================================================================================
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, AS AMENDED
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
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
----------
DIVERSIFIED SECURITY SOLUTIONS, INC.
(Name of small business issuer as specified in its charter)
----------
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
----------
Securities registered pursuant to Section 12(b) of the Act: None
----------
Securities registered pursuant to Section 12(g) of the Act:
----------
Common Stock, $.01 par value
(Title of Class)
----------
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: $27,319,534 (based upon the closing price of Issuer's Common
Stock, $.01 par value, as of March 22, 2005).
The Registrant's revenues for the year ended December 31, 2004 were
$29,725,718.
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 5,739,398
(Title of Class) (No. of Shares Outstanding
at March 22, 2005)
Documents Incorporated By Reference:
None
================================================================================
DIVERSIFIED SECURITY SOLUTIONS, INC.
Table of Contents
PART I............................................................................................3
Item 1. Description of Business...................................................................3
Item 2. Description of Property..................................................................10
Item 3. Legal Proceedings........................................................................11
Item 4. Submission of Matters to a Vote of Stockholders..........................................11
PART II..........................................................................................11
Item 5. Market for Common Equity and Related Stockholder Matters.................................11
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations....13
Item 7. Financial Statements.....................................................................18
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....18
Item 8a. Controls and Procedures.................................................................18
PART III.........................................................................................19
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Sections
(16a) of the Exchange Act and Code of Ethics.....................................................19
Item 10. Executive Compensation..................................................................22
Item 11. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholders Matters.............................................................................25
Item 12. Certain Relationships and Related Transactions..........................................27
Item 13. Exhibits and Reports on Form 8-K........................................................27
Item 14. Principal Accountant Fees and Services..................................................27
Signatures.......................................................................................29
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. 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.
2
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, Inc. ("CGI") in 1985.
In 1989, Jim Henry, our Chairman and Chief Executive Officer, and Irvin
Witcosky, our President and Chief Operating Officer reacquired certain assets,
including the name Henry Bros. Electronics ("HBE") from CGI. In 1991 we acquired
the assets of the former Motorola CCTV division and formed Viscom Products, Inc.
("Viscom"). In 1999 we formed a company named Integcom Corp. incorporated in
Delaware into which we transferred the both HBE and Viscom. In 2001 we changed
our name to Diversified Security Solutions, Inc.
In November 2001, we completed our initial public offering, including the
underwriter's over-allotment option of an aggregate of 1,725,000 shares of
common stock. Our shares are traded on the American Stock Exchange under the
ticker symbol DVS.
In May 2002, we purchased Photo Scan Systems, Inc. ("Photo Scan") a
security integrator located in southern California and changed its name to Henry
Bros. Electronics, Inc. in December 2002.
In August 2002, Photo Scan acquired National Safe of California, Inc. which
sells and services alarm security equipment, lock and timing mechanisms, vault
security, control and backup systems and high resolution security equipment used
by commercial banks.
In September 2002, Photo Scan acquired Corporate Security Integration, LLC.
("CSI") a security integrator located in Phoenix, Arizona, and subsequently
changed its name to Henry Bros. Electronics, LLC.
In April 2004, we acquired Airorlite Communications, Inc., a company
located in Saddle Brook, New Jersey, that specializes in the design, manufacture
and maintenance of wireless communications equipment used to enhance emergency
radio frequency services and cellular communication for both fixed and mobile
applications.
Our principal executive offices are located at 280 Midland Avenue, Saddle
Brook, New Jersey 07663, and our telephone number is (201) 794-6500.
(b) Business of Issuer
We are a single-source/turn-key provider of technology-based security
solutions for medium and large commercial enterprises and government agencies in
the United States.
Security Distributing and Marketing magazine ("SDM") ranks by 2003 revenue
the top 100 largest firms selling closed circuit TV ("CCTV"), access control and
integrated security systems. We were ranked No. 26 in SDM's Top Systems
Integrators Report published in July 2004.
As a single-source/turn-key provider of diversified technology-based
integrated security solutions, we can expedite project completion and optimize
system manpower performance. The continually evolving security requirements of
commercial and government entities, together with
3
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.
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;
o Sell additional services to our established client base; and
o Pursue strategic acquisitions that would be complementary to our
business and accretive to earnings
Our three operating units are integration, emergency preparedness planning
programs and specialty products.
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 the client and us and often serves 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;
4
o Survey the site(s), 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.
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 to
understand 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 select system components required under the specifications and drawings. We
recommend that our customers buy proven off-the-shelf devices and software and
resort to custom equipment only when absolutely necessary.
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
available from a wide range of manufacturers enables us to select components
that will best meet a project's requirements.
Systems Installation and Management
Under the supervision of the manager of the project, our technicians
install hardware, integrate hardware and software, and validate and test the
system. Subcontractors typically perform the aspects of systems integration that
do not require a high level of technical expertise, such as wire installation
and basic construction. 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;
5
o Intrusion detection systems, which detect unauthorized door and window
openings, glass breakage, vibration, motion, noise and alarms and
other peripheral equipment;
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 Intercoms, public address, fire detection signals and network
connectivity that can expand a local security system into a closely
controlled worldwide system.
Systems Training
Upon completion of a systems integration project, we typically will provide
the customer with system documentation and training in the operation and
maintenance of the 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.
Our Emergency Preparedness Planning Programs Solution
Our Emergency Preparedness Planning Programs ("EPPP") division works with
companies and managers of high-rise office buildings to analyze their specific
facilities needs with emergency preparedness plans. We provide demonstrations,
training and recommendation to clients. Our evacuation planning division
provides a wide array of services, including:
o Develop emergency plans and procedures;
o Expand existing fire/emergency and preparedness response plans;
o Articulate building strategy to the tenants;
o Provide tenant inclusion;
o Increase building community unity, awareness and confidence; and
o Employee training.
Our Specialty Products Solutions
The Company's specialty products solutions are provided by two wholly owned
subsidiaries, Viscom's Products, Inc. ("Viscom") and Airorlite Communications,
Inc. ("Airorlite"). Viscom has an integrated standard solution for mobile
digital records for deployment on municipal buses and trains. Viscom products
are manufactured by a third party vendor. Airorlite specializes in designing,
manufacturing and maintaining wireless communications equipment used to enhance
and extend emergency radio frequency services and cellular communication for
both fixed and mobile applications.
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
6
national level, we conduct analyses of various industries and target those with
significant 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 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 and seaports, high-rise buildings, public transportation systems,
healthcare, financial, educational and other vertical markets. We have
identified several key industries or facility types that we believe have
substantial and increasing requirements for security services, including
corporate campuses and federal 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
and have provided services to customers representing each of the vertical
markets described under Marketing.
Competition
The security industry is highly fragmented and competitive. We compete on a
local, regional and national basis with systems integrators, consulting firms
and engineering and design firms. Our competitors include equipment
manufacturers and vendors that also provide security services. Many of our
competitors have greater name recognition and financial resources. We believe
that we compete primarily on our ability to deliver solutions that effectively
meet a client's requirements and, to a lesser extent and primarily in
competitive bid situations, on price. Many of the larger public sector projects
require performance bonds, which may limit our ability to compete with larger
competitors as the prime contractor, depending upon the specifications of the
project.
Employees
As of February 2005, we had 148 full time employees, including officers, of
whom: 99 were engaged in engineering, systems installation and maintenance
services, 32 in administration and accounting, and 17 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. Systems
integration projects are based upon the estimated cost of the equipment for the
project including a profit margin, plus the estimated hours for each skill set,
required to complete the project multiplied by the rate quoted, plus a profit
margin. Pricing for engineering and maintenance services are determined based on
the scope
7
of the specific project and the length of our engagement. Proposals for
consulting and threat assessment services are priced based on an estimate of
hours multiplied by standard rates.
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.
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 revenues. Although, no single customer comprised more then 10% of total
revenues during 2004, our five largest projects represented approximately 25% of
our revenues. Revenues from governmental agencies accounted for 20% in 2004
versus 21% in 2003. Consequently, we are often required to replace one customer
with one or more other customers in order to generate the same amount of
revenues. There can be no assurance that we will continue to be able to do so.
Some of our orders and contracts may be cancelled or modified so there is a
risk that our backlog may not be fulfilled
Some of our orders and contract backlog are subject to cancellation or
modification by our customers at any time so we cannot be certain that we will
recognize revenues from them. As of December 31, 2004, our backlog was
approximately $20,503,000.
We are dependent on a few vendors and rely on timely delivery of equipment
from outside sources
There are a few vendors from whom we obtain devices and software for
specific access control, imaging, remote transmission, smart key and mobile
applications. The loss of any one of these companies as suppliers could have a
materially adverse impact on our business, financial condition and results of
operations if we are unable to develop or acquire new technologies from other
sources. We believe there are alternative vendors to source such products.
Timely vendor deliveries of equipment meeting our quality control standards
from all suppliers are also important to our business because each installed
system requires the integration of a variety of elements to be fully functional.
The failure to deliver any component when required, in operating condition, can
delay the project, triggering contract penalties, delay in progress payments and
may result in cancellation of the project.
We have not been consistently profitable and may not be profitable in the
future
For the years ended December 31, 2004 and 2003 our revenues were
$29,725,718 and $18,261,065, respectively, and our net income (loss) was $44,021
and $(2,957,102), respectively. Our profit has not been continuous and we can
make no assurances that we will be profitable in the future.
We experience intense competition for business from a variety of sources
In systems integration, we compete for new business with large construction
firms, electrical
8
contractors and consultants in the security business and other systems
integrators. Many of our competitors are much larger 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 and Irvin F. Witcosky, our two key executives, are vital to
our business operations. The loss of either of them could have a materially
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 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. There is no assurance
that we will be able to retain our skilled employees or attract, assimilate and
retain other highly skilled employees in the future.
Lengthy revenues cycle
Revenue 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 make a proposal to
when we can recognize revenues from the project.
Seasonality
Revenues of our services have typically been seasonal in nature and there
could be periods of fluctuations in revenue volume due to the timing of project
installations or factors that are beyond the Company's control, such as weather
and construction delays.
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, the
occurrence of which could have a materially adverse impact on our business,
financial condition or results of operations:
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 a significant portion of our available cash.
o We could have difficulty assimilating the acquired company's
operations and personnel or working with the joint venture. These
difficulties could disrupt our
9
ongoing business, distract our management and employees and
increase our expenses and charges.
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 such
acquisition, which will dilute existing shareholders.
o We may have to incur significant accounting charges, such as for
an impairment of intangible assets, which may adversely affect
our results of operations.
The Chief Executive Officer and Chief Operating Officer own a significant
amount of our common stock and their interests may be different from and
conflict with yours
The interests of the Chief Executive Officer and Chief Operating Officer
could conflict with the interests of our other stockholders. Mr. Henry and Mr.
