**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended September 30, 2006**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                        to                        **

**CommissionFile Number 001-08123**

**QUIXOTE CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                              |   | **36-2675371**          |
|-------------------------------------------|--------|-------------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer        |
| incorporation or  organization)           |   | Identification  Number) |
| **35 East Wacker Drive**                  |   |                    |
| **Chicago,  Illinois**                    |   | **60601**               |
| (Address of  principal executive offices) |   | (Zip Code)              |

 

**(312) 467-6755**

(Registrant’s telephonenumber, including area code)

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o               Acceleratedfiler x               Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  o YES     x NO

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date: 8,908,277 shares of the Company’s Common Stock ($.012¤3par value) were outstanding as of October 31, 2006.

 

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**PART I—FINANCIALINFORMATION**

**ITEM 1.**                FINANCIALSTATEMENTS

**QUIXOTE CORPORATIONAND SUBSIDIARIESConsolidated Statements of Operations(Unaudited)**

| ** **                                  | ** ** | **Three Months Ended September 30,**                                                             | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| Net sales                                   |       |                                                                                                                 | $          | 34,161,000 |   |   |   | $ | 39,391,000 |   |   |
| Cost of sales                               |       |                                                                                                                 | 26,132,000 |   |   |   | 28,445,000 |   |   |
| Gross profit                                |       |                                                                                                                 | 8,029,000  |   |   |   | 10,946,000 |   |   |
| Operating  expenses:                        |       |                                                                                                                 |       |   |   |   |   |   |   |
| Selling & administrative           |       |                                                                                                                 | 9,990,000  |   |   |   | 8,522,000 |   |   |
| Research & development             |       |                                                                                                                 | 1,366,000  |   |   |   | 1,430,000 |   |   |
| Gain on legal settlement                    |       |                                                                                                                 |       |   |   |   | (633,000 | ) |   |
| Gain on sale of assets                      |       |                                                                                                                 | (497,000   | ) |   |   |   |   |   |
| Restructuring costs                         |       |                                                                                                                 | 5,595,000  |   |   |   |   |   |   |
|                                        |       |                                                                                                                 | 16,454,000 |   |   |   | 9,319,000 |   |   |
| Operating profit (loss)                     |       |                                                                                                                 | (8,425,000 | ) |   |   | 1,627,000 |   |   |
| Other income  (expense):                    |       |                                                                                                                 |       |   |   |   |   |   |   |
| Interest income                             |       |                                                                                                                 | 15,000     |   |   |   | 1,000 |   |   |
| Interest expense                            |       |                                                                                                                 | (1,098,000 | ) |   |   | (1,183,000 | ) |   |
|                                        |       |                                                                                                                 | (1,083,000 | ) |   |   | (1,182,000 | ) |   |
| Earnings (loss)  before income taxes        |       |                                                                                                                 | (9,508,000 | ) |   |   | 445,000 |   |   |
| Income tax  provision (benefit)             |       |                                                                                                                 | (3,613,000 | ) |   |   | 169,000 |   |   |
| Net earnings  (loss)                        |       |                                                                                                                 | $          | (5,895,000 | ) |   |   | $ | 276,000 |   |   |
| Per share data—basic:                  |       |                                                                                                                 |       |   |   |   |   |   |   |
| Net earnings (loss)                         |       |                                                                                                                 | $          | (.66 | ) |   |   | $ | .03 |   |   |
| Weighted average common shares outstanding  |       |                                                                                                                 | 8,902,310  |   |   |   | 8,909,581 |   |   |
| Per share data—diluted:                |       |                                                                                                                 |       |   |   |   |   |   |   |
| Net earnings (loss)                         |       |                                                                                                                 | $          | (.66 | ) |   |   | $ | .03 |   |   |
| Weighted average  common shares outstanding |       |                                                                                                                 | 8,902,310  |   |   |   | 9,061,500 |   |   |

 

See Notes to Consolidated Financial Statements.

