Annual Report — Small Business — [x] Reg. S-B Item 405 — Form 10-KSB
Filing Table of Contents
Document/Exhibit Description Pages Size
1: 10KSB40 Annual Report -- Small Business -- [x] Reg. S-B 42 245K
Item 405
2: EX-2.3 Plan of Acquisition, Reorganization, Arrangement, 32 120K
Liquidation or Succession
3: EX-2.4 Plan of Acquisition, Reorganization, Arrangement, 54 215K
Liquidation or Succession
4: EX-2.5 Plan of Acquisition, Reorganization, Arrangement, 3 16K
Liquidation or Succession
7: EX-10.13 Material Contract 4 17K
5: EX-10.4 Material Contract 5 26K
6: EX-10.6 Material Contract 4 19K
8: EX-21 Subsidiaries of the Registrant 1 5K
9: EX-23 Consent of Experts or Counsel 1 7K
10KSB40 — Annual Report — Small Business — [x] Reg. S-B Item 405
Document Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10-KSB
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the fiscal year ended December 31, 2000.
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the transition period __________ to __________.
Commission File Number ______
IMAGEWARE SYSTEMS, INC.
--------------------------------------------------------------------------------
(Name of Small Business Issuer in Its Charter)
California 33-0224167
------------------------------- ------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10883 Thornmint Road, San Diego, California 92127
--------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(858) 673-8600
--------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange on
Title of Each Class Which Registered
---------------------------------------- ----------------------------
Common Stock, $0.01 par value American Stock Exchange
Warrants to Purchase Common Stock American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
-------- --------
Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to be the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |X|
The issuer's revenues for the fiscal year ending December 31, 2000 were
$9,398,315.
The aggregate market value of the voting stock and non-voting common
equity held by non-affiliates of the issuer, based on the average of the high
and low sales prices of the issuer's Common Stock on March 23, 2001 as
reported on the American Stock Exchange, was $15,537,371. 577,320 shares of
Common Stock held by each current executive officer and director and by each
person who is known by the registrant to own 5% or more of the outstanding
Common Stock have been excluded from this computation in that such persons
may be deemed to be affiliates of the issuer. Share ownership information of
certain persons known by the issuer to own greater than 5% of the outstanding
Common Stock for purposes of the preceding calculation is based solely on
information on Schedule 13G filed with the Commission and is as of March 23,
2001. This determination of affiliate status is not a conclusive
determination for other purposes.
The number of shares of Common Stock outstanding as of March 23, 2001 was
4,190,662.
Transitional Small Business Disclosure Format (check one):
Yes No X
-------- --------
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Part III (Items 9, 10, 11 and 12) is
incorporated by reference to portions of the registrant's definitive proxy
statement for the 2001 Annual Meeting of Shareholders which will be filed with
the Securities and Exchange Commission ("SEC") within 120 days after the fiscal
year ended December 31, 2000.
IMAGEWARE SYSTEMS, INC.
2000 ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS
[Enlarge/Download Table]
PAGE
PART I............................................................................................................1
ITEM 1. Description of Business.......................................................................1
ITEM 2. Description of Property......................................................................11
ITEM 3. Legal Proceedings............................................................................12
ITEM 4. Submission Of Matters To A Vote Of Security Holders..........................................12
PART II..........................................................................................................12
ITEM 5. Market for Common Equity and Related Stockholder Matters.....................................12
ITEM 6. Management's Discussion and Analysis of Financial Condition and Results of Operations........13
ITEM 7. Financial Statements.........................................................................17
ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures........17
PART III.........................................................................................................18
ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with
Section 16(a) of the Exchange Act............................................................18
ITEM 10. Executive Compensation.......................................................................18
ITEM 11. Security Ownership of Certain Beneficial Owners and Management...............................18
ITEM 12. Certain Relationships and Related Transactions...............................................18
ITEM 13. Exhibits, Lists and Reports on Form 8-K......................................................18
i
ImageWare, C.R.I.M.E.S., Crime Capture System, Face ID, Suspect ID,
Crime Lab, Vehicle ID, Crime Web, Winbadge NT and Winbadge Aviation are
trademarks of the Company.
ID Cardmaker is a trademark of Imaging Technology Corporation.
All other trademarks, service marks and/or trade names appearing in this
document are the property of their respective holders.
PART I
The statements contained in this Annual Report on Form 10-KSB that are
not historical are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended (the "Securities Act"), and Section
21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
including statements regarding our expectations, beliefs, intentions or
strategies regarding the future. Forward-looking statements include, without
limitation, statements regarding the extent and timing of future revenues and
expenses and customer demand, statements regarding deployment of our products,
and statements regarding reliance on third parties. All forward-looking
statements included in this report are based on information available to us as
of the date hereof and we assume no obligation to update any forward-looking
statements. Forward-looking statements involve known or unknown risks,
uncertainties and other factors, which may cause our actual results, performance
or achievements, or industry results to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such
differences include but are not limited to: fluctuations in our operating
results, continued new product introductions, market acceptance of our new
product introductions, new product introductions by competitors, technological
changes in the digital imaging industry, uncertainties regarding intellectual
property rights and the other factors referred to herein including, but not
limited to, the items discussed under "Risk Factors" in the section of this
report entitled "Description of Business."
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
ImageWare Systems, Inc. was founded in February 1987. In November
1994, a group of employees and outside investors acquired a controlling
interest in the company and redirected the company toward the development of
image-based software products for the law enforcement community. Since 1994,
we have devoted substantially all of our resources to designing, developing,
producing and marketing image-based software products for law enforcement
agencies. We have also acquired other companies which operate related
businesses.
In January 1998, we acquired all of the outstanding stock of XImage
Corporation ("XImage") for a combination of approximately $2.1 million in cash
and warrants to purchase 61,611 shares of our common stock. XImage, based in San
Jose, California, was founded in 1987 and designed and marketed digital 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's operations into our San Diego offices during the second
and third quarters of 1998.
In March 2000, we completed an initial public offering ("IPO") of our
securities in which we sold 2,156,250 units for $8.00 each, raising a total of
$17,250,000. Each unit included a share of common stock and a warrant,
exercisable within five years, to purchase a share of common stock for 120% of
the $8.00 offering price for the unit (the strike price of the warrant to
increase to 150% of the offering price upon the first anniversary of the closing
of the IPO). With the proceeds of the IPO we were able to strengthen our balance
sheet by paying off debt and other liabilities and provide additional working
capital to fund our business plan for growth.
In August 2000, we acquired Imaging Technology Corporation ("ITC") for
625,000 shares of our common stock in a pooling-of-interests transaction. ITC,
based in Hudson, Massachusetts, was founded in 1994 and designed and marketed
software for digital ID systems. ITC's proprietary solutions encompassed such
technologies as a
1
Polaroid-branded ID card product, and full identification solutions provided to
Massachusetts Institute of Technology, the U.S. Bureau of Engraving and
Printing, JFK International Airport and such countries as Nigeria and Peru.
In September 2000, ITC acquired the assets of Goddard Technologies,
Inc. ("Goddard") for 40,322 shares of common stock and the assumption of
certain liabilities. Goddard, which was founded in 1987 and based in
Greenville, South Carolina, designed and marketed digital ID systems through
a direct sales force. Goddard focused on the airport, university and
education markets with customers including Dulles International Airport,
Ronald Reagan Airport, Atlanta Hartsfield International Airport, Columbia
University, Notre Dame University, Ohio State University, the United Nations,
Delta Airlines, the World Trade Center and the Atlanta Braves.
In March 2001, we announced our intention to acquire the assets of G&A
Technologies, Inc. ("G&A") for a combination of stock and cash. Upon closing of
the transaction, we expect that G&A will expand our presence in the digital ID
software market by more than two-fold and afford us an international presence
through its subsidiaries in Stuttgart, Germany and Singapore and its corporate
headquarters in Hull, Canada. G&A markets its products in North America through
a network of distributors. Its major North American customers include Boeing,
Sears, Novell, Lockheed Martin, and Home Depot. G&A's international sales
efforts are managed out of Germany and Singapore where it markets directly to
system integrators and provides ongoing support and consumables to its
customers. Internationally, its systems are installed at companies such as
Lufthansa, BASF, and Deutsch Post, and in Indonesia for the production of
drivers' licenses.
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 such, our target
customers include local police departments, sheriffs' departments and offices,
primary state law enforcement agencies, special police agencies, county
constable offices, and federal agencies such as the FBI and the DEA.
The federal government has promoted the development and use of nationwide
criminal history record databases called the Interstate Identification Index
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 these acts based on their initiatives to develop,
oversee, plan and implement integrated information technology, including
technology of the type we produce, however, these acts merely authorize this
funding and are contingent on Congress passing legislation to appropriate the
funds each year.
IDENTIFICATION MARKETS
Our technology also has emerging applications in markets related to
access control and identification. Organizations concerned with security issues
can use our technology 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.
Digital ID systems have historically been sold based upon the
cost-savings digital systems offer over traditional photo-based systems.
Furthermore, we believe that the ability to easily capture images and data in a
2
digital database and to enable immediate and widespread access to that
database for remote identification will be the functionality that customers
will require in the future and that such functionality will be the primary
driver for future growth within this market. With the acquisitions of ITC and
Goddard we are able to provide field-proven digital ID products with
reference accounts across the board in terms of size and complexity of
systems and users. When combined with the proven facial recognition and web
capabilities we currently offer with our law enforcement products, we believe
we can provide a leading product offering.
PRODUCTS AND SERVICES
LAW ENFORCEMENT AND PUBLIC SAFETY
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.
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 hardwares as needed. The Crime Capture System
allows customers to capture and store images and other information in a database
and to 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.
CCS CAPTURE. This software module allows users to capture and
store facial images as well as images of distinguishing features such
as scars, tattoos and other marks. Each entry contains both images and
text information in an easy-to-view format made up of distinct fields.
Current customers of this module range from agencies that capture a few
thousand mugshots per year to those that capture hundreds of thousands
of mugshots each 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 in
the foreseeable future, we have upgraded most current customers from
the ForceField 2000 to the Crime Capture System.
