UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 10-K
(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2008.

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: 1-15087

I.D. SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
22-3270799
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
identification No.)

One University Plaza, Hackensack, New Jersey
 
07601
  (Address of principal executive offices)
 
(Zip Code)

(201) 996-9000
(Registrant's telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01 per share
(Title of class)

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes o or No x

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o or No x

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.
Yes x or No o
 
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 to this Form 10-K. o

 
 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934.
Large accelerated filer o   Accelerated filer x  

Non-accelerated filer ¨ (Do not check if a smaller reporting company)   Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes o or No x

The aggregate market value of the registrant’s common stock, par value $0.01 per share (“Common Stock”), held by non-affiliates is $62.7 million, computed by reference to the price at which the Common Stock was last sold on June 30, 2008, as reported on the Nasdaq National Market.
 
The number of shares of Common Stock outstanding as of February 24, 2009 was 10,893,000 shares.

DOCUMENTS INCORPORATED BY REFERENCE
 
Document
 
Part of Form 10-K
     
Proxy Statement For 2008 Annual Meeting of Stockholders
 
Part III
 
 
 

 

I.D. SYSTEMS, INC.
 
TABLE OF CONTENTS
 
 
Page
PART I.
 
Item 1.
Business
4
Item 1A.
Risk Factors
13
Item 1B.
Unresolved Staff Comments
22
Item 2.
Properties
22
Item 3.
Legal Proceedings
22
Item 4.
Submission of Matters to a Vote of Security Holders
22
     
PART II.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
23
Item 6.
Selected Financial Data
25
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 8.
Financial Statement and Supplementary Data
36
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
56
Item 9A.
Controls and Procedures
56
Item 9B.
Other Information
57
     
PART III.
 
Item 10.
Directors, Executive Officers and Corporate Governance
58
Item 11.
Executive Compensation
58
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
58
Item 13.
Certain Relationships and Related Transactions, and Director Independence
59
Item 14.
Principal Accountant Fees and Services
59
     
PART IV.
 
Item 15.
Exhibits, Financial Statement Schedules
60
 
 
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PART I.

In addition to historical information, this Annual Report on Form 10-K contains “forward-looking statements” (within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that involve risks and uncertainties. See “Risk Factors - Cautionary Note Regarding Forward-Looking Statements.” I.D. Systems, Inc. has, or has applied for, trademark protection for I.D. Systems, Inc.®, Intelli-Listening®, Vehicle Asset Communicator®, ChaMP™, Wireless Asset Net®, AvRamp®, Opti-Kan®, WiFree® and PowerKey®.
  
Item 1. Business
 
Overview
 
We develop, market and sell wireless solutions for managing and securing high-value enterprise assets. These assets include industrial vehicles, such as forklifts and airport ground support equipment, and rental vehicles. Our patented Wireless Asset Net system, which utilizes radio frequency identification, or RFID, technology, addresses the needs of organizations to control, track, monitor and analyze their assets. Our solutions enable customers to achieve tangible economic benefits by making timely, informed decisions that increase the security, productivity and efficiency of their operations.
 
We have focused our business activities on two primary applications - industrial fleet management and security, and rental fleet management. Our solution for industrial fleet management and security allows our customers to reduce operating costs and capital expenditures and to comply with certain safety regulations by accurately and reliably measuring and controlling fleet activity. This solution also enhances security at industrial facilities and areas of critical infrastructure, such as airports, by controlling access to, and restricting the use of, vehicles and equipment. Our solution for rental fleet management allows rental car companies to generate higher revenue by more accurately tracking vehicle data, such as fuel consumption and odometer readings, and improve customer service by expediting the rental and return processes. In addition to focusing on these core applications, we have adapted, and intend to continue to adapt, our solutions to meet our customers’ broader asset management needs.
 
We market and sell our solutions to a wide range of customers in the commercial and government sectors. Our customers operate in diverse markets, such as automotive manufacturing, heavy industry, retail and wholesale distribution, aerospace and defense, homeland security and vehicle rental. Based on revenues for 2008, our top customers are:
 
 
·
U.S. Postal Service; and
 
 
 
·
Wal-Mart Stores, Inc.
 
We were incorporated in the State of Delaware in 1993.

Our Solution
 
We design and implement solutions that focus primarily on the closed-loop asset management and security segment of the market for RFID and other wireless-based technologies. In this segment, RFID-based devices that provide on-board control, location tracking and data processing are integrated with enterprise assets to provide real-time visibility of, and two-way communications with, such assets. Our Wireless Asset Net system provides architectural and functional advantages that differentiate it from systems used for inventory and logistics tracking. For example, while inventory tracking systems rely on consistent radio frequency, or RF, connectivity to perform core functions, our system requires only periodic RF communications, and our on-asset devices perform their core functions autonomously. Unlike logistics tracking systems, which typically require substantial monthly expenditures for cellular or satellite communications, our system does not require customers to incur wireless communications costs and can track mobile assets indoors, where global positioning systems, or GPS, receivers typically do not work and cellular coverage can be sporadic.
 
Our Wireless Asset Net tracking and management system consists of three principal elements:
 
 
·
miniature wireless programmable computers attached to assets;
 
 
 
·
fixed-position communication infrastructure consisting of network computers with two-way RF capabilities, RF-based location-emitting beacons and application-specific network servers; and
 
 
 
·
proprietary software, which is a user-friendly, Windows-based and browser-based graphical user interface that provides visibility and control of the system database.
 
 
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Each of these system elements processes and stores information independently to create a unique, patented system of “distributed intelligence,” which mitigates the risk that a single point of failure could compromise system integrity or data and asset security. Our on-asset hardware stores and processes information locally so that it can autonomously and automatically control the asset and monitor asset activity regardless of the status or availability of other system components. Our on-asset hardware performs its functions even when outside the RF range of any other system component or if the facility computer network is unavailable. Our communication infrastructure independently processes data and executes programmable application logic, in addition to linking monitored mobile asset data automatically to our system’s database. Our server software populates the database and is designed to mitigate the effects of any computer outages that could affect real-time availability of the database. Finally, our client software interfaces only with the database, not directly with our communication infrastructure or on-asset hardware, which restricts access to, and limits corruption of, system information and minimizes network bandwidth usage.

We have focused our business activities on two primary applications - industrial fleet management and security and rental fleet management. In addition to focusing on these core applications, we have adapted, and intend to continue to adapt, our wireless solutions to meet our customers’ broader asset management needs.

Industrial Fleet Management and Security

Our solution for industrial fleet management and security allows fleet operators to reduce operating costs and capital expenditures, comply with certain safety regulations and enhance security.
 
To analyze and benchmark vehicle utilization and operator productivity, our system automatically records a wide range of activity and enables detailed performance comparisons to help management make informed decisions about vehicle and manpower allocations. This can lead to fleet and personnel reductions as well as increases in productivity from existing fleets. The system also provides real-time and historical visibility of vehicle movements.

To help reduce fleet maintenance costs, our system can automate and enforce preventative maintenance scheduling by:
 
 
·
wirelessly uploading usage data from each vehicle;
 
 
 
·
automatically prioritizing maintenance events based on weighted, user-defined variables;
 
 
 
·
automatically sending reminders to individual vehicles or operators via the system’s text messaging module;
 
 
 
·
enabling remote lock-out of vehicles overdue for maintenance; and
 
 
 
·
allowing maintenance personnel to locate and retrieve vehicles due for service via the system’s graphical viewer software.

To help improve fleet safety and security, our system provides, among other things:
 
 
·
compatibility with a variety of technologies that verify driver identity;
 
 
 
·
wireless vehicle access control to ensure that only trained and authorized personnel use equipment as required by the Occupational Safety and Health Administration, or OSHA;
 
 
 
·
electronic vehicle inspection checklists for paperless proof of OSHA compliance;
 
 
 
·
automatic reporting of emerging vehicle safety issues;
 
 
 
·
automatic on-vehicle intervention, such as alarms and the disabling of equipment, in response to user-definable safety and security parameters;
 
 
 
·
remote vehicle deactivation capabilities, allowing a vehicle to be shut down manually or automatically under defined conditions;
 
 
 
·
impact sensing to assign responsibility for abusive driving;
 
 
 
·
geo-fencing to restrict vehicles from operating in prohibited areas or issue alerts upon unauthorized entry to such areas; and
 
 
 
·
a graphical, icon-based view of vehicle safety/security/operational status on a facility map, filterable by a variety of conditions, both historically and in real time.

A specialized application of our solution in the industrial fleet management and security market is vehicle security, particularly at airports, seaports and other areas of critical infrastructure. The Transportation Security Act of 2001 mandates security for aircraft servicing equipment, including aircraft tow tractors, baggage tugs, cargo loaders, catering vehicles and fuel trucks.
 
 
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Rental Fleet Management

Our solution for rental fleet management is designed both to enhance the consumer’s rental experience and benefit the rental company by providing information that can be used to increase revenues, reduce costs and improve customer service. Our system automatically uploads vehicle identification number, mileage and fuel data as a vehicle enters and exits the rental lot, which can significantly expedite the rental and return processes for travelers and provide the rental company with more timely inventory status, more accurate billing data that can generate higher fuel-related revenue, and an opportunity to utilize customer service personnel for more productive activities, such as inspecting vehicles for damage and helping customers with luggage.

Growth Strategy

Our objective is to become the leading global provider of wireless solutions for managing and securing enterprise assets. To achieve this goal, we intend to:

Increase sales in existing markets to existing customers and pursue opportunities with new customers by:
 
 
·
maintaining a sales and marketing team that is focused on identifying, seizing and managing revenue opportunities, with the primary goal of expanding our customer base and achieving wider market penetration;
 
 
 
·
utilizing a performance services team to (a) shorten our initial sales cycles by helping prospective customers identify and quantify benefits expected from our system, (b) accelerate transitions from initial implementation to roll-out programs by helping customers achieve and prove expected system benefits, and (c) build service revenue through long-term consultative engagements that help customers use our system to attain continuous improvements in their operations;
 
 
 
·
utilizing a business development team to establish and manage value-added channel partners that provide (a) new sales, marketing, distribution and support networks, (b) opportunities for system integration and development of unique, integrated value propositions, and (c) software development opportunities to expand our product and application offerings;
 
 
 
·
utilizing a strategic markets team to identify opportunities for and expand sales in key vertical markets—such as automotive, aviation, civilian government, defense, and rental cars—where our solutions can be effectively branded and marketed with specific functionality and subject matter expertise; and

 
·
expanding our resources and activities internationally, especially in Europe, where re-packaging, promoting and supporting our products represents a large, untapped growth opportunity.

Expand into new applications and markets for our technology by:

 
·
pursuing opportunities to integrate our system with computer hardware and software vendors, including original equipment manufacturers;

 
·
establishing relationships with global distributors to market and sell our system internationally; and

 
·
pursuing acquisitions of companies that we believe will enhance the functionality and broaden the applicability of our solutions.

Products and Services

We offer our customers integrated wireless solutions to control, monitor, track and analyze their enterprise assets. Our solutions are comprised of hardware and software, as well as maintenance, support and consulting services.

Principal Products

On-Asset Hardware . With a variety of mounting and user-interface options, our on-asset hardware is designed to be installed quickly and easily and provide an autonomous means of asset control and monitoring. Our on-asset hardware:

 
·
contains an integrated computer, programmed with a product-specific application, and an advanced wireless transceiver with a communication range of up to one-half mile;

 
·
controls equipment access with a variety of electronic interface options;
 
 
 
·
is compatible with most existing facility access security systems;
 
 
6

 

 
·
generates paperless electronic safety checklists via a built-in display and keypad;

 
·
wirelessly and automatically uploads and downloads data to and from other system components;

 
·
performs monitoring and control functions at all times, independent of RF or network connectivity; and

 
·
incorporates a multi-voltage power supply designed to control electrical anomalies.

Wireless Asset Managers. Most of our Wireless Asset Net system deployments require at least one fixed-position communication device, referred to as a Wireless Asset Manager, to link the mobile assets being monitored with the customer’s computer network. Our Wireless Asset Managers conduct two-way RF communications with the assets being monitored and can communicate on either a local or wide area network. The Wireless Asset Managers solution offers flexible configuration options and scalability. A single Wireless Asset Manager is enough to operate an entire asset management system. For expanded, real-time data communication and location tracking, Wireless Asset Managers can be added incrementally as needed. They also allow system settings and on-asset functionality to be changed without physically interfacing with on-asset hardware, which can save significant time and money.
 
Each of our Wireless Asset Managers:

 
·
incorporates an integrated computer, programmed with a product specific application, and an advanced wireless transceiver with a communication range of up to one-half mile;

 
·
accommodates an unlimited number of on-asset hardware devices;

 
·
automatically uploads and downloads data to and from other system components;

 
·
employs built-in self-diagnostic capabilities; and

 
·
is configurable to achieve a wide range of asset management goals.

