UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, ~~2017~~2018

o¨ 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~~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 o¨

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 o¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 o¨	Accelerated filer o¨
Non-accelerated filer o¨ (Do not check if a smaller reporting company)	Smaller reporting company x
	Emerging growth company o¨

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. o¨

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

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, ~~2017~~2018
Common Stock, $0.01 par value per share		~~5,147,916~~5,256,226 shares

IMAGE SENSING SYSTEMS, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION	3
Item 1. Financial Statements (unaudited)	3
Condensed Consolidated Balance Sheets	3
Condensed Consolidated Statements of Operations	4
Condensed Consolidated Statements of Comprehensive Income (Loss)	5
Condensed Consolidated Statements of Cash Flows	6
Notes to Condensed Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk	22
Item 4. Controls and Procedures	22
PART II. OTHER INFORMATION	23
Item 1. Legal Proceedings	23
Item 1A. Risk Factors	23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 3. Defaults Upon Senior Securities	23
Item 4. Mine Safety Disclosures	23
Item 5. Other Information	23
Item 6. Exhibits	24
SIGNATURES ~~SIGNATURES~~	25
EXHIBIT INDEX	26

PART I. FINANCIAL INFORMATION

Item 1.1. 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,

2017

December 31,

(Unaudited)

2016
ASSETS

Current assets:

Cash and cash equivalents
$
         2,120

$
              1,547
Accounts receivable, net of allowance for doubtful accounts of $72 and $90 respectively

         2,812

              3,011
Inventories

            224

                 141
Prepaid expenses and other current assets

            290

                 281
Total current assets

         5,446

              4,980

Property and equipment:

Furniture and fixtures

            487

                 486
Leasehold improvements

            426

                 426
Equipment

         3,612

              3,561

         4,525

              4,473
Accumulated depreciation

         4,173

              4,102

            352

                 371

Intangible assets, net

         2,879

              2,795
Deferred income taxes

              58

                   58
TOTAL ASSETS
$
         8,735

$
              8,204

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:

Accounts payable
$
            641

$
                 256
Warranty

         1,124

              1,223
Accrued compensation

            239

                 193
Other current liabilities

            250

                 323
Total current liabilities

         2,254

              1,995

Deferred tax liabilities

                1

                   -
TOTAL LIABILITIES
         2,255

              1,995

Shareholders' equity

Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued or outstanding

               -

                   -
Common stock, $.01 par value; 20,000,000 shares authorized, 5,147,916 and 5,094,473 issued and

outstanding at March 31, 2017 and December 31, 2016, respectively.

              51

                   50
Additional paid-in capital

      24,120

            24,055
Accumulated other comprehensive loss

          (356)

               (363)
Accumulated deficit

     (17,335)

          (17,533)
Total shareholders' equity

         6,480

              6,209
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
         8,735

$
              8,204

See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

Three-Month Periods Ended
March 31,

2017

2016
Revenue:

Product sales
$
          1,440

$
          1,614
Royalties

          1,644

          1,624

          3,084

          3,238
Cost of revenue:

Product sales

             544

             918
Software amortization

               90

                -

             634

             918
Gross profit

          2,450

          2,320

Operating expenses:

Selling, general and administrative

          1,436

          1,689
Research and development

             816

             794
Restructuring

                -

             126

          2,252

          2,609
Operating income (loss) from operations

             198

           (289)
Other, net

                 3

               (1)
Income (loss) from operations before income taxes

             201

           (290)
Income tax expense

                 4

                 2
Net income (loss)
$
             197

$
           (292)
Net income (loss) per share:

Basic
$
            0.04

$
          (0.06)
Diluted
$
            0.04

$
          (0.06)

Weighted average number of common shares outstanding:

Basic

          5,096

          5,030
Diluted

          5,096

          5,030

See accompanying notes to the condensed consolidated financial statements.

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

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

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

See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(in thousands)

Three-Month Periods Ended
March 31,

2017

2016
Net income (loss)
$
           197

$
          (292)
Other comprehensive income:

Foreign currency translation adjustment

               7

               1
Comprehensive income (loss)
$
           204

$
          (291)

See accompanying notes to the condensed consolidated financial statements.

