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ISNS > SEC Filings for ISNS > Form 10-Q on 4-Aug-2014All Recent SEC Filings

Show all filings for IMAGE SENSING SYSTEMS INC

Form 10-Q for IMAGE SENSING SYSTEMS INC


4-Aug-2014

Quarterly Report


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

Overview

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 are sold to distributors and end users of traffic management products in the United States, Mexico, Canada and the Caribbean and Latin America by Econolite Control Products, Inc. ("Econolite"), our exclusive licensee in these regions. From July 24, 2012 until July 14, 2014, our Autoscope® radar systems also were sold by Econolite in these geographic areas under the same arrangement. As described elsewhere in this Quarterly Report on Form 10-Q, effective July 14, 2014, the marketing, manufacturing and distribution of the Autoscope® radar product line in the United States, Mexico, Canada and the Caribbean transitioned from Econolite to the Company. We sell LPR systems to distributors and end users in the United States, Canada and Mexico. 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 LPR 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.

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 (July 24, 2012 until July 14, 2014) systems in the United States, Mexico, Canada and the Caribbean and Latin America and (2) revenue received from the direct sales of our Autoscope® radar (before July 24, 2012) and LPR systems in the United States, Mexico, Canada and the Caribbean 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.


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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          Six-Month Periods Ended
                                                       June 30,                          June 30,
                                                2014             2013             2014             2013

Loss from operations                        $      (1,558 )  $      (2,157 )  $      (5,314 )  $      (5,106 )
Amortization of intangible assets                     393              340              782              681
Investigation matter                                   36            1,129              152            2,738
Restructuring charges                                   -                -              460                -
Non-GAAP loss from operations               $      (1,129 )  $        (688 )  $      (3,920 )  $      (1,687 )

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 and six month periods ended June 30, 2014 and 2013 is summarized as follows (in thousands):

                                                 Three Months Ended June 30,
                         Intersection           Highway               LPR                 Total
                        2014      2013      2014      2013      2014      2013       2014       2013

Revenue                $ 3,625   $ 3,765   $ 1,094   $   842   $ 1,219   $ 2,861   $  5,938   $  7,468
Gross profit             3,242     3,171       488       108       533     1,684      4,263      4,963
Amortization of
intangible assets            -         -       121       122       272       218        393        340
Intangible assets            -         -       698     1,644     5,065     4,562      5,763      6,206

                                                  Six Months Ended June 30,
                         Intersection           Highway               LPR                 Total
                        2014      2013      2014      2013      2014      2013       2014       2013

Revenue                $ 5,808   $ 6,707   $ 2,169   $ 1,615   $ 2,283   $ 3,760   $ 10,260   $ 12,082
Gross profit             5,347     5,905     1,166       431       867     2,179      7,380      8,515
Amortization of
intangible assets            -         -       244       245       538       436        782        681
Intangible assets            -         -       698     1,644     5,065     4,562      5,763      6,206


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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.



                                                                                           Quarter
                                                                                             Over
                                                       Three-Months ended June 30,         Quarter
                                                        2014                2013            Change
Product sales                                                 44.6 %              57.2 %       (37.9 )%
Royalties                                                     55.4                42.8           2.8
Total revenue                                                100.0               100.0         (20.5 )
Gross profit - product sales                                  36.8                41.3         (44.7 )
Gross profit - royalties                                     100.0               100.0           2.8
Selling, marketing and product support                        41.6                36.2          (8.6 )
General and administrative                                    25.2                21.3          (5.9 )
Research and development                                      24.0                18.2           4.9
Investigation matter                                           0.6                15.1         (96.8 )
Amortization of intangible assets                              6.6                 4.6          15.6
Loss from operations                                         (26.2 )             (28.9 )       (27.8 )
Income tax benefit                                            (0.2 )              (5.6 )       (97.6 )
Net loss                                                     (25.8 )             (23.4 )       (12.2 )


                                                                                            Period
                                                                                             Over
                                                        Six-Months ended June 30,           Period
                                                        2014                2013            Change
Product sales                                                 44.3 %              52.3 %       (28.0 )%
Royalties                                                     55.7                47.7          (1.0 )
Total revenue                                                100.0               100.0         (15.1 )
Gross profit - product sales                                  36.7                43.5         (39.3 )
Gross profit - royalties                                     100.0               100.0          (1.0 )
Selling, marketing and product support                        50.6                39.3           9.2
General and administrative                                    28.0                24.5          (3.1 )
Research and development                                      31.6                20.6          30.2
Investigation matter                                           1.5                22.7         (94.4 )
Restructuring                                                  4.5                   -             -
Amortization of intangible assets                              7.6                 5.6          14.8
Loss from operations                                         (51.8 )             (42.3 )         4.1
Income tax benefit                                            (0.1 )             (15.8 )       (99.5 )
Net loss                                                     (51.6 )             (26.5 )        65.4

