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

| |           | 
| | --------- | 
| |           | 
| |           | 
| | FORM 10-Q | 
| |           | 
| |           | 

|  |                                                                                          
|- | -----------------------------------------------------------------------------------------
|x | QUARTERLY
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|  |                                                                                          
|  | For the quarterly period
 ended June 30, 2010                                            
|  |                                                                                          
|  | OR                                                                                       
|  |                                                                                          
|o | TRANSITION
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  |                                                                                          
|  | For the transition period
 from ________________ to ________________                     

|                                                        |  | 
|------------------------------------------------------- |  | 
|Commission
file number: 0-26056                        
|                                                       
|                                                        |  | 
|                                                       
|Image Sensing Systems, Inc.                            
|(Exact
 name of registrant as specified in its charter)

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

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

| |  | 
| |  | 
| |  | 

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

Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o     No
o

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

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

Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes o     No
x

Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of the
latest practicable date.

|                                         |  |                               
|---------------------------------------- |  | ------------------------------
|Class                                    |  | Outstanding
 at August 2, 2010
|Common
 Stock, $0.01 par value per share |  | 4,861,319
 shares             







IMAGE SENSING
SYSTEMS, INC.

TABLE OF CONTENTS

|               |  |                                                                                        |  |          
|-------------- |  | -------------------------------------------------------------------------------------- |  | ---------
|               |  |                                                                                        |  | Page
 No.
|               |  |                                                                                        |  |          
|PART
 I.       |  | FINANCIAL
 INFORMATION                                                                 |  | 1        
|               |  |                                                                                        |  |          
|Item
 1.       |  | Financial
 Statements (unaudited):                                                     |  | 1        
|               |  |                                                                                        |  |          
|               |  | Condensed
 Consolidated Balance Sheets                                                 |  | 1        
|               |  |                                                                                        |  |          
|               |  | Condensed
 Consolidated Statements of Income                                           |  | 2        
|               |  |                                                                                        |  |          
|               |  | Condensed
 Consolidated Statements of Cash Flows                                       |  | 3        
|               |  |                                                                                        |  |          
|               |  | Notes
 to Condensed Consolidated Financial Statements                                  |  | 4        
|               |  |                                                                                        |  |          
|Item
 2.       |  | Managements
 Discussion and Analysis of Financial Condition and Results of Operations |  | 9        
|               |  |                                                                                        |  |          
|Item
 3.       |  | Quantitative
 and Qualitative Disclosures About Market Risk                            |  | 16       
|               |  |                                                                                        |  |          
|Item
 4T.      |  | Controls
 and Procedures                                                               |  | 16       
|               |  |                                                                                        |  |          
|PART
 II.      |  | OTHER
 INFORMATION                                                                     |  | 17       
|               |  |                                                                                        |  |          
|Item
 1.       |  | Legal
 Proceedings                                                                     |  | 17       
|               |  |                                                                                        |  |          
|Item
 1A.      |  | Risk
 Factors                                                                          |  | 17       
|               |  |                                                                                        |  |          
|Item
 2.       |  | Unregistered
 Sales of Equity Securities and Use of Proceeds                           |  | 17       
|               |  |                                                                                        |  |          
|Item
 3.       |  | Defaults
 Upon Senior Securities                                                       |  | 17       
|               |  |                                                                                        |  |          
|Item
 4.       |  | Removed
 and Reserved                                                                  |  | 17       
|               |  |                                                                                        |  |          
|Item
 5.       |  | Other
 Information                                                                     |  | 17       
|               |  |                                                                                        |  |          
|Item
 6.       |  | Exhibits                                                                               |  | 17       
|               |  |                                                                                        |  |          
|SIGNATURES     |  | 18                                                                                    
|               |  |                                                                                       
|EXHIBIT
 INDEX |  | 19                                                                                    

---



PART I. FINANCIAL INFORMATION

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

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

|                                           |  |                |        |                    |   |        |  
|------------------------------------------ |  | -------------- | ------ | ------------------ | - | ------ | -
|                                           |  | June 30,
 2010 |        | December 31,
 2009 |  
|Assets                                     |  |                |        |                    |   |        |  
|Current assets:                            |  |                |        |                    |   |        |  
|Cash and cash equivalents                  |  | $              | 13,661 |                    | $ | 14,084 |  
|Investments                                |  |                | 3,421  |                    |   | 3,935  |  
|Accounts receivable, net                   |  |                | 6,633  |                    |   | 5,660  |  
|Inventories                                |  |                | 3,352  |                    |   | 2,734  |  
|Prepaid expenses                           |  |                | 1,095  |                    |   | 588    |  
|Deferred income taxes                      |  |                | 328    |                    |   | 328    |  
|Total current assets                       |  |                | 28,490 |                    |   | 27,329 |  
|                                           |  |                |        |                    |   |        |  
|Property and equipment, net                |  |                | 1,172  |                    |   | 998    |  
|                                           |  |                |        |                    |   |        |  
|Deferred income taxes                      |  |                | 1,485  |                    |   | 1,485  |  
|Goodwill and intangible assets             |  |                | 20,978 |                    |   | 11,338 |  
|Total assets                               |  | $              | 52,125 |                    | $ | 41,150 |  
|                                           |  |                |        |                    |   |        |  
|Liabilities and Shareholders Equity       |  |                |        |                    |   |        |  
|Current liabilities:                       |  |                |        |                    |   |        |  
|Accounts payable                           |  | $              | 1,224  |                    | $ | 953    |  
|Current portion of bank debt               |  |                | 2,315  |                    |   | 4,000  |  
|Accrued compensation                       |  |                | 747    |                    |   | 858    |  
|Accrued warranty and other                 |  |                | 1,285  |                    |   | 643    |  
|Earn-out payable                           |  |                | 1,010  |                    |   | 1,541  |  
|Income taxes payable                       |  |                | 106    |                    |   | 234    |  
|Total current liabilities                  |  |                | 6,687  |                    |   | 8,229  |  
|                                           |  |                |        |                    |   |        |  
|Income taxes payable                       |  |                | 186    |                    |   | 208    |  
|Long-term portion of bank debt             |  |                | 2,280  |                    |   |       |  
|                                           |  |                |        |                    |   |        |  
|Shareholders equity:                      |  |                |        |                    |   |        |  
|Common stock                               |  |                | 49     |                    |   | 40     |  
|Additional paid-in capital                 |  |                | 21,774 |                    |   | 11,994 |  
|Accumulated other comprehensive loss       |  |                | (470   | )                  |   | (171   | )
|Retained earnings                          |  |                | 21,619 |                    |   | 20,850 |  
|                                           |  |                | 42,972 |                    |   | 32,713 |  
|Total liabilities and shareholders equity |  | $              | 52,125 |                    | $ | 41,150 |  

See accompanying notes.

