| UNITED STATES |
| SECURITIES AND EXCHANGE COMMISSION |
| Washington, D.C. 20549 |
| FORM 10-K |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the year ended December 31, 2003 | 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 | (IRS Employer Identification No.) | ||
| incorporation or organization) |
| 6470 Sycamore Court North Maple Grove, MN 55369 |
| (Address of principal executive offices) |
Registrant’s telephone number, including area code: (763) 392-6200 |
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None |
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.01 par value |
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 report(s), and
(2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment of this Form 10-K.
Yes [ ] No [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2) of the Act. Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of the last business day of the second quarter (June 30, 2003) was approximately $55,025,000 based upon the last sale price of the registrant’s Common Stock on such date.
Number of shares outstanding of Common Stock, $.01 par value, as of March 25, 2004, was 12,475,625.
DOCUMENTS INCORPORATED BY REFERENCE:
Insignia Systems, Inc. Proxy Statement to be filed for the Annual Meeting of Shareholders
to be held on May 20, 2004 (Part III – Items 10, 11, 12, 13 and 14)
| PART I. | |||||
Item 1. | Business | 1 | |||
Item 2. | Properties | 5 | |||
Item 3. | Legal Proceedings | 6 | |||
Item 4. | Submission of Matters to a Vote of Security Holders | 6 | |||
Item 4A. | Executive Officers of the Registrant | 6 | |||
PART II. | |||||
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and | ||||
| Issuer Purchases of Equity Securities | 7 | ||||
Item 6. | Selected Financial Data | 8 | |||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operation | 8 | |||
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | 14 | |||
Item 8. | Financial Statements and Supplementary Data | 15 | |||
Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | 32 | |||
Item 9A. | Controls and Procedures | 33 | |||
PART III. | |||||
Item 10. | Directors and Executive Officers of the Registrant | 33 | |||
Item 11. | Executive Compensation | 33 | |||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and | ||||
| Related Stockholder Matters | 33 | ||||
Item 13. | Certain Relationships and Related Transactions | 34 | |||
Item 14. | Principal Accounting Fees and Services | 34 | |||
Item 15. | Exhibits, Financial Statement Schedules, and Reports on Form 8-K | 34 |
Item 1. Business
Insignia Systems, Inc., (the “Company”) markets in-store advertising products, programs and services to retailers and consumer packaged goods manufacturers. The Company has been in business since 1990. Since 1998, the Company has been focusing on providing in-store services through the Insignia Point-Of-Purchase Services (POPS) in-store advertising program. Insignia POPS® includes both the Insignia POPSign™ and VALUStix® programs.
Insignia’s POPSign is a national, account-specific, in-store, shelf-edge advertising program that delivers significant sales increases. Funded by consumer packaged goods manufacturers, the program allows manufacturers to deliver vital product information to consumers at the point-of-purchase. The brand information is combined with each retailer’s store-specific prices and is displayed on the retailer’s unique sign format. The combining of manufacturer and retailer information produces a complete “call to action” that gets consumers the information they want and need to make purchasing decisions, while building store and brand equity.
For retailers, Insignia’s POPSign program is a source of incremental revenue and is the first in-store advertising program that delivers a complete “call to action” on a product- and store-specific basis, with all participating retail stores updated weekly. For consumer goods manufacturers, Insignia’s POPSign program provides access to the optimum retail advertising site for their products – the retail shelf-edge. In addition, manufacturers benefit from significant sales increases, short lead times, micro-marketing capabilities, such as store-specific and multiple language options, and a wide variety of program features and enhancements that provide unique advertising advantages.
Acquired in December 2002, the VALUStix program allows retailers and manufacturers to deliver coupons and other information to consumers at the point-of-purchase. The account-specific booklets are attached to host products that have high household-penetration and include multiple product coupons that tie into key seasonal or themed events. The Company believes the VALUStix program complements the POPSign program by delivering immediately actionable offers and information that help make a difference in shoppers’ purchasing decisions.
The Company’s Internet address is www.insigniasystems.com. The Company has made available on its Web site, all of the reports it files with the SEC. Copies can also be obtained free of charge by requesting them from Insignia Systems, Inc., 6470 Sycamore Court North, Maple Grove, Minnesota 55369-6032; Attention: CFO; telephone 763-392-6200.
According to Point-Of-Purchase Advertising International (POPAI), an industry non-profit trade association, more than 70% of brand purchase decisions are being made in-store. As a result, product manufacturers are constantly seeking in-store vehicles to motivate consumers to buy their branded products. Industry studies estimate that manufacturers spend approximately $867 million annually on in-store services. The Company’s market studies indicate that the shelf-edge sign represents the final and best opportunity for manufacturers to convince the consumer to buy. In fact, a 1996 industry study concluded the shelf is second only to end-aisle displays for in-store effectiveness.