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

See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

	Three-Month Periods Ended March 31,				Three-Month Periods Ended March 31,
	2017		2016		2018			2017
Operating activities:
Net income (loss)	$	197	$	(292)	$	(17	)	$	197

Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		65		75		63			65
Software amortization		90		-		111			90
Stock-based compensation		65		59		85			65
Loss on disposal of assets						1			—
Changes in operating assets and liabilities:
Accounts receivable, net		199		544		583			199
Inventories		(83)		272		(53	)		(83	)
Prepaid expenses and other current assets		(10)		(36)		(69	)		(10	)
Accounts payable		297		(705)		24			297
Accrued expenses and other current liabilities		(126)		(534)		(472	)		(126	)
Net cash provided by (used for) operating activities		694		(617)
Net cash provided by operating activities						256			694

Investing activities:
Capitalized software development costs		(95)		(601)		(66	)		(95	)
Purchases of property and equipment		(33)		(24)		(47	)		(33	)
Net cash used for investing activities		(128)		(625)		(113	)		(128	)

Financing activities:
Stock for tax withholding						(10	)		—
Net cash used for financing activities						(10	)		—

Effect of exchange rate changes on cash		7		(3)		(1	)		7
Increase (decrease) in cash and cash equivalents		573		(1,245)
Increase in cash and cash equivalents						132			573

Cash and cash equivalents at beginning of period		1,547		2,648		3,190			1,547
Cash and cash equivalents at end of period	$	2,120	$	1,403	$	3,322		$	2,120


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

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

IMAGE SENSING SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

March 31, ~~2017~~2018

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 ended March 31, ~~2017~~2018 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2017.~~2018. 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, ~~2016~~2017 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

WeOn January 1, 2018, we adopted Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers(Topic 606), using the full retrospective transition method. The Company's adoption of ASU 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, we recognize revenue ~~on a sales arrangement~~ when itcontrol of the promised goods or services is ~~realized~~transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or ~~realizable~~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

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

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

Product Sales:

Product revenue is generated from the direct sales of ~~an arrangement exists; delivery~~our RTMS radar systems worldwide and ~~title transfer have occurred~~our Autoscope video systems in Europe and Asia. Revenue is recognized when control of the promised goods or services ~~have been rendered;~~is transferred to our customers in an amount that reflects the ~~sales price is fixed and determinable; collectability is reasonably assured; and all significant obligations~~consideration we expect to ~~the customer have been fulfilled.~~be entitled to in exchange for those goods or services.

Certain product sales may contain multiple ~~elements~~performance obligations for revenue recognition purposes. ~~We consider each deliverable that provides value to the customer on a standalone basis as a separable element. Separable elements in these arrangements~~Multiple performance obligations may include the hardware, software, installation services, training, and support. ~~We initially allocate consideration~~In arrangements where we have multiple performance obligations, the transaction price is allocated to each ~~separable element~~performance obligation using the relative stand-alone selling ~~price method. Selling~~price. We generally determine stand-alone selling prices ~~are determined by us~~ based on ~~either vendor-specific objective evidence ("VSOE") (the actual~~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 of similar products and services sold on a standalone basis) or, in the absence of VSOE, our best estimate of the selling price. Factors considered by us in determining estimated selling prices for applicable elements generally include overall economic conditions, customer demand, costs incurred by us to provide the deliverable, as well as our historical pricing practices. Under these arrangements, revenue associated with each delivered element is recognized in an amount equal to the lesser of the consideration initially allocated to the delivered element or the amount for which payment is not deemed contingent upon future delivery of other elements in the arrangement. Under arrangements where special acceptance protocols exist, installation services and training may not be considered separable. Under those circumstances, revenue for the entire arrangement is recognized upon the completion of installation, training and fulfillment of any other significant obligations specific to the terms of the arrangement. Arrangements that do not contain any separable elements are typically recognized when the products are shipped and title has transferred to the customer.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 the products or services are delivered to the customer.

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

Practical Expedients and Exemptions:

We ~~record provisions against~~generally expense sales commissions when incurred because the amortization periods would have been one year or 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 year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice 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.~~services performed.

Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.

Inventories

Inventories are primarily electronic components and finished goods and are valued at the lower of cost or ~~market~~net realizable value on 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 or a method that results in cost recognition in future periods 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 ~~are~~is determined to be in excess of net realizable value ~~have~~has been expensed in the period in which such a determination is made. ~~We reached~~Subsequent to reaching technological feasibility for certain software products ~~and, as~~in a ~~result,~~prior quarter, we capitalized approximately ~~$174,000~~$66,000 and ~~$601,000~~$174,000 of software development costs during the quarters ended March 31, ~~2017~~2018 and ~~2016,~~2017, respectively.

