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# UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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# FORM 10-Q

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

For the quarterly period ended March 31, 2006

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

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

|Minnesota                                                     | 41-1519168                         
|------------------------------------------------------------- | -----------------------------------
|(State or other jurisdiction ofincorporation or organization) | (I.R.S. EmployerIdentification No.)
|                                                             
|
|(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)

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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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

|Large accelerated filer o | Accelerated filer o | Non-accelerated filer x
|------------------------- | ------------------- | -----------------------

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 April 24, 2006
|--------------------------------------- |  | -----------------------------
|Common Stock, $0.01 par value per share |  | 3,707,405 shares             





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IMAGE SENSING SYSTEMS, INC.

TABLE OF CONTENTS

|              |    |  |                                                                                                           |  |  |  |    | 
|------------- | -- |  | --------------------------------------------------------------------------------------------------------- |  |  |  | -- | 
|
|              |    |  | PART I.    FINANCIAL INFORMATION                                                                          |  |  |  |    | 
|             
|Item 1        |    |  | Financial Statements:                                                                                     |  | 
|             
|              |    |  | Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005                          |  |  |  | 3  | 
|             
|              |    |  | Condensed Consolidated Statements of Income for the three-month periods ended March 31, 2006 and 2005     |  |  |  | 4  | 
|             
|              |    |  | Condensed Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2006 and 2005 |  |  |  | 5  | 
|             
|              |    |  | Notes to Condensed Consolidated Financial Statements                                                      |  |  |  | 6  | 
|             
|Item 2        |    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  |  |  | 9  | 
|             
|Item 4        |    |  | Controls and Procedures                                                                                   |  |  |  | 13 | 
|             
|              |    |  | PART II.    OTHER INFORMATION                                                                             |  | 
|             
|Item 1        |    |  | Legal Proceedings                                                                                         |  |  |  | 13 | 
|             
|Item 6        |    |  | Exhibits                                                                                                  |  |  |  | 14 | 
|             
|Signatures    | 15 | 
|             
|Exhibit Index | 16 | 

2

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Table of Contents

PART I  FINANCIAL INFORMATION
Item 1.   Financial Statements

# IMAGE SENSING SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

|                                            |  | March 31,2006 |   | December 31,2005
|------------------------------------------- |  | ------------- | - | ----------------
|
|
|Current assets:                             |  |               |   |                 
|Cash and cash equivalents                   |  |               | $ | 8,987,000       
|Short-term investments                      |  |               |   | 1,800,000       
|Accounts receivable                         |  |               |   | 2,366,000       
|Finished goods inventory                    |  |               |   | 344,000         
|Investment in FHLB bond                     |  |               |   | 2,300,000       
|Prepaid expenses                            |  |               |   | 187,000         
|Deferred income taxes                       |  |               |   | 14,000          
|                                            |  |               |   |                 
|Total current assets                        |  |               |   | 15,998,000      
|                                           
|Property and equipment, net                 |  |               |   | 405,000         
|                                           
|Other assets:                               |  |              
|Capitalized software development costs, net |  |               |   | 97,000          
|Goodwill                                    |  |               |   | 1,050,000       
|                                            |  |               |   |                 
|                                            |  |               |   | 1,147,000       
|                                            |  |               |   |                 
|                                           
|Total assets                                |  |               | $ | 17,550,000      
|                                            |  |               |   |                 
|                                           
|Liabilities and Shareholders Equity        |  |              
|Current liabilities:                        |  |              
|Accounts payable                            |  |               | $ | 640,000         
|Accrued compensation                        |  |               |   | 235,000         
|Income taxes payable                        |  |               |   | 330,000         
|                                            |  |               |   |                 
|Total current liabilites                    |  |               |   | 1,205,000       
|Deferred income taxes                       |  |               |   | 52,000          
|Shareholders equity:                       |  |              
|Common stock                                |  |               |   | 37,000          
|Additional paid-in capital                  |  |               |   | 7,709,000       
|Retained earnings                           |  |               |   | 8,547,000       
|                                            |  |               |   |                 
|                                            |  |               |   | 16,293,000      
|                                            |  |               |   |                 
|Total liabilities and shareholders equity  |  |               | $ | 17,550,000      
|                                            |  |               |   |                 

Note:   The balance sheet at December 31, 2005 has been derived from the
audited financial statements at that date but does not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete financial statements.