Server Software. Each of our Wireless Asset Net system deployments requires at least one installation of our server software, which automatically manages data communications between the system’s database and either the Wireless Asset Managers or On-Asset Hardware. Our server software:

 
·
is a set of Windows services;

 
·
automatically processes data between our devices and system databases;

 
·
actively polls Wireless Asset Managers to retrieve data on demand;

 
·
passively listens to allow remote systems to initiate data communications for data download;

 
·
automates event scheduling, including data downloads, database archiving and diagnostic notifications;

 
·
interfaces with certain existing external systems, including maintenance and training systems;

 
·
supports remote control/management of event processes;

 
·
automatically performs diagnostics on system components; and

 
·
automatically e-mails event alerts and customizable reports.

Client Software . Our client software, referred to as the Wireless Asset Net Console, provides an intuitive, easy-to-use, user interface. The console is deployed either as a standard client-server application or as a thin-client. The console interfaces only with the system database, not directly with our communication infrastructure or on-asset hardware, which restricts access to, and limits corruption of, system information and minimizes network bandwidth usage. An unlimited number of clients can be used on a network at any given time.

The Wireless Asset Net console:

 
·
shows the location, status and inventory of vehicles - in real time and historically - in each area of a facility;

 
·
allows real-time, two-way text communications, including broadcast text paging to all operators simultaneously;

 
7

 

 
·
searches, sorts and analyzes assets by drive time, idle time, location, status, group, maintenance condition and other parameters;

 
·
displays and prints predefined and ad hoc reports; and

 
·
allows remote access by management, customers and vendors through the Internet.

Additional Products

Battery ChaMP . Our Battery Charger Monitoring Point, which we refer to as Battery ChaMP, tracks data on industrial battery fast-charge and battery swap systems. The Battery ChaMP provides automatic data uploads, real-time system visibility and data collection for electric vehicle batteries and chargers. The Battery ChaMP:

 
·
tracks vehicle operator compliance with battery charging requirements;

 
·
enforces critical equalization charging schedules;

 
·
monitors data necessary for battery warranty compliance; and

 
·
simplifies battery life management.

Line Asset Communicator . Our Line Asset Communicator is a wireless messaging device that triggers automatic, real-time task requests via radio frequency. Our Line Asset Communicator is designed to automatically forward requests to the material handling resource that:

 
·
has been designated as capable of performing the work requested;

 
·
is available for work at the moment of request; and
 
 
 
·
is physically closest to the site where the work must be performed.

The Line Asset Communicator is a key component of our OptiKan system, an optimized, wireless, electronic "kanban" system. "Kanban" refers to a method of signaling for parts replenishment on an assembly line, popularized by Japanese automobile manufacturers to achieve "just in time" production efficiencies. Our OptiKan system is designed to (i) eliminate dependence on line-of-sight parts replenishment calls, which can optimize material handling efficiency by reducing vehicle travel and eliminating unnecessary down time and (ii) provide a more dynamic, intelligent allocation of tasks to the material handling workforce that feeds the assembly line, which can both increase the timeliness and accuracy of parts replenishment and significantly reduce indirect labor costs.

Services

Maintenance Services . We provide a warranty on all hardware and software components of our system. During the warranty period, we either replace or repair defective hardware. We also make extended maintenance contracts available to customers and offer ongoing maintenance and support on a time and materials basis. Pricing for our extended maintenance and support contracts is dependent upon the level of service we expect to provide. Our maintenance and support services typically include remote system monitoring, help desk technical support, escalation procedure development and routine diagnostic data analysis. Expenses to fulfill our warranty obligations have historically been minimal.

Customer Support and Consulting Services . We have developed a framework for the various phases of system training and support that offers our customers both structure and flexibility. Major training phases include hardware installation and troubleshooting, software installation and troubleshooting, train-the-trainer training on asset hardware operation, preliminary software user training, system administrator training, information technology issue training, ad hoc training during system launch and advanced software user training. These services are priced based on the extent of training that the customer requests.

Following system launch and advanced training, we make additional, refresher training available for a fee, either at the customer’s site or at our offices. The customer may also elect to purchase additional training as part of a larger extended maintenance contract.

To help our customers derive the most benefit from our system, we supply a broad range of support documentation and provide initial post-launch data consulting. Our support documentation includes hardware user guides, software manuals, vehicle installation overviews, troubleshooting guides and issue escalation procedures. Our initial data consulting is intended to help the customer determine which reports and charts are most meaningful to different system users and which specific data may represent cost-saving or productivity-enhancing opportunities.

We have provided our consulting services, both as a stand-alone service to study the potential benefits of implementing a wireless fleet management system, and as part of the system implementation itself.

 
8

 

In certain instances customers prepay us for extended maintenance, support and consulting services. In those instances the amount is recorded as deferred revenue and revenue is recognized over the service period.

Sales and Marketing

Our sales and marketing objective is to achieve broad market penetration, with an emphasis both on expanding business opportunities with existing customers and on securing new customers. As of February 24, 2009, we had 27 employees, including three based in Germany, devoted to sales and marketing.

We primarily market our systems directly to commercial and government organizations. To complement our direct sales activities, we sell through indirect sales channels, such as industrial equipment dealers. In addition, we are actively pursuing strategic relationships with key companies in our target markets — including original equipment manufacturers, complementary hardware and software vendors, and service providers — to further penetrate these markets by embedding our products in the assets our systems monitor and integrating our solutions with other systems.

We sell our systems to both executive and division-level management. Typically, our initial system deployment serves as a basis for potential expansion across the customer’s organization. Ford Motor Company, Walgreens, the U.S. Postal Service, Target and Wal-Mart Stores, Inc. are all examples of this progression.

 
·
Ford initially implemented our system at one plant in 1999, which led to a blanket purchase order to deploy our system across its North American operations. As of December 31, 2008, we had deployed our system at 38 Ford facilities.

 
·
Walgreens initially deployed our system at a single distribution center in 2003.As of December 31, 2008, we had deployed our system at 12 distribution centers.

 
·
The U.S. Postal Service used the implementation of our system at one of its facilities to form the basis of a solicitation for competitive bids for a powered vehicle management system. Based on our proposal for that program, the U.S. Postal Service awarded us a national contract in 2004 to deploy our system at up to 460 U.S. Postal Service facilities nationwide. As of December 31, 2008, we had deployed our system at 113 facilities.

 
·
Beginning in 2003, Target utilized our system on a limited number of vehicles at one of its facilities. As of December 31, 2008, we had deployed our system at 31 facilities.

 
·
Wal-Mart initially deployed our system at a single distribution center in 2005. After testing our system, Wal-Mart ordered our system to be deployed in 50 facilities as of December 31, 2008.

We work closely with customers like these to help maximize the utilization and benefits of our system and demonstrate the value of enterprise-wide deployments.

Customers

We market and sell our wireless solutions to a wide range of customers in the commercial and government sectors. Our customers operate in diverse markets, such as automotive manufacturing, heavy industry, retail and wholesale distribution, aerospace and defense, homeland security and vehicle rental.
 
During the year ended December 31, 2008, the U.S. Postal Service and Wal-Mart Stores, Inc. accounted for 42% and 41% of our revenues, respectively. During the year ended December 31, 2007, the U.S. Postal Service, Wal-Mart Stores, Inc. and Ford Motor Company accounted for 37%, 32% and 10% of our revenues, respectively. No other customer accounted for greater than 10% of our net revenues during these periods.

We strive to establish long-term relationships with our customers in order to maximize opportunities for new application development and increased sales. Our relationship with the U.S. Postal Service illustrates this effort. We started working with the U.S. Postal Service in 1995, under a research and development contract. We have a contract with the U.S. Postal Service through December 31, 2010 to continue deploying our system in postal facilities nationwide.  As of December 31, 2008, we had implemented our system in 113 U.S. Postal Service facilities. 
 
Competition

The market for RFID solutions is rapidly evolving, highly competitive and fragmented. Our target markets are also subject to quickly changing product technologies, shifting customer needs, regulatory requirements and frequent introductions of new products and services. A significant number of companies have developed or are developing and marketing software and hardware for RFID-based and other wireless products that currently compete or will compete directly with our solutions. We compete with organizations varying in size, including many small, start-up companies as well as large, well capitalized organizations. While some of our competitors focus exclusively on providing RFID solutions, many are involved in RFID technology as an extension of a more expansive business strategy. Many of our larger competitors are able to dedicate extensive financial resources to the research and development and deployment of RFID solutions. As government and commercial entities expand the use of RFID technologies, we expect that competition will continue to increase within our target markets.

 
9

 

We distinguish ourselves from our competitors by focusing on two distinct applications - industrial fleet management and security, and rental fleet management. This focus has enabled us to direct product development efforts specifically suited for our target markets. Our on-asset device for industrial fleet management and security is designed to operate independently of other system components, allowing for continuous asset control and data gathering even when the vehicle is out of RF communication range. We believe that our proprietary technology as well as our experience in designing and developing products for our target markets distinguishes us within these markets.

In each of our markets, we encounter different competitors due to the competitive dynamics of each segment. In the industrial fleet management and security market, the wireless control, tracking and management of enterprise assets is relatively new. Although we are not aware of any current competitors that provide the precise capabilities of our systems, we are aware of competitors that offer subsets of our system capabilities or alternate approaches to the needs our products address. Those companies include both emerging companies with limited operating histories, such as ShockWatch, a division of Media Recovery Inc., and Access Control Group, and companies with longer operating histories, greater name recognition and/or significantly greater financial, technical and marketing resources than ours, such as Savi Technology, which was acquired by Lockheed Martin Company in June 2006, Symbol Technologies, which was acquired by Motorola, Inc. in January 2007, Intermec, Inc. and WhereNet Corp., which was acquired by Zebra Technologies Corporation in January 2007.

In the rental fleet management market, we compete primarily against handheld device companies that currently provide the solutions used by vehicle rental companies. Currently, our principal competitors in this market are handheld device providers, such as Motorola,   and other RFID-focused companies, such as WhereNet. Although handheld device providers currently control the majority of the rental fleet market, we believe a shift to RFID represents a compelling opportunity for vehicle rental companies, given the potential for increased customer satisfaction and efficiency resulting from the use of an RFID system. Because of these potential benefits, we believe our focused RFID product development strategy, portfolio of intellectual property and proven system efficacy are key competitive advantages in this market.

Research and Development

As of February 24, 2009, including our executive vice president of engineering, our research and development group was comprised of 14 full-time employees. These employees have expertise in areas such as software and hardware design, wireless communications and mechanical and electrical engineering.

We have focused our research and development efforts on the evolution of our Wireless Asset Net system as a “universal system” to promote more widespread use of our technology for a broader range of equipment, with easier installations, maintenance and support, and with fewer configuration concerns. Using our universal platform, we have adapted our technology to meet the needs of several emerging markets, including rental fleet management, airport vehicle security, industrial battery charging management and remote automated machine monitoring. As a result of what we believe to be the end-user benefits inherent in these developments, including the important security implications of our technology in the airport environment, we have received funding from our customers, including the U.S. Department of Homeland Security, for programs that required adaptations of our system.

In our effort to expand our product beyond North America, we achieved product compliance certification, including European Telecommunications Standard Institutes and European Conformity certification, for our primary product line. In addition, we have completed our conversion of those products to meet the requirements of the European Union’s Restriction of certain Hazardous Substances Directive (RoHS) and its Waste Electrical and Electronic Equipment (WEEE) regulations. These efforts included redesign of circuitry, replacement of components and materials, and new marking and documentation. This has permitted us to market and sell our integrated wireless solutions in the European Union.

Additionally, we have utilized resources to design an alternative system architecture that leverages customers’ existing Wi-Fi (802.11 b/g) wireless network infrastructures. Leveraging the “distributed intelligence” of our patented system design, our Wi-Fi solution overcomes many of the complexities and limitations of a mobile Wi-Fi implementation. In our Wi-Fi system deployments, Wireless Asset Managers are not required, but can still be used to improve the effectiveness of the system. With this new Wi-Fi architecture, we now can provide more flexibility to end-users who want the operational benefits of our system but require the use of their existing Wi-Fi wireless infrastructure.

Our current research and development efforts are focused on:

 
·
enhancing productivity by continuing to add to the functionality and reduce the costs of our system;

 
·
expanding our system to meet the needs of potential markets and to provide new solutions to our customers; and

 
·
improving our core products by utilizing continuing advances in technology.
 
 
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We spent $2.9 million, $2.8 million and $2.6 million for research and development during years ended December 31, 2008, 2007 and 2006, respectively.

