UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-26056
IMAGE SENSING SYSTEMS, INC.
(Name of small business issuer in its charter)
MINNESOTA 41-1519168
State or other jurisdiction of I.R.S. Employer Identification No.
incorporation of organization
1600 UNIVERSITY AVE. W., #500, ST. PAUL, MN 55104 (651) 603-7700
Address of principal executive offices Issuer's telephone number
|
Securities registered under Section 12(b) of the Exchange act:
NONE
Title of each class
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
Title of each class
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. [X] Yes No [ ]
Check if there is no disclosure of delinquent filers in response to Items 405 of Regulation S-B in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form-10-KSB. [X]
The registrant's revenues for the fiscal year ended December 31, 1998 totaled $3,368,000.
Based on the closing bid price at March 23, 1999, the aggregate market value of the voting stock held by nonaffiliates of the registrant was $4,015,650.
The number of shares outstanding of the registrant's $.01 par value common stock, as of March 23, 1999, was 2,479,200 shares.
Transitional Small Business Issuer Format: Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant's Annual Report to Shareholders for the year ended December 31, 1998, which was filed as an exhibit hereto, are incorporated by reference into Parts I and II.
Portions of the registrant's Proxy Statement for its May 11, 1999 Annual Meeting, which will be filed prior to April 30, 1999, are incorporated by reference in Part III.
SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-KSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements involve risks and uncertainties that may cause the
Company's actual results to differ materially from the results discussed in the
forward-looking statements. Factors that might cause such differences include,
but are not limited to, lack of market acceptance of the Company's products;
dependence on third parties for manufacturing and marketing capabilities and
continuing ability to pay royalties owed; inability of the Company to diversify
its product offerings; revenue fluctuations caused by the Company's dependence
on sales to governmental entities; failure of the Company to secure adequate
protection for the Company's intellectual property rights; failure of the
Company to respond to evolving industry standards and technological changes;
inability of the Company to properly manage growth in revenues and/or production
requirements; inability of the Company to meet its future additional capital
requirements; and control of the voting stock by insiders. The forward-looking
statements are qualified in their entirety by the cautions and risk factors set
forth in Exhibit 99, under the caption "Cautionary Statement," to this Annual
Report on Form 10-KSB for the year ended December 31, 1998.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
ISS was founded in 1984 to develop and market products using video image processing technology for use in advanced traffic management systems and traffic data collection. Video image processing, also known as machine vision or artificial vision, is a technology that analyzes video images through computer programs and special purpose hardware. By using video cameras and computers to emulate the function of the human eye, machine vision has been used in a variety of industrial applications. ISS has combined its proprietary machine vision technology, consisting of complex algorithms, software, and special purpose hardware with commercially available computer hardware and video cameras, to create a system that collects, processes, and analyzes video images.
The Company's first product, the Autoscope(R) Wide Area Video Vehicle Detection System, converts video images of a traffic scene into digitized traffic data that may be transmitted to local or remote locations for real-time traffic management or stored for later analysis. The Autoscope system is modular, flexible, and expandable and has a variety of current and potential applications in intersection control, freeway traffic management, and traffic data collection. Automated vehicle detection for traffic management has traditionally been performed with inductive wire loops buried in the pavement. The Autoscope system is easier to install and maintain than these embedded loop
detectors; is non-destructive to road surfaces; and is capable of wide-area vehicle detection with a single camera, thus enabling one camera to do the work of many loops. The Company believes that the Autoscope system is superior to loop detectors or most other commercially available vehicle detection systems in its current range of applications and its ability to support new applications for advanced technology solutions to traffic management problems.
In 1987, the University of Minnesota, utilizing the technology underlying the Autoscope system, demonstrated the first working traffic application of image processing technology. The U.S. patent for certain aspects of the technology underlying the Autoscope system was issued in 1989 to the University of Minnesota. The Company has an exclusive worldwide license from the University of Minnesota for that technology and the patent and pays royalties to the University of Minnesota in exchange for such license. The Company has sublicensed the exclusive right to manufacture and market the Autoscope system in North America and the Caribbean to Econolite Control Products, Inc. (Econolite) of Anaheim, California and receives royalties from Econolite on sales of the Autoscope system in those territories. Econolite also manufactures the Autoscope system on a non-exclusive basis for direct sales by the Company outside of North America and the Caribbean. In 1997, ISS and Econolite jointly entered into a Production Agreement with Cohu, Inc., Electronic Division (Cohu), wherein ISS and Econolite each granted to Cohu a non-exclusive right to manufacture the Autoscope Solo product solely for sale to ISS and Econolite.
The Autoscope system was first marketed and sold commercially in 1991. In 1993, the Company began to market the Autoscope system outside of North America through distributor arrangements, and the Company intends to continue to increase its marketing efforts in foreign countries. The Company currently has twenty-one distributors covering countries primarily in Europe, Asia, and South America.
TECHNOLOGY
The machine vision industry utilizes technology that converts real world "scenic" information into digital electronic signals for processing by computer. Machine vision has a number of industrial applications. For example, machine vision technology is used for quality control in manufacturing processes. An image of a manufactured product can be fed by video into a computer and analyzed to determine if that finished product satisfies production standards that have been programmed into the computer. The defense industry has used machine vision in a number of applications. For example, "smart" bombs use video imaging technology to identify targets through the use of special optic sensors that feed scenic information into sophisticated computer programs that process the scenic information into target location coordinates.
Through the use of its sophisticated proprietary technology, the Company has been able to apply machine vision technology to traffic management problems. The Company's technology was initially developed by Dr. Panos Michalopoulos, Chairman of the Board and Chief Scientific Advisor of ISS and a Professor at the University of Minnesota, and was further developed at the University of Minnesota from 1985 to 1991 with involvement by Dr. Michalopoulos. The technology uses standard video and computer equipment, combined with proprietary technology, including complex detection algorithms, computer software, special purpose hardware, and a Microsoft Windows(R)-based graphical user interface that enables standard video cameras to work with the Autoscope system.
THE AUTOSCOPE SYSTEM
The Autoscope 2004 system generally consists of one to four video cameras, a flexible modular microprocessor with specialized software and circuitry, and a supervisor computer with a video monitor, keyboard, and mouse. The Autoscope Solo system (Solo) incorporates the microprocessor and circuitry into a single video camera. The Autoscope microprocessor in both the 2004 and Solo systems accepts scenic input from the video cameras and, through a series of complex algorithms and computer software, converts the scenic data into digitized data. This data can then be used for traffic control, research, management, and planning purposes. Most brands of commercially available personal computers with standard configurations can be used as the supervisor computer in the system.
The Autoscope system permits a user to draw detection zones on a video screen displaying the traffic scene and derive traffic data from the portion of the image specified by the detection zones displayed on the screen. The system analyzes virtual detection zones that appear only on the video screen, not on the roadway. Each detection zone represents an area in the field of view of the camera that the system user wishes to analyze for determining the presence of vehicles or extracting other pertinent traffic data. Over 100 detection zones can be programmed into multi-camera systems. The system user determines the detection zones by drawing them on a video monitor with a mouse. Different types of detection zones can be selected and may be placed anywhere in any orientation within the field of view of the cameras using the system's unique interactive graphics. The detection zones can be changed simply by using the mouse to resize, reshape, or relocate the detection zones on the video monitor. Once a new detection configuration has been created, the supervisor computer system can display the detection zones on its own video monitor, together with the live video image, to monitor the system in operation. When a vehicle is under the detection zone, the detection zone changes in color or intensity, thereby providing visual verification of correct system operation. Measured traffic data may be displayed on the video monitor of the supervisor computer in numeric format. The traffic data may be transmitted to another host computer via modem and dial-up telephone lines, private cable, fiber optic network, direct cable connection, or various other wireless communications equipment. Vehicle detection output can also be routed to intersection signal controllers. A detection signal is generated each time a vehicle crosses one of the virtual detection zones, thus enabling the system to accumulate measured traffic data in user-selected categories, such as volume, average speed, time occupancy (percent of time the detection zone is occupied), headways (time interval between vehicles), flow rate (vehicles per hour per lane), and vehicle length. Information from the system can be processed in real-time or stored for later analysis.
The Autoscope system is modular, flexible, and expandable. The Autoscope supervisor computer and video monitor may be disconnected once the detection zone configuration has been transferred to the microprocessor. The system can then operate independently, providing detection zone outputs and storing traffic data in the microprocessor's internal memory. The same portable supervisor computer and video monitor may be used with multiple Autoscope systems. New detection zone configurations can be saved to diskette, and previously saved detection zone configurations can be retrieved from diskette for downloading into each system. The same Autoscope microprocessor can be used with multiple cameras, each with its own detection zone configuration.
The Company introduced its new product, Autoscope Solo, in October 1998. The Solo, which integrates the video image processor camera and peripherals, was developed over the last two years and has now been deployed in two large projects in Minneapolis and St. Paul, Minnesota.
CURRENT APPLICATIONS AND INSTALLATIONS
The current Autoscope system may be used in a number of applications, primarily for intersections, freeways, tunnels, and traffic count stations. In addition, the Company has identified additional potential traffic and non-traffic related applications for the system that it intends to pursue.
INTERSECTION APPLICATIONS. The Autoscope system can be installed at an intersection to provide traffic detection information as required by an intersection signal controller. An intersection signal controller is essentially a device that contains a set of sophisticated computer programs, separate from the vehicle detection system, that uses the traffic detection information to control the green, yellow, and red lights for each of the turning or through lanes to provide for safe and efficient movement of vehicles through the intersection. More sophisticated intersection signal controllers use detection information to maximize the efficient flow of traffic through one or more intersections. The extent to which a signal controller is successful is dependent not only on the level of sophistication of the controller but also on the quality and reliability of the detection system and the type of traffic data provided.
The Autoscope system can be programmed to provide data with respect to vehicle presence, traffic volume, time occupancy (percent of time the detection zone is occupied), vehicle speed, turning movements, queue lengths, stopped vehicles, vehicle direction, and vehicle length. This information is then routed to the intersection signal controller to control the flow of traffic at the intersection or provide alarms at centralized traffic control centers. For example, the Autoscope system can determine that a queue has developed at a stoplight and route that information to the intersection controller so that the signal times can be adjusted appropriately or a left turn signal phase can be engaged if a line develops at the left turn lane. In addition, selected detection zones in the Autoscope system can be programmed so that they only detect cars moving in one direction. This capability can be used to prevent undesired detections, such as a left turning vehicle that has turned too sharply and is momentarily driving in the wrong lane. This capability can also be used to detect cars going the wrong way on a one way street or the wrong way on a freeway exit-ramp. A majority of all commercially installed Autoscope systems are currently being used for intersection control applications.
FREEWAY APPLICATIONS. For freeway applications, Autoscope provides information for traffic management analysis, ramp control, incident detection, and automated surveillance. Typical traffic information provided by the system includes traffic volumes, time occupancy, vehicle speeds and vehicle counts of three different vehicle classes based on length. The system is also used to signal an alarm if it detects stopped vehicles or the sudden onset of congestion in a detection zone indicating a traffic incident on the highway. Using a video camera next to a freeway on-ramp, the Autoscope system detects traffic movement on a freeway on-ramp or in the
merging area on the freeway, and the resulting data is used to prevent a queue from developing on a side street, to control on-ramp traffic signals, or to determine the capacity of a merge area for planning and control purposes.
TRAFFIC INFORMATION GATHERING AND ANALYSIS. The Autoscope system is also used for basic traffic information gathering and analysis on intersections, freeways, and other roadways. Traffic planners use the traffic data collected by the Autoscope system to design roadway changes, define signal timing plans, approve commercial development plans, and define the environmental impact of traffic congestion. The Autoscope system has been deployed in temporary or semi-permanent configurations as a portable detection system during road repairs, construction, or resurfacing and for special studies, such as traffic data collection by a planning department, a traffic consultant or a university. The Autoscope system captures vast amounts of traffic data in its own memory or on a hard disk of the supervisor computer for later off-line graphing and analysis. Further flexibility is gained with the ability to videotape a section of roadway with a portable video camera and measure the traffic data off-line with the Autoscope processor.
POTENTIAL PRODUCT APPLICATIONS AND ENHANCEMENTS. The Company is engaged in a continuous effort to increase the number of applications and develop enhancements for the Autoscope system. Enhancements to the system are often a result of responses to needs identified by customers in the field. The Company has been involved in a number of consulting arrangements in which the Company has been engaged to manage the deployment of custom applications of the Autoscope system.
While the Company believes that it will be able to develop and commercialize these product enhancements and applications, there can be no assurance that it will be able to do so or that offering such enhancements or applications will provide the Company any unique competitive advantage over existing or developed technology.
RESEARCH AND DEVELOPMENT
The Company is engaged in continued research and development in order to lower manufacturing unit costs, develop less expensive system configurations, and improve product quality. The Company's research and development activities also are focused on broadening the applications of the Company's system and developing product enhancements. New applications and product enhancements are often a result of research and development in response to needs identified by customers in the field.
The size of the Company's research and development staff varies in numbers depending on the allocation of engineering resources to outside projects and product support. Generally eleven individuals, of whom four hold advanced degrees, are presently involved in research and development. The Company's research and development expenditures totaled approximately $203,000 in 1998 and $643,000 in 1997. In addition, the Company capitalized software development costs during the application development stage for the Solo product totaling $825,000 in 1998 and $75,000 in 1997. The combination of capitalized software development costs and research and development costs was $1,028,000 in 1998 and $718,000 in 1997. The
Company expects its research and development costs in 1999 to be comparable to the combined capitalized software development and research and development costs incurred in 1998.
MARKETS
Urban traffic congestion is a major global problem. Consequently, in the United States and in many developed countries throughout the world, there is a growing demand for traffic management and control technology. In the U.S. local and national government agencies continuously seek new solutions to traffic congestion. Traffic planners can build new roads or develop mass transit. However, both of these options are expensive, time consuming, and in many situations not feasible. In this era of governmental budgetary constraints, traffic planners are increasingly seeking solutions that will maximize the efficiency and utilization of the existing roadways.
The costs due to congestion, including wasted fuel, increased accidents, and time lost, are substantial. In a report to Congress, the U.S. Secretary of Transportation estimated that lost productivity due to urban traffic congestion for the twenty-five largest U.S. metropolitan areas is approximately $34 billion per year and approximately $100 billion per year for the entire country. In an effort to reduce these costs, the U.S. Congress, in 1991, enacted the Intermodal Surface Transportation Efficiency Act (ISTEA), the purpose of which is to develop economically efficient and environmentally sound solutions to transportation system problems in the U.S. As part of ISTEA Congress endorsed a national transportation initiative known as Intelligent Transportation Systems (ITS) and appropriated substantial funding for ITS projects. Under ISTEA the U.S. Department of Transportation must report to Congress periodically regarding the progress of ITS projects.
ITS represents a new and growing area of interest within the transportation industry, dedicated to the application of advanced technology to meet the increased demands on the nation's transportation systems. One central principle of the ITS program is that solutions to transportation problems in the U.S. should focus on more efficient use of the current roads and systems, rather than merely increasing the quantity of roads and systems. ITS encourages technological developments that will improve highway safety, system operating efficiency, environmental quality, or energy utilization in transportation through improved interactions between roads, vehicles, and their drivers. ITS is an interdisciplinary initiative composed of a number of technologies, including those developed and used in the defense industry, information processing, communications, control, and electronics. With funding and oversight from the U.S. Department of Transportation, the Federal Highway Administration, and the state departments of transportation, the ITS program seeks to develop and implement a variety of transportation user services.
