Annual Report 2013
To Our Shareholders:
Last year was pivotal in the growth
innovation despite these constraints.
Full-year Product and Solutions
trajectory for Image Sensing Systems,
Our new product and solutions
sales rose 17 percent over 2012 to
marked by significant progress
offering truly differentiates us within
$14.7 million, while our License Plate
in product development and the
our chosen markets, and we are
Recognition product group revenue
continued traction we are seeing in
getting great receptivity at trade
increased 34 percent year-over-year
the growth of our sales pipeline, both
shows and from potential customers.
to $6.4 million.
in terms of size and quality. From a
In a market ripe for innovation, we are
strategic point of view, we defined
shifting the focus to customer-led,
our company’s direction around
benefit-based high tech solutions.
making cities safer with our existing
We’re very excited about the growth
and future technology solutions and
potential from this suite of products.
We believe that helping mayors, the
police and public works departments
leverage our robust solutions to
make their cities safer is a force
multiplier and cost containment
innovations. We are encouraged by
the momentum we had in product
sales growth in the second half of
2013. We’re also excited about our
recent product launches, including
our best-in-class CitySync Safety
solution, that reads license or number
plates for traffic data, security, police,
and parking applications.
2013: A Year of Transition
While we made tremendous strides
in starting to leverage our core
competencies and the many assets
we have developed, we continued
to fight economic headwinds in
the global economies. We were
also slowed, in our transition, by a
Foreign Corrupt Practices Act (FCPA)
investigation into matters originating
in Poland and quality and warranty
issues within our legacy product
portfolio.
During the year, we saw further
strategy to help manage their already
recovery and stabilization in the North
constrained budgets. Through in-
American and international markets
depth market research around our
that we serve. While that improvement
safe city strategy, we are focused
was uneven within our target
on delivering technologies that can
international markets, we made good
be deployed today, as well as the
progress and grew in both our EMEA
many new innovations that we and
and Asia Pacific regions. In North
our partners will develop to benefit
America, we continued to strengthen
citizen safety in any environment
our partnership relationship with
in the future. We understand that
Econolite and collaborated with
citizens and the people who run cities
them to address a number of market
and municipalities hold safety as their
opportunities. We also began to build
foremost concern, and Image Sensing
out our Safety Management portfolio
Systems will be there with innovative
of products and solutions for the
products and technologies to support
Crime/Law Enforcement, Parking and
these issues.
Security/Access Control markets.
Our leading-edge Safe City
From a revenue perspective, full-
technology provides the data and
year 2013 revenue grew 5 percent
analytics that law enforcement,
over 2012, to $26.3 million. More
security, parking, and traffic
importantly, we saw accelerated
management professionals need to
product sales growth in the second
construct and build a safe locale. We
half of the year as a result of our
currently have an early installation in a
However, we continued to drive
investments and development efforts.
U.S. city that’s showing great returns
in solving crimes quickly; we will keep
no ongoing maintenance. It is also
and Safety Management markets.
you updated on our progress.
suitable for both highway and urban
We believe that combining our world
renowned LPR engine with the
highest quality fixed cameras and a
crime-solving back office software is
an industry first.
Key Milestones
Traffic Management
In our Traffic Management market
segment we made three key
announcements in 2013. To support
our mission to be a customer-led
company, the first product to come
from that effort is an entry level
Autoscope video detection product
for intersections, the Sn-500 and Sn-
510. In conjunction with these new
video products, we also announced
an industry-leading intersection
set-up tool, the Autoscope Zone
Detection Tool (ZDT). Our new, easy-
to-use graphical user interface, or
GUI, can set-up an four approach
intersection in as little as 15 minutes
and has set a new industry standard.
traffic management applications. We
are very excited about the growth
potential from this product.
Safety Management
In the Safety Management market,
we had a major launch in October of
our cloud and on-premises analytics
back office solution-CitySync Safety.
This product is unique in its market
focus, as it provides the ability to
quickly locate vehicles near a crime
scene, and is able to run other
analytic queries that assist the police
department in rapid crime solving
capabilities.
CitySync Safety can generate value
for a city and police department. As
stated earlier, indications are very
promising and we believe that better
and more precise decisions can be
driven from the data and analytics
that our solution delivers.
Looking Ahead
This overall solution addresses a key
As we discussed in last year’s
We have spent the last year building
out our suite of products and services
and we expect the investments we
have made will start to pay dividends
in 2014. We are seeing increased
momentum in our product and
solutions sales and are confident in
the springboard for growth that our
platform provides. I’m proud of our
progress and our dedicated team
of employees who have combined
to create our industry-leading
products and solutions offerings.
We continue to face tremendous
growth opportunities in both domestic
and international markets and are
positioned to capitalize on them.
Lastly, we have added strength to
our executive management team
as well as the sales, marketing and
engineering functions. These new
additions further augment our existing
talented team of individuals as we
continue to execute on our strategy.
We are confident in our future and
the ISS team is passionate about
returning the company to historical
profitability levels and growing
shareholder value. Thank you again
market segment and is targeted at
lower cost markets: municipalities
that have very limited resources and
budgets.
We also introduced our back office
software solution, CitySync Metro,
for the Traffic Management market.
CitySync Metro was designed for
reliability and accuracy in all weather
conditions and large scale projects.
The product is also easy to install -
with no lane closures - and requires
shareholder letter, we believe the
future is bright for Image Sensing
Systems. We are also confident that
for your continued support and we
the FCPA and product issues are
look forward to updating you on our
winding down and we can focus all
milestones throughout the year.
of our energies on adding value to
cities and municipalities, throughout
the world. From a product and
solution portfolio perspective, we
are more focused than ever on user
and customer needs and believe that
ISS is a strategic value-add to our
customers’ operations in the Traffic
Thank You,
Kris Tufto
Chief Executive Officer
(This page has been left blank intentionally.)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
or
☐ TRANSITION REPORT PURSUANT TO 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.
(Exact name of registrant as specified in its charter)
Minnesota
(State or other jurisdiction of incorporation or organization)
500 Spruce Tree Centre, 1600 University Avenue West,
St. Paul, MN
(Address of principal executive offices)
41-1519168
(I.R.S. Employer Identification No.)
55104
(Zip Code)
(651) 603-7700
(Registrant’s telephone number, including area code)
Not applicable.
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, $0.01 par value
Name of each exchange on which registered
The NASDAQ Capital Market
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 15(d) of the Securities Exchange
Act of 1934 during the preceding 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. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment
to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer ☐
Non-accelerated filer ☐
(Do not check if a smaller reporting company.)
Accelerated filer ☐
Smaller reporting company ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of June 30, 2013, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $22,081,730 based on
the closing sale price as reported on The NASDAQ Capital Market. The number of shares outstanding of the registrant’s $0.01 par value common stock as of
February 28, 2014 was 4,974,847 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Document
Parts Into Which Incorporated
Proxy Statement for the 2014 Annual Meeting of Shareholders (Proxy
Statement)
Part III
TABLE OF CONTENTS
PART I ....................................................................................................................................................................................................... 1
Item 1. Business ........................................................................................................................................................................................ 1
Item 1A. Risk Factors .................................................................................................................................................................................. 8
Item 1B. Unresolved Staff Comments ....................................................................................................................................................... 16
Item 2. Properties .................................................................................................................................................................................... 16
Item 3. Legal Proceedings ....................................................................................................................................................................... 16
Item 4. Mine Safety Disclosures ............................................................................................................................................................. 16
PART II .................................................................................................................................................................................................... 17
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ................. 17
Item 6. Selected Financial Data ............................................................................................................................................................... 18
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ..................................................... 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .................................................................................................... 26
Item 8. Financial Statements and Supplementary Data ........................................................................................................................... 27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..................................................... 47
Item 9A. Controls and Procedures ............................................................................................................................................................. 47
Item 9B. Other Information ....................................................................................................................................................................... 47
PART III .................................................................................................................................................................................................. 48
Item 10. Directors, Executive Officers and Corporate Governance ......................................................................................................... 48
Item 11. Executive Compensation ............................................................................................................................................................ 48
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .................................. 48
Item 13. Certain Relationships and Related Transactions, and Director Independence ........................................................................... 48
Item 14. Principal Accountant Fees and Services ..................................................................................................................................... 48
PART IV ................................................................................................................................................................................................... 49
Item 15. Exhibits and Financial Statement Schedules .............................................................................................................................. 49
Signatures ................................................................................................................................................................................................. 52
Exhibit Index ........................................................................................................................................................................................... 53
i
PART I
Item 1. Business
Business
Image Sensing Systems, Inc. (referred to in this Annual Report on Form 10-K as “we,” “us,” “our” and the “Company”) develops and
markets video and radar processing products for use in traffic, security, police and parking applications such as intersection control,
highway, bridge and tunnel traffic management, venue security, entry control, license plate recognition and traffic data collection.
We are a leading provider of software-based computer enabled detection (“CED”) products and solutions for the intelligent
transportation systems (“ITS”) industry and adjacent security and law enforcement markets. Our family of products, which we market
as Autoscope® video (video or video products), Autoscope® radar (radar or radar products) and automatic license plate recognition
(“LPR”), provides end users with the tools needed to optimize traffic flow, enhance driver safety, regulate air quality and address
security/surveillance concerns. Our technology analyzes signals from sophisticated sensors and transmits the information to
management systems and controllers or directly to users. Our software solutions, which we market as CitySync, provide end users
with complete solutions of our hardware and software for the law enforcement, security and parking market.
CED is a process in which software rather than humans examines outputs from various types of sophisticated sensors to determine
what is happening in a field of view. In the ITS industry, CED is a critical component of managing congestion and traffic flow. In
many markets, it is not possible to build roads, bridges and highways quickly enough to accommodate increasing automobile
ownership. For example, in China, 22 million vehicles were introduced in 2013, up from the 19 million vehicles introduced in 2012.
This is expected to rise to 30 million vehicles per year by 2020. In 2014, the number of vehicles in China surpassed 250 million. We
believe this growing use of vehicles worldwide will make CED-based ITS solutions increasingly necessary to complement existing
and new roadway infrastructure to manage traffic flow and optimize throughput.
We believe our CED solutions are technically superior to those of our competitors because they have a higher level of accuracy, limit
the occurrence of false detection, are generally easier to install with lower costs of ownership, work effectively in a multitude of light
and weather conditions, and provide end users the ability to manage inputs from a variety of sensors for a number of tasks. It is our
view that the technical advantages of our products make our solutions well suited for use in ITS as well as adjacent security markets.
We believe that the market for CED is increasingly favoring converged solutions that include ITS, security/surveillance and
environmental management, which we expect to increase demand for CED products such as ours.
We believe the strength of our distribution channels positions us to increase the penetration of our technology-driven solutions in the
marketplace. We market our Autoscope products in North America, the Caribbean and Latin America through exclusive agreements
with Econolite Control Products, Inc. (“Econolite”), which we believe is the leading distributor of ITS intersection control products in
North America and the Caribbean. In January 2011, we entered into an agreement granting to Econolite and its affiliate, Econolite
Canada, Inc., the exclusive right to distribute our Autoscope radar products in Canada. In December 2011, we modified our agreement
with Econolite to grant it the exclusive right to manufacture and distribute our Autoscope radar products in the United States and
Mexico.
We market our Autoscope video, Autoscope radar and LPR products outside of North America, the Caribbean and Latin America
through a combination of distribution and direct sales channels, including our wholly-owned subsidiaries in Hong Kong and the
United Kingdom. Our end users primarily include governmental agencies and municipalities, and, as of December 31, 2013, we had
sold over 150,000 units in more than 60 countries.
Industry Overview
The Intelligent Transportation Systems Market. ITS encompasses a broad range of information processing and control electronics
technologies that, when integrated into roadway infrastructure, help monitor and manage traffic flow, reduce congestion and enhance
driver safety. The ITS market has been built around the detection of conditions that impact the proper operation of roadway
infrastructure. ITS applications include a wide array of traffic management systems, such as traffic signal control, tolling and variable
messaging signs. ITS technologies include video vehicle detection, LPR, inductive loop detection, sensing technologies (such as
radars), floating cellular data, computational technologies and wireless communications.
In traffic management applications, CED products are used for automated vehicle detection and are a primary data source upon which
ITS solutions are built. Traditionally, automated vehicle detection is performed using inductive wire loops buried in the pavement.
However, in-pavement loop detectors are costly to install, difficult to maintain, expensive to repair and not capable of either wide-area
vehicle detection without installations of multiple loops or recognizing license plate numbers.
1
Above-ground CED solutions for ITS offer several advantages to in-pavement loop detectors. Above-ground CED solutions tend to
have lower total cost of ownership than in-pavement loop detectors because above-ground CED solutions are non-destructive to road
surfaces, do not require closing roadways to install or repair, and are capable of wide-area vehicle detection with a single device, thus
enabling one input device to do the work of many in-pavement loops. Due to their location above-ground, CED solutions have no
exposure to the wear and tear associated with expanding and contracting pavement and generally less exposure to the vibration and
compaction caused by traffic. Furthermore, in the event of malfunction or product failure, above-ground CED solutions can be
serviced and repaired without shutting down the roadway. Each of these factors results in greater up-time and increased reliability of
above-ground CED solutions compared to in-pavement loop detectors. Above-ground CED solutions also offer a broader set of
detection capabilities and a wider field of view than in-pavement loop detectors. For example, unlike in-pavement loops,
above-ground CED solutions can detect smoke and debris. In addition, a single unit video- or radar-based CED system can detect and
measure a variety of parameters, including vehicle presence, counts, speed, length, time occupancy, headway and flow rate as well as
environmental factors and obstructions to the roadway. An equivalent installation using loops would require many installations per
lane.
We believe our Autoscope video and Autoscope radar products are competitive with and can take market share from in-pavement loop
detectors. Based on our determination, the U.S. ITS above-ground detection market sales in 2012 were approximately $100 to $120
million and the worldwide ITS above-ground detection market was approximately $200 million. We believe that we are the leader in
the U.S. above-ground detection market in terms of sales volume, and we estimate that U.S. sales of in-pavement loop detectors that
our Autoscope and Autoscope radar products can supplant were approximately $250 million in 2012.
Our CitySync solutions add further to our offerings in ITS. In many ITS applications, such as journey time measurement, it is critical
to ascertain the identity of the vehicle or to be able to uniquely identify a vehicle at a different time or location. LPR is among the
most widely used methods for these applications.
As part of our CitySync solutions, we have dedicated research and development time to creating our CitySync initiative called “Safe
Cities,” which helps communities improve safety and efficiency. We are investing thought leadership into this initiative by
investigating new ways to combine leading-edge above-ground detection technology, radar, and “Big Data” collection and analysis to
give law enforcement, security, parking and traffic management professionals more precise and accurate information. With increased
real-time reaction capabilities and in-depth analytics, these professionals will be able to make more confident and proactive decisions
that will streamline operations and improve safety.
We believe that several trends are driving the growth in ITS and adjacent market segments:
Proliferation of Traffic. In many countries, there has been a surge in the number of vehicles on roadways. Due to the growth of
emerging economies and elevated standards of living, more people desire and are able to afford automobiles. The number of vehicles
utilizing the world’s roadway infrastructure is growing at a quicker pace than new roads, bridges and highways are being constructed.
The population of the United States grew by about 20%, or 65 million, from 1990 to 2010, while highway miles have increased by
approximately 4% in the same period. Between 1990 and 2010, the number of registered highway vehicles in the U.S. increased from
193 million to 255 million. Overall, the growth in roadway infrastructure is failing to match the surge in the number of vehicles using
it. CED-based traffic management and control systems address the problem by monitoring high traffic areas and analyzing data that
can be used to mitigate traffic problems.
The Demographics of Urbanization. Accelerated worldwide urbanization drives the creation and expansion of middle classes and
produces heightened demand for automobiles. Currently, there are at least 400 cities in the world with over 1 million people. Because
automobiles can be introduced to a metropolitan area faster than roadway infrastructure can be constructed, the result is continuously
worsening traffic. Because expanding the roadway infrastructure is slow and costly to implement, and often environmentally
undesirable, government agencies are increasingly turning to technology-based congestion solutions that optimize performance and
throughput of existing and new roadway infrastructure. Detection is the requisite common denominator for any technology-based
solution.
The Melding of Large City Service Domains. Large cities require a wide range of service domains, including traffic,
security/surveillance and environmental protection. These cities are increasingly turning to centralized management of these service
domains, employing a command and control model that requires sharing and integrating data across service domains to operate
effectively and lower total cost – so called “Safe Cities” initiatives. For example, data collected for the traffic management service
domain is relevant to all of the other service domains. This means that each CED sensor can supply information to multiple domain
services. In turn, the sharing of detection information across service domains should increase the level of sophistication required to
process and interpret that information. Additionally, CED is becoming less costly to manufacture while becoming more capable of
performing certain complicated tasks than humans. This makes the concepts of “rich sensing” and “instrumenting the city” through
CED solutions cost effective, which we believe will result in the extensive proliferation of sophisticated sensors and detection devices.
2
The non- ITS LPR Market. In addition to ITS, LPR is widely used for applications in security, police and parking, among others.
We believe the sum of these world-wide markets is significant and currently is in excess of $350 million for their LPR components.
We also believe the competitive landscape is fragmented, with no dominant market share for any one competitor.
Security. LPR is used in security applications world-wide for border crossings, airports and venues such as convention centers and
sports arenas. Additionally, private industry uses LPR to help control entrances at high value locations, such as power plants.
Homeland security and counter-terrorism activities benefit from LPR as part of the solution.
Police. Law enforcement has adopted LPR for a variety of applications. Police may use LPR to gather information on a stopped
vehicle in a faster, automated fashion. LPR can scan for vehicles of interest from a fixed position or from a moving police vehicle,
looking for stolen cars or for automobiles of individuals with arrest warrants outstanding. Also, LPR is regularly used as a component
of red light, speed and bus lane enforcement systems.
Parking. Both public and private parking facilities have recently undergone a significant period of automation where human
attendants have been replaced by machines that control access. LPR is employed in numerous parking functions, including automatic
entrance/exit, open spot locator assistance, lost vehicle location, theft avoidance and related security aspects.
Solutions for Adjacent Markets. We believe that the adjacent markets of ITS, security/surveillance and environmental management
are converging, and that this convergence will accelerate as CED systems become more cost-effective now that a single CED unit can
be used for multiple purposes. Because the CED technologies involved are closely related, our CED technology can be adapted to or is
already capable of addressing these adjacent markets.
Our Competitive Strengths
We are a leading provider of software-based CED products and solutions for the ITS industry and related security and law
enforcement markets. We have the following competitive strengths that we expect will continue to enhance our leadership position:
Leading Proprietary Technologies. Over the last two decades, we have developed or acquired a proprietary portfolio of complex
software algorithms and applications that we have continuously enhanced and refined. These algorithms, which include our advanced
signal processing technologies, allow our video and radar detection and LPR products to capture and analyze objects in diverse
weather and lighting conditions and to balance the accuracy of positive detection and the avoidance of false detections. Due to the
strength of our proprietary technologies, we believe we command premium pricing. CED technologies similar to ours are also difficult
to develop and refine in a commercially viable manner. We therefore should be well positioned to quickly introduce next-generation
products to market.
Proven Ability to Develop, Enhance and Market New Products. We are continually developing and enhancing our product offerings.
