---

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, 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, 2011                                           
|  |                                                                                          
|  | 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 2, 2011
|Common
 Stock, $0.01 par value per share |  | 4,882,619
 shares          

---

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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 Operations                                       |  | 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                            |  | 15       
|               |  |                                                                                        |  |          
|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                                                                                    

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PART I.
FINANCIAL INFORMATION

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

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

|                                           |  |                 |        |                    |   |        | 
|------------------------------------------ |  | --------------- | ------ | ------------------ | - | ------ | 
|                                           |  | March 31,
 2011 |        | December 31,
 2010 |  
|Assets                                     |  |                 |        |                    |   |        | 
|Current assets:                            |  |                 |        |                    |   |        | 
|Cash and cash equivalents                  |  | $               | 4,101  |                    | $ | 8,021  | 
|Investments                                |  |                 | 3,641  |                    |   | 3,954  | 
|Accounts receivable, net                   |  |                 | 9,607  |                    |   | 10,137 | 
|Inventories                                |  |                 | 5,131  |                    |   | 4,649  | 
|Prepaid expenses and other receivables     |  |                 | 2,229  |                    |   | 2,017  | 
|Deferred income taxes                      |  |                 | 199    |                    |   | 230    | 
|Total current assets                       |  |                 | 24,908 |                    |   | 29,008 | 
|                                           |  |                 |        |                    |   |        | 
|Property and equipment, net                |  |                 | 1,155  |                    |   | 1,122  | 
|                                           |  |                 |        |                    |   |        | 
|Goodwill and intangible assets             |  |                 | 24,230 |                    |   | 24,226 | 
|Total assets                               |  | $               | 50,293 |                    | $ | 54,356 | 
|                                           |  |                 |        |                    |   |        | 
|Liabilities and Shareholders Equity       |  |                 |        |                    |   |        | 
|Current liabilities:                       |  |                 |        |                    |   |        | 
|Accounts payable                           |  | $               | 1,061  |                    | $ | 2,094  | 
|Accrued compensation                       |  |                 | 847    |                    |   | 1,364  | 
|Accrued warranty and other                 |  |                 | 1,273  |                    |   | 1,467  | 
|Earn-outs payable                          |  |                 | 618    |                    |   | 2,928  | 
|Income taxes payable                       |  |                 |       |                    |   | 17     | 
|Total current liabilities                  |  |                 | 3,799  |                    |   | 7,870  | 
|                                           |  |                 |        |                    |   |        | 
|Deferred income taxes                      |  |                 | 322    |                    |   | 290    | 
|Income taxes payable                       |  |                 | 150    |                    |   | 175    | 
|                                           |  |                 |        |                    |   |        | 
|Shareholders equity:                      |  |                 |        |                    |   |        | 
|Common stock                               |  |                 | 49     |                    |   | 49     | 
|Additional paid-in capital                 |  |                 | 22,194 |                    |   | 22,065 | 
|Accumulated other comprehensive income     |  |                 | 732    |                    |   | 52     | 
|Retained earnings                          |  |                 | 23,047 |                    |   | 23,855 | 
|                                           |  |                 | 46,022 |                    |   | 46,021 | 
|Total liabilities and shareholders equity |  | $               | 50,293 |                    | $ | 54,356 | 

See accompanying notes.

- 1 -

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

|                                                      |  |                                      |        |      |   |       |  
|----------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ----- | -
|                                                      |  | Three-Month Periods Ended
 March 31, |       
|                                                      |  | 2011                                 |        | 2010 |  
|Revenue:                                              |  |                                      |        |      |   |       |  
|Product sales                                         |  | $                                    | 3,447  |      | $ | 2,812 |  
|Royalties                                             |  |                                      | 2,698  |      |   | 2,591 |  
|                                                      |  |                                      | 6,145  |      |   | 5,403 |  
|                                                     
|Costs of revenue:                                     |  |                                      |        |      |   |       |  
|Product sales                                         |  |                                      | 1,664  |      |   | 932   |  
|Gross profit                                          |  |                                      | 4,481  |      |   | 4,471 |  
|                                                      |  |                                      |        |      |   |       |  
|Operating expenses:                                   |  |                                      |        |      |   |       |  
|Selling,
 marketing and product support               |  |                                      | 2,620  |      |   | 1,856 |  
|General
 and administrative                           |  |                                      | 1,472  |      |   | 1,038 |  
|Research
 and development                             |  |                                      | 1,029  |      |   | 777   |  
|Amortization
 of intangible assets                    |  |                                      | 412    |      |   | 192   |  
|                                                      |  |                                      | 5,533  |      |   | 3,863 |  
|Income (loss) from operations                         |  |                                      | (1,052 | )    |   | 608   |  
|                                                      |  |                                      |        |      |   |       |  
|Other income (expense), net                           |  |                                      | 4      |      |   | (36   | )
|Income (loss) before income taxes                     |  |                                      | (1,048 | )    |   | 572   |  
|Income tax expense (benefit)                          |  |                                      | (240   | )    |   | 170   |  
|Net income (loss)                                     |  | $                                    | (808   | )    | $ | 402   |  
|                                                      |  |                                      |        |      |   |       |  
|Net income (loss) per common share:                   |  |                                      |        |      |   |       |  
|Basic                                                 |  | $                                    | (0.17  | )    | $ | 0.10  |  
|Diluted                                               |  | $                                    | (0.17  | )    | $ | 0.10  |  
|                                                      |  |                                      |        |      |   |       |  
|Weighted average number of common shares outstanding: |  |                                      |        |      |   |       |  
|Basic                                                 |  |                                      | 4,824  |      |   | 3,989 |  
|Diluted                                               |  |                                      | 4,824  |      |   | 4,089 |  