On June 9, 1998, the Transportation Equity Act for the 21st Century (TEA-21) was signed into law by the President of the United States. This law authorizes $198 billion in spending for highways, highway safety, transit and other surface transportation programs over the next five years. Over $10 billion is earmarked for mitigation of congestion and air quality improvement, to develop and deploy advanced intelligent transportation system technologies and for transportation research and technology deployment. TEA-21 will provide transportation
managers with increased funding over the next five years to enable more deployment of machine vision technology.
The Company believes that implementation of advanced traffic management schemes envisioned by ITS requires collection of real-time traffic conditions including traffic volume, roadway occupancy, traffic speed, stopped vehicles, vehicle direction, vehicle length, and traffic incidents. Loop detectors are generally too expensive to install and maintain in the large quantities required for implementing some of the more aggressive ITS programs.
While the Company is optimistic that its Autoscope machine vision technology will be selected for deployment in the United States with increasing frequency, there can be no assurance that traffic managers responsible for selecting Intelligent Transportation Systems will choose machine vision technology over embedded loop detectors, pressure plates, radar, microwave or other competing technologies or will choose the Autoscope system over competing machine vision products.
The Company is aware that other countries are initiating or contemplating initiating programs similar to ITS. For example, the European Community has a program called ERTICO, which is attempting to manage traffic with advanced technology. The Company believes that as market acceptance increases in such countries, the utilization of the Autoscope system for freeway applications in such programs may increase. To date the Company has generated revenues from involvement in an ITS-type program in South Korea.
CUSTOMERS
The customers for Autoscope are primarily federal, state, city, and county departments of transportation; road commissions; and port, turnpike, tunnel, and other transportation authorities. The decision makers within these government entities are typically traffic planners and government engineers, who in turn often rely on consulting firms that perform planning and feasibility studies for those entities. Most Autoscope systems deployed as part of an ITS program are ordered as components of major construction contracts, under subcontracts to system integrators or other suppliers of systems and services. Otherwise, state and local government agencies often install and maintain their own equipment. In order to increase sales of the Autoscope system, the Company must continue to increase product and technology awareness within these customer groups.
BACKLOG
The Company's backlog of unfulfilled firm orders from distributors was approximately $288,000 as of December 31, 1998 and was not material as of December 31, 1997. Terms of agreements between distributors of the Company's products and government contractors and other customers generally provide for cancellation or rescheduling of delivery. Accordingly, the Company's backlog at a particular date may not be indicative of its future revenue.
COMPETITION
Competition in the area of advanced traffic management and surveillance is growing, due in part to the increased federal funding of advanced technologies under the ITS program. Some of the companies that may compete with the Company in the business of developing and implementing traffic control systems include companies that have substantially more financial, technological, marketing, personnel, and research and development resources than the Company. The Company's products will compete not only with conventional methods of vehicle detection and traffic control, such as embedded loop detectors, but also with new technologies that may be applied to problems of urban traffic congestion. New technologies or applications in traffic control systems may provide the Company's customers with alternatives to the Autoscope system. Various technologies have been used as traffic sensing devices in the past and will continue to be developed for application to traffic management. These technologies include embedded loop detectors, pressure plates, pneumatic tubes, radars, lasers, magnetometers, acoustics, and microwaves. The Company estimates that over 95% of the detector systems currently in use in the U.S. are embedded loop detectors. Embedded loop detectors are relatively easy to manufacture and are currently manufactured by numerous companies throughout the world.
The Company is aware of several companies that are developing traffic management devices using machine vision technology or other advanced technology. Among the companies that are expected to provide direct competition to the Company's Autoscope system in the use of machine vision technology in traffic management are Traficon N.V. (Traficon), Peek business unit of Thermo Power Corp. (Peek), Nestor, Inc., and Odetics, Inc., (Odetics). To the Company's knowledge, Traficon, Odetics, and Peek have working installations of their machine vision systems in the U.S. and other parts of the world. However, these companies do not have as many installations as ISS. To the Company's knowledge, machine vision systems are also being developed by Nestor, Inc. The Company is aware that these and other companies will continue to develop technologies for use in traffic management and surveillance. One or more of these technologies could in the future provide increased competition for the Autoscope system. Nevertheless, the Company believes that its products have undergone more extensive field-testing and are at a more advanced stage of development than any of its competitors' products.
MARKETING AND MANUFACTURING
Marketing and manufacturing of the Autoscope system in North America and the Caribbean (the Econolite Territory) has been performed by Econolite Control Products, Inc. of Anaheim, California pursuant to a Manufacturing, Distributing and Technology License Agreement (the Econolite Agreement). Pursuant to that agreement, ISS has appointed Econolite as its licensee to make, have made, use, license, distribute and sell the Autoscope system and related technology in the Econolite Territory. Econolite has agreed to use its best efforts to promote the sale of the Autoscope system and not to distribute products that compete with the Autoscope system. Econolite pays ISS a royalty on all revenue derived by Econolite from sales of the Autoscope system. Econolite has over 64 years of experience in the traditional traffic intersection control industry.
In January 1998, Econolite was certified as to ISO 9002 standards in its manufacture of machine vision products for the transportation management industry.
The Company also obtained Conformite Europeenne (CE) Mark approval in 1998 for its Autoscope technology. The CE Mark is a worldwide standard for safety and quality assurance.
ISS may terminate the Econolite Agreement if a minimum annual sales level is not met. The initial term of the Econolite Agreement is 15 years, ending in 2007, automatically renewable thereafter for additional one-year periods unless terminated by either party on 60 days notice prior to the end of the initial term or any extension term.
The Econolite Agreement grants a license to Econolite that encompasses any knowledge, information, know-how, software or devices relating to vehicle detection, whether patentable or not, that is licensed to ISS pursuant to the License Agreement with the University of Minnesota described below under "Patents and Proprietary Rights," and any knowledge, information, know-how, software or devices relating to vehicle detection owned or licensable by ISS. Econolite has a first negotiation right for extension of the license granted in the Econolite Agreement to include rights in countries outside the Econolite Territory. Currently, Econolite has agreed to manufacture, on a non-exclusive basis, the Autoscope systems sold outside the Econolite Territory.
In 1997, ISS and Econolite jointly entered into a Production Agreement with Cohu, Inc., Electronic Division (Cohu), wherein ISS and Econolite each granted to Cohu a non-exclusive, non-transferable, non-assignable, royalty-free right and license to use such of the Company's Intellectual Property and Econolite Intellectual Property as may be necessary to make, design, develop, assemble, manufacture, and repair the Solo product solely for sale to ISS and Econolite. Cohu acquired no right, title, or interest in or to the Company's Intellectual Property or the Econolite Intellectual Property other than the foregoing limited license, nor does Cohu have the right or authority to sublicense all or any portion of the Company's Intellectual Property or Econolite Intellectual Property.
Cohu agreed to manufacture and sell exclusively to ISS and Econolite so many units of the Solo product as ISS and Econolite may order from time to time. ISS and Econolite each agreed to purchase from Cohu all of their respective requirements for the Solo product for sale to end users in the Company's and Econolite's territories until such time as ISS and/or Econolite have purchased 5,000 units in the aggregate. Econolite agreed to continue to purchase all of its requirements for the Solo product thereafter, subject to Econolite's option to manufacture the Solo product and the Company's right of termination. Notwithstanding the foregoing, nothing in the Production Agreement requires either ISS or Econolite to purchase a minimum number of units from Cohu.
ISS may terminate the Production Agreement, with or without cause, upon sixty days' prior written notice. Cohu may terminate the Production Agreement, with or without cause, upon twelve months' prior written notice. In the event ISS terminates the Production Agreement with cause, Cohu shall promptly deliver to ISS all tooling specific to production of the Solo product, and Cohu shall not be entitled to any further payment for development services.
In the event ISS terminates the Production Agreement without cause as provided in the agreement, ISS will purchase from Cohu all of Cohu's inventory related solely to the manufacture or sale, including raw materials, unique parts, work in process, and finished goods up to a maximum purchase price of $90,000. The purchase price of such inventory would be at Cohu's cost.
Econolite provides a two-year warranty on the current Autoscope system and must provide all service required under such warranties. Cohu provides a two-year warranty to ISS and Econolite on the Solo product. Some of the component hardware incorporated into the Autoscope system, such as the supervisor computer and the video monitor, are standard computer hardware products that are available from multiple sources. Other parts, such as the microprocessor and digitizer are manufactured to certain specifications by third party vendors for integration into the system. While current vendors of components for the Autoscope system are meeting Econolite's, Cohu's and the Company's quality and performance expectations, the Company believes alternative component vendors are available should the necessity arise. Nevertheless, shortages of parts or the need to change vendors could adversely affect Econolite's or Cohu's ability to manufacture the Autoscope system, which could, in turn, adversely affect the Company's business.
The Company continues to strengthen its sales and marketing effort by investing in promotional activities to support Econolite's marketing efforts in the Econolite Territory. As part of this effort, ISS and Econolite have an integrated marketing communications program. This program attempts to increase market awareness of the Company's technology and its product. ISS and Econolite have engaged in direct mailings of Autoscope brochures, manuals and videos to potential customers.
ISS has established a sales and marketing capability in countries outside the Econolite Territory. In November 1998, the Company employed a Director of Asian Operations to be responsible for sales and marketing efforts, including revitalization and growth of distributors in this market. In addition, on February 1, 1999, the Company acquired a sixty- percent equity interest in a sales organization in Hong Kong. This affiliate, under the direction of the Director of Asian Operations, will market the Company's products as well as related traffic control products in Asia.
The Company also employs a business development manager to expand the distribution network in Europe and Latin America. The Company currently has distributor agreements with twenty-one distributors covering countries primarily in Europe, Asia, and South America. Under the distributor agreements each distributor agrees to use its best efforts to market and sell the Autoscope system and to purchase one demonstration system of the Autoscope for use in its marketing efforts.
PATENTS AND PROPRIETARY RIGHTS
The Company intends to actively protect its intellectual property assets and will actively seek, when appropriate, protection for owned or licensed products and proprietary information by means of U.S. and foreign patents, trademarks, and contractual arrangements. In addition, the
Company relies upon trade secrets and contractual arrangements to protect certain of its proprietary information. The Company has a federally registered trademark right to "Autoscope."
The technology underlying the Autoscope system was initially developed by Dr. Panos Michalopoulos, Chairman of the Board and Chief Scientific Advisor of ISS and a Professor at the University of Minnesota, and was further developed at the University of Minnesota from 1985 to 1991 with involvement by Dr. Michalopoulos. Additional system developments were funded, in part, by the Minnesota Department of Transportation and the Federal Highway Administration from 1985 to 1989. The U.S. patent for certain aspects of the technology underlying the Autoscope system was issued in 1989 to the University of Minnesota. The University of Minnesota has filed to perfect related patents in France, Germany, the United Kingdom, and Japan. Dr. Michalopoulos has assigned all of his rights in such technology to the Company or to the University of Minnesota. The Company entered into a License Agreement (the License Agreement) with the University of Minnesota in 1991.
Under the License Agreement, the Company has been granted an exclusive, worldwide license, with a right to grant sublicenses, to make, have made, use, sell, and lease any product that incorporates knowledge, information, know-how, software and devices, whether patentable or not, in the possession of the University and related to a video vehicle detection system developed by the University of Minnesota, solely or jointly with the Company, including certain improvements made to such technology. In exchange for that license, the Company pays to the University of Minnesota (i) a royalty of 3% of the net sales of licensed products, (ii) 50% of all site license revenue, and (iii) 10% of all sublicensing revenue. For purposes of the License Agreement, net sales means the gross amount collected for sales, leases or licenses of licensed products. Licensed products include any manufactured product that incorporates the technology or improvements covered by the License Agreement. Site license revenue equals all revenue collected by the Company and specifically allocable to the Company for granting a license to use the licensed products at a specific location or by a specific user. Sublicensing revenue equals all revenue collected by the Company from parties to whom the Company grants sublicense rights to make or sell the licensed products. The University of Minnesota has retained a nonexclusive and nontransferable right to use the licensed technology for educational and research purposes. The License Agreement terminates at the termination of the patent covering the technology. The University of Minnesota may terminate the License Agreement if the royalties due thereunder are unpaid, if there is a material breach of the agreement by the Company or if the Company fails to use best efforts to effect commercial sales of the licensed products. The Company has agreed to indemnify the University of Minnesota against all liabilities or losses arising from (i) manufacture, use, lease or sale of a licensed product by the Company or a sublicensee of the Company, or (ii) a third party's use of a licensed product purchased from the Company or a sublicensee of the Company or (iii) a third party's manufacture of a licensed product at the request of the Company.
The Company has sublicensed certain of its rights in the Autoscope technology to Econolite pursuant to the Econolite Agreement. See "Marketing and Manufacturing" above.
The Company's technology is dependent upon the knowledge, experience, and skills of its key scientific and technical personnel. To protect its rights to its proprietary know-how and technology, Company policy requires all employees and consultants to execute confidentiality agreements that prohibit the disclosure of confidential information to anyone outside the Company. These agreements also require disclosure and assignment to the Company of any discoveries and inventions made by such persons while devoted to Company activities.
EMPLOYEES
As of March 18, 1999, the Company had 23 full time employees, of which 11 were engaged in research and development; 5 in product and customer support; 2 in sales and marketing; and 5 in management, administration, finance, and human resources. No employee is represented by a union. The Company believes its employee relations are good.
LIABILITY INSURANCE
Econolite currently maintains $15,000,000 of product liability insurance, and ISS maintains $2,000,000 of product liability insurance. In addition, Econolite has agreed to indemnify and hold harmless ISS from and against any losses, damages, or expenses arising out of the products made or sold by Econolite pursuant to the Econolite Agreement. There can be no assurance that the Company will be able to obtain adequate insurance in the future or that claims will not be made in excess of any insurance coverage obtained.
ITEM 2. DESCRIPTION OF PROPERTY
The Company currently leases approximately 10,000 square feet of office space in St. Paul, Minnesota. The lease expires in November 2001, with an option to extend the lease through November 2004. Aggregate annual lease payments under the lease are approximately $138,000. The Company believes its facilities are sufficient for its current needs.
ITEM 3. LEGAL PROCEEDINGS
During 1998, the Company was not involved in any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of the calendar year covered by this report.
PART II
ITEM 5. MARKET PRICE OF COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION
Price Range of Common Stock on page 21 of the Annual Report to Shareholders for the year ended December 31, 1998, is incorporated herein by reference.
HOLDERS
As of March 23, 1999, the Company had approximately 36 holders of record of its Common Stock and approximately 650 shareholders.
DIVIDENDS
The Company has never declared or paid a cash dividend on its Common Stock. The Company currently intends to retain earnings for use in the operation and expansion of its business; and therefore, it does not anticipate paying any dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 10 and 11 of the Annual Report to Shareholders for the year ended December 31, 1998 are incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and report of independent auditors included on pages 12 through 20 of the Annual Report to Shareholders for the year ended December 31, 1998 are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None
PART III
ITEM 9. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information contained on pages 2 and 3 of Image Sensing Systems, Inc.'s Proxy Statement dated April 5, 1999, with respect to directors and executive officers of the Company, is incorporated herein by reference in response to this item.
ITEM 10. EXECUTIVE COMPENSATION
The information contained on pages 4 and 5 of Image Sensing Systems, Inc.'s Proxy Statement dated April 5, 1999, with respect to executive compensation and transactions, is incorporated herein by reference in response to this item.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained on page 7 of Image Sensing Systems, Inc.'s Proxy Statement dated April 5, 1999, with respect to security ownership or certain beneficial owners and management, is incorporated herein by reference in response to this item.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART III
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) LIST OF DOCUMENTS FILED AS PART OF THE REPORT:
1. Financial statements referenced in Item 7
2. Exhibits:
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 Restated Articles of Incorporation of the Company,
incorporated by reference to the Company's
registration statement on Form SB-2 (Registration No.
