UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2001
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _____________ to __________
Commission file number 0-26056
IMAGE SENSING SYSTEMS, INC.
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(Name of small business issuer in its charter)
MINNESOTA 41-1519168
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State or other jurisdiction of IRS Employer Identification No.
incorporation of organization
500 SPRUCE TREE CENTRE
1600 UNIVERSITY AVE. W.
ST. PAUL, MN 55104 (651) 603-7700
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Address of principal executive offices Issuer's telephone number
Securities registered under Section 12(b) of the Exchange act:
NONE
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Title of each class
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
----------------------------
Title of each class
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. [X] Yes [ ] No
Check if there is no disclosure of delinquent filers in response to
Items 405 of Regulation S-B in this form, and no disclosure will 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. [X]
The registrant's revenues for the fiscal year ended December 31, 2001
totaled $6,682,000.
Based on the closing bid price at March 12, 2002, the aggregate market
value of the voting stock held by nonaffiliates of the registrant was
$6,305,554.
The number of shares outstanding of the registrant's $.01 par value
common stock, as of March 12, 2002, was 3,152,777 shares.
Transitional Small Business Issuer Format: [ ] Yes [X] No
DOCUMENTS INCORPORATED BY REFERENCE
Portions of our proxy statement for our May 16, 2002 annual meeting of
shareholders, which will be filed on or prior to April 30, 2002, are
incorporated by reference into Part III of this Form 10-KSB.
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SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-KSB 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 "believes,"
"expects," "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 discussed in the forward-looking statements. Factors
that might cause these differences include, but are not limited to:
- lack of market acceptance of our products;
- dependence on third parties for manufacturing and marketing
capabilities and continuing ability to pay royalties owed;
- inability to diversify our product offerings;
- revenue fluctuations caused by our dependence on sales to
governmental entities;
- failure to secure adequate protection for our intellectual property
rights;
- failure to respond to evolving industry standards and technological
changes;
- inability to properly manage a growth in revenue and/or production
requirements;
- inability to meet our future additional capital requirements; and
- control of our voting stock by insiders.
We caution that the forward-looking statements made in this report or in other
announcements made by Image Sensing Systems are further qualified by the factors
set forth in Exhibit 99 to this Annual Report on Form 10-KSB, under the caption
"Cautionary Statement."
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
Image Sensing Systems develops and markets video image processing
products for implementation in advanced traffic management systems, freeway
incident detection and traffic data collection. Video image processing, also
known as machine vision or artificial vision, is a technology that captures and
analyzes video images through the use of sophisticated algorithms and computer
software combined with special purpose hardware. Combining this technology with
commercially available computer hardware and video cameras, we created our core
product, the Autoscope(R) Wide Area Video Vehicle Detection System. The
Autoscope system converts video images of a traffic scene into digitized traffic
data that may be transmitted to local or remote locations for real-time traffic
management or stored for later analysis. The Autoscope system is modular,
flexible, and expandable and has a variety of applications in intersection
control, freeway traffic management, and traffic data collection. The system can
be used by traffic managers for traffic control, management, planning, research,
and other applications and ultimately can help reduce traffic congestion,
improve roadway planning, and increase cost efficiencies in traffic management
and control.
The original Autoscope system was first marketed and sold commercially
in 1991. Since that time, we have developed a number of Autoscope products,
including the Autoscope 2004, the Autoscope Solo(R), the Autoscope Solo Pro(TM)
and the Autoscope Image Sensor Camera (AIS). The Autoscope 2004 system,
introduced in 1991, generally consists of one to four video cameras, a flexible
modular microprocessor with specialized software and circuitry, and a supervisor
computer with a video monitor, keyboard, and mouse. The Autoscope Solo system,
introduced in 1998, is a one-camera version of the Autoscope 2004. The Autoscope
Solo Pro, introduced in 2000, upgraded the Autoscope Solo by including a zoom
lens and producing a color video image. The new AIS is our stand-alone camera
that takes advantage of the zoom lens and color video image. It can be used with
our Autoscope 2004 and integrated with competitor products. A Microsoft
Windows(R)-based graphical user interface enables standard video cameras to work
with our Autoscope products.
In addition to the Autoscope family of products, in the past we also
have marketed and sold a suite of products that provide wireless transmission of
video and digital data, as well as the Mobile Blocker(TM) cellular telephone and
pager jamming device. We have decided to exit this business generally because we
have not seen satisfactory returns; in addition, the effort has been dilutitive
from our core Autoscope business. Consequently, we intend to discontinue the
Mobile Blocker and non-traffic related wireless business in 2002 and focus on
our core business of developing and marketing video imaging technology
applications to address traffic and other transportation problems. We do
however, intend to continue to market a wireless transmission system for video
and data that is applicable to the transportation industry and is a value-added
product to our core Autoscope business.
Image Sensing Systems was incorporated in Minnesota in 1984.
The Autoscope System
Automated vehicle detection for traffic management traditionally has
been performed with inductive wire loops buried in the pavement. However,
embedded loop detectors are difficult to install and maintain, are destructive
to road surfaces, and are not capable of wide-area vehicle detection without the
use of many loops. The Autoscope system is easier to install and maintain than
embedded loop detectors, is non-destructive to road surfaces, and is capable of
wide-area vehicle detection with a single camera, thus enabling one camera to do
the work of many loops. We believe that the Autoscope system's range of
applications and its ability to support new applications for advanced technology
solutions to traffic management problems make it superior to loop detectors and
most other commercially available vehicle detection systems.
The Autoscope system permits users to draw detection zones on a video
screen displaying the traffic scene and to derive traffic data from the portion
of the image specified by the detection zones displayed on the screen. The
system analyzes virtual detection zones that appear only on the video screen,
not on the roadway. Each detection zone represents an area in the field of view
of the camera that the system user wishes to analyze for determining the
presence of vehicles or extracting other pertinent traffic data. More than 100
detection zones can be
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programmed into multi-camera systems. The system user determines the detection
zones by drawing them on a video monitor with a mouse. Different types of
detection zones can be selected and may be placed anywhere in any orientation
within the field of view of the cameras using the system's unique interactive
graphics. The detection zones can be changed easily by using the mouse to
resize, reshape, or relocate the detection zones on the video monitor.
Once a detection configuration has been created, the supervisor
computer system can display the detection zones on its own video monitor,
together with the live video image, to monitor the system in operation. When a
vehicle is under the detection zone, the detection zone changes in color or
intensity, thereby providing visual verification of correct system operation.
Measured traffic data may be displayed on the video monitor of the supervisor
computer in numeric format. The traffic data may be transmitted to another host
computer via modem and dial-up telephone lines, private cable, fiber optic
network, direct cable connection, or various other wireless communications
equipment. Vehicle detection output also can be routed to intersection signal
controllers. A detection signal is generated each time a vehicle crosses one of
the virtual detection zones, thus enabling the system to accumulate measured
traffic data in user-selected categories, such as volume, average speed, time
occupancy (percent of time the detection zone is occupied), headways (time
interval between vehicles), flow rate (vehicles per hour per lane), and vehicle
length. Information from the system can be processed in real time or stored for
later analysis.
The Autoscope supervisor computer and video monitor may be disconnected
once the detection zone configuration has been transferred to the
microprocessor. The system can then operate independently, providing detection
zone outputs and storing traffic data in the microprocessor's internal memory.
The same portable supervisor computer and video monitor may be used with
multiple Autoscope systems. New detection zone configurations can be saved to
diskette, and previously saved detection zone configurations can be retrieved
from diskette for downloading into each system. The same Autoscope
microprocessor can be used with multiple cameras, each with its own detection
zone configuration.
In 1998 we obtained Conformite Europeenne (CE) Mark approval for our
Autoscope technology. The CE Mark is a worldwide standard for safety and quality
assurance.
Product Applications and New Product Development
The Autoscope system currently is used primarily for intersections,
freeways, tunnels, and traffic count stations. We also are continuously
exploring new uses for the Autoscope system.