See accompanying notes

3

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# IMAGE SENSING SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

|                                                      |  | Three-Month Periods EndedMarch 31 |   |          
|----------------------------------------------------- |  | --------------------------------- | - | ---------
|
|
|                                                      |  |                                   |   |          
|Revenue:                                              |  |                                   |   |          
|International sales                                   |  |                                   | $ | 413,000  
|Royalties                                             |  |                                   |   | 2,176,000
|                                                      |  |                                   |   |          
|                                                      |  |                                   |   | 2,589,000
|                                                     
|Costs of revenue:                                     |  |                                  
|Cost of product sold                                  |  |                                   |   | 177,000  
|Royalties                                             |  |                                   |   | 103,000  
|                                                      |  |                                   |   |          
|                                                      |  |                                   |   | 280,000  
|                                                      |  |                                   |   |          
|Gross profit                                          |  |                                   |   | 2,309,000
|                                                     
|Operating expenses:                                   |  |                                  
|Selling, marketing and product support                |  |                                   |   | 622,000  
|General and administrative                            |  |                                   |   | 562,000  
|Research and development                              |  |                                   |   | 482,000  
|                                                      |  |                                   |   |          
|                                                      |  |                                   |   | 1,666,000
|                                                      |  |                                   |   |          
|Income from operations                                |  |                                   |   | 643,000  
|                                                     
|Other income, net                                     |  |                                   |   | 97,000   
|                                                      |  |                                   |   |          
|Income before income taxes                            |  |                                   |   | 740,000  
|Income taxes                                          |  |                                   |   | 237,000  
|                                                      |  |                                   |   |          
|Net income                                            |  |                                   | $ | 503,000  
|                                                      |  |                                   |   |          
|                                                     
|Net income per common share:                          |  |                                  
|Basic                                                 |  |                                   | $ | 0.14     
|                                                      |  |                                   |   |          
|Diluted                                               |  |                                   | $ | 0.13     
|                                                      |  |                                   |   |          
|                                                     
|Weighted average number of common shares outstanding:
|Basic                                                 |  |                                   |   | 3,705,000
|                                                      |  |                                   |   |          
|Diluted                                               |  |                                   |   | 3,898,000
|                                                      |  |                                   |   |          

See accompanying notes

4

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# IMAGE SENSING SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                                                                                          |  | Three-Month Periods EndedMarch 31
|------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------
|
|
|                                                                                                                          |  |                                  
|Operating activities:                                                                                                     |  |                                  
|Net income                                                                                                                |  |                                  
|Adjustments to reconcile net income to net cash provided by operating activities
           Depreciation and amortization |  |                                  
|Change in operating assets and liabilities                                                                                |  |                                  
|                                                                                                                          |  |                                  
|Net cash provided by operating activities                                                                                 |  |                                  
|                                                                                                                         
|Investing activities:                                                                                                     |  |                                  
|Purchase of property and equipment                                                                                        |  |                                  
|Purchase of short-term investments                                                                                        |  |                                  
|                                                                                                                          |  |                                  
|Net cash used in investing activities                                                                                     |  |                                  
|                                                                                                                         
|Financing activities:                                                                                                     |  |                                  
|Proceeds from exercise of stock options                                                                                   |  |                                  
|                                                                                                                          |  |                                  
|Net cash provided by financing activities                                                                                 |  |                                  
|                                                                                                                          |  |                                  
|                                                                                                                         
|Increase (decrease) in cash and cash equivalents                                                                          |  |                                  
|                                                                                                                         
|Cash and cash equivalents, beginning of period                                                                            |  |                                  
|                                                                                                                          |  |                                  
|                                                                                                                         
|Cash and cash equivalents, end of period                                                                                  |  |                                  
|                                                                                                                          |  |                                  

See accompanying notes

5

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IMAGE SENSING SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2006

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, 2006 are not necessarily indicative of the results that may be expected for the year
ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto in our
Annual Report on Form 10-KSB for the year ended December 31, 2005.