90298C) filed with the Commission on March 14, 1995.
3.3 Bylaws of the Company, incorporated by reference to
the Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
4.1 Specimen form of the Company's Common Stock
Certificate, incorporated by reference to the
Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
4.2 1995 Long-Term Incentive and Stock Option Plan and
form of Option Agreement, incorporated by reference
to the Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
10.1 Manufacturing Distributing and Technology License
Agreement dated June 11, 1991, as amended December
15, 1992, between Econolite Control Products, Inc.
and the Company, incorporated by reference to the
Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
10.2 License Agreement dated June 10, 1991 between the
University of Minnesota and the Company, incorporated
by reference to the Company's registration statement
on Form SB-2 (Registration No. 90298C) filed with the
Commission on March 14, 1995.
10.3 Form of Distributor Agreement, incorporated by
reference to the Company's registration statement on
Form SB-2 (Registration No. 90298C) filed with the
Commission on March 14, 1995.
10.4 Employment Agreement dated January 3, 1995 between
the Company and Panos G. Michalopoulos, incorporated
by reference to the Company's registration statement
on Form SB-2 (Registration No. 90298C) filed with the
Commission on March 14, 1995.
10.5 Employment Agreement dated January 3, 1995 between
the Company and Spiro G. Voglis, incorporated by
reference to the Company's registration statement on
Form SB-2 (Registration No. 90298C) filed with the
Commission on March 14, 1995.
10.6 Commercial Note with Norwest Bank Minnesota, N.A.
dated February 16, 1995, incorporated by reference to
the Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
10.7 Form of Data Exchange and Disclosure Agreement,
incorporated by reference to the Company's
registration statement on Form SB-2 (Registration No.
90298C) filed with the Commission on March 14, 1995.
10.8 Lease Agreement dated January 14, 1994 between the
Company and Bradley Real Estate Trust, incorporated
by reference to the Company's registration statement
on Form SB-2 (Registration No. 90298C) filed with the
Commission on March 14, 1995.
10.9 Assignment from Panos G. Michalopoulos to the Company
dated January 19, 1985, incorporated by reference to
the Company's registration statement on Form SB-2
(Registration No. 90298C) filed with the Commission
on March 14, 1995.
10.10 Office Lease Amendment I dated June 8, 1995, by and
between Spruce Tree Centre L.L.P. and Image Sensing
Systems, Inc., filed as Exhibit 10.10 to the
Company's Form 10-KSB for the year ended December 31,
1995 and incorporated herein by reference.
|
10.11 Second Lease Amendment dated October 13, 1995, by and
between Spruce Tree Centre L.L.P. and Image Sensing
Systems, Inc. filed as Exhibit 10.11 to the Company's
Form 10-KSB for the year ended December 31, 1995 and
incorporated herein by reference.
10.12 Extension of Spiro Voglis's employment agreement,
filed as Exhibit 10.12 to the Company's Form 10-KSB
for the year ended December 31, 1995 and incorporated
herein by reference.
10.13 Consulting Agreement dated February 24, 1997, by and
between Arthur J. Bourgeois and Image Sensing
Systems, Inc., filed as Exhibit 10.13 to the
Company's Form 10-KSB for the year ended December 31,
1995 and incorporated herein by reference.
10.14 Production Agreement dated July 8, 1997, between the
Company, Cohu, Inc., and Econolite Control Products,
Inc., filed as Exhibit 10.14 to the Company's Form
10-KSB for the year ended December 31, 1997 and
incorporated herein by reference.
10.15 Extension of Mr. Bourgeois's consulting agreement,
filed as Exhibit 10.15 to the Company's Form 10-KSB
for the year ended December 31, 1997 and incorporated
herein by reference.
10.16 Executive Employment Agreement between the Company
and William L. Russell, dated June 10, 1998, filed as
Exhibit 10 to the Company's Form 10-QSB for the
quarter ended June 30, 1998 and incorporated herein
by reference.
10.17 Conditional Credit Line Letter Agreement with Norwest
Bank Minnesota, N.A. dated September 14, 1998
10.18 Office Lease Agreement by and between Spruce Tree
Centre L.L.P and the Company, dated November 24, 1998
13 Annual Report of the Company for the year ended
December 31, 1998, certain portions of which are
incorporated by reference into this Annual Report on
Form 10-KSB.
23 Consent of Ernst & Young LLP
99 Cautionary Statement
27 Financial data schedule
|
b) REPORTS ON FORM 8-K FILED DURING FOURTH QUARTER OF 1998: NONE
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Image Sensing Systems, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:
IMAGE SENSING SYSTEMS, INC.
/s/ William L. Russell Date: March 30, 1999
---------------------- ---------------------
By: William L. Russell, President and CEO
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Each person whose signature to this report on Form 10-KSB appears below hereby constitutes and appoints William L. Russell and Arthur J. Bourgeois, and each of them, as his or her true and lawful attorney-in-fact and agent, with full power of substitution, to sign on his or her behalf individually and in the capacity stated below and to perform any acts necessary to be done in order to file all amendments to this report on Form 10-KSB, and any and all instruments or documents filed as part of or in connections with this report on Form 10-KSB or the amendments thereto and each of the undersigned does hereby ratify and confirm all that said attorney-in-fact and agent, or his substitutes, shall do or cause to be done by virtue hereof.
/s/ Panos G. Michalopoulo Date: March 30, 1999
--------------------------------------------------------
By: Panos G. Michalopoulos
Chairman of the Board & Director
/s/ William L. Russel Date: March 30, 1999
--------------------------------------------------------
By: William L. Russell
President & Director (Chief Executive Officer)
/s/ Richard P. Braun Date: March 30, 1999
--------------------------------------------------------
By: Richard P. Braun
Director
/s/ Richard C. Magnuson Date: March 30, 1999
--------------------------------------------------------
By: Richard C. Magnuson
Director
/s/ James Murdakes Date: March 30, 1999
--------------------------------------------------------
By: James Murdakes
Director
/s/ C. (Dino) Xykis Date: March 30, 1999
--------------------------------------------------------
By: C. (Dino) Xykis
Director
/s/ Arthur J. Bourgeois Date: March 30, 1999
--------------------------------------------------------
By: Arthur J. Bourgeois
Chief Financial Officer
|
EXHIBIT 10.17
GARY R. ANDERSON
ASSISTANT VICE PRESIDENT/COMMERCIAL BANKING
OFFICER
[LOGO] NORWEST BANKS
NORWEST BANK MINNESOTA, N.A.
ST. PAUL COMMERCIAL BANKING
55 EAST FIFTH STREET
SL PAUL, MINNESOTA 55101-2318
651 1205-8534FAX 651 1205-8537
August 14, 1998
Mr. William L. Russell
Image Sensing Systems, Inc.
500 Spruce Tree Center
1600 University Avenue West
St. Paul, Minnesota 55104-3825
Dear Mr. Russell:
We are pleased to advise you that Norwest Bank Minnesota, National Association (the "Bank") has renewed a secured, revolving, Conditional Credit Line (the "Line") for Imaging Sensing Systems, Inc. in an amount not to exceed $500,000. You may prepay and re-borrow as long as no borrowing causes that dollar limit to be exceeded.
The Revolving Credit Line is subject to the terms and conditions outlined below:
o Credit Advances. Loans made under the Line will be at the Bank Officers' sole discretion, that is, the Officers have no obligation to make any loan under the Line. The Officers will make a separate credit decision each time a request is made.
o The Note. Your obligation to repay all loans made by us under the Line will be evidenced by a single promissory note due on demand with a final maturity of July 31, 2000. This note will also specify events of default and the rights and remedies available to us upon the occurrence of an event of default.
o Interest Rate. The Note will bear interest (computed on the basis of actual days elapsed in a 360-day year) on the principal balance outstanding. Interest accrues from the date of the initial advance until the Note is paid in full at a floating rate of 1.25% per annum in excess of the Base Rate of Norwest Bank Minnesota, N.A.. The rate of interest shall be adjusted with each change in the Base Rate.
o Adverse Conditions. The Line may be terminated at any time by the Bank by written notice to the Borrower and shall terminate automatically, without notice, if materially adverse conditions develop at any time, whether before or after acceptance of this letter. If the Line is terminated, each and every note evidencing loans, if any, made under the Line will be immediately due and payable.
o Security. The Note is secured by a security interest in your accounts receivable, inventory, equipment and general intangibles. This property is more fully described in the security agreement. The security interest extends to property of the type described, whether now owned or hereafter acquired.
o Accounts Receivable. All loan advances will not exceed 65% of eligible accounts receivable. We define ineligible accounts receivable as follows:
o Those receivables that are more than 90 days old.
o Those receivables subject to the 10% rule (i.e. any account in which 10% or more of the total outstanding receivable is delinquent 90 or more days will be entirely ineligible).
o Contra accounts - those accounts subject to offset, dispute or retainage.
o Those receivables due from the U.S. Government, foreign entities (unless insured or backed by Documentary Letters of Credit), or affiliates or subsidiaries of the Borrower.
Insurance. Borrower will maintain insurance with financially sound and reputable insurers covering properties and business against those casualties and contingencies and in the types and amounts as are in accordance with sound business and industry practices, with the Bank named as loss payee.
Collateral Audits. The Borrower will allow the Bank to conduct annual collateral audits of its books and records, if the Bank chooses to do so. The audits will be performed by Norwest's collateral audit team, and all costs associated with the audits will be paid by the Borrower.
FINANCIAL AND AFFIRMATIVE COVENANTS
So long as the Line is in effect, the Borrower will:
o Maintain its primary depository accounts at Norwest Bank Minnesota, N.A. - St. Paul office.
o Maintain Tangible Net Worth of not less than $3,000,000 as of 12/31/98.
o Achieve Net Earnings after Tax in fiscal 1998 of at least $1.00.
o Maintain Debt to Tangible Net Worth of no more than 0.50:1 as of 12/31/98.
NEGATIVE COVENANTS
So long as the Line is in effect, and without the written consent of the Bank, the Borrower will not:
o Consolidate with, or merge into, any other corporation, or permit any other corporation to merge into it, nor will it convey, lease or sell all or a material portion of its assets or business, except in the ordinary course of business; nor will it lease, purchase, or acquire all or a material portion of the assets or business of any other corporation or entity.
o Purchase or acquire any securities of, or make any investments in any person, firm or corporation, except obligations of the United States Government, open market commercial paper rated prime, or certificates of deposit in commercial banks.
o Incur indebtedness for borrowed money or installment obligations, except indebtedness to the Bank and existing indebtedness disclosed to the Bank in writing.
o Create, or permit to exist, any lien on any of its property, real or personal, except liens to secure permitted indebtedness, liens to the Bank, and liens incurred in the ordinary course of business.
FINANCIAL REPORTING
So long as the Line is in effect, the Borrower is required to provide financial information to the Bank as described below. The Borrower will:
o Furnish annual audited financial statements within 90 days of fiscal year end, prepared by an independent certified public accountant chosen by Borrower and satisfactory to the Bank.
o Furnish compiled interim statements within 45 days of each quarter end, or when debt is outstanding on the line of credit, furnish monthly interim statements. These statements may be prepared internally or by an outside accounting firm.
o Furnish projected balance sheet, income statement and statements of cash flow for the upcoming fiscal year within 60 days of the most recent year end.
o Provide quarterly listings and agings of accounts receivable within 30 days of each quarter end, when the line is utilized.
o Provide quarterly listings and agings of accounts payable within 30 days of each quarter end, when the line is utilized,
If the foregoing is agreeable to you, please sign the attached copy of this letter and return it to me. If you have any questions regarding this letter, please call me at 205-8534. Thank you for your continued relationship with Norwest Banks. Your business is appreciated.
Yours truly,
/s/ Gary R. Anderson Gary R. Anderson Assistant Vice President |
Accepted this 14th day of August, 1998.
IMAGE SENSING SYSTEMS, INC.
By /s/ illegible signature By: ________________________________ Its: President Its: _______________________________ |
EXHIBIT 10.18
OFFICE LEASE AGREEMENT BY AND BETWEEN
SPRUCE TREE CENTRE L.L.P.
AND
IMAGE SENSING SYSTEMS, INC.
ARTICLE PAGE
------- ----
1 PREMISES AND TERMS .....................................................1
2 ACCEPTANCE OF PREMISES .................................................1
3 FIXED RENT .............................................................2
4 TAX ADJUSTMENT .........................................................2
5 OPERATING COST ADJUSTMENT ..............................................3
6 RENTABLE AREA ..........................................................4
7 SECURITY DEPOSIT .......................................................5
8 ACCOUNTING .............................................................5
9 USE ....................................................................5
10 BUSINESS HOURS .........................................................5
11 REPAIRS BY LESSOR ......................................................6
12 TENANT'S REPAIRS .......................................................6
13 ALTERATIONS ............................................................6
14 SIGNS ..................................................................7
15 ACCESS BY LESSOR .......................................................7
16 UTILITIES AND SERVICES .................................................8
17 ASSIGNMENT AND SUBLETTING ..............................................10
18 FIRE AND OTHER CASUALTY ................................................11
19 SUBROGATION ............................................................12
20 LIABILITY ..............................................................12
21 EMINENT DOMAIN .........................................................12
22 HOLDING OVER ...........................................................13
23 QUIET ENJOYMENT ........................................................13
24 EVENTS OF DEFAULT ......................................................13
25 DEFAULT ................................................................14
26 SUBORDINATION OF LEASE .................................................14
27 NOTICES ................................................................15
28 RULES AND REGULATIONS ..................................................15
29 ENERGY; GOVERNMENTAL ACTION ............................................15
30 LIGHT AND AIR ..........................................................15
31 BROKERAGE FEES .........................................................16
32 SUBSTITUTE PREMISES ....................................................16
33 LESSOR'S USE ...........................................................16
34 MISCELLANEOUS TAXES ....................................................17
35 ESTOPPEL CERTIFICATE ...................................................17
36 MISCELLANEOUS ..........................................................17
37 NO PARTNERSHIP, JOINT VENTURE OR
FIDUCIARY RELATIONSHIP .................................................18
38 INVALIDITY OF PARTICULAR PROVISIONS ....................................18
|
EXHIBITS
A FLOOR PLAN
B PROPERTY DESCRIPTION
C LEASEHOLD IMPROVEMENTS
D BUILDING RULES AND REGULATIONS
E PARKING
LEASE AGREEMENT
THIS LEASE AGREEMENT, made and entered into this 24th day of November 1998 by and between Spruce Tree Centre L.L.P. (hereinafter referred to as "Lessor"), and Image Sensing Systems, Inc. (hereinafter referred to as "Tenant", whether one or more).
WITNESSETH:
PREMISES AND TERMS
1. In consideration of the obligation of Tenant to pay rent as herein provided, and in consideration of the other terms, provisions and covenants hereof, Lessor hereby demises and leases to Tenant, and Tenant hereby takes from Lessor, certain premises (hereinafter referred to as the "Leased Premises") situated within the County of Ramsey, State of Minnesota, consisting of approximately 9,278 rentable square feet; known as Suites 420 and 500, as shaded with cross-hatch on the floor plan attached hereto as Exhibit A and made a part hereof including a proportionate share of common area as described under the definition of Rentable Area (Articles 6a, 6b and 6c of this Lease), on the fourth and fifth floors of the building commonly known as Spruce Tree Centre (hereinafter referred to as the "Building") located at 1600 University Avenue, St. Paul, Minnesota 55104, which Building is situated upon the real property described on Exhibit B attached hereto and hereby made a part hereof (the Building and said real property are hereinafter referred to as the "Project"), together with all rights, privileges, easements, appurtenances and amenities belonging to or in any way pertaining to the Leased Premises, and together with the right to use in common with Lessor and other tenants in the Project, and its and their employees, agents, representatives and invitees, any common areas and facilities of the Project.