See accompanying notes.

- 2 -

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

|                                                                                                   |  |                                      |        |      |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ------ | -
|                                                                                                   |  | Three-Month Periods Ended
 March 31, |       
|                                                                                                   |  | 2011                                 |        | 2010 |  
|Operating activities:                                                                              |  |                                      |        |      |   |        |  
|Net income (loss)                                                                                  |  | $                                    | (808   | )    | $ | 402    |  
|Adjustments to reconcile net income (loss) to net cash provided by
 (used in) operating activities |  |                                      |        |      |   |        |  
|Depreciation and amortization                                                                      |  |                                      | 537    |      |   | 312    |  
|Stock option expense                                                                               |  |                                      | 94     |      |   | 80     |  
|Change in operating assets and liabilities                                                         |  |                                      | (1,887 | )    |   | (571   | )
|Net cash provided by (used in) operating activities                                                |  |                                      | (2,064 | )    |   | 223    |  
|                                                                                                   |  |                                      |        |      |   |        |  
|Investing activities:                                                                              |  |                                      |        |      |   |        |  
|Net purchases of property and equipment                                                            |  |                                      | (158   | )    |   | (135   | )
|Payments of earn-outs                                                                              |  |                                      | (2,361 | )    |   | (1,541 | )
|Net sales of investments                                                                           |  |                                      | 313    |      |   | 24     |  
|Net cash used in investing activities                                                              |  |                                      | (2,206 | )    |   | (1,652 | )
|                                                                                                   |  |                                      |        |      |   |        |  
|Financing activities:                                                                              |  |                                      |        |      |   |        |  
|Repayment of bank debt                                                                             |  |                                      |       |      |   | (100   | )
|Proceeds from exercise of stock options                                                            |  |                                      | 35     |      |   | 61     |  
|Net cash provided by (used in) financing activities                                                |  |                                      | 35     |      |   | (39    | )
|                                                                                                   |  |                                      |        |      |   |        |  
|Effect of exchange rate changes on cash                                                            |  |                                      | 315    |      |   | (41    | )
|                                                                                                   |  |                                      |        |      |   |        |  
|Decrease in cash and cash equivalents                                                              |  |                                      | (3,920 | )    |   | (1,509 | )
|                                                                                                   |  |                                      |        |      |   |        |  
|Cash and cash equivalents, beginning of period                                                     |  |                                      | 8,021  |      |   | 14,084 |  
|Cash and cash equivalents, end of period                                                           |  | $                                    | 4,101  |      | $ | 12,575 |  

See
accompanying notes.

- 3 -

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IMAGE SENSING SYSTEMS, INC.

Notes to Condensed Consolidated Financial
Statements
(Unaudited) 
March 31, 2011

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 the Quarterly Report
on 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, 2011 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2011. 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, 2010.

Note B: Acquisition

In June 2010,
we purchased all of the outstanding equity of CitySync Limited, a
privately-held developer and marketer of automatic number plate recognition
(ANPR) products. As part of the purchase agreement, the sellers are eligible to
receive an earn-out based on the performance of the business for the 18 months
following the acquisition date. Earn-outs will be calculated as of each
calendar year end and paid within 90 days thereof. The earn-out is based on
achieving certain revenue and minimum gross margins from the sale of CitySync
ANPR systems and it is calculated in two separate periods, each ending on
December 31. In each period there are two tiers and superior performance could
lead to a total earn-out of $2 million or higher, as the earn-out is not
capped. For 2010, the sellers earned an earn-out of $696,000 which was paid in
March 2011. We monitor the estimated fair value of the 2011 earn-out and its
associated recorded liability regularly and have determined the estimate has
not materially changed from the initial estimate. The determination of the fair
value is based on a probabilistic calculation where we assign probabilities to
achieving each of the tiers in the period.

