|                                   |           | 
|---------------------------------- | --------- | 
|UNITED STATES                     
|SECURITIES AND EXCHANGE COMMISSION
|Washington, D.C. 20549            
|                                   |           | 
|                                   |           | 
|                                   | FORM 10-Q | 
|                                   |           | 

|                                 |                                                                                          
|-------------------------------- | -----------------------------------------------------------------------------------------
|x                                | QUARTERLY
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                 |                                                                                          
|                                 | For the quarterly period
 ended March 31, 2010                                           
|                                 |                                                                                          
|                                 | OR                                                                                       
|                                 |                                                                                          
|o                                | TRANSITION
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                 |                                                                                          
|                                 | For the transition period
 from ________________ to ________________                     
|                                 |                                                                                          
|Commission
 file number: 0-26056

|                                                        |  | 
|------------------------------------------------------- |  | 
|                                                        |  | 
|                                                       
|Image Sensing Systems, Inc.                            
|(Exact
 name of registrant as specified in its charter)

|                                          |                     
|----------------------------------------- | --------------------
|Minnesota                                 | 41-1519168          
|(State
 or other jurisdiction of          | (I.R.S.
 Employer   
|incorporation
 or organization)           | Identification
 No.)
|                                          |                     
|500 Spruce Tree Centre                    |                     
|1600 University Avenue West               |                     
|St. Paul, MN                              | 55104               
|(Address
 of principal executive offices) | (Zip
 Code)         

|                                                                                    |  | 
|----------------------------------------------------------------------------------- |  | 
|(651) 603-7700                                                                     
|(Registrants
 telephone number, including area code)                              
|                                                                                   
|Not Applicable                                                                     
|(Former
 name, former address and former fiscal year, if changed since last report)
|                                                                                    |  | 

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

Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):

| |                                                |                            
| | ---------------------------------------------- | ---------------------------
| | Large accelerated filer o                      | Accelerated filer o        
| |                                                |                            
| | Non-accelerated filer o                        | Smaller reporting company x
| | (Do not check if a smaller
 reporting company) |                            

Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange 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 May 7, 2010
|Common
 Stock, $0.01 par value per share |  | 4,792,819
 shares          







IMAGE SENSING SYSTEMS,
INC.

TABLE OF CONTENTS

|               |                                                                                        |    |          
|-------------- | -------------------------------------------------------------------------------------- | -- | ---------
|               |                                                                                        |    | Page
 No.
|               |                                                                                        |    |          
|PART
 I.       | FINANCIAL
 INFORMATION                                                                 |    | 1        
|               |                                                                                        |    |          
|Item
 1.       | Financial
 Statements (unaudited):                                                     |    | 1        
|               |                                                                                        |    |          
|               | Condensed
 Consolidated Balance Sheets                                                 |    | 1        
|               |                                                                                        |    |          
|               | Condensed
 Consolidated Statements of Income                                           |    | 2        
|               |                                                                                        |    |          
|               | Condensed
 Consolidated Statements of Cash Flows                                       |    | 3        
|               |                                                                                        |    |          
|               | Notes
 to Condensed Consolidated Financial Statements                                  |    | 4        
|               |                                                                                        |    |          
|Item
 2.       | Managements
 Discussion and Analysis of Financial Condition and Results of Operations |    | 8        
|               |                                                                                        |    |          
|Item
 3.       | Quantitative
 and Qualitative Disclosures About Market Risk                            |    | 14       
|               |                                                                                        |    |          
|Item
 4T.      | Controls
 and Procedures                                                               |    | 15       
|               |                                                                                        |    |          
|PART
 II.      | OTHER
 INFORMATION                                                                     |    | 16       
|               |                                                                                        |    |          
|Item
 1.       | Legal
 Proceedings                                                                     |    | 16       
|               |                                                                                        |    |          
|Item
 1A.      | Risk
 Factors                                                                          |    | 16       
|               |                                                                                        |    |          
|Item
 2.       | Unregistered
 Sales of Equity Securities and Use of Proceeds                           |    | 16       
|               |                                                                                        |    |          
|Item
 3.       | Defaults
 Upon Senior Securities                                                       |    | 16       
|               |                                                                                        |    |          
|Item
 4.       | Removed
 and Reserved                                                                  |    | 16       
|               |                                                                                        |    |          
|Item
 5.       | Other
 Information                                                                     |    | 16       
|               |                                                                                        |    |          
|Item
 6.       | Exhibits                                                                               |    | 16       
|               |                                                                                        |    |          
|SIGNATURES     |                                                                                        | 17
|               |                                                                                        |    |          
|EXHIBIT
 INDEX |                                                                                        | 18

---



PART I. FINANCIAL INFORMATION

|        |                                  
|------- | ---------------------------------
|Item 1. | Financial Statements (unaudited):

Image Sensing Systems, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(in thousands)

