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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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                                   FORM 10-QSB

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

For the period ended September 30, 1998           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 Identification No.
incorporation organization

                             500 SPRUCE TREE CENTRE
                             1600 UNIVERSITY AVE. W.
                             ST. PAUL, MN 55104-3825
                    (Address of principal executive offices)
       Registrant's telephone number, including area code: (651) 603-7700


                                 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 ___

                      APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.

    Common Stock, $.01 Par Value -- 2,482,075 shares as of October 20, 1998.
    ------------------------------------------------------------------------

Transitional small business disclosure format (check): Yes ___ No _X_


                                       1

<PAGE>


                           IMAGE SENSING SYSTEMS, INC.

                                      INDEX

         PART I. FINANCIAL INFORMATION                                  Page No.
                                                                        --------

Item 1.  Condensed Financial Statements:

         Condensed Balance Sheets
         September 30, 1998 and December 31, 1997                            3

         Condensed Statements of Operations
         Three- and nine-month periods ended September 30, 1998 and 1997     4

         Condensed Statements of Cash Flows
         Nine-month periods ended September 30, 1998 and 1997                5

         Notes to Condensed Financial Statements                             6


Item 2.  Management's Discussion and Analysis of
         Results of Operations and Financial Condition                       7


         PART II. OTHER INFORMATION


Item 5.  Other Information                                                  11

Item 6.  Exhibits and Reports on Form 8-K                                   11

         Signatures                                                         12


                                       2

<PAGE>


                         PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

                           IMAGE SENSING SYSTEMS, INC.
                            CONDENSED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                   September 30      December 31,
                                                      1998               1997
                                                  --------------    -------------
<S>                                                <C>               <C>        
ASSETS                                             (Unaudited)          (Note)
Current assets:
         Cash and cash equivalents                 $ 1,422,000       $ 2,000,000
         Accounts receivable                           829,000         1,164,000
         Inventories                                    25,000           144,000
         Prepaid expenses                              101,000            67,000
         Deferred income taxes                          54,000            54,000
                                                   -----------       -----------
Total current assets                                 2,431,000         3,429,000

Property and equipment, net                            501,000           575,000

Other asset - capitalized software                     901,000            75,000
                                                   -----------       -----------
Total assets                                       $ 3,833,000       $ 4,079,000
                                                   ===========       ===========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
         Accounts payable                          $   197,000       $   351,000
         Accrued expenses                              167,000           184,000
         Deferred revenue                              218,000           361,000
                                                   -----------       -----------
Total current liabilities                              582,000           896,000

Deferred income tax liability                           45,000            45,000

Shareholders' equity:
         Common stock                                   25,000            25,000
         Additional paid-in capital                  3,890,000         3,886,000
         Retained earnings (deficit)                  (709,000)         (773,000)
                                                   -----------       -----------
                                                     3,206,000         3,138,000
                                                   -----------       -----------

Total liabilities and shareholders' equity         $ 3,833,000       $ 4,079,000
                                                   ===========       ===========
</TABLE>


Note: The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.


See accompanying notes


                                       3

<PAGE>


                           IMAGE SENSING SYSTEMS, INC.
                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                Three-Month Period Ended       Nine-Month Period Ended
                                                                      September 30                   September 30
                                                              ---------------------------    ---------------------------
                                                                  1998           1997            1998           1997
                                                              ---------------------------    ---------------------------
<S>                                                           <C>             <C>            <C>             <C>        
REVENUE:
        Product sales                                         $   222,000     $   307,000    $   733,000     $   955,000
        Royalties and commissions                                 344,000         864,000      1,313,000       2,169,000
        Consulting and contract fees                              111,000           7,000        178,000          90,000
                                                              ---------------------------    ---------------------------
                                                                  677,000       1,178,000      2,224,000       3,214,000

COSTS OF REVENUE:
        Product sales                                              80,000         227,000        342,000         460,000
        Royalties and commissions                                  40,000          75,000        150,000         229,000
        Consulting and contract fees                               41,000           7,000         66,000          65,000
                                                              ---------------------------    ---------------------------
                                                                  161,000         309,000        558,000         754,000
                                                              ---------------------------    ---------------------------
Gross profit                                                      516,000         869,000      1,666,000       2,460,000

OPERATING EXPENSES:
        Selling, general and administrative                       522,000         515,000      1,680,000       1,562,000
        Research and development                                     --           157,000                        488,000
                                                              ---------------------------    ---------------------------
                                                                  522,000         672,000      1,680,000       2,050,000
                                                              ---------------------------    ---------------------------
Income (loss) from operations                                      (6,000)        197,000        (14,000)        410,000

Other income, net                                                  23,000          23,000         78,000          72,000
                                                              ---------------------------    ---------------------------
Income before income taxes                                         17,000         220,000         64,000         482,000
Income taxes                                                         --              --             --              --
                                                              ---------------------------    ---------------------------
Net income                                                    $    17,000     $   220,000    $    64,000     $   482,000
                                                              ===========================    ===========================


Net income per common share-basic and diluted                 $      0.01     $      0.09    $      0.03     $      0.19
                                                              ===========================    ===========================

