The following table sets forth, for the periods indicated, (1) certain statements of income data as a percent of total revenue, (2) gross profit on product sales and royalties as a percentage of product sales and royalties, respectively, and (3) period-to-period changes of items in the consolidated statements of income from 2009 to 2008:
Total revenue decreased to $6.3 million in the three-month period ended June 30, 2009 from $6.7 million in the same period in 2008, a decrease of 6.9%, and to $11.1 million in the first half of 2009 from $12.6 million in the same period in 2008, a decrease of 12.2%. Royalties were $3.4 million in both the second quarter of 2009 and 2008, and they decreased to $5.7 million in the first half of 2009 from $6.3 million in the same period in 2008, a decrease of 9.4%. We attribute the decrease in royalties to the economic recession in North America and its negative impact on state and federal spending. North American sales, which are sales of RTMS in North America, decreased to $1.7 million in the second quarter of 2009 from $1.9 million in the same period in 2008, a decrease of 9.6%, and to $3.1 million in the first half of 2009 from $3.5 million in the same period in 2008, a decrease of 14.0%, also reflecting the difficult economic environment in North America. International sales, which include both Autoscope and RTMS sales outside of North America, decreased to $1.2 million in the second quarter of 2009 from $1.4 million in the second quarter of 2008, a decrease of 19.8%, and to $2.3 million in the first half of 2009 from $2.8 million in the first half of 2008, a decrease of 16.4%. The decrease was due mainly to weakness in the Asian market.
Table of Contents
Gross margins for international sales increased to 71.9% in the three months ended June 30, 2009 from 56.2% in the same period in 2008, and to 69.2% in the first half of 2009 from 55.7% in the same period in 2008. Gross margins for North American sales increased to 66.3% in the second quarter of 2009 from 59.8% in the first quarter of 2008 and to 68.6% in the first half of 2009 from 61.5% in the first half of 2008. The increases resulted mainly from a positive revenue mix shift and to a lesser extent from positive currency exchange rates and lower inventory reserves recorded in 2009 as compared to 2008. Gross margins on royalty income remained consistent at 100.0% in each of the periods of 2009 and 2008.
Selling, marketing and product support expense increased to $1.9 million, or 30.6% of total revenue, in the three months ended June 30, 2009 from $1.7 million, or 24.6% of total revenue, in the second quarter of 2008, and to $3.6 million, or 32.1% of total revenue, in the first half of 2009 from $3.0 million, or 23.7% of total revenue, in the first half of 2008. The change related mostly to an investment in market expansion activities in Eastern Europe and Asia and the realization of the impact of headcount additions made late in 2008. We anticipate that for the remainder of 2009, the dollar amount of our quarterly selling, marketing and product support expense will remain at levels similar to or below those of the 2009 first half level.
General and administrative expense decreased to $803,000, or 12.8% of total revenue, in the three months ended June 30, 2009, from $1.0 million, or 15.1% of total revenue, in the same period in 2008, and to $1.8 million, or 16.1% of total revenue, in the first half of 2009, from $1.9 million, or 15.1% of total revenue, in the same period in 2008. The 2009 decrease in costs resulted mainly from lower incentive pay expense which was partially offset by increased professional services expenses. We anticipate that for the remainder of 2009, the dollar amount of our quarterly general and administrative expense will remain at levels similar to that of the second quarter of 2009.
Research and development expense increased to $862,000, or 13.7% of total revenue, in the first quarter of 2009, up from $765,000, or 11.3% of total revenue, in the same period in 2008, and to $1.7 million, or 15.1% of total revenue, in the first half of 2009, up from $1.5 million, or 11.6% of total revenue, in the same period in 2008. The increase was directly related to our investment in video/radar hybrid solutions and tailored international offerings, development projects to reduce manufacturing costs, and the realization of the impact of headcount additions made late in 2008. We anticipate that for the remainder of 2009, the dollar amount of our quarterly research and development expense will remain at levels similar to that of the second quarter of 2009.