|                                           |  |                 |        |                    |   |        |  
|------------------------------------------ |  | --------------- | ------ | ------------------ | - | ------ | -
|                                           |  | March 31,
 2010 |        | December 31,
 2009 |  
|Assets                                     |  |                 |        |                    |   |        |  
|Current assets:                            |  |                 |        |                    |   |        |  
|Cash and cash equivalents                  |  | $               | 12,575 |                    | $ | 14,084 |  
|Investments                                |  |                 | 3,911  |                    |   | 3,935  |  
|Accounts receivable, net                   |  |                 | 4,986  |                    |   | 5,660  |  
|Inventories                                |  |                 | 2,979  |                    |   | 2,734  |  
|Prepaid expenses                           |  |                 | 631    |                    |   | 588    |  
|Deferred income taxes                      |  |                 | 328    |                    |   | 328    |  
|Total current assets                       |  |                 | 25,410 |                    |   | 27,329 |  
|                                           |  |                 |        |                    |   |        |  
|Property and equipment, net                |  |                 | 1,013  |                    |   | 998    |  
|                                           |  |                 |        |                    |   |        |  
|Deferred income taxes                      |  |                 | 1,485  |                    |   | 1,485  |  
|Goodwill and intangible assets             |  |                 | 11,146 |                    |   | 11,338 |  
|Total assets                               |  | $               | 39,054 |                    | $ | 41,150 |  
|                                           |  |                 |        |                    |   |        |  
|Liabilities and Shareholders Equity       |  |                 |        |                    |   |        |  
|Current liabilities:                       |  |                 |        |                    |   |        |  
|Accounts payable                           |  | $               | 403    |                    | $ | 953    |  
|Bank debt                                  |  |                 | 3,900  |                    |   | 4,000  |  
|Accrued compensation                       |  |                 | 575    |                    |   | 858    |  
|Accrued warranty and other                 |  |                 | 721    |                    |   | 643    |  
|EIS earn-out payable                       |  |                 |       |                    |   | 1,541  |  
|Income taxes payable                       |  |                 | 54     |                    |   | 234    |  
|Total current liabilities                  |  |                 | 5,653  |                    |   | 8,229  |  
|                                           |  |                 |        |                    |   |        |  
|Income taxes payable                       |  |                 | 186    |                    |   | 208    |  
|                                           |  |                 |        |                    |   |        |  
|Shareholders equity:                      |  |                 |        |                    |   |        |  
|Common stock                               |  |                 | 40     |                    |   | 40     |  
|Additional paid-in capital                 |  |                 | 12,135 |                    |   | 11,994 |  
|Accumulated other comprehensive loss       |  |                 | (212   | )                  |   | (171   | )
|Retained earnings                          |  |                 | 21,252 |                    |   | 20,850 |  
|                                           |  |                 | 33,215 |                    |   | 32,713 |  
|Total liabilities and shareholders equity |  | $               | 39,054 |                    | $ | 41,150 |  

See accompanying notes.

- 1 -

---



Image Sensing Systems, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(in thousands, except per share data)

|                                                       |  |                                      |       |      |   |       |  
|------------------------------------------------------ |  | ------------------------------------ | ----- | ---- | - | ----- | -
|                                                       |  | Three-Month Periods Ended
 March 31, |      
|                                                       |  | 2010                                 |       | 2009 |  
|Revenue:                                               |  |                                      |       |      |   |       |  
|International sales                                    |  | $                                    | 1,115 |      | $ | 1,182 |  
|North American sales                                   |  |                                      | 1,697 |      |   | 1,312 |  
|Royalties                                              |  |                                      | 2,591 |      |   | 2,296 |  
|                                                       |  |                                      | 5,403 |      |   | 4,790 |  
|                                                       |  |                                      |       |      |   |       |  
|Costs of revenue:                                      |  |                                      |       |      |   |       |  
|International sales                                    |  |                                      | 388   |      |   | 394   |  
|North American sales                                   |  |                                      | 544   |      |   | 373   |  
|                                                       |  |                                      | 932   |      |   | 767   |  
|Gross profit                                           |  |                                      | 4,471 |      |   | 4,023 |  
|                                                       |  |                                      |       |      |   |       |  
|Operating expenses:                                    |  |                                      |       |      |   |       |  
|Selling, marketing and product support                 |  |                                      | 1,856 |      |   | 1,630 |  
|General and administrative                             |  |                                      | 1,038 |      |   | 975   |  
|Research and development                               |  |                                      | 777   |      |   | 811   |  
|Amortization of intangible assets                      |  |                                      | 192   |      |   | 192   |  
|                                                       |  |                                      | 3,863 |      |   | 3,608 |  
|Income from operations                                 |  |                                      | 608   |      |   | 415   |  
|                                                       |  |                                      |       |      |   |       |  
|Other expense, net                                     |  |                                      | (36   | )    |   | (12   | )
|Income
 before income taxes                            |  |                                      | 572   |      |   | 403   |  
|Income taxes                                           |  |                                      | 170   |      |   | 142   |  
|Net income                                             |  | $                                    | 402   |      | $ | 261   |  
|                                                       |  |                                      |       |      |   |       |  
|Net income
 per common share:                          |  |                                      |       |      |   |       |  
|Basic                                                  |  | $                                    | 0.10  |      | $ | 0.07  |  
|Diluted                                                |  | $                                    | 0.10  |      | $ | 0.06  |  
|                                                       |  |                                      |       |      |   |       |  
|Weighted
 average number of common shares outstanding: |  |                                      |       |      |   |       |  
|Basic                                                  |  |                                      | 3,989 |      |   | 3,985 |  
|Diluted                                                |  |                                      | 4,089 |      |   | 4,055 |  

See
accompanying notes.

- 2 -

---



Image Sensing Systems, Inc.
Condensed Consolidated Statements of Cash Flows 
(Unaudited) 
(in thousands)

|                                                                                  |  |                                    |        |      |   |        |  
|--------------------------------------------------------------------------------- |  | ---------------------------------- | ------ | ---- | - | ------ | -
|                                                                                  |  | Three-Month Periods EndedMarch 31, |       
|                                                                                  |  | 2010                               |        | 2009 |  
|Operating activities:                                                             |  |                                    |        |      |   |        |  
|Net income                                                                        |  | $                                  | 402    |      | $ | 261    |  
|Adjustments to reconcile net income to net
 cash provided by operating activities |  |                                    |        |      |   |        |  
|Depreciation and amortization                                                     |  |                                    | 312    |      |   | 286    |  
|Stock option expense                                                              |  |                                    | 80     |      |   | 93     |  
|Change in operating assets and liabilities                                        |  |                                    | (612   | )    |   | 1,002  |  
|Net cash provided by operating activities                                         |  |                                    | 182    |      |   | 1,642  |  
|                                                                                  |  |                                    |        |      |   |        |  
|Investing activities:                                                             |  |                                    |        |      |   |        |  
|Net purchases of property and equipment                                           |  |                                    | (135   | )    |   | (149   | )
|Payment of EIS earn-out                                                           |  |                                    | (1,541 | )    |   | (1,162 | )
|Net sales of investments                                                          |  |                                    | 24     |      |   | 4,000  |  
|Net cash provided by (used in) investing
 activities                              |  |                                    | (1,652 | )    |   | 2,689  |  
|                                                                                  |  |                                    |        |      |   |        |  
|Financing activities:                                                             |  |                                    |        |      |   |        |  
|Repayment of bank debt                                                            |  |                                    | (100   | )    |   | (3,750 | )
|Proceeds from exercise of stock options                                           |  |                                    | 61     |      |   |       |  
|Net cash used in financing activities                                             |  |                                    | (39    | )    |   | (3,750 | )
|                                                                                  |  |                                    |        |      |   |        |  
|Increase (decrease) in cash and cash
 equivalents                                 |  |                                    | (1,509 | )    |   | 581    |  
|                                                                                  |  |                                    |        |      |   |        |  
|Cash and cash equivalents, beginning of
 period                                   |  |                                    | 14,084 |      |   | 10,289 |  
|Cash and cash equivalents, end of period                                          |  | $                                  | 12,575 |      | $ | 10,870 |  