Average common shares outstanding:
        Weighted average number of common
          shares outstanding                                    2,482,000       2,476,000      2,481,000       2,475,000
        Dilutive effect of stock options outstanding after
          application of treasury stock method                       --            14,000          3,000           2,000
                                                              ---------------------------    ---------------------------
                                                                2,482,000       2,490,000      2,484,000       2,477,000
                                                              ===========================    ===========================
</TABLE>


See accompanying notes


                                       4

<PAGE>


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

<TABLE>
<CAPTION>
                                                                 Nine-Month Period Ended
                                                                      September 30
                                                              -----------------------------
                                                                  1998             1997
                                                              -----------------------------
<S>                                                           <C>               <C>        
OPERATING ACTIVITIES:
           Net income                                         $    64,000       $   482,000
           Adjustments to reconcile net income to
               net cash provided by operating activities          249,000          (192,000)
                                                              -----------------------------
           Net cash provided by operating activities              313,000           290,000


INVESTING ACTIVITIES:
           Capitalized software development costs                (825,000)
           Purchase of property and equipment                     (70,000)          (90,000)
                                                              -----------------------------
           Net cash used in investing activities                 (895,000)          (90,000)


FINANCING ACTIVITIES:
           Proceeds from exercise of stock option                   4,000            10,000
                                                              -----------------------------
           Net cash provided by financing activities                4,000            10,000
                                                              -----------------------------

Increase (decrease) in cash and cash equivalents                 (578,000)          210,000

Cash and cash equivalents, beginning of period                  2,000,000         1,694,000
                                                              -----------------------------
Cash and cash equivalents, end of period                      $ 1,422,000       $ 1,904,000
                                                              =============================
</TABLE>


See accompanying notes


                                       5

<PAGE>


                           IMAGE SENSING SYSTEMS, INC.

                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                   (Unaudited)
                               September 30, 1998

Note A: Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
three- and nine-month periods ended September 30, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998. For further information, refer to the financial statements and footnotes
thereto for the year ended December 31, 1997.

Note B: Net Income Per Share

In 1997, the Financial Accounting Standards Board (FASB) issued FASB Statement
No. 128, "Earnings Per Share." This Statement replaced the previously reported
primary and fully-diluted earnings per share (EPS) with basic and diluted EPS.
Unlike primary EPS, basic EPS excludes any dilutive effects of options,
warrants, and convertible securities. Diluted EPS is very similar to the
previously reported fully-diluted EPS. All EPS amounts for all periods have been
presented, and where necessary, restated to conform to the FASB Statement
requirements.


                                       6

<PAGE>


Item 2.
                     MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  RESULTS OF OPERATIONS AND FINANCIAL CONDITION

            (Three- and Nine-Month Periods Ended September 30, 1998)


Revenues for the third quarter of 1998 were $677,000, a decrease of 43% from
$1,178,000 for the same period a year ago, while revenues for the nine-month
period ended September 30, 1998 were $2,224,000, a decrease of 31% from
$3,214,000 a year ago. The decrease in revenues for the quarter and nine-month
period was due primarily to fewer sales of Autoscope(R) systems by both Image
Sensing Systems, Inc. (ISS) and its North American distributor. Revenue from the
three categories of revenue for the three- and nine-month period ended September
30, 1998 increased (decreased) relative to 1997 as follows:

                                    Three-Month Period      Nine-Month Period
                                    ------------------      -----------------
Product sales                              (28%)                  (23%)
Royalties and commissions                  (60%)                  (39%)
Consulting and contract fees             1,486%                    98%

The Company believes the delay in passage of the transportation bill by the
United States Congress caused traffic managers to put off traffic management
projects otherwise planned for the first half of 1998. The Asian economic crisis
appears to be having a negative impact on direct sales overseas as sales to
customers in Pacific Rim countries for the nine-month period ended September 30,
1998 were $83,000 compared to $304,000 for the same period in 1997. Revenue from
consulting and contract services increased for the third quarter and nine-month
period ended September 30, 1998 as the Company provided more engineering
services compared to 1997.

Gross profit was $516,000 in the third quarter of 1998, or 76% of revenue,
compared to $869,000, or 74% of revenue, for the same period a year ago. The
slight increase in margin was due primarily to higher margins on direct sales
compared to last year when the first sale of the Autoscope Solo product was made
at less than normal margins. Gross


                                       7

<PAGE>


profit for the nine-month period ended September 30, 1998 was $1,666,000, or 75%
of revenue, compared to $2,460,000, or 77% of revenue, for the same period a
year ago. The slightly lower margins in 1998 were due primarily to deriving
proportionately more revenue from direct sales and consulting and contract fees
than from royalties, the former two categories of revenue having a lower gross
profit margin than royalty income.

Selling, general and administrative expenses were $522,000 and $1,680,000,
respectively, for the three- and nine-month periods ended September 30, 1998
compared to $515,000 and $1,562,000 for the same periods a year ago. The slight
increase in the third quarter was due primarily to added travel, while the
increase for the nine-month period was due primarily to added costs related to
preparing for introduction of the new Autoscope Solo product.

