of the options. The term of the
options granted under the plan may not exceed five

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years. No options may be granted after August 31, 2004. The exercise price of
the options granted under this plan must be equal to or greater than 85% of the
fair market value of the shares of our common stock on the date the option is
granted.

The 1999 stock option plan is a combined incentive and non-qualified stock
option plan which authorizes us to issue options to purchase up to 100,000
shares of our common stock. Under this plan, we have issued options to purchase
95,000 shares at $8.00 per share, including 11,000 options to Mr. Miller, 7,000
options to Mr. Wetherell and 7,000 options to Mr. Devermann. The plan is
administered by our board of directors. Subject to the provisions of this plan,
the board determines who will receive options, the number of options granted,
the manner of exercise and the exercise price of the options. The term of the
options granted under the plan may not exceed ten years, or five years for
options granted to an optionee owning more than 10% of our voting stock. No
additional options are currently available for issuance under this plan.

The exercise price of an incentive stock option granted under the 1999 stock
option plan must be equal to or greater than the fair market value of the shares
of our common stock on the date the option is granted. The exercise price of a
non-qualified option granted under this plan must be equal to or greater than
85% of the fair market value of the shares of our common stock on the date the
option is granted. In either case, an option granted to an optionee owning more
than 10% of our voting stock must have an exercise price equal to or greater
than 110% of the fair market value of our common stock on the date the option is
granted.

Effective immediately upon the determination of the initial public offering
price of the units in this offering, the 1999 stock option plan will be amended
to authorize us to issue options to purchase an additional 150,000 shares of our
common stock. We have entered into agreements with Mr. Miller, Mr. Wetherell and
Mr. Devermann to grant them 64,000, 43,000 and 43,000 of these options,
respectively, as of the determination of the initial public offering price of
the units, at an exercise price equal to the initial public offering price of
the units.

In February 1999, all then-outstanding options were repriced so that the new
exercise price of these options became $5.28 per share, as adjusted to reflect
the 5.275-to-1 reverse stock split in November 1999. No outstanding options,
except those issued pursuant to our qualified stock option plans, may be
exercisable more than five years from the date of this offering.

EMPLOYMENT AGREEMENTS

S. JAMES MILLER, JR. In September 1997, we entered into an amended
employment agreement with Mr. Miller pursuant to which Mr. Miller will serve as
our president and chief executive officer. This agreement is for an initial
three-year term ending December 31, 2001, which period is renewed annually on
January 1(st) of each year for a three-year term unless we give Mr. Miller
one-year prior notice of termination. This agreement provides for annual base
compensation in the amount of 155,000 which was increased by the compensation
committee on August 30, 1999 to $185,000, which amount will be increased based
on cost-of-living increases, and a $750 per month auto allowance. Under this
agreement, we will reimburse Mr. Miller for reasonable expenses incurred in
connection with our business. If we terminate Mr. Miller's employment without
cause or if we move our principal offices out of San Diego, Mr. Miller will be
entitled to a lump sum amount equal to the full amount of his base salary for
the remainder of the term of the agreement. Upon a change in control of the
company or a material reduction of Mr. Miller's duties by the board of
directors, Mr. Miller may provide 30 days notice of the termination of his
employment and will be entitled to his entire unpaid base salary for the
remainder of the term of the agreement.

WAYNE G. WETHERELL. On March 1, 1999, we entered into an amended employment
agreement with Mr. Wetherell pursuant to which Mr. Wetherell will serve as our
chief financial officer. This agreement is for a term ending April 30, 2002.
This agreement provides for annual base salary in the

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amount of $112,144, which amount will be increased based on cost-of-living
increases and may also be increased based on performance reviews. Currently, Mr.
Wetherell's annual salary is $125,000. Under this agreement, we will reimburse
Mr. Wetherell for reasonable expenses incurred in connection with our business.
If we terminate Mr. Wetherell's employment without cause, Mr. Wetherell will be
entitled to the full amount of his base salary for a period of one year after
termination. Upon a change in control of the company or a material reduction of
Mr. Wetherell's duties by the board of directors, Mr. Wetherell may provide
30 days notice of the termination of his employment and will be entitled to his
entire unpaid base salary for a period of one year from the date of termination.

PAUL J. DEVERMANN. On March 1, 1999, we entered into an amended employment
agreement with Mr. Devermann pursuant to which Mr. Devermann will serve as our
vice president of sales and business development. This agreement is for a term
ending February 28, 2002. This agreement provides for annual base salary in the
amount of $103,731, which amount will be increased based on cost-of-living
increases and may also be increased based on performance reviews. Currently
Mr. Devermann's annual salary is $125,000. Under this agreement, we will
reimburse Mr. Devermann for reasonable expenses incurred in connection with our
business. If we terminate Mr. Devermann's employment without cause,
Mr. Devermann will be entitled to a lump sum equal to the full amount of his
base salary for a period of one year after termination. Upon a change in control
of the company or a material reduction of Mr. Devermann's duties by the board of
directors, Mr. Devermann may provide 30 days notice of the termination of his
employment and will be entitled to his entire unpaid base salary for a period of
one year from the date of termination.

CERTAIN TRANSACTIONS

TRANSACTIONS WITH DIRECTORS AND OFFICERS

In connection with our acquisition of XImage in January 1998, we borrowed
$700,000 from Imperial Bank. On September 18, 1998, we borrowed an additional
$500,000 from Imperial Bank which has been paid in full. The maturity date of
the outstanding balance of the $700,000 loan has been extended until March 3,
2000. Both of the loans were personally guaranteed by Mr. Miller, Mr. Wetherell
and Mr. Devermann, and by William E. Guthner, one of our former directors. In
consideration of these guarantees, we issued to each of Mr. Miller,
Mr. Wetherell, Mr. Devermann and Mr. Guthner 27,014 shares of common stock,
warrants to purchase 3,318 shares of common stock at $15.825 per share, and
warrants to purchase 2,370 shares of common stock at $7.91 per share. These
guarantees will be released upon payment of the outstanding loan from Imperial
Bank. We intend to pay this loan in full with the proceeds of this offering.

We have also entered into letter agreements with Mr. Miller, Mr. Wetherell
and Mr. Devermann which provides that, immediately upon the determination of the
initial public offering price of the units, we will grant them options to
purchase common stock at an exercise price equal to the initial public offering
price of the units, in return for services rendered. Under these agreements, we
are obligated to grant 64,000 options to Mr. Miller, 43,000 options to Mr.
Wetherell and 43,000 options to Mr. Devermann.

Mr. Miller loaned us $267,500 pursuant to the terms of a convertible note
dated June 15, 1995. This debt was incurred to meet working capital needs. The
note provides for quarterly payments of interest at an annual rate of 8%, with
the entire amount due and payable on June 15, 2000. The amount due under the
note may be converted, at Mr. Miller's election, into units comprised of shares
of Series B preferred stock and warrants to purchase common stock on the same
terms as sold to our current Series B preferred shareholders in a 1995 private
placement. If Mr. Miller converts the note, he will be entitled to any dividends
which accrue on the Series B preferred stock after the date of conversion but
not before.

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As of December 31, 1999, we have an outstanding debt of approximately
$33,000 to Patrick J. Downs, a director of the company, pursuant to the terms of
a convertible note dated June 15, 1995. This debt was incurred to meet working
capital needs. The note provides for quarterly payments of interest at an annual
rate of 8%, with the entire amount due and payable on June 15, 2000. The amount
due under the note may be converted, at Mr. Downs election, into units comprised
of shares of Series B preferred stock and warrants to purchase common stock on
the same terms as sold to our current Series B preferred shareholders in a 1995
private placement. If Mr. Downs converts the note, he will be entitled to any
dividends which accrue on the Series B preferred stock after the date of
conversion but not before.

We also have an outstanding debt of $55,000 to the Nossaman, Guthner,
Knox & Elliot Profit Sharing & Savings Plan dated April 1, 1969 for the benefit
of W.E. Guthner, Jr., our former director, pursuant to the terms of a promissory
note dated November 5, 1998. This debt was incurred to meet working capital
needs. The note provides for interest to accrue at the rate of 10% with a
payment of principal and interest which was due on January 31, 1999. This note
is secured by a security agreement granting a security interest in all of our
assets. The William Guthner Estate has not enforced its rights with respect to
repayment of the note. We intend to repay this obligation from the proceeds of
this offering.

We have entered into a letter agreement with Takenaka & Company LLC pursuant
to which Takenaka & Company has agreed to assist us in communicating with Atlus,
our largest shareholder. Pursuant to the terms of the letter agreement,
Takenaka & Company LLC will be compensated for its services on an hourly basis
ranging from $250 to $375 per hour depending on the level of experience of the
professional staff involved. Mr. Takenaka is the president of Takenaka & Company
LLC and one of our directors.

TRANSACTIONS WITH ATLUS CO., LTD.

Atlus Co., Ltd., a Japanese corporation, beneficially owns approximately 31%
of our common stock. In conjunction with an investment by Atlus in March of
1997, we entered into a securities purchase agreement and a license agreement
with Atlus. The license agreement is described in "Business--Intellectual
Property." The securities purchase agreement entitles Atlus to purchase, at the
end of each quarter until the date of an initial public offering of our common
stock, the number of warrants to purchase shares of common stock at $21.10 per
share which, if exercised, would result in Atlus owning 33 1/3% of our
outstanding common stock at the end of such quarter. The warrants granted to
Atlus would be exercisable for a period of five years after their date of
issuance. Atlus has not purchased any warrants under the securities purchase
agreement.

The securities purchase agreement also grants to Atlus a right of first
refusal to participate, on a pro rata basis, in future securities offerings, and
the right to approve of:

- any changes to our articles of incorporation,

- our obtaining a controlling interest in any other entity,

- the sale of any of our intellectual property,

- any change in the nature of our business, or

- the encumbrance of any of our material assets.

The securities purchase agreement with Atlus will be terminated effective upon
the completion of this offering.