Note B:   Investments

Investments, at cost, consisted of the following at March 31, 2006 and
December 31, 2005:

|                                                 |  | March 31, 2006 |   | December 31, 2005
|------------------------------------------------ |  | -------------- | - | -----------------
|Short-term investments - Auction Rate Securities |  |                | $ | 1,800,000        
|Callable Federal Home Loan Bonds                 |  |                |   | 2,300,000        
|                                                 |  |                |   |                  
|Total                                            |  |                | $ | 4,100,000        
|                                                 |  |                |   |                  

As of March 31, 2006 and December 31, 2005, investments are classified
as available-for-sale. The cost of investments approximate market value and therefore no amount is recorded in accumulated other
comprehensive income. The cost of securities sold is based on the specific identification method.

There were no sales or maturities in the three-month periods ended March 31,
2006 or 2005. There consequently were no realized gains or losses related to sales or unrealized gains and losses during the
three-month periods ended March 31, 2006 or 2005.

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Note C:   Net Income Per Common Share

The following table sets forth the computations of basic and diluted net
income per common share for the three-month periods ended March 31, 2006 and 2005:

|                                                                |  | 2006 |   | 2005     
|--------------------------------------------------------------- |  | ---- | - | ---------
|                                                                |  |      |   |          
|Numerator:                                                      |  |      |   |          
|Net income                                                      |  |      | $ | 503,000  
|                                                                |  |      |   |          
|                                                               
|Denominator:                                                    |  |     
|Shares used in basic net income per common share calculation    |  |      |   | 3,705,000
|Effect of diluted securities:                                   |  |     
|Employee and director stock options                             |  |      |   | 193,000  
|                                                                |  |      |   |          
|Shares used in diluted net income per common share calculations |  |      |   | 3,898,000
|                                                                |  |      |   |          
|                                                               
|Basic net income per common share                               |  |      | $ | 0.14     
|Diluted net income per common share                             |  |      | $ | 0.13     

Note D:   Stock-based Compensation

Commencing January 1, 2006, we adopted Statement of Financial Accounting
Standard No. 123(R), Share Based Payment(SFAS 123(R)), which requires all share-based payments, including grants of
stock options, to be recognized in the income statement as an operating expense, based on their fair value over the requisite
service period. We recorded $43,000 of related compensation expense included in general and administrative expense for the
three-month period ended March 31, 2006. The related tax benefit from recording this non-cash expense was approximately
$14,000. The net compensation expense reduced both basic and diluted net income per common share by $0.01. As of March 31,
2006, $128,000 of total unrecognized compensation expense related to non-vested stock option awards is expected to be recognized
over a weighted average period of one year.

Prior to adopting SFAS 123(R), we accounted for stock-based compensation
under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.We have applied the
modified prospective method in adopting SFAS 123(R). Accordingly, periods prior to our adoption of SFAS 123(R) have not been
restated. The following table illustrates the effect on net income and net income per share if the fair value based method had
been applied to the comparable three-month period ended March 31, 2005:

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|                                                                                                       | 
|------------------------------------------------------------------------------------------------------ | 
|Net income, as reported                                                                                | 
|Add: stock-based consultants compensation included in reported net income, net of related tax effects | 
|Less: stock-based compensation determined under the fair value method, net of related tax effects      | 
|                                                                                                       | 
|Pro forma net income, assuming fair value method for all stock-based awards                            | 
|                                                                                                       | 
|                                                                                                      
|Net income per common share:                                                                           | 
|Basic - as reported                                                                                    | 
|Diluted - as reported                                                                                  | 
|                                                                                                      
|Basic - pro forma                                                                                      | 
|Diluted - pro forma                                                                                    | 

We use the Black-Scholes option pricing model to determine the weighted
average fair value of options. No options were granted during the three-month periods ended March 31, 2006 and 2005.

