UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, ~~2018~~2019

¨TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 0-26056

Image Sensing Systems, Inc.

(Exact Name of Registrant as Specified in its Charter)

Minnesota		41-1519168
State or Other Jurisdiction of Incorporation or Organization		I.R.S. Employer Identification No.

500 Spruce Tree Centre
1600 University Avenue West
St. Paul, MN		55104
Address of Principal Executive Offices		Zip Code

(651) 603-7700

Registrant’s Telephone Number, Including Area Code

Not Applicable

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit ~~and post~~ such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨	~~Accelerated filer~~ ¨
~~Non-accelerated~~Accelerated filer ¨ ~~(Do not check if a smaller reporting company)~~	~~Smaller reporting company~~ x
Non-accelerated filer¨
Smaller reporting companyx
Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.01 par value	ISNS	The NASDAQ Capital Market
Preferred Stock Purchase Rights	ISNS	The NASDAQ Capital Market

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class		Outstanding at April 30, ~~2018~~2019
Common Stock, $0.01 par value per share		~~5,256,226~~5,304,457 shares

IMAGE SENSING SYSTEMS, INC.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION	34
Item 1. Financial Statements ~~(unaudited)~~	34
Condensed Consolidated Balance Sheets	34
Condensed Consolidated Statements of Operations	45
Condensed Consolidated Statements of Comprehensive Income (Loss)	56
Condensed Consolidated Statements of Cash Flows	67
Condensed Consolidated Statements of Shareholders' Equity	8
Notes to Condensed Consolidated Financial Statements	79
Item 2. ~~Management’s~~Management's Discussion and Analysis of Financial Condition and Results of Operations	1620
Item 3. Quantitative and Qualitative Disclosures About Market Risk	2226
Item 4. Controls and Procedures	2226
PART II. OTHER INFORMATION	2327
Item 1. Legal Proceedings	2327
Item 1A. Risk Factors	2327
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	2327
Item 3. Defaults Upon Senior Securities	2327
Item 4. Mine Safety Disclosures	2327
Item 5. Other Information	2327
Item 6. Exhibits	2428
SIGNATURES	2529
EXHIBIT INDEX	2630

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Image Sensing Systems, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

March 31,
2018

December 31,

(Unaudited)

2017
ASSETS

Current assets:

Cash and cash equivalents
$
3,322

$
3,190

Accounts receivable, net of allowance for doubtful accounts of $23 and $20, respectively

2,756

3,339

Inventories

388

335

Prepaid expenses and other current assets

347

255

Total current assets
6,813

7,119

Property and equipment:

Furniture and fixtures

164

164

Leasehold improvements

26

26

Equipment

1,046

998

1,236

1,188

Accumulated depreciation

764

702

472

486

Intangible assets, net

3,440

3,485

Deferred income taxes

37

38

TOTAL ASSETS
$
10,762

$
11,128

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:

Accounts payable
$
  612

$
563

Warranty

777

858

Accrued compensation

170

288

Other current liabilities

505

778

Total current liabilities

2,064

2,487

TOTAL LIABILITIES

2,064

2,487

Shareholders' equity:

Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued or outstanding

—

—

Common stock, $0.01 par value; 20,000,000 shares authorized, 5,256,226 and 5,210,448


issued and outstanding at March 31, 2018 and December 31, 2017, respectively

52

51

Additional paid-in capital

24,429

24,355

Accumulated other comprehensive loss

(311
)

(310
)
Accumulated deficit

(15,472
)

(15,455
)
Total shareholders' equity

8,698

8,641

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
10,762

$
11,128

See accompanying notes to the condensed consolidated financial statements.

	March 31, 2019			December 31,
	(Unaudited)			2018
ASSETS
Current assets:
Cash and cash equivalents	$	3,948		$	4,236
Accounts receivable, net of allowance for doubtful accounts of $74 and $72, respectively		3,417			3,830
Inventories		1,208			1,289
Prepaid expenses and other current assets		353			410
Total current assets		8,926			9,765

Property and equipment:
Furniture and fixtures		163			162
Leasehold improvements		8			8
Equipment		1,131			1,058
		1,302			1,228
Accumulated depreciation		936			882
		366			346

Operating lease assets, net		370			—
Intangible assets, net		3,586			3,317
Deferred income taxes		57			56
TOTAL ASSETS	$	13,305		$	13,484

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	248		$	878
Deferred revenue		628			716
Warranty		573			656
Accrued compensation		145			224
Operating lease obligations		254			—
Other current liabilities		291			373
Total current liabilities		2,139			2,847

Operating lease obligations		116			—
TOTAL LIABILITIES		2,255			2,847

Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued or outstanding		—			—
Common stock, $0.01 par value; 20,000,000 shares authorized, 5,293,941 and 5,278,485
issued and outstanding at March 31, 2019 and December 31, 2018, respectively		52			52
Additional paid-in capital		24,592			24,550
Accumulated other comprehensive loss		(342	)		(372	)
Accumulated deficit		(13,252	)		(13,593	)
Total shareholders' equity		11,050			10,637
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	13,305		$	13,484

See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

~~(Unaudited)~~

(in thousands, except per share data)

		Three-Month Periods Ended March 31,					Three-Month Periods Ended March 31,
		2018			2017		2019		2018
Revenue:
Product sales		$	844		$	1,440	$	1,621	$	844
Royalties			2,166			1,644		1,751		2,166
			3,010			3,084		3,372		3,010
Cost of revenue:
Product sales			355			544		685		355
Royalties			92			90		92		92
			447			634		777		447
Gross profit			2,563			2,450		2,595		2,563

Operating expenses:
Selling, general and administrative			1,761			1,436		1,665		1,761
Research and development			819			816		620		819
Restructuring charges								2		—
			2,580			2,252		2,287		2,580
Operating income (loss) from operations			(17	)		198		308		(17	)
Other, net			—			3
Income (loss) from operations before income taxes			(17	)		201		308		(17	)
Income tax expense			—			4		—		—
Net income (loss)		$	(17	)	$	197	$	308	$	(17	)
Net income (loss) per share:
Basic		$	(0.00	)	$	0.04	$	0.06	$	(0.00	)
Diluted		$	(0.00	)	$	0.04	$	0.06	$	(0.00	)

Weighted average number of common shares outstanding:
Basic			5,181			5,096		5,224		5,181
Diluted			5,181			5,096		5,243		5,181

See accompanying notes to the condensed consolidated financial statements.	See accompanying notes to the condensed consolidated financial statements.						See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

~~(Unaudited)~~

(in thousands)

		Three-Month Periods Ended March 31,					Three-Month Periods Ended March 31,
		2018			2017		2019		2018
Net income (loss)		$	(17	)	$	197	$	308	$	(17	)
Other comprehensive income (loss):
Foreign currency translation adjustment			(1	)		7		30		(1	)
Comprehensive income (loss)		$	(18	)	$	204	$	338	$	(18	)

See accompanying notes to the condensed consolidated financial statements.	See accompanying notes to the condensed consolidated financial statements.						See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

~~(Unaudited)~~

(in thousands)

	Three-Month Periods Ended March 31,						Three-Month Periods Ended March 31,
	2018			2017			2019			2018
Operating activities:
Net income (loss)	$	(17	)	$	197		$	308		$	(17	)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		63			65			51			63
Software amortization		111			90			150			111
Stock-based compensation		85			65			50			85
Loss on disposal of assets		1			—			—			1
Changes in operating assets and liabilities:
Accounts receivable, net		583			199			413			583
Inventories		(53	)		(83	)		81			(53	)
Prepaid expenses and other current assets		(69	)		(10	)		57			(69	)
Accounts payable		24			297			(626	)		24
Accrued expenses and other current liabilities		(472	)		(126	)		(300	)		(472	)
Net cash provided by operating activities		256			694			184			256

Investing activities:
Capitalized software development costs		(66	)		(95	)		(419	)		(66	)
Purchases of property and equipment		(47	)		(33	)		(75	)		(47	)
Net cash used for investing activities		(113	)		(128	)		(494	)		(113	)

Financing activities:
Stock for tax withholding		(10	)		—			(12	)		(10	)
Proceeds from stock options exercised								4			—
Net cash used for financing activities		(10	)		—			(8	)		(10	)

Effect of exchange rate changes on cash		(1	)		7			30			(1	)
Increase in cash and cash equivalents		132			573
Change in cash and cash equivalents								(288	)		132

Cash and cash equivalents at beginning of period		3,190			1,547			4,236			3,190
Cash and cash equivalents at end of period	$	3,322		$	2,120		$	3,948		$	3,322


Non-Cash investing and financing activities:
Purchase of property and equipment in accounts payable	$	25		$	11		$	9		$	25
Capitalization of software development costs in accounts payable		—			79

See accompanying notes to the condensed consolidated financial statements.