See
accompanying notes.

- 3 -

---



IMAGE SENSING SYSTEMS, INC.

Notes to
Condensed Consolidated Financial Statements 
(Unaudited) 
March 31, 2010

Note A: Basis of Presentation

The
accompanying unaudited condensed consolidated financial statements of Image
Sensing Systems, Inc. (the Company) have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America 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. Operating results for the three-month period ended March 31, 2010
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2010. For further information, refer to the consolidated
financial statements and footnotes thereto in our Annual Report on Form 10-K
for the year ended December 31, 2009.

Note B: Acquisition

In 2007, we
purchased certain assets of EIS Electronic Integrated Systems, Inc. (EIS),
including its RTMS radar product line. As part of the purchase agreement, the
sellers are eligible to receive an earn-out based on the performance of the EIS
assets purchased for approximately the three years after the December 2007
purchase date. Earn-outs will be calculated and paid annually. Based on target
achievement, the sellers would receive $2.0 million annually or a total of $6.0
million. Earn-out payments related to the EIS asset purchase are recorded as
additional goodwill when earned. In 2009 and 2008, the sellers earned an
earn-out of approximately $1.5 million and $1.2 million, respectively which
were paid in March of the subsequent year.

Note C: Goodwill and Intangible Assets

Goodwill
consists of $1.1 million related to our acquisition of Flow Traffic Ltd. and
$6.6 million related to the EIS asset purchase, consisting of $3.8 million
recorded at the purchase date and an additional $2.7 million recognized for
earn-out consideration earned in 2009 and 2008.

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

|                                           |  |                 |        |                    |   |        |  
|------------------------------------------ |  | --------------- | ------ | ------------------ | - | ------ | -
|                                           |  | March 31,
 2010 |        | December 31,
 2009 |  
|Developed technology (8 year life)         |  | $               | 3,900  |                    | $ | 3,900  |  
|Trade names (5 year life)                  |  |                 | 1,200  |                    |   | 1,200  |  
|Other intangibles (5 year life)            |  |                 | 200    |                    |   | 200    |  
|Less: Accumulated amortization             |  |                 | (1,778 | )                  |   | (1,586 | )
|Total
 identifiable intangible assets, net |  | $               | 3,522  |                    | $ | 3,714  |  

We have and
expect to continue to recognize amortization expense for the intangible assets
in the above table of $768,000 in each of our years ending December 31, 2009,
2010 and 2011, $749,000 in 2012 and $488,000 in 2013. Goodwill and intangible
assets related to the EIS asset purchase are deductible for tax purposes over
15 years.

We monitor on
a quarterly basis our carrying value, the market capitalization of our stock
and other variables to determine whether a triggering event has occurred that
would require an interim impairment evaluation of our goodwill. We have
concluded that no triggering events have occurred during the quarter ended
March 31, 2010.

- 4 -

---



Note D: Net Income Per Common Share and Comprehensive Income (Loss)

The following
table sets forth the computations of basic and diluted net income per common
share for the three-month periods ended March 31, 2010 and 2009 (in thousands,
except per share data):

|                                                                 |  |      |       |      |   |       | 
|---------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- | 
|                                                                 |  | 2010 |       | 2009 |  
|Numerator:                                                       |  |      |       |      |   |       | 
|Net income                                                       |  | $    | 402   |      | $ | 261   | 
|Denominator:                                                     |  |      |       |      |   |       | 
|Shares used in basic net income per common
 share calculation    |  |      | 3,989 |      |   | 3,985 | 
|Effect of diluted securities:                                    |  |      |       |      |   |       | 
|Employee and director stock options                              |  |      | 100   |      |   | 70    | 
|Shares used in diluted net income per
 common share calculations |  |      | 4,089 |      |   | 4,055 | 
|Basic net income per common share                                |  | $    | 0.10  |      | $ | 0.07  | 
|Diluted net income per common share                              |  | $    | 0.10  |      | $ | 0.06  | 

Our
comprehensive income (loss) for the three-month periods ended March 31, 2010
and 2009 was $361,000 and $(174,000), respectively. In each period, the main
difference between net income and comprehensive income (loss) arose from
foreign currency translation adjustments.

Note E: Stock-based Compensation

We recorded
$80,000 and $93,000 of stock-based compensation in general and administrative
expense for the three-month periods ended March 31, 2010 and 2009, respectively.
Options to purchase 40,000 shares, at a weighted average exercise price of
$12.75, and options to purchase 4,000 shares, at a weighted average exercise
price of $7.00, were granted during the three-month periods ended March 31,
2010 and 2009, respectively. As of March 31, 2010, $897,000 of total
unrecognized compensation expense related to non-vested stock option awards is
expected to be recognized over a weighted average period of 2.8 years.

We used the
Black-Scholes option pricing model to determine the weighted average fair value
of options during the three-month periods ended March 31, 2010 and 2009,
respectively.

The Companys
stock options generally vest over three to five years of service and have a
contractual life of six to ten years. As of March 31, 2010, we had 75,500
shares available for grants under the 2005 Stock Incentive Plan.