Intellectual Property

Patents

We attempt to protect our technology and products through the pursuit of patent protection in the United States and certain foreign jurisdictions. We have built a portfolio of patents and patent applications relating to aspects of our technology and products. We have five U.S. patents and twenty-three pending U.S. patent applications. With the timely payment of all maintenance fees, our U.S. patent that covers our Wireless Asset Net system (U.S. Patent Number 5,682,142) expires on October 28, 2014, our U.S. patent that covers our rental car fleet management system (U.S. Patent Number 6,898,493) expires on April 6, 2020, our U.S. patent that covers our Wireless Asset Net system (U.S. Patent Number 7,165,040) expires on April 28, 2023), our U.S. patent that covers our Wireless Asset Net system (U.S. Patent Number 7,171,381) expires on December 20, 2019, and our U.S. patent that covers our Wireless Asset Net system (U.S. Patent Number 7,356,494) expires on December 10, 2023.

U.S. Patent Number 5,682,142, entitled “Electronic Control System/Network,” is directed toward a network of programmable, location marking and processing, movable tag nodes and a fixed position tag node. The movable and fixed tag nodes communicate directly and are capable of location identification and logical control of environmental conditions without requiring a central processor.

U.S. Patent Number 6,898,493, entitled “Fully Automated Vehicle Rental System,” is directed toward an automated vehicle rental system. The system uses vehicle monitors mounted in each rental vehicle for keeping track of vehicle data, such as mileage, fuel level and location of the vehicle. The system transmits the vehicle data to a central database for automatically completing the checkout of the vehicle.
 
U.S. Patent Number 7,356,494, entitled “Robust Wireless Communications System Architecture and Asset Management Applications Performed Thereon,” is directed toward an automated asset monitoring and control system.  The system uses asset monitors mounted on each asset to collect data regarding the asset and to transmit the collected data to a management computer.  The asset monitor also controls the operation of the asset based on the collected data and on control data received from the management computer.

U.S. Patent Number 7,165,040 and U.S. Patent Number 7,171,381, entitled “System and Method for Managing Remotely and Distantly Located Assets” and “System Architecture and Communications for an Asset Management System,” respectively, are directed toward protection for wireless, bi-directional communications between intelligent asset monitoring devices and central data processing nodes.  The patented systems enable monitoring and control of remote assets in environments where wireless communication networks are overburdened or not reliable.
 
We have foreign patents in China, Australia and Mexico covering our Wireless Asset Net system. We also have patent applications for our Wireless Asset Net system pending in Japan, Europe and Canada and patent applications for our mobile RFID portal pending in Canada, China, Mexico, Europe and Australia. Because of the differences in patent laws and laws concerning proprietary rights, the extent of protection provided by U.S. patents or proprietary rights owned by us may differ from that of their foreign counterparts.

Trademarks

We have, or have applied for, trademark protection for I.D. Systems, Inc.®, Intelli-Listening®,  Vehicle Asset Communicator®, ChaMP®, Wireless Asset Net®, AvRamp®, Opti-Kan®, WiFree® and PowerKey®.

We attempt to avoid infringing known proprietary rights of third parties in our product development and sales efforts. However, it is difficult to proceed with certainty in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential at the time of the application filing, with regard to similar technologies. If we were to discover that our products violate third-party proprietary rights, we may not be able to:

 
·
obtain licenses to continue offering such products without substantial reengineering;

 
·
reengineer our products successfully to avoid infringement;

 
·
obtain licenses on commercially reasonable terms, if at all; or

 
·
litigate an alleged infringement successfully or settle without substantial expense and damage awards.

Any claims against us relating to the infringement of third-party proprietary rights, even if without merit, could result in the expenditure of significant financial and managerial resources or in injunctions preventing us from distributing certain products. Such claims could materially adversely affect our business, financial condition and results of operations.

 
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Our software products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult. In general, our efforts to protect our intellectual property rights through patent, copyright, trademark and trade secret laws and contractual safeguards may not be effective to prevent misappropriation of the technology, or to prevent the development and design by others of products or technologies similar to or competitive with those developed by us. Our failure or inability to protect our proprietary rights could materially adversely affect our business, financial condition and results of operations.

Manufacturing

We outsource our hardware manufacturing operations to leading contract manufacturers, such as Flextronics International Ltd. This strategy enables us to focus on our core competencies — designing hardware and software systems and delivering solutions to customers — and avoid investing in capital-intensive electronics manufacturing infrastructure. Outsourcing also provides us with the ability to ramp up deliveries to meet increases in demand without increasing fixed expenses.

Our manufacturers are responsible for obtaining the necessary components and supplies to manufacture our products. While components and supplies are generally available from a variety of sources, manufacturers generally depend on a limited number of suppliers. In the past, unexpected demand for communication products caused worldwide shortages of certain electronic parts and allocation of such parts by suppliers that had an adverse impact on the ability of manufacturers to deliver products as well as on the cost of producing such products.

Due to the general availability of manufacturers for our products, we do not believe that the loss of any of our manufacturers would have a long-term material adverse effect on our business, although there could be a short-term adverse effect on our business.

We generally attempt to maintain sufficient inventory to meet customer demand for products, as well as to meet anticipated sales levels. If our product mix changes in unanticipated ways, or if sales for particular products do not materialize as anticipated, we may have excess inventory or inventory that becomes obsolete. In such cases, our operating results could be negatively affected.

Government Regulations

The use of radio emissions are subject to regulation in the United States by various federal agencies including the FCC and OSHA. Various state agencies also have promulgated regulations which concern the use of lasers and radio/electromagnetic emissions standards.

Regulatory changes in the United States and other countries in which we may operate in the future could require modifications to some of our products for us to continue manufacturing and marketing our products.

Our products intentionally transmit radio signals, including narrow band and spread spectrum signals, as part of their normal operation. We have obtained certification from the FCC for our products that require certification. Users of these products in the United States do not require any license from the FCC to use or operate our products. To market and sell our integrated wireless solutions in the European Union, we also utilize unlicensed radio spectra, and have obtained the required European Norm (EN) certifications.

In addition, some of our operations use substances regulated under various federal, state and local laws governing the environment and worker health and safety, including those governing the discharge of pollutants into the ground, air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. Certain of our products are subject to various federal, state and local laws governing chemical substances in electronic products.

The adoption of unfavorable regulations, or unfavorable interpretations of existing regulations by courts or regulatory bodies, could require us to incur significant compliance costs, cause the development of the affected markets to become impractical or otherwise adversely affect our ability to produce or market our products.

Employees

As of February 24, 2009 we had 99 full-time employees, of which 33 are engaged in customer service, 14 in product development (which includes engineering), 10 in operations, 27 in sales and marketing, and 15 in finance and administration. None of our employees are represented by union or collective bargaining agreements. We believe that our relationships with our employees are good.

Available Information

Our website is “www.id-systems.com.” We make available on this website free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish such information to, the Securities and Exchange Commission (“SEC”). We also make available on this website, free of charge, our Code of Ethics for Senior Financial Officers, which applies to our principal executive officer, principal financial officer and principal accounting officer.

 
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Item 1A.   Risk Factors

We have incurred significant losses and have a substantial accumulated deficit. If we cannot achieve profitability, the market price of our common stock could decline significantly.

Although we generated net income of $851,000 for the year ended December 31, 2005, we incurred net losses of approximately $1.6 million, $7.3 million and $4.2 million for the years ended December 31, 2006, 2007 and 2008 respectively, and have incurred additional net losses since inception. At December 31, 2008, we had an accumulated deficit of approximately $23.7 million. Our ability to increase our revenues from the sale of our products will depend on our ability to successfully implement our growth strategy and the continued expansion of our markets. During 2008, the market price of our common stock declined significantly. If our revenues do not grow or if our operating expenses continue to increase, we may not be able to become profitable as we were in 2005 and the market price of our common stock could decline further.

We are highly dependent upon sales of our Wireless Asset Net system to a few customers. The loss of any of these customers, or any material reduction in the amount of our products they purchase, could materially and adversely affect our financial condition and results of operations.

During the year ended December 31, 2008, the U.S. Postal Service and Wal-Mart Stores, Inc. accounted for 42% and 41% of our revenues, respectively. During the year ended December 31, 2007, the U.S. Postal Service, Wal-Mart Stores, Inc. and Ford Motor Company accounted for 37%, 32% and 10% of our revenues, respectively. Some of these and other customers operate in markets that have suffered business downturns in the past few years or may so suffer in the future. The loss of or any material reduction in the amount of our products that these customers purchase, or any material adverse change in the financial condition of such customers, could materially and adversely affect our financial condition and results of operations. If we are unable to replace such revenue from existing or new customers, the market price of our common stock could decline significantly.

If the market for our technology does not develop or become sustainable, expands more slowly than we expect or becomes saturated, our revenues will continue to decline and our financial condition and results of operations could be materially and adversely affected.

Our success is highly dependent on the continued market acceptance of our Wireless Asset Net system. The market for our wireless products and services is new and rapidly evolving. If the market for our products and services does not become sustainable, or becomes saturated with competing products or services, our revenues will continue to decline and our financial condition and results of operations could be materially and adversely affected.

If we are unable to keep up with rapid technological change, we may be unable to meet the needs of our customers, which could materially and adversely affect our financial condition and results of operations and reduce our ability to grow our market share.
 
Our market is characterized by rapid technological change and frequent new product announcements. Significant technological changes could render our existing technology obsolete. We are active in the research and development of new products and technologies and in enhancing our current products. However, research and development in our industry is complex and filled with uncertainty. For example, it is common for research and development projects to encounter delays due to unforeseen problems, resulting in low initial volume production, fewer product features than originally considered desirable and higher production costs than initially budgeted, any of which may result in lost market opportunities. In addition, these new products may not adequately meet the requirements of the marketplace and may not achieve any significant degree of market acceptance. If our efforts do not lead to the successful development, marketing and release of new products that respond to technological developments or changing customer needs and preferences, our revenues and market share could be materially and adversely affected. We may expend a significant amount of resources in unsuccessful research and development efforts. In addition, new products or enhancements by our competitors may cause customers to defer or forego purchases of our products. Any of the foregoing could materially and adversely affect our financial condition and results of operations and reduce our ability to grow our market share.

If we are unable to effectively manage our growth, our business may become inefficient and we may not be able to effectively compete, increase our revenues or control our expenses.

Historically, we have grown our business rapidly. Between the fiscal years ended December 31, 2001 and 2006, our revenues increased at a compounded annual growth rate of 93%, between fiscal years ended December 31, 2006 and 2007, our revenues decreased by 30.9% and between fiscal years ended December 31, 2007 and 2008, our revenues increased by 58.3%. During 2007 and 2008, we increased our operating expenses to expand our sales and marketing capabilities and broadened our customer support capabilities and fund greater levels of research and development. Our rapid growth has placed, and is expected to continue to place, a significant strain on our managerial, technical, operational and financial resources. To manage our growth, we will have to:

 
·
retain existing personnel;

 
·
hire, train, manage and retain additional qualified personnel, including sales and marketing and research and development personnel;

 
·
implement additional operational controls, reporting and financial systems and procedures; and

 
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·
effectively manage and expand our relationships with customers, subcontractors and other third parties responsible for manufacturing and delivering our products.

The long and variable sales cycles for our solutions may cause our revenues and operating results to vary significantly from quarter to quarter or year to year, which could adversely affect the market price of our common stock.

We expect that customers who utilize our solutions will do so as part of a large-scale deployment of these solutions across multiple or all divisions of their organizations. A customer’s decision to deploy our solutions throughout its organization will involve a significant commitment of its resources. Accordingly, initial implementations may precede any decision to deploy our solutions enterprise-wide. Throughout this sales cycle, we may spend considerable time and expense educating and providing information to prospective customers about the benefits of our solutions.

The timing of the deployment of our solutions may vary widely and will depend on the specific deployment plan of each customer, the complexity of the customer’s organization and the difficulty of such deployment. Customers with substantial or complex organizations may deploy our solutions in large increments on a periodic basis. Accordingly, we may receive purchase orders for significant dollar amounts on an irregular and unpredictable basis. Because of our limited operating history and the nature of our business, we cannot predict the timing or size of these sales and deployment cycles. Long sales cycles, as well as our expectation that customers will tend to place large orders sporadically with short lead times, may cause our revenue and results of operations to vary significantly and unexpectedly from quarter to quarter. These variations could materially and adversely affect the market price of our common stock.

If we are unable to protect our intellectual property rights, our financial condition and results of operations could be materially and adversely affected.

We rely on a combination of patents, copyrights, trademarks, trade secrets and contractual measures to protect our intellectual property rights. Third parties may seek to challenge, invalidate, circumvent or render unenforceable any patents or proprietary rights owned by us. If such challenges are successful, our business will be materially and adversely affected.

Our employees, consultants and advisors enter into confidentiality agreements with us that prohibit the disclosure or use of our confidential information. We also have entered into confidentiality agreements to protect our confidential information delivered to third parties for research and other purposes. Despite these efforts, we cannot assure you that we will be able to effectively enforce these agreements or our confidential information will not be disclosed, that others will not independently develop substantially equivalent confidential information and techniques or otherwise gain access to our confidential information or that we can meaningfully protect our confidential information.