IMAGE SENSING SYSTEMS, INC.

Condensed Consolidated Statements of Shareholders' Equity

(in thousands, except share data)

	Three-Month Period Ended March 31, 2018
	Shares Issued		Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total

Balance, December 31, 2017	5,210,448		$	51	$	24,355		$	(310	)	$	(15,455	)	$	8,641

Stock-based compensation	48,026			1		84			—			—			85
Stock for tax withholding	(2,248	)		—		(10	)		—			—			(10	)
Comprehensive income (loss):
Foreign currency translation adjustment	—			—		—			(1	)		—			(1	)
Net loss	—			—		—			—			(17	)		(17	)
Balance, March 31, 2018	5,256,226		$	52	$	24,429		$	(311	)	$	(15,472	)	$	8,698

	Three-Month Period Ended March 31, 2019
	Shares Issued			Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total

Balance, December 31, 2018	5,278,485		$	52	$	24,550		$	(372	)	$	(13,593	)	$	10,637

Stock-based compensation	16,818			—		50			—			—			50
Stock options exercised	1,000			—		4			—			—			4
Stock for tax withholding	(2,362	)		—		(12	)		—			—			(12	)
Comprehensive income:
Foreign currency translation adjustment	—			—		—			30			—			30
Net income	—			—		—			—			308			308
Cumulative effect from adoption of ASU No. 2016-02	—			—		—			—			33			33
Balance, March 31, 2019	5,293,941		$	52	$	24,592		$	(342	)	$	(13,252	)	$	11,050

See accompanying notes to the condensed consolidated financial statements

IMAGE SENSING SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

~~(Unaudited)~~

March 31, ~~2018~~
2019

Note A: Basis of Presentation

Image Sensing Systems, Inc. (referred to in this Quarterly Report on Form 10-Q as "we," "us," "our" and the "Company") develops and markets video and radar processing products for use in applications such as intersection control, highway, bridge and tunnel traffic management and traffic data collection. We sell our products primarily to distributors and also receive royalties under a license agreement with a manufacturer/distributor for certain of our products. Our products are used primarily by governmental entities.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to the Quarterly Report on Form 10-Q, which require the Company to make estimates and assumptions that affect amounts reported. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. It is the opinion of management that the unaudited condensed consolidated financial statements include all adjustments consisting of normal recurring accruals considered necessary for a fair presentation. All significant intercompany balances and transactions have been eliminated.

Operating results for the three month ~~period~~ periods ended March 31, ~~2018~~2019 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2018~~2019. The accompanying condensed consolidated financial statements of the Company should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, ~~2017~~2018 as filed with the SEC.

Summary of Significant Accounting Policies

The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company's results of operations and financial position and may require the application of a higher level of judgment by the Company's management and, as a result, are subject to an inherent degree of uncertainty.

Revenue Recognition

On January 1, 2018, we adopted Accounting Standards Update ("ASU") No. ~~2014-09,~~2014-09, Revenue from Contracts with Customers (Topic ~~606)~~606), using the full retrospective transition method. The Company's adoption of ASU ~~2014-09~~2014-09 did not have a material impact on the amount and timing of revenue recognized in its consolidated financial statements.

Under ASU ~~2014-09,~~2014-09, we recognize revenue when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

We determine revenue recognition through the following steps:
●	Identification of a contract, or contracts, with a customer;
●	Identification of performance obligations in the contract;
●	Determination of the transaction price;
●	Allocation of the transaction price to the performance obligations in the contract; and
●	Recognition of revenue when, or as, we satisfy a performance ~~obligation~~obligation.

Revenue disaggregated by revenue source for the three months ended March 31, ~~2018~~2019 and ~~2017,~~2018 consists of the following (in thousands)~~. Revenue~~: revenue excludes sales and usage-based taxes where it has been determined that we are acting as a pass-through agent.

	Three Months Ended March 31,				Three Months Ended March 31,
	2018		2017		2019		2018
Product sales	$	844	$	1,440	$	1,621	$	844
Royalties		2,166		1,644		1,751		2,166
Total revenue	$	3,010	$	3,084	$	3,372	$	3,010

Product Sales:

Product revenue is generated from the direct sales of our RTMS radar systems worldwide and our Autoscope video systems ~~in Europe and Asia.~~outside of North America. Revenue is recognized when control of the promised goods or services is transferred to our customers in an amount that reflects the ~~consideration~~amount we expect to ~~be entitled to~~receive in exchange for those goods or services.

Certain product sales may contain multiple performance obligations for revenue recognition purposes. Multiple performance obligations may include the hardware, software, installation services, training, and support.In arrangements ~~where~~when we have multiple performance obligations, the transaction price is allocated to each performance obligation using the relative stand-alone selling price.We generally determine stand-alone selling prices based on the observable stand-alone prices charged to customers.For performance obligations without observable stand-alone prices charged to customers, we evaluate the adjusted market assessment approach, the expected cost plus margin approach, and stand-alone sales to estimate the stand-alone selling prices.

Revenue from arrangements for services such as maintenance, repair, consulting and technical support are recognized either as the service is performed or ratably over the defined contractual period for service maintenance contracts. Our payment terms may vary by the type and location of our customer and the products or services offered.

We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable.The term between invoicing and when payment is due is not significant.For certain products or services and customer types, we require payment before we deliver the products or ~~services are delivered to the customer.~~perform services.

We record provisions against sales revenue for estimated returns and allowances in the period when the related revenue is recorded based on historical sales returns and changes in end user demand.

Royalties:

Econolite Control Products, Inc. (“Econolite”) is our licensee that sells our Autoscope video system products in the United States, Mexico, Canada and the Caribbean. ~~The~~We earn and recognize the royalty of approximately 50% of ~~the~~Econolite's gross profit on licensed products ~~is recognized~~ when the products are shipped or delivered ~~by Econolite~~ to its customers.

Practical Expedients and Exemptions:

We generally expense sales commissions when incurred because the amortization periods would have been one yearor less.These costs are recorded within sales and marketing expense.

We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one yearor less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

810

Inventories

Inventories are primarily electronic components and finished goods and are valued at the lower of cost or net realizable value ondetermined under the first-in, first-out accounting method.

Income Taxes

We record a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. We believe it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on our financial condition and operating results. We recognize penalties and interest expense related to unrecognized tax benefits in income tax expense.

Intangible Assets

We capitalize certain software development costs related to software to be sold, leased, or otherwise marketed. Capitalized software development costs include purchased materials, services, internal labor and other costs associated with the development of new products and services. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. Based on our product development process, technological feasibility is generally established once product and detailed program designs have been completed, uncertainties related to high-risk development issues have been resolved through coding and testing, and we have established that the necessary skills, hardware, and software technology are available for production of the product. Once a software product is available for general release to the public, capitalized development costs associated with that product will begin to be amortized to cost of sales over the product's estimated economic selling life, using the ~~greater of~~ straight-line ormethod in a ~~method that results in cost recognition in future periods~~manner that is consistent with the anticipated timing of product revenue recognition.