The results of
CitySync operations are included in the accompanying financial statements since
the date of the acquisition. The following pro forma summary presents the
results of operations for the three months ended March 31, 2010 as if the
acquisition had occurred on January 1, 2009 and includes CitySync based on a
January 31 fiscal year end. The pro forma results are not necessarily indicative
of the results that would have been achieved had the CitySync acquisition taken
place on that date (in thousands, except per share amounts):

|                       |  |   |       | 
|---------------------- |  | - | ----- | 
|Total
 revenue         |  | $ | 6,851 | 
|                      
|Net income             |  |   | 262   | 
|                       |  |   |       | 
|Net income
 per share: |  |   |       | 
|Basic                  |  | $ | 0.06  | 
|Diluted                |  | $ | 0.06  | 

- 4 -

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Note C: Goodwill and Intangible Assets

Goodwill
consists of $1.1 million related to our acquisition of Flow Traffic Ltd., $8.2
million related to the EIS asset purchase and $5.6 million related to our
acquisition of CitySync. Because the goodwill and intangible assets related to
the CitySync acquisition are accounted for in Great Britain Pounds, they are
impacted by period-end rates of exchange to United States Dollars and therefore
may vary in different reporting periods.

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

|                                           |  |                 |        |                    |   |        |  
|------------------------------------------ |  | --------------- | ------ | ------------------ | - | ------ | -
|                                           |  | March 31,
 2011 |        | December 31,
 2010 |  
|Developed technology (8 year life)         |  | $               | 7,476  |                    | $ | 7,364  |  
|Trade names (5 to 9 year life)             |  |                 | 3,259  |                    |   | 3,193  |  
|Other intangibles (3 to 8 year life)       |  |                 | 1,825  |                    |   | 1,774  |  
|Less: Accumulated amortization             |  |                 | (3,231 | )                  |   | (2,818 | )
|Total
 identifiable intangible assets, net |  | $               | 9,329  |                    | $ | 9,513  |  

We expect to
recognize amortization expense for the intangible assets in the above table in
our years ending December 31 of $1.6 million in each of 2011 and 2012 and $1.3
million in each of 2013, 2014 and 2015. The weighted average amortization
period remaining for intangible assets is 6.2 years. 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, 2011.

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

The following
table sets forth the computations of basic and diluted net income (loss) per
common share for the three-month periods ended March 31, 2011 and 2010 (in
thousands, except per share data):

|                                                                                                                     |  |      |       |      |   |       | 
|-------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- | 
|                                                                                                                     |  | 2011 |       | 2010 |  
|Numerator:                                                                                                           |  |      |       |      |   |       | 
|Net income (loss)                                                                                                    |  | $    | (808  | )    | $ | 402   | 
|Denominator:                                                                                                         |  |      |       |      |   |       | 
|                                                                                                                    
|Shares used in basic net income (loss) per
 common share calculation (2011 is net of 57 contingent shares in escrow) |  |      | 4,824 |      |   | 3,989 | 
|Effect of diluted securities:                                                                                        |  |      |       |      |   |       | 
|Employee and director stock options
 (anti-dilutive for 2011)                                                        |  |      |      |      |   | 100   | 
|Shares used in diluted net income (loss)
 per common share calculations                                              |  |      | 4,824 |      |   | 4,089 | 
|Basic net income (loss) per common share                                                                             |  | $    | (0.17 | )    | $ | 0.10  | 
|Diluted net income (loss) per common share                                                                           |  | $    | (0.17 | )    | $ | 0.10  | 

Our
comprehensive income (loss) for the three-month periods ended March 31, 2011
and 2010 was $(128,000) and $361,000, respectively. In each period, the main
difference between net income (loss) and comprehensive income (loss) arose from
foreign currency translation adjustments.

Note E: Stock-based Compensation

We recorded
$94,000 and $80,000 of stock-based compensation in general and administrative
expense for the three-month periods ended March 31, 2011 and 2010, respectively.
Options to purchase 15,000 shares, at a weighted average exercise price of
$13.48, and options to purchase 40,000 shares, at a weighted average exercise
price of $12.75, were granted during the three-month periods ended March 31,
2011 and 2010, respectively. We use the Black-Scholes option pricing model to
determine the fair value of options. The fair value of options granted were
$68,000 and $183,000 during the three-month periods ended March 31, 2011 and
2010, respectively. As of March 31, 2011, $742,000 of total unrecognized
compensation expense related to non-vested stock option awards is expected to
be recognized over a weighted average period of 2.3 years.

- 5 -

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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, 2011, we had 157,500
shares available for grants under the 2005 Stock Incentive Plan.