CCS RETRIEVAL. This software module allows users to search the
database created with CCS Capture. Officers can conduct text searches
in many fields, including file number, name, alias, distinctive
features, and other information such as gang membership and criminal
history. 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.
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 facial images 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
3
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.
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.
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.
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 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.
CRIME WEB. This Web-based investigative software tool, enables authorized
personnel to access and search the County's booking records stored on
ImageWare's Crime Capture System through a standard web browser from within the
customer's intranet. Crime Web allows remote access to the Crime Capture System
database without requiring the user to be physically connected to the customer's
network. Crime Web requires only that the user have access to the Internet and
authorization to access the County intranet. We first introduced Crime Web in
1999.
IDENTIFICATION
Our digital identification products consist of the following products
acquired through our acquisitions of ITC and Goddard.
IDENTIFIER FOR WINDOWS. This family of products combines the ability
to capture photographic images digitally with the ability to create a
database and to print identification cards. Identifier for Windows offers a
powerful, versatile, and user-friendly application which can be used by
schools, hospitals, corporations or governments.
ID CARD MAKER. The ID Card Maker family of products provides
substantially the same capabilities as Identifier for Windows and is sold and
supported by Polaroid Corporation's authorized dealers within the United States.
PASSPRINT. This temporary pass ID badging software program allows the
user to create sequentially numbered temporary identification passes without the
need for a stored database or captured photos.
WINBADGE NT. This Microsoft Windows-based technology photo ID system is
for the production and tracking of identification cards. The system encompasses
a suite of applications and tools to easily enter data and images into a
database and customize the entry screens for each operator or create new badge
designs. The system is capable of producing various documents, including cards,
badges, dossiers, and FaceBook files containing images, text, and logos.
WinBadge NT is designed to operate in many different modes: as a stand-alone,
turnkey personnel imaging & data management system; as part of a network of
image capture stations with image retrieval and verification stations; and as
interfaced with access control security systems or a human resource mainframe
computer.
4
WINBADGE AVIATION. This product for the airport industry has numerous
features, from tracking badges to ensuring proper security training. It also
tracks driver training, driver violations and information required by companies
authorized to request the issuance of ID cards. Accelerator keys minimize the
need for moving a computer mouse in a high badge production environment.
Keyboard control of camera pan, tilt, and zoom also minimize operator movement.
CERTIFY. This product was created in conjunction with South Carolina's
Center for Child Care Career Development. It is an automated personnel registry
system for course tracking and student record-keeping. The system's features
include:
- the ability to issue full-color student photo ID cards with
barcodes, either locally or at a central production site;
- collection of class attendance with hand-held barcode scanners;
- importation of attendance data from scanners directly into the
database;
- maintenance of data on each student, employer, class schedules,
subject areas and class attendance; and
- the ability to print certificates, transcripts and other reports,
all with custom formats and calculations.
ADMIT. This product is an automated student admittance system. ADMIT
electronically logs students who have arrived at school late or who need to
leave early. This system was designed to eliminate the timely process of manual
filling out forms and to increase the accuracy of student attendance. ADMIT
works in conjunction with existing student information management systems, photo
identification systems and the state attendance systems.
MAINTENANCE AND CUSTOMER SUPPORT
As part of our installation of a system, we train our customers'
employees as to the effective use of our products. We also provide training 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. Providing customer support services typically provides
us with annual revenue of 12% to 18% of the initial sales price of the hardware
and software purchased by our customers.
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 with software which we specifically configure to operate on their
existing computer system. 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. 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 customers' location.
OUR STRATEGY
Key elements of our strategy for growth include the following:
FULLY EXPLOIT THE EXPANDING LAW ENFORCEMENT AND PUBLIC SAFETY MARKETS
5
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
counties and 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 plan to 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 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 quickly and accurately check his identity against a database of
authorized persons, and either allow or deny access as required. 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 a picture ID system for the governments of Kuwait, Peru,
Uganda, and Nigeria. We believe that our acquisitions of ITC and Goddard have
accelerated our push into the these markets through the acquisition of accepted
and proven technology and a significant and high profile installed customer
base.
DEVELOP THE INTERNET AND WIRELESS CAPABILITIES OF OUR PRODUCTS
One of our latest software modules, Crime Web, allows users to use the
Internet or secure Intranets to conduct investigative searches of digital
booking systems. Crime Web includes 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 are also developing internet modules for our identification
software which will provide the same remote access capabilities for our ID
customers.
We also intend to develop the wireless capabilities of our products.
Public agencies as well as private sector customers require information to be
available to remote locations. Our customers are investigating the feasibility
of handheld devices which can operate in the field and accompany users wherever
they are located. In order to facilitate the transfer of records and information
retrieval tools to 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
6
We may in the future acquire additional businesses that will complement
our growth strategy and enhance our competitive position in our current markets
and other markets that utilize our core imaging technology.
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,
Oregon, South Carolina, Washington D.C. and California.
Our domestic sales organization includes our director of sales, our
director of major account development, our vice president of sales and
marketing and nine regional sales personnel. Our vice president of business
development develops relationships with systems integrators and other
strategic partners. 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.
Our ID products are sold to large integrators, direct via our sales force
and through distributors. Depending on the customer's requirements, there may be
instances that require an RFP. The sales cycle can vary from a few weeks to 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 we also gain access to
large clients. In this context, we provide agencies with digital image
booking systems and our related investigative software products. We are a
subcontractor to the following primary 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; and
- DIGITAL BIOMETRICS, INC., for the Los Angeles County Sheriff's
Department.
We have also entered into agreements or arrangements with INTELLIGENCE
AND STRATEGIC PROCESSES PTY LTD., an Australian company, to jointly bid on an
opportunity 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. We have 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.
Polaroid has been selling an OEM version of ITC's identification
software for several years in the United States. In September 2000
7
Polaroid agreed to begin selling an OEM version of ImageWare's
digital booking system to small and midsized law enforcement
agencies. In November 2000 Polaroid agreed to sell the OEM
identification product in Europe, the Middle East, Australia and
Asia Pacific beginning in the first quarter of 2001; and
- H.T.E., INC. We have 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, the International Association for
Identification, CARDTECH/SECURETECH, the American Society of Industrial Security
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.
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.
CUSTOMERS
We have a broad range of domestic and international customers. Most of
our C.R.I.M.E.S. 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. The customer base for our digital identification systems includes
domestic and foreign government agencies, universities, airports, and private
sector companies, many of which are Fortune 500 or Fortune 1000 companies. In
many cases customers for our C.R.I.M.E.S. products can be customers for our
identification systems as well.
COMPETITION
THE LAW ENFORCEMENT AND PUBLIC SAFETY MARKETS
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; and
- the responsiveness, availability and reliability of our customer
support.
Our law enforcement product line faces competition from other companies
such as Printrak International, Inc., Digital Descriptors Systems, Inc, Identix
Corp., Dynamic Imaging, Inc. and Epic Solutions, Inc. Internationally, there are
often a number of local companies offering solutions in most countries. Most
competitors' products in this niche offer basic image capture and storage but
lack the functionality of integrated investigative products, including facial
recognition and image editing and enhancement.
IDENTIFICATION MARKETS
Due to the breadth of our software offering in the secure ID market
space, we face differing degrees of competition in certain market segments. The
strength of our competitive position is based upon:
8
- our strong brand reputation with a broad customer base
which includes small and medium sized businesses, Fortune 500
corporations and large government projects;
- the ease of integrating our technology into other complex
applications; and
- the leveraged strength that comes from offering customers software
tools, packaged solutions and web-based service applications that
support a wide range of hardware peripherals.
Our software faces strong competition from Datacard, a privately held
manufacturer of hardware, software and consumables for the ID market. There are
also a considerable number of smaller software competitors such as NFive,
Loronix and Fox who compete in differing geographies, primarily in the packaged
product segment.
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
including the trademark ImageWare, as well as trademarks for which there are
pending trademark registrations with the United States Patent & Trademark
Office.
We license and depend on intellectual property from third parties for our
facial recognition product. We license search engine technology from Visionics,
Inc. ("Visionics"). Our license from Visionics is on a nonexclusive, worldwide
basis and expires in July 2001. We believe that, prior to expiration of the
Visionics license, we will be able to enter into a new license agreement with
Visionics.
RESEARCH AND DEVELOPMENT
Our research and development team is made up of 18 programmers, engineers
and other employees. We spent approximately $1.5 million on research and
development in 1999 and $1.6 million in 2000. Our research and development is
managed centrally. We continually work to increase the speed, accuracy, and
functionality of our existing products. We anticipate that our research and
development efforts will continue to focus on new technology and products for
the law enforcement and identification markets.
EMPLOYEES
As of March 15, 2001, we had a total of 82 full-time employees, including
20 in sales and marketing, 29 in customer support and installation, 18 in
research and development, and 15 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.
RISK FACTORS
WE HAVE A HISTORY OF SIGNIFICANT RECURRING LOSSES TOTALLING APPROXIMATELY $24.5
MILLION AND EXPECT TO INCUR LOSSES IN THE FUTURE.
As of December 31, 2000, we had an accumulated deficit of $24.5 million
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.
9
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 three years, we have derived a substantial portion of our
revenues from a small number of sales of large, relatively expensive systems,
typically ranging in price from $300,000 to $600,000. As a result, if we fail to
receive orders for these large systems in a given sales cycle on a consistent
basis, our business could be significantly harmed. Further, our quarterly
results are difficult to predict because we cannot predict in which quarter, if
any, large system sales will occur in a given year. As a result, we believe that
quarter-to-quarter comparisons of our results of operations are not a good
indication of our future performance. In some future quarters our operating
results may be below the expectations of securities analysts and investors, in
which case the market price of our common stock may decrease significantly.
OUR LENGTHY SALES CYCLE MAY CAUSE US TO EXPEND SIGNIFICANT RESOURCES FOR AS LONG
AS ONE YEAR IN ANTICIPATION OF A SALE, YET WE STILL MAY FAIL TO COMPLETE THE
SALE.
When considering the purchase of a large computerized booking 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.
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, and provisions
permitting the agency to perform investigations or audits of our business
practices.