The following
table summarizes information about the stock options outstanding at March 31,
2010:

|                         |             |                     |                     |                                                 |                     |                                    |           |                     |   |                                   |  |  |         |  |   |       | 
|------------------------ | ----------- | ------------------- | ------------------- | ----------------------------------------------- | ------------------- | ---------------------------------- | --------- | ------------------- | - | --------------------------------- |  |  | ------- |  | - | ----- | 
|                         |             |                     | Options Outstanding |                                                 | Options Exercisable |                                   
|Range of
 Exercise Price |             | Number
 Outstanding |                     | Weighted
 Average
 Remaining
 Contractual
 Life |                     | Weighted
 Average
 Exercise
 Price |           | Number
 Exercisable |   | Weighted
 Average
 Exercise Price | 
|$                        | 1.30-1.99   |                     |                     | 57,000                                          |                     |                                    | 2.2 years |                     | $ | 1.35                              |  |  | 57,000  |  | $ | 1.35  | 
|                         | 2.00-2.99   |                     |                     | 16,200                                          |                     |                                    | 1.9 years |                     |   | 2.35                              |  |  | 16,200  |  |   | 2.35  | 
|                         | 3.00-3.99   |                     |                     | 38,933                                          |                     |                                    | 2.5 years |                     |   | 3.15                              |  |  | 38,933  |  |   | 3.15  | 
|                         | 7.00-7.99   |                     |                     | 4,000                                           |                     |                                    | 5.1 years |                     |   | 7.00                              |  |  | 1,000   |  |   | 7.00  | 
|                         | 8.00-8.99   |                     |                     | 48,000                                          |                     |                                    | 6.6 years |                     |   | 8.63                              |  |  | 7,500   |  |   | 8.89  | 
|                         | 9.00-9.99   |                     |                     | 173,000                                         |                     |                                    | 5.1 years |                     |   | 9.20                              |  |  | 39,625  |  |   | 9.22  | 
|                         | 12.00-12.99 |                     |                     | 89,000                                          |                     |                                    | 5.4 years |                     |   | 12.59                             |  |  | 33,500  |  |   | 12.50 | 
|                         | 15.00-15.99 |                     |                     | 28,000                                          |                     |                                    | 1.8 years |                     |   | 15.30                             |  |  | 28,000  |  |   | 15.30 | 
|                         |             |                     |                     | 454,133                                         |                     |                                    | 4.4 years |                     |   | 8.41                              |  |  | 221,758 |  |   | 6.87  | 

- 5 -

---



Note F: Segment Information

We currently
operate in two reportable segments: Autoscope and RTMS. Autoscope is our
machine-vision product line, and revenue consists of royalties (all of which
are received from Econolite Control Products, Inc.), as well as a portion of
international sales. RTMS is our radar product line acquired in the EIS asset
purchase in 2007, and revenue consists of all North American sales and a
portion of international sales. All segment revenues are derived from external
customers.

The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the three-month period ended March 31, 2010
(in thousands):

|                                   |  |           |        |      |   |        |  |   |        | 
|---------------------------------- |  | --------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |        | RTMS |   | Total  | 
|Revenue                            |  | $         | 3,009  |      | $ | 2,394  |  | $ | 5,403  | 
|Depreciation                       |  |           | 69     |      |   | 51     |  |   | 120    | 
|Amortization
 of intangible assets |  |           |       |      |   | 192    |  |   | 192    | 
|Income
 (loss) before income taxes |  |           | (52    | )    |   | 624    |  |   | 572    | 
|Capital
 expenditures              |  |           | 95     |      |   | 40     |  |   | 135    | 
|Total assets                       |  |           | 27,874 |      |   | 11,180 |  |   | 39,054 | 

The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the three-month period ended March 31, 2009
(in thousands):

|                                   |  |           |        |      |   |        |  |   |        | 
|---------------------------------- |  | --------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |        | RTMS |   | Total  | 
|Revenue                            |  | $         | 3,246  |      | $ | 1,544  |  | $ | 4,790  | 
|Depreciation                       |  |           | 66     |      |   | 28     |  |   | 94     | 
|Amortization
 of intangible assets |  |           |       |      |   | 192    |  |   | 192    | 
|Income
 before income taxes        |  |           | 367    |      |   | 36     |  |   | 403    | 
|Capital
 expenditures              |  |           | 124    |      |   | 25     |  |   | 149    | 
|Total assets                       |  |           | 19,680 |      |   | 11,022 |  |   | 30,702 | 

Note G: Derivative Instruments

We have
purchased foreign currency forward contracts with our bank to reduce the
exposure and volatility arising from fluctuations in foreign currency exchange
rates as it relates to payroll and inventory purchases in certain foreign
locations. These contracts have been designated as effective cash flow hedges.
At March 31, 2010, we had future commitments through May 2010 to purchase
$486,000 of British pounds at rates of approximately 1.62.

The fair value
of the Companys derivative instruments is estimated in accordance with the
framework for measuring fair value and is recorded as either an asset or
liability in the balance sheet based on changes in the current spot rate, as
compared to the exchange rates specified in the contracts. For these
instruments, the effective portion of the gain or loss on the derivative is
reported as a component of other comprehensive income and is reclassified into
earnings in the same period or periods during which the hedged transaction
affects earnings. Gains and losses on the derivative representing either hedge
ineffectiveness or hedge components excluded from the assessment of
effectiveness are recognized in current earnings. The fair value measurement of
the Companys derivative instruments is estimated using Level 2 inputs which
are inputs other than quoted prices that are directly or indirectly observable
for the asset or liability. We did not record any unrealized gain or losses on
our derivative instruments as of March 31, 2010 as the currency spot rates were
materially equivalent to the contract rates.

