LENDWAY, INC. - Quarter Report: 2005 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
x
Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2005
or
o
Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from ___________________ to _________________
Commission File Number: 1-13471
INSIGNIA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
| Minnesota | 41-1656308 | ||
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
6470 Sycamore Court North
Maple Grove, MN 55369
(Address of principal executive offices)
(763) 392-6200
(Registrant’s telephone number, including area code)
Not applicable.
(Former name, former address and former fiscal year if changed since last report)
Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes
o No
Indicate by check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
o Yes
x No
Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes
x No
Number of shares outstanding of Common Stock, $.01 par value, as of October 31, 2005 was 15,001,856.
Insignia Systems, Inc.
TABLE OF CONTENTS
Page 2 of 20
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Insignia Systems, Inc.
BALANCE SHEETS
(Unaudited)
| September 30, 2005 | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash and cash equivalents | $ | 2,718,000 | $ | 6,156,000 | ||||
| Accounts receivable, net | 2,963,000 | 2,234,000 | ||||||
| Inventories | 476,000 | 495,000 | ||||||
| Prepaid expenses and other | 946,000 | 516,000 | ||||||
| Total Current Assets | 7,103,000 | 9,401,000 | ||||||
| Property and Equipment: | ||||||||
| Production tooling, machinery and equipment | 1,657,000 | 1,656,000 | ||||||
| Office furniture and fixtures | 191,000 | 258,000 | ||||||
| Computer equipment and software | 578,000 | 697,000 | ||||||
| Leasehold improvements | 327,000 | 283,000 | ||||||
| 2,753,000 | 2,894,000 | |||||||
| Accumulated depreciation and amortization | (2,288,000 | ) | (2,374,000 | ) | ||||
| Total Property and Equipment | 465,000 | 520,000 | ||||||
| Total Assets | $ | 7,568,000 | $ | 9,921,000 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Current Liabilities: | ||||||||
| Line of credit | $ | 243,000 | $ | 228,000 | ||||
| Accounts payable | 1,650,000 | 1,929,000 | ||||||
| Accrued liabilities | ||||||||
| Compensation | 475,000 | 426,000 | ||||||
| Employee stock purchase plan | 72,000 | 104,000 | ||||||
| Legal | 89,000 | 87,000 | ||||||
| Retailer guarantees | 1,277,000 | 1,429,000 | ||||||
| Other | 105,000 | 93,000 | ||||||
| Deferred revenue | 274,000 | 292,000 | ||||||
| Total Current Liabilities | 4,185,000 | 4,588,000 | ||||||
| Shareholders’ Equity: | ||||||||
| Common stock, par value $.01; | ||||||||
| Authorized shares – 20,000,000 | ||||||||
| Issued and outstanding shares – 15,002,000 at September 30, 2005 | ||||||||
| and 14,974,000 at December 31, 2004 | 150,000 | 150,000 | ||||||
| Additional paid-in capital | 29,165,000 | 29,118,000 | ||||||
| Accumulated deficit | (25,932,000 | ) | (23,935,000 | ) | ||||
| Total Shareholders’ Equity | 3,383,000 | 5,333,000 | ||||||
| Total Liabilities and Shareholders’ Equity | $ | 7,568,000 | $ | 9,921,000 | ||||
See accompanying notes to financial statements.
Page 3 of 20
Insignia Systems, Inc.
STATEMENTS OF OPERATIONS
(Unaudited)
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Services revenues | $ | 4,498,000 | $ | 4,524,000 | $ | 13,276,000 | $ | 12,237,000 | ||||||
| Products sold | 787,000 | 813,000 | 2,377,000 | 2,878,000 | ||||||||||
| Total Net Sales | 5,285,000 | 5,337,000 | 15,653,000 | 15,115,000 | ||||||||||
| Cost of services | 2,875,000 | 2,831,000 | 8,561,000 | 8,267,000 | ||||||||||
| Cost of products sold | 430,000 | 408,000 | 1,272,000 | 1,508,000 | ||||||||||
| Total Cost of Sales | 3,305,000 | 3,239,000 | 9,833,000 | 9,775,000 | ||||||||||
| Gross Profit | 1,980,000 | 2,098,000 | 5,820,000 | 5,340,000 | ||||||||||
| Operating Expenses: | ||||||||||||||
| Selling | 1,438,000 | 1,462,000 | 4,316,000 | 4,475,000 | ||||||||||
| Marketing | 246,000 | 288,000 | 911,000 | 828,000 | ||||||||||
| General and administrative | 742,000 | 1,777,000 | 2,601,000 | 4,090,000 | ||||||||||
| Impairment of goodwill | — | — | — | 960,000 | ||||||||||
| Total Operating Expenses | 2,426,000 | 3,527,000 | 7,828,000 | 10,353,000 | ||||||||||
| Operating Loss | (446,000 | ) | (1,429,000 | ) | (2,008,000 | ) | (5,013,000 | ) | ||||||
| Other Income (Expense): | ||||||||||||||
| Interest income | 18,000 | 16,000 | 55,000 | 44,000 | ||||||||||
| Interest expense | (12,000 | ) | — | (36,000 | ) | — | ||||||||
| Other income (expense) | 8,000 | — | (8,000 | ) | (45,000 | ) | ||||||||
| Total Other Income (Expense) | 14,000 | 16,000 | 11,000 | (1,000 | ) | |||||||||
| Net Loss | $ | (432,000 | ) | $ | (1,413,000 | ) | $ | (1,997,000 | ) | $ | (5,014,000 | ) | ||
| Net loss per share: | ||||||||||||||
| Basic and diluted | $ | (0.03 | ) | $ | (0.11 | ) | $ | (0.13 | ) | $ | (0.40 | ) | ||
| Shares used in calculation of net loss per share: | ||||||||||||||
| Basic and diluted | 15,002,000 | 12,476,000 | 15,002,000 | 12,474,000 | ||||||||||
See accompanying notes to financial statements.
