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.
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SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-KSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange 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
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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.
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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.
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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
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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
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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
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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.
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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.
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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.
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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
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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.
12
<PAGE>
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.
13
<PAGE>
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
14
<PAGE>
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.
15
<PAGE>
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.
16
<PAGE>
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
17
<PAGE>
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
18
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:
<PAGE>
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.
Page 2 of 4
<PAGE>
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: _______________________________
Page 3 of 4
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
<PAGE>
EXHIBITS
A FLOOR PLAN
B PROPERTY DESCRIPTION
C LEASEHOLD IMPROVEMENTS
D BUILDING RULES AND REGULATIONS
E PARKING
2
<PAGE>
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.
1
<PAGE>
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.
2
<PAGE>
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.
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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.
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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.
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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.
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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.
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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.
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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.
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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;
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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.
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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.
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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.
13
<PAGE>
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.
14
<PAGE>
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.
15
<PAGE>
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.
16
<PAGE>
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.
17
<PAGE>
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
18
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.
<PAGE>
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
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31 1998 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
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
=================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
12 Image Sensing Systems, Inc.
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997
- ----------------------------------------------------------------------------------
<S> <C> <C>
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
==================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
Image Sensing Systems, Inc. 13
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
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
======================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
14 Image Sensing Systems, Inc.
<PAGE>
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional Retained
Shares Common Paid-In Earnings
DESCRIPTION Issued Stock Capital (Deficit)
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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)
=====================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
Image Sensing Systems, Inc. 15
<PAGE>
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.
<PAGE>
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
<PAGE>
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:
YEAR ENDING DECEMBER 31:
- -----------------------------------------------------------------------
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.
<PAGE>
<TABLE>
<CAPTION>
OPTIONS PLAN OPTIONS OUTSTANDING NON-PLAN WEIGHTED AVERAGE
AVAILABLE --------------------------- OPTIONS EXERCISE PRICE
FOR GRANT ISO NSO OUTSTANDING PER SHARE
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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
================================================================================================
</TABLE>
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
<PAGE>
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.
<PAGE>
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
1
<PAGE>
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
2
<PAGE>
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
3
<PAGE>
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.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<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
0
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
</TABLE>