To have and to hold for a term of three (3) years and no months, commencing on the first day of December , 1998, and ending on the 30th day of November, 2001. Tenant acknowledges that it has inspected the Leased Premises and accepts them in their present condition as suitable for the purpose for which they are leased, and further acknowledges that no representations as to the repair of the Leased Premises nor promises to alter, remodel or improve the Leased Premises have been made by Lessor or its agents, except as may be provided on the attached Exhibit C.
ACCEPTANCE OF PREMISES
2. If Lessor does not complete leasehold improvements, as described in Exhibit C, if any, to be completed by Lessor, and deliver possession of the Leased Premises on or before said commencement date, or if Lessor is unable for any other reason to deliver possession of the Leased Premises by such date, Lessor shall not thereby be deemed to be in default hereunder, and shall not thereby be liable to Tenant for any loss, damage, cost and expense suffered or incurred by Tenant, nor shall the commencement date of the lease or the term of the Lease be affected or changed thereby, and Tenant agrees to accept possession of the Leased Premises at such time as Lessor is able to tender the same; provided, however, Lessor hereby waives payment of rent covering any period prior to the tendering of possession to Tenant hereunder, except as otherwise provided on the attached Exhibit C.
BASE RENT
3a. Tenant shall pay to Lessor during the Lease Term:
YEAR DATES ANNUAL RENT MONTHLY RENT ------------------------------------------------------------ 1 12/01/1998 - 11/30/1999 $65,873.80 $5,489.48 2 12/01/1999 - 11/30/2000 67,850.00 5,654.17 3 12/01/2000 - 11/30/2001 69,885.50 5,823.79 |
payable in advance on the first day of each month during the Lease Term in lawful money of the United States, to Lessor without any deduction, offset, counterclaim or reduction whatsoever, at the office of Garsten/Perennial Management Corporation, Spruce Tree Centre, Suite 310, 1600 University Avenue, St. Paul, Minnesota 55104, or such other place as Lessor shall designate.
3b. In the event the Lease Tenn commences on a day other than the first day of a month, or terminates on a day other than the last day of a month, or both, the rent, including any adjustments therein made in accordance with this Lease, payable during such first or last month, shall be adjusted on a prorata basis.
3c. All Fixed rent and other sums payable hereunder by Tenant ("Rent") which are not paid within ten (10) days after due shall bear interest from the date paid at the rate of twelve percent (12%) per annum, or the highest rate permitted by law, whichever is less.
TAX PAYMENT
4a. In addition to Fixed rent, Tenant shall, each year during the Tenn of this Lease or any extensions or renewals thereof, pay its pro rata share (equal to a fraction, the numerator of which is the rentable area of the Leased Premises and the denominator of which is the total rentable square feet of office area in the Project) of the amount of the general real estate taxes and installments of special assessments due and payable with respect to the Project in such year ("Tax Costs"), including any payments made by Lessor to any governmental body either "in lieu of taxes" or as an additional tax or assessment of any kind associated in whole or part with the project but excluding any income taxes paid by Lessor resulting from its ownership of the building. Such payment by Tenant shall be paid at the same time as Monthly Fixed rent in equal monthly installments, as estimated by Lessor, representing 1/12 of the Tax Costs due and payable in any such year, which initially shall be estimated at a rate of $3.40 per square foot of rentable area in the Leased Premises ("Base Tax Costs"). Prior to the commencement of the Lease Term and prior to March I of each ensuing calendar year, or as soon as is practicable thereafter, Lessor shall furnish Tenant with an estimate of the Tax Costs (if such estimate is higher than the Base Tax Costs) for the then current calendar year, and the new monthly amount payable on the first day of each month during the remainder of such calendar year. Within ten (10) days after Lessor furnishes Tenant with such estimate, Tenant shall also pay to Lessor, as an additional payment, any amount due for any monthly periods prior to the date Lessor issued its revised estimate of Tax Costs, if such amount exceeds the payments made by Tenant for such monthly periods.
4b. After expiration of each calendar year during the Lease Term, through and including the calendar year in which the Lease Term expires, Lessor shall furnish Tenant with a statement of the actual Tax Costs for the immediately preceding calendar year. If the actual Tax Costs differ from the estimated Tax Costs, within ten (10) days after Lessor has furnished such statement to Tenant, Tenant shall pay to Lessor for any shortage for the immediately preceding calendar year, or Lessor shall refund to Tenant any overpayment for the preceding calendar year, as the case may be.
4c. If the first or last day of the Lease Term occurs on a day other than the first or last day, respectively, of a calendar year, then Tenant's obligation under this Article 4 shall be pro rated based on a 365 day calendar year.
4d. Lessor's reasonable determination of Tax Costs, both estimated and actual, shall be binding upon Tenant. Lessor has the right in its sole discretion to determine the rentable area of the Leased Premises and the Project.
4e. Tenant's failure to pay any amounts due under this Article 4 when due shall be treated in the same manner as a default in the payment of Fixed rent.
OPERATING COST PAYMENT
5a. In addition to Fixed rent, Tenant shall, each year during the Term of this Lease or any extensions or renewals thereof, pay its pro rata share (equal to a fraction, the numerator of which is the rentable area of the Leased Premises and the denominator of which is the total rentable square feet of office area in the Project) of the total "Operating Costs" (as defined below) for the Project in such year. Such payment by Tenant shall be paid at the same time as Monthly Fixed rent in equal monthly installments, as estimated by Lessor, representing 1/12 of the Operating Costs for any such year, which initially shall be estimated at a rate of $ 4.72 per square foot of rentable area in the Leased Premises ("Base Operating Costs"). Prior to the commencement of the Lease Term and within 30 days after the expiration of each ensuing calendar year, or as soon as is practicable thereafter, Lessor shall furnish Tenant with an estimate of the Operating Costs (if such estimate is higher than the Base Operating Costs) for the then current calendar year, and the new monthly amount payable on the first day of each month during the remainder of such calendar year. Within ten (10) days after Lessor furnishes Tenant with such estimate, Tenant shall also pay to Lessor, as an additional payment, any amount due for any monthly periods prior to the date Lessor issued its revised estimate of Operating Costs, if such amount exceeds the payments made by Tenant for such monthly periods.
5b. Within 30 days after expiration of each calendar year during the Lease Term, through and including the calendar year in which the Lease Tenn expires, Lessor shall furnish Tenant with a statement of the actual Operating Costs for the immediately preceding calendar year. If the actual Operating Costs differ from the estimated Operating Costs, within ten (10) days after Lessor has furnished such statement to Tenant, Tenant shall pay to Lessor for any shortage for the immediately preceding calendar year, or Lessor shall refund to Tenant any overpayment for the preceding calendar year, as the case may be.
5c. If the first or last day of the Lease Term occurs on a day other than the first or last day, respectively, of a calendar year, then Tenant's obligation under this Article 5 shall be pro rated based on a 365 day calendar year.
5d. The term "Operating Costs" shall mean all costs and expenses of every kind and nature which Lessor incurs, pays or becomes obligated to pay in owning, maintaining, managing (including management fees), insuring and operating the Project, the adjacent parking ramp when applicable and every part thereof exclusive of depreciation, interest or payments of any principal on any mortgage. Without limiting the generality of the foregoing, Operating Costs shall include amortization of capital expenditures that produce a reduction in energy or other Operating Costs, to the extent that Operating Costs are thereby reduced, over such reasonable period as Lessor shall determine, together with interest at the rate of 12% per annum on the unamortized balance. If, as a result of such capital expenditure, Lessor eliminates an item of Operating Costs which was included in Base Operating Costs, Base Operating Costs shall be reduced by the amount of such eliminated item for purposes of this Article.
5e. Lessor's reasonable determination of Operating Costs, both estimated and actual, shall be binding upon Tenant. Lessor has the right in its sole discretion to determine the rentable area of the Leased Premises and the Project.
5f. Tenant's failure to pay any amounts due under this Article 5 when due shall be treated in the same manner as a default in the payment of Fixed rent.
RENTABLE AREA
6a. Rentable area of a single tenancy floor, whether above or below grade, shall be computed by measuring to the outside finish of permanent outer building walls, or from the glass line where at least 50% of the outer building wall is glass. Rentable area shall include all area within outside walls less stairs, elevator shafts, flues, pipe shafts, and vertical ducts, and not actually available to the Tenant for its furnishings and personnel, and their enclosing walls. Toilet rooms within and exclusively serving only that floor shall be included in rentable area.
6b. Rentable area for a partial floor shall include all space within the demising; walls (measured from the midpoint of demising walls and in the case of exterior walls measured as set forth in (a) above), excluding vertical penetrations such as building stairs, fire towers, elevator shafts, flues, vents, stacks, pipe shafts, and vertical ducts, plus Tenant's proportionate share of the common areas such as lobbies, corridors, toilet and mechanical rooms, telephone and electrical closets, and service areas in the Project. Vertical penetrations which are for a specific use of Tenant, such as special stairs or elevators, shall be included as rentable area. No deductions from rentable area will be made for columns or projections necessary to the support of the Project.
6c. For purposes of computing rentable area, tenants' share of common area shall be a factor of .15. Rentable area = usable area / .85. For purposes of this lease, rentable area shall be 9,278 rentable square feet.
SECURITY DEPOSIT
7. Tenant has deposited with Lessor the sum of Five Thousand Five Hundred Dollars ($5,500.00 ). Said sum shall be held by Lessor as security for the faithful performance by Tenant of all the terms, covenants and conditions of this Lease to be kept and performed by Tenant during the Lease Term. No interest shall be payable on said deposit. If Tenant defaults with respect to any provision of this Lease, including, but not limited to the provisions relating to the payment of Rent, Lessor may (but shall not be required to, use, apply or retain all or any part of said security deposit for the payment of any Rent or any other sum in default, or for the payment of any amount which Lessor may spend or become obligated to spend by reason of Tenant's default, or to compensate Lessor for any other loss or damage which Lessor may suffer by reason of Tenant's default. If any portion of said security deposit is so used or applied, Tenant shall, within five (5) days after written demand therefor, deposit cash with Lessor in an amount sufficient to restore said security deposit to its original amount and Tenant's failure to do so shall be a material breach of this Lease. If Tenant shall fully and faithfully perform every provision of this Lease to be performed by it, the security deposit or any balance thereof shall be returned to Tenant (or, at Lessor's option, to the last assignee of Tenant's interest hereunder) at the expiration of the Lease Term. In the event Lessor assigns its interest in this Lease, Lessor shall transfer said security deposit to Lessor's successor in interest.
ACCOUNTING
8. Lessor shall, in its reasonable discretion, determine, from time to time, the method of computing operating costs, the allocation of operating costs to various types of space within the Project and the extent of the appurtenances to the Project, and Tenant shall be bound thereby. Notwithstanding the foregoing, no decrease in Tax Costs and/or Operating Costs shall reduce Tenant's rent below the annual Fixed rent set forth in Article 3 above.
USE
9. The Leased Premises shall be used for the purpose of general business only. No part of the Leased Premises shall be used for any purpose which constitutes a nuisance or which is illegal, offensive, termed extra hazardous by insurance companies or which may make void or voidable any insurance on the Project or which may increase the premiums therefor, or which will interfere with the general safety, comfort and convenience of the Lessor and other Tenants of the Project. There shall be no sale of food or beverages, including intoxicating liquors, by any means without the prior written consent of Lessor. Tenant may install vending machines for use by its employees. Tenant shall not permit illegal substances to be kept or sold in the Leased Premises.
BUSINESS HOURS
10. Usual business hours as used herein shall mean the hours between
8:00 a.m. and 6:00 p.m., Monday through Friday, and between 8:00 a.m. and 1:00
p.m. Saturday, holidays excepted. All persons entering or leaving the Project
between the hours of 6:00 p.m. and 8:00 a.m., Monday through Friday, or after
1:00 p.m. Saturday, or at any time on Sundays or holidays, may be required to do
so under such reasonable regulations as Lessor may impose. Lessor may exclude or
expel any peddler or solicitor.
REPAIRS BY LESSOR
11. Lessor shall at its expense maintain, repair and replace as necessary, only the structural component of the roof, foundation and the exterior walls of the Building and those portions of the heating, air conditioning, plumbing and electrical systems located within, but not serving exclusively, the Leased Premises, in good repair, reasonable wear and tear excepted and in a manner consistent with similar office buildings in St. Paul. Tenant shall repair and pay for any damage caused by the act or negligence of Tenant or Tenant's employees, agents, representatives or invitees, or caused by Tenant's default hereunder. The term "walls" as used herein shall not include windows, glass or plate glass or doors. Tenant shall immediately give Lessor written notice of defect or need for repairs, after which Lessor shall have reasonable opportunity to repair same or cure such defect. Lessor's liability hereunder shall be limited to the cost of such repairs or curing such defect. Where applicable, the costs of repair and maintenance incurred by Lessor shall be included in "Operating Costs" as defined in Article 5.
TENANT'S REPAIRS
12. Tenant shall at its own cost and expense repair and maintain all other parts of the Leased Premises, including glass, in good repair, reasonable wear and tear excepted, and shall take good care of the Leased Premises and its fixtures and suffer no waste. Tenant will keep the whole of the Leased Premises in a clean, sanitary and safe condition, and will at the expiration of the term of this Lease or other tennination of the term of this Lease, surrender the same to Lessor, broom clean, and in the same order and condition as they were in at the commencement of the term of this Lease, reasonable wear and tear excepted.
ALTERATIONS
13. Tenant shall not make any alterations of, or additions to, the Leased Premises without the prior written consent of Lessor. Lessor shall have the right to approve all plans, specifications, contractors, laborers to be used for such alteration or addition. Tenant will not permit any mechanics', laborers' or materialmens' liens to stand against the Leased Premises or the Project for labor or materials claimed to have been furnished in connection with any work performed or claimed to have been performed in or about the Leased Premises.
At the termination of this Lease, Tenant shall, if Lessor so elects, remove all alterations and additions erected by Tenant and restore the Leased Premises to their original condition; otherwise such improvements shall be delivered up to the Lessor with the Leased Premises. All movable office firrnishings and trade fixtures installed by Tenant may be removed by Tenant at the termination of this Lease if Tenant so elects, and shall be removed if required by Lessor. All such removals and restoration shall be accomplished in a good and workmanlike manner so as not to damage the primary structure or structural qualities of the Leased Premises. Personal property remaining in the Leased Premises at the expiration or termination of the term of this Lease shall be deemed abandoned, and become the property of Lessor, and Lessor may dispose of the same as Lessor deems expedient.
Notwithstanding anything to the contrary contained in this Lease, Lessor shall in all events have the right to prescribe the weight and position of any safes and other heavy equipment placed in or on the Leased Premises by Tenant. Any and all damage or injury to the Leased Premises or the Project caused by moving the property of Tenant in or out of the Leased Premises, or due to the same being in or on the Leased Premises, shall be repaired by Tenant at its sole cost and expense. No equipment, fixtures, furniture or other bulky matter will be received into or carried in the Project, except in or at such places, at such times and in such manner as are approved by Lessor, and all moving of Tenant's property in or out of the Leased Premises shall be done only under the direct control and supervision of Lessor; provided, however, that Lessor shall not be responsible for any damage to or charges for moving such property.