Page 1
Many consumers seek product information beyond price in order to make educated buying decisions. The Company’s marketing studies indicate the most effective sign contains information supplied by the product manufacturer in combination with the retailer’s price and design look.
Insignia’s POPSign Program
Insignia’s POPSign
program is an in-store, shelf-edge point-of-purchase advertising program that
enables manufacturers to deliver product-specific messages quickly and
accurately – in designs and formats that have been pre-approved and
supported by participating retailers. Insignia POPSigns deliver vital product
selling information from manufacturers, such as product uses and features,
nutritional information, advertising tag lines and product images. The brand
information is combined with the retailer’s store-specific prices and is
displayed on the retailer’s unique sign format that includes their logo,
headline and store colors. Each sign is displayed directly in front of the
manufacturer’s product in the participating retailer’s stores.
Insignia’s POPSign program offers special features and enhancements, such
as Advantage and Custom Advantage flags that allow manufacturers to add
visibility and highlight any message at-shelf. Insignia offers Color POPSigns
with customizable, image-building full-color graphics. Insignia UltraColor™
POPSigns offer 75 percent more area for the full-color creative than Color
POPSigns.
Utilizing proprietary technology, the Company collects and organizes the data from both manufacturers and retailers, then formats, prints and delivers the signs to retailers for distribution and display. Store personnel place the signs at the shelf for two-week or four-week display cycles. The Company charges manufacturers for the signs placed, per cycle, and generally per store. Retailers are paid a flat fee per sign, per display cycle, by the Company based upon compliance and retailer-supplied product movement data provided to Insignia.
VALUStix Program
The VALUStix business
includes a proprietary system that allows retailers and manufacturers to deliver
coupons and other information to consumers at the point-of-purchase. The
pressure sensitive booklets are attached to a single host product at the
point-of-production via customized equipment. The account-specific booklets
include multiple product coupons that tie into key seasonal or themed events and
can be adhered to all categories of products, including frozen foods,
refrigerated foods, dairy products and packaged produce.
The VALUStix business was acquired in December 2002 and is in the process of being integrated into the Company’s POPS program. The Company recorded no revenue from the sale of VALUStix products during 2003.
The Impulse Retail System and SIGNright Sign System
Prior to 1996, the
Company’s primary product offering was the Impulse Retail System, a system
developed by an independent product design and development firm (the
“Developer”). In 1996, the Company replaced the Impulse Retail System
with the SIGNright Sign System. In 1998, the Company ceased the active domestic
sales of the SIGNright Sign System.
Cardstock for the two systems are sold by the Company in a variety of sizes and colors that can be customized to include pre-printed custom artwork, such as a retailer’s logo. Approximately 7% of 2003 revenues came from the sale of cardstock. The Company expects this percentage to be lower in the future.
Stylus Software
In late 1993, the Company
introduced Stylus, a PC-based software application used by retailers to produce
signs, labels, and posters. The Stylus software allows retailers to create
signs, labels and posters by manually entering the information or by importing
information from a database. Approximately 2% of 2003
Page 2
revenues came from the sale of Stylus products and maintenance. The Company expects this percentage to be lower in the future.
The Company directly markets the Insignia POPSign program to food and drug manufacturers and retailers. By utilizing the Insignia POPSign program, these manufacturers and retailers can easily accomplish what had previously been either impossible or extremely difficult: tailoring national in-store advertising programs to regional and local needs with minimal effort. In addition to the benefits provided to manufacturers and retailers, Insignia’s POPSign program provides consumers more information and clearer messages to aid in purchasing decisions. The Company believes its POPSign program is the most complete in-store advertising sign program available, benefiting consumer, retailer, and manufacturer.
Prior to April 1998, the Company marketed the Impulse Retail System and the SIGNright Sign System through telemarketing by in-house sales personnel and independent sales representatives. In May 1998, the Company discontinued the active marketing of the systems to U.S. customers, but continues to sell the systems through the Company’s international distributors covering 10 countries. The Company sells cardstock and supplies related to these systems to many U.S. and international customers.
The Company markets its Stylus software in the United States and internationally primarily through resellers that integrate Stylus as an Open Database Connectivity design and publishing component into their retail data and information management software applications.
During 2003, 2002 and 2001, foreign sales accounted for approximately 1%, 2% and 4% of total net sales. The Company expects sales to foreign distributors will be less than 1% of total net sales in 2004.
Insignia’s POPSign Program
The Insignia POPSign program
is competing for the marketing expenditures of branded product manufacturers for
at-shelf advertising-related signage. The Insignia POPSign program has two major
competitors in its market: News America Marketing In-Store®, Inc.
