Table of Contents





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, 2009                                           
|  |                                                                                         
|  | 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 6, 2009
|Common Stock, $0.01 par value per share |  | 3,985,219 shares          





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IMAGE SENSING SYSTEMS, INC.

TABLE OF CONTENTS

|              |  |                                                                                        |  |         
|------------- |  | -------------------------------------------------------------------------------------- |  | --------
|              |  |                                                                                        |  | Page No.
|             
|PART I.       |  | FINANCIAL INFORMATION                                                                  |  | 3       
|              |  |                                                                                        |  |         
|Item 1.       |  | Financial Statements (unaudited):                                                      |  | 3       
|              |  |                                                                                        |  |         
|              |  | Condensed Consolidated Balance Sheets                                                  |  | 3       
|              |  |                                                                                        |  |         
|              |  | Condensed Consolidated Statements of Income                                            |  | 4       
|              |  |                                                                                        |  |         
|              |  | Condensed Consolidated Statements of Cash Flows                                        |  | 5       
|              |  |                                                                                        |  |         
|              |  | Notes to Condensed Consolidated Financial Statements                                   |  | 6       
|              |  |                                                                                        |  |         
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and
 Results of Operations |  | 10      
|              |  |                                                                                        |  |         
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risks                            |  | 17      
|              |  |                                                                                        |  |         
|Item 4T.      |  | Controls and Procedures                                                                |  | 17      
|              |  |                                                                                        |  |         
|PART II.      |  | OTHER INFORMATION                                                                      |  | 18      
|              |  |                                                                                        |  |         
|Item 1.       |  | Legal Proceedings                                                                      |  | 18      
|              |  |                                                                                        |  |         
|Item 1A.      |  | Risk Factors                                                                           |  | 18      
|              |  |                                                                                        |  |         
|Item 2.       |  | Unregistered Sales of Equity Securities and Use of Proceeds                            |  | 18      
|              |  |                                                                                        |  |         
|Item 3.       |  | Defaults Upon Senior Securities                                                        |  | 18      
|              |  |                                                                                        |  |         
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                    |  | 18      
|              |  |                                                                                        |  |         
|Item 5.       |  | Other Information                                                                      |  | 18      
|              |  |                                                                                        |  |         
|Item 6.       |  | Exhibits                                                                               |  | 18      
|              |  |                                                                                        |  |         
|SIGNATURES    |  | 19                                                                                    
|              |  |                                                                                       
|EXHIBIT INDEX |  | 20                                                                                    

2

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Table of Contents

PART I. FINANCIAL INFORMATION

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

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

|                                            |  |                 |        |                    |   |        |  
|------------------------------------------- |  | --------------- | ------ | ------------------ | - | ------ | -
|                                            |  | March 31,
 2009 |        | December 31,
 2008 |  
|Assets                                      |  |                 |        |                    |   |        |  
|Current assets:                             |  |                 |        |                    |   |        |  
|Cash and cash
equivalents                   |  | $               | 10,870 |                    | $ | 10,289 |  
|Restricted investments,
net                 |  |                 |       |                    |   | 4,000  |  
|Accounts receivable,
net                    |  |                 | 4,753  |                    |   | 6,620  |  
|Inventories                                 |  |                 | 1,711  |                    |   | 1,608  |  
|Prepaid expenses                            |  |                 | 262    |                    |   | 376    |  
|Deferred income taxes                       |  |                 | 376    |                    |   | 376    |  
|Total current assets                        |  |                 | 17,972 |                    |   | 23,269 |  
|                                            |  |                 |        |                    |   |        |  
|Property and equipment,
 net                |  |                 | 783    |                    |   | 728    |  
|                                            |  |                 |        |                    |   |        |  
|Deferred income taxes                       |  |                 | 1,575  |                    |   | 1,575  |  
|Goodwill and intangible
 assets             |  |                 | 10,372 |                    |   | 10,536 |  
|Total assets                                |  | $               | 30,702 |                    | $ | 36,108 |  
|                                            |  |                 |        |                    |   |        |  
|Liabilities
 and Shareholders Equity       |  |                 |        |                    |   |        |  
|Current liabilities:                        |  |                 |        |                    |   |        |  
|Accounts payable                            |  | $               | 627    |                    | $ | 251    |  
|Bank debt, current
portion                  |  |                 |       |                    |   | 1,000  |  
|Accrued compensation                        |  |                 | 537    |                    |   | 1,091  |  
|Accrued warranty and
other                  |  |                 | 566    |                    |   | 793    |  
|EIS earn-out payable                        |  |                 | 30     |                    |   | 1,164  |  
|Income taxes payable                        |  |                 | 245    |                    |   | 283    |  
|Total current liabilities                   |  |                 | 2,005  |                    |   | 4,582  |  
|                                            |  |                 |        |                    |   |        |  
|Bank debt, long-term                        |  |                 |       |                    |   | 2,750  |  
|Income taxes payable                        |  |                 | 248    |                    |   | 246    |  
|                                            |  |                 |        |                    |   |        |  
|Shareholders equity:                       |  |                 |        |                    |   |        |  
|Common stock                                |  |                 | 40     |                    |   | 40     |  
|Additional paid-in
capital                  |  |                 | 11,746 |                    |   | 11,652 |  
|Accumulated other comprehensive
loss        |  |                 | (582   | )                  |   | (147   | )
|Retained earnings                           |  |                 | 17,245 |                    |   | 16,985 |  
|                                            |  |                 | 28,449 |                    |   | 28,530 |  
|Total liabilities and
 shareholders equity |  | $               | 30,702 |                    | $ | 36,108 |  