Disputes may arise in the future with respect to the ownership of rights to any technology developed with advisors or collaborators. These and other possible disagreements could lead to delays in the collaborative research, development or commercialization of our systems, or could require or result in costly and time-consuming litigation that may not be decided in our favor. Any such event could materially and adversely affect our financial condition and results of operations.

Policing the unauthorized use of our intellectual property is difficult, and we cannot assure you that the steps we have taken will prevent unauthorized use of our technology or other intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Accordingly, we may not be able to protect our proprietary rights against unauthorized third party copying or use. If we are unsuccessful in protecting our intellectual property, we may lose any technological advantages we have over competitors and our financial condition and results of operations could be materially and adversely affected.

We may become involved in an intellectual property dispute that could subject us to significant liability, divert the time and attention of our management and prevent us from selling our products, any of which could materially and adversely affect our financial condition and results of operations.

In recent years, there has been significant litigation in the United States and internationally involving claims of alleged infringement of patents and other intellectual property rights. Litigation may be necessary to enforce our intellectual property rights, defend ourselves against alleged infringement and determine the scope and validity of our intellectual property rights.

Any such litigation, whether or not successful, could result in substantial costs, divert the time and attention of our management and prevent us from selling our products. If a claim of patent infringement was decided against us, we could be required to:

 
·
pay substantial damages to the party making such claim;

 
·
stop selling, making, having made or using products or services that incorporate the challenged intellectual property;

 
·
obtain from the holder of the infringed intellectual property right a license to sell, make or use the relevant technology, which license may not be available on commercially reasonable terms, or at all; or


 
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·
redesign those products or services that incorporate such intellectual property.

The failure to obtain the necessary licenses or other rights could preclude the sale, manufacture or distribution of our products and could materially and adversely affect our financial condition and results of operations.

The U.S. government’s right to use technology developed by us with government funds could limit our intellectual property rights.

We have developed, and may in the future develop, improvements to our technology that are funded in part by the U.S. government. As a result, we do not have the right to prohibit the U.S. government from using certain technologies developed by us with such government funds or to prohibit third parties from using those technologies to provide products and services at the request of the U.S. government. Although such government rights do not affect our ownership of the technology developed using such funds, the U.S. government has the right to royalty-free use of technologies that we have developed under such contracts. We are free to commercially exploit those government funded technologies and may assert our intellectual property rights to seek to block other non-government users thereof, but we cannot assure you that we can successfully do so.

We rely on subcontractors to manufacture and deliver our products. Any quality or performance failures by our subcontractors or changes in their financial condition could disrupt our ability to supply quality products to our customers in a timely manner, resulting in business interruptions, increased costs, claims for damages, reputation damage and reduced revenue.

In order to meet the requirements under our contracts, we rely on subcontractors to manufacture and deliver our products to our customers. Any quality or performance failures by our subcontractors or changes in their financial or business condition could disrupt our ability to supply quality products to our customers in a timely manner. If we are unable to fulfill orders from our customers in a timely manner, we could experience business interruption, increased costs, damage to our reputation and loss of our customers. In addition, we may be subject to claims from our customers for failing to meet our contractual obligations. Although we have several sources for production, the inability to provide our products to our customers in a timely manner could result in the loss of customers and our revenues could be materially reduced. In addition, there is great competition for the most qualified and competent subcontractors. If we are unable to hire qualified subcontractors, the quality of our services and products could decline. Furthermore, third-party manufacturers in the electronic component industry are consolidating. The consolidation of third-party manufacturers may give remaining manufacturers greater leverage to increase the prices that they charge, thereby increasing our manufacturing costs. If we are unable to pass the increased costs onto our customers, our profitability could be materially and adversely affected.

We rely on a limited number of suppliers for several significant components and raw materials in our products. If we are unable to obtain these components or raw materials on a timely basis, we will be unable to meet our customers’ orders, which could reduce our revenues, subject us to claims for damages and adversely affect our relationships with our customers.

We rely on a limited number of suppliers for the components and raw materials used in our products, including Flextronics. Although there are many suppliers for most of our component parts and raw materials, we are dependent on a limited number of suppliers for many of our significant components and raw materials. This reliance involves a number of significant risks, including:

 
·
unavailability of materials and interruptions in delivery of components and raw materials from our suppliers, which could result in manufacturing delays; and

 
·
fluctuations in the quality and price of components and raw materials.

We currently do not have any long-term or exclusive purchase commitments with any of our suppliers. In addition, our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable terms or at all. We may not be able to develop alternative sources for the components and raw materials. Even if alternate suppliers are available to us, identifying them is often difficult and time consuming. If we are unable to obtain ample supply of product or raw materials from our existing suppliers or alternative sources of supply, we may be unable to satisfy our customers’ orders, which could reduce our revenues, subject us to claims for damages and adversely affect our relationships with our customers.

If we lose our executive officers, or are unable to recruit additional personnel, our ability to manage our business could be materially and adversely affected.

We are dependent on the continued employment and performance of our executive officers. We currently do not have employment agreements with any of our executive officers. Like other companies in our industry, we face intense competition for qualified personnel. Many of our competitors have greater resources than we have to hire qualified personnel. Accordingly, if we are not successful in attracting or retaining qualified personnel in the future, our ability to manage our business could be materially and adversely affected.

The industry in which we operate is highly competitive, and competitive pressures from existing and new companies could have a material adverse effect on our financial condition and results of operations.

The industry in which we operate is highly competitive and influenced by the following:

 
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·
advances in technology;

 
·
new product introductions;

 
·
evolving industry standards;

 
·
product improvements;

 
·
rapidly changing customer needs;

 
·
intellectual property invention and protection;

 
·
marketing and distribution capabilities;

 
·
ability to attract highly skilled professionals;

 
·
competition from highly capitalized companies;

 
·
entrance of new competitors;

 
·
ability of customers to invest in information technology; and

 
·
price competition.

The products marketed by us and our competitors are becoming more complex. As the technological and functional capabilities of future products increase, these products may begin to compete with products being offered by traditional computer, network and communications industry participants that have substantially greater financial, technical, marketing and manufacturing resources than we do.

Although we are not aware of any current competitors that provide the precise capabilities of our systems, we are aware of competitors that offer subsets of our system capabilities or alternate approaches to the needs our products address. Those companies include both emerging companies with limited operating histories, such as ShockWatch, a division of Media Recovery, Inc., and Access Control Group L.L.C., and companies with longer operating histories, greater name recognition and/or significantly greater financial, technical and marketing resources than ours, such as Savi Technology, Inc., which was acquired by Lockheed Martin Company in June 2006, Symbol Technologies, Inc., which was acquired by Motorola, Inc. in January 2007, Intermec, Inc. and WhereNet Corp, which was acquired by Zebra Technologies Corporation in January 2007.

If we do not keep pace with product and technology advances, including the development of superior products by our competitors, or if we are unable to otherwise compete successfully against our competitors, there could be a material adverse effect on our competitive position, revenues and prospects for growth. As a result, our financial condition and results of operations could be materially and adversely affected.

The federal government or independent standards organizations may implement significant regulations or standards that could adversely affect our ability to produce or market our products.

Our products transmit radio frequency waves, the transmission of which is governed by the rules and regulations of the Federal Communications Commission, or FCC, as well as other federal and state agencies. Our ability to design, develop and sell our products will continue to be subject to these rules and regulations for the foreseeable future. In addition, our products and services may become subject to independent industry standards. The implementation of unfavorable regulations or industry standards, or unfavorable interpretations of existing regulations by courts or regulatory bodies, could require us to incur significant compliance costs, cause the development of the affected products to become impractical or otherwise adversely affect our ability to produce or market our products. The adoption of new industry standards applicable to our products may require us to engage in rapid product development efforts that would cause us to incur higher expenses than we anticipated. In some circumstances, we may not be able to comply with such standards, which could materially and adversely affect our ability to generate revenues through the sale of our products.

Because our products are complex, they may have undetected errors or failures when they are introduced that could seriously harm our business.

Technical products like ours often contain undetected errors or failures when first introduced. Despite our efforts to eliminate these flaws, there still may be flaws in our products, even after the commencement of commercial shipments. Because our products are used in business-critical applications, we could be subject to product liability claims if our systems fail to perform as intended. Even unsuccessful claims against us could result in costly litigation and the diversion of management’s time and resources and could damage our reputation and impair the marketability of our systems. Although we maintain insurance, we cannot assure you that:

 
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·
our insurance will provide adequate coverage against potential liabilities if our products cause harm or fail to perform as promised; or

 
·
adequate product liability insurance will continue to be available to us in the future on commercially reasonable terms or at all.

If our insurance is insufficient to pay any product liability claim, our financial condition and results from operations could be materially and adversely affected. In addition, any such claims could permanently injure our reputation.

We may need to obtain additional capital to fund our operations that could have negative consequences on our business.

We may require additional capital in the future to develop and commercialize additional products and technologies or take advantage of other opportunities that may arise, including potential acquisitions. We may seek to raise the necessary funds through public or private equity offerings, debt financings or strategic alliances and licensing arrangements. To the extent we raise additional capital by issuing equity securities, our existing stockholders may experience substantial dilution. If additional capital is raised through debt, such debt may subject us to significant restrictive covenants that could affect our ability to operate our business. In addition, we may be required to relinquish rights to our technologies or systems, or grant licenses on terms that are not favorable to us in order to raise additional funds through alliance, joint venture and licensing arrangements. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our development programs, and our business, financial condition, results of operations and stock price could be materially and adversely affected.

 
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If we do not adequately anticipate and respond to the risks inherent in growing our business internationally, our operating results and the market price of our common stock could be materially and adversely affected.

We have not generated significant revenues outside of North America. As part of our growth strategy, we are seeking ways to expand our operations outside of North America by establishing offices overseas and developing relationships with global distributors to market and sell our systems internationally. For example, as of February 24, 2009, we had three employees in Germany who market and sell our systems in Europe. There are a number of risks inherent in doing business in such markets, including:

 
·
unexpected legal or regulatory changes;

 
·
unfavorable political or economic factors;

 
·
less developed infrastructure;

 
·
difficulties in recruiting and retaining personnel, and managing international operations;

 
·
fluctuations in foreign currency exchange rates;

 
·
lack of sufficient protection for intellectual property rights; and

 
·
potentially adverse tax consequences.

Until recently, we had no operations outside of North America, and we have limited experience establishing or operating businesses outside of North America. If we do not adequately anticipate and respond to the risks inherent in international operations, our operating results and the market price of our common stock could be materially and adversely affected. In addition, although we intend to expand our business outside of North America, there are risks associated with conducting an international operation, including the risks listed above, and such expansion may not be successful or have a positive effect on our financial condition and results of operations.

Since our inception, we have not made any acquisitions other than one small acquisition during 2008, and we cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future.

We may, from time to time, consider investments in complementary companies, products or technologies. In the event of any future acquisitions, we could:

 
·
issue stock that would dilute our current stockholders’ percentage ownership;

 
·
incur debt;

 
·
assume liabilities;

 
·
incur expenses related to the impairment of goodwill; or

 
·
incur large and immediate write-offs.

Our operation of any acquired business will also involve numerous risks, including:

 
·
problems combining the acquired operations, technologies or products;

 
·
unanticipated costs;

 
·
diversion of management’s time and attention from our core business;

 
·
adverse effects on existing business relationships with suppliers and customers;

 
·
risks associated with entering markets in which we have no or limited prior experience; and

 
·
potential loss of key employees, particularly those of acquired companies.

Since our inception, we have not made any acquisitions other than one small acquisition during 2008, and we cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future. Any failure to do so could have a material adverse effect on our financial condition and results of operations.

 
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The concentration of common stock ownership among our executive officers and directors could limit your ability to influence the outcome of corporate transactions or other matters submitted for stockholder approval.

As of February 24, 2009, our executive officers and directors beneficially owned, in the aggregate, 10.5% of our outstanding common stock, not including 1,373,300 shares of common stock that our executive officers and directors may acquire upon the exercise of outstanding options or if they otherwise acquire additional shares of common stock in the future. As a result, our officers and directors may have the ability to influence the outcome of all corporate actions requiring stockholder approval, irrespective of how our other stockholders may vote, including the following actions:

 
·
the election of directors;

 
·
adoption of stock option plans;

 
·
the amendment of our organizational documents; and

 
·
the approval of certain mergers and other significant corporate transactions, including a sale of substantially all of our assets.

The unpredictability of our quarterly operating results could adversely affect the market price of our common stock.

Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which could adversely affect the market price of our common stock. The main factors that may affect us include the following:

 
·
variations in the sales of our products to our significant customers;

 
·
variations in the mix of products and services provided by us;

 
·
the timing and completion of initial programs and larger or enterprise-wide purchases of our products by our customers;
 
 
·
the length and variability of the sales cycle for our products;

 
·
the timing and size of sales;

 
·
changes in market and economic conditions, including fluctuations in demand for our products; and

 
·
announcements of new products by our competitors.