WE MAY FAIL TO CREATE NEW APPLICATIONS FOR OUR PRODUCTS AND ENTER NEW MARKETS,
WHICH MAY AFFECT OUR FUTURE SUCCESS.
We believe our future success depends in part on our ability to develop
and market our technology for applications other than booking systems for the
law enforcement market. If we fail in these goals, our business strategy and
ability to generate revenues and cash flow would be significantly impaired. We
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 OCCASIONALLY 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 occasionally 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
10
promote our products or they may price their services in such a way as to make
it unprofitable for us to continue our relationship with them. Further, they may
fail to perform under agreements with their customers, in which case we might
lose sales to these customers. If we lose our relationships with these
companies, our business may suffer.
WE RELY ON A LICENSE OF TECHNOLOGY FROM VISIONICS, INC., AND THIS LICENSE MAY BE
TERMINATED IN THE FUTURE.
We depend on a licensing arrangement with Visionics for technology
related to the search engine used in our systems. Our present licensing
arrangement with Visionics expires in 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
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.
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. Accordingly, our ability to operate and exploit our
technology overseas could be significantly hindered.
WE RECENTLY HAVE ACQUIRED SEVERAL BUSINESSES AND FACE RISKS ASSOCIATED WITH
INTEGRATING THESE BUSINESSES AND POTENTIAL FUTURE ACQUISITIONS.
We recently completed the acquisitions of ITC and Goddard, and have
signed a definitive agreement for the acquisition of G&A. We are in the
process of integrating, and preparing to integrate, these businesses. We plan
to continue to review potential acquisition candidates in the ordinary course
of our business and our strategy includes building our business through
acquisitions. However, acquisition candidates may not be available in the
future or may not be available on terms and conditions acceptable to us.
Acquisitions involve numerous risks, including among others, difficulties
and expenses incurred in the consummation of acquisitions and assimilation of
the operations, personnel and services or products of the acquired companies,
difficulties of operating new businesses, the diversion of management's
attention from other business concerns and the potential loss of key employees
of the acquired company. If we do not successfully integrate the businesses we
recently acquired or any businesses we may acquire in the future, our business
will suffer.
ITEM 2. DESCRIPTION OF PROPERTY.
We have three operating leases for an aggregate of approximately 35,800
square feet of office space. Our corporate headquarters are located in San
Diego, California. This lease continues through July 2003 at a cost of
approximately $24,000 per month. We occupy 14,300 square feet in Hudson,
Massachusetts. These premises are leased until June 2005 at a cost of
approximately $13,100 per month. We also occupy 5,500 square feet in
11
Greenville, South Carolina. These premises are leased until October 2003 at a
cost of approximately $4,000 per month.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the
fourth quarter of the fiscal year ended December 31, 2000.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION.
Our Common Stock is quoted under the symbol "IW" on the American Stock
Exchange.
The following table sets forth the high and low sales prices for our
Common Stock as reported by the American Stock Exchange for each quarter
since our initial listing on the American Stock Exchange:
[Download Table]
2000 FISCAL QUARTERS HIGH LOW
---------------------------------------------------------------
First Quarter(1) -- --
Second Quarter(2) $ 8.625 $ 5.500
Third Quarter(3) $16.375 $ 7.875
Fourth Quarter(3) $13.875 $ 3.875
----------
(1) During this period our Common Stock traded only as a unit consisting
of one share of Common Stock and one public warrant to purchase an
additional share of Common Stock.
(2) As of May 1, 2000, our Common Stock and warrants began trading
separately. These prices reflect the sales prices of our Common
Stock beginning on May 1, 2000.
(3) These prices reflect the sales prices of our Common Stock.
HOLDERS.
As of March 15, 2001 there were approximately 250 holders of record of
our Common Stock.
DIVIDENDS.
We have never declared or paid dividends on our Common Stock and do not
anticipate paying any cash dividends on our shares of Common Stock in the
foreseeable future. Pursuant to the terms of our Series B Preferred Stock we are
obligated to pay cumulative cash dividends on shares of Series B Preferred Stock
from legally available funds at the annual rate of $0.2125 per share, payable in
two semi-annual installments of $0.10625 each, which cumulative dividends must
be paid prior to payment of any dividend on our Common Stock.
RECENT SALES OF UNREGISTERED SECURITIES.
In October 2000, we entered into an agreement with Dominick & Dominick
LLC for financial advisory services whereby we agreed to issue warrants to
purchase 3% of our fully diluted common stock at a price equivalent to 110% of
the current market price of our Common Stock. The warrants vest 50% immediately
and 4.17% per month thereafter and are exercisable for a period of five years.
Pursuant to this agreement, we issued 132,184 warrants to purchase shares of
common stock at $10.86 per share in 2000. Such issuance was exempt from
12
registration under the Securities Act pursuant to Section 4(2) thereof, as a
transaction not involving any public offering.
In June 2000, we issued warrants to purchase 31,000 shares of our Common
Stock at a price of $6.25 per share and exercisable for a period of three years,
as consideration for financial consulting services provided by a financial
advisor. Such issuance was exempt from registration under the Securities Act
pursuant to Section 4(2) thereof, as a transaction not involving any public
offering.
In September 2000, we issued warrants to purchase 10,000 shares of our
Common Stock at a price of $15.00 per share to Luce, Forward, Hamilton &
Scripps, LLP as consideration for previously-provided legal services. These
warrants are exercisable for a period of five years. Such issuance was exempt
from registration under the Securities Act pursuant to Section 4(2) thereof, as
a transaction not involving any public offering.
In August 2000, we issued 625,000 shares of our Common Stock pursuant to
our acquisition of ITC. Such issuance was exempt from registration under the
Securities Act pursuant to Section 4(2) thereof, as a transaction not involving
any public offering.
In September 2000, we issued 40,332 shares of our Common Stock pursuant
to an asset purchase agreement between ITC and Goddard. Such issuance was exempt
from registration under the Securities Act pursuant to Section 4(2) thereof, as
a transaction not involving any public offering.
USE OF PROCEEDS FROM REGISTERED SECURITIES.
On March 30, 2000, the SEC declared Amendment No. 2 of our
Registration Statement on Form SB-2 (333-93131) effective. The registered
securities, consisting of 1,875,000 units, were offered to the public on
March 31, 2000, and the offering terminated on the same day, with the sale of
all of the units. The underwriters exercised the over allotment option to
purchase an additional 281,250 units on May 2, 2000. The aggregate offering
price of all of the 2,156,250 units registered and sold aggregated
approximately $17,250,000.
The managing underwriters of the offering were Paulson Investment
Company, Inc. and I-Bankers Securities, Inc. Each unit consisted of one share of
Common Stock and one public warrant to purchase an additional share of Common
Stock. The Common Stock and public warrants traded only as a unit until May 1,
2000, when the units separated and the Common Stock and warrants began trading
separately.
Our net proceeds from the offering and the units sold pursuant to the
underwriters' exercise of the over allotment option aggregated approximately
$15,500,000.
Through December 31, 2000, we had used approximately $14,028,000 of the
proceeds from the offering as follows:
[Download Table]
Underwriters' Commission $1,296,000
Underwriters' Expenses $ 300,000
Other Expenses in Connection With the Offering $ 154,000
Total Expenses in Connection With the Offering $2,436,000
Repayment of Indebtedness $3,540,000
Accrued Liabilities and Dividends $2,935,000
Sales and Marketing $2,000,000
Research and Development $1,629,000
Working Capital and General Corporate Purposes $1,488,000
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere within
this report. Fluctuations in annual and quarterly results may occur as a result
of factors affecting demand for our products such as the timing of new product
introductions by us and by our
13
competitors and our customers' political and budgetary constraints. Due to such
fluctuations, historical results and percentage relationships are not
necessarily indicative of the operating results for any future period.
OVERVIEW
We develop, sell and support a suite of modular software products used by
law enforcement and public safety agencies to manage criminal history records
and to investigate crime. Our software systems and associated hardware enable
our customers to quickly capture, archive, search, retrieve and share digital
photographs and criminal history records. ITC became our wholly owned subsidiary
in August 2000. ITC develops software and designs systems which utilize digital
imaging in the production of photo identification cards and documents. ITC
purchased substantially all the assets of Goddard in September 2000. Goddard
develops software for identification badging systems.
The selected statement of income data and balance sheet data presented
below set forth a summary of data relating to our results of operations. This
data has been derived from our audited consolidated financial statements and
should be read in conjunction with the financial statements and notes included
elsewhere in this report.
[Download Table]
YEAR ENDED DECEMBER 31,
1999 2000
----------- -----------
STATEMENT OF INCOME DATA
Revenues $ 8,939,308 $ 9,398,315
Cost of revenues $ 3,717,397 $ 4,227,757
Gross profit $ 5,221,911 $ 5,170,558
Operating expenses $ 7,686,555 $ 8,941,575
Loss from operations $(2,464,644) $(3,771,017)
Interest expense, net $ 430,882 $ 844,354
Other expense, net $ 501,766 $ 674,000
Loss before income taxes and extraordinary items $(3,397,292) $(5,289,371)
Extraordinary items:
Gain on debt extinguishments
net of income taxes of $0 -- $ 1,168,391
Net loss $(3,397,292) $(4,120,980)
Basic (loss) per share
Loss before extraordinary item $ (2.12) $ (1.55)
Extraordinary item $ -- $ 0.34
----------- -----------
Net loss $ (2.12) $ (1.21)
=========== ===========
Weighted average shares (basic) 1,641,399 3,467,711
[Download Table]
YEAR ENDED DECEMBER 31,
1999 2000
----------- -----------
BALANCE SHEET DATA
Cash $ 159,262 $ 6,899,559
Intangibles, net $ 2,346,557 $ 1,628,096
Total assets $ 6,522,879 $13,005,210
Total current liabilities $ 8,929,407 $ 3,115,439
Notes payable, net of current portion $ 35,542 --
Total liabilities $ 8,964,949 $ 3,115,439
Total shareholders' equity (deficit) $(2,442,070) $ 9,889,771
14
YEARS ENDED DECEMBER 31, 1999 AND 2000
REVENUES. Product revenues increased 6% from $7.48 million for the year
ended December 31, 1999 to $7.90 million for the corresponding period in 2000.
