Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Selected Financial Data and our Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward‑looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in “Risk Factors” included elsewhere in this Annual Report on Form 10-K.
General . We are a leading provider of above-ground detection products and solutions for the intelligent transportation systems ("ITS") industry. Our family of products, which we market as Autoscope video or video products and RTMS radar or radar products ("RTMS"), provides end users with the tools needed to optimize traffic flow and enhance driver safety. Our technology analyzes signals from sophisticated sensors and transmits the information to management systems and controllers or directly to users. Our products provide users with complete solutions for the intersection and transportation markets.
Our technology is a process in which software, rather than humans, examines outputs from various types of sophisticated sensors to determine what is happening in a field of view. In the ITS industry, this process is a critical component of managing congestion and traffic flow. In many cities, it is not possible to build roads, bridges and highways quickly enough to accommodate the increasing congestion levels. During 2020, congestion levels decreased significantly as a result of COVID-19 related government lockdowns, although automobile travel has rebounded in many areas, causing congestion levels to begin returning to previous levels (per INRIX 2020 Global Traffic scorecard). In 2021, on average, United States commuters lost 36 hours a year in congestion, which costs an average of $564 per driver in wasted time (per INRIX 2021 Global Traffic scorecard). We believe this growing use of vehicles will make our ITS solutions increasingly necessary to complement existing and new roadway infrastructure to manage traffic flow and optimize throughput.
We believe our solutions are technically superior to those of our competitors because they have a higher level of accuracy, limit the occurrence of false detection, are generally easier to install with lower costs of ownership, work effectively in a multitude of light and weather conditions, and provide end users the ability to manage inputs from a variety of sensors for a number of tasks. It is our view that the technical advantages of our products make our solutions well suited for use in ITS markets.
We believe the strength of our distribution channels positions us to increase the penetration of our technology ‑ driven solutions in the marketplace. We market our Autoscope video products in the United States, Mexico, Canada and the Caribbean through an exclusive agreement with Econolite Control Products, Inc. ("Econolite"), which we believe is the leading distributor of ITS intersection control products in these markets.
We market the RTMS radar systems to a network of distributors in North America, the Caribbean and Latin America. On a limited basis, we sell directly to the end user in these geographic areas. We market our Autoscope video and RTMS radar products outside of the United States, Mexico, Canada and the Caribbean through a combination of distribution and direct sales channels through our office in Spain. Our end users primarily include governmental agencies and municipalities.
The following discussion of year-to-year trends in financial statement results under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” aligns with the financial statement presentation described above.
Trends and Challenges in Our Business
We believe the expected growth in our business can be attributed primarily to the following global trends:
worsening traffic caused by increased numbers of vehicles in metropolitan areas without corresponding expansions of road infrastructure and the need to automate safety, security and access applications for automobiles and trucks, which has increased demand for our products;
advances in information technology, which have made our products easier to market and implement;
the continued funding allocations for centralized traffic management services and automated enforcement schemes, which have increased the ability of our primary end users to implement our products; and
general increases in the cost‑effectiveness of electronics, which make our products more affordable for end users.
We believe our continued growth primarily depends upon:
continued adoption and governmental funding of ITS and other automated applications for traffic control, safety and enforcement in developed countries;
a propensity by traffic engineers to implement lower cost technology‑based solutions rather than civil engineering solutions such as widening roadways;
countries in the developing world adopting above‑ground detection technology, such as video or radar, instead of in‑pavement loop technology to manage traffic;
our ability to develop new products that provide increasingly accurate information and enhance the end users’ ability to cost‑effectively manage traffic and environmental issues; and
value created through strategic acquisitions and partnerships that can leverage the reputation, assets and talents within the Company.
Because the majority of our end users are governmental entities, we are faced with challenges related to potential delays in purchase decisions by those entities and changes in budgetary constraints. These contingencies could result in significant fluctuations in our revenue between periods. The ongoing economic environment in Europe and the United States is further adding to the unpredictability of purchase decisions, creating more delays than usual and decreasing governmental budgets, and it is likely to continue to affect our revenue.
Key Financial Terms and Metrics
Revenue . We derive revenue from two sources: (1) royalties received from Econolite for sales of the Autoscope video systems in the United States, Mexico, Canada and the Caribbean and (2) revenue received from the direct sales of our RTMS radar systems and our Autoscope video systems in Europe and Asia. Autoscope video royalties are calculated using a profit sharing model where the gross profits on sales of product made through Econolite are shared equally with Econolite. This royalty arrangement has the benefit of decreasing our cost of revenues and our selling, marketing and product support expenses because these costs and expenses are borne primarily by Econolite. Although this royalty model has a positive impact on our gross margin, it also negatively impacts our total revenue, which would be higher if all the sales made by Econolite were made directly by us. The royalty arrangement is exclusive under a long‑term agreement.