Over the last two decades, we have demonstrated our ability to lead the market with new products and product enhancements. For
example, the Autoscope Solo system was the first fully integrated color camera, zoom lens and machine vision processor in the above-
ground detection market. Electronic Integrated Systems, Inc. (“EIS”), from which we purchased our radar product line, was one of the
first companies to introduce radar-based technology solutions for ITS applications, and we continue to lead the market with
technology enhancements and new products, such as Autoscope radar. Additionally, the CitySync system we acquired from Image
Sensing Systems UK Limited (“ISS UK”), formerly known as CitySync Limited, was the first in the LPR market to capture multiple
license plates in the same lane with a standard configuration. Our CitySync solution offering includes the first cloud computing
platform for providing rich data analytics in real-time. Furthermore, our hybrid CED product, Autoscope® Duo™, is the first
commercial product to combine video and radar capabilities in a single unit to provide high accuracy in all weather conditions and
gives us an entrée to significantly expand our accessible market by continuing to drive the conversion from legacy loop detection to
above-ground detection. We have successfully collaborated with our long-term channel partners to market these products. We believe
that developing, enhancing and marketing new products with our partners translates into strong organic revenue growth and high
levels of profitability.
Leading Distribution Channel. We have maintained a relationship with Econolite for the exclusive manufacture and distribution of
our Autoscope products in North America and the Caribbean since 1991 and in Latin America since 2002. We have now expanded
this relationship to include the manufacture and distribution of our Autoscope radar products in the United States, Canada and Mexico.
We believe that Econolite is the leading distributor of ITS control products in North America and the Caribbean. This relationship
enhances our ability to commercialize and market new products and allows us to focus more resources on developing advanced signal
processing software algorithms.
Broad Product Portfolio. Our product portfolio leverages our core software-based algorithms for CED to enable end users to detect
and monitor objects in a designated field of view. We believe that our family of Autoscope video, radar and LPR products allows us to
offer a broad product portfolio that meets the needs of our end users. Additionally, our intention is to use our broad product portfolio
3
to offer hybrid products that satisfy traffic, security/surveillance and environmental management requirements, such as Autoscope®
Duo™.
Experienced Management Team and Engineering Staff. Our management team and engineering staff are highly experienced in the
ITS and software industries. Additionally, the continuity of our engineering staff should allow the uninterrupted development of new
or improved products.
Our Growth Strategy
As part of our growth strategy, we seek to:
Enhance and Extend Our Technology Leadership in ITS. We believe we have established ourselves as a leading provider of CED in
the ITS market segment. We believe that we continue to have an opportunity to accelerate our growth. We plan to do this by
improving the accuracy and functionality of our products and opportunistically expanding our product offering into adjacent markets,
as well as expanding our portfolio and channels through licensing. Having developed and introduced a hybrid CED product,
Autoscope®Duo™, we expect to take advantage of our technical leadership in ITS and further differentiate us from our competitors.
Expand LPR Markets. We believe that the LPR market is poised for growth at a higher rate than the ITS market. Further, we believe
that our financial strength, distribution channels and customer base will add to our ability to grow Autoscope LPR-related revenue and
our CitySync Safety solutions.
Expand into Adjacent Markets. Our core skill is the implementation of software-based CED products and solutions. Over the past
two decades, we have been developing and refining our complex signal processing software algorithms. We should be able to
effectively utilize our core software skills more broadly as markets, including security/surveillance and environmental management
systems, converge. We believe that a driver of this convergence is that CED systems will become more cost-effective when a single
CED unit can be used for multiple purposes. As a result, our objective is to become the leading supplier of critical CED components to
third party management systems, particularly those that exploit the convergence of traffic, security/surveillance and environmental
management systems. To do this, we are integrating this concept into our long-range engineering development road-map and will
evaluate the use of technology licensing and channel strategies that support this vision.
Increase the Scope of Our Distribution and Direct Sales. We have made substantial investments in product adjustments to tailor our
solutions to the differing needs of our international end users and in new product acquisitions for both domestic and international
markets. We have also invested in sales and marketing expansion, with a focus on our European and Asian subsidiaries. Markets in
Eastern Europe, the Asia/Pacific region, the Middle East, Africa and South America, which have historically lagged North America
and Western Europe in their use of CED, have recently begun to increase the adoption of CED in their traffic, security/surveillance
and environmental management systems. We intend to continue to refine our product offerings through engineering development and
technology licensing to take advantage of the accelerated pace of the adoption of CED throughout the developing world.
Our Products and Solutions
Our vehicle and traffic detection products are critical components of many ITS and adjacent security and law enforcement
applications. Our Autoscope video systems and Autoscope radar systems convert sensory input collected by video cameras and radar
units into vehicle detection and traffic data used to operate, monitor and improve the efficiency of roadway infrastructure. Our
Autoscope LPR systems use video sensors in the visible and infrared spectrums to read license or number plates for traffic data,
security, police and parking applications. At the core of each product line are proprietary digital signal processing algorithms and
sophisticated embedded software that analyze sensory input and deliver actionable data to integrated applications. We invested
approximately $5.0 million, $4.1 million and $4.4 million on research and development in 2013, 2012 and 2011, respectively, to
develop and enhance our product technology. Our digital signal processing software algorithms represent a foundation on which
support for additional sensory inputs such as acoustic, chemical, smoke, weather and vibration sensors may be added in the future. A
diagram displaying our fundamental product architecture is shown below.
4
The Image Sensing Product Architecture
Autoscope Video. Our Autoscope video system processes video input from a traffic scene in real time and extracts the required traffic
data, including vehicle presence, counts, speed, length, time occupancy (percent of time the detection zone is occupied), average
headway (time interval between vehicles) and flow rate (vehicles per hour per lane). Autoscope supports a variety of standard video
cameras or can be purchased with an integrated video camera. For intersections, the system communicates with the intersection signal
controller, which changes the traffic lights based on the data provided. In highway applications, the system gathers vehicle count and
flow rates and detects anomalous incidents, such as stopped or wrong-way vehicles. In tunnel safety applications, Autoscope provides
alerts to operators upon detecting stopped, wrong-way or slow moving vehicles and upon detecting pedestrians, debris or smoke. In
any application, the data may also be transmitted to a traffic management center via the internet or other standard communication
means and processed in real time to assist in traffic management and stored for later analysis for traffic planning purposes.
The Autoscope system comes in two varieties. Autoscope Encore is our integrated unit with a color zoom camera and a machine
vision processing computer contained in a compact housing that is our leading offering in the North American market. Autoscope
RackVision is our card only machine vision processing computer that is located in an intersection signal controller, control hub,
incident management center or traffic management center that receives video from a separate camera. The RackVision and its variants
are our top selling Autoscope products in international markets. Autoscope products offer digital MPEG-4 video streaming, high
speed Ethernet interface, web browser maintenance and data and video over power line communications.
Autoscope Radar. Our Autoscope radar systems use radar to measure vehicle presence, volume, occupancy, speed and classification
information for roadway monitoring applications. Data is transmitted to a central computer at a traffic management center via standard
communication means, including wireless. Data can be processed in real time to assist in traffic management and stored for later
analysis for traffic planning purposes.
Autoscope radar is an integrated radar transmitter/receiver and special purpose computer contained in a compact, self-contained unit.
The unit is typically situated on roadway poles and side-fired, making it especially well-suited for highway detection applications.
Autoscope LPR. Our LPR systems process video information gathered from the visible and infrared spectrum to perform LPR for ITS,
security, police and parking applications. Data is transmitted to other integrated systems or stored in onboard vehicle systems for later
processing. Data can be processed to assist in traffic and parking management, real-time law enforcement and traffic alerts and stored
for later analysis for traffic, security and commercial purposes.
At the core of each Autoscope LPR system is the Autoscope Base software suite, which runs the LPR algorithms and related
processes, including communications. Autoscope Base operates with both non-proprietary and proprietary cameras. We offer a range
of proprietary analog, high definition and intelligent cameras for both fixed and mobile systems.
5
Hybrid. Video detection is best suited to applications in which the ability to act on complex and detailed information is desired.
However, video can encounter difficulties in poorly-lit environments, in adverse weather conditions (such as fog or driving snow), in
situations in which vehicles are obscured (for example, by other vehicles), or in extraordinarily dirty environments in which airborne
particulates obscure the view. Also, despite the compensating factors of using high-quality color video, video can be susceptible to
false detections due to shadows or reflections. Radar is less able to distinguish fine details than video but is considerably less affected
by adverse environmental conditions and, to some degree, can see through certain kinds of obstructions. It also does not recognize
shadows or visual reflections.
By combining video and radar sensors and algorithmically comparing their outputs in our hybrid Autoscope® Duo™ product, we
believe we are able to offer our end users a product that provides superior accuracy in all weather conditions. The Autoscope®Duo™
is able to coalesce the strengths of each type of sensor to overcome the other’s limitations. The result is improved overall performance
in a broader range of circumstances, allowing us access to a larger market.
CitySync. Our CitySync solutions provide the end user with a complete package including hardware and software. CitySync solutions
are currently positioned around our LPR technology and platform. These solutions combine intelligent cameras with our market
specific software packages that we believe offer our end users with complete LPR solutions. The Rapid Plate Recognition technology
reads a license plate numerous times and uses multiple advanced methods for both optical character recognition and plate finding for
each plate read. The speed of our solutions allows us the capability to read hundreds of plates simultaneously. We believe our
CitySync solutions provide the highest accuracy for the markets we serve. We believe in the development of our CitySync solutions
and will continue to grow and enhance these solutions into all of our markets.
Distribution, Sales and Marketing
We market and sell our products globally. As of December 31, 2013, we had supplied systems for more than 150,000 units in more
than 60 countries. Together with our partners, we offer a combination of high-performance CED technology and experienced local
support. Our end users primarily consist of federal, state, city and county departments of transportation, port, highway, tunnel and
other transportation authorities, law enforcement agencies and parking facility operators. The decision-makers within these entities
typically are traffic planners and engineers, who in turn often rely on consulting firms that perform planning and feasibility studies.
Our products sometimes 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.
Sales of Autoscope Video and Autoscope Radar in North America, the Caribbean and Latin America. We have granted Econolite
an exclusive right to manufacture, market and distribute the Autoscope system in North America, the Caribbean and Latin America. In
January 2011, we entered into an agreement granting to Econolite and its affiliate, Econolite Canada, Inc., the exclusive right to
distribute our Autoscope radar products in Canada. In December 2011, we modified our agreement with Econolite to grant it the
exclusive right to manufacture and distribute our Autoscope radar products in the United States and Mexico. The agreements with
Econolite grant it a first refusal right that arises when we make a proposal to Econolite to extend the license to additional products in
North America, the Caribbean and Latin America and a first negotiation right that arises when we make a proposal to Econolite to
include rights corresponding to Econolite’s rights under our current agreements in countries not in these territories. Econolite provides
the marketing and technical support needed for its sales in these territories. Econolite pays us a royalty on the revenue derived from its
sales of the Autoscope system. In January 2011, Econolite began paying us a royalty on Autoscope radar sales in Canada and, in
January 2012, on sales of radar products in the United States and Mexico. We cooperate in marketing Autoscope video and radar
products with Econolite for North America, the Caribbean and Latin America and provide second-tier technical support. We have the
right to terminate our agreements with Econolite if it does not meet minimum annual sales levels or if Econolite fails to make
payments as required by the agreements. In 2008, the term of the original agreement with Econolite, as amended, was extended to
2031. The term of the agreement with Econolite to manufacture and distribute our Autoscope radar products in Canada expires in
2028. The agreements can be terminated by either party upon three years’ notice.
Sales of Autoscope LPR in North America, the Caribbean and Latin America. We market the Autoscope LPR systems to a network
of distributors covering countries in North America, the Caribbean and Latin America. On a limited basis, we sell directly to the end
user. We provide technical support to these distributors from our various North American locations.
Sales in Europe, Asia, the Middle East and Africa. We market our Autoscope video, radar and LPR lines of products to a network of
distributors covering countries in Europe, the Middle East, Africa and Asia through our wholly-owned subsidiaries that have offices in
Hong Kong and the United Kingdom. On a limited basis, we sell directly to the end user. Technical support to these distributors is
provided by our wholly-owned subsidiaries in Europe and Asia, with second-tier support provided by our engineering groups. From
time to time, we may grant exclusive rights to Econolite for markets outside of our significant markets for certain jurisdictions or
product sales based on facts and circumstances related to the opportunities.
6
Competition
We compete with companies that develop, manufacture and sell traffic management devices using video and radar sensing
technologies as well as other above-ground CED technologies based on laser, infrared and acoustic sensors. For ITS applications, we
also compete with providers of in-pavement loop detectors and estimate that more than 70% of the traffic management systems
currently in use in the U.S. use in-pavement loop detectors. For competition with other above-ground CED products, we typically
compete on performance and functionality, and to a lesser extent on price. When competing against providers of loop detectors, we
compete principally on ease of installation and the total cost of ownership over a multi-year period, and to a lesser extent on
functionality.
Among the companies that provide direct competition to Autoscope video worldwide are FLIR Systems, Inc., Signal Group Inc.
(Semex), Iteris, Inc. and Citilog S.A. Among the companies that provide direct competition to Autoscope radar worldwide are
Wavetronix, LLC, MS Sedco Inc. and Xtralis, LLC. Among the companies that provide direct competition to Autoscope LPR
worldwide are 3M Company, Perceptics LLC, Genetec Inc., Vigilant Solutions and Elsag Datamat S.p.a. All of these companies have
working installations of their systems in the U.S. and other parts of the world. To our knowledge, Autoscope and Autoscope radar
have the largest number of installations as compared to their direct competitors. In addition, there are smaller local companies
providing direct competition in specific markets throughout the world. We are aware that these and other companies will continue to
develop technologies for use in traffic management, security, police and parking applications. One or more of these technologies could
in the future provide increased competition for our systems.
Other potential competitors of which we are aware include Siemens AG, Cognex Corp., Augusta Technologie AG, Matsushita Electric
Industrial Co., Ltd. (Panasonic), Sumitomo Corporation and Omron Electronics LLC. These companies have machine vision or radar
capabilities and have substantially more financial, technological, marketing, personnel and research and development resources than
we have.
Manufacturing
Autoscope video products for sale under the Econolite license agreement are manufactured through agreements with Econolite and
Wireless Technology, Inc. In January 2011, we entered into an agreement with Econolite to distribute our Autoscope radar products
in Canada. In December 2011, our original agreement with Econolite was amended to include the exclusive manufacture and
distribution of Autoscope radar products in the United States and Mexico beginning on January 1, 2012. Econolite is responsible for
setting warranty terms and must provide all service required under this warranty. In Europe and Asia, we engage contract
manufacturers to manufacture the Autoscope family of products.
Until January 2012, we engaged contract manufacturers to produce subassemblies for our radar products based on our designs. These
subassemblies were then shipped to our facilities in Toronto, where we performed final assembly, testing and calibration and
packaging of finished units for shipment. We also performed warranty and post-warranty repairs of radar units in Toronto. Beginning
in January 2012, Econolite is responsible for setting warranty terms and must provide all service required under this warranty for radar
products for product sales in North America.
Autoscope LPR products are manufactured through contract manufacturers in the United Kingdom and the United States.
We typically provide a two-year warranty on our products.
Most of the hardware components used to manufacture our products are standard electronics components that are available from
multiple sources. Although some of the components used in our products are obtained from single-source suppliers, we believe other
component vendors are available should the necessity arise. The European Parliament has enacted a directive for the restriction of the
use of certain hazardous substances in electrical and electronic equipment (“RoHS”). To our knowledge, our contract manufacturing
and component vendors in Europe and Asia comply with the European directive on RoHS.
Intellectual Property
To protect our rights to our proprietary know-how, technology and other intellectual property, it is our policy to require all employees
and consultants to sign 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 also rely on trade secret, copyright and trademark laws to protect our intellectual
property. We have also entered into exclusive and non-exclusive license and confidentiality agreements relating to our own and
third-party technologies. We aggressively protect our processes, products, and strategies as proprietary trade secrets. Our efforts to
protect intellectual property and avoid disputes over proprietary rights include ongoing review of third-party patents and patent
applications.
7
Environmental Matters
We believe our operations are in compliance with all applicable environmental regulations within the jurisdictions in which we
operate.
Employees
As of December 31, 2013, we had 124 employees, consisting of 69 employees in North America, 45 employees in Europe and 10
employees in Asia. None of our employees are represented by a union.
Item 1A. Risk Factors
Information Regarding Forward-Looking Statements
This Annual Report on Form 10-K 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,” “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. Some factors that might cause these differences include the factors listed below. Although we have
attempted to list these factors comprehensively, we wish to caution investors that other factors may prove to be important in the future
and may affect our operating results. New factors may emerge from time to time, and it is not possible to predict all of these factors,
nor can we assess the effect each factor or combination of factors may have on our business.
We further caution you not to unduly rely on any forward-looking statements because they reflect our views only as of the date the
statements were made. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of
new information, future events or otherwise.
If governmental entities elect not to use our products due to budgetary constraints, project delays or other reasons, our revenue
may fluctuate severely or be substantially diminished.
Our products are sold primarily to governmental entities. We expect that we will continue to rely substantially on revenue and
royalties from sales of our systems to governmental entities. In addition to normal business risks, it often takes considerable time
before governmental initiated projects are developed to the point at which a purchase of our systems would be made, and a purchase
of our products also may be subject to a time-consuming approval process. Additionally, governmental budgets and plans may change
without warning. Other risks of selling to governmental entities include dependence on appropriations and administrative allocation of
funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments,
significant changes in contract scheduling, competitive bidding and qualification requirements, performance bond requirements,
intense competition for government business and termination of purchase decisions for the convenience of the governmental entity.
Substantial delays in purchase decisions by governmental entities, or governmental budgetary constraints, could cause our revenue and
income to drop substantially or to fluctuate significantly between fiscal periods.
A majority of our gross profit has been generated from sales of our Autoscope family of products, and if we do not maintain the
market for these products, our business will be harmed.
Historically, a majority of our gross profit has been generated from sales of, or royalties from the sales of, Autoscope products. Gross
profit from Autoscope sales accounted for approximately 71% of our gross profit in 2013, 77% in 2012 and 71% in 2011. We
anticipate that gross profit from the sale of Autoscope systems will continue to account for a substantial portion of our gross profit for
the foreseeable future. As such, any significant decline in sales of our Autoscope system would have a material adverse impact on our
business, financial condition and results of operations.
If Econolite’s sales volume decreases or if it fails to pay royalties to us in a timely manner or at all, our financial results will suffer.
We have agreements with Econolite under which Econolite is the exclusive distributor of the Autoscope® video system in North
America, the Caribbean and Latin America and the Autoscope® radar products in the United States, Canada and Mexico. The
agreements grant Econolite a first refusal right that arises when we make a proposal to Econolite to extend the license to additional
products in North America, the Caribbean and Latin America. In addition, the agreements grant Econolite a first negotiation right that
arises when we make a proposal to Econolite to include rights corresponding to Econolite’s rights under our current agreements in
countries not in these territories. In exchange for its rights under the agreements, Econolite pays us royalties for sales of the
Autoscope® video system and the Autoscope® radar products. Since 2002, a substantial portion of our revenue has consisted of
8
royalties resulting from sales made by Econolite, including 44% in 2013, 50% in 2012 and 43% in 2011. Econolite’s account
receivable represented 26% of our accounts receivable at December 31, 2013 and 35% of our accounts receivable at December 31,
2012. We expect that Econolite will continue to account for a significant portion of our revenue for the foreseeable future. Any
decrease in Econolite’s sales volume could significantly reduce our royalty revenue and adversely impact earnings. A failure by
Econolite to make royalty payments to us in a timely manner or at all will harm our financial condition. In addition, we believe sales
of our products are a material part of Econolite’s business, and any significant decrease in Econolite’s sales of the other products it
sells could harm Econolite, which could have a material adverse effect on our business and prospects.
The features and functions in our products have not been as widely utilized as traditional products offered by our competitors, and
the failure of our end users to accept the features and functions in our products could adversely affect our business and growth
prospects.
Video and radar technologies have not been utilized in the traffic management industry as extensively as other more traditional
technologies, mainly in-pavement loop detectors. Our financial success and growth prospects depend on the continued development of
the market for advanced technology solutions for traffic detection and management and the acceptance of our current Autoscope®
video, Autoscope® radar and LPR systems and also future systems we may develop as reliable, cost-effective alternatives to
traditional vehicle detection systems. We cannot assure you that we will be able to utilize our technology profitably in other products
or markets. If our end users do not continue to increase their acceptance of the features and functions provided by our current systems
or other systems we may develop in the future, our business and growth prospects could be adversely affected.