Page 4 of 20
Insignia Systems, Inc.
STATEMENTS OF CASH FLOWS
(Unaudited)
| Nine Months Ended September 30 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | |||||||
| Operating Activities: | ||||||||
| Net loss | $ | (1,997,000 | ) | $ | (5,014,000 | ) | ||
| Adjustments to reconcile net loss to net cash | ||||||||
| used in operating activities: | ||||||||
| Depreciation and amortization | 185,000 | 192,000 | ||||||
| Impairment of goodwill | — | 960,000 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (729,000 | ) | 252,000 | |||||
| Inventories | 19,000 | 188,000 | ||||||
| Prepaid expenses and other | (430,000 | ) | 162,000 | |||||
| Accounts payable | (279,000 | ) | 405,000 | |||||
| Accrued liabilities | (121,000 | ) | 1,220,000 | |||||
| Deferred revenue | (18,000 | ) | 56,000 | |||||
| Net cash used in operating activities | (3,370,000 | ) | (1,579,000 | ) | ||||
| Investing Activities: | ||||||||
| Purchases of property and equipment | (130,000 | ) | (75,000 | ) | ||||
| Net cash used in investing activities | (130,000 | ) | (75,000 | ) | ||||
| Financing Activities: | ||||||||
| Net change in line of credit | 15,000 | — | ||||||
| Proceeds from issuance of common stock, net | 47,000 | 126,000 | ||||||
| Net cash provided by financing activities | 62,000 | 126,000 | ||||||
| Decrease in cash and cash equivalents | (3,438,000 | ) | (1,528,000 | ) | ||||
| Cash and cash equivalents at beginning of period | 6,156,000 | 5,225,000 | ||||||
| Cash and cash equivalents at end of period | $ | 2,718,000 | $ | 3,697,000 | ||||
See accompanying notes to financial statements.
Page 5 of 20
Insignia Systems, Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
| 1. | Summary of Significant Accounting Policies. |
| Description of Business. Insignia Systems, Inc. (the “Company”) markets in-store advertising programs, services and products to retailers and consumer packaged goods manufacturers. The Company’s services and products include the Insignia Point-of-Purchase Services (POPS) in-store advertising program, thermal sign card supplies for the Company’s SIGNright and Impulse systems, Stylus software and laser printable cardstock and label supplies. |
| Basis of Presentation. Financial statements for the interim periods included herein are unaudited; however, they contain all adjustments, including normal recurring accruals, which in the opinion of management, are necessary to present fairly the financial position of the Company at September 30, 2005, and its results of operations and cash flows for the three and nine months ended September 30, 2005 and 2004. Results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. |
| The financial statements do not include certain footnote disclosures and financial information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America and, therefore, should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. |
| The Summary of Significant Accounting Policies in the Company’s 2004 Annual Report on Form 10-K describes the Company’s accounting policies. |
| Inventories. Inventories are primarily comprised of parts and supplies for Impulse and SIGNright machines, sign cards, and rollstock. Inventory is valued at the lower of cost or market using the first-in, first-out (FIFO) method, and consists of the following: |
| September 30, 2005 | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Raw materials | $ | 158,000 | $ | 196,000 | ||||
| Work-in-process | 20,000 | 6,000 | ||||||
| Finished goods | 298,000 | 293,000 | ||||||
| $ | 476,000 | $ | 495,000 | |||||
| Stock-Based Compensation. The Company has stock-based employee compensation plans, which are described more fully in the notes included in the Company’s 2004 Annual Report on Form 10-K. The Company applies Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its plans. Under this method, compensation expense is recognized for the amount by which the market price of the common stock on the date of grant exceeds the exercise price of an option. No compensation costs related to stock option grants have been recognized in the Statements of Operations. The following table illustrates the effect on the Company’s net loss if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement 123, Accounting for Stock-Based Compensation, to its stock-based employee plans. |
Page 6 of 20
| Nine Months Ended September 30 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | |||||||
| Net loss, as reported | $ | (1,997,000 | ) | $ | (5,014,000 | ) | ||
| Deduct: Total stock-based employee compensation | ||||||||
| expense determined under fair value based | ||||||||
| methods for all awards, net of tax | 424,000 | 882,000 | ||||||
| Pro forma net loss | $ | (2,421,000 | ) | $ | (5,896,000 | ) | ||
| Basic and diluted net loss per share: | ||||||||
| As reported | $ | (0.13 | ) | $ | (0.40 | ) | ||
| Pro forma | $ | (0.16 | ) | $ | (0.47 | ) | ||