Amortization of intangibles expense was $192,000 in the second quarter of 2009 and $384,000 in the first half of 2009, the same as in these periods in 2008, and reflects the amortization of intangible assets acquired in the EIS asset purchase. Assuming there are no changes to our intangible assets, we anticipate amortization expense will be $768,000 for all of 2009.
Other income was $9,000 in the first half of 2009 as compared to other income of $64,000 in the same period in 2008. In 2009, interest on bank debt offset most interest income as we moved into securities that had lower yields than in 2008.
Income tax expense was $442,000, or 27.4% of pretax income, in the second quarter of 2009, compared to $512,000, or 29.6% of pretax income, in the comparable quarter of 2008, and was $584,000, or 29.0% of pretax income, in the first half of 2009, compared to $1.1 million, or 31.7% of pretax income, in the comparable period of 2008. We anticipate an effective tax rate of approximately 30% for all of 2009.
Liquidity and Capital Resources
At June 30, 2009, we had $7.6 million in cash and cash equivalents and $4.0 million in short-term investments, compared to $10.3 million in cash and cash equivalents and $4.0 million in short-term investments at December 31, 2008. Our investments held at December 31, 2008 were auction rate securities that were redeemed at par in January 2009.
- 12 -
Table of Contents
Net cash provided by operating activities was $2.5 million in the first six months of 2009, compared to $2.2 million in 2008. The increase in 2009 was mainly a result of decreased receivable balances as opposed to an increase in 2008, which more than offset lower net income. We anticipate that average receivable collection days in 2009 will increase over 2008 but that the increase will not have a material impact on our liquidity. Our planned additions of property and equipment are discretionary, and we do not expect them to exceed historical levels in 2009. In addition to equipment purchases, in 2009 we paid our 2008 earn-out liability of $1.2 million to the sellers of the EIS assets. We also retired our bank debt in full in February 2009, paying a total of $3.75 million during the quarter ended March 31, 2009.
We have a revolving line of credit agreement with our bank, Associated Bank. The revolving line of credit provides for up to $5.0 million at an annual interest rate equal to the greater of 4.5% or LIBOR plus 2.75%, as reset from time to time by the bank. Advances on the line of credit cannot exceed a borrowing base determined under a formula, which is a percentage of the amounts of receivables. The line of credit currently has no borrowings outstanding and matures on May 1, 2011. We believe, on an ongoing basis, we have regular availability to draw a minimum of $3.0 million on our line of credit based on qualifying assets.
In conjunction with our EIS asset purchase, the sellers have an earn-out arrangement over approximately three years from the December 2007 date of purchase. The earn-out is based on earnings from RTMS sales less related cost of revenue and operating expenses, depreciation and amortization, and it is calculated annually. If the earnings are at target levels, the sellers would receive $2.0 million annually, or $6.0 million in total. Superior performance of the assets could lead to an earn-out in excess of $2 million, as the earn-out is not capped. Earn-out payments generally are due within three months of the end of an earn-out period. The first earn-out period ran from December 6, 2007 to December 31, 2008. Based on the results for RTMS for the first earn-out period, which ended December 31, 2008, the sellers of the EIS assets were entitled to receive a $1.2 million earn-out payment, which was paid in March and April 2009. If we are acquired or sell substantially all of our assets before December 6, 2010, we must pay EIS $6.0 million less earn-out amounts previously paid as an acceleration of potential earn-out payments under the EIS asset purchase agreement.
EIS was named in a U.S. lawsuit in 2006 for infringement of a patent. On October 31, 2007, the court entered judgment that EIS had not infringed on the patent. The plaintiff has appealed the decision, and EIS has continued its defense as provided in the EIS asset purchase agreement. In addition, EIS must indemnify us for all expenses, claims or judgments related to this lawsuit up to the amount of the purchase price, including any earn-out payments. Management believes that the ultimate outcome of this legal action will not have a material adverse effect on our financial statements or liquidity.
We believe that cash and cash equivalents on hand at June 30, 2009, along with the availability of funds under our $5.0 million revolving line of credit and cash provided by operating activities, will satisfy our projected working capital needs, payments under the EIS earn-out, investing activities, and other cash requirements for the foreseeable future.