Existing and future laws, ordinances and regulations and constitutional provisions protecting privacy rights could negatively affect
the acceptance and sale of our video and LPR products and systems and have a negative effect on our financial condition and
results of operations.
The use of video and LPR products and systems has been challenged, limited and banned under existing laws, ordinances and
regulations and constitutional provisions protecting privacy rights. In addition, governments and governmental agencies have stopped
or suspended their use of LPR systems. For example, Maine, New Jersey and Virginia have laws limiting the use of LPR systems;
New Hampshire bans their use; legislation has been proposed in Minnesota limiting the use of data collected by LPR systems; and the
Boston Police Department has indefinitely halted its use of LPR systems. In addition, laws, ordinances, regulations and constitutional
provisions may be adopted in the future to limit the use of video and LPR products and systems. These existing and new laws,
ordinances, regulations and constitutional provisions could negatively affect the acceptance and sale of our video and LPR products
and systems and thus have a negative effect on our financial condition and results of operations.
Our operating costs tend to be fixed, while our revenue tends to be seasonal, thereby resulting in operating results that fluctuate
from quarter to quarter.
Our expense levels are based in part on our product development efforts and our expectations regarding future revenues and, in the
short-term, are generally fixed. Our quarterly revenues, however, have varied significantly in the past, with our first quarter
historically being the weakest due to weather conditions in parts of North America, Europe and Asia that make roadway construction
more difficult. Additionally, our international revenues have a significant large project component, resulting in a varying revenue
stream. We expect the seasonality of our revenue and the fixed nature of our operating costs to continue in the foreseeable future.
Therefore, we may be unable to adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. As a
result, if anticipated revenues in any quarter do not occur or are delayed, our operating results for the quarter would be
disproportionately affected. Operating results also may fluctuate due to factors such as the demand for our products; product life cycle;
the development, introduction and acceptance of new products and product enhancements by us or our competitors; changes in the
mix of distribution channels through which our products are offered; changes in the level of operating expenses; end user order
deferrals in anticipation of new products; competitive conditions in the industry; and economic conditions generally. No assurance can
be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future.
Increased competition may make it difficult for us to acquire and retain end users. If we are unsuccessful in developing new
applications and product enhancements, our products may become noncompetitive or obsolete.
Competition in the areas of ITS, security and parking management is continuing to grow. Some of the companies that may compete
with us in the business of developing and implementing traffic control and related security systems have substantially more financial,
technological, marketing, personnel and research and development resources than we have. Therefore, they may be able to respond
more quickly than we can to new or changing opportunities, technologies, standards or end user requirements. If we are unable to
compete successfully with these companies, the market share for our products will decrease, and competitive pressures may seriously
harm our business.
9
Additionally, the market for vehicle detection and LPR is continuously seeking more advanced technological solutions to problems.
Technologies such as embedded loop detectors, pressure plates, pneumatic tubes, radars, lasers, magnetometers, acoustics and
microwaves that have been used as traffic sensing devices in the past are being enhanced for use in the traffic management industry,
and new technologies may be developed. We are aware of several companies that are developing traffic management devices using
machine vision technology or other advanced technology. Floating vehicle and/or radio frequency identification (RFID) tagged license
plate initiatives are under consideration and may be implemented. We expect to face increasingly competitive product developments,
applications and enhancements. New technologies or applications in traffic control systems from other companies may provide our
end users with alternatives to our products and could render our solutions noncompetitive or obsolete. If we are unable to increase the
number of our applications and develop and commercialize product enhancements and applications in a timely and cost-effective
manner that respond to changing technology and satisfy the needs of our end users, our business and financial results will suffer.
We may not achieve our growth plans for the expansion of our business.
In addition to market penetration, our long-term success depends on our ability to expand our business through new product
development, mergers and acquisitions, and/or geographic expansion.
New product development requires that we maintain our ability to improve existing products, continue to bring innovative products to
market in a timely fashion, and adapt products to the needs and standards of current and potential customers. Our products and
services may become less competitive or eclipsed by technologies to which we do not have access or which render our solutions
obsolete.
Geographic expansion will be primarily outside of the U.S. and hence will be disproportionately subject to the risks of international
operations discussed in this Annual Report on Form 10-K.
Mergers and acquisitions will be accompanied by risks which may include:
failure to achieve the financial and strategic goals for the acquired and combined businesses;
● difficulties identifying suitable acquisition candidates at acceptable costs;
● unavailability of capital to conduct acquisitions;
●
● difficulty assimilating the operations and personnel of the acquired businesses;
● disruption of ongoing business and distraction of management from the ongoing business;
● dilution of existing shareholders and earnings per share;
● unanticipated, undisclosed or inaccurately assessed liabilities, legal risks and costs; and
● difficulties retaining our key vendors, customers or employees or those of the acquired business.
In addition, acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of
international operations discussed in this Annual Report on Form 10-K.
Our dependence on third parties for manufacturing and marketing our products may prevent us from meeting customers’ needs in
a timely manner.
We do not have, and do not intend to develop in the near future, internal capabilities to manufacture our products. We have entered
into agreements with Econolite and Wireless Technology, Inc. (“WTI”) to manufacture the Autoscope system, the Autoscope® radar
products and related products for sales in North America, the Caribbean and Latin America. We have arrangements with Hansatech
EMS Limited (“Hansatech”) in the United Kingdom to manufacture our LPR systems. We work with suppliers, most of whom are
overseas, to manufacture the rest of our products. We also need to comply with the European Union’s regulatory RoHS directive
restricting the use of certain hazardous substances in electrical and electronic equipment. If Econolite, WTI, Hansatech or our other
suppliers are unable to manufacture our products in the future, we may be unable to identify other manufacturers able to meet product
and quality demands in a timely manner or at all. Our inability to find suitable manufacturers for our products could result in delays or
reductions in product shipments, which in turn may harm our business reputation and results of operations. In addition, we have
granted Econolite the exclusive right to market the Autoscope® video system and related products in North America, the Caribbean
and Latin America and the Autoscope® radar products in the United States, Canada and Mexico. Consequently, our revenue depends
to a significant extent on Econolite’s marketing efforts. Econolite’s inability to effectively market the Autoscope® video system or the
Autoscope® radar products, or the disruption or termination of that relationship, could result in reduced revenue and market share for
our products.
10
We and our third party manufacturers obtain some of the components of our products from a single source, and an interruption in
the supply of those components may prevent us from meeting customers’ needs in a timely manner and could therefore reduce our
sales.
Although substantially all of the hardware components incorporated into our products are standard electronics components that are
available from multiple sources, we and our third party manufacturers obtain some of the components from a single source. The loss
or interruption of any of these supply sources could force us or our manufacturers to identify new suppliers, which could increase our
costs, reduce our sales and profitability, or harm our customer relations by delaying product deliveries.
Regulations related to the use of conflict-free minerals may increase our costs and cause us to incur additional expenses.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve the transparency and accountability
of the use by public companies in their products of minerals mined in certain countries and to prevent the sourcing of such “conflict”
minerals. As a result, the Securities and Exchange Commission enacted new annual disclosure and reporting requirements for public
companies who use these minerals in their products, which apply to us. Under the final rules, we are required to conduct due diligence
to determine the source of any conflict minerals used in our products, and we are required to file our first conflict minerals report with
the Securities and Exchange Commission on or before May 31, 2014. Although we expect to file the required report on a timely basis,
our supply chain is broad-based and complex, and we may not be able to easily verify the origins for all minerals used in our products.
To the extent that any information furnished to us by our suppliers is inaccurate or inadequate, we could face reputational and
enforcement risks. In addition, the new rules could reduce the number of suppliers who provide components and products containing
conflict-free minerals and thus could disrupt our supply chain or that of our manufacturers and increase the cost of the components
used in manufacturing our products and the costs of our products to us. Any increased costs and expenses could have a material
adverse impact on our financial condition and results of operations.
Some of our products are covered by our warranties and, if the cost of fulfilling these warranties exceeds our warranty allowance,
it could adversely affect our financial condition and results of operations.
Unanticipated warranty and other costs for defective products could adversely affect our financial condition and results of operations
and our reputation. We generally provide a two-year warranty on our product sales. These warranties require us to repair or replace
faulty products, among other customary warranty provisions. Although we monitor our warranty claims and provide an allowance for
estimated warranty costs, unanticipated claims in excess of the allowance could have a material adverse impact on our financial
condition and results of operations. Additionally, we rely on our third party manufacturers to fulfill our warranty repair obligations to
our customers. Adverse changes in these parties’ abilities to perform these repairs could cause a delay in repairs or require us to
source other parties to perform the repairs and could adversely affect impact our financial condition and results of operations. In
addition, the need to repair or replace products with design or manufacturing defects could adversely affect our reputation.
We may face increased competition if we fail to adequately protect our intellectual property rights, and any efforts to protect our
intellectual property rights may result in costly litigation.
Our success depends in large measure on the protection of our proprietary technology rights. We rely on trade secret, copyright and
trademark laws, confidentiality agreements with employees and third parties, and patents, all of which offer only limited protection.
We cannot assure you that the scope of these protective measures will exclude competitors or provide a competitive advantages to us.
We also cannot assure you that we will become aware of all instances in which others develop similar products, duplicate any of our
products, or reverse engineer or misappropriate our proprietary technology. If our proprietary technology is misappropriated, our
business and financial results could be adversely affected. Litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. In addition, we may be the
subject of lawsuits by others who claim we violate their intellectual property rights.
Intellectual property litigation is very costly and could result in substantial expense and diversions of our resources, either of which
could adversely affect our business and financial condition and results of operations. In addition, there may be no effective legal
recourse against infringement of our intellectual property by third parties, whether due to limitations on enforcement of rights in
foreign jurisdictions or as a result of other factors.
We have not applied for patent protection in all countries in which we market and sell our products. Consequently, our proprietary
rights in the technology underlying our systems in countries other than the U.S. will be protected only to the extent that trade secret,
copyright or other non-patent protection is available and to the extent we are able to enforce our rights. The laws of other countries in
which we market our products may afford little or no effective protection of our proprietary technology, which could harm our
business.
11
We plan to continue introducing new products and technologies and may not realize the degree or timing of benefits we initially
anticipated, which could adversely affect our business and results of operations.
We regularly invest substantial amounts in research and development efforts that pursue advancements in a range of technologies,
products and services. Our ability to realize the anticipated benefits of these advancements depends on a variety of factors, including
meeting development, production, certification and regulatory approval schedules; the execution of internal and external performance
plans; the availability of supplier-produced parts and materials; the performance of suppliers and vendors; achieving cost efficiencies;
the validation of innovative technologies; and the level of end user interest in new technologies and products. These factors involve
significant risks and uncertainties. We may encounter difficulties in developing and producing these new products and may not realize
the degree or timing of benefits initially anticipated. In particular, we cannot predict with certainty whether, when or in what quantities
our current or potential end users will have a demand for products currently in development or pending release. Moreover, as new
products are announced, sales of current products may decrease as end users delay making purchases until such new products are
available. Any of the foregoing could adversely affect our business and results of operations.
Our business could be adversely affected by product liability and commercial litigation.
Our products or services may be claimed to cause or contribute to personal injury or property damage to our customers’ employees or
facilities. Additionally, we are, at times, involved in commercial disputes with third parties, such as customers, vendors and others.
The ensuing claims may arise singularly, in groups of related claims, or in class actions involving multiple claimants. Such claims and
litigation are frequently expensive and time-consuming to resolve and may result in substantial liability to us, which liability and
related costs and expenses may not be recoverable through insurance or any other forms of reimbursement.
Our business could be affected by various legal and regulatory compliance risks, including those involving antitrust,
environmental, anti-bribery or anti-corruption laws and regulations.
We are subject to various legal and regulatory requirements and risks in the U.S. and other countries in which we have facilities or sell
our products involving compliance with antitrust, environmental, anti-bribery and anti-corruption laws and regulations, including the
U.S. Foreign Corrupt Practices Act and the U.K. Anti-Bribery Act. Although we have internal policies and procedures with the
intention of assuring compliance with these laws and regulations, our employees, contractors, agents and licensees involved in our
international sales may take actions in violation of such policies. For more information, see the discussion in Note 15 of our Notes to
Consolidated Financial Statements contained elsewhere in this Annual Report on Form 10-K. Any future adverse development, ruling
or settlement could result in charges that could have an adverse effect on our results of operations or cash flows.
We price certain of our products at a premium compared to other technologies. As such, we may not be able to quickly respond to
emerging low-cost competitors, and our inability to do so could adversely affect revenue and profitability.
We price certain of our products at a premium as compared to products using less sophisticated technologies. As the technological
sophistication of our competitors and the size of the market increase, competing low-cost developers of machine vision products for
traffic are likely to emerge and grow stronger. If end users prefer low-cost alternatives over our products, our revenue and profitability
could be adversely affected.
Our revenue could be adversely affected by the emergence of local competitors and local biases in international markets.
Our experience indicates that local officials that purchase traffic management products in the international markets we serve favor
products that are developed and manufactured locally. As local competitors to our products emerge, local biases could erode our
revenue in Europe and Asia and adversely affect our sales and revenue in those markets.
Our failure to predict technological convergence could harm our business and could reduce our sales.
Within our product families, we currently utilize only certain detection technologies available in the ITS field. If we fail to predict
convergence of technology preferences in the market for ITS, or fail to identify and acquire complementary businesses or products
that broaden our current product offerings, we may not capture certain segments of the market, which could harm our business and
reduce our sales.
We sell our products internationally and are subject to various risks relating to such international activities, which could harm our
international sales and profitability.
Sales outside of the United States, including export sales from our U.S. business locations, accounted for approximately 51% of our
total revenue in 2013. By doing business in international markets, we are exposed to risks separate and distinct from those we face in
our U.S. operations. Our international business may be adversely affected by changing political and economic conditions in foreign
12
countries. Additionally, fluctuations in currency exchange rates could affect demand for our products or otherwise negatively affect
profitability. Engaging in international business inherently involves a number of other difficulties and risks, including:
•
•
•
•
•
•
•
•
•
•
•
•
•
export restrictions and controls relating to technology;
pricing pressure that we may experience internationally;
exposure to the risk of currency value fluctuations, where payment for products is denominated in a currency other than
U.S. dollars;
variability in the U.S. dollar value of foreign currency-denominated assets, earnings and cash flows;
required compliance with existing and new foreign regulatory requirements and laws;
laws and business practices favoring local companies;
longer payment cycles;
difficulty of enforcing agreements, including patent and trademarks, and collecting receivables through foreign legal
systems;
political and economic instability, including volatility in the economic environment of the European Union caused by the
ongoing sovereign debt crisis in Europe;
tax rates in certain foreign countries that exceed those in the U.S. and the imposition of withholding requirements on
foreign earnings;
higher danger of terrorist activity, war or civil unrest compared to domestic operations;
difficulties and costs of staffing and managing foreign operations; and
difficulties in enforcing intellectual property rights.
Our exposure to each of these risks may increase our costs, lengthen our sales cycle and require significant management attention. One
or more of these factors may harm our business.
Our inability to comply with European and Asian regulatory restrictions over hazardous substances and electronic waste could
restrict product sales in those markets and reduce profitability in the future.
The European Union’s Waste Electrical and Electronic Equipment (“WEEE”) directive makes producers of electrical goods
financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. This directive
must be enacted and implemented by individual European Union governments, and certain producers will be financially responsible
under the WEEE legislation. This may impose requirements on us, which, if we are unable to meet them, could adversely affect our
ability to market our products in European Union countries, and sales revenues and profitability would suffer as a consequence. In
addition, the European Parliament has enacted a directive for the restriction of the use of certain hazardous substances in electrical and
electronic equipment. This RoHS legislation restricts the use of such substances as mercury, lead, cadmium and hexavalent cadmium.
If we are unable to have our products manufactured in compliance with the RoHS directive, we would be unable to market our
products in European Union countries, and our revenues and profitability would suffer. In addition, various Asian governments could
adopt their own versions of environment-friendly electronic regulations similar to the European directives, RoHS and WEEE. This
could require new and unanticipated manufacturing changes, product testing and certification requirements, thereby increasing cost,
delaying sales and lowering revenue and profitability.
Our inability to manage growth effectively could seriously harm our business.
Growth and expansion of our business could significantly strain our capital resources as well as the time and abilities of our
management personnel. Our ability to manage growth effectively will require continued improvement of our operational, financial and
management systems and the successful training, motivation and management of our employees. If we are unable to manage growth
successfully, our business and operating results will suffer.
13
Our business operations will be severely disrupted if we lose key personnel or if we fail to attract and retain qualified personnel.
Our technology depends upon the knowledge, experience and skills of our key management and scientific and technical personnel.
Additionally, our ability to continue technological developments and to market our products, and thereby develop a competitive edge
in the marketplace, depends in large part on our ability to attract and retain qualified scientific and technical personnel. Competition
for qualified personnel is intense, and we cannot assure you that we will be able to attract and retain the individuals we need,
especially if our business expands and requires us to employ additional personnel. In addition, the loss of personnel or our failure to
hire additional personnel could materially and adversely affect our business, operating results and ability to expand. The loss of key
personnel, or our inability to hire and retain qualified personnel, would harm our business.
We may not be successful in integrating acquired companies into our business, which could materially and adversely affect our
financial condition and operating results.
Part of our business strategy has been to acquire or invest in companies, products or technologies that complement our current
products, enhance our market coverage or technical capabilities or offer growth opportunities. For any acquisition, a significant
amount of management’s time and financial resources may be required to complete the acquisition and integrate the acquired business
into our existing operations. Even with this investment of management time and financial resources, an acquisition may not produce
the revenue, earnings or business synergies anticipated. Acquisitions involve numerous other risks, including the assumption of
unanticipated operating problems or legal liabilities; problems integrating the purchased operations, technologies or products; the
diversion of management’s attention from our core businesses; restrictions on the manner in which we may use purchased companies
or assets imposed by acquisition agreements; adverse effects on existing business relationships with suppliers and customers; incorrect
estimates made in the accounting for acquisitions and amortization of acquired intangible assets that would reduce future reported
earnings (such as goodwill impairments); ensuring acquired companies’ compliance with the requirements of the U.S. federal
securities laws and accounting rules; and the potential loss of customers or key employees of acquired businesses. We cannot assure
you that any acquisitions, investments, strategic alliances or joint ventures will be completed or integrated in a timely manner or
achieve anticipated synergies, will be structured or financed in a way that will enhance our business or creditworthiness, or will meet
our strategic objectives or otherwise be successful.
We may be required to recognize impairment charges for long-lived assets.
As of December 31, 2013, the net carrying value of long-lived assets (property and equipment, deferred tax assets and other intangible
assets) totaled approximately $8.1 million. In accordance with generally accepted accounting principles, we periodically assess these
assets to determine if they are impaired. Significant negative industry or economic trends, a significant and sustained decline in our
stock price, disruptions to our businesses, significant unexpected or planned changes in our use of assets, divestitures and market
capitalization declines may result in impairments to our goodwill and other long-lived assets. Future impairment charges could
significantly affect our results of operations in the periods recognized.
Our stock is thinly traded and our stock price is volatile.
Our common stock is thinly traded, with 3,350,684 shares of our 4,974,847 outstanding shares held by non-affiliates as of February
28, 2014. Based on the trading history of our common stock and the nature of the market for publicly traded securities of companies in
evolving high-tech industries, we believe there are several factors that have caused and are likely to continue to cause the market price
of our common stock to fluctuate substantially. The fluctuations may occur on a day-to-day basis or over a longer period of time.