| Net Income (Loss) Per Share. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average shares outstanding and excludes any dilutive effects of options, warrants and convertible securities. Diluted net income per share gives effect to all diluted potential common shares outstanding during the period. Options and warrants to purchase approximately 2,219,000 and 2,122,000 shares of common stock with weighted average exercise prices of $4.07 and $4.76 were outstanding at September 30, 2005 and 2004 and were not included in the computation of common stock equivalents for the three months ended September 30, 2005 and 2004 because their exercise prices were higher than the average fair market value of the common shares during the reporting period. Options and warrants to purchase approximately 1,747,000 and 1,698,000 shares of common stock with weighted average exercise prices of $4.92 and $5.67 were outstanding at September 30, 2005 and 2004 and were not included in the computation of common stock equivalents for the nine months ended September 30, 2005 and 2004 because their exercise prices were higher than the average fair market value of the common shares during the reporting period. For the three months and nine months ended September 30, 2005 and 2004, the effect of options and warrants was anti-dilutive due to the net losses incurred during the periods. Had net income been achieved, approximately zero, 3,000, 192,000 and 46,000 of common stock equivalents would have been included in the computation of diluted net income per share. |
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Denominator for basic net income (loss) | ||||||||||||||
| per share – weighted averages shares | 15,002,000 | 12,476,000 | 15,002,000 | 12,474,000 | ||||||||||
| Effect of dilutive securities: | ||||||||||||||
| Stock options and warrants | — | — | — | — | ||||||||||
| Denominator for diluted net income (loss) | ||||||||||||||
| per share – adjusted weighted average shares | 15,002,000 | 12,476,000 | 15,002,000 | 12,474,000 | ||||||||||
| 2. | Acquisition. In December 2002, the Company acquired all of the assets comprising the VALUStix business from Paul A. Richards, Inc., a New York company (“PAR”), for $3,000,000 in cash, plus a five-year royalty based on annual net sales over a threshold amount, pursuant to an Asset Purchase Agreement between the Company and PAR. |
| The Company was not successful in integrating the VALUStix business into the POPS program during 2003 and 2004 based on a number of factors and therefore made a decision to de-emphasize that business. Utilizing discounted cash flows to determine the fair value of the VALUStix business, the Company determined that the carrying amount of goodwill exceeded the fair value of the business. As a result, the Company wrote off goodwill associated with the acquisition of $2,133,000 in the fourth quarter of 2003 and $960,000 in the second quarter of 2004. The primary factor leading to the impairment was the continued inability of the VALUStix acquisition to generate positive cash flow from operations. As of June 30, 2004, there was no goodwill remaining associated with the VALUStix acquisition. |
Page 7 of 20
| In September 2005, the Company brought a suit against PAR and Paul Richards in Federal District Court in Minneapolis, Minnesota alleging fraud and misrepresentation related to the acquisition. The suit asks that the acquisition be rescinded and all parties restored to their pre-acquisition status. In conjunction with this suit, the Company ceased payments to Paul Richards under the employment agreement entered into at the time of the acquisition (see additional discussion under note 4). |
| 3. | Line of Credit. On September 16, 2004, the Company entered into a Financing Agreement, Security Agreement and Revolving Note (collectively, “the Credit Agreement”) with Itasca Business Credit, Inc. that initially provided for borrowings up to $1,500,000 for twelve months, subject to collateral availability. The borrowings are secured by all of the Company’s assets. The Credit Agreement provides that borrowings will bear interest at 2.5% over prime, with a minimum monthly interest charge of $2,500, and an annual fee of 1% of the Revolving Note payable. The Credit Agreement includes various other customary terms and conditions. On November 22, 2004 the Company entered into an amendment to the Credit Agreement to extend the term to April 30, 2006. Borrowings of $243,000 were outstanding with an effective rate of 9.25% as of September 30, 2005. |
| 4. | Commitments and Contingencies. |
| Legal. In August 2000, News America Marketing In-Store, Inc. (News America), brought suit against the Company in U.S. District Court in New York, New York. The case was settled in November 2002. The terms of the settlement agreement are confidential. The settlement did not impact the Company’s operating results. |
| In October 2003, News America brought suit against the Company in U.S. District Court in New York, New York. In this action, News America has alleged that the Company has engaged in deceptive acts and practices, has interfered with existing business relationships with retailers and prospective economic advantage, and has engaged in unfair competition. The suit seeks unspecified damages and injunctive relief. The Company filed a Motion to Dismiss in February 2004. In June 2004 News America amended the suit against the Company and the Company filed an amended Motion to Dismiss in August 2004. The Company is awaiting decision by the Court. Discovery has been stayed in this action. Management believes the allegations are without merit and that the Company will prevail. |