(News America) and FLOORgraphics®, Inc. (FLOORgraphics).
News America offers a network for in-store advertising, promotion and sales merchandising services. News America has branded their in-store shelf signage products as SmartSource Shelftalk™, SmartSource Shelfvision™ and SmartSource Price Pop™.
FLOORgraphics offers a network for in-store advertising and promotion programs. FLOORgraphics has branded their advertising shelf signage product SHELFplus! ®.
The main strengths of the Insignia POPSign program in relation to its competitors are:
– the
linking of manufacturers to retailers at a central coordination point
– providing a complete “call to action”
– supplying product-specific and store-specific messages at the retail shelf
– short lead times – significant sales increases
Page 3
The Company has developed and is using a number of trademarks, service marks, slogans, logos and other commercial symbols to advertise and sell its products. The Company owns U.S. registered trademarks for Insignia Systems, Inc.® (and Design), Insignia POPS®, POPS Select®, Insignia Color POPS®, VALUStix®, Stylus®, Stylus Work Center ®, SIGNright®, Impulse®, DuraSign®, I-Care® and Check This Out.®
The Company is in the process of obtaining trademark registration in the United States for the trademarks “Insignia E-POPS,” “POPSign,” “UltraColor,” “POPSRx,” “Moment of Truth” and “POPS Ads.”
The barcode which the Company uses on the sign cards for the Impulse and SIGNright Sign Systems was also developed by the Developer, which has granted the Company an exclusive worldwide license of its rights to the barcode. The license requires the Company to pay a royalty of 1% of the net sales price received by the Company on each cardstock or other supply item that bears the barcode used by the Impulse Sign Systems. Although a patent has been issued to the Developer, which covers the use of the barcode, there is no assurance that the Company will be able to prevent other suppliers of cardstock from copying the barcode used by the Company. However, the Company believes that the number, relatively small size and geographic dispersal of Impulse and SIGNright users, their relationship with the Company and the Company’s retention of its customer list as a trade secret will discourage other sign card suppliers from offering bar-coded sign cards for use on the Impulse and SIGNright machines.
Key employees are required to enter into nondisclosure and invention assignment agreements, and customers, vendors and other third parties also must agree to nondisclosure restrictions prior to disclosure of our trade secrets or other confidential or proprietary information.
Product development for Insignia’s POPSign program has been conducted internally and includes the proprietary data management and operations system, as well as the current offering of point-of-purchase and other advertising products. Ongoing internal systems enhancements, as well as the development of point-of-purchase and other advertising or promotional products, will be conducted utilizing both internal and external resources as appropriate.
Product development on the SIGNright Sign System was primarily conducted by the Developer on a contract basis. The Company continues to introduce complementary products such as new cardstock formats, styles and colors.
The Company plans no further development to the Stylus software product.
Pfizer, Inc. and Nestle Co. accounted for 16% and 12% of the Company’s total net sales for the year ended December 31, 2003. Kellogg Company accounted for 13% of the Company’s total net sales for the year ended December 31, 2002. Pillsbury Company accounted for 14% of the Company’s total net sales for the year ended December 31, 2001.
Sales backlog at February 29, 2004 was approximately $11 million, all of which is for delivery during 2004. The orders are believed to be firm but there is no assurance that all of the backlog will actually result in sales. Sales backlog at February 28, 2003 was approximately $15 million.
Page 4
The Company’s results of operations have fluctuated from quarter to quarter due to variations in net sales and operating expenses. In prior years, the Company generated a significant portion of operating income in the fourth quarter of the fiscal year because of seasonal events that affected when customers purchased Insignia POPSign programs. However, the POPSign revenues for 2003 did not reflect the same seasonality pattern. It is unclear whether there will be a consistent seasonality pattern in the future.
Any factor that negatively affects net sales or increases operating expenses could negatively affect annual results of operations, and in particular, quarterly results. As a result of the seasonality of the business, the Company may incur losses in a given quarter. In certain quarters the Company may realize strong sales, but due to increased sales promotion activities and investments in growing the business, we may experience reduced operating income. The results of operations fluctuate from quarter to quarter as a result of the following:
• The timing of seasonal events for customers;
• The timing of new retail stores being added;
• Costs associated with various sales promotion activities;
• Expenses incurred to support expansion strategies; and
• Litigation fees.
The thermal paper used by the Company in its SIGNright and Impulse thermal sign cards is purchased exclusively from one supplier. While the Company believes that an alternative supplier would be available if necessary, any disruption in the relationship with or deliveries by the current supplier could have an adverse effect on the Company.
