Sunday, November 7, 2010

Image Sensing Systems ( ISNS - Nasdaq )

Image Sensing Systems (ISNS $12.50) is the leading provider of machine vision systems used in traffic applications.  The company's products are mounted at intersections to optimize traffic flow.  The technology is superior to underground sensors, which cost more to maintain because the entire road has to be torn up when mechanical problems occur.  The systems' ability to "see" and mathematically interpret the situation also speeds up response time.  Image Sensing additionally sells units for use in tunnels (to spot fires), along busy highways (accidents), and in a variety of other applications.  An acquisition last year added a complementary technology that relies on radar detection.  Poor lighting conditions sometimes confuse the machine vision software algorithms.  Radar provides a second tool for confirming where the cars are.  In the June quarter of 2010 Image Sensing purchased a provider of automated license reading systems, as well.  That line already enjoys a growing stand alone customer base, primarily for police and anti-terror applications.  The company hopes to generate further leverage by marketing it together it with its traditional traffic control business, creating more competitive differentiation and higher average selling prices.

Financial results have been under pressure due to the worldwide recession.  State and local governments have scaled back highway projects in the United States because of budgetary shortfalls.  International business has held up better, mainly as a result of new road construction in third world nations.  But the pace of that growth has been constrained, as well.  Overall sales dipped 7% in 2009 to $24.6 million despite a modest contribution from the acquired radar line.  Earnings narrowed 20% to $1.15 a share.  (See "Accounting Notes.")  Same store sales have been relatively flat so far in 2010, a good showing in light of the ongoing budget pressures.  Overall sales are poised to increase 22% to $30 million, bolstered by the two acquisitions.  Higher marketing, product development, and integration costs have prevented income from keeping pace, though.  Those efforts are laying the groundwork for market share gains in the future.  Meantime, though, full year earnings likely will decline again, this time by 22% to $.90 a share.

A major rebound could begin 2011.  Image Sensing has tooled up its direct sales operation in China and other Far East nations over the past three years.  That effort is bearing fruit as the level of highway construction continues to ramp up in those markets.  Sales to Eastern Europe are bouncing back, as well.  And U.S. business could take off if the funding issues are neutralized.  Traffic congestion could intensify if the economy recovers.  Image Sensing's technology provides a cost effective alternative to new construction by making existing roads more efficient.  The company's competitive position has improved dramatically over the past few years, since smaller operators have been unable to match Image Sensing's ongoing investment in marketing and new product development.  The combination of resurgent demand and superior products could lay the foundation for accelerating financial performance over the next several years.

We estimate 2011 income will improve 50% to $1.35 a share on a 33% gain in sales ($40 million).  Growth could be sustained at above average rates in subsequent years as sales to China and other international markets keep expanding, and Image Sensing's share of the North American market widens.  Higher average selling prices, made possible by combining the license plate reading and radar technologies with the core machine vision line, should generate further leverage.  In 2-3 years sales could attain $60 million to deliver earnings of $2.25 a share.  Applying a P/E multiple of 18x suggests a target price of $40 a share, potential appreciation of 220% from the prevailing quote.

(Click on table to enlarge)

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