| On September 23, 2004, the Company brought suit against News Corporation, LTD (News Corp.), News America, and Albertson’s Inc. in Federal District Court in Minneapolis, Minnesota, for violations of federal and state antitrust and false advertising laws. In this action, the Company has alleged that News Corp., through its wholly owned subsidiary, News America, has acquired and maintained monopoly power through various wrongful acts designed to harm the Company in the in-store advertising and promotion products and services market. The suit seeks injunctive relief sufficient to prevent further antitrust injury and an award of treble damages to be determined at trial for the harm caused to the Company. In August 2005 the Court dismissed the suit, but permitted the Company to file an Amended Complaint with more specific information regarding the illegal actions taken by the defendants. The Company filed the Amended Complaint on September 23, 2005 and is awaiting a hearing scheduled for January 24, 2006. |
| Management currently expects the amount of legal fees that will be incurred in connection with the ongoing lawsuits to be significant throughout 2005. Also, if the Company is required to pay a significant amount in settlement or damages, it will have a material adverse effect on its operations and financial condition. In addition, a negative outcome of this litigation could affect long-term competitive aspects of the Company’s business. During the nine months ended September 30, 2005, the Company incurred legal fees of $814,000 related to the News America litigation. |
Page 8 of 20
| In September 2005, the Company brought a suit against Paul A. Richards, Inc. and Paul Richards in Federal District Court in Minneapolis, Minnesota alleging fraud and misrepresentation related to the VALUStix acquisition. The suit asks that the acquisition be rescinded and all parties restored to their pre-acquisition status. In conjunction with this suit, the Company ceased payments to Paul Richards under the employment agreement entered into at the time of the acquisition. Paul Richards has counterclaimed alleging entitlement to approximately $350,000 of salary over the contract’s remaining term. The Company and its attorney believe that the Company will prevail in its action to have the employment agreement rescinded and no additional amounts will be due under the contract. Therefore it has recorded no liability at September 30, 2005 related to this matter. |
| The Company is subject to various legal proceedings in the normal course of business. Management believes the outcome of these proceedings will not have a material adverse effect on the Company’s financial position or results of operations. |
| Retailer Agreements. The Company has contracts in the normal course of business with various retailers, some of which provide for minimum annual program levels. If those minimum levels are not met, the Company is obligated to pay the contractual difference to the retailers. The Company calculates these estimated minimum payments based on actual activity to date. Due to the annual nature of these contracts, increased activity with these retailers in subsequent fiscal quarters could decrease the estimated payment amounts recorded in the current period. During the nine months ended September 30, 2005 and 2004 the Company incurred approximately $1,743,000 and $2,099,000 of costs related to these minimums. The amounts were recorded in Cost of Services in the Statements of Operations. |
| 5. | Concentrations. During the nine months ended September 30, 2005 two customers accounted for 16.5% and 14.1% of the Company’s total net sales. At September 30, 2005 these customers represented 36.5% of the Company’s total accounts receivable. During the nine months ended September 30, 2004 these customers accounted for 11.7% and 16.2% of the Company’s total net sales. |
| Although there are a number of customers that the Company sells to, the loss of a major customer could adversely affect operating results. |
| 6. | New Accounting Guidance. In December 2004, the Financial Accounting Standards Board (FASB) issued its standard on accounting for share-based payments, SFAS No. 123 (revised 2004), Share-Based Payment requiring companies to recognize compensation cost relating to share-based payment transactions in the financial statements. SFAS No. 123(R) requires the measurement of compensation cost to be based on the fair value of the equity or liability instruments issued. Upon issuance, SFAS No. 123(R) required public companies to apply SFAS No. 123(R) in the first interim or annual reporting period beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) approved a new rule that delays the effective date, requiring public companies to apply SFAS 123(R) in the first annual period beginning after June 15, 2005. Except for the deferral of the effective date, the guidance in SFAS 123(R) is unchanged. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123(R) replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees. The Company is currently assessing the impact of SFAS No. 123(R) and considering the valuation models available. The Company expects to adopt SFAS No. 123(R) effective January 1, 2006. |