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TRANSACTION WITH PRESIDENT OF ATLUS

Naoya Harano, the president of Atlus, loaned $1,250,000 to us pursuant to
the terms of a convertible promissory note dated November 10, 1999. The
convertible promissory note provides for payment upon the earlier of
February 10, 2001 or five days after the completion of this offering. The
repayment of the debt is in United States dollars, but the amount to be repaid
will be adjusted based upon the change in the exchange rate between the United
States dollar and the Japanese yen between the date of the promissory note and
the date of repayment. Changes in the value of the yen relative to the U.S.
dollar could cause currency transaction gains or losses. We may experience
significant currency exchange transaction losses when it is time to repay such
loan. To date, we have not hedged this loan transaction to protect us from risks
associated with foreign currency fluctuations.

If the convertible promissory note is not paid before April 1, 2000, the
holder may convert the outstanding balance due into our common stock at $1.00
per share. The amount due under the convertible promissory note accrues interest
at the rate of 10% per year. In connection with this loan, Mr. Harano received
warrants to purchase 125,000 shares of our common stock exercisable at $6.00 per
share. The note has been recorded net of a discount equal to the fair value
allocated to the warrants issued of approximately $361,000, which will be
amortized over the life of the note. These warrants are exercisable at any time
after January 1, 2001 and before November 10, 2004.

All future material transactions between us and our affiliates, including
loans and forgiveness of loans, will be made or entered into on terms that are
no less favorable to the company than those that can be obtained from
unaffiliated third parties. In addition, these future transactions will be
approved by a majority of our independent directors who do not have an interest
in the transaction and who have access to legal counsel at our expense.

All previous material transactions between us and our affiliates were
ratified by a majority of our independent directors who did not have an interest
in the transaction and who had access to legal counsel at our expense. There
were at least two independent directors on our board at the time of all such
transactions.

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SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of our common stock as of February 29, 2000, and as adjusted to
reflect the sale of 1,875,000 units in this offering, by:

- each person or group of affiliated persons known to be the beneficial
owner of more than 5% of our outstanding common stock,

- each of our directors,

- each our executive officers, and

- all of our directors and executive officers as a group.

As of such date, there were 1,161,802 shares of common stock outstanding
before giving effect to the sale of units in the offering. The Company believes
that, except as otherwise listed below, each named beneficial owner has sole
voting and investment power with respect to the shares listed.

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PERCENT OF SHARES
BENEFICIALLY OWNED
------------------------
NUMBER OF SHARES BEFORE THIS AFTER THIS
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIALLY OWNED OFFERING OFFERING
---------------------------------------- ------------------ ----------- ----------

Atlus Co., Ltd.......................................... 365,116(2) 30.7% 11.9%
S. James Miller, Jr..................................... 184,054(3) 15.1% 5.9%
R Squared Limited(4) ................................... 120,943 10.4% 4.0%
c/o Royal Bank of Canada Trust Co.
P.O. Box 1856
Cardinal Avenue, George Town, Grand Cayman
Cayman Islands, B.W.I.
Wayne G. Wetherell...................................... 56,398(5) 4.7% 1.8%
Paul J. Devermann....................................... 53,649(6) 4.5% 1.8%
Patrick J. Downs........................................ 61,426(7) 5.3% 2.0%
John L. Holleran........................................ 10,332(8) 0.9% 0.3%
Yukuo Takenaka.......................................... 4,076(9) 0.3% 0.1%
369,935(10) 28.7% 11.9%
All directors and executive officers as a group (6
persons)..............................................

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

(1) Unless otherwise indicated, the address of each person in this table is c/o
ImageWare Systems, Inc., 10833 Thornmint Road, San Diego, California 92127.

(2) Includes 26,540 shares subject to warrants that are exercisable within
60 days. Atlus Co., Ltd. is a Japanese company publicly traded in Japan.

(3) Includes 60,663 shares subject to options, warrants or convertible
securities that are exercisable or convertible within 60 days, and 9,479
shares held by members of Mr. Miller's immediate family.

(4) R Squared Limited is owned by a private trust whose ultimate beneficiary is
the International Red Cross.

(5) Includes 26,635 shares subject to options or warrants that are exercisable
within 60 days.

(6) Includes 26,635 shares subject to options or warrants that are exercisable
within 60 days.

(7) Includes 7,397 shares subject to options or convertible securities that are
exercisable or convertible within 60 days.

(8) Includes 2,370 shares subject to options that are exercisable within
60 days.

(9) Includes 3,507 shares subject to options that are exercisable or convertible
within 60 days.

(10) Includes 127,207 shares subject to options, warrants or convertible
securities that are exercisable or convertible within 60 days.

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DESCRIPTION OF SECURITIES

Upon completion of the offering, our authorized capital stock will consist
of (1) 50,000,000 authorized shares of common stock, $0.01 par value, and
(2) 4,000,000 authorized shares of preferred stock, $0.01 par value, of which
there will be 3,036,802 shares of common stock and 389,400 shares of preferred
stock outstanding. The following description of our capital stock is a summary
and is qualified by the provisions of our amended and restated articles of
incorporation and our bylaws, copies of which have been filed as exhibits to the
registration statement.

UNITS

Each unit consists of one share of common stock and one public warrant to
purchase an additional share of common stock. The common stock and warrants will
trade only as a unit for at least 30 days following this offering. Paulson
Investment Company, Inc. will then determine when the units separate, after
which the common stock and the public warrants will trade separately.

COMMON STOCK

Holders of our common stock are entitled to one vote for each share on all
matters submitted to a shareholder vote and, in the election of directors, may
upon proper notice cumulate their votes and cast them for one or more directors.
Holders of common stock are entitled to share in dividends that the board of
directors, in its discretion, declares from legally available funds. In the
event of the liquidation or dissolution of the company, each outstanding share
entitles its holder to a proportionate share of all assets that remain after
payment of liabilities subject to the rights of any outstanding preferred stock.

Holders of our common stock have no conversion, preemptive or other
subscription rights, and there are no redemption provisions applicable to our
common stock. The rights of the holders of common stock are subject to the
rights of holders of preferred stock. All outstanding shares of common stock
are, and the shares underlying all options and public warrants will be, duly
authorized, validly issued, fully paid and non-assessable upon our issuance of
such shares.

PREFERRED STOCK

Our amended and restated articles of incorporation provide for the issuance
of up to 750,000 shares of Series B preferred stock. As of the date of this
prospectus, there are 389,400 outstanding shares of Series B preferred stock.
The Series B preferred stock have rights and preferences which are superior to
the rights of the holders of our common stock. These rights and preferences
include the right to receive a cumulative cash dividend at the rate of $0.2125
per share per year, a preference in the distribution of our assets over the
holders of common stock in event of the liquidation or dissolution of the
company, the right to convert to shares of common stock, and the right to elect
a director in the event we are in default of the provisions of the amended and
restated articles of incorporation with respect to the Series B preferred stock.
Subject to certain limitations prescribed by law and the rights and preferences
of the Series B preferred stock, our board of directors is authorized from time
to time to issue up to an aggregate of 3,610,600 shares of our preferred stock.

Each new series of preferred stock may have different rights and preferences
that may be established by our board of directors. The rights and preferences of
future series of preferred stock may include:

- number of shares to be issued;

- dividend rights and dividend rates;

- right to convert the preferred stock into a different type of security;

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- voting rights attributable to the preferred stock;

- right to receive preferential payments upon a liquidation of the company;

- right to set aside a certain amount of assets for payments relating to the
preferred stock; and

- prices to be paid upon redemption of the preferred stock.

PUBLIC WARRANTS

GENERAL

Each public warrant entitles the holder to purchase one share of our common
stock at an exercise price per share of 120% of the initial public offering
price of the units during the first year after the offering and 150% of the
initial public offering price of the units thereafter. The exercise price is
subject to adjustment upon the occurrence of certain events as provided in the
public warrant certificate and summarized below. Our public warrants may be
exercised at any time during the period commencing 30 days after this offering
and ending on the fifth anniversary date of the closing of the offering, which
is the expiration date. Those of our public warrants which have not previously
been exercised will expire on the expiration date. A public warrant holder will
not be deemed to be a holder of the underlying common stock for any purpose
until the public warrant has been properly exercised.

SEPARATE TRANSFERABILITY

Our public warrants will trade only as a unit for a period of at least 30
days following this offering. Paulson Investment Company, Inc. will then
determine when the units separate, after which the common stock and the public
warrants will trade separately.

REDEMPTION

We have the right, commencing six months after the closing of this offering,
to redeem the public warrants issued in the offering at a redemption price of
$0.25 per public warrant after providing 30 days prior written notice to the
public warrant holders, if the average closing bid price of the common stock
equals or exceeds 200% of the initial public offering price of the units for ten
consecutive trading days ending prior to the date of the notice of redemption.
We will send the written notice of redemption by first class mail to public
warrant holders at their last known addresses appearing on the registration
records maintained by the transfer agent for our public warrants. No other form
of notice or publication or otherwise will be required. If we call the public
warrants for redemption, they will be exercisable until the close of business on
the business day next preceding the specified redemption date.

EXERCISE

A public warrant holder may exercise our public warrants only if an
appropriate registration statement is then in effect with the Securities and
Exchange Commission and if the shares of common stock underlying our public
warrants are qualified for sale under the securities laws of the state in which
the holder resides.

Our public warrants may be exercised by delivering to our transfer agent the
applicable public warrant certificate on or prior to the expiration date or the
redemption date, as applicable, with the form on the reverse side of the
certificate executed as indicated, accompanied by payment of the full exercise
price for the number of public warrants being exercised. Fractional shares will
not be issued upon exercise of our public warrants.

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ADJUSTMENTS OF EXERCISE PRICE

The exercise price is subject to adjustment if we declare any stock dividend
to shareholders or effect any split or share combination with respect to our
common stock. Therefore, if we effect any stock split or stock combination with
respect to our common stock, the exercise price in effect immediately prior to
such stock split or combination will be proportionately reduced or increased, as
the case may be. Any adjustment of the exercise price will also result in an
adjustment of the number of shares purchasable upon exercise of a public warrant
or, if we elect, an adjustment of the number of public warrants outstanding.