See accompanying notes.

3

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Table of Contents

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

|                                                       |  |                                      |       |      |   |       | 
|------------------------------------------------------ |  | ------------------------------------ | ----- | ---- | - | ----- | 
|                                                       |  | Three-Month Periods Ended
 March 31, |      
|                                                       |  | 2009                                 |       | 2008 |  
|Revenue:                                               |  |                                      |       |      |   |       | 
|International sales                                    |  | $                                    | 1,182 |      | $ | 1,355 | 
|North American sales                                   |  |                                      | 1,312 |      |   | 1,625 | 
|Royalties                                              |  |                                      | 2,296 |      |   | 2,892 | 
|                                                       |  |                                      | 4,790 |      |   | 5,872 | 
|                                                       |  |                                      |       |      |   |       | 
|Costs of
 revenue:                                     |  |                                      |       |      |   |       | 
|International sales                                    |  |                                      | 394   |      |   | 608   | 
|North American sales                                   |  |                                      | 373   |      |   | 594   | 
|                                                       |  |                                      | 767   |      |   | 1,202 | 
|Gross profit                                           |  |                                      | 4,023 |      |   | 4,670 | 
|                                                       |  |                                      |       |      |   |       | 
|Operating
 expenses:                                   |  |                                      |       |      |   |       | 
|Selling, marketing and
 product support                |  |                                      | 1,630 |      |   | 1,333 | 
|General and administrative                             |  |                                      | 975   |      |   | 888   | 
|Research and development                               |  |                                      | 811   |      |   | 701   | 
|Amortization of intangible
 assets                     |  |                                      | 192   |      |   | 192   | 
|                                                       |  |                                      | 3,608 |      |   | 3,114 | 
|Income from operations                                 |  |                                      | 415   |      |   | 1,556 | 
|                                                       |  |                                      |       |      |   |       | 
|Other income (expense),
 net                           |  |                                      | (12   | )    |   | 41    | 
|Income before income taxes                             |  |                                      | 403   |      |   | 1,597 | 
|Income taxes                                           |  |                                      | 142   |      |   | 541   | 
|Net income                                             |  | $                                    | 261   |      | $ | 1,056 | 
|                                                       |  |                                      |       |      |   |       | 
|Net income per common
 share:                          |  |                                      |       |      |   |       | 
|Basic                                                  |  | $                                    | 0.07  |      | $ | 0.27  | 
|Diluted                                                |  | $                                    | 0.06  |      | $ | 0.26  | 
|                                                       |  |                                      |       |      |   |       | 
|Weighted average number of
 common shares outstanding: |  |                                      |       |      |   |       | 
|Basic                                                  |  |                                      | 3,985 |      |   | 3,928 | 
|Diluted                                                |  |                                      | 4,055 |      |   | 4,026 | 

See accompanying notes.