The Company subcontracts with one vendor for the printing and application of the VALUStix program coupons. Although there are a limited number of printers capable of providing this service, management believes that other printers could provide the coupons on comparable terms. Though the Company recorded no VALUStix revenue during 2003, the time required to locate and qualify other printers could cause a delay that may be financially disruptive to the Company in the future.
No special or unusual practices affect the Company’s working capital. The Company generally requires payment from its customers within 30 days and pays its vendors within 30-60 days. Given the nature of the Company’s business, there are no significant investments in inventory required.
As of February 29, 2004, the Company had 98 employees, including all full-time and part-time employees.
Item 2. Properties
The Company is located in approximately 47,000 square feet of office and warehouse space in suburban Minneapolis, Minnesota, which has been leased until January 2010. The Company believes that this facility is meeting the Company’s current and foreseeable needs.
Page 5
Item 3. 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 two 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 and is awaiting decision by the Court. The Company believes the allegations are without merit and that the Company will prevail.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2003.
Item 4A. Executive Officers of the Registrant
The names, ages and positions of the Company’s executive officers are as follows:
| Name | Age | Position | |||
|---|---|---|---|---|---|
| Scott F. Drill | 51 | President and Chief Executive Officer and Director | |||
| Gary L. Vars | 63 | President, POPS Division and Director | |||
| Denni J. Lester | 45 | Vice President of Finance, Chief Financial Officer, Secretary and Treasurer | |||
| Thomas N. Wilkolak | 55 | Executive Vice President and General Manager, POPS Division | |||
Scott F. Drill has been President and Chief Executive Officer of the Company since February 24, 1998. From 1996 to December 2002, he was also a partner in Minnesota Management Partners (MMP), a venture capital firm located in Minneapolis, Minnesota. Mr. Drill co-founded Varitronic Systems, Inc. in 1983, and was its President and CEO until it was sold in 1996. Prior to starting Varitronics, Mr. Drill held senior management positions in sales and marketing at Conklin Company and Kroy, Inc.
Gary L. Vars has been President of the POPS Division since December 2002. Mr. Vars was Chairman of the Board of Directors from March 2001 to March 2004. From September 1998 to December 2002, he held the position of Executive Vice President and General Manager of the POPS Division. Prior to joining the Company in 1998, Mr. Vars spent 22 years as a marketing and business development consultant to Fortune 500 companies. From 1966 to 1976 Mr. Vars held various management positions at the Pillsbury Co., including Director of Marketing and New Product Development, Grocery Products Division.
Denni J. Lester has been Vice President of Finance, Chief Financial Officer and Treasurer since December 2002 and Secretary since May 2003. Prior to joining the Company, Ms. Lester spent 22 years at Grant Thornton LLP, a national public accounting firm, including the last nine years as a partner.
Thomas N. Wilkolak has been Executive Vice President and General Manager of the POPS Division since December 2003. From June 2002 to May 2003 he held the position of Vice President, Business Development of the POPS Division. From May 2003 to December 2003, he held the position of Executive Vice President of Sales and Marketing of the POPS Division. Prior to joining the Company in 2002, Mr. Wilkolak held various general management positions with Carlson Companies and Gage Marketing Group. From 1978 until 1990,
Page 6
Mr. Wilkolak held various management positions in sales and marketing at The Pillsbury Company, including Group Marketing Manager and Vice President Sales of the Frozen Foods Division.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock trades on the Nasdaq National Market System under the symbol ISIG. The following table sets forth the range of high and low bid prices reported on the Nasdaq System. These quotations represent prices between dealers and do not reflect retail market-ups, markdowns or commission.
| 2003 | High | Low | 2002 | High | Low | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| First Quarter | $ | 10.51 | $ | 3.51 | First Quarter | $ | 9.19 | $ | 6.60 | ||||||||
| Second Quarter | 6.70 | 3.73 | Second Quarter | 10.08 | 6.90 | ||||||||||||
| Third Quarter | 7.00 | 4.45 | Third Quarter | 9.15 | 6.95 | ||||||||||||
| Fourth Quarter | 4.78 | 2.00 | Fourth Quarter | 11.43 | 8.10 | ||||||||||||
On February 19, 2004, Nasdaq notified the Company that it was not in compliance with the $10 million shareholders’ equity requirement for continued listing on the Nasdaq National Market. If the Company is unable to regain compliance by April 30, 2004, the deadline set by Nasdaq, it will apply for listing of its common stock on the Nasdaq Small Cap Market.
As of February 29, 2004, the Company had one class of Common Stock beneficially held by approximately 2,645 owners.
The Company has never paid cash dividends on its common stock. The Board of Directors presently intends to retain all earnings for use in the Company’s business and does not anticipate paying cash dividends in the foreseeable future.