PRIOR WARRANTS

As of the date of this prospectus, we had issued and outstanding warrants to
purchase 328,662 shares of our common stock at a weighted average exercise price
of $9.34, the forms of which have been filed as exhibits to the registration
statement. These warrants include warrants issued to Imperial Bank to purchase
13,586 shares of our common stock. These warrants grant to Imperial Bank the
right to require us to purchase such warrants from Imperial Bank for $70,000 on
or after January 15, 2001 or within 20 days after a merger, consolidation or
sale of assets of the company or the liquidation, dissolution or winding up of
the company. No issued and outstanding warrants are exercisable more than five
years from the date of this offering.

REGISTRATION RIGHTS

GENERAL

We have granted certain registration rights with respect to 505,176 of our
securities. We will pay for all expenses incurred in connection with these
registrations, other than underwriting discounts and commissions. The following
is only a summary of certain of the terms and conditions of the agreements
involving parties which have registration rights. Copies of the actual
agreements have been filed with the Securities and Exchange Commission as
exhibits to the registration statement. Holders of registration rights with
respect to 441,312 of our securities have waived such registration rights for at
least six months following the completion of this offering.

GRANTED TO THE SERIES B PREFERRED SHAREHOLDERS IN A 1995 PRIVATE PLACEMENT

We granted demand and incidental registration rights to our Series B
preferred shareholders with respect to the shares underlying the Series B
preferred shares and warrants issued to them in connection with the 1995 private
placement of our Series B units. Holders of Series B preferred shares may demand
to have our common stock underlying their Series B preferred shares registered
at any time after completion of this offering and before April 30, 2000. The
Series B warrants have expired. Additionally, if we register an issuance of any
of our equity securities, other than shares issuable under employee stock option
plans, at any time prior to April 30, 2000, the Series B preferred shareholders
may request that such underlying common stock be included in the registration.
However, holders of Series B preferred shares convertible, as of February 29,
2000, into 67,675 shares of common stock agreed to waive such registration
rights for six months following completion of this offering.

GRANTED TO ATLUS

We also granted demand and incidental registration rights to Atlus with
respect to all shares held by Atlus pursuant to the securities purchase
agreement with Atlus. The securities purchase agreement with Atlus will be
terminated effective upon the completion of this offering.

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GRANTED TO FORMER XIMAGE SHAREHOLDERS

The former XImage shareholders have also been granted demand and incidental
registration rights with respect to 71,090 shares underlying the warrants held
by them. The holders of a majority of all registrable securities owned by these
shareholders may demand registration for the resale of any or all of their
shares at any time after this offering and before November 30, 2003.
Additionally, if we register an issuance of our equity securities, other than
shares issuable under our employee stock option plans at any time prior to
November 30, 2003, these holders may request to include their shares in the
registration. However, holders of warrants with respect to 53,341 shares
underlying the warrants agreed to waive such registration rights for one year
following the completion of this offering.

GRANTED TO FORMER XIMAGE OFFICERS, NOTEHOLDERS AND OTHER INVESTORS

We have also granted certain former XImage officers, noteholders and other
investors "piggyback" registration rights under which they can request to be
included in a registration of our securities, other than a registration of
shares issuable under an employee stock option plan.

GRANTED TO OFFICERS, DIRECTORS AND OTHER PARTIES

Mr. Miller, Mr. Wetherell, Mr. Devermann and the William Guthner estate have
the same registration rights as the former XImage Shareholders described above.
Mr. Miller, Mr. Wetherell and Mr. Devermann have agreed not to make a demand for
registration for a period of at least one year after this offering.

Mr. Miller and Mr. Downs also have registration rights with respect to their
convertible promissory notes. These registration rights are identical to the
registration rights which have been granted to the Series B preferred
shareholders as described above.

William Guthner and related parties converted their convertible promissory
notes in December 1997 into shares of Series B preferred stock and warrants to
purchase common stock. The registration rights granted to these parties, which
apply to the shares and warrants they received upon conversion of their
convertible notes, are identical to the registration rights which have been
granted to the Series B preferred shareholders as described above.

GRANTED TO IMPERIAL BANK

In January 1998 and September 1998, in connection with the credit line
extended to us, we granted demand and incidental registration rights to Imperial
Bank with respect to shares of common stock underlying the warrants held by
Imperial Bank. Imperial Bank has the same registration rights as the Series B
preferred shareholders in the 1995 private placement described above. Imperial
Bank has agreed not to make a demand for registration for a period of at least
one year after this offering.

GRANTED TO PAULSON AND I-BANKERS

We have entered into a warrant agreement with Paulson Investment
Company, Inc. and I-Bankers Securities, Inc. as representatives of the
underwriters of this offering. These representatives' warrants, as well as the
shares of common stock and warrants included in the units issuable upon exercise
of the representatives' warrants, are being registered on the registration
statement. We will cause the registration statement to remain effective until
the earlier of the time that all of the representatives' warrants have been
exercised and the date which is five years after the effective date of the
offering. The common stock and warrants issued to the representatives upon
exercise of these warrants will be freely tradable. All expenses incurred in
connection with the registration of the shares of common stock and warrants
included in the units issuable upon the exercise of the representatives'
warrants will be borne by us. Under the warrant agreement, the parties will also
be bound by standard indemnification

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and contribution provisions with respect to the registration of the warrant
shares issuable upon the exercise of the representatives' warrants.

GRANTED TO R SQUARED LIMITED

In connection with a loan made to us, R Squared Limited has also been
granted the right to include their shares in any registration made by us. R
Squared Limited has agreed to waive such registration rights for one year
following the completion of this offering.

GRANTED TO THE PRESIDENT OF ATLUS

In connection with a loan made to us, Mr. Harano has been issued warrants to
purchase common stock. Mr. Harano has been granted the same demand and
incidental registration rights with respect the common stock underlying these
warrants as we have granted to the former XImage shareholders. Mr. Harano has
agreed to waive such registration rights for one year following the completion
of this offering.

TRANSFER AGENT AND PUBLIC WARRANT AGENT

The transfer agent for our common stock, units and public warrants is
American Securities Transfer & Trust, Inc., Denver, Colorado.

SHARES ELIGIBLE FOR FUTURE SALE

THIS OFFERING

Upon completion of the offering, we expect to have 3,036,802 shares of
common stock outstanding, assuming no exercise of outstanding options or
warrants, or 3,318,052 shares if the over-allotment is exercised in full. Of
these shares, the 1,875,000 shares of common stock issued as part of the units
sold in the offering will be freely tradeable without restrictions or further
registration under the Securities Act of 1933, except that any shares purchased
by our "affiliates", as that term is defined under the Securities Act, may
generally only be sold in compliance with the limitations of Rule 144 under the
Securities Act. The 1,875,000 shares of common stock underlying the public
warrants issued as part of the units sold in this offering will also be freely
tradeable, except for shares purchased by our affiliates. As of the date of this
prospectus, there are approximately 104 holders of our common stock.

OUTSTANDING RESTRICTED STOCK

The remaining 1,161,802 outstanding shares of common stock are restricted
securities within the meaning of Rule 144 and may not be sold in the absence of
registration under the Securities Act unless an exemption from registration is
available, including the exemption from registration offered by Rule 144.
Holders of 916,263 of our outstanding restricted shares of common stock have
agreed not to sell or otherwise dispose of any of their shares of common stock
for a period of one year after completion of the offering, without the prior
written consent of Paulson Investment Company, Inc., subject to certain limited
exceptions. Prior to the expiration of this lock-up period, 245,539 shares of
our outstanding restricted common stock may be sold in the public market
pursuant to Rule 144. After the expiration of this lock-up period, or earlier
with the prior written consent of Paulson Investment Company, Inc., all
1,161,802 of these outstanding restricted shares may be sold in the public
market pursuant to Rule 144.

In general, under Rule 144, as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned restricted
shares for at least one year, including a person who may be deemed to be our
affiliate, may sell within any three-month period a number of shares of common
stock that does not exceed a specified maximum number of shares. This maximum is
equal to the greater of 1% of the then outstanding shares of our common stock or
the average weekly

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trading volume in the common stock during the four calendar weeks immediately
preceding the sale. Sales under Rule 144 are also subject to restrictions
relating to manner of sale, notice and availability of current public
information about us. In addition, under Rule 144(k) of the Securities Act, a
person who is not our affiliate, has not been an affiliate of ours within three
months prior to the sale and has beneficially owned shares for at least two
years would be entitled to sell such shares immediately without regard to volume
limitations, manner of sale provisions, notice or other requirements of
Rule 144.

SERIES B PREFERRED STOCK

As of February 29, 2000, we had 389,400 shares of Series B preferred stock
outstanding. These shares, plus accrued but unpaid dividends, are convertible at
the option of the holders into an aggregate of approximately 88,314 shares of
our common stock. Any shares issued upon the conversion of the Series B
preferred stock will be eligible for sale pursuant to Rule 144, except that
298,400 of these shares are subject to lockup agreements for a period of six
months after the completion of this offering.

OPTIONS

Beginning 90 days after the date of this prospectus, certain shares issued
or issuable upon the exercise of options granted by us prior to the date of this
prospectus will also be eligible for sale in the public market pursuant to
Rule 701 under the Securities Act of 1933, except that 268,081 of these shares
are subject to the lock-up agreements for a period of one year after completion
of this offering. Pursuant to Rule 701, persons who purchase shares upon
exercise of options granted under a written compensatory plan or contract may
sell such shares in reliance on Rule 144 without having to comply with the
holding period requirements of Rule 144, and in the case of non-affiliates,
without having to comply with the public information, volume limitation or
notice provisions of Rule 144. As of February 29, 2000, we had options
outstanding to purchase 276,611 shares of common stock which have not been
exercised and which become exercisable at various times in the future. Any
shares issued upon the exercise of these options will be eligible for sale
pursuant to Rule 701.

We intend to file registration statements on Form S-8 under the Securities
Act to register approximately 7,962 shares of our common stock issuable under
our stock option plans. These registration statements are expected to be filed
within three to six months after the completion of this offering. Shares of
common stock registered under these registration statements will be available
for resale in the public market, subject to Rule 144 volume limitations
applicable to our affiliates and to the lock-up agreements which will be in
effect for a period of one year after the completion of this offering.