The following
table summarizes information about the stock options outstanding at March 31,
2011:

|                         |             |                     |  |                                                 |  |                                   |           |                     |   |                                   |  |  |         |  |   |       | 
|------------------------ | ----------- | ------------------- |  | ----------------------------------------------- |  | --------------------------------- | --------- | ------------------- | - | --------------------------------- |  |  | ------- |  | - | ----- | 
|                         |             | 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   |                     |  | 46,000                                          |  |                                   | 1.2 years |                     | $ | 1.36                              |  |  | 46,000  |  | $ | 1.36  | 
|                         | 3.00-3.99   |                     |  | 38,333                                          |  |                                   | 1.5 years |                     |   | 3.13                              |  |  | 38,333  |  |   | 3.13  | 
|                         | 8.00-8.99   |                     |  | 48,000                                          |  |                                   | 5.6 years |                     |   | 8.63                              |  |  | 13,500  |  |   | 8.58  | 
|                         | 9.00-9.99   |                     |  | 169,000                                         |  |                                   | 4.1 years |                     |   | 9.20                              |  |  | 55,125  |  |   | 9.16  | 
|                         | 11.00-11.99 |                     |  | 15,000                                          |  |                                   | 5.6 years |                     |   | 11.19                             |  |  |        |  |   |      | 
|                         | 12.00-12.99 |                     |  | 115,000                                         |  |                                   | 4.7 years |                     |   | 12.53                             |  |  | 48,250  |  |   | 12.54 | 
|                         | 13.00-13.99 |                     |  | 15,000                                          |  |                                   | 5.8 years |                     |   | 13.48                             |  |  |        |  |   |      | 
|                         | 15.00-15.99 |                     |  | 28,000                                          |  |                                   | 0.7 years |                     |   | 15.30                             |  |  | 28,000  |  |   | 15.30 | 
|                         |             |                     |  | 474,333                                         |  |                                   | 3.8 years |                     |   | 9.26                              |  |  | 229,208 |  |   | 8.01  | 

Note F: Segment Information

We disclose
segment information in accordance with Accounting Standards Codification 280, Segment
Reporting, which defines an operating segment as a component of a
company for which operating results are reviewed regularly by the chief
operating decision-makers to determine resource allocation and assess
performance. We have three reportable segments: Autoscope, RTMS and CitySync.
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 product sales. RTMS is our radar product line acquired in the EIS
asset purchase in 2007 and CitySync is our ANPR product line acquired in the
CitySync purchase in June 2010. All segment revenues are derived from external
customers.

Our
presentation of segments has changed from our previous filings as company-wide
organizational changes completed in early 2011 focus the chief operating
decision-makers on segment gross profit. The segment information below has been
reclassified to reflect these changes. Operating expenses and total assets are
not allocated to the segments for internal reporting purposes.

The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the three-month periods ended March 31, 2011
and 2010 (in thousands):

|                                   |  |           |       |      |   |          |  |       |        |      |   |        |  |      |        |      |   |   |  |   |        |  |   |        | 
|---------------------------------- |  | --------- | ----- | ---- | - | -------- |  | ----- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | - |  | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |       | RTMS |   | CitySync |  | Total |       
|                                   |  | 2011      |       | 2010 |   | 2011     |  | 2010  |        | 2011 |   | 2010   |  | 2011 |        | 2010 |  
|Revenue                            |  | $         | 3,064 |      | $ | 3,009    |  | $     | 961    |      | $ | 2,394  |  | $    | 2,120  |      | $ |  |  | $ | 6,145  |  | $ | 5,403  | 
|Gross profit                       |  |           | 2,905 |      |   | 2,808    |  |       | 441    |      |   | 1,663  |  |      | 1,135  |      |   |  |  |   | 4,481  |  |   | 4,471  | 
|Amortization
 of intangible assets |  |           |      |      |   |         |  |       | 192    |      |   | 192    |  |      | 220    |      |   |  |  |   | 412    |  |   | 192    | 
|Intangible
 assets and goodwill    |  |           | 525   |      |   | 525      |  |       | 11,518 |      |   | 10,621 |  |      | 12,187 |      |   |  |  |   | 24,230 |  |   | 11,146 | 

- 6 -

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Note G: New Accounting Pronouncements

In October
2009, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements.
The new standard changes the requirements for establishing separate units of
accounting in a multiple element arrangement and requires the allocation of
arrangement consideration to each deliverable based on the relative selling
price. The selling price for each deliverable is based on vendor-specific
objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE
is not available, or estimated selling price if neither VSOE nor TPE is
available. ASU No. 2009-13 became effective for us on January 1, 2011 and did
not have a material impact on our consolidated financial statements.