Witcosky beneficially own a total of approximately 48.8% of our outstanding
common stock. Accordingly, if they act together, they may have the power to
control the election of all of our directors or other issues for which the
approval of our shareholders is required.
Item 2. Description of Property
We lease a 17,055 square foot sales, office, and integration facility that
also serves as our corporate office in Saddle Brook, New Jersey. This facility
is a portion of a single-story, modern brick building in a commercial and
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, plus taxes of approximately $600 per month. We are also
responsible for the cost of property tax increases, utilities, repairs,
maintenance, alterations, cleaning and insurance.
We lease a 9,553 square foot sales and office facility in Fullerton,
California. A two-story, concrete building in an office complex, this space is
leased until November 15, 2006 at an average annual rent of $111,108 payable in
equal monthly installments of $9,257, with additional costs for insurance,
repairs and alterations, utilities, taxes and cleaning.
We lease a 4,200 square foot revenues and 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 February 28, 2007 at an annual
average rental of $39,900, payable in equal monthly installments of $3,325, with
additional costs for insurance, repairs and alterations, utilities, taxes and
cleaning.
We lease a 3,906 square foot revenues and office facility in Phoenix,
Arizona. A single-story, concrete building in an office complex, this space is
leased until August 2006 at an average annual rental of $44,820, payable in
average monthly installments of $3,735, with additional costs for insurance,
repairs and alterations, utilities, taxes and cleaning.
10
We sublease approximately 1,750 square feet of office space in New York
City for sales and project management personnel. This lease expires on October
31, 2006, with an annual rental of $28,800, payable in equally monthly
installments of $2,400, inclusive of utilities.
Our Airorlite subsidiary leases a 5,440 square foot sales, office and
warehouse facility in Saddle Brook, New Jersey. This facility is in a
single-story, modern brick building in a commercial and industrial area. The
lease on this space terminates on November 30, 2005, and provides for an annual
rent of $34,906 until that date, payable in equal monthly installments. We are
also responsible for the cost of property taxes, utilities, repairs,
maintenance, alterations, cleaning and insurance.
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 2004 Annual Meeting of Stockholders held on November 5, 2004, 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 5,134,264 15,950
Robert L. DeLia Sr. 5,132,764 17,450
James E. Henry 5,095,164 55,050
Joseph P. Ritorto 5,134,264 15,950
Brian Reach 5,127,764 22,450
Irvin F. Witcosky 5,127,764 22,450
The stockholders also voted to ratify the selection of Demetrius & Company,
L.L.C. as our independent auditors for 2004. The results of the voting of this
proposal were 5,102,313 in favor, 19,501 against and 28,400 abstentions.
Stockholders also approved the granting of 52,550 shares of the Company's Common
Stock to certain of its employees voting 5,071,053 in favor, 56,959 against and
22,202 abstaining.
PART II
Item 5. Market for 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 stock prices for each
period.
11
2003 High Low
---- ----- -----
First Quarter $7.70 $6.52
Second Quarter $7.35 $6.30
Third Quarter $7.15 $6.10
Fourth Quarter $6.70 $5.26
2004
----
First Quarter $6.88 $5.50
Second Quarter $9.90 $6.35
Third Quarter $9.00 $5.20
Fourth Quarter $5.55 $4.81
(b) Number of Holders of Common Stock. The number of holders of record of
our Common Stock on March 22, 2005 was 37. Since a portion of the
shares of the common stock are held in street or nominee name, it is
believed that there are significant number of additional number of
beneficial owners of common stock.
(c) Dividends. There were no cash dividends or other cash distributions
made by us during the year ended December 31, 2004. Future dividend
policy will be determined by our Board of Directors based on our
earnings, financial condition, capital requirements and other 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.
----------------------------------------------------------------------------------------------------------------
Number of securities
Weighted average remaining available for
Number of securities to exercise price of future issuance under equity
be issued upon exercise outstanding compensation plans (excluding
of outstanding options, options, warrants securities reflected in
warrants and rights and rights column (a))
Plan category (a) (b) (c)
----------------------------------------------------------------------------------------------------------------
Equity compensation plans approved 309,575 * $6.79 401,900
by security holders
----------------------------------------------------------------------------------------------------------------
Equity compensation plans not 383,666 ** $9.08 383,666
approved by security holders
----------------------------------------------------------------------------------------------------------------
Total 693,241 $8.06 785,566
----------------------------------------------------------------------------------------------------------------
----------
* This amount includes options issuable pursuant to our 2002 Stock Option
Plan. Our Board of Directors approved this plan on May 10, 2002. Our
shareholders' approved it 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. The Board of Directors and our shareholders approved the adoption of the
Incentive Stock Option Plan on December 23, 1999. Our Incentive Stock Option
Plan provides for the granting of options to purchase a maximum of 500,000
shares of the
12
Company's common stock.
** This amount includes a warrant to purchase 40,000 shares of our common
stock granted on November 1, 2001 to the Wall Street Consultants, Inc. ("WSC")
at a price of $7.00. This warrant was granted in consideration of services
provided by WSC to the Company and expires in November 2006. Also included is a
warrant to purchase 150,000 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 and expires on November 21, 2005. In addition, warrants
to purchase 138,333 and 55,333 shares at $7.60 expiring January 27, 2010, were
granted in connection with the issuance of 553,333 shares of our common stock to
certain qualified institutional investors and the placement agent, respectively,
in July 2004.
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, evacuation planning and specialty products.
Our integration unit designs, customizes, installs, connects and maintains
CCTV (closed circuit television) 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, via a third party central station. 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 systems. We
also provide maintenance and technical support.
Our emergency preparedness planning programs division works with companies
and managers of high-rise office buildings to analyze their specific facility
needs with emergency preparedness plans. We provide demonstrations, training and
recommendation to clients. Our evacuation planning division provides a wide
array of services, including:
o Develop emergency plans and procedures;
o Expand existing fire/emergency and preparedness response plans;
o Articulate building strategy to the tenants;
o Provide tenant inclusion; and
o Increase building community unity, awareness and confidence.
Our specialty products business is comprised of two wholly owned
subsidiaries, Viscom and Airorlite Communications. Viscom has an integrated
standard solution for mobile digital recording used on municipal buses and
trains. This product is being manufactured by a third party vendor. Airorlite
specializes in designing, manufacturing and maintaining wireless communications
equipment used to enhance and extend emergency radio frequency services and
cellular communication for both fixed and mobile applications.
13
Comparison of the year ended December 31, 2004 to the year ended December 31,
2003
Revenues
Revenues for the year ended December 31, 2004 were $29,725,718,
representing an increase of $11,464,653 or 62.8%, as compared to $18,261,065 for
the year ended December 31, 2003. The increase in revenues was principally
related to an increase of $8,737,089 in the Company's integration business. The
companies that we acquired during 2002 continued to contribute significant
revenues growth in 2004 as revenues doubled in the Company's California and
Arizona regions. Revenues for 2004 in the New Jersey region increased by 11%, as
government funding for security related projects has increased. In April 2004,
the Company acquired Airorlite Communications Inc., a provider of wireless
communication solutions. Revenues for Airorlite were $2,503,776 for the period
April 1, 2004 through December 31, 2004. Revenues to governmental agencies
represented 20% and 21% of total revenues, for the years ended December 31, 2004
and 2003, respectively.
Cost of Revenues
Cost of revenues for the year ended December 31, 2004 was $22,305,632, as
compared to $14,908,700 for the year ended December 31, 2003. This was an
increase of $7,396,932 or 49.6%. Gross profit margin was 25.0% for the year
ended December 31, 2004, as compared to 21.5 % for the year ended December 31,
2003 (excluding the 2003 restructuring charge for Viscom Products). We attribute
the increase in our gross margin percentage to the Airorlite Communications
acquisition, which operates at a higher gross margin percentage than the
Company's integration business. Integration margin for the year ended December
31, 2004 was 23.0%, as compared to 23.4% for the prior year. The company
experienced cost overruns on three significant jobs in 2004, which resulted in
the slightly lower margin.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased to $7,020,885 for
the year ended December 31, 2004, from $8,339,337 for the year ended December
31, 2003. Selling, general and administrative expenses as a percentage of
revenues decreased to 23.6% for the year ended December 31, 2004 versus 44.9%
for the year ended December 31, 2003 excluding the Viscom restructuring charge.
This decrease of $1,318,452, or 15.8%, was primarily attributable to lower 2004
spending as the 2003 shutdown of Viscom Products manufacturing operations had a
full year impact, lower 2004 spending for marketing and revenues efforts of
establishing the acquired companies from 2002, lower salary and related benefits
and a one time 2003 charge from stock grants to employees. Partially offsetting
these savings were increased provisions for doubtful accounts based on our
strong revenue growth. As the Company's revenues increased in 2004, the
infrastructure costs of the Company were absorbed, resulting in the favorable
selling, general and administrative expenses as a percentage of revenues. The
Company continues to search for productivity improvements to improve this ratio
for 2005.
Interest Income
Interest income for the year ended December 31, 2004 was $12,624, as
compared to $10,326 for year ended December 31, 2003. The increase of $2,298 was
due to having increased cash to invest.
14
Interest Expense
Interest expense for the year ended December 31, 2004 was $94,039, as
compared to $106,464 for the ended December 31, 2003. The decrease of $12,425
was attributable to having an average lower debt balance of $1,783,342 for the
year ended December 31, 2004 as compared to $2,306,076 for the year ended
December 31, 2003.
Net (Loss) Income
As a result of the factors noted above, for the year ended December 31,
2004 our net income was $44,021, as compared to a net loss of ($2,957,102) for
the year ended December 31, 2003. This resulted in basic earnings per share of
$0.01 on weighted average common shares outstanding of 5,411,964 for the year
ended December 31, 2004, as compared to basic loss per share of ($0.58) on
weighted average common shares outstanding of 5,121,877 for the year ended
December 31, 2003.
Liquidity and Capital Resources
As of December 31, 2004, we had cash and cash equivalents of $3,154,972,
versus $1,927,416 as of December 31, 2003. This increase is attributable to the
equity private funding in July 2004, in the net amount of $2,958,058. We have a
total loan facility of $4,500,000 with Hudson United Bank and have certain debt
maturing from May 2005 through November 2005. The amount available under the
revolving credit facility was approximately $2,330,000, as of December 31, 2004.
We are in compliance with the various loan covenants as of December 31, 2004.
Our working capital was $9,187,176 as of December 31, 2004. We have total
short-term debts due of approximately $1,394,809 and purchase orders with our
vendors to fulfill customer orders of approximately $3,840,000.