4

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

|                                                                                  |  |                                      |        |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ------ | -
|                                                                                  |  | Three-Month Periods Ended
 March 31, |       
|                                                                                  |  | 2009                                 |        | 2008 |  
|Operating activities:                                                             |  |                                      |        |      |   |        |  
|Net income                                                                        |  | $                                    | 261    |      | $ | 1,056  |  
|Adjustments to reconcile net income to net
 cash provided by operating activities |  |                                      |        |      |   |        |  
|Depreciation and amortization                                                     |  |                                      | 286    |      |   | 290    |  
|Stock option expense                                                              |  |                                      | 93     |      |   | 73     |  
|Change in operating assets and liabilities                                        |  |                                      | 1,002  |      |   | (249   | )
|Net cash provided by operating activities                                         |  |                                      | 1,642  |      |   | 1,170  |  
|                                                                                  |  |                                      |        |      |   |        |  
|Investing activities:                                                             |  |                                      |        |      |   |        |  
|Net purchases of property and equipment                                           |  |                                      | (149   | )    |   | (37    | )
|Payment of EIS earn-out                                                           |  |                                      | (1,162 | )    |   |       |  
|Net (purchases) sales of investments                                              |  |                                      | 4,000  |      |   | (5,450 | )
|Net cash provided by (used in) investing
 activities                              |  |                                      | 2,689  |      |   | (5,487 | )
|                                                                                  |  |                                      |        |      |   |        |  
|Financing activities:                                                             |  |                                      |        |      |   |        |  
|Repayment of bank debt                                                            |  |                                      | (3,750 | )    |   |       |  
|Cash released from restriction                                                    |  |                                      |       |      |   | 1,789  |  
|Net cash provided by (used in) financing
 activities                              |  |                                      | (3,750 | )    |   | 1,789  |  
|                                                                                  |  |                                      |        |      |   |        |  
|Increase (decrease) in cash and cash
 equivalents                                 |  |                                      | 581    |      |   | (2,528 | )
|                                                                                  |  |                                      |        |      |   |        |  
|Cash and cash equivalents, beginning of
 period                                   |  |                                      | 10,289 |      |   | 5,613  |  
|Cash and cash equivalents, end of period                                          |  | $                                    | 10,870 |      | $ | 3,085  |  

See accompanying notes.

5

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Table of Contents

IMAGE SENSING SYSTEMS, INC.

Notes to Condensed Consolidated Financial
Statements 
(Unaudited) 
March 31, 2009

Note A: Basis of Presentation

The
accompanying unaudited condensed consolidated financial statements of Image Sensing
Systems, Inc. (the Company) have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. It is the opinion of management that the unaudited
condensed consolidated financial statements include all adjustments consisting
of normal recurring accruals considered necessary for a fair presentation.
Operating results for the three-month period ended March 31, 2009 are not
necessarily indicative of the results that may be expected for the year ending December
31, 2009. 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, 2008.

Note B: Investments

Investments
and marketable securities that do not qualify as cash equivalents have been
designated as trading at December 31, 2008 in accordance with Statement of
Financial Accounting Standard (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities. At December
31, 2008, we held $4.0 million (par value) of investments comprised of auction
rate securities, or ARS. In January 2009, our ARS were purchased by our
broker/dealer at par.

The balance of
investments consists of the combination of the fair value of ARS as determined
under SFAS No. 157, Fair Value Measurements,
and the fair value of the settlement rights that we received from the
broker/dealer under a settlement agreement reached in November 2008. The
settlement rights allowed us to put the ARS to the broker/dealer at par between
the dates of January 2, 2009 and January 2, 2011.

Note C: Acquisition

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

EIS was named
in a U.S. lawsuit in 2006 for infringement of a patent. On October 31, 2007,
the court entered judgment that EIS had not infringed on the patent. The
plaintiff has appealed the decision, and EIS has continued its defense as
provided in the EIS asset purchase agreement. In addition, EIS must indemnify
us for all expenses, claims or judgments related to this lawsuit up to the
amount of the purchase price, including any earn-out payments. Management
believes that the ultimate outcome of this legal action will not have a
material adverse effect on our financial statements.

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Note D: Goodwill and intangible assets

Goodwill
consists of $1.1 million related to our acquisition of Flow Traffic Ltd. and
$5.0 million related to the EIS asset purchase, consisting of $3.8 million
recorded at the purchase date and an additional $1.2 million recognized for
earn-out consideration earned for 2008.

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

|                                           |  |                 |        |                    |   |       |  
|------------------------------------------ |  | --------------- | ------ | ------------------ | - | ----- | -
|                                           |  | March 31,
 2009 |        | December 31,
 2008 |  
|Developed technology (8 year life)         |  | $               | 3,900  |                    | $ | 3,900 |  
|Trade names (5 year life)                  |  |                 | 1,200  |                    |   | 1,200 |  
|Other intangibles (5 year life)            |  |                 | 200    |                    |   | 200   |  
|Less: Accumulated amortization             |  |                 | (1,011 | )                  |   | (819  | )
|Total
 identifiable intangible assets, net |  | $               | 4,289  |                    | $ | 4,481 |  

We have and
expect to continue to recognize amortization expense for the intangible assets
in the above table of $768,000 in each of our years ending December 31, 2008,
2009, 2010 and 2011 and of $749,000 in 2012. 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, 2009.