Page 9 of 20
| 7. | Subsequent Event. As of November 7, 2005, POPS program bookings of $3,036,000 for the fourth quarter of 2005 were significantly below actual fourth quarter 2004 POPS revenue of $5,104,000. Prospects for additional bookings for the fourth quarter of 2005 are limited. Additionally, POPS program bookings in August and September of 2005 for the 2006 year were significantly behind prior year levels. The Company believes that the cumulative effect of the News America litigation and the conduct of News America in the marketplace are responsible for this negative impact on POPS program bookings. Therefore, the Company believes that based upon current business conditions, its existing cash balance and borrowing capacity, along with amounts generated from operations, will only be sufficient to meet the Company’s cash requirements for the next six months. The Company continues to evaluate the potential for private equity placements of its common stock, new borrowings, or other alternatives to improve its liquidity and has retained Manchester Companies, Inc. to assist with an evaluation of the business and the development of viable options for moving forward. |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Insignia Systems, Inc. markets in-store advertising programs, services and products to retailers and consumer packaged goods manufacturers. The Company’s services and products include the Insignia Point-of-Purchase Services (POPS) in-store advertising program, thermal sign card supplies for the Company’s SIGNright and Impulse systems, Stylus software and laser printable cardstock and label supplies.
Results of Operations
The following table sets forth, for the periods indicated, certain items in the Company’s Statements of Operations as a percentage of total net sales.
| Three Months Ended September 30 | Nine Months Ended September 30 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
| Cost of sales | 62.5 | 60.7 | 62.8 | 64.7 | ||||||||||
| Gross profit | 37.5 | 39.3 | 37.2 | 35.3 | ||||||||||
| Operating expenses: | ||||||||||||||
| Selling | 27.2 | 27.4 | 27.6 | 29.6 | ||||||||||
| Marketing | 4.7 | 5.4 | 5.8 | 5.4 | ||||||||||
| General and administrative | 14.0 | 33.3 | 16.6 | 27.1 | ||||||||||
| Impairment of goodwill | — | — | — | 6.4 | ||||||||||
| Total operating expenses | 45.9 | 66.1 | 50.0 | 68.5 | ||||||||||
| Operating loss | (8.4 | ) | (26.8 | ) | (12.8 | ) | (33.2 | ) | ||||||
| Other income (expense) | 0.2 | 0.3 | 0.0 | — | ||||||||||
| Net loss | (8.2 | )% | (26.5 | )% | (12.8 | )% | (33.2 | )% | ||||||
Net sales in the third quarter of 2005 were comparable to the third quarter of 2004.
The Company experienced a significant loss during the third quarter of 2005 due to the following reasons:
- The number of POPSign programs during the quarter was significantly below levels required under retailer minimum commitment agreements; and
- Legal fees related to the ongoing litigation.
Page 10 of 20
The net loss during the third quarter of 2005 was significantly below the net loss during the third quarter of 2004 primarily due to decreased legal fees. Legal fees in the third quarter of 2004 reflect the discovery process in the New York litigation.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are described in Note 1 to the annual financial statements as of and for the year ended December 31, 2004, included in our Form 10-K filed with the Securities and Exchange Commission on March 30, 2005. We believe our most critical accounting policies and estimates include the following:
- revenue recognition;
- allowance for doubtful accounts;
- inventory valuation;
- accounting for deferred income taxes;
- valuation of long-lived and intangible assets;
- accounting for accrued retailer guarantees; and
- stock-based compensation.
Three and Nine Months ended September 30, 2005 Compared to Three and Nine Months Ended September 30, 2004
Net Sales. Net sales for the three months ended September 30, 2005 decreased 1.0% to $5,285,000 compared to $5,337,000 for the three months ended September 30, 2004. Net sales for the nine months ended September 30, 2005 increased 3.6% to $15,653,000 compared to $15,115,000 for the nine months ended September 30, 2004.
Service revenues from our POPS programs for the three months ended September 30, 2005 decreased 0.6% to $4,498,000 compared to $4,524,000 for the three months ended September 30, 2004. Service revenues from our POPS programs for the nine months ended September 30, 2005 increased 8.5% to $13,276,000 compared to $12,237,000 for the nine months ended September 30, 2004. The increase for the nine month period was primarily due to an increase in the number of POPSign programs sold to customers (consumer packaged goods manufacturers) during the period.