In January
2010, the FASB issued ASU 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 became effective on January 1, 2011. Adoption of this
pronouncement has not had a significant effect on our consolidated financial
statements disclosures.

In September
2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing
Receivables and the Allowance for Credit Losses, to enhance the
disclosures required for financing receivables (for example, loans, trade
accounts receivable, notes receivable, and receivables relating to a lessors
leveraged, direct financing, and sales-type leases) and allowances for credit
losses. The amended disclosures are designed to provide more information to
financial statement users regarding the credit quality of a creditors financing
receivables and the adequacy of its allowance for credit losses. We adopted all
of the requirements of the amended guidance on December 31, 2010, its effective
date, except for the disclosures regarding the activity during a reporting
period which became effective on January 1, 2011. Adoption of the pronouncement
has not had a significant effect on our consolidated financial statement
disclosures.

In December
2010, FASB issued ASU 2010-28, When to
Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or
Negative Carrying Amounts, which states that for an entity with
reporting units having zero or negative carrying amounts, the second step of
the impairment test shall be performed to measure the amount of impairment
loss, if any, when it is more likely than not that a goodwill impairment
exists. In considering whether it is more likely than not that a goodwill
impairment exists, an entity shall evaluate whether there are adverse
qualitative factors. We adopted ASU 2010-28 effective January 1, 2011 and do
not expect it to have a significant impact on our consolidated financial
statements.

- 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, RTMS® Radar
Detection System and CitySync Automatic Number Plate Recognition (ANPR) System,
operate using our proprietary application software in conjunction with video
cameras or radar and commonly available electronic components. Our systems are
used by traffic managers primarily to improve the flow of vehicle traffic and
to enhance safety at intersections, main thoroughfares, freeways and tunnels
and by parking and toll managers and law enforcement officials to read license
plates for various safety, security, access and enforcement ANPR applications.

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 and
CitySync systems to distributors and end users in North America. We sell all of
our systems to distributors and end users in Europe and Asia through our
European and Hong Kong subsidiaries, respectively. The majority of our sales
are to end users that are funded by government agencies responsible for traffic
management or traffic law enforcement.

CitySync
Acquisition. In
June 2010, we purchased all of the outstanding equity of CitySync Limited
through which we own its principal product line, the CitySync ANPR system. We
believe the CitySync acquisition expands our addressable market, strengthens
our selling presence in Europe and extends our opportunities for hybrid product
developments. In its fiscal year ended January 31, 2010, CitySync had revenue
of $7.4 million, substantially all of which related to ANPR system sales.

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 historical growth in our business can be attributed primarily to
the following global trends:

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

- 8 -

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| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continued adoption and
 governmental funding of intelligent transportation systems, or ITS, and other
 automated applications for traffic control, safety and enforcement in
 developed countries;                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                    
| |  | a propensity by traffic
 engineers to implement lower cost technology-based solutions rather than
 civil engineering solutions such as widening roadways;                                                                                                                                          
| |   |                                                                                                                                                                                                                                                                                                    
| |  | countries in the developing
 world adopting above-ground detection technology, such as video or radar,
 instead of in-pavement loop technology to manage traffic;                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                    
| |  | the 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
the majority of our end users are governmental entities, we are faced with
challenges related to potential delays in purchase decisions by those entities
and changes in budgetary constraints. These contingencies could result in
significant fluctuations in our revenue between periods. The slow rate at which
the worldwide recession is ending 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 revenue. We
believe we will continue to be a beneficiary of the federal stimulus bills
enacted in 2009 and 2010, but it is difficult to determine the level of impact
it has on our operations.

Key
Financial Terms and Metrics

Revenue.
We derive revenue 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 the direct sales of our RTMS and CitySync systems
in North America, the Caribbean and Latin America and all of our systems in
Europe and Asia. We calculate the royalties using a profit sharing model where
we split with Econolite 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.

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 product sales consists primarily of the amount charged by our third party
contractors to manufacture hardware platforms, which is influenced mainly by
the cost of electronic components. The cost of revenue also includes logistics
costs and estimated expenses for product warranties and inventory reserves. The
key metric that we follow is achieving certain gross margin percentages by
geographic region and to a lesser extent by product line.

Operating
Expenses. Our
operating expenses fall into three categories: (1) selling, marketing and
product support; (2) general and administrative; and (3) research and
development. Selling, marketing and product support expenses consist of various
costs related to sales and support of our products, including salaries, benefits
and commissions paid to our personnel; commissions paid to third parties;
travel, trade show and advertising costs; second-tier technical support for
Econolite; and general product support, where applicable. General and
administrative expenses consist of certain corporate and administrative
functions that support the development and sales of our products and provide an
infrastructure to support future growth. 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 are acquisition related
expenses and non-cash expense for intangible asset amortization.