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**QUIXOTE CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (Unaudited)**

| ** **                                                                                                                     | ** ** | **September 30,** | ** **  | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-------------------|------------|
| ** **                                                                                                                     | ** ** | **2006**               | ** **  | **2006**          | ** ** |
| **ASSETS**                                                                                                                     |       |                   |        |              |       |
| Current assets:                                                                                                                |       |                   |        |              |       |
| Cash and cash equivalents                                                                                                      |       | $                      | 920,000     |              | $          | 869,000 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $2,428,000 at September 30 and $1,816,000 at June 30 |       | 29,121,000             |        | 36,481,000        |       |
| Refundable income taxes                                                                                                        |       |                   |        | 238,000           |       |
| Inventories, net:                                                                                                              |       |                   |        |              |       |
| Raw materials                                                                                                                  |       | 9,643,000              |        | 10,356,000        |       |
| Work in process                                                                                                                |       | 4,846,000              |        | 6,642,000         |       |
| Finished goods                                                                                                                 |       | 9,139,000              |        | 8,467,000         |       |
|                                                                                                                           |       | 23,628,000             |        | 25,465,000        |       |
| Deferred income tax assets                                                                                                     |       | 7,532,000              |        | 3,824,000         |       |
| Other current assets                                                                                                           |       | 1,895,000              |        | 952,000           |       |
| Total current  assets                                                                                                          |       | 63,096,000             |        | 67,829,000        |       |
| Property, plant and equipment, at cost                                                                                         |       | 42,410,000             |        | 46,714,000        |       |
| Less accumulated  depreciation                                                                                                 |       | (24,272,000            | )           | (27,179,000       | )          |
|                                                                                                                           |       | 18,138,000             |        | 19,535,000        |       |
| Goodwill                                                                                                                       |       | 17,385,000             |        | 17,385,000        |       |
| Intangible  assets, net                                                                                                        |       | 6,176,000              |        | 6,467,000         |       |
| Deferred income  tax assets                                                                                                    |       | 11,844,000             |        | 11,844,000        |       |
| Other assets                                                                                                                   |       | 1,979,000              |        | 2,143,000         |       |
|                                                                                                                           |       | $                      | 118,618,000 |              | $          | 125,203,000 |   |

 

See Notes to Consolidated Financial Statements.

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**QUIXOTE CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (Continued) (Unaudited)**

 

| ** **                                                                                                                               | ** ** | **September 30,** | ** **  | **June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-------------------|------------|
| ** **                                                                                                                               | ** ** | **2006**               | ** **  | **2006**          | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                           |       |                   |        |              |       |
| Current  liabilities:                                                                                                                    |       |                   |        |              |       |
| Current portion of long-term debt                                                                                                        |       | $                      | 453,000     |              | $          | 465,000 |   |
| Accounts payable                                                                                                                         |       | 9,251,000              |        | 13,234,000        |       |
| Dividends payable                                                                                                                        |       |                   |        | 1,688,000         |       |
| Accrued restructuring costs                                                                                                              |       | 3,752,000              |        | 497,000           |       |
| Accrued expenses                                                                                                                         |       | 7,404,000              |        | 8,164,000         |       |
| Total current  liabilities                                                                                                               |       | 20,860,000             |        | 24,048,000        |       |
| Long-term debt, net of current portion                                                                                                   |       | 53,359,000             |        | 51,122,000        |       |
| Other long-term  liabilities                                                                                                             |       | 1,081,000              |        | 1,087,000         |       |
|                                                                                                                                     |       | 75,300,000             |        | 76,257,000        |       |
| Commitments and  contingent liabilities (Note 9)                                                                                         |       |                   |        |              |       |
| Shareholders’  equity:                                                                                                              |       |                   |        |              |       |
| Preferred stock, no par value; authorized 100,000  shares; none issued                                                                   |       |                   |        |              |       |
| Common stock, par value $.012¤3;  authorized 30,000,000 shares; issued 10,904,678 shares at September 30  and at June 30. |       | 182,000                |        | 182,000           |       |
| Capital in excess of par value of common stock                                                                                           |       | 62,656,000             |        | 62,434,000        |       |
| Retained earnings                                                                                                                        |       | 4,331,000              |        | 10,226,000        |       |
| Accumulated other comprehensive income                                                                                                   |       | 197,000                |        | 227,000           |       |
| Treasury stock, at cost, 2,002,008 shares at  September 30 and 2,008,636 shares at June 30                                |       | (24,048,000            | )           | (24,123,000       | )          |
| Total  shareholders’ equity                                                                                                         |       | 43,318,000             |        | 48,946,000        |       |
|                                                                                                                                     |       | $                      | 118,618,000 |              | $          | 125,203,000 |   |

