isns-20210331.htm

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, 2021

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

For the transition period from to

Commission file number: 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.

Spruce Tree Centre, Suite 400
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

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 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 every Interactive Data File required to be submitted 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 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 filer x

Smaller reporting company x

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

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, 2021
Common Stock, $0.01 par value per share		5,354,337 shares

IMAGE SENSING SYSTEMS, INC.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION	4
Item 1. Financial Statements (Unaudited)	4
Condensed Consolidated Balance Sheets	4
Condensed Consolidated Statements of Operations	5
Condensed Consolidated Statements of Comprehensive Income	6
Condensed Consolidated Statements of Cash Flows	7
Condensed Consolidated Statements of Shareholders' Equity	8
Notes to Condensed Consolidated Financial Statements	9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3. Quantitative and Qualitative Disclosures About Market Risk	27
Item 4. Controls and Procedures	27
PART II. OTHER INFORMATION	28
Item 1. Legal Proceedings	28
Item 1A. Risk Factors	28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3. Defaults Upon Senior Securities	28
Item 4. Mine Safety Disclosures	28
Item 5. Other Information	28
Item 6. Exhibits	29
SIGNATURES	30
EXHIBIT INDEX	31

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Image Sensing Systems, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

	March 31, 2021		December 31,
	(Unaudited)		2020
ASSETS
Current assets:
Cash and cash equivalents	$	8,212	$	8,605
Accounts receivable, net of allowance for doubtful accounts of $5 and $2 respectively		2,850		2,261
Inventories		829		770
Prepaid expenses and other current assets		434		480
Total current assets		12,325		12,116

Property and equipment:
Furniture and fixtures		154		154
Leasehold improvements		6		6
Equipment		1,222		1,215
		1,382		1,375
Accumulated depreciation		1,114		1,072
		268		303

Operating lease assets, net		82		136
Intangible assets, net		3,097		3,161
Deferred income taxes		5,507		5,708
TOTAL ASSETS	$	21,279	$	21,424

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	301	$	547
Deferred revenue		38		37
Warranty		130		141
Accrued compensation		128		148
Operating lease obligations		75		126
Short-term debt		—		349
Other current liabilities		124		124
Total current liabilities		796		1,472

Operating lease obligations		6		8
Long-term debt		—		574
TOTAL LIABILITIES		802		2,054

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, 5,354,337 and 5,352,626
issued and outstanding at March 31, 2021 and December 31, 2020, respectively		54		54
Additional paid-in capital		24,997		24,968
Accumulated other comprehensive loss		(203)		(150	)
Accumulated deficit		(4,371)		(5,502	)
Total shareholders' equity		20,477		19,370
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	21,279	$	21,424

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,
	2021		2020
Revenue:
Product sales	$	1,163	$	1,050
Royalties		1,816		2,109
		2,979		3,159
Cost of revenue:
Product sales		613		531
Royalties		93		92
		706		623
Gross profit		2,273		2,536

Operating expenses:
Selling, general and administrative		1,366		1,909
Research and development		496		902
		1,862		2,811
Income (loss) from operations		411		(275	)
Other income, net		925		—
Income (loss) from operations before income taxes		1,336		(275	)
Income tax expense (benefit)		205		(164	)
Net income (loss)	$	1,131	$	(111	)
Net income (loss) per share:
Basic	$	0.21	$	(0.02	)
Diluted	$	0.21	$	(0.02	)

Weighted average number of common shares outstanding:
Basic		5,322		5,267
Diluted		5,342		5,267

See accompanying notes to the condensed consolidated financial statements.

Image Sensing Systems, Inc.

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(in thousands)

	Three-Month Periods Ended March 31,
	2021			2020
Net income (loss)	$	1,131		$	(111	)
Other comprehensive income (loss):
Foreign currency translation adjustment		(53	)		(106	)
Comprehensive income (loss)	$	1,078		$	(217	)

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,
	2021			2020
Operating activities:
Net income (loss)	$	1,131		$	(111	)

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		40			50
Software amortization		187			174
Stock-based compensation		53			59
Deferred income tax expense		201			—
Forgiveness income from PPP Loan (Note L)		(931	)		—
Changes in operating assets and liabilities:
Accounts receivable, net		(590	)		228
Inventories		(59	)		95
Prepaid expenses and other current assets		46			(108	)
Accounts payable		(242	)		186
Accrued expenses and other current liabilities		(22	)		(79	)
Net cash provided by (used for) operating activities		(186	)		494

Investing activities:
Capitalized software development costs		(123	)		(22	)
Purchases of property and equipment		(10	)		(75	)
Net cash used for investing activities		(133	)		(97	)