Capitalized software development costs are subject to an ongoing assessment of recoverability, which is impacted by estimates and assumptions of future revenues and expenses for these software products, as well as other factors such as changes in product technologies. Any portion of unamortized capitalized software development costs that is determined to be in excess of net realizable value has been expensed in the period in which such a determination is made. Subsequent to reaching technological feasibility for certain software products, ~~in a prior quarter,~~ we capitalized approximately $~~66,000~~$419,000 and $~~174,000~~$66,000 of software development costs during the quarters ended March 31, ~~2018~~2019 and ~~2017~~2018, respectively.

Intangible assets with finite lives are amortized on a straight-line basis over the expected period to be benefited by future cash flows and reviewed for impairment. At both March 31, ~~2018~~2019 and ~~December 31, 2017~~2018, we determined there was no impairment of intangible assets. At both March 31, ~~2018~~2019 and ~~2017~~2018, there were no indefinite-lived intangible assets.

911

Note B: Recent Accounting Pronouncements

Accounting ~~pronouncements~~pronouncement recently adopted

In ~~May 2014,~~February 2016, the Financial Accounting Standards Board ~~(the "FASB"~~("FASB") issued ASU 2014-09, which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) Topic 605, Revenue Recognition (Topic 605). We adopted Topic 606 as of January 1, 2018 using the full retrospective transition method. See ~~Revenue Recognition~~ ~~above for further details.~~

~~Accounting pronouncements not yet adopted~~

~~In February 2016, the FASB~~ issued ASU No. 2016-02, "Leases (Topic 842)". We adopted ASU 2016-02 ~~provides guidance~~and its amendments and elected the effective date transition method as of January 1, 2019, which included recognizing a cumulative effect adjustment through opening accumulated deficit as of that date. Prior year amounts were not recast under the transition approach and, therefore, prior year amounts are excluded from the operating leases footnote. See Note E: Operating Leases for further details.

In June 2018, the FASB issued ASU No. 2018-07, "Compensation-Stock Compensation (Topic 718)". ASU 2018-07 largely aligns the accounting for share-based payment awards issued to employees and nonemployees by expanding the scope of Accounting Standards Codification 718 to apply to nonemployee share-based transactions, as long as the transaction is not effectively a form of financing. We adopted ASU No. 2018-07 as of January 1, 2019. There was no impact to the Company's consolidated financial statements.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, "Disclosure Update and Simplification," amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on ~~how~~the analysis of stockholders' equity for interim financial statements. Under the amendments, an ~~entity should account~~analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis must present a reconciliation of the beginning balance to the ending balance for ~~leases~~each period for which a statement of comprehensive income is required to be filed. We adopted these changes as of January 1, 2019.

Accounting pronouncements not yet adopted

In August 2018, the FASB issued ASU No. 2018-13, "Fair Value Measurements (Topic 820)." ASU 2018-13 eliminates, amends and ~~recognize associated lease assets and liabilities. ASU 2016-02~~adds disclosure requirements for fair value measurements. The standard is ~~effective~~required to be adopted for ~~fiscal years, and interim~~annual periods ~~within those years,~~ beginning after December 15, ~~2018, and early~~2019, including interim periods within that annual period, which is our fiscal year 2020. Certain disclosures in the amendment are to be applied using a retrospective approach while other disclosures are to be applied using a prospective approach. Early adoption is permitted. ASU 2016-02 must be adopted using a modified retrospective transition, and it provides for certain practical expedients. In addition, the transition will require application of ASU 2016-02 at the beginning of the earliest comparative period presented. We ~~are currently assessing~~have not yet evaluated the impact the adoption of ~~ASU 2016-02~~this guidance may have on ~~the consolidated~~our financial ~~statements.~~condition, results of operations or disclosures.

Note C: Fair Value Measurements

The guidance for fair value measurements establishes the authoritative definition of fair value, sets out a framework for measuring fair value and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and non-observable inputs as follows:

	Level 1 -	observable inputs such as quoted prices in active markets;
	Level 2 -	inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
	Level 3 -	unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

~~Level~~ 1 ~~- observable inputs such as quoted prices in active markets;~~

~~Level~~ 2 ~~- inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and~~

~~Level~~ 3 ~~- unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.~~

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

Our intangible assets and other long-lived assets are nonfinancial assets that were acquired either as part of a business combination, individually or with a group of other assets. These nonfinancial assets were initially, and have historically been, measured and recognized at amounts equal to the fair value determined as of the date of acquisition.

Financial Instruments not Measured at Fair Value

Certain of our financial instruments are not measured at fair value and are recorded at carrying amounts approximating fair value, based on their short-term nature or variable interest rate. These financial instruments include cash and cash equivalents, accounts receivable, accounts payable and other current financial assets and liabilities.

1012

Note D: Inventories

Inventories consisted of ~~approximately $388,000~~the following (in thousands):

	March 31, 2019		December 31, 2018
Finished goods	$	856	$	949
Components		352		340
Total	$	1,208	$	1,289

Note E: Operating Leases

On January 1, 2019, we adopted ASU No. 2016-02, Leases (Topic 842), and $~~335,000~~ ~~of finished goods~~its amendments and elected the effective date transition method, which included recognizing a cumulative effect adjustment through opening accumulated deficit as of that date.

The Company is subject to various non-cancelable operating leases for office space and IT equipment expiring at various dates through November 2022. These leases do not have significant rent escalation, holidays, concessions, leasehold improvement incentives, or other build-out clauses. Further, the leases do not contain contingent rent provisions.

Most of these leases include an option to renew. The exercise of lease renewal options is typically at our sole discretion; therefore, the majority of renewals to extend the lease terms are not included in our right-of-use ("ROU") assets and lease liabilities because they are not reasonably certain of exercise. We regularly evaluate the renewal options and, when they are reasonably certain of exercise, we include the renewal period in our lease term.

Because most of our leases do not provide an implicit rate, we use our incremental borrowing rate in determining the present value of the lease payments. The incremental borrowing rate represents an estimate of the interest rate we would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease. We used incremental borrowing rates as of January 1, 2019 for operating leases that commenced prior to that date. We have a centrally managed treasury function, therefore, based on the applicable lease terms and the current economic environment, we apply a portfolio approach for determining the incremental borrowing rate.

Under ASC 840, rent expense for office facilities for the period ended March 31, 2018 ~~and~~ ~~December~~ was $146,000.

The cost components of our operating leases were as follows (in thousands) for the period ended March 31, ~~2017, respectively.~~

~~Note E: Intangible Assets~~2019:

	Three-Month Period
	Total
Operating lease costs	$	65
Variable lease cost		76
Short-term lease cost		—
Total	$	141

Variable lease costs consist primarily of property taxes, insurance, and common area or other maintenance costs for our leased facilities and equipment which are paid based on actual costs incurred by the lessor.

Maturities or our lease liabilities for all operating leases are as follows (in thousands) as of March 31, 2019:

	Total
2019	$	265
2020		104
2021		9
2022		5
2023		—
2024 and thereafter		—
Total lease payments		383
Less: Interest		(13	)
Present value of lease liabilities	$	370

The weighted average remaining lease terms and discount rates for all of our operating leases were as follows as of March 31, 2019:

	March 31, 2019
Remaining lease term and discount rate:
Weighted average remaining lease term (years)	1.6
Weighted average discount rate	4.75	%

Cash paid for amounts included in the measurement of operating lease liabilities were $65,000 for the three months ended March 31, 2019 and this amount is included in operating activities in the condensed consolidated statements of cash flows. Separate from the initial recognition of the existing leases, there were no operating lease assets obtained in exchange for new operating lease liabilities for the three months ended March 31, 2019.