WARRANTS

As of February 29, 2000, we had warrants outstanding to purchase 328,662
shares of common stock which have not been exercised and which become
exercisable at various times in the future. Any shares issued upon the exercise
of these warrants will be eligible for sale pursuant to Rule 144, except that
278,193 of these shares are subject to the lock-up agreements for a period of
one year after the completion of this offering.

REPRESENTATIVES' WARRANTS

In connection with the offering, we have agreed to issue to the
representatives of the underwriters warrants to purchase 181,339 units. This
number is equal to 10% of the number of units being offered by this prospectus,
excluding over-allotment shares, less certain warrants previously granted to a
finder. The representatives' warrants will be exercisable into units at any time
during the four-year period

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commencing one year after the effective date of the offering. We will cause the
registration statement to remain effective until the earlier of the time that
all of the representatives' warrants have been exercised and the date which is
five years after the effective date of the offering. The common stock and
warrants issued to the representatives upon exercise of these warrants will be
freely tradable.

REGISTRATION RIGHTS

As of February 29, 2000, holders of approximately 505,176 shares of our
outstanding or issuable common stock had the right to include their shares in
registration statements relating to our securities or to require us to register
their shares. Holders of 441,312 of these shares, have agreed to waive these
registration rights for at least six months following the completion of this
offering or shorter as determined by Paulson Investment Company, Inc. Holders of
registration rights may cause the price of our common stock to fall by
exercising their registration rights and causing a large number of shares to be
registered and sold in the public market. In addition, any demand for future
registration of these shares could have a material adverse effect on our ability
to raise needed capital.

Prior to the offering, there has been no public market for our common stock
and there can be no assurance that a significant public market for the common
stock will develop or be sustained after the offering.

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UNDERWRITING

Paulson Investment Company, Inc. and I-Bankers Securities, Inc. are acting
as representatives of the underwriters. We and the underwriters named below have
entered into an underwriting agreement with respect to the units being offered.
In connection with this offering and subject to certain conditions, each of the
underwriters named below has severally agreed to purchase, and we have agreed to
sell, the number of units set forth opposite the name of each underwriter.

[Download Table]

UNDERWRITERS NUMBER OF UNITS
------------ ---------------

Paulson Investment Company, Inc............................. 1,400,000
I-Bankers Securities, Inc................................... 300,000
marion bass securities corporation.......................... 175,000
---------
Total..................................................... 1,875,000

The underwriting agreement provides that the underwriters are obligated to
purchase all of the units offered by this prospectus, other than those covered
by the over-allotment option, if any units are purchased. The underwriting
agreement also provides that the obligations of the several underwriters to pay
for and accept delivery of the units are subject to the approval of certain
legal matters by counsel and certain other conditions. These conditions include
the requirements that no stop order suspending the effectiveness of the
registration statement be in effect and that no proceedings for such purpose
have been instituted or threatened by the Securities and Exchange Commission.

The representatives have advised us that the underwriters propose to offer
our units to the public initially at the offering price set forth on the cover
page of this prospectus and to selected dealers at such price less a concession
of not more than $0.32 per unit. The underwriters and selected dealers may
reallow a concession to other dealers, including the underwriters, of not more
than $0.10 per unit. After completion of the initial public offering of the
units, the offering price, the concessions to selected dealers and the
reallowance to their dealers may be changed by the underwriters.

The underwriters have informed us that they do not expect to confirm sales
of our units offered by this prospectus to any accounts over which they exercise
discretionary authority.

OVER-ALLOTMENT OPTION

Pursuant to the underwriting agreement, we have granted Paulson Investment
Company, Inc. an option, exercisable for 45 days from the date of this
prospectus, to purchase up to an additional 281,250 units on the same terms as
the units being purchased by the underwriters from us. Paulson Investment
Company, Inc. may exercise the option solely to cover over-allotments, if any,
in the sale of the units that the underwriters have agreed to purchase. If the
over-allotment option is exercised in full, the total public offering price,
underwriting discounts and commissions, and proceeds to the company before
offering expenses will be $17,250,000, $1,250,625 and $15,999,375, respectively.

STABILIZATION

Until the distribution of the units offered by this prospectus is completed,
rules of the Securities and Exchange Commission may limit the ability of the
underwriters to bid for and purchase units. As an exception to these rules, the
underwriters may engage in transactions that stabilize the price of the units.
Paulson Investment Company, Inc., on behalf of the underwriters, may engage in
over-allotment sales, stabilizing transactions, syndicate covering transactions
and penalty bids in accordance with Regulation M under the Securities Exchange
Act of 1934.

- Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.

- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.

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- Syndicate covering transactions involve purchases of the common stock and
public warrants in the open market after the distribution has been
completed in order to cover syndicate short positions. The underwriters
may also elect to reduce any short position by exercising all or part of
the over-allotment option to purchase additional units as described above.

- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the units originally sold by the syndicate
member are purchased in a syndicate covering transaction to cover
syndicate short positions.

In general, the purchase of a security to stabilize or to reduce a short
position could cause the price of the security to be higher than it might be
otherwise. These transactions may be effected on the American Stock Exchange or
otherwise. Neither we nor the underwriters can predict the direction or
magnitude of any effect that the transactions described above may have on the
price of the units. In addition, neither we nor the underwriters can represent
that the underwriters will engage in these types of transactions or that these
types of transactions, once commenced, will not be discontinued without notice.

INDEMNIFICATION

The underwriting agreement provides for indemnification between us and the
underwriters against specified liabilities, including liabilities under the
Securities Act, and for contribution by us and the underwriters to payments that
may be required to be made with respect to those liabilities. We have been
advised that, in the opinion of the Securities and Exchange Commission,
indemnification for liabilities under the Securities Act of 1933 is against
public policy as expressed in the Securities Act and is therefore unenforceable.

UNDERWRITERS' COMPENSATION

We have agreed to sell the units to the underwriters at the initial offering
price of $8.00, less the 7.25% underwriting discount. The underwriting agreement
also provides that upon the closing of the sale of the units offered, Paulson
Investment Company, Inc. will be paid a nonaccountable expense allowance equal
to two percent of the gross proceeds from the sale of the units offered by this
prospectus, including the over-allotment option.

We have also agreed to issue warrants to the representatives to purchase
from us up to 181,339 units at an exercise price per unit equal to 120% of the
offering price per unit. These warrants are exercisable during the four-year
period beginning one year from the date of effectiveness of the registration
statement. These warrants, and the securities underlying the warrants, are not
transferable for one year following the effective date of the registration,
except to an individual who is an officer or partner of an underwriter, by will
or by the laws of descent and distribution, and are not redeemable. These
warrants will have registration rights. We will cause the registration statement
to remain effective until the earlier of the time that all of the
representatives' warrants have been exercised and the date which is five years
after the effective date of the offering. The common stock and warrants issued
to the representatives upon exercise of these warrants will be freely tradable.

The holders of the representatives' warrants will have, in that capacity, no
voting, dividend or other shareholder rights. Any profit realized by the
representatives on the sale of the securities issuable upon exercise of the
representatives' warrants may be deemed to be additional underwriting
compensation. The securities underlying the representatives' warrants are being
registered on the registration statement. During the term of the
representatives' warrants, the holders thereof are given the opportunity to
profit from a rise in the market price of our common stock. We may find it more
difficult to raise additional equity capital while the representatives' warrants
are outstanding. At any time at which the representatives' warrants are likely
to be exercised, we may be able to obtain additional equity capital on more
favorable terms.

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LOAN BY CHESTER PAULSON

Chester L.F. Paulson, the chairman and indirect majority shareholder of
Paulson Investment Company, Inc., loaned $500,000 to us pursuant to a promissory
note and loan agreement dated November 24, 1999. Mr. Paulson has borrowed the
$500,000 which he has loaned to us from U.S. Bank National Association. Paulson
Investment Company, Inc. has agreed to indemnify Mr. Paulson against any default
by us. We are paying Paulson Investment Company, Inc. a $75,000 loan fee.

We must repay the loan to Mr. Paulson upon the earlier of a demand for
payment by U.S. Bank, the completion of this offering, or April 3, 2000. If this
offering is not completed, we must offer to pay Paulson Investment
Company, Inc. from the proceeds of any other financing in excess of $575,000
which we complete prior to December 31, 2000. The amount due under the
promissory note accrues interest at the same variable rate of interest which
Mr. Paulson must pay U.S. Bank, which is based on the prime lending rate. The
initial interest rate is 9%.

LOCK-UP AGREEMENT

Our officers and directors have agreed that for a period of one year, and
certain of our shareholders have agreed for a period of at least six months,
from the date this registration statement becomes effective that they will not
sell, contract to sell, grant any option for the sale or otherwise dispose of
any of our equity securities, or any securities convertible into or exercisable
or exchangeable for our equity securities, other than through intra-family
transfers or transfers to trusts for estate planning purposes, without the
consent of Paulson Investment Company, Inc., as a representative of the
underwriters, which consent will not be unreasonably withheld.

EXPENSES

The following table sets forth an itemization of all expenses we will pay in
connection with the issuance and distribution of the securities being
registered. Except for the SEC registration fee, the NASD filing fee and The
American Stock Exchange listing fee, the amounts listed below are estimates:

[Download Table]

NATURE OF EXPENSE AMOUNT
----------------- --------

SEC registration fee........................................ $ 15,525
NASD filing fees............................................ 6,381
The American Stock Exchange listing fee..................... 38,000
Accounting fees and expenses................................ 200,000
Legal fees and expenses..................................... 300,000
Director and officer insurance expenses..................... 85,000
Printing and related expenses............................... 170,000
Blue sky legal fees and expenses............................ 65,000
Transfer agent fees and expenses............................ 1,250
Miscellaneous expenses...................................... 25,044
--------
TOTAL..................................................... $906,200

In addition, we have been advised that Paulson Investment Company, Inc. will
pay $50,000 to J. Michael Reisert for services as a finder in connection with
the offering. This payment, payable only if the offering is completed, is the
customary fee paid to a third party who introduces a company to an underwriter.