Financing activities:
Stock for tax withholding		(24	)		—
Net cash used for financing activities		(24	)		—

Effect of exchange rate changes on cash		(50	)		(90	)
Change in cash and cash equivalents		(393	)		307

Cash and cash equivalents at beginning of period		8,605			5,118
Cash and cash equivalents at end of period	$	8,212		$	5,425


Non-Cash investing and financing activities:
Purchase of property and equipment in accounts payable	$	3		$	25

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, 2020
	Shares Issued		Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total

Balance, December 31, 2019	5,322,849		$	53	$	24,751		$	(306	)	$	(6,565	)	$	17,933

Stock-based compensation	8,950			—		59			—			—			59
Comprehensive income (loss):
Foreign currency translation adjustment	—			—		—			(106	)		—			(106	)
Net income (loss)	—			—		—			—			(111	)		(111	)
Balance, March 31, 2020	5,331,799		$	53	$	24,810		$	(412	)	$	(6,676	)	$	17,775

	Three-Month Period Ended March 31, 2021
	Shares Issued		Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total

Balance, December 31, 2020	5,352,626		$	54	$	24,968		$	(150	)	$	(5,502	)	$	19,370

Stock-based compensation	7,035			—		53			—			—			53
Stock for tax withholding	(5,324	)		—		(24	)		—			—			(24	)
Comprehensive income:
Foreign currency translation adjustment	—			—		—			(53	)		—			(53	)
Net income	—			—		—			—			1,131			1,131
Balance, March 31, 2021	5,354,337		$	54	$	24,997		$	(203	)	$	(4,371	)	$	20,477

See accompanying notes to the condensed consolidated financial statements

IMAGE SENSING SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

March 31, 2021

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, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. 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, 2020 as filed with the SEC.

Corporate Reorganization

On April 28, 2021, the Board of Directors of the Company approved proceeding with the implementation of a reorganization (the “Reorganization”) of the Company's corporate structure into a holding company structure. When implemented, the Company will become a wholly-owned subsidiary of a new holding company, Autoscope Technologies Corporation (“Autoscope”), which will replace the Company as the public company trading on the Nasdaq Stock Market. Outstanding shares of the Company will be automatically converted into shares of common stock of Autoscope. The holding company reorganization is not expected to result in a change in the directors, executive officers, management or business of the Company.

The Reorganization is intended to be a tax-free transaction for U.S. federal income tax purposes for the Company’s shareholders and, subject to obtaining required approvals or any other intervening developments, is expected to be completed in the second quarter of 2021.

Cash Dividend

On April 28, 2021, the Board of Directors of the Company approved a cash dividend of $0.12 per share to shareholders of record on the close of business on May 10, 2021, which is payable to shareholders on May 20, 2021.

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

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.

Revenue disaggregated by revenue source for the three months ended March 31, 2021 and 2020 consists of the following (in thousands); revenue excludes sales and usage-based taxes when or if it has been determined that we are acting as a pass-through agent:

	Three Months Ended March 31,
	2021		2020
Product sales	$	1,163	$	1,050
Royalties		1,816		2,109
Total revenue	$	2,979	$	3,159

Product Sales:

Product revenue is generated primarily from the direct sales of our RTMS radar systems worldwide and our Autoscope video systems in Europe and Asia. Revenue is recognized when control of the promised goods or services is transferred to our customers in an amount that reflects the amount we expect 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 hardware, software, installation services, training, support, and extended warranties. In arrangements where 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 for services such as maintenance, repair, and technical support is recognized either as the service is performed or ratably over the defined contractual period for service maintenance contracts. From time to time, our payment terms may vary by the type and location of our customer and the products or services offered. Revenue for extended warranties are deferred until the coverage period and then recognized ratably over the extended warranty term.

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”) is our licensee that sells 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 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 services performed.

Inventories

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

Income Taxes

We record a tax provision for the anticipated tax consequences of our 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 our deferred tax assets. If 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 determined to be in excess of net realizable value have been expensed in the period in which such a determination is made. Subsequent to reaching technological feasibility for certain software products, we capitalized approximately $123,000 and $22,000 of software development costs during the quarters ended March 31, 2021 and 2020, 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, 2021 and 2020, we determined there was no impairment of intangible assets. At both March 31, 2021 and 2020, there were no indefinite-lived intangible assets.