 

See Notes to Consolidated Financial Statements.

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**QUIXOTE CORPORATION AND SUBSIDIARIESConsolidated Statements of Cash Flows(Unaudited)**

| ** **                                                                                                                           | ** ** | **Three Months Ended September 30,**                                                             | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| Operating activities:                                                                                                                |       |                                                                                                                 |       |   |   |   |   |   |   |
| Net earnings (loss)                                                                                                                  |       |                                                                                                                 | $          | (5,895,000 | ) |   |   | $ | 276,000 |   |   |
| Adjustments to  reconcile net earnings (loss) to net cash provided by (used in)  operating activities of continuing operations: |       |                                                                                                                 |       |   |   |   |   |   |   |
| Depreciation                                                                                                                         |       |                                                                                                                 | 1,018,000  |   |   |   | 1,167,000 |   |   |
| Amortization                                                                                                                         |       |                                                                                                                 | 433,000    |   |   |   | 428,000 |   |   |
| Non-cash inventory disposal                                                                                                          |       |                                                                                                                 | 3,620,000  |   |   |   |   |   |   |
| Gain on sale of assets                                                                                                               |       |                                                                                                                 | (497,000   | ) |   |   |   |   |   |
| Provisions for losses on accounts receivable                                                                                         |       |                                                                                                                 | 612,000    |   |   |   | (171,000 | ) |   |
| Common stock issued for 401K plan                                                                                                    |       |                                                                                                                 | 117,000    |   |   |   | 211,000 |   |   |
| Stock-based compensation expense                                                                                                     |       |                                                                                                                 | 180,000    |   |   |   | 213,000 |   |   |
| Changes in operating  assets and liabilities:                                                                                        |       |                                                                                                                 |       |   |   |   |   |   |   |
| Accounts receivable                                                                                                                  |       |                                                                                                                 | 6,748,000  |   |   |   | (1,096,000 | ) |   |
| Inventories                                                                                                                          |       |                                                                                                                 | (1,783,000 | ) |   |   | (605,000 | ) |   |
| Other assets                                                                                                                         |       |                                                                                                                 | (943,000   | ) |   |   | (890,000 | ) |   |
| Income taxes                                                                                                                         |       |                                                                                                                 | (3,470,000 | ) |   |   | 261,000 |   |   |
| Accounts payable and accrued expenses                                                                                                |       |                                                                                                                 | (1,572,000 | ) |   |   | (1,170,000 | ) |   |
| Other long-term liabilities                                                                                                          |       |                                                                                                                 | (6,000     | ) |   |   | (4,000 | ) |   |
| Net cash used in  operating activities                                                                                               |       |                                                                                                                 | (1,438,000 | ) |   |   | (1,380,000 | ) |   |
| Investing  activities:                                                                                                               |       |                                                                                                                 |       |   |   |   |   |   |   |
| Capital expenditures                                                                                                                 |       |                                                                                                                 | (808,000   | ) |   |   | (253,000 | ) |   |
| Patent expenditures                                                                                                                  |       |                                                                                                                 | (8,000     | ) |   |   | (73,000 | ) |   |
| Proceeds from sale of assets                                                                                                         |       |                                                                                                                 | 1,768,000  |   |   |   |   |   |   |
| Net cash provided  by (used in) investing activities                                                                                 |       |                                                                                                                 | 952,000    |   |   |   | (326,000 | ) |   |
| Financing  activities:                                                                                                               |       |                                                                                                                 |       |   |   |   |   |   |   |
| Proceeds from revolving credit agreement                                                                                             |       |                                                                                                                 | 9,750,000  |   |   |   | 13,500,000 |   |   |
| Payments on revolving credit agreement                                                                                               |       |                                                                                                                 | (7,400,000 | ) |   |   | (7,600,000 | ) |   |
| Payments on notes payable                                                                                                            |       |                                                                                                                 | (125,000   | ) |   |   | (103,000 | ) |   |
| Payment of semi-annual cash dividend                                                                                                 |       |                                                                                                                 | (1,688,000 | ) |   |   | (1,595,000 | ) |   |
| Purchase of treasury stock                                                                                                           |       |                                                                                                                 |       |   |   |   | (3,105,000 | ) |   |
| Proceeds from exercise of common stock options                                                                                       |       |                                                                                                                 |       |   |   |   | 852,000 |   |   |
| Net cash provided  by financing activities                                                                                           |       |                                                                                                                 | 537,000    |   |   |   | 1,949,000 |   |   |
| Increase in cash and cash equivalents                                                                                                |       |                                                                                                                 | 51,000     |   |   |   | 243,000 |   |   |
| Cash and cash  equivalents at beginning of period                                                                                    |       |                                                                                                                 | 869,000    |   |   |   | 156,000 |   |   |
| Cash and cash  equivalents at end of period                                                                                          |       |                                                                                                                 | $          | 920,000 |   |   |   | $ | 399,000 |   |   |