- 1 -

---



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

|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|------------------------------------------------------ |  | ----------------------------------- | ----- | --------------------------------- | - | ----- |  | ---- | ------ | - | - | ------ | 
|                                                       |  | Three-Month Periods Ended
 June 30, |       | Six-Month Periods Ended
 June 30, |  
|                                                       |  | 2010                                |       | 2009                              |   | 2010  |  | 2009 |       
|Revenue:                                               |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|International sales                                    |  | $                                   | 1,894 |                                   | $ | 1,159 |  | $    | 3,009  |   | $ | 2,341  | 
|North American sales                                   |  |                                     | 1,503 |                                   |   | 1,738 |  |      | 3,200  |   |   | 3,050  | 
|Royalties                                              |  |                                     | 3,187 |                                   |   | 3,383 |  |      | 5,778  |   |   | 5,679  | 
|                                                       |  |                                     | 6,584 |                                   |   | 6,280 |  |      | 11,987 |   |   | 11,070 | 
|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Costs of
 revenue:                                     |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|International sales                                    |  |                                     | 741   |                                   |   | 326   |  |      | 1,129  |   |   | 720    | 
|North American sales                                   |  |                                     | 769   |                                   |   | 585   |  |      | 1,313  |   |   | 958    | 
|                                                       |  |                                     | 1,510 |                                   |   | 911   |  |      | 2,442  |   |   | 1,678  | 
|Gross profit                                           |  |                                     | 5,074 |                                   |   | 5,369 |  |      | 9,545  |   |   | 9,392  | 
|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Operating
 expenses:                                   |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Selling, marketing and product support                 |  |                                     | 2,146 |                                   |   | 1,921 |  |      | 4,002  |   |   | 3,551  | 
|General and administrative                             |  |                                     | 938   |                                   |   | 803   |  |      | 1,976  |   |   | 1,778  | 
|Research and development                               |  |                                     | 834   |                                   |   | 862   |  |      | 1,611  |   |   | 1,673  | 
|Acquisition related expenses                           |  |                                     | 527   |                                   |   |      |  |      | 527    |   |   |       | 
|Amortization of intangible assets                      |  |                                     | 216   |                                   |   | 192   |  |      | 408    |   |   | 384    | 
|                                                       |  |                                     | 4,661 |                                   |   | 3,778 |  |      | 8,524  |   |   | 7,386  | 
|Income from operations                                 |  |                                     | 413   |                                   |   | 1,591 |  |      | 1,021  |   |   | 2,006  | 
|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Other income (expense),
 net                           |  |                                     | (36   | )                                 |   | 21    |  |      | (72    | ) |   | 9      | 
|Income before income taxes                             |  |                                     | 377   |                                   |   | 1,612 |  |      | 949    |   |   | 2,015  | 
|Income taxes                                           |  |                                     | 10    |                                   |   | 442   |  |      | 180    |   |   | 584    | 
|Net income                                             |  | $                                   | 367   |                                   | $ | 1,170 |  | $    | 769    |   | $ | 1,431  | 
|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Net income per common
 share:                          |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Basic                                                  |  | $                                   | 0.08  |                                   | $ | 0.29  |  | $    | 0.18   |   | $ | 0.36   | 
|Diluted                                                |  | $                                   | 0.08  |                                   | $ | 0.29  |  | $    | 0.17   |   | $ | 0.35   | 
|                                                       |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Weighted average number of
 common shares outstanding: |  |                                     |       |                                   |   |       |  |      |        |   |   |        | 
|Basic                                                  |  |                                     | 4,676 |                                   |   | 3,985 |  |      | 4,333  |   |   | 3,985  | 
|Diluted                                                |  |                                     | 4,751 |                                   |   | 4,067 |  |      | 4,420  |   |   | 4,061  | 

See accompanying notes.

- 2 -

---



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

|                                                                                  |  |                                   |        |      |   |        |  
|--------------------------------------------------------------------------------- |  | --------------------------------- | ------ | ---- | - | ------ | -
|                                                                                  |  | Six-Month Periods Ended
 June 30, |       
|                                                                                  |  |                                   |       
|                                                                                  |  | 2010                              |        | 2009 |  
|                                                                                  |  |                                   |        |      |  
|Operating activities:                                                             |  |                                   |        |      |   |        |  
|Net income                                                                        |  | $                                 | 769    |      | $ | 1,431  |  
|Adjustments to reconcile net income to net
 cash provided by operating activities |  |                                   |        |      |   |        |  
|Depreciation and amortization                                                     |  |                                   | 653    |      |   | 600    |  
|Stock option expense                                                              |  |                                   | 164    |      |   | 180    |  
|Change in operating assets and liabilities,
 net of acquisition                   |  |                                   | (1,155 | )    |   | 301    |  
|Net cash provided by operating activities                                         |  |                                   | 431    |      |   | 2,512  |  
|                                                                                  |  |                                   |        |      |   |        |  
|Investing activities:                                                             |  |                                   |        |      |   |        |  
|Net purchases of property and equipment                                           |  |                                   | (209   | )    |   | (340   | )
|Purchase of CitySync                                                              |  |                                   | (7,871 | )    |   |       |  
|Repayment of CitySync seller loans                                                |  |                                   | (445   | )    |   |       |  
|Payment of EIS earn-out                                                           |  |                                   | (1,541 | )    |   | (1,192 | )
|Net sales of investments                                                          |  |                                   | 514    |      |   | 33     |  
|Net cash used in investing activities                                             |  |                                   | (9,552 | )    |   | (1,499 | )
|                                                                                  |  |                                   |        |      |   |        |  
|Financing activities:                                                             |  |                                   |        |      |   |        |  
|Proceeds from exercise of stock options                                           |  |                                   | 80     |      |   | 4      |  
|Repayment of bank debt                                                            |  |                                   | (200   | )    |   | (3,750 | )
|Net proceeds from common stock offering                                           |  |                                   | 8,818  |      |   |       |  
|Net cash provided by (used in) financing
 activities                              |  |                                   | 8,698  |      |   | (3,746 | )
|                                                                                  |  |                                   |        |      |   |        |  
|Decrease in
 cash and cash equivalents                                            |  |                                   | (423   | )    |   | (2,733 | )
|                                                                                  |  |                                   |        |      |   |        |  
|Cash and
 cash equivalents, beginning of period                                   |  |                                   | 14,084 |      |   | 10,289 |  
|Cash and
 cash equivalents, end of period                                         |  | $                                 | 13,661 |      | $ | 7,556  |  

See
accompanying notes.

- 3 -

---



IMAGE SENSING
SYSTEMS, INC.

