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ISNS > SEC Filings for ISNS > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for IMAGE SENSING SYSTEMS INC



Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations


General. We provide software based computer enabled detection ("CED") products and solutions that use advanced signal processing software algorithms to detect and monitor objects in a designated field of view. Our technology analyzes signals from a sophisticated sensor and passes the information along to management systems, controllers or directly to users. Our core products, the Autoscope® Video Vehicle Detection System, Autoscope® Radar Detection System and Autoscope® License Plate Recognition ("LPR") System, operate using our proprietary application software in conjunction with video cameras or radar and commonly available electronic components. Our systems are used by traffic managers primarily to improve the flow of vehicle traffic and to enhance safety at intersections, main thoroughfares, freeways and tunnels and by parking and toll managers and law enforcement officials to read license plates for various safety, security, access and enforcement LPR applications.

Autoscope® video and radar systems are sold to distributors and end users of traffic management products in North America, the Caribbean and Latin America by Econolite Control Products, Inc. ("Econolite"), our exclusive licensee in these regions. We sell LPR systems to distributors and end users in North America. We sell all of our systems to distributors and end users in Europe and Asia through our subsidiaries. The majority of our sales are to end users that are funded by government agencies responsible for traffic management or traffic law enforcement.

Trends and Challenges in Our Business

We believe the expected growth in our business can be attributed primarily to the following global trends:

• worsening traffic caused by increased numbers of vehicles in metropolitan areas without corresponding expansions of road infrastructure and the need to automate safety, security and access applications for automobiles and trucks, which has increased demand for our products;

• advances in information technology, which have made our products easier to market and implement;

• the continued funding allocations for centralized traffic management services and automated enforcement schemes, which has increased the ability of our primary end users to implement our products; and

• general increases in the cost-effectiveness of electronics, which make our products more affordable for end users.

We believe our continued growth primarily depends upon:

• continued adoption and governmental funding of intelligent transportation systems ("ITS") and other automated applications for traffic control, safety and enforcement in developed countries;

• a propensity by traffic engineers to implement lower cost technology-based solutions rather than civil engineering solutions such as widening roadways;

• countries in the developing world adopting above-ground detection technology, such as video or radar, instead of in-pavement loop technology to manage traffic;

• the adoption of automatic license plate recognition for law enforcement and homeland security applications in metropolitan areas;

• the use of CED to provide solutions to security/surveillance and environmental issues associated with increasing automobile use in metropolitan areas; and

• our ability to develop new products, such as hybrid CED devices incorporating, for example, radar and video technologies, that provide increasingly accurate information and enhance the end users' ability to cost-effectively manage traffic, security/surveillance and environmental issues.

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Because the majority of our end users are governmental entities, we are faced with challenges related to potential delays in purchase decisions by those entities and changes in budgetary constraints. These contingencies could result in significant fluctuations in our revenue between periods. The ongoing difficult economic environment in Europe and the United States is further adding to the unpredictability of purchase decisions, creating more delays than usual and decreasing governmental budgets, and it is likely to continue to negatively affect our revenue.

Key Financial Terms and Metrics

Revenue. We derive revenue from two sources: (1) royalties received from Econolite for sales of the Autoscope® video and Autoscope® radar (2012 and later) systems in North America, the Caribbean and Latin America and (2) revenue received from the direct sales of our Autoscope® radar (2011 and before) and LPR systems in North America, the Caribbean and Latin America and all of our systems in Europe and Asia. Royalties are calculated using a profit sharing model where the gross profits on sales of product made through Econolite are shared equally with Econolite. This royalty arrangement has the benefit of decreasing our cost of revenues and our selling, marketing and product support expenses because these costs and expenses are borne primarily by Econolite. Although this royalty model has a positive impact on our gross margin, it also negatively impacts our total revenue, which would be higher if all the sales made by Econolite were made directly by us. The royalty arrangement is exclusive under a long-term agreement.

Cost of Revenue. There is no cost of revenue related to royalties, as virtually all manufacturing, warranty and related costs are incurred by Econolite. Cost of revenue related to product sales consists primarily of the amount charged by our third party contractors to manufacture hardware platforms, which is influenced mainly by the cost of electronic components. The cost of revenue also includes logistics costs, estimated expenses for product warranties, restructuring costs and inventory reserves. The key metric that we follow is achieving certain gross margin percentages on product sales by geographic region and to a lesser extent by product line.