Product sales for the three months ended September 30, 2005 decreased 3.2% to $787,000 compared to $813,000 for the three months ended September 30, 2004. Product sales for the nine months ended September 30, 2005 decreased 17.4% to $2,377,000 compared to $2,878,000 for the nine months ended September 30, 2004. The decreases were due to the loss of a miscellaneous printing customer in 2005, a one-time printing order in 2004 and general decreasing demand for our products from our customers.
Gross Profit. Gross profit for the three months ended September 30, 2005 decreased 5.6% to $1,980,000 compared to $2,098,000 for the three months ended September 30, 2004. Gross profit for the nine months ended September 30, 2005 increased 9.0% to $5,820,000 compared to $5,340,000 for the nine months ended September 30, 2004. Gross profit as a percentage of total net sales decreased to 37.5% for the three months ended September 30, 2005, compared to 39.3% for the three months ended September 30, 2004. Gross profit as a percentage of total net sales increased to 37.2% for the nine months ended September 30, 2005, compared to 35.3% for the nine months ended September 30, 2004.
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Gross profit from our POPS program revenues for the three months ended September 30, 2005 decreased 4.1% to $1,623,000 compared to $1,693,000 for the three months ended September 30, 2004. The decrease in the gross profit for the three months was primarily due to decreased revenues in 2005, the effect of fixed costs and lower guarantee expense in 2005. Gross profit from our POPS program revenues for the nine months ended September 30, 2005 increased 18.8% to $4,715,000 compared to $3,970,000 for the nine months ended September 30, 2004. The increase in the gross profit for the nine months was primarily due to the effect of fixed costs and significantly higher POPSign program revenues. Gross profit as a percentage of POPS program revenues for the three months ended September 30, 2005 decreased to 36.1% compared to 37.4% for the three months ended September 30, 2004. Gross profit as a percentage of POPS program revenues for the nine months ended September 30, 2005 increased to 35.5%, compared to 32.4% for the nine months ended September 30, 2004. The increases for both the quarter and nine months were primarily due to the effect of fixed costs on higher POPSign program revenues and lower guarantee expense in 2005 due to changes in the terms of retailer minimum commitment agreements.
Gross profit from our product sales for the three months ended September 30, 2005 decreased 11.9% to $357,000 compared to $405,000 for the three months ended September 30, 2004. Gross profit from our product sales for the nine months ended September 30, 2005 decreased 19.3% to $1,105,000 compared to $1,370,000 for the nine months ended September 30, 2004. The decreases in gross profit were primarily due to decreased sales and changes in sales mix. Gross profit as a percentage of product sales was 45.4% for the three months ended September 30, 2005 compared to 49.8% for the three months ended September 30, 2004. Gross profit as a percentage of product sales was 46.5% for the nine months ended September 30, 2005 compared to 47.6% for the nine months ended September 30, 2004.
Operating Expenses
Selling. Selling expenses for the three months ended September 30, 2005 decreased 1.6% to $1,438,000 compared to $1,462,000 for the three months ended September 30, 2004, primarily due to reduced compliance audit costs. Selling expenses for the nine months ended September 30, 2005 decreased 3.6% to $4,316,000 compared to $4,475,000 for the nine months ended September 30, 2004, primarily due to reduced compliance audit costs and a decrease in the number of sales related employees, partially offset by increased sales commissions and increased travel related expense.
Selling expenses as a percentage of total net sales decreased to 27.2% for the three months ended September 30, 2005 compared to 27.4% for the three months ended September 30, 2004, due to the factors discussed above. Selling expenses as a percentage of total net sales decreased to 27.6% for the nine months ended September 30, 2005 compared to 29.6% for the nine months ended September 30, 2004, due to the factors discussed above, plus the effect of higher net sales during the nine months of 2005.
Marketing. Marketing expenses for the three months ended September 30, 2005 decreased 14.6% to $246,000 compared to $288,000 for the three months ended September 30, 2004 primarily due to decreased labor costs. Marketing expenses for the nine months ended September 30, 2005 increased 10.0% to $911,000 compared to $828,000 for the nine months ended September 30, 2004 primarily due to increased data acquisition and advertising costs which were partially offset by decreased labor costs.
Marketing expenses as a percentage of total net sales decreased to 4.7% for the three months ended September 30, 2005 compared to 5.4% for the three months ended September 30, 2004 due to the reasons discussed above on comparable period-to-period sales. Marketing expenses as a percentage of total net sales increased to 5.8% for the nine months ended September 30, 2005 compared to 5.5% for the nine months ended September 30, 2004.
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General and administrative. General and administrative expenses for the three months ended September 30, 2005 decreased 58.2% to $742,000 compared to $1,777,000 for the three months ended September 30, 2004. General and administrative expenses for the nine months ended September 30, 2005 decreased 36.4% to $2,601,000 compared to $4,090,000 for the nine months ended September 30, 2004. Decreases in both periods were primarily due to lower legal fees and decreased labor costs.