Notes to Condensed Consolidated Financial
Statements 
(Unaudited) 
June 30, 2010

Note A: Basis of Presentation

The
accompanying unaudited condensed consolidated financial statements of Image
Sensing Systems, Inc. (the Company) have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to the Quarterly Report
on Form 10-Q. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. It is the opinion of
management that the unaudited condensed consolidated financial statements
include all adjustments consisting of normal recurring accruals considered
necessary for a fair presentation. Operating results for the three-month and
six-month periods ended June 30, 2010 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2010. For further
information, refer to the consolidated financial statements and footnotes
thereto in our Annual Report on Form 10-K for the year ended December 31, 2009.

Note B: Acquisitions

On June 21,
2010, we purchased all of the outstanding equity of CitySync Limited, a
privately-held developer and marketer of automatic number plate recognition
products. We believe the CitySync acquisition expands our addressable market,
strengthens our selling presence in Europe and extends the opportunities for
hybrid product developments. The purchase price was $7.9 million in cash plus
57,000 shares of our common stock, valued using the closing price on the day
before the acquisition, totaling approximately $727,000. In conjunction with
the purchase, we repaid seller loans, including accrued interest, of $601,000.
As part of the purchase agreement, the sellers are eligible to receive an
earn-out based on the performance of the business for the next 18 months.
Earn-outs will be calculated as of each calendar year end and paid within 90
days thereof. The earn-out is based on achieving certain revenue and minimum
gross margins from the sale of CitySync ANPR systems and it is calculated in
two separate periods, each ending on December 31. In each period there are two
tiers, and superior performance could lead to a total earn-out of $2 million or
higher as the earn-out is not capped. We have determined the fair value of the
earn-out to be $1.0 million and have recorded a liability and additional
purchase price in that amount as of June 30, 2010. We determined the fair value
by assigning probabilities to achieving each of the tiers in each of the
periods and then discounted the total to its net present value. Following the
acquisition, CitySync became a wholly-owned subsidiary of ISS/Europe.

The purchase
price was allocated on the basis of estimated fair value at the date of the
purchase. The purchase price allocation, which is preliminary pending further
study of the fair values assigned, is as follows (in thousands):

|                                 |  |   |        |  
|-------------------------------- |  | - | ------ | -
|Purchase
 price:                 |  |   |        |  
|Cash                             |  | $ | 7,871  |  
|Fair value of common stock       |  |   | 727    |  
|Estimated fair value of earn-out |  |   | 1,010  |  
|Total purchase price             |  |   | 9,608  |  
|                                 |  |   |        |  
|Allocation:                      |  |   |        |  
|Net tangible current assets      |  |   | (1,769 | )
|Property and equipment           |  |   | (242   | )
|Liabilities                      |  |   | 2,450  |  
|Developed technology             |  |   | (3,300 | )
|Trade names                      |  |   | (1,900 | )
|Other intangibles                |  |   | (1,500 | )
|Goodwill                         |  | $ | 3,347  |  

In conjunction
with the acquisition, all of the shares of common stock issued in connection
with the transaction were placed in escrow to secure potential indemnification
obligations. Any shares remaining in escrow on December 31, 2012 will be
released to the sellers.

- 4 -

---



The results of
CitySync operations, including $309,000 of revenue, are included in the
accompanying financial statements since the date of the acquisition. The
following pro forma summary presents the results of operations as if the
acquisition had occurred on January 1, 2009. The table below includes our
results for the periods as shown and for CitySync based on a January fiscal
year.

The pro forma
results are not necessarily indicative of the results that would have been
achieved had the CitySync acquisition taken place on that date (in thousands,
except per share amounts):

|                       |  |                             |       |                           |   |       |  |      |        |  |   |        | 
|---------------------- |  | --------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ------ |  | - | ------ | 
|                       |  | Three-Months
 EndedJune 30, |       | Six-Months
 EndedJune 30, |  
|                       |  | 2010                        |       | 2009                      |   | 2010  |  | 2009 |       
|                       |  |                             |       |                           |   |       |  |      |        |  |   |        | 
|Total
 revenue         |  | $                           | 7,543 |                           | $ | 7,912 |  | $    | 14,394 |  | $ | 13,668 | 
|                       |  |                             |       |                           |   |       |  |      |        |  |   |        | 
|Net income             |  |                             | 35    |                           |   | 669   |  |      | 297    |  |   | 147    | 
|                       |  |                             |       |                           |   |       |  |      |        |  |   |        | 
|Net income
 per share: |  |                             |       |                           |   |       |  |      |        |  |   |        | 
|Basic                  |  | $                           | 0.01  |                           | $ | 0.17  |  | $    | 0.07   |  | $ | 0.04   | 
|Diluted                |  | $                           | 0.01  |                           | $ | 0.16  |  | $    | 0.07   |  | $ | 0.04   | 

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 three years after the December 2007 purchase
date. Earn-outs are calculated and paid annually. Based on target achievement,
the sellers would receive $2.0 million annually or a total of $6.0 million. 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. Earn-out payments related to the EIS asset purchase are recorded as
additional goodwill when earned. In 2009 and 2008, the sellers earned an
earn-out of approximately $1.5 million and $1.2 million, respectively which
were paid in March of the subsequent year.

Note C: Goodwill and Intangible Assets

Goodwill
consists of $1.1 million related to our acquisition of Flow Traffic Ltd.; $6.6
million related to the EIS asset purchase, consisting of $3.8 million recorded
at the purchase date and an additional $2.7 million recognized for earn-out
consideration earned in 2009 and 2008; and $3.3 million related to our
acquisition of CitySync.

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

|                                           |  |                |        |                    |   |        |  
|------------------------------------------ |  | -------------- | ------ | ------------------ | - | ------ | -
|                                           |  | June 30,
 2010 |        | December 31,
 2009 |  
|Developed technology (8 year life)         |  | $              | 7,200  |                    | $ | 3,900  |  
|Trade names (5 to 9 year life)             |  |                | 3,100  |                    |   | 1,200  |  
|Other intangibles (3 to 8 year life)       |  |                | 1,700  |                    |   | 200    |  
|Less: Accumulated amortization             |  |                | (1,994 | )                  |   | (1,586 | )
|Total
 identifiable intangible assets, net |  | $              | 10,006 |                    | $ | 3,714  |  

We expect to
recognize amortization expense for the intangible assets in the above table in
each of our years ending December 31, of $1.2 million in 2010, $1.6 million in
each of 2011 and 2012, and $1.3 million in each of 2013 and 2014. Goodwill and
intangible assets related to the EIS asset purchase are deductible for tax
purposes over 15 years.

- 5 -

---



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 June
30, 2010.

Note D: Bank Debt

Prior to the
completion of our acquisition of CitySync, our term loan with Associated Bank,
N.A. was callable under certain circumstances and was classified as a current
liability on the balance sheet. After the acquisition was completed, the bank
waived the call provision and the loan is now classified according to its three
year repayment term.

Note E: Income Taxes

In the three
month period ended June 30, 2010, our effective income tax rate was
significantly below our historical rates due to revisions to research and
development tax credit estimates.