Page 7
Item 6. Selected Financial Data
(In thousands, except per share amounts.)
| For the Years Ended December 31 |
2003 | 2002 | 2001 | 2000 | 1999 | ||||||||||||
| Net sales | $ | 26,138 | $ | 24,821 | $ | 19,933 | $ | 12,830 | $ | 9,287 | |||||||
| Operating income (loss) | (4,316 | )* | 411 | 119 | (809 | ) | (1,394 | ) | |||||||||
| Net income (loss) | (4,252 | ) | 333 | 121 | (824 | ) | (1,411 | ) | |||||||||
| Net income (loss) per share: | |||||||||||||||||
| Basic and diluted | $ | (0.35 | ) | $ | .03 | $ | .01 | $ | (.08 | ) | $ | (.16 | ) | ||||
| Shares used in calculation of | |||||||||||||||||
| Net income (loss) per share: | |||||||||||||||||
| Basic | 12,259 | 10,872 | 10,470 | 9,880 | 8,828 | ||||||||||||
| Diluted | 12,259 | 11,800 | 11,540 | 9,880 | 8,828 | ||||||||||||
| Working capital | $ | 5,797 | $ | 7,324 | $ | 2,883 | $ | 2,362 | $ | 1,798 | |||||||
| Total assets | 11,676 | 16,722 | 6,631 | 5,065 | 4,043 | ||||||||||||
| Total shareholders' equity | 7,822 | 11,258 | 3,239 | 2,612 | 2,017 | ||||||||||||
* Includes a $2,133 impairment of goodwill more fully described in Note 3 to the financial statements.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
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.
| Year ended December 31 | 2003 | 2002 | 2001 | ||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | |
| Cost of sales | 58.1 | 49.1 | 53.3 | ||||
| Gross profit | 41.9 | 50.9 | 46.7 | ||||
| Operating expenses: | |||||||
| Selling | 32.3 | 29.6 | 29.2 | ||||
| Marketing | 5.3 | 7.8 | 5.4 | ||||
| General and administrative | 12.6 | 11.9 | 11.5 | ||||
| Impairment of goodwill | 8.2 | — | — | ||||
| Total operating expenses | 58.4 | 49.3 | 46.1 | ||||
| Operating income (loss) | (16.5 | ) | 1.6 | 0.6 | |||
| Other income (expense) | 0.2 | (0.3 | ) | — | |||
| Net income (loss) | (16.3 | )% | 1.3 | % | 0.6 | % | |
The discussion and analysis of our financial condition and results of operation are based on 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 assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Page 8
Critical accounting policies are defined as those that involve significant judgments and uncertainties and potentially result in materially different results under different assumptions and conditions. Application of these policies is particularly important to the portrayal of our financial condition and results of operation. We believe the accounting policies described below meet these characteristics. Our significant accounting policies are more fully described in the notes to the financial statements included in this annual report on Form 10-K.
Revenue Recognition. The Company recognizes revenue from Insignia POPSigns ratably over the period of service, which is either a two-week or four-week display cycle. Revenue related to VALUStix is recognized upon completion of our responsibilities as defined in each contract. We recognize revenue related to equipment, software and sign card sales at the time the products are shipped to customers. Revenue associated with maintenance agreements is recognized ratably over the life of the contract. Revenue that has been billed and not yet recognized is reflected as deferred revenue on our balance sheet.
Allowance for Doubtful Accounts. An allowance is established for estimated uncollectible accounts receivable. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, the condition of the general economy and the industry as a whole and other relevant facts and circumstances. Unexpected changes in the aforementioned factors could result in materially different amounts.
Inventories Valuation. Inventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method. The Company records a provision to adjust slow moving and obsolete inventories to the lower of cost or market, based on historical experience and current product demand. The Company evaluates the carrying value of its inventories on a quarterly basis and adjusts the provision as needed.
Goodwill. The carrying value of goodwill is tested for impairment on an annual basis or when factors indicating impairment are present. Projected discounted cash flows are used in assessing the carrying value of goodwill. Goodwill of $2,133,000 was written off during 2003 as a result of the annual impairment test. See Note 3 to the financial statements.
Deferred Income Taxes. The Company records income taxes using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. A valuation allowance is established when management determines it is more likely than not that a deferred tax asset is not realizable in the foreseeable future. At December 31, 2003, all of the Company’s net deferred tax assets were offset with a valuation allowance, which amounted to $7.8 million. The Company cannot be certain that it will be more likely than not that these deferred tax assets will be realized in future years.