SIGNS
14. Tenant shall not display, inscribe, print, maintain, or affix on any place in or about the Project any sign, notice, legend, direction, figure or advertisement, except on the doors of the Leased Premises and on the Project Directory, and then only such name(s) and matter, and in such color, size, style, place and materials, as shall first have been approved by the Lessor. The listing of any name other than that of the Tenant, whether on the doors of the Leased Premises, on the Project Directory, or otherwise, shall not operate to vest any right or interest in this Lease or in the Leased Premises or be deemed to be written consent of the Lessor, it being expressly understood that any such listing is a privilege extended by Lessor revocable at will by written notice to Tenant. Lessor shall at its option have the right to furnish all sign painting and lettering, ice, drinking water, towels, toilet supplies, shoe shining, vending machines, mobile vending service, catering, and like services used on the Leased Premises or in the Project. The Lessor also reserves the right to name the Project and to change the name or street address of the Project. Also, Lessor shall have the right to install and maintain a sign or signs on the exterior or interior of the Project.
ACCESS BY LESSOR
15a. Lessor, its agents and representatives shall be entitled to keep pass keys to the Leased Premises and shall have the right to enter and inspect the Leased Premises at any time for the purpose of ascertaining the condition thereof or in order to make such repairs as may be required to be made by Lessor under the terms of this Lease or as Lessor may deem necessary. During the period that is six (6) months prior to end of the term hereof, Lessor and Lessor's agents and representatives shall have the right to enter the Leased Premises at reasonable times for the purpose of showing the Leased Premises and shall have the right to erect on the Leased Premises a suitable sign indicating that the Leased Premises are available. Any such entry by Lessor shall not be deemed an eviction or disturbance of Tenant's possession of the Leased Premises, or render Lessor liable to Tenant for damages, or relieve Tenant from performance of Tenant's obligations under this Lease.
15b. The right of entry reserved shall not be deemed to impose any greater obligation on Lessor to clean, maintain, repair or change the Leased Premises than is specifically provided in this Lease. The Lessor, its agents and representatives may at any time in case of emergency enter the Leased Premises and do such acts as Lessor may deem proper in order to protect the Leased Premises, the Project, or any occupants of the Project.
UTILITIES AND SERVICES
AIR CONDITIONING AND HEAT
16a. Lessor shall furnish air conditioning and heat for normal
purposes only, to provide in Lessor's judgment, comfortable occupancy Monday
through Friday from 8:00 a.m. to 6:00 p.m., and Saturday from 8:00 a.m. to 1:00
p.m., holidays excepted. Tenant agrees not to use any apparatus or device, in or
upon or about the Leased Premises, which in any way may increase the amount of
such services usually furnished or supplied to the Leased Premises, and Tenant
further agrees not to connect any apparatus or device with the conduits or
pipes, or other means by which such services are supplied, for the purpose of
using additional or unusual amounts of such services, without the prior, written
consent of Lessor. Should Tenant use such services to excess, or request the use
of such services at other than the operating hours listed above, Lessor reserves
the right to charge for such services. The charge shall be payable as additional
Rent. Furthermore Lessor may require Tenant to bear the expense of metering or
monitoring equipment to determine the amount of such excess usage and
subsequently bill Tenant, as additional Rent, for said excess usage, at a rate
determined by Lessor. Should Tenant fail to make payment upon demand of Lessor,
such failure shall constitute a breach of the obligation to pay Rent under this
Lease and shall entitle Lessor to the rights hereinafter granted for such
breach.
ADDITIONAL ELECTRICAL SERVICE
l6b. Lessor shall maintain electrical facilities to provide sufficient power for typewriters, low consumption data processing equipment, and other office machines of similar low electrical consumption, but not including electricity required for high electrical consumption electronic data processing equipment, special lighting in excess of building standard, and any other item of electrical equipment which (singly) consumes more than .5 kilowatts per hour at rated capacity or requires a voltage other than one hundred twenty (120) volts single phase; and provided that if the installation of said electrical equipment requires additional air conditioning capacity above that provided by the building standard system, then the additional air conditioning installation and continued operation and costs will be the obligation of Tenant.
LIGHTING
16c. Leased Premises. Lessor shall supply building standard lamps, bulbs, starters and ballasts used on the Leased Premises.
KEYS
16d. Lessor shall furnish Tenant with two (2) keys for each corridor door entering the Leased Premises, and additional keys ordered by Tenant at Tenant's cost. All such keys shall remain the property of Lessor. No additional locks shall be allowed on any door of the Leased Premises without Lessor's prior written permission, and Tenant shall not make, or permit to be made, any duplicate keys, except those furnished by Lessor. Upon termination of this Lease, Tenant shall surrender to Lessor all keys to the Leased Premises, and give to Lessor the combination of all locks for safes, safe cabinets and vault doors, if any, in the Leased Premises.
ELEVATORS
l6e. Lessor shall furnish passenger elevator service whenever the Project is open during usual business hours per Article 10. During other than usual business hours Tenant shall have elevator service to access its floor/space via procedures established by Lessor. Lessor shall have the right to stop the operation of said elevators for alterations, improvements or repairs therein or in the machinery or appliances connected therewith which are necessary or desirable in Lessor's sole judgment and shall not be liable for damages for any such stoppage of service.
JANITORIAL
l6f. Lessor shall furnish such janitor service as, in the sole judgment of Lessor, is necessary for the comfortable use and occupancy of the Leased Premises, except on Saturdays, Sundays and holidays. All janitorial services shall be performed in accordance with work schedules established by Lessor.
WATER
l6g. Lessor shall provide water for drinking, lavatory and toilet purposes.
UTILITIES
16h. Except as otherwise provided herein to the contrary, Tenant agrees to pay for all its requirements for utilities such as gas, steam, water and electricity and for all other services to the Leased Premises. In the event Lessor shall offer to supply any of such utilities or services, Tenant covenants and agrees to purchase the same from Lessor, provided the rate charged by Lessor does not exceed the charge for similar services which Tenant would be required to pay a public utility company or independent contractor. Charges for any such utilities or services, whether or not furnished by Lessor, shall be paid by Tenant within ten (10) days after receipt by Tenant of a statement of charges therefor, and, in the event such charges are not paid when due, may, at the option of Lessor, be added to and become a part of the next rental installment coming due hereunder.
COMMUNICATIONS & ELECTRONICS
l6i. Tenant shall be responsible for the installation of its telephone, cable, computer and any other communication or electronic service or system.
WASTE
16j. Tenant shall not waste electricity, water, heat or air conditioning or any other utility, and shall cooperate fully with Lessor to insure the most effective operation of the Project's heating and air conditioning, which shall include closing venetian blinds and drapes and keeping all windows closed when air conditioning is in use, and shall refrain from attempting to adjust any controls other than room thermostats, if any, installed for Tenant's use.
TEMPORARY INTERRUPTION OF SERVICES
16k. Lessor shall not be liable to Tenant, its agents, employees, representatives, customers or invitees for any inconvenience, loss or damage or for any injury to any person or property caused by or resulting from any casualties, riots, strikes, picketing, accidents, breakdowns or any cause beyond Lessor's reasonable control, or from any temporary failure or lack of services and Tenant shall indemnify Lessor and hold Lessor harmless from any claim or damage because of such inconvenience, loss, damage or injury. No variation, interruption or failure of such services incident to the making of repairs, alterations or improvements or due to casualties, riots, strikes, picketing, accidents, breakdowns or any cause beyond Lessor's reasonable control or temporary failure or lack of such services shall be deemed an eviction of Tenant or relieve Tenant from any of Tenant's obligations hereunder.
GENERAL
161. Except for specific items to the contrary, the expense of all items to be provided by Lessor in this Article 16 shall be deemed "Operating Costs" per Article 5 of this Lease.
ASSIGNMENT AND SUBLETTING
17. Since Lessor wishes the party in possession of the Lease Premises to be bound to Lessor by direct privity of contract, Tenant may not sublease the whole or any part of the Leased Premises without the prior written consent of Lessor, which consent may be withheld in Lessor's sole and absolute discretion.
Tenant may not, voluntarily or by operation of law, assign, mortgage, pledge or otherwise transfer this Lease without the prior written consent of Lessor. If Tenant is a corporation, then any transfer of this Lease by merger, consolidation or liquidation, or any change in ownership of the shares of voting stock shall constitute an assignment of this Lease, and, as such, shall require the prior written consent of Lessor. If Tenant is a partnership, any transfer, assignment or sale of a partnership interest, or any change in the partners comprising Tenant, shall constitute an assignment of this Lease, and, as such, shall require the prior, written consent of Lessor.
The prior written consent of Lessor to any such proposed assignment or transfer shall not be withheld unreasonably, if all of the following conditions are met:
a. The proposed assignee has a net worth at least equal to Tenant and Tenant's Guarantor(s) (if any) as of the date of signing this Lease, or the date of the proposed assignment, whichever is greater;
b. The proposed assignee is creditworthy considering the obligations to be assumed under the Lease;
c. The proposed assignee has experience and expertise in operating a business similar to that being conducted in the Leased Premises;
d. The use of the Leased Premises will comply with Article 9, and, in addition, the proposed assignee's use will not conflict with Lessor's current or projected tenant mix of the Building or with exclusive uses granted or to be granted to any other tenant(s) of the Building;
c. Tenant and Tenant's Guarantor(s) (if any) acknowledge in writing that they will remain liable for the performance of all obligations pursuant to the Lease;
f. Tenant, Tenant's Guarantor(s) (if any) and the proposed assignee agree in a written amendment to this Lease, in form and substance acceptable to Lessor, that the Fixed rent, as of the effective date of such assignment shall become the greatest of the following:
(1) The Fixed rent then applicable;
(2) The prevailing market rate determined by Lessor for Fixed rent for similar space in the Building at the time of the assignment.
g. No default by Tenant shall be in existence at the time of the request for consent or at the time of the actual assignment.
If Tenant desires to assign the Lease, it shall so notify Lessor in writing at least thirty (30) days prior to the proposed effective date of the assignment. Tenant shall provide Lessor with: a copy of the proposed assignment, financial information, bank references and financial statements of the proposed assignee; a copy of the agreements referenced in Sub-Articles l7e and 17f above, and, such further information as Lessor might request concerning the proposed assignee. Within fifteen (15) days after Lessor's receipt of all required information concerning the proposed assignee, and the satisfaction of all of the conditions specified in Sub-Articles 17a through 17g above, Lessor shall have the following options:
(1) To cancel this Lease and upon such cancellation, all parties shall be released from liability hereunder for obligations arising thereafter and Tenant will immediately vacate the Leased Premises;
(2) To consent to the proposed assignment; or
(3) To refuse to consent if reasonable grounds exist therefor, provided that if the conditions specified in Sub-Articles 17a through 17g are not satisfied, Lessor's consent to the proposed assignment may be withheld or granted in its sole and absolute discretion.
FIRE AND OTHER CASUALTY
18. If the Project or any part thereof is damaged or destroyed by fire or other casualty, Lessor shall have the right to terminate this Lease, provided it gives written notice thereof to the Tenant within ninety (90) days after such damage or destruction. If a portion of the Leased Premises is damaged by fire or other casualty and this Lease is not thereby terminated, the Lessor shall, at its expense, restore the Leased Premises, exclusive of any improvements or other changes made to the Leased Premises by the Tenant, to as near the condition which existed immediately prior to such damage or destruction as reasonably possible, and Fixed rent and any other Rent shall abate during such period of time as the Leased Premises are untenantable in the proportion that the untenantable portion of the Leased Premises bears to the entire Leased Premises. The Lessor shall not be responsible to the Tenant for damage to, or destruction of personal property, any furniture, equipment, improvements or other changes made by the Tenant in, on or about the Leased Premises regardless of the cause of the damage or destruction.
SUBROGATION
19a. Lessor and Tenant each hereby release the other from any and all liability or responsibility to the other or anyone claiming through or under them by way of subrogation or otherwise for any loss or damage to property caused by fire or any of the extended coverage casualties covered by the insurance maintained hereunder, provided, however, that this release shall be applicable and in force and effect only with respect to loss or damage occurring during such times as the releasor's policies shall contain a clause or endorsement to the effect that any release shall not adversely affect or impair said policies or prejudice the right of the releasor to recover thereunder. Lessor and Tenant each agree that it will request its insurance carriers to include in its policies such a clause or endorsement.
19b. Lessor covenants and agrees to maintain standard fire and extended coverage insurance covering the Project in an amount not less than eighty percent (80%) of the appraised value thereof. Tenant covenants and agrees to maintain standard fire and extended coverage insurance covering its property located in, on or about the Leased Premises.
19c. Tenant assumes all responsibility for protecting the Leased Premises from theft, robbery and pilferage, which includes keeping doors locked and other means of entry to the Leased Premises closed and secured after normal business hours.
LIABILITY
20. Lessor and Tenant shall, at their own expense, carry public liability insurance in the amounts of not less than One Million Dollars ($1,000,000.00) for personal injuries sustained by any one person, One Million Dollars (1,000,000.00) for injuries sustained in any one accident, and One Hundred Thousand Dollars ($100,000.00) for property damage. All policies of insurance shall name both Lessor and Tenant as insured thereunder. Certificates of said insurance providing for not less than fifteen (15) days notice to Lessor prior to cancellation thereof shall be furnished to Tenant and Lessor upon taking possession of the Leased Premises.
EMINENT DOMAIN
21. If the entire Project is taken by eminent domain, this Lease shall automatically terminate as of the date of taking. If a portion of the Project is taken by eminent domain, Lessor shall have the right to terminate this Lease by giving written notice thereof to Tenant within ninety (90) days after the date of taking. If a portion of the Leased Premises is taken by eminent domain and this Lease is not thereby terminated, Lessor shall, at its expense, restore the Leased Premises, exclusive of any improvements or other changes made to the Premises by Tenant, to as near the condition which existed immediately prior to the date of taking as reasonably possible, and Rent shall abate during such period of time as the Leased Premises are untenantable, in the proportion that the untenantable portion of the Leased Premises bears to the entire Leased Premises. All damages awarded for a taking under the power of eminent domain, whether for the whole or a part of the Leased Premises, shall belong to, and be the property of Lessor, whether such damages shall be awarded as compensation for diminution in value to the leasehold estate hereby created or to the fee of the Leased Premises; provided, however, that Lessor shall not be entitled to any separate award made to Tenant for loss of business, fair value of, and cost of removal of stock and fixtures. The term "eminent domain" shall include the exercise of any similar governmental power and any purchase or other acquisition in lieu of condemnation.
HOLDING OVER
22. Should Tenant, or any of its successors in interest, hold over the Leased Premises or any part thereof, after the expiration of the term of this Lease, such holding over, at the sole election of Lessor, shall constitute and be construed as a tenancy from month to month only. The inclusion of the preceding sentence shall not be construed as Lessor's permission for Tenant to hold over. Holdovers may be charged up to twice the Rent in effect at the expiration of the Lease Term.
QUIET ENJOYMENT
23. Lessor covenants that if Tenant pays the Fixed rent or any other Rent, and all other charges provided for in this Lease, performs all of its obligations provided for under this Lease, and observes all of the other provisions of this Lease, Tenant shall peaceably and quietly enjoy the Demised Premises in accordance with the terms of this Lease without any interruption or disturbance from Lessor. Lessor shall not be responsible or liable for the actions of third parties, including other tenants in the building.
EVENTS OF DEFAULT
24. The following events shall be deemed to be events of default by Tenant under this Lease:
24a. Tenant shall fail to pay any installments of Fixed rent hereby reserved or any other Rent when due or any other charge payable hereunder when due.
24b. Tenant shall become insolvent, or shall make a transfer in fraud of creditors, or shall make an assignment for the benefit of creditors.