- 9 -

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Non-GAAP
Operating Measure. We use non-GAAP net income, which excludes the impact, net of
tax, of amortizing the intangible assets from the EIS asset acquisition and the
CitySync acquisition and expenses related to these acquisitions, including
earn-out adjustments and other unusual items, to analyze our business. Management
believes that this non-GAAP operating measure, when shown in conjunction with
GAAP measures, facilitates the comparison of our current operating results to
historical operating results. We use this non-GAAP information to evaluate
short-term and long-term operating trends in our core operations. Further, we believe that this non-GAAP
measure improves managements and investors ability to compare our financial
performance with other companies in the technology industry. Non-GAAP
information is not prepared in accordance with GAAP and should not be
considered a substitute for or an alternative to GAAP financial measures and
may not be computed the same as similarly titled measures used by other
companies.

Reconciliations
of GAAP net income to non-GAAP net income are as follows (dollars in thousands,
except per share amounts):

|                                                       |  |                                     |       |      |   |      |  
|------------------------------------------------------ |  | ----------------------------------- | ----- | ---- | - | ---- | -
|                                                       |  | Three-Month Period Ended
 March 31, |      
|                                                       |  | 2011                                |       | 2010 |  
|                                                      
|GAAP net income (loss)                                 |  | $                                   | (808  | )    | $ | 4022 |  
|Adjustments to reconcile to non-GAAP net income (loss) |  |                                     |       |      |   |      |  
|Amortization of intangible assets                      |  |                                     | 412   |      |   | 192  |  
|Impact on income taxes of amortization expense         |  |                                     | (140  | )    |   | (65  | )
|Non-GAAP net income (loss)                             |  | $                                   | (536  | )    | $ | 529  |  
|                                                       |  |                                     |       |      |   |      |  
|GAAP diluted earnings (loss) per share                 |  | $                                   | (0.17 | )    | $ | 0.10 |  
|Non-GAAP diluted earnings (loss) per share             |  |                                     | (0.11 | )    |   | 0.13 |  

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.

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 have three reportable segments: Autoscope, RTMS and CitySync.
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 product
sales. RTMS is our radar product line acquired in the EIS asset purchase in
2007 and CitySync is our ANPR product line acquired in the CitySync purchase in
June 2010. All segment revenues are derived from external customers. Total
assets are not allocated to the segments for internal reporting purposes.

- 10 -

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The
following table sets forth selected unaudited financial information for each of
the Companys reportable segments for the three-month periods ended March 31,
2011 and 2010 (in thousands):

|                                  |  |           |       |      |   |          |  |       |        |      |   |        |  |      |        |      |   |   |  |   |        |  |   |        | 
|--------------------------------- |  | --------- | ----- | ---- | - | -------- |  | ----- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | - |  | - | ------ |  | - | ------ | 
|                                  |  | Autoscope |       | RTMS |   | CitySync |  | Total |       
|                                  |  | 2011      |       | 2010 |   | 2011     |  | 2010  |        | 2011 |   | 2010   |  | 2011 |        | 2010 |  
|Revenue                           |  | $         | 3,064 |      | $ | 3,009    |  | $     | 961    |      | $ | 2,394  |  | $    | 2,120  |      | $ |  |  | $ | 6,145  |  | $ | 5,403  | 
|Gross profit                      |  |           | 2,905 |      |   | 2,808    |  |       | 441    |      |   | 1,663  |  |      | 1,135  |      |   |  |  |   | 4,481  |  |   | 4,471  | 
|Amortization of intangible assets |  |           |      |      |   |         |  |       | 192    |      |   | 192    |  |      | 220    |      |   |  |  |   | 412    |  |   | 192    | 
|Intangible assets and goodwill    |  |           | 525   |      |   | 525      |  |       | 11,518 |      |   | 10,621 |  |      | 12,187 |      |   |  |  |   | 24,230 |  |   | 11,146 | 