Intersection Applications. Installed at an intersection, the Autoscope
system can be programmed to provide signal controllers with data including
vehicle presence, traffic volume, time occupancy (percent of time the detection
zone is occupied), vehicle speed, turning movements, queue lengths, stopped
vehicles, vehicle direction, and vehicle length. This information can help
signal controllers to control the flow of traffic at the intersection or provide
alarms at centralized traffic control centers. For example, the Autoscope system
can determine that a queue has developed at a stoplight and route that
information to the intersection controller so that the signal times can be
adjusted appropriately or a left turn signal phase can be engaged if a line
develops at the left turn lane. In addition, the Autoscope system can be
programmed so that selected detection zones detect cars moving in only one
direction. This capability can be used to prevent undesired detections, such as
a left-turning vehicle that has turned too sharply and is momentarily driving in
the wrong lane. This capability also can be used to detect cars going the wrong
way on a one-way street or the wrong way on a freeway exit ramp. The majority of
all commercially installed Autoscope systems currently are being used for
intersection control applications.
Freeway and Tunnel Applications. Typical freeway traffic and tunnel
information provided by the Autoscope system includes traffic volumes, time
occupancy, vehicle speeds, and vehicle counts of five different vehicle classes
based on length. The system also can be programmed to signal an alarm if it
detects stopped vehicles or the sudden onset of congestion in a detection zone
indicating a traffic incident on the freeway or in the tunnel. By placing a
video camera next to a freeway on-ramp, the Autoscope system detects traffic
movement on the on-ramp or in the merging area onto the freeway. The resulting
data can be used to prevent a queue from developing on a side street, to control
on-ramp traffic signals, or to determine the capacity of a merge area for
planning and control purposes.
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Traffic Information Gathering and Analysis. Traffic planners use
traffic data collected by the Autoscope system at intersections and on freeways
and other roadways to design roadway changes, define signal timing plans,
approve commercial development plans, and define the environmental impact of
traffic congestion. The Autoscope system has been deployed in temporary or
semi-permanent configurations as a portable detection system during road
repairs, construction, or resurfacing and for special studies, such as traffic
data collection by a planning department, a traffic consultant, or a university.
The Autoscope system captures vast amounts of traffic data in its own memory or
on a hard disk of the supervisor computer for later off-line graphing and
analysis. Further flexibility is gained with the ability to videotape a section
of roadway with a portable video camera and measure the traffic data off-line
with the Autoscope microprocessor.
Applications Under Development. In May 2001 we entered into an
agreement with Detector Electronics Corporation (also known as Det-Tronics), an
international supplier of fire and gas detection products, to develop an
integrated vehicular traffic and fire detection system to add to our Autoscope
product line. With Det-Tronics we currently are testing and reviewing
performance issues related to the fire detection aspects of the system. Once we
are satisfied with product performance we intend to seek regulatory approvals so
that we can commence domestic and international sales of the product.
Ongoing Research and Development. We engage in ongoing research and
development to reduce manufacturing costs, develop less expensive system
configurations, and improve product quality. We also engage in research and
development to broaden current applications for the Autoscope system and to
develop new products and product enhancements. The amount of our research and
development cost varies depending on the allocation of engineering resources to
outside projects and product support. As of March 1, 2002, 10 individuals, six
of whom hold advanced degrees, are involved in research and development. We
incurred $961,000 in research and development costs in 2001, and $615,000
research and development costs in 2000. In 2000 all of our research and
development costs were related to software development costs for the development
of the Autoscope Solo, Solo Pro and Comserver products, and were capitalized. We
did not capitalize any software development costs in 2001. We expect our
research and development costs in 2002 to be comparable to our research and
development costs in 2001. In 2002 we will be working primarily on new
applications and enhanced support for our existing products, including
developing a replacement product for our four camera Autoscope 2004 system and
releasing the new Solo Pro NC system that offers video processing remote from
the camera sensor.
Customers
Our customers primarily consist of federal, state, city, and county
departments of transportation; road commissions; and port, turnpike, tunnel, and
other transportation authorities. We market and sell our products to customers
both inside and outside the United States. The decision-makers within these
government entities typically are traffic planners and government engineers, who
in turn often rely on consulting firms that perform planning and feasibility
studies for the government entities. Our products sometimes also are sold
directly to system integrators or other suppliers of systems and services who
are operating under subcontracts in connection with major road construction
contracts.
Manufacturing, Marketing, and Distribution
Our products are manufactured in the United States pursuant to
long-term production agreements with three companies: Econolite Control
Products, Inc., the Electronic Division of Cohu, Inc., and Wireless Technology,
Inc. The production agreements are described in more detail below. We have
granted Econolite an exclusive right to market the Autoscope system in North
America and the Caribbean. We market our products outside of North America
through our wholly owned Asian subsidiary, Flow Traffic Ltd., and through
agreements with 31 distributors covering countries in Europe, the Middle East,
and South America. Under the distributor agreements, each distributor agrees to
use its best efforts to market and sell the Autoscope system and to purchase one
Autoscope demonstration system for use in its marketing efforts. Our Vice
President for International Business is responsible for the operations of Flow
Traffic Ltd. and for the business development activities of expanding the
distribution network in Europe and Latin America. To date, we have installed
Autoscope systems in more than 40 countries around the world, including a large
number of U.S. sites. We intend to continue to increase our marketing efforts in
foreign countries.
5
Econolite Control Products, Inc. Econolite manufactures and markets the
Autoscope system in North America and the Caribbean pursuant to a manufacturing,
distribution, and technology license agreement. Pursuant to that agreement, we
have appointed Econolite as our licensee to make, have made, use, license,
distribute and sell the Autoscope system and related technology in North America
and the Caribbean. Econolite has agreed to use its best efforts to promote the
sale of the Autoscope system in this territory and not to distribute products
that compete with the Autoscope system. Econolite pays us a royalty on revenue
derived by Econolite from sales of the Autoscope system. Econolite has more than
65 years of experience in the traditional traffic intersection control industry
and is certified as to ISO 9002 standards in its manufacture of machine vision
products for the transportation management industry.
We may terminate our agreement with Econolite if a minimum annual sales
level is not met. The initial term of the agreement was 15 years, ending in
2007, automatically renewable thereafter for additional one-year periods unless
terminated by either party on 60 days' notice prior to the end of the initial
term or any extension term. At a board meeting on October 4, 2001, our board
approved a five-year extension of our agreement with Econolite, extending its
term to 2012.
Econolite's license encompasses any knowledge, information, know-how,
software, or devices relating to vehicle detection, whether patentable or not,
that is or are licensed to us pursuant to our license agreement with the
University of Minnesota (described under "Patents and Proprietary Rights" below)
and any knowledge, information, know-how, software, or devices relating to
vehicle detection owned or licensable by us. Econolite has a right of first
refusal for extension of its license to include rights related to distribution
of the Autoscope system in countries outside North America and the Caribbean.
Econolite also currently manufactures, on a non-exclusive basis, the Autoscope
systems sold outside its distribution territory.
We support Econolite's marketing efforts in North America and the
Caribbean through an integrated marketing communications program with Econolite.
This program attempts to increase market awareness of our technology and our
products by direct mailings of Autoscope brochures, manuals and videos to
potential customers, also by joint planning and sharing of advertising and
exhibition budgets.
Econolite provides a two-year warranty on the current Autoscope system
and must provide all service required under this warranty.
Cohu, Inc. In July 1997 we entered into a production agreement with
Econolite and the Electronic Division of Cohu, Inc. Under this agreement, Cohu
manufactures and sells exclusively to us and Econolite as many units of the
Autoscope Solo product as each of us may order from time to time, and each of us
has agreed to purchase from Cohu all of our respective requirements for the
Autoscope Solo product for sale to end users in our respective distribution
territories until such time as Econolite and/or we have purchased 5,000 units in
the aggregate. Econolite has agreed to continue thereafter to purchase all of
its requirements for the Autoscope Solo product from Cohu, subject to
Econolite's option to manufacture the Solo product and our right of termination.