General and administrative expenses as a percentage of total net sales decreased to 14.0% for the three months ended September 30, 2005 compared to 33.3% for the three months ended September 30, 2004. General and administrative expenses as a percentage of total net sales decreased to 16.6% for the nine months ended September 30, 2005 compared to 27.1% for the nine months ended September 30, 2004. Decreases in both periods were primarily due to the decreased legal fees and labor costs. The decrease in the percentage of total net sales in the nine-month periods was also impacted by the effect of higher net sales during 2005.
Legal fees for the three months ended September 30, 2005 were $235,000 compared to $1,165,000 for the three months ended September 30, 2004. Legal fees for the nine months ended September 30, 2005 were $995,000 compared to $2,308,000 for the nine months ended September 30, 2004. The legal fees in each period were incurred primarily in connection with two News America lawsuits. The first suit was initiated against the Company in October 2003 and has not yet been settled nor dismissed. The second one was originally initiated by the Company in September 2004 and was dismissed in August 2005, but was amended and re-filed in September 2005 as permitted by the Court.. The amended suit is awaiting a hearing scheduled for January 2006. Legal fees for the periods in 2005 were less than for the periods in 2004 primarily as a result of discovery being stayed in the suit against the Company pending a ruling on its motion to dismiss, which was partially offset by legal fees in 2005 related to the suit filed by the Company against News America. We currently expect the amount of additional legal fees that will be incurred in connection with the ongoing lawsuits to be significant throughout the remainder of 2005. Also, if the Company is required to pay a significant amount in settlement or damages, it will have a material adverse effect on its operations and financial condition. In addition, a negative outcome of this litigation could affect long-term competitive aspects of the Company’s business.
Impairment of goodwill. The company recorded an impairment charge of $960,000 during the second quarter of fiscal 2004, writing off the remaining goodwill related to the 2002 acquisition of VALUStix (see note 2 of the Notes To Financial Statements).
Other Income (Expense). Other income for the three months ended September 30, 2005 was $14,000 compared to $16,000 for the three months ended September 30, 2004. Other income (expense) for the nine months ended September 30, 2005 was $11,000 compared to $(1,000) for the nine months ended September 30, 2004. The differences were due primarily to interest expense on advances from the line of credit put in place in September 2004, partially offset by increased interest income, and a one-time fee of $45,000 in 2004 to move to the Nasdaq Capital Market.
Net Loss. Our net loss for the three months ended September 30, 2005 was $(432,000) compared to $(1,413,000) for the three months ended September 30, 2004. Our net loss for the nine months ended September 30, 2005 was $(1,997,000) compared to $(5,014,000) for the nine months ended September 30, 2004.
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Liquidity and Capital Resources
The Company has financed its operations with proceeds from public and private equity placements and sales of its services and products. At September 30, 2005, working capital was $2,918,000 compared to $4,813,000 at December 31, 2004. During the nine months ended September 30, 2005, cash and cash equivalents decreased $3,438,000.
Net cash used in operating activities during the nine months ended September 30, 2005 was $3,370,000. The net cash used resulted primarily from the $(1,997,000) net loss for the period and the payment of retailer guaranteed payments which were accrued at December 31, 2004. Accounts receivable increased $729,000 during the nine months ended September 30, 2005 primarily due to higher sales in September 2005 compared to December 2004. Prepaid expenses increased $430,000 during the nine months ended September 30, 2005 due primarily to certain retailer payments made in advance. Accrued liabilities decreased $121,000 during the nine months ended September 30, 2005 due to the payment of retailer guarantees which were accrued at December 31, 2004, partially offset by accruals for 2005 which are not payable until after the end of 2005. The Company expects accounts receivable and accounts payable to fluctuate during 2005 depending on the level of quarterly POPS revenues.
Net cash of $130,000 was used in investing activities during the nine months ended September 30, 2005 due to the purchase of property and equipment. No major capital expenditures are expected in 2005.
Net cash of $62,000 was provided by financing activities during the nine months ended September 30, 2005. $47,000 of the cash provided was from the issuance of common stock, net of expenses, related to the employee stock purchase plan. Net borrowings of $15,000 on the line of credit provided the remaining cash.