Results of Operations

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

|                                        |  |                                     |       |                                |  |       |   |  |       |  
|--------------------------------------- |  | ----------------------------------- | ----- | ------------------------------ |  | ----- | - |  | ----- | -
|                                        |  | Three-Month Period Ended
 March 31, |       | Quarter Over 
 Quarter
 Change | 
|                                        |  | 2011                                |       | 2010                           |  |      
|Product sales                           |  |                                     | 56.1  | %                              |  | 52.0  | % |  | 22.6  | %
|Royalties                               |  |                                     | 43.9  |                                |  | 48.0  |   |  | 4.1   |  
|Total revenue                           |  |                                     | 100.0 |                                |  | 100.0 |   |  | 13.7  |  
|Gross marginproduct sales              |  |                                     | 51.7  |                                |  | 66.9  |   |  | (5.2  | )
|Gross marginroyalties                  |  |                                     | 100.0 |                                |  | 100.0 |   |  |      |  
|Selling, marketing and
 product support |  |                                     | 42.6  |                                |  | 34.4  |   |  | 41.2  |  
|General and administrative              |  |                                     | 23.9  |                                |  | 19.2  |   |  | 41.8  |  
|Research and development                |  |                                     | 16.7  |                                |  | 14.4  |   |  | 32.4  |  
|Amortization of
 intangibles            |  |                                     | 6.7   |                                |  | 3.6   |   |  | 114.6 |  
|Income (loss) from
 operations          |  |                                     | (17.1 | )                              |  | 11.3  |   |  | nm    |  
|Income tax expense
 (benefit)           |  |                                     | (3.9  | )                              |  | 3.1   |   |  | nm    |  
|Net income (loss)                       |  |                                     | (13.1 | )                              |  | 7.4   |   |  | nm    |  

Total revenue increased to
$6.1 million in the three-month period ended March 31, 2011 from $5.4 million
in the same period in 2010, an increase of 13.7%. Royalties increased to $2.7
million in the first quarter of 2011 from $2.6 million in the same period in
2010, an increase of 4.1%. Product sales increased to $3.4 million in the first
quarter of 2011 from $2.8 million in the same period in 2010, an increase of
22.6%. The increase is due to the addition of the CitySync product line which
was partially offset by lower sales of RTMS product and sales in Asia. Revenue
for the Autoscope segment increased slightly to $3.1 million in 2011 up from
$3.0 million in 2010. Revenue for the RTMS segment decreased to $1.0 million in
2011 from $2.4 million in 2010. The decrease resulted mainly as a result of
decreased sales in North America and Asia and reflects the variable nature of
our product sales, especially in our seasonally slowest quarter.

Gross margins for product
sales decreased to 51.7% in the three months ended March 31, 2011 from 66.9% in
the same period in 2010. The decrease resulted mainly from a negative revenue
mix shift, including CitySync, which typically earns lower margins than RTMS or
Autoscope, and a high percentage of third party product, and the impact of
fixed manufacturing costs on decreased volume, especially for RTMS. Gross
margins on royalty income remained consistent at 100.0% in each of the first
quarters of 2011 and 2010.

Selling, marketing and
product support expense increased to $2.6 million, or 42.6% of total revenue,
in the first three months of 2011 from $1.9 million, or 34.4% of total revenue,
in the first three months of 2010. The change related mainly to the addition of
CitySync operations but also reflected investments in market expansion
activities in Europe and Asia. We anticipate that for the remainder of 2011,
the dollar amount of our quarterly selling, marketing and product support
expense will increase slightly from the 2011 first quarter level.

- 11 -

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General and administrative
expense increased to $1.5 million, or 23.9% of total revenue, in the first
quarter of 2011, up from $1.0 million, or 19.2% of total revenue, in the same
period in 2010. The increase related mostly to the addition of CitySync
operations. We anticipate that for the remainder of 2011, 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 2011.

Research and development
expense increased to $1.0 million, or 16.7% of total revenue, in the first
quarter of 2011, up from $777,000, or 14.4% of total revenue, in the same
period in 2010. The increase related mostly to the addition of CitySync
operations. We anticipate that for the remainder of 2011, the dollar amount of
our quarterly research and development expense will increase from the first
quarter of 2011 level.

Amortization of intangibles
expense was $412,000 in the first quarter of 2011 and reflects the amortization
of intangible assets acquired in the EIS asset purchase and CitySync
acquisition. Assuming there are no changes to our intangible assets, we
anticipate amortization expense will be $1.6 million for all of 2011.

Other income was $4,000 in
2011 compared to other expense of $36,000 in the first quarter of 2010. In
2010, there was bank debt outstanding for the first quarter.

Income tax benefit was
$240,000, or 22.9% of pretax loss, in the first quarter of 2011, compared to
income tax expense of $170,000, or 29.7% of pretax income, in the comparable
quarter of 2010. We anticipate an effective tax rate of below 25% for all of
2011.

Liquidity and Capital Resources

At March 31, 2011, we had
$4.1 million in cash and cash equivalents and $3.6 million in short-term
investments, compared to $8.0 million in cash and cash equivalents and $4.0
million in short-term investments at December 31, 2010.

Net cash used by operating
activities in the three-month period ended March 31, 2011 was $2.1 million,
compared to net cash provided of $223,000 in the same period of 2010. The
decrease in 2011 was due mainly to a combination of the 2011 loss and a greater
change in payables and accruals in the 2011 quarter as compared to the same
period of 2010. We anticipate that average receivable collection days in 2011
will be similar to 2010 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 2011. In addition to equipment
purchases, in 2011 we paid 2010 related earn-out liabilities of $2.4 million to
the sellers of the EIS assets and CitySync.