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

The following
table sets forth the computations of basic and diluted net income per common
share for the three-month periods ended March 31, 2009 and 2008 (in thousands,
except per share data):

|                                                                 |  |      |       |      |   |       | 
|---------------------------------------------------------------- |  | ---- | ----- | ---- | - | ----- | 
|                                                                 |  | 2009 |       | 2008 |  
|Numerator:                                                       |  |      |       |      |   |       | 
|Net income                                                       |  | $    | 261   |      | $ | 1,056 | 
|Denominator:                                                     |  |      |       |      |   |       | 
|Shares used in basic net income per common
 share calculation    |  |      | 3,985 |      |   | 3,928 | 
|Effect of diluted securities:                                    |  |      |       |      |   |       | 
|Employee and director stock options                              |  |      | 70    |      |   | 98    | 
|Shares used in diluted net income per
 common share calculations |  |      | 4,055 |      |   | 4,026 | 
|Basic net
 income per common share                               |  | $    | 0.07  |      | $ | 0.27  | 
|Diluted net
 income per common share                             |  | $    | 0.06  |      | $ | 0.26  | 

Our
comprehensive income (loss) for the three-month periods ended March 31, 2009
and 2008 was $(174,000) and $935,000, respectively. In each period, the main
difference between net income and comprehensive income (loss) arose from
foreign currency translation adjustments.

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Table of Contents

Note F: Stock-based Compensation

We recorded
$93,000 and $73,000 of stock-based compensation in general and administrative
expense for the three-month periods ended March 31, 2009 and 2008,
respectively. Options to purchase 4,000 shares, at a weighted average exercise
price of $7.00, and options to purchase 44,000 shares, at a weighted average
exercise price of $12.37, were granted during the three-month periods ended
March 31, 2009 and 2008, respectively. As of March 31, 2009, $736,000 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.

We used the
Black-Scholes option pricing model to determine the weighted average fair value
of options during the three-month periods ended March 31, 2009 and 2008,
respectively.

The Companys
stock options generally vest over three to five years of service and have a
contractual life of six to ten years. As of March 31, 2009, we had 161,500
shares available for grants under the 2005 Stock Incentive Plan.

The following
table summarizes information about the stock options outstanding at March 31,
2009:

|                         |             |                     |                     |                                                 |                     |                                    |  |                     |       |                                   |  |         |  |   |       | 
|------------------------ | ----------- | ------------------- | ------------------- | ----------------------------------------------- | ------------------- | ---------------------------------- |  | ------------------- | ----- | --------------------------------- |  | ------- |  | - | ----- | 
|                         |             |                     | 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   |                     |                     | 59,100                                          |                     | 3.2 years                          |  | $                   | 1.34  |                                   |  | 59,100  |  | $ | 1.34  | 
|                         | 2.00-2.99   |                     |                     | 16,200                                          |                     | 3.3 years                          |  |                     | 2.35  |                                   |  | 16,200  |  |   | 2.35  | 
|                         | 3.00-3.99   |                     |                     | 38,933                                          |                     | 3.8 years                          |  |                     | 3.15  |                                   |  | 38,933  |  |   | 3.15  | 
|                         | 7.00-7.99   |                     |                     | 10,000                                          |                     | 3.1 years                          |  |                     | 7.30  |                                   |  | 6,000   |  |   | 7. 50 | 
|                         | 12.00-12.99 |                     |                     | 62,000                                          |                     | 6.0 years                          |  |                     | 12.44 |                                   |  | 23,000  |  |   | 12.50 | 
|                         | 14.00-14.99 |                     |                     | 105,500                                         |                     | 4.6 years                          |  |                     | 14.25 |                                   |  | 36,500  |  |   | 14.20 | 
|                         | 15.00-15.99 |                     |                     | 39,000                                          |                     | 2.7 years                          |  |                     | 15.34 |                                   |  | 37,50   |  |   | 15.70 | 
|                         | 16.00-16.99 |                     |                     | 15,000                                          |                     | 4.9 years                          |  |                     | 16.00 |                                   |  | 16,750  |  |   | 16.00 | 
|                         | 17.00-17.99 |                     |                     | 32,000                                          |                     | 3.9 years                          |  |                     | 17.50 |                                   |  | 8,000   |  |   | 17.50 | 
|                         |             |                     |                     | 377,733                                         |                     | 4.2 years                          |  |                     | 10.55 |                                   |  | 208,233 |  |   | 7.46  | 