The agreement with Cohu does not require either us or Econolite to purchase a
minimum number of units from Cohu on an annual basis. Under the agreement, we
and Econolite granted Cohu a non-exclusive, non-transferable, non-assignable,
royalty-free right and license to use such of our respective intellectual
property as may be necessary to make, design, develop, assemble, manufacture,
and repair the Autoscope Solo product solely for sale to us and Econolite. Cohu
acquired no right, title, or interest in or to our intellectual property other
than the foregoing limited license, nor does Cohu have the right or authority to
sublicense all or any portion of either of our intellectual property.
We may terminate the agreement with Cohu, with or without cause, upon
60 days' prior written notice. Cohu may terminate the agreement, with or without
cause, upon 12 months' prior written notice. If we terminate the agreement with
cause, Cohu must deliver to us all tooling specific to production of the
Autoscope Solo product, and Cohu is not entitled to any further payment after
termination. If we terminate the agreement without cause, we must purchase from
Cohu all of its inventory, including raw materials, unique parts, work in
process, and finished goods, for a purchase price equal to Cohu's cost, up to a
maximum purchase price of $90,000.
Cohu provides a two-year warranty to Econolite and us for the Autoscope
Solo product it manufactures.
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Wireless Technology, Inc. In 2000, we entered into a verbal production
agreement with Econolite and Wireless Technology, Inc. (or "WTI"), which was
formalized and signed by all parties in February 2002. Under the agreement, WTI
manufactures and sells exclusively to us and Econolite as many units of the Solo
Pro and Autoscope Image Sensor (or "AIS") camera products as each of us may
order from time to time, and each of us has agreed to purchase from WTI all of
our respective requirements for the Solo Pro and AIS camera products for sale to
end users in our respective distribution territories. The agreement does not
require either us or Econolite to purchase a minimum number of units from WTI.
Under the agreement, we and Econolite granted WTI a non-exclusive,
non-transferable, non-assignable, royalty-free right and license to use such of
our respective intellectual property as may be necessary to make, design,
develop, assemble, manufacture, and repair the Solo Pro and AIS camera products
solely for sale to us and Econolite. WTI acquired no right, title, or interest
in or to our intellectual property or the Econolite intellectual property other
than the foregoing limited license, nor does WTI have the right or authority to
sublicense all or any portion of our intellectual property.
We may terminate the agreement with WTI, with or without cause, upon
six months' prior written notice. WTI may terminate the agreement, with or
without cause, upon 12 months' prior written notice. WTI is not entitled to any
further payment after termination. If we terminate the agreement with cause, WTI
must deliver to us all tooling specific to production of the Solo Pro and AIS
camera products. If we terminate the WTI Agreement without cause, we must
purchase all of WTI's inventory, including raw materials, unique parts, work in
process, and finished goods, for a purchase price equal to WTI's cost plus 10%,
up to a maximum purchase price of $100,000.
WTI provides a two-year warranty to Econolite and us on the Solo Pro
and AIS camera products it manufactures.
Product Liability Insurance
Econolite currently maintains $15,000,000 of product liability
insurance, and we maintain $2,000,000 of product liability insurance. In
addition, Econolite has agreed to indemnify us and hold us harmless from and
against any losses, damages, or expenses arising out of the products made or
sold by Econolite pursuant to our manufacturing, distribution, and technology
license agreement with Econolite.
Suppliers
Some of the component hardware incorporated in the Autoscope products
are standard computer hardware products that are available from multiple
sources. Other parts, such as the Autoscope microprocessor and digitizer, are
manufactured to our specifications by third-party vendors for integration into
our products. To date, our current vendors of these components have met our
quality and performance expectations. However, we believe alternative component
vendors are available should the necessity arise. Nevertheless, shortages of
parts or the need to change vendors could hinder Econolite's, Cohu's, and WTI's
ability to manufacture our products, which could, in turn, decrease our revenues
and harm our business.
Backlog
Our backlog of unfulfilled firm orders from distributors was not
material as of December 31, 2001 and was approximately $2,430,000 December 31,
2000. The 2000 backlog was attributable solely to an unfulfilled order for the
Mobile Blocker product which was never confirmed. In 2002, we decided to exit
certain markets for wireless products, including Mobile Blocker. Terms of
agreements between distributors of our products and government contractors and
other customers generally provide for cancellation or rescheduling of delivery
in the case of backlogs. A backlog in our orders as of a particular date may not
be a relevant factor in predicting our future revenue.
Intellectual Property
The technology underlying the Autoscope system was initially developed
by Dr. Panos Michalopoulos, one of our directors and a professor at the
University of Minnesota, and was further developed at the University of
Minnesota from 1985 to 1991 with involvement by Dr. Michalopoulos. Between 1985
and 1989, additional system
7
developments were funded partially by the Minnesota Department of Transportation
and the Federal Highway Administration. Dr. Michalopoulos has assigned all of
his rights in the technology underlying the Autoscope system to us or to the
University of Minnesota. The U.S. patent for aspects of the technology
underlying the Autoscope system was issued in 1989 to the University of
Minnesota. The University of Minnesota has filed to perfect related patents in
France, Germany, the United Kingdom, and Japan.
We entered into a license agreement with the University of Minnesota in
1991. Under the agreement, we have been granted an exclusive, worldwide license,
with a right to grant sublicenses, to make, have made, use, sell, and lease any
product that incorporates knowledge, information, know-how, software, and
devices, whether patentable or not, in the possession of the University of
Minnesota and related to a video vehicle detection system developed by the
University of Minnesota, solely or jointly with us, including certain
improvements made to this technology. In exchange for our license, we pay to the
University of Minnesota:
- a royalty of 3% of the net sales of licensed products (as defined
below);
- 50% of all site license revenue; and
- 10% of all of our sublicensing revenue.
For these purposes, the licensed products include any manufactured product that
incorporates the technology or improvements covered by the license agreement.
Site license revenue equals all revenue collected by us and specifically
allocable to us for granting a license to use the licensed products at a
specific location or by a specific user. Sublicensing revenue equals all revenue
collected by us from parties to whom we grant sublicense rights to make or sell
the licensed products. The University of Minnesota has retained a non-exclusive
and non-transferable right to use the licensed technology for educational and
research purposes. The license agreement terminates at the termination of the
patent covering the technology. The University of Minnesota may terminate the
License Agreement if the royalties are not paid, if there is a material breach
of the agreement by us, or if we fail to use our best efforts to effect
commercial sales of the licensed products. We have agreed to indemnify the
University of Minnesota against all liabilities or losses arising from (1) the
manufacture, use, lease, or sale of a licensed product by us or a sublicensee of
us, (2) a third party's use of a licensed product purchased from us or a
sublicensee of us, and (3) a third party's manufacture of a licensed product at
our request.
We have sublicensed some of our rights in the Autoscope technology to
Econolite pursuant to the Econolite Agreement. See "Marketing and Manufacturing"
above.
Our technology is dependent upon the knowledge, experience, and skills
of our key scientific and technical personnel. To protect our rights to our
proprietary know-how and technology, we require all employees and consultants to
execute confidentiality agreements that prohibit the disclosure of confidential
information to any third parties. These agreements also require disclosure and
assignment to us of any discoveries and inventions made by employees and
consultants while they are devoted to our business activities.
We intend to actively protect our intellectual property assets and will
actively seek, when appropriate, protection for owned or licensed products and
proprietary information by means of United States and foreign patents,
trademarks, and contractual arrangements. In addition, we rely upon trade
secrets and contractual arrangements to protect some of our proprietary
information. We have federally registered trademark rights to "Autoscope" and
"Autoscope Solo."