Cost of Revenue . Software amortization is the sole cost of revenue related to royalties, as virtually all manufacturing, warranty and related costs are incurred by Econolite. Cost of revenue related to product sales consists primarily of the amount charged by our third party contractors to manufacture hardware platforms, which is influenced mainly by the cost of electronic components. The cost of revenue also includes logistics costs, estimated expenses for product warranties, restructuring costs and inventory reserves. The key metric that we follow is achieving certain gross margin percentages on product sales by geographic region and to a lesser extent by product line.
Operating Expenses . Our operating expenses fall into three categories: (1) selling, marketing and product support; (2) general and administrative; and (3) research and development. Selling, marketing and product support expenses consist of various costs related to sales and support of our products, including salaries, benefits and commissions paid to our personnel; commissions paid to third parties; travel, trade show and advertising costs; second‑tier technical support for Econolite; and general product support, where applicable. General and administrative expenses consist of certain corporate and administrative functions that support the development and sales of our products and provide an infrastructure to support future growth. These expenses include management, supervisory and staff salaries and benefits, legal and auditing fees, travel, rent and costs associated with being a public company, such as board of director fees, listing fees and annual reporting expenses. Research and development expenses consist mainly of salaries and benefits for our engineers and third party costs for consulting and prototyping. We measure all operating expenses against our annually approved budget, which is developed with achieving a certain operating margin as a key focus. Also included in operating expenses are any restructuring costs.
Non‑GAAP Operating Measure. We provide certain non-GAAP financial information as supplemental information to financial measures calculated and presented in accordance with U.S. GAAP (Generally Accepted Accounting Principles in the United States). This non-GAAP information excludes the impact of depreciating fixed assets and amortizing intangible assets and may exclude other non-recurring items. Management believes that this presentation facilitates the comparison of our current operating results to historical operating results. Management uses this non-GAAP information to evaluate short-term and long-term operating trends in our core operations. Non-GAAP information is not prepared in accordance with GAAP and should not be considered a substitute for or an alternative to GAAP financial measures and may not be computed the same as similarly titled measures used by other companies.
The table below reconciles non-GAAP income from income from operations, which is a non-GAAP financial measure, to comparable GAAP financial measures (in thousands):
Years Ended December 31,
Income from operations
Adjustments to reconcile to non-GAAP income
Amortization of intangible assets
Depreciation
Non-GAAP operating income
Seasonality . Our quarterly revenues and operating results have varied significantly in the past due to the seasonality of our business. Our first quarter generally is the weakest due to weather conditions that make roadway construction more difficult in parts of North America, Europe and northern Asia. We expect such seasonality to continue for the foreseeable future. Additionally, our international revenues regularly contain individually significant sales. This can result in significant variations of revenue between periods. Accordingly, we believe that quarter‑to‑quarter comparisons of our financial results should not be relied upon as an indication of our future performance. No assurance can be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future.
Segments . We currently operate in two reportable segments: Intersection and Highway. Autoscope video is our machine‑vision product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international product sales. Video products are normally sold in the Intersection segment. The RTMS radar is our radar product line, and revenue consists of sales to external customers. Radar products are normally sold in the Highway segment. As a result of business model changes and modifications in how we manage our business, we may reevaluate our segment definitions in the future.
The following tables set forth selected financial information for each of our reportable segments (in thousands):
For the year ended December 31, 2021
Intersection
Highway
Total
Revenue
Gross profit
Amortization of intangible assets
Intangible assets
For the year ended December 31, 2020
Intersection
Highway
Total
Revenue
Gross profit
Amortization of intangible assets
Intangible assets
Results of Operations
The following table sets forth, for the periods indicated, certain consolidated statements of operations data as a percent of total revenue and gross profit on product sales and royalties as a percentage of international sales and royalties, respectively.
Years Ended December 31,
Product sales
Royalties
Total revenue
Gross profit - product sales
Gross profit - royalties
Selling, marketing and product support
General and administrative
Research and development
Income from operations
Income tax expense (benefit)
Net income
Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 . Total revenue remained unchanged at $13.2 million in 2021 compared to 2020. Royalty income increased to $8.5 million in 2021 compared to $8.3 million in 2020, an increase of 2.3% Product sales decreased to $4.7 million in 2021 from $4.8 million in 2020, a decrease of 2.5%. The decrease in product sales was primarily the result of labor shortages causing installation delays and impacting project timing.
Revenue for the Intersection segment remained unchanged at $9.3 million in 2021 compared to 2020.
Revenue for the Highway segment remained unchanged at $3.9 million in 2021 compared to 2020.