- 6 -

---



Note H: New Accounting Pronouncements

In June 2009,
the Financial Accounting Standards Board (FASB) amended Accounting Standards
Codification (ASC) 810, Consolidation,
to improve how enterprises disclose their involvement with variable interest
entities (VIE), which are special-purpose entities, and other entities whose
equity at risk is insufficient or lacks certain characteristics. Among other
things, ASC 810 changes how an entity determines whether it is the primary
beneficiary of a VIE and whether that VIE should be consolidated. ASC 810
requires an entity to provide significantly more disclosures about its
involvement with a VIE. Companies must comprehensively review involvements with
potential VIEs, including those previously considered to be qualifying
special-purpose entities, to determine the effect on their consolidated
financial statements and related disclosures. ASC 810 is effective
prospectively for interim or annual reporting periods beginning after December
15, 2009. We do not believe that the adoption of this portion of ASC 810 will
have a significant effect on our consolidated financial statements.

In
January 2010, the FASB issued Accounting Standards Update
No. 2010-06, Improving Disclosures
about Fair Value Measurements (ASU 2010-06). ASU 2010-06 requires
new disclosures regarding transfers in and out of Levels 1 and 2 and activity
in Level 3 fair value measurements. It also clarifies existing disclosure
requirements regarding the level of disaggregation in certain disclosures,
inputs, and valuation techniques used in ASC 820, Fair Value Measurements and Disclosures. We adopted all of
the requirements of this update on January 1, 2010, its effective date,
except for the new requirement regarding activity in Level 3 fair value measurements
which has a later effective date under the provisions of ASU 2010-6, and will
become effective on January 1, 2011. Adoption of this pronouncement has
not had, and is not expected to have, a significant effect on our consolidated
financial statements disclosures.

Note I: Subsequent Event

In April 2010,
we sold 798,000 shares of our common stock to investors at $12.25 per share
under a registration statement on Form S-3 declared effective by the Securities
and Exchange Commission in December 2009. Net of underwriting fees and other
offering expenses, we estimate we will net $8.9 million in cash from the stock
sale.

- 7 -

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|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis of Financial
 Condition and Results of Operations

Overview

General. We provide software based computer enabled
detection, or CED, products and solutions that use advanced signal processing
software algorithms to detect and monitor objects in a designated field of
view. Our technology analyzes the signal from a sophisticated sensor and passes
the information along to management systems, controllers or directly to users.
Our core products, the Autoscope® Video Vehicle Detection System and the RTMS®
Radar Detection System, operate using our proprietary software in conjunction
with video cameras or radar and commonly available electronic components. Each
of these systems is used by traffic managers primarily to improve the flow of
vehicle traffic and to enhance safety at intersections, main thoroughfares,
freeways and tunnels.

Autoscope systems are sold
to distributors and end users of traffic management products in North America,
the Caribbean and Latin America by Econolite Control Products, Inc., or
Econolite, our exclusive licensee in these regions. We sell RTMS systems to
distributors and end users in North America. We also sell both Autoscope and
RTMS systems to distributors and end users in Europe and Asia through our
European and Hong Kong subsidiaries, respectively. End users of our products
throughout the world are generally funded by government agencies responsible
for traffic management or traffic law enforcement.

EIS Asset Purchase. In 2007, we purchased certain assets from
EIS Electronic Integrated Systems Inc., or EIS, including its principal product
line, the RTMS system. In its fiscal year ended September 30, 2007, EIS had
revenue of $8.7 million, substantially all of which related to RTMS sales.

Trends
and Challenges in Our Business

We believe the
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, which has increased demand for our
 products;          
| |   |                                                                                                                                                                                                   
| |  | advances in information
 technology, which have made our products easier to market and implement;                                                                                                 
| |   |                                                                                                                                                                                                   
| |  | the continuing rise in
 funding allocations in large cities for centralized traffic management
 services, which has 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 intelligent transportation systems, or ITS, for
 traffic control in developed countries;                         
| |   |                                                                                                                                                                  
| |  | countries in the developing
 world adopting above-ground detection technology, such as video or radar,
 instead of in-pavement loop technology to manage traffic;

- 8 -

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| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | use of CED to provide
 solutions to security/surveillance and environmental issues associated with
 increasing automobile use in metropolitan areas; and                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                    
| |  | our ability to develop new
 products, such as hybrid CED devices incorporating, for example, radar and
 video technologies, that provide increasingly accurate information and
 enhance the end users ability to cost-effectively manage traffic,
 security/surveillance and environmental issues.

Because our
principal 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 current worldwide recession 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 negatively affect our 2010 revenue. We believe we will continue to
be a beneficiary of the federal stimulus bill enacted early in 2009, but it is
difficult to determine the level of impact it has on our operations.

Key
Financial Terms and Metrics

Revenue. Revenue historically has been
derived from two sources: (1) royalties received from Econolite for sales of
the Autoscope system in North America, the Caribbean and Latin America and (2)
revenue received from direct sales of Autoscope systems in Europe and Asia.
Royalties from Econolite historically have provided the majority of our
revenue. We calculate the royalties using a profit sharing model where we split
the gross profit on sales of Autoscope product made through 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. Our acquisition of the RTMS product line in December 2007 gives us
an additional source of revenue that increased our overall revenue and helped
to lessen fluctuations in our revenue from period to period due to our
ownership of more than one product line and the higher volumes it brings, notwithstanding
normal seasonality.

Cost of Revenue. There is no cost of revenue related to
royalties, as virtually all manufacturing, warranty and related costs are
incurred by Econolite. Cost of revenue related to direct product sales consists
primarily of the amount charged by our third party contractors to manufacture
the Autoscope and RTMS hardware platforms, which is influenced mainly by the
cost of electronic components. The cost of revenue also includes logistics
costs and estimated expenses for product warranties and inventory reserves. The
key metric that we follow is achieving certain gross margin percentages by
geographic region.

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. General and administrative expenses reflect 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,
Sarbanes-Oxley compliance, 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 is non-cash expense for intangible asset amortization.

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 North America, Europe and northern Asia.
We expect such seasonality to continue for the foreseeable future.
Additionally, our international revenues have a significant large project
component, resulting in a varying revenue stream. 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.