Competition
Competition in the area of advanced traffic management and surveillance
is growing, due in part to increased federal funding of advanced technologies
under the U.S. government's national Intelligent Transportation Systems
initiative, which was formally endorsed by the U.S. Congress in 1991 and was
strengthened in 1998 when Congress earmarked more than $10 billion of its
transportation funding bill for mitigation of congestion, highway safety,
transit, and other surface transportation projects for spending over the
subsequent five years.
8
We are aware of several companies that are developing traffic
management devices using machine vision technology or other advanced technology.
Among the companies that are expected to provide direct competition to the
Autoscope system are Traficon N.V., the Peek business unit of First Atlantic,
Nestor, Inc., and Odetics, Inc. To our knowledge, Traficon, Odetics, and Peek
have working installations of their machine vision systems in the United States
and other parts of the world. However, these companies do not have as many
installations as we have. To our knowledge, machine vision systems are also
under development by Nestor. We are aware that these and other companies will
continue to develop technologies for use in traffic management and surveillance.
One or more of these technologies could in the future provide increased
competition for the Autoscope system. Nevertheless, we believe that our products
have undergone more extensive field-testing and are at a more advanced stage of
development than any of our competitors' products.
Other potential competitors include companies that have substantially
more financial, technological, marketing, personnel, and research and
development resources than we have. Our products will compete not only with
conventional methods of vehicle detection and traffic control, such as embedded
loop detectors, but also with new technologies that may be applied to urban
traffic congestion problems. Various technologies have been used as traffic
sensing devices in the past and will continue to be developed for application to
traffic management. These technologies include embedded loop detectors, pressure
plates, pneumatic tubes, radars, lasers, magnetometers, acoustics, and
microwaves. We estimate that more than 95% of the detector systems currently in
use in the United States are embedded loop detectors. Embedded loop detectors
are relatively easy to manufacture, are currently manufactured by numerous
companies throughout the world, and require lower initial capital commitment
than the Autoscope system.
Employees
As of March 1, 2002, we had 29 full-time employees, 11 of whom are
employed by Flow Traffic Ltd. Of our U.S. employees, 10 are involved in research
and development, two provide product and customer support, one is engaged in
sales and marketing, and five are involved in management, administration,
finance, and human resources. None of our employees is represented by a union.
We believe our employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
Image Sensing Systems currently leases approximately 10,000 square feet
of office space in St. Paul, Minnesota, pursuant to an operating lease that
expires in November 2002, with options to renew through November 2004. The lease
provides for monthly payments of $13,230 and we are responsible for our
proportionate share of increases in operating expenses that exceed a base rent
factor. Rent expense amounted to $153,400 in 2001 and $145,000 in 2000. At
December 31, 2001, future minimum annual lease payments are $134,000.
We believe that our current space exceeds our future needs and intend
to negotiate a new lease during 2002 for approximately 7,000 square feet of
office space, in the same building at approximately the same lease cost per
square foot.
Flow Traffic Ltd. leases office space in Hong Kong, China and Thailand.
Aggregate lease payments under theses leases are $84,000 in 2002 and $25,600 in
total non-cancelable lease payments in 2003 through 2006. We believe these
facilities will be sufficient for Flow Traffic's current and foreseeable future
needs.
We do not otherwise invest in real estate in any manner.
ITEM 3. LEGAL PROCEEDINGS
During 2001, we were not involved in any legal proceedings, and we
currently are not subject to any legal proceedings.
9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the fourth quarter of the calendar year covered by this report.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Market Information
Our common stock is traded on the Nasdaq Small Cap Market under the
symbol "ISNS." The quarterly high and low sales prices for our common stock for
our last two fiscal years are set forth below.
FY 2001 FY 2000
--------------------------- -------------------------
QUARTER HIGH LOW HIGH LOW
-------------- --------------------------- -------------------------
First $4.19 $2.88 $9.44 $3.63
Second 4.60 1.99 11.50 5.75
Third 2.82 1.47 5.97 4.25
Fourth 3.25 1.76 5.98 3.63
Shareholders
As of March 12, 2002, there were 27 holders of record of our common
stock and approximately 650 beneficial holders of our common stock.
Dividends
We have never declared or paid a cash dividend on our common stock. We
currently intend to retain earnings for use in the operation and expansion of
our business, and, consequently, we do not anticipate paying any dividends in
the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Our critical accounting policies, including the assumptions and
judgments underlying them, are disclosed in Note 1 to the Consolidated Financial
Statements. These policies have been consistently applied in all material
respects and address such matters as revenue recognition, depreciation methods,
asset impairment recognition, deferred tax valuation allowance, business
combination and accounting. While the estimates and judgments associated with
the application of these policies may be affected by different assumptions or
conditions, we believe the estimates and judgments associated with the reported
amounts are appropriate in the circumstances.
The following table sets forth, for the periods indicated, certain
statements of operational data as a percent of revenue:
Year Ended December 31
2001 2000
---- ----
Product sales 36.1 % 53.2 %
Royalties 60.0 44.5
Consulting services 3.9 2.3
----------------------------
Total revenue 100.0 100.0
Cost of revenue 31.1 38.5
----------------------------
Gross profit 68.9 61.5
Selling, marketing and product support 33.4 26.7
General and administrative 30.0 38.2
Research and development 14.4 0.0
----------------------------
Loss from operations (8.9) (3.4)
Net loss (6.8) (.8)
Product sales for 2001 decreased to $2,410,000 compared to $3,210,000
in 2000. The decrease was due primarily to lower sales in Asia ($1,866,000 in
2001 compared to $2,643,000 in 2000). The difference is attributable to large
orders from Korea and Hong Kong in 2000 with a value of approximately
$1,300,000. Royalty income increased to $4,010,000 in 2001, compared to
$2,684,000 in 2000. The increase in royalty income in 2001
10
resulted primarily from the introduction of the AutoScope Solo Pro(TM), which is
more cost effective than the prior version of the Solo product. Revenue from
consulting services increased to $262,000 in 2001 from $142,000 in 2000. The
majority of consulting income came from our contract with Oakland County in
Michigan.
Gross profits were $4,601,000, or 68.9% of revenue, in 2001, compared
to $3,711,000, or 61.5% of revenue, in 2000. The gross profit was 74.4% before
the write-off of Mobile Blocker inventory and write down of old style Solo
inventory. This inventory adjustment total was $368,000. The increase in our
gross profit margin percentage was due primarily to greater royalty revenue from
Econolite as a percent of total revenues. We expect the revenue mix to be
comparable to 2001 levels in 2002.
Selling, marketing, and product support expenses were $2,229,000, or
33.4% of revenue, in 2001, compared to $1,609,000, or 26.7% of revenue, in 2000.
The increase resulted primarily from increased spending for sales and marketing
personnel and other business development costs related to our international
business, and the development of the business infrastructure for the sales and
marketing of our suite of wireless products, including the Mobile Blocker
product. We expect selling, marketing and product expenses to decrease in 2002
based on the fact that we are returning primary focus to our core business.
General and administrative expenses were $2,006,000, or 30.0% of
revenue, in 2001, compared to $2,305,000, or 38.2% of revenue, in 2000. The
decrease was due primarily to cost cutting in 2001, eliminating two part-time
positions, cutting back in travel, dues, and quarterly shareholder mailings
along with the absence in 2001 of the incremental expense we incurred in 2000
related to our stock dividend and fees related to the issuance of additional
shares in connection with the dividend.
The research and development expenses and capitalized software
development costs totaled $961,000 in 2001 compared to $615,000 in 2000. The
increase resulted primarily from the fact that we focused on the development of
enhancements to existing products in 2001, and additionally on the development
work on Flame Detection. We also added two engineers in January 2001, which
increased our research and development cost. In early 2002 we laid off five
engineers and believe our development expense for 2002 will be closer to the
levels in 2000.