During the year ended December 31, 2004, net cash used in operations was
$269,351. We purchased property and equipment of $236,295 and generated
$1,900,077 in cash from financing activities. In addition, the company utilized
$166,875 of net cash to acquire Airorlite Communications, Inc. in 2004
Our capital requirements have grown substantially as a result of the growth
of our operations and staffing since our public offering. Our cash and cash
equivalents have increased by $1,227,556 significantly during the year ended
December 31, 2004, due primarily to our sale of 553,333 shares of our common
stock, which was partially offset by total debt payments of $1,081,273. We
believe that our current cash and available lines of credit should be sufficient
to meet our capital requirements for the next twelve months. However, we may
seek additional equity and /or debt financing to grow our operations.
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
15
differ from those estimates. Management uses its best judgment in valuing these
estimates and may, as warranted, solicit external professional advice. 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
Revenue from system installations are generally recognized on the
completed-contract method, in which revenues are recognized when the contract is
substantially complete. The completed-contract method applies to those contracts
completed within a period of time, generally, less then two months. Contracts
that are expected to be longer than two months are accounted for on the
percentage-of-completion method.
The percentage-of-completion method recognizes revenues earned based on the
percentage of contract costs incurred to the estimated total contract costs. The
excess of costs and estimated earnings over billings and excess of accumulated
billings over costs are not presented in periods in which management has
determined that the amounts are not material. Provision for estimated earnings
and losses, if any, on uncompleted contracts are made in periods in which such
losses are determined. In general, we determine a contract to be substantially
completed after:
1. The scope of work is completed which includes installing the equipment
as required in the contract.
2. System is functional and has been tested.
3. Training has been provided.
On larger projects (generally those in excess of $50,000) a substantial
completion document is issued and final submittals are provided after the above
is completed. Each month, the Chief Financial Officer meets with Operational
Management to discuss the status of all open projects and to review each
project's financial results. Based upon these discussions, a formal decision is
made to close the project for financial reporting purposes once a project is
determined to be substantially complete. The majority of the Company's contracts
are completed within a year.
Service contracts, which are generally separate and distinct legal
agreements from project contracts, are billed either monthly or quarterly on the
last day of the month covered by the contract. Accordingly, revenues from
service contracts are recognized monthly. In 2004, the Company did not bundle
any significant service contracts within our systems installation work.
The Emergency Preparedness Planning Programs division provides emergency
planning services to commercial real estate owners and managers. In general,
project labor is the predominant cost associated with the completion of these
projects. The Company utilizes labor as the output measure in order to recognize
revenue and believes this to be an accurate matching of costs and revenue.
Revenue from product sales (primarily specialty products) are recognized
when title and risk of loss passes to the customer.
16
Trade Receivables and Allowance for Doubtful Accounts
The preparation of financial statements requires our management to make
estimates and assumptions relating to the collectibility 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
revenues to the government and local agencies. The credit evaluation process has
mitigated the credit risk, while losses have been minimal and within
management's expectations.
Inventory Valuation
Inventories are stated at the lower of cost or market value. Cost has been
determined using the first-in, first-out method. Inventory quantities on-hand
are regularly reviewed, based on product demand and revenue forecast data. Where
necessary, provisions for excess and obsolete inventory are recorded. A
significant change in the demand or forecast, in addition to inventory
purchases, can result in excess inventory on hand, requiring additional
write-downs.
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 and Accounting Standards (SFAS) 142 "Goodwill and Other Intangible
Assets." In accordance with that statement, goodwill and intangible assets with
indefinite lives are not amortized, but are tested at least annually for
impairment. Prior to January 1, 2002 the company had not recorded goodwill or
other intangible assets of indefinite lives. Intangible assets with estimable
useful lives, consisting primarily of acquired customer lists, service contracts
and covenants not to compete, are amortized on straight-line bases over their
estimated useful lives of three to fifteen years and are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset or asset group may not be recoverable. If the intangible assets'
remaining useful life is changed, the amortization of the intangible asset will
be amortized over the remaining useful life. If the asset being amortized is
determined to have an indefinite useful life, the asset will be tested for
impairment. The impairment test will consist of measuring its fair value with
its carrying amount. If the carrying amount of the intangible assets exceeds its
fair value, an impairment loss is recognized for an amount equal to the excess
and the adjusted carrying amount is recognized as its new accounting basis.
17
Goodwill
The Company's goodwill impairment test is based on a two part procedure
consistent with the requirements of SFAS 142. The first test consists of
determining the fair value of the reporting unit and comparing it to the
carrying value of the reporting unit. If the carrying value of the reporting
unit exceeds the fair value of the reporting unit, a second test is performed.
In step two, the implied fair value of the goodwill (which is the excess of the
fair value of the reporting unit over the fair value of the net assets) is
compared to the carrying value of the goodwill. An impairment loss is recognized
for any excess value of goodwill over the implied value. We determined the
Company's reporting unit by analyzing geographic region as management evaluates
the Company's performance in this manner. We identified four separate and
distinct operating units for the testing requirements of SFAS 142. We evaluated
each reporting unit for impairment.
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 carry forwards 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.
Item 7. Financial Statements
Refer to pages F-1 through F-24.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During the year ended December 31, 2004, there were no changes in or
disagreements with the Company's principal independent accountant on accounting
or financial disclosure.
Item 8a. Controls and Procedures
(a) The Company carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chief
Executive Officer, Chief Operating Officer and Chief Financial Officer, of the
design and operation of the Company's disclosure controls and procedures, as
defined under Rule 13a-15(e) of the Securities and Exchange Act of 1934, as of
the end of the period covered by this report. Based upon that evaluation, the
Company's Chief Executive Officer, Chief Operating Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures:
18
(i) are effective in timely alerting them to material information relating
to the Company (including its consolidated subsidiaries) required to
be included in the Company's periodic SEC filings;
(ii) are designed to ensure that information required to be disclosed by
the Company in the reports that it files or submits under the
Securities and Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Commission's rules
and forms; and
(iii) include, without limitations, controls and procedures designed to
ensure that information required to be disclosed by the Company in the
reports that it files or submits under the Securities and Exchange Act
is accumulated and communicated to the Company's management, including
its principal executive and principal financial officers or persons
performing similar functions, as appropriate to allow timely decisions
regarding required disclosure.
(b) Change in Internal Controls over Financial Reporting
As required by Rule 13a-15(d), the Company's executive management including
the Chief Executive Officer, the Chief Operating officer and the Chief Financial
Officer, also conducted an evaluation of the Company's internal controls over
financial reporting to determine whether any change occurred during the
Company's last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal controls over financial
reporting. Based on that evaluation, there have been no changes in the Company's
internal controls over financial reporting during the year covered by this
report that have materially affected, or are reasonably likely to materially
affect our internal controls over financial reporting.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act and Code of Ethics
As of March 15, 2005, the Company's directors and executive officers were
as follows:
Name Age Position
---- --- ---------------------------------------------------------
James E. Henry 51 Chairman, Chief Executive Officer, Treasurer and Director
Brian Reach 50 Vice Chairman, Secretary and Director
Irvin F. Witcosky 66 President, Chief Operating Officer and Director
Douglas West 43 Chief Financial Officer
Robert S. Benou 70 Director
Robert DeLia Sr. 57 Director
Joseph P. Ritorto 73 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
19
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.
Brian Reach became a member of our board of directors in February 2004,
serving as the Chairman of our Audit Committee until June 2004, when Mr. Reach
became our Vice Chairman. In November 2004 Mr. Reach was appointed our
Secretary. Mr. Reach began his career over 25 years ago with
PricewaterhouseCoopers, becoming a CPA in 1980. From 1999 through 2002 Mr. Reach
served as the Chief Financial Officer for Globix Corporation. Mr. Reach has also
served as the Chief Financial Officer of IPC Communications, Inc., Celadon
Group, Inc. and Cantel Medical Corp. Mr. Reach has a wide range of corporate
finance, restructuring and governance experiences having led the financing
efforts to raise over $1 billion during his career. He has also played key
leadership roles in mergers and acquisitions, a leveraged recapitalization, debt
restructurings and the development of controls for internal and external
financial reporting. Mr. Reach graduated with a Bachelor of Science degree in
Accounting from the University of Scranton.
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
from 1989 to November 2004 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.
Douglas West joined Diversified Security Solutions, Inc. in June 2004 as
Chief Financial Officer. Mr. West has over twenty years experience in accounting
and finance. Mr. West has been employed by such companies as Ernst & Young,
American Cyanamid Company, Danka Business Systems and A&E Products Group. He has
been responsible for providing management with financial and strategic
direction, productivity/process improvements, systems integrations, expense
control and budgeting and financial analysis. He is a Certified Public
Accountant and holds a Bachelor of Science degree from Montclair State
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 completing industrial management courses at Newark
College of Engineering. Mr. Benou is a member of the Board of Director of
eXeogenics, Inc.
Robert L. De Lia, Sr. has been a member of our Board since May 2004. From
2002 to 2003, Mr. DeLia was the chief executive officer of Airorlite
Communications, Inc., a company that specialized in design, manufacturing and
maintaining wireless communications equipment used to enhance and extend
emergency radio frequency services and cellular communication for both fixed and
mobile applications. In April 2004 a wholly-owned subsidiary of the Company
purchased all of the issued and outstanding shares of stock of Airorlite
20
Communications, Inc. From 1987 to 1999, Mr. De Lia was the president and chief
executive officer of Fiber Options, Inc. Mr. De Lia graduated from the New York
Institute of Technology in 1969.
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 President and Chief Operating Officer of Silverstein Properties, Inc. and
was responsible for leasing, operations and directing the lease administration
of Silverstein owned and managed properties.
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 project installations, engineering 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 master 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.
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 Revenues and Marketing for UAC Security Systems where he oversaw UAC's
integrated security system revenues and operations department.
Lee Masoian has been President of Airorlite Communications Inc. since its
acquisition in April 2004. Mr. Masoian was the founder of Airorlite
Communication Inc. and served as its President since incorporation in 2002. Mr.
Masoian has held numerous technical positions in the wireless field for the past
thirty years. He is a practicing engineer and led the development and design of
many of the products that are offered by Airorlite. Mr. Masoian is a patent
holder of several products. During his career, Mr. Masoian has held several
positions of instructor and assistant professor at a number of junior and four
year colleges. Mr. Masoian holds a BSEE and an MSEE from the Polytechnic
Institute of NY with majors in communication theory.
Audit Committee and Audit Committee Financial Expert
The Board has a separately designated, standing Audit Committee, in
accordance with regulations of the Securities and Exchange Commission. The Audit
Committee reviews, with the
21
Company's independent public accountants, the scope and adequacy of the audit to
be performed by the accountants, the Company's accounting practices, procedures
and policies, and all related-party transactions. The Audit Committee has
adopted an Audit Committee Charter. The Audit Committee met four times during
2004. The Audit Committee currently consists of Robert Benou and Joseph Ritorto.
The Board of Directors has determined that it has at least one expert serving on
the Company's Audit Committee. The Company's Board of Director believes that
Robert Benou is an "audit committee financial expert" and is an independent
member of the Board of Directors.