Note F: Intangible Assets

Intangible assets consisted of the following (dollars in thousands):

	March 31, 2018								March 31, 2019
								Weighted								Weighted
	Gross					Net		Average	Gross					Net		Average
	Carrying		Accumulated			Carrying		Useful Life	Carrying		Accumulated			Carrying		Useful Life
	Amount		Amortization			Value		(in Years)	Amount		Amortization			Value		(in Years)
Developed technology	$	3,900	$	(3,900	)	$	—	—	$	3,900	$	(3,900	)	$	—	—
Vision development costs		2,929		(544	)		2,385	8.0		2,929		(911	)		2,018	8.0
Software development in process costs		846		—			846	—		1,093		—			1,093	—
IntellitraffiQ development costs										468		(88	)		380	4.0
Wrong Way development costs		228		(19	)		209	2.0		228		(133	)		95	2.0
Total	$	7,903	$	(4,463	)	$	3,440	7.6	$	8,618	$	(5,032	)	$	3,586	7.1

December 31, 2017

Weighted

Gross

Net

Average

Carrying

Accumulated

Carrying

Useful Life

Amount

Amortization

Value

(in Years)

Developed technology
$
3,900

$
(3,900
)

$
—

—

Vision development costs

2,929

(452
)

2,477

8.0

Software development in process costs

1,008

—

1,008

—

$
7,837

$
(4,352
)

$
3,485

8.0

	December 31, 2018
								Weighted
	Gross					Net		Average
	Carrying		Accumulated			Carrying		Useful Life
	Amount		Amortization			Value		(in Years)
Developed technology	$	3,900	$	(3,900	)	$	—	—
Vision development costs		2,929		(819	)		2,110	8.0
Software development in process costs		674		—			674	—
IntellitraffiQ development costs		468		(59	)		409	4.0
Wrong Way development costs		228		(104	)		124	2.0
Total	$	8,199	$	(4,882	)	$	3,317	7.1

~~Note F: Credit Facilities~~

In May 2014, the Company entered into a credit agreement and related documents with Alliance Bank which provided for a revolving line of credit for the Company. The credit agreement and related documents with Alliance Bank (collectively, the "Alliance Credit Agreement") provided up to a $~~5.0~~ ~~million revolving line of credit bearing interest at a fixed annual rate of~~ ~~3.95~~%. Any advances would have been secured by the Company's inventories, accounts receivable, cash, marketable securities, and equipment. We were subject to certain covenants under the Alliance Credit Agreement. In April 2016, we entered into an agreement with Alliance Bank amending the Alliance Credit Agreement to extend the maturity date from April 1, 2016 to ~~May 12, 2017. We chose not to renew the Alliance Credit Agreement.~~

Note G: Warranties

We generally provide a ~~two~~2 to ~~five~~5 yearwarranty on product sales. Reserves to honor warranty claims are estimated and recorded at the time of sale based on historical claim information and are analyzed and adjusted periodically based on actual claim trends.

Warranty liability and related activity consisted of the following (in thousands):

	Three-Month Periods Ended March 31,						Three-Month Periods Ended March 31,
	2018			2017			2019			2018

Beginning balance	$	858		$	1,223		$	656		$	858
Warranty provisions		30			10			30			30
Warranty claims		(11	)		(60	)		(33	)		(11	)
Adjustments to preexisting warranties		(102	)		(51	)		(81	)		(102	)
Currency		2			2			1			2
Ending balance	$	777		$	1,124		$	573		$	777

Note H: Stock-Based Compensation

We compensate officers, directors, key employees and consultants with stock-based compensation under ~~stock option~~the Image Sensing Systems, Inc. 2005 Stock Incentive Plan (the "2005 Plan") and ~~incentive plans~~the Image Sensing Systems, Inc. 2014 Stock Option and Incentive Plan (the ~~"Plans"~~"2014 Plan"), both of which were approved by our shareholders and are administered under the supervision of our Board of Directors. Although stock options granted under the 2005 Plan are still outstanding, the 2005 Plan expired, and the Company can no longer grant options or other awards under the 2005 Plan. Stock option awards are granted at exercise prices equal to the closing price of our stock on the day before the date of grant. Generally, options vest ~~proportionally~~ratably over periods of ~~three~~3 to ~~five~~5 years from the dates of the grant, beginning one year from the date of grant, and have a contractual term of ~~nine~~9 to ~~ten~~10 years.

Performance stock options are time based; however, the final number of awards earned and the related compensation expense are adjusted up or down to the extent the performance target is met. The actual number of shares that will ultimately vest ranges from 90~~% to~~ ~~100~~% of the targeted amount if the minimum performance target is achieved. We evaluate the likelihood of meeting the performance target at each reporting period and adjust compensation expense, on a cumulative basis, based on the expected achievement of each performance target.

Compensation expense, net of estimated forfeitures, is recognized ratably over the vesting period. Stock-based compensation expense included in general and administrative expense for the three-month periods ended March 31, ~~2018~~2019 and ~~2017~~2018 was $~~85,000~~$50,000 and $~~65,000~~, 85,000,respectively.At March 31, ~~2018~~2019, ~~142,887~~108,420 shares were available for grant under the Company's ~~stock option and incent~~i~~ve plan.~~2014 Plan.

Stock Options

A summary of the option activity for the first three months of ~~2018~~2019 is as follows:

	Number of Shares			Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Options outstanding at December 31, 2018		39,000		$	6.26		2.80	$	4,480
Granted		—		$	—		—	$	—
Exercised		(1,000	)	$	4.22		—	$	950
Expired		—		$	—		—	$	—
Forfeited		(4,000	)	$	4.22		—	$	3,360

Options outstanding at March 31, 2019		34,000		$	6.56		2.20	$	9,420
Options exercisable at March 31, 2019		34,000		$	6.56		2.20	$	9,420

Number of
Shares Weighted
Average
Exercise
Price per
Share Weighted
Average
Remaining
Contractual
Term (in years) Aggregate
Intrinsic
Value
Options outstanding at December 31, 2017
85,750 $ 5.78 4.00 $ —
Granted
— $ — — $ —
Exercised
— $ — — $ —
Expired
— $ — — $ —
Forfeited
(13,500 )
$ 5.25 — $ —

Options outstanding at March 31, 2018 72,250
$ 5.88
3.50
$ 668
Options exercisable at March 31, 2018 67,625 $ 6.00 3.32
$ 529

There were options to purchase 1,000 shares of common stock exercised during the three-month period ended March 31, 2019 and no options exercised ~~during~~in the ~~three-month periods~~three-month period ended March 31, 2018 ~~and~~ . During the three-month period ended March 31, ~~2017~~2019 we recognized no stock-based compensation expense related to stock options compared to $1,000 recognized during the three-month period ended March 31, 2018. As of March 31, ~~2018~~2019, there was $~~1,000~~ ~~of total~~no unrecognized compensation cost related to non-vested stock options. ~~The weighted average period over which the compensation cost is expected to be recognized is~~ ~~0.11~~ ~~of a year.~~

Restricted Stock Awards and Stock Awards

Restricted stock awards are granted under the 2014 Plan at the discretion of the Compensation Committee of our Board of Directors. We issue restricted stock awards to executive officers and key consultants. These awards may contain certain performance conditions or time-based vesting criteria. The restricted stock awards granted to executive officers vest if the various performance or time-based metrics are met. Stock-based compensation is recognized for the number of awards expected to vest at the end of the period and is expensed beginning on the grant date through the end of the vesting period. At the time of vesting of the restricted stock awards, the recipients of common stock may request to receive a net of the number of shares required for employee withholding taxes, which can be withheld up to the relevant jurisdiction's maximum statutory rate. ~~Stock awards to consultants are recognized over the performance period based on the stock price on the date when the consultant's performance is complete.~~

We also issue stock awards as a portion of the annual retainer for each director on a quarterly basis. The stock awards are fully vested at the time of issuance. Compensation expense related to any stock awards issued to employees is determined on the grant date based on the publicly-quoted fair market value of our common stock and is charged to earnings on the grant date.

