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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO __________________
Commission File No. 005-62411
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DIVERSIFIED SECURITY SOLUTIONS, INC.
(Name of small business issuer as specified in its charter)
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Delaware 22-3690168
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
280 Midland Avenue 07663
Saddle Brook, New Jersey (Zip Code)
(address of principal executive offices)
Issuer's Telephone number, including area code: (201) 794-6500
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
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Common Stock, $.01 par value
(Title of Class)
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Check whether 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 Issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if disclosure of delinquent filers pursuant to item 405 of Regulation
S-B is not contained herein, and will not be contained, to 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. [ ]
State the aggregate market value of the voting stock held by non-affiliates
of the Issuer: $14,733,963 (based upon the closing price of Issuer's Common
Stock, $.01 par value, as of March 10, 2003).
The Registrant's sales for the year ended December 31, 2002 were
$18,830,093.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Common Stock, $.01 Par Value 5,138,357
(Title of Class) (No. of Shares Outstanding
at March 10, 2003)
Documents Incorporated By Reference:
None
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DIVERSIFIED SECURITY SOLUTIONS, INC.
Table of Contents
PART I 1
Item 1. Description of Business 1
Item 2. Description of Property 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Stockholders 10
PART II 11
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 11
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 7. Financial Statements 17
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 18
PART III 18
Item 9. Directors and Executive Officers of the Company 18
Item 10. Executive Compensation 21
Item 11. Security Ownership of Certain Beneficial Owners and Management 23
Item 12. Certain Relationships and Related Transactions 24
Item 13. Exhibits and Reports on Form 8-K 25
Item 14. Controls and Procedures 25
Forward Looking Statements
This annual report contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, as amended.
Forward-looking statements inherently involve risks and uncertainties that could
cause actual results to differ materially from those stated. Such statements are
subject to certain risks and uncertainties, including our ability to utilize the
acquisitions we have made; possible significant variations in recognized revenue
due to customer caused delays in installations; cancellation of contracts by our
customers and competition, that could cause actual results to differ materially
from historical earnings and those presently anticipated or projected.
Furthermore, there can be no assurance that our sales will continue to increase.
The Company does not assume any obligation to update the forward-looking
information and cautions readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made.
PART I
Item 1. Description of Business
(a) Business Development. In 1950, John, Ray, and Hartford Henry founded
Henry Bros. Electronics. They sold Henry Bros. Electronics to Communication
Group in 1985. In 1989, Jim Henry, our Chairman and Chief Executive Officer, and
Irvin Witcosky, our President and Chief Operating Officer, formed our
predecessor company. We were incorporated in Delaware on November 18, 1999.
In November 2001, we completed our initial public offering of 1,500,000
shares of common stock which is traded on the American Stock Exchange under the
ticker symbol DVS. In December 2002, GunnAllen Financial, Inc., the underwriter
of our initial public offering, exercised its over-allotment option to purchase
225,000 shares of our common stock.
(b) Business of Issuer
We are a single-source/turn-key provider of technology-based security
solutions for medium and large commercial and governmental facilities in the
United States.
Security Distributing and Marketing magazine (SDM) ranks the top 100
largest firms selling closed circuit TV (CCTV), access control and integrated
security systems. We were ranked No. 32 in SDM's 7th annual Top Systems
Integrators Report published in July 2002.
As a single-source/turn-key provider of diversified technology-based
integrated security solutions, we can expedite project completion and reduce our
clients' personnel power requirements and personnel power costs. The continually
evolving security requirements of commercial and government entities, together
with rapidly advancing technology, provides numerous opportunities for us to
assist our clients with their security needs.
We believe that the following key attributes provide us with a sustainable
competitive advantage:
o Experience and expertise;
o Technological sophistication;
o Quality control; and
o Strong list of references.
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Our Strategy
Our strategy consists of the following components:
o Maintain and develop long-term relationships with clients;
o Focus on high value added services;
o Continue to expand our client base in targeted industries;
o Maintain a high level of technological sophistication; and
o Sell additional services to our established client base.
Our three operating units are integration, threat assessment and
manufacturing.
Our Integration Solution
At the beginning of each new client relationship, we designate one member
of our professional staff as the client service contact. This individual is the
point person for communications between us and the client and often acts as the
client's project manager for all of its security needs. Our engagement may
include:
o Consulting and planning;
o Engineering and design;
o Systems installation and management;
o Systems training; and
o Maintenance and technical support.
Consulting and Planning
Security consulting and planning are the initial phases of determining a
security solution for a project. We have developed a planning process that
identifies all systems, policies and procedures that are required for the
successful operation of a security system that will both meet a client's current
needs and accommodate its projected future requirements. Our consulting and
planning process includes the following steps:
o Identify the client's objectives and security system requirements;
o Survey the site, including inventory of physical components and
software and evaluation of client's existing infrastructure and
security system;
o Assess and prioritize the client's vulnerabilities;
o Develop and evaluate system alternatives;
o Recommend a conceptual security plan design;
o Estimate the cost of implementing the conceptual plan; and
o Develop a preliminary implementation schedule.
As a result of this process, we provide the client with a master plan for
an effective security solution that addresses routine operating needs as well as
emergency situations.
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We believe that our comprehensive planning process enables our clients to
budget for their security requirements on a long-term basis, identify
opportunities for cost reduction and prepare for future risks.
Engineering and Design
The engineering and design process involves preparation of detailed project
specifications and working drawings by a team of our engineers, systems
designers and computer-aided design system operators. These specifications and
drawings detail the camera sensitivity requirements, layout of the control
center, placement of cameras, card readers and other equipment and electrical
requirements. Throughout our engineering and design process, our goal is
understanding our client's operational preferences in order to design a system
that is functional, cost-effective and accommodates our client's present and
future requirements. In addition, we attempt to incorporate our client's
existing personnel, equipment and other physical resources into the system
design.
When retained as a single-source provider for turnkey security solutions,
we also select the system components required under the specifications and
drawings we have prepared. To minimize development costs, to the extent
possible, we recommend that our customers buy off-the-shelf devices and software
purchased from other vendors as well as those manufactured by us and only
recommend custom equipment when absolutely necessary. If off-the-shelf equipment
and software are not available or applicable, we manufacturer the missing
product and incorporate it into the system.
We have made a strategic decision not to represent any equipment
manufacturer exclusively, thereby maintaining objectivity and flexibility in
equipment selection. We believe that our technical proficiency with the products
of a wide range of manufacturers enables us to select components that will best
meet a project's requirements.
Installation
Under the supervision of our project manager, our technicians install
hardware, integrate hardware and software, and validate and test the system. The
aspects of systems integration that do not require a high level of technical
expertise, such as wire installation and basic construction, are typically
performed by subcontractors.
Components that may be integrated in a security system include the
following:
o Access control systems, which are designed to exclude unauthorized
personnel from specified areas;
o Intrusion detection systems, which detect unauthorized door and window
openings, glass breakage, vibration, motion, noise and alarms and
other peripheral equipment;
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o Closed circuit television systems, which monitor and record entry and
exit activity or provide surveillance of designated areas;
o Critical condition monitoring systems, which provide alarm monitoring
and supervision of various systems and facilities; and
o Fire detection systems, intercoms, public address and network
connectivity which can expand a local security system into a closely
controlled worldwide system.
Maintenance and Technical Support
We provide maintenance and technical support services on a scheduled,
on-call, or emergency basis. These services include developing and implementing
maintenance programs both for security systems designed, engineered, or
integrated by us and for existing systems.
Threat Assessment
Our threat assessment division works with companies, governmental agencies
and managers of high-rise office buildings to analyze their specific facilities
and make risk management and security assessments. We then recommend the
appropriate measures a client should take to protect itself and its employees.
Our threat assessment division provides a wide array of services, including:
o Analysis of emergency plans and procedures;
o Assessment of vulnerabilities and response capabilities;
o Crisis management planning;
o Business resumption planning;
o Chemical, biological response plans and procedures;
o Development of emergency plans and procedures;
o Equipment purchase and identification;
o Field operating guides;
o Integration of local, State, and Federal plans; and
o Operational plans, procedures, and systems design.
Manufacture and Supply
Through our subsidiary, Viscom Products, Inc., we manufacture, develop and
assemble various security related products, which we use in our own
installations and for sales to other integrators. Our design, engineering,
manufacturing and assembly facilities are located in our Saddle Brook, New
Jersey headquarters.
Marketing
Our marketing activities are conducted on both national and regional
levels. We obtain engagements through direct negotiation with clients,
competitive bid processes and referrals. At the national level, we conduct
analyses of various industries and target those with significant
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potential demand for security solutions. At a regional level, we have developed
and implemented a marketing plan that targets specific regions of the country.
The plan identifies prospective clients within the specific regions of the
country and sets forth a strategy for developing relationships with them.
We have developed expertise in the security regulations applicable to
airports, high-rise buildings, public transportation systems, prisons and
nuclear utilities. We have identified several key industries or facility types
that we believe have substantial and increasing requirements for security
services, including corporate complexes, commercial and federal and facilities.
Customers
We provide our products and services to customers in the public and private
sectors through direct sales to end-users and through subcontracting agreements.
We have provided services to transit authorities, airports, universities,
high-rise office-buildings, hospitals and airlines. The table below sets forth
the approximate percentage of aggregate revenues from each of our largest
customers/end-users for the year ended December 31, 2002:
PERCENTAGE OF
AGGREGATE
REVENUE
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New York Metropolitan Transportation Authority (MTA) 19.8%
Port Authority of New York & New Jersey 17.7%
San Francisco Muni 12.9%
Vornado Realty Trust 7.6%
New York City Transit Authority 4.5%
Silverstein Properties 3.4%
Scottsdale Airport 2.5%
Hohokus Mansion 2.1%
Energy Nuclear Northeast 1.7%
UU - South Western Medical 1.7%
Competition
The security industry is highly competitive. We compete on a local, regional and
national basis with systems integrators, consulting firms and engineering and
design firms. We will compete with different companies depending upon the nature
of the project and the services being offered. For example, we have competed
with ADT and Siemens for systems integration work. Many of our competitors have
greater name recognition and financial resources. Our competitors also include
equipment manufacturers and vendors that also provide security services. We
believe that we compete primarily on our ability to deliver solutions that
effectively meet a clients' requirements and, to a lesser extent and primarily
in competitive bid situations, on price. Since completing our initial public
offering in November 2001, we are able to get larger bonds, and, therefore, we
can compete for larger projects as a primary contractor.
5
Employees
As of February 2003, we had 116 full time employees including officers, of
whom: 74 were engaged in manufacturing, engineering, research and development or
in systems installation and repair services, 28 in administration and financial
control and 14 in marketing and sales. None of our employees are covered by a
collective bargaining agreement or are represented by a labor union. We consider
our relationship with our employees to be satisfactory.
Our business requires substantial technical capabilities in many
disciplines from mechanics and computer science to electronics and advanced
software. We emphasize continued training for new and existing technical
personnel. Accordingly, we conduct training classes and seminars in-house, send
select employees to technical schools and avail ourselves of training
opportunities offered by equipment manufacturers and other specialists on a
regular basis.
Pricing
We employ a variety of pricing strategies for our services. Proposals for
consulting and threat assessment services are priced based on an estimate of
hours multiplied by standard rates. Systems integration projects are based upon
the estimated cost of the equipment for the project, plus the estimated hours
for each skill set multiplied by the rate quoted, plus a profit margin. Prices
for Viscom Products are based on the cost of the equipment plus a profit margin.
Pricing for engineering and maintenance services are determined based on the
scope of the specific project and the length of our engagement.