Compliance with Section 16(a) of the Exchange Act
The Securities and Exchange Act of 1934 requires our directors, officers
and persons who own more than 10% of our Common Stock to file with the
Securities and Exchange Commission initial reports and changes in beneficial
ownership of our Common Stock and other equity securities. Our directors,
officers and greater than 10% beneficial owners are required by SEC regulation
to furnish us with copies of all Section 16(a) forms they file. To our
knowledge, for the year ended December 31, 2004, based solely on a review of the
copies of such reports furnished to the Company and representations by these
individuals that no other reports were required during the year ended December
31, 2004, all Section 16(a) filing requirements applicable to our directors,
officers and greater than 10% beneficial owners have been timely filed except
that Joseph Ritorto and Douglas Beck (our former Chief Financial Officer) did
not timely file a Form Four for Messrs. Ritorto and Beck which have since been
filed.
Code of Ethics
The Company has adopted a code of ethics that applies to its principal
executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions.
Item 10. Executive Compensation
The table below reflects information concerning the annual compensation for
services in all capacities to the corporation for the fiscal years ended
December 31, 2004, 2003 and 2002 of those persons who were, as of December 31,
2004, (a) the Chief Executive Officer, and (b) the four the most highly
compensated executive officers to the extent that such persons, total annual
salary and bonus exceeded $100,000.
22
SUMMARY COMPENSATION TABLE
Long-Term
Compensation
Awards Payouts
-------------- ------------
Annual Compensation Securities All Other
---------------------------------- Underlying Compensation
Name and Principal Position Year(s) Salary ($)(1) Bonus($) Options/SARS # ($)
-------------------------------------------- ------- ------------- -------- -------------- ------------
James E. Henry 2004 130,680 -- -- --
Chairman and Chief Executive Officer, 2003 163,350 -- -- 3,393(2)
Treasurer and Director 2002 148,500 -- -- 4,455(2)
Irvin F. Witcosky 2004 130,680 -- -- --
President, Chief Operating Officer, 2003 163,350 -- -- 3,393(2)
and Director 2002 148,500 -- -- 4,455(2)
Douglas West, CPA 2004 53,338 -- 15,000 --
Chief Financial Officer
Douglas Beck, CPA 2004 63,623 -- -- 157(6)
Former Chief Financial Officer 2003 100,000 -- -- --
Louis Massad 2004 78,000 -- -- 7,200(3)
Former Vice President, former Treasurer, 2003 121,000 -- -- 9,964(4)
former Chief Financial Officer and former 2002 110,000 -- 5,000 10,830(5)
Director
----------
(1) Effective in December 2003, Messrs Henry and Witcosky voluntarily reduced
their salaries by twenty percent and Mr. Beck reduced his salary by 10% as
a cost reduction measure. Mr. Beck resigned as our Chief Financial Officer
in June 2004 and was replaced by Douglas West in the same month.
(2) Company matching contribution under its 401-K and profit sharing plan.
(3) Consists of a $7,200 auto allowance.
(4) Consists of a $7,200 auto allowance and $2,764 company match contribution
under its 401-K and profit sharing Plan.
(5) Consists of a $7,200 auto allowance and $3,630 company match contribution
under its Simple IRA Plan.
(6) Consists of an option exercise of 100 shares of the Company's common stock
at an option price of $6.75.
23
The following table sets forth certain information with respect to stock options
grants made to the named Executive Officers during 2004.
Option Grants in 2004
Individual Grants
Number of % of Total
Securities Options
Underlying Granted to Exercised
Options Employees price
Granted in Fiscal per Expiration
Name # Year Share Date
------------ ---------- ---------- --------- ----------
Brian Reach 100,000 73.53% $7.10 05/31/09
Douglas West 15,000 11.03% $7.34 06/14/14
The following table sets forth information regarding options held by the named
Executive Officers at December 31, 2004.
Aggregated Exercises and Year End Option Values in 2004
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options at Options at
Year End # Year End $
Shares ------------- -------------
Acquired on Values Exercisable/ Exercisable/
Name Exercise Realized Unexercisable Unexercisable
------------ ----------- -------- ------------- -------------
Brian Reach -- -- 28,000/72,000 --
Douglas West -- -- 0/15,000 --
Compensation of Directors
Directors who are also our employees receive no additional compensation for
attendance at board meetings. The Company non-employee directors receive a
quarterly fee of $1,250 and annual stock option grant to purchase 2,000 shares
of the Company's common stock at the closing share price on the day of the grant
and $1,000 for attendance at each Board or Committee meeting. In May 2004,
Messrs. Benou, DeLia Sr. and Ritorto each received an option to purchase 2,000
shares of our common stock at $7.19 exercisable through May 2009. All 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 and Termination of Employment and Change in Control
Arrangements
Messrs. Henry and Witcosky are serving as Chairman and Chief Executive
Officer and President and Chief Operating Officer, respectively, under
employment agreements for five years that 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
24
agreements and an one-year non-competition covenant covering the security
business that commences after termination of employment. In December 2003,
Messrs. Henry and Witcosky voluntarily waived the receipt of their respective
salaries by twenty percent to help reduce the Company's costs. This salary
reduction was not restored in 2004.
In August 2003, Mr. Massad resigned from his position as Vice President,
Treasurer, and Chief Financial Officer. Mr. Massad also resigned from the
Company's Board of Directors. Prior to his resigning as the company's Treasurer,
Chief Financial Officer and Vice President, Mr. Massad had entered into a
five-year agreement with the Company that commenced January 1, 2000. His initial
annual compensation under such contract was $110,000. The agreement also
provided for a 10% increase per annum as of January 2002 and in each subsequent
year of the agreement. Mr. Massad was granted an option to purchase 9,000 shares
of the Company's common stock. This option was granted under the Company's
Incentive Stock Option Plan and is exercisable at $5.625 per share. The option
expires in December 2009. Mr. Massad's employment agreement has been amended and
provides for a reduced salary and terminates on December 31, 2005.
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth, as of March 22, 2005 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.
25
The applicable percentage of ownership is based on 5,739,398 shares
outstanding as of March 22, 2005.
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,
Treasurer and Director .................................. 1,400,000 24.4%
Irvin F. Witcosky, Chief Operating Officer, President,
and Director ............................................ 1,400,000 24.4%
Brian Reach, Vice Chairman, Secretary and Director (1) ..... 86,000 1.5%
Robert Benou, Director (2) ................................. 7,000 *
Robert DeLia Sr., Director (3) ............................. 39,000 *
Joseph Ritorto, Director (2) ............................... 42,000 *
All executive officers and directors as a group
(6 persons) (4) ......................................... 2,974,000 51.4%
Michael J. Frey (5) ........................................ 488,400 8.5%
John D. Brandenborg (5) .................................... 488,400 8.5%
Global Capital Management, Inc. (5) ........................ 488,400 8.5%
EBF & Associates, L.P. (6) ................................. 344,883 6.0%
Hunter Capital Management, L.P. (6) ........................ 344,883 6.0%
* less than 1%
(1) The amount shown for Mr. Reach includes a currently exercisable option to
purchase 36,000 shares of the Company's Common Stock at a price of $7.10 per
share.
(2) The amount shown for Messrs. Benou and Ritorto includes currently
exercisable options to purchase 5,000 shares and 2,000 shares each at $7.95 and
$7.19 per share, respectively of the Company's common stock.
(3) The amount shown for Mr. DeLia Sr. includes a currently exercisable option
to purchase 2,000 shares of the Company's Common Stock at a price of $7.19 per
share.
(4) The amount shown includes currently exercisable options to purchase 52,000
shares of the Company's common stock.
(5) Based on Schedule 13G filed February 2, 2005, John D. Brandenborg and
Michael J. Frey, Chief Executive Officer and Chief Operating Officer,
respectively, are Natural Control Persons of Global Capital Management, Inc. The
amount shown includes currently exercisable warrants to purchase 100,000 shares
of
26
the Company's common stock expiring July 27, 2009. Such warrants are
exercisable at $7.60. Messrs. Brandenborg and Frey disclaim beneficial ownership
in the shares herein reported except to the extent of their pecuniary interest
therein.
(6) Based on Schedule 13G filed February 2, 2005, Global Capital Management,
Inc. is the general partner of EBF & Associates, LP. EBF & Associates, LP is the
general partner of Hunter Capital Management, LP. The amount shown includes
currently exercisable warrants to purchase 100,000 shares of the Company's
common stock expiring July 27, 2009. Such warrants are exercisable at $7.60.
These entities disclaim beneficial ownership in the shares herein reported
except to the extent of their pecuniary interest therein.
Item 12. Certain Relationships and Related Transactions
A corporation that Robert Benou, a Company director, is an officer was paid
consulting fees of $3,000 for services provided during the year ended December
31, 2004.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits.
See index of exhibits annexed hereto.
(b) Report on Form 8-K.
On February 25, 2005, the Company filed a Report on Form 8-K with respect
to an Item 2.02 event to report that the Company issued a press release to
announce its financial results for the year ended December 31, 2004.
Item 14. Principal Accountant Fees and Services
Audit Fees
The aggregate fees billed by Demetrius & Company, L.L.C. for professional
services rendered for the audits of the Company's annual financial statements on
Form 10-KSB and the reviews of the financial statements on Form 10-QSB for the
fiscal year ended December 31, 2004 were $60,400 and for the year ended December
31, 2003 were approximately $63,100.
Audit Related Fees
The aggregate fees billed for audit related services by the principal
accountant for the year ended December 31, 2004 were approximately $14,900 and
for the year ended December 31, 2003 were $4,200. Audit related services include
due diligence in connection with acquisitions, consultation on accounting and
internal control matters, audits in connection with proposed or consummated
acquisitions and review of registration statements.
Tax Fees
The aggregate fees billed for tax compliance, tax advice and tax planning
rendered by our
27
independent auditors for the fiscal year ended December 31, 2004 was $20,000,
and for the year ended December 31, 2003 was $17,000. The services comprising
these fees include tax consulting and submitting tax returns.
All Other Fees
The aggregate fees billed for all other professional services rendered by
the Company's independent auditors for the year ended December 31, 2004 was $800
and for the year ended December 31, 2003 was $2,925.
The Audit Committee approved 100% of the fees paid to the principal
accountant for audit-related, tax and other fees. The Audit Committee
pre-approves all non-audit services to be performed by the auditor. The
percentage of hours expended on the principal accountant's engagement to audit
the Company's financial statements for the most recent year that were attributed
to work performed by persons other than the principal accountant's full-time,
permanent employees was 0%.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934 as amended, the Registrant had duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 24, 2005 DIVERSIFIED SECURITY SOLUTIONS, INC.