The following table summarizes restricted stock award activity for the first three months of ~~2018~~2019:

	Number of Shares			Weighted Average Grant Date Fair Value	Number of Shares			Weighted Average Grant Date Fair Value
Awards outstanding December 31, 2017	32,000		$	2.95
Awards outstanding December 31, 2018					58,877		$	3.22
Granted	58,026			3.32	28,644			5.04
Vested	(28,636	)		3.57	(22,976	)		3.54
Forfeited	(10,000	)		2.95	(11,826	)		3.04
Awards outstanding at March 31, 2018	51,390		$	3.02
Awards outstanding at March 31, 2019					52,719		$	4.11

As of March 31, ~~2018~~2019, the total stock-based compensation expense related to non-vested awards not yet recognized was $~~145,000~~,$198,000, which is expected to be recognized over a weighted average period of ~~2.7~~2.5 years. ~~The weighted average grant date fair value of restricted stock awards granted during~~During the three-month ~~period~~ periods ended March 31, 2019 and March 31, 2018 ~~was $3.32. We granted restricted stock awards of~~ ~~58,026~~ ~~shares during the~~ ~~three-month~~ ~~period ended~~ ~~March 31, 2018. During the~~ ~~three-month~~ ~~periods ended~~ ~~March 31, 2018~~ ~~and~~ ~~March 31, 2017~~, we recognized $~~84,000~~$50,000 and $~~63,000~~,$84,000, respectively, of stock-based compensation expense related to restricted stock awards.

Note I: Income ~~(loss)~~ per Common Share

Net income (loss) per share is computed by dividing net income ~~(loss)~~ by the daily weighted average number of common shares outstanding during the applicable periods. Diluted net income ~~(loss)~~ per share includes the potentially dilutive effect of common shares subject to outstanding stock options and restricted stock awards using the treasury stock method. Under the treasury stock method, shares subject to certain outstanding stock options and restricted stock awards have been excluded from the diluted weighted average shares outstanding calculation because the exercise of those options or the vesting of those restricted stock awards would lead to a net reduction in common shares outstanding. As a result, stock options and restricted stock awards to acquire~~83,086~~ 23,000 and ~~125,222~~83,086 weighted common shares have been excluded from the diluted weighted shares outstanding for the three-month periods ended March 31, ~~2018~~2019 and ~~2017~~2018, respectively.

A reconciliation of net income ~~(loss)~~ per share is as follows (in thousands, except per share data):

Three-Month Periods Ended
March 31,
2018 2017

Numerator:

Net income (loss)
$ (17 ) $ 197
Denominator:

Weighted average common shares outstanding
5,181 5,096
Dilutive potential common shares
— —
Shares used in diluted net loss per common share calculations
5,181 5,096
Basic net income (loss) per common share
$ (0.00 ) $ 0.04
Diluted net income (loss) per common share
$ (0.00 ) $ 0.04

	Three-Month Periods Ended March 31,
	2019		2018

Numerator:
Net income (loss)	$	308	$	(17	)
Denominator:
Weighted average common shares outstanding		5,224		5,181
Dilutive potential common shares		19		—
Shares used in diluted net income per common share calculations		5,243		5,181
Basic net income (loss) per common share	$	0.06	$	(0.00	)
Diluted net income (loss) per common share	$	0.06	$	(0.00	)

Note J: Segment Information

The Company's Chief Executive Officer and management regularly review financial information for the Company's discrete operating segments. Based on similarities in the economic characteristics, nature of products and services, production processes, type or class of customer served, method of distribution and regulatory environments, the operating segments have been aggregated for financial statement purposes and categorized into two reportable segments: Intersection and Highway.

Autoscope video is our machine-vision product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international product sales. Video products are normally sold in the Intersection segment. RTMS is our radar product line, and revenue consists of international and North American product sales. Radar products are normally sold in the Highway segment. All segment revenues are derived from external customers.

Operating expenses and total assets are not allocated to the segments for internal reporting purposes. Due to the changes in how we manage our business, we may reevaluate our segment definitions in the future.

The following ~~tables set~~table sets forth selected unaudited financial information for each of our reportable segments (in thousands):

Three Months Ended March 31,

Intersection

Highway

Total

2018

2017

2018

2017

2018

2017

Revenue

$
2,417

$
1,904

$
593

$
1,180

$
3,010

$
3,084
Gross profit

2,186

1,735

377

715

2,563

2,450
Amortization of intangible assets

92

90

19

—

111

90
Intangible assets

2,385

2,772

1,055

107

3,440

2,879

	Three Months Ended March 31,
	Intersection				Highway				Total
	2019		2018		2019		2018		2019		2018

Revenue	$	2,072	$	2,417	$	1,300	$	593	$	3,372	$	3,010
Gross profit		1,792		2,186		803		377		2,595		2,563
Amortization of intangible assets		92		92		58		19		150		111
Intangible assets		2,018		2,385		1,568		1,055		3,586		3,440

1418

Note K: Restructuring and Exit Activities

In the third quarter of 2018, we initiated the closure of our Bucharest, Romania office location, which was a sales office for Image Sensing Systems EMEA Limited. The Company will continue doing business in the European region utilizing the Barcelona, Spain sales office. We incurred $2,000 of costs for the closure of our office in Romania in the three-month period ended March 31, 2019. No costs related to the closure of the Romania location were incurred in the three-month period ended March 31, 2018.

The following table shows the restructuring activity for the first three months of 2019 (in thousands):

	Termination Benefits		Facility Costs and Contract Termination		Total
Balance at December 31, 2018	$	18	$	4	$	22
Charges		2		—		2
Settlements		(9)		(4)		(13)
Balance at March 31, 2019	$	11	$	—	$	11

In the third quarter of 2016, in order to streamline our operating and cost structure, we initiated the closure of our following wholly-owned subsidiaries, Image Sensing Systems HK Limited (ISS HK) located in Hong Kong; Image Sensing Systems (Shenzhen) Limited (ISS WOFE) located in China; ~~Image Sensing Systems Europe Limited (ISS Europe) located in the United Kingdom; Image Sensing Systems Europe Limited S.P.Z.O.O (ISS Poland) located in Poland;~~ and Image Sensing Systems Germany, GmbH (ISS Germany) located in Germany. We incurred no costs for these entity closures in the three-month periods ended March 31, ~~2018~~2019 and ~~2017.~~ March 31, 2018.

Note L: Commitments and Contingencies

Litigation

We are involved from time to time in various legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with GAAP, we record a liability in our Consolidated Financial Statements with respect to any of these matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. With respect to any currently pending legal proceedings, we have not established an estimated range of reasonably possible additional losses either because we believe that we have valid defenses to claims asserted against us or the proceeding has not advanced to a stage of discovery that would enable us to establish an estimate. We currently do not expect the outcome of these matters to have a material effect on our consolidated results of operations, financial position or cash flows. Litigation, however, is inherently unpredictable, and it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our results of operations, financial position or cash flows. We expense legal costs as incurred.

1519

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

~~Overview~~

General. We are a leading provider of above-ground detection products and solutions for the intelligent transportation systems ~~("ITS"~~(“ITS”) industry. Our family of products, which we market as Autoscope®video or video products (“Autoscope”), ~~and~~ RTMS®radar or radar products ~~("RTMS"~~(“RTMS”), and IntellitraffiQ® or iQ products provides end users with the tools needed to optimize traffic flow and enhance driver safety. Our technology analyzes signals from sophisticated sensors and transmits the information to management systems and controllers or directly to users. Our products provide end users with complete solutions for the intersection and transportation markets.

Our technology is a process in which software, rather than humans, examines outputs from various types of sophisticated sensors to determine what is happening in a field of view. In the ITS industry, this process is a critical component of managing congestion and traffic flow. In many cities, it is not possible to build roads, bridges and highways quickly enough to accommodate the increasing congestion levels. On average, United States commuters ~~spend~~ 42lose 97 hours a year ~~stuck~~ in ~~traffic, and~~ congestion, which costs motorists $~~160~~87 billion a ~~year.~~year in time, an average of $1,348 per driver. We believe this growing use of vehicles will make our ITS solutions increasingly necessary to complement existing and new roadway infrastructure to manage traffic flow and optimize throughput.

We believe our solutions are technically superior to those of our competitors because they have a higher level of accuracy, limit the occurrence of false detection, are generally easier to install, ~~with~~have lower costs of ownership, work effectively in a multitude of light and weather conditions, and provide end users the ability to manage inputs from a variety of sensors for a number of tasks. It is our view that the technical advantages of our products make our solutions well suited for use in ITS markets.