Intangible assets with finite lives are amortized on a ~~straight‑line~~straight-line basis over the expected period to be benefited by future cash flows and reviewed for impairment. At both March 31, ~~2017~~2018 and December 31, ~~2016,~~2017, we determined there was no impairment of intangible assets. At both March 31, ~~2017~~2018 and ~~2016,~~2017, there were no ~~indefinite‑lived~~ indefinite-lived intangible assets.

Note B: Recent Accounting Pronouncements

Accounting pronouncements recently adopted

In ~~March 2016,~~May 2014, the Financial Accounting Standards Board ~~("FASB"~~(the "FASB") issued ASU 2014-09, which supersedes the revenue recognition requirements in Accounting Standards ~~Update ("ASU") No. 2016-09, “Compensation-Stock Compensation~~Codification (ASC) Topic 605, Revenue Recognition (Topic ~~718)~~605)." ASU 2016-09 provides new guidance on how an entity should account for stock compensation. It is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. The Company We adopted ~~ASU 2016-09 effective~~Topic 606 as of January 1, ~~2017 and~~2018 using the ~~adoption did~~full retrospective transition method. See Revenue Recognition above for further details.

Accounting pronouncements not ~~have a material impact to the consolidated financial statements and related disclosures.~~yet adopted

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)"." ASU 2016-02 provides ~~new~~ guidance on how an entity should account for leases and recognize associated lease assets and liabilities. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. ~~The new guidance~~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 ~~the new guidance~~ASU 2016-02 at the beginning of the earliest comparative period presented. We are currently ~~determining our implementation approach and~~ assessing the impact of ASU 2016-02 on the consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 provides guidance related to how an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASU 2014-09 specifies accounting for costs associated with obtaining or fulfilling contracts with customers and expands the required disclosures related to revenue and cash flows from contracts with customers.

On July 9, 2015, the FASB affirmed its proposal to defer the effective date of ASU 2014-09 for all entities by one year. As a result, public business entities, certain not-for-profit entities, and certain employee benefit plans will apply this new revenue standard to annual reporting periods beginning after December 15, 2017. All other entities will apply this new revenue standard to annual reporting periods beginning after December 15, 2018. Additionally, the FASB affirmed its proposal to permit all entities to apply ASU 2014-09 early, but not before the original effective date for public business entities, certain not-for-profit entities, and certain employee benefit plans (that is, annual periods beginning after December 15, 2016). Entities choosing to implement early will apply ASU 2014-09 to all interim reporting periods within the year of adoption. The Company is currently determining its implementation approach and assessing the impact of ASU 2014-09 on the consolidated financial statements.

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~~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.

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.

Note D: Inventories

Inventories consisted of approximately ~~$224,000~~$388,000 and ~~$141,000~~$335,000 of finished goods as of March 31, ~~2017~~2018 and December 31, ~~2016,~~2017, respectively.

Note E: Intangible Assets

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

	March 31, 2017							March 31, 2018
							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		2,885		(180)		2,705	8.0		2,929		(544	)		2,385	8.0
Software development costs		174		-		174	-
Software development in process costs									846		—			846	—
Wrong Way development costs									228		(19	)		209	2.0
Total	$	6,959	$	(4,080)	$	2,879	8.0	$	7,903	$	(4,463	)	$	3,440	7.6

	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, 2016

Weighted

Gross

Net

Average

Carrying

Accumulated

Carrying

Useful Life

Amount

Amortization

Value

(in Years)
Developed technology
$
           3,900

$
           (3,900)

$
                    -

                   -
Vision development costs

           2,885

                (90)

              2,795

                 8.0

$
           6,785

$
           (3,990)

$
              2,795

                 8.0

Note F: Credit Facilities

In May 2014, the Company entered into a credit agreement and related documents with Alliance Bank ~~providing~~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") ~~provides~~provided up to a ~~$5.0~~$5.0 million revolving line of ~~credit. Amounts due under the Alliance Credit Agreement bear~~credit bearing interest at a fixed annual rate of ~~3.95%~~3.95%. Any advances ~~are~~would have been secured by the Company's inventories, accounts receivable, cash, marketable securities, and equipment. We ~~are~~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. At March 31,~~ 2017 ~~we had no borrowings under~~. We chose not to renew the Alliance Credit ~~Agreement, and we were in compliance with all financial covenants. As of March 31, 2017, available borrowings were $1.7 million, and we do not anticipate renewing the line of credit~~Agreement.