- 9 -

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History. We were incorporated in the state of
Minnesota in December 1984 and began operations by pioneering the commercial
application of wide-area video vehicle detection for traffic management. The
technology underlying our products was initially developed at the University of
Minnesota. In 1989, the University was awarded a patent for that technology,
which it exclusively licensed to us. In 1991, we sub-licensed this technology to
Econolite, a leading manufacturer and seller of traffic control products in
North America and the Caribbean, to manufacture and distribute products
incorporating the technology.

Segments. We currently operate in two
reportable segments: Autoscope and RTMS. Autoscope 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 sales. RTMS is our radar
product line acquired in the EIS asset purchase in December 2007, and revenue
consists of all North American sales and a portion of international sales. All
segment revenues are derived from external customers.

The following table sets forth
selected unaudited financial information for each of the Companys reportable
segments for the three-month period ended March 31, 2010 (in thousands):

|                                   |  |           |        |      |   |        |  |   |        | 
|---------------------------------- |  | --------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |        | RTMS |   | Total  | 
|Revenue                            |  | $         | 3,009  |      | $ | 2,394  |  | $ | 5,403  | 
|Depreciation                       |  |           | 69     |      |   | 51     |  |   | 120    | 
|Amortization of intangible
 assets |  |           |       |      |   | 192    |  |   | 192    | 
|Income (loss) before
 income taxes |  |           | (52    | )    |   | 624    |  |   | 572    | 
|Capital expenditures               |  |           | 95     |      |   | 40     |  |   | 135    | 
|Total assets                       |  |           | 27,874 |      |   | 11,180 |  |   | 39,054 | 

The following table sets
forth selected unaudited financial information for each of the Companys
reportable segments for the three-month period ended March 31, 2009 (in
thousands):

|                                   |  |           |        |      |   |        |  |   |        | 
|---------------------------------- |  | --------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |        | RTMS |   | Total  | 
|Revenue                            |  | $         | 3,246  |      | $ | 1,544  |  | $ | 4,790  | 
|Depreciation                       |  |           | 66     |      |   | 28     |  |   | 94     | 
|Amortization of intangible
 assets |  |           |       |      |   | 192    |  |   | 192    | 
|Income before income taxes         |  |           | 367    |      |   | 36     |  |   | 403    | 
|Capital expenditures               |  |           | 124    |      |   | 25     |  |   | 149    | 
|Total assets                       |  |           | 19,680 |      |   | 11,022 |  |   | 30,702 | 

Results of Operations

The following table sets
forth, for the periods indicated, certain statements of income data as a
percent of total revenue and gross margin on international sales, North
American sales and royalties as a percentage of international sales, North
American sales and royalties, respectively.

- 10 -

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|                                       |  |                                     |       |                                |  |       |   |  |      |   
|-------------------------------------- |  | ----------------------------------- | ----- | ------------------------------ |  | ----- | - |  | ---- | --
|                                       |  | Three-Month Period Ended
 March 31, |       | Quarter Over 
 Quarter
 Change | 
|                                       |  | 2010                                |       | 2009                           |  |      
|International sales                    |  |                                     | 20.6  | %                              |  | 24.7  | % |  | (5.7 | )%
|North American sales                   |  |                                     | 31.4  |                                |  | 27.4  |   |  | 29.3 |   
|Royalties                              |  |                                     | 48.0  |                                |  | 47.9  |   |  | 12.8 |   
|Total revenue                          |  |                                     | 100.0 |                                |  | 100.0 |   |  | 12.8 |   
|Gross margininternational sales       |  |                                     | 65.2  |                                |  | 66.7  |   |  | (7.7 | ) 
|Gross marginNorth American sales      |  |                                     | 67.9  |                                |  | 71.6  |   |  | 22.8 |   
|Gross marginroyalties                 |  |                                     | 100.0 |                                |  | 100.0 |   |  |     |   
|Selling, marketing and product support |  |                                     | 34.4  |                                |  | 34.0  |   |  | 13.9 |   
|General and administrative             |  |                                     | 19.2  |                                |  | 20.4  |   |  | 6.5  |   
|Research and development               |  |                                     | 14.4  |                                |  | 16.9  |   |  | (4.2 | ) 
|Amortization of intangibles            |  |                                     | 3.6   |                                |  | 4.0   |   |  |     |   
|Income from operations                 |  |                                     | 11.3  |                                |  | 8.7   |   |  | 46.5 |   
|Income tax expense                     |  |                                     | 3.1   |                                |  | 3.0   |   |  | 19.7 |   
|Net income                             |  |                                     | 7.4   |                                |  | 5.4   |   |  | 54.0 |   

Total revenue increased to
$5.4 million in the three-month period ended March 31, 2010 from $4.8 million
in the same period in 2009, an increase of 12.8%. Royalties increased to $2.6
million in the first quarter of 2010 from $2.3 million in the same period in
2009, an increase of 12.8%. We attribute the increase in royalties to the
easing of the economic recession in North America which severely impacted 2009.
North American sales, which are sales of RTMS in North America, increased to
$1.7 million, or 31.4% of revenue, in the first quarter of 2010 from $1.3
million, or 27.4% of revenue, in the same period in 2009, an increase of 29.3%,
also reflecting the improved economic environment in North America.
International sales, which include both Autoscope and RTMS sales outside of
North America, decreased to $1.1 million in the first quarter of 2010 from $1.2
million in the first quarter of 2009, a decrease of 5.7%. Revenue for the
Autoscope segment decreased to $3.0 million in 2010 from $3.2 million in 2009,
a decrease of 7.3%. The decrease reflects the variable nature of our
international business, especially in our seasonally slowest quarter. Revenue
for the RTMS segment increased to $2.4 million in 2010 from $1.5 million in
2009, an increase of 55.1%. The increase resulted mainly as a result of
improved sales in North America and Asia.

Gross margins for
international sales decreased to 65.2% in the three months ended March 31, 2010
from 66.7% in the same period in 2009, and gross margins for North American
sales decreased to 67.9% in the first quarter of 2010 from 71.6% in the first
quarter of 2009. The decreases resulted mainly from a negative revenue mix
shift. Gross margins on royalty income remained consistent at 100.0% in each of
the first quarters of 2010 and 2009.