Note B: Recent Accounting Pronouncements

Accounting pronouncements recently adopted

In August 2018, the FASB issued Accounting Standards Update (ASU) No. 2018-13, "Fair Value Measurements (Topic 820)." ASU 2018-13 eliminates, amends and adds disclosure requirements for fair value measurements. ASU 2018-13 is required to be adopted for annual periods beginning after December 15, 2019, including interim periods within that annual period, which is our fiscal year 2020. We adopted these changes as of January 1, 2020; however, there are no required changes that apply to our fair value measurements 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.

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 the following (in thousands):

	March 31, 2021		December 31, 2020
Finished goods	$	736	$	661
Components		93		109
Total	$	829	$	770

Note E: Operating Leases

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.

The cost components of our operating leases were as follows (in thousands):

	Three-Month Periods Ended March 31,
	2021		2020
Operating lease costs	$	55	$	66
Variable lease cost		43		76
Total	$	98	$	142

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 for our lease liabilities for all operating leases are as follows (in thousands) as of March 31, 2021:

	Total
2021	$	74
2022		8
2023 and thereafter		—
Total lease payments		82
Less: Interest		(1	)
Present value of lease liabilities	$	81

The weighted average remaining lease terms and discount rates for all of our operating leases were as follows as of March 31, 2021:

	March 31, 2021
Remaining lease term and discount rate:
Weighted average remaining lease term (years)	0.59
Weighted average discount rate	4.75	%

Cash paid for amounts included in the measurement of operating lease liabilities was $55,000 and $67,000 for the three months ended March 31, 2021 and 2020, respectively, and these amounts are included in operating activities in the condensed consolidated statements of cash flows. There were no operating lease assets obtained in exchange for new operating lease liabilities for the three months ended March 31, 2021 and 2020.

Note F: Intangible Assets

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

	March 31, 2021
							Weighted
	Gross				Net		Average
	Carrying		Accumulated		Carrying		Useful Life
	Amount		Amortization		Value		(in Years)
Wrong Way development costs	$	228	$	(228)	$	—	—
Vision development costs		3,052		(1,645)		1,407	8.0
Echo development costs		1,852		(308)		1,544	7.0
IntellitraffiQ development costs		468		(322)		146	4.0
Total	$	5,600	$	(2,503)	$	3,097	7.0

	December 31, 2020
								Weighted
	Gross					Net		Average
	Carrying		Accumulated			Carrying		Useful Life
	Amount		Amortization			Value		(in Years)
Wrong Way development costs	$	228	$	(228	)	$	—	—
Vision development costs		2,929		(1,553	)		1,376	8.0
Echo development costs		1,852		(242	)		1,610	7.0
IntellitraffiQ development costs		468		(293	)		175	4.0
Total	$	5,477	$	(2,316	)	$	3,161	7.3

Note G: Warranties

We generally provide a two to three 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 actual claim trends.

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

	Three-Month Periods Ended March 31,
	2021			2020

Beginning balance	$	141		$	313
Warranty provisions		12			7
Warranty claims		(7	)		(23	)
Adjustments to preexisting warranties		(13	)		(75	)
Currency		(3	)		(2	)
Ending balance	$	130		$	220

Note H: Stock-Based Compensation

We compensate officers, directors, key employees and consultants with stock-based compensation under the Image Sensing Systems, Inc. 2014 Stock Option and Incentive Plan (the "2014 Plan"), which was approved by our shareholders and is administered under the supervision of our Board of Directors. 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 ratably over periods of three to five years from the dates of the grant, beginning one year from the date of grant, and have a contractual term of nine to 10 years.

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, 2021 and 2020 was $53,000 and $59,000, respectively. At March 31, 2021, 148,024 shares were available for grant under the Company's 2014 Plan.

Stock Options

A summary of the stock option activity for the first three months of 2021 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, 2020		15,000		$	4.76		2.94	$	2,700
Granted		—		$	—		—	$	—
Exercised		—		$	—		—	$	—
Expired		—		$	—		—	$	—
Forfeited		(1,000	)	$	4.22		—	$	320

Options outstanding at March 31, 2021		14,000		$	4.80		2.66	$	2,611
Options exercisable at March 31, 2021		14,000		$	4.80		2.66	$	2,611

There were no stock options exercised or expired and options to purchase 1,000 shares were forfeited during the three-month period ended March 31, 2021, and there were no options exercised, expired, or forfeited during the three-month period ended March 31, 2020. During each of the three-month periods ended March 31, 2021 and 2020, we recognized no stock-based compensation expense related to stock options. As of March 31, 2021, there was no unrecognized compensation cost related to non-vested stock options.

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. 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.

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.