Note G: Segment Information

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

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

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

The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the three-month period ended March 31, 2008
(in thousands):

|                                   |  |           |        |      |   |        |  |   |        | 
|---------------------------------- |  | --------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                   |  | Autoscope |        | RTMS |   | Total  | 
|Revenue                            |  | $         | 4,063  |      | $ | 1,809  |  | $ | 5,872  | 
|Depreciation                       |  |           | 72     |      |   | 26     |  |   | 98     | 
|Amortization
 of intangible assets |  |           |       |      |   | 192    |  |   | 192    | 
|Income
 before income taxes        |  |           | 1,334  |      |   | 263    |  |   | 1,597  | 
|Capital
 expenditures              |  |           | 37     |      |   |       |  |   | 37     | 
|Total assets                       |  |           | 21,275 |      |   | 10,549 |  |   | 31,824 | 

Note H: Derivative Instruments



We have purchased foreign currency forward contracts with our bank to reduce the exposure and volatility arising from fluctuations in foreign currency exchange rates as it relates to payroll and inventory purchases in certain foreign locations.  These contracts have been designated as effective cash flow hedges.  At March 31, 2009, we had future commitments through September 2009 to purchase $1.2 million of Canadian dollars at rates ranging from .8040 to .8072 and $600,000 of British pounds at rates ranging from 1.4435 to 1.4788.



The fair value of the Companys derivative instruments is estimated in accordance with the framework for measuring fair value contained in SFAS No. 157, and is recorded as either an asset or liability in the balance sheet based on changes in the current spot rate, as compared to the exchange rates specified in the contracts. For these instruments, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The fair value measurement of the Companys derivative instruments is estimated using Level 2 inputs which, as defined in SFAS No. 157, are inputs
other than quoted prices that are directly or indirectly observable for the asset or liability.  We did not record any unrealized gain or losses on our derivative instruments as of March 31, 2009 as the currency spot rates were materially equivalent to the contract rates.

Note I: New Accounting Pronouncements

In December
2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 (Revised
2007), Business Combinations.
SFAS No. 141(R) will significantly change the accounting for business
combinations. Under SFAS No. 141(R), an acquiring entity will be required to
recognize all the assets acquired and liabilities assumed in a transaction at
the acquisition-date fair value with limited exceptions. SFAS No. 141(R) will
change the accounting treatment for certain specific items. SFAS No. 141(R)
also includes a substantial number of new disclosure requirements. SFAS No.
141(R) applies to us prospectively for business combinations beginning in 2009,
and this adoption did not have a material impact on our financial statements.

In December
2007, the FASB issued SFAS No. 160, Noncontrolling
Interests in Consolidated Financial Statements  An Amendment of ARB No. 51.
SFAS No. 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS No. 160 also includes expanded disclosure requirements
regarding the interests of the parent and its noncontrolling interest. SFAS No.
160 is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. The adoption of SFAS No. 160 did not
have a material impact on our financial statements. In May 2008, the FASB
issued SFAS No. 162, The Hierarchy of
Generally Accepted Accounting Principles. SFAS No. 162 identifies
the sources of accounting principles and the framework for selecting the
principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally
accepted accounting principles. SFAS No. 162 is effective 60 days following the
approval by the Securities and Exchange Commission of the Public Company Accounting
Oversight Board amendments to AU Section 411, The
Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles. We do not anticipate that the adoption of SFAS No. 162
will materially impact the Company.

9

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Table of Contents

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

Overview

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

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

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

Trends and Challenges
in Our Business

We believe
recent growth in our business can be attributed primarily to the following
global trends:

| |   |                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | worsening
 traffic caused by increased numbers of vehicles in metropolitan areas without
 corresponding expansions of road infrastructure, which has increased demand
 for our products;          
| |   |                                                                                                                                                                                                   
| |  | advances in
 information technology, which have made our products easier to market and
 implement;                                                                                                
| |   |                                                                                                                                                                                                   
| |  | the
 continuing rise in funding allocations in large cities for centralized
 traffic management services. which has increased the ability of our primary
 end users to implement our products; and
| |   |                                                                                                                                                                                                   
| |  | general
 increases in the cost-effectiveness of electronics, which make our products
 more affordable for end users.                                                                              

We believe our
continued growth primarily depends upon:

| |   |                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continued
 adoption and governmental funding of intelligent transportation systems, or
 ITS, for traffic control in developed countries;                         
| |   |                                                                                                                                                                  
| |  | countries in
 the developing world adopting above-ground detection technology, such as
 video or radar, instead of in-pavement loop technology to manage traffic;
| |   |                                                                                                                                                                  
| |  | the use of
 CED to provide solutions to security/surveillance and environmental issues
 associated with increasing automobile use in metropolitan areas; and     

10

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Table of Contents

| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability
 to develop new products, such as hybrid CED devices incorporating, for
 example, radar and video technologies, that provide increasingly accurate
 information and enhance the end users ability to cost-effectively manage
 traffic, security/surveillance and environmental issues.