The Companys stock options generally vest over three to five years of
service and have a contractual life of 10 years. We have 281,200 shares authorized for grant under the 2005 Stock Incentive
Plan. The following table summarizes information about the stock options outstanding at March 31, 2006:

|  |           | Options Outstanding |  | Options Exercisable
|- | --------- | ------------------- |  | -------------------
|
|
|
|$ | 1.301.99 |                     |  | 100,200            
|  | 2.002.99 |                     |  | 83,700             
|  | 3.003.99 |                     |  | 42,532             
|  | 7.007.93 |                     |  | 26,000             
|  |           |                     |  |                    
|  |           |                     |  | 252,432            
|  |           |                     |  |                    

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

Overview:

Image Sensing Systems, Inc. (referred to in this report as we,
us, our and the Company) have developed proprietary machine vision technology that converts
real world information into digital electronic signals for processing by computer and have applied it to traffic management
problems. Our technology uses standard video and computer equipment, combined with proprietary technology, including complex
detection algorithms, computer software, special purpose hardware, and a Microsoft Windows®-based graphical user
interface that enables standard video cameras to work with the Autoscope® Wide Area Video Vehicle Detection System.

Autoscope systems are sold to distributors and end users of traffic
management products in North America and Latin America by Econolite Control Products, Inc. (Econolite), our exclusive distributor
in those locations. We also sell Autoscope products to distributors and end users in Europe and Asia through our European and Hong
Kong subsidiaries, respectively. The Autoscope system is used by traffic managers primarily to improve the flow of vehicle traffic
and to enhance safety at intersections, main thoroughfares, freeways and tunnels.

The majority of our revenue is derived from royalties received from
Econolite, with a second primary source of revenue received from direct product sales in Europe and Asia. End users of the
Autoscope system throughout the world are generally funded by government agencies responsible for traffic management and/or
traffic law enforcement.

Our success is primarily dependent upon (1) continued governmental funding of
Intelligent Transportation Systems, such as machine vision for traffic control; (2) our ability, through Econolite and
our sales representatives in Europe and Asia, to successfully market the Autoscope System to individual traffic managers and (3)
our ability to develop new machine vision products and applications that enhance the traffic managers ability to
cost-effectively improve traffic flow and safety.

Our quarterly revenues and operating results have varied significantly in the
past due to the seasonality of our business with the second and third quarters being the strongest and the first and fourth
quarters being the weakest generally due to weather conditions that make roadway construction more difficult. We expect such
seasonality to continue for the foreseeable future. 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.

Critical Accounting Policies:

Goodwill.   Goodwill and other intangible assets with
indefinite lives are not amortized but are tested for impairment annually or whenever an impairment indicator arises. Our recorded
goodwill relates to our Flow Traffic subsidiary and is tested for impairment on December 31 of each year. The impairment test
requires us to estimate the fair value of our subsidiary and then compare it to the carrying value of the subsidiary. If the
carrying value exceeds the fair value, further analysis is performed to determine if there is an impairment loss. We estimate the
fair value by using the income approach, where fair value is dependent on the present value of future economic benefits to be
derived from ownership of Flow Traffic. If Flow Traffic does not provide the future economic benefits we project, the fair value
of this subsidiary may become impaired and we would need to record an impairment loss.

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Revenue recognition.   Royalty income is recognized
based upon a monthly royalty report provided to us by Econolite. This report is prepared by Econolite based on its sales of
products we developed and is based on sales delivered and accepted by its customers. We recognize revenue from international sales
at the time of delivery and acceptance, the selling price is fixed or determinable and collectibility is reasonably assured. We
record provisions against sales revenue for estimated returns and allowances in the period when the related revenue is recorded
based upon historical sales returns and changes in customer demands.

Income taxes.   Income taxes are accounted for under
the liability method. Deferred income taxes reflect the effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and amounts used for income tax purposes. Deferred tax assets are offset by a
valuation allowance as deemed necessary based on our estimate of our future sources of taxable income and the expected timing of
temporary difference reversals.