Factors that may cause fluctuations in our stock price include announcements of large orders obtained by us or our competitors,
substantial cutbacks in government funding of highway projects or of the potential availability of alternative technologies for use in
traffic control and safety, quarterly fluctuations in our financial results or the financial results of our competitors, consolidation among
our competitors, fluctuations in stock market prices and volumes, and the volatility of the stock market.
Difficult and volatile conditions in the capital, credit and commodities markets and in the overall economy could continue to
adversely affect our financial position, results of operations and cash flows, and we do not know if these conditions will improve in
the near future.
Our financial position, results of operations and cash flows could continue to be adversely affected by difficult conditions and
significant volatility in the capital, credit and commodities markets and in the overall worldwide economy. Although certain economic
conditions in the United States have improved or shown signs of improvement, economic growth has been slow and uneven. In recent
years, the weak global economic conditions, particularly in the U.S. and Europe, have negatively affected our sales and profitability.
During economic downturns, governmental entities in particular, which constitute most of our end users, reduce or delay their
purchase of our products, which has had and may continue to have an adverse effect on our business. Any uncertainty about the
federal budget in the U.S. could have a negative effect on the U.S. and global economy. The continuing impact that these factors
might have on us and our business is uncertain and cannot be estimated at this time. Current economic conditions have accentuated
14
each of these risks and magnified their potential effect on us and our business. The difficult conditions in these markets and the overall
economy affect our business in a number of ways. For example:
• Although we believe we have sufficient liquidity under our financing arrangements to run our business, under extreme
market conditions, there can be no assurance that such funds would be available or sufficient, and, in such a case, we
may not be able to successfully obtain additional financing on favorable terms, or at all.
• Continuing market volatility has exerted downward pressure on our stock price, which could make it more difficult or
unfavorable for us to raise additional capital in the future.
•
Economic conditions could result in customers in our markets continuing to experience financial difficulties, including
limited liquidity and their inability to obtain financing or electing to limit spending because of the economy which may
result, for example, in customers’ inability to pay us at all or on a timely basis and in declining tax revenue for our
customers that are governmental entities, which in turn could result in decreased sales and earnings for us.
We do not know if market conditions or the state of the overall economy will improve in the near future, when improvement will
occur or if any improvement will benefit our market segment.
Our articles of incorporation and bylaws and Minnesota law may inhibit a takeover that shareholders consider favorable.
Provisions of our articles of incorporation and bylaws and applicable provisions of Minnesota law may delay or discourage
transactions involving an actual or potential change in our control or change in our management, including transactions in which
shareholders might otherwise receive a premium for their shares or transactions that our shareholders might otherwise deem to be in
their best interests. These provisions:
•
•
•
•
permit our board of directors to issue up to 5,000,000 shares of preferred stock with any rights, preferences and
privileges as it may designate, including the right to approve an acquisition or other change in our control;
provide that the authorized number of directors may be increased by resolution of the board of directors;
provide that all vacancies, including newly-created directorships, may, except as otherwise required by law, be filled by
the affirmative vote of a majority of directors then in office, even if less than a quorum; and
eliminate cumulative voting rights, therefore allowing the holders of a majority of the shares of common stock entitled to
vote in any election of directors to elect all of the directors standing for election, if they should so choose.
Section 302A.671 of the Minnesota Business Corporation Act (“MBCA”) generally limits the voting rights of a shareholder acquiring
a substantial percentage of our voting shares in an attempted takeover or otherwise becoming a substantial shareholder of our
company unless holders of a majority of the voting power of all outstanding shares and the disinterested shares approve full voting
rights for the substantial shareholder. Section 302A.673 of the MBCA generally limits our ability to engage in any business
combination with certain persons who own 10% or more of our outstanding voting stock or any of our associates or affiliates who at
any time in the past four years have owned 10% or more of our outstanding voting stock. These provisions of the MBCA may have
the effect of entrenching our management team and may deprive shareholders of the opportunity to sell their shares to potential
acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our
common stock.
In addition, in June 2013, we adopted a shareholder rights plan and declared a dividend to our shareholders of one preferred share
purchase right for each outstanding share of common stock. Generally, the shareholder rights plan provides that if a person or group
acquires 20% or more of our outstanding shares of common stock, subject to certain exceptions and under certain circumstances, the
rights may be exchanged by us for common stock or the holders of the rights, other than the acquiring person or group, could acquire
additional shares of our capital stock at a discount of the then current market price. Such exchanges or exercise of rights could cause
substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a
shareholder rights plan often delays or makes a merger, tender offer or other acquisition more difficult to complete.
We can issue shares of preferred stock without shareholder approval, which could adversely affect the rights of common
shareholders.
Our articles of incorporation permit our board of directors to establish the rights, privileges, preferences and restrictions, including
voting rights, of future series of our preferred stock and to issue such stock without approval from our shareholders. The rights of
holders of our common stock may suffer as a result of the rights granted to holders of preferred stock that may be issued in the future.
15
In addition, we could issue preferred stock to prevent a change in control of our company, depriving common shareholders of an
opportunity to sell their stock at a price in excess of the prevailing market price.
We do not intend to declare cash dividends on our stock in the foreseeable future.
We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate
declaring or paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends on our common
stock will be at the discretion of our board of directors and will depend upon our operating results, earnings, current and anticipated
cash needs, capital requirements, financial condition, future prospects, any contractual restrictions and any other factors deemed
relevant by our board of directors. Therefore, shareholders should not expect to receive dividend income from shares of our common
stock.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Properties
We currently lease and occupy approximately 20,000 square feet in St. Paul, Minnesota for our headquarters. In February 2014, we
entered into an amendment to the lease for our headquarters which expands the leased space to approximately 26,775 square feet,
extends the term of the lease to July 2020, and gives us the right to further extend the term of the lease for one additional five-year
term. Our office in suburban north London, United Kingdom consists of 17,000 square feet of space, and our lease for this space
expires at our option in January 2015. We also lease smaller facilities in Canada, Hong Kong, China, Germany, Spain, Romania and
Poland.
We believe that our current space is generally adequate to meet our current expected needs, and we do not intend to lease significantly
more space in 2014.
Item 3. Legal Proceedings
We are involved in legal actions and claims relating to various matters. Although we are unable to predict the ultimate outcome of
these legal actions and claims, it is the opinion of management that the disposition of these matters, taken as a whole, will not have a
material adverse effect on our Consolidated Financial Statements.
Item 4. Mine Safety Disclosures
Not applicable.
16
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Market Information
Our common stock is traded on The NASDAQ Capital 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.
Quarter
First
Second
Third
Fourth
Shareholders
2013
2012
High
Low
High
Low
$
7.39
8.28
7.70
6.00
$
4.78
6.50
4.62
4.29
$
7.26
7.80
5.48
5.30
$
6.02
4.64
4.61
4.57
As of February 28, 2014, there were 19 holders of record of our common stock. The number of holders of record is based upon the
actual number of holders registered at such date and does not include holders of shares in “street names” or persons, partnerships,
associates, corporations, or other entities identified in security position listings maintained by depositories.
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.
Debt Covenants
Our credit agreement includes certain financial covenants, including minimum debt service ratios, minimum cash flow coverage
ratios, and other financial measures. These financial covenants may restrict our ability to pay dividends and purchase outstanding
shares of common stock. At December 31, 2013 and December 31, 2012, we were in compliance with these financial covenants.
Information on our debt agreements is included in Item 7 of this Annual Report on Form 10-K.
17
Item 6.
Selected Financial Data
The following table sets forth selected consolidated financial data for each of the five fiscal years ended December 31, 2013. The
statement of income and balance sheet data for the years ended and as of December 31, 2013, 2012, 2011, 2010 and 2009 are derived
from our audited Consolidated Financial Statements. The following information should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and with our Consolidated Financial Statements and the
related notes thereto included elsewhere in this Annual Report on Form 10-K.
2013
2010
2011
2012
(in thousands, except per share data)
2009
Consolidated Statement of Operations Data:
Revenue:
Product sales
Royalties
Cost of revenue:
Product sales
Restructuring
Gross profit
Operating expenses:
Selling, marketing and product support
General and administrative
Research and development
Investigation matter
Amortization of intangible assets
Restructuring
Goodwill impairment
Acquisition related expenses (income)
Income (loss) from operations
Other income (expense), net
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Net income (loss) per share:
Basic
Diluted
Weighted average number of common shares outstanding:
Basic
Diluted
Consolidated Balance Sheet Data:
Total assets
Bank debt
Total shareholders' equity
$
$
$
$
$
12,564
12,399
24,963
6,706
—
6,706
18,257
7,289
5,167
4,135
—
1,622
430
3,175
—
21,818
(3,561)
29
(3,532)
(180)
(3,352)
(0.69)
(0.69)
4,886
4,886
38,536
—
33,980
$
$
$
$
$
17,475
13,046
30,521
8,769
448
9,217
21,304
10,609
6,315
4,424
—
1,650
287
11,685
(618)
34,352
(13,048)
9
(13,039)
(3,022)
(10,017)
(2.07)
(2.07)
4,834
4,834
41,254
—
36,326
$
$
$
$
$
19,162
12,519
31,681
7,799
—
7,799
23,882
9,807
4,372
3,630
—
1,218
—
—
817
19,844
4,038
(123)
3,915
910
3,005
0.66
0.64
4,555
4,667
54,356
—
46,021
12,483
12,110
24,593
4,297
—
4,297
20,296
7,201
3,779
3,336
—
768
—
—
—
15,084
5,212
7
5,219
1,354
3,865
0.97
0.95
3,985
4,081
41,150
4,000
32,713
$
$
$
$
$
$
$
$
$
$
14,692
11,598
26,290
9,889
—
9,889
16,401
11,768
6,290
5,036
3,723
1,554
—
—
—
28,371
(11,970)
6
(11,964)
3,937
(15,901)
(3.21)
(3.21)
4,955
4,955
24,385
—
18,514
18
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the
Selected Financial Data and our financial statements and the accompanying notes included elsewhere in this Annual Report on Form
10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion
as a result of certain factors, including, but not limited to, those discussed in “Risk Factors” and “Information Regarding
Forward-Looking Statements” included elsewhere in this Annual Report on Form 10-K.
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 License Plate Recognition (“LPR”) System, operate using
our proprietary application software in conjunction with video cameras or radar and commonly available electronic components. Our
systems are used by traffic managers primarily to improve the flow of vehicle traffic and to enhance safety at intersections, main
thoroughfares, freeways and tunnels and by parking and toll managers and law enforcement officials to read license plates for various
safety, security, access and enforcement LPR applications.
Autoscope® video and radar systems are sold to distributors and end users of traffic management products in North America, the
Caribbean and Latin America by Econolite Control Products, Inc. (“Econolite”), our exclusive licensee in these regions. We sell LPR
systems to distributors and end users in North America. We sell all of our systems to distributors and end users in Europe and Asia
through our European and Hong Kong subsidiaries, respectively. The majority of our sales are to end users that are funded by
government agencies responsible for traffic management or traffic law enforcement.
Autoscope® Radar Business Model Change. Beginning in 2012, we changed part of our Autoscope® radar business model by
granting an exclusive license to manufacture and distribute Autoscope® radar products in North America to Econolite under terms
substantially the same as our Autoscope royalty arrangement. In conjunction with this agreement, certain of our sales and marketing
employees dedicated to Autoscope® radar became employed directly by Econolite. As a result, in 2012, revenue earned from sales of
Autoscope® radar in North America are in the form of a royalty rather than a sale directly to the purchaser, and there is no cost of
revenue in 2012 and future periods, as Econolite is now responsible for manufacturing and post-sales support, except for transitional
legacy items.
Simultaneously with the Autoscope® radar changes, we restructured aspects of our North American Autoscope® radar and LPR
businesses. Most significantly, the assembly of our Autoscope® radar product was moved from our Toronto facility to a third party,
and our production and administrative support headcount was reduced early in 2012.
Trends and Challenges in Our Business
We believe the 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;
19
•
•
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 (2012 and later) systems in North America, the Caribbean and Latin America and (2) revenue received from the
direct sales of our Autoscope® radar (2011 and before) and LPR systems in North America, the Caribbean and Latin America and all
of our systems in Europe and Asia. Royalties are calculated using a profit sharing model where the gross profits on sales of product
made through Econolite are shared equally with Econolite. This royalty arrangement has the benefit of decreasing our cost of revenues
and our selling, marketing and product support expenses because these costs and expenses are borne primarily by Econolite. Although
this royalty model has a positive impact on our gross margin, it also negatively impacts our total revenue, which would be higher if all
the sales made by Econolite were made directly by us. The royalty arrangement is exclusive under a long-term agreement.
Cost of Revenue. There is no cost of revenue related to royalties, as virtually all manufacturing, warranty and related costs are incurred
by Econolite. Cost of revenue related to product sales consists primarily of the amount charged by our third party contractors to
manufacture hardware platforms, which is influenced mainly by the cost of electronic components. The cost of revenue also includes
logistics costs, estimated expenses for product warranties, restructuring costs and inventory reserves. The key metric that we follow is
achieving certain gross margin percentages on product sales by geographic region and to a lesser extent by product line.
Operating Expenses. Our operating expenses fall into three categories: (1) selling, marketing and product support; (2) general and
administrative; and (3) research and development. Selling, marketing and product support expenses consist of various costs related to
sales and support of our products, including salaries, benefits and commissions paid to our personnel; commissions paid to third
parties; travel, trade show and advertising costs; second-tier technical support for Econolite; and general product support, where
applicable. General and administrative expenses consist of certain corporate and administrative functions that support the development
and sales of our products and provide an infrastructure to support future growth. These expenses include management, supervisory and
staff salaries and benefits, legal and auditing fees, travel, rent and costs associated with being a public company, such as board of
director fees, listing fees and annual reporting expenses. Research and development expenses consist mainly of salaries and benefits
for our engineers and third party costs for consulting and prototyping. We measure all operating expenses against our annually
approved budget, which is developed with achieving a certain operating margin as a key focus. Also included in operating expenses
are acquisition related expenses, income related to the earn-out reversal, impairment charges, restructuring costs and non-cash expense
for intangible asset amortization.
Non-GAAP Operating Measure. We prepare our consolidated financial statements in accordance with U.S. generally accepted
accounting principles (“GAAP”). However, we use Non-GAAP Income (Loss) from Operations to analyze our business. We define
Non-GAAP Income (Loss) from Operations as income (loss) from operations before amortization of intangible assets, investigation
matter expense, restructuring expense, and goodwill impairment for the applicable periods. Management believes Non-GAAP Income
(Loss) from Operations is a useful indicator of our financial performance and our ability to generate cash flows from operations. Our
definition of Non-GAAP Income (Loss) from Operations may not be comparable to similarly titled definitions used by other
companies. The table below reconciles Non-GAAP Income (Loss) from Operations, which is a non-GAAP financial measure, to
comparable GAAP financial measures:
20
Income (loss) from operations
Amortization of intangible assets
Investigation matter
Restructuring charges
Goodwill impairment
Year Ended
December 31,
2013
$(11,970)
2012
$(3,561)
2011
$(13,048)
1,554
3,723
--
--
1,622
--
430
3,175
1,650
--
287
11,685
Non-GAAP income (loss) from operations
$(6,693)
$1,666
$574
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.
The following tables set forth selected unaudited financial information for each of our reportable segments (in thousands):
For the year ended December 31, 2013
Intersection
Highway
LPR
Total
Revenue
Gross profit
Amortization of intangible assets
Intangible assets
$
13,428
11,559
—
—
$
6,414
1,862
488
942
$
6,448
2,980
1,066
5,521
$
26,290
16,401
1,554
6,463
For the year ended December 31, 2012
Intersection
Highway
LPR
Total
Revenue
Gross profit
Goodwill impairment
Amortization of intangible assets
Intangible assets
$
16,031
14,010
—
—
—
$
4,118
1,798
1,372
748
1,430
$
4,814
2,449
1,803
874
5,059
$
24,963
18,257
3,175
1,622
6,489
For the year ended December 31, 2011
Intersection
Highway
LPR
Total
Revenue
Gross profit
Goodwill impairment
Amortization of intangible assets
Intangible assets and goodwill
$
17,445
15,096
525
—
—
$
7,366
3,512
7,392
768
3,551
$
5,710
2,696
3,768
882
7,457
$
30,521
21,304
11,685
1,650
11,008
21
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
profit on product sales and royalties as a percentage of international sales and royalties, respectively.
Product sales
Royalties
Total revenue
Gross profit - product sales
Gross profit - royalties
Selling, marketing and product support
General and administrative
Research and development
Investigation matter
Amortization of intangible assets
Goodwill impairment
Restructuring charges
Acquisition related expenses (income)
Loss from operations
Income tax expense (benefit)
Net loss
Year Ended December 31,
2013
2012
2011
%
55.9
44.1
100.0
32.7
100.0
44.8
23.9
19.2
14.2
5.9
—
—
—
(45.5)
15.0
(60.5)
%
50.3
49.7
100.0
46.6
100.0
29.2
20.7
16.6
—
6.5
12.7
1.7
—
(14.3)
(0.7)
(13.4)
%
57.3
42.7
100.0
47.3
100.0
34.8
20.7
14.5
—
5.4
38.3
0.9
(2.0)
(42.8)
(9.9)
(32.8)
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012. Total revenue increased to $26.3 million in 2013
from $25.0 million in 2012, an increase of 5.3%. Royalty income decreased to $11.6 million in 2013 from $12.4 million in 2012, a
decrease of 6.5%. 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 2013 compared to 2012 as a result of lower unit volume.
Product sales increased to $14.7 million in 2013 from $12.6 million in 2012, an increase of 16.9%. The increase in product sales was
mainly due to higher sales volume in Europe and Asia.
Revenue for the Intersection segment decreased to $13.4 million in 2013 from $16.0 million in 2012, a decrease of 16.2%. The
increase in the Intersection segment was mainly due to lower sales volume in Europe.
Revenue for the Highway segment increased to $6.4 million in 2013 from $4.1 million in 2012, an increase of 55.8%. The increase in
Highway was due mainly to higher sales worldwide.
Revenue for the LPR segment increased to $6.4 million in 2013 from $4.8 million in 2012, an increase of 33.9%. The increase in
revenue for the LPR segment in 2013 over 2012 is due to higher sales volumes in North America and Europe.
Gross profit for product sales decreased to 32.7% in 2013 from 46.6% in 2012. 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 profit. Generally, lower sales volumes of Highway or LPR products will reduce gross profit because
of fixed manufacturing costs for these products. We anticipate that gross profit for our product sales will be higher in 2014 as
compared to 2013, while we expect royalty gross profit will be 100% in 2014.
Selling, marketing and product support expense increased to $11.8 million or 44.8% of total revenue in 2013 from $7.3 million or
29.2% of total revenue in 2012. Our selling, marketing and product support expense increased mainly due to our investments in
additional sales and marketing resources. We anticipate that annual selling, marketing and product support expense will increase in
dollar amount in 2014 as compared to 2013.
General and administrative expense increased to $6.3 million or 23.9% of total revenue in 2013, from $5.2 million or 20.7% of total
revenue in 2012. General and administrative expenses increased in 2013 mainly as a result of legal and other professional fees related
to the investigation and remediation actions described in Note 15 of our Notes to Consolidated Financial Statements set forth
elsewhere in this Annual Report on Form 10-K and severance costs related to the separation from former employees. Our direct costs
22
related to the investigation were approximately $3.7 million for the year ended December 31, 2013 and immaterial in 2012. We are
unable to determine the likely outcome or range of loss, if any, from the investigation, or predict with certainty the timeline for
resolution of the investigation. We anticipate that annual general and administrative expenses will decrease as a percentage of revenue
in 2014 as compared to 2013.
Research and development expense increased to $5.0 million or 19.2% of total revenue in 2012, from $4.1 million or 16.6% of total
revenue in 2012. The increase was mainly related to the increased expenditures on new research and development projects, the
acceleration of previously existing projects and other product developments.