Note F: 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 and six-month periods ended June 30, 2010 and 2009
(in thousands, except per share data):

|                                                                 |  |                                     |       |                                   |   |       |  |      |       |  |   |       | 
|---------------------------------------------------------------- |  | ----------------------------------- | ----- | --------------------------------- | - | ----- |  | ---- | ----- |  | - | ----- | 
|                                                                 |  | Three-Month Periods
 Ended June 30, |       | Six-Month Periods Ended
 June 30, |  
|                                                                 |  | 2010                                |       | 2009                              |   | 2010  |  | 2009 |      
|Numerator:                                                       |  |                                     |       |                                   |   |       |  |      |       |  |   |       | 
|Net income                                                       |  | $                                   | 367   |                                   | $ | 1,170 |  | $    | 769   |  | $ | 1,431 | 
|Denominator:                                                     |  |                                     |       |                                   |   |       |  |      |       |  |   |       | 
|Shares used in basic net income per common
 share calculation    |  |                                     | 4,676 |                                   |   | 3,985 |  |      | 4,333 |  |   | 3,985 | 
|Effect of diluted securities:                                    |  |                                     |       |                                   |   |       |  |      |       |  |   |       | 
|Employee and director stock options                              |  |                                     | 75    |                                   |   | 82    |  |      | 87    |  |   | 76    | 
|Shares used in diluted net income per
 common share calculations |  |                                     | 4,751 |                                   |   | 4,067 |  |      | 4,420 |  |   | 4,061 | 
|Basic net
 income per common share                               |  | $                                   | 0.08  |                                   | $ | 0.29  |  | $    | 0.18  |  | $ | 0.36  | 
|Diluted net
 income per common share                             |  | $                                   | 0.08  |                                   | $ | 0.29  |  | $    | 0.17  |  | $ | 0.35  | 

Our
comprehensive income for the three-month periods ended June 30, 2010 and 2009
was $109,000 and $1.5 million, respectively, and for the six-month periods
ended June 30, 2010 and 2009 was $470,000 and $1.3 million, respectively. In
each period, the main difference between net income and comprehensive income
arose from foreign currency translation adjustments.

Note G: Equity and Stock-based Compensation

In April 2010,
we sold 798,000 shares of our common stock to investors at $12.25 per share
under a registration statement on Form S-3 declared effective by the Securities
and Exchange Commission in December 2009. Net of underwriting fees and other
offering expenses, we received $8.8 million in cash from the stock sale.

We recorded
$164,000 and $180,000 of stock-based compensation in general and administrative
expense for the six-month periods ended June 30, 2010 and 2009, respectively.
Options to purchase 20,000 and 64,000 shares at a weighted average exercise
price of $12.50 and $8.72, and options to purchase 60,000 and 68,000 shares at
a weighted average exercise price of $12.67 and $8.62, were granted during the
three-month and six-month periods ended June 30, 2010 and 2009, respectively.
In addition, in June 2009, under a shareholder approved plan, we exchanged
options to purchase 168,500 shares with exercise prices ranging from $12.37 to
$17.50 on a one-for-one basis for options at an exercise price of $9.22. As of
June 30, 2010, $843,000 of total unrecognized compensation expense related to
non-vested stock option awards is expected to be recognized over a weighted
average period of 2.6 years.

- 6 -

---



We used the
Black-Scholes option pricing model to determine the weighted average fair value
of options during the three-month and six-month periods ended June 30, 2010 and
2009, respectively.

The Companys
stock options generally vest over three to five years of service and have a
contractual life of six to ten years. As of June 30, 2010, we had 194,500
shares available for grants under the 2005 Stock Incentive Plan, which includes
an additional 135,000 shares added to the plan under an amendment approved by
shareholders in May 2010.

The following
table summarizes information about the stock options outstanding at June 30,
2010:

|                         |             |                     |                     |                                                 |                     |                                   |           |                     |   |                                   |  |  |         |  |   |       | 
|------------------------ | ----------- | ------------------- | ------------------- | ----------------------------------------------- | ------------------- | --------------------------------- | --------- | ------------------- | - | --------------------------------- |  |  | ------- |  | - | ----- | 
|                         |             |                     | Options Outstanding |                                                 | Options Exercisable |                                  
|Range of
 Exercise Price |             | Number
 Outstanding |                     | Weighted
 Average
 Remaining
 Contractual
 Life |                     | Weighted
 Average
 Exercise Price |           | Number
 Exercisable |   | Weighted
 Average
 Exercise Price | 
|$                        | 1.30-1.99   |                     |                     | 46,000                                          |                     |                                   | 2.0 years |                     | $ | 1.36                              |  |  | 46,000  |  | $ | 1.36  | 
|                         | 2.00-2.99   |                     |                     | 16,200                                          |                     |                                   | 1.6 years |                     |   | 2.35                              |  |  | 16,200  |  |   | 2.35  | 
|                         | 3.00-3.99   |                     |                     | 38,933                                          |                     |                                   | 2.3 years |                     |   | 3.15                              |  |  | 38,933  |  |   | 3.15  | 
|                         | 7.00-7.99   |                     |                     | 4,000                                           |                     |                                   | 4.9 years |                     |   | 7.00                              |  |  | 1,000   |  |   | 7.00  | 
|                         | 8.00-8.99   |                     |                     | 48,000                                          |                     |                                   | 6.4 years |                     |   | 8.63                              |  |  | 13,500  |  |   | 8.58  | 
|                         | 9.00-9.99   |                     |                     | 172,500                                         |                     |                                   | 4.8 years |                     |   | 9.20                              |  |  | 55,125  |  |   | 9.16  | 
|                         | 12.00-12.99 |                     |                     | 105,000                                         |                     |                                   | 5.3 years |                     |   | 12.58                             |  |  | 31,500  |  |   | 12.51 | 
|                         | 15.00-15.99 |                     |                     | 28,000                                          |                     |                                   | 1.5 years |                     |   | 15.30                             |  |  | 28,000  |  |   | 15.30 | 
|                         |             |                     |                     | 458,633                                         |                     |                                   | 4.3 years |                     |   | 8.72                              |  |  | 230,258 |  |   | 7.27  | 

Note H: Segment Information

We 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. We have deemed
the CitySync operations to be immaterial for the period ended June 30, 2010 and
thus included those results in Other.