We believe the strength of our distribution channels positions us to increase the penetration of our technology‑driven solutions in the marketplace. We market our Autoscope video products in the United States, Mexico, Canada and the Caribbean through an exclusive agreement with Econolite Control Products, Inc. ("Econolite"), which we believe is the leading distributor of ITS intersection control products in these markets.

We market the RTMS radar systems to a network of distributors ~~in North America, the Caribbean and Latin America.~~globally. On a limited basis, we may sell directly to the end ~~user in these geographic areas.~~user. We market our Autoscope video ~~and RTMS radar~~ products outside of the United States, Mexico, Canada and the Caribbean through a combination of distribution and direct sales channels, through our ~~offices~~office in ~~Spain and Romania.~~Spain. Our end users primarily include governmental agencies and municipalities.

The following discussion of period-to-period changes and trends in financial statement results under "Management's Discussion and Analysis of Financial Condition and Results of Operations" aligns with the financial statement presentation discussed above.

Trends and Challenges in Our Business

We believe the expected growth in our business can be attributed primarily to the following global trends:

worsening traffic caused by increased numbers of vehicles in metropolitan areas without corresponding expansions of road infrastructure and the need to automate safety, security and access applications for automobiles and trucks, which has increased demand for our products;
advances in information technology, which have made our products easier to market, implement and ~~implement;~~integrate;
the continued funding allocations for centralized traffic management services and automated enforcement schemes, which have increased the ability of our primary end users to implement our products; and
general increases in the cost effectiveness of electronics, which make our products more affordable for end users.

We believe our continued growth primarily depends upon:

continued adoption and governmental funding of ITS and other automated applications for traffic control, safety and enforcement in developed countries;
a propensity by traffic engineers to implement lower cost technology-based solutions rather than civil engineering solutions such as widening roadways;
countries in the developing world adopting above-ground detection technology, such as video or radar, instead of in-pavement loop technology to manage traffic; and

1620

our ability to develop new products that provide increasingly accurate information and enhance the end users' ability to cost-effectively manage traffic and environmental issues.

Because the majority of our end users are governmental entities, we are faced with challenges related to potential delays in purchase decisions by those entities and changes in budgetary constraints. These contingencies could result in significant fluctuations in our revenue ~~between~~among periods. The ongoing economic environment in Europe and the United States is further adding to the unpredictability of purchase decisions, creating more delays than usual and decreasing governmental budgets, and it is likely to continue to affect our revenue.

Key Financial Terms and Metrics

Revenue. We derive revenue from two sources: (1) royalties received from Econolite for sales of the Autoscope video systems in the United States, Mexico, Canada and the Caribbean and (2) revenue received from the direct sales of our RTMS radar systems and our Autoscope video systems in Europe and Asia. Autoscope video royalties are calculated using a profit sharing model ~~where~~in which the gross profits on sales of product made through Econolite are shared equally with Econolite. This royalty arrangement has the benefit of decreasing our cost of revenues and our selling, marketing and product support expenses because these costs and expenses are borne primarily by Econolite. Although this royalty model has a positive impact on our gross margin, it also negatively impacts our total revenue, which would be higher if all the sales made by Econolite were made directly by us. The royalty arrangement is exclusive under a long-term agreement.

Cost of Revenue. Software amortization is the sole cost of revenue related to royalties, as virtually all manufacturing, warranty and related costs are incurred by Econolite. Cost of revenue related to product sales consists primarily of the amount charged by our third party contractors to manufacture hardware platforms, which is influenced mainly by the cost of electronic components. The cost of revenue also includes logistics costs, estimated expenses for product warranties, restructuring costs and inventory reserves. The key metric that we follow is achieving certain gross margin percentages on product sales by geographic region and to a lesser extent by product line.

Operating Expenses. Our operating expenses fall into three categories: (1) selling, marketing and product support; (2) general and administrative; and (3) research and development. Selling, marketing and product support expenses consist of various costs related to sales and support of our products, including salaries, benefits and commissions paid to our personnel; commissions paid to third parties; travel, trade show and advertising costs; second-tier technical support for Econolite; and general product support, where applicable. General and administrative expenses consist of certain corporate and administrative functions that support the development and sales of our products and provide an infrastructure to support future growth. These expenses include management, supervisory and staff salaries and benefits; legal and auditing fees; travel; rent; and costs associated with being a public company, such as board of director fees, listing fees and annual reporting expenses. Research and development expenses consist mainly of salaries and benefits for our engineers and third party costs for consulting and prototyping. We measure all operating expenses against our annually approved budget, which is developed with achieving a certain operating margin as a key focus. ~~Also included~~We also include any restructuring costs in operating ~~expenses are any restructuring costs.~~expenses.

Non-GAAP Operating Measure. We provide certain non-GAAP financial information as supplemental information to financial measures calculated and presented in accordance with GAAP (Generally Accepted Accounting Principles in the United States). This non-GAAP information excludes the impact of depreciating fixed assets and amortizing intangible assets, and may exclude other non-recurring items. Management believes that this presentation facilitates the comparison of our current operating results to historical operating results. Management uses this non-GAAP information to evaluate short-term and long-term operating trends in our core operations. Non-GAAP information is not prepared in accordance with GAAP and should not be considered a substitute for or an alternative to GAAP financial measures and may not be computed the same as similarly titled measures used by other companies.

Reconciliations of GAAP income (loss) from operations to non-GAAP income from operations are as follows (in thousands):

	Three-Month Periods Ended March 31,					Three-Month Periods Ended March 31,
	2018			2017		2019		2018

Income (loss) from operations	$	(17	)	$	198	$	308	$	(17	)
Adjustments to reconcile to non-GAAP income
Amortization of intangible assets							150		111
Depreciation		63	��		65		51		63
Amortization of intangible assets		111			90
Restructuring charges		—			—
Restructuring							2		—
Non-GAAP income from continuing operations	$	157		$	353	$	511	$	157

1721

Seasonality. Our quarterly revenues and operating results have varied significantly in the past due to the seasonality of our business. Our first quarter generally is the weakest due to weather conditions that make roadway construction more difficult in parts of North America, Europe and northern Asia. We expect such seasonality to continue for the foreseeable future. Additionally, our international revenues regularly contain individually significant sales. This can result in significant variations of revenue between periods. Accordingly, we believe that quarter-to-quarter comparisons of our financial results should not be relied upon as an indication of our future performance. No assurance can be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future.

Segments. We currently operate in two reportable segments: Intersection and Highway. Autoscope video is our machine-vision product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international product sales. Video products are normally sold in the Intersection segment. The RTMS is our radar product line, and revenue consists of sales to external customers. Radar products are normally sold in the Highway segment.As a result of business model changes and modifications in how we manage our business, we may reevaluate our segment definitions in the future.

The following ~~tables set~~table sets forth selected unaudited financial information for each of our reportable segments (in thousands):

Three Months Ended March 31,

Intersection

Highway

Total

2018

2017

2018

2017

2018

2017

Revenue

$
2,417

$
1,904

$
593

$
1,180

$
3,010

$
3,084
Gross profit

2,186

1,735

377

715

2,563

2,450
Amortization of intangible assets

92

90

19

—

111

90
Intangible assets

2,385

2,772

1,055

107

3,440

2,879

	Three Months Ended March 31,
	Intersection				Highway				Total
	2019		2018		2019		2018		2019		2018

Revenue	$	2,072	$	2,417	$	1,300	$	593	$	3,372	$	3,010
Gross profit		1,792		2,186		803		377		2,595		2,563
Amortization of intangible assets		92		92		58		19		150		111
Intangible assets		2,018		2,385		1,568		1,055		3,586		3,440

Results of Operations

The following table sets forth, for the periods indicated, certain statements of operations data as a percent of total revenue and gross profit on product sales and royalties as a percentage of product sales and royalties, respectively.