The following table summarizes restricted stock award activity for the first three months of 2021:

	Number of Shares			Weighted Average Grant Date Fair Value
Awards outstanding December 31, 2020	33,330		$	4.52
Granted	7,035			4.44
Vested	(21,555	)		4.20
Forfeited	—			—
Awards outstanding at March 31, 2021	18,810		$	4.86

As of March 31, 2021, the total stock-based compensation expense related to non-vested awards not yet recognized was $59,000, which is expected to be recognized over a weighted average period of 0.98 years. During the three-month periods ended March 31, 2021 and March 31, 2020, we recognized $53,000 and $59,000, 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 calculation of the diluted weighted average shares outstanding 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 5,000 weighted common shares have been excluded from the diluted weighted shares outstanding for the three-month periods ended March 31, 2021 and 2020.

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

	Three-Month Periods Ended March 31,
	2021		2020

Numerator:
Net income (loss)	$	1,131	$	(111	)
Denominator:
Weighted average common shares outstanding		5,322		5,267
Dilutive potential common shares		20		—
Shares used in diluted net income (loss) per common share calculations		5,342		5,267
Basic net income (loss) per common share	$	0.21	$	(0.02	)
Diluted net income (loss) per common share	$	0.21	$	(0.02	)

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

	Three Months Ended March 31,
	Intersection				Highway				Total
	2021		2020		2021		2020		2021		2020

Revenue	$	1,892	$	2,250	$	1,087	$	909	$	2,979	$	3,159
Gross profit		1,724		2,069		549		467		2,273		2,536
Amortization of intangible assets		92		92		95		82		187		174
Intangible assets		1,407		1,651		1,690		2,071		3,097		3,722

Note K: Restructuring and Exit Activities

In the third quarter of 2016, in order to streamline our operating and cost structure, we initiated the closure of our wholly-owned subsidiaries, Image Sensing Systems HK Limited (ISS HK) in Hong Kong; Image Sensing Systems (Shenzhen) Limited (ISS WOFE) in China; Image Sensing Systems Europe Limited (ISS Europe) in the United Kingdom; Image Sensing Systems Europe Limited SP.Z.O.O (ISS Poland) in Poland; and Image Sensing Systems Germany, GmbH (ISS Germany) in Germany. At December 31, 2018, Image Sensing Systems Europe Limited and Image Sensing Systems Europe Limited SP.Z.O.O were fully closed. At December 31, 2019, Image Sensing Systems Germany, GmbH was fully closed. During 2020, we initiated the closure of Image Sensing Systems EMEA Limited (ISS UK) and Image Sensing Systems Holdings Limited (ISS Holdings). At March 31, 2021, Image Sensing Systems (Shenzhen) Limited was fully closed. We incurred $16,000 and $30,000 for these entities' closure costs in the three-month periods ended March 31, 2021 and March 31, 2020, respectively.

Note L: Commitments and Contingencies

Debt

Under the Paycheck Protection Program ("PPP"), the United States Small Business Administration ("SBA") approved the Company's application to receive a loan in the amount of $923,700 (the "PPP Loan"). The PPP was established under the congressionally approved Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") and is administered by the SBA. The PPP Loan to the Company was made through BMO Harris Bank N.A. (the "Lender"). On April 21, 2020, the Company's Board of Directors approved the PPP Loan, and the Company signed the promissory note (the "Note") evidencing the PPP Loan, which was dated as of April 17, 2020. The Lender distributed the $923,700 of proceeds of the PPP Loan to the Company on April 22, 2020.

The term of the PPP loan was 24 months after the date of the Note (the "Maturity Date"). The annual interest rate on the PPP Loan was 1.00%. No payments of principal or interest were due during the six months beginning on the date of the Note (the "Deferred Period"). The Company's obligations under the Note were not secured by a security interest in the Company's assets. The Note required the Lender's consent if the Company wanted to reorganize, merge, consolidate, or otherwise change its ownership or structure. The Note contained customary events of default by the Company relating to, among other things, payment defaults and the breach of representations and warranties or other provisions of the Note. Upon a default by the Company under the Note, the Lender could have accelerated the Company's obligations under the Note and pursued its rights against the Company under applicable law, including by filing suit and obtaining a judgment against the Company.

Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of loans made under the PPP after 24 weeks if the recipients use the PPP loan proceeds for eligible purposes, including payroll costs, mortgage interest, rent or utility costs and meet other requirements regarding, among other things, the maintenance of employment and compensation levels. On February 2, 2021, the Company was notified by the Lender that the Lender had received payment in full of the PPP Loan from the United States government, and the Company's PPP Loan had been forgiven. The Company recognized the amount of the loan and accrued interest forgiven totaling approximately $931,000 as other non-operating income in the first quarter of 2021.