Acquisitions
In May 2002, we purchased all of the issued and outstanding shares of Photo
Scan Systems, Inc. ("Photo Scan"). Photo Scan, which is located in California,
specializes in security systems for medical facilities and provides sales,
system design, installation, service and maintenance of integrated security
systems which include access control, closed circuit television, intercom, audio
alarm and property intrusion detection. In December 2002, we changed Photo
Scan's name to Henry Bros. Electronics, Inc.
In August 2002, Photo Scan purchased all of the issued and outstanding
stock of National Safe of California, Inc. ("National Safe"). National Safe
supplies and services alarm security equipment, backup high security systems,
lock and locking mechanisms, timing mechanisms, vault security, control systems
and high resolution surveillance equipment.
In September 2002, Photo Scan acquired Corporate Security Integration, LLC
("CSI"). CSI is located in Phoenix, Arizona and specializes in access control
and closed circuit television monitoring.
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Risk Factors
You should carefully consider the risks and uncertainties described below,
as well as all of the other information included in this annual report on Form
10-KSB before you decide to invest in our common stock. Any of the following
risks could materially adversely affect our business, financial condition or
operating results and could result in a partial or full loss of your investment.
We are dependent upon a small number of customers for a large portion of our
revenues
We have a small number of customers from which we receive a large portion
of our revenue. For example, in the year ended December 31, 2002, MTA, the Port
Authority of New York & New Jersey, San Francisco Muni and Vornado Realty Trust
accounted for approximately 58% of our revenue. Our experience has been that
some of these substantial customers will be a source of significant revenues in
the succeeding year and some will not. Consequently, we are often required to
replace one customer with one or more other customers in order to generate the
same amount of revenue. There can be no assurance that we will continue to be
able to do so.
All of our orders and contracts may be cancelled so there is a risk that our
backlog may not be fulfilled
All of our orders and contracts are subject to cancellation by our
customers at any time so we cannot be certain that we will recognize revenue
from them.
We experience intense competition for business from a variety of sources
In systems integration, we compete for new business with large construction
firms, electrical contractors, consultants in the security business and other
systems integrators. In our manufacturing operations, we compete with numerous
manufacturers such as -- Vicon, Sensormatic, Pelco and Phillips. Many of our
competitors are much larger than we are and have greater resources. In order to
effectively compete in the future, we may have to charge less for our services
which may result in lower profit margins.
We rely on only a few key executives
James E. Henry, Irvin F. Witcosky, Sal Lifrieri and Louis Massad, our four
top executives, are vital to our business operations. The loss of any one of
them could have a material adverse impact on our business, financial condition
or results of operations.
Our business and growth will suffer if we are unable to hire and retain highly
skilled personnel
Competition for highly skilled employees is intense in our industry. The
design and manufacture of our equipment and the installation of our systems
requires substantial technical capabilities in many disparate disciplines from
mechanics and computer science to electronics
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and advanced software. Our future success depends on our ability to attract,
train, motivate and retain highly skilled employees. If we are unable to hire
and retain skilled personnel, our growth may be restricted, the quality of our
products and services diminished and our revenues and the value of your
investment reduced. We may be unable to retain our skilled employees or attract,
assimilate and retain other highly skilled employees in the future.
Lengthy sales cycle
The sale of our services and products frequently involves a substantial
commitment of resources to evaluate a potential project and prepare a proposal.
In addition, approval of proposals often involves a lengthy process due to
clients' internal procedures and capital expenditure approval processes. We may
not be awarded a project that we have prepared a proposal for and, even if we
are, a substantial period of time may elapse from when we made the proposal to
when we recognize revenue from the project.
We may make acquisitions or form joint ventures that are unsuccessful
Part of our growth strategy involves acquisitions or joint ventures with
other system integrators.
This strategy is subject to the following risks:
o We may not be able to identify suitable acquisition and joint venture
candidates.
o If the purchase price of an acquisition includes cash, we may need to
use all or a portion of our available cash.
o Even if we make an acquisition of a company or form a joint venture,
we could have difficulty assimilating the acquired company's
operations and personnel or working with the joint venture. These
difficulties could disrupt our ongoing business, distract our
management and employees and increase our expenses and charges, and,
thus, could have a material impact on our business, financial
condition and results of operations.
o We may not be able to retain key employees of the acquired companies
or maintain good relations with its customers or suppliers.
o We may be required to incur additional debt.
o We may be required to issue equity securities to pay for acquisition,
which will dilute existing shareholders.
o We may have to incur significant accounting charges, such as for
goodwill, which may adversely affect our results of operations.
We have no patents, or copyrights, and we may not be able to protect our
proprietary rights and may infringe on the proprietary rights of others
Although we have filed a patent application for our Mobil Digital Video
Recorder, we currently have no patents or copyrights. We regard our trade
secrets and similar intellectual property as important to our success. However,
our efforts to establish and protect our
8
proprietary rights may be inadequate to prevent misappropriation or infringement
of them. If we are unable to safeguard our intellectual property rights, our
business, results of operations and financial condition could be materially
harmed. Third parties may bring claims of copyright or trademark infringement
against us or claim that our use of certain technologies violates a patent.
Third parties may also claim that we have misappropriated their technology or
otherwise infringed on their proprietary rights. At present, we are not aware of
any such claims. Any claims of infringement, with or without merit, could be
time-consuming to defend, result in costly litigation, divert management's
attention, require us to enter into expensive royalty or licensing arrangements
or prevent us from using important technologies or methods. These eventualities,
together or alone, could damage our business, financial condition and results of
operations.
Our management owns the majority of our common stock and their interests may be
different from and conflict with yours
The interests of management could conflict with the interests of our other
stockholders. Mr. Henry and Mr. Witcosky beneficially own a total of
approximately 55% of our outstanding common stock. Accordingly, if they act
together, they will have the power to control the election of all of our
directors and other issues for which the approval of our shareholders is
required.
Item 2. Description of Property
We lease a 17,055 square foot facility in Saddle Brook, New Jersey for our
corporate headquarters, integration operations and our manufacturing plant. This
facility is a one-story, modern brick building in a commercial-industrial area.
The lease on this space terminates on June 30, 2006, and provides for an annual
rent of $98,400 until that date, payable in equal monthly installments of
$8,200. We are also responsible for the cost of property taxes, utilities,
repairs, maintenance, alterations, cleaning and insurance.
We also lease a 9,553 square foot office facility, in Fullerton,
California. A two-story, concrete building in an office complex, this space is
leased until November 2006 at an annual rent of $97,440, payable in equal
monthly installments of $8,120 with additional costs to us for insurance,
repairs and alterations, utilities, taxes and cleaning.
We also lease a 4,200 square foot office facility, in Grand Prairie, Texas,
near the Dallas Fort Worth Airport. A single-story, cinder block building in an
office complex, this space is leased until January 31, 2004 at an annual rent
of $41,300, payable in equal monthly installments of $3,442 with additional
costs to us for insurance, repairs and alterations, utilities, taxes and
cleaning.
We also lease a 3,906 square foot office facility, in Phoenix, Arizona. A
single-story, concrete building in an office complex, this space is leased until
August 2006 at an average
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annual rent of $51,081, payable in an average monthly installments of $4,278
with additional costs to us for insurance, repairs and alterations, utilities,
taxes and cleaning.
We also lease a 2,137 suite in an office building in White Plains, New
York. The monthly rent is $8,735.
These facilities should meet our operational needs for the foreseeable
future.
Item 3. Legal Proceedings
We know of no material litigation or proceeding, pending or threatened, to
which we are or may become a party.
Item 4. Submission of Matters to a Vote of Stockholders
At our 2002 Annual Meeting of Stockholders held on October 28, 2002, the
following individuals, constituting all of the members of the Board of
Directors, were elected. For each elected director, the results of the voting
were:
Name Number of Votes For Votes Withheld
---- ------------------- --------------
Robert S. Benou 4,715,200 4,350
James E. Henry 4,709,700 9,850
Leroy Kirchner 4,715,200 4,350
Sal Lifrieri 4,709,700 9,850
Louis S. Massad 4,709,700 9,850
Joseph P. Ritorto 4,715,200 4,350
Irvin F. Witcosky 4,709,680 9,870
The stockholders also voted to ratify the selection of Demetrius & Company,
L.L.C. as our independent accountants for 2002. The results of the voting of
this proposal were 4,712,150 in favor, 4,500 against and 2,900 abstentions.
The stockholders also approved adoption of the Company's 2002 Stock Option
Plan. The results of the voting of this proposal were 4,665,360 in favor, 44,690
against and 9,500 abstentions.
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PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our Common Stock is traded on the American Stock Exchange under the Symbol
"DVS".
(a) The following table indicates high and low sales quotations for the
periods indicated based upon information supplied by AMEX.
2001
----
Fourth Quarter (11/15/01-12/31/01) 8.35 7.00
2002
----
First Quarter 8.80 6.65
Second Quarter 8.20 6.75
Third Quarter 7.30 6.50
Fourth Quarter 7.00 6.55
(b) Number of Holders of Common Stock. The number of holders of record of
our Common Stock on March 25, 2003 was 17, which does not include individual
participants in security position listings.
(c) Dividends. There were no cash dividends or other cash distributions
made by us during the fiscal year December 31, 2002. Future dividend policy will
be determined by our Board of Directors based on our earnings, financial
condition, capital requirements and other then existing conditions. It is
anticipated that cash dividends will not be paid to the holders of our common
stock in the foreseeable future.
(d) Securities authorized for issuance under equity compensation plans.
Equity Compensation Plan Information
----------------------------- -------------------- ----------------- -------------------------
Weighted-average Number of securities
Number of securities average exercise remaining available for
to be issued upon price of future issuance under
exercise of outstanding equity compensation plans
outstanding options, options, warrants (excluding securities
warrants and rights and rights reflected in column (a))
Plan category (a) (b) (c)
----------------------------- -------------------- ----------------- -------------------------
Equity compensation plans
approved by security holders 145,000* $6.49 585,000
----------------------------- -------------------- ----------------- -------------------------
Equity compensation plans not
approved by security holders 40,000** $7.00
----------------------------- -------------------- ----------------- -------------------------
Total 185,000 $6.60 585,000
----------------------------- -------------------- ----------------- -------------------------
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* This amount includes options issuable pursuant to our 2002 Stock Option Plan.
This plan was approved by our Board of Directors on May 10, 2002. It was
approved by our shareholders on October 28, 2002. The plan authorizes the
issuance of options to purchase up to 230,000 share of our Common Stock to
employees, directors, and consultants of the Company.
Also included are options issuable pursuant to our Incentive Stock Option
Plan. Our Incentive Stock Option Plan was adopted by our Board of Directors and
our Shareholders on December 23, 1999. Our Incentive Stock Option Plan provides
for the granting of option to purchase a maximum of 500,000 shares of the
Company's common stock.
** This amount includes an option to purchase 40,000 shares of our common stock
granted on November 1, 2001 to Wall Street Consultants, Inc. ("WSG") at a price
of $7.00. This option was granted in consideration of services to be provided by
WSG to the Company. The option expires in November 2006.
Also included is a warrant to purchase shares of our common stock granted
to GunnAllen Financial, Inc. at a purchase price of $11.55 per share. The
warrant was granted to GunnAllen as part of its compensation for acting as the
underwriter of our initial public offering. The option was granted on November
21, 2002 and expires in November 2005.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(a) Overview
We are a turn-key provider of technology-based integrated security
solutions for commercial enterprises and governmental agencies. Our three
operating units are integration, threat assessment and manufacturing.