Note G: Warranties

~~Note G: Warranties~~

We generally provide a two to five year warranty 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 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,
	2017		2016		2018			2017

Beginning balance	$	1,223	$	760	$	858		$	1,223
Warranty provisions		10		71		30			10
Warranty claims		(60)		(95)		(11	)		(60	)
Adjustments to preexisting warranties		(51)		24		(102	)		(51	)
Currency		2		-		2			2
Ending balance	$	1,124	$	760	$	777		$	1,124

Stock Options

A summary of the option activity for the first three months of ~~2017~~2018 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, 2016
          132,500

$        6.15

4.50

$               -
Granted
                    -

               -

                        -

                  -
Exercised
                    -

               -

                        -

                  -
Expired
                    -

               -

                        -

                  -
Forfeited
           (22,000)

           5.72

                        -

                  -

Options outstanding at March 31, 2017
          110,500

$        6.24

4.00

$               -
Options exercisable at March 31, 2017
            92,000

$        6.56

3.38

$               -

	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 no options exercised during the three ~~month~~-month periods ended March 31, 2018 and March 31, 2017 ~~and~~ . As of March 31, ~~2016. As of March 31, 2017,~~2018, there was ~~$23,000~~$1,000 of total unrecognized compensation cost related to non-vested stock options. The weighted average period over which the compensation cost is expected to be recognized is ~~one~~0.11 of a year.

Restricted Stock Awards and Stock Awards

Restricted stock awards are granted under the 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. ~~Executive officers vest in the~~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 netof 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 stock awards to employees is determined on the grant date based on the ~~publicly quoted~~publicly-quoted fair market value of our common stock and is charged to earnings on the grant date.

~~A summary of the~~The following table summarizes restricted ~~stock awards and~~ stock award activity for the first three months of ~~2017 is as follows:~~2018:

Number of Shares

Weighted Average Grant Date Fair Value
Awards outstanding December 31, 2016
                        -

$
                   -
Granted
                 53,443

                2.93
Exercised
               (21,443)

                2.90
Expired
                        -

                   -
Forfeited
                        -

                   -
Awards outstanding at March 31, 2017
                 32,000

$
                2.95

	Number of Shares			Weighted Average Grant Date Fair Value
Awards outstanding December 31, 2017	32,000		$	2.95
Granted	58,026			3.32
Vested	(28,636	)		3.57
Forfeited	(10,000	)		2.95
Awards outstanding at March 31, 2018	51,390		$	3.02

As of March 31, ~~2017,~~2018, the total stock-based compensation expense related to non-vested awards not yet recognized was ~~$74,000,~~$145,000, which is expected to be recognized over a weighted average period of ~~2.95~~2.7 years. The weighted average grant date fair value of restricted stock ~~units~~awards granted during the three-month period ended March 31, ~~2017~~2018 was ~~$2.95.~~$3.32. We granted restricted stock awards of ~~53,443~~58,026 shares during the three-month period ended March 31, ~~2016.~~2018. During the three-month periods ended March 31, 2018 and March 31, 2017 ~~and March 31, 2016,~~, we recognized ~~$63,000~~$84,000 and ~~$29,000,~~$63,000, respectively, of stock-based compensation expense related to restricted stock awards.

Note I: Income ~~(Loss)~~(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 ~~125,222~~83,086 and ~~278,500~~125,222 weighted common shares have been excluded from the diluted weighted shares outstanding for the three-month periods ended March 31, ~~2017~~2018 and ~~2016,~~2017, respectively.

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

					Three-Month Periods Ended March 31,
	Three-Month Periods Ended March 31,				2018			2017
	2017		2016
Numerator:
Net income (loss)	$	197	$	(292)	$	(17	)	$	197
Denominator:
Weighted average common shares outstanding		5,096		5,030		5,181			5,096
Dilutive potential common shares		-		-		—			—
Shares used in diluted net loss per common share calculations		5,096		5,030		5,181			5,096
Basic net income (loss) per common share	$	0.04	$	(0.06)	$	(0.00	)	$	0.04
Diluted net income (loss) per common share	$	0.04	$	(0.06)	$	(0.00	)	$	0.04

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 forth selected unaudited financial information for each of our reportable segments (in thousands):

	Three Months Ended March 31,												Three Months Ended March 31,
	Intersection				Highway				Total				Intersection				Highway				Total
	2017		2016		2017		2016		2017		2016		2018		2017		2018		2017		2018		2017

Revenue	$	1,904	$	1,904	$	1,180	$	1,334	$	3,084	$	3,238	$	2,417	$	1,904	$	593	$	1,180	$	3,010	$	3,084
Gross profit		1,735		1,718		715		602		2,450		2,320		2,186		1,735		377		715		2,563		2,450
Amortization of intangible assets		90		-		-		-		90		-		92		90		19		—		111		90
Intangible assets		2,772		1,811		107		-		2,879		1,811		2,385		2,772		1,055		107		3,440		2,879