Operating Expenses. Our operating expenses fall into three categories: (1) selling, marketing and product support; (2) general and administrative; and (3) research and development. Selling, marketing and product support expenses consist of various costs related to sales and support of our products, including salaries, benefits and commissions paid to our personnel; commissions paid to third parties; travel, trade show and advertising costs; second-tier technical support for Econolite; and general product support, where applicable. General and administrative expenses consist of certain corporate and administrative functions that support the development and sales of our products and provide an infrastructure to support future growth. These expenses include management, supervisory and staff salaries and benefits, legal and auditing fees, travel, rent and costs associated with being a public company, such as board of director fees, listing fees and annual reporting expenses. Research and development expenses consist mainly of salaries and benefits for our engineers and third party costs for consulting and prototyping. We measure all operating expenses against our annually approved budget, which is developed with achieving a certain operating margin as a key focus. Also included in operating expenses are restructuring costs and non-cash expense for intangible asset amortization.

Non-GAAP Operating Measure. We provide certain non-GAAP financial information as supplemental information to financial measures calculated and presented in accordance with GAAP (Generally Accepted Accounting Principles in the United States). This non-GAAP information excludes the impact of amortizing intangible assets and may exclude other non-recurring items. Management believes that this presentation facilitates the comparison of our current operating results to historical operating results. Management uses this non-GAAP information to evaluate short-term and long-term operating trends in our core operations. Non-GAAP information is not prepared in accordance with GAAP and should not be considered a substitute for or an alternative to GAAP financial measures and may not be computed the same as similarly titled measures used by other companies.

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Reconciliations of GAAP net loss to non-GAAP net loss are as follows (dollars in thousands, except per share amounts):

                                      Three-Month Periods Ended
                                              March 31,
                                        2014             2013

Loss from operations                $      (3,756 )  $      (2,949 )
Amortization of intangible assets             389              341
Investigation matter                          116            1,609
Restructuring charges                         460                -
Non-GAAP loss from operations       $      (2,791 )  $        (999 )

Seasonality. Our quarterly revenues and operating results have varied significantly in the past due to the seasonality of our business. Our first quarter generally is the weakest due to weather conditions that make roadway construction more difficult in parts of North America, Europe and northern Asia. We expect such seasonality to continue for the foreseeable future. Additionally, our international revenues have a significant large project component, resulting in a varying revenue stream. Accordingly, we believe that quarter-to-quarter comparisons of our financial results should not be relied upon as an indication of our future performance. No assurance can be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future.

Segments. We currently operate in three reportable segments: Intersection, Highway and LPR. Autoscope® video is our machine-vision product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international product sales. Video products are normally sold in the Intersection segment. The Autoscope® radar is our radar product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international sales. Radar products are normally sold in the Highway segment. Autoscope® license plate recognition is our LPR product line. All segment revenues are derived from external customers. As a result of business model changes and modifications in how we manage our business, we may reevaluate our segment definitions in the future.

Financial information by reportable segment for the three month periods ended March 31, 2014 and 2013 is summarized as follows (in thousands):

                                          For the three months ended March 31, 2014
                                     Intersection       Highway          LPR        Total

Revenue                             $        2,183    $     1,075    $     1,064   $ 4,322
Gross profit                                 2,105            678            334     3,117
Amortization of intangible assets                -            122            267       389
Intangible assets                                -            820          5,265     6,085

                                          For the three months ended March 31, 2013
                                     Intersection       Highway          LPR        Total

Revenue                             $        2,942    $       773    $       899   $ 4,614
Gross profit                                 2,734            323            495     3,552
Amortization of intangible assets                -            123            218       341
Intangible assets                                -          1,464          4,779     6,243

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Results of Operations

The following table sets forth, for the periods indicated, certain statements of
operations data as a percent of total revenue and gross margin on product sales
and royalties as a percentage of product sales and royalties, respectively.