Our integration unit designs, customizes, installs, connects and maintains
CCTV and access control systems for customers in the private and public sectors
under the trade names, HBE and Henry Bros. Electronics. As part of an access
control system, we may also install, maintain and monitor intrusion alarms and
monitor alarms for building maintenance systems and fire alarm systems. We are
able to offer a customer seamless solutions to its electronic security needs. We
work with a customer to plan, engineer, design and install their security
system. We also provide maintenance and technical support.
Our threat assessment division advises clients, which include companies,
governmental agencies and high-rise office buildings, on how they can improve
their overall security infrastructure. Our threat assessment division provides
a wide array of services, including:
o analysis of emergency plans and procedures;
o assessment of vulnerabilities and response capabilities;
o crisis management planning;
o business resumption planning;
o chemical, biological response plans and procedures;
o development of emergency plans and procedures;
o equipment purchase and identification;
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o field operating guides;
o integration of local, State, and Federal plans; and
o operational plans, procedures, and systems design.
Through our subsidiary, Viscom Products, we manufacture, develop and
assemble various security related products, which we use in our own
installations and for sales to other integrators.
(b) Management's Discussion and Analysis of Financial Condition and Results
of Operations
Comparison of the year ended December 31, 2002 to year ended December 31,
2001
Sales. Sales increased to $18,830,093 for the year ended December 31, 2002
from $11,928,613 for the year ended December 31, 2001, an increase of
$6,901,480, or 57.9%. Of this increase, approximately $2.9 million or 41.9% was
attributable to sales from the companies we acquired during 2002. The balance
was from internal growth caused by increased demand for our services from our
existing and new customers. We attribute the increased demand for our services
to the priority that is being placed on improved security due to world events.
Our five largest customers accounted for 62.5% of our revenue for the year ended
December 31, 2002 compared with 60% of revenue for the year ended December 31,
2001. Our largest customer, MTA/NYC Transit, accounted for 24% and 13%, of our
revenues in each of the years ended December 31, 2002 and 2001, respectively.
We anticipate that NYC MTA/NYC Transit, will account for a significant portion
of our future revenues.
Cost of Goods Sold. Costs of goods sold increased 61.4% from $7,733,114 for
the year ended December 31, 2001 to $12,485,363 for the year ended December 31,
2002. For the year ended December 31, 2002, costs of goods sold were 66.3% of
our revenue compared with 64.8% of our revenue for the year ended December 31,
2001. We attribute the overall increase in the cost of goods sold to our
increased sales. Cost of goods sold as a percentage of revenue remained
relatively stable at approximately 68% of sales for the year ended December 31,
2002 compared to approximately 65% of sales for the year ended December 31,
2001.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $5,750,577 for the year ended December 31,
2002 from $3,474,530 for the year ended December 31, 2001. We attribute this to
increased sales, costs incurred in hiring additional personnel and the
additional costs associated with our west coast offices. Selling general and
administrative expenses remained relatively stable at 30.5% of sales for the
year ended December 31, 2002 compared to 29.0% of sales for the year ended
December 31, 2001.
Operating Income. Operating Income for the year ended December 31, 2002
decreased 19.0% to $594,154 from $720,969 for the year ended December 31, 2001.
The decrease in operating income is attributable to recruiting expenses, and
hiring more than twenty-five employees to help us grow as well as the cost
involved in assimilating our acquisitions into our company.
13
Interest Income. Interest income increased to $72,981 for the year ended
December 31, 2002 as compared to interest income of $12,379 for the year ended
December 31, 2001. The increase was due to having higher cash balances during
2002 than in 2001.
Interest Expense. Interest expense decreased to $136,896 for the year ended
December 31, 2002 as compared to interest expense of $217,858 for the year ended
December 31, 2001. This was due to lower debt levels and lower interest rates.
Net Income. For the year ended December 31, 2002, our net income totaled
$305,052, or 1.6% of sales, as compared to net income of $289,731, or 2.4% of
sales, for the year ended December 31, 2001. This resulted in basic earnings per
share of $0.06 on 4,939,484 basic weighted average common share outstanding for
the year ended December 31, 2002 compared with $0.09 per share on 3,175,274
basic weighted average common shares for the year ended December 31, 2001.
Liquidity and Capital Resources
Since our inception, we have financed our operations through bank debt,
loans and equity from our principals, loans from third parties and funds
generated by our business. In November 2001, we sold 1,500,000 shares of our
common stock in an initial public offering. The public offering price of this
offering was $7.00 per share, and we received net proceeds of $8,613,014, after
deducting the underwriter's discount of $1,050,000 and offering expenses of
$836,986.
In December 2001, GunnAllen Financial, Inc., the managing underwriter of
our initial public offering, exercised its over-allotment option to purchase an
additional 225,000 shares of common stock and we received net proceeds of
$1,370,250.
As of December 31, 2002, we had cash and cash equivalents of $4,472,271.
Net Cash Used in Operating Activities. Net cash used in operating
activities was for the year ended December 31, 2002 as compared to $1,426,726
during the prior year. In 2002, the use of cash was attributable to the growth
of the Company. In 2002, the use of cash was primarily used for increases in
account receivable of $1,733,513, inventories and contract costs of $1,165,621,
offset by an increase in accrued expenses and accounts payable of $514,774. The
use of cash during 2001 was caused by a substantial increase in billings in the
fourth quarter. This primarily resulted in an increase of accounts receivable of
$1,956,098 and contract costs of $298,879, a reduction of $233,096 in accounts
payable and accrued expenses, offset by an increase of customer deposits and
billings in excess of costs of $439,145.
Net Cash From (Used In) Investing Activities. Net cash from investing
activities was $50,705 for the year ended December 31, 2002 as compared to net
cash used in investing activities in the amount of $1,255,167 for the year ended
December 31, 2001. The increase in 2002 was primarily attributable to the sale
of certificate of deposits of $802,235, purchase of equipment and software
development of $266,444 and the issuance of a note of $500,000. The
14
use in 2001 was attributed to $802,235 from the proceeds of our initial public
offering invested in bank certificates of deposits and $452,932 on purchases of
equipment and software development.
Net Cash (Used In) From Financing Activities. Net cash used in financing
activities was $2,228,244 for the year ended December 31, 2002 as compared to
$11,028,798 for the year ended December 31, 2001. The use of cash in 2002 was
attributed to acquisition of our subsidiaries of $1,086,910 and reducing net
bank debt of $1,141,334. The increase in 2001 was principally caused by the
sale of 1,725,000 shares of our common stock for net proceeds of $9,983,264,
additional bank borrowings of $1,056,135 net of a repayment of bank loan in the
amount of $1,000,000.
Although our capital requirements have grown substantially since our
inception with the growth of our operations, staffing and acquisitions, we
believe that our current cash, and available lines of credit should be
sufficient to meet our capital requirements.
Critical Accounting Policies
The Company's consolidated financial statements have been prepared in
conformity with generally accepted accounting principles in the United States of
America, which 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
amount of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Management uses its best judgment in valuing
these estimates and may as warranted, solicit external professional advice.
Estimates are based upon current facts and circumstances, prior judgment in
valuing these estimates and may, as warranted, solicit external professional
advice and other assumptions believed to be reasonable. The following critical
accounting policies, some of which are impacted significantly by judgments,
assumptions and estimates, affect the Company's consolidated financial
statements.
Income Recognition
Sales revenues from systems installations that are recognized on the
completed-contract method, in which revenue is recognized when the contract is
substantially complete. Most contracts are completed in less than a year. The
completed method applies to those contracts completed within the fiscal year.
Contracts that are expected to be completed in more than a year are accounted
for on the percentage of completion method.
The complete contract method recognizes sales earned based on the
percentage of total estimated contract costs incurred to date. Mobilization
charges are accounted for as a direct contract cost and included in the
estimated cost to complete for determination of sales recognition on the
percentage of completion method. The excess of costs and estimated earnings
over billings and excess of accumulated billings over costs are not presented
in periods which management has determined that the amounts are not material.
Provision for estimated earnings and losses, if any, on uncompleted contracts
are made in period in which such losses are determined.
15
Service contracts are generally billed monthly or quarterly on the last day
of the month covered by the contract. Accordingly, sales from service contracts
are recognized monthly on the straight- line method.
Trade Receivables and Allowance for Doubtful Accounts
The preparation of financial statements requires our management to make
estimates and assumptions relating to the collectivity of our accounts
receivable. Management specifically analyzes historical bad debts, customer
credit worthiness, current economic trends and changes in our customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. The
Company has a concentration risk in trade accounts receivable with significant
sales to the government and local agencies. The credit evaluation process has
mitigated the credit risk, such losses have been minimal, and within management
expectations.
Inventory Valuations
Inventories are valued at lower of cost or market. Determined by the
first-in, first-out ("FIFO") method. Management reviews inventory for
salability.
Warranty
The Company offers warranties on all products, including parts and labor
that range from one year to four years depending upon the type of product
concerned. For products made by others, the Company passes along the
manufacturer's warranty to the end user.
Intangible Assets
The Company's intangible assets include goodwill and other intangibles that
consist of the fair value of acquired customer lists, service contracts
acquired, trade names and covenants not to compete. Goodwill represents the
excess of purchase price over the fair value of net assets acquired.
Effective January 1, 2002, the Company adopted the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other
Intangible Assets. Under SFAS No. 142, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized. The cost of acquired customer
lists, service contracts and, covenants not to compete are amortized using the
straight-line method over their estimated lives, which range from five to
fifteen years.
Goodwill is evaluated for possible impairment on an annual basis or more
frequently if events and circumstances occur that may indicate the potential for
impairment. Goodwill assigned to a reporting unit is evaluated for potential
impairment following a two-step procedure. The fair value of the reporting unit
is initially determined and compared to its carrying value. If the carrying
value exceeds the fair value of the applicable reporting unit, the implied fair
value of
16
the reporting unit is then determined. If it is determined that the fair value
of the underlying assets and liabilities of the reporting unit is less than the
carrying value of goodwill, an impairment loss is recorded. The impairment test
will be performed annually.
Impairment of Long Lived Assets
The Company adopted in 2002 SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 requires that long-lived
assets, to be held and used by an entity, be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of the
assets may not be recoverable. Under SFAS 144, if the sum of the expected future
cash flows (undiscounted and without interest charges) of the long-lived assets
is less than the carrying amount of such assets, an impairment loss would be
recognized, and the assets are written down to their estimated fair values.
The adoption of SFAS 144 did not have any material impact on the financial
position and results of operations. There have been no impairment losses through
December 31, 2002.
Income Taxes
Deferred taxes are provided on an asset and liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss carryforwards and deferred tax liabilities are recognized for
taxable temporary differences. Temporary differences are the differences between
the reported amounts of assets and liabilities and their tax basis. 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. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.
Recently Issued Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure". This Statement amends SFAS No. 123, to
provide alternative methods of transition to SFAS No. 123's fair value method of
accounting for stock-based employee compensation. SFAS 148 also amends the
disclosure provision of SFAS No. 123 and APB No. 28, Interim Financial
Reporting, to require disclosure in the summary of significant accounting
policies of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share
in annual and interim financial statements. The Company has elected to continue
accounting for employee stock based compensation in accordance with APB 25 and
related interpretations and has adopted the disclosure requirements under SFAS
No. 148 commencing on December 31, 2002.
Item 7. Financial Statements
Refer to pages F-1 through F-24.
17
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During the year ended December 31, 2002, there were no changes in or
disagreements with the Company's principal independent accountant on accounting
or financial disclosure.