By: /s/ James E. Henry
-----------------------------------
James E. Henry
Chairman, Chief Executive Officer,
Treasurer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934 as amended,
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 24, 2005 /s/ James E. Henry
---------------------------------------
James E. Henry
Chairman, Chief Executive Officer,
Treasurer and Director
Date: March 24, 2005 /s/ Irvin F. Witcosky
---------------------------------------
Irvin F. Witcosky
Chief Operating Officer, President and
Director
Date: March 24, 2005 /s/ Douglas West
---------------------------------------
Douglas West
Chief Financial Officer
Date: March 24, 2005 /s/ Robert S. Benou
---------------------------------------
Robert S. Benou
Director
Date: March 24, 2005 /s/ Joseph P. Ritorto
---------------------------------------
Joseph P. Ritorto
Director
Date: March 24, 2005 /s/ Brian Reach
---------------------------------------
Brian Reach
Vice Chairman, Secretary and Director
Date: March 24, 2005 /s/ Robert DeLia Sr.
---------------------------------------
Robert DeLia Sr.
Director
29
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004
Report of Independent Registered Public Accounting Firm Report...............F-1
Consolidated Balance Sheet as of December 31, 2004.........................F - 2
Consolidated Statement of Operations for the Years Ended December
31, 2004 and 2003.......................................................F - 3
Consolidated Statement of Changes in Stockholders' Equity..................F - 4
Consolidated Statement of Cash Flows for the Years Ended December
31, 2004 and 2003.......................................................F - 5
Notes to Consolidated Financial Statements.........................F - 6 - F -24
30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Diversified Security Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Diversified
Security Solutions, Inc. as of December 31, 2004, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the years in the two year period then ended December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with standards of the Public Company
Oversight Board (United States). 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. as of December 31, 2004, and the consolidated results
of its operations and its cash flows for each of the years in the two-year
period then ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America.
s/s DEMETRIUS & COMPANY, L.L.C.
Wayne, New Jersey
February 21, 2005
F-1
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 2004
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 3,154,972
Accounts receivable-net of allowance for doubtful accounts- $357,500 9,035,460
Inventory 874,575
Costs in excess of billings and estimated profits 2,584,922
Deferred tax asset 1,011,263
Prepaid expenses and income tax receivable 470,397
Other assets 47,830
-----------
Total current assets 17,179,419
PROPERTY AND EQUIPMENT - net of accumulated depreciation of $1,383,703 1,301,428
GOODWILL 2,134,344
INTANGIBLE ASSETS - net of accumulated amortization of $310,491 1,191,852
DEFERRED TAX ASSET 742,070
OTHER ASSETS 539,307
-----------
TOTAL ASSETS $23,088,419
===========
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,337,310
Accrued taxes and expenses 1,833,934
Billings in excess of costs and estimated profits 1,351,298
Deferred income 42,494
Current portion of long term debt 1,394,809
Deferred tax liability 32,398
-----------
Total current liabilities 7,992,243
LONG-TERM DEBT, LESS CURRENT PORTION 168,989
DEFERRED TAX LIABILITY 188,163
-----------
TOTAL LIABILITIES 8,349,395
-----------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued --
Common stock, $.01 par value; 10,000,000 shares authorized;
5,739,398 shares issued and outstanding 57,394
Additional paid in capital 16,602,366
Deferred compensation (178,942)
Accumulated deficit (1,741,794)
-----------
TOTAL EQUITY 14,739,024
-----------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $23,088,419
===========
The accompanying notes are an integral part of these financial statements.
F-2
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the twelve months
ended
December 31,
--------------------------
2004 2003
(Restated)
----------- ------------
Revenue $29,725,718 $ 18,261,065
Cost of revenue 22,305,632 14,908,700
----------- ------------
Gross profit 7,420,086 3,352,365
----------- ------------
Operating Expenses:
Selling general & administrative expenses 7,020,885 8,339,337
----------- ------------
Operating profit (loss) 399,201 (4,986,972)
----------- ------------
Interest Income 12,624 10,326
Interest Expense (94,039) (106,464)
----------- ------------
Net income (loss) before tax expense (benefit) 317,786 (5,083,110)
Tax expense (benefit) 273,765 (2,126,008)
----------- ------------
Net income (loss) after taxes $ 44,021 ($ 2,957,102)
=========== ============
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Basic Profit (Loss) Per Common Share $ 0.01 ($ 0.58)
=========== ============
Weighted Average Common Shares 5,411,964 5,121,877
=========== ============
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Diluted Profit (Loss) Per Common Share: $ 0.01 ($ 0.58)
=========== ============
Weighted Average Diluted Common Shares 5,411,964 5,121,877
=========== ============
The accompanying notes are an integral part of these financials statements.
F-3
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock
par value $.01
10,000,000 Authorized Treasury Stock
--------------------- ------------------
Shares Amount Shares Amount
--------- ------- ------- --------
Balance at December 31, 2002 5,138,357 $51,384
Shares issued in connection with
the acquisition of National Safe, Inc. 10,524 105
Shares received in connection with
a loan default 70,891 (500,000)
Employee stock grants 52,550 526
Net loss for the year 2003
--------- ------- ------- --------
Balance at December 31, 2003 5,201,431 52,015 70,891 (500,000)
--------- ------- ------- --------
Shares issued in connection with
the acquisition of Airorlite
Communications, Inc. 37,000 370
Shares issued in July 2004 net
of expenses 553,333 5,533
Employee stock options exercised 18,525 185
Value of stock option grants
Amortization of value assigned to
stock option grants
Treasury shares cancelled (70,891) (709) (70,891) 500,000
Net Income for 2004
--------- ------- ------- --------
Balance at December 31, 2004 5,739,398 $57,394 -- --
========= ======= ======= ========
Additional Deferred
Paid-in Comp- Retained
Capital ensation Earnings Total
----------- --------- ----------- -----------
Balance at December 31, 2002 $13,150,681 $1,171,289 $14,373,354
Shares issued in connection with
the acquisition of National Safe, Inc. 68,504 68,609
Shares received in connection with
a loan default (500,000)
Employee stock grants 293,754 294,280
Net loss for the year 2003 (2,957,104) (2,957,104)
----------- --------- ----------- -----------
Balance at December 31, 2003 13,512,939 -- (1,785,815) 11,279,139
----------- --------- ----------- -----------
Shares issued in connection with
the acquisition of Airorlite
Communications, Inc. 266,030 266,400
Shares issued in July 2004 net
of expenses 2,952,524 2,958,057
Employee stock options exercised 123,108 123,293
Value of stock option grants 247,056 (247,056) --
Amortization of value assigned to
stock option grants 68,114 68,114
Treasury shares cancelled (499,291) --
Net Income for 2004 44,021 44,021
----------- --------- ----------- -----------
Balance at December 31, 2004 $16,602,366 $(178,942) $(1,741,794) $14,739,024
=========== ========= =========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the twelve months
ended
December 31,
-------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 44,021 ($2,957,102)
Adjustments to reconcile net income (loss) from operations
to net cash provide by (used in) operating activities:
Depreciation and amortization 490,856 522,186
Bad debt expense 203,324 35,000
Impairment Charges 77,000 221,621
Stock option expense 68,114 294,280
Deferred income taxes 471,228 (2,122,000)
Gain on sale of equipment -- (2,571)
Changes in operating assets and liabilities:
Accounts receivable (2,525,791) (357,679)
Inventories 214,664 1,332,144
Costs in excess of billings and estimated profits (1,819,017) (55,580)
Other assets 69,168 43,103
Prepaid Expenses and income tax receivable (284,770) (185,627)
Accounts payable 1,121,607 652,397
Accrued expenses 839,245 (222,375)
Billings in excess of cost and estimated profits 873,783 353,645
Deferred income (112,783) 155,277
----------- -----------
Net cash used in operating activities (269,351) (2,293,281)
----------- -----------
Cash flows from investing activities:
Purchase of business, net of cash acquired (166,875) --
Purchase of property and equipment (236,295) (273,585)
Proceeds from revenue of property and equipment -- 11,470
Increase in Goodwill -- (71,728)
----------- -----------
Cash proceeds from (used for) investing activities (403,170) (333,843)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock - net of fees 3,081,350 --
Net (payments) and proceeds from revolving bank lines (600,000) 150,000
Payments of bank loans (305,215) (161,791)
Net (payments) and proceeds of other debt (149,699) 97,997
Capitalized lease payments (26,359) (3,937)
Payment of loan payable to owner of acquired company (100,000) --
----------- -----------
Cash (used) and proceeds in financing activities 1,900,077 82,269
----------- -----------
Increase (decrease) in cash and cash equivalents 1,227,556 (2,544,855)
Cash and cash equivalents - beginning of period 1,927,416 4,472,271
----------- -----------
Cash and cash equivalents - end of period $ 3,154,972 $ 1,927,416
=========== ===========
Supplemental disclosure of cash flow information:
Amount paid for the period for:
Interest $ 94,039 $ 106,693
Taxes $ 9,334 $ 178,304
Non-cash investing and financing activities:
Equipment financed $ 258,841 $ 56,120
Issuance of stock to acquire businesses $ 266,400 $ 68,309
Receipt of 70,891 shares of stock from the default on a loan -- $ 500,000
Value of stock options issued to employees $ 247,056 --
The accompanying notes are an integral part of these financial statements.
F-5
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
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. The Company
markets nationwide with an emphasis in the New York, Dallas, Phoenix and
Southern California metropolitan areas. Customers are primarily medium and large
businesses and governmental agencies. The Company derives a majority of its
revenues from project installations and to a smaller extent, maintenance service
revenues. In April 2004, the Company completed its acquisition of Airorlite
Communications, Inc. ("Airorlite"). Airorlite specializes in designing,
manufacturing and maintaining wireless communications equipment used to enhance
and extend emergency radio frequency services and cellular communication for
both fixed and mobile applications. There has been a shift in revenues by
geographic region and the table below shows the revenues percentages by
geographic location for the years ended December 31, 2004 and 2003:
December 31,
------------
2004 2003
---- ----
New Jersey/ New York 35% 54%
California 33 26
Texas 13 12
Arizona 7 5
--- ---
Total integration 88 97
Specialty Products 12 3
--- ---
Total revenues 100% 100%
=== ===
The Company's headquarters are located in Saddle Brook, New Jersey. Sales
and service facilities are located near the Dallas-Fort Worth Airport, Phoenix
Arizona Airport, two facilities in the New York City metro area (Saddle Brook,
New Jersey), and Fullerton, California. During the third quarter of 2003, the
Company's subsidiary, Viscom Products ("Viscom"), restructured its operations
and began purchasing products from a third party vendor. Viscom will continue to
sell product and maintain system installations.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company and its subsidiaries. All material intercompany
transactions have been eliminated in consolidation.