Selling, marketing and
product support expense increased to $1.9 million, or 34.4% of total revenue,
in the first three months of 2010 from $1.6 million, or 34.0% of total revenue,
in the first three months of 2009. The change related mostly to an investment
in market expansion activities in Europe and Asia and increased product support
expenses. We anticipate that for the remainder of 2010, the dollar amount of
our quarterly selling, marketing and product support expense will increase from the 2010 first quarter level.

General and administrative
expense increased slightly to $1.0 million, or 19.2% of total revenue, in the
first quarter of 2010, up from $975,000, or 20.4% of total revenue, in the same
period in 2009. We anticipate that for the remainder of 2010, the dollar amount
of our quarterly general and administrative expense will remain at levels
similar to or slightly higher than that of the first quarter of 2010.

Research and development
expense decreased slightly to $777,000, or 14.4% of total revenue, in the first
quarter of 2010, down from $811,000, or 16.9% of total revenue, in the same
period in 2009. We anticipate that for the remainder of 2010, the dollar amount
of our quarterly research and development expense will increase from the first
quarter of 2010 level.

- 11 -

---



Amortization
of intangibles expense was $192,000 in the first quarter of 2010 and reflects
the amortization of intangible assets acquired in the EIS asset purchase.
Assuming there are no changes to our intangible assets, we anticipate
amortization expense will be $768,000 for all of 2010.

Other expense
was $36,000 in the first quarter of 2010 as compared to $12,000 in the same
period in 2009. In 2009, bank debt was outstanding for only a portion of the
first quarter.

Income before
income taxes for the Autoscope segment decreased to a loss of $52,000 in 2010
from income of $367,000 in 2009. The decrease was mainly due to lower revenues
and increased market expansion activities in international markets in the
segment. Income before income taxes for the RTMS segment increased to $624,000
in 2010 from $36,000 in 2009. The increase was mainly due to higher revenues in
the segment.

Income tax
expense was $170,000, or 29.7% of pretax income, in the first quarter of 2010,
compared to $142,000, or 35.2% of pretax income, in the comparable quarter of
2009. We anticipate an effective tax rate of below 30% for all of 2010.

Liquidity and Capital Resources

At March 31,
2010, we had $12.6 million in cash and cash equivalents and $3.9 million in
short-term investments, compared to $14.1 million in cash and cash equivalents
and $3.9 million in short-term investments at December 31, 2009. Subsequent to
March 31, 2010, we raised approximately $8.9 million through a registered
offering of our common stock. The offering closed in April 2010.

Net cash
provided by operating activities in the three-month period ended March 31, 2010
was $182,000, compared to $1.6 million in the same period of 2009. The decrease
in 2010 was due to a combination of a lower change in receivables in the 2010
quarter as compared to 2009 and a greater change in payables and accruals in
the 2010 quarter as compared to 2009. We anticipate that average receivable
collection days in 2010 will be similar to 2009 and will not have a material
impact on our liquidity. Our planned additions of property and equipment are
discretionary, and we do not expect them to exceed historical levels in 2010.
In addition to equipment purchases, in 2010 we paid our 2009 earn-out liability
of $1.5 million to the sellers of the EIS assets.

In December
2009, we entered into a term loan agreement for $4.0 million with Associated
Bank, National Association, or Associated Bank. The interest rate for the term
loan is based on a formula of LIBOR plus 3.75% (current rate is 4.0%). The term
loan had $3.9 million outstanding at March 31, 2010 and contains a call
provision that would require us to repay the note in full in August 2010 if we
do not meet certain covenants. The call provision originally triggered in May
2010 but was extended by Associated Bank in April 2010. We previously had a
separate $4.0 million term note with Associated Bank that originated in May
2008 and was fully repaid in February 2009.

We also have a
revolving line of credit agreement with Associated Bank. The revolving line of
credit provides for up to $5.0 million at an annual interest rate equal to the
greater of 4.5% or LIBOR plus 2.75%, as reset from time to time by the bank.
Advances on the line of credit cannot exceed a borrowing base determined under
a formula, which is a percentage of the amounts of eligible receivables. The
line of credit currently has no borrowings outstanding and matures on May 1,
2011. We believe, on an ongoing basis, we will have regular availability to
draw a minimum of $3.0 million on our line of credit based on our qualifying
assets.

In conjunction
with our EIS asset purchase, the sellers have an earn-out arrangement over
approximately three years from the December 2007 date of purchase. The earn-out
is based on earnings before taxes from RTMS sales less related cost of revenue
and operating expenses, excluding depreciation, amortization and interest
expenses, and it is calculated annually. If the earnings are at target levels,
the sellers would receive $2.0 million annually, or $6.0 million in total.
Superior performance of the assets could lead to an earn-out in excess of $2
million, as the earn-out is not capped. Earn-out payments generally are due
within three months of the end of an earn-out period. For the first earn-out
period, the sellers of the EIS assets received a $1.2 million earn-out payment.
For the second earn-out period, which was fiscal 2009, the sellers were
entitled to a $1.5 million earn-out, which was paid in March 2010. If we are
acquired or sell substantially all of our assets before December 6, 2010, we
must pay EIS $6.0 million less earn-out amounts previously paid as an
acceleration of potential earn-out payments under the EIS asset purchase
agreement.

- 12 -

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We believe
that cash and cash equivalents on hand at March 31, 2010, along with the
availability of funds under our $5.0 million revolving line of credit and cash
provided by operating activities, will satisfy our projected working capital
needs, payments under the EIS earn-out, investing activities, and other cash
requirements for the foreseeable future. The net proceeds from our April 2010
common stock sale are intended for general corporate use, including acquiring
or investing in businesses, products or technologies. We currently have no
commitments or agreements related to any such a transaction.

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, 2009. The accounting policies used in preparing our interim 2010
Condensed Consolidated Financial Statements set forth elsewhere in this
Quarterly Report on Form 10-Q are the same as those described in our Annual
Report on Form 10-K.