Total revenue decreased to $5.9 million in the three month period ended June 30, 2014 from $7.5 million in the same period in 2013, a decrease of 20.5%, and to $10.3 million in the first half of 2014 from $12.1 million in the same period in 2013, a decrease of 15.1%. Royalties increased to $3.3 million in the second quarter of 2014 from $3.2 million in the second quarter of 2013, an increase of 2.8% and they decreased to $5.7 million in the first half of 2014 from $5.8 million in the same period in 2013, a decrease of 1.0%. 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 June 30, 2014 compared to the three months ended June 30, 2013 as a result of lower unit volume. Product sales decreased to $2.7 million in the second quarter of 2014 from $4.3 million in the second quarter of 2013, a decrease of 37.9%, and decreased to $4.5 million in the first half of 2014 from $6.3 million in the first half of 2013, a decrease of 28.0%. The decrease in product sales was mainly due to lower sales volume in Europe slightly offset by higher sales volume in Asia. The decrease in European sales volume was primarily the result of the Polish office closure and the transition of operations to other jurisdictions.


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Revenue for the Intersection segment decreased to $3.6 million in the three-month period ended June 30, 2014 from $3.8 million in the three-month period ended June 30, 2013, a decrease of 3.7%. Revenue for the Intersection segment decreased to $5.8 million in the first six months of 2014 from $6.7 million in the first half of 2013, a decrease of 13.4%. The decrease in revenue for the Intersection segment was mainly due to lower sales volume in Europe.

Revenue for the Highway segment increased to $1.1 million in the second quarter of 2014 from $842,000 in the second quarter of 2013, an increase of 30.0% and increased in the first half of 2014 to $2.2 million from $1.6 million in the first half of 2013, an increase of 34.3%. The increase in revenue for the Highway segment was due mainly to higher sales volume worldwide.

Revenue for the LPR segment decreased to $1.2 million in the period ended June 30, 2014 from $2.9 million in the period ended June 30, 2013, a decrease of 57.4%, and decreased to $2.3 million in the six month period ended June 30, 2014 from $3.8 million in the same period in 2013, a decrease of 39.3%. The decrease in revenue for the LPR segment in 2014 over 2013 is due to lower sales volumes in North America and Europe.

Gross profit for product sales decreased to 36.8% in the quarter ended June 30, 2014 from 41.3% in the quarter ended June 30, 2013 and decreased to 36.7% in the first half of 2014 from 43.5% in the first half of 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 decreased to $2.5 million or 41.6% of total revenue in the three months ended June 30, 2014 from $2.7 million or 36.2% of total revenue in the three months ended June 30, 2013 and increased to $5.2 million or 50.6% of total revenue in the first half of 2014 from $4.8 million or 39.3% of total revenue in the first half of 2013. Our selling, marketing and product support expense increased in the first half of 2014 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 decreased to $1.5 million or 25.2% of total revenue for the second quarter of 2014 from $1.6 million or 21.3% of total revenue in the second quarter of 2013 and to $2.9 million or 28.0% of total revenue in the first half of 2014 from $3.0 million or 24.5% of total revenue in the first half of 2013. We anticipate that annual general and administrative expenses for 2014 will approximate the expenses of 2013.

Research and development expense was to $1.4 million or 24.0% of total revenue in the three months ended June 30, 2014 and $1.4 million or 18.2% of total revenue in the same period in 2013, and it increased to $3.2 million or 31.6% of total revenue in the first half of 2014 from $2.5 million or 20.6% of total revenue in the first half of 2013. The increase in the first half of 2014 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 in the first quarter of 2014 related primarily to facilities and employee terminations.

Amortization of intangibles was $393,000 in the second quarter of 2014 and $782,000 in the first half of 2014 compared to $340,000 in the second quarter of 2013 and $681,000 in the first half of 2013. This 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.

We recorded an income tax benefit of $10,000 for the three and six months ended June 30, 2014, compared to income tax benefit of $415,000 and $1.9 million for the three and six months ended June 30, 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 June 30, 2014, we had $2.6 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.


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Net cash used in operating activities was $3.6 million in the first six months of 2014 compared to cash used in operating activities of $2.8 million in the same period in 2013. The primary reason for the decrease in cash was the loss for the first six months of 2014 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 $2.4 million for the first half of 2014 compared to cash used in investing activities of $576,000 in the first half of 2013. Our planned additions of property and equipment are discretionary, and we do not expect them to exceed historical levels in 2014.

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 provide 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. At June 30, 2014, we had no borrowings under the Alliance Credit Agreement, and we were in compliance with all financial covenants.

Prior to May 12, 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. We requested, and Associated Bank granted, a termination to the Credit Agreement effective on May 12, 2014 in connection with the revolving line of credit from Alliance Bank described above.

We believe that cash and cash equivalents on hand at June 30, 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.

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 and six months ended June 30, 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;


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

. . .

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