Net loss was $455,000 (Image Sensing Systems loss of $416,000 and loss
from Flow Traffic of $39,000), or 6.8% of revenue, in 2001, compared to a loss
of $50,000 (Image Sensing Systems loss of $242,000 and income from Flow Traffic
of $192,000), or 0.8% of revenue, in 2000. There was an $87,000 domestic tax
benefit in 2000 that mitigated 2000 losses. There was no tax provision in 2001.
The primary difference in the 2001 loss as compared to 2000 is the write off of
$370,000 of inventory, $325,000 of which is attributable to the Mobile Blocker
product. We took the write off in connection with our decision to cease our
efforts to enter the Mobile Blocker and non-traffic related wireless business.
Liquidity and Capital Resources
At December 31, 2001, we had $1,200,000 in cash and cash equivalents,
compared to $1,780,000 at December 31, 2000. We had working capital of
$2,175,000, and a ratio of current assets to current liabilities of 2.9 to 1 at
December 31, 2001, compared to $2,395,000 and 3.6 to 1, respectively, at the end
of 2000. We believe that our decision to exit unprofitable business, related
staff reductions and reduced business development expenses will have a positive
impact on our liquidity in 2002.
Net cash provided by operating activities was $374,000 in 2001,
compared to $563,000 in 2000. The decrease in 2001 was due primarily to an
increase in accounts receivable, which was attributable to the increased royalty
income from Econolite. We anticipate 2002 accounts receivable to be similar to
2001 levels, and cash from operating activity to increase, for the same reasons
we expect liquidity to increase in 2002, as described above.
11
In 2001 we received cash of approximately $28,000 in connection with
the exercise of stock options and warrants.
We believe that cash and cash equivalents on hand at December 31, 2001,
along with an available $500,000 revolving line of credit with a bank and
savings from recent restructuring, will satisfy our projected working capital
needs, investing activities, and other cash requirements through 2002. Current
availability on our line of credit is $50,000 with the balance used to secure
the letter of credit issued to our Flow Traffic minority shareholders (see
Recent Developments).
Recent Developments
On January 7, 2002 we purchased all of the shares then held by the
minority shareholders of our subsidiary Flow Traffic Ltd., making Flow Traffic
our wholly owned subsidiary. The purchase was made in accordance with the Shares
Sale and Purchase Agreement dated November 28, 2001, as amended on December 31,
2001, among Image Sensing Systems and the minority shareholders of Flow Traffic.
The minority shareholders then included Johan Billow and Grove Place Limited (a
consulting company), affiliated with Anthony H. Gould. Subsequently, in February
2002, Anthony Gould and Johan Billow were elected to our Board of Directors,
Anthony Gould was appointed as our President and Chief Executive Officer and
Johan Billow was appointed as our Vice President for International Business. The
agreement is filed as an exhibit to this Form 10-KSB. Prior to this purchase, we
owned six shares of Flow Traffic, and the minority shareholders collectively
owned four shares of Flow Traffic.
We agreed to pay the following amounts to the minority shareholders as
consideration for their shares:
- Cash payments at the time of purchase totaling $250,000.
- Additional payments totaling $450,000, payable at any time between
April 1, 2003 and April 30, 2003 upon the request of the minority
shareholders, which payments are secured by letters of credit drawn
in favor of the minority shareholders and expiring on April 30,
2003.
- Non-interest bearing notes, maturing on January 7, 2007, in the
aggregate principal amount of $250,000, and convertible into an
aggregate of 100,000 shares of our common stock. The holders may
demand payment for their notes at any time after April 1, 2003. The
notes may be prepaid by us at any time during calendar year 2002
for their aggregate principal amount of $250,000 and without
penalty or additional fees, or may be prepaid by us at any time
after April 1, 2003, for the aggregate principal amount of $250,000
plus additional payments totaling $50,000. If not converted or paid
by January 7, 2007, each note will be redeemed by us on that date
for its principal amount. Each note also provides that if the note
is converted into shares of our common stock, we will register such
shares with the Securities and Exchange Commission, if so requested
by the holder.
In addition to the foregoing consideration, if Flow Traffic achieves an
audited net profit before tax of HK$1,418,000 (approximately US$181,795) or
greater for fiscal year 2002, we will make an additional cash payment totaling
$100,000 to the minority shareholders, payable within 10 days after completion
of Flow Traffic's annual audit.
In the first quarter of 2002 we laid off seven full-time employees. Of
the seven employees, five were in engineering and two were in sales and
marketing. Additionally in the first quarter of 2002, William L. Russell, our
Chairman, President and Chief Executive Officer, left Image Sensing Systems to
pursue other interests. Mr. Russell was replaced as President and Chief
Executive Officer by Anthony H. Gould, then serving as Managing Director of our
subsidiary Flow Traffic Ltd. We will incur $277,000 in severance expense in the
first quarter of 2002.
12
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET
December 31
----------------------------------------
ASSETS 2001 2000
----------------------------------------
Current assets:
Cash and cash equivalents $1,200,000 $1,780,000
Accounts receivable, net of allowance for returns and doubtful accounts of
$41,000 in 2001 & $43,000 in 2000 1,589,000 943,000
Inventories 341,000 370,000
Prepaid expenses 88,000 117,000
Deferred income taxes 92,000 92,000
----------------------------------------
Total current assets 3,310,000 3,302,000
Property and equipment:
Furniture and fixtures 181,000 210,000
Leasehold improvements 107,000 104,000
Equipment 1,444,000 1,234,000
----------------------------------------
1,732,000 1,548,000
Accumulated depreciation (1,381,000) (1,165,000)
----------------------------------------
351,000 383,000
Deferred income taxes 34,000 34,000
Goodwill, net of accumulated amortization of $13,000 in 2001 & $9,000 in
2000 77,000 81,000
Other Assets 37,000 29,000
Capitalized software development costs, net of accumulated amortization of
$607,000 in 2001 ($349,000 in 2000) 1,195,000 1,453,000
----------------------------------------
TOTAL ASSETS $5,004,000 $5,282,000
========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $720,000 $433,000
Accrued compensation 374,000 365,000
Deferred revenue 40,000 109,000
----------------------------------------
Total current liabilities 1,134,000 907,000
Minority Interest 56,000 134,000
Shareholders' equity:
Preferred stock, $.01 par value:
Authorized shares - 2,000,000
Issued and outstanding - none
Common stock, $.01 par value:
Authorized shares - 5,000,000
Issued and outstanding - 3,153,000 in 2001 & 3,143,000 in 2000 32,000 32,000
Additional paid-in capital 4,600,000 4,572,000
Retained earnings (deficit) (818,000) (363,000)
----------------------------------------
Total shareholders' equity 3,814,000 4,241,000
----------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,004,000 $ 5,282,000
========================================
13
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
Year ended December 31
2001 2000
---------------------------------------
Revenue:
Product sales $2,410,000 $3,210,000
Royalties 4,010,000 2,684,000
Consulting services 262,000 142,000
---------------------------------------
6,682,000 6,036,000
Cost of revenue:
Product sales (see Note 2) 1,613,000 1,936,000
Royalties 285,000 271,000
Consulting services 183,000 118,000
---------------------------------------
2,081,000 2,325,000
---------------------------------------
Gross profit 4,601,000 3,711,000
Operating expenses:
Selling, marketing and product support 2,230,000 1,609,000
General and administrative 2,006,000 2,305,000
Research and development 961,000 --
---------------------------------------
5,197,000 3,914,000
---------------------------------------
Loss from operations (596,000) (203,000)
Interest income 115,000 120,000
---------------------------------------
Loss before income taxes (481,000) (83,000)
Income taxes (benefit) 2,000 (87,000)
---------------------------------------
Income/(loss) before minority interest (483,000) 4,000
Minority interest 28,000 (54,000)
---------------------------------------
Net loss $(455,000) $(50,000)
=======================================
Net loss per common share--basic and diluted $(0.14) $(0.02)
=======================================
Weighted average number of common shares outstanding 3,147,567 3,142,837
=======================================
See accompanying notes.