Accrued Retailer Guarantees. The Company has contracts with many retailers that provide for the retailer to be paid on a per sign basis for the services rendered by the retailer to hang the Company’s POPSigns in their respective stores. Some of the retailer contracts provide for minimum annual payment amounts. If those minimum levels are not met based upon the annual activity with those retailers, the Company is obligated to pay the contractual difference to the retailers. Excess amounts to be paid are computed and recorded on a quarterly basis and paid on either a quarterly basis or annual basis. These amounts are included as expense within Cost of Services and thus affect the Company’s gross profit margin.
Stock-Based Compensation. The Company accounts for employee stock-based compensation under the “intrinsic value” method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as opposed to the “fair value” method prescribed by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Pursuant to the provisions of APB 25, the Company generally does not record an expense for the value of stock-based awards granted to employees. If proposals currently under consideration by various accounting standards organizations and governmental authorities are adopted, we may be required to treat the value of
Page 9
stock-based awards granted to employees as compensation expense in the future, which could have a material adverse effect on our reported operating results. If these proposals are adopted, we could decide to reduce the number of stock-based awards granted to employees in the future, which could adversely impact our ability to attract qualified candidates or retain existing employees without increasing their cash compensation and, therefore, have a material adverse effect on our business, results of operations and financial condition.
On December 23, 2002, we acquired the VALUStix business from an unrelated party for $3,000,000 in cash, plus a five-year royalty based on annual net sales over a threshold amount. This acquisition gave us the opportunity to expand our product offerings to our POPSign customers.
The VALUStix business includes a proprietary system that allows retailers and manufacturers to attach coupons and other promotional materials to products that are sold in grocery stores and other retail locations. The VALUStix program can deliver immediately actionable offers and information to shoppers at the point-of-purchase.
During the year ended December 31, 2003, the Company incurred $1,015,000 of operating expenses related to VALUStix that were recorded in Selling expenses in the Statement of Operations. The Company also incurred $101,000 of expenses related to test programs during the year; these costs were recorded in Cost of Services in the Statement of Operations. Additionally, the Company incurred an operating expense of $2,133,000 related to the impairment of goodwill associated with the VALUStix business. Total operating expenses for VALUStix during the year ended December 31, 2003 were $3,249,000. The Company recorded no revenue from the sale of VALUStix products during 2003.
The Company performed an annual impairment test as of December 31, 2003, related to the goodwill recorded in connection with the VALUStix business. The Company’s goodwill impairment test utilized discounted cash flows to determine the fair value of the VALUStix business. The Company determined that the carrying amount of the goodwill exceeded the fair value of the VALUStix business and recorded an impairment charge of $2,133,000 during the fourth quarter of fiscal 2003. The primary factor leading to the impairment was substantially lower cash flow forecasts due to the prolonged period of time to integrate the VALUStix business into the POPS program. The Company has $960,000 of remaining goodwill as of December 31, 2003.
The Company believes the VALUStix program will complement the POPSign program and expects there will be future synergies to our existing business. However, the process to integrate VALUStix into the POPS program has taken longer than management initially expected.
Net Sales. Net sales for the year ended December 31, 2003 increased 5.3% to $26,138,000 compared to $24,821,000 for the year ended December 31, 2002.
Service revenues from our POPSign programs for the year ended December 31, 2003 increased 10.1% to $22,155,000 compared to $20,114,000 for the year ended December 31, 2002. The increase was primarily due to an increase in the number of retail stores on line. Our POPSign revenues fluctuated significantly quarter to quarter during 2003 and did not follow the same pattern of seasonality we have historically experienced. We currently expect that the first two quarters of 2004 will have lower revenues than the prior fiscal year and that the last two quarters of fiscal 2004 will have higher revenues than the prior fiscal year. We expect to begin generating modest revenues related to VALUStix during the first quarter of fiscal 2004.
Page 10
Product sales for the year ended December 31, 2003 decreased 15.4% to $3,983,000 compared to $4,707,000 for the year ended December 31, 2002. The decrease was primarily due to decreasing sales of our other product categories based on decreased demand for those products from our customers. We expect our sales of our other product categories to continue to decline throughout 2004.
Gross Profit. Gross profit for the year ended December 31, 2003 decreased 13.2% to $10,965,000 compared to $12,635,000 for the year ended December 31, 2002. Gross profit as a percentage of total net sales decreased to 41.9% for 2003 compared to 50.9% for 2002.
Gross profit from our POPSign program revenues for the year ended December 31, 2003 decreased 8.0% to $9,286,000 compared to $10,091,000 for the year ended December 31, 2002. The decrease was primarily due to increased payments to retailers, increased occupancy costs and increased equipment costs. Gross profit as a percentage of POPSign program revenues decreased to 41.9% for 2003 compared to 50.2% for 2002, due to the factors discussed above. Gross profit from our POPSign revenues fluctuated significantly quarter to quarter during 2003. The fluctuations are due to a number of factors including level of revenues and related levels of guaranteed payments to retailers, as well as average price per sign. We currently expect that the first two quarters of 2004 will have lower gross profit than the prior fiscal year and that the last two quarters of fiscal 2004 will have higher gross profit than the prior fiscal year. We expect gross profit as a percentage of POPSign revenues to be lower in 2004 due to increased guaranteed payments to retailers.