F-6
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Income Recognition - Revenue from system installations are generally
recognized on the completed-contract method, in which revenues are recognized
when the contract is substantially complete. The completed-contract method
applies to those contracts completed within a period of time, generally, less
then two months. Contracts that are expected to be longer than two months are
accounted for on the percentage of completion method.
The percentage of completion method recognizes revenues earned based on the
percentage of contract costs incurred to total estimated contract costs. The
excess of costs and estimated earnings over billings and excess of accumulated
billings over costs are not presented in periods in which management has
determined that the amounts are not material. Provision for estimated earnings
and losses, if any, on uncompleted contracts are made in periods in which such
losses are determined. In general, we determine a contract to be substantially
completion after:
1. The scope of work is completed which includes installing the equipment
as required in the contract.
2. System is functional and has been tested.
3. Training has been provided.
On larger projects (generally those in excess of $50,000) a substantial
completion document is issued and final submittals are provided after the above
is completed. Each month, the Chief Financial Officer meets with Operational
Management to discuss the status of all open projects and review the project's
financial results. Based upon these discussions, a formal decision is made to
close the project for financial reporting purposes once a project is determined
to be substantially complete. The majority of the Company's contracts are
completed within a year.
Service contracts, which are generally separate and distinct legal
agreements from project contracts, are billed either monthly or quarterly on the
last day of the month covered by the contract. Accordingly, revenues from
service contracts are recognized monthly. In 2004, the company did not bundle
any significant service contracts with our systems installation work.
The Emergency Preparedness Planning Programs division provides emergency
planning services to commercial real estate owners and managers. In general,
project labor is the predominant cost associated with the completion of these
projects. The company utilizes labor as the output measure in order to recognize
revenue and believes this to be an accurate matching of costs and revenue.
Revenue from product sales (primarily specialty products) are recognized
when title and risk of loss passes to the customer.
F-7
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Use of Estimates - The preparation of financial statements, in conformity
with generally accepted accounting principles in the United States, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the 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.
Trade Receivables - Trade receivables are stated at net realizable value.
This value includes an appropriate allowance for estimated uncollectible
accounts. The allowance is calculated based upon the evaluation and the level of
past due accounts and the relationship with and the economic status of our
customers.
Inventories - Inventories are stated at the lower of cost or market value.
Cost has been determined using the first-in, first-out method. Inventory
quantities on-hand are regularly reviewed, and where necessary, reserves for
excess and obsolete inventories are recorded.
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
amortized over the shorter of related lease terms or the estimated useful lives.
Upon retirement or sale, the costs of the assets disposed of 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. Annually, the Company routinely reviews its property
and equipment for impairment, and accordingly, will write-down those assets to
their estimated fair value.
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 fair value of net assets acquired.
Effective January 1, 2002, the company adopted the provisions of Statement
of Financial and Accounting Standards (SFAS) 142 "Goodwill and Other Intangible
Assets". In accordance with that statement goodwill and intangible assets with
indefinite lives are not amortized, but are tested at least annually for
impairment. Prior to January 1, 2002, the company had not recorded goodwill or
other intangible assets of indefinite lives. Intangible assets with estimable
useful lives, consisting primarily of acquired customer lists, service contracts
and covenants not to compete are amortized on a straight-line basis over their
estimated useful lives of five to fifteen years and are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset or asset group may not be recoverable. If the intangible asset's
remaining useful life is changed, the intangible asset will be amortized over
the remaining useful life. If the asset being amortized is determined to have an
indefinite useful life, the asset will be tested for impairment. The impairment
test will consist of measuring its fair value with its carrying amount. If the
carrying
F-8
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
amount of the intangible assets exceeds its fair value, an impairment loss is
recognized for an amount equal to the excess and the adjusted carrying amount is
recognized as its new accounting basis. The company recorded an impairment
charge of approximately $77,000 and $21,000 for the write down of customer lists
and service contract rights for the years ended December 31, 2004 and December
31, 2003, respectively. In addition, the Company recorded an impairment charge
of approximately $65,000 for the write-down of a trade name for the year ended
December 31, 2003.
Goodwill - The Company's goodwill impairment test is based on a two part
procedure consistent with the requirements of SFAS 142. The first test consists
of determining the fair value of the reporting unit and comparing it to the
carrying value of the reporting unit. If the carrying value of the reporting
unit exceeds the fair value of the reporting unit, a second test is performed.
In step two, the implied fair value of the goodwill (which is the excess of the
fair value of the reporting unit over the fair value of the net assets) is
compared to the carrying value of the goodwill will. An impairment loss is
recognized for any excess value of goodwill over the implied value. We
determined the Company's reporting unit by analyzing geographic region as
management evaluates the Company's performance in this manner. We identified
four separate and distinct operating units for the testing requirements of SFAS
142. We evaluated each reporting unit for impairment. In 2004 and 2003, no
charges to operations resulted from the required goodwill impairment
evaluations.
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 revenues. 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 approximately $694,000 as of
December 31, 2003.
These costs were amortized over the estimated product life using the
straight-line method up to a maximum of five years. Management decided to
outsource the manufacturing operations for Viscom during the third quarter of
2003. Accordingly, in addition to regular amortization expense of approximately
$79,000 for the year ended December 31, 2003, the Company expensed approximately
$136,000 of the unamortized value of computer software development costs for the
year ending December 31, 2003 to operations. The company did not incur any
capitalized software product costs in 2004.
Concentrations of Credit Risk - Financial instruments that potentially
subject the Company to concentrations of credit risk consist primarily of cash,
cash equivalents and accounts receivable. As of December 31, 2004, 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
F-9
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
credit risk beyond the normal credit risk associated with commercial banking
relationships.
Credit risk is generally diversified due to the large number of customers
that make up the Company's customer base and their geographic dispersion
resulting from three acquisitions in 2002. The Company performs ongoing credit
evaluation of its customers. In 2004, there were no revenues to a single
customer in excess of 10% of the Company's total revenues. Revenues to local
government agencies were 20% and 21% of total revenues for the years ended
December 31, 2004 and 2003, respectively.
Income Taxes - Deferred taxes are provided on the asset and liability
method whereby assets and liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the amounts
reported for financial statement purposes and corresponding amounts for tax
purposes. 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.
Fair Value of Financial Instruments - The carrying amounts of the Company's
financial instruments, which include cash equivalents, accounts receivable,
accounts payable, accrued expenses, short and long-term debt, approximate their
fair values as of December 31, 2004.
Advertising Costs - The Company expenses advertising cost when the
advertisement occurs. Total advertising expenses amounted to approximately
$44,466 and $39,000 for the years ended December 31, 2004 and 2003,
respectively.
Stock Based Compensation - In December 2002, the FASB issued SFAS No. 148
"Accounting for Stock Based Compensation - Transition and Disclosure". SFAS No.
148 provides alternative methods of transitions to SFAS No 123's fair value
method of accounting for stock based employee compensation, but does not require
companies to use fair value method. It also amends the disclosure provisions of
SFAS No. 123 and APB No.25 to require, in the summary of significant policies,
the effect 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 provision of this statement is effective for fiscal
years ending after December 15, 2002, and interim reporting periods beginning
after December 15, 2002. Accordingly, the fair value of all options granted on
and after January 1, 2003 is to be charged against income over the vesting
period. In 2004, the company charged $68,114 to operations for the fair value of
those options granted subsequent to January 1, 2003. Those issued prior to
adoption are accounted for under the intrinsic value method in accordance with
APB No. 25. Refer to footnote 8 to the financial statement illustrating the
effect on the earnings (loss). The Company adopted the perspective method as
permitted by SFAS No. 148 on January 1, 2003.
Research and Development Costs - Costs of research and development for new
products are charged to operations as incurred. The Company charged
approximately $35,000 for the year ended December 31, 2003. No amounts were
incurred for research and development in 2004.
F-10
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Warranty - The Company offers warranties on all products, including parts
and labor that ranges from one (1) to four (4) years, depending upon the
product. 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, 2004 and 2003,
warranty expense was approximately $152,500 and $401,000, respectively.
Net Income (Loss) Per Share - The computation of basic earnings (loss) per
share is based upon the weighted average number of shares of common stock
outstanding during the period. The computation of diluted earnings per share
includes the dilutive effects of common stock equivalents of options and
warrants.
Segment Information - FASB 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 has identified two
operating segments in which it operates (integration and specialty products).
The Company provides integration - the installation services for companies in
need of closed circuit TV and access control systems (and associated maintenance
and service of these systems) that are located throughout the United States: the
specialty products and services segment is comprised of Viscom Products,
Airorlite Communications and the Emergency Preparedness Planning Programs
division. This division accounted for 1.4% and 1.5% of the Company's
consolidated revenue for the period ended December 31, 2004 and December 31,
2003, respectively. The Company has consolidated this division with the
specialty products and services segment due to quantitative threshold. The
operating segments (see Note 14) are segments for which separate financial
information is available and for which the operations are regularly evaluated by
the Company's senior management in assessing performance and in deciding how to
allocate resources.
Recently Issued Accounting Standards - In November 2004, the FASB issued
Statement No. 151, Inventory Costs-an amendment of ARB No. 43, Chapter 4 (FAS
151), which is effective beginning January 1, 2006. FAS 151requires that
abnormal amounts of idle facility expense, freight, handling costs and wasted
material to be recognized as current period charges. The Statement also requires
that the allocation of fixed production overhead be based on the normal capacity
of the production facilities. The effect of this Statement on the Company's
financial position or results of operations has not yet been determined.
In December 2004, the FASB issued Statement No. 123R, Share-Based Payment
(FAS 123R), which is effective beginning July 1, 2005. FAS 123R requires all
share-based payments to employees to be expensed over the requisite service
period based on the grant-date fair value of the awards. The Statement allows
for either prospective or retrospective adoption and requires that the unvested
portion of all outstanding awards upon adoption be recognized using the same
fair value and attribution methodologies previously determined under Statement
No. 123, Accounting for Stock-Based Compensation. The effect of this Statement
on the Company's financial position or results of operations has not yet been
determined. As a result, pro forma
F-11
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
compensation expense, as reflected in Note 8, may not be indicative of future
expense to be recognized under FAS123R.
Certain amounts in the financial statements for the year ended December 31,
2003 have been reclassified to conform with the current year presentation.
2. INVENTORIES
Inventories consist of the following at December 31, 2004:
2004
--------
Component parts $ 50,000
Finished goods 824,575
--------
$874,575
========
3. PROPERTIES AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2004:
2004
-----------
Office equipment $ 227,951
Demo and testing equipment 86,477
Automotive equipment 1,287,297
Computer equipment 853,759
Machinery and equipment 174,021
Leasehold improvements 55,626
-----------
2,685,131
Less accumulated depreciation (1,383,703)
-----------
$ 1,301,428
===========
Depreciation expense was approximately $340,268 and $327,207 for the years
ended December 31, 2004 and December 31, 2003, respectively. In 2004, the
company wrote-off approximately $286,000 of fully depreciated assets.