14
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CASH FLOW
Year ended December 31
2001 2000
--------------------------------------
Operating activities:
Net loss $(455,000) $(50,000)
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation 216,000 238,000
Amortization 262,000 181,000
Minority interest in subsidiary's earnings (28,000) 54,000
Changes in operating assets and liabilities:
Receivables (646,000) 485,000
Inventories 29,000 (286,000)
Deferred income taxes - (117,000)
Prepaid expenses 21,000 (89,000)
Accounts payable 287,000 4,000
Accrued compensation 9,000 87,000
Deferred revenue (69,000) 56,000
--------------------------------------
Net cash (used in) provided by operating activities (374,000) 563,000
Investing activities:
Flow Traffic Dividend (50,000) -
Purchases of property and equipment (184,000) (176,000)
Capitalized software development costs - (615,000)
--------------------------------------
Net cash used in investing activities (234,000) (791,000)
Financing activities:
Proceeds from sale of common stock 28,000 689,000
--------------------------------------
Net cash provided by financing activities 28,000 689,000
Increase (decrease) in cash (580,000) 461,000
Cash and cash equivalents at beginning of year 1,780,000 1,319,000
--------------------------------------
Cash and cash equivalents at end of year $ 1,200,000 $ 1,780,000
======================================
See accompanying notes.
15
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
ADDITIONAL RETAINED
SHARES COMMON PAID-IN EARNINGS
DESCRIPTION ISSUED STOCK CAPITAL (DEFICIT) TOTAL
----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1999 2,479,200 $ 25,000 $ 3,890,000 $ (313,000) $ 3,602,000
Common stock issued in 20% Dividend 503,000 5,000 (5,000) -- --
Common stock issued for options and
warrants exercised 161,200 2,000 687,000 -- 689,000
Net Loss -- -- -- (50,000) (50,000)
-----------------------------------------------------------------------------------------
Balance at December 31, 2000 3,143,400 $ 32,000 $ 4,572,000 $ (363,000) $ 4,241,000
Common stock issued for options
exercised 9,940 -- 28,000 -- 28,000
Net Loss -- -- -- (455,000) (455,000)
-----------------------------------------------------------------------------------------
Balance at December 31, 2001 3,153,340 $ 32,000 $ 4,600,000 $ (818,000) $ 3,814,000
=========================================================================================
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
DECEMBER 31, 2001
1. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Image Sensing Systems, Inc. ("ISS") develops and markets video image processing
technology and products for use in advanced traffic management systems and
traffic data collection. ISS sells its products primarily to foreign
distributors of its products and receives a royalty for sales made by a sub
licensee to North American distributors. ISS also provides technical expertise
in image processing, hardware and software design, and traffic management and
control. ISS's products are used primarily by governmental entities.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ISS and its
majority-owned subsidiary, Flow Traffic Ltd., located in Hong Kong. All
significant inter-company transactions and accounts have been eliminated in
consolidation.
REVENUE RECOGNITION
Revenue from product sales and royalties from the sale of products by a
sub-licensee are recorded upon shipment by the sub licensee. All direct and
distributor sales are recorded upon shipment. Consulting fees are recorded as
earned.
CASH AND CASH EQUIVALENTS
ISS considers all highly liquid investments with a maturity date of three months
or less when purchased to be cash equivalents. Investments classified as cash
equivalents consist of commercial paper. The market value of these investments
approximates cost at December 31, 2001 and 2000.
INVENTORIES
Inventories are primarily finished goods and are valued at the lower of cost or
market on the first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed by the
straight-line method over a three- to seven-year period for financial reporting
purposes and by accelerated methods for income tax purposes.
17
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred income taxes
reflect the effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and amounts used for
income tax purposes.
STOCK-BASED COMPENSATION
ISS follows Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB 25"), and related interpretations in accounting for
its stock options. Under APB 25, when the exercise price of stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized.
ISS has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). Accordingly, ISS has made pro forma disclosures of what net income
and net income per share would have been had the provisions of SFAS 123 been
applied to ISS's stock options.
ADVERTISING
Advertising and promotion costs are expensed as incurred and amounted to
approximately $224,000 and $117,000 in the fiscal years ended 2001 and 2000,
respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from the estimates.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS
ISS records losses on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations in the period incurred.
SOFTWARE DEVELOPMENT COSTS
ISS capitalizes software development costs in accordance with the provisions of
SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased,
or Otherwise Marketed. Capitalization of software development costs, including
significant product enhancements, begins upon the establishment of technological
feasibility for the product and concludes when the product is available for
release to distributors. The establishment of technological feasibility and the
ongoing assessment of the recoverability of these costs requires considerable
judgment by management with respect to certain external factors, including, but
not limited to, anticipated future gross product revenue or royalties, estimated
economic life, and changes in software and hardware technology. ISS amortizes
software development costs based on projected revenue, with minimum annual
amortization based on a seven-year life using the straight-line method.
EARNINGS PER COMMON SHARE
Basic earnings per share are computed using the weighted average number of
common shares outstanding during the period. Fully diluted and basic earnings
per share are the same because the effect of common equivalent shares from stock
options are not material and were antidilutive for 2001 and 2000.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill will no longer be amortized but
will be subject to annual impairment tests in accordance with the Statements.
Other intangible assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. During 2002, the
Company will perform the first of the required impairment tests of goodwill and
indefinite lived intangible assets and has not yet determined what the effect of
these tests will be on the earnings and financial position of the Company.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. INVENTORY
Cost of revenue for 2001 product sales included a write-off of $368,000
related to Mobile Blocker and our old-style Solo product.
3. CREDIT FACILITY
ISS has a credit agreement that provides up to $500,000 in short-term borrowings
at 1.25% over the prime rate (6.00% at December 31, 2001). The agreement limits
the amount of short-term borrowings to 65% of eligible receivables.
Substantially all assets are pledged as collateral on the borrowings. The credit
agreement further
18
includes covenants that relate to certain financial statement ratios and
restrictions. ISS had no outstanding borrowings in 2001 or 2000.
4. LEASE COMMITMENT
ISS rents office space under an operating lease agreement expiring in November
2002, with options to renew through November 2004. The lease provides for
monthly payments of $12,000 and ISS is responsible for its proportionate share
of increases in operating expenses that exceed a base rent factor. Rent expense
amounted to $153,400 in 2001 and $145,000 in 2000.
At December 31, 2001, future minimum annual lease payments are $134,000 for
2002.
5. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
ISS's deferred tax assets and liabilities are as follows:
December 31
2001 2000
-----------------------------------
Deferred tax assets:
Accounts receivable allowances $ 3,000 $ 15,000
Other reserves 16,000 -
Accrued compensation 23,000 32,000
Warranty reserve 5,000 5,000
Inventory reserve 126,000 -
Deferred revenue 15,000 40,000
Research and development tax credits 290,000 245,000
Net operating loss carry forward 548,000 549,000
Less valuation allowance (458,000) (216,000)
-----------------------------------
568,000 670,000
Deferred tax liabilities:
Tax depreciation in excess of book $ - $ 6,000
Capitalized SW development costs 442,000 538,000
-----------------------------------
442,000 544,000
-----------------------------------
Net deferred taxes $ 126,000 $ 126,000
===================================
ISS has net operating loss carry forwards for income tax purposes of $1,882,000
and research and development tax credits of $290,000 that expire in the years
2007 through 2020. Included in the NOL is approximately $170,000 of deductions
resulting from disqualifying dispositions of stock options. These deductions
currently have a full valuation allowance; and when realized for financial
statement purposes, they will not result in a reduction in income tax expense.
Rather, the benefit will be recorded as additional paid-in capital.
Cash paid for income taxes amounted to $1,900 in 2001 and $4,400 in 2000.
Deferred tax assets have been offset by a valuation allowance as deemed
necessary based on ISS estimates of its future sources of taxable income and the
expected timing of temporary difference reversals. Despite the reported
cumulative net loss for fiscal 2001, ISS believes recorded net deferred tax
assets are more likely than not to be recoverable, based upon its estimates of
future sources of taxable income and the expected timing of temporary difference
reversals.