As of November 7, 2005, POPS program bookings of $3,036,000 for the fourth quarter of 2005 were significantly below actual fourth quarter 2004 POPS revenue of $5,104,000. Prospects for additional bookings for the fourth quarter of 2005 are limited. Additionally, POPS program bookings in August and September of 2005 for the 2006 year were significantly behind prior year levels. The Company believes that the cumulative effect of the News America litigation and the conduct of News America in the marketplace are responsible for this negative impact on POPS program bookings. Additionally, significant increases in legal fees or the inability to renew significant retailer contracts when their terms expire could negatively affect the Company’s financial position. Therefore, the Company believes that based upon current business conditions, its existing cash balance and borrowing capacity, along with amounts generated from operations, will only be sufficient to meet the Company’s cash requirements for the next six months. The Company continues to evaluate the potential for private equity placements of its common stock, new borrowings, or other alternatives to improve its liquidity and has retained Manchester Companies, Inc. to assist with an evaluation of the business and the development of viable options for moving forward.
Cautionary Statement Regarding Forward Looking Information
Statements made in this quarterly report on Form 10-Q, in the Company’s other SEC filings, in press releases and in oral statements to shareholders and securities analysts, which are not statements of historical or current facts, are “forward looking statements.” Such forward looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results or performance of the Company to be materially different from the results or performance expressed or implied by such forward looking statements. The words “believes,” “expects,” “anticipates,” “seeks” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward looking statements, which speak only as of the date the statement was made. These statements are subject to the risks and uncertainties that could cause actual results to differ materially and adversely from the forward looking statements. These risks and uncertainties include, but are not limited to: we will need additional external financing in the next six months which may not be available on acceptable terms; we have had significant losses in recent periods; we are involved in major litigation with a significant competitor resulting in significant legal fees; we are dependent on our contracts with retailers and our ability to renew those contracts when their terms expire; our results of operations may be subject to significant fluctuations; we face intense competition from other providers of at-shelf advertising signage; reductions in advertising expenditures by branded product manufacturers due to changes in economic or other conditions would adversely affect us; we are dependent on the success of the Insignia POPSign program; we are dependent on manufacturer partners achieving sales increases attributable to POPSigns; we are dependent on members of our management team; we have a significant amount of options and warrants outstanding that could affect the market price of our common stock; and the market price of our common stock has been volatile.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the evaluation date are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic filings under the Exchange Act.
(b) Changes in Internal Controls Over Financial Reporting
There was no change in our internal controls over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In August 2000, News America Marketing In-Store, Inc. (News America), brought suit against the Company in U.S. District Court in New York, New York. The case was settled in November 2002. The terms of the settlement agreement are confidential. The settlement did not impact the Company’s operating results.
In October 2003, News America brought suit against the Company in U.S. District Court in New York, New York. In this action, News America has alleged that the Company has engaged in deceptive acts and practices, has interfered with existing business relationships with certain retailers and prospective economic advantage, and has engaged in unfair competition. The suit seeks unspecified damages and injunctive relief. The Company filed a Motion to Dismiss in February 2004. In September 2004 News America amended the suit against the Company and the Company filed an amended Motion to Dismiss in August 2004. The Company is awaiting decision by the Court. Discovery has been stayed in this action. Management believes the allegations are without merit and that the Company will prevail.
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On September 23, 2004, the Company brought suit against News Corporation, LTD (News Corp.), News America, and Albertson’s Inc. in Federal District Court in Minneapolis, Minnesota, for violations of federal and state antitrust and false advertising laws. In this action, the Company has alleged that News Corp., through its wholly owned subsidiary, News America, has acquired and maintained monopoly power through various wrongful acts designed to harm the Company in the in-store advertising and promotion products and services market. The suit seeks injunctive relief sufficient to prevent further antitrust injury and an award of treble damages to be determined at trial for the harm caused to the Company. In August 2005 the Court dismissed the suit, but permitted the Company to file an Amended Complaint with more specific information regarding the illegal actions taken by the defendants. The Company filed the Amended Complaint on September 23, 2005 and is awaiting a hearing scheduled for January 24, 2006.
In September 2005, the Company brought a suit against Paul A. Richards, Inc. and Paul Richards in Federal District Court in Minneapolis, Minnesota alleging fraud and misrepresentation related to the VALUStix acquisition. The suit asks that the acquisition be rescinded and all parties restored to their pre-acquisition status. In conjunction with this suit, the Company ceased payments to Paul Richards under the employment agreement entered into at the time of the acquisition. Paul Richards has counterclaimed alleging entitlement to approximately $350,000 of salary over the contract’s remaining term. The Company and its attorney believe that the Company will prevail in its action to have the employment agreement rescinded and no additional amounts will be due under the contract.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
The following exhibits are included herein:
| 31.1 Certification of Principal Executive Officer
31.2 Certification of Principal Financial Officer 32 Section 1350 Certification |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Dated: November 14, 2005 | Insignia Systems, Inc. (Registrant) |
| /s/ Scott F. Drill | |
| Scott F. Drill President and Chief Executive Officer (principal executive officer) | |
| /s/ Justin W. Shireman | |
| Justin W. Shireman Vice President, Finance and Chief Financial Officer (principal financial officer) |
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