Note K: Restructuring and Exit Activities

In the ~~first~~third quarter of 2016, in order to streamline our operating and cost structure, we initiated the ~~Company implemented restructuring plans~~closure of our wholly-owned subsidiaries, Image Sensing Systems HK Limited (ISS HK) located in ~~Canada. Because of these actions, restructuring charges of approximately $126,000 were recorded~~Hong Kong; Image Sensing Systems (Shenzhen) Limited (ISS WOFE) located in China; Image Sensing Systems Europe Limited (ISS Europe) located in the ~~first three months of 2016 related to employee terminations.~~

~~The following table shows~~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 entity closures in the ~~restructuring activity for the three months~~periods ended March 31, ~~2016 (in thousands):~~2018 and 2017.

Facility Costs

Termination

and Contract

Benefits

Termination

Total

Balance at January 1, 2016

$            -

$            -

$            -
Charges

            126

               -

            126
Payments/settlements

               -

               -

               -
Balance at March 31, 2016

$         126

$            -

$         126

~~No restructuring charges were recorded in the three months ended March 31, 2017.~~

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 ~~generally accepted accounting principles in the United States,~~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.

On May 5, 2016, Econolite, our exclusive North American manufacturer and distributor, served a complaint on us for a lawsuit filed by Econolite in the Superior Court of the State of California for the County of Orange. The complaint asserted claims against us under the Manufacturing, Distributing and Technology License Agreement, as amended, with Econolite (the "Econolite Agreement") for breach of contract and breach of implied covenant of good faith and fair dealing and sought specific performance related to the transition of North American RTMS sales and marketing activities from Econolite to us in July 2014. In the complaint, Econolite requested damages from us in an amount to be proven at trial and sought certain other remedies. On May 27, 2016, we removed the case to the Federal District Court, District of Central California. On November 15, 2016, Econolite and the Company entered into an Arbitration Agreement. On November 16, 2016, Econolite voluntarily dismissed all of its claims against the Company in the U.S. District Court but filed a demand for arbitration with JAMS (which is an alternative dispute resolution provider), asserting the same claims against the Company that it had asserted in the lawsuit. Arbitration commenced on November 16, 2016, and it remains ongoing. We believe that Econolite's claims are without merit, and we plan to vigorously defend against them. However, we cannot predict the outcome of this matter at this time or whether it will have a material adverse impact on our business prospects, financial condition, operating results or cash flow.

Item 2.2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

General.We are a leading provider of above-ground detection products and solutions for the intelligent transportation systems ("ITS") industry. Our family of products, which we market as Autoscope® video or video products (“Autoscope”), and RTMS® radar or radar products ("RTMS"), 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 42 hours a year stuck in traffic, and congestion costs motorists ~~$160~~$160 billion a year. 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 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 ~~agreements~~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. On a limited basis, we sell directly to the end user in these geographic areas. 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 in Spain and Romania. 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 and implement;
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‑~~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;
16

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

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 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)~~(1) royalties received from Econolite for sales of the Autoscope video systems in the United States, Mexico, Canada and the Caribbean and ~~(2)~~(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 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)~~(1) selling, marketing and product support; ~~(2)~~(2) general and administrative; and ~~(3)~~(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,~~benefits; legal and auditing ~~fees, travel, rent~~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 in operating expenses are any restructuring ~~costs and non-cash expense for intangible asset amortization.~~costs.

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 depreciation,~~ 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 ~~(loss)~~ from operations are as follows (in thousands):

Three-Month Periods Ended
March 31,

2017

2016

Income (loss) from operations
$
           198

$
          (289)
Adjustments to reconcile to non-GAAP income (loss)

Depreciation

             65

             75
Amortization of intangible assets

             90

              -
Restructuring charges

              -
��
           126
Non-GAAP income (loss) from operations
$
           353

$
            (88)

	Three-Month Periods Ended March 31,
	2018			2017

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

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 forth selected unaudited financial information for each of our reportable segments (in thousands):