The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the three-month periods ended June 30, 2010
and 2009 (in thousands):

|                                  |  | Autoscope |        | RTMS |   | Other  |  | Total |       
|--------------------------------- |  | --------- | ------ | ---- | - | ------ |  | ----- | ------
|                                  |  | 2010      |        | 2009 |   | 2010   |  | 2009  |       
|Revenue                           |  | $         | 4,197  |      | $ | 4,164  |  | $     | 2,078 
|Depreciation                      |  |           | 91     |      |   | 81     |  |       | 34    
|Amortization of intangible assets |  |           |       |      |   |       |  |       | 192   
|Income (loss) before income taxes |  |           | 428    |      |   | 1,187  |  |       | (51   
|Capital expenditures              |  |           | 74     |      |   | 161    |  |       | 10    
|Total assets                      |  | $         | 30,798 |      | $ | 22,018 |  | $     | 11,304

- 7 -

---



The following
table sets forth selected unaudited financial information for each of the
Companys reportable segments for the six-month periods ended June 30, 2010 and
2009 (in thousands):

|                                  |  | Autoscope |        | RTMS |   | Other  |  | Total |       
|--------------------------------- |  | --------- | ------ | ---- | - | ------ |  | ----- | ------
|                                  |  | 2010      |        | 2009 |   | 2010   |  | 2009  |       
|Revenue                           |  | $         | 7,206  |      | $ | 7,410  |  | $     | 4,472 
|Depreciation                      |  |           | 160    |      |   | 147    |  |       | 85    
|Amortization of intangible assets |  |           |       |      |   |       |  |       | 384   
|Income (loss) before income taxes |  |           | 376    |      |   | 1,554  |  |       | 573   
|Capital expenditures              |  |           | 169    |      |   | 285    |  |       | 50    
|Total assets                      |  | $         | 30,798 |      | $ | 22,018 |  | $     | 11,304

Note I: 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 June 30, 2010, we had future commitments through November 2010 to purchase
$1.5 million of Canadian dollars at rates ranging from approximately .9282 to
..9296.

The fair value
of the Companys derivative instruments is estimated in accordance with the
framework for measuring fair value and is recorded as either an asset or
liability in the balance sheet based on changes in the current spot rate as
compared to the exchange rates specified in the contracts. For these
instruments, the effective portion of the gain or loss on the derivative is
reported as a component of other comprehensive income and is reclassified into
earnings in the same period or periods during which the hedged transaction
affects earnings. Gains and losses on the derivative representing either hedge
ineffectiveness or hedge components excluded from the assessment of
effectiveness are recognized in current earnings. The fair value measurement of
the Companys derivative instruments is estimated using Level 2 inputs which
are inputs other than quoted prices that are directly or indirectly observable
for the asset or liability. We did not record any unrealized gain or losses on
our derivative instruments as of June 30, 2010, as the currency spot rates were
materially equivalent to the contract rates.

Note J: New Accounting Pronouncements

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

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

- 8 -

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

Overview

General. We provide software based computer enabled
detection, or CED, products and solutions that use advanced signal processing
software algorithms to detect and monitor objects in a designated field of
view. Our technology analyzes the signal from a sophisticated sensor and passes
the information along to management systems, controllers or directly to users.
Our core products, the Autoscope® Video Vehicle Detection System, RTMS® Radar
Detection System and CitySync Automatic Number Plate Recognition (ANPR) System,
operate using our proprietary software in conjunction with video cameras or
radar and commonly available electronic components. Our systems are used by
traffic managers primarily to improve the flow of vehicle traffic and to
enhance safety at intersections, main thoroughfares, freeways and tunnels and
by parking and toll managers and law enforcement officials to read license
plates for various safety, security, access and enforcement ANPR applications.

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

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

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

Trends and Challenges in Our Business

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

| |   |                                                                                                                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | worsening traffic caused by
 increased numbers of vehicles in metropolitan areas without corresponding
 expansions of road infrastructure and the need to automate safety, security
 and access applications for automobiles and trucks, which has increased
 demand for our products;
| |   |                                                                                                                                                                                                                                                                                       
| |  | advances in information
 technology, which have made our products easier to market and implement;                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                       
| |  | the continuing rise in
 funding allocations for centralized traffic management services and automated
 enforcement schemes, 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.                                                                                                                                                                  

- 9 -

---



We believe our continued
growth primarily depends upon:

| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | continued adoption and
 governmental funding of intelligent transportation systems, or ITS, and other
 automated applications for traffic control, safety and enforcement 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;                                                                                                                                  
| |   |                                                                                                                                                                                                                                                                                                    
| |  | use of CED to provide
 solutions to security/surveillance and environmental issues associated with
 increasing automobile use in metropolitan areas; and                                                                                                                                           
| |   |                                                                                                                                                                                                                                                                                                    
| |  | our ability to develop new
 products, such as hybrid CED devices incorporating, for example, radar and
 video technologies, that provide increasingly accurate information and
 enhance the end users ability to cost-effectively manage traffic,
 security/surveillance and environmental issues.

Because the majority of our
end users are governmental entities, we are faced with challenges related to
potential delays in purchase decisions by those entities and changes in
budgetary constraints. These contingencies could result in significant
fluctuations in our revenue between periods. The current worldwide recession is
further adding to the unpredictability of purchase decisions, creating more
delays than usual and decreasing governmental budgets, and it is likely to
continue to negatively affect our 2010 revenue. We believe we will continue to
be a beneficiary of the federal stimulus bill enacted early in 2009, but it is
difficult to determine the level of impact it has on our operations.

Key Financial Terms and Metrics

Revenue. We derive revenue from two sources: (1)
royalties received from Econolite for sales of the Autoscope system in North
America, the Caribbean and Latin America and (2) revenue received from the
direct sales of our RTMS and CitySync systems in North America, the Caribbean
and Latin America and all of our systems in Europe and Asia. 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.

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

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

- 10 -

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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 December 2007, and revenue consists of
all North American sales and a portion of international sales. All segment
revenues are derived from external customers. We have deemed the CitySync
operations to be immaterial for the period ended June 30, 2010 and thus
included those results in Other. Due to the CitySync acquisition and related
changes in how we manage our business, we may reevaluate our segment
definitions in the future.

The following table sets
forth selected unaudited financial information for each of the Companys
reportable segments for the three-month periods ended June 30, 2010 and 2009
(in thousands):

|                                  |  | Autoscope |        | RTMS |   | Other  |  | Total |       
|--------------------------------- |  | --------- | ------ | ---- | - | ------ |  | ----- | ------
|                                  |  | 2010      |        | 2009 |   | 2010   |  | 2009  |       
|Revenue                           |  | $         | 4,197  |      | $ | 4,164  |  | $     | 2,078 
|Depreciation                      |  |           | 91     |      |   | 81     |  |       | 34    
|Amortization of intangible assets |  |           |       |      |   |       |  |       | 192   
|Income (loss) before income taxes |  |           | 428    |      |   | 1,187  |  |       | (51   
|Capital expenditures              |  |           | 74     |      |   | 161    |  |       | 10    
|Total assets                      |  | $         | 30,798 |      | $ | 22,018 |  | $     | 11,304