Amortization of intangibles was $1.6 million in both 2013 and 2012 and reflects the amortization of intangible assets acquired in
acquisitions. Assuming there are no changes to our intangible assets, we anticipate amortization expense will be approximately $1.8
million in 2014.
Other income, net was $6,000 and $29,000 in 2013 and 2012, respectively, primarily consisting of interest income.
Income tax expense of $3.9 million, or 33.3% of our pretax loss, was recorded for the year ended December 31, 2013, compared to
income tax benefit of $180,000, or 5.4% of pretax loss, for the year ended December 31, 2012. The income tax expense increase is
primarily driven by the recognition of a valuation allowance of $8.1 million for the United States and United Kingdom jurisdictions in
2013.
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011. Total revenue decreased to $25.0 million in 2012
from $30.5 million in 2011, a decrease of 18.2%. Royalty income decreased to $12.4 million in 2012 from $13.0 million in 2011, a
decrease of 5.0%. The decrease in royalties was the result of a decrease in Autoscope® video royalties slightly offset by the inclusion
of Autoscope® radar royalties as a result of changing our Autoscope® radar product line to a royalty business model in January 2012.
Autoscope® video royalties were lower in 2012 compared to 2011 as a result of lower unit volume. Product sales decreased to $12.6
million in 2012 from $17.5 million in 2011, a decrease of 28.1%. The decrease in product sales was mainly due to the Autoscope®
radar model change and to a lesser extent lower sales volume in Europe resulting, in part, from economic pressures. Revenue for the
Intersection segment decreased to $16.0 million in 2012 from $17.4 million in 2011, a decrease of 8.1%. Revenue for the Highway
segment decreased to $4.1 million in 2012 from $7.4 million in 2011, a decrease of 44.1%. The decrease in LPR was due to lower
sales volume in North America and, to a lesser extent, in Europe. The decrease in the Highway segment was due mainly to the
business model change that resulted in revenues in the form of a royalty rather than a direct product sale to a purchaser. Revenue for
the LPR segment decreased to $4.8 million in 2012 from $5.7 million in 2011, a decrease of 15.7%. This was due to lower sales
volume in 2012 and is reflective of a difficult environment for selling security applications to government customers in Europe and the
United States that we believed was caused by constrained government budgets.
Gross margins for product sales decreased to 46.6% in 2012 from 47.3% in 2011. Gross margins for the LPR product line have
historically been lower than gross margins for the Intersection and Highway product lines and therefore the mix of the product lines in
any given period can result in varying margins. Generally, lower sales volumes of Highway or LPR products will reduce gross
margins because of fixed manufacturing costs for these products. The decrease in gross margins for 2012 compared to 2011 was
reflective of lower sales volume. Additionally, during 2012, we recorded a $200,000 lower of cost or market adjustment to inventory
procured for a subsequently cancelled order. Gross margins on royalty income remained consistent at 100.0% in 2012 and 2011.
Selling, marketing and product support expense decreased to $7.3 million or 29.2% of total revenue in 2012 from $10.6 million or
34.8% of total revenue in 2011. Our selling, marketing and product support expense decreased mainly due to the workforce reduction
resulting from restructuring activities and the Autoscope® radar business model change.
General and administrative expense decreased to $5.2 million or 20.7% of total revenue in 2012, from $6.3 million or 20.7% of total
revenue in 2011. General and administrative expenses decreased in 2012 mainly as a result of restructuring initiatives, partially offset
by severance for the separation of our former President and Chief Executive Officer, and the Autoscope® radar business model
change.
Research and development expense decreased to $4.1 million or 16.6% of total revenue in 2012, down from $4.4 million or 14.5% of
total revenue in 2012. The decrease was mainly related to decreased expenditures on our hybrid product development.
We recognized goodwill impairment charges in 2012 and 2011 of $3.2 million and $11.7 million, respectively, that were triggered by
significant declines in our market capitalization.
As discussed above, beginning in January 2012, we changed our North American business model for the Autoscope® radar product
line and undertook restructuring initiatives. In June 2012, we expanded the restructuring initiative to include aspects of our Europe-
based LPR business and our non-China Asian business. The majority of restructuring expense recognized in 2012 related to employee
severance.
23
Amortization of intangibles expense was $1.6 million in both 2012 and 2011 and reflects the amortization of intangible assets acquired
in acquisitions.
Other income, net was $29,000 and $9,000 in 2012 and 2011, respectively, primarily consisting of interest income.
Income tax benefit of $180,000, or 5.4% of our pretax loss, was recorded for the year ended December 31, 2012, compared to income
tax benefit of $3.0 million, or 23.2% of pretax loss, for the year ended December 31, 2011. The decrease in the effective rate resulted
from the nondeductible goodwill impairment charge, nondeductible stock option expense and valuation for net operating losses in
certain jurisdictions.
Liquidity and Capital Resources
At December 31, 2013, we had $3.6 million in cash and cash equivalents and $2.6 million in short-term investments, compared to $8.3
million in cash and cash equivalents and $4.8 million in short-term investments at December 31, 2012. Our investment objectives are
to preserve principal, maintain liquidity, and achieve the best available return consistent with the primary objectives of safety and
liquidity.
Net cash used for operating activities was $5.5 million in 2013, compared to cash provided of $5.9 million in 2012 and cash used of
$1.3 million in 2011. The primary reasons for the decrease in cash were the on-going expenses related to the investigation and
investments made in the Company’s product offerings. The primary reasons for the increase in cash in 2012 were collections of
outstanding receivables and conversions of inventory, mostly driven by the transition to the Autoscope® radar royalty structure, offset
by reductions in payables and the generation of operating income after taking into account non-cash charges for goodwill impairment,
depreciation and amortization. We anticipate that average receivable collection days in 2014 will be similar to 2013 and that it will not
have a material impact on our liquidity.
Net cash provided by investing activities was $791,000 in 2013, compared to cash used in investing activities of $3.2 million and $1.4
million in 2012 and 2011, respectively. Our planned additions of property and equipment are discretionary, and we do not expect them
to exceed historical levels in 2014.
Net cash provided by financing activities was $9,000 in 2013, compared to cash provided of $121,000 and $105,000 in 2012 and
2011, respectively.
We have a revolving line of credit with Associated Bank, National Association (“Associated Bank”) that was initially entered into as
of May 1, 2008. Our current revolving line of credit agreement (“Credit Agreement”) with Associated Bank provides up to $5.0
million of credit. The Credit Agreement expires in May 2014 and bears interest at an annual rate equal to the greater of (a) 4.5% or
(b) LIBOR plus 2.75%. Any advances are secured by inventories, accounts receivable and equipment. We are subject to certain
financial covenants under the Credit Agreement, including minimum debt service coverage ratios, minimum cash flow coverage ratios
and financial measures. At December 31, 2013, we had no borrowings under the Credit Agreement, and we were in compliance with
all financial covenants.
We believe that cash and cash equivalents on hand at December 31, 2013, 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 Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K are prepared in accordance with U.S.
generally accepted accounting principles (“GAAP”), which require us to make estimates and assumptions in certain circumstances that
affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain
amounts, giving due consideration to materiality. We believe that of our significant accounting policies, the following are particularly
important to the portrayal of our results of operations and financial position, may require the application of a higher level of judgment
by our management, and as a result, are subject to an inherent degree of uncertainty. For further information see Note 1 to the
Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Revenue Recognition and Allowance for Doubtful Accounts. We are required to comply with a variety of technical accounting
requirements in order to achieve consistent and accurate revenue recognition. Royalty income is recognized based on sales shipped or
24
delivered to our customers as reported to us by Econolite. Revenue is recognized when both product ownership and the risk of loss
have transferred to the customer and we have no remaining obligations. Allowances for doubtful accounts are estimated by
management based on an evaluation of potential losses related to customer receivable balances. We determine the allowance based on
historical write-off experience in the industry, regional economic data, and an evaluation of specific customer accounts for risk of loss.
We review our allowance for doubtful accounts monthly. Account balances are charged off against the allowance when we believe it
is probable the receivable will not be recovered. We do not have any off-balance sheet credit exposure related to our customers. The
establishment of this reserve requires the use of judgment and assumptions regarding the potential for losses on receivable balances.
Although management considers these balances adequate and proper, changes in economic conditions in specific markets in which we
operate could have an effect on reserve balances required.
Inventories. We maintain a material amount of inventory to support our engineering and manufacturing operations. This inventory is
stated at the lower of cost or market. On a regular basis, we review our inventory and identify that which is excess, slow moving, and
obsolete by considering factors such as inventory levels, expected product life, and forecasted sales demand. Any identified excess,
slow moving, and obsolete inventory is written down to its market value through a charge to income from operations. It is possible
that additional inventory write-down charges may be required in the future if there is a significant decline in demand for our products.
Impairment of Long-Lived Assets. We review the carrying value of long-lived assets or asset groups, such as property and equipment
and intangibles subject to amortization, when events or changes in circumstances such as asset utilization, physical change, legal
factors, or other matters indicate that the carrying value may not be recoverable. When this review indicates the carrying value of an
asset or asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the
asset or asset group, we recognize an asset impairment charge against operations. The amount of the impairment loss recorded is the
amount by which the carrying value of the impaired asset or asset group exceeds its fair value.
Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment
to identify events or changes in circumstances indicating the carrying value of assets may not be recoverable, estimate future cash
flows, estimate asset fair values, and select a discount rate that reflects the risk inherent in future cash flows. Expected cash flows
may not be realized, which could cause long-lived assets to become impaired in future periods and could have a material adverse
effect on future results of operations.
Warranty Liabilities. The estimated cost to service warranty and customer service claims is included in cost of sales. This estimate is
based on historical trends of warranty claims. We regularly assess and adjust the estimate of accrued warranty claims by updating
claims rates for actual trends and projected claim costs. Our warranty liability contains uncertainties because our warranty obligations
cover an extended period of time. While these liability levels are based on historical warranty experience, they may not reflect the
actual claims that will occur over the upcoming warranty period, and additional warranty reserves may be required. A revision of
estimated claim rates or the projected cost of materials and freight associated with sending replacement parts to customers could have
a material adverse effect on future results of operations.
Income Taxes. We record a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax
assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which
those deferred tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce deferred tax
assets to the amount that is believed more likely than not to be realized. We believe it is more likely than not that forecasted income,
including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax
liabilities, will be sufficient to fully recover the remaining net realizable value of our deferred tax assets. In the event that all or part of
the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged
to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in
estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner
inconsistent with management’s expectations could have a material impact on our financial condition and operating results.
New and Recently Adopted Accounting Pronouncements
We do not anticipate that recently issued accounting guidance that has not yet been adopted will have a material impact on our
consolidated financial statements.
25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
Approximately 40% of our revenue has historically been derived from shipments to customers outside of the United States, and a large
portion of this revenue is denominated in currencies other than the U.S. dollar. Our international subsidiaries have functional
currencies other than our U.S. dollar reporting currency and, occasionally, transact business in currencies other than their functional
currencies. These non-functional currency transactions expose us to market risk on assets, liabilities and cash flows recognized on
these transactions.
The strengthening of the U.S. dollar relative to foreign currencies decreases the value of foreign currency-denominated revenue and
earnings when translated into U.S. dollars. Conversely, a weakening of the U.S. dollar increases the value of foreign
currency-denominated revenue and earnings. A 10% adverse change in foreign currency rates, if we have not properly hedged, could
have a material effect on our results of operations or financial position.
26
Item 8.
Financial Statements and Supplementary Data
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents
Marketable securities
Accounts receivable, net of allowance for doubtful accounts of $1,173 and $796, respectively
Inventories
Prepaid expenses and other current assets
Deferred income taxes
$
Total current assets
Property and equipment:
Furniture and fixtures
Leasehold improvements
Equipment
Accumulated depreciation
Deferred income taxes
Intangible assets, net
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable
Accrued compensation
Warranty and other current liabilities
Total current liabilities
Deferred income taxes
Other long-term liabilities
Shareholders' equity
$
$
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued or outstanding
Common stock, $.01 par value; 20,000,000 shares authorized, 4,974,847 and 4,966,619 issued and
outstanding, respectively
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Total shareholders' equity
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
See accompanying notes to the consolidated financial statements.
$
27
December 31,
2013
2012
3,564
2,639
5,252
3,589
1,414
—
16,458
620
511
3,988
5,119
4,094
1,025
139
6,463
300
24,385
2,409
1,202
1,959
5,570
175
126
—
49
23,276
604
(5,415)
18,514
24,385
$
$
$
$
8,334
4,817
6,722
4,485
1,611
186
26,155
461
471
4,427
5,359
3,484
1,875
4,017
6,489
—
38,536
2,112
949
1,086
4,147
241
168
—
49
23,055
390
10,486
33,980
38,536
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share data)
Years ended December 31,
2012
2011
2013
Revenue:
Product sales
Royalties
Cost of revenue:
Product sales
Restructuring
Gross profit
Operating expenses:
Selling, marketing and product support
General and administrative
Research and development
Investigation matter
Amortization of intangible assets
Restructuring
Goodwill impairment
Acquisition related income
Loss from operations
Other income, net
Loss before income taxes
Income tax expense (benefit)
Net loss
Net loss per share:
Basic
Diluted
Weighted average number of common shares outstanding:
Basic
Diluted
$
$
$
$
$
$
$
$
14,692
11,598
26,290
9,889
—
9,889
16,401
11,768
6,290
5,036
3,723
1,554
—
—
—
28,371
(11,970)
6
(11,964)
3,937
(15,901)
(3.21)
(3.21)
4,955
4,955
$
$
$
$
12,564
12,399
24,963
6,706
—
6,706
18,257
7,289
5,167
4,135
—
1,622
430
3,175
—
21,818
(3,561)
29
(3,532)
(180)
(3,352)
(0.69)
(0.69)
4,886
4,886
17,475
13,046
30,521
8,769
448
9,217
21,304
10,609
6,315
4,424
—
1,650
287
11,685
(618)
34,352
(13,048)
9
(13,039)
(3,022)
(10,017)
(2.07)
(2.07)
4,834
4,834
See accompanying notes to the consolidated financial statements.
28
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
Loss before income taxes
Other comprehensive income:
Foreign currency translation adjustment
Comprehensive loss
$
$
Years ended December 31,
2012
(3,352)
$
2011
(10,017)
570
(2,782)
$
(232)
(10,249)
2013
(15,901)
214
(15,687)
$
$
See accompanying notes to the consolidated financial statements.
29
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
Operating activities:
Net loss
Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
Years ended December 31,
2012
2013
2011
$
(15,901)
$
(3,352)
$
(10,017)
Depreciation
Amortization
Tax benefit from disqualifying dispositions
Stock-based compensation
Goodwill impairment
Deferred income tax expense (benefit)
Acquisition related income
Changes in operating assets and liabilities:
Accounts receivable, net
Inventories
Prepaid expenses and current assets
Accounts payable
Accrued expenses and other liabilities
Net cash provided by (used for) operating activities
Investing activities:
Purchases of marketable securities
Sales and maturities of marketable securities
Purchase of other investments
Capitalized software development costs
Purchases of property and equipment
Payments of earn-outs
Net cash provided by (used for) investing activities
Financing activities:
Proceeds from exercise of stock options
Net cash provided by financing activities
Effect of exchange rate on changes on cash
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
See accompanying notes to the consolidated financial statements.
673
1,554
—
213
—
4,085
—
1,470
896
197
297
999
(5,517)
(5,507)
7,685
(300)
(867)
(221)
—
790
9
9
(52)
(4,770)
8,334
3,564
$
$
727
1,622
71
244
3,175
(402)
—
2,777
1,657
33
114
(727)
5,939
(10,027)
7,303
—
—
(487)
—
(3,211)
121
121
261
3,110
5,224
8,334
548
1,650
37
412
11,685
(3,620)
(618)
(11)
(1,493)
496
(96)
(284)
(1,311)
(7,340)
9,201
—
—
(859)
(2,361)
(1,359)
105
105
(232)
(2,797)
8,021
5,224
$
30
IMAGE SENSING SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands, except share data)
Accumulated
O ther
Additional
Comprehensive
Shares
Issued
Common
Stock
Paid-In
Captal
Income
(Loss)
Retained
Earnings
Total
Balance at December 31, 2010
4,878,519
$
49
$
22,065
$
52
$
23,855
$
46,021
Tax benefit from disqualifying disposition
Common stock issued for options exercised
Stock-based compensation
Comprehensive loss:
Foreign currency translation adjustment
Net loss
Total comprehensive loss
Balance at December 31, 2011
Tax benefit from disqualifying disposition
Common stock issued for options exercised
Stock-based compensation
Comprehensive loss:
Foreign currency translation adjustment
Net loss
Total comprehensive loss
Balance at December 31, 2012
Tax benefit from disqualifying disposition
Stock awards issued
Common stock issued for options exercised
Acquisition-related shares surrendered
Stock-based compensation
Comprehensive loss:
Foreign currency translation adjustment
Net loss
Total comprehensive loss
Balance at December 31, 2013
-
32,100
-
-
-
-
4,910,619
-
56,000
-
-
-
-
4,966,619
-
13,395
2,333
(7,500)
-
-
-
-
37
105
412
-
-
-
$
49
-
-
-
22,619
$
-
-
-
(232)
-
$
(180)
-
-
-
37
105
412
-
(10,017)
-
13,838
$
(232)
(10,017)
(10,249)
36,326
$
-
-
-
71
121
244
-
-
-
-
-
-
71
121
244
-
-
-
$
49
-
-
-
23,055
$
570
-
-
390
$
-
(3,352)
-
10,486
$
570
(3,352)
(2,782)
33,980
$
-
-
-
-
-
-
75
8
-
138
-
-
-
-
-
-
-
-
-
75
8
-
138
-
-
-
4,974,847
-
-
-
$
49
-
-
-
23,276
$
214
-
-
604
$
-
(15,901)
-
(5,415)
$
214
(15,901)
(15,687)
18,514
$
See accompanying notes to the consolidated financial statements.
31
Notes to Consolidated Financial Statements
December 31, 2013
1.
DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Image Sensing Systems, Inc. (referred to herein as “we,” the “Company,” “us” and “our”) develops and markets software-based
computer enabled detection products for use in traffic, safety, security, police and parking applications. We sell our products primarily
to distributors and also receive royalties under a license agreement with a manufacturer/distributor for certain of our products. Our
products are used primarily by governmental entities.
PRINCIPLES OF CONSOLIDATION
The Consolidated Financial Statements include the accounts of Image Sensing Systems, Inc. and its wholly-owned subsidiaries: Image
Sensing Systems HK Limited (ISS HK) located in Hong Kong; Image Sensing Systems (Shenzhen) Limited (ISS WOFE) and Image
Sensing Systems HK Limited Shenzhen Representative Office located in China; Image Sensing Systems Holdings Limited (ISS
Holdings), Image Sensing Systems Europe Limited (ISS Europe), Image Sensing Systems UK Limited (ISS UK) and Image Sensing
Systems England (ISS England) located in the United Kingdom; Image Sensing Systems Europe Limited SP.Z.O.O., (ISS Poland)
located in Poland; Image Sensing Systems Spain SLU (ISS Spain) located in Spain; and ISS Image Sensing Systems Canada Limited
(ISS Canada) and ISS Canada Sales Corp. (ISS Sales) located in Canada. All significant inter-company transactions and balances have
been eliminated in consolidation.
REVENUE RECOGNITION
We recognize revenue on a sales arrangement when it is realized or realizable and earned, which occurs when all of the following
criteria have been met: persuasive evidence of an arrangement exists; delivery and title transfer has occurred or services have been
rendered; the sales price is fixed and determinable; collectability is reasonably assured; and all significant obligations to the customer
have been fulfilled.