As a result of these and other factors, revenues for any quarter are subject to significant variation that could adversely affect the market price for our common stock.

Future sales of our common stock, including sales of our common stock acquired upon the exercise of outstanding options, may cause the market price of our common stock to decline.

The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the market, or sales of our common stock acquired upon the exercise of outstanding options, or the perception that these sales could occur. These sales also may make it more difficult for us to sell equity securities at a time and price that we deem appropriate.

We have 10,893,000 shares of common stock outstanding as of February 24, 2009, of which 9,748,000 shares are freely transferable without restriction and 1,145,000 shares are held by our officers and directors which are subject to the applicable volume, manner of sale, holding period and other limitations of Rule 144. In addition, as of December 31, 2008, options to purchase 2,601,000 shares of our common stock were issued and outstanding, of which 1,486,000 were vested. The remaining options will vest ratably over a five-year period measured from the date of grant. The weighted-average exercise price of the vested stock options is $9.37. We also may issue additional shares of stock in connection with our business, including in connection with acquisitions, and may grant additional stock options to our employees, officers, directors and consultants under our stock option plans or warrants to third parties. If a significant portion of these shares were sold in the public market, the market value of our common stock could be adversely affected.

 
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A decline in the value of the auction rate securities included in our investments and an inability to realize proceeds from our auction rate securities right issued by UBS AG could materially adversely affect our liquidity and income.

At December 31, 2007 and 2008, we held approximately $25.1 million ($25.1 million par value) and $18.1 million ($20.4 million par value), respectively, in investments in auction rate securities which represent interests in collateralized pools of student loan receivables issued by agencies established by counties, cities, states and other municipal entities. We sold approximately $5.0 million of these investments in 2008. Since February 2008 we have experienced difficulty in effecting additional sales of such securities because of the failure of the auction mechanism as a result of sell orders exceeding buy orders. Liquidity for these auction rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals. Holders of the securities continue to receive interest on the investments, and the securities continue to be auctioned at the pre-determined intervals (typically every 28 days) until the auction succeeds, the issuer calls the securities, or they mature. These failed auctions represent liquidity risk exposure and are not defaults or credit events. A decline in the value of these securities that is not temporary could materially adversely affect our liquidity and income.
 
In October 2008, we received an offer (the “Offer”) from UBS for a put right permitting us to sell to UBS at par value all auction rate securities previously purchased from UBS at a future date (any time during a two-year period beginning June 30, 2010). The Offer also included a commitment to loan us 75% of the UBS-determined value of the auction rate securities at any time until the put is exercised. In exchange for the Offer, we were required to provide UBS with a general release of claims (other than certain consequential damages claims) concerning our auction rate securities and grant UBS the right to purchase our auction rate securities at any time for full par value. The Offer was non-transferable and expired on November 14, 2008. During November 2008, we accepted the Offer.
 
Given the substantial dislocation in the financial markets and among financial services companies, we cannot assure you that UBS ultimately will have the ability to repurchase our auction rate securities at par, or at any other price, as these rights will be an unsecured contractual obligation of UBS or that if UBS determines to purchase our auction rate securities at any time, we will be able to reinvest the cash proceeds of any such sale at the same interest rate or dividend yield currently being paid to us. Also, as a condition of accepting the auction rate securities rights, we were required to sign a release of claims against UBS, which will prevent us from making claims against UBS related to our investment in auction rate securities, other than claims for consequential damages.

Interest rate fluctuations may adversely affect our income and results of operations.

As of December 31, 2008, we had cash, cash equivalents and investments, which include auction rate securities and an auction rate securities right, of $56.0 million. In a declining interest rate environment, reinvestment typically occurs at less favorable market rates, negatively impacting future investment income. Accordingly, interest rate fluctuations may adversely affect our income and results of operations.
 
Our cash and cash equivalents could be adversely affected by the current downturn in the financial and credit markets.

We maintain our cash and cash equivalents with major financial institutions; however, our cash and cash equivalent balances with these institutions exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor on a systematic basis the cash and cash equivalent balances in the operating accounts and adjust the balances as appropriate, these balances could be impacted if one or more of the financial institutions with which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date, we have experienced no loss of principal or lack of access to our invested cash or cash equivalents; however, we can provide no assurance that access to our invested cash and cash equivalents will not be affected if the financial institutions in which we hold our cash and cash equivalents fail or the financial and credit markets continue to worsen.
 
Declines in general economic conditions could result in decreased demand for our products and services, which could adversely affect our business, financial condition and results of operations.

Our results of operations are affected by the levels of business activities of our customers, which can be affected by economic conditions in the U.S. and globally.  During periods of economic downturns, our customers may decrease their demand for wireless technology solutions, as well as the maintenance, support and consulting services we provide.   As we enter 2009, the United States economy is experiencing a significant slowdown in growth.  This slowdown may have an adverse effect on the wireless solutions industry in general and on demand for our products and services, but the magnitude of that impact is uncertain. Our future growth is dependent, in part, upon the demand for our products and services. Prolonged weakness in the economy may cause business enterprises to delay or cancel wireless solutions projects, reduce their overall wireless solutions budgets and/or reduce or cancel orders for our services. This, in turn, may lead to longer sales cycles, delays in purchase decisions, payment and collection issues, and may also result in price pressures, causing us to realize lower revenues and operating margins. Additionally, if our customers cancel or delay their wireless solutions initiatives, our business, financial condition and results of operations could be materially and adversely affected.

Provisions of Delaware law or our charter documents could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders, and could make it more difficult for you to change management.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. This is because these provisions may prevent or frustrate attempts by stockholders to replace or remove our current management or members of our board of directors. These provisions, among other things:

 
20

 

 
·
permit our board of directors to issue, without further action by our stockholders, up to 5,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate, including the right to approve an acquisition or other change in control;

 
·
provide that special meetings of stockholders may be called only by (i) our board of directors pursuant to a resolution adopted by a majority of the entire board of directors, either upon motion of a director or upon written request by the holders of at least 50% of the voting power of all the shares of our capital stock entitled to vote in the election of directors, voting as a single class, or (ii) our Chairman of the Board or President; and

 
·
require the affirmative vote of at least 75% of the voting power of all the shares of our capital stock entitled to vote in the election of directors, voting as a single class, to amend or repeal the provisions dealing with meetings of stockholders.

In addition, Section 203 of the Delaware General Corporation Law prohibits us from engaging in a business combination with any of our interested stockholders for three years after such stockholder became an interested stockholder unless certain specified conditions are met. As a result, these provisions and Delaware law could limit the price that investors are willing to pay in the future for shares of our common stock.

Cautionary Note Regarding Forward-Looking Statements.

This Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act.

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “can,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 
·
future economic and business conditions;

 
·
the loss of any of our key customers or reduction in the purchase of our products by any such customers;

 
·
the failure of the market for our products to continue to develop;

 
·
our inability to protect our intellectual property;

 
·
our inability to manage our growth;

 
·
the effects of competition from a wide variety of local, regional, national and other providers of wireless solutions;

 
·
changes in laws and regulations, including tax and securities laws and regulations and interstate and regulations promulgated by the FCC;

 
·
changes in accounting policies, rules and practices;

 
·
changes in technology or products, which may be more difficult or costly, or less effective than anticipated; and

 
·
the other factors listed under this Item 1A - “Risk Factors.”

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We have no obligation, and expressly disclaim any obligation, to update, revise or correct any of the forward-looking statements, whether as a result of new information, future events or otherwise. We have expressed our expectations, beliefs and projections in good faith and we believe they have a reasonable basis. However, we cannot assure you that our expectations, beliefs or projections will result or be achieved or accomplished.

 
21

 

Item 1B.   Unresolved Staff Comments

None.
 
Item 2.   Properties

Our executive and administrative offices are located in Hackensack, New Jersey. In November 1999, we entered into a lease for this facility, covering approximately 22,500 square feet, that expires on March 31, 2010. The rent is currently $34,825 per month. During 2003, we entered into an agreement to sublease to a third party 6,270 square feet through the end of the lease. The sublease provided for monthly payments of $11,619, subject to adjustments for increases in real estate taxes and certain operating expenses. In July 2007, the Company released the sublessee from the sublease and reassumed the space.

In February 2007, we entered into a lease in Edgewater, NJ. The lease expires in February 2010 and the rent is currently $1,995 per month.

In March 2007, we entered into a lease for office space located in Suwanee, Georgia for sales, marketing and customer service. The current six month renewal option lease extension expired in September 2008 and was subsequently renewed until March 2009. The rent is currently $1,120 per month.

In September 2007, we entered into a lease for warehouse space located in Clifton, New Jersey. The lease expired in September 2008 and automatically renews on an annual basis. The rent is currently $800 per month.

We believe that our existing facilities are adequate for our existing needs.
 
Item 3.   Legal Proceedings

As of February 24, 2009, we were not involved in any material litigation.
 
Item 4.   Submission of Matters to a Vote of Security Holders

Our annual meeting of stockholders (the “Annual Meeting”) for our fiscal year ended December 31, 2007 was held on December 15, 2008, at which time our stockholders elected the following individuals to serve as our directors until the next annual meeting of stockholders and until their successors are duly elected and qualified: Jeffrey Jagid, Kenneth S. Ehrman, Lawrence Burstein, Harold D. Copperman and Michael Monaco. There were 10,892,993 shares of our common stock outstanding and entitled to vote at the record date for the Annual Meeting. There were present at the Annual Meeting, in person or by proxy, stockholders holding 9,822,145 shares of our common stock, which represented approximately 90% of the total capital stock outstanding and entitled to vote.
 
The matters voted upon at the Annual Meeting and the results of the voting at the Annual Meeting are set forth below:
 
(i)    With respect to the election of our directors by the holders of our common stock, the persons named below received the following number of votes:
 
Name
 
Votes For
   
Votes Withheld
 
Jeffrey Jagid
    9,411,178       410,967  
Kenneth S. Ehrman
    9,240,796       581,349  
Harold D. Copperman
    9,394,074       428,071  
Lawrence Burstein
    9,203,406       618,739  
Michael Monaco
    9,394,274       427,871  

(ii)    With respect to the proposal to adopt and approve our Non-Employee Director Equity Compensation Plan, the votes cast by the holders of our common stock were as follows: 1,613,582 shares were voted in favor; 4,366,554 shares were voted against; and 19,264 shares abstained from voting on the proposal. There were no broker non-votes with respect to such proposal.
 
(iii)    With respect to the proposal to ratify the appointment of Eisner LLP to serve as our independent registered public accounting firm for the fiscal year ending December 31, 2008, the votes cast by the holders of our common stock were as follows: 9,706,911 shares were voted in favor; 89,810 shares were voted against; and 25,424 shares abstained from voting on the proposal. There were no broker non-votes with respect to such proposal.
22

 
PART II.

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a) Market Information . Our common stock is quoted on the Nasdaq National Market under the symbol “IDSY.” The following table sets forth, for the periods indicated, the high and low sales price for our common stock as reported on such quotation system.
 
Quarter Ending
 
High
   
Low
 
2007
           
March 31, 2007
  $ 18.90     $ 11.82  
June 30, 2007
    14.85       11.13  
September 30, 2007
    13.09       8.96  
December 31, 2007
    14.75       11.89  
                 
2008
               
March 31, 2008
  $ 12.94     $ 5.94  
June 30, 2008
    9.60       6.22  
September 30, 2008
    9.31       5.50  
December 31, 2008
    8.75       2.78  

Set forth below is a line-graph presentation comparing the cumulative shareholder return on our common stock on an indexed basis against the cumulative total returns of the Nasdaq Market Value Index and the Hemscott Industry Communication Equipment Group Index (consisting of 74 publicly traded communication equipment companies) (“Hemscott Group Index”) for the period from January 1, 2003 through December 31, 2008.


   
Fiscal Year Ending
 
COMPANY/INDEX/MARKET
 
12/31/2003
   
12/31/2004
   
12/30/2005
   
12/29/2006
   
12/31/2007
   
12/31/2008
 
I.D. Systems Inc
    100.00       266.95       341.20       269.24       178.25       57.94  
Communication Equipment
    100.00       121.50       136.99       146.49       158.22       86.05  
NASDAQ Market Index
    100.00       108.41       110.79       122.16       134.29       79.25  
 
 
23

 

(b) Holders . As of February 24, 2009, there were 26 registered holders of our common stock.

(c) Dividends . We have never paid a cash dividend on our common stock and do not expect to pay a cash dividend in the near future. We currently intend to retain future earnings, if any, to finance our operations and expand our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend upon our financial condition, operating results, capital requirements and any other factors our board of directors deems relevant. In addition, our agreements with our lenders may, from time to time, restrict our ability to pay dividends.

(d) Sales of Unregistered Securities .