The following table sets forth
selected unaudited financial information for each of the Companys reportable
segments for the six-month periods ended June 30, 2010 and 2009 (in thousands):

|                                  |  | Autoscope |        | RTMS |   | Other  |  | Total |       
|--------------------------------- |  | --------- | ------ | ---- | - | ------ |  | ----- | ------
|                                  |  | 2010      |        | 2009 |   | 2010   |  | 2009  |       
|Revenue                           |  | $         | 7,206  |      | $ | 7,410  |  | $     | 4,472 
|Depreciation                      |  |           | 160    |      |   | 147    |  |       | 85    
|Amortization of intangible assets |  |           |       |      |   |       |  |       | 384   
|Income (loss) before income taxes |  |           | 376    |      |   | 1,554  |  |       | 573   
|Capital expenditures              |  |           | 169    |      |   | 285    |  |       | 50    
|Total assets                      |  | $         | 30,798 |      | $ | 22,018 |  | $     | 11,304

- 11 -

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Results of Operations

The following table sets
forth, for the periods indicated, (1) certain statements of income data as a
percent of total revenue, (2) gross profit on product sales and royalties as a
percentage of product sales and royalties, respectively, and (3)
period-to-period changes of items in the consolidated statements of income from
2010 to 2009:

|                                                 |  |                                     |       |                             |  |       |   |  |       |  
|------------------------------------------------ |  | ----------------------------------- | ----- | --------------------------- |  | ----- | - |  | ----- | -
|                                                 |  | Three-Month Periods
 Ended June 30, |       | Quarter OverQuarter
 Change | 
|                                                 |  | 2010                                |       | 2009                        |  |      
|International sales                              |  |                                     | 28.8  | %                           |  | 18.4  | % |  | 63.4  | %
|North American sales                             |  |                                     | 22.8  |                             |  | 27.7  |   |  | (13.5 | )
|Royalties                                        |  |                                     | 48.4  |                             |  | 53.9  |   |  | (5.8  | )
|Total revenue                                    |  |                                     | 100.0 |                             |  | 100.0 |   |  | 4.8   |  
|Gross profit 
 international sales              |  |                                     | 60.9  |                             |  | 71.9  |   |  | 38.4  |  
|Gross profit  North
 American sales             |  |                                     | 48.8  |                             |  | 66.3  |   |  | (36.3 | )
|Gross profit  royalties                         |  |                                     | 100.0 |                             |  | 100.0 |   |  | (5.8  | )
|Selling, marketing and
 product support expenses |  |                                     | 32.6  |                             |  | 30.6  |   |  | 11.7  |  
|General and administrative
 expenses             |  |                                     | 14.2  |                             |  | 12.8  |   |  | 16.8  |  
|Research and development
 expenses               |  |                                     | 12.7  |                             |  | 13.7  |   |  | (3.2  | )
|Acquisition related
 expenses                    |  |                                     | 8.0   |                             |  |      |   |  | n/m   |  
|Amortization of intangible
 assets               |  |                                     | 3.3   |                             |  | 3.1   |   |  | 12.5  |  
|Income from operations                           |  |                                     | 6.3   |                             |  | 25.3  |   |  | (74.0 | )
|Other income (expense), net                      |  |                                     | (0.5  | )                           |  | 0.3   |   |  | n/m   |  
|Income taxes                                     |  |                                     | 0.2   |                             |  | 7.0   |   |  | (97.7 | )
|Net income                                       |  |                                     | 5.6   |                             |  | 18.6  |   |  | (68.6 | )
|                                                 |  |                                     |       |                             |  |       |   |  |       |  

|                                                 |  |                                   |       |                             |  |       |   |  |       |  
|------------------------------------------------ |  | --------------------------------- | ----- | --------------------------- |  | ----- | - |  | ----- | -
|                                                 |  | Six-Month Periods
 Ended June 30, |       | Period Over
 Period
 Change | 
|                                                 |  | 2010                              |       | 2009                        |  |      
|International sales                              |  |                                   | 25.1  | %                           |  | 21.1  | % |  | 28.5  | %
|North American sales                             |  |                                   | 26.7  |                             |  | 27.6  |   |  | 4.9   |  
|Royalties                                        |  |                                   | 48.2  |                             |  | 51.3  |   |  | 1.7   |  
|Total revenue                                    |  |                                   | 100.0 |                             |  | 100.0 |   |  | 8.3   |  
|Gross profit 
 international sales              |  |                                   | 62.5  |                             |  | 69.2  |   |  | 16.0  |  
|Gross profit  North
 American sales             |  |                                   | 59.0  |                             |  | 68.6  |   |  | (9.8  | )
|Gross profit  royalties                         |  |                                   | 100.0 |                             |  | 100.0 |   |  | 1.7   |  
|Selling, marketing and
 product support expenses |  |                                   | 33.4  |                             |  | 32.1  |   |  | 12.7  |  
|General and administrative
 expenses             |  |                                   | 16.5  |                             |  | 16.1  |   |  | 11.1  |  
|Research and development
 expenses               |  |                                   | 13.4  |                             |  | 15.1  |   |  | (3.7  | )
|Acquisition related
 expenses                    |  |                                   | 4.4   |                             |  |      |   |  | n/m   |  
|Amortization of intangible
 assets               |  |                                   | 3.4   |                             |  | 3.5   |   |  | 6.3   |  
|Income from operations                           |  |                                   | 8.5   |                             |  | 18.1  |   |  | (49.1 | )
|Other income (expense), net                      |  |                                   | (0.6  | )                           |  | 0.1   |   |  | n/m   |  
|Income taxes                                     |  |                                   | 1.5   |                             |  | 5.3   |   |  | (69.2 | )
|Net income                                       |  |                                   | 6.4   |                             |  | 12.9  |   |  | (46.3 | )

Total revenue increased to
$6.6 million in the three-month period ended June 30, 2010 from $6.3 million in
the same period in 2009, an increase of 4.8%, and to $12.0 million in the first
half of 2010 from $11.1 million in the same period in 2009, an increase of
8.3%. Royalties decreased to $3.2 million in the second quarter of 2010 from
$3.4 million in the same period of 2009, a decrease of 5.8%, and they increased
to $5.8 million in the first half of 2010 from $5.7 million in the same period
in 2009, an increase of 1.7%. We attribute the relative flatness in royalties
to the ongoing economic recession in North America and its negative impact on
state and federal spending. North American sales, which are sales of RTMS and
CitySync in North America, decreased to $1.5 million in the second quarter of
2010 from $1.7 million in the same period in 2009, a decrease of 13.5%, and
increased to $3.2 million in the first half of 2010 from $3.1 million in the
same period in 2009, an increase of 4.9%, also reflecting the difficult
economic environment in North America. International sales, which include all
product line sales outside of North America, increased to $1.9 million in the
second quarter of 2010 from $1.2 million in the second quarter of 2009, an
increase of 63.4%, and to $3.0 million in the first half of 2010 from $2.3
million in the first half of 2009, an increase of 28.5%. The increases were due
mainly to adding the CitySync product line in June 2010 and to partially
recovering from weakness in the Asian market in 2009.