	Three-Month Periods Ended March 31,				Three-Month Periods Ended March 31,
	2018		2017		2019		2018
Product sales	28.0	%	46.7	%	48.1	%	28.0	%
Royalties	72.0		53.3		51.9		72.0
Total revenue	100.0		100.0		100.0		100.0
Gross profit - product sales	57.9		62.2		57.7		57.9
Gross profit - royalties	95.8		94.5		94.7		95.8
Selling, general and administrative	58.5		46.6		49.4		58.5
Research and development	27.2		26.5		18.4		27.2
Income (loss) from operations	(0.6	)	6.5		9.1		(0.6	)
Income tax expense	—		0.1		—		—
Net income (loss)	(0.6	)	6.4		9.1		(0.6	)

1822

Total revenue ~~decreased~~increased to $~~3.0~~3.4 million in the three-month period ended March 31, ~~2018~~,2019 from $~~3.1~~3.0 million in the same period in ~~2017~~2018, ~~a decrease~~an increase of ~~2.4%~~12.0%. Royalty income ~~increased~~decreased to $~~2.2~~1.8 million in the first quarter of ~~2018~~2019 from $~~1.6~~2.2 million in the first quarter of ~~2017~~2018, ~~an increase~~a decrease of ~~31.8%~~19.2%. The decrease in royalties was due to a particularly harsh winter, which exaggerated the effects of seasonality on royalty income. Product sales ~~decreased~~increased to $1.6 million in the first quarter of 2019 from $844,000 in the first quarter of 2018 ~~from $1.4~~ ~~million in the~~ ~~first quarter~~, an increase of ~~2017~~, ~~a decrease~~ of ~~41.4%~~92.1%. ~~The decrease~~ ~~in product sales resulted from lower volumes in all jurisdictions.~~

Revenue for the Intersection segment ~~increased~~decreased to $~~2.4~~2.1 million in the three-month period ended March 31, ~~2018~~,2019 from $~~1.9~~2.4 million in the three-month period ended March 31, ~~2017~~2018, ~~an increase~~a decrease of ~~26.9%~~14.3%. ~~The increase can be primarily attributed to higher sales volumes by our partner, Econolite.~~

Revenue for the Highway segment ~~decreased~~increased to $1.3 million in the three-month period endedMarch 31, 2019 from $593,000 in the three-month period ended March 31, 2018, ~~from $1.2~~ ~~million in the~~ ~~three-month~~ ~~period ended~~ ~~March 31, 2017~~, ~~a decrease~~an increase of ~~49.7%~~119.2%.The ~~decrease~~increase in revenue in the Highway segment is attributable to ~~reduced product~~an increased focus on improving sales ~~into all jurisdictions. Product sales gross profit for the Intersection product lines has historically been lower than gross profit for the Highway product lines~~tactics and ~~therefore the mix~~better management of the product lines sold in any given period can result in varying gross profit. Additionally, the geographic sales mix of our product sales can influence margins, as products sold in some jurisdictions have lower margins.channel partners.

Gross profit for product sales decreased to ~~57.9%~~57.7% in the three months ended March 31, 2019 from 57.9% in the three months ended March 31, 2018. The dollar amount of product sales gross profit increased $447,000 or 91.4%, ~~from~~ ~~62.2%~~ in the three months ended March 31, ~~2017. Product sales gross profit decreased $407,000 or 45.4% in the~~ ~~three~~ ~~months~~ ~~ended~~ ~~March 31, 2018~~,2019 compared to the prior year period. ~~The decrease in gross margin percent in the~~ ~~three~~ ~~months ended~~ ~~March 31, 2018, is~~ ~~primarily due~~ ~~to a higher percentage of Autoscope video product sold during the quarter, compared to the same period in the prior year.~~ ~~Additionally, the geographic sales mix of our product sales can influence margins, as product sold in some jurisdictions have higher margins.~~

Gross profit for royalty sales for the three months ended March 31, ~~2018, increased~~2019decreased to ~~95.8%~~94.7% from ~~94.5%~~95.8% in the same period in ~~2017. Gross~~2018. The dollar amount of gross profit from royalties ~~increased $520,000~~decreased $415,000, or ~~33.5%~~20.0%, in the three months ended March 31, ~~2018~~,2019 compared to the prior year period. The ~~increase~~decrease in royalty gross margin percent is due to lower royalty revenues while software amortization remained substantially the ~~higher volume of royalty sales in the first quarter of 2018, compared to the prior year period.~~same.

Selling, general and administrative expense was $~~1.8~~1.7 million, or ~~58.5%~~49.4% of total revenue, in the first quarter of ~~2018~~2019 compared to $~~1.4~~1.8 million, or ~~46.6%~~58.5% of total revenue, in the first quarter of ~~2017~~2018. The ~~increase~~decrease in expense in the three months of 2019is primarily ~~the~~a result of ~~increased sales and marketing~~the timing of costs related to a semi-annual trade show, Intertraffic, that took place in the first quarter of ~~2018.~~2018.

Research and development expense ~~increased~~decreased to ~~$819,000~~$620,000, or ~~27.2%~~18.4% of total revenue, in the three-month period ended March 31, ~~2018~~2019 from $819,000, ~~from $816,000~~ or ~~26.5%~~27.2% of total revenue, in the three-month period ended March 31, ~~2017~~2018. WeThe decrease is partially due to increased capitalized ~~$66,000 of costs associated with~~ software development ~~projects~~costs in the three-month period ended March 31, ~~2018,~~2019 of $419,000 compared to capitalized software costs of ~~$174,000~~$66,000 in the comparable prior year period.

~~Income tax expense of $4,000~~ or~~0.1% of revenue was recorded~~ After normalizing for software development costs, overall research and development expenditures increased in the ~~quarter~~three-month period ended March 31, ~~2017~~. 2019 compared to the same period in the prior year. This increase is due to increased salary expenses due to headcount and outside consultant professional fees.

There was no income tax expense recorded in the first ~~quarter~~three months of 2019 or 2018.

Consolidated net ~~loss from operations~~income was $~~17,000~~308,000, or $0.06 per basic and diluted share, in the three ~~month~~-month period ended March 31, ~~2018~~2019 compared to a net ~~income from operations~~loss of ~~$198,000~~$17,000, or $0.00 per basic and diluted share in the comparable prior year period. ~~There was no consolidated~~ ~~net loss per basic share for the~~ ~~three~~ ~~months ended~~ ~~March 31, 2018, compared to a net income per basic share of $0.04~~ ~~for the~~ ~~three~~ ~~months ended~~ ~~March 31, 2017~~.

1923

Liquidity and Capital Resources

At March 31, ~~2018~~2019, we had $~~3.3~~$3.9 million in cash and cash equivalents compared to $~~3.2~~4.2 million in cash and cash equivalents at December 31, ~~2017~~2018.

Net cash provided by operating activities was ~~$256,000~~$184,000 in the first three months of ~~2018~~2019 compared to net cash provided by operating activities of $~~694,000~~256,000 in the same period in ~~2017~~2018. The decrease in net cash provided by operating activities in the first three months of ~~2018~~2019 compared to the prior year period can be primarily attributed to ~~a $214,000 decrease in net income as well as~~ the ~~payment~~ timing of payments related to outstanding ~~payables~~accruals and ~~accruals.~~accounts payable balances and offset by the timing of collections for outstanding receivable balances in the first three months of 2019 compared to the prior year period.

Net cash used for investing activities was $~~113,000~~494,000 for the first three months of ~~2018~~2019 compared to net cash used for investing activities of ~~$128,000~~$113,000 in the same period in ~~2017~~2018.The ~~decrease~~increase of the amount of net cash used for investing activities in the first three months of ~~2018~~2019 compared to the prior year period is primarily the result of increased capitalized internal software development costs ~~decreasing~~ compared to the prior year period.

~~In May 2014, the Company entered into a credit agreement and related documents with Alliance Bank which provided for a revolving line of credit for the Company.~~ ~~The credit agreement and related documents with Alliance Bank (collectively, the "Alliance Credit Agreement") provided up to a $5.0~~ ~~million revolving line of credit bearing interest at a fixed annual rate of~~ ~~3.95~~%. Any advances would have been secured by the Company's inventories, accounts receivable, cash, marketable securities, and equipment. We were subject to certain covenants under the Alliance Credit Agreement. In April 2016, we entered into an agreement with Alliance Bank amending the Alliance Credit Agreement to extend the maturity date from April 1, 2016 to May 12, 2017. We chose not to renew the Alliance Credit Agreement.