PART III
Item 9. Directors and Executive Officers of the Company
As of March 24, 2003, the Company's directors and executive officers were
as follows:
Name Age Position
---- --- --------
James E. Henry 49 Chairman, Chief Executive Officer and Director
Irvin F. Witcosky 64 President, Chief Operating Officer, Secretary and Director
Louis Massad 65 Vice President, Treasurer, Chief Financial Officer and Director
Sal Lifrieri 45 Executive Vice President and Director
Leroy Kirchner 60 Director
Robert S. Benou 68 Director
Joseph P. Ritorto 71 Director
James E. Henry, our Chief Executive Officer, co-founded our predecessor
company in 1989 and served as our President until December 2001 when he was
elected our Chief Executive Officer and Chairman of the Board. Mr. Henry
graduated from the University of New Hampshire with a bachelor of science degree
in electrical engineering. In addition to his other responsibilities, Mr. Henry
has continued to design, install, integrate and market security and
communications systems as well as manage our research and development.
Irvin F. Witcosky co-founded our predecessor company in 1989 and served as
our Executive Vice President until December 2001 when he was elected our Chief
Operating Officer and President. Mr. Witcosky has also served as our Secretary
since 1989 and is on our Board of Directors. Mr. Witcosky graduated from
California Polytechnic University with a bachelor of science degree in
aeronautical engineering. In addition to his other responsibilities, Mr.
Witcosky has continued to design, integrate and market security and
communication systems as well as manage our operations and administration.
Louis Massad became our Vice President, Treasurer and Chief Financial
Officer in 1999. Mr. Massad is also on our Board of Directors. From 1996 to
1999, he functioned as an independent accountant and financial advisor to
several companies, including us. Since 1995, Mr. Massad has been a director of
Conolog Corporation, a publicly-held company that manufactures electronic
components and subassemblies for communication equipment and provides
engineering and design services and technical personnel placement to a variety
of
18
industries. He holds bachelor of science and masters degrees in accounting from
Cairo University in Egypt and a masters in business administration in finance
from Long Island University.
Sal Lifrieri became our Executive Vice President in August 2002. Mr.
Lifrieri has been a member of our board since October 2002. Mr. Lifrieri retired
from the New York City Police Department in January 2002 after 20 years of
service. From January 1996 to January 2001, Mr. Lifrieri served as the Director
of Security and Intelligence Operations for the Office of Emergency Management
where he was responsible for the management of security intelligence and counter
surveillance operations for New York City. From 1994 to 1996, Mr. Lifrieri was a
member of New York City's Municipal Security Section where he headed the
Protective Operations Unit. As head of the Protective Operations Unit, Mr.
Lifrieri's responsibilities included protecting critical New York City
infrastructure and key public buildings.
Leroy Kirchner was elected to our board of directors in December 1999.
Since 1999, Mr. Kirchner has acted as a consultant to the communications
industry and from May 1999 to December 31, 2001, he also served as the Director
of Indirect Distribution for NeoWorld, Inc. From 1996 through 1998, he worked in
various capacities for Motorola Inc., primarily in sales and marketing. From
1966 through 1998, he functioned as vice president and strategist for a Motorola
subsidiary engaged in sales of related radio equipment and systems. Mr. Kirchner
holds a bachelor of science degree and a masters in business administration
degree from Fairleigh Dickinson University.
Robert S. Benou was elected to our board of directors in June 2001. He has
been a director of Conolog Corporation since 1968 and served as its President
from 1968 until May 2001 when he was elected Conolog's Chairman and Chief
Executive Officer. Mr. Benou is a graduate of Victoria College and holds a BS
degree from Kingston College, England and a BSEE from Newark College of
Engineering, in addition to industrial management courses at Newark College of
Engineering.
Joseph P. Ritorto was elected to our board of directors in January 2002.
Mr. Ritorto is the co-founder of First Aviation Services, Inc., which is located
on Teterboro Airport in New Jersey and provides a variety of aviation support
services. Mr. Ritorto has been an officer of First Aviation Services since 1986.
From 1991, until he retired in May 2001, Mr. Ritorto served as Senior Executive
Vice Present and Chief Operating Officer of Silverste in Properties, Inc. and
was responsible for leasing, operations and directing the lease administration
of Silverstein owned and managed properties.
19
Background Information About Certain Key Employees
Theodore Gjini has worked for us since 1988 in various capacities,
including as a sales engineer and project manager. In his current position as a
Vice President, he supervises the coordination of our personnel and their
activities in sales and marketing, project installations and maintenance. Mr.
Gjini graduated from the New Jersey Institute of Technology with a bachelor of
science degree in electrical engineering and William Paterson College with a
masters in business administration.
Emil J. Marone has worked for us since 1965 in various capacities,
including as a hospital communication system specialist, security systems
supervisor, systems engineer, and quality control specialist. In his current
position as our Chief Technology Officer, he is responsible for the development
of special products and testing procedures as well as quality assurance and
management. He holds an associate science degree from Bergen County Community
College.
Patrick Warner has been a Vice President of Henry Bros. Electronics, Inc.
since September 2002. Mr. Warner's responsibilities include managing Corporate
Security Integration LLC, a security systems integrator located in Phoenix,
Arizona which was acquired by us in September 2002. From April 2001 until it was
acquired by us, Mr. Warner was the chief corporate officer of Corporate Security
Integration, LLC.
Alex Pavlis has been a Vice President since April 2002. From January 2000
until March 2001, Mr. Pavlis was a Vice President of Sales and Marketing at
Intellisec a systems integrator. In this capacity, Mr. Pavlis was responsible
for all integrated security system sales in Northern and Southern California and
in Arizona. From October 1983 to January 2000, Mr. Pavlis was a Vice President
of Sales and Marketing for UAC Security Systems where he oversaw UAC's
integrated security system sales and operations department.
Compliance with Section 16(a) of the Exchange Act
The Securities and Exchange Commission has adopted rules relating to the
filing of ownership reports under Section 16 (a) of the Securities Exchange Act
of 1934. One such rule requires disclosure of filings which under the
Commission's rules, are not deemed to be timely. During its review, the Company
discovered that Mr. Lifrieri failed to timely file a Form 3 reporting his status
as an executive officer of the Company. This report was subsequently filed.
20
Item 10. Executive Compensation
The following table sets forth the total compensation paid to each
executive officer whose 2002 compensation equaled or exceeded $100,000.
SUMMARY COMPENSATION TABLE
Long-Term Compensation
-----------------------------
Awards Payouts
-------------- ------------
Annual Compensation Securities All Other
------------------------------ Underlying Compensation
Name and Principal Position Year(s) Salary($) Bonus($) Options/SARS # ($)(1)
--------------------------- ------- --------- -------- -------------- ------------
James E. Henry 2002 148,500 4,455
Chairman and Chief Executive Officer 2001 135,000 -- -- 2,700
2000 135,000 13,500 -- 2,700
Irvin F. Witcosky 2002 148,500 4,455
President, Chief Operating Officer 2001 135,000 -- -- 2,700
and Secretary 2000 135,000 13,500 -- 2,700
Louis Massad 2002 121,000 5,000 3,600
Vice President, Treasurer and Chief 2001 110,000 -- -- 2,200
Financial Officer 2000 110,000 11,000 9,000 2,200
Sal Lifrieri(2) 2002 135,000 50,000(3)
Executive Vice President
----------
(1) Company matching contribution under its Simple IRA Plan.
(2) Mr. Lifrieri became an Executive Vice President in August 2002.
(3) The amount shown for Mr. Lifrieri does not include options to purchase
50,000 shares of the Company's common stock which are not exercisable until
August 12, 2003.
Option/SAR Grants in Last Fiscal Year
(Individual Grants)
The following table summarizes options granted during the year ended December
31, 2002 to the named executive officers.
Number of % of Total
Securities Options
Underlying Granted to
Options Employees in Exercise Expiration
Name Granted 2002 Price Date
---- ---------- ------------ -------- ----------
Louis Massad 5,000 9% $7.95 5/9/07
Sal Lifrieri 50,000* 91% $7.20 8/12/12
21
The options were granted under the Company's 2002 Stock Option Plan.
----------
* Mr. Lifrieri may exercise 20% of this option per year beginning on August
12, 2003, subject to the terms of his option agreement. This option expires
on August 12, 2012.
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR
Values
None.
Long-Term Incentive Plans - Awards in Last Fiscal Year
None.
Compensation of Directors
Directors who are also our employees receive no additional compensation for
attendance at board meetings. In May 2002, our Board granted Messrs. Massad,
Benou, Kirchner and Ritorto options for each to purchase 5,000 shares of our
common stock. These options are exercisable at $7.95 per share and expire in May
2007. Non-employee directors are entitled to be reimbursed for their travel,
lodging and other out-of-pocket expenses related to their attendance at board
and committee meetings.
Employment Agreements
Messrs. Henry and Witcosky are serving as Chairman and Chief Executive
Officer and President, Chief Operating Officer and Secretary, respectively,
under employment agreements for five years which commenced January 1, 2000.
These agreements provide for an initial annual compensation of $135,000, an
increase of 10% in compensation as of January 2002 and in each subsequent year
of the agreements and a one-year non-competition covenant covering the security
business that commences after termination of employment.
Mr. Massad has entered into a five year written employment contract with us
which commenced January 1, 2000. His initial annual compensation under such
contract is $110,000. The agreement also provides for a 10% increase per annum
as of January 2002 and in each subsequent year of the agreement.
Mr. Lifrieri has entered into a five year written employment contract with
us which commenced on August 13, 2002. His initial annual compensation under
such contract is $135,000.
22
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of March 10, 2003 certain information
regarding beneficial ownership of our common stock by each person who is known
by us to beneficially own more than 5% of our common stock. The table also
identifies the stock ownership of each of our directors, each of our officers,
and all directors and officers as a group. Except as otherwise indicated, the
stockholders listed in the table have sole voting and investment powers with
respect to the shares indicated.
Unless otherwise indicated, the address for each of the named individuals
is Diversified Security Solutions, Inc., 280 Midland Avenue, Saddle Brook, New
Jersey 07663.
Shares of common stock which an individual or group has a right to acquire
within 60 days pursuant to the exercise or conversion of options, warrants or
other similar convertible or derivative securities are deemed to be outstanding
for the purpose of computing the percentage ownership of such individual or
group, but are not deemed to be outstanding for the purpose of computing the
percentage ownership of any other person shown in the table.
The applicable percentage of ownership is based on 5,138,357 shares
outstanding as of March 10, 2003.
Number of Percentage of
Shares Common Stock
Name, Address and Title Beneficially Beneficially
of Beneficial Owner Owned Owned
----------------------- ------------ -------------
James E. Henry, Chairman, Chief Executive Officer
and Director........................................... 1,425,000 27.7%
Irvin F. Witcosky, Chief Operating Officer, President,
Secretary and Director................................. 1,425,000 27.7%
Louis Massad, Chief Financial Officer, Treasurer
and Director (1) (2)................................... 132,000 2.6%
Sal Lifrieri, Executive Vice President (3)............... -- *
Leroy Kirchner, Director (1)............................. 5,000 *
Robert Benou, Director (1)............................... 5,000 *
Joseph Ritorto, Director (1)............................. 40,000 *
Lee A. Kann (4).......................................... 283,566 5.5%
23
All executive officers and directors as a group
(7 persons) (5)........................................ 3,032,000 59.0%
----------
* less than 1%
(1) The amount shown for Messrs. Massad, Kirchner, Benou and Ritorto includes
options to purchase 5,000 shares each of the Company's common stock at $7.95 per
share.