Three Months Ended March 31,

Intersection

Highway

Total

2017

2016

2017

2016

2017

2016

Revenue

$
    1,904

$
    1,904

$
    1,180

$
    1,334

$
      3,084

$
      3,238
Gross profit

    1,735

    1,718

       715

       602

      2,450

      2,320
Amortization of intangible assets

         90

          -

          -

          -

           90

            -
Intangible assets

    2,772

    1,811

       107

          -

      2,879

      1,811

	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

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,
	2017		2016		2018		2017
Product sales	46.7	%	49.8	%	28.0	%	46.7	%
Royalties	53.3		50.2		72.0		53.3
Total revenue	100.0		100.0		100.0		100.0
Gross profit - product sales	62.2		43.1		57.9		62.2
Gross profit - royalties	94.5		100.0		95.8		94.5
Selling, general and administrative	46.6		52.2		58.5		46.6
Research and development	26.5		24.5		27.2		26.5
Restructuring	-		3.9
Income from operations	6.4		(9.0)
Income (loss) from operations					(0.6	)	6.5
Income tax expense	0.1		0.1		—		0.1
Net income (loss) from operations	6.5		(9.0)
Net income (loss)	6.4		(9.0)		(0.6	)	6.4

Total revenue decreased to ~~$3.1~~$3.0 million in the three-month period ended March 31, ~~2017~~2018, from ~~$3.2~~$3.1 million in the same period in ~~2016,~~ 2017, a decrease of ~~4.8%~~2.4%. Royalty income ~~remained constant at $1.6~~increased to $2.2 million in the first quarter of ~~2017 compared to the first quarter of 2016.~~

~~Product sales decreased to $1.4~~2018 from $1.6 million in the first quarter of 2017, an increase of 31.8%. Product sales decreased to $844,000 in the first quarter of 2018 from ~~$1.6~~$1.4 million in the first quarter of ~~2016,~~ 2017, a decrease of ~~10.8%~~41.4%. The decrease in product sales ~~was primarily driven by a soft demand~~resulted from lower volumes in ~~the Middle East and Europe due to the suppressed oil prices and reduced European Union funding, respectively.~~all jurisdictions.

Revenue for the Intersection segment ~~remained constant at $1.9~~increased to $2.4 million in the three-month period ended March 31, 2018, from $1.9 million in the three-month period ended March 31, 2017 ~~compared~~, an increase of 26.9%. The increase can be primarily attributed to ~~the prior year period.~~higher sales volumes by our partner, Econolite.

Revenue for the Highway segment decreased to ~~$1.2~~$593,000 in the three-month period ended March 31, 2018, from $1.2 million in the three-month period ended March 31, 2017 ~~from $1.3 million in the three-month period ended March 31, 2016,~~ , a decrease of ~~11.5%~~49.7%. The decrease in revenue in the ~~highway~~Highway segment ~~compared~~is attributable to ~~prior year period is due to an individually significant radar project~~reduced product sales into ~~the Middle East that was recognized in the prior year period.~~

~~Gross~~all jurisdictions. Product sales gross profit for the Intersection product ~~sales increased to 62.2%~~lines has historically been lower than gross profit for the Highway product lines and therefore the mix of the product lines sold in ~~the three months ended March 31, 2017 from 43.1%~~any given period can result in ~~the three months ended March 31, 2016, an increase of 28.7%. The increase in~~varying gross margin in the three months ended March 31, 2017 is primarily due to a reduction in warranty reserve related to expired warranty coverage for legacy product and improved RTMS margins in the United States.profit. Additionally, the geographic sales mix of our product sales ~~caninfluence~~can influence margins, as products sold in some jurisdictions have lower margins.

Gross profit for product sales decreased to 57.9% in the three months ended March 31, 2018, 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, 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. ~~We anticipate that gross profit for our product sales will be similar in 2017 as compared to 2016.~~

Gross profit for royalty sales for the ~~first~~ three months ended March 31, ~~2017 was 94.5%~~2018, ~~a decrease of 4.3%~~increased to 95.8% from 94.5% in the same period in 2017. Gross profit from royalties increased $520,000 or 33.5% in the three months ended March 31, 2018, compared to the prior year period. The increase in royalty gross margin ~~of 100% in prior year period,~~percent is due to the ~~amortization~~higher volume of ~~software capitalization costs related~~royalty sales in the first quarter of 2018, compared to the Autoscope Vision product released for sale in October 2016. We expect that royalty gross profit percentage will decrease in 2017 compared to 2016 due to this amortization, but that overall royalty gross profit dollar amount should increase in 2017 compared to 2016.prior year period.

Selling, general and administrative expense was ~~$1.4~~$1.8 million or ~~46.6%~~58.5% of total revenue in the first quarter of ~~2017~~2018 compared to ~~$1.7~~$1.4 million or ~~52.2%~~46.6% of total revenue in the first quarter of 2017. The increase in expense is primarily the result of increased sales and marketing costs related to a semi-annual trade show, Intertraffic, that took place in the first quarter of 2016. The reduction in expense is the result of cost saving measures enacted in 2016. Overall, we anticipate that in 2017 as compared to 2016, selling, general and administrative expense will decrease in both dollar amount and as a percentage of revenue.2018.