None.

(e) Purchases of Equity Securities by the Issuer .

The following table provides a month-to-month summary of our share repurchase activity during the three months ended December 31, 2008:

Issuer Purchases of Equity Securities (1)
 
Period
 
Total number of
shares (or unit)
purchased
   
Average price
paid per share (or
unit)
   
Total number of
shares (or units)
purchased as part of
publicly announced
plans or programs
   
Maximum number (or
approximate dollar
value) of shares (or
units) that may yet be
purchased under the
plans or programs
 
10/1/08 through 10/31/08
    45,546       6.45       45,546     $ 30,305  
11/1/08 through 11/30/08
    -       -       -     $ 30,305  
12/1/08 through 12/31/08
    -       -       -     $ 30,305  
Total
    45,546       6.45       45,546     $ 30,305  

(1)   On May 3, 2007, we announced that our Board of Directors had authorized the repurchase of issued and outstanding shares of our common stock having an aggregate value of up to $10,000,000 pursuant to a share repurchase program established under Rule 10b-18 of the Securities Exchange Act of 1934, as amended. The amount and timing of such repurchases are dependent upon the price and availability of shares, general market conditions and the availability of cash, as determined in the discretion of our management. The repurchases are funded from our working capital. Our share repurchase program does not have an expiration date, and we may discontinue or suspend the share repurchase program at any time. All of the repurchases set forth in this table were made under the share repurchase program in open market transactions. All shares of common stock repurchased under our share repurchase program are held as treasury stock.

 
24

 

Item 6. Selected Financial Data

The following table sets forth selected financial data for each of the five years ended December 31, 2008 derived from our audited financial statements. You should read the information in the table below together with the section of this Annual Report on Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,”, which discusses the 2006, 2007 and 2008 fiscal year, and our financial statements and related notes and the other financial data included elsewhere in this Annual Report on Form 10-K.
  
   
Year Ended December 31,
 
   
2004
   
2005
   
2006
   
2007
   
2008
 
Statement of Operations Data:
                             
Revenues
  $ 13,741,000     $ 19,004,000     $ 24,740,000     $ 17,083,000     $ 27,046,000  
Cost of revenues
    6,509,000       9,708,000       13,701,000       8,929,000       13,466,000  
                                         
Gross profit
    7,232,000       9,296,000       11,039,000       8,154,000       13,580,000  
Operating expenses:
                                       
Selling, general and administrative expenses
    5,879,000       7,140,000       12,943,000       15,963,000       16,760,000  
Research and development expenses
    1,234,000       1,625,000       2,639,000       2,849,000       2,883,000  
                                         
Income (loss) from operations
    (119,000 )     531,000       (4,543,000 )     (10,658,000 )     (6,063,000 )
Interest income
    195,000       222,000       2,801,000       3,238,000       2,226,000  
Interest expense
    (63,000 )     (53,000 )     (29,000 )     (10,000 )     -  
Other income (loss)
    147,000       151,000       155,000       89,000       (338,000 )
                                         
Net income (loss)
  $ 398,000     $ 851,000     $ (1,616,000 )   $ (7,341,000 )   $ (4,175,000 )
                                         
Net income (loss) per share - basic
  $ 0.05     $ 0.11     $ (0.15 )   $ (0.66 )   $ (0.38 )
                                         
Net income (loss) per share - diluted
  $ 0.05     $ 0.09     $ (0.15 )   $ (0.66 )   $ (0.38 )
                                         
Weighted average common shares outstanding - basic
    7,455,000       7,771,000       10,501,000       11,205,000       10,887,000  
                                         
Weighted average common shares outstanding - diluted
    8,783,000       9,332,000       10,501,000       11,205,000       10,887,000  
                                         
Balance Sheet Data (at end of period):
                                       
                                         
Cash and cash equivalents
    8,440,000       2,138,000       9,644,000       5,103,000       12,558,000  
                                         
Investments
    3,195,000       5,463,000       60,716,000       59,900,000       43,461,000  
                                         
Total assets
    17,159,000       19,840,000       84,905,000       74,796,000       69,948,000  
                                         
Long-term debt
    648,000       449,000       240,000       19,000       -  
                                         
Total stockholders’ equity
    13,572,000       15,166,000       81,284,000       71,670,000       67,085,000  
 
25

 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following discussion is intended to assist you in understanding our financial condition and results of operations and should be read in conjunction with the financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Many of the amounts and percentages in this section have been rounded for convenience of presentation, but actual recorded amounts have been used in computations. Accordingly, some information may appear not to compute accurately.

Overview

We develop, market and sell wireless solutions for managing and securing high-value enterprise assets. These assets include industrial vehicles, such as forklifts and airport ground support equipment, and rental vehicles. Our patented Wireless Asset Net system, which utilizes RFID technology, addresses the needs of organizations to control, track, monitor and analyze their assets. Our solutions enable our customers to achieve tangible economic benefits by making timely, informed decisions that increase the security, productivity and efficiency of their operations.

We sell our system to both executive and division-level management. Typically, our initial system deployment serves as a basis for potential expansion across the customer’s organization. Ford Motor Company, Walgreens, the U.S. Postal Service, Target and Wal-Mart Stores, Inc. are all examples of this progression.

 
·
Ford initially implemented our system at one plant in 1999, which led to a blanket purchase order to deploy our system across its North American operations. As of December 31, 2008, we had deployed our system at 38 Ford facilities.

 
·
Walgreens initially deployed our system at a single distribution center in 2003.As of December 31, 2008, we had deployed our system at 12 distribution centers.

 
·
The U.S. Postal Service used the implementation of our system at one of its facilities to form the basis of a solicitation for competitive bids for a powered vehicle management system. Based on our proposal for that program, the U.S. Postal Service awarded us a national contract in 2004 to deploy our system at up to 460 U.S. Postal Service facilities nationwide. As of December 31, 2008, we had deployed our system at 113 facilities.

 
·
Beginning in 2003, Target utilized our system on a limited number of vehicles at one of its facilities As of December 31, 2008, we had deployed our system at 31 facilities.

 
·
Wal-Mart initially deployed our system at a single distribution center in 2005. After testing our system, Wal-Mart ordered our system to be deployed in 50 facilities as of December 31, 2008.

We work closely with customers like these to help maximize the utilization and benefits of our system and demonstrate the value of enterprise-wide deployments.

We have incurred net losses of approximately $7.3 million and $4.2 million for the years ended December 31, 2007 and 2008, respectively, and have incurred additional net losses since inception. At December 31, 2008, we had an accumulated deficit of approximately $23.7 million.
 
During the year ended December 31, 2008, we generated revenues of $27 million, and the U.S. Postal Service and Wal-Mart Stores, Inc. accounted for 42% and 41% of our revenues, respectively. During the year ended December 31, 2007, we generated revenues of $17.1 million, and the U.S. Postal Service, Wal-Mart Stores, Inc. and Ford Motor Company accounted for 37%, 32% and 10% of our revenues, respectively.

Our ability to increase our revenues and generate net income will depend on a number of factors, including our ability to:

 
·
increase sales of products and services to our existing customers;

 
·
convert our initial programs into larger or enterprise-wide purchases by our customers;

 
·
increase market acceptance and penetration of our products; and

 
·
develop and commercialize new products and technologies.

 
26

 
 
Critical Accounting Policies And Estimates

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in Note B to our financial statements. Certain accounting policies involve significant judgments and assumptions by our management that can have a material impact on the carrying value of certain assets and liabilities. We consider such accounting policies to be our critical accounting policies. The judgments and assumptions used by our management in these critical accounting policies are based on historical experience and other factors that our management believes to be reasonable under the circumstances. Because of the nature of these judgments and assumptions, actual results could differ significantly from these judgments and estimates, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. Our critical accounting policies are described below.

Revenue Recognition

We derive our revenues from: (i) sales of our Wireless Asset Net system, which includes training and technical support; (ii) post-contract maintenance and support agreements; and periodically (iii) leasing arrangements. Our system consists of on-asset hardware, communication infrastructure and software. Revenue is allocated to each element based upon vendor specific objective evidence (VSOE) of the fair value of the element. VSOE of the fair value is based upon the price charged when the element is sold separately. Revenue from the sale of our system is recognized as the element is earned based on the selling price of each element and when there are no undelivered elements that are essential to the functionality of the delivered elements. Our system is typically implemented by the customer or a third party and, as a result, revenues are recognized when title and risk of loss passes to the customer, which usually is upon delivery of the system, pervasive evidence of an arrangement exists, sales price is fixed and determinable, collectability is reasonably assured and contractual obligations have been satisfied. In some instances, we are also responsible for providing installation services. The additional installation services, which could be performed by third parties, are considered another element in a multi-element deliverable and revenue for installation services is recognized at the time the installation is provided. Revenues from training and technical support are recognized as such services are provided.

We also enter into post-contract maintenance and support agreements. Revenues are recognized over the service period and the cost of providing these services is expensed as incurred.

Stock-Based Compensation

Prior to January 1, 2006, we accounted for stock-based employee compensation under Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and had adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which replaced SFAS 123 and superseded APB Opinion No. 25. Under the provisions of SFAS 123R, companies are generally required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. SFAS 123R requires that compensation expense be recognized for the unvested portions of existing options granted prior to its effective date and the cost of options granted to employees after the effective date based on the fair value of the stock options at grant date. Commencing January 1, 2006, we adopted SFAS 123R, and have applied the modified prospective method such that periods prior to adoption have not been restated. Pursuant to SFAS No. 123(R), stock based compensation expense amounted to $2,975,000, $3,288,000 and $2,989,000 for the fiscal years ended December 31, 2006, 2007 and 2008, respectively.

 
27

 

Results of Operations

The following table sets forth certain items related to our statement of operations as a percentage of revenues for the periods indicated and should be read in conjunction with our financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. A detailed discussion of the material changes in our operating results is set forth below.
  
   
Year Ended December 31,
 
   
2006
 
2007
 
2008
 
Revenues:
             
Products
   
65.5
%
64.6
%
74.2
%
Services
   
34.5
 
35.4
 
25.8
 
     
100.0
 
100.0
 
100.0
 
Cost of Revenues:
               
Products
   
33.3
 
34.3
 
37.0
 
Services
   
22.1
 
18.0
 
12.8
 
                 
Total Gross Profit
   
44.6
 
47.7
 
50.2
 
                 
Selling, general and administrative expenses
   
52.3
 
93.4
 
62.0
 
Research and development expenses
   
10.7
 
16.7
 
10.7
 
                 
Loss from operations
   
(18.4
)
(62.4
)
(22.4
)
Interest income
   
11.3
 
19.0
 
8.2
 
Interest expense
   
(0.1
)
(0.1
)
   
Other income (loss)
   
0.6
 
0.5
 
(1.2)
 
                 
Net loss
   
(6.5)
%
(43.0)
%
(15.4)
%
 
 
28

 

Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007

REVENUES. Revenues increased by $9.9 million, or 58.3%, to $27.0 million in 2008 from $17.1 million in 2007.

Revenues from product increased by $9.0 million, or 81.9%, to $20.0 million in 2008 from $11.0 million in 2007. The increase in product revenue was primarily attributable to an increase in product revenue from the U.S. Postal Service and Wal-Mart Stores, Inc.

Revenues from service increased $928,000, or 15.3%, to $6.9 million in 2008 from $6.0 million in 2007. The increase in revenues was primarily attributable to an increase in service revenue from the U.S. Postal Service.

COST OF REVENUES. Cost of revenues increased by $4.5 million, or 50.8%, to $13.4 million in 2008 from $8.9 million in 2007. Gross profit was $13.6 million in 2008 compared to $8.2 million in 2007. As a percentage of revenues, gross profit increased to 50.2% in 2008 from 47.7% in 2007.

Cost of product increased by $4.1 million, or 70.6%, to $10.0 million in 2008 from $5.9 million in the same period in 2007. Gross profit from product revenue was $10.0 million in 2008 compared to $5.2 million in 2007. As a percentage of product revenues, gross profit increased to 50.2% in 2008 from 46.9% in 2007. The increase in gross profit is primarily attributable to a lesser amount reserved for inventory obsolescence in 2008 as compared to 2007. The amount of inventory identified as obsolete and therefore charged to cost of product was $517,000 in 2007 and $126,000 in 2008.
 
Cost of service increased by $400,000, or 13.0%, to $3.5 million in 2008 from $3.1 million in the same period in 2007. Gross profit from service revenue was $3.5 million in 2008 compared to $3.0 million in 2007. As a percentage of service revenues, gross profit slightly increased to 50.2% in 2008 from 49.2% in 2007. The increase was marginal and was attributed to increased service revenue, in general.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $797,000, or 5.0%, to $16.8 million in 2008 compared to $16.0 million in 2007. This increase was attributable primarily to (i) the increase in payroll and related costs of approximately $661,000 primarily resulting from the hiring of additional staff within our sales and customer service departments and (ii) an increase in insurance expense of approximately $183,000 in 2008. As a percentage of revenues, selling, general and administrative expenses decreased to 62.0% in 2008 from 93.4% in 2007 due to an increase in revenue, partially offset by the aforementioned increase to payroll and payroll related expenses.