DETERMINATION OF OFFERING PRICE

Before this offering, there has been no public market for the units and the
common stock and public warrants contained in the units. Accordingly, the
initial public offering price of the units offered by this prospectus and the
exercise price of the public warrants were determined by negotiation

424B1 51st Page of 71 TOC 1st Previous Next ↓Bottom Just 51st
between us and the underwriters. Among the factors considered in determining the
initial public offering price of the units and the exercise price of the public
warrants were:

- our history and our prospects,

- the industry in which we operate,

- the status and development prospects for our proposed products and
services,

- our past and present operating results,

- the previous experience of our executive officers, and

- the general condition of the securities markets at the time of this
offering.

The offering price stated on the cover page of this prospectus should not be
considered an indication of the actual value of the units. That price is subject
to change as a result of market conditions and other factors, and we cannot
assure you that the units, or the common stock and public warrants contained in
the units, can be resold at or above the initial public offering price.

LEGAL MATTERS

The validity of the securities being offered hereby will be passed upon on
our behalf by Luce, Forward, Hamilton & Scripps LLP, 600 West Broadway, Suite
2600, San Diego, CA 92101. Certain legal matters will be passed upon for the
underwriters by Tonkon Torp LLP, 1600 Pioneer Tower, 888 SW Fifth Avenue,
Portland, Oregon 97204.

EXPERTS

The financial statements for the years ended December 31, 1999 and 1998
included in this prospectus have been included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.

AVAILABLE INFORMATION

We have filed a registration statement on Form SB-2 under the Securities Act
with the Securities and Exchange Commission with respect to the units offered
hereby. This prospectus does not contain all of the information contained in the
registration statement and the exhibits to the registration statement.
Statements made in this prospectus concerning any contracts, agreements or
documents are not necessarily complete. We refer you to the copies of these
contracts, agreements and documents filed as exhibits to the registration
statement. These statements are qualified in all respects by this reference to
these exhibits.

The registration statement and the exhibits and schedules thereto filed with
the Securities and Exchange Commission may be inspected by you at the Securities
and Exchange Commission's principal office in Washington, D.C. Copies of all or
any part of the registration statement may be obtained from the Public Reference
Section of the Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the commissions' regional offices located at
Seven World Trade Center, 13(th)Floor, New York, New York 10048 and 500 West
Madison Street, Suite 11400, Chicago, Illinois 60661. The commission also
maintains a website (http://www.sec.gov) that contains reports, proxy statements
and information statements and other information regarding registrants that file
electronically with the Commission. For further information pertaining to us and
the units offered by this prospectus, reference is made to the registration
statement.

We intend to furnish our shareholders with annual reports containing
financial statements audited by our independent accountants.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

[Download Table]

PAGE
--------

IMAGEWARE SYSTEMS, INC.:

Report of Independent Accountants........................... F-2

Consolidated Balance Sheets as of December 31, 1998 and
1999...................................................... F-3

Consolidated Statements of Operations for the Years Ended
December 31, 1998 and 1999................................ F-4

Consolidated Statements of Shareholders' Equity (Deficit)
for the Years Ended December 31, 1998 and 1999............ F-5

Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998 and 1999................................ F-6

Notes to Consolidated Financial Statements.................. F-7

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors of
ImageWare Systems, Inc.

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
ImageWare Systems, Inc. and its subsidiary at December 31, 1998 and 1999 and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a negative working capital that raises substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

PricewaterhouseCoopers LLP

San Diego, California
February 25, 2000

F-2

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IMAGEWARE SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1998 AND 1999

[Enlarge/Download Table]

1998 1999
------------ ------------

ASSETS

Current assets
Cash...................................................... $ 45,793 $ 156,063
Accounts receivable, net.................................. 931,654 2,919,857
Inventories............................................... 43,386 112,250
Other current assets...................................... 256,838 183,062
------------ ------------
Total current assets.................................. 1,277,671 3,371,232
Property and equipment, net................................. 269,594 191,798
Intangible assets, net of accumulated amortization of
$1,190,183 in 1998 and $2,172,888 in 1999................. 2,836,740 2,346,557
------------ ------------
$ 4,384,005 $ 5,909,587
============ ============

LIABILITIES AND SHAREHOLDERS' DEFICIT

Current liabilities
Accounts payable.......................................... $ 1,030,716 $ 1,624,940
Deferred revenue.......................................... 421,351 853,003
Accrued expenses.......................................... 1,342,901 2,226,876
Deferred compensation..................................... 261,015 294,330
Accrued interest.......................................... 300,440 437,244
Notes payable to bank..................................... 700,000 500,000
Notes payable to related parties.......................... 299,775 1,719,047
------------ ------------
Total current liabilities............................. 4,356,198 7,655,440
Notes payable to bank, net of current portion............... 500,000 --
Notes payable to related parties, net of current portion.... 973,172 924,542
------------ ------------
Total liabilities........................................... 5,829,370 8,579,982
------------ ------------
Commitments and contingencies

Shareholders' deficit
Preferred stock, $.01 par value, authorized
4,000,000 shares........................................
Series B convertible redeemable preferred stock,
designated 750,000 shares, 389,400 shares issued and
outstanding, $973,500 liquidation preference.......... 3,894 3,894
Common stock, $.01 par value, 50,000,000 shares
authorized, 899,081 and 1,161,802 shares issued and
outstanding............................................. 8,991 11,618
Additional paid-in capital................................ 14,792,783 16,599,720
Accumulated deficit....................................... (16,251,033) (19,285,627)
------------ ------------
Total shareholders' deficit........................... (1,445,365) (2,670,395)
------------ ------------
$ 4,384,005 $ 5,909,587
============ ============

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

F-3

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IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

[Enlarge/Download Table]

1998 1999
----------- -----------

REVENUES
Product................................................... $ 2,708,856 $ 4,276,201
Maintenance............................................... 1,307,286 1,404,709
License and other......................................... 220,175 210,567
----------- -----------
4,236,317 5,891,477
COST OF REVENUES
Product................................................... 1,354,920 1,896,916
Maintenance............................................... 1,065,740 862,816
----------- -----------
Gross margin............................................ 1,815,657 3,131,745
----------- -----------
Operating, general and administrative expenses.............. 2,265,312 2,531,079
Sales and marketing expenses................................ 960,246 1,024,224
Research and development expenses........................... 831,034 1,150,914
Depreciation and amortization............................... 988,838 1,096,484
----------- -----------
5,045,430 5,802,701
----------- -----------
Loss from operations.................................... (3,229,773) (2,670,956)
----------- -----------
Interest expense, net....................................... 204,287 363,638
----------- -----------
Loss before income taxes................................ (3,434,060) (3,034,594)
----------- -----------
Provision for income taxes.................................. -- --
----------- -----------
Net loss................................................ $(3,434,060) $(3,034,594)
=========== ===========
Net loss per common share (see Note 2)...................... $ (4.08) $ (3.07)
=========== ===========
Basic and diluted common shares............................. 861,875 1,016,399
=========== ===========

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

F-4

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IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

[Enlarge/Download Table]

SERIES B
CONVERTIBLE,
REDEEMABLE
PREFERRED COMMON STOCK ADDITIONAL
------------------- -------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
-------- -------- --------- -------- ----------- ------------ -----------

Balance at December 31,
1997................... 389,400 $3,894 845,163 $ 8,452 $14,296,302 $(12,816,973) $ 1,491,675
Issuance of common stock
for loan guarantees.... -- -- 44,866 449 359,571 -- 360,020
Issuance of common stock
for payment of Board
fees................... -- -- 10,236 102 161,898 -- 162,000
Repurchase of shares..... -- -- (1,184) (12) (24,988) -- (25,000)
Net loss................. -- -- -- -- -- (3,434,060) (3,434,060)
------- ------ --------- ------- ----------- ------------ -----------
Balance at December 31,
1998................... 389,400 3,894 899,081 8,991 14,792,783 (16,251,033) (1,445,365)
Issuance of common stock
for loan guarantees.... -- -- 73,466 735 348,044 -- 348,779
Issuance of common stock
for cash............... -- -- 47,393 473 374,527 -- 375,000
Conversion of note
payable to common
stock.................. -- -- 141,862 1,419 738,290 -- 739,709
Financing commission..... -- -- -- -- (15,000) -- (15,000)
Detachable warrants
issued with debt....... -- -- -- -- 361,076 -- 361,076
Net loss................. -- -- -- -- -- (3,034,594) (3,034,594)
------- ------ --------- ------- ----------- ------------ -----------
Balance at December 31,
1999................... 389,400 $3,894 1,161,802 $11,618 $16,599,720 $(19,285,627) $(2,670,395)
======= ====== ========= ======= =========== ============ ===========

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

F-5

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IMAGEWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

[Enlarge/Download Table]

1998 1999
----------- -----------

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................................. $(3,434,060) $(3,034,594)
Adjustments to reconcile net loss to net cash used by
operating activities
Depreciation and amortization........................... 988,838 1,096,484
Deferred revenue........................................ (431,271) 431,652
Noncash compensation and fees........................... 522,020 423,488
Change in assets and liabilities
Accounts receivable, net.............................. 40,482 (1,988,203)
Inventory............................................. 69,895 (68,864)
Other current assets.................................. 114,313 73,776
Other long-term assets................................ -- (492,883)
Accounts payable...................................... 292,320 594,224
Accrued expenses...................................... (165,925) 917,271
Accrued interest...................................... 61,344 168,902
----------- -----------
Total adjustments................................... 1,492,016 1,155,847
----------- -----------
Net cash used by operating activities............... (1,942,044) (1,878,747)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment........................ (68,991) (35,983)
Acquisition of business, net of cash acquired............. (2,129,331) --
----------- -----------
Net cash used by investing activities............... (2,198,322) (35,983)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal repayments on amounts due stockholders.......... -- (150,000)
Proceeds from issuance of stock........................... -- 375,000
Repurchase of common stock................................ (25,000) --
Proceeds from issuance of notes payable................... 1,905,000 2,500,000
Repayment of loans........................................ (3,700) (700,000)
----------- -----------
Net cash provided by financing activities........... 1,876,300 2,025,000
----------- -----------
Net increase (decrease) in cash..................... (2,264,066) 110,270
Cash at beginning of period................................. 2,309,859 45,793
----------- -----------
Cash at end of period............................... $ 45,793 $ 156,063
=========== ===========

SUPPLEMENTAL CASH FLOWS INFORMATION
Cash paid for interest.................................... $ 99,079 $ 141,930
=========== ===========
Conversion of notes payable to common stock............... $ -- $ 650,000
=========== ===========
Issuance of common stock to loan guarantors............... $ 360,020 $ 348,779
=========== ===========
Issuance of common stock for Board of Director's fees..... $ 162,000 $ --
=========== ===========

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

F-6

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1998 AND 1999

1. DESCRIPTION OF BUSINESS AND OPERATIONS

ImageWare Systems, Inc. (the "Company"), formerly known as ImageWare
Software, Inc., was incorporated in the State of California on February 6,
1987 for the purpose of developing, manufacturing and distributing products
utilizing electronic imaging technology. The Company has developed the Crime
Reduction, Image Management and Enhancement System ("CRIMES") and several
related products which are being marketed to law enforcement agencies
throughout the United States.