 

See Notes to Consolidated Financial Statements.

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**QUIXOTE CORPORATIONAND SUBSIDIARIESNotes to Consolidated Financial Statements(Unaudited)**

**1.    **The accompanyingunaudited consolidated financial statements present information in accordancewith generally accepted accounting principles for interim financial informationand applicable rules of Regulation S-X. Accordingly, they do not includeall information or footnotes required by generally accepted accountingprinciples for complete financial statements. The June 30, 2006consolidated balance sheet as presented was derived from the audited financialstatements. The interim financial statements and notes should be read inconjunction with the consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended June 30,2006. Management believes the financial statements include all normal recurringadjustments necessary for a fair presentation of the results for the interimperiods presented.

*Recently IssuedAccounting Pronouncements*

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements” (SAB 108). SAB 108 provides guidance on how prioryear misstatements should be taken into consideration when quantifyingmisstatements in current year financial statements for purposes of determiningwhether the current year’s financial statements are materially misstated. SAB108 requires registrants to apply the new guidance for the first time that itidentifies material errors in existence at the beginning of the first fiscalyear ending after November 15, 2006 by correcting those errors through aone-time cumulative effect adjustment to beginning-of-year retained earnings.SAB 108 becomes effective during our 2007 fiscal year. We do not expect theadoption of SAB 108 to have a material impact on our financial statements.

In September 2006, the Financial AccountingStandards Board (FASB) issued SFAS No. 157, “Fair Value Measurements”(SFAS No.157). This statement clarifies the definition of fair value,establishes a framework for measuring fair value, and expands the disclosureson fair value measurements. SFAS No. 157 is effective for fiscal yearsbeginning after November 15, 2007. We have not determined the effect, ifany, that the adoption of this statement will have on our results of operationsor financial position.

In September 2006, the FASB issued SFASNo. 158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, an amendment of FASB Statements No. 87, 106, and132(R)” (SFAS No.158). This statement requires companies to recognize a netliability or asset and an offsetting adjustment to accumulated othercomprehensive income to report the funded status of defined benefit pension andother postretirement benefit plans. Additionally, SFAS No. 158 requirescompanies to measure plan assets and obligations at their year-end balancesheet date. Because we currently do not have any such benefit plans, we do notexpect the adoption of SFAS No. 158 to have an impact on our results ofoperations or financial position.