Gross profit for product sales decreased to 44.6% in 2021 from 49.9% in 2020. Product sales gross profit in 2021 decreased $308,000 or 12.8% compared to the prior year. The decrease in product sales gross profit is primarily the result of COVID-19 related challenges that continued to impact regions throughout the year, as well as labor shortages that caused installation delays and impacted project timing. Product sales gross profit for the Highway product lines has historically been lower than gross profit for the Intersection product lines and therefore the mix of the product lines sold in any given period can result in varying gross profit. Additionally, the geographic sales mix of our product sales can influence margins, as products sold in some jurisdictions have lower margins.
Gross profit for royalty sales decreased to 95.3% in 2021 compared to 95.6% in 2020. Gross profit for royalties in 2021 increased $155,000 or 1.9% compared to the prior year. The decrease in royalty gross profit percent is primarily the result of increased amortization costs associated with the release of pedestrian detection software.
Selling, marketing and product support expense decreased to $2.1 million, or 16.1% of total revenue, in 2021 compared to $2.5 million, or 19.3% of total revenue, in 2020. The decrease in selling, marketing, and product support expense is primarily the result of decreased headcount.
General and administrative expense decreased to $3.6 million, or 27.2% of total revenue, in 2021 compared to $3.9 million, or 29.6% of total revenue, in 2020. A portion of expense during 2020 consisted of expenses for legal and outside consulting costs related to the efforts around exploring strategic alternatives to maximize shareholder value that we announced in January 2020. In light of then current market conditions, including the effects of the COVID-19 pandemic, the strategic review process was terminated in October 2020.
Research and development expense decreased to $2.2 million, or 16.7% of total revenue, in 2021, from $3.3 million, or 25.3% of total revenue, in 2020. The decrease is due to increased capitalized software development costs in 2021 of $485,000 compared to capitalized software costs of $22,000 in 2020. After normalizing for software development costs, overall research and development expenditures decreased in 2021 compared to 2020 due to decreased headcount.
Income tax expense of $905,000 wa s recorded for the year ended December 31, 2021 compared to income tax benefit of $ 462,000 for the year ended December 31, 2020 . The increase in income tax expense is due to higher pre-tax income in 2021 compared to 2020 and increased research and development tax credits and other adjustments, recognized in 2020.
Consolidated net income was $2.3 million, or $0.43 per basic and diluted share, in 2021 compared to $1.1 million, or $0.20 per basic and diluted share, in 2020 .
Liquidity and Capital Resources
At December 31, 2021, we had $8.2 million in cash and cash equivalents compared to $8.6 million at December 31, 2020.
Net cash provided by operating activities remained constant at $2.6 million in 2021 compared to 2020. Net cash provided by operating activities in 2021 remained unchanged compared to the prior year, primarily because the increase in net income was offset by increased inventory levels, forgiveness of our Paycheck Protection Program Loan (as described below), and a decrease in the accounts payable at December 31, 2021 compared to the prior year. To minimize any unforeseen supply chain delays, the Company built up finished goods inventory in 2021.
Net cash used for investing activities was $2.6 million in 2021, compared to net cash used for investing activities of $151,000 in 2020. The increase in the amount of net cash used for investing activities in 2021 compared to the prior year is primarily the result of increased capitalized internal software development costs when compared to 2020 and the increase in cash used to purchase property and equipment, including the purchase of the Property in December 2021.
Net cash used for financing activities was $229,000 in 2021 compared to net cash provided by financing activities of $918,000 in 2020. The decrease in net cash provided by financing activities is attributed to the funding of $924,000 we received from the United States Small Business Administration (SBA) in the form of the Paycheck Protection Program loan (the "PPP Loan") in 2020, as well as cash dividends paid to shareholders during 2021, offset by the $1,742,500 in Loan proceeds from financing the purchase of the Property in December 2021.
On December 10, 2021, in the Closing, ISNS closed on the purchase of the Property under the terms of the Purchase Agreement and the Loan in the original principal amount of $1,742,500 from Coulee Bank (the "Bank") to ISNS to finance the purchase of the Property.
The principal documents evidencing the Loan (the "Loan Documents"), all of which are dated as of December 10, 2021, and their principal terms are as follows:
The Business Loan Agreement (the "Loan Agreement") contains standard representations and warranties by ISNS to the Bank, affirmative agreements and covenants by ISNS, and agreements by ISNS not to take certain actions. Upon the occurrence of an event of default under the Loan Agreement, all indebtedness of ISNS to the Bank immediately will become due and payable, all without notice of any kind to ISNS. In addition, upon a default, the Bank will have all the rights and remedies provided in the Loan Documents or available at law, in equity, or otherwise.
The Loan is evidenced by a Promissory Note (the "Note") in the original principal amount of $1,742,500 with a term of five years and which bears interest at the fixed annual rate of 3.950% unless ISNS defaults under the terms of the Note, in which case a higher interest rate will go into effect calculated as provided in the Note. The Note is payable in 59 consecutive monthly payments of principal and interest of $10,566, with the first payment due on January 10, 2022 and one final payment consisting of the balance of the entire remaining principal amount together with all accrued and unpaid interest, estimated at $1,438,256, due and payable on December 10, 2026.