                                                     Three-Months ended March 31,         Quarter
                                                       2014                2013           Change

Product sales                                                43.9 %              44.3 %        (7.2 )%
Royalties                                                    56.1                55.7          (5.6 )
Total revenue                                               100.0               100.0          (6.3 )
Gross profit - product sales                                 36.5                48.1         (29.5 )
Gross profit - royalties                                    100.0               100.0          (5.6 )
Selling, marketing and product support                       62.9                44.4          32.7
General and administrative                                   31.7                29.7           0.1
Research and development                                     42.0                24.5          60.6
Investigation matter                                          2.7                34.9         (92.8 )
Restructuring                                                10.6                   -           N/A

Total revenue decreased to $4.3 million in the three month period ended March 31, 2014 from $4.6 million in the three month period ended March 31, 2013, a decrease of 6.3%. Royalty income decreased to $2.4 million in the first quarter of 2014 from $2.6 million in the first quarter of 2013, a decrease of 5.6%. The decrease in royalties was the result of a decrease in Autoscope® video royalties slightly offset by an increase in Autoscope® radar royalties. Autoscope® video royalties were lower in the three months ended March 31, 2014 compared to the three months ended March 31, 2013 as a result of lower unit volume. Product sales decreased to $1.9 million in the first quarter of 2014 from $2.0 million in the first quarter of 2013, a decrease of 7.2%. The decrease in product sales was mainly due to lower sales volume in Europe slightly offset by higher sales volume in Asia.

Revenue for the Intersection segment decreased to $2.2 million in the first three months of 2014 from $2.9 million in the first three months of 2013, a decrease of 25.8%. The decrease in the Intersection segment was mainly due to lower sales volume in Europe.

Revenue for the Highway segment increased to $1.1 million in the first quarter of 2014 from $773,000 in the first quarter of 2013, an increase of 39.1%. The increase in Highway was due mainly to higher sales volume worldwide.

Revenue for the LPR segment increased to $1.1 million in the period ended March 31, 2014 from $899,000 in the period ended March 31, 2013, an increase of 18.4%. The increase in revenue for the LPR segment in 2014 over 2013 is due to higher sales volumes in North America and Europe.

Gross profit for product sales decreased to 36.5% in the three months ended March 31, 2014 from 48.1% in the three months ended March 31, 2013. Gross profit for the LPR product line have historically been lower than gross profit for the Intersection and Highway product lines and therefore the mix of the product lines sold in any given period can result in varying gross profit. Generally, lower sales volumes of Highway or LPR products will reduce gross profit because of fixed manufacturing costs for these products. Additionally, the geographic sales mix of our product sales can influence margins, as product sold in some jurisdictions have lower margins. We anticipate that gross profit for our product sales will be higher in 2014 as compared to 2013, while we expect royalty gross profit will be 100% in 2014.

Selling, marketing and product support expense increased to $2.7 million or 62.9% of total revenue in the first three months of 2014 from $2.1 million or 44.4% of total revenue in the first three months of 2013. Our selling, marketing and product support expense increased mainly due to our investments in additional sales and marketing resources. We anticipate that annual selling, marketing and product support expense will increase in dollar amount in 2014 as compared to 2013.

General and administrative expense was $1.4 million for the three months ended March 31, 2014 and 2013. General and administrative expense increased as a percentage of revenue to 31.7% in the first quarter of 2014 from 29.7% in the first quarter of 2013. We anticipate that annual general and administrative expenses for 2014 will approximate the expenses of 2013.

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Research and development expense increased to $1.8 million or 42.0% of total revenue in the period ended March 31, 2014 from $1.1 million or 24.5% of total revenue in the period ended March 31, 2013. The increase was mainly related to the increased expenditures on new research and development projects, the acceleration of previously existing projects and other product developments.

In the first quarter of 2014, we implemented restructuring plans to improve our financial performance in Europe. These plans included the closure of our office in Poland. Because of these actions, restructuring charges of approximately $460,000 were recorded related primarily to facilities and employee terminations.

Amortization of intangibles was $389,000 in the first three months of 2014 compared to $341,000 in the first three months of 2013 and reflects the amortization of intangible assets acquired in acquisitions. Assuming there are no changes to our intangible assets, we anticipate amortization expense will be approximately $1.8 million in 2014.

There was no income tax expense recorded for the three months ended March 31, 2014, compared to income tax benefit of $1.5 million, or 50.7% of pretax loss, for the three months ended March 31, 2013. Certain jurisdictions have net operating loss carry forwards. The benefits of these net operating loss carryforwards are uncertain and, as a result, the Company is not recording the related tax benefits.

Liquidity and Capital Resources

At March 31, 2014, we had $2.9 million in cash and cash equivalents and no marketable securities, compared to $3.6 million in cash and cash equivalents and $2.6 million in marketable securities at December 31, 2013. Our investment objectives are to preserve principal, maintain liquidity, and achieve the best available return consistent with our primary objectives of safety and liquidity.