In July 2006,the Financial Accounting Standards Board (FASB) issued FASB InterpretationNo. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109”. FIN 48 clarifies the accountingfor uncertainty in income taxes recognized in an entity’s financial statementsin accordance with FASB Statement No. 109, “Accounting for Income Taxes”.FIN 48 prescribes a recognition threshold and measurement attribute forfinancial statement disclosure of tax positions taken or expected to be takenon a tax return. Additionally, FIN 48 provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and 

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transition.FIN 48 will be effective for our 2008 fiscal year. We are evaluating the impactthat this statement will have on our results of operations and financialposition.

**2.    **In December 2004,the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123(R)),“Share-Based Payment”. We adopted the provisions of SFASNo. 123(R) as of July 1, 2005 using the modified prospectivemethod. Under this transition method, share-based compensation cost recognizedin the quarters ended September 30, 2006 and 2005 includes compensationcost for all share-based awards which were unvested as of July 1, 2005 aswell as compensation cost for all share-based awards granted subsequent toJuly 1, 2005, based on the grant date fair value estimated in accordancewith the provisions of SFAS No. 123(R). The fair value of the optionsgranted is being amortized on a straight-line basis over the requisite serviceperiod, which is generally the vesting period. We have two current share-basedcompensation plans, which are described below.

*Plan Descriptions*

Our 2001 Employee Stock Incentive Plan (the Plan),which is shareholder-approved, permits the grant of share options andrestricted shares to its employees for up to 1,125,000 shares, of which 150,000shares were reserved for the grant of restricted stock awards. We believe thatgrants of stock options to employees generate an increased incentive for theemployee to contribute to the Company’s future success and prosperity, thusenhancing the value of the Company for the benefit of its stockholders. ThePlan provides for grants of stock options and restricted stock for employees asmay be determined by the Compensation Committee of the Board of Directors. Nograntee may receive option grants in excess of 100,000 shares per year. Thestock options are granted with an exercise price equal to or greater than thefair market value of our stock on the date of grant. Employee options grantedunder the current plan expire not more than ten years from the grant date withvesting to be determined by the Committee. For grants currently outstanding,vesting is over a three year period, with one-third of the grant becomingexercisable at the end of each of the three years. Option awards provide foraccelerated vesting if there is a change in control, as defined in the Plan.

Our 2001 Non-Employee Directors Stock Option Plan (theDirector Plan), which is also shareholder-approved, permits the grant of shareoptions to our non-employee directors for up to 135,000 shares. We believe thatgrants of stock options to non-employee directors encourage the directors toacquire a long term proprietary interest in the growth and performance of theCompany, and generate an increased incentive for the directors to contribute tothe Company’s future success and prosperity, thus enhancing the value of theCompany for the benefit of its stockholders. The Director Plan provides for anannual grant of stock options for directors based on a fixed amount, which iscurrently 5,000 stock options per each non-employee director annually. Thestock options are granted with an exercise price equal to the fair market valueof our stock on the date of grant. Options granted under the Director Planexpire not more than seven years from the grant date. Vesting is over not lessthan a six-month period. Option awards provide for accelerated vesting if thereis a change in control, as defined in the Director Plan. Vesting is alsoaccelerated upon the death of a director optionee.

Shares issued as a result of stock option exercises orrestricted stock grants may be issued as new shares, funded from Treasury stockor may be shares purchased on the open market. We believe that we currentlyhave adequate Treasury and authorized unissued shares to meet any requirementsto issue shares during fiscal 2007. The authorization for issuance willterminate on November 1, 2011 for both the Plan and the Director plan.