Product revenues related to our Crime Capture System increased 8% from $4.49
million for the year ended December 31, 1999 to $4.86 million for the
corresponding period in 2000 reflect purchases of the Crime Capture System by
new and existing customers. Product revenues from identification card systems
increased 1% from $2.99 million for the year ended December 31, 1999 to $3.03
million for the corresponding period in 2000.
Maintenance revenues increased 3% from $1.46 million for the year ended
December 31, 1999 to $1.50 million for the corresponding period in 2000. In
1999, we offered our UNIX-based customers incentives to upgrade to the
Windows-based Crime Capture System. As part of the upgrade incentives, the
customers received reduced maintenance fees in 1999, a portion of which carried
over into 2000 due primarily to the timing of the installations late in 1999
with 90-day warranties and maintenance commencing 90 days after final system
acceptance. These price reductions were 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 further along with our expanded installed base.
COST OF REVENUES. Cost of products and maintenance increased 14% from
$3.72 million, or 42% of revenue, for the year ended December 31, 1999 to $4.22
million, or 45% of revenue, for the corresponding period in 2000. Cost of
product revenues increased 5% from $2.85 million, or 38% of product revenue, for
the year ended December 31, 1999 to $2.98 million, or 38% of product revenue,
for the corresponding period in 2000. Costs of products can vary as a percentage
of product revenue from period to period depending upon product mix and the
hardware content included in systems installed during a given period. Cost of
maintenance revenue increased $380,000 from $870,000 to $1.25 million primarily
due to the Company increasing staffing levels to maintain optimal service to its
expanding installed base.
GROSS MARGINS. Total gross margins decreased from $5.22 million, or 58%
of revenues, for the year ended December 31, 1999 to $5.17 million, or 55% of
revenues, for the corresponding period in 2000. Gross margins related to product
sales increased from $4.63 million, or 62% of revenues, for the year ended
December 31, 1999, to $4.92 million, or 62% of revenues, for the corresponding
period in 2000. Gross margins related to maintenance revenues decreased from
$590,000 for the year ended December 31, 1999 to $250,000 for the corresponding
period in 2000 due to increased staffing levels and the impact of the upgrades
of our UNIX-based customers on maintenance revenue.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
are comprised primarily of salaries and other employee-related costs for
executive, financial, and other infrastructure personnel. General legal,
accounting and consulting services, insurance, occupancy and communication costs
are also included with general and administrative expenses. Such expenses
increased 25% from $3.42 million for the year ended December 31, 1999 to $4.28
million for the corresponding period in 2000. The increase in general and
administrative expenses was primarily due to professional fees incurred in
conjunction with the ITC merger, higher public company costs consisting
primarily of professional fees and consulting services and increased personnel
costs due to increased headcount.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
the salaries, commissions, other incentive compensation, employee benefits and
travel expenses of our sales force. Such expenses increased 20% from $1.67
million for the year ended December 31, 1999 to $2.00 million for the
corresponding period in 2000 due primarily to increased salaries and commissions
as we enlarged and restructured our sales force to better capture market
opportunities.
RESEARCH AND DEVELOPMENT. Research and development costs consist
primarily of salaries, employee benefits and outside contractors for new product
development, product enhancements and custom integration work. Such expenses
increased 8% from $1.50 million for the year ended December 31, 1999 to $1.63
million for the corresponding period in 2000 due primarily to slightly higher
headcount offset by reduced contract services. We expect to continue to invest
in the development of products for which we believe there is a need in the
15
market; however, there can be no assurance that research and development
programs we invest in will be successful or that products resulting from such
programs will achieve market acceptance.
OPERATING INCOME (LOSS). Operating losses increased $1.31 million, from
$2.46 million for the year ended December 31, 1999 to $3.77 million for the
corresponding period in 2000 due primarily to higher general and administrative
and selling expenses. General and administrative expense, increased due to
acquisition costs related to the ITC and Goddard acquisitions, higher public
company costs consisting primarily of professional fees, and higher personnel
costs due to increased headcount. Selling expenses increased primarily because
of higher salaries and commissions due to sales force restructuring.
EXTRAORDINARY ITEMS. In November 1999, we 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 owned approximately 31% of our shares of
outstanding Common Stock at the time of the issuance of the note). Under the
terms of the note, the principal amount was fixed in Japanese yen and would 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 had not been paid prior to April 1, 2000, the note would have become
convertible to common stock at $1.00 per share. In conjunction with the note, we
issued the individual a warrant to purchase 125,000 shares of common stock for
$6.00 per share. We recorded the note net of a discount equal to the fair value
allocated to the warrants issued of approximately $361,000.
The convertible note also contained a beneficial conversion feature which
resulted in an additional debt discount of $889,000. The value of the beneficial
conversion feature was measured using its intrinsic value, i.e., the excess of
the aggregate fair value of the common stock into which the debt is convertible
over the proceeds allocated to the security. The intrinsic value of the
beneficial conversion feature of approximately $10 million exceeded the proceeds
allocated to the debt of approximately $889,000; therefore, we limited
recognition of the beneficial conversion feature to the approximately $889,000
of proceeds allocated to the debt. We accreted the entire amount of the
beneficial conversion feature as interest expense over the period from the date
of issuance, November 10, 1999, to the date the note becomes immediately
convertible, April 1, 2000, using the effective interest rate method, which
resulted in a charge of $889,000 during the first quarter of 2000.
On April 5, 2000, we used a portion of the proceeds from our initial
public offering to extinguish this outstanding debt. The difference between the
debt payment amount of $1,250,000 and the carrying amount of the debt of
$628,000 was recorded as an extraordinary gain of $622,000 (net of income tax of
$0).
In September 2000, we recorded an extraordinary gain on debt
extinguishment of $547,000, net of income taxes, based on the opinion of legal
counsel that we had no legal obligation to repay such debt.
STOCK-BASED COMPENSATION. On July 1, 2000, we adopted Financial
Accounting Standards Board Interpretation No. 44 (FIN 44), "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of ABP
Opinion No. 25." FIN 44 clarifies the accounting consequences of various
modifications to the terms of a previously granted stock option or award. Due to
a significant decline in the estimated fair value of our Common Stock, in
February 1999 when the Company was private, the exercise price of previously
granted stock options was repriced to $5.28 per share, which was based upon the
fair value of our common stock as of that date, as determined by the Board of
Directors. In accordance with FIN 44, the options are accounted for as variable
from the date of the adoption of FIN 44 until the date the option is exercised,
forfeited, or expires unexercised. For the year ended December 31, 2000, no
additional stock-based compensation expense was required as a result of
revaluing the repriced options under variable accounting treatment.
Additionally, we recognized non-employee stock-based compensation expense of
$478,000 related to the issuance of stock purchase warrants as compensation for
services rendered.
INTEREST EXPENSE, NET. For the year ended December 31, 1999, we
recognized interest income of $7,000 and interest expense of $438,000. For the
year ended December 31, 2000, we recognized interest income of $321,000 and
interest expense of $1,165,000. Our interest expense of $1,165,000 for the year
ended December 31, 2000 includes $889,000 relating to the recognition of a debt
discount resulting from a beneficial conversion feature embedded in our
convertible promissory note issued in November 1999 as more fully explained in
Note 6 to the Consolidated Financial Statements. Interest income increased
substantially due to higher cash and cash equivalents held in interest bearing
accounts, resulting from the proceeds of our initial public offering which we
received on
16
April 5, 2000. Interest expense, exclusive of the $889,000 related to the
beneficial conversion feature described above and in Note 6, decreased due to
the paydown of interest bearing obligations which commenced in the second
quarter of 2000 upon receipt of the initial public offering proceeds.
OTHER EXPENSE. Prior to the consummation of the ITC transaction, ITC
advanced funds to related entities on a regular basis. Due to management's
assessment of the collectibility of the advances from these affiliated entities,
the advances were charged to expense at the time of the advance. Also charged to
expense due to management's estimate of collectibility was a note receivable we
issued to an affiliated entity to secure an acquisition right of first refusal.
Such advances are included in other expenses on the statement of operations. For
the year ended December 31, 1999 and 2000, we recognized non-operating expense
of $500,000 and $674,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES. Since inception, we have funded
operations primarily from proceeds from the sale of stock and borrowings from
individuals and financial institutions. On March 31, 2000, we completed an IPO
of 1,875,000 units, (units consist of one share of common stock and a warrant to
purchase one share of common stock) at $8.00 per unit. Net proceeds aggregated
approximately $13.5 million. The IPO proceeds were received on April 5, 2000. On
May 2, 2000 we received approximately $2.0 million in additional net proceeds
from the exercise of the over allotment option by the underwriter to sell an
additional 281,250 units. During the twelve month period ended December 31,
2000, we received proceeds of $1.7 million from the exercise of 176,673 warrants
and 1,896 options.
As of December 31, 2000, we had total current assets of $10.84 million
and total current liabilities of $3.12 million, or working capital of $7.72
million.
Net cash used in operating activities was $1,913,000 for the year ended
December 31, 1999 as compared to $5,837,000 for the corresponding period in
2000. We used cash to fund net losses of $3,397,000 for the year ended December
31, 1999 and $4,121,000 for the corresponding period in 2000. For the year ended
December 31, 1999, we used cash of $2,170,000 to fund increases in current
assets offset by increases in current liabilities of $2,102,000 (excluding debt)
and $1,552,000 from non cash expenses (depreciation, amortization and non cash
compensation). In 2000, we used cash of $252,000 to fund increases in current
assets and intangible assets, $2,798,000 from decreases in current liabilities
and deferred revenues (excluding debt) offset by $1,334,000 from non cash
expenses (depreciation, amortization and non cash compensation and extraordinary
gain on debt extinguishment).
Net cash used by investing activities was $26,000 for the year ended
December 31, 1999 as compared to $708,000 for the corresponding period in 2000.