24c. Tenant shall file a petition under any section or chapter of the National Bankruptcy Act, as amended, or under any similar law or statute of the United States or any state thereof, or Tenant shall be adjudged bankrupt or insolvent in proceedings filed against Tenant thereunder.
24d. A receiver or trustee shall be appointed for all or substantially all of the assets of Tenant.
24e. Tenant shall desert or vacate any substantial portion of the Leased Premises.
24f. Tenant shall cause or suffer a lien to be filed against the Project or any part thereof.
24g. Tenant shall fail to comply with any term, provision or covenant of this Lease (other than the foregoing in this Article 24) and shall not cure such failure within ten (10) days after notice from Lessor.
DEFAULT
25a. Tenant hereby agrees that in case Tenant shall default in making its payments hereunder or in performing any of the other agreements, terms, and conditions of this Lease, then, in any such event, Lessor, in addition to all other rights and remedies available to Lessor by law or by other provisions hereof, at Lessor's option, may reenter and recover possession of the Leased Premises (with or without terminating this Lease) and/or may annul and cancel this Lease as to all future rights of Tenants. Tenant further agrees that in case of any such termination Tenant will indemnify the Lessor against all loss of rents and other damage which Lessor may incur by reason of such termination, including, but not limited to, costs of restoring and repairing the Leased Premises and putting the same in rentable condition, costs of renting the Leased Premises to another tenant, loss or diminution of rents and other damage which Lessor may incur by reason of such termination and all reasonable attorney fees and expenses incurred in enforcing any of the terms of this Lease. Neither acceptance of rent by Lessor, with or without knowledge of breach, nor failure of Lessor to take action on account of any breach hereof, or to enforce its rights hereunder shall be deemed a waiver of any breach and absent written notice or consent said breach shall be a continuing one.
25b. In the event Tenant fails to pay any installment of Fixed rent or any other Rent hereunder as and when such installment is due, or any other charge payable hereunder as and when such charge is due, Tenant, if permitted by law, shall pay to Lessor on demand a late charge in an amount equal to five percent (5%) of such installment or such other charge, or $250.00, whichever is less, and failure to pay such late charge within ten (10) days after the date due shall be an event of default hereunder. The provision for such late charge shall be in addition to all of Lessor's other rights and remedies hereunder or at law and shall not be construed as liquidated damages or as limiting Lessor's remedies in any manner.
SUBORDINATION OF LEASE NOTICES
26. The rights of the Tenant under this Lease shall be and are subject and subordinate at all times to all ground leases, and/or underlying leases, if any, now or hereafter in force against the Project, and to any mortgage or mortgages now or hereafter in force against such leases and/or the Project, and to all advances made or hereafter to be made upon the security thereof, and to all renewals, modifications, consolidations, replacements and extensions thereof. This Article 26 is self-operative and no further instrument of subordination shall be required. In confirmation of such subordination Tenant shall promptly execute such further instruments as may be requested by the Lessor. The Tenant hereby irrevocably appoints the Lessor as attorney-in-fact for the Tenant with full power and authority to execute and deliver in the name of the Tenant any such instrument or instruments. Tenant at the option of any mortgagee, or the lessor under any such ground lease or underlying lease, agrees to attorn to such mortgagee or lessor in the event of a foreclosure sale or deed in lieu thereof or termination by the lessor of any such lease. Failure of the Tenant to execute any of the above instruments within fifteen (15) days upon written request to do so by Lessor shall constitute a breach of this Lease and the Lessor may, at its option, in addition to any other remedies, cancel this Lease and terminate the Tenant's interest therein.
27a. Each provision of this instrument or of any applicable governmental laws, ordinances, regulations and other requirements with reference to the sending, mailing or delivery of any notice or the making of any payment by Lessor to Tenant or by Tenant to Lessor shall be deemed to be complied with, when and if, the following steps set forth in Article 27b are taken.
27b. Any notice or document required or permitted to be delivered hereunder shall be deemed to be delivered, whether actually received or not, when deposited in the United States mail, postage prepaid, certified or registered mail, addressed to the parties hereto at the respective addresses set out opposite their names below, or at such other address as they have theretofore specified by written notice delivered in accordance herewith:
Lessor: Tenant: Spruce Tree Centre L.L.P. Image Sensing Systems, Inc. Spruce Tree Centre, Suite 310 Spruce Tree Centre, Suite 500 1600 University Avenue 1600 University Avenue St. Paul, MN 55104 St. Paul, MN 55104 |
27c. Any notice or document required or permitted to be delivered hereunder by Lessor to Tenant also shall be deemed to be delivered if and when delivered personally to Tenant at the Leased Premises.
RULES AND REGULATIONS
28. Tenant shall observe such rules and regulations, including those set forth in Exhibit D, which from time to time may be put in effect by Lessor for the general safety, comfort and convenience of Lessor, occupants and tenants of said Project. Such rules and regulations to be directed to all tenants and not specifically to any single tenant.
ENERGY; GOVERNMENTAL ACTION
29. Wherever in this Lease any terms, covenants or conditions are required to be kept or performed by Lessor, Lessor shall be deemed to have kept and performed such terms, covenants and conditions notwithstanding any action taken by the Lessor, if such action is pursuant to any governmental regulations, requirements, directives or requests, or if Lessor deems such action to be for the benefit of our national interest or the general public. Without limiting the generality of the foregoing, Lessor may reduce the quantity and quality of all utility and other services and impose such regulations as the Lessor deems necessary in order to conserve energy, and may change the normal hours of operation of the Project. Utility in the sense of this Article 29 includes, but is not limited to heating, cooling, electricity, water and all the sources of energy needed to provide such.
LIGHT AND AIR
30. Tenant has no right to light or air over any premises adjoining the Project.
BROKERAGE FEES
31. Tenant represents and warrants that it has dealt with no broker, agent or other person in connection with this Lease other than Garsten Perennial Management and Tenant hereby indemnifies and holds Lessor harmless from and against any claims by any other broker, agent or other person claiming a commission or other form of compensation by virtue of having dealt with Tenant with regard to this Lease. The provisions of this Article 31 shall survive the expiration or termination of this Lease.
SUBSTITUTE PREMISES
32. Lessor shall have the right at any time during the term hereof upon giving Tenant not less than one hundred twenty (120) days prior written notice, to provide and furnish Tenant with space elsewhere in the Project under the following conditions:
a. The substitute premises shall be the same or greater usable square footage,
b. The substitute premises shall be at a rental rate no greater than the monthly rate provided for under the terms of the lease,
c. The substitute premises shall be in a location in the project considered to be equal to or better than the leased premises herein,
d. Lessor will be responsible for all the expenses of moving tenant, including but not limited to all communications and electronic systems, office furniture and supplies, signs, replacement of stationary and business cards, reasonable costs associated with notices of change of address, and all other reasonable expenses except for inconvenience. Lessor shall choose a responsible mover or may use Lessor's own personnel. Fragile contents shall be moved by tenant at tenant's expense. Moving shall be accomplished as quickly as possible and Lessor shall accede to tenant's demands to move on a weekend if so instructed.
LESSOR'S USE
33. It is understood that Lessor may occupy portions of the Project in the conduct of the Lessor's business. In such event, all references herein to other tenants of the Project shall be deemed to include Lessor as an occupant or tenant.
MISCELLANEOUS TAXES
34a. Tenant shall pay prior to delinquency all taxes assessed against or levied upon its occupancy of the Leased Premises, or upon the fixtures, furnishings, equipment and personal property of Tenant located in the Leased Premises, if nonpayment thereof shall or would give rise to a lien on the Project or any part thereof, and when possible, Tenant shall cause said fixtures, furnishings, equipment and personal property to be assessed and billed separately from the property of Lessor. In the event any or all of Tenant's fixtures, furnishings, equipment and personal property, or Tenant's occupancy of the Leased Premises, shall be assessed and taxed with the property of Lessor, Tenant shall pay to Lessor its share of such taxes within ten (10) days after delivery to Tenant by Lessor of a statement in writing setting forth the amount of such taxes applicable to Tenant's fixtures, furnishings, equipment or personal property, or occupancy of the Leased Premises.
34b. If, under the laws of the United States or any state thereof or any political subdivision in which the Leased Premises are situated, a tax or excise on rents or other tax, however described, is levied or assessed against Lessor or the rent reserved hereunder, in addition to, in lieu of or as a substitute in whole or in part for taxes and assessments commonly known as real estate taxes, Tenant shall pay and discharge such tax or excise on rents or other tax, but only to the extent of the amount thereof which is lawfully assessed or imposed upon Lessor, and which was so assessed or imposed as a direct result of Lessor's ownership of the Leased Premises or of this Lease, or of the rental accruing under this Lease.
ESTOPPEL CERTIFICATE
35. Tenant agrees, within ten (10) days after request of Lessor, to deliver to Lessor, or Lessor's designee, including without limitation, the present or any future holder of any mortgage(s) and/or deed(s) or trust and/or ground lease(s) and/or underlying lease(s) on the Project or Leased Premises, or any prospective purchaser of the Project or Leased Premises, an estoppel certificate stating that this Lease is in full force and effect, the date to which rent and other charges have been paid, the unexpired term of this Lease, whether or not Lessor is in default hereunder, and the nature of any such default, and such other matters pertaining to this Lease as may be requested by Lessor.
MISCELLANEOUS
36a. Words of any gender used in this Lease shall be held and construed to include any other gender, and words in the singular number shall be held to include the plural, unless the context otherwise requires.
36b. The terms, provisions and covenants and conditions contained in this Lease shall apply to, inure to the benefit of, and be binding upon, the parties hereto and upon their respective heirs, legal representatives, successors and permitted assigns, except as otherwise herein expressly provided.
36c. Failure of Lessor to insist, in any or more instances, upon strict performance of any term, covenant or condition of this Lease, or to exercise any option herein contained shall not be construed as a waiver, or a relinquishment for the future, or such term, covenant, condition or option, but the same shall continue and remain in full force and effect. The receipt by Lessor of rents with knowledge of a breach in any of the terms, covenants or conditions of the Lease to be kept or performed by Tenant shall not be deemed waiver of such breach, and Lessor shall not be deemed to have waived any provision of this Lease unless expressed in writing and signed by Lessor.
36d. For purposes of this Lease, holidays shall be defined as New Years Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
NO PARTNERSHIP, JOINT VENTURE OR FIDUCIARY RELATIONSHIP INVALIDITY OF PARTICULAR PROVISIONS
37. Nothing contained in this lease shall be interpreted as creating a partnership, joint venture or relationship of principal and agent between the lessor and the lessee, it being understood that the sole relationship created hereby is one of landlord and tenant.
38. If any clause or provision of this Lease is or becomes illegal, invalid, or unenforceable because of present or future laws or any rule or regulation of any governmental body or entity, effective during its term, the intention of the parties hereto is that the remaining parts of this Lease shall not be affected thereby unless such illegality, invalidity, or unenforceability is, in the sole determination of Lessor, essential to the rights of both parties in which event Lessor has the right to terminate this Lease on written notice to Tenant.
The Exhibit(s) attached to this Lease (Exhibits A-E consisting of ___ pages) is (are) hereby declared to be part of this Lease to the same extent and in the same manner as if the provisions thereof were actually embodied in this Lease.
IN WITNESS WHEREOF, the Lessor and Tenant have duly signed and sealed these presents the day and year first hereinbefore written.
LESSOR: TENANT: By: illegible signature By: illegible signature Its: Agent for the Owner Its: President/CEO |
EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain statement of operations data as a percent of revenue:
YEAR ENDED DECEMBER 31 1998 1997 ------------------------------------------------------------------------------- Product sales 26.2% 33.1% Royalties 65.8 63.4 Consulting services 8.0 3.5 ------------------------------------------------------------------------------- Total revenue 100.0 100.0 Cost of revenue 22.1 27.4 ------------------------------------------------------------------------------- Gross profit 77.9 72.6 Selling, marketing and product support 29.9 24.2 General and administrative 38.7 24.3 Research and development 6.0 14.9 ------------------------------------------------------------------------------- Income from operations 3.3 9.2 Net income 6.2 11.3 |
Product sales for 1998 decreased to $881,000 compared to $1,434,000 in 1997. The
decrease was due primarily to fewer sales in Asia, $140,000 in 1998 compared to
$453,000 in 1997, and less sales to the Minnesota Department of Transportation
(MnDOT) for test sites, $330,000 in 1998 compared to $569,000 in 1997. Royalty
income decreased to $2,216,000 in 1998 compared to $2,742,000 in 1997. The
decrease was due to less sales and upgrades of Autoscope systems by Econolite
Control Products, Inc. (Econolite), our North American manufacturing and
distribution partner. The Company believes Econolite's sales of Autoscope
systems were affected by the nine-month delay in the U. S. Congress in passing
the U. S. transportation bill. Federal funding is generally critical for major
municipal and state projects that use the Company's Autoscope technology.
Revenue from consulting services increased to $271,000 in 1998 from $152,000 in
1997. The increase resulted primarily from assignment of more technical
resources to consulting projects in 1998.
Gross profits were $2,624,000 or 77.9% of revenue in 1998, compared to
$3,143,000 or 72.6% of revenue in 1997. The increase in gross profit margin was
due primarily to a more favorable mix of revenues as well as improved margins on
product sales and consulting projects.
Selling, marketing and product support expenses were $1,006,000 or 29.9% of
revenue in 1998, compared to $1,051,000 or 24.2% of revenue in 1997. The
decrease resulted primarily from reduced spending for sales and marketing
personnel and less costs for international travel. General and administrative
expenses were $1,303,000 or 38.7% of revenue in 1998, compared to $1,052,000 or
24.3% of revenue in 1997. The increase was due primarily to severance pay for
the outgoing CEO and recruitment costs for the new CEO.
Research and development expenses were $203,000 or 6.0% of revenue in 1998,
compared to $643,000 or 14.9% of revenue in 1997. The decrease was due to
capitalization of $825,000 in software development costs in 1998 compared to
$75,000 in 1997. The Company capitalized software development costs for its new
Autoscope Solo product during the application development stage, which took
place from December 1997 through October 1998. The combination of research and
development expenses and capitalized software development costs was $1,028,000
in 1998 compared to $718,000 in 1997. The increase resulted primarily from
expediting completion of the new Autoscope Solo product.
Net income was $209,000 or 6.2% of revenue in 1998, compared to $487,000 or
11.3% of revenue in 1997. There was no tax provision in 1998 primarily due to a
decrease in the Company's valuation allowance. In 1997, the Company was able to
utilize operating loss carryforwards to offset all of its taxable income.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998 the Company had $1,326,000 in cash and cash equivalents
compared to $2,000,000 at December 31, 1997. The Company had working capital of
$2,073, 000 and a current ratio of 3.5 to 1 at December 31, 1998 compared to
$2,533,000 and 3.8 to 1 at the end of 1997. The decrease in liquidity in 1998
was due primarily to investment in the Autoscope Solo product, including
capitalized software development costs. Net cash provided by operating
activities was $249,000 in 1998, compared to $393,000 in 1997. The decrease was
due primarily to reduced earnings and an increase in accounts receivable.
The Company believes that cash and cash equivalents on hand at December 31,
1998 along with an available $500,000 revolving line of credit with a bank will
satisfy the Company's projected working capital needs and investing activities,
including acquisition of a sixty percent equity interest in a foreign sales
organization, and other cash requirements through 1999.