Certain sales may contain multiple elements for revenue recognition purposes. We consider each deliverable that provides value to the
customer on a standalone basis as a separable element. Separable elements in these arrangements may include the hardware, software,
installation services, training and support. We initially allocate consideration to each separable element using the relative selling price
method. Selling prices are determined by us based on either vendor-specific objective evidence (“VSOE”) (the actual selling prices of
similar products and services sold on a standalone basis) or, in the absence of VSOE, our best estimate of the selling price. Factors
considered by us in determining estimated selling prices for applicable elements generally include overall economic conditions,
customer demand, costs incurred by us to provide the deliverable, as well as our historical pricing practices. Under these
arrangements, revenue associated with each delivered element is recognized in an amount equal to the lesser of the consideration
initially allocated to the delivered element or the amount for which payment is not deemed contingent upon future delivery of other
elements in the arrangement. Under arrangements where special acceptance protocols exist, installation services and training may not
be considered separable. Under those circumstances, revenue for the entire arrangement is recognized upon the completion of
installation, training and fulfillment of any other significant obligations specific to the terms of the arrangement. Arrangements that do
not contain any separable elements are typically recognized when the products are shipped and title has transferred to the customer.
Revenue from arrangements for services such as maintenance, repair, consulting and technical support are recognized either as the
service is performed or ratably over the defined contractual period for service maintenance contracts.
Econolite Control Products, Inc. (Econolite) is our licensee that sells certain of our products in North America, the Caribbean and
Latin America. The royalty of approximately 50% of the gross profit on licensed products is recognized when the products are shipped
or delivered by Econolite to its customers.
We record provisions against sales revenue for estimated returns and allowances in the period when the related revenue is recorded
based on historical sales returns and changes in end user demand.
Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes
recorded as current liabilities until remitted to the relevant government authority.
32
SHIPPING AND HANDLING
Freight revenue billed to customers is reported within revenue on the Consolidated Statements of Operations, and expenses incurred
for shipping products to customers are reported within cost of revenue on the Consolidated Statements of Operations.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents.
Cash equivalents, both inside and outside the United States, are invested in money market funds and bank deposits in local currency
denominations. Cash located in foreign banks was $1.8 million and $2.6 million at December 31, 2013 and 2012, respectively. We
hold our cash and cash equivalents with financial institutions and, at times, the amounts of our balances may be in excess of insurance
limits.
MARKETABLE SECURITIES
We classify marketable debt securities as available-for-sale investments and these securities are stated at their estimated fair value.
The value of these securities is subject to market and credit volatility during the period these investments are held.
ACCOUNTS RECEIVABLE
We grant credit to customers in the normal course of business and generally do not require collateral from domestic customers. When
deemed appropriate, receivables from customers outside the United States are supported by letters of credit from financial institutions.
Management performs on-going credit evaluations of customers. The allowance for doubtful accounts is based on management’s
assessment of the collectability of specific customer accounts and includes consideration of the credit worthiness and financial
condition of those specific customers. We record an allowance to reduce receivables to the amount that is reasonably believed to be
collectible and consider factors such as the financial condition of the customer and the aging of the receivables. If there is a
deterioration of a customer’s financial condition, if we become aware of additional information related to the credit worthiness of a
customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, we may have to adjust
our allowance for doubtful accounts, which would affect earnings in the period the adjustments were made.
INVENTORIES
Inventories are primarily electronic components and finished goods and are valued at the lower of cost or market determined under the
first-in, first-out accounting method.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Additions, replacements, and improvements are capitalized at cost, while maintenance and
repairs are charged to operations as incurred. Depreciation is recorded using the straight-line method over the estimated useful lives
of the assets. Leasehold improvements are depreciated over the shorter of the estimated useful lives of the assets or the contractual
term of the lease, with consideration of lease renewal options if renewal appears probable. Depreciation is recorded over a three- to
seven-year period for financial reporting purposes and by accelerated methods for income tax purposes.
INCOME TAXES
We record a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities
are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax
assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount
that is believed more likely than not to be realized. We believe it is more likely than not that forecasted income, including income that
may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be
sufficient to fully recover the remaining net realizable value of deferred tax assets. In the event that all or part of the net deferred tax
assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the
period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact
of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s
expectations could have a material impact on our financial condition and operating results. We recognize penalties and interest
expense related to unrecognized tax benefits in income tax expense.
33
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of acquisition costs over the fair value of the net assets of businesses acquired. Goodwill is not
amortized, but instead tested at least annually for impairment. Goodwill is also tested for impairment as changes in circumstances
occur indicating that the carrying value may not be recoverable.
Goodwill impairment testing first requires a comparison of the fair value of each reporting unit to the carrying value. If the carrying
value of the reporting unit exceeds fair value, goodwill is considered impaired. Impairment testing for indefinite-lived intangible
assets requires a comparison between the fair value and the carrying value of the asset. If the carrying value of the asset exceeds its
fair value, the asset is reduced to fair value. See Note 4 to the Consolidated Financial Statements for additional information on
goodwill.
Intangible assets with finite lives are amortized on a straight-line basis over the expected period to be benefited by future cash flows
and reviewed for impairment. At both December 31, 2013 and 2012, we determined there was no impairment of intangible assets. At
both December 31, 2013 and 2012, there were no indefinite-lived intangible assets.
We capitalize certain software development costs related to software to be sold, leased, or otherwise marketed. Capitalized software
development costs include purchased materials and services and other costs associated with the development of new products and
services. Software development costs are expensed as incurred until technological feasibility has been established, at which time
future costs incurred are capitalized until the product is available for general release to the public. Based on our product development
process, technological feasibility is generally established once product and detailed program designs have been completed,
uncertainties related to high-risk development issues have been resolved through coding and testing, and we have established that the
necessary skills, hardware, and software technology are available for production of the product. Once a software product is available
for general release to the public, capitalized development costs associated with that product will begin to be amortized to cost of sales
over the product’s estimated economic life, using the greater of straight-line or a method that results in cost recognition in future
periods that is consistent with the anticipated timing of product revenue recognition.
Our capitalized software development costs are subject to an ongoing assessment of recoverability, which is impacted by estimates
and assumptions of future revenues and expenses for these software products, as well as other factors such as changes in product
technologies. Any portion of unamortized capitalized software development costs that are determined to be in excess of net realizable
value will be expensed in the period in which such a determination is made. We reached technological feasibility for certain software
products and, as a result, capitalized $867,000 of software development costs during the year ended December 31, 2013. Once the
software products are available for release, the capitalized development costs will begin to be amortized to cost of sales over the
products’ estimated economic life using the greater of straight-line or a method that results in cost recognition in future periods that is
consistent with the anticipated time of product revenue recognition.
IMPAIRMENT OF LONG-LIVED ASSETS
We review the carrying value of long-lived assets or asset groups, such as property and equipment and intangibles subject to
amortization, when events or changes in circumstances such as asset utilization, physical change, legal factors, or other matters
indicate that the carrying value may not be recoverable. When this review indicates the carrying value of an asset or asset group
exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group, we
recognize an asset impairment charge against operations. The amount of the impairment loss recorded is the amount by which the
carrying value of the impaired asset or asset group exceeds its fair value. No such impairment losses were recorded during the years
ended December 31, 2013, 2012 or 2011.
RESEARCH AND DEVELOPMENT
Research and development costs associated with new products are charged to operations in the period incurred.
WARRANTIES
We generally provide a standard two-year warranty on product sales. We record estimated warranty costs at the time of sale and
accrue for specific items at the time that their existence is known and the amounts are determinable. We estimate warranty costs using
standard quantitative measures based on historical warranty claim experience and an evaluation of specific customer warranty issues.
In addition, warranty provisions are also recognized for certain nonrecurring product claims that are individually significant.
FOREIGN CURRENCY
The financial position and results of operations of our foreign subsidiaries are measured using local currency as the functional
currency. Assets and liabilities are translated using fiscal period-end exchange rates, and statements of operations are translated using
34
average exchange rates applicable to each period, with the resulting translation adjustments recorded as a separate component of
shareholders’ equity under “Accumulated other comprehensive income (loss)”. Gains and losses from foreign currency transactions
are recognized in the Consolidated Statements of Operations.
NET LOSS PER SHARE
Basic loss per share excludes dilution and is computed by dividing net loss attributable to common shareholders by the
weighted-average number of common shares outstanding during the period. Diluted loss per share includes potentially dilutive
common shares consisting of stock options, restricted stock and warrants using the treasury stock method. Under the treasury stock
method, shares associated with certain stock options have been excluded from the diluted weighted average shares outstanding
calculation because the exercise of those options would lead to a net reduction in common shares outstanding. As a result, stock
options to acquire 348,000, 481,000 and 404,000 weighted common shares have been excluded from the diluted weighted shares
outstanding calculation for the years ended December 31, 2013, 2012 and 2011, respectively, because the exercise prices were greater
than the average market price of the common shares during the period and were excluded from the calculation of diluted net income
per share.
USE OF ESTIMATES
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities
as of the date of the financial statements, and reported amounts of revenue and expense during the reporting period. Predicting future
events is inherently an imprecise activity and, as such, requires the use of judgment. Ultimate results could differ from those estimates.
Changes in these estimates will be reflected in the financial statements in future periods.
STOCK-BASED COMPENSATION
We measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the
award at the date of grant and recognize the cost over the period during which an employee is required to provide services in exchange
for the award. Stock options are granted at exercise prices equal to the closing market price of our stock on the date of grant.
For purposes of determining estimated fair value of stock-based payment awards, we utilize a Black-Scholes option pricing model,
which requires the input of certain assumptions requiring management judgment. Because our employee stock option awards have
characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect
fair value estimates, existing models may not provide a reliable single measure of the fair value of employee stock options.
Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of stock-based
compensation. Circumstances may change and additional data may become available over time that could result in changes to these
assumptions and methodologies and thereby materially impact the fair value determination of future grants of stock-based payment
awards. If factors change and we employ different assumptions in future periods, the compensation expense recorded may differ
significantly from the stock-based compensation expense recorded in the current period.
2.
FAIR VALUE MEASUREMENTS AND MARKETABLE SECURITIES
The guidance for fair value measurements establishes the authoritative definition of fair value, sets out a framework for measuring fair
value and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an
asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly
transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and
non-observable inputs as follows:
•
•
•
Level 1 – observable inputs such as quoted prices in active markets;
Level 2 – inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3 – unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own
assumptions.
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
The fair value hierarchy requires the use of observable market data when available. In instances in which the inputs used to measure
fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest
level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the
fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
35
Investments are comprised of high-grade municipal bonds, U.S. government securities and commercial paper and are classified as
Level 1 or Level 2, depending on trading frequency and volume and our ability to obtain pricing information on an ongoing basis.
The amortized cost and market value of our available-for-sale securities by major security type were as follows (in thousands):
Bank certificates of deposit
Bank certificates of deposit
U.S. government obligations
Corporate obligations
State and municipal bonds
Level 1
—
—
$
$
$
$
—
880
453
—
1,333
$
$
$
$
December 31, 2013
Level 2
2,639
2,639
Level 3
—
—
$
$
December 31, 2012
2,524
504
—
456
3,484
$
$
—
—
—
—
—
Total
2,639
2,639
2,524
1,384
453
456
4,817
$
$
$
$
We evaluate impairment at each reporting period for securities where the fair value of the investment is less than its cost. Unrealized
gains and losses on our available-for-sale investments are primarily attributable to general changes in interest rates and market
conditions. We do not believe the unrealized losses represent other-than-temporary impairments based on our evaluation of available
evidence as of December 31, 2013. The aggregate unrealized gain or loss on available-for-sale investments was immaterial as of
December 31, 2013 and 2012.
Classification of available-for-sale investments as current or noncurrent is dependent upon our intended holding period, the security’s
maturity date, or both. Contractual maturities were less than one year for all available-for-sale investments as of December 31, 2013.
There were no available-for-sale investments with gross unrealized losses that had been in a continuous unrealized loss position for
more than 12 months as of December 31, 2013 and 2012.
Proceeds from maturities or sales of available-for-sale securities were $7.7 million, $7.3 million and $9.2 million during the years
ended December 31, 2013, 2012 and 2011, respectively. Realized gains and losses are determined using the specific identification
method. Realized gains and losses related to sales of available-for-sale investments during the years ended December 31, 2013, 2012
and 2011 were immaterial and included in other income.
Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis
Our intangible assets and other long-lived assets are nonfinancial assets that were acquired either as part of a business combination,
individually or with a group of other assets. These nonfinancial assets were initially, and have historically been, measured and
recognized at amounts equal to the fair value determined as of the date of acquisition.
Periodically, these nonfinancial assets are tested for impairment by comparing their respective carrying values to the estimated fair
value of the reporting unit or asset group in which they reside. In the quarters ended June 30, 2012 and September 30, 2011, certain of
these nonfinancial assets were deemed to be impaired (see Note 4), and we recognized an impairment loss equal to the amount by
which the carrying value of each reporting unit exceeded their estimated fair value. Fair value measurements of the reporting units
were estimated using certain Level 3 inputs requiring management judgment, including projections of economic conditions and
customer demand, revenue and margins, changes in competition, operating costs, working capital requirements, and new product
introductions.
Financial Instruments not Measured at Fair Value
Certain of our financial instruments are not measured at fair value and are recorded at carrying amounts approximating fair value,
based on their short-term nature or variable interest rate. These financial instruments include cash and cash equivalents, accounts
receivable, accounts payable and other current assets and liabilities.
36
3.
INVENTORIES
Inventories consisted of the following (in thousands):
Components
Finished goods
December 31,
2013
2012
$
$
2,797
792
3,589
$
$
3,001
1,484
4,485
4.
GOODWILL AND INTANGIBLE ASSETS
We apply a fair value based impairment test to the carrying value of goodwill for each reporting unit on an annual basis and on an
interim basis if certain events or circumstances indicate that an impairment loss may have occurred. In the second quarter of 2012 and
the third quarter of 2011, we experienced a significant and sustained decline in our stock price. The decline resulted in our market
capitalization falling significantly below the recorded value of our consolidated net assets. As a result, we concluded a triggering
event had occurred and performed an impairment test of goodwill for each reporting unit at that time.
Based on the results of our initial assessment of impairment of our goodwill (step 1), we determined that the carrying value of each
reporting unit exceeded its estimated fair value. Therefore, we performed the second step of the impairment assessment to determine
the implied fair value of goodwill. In performing the goodwill assessment, we used current market capitalization, discounted cash
flows and other factors as the best evidence of fair value.
We recorded $3.2 million of goodwill impairment charges in the second quarter of 2012 and $11.7 million of goodwill impairment
charges in the third quarter of 2011.
Intangible Assets
Because the intangible assets related to the ISS Europe acquisition are accounted for in Great Britain Pounds, they are impacted by
period-end rates of exchange to United States Dollars and therefore varied in different reporting periods.
Intangible assets consisted of the following (dollars in thousands):
Developed technology
Trade names
Other intangible costs
Software development costs
Total
Developed technology
Trade names
Other intangible assets
Total
Gross
Carrying
Amount
8,152
3,267
1,874
867
14,160
Gross
Carrying
Amount
7,490
3,267
1,840
12,597
$
$
$
$
December 31, 2013
Accumulated
Amortization
$
(4,587)
(2,110)
(1,001)
—
(7,698)
$
$
$
Net
Carrying
Value
3,566
1,157
873
867
6,463
December 31, 2012
Accumulated
Amortization
$
(3,480)
(1,853)
(775)
(6,108)
$
$
$
Net
Carrying
Value
4,010
1,414
1,065
6,489
Weighted
Average
Useful Life
(in Years)
3.6
4.5
3.1
3.0
3.5
Weighted
Average
Useful Life
(in Years)
4.6
5.8
5.2
4.9
37
The estimated future amortization expense related to other intangible assets for the next five fiscal years is as follows (dollars in
thousands):
Amortization
Expense
$
2014
2015
2016
2017
2018
1,841
1,811
1,136
846
624
Future amortization amounts presented above are estimates. Actual future amortization expense may be different due to future
acquisitions, impairments, changes in amortization periods, or other factors.
In connection with the triggering events discussed above, we reviewed our long-lived assets and determined that none of the
long-lived assets were impaired for our asset groups. The determination was based on reviewing estimated undiscounted cash flows
for our asset groups, which were greater than their carrying values. As required under GAAP, this impairment analysis occurred
before the goodwill impairment assessment.
The evaluation of the recoverability of long-lived assets requires us to make significant estimates and assumptions. These estimates
and assumptions primarily include, but are not limited to, the identification of the asset group at the lowest level of independent cash
flows and the primary asset of the group; and long-range forecasts of revenue, reflecting management’s assessment of general
economic and industry conditions, operating income, depreciation and amortization and working capital requirements.
5.
CREDIT FACILITIES
We have a revolving line of credit with Associated Bank, National Association (“Associated Bank”) that was initially entered into as
of May 1, 2008. Our current revolving line of credit agreement (“Credit Agreement”) with Associated Bank provides up to $5.0
million of credit. The Credit Agreement expires in May 2014 and bears interest at an annual rate equal to the greater of (a) 4.5% or
(b) LIBOR plus 2.75%. Any advances are secured by inventories, accounts receivable and equipment. We are subject to certain
financial covenants under the Credit Agreement, including minimum debt service coverage ratios, minimum cash flow coverage ratios
and financial measures. At December 31, 2013, we had no borrowings under the Credit Agreement, and we were in compliance with
all financial covenants.
6.
WARRANTIES
Warranty liability and related activity consisted of the following (in thousands):
Beginning balance
Warranty provisions
Warranty claims
Adjustments to preexisting warranties
Ending balance
Years ended December 31,
2012
2011
2013
$
$
520
209
(297)
502
934
$
$
423
234
(233)
96
520
$
$
624
198
(318)
(81)
423
38
7.
INCOME TAXES
The components of loss before income taxes were as follows (in thousands):
Loss before income taxes
Domestic
Foreign
Total
Years ended December 31,
2012
2011
2013
$
(9,041)
(2,923)
$ (11,964)
$
$
(136)
(3,396)
(3,532)
$
(6,761)
(6,278)
$ (13,039)
The components of income tax expense (benefit) were as follows (in thousands):
Current:
Federal
State
Foreign
Total
Deferred:
Federal
State
Foreign
Total
Years ended December 31,
2012
2013
2011
$
$
$
$
(234)
(3)
153
(84)
4,130
61
(170)
4,021
3,937
$
$
$
$
(48)
(1)
90
41
(31)
—
(190)
(221)
(180)
$
$
$
$
279
4
315
598
(2,358)
(35)
(1,227)
(3,620)
(3,022)
A reconciliation from the federal statutory income tax provision to our effective tax expense (benefit) is as follows (in thousands):
United States federal tax statutory rate
State taxes, net of federal benefit
Valuation allowances against deferred tax assets
Research and development tax credits
Foreign provision different than U.S. tax rate
Stock option expense
Adjustment of prior year tax credits and refunds
Goodwill impairment
Uncertain tax positions
Other
Years ended December 31,
2012
2011
2013
$
$
$
(3,976)
(51)
7,890
(252)
391
28
(63)
-
(8)
(22)
(1,201)
3
90
(135)
545
(27)
69
417
(19)
78
(4,433)
(36)
121
(412)
641
82
50
1,299
(138)
(196)
Total
$
3,937
$
(180)
$
(3,022)
39
A summary of the deferred tax assets and liabilities is as follows (in thousands):
Current deferred tax assets (liabilities):
Accrued compensation and benefits
Prepaid expenses and other
Inventory reserves
Allowance for doubtful accounts
Warranty reserves
Total current deferred tax asset:
Non-current deferred tax assets:
Intangible and other assets
Foreign net operating loss carryforwards
Non-qualified stock option expense
Property, equipment and other
Research and development credit
Non-current deferred tax asset:
Less: valuation allowance
Non-current deferred tax asset (liability):
Years ended December 31,
2013
2012
$
$
66
(88)
240
237
162
617
3,525
3,320
47
147
378
7,417
(8,156)
(739)
42
(31)
21
115
39
186
3,617
280
63
96
-
4,056
(280)
3,776
Total net deferred tax asset (liability)
$
(122)
$
3,962
As of December 31, 2013, certain of our subsidiaries in the United States, United Kingdom, Hong Kong and Canada had net operating
loss carryovers of $6,797,000, $3,864,000, $798,000 and $195,000, respectively. We determined that the benefits of the net operating
loss carryovers for the United States, United Kingdom and Hong Kong are uncertain. Accordingly, as of December 31, 2013, we had a
full valuation allowance against those deferred tax assets in the amount of $8,156,000.