We used cash to fund capital expenditures of computer equipment and software,
furniture and fixtures and leasehold improvements of approximately $392,000 for
the year ended December 31, 2000. The level of equipment purchases resulted
primarily from continued growth of the business and replacement of older
equipment. We used cash of approximately $300,000 to secure non-competition
agreements from key personnel of businesses acquired during the year ended
December 31, 2000.
Net cash generated by financing activities was $2,053,000 for the year
ended December 31, 1999 as compared to $13,285,000 for the corresponding period
in 2000. Net cash generated for the year ending December 31, 2000 was primarily
from net proceeds of $15,579,000 from our initial public offering and $1,704,000
from the exercise of options and warrants, and $156,000 from the issuance of
notes payable, offset by repayment of loans of $3,844,000, dividends paid on our
Series B preferred stock of $246,000 and the repurchase of $64,000 of our Common
Stock.
We believe that the funds held in cash and cash equivalents and funds
provided by operations will be sufficient to finance our working capital
requirements for at least the next twelve months.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements are included herein following Part III, Item 13,
and are filed as part of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
17
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information concerning the identification and business experience of
our directors is set forth in the definitive proxy statement for the 2001 Annual
Meeting of Shareholders under the heading "Proposal 1-Election of Directors,"
which information is incorporated herein by reference.
The information concerning the identification and business experience of
our executive officers is set forth in the definitive proxy statement for the
2001 Annual Meeting of Shareholders under the heading "Executive Officers,"
which information is incorporated herein by reference.
The information concerning compliance with Section 16(a) of the Exchange
Act is set forth in ImageWare's definitive proxy statement for the 2001 Annual
Meeting of Shareholders under the heading "Security Ownership of Certain
Beneficial Owners and Management--Section 16(a) Beneficial Ownership Reporting
Compliance," which information is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information concerning executive compensation is set forth in the
definitive proxy statement for the 2001 Annual Meeting of Shareholders under the
heading "Executive Compensation," which information is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information concerning security ownership of certain beneficial
owners and management is set forth in the definitive proxy statement for the
2001 Annual Meeting of Shareholders under the heading "Security Ownership of
Certain Beneficial Owners and Management," which information is incorporated
herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information concerning certain relationships and related transactions
is set forth in the definitive proxy statement for the 2001 Annual Meeting of
Shareholders under the heading "Certain Transactions," which information is
incorporated herein by reference.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------ ------------------------------------------------------------
2.1 Agreement of Merger and Plan of Reorganization dated July 6,
2000, among the Company, Imaging Technology Corporation and
ITC Acquisition Corporation****
2.2 First Amendment to the Agreement of Merger and Plan of
Reorganization dated August 11, 2000****
2.3 Plan and Agreement of Reorganization among Goddard
Technology Corporation and Imaging Technology Corporation
dated as of September 13, 2000
2.4 Asset Purchase Agreement dated March 8, 2001, among the
Company, I.W. Systems Canada Company, G&A Imaging Ltd. and
R&G Imaging Ltd.
2.5 First Amendment to Asset Purchase Agreement dated March 29,
2001
3.1 Amended and Restated Articles of Incorporation of ImageWare
Systems, Inc.*
3.2 Bylaws of ImageWare Systems, Inc.*
4.1 Form of Common Stock Certificate*
4.2 Reference is made to page 1-5 and 12-15 of Exhibit 3.2*
18
EXHIBIT
NUMBER DESCRIPTION
------ ------------------------------------------------------------
4.3 Form of Public Warrant*
4.4 Form of Representatives' Warrant**
4.5 Form of Warrant and Unit Agreement***
4.6 Convertible Promissory Note in favor of Naoya Harano dated
November 10, 1999**
4.7 Stock Purchase Warrant in favor of Naoya Harano dated
November 10, 1999***
4.8 Form of Warrant (Former XImage Shareholders)*
4.9 Form of Warrant (Former XImage Officers, Noteholders and
Other Investors)*
4.10 Form of Warrant (Officers and directors)*
4.11 Warrant to Purchase Common Stock in favor of Imperial Bank*
4.12 Registration Rights Agreement with R. Squared Limited dated
February 1999*
4.13 Promissory Note in favor of Chester L.F. Paulson dated
November 1999*
10.1 Employment Agreement with S. James Miller dated January 1,
1996, as amended September 1997*
10.2 Employment Agreement with Wayne G. Wetherell dated April 1,
1997, as amended March 1, 1999*
10.3 Employment Agreement with Paul J. Devermann dated July 20,
1997, as amended March 1, 1999*
10.4 Employment Agreement with William Ibbetson dated November
15, 2000
10.5 Form of Indemnity Agreement entered into by the registrant
with its directors and executive officers*
10.6 Consulting Agreement with John Callen dated November 14,
2000.
10.7 1994 Employee Stock Option Plan*
10.8 1994 Nonqualified Stock Option Plan*
10.9 1999 Stock Option Plan*
10.10 Loan and Indemnification Agreement with Chester L.F.
Paulson*
10.11 Value Added Reseller Agreement with Intelligence and
Strategic Processes Pty. Ltd. dated January 1, 1999*
10.12 Lease between Thormint I and the Company dated June 9, 1998*
10.13 Lease between RDL Holding, LTD and Imaging Technology
Corporation dated July 1, 2000.
10.14 Teaming Agreement with PRC Inc. dated November 5, 1998*
10.15 Memorandum of Understanding with Polaroid Corporation dated
September 13, 1999*
10.16 Teaming Agreement with H.T.E., Inc. dated August 6, 1999*
10.17 Software License and Services Subcontract with PRC Inc.
dated June 29, 1999*
10.18 Agreement with State Procurement Office of Arizona dated
January 14, 1999*
10.19 Subcontract Agreement between Science Applications
International Corporation and Ximage Corporation dated
September 26, 1996 with regard to the City of New York
Police Department*
10.20 License Agreement with Atlus Co., Ltd. Dated March 7, 1997*
10.21 Value Added Reseller Agreement with Visionics Corporation
dated October 7, 1998*
21 Subsidiaries of the Small Business Issuer
23 Consent of PricewaterhouseCoopers LLP, independent auditors
---------------
* Incorporated by reference to the Company's Registration Statement for
Small Business Issuers, Form SB-2 as filed with the SEC on December 20,
1999 (No. 333-93131).
** Incorporated by reference to the Company's Amended Registration Statement
for Small Business Issuers, Form SB-2/A as filed with the SEC on February
8, 2000.
*** Incorporated by reference to the Company's Amended Registration Statement
for Small Business Issuers, Form SB-2/A as filed with the SEC on March
15, 2000.
19
**** Incorporated by reference to the Company's Current Report, Form 8-K as
filed with the SEC on August 22, 2000.
(B) REPORTS ON FORM 8-K.
The Company filed a report on Form 8-K on September 7, 2000 to report its
acquisition of ITC on August 22, 2000.
20
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
IMAGEWARE SYSTEMS, INC.
March 30, 2001 By: /s/ S. James Miller, Jr.
----------------------------------------
S. JAMES MILLER, JR.
Chief Executive Officer, President and
Chairman of the Board of Directors
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
[Enlarge/Download Table]
SIGNATURE TITLE DATE
--------- ----- ----
/s/ S. James Miller, Jr. Chief Executive Officer, President and Chairman March 30, 2001
----------------------------------------------- of the Board of Directors (PRINCIPAL EXECUTIVE
S. James Miller, Jr. OFFICER)
/s/ Wayne G. Wetherell Vice President of Finance and Chief Financial March 30, 2001
----------------------------------------------- Officer (PRINCIPAL FINANCIAL AND ACCOUNTING
Wayne G. Wetherell OFFICER)
/s/ John Callan Director March 30, 2001
-----------------------------------------------
John Callan
/s/ Patrick J. Downs Director March 30, 2001
-----------------------------------------------
Patrick J. Downs
/s/ John L. Holleran Director March 30, 2001
-----------------------------------------------
John L. Holleran
/s/ Yukuo Takenaka Director March 30, 2001
-----------------------------------------------
Yukuo Takenaka
21
IMAGEWARE SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS F-2
CONSOLIDATED FINANCIAL STATEMENTS:
BALANCE SHEETS F-3
STATEMENTS OF OPERATIONS F-4
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) F-5
STATEMENTS OF CASH FLOW F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To Board of Directors and Shareholders 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 subsidiaries at December 31, 1999 and 2000, and
the results of their operations and their cash flows for each of the two years
then ended in conformity with accounting principles generally accepted in the
United States of America. 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 of America, 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 our opinion.