19
There are no undistributed earnings of ISS foreign subsidiary at
December 31, 2001.
The components of income tax (benefit) expense as recorded by ISS for
December 31, 2001 and 2000 are as follows:
Year Ended December 31
2001 2000
----------------------------
Current:
Federal $ -- $ --
State 4,000 4,000
Foreign (2,000) 26,000
----------------------------
2,000 30,000
----------------------------
Deferred:
Federal -- (117,000)
State -- --
Foreign -- --
----------------------------
-- (117,000)
----------------------------
Total income tax expense $ 2,000 $ (87,000)
============================
A reconciliation of income taxes to the statutory federal rate is as follows:
December 31
2001 2000
---------------------------------------
Federal tax (benefit) statutory rate $ (163,000) $ (28,000)
State taxes net of federal benefit (19,000) (14,000)
Meals and entertainment 7,000 7,000
Research and development tax credits (45,000) --
Effect of lower rates for Flow Traffic Ltd. 22,000 (65,000)
Change in valuation allowance 242,000 24,000
Other (42,000) (11,000)
---------------------------------------
Income taxes (benefit) $ 2,000 $ (87,000)
=======================================
6. LICENSING
The United States patent for some aspects of the technology underlying ISS's
Autoscope system was issued in 1989 to the University of Minnesota. ISS has an
exclusive worldwide license from the University of Minnesota for that technology
and pays royalties to the University of Minnesota in exchange for such license.
Royalty expense under the agreement was $285,000 in 2001 and $271,000 in 2000.
ISS has sublicensed the right to manufacture and market the Autoscope technology
in North America and the Caribbean to Econolite Control Products, Inc., of
Anaheim, California and receives royalties from Econolite on sales of the
Autoscope system in those territories. Econolite also manufactures the Autoscope
system on a non-exclusive basis for direct sales by ISS outside of North America
and the Caribbean. ISS recognized royalty income from this agreement of
$4,010,000 in 2001 and $2,684,000 in 2000. Accounts receivable from Econolite
were $1,276,000 and $859,000 at December 31, 2001 and 2000, respectively.
20
7. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
ISS derived the following percentages of its net revenues from the
following geographic regions:
2001 2000
---- ----
Asia Pacific 28% 44%
Europe 5% 9%
North America 67% 47%
Shown below are the percentages of sales of specific customers, which exceed 10%
for the years shown.
2001 2000
---- ----
Econolite Control Products, Inc. 60% 44%
8. RETIREMENT PLAN
Substantially all employees of ISS may participate in a qualified defined
contribution 401(k) plan in which participants may elect to have a specified
portion of their salary contributed to the plan. ISS may make contributions to
the plan. No discretionary contributions were made by ISS in 2001 and 2000.
9. EMPLOYMENT AGREEMENTS
ISS has employment agreements with its chief executive officer and chief
financial officer. The agreements provide for a minimum salary and a stock
option grant and include non-compete and non-solicitation provisions. The
agreement with the chief financial officer additionally provides for severance
pay in the event of involuntary termination or termination resulting from a
sale, acquisition or merger of ISS. The maximum severance is the chief financial
officer's current salary for up to one year. During the first quarter of 2002,
ISS will incur approximately $277,000 in severance related expenses primarily as
a result of the replacement of its President and Chief Executive Officer.
10. STOCK OPTIONS
In February 1995, ISS adopted the 1995 Long-Term Incentive and Stock Option Plan
(the "1995 Plan"), which provides for the granting of incentive (ISO) and
non-incentive (NSO) stock options, stock appreciation rights, restricted stock
awards and performance awards to officers, directors, employees, consultants and
independent contractors of ISS and its subsidiaries. The following table
summarizes stock option activity for 2001 and 2000:
PLAN
OPTIONS NON-PLAN WEIGHTED AVERAGE
AVAILABLE PLAN OPTIONS OPTIONS EXERCISE PRICE
FOR GRANT OUTSTANDING OUTSTANDING PER SHARE
------------------------------------------------------------------------------
ISO NSO
------------------------------------------------------------------------------
Balance at December 31, 1999 50,450 327,350 18,000 244,200 $3.77
Stock Dividend - 20% 10,090 60,470 3,600 44,840 --
Granted (15,000) 15,000 -- 126,000 6.90
Exercised -- (27,200) (6,000) (20,000) 3.29
Canceled 53,100 (37,500) (15,600) -- 3.96
------------------------------------------------------------------------------
Balance at December 31, 2000 98,640 338,120 -- 395,040 3.68
Reserved for options under Plan 420,000 -- -- -- --
Granted (28,000) 28,000 -- -- 4.13
Exercised -- (9,940) -- -- 2.83
Canceled 62,160 (52,560) -- (9,600) 3.11
------------------------------------------------------------------------------
Balance at December 31, 2001 552,800 303,620 -- 385,440 $3.93
==============================================================================
21
The following table summarizes information about the stock options outstanding
at December 31, 2001.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------------------------------------------------------------
EXERCISABLE
-------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICE NUMBER OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------------------------------------------------------------------------------------------------------------
$ 2.40 - 3.80 300,740 6.4 years $ 2.53 236,600 $ 2.53
3.01 - 4.00 219,320 4.7 years 3.41 239,960 3.41
Over 4.00 163,000 8.5 years 6.44 49,000 5.38
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$ 2.40 - 7.50 689,060 6.3 years $ 3.93 525,560 $ 3.20
-------------------------------------------------------------------------------------------------------------------
Options under the 1995 Plan and Non-Plan options expire at various dates through
2010. At December 31, 2001 there were 689,060 options exercisable at a weighted
average exercise price of $3.93. Options outstanding have a weighted average
remaining contractual life of 6.3 years. The weighted average fair value of
options granted during 2001 and 2000 was $1.63 and $3.84, respectively.
Pro forma information regarding net loss and net loss per share is required by
SFAS 123 and has been determined as if ISS had accounted for its employee stock
options under the fair value method of SFAS 123. The fair value for these
options was estimated at the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions: a risk-free
interest rate of 4.82% for 2001 and 6.05% for 2000, a volatility factor of the
expected market price of ISS's common stock of .742 for 2001 and .518 for 2000,
and a weighted average expected life of the option of ten years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because ISS's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions may materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. ISS's pro forma
information is as follows:
2001 2000
-------------------------------------
Pro forma net loss $ (689,000) $(302,000)
Pro forma net loss per common share, basic and diluted $ (.22) $ (.10)
11. SUBSEQUENT EVENT
On January 7, 2002, ISS acquired the remaining 40% of Flow Traffic Ltd. The
acquisition included a $250,000 cash payment, additional future cash payments
totaling $450,000, secured by letters of credit, and notes payable totaling
$250,000. The additional payments of $450,000 are payable at any time between
April 1, 2003 and April 30, 2003, and the letters of credit expire on April 30,
2003. The notes payable totaling $250,000 are due on demand after April 1, 2003,
mature on January 7, 2007, are non-interest bearing and are unsecured.
The total purchase consideration does not reflect contingent consideration
related to earn-out arrangements totaling $100,000. Any contingent consideration
will result in additional goodwill when earned.
22
Report of Independent Auditors
Shareholders and Board of Directors
IMAGE SENSING SYSTEMS, INC.
We have audited the accompanying consolidated balance sheets of Image Sensing
Systems, Inc. as of December 31, 2001 and 2000, and the related consolidated
statements of operations, shareholders' equity and cash flows for the years then
ended. 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 did not audit the financial statements of
Flow Traffic Ltd., a 60%-owned subsidiary, which statements reflect total assets
of $638,000 and $738,000 as of December 31, 2001 and 2000, respectively, and
total revenues of $1,866,000 and $2,643,000, respectively, for the years then
ended. Those statements were audited by other auditors whose report was
furnished to us, and our opinion, insofar as it relates to data included for
Flow Traffic Ltd., is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the 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 and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Image Sensing Systems, Inc. at December
31, 2001 and 2000, and the consolidated results of its operations and its cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States.