- 12 -

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On a segment basis, revenue
for the Autoscope segment was flat in the second quarter of 2010 compared to
the same period of 2009, and decreased to $7.2 million in the first half of
2010 from $7.4 million in the same period in 2009. The decrease reflects the
variable nature of our international business, especially in our seasonally
slowest quarter, our fiscal first quarter. Revenue for the RTMS segment was
$2.1 million in both the second quarter of 2010 and the same period in 2009,
and increased to $4.5 million in the first half of 2010 from $3.7 million in
the same period in 2009. The increase resulted mainly as a result of improved
sales in North America and Asia.

Gross margins for international
sales decreased to 60.9% in the three months ended June 30, 2010 from 71.9% in
the same period in 2009, and to 62.5% in the first half of 2010 from 69.2% in
the same period in 2009. Gross margins for North American sales decreased to
48.8% in the second quarter of 2010 from 66.3% in the second quarter of 2009
and to 59.0% in the first half of 2010 from 68.6% in the first half of 2009.
The decreases resulted mainly from a negative revenue mix shift in 2010 to both
lower margin products and to higher third-party equipment content. Gross
margins on royalty income remained consistent at 100.0% in each of the periods
of 2010 and 2009.

Selling, marketing and
product support expense increased to $2.1 million, or 32.6% of total revenue,
in the three months ended June 30, 2010 from $1.9 million, or 30.6% of total
revenue, in the second quarter of 2009, and to $4.0 million, or 33.4% of total
revenue, in the first half of 2010 from $3.6 million, or 32.1% of total
revenue, in the first half of 2009. The change related mostly to an investment
in market expansion activities in Europe and Asia and increased product support
expenses. We anticipate that for the remainder of 2010, the dollar amount of
our quarterly selling, marketing and product support expense will increase from
the 2010 second quarter level.

General and administrative
expense increased to $938,000, or 14.2% of total revenue, in the three months
ended June 30, 2010, from $803,000, or 12.8% of total revenue, in the same
period in 2009, and to $2.0 million, or 16.5% of total revenue, in the first
half of 2010, from to $1.8 million, or 16.1% of total revenue, in the same
period in 2009. The 2010 increase in costs resulted mainly from lower exchange
gains relative to 2009. We anticipate that for the remainder of 2010, the
dollar amount of our quarterly general and administrative expense will be
higher than that of the second quarter of 2010.

Research and development
expense decreased slightly to $834,000, or 12.7% of total revenue, in the first
quarter of 2010, from $862,000, or 13.7% of total revenue, in the same period
in 2009, and to $1.6 million, or 13.4% of total revenue, in the first half of
2010, from $1.7 million, or 15.1% of total revenue, in the same period in 2009.
We anticipate that for the remainder of 2010, the dollar amount of our
quarterly research and development expense will increase from the 2010 second
quarter level.

Amortization of intangibles
expense was $216,000 in the second quarter of 2010 and $408,000 in the first
half of 2010, an increase of $24,000 over these same periods in 2009, and
reflects the amortization of intangible assets acquired in the EIS asset
purchase and a partial month amortization for the CitySync acquisition.
Assuming there are no changes to our intangible assets, we anticipate
amortization expense will be $1.2 million for all of 2010.

Other expense was $36,000 and
$72,000 in the second quarter and first half of 2010, respectively, as compared
to other income of $21,000 and $9,000, respectively, in the same periods in
2009. In 2009, bank debt was outstanding for only a portion of the first
quarter.

Income before income taxes
for the Autoscope segment decreased to $428,000 in the second quarter of 2010,
compared to $1.2 million in the comparable quarter of 2009, and to $376,000 in
the first half of 2010, compared to $1.6 million in the comparable period of
2009. The decreases were mainly due to lower gross margins, increased market
expansion activities in international markets in the segment and acquisition
costs incurred in 2010. Income before income taxes for the RTMS segment
decreased to a loss of $51,000 in the second quarter of 2010, compared to
income of $425,000 in the comparable quarter of 2009, and increased to $573,000
in the first half of 2010, compared to $461,000 in the comparable period of
2009. The increase for the six-month period was mainly due to increased sales
volumes and the decrease for the quarter was due mainly to lower gross margins
caused by a higher than usual mix of third party components.

- 13 -

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Income tax expense was
$10,000, or 2.7% of pretax income, in the second quarter of 2010, compared to
$442,000, or 27.4% of pretax income, in the comparable quarter of 2009, and was
$180,000, or 19.0% of pretax income, in the first half of 2010, compared to
$584,000, or 29.0% of pretax income, in the comparable period of 2009. The
second quarters rate was favorably impacted by revisions to estimated tax
credits. We anticipate an effective tax rate below 30% for the second half of
2010.

Liquidity and Capital Resources

At June 30, 2010, we had
$13.7 million in cash and cash equivalents and $3.4 million in short-term
investments, compared to $14.1 million in cash and cash equivalents and $3.9
million in short-term investments at December 31, 2009.

Net cash provided by
operating activities in the six-month period ended June 30, 2010 was $431,000,
compared to $2.5 million in the same period of 2009. The decrease in 2010 was
due to lower net income in 2010 and a combination of a lower change in receivables
in the 2010 period as compared to 2009 and a greater change in payables and
accruals in the 2010 period as compared to 2009. In the six-month period ended
June 30, 2010, we used $7.9 million in cash to purchase the outstanding equity
of CitySync and we also repaid $445,000 in CitySync seller loans. This was
offset by the proceeds from our offering of common stock which netted us $8.8
million in cash. We anticipate that average receivable collection days in 2010
will be similar to 2009 and will not have a material impact on our liquidity.
Our planned additions of property and equipment are discretionary, and we do
not expect them to exceed historical levels in 2010. In addition to equipment
purchases, in 2010 we paid our 2009 earn-out liability of $1.5 million to the
sellers of the EIS assets. Subsequent to June 30, 2010, we repaid all CitySync
bank debt of $795,000.

In December 2009, we entered
into a term loan agreement for $4.0 million with Associated Bank, National
Association, or Associated Bank, which matures December 2012 and requires
quarterly principal payments. Prior to the completion of our acquisition of
CitySync, our term loan with Associated Bank was callable under certain
circumstances and was classified as a current liability on the balance sheet.
After the acquisition was completed, Associated Bank waived the call provision
and the loan is now classified according to its three year repayment term. The
interest rate for the term loan is based on a formula of LIBOR plus 3.75%
(current rate is 4.0%). The term loan had $3.8 million outstanding at June 30,
2010. We previously had a separate $4.0 million term note with Associated Bank
that originated in May 2008 and was fully repaid in February 2009.