PricewaterhouseCoopers LLP
San Diego, CA
March 9, 2001
F-2
IMAGEWARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
[Enlarge/Download Table]
DECEMBER 31,
------------------------------
1999 2000
------------ ------------
(RESTATED -
SEE NOTE 3)
Current Assets:
Cash $ 159,262 $ 6,899,559
Accounts receivable, net 3,358,306 2,944,755
Inventory 275,463 286,235
Other assets 191,493 711,221
------------ ------------
Total Current Assets 3,984,524 10,841,770
Property and equipment, net 191,798 535,344
Intangible assets, net of accumulated amortization of $2,172,888 in 1999
and $3,108,770 in 2000 2,346,557 1,628,096
------------ ------------
TOTAL ASSETS $ 6,522,879 $ 13,005,210
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,979,410 $ 790,905
Deferred revenue 883,589 610,704
Accrued expenses 2,226,876 751,841
Accrued expenses - related parties 456,237 320,769
Deferred compensation 294,330 --
Accrued interest 636,793 299,165
Notes & advances payable to bank and 3rd parties 500,000 131,930
Current portion of notes payable to related parties 1,952,192 210,125
------------ ------------
Total Current Liabilities 8,929,407 3,115,439
Notes payable to related parties, net of current portion 35,542 --
------------ ------------
Total Liabilities 8,964,949 3,115,439
Commitments and Contingencies
Shareholders' equity (deficit):
Preferred stock, $.01 par value, authorized 4,000,000 shares Series B
convertible redeemable preferred stock, designated 750,000 shares, 389,400
shares issued, 389,400 and 334,400 shares outstanding in 1999 and 2000
respectively, $973,500 and $836,000
liquidation preference in 1999 and 2000 3,894 3,344
Common stock, $.01 par value, 50,000,000 shares authorized,
1,786,802 and 4,183,958 shares issued and outstanding 16,618 40,724
Additional paid in capital 17,715,346 34,667,147
Unearned stock-based compensation -- (63,126)
Treasury stock, at cost - 6,704 shares -- (63,688)
Shareholder note receivable -- (150,000)
Accumulated deficit (20,177,928) (24,544,630)
------------ ------------
Total shareholders' equity (deficit) (2,442,070) 9,889,771
------------ ------------
TOTAL SHAREHOLDERS' EQUITY AND LIABILITIES $ 6,522,879 $ 13,005,210
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
IMAGEWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31,
1999 2000
----------- -----------
(Restated -
See Note 3)
REVENUES:
Product $ 7,477,038 $ 7,895,757
Maintenance 1,462,270 1,502,558
----------- -----------
8,939,308 9,398,315
COST OF REVENUES:
Product 2,846,837 2,975,272
Maintenance 870,560 1,252,485
----------- -----------
Gross profit 5,221,911 5,170,558
----------- -----------
OPERATING EXPENSES:
General & administrative 3,417,669 4,284,231
Sales and marketing 1,667,838 2,009,311
Research & development 1,504,564 1,628,908
Depreciation and amortization 1,096,484 1,019,125
----------- -----------
7,686,555 8,941,575
----------- -----------
Loss from operations (2,464,644) (3,771,017)
Interest expense, net 430,882 844,354
Other expense, net 501,766 674,000
----------- -----------
Loss before income taxes and extraordinary items (3,397,292) (5,289,371)
Income taxes -- --
----------- -----------
Loss before income taxes and extraordinary items (3,397,292) (5,289,371)
Extraordinary items:
Gain on debt extinguishments net of income taxes of $0 -- 1,168,391
----------- -----------
Net loss $(3,397,292) $(4,120,980)
=========== ===========
Basic and diluted (loss) per share - see note 2
Loss before extraordinary item $ (2.12) $ (1.55)
Extraordinary item $ -- $ 0.34
----------- -----------
Net loss $ (2.12) $ (1.21)
=========== ===========
Weighted average shares (basic and diluted) 1,641,399 3,467,711
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
IMAGEWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000
[Enlarge/Download Table]
SERIES B CONVERTIBLE,
REDEEMABLE PREFERRED COMMON STOCK TREASURY STOCK
--------------------------- -------------------------- --------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------ ------------ --------
Balance at December 31, 1998 389,400 $ 3,894 899,081 $ 8,991 -- $ --
Restatement to give effect to issuance
of pooling shares -- -- 625,000 5,000 --
------------ ------------ ------------ ------------ ------------ --------
Restated Balances 389,400 3,894 1,524,081 13,991 -- --
Issuance of common stock for loan guarantees -- -- 73,466 735 -- --
Issuance of common stock for cash -- -- 47,393 473 -- --
Conversion of note payable to common stock -- -- 141,862 1,419 -- --
Financing commission -- -- -- --
Beneficial conversion feature of convertible
debt
Detachable warrants issued with debt -- -- -- -- -- --
Net loss
------------ ------------ ------------ ------------ ------------ --------
Balance at December 31, 1999 389,400 3,894 1,786,802 16,618 -- --
Issuance of common stock for cash, net of
financing commissions and IPO expenses -- -- 2,156,250 21,563 -- --
Issuance of common stock pursuant to
option and warrant exercise for cash -- -- 178,569 1,786 -- --
Issuance of common stock pursuant to
warrant exercise for note receivable -- -- 25,000 250 -- --
Warrants issued to non- employees
for services -- -- -- -- --
Elimination of beneficial conversion feature
upon debt extinguishment
Preferred Stock conversion to common stock (55,000) (550) 10,423 104 -- --
Dividends on Series B Preferred Stock -- -- -- -- --
Issuance of common stock for asset purchase -- -- 40,322 403 --
Deferred compensation for stock options
granted to employees -- -- -- -- --
Amortization of stock-based compensation -- -- -- -- --
Repurchase of common shares -- -- -- (6,704) (63,688)
Net loss -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ --------
Balance at December 31, 2000 334,400 $ 3,344 4,197,366 $ 40,724 (6,704) $(63,688)
============ ============ ============ ============ ============ ========
UNEARNED
ADDITIONAL STOCK SHAREHOLDER
PAID-IN BASED NOTE ACCUMULATED
CAPITAL COMPENSATION RECEIVABLE DEFICIT TOTAL
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1998 $ 14,792,783 $- $- $(16,251,033) $ (1,445,365)
Restatement to give effect to issuance
of pooling shares 226,626 -- -- (529,603) (297,977)
------------ ------------ ------------ ------------ ------------
Restated Balances 15,019,409 -- -- (16,780,636) (1,743,342)
Issuance of common stock for loan guarantees 348,044 -- -- -- 348,779
Issuance of common stock for cash 374,527 -- -- -- 375,000
Conversion of note payable to common stock 738,290 -- -- -- 739,709
Financing commission (15,000) -- -- -- (15,000)
Beneficial conversion feature of convertible
debt 889,000 889,000
Detachable warrants issued with debt 361,076 -- -- -- 361,076
Net loss (3,397,292) (3,397,292)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1999 17,715,346 -- -- (20,177,928) (2,442,070)
Issuance of common stock for cash, net of
financing commissions and IPO expenses 14,792,862 -- -- -- 14,814,425
Issuance of common stock pursuant to
option and warrant exercise for cash 1,701,796 -- -- -- 1,703,582
Issuance of common stock pursuant to
warrant exercise for note receivable 149,750 -- (150,000) -- --
Warrants issued to non- employees
for services 501,662 -- 501,662
Elimination of beneficial conversion feature
upon debt extinguishment (889,000) (889,000)
Preferred Stock conversion to common stock 446 -- -- -- --
Dividends on Series B Preferred Stock -- -- (245,722) (245,722)
Issuance of common stock for asset purchase 599,597 -- -- -- 600,000
Deferred compensation for stock options
granted to employees 94,688 (94,688) -- -- --
Amortization of stock-based compensation -- 31,562 -- -- 31,562
Repurchase of common shares -- -- -- -- (63,688)
Net loss -- -- -- (4,120,980) (4,120,980)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2000 $ 34,667,147 $ (63,126) $ (150,000) $(24,544,630) $ 9,889,771
============ ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
IMAGEWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000
[Enlarge/Download Table]
1999 2000
------------ ------------
(Restated -
See Note 3)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,397,292) $ (4,120,980)
Adjustments to reconcile net loss to net cash used by
operating activities
Depreciation and amortization 1,096,485 1,019,125
Amortization of debt discount 32,002 951,000
Stock-based compensation 423,467 533,227
Deferred revenue 268,959 (272,885)
Extraordinary gain on debt extinguishment -- (1,168,391)
Change in assets and liabilities
Accounts receivable, net (1,710,990) 572,311
Inventory (38,162) 68,521
Other current assets 71,439 (504,737)
Intangible assets (492,522) (388,530)
Accounts payable 639,698 (1,233,815)
Accrued expenses 824,227 (1,160,420)
Deferred compensation 369,668 (294,330)
Accrued interest (264) 163,073
Total adjustments 1,484,007 (1,715,851)
------------ ------------
Net cash used by operating activities (1,913,285) (5,836,831)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (26,371) (391,784)
Acquisition of business, net of cash acquired 8,839
Payment on advances from related stockholders (25,000)
Purchase of other long-term assets (300,000)
------------ ------------
Net cash used by investing activities (26,371) (707,945)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 2,528,125 156,000
Repayment of notes payable (850,000) (3,844,467)
Proceeds from issuance of stock, net of issuance costs 375,000 15,579,375
Proceeds from exercise of options and warrants -- 1,703,575
Repurchase of common stock -- (63,688)
Dividends paid -- (245,722)
------------ ------------
Net cash provided by financing activities 2,053,125 13,285,073
------------ ------------
Net increase in cash 113,469 6,740,297
Cash at beginning of year 45,793 159,262
------------ ------------
Cash at end of year $ 159,262 $ 6,899,559
============ ============
Supplemental cash flows information
Cash paid for interest $ 141,930 $ 392,984
Conversion of notes payable to common stock $ 650,000 $ --
Issuance of common stock to loan guarantors $ 348,779 $ --
Exercise of warrants for note receivable $ -- $ 150,000
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
IMAGEWARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000
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.
The Company develops, sells and supports a suite of modular software products
used by law enforcement and public safety agencies to manage criminal history
records and to investigate crime and designs systems which utilize digital
imaging in the production of photo identification cards, documents and
identification badging systems.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. 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 of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
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 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. Long-lived assets and identifiable intangibles are
reviewed for impairment using fair value methodologies whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. At December 31, 1999 and 2000, there was no impairment of the
Company's long-lived assets.
INTANGIBLE ASSETS. Intangible assets consist of patents, goodwill and
non-competition agreements which are stated at cost. Amortization is calculated
using the straight-line method over the period of estimated economic benefit of
five years for patents, four years for goodwill and over the life of
non-competition agreements which range from two to three years.
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 $229,528 and $226,096 at December 31, 1999
and 2000, respectively.
In 1999, there were no customers who accounted for more than 10% of the
Company's revenues. In 2000, one customer accounted for 12% of the Company's
revenues.
As of December 31, 1999, one customer accounted for 11% of total accounts
receivable. At December 31, 2000, the Company had no amounts due from customers
who accounted for 10% or greater of total accounts receivable.
STOCK-BASED COMPENSATION. Stock-based compensation to employees has been
recognized as the difference between the per share fair value of the underlying
stock and the stock option exercise at the initial grant
F-7
date. The cost of stock options granted for services, other than those issued to
employees, are recorded at the fair value of the stock option.
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.
REVENUE RECOGNITION. 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. The Company's revenue from periodic maintenance agreements is
generally recognized ratably over the respective maintenance periods provided no
significant obligations remain and collectibility of the related receivable is
probable. Amounts received under contracts in advance of performance are
recorded as deferred revenue and are recognized when performance is complete
which is generally within one year from receipt. Contract losses are recorded as
a charge to income in the period such losses are 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.