Under the Mortgage granted by ISNS to the Bank (the "Mortgage"), ISNS mortgaged and conveyed to the Bank, with power of sale, all of ISNS's right, title, and interest in and to the Real Property.
As provided in the Assignment of Rents between ISNS and the Bank (the "Assignment"), ISNS has granted to the Bank a continuing security interest in all of ISNS's right, title, and interest in and to the rents from the Real Property. The Assignment provides that unless and until the Bank exercises its right to collect the rents as provided in the Assignment and so long as there is no default under the Assignment, ISNS may remain in possession and control of and operate and manage the Real Property and collect the rents.
The events of default under all of the Loan Documents are similar. As of December 31, 2021, ISNS was in compliance with all of its applicable covenants under the Loan Documents.
The above description of the Loan Documents is qualified in its entirety by reference to the Loan Agreement, the Note, the Mortgage, and the Assignment which are filed as Exhibit 10.22, Exhibit 10.23, Exhibit 10.24, and Exhibit 10.25, respectively, with this Annual Report on Form 10-K and are incorporated herein by reference.
We believe that cash and cash equivalents on hand at December 31, 2021, along with the cash provided by operating activities, will satisfy our projected working capital needs, investing activities, and other cash requirements for the foreseeable future.
Off‑Balance Sheet Arrangements
We do not participate in transactions or have relationships or other arrangements with an unconsolidated entity, including special purpose and similar entities or other off‑balance sheet arrangements.
Critical Accounting Policies
Our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which require us to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. We believe that of our significant accounting policies, the following are particularly important to the portrayal of our results of operations and financial position, may require the application of a higher level of judgment by our management, and as a result, are subject to an inherent degree of uncertainty. For further information, see Note 1 of our Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10‑K
Revenue Recognition and Allowance for Doubtful Accounts . We are required to comply with a variety of technical accounting requirements in order to achieve consistent and accurate revenue recognition. Royalty income is recognized based on sales shipped or delivered to our customers as reported to us by Econolite. Revenue is recognized when both product ownership and the risk of loss have transferred to the customer and we have no remaining obligations. Allowances for doubtful accounts are estimated by management based on an evaluation of potential losses related to customer receivable balances. We determine the allowance based on historical write‑off experience in the industry, regional economic data, and an evaluation of specific customer accounts for risk of loss. We review our allowance for doubtful accounts monthly. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. We do not have any off‑balance sheet credit exposure related to our customers. The establishment of this allowance requires the use of judgment and assumptions regarding the potential for on receivable balances. Although management considers these balances adequate and proper, changes in economic conditions in specific markets in which we operate could have an effect on reserve balances required.
Warranty Liabilities . The estimated cost to service warranty and customer service claims is included in cost of sales. This estimate is based on historical trends of warranty claims. We regularly assess and adjust the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs. Our warranty liability contains uncertainties because our warranty obligations cover an extended period of time. While these liability levels are based on historical warranty experience, they may not reflect the actual claims that will occur over the upcoming warranty period, and additional warranty reserves may be required. A revision of estimated claim rates or the projected cost of materials and freight associated with sending replacement parts to customers could have a material adverse effect on future results of operations.
Software Development Costs . We incur costs associated with the development of software to be sold, leased, or otherwise marketed. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. A significant amount of judgment and estimation is required to assess when technological feasibility is established as well as in the ongoing assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized software costs, we compare expected product performance, utilizing forecasted revenue amounts, to the total costs incurred to date and estimates of additional costs to be incurred. If revised forecasted product revenue is less than, and/or revised forecasted costs are greater than, the previously forecasted amounts, the net realizable value may be lower than previously estimated, which could result in recognition of an impairment charge in the period in which such a determination is made.
Impairment of Long‑Lived Assets . We review the carrying value of long‑lived assets or asset groups, such as property and equipment and intangibles subject to amortization, when events or changes in circumstances such as asset utilization, physical change, legal factors, or other matters indicate that the carrying value may not be recoverable. When this review indicates the carrying value of an asset or asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group, we recognize an asset impairment charge against operations. The amount of the impairment loss recorded is the amount by which the carrying value of the impaired asset or asset group exceeds its fair value.
Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to identify events or changes in circumstances indicating the carrying value of assets may not be recoverable, estimate future cash flows, estimate asset fair values, and select a discount rate that reflects the risk inherent in future cash flows. Expected cash flows may not be realized, which could cause long‑lived assets to become impaired in future periods and could have a material adverse effect on future results of operations.
Income Taxes . We record a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. We believe it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of our deferred tax assets. If all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on our financial condition and operating results.