F-12
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
4. INTANGIBLE ASSETS
Intangible assets consisted of the following:
Acquired Covenant Total
Customer Service Not to Amortizable Trade Total
List Rights Compete Intangibles Name Intangibles
-------- --------- --------- ----------- -------- -----------
Gross carrying value:
December 31, 2003 $464,201 $ 485,101 $ 258,773 $1,208,075 $275,114 $1,483,189
Additions 46,960 29,000 75,960 40,000 115,960
Impairment charge (37,953) (58,853) (96,806) (96,806)
-------- --------- --------- ---------- -------- ----------
December 31, 2004 464,201 494,108 228,920 1,187,229 315,114 1,502,343
-------- --------- --------- ---------- -------- ----------
Accumulated amortization:
December 31, 2003 (49,945) (49,845) (79,919) (179,709) (179,709)
Amortization (30,943) (60,640) (59,005) (150,588) (150,588)
Impairment charge 9,848 9,958 19,806 19,806
-------- --------- --------- ---------- ----------
December 31, 2004 (71,040) (100,527) (138,924) (310,491) (310,491)
-------- --------- --------- ---------- ----------
December 31, 2004
Net Carrying Value $393,161 $ 393,581 $ 89,996 $ 876,738 $315,114 $1,191,852
======== ========= ========= =========== ======== ===========
Weighted average life in years 11 6 3 6
Amortization expense was $150,588 and $116,454 for the years ended December 31,
2004 and December 31, 2003, respectively.
Future amortization expense for the next five years is as follows:
December 31,
------------
2005 $141,000
2006 127,000
2007 89,000
2008 63,000
2009 63,000
F-13
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
5. GOODWILL
Goodwill, as of December 31, 2004, consisted of the following:
National Safe of California $1,267,580
Photo Scan Systems 346,000
Henry Bros. Electronics (Arizona) 317,000
----------
1,930,694
Airorlite Communications acquisition 203,650
----------
$2,134,344
==========
6. LONG-TERM DEBT
A subsidiary of the Company has a revolving loan facility with Hudson
United Bank (the "bank") whereby the subsidiary may borrow up to $3,500,000 at
the bank's prime interest rate through May 1, 2005. In addition, the subsidiary
has an equipment line of credit of $500,000 through November 1, 2005, with
monthly interest payments at 1/2% above the bank's prime rate. The subsidiary
also has a term loan for $500,000 due November 1, 2005, payable in monthly
installments of $13,483 plus interest at bank's prime interest rate plus 1/2%.
As of December 31, 2004 these lines are summarized as follows:
Amount of Facility Balance Due Unused Line
------------------ ----------- -----------
Revolving line $3,500,000 $1,170,000 $2,330,000
Equipment line 500,000 -- 500,000
Term loan 500,000 148,308 --
---------- ---------- ----------
Total $4,500,000 $1,318,308 $2,830,000
========== ========== ==========
During 2004, the Company was able to pay $600,000 of the revolving line of
credit and pay off the equipment loan of $143,425. The revolving line loan
agreement requires the Company to maintain certain loan covenants. In addition,
the agreement prohibits selling, assigning, transferring or disposing of any
fixed assets without obtaining the bank's consent in writing. The loan is
cross-guaranteed by the parent company and the various subsidiary companies. As
of December 31, 2004, the Company was in compliance with the various loan
covenants. The line of credit will mature in 2005. The Company has begun
discussions with Hudson United Bank to renew this line of credit.
F-14
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Long-term debt consisted of the following at December 31, 2004:
Revolving line with interest at bank's prime
rate. Maturity date of this line is May 1, 2005 $ 1,170,000
Term loan at 1/2% above bank's prime rate,
due in monthly installments of $13,483 plus interest
maturing on November 1, 2005 148,308
Capitalized lease obligations due in monthly installments of
$5,668, including interest ranging from 4.25% to 5.0% 237,006
Other miscellaneous debt 8,484
-----------
1,563,798
Less: current portion (1,394,809)
-----------
$ 168,989
===========
Prime rate as of December 31, 2004 was 5.25%.
The debts mature over the next four years as follows:
Year ending December 31,
------------------------
2005 $1,394,809
2006 63,631
2007 63,562
2008 41,796
F-15
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
7. INCOME TAXES
The tax provision (benefit) for income for the years ended December 31,
2004 and 2003 include the following components:
Years Ended December 31
-----------------------
2004 2003
-------- ------------
Federal
Current $ 5,117 $ (17,722)
Deferred 122,704 (1,803,700)
State
Current 115,268 13,714
Deferred 30,676 (318,300)
-------- -----------
$273,765 $(2,126,008)
======== ===========
The components of the deferred tax asset (liability) as of December 31,
2004 are as follows:
Deferred tax asset:
Allowance for uncollectible accounts $ 145,145
Accrued absences 111,843
Accrued warranty 142,689
Inventory 10,592
Stock compensation 119,478
Intangible assets 37,852
Net operating loss carryforward 1,185,734
----------
Total deferred tax asset 1,753,333
----------
Short- term 1,011,263
Long-term 742,070
Deferred tax liability:
Cash to accrual basis (32,398)
Intangible assets (150,634)
Property and equipment (37,529)
----------
Total deferred tax liability (220,561)
Short- term (32,398)
----------
Long-term (188,163)
----------
Net deferred tax asset $1,532,772
==========
The Company has a Federal net operating loss carryforward of approximately
$2,920,528 that expires in 2023.
F-16
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
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,
-----------------------
2004 2003
-------- -----------
Provision (benefit) for taxes computed using
statutory rate $108,048 $(1,728,257)
State taxes, net of federal tax benefit 69,916 (412,945)
Permanent differences 15,066 15,194
Revised estimate to deferred tax 71,401 --
Additional state income tax from prior year 9,334 --
-------- -----------
Provision (benefit) for income taxes $273,765 $(2,126,008)
======== ===========
8. INCENTIVE STOCK OPTION PLAN
The Company has a Stock Option Plan (the "1999 Plan"), for the benefit of
employees of the Company, under which options to purchase up to a maximum of
500,000 shares of its common stock may be issued.
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 to exceed 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% annually, beginning on the first anniversary
of the option grant, subject to the discretion of the Compensation Committee of
the Board of Directors.
The 1999 Plan will terminate on 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.
In November 2001, the Company granted 40,000 options with an exercise price
of $7.00 per share, to a consultant for services rendered. These options vest
ratably over five years and expire in November 2006. The options were not
granted as part of the Company's 1999 Plan or 2002 Plan.
On May 10, 2002, the Board of Directors approved the 2002 Incentive Stock
Option Plan (the "2002 Plan"), which the shareholders subsequently approved on
October 28, 2002. The 2002 Plan allows the granting of incentive stock options
or non-qualified stock options to the Company's employees, directors and
consultants, up to a maximum purchase of 230,000 shares of its common stock. 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 expire 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
F-17
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
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 fair market
value. Vesting is at the discretion of the Compensation Committee. The 2002 Plan
allows for immediate vesting if there is a change of control. As of December 31,
2004, a total of 401,900 options are available for future grant under both the
1999 Plan and the 2002 Plan.
A summary of stock option activity under the 1999 Plan and the 2002 Plan
are as follows:
Shares
Shares Weighted subject to
subject to average exercisable
options exercise price options
---------- -------------- -----------
December 31, 2002 305,400 129,733
Options granted --
Options exercised --
Options terminated (82,200)
-------
December 31, 2003 223,200 $6.51 147,924
=======
Options granted 136,000 $7.12
Options exercised (18,525) $6.66
Options terminated (31,100) $6.91
-------
December 31, 2004 309,575 $6.79 192,457
=======
The following tables summarize information about stock options outstanding
under the 1999 Plan and 2002 Plan as of December 31, 2004:
Options Outstanding Options Exercisable
-------------------------------------- ----------------------
Weighted
Average Weighted Number Weighted
Number Remaining Average Exercisable Average
Range of Outstanding Contractual Exercise At Exercise
Exercise Prices At Dec. 2004 Life (Years) Price Dec. 2004 Price
--------------- ------------ ------------ -------- ----------- --------
$5.625-$7.95 309,575 7.40 $6.79 192,457 $6.62
F-18
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Based upon the fair method value to measure compensation expense, the pro forma
expense for December 31, 2004 and 2003 is as follows:
2004 2003
-------- -----------
Net Profit (Loss) per Financial Statements $ 44,021 ($2,957,102)
======== ===========
Stock based-employee compensation
expense included in reported net loss,
net of related tax expense 40,187 --
Total stock-based employee compensation
expense determined under fair valued based,
net of related tax effects (46,720) (16,338)
-------- -----------
Pro Forma Net Profit (Loss) $ 37,488 ($2,973,440)
======== ===========
Profit (Loss) per share:
Basis and diluted shares as reported $ 0.01 ($0.58)
======== ===========
Basis and diluted shares as pro forma $ 0.01 ($0.58)
======== ===========
Deferred compensation cost is being amortized over a three year vesting
period. For pro forma 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
-----------
2004 2003
---- ----
Expected Life (years) 3 3
Expected volatility 20.7% 4.9%
Risk-free interest rates 3.3% 3.0%
The weighted average fair value per share of options granted for 2004 was
$7.12. There were no options granted during 2003.
9. STOCKHOLDERS' EQUITY
Pursuant to a Stock Purchase Agreement (the "Stock Purchase Agreement"), on
August 13, 2002, a wholly owned subsidiary of the Company acquired all of the
issued and outstanding common stock of National Safe of California, Inc.
("National Safe"). The purchase price of the acquisition was $2,000,000, subject
to certain adjustments specified in the Stock Purchase Agreement, which was paid
by issuing an aggregate of 283,566 shares of the Company's common stock. The
Stock Purchase Agreement provided that in the event that the average closing
price of
F-19
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
the Company's common stock for the ten trading days immediately prior to August
13, 2003 was less than $7.053 per share, the Company would, 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 pay the
seller an 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 such average closing price. In August 2003, the Company recorded
additional goodwill of approximately $ 46,000 for the guarantee of the stock
price. The Company issued 10,624 shares of common stock in connection with
required adjustments to the purchase price of the acquisition. The value of the
shares was approximately $69,000.
Effective April 1, 2004, ACI Acquisition Corporation, a wholly-owned
subsidiary of the Company, purchased all of the issued and outstanding stock of
Airorlite Communications, Inc ("Airorlite"). Airorlite was purchased for
$200,000 cash and 37,000 shares of the Company's common stock, valued at
$266,400. ACI Acquisition Corporation was subsequently renamed to Airorlite
Communication's Inc. These shares were issued in reliance on the exemption
provided by Section 4(2) of the Securities Act of 1933, as amended, regarding
transactions not involving a public offering.