In December 1999, the SEC issued Staff Accounting Bulletin 101, "Revenue
Recognition," or SAB 101, which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosure related to revenue recognition policies.
The adoption of the principles of SAB 101 has not had a significant impact on
the Company's financial statements.
CAPITALIZED SOFTWARE DEVELOPMENT 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 (LOSS) PER SHARE. Effective November 29, 1999, the Company
declared a 5.275-for-1 reverse stock split of common stock. On August 22, 2000
the Company consummated a merger that was accounted for as a
pooling-of-interests. 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 and the
pooling of interests transaction.
Basic earnings (loss) 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, if dilutive, had been issued. The dilutive effect of
outstanding stock options is included in the calculation of diluted earnings per
common share, if dilutive, using the treasury stock method. During the years
ended December 31, 1999 and 2000, 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.
The following table sets forth the computation of basic and diluted loss
per share for the years ended December 31, 1999 and 2000:
F-8
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31,
1999 2000
----------- -----------
Numerator
Loss before income taxes and extraordinary item $(3,397,292) $(5,289,371)
Less Series B preferred dividends (82,748) (80,096)
----------- -----------
Loss available to common shareholders before extraordinary
items $(3,480,040) $(5,369,467)
Extraordinary items - see note 14 $ -- $ 1,168,391
----------- -----------
Net loss available to common shareholders $(3,480,040) $(4,201,076)
=========== ===========
Denominator
Weighted-average shares outstanding 1,641,399 3,467,711
=========== ===========
Basic and diluted loss per share before extraordinary item $ (2.12) $ (1.55)
Extraordinary item $ -- $ 0.34
----------- -----------
Net loss $ (2.12) $ (1.21)
----------- -----------
SEGMENT INFORMATION
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. ACQUISITIONS
On August 22, 2000, the Company consummated a merger with Imaging
Technology Corporation ("ITC") by acquiring all of the outstanding common stock
of ITC in exchange for newly issued common stock of ImageWare Systems Inc.
whereby ITC became a wholly-owned subsidiary of the Company (the "ITC
transaction"). The transaction was accounted for as a pooling of interests and,
accordingly, the accompanying consolidated financial statements have been
restated to include the accounts and operations of ITC for all periods
presented. The Company issued 1.231527 shares of its common stock for each share
of ITC's outstanding common stock and $200,000 as consideration for the
execution of non-competition agreements. The ITC transaction increased the
Company's outstanding shares of common stock by 625,000 shares.
The consolidated balance sheets at December 31, 1999 and 2000, reflect
the combining of (a) ImageWare Systems, Inc. prior to consummation of the ITC
transaction and (b) ITC as of those dates. Combined and separate results of
operations for the year ended December 31, 1999 and 2000 of ImageWare Systems,
Inc. and ITC for the restated periods are as follows:
[Enlarge/Download Table]
IMAGEWARE SYSTEMS IMAGING TECHNOLOGY COMBINED
----------------- ------------------ ------------------
YEAR ENDED DECEMBER 31, 2000:
Operating Revenues $ 6,275,587 $ 2,844,615 $ 9,120,202
Income (loss) from continuing
operations before income taxes (4,447,240) (677,475) (5,124,715)
Net (loss) (3,278,849) (677,475) (3,956,324)
YEAR ENDED DECEMBER 31, 1999:
Operating Revenues 5,891,477 3,047,831 8,939,308
Income (loss) from continuing
operations before income taxes (3,034,594) (362,698) (3,397,292)
Net (loss) (3,034,594) (362,698) (3,397,292)
F-9
In connection with the ITC transaction, the Company incurred direct
transaction costs of $255,000 consisting primarily of professional fees which
were expensed.
On September 29, 2000, the Company completed the purchase of Goddard
Technology Corporation ("Goddard"), a privately held developer of software
identification badging systems, by acquiring substantially all of its assets for
shares of common stock of the Company and the assumption of certain liabilities
for a total purchase price of $600,000. The acquisition was accounted for using
the purchase method of accounting and, accordingly, Goddard's results of
operations have been included in the consolidated financial statements since the
date of acquisition.
The following table presents the allocation of the acquisition cost to
the assets acquired and liabilities assumed:
[Download Table]
Cash and cash equivalents $ 8,840
Accounts receivable 158,760
Inventories 79,293
Other current assets 14,990
Property, plant, and equipment, net 68,338
Goodwill 335,505
---------
Total assets 665,726
---------
Amounts payable to banks and long-term debt due within
one year (20,392)
Other current liabilities (45,334)
---------
Total liabilities (65,726)
---------
Total acquisition cost $ 600,000
=========
The following (unaudited) pro forma consolidated results of operations
have been prepared as if the acquisition of Goddard had occurred at January 1,
1999:
[Download Table]
DECEMBER 31, 1999 DECEMBER 31, 2000
----------------- -----------------
Revenues $ 10,410,566 $ 10,294,789
Net Loss $ (3,391,705) $ (4,119,370)
Net loss per share-- basic $ (2.12) $ (2.56)
4. RESTRICTED CASH
At December 31, 2000, the Company has $529,663 of restricted cash which
is classified as other current assets. The restricted cash serves as collateral
for irrevocable standby letter of credits that provide financial assurance that
the Company will fulfill its obligations under certain commitments discussed in
Note 8. The cash is held in custody by the issuing bank, is restricted as to
withdrawal or use, and is currently invested in time certificates of deposits.
Income from these investments is paid to the Company.
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1999 and 2000 consists of:
[Download Table]
1999 2000
----------- -----------
Equipment $ 839,990 $ 1,289,043
Furniture 63,314 192,944
----------- -----------
903,304 1,481,987
Less accumulated depreciation (711,506) (946,643)
----------- -----------
$ 191,798 $ 535,344
=========== ===========
F-10
Total depreciation expense for the years ended December 31, 1999 and 2000
was $113,780 and $116,576, respectively.
6. NOTES PAYABLE
Notes payable consists of the following:
[Enlarge/Download Table]
1999 2000
----------- -----------
Short-term note payable to shareholder. Such note accrues interest at
prime and is due upon demand. This note was paid in July 2000 $ 30,000 $ 0
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. This note was paid in June 2000 208,150 0
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. This note was paid in June 2000 50,000 0
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 $1,217,998
as of December 31, 1999. This note was paid in April 2000 32,002 0
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. This note was paid in April, 2000 500,000 0
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. This
note was paid in April 2000 500,000 0
Short-term notes payable to lending institution. Such notes accrue at
prime plus 2%and were due September 28, 1999. This note was paid in April 2000 100,000 0
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. This note was paid in April 2000 55,000 0
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
These notes were paid in April 2000 550,000 0
F-11
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. These
notes were repaid in April 2000 152,000 0
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
This note was paid in April 2000 51,000 0
Short-term note payable to third party to accrue interest at 10%. Note
due upon demand 0 100,000
Short-term note payable to third party 0 13,703
Short-term note payable to ITC shareholders. Such note accrued interest at 10%
and is due upon demand 233,125 210,125
Short-term notes payable to certain vendors 26,457 18,227
----------- -----------
Less current portion 2,487,734 342,055
----------- -----------
Long-term notes payable $ 35,542 $ 0
=========== ===========
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 Black-Scholes 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 April 2000, the Company paid the remaining
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 June 2000, the Company paid the note.
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 owned approximately 31% of the Company's common
shares outstanding at the time of note issuance). Under the terms of the note,
the principal amount was fixed in Japanese yen and repayable 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 had not been paid prior to April
1, 2000, the note became convertible to common stock at $1.00 per share. In
conjunction with the note, the Company issued the individual a warrant to
purchase 125,000 shares of common stock for $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.
The convertible note also contained a beneficial conversion feature which
resulted in additional debt discount of $889,000. The value of the beneficial
conversion feature was measured using its intrinsic value, i.e., the excess of
the aggregate fair value of the common stock into which the debt is convertible
over the proceeds allocated to the security. The intrinsic value of the
beneficial conversion feature of approximately $10 million exceeded the proceeds
allocated to the debt of approximately $889,000; therefore, the Company limited
recognition of the beneficial conversion feature to the approximately $889,000
of proceeds allocated to the debt. The Company accreted the entire amount of the
beneficial conversion feature as interest expense over the period from the date
of issuance, November 10, 1999, to the date the note becomes immediately
convertible, April 1, 2000, using the effective interest rate method, which
resulted in a charge of $889,000 during the 1st quarter of 2000.
F-12
On April 5, 2000, the Company used a portion of the proceeds from its
initial public offering to extinguish this outstanding debt. The difference
between the debt payment amount of $1,250,000 and the carrying amount of the
debt of $628,000, net of income taxes, was recorded as an extraordinary gain of
$622,000.
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 was 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. This note was paid in
April 2000.
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. The balances on these obligation was paid in April 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.
7. INCOME TAXES
Due to the Company's net loss position for the years ended December 31,
1999 and 2000 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, 1999
and 2000:
[Download Table]
1999 2000
------ ------
Tax provision (benefit) at statutory rate (34)% (34%)
State tax, net of federal benefit (3) (2)
Research credits (3) (2)
Goodwill amortization 10 7
Other permanent differences 6 0
Net change in valuation allowance 24 31
--- ---
0% 0%
=== ===
The components of the net deferred tax assets at December 31, 1999 and
2000 are as follows:
[Download Table]
1999 2000
----------- -----------
Intangible assets $ 122,012 $ 106,703
Fixed assets (40,060) (48,548)
Reserve and accrued expenses 162,640 310,264
Net operating loss carryforwards 2,335,618 3,335,617
Research credit carryforwards 330,888 428,587
----------- -----------
(2,911,098) 4,123,623
Less valuation allowance (2,911,098) (4,123,623)
----------- -----------
Net deferred tax assets $ 0 $ 0
=========== ===========
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 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, 1999 and 2000, the Company had federal net operating loss
carryforwards of approximately $6,200,000 and $8,800,000, respectively, and
state net operating loss carryforwards of approximately $3,900,000 and
$4,800,000, respectively, which may be available to offset future taxable income
for tax purposes. The federal
F-13
net operating loss carryforwards expire at various dates from 2002 through 2020.