We have a revolving line of
credit agreement with Associated Bank, National Association, or 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, 2012. We believe that 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
acquisition of CitySync, the sellers have an earn-out arrangement over
approximately 18 months from the June 2010 date of purchase. The earn-out is
based on achieving certain revenue and minimum gross margins from the sale of
CitySync ANPR systems and it is calculated in two separate periods, each ending
on December 31. In each period there are two tiers and superior performance
could lead to a total earn-out of $2 million or higher, as the earn-out is not
capped. Earn-out payments are due within three months of the end of an earn-out
period. Based on the 2010 results, the sellers received a $696,000 earn-out for
the first period which ran from the June acquisition date to December 31, 2010.
The payment was made in March 2011, and the remaining liability recorded on our
balance sheet as of March 31, 2011 is the estimate for the second period
earn-out which runs from January 1, 2011 to December 31, 2011.

We believe that cash and
cash equivalents on hand at March 31, 2011, 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 CitySync earn-out, investing activities, and other cash
requirements for the foreseeable future.

- 12 -

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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, 2010. The
accounting policies used in preparing our interim 2011 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 October 2009, the
Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements.
The new standard changes the requirements for establishing separate units of
accounting in a multiple element arrangement and requires the allocation of
arrangement consideration to each deliverable based on the relative selling
price. The selling price for each deliverable is based on vendor-specific
objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE
is not available, or estimated selling price if neither VSOE nor TPE is
available. ASU No. 2009-13 became effective for us on January 1, 2011 and
did not have a material impact on our consolidated financial statements.

In January 2010, the
FASB issued ASU 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 became effective on January 1, 2011. Adoption of this
pronouncement has not had a significant effect on our consolidated financial
statements disclosures.

In September 2010, the
FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing
Receivables and the Allowance for Credit Losses, to enhance the
disclosures required for financing receivables (for example, loans, trade
accounts receivable, notes receivable, and receivables relating to a lessors
leveraged, direct financing, and sales-type leases) and allowances for credit
losses. The amended disclosures are designed to provide more information to
financial statement users regarding the credit quality of a creditors
financing receivables and the adequacy of its allowance for credit losses. We
adopted all of the requirements of the amended guidance on December 31, 2010,
its effective date, except for the disclosures regarding the activity during a
reporting period which became effective on January 1, 2011. Adoption of the
pronouncement has not had a significant effect on our consolidated financial
statement disclosures.

In December 2010, FASB
issued ASU 2010-28, When to Perform Step 2
of the Goodwill Impairment Test for Reporting Units with Zero or Negative
Carrying Amounts, which states that for an entity with reporting
units having zero or negative carrying amounts, the second step of the
impairment test shall be performed to measure the amount of impairment loss, if
any, when it is more likely than not that a goodwill impairment exists. In
considering whether it is more likely than not that a goodwill impairment
exists, an entity shall evaluate whether there are adverse qualitative factors.
We adopted ASU 2010-28 effective January 1, 2011 and do not expect it to
have a significant impact on our consolidated financial statements.

- 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;                                                                                                                              
| |   |                                                                                                                                                                                         
| |  | the mix of and margin on
 the products we sell;                                                                                                                                         
| |   |                                                                                                                                                                                         
| |  | dependence on third
 parties for manufacturing and marketing our products;                                                                                                              
| |   |                                                                                                                                                                                         
| |  | dependence on
 single-source suppliers to meet manufacturing needs;                                                                                                                     
| |   |                                                                                                                                                                                         
| |  | our increased
 international presence;                                                                                                                                                  
| |   |                                                                                                                                                                                         
| |  | 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;                                                                                                                    
| |   |                                                                                                                                                                                         
| |  | unanticipated delays,
 costs and expenses inherent in the development and marketing of new products,
 including ANPR and hybrid products;                                               
| |   |                                                                                                                                                                                         
| |  | 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
 successfully integrate acquisitions;                                                                                                                                  
| |   |                                                                                                                                                                                         
| |  | 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.                                                                                

- 14 -

---



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, 2010.

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

|         |                        
|-------- | -----------------------
|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 -

---



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, 2010. 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, 2011:

|               |  |                                                                                                     
|-------------- |  | ----------------------------------------------------------------------------------------------------
|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 12, 2011 | By:                          | /s/ Kenneth R. Aubrey                        
|                    |                              | Kenneth R. Aubrey                            
|                    |                              | President and Chief
 Executive Officer       
|                    |                              | (principal executive
 officer)               
|                    |                              |                                              
|Dated: May 12, 2011 | 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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