We also have a retirementstock award program for certain key executives that was originally authorizedunder the 1993 Long-Term Stock Ownership Incentive Plan and has since beenreplaced by the Plan. This retirement stock award program is further describedin Note 10 to the consolidated financial statements in our Annual Report onForm 10-K for the year ended June 30, 2006.

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*Share-basedCompensation Expense*

The share-based compensation cost that has beencharged against income for those plans was $180,000 and $249,000 for the threemonths ended September 30, 2006 and 2005, respectively. The total incometax benefit recognized in the income statement for share-based compensationarrangements was $29,000 and $36,000 for those periods, and the net expenserecorded was $151,000 and $213,000, which was $0.02 per basic and diluted shareoutstanding for both periods.

As of September 30,2006, the total compensation cost related to unvested share-based awardsgranted under our stock option plans not yet recognized was approximately$1,427,000. This cost will be amortized on a straight-line basis over aweighted average period of approximately 1.6 years and will be adjusted forsubsequent changes in estimated forfeitures. The 274,866 unvested optionsoutstanding at September 30, 2006 had a weighted-average fair value of$5.60.

*Determining FairValue*

Thefair value of stock options granted is estimated using the Black-Scholesoption-pricing model that uses the assumptions noted below for the first threemonths of fiscal years 2007 and 2006. Expected volatilities are based onhistorical volatility of the Company’s stock. We use historical data toestimate option exercise patterns, employee termination and forfeiture rateswithin the valuation model; separate groups of optionees that have similarhistorical exercise behavior are considered separately for valuation purposes.The expected term of options granted is derived from the output of the optionvaluation model and represents the period of time that options granted areexpected to be outstanding; the range given below results from certain groupsof employees exhibiting different behavior. The risk-free rate for periodswithin the contractual life of the option is based on the U.S. Treasury yieldcurve in effect at the time of the grant. The expected dividend yield isdetermined by dividing the current level of per share dividend by the grantdate stock price. We do not incorporate changes in dividends anticipated bymanagement unless those changes have been communicated to marketplaceparticipants.

| ** **                              | ** ** | **2007 YTD**    | ** ** | **2006 YTD**    | ** ** |
|-----------------------------------------|------------|----------------------|------------|----------------------|------------|
| Risk free  interest rate                |       | 4.8%                 |       | 4.0%                 |       |
| Expected dividend  yield                |       | 2.28%                |       | 1.72%                |       |
| Weighted average  expected volatility   |       | 39%                  |       | 43%                  |       |
| Expected term                           |       | 3.9 – 4.3 years |       | 3.7 – 4.4 years |       |
| Weighted average  expected term         |       | 4.2 years            |       | 4.1 years            |       |
| Weighted average grant  date fair value |       | $                    | 4.68       |                 | $          | 7.09 |   |
|                                         |            |                      |            |                      |            |  |  |

 

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*Stock OptionActivity*

Informationwith respect to stock option activity under our plans is as follows:

| ** **                              | ** ** | ** ** | ** ** | ** **    | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|-----------------------------------------|------------|------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **Weighted-** | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Average**   | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                              | ** ** | **Common** | ** ** | **Exercise**  | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                              | ** ** | **Shares** | ** ** | **Price**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at  July 1, 2005       |       | 1,009,971  |       |          | $          | 18.19           |       |          |       |   |   |   |   |   |
| Granted                                 |       | 89,200     |       |          | $          | 21.15           |       |          |       |   |   |   |   |   |
| Exercised                               |       | (98,550    | )          |          | $          | 15.86           |       |          |       |   |   |   |   |   |
| Cancelled or  expired                   |       | —     |       |          | —     |            |       |          |       |   |   |   |   |
| Outstanding at  September 30, 2005 |       | 1,000,621  |       |          | $          | 18.68           |       |          |       | 4.0 Years |   |   | $ | 2,711,000 |   |
| Outstanding at July 1, 2006        |       | 944,902    |       |          | $          | 18.98           |       |          |       |   |   |   |   |   |
| Granted                                 |       | 162,000    |       |          | $          | 18.64           |       |          |       |   |   |   |   |   |
| Exercised                               |       | —     |       |          | —     |            |       |          |       |   |   |   |   |
| Cancelled or  expired                   |       | (133,500   | )          |          | $          | 24.87           |       |          |       |   |   |   |   |   |
| Outstanding at  September 30, 2006 |       | 973,402    |       |          | $          | 18.11           |       |          |       | 3.6 Years |   |   | $ | 1,639,000 |   |
| Vested at  September 30, 2006      |       | 698,536    |       |          | $          | 17.64           |       |          |       | 3.2 Years |   |   | $ | 1,587,000 |   |