YEAR 2000 ISSUE
BACKGROUND. Many currently installed computer systems and software are coded to accept only two-digit entries in the date code fields. These date code fields will need to accept four-digit entries to distinguish 21st century dates
10 Image Sensing Systems, Inc.
from 20th century dates. This problem could result in system failures or miscalculations causing disruptions of business operations (including, among other things, a temporary inability to process transactions, send invoices or engage in other similar business activities). As a result, many companies' computer systems and software will need to be upgraded or replaced in order to comply with year 2000 requirements. The potential global impact of the year 2000 problem is not known, and, if not corrected in a timely manner, could affect the Company and the U.S. and world economies generally.
STATE OF READINESS. The Company has analyzed the potential effect of the
year 2000 issue on both the system software included in the Company's products
and its internal systems (e.g., word processing and billing software), including
its information technology ("IT") and non-IT systems. The Company's year 2000
compliance program includes the following phases: identifying systems that need
to be modified or replaced; carrying out remediation work to modify existing
systems or convert to new systems; and conducting validation testing of systems
and applications to ensure compliance. The Company is currently in the
remediation phase of this program with respect to software purchased or licensed
from software vendors by the Company and used internally and has completed the
validation phase of this program with respect to its own products.
The amount of remediation work required to address year 2000 problems is not
expected to be extensive. The Company has tested all of the system software
included in its products and determined that it is year 2000 compliant. In
addition, the Company has requested and received documentation from vendors
supplying software for its primary business applications addressing year 2000
compliance. In all cases, vendors' responses indicated that their applications
were either currently year 2000 compliant or that they would be compliant by the
end of 1998. Therefore, the Company will be required to replace or modify some
of its existing software applications in order for its internal computer systems
to function properly in the year 2000 and thereafter. The Company estimates that
it will complete its year 2000 compliance program for all of its significant
internal systems no later than July 1, 1999. The Company also has had informal
discussions with its major suppliers and customers regarding their efforts to
address the year 2000 problem. These actions are intended to help mitigate the
possible external impact of the year 2000 problem. However, it is impossible to
fully assess the potential consequences in the event service interruptions from
suppliers occur or in the event that there are disruptions in such
infrastructure areas as utilities, communications, transportation, banking and
government.
COSTS. Because essentially all of the Company's products and internal systems were created in the last few years, such products and internal systems were designed to avoid the year 2000 problem. As a result, the total cost for resolving the Company's year 2000 issues is expected to be less than $35,000, a negligible amount of which has been spent through December 31, 1998. The total cost estimate includes the cost of replacing or upgrading non-compliant systems that were otherwise planned (but perhaps accelerated due to the year 2000 issue) or which have significant improvements and benefits unrelated to year 2000 issues. Estimates of year 2000 costs are based on numerous assumptions, and there can be no assurance that the estimates are correct or that actual costs will not be materially greater than anticipated.
CONTINGENCY. The Company has not yet developed a contingency plan to provide for continuity of processing in the event of various problem scenarios, but it will assess the need to develop such a plan based on the outcome of the validation phase of all of its systems and any additional results from surveys of its major suppliers and customers with respect to their year 2000 compliance.
RISK. Based on its assessments to date, the Company believes it will not experience any material disruption as a result of year 2000 problems with respect to its products and the third-party systems it uses for its internal functions, and, in any event, the Company does not anticipate the year 2000 issues it will encounter will be significantly different than those encountered by other computer hardware and software manufacturers, including its competitors. For example, if certain critical third-party providers, such as those providers supplying electricity, water or telephone service, experience difficulties resulting in disruption of service to the Company, a shutdown of the Company's operations at individual facilities could occur for the duration of the disruption. Assuming no major disruption in service from utility companies or other critical third-party providers, the Company believes that it will be able to manage its total year 2000 transition without any material effect on the Company's results of operations or financial condition.
Image Sensing Systems, Inc. 11
BALANCE SHEETS
DECEMBER 31 1998 1997
-------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,326,000 $ 2,000,000
Accounts receivable, net of allowance for
returns and doubtful accounts of $43,000 (1997--$49,000) 1,402,000 1,164,000
Inventories 74,000 144,000
Prepaid expenses 32,000 67,000
Deferred income taxes 57,000 54,000
-------------------------------------------------------------------------------------------------
Total current assets 2,891,000 3,429,000
Property and equipment:
Furniture and fixtures 129,000 127,000
Leasehold improvements 101,000 101,000
Equipment 950,000 850,000
-------------------------------------------------------------------------------------------------
1,180,000 1,078,000
Accumulated depreciation (710,000) (503,000)
-------------------------------------------------------------------------------------------------
470,000 575,000
-------------------------------------------------------------------------------------------------
Deferred income taxes 318,000 --
Capitalized software development costs,
net of accumulated amortization of $44,000 (1997--none) 856,000 75,000
-------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 4,535,000 $ 4,079,000
=================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 296,000 $ 351,000
Accrued compensation 270,000 184,000
Deferred revenue 252,000 361,000
-------------------------------------------------------------------------------------------------
Total current liabilities 818,000 896,000
Deferred income taxes 366,000 45,000
Commitments
Shareholders' equity:
Preferred stock, $.01 par value:
Authorized shares--2,000,000
Issued and outstanding--none
Common stock, $.01 par value:
Authorized shares--5,000,000
Issued and outstanding--2,479,200 (1997--2,478,200) 25,000 25,000
Additional paid-in capital 3,890,000 3,886,000
Retained earnings (deficit) (564,000) (773,000)
-------------------------------------------------------------------------------------------------
Total shareholders' equity 3,351,000 3,138,000
-------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,535,000 $ 4,079,000
=================================================================================================
|
SEE ACCOMPANYING NOTES.
12 Image Sensing Systems, Inc.
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31 1998 1997
----------------------------------------------------------------------------------
Revenue:
Product sales $ 881,000 $1,434,000
Royalties 2,216,000 2,742,000
Consulting services 271,000 152,000
----------------------------------------------------------------------------------
3,368,000 4,328,000
Cost of revenue:
Product sales 406,000 797,000
Royalties 238,000 297,000
Consulting services 100,000 91,000
----------------------------------------------------------------------------------
744,000 1,185,000
----------------------------------------------------------------------------------
Gross profit 2,624,000 3,143,000
Operating expenses:
Selling, marketing and product support 1,006,000 1,051,000
General and administrative 1,303,000 1,052,000
Research and development 203,000 643,000
----------------------------------------------------------------------------------
2,512,000 2,746,000
----------------------------------------------------------------------------------
Income from operations 112,000 397,000
Interest income 97,000 90,000
----------------------------------------------------------------------------------
Income before income taxes 209,000 487,000
Income taxes -- --
----------------------------------------------------------------------------------
Net income $ 209,000 $ 487,000
==================================================================================
Net income per common share--basic and diluted $ 0.08 $ 0.20
==================================================================================
Weighted average number of common shares
and dilutive potential common shares outstanding 2,480,000 2,478,000
==================================================================================
|
SEE ACCOMPANYING NOTES.
Image Sensing Systems, Inc. 13
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31 1998 1997
--------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 209,000 $ 487,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 207,000 177,000
Amortization 44,000
Changes in operating assets and liabilities:
Receivables (238,000) (374,000)
Inventories 70,000 (144,000)
Prepaid expenses 35,000 (67,000)
Accounts payable (55,000) 55,000
Accrued compensation 86,000 25,000
Deferred revenue (109,000) 234,000
--------------------------------------------------------------------------------------
Net cash provided by operating activities 249,000 393,000
INVESTING ACTIVITIES:
Purchases of property and equipment (102,000) (138,000)
Capitalized software development costs (825,000) (75,000)
--------------------------------------------------------------------------------------
Net cash used in investing activities (927,000) (213,000)
--------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from sale of common stock 4,000 11,000
--------------------------------------------------------------------------------------
Net cash provided by financing activities 4,000 11,000
--------------------------------------------------------------------------------------
Increase (decrease) in cash (674,000) 306,000
Cash and cash equivalents at beginning of year 2,000,000 1,694,000
--------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,326,000 $ 2,000,000
======================================================================================
|
SEE ACCOMPANYING NOTES.
14 Image Sensing Systems, Inc.
STATEMENTS OF SHAREHOLDERS' EQUITY
Additional Retained
Shares Common Paid-In Earnings
DESCRIPTION Issued Stock Capital (Deficit)
----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 2,475,000 $ 25,000 $ 3,875,000 $(1,260,000)
Common stock issued for options exercised 3,200 -- 11,000
Net income 487,000
---------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 2,478,200 25,000 3,886,000 (773,000)
Common stock issued for options exercised 1,000 -- 4,000
Net income 209,000
---------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 2,479,200 $ 25,000 $ 3,890,000 $ (564,000)
=====================================================================================================================
|
SEE ACCOMPANYING NOTES.
Image Sensing Systems, Inc. 15
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1
SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
The Company develops and markets video image processing technology and products
for use in advanced traffic management systems and traffic data collection. The
Company sells its product primarily to foreign distributors of its product and
receives a royalty for sales made by a sublicensee to North American
distributors. The Company also provides technical expertise in image processing,
hardware and software design and traffic management and control. The Company's
products are used primarily by governmental entities.
REVENUE RECOGNITION
Revenue from product sales and royalties from the sale of products by a
sublicensee are recorded upon shipment. Consulting fees are recorded as earned.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Investments classified as
cash equivalents consist of commercial paper. Market value of these investments
approximates cost at December 31, 1998 and 1997.
INVENTORIES
Inventories are primarily finished goods and are valued at the lower of cost or
market on the first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed by the
straight-line method over a three to seven-year period for financial reporting
purposes and by accelerated methods for income tax purposes.
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred income taxes
reflect the effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and amounts used for
income tax purposes.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting
for its stock options. Under APB 25, when the exercise price of stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("STATEMENT 123"). Accordingly, the Company has made pro forma
disclosures of what net income and net income per share would have been had the
provisions of Statement 123 been applied to the Company's stock options.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from the estimates.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS
The Company records losses on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations in the period incurred.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs in accordance with the
provisions of SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE
SOLD, LEASED, OR OTHERWISE MARKETED. Capitalization of software development
costs, including significant product enhancements, begins upon the establishment
of technological feasibility for the product and concludes when the product is
available for release to distributors. The establishment of technological
feasibility and the
16 Image Sensing Systems, Inc.
ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenue or royalties, estimated economic life and changes in software and hardware technology. The Company amortizes software development costs based on projected revenue, with minimum annual amortization based on a seven-year life using the straight-line method.
EARNINGS PER COMMON SHARE
The Company follows SFAS No. 128, EARNINGS PER SHARE. This Statement replaces
previously reported primary and fully diluted earnings per share with basic
and diluted earnings per share. Unlike primary EPS, basic EPS excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to previously reported fully diluted earnings
per share.
NOTE 2
CREDIT FACILITY
The Company has a credit agreement that provides up to $500,000 in short-term
borrowings at 1.25% over the prime rate (9.00% at December 31, 1998). The
agreement limits the amount of short-term borrowings to 65% of eligible
receivables. Substantially all assets are pledged as collateral on the
borrowings. The credit agreement further includes covenants which relate to
certain financial statement ratios and restrictions. The Company had no
outstanding borrowings in 1998 or 1997.
NOTE 3
INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31 1998 1997
-------------------------------------------------------------------------------
Deferred tax assets:
Accounts receivable allowances $ 16,000 $ 19,000
Accrued compensation 17,000 15,000
Warranty reserve 6,000 8,000
Deferred revenue 47,000 135,000
Research and development
tax credits 148,000 98,000
Net operating loss carryforward 335,000 35,000
-------------------------------------------------------------------------------
569,000 310,000
Deferred tax liabilities:
Tax depreciation in excess of book 49,000 45,000
Capitalized software
development costs 317,000 --
-------------------------------------------------------------------------------
366,000 45,000
-------------------------------------------------------------------------------
Net deferred tax assets 203,000 265,000
Less valuation allowance 194,000 256,000
------------------------------------------------------------------------------
Net deferred taxes $ 9,000 $ 9,000
===============================================================================
|
The Company has net operating loss carryforwards for income tax purposes of
$915,000 and research and development tax credits of $148,000 which both expire
in 2013. Cash paid for income taxes amounted to $4,600 in 1998 and $300 in 1997.
No provision has been made for income taxes for 1998 or 1997. A
reconciliation of income taxes to the statutory federal rate is as follows:
YEAR ENDED DECEMBER 31 1998 1997 ------------------------------------------------------------------------------- Federal tax at statutory rate $ 71,000 $166,000 Utilization of operating loss carryforward -- ( 81,000) Change in valuation allowance (62,000) (107,000) Other ( 9,000) 22,000 ------------------------------------------------------------------------------- Income taxes $ -- $ -- =============================================================================== Effective tax rate --% --% =============================================================================== |
Image Sensing Systems, Inc. 17
MOTES TO FINANCIAL STATEMENTS (continued)
NOTE 4
LEASE COMMITMENT
The Company rents office space under an operating lease agreement expiring in
November 2001, with options to renew through November 2004. The lease provides
for monthly payments of $12,000 and the Company is responsible for its
proportionate share of increases in operating expenses which exceed a base rent
factor. Rent expense amounted to $139,000 in 1998 and $138,000 in 1997.
At December 31, 1998, future minimum annual lease payments are as follows:
1999 $138,000
2000 138,000
2001 115,000
-----------------------------------------------------------------------
$391,000
=======================================================================
|
NOTE 5
COMMON STOCK
In connection with the offering of shares of common stock in 1995, the Company
issued warrants to the underwriter to purchase 90,000 shares for a period of
five years from the effective date of the Registration Statement. The exercise
price for the warrants is $5.70 per share.
NOTE 6
LICENSING
The U.S. patent for certain aspects of the technology underlying the Company's
Autoscope system was issued in 1989 to the University of Minnesota. The Company
has an exclusive worldwide license from the University of Minnesota for that
technology and pays royalties to the University of Minnesota in exchange for
such license. Royalty expense under the agreement was $238,000 in 1998 and
$297,000 in 1997.
The Company has sublicensed the right to manufacture and market the
Autoscope technology in North America and the Caribbean to Econolite Control
Products, Inc., of Anaheim, California (Econolite) and receives royalties from
Econolite on sales of the Autoscope system in those territories. Econolite also
manufactures the Autoscope system on a non-exclusive basis for direct sales by
the Company outside of North America and the Caribbean. The Company recognized
royalty income from this agreement of $2,216,000 in 1998 and $2,742,000 in 1997.
Accounts receivable from Econolite were $1,310,000 and $979,000 at December 31,
1998 and 1997, respectively.
NOTE 7
EXPORT SALES
Product sales to foreign customers were $541,000 in 1998 and $644,000 in 1997.
NOTE 8
RETIREMENT PLAN
Substantially all employees of the Company may participate in a qualified
defined contribution 401(k) plan in which participants may elect to have a
specified portion of their salary contributed to the plan. The Company may make
contributions to the plan. Company discretionary contributions totaled $44,000
in 1998 and $41,000 in 1997.
NOTE 9
EMPLOYMENT AGREEMENTS
The Company has an employment agreement with the chief executive officer of the
Company. The agreement provides for a minimum salary, stock options and
severance pay in the event of involuntary termination or termination resulting
from a sale, acquisition or merger of the Company. The maximum severance for the
executive officer under the agreement is $140,000.