Results of Operations:   (Comparison of three-month
periods ended March 31, 2006 and 2005)

The following table sets forth, for the periods indicated, (1) certain
statements of income data as a percent of total revenue, (2) gross profit on product sales and royalties as a percentage of
product sales and royalties, respectively, and (3) period to period changes of items in the consolidated statement of income from
2004 to 2005:

|                                       |  | Three-Month PeriodEnded March 31 |  | Quarter OverQuarter
|-------------------------------------- |  | -------------------------------- |  | -------------------
|
|                                       |  |                                  |  |                    
|International sales                    |  |                                  |  | 16.0               
|Royalties                              |  |                                  |  | 84.0               
|                                       |  |                                  |  |                    
|Total revenue                          |  |                                  |  | 100.0              
|Gross profit - International sales     |  |                                  |  | 57.1               
|Gross profit - royalties               |  |                                  |  | 95.3               
|Selling, marketing and product support |  |                                  |  | 24.0               
|General and administrative             |  |                                  |  | 21.7               
|Research and development               |  |                                  |  | 18.6               
|Income from operations                 |  |                                  |  | 24.8               
|Other income, net                      |  |                                  |  | 3.7                
|Income taxes                           |  |                                  |  | 9.2                
|Net income                             |  |                                  |  | 19.4               

Total revenue increased to $2,589,000 in the first quarter of 2006 from
$2,127,000 in the first quarter of 2005, an increase of 21.7%. International sales for 2006 decreased to $413,000, or 16.0% of
revenue, from $430,000, or 20.2% of revenue, in 2005. The 4.0% decrease in international sales compared to 2005 was due primarily
to a temporary delay in shipment of product to the Asian market. Royalty income for the first quarter of 2006 increased to
$2,176,000, or 84.0% of revenue, from $1,697,000, or 79.8% of revenue, in 2005. The 28.2% increase in royalty income in 2006
resulted primarily from a similar increase in sales volume of Autoscope products by Econolite.

10

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Gross profits on international sales for the first quarter of 2006 were
$236,000, a 4.5% decrease from $247,000 in the comparable quarter of 2005, a result of the decrease in sales in the quarter. Gross
profit margins on international sales were 57.1%, compared to 57.4% in 2005. Gross profit margins on royalty income remained
unchanged.

Operating expenses increased to $1,666,000 for the first quarter from
$1,268,000 for the comparable period in 2005, a 31.4% increase. The primary increases were in research and development, which
reflects the increased commitment to develop new hardware and software products, and in general and administrative expenses which
included added professional fees and travel costs associated with the evaluation of our international operations, increased legal
and audit fees, added payroll taxes, share-based compensation related to adoption of Statement of Financial Accounting Standard
123(R) and the added cost of a corporate controller which we hired in the fourth quarter of 2005. We expect the level of general
and administrative expenses to decrease marginally over the remaining three quarters of 2006. We expect that research and
development expenses will continue to increase marginally in 2006 as we complete or advance the development of new products and
software applications.

Income from operations in the first quarter of 2006 was $643,000, or 24.8% of
revenue, compared to $596,000, or 28.0% of revenue, in the comparable quarter in 2005, an increase of 7.9%. The increase resulted
primarily from the 28.2% growth in revenue from royalties offset in part by lower international sales and increased operating
expenses as described above.

Other income, net increased to $97,000 in the first quarter of 2006 from
$44,000 in the comparable quarter of 2005, primarily due to higher yield on investments and more excess cash invested.

Income taxes were $237,000 or 32.0% of pretax income in the first quarter of
2006, compared to $243,000 or 38.0% of pretax income in the comparable quarter of 2005. The decrease in income taxes was due
primarily to added research and experimental credits expected to be earned in 2006 compared to 2005. We expect the effective
income tax rate to decrease to about 28% of pretax income if our foreign subsidiaries become profitable in the remaining quarters
of 2006.