Research and Development Expenses. Research and development expenses were nearly flat with a minor increase of $34,000, or 1.2%, to $2.9 million in 2008 from $2.8 million in 2007. As a percentage of revenues, research and development expenses decreased to 10.7% in 2008 from 16.7% in 2007 due to an increase in revenue.

Interest Income. Interest income decreased $1.0 million, or 31.2%, to $2.2 million in 2008 from $3.2 million in 2007. This decrease was attributable to the decrease in interest rates as well as a decrease in the amount of cash, cash equivalents and investments in 2008.

Interest Expense. Interest expense decreased $10,000 to $0 in 2008 from $10,000 in 2007. The decrease was attributable to the payoff of our outstanding debt in February 2008.

Other Income (loss). Other loss of $338,000 in 2008 reflects a charge to operations related to our auction rate securities and auction rate securities right as disclosed in Note C of the financial statements. Other income of $89,000 in 2007 reflects rental income earned from a sublease arrangement. In July 2007, we released the sub-lessee from the sublease and reassumed the space.
 
Net Loss. Net loss was $4.2 million, or $(0.38) per basic and diluted share for the year ended December 31, 2008, as compared to net loss of $7.3 million or $(0.66) per basic and diluted share for the year ended December 31, 2007. The decrease in net loss was due primarily to the reasons described above with emphasis on the increase in revenue and an improvement in the gross profit percentage.

Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006

REVENUES. Revenues decreased by $7.7 million, or 30.9%, to $17.1 in 2007 from $24.7 million in 2006.

Revenues from product decreased by $5.2 million, or 31.9%, to $11.0 million in 2007 from $16.2 million in 2006. The decrease in product revenue was primarily attributable to a decrease in product revenue from the U.S. Postal Service of approximately $6.2 million, offset by an increase of product revenue from Wal-Mart Stores, Inc of approximately $2.0 million, and a decrease in product revenue from other customers.

Revenues from service decreased $2.5 million, or 29.2%, to $6.0 million in 2007 from $8.5 million in 2006. The decrease in revenues was primarily attributable to a decrease in service revenue from the U.S. Postal Service of approximately $2.7 million, partially offset by an increase in service revenue from other customers.

 
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COST OF REVENUES . Cost of revenues decreased by $4.8 million, or 34.8%, to $8.9 million in 2007 from $13.7 million in 2006. Gross profit was $8.2 million in 2007 compared to $11.0 million in 2006. As a percentage of revenues, gross profit increased to 47.7% in 2007 from 44.6% in 2006.

Cost of product decreased by $2.4 million, or 28.8%, to $5.9 million in 2007 from $8.2 million in the same period in 2006. Gross profit from product revenue was $5.2 million in 2007 compared to $8.0 million in 2006. As a percentage of product revenues, gross profit decreased to 46.9% in 2007 from 49.2% in 2006. The decrease in gross profit is primarily attributable to a greater amount reserved for inventory obsolescence in 2007 as compared to 2006. The amount of inventory identified as obsolete and therefore charged to cost of product was $517,000 in 2007 and $100,000 in 2006.
 
Cost of service decreased by $2.4 million, or 43.9%, to $3.1 million in 2007 from $5.5 million in the same period in 2006. Gross profit from service revenue was $3.0 million in 2007 compared to $3.1 million in 2006. As a percentage of service revenues, gross profit increased to 49.2% in 2007 from 35.9% in 2006. The increase was primarily attributable to the fact that a larger percentage of the service revenue in 2007 was from engineering services and maintenance, which typically have higher gross margins than revenue from implementation services.

Selling, General and Administrative Expenses . Selling, general and administrative expenses increased $3.0 million, or 23.3%, to $16.0 million in 2007 compared to $12.9 million in 2006. This increase was attributable primarily to (i) the increase in payroll of approximately $2.2 million primarily resulting from the hiring of additional staff within our sales and customer service departments and (ii) an increase to the stock based employee compensation expense of $439,000 in 2007. As a percentage of revenues, selling, general and administrative expenses increased to 93.4% in 2007 from 52.3% in 2006 due to the aforementioned increase to payroll and payroll related expenses as well as to a decrease in revenue.

Research and Development Expenses. Research and development expenses increased $210,000, or 8.0%, to $2.8 million in 2007 from $2.6 million in 2006. This increase was attributable primarily to the work performed relating to the development of European compliant products. As a percentage of revenues, research and development expenses increased to 16.7% in 2007 from 10.7% in 2006 due to the aforementioned increase to expenses as well as to a decrease in revenue.

Interest Income. Interest income increased $437,000, or 15.6%, to $3.2 million in 2007 from $2.8 million in 2006. This increase was attributable primarily to the increase in cash and cash equivalents and investments resulting from the proceeds received in connection with the public offering completed by us in March 2006.
Interest Expense. Interest expense decreased $19,000, or 65.5%, to $10,000 in 2007 from $29,000 in 2006. The decrease was attributable to a reduction in the principal amount of our outstanding debt in 2007.

Other Income. Other income decreased $66,000, or 42.6%, to $89,000 in 2007 from $155,000 in 2006 and reflects rental income earned from a sublease arrangement. In July 2007, we released the sublessee from the sublease and reassumed the space.

Net Income (Loss). Net loss was $7.3 million or $(0.66) per basic and diluted share in the year ended December 31, 2007 as compared to net loss of $1.6 million or $(0.15) per basic and diluted share for the year ended December 31, 2006. The increase in net loss was due primarily to the reasons described above.

Liquidity and Capital Resources

Historically, our capital requirements have been funded from cash flow generated from our business and net proceeds from the issuance of our securities, including the issuance of our common stock upon the exercise of options and warrants. As of December 31, 2008, we had cash, cash equivalents and investments, which include auction rate securities and an auction rate securities right, of $56.0 million and working capital of $30.9 million compared to $65.0 million and $31.9 million, respectively, as of December 31, 2007.

At December 31, 2007 and 2008, we held approximately $25.1 million ($25.1 million par value) and $18.1 million ($20.4 million par value), respectively, in investments in auction rate securities which represent interests in collateralized pools of student loan receivables issued by agencies established by counties, cities, states and other municipal entities. We sold approximately $5.0 million of these investments in 2008. Since February 2008 we have experienced difficulty in effecting additional sales of such securities because of the failure of the auction mechanism as a result of sell orders exceeding buy orders. Liquidity for these auction rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals. Holders of the securities continue to receive interest on the investments, and the securities continue to be auctioned at the pre-determined intervals (typically every 28 days) until the auction succeeds, the issuer calls the securities, or they mature. These failed auctions represent liquidity risk exposure and are not defaults or credit events. A decline in the value of these securities that is not temporary could materially adversely affect our liquidity and income.
 
In October 2008, we received an offer (the “Offer”) from UBS for a put right permitting us to sell to UBS at par value all auction rate securities previously purchased from UBS at a future date (any time during a two-year period beginning June 30, 2010). The Offer also included a commitment to loan us 75% of the UBS-determined value of the auction rate securities at any time until the put is exercised. In exchange for the Offer, we were required to provide UBS with a general release of claims (other than certain consequential damages claims) concerning our auction rate securities and grant UBS the right to purchase our auction rate securities at any time for full par value. The Offer was non-transferable and expired on November 14, 2008. During November 2008, we accepted the Offer. Our right under the Offer is in substance a put right (with the strike price equal to the par value of the auction rate securities) which we recorded as an asset, measured at its fair value (pursuant to election under SFAS No. 159), with the resultant gain recognized in earnings. Pursuant to SFAS No. 159, we recorded the put right at a fair value of $2.0 million and recognized the gain in operations. As we have classified the auction rate securities as trading securities, the $2.3 million decline in fair value of the auction rate securities was charged to operations in 2008. The net charge to operations in 2008 was $338,000 which was included in other expense. The fair value of the put right was based on an approach in which the present value of all expected future cash flows were subtracted from the current fair market value of the security and the resultant value was calculated as a future value at an interest rate reflective of counterparty risk.
 
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Given the substantial dislocation in the financial markets and among financial services companies, we cannot assure you that UBS ultimately will have the ability to repurchase our auction rate securities at par, or at any other price, as these rights will be an unsecured contractual obligation of UBS or that if UBS determines to purchase our auction rate securities at any time, we will be able to reinvest the cash proceeds of any such sale at the same interest rate or dividend yield currently being paid to us. Also, as a condition of accepting the auction rate securities rights, we were required to sign a release of claims against UBS, which will prevent us from making claims against UBS related to our investment in auction rate securities, other than claims for consequential damages.

Business Acquisition

On April 18, 2008, we acquired the assets of PowerKey, the industrial vehicle monitoring products division of International Electronics, Inc., a manufacturer of access control and security equipment, for approximately $573,000, which includes approximately $73,000 of direct acquisition costs. The tangible assets acquired include inventory (totaling approximately $191,000), and fixed assets (totaling approximately $4,000).

Allocation of the purchase price of the intangible assets consists of the following: goodwill (totaling approximately $200,000), trademarks and trade names (totaling approximately $74,000), and a customer list (totaling approximately $104,000) resulting from the acquisition of PowerKey are carried at cost.
 
Operating Activities

Net cash used in operating activities was $4.9 million for the year ended December 31, 2008 compared to net cash provided by operating activities of $604,000 for the year ended December 31, 2007. The change was due primarily to an increase in accounts receivable resulting from the increase in revenue, partially offset by a decrease in net loss.

Net cash provided by operating activities was $604,000 for the year ended December 31, 2007 compared to net cash used in operating activities of $1.1 million for the year ended December 31, 2006. The change was due primarily to (i) a decrease in accounts receivable resulting from improved collections and (ii) a decrease in finished goods inventory, partially offset by an increase in net loss.

Investing Activities

Net cash provided by investing activities was $15.4 million for the year ended December 31, 2008 compared to net cash provided by investing activities of $284,000 for the year ended December 31, 2007. The increase was due to an increase in the maturities of investments, partially offset by fewer purchases of investments in 2008 and the business acquisition of Powerkey.

Net cash provided by investing activities was $284,000 for the year ended December 31, 2007 compared to net cash used in investing activities of $56.0 million for the year ended December 31, 2006. The change was due primarily to an increase in the maturities of investments and fewer purchases of investments in 2007.

Financing Activities

Net cash used in financing activities was $3.0 million for the year ended December 31, 2008 compared to net cash used in financing activities of $5.4 million for the year ended December 31, 2007. The decrease in cash used was due primarily to less cash used to purchase shares of our issued and outstanding common stock during 2008 pursuant to our share repurchase program authorized by our Board of Directors in May 2007 and an increase in proceeds from the exercise of stock options.

Net cash used in financing activities was $5.4 million for the year ended December 31, 2007 compared to net cash provided by $64.5 million for the year ended December 31, 2006. The decrease was due primarily to the proceeds received in connection with the public offering that was completed in March 2006 that were not received in 2007, as well as the purchase of shares of our issued and outstanding common stock during 2007 pursuant to our share purchase program authorized by our Board of Directors in May 2007.

 
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Capital Requirements

We believe that with the proceeds received from our public offering that was completed by us in March 2006, the cash we have on hand and operating cash flows we expect to generate, we will have sufficient funds available to cover our capital requirements for at least the next 12 months.

Our capital requirements depend on a variety of factors, including, but not limited to, the length of the sales cycle, the rate of increase or decrease in our existing business base, the success, timing, and amount of investment required to bring new products to market, revenue growth or decline and potential acquisitions. Failure to generate positive cash flow from operations will have a material adverse effect on our business, financial condition and results of operations. We may determine in the future that we require additional funds to meet our long-term strategic objectives, including to complete potential acquisitions. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve significant restrictive covenants, and we cannot assure you that such financing will be extended on terms acceptable to us or at all.

Term Loan

In January 2003, we closed on a five-year term loan for $1,000,000 with a financial institution. Interest at the 30-day LIBOR plus 1.75% and principal are payable monthly. To hedge the loan’s floating interest expense, we entered into an interest rate swap contemporaneously with the closing of the loan and fixed the rate of interest at 5.28% for the five-year term. At December 31, 2007 the outstanding balance on the loan was $19,000. In February 2008 we paid off the remaining principal balance on the loan which is $0 at December 31, 2008. The term-loan expired in 2008.

Contractual Obligations and Commitments

The following table summarizes our significant contractual obligations and commitments as of December 31, 2008:
  
 
Payment due by Period
 
 
Total
 
Less than
one year
 
1 to 3 years
 
3 to 5 years
 
After 5
years
 
Operating Leases
    563,000       455,000       108,000              
                                         
Total Contractual Cash Obligations
  $ 563,000     $ 455,000     $ 108,000     $     $  

Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Although we have entered into contracts for services, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.