 

Options outstanding at September 30, 2006 areexercisable as follows: 698,536 currently, 138,610 within one year, 82,256 intwo years and 54,000 thereafter. At September 30, 2005, 758,866 optionswere exercisable. As of September 30, 2006, we have 522,054 common sharesreserved for our option and award plans available for future grants.

Duringthe three months ended September 30, 2006 and 2005, the following activityoccurred under our plans:

| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **September 30,**           | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Total intrinsic  value of stock options exercised |       | —                           |       | $ | 653,000 |   |
| Total fair value of  stock options vested         |       | $                                | 28,000     |   | $ | 935,000 |   |
|                                                   |            |                                  |            |  |  |  |  |

 

**3.    **Theincome tax benefit for the current quarter is based upon the estimatedeffective income tax rate for the full fiscal year.

**4.    **Operatingresults for the first three months of fiscal 2007 are not necessarilyindicative of the performance for the entire year. Our business is generallyseasonal with a higher level of sales in the fourth fiscal quarter.

9

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**5.    **The computation of basicand diluted earnings per share is as follows:

| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **September 30,**           | ** ** |
| ** **                                            | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| *Numerator:*                                          |       |                             |       |   |   |
| Net earnings  (loss) available to common shareholders |       | $                                | (5,895,000 | ) | $ | 276,000 |   |
| *Denominator:*                                        |       |                             |       |   |   |
| Weighted average  shares outstanding—basic       |       | 8,902,310                        |       | 8,909,581 |   |
| Effect of dilutive securities-common stock options    |       | —                           |       | 151,919 |   |
| Weighted average shares outstanding—diluted      |       | 8,902,310                        |       | 9,061,500 |   |
| *Net  earnings (loss) per share of common stock:*     |       |                             |       |   |   |
| Basic                                                 |       | $                                | (0.66      | ) | $ | .03 |   |
| Diluted                                               |       | $                                | (0.66      | ) | $ | .03 |   |

 

Therewere outstanding options to purchase common stock at prices that exceeded theaverage market price for the income statement periods. These options have beenexcluded from the computation of diluted earnings per share for the three-monthperiods ended September 30, 2006 and 2005 and are as follows:

| ** **                        | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **September 30,**           | ** ** |
| ** **                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Average exercise  price per share |       | $                                | 20.90      |   | $ | 25.20 |   |
| Number of shares                  |       | 607,966                          |       | 268,300 |   |
|                                   |            |                                  |            |  |  |  |  |

 

In addition, stock options totaling 61,075 shares forthe three-month period ended September 30, 2006 were not included in thediluted weighted average shares calculation because the effects of thesesecurities were anti-dilutive due to the net loss recorded for that period.

**6.    **Accumulated othercomprehensive income consists of the following:

| ** **                                 | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2006**               | ** ** | **2005**               | ** ** |
| Unrealized gain on  derivative instrument: |       |                   |       |                   |       |   |   |   |   |
| Beginning balance—July 1         |       |                   | $          | 227,000                |       |   |   | $ | 345,000 |   |   |
| Change in derivative instrument            |       |                   |       |                   |       |   |   |   |   |
| Amortization to earnings                   |       |                   | (30,000    | )                      |       |   | (29,000 | ) |   |
| Total accumulated  comprehensive income    |       |                   | $