Because our
principal end users are governmental entities, we are faced with challenges
related to potential delays in purchase decisions by those entities and changes
in budgetary constraints. These contingencies could result in significant
fluctuations in our revenue between periods. The current worldwide recession is
further adding to the unpredictability of purchase decisions, creating more
delays than usual and decreasing governmental budgets, and it is likely to
negatively affect our 2009 revenue. We believe we may be a beneficiary of the
federal stimulus bill enacted early in 2009, but it is too early to determine
the level or timing of impact to our operations.

Key Financial Terms
and Metrics

Revenue. Revenue
historically has been derived from two sources: (1) royalties received from
Econolite for sales of the Autoscope system in North America, the Caribbean and
Latin America and (2) revenue received from direct sales of Autoscope systems
in Europe and Asia. Royalties from Econolite historically have provided the
majority of our revenue. We calculate the royalties using a profit sharing
model where we split the gross profit on sales of Autoscope product made
through Econolite. This royalty arrangement has the benefit of decreasing our
cost of revenues and our selling, marketing and product support expenses
because these costs and expenses are borne primarily by Econolite. Although
this royalty model has a positive impact on our gross margin, it also
negatively impacts our total revenue, which would be higher if all the sales
made by Econolite were made directly by us. The royalty arrangement is
exclusive under a long-term agreement. Our acquisition of the RTMS product line
in 2007, which we assemble, gives us an additional source of revenue that has
increased our overall revenue and lessened fluctuations in our revenue from
period to period due to our ownership of more than one product line and the
higher volumes it brings, notwithstanding normal seasonality.

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

Operating Expenses.
Our operating expenses fall into three categories: (1) selling, marketing and
product support; (2) general and administrative; and (3) research and
development. Selling, marketing and product support expenses consist of various
costs related to sales and support of our products, including salaries,
benefits and commissions paid to our personnel, commissions paid to third
parties, travel, trade show and advertising costs, second-tier technical
support for Econolite, and general product support, where applicable. General
and administrative expenses consist of certain corporate and administrative
functions that support the development and sales of our products and
provide an infrastructure to support future growth. General and administrative
expenses reflect management, supervisory and staff salaries and benefits, legal
and auditing fees, travel, rent and costs associated with being a public
company, such as board of director fees, Sarbanes-Oxley compliance, listing
fees and annual reporting expenses. Research and development expenses consist
mainly of salaries and benefits for our engineers and third party costs for
consulting and prototyping. We measure all operating expenses against our
annually approved budget, which is developed with achieving a certain operating
margin as a key focus. Also included in operating expenses is non-cash expense
for intangible asset amortization.

11

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

12

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Table of Contents

Results of Operations

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

|                                        |  |                                     |       |                                 |  |       |   |  |       |   
|--------------------------------------- |  | ----------------------------------- | ----- | ------------------------------- |  | ----- | - |  | ----- | --
|                                        |  | Three-Month Period Ended
 March 31, |       | Quarter
 Over 
 Quarter
 Change | 
|                                        |  | 2009                                |       | 2008                            |  |      
|International
 sales                    |  |                                     | 24.7  | %                               |  | 23.1  | % |  | (12.8 | )%
|North
 American sales                   |  |                                     | 27.4  |                                 |  | 27.7  |   |  | (19.3 | ) 
|Royalties                               |  |                                     | 47.9  |                                 |  | 49.2  |   |  | (20.6 | ) 
|Total revenue                           |  |                                     | 100.0 |                                 |  | 100.0 |   |  | (18.4 | ) 
|Gross
 margininternational sales       |  |                                     | 66.7  |                                 |  | 55.1  |   |  | 5.5   |   
|Gross
 marginNorth American sales      |  |                                     | 71.6  |                                 |  | 63.4  |   |  | (8.9  | ) 
|Gross
 marginroyalties                 |  |                                     | 100.0 |                                 |  | 100.0 |   |  |      |   
|Selling,
 marketing and product support |  |                                     | 34.0  |                                 |  | 22.7  |   |  | 22.3  |   
|General and
 administrative             |  |                                     | 20.4  |                                 |  | 15.1  |   |  | 10.0  |   
|Research and
 development               |  |                                     | 16.9  |                                 |  | 11.9  |   |  | 15.7  |   
|Amortization
 of intangibles            |  |                                     | 4.0   |                                 |  | 3.3   |   |  |      |   
|Income from
 operations                 |  |                                     | 8.7   |                                 |  | 26.5  |   |  | (73.3 | ) 
|Income tax
 expense                     |  |                                     | 3.0   |                                 |  | 9.2   |   |  | (73.8 | ) 
|Net income                              |  |                                     | 5.4   |                                 |  | 18.0  |   |  | (75.3 | ) 