Net cash used in operating activities was $3.2 million in the first three months of 2014, compared to cash used in operating activities of $239,000 in the same period in 2013. The primary reason for the decrease in cash was the loss for the quarter offset in part by the collection of outstanding receivables and the conversion of inventory. We anticipate that average receivable collection days in 2014 will improve from 2013 but that the improvement will not have a material impact on our liquidity.

Net cash provided by investing activities was $2.6 million for the first quarter of 2014, compared to cash used in investing activities of $258,000 in the first quarter of 2013. Our planned additions of property and equipment are discretionary, and we do not expect them to exceed historical levels in 2014.

As of March 31, 2014, we had a revolving line of credit with Associated Bank, National Association ("Associated Bank") that was initially entered into as of May 1, 2008. The revolving line of credit agreement ("Credit Agreement") with Associated Bank provided up to $5.0 million of credit. The Credit Agreement provided that any amounts outstanding under the Credit Agreement bore interest at an annual rate equal to the greater of (a) 4.5% or (b) LIBOR plus 2.75%. Any advances were secured by inventories, accounts receivable and equipment. We were subject to certain financial covenants under the Credit Agreement, including minimum debt service coverage ratios, minimum cash flow coverage ratios and financial measures. At March 31, 2014 and December 31, 2013, we had no borrowings under the Credit Agreement, and we were in compliance with all financial covenants. Additionally, we requested, and Associated Bank granted, a termination to the Credit Agreement effective on May 12, 2014. The Credit Agreement with Associated Bank was terminated in connection with the revolving line of credit from Alliance Bank described below.

On May 12, 2014, the Company entered into a revolving line of credit with Alliance Bank. This revolving line of credit agreement and related documents (collectively, "Alliance Credit Agreement") with Alliance Bank provides up to $5.0 million of credit. The Alliance Credit Agreement expires in May 2015 and bears interest at a fixed annual rate of 3.95%. Any advances are secured by inventories, accounts receivable, cash, marketable securities, and equipment. We are subject to certain covenants under the Alliance Credit Agreement.

We believe that cash and cash equivalents on hand at March 31, 2014, along with the availability of funds under our revolving line of credit and cash provided by operating activities, will satisfy our projected working capital needs, investing activities, and other cash requirements for the foreseeable future.

Off-Balance Sheet Arrangements

We do not participate in transactions or have relationships or other arrangements with an unconsolidated entity, including special purpose and similar entities, or other off-balance sheet arrangements.

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Critical Accounting Policies

Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2013. The accounting policies used in preparing our interim Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2014 set forth elsewhere in this Quarterly Report on Form 10-Q are the same as those described in our Annual Report on Form 10-K.

Cautionary Statement:

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange of 1934, as amended. Forward-looking statements represent our expectations or beliefs concerning future events and can be identified by the use of forward-looking words such as "expects," "believes," "may," "will," "should," "intends," "plans," "estimates," or "anticipates" or other comparable terminology. Forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from the results described in the forward-looking statements. Factors that might cause such differences include, but are not limited to:

• our historical dependence on a single product for most of our revenue;

• budget constraints by governmental entities that purchase our products, including constraints caused by declining tax revenue;

• the continuing ability of Econolite to pay royalties owed;

• the mix of and margin on the products we sell;

• our dependence on third parties for manufacturing and marketing our products;

• our dependence on single-source suppliers to meet manufacturing needs;

• our increased international presence;

• our failure to secure adequate protection for our intellectual property rights;

• our inability to develop new applications and product enhancements;

• unanticipated delays, costs and expenses inherent in the development and marketing of new products;

• our inability to respond to low-cost local competitors in Asia and elsewhere;

• our inability to properly manage any growth in revenue and/or production requirements;

• the influence over our voting stock by affiliates;

• our inability to hire and retain key scientific and technical personnel;

• the effects of legal matters in which we may become involved;

• our inability to achieve and maintain effective internal controls;

• our inability to successfully integrate acquisitions;

• political and economic instability, including continuing volatility in the economic environment of the European Union;

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• our inability to comply with international regulatory restrictions over hazardous substances and electronic waste; and

• conditions beyond our control such as war, terrorist attacks, health epidemics and economic recession.

We caution that the forward-looking statements made in this report or in other announcements made by us are further qualified by the risk factors set forth in Item 1A. to our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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