We believe that cash and cash equivalents on hand at March 31, ~~2018~~2019 and cash provided by operating activities will satisfy our projected working capital needs, investing activities, and other cash requirements for the foreseeable future.

Off-Balance Sheet Arrangements

We do not participate in transactions or have relationships or other arrangements with an unconsolidated entity, including special purpose and similar entities, or other off-balance sheet arrangements.

Critical Accounting Policies

Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018. The accounting policies used in preparing our interim Condensed Consolidated Financial Statements as of and for the three months ended March 31, ~~2018~~2019 are set forth elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction with those described in our Annual Report on Form 10-K.

2024

Cautionary Statement:

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange of 1934, as amended. Forward-looking statements represent our expectations or beliefs concerning future events and can be identified by the use of forward-looking words such as "expects," "believes," "may," "will," "should," "intends," "plans," "estimates," or "anticipates" or other comparable terminology. Forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from the results described in the forward-looking statements. Factors that might cause such differences include, but are not limited to:

our historical dependence on a single product for most of our revenue;
budget constraints by governmental entities that purchase our products, including constraints caused by declining tax revenue;
the continuing ability of Econolite to pay royalties owed;

the mix of and margin on the products we sell;
our dependence on third parties for manufacturing and marketing our products;
our dependence on single-source suppliers to meet manufacturing needs;
our failure to secure adequate protection for our intellectual property rights;
our inability to develop new applications and product enhancements;
the potential disruptive effect on the markets we serve of new and emerging technologies and applications, including vehicle-to-vehicle communications and autonomous vehicles;
unanticipated delays, costs and expenses inherent in the development and marketing of new products;
our inability to respond to low-cost local competitors;
our inability to properly manage any growth in revenue and/or production requirements;
the influence over our voting stock by affiliates;
our inability to hire and retain key scientific and technical personnel;
the effects of legal matters in which we may become involved;
our inability to achieve and maintain effective internal controls;
our inability to successfully integrate any acquisitions;
tariffs and other trade barriers;
political and economic instability, including continuing volatility in the economic and politacal environment of the European Union;
our inability to comply with international regulatory restrictions over hazardous substances and electronic waste; and
conditions beyond our control such as war, terrorist attacks, health epidemics and economic recession.

We caution that the forward-looking statements made in this report or in other announcements made by us are further qualified by the risk factors set forth in Item 1A. to our Annual Report on Form 10-K for the fiscal year ended December 31, ~~2017~~2018.

2125

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Approximately 20% of our revenue has historically been derived from shipments to customers outside the United States, and a large portion of this revenue is denominated in currencies other than the U.S. dollar. Our international subsidiaries have functional currencies other than our U.S. dollar reporting currency and, occasionally, transact business in currencies other than their functional currencies. These non-functional currency transactions expose us to market risk on assets, liabilities and cash flows recognized on these transactions.

~~Our~~The strengthening of the U.S. dollar relative to foreign ~~sales and results of operations are subject to~~currencies decreases the ~~impact~~value of foreign ~~currency fluctuations. From time to time, we enter~~currency-denominated revenue and earnings when translated into ~~currency hedges to attempt to lower our exposure to translation gains and losses as well as to limit~~U.S. dollars. Conversely, a weakening of the ~~impact~~U.S. dollar increases the value of foreign ~~currency translation upon the consolidation of our foreign subsidiaries.~~currency-denominated revenue and earnings. A 10%10% adverse change in foreign currency rates ~~if we have not properly hedged,~~ could have a material effect on our results of operations or financial position.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and our ~~Interim~~ Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")). Based upon that evaluation, our Chief Executive Officer and our ~~Interim~~ Chief Financial Officer concluded that, as of March 31, ~~2018~~2019, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

During the fiscal quarter covered by this Quarterly Report on Form 10-Q, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

2226

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

~~None.~~

Item 1A. Risk Factors

Some of the risk factors to which we and our business are subject are described in the section entitled "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018. The risks and uncertainties described in our Annual Report are not the only risks we face. Additional risks and uncertainties not presently known to us or that our management currently deems immaterial also may impair our business operations. If any of the risks described were to occur, our business, financial condition, operating results and cash flows could be materially adversely affected.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

~~None.~~

Item 3. Defaults Upon Senior Securities

None.

~~None.~~

Item 4. Mine Safety Disclosures

None.

~~None.~~

Item 5. Other Information

None.

~~None.~~

2327

Item 6. Exhibits

The following exhibits are filed as part of this Quarterly Report on Form 10-Q for the quarterly period ended March 31, ~~2018~~2019:


Exhibit Number		Description


31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

31.2		Certification of ~~Interim~~ Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

32.2		Certification of ~~Interim~~ Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

101		The following financial information from the Quarterly Report on Form 10-Q for the quarter ended March 31, ~~2018~~2019, formatted in ~~XBRL (Extensible~~iXBRL (Inline Extensible Business Reporting Language), (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) the Notes to Condensed Consolidated Financial Statements (filed herewith).

2428

SIGNATURES

~~SIGNATURES~~

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	Image Sensing Systems, Inc.

Dated: May ~~14, 2018~~7, 2019	By:	/s/ Chad A. Stelzig
		Chad A. Stelzig
		President and Chief Executive Officer
		(Principal Executive Officer)


Dated: May ~~14, 2018~~7, 2019	By:	/s/ ~~Todd C. Slawson~~Frank G. Hallowell
		~~Todd C. Slawson~~Frank G. Hallowell
		~~Interim~~ Chief Financial Officer
		(Principal Financial Officer and Principal Accounting Officer)

2529

EXHIBIT INDEX


Exhibit No.		Description


31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

31.2		Certification of ~~Interim~~ Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).

32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

32.2		Certification of ~~Interim~~ Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

101		The following financial information from the Quarterly Report on Form 10-Q for the quarter ended March 31, ~~2018~~2019, formatted in ~~XBRL (Extensible~~iXBRL (Inline Extensible Business Reporting Language), (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) the Notes to Condensed Consolidated Financial Statements (filed herewith).

2630

	March 31, 2018			December 31,
	(Unaudited)			2017
ASSETS
Current assets:
Cash and cash equivalents	$	3,322		$	3,190
Accounts receivable, net of allowance for doubtful accounts of $23 and $20, respectively		2,756			3,339
Inventories		388			335
Prepaid expenses and other current assets		347			255
Total current assets		6,813			7,119

Property and equipment:
Furniture and fixtures		164			164
Leasehold improvements		26			26
Equipment		1,046			998
		1,236			1,188
Accumulated depreciation		764			702
		472			486

Intangible assets, net		3,440			3,485
Deferred income taxes		37			38
TOTAL ASSETS	$	10,762		$	11,128

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	612		$	563
Warranty		777			858
Accrued compensation		170			288
Other current liabilities		505			778
Total current liabilities		2,064			2,487
TOTAL LIABILITIES		2,064			2,487

Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued or outstanding		—			—
Common stock, $0.01 par value; 20,000,000 shares authorized, 5,256,226 and 5,210,448
issued and outstanding at March 31, 2018 and December 31, 2017, respectively		52			51
Additional paid-in capital		24,429			24,355
Accumulated other comprehensive loss		(311	)		(310	)
Accumulated deficit		(15,472	)		(15,455	)
Total shareholders' equity		8,698			8,641
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	10,762		$	11,128

See accompanying notes to the condensed consolidated financial statements.

	December 31, 2017
								Weighted
	Gross					Net		Average
	Carrying		Accumulated			Carrying		Useful Life
	Amount		Amortization			Value		(in Years)
Developed technology	$	3,900	$	(3,900	)	$	—	—
Vision development costs		2,929		(452	)		2,477	8.0
Software development in process costs		1,008		—			1,008	—
	$	7,837	$	(4,352	)	$	3,485	8.0