Net income was $503,000 in the first quarter of 2006, a 26.7% increase
compared to $397,000 in the comparable quarter of 2005, due to the factors discussed above.

Liquidity and Capital Resources:

At March 31, 2006, we had $8,987,000 in cash and cash equivalents, compared
to $9,006,000 at December 31, 2005.

Net cash provided by operating activities was $1,849,000 in the first quarter
of 2006, compared to $796,000 in 2005. The primary reason for the increase was that we received unusually large royalty payments
on accounts receivable from Econolite for sales they made in the fourth quarter of 2005. We invested $1,800,000 of the cash
generated from operating activities in short-term tax-exempt bonds.

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We have a credit agreement that provides up to $1,000,000 in short-term
borrowings at .5% over the prime rate (effective rate of 8.25% at March 31, 2006), expiring May 31, 2006. Loans would be secured
by inventories, accounts receivable and equipment and the bank would have the right of setoff against checking, savings and other
accounts we have with the bank. We had no outstanding borrowings under the credit agreement in 2006 or 2005. We expect to renew
the agreement at substantially the same terms and conditions prior to expiration.

We believe that cash and cash equivalents on hand at March 31, 2006, our
$1,000,000 revolving line of credit with Wells Fargo Bank Minnesota, N.A. and cash provided by operating activities will satisfy
our projected working capital needs, investing activities and other cash requirements in the foreseeable future.

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 discussed in the forward-looking statements. Factors that might cause such differences include, but
are not limited to:

- dependence on a single product for most of our revenue;
- budget constraints by governmental entities that purchase our products;
- continuing ability of our licensee to pay royalties owed;
- dependence on third parties for manufacturing and marketing our products;
- our inability to prevail against the claim filed against us by Econolite, our North American manufacturer and distributor;
- 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 have licensed from the University of Minnesota, which expires in July 2006;
- our inability to develop new applications and product enhancements;

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- our inability to respond to low-cost local competitors in Asia;
- our inability to properly manage a growth in revenue and/or production requirements;
- control of our voting stock by insiders;
- our inability to 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 1 to our Annual Report on Form 10-KSB
for the fiscal year ended December 31, 2005.

|Item 4. |  | Controls and Procedures
|------- |  | -----------------------

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including
our Chief Executive Officer and 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.

# PART II  OTHER INFORMATION

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

On September 15, 2005, Econolite, our exclusive North American manufacturer
and distributor, filed a complaint against us in the United States District Court for the Central District of California.
Econolite has asserted claims for breach of contract and unjust enrichment and claims damages of at least $684,000.
Econolites claims are based on its theory that it has overpaid royalties due to us under our agreement with Econolite and
that it is entitled to take into account allegedly higher costs it has incurred. We deny Econolites claims and believe that
royalties have been correctly calculated under the specific formula set forth in the agreement, and we plan to defend the case
vigorously. The case is at the beginning stages of discovery.

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|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, 2006.

|ExhibitNumber |  | Description
|------------- |  | -----------

|10.1 |  | Employment Agreement between the Company and Arthur Bourgeois
dated March 23, 2006 (incorporated by reference to Exhibit 10.2 to the Companys Form 10-KSB for the fiscal year ended
December 31, 2005).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 |  | Employment Agreement between the Company and James Murdakes dated
April 7, 2006 (incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on April 11,
2006).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- |  | ---------------------------------------------------------------------------------------------------

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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 5, 2006 | By:                        
|                     |                            
|                    
|                    
|Dated:   May 5, 2006 |                            
|                     |                            

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# EXHIBIT INDEXTO FORM 10-Q

|Exhibit No. |  | Description
|----------- |  | -----------

|10.1 |  | Employment Agreement between the Company and Arthur Bourgeois
dated March 23, 2006 (incorporated by reference to Exhibit 10.2 to the Companys Form 10-KSB for the fiscal year ended
December 31, 2005).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 |  | Employment Agreement between the Company and James Murdakes dated
April 7, 2006 (incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on April 11,
2006).
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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.
|---- |  | ---------------------------------------------------------------------------------------------------

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