Total revenue
decreased to $4.8 million in the three-month period ended March 31, 2009 from
$5.9 million in the same period in 2008, a decrease of 18.4%. Royalties decreased
to $2.3 million in the first quarter of 2009 from $2.9 million in the same
period in 2008, a decrease of 20.6%. We attribute the decrease in royalties to
the economic recession in North America and its negative impact on state and
federal spending. North American sales, which are sales of RTMS in North
America, decreased to $1.3 million, or 27.4% of revenue, in the first quarter
of 2009 from $1.6 million, or 27.7% of revenue, in the same period in 2008,
also reflecting the difficult economic environment in North America.
International sales, which include both Autoscope and RTMS sales outside of
North America, decreased to $1.2 million in the first quarter of 2009 from $1.4
million in the first quarter of 2008, a decrease of 12.8%. The first quarter of
2008 was unusually strong for international sales.

Gross margins
for international sales increased to 66.7% in the three months ended March 31,
2009 from 55.1% in the same period in 2008, and gross margins for North
American sales increased to 71.6% in the first quarter of 2009 from 63.4% in
the first quarter of 2008. The increases resulted mainly from a positive
revenue mix shift and to a lesser extent from lower inventory reserves recorded
in 2009 as compared to 2008. Gross margins on royalty income remained
consistent at 100.0% in each of the first quarters of 2009 and 2008.

Selling,
marketing and product support expense increased to $1.6 million, or 34.0% of
total revenue, in the first three months of 2009 from $1.3 million, or 22.7% of
total revenue, in the first three months of 2008. The change related mostly to
an investment in market expansion activities in Eastern Europe and Asia and the
realization of the impact of headcount additions made late in 2008. We
anticipate that for the remainder of 2009, the dollar amount of our quarterly selling, marketing and product
support expense will increase from the 2009 first quarter level.

13

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General and
administrative expense increased to $975,000, or 20.4% of total revenue, in the
first quarter of 2009, up from $888,000, or 15.1% of total revenue, in the same
period in 2008. The 2009 increase in costs resulted mainly from increased
professional services expenses. We anticipate that for the remainder of 2009, the dollar amount of our quarterly
general and administrative expense will remain at levels similar to that of the
first quarter of 2009.

Research and
development expense increased to $811,000, or 16.9% of total revenue, in the
first quarter of 2009, up from $701,000, or 11.9% of total revenue, in the same
period in 2008. The increase was directly related to our investment in
video/radar hybrid solutions and tailored international offerings and the
realization of the impact of headcount additions made late in 2008. We
anticipate that for the remainder of 2009, the dollar amount of our quarterly  research and development expense
will increase from the first quarter of 2009 level.

Amortization
of intangibles expense was $192,000 in the first quarter of 2009 and reflects
the amortization of intangible assets acquired in the EIS asset purchase.
Assuming there are no changes to our intangible assets, we anticipate amortization
expense will be $768,000 for all of 2009.

Other expense
was $12,000 in the first quarter of 2009 as compared to other income of $41,000
in the same period in 2008. In 2009, interest on bank debt exceeded interest
income as we moved into securities that had lower yields than in 2008.

Income tax
expense was $142,000, or 35.2% of pretax income, in the first quarter of 2009,
compared to $541,000, or 33.9% of pretax income, in the comparable quarter of
2008. We anticipate an effective tax rate of from 30% to 35% for all of 2009.

Liquidity and Capital Resources

At March 31,
2009, we had $10.9 million in cash and cash equivalents, compared to $10.3
million in cash and cash equivalents and $4.0 million in short-term
investments at December 31, 2008. Our investments held at December 31, 2008
were auction rate securities that were redeemed at par in January 2009.

Net cash
provided by operating activities was $1.6 million in 2009, compared to $1.2
million in 2008. The increase in 2009 was mainly a result of decreasing
receivable balances as opposed to the activity in 2008. We anticipate that
average receivable collection days in 2009 will increase over 2008 but that it
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 2009. In addition to equipment purchases, in 2009 we paid
our 2008 earn-out liability of $1.2 million to the sellers of the EIS assets.
We also retired our bank debt in full in February 2009, paying a total of $3.75
million during the quarter ended March 31, 2009.

We have a
revolving line of credit agreement with our bank, 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 receivables. The line of credit currently has no borrowings outstanding and
matures on May 1, 2011. We believe, on an ongoing basis, we have regular
availability to draw a minimum of $3.0 million on our line of credit based on
qualifying assets.