The California net operating loss carryforwards expire at various dates from
2001 through 2005.
The Company also had federal research credit carryforwards of
approximately $227,000 and $290,000 and state research credit carryforwards of
approximately $103,000 and $138,000 for tax purposes at December 31, 1999 and
2000, 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, 1995 and 2000. The effect of the existing
limitations has been reflected in the above summary of deferred tax assets.
8. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENTS
The Company has employment agreements with its President, Vice President
of Finance, Vice President of Sales and Business Development and Vice President
of Research and 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, Sales and Business Development, and of Research and
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 the Company's operating lease for its
office and research and development facilities, the Company is contingently
liable under an irrevocable standby letter of credit in the amount of $120,000.
The letter of credit expires July 31, 2003 and was reduced to $90,000 on August
1, 2000, and will further reduce to $60,000 on August 1, 2001, and $30,000 on
August 1, 2002 provided there are no drawings against the outstanding balance.
As a condition, the bank required the Company to invest $120,000 in the form of
a one year certificate of deposit which matures in June 2001. As of December 31,
2000, there were no drawings against the outstanding balance.
As collateral for performance on various software installation and
implementation contracts, the Company is contingently liable under irrevocable
standby letter of credits in an aggregate amount of approximately $410,000.
These letters of credit expire at various times in September 2001: $300,000 in
February 2001; $45,000 in June 2001; and $65,000 in July 2001. As a condition,
the bank required the Company to invest an equal amount in the form of
certificates of deposit, which matures at various times during 2001.
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. As of December 31, 2000, the Company was not a
party to any pending legal proceedings.
LEASES
The Company currently leases office and research and development space
under operating leases which expire at various dates through June 2005.
F-14
At December 31, 2000, future minimum lease payments are as follows:
[Download Table]
OPERATING CAPITAL
YEAR ENDING DECEMBER 31 LEASES LEASES TOTAL
------------------------- ------------ ------------ ------------
2001 .................... $ 493,222 $ 3,540 $ 496,762
2002 .................... 503,930 0 503,930
2003 .................... 372,959 0 372,959
2004 .................... 157,299 0 157,299
2005 .................... 78,649 0 78,649
------------ ------------ ------------
$ 1,606,059 $ 3,540 $ 1,609,599
============ ============ ============
Rental expense under operating leases for the years ended December 31,
1999 and 2000 was $396,599 and $441,261, respectively.
9. 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
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.
The Company issued 73,466 and 0 shares of common stock during 1999 and
2000, respectively, to certain officers and directors as compensation for
personally guaranteeing the $1,200,000 bank note. The estimated fair value of
$348,779 in 1999 was capitalized as loan fees and amortized as interest expense
over the term of the note.
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, 1999, the Company had 389,400 shares of Series B
outstanding. During 2000, 55,000 shares were converted into 10,423 shares of
common stock. At December 31, 1999 and 2000, the Company had cumulative
undeclared dividends of $177,573 and $13,523, respectively.
F-15
WARRANTS
As of December 31, 2000, warrants to purchase 2,908,116 shares of common
stock at prices ranging from $6.00 to $31.65 were outstanding. All warrants are
exercisable as of December 31, 2000 and expire at various dates through December
2005.
10. 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 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. The Company is 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 years ended December 31, 1999
and 2000, the Company recorded no compensation expense as the exercise price was
equal or above 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.
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, 1999
and 2000:
[Download Table]
1999 2000
-------------- --------------
NET LOSS
As reported .............. (3,397,292) $ (4,120,980)
Pro forma ................ (3,468,953) (4,767,988)
EARNINGS PER COMMON SHARE
As reported .............. $ (2.12) $ (1.21)
Pro forma ................ (2.16) (1.40)
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 4.46% to 6.16%,
expected stock volatility of 40%, and expected lives of five years. The
volatility of the Company's common
F-16
stock underlying the options was not considered for options granted up to March
31, 2000 because the Company's stock was not publicly traded. For purposes of
pro forma disclosures, the estimated fair value of options is amortized to
expense over the options' vesting periods using an accelerated graded method in
accordance with Financial Accounting Standards Board Interpretation 28.
The following table summarizes employee stock option activity since
December 31, 1998:
[Download Table]
WEIGHTED- AVERAGE
OPTIONS EXERCISE PRICE
--------- --------------
Balance at December 31, 1998 148,152 $5.28
Granted 277,275 $6.37
Expired/canceled (148,152) $5.28
---------
Balance at December 31, 1999 277,275 $6.37
Granted 363,248 $6.36
Expired/canceled (45,924) $6.46
Exercised (1,896) $5.28
---------
Balance at December 31, 2000 592,703 $6.36
=========
At December 31, 2000, a total of 222,328 options were exercisable at a
weighted average price of $6.08 per share.
The following table summarizes information about employee stock options
outstanding and exercisable at December 31, 2000:
[Enlarge/Download Table]
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- -------------------------------
WEIGHTED- AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING LIFE AVERAGE EXERCISE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING (YEARS) PRICE EXERCISABLE EXERCISE PRICE
-------------- ----------- ------- ----- ----------- --------------
$ 5.28-6.29 486,210 4.01 $5.93 179,961 $5.57
$ 8.00 96,493 3.95 $8.00 39,035 $8.00
$11.00 10,000 4.78 $11.00 3,333 $11.00
--------- -------
TOTAL 592,703 222,328
========= =======
The weighted-average grant-date fair value per share of options granted
to employees during the years ended December 31, 1999 and 2000 was $1.12 and
$2.94, respectively.
11. 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. The Company made a contribution
in 2000 for the 1999 plan year of $14,274 and made a contribution of $42,031 in
2001 for the 2000 plan year.
12. EXTRAORDINARY GAINS
As more fully explained in Note 6, on April 5, 2000, the Company used a
portion of the proceeds from its initial public offering to extinguish an
outstanding debt. The difference between the debt payment amount of
F-17
$1,250,000 and the carrying amount of the debt of approximately $628,000 was
recorded as an extraordinary gain of $622,000.
In September 2000, the Company recorded an extraordinary gain on debt
extinguishment of $547,000, net of income taxes, based on the opinion of legal
counsel that there exists no legal obligation to the Company regarding the
repayment of the aforementioned debt.
13. RELATED PARTY TRANSACTIONS
On March 30, 2000, two officers of the Company loaned ImageWare $56,000
pursuant to promissory notes. This debt was incurred to meet working capital
needs. The entire amount of the notes was due on the date the Company closed its
Initial Public Offering. The loan was paid in full on April 5, 2000.
On June 15, 2000, the Company paid in full two short-term promissory
notes due an officer of the Company and a member of the Board of Directors in
accordance with the maturity date of the notes.
America Technology Corporation (ATC), Identigraphix Inc. (IGX), Amcard
Systems Incorporated (Amcard), RDL Holdings LTD (RDL) and ISI International,
Inc. (ISI) are considered to be affiliated entities because major shareholders
of each entity are also major shareholders of the Company.
ITC entered into a five-year operating lease for its office and research
and development facilities from RDL. Rent and facility expense paid to RDL was
$135,000 and $270,000 for the years ended December 31, 1999 and 2000,
respectively. Amounts due to RDL at December 31, 1999 and 2000 were $45,000 and
$0, respectively.
In the normal course of business, the Company entered into transactions
with ATC, IGX, Amcard and ISI for the purchase of inventory items. The total
purchases from these companies for the years ended December 31, 1999 and 2000
amounted to $102,000 and $75,000, respectively.
Prior to the consummation of the merger, ITC advanced funds to ATC and
IGX on a regular basis. Due to management's assessment of the collectibility of
the advances from these affiliated entities, the advances were charged to
expense at the time of the advance. Such advances are included in other expenses
on the statement of operations. For the years ended December 31, 1999 and 2000,
ITC advanced $502,000 and $374,000, respectively.
Prior to the consummation of the ITC merger, certain ITC shareholders
advanced funds to ITC on a regular basis for general corporate and working
capital purposes. Amounts owed to the shareholders for these advances at
December 31, 1999 and 2000 were $233,000 and $208,000, respectively.
The Company has a development contract with a non-employee shareholder.
Costs incurred under the development contract amounted to $153,000 and $120,000
for the years ended December 31, 1999 and 2000, respectively, and are recorded
in research and development expenses. Amounts due the shareholder at December
31, 1999 and 2000 were $153,000 and $170,000, respectively, and are included in
accrued expenses -- related parties. In conjunction with the ITC transaction,
the shareholder became an employee of the Company.
A shareholder of the Company receives an annual fee for management
services provided to the Company. Costs incurred for these management services
amounted to $100,000 and $100,000 for the years ended December 31, 1999 and
2000, respectively. Amounts owed to the shareholder at December 31, 1999 and
2000 were $302,000 and $151,000, respectively. In conjunction with the ITC
transaction, the shareholder became an employee of the Company.
Amounts due to shareholders for advances, development contract services
and management services accrue interest at a rate of 10% per annum. At December
31, 2000, the Company owed shareholders $264,000 for accrued interest.
14. SUBSEQUENT EVENTS (UNAUDITED)
G AND A ACQUISITION
F-18
In March 2001, the Company entered into a definitive agreement to acquire
the assets of G&A Technologies, Inc. ("G&A"), a leading supplier of digital ID
software. The agreed purchase price consists of a cash component of $2,500,000
payable at closing, and the issuance of 665,000 shares of the Company's common
stock.
The acquisition will be accounted for under the purchase method, whereby
the purchase price will be allocated to the underlying assets and liabilities
based on their estimated fair values.
F-19
Dates Referenced Herein and Documents Incorporated by Reference
↑Top
Filing Submission 0000912057-01-506459 – Alternative Formats (Word / Rich Text, HTML, Plain Text, et al.)
Copyright © 2024 Fran Finnegan & Company LLC – All Rights Reserved.
About — Privacy — Redactions — Help —
Wed., May 1, 10:30:47.2am ET 