In accordance with Accounting Standards Codification (“ASC”) 740-30, we have not recognized a deferred tax liability for the
undistributed earnings of certain of our foreign operations because those subsidiaries have invested or will invest the undistributed
earnings indefinitely. At December 31, 2013, undistributed earnings were approximately $1,418,000. It is impractical for us to
determine the amount of unrecognized deferred tax liabilities on these indefinitely reinvested earnings. Deferred taxes are recorded for
earnings of foreign operations when we determine that such earnings are no longer indefinitely reinvested.
We realize an income tax benefit from the exercise or early disposition of certain stock options. This benefit results in a decrease in
current income taxes payable and an increase in additional paid-in capital.
A reconciliation of the beginning and ending amount of the tax liability for uncertain tax positions is as follows (in thousands):
Balance at December 31, 2011
Additions for current year tax positions
Reductions as a result of lapses in statute of limitations
Balance at December 31, 2012
Additions for current year tax positions
Reductions as a result of lapses in statute of limitations
Balance at December 31, 2013
$
$
$
36
-
(18)
18
-
(10)
8
Included in the balance of uncertain tax positions at December 31, 2013 are immaterial potential benefits that, if recognized, would
affect the effective tax rate. The amount of unrecognized tax benefits are not expected to change materially within the next 12
months. At December 31, 2013 and 2012, we had no accrued interest related to uncertain income tax positions. At December 31,
2013 and 2012, no accrual for penalties related to uncertain tax positions existed. Interest and penalties related to uncertain tax
positions are included in interest expense and general and administrative expense, respectively, on our Consolidated Statements of
Operations.
40
We are subject to income taxes in the U.S. federal jurisdiction and various state and foreign jurisdictions. Tax regulations within each
jurisdiction are subject to the interpretation of the related tax laws and require significant judgment to apply. Generally, we are subject
to U.S. federal, state, local and foreign tax examinations by taxing authorities for years after the fiscal year ended December 31, 2009.
At December 31, 2013 and 2012, domestic and certain of our foreign subsidiaries were expected to receive income tax refunds within
the next fiscal year. As a result, at December 31, 2013 and 2012, we recognized a current income tax receivable of $244,000 and
$452,000, respectively, which is included in Prepaid Expenses and Other Current Assets on our Consolidated Balance Sheets.
8.
LICENSING
We have licensed the exclusive right to manufacture and market the Autoscope® video and Autoscope® radar technology in North
America, the Caribbean and Latin America to Econolite, and we receive royalties from Econolite on sales of systems in those
territories as well as in non-exclusive territories as allowed from time to time. We may terminate our agreement with Econolite if a
minimum annual sales level is not met or if Econolite fails to make royalty payments as required by the agreement. The agreement’s
term runs to 2031, unless terminated by either party upon three years’ notice.
We recognized royalty income from this agreement of $11.6 million, $12.4 million and $13.0 million in 2013, 2012 and 2011,
respectively.
9.
SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
Royalty income from Econolite comprised 44%, 50% and 43% of revenue in the years ended December 31, 2013, 2012 and 2011,
respectively. Accounts receivable from Econolite were $1.6 million and $2.6 million at December 31, 2013 and 2012, respectively.
Major disruptions in the manufacturing and distribution of our products by Econolite or the inability of Econolite to make payments
on its accounts receivable with us could have a material adverse effect on our business, financial condition and results of operations.
Econolite was the only customer that comprised more than 10% of accounts receivable as of December 31, 2013. During the period
from April 2011 through August 2012, the Chief Executive Officer of the parent company of Econolite served on our Board of
Directors.
10.
RETIREMENT SAVINGS PLANS
Substantially all of our employees in the United States are eligible to participate in a qualified defined contribution 401(k) plan.
Participants may elect to have a specified portion of their salary contributed to the plan, and we may make discretionary contributions
to the plan. ISS HK and ISS UK are obligated to contribute to certain employee pension plans. We made contributions totaling
$128,000, $132,000 and $170,000 to the plans for 2013, 2012 and 2011, respectively.
11.
SHAREHOLDERS’ EQUITY
Stock-Based Compensation
We compensate officers, directors, and employees with stock-based compensation under two stock plans approved by the Company’s
shareholders in 2006 and 2011 and administered under the supervision of our Board of Directors. In February 1995 and April 2005,
we adopted the 1995 Long-Term Incentive and Stock Option Plan (the 1995 Plan) and the 2005 Stock Incentive Plan (the 2005 Plan),
respectively, which provide for the granting of incentive (ISO) and non-qualified (NQO) stock options, stock appreciation rights,
restricted stock awards and performance awards to our officers, directors, employees, consultants and independent contractors. The
1995 Plan terminated in February 2005, although options granted under the 1995 Plan remain outstanding according to their terms.
Options granted under the plans generally vest over three to five years and have a contractual term of six to 10 years. At December
31, 2013, a total of 205,750 shares were available for future grant under the 2005 Plan. Shares will be available for issuance under the
2005 Plan until May 17, 2015.
41
The following table summarizes stock option activity for 2013, 2012 and 2011:
Options outstanding at beginning of year
Granted
Exercised
Expired
Forfeited
Options outstanding at end of year
Options eligible for exercise at year-end
________________________________
*Weighted Average Exercise Price
2013
2012
Shares
398,893
86,000
(2,333)
(4,000)
(138,810)
339,750
130,688
WAEP*
7.95
6.82
3.65
9.00
10.28
6.73
7.71
$
$
$
$
$
$
$
Shares
535,333
159,750
(56,000)
(16,000)
(224,190)
398,893
160,143
WAEP*
9.58
5.12
2.17
15.00
10.74
7.95
9.84
$
$
$
$
$
$
$
2011
Shares
463,433
156,000
(32,100)
(12,000)
(40,000)
535,333
249,333
$
$
$
$
$
$
$
WAEP*
9.11
10.21
3.29
15.70
9.79
9.58
8.81
Options outstanding at December 31, 2013 had a weighted average remaining contractual term of 6.9 years and an aggregate intrinsic
value of approximately $9,000. Options eligible for exercise at December 31, 2013 had a weighted average remaining contractual term
of 5.0 years and an aggregate intrinsic value of $2,250.
The total intrinsic value of stock options exercised during the fiscal years ended December 31, 2013, 2012 and 2011 was $4,000,
$208,000 and $211,000, respectively.
The fair value of stock options granted under stock-based compensation programs has been estimated as of the date of each grant
using the multiple option form of the Black-Scholes valuation model, based on the grant price and assumptions regarding the expected
grant life, stock price volatility, dividends, and risk-free interest rates. Each vesting period of an option award is valued separately,
with this value being recognized evenly over the vesting period. The weighted average per share grant date fair value of options to
purchase 86,000, 159,750 and 156,000 shares granted for the years ended December 31, 2013, 2012 and 2011 was $3.53, $1.82 and
$3.35, respectively. The weighted average assumptions used to determine the fair value of stock options granted during those fiscal
years were as follows:
Expected life (in years)
Risk-free interest rate
Expected volatility
Dividend yield
2013
5.0
1.52
60
%
%
0 %
2012
4.8
0.72
42
%
%
0 %
2011
3.1
1.47
44
%
%
0 %
The expected life represents the period that the stock option awards are expected to be outstanding and was determined based on
historical and anticipated future exercise and expiration patterns. The risk-free interest rate used is based on the yield of constant
maturity U.S. Treasury bonds on the grant date with a remaining term equal to the expected life of the grant. We estimate stock price
volatility based on a historical weekly price observation. The dividend yield assumption is based on the annualized current dividend
divided by the share price on the grant date. We have not historically paid any cash dividends and do not expect to do so in the
foreseeable future.
Other information pertaining to options for the years ended December 31, 2013, 2012 and 2011 is as follows:
Cash received from the exercise of options
Stock-based compensation expense recognized
within general and administrative expense on
the consolidated statements of operations
Excess income tax benefits from exercise of stock options
Stock Awards
2013
2012
2011
$
8,500
$
121,000
$
105,000
213,000
-
244,000
71,000
412,000
37,000
We issue stock awards as a portion of the annual retainer for each director on a quarterly basis. The stock awards are fully vested at
the time of issuance. Compensation expense related to stock awards is determined on the grant date based on the publicly quoted fair
market value of our common stock and is charged to earnings on the grant date. During the quarter ended December 31, 2013, there
42
were stock awards issued for 3,645 shares with a weighted-average grant date fair value of $5.14. For the year ended December 31,
2013, there were stock awards issued for 13,395 shares with a weighted-average grant date fair value of $5.60.
12.
RESTRUCTURING
In the fourth quarter of 2011 and second quarter of 2012, we implemented restructuring plans to improve our financial performance.
As a result of these actions, we recorded restructuring charges within all reportable segments that were comprised of termination
benefits, facility closure costs and inventory charges. In 2012, approximately $430,000 was recorded in operating expenses in the
Consolidated Statement of Operations as a result of these restructuring plans and, in 2011, approximately $448,000 was recorded in
cost of revenue and $287,000 was recorded in operating expenses.
The following table shows the restructuring activity for 2012 (in thousands):
Balance at January 1, 2011
Charges
Settlements
Balance at December 31, 2011
Charges
Settlements
Balance at December 31, 2012
13.
SEGMENT INFORMATION
$
$
Termination
Benefits
-
208
(45)
163
359
(522)
--
$
Facility Costs and
Contract
Termination
-
$
101
(36)
65
71
(136)
--
$
$
$
$
$
$
Inventory
Charges
-
426
(42)
384
--
(384)
--
$
$
Total
-
735
(123)
612
430
(1,042)
--
The Company’s Chief Executive Officer and management regularly review financial information for the Company’s three discrete
operating segments. Based on similarities in the economic characteristics, nature of products and services, production processes, type
or class of customer served, method of distribution and regulatory environments, the operating segments have been aggregated for
financial statement purposes and categorized into three reportable segments: Intersection, Highway and License Plate Recognition
(“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.
Operating expenses and total assets are not allocated to the segments for internal reporting purposes. Due to the changes in how we
manage our business, we may reevaluate our segment definitions in the future.
The following tables set forth selected unaudited financial information for each of our reportable segments (in thousands):
For the ye ar e nde d De ce mbe r 31, 2013
Inte rse ction
Highway
LPR
Total
Revenue
Gross profit
Amortization of intangible assets
Intangible assets
$
13,428
11,559
—
—
$
6,414
1,862
488
942
$
6,448
2,980
1,066
5,521
$
26,290
16,401
1,554
6,463
For the ye ar e nde d De ce mbe r 31, 2012
Inte rse ction
Highway
LPR
Total
Revenue
Gross profit
Goodwill impairment
Amortization of intangible assets
Intangible assets
$
16,031
14,010
—
—
—
$
4,118
1,798
1,372
748
1,430
$
4,814
2,449
1,803
874
5,059
$
24,963
18,257
3,175
1,622
6,489
43
For the ye ar e nde d De ce mbe r 31, 2011
Inte rse ction
Highway
LPR
Total
Revenue
Gross profit
Goodwill impairment
Amortization of intangible assets
Intangible assets and goodwill
$
17,445
15,096
525
—
—
$
7,366
3,512
7,392
768
3,551
$
5,710
2,696
3,768
882
7,457
$
30,521
21,304
11,685
1,650
11,008
We derived the following percentages of our net revenues from the following geographic regions:
Asia Pacific
Europe
North America
2013
10%
41%
49%
2012
11%
35%
54%
2011
4%
31%
65%
No countries other than the United States and the United Kingdom had revenue in excess of 10% of our total revenue during any
periods presented. The aggregate net book value of long-lived assets held outside of the United States, not including intangible assets,
was $323,000 and $1.2 million at December 31, 2013 and 2012, respectively.
14.
OTHER ASSETS
In January 2013, we acquired a minority interest in the shares of common stock of Municipal Parking Services, Inc. (MPS) for an
aggregate purchase price of $300,000. The investment is accounted for under the cost method and is included in Other Assets on our
consolidated balance sheets. In April 2013, the Chief Executive Officer of MPS was appointed to our Board of Directors.
15.
COMMITMENTS AND CONTINGENCIES
Operating Leases
We rent office space and equipment under operating lease agreements expiring at various dates through January 2016. Rent expense
for office facilities was $946,000 in 2013, $947,000 in 2012 and $1.1 million in 2011. Minimum annual rental commitments under
noncancelable operating leases are as follows (in thousands):
$
Future Lease
Payments
398
83
2
2014
2015
2016
Litigation
We are involved from time to time in various legal proceedings arising in the ordinary course of our business, including primarily
commercial, product liability, employment and intellectual property claims. In accordance with generally accepted accounting
principles in the United States, we record a liability in our Consolidated Financial Statements with respect to any of these matters
when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. With respect to
currently pending legal proceedings, we have not established an estimated range of reasonably possible additional losses either
because we believe that we have valid defenses to claims asserted against us or the proceeding has not advanced to a stage of
discovery that would enable us to establish an estimate. We currently do not expect the outcome of these matters to have a material
effect on our consolidated results of operations, financial position or cash flows. Litigation, however, is inherently unpredictable, and
it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our results of operations,
financial position or cash flows. We expense legal costs as incurred.
44
Investigation Matter
As previously disclosed, Polish authorities are conducting an investigation into violations of Polish law related to tenders in the City
of Łodź, Poland. In December 2012, the regional prosecutor charged two employees of Image Sensing Systems Europe Limited
SP.Z.O.O., our Polish subsidiary (“ISS Poland”), with, among other things, criminal violations of Polish tender and corruption law
related to a project in Łodź. Neither the Company nor any of our subsidiaries has been charged with any offense. A Special
Subcommittee of our Audit Committee comprised solely of independent directors has retained independent counsel and accounting
advisors to conduct an investigation focusing on possible violations of Company policy, internal controls, and laws, including the
Foreign Corrupt Practices Act, the U.K. Anti-Bribery Act and Polish law. This investigation is ongoing, and we have voluntarily
disclosed this matter to the Securities and Exchange Commission and the Department of Justice.
We are cooperating with the Polish prosecutor and intend to cooperate with any other governmental investigation into these matters.
We have taken remedial actions, including ending the employment of the two Polish employees, and we are assessing and
implementing enhancements to our internal policies, procedures and controls. We cannot predict the outcome of this matter at this
time or whether it will have a material adverse impact on our business prospects, financial condition, operating results or cash flows.
45
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Image Sensing Systems, Inc.
We have audited the accompanying consolidated balance sheets of Image Sensing Systems, Inc. (a Minnesota corporation) and
subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations,
comprehensive loss, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. These
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Image Sensing Systems, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted
in the United States of America.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
March 6, 2014
46
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of disclosure controls and procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (Exchange Act)), that are designed to reasonably ensure that information required to be disclosed by us in the
reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our
management, including our principal executive officer and principal financial officer, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that, as of the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and
procedures were effective.
Management’s report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal
control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the
United States of America. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets; (ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in
accordance with generally accepted accounting principles in the United States of America and that our receipts and expenditures are
being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the
financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its
inherent limitations. Internal control over financial reporting is a process that involves human diligence and is subject to lapses in
judgment or breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by
collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known
features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, although not
eliminate, these risks.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Further,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this
assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in “Internal Control—Integrated Framework”. Based on this assessment, management has concluded that our internal control
over financial reporting was effective as of December 31, 2013.
Changes in internal control over financial reporting
During the most recent fiscal quarter covered by this Annual Report on Form 10-K, there has been no change in our internal control
over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
47
PART III
Item 10. Directors, Executive Officers and Corporate Governance
We have adopted a Code of Ethics which applies to our principal executive, accounting and financial officers. The Code of Ethics is
published on our website at www.imagesensing.com. Any amendments to the Code of Ethics and waivers of the Code of Ethics for
our principal executive, accounting and financial officers will be published on our website.
The sections entitled “Proposal I - Election of Directors,” “Audit Committee” and “Section 16(a) Beneficial Ownership Reporting
Compliance” in our definitive proxy statement for our 2014 annual meeting of shareholders are incorporated into this Annual Report
on Form 10-K by reference.
Item 11. Executive Compensation
The sections entitled “Executive Compensation” and “Compensation of Directors” in our definitive proxy statement for the 2014
annual meeting of shareholders are incorporated into this Annual Report on Form 10-K by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Equity Compensation Plan Information
The following table provides information as of December 31, 2013 about our shares of common stock subject to outstanding awards
or available for future awards under our equity compensation plans and arrangements.
Number of securities remaining
Number of securities to
Weighted-average exercise
available for future issuance
be issued upon exercise
price of outstanding
under equity compensation plans
of outstanding options,
warrants and rights
options, warrants and
rights
(excluding securities reflected in
the first column)(2)
Plan Category
Equity compensation plans approved by shareholders (1)
339,750
$
6.73
205,750
(1) Includes shares underlying stock options granted under the Image Sensing Systems, Inc. 1995 Long-Term Incentive and
Stock Option Plan (1995 Plan) and non-qualified stock options granted outside the 1995 Plan between 1996 and 2000 to current and
former members of the Board of Directors.
(2) The 205,750 shares available for grant under the 2005 Stock Incentive Plan may become the subject of future awards in
the form of stock options, stock appreciation rights, restricted stock, performance awards or other stock-based awards.
The section entitled “Security Ownership of Certain Beneficial Owners and Management” in our definitive proxy statement for the
2014 annual meeting of shareholders is incorporated into this Annual Report on Form 10-K by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The section entitled “Certain Relationships and Related Transactions” in our definitive proxy statement for the 2014 annual meeting of
shareholders is incorporated into this Annual Report on Form 10-K by reference.
Item 14. Principal Accountant Fees and Services
The sections entitled “Audit Fees,” “Audit-Related Fees,” “Tax Fees,” “All Other Fees” and “Policy on Audit Committee
Pre-Approval of Audit and Permissible Non-Audit Services Provided by Our Independent Registered Public Accounting Firm” in our
definitive proxy statement for our 2014 annual meeting of shareholders are incorporated into this Annual Report on Form 10-K by
reference.
48
Item 15. Exhibits and Financial Statement Schedules
(a)
Documents filed as part of this report:
1.
Financial statements
PART IV
The following Consolidated Financial Statements are included in Part II, Item 8. “Financial Statements and
Supplementary Data”:
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flow for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
2.
Financial Statement Schedules:
All financial statement schedules have been omitted because they are not required.
3.
The following documents are filed as exhibits to this report:
Exhibit No.
Description
3(i).1
3(i).2
3(ii)
4.1
10.1
10.2*
10.3*
10.4*
10.5
Restated Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.1 to ISS’ Registration
Statement on Form SB-2 (Registration No. 33-90298C) filed on March 15, 1995, as amended
(Registration Statement).
Articles of Amendment to Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.2 to
ISS’ Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001 (File No. 0-26056).
Bylaws of ISS, incorporated by reference to Exhibit 3(ii) to ISS’ Quarterly Report on Form 10-Q for the
quarter ended September 30, 2011 (File No. 0-26056).
Specimen form of ISS’ common stock certificate, incorporated by reference to Exhibit 4.1 to ISS’
Registration Statement.
Form of Distributor Agreement, incorporated by reference to Exhibit 10.1 to ISS’ Registration
Statement.