NOTE 10
STOCK OPTIONS
In February 1995, the Company adopted the 1995 Long-Term Incentive and Stock
Option Plan (the 1995 Plan), which provides for the granting of incentive (ISO)
and non-incentive (NSO) stock options, stock appreciation rights, restricted
stock awards and performance awards to officers, directors, employees,
consultants and independent contractors of the Company and its subsidiaries. In
addition, in 1998 the Board authorized and granted an additional 100,000 shares
under the 1995 Plan subject to shareholder approval and granted options outside
of the 1995 Plan (the Non-Plan) in 1995, 1997 and 1998. The following table
summarizes stock option activity for 1998 and 1997:
18 Image Sensing Systems, Inc.
OPTIONS PLAN OPTIONS OUTSTANDING NON-PLAN WEIGHTED AVERAGE
AVAILABLE --------------------------- OPTIONS EXERCISE PRICE
FOR GRANT ISO NSO OUTSTANDING PER SHARE
-----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 1,900 200,100 18,000 148,200 $4.31
Exercised (3,200) 3.68
Canceled 35,750 (35,750) 4.19
------------------------------------------------------------------------------------------------
Balance at December 31, 1997 37,650 161,150 18,000 148,200 4.33
Reserved for options under Plan 100,000
Granted (119,500) 119,500 125,000 3.12
Exercised (1,000) 3.88
Canceled 32,300 (32,300) (29,000) 4.32
------------------------------------------------------------------------------------------------
Balance at December 31, 1998 50,450 247,350 18,000 244,200 3.81
================================================================================================
|
Exercise prices for options as of December 31, 1998 ranged from $2.875 to
$4.75. Options under the 1995 Plan and Non-Plan expire at various dates through
2008. At December 31, 1998 there were 279,888 options exercisable at a weighted
average exercise price of $4.06. Options outstanding have a weighted average
remaining contractual life of 8.3 years. The weighted average fair value of
options granted during 1998 was $3.12. There were no options granted in 1997.
Pro forma information regarding net income and net income per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
Statement 123. The fair value for these options was estimated at the date of
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions: risk-free interest rate of 5.0%; volatility factor
of the expected market price of the Company's common stock of .838 and
weighted-average expected life of the option of ten years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options, which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
1998 1997
-------------------------------------------------------------------------------
Pro forma net income $1,000 $259,000
Pro forma net income
per common share $ .00 $ .11
|
NOTE 11
SUBSEQUENT EVENT
In February 1999, the Company acquired a sixty percent equity interest in a
foreign sales organization for $200,000.
Image Sensing Systems, Inc. 19
REPORT OF INDEPENDENT AUDITORS
SHAREHOLDERS AND BOARD OF DIRECTORS
IMAGE SENSING SYSTEMS, INC.
We have audited the accompanying balance sheets of Image Sensing Systems, Inc.
as of December 31, 1998 and 1997, and the related statements of operations,
shareholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Image Sensing Systems, Inc.
at December 31, 1998 and 1997, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP Minneapolis, Minnesota February 12, 1999 |
20 Image Sensing Systems, Inc.
CORPORATE INFORMATION
DIRECTORS AND OFFICERS
Panos G. Michalopoulos
CHAIRMAN
William L. Russell
PRESIDENT, CHIEF EXECUTIVE OFFICER, AND DIRECTOR
Richard P. Braun#
DIRECTOR
Richard C. Magnuson*
DIRECTOR
James Murdakes#
DIRECTOR AND SECRETARY
C. (Dino) Xykis*#
DIRECTOR
Arthur J. Bourgeois
CHIEF FINANCIAL OFFICER AND TREASURER
* MEMBER OF AUDIT COMMITTEE. # MEMBER OF COMPENSATION COMMITTEE
ANNUAL SHAREHOLDERS' MEETING
The annual meeting of the shareholders will be held on May 11, 1999, at 3:30
p.m. CDT at the Crowne Plaza Northstar Hotel, Minneapolis, MN.
LEGAL COUNSEL
Dorsey & Whitney LLP
INDEPENDENT AUDITORS
Ernst & Young LLP
STOCK TRANSFER AGENT
Norwest Bank Minnesota, N.A.
A copy of Form 10-KSB, filed with the Securities and Exchange Commission, may be obtained without charge upon written request to the Company.
LOCATION
CORPORATE HEADQUARTERS
500 Spruce Tree Centre
1600 University Avenue West
St. Paul, Minnesota 55104-3825 USA
PRICE RANGE OF COMMON STOCK
The Company's common stock trades on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market under the symbol ISNS. The table below presents the price range of high and low trading prices for the Company's common stock for each period indicated as reported by Nasdaq:
1998 1997
QUARTER HIGH LOW HIGH LOW
-------------------------------------------------------------------------------
First $4.38 $2.38 $4.00 $2.38
Second 5.00 3.06 3.50 2.13
Third 3.81 1.56 5.88 2.63
Fourth 3.88 2.25 5.25 3.50
|
EXHIBIT 23
Consent of Ernst & Young LLP
We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-09289) pertaining to the 1995 Long-Term Incentive and Stock Option Plan of Image Sensing Systems, Inc., of our report dated February 12, 1999, with respect to the financial statements of Image Sensing Systems, Inc. incorporated by reference in this Annual Report (Form 10-KSB) for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 26, 1999
|
EXHIBIT 99
CAUTIONARY STATEMENT
Image Sensing Systems, Inc. (the Company), or persons acting on behalf of the Company, or outside reviewers retained by the Company making statements on behalf of the Company, or underwriters, from time to time make, in writing or orally, "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in conjunction with an identified forward-looking statement, this Cautionary Statement is for the purpose of qualifying for the "safe harbor" provisions of such sections and is intended to be a readily available written document that contains factors which could cause results to differ materially from such forward-looking statements. These factors are in addition to any other cautionary statements, written or oral, which may be made or referred to in connection with any such forward-looking statement.
The following matters, among others, may have a material adverse effect on the business, financial condition, liquidity, results of operations or prospects, financial or otherwise, of the Company. Reference to this Cautionary Statement in the context of a forward-looking statement or statements shall be deemed to be a statement that any or more of the following factors may cause actual results to differ materially from those in such forward-looking statement or statements:
MARKET ACCEPTANCE OF AUTOSCOPE SYSTEM. The success of the Company is dependent upon increasing acceptance of its Autoscope system vehicle detection system in the markets in which that product is sold. The application of machine vision technology to traffic management is a relatively new concept in the traffic management industry. A substantial portion of the Company's revenues to date has been from royalties from sales of the Autoscope system for deployment in conjunction with federally funded ITS programs or for evaluation purposes. The Company's future results of operations and immediate prospects for future growth will depend in large part on the continued development of the market for advanced technology solutions for traffic management and the acceptance of the Autoscope system as a reliable, cost-effective alternative to traditional vehicle detection systems. There is no assurance that the Autoscope system will gain sufficient market acceptance to enable the Company to sustain profitable operations.
DEPENDENCE ON THIRD PARTIES FOR MANUFACTURING AND MARKETING. The Company does not have and does not in the near future intend to develop the capability to manufacture its products. Pursuant to the Econolite Agreement, the Company appointed Econolite as its licensee to manufacture, distribute and sell the Autoscope system and related technology on an exclusive basis in North America and the Caribbean. Pursuant to the Cohu Production Agreement, the Company appointed Cohu to manufacture the Autoscope Solo product. The Company believes that alternative manufacturing sources could be obtained, if necessary, but the inability to obtain alternative sources, if and as required in the future, could result in delays or reductions in product shipments which in turn may have an adverse effect on the Company's operating results. In addition, Econolite has the exclusive right to market the Autoscope system and related products in North America
and the Caribbean. Consequently, the Company's revenues depend to a significant extent on the marketing efforts of Econolite. The inability of Econolite to adequately manufacture or effectively market the Autoscope system, or the disruption or termination of that relationship could have a material adverse effect on the Company's operations.
DEPENDENCE ON PRIMARY DISTRIBUTOR. Pursuant to the Econolite Agreement, Econolite pays a royalty to the Company for sales of Autoscope systems. Since 1991, over sixty percent of the Company's revenue has been from royalties resulting from sales made by the Company's primary distributor, Econolite. Although Econolite has consistently made payments to the Company when due and although the Company has no reason to believe that Econolite will not continue to do so in the future, there can be no assurance that Econolite will continue to make such payments in a timely manner, whether due to financial insolvency, liquidity problems or other reasons. The inability of Econolite to make such payments could have a material adverse effect on the Company's financial condition and operations.
DEPENDENCE ON ONE PRODUCT. Over eighty percent of the Company's revenues since inception have been generated from sales of, or royalties from the sale of, the Autoscope system. The Autoscope system is currently the Company's only product sold commercially. The Company expects the Autoscope system to gain greater market acceptance and the number of applications for the system to increase. There can be no assurance, however, that a significant sustainable market will develop for the Autoscope system or that the Company will be able to profitably utilize its technology in other products or markets.
DEPENDENCE ON SALES TO GOVERNMENTAL ENTITIES; PERIODIC FLUCTUATIONS IN SALES. Sales of the Autoscope system are made primarily to governmental entities. Purchase decisions by governmental entities often take considerable time, and there can be no assurance that, notwithstanding the marketing efforts by the Company or Econolite, such purchase decisions will not be substantially delayed and adversely affect the Company's business operations. Until broader market acceptance of the Autoscope system is achieved, revenues and royalties from sales of the Autoscope system will come substantially from sales to governmental entities for use in large traffic control projects using advanced traffic control technologies. It often takes considerable time before these projects are developed to the point where an actual purchase of the Autoscope system is made. Once a governmental entity decides to purchase the Autoscope system, however, it will often purchase a significant number. Consequently, the Company's revenues and income may fluctuate significantly between fiscal periods. Moreover, there can be no assurance that, once market acceptance of the Company's technology is obtained, governmental budgetary constraints in the U.S. and elsewhere will not delay or decrease purchases of the Company's product by such entities.
PATENTS AND PROPRIETARY RIGHTS. The Company's success depends in part on its ability to maintain its proprietary rights in the technology underlying the Autoscope system. The Company relies on a combination of trade secrets, copyrights and patents to protect its proprietary rights in the system. The U.S. and foreign patents for certain aspects of the underlying technology for the Autoscope system are owned by the University of
Minnesota. The Company has entered into a license agreement with the University of Minnesota, pursuant to which the Company has been granted an exclusive, worldwide license, with a right to grant sub-licenses, to make, have made, use, sell and lease products incorporating such technology, and the Company pays the University a royalty for the license. The University of Minnesota may terminate the license only in limited circumstances. Nevertheless, termination of the license agreement with the University of Minnesota for whatever reason, could have a material adverse effect on the Company's operations. The Company has not applied for patent protection in all foreign countries in which it may market and sell the Autoscope system. Consequently, the Company's proprietary rights in the technology underlying the Autoscope system will be protected only to the extent that trade secret, copyright or other non-patent protection is available in such countries and to the extent the Company is able to enforce such rights. No assurance can be given that the scope of current or any future patents relating to the Company's product will exclude competitors or provide competitive advantages to the Company or that the current patent on the technology underlying the Autoscope system will be held valid if subsequently challenged. There can be no assurance that others have not developed or will not develop similar products, duplicate any of the Company's products or design around such patents. Litigation, which could result in substantial cost to and diversion of effort by the Company, may be necessary to enforce patents related to the Company's products, to defend the Company against claimed infringement of the rights of others or to determine the ownership, scope or validity of the proprietary rights of the Company and others. The Company also relies on trade secrets to protect technology not covered by patent. The Company has entered into confidentiality agreements with its employees, consultants and others, however, there can be no assurance that confidentiality obligations will be honored or that the Company's trade secrets will not otherwise become known or independently developed by competitors.
TECHNOLOGICAL RISK. The Company believes that the Autoscope system is the most advanced and adaptive technology commercially available for vehicle detection, and the market served by the Company is increasingly seeking advanced technological solutions to traffic management and control problems. Consequently, competitive product developments, introductions and enhancements are increasing. There can be no assurance that developments by current or future competitors of the Company will not render the Company's products or technologies noncompetitive or obsolete.
MANAGEMENT OF GROWTH. The Company intends to increase its Asian operations and intensify its marketing efforts and distribution arrangements in Asia through its sixty-percent owned affiliate. If the Company's increased marketing efforts are successful and its expansion occurs, the Company may experience a period of significant growth. This growth and expansion could place a significant strain on the Company's resources, including working capital resources, and result in an increase in the level of responsibility of the Company's management personnel. The Company's ability to manage its growth effectively will require it to continue to improve its operational, financial and management systems, and to successfully train, motivate and manage its employees. If the Company's management is unable to manage its growth effectively, the Company's
results of operations could be materially adversely affected. While the Company believes that it can manage such growth, there can be no assurances that it will be able to do so.
CONTROL BY EXISTING SHAREHOLDERS. As of December 31, 1998, directors and executive officers of the Company owned beneficially approximately 54.5% of the Company's outstanding Common Stock. Accordingly, these shareholders may be able to influence the outcome of shareholder votes, including votes concerning the election of directors and the outcome of corporate actions requiring shareholder approval, such as mergers and acquisitions, regardless of how other shareholders of the Company may vote. This concentration of voting control may have a significant effect in delaying, deferring or preventing a change in management or change in control of the Company and may adversely affect the voting or other rights of other holders of Common Stock.
YEAR 2000 ISSUE. Many currently installed computer systems and software are coded to accept only two-digit entries in the date code fields. These date code fields will need to accept four-digit entries to distinguish 21st century dates from 20th century dates. This problem could result in system failures or miscalculations causing disruptions of business operations (including, among other things, a temporary inability to process transactions, send invoices or engage in other similar business activities). As a result, many companies' computer systems and software will need to be upgraded or replaced in order to comply with year 2000 requirements. The potential global impact of the year 2000 problem is not known, and, if not corrected in a timely manner, could affect the Company and the U.S. and world economies generally.
Based on assessments to date, the Company believes it will not experience any material disruption as a result of year 2000 problems with respect to its products and the third-party systems the Company uses for its internal functions, and, in any event, the Company does not anticipate the year 2000 issues it will encounter will be significantly different than those encountered by other computer hardware and software manufacturers, including our competitors. For example, if certain critical third-party providers, such as those providers supplying electricity, water or telephone service, experience difficulties resulting in disruption of service to the Company, a shutdown of the Company's operations could occur for the duration of the disruption. Assuming no major disruption in service from utility companies or other critical third-party providers, the Company believes that it will be able to manage its year 2000 transition without any material effect on the Company's results of operations or financial condition.
| ARTICLE 5 |
| PERIOD TYPE | YEAR |
| FISCAL YEAR END | DEC 31 1998 |
| PERIOD END | DEC 31 1998 |
| CASH | 1,326,000 |
| SECURITIES | 0 |
| RECEIVABLES | 1,445,000 |
| ALLOWANCES | 43,000 |
| INVENTORY | 74,000 |
| CURRENT ASSETS | 2,891,000 |
| PP&E | 1,180,000 |
| DEPRECIATION | 710,000 |
| TOTAL ASSETS | 4,535,000 |
| CURRENT LIABILITIES | 818,000 |
| BONDS | 0 |
| PREFERRED MANDATORY | 0 |
| PREFERRED | 0 |
| COMMON | 25,000 |
| OTHER SE | 3,326,000 |
| TOTAL LIABILITY AND EQUITY | 4,535,000 |
| SALES | 881,000 |
| TOTAL REVENUES | 3,368,000 |
| CGS | 406,000 |
| TOTAL COSTS | 3,256,000 |
| OTHER EXPENSES | 0 |
| LOSS PROVISION | 0 |
| INTEREST EXPENSE | 0 |
| INCOME PRETAX | 209,000 |
| INCOME TAX | 0 |
| INCOME CONTINUING | 209,000 |
| DISCONTINUED | 0 |
| EXTRAORDINARY | 0 |
| CHANGES | 0 |
| NET INCOME | 209,000 |
| EPS PRIMARY | .08 |
| EPS DILUTED | .08 |