New and Recently Adopted Accounting
Pronouncements

In June 2009,
the Financial Accounting Standards Board (FASB) amended Accounting Standards
Codification (ASC)810, Consolidation, to
improve how enterprises disclose their involvement with variable interest
entities (VIE), which are special-purpose entities, and other entities whose
equity at risk is insufficient or lacks certain characteristics. Among other
things, ASC 810 changes how an entity determines whether it is the primary
beneficiary of a VIE and whether that VIE should be consolidated. ASC 810 requires
an entity to provide significantly more disclosures about its involvement with
a VIE. Companies must comprehensively review involvements with potential VIEs,
including those previously considered to be qualifying special-purpose
entities, to determine the effect on their consolidated financial statements
and related disclosures. ASC 810 is effective prospectively for interim or
annual reporting periods beginning after December 15, 2009. We do not believe
that the adoption of this portion of ASC 810 will have a significant effect on
our consolidated financial statements.

In January
2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements
(ASU 2010-06). ASU 2010-06 requires new disclosures regarding transfers in
and out of Levels 1 and 2 and activity in Level 3 fair value measurements. It
also clarifies existing disclosure requirements regarding the level of
disaggregation in certain disclosures, inputs, and valuation techniques used in
ASC 820, Fair Value Measurements and
Disclosures. We adopted all of the requirements of this update on
January 1, 2010, its effective date, except for the new requirement regarding
activity in Level 3 fair value measurements which has a later effective date
under the provisions of ASU 2010-6, and will become effective on January 1,
2011. Adoption of this pronouncement has not had, and is not expected to have,
a significant effect on our consolidated financial statements disclosures.

- 13 -

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Cautionary Statement:

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

| |   |                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;                                                         
| |   |                                                                                                                                                                                          
| |  | continuing
 ability of our licensee to pay royalties owed;                                                                                                                               
| |   |                                                                                                                                                                                          
| |  | dependence
 on third parties for manufacturing and marketing our products;                                                                                                               
| |   |                                                                                                                                                                                          
| |  | dependence
 on single-source suppliers to meet manufacturing needs;                                                                                                                      
| |   |                                                                                                                                                                                          
| |  | failure to
 secure adequate protection for our intellectual property rights;                                                                                                             
| |   |                                                                                                                                                                                          
| |  | development
 of a competing product by another business using the underlying technology
 included in the patent we had licensed from the University of Minnesota,
 which expired in 2006;
| |   |                                                                                                                                                                                          
| |  | our
 inability to develop new applications and product enhancements;                                                                                                                     
| |   |                                                                                                                                                                                          
| |  | our
 inability to respond to low-cost local competitors in Asia and elsewhere;                                                                                                           
| |   |                                                                                                                                                                                          
| |  | our
 inability to properly manage a growth in revenue and/or production
 requirements;                                                                                                   
| |   |                                                                                                                                                                                          
| |  | the
 influence over our voting stock by affiliates;                                                                                                                                      
| |   |                                                                                                                                                                                          
| |  | our
 inability to hire and retain key scientific and technical personnel;                                                                                                                
| |   |                                                                                                                                                                                          
| |  | our
 inability to achieve and maintain effective internal controls;                                                                                                                      
| |   |                                                                                                                                                                                          
| |  | our
 inability to comply with international regulatory restrictions over hazardous
 substances and electronic waste; and                                                                 
| |   |                                                                                                                                                                                          
| |  | conditions
 beyond our control such as war, terrorist attacks, health epidemics and
 economic recession.                                                                                 

We caution
that the forward-looking statements made in this report or in other
announcements made by us are further qualified by the risk factors set forth in
Item 1A. to our Annual Report on Form 10-K for the fiscal year ended December
31, 2009.

|         |                                                            
|-------- | -----------------------------------------------------------
|Item
 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% adverse change in foreign currency rates, if we have not
hedged, could have a material effect on our results of operations or financial
position. Our current greatest exposure for a negative material impact to our
operations is a rising Canadian Dollar versus the U.S. Dollar.

- 14 -

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|          |                        
|--------- | -----------------------
|Item
 4T. | 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 Chief Financial Officer, we evaluated the effectiveness
of the design and operation of our disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the
Exchange Act)). Based upon that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

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

- 15 -

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PART II. OTHER INFORMATION

|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

None.

|         |             
|-------- | ------------
|Item 1A. | Risk Factors

Some of the risk factors to
which we and our business are subject are described in the section entitled
Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended
December 31, 2009. 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. | Removed and Reserved.                                       
|        |                                                             
|Item 5. | Other Information                                           
|        |                                                             
|None.   |                                                             
|        |                                                             
|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, 2010:

|                |  |                                                                                                     
|--------------- |  | ----------------------------------------------------------------------------------------------------
|Exhibit
 Number |  | Description                                                                                         
|                |  |                                                                                                     
|31.1            |  | Certification of Chief
 Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|                |  |                                                                                                     
|31.2            |  | Certification of Chief
 Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|                |  |                                                                                                     
|32.1            |  | Certification of Chief
 Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|                |  |                                                                                                     
|32.2            |  | Certification of Chief
 Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

- 16 -

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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 11, 2010 | By:                          | /s/ Kenneth R. Aubrey                        
|                    |                              | Kenneth R. Aubrey                            
|                    |                              | President and Chief
 Executive Officer       
|                    |                              | (principal executive
 officer)               
|                    |                              |                                              
|Dated: May 11, 2010 | By:                          | /s/ Gregory R. L. Smith                      
|                    |                              | Gregory R. L. Smith                          
|                    |                              | Chief Financial Officer                      
|                    |                              | (principal financial and
 accounting officer)

- 17 -

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EXHIBIT INDEX

|            |  |                                                                                                     
|----------- |  | ----------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                         
|            |  |                                                                                                     
|31.1        |  | Certification of Chief
 Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                     
|31.2        |  | Certification of Chief
 Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                     
|32.1        |  | Certification of Chief
 Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                     
|32.2        |  | Certification of Chief
 Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

- 18 -

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