The Company has incurred losses of $3,434,060 and $3,034,594 for the years
ended December 31, 1998 and 1999, respectively. The Company also has
significant working capital deficiencies as of December 31, 1998 and 1999.

The Company operates in markets that are emerging and highly competitive.
Moreover, the Company's sales are typically concentrated in large orders
derived from a small base of customers and, accordingly, new orders, sales
levels and operating profits, if any, can and will fluctuate on a
quarter-by-quarter basis. There is no assurance that the Company will
operate at a profit in the future.

New financing will be required to fund working capital and operations. The
Company believes that additional financing will be available under terms and
conditions that are acceptable to the Company. However, there can be no
assurance that additional financing will be available. In the event
financing is not available in the time frame required, then the Company will
be forced to reduce its rate of sales growth, if any, reduce operating
expenses and reschedule research and development projects. In addition, the
Company might be required to sell certain of its assets or license its
technologies to others. These actions, while necessary for the continuance
of operations during a time of cash constraints and a shortage of working
capital, could adversely effect the Company's long-term business.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary which was acquired on January 26, 1998 (see
Note 3). All significant intercompany transactions and balances have been
eliminated.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 revenue and
expense during the reporting period. Actual results could differ from
estimates.

PROPERTY AND EQUIPMENT

Property and equipment, consisting of furniture and equipment, are stated at
cost and are being depreciated on a straight-line basis over the estimated
useful lives of the assets, which range from

F-7

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
three to five years. Maintenance and repairs are charged to expense as
incurred. Major renewals or improvements are capitalized. When assets are
sold or abandoned, the cost and related accumulated depreciation are removed
from the accounts and the resulting gain or loss is recognized.

Long-lived assets and identifiable intangibles are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. The Company has recorded no
impairment losses.

INTANGIBLE ASSETS

Intangible assets consist of patents and goodwill which are stated at cost.
Amortization is calculated using the straight-line method over five years
for patents and four years for goodwill.

CONCENTRATION OF CREDIT RISK

Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade accounts
receivable. Sales are typically made on credit and the Company generally
does not require collateral. The Company performs ongoing credit evaluations
of its customers' financial condition and maintains an allowance for
estimated potential losses. Accounts receivable are presented net of an
allowance for doubtful accounts of $10,000 and $28,517 at December 31, 1998
and 1999, respectively.

The Company had combined sales to two major customers which represented 30%
and 23% of total revenues for the years ended December 31, 1998 and 1999,
respectively.

As of December 31, 1998 and 1999, the Company had amounts due from three
major customers which represented 41% and 55%, respectively, of total
accounts receivable.

STOCK-BASED COMPENSATION

The Company measures compensation costs related to stock option plans using
the intrinsic value method and provides pro forma disclosures of net income
(loss) and earnings (loss) per common share as if the fair value based
method had been applied in measuring compensation costs. Accordingly,
compensation cost for stock options is measured as the excess, if any, of
the fair value of the Company's common stock at the date of measurement over
the amount an employee must pay to acquire the stock and is amortized over
the vesting period, generally three years.

INCOME TAXES

Current income tax expense or benefit is the amount of income taxes expected
to be payable or refundable for the current year. A deferred income tax
asset or liability is computed for the expected future impact of differences
between the financial reporting and tax bases of assets and liabilities and
for the expected future tax benefit to be derived from tax credits and loss
carryforwards. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized.

F-8

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION

The Company's revenue from periodic software license and maintenance
agreements is generally recognized ratably over the respective license
periods provided no significant obligations remain and collectibility of the
related receivable is probable. The Company's revenue from software and
hardware installation and implementation and from contract services is
generally recognized as the services are performed using the percentage of
completion method based on costs incurred to date compared to total
estimated costs at completion. Amounts received under contracts in advance
of performance are recorded as deferred revenue and are generally recognized
within one year from receipt. Contract losses are recorded as a charge to
income in the period such losses are first identified. Unbilled accounts
receivable are stated at estimated realizable value. Revenue from contract
services for which the Company cannot reliably estimate total costs are
recognized upon completion.

Revenue from royalties is recognized in the period earned.

CAPITALIZED SOFTWARE COSTS

Software development costs incurred prior to the establishment of
technological feasibility are charged to research and development expense as
incurred. Technological feasibility is established upon completion of a
working model. Software development costs incurred subsequent to the time a
product's technological feasibility has been established, through the time
the product is available for general release to customers, are capitalized
if material. To date, the Company has not capitalized any software costs as
the period between achieving technological feasibility and the general
availability of the related products has been short and software development
costs qualifying for capitalization have been insignificant.

EARNINGS PER COMMON SHARE

Effective November 29, 1999, the Company declared a 5.275-for-1 reverse
stock split of common stock. All references to the number of shares, per
share amounts, conversion amounts and stock option data of the Company's
common stock have been restated to reflect this reverse stock split for all
periods presented.

Basic earnings per common share is calculated by dividing net income (loss)
available to common shareholders for the period by the weighted-average
number of common shares outstanding during the period. Diluted earnings per
common share is calculated by dividing net income (loss) available to common
shareholders for the period by the weighted-average number of common shares
outstanding during the period, increased to include, if dilutive, the number
of additional common shares that would have been outstanding if the
potential common shares had been issued. The dilutive effect of outstanding
stock options is included in the calculation of diluted earnings per common
share using the treasury stock method. During the years ended December 31,
1998 and 1999, the Company has excluded all convertible preferred stock and
outstanding stock options from the calculation of diluted loss per share, as
their effect would have been antidilutive.

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table sets forth the computation of basic and diluted loss per
share for the years ended December 31, 1998 and 1999:

[Download Table]

1998 1999
----------- -----------

Numerator
Net loss......................................... $(3,434,060) $(3,034,594)
Less Series B preferred dividends................ (82,748) (82,748)
----------- -----------
Loss available to common shareholders............ $(3,516,808) $(3,117,342)
=========== ===========

Denominator
Weighted-average shares outstanding.............. 861,875 1,016,399
=========== ===========
Basic and diluted earnings per share............. $ (4.08) $ (3.07)
=========== ===========

COMPREHENSIVE INCOME

Effective January 1, 1998, the Company adopted SFAS No. 130, REPORTING
COMPREHENSIVE INCOME. This statement requires that all components of
comprehensive income be reported in the financial statements in the period
in which they are recognized. During the years ended December 31, 1998 and
1999, the Company did not have any components of comprehensive income.

SEGMENT INFORMATION

Effective January 1, 1998, the Company adopted SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. This statement
requires disclosure of certain information about the Company's operating
segments, products, geographic areas in which it operates and its major
customers. This statement also allows a company to aggregate similar
segments for reporting purposes. Management has determined that its
operations can be aggregated into one reportable segment. Additionally, as
the Company's products are sold primarily within the U.S., no segment
disclosures have been included in the accompanying notes to the consolidated
financial statements.

RECLASSIFICATIONS

Certain reclassifications were made to prior years' consolidated financial
statements to conform to the current year presentation.

3. ACQUISITION

On January 26, 1998, the Company completed the acquisition of all the
outstanding common stock of XImage Corporation ("XImage") located in San
Jose, California. XImage's principal business activity is the design,
implementation and maintenance of digital booking systems.

The Company paid approximately $2,150,000 in cash, issued warrants to
purchase 61,611 shares of the Company's common stock and incurred
approximately $310,000 in direct acquisition costs. The acquisition was
accounted for as a purchase with goodwill being amortized over four years.

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

3. ACQUISITION (CONTINUED)
The purchase price was allocated to identifiable assets and liabilities
based on their estimated fair values, with the excess of the purchase price
over the fair value of such net liabilities acquired reflected as goodwill,
as follows:

[Download Table]

Current assets.............................................. $ 947,177
Property and equipment...................................... 53,132
Goodwill.................................................... 3,526,322
Liabilities assumed......................................... (2,069,100)
-----------
Purchase price.............................................. $ 2,457,531
===========

The results of operations of XImage for the period from January 26, 1998
(acquisition) through December 31, 1998 and for the year ended December 31,
1999 are included in the Company's consolidated statements of operations for
the years ended December 31, 1998 and 1999.

4. PROPERTY AND EQUIPMENT

Property and equipment at December 31, 1998 and 1999 consists of:

[Download Table]

1998 1999
--------- ---------

Equipment............................................. $ 804,007 $ 839,990
Furniture............................................. 63,313 63,314
--------- ---------
867,320 903,304
Less accumulated depreciation......................... (597,726) (711,506)
--------- ---------
$ 269,594 $ 191,798
========= =========

Total depreciation expense for the years ended December 31, 1998 and 1999
was $100,215 and $113,780, respectively.