1995 Long-Term Incentive and Stock Option Plan, amended and restated through May 17, 2001,
incorporated by reference to Exhibit 10.10 to ISS’ Annual Report on Form 10-KSB for the year ended
December 31, 2001 (File No. 0-26056).
Employment Agreement between ISS and Kenneth R. Aubrey, dated December 12, 2006, effective on or
about January 15, 2007 (in capacity as President) and effective on or about June 1, 2007 (in capacity of
President and Chief Executive Officer), incorporated by reference to Exhibit 10.1 to ISS’ Current Report
on Form 8-K dated December 14, 2006 (File No. 0-26056).
Employment Agreement between ISS and Gregory R. L. Smith, dated December 8, 2006, incorporated
by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 8, 2006 (File No. 0-
26056).
Amendment VII to Office Lease Agreement dated April 26, 2007 by and between ISS and Spruce Tree
Centre L.L.P., incorporated by reference to Exhibit 10.11 to ISS’ Annual Report on Form 10-K for the
year ended December 31, 2007 (File No. 0-26056) (2007 Form 10-K).
49
10.6
10.7*
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
Modification to Manufacturing, Distributing and Technology License Agreement dated September 1,
2000 by and between ISS and Econolite Control Products, Inc. (Econolite), incorporated by reference to
Exhibit 10.12 to ISS’ 2007 Form 10-K.
Image Sensing Systems, Inc. 2005 Stock Incentive Plan, incorporated by reference to Appendix A to
ISS’ proxy statement filed with the SEC on April 19, 2005 (File No. 0-26056).
Manufacturing, Distributing and Technology License Agreement dated June 11, 1991 by and between
ISS and Econolite Control Products, Inc. (Econolite), incorporated by reference to Exhibit 10.1 to the
Registration Statement.
Extension and Second Modification to License Agreement dated July 13, 2001 by and between ISS and
Econolite, incorporated by reference to Exhibit 10.12 to ISS’ Annual Report on Form 10-KSB for the
year ended December 31, 2001 (File No. 0-26056) (2001 Form 10-KSB).
Office Lease Agreement dated November 24, 1998 by and between ISS and Spruce Tree Centre L.L.P.,
incorporated by reference to Exhibit 10.18 to ISS’ Annual Report on Form 10-KSB for the year ended
December 31, 1998 (File No. 0-26056).
Production Agreement dated February 14, 2002 by and among ISS, Wireless Technology, Inc. and
Econolite, incorporated by reference to Exhibit 10.20 to ISS’ 2001 Form 10-KSB.
Extension and Third Modification to Manufacturing Distributing and Technology License Agreement
dated July 3, 2008 by and between ISS and Econolite, incorporated by reference to Exhibit 10.1 to ISS’
Current Report on Form 8-K dated July 3, 2008 (File No. 0-26056).
Fourth Modification to Manufacturing, Distributing and Technology License Agreement dated as of
December 15, 2011 by and between ISS and Econolite, incorporated by reference to Exhibit 10.1 to ISS’
Current Report on Form 8-K dated December 15, 2011 (File No. 0-26056).
Loan Agreement dated May 1, 2008 (2008 Loan Agreement) by and between ISS and Associated Bank,
National Association (Associated Bank), incorporated by reference to Exhibit 10.19 to ISS’ Registration
Statement on Form S-1 filed on May 12, 2008 (Registration No. 333-150852) (Form S-1).
Security Agreement dated May 1, 2008 by and between ISS and Associated Bank, incorporated by
reference to Exhibit 10.20 to ISS’ Form S-1.
Promissory Note (Line of Credit) dated May 1, 2008 in the original principal amount of $5,000,000
issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.21 to ISS’ Form S-1.
Promissory Note (Loan) dated May 1, 2008 in the original principal amount of $3,000,000 issued by ISS
to Associated Bank, incorporated by reference to Exhibit 10.22 to ISS’ Form S-1.
Modification Agreement dated December 28, 2009 by and between ISS and Associated Bank under
which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.18 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2009 (File No. 0-
26056) (2009 Form 10-K).
Promissory Note (Loan) dated December 28, 2009 in the original principal amount of $4,000,000 issued
by ISS to Associated Bank, incorporated by reference to Exhibit 10.19 to the 2009 Form 10-K.
Lease dated February 1, 2010 between Image Sensing Systems UK Limited and Nortrust Nominees
Limited, incorporated by reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the
quarter ended June 30, 2010 (File No. 0-26056).
Third Modification Agreement dated December 28, 2010 by and between ISS and Associated Bank
under which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.21 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2010 (File No. 0-
26056).
50
10.22
10.23
10.24*
10.25*
Fourth Modification Agreement dated December 22, 2011 by and between ISS and Associated Bank
under which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 22, 2011 (File No. 0-26056).
Fifth Modification Agreement dated December 24, 2012 by and between ISS and Associated Bank under
which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 24, 2012 (File No. 0-26056).
Employment Agreement between ISS and Kris B. Tufto dated October 30, 2012, incorporated by
reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended September 30,
2012 (File No. 0-26056).
Employment Agreement between ISS and Dale E. Parker dated June 30, 2013, incorporated by reference
to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 (File No. 0-
26056).
10.26**
Amendment XIII to Office Lease Agreement by and between Spruce Tree Centre L. L. P. and Image
Sensing Systems dated as of February 18, 2014 (filed herewith).
21
23.1
24
31.1
31.2
32.1
32.2
99.1
99.2
99.3
List of Subsidiaries of ISS (filed herewith).
Consent of Independent Registered Public Accounting Firm (filed herewith).
Power of Attorney (included on signature page).
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Extension of Modification to Manufacturing, Distributing and Technology License Agreement dated
May 31, 2002 by and between ISS and Econolite, incorporated by reference to Exhibit 99.2 to ISS’ 2007
Form 10-K.
Letter agreement dated June 19, 1997 by and between ISS and Econolite, incorporated by reference to
Exhibit 99.3 to ISS’ 2007 Form 10-K.
License and Distribution Agreement dated January 2, 2011 by and among ISS, Econolite and Econolite
Canada Inc., incorporated by reference to Exhibit 99.3 to ISS’ Annual Report on Form 10-K for the year
ended December 31, 2011 (File No. 0-26056).
*
**
Management contract or compensatory plan or arrangement.
Portions of this exhibit are treated as confidential pursuant to a request for confidential treatment filed by ISS with the SEC.
Copies of all exhibits not attached will be furnished without charge upon written request to the Company at the address set
forth on the inside back cover page of this Annual Report on Form 10-K.
51
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Image Sensing Systems, Inc.
/s/ Kris B. Tufto
Kris B. Tufto
President and Chief Executive Officer
(Principal Executive Officer)
Date: March 6, 2014
Each person whose signature to this Annual Report on Form 10-K appears below hereby constitutes and appoints Kris B.
Tufto and Dale E. Parker, 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 Annual Report on Form 10-K, and any and all instruments or documents filed as part of or in connection with this
Annual Report on Form 10-K or any 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.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated:
/s/ Kris B. Tufto
Kris B. Tufto
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Dale E. Parker
Dale E. Parker
Chief Financial Officer
(Principal Financial and Principal Accounting Officer
/s/ James W. Bracke
James W. Bracke
Chairman of the Board of Directors
/s/ Thomas G. Hudson
Thomas G. Hudson
Director
/s/ Paul F. Lidsky
Paul F. Lidsky
Director
Date: March 6, 2014
Date: March 6, 2014
Date: March 6, 2014
Date: March 6, 2014
Date: March 6, 2014
52
Exhibit Index
Exhibit No.
Description
3(i).1
3(i).2
3(ii)
4.1
10.1
10.2*
10.3*
10.4*
10.5
10.6
10.7*
10.8
10.9
10.10
Restated Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.1 to ISS’ Registration
Statement on Form SB-2 (Registration No. 33-90298C) filed on March 15, 1995, as amended
(Registration Statement).
Articles of Amendment to Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.2 to
ISS’ Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001 (File No. 0-26056).
Bylaws of ISS, incorporated by reference to Exhibit 3(ii) to ISS’ Quarterly Report on Form 10-Q for the
quarter ended September 30, 2011 (File No. 0-26056).
Specimen form of ISS’ common stock certificate, incorporated by reference to Exhibit 4.1 to ISS’
Registration Statement.
Form of Distributor Agreement, incorporated by reference to Exhibit 10.1 to ISS’ Registration
Statement.
1995 Long-Term Incentive and Stock Option Plan, amended and restated through May 17, 2001,
incorporated by reference to Exhibit 10.10 to ISS’ Annual Report on Form 10-KSB for the year ended
December 31, 2001 (File No. 0-26056).
Employment Agreement between ISS and Kenneth R. Aubrey, dated December 12, 2006, effective on
or about January 15, 2007 (in capacity as President) and effective on or about June 1, 2007 (in capacity
of President and Chief Executive Officer), incorporated by reference to Exhibit 10.1 to ISS’ Current
Report on Form 8-K dated December 14, 2006 (File No. 0-26056).
Employment Agreement between ISS and Gregory R. L. Smith, dated December 8, 2006, incorporated
by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 8, 2006 (File No. 0-
26056).
Amendment VII to Office Lease Agreement dated April 26, 2007 by and between ISS and Spruce Tree
Centre L.L.P., incorporated by reference to Exhibit 10.11 to ISS’ Annual Report on Form 10-K for the
year ended December 31, 2007 (File No. 0-26056) (2007 Form 10-K).
Modification to Manufacturing, Distributing and Technology License Agreement dated September 1,
2000 by and between ISS and Econolite Control Products, Inc. (Econolite), incorporated by reference to
Exhibit 10.12 to ISS’ 2007 Form 10-K.
Image Sensing Systems, Inc. 2005 Stock Incentive Plan, incorporated by reference to Appendix A to
ISS’ proxy statement filed with the SEC on April 19, 2005 (File No. 0-26056).
Manufacturing, Distributing and Technology License Agreement dated June 11, 1991 by and between
ISS and Econolite Control Products, Inc. (Econolite), incorporated by reference to Exhibit 10.1 to the
Registration Statement.
Extension and Second Modification to License Agreement dated July 13, 2001 by and between ISS and
Econolite, incorporated by reference to Exhibit 10.12 to ISS’ Annual Report on Form 10-KSB for the
year ended December 31, 2001 (File No. 0-26056) (2001 Form 10-KSB).
Office Lease Agreement dated November 24, 1998 by and between ISS and Spruce Tree Centre L.L.P.,
incorporated by reference to Exhibit 10.18 to ISS’ Annual Report on Form 10-KSB for the year ended
December 31, 1998 (File No. 0-26056).
53
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24*
10.25*
Production Agreement dated February 14, 2002 by and among ISS, Wireless Technology, Inc. and
Econolite, incorporated by reference to Exhibit 10.20 to ISS’ 2001 Form 10-KSB.
Extension and Third Modification to Manufacturing Distributing and Technology License Agreement
dated July 3, 2008 by and between ISS and Econolite, incorporated by reference to Exhibit 10.1 to ISS’
Current Report on Form 8-K dated July 3, 2008 (File No. 0-26056).
Fourth Modification to Manufacturing, Distributing and Technology License Agreement dated as of
December 15, 2011 by and between ISS and Econolite, incorporated by reference to Exhibit 10.1 to
ISS’ Current Report on Form 8-K dated December 15, 2011 (File No. 0-26056).
Loan Agreement dated May 1, 2008 (2008 Loan Agreement) by and between ISS and Associated Bank,
National Association (Associated Bank), incorporated by reference to Exhibit 10.19 to ISS’
Registration Statement on Form S-1 filed on May 12, 2008 (Registration No. 333-150852) (Form S-1).
Security Agreement dated May 1, 2008 by and between ISS and Associated Bank, incorporated by
reference to Exhibit 10.20 to ISS’ Form S-1.
Promissory Note (Line of Credit) dated May 1, 2008 in the original principal amount of $5,000,000
issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.21 to ISS’ Form S-1.
Promissory Note (Loan) dated May 1, 2008 in the original principal amount of $3,000,000 issued by
ISS to Associated Bank, incorporated by reference to Exhibit 10.22 to ISS’ Form S-1.
Modification Agreement dated December 28, 2009 by and between ISS and Associated Bank under
which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.18 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2009 (File No. 0-
26056) (2009 Form 10-K).
Promissory Note (Loan) dated December 28, 2009 in the original principal amount of $4,000,000
issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.19 to the 2009 Form 10-K.
Lease dated February 1, 2010 between Image Sensing Systems UK Limited and Nortrust Nominees
Limited, incorporated by reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the
quarter ended June 30, 2010 (File No. 0-26056).
Third Modification Agreement dated December 28, 2010 by and between ISS and Associated Bank
under which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.21 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2010 (File No. 0-
26056).
Fourth Modification Agreement dated December 22, 2011 by and between ISS and Associated Bank
under which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 22, 2011 (File No. 0-26056).
Fifth Modification Agreement dated December 24, 2012 by and between ISS and Associated Bank
under which ISS and Associated Bank amended the 2008 Loan Agreement, incorporated by reference to
Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 24, 2012 (File No. 0-26056).
Employment Agreement between ISS and Kris B. Tufto dated October 30, 2012, incorporated by
reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended September 30,
2012 (File No. 0-26056).
Employment Agreement between ISS and Dale E. Parker dated June 30, 2013, incorporated by
reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2013
(File No. 0-26056).
10.26**
Amendment XIII to Office Lease Agreement by and between Spruce Tree Centre L. L. P. and Image
Sensing Systems dated as of February 18, 2014 (filed herewith).
54
21
23.1
24
31.1
31.2
32.1
32.2
99.1
99.2
99.3
List of Subsidiaries of ISS (filed herewith).
Consent of Independent Registered Public Accounting Firm (filed herewith).
Power of Attorney (included on signature page).
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Extension of Modification to Manufacturing, Distributing and Technology License Agreement dated
May 31, 2002 by and between ISS and Econolite, incorporated by reference to Exhibit 99.2 to ISS’
2007 Form 10-K.
Letter agreement dated June 19, 1997 by and between ISS and Econolite, incorporated by reference to
Exhibit 99.3 to ISS’ 2007 Form 10-K.
License and Distribution Agreement dated January 2, 2011 by and among ISS, Econolite and Econolite
Canada Inc., incorporated by reference to Exhibit 99.3 to ISS’ Annual Report on Form 10-K for the
year ended December 31, 2011 (File No. 0-26056).
*
**
Management contract or compensatory plan or arrangement.
Portions of this exhibit are treated as confidential pursuant to a request for confidential treatment filed by ISS with the SEC.
Copies of all exhibits not attached will be furnished without charge upon written request to the Company at the address set
forth on the inside back cover page of this Annual Report on Form 10-K.
55
List of Subsidiaries of Image Sensing Systems, Inc.
Exhibit 21
Name of Subsidiaries
Image Sensing Systems HK Limited
Jurisdiction of Incorporation or Organization
Hong Kong Special Administrative Region of the People’s
Republic of China
Image Sensing Systems (Shenzhen) Limited
Image Sensing Systems HK Limited Shenzhen Representative
Office
Image Sensing Systems Europe Limited
Image Sensing Systems Holdings Limited
Image Sensing Systems UK Limited
Image Sensing Systems Europe Limited
Image Sensing Systems Europe Limited SP.Z.O.O.
Image Sensing Systems Spain SLU
ISS Image Sensing Systems Canada Ltd.
ISS Canada Sales Corp.
China (PRC)
China (PRC)
United Kingdom
United Kingdom
United Kingdom
United Kingdom
Poland
Spain
Canada
Canada
56
Consent of Independent Registered Public Accounting Firm
We have issued our report dated March 6, 2014, with respect to the consolidated financial statements included in the Annual Report of
Image Sensing Systems, Inc. on Form 10-K for the year ended December 31, 2013. We hereby consent to the incorporation by
reference of said report in the Registration Statements of Image Sensing Systems, Inc. on Forms S-3 (File No. 333-162810, effective
November 18, 2009 and File No. 333-41706, effective July 19, 2000) and on Forms S-8 (File No. 333-167496, effective June 14,
2010; File No. 333-165303, effective March 8, 2010; File No. 333-152117, effective July 3, 2008; File No. 333-142449, effective
April 30, 2007; File No. 333-82546, effective February 11, 2002; File No. 333-86169, effective August 30, 1999; and File No. 333-
09289, effective July 31, 1996).
Exhibit 23.1
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
March 6, 2014
57
Exhibit 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Kris B. Tufto, certify that:
1.
I have reviewed this annual report on Form 10-K of Image Sensing Systems, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined
in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being
prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred
during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control
over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant
role in the registrant’s internal control over financial reporting.
Date: March 6, 2014
/s/ Kris B. Tufto
Name: Kris B. Tufto
Title: President and Chief Executive Officer
58
Exhibit 31.2
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Dale E. Parker, certify that:
1.
I have reviewed this annual report on Form 10-K of Image Sensing Systems, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined
in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being
prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred
during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control
over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant
role in the registrant’s internal control over financial reporting.
Date: March 6, 2014
/s/ Dale E. Parker
Name: Dale E. Parker
Title: Chief Financial Officer
59
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.1
In connection with the Annual Report on Form 10-K of Image Sensing System, Inc. (the “Company”) for the fiscal year
ended December 31, 2013, as filed with the Securities and Exchange Commission (the “Report”), I, Kris B. Tufto, President and Chief
Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
/s/ Kris. B Tufto
Kris B. Tufto
President and Chief Executive Officer
March 6, 2014
60
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32.2
In connection with the Annual Report on Form 10-K of Image Sensing System, Inc. (the “Company”) for the fiscal year
ended December 31, 2013, as filed with the Securities and Exchange Commission (the “Report”), I, Dale E. Parker, Chief Financial
Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
The information contained in the Report fairly presents, in all material respects, the financial condition and results of
operations of the Company.
/s/ Dale E. Parker
Dale E. Parker
Chief Financial Officer
March 6, 2014
61
Corporate Information
Directors and Officers
James W. Bracke*†‡
Chairman of the Board
Thomas G. Hudson*†‡
Director
Paul F. Lidsky*†‡
Director
Kris B. Tufto
Director, President and Chief Executive Officer
Dale E. Parker
Director, Chief Financial Officer, Chief Operating Officer,
Treasurer and Secretary
*Member of audit committee
† Member of compensation and stock option committee
‡ Member of nominating and corporate governance committee
Annual Shareholders’ Meeting
The annual meeting of the shareholders will be held on May
13, 2013, at 9:00 am CDT at the Image Sensing Systems,
Inc. Headquarters, 1600 University Avenue West, Suite 500,
Saint Paul, Minnesota, 55104.
Legal Counsel
Winthrop & Weinstine, P.A.
Independent Registered Public
Accounting Firm
Grant Thornton LLP
Stock Transfer Agent
Continental Stock Transfer & Trust Company
Location
Corporate Headquarters
500 Spruce Tree Centre
1600 University Avenue West
St. Paul, Minnesota 55104-3825
A copy of the Company’s Form 10-K, filed with the Securities
and Exchange Commission, may be obtained without charge
upon written request to the Company.
A copy of this 2013 Annual Report to Shareholders can be
obtained from our Web site: imagesensing.com
Price Range for Common Stock
The Company’s common stock trades on The Nasdaq Capital Market tier of The Nasdaq Stock Market under the symbol ISNS.
The table below presents the price range of the high and low trading prices for the Company’s common stock for each period
indicated as reported by Nasdaq.
Quarter
First
Second
Third
Fourth
2013
2012
High
$ 6.00
7.70
8.28
7.39
Low
$4.29
4.62
6.50
4.78
High
$ 7.26
7.80
5.48
5.30
Low
$6.02
4.64
4.61
4.57
Image Sensing Systems, Inc. 1600 University Avenue West, Suite 500, St. Paul, Minnesota 55104
Phone +1.651.603.7700 Fax +1.651.305.6402 imagesensing.com