(2) The amount shown for Mr. Massad also includes a currently exercisable option
to purchase 9,000 shares of the Company's Common Stock at a price of $5.625 per
share.
(3) The amount shown for Mr. Lifrieri does not include options to purchase
50,000 shares of the Company's common stock which are not exercisable until
August 12, 2003.
(4) Mr. Kann's address is c/o Diversified Security Solutions, Inc., 1511 East
Orangethorpe Avenue, Suite A, Fullerton, CA 92831. The amount shown for Mr. Kann
is based on a Schedule 13G filed by him on September 5, 2002.
(5) The amount shown includes currently exercisable options to purchase 29,000
shares of the Company's common stock.
Item 12. Certain Relationships and Related Transactions
On August 13, 2002 (the "Closing"), the Company, Photo Scan Systems, Inc.,
Lee A. Kann and National Safe of California, Inc. entered into a stock purchase
agreement, pursuant to which Photo Scan, a wholly-owned subsidiary of the
Company, purchased all of the issued and outstanding stock of National Safe from
Mr. Kann. The purchase price of the acquisition was $2,000,000 which was paid by
issuing an aggregate of 283,566 unregistered and restricted shares of the
Company's common stock (the "Shares"). As part of this transaction, Photo Scan
made a $500,000 non-recourse loan to Mr. Kann due August 12, 2003. As collateral
for the payment of the promissory note, Mr. Kann pledged 70,891 of the Shares.
The Stock Purchase Agreement provides that in the event that one year from the
Closing (the "Reference Date"), the average closing sale price of the Company's
common stock for the ten trading days immediately prior to the Reference Date is
less than $7.053 per share (the "Current Market Price"), the Company and/or
Photo Scan at their sole discretion shall within 10 days of the Reference Date
either purchase 212,675 of the Shares for $1,500,000 (subject to certain
adjustments detailed in the Stock Purchase Agreement) or pay Mr. Kann an amount
equal to the difference between (i) $1,500,000 and (ii) 212,675 (subject to
certain adjustments) multiplied by the Current Market Price. As part of this
transaction, the Company and Mr. Kann entered into a Consulting Agreement
pursuant to which Mr. Kann would consult to the Company for a period of nine
months and would be paid $50,000 over the term of the Consulting Agreement.
Under a bank loan agreement between the Company and Hudson United Bank
dated September 1, 1999, Messrs. Henry and Witcosky personally guaranteed up to
$4,000,000 of the Company's potential
24
indebtedness to the bank, plus accrued interest. In December 2001, these
guarantees were terminated.
In the early 1990's, Messrs. Henry and Witcosky and HAC had orally agreed
with Alfred Albrecht, to settle a variety of disputes to extinguish any equity
claims. The settlement agreement was memorialized in writing in December 1999.
Under the settlement agreement, the Company was obligated to pay an aggregate of
$128,685, plus accrued interest to Mr. Albrecht at the rate of 10% per annum
until December 1, 2003 in monthly installments under two promissory notes. Mr.
Henry and Mr. Witcosky were also obligors under these notes. The Company paid
the notes, including accrued interest, in May 2002 and they have been canceled.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits.
See index of exhibits annexed hereto.
(b) Reports on Form 8-K.
On August 27, 2002, we filed an 8-K reporting an Item 2 event announcing a
definitive agreement to purchase all of the issued and outstanding common stock
of National Safe of California, Inc. On October 25, 2002, we filed Amendment
Number 1 to the 8-K filed on August 27, 2002 to file the unaudited pro forma
condensed combined balance sheet as of June 30, 2002 and unaudited pro forma
condensed combined statement of operations for the six months ended June 30,
2002 and the year ended December 31, 2001 to reflect the acquisition of National
Safe of California, Inc.
Item 14. Controls and Procedures
Within 90 days prior to the date of this Form 10-KSB, the Company carried
out an evaluation, under the supervision and with the participation of its
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in its periodic SEC filings. There have
been no significant changes in the Company's internal controls or, to its
knowledge, in other factors that could significantly affect internal controls
subsequent to the date the Company carried out its evaluation.
The Company's management, including its CEO and CFO, does not expect that
its disclosure controls and procedures or its internal controls will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, provides reasonable, not absolute, assurance that the objectives of
the control system are met. Because there are inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control
25
issues and instances of fraud, if any, within the Company have been
or will be detected. These inherent limitations include the realities that
judgments in decision-making can be faulty and that breakdowns occur because of
simple error or mistake. Controls can be circumvented by the individual acts of
some persons or by collusion of two or more people. The design of any system of
controls is based in part upon certain assumptions about the likelihood of
future events. There can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with the policies or procedures. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant had duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 2003 DIVERSIFIED SECURITY SOLUTIONS, INC.
By: /s/ James E. Henry
----------------------------------------------
James E. Henry
Chairman, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE
Date: March 28, 2003 /s/ James E. Henry
----------------------------------------------
James E. Henry
Chairman, Chief Executive Officer and Director
Date: March 28, 2003 /s/ Irvin F. Witcosky
----------------------------------------------
Irvin F. Witcosky
Chief Operating Officer,
President, Secretary and Director
Date: March 28, 2003 /s/ Louis Massad
----------------------------------------------
Louis Massad
Vice President, Treasurer,
Chief Financial Officer and Director
Date: March 28, 2003
----------------------------------------------
Sal Lifrieri
Executive Vice President and Director
Date: March 28, 2003
----------------------------------------------
Leroy Kirchner
Director
Date: March 28, 2003 /s/ Robert S. Benou
----------------------------------------------
Robert S. Benou
Director
Date: March 28, 2003 /s/ Joseph P. Ritorto
----------------------------------------------
Joseph P. Ritorto
Director
Certification of Chief Executive Officer
for Annual Report on Form 10-KSB
I, James E. Henry, certify that:
1. I have reviewed this annual report on Form 10-KSB of Diversified
Security Solutions, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions);
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ James E. Henry
----------------------------------------------------
James E. Henry, Chairman and Chief Executive Officer
Certification of Chief Financial Officer
for Annual Report on Form 10-KSB
I, Louis Massad, certify that:
1. I have reviewed this annual report on Form 10-KSB of Diversified
Security Solutions, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions);
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Louis Massad
-----------------------------------------------------
Louis Massad, Chief Financial Officer, Vice President
and Treasurer
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002
Independent Auditors' Report...............................................F - 2
Consolidated Balance Sheet as of December 31, 2002.........................F - 3
Consolidated Statements of Operations and Retained Earnings
for the Years Ended December 31, 2002 and 2001..........................F - 4
Consolidated Statements of Changes in Stockholders' Equity.................F - 5
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002 and 2001..........................F - 6
Notes to Financial Statements.....................................F - 7 - F - 24
F - 1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Diversified Security Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Diversified
Security Solutions, Inc. and Subsidiaries at December 31, 2002, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the two year period ended December 31, 2002. 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 audit.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly
in all material respects the consolidated financial position of Diversified
Security Solutions, Inc. and Subsidiaries as of December 31, 2002, and the
consolidated results of their operations and their cash flows for each of the
two years in the period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America.
DEMETRIUS & COMPANY, L.L.C.
Wayne, New Jersey
March 19, 2003
F - 2
DIVERSIFIED SECURITY SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEET
ASSETS
Current assets:
Cash and cash equivalents $ 4,472,271
Accounts receivable - net of allowance for doubtful accounts
of $100,000 6,263,995
Note receivable 500,000
Inventory 2,169,999
Costs and profit in excess of billings 710,325
Deferred tax asset 161,000
Other current assets 339,403
-----------
Total current assets 14,616,993
Property and equipment, net of accumualed depreciation of
$1,070,718 1,167,680
Computer software product cost - net of accumulated amortization
of $479,472 214,620
Goodwill 1,790,357
Intangible assets 1,505,460
Other assets 366,654
-----------
$19,661,764
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,467,436
Accrued expenses 1,015,198
Billings in excess of cost 123,870
Deferred tax liability 97,000
Long-term debt current portion 217,426
Capitalized lease obligations, current portion 3,938
Customer deposits held 155,065
-----------
Total current liabilities 3,079,933
-----------
Capitalized lease obligations, less current portion 9,074
Long-term debt, less current portion 2,017,403
Deferred tax liability 182,000
-----------
Total liabilities 5,288,410
-----------
Stockholders' Equity:
Preferred stock,$.01 par value; 2,000,000 shares authorized;
no shares issued
Common stock, $.01 par value; 10,000,000 shares authorized;
5,138,357 shares outstanding 51,384
Additional paid-in capital 13,150,681
Retained earnings 1,171,289
-----------
Total stockholders' equity 14,373,354
-----------
$19,661,764
===========
The accompanying notes are an integral part of the statements
F - 3
DIVERSIFIED SECURITY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
Year Ended December 31,
-------------------------
2002 2001
----------- -----------
Sales $18,830,093 $11,928,613
Cost of Sales 12,485,362 7,733,114
----------- -----------
Gross Profit 6,344,731 4,195,499
Operating Expenses
Selling, general and administrative 5,750,578 3,474,530
----------- -----------
Operating income 594,153 720,969
Interst income 72,987 12,379
Interest expense (136,896) (217,858)
----------- -----------
Income before income taxes 530,244 515,490
Provision for income taxes 225,192 225,759
----------- -----------
Net Income $ 305,052 $ 289,731
=========== ===========
Basic and diluted earnings per common share:
Basic earnings per common share $ 0.06 $ 0.09
=========== ===========
Weighted average common shares 4,939,484 3,175,274
Diluted earnings per common share $ 0.06 $ 0.09
=========== ===========
Weighted average diluted shares 4,952,352 3,268,767
The accompanying notes are an integral part of the statements
F - 4
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Preferred Stock Common Stock Additional
par value $.01 par value $.01 Paid-in
2,000,000 Authorized 10,000,000 Authorized Capital
-------------------- --------------------- -----------
Shares Amount Shares Amount
------ ------ --------- -------
Balance December 31, 2001 none none 4,725,000 $47,250 $10,209,814
Net income for the year 2002
Amortization of deferred compensation
Issuance of shares for acquisitions 413,357 4,134 2,940,867
---- ---- --------- ------- -----------
Balance December 31, 2002 none none 5,138,357 $51,384 $13,150,681
==== ==== ========= ======= ===========
Deferred Retained
Compensation Earnings Total
------------ ---------- -----------
Balance December 31, 2001 $(20,834) $ 866,237 $11,102,467
Net income for the year 2002 305,052 305,052
Amortization of deferred compensation 20,834 20,834
Issuance of shares for acquisitions 2,945,001
-------- ---------- -----------
Balance December 31, 2002 $ -- $1,171,289 $14,373,354
======== ========== ===========
The accompanying notes are an integral part of the statements.