5. NOTES PAYABLE

Notes payable consists of the following:

[Download Table]

1998 1999
---------- -----------

Short-term note payable to shareholder. Such note accrues
interest at prime and is due upon demand.................. $ 30,000 $ 30,000

8% convertible notes payable to shareholders due June 15,
2000. At the option of either the Company or the holder,
interest may be accrued and added to principal or paid.
The notes, at the option of the holders, shall be prepaid
to the extent of 20% of the Company's pre-tax income
earned subsequent to June 30, 1995. The principal amount
of the notes plus accrued interest shall be convertible,
at the option of the holder, at any time after date of
issuance, into units of Series B preferred stock and
common stock purchase warrants of the Company at $13.19
per unit, subject to adjustment........................... 208,150 208,150

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

5. NOTES PAYABLE (CONTINUED)

[Enlarge/Download Table]

1998 1999
---------- -----------

8% convertible note payable to employee, due June 15, 2000.
At the option of either the Company or the holder,
interest may be accrued and added to principal or paid.
The principal amount of the note plus accrued interest
shall be convertible, at the option of the holder, at any
time after the date of issuance in common stock at $7.91
per share................................................. -- 50,000

10% convertible note payable to shareholder affiliate, due
earlier of February 10, 2001 or five days following the
close of an initial public offering. The principal amount
and accrued interest shall be convertible into common
stock at $1.00 per share if principal and interest is not
paid prior to June 1, 2000. Note is net of unamortized
discount of $328,998 as of December 31, 1999.............. -- 921,002

Short-term note payable to a third party with interest of
9%, payable monthly beginning December 15, 1999. Note due
at the earlier of: (1) any written or oral demand by
lender, (2) closing of borrowers' initial public offering,
or (3) April 3, 2000...................................... -- 500,000

Short-term notes payable to financial institution. Such
notes accrue interest at prime plus 2% and were due
April 15, 1999. Due date extended to November 7, 1999 for
$500,000 and March 3, 2000 for the remaining $500,000. The
notes are collateralized by substantially all the assets
of the Company and guaranteed by certain officers and
directors of the Company.................................. 1,200,000 500,000

Short-term notes payable to lending institution. Such notes
accrue at prime plus 2% and were due September 28,
1999...................................................... -- 100,000

Short-term notes payable to shareholders and other related
parties. Such notes accrue interest at 10% and are due on
the earlier of February 15, 1999 or the closing of
permanent financing....................................... 150,000 --

Short-term note payable to shareholder to accrue interest at
10%. Note due the earlier of January 31, 1999 (extended to
March 15, 2000) or the closing of permanent financing..... $ 55,000 $ 55,000

Short-term notes payable to previous XImage employees. Such
notes accrue interest at prime plus 2% and were due
December 31, 1998. The notes' terms were revised to
include monthly payments through November 2000............ 600,000 550,000

Short-term notes payable to XImage officers. Such notes
accrue interest at 10% and were due upon the acquisition
of XImage. The note's terms were revised to include
monthly payments through November 2000.................... 152,500 152,500

F-12

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

5. NOTES PAYABLE (CONTINUED)

[Enlarge/Download Table]

1998 1999
---------- -----------

Short-term note payable to prior XImage shareholder. Such
note accrues interest at 10% and was due upon acquisition
of XImage. The note's terms were revised to include
monthly payments through November 2000.................... 51,000 51,000

Short-term notes payable to certain vendors................. 26,297 25,937
---------- -----------

2,472,947 3,143,589

Less current portion........................................ (999,775) (2,219,047)
---------- -----------

Long-term notes payable..................................... $1,473,172 $ 924,542
========== ===========

In February 1999, the Company issued a promissory note to a third party for
$500,000 at an interest rate of 9.75% to mature February 2000. In
conjunction with the note, the Company issued a warrant to purchase 324,300
shares of common stock at $4.75 per share. The fair value of the warrants
was calculated using the minimum value method and was determined to be $0.07
per share. In August 1999, the note plus accrued interest was converted into
120,944 shares of common stock.

In August 1999, the Company issued two $100,000 promissory notes at prime
plus 2%. Principal and interest was due September 28, 1999 and October 1,
1999 with a 30-day extension option. The Company has exercised the 30-day
extension options in exchange for warrants to acquire 10,000 shares of
common stock at $7.91 per share. In October 1999, the Company made a
principal payment of $20,000 on one of the promissory notes, and in November
1999 paid off the remaining balance on that note.

In September 1999, the Company issued a promissory note for $50,000 due
June 15, 2000 to an employee with interest at 8%, convertible into common
stock at $7.91 at the option of the holder.

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

In November 1999, the Company issued a $500,000 note to a related party with
interest payable monthly beginning on December 15, 1999. The note is due at
the earlier of (i) any written or oral demand by lender, (ii) the closing of
borrower's initial public offering or (iii) April 3, 2000.

F-13

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

5. NOTES PAYABLE (CONTINUED)
In November 1999, the maturity date for the remaining $500,000 balance of
the note to the financial institution was extended to March 3, 2000.
Additionally, approximately $800,000 in notes to shareholders and XImage
employees, officers and shareholders were revised to include payments
through November 2000.

In December 1999, the $150,000 of short-term notes to shareholders and other
related parties plus accrued interest were converted into 20,919 shares of
common stock.

At December 31, 1999, approximately $100,000 of uncollateralized notes
payable were in default for non-payment.

6. INCOME TAXES

Due to the Company's net loss position for the years ended December 31, 1998
and 1999 and as the Company has recorded a full valuation allowance against
deferred tax assets, there was no provision for income taxes recorded.

The following is a reconciliation of the statutory federal income tax rate
to the Company's effective tax rate for the years ended December 31, 1998
and 1999:

[Download Table]

1998 1999
-------- --------

Tax provision (benefit) at statutory rate................... (34)% (34)%
State tax, net of federal benefit........................... 3 (3)
Research credits............................................ (2) (3)
Goodwill amortization....................................... 8 10
Other permanent differences................................. 1 6
Net change in valuation allowance........................... 24 24
--- ---
0% 0%
=== ===

The components of the net deferred tax assets at December 31, 1998 and 1999
are as follows:

[Download Table]

1998 1999
----------- -----------

Intangible assets.................................. $ 102,459 $ 122,012
Fixed assets....................................... (34,111) (40,060)
Reserves and accrued expenses...................... 169,667 73,070
Net operating loss carryforwards................... 1,683,180 2,335,618
Research credit carryforwards...................... 209,497 330,888
----------- -----------
2,130,692 2,821,528
Less valuation allowance........................... (2,130,692) (2,821,528)
----------- -----------
Net deferred tax asset............................. $ -- $ --
=========== ===========

The Company has established a valuation allowance against its deferred tax
asset due to the uncertainty surrounding the realization of such asset.
Management periodically evaluates the

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

6. INCOME TAXES (CONTINUED)
recoverability of the deferred tax asset. At such time as it is determined
that it is more likely than not that deferred tax assets are realizable, the
valuation allowance will be reduced.

At December 31, 1998 and 1999, the Company had federal net operating loss
carryforwards of approximately $4,400,000 and $6,200,000, respectively, and
state net operating loss carryforwards of approximately $3,000,000 and
$3,900,000, respectively, which may be available to offset future taxable
income for tax purposes. The federal net operating loss carryforwards expire
at various dates from 2002 through 2019. The California net operating loss
carryforwards expire at various dates from 2000 through 2004.

The Company also had federal research credit carryforwards of approximately
$152,000 and $227,000 and state research credit carryforwards of
approximately $87,000 and $157,000 for tax purposes at December 31, 1998 and
1999, respectively. The federal carryforwards will begin expiring, if
unused, in 2005.

The Internal Revenue Code (the "Code") limits the availability of net
operating losses and certain tax credits that arose prior to certain
cumulative changes in a corporation's ownership resulting in a change of
control of the Company. The Company's use of its net operating loss
carryforwards and tax credit carryforwards will be significantly limited
because the Company underwent "ownership changes" in 1991 and 1995. The
affect of the existing limitations has been reflected in the above summary
of deferred tax assets.

7. COMMITMENTS AND CONTINGENCIES

EMPLOYMENT AGREEMENTS

The Company has employment agreements with its President, Vice President of
Finance and Vice President of Sales and Business Development. The Company
may terminate the agreements with or without cause. Should the Company
terminate the agreements without cause, the President is entitled to
compensation for up to 36 months of salary and the Vice Presidents of
Finance and of Sales and Business Development are entitled to compensation
equal to 12 months of salary.

LICENSE AGREEMENTS

During 1998, the Company entered into certain license agreements related to
technology used in its products. Under the terms of the agreements, the
Company is required to pay royalties at fixed fees or percentages based upon
product sales. The agreements expire at various dates through October 2001.

LETTER OF CREDIT

As collateral for performance on a software installation and implementation
contract, the Company is contingenlty liable under an irrevocable standby
letter of credit in the amount of $100,000. The letter of credit expires in
September 2000. As a condition, the bank required the Company to invest
$100,000 in the form of a one year certificate of deposit, which matures in
September 2000.

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LITIGATION

The Company is, from time to time, subject to legal proceedings and claims
which arise in the normal course of its business. In the opinion of
management, the amount of ultimate liability with respect to these actions
will not have a material adverse effect on the Company's financial position,
results of operations or cash flows.

LEASES

The Company entered into a 5-year operating lease for its office and
research and development facilities which commenced August 1998.

At December 31, 1999, future minimum lease payments are as follows:

[Download Table]

OPERATING CAPITAL
YEAR ENDING DECEMBER 31, LEASES LEASES TOTAL
------------------------ --------- -------- --------

2000............................................... $270,338 $8,496 $278,834
2001............................................... 281,152 3,540 284,692
2002............................................... 292,398 -- 292,398
2003............................................... 174,480 -- 174,480

Rental expense under operating leases for the years ended December 31, 1998
and 1999 was approximately $311,985 and $262,223, respectively.

8. EQUITY

The Company's Articles of Incorporation were amended effective August 31,
1994 and authorize the issuance of two classes of stock to be designated
"Common Stock" and "Preferred Stock," provide that both Common and Preferred
Stock shall have a par value of $.01 per share and authorize the Company to
issue 50,000,000 shares of Common Stock and 4,000,000 shares of Preferred
Stock. The Preferred Stock may be divided into such number of series and
with the rights, preferences, privileges and restrictions as the Board of
Directors may determine.

COMMON STOCK

The Company issued 44,866 and 73,466 shares of common stock during 1998 and
1999, respectively, to certain officers and directors as compensation for
personally guaranteeing the $1,200,000 bank note. The estimated fair value
of $360,020 and $348,779 in 1998 and 1999, respectively, was capitalized as
loan fees and amortized as interest expense over the term of the note.