Off-Balance Sheet Arrangements
We do not participate in transactions or have relationships or other arrangements with an unconsolidated entity, including special purpose and similar entities or other off-balance sheet arrangements.
Critical Accounting Policies
Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2008. The accounting policies used in preparing our interim 2009 Condensed Consolidated Financial Statements set forth elsewhere in this Quarterly Report on Form 10-Q are the same as those described in our Annual Report on Form 10-K.
New and Recently Adopted Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 141 (Revised 2007),Business Combinations. SFAS No. 141(R) will significantly change the accounting for business combinations. Under SFAS No. 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141(R) will change the accounting treatment for certain specific items. SFAS No. 141(R) also includes a substantial number of new disclosure requirements. SFAS No. 141(R) applies to us prospectively for business combinations beginning in 2009, and its adoption did not have a material impact on our financial statements.
- 13 -
Table of Contents
In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The adoption of SFAS No. 160 did not have a material impact on our financial statements.
In May 2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS No. 162 is effective 60 days following the approval by the Securities and Exchange Commission of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. We do not anticipate that the adoption of SFAS No. 162 will materially impact the Company.
In May 2009, the FASB issued SFAS No. 165,Subsequent Events, to incorporate the accounting and disclosure requirements for subsequent events into U.S. generally accepted accounting principles (GAAP). SFAS No. 165 introduces new terminology, defines a date through which management must evaluate subsequent events, and lists the circumstances under which an entity must recognize and disclose events or transactions occurring after the balance sheet date. It is effective prospectively for interim or annual reporting periods ending after June 15, 2009. We adopted SFAS No. 165 as of the required effective date and have applied its provisions. We do not believe the adoption of SFAS No. 165 will have a material effect on our consolidated financial statements.
In June 2009, the FASB issued SFAS No. 168,The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement 162. The FASB Accounting Standards Codification (Codification) will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of SFAS No. 168, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. After the effective date of SFAS No. 168, the Board will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates, which will not be authoritative in their own right, but will serve only to update the Codification. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We will adopt SFAS No. 168 as of the required effective date, September 15, 2009, and we will apply its provisions prospectively. We do not believe the adoption of SFAS No. 168 will have a material effect on our consolidated financial statements.
Cautionary Statement:
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange of 1934, as amended. Forward-looking statements represent our expectations or beliefs concerning future events and can be identified by the use of forward-looking words such as “expects,” “believes,” “may,” “will,” “should,” “intends,” “plans,” “estimates,” or “anticipates” or other comparable terminology. Forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from the results described in the forward-looking statements. Factors that might cause such differences include, but are not limited to:
| | |
| • | historical dependence on a single product for most of our revenue; |
- 14 -
Table of Contents
| | |
| • | budget constraints by governmental entities that purchase our products, including constraints caused by declining tax revenue; |
| | |
| • | continuing ability of our licensee to pay royalties owed; |
| | |
| • | dependence on third parties for manufacturing and marketing our products; |
| | |
| • | dependence on single-source suppliers to meet manufacturing needs; |
| | |
| • | failure to secure adequate protection for our intellectual property rights; |
| | |
| • | development of a competing product by another business using the underlying technology included in the patent we had licensed from the University of Minnesota, which expired in 2006; |
| | |
| • | our inability to develop new applications and product enhancements; |
| | |
| • | our inability to respond to low-cost local competitors in Asia and elsewhere; |
| | |
| • | our inability to properly manage any growth in revenue and/or production requirements; |
| | |
| • | the influence over our voting stock by insiders; |
| | |
| • | our inability to hire and retain key scientific and technical personnel; |
| | |
| • | our inability to achieve and maintain effective internal controls; |
| | |
| • | our inability to comply with international regulatory restrictions over hazardous substances and electronic waste; and |
| | |
| • | conditions beyond our control such as war, terrorist attacks, health epidemics and economic recession. |
We caution that the forward-looking statements made in this report or in other announcements made by us are further qualified by the risk factors set forth in Item 1A. to our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
| |
Item 3. | Quantitative and Qualitative Disclosures About Market Risks |
Our foreign sales and results of operations are subject to the impact of foreign currency fluctuations. We have not historically hedged our exposure to translation gains and losses. Beginning in 2009, we have entered into a limited number of hedges that we anticipate will decrease our overall translation exposure. A 10% adverse change in foreign currency rates would not have a material effect on our results of operations or financial position.