Research and development expense increased to $819,000 or 27.2% of total revenue in the three-month period ended March 31, 2018, from $816,000 or 26.5% of total revenue in the three-month period ended March 31, 2017. We capitalized $66,000 of costs associated with software development projects in the three-month period ended March 31, ~~2017 from $794,000 or 24.5%~~2018, compared to capitalized software of ~~total revenue~~$174,000 in the ~~three-month period ended March 31, 2016. The increase is primarily due to lower software capitalization compared to the~~comparable prior year period. In

Income tax expense of $4,000 or0.1% of revenue was recorded for the ~~three months~~quarter ended March 31, 2017 ~~we capitalized $174,000 of costs associated with software development projects compared to $601,000~~. There was no income tax expense recorded in ~~the prior year period. We anticipate that research and development costs will increase in dollar amount in 2017 compared to 2016.~~

In the first quarter of 2016, the Company implemented restructuring plans in Canada. Because of these actions, restructuring charges of approximately $126,000 were recorded related to employee terminations. There were no restructuring charges recorded in the three months ended March 31, 2017.2018.

Consolidated net ~~income~~loss from operations was ~~$197,000~~$17,000 in the three month period ended March 31, ~~2017~~2018 compared to a net ~~loss~~income from operations of ~~$292,000~~$198,000 in the comparable prior year period. ~~Consolidated~~There was no consolidated net loss per basic share for the three months ended March 31, 2018, compared to a net income per basic ~~and diluted~~ share ~~was $0.04~~of $0.04 for the three months ended March 31, 2017 ~~compared to a net loss of $0.06 per basic and diluted share for the prior year period.~~.

Liquidity and Capital Resources

At March 31, ~~2017,~~2018, we had ~~$2.1~~$3.3 million in cash and cash equivalents compared to ~~$1.5~~$3.2 million in cash and cash equivalents at December 31, ~~2016.~~2017.

Net cash provided by operating activities was ~~$694,000~~$256,000 in the first three months of ~~2017~~2018 compared to net cash ~~used for~~provided by operating activities of ~~$617,000~~$694,000 in the same period in ~~2016.~~ 2017.The ~~primary reason for~~decrease in net cash provided by operating activities in the first three months of ~~2017~~2018 compared to the ~~same~~prior year period ~~in 2016 was the increase~~can be primarily attributed to a $214,000 decrease in net income ~~combined with~~as well as the payment timing ~~of the payment~~ of outstanding payables and ~~collection of receivables. We anticipate that average receivable collection days in 2017 will be similar to 2016 and that they will not have a material impact on our liquidity.~~accruals.

Net cash used byfor investing activities was ~~$128,000~~$113,000 for the first three months of ~~2017~~2018 compared to net cash used byfor investing activities of ~~$625,000~~$128,000 in the same period in ~~2016.~~ 2017.The decrease of the amount of net cash used byfor investing activities in the first three months of ~~2017~~2018 compared to the prior year period is the result of capitalized internal software development costs decreasing compared to the prior year period. At March 31, 2017, approximately $79,000 of capitalized software costs were in accounts payable. Our planned additions of property and equipment are discretionary, and we do not expect them to exceed historical levels in 2016.

In May 2014, the Company entered into a credit agreement and related documents with Alliance Bank ~~providing~~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") ~~provide~~provided up to a ~~$5.0~~$5.0 million revolving line of ~~credit. Amounts due under the Alliance Credit Agreement bear~~credit bearing interest at a fixed annual rate of ~~3.95%~~3.95%. Any advances ~~are~~would have been secured by the Company's inventories, accounts receivable, cash, marketable securities, and equipment. We ~~are~~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. ~~At March 31, 2017, we had no borrowings under~~We chose not to renew the Alliance Credit ~~Agreement, and we were in compliance with all financial covenants. As of March 31, 2017, available borrowings were $1.7 million, and we do not anticipate renewing this line of credit.~~Agreement.

We believe that cash and cash equivalents on hand at March 31, ~~2017~~2018 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, ~~2016.~~2017. The accounting policies used in preparing our interim Condensed Consolidated Financial Statements as of and for the three months ended March 31, ~~2017~~2018 are set forth elsewhere in this Quarterly Report on Form 10-Q and ~~are the same as~~should be read in conjunction with those described in our Annual Report on Form 10-K.