The expected timing or payment of obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on changes to agreed upon amounts for some obligations.

Inflation

We believe our operations have not been and, in the foreseeable future, will not be materially and adversely affected by inflation or changing prices.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Recently Issued Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment to SFAS No. 115” (“SFAS No. 159”) which is effective for fiscal years beginning after November 15, 2007. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reporting earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurements, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. We have elected to account for our auction rate security put right under the provisions of SFAS No. 159. Therefore, material financial assets and liabilities such as our accounts receivables and payables are still reported at their carrying value which approximates fair value.

 
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In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (“SFAS No. 157”), to define fair value, establish framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements, which is effective for fiscal years beginning after November 15, 2007, the beginning of our 2008 fiscal year. However, in February 2008, the FASB issued FASB Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which provides a one year deferral of the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). FSP 157-2 defers the effective date of SFAS No. 157 as it relates to non-financial assets to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of FSP 157-2. We adopted the provisions of SFAS No. 157 effective January 1, 2008.

In December 2007, the FASB issued SFAS No. 141R,“Business Combinations” (“SFAS No. 141R”), which replaces SFAS No. 141. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquire and the goodwill acquired. This statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Earlier adoption is prohibited. The impact, if any, that the implementation of SFAS No. 141R will have on our results of operations or financial condition will, in the future, be dependent on future acquisition activity, occurring after the effective date.
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidated date. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. As we do not presently have any noncontrolling interest in a subsidiary, the adoption of SFAS No. 160 is not expected to have a significant effect on us.

In March 2008, the FASB issued FASB No. 161, “Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133” (“SFAS No. 161”). This statement requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. This statement has the same scope as Statement 133. This statement applies to all derivative instruments, including bifurcated derivative instruments (and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42 of Statement 133) and related hedged items accounted for under Statement 133 and its related interpretations. We have not yet determined the impact, if any, that the implementation of SFAS No. 161 will have on our results of operations or financial condition.

In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS No. 142-3”). FSP FAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141 (revised 2007), Business Combinations, and other US GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company has not yet determined the impact, if any, FSP FAS No. 142-will have on the our financial position, results of operations or cash flows.
 
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with United States Generally Accepted Accounting Principles. SFAS 162 became effective in September 2008 following the approval by the SEC. We currently adhere to the hierarchy of U.S. GAAP as presented in SFAS 162, and adoption is not expected to have a material impact on our consolidated financial statements.

In September 2008, the EITF issued EITF No. 08-6, Equity Method Investment Accounting Considerations (“EITF 08-6”). EITF 08-6 addresses the effect of SFAS No. 141(R) and SFAS No. 160 on the equity method of accounting. EITF 08-0 is effective in fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. Currently, we have no equity investees and therefore, this standard will have no current impact on our financial position, results of operations or cash flows. The impact, if any, that the implementation of EITF No. 08-06 will have on our results of operations or financial condition will, in the future, be dependent on future acquisition or investment activity, occurring after the effective date, if any.

 
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In October 2008, the FASB issued FASB Staff Position (“FSP”) 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP 157-3 clarified the application of FAS 157. FSP 157-3 demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The guidance provided by FSP 157-3 is consistent with our approach to valuing our auction rate securities for which there is no active market.
 
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risks in the form of changes in corporate income tax rates, which risks are currently immaterial to us.

We also are subject to market risk from changes in interest rates which could affect our future results of operations and financial condition. We manage our exposure to these risks through our regular operating and financing activities. As of December 31, 2008, we had cash, cash equivalents and investments, which includes auction rate securities and an auction rate securities right, of $56.0 million.

As of December 31, 2008 the carrying value of our cash and cash equivalents approximated fair value. In a declining interest rate environment, as short-term investments mature, reinvestment occurs at less favorable market rates, negatively impacting future investment income. We maintain our cash and cash equivalents with major financial institutions; however, our cash and cash equivalent balances with these institutions exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. While we monitor on a systematic basis the cash and cash equivalent balances in the operating accounts and adjust the balances as appropriate, these balances could be impacted if one or more of the financial institutions with which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date, we have experienced no loss of principal or lack of access to our invested cash or cash equivalents; however, we can provide no assurance that access to our invested cash and cash equivalents will not be affected if the financial institutions in which we hold our cash and cash equivalents fail or the financial and credit markets continue to worsen.

At December 31, 2007 and 2008, we held approximately $25.1 million ($25.1 million par value) and $18.1 million ($20.4 million par value), respectively, in investments in auction rate securities which represent interests in collateralized pools of student loan receivables issued by agencies established by counties, cities, states and other municipal entities. We sold approximately $5.0 million of these investments in 2008. Since February 2008 we have experienced difficulty in effecting additional sales of such securities because of the failure of the auction mechanism as a result of sell orders exceeding buy orders. Liquidity for these auction rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals. Holders of the securities continue to receive interest on the investments, and the securities continue to be auctioned at the pre-determined intervals (typically every 28 days) until the auction succeeds, the issuer calls the securities, or they mature. These failed auctions represent liquidity risk exposure and are not defaults or credit events. A decline in the value of these securities that is not temporary could materially adversely affect our liquidity and income.
 
In October 2008, we received an offer (the “Offer”) from UBS for a put right permitting us to sell to UBS at par value all auction rate securities previously purchased from UBS at a future date (any time during a two-year period beginning June 30, 2010). The Offer also included a commitment to loan us 75% of the UBS-determined value of the auction rate securities at any time until the put is exercised. In exchange for the Offer, we were required to provide UBS with a general release of claims (other than certain consequential damages claims) concerning our auction rate securities and grant UBS the right to purchase our auction rate securities at any time for full par value. The Offer was non-transferable and expired on November 14, 2008. During November 2008, we accepted the Offer. Our right under the Offer is in substance a put right (with the strike price equal to the par value of the auction rate securities) which we recorded as an asset, measured at its fair value (pursuant to SFAS No. 159), with the resultant gain recognized in earnings. We recorded the put right at a fair value of $2.0 million and recognized the gain in operations, which, together with the $2.3 million decline in fair value of the auction rate securities, resulted in a net charge to operations in 2008 of $338,000 included in other expense. The fair value of the put right was based on an approach in which the present value of all expected future cash flows were subtracted from the current fair market value of the security and the resultant value was calculated as a future value at an interest rate reflective of counterparty risk.

Given the substantial dislocation in the financial markets and among financial services companies, we cannot assure you that UBS ultimately will have the ability to repurchase our auction rate securities at par, or at any other price, as these rights will be an unsecured contractual obligation of UBS or that if UBS determines to purchase our auction rate securities at any time, we will be able to reinvest the cash proceeds of any such sale at the same interest rate or dividend yield currently being paid to us. Also, as a condition of accepting the auction rate securities rights, we were required to sign a release of claims against UBS, which will prevent us from making claims against UBS related to our investment in auction rate securities, other than claims for consequential damages.

 
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Item 8. Financial Statements and Supplementary Data
  
INDEX TO FINANCIAL STATEMENTS
 
 
Page
   
Report of Independent Registered Public Accounting Firm
36
Balance Sheets at December 31, 2007 and 2008
38
Statements of Operations for the Years
 
Ended December 31, 2006, 2007 and 2008
39
Statements of Changes in Stockholders' Equity for the Years
 
Ended December 31, 2006, 2007 and 2008
40
Statements of Cash Flows for the Years
 
Ended December 31, 2006, 2007 and 2008
41
Notes to the Financial Statements
42

 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
Board of Directors and Stockholders of
I.D. Systems, Inc.

We have audited the accompanying balance sheets of I.D. Systems, Inc. as of December 31, 2007 and 2008 and the related statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008. Our audits also included the financial statement schedule II - Valuation and Qualifying Accounts for each of the years in the three-year period ended December 31, 2008 listed in Item 15.(a)(2) in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of I.D. Systems, Inc. as of December 31, 2007 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements, taken as a whole, presents fairly, in all material respects, the information stated therein.

As described in Note B to the financial statements, effective January 1, 2008, the Company elected to adopt Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Liabilities.”
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), I.D. Systems, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 12, 2009 expressed an unqualified opinion thereon.

/s/ Eisner LLP
 
New York, New York
March 12, 2009

 
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I.D. SYSTEMS, INC.
Balance Sheets

   
As of December 31,
 
   
2007
   
2008
 
ASSETS  
           
Current assets:
           
Cash and cash equivalents
  $ 5,103,000     $ 12,558,000  
Restricted cash
          230,000  
Investments – short term
    21,385,000       8,550,000  
Accounts receivable, net of allowance for doubtful accounts of $239,000 in 2007 and 2008
    2,875,000       8,245,000  
Unbilled receivables
    580,000       168,000  
Inventory, net
    4,420,000       3,273,000  
Interest receivable
    142,000       217,000  
Prepaid expenses and other current assets
    291,000       261,000  
                 
Total current assets
    34,796,000       33,502,000  
                 
Investments –long term
    38,515,000       34,911,000  
Fixed assets, net
    1,398,000       1,050,000  
Goodwill
          200,000  
Other intangible assets
     —       178,000  
Other assets
    87,000       107,000  
                 
    $ 74,796,000     $ 69,948,000  
                 
LIABILITIES
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 2,594,000     $ 2,175,000  
Current portion of long term debt
    19,000        
Deferred revenue
    291,000       424,000  
                 
Total current liabilities
    2,904,000       2,599,000  
                 
Deferred revenue
    167,000       231,000  
Deferred rent
    55,000       33,000  
                 
      3,126,000       2,863,000  
Commitments and Contingencies (Note J)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock; authorized 5,000,000 shares, $0.01 par value; none issued
           
Common stock; authorized 50,000,000 shares, $.01 par value; 11,561,000 and 12,082,000 shares issued at December 31, 2007 and 2008, respectively, shares outstanding, 11,015,000 and 10,893,000 at December 31, 2007 and 2008, respectively
    115,000       120,000  
Additional paid-in capital
    97,076,000       101,437,000  
Accumulated deficit
    (19,492,000 )     (23,667,000 )
Accumulated other comprehensive income
    11,000       46,000  
      77,710,000       77,936,000  
Treasury stock; 546,000 shares and 1,189,000 shares at cost at December 31, 2007 and 2008, respectively
    (6,040,000 )     (10,851,000 )
Total stockholders’ equity
    71,670,000       67,085,000  
Total liabilities and stockholders’ equity
  $ 74,796,000     $ 69,948,000  

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

 
38

 

I.D. SYSTEMS, INC.
Statements of Operations

   
Year Ended December 31,
 
   
2006
   
2007
   
2008
 
                   
Revenues:
                 
Products
  $ 16,205,000     $ 11,037,000     $ 20,072,000  
Services
    8,535,000       6,046,000       6,974,000  
      24,740,000       17,083,000       27,046,000  
Cost of Revenues:
                       
Cost of products
    8,229,000       5,859,000       9,996,000  
Cost of services
    5,472,000       3,070,000       3,470,000  
      13,701,000       8,929,000       13,466,000  
                         
Gross Profit
    11,039,000       8,154,000       13,580,000  
                         
Operating expenses:
                       
Selling, general and administrative expenses
    12,943,000       15,963,000       16,760,000  
Research and development expenses
    2,639,000       2,849,000       2,883,000  
                         
      15,582,000       18,812,000       19,643,000  
                         
Loss from operations
    (4,543,000 )     (10,658,000 )     (6,063,000 )
Interest income
    2,801,000       3,238,000       2,226,000  
Interest expense
    (29,000 )     (10,000 )      
Other income (loss)
    155,000       89,000       (338,000 )
                         
Net loss
  $ (1,616,000 )   $ (7,341,000 )   $ (4,175,000 )
                         
Net loss per share – basic and diluted
  $ (0.15 )   $ (0.66 )   $ (0.38 )
                         
Weighted average common shares outstanding – basic and diluted
    10,501,000       11,205,000       10,887,000  

SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS

 
39

 

I.D. SYSTEMS, INC.
Statements of Changes in Stockholders' Equity
                     
Accumulated
             
   
Common Stock
   
Additional
         
Other
             
   
Number of
         
Paid-in
   
Accumulated
   
Comprehensive
   
Treasury
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Deficit
   
Income
   
Stock
   
Equity
 
                                           
Balance at January 1, 2006
    7,851,000     $ 79,000     $ 25,735,000     $ (10,535,000 )         $ (113,000 )   $ 15,166,000  
Net loss
                            (1,616,000 )                     (1,616,000 )
Comprehensive income - unrealized gain on investments
                                    12,000               12,000  
Total comprehensive loss
                                                    (1,604,000 )
Shares issued pursuant to exercise of stock options
    200,000       2,000       784,000                               786,000  
Shares issued pursuant to a public offering
    2,750,000       28,000       55,500,000