On July 28, 2004, the Company completed a $3,319,998 private placement of
its common stock to certain qualified institutional investors. Under the terms
of the agreement, the Company sold an aggregate of 553,333 shares of common
stock to Lakeshore International, Ltd, Global Bermuda Limited Partnership,
Merced Partners Limited Partnership, Tamarack International, Ltd., SRG Capital
LLC, TCMP Partners and Bristol Investment Fund, Ltd., each a qualified
institutional investor, for $6.00 per share. The Company also has granted the
investors a warrant to acquire 138,333 shares of common stock at an exercise
price of $7.60 per share, exercisable for a period commencing six months after
the date of issuance through the fifth anniversary of the issuance. In addition,
the Placement Agent received a commission of 8% of the proceeds plus expenses
and was issued a warrant to acquire 55,333 shares of common stock with the same
terms as those issued to the institutional investors. After expenses, the net
proceeds of the transaction were $2,958,058. The Company intends to use the net
proceeds of the private placement for general corporate purposes. The securities
issued in the private placement were offered and sold to the investors without
registration under the Securities Act of 1933, in reliance upon the exemption
provided by Regulation D and Section 4(2) of the Securities Act. Such securities
may not be offered or sold in the United States in the absence of an effective
registration statement or an exemption from registration requirements under the
Securities Act. The Company filed a registration statement with the SEC covering
the resale of the shares sold under this private placement and the shares
issuable upon the exercise of the warrants on August 29, 2004, which statement
was declared effective on September 7, 2004.
On December 31, 2003, the Board of Directors authorized the issuance of
52,550 shares of restricted stock to employees. These shares were valued at
$294,280 and the Company included this expense in the Consolidated Statements of
Operations for 2003. On November 5, 2004, the Company's shareholders approved
the issuance of these shares. These shares carried a one year restriction and
were issued on January 3, 2005.
F-20
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
During 2004, several individuals exercised their employee incentive stock
options. Through December 31, 2004, options to exercise 18,525 shares of the
Company's common stock have been issued.
Holders of common stock are entitled to one vote for each share held on all
matters submitted for 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. 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.
Treasury Stock - In connection with the National Safe acquisition (as
described above), the Company made a $500,000 non-recourse loan at 6% interest
rate per annum, to the seller of National Safe that was collateralized by 70,891
shares of the Company's stock. On September 23, 2003, 70,891 shares of the
Company's stock were placed in treasury when the seller defaulted on a note
receivable to the Company. The Company cancelled the note and recorded treasury
stock at a cost of $500,000 in 2003.
On November 5, 2004, a resolution of the Board of Directors determined that
the shares held in treasury be restored to the status of authorized but
unissued. The company recorded this transaction in 2004.
Preferred Stock - Our board of directors is authorized, 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. The issuance of
preferred stock could decrease the amount 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 have no plans to issue preferred stock in the foreseeable future.
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 warrant exercise price is $11.55 a share and
will expire in November 2005. The warrants contain provisions that protect
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 shares outstanding, except for
shares issued under certain circumstances, including shares issued under the
incentive stock option plan or any equity securities for which adequate
consideration is received. The holder of the warrant does not possess
F-21
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
any rights as a stockholder until and unless the warrant is exercised.
In connection with the Company's private placement of its common stock to
certain qualified institutional investors (as noted above), such investors were
issued warrants to acquire 138,333 shares of common stock at an exercise price
of $7.60 per share, exercisable for a period commencing six months after the
date of issuance through the fifth anniversary of the issuance. In addition, the
Placement Agent was issued warrants to acquire 55,333 shares of common stock
with the same terms as those issued to the institutional investors. These
warrants will expire January 27, 2010.
A total of 1,095,141 common shares are reserved for exercise of employee
stock options and warrants as of December 31, 2004.
10. COMMITMENTS
Leases - The Company leases its office and revenues facilities under
operating leases that expire through 2007. Future minimum rental payments, under
non-cancelable leases as of December 31, 2004, are as follows:
2005 $384,500
2006 257,000
2007 6,500
--------
Total $648,000
========
Rent expense under operating leases were approximately $381,000 and
$368,000 for the years ended December 31, 2004 and 2003, respectively.
Employment Agreements - The Company had entered into employment agreements
with two of its officers through 2005. The employment agreements provide for
minimum aggregate annual compensation of approximately $359,000 for 2004, plus
unspecified annual bonuses and 10% raises through 2005. Also, there is a
one-year non-competition covenant that commences after termination of employment
in certain contracts. In December 2003, both officers agreed to waive their
salaries by 20% to approximately $261,000 until the Company becomes profitable.
In 2004, the Company returned to profitability. However, these officers did not
restore their salaries to the former levels.
11. EMPLOYEE BENEFIT PLAN
As of January 1, 2003, the Company sponsored a 401-K plan, including
discretionary profit sharing (the "401-K Plan"). The Company may match up to
three percent of qualifying employees' compensation when contributed to the
401-K Plan. As of September 1, 2003, the Company temporarily stopped matching
contributions to the 401-K Plan but may resume discretionary matches in the
future. The Company's contributions to the employees' accounts vests equally
over three years
F-22
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
and the employee contribution to their own account vests immediately. The
Company's contribution to the 401-K Plan during 2003 was approximately $68,000.
There were no contributions to the 401-K plan during 2004.
12. RELATED PARTED TRANSACTIONS
The Company paid consulting fees of approximately of $3,000 and $51,000,
for the years ended December 31, 2004 and December 31, 2003, respectively, to a
corporation that had one of the Company's directors as an officer.
The Company paid a former Director consulting fees of $2,400 for the year
ended December 31, 2003.
13. RESTATEMENT
In conjunction with the Company's decision, in the third quarter of 2003,
to outsource a product formerly manufactured by Viscom Products, the Company
wrote-down inventory of approximately $582,000 and software development cost of
approximately $136,000. In 2003, the Company inadvertently reported this as a
single line item entitled Restructuring Charge in the Consolidated Statement of
Operations. The Company has subsequently reclassified these items in the
Consolidated Statements of Operations for 2003 and included these charges in the
applicable line item.
14. SEGMENT DATA
Selected information by business segment is presented in the following
tables for the years December 31, 2004 and 2003, respectively:
Percentage Percentage
Revenue 2004 of Total 2003 of Total
------------------------------- ----------- ---------- ----------- ----------
Total Integration $26,255,044 88% $17,645,271 97%
Specialty Products and Services 3,470,374 12% 615,794 3%
----------- --- ----------- ---
Total Revenue $29,725,418 100% $18,261,065 100%
=========== === =========== ===
F-23
DIVERSIFIED SECURITY SOLUTIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Operating Profit (Loss) 2004 2003
------------------------------- ----------- -----------
Total Integration $ 630,433 $(2,199,017)
Specialty Products and Services 1,084,167 (1,474,786)
Corporate (1,315,399) (1,313,169)
----------- -----------
Total Operating Profit (Loss) $ 399,201 $(4,986,972)
=========== ===========
Selected balance sheet information by business segment is presented in the
following table for the years December 31, 2004:
Total Assets 2004
------------------------------- -----------
Total Integration $17,643,412
Specialty Products and Services 2,583,860
Corporate 2,861,147
-----------
Total Assets $23,088,419
===========
15. 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. In management's opinion,
none of these claims is likely to have a material affect on the Company's
consolidated financial statements
16. SUBSEQUENT EVENT
In January 2005, the Company entered into an agreement with Administaff, Inc. to
outsource its human resources and payroll functions. With the decision to
outsource these functions, the company and its employees receive benefits that
are available to larger companies. The Company's employees will enter into a
co-employment relationship with Administaff. Administaff will handle the daily
management of the human resource and payroll functions, for which they receive
an administrative fee. The Company does not anticipate any adverse financial
impact due to this change.
F-24
EXHIBIT INDEX
The following exhibits are filed herewith as part of this Report on Form 10-KSB:
Exhibit Method
Number Description of Document of Filing
-------- ----------------------- ---------
3.1 -- Certificate of Incorporation of the Company ............................ (1)
3.2 -- By-laws of the Company ................................................. (1)
3.3 -- Certificate of Amendment of the Certificate of Incorporation of the
Company, filed on July 5, 2001 ......................................... (2)
3.4 -- Certificate of Amendment of the Certificate of Incorporation of the
Company, filed on August 28, 2001 ...................................... (2)
4.1 -- Specimen Common Stock Certificate of the Company ....................... (3)
4.2 -- Underwriter's Warrant Agreement ........................................ (3)
10.1 -- 2002 Stock Option Plan ................................................. (5)
10.2 -- Employment Agreement between the Company and James E. Henry ............ (1)
10.3 -- Employment Agreement between the Company and Irvin F. Witcosky ......... (1)
10.4 -- Employment Agreement between the Company and Louis Massad .............. (1)
10.5 -- 1999 Incentive Stock Option Plan and form of Stock Option Agreement .... (1)
10.6 -- Amendment to Employment Agreement between the Company and
Louis Massad............................................................ (2)
10.7 -- Office Lease between the Company and Midland Holding Co., Inc. ......... (4)
10.8 -- Office Lease between the Company and Eagle-DFW, Inc. ................... (4)
10.9 -- Amendment to Employment Agreement between the Company and James
E. Henry ............................................................... (4)
10.10 -- Amendment to Employment Agreement between the Company and Irvin
F. Witcosky ............................................................ (4)
10.11 -- Agreement between the Company and Administaff, Inc. .................... (*)
14.1 -- Code of Ethics ......................................................... (6)
21.1 -- List of Subsidiaries ................................................... (*)
31.1 -- Certification of Chief Executive Officer pursuant to Rule 13a- 14
(a) or Rule 15d- 14(a) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 ............................................. (*)
31.2 -- Certification of Chief Operating Officer pursuant to Rule 13a- 14
(a) or Rule 15d- 14(a) as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 ............................................. (*)
31.3 -- Certification of Chief Financial Officer pursuant to Rule 13a- 4(a)
or Rule 15d- 14(a) as adopted pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 ...................................................... (*)
32 -- Section 1350 Compliance ................................................ (*)
1. 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(The "Registration Statement").
2. Incorporated by reference to Amendment No. 4 to the Registration Statement
filed with the Securities and Exchange Commission on September 25, 2001.
3. Incorporated by reference to Amendment No. 6 to the Registration Statement
filed with the Securities and Exchange Commission on November 13, 2001.
4. Incorporated by reference to Post-Effective Amendment No. 1 to the
Registration Statement filed on February 8, 2001.
5. Incorporated by reference to the Company's Definitive Proxy on Form 14A,
filed with the Securities and Exchange Commission on September 27, 2002.
6. Incorporated by reference to the Company's Annual Report on 10-KSB for the
Company for the Year Ended December 31, 2003 filed with the Securities and
Exchange Commission on April 1, 2004.
* Filed herewith.