In conjunction
with our EIS asset purchase, the sellers have an earn-out arrangement over
approximately three years from the December 2007 date of purchase. The earn-out
is based on earnings from RTMS sales less related cost of revenue and operating
expenses, depreciation and amortization, and it is calculated annually. If the
earnings are at target levels, the sellers would receive $2.0 million annually,
or $6.0 million in total. Superior performance of the assets could lead to an
earn-out in excess of $2 million, as the earn-out is not capped. Earn-out
payments generally are due within three months of the end of an earn-out
period. The first earn-out period ran from December 6, 2007 to December 31,
2008. Based on the results for RTMS for the first earn-out period, which ended December 31, 2008, the sellers of the EIS assets were
entitled to receive a $1.2 million earn-out payment, which was paid in March
and April 2009. If we are acquired or sell substantially all of our assets
before December 6, 2010, we must pay EIS $6.0 million less earn-out amounts
previously paid as an acceleration of potential earn-out payments under the EIS
asset purchase agreement.

14

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Table of Contents

We believe
that cash and cash equivalents on hand at March 31, 2009, along with the
availability of funds under our $5.0 million revolving line of credit and cash
provided by operating activities, will satisfy our projected working capital
needs, payments under the EIS earn-out, investing activities, and other cash
requirements for the foreseeable future.

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, 2008. The accounting policies used in preparing our interim 2009
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 December
2007, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standard (SFAS) No. 141 (Revised 2007), Business Combinations. SFAS
No. 141(R) will significantly change the accounting for business
combinations. Under SFAS No. 141(R), an acquiring entity will be required
to recognize all the assets acquired and liabilities assumed in a transaction
at the acquisition-date fair value with limited exceptions. SFAS
No. 141(R) will change the accounting treatment for certain specific
items. SFAS No. 141(R) also includes a substantial number of new
disclosure requirements. SFAS No. 141(R) applies to us prospectively for
business combinations beginning in 2009, and its adoption did not have a
material impact on our financial statements.

In December
2007, the FASB issued SFAS No. 160, Noncontrolling
Interests in Consolidated Financial Statements  An Amendment of ARB No. 51.
SFAS No. 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS No. 160 also includes expanded disclosure requirements
regarding the interests of the parent and its noncontrolling interest. SFAS
No. 160 is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. The adoption of SFAS
No. 160 did not have a material impact on our financial statements.

In May 2008,
the FASB issued SFAS No. 162, The
Hierarchy of Generally Accepted Accounting Principles. SFAS
No. 162 identifies the sources of accounting principles and the framework
for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles. SFAS No. 162 is effective 60
days following the approval by the Securities and Exchange Commission of the
Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles. We do not anticipate that
the adoption of SFAS No. 162 will materially impact the Company.

15

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Cautionary Statement:

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

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

We caution
that the forward-looking statements made in this report or in other
announcements made by us are further qualified by the risk factors set forth in
Item 1A. to our Annual Report on Form 10-K for the fiscal year ended December
31, 2008.

16

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Table of Contents

|        |                                                             
|------- | ------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures About
 Market Risks

Our foreign
sales and results of operations are subject to the impact of foreign currency
fluctuations. We have not historically hedged our exposure to translation gains
and losses. Beginning in 2009, we have entered in to a limited number of hedges
that we anticipate will decrease our overall translation exposure. A 10%
adverse change in foreign currency rates would not have a material effect on
our results of operations or financial position.

We entered
into a number of currency hedging arrangements in 2009. The purpose of the
hedging was to lock in what we believe to be favorable rates on certain
currencies and to increase our predictability on certain expenses at our
foreign subsidiaries. All hedging activity is intended to qualify for hedge
accounting under SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, as amended. We
believe all contracts will be utilized to provide funds to cover operating
expenses.

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

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PART II. OTHER INFORMATION

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

None.

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

Some of the risk factors to
which we and our business are subject are described in the section entitled
Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended
December 31, 2008. 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. | Submission of Matters to a Vote of Security Holders.

None.

|        |                  
|------- | -----------------
|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, 2009:

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

18

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Table of Contents

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 13, 2009 | By:                          | /s/ Kenneth R. Aubrey                        
|                    |                              | Kenneth R. Aubrey                            
|                    |                              | President and Chief
 Executive Officer       
|                    |                              | (principal executive
 officer)               
|                    |                              |                                              
|Dated: May 13, 2009 | By:                          | /s/ Gregory R.L. Smith                       
|                    |                              | Gregory R.L. Smith                           
|                    |                              | Chief Financial Officer                      
|                    |                              | (principal financial and
 accounting officer)

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Table of Contents

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.

20

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