F - 5
DIVERSIFIED SECURITY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
-------------------------
2002 2001
----------- -----------
Cash flows from operating activities:
Net income $ 305,052 $ 289,731
Adjustments to reconcile net income to net cash used in
operating activities:
Amortization of stock based compensation 20,834 20,833
Depreciation and amortization 302,968 298,030
Bad debt expense 34,500 --
Deferred income taxes 48,000 65,000
Changes in operating assets and liabilities:
Accounts receivable (1,733,513) (1,956,098)
Inventory (754,175) 21,883
Costs and profits in excess of cost (411,446) (298,879)
Other assets (243,256) (45,601)
Accounts payable 109,135 (153,048)
Accrued expenses 405,943 (80,048)
Income taxes payable (143,096) (674)
Billings in excess of cost (67,384) 191,254
Other liabilities -- (27,000)
Customer deposits held (138,224) 247,891
----------- -----------
Cash used in operating activities (2,264,662) (1,426,726)
----------- -----------
Cash flows from investing activities:
Proceeds (purchases) of securities held to maturity 802,235 (802,235)
Computer software development costs (80,280) (86,250)
Purchase of property and equipment and leasehold improvements (186,165) (366,682)
Proceeds from sale of property and equipment 14,914 --
Issuance of note receivable (500,000) --
----------- -----------
Cash provided by (used in) investing activities 50,704 (1,255,167)
----------- -----------
Cash flows from financing activities:
Net (payments) proceeds of revolving bank line (910,000) 1,531,993
Proceeds of loan payable (275,729) 554,563
Scheduled payments on special projects and other notes payable -- (30,421)
Repayment of special projects bank loan -- (1,000,000)
Proceeds of sale of common stock -- 9,983,264
Proceeds of other notes 55,635 5,000
Acquisition of subsidiaries (1,086,910) --
Capitalized lease obligation payments (11,240) (15,601)
----------- -----------
Cash (used in) provided by financing activities (2,228,244) 11,028,798
----------- -----------
(Decrease) increase in cash and cash equivaents (4,442,202) 8,346,905
Cash and cash equivalents - beginning of year 8,914,473 567,567
----------- -----------
Cash and cash equivalents - end of year $ 4,472,271 $ 8,914,472
=========== ===========
The accompanying notes are an integral part of the statements.
F - 6
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
NATURE OF OPERATIONS
Diversified Security Solutions, Inc., the ("Company") and its subsidiaries,
are systems integrators providing design, installation and support services for
a wide variety of security, communications and control systems. The Company
specializes in turnkey systems that integrate many different technologies.
Systems are customized to meet the specific needs of its customers. In addition,
we manufacture and assemble CCTV equipment and provide security consulting
services to our clients. Diversified Security Solutions, Inc. markets nationwide
with an emphasis on the New York, Dallas, Phoenix and Southern California
metropolitan areas. Customers are primarily medium and large commercial and
government agencies.
The Company's headquarters and manufacturing facility is located in Saddle
Brook, New Jersey. Sales and service facilities are located near Dallas, Texas,
Phoenix, Arizona and Fullerton, California.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company and its subsidiaries. Following the acquisitions of
Photo Scan System, Inc., National Safe of California, Inc. and Corporate
Security Systems, LLC, the Company consolidates its results with the acquired
companies' results from the date of the acquisition (see note 12). All material
intercompany transactions have been eliminated in consolidation.
Income Recognition - Sales revenues from systems installations are
generally recognized on the completed-contract method, in which revenue is
recognized when the contract is substantially, complete. Most contracts are
completed in less than a year. The completed method applies to those contracts
completed within the fiscal year. Contracts that are expected to be completed in
more than a year are accounted for on the percentage of completion method.
The percentage of completion method recognizes sales earned based on the
percentage of total estimated contract costs incurred to date. Mobilization
charges are accounted for as a direct contract cost and included in the
estimated cost to complete for determination of revenue recognition on the
percentage of completion method. The excess of costs and estimated earnings over
billings and excess of accumulated billings over costs are not presented in
periods which management has determined that the amounts are not material.
Provision for estimated earnings and losses, if any, on uncompleted contracts
are made in period in which such losses are determined.
Service contracts are billed either monthly or quarterly on the last day of
the month covered by the contract. Accordingly, revenue from service contracts
is recognized monthly on the straight-line method.
F - 7
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles 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 amount of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Cash Equivalents - The Company considers highly liquid instruments with
original maturity of three months or less to be cash equivalents.
Inventories - Inventories are stated at the lower of cost or market. Cost
has been determined using the first-in, first-out method.
Property and Equipment - Property and equipment are recorded at cost, net
of accumulated depreciation. Depreciation is computed on a straight-line basis
over estimated useful lives of five to seven years. Leasehold improvements are
depreciated over the shorter of related lease terms or the estimated useful
lives. Upon retirement or sale, the costs of the assets disposed and the related
accumulated depreciation are removed from the accounts and any resulting gain or
loss is included in the determination of income. Repairs and maintenance costs
are expensed as incurred.
Intangible Assets - The Company's intangible assets include goodwill and
other intangibles that consists of the fair value of acquired customer lists,
service contracts acquired, trade names and covenants not to compete. Goodwill
represents the excess of purchase price over the fair value of net assets
acquired.
Effective January 1, 2002, the Company adopted the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other
Intangible Assets. Under SFAS No. 142, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized. At that date the Company had not
recorded goodwill or other intangible assets of indefinite lives. The cost of
acquired customer lists, service contracts and covenants not to compete are
amortized using the straight-line method over their estimated lives, which range
from five to fifteen years.
Goodwill is evaluated for possible impairment on an annual basis or more
frequently if events and circumstances occur that may indicate the potential for
impairment. Goodwill assigned to a reporting unit is evaluated for potential
impairment following a two step procedure. The fair value of the reporting unit
is initially determined and compared to its carrying value. If the carrying
value exceeds the fair value of the applicable reporting unit, the implied fair
value of the reporting unit is then determined. If it is determined that the
fair value of the underlying assets and liabilities of the reporting unit is
less than the carrying value of goodwill, an impairment loss is recorded. The
impairment test will be performed annually.
F - 8
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
Computer Software Product Cost - The Company accounts for software
development costs in accordance with Statement of Financial Accounting Standards
No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed" ("SFAS 86") under which certain software development costs
incurred subsequent to the establishment of technological feasibility are
capitalized and amortized over the estimated lives of the related products.
Technological feasibility is established upon completion of a working
model. All costs incurred prior to demonstrating technical feasibility have been
charged to cost of sales. These capitalized costs are subject to an ongoing
assessment of recoverability based on anticipated future revenues and changes in
hardware and software technologies. To date, costs incurred subsequent to the
establishment of technological feasibility were $694,092 as of December 31,
2002.
These costs are amortized over the estimated product life using the
straight-line method up to a maximum of five years. Included in operations is
amortization expense of $50,098 and $116,908 for the years ended December 31,
2002 and 2001 respectively. Accumulated amortization amounted to $479,472 as of
December 31, 2002.
Impairment of Long Lived Assets - The Company adopted in 2002 SFAS No. 144
"Accounting for the Impairment of Disposal of Long-Lived Assets" ("SFAS 144").
SFAS 144 requires that long-lived assets, to be held and used by an entity, be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of assets may not be recoverable. Under SFAS 144, if
the sum of the expected future cash flows (undiscounted and without interest
charges) of the long lived assets is less than the carrying amount of such
assets, an impairment loss would be recognized, and the assets are written down
to their estimated fair values.
The adoption of SFAS 144 did not have any material impact on the financial
position and results of operations. There have been no impairment losses through
December 31, 2002.
Concentrations of Credit Risk - Financial instruments which potentially
subject the Company to concentrations of credit risk consist primarily of cash,
cash equivalents and accounts receivable. As of December 31, 2002, the Company
had cash balances at certain financial institutions in excess of federally
insured limits. However, the Company does not believe that it is subject to
unusual credit risk beyond the normal credit risk associated with commercial
banking relationships.
Sales to our largest customer in 2002 were 24%, 18% and 13%, as compared
to 19%, 12% and 10% in 2001. Sales to local government agencies were 57% and
59% of sales for the years ended December 31, 2002 and December 31, 2001,
respectively.
F - 9
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
Income Taxes - Deferred taxes are provided on an asset and liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss carryforwards and deferred tax liabilities are recognized for
taxable temporary differences. Temporary differences are the difference between
the reported amounts of assets and liabilities and their tax basis. 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 be realized. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.
Fair Value of Financial Instruments - The carrying amounts of the Company's
financial instruments, which include cash equivalents, accounts receivable,
notes receivable, accounts payable, accrued expenses and notes payable
approximate their fair values at December 31, 2002.
Advertising Costs - The Company expenses advertising costs when the
advertisement occurs. Total advertising expense amounted to approximately
$92,000 and $39,500 for the years ended December 31, 2002 and 2001,
respectively.
Comprehensive Income - Comprehensive income for 2002 and 2001 represents
net income as defined pursuant to Statement of Financial Accounting Statement
Accounting Standards No. 130, "Reporting Comprehensive Income."
Stock Based Compensation - Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"), encourages, but
does not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has elected to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations. Accordingly, compensation cost for
stock options issued to employees is measured as the excess, if any, of the fair
market value of the Company's Common Stock at the date of grant over the amount
the employee must pay to acquire the stock. Pro forma disclosure of net income
based on the provisions of SFAS 123 is discussed in Note 8.
Research and Development Costs - Costs of research and development for new
products are charged to operations as incurred and amounted to approximately
$180,000 and $174,000 for the years ended December 31, 2002 and 2001,
respectively.
Warranty - The Company offers warranties on all products, including parts
and labor that range from one year to four years depending upon the type of
product concerned. For products made by others, the Company passes along the
manufacturer's warranty to the end user. The Company charges operations with
warranty expenses as incurred. For the years ended December 31, 2002 and 2001,
net warranty expense was $109,000 and $71,000, respectively.
F - 10
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
Historical Net Income Per Share - The Company computes net income per
common share in accordance with SFAS No. 128, "Earnings Per Share" and SEC Staff
Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS No. 128 and
SAB 98, basic and diluted net loss per common share are computed by dividing
the net income available to common shareholders for the period by the weighted
average number of shares of common stock outstanding during the period.
Accordingly, the number of weighted average shares outstanding as well as
the amount of net income per share are presented for basic and diluted per
share calculations for all periods reflected in the accompanying financial
statements.
Reclassification - Certain reclassification to the 2001 financial
statements have been made to conform to the 2002 presentation.
Segment Information -Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosure About Segments of an
Enterprise and Related Information" ("Statement 131"), that establishes
standards for the reporting by public business enterprises of financial and
descriptive information about reportable operating segments in annual financial
statements and interim financial reports issued to shareholders. The Company
primarily provides installation services for companies in need of closed-circuit
access control systems that are located throughout the United States and
considers all of its operations as one segment because expenses support multiple
products and services. Management uses one measurement of profitability and does
not disaggregate its business for internal reporting.
Recent Accounting Pronouncements - In December 2002, the FASB issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure".
This Statement amends SFAS No. 123, to provide alternative methods of transition
to SFAS No. 123's fair value method of accounting for stock-based employee
compensation. SFAS 148 also amends the disclosure provision of SFAS No. 123 and
APB No. 28, Interim Financial Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. The Company has
elected to continue accounting for employee stock based compensation in
accordance with APB 25 and related interpretations and has adopted the
disclosure requirements under SFAS No. 148 commencing on December 31, 2002.
F - 11
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
2. INVENTORIES
Inventories at December 31, 2002 consist of the following:
Parts $1,070,577
Finished Goods 1,099,422
----------
$2,169,999
==========
3. PROPERTY AND EQUIPMENT
Property, plant and equipment at December 31, 2002 consisted of the
following:
Office equipment $ 474,597
Demo and testing equipment 264,630
Vehicles 984,358
Computer equipment 466,217
Leasehold improvements 48,596
-----------
2,238,398
Less accumulated depreciation (1,070,718)
-----------
$ 1,167,680
===========
Depreciation expense amounted to $189,816 and $181,122 for the years ended
December 31, 2002 and 2001, respectively.
Included in property and equipment as of December 31, 2002 is capitalized
leases of $13,610.