No research and development expenses were incurred in the three- and nine-month
periods ended September 30, 1998 compared to $157,000 and $488,000,
respectively, incurred in the same periods a year ago. The decrease resulted
because all development efforts through September 30, 1998 were incurred in
software development for the new Autoscope Solo product. The Solo product is now
ready for marketing and, accordingly, beginning October 1998, the capitalized
software development costs will be amortized over the expected life of the new
product.

Other income, net, was $23,000 and $78,000, respectively, for the three- and
nine-month periods ended September 30, 1998 compared to $23,000 and $72,000,
respectively, for the same periods a year ago. The small increase resulted
primarily from holding more cash in interest bearing cash equivalents during the
second quarter of 1998.

The Company expects to utilize a portion of its operating loss carryforward and
incur no income tax expense in 1998.


                                       8

<PAGE>


Liquidity and Capital Resources:

The Company completed an initial public offering in June 1995 with the sale of
990,000 shares of common stock, receiving net proceeds of approximately $3.9
million. The proceeds are being used for the expansion of the business and the
unused portion is currently held in interest-bearing cash equivalents.

Cash provided by operating activities was $313,000 for the nine-month period
ended September 30, 1998, compared to $290,000 for the same period in 1997. The
increase in cash flow from operations was primarily due to reduction in
receivables and inventories compared to the prior year.

Capital expenditures were $70,000 for the nine-month period ended September 30,
1998, compared to $90,000 for the same period in 1997. The Company does not
expect to make significant changes to the level of investments in capital
expenditures for the balance of 1998. Capitalized software development costs
were $825,000 for the nine-month period ended September 30, 1998. The Company
began capitalizing software development costs in the fourth quarter of 1997 when
technological feasibility for the new Autoscope Solo product was assured. The
product is now available for distribution and continued software development
will be expensed as incurred.

Management believes that its cash and investment position, anticipated cash
flows from operations, and funds available through its bank line of credit will
be sufficient to meet working capital requirements for current operations and
planned new product introductions for the foreseeable future.

Impact of the Year 2000 Issue

The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Some computer programs
that have date-


                                       9

<PAGE>


sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. All of the software produced by the Company has been analyzed and
the Company is not aware of any potential for date recognition problems in its
products. However, the Company also uses off-the-shelf software (Administrative
Software) produced by third parties for use in administrative functions such as
word processing, network administration, voice mail messaging, billing and
record keeping. In the event that any of such programs are susceptible to date
recognition problems, this could result in a system failure or miscalculations
causing disruption of operations, including, among other things, intra-company
communications, preparation of invoices and collection of accounts receivables,
and many other normal business activities.

The Company has made every attempt to identify all relevant software that may
affect the Company's operations through surveys and examination. Based on risk
assessments that have been completed for the majority of the Company's
operations, the Company must replace some of its Administrative Software so that
its computer systems will properly utilize dates beyond December 31, 1999. The
Company expects to convert the majority of its business operations to new Year
2000 compatible software during 1998 and early 1999 by a combination of
conversion to new software and upgrading existing software. The cost of these
conversions is expected to be less than $35,000. However, there can be no
guarantee that the Administrative Software on which the Company's systems rely
will be timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse effect on the Company.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This Quarterly Report on Form 10-QSB 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 Act of 1934, as amended. These
forward-looking statements involve risks and uncertainties that may cause the
Company's actual results to differ


                                       10

<PAGE>


materially from the results discussed in the forward-looking statements. Factors
that might cause such differences include but are not limited to, the ability
and willingness of governmental agencies responsible for roadway planning to
invest in Autoscope machine vision technology for advanced traffic management,
the impact of new products introduced by competitors, higher than expected
expenses to establish a worldwide marketing presence and the ability of the
Company's North American manufacturing and distribution partner, Econolite
Control Products, Inc., to adequately manufacture and effectively market the
Autoscope system and to pay royalties owed the Company for sales of the
Autoscope system.


PART II: OTHER INFORMATION

Item 1.     Legal Proceedings

            Not applicable

Item 2.     Changes in Securities and Use of Proceeds

            Not applicable

Item 3.     Defaults upon Senior Securities

            Not applicable

Item 4.     Submission of Matters to a Vote of Security Holders

            Not applicable

Item 5.     Other Information

            Not applicable

Item 6.     Exhibits and Reports on Form 8-K

            (a)  Exhibit

                    27  Financial Data Schedule

            (b)  Reports

            No reports on Form 8-K were filed during the quarter covered by
            this Form 10-QSB


                                       11

<PAGE>


                                   SIGNATURES


Pursuant to 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.
                                    ---------------------------
                                    (Registrant)



Dated: October 30, 1998                      /s/ William L. Russell
                                    --------------------------------------------
                                    William L. Russell
                                    President and Chief Executive Officer
                                    (principal executive officer)



Dated: October 30, 1998                      /s/ Arthur J. Bourgeois
                                    --------------------------------------------
                                    Arthur J. Bourgeois
                                    Chief Financial Officer
                                    (principal financial and accounting officer)