Cautionary Statement:

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section ~~27A~~27A of the Securities Act of 1933, as amended, and Section ~~21E~~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;~~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;
21

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;

political and economic instability, including continuing volatility in the economic 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.~~1A. to our Annual Report on Form 10-K for the fiscal year ended December 31, ~~2016.~~2017.

Item 3.3. Quantitative and Qualitative Disclosures About Market Risk

Our foreign sales and results of operations are subject to the impact of foreign currency fluctuations. From time to time, we enter into currency hedges to attempt to lower our exposure to translation gains and losses as well as to limit the impact of foreign currency translation upon the consolidation of our foreign subsidiaries. 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 4.4. 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)~~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, ~~2017,~~2018, 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)~~13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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, ~~2016.~~2017. 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.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

~~None.~~

None.

Item 6. Exhibits

~~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, ~~2017:~~2018:


Exhibit Number		Description
~~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, ~~2017,~~2018, formatted in XBRL (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).

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 ~~10, 2017~~14, 2018	By:	/s/ Chad A. Stelzig
		Chad A. Stelzig
		President and Chief Executive Officer
		(Principal Executive Officer)



Dated: May ~~10, 2017~~14, 2018	By:	/s/ ~~Richard A. Ehrich~~Todd C. Slawson
		Todd C. Slawson
		Interim Chief Financial Officer

EXHIBIT INDEX

		~~Richard A. Ehrich~~
		~~Chief Financial Officer~~
		~~(Principal Financial Officer~~
		~~and Principal Accounting Officer)~~

~~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, ~~2017,~~2018, formatted in XBRL (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).

		March 31,
	2017		December 31,
	(Unaudited)		2016
ASSETS
Current assets:
Cash and cash equivalents	$	2,120	$	1,547
Accounts receivable, net of allowance for doubtful accounts of $72 and $90 respectively		2,812		3,011
Inventories		224		141
Prepaid expenses and other current assets		290		281
Total current assets		5,446		4,980

Property and equipment:
Furniture and fixtures		487		486
Leasehold improvements		426		426
Equipment		3,612		3,561
		4,525		4,473
Accumulated depreciation		4,173		4,102
		352		371

Intangible assets, net		2,879		2,795
Deferred income taxes		58		58
TOTAL ASSETS	$	8,735	$	8,204

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	641	$	256
Warranty		1,124		1,223
Accrued compensation		239		193
Other current liabilities		250		323
Total current liabilities		2,254		1,995


Deferred tax liabilities		1		-
TOTAL LIABILITIES		2,255		1,995

Shareholders' equity
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued or outstanding		-		-
Common stock, $.01 par value; 20,000,000 shares authorized, 5,147,916 and 5,094,473 issued and
outstanding at March 31, 2017 and December 31, 2016, respectively.		51		50
Additional paid-in capital		24,120		24,055
Accumulated other comprehensive loss		(356)		(363)
Accumulated deficit		(17,335)		(17,533)
Total shareholders' equity		6,480		6,209
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	8,735	$	8,204

See accompanying notes to the condensed consolidated financial statements.

	December 31, 2016
							Weighted
	Gross				Net		Average
	Carrying		Accumulated		Carrying		Useful Life
	Amount		Amortization		Value		(in Years)
Developed technology	$	3,900	$	(3,900)	$	-	-
Vision development costs		2,885		(90)		2,795	8.0
	$	6,785	$	(3,990)	$	2,795	8.0

	Number of Shares	Weighted Average Exercise Price per Share	Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Options outstanding at December 31, 2016	132,500	$ 6.15	4.50	$ -
Granted	-	-	-	-
Exercised	-	-	-	-
Expired	-	-	-	-
Forfeited	(22,000)	5.72	-	-

Options outstanding at March 31, 2017	110,500	$ 6.24	4.00	$ -
Options exercisable at March 31, 2017	92,000	$ 6.56	3.38	$ -

	Number of Shares		Weighted Average Grant Date Fair Value
Awards outstanding December 31, 2016	-	$	-
Granted	53,443		2.93
Exercised	(21,443)		2.90
Expired	-		-
Forfeited	-		-
Awards outstanding at March 31, 2017	32,000	$	2.95

		Facility Costs
	Termination	and Contract
	Benefits	Termination	Total

Balance at January 1, 2016	$ -	$ -	$ -
Charges	126	-	126
Payments/settlements	-	-	-
Balance at March 31, 2016	$ 126	$ -	$ 126