F - 12
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
4. INTANGIBLE ASSETS
Intangible assets at December 31, 2002 consisted of the following:
Definite life (amortizable) Amount
--------------------------- ----------
Acquired customer lists $ 485,201
Service contracts 485,201
Covenants not to compete 258,773
----------
1,229,175
Less accumulated amortization (63,356)
----------
1,246,687
Indefinite life (non-amortizable)
---------------------------------
Trade names 258,773
----------
$1,505,460
==========
The weighted average of the number of years remaining on the assets life is
thirteen years.
5. LONG-TERM DEBT
On September 8, 1999, the Company refinanced its bank debt by obtaining
several lines of credit from the Hudson United Bank (HUB). Under the terms of
the HUB revolving line of credit amended January 2, 2002, the Company may borrow
up to $3,500,000 at 1/2% above the bank's prime interest rate through May 1,
2003. On October 24, 2002, the revolving line of credit was amended whereby the
interest rate was charged at the bank's prime rate. In March, 2003 HUB, extended
the line of credit to May 1, 2005. The line of credit is unsecured.
Also on September 8, 1999, as amended, HUB granted the Company an equipment
line of credit in the amount of $500,000, until April 30, 2003. Interest is at
the banks' prime interest rate plus 1/2%. Effective November 1, 2002. HUB
amended its equipment note and is due November 1, 2004. Monthly payments are
interest only at the banks' prime rate of interest plus 1/2%.
Effective November 1, 2002, HUB entered in with the Company a term loan for
$500,000. The loan is due November 1, 2005 and is payable monthly installments
of $13,483 plus interest at the banks' prime interest rate plus 1/2%. The loan
is collateralized by equipment.
HUB had granted the Company a special projects revolving line of credit of
$1,500,000 at 1 1/2% of the bank's prime rate through October 1, 2002. This line
was discontinued as of January 2, 2002, and the balance due at December 31, 2001
was transferred to the revolving line of credit.
F - 13
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
As of December 31, 2002 these lines are summarized as follows:
Amount of Facility Balance Due Unused Line
------------------ ----------- -----------
Revolving line $3,500,000 $1,620,000 $1,880,000
Equipment line 500,000 87,305 412,695
Term Loan 500,000 71,889 28,111
---------- ---------- ----------
Term loan $4,500,000 $2,179,194 $2,320,806
========== ========== ==========
Among other provisions, the loan agreement requires the Company to maintain
net tangible networth, as defined, and maintain appropriate insurance coverage
on tangible and intangible assets. In addition, the agreement prohibits selling,
assigning, transferring or disposing of any fixed assets without obtaining the
bank's consent in writing. The equipment line of credit is collateralized by all
the Company's equipment. These loans are cross-guaranteed by the parent company
and the various subsidiary companies. As of December 31, 2002, the Company was
in compliance with its loan covenants.
Long-term debt consisted of the following:
Revolving Line facility with HUB interest at the banks'
prime rate. All borrowings under this line are due
May 1, 2005 $1,620,000
Equipment Note with HUB at 1/2% above bank's prime
rate. All borrowings are due November 1, 2004. 87,305
Term loan with HUB at 1/2% above bank's prime rate,
due in monthly installments of $13,483 plus interest,
maturing on November 1, 2005. 471,889
Loan payable, due in monthly installments of
$6,475 a month, including interest at 12.2%
per annum maturing September 2003 55,635
Less: current portion (217,426)
----------
2,017,403
==========
F - 14
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
This debt matures over the next three years as follows::
Year ending December 31:
------------------------
2003.................................... $ 217,426
2004.................................... $ 249,095
2005.................................... $1,768,308
6. COMMITMENTS
(a) Leases - The Company leases its office facilities under operating
leases expiring through 2006. The Company also leases certain equipment under
capital lease. The future minimum rental payments under non-cancelable leases
and equipment loans as of December 31, 2002 were as follows:
Operating Capital
--------- --------
2003................................................... $321,000 $ 5,747
2004................................................... 252,000 5,747
2005................................................... 250,000 4,789
2006................................................... 172,000
-------- -------
Total minimum lease payments........................... $995,000 16,283
========
Amount representing interest........................... 3,271
-------
Net present value of future payments................... 13,012
Current portion of capital lease obligations........... 3,938
-------
$ 9,074
=======
Rent expense under operating leases was approximately $208,000 and $141,000
and for the years ended December 31, 2002 and 2001, respectively.
(b) Employment Agreements - The Company entered into employment agreement
with four of its officers through 2006. The employment agreements provide for
minimum aggregated annual compensation of $594,800 for 2003 plus unspecified
annual bonuses and 10% raises in certain contracts. Also, there are one-year
non-competition covenant that commences after termination of employment in
certain contracts.
F - 15
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
7. INCOME TAXES
Income taxes for the years ended December 31, 2002 and 2001 include the
following components:
Years Ended December 31
-----------------------
2002 2001
-------- --------
Federal
Current $117,397 $164,000
Deferred 38,400 45,050
State
Current 59,795 8,759
Deferred 9,600 7,950
-------- --------
$225,192 $225,759
======== ========
The components of the deferred tax asset (liability) as of December 31,
2002 are as follows:
Deferred tax asset:
Allowance for uncollectible accounts $ 41,000
Accrued absences 80,000
Accrued warranty 29,000
Inventory 11,000
---------
Total deferred tax asset 161,000
Deferred tax liability:
Cash to accrual basis (97,000)
Intangible assets (28,000)
Capitalized software development (87,000)
Fixed assets (67,000)
---------
Total deferred tax liability (279,000)
---------
Net deferred tax liability $(118,000)
=========
F - 16
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
The reconciliation of estimated income taxes attributed to operations at
the United States statutory tax rate to reported provision for income taxes is
as follows:
Year Ended December 31
----------------------
2002 2001
--------- --------
Provision for taxes computed using
statutory rate $171,100 $175,300
State taxes net of federal tax benefit 39,400 36,000
Depreciation and amortization -- 29,000
Utilization of state net operating losses -- (13,300)
Permanent differences 13,800
Other 892 (1,941)
-------- --------
Provision for income taxes $225,192 $225,759
======== ========
8. INCENTIVE STOCK OPTION PLAN
On December 23, 1999, the directors and shareholders approved the adoption
of an Incentive Stock Option Plan (the "Plan"). Under the Plan, options to
purchase a maximum of 500,000 shares of its common stock may be granted to
officers and other key employees of the Company.
The maximum term of any option is ten years, and the option price per share
may not be less than the fair market value of the Company's shares at the date
the option is granted. However, options granted to persons owning more than 10%
of the voting shares will have a term not in excess of five years, and the
option price will not be less than 110% of fair market value. Options granted to
an optionee will usually vest 33 1/3% of each full year beginning on the first
anniversary of the options grant subject to the discretion of the Compensation
Committee of the Board of Directors.
The plan will terminate at December 23, 2009 or on such earlier date as the
board of directors may determine. Any option outstanding at the termination date
will remain outstanding until it expires or is exercised in full, which ever
occurs first.
As of December 23, 1999, options to acquire an aggregate of 75,000 shares
of common stock, all at an exercise price of $5.625 per share, had been granted
under the 1999 Plan to key employees of the Company.
No options were granted to Messers. Henry and Witcosky, the two top
executive officers. In 1999, Mr. Massad, the Chief Financial Officer
was, granted 9,000 options at $5.625 per share that are currently exerciseable
and expire in December 2009. In addition, in May 2002, Mr. Massad was granted
5,000 options as a Board of Director member $7.95 per share that vests
immediately and expire in May 2007.
F - 17
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
In November 2001 the Company granted 40,000 options to a consultant for
services, that has an exercise price of $7.00 per share, vests one fifth per
year and expires in November 2006. The option was not granted a part from the
Company's 1999 or 2002 plan.
On May 10 2002, The Board of Directors and shareholders approved the 2002
Stock Incentive Stock Option Plan ("2002 Plan") and the shareholders
subsequently approved the 2002 Plan on October 28, 2002. The 2002 Plan grants
incentive stock options or non-qualified stock options to purchase a maximum
230,000 shares of its common stock to the Company's employees, directors and
consultants. All stock options granted under the 2002 Plan will be exercisable
at such time or times and in such installments, if any as our compensation
committee or the Board may determine and expires no more than ten years from the
date of grant. The 2002 Plan will terminate on May 9, 2012 or such earlier date
as the Board of Directors may determine. Any option outstanding at the
termination date will remain outstanding until it expires or is exercised in
full, which ever occurs first. The exercise price of the stock option will be at
the fair market value. Vesting is at the desecration of Compensation Committee
of the Board of Directors. The 2002 Plan allows immediate vesting of stock
options if there is a change of change of control.
A summary of stock option activity under 1999 and 2002 Plans are as
follows:
Options Outstanding
----------------------------------------
Available
For Number of Weighted-Average
Grant Shares Exercise Price
--------- --------- ----------------
Balance as of December 31, 2000 425,000 75,000 $5.625
Granted
Cancelled
Balance as of December 31, 2001 425,000 75,000 $5.625
Shares made available for grant 230,000
Granted (70,000) 70,000 $ 7.41
Cancelled
Balance as of December 31, 2002 585,000 145,000 $ 6.49
F - 18
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
The following tables summarize information about stock options outstanding
under the 1999 and 2002 Plan as of December 31, 2002:
Options Outstanding Options Exercisable
-------------------------------------- ----------------------
Weighted
Average Weighted Number Weighted
Number Remaining Average Exercisable Average
Range of Outstanding Contractual Exercise At Exercise
Exercise Prices At 12/31/02 Life (Years) Price 12/31/02 Price
--------------- ----------- ------------- -------- ----------- --------
$5.625-$7.95 145,000 8.23 $6.49 95,000 $6.11
At December 31, 1999, deferred compensation cost was recorded in the amount
of $62,500, being the difference between the expected public offering price at
the time the options were granted at a price of $6.459 or market value less
the $5.625, the exercise price times the number of options granted. Deferred
compensation cost was amortized over three years.
For proforma purposes, the fair value of the Company's stock option awards
was estimated assuming no expected dividends and the following
weighted-average assumptions for the years ended December 31:
Options
-----------
2002 2001
---- ----
Expected Life (years) 3 N/A
Expected volatility 4.9% N/A
Risk-free interest rates 3.0% N/A
The weighted average fair value per share of options granted for 2002 was
$7.41. There were no options granted during 2001.
Had deferred compensation cost for the stock option plan been determined
based on the fair value at the grant date for the awards made in 1999,
consistent with the provisions of SFAS No. 123, the Company's net earnings per
share in the years 2002 and 2001 would have been reduced to the proforma amounts
indicated below:
F - 19
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
2002 2001
-------- --------
Net income (loss)
As reported $305,052 $289,931
Proforma $303,887 $229,439
Earnings (loss) per share
As reported
Basic $ .06 $ .09
Diluted $ .06 $ .09
Proforma
Basic $ .06 $ .07
Diluted $ .06 $ .07
9. EMPLOYEE BENEFIT PLAN
The Company began a "Simple IRA" plan for all eligible employees wishing to
contribute. An eligible employee is one that has $1,000 or more in compensation.
The Company will matches the employees' contribution up to 3% and 2% of salary
to a maximum of $7,500 and $6,000 for the year 2002 and 2001. The employee's
contribution cannot exceed $7,500 in 2002 and $6,000 in 2001. Diversified
Security Solutions, Inc.'s contributions were $58,458 in 2002 and $36,786 in
2001, respectively.