During 1998, the Company issued 10,236 shares of common stock to directors
for payment of board fees. The estimated fair value of $162,000 was expensed
during 1998.

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

8. EQUITY (CONTINUED)
SERIES B CONVERTIBLE, REDEEMABLE PREFERRED STOCK

In April 1995, the Company's Articles of Incorporation were amended to
authorize 750,000 shares of Series B Convertible Redeemable Preferred Stock
("Series B").

The holders of Series B are entitled to cumulative preferred dividends
payable at the rate of $.2125 per share per annum commencing April 30, 1996,
subject to legally available funds. The Series B plus accrued but unpaid
dividends are convertible at the option of the holder into shares of common
stock at a conversion price equal to the original Series B issue price as
adjusted to prevent dilution. The Series B will automatically be converted
into shares of common stock upon the closing of a firm commitment
underwritten public offering at a price per common share of not less than
$31.65. If the public offering price is less than $31.65 but at least $21.10
per share, the conversion shall still be automatic upon written consent of a
majority of the then outstanding shareholders of Series B.

The Series B, on an as-converted basis, have the same voting rights per
share as the Company's common shares. The Series B are entitled to initial
distributions of $13.19 per share, upon liquidation and in preference to
common shares and any other series of preferred stock, except Series A, plus
all accrued but unpaid dividends.

Any time after December 31, 2000, the Company has the right to redeem all or
some of the outstanding shares of Series B at a price equal to the original
issue price, plus all accrued but unpaid dividends.

As of December 31, 1998 and 1999, the Company had cumulative undeclared
dividends of $94,825 and $177,573, respectively.

WARRANTS

As of December 31, 1999, warrants to purchase 328,662 shares of common stock
at prices ranging from $6.00 to $21.00 were outstanding. All warrants are
exercisable as of December 31, 1999 and expire at various dates through
November 2004.

9. STOCK OPTION PLANS

On August 31, 1994, the directors of the Company adopted the Company's 1994
Employee Stock Option Plan (the "1994 Plan") and the 1994 Nonqualified Stock
Option Plan (the "Nonqualified Plan"). The 1992 Stock Option Plan and
options previously granted were canceled by the Board of Directors.

The 1994 Plan provides that officers and other key employees may receive
nontransferable incentive stock options to purchase up to 170,616 shares of
the Company's common stock. The option price per share must be at least
equal to 100% of the market value of the Company's common stock on the date
of grant and the term may not exceed ten years.

The Nonqualified Plan provides that directors and consultants may receive
nontransferable options to purchase up to 18,957 shares of the Company's
common stock. The option price per share must

F-17

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

9. STOCK OPTION PLANS (CONTINUED)
be at least equal to 85% of the market value of the Company's common stock
on the date of grant and the term may not exceed five years.

Both the 1994 Plan and the Nonqualified Plan are administered by the Board
of Directors or a Committee of the Board which determines the employees,
directors or consultants which will be granted options and the terms of the
options, including vesting provisions which to date has been over a three
year period. Both the 1994 Plan and the Nonqualified Plan expire in ten
years.

Due to a significant decline in the estimated fair value of the Company's
common stock, in February 1999, the exercise price of previously granted
stock options was repriced to $5.28 per share, which was based upon the fair
value of the Company's common stock as of that date, as determined by the
Company's Board of Directors. Under proposed accounting rules, the Company
will be required to record compensation expense equal to the difference
between the estimated fair value of the common stock and the exercise price
of the repriced options. For the year ended December 31, 1999, the Company
recorded no compensation expense as the exercise price was equal to the
estimated fair value.

In December 1999, the Company's Board of Directors adopted the ImageWare
Systems, Inc. Amended and Restated 1999 Stock Option Plan (the "1999 Plan").
Under the terms of the 1999 Plan, the Company may issue up to 350,000
non-qualified or incentive stock options to purchase common stock of the
Company. The 1999 Plan has substantially the same terms as the 1994 Employee
Stock Option Plan and the 1994 Nonqualified Stock Option Plan and expires in
ten years.

The Company has adopted the disclosure-only provisions of SFAS 123. Had
compensation cost for the Company's stock option plan been determined based
on the fair value at the grant date for awards consistent with the
provisions of SFAS No. 123, the Company's net losses would have been
increased to the pro forma amount indicated below for the years ended
December 31, 1998 and 1999:

[Download Table]

1998 1999
----------- -----------

NET LOSS
As reported...................................... $(3,434,060) $(3,034,594)
Pro forma........................................ (3,709,771) (3,106,255)

EARNINGS PER COMMON SHARE
As reported...................................... $ (4.08) $ (3.07)
Pro forma........................................ (4.30) (3.14)

The fair value of each option grant is estimated on the date of grant using
the minimum value method with the following weighted-average assumptions:
dividend yield of 0%, risk-free interest rate ranging from 4.65% to 5.99%,
and expected lives of five years.

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IMAGEWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1998 AND 1999

9. STOCK OPTION PLANS (CONTINUED)
Stock option activity was as follows:

[Download Table]

WEIGHTED-
AVERAGE
OPTIONS PRICE
-------- ---------

Balance at January 1, 1997............................... 66,825 $5.28
Granted................................................ 95,261 $5.28
Expired/canceled....................................... (38,389) $5.28
--------
Balance at December 31, 1997............................. 123,697 $5.28
Granted................................................ 24,455 $5.28
Expired/canceled....................................... --
--------
Balance at December 31, 1998............................. 148,152 $5.28
Granted................................................ 276,611 $6.37
Expired/canceled....................................... (148,152) $5.28
--------
Balance at December 31, 1999............................. 276,611 $6.37
========

At December 31, 1999, a total of 110,834 options were exercisable at a
weighted average price of $5.48 per share.

10. EMPLOYEE BENEFIT PLAN

During 1995, the Company adopted a defined contribution 401(k) retirement
plan (the "Plan"). All employees aged 21 years and older become participants
after completion of three months of employment. The Plan provides for annual
contributions by the Company determined at the discretion of the Board of
Directors. Participants may contribute up to 20% of their compensation.

Employees are fully vested in their share of the Company's contributions
after the completion of five years of service. For the years ended
December 31, 1998 and 1999, there were no contributions to the Plan by the
Company.

11. SUBSEQUENT EVENTS

Stock Option Plan

In February 2000, the Company's Board of Directors amended the Amended and
Restated 1999 Stock Option Plan (the "1999 Plan") to decrease the number of
shares of common stock subject to options under the 1999 Plan from 350,000
to 100,000. Additionally, the Board of Directors resolved that the number of
shares of common stock set aside for issuance under the 1999 Plan shall be
set at 100,000 shares. Upon the closing of an initial public offering, the
number of shares subject to options and reserved for the 1999 Plan will
increase from 100,000 to 250,000 shares.

Note Payable (unaudited)

As of March 4, 2000 the Company was in default for nonpayment under the
terms of the short term note payable to a financial institution.

F-19

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

YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THE
INFORMATION CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING
OFFERS TO BUY, UNITS ONLY IN JURISDICTIONS IN WHICH OFFERS AND SALES ARE
PERMITTED.

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

TABLE OF CONTENTS

[Download Table]

PAGE
--------

Prospectus Summary.................... 1
Risk Factors.......................... 4
Use of Proceeds....................... 8
Dividend Policy....................... 10
Capitalization........................ 11
Dilution.............................. 12
Selected Financial Information........ 13
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 14
Business.............................. 20
Management............................ 31
Certain Transactions.................. 35
Security Ownership of Certain
Beneficial Owners and Management.... 38
Description of Securities............. 39
Shares Eligible for Future Sale....... 43
Underwriting.......................... 46
Legal Matters......................... 49
Experts............................... 49
Available Information................. 49
Index to Consolidated Financial
Statements.......................... F-1

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

UNTIL APRIL 24, 2000 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
BROKER-DEALERS THAT EFFECT THE TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

1,875,000 UNITS

[LOGO]
---------------------

PROSPECTUS

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

PAULSON INVESTMENT
COMPANY, INC.

I-BANKERS SECURITIES, INC.

MARCH 30, 2000

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Dates Referenced Herein and Documents Incorporated by Reference

		Referenced-On Page
This ‘424B1’ Filing	Date	First	Last	Other Filings

	11/18/04	35
	11/10/04	39
	8/31/04	35	36
	11/30/03	44
	7/31/03	32
	4/30/02	36
	2/28/02	37
	12/31/01	36		10KSB
	4/29/01	30
	2/10/01	20	64
	1/15/01	43
	1/1/01	39		8-K
	12/31/00	30	68	10KSB40
	6/15/00	37	64
	6/1/00	63
	4/30/00	43
	4/24/00	71
Filed as of:	4/3/00	20	64
	4/1/00	39	64
Filed on:	3/31/00			10QSB, 10QSB/A
	3/30/00	1	71
	3/15/00	63		SB-2/A
	3/4/00	70
	3/3/00	20	65
	2/29/00	4	47
	2/25/00	53
	12/31/99	5	70
	12/15/99	63	64
	11/29/99	4	67
	11/24/99	50
	11/10/99	39
	11/7/99	63
	10/29/99	30
	10/1/99	64
	9/28/99	63	64
	8/30/99	36
	8/28/99	31
	6/30/99	31
	4/15/99	63
	3/1/99	36	37
	2/15/99	63
	1/31/99	38	63
	12/31/98	15	70
	11/5/98	38
	9/18/98	37
	1/26/98	58	62
	1/1/98	61
	12/31/97	56	70
	1/1/97	70
	4/30/96	68
	6/30/95	62
	6/15/95	37	38
	8/31/94	67	68
				List all Filings

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Filing Submission 0000912057-00-015759 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)

Imageware Systems Inc – ‘424B1’ on 3/31/00

On: Friday, 3/31/00 · As of: 4/3/00 · Accession #: 912057-0-15759 · File #: 333-93131

Prospectus — Rule 424(b)(1)Filing Table of Contents

Document Table of Contents

Dates Referenced Herein and Documents Incorporated by Reference

Prospectus — Rule 424(b)(1)
Filing Table of Contents