The foregoing description of the Note does not purport to be complete and is qualified in its entirety by reference to the full text of the Note filed as Exhibit 10.1 with the Company’s Current Report on Form 8-K filed with the SEC on April 23, 2020 and incorporated herein by reference.

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.

Note M: Risks and Uncertainties

In December 2019, the outbreak of a novel strain of coronavirus, called COVID-19, originated in Wuhan, China, and has since spread worldwide, including to the U.S. To date, the COVID-19 pandemic has caused widespread disruptions to the U.S. and global economy and has contributed to significant volatility and negative pressure in financial markets. The global impact of the outbreak is continually evolving and, as additional cases of the virus are identified, many countries, including the U.S., have reacted by instituting quarantines, restrictions on travel, and mandatory closures of businesses. Certain states and cities, including where we or the third parties with whom we engage operate, have also reacted by instituting quarantines, restrictions on travel, “stay at home” rules, restrictions on types of business that may continue to operate, and restrictions on the types of construction projects that may be undertaken.

The extent to which the COVID-19 pandemic impacts our business, financial condition and results of operations will depend on future developments, which are highly uncertain and cannot be predicted with any confidence, including the scope, severity and duration of the pandemic; the actions taken to contain the pandemic or mitigate its impact, including the adoption, effectiveness, and availability of COVID-19 vaccines; the effect of any relaxation of current restrictions in the community and regions in which we, our customers and end users do business; and the direct and indirect economic effects of the pandemic and containment measures, among others. The rapid development and fluidity of this situation precludes any prediction as to the full adverse impact of the COVID-19 pandemic. Nevertheless, the COVID-19 pandemic has affected, and may continue to adversely affect, our business, financial condition and results of operations, and it has had, and probably will continue to have, the effect of exacerbating many of the risks described in our Annual Report on Form 10-K for the year ended December 31, 2020 including, but not limited to, the following:

We currently rely on third parties to, among other things, manufacture, supply and market our products and supply other goods and services to run our business. If any such third party is adversely impacted by restrictions resulting from the COVID-19 pandemic, including staffing shortages, production slowdowns, the closure of facilities, and disruptions in delivery systems, our supply chain may be disrupted, which could limit our ability to manufacture our products and conduct research and development.
We have established a work-from-home policy for all employees, other than those who are performing or supporting business-critical operations or other essential activities. Our increased reliance on personnel working from home may negatively impact productivity or disrupt, delay or otherwise adversely impact our business. In addition, this could increase our cyber security risks, create data accessibility concerns, and make us more susceptible to communication disruptions, any of which could adversely impact our business operations or delay necessary interactions with governmental authorities, third party manufacturers and manufacturing sites, customers and end users, and other important agencies and third parties.
The trading prices for our common stock have been highly volatile as a result of the COVID-19 pandemic. As a result, we may face difficulties raising capital through any sales of our common stock, or such sales may be on unfavorable terms. In addition, a recession, depression or other sustained adverse market event resulting from the COVID-19 pandemic could materially and adversely affect our business and the value of our common stock.

Item 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”), RTMS® radar or radar products (“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 lose 99 hours a year in congestion, which costs motorists $88 billion a year in time, an average of $1,377 per driver (per INRIX 2019 Global Traffic scorecard). 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 exclusive agreements 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 globally. On a limited basis, we may sell directly to the end user. We market our Autoscope video products outside the United States, Mexico, Canada and the Caribbean through a combination of distribution and direct sales channels through our office in 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 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

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 purchasing decisions by those entities and changes in budgetary constraints. These contingencies could result in significant fluctuations in our revenue among periods. The ongoing economic environment in Europe and the United States and the COVID-19 pandemic declared in March 2020 are further adding to the unpredictability of purchasing decisions, creating more delays than usual and decreasing governmental budgets, and they are 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 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 the long-term Manufacturing, Distributing and Technology Agreement dated as of June 11, 1991, as amended (the “Econolite Agreement”), between the Company and Econolite.

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 products, whose costs are influenced mainly by the cost of electronic components. The cost of revenue also includes logistics costs, estimated expenses for product warranties, and inventory obsolescence. The key metric that we follow is achieving certain gross margin percentages on product sales by operating segment.

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. We also include any restructuring costs in operating expenses.

Non-GAAP Operating Measures. 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 it 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 from operations to non-GAAP income from operations are as follows (in thousands):

	Three-Month Period Ended March 31,
	2021		2020

Income (loss) from operations	$	411	$	(275	)
Adjustments to reconcile to non-GAAP income
Amortization of intangible assets		187		174
Depreciation		40

SEC Form 10-Q filed by Image Sensing Systems, Inc.