10. STOCKHOLDERS' EQUITY
Common Stock - Holders of common stock are entitled to one vote for each
share held on all matters submitted to a vote of stockholders and do not have
cumulative voting rights. Apart from preferences that may be applicable to any
shares of preferred stock outstanding at the time, holders of our common stock
are entitled to receive dividends ratably, if any, as may be declared from time
to time by our board of directors out of funds legally available therefor. Upon
the liquidation, dissolution or winding up of the Company, the holders of common
stock are entitled to receive ratably, the net assets available after the
payment of all liabilities and liquidation preferences on any outstanding
preferred stock. Holders of common stock have no preemptive, subscription,
redemption or conversion rights, and there are no redemption or sinking fund
provisions applicable to the common stock.
Preferred Stock - Our board of directors is authorize, without stockholder
approval, to issue up to 2,000,000 shares of preferred stock in one or more
series and to fix the rights, preferences, privileges and restrictions of these
shares, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, and to fix the number of shares
constituting any series and the designations of these series. These shares may
have rights senior to our common stock. The issuance of preferred stock may have
the effect of delaying or preventing a change in control of us. The issuance of
preferred stock could decrease the amount
F - 20
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
of earnings and assets available for distribution to the holders of our common
stock or could aversely affect the rights and powers, including voting rights,
of the holders of our common stock. At present, we do not intend to issue any
shares of our preferred stock in the foreseeable future. No preferred stock
can be issued until November 2003 without the consent of the underwriter,
which shall not be unreasonably withheld.
Warrants - In connection with the Company's initial public offering in
November 2001, the Company's underwriter was granted warrants to purchase up to
150,000 shares of common stock. The exercise price of the warrants is 165% of
the public offering price of $7.00 a share or $11.55 a share. The warrants
contain provisions that protect their holders against dilution by adjustment of
the exercise price and number of shares issuable upon exercise on the occurrence
of specific events such as stock dividends or other changes in the number of
outstanding except for shares issued under certain circumstances, including
shares issued under the incentive stock option plan and any equity securities
which adequate consideration is received. The holder of warrant does not possess
any rights as a stockholder unless the warrant is exercised.
11. SUPPLEMENTAL CASH FLOW DISCLOSURE
Years Ended December 31,
------------------------
2002 2001
-------- --------
Cash paid for:
Taxes paid $370,619 $173,433
Interest paid $142,180 $217,858
During 2002, the Company purchased three subsidiaries through an exchange
of stock for an aggregate of $2,945,000 as described in note 12.
In addition, the Company borrowed $229,312 for equipment and entered into a
capital lease for $13,610.
12. ACQUISTIONS AND CONTINGENCIES
On May 17, 2002, we purchased all of the issued and outstanding shares of
Photo Scan Systems, Inc. ("Photo Scan") from Secure Alarm Systems, Inc. ("Secure
Alarm"). Photo Scan is located in California, specializes in security systems
for medical facilities and provide sales, system design, installation, service
and maintenance of integrated security systems which include access control,
closed circuit television, intercom, audio alarm and property intrusion
detection. The purchase price for the issued and outstanding, shares of Photo
Scan was $600,000 of which $200,000 was paid in cash and balance was paid by
issuing 51,249 shares of our restricted common stock. Pursuant to the purchase
agreement, we also paid off a $200,000 note made by Photo Scan Alarm. The
purchase agreement provides that in the event that one year from May 17, 2002
(the "Reference Date"), the average closing sale price of our common stock for
the ten
F - 21
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
trading days immediately prior to the Reference Date (the current Market
Price) is less than approximately $7.81 per share we will pay in cash Secure
Alarm an amount equal to the difference between $400,000 and the 51,249 shares
multiplied by the Current Market Price. The Company entered into this
transaction because Photo Scan is a provider of installers of security systems
to the medial sector and is located in the west coast. The purchase price was
determined based upon fair market value method based upon future revenues.
On August 13, 2002 we acquired all of the issues and outstanding common
stock of National Safe of California, Inc. ("National"). National supplies and
services alarm security equipment, backup high security systems, lock and
locking mechanisms, vault security, control systems and high-resolution
surveillance equipment. The purchase price of the acquisition was $2,000,000,
which was paid by issuing an aggregate of 283,566 shares. As part of this
transaction, Photo Scan made a $500,000 non-recourse loan, to the seller of
National and is secured by 70,000 shares of the Company's stock. The Stock
Purchase Agreement provides that in the event that one year from the Closing
(the "Reference Date"), the average closing sale price of our common stock for
the ten trading days immediately prior to the Reference Date is less than$7.053
per share (the "Current Market Price"), we can within 10 days of the Reference
Date, either purchase 212,675 of the Shares of $1,500,000 (subject to certain
adjustments detailed in the Stock Purchase Agreement) or the seller amount equal
to the difference between (i) $1,500,000 and (ii) 212,675 (subject to certain
adjustments detailed in the Stock Purchase Agreement) multiplied by the Current
Market Price. The Company entered into this transaction because National is a
provider of installers of security systems to the banking sector and is located
in the west coast. The purchase price was determined based upon fair market
value method based upon future revenues.
The following is a summary of the total purchase price of National as of
the acquisition date:
Purchase price $2,000,000
Acquisition cost 377,468
----------
Total purchase price $2,377,468
----------
Assets 503,903
Property and equipment 970,000
Identifiable intangible assets 40,000
Goodwill 1,153,245
Liabilities (289,680)
----------
$2,377,468
==========
F - 22
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31, 2002
Of the $970,000 of acquired intangible assets, $160,000 was assigned to a
trade name that is not subject to amortization, $160,000 was assigned to a
covenant not to compete that is being amortized on a straight line basis over
the life of the contract of five years, acquired customer list and service
contracts each were assigned $300,000 and are amortized on a straight line
basis over fifteen years.
On September 22, 2002, Photo Scan Systems acquired Corporate Security
Integration, LLC ("CSI"). CSI is located in Phoenix, Arizona and specializes in
access controls and closed circuit television monitoring. The purchase price for
CSI was $815,000 of which $270,000 was paid in cash and $545,000 was paid by
issuing 78,542 shares of common stock. The Company entered into this transaction
because we were looking for a presence out west to compliment our east coast
operation. The purchase price was determined based upon fair market value method
based upon future revenues.
The following is a summary of the total purchase price of Photo Scan and
CSI as of the acquisition date:
Purchase price $1,615,000
Acquisition cost 123,471
----------
Total purchase price $1,738,471
----------
Assets 501,312
Property and equipment 430,361
Identifiable intangible assets 598,816
Goodwill 637,112
Liabilities (429,130)
----------
$1,738,471
==========
Of the $598,816, of acquired intangible assets, $129,641 was assigned to a
trade name that is not subject to amortization, $98,773 was assigned to a
covenant not to compete that is being amortized on a straight line basis over
the life of the contract of five years, acquired customer list and service
contracts each were assigned $185,201 and are amortized on a straight line basis
over fifteen years.
The following table provides pro forma results of operations for the year
2002 and 2001, as if National had been acquired at January 1, 2001. The pro
forma results do not include any anticipated cost savings or other effects of
the planned integration of National. Accordingly, such amounts are not
indicative necessarily of the results that would have occurred if the
acquisition had been completed on the date indicated or that may result in the
future.
F - 23
DIVERSIFIED SECURITY SOLUTIONS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
DECEMBER 31, 2002
Pro Forma Condensed Consolidated Results (Unaudited)
Year Ended December 31, 2002
Historical
------------------------
Company National Adjustment Pro Forma
----------- ---------- ---------- ---------
Sales $17,666,461 $4,075,177 $21,741,638
Net income (loss) $ 120,633 $ (76,330) $(20,880) (1,2) $ 23,423
Income per share:
Basic $ 0.02 $ 0.00
Diluted $ 0.02 $ 0.00
Pro Forma Condensed Consolidated Results (Unaudited)
Year Ended December 31, 2001
Historical
------------------------
Company National Adjustment Pro Forma
----------- ---------- ----------- ---------
Sales $11,928,613 $2,864,430 $14,793,043
Net income (Loss) $ 289,731 $ (179,545) $ (41,760)(1,2) $ 68,426
Income per share:
Basic $ 0.08 $ 0.02
Diluted $ 0.08 $ 0.02
(1) To amortize intangible assets (covenant not to compete for five years
and service rights and acquired customer list for fifteen years) on a
straight-line basis.
(2) To record effects of income tax benefit related to pro forma
adjustments using a 42% tax rate.
13. CONTINGENT LIABILITIES
From time to time, the Company is subject to various claims with respect to
matters arising out of the normal course of business.
F - 24
EXHIBIT INDEX
The following exhibits are filed herewith as part of this 10-KSB:
Exhibit Method
Number Description of Document of Filing
------- ------------------------------------------------------------------------------ ---------
2.1 -- Stock Purchase Agreement by and among Diversified Security Solutions,
Inc., Photo Scan Systems, Inc., National Safe of California, Inc. and Lee
A. Kann, dated as of August 13, 2002............................................... (1)
3.1 -- Certificate of Incorporation of the Company........................................ (2)
3.2 -- By-laws of the Company............................................................. (2)
3.3 -- Certificate of Amendment of the Certificate of Incorporation of the
Company, filed on July 5, 2001..................................................... (3)
3.4 -- Certificate of Amendment of the Certificate of Incorporation of the
Company, filed on August 28, 2001.................................................. (3)
4.1 -- Specimen Common Stock Certificate of the Company................................... (4)
4.2 -- Underwriter's Warrant Agreement.................................................... (5)
10.1 -- Employment Agreement between the Company and Sal Lifrieri.......................... (6)
10.2 -- 2002 Stock Option Plan............................................................. (7)
10.3 -- Employment Agreement between the Company and James E. Henry........................ (2)
10.4 -- Employment Agreement between the Company and Irvin F. Witcosky..................... (2)
10.5 -- Employment Agreement between the Company and Louis Massad.......................... (2)
10.6 -- 1999 Incentive Stock Option Plan and form of Stock Option Agreement................ (2)
10.7 -- Amendment to Employment Agreement between the Company and James E. Henry........... (3)
10.8 -- Amendment to Employment Agreement between the Company and Irvin F. Witcosky........ (3)
10.9 -- Amendment to Employment Agreement between the Company and Louis Massad............. (3)
10.10 -- Office Lease between the Company and Midland Holding Co., Inc...................... (5)
10.11 -- Office Lease between the Company and Eagle-DFW, Inc................................ (5)
10.12 -- Underwriting Agreement between the Company and GunnAllen Financial, Inc............ (5)
21.1 -- List of Subsidiaries............................................................... (8)
99.1 -- Written Statements of the Chief Executive Officer and Chief Financial
Officer of the Company Pursuant to 18U:SC SS 1350.................................. (8)
---------
1. Incorporated by reference to the 8-K of the Company filed with the Securities
and Exchange Commission on August 27, 2002.
2 Incorporated by reference to the Registration Statement on Form SB-2 File No.
333-94477, filed with the Securities and Exchange Commission on January 12,
2002.
3 Incorporated by reference to Amendment No. 4 to the Registration Statement
filed with the Securities and Exchange Commission on September 25, 2001.
4 Incorporated by reference to Amendment No. 6 to the Registration Statement
filed with the Securities and Exchange Commission on November 13, 2001.
5 Incorporated by reference to Post-Effective Amendment No. 1 to the
Registration Statement filed on February 8, 2001.
6 Incorporated by reference to the 10QSB of the Company for the Quarter Ended
September 30, 2002 filed with the Securities and Exchange Commission on November
14, 2002.
7 Incorporated by reference to the Company's Definitive Proxy on Form 14A filed
with the Securities and Exchange Commission on September 27, 2002.
8 Filed herewith.