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

In conjunction with our
acquisition of CitySync, the sellers have an earn-out arrangement over
approximately 18 months from the June 2010 date of purchase. The earn-out is
based on achieving certain revenue and minimum gross margins from the sale of
CitySync ANPR systems and it is calculated in two separate periods, each ending
on December 31. In each period there are two tiers and superior performance
could lead to a total earn-out of $2 million or higher, as the earn-out is not
capped. Earn-out payments are due within three months of the end of an earn-out
period.

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

- 14 -

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We believe that cash and cash
equivalents on hand at June 30, 2010, along with the availability of funds
under our $5.0 million revolving line of credit and cash provided by operating
activities, will satisfy our projected working capital needs, payments under
the CitySync and EIS earn-outs, bank debt principal repayments, 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, 2009. The
accounting policies used in preparing our interim 2010 Condensed Consolidated
Financial Statements set forth elsewhere in this Quarterly Report on Form 10-Q
are the same as those described in our Annual Report on Form 10-K.

New and Recently Adopted Accounting Pronouncements

New and recently adopted
pronouncements are set forth in Note J in the Notes to Condensed Consolidated
Financial Statements in Item 1 of this Quarterly Report on Form 10-Q.

Cautionary
Statement:

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

| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | historical dependence on a
 single product for most of our revenue;                                                             
| |   |                                                                                                                                 
| |  | budget constraints by
 governmental entities that purchase our products, including constraints
 caused by declining tax revenue;
| |   |                                                                                                                                 
| |  | continuing ability of our
 licensee to pay royalties owed;                                                                      
| |   |                                                                                                                                 
| |  | the mix of and margin on
 the products we sell;                                                                                 
| |   |                                                                                                                                 
| |  | dependence on third parties
 for manufacturing and marketing our products;                                                      
| |   |                                                                                                                                 
| |  | dependence on single-source
 suppliers to meet manufacturing needs;                                                             
| |   |                                                                                                                                 
| |  | our increased international
 presence;                                                                                          
| |   |                                                                                                                                 
| |  | failure to secure adequate
 protection for our intellectual property rights;                                                    

- 15 -

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| |   |                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | development of a competing
 product by another business using the underlying technology included in the
 patent we had licensed from the University of Minnesota, which expired in
 2006;
| |   |                                                                                                                                                                                          
| |  | our inability to develop
 new applications and product enhancements;                                                                                                                     
| |   |                                                                                                                                                                                          
| |  | unanticipated delays, costs
 and expenses inherent in the development and marketing of new products,
 including ANPR products;                                                           
| |   |                                                                                                                                                                                          
| |  | our inability to respond to
 low-cost local competitors in Asia and elsewhere;                                                                                                           
| |   |                                                                                                                                                                                          
| |  | our inability to properly
 manage a growth in revenue and/or production requirements;                                                                                                    
| |   |                                                                                                                                                                                          
| |  | the influence over our voting stock by affiliates;                                                                                                                                       
| |   |                                                                                                                                                                                          
| |  | our inability to hire and retain key scientific and technical
 personnel;                                                                                                                
| |   |                                                                                                                                                                                          
| |  | our inability to
 achieve and maintain effective internal controls;                                                                                                                      
| |   |                                                                                                                                                                                          
| |  | our inability to comply
 with international regulatory restrictions over hazardous substances and
 electronic waste; and                                                                 
| |   |                                                                                                                                                                                          
| |  | conditions beyond our
 control such as war, terrorist attacks, health epidemics and economic
 recession.                                                                                 

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

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

Our foreign sales and results
of operations are subject to the impact of foreign currency fluctuations. From
time to time, we enter into currency hedges to attempt to lower our exposure to
translation gains and losses as well as to limit the impact of foreign currency
translation upon the consolidation of our foreign subsidiaries. A 10% adverse
change in foreign currency rates, if we have not hedged, could have a material
effect on our results of operations or financial position. Our current greatest
exposure for a negative material impact to our operations is a rising Canadian
Dollar versus the U.S. Dollar.

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

- 16 -

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PART II. OTHER INFORMATION

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

None.

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

Some of the risk factors to
which we and our business are subject are described in the section entitled
Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended
December 31, 2009. The risks and uncertainties described in our Annual Report
are not the only risks we face. Additional risks and uncertainties not
presently known to us or that our management currently deems immaterial also
may impair our business operations. If any of the risks described were to
occur, our business, financial condition, operating results and cash flows
could be materially adversely affected.

|        |                                                             
|------- | ------------------------------------------------------------
|Item 2. | Unregistered Sales of Equity Securities and Use of
 Proceeds
|        |                                                             
|None.   |                                                             
|        |                                                             
|Item 3. | Defaults Upon Senior Securities                             
|        |                                                             
|None.   |                                                             
|        |                                                             
|Item 4. | Removed and Reserved.                                       
|        |                                                             
|Item 5. | Other Information                                           
|        |                                                             
|None.   |                                                             
|        |                                                             
|Item 6. | Exhibits                                                    

The following exhibits are
filed as part of this quarterly report on Form 10-Q for the quarterly period
ended June 30, 2010:

|                |  |                                                                                                                                                                                            
|--------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
 Number |  | Description                                                                                                                                                                                
|                |  |                                                                                                                                                                                            
|2.1             |  | Share Purchase Agreement
 dated June 21, 2010 by and among Image Sensing Systems, Inc., Image Sensing
 Systems Europe Limited, CitySync Limited and three shareholders of CitySync Limited.
|                |  |                                                                                                                                                                                            
|10.1            |  | Lease dated February 1,
 2010 between CitySync Limited and Nortrust Nominees Limited.                                                                                                      
|                |  |                                                                                                                                                                                            
|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.                                                                                       

- 17 -

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SIGNATURES

In accordance with the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

|                      |                             |                                              
|--------------------- | --------------------------- | ---------------------------------------------
|                      | Image Sensing Systems, Inc.
|                      |                             |                                              
|Dated: August 9, 2010 | By:                         | /s/ Kenneth R. Aubrey                        
|                      |                             | Kenneth R. Aubrey                            
|                      |                             | President and Chief
 Executive Officer       
|                      |                             | (principal executive
 officer)               
|                      |                             |                                              
|Dated: August 9, 2010 | By:                         | /s/ Gregory R.L. Smith                       
|                      |                             | Gregory R.L. Smith                           
|                      |                             | Chief Financial Officer                      
|                      |                             | (principal financial and
 accounting officer)

- 18 -

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EXHIBIT
INDEX

|            |  |                                                                                                                                                                                             
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                 
|            |  |                                                                                                                                                                                             
|2.1         |  | Share Purchase Agreement
 dated June 21, 2010 by and among Image Sensing Systems, Inc., Image Sensing
 Systems Europe Limited, CitySync Limited and three shareholders of CitySync
 Limited.
|            |  |                                                                                                                                                                                             
|10.1        |  | Lease dated February 1,
 2010 between CitySync Limited and Nortrust Nominees Limited.                                                                                                       
|            |  |                                                                                                                                                                                             
|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.                                                                                        

- 19 -

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