We entered into a number of currency hedging arrangements in 2009. The purpose of the hedging was to lock in what we believe to be favorable rates on certain currencies and to increase our predictability on certain expenses at our foreign subsidiaries. All hedging activity is intended to qualify for hedge accounting under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended. We believe all contracts will be utilized to provide funds to cover operating expenses.
| |
Item 4T. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
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 (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
During the fiscal quarter covered by this report, there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
- 15 -
Table of Contents
PART II. OTHER INFORMATION
None.
Some of the risk factors to which we and our business are subject are described in the section entitled “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008. The risks and uncertainties described in our Annual Report are not the only risks we face. Additional risks and uncertainties not presently known to us or that our management currently deems immaterial also may impair our business operations. If any of the risks described were to occur, our business, financial condition, operating results and cash flows could be materially adversely affected.
| |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
| |
Item 3. | Defaults Upon Senior Securities |
None.
| |
Item 4. | Submission of Matters to a Vote of Security Holders |
We held our Annual Meeting of Shareholders on May 20, 2009 in St. Paul, Minnesota. In connection with the Annual Meeting, we filed our definitive proxy statement with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act and solicited proxies. The only matters voted on at the Annual Meeting were the election of directors, approval of a stock option exchange program and the approval of Grant Thornton LLP as our independent registered public accounting firm for 2009. The votes on these matters were as follows:
| | | | | | |
| Director | | For | | Withhold Authority |
| | | | | |
| Kenneth R. Aubrey | | 3,537,892 | | 227,934 | |
| James W. Bracke | | 3,674,404 | | 91,422 | |
| Michael G. Eleftheriou | | 3,669,876 | | 95,950 | |
| Panos G. Michalopoulos | | 3,499,744 | | 266,082 | |
| James Murdakes | | 3,590,562 | | 175,264 | |
| Sven A. Wehrwein | | 3,611,479 | | 154,347 | |
| |
2. | Approval of a stock option exchange program: |
| | | | | | |
For | | Against | | Abstain | | Broker
Non-votes |
| | | | | | |
2,026,157 | | 574,540 | | 17,831 | | 1,147,298 |
- 16 -
Table of Contents
| |
3. | Approval of Grant Thornton LLP as our independent registered public accounting firm for fiscal year 2009: |
| | | | |
For | | Against | | Abstain |
| | | | |
3,698,938 | | 11,300 | | 55,588 |
None.
The following exhibits are filed as part of this quarterly report on Form 10-Q for the quarterly period ended June 30, 2009:
| | |
Exhibit
Number | | Description |
| | |
31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32.1 | | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
32.2 | | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
99.1 | | Amendment X to Office Lease Agreement dated May 12, 2009 by and between Image Sensing Systems, Inc. and Spruce Tree Centre L.L.P. |
- 17 -
Table of Contents
SIGNATURES
In accordance with the requirements 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. |
| | |
Dated: August 13, 2009 | By: | /s/ Kenneth R. Aubrey |
| | Kenneth R. Aubrey |
| | President and Chief Executive Officer |
| | (principal executive officer) |
| | |
Dated: August 13, 2009 | By: | /s/ Gregory R. L. Smith |
| | Gregory R. L. Smith |
| | Chief Financial Officer |
| | (principal financial and accounting officer) |
- 18 -
Table of Contents
EXHIBIT INDEX
| | |
Exhibit No. | | Description |
| | |
31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32.1 | | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
32.2 | | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | |
99.1 | | Amendment X to Office Lease Agreement dated May 12, 2009 by and between Image Sensing Systems, Inc. and Spruce Tree Centre L.L.P. |
- 19 -