/s/Ernst & Young LLP
Minneapolis, Minnesota
February 8, 2002
23
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART II
ITEM 9. DIRECTORS AND OFFICERS OF THE REGISTRANT
The sections entitled "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in our definitive proxy statement for
our 2002 annual meeting of shareholders to be filed on or before April 30, 2002
are incorporated into this Form 10-KSB by reference.
ITEM 10. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" in our definitive proxy
statement for the 2002 annual meeting of shareholders is incorporated into this
Form 10-KSB by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Security Ownership of Certain Beneficial Owners
and Management" in our definitive proxy statement for the 2002 annual meeting of
shareholders is incorporated into this Form 10-KSB by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Certain Relationships and Related Transactions"
in our definitive proxy statement for the 2002 annual meeting of shareholders is
incorporated into this Form 10-KSB by reference.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of the report:
1. Financial statements referenced in Item 7
2. Exhibits:
Exhibit No. Description
----------- -----------
3.1 Restated Articles of Incorporation of ISS, incorporated by
reference to ISS's registration statement on Form SB-2
(Registration No. 90298C) filed on March 14, 1995.
3.2 Articles of Amendment to Articles of Incorporation of ISS,
incorporated by reference to ISS's quarterly report on Form
10-QSB for the quarter ended June 30, 2001.
3.3 Bylaws of ISS, incorporated by reference to ISS's registration
statement on Form SB-2 (Registration No. 90298C) filed on
March 14, 1995.
4.1 Specimen form of ISS's common stock certificate, incorporated
by reference to ISS's registration statement on Form SB-2
(Registration No. 90298C) filed on March 14, 1995.
10.1 Manufacturing, Distributing and Technology License Agreement
dated June 11, 1991, as amended on December 15, 1992, between
Econolite Control Products, Inc. and ISS, incorporated by
reference to ISS's registration statement on Form SB-2
(Registration No. 90298C) filed on March 14, 1995.
24
10.2 License Agreement dated June 10, 1991, between the University
of Minnesota and ISS, incorporated by reference to ISS's
registration statement on Form SB-2 (Registration No. 90298C)
filed on March 14, 1995.
10.3 Form of Distributor Agreement, incorporated by reference to
ISS's registration statement on Form SB-2 (Registration No.
90298C) filed on March 14, 1995.
10.4 Assignment from Panos G. Michalopoulos to ISS dated January
19, 1985, incorporated by reference to ISS's registration
statement on Form SB-2 (Registration No. 90298C) filed on
March 14, 1995.
10.5 Production Agreement dated July 8, 1997, between ISS, Cohu,
Inc., and Econolite Control Products, Inc., incorporated by
reference to Exhibit 10.14 to ISS's annual report on Form
10-KSB for the year ended December 31, 1997.
10.6 Conditional Credit Line Letter Agreement with Wells Fargo Bank
Minnesota, N.A. dated September 14, 1998, incorporated by
reference to Exhibit 10.17 to ISS's annual report on Form
10-KSB for the year ended December 31, 1998.
10.7 Office Lease Agreement by and between Spruce Tree Centre L.L.P
and ISS, dated November 24, 1998, incorporated by reference to
Exhibit 10.18 to ISS's annual report on Form 10-KSB for the
year ended December 31, 1998.
10.8* Executive Employment Agreement between ISS and Jeffrey F.
Martin, dated December 21, 1999, incorporated by reference to
Exhibit 10.19 to ISS's annual report on Form 10-KSB for the
year ended December 31, 1999.
10.9* Executive Employment Agreement dated June 12, 2000, between
ISS and William L. Russell, incorporated by reference to
Exhibit 10.21 to ISS's quarterly report on Form 10-QSB for the
quarter ended June 30, 2000.
10.10* 1995 Long-Term Incentive and Stock Option Plan, amended and
restated through May 17, 2001.
10.11 Distribution Agreement dated April 20, 2001, between ISS and
Wireless Technology, Inc., incorporated by reference to ISS's
quarterly report on Form 10-QSB for the quarter ended June 30,
2001.
10.12 Extension and Second Modification dated July 13, 2001, to
Manufacturing, Distributing and Technology License Agreement
dated June 11, 1991, between ISS and Econolite Control
Products, Inc.
10.13 Definitive Agreement dated July 20, 2001, between ISS and
Detector Electronics Corporation, incorporated by reference to
ISS's quarterly report on Form 10-QSB for the quarter ended
September 30, 2001.
10.14 Shares Sale and Purchase Agreement dated November 28, 2001,
among ISS and Berkeley Development Limited, Mats Johan Billow
and Grove Place Limited.
10.15 Amendment No. 1 dated as of December 31, 2001, to Shares Sale
and Purchase Agreement dated November 28, 2001, among ISS and
Berkeley Development Limited, Mats Johan Billow and Grove
Place Limited.
10.16 Non-Interest Bearing Convertible Note due January 7, 2002, of
Image Sensing Systems, Inc. in favor of Mats Johan Billow.
25
10.17 Non-Interest Bearing Convertible Note due January 7, 2002, of
Image Sensing Systems, Inc. in favor of Anthony H. Gould.
10.18* Settlement and Release Agreement dated February 11, 2002
between ISS and William L. Russell.
10.19* Employment Arrangement between ISS and Anthony H. Gould.
10.20 Production Agreement dated February 14, 2002, among ISS,
Wireless Technology, Inc. and Econolite Control Products, Inc.
21 List of Subsidiaries of ISS.
23 Consent of Ernst & Young LLP.
24 Power of Attorney (included on signature page).
99 Cautionary Statement.
*Management contract or compensatory plan or arrangement.
B) REPORTS ON FORM 8-K FILED DURING FOURTH QUARTER OF 2001:
None
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Image Sensing Systems, Inc. has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized:
IMAGE SENSING SYSTEMS, INC.
/s/ Anthony H. Gould Date: April 1, 2002
------------------------------------------ -------------------
By: Anthony H. Gould, President and Chief
Executive Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Each person whose
signature to this report on Form 10-KSB appears below hereby constitutes and
appoints Anthony H. Gould and Jeffrey F. Martin, and each of them, as his or her
true and lawful attorney-in-fact and agent, with full power of substitution, to
sign on his or her behalf individually and in the capacity stated below and to
perform any acts necessary to be done in order to file all amendments to this
report on Form 10-KSB, and any and all instruments or documents filed as part of
or in connection with this report on Form 10-KSB or the amendments hereto, and
each of the undersigned does hereby ratify and confirm all that said
attorney-in-fact and agent, or his substitutes, shall do or cause to be done by
virtue hereof.
/s/ Anthony H. Gould Date: April 1, 2002
----------------------------------------------------- -------------------
By: Anthony H. Gould
President and Chief Executive Officer, Director (Principal Executive Officer)
/s/ Jeffrey F. Martin Date: April 1, 2002
----------------------------------------------------- -------------------
By: Jeffrey F. Martin
Chief Financial Officer (Principal Financial & Accounting Officer)
/s/ James Murdakes Date: April 1, 2002
----------------------------------------------------- -------------------
By: James Murdakes
Chairman of the Board
/s/ Panos G. Michalopoulos Date: April 1, 2002
----------------------------------------------------- -------------------
By: Panos G. Michalopoulos
Director
/s/ Richard P. Braun Date: April 1, 2002
----------------------------------------------------- -------------------
By: Richard P. Braun
Director
/s/ Richard C. Magnuson Date: April 1, 2002
----------------------------------------------------- -------------------
By: Richard C. Magnuson
Director
/s/ Mats Johan Billow Date: April 1, 2002
----------------------------------------------------- -------------------
By: Mats Johan Billow
Director
27