Gross profit from our product sales for the year ended December 31, 2003 decreased 34.0% to $1,679,000 compared to $2,544,000 for the year ended December 31, 2002. Gross profit as a percentage of product sales decreased to 42.2% for 2003 compared to 54.1% for 2002. The decreases were primarily due to the effect of fixed costs on lower product sales, changes in product mix and adjustments related to obsolescence and lower of cost or market. We expect the gross profit from the sales of our other product categories to continue to decline throughout 2004.
Operating Expenses
Selling. Selling expenses for the year ended December 31, 2003 increased 15.0% to $8,459,000 compared to $7,354,000 for the year ended December 31, 2002, primarily due to VALUStix operating expenses of $1,015,000 incurred during the year. Selling expenses as a percentage of total net sales increased to 32.3% in 2003 compared to 29.6% in 2002, due to the increase described, net of the effect of increased total net sales. We expect selling expenses to decrease due to reduced operating expenses related to VALUStix and reduced personnel.
Marketing. Marketing expenses for the year ended December 31, 2003 decreased 28.0% to $1,383,000 compared to $1,922,000 for the year ended December 31, 2002, primarily due to decreased promotion expenses for the POPSign programs. During the year ended December 31, 2002 the Company incurred approximately $492,000 of expense related to expanding our program to the retail drug industry. Marketing expenses as a percentage of total net sales decreased to 5.3% in 2003 compared to 7.8% in 2002, primarily due to the decreased promotion expenses, partially offset by the effect of higher net sales during the year. We expect marketing expenses to continue to decrease due to planned reductions in discretionary expenses and reduced personnel.
General and Administrative. General and administrative expenses for the year ended December 31, 2003 increased 12.1% to $3,306,000 compared to $2,948,000 for the year ended December 31, 2002, primarily due to additions to our management team and the increased cost of our new facilities. General and administrative expenses as a percentage of total net sales increased to 12.6% in 2003 compared to 11.9% in 2002, primarily due to the factors discussed above. We expect general and administrative expenses, exclusive of legal fees, to decrease slightly due to planned reductions in discretionary expenses and reduced personnel, net of increased costs related to complying with Sarbanes-Oxley and other requirements. Legal fees were $976,000 for the year ended December 31, 2003 compared to $978,000 for the year ended December 31, 2002. The significant legal
Page 11
fees in each year were incurred primarily in connection with News America lawsuits, one of which was settled in November 2002 and the additional one initiated in October 2003, that has not yet been settled nor dismissed. The amount of additional legal fees that will be incurred in connection with the ongoing lawsuit will be significant for the first quarter of fiscal 2004 and may continue to be significant throughout 2004.
Impairment of Goodwill. See discussion under Recent Acquisition.
Other Income (Expense). Other income for the year ended December 31, 2003 was $64,000 compared to other expense of $(78,000) for the year ended December 31, 2002. The differences were primarily due to an increase in interest income as a result of the funds received from the private placement financing in December 2002, minimal interest expense as the line of credit was fully repaid during December 2002 and a one-time fee during 2002 to move to the Nasdaq National Market.
Net Income. Our net loss for the year ended December 31, 2003 was $(4,252,000) compared to net income of $333,000 for the year ended December 31, 2002.
Net Sales. Net sales for the year ended December 31, 2002 increased 24.5% to $24,821,000 compared to $19,933,000 for the year ended December 31, 2001.
Service revenues from our POPSign programs for the year ended December 31, 2002 increased 39.1% to $20,114,000 compared to $14,455,000 for the year ended December 31, 2001. The increase was primarily due to a significant increase in the number of POPSign programs sold to manufacturers and partially due to a higher average selling price due to color enhancements to our POPSign program.
Product sales for the year ended December 31, 2002 decreased 14.1% to $4,707,000 compared to $5,478,000 for the year ended December 31, 2001. The decrease was primarily due to decreasing sales of our other product categories based on decreased demand for those products from our customers.
Gross Profit. Gross profit for the year ended December 31, 2002 increased 35.6% to $12,635,000 compared to $9,316,000 for the year ended December 31, 2001. Gross profit as a percentage of total net sales increased to 50.9% for 2002 compared to 46.7% for 2001.
Gross profit from our POPSign program revenues for the year ended December 31, 2002 increased 52.6% to $10,091,000 compared to $6,611,000 for the year ended December 31, 2001. The increase was primarily due to a significant increase in volume. Gross profit as a percentage of POPSign program revenues increased to 50.2% for 2002 compared to 45.7% for 2001, primarily due to a higher average selling price due to color enhancements to our POPS programs.
Gross profit from our product sales for the year ended December 31, 2002 decreased 5.9% to $2,544,000 compared to $2,705,000 for the year ended December 31, 2001. The decrease was primarily due to decreased sales from our other product categories based on decreased demand for those products from our customers. Gross profit as a percentage of other sales increased to 54.1% for 2002 compared to 49.4% for 2001, primarily due to the write-off of inventory in 2001.
Operating Expenses
Selling. Selling expenses for the year ended December 31, 2002 increased 26.5% to $7,354,000 compared to $5,815,000 for the year ended December 31, 2001, primarily due to an increase in the number of sales related employees due to the significant increase in the volume of POPSign program revenues and the related increased commissions expense. Selling expenses as a percentage of total net sales increased to 29.6% in 2002
Page 12
compared to 29.2% in 2001, primarily due to the increase described, net of the effect of increased total net sales.
Marketing. Marketing expenses for the year ended December 31, 2002 increased 78.0% to $1,922,000 compared to $1,080,000 for the year ended December 31, 2001, primarily due to increased promotion expenses for the POPSign programs, including approximately $492,000 related to expanding our program to the retail drug industry. Marketing expenses as a percentage of total net sales increased to 7.8% in 2002 compared to 5.4% in 2001, primarily due to the increased promotion expenses, partially offset by the effect of higher net sales during the year.
General and Administrative. General and administrative expenses for the year ended December 31, 2002 increased 28.1% to $2,948,000 compared to $2,302,000 for the year ended December 31, 2001, primarily due to increased legal fees related to the News America litigation that was settled during the fourth quarter of 2002 and expenses related to our corporate move during December 2002. General and administrative expenses as a percentage of total net sales increased to 11.9% in 2002 compared to 11.5% in 2001, primarily due to moving expenses of $200,000 and higher legal fees, offset by a reduction to the allowance for doubtful accounts that resulted in a bad debt recovery of $53,000 for the year compared to bad debt expense of $72,000 in 2001. This change in allowance resulted from the changing nature of the Company’s customer base, as POPSign revenues represent a more significant portion of total net sales.
Other Income (Expense). Other expenses of $78,000 for the year ended December 31, 2002 were primarily due to a one-time fee to move to the NASDAQ National Market.
Net Income. Our net income for the year ended December 31, 2002 was $333,000 compared to $121,000 for the year ended December 31, 2001.
The Company has financed its operations with proceeds from public and private equity placements. At December 31, 2003, working capital was $5,797,000 compared to $7,324,000 at December 31, 2002. During the same period total cash and cash equivalents decreased $1,247,000.
Net cash used in operating activities during 2003 was $1,879,000, primarily due to the $4,252,000 net loss, net of the $2,133,000 non-cash impairment of goodwill. Accounts receivable decreased $1,988,000 in 2003 due to POPS revenues in the fourth quarter of 2003 being substantially lower than the fourth quarter of 2002. Accounts payable decreased $1,374,000 as a result of decreased payments due to participating retailers, resulting from the lower quarterly POPS revenue. Deferred revenue decreased $444,000 due to the lower quarterly POPS revenue and the timing of the POPS program cycles at year-end. The Company expects accounts receivable and accounts payable to fluctuate during 2004 depending on the level of quarterly POPS revenues. The Company expects inventory levels to remain flat during 2004.
Net cash of $184,000 was used in investing activities in 2003, primarily due to the purchase of property and equipment of $132,000. No major capital expenditures are expected in 2004.
Net cash of $816,000 was provided by financing activities from the issuance of common stock, net of expenses. The issuance of common stock related to the exercise of stock options and the issuance of shares related to the employee stock purchase plan.
The Company anticipates that its working capital needs will remain consistent with prior years. The Company’s $2 million line of credit with a finance institution was paid in full during 2002 and the related agreement expired on December 31, 2002. The Company is currently in discussions with a lender to obtain financing under a new line of credit arrangement. The Company believes that it has sufficient cash resources and borrowing capacity to fund its current business operations and anticipated growth for the next year.
Page 13
The following table summarizes the Company’s contractual obligations and commercial commitments as of December 31, 2003:
| Total | Less than 1 Year | 1-3 Years | 4-5 Years | After 5 years | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Obligations: | |||||||||||||||||
| Operating leases, excluding | |||||||||||||||||
| operating costs | $ | 4,626,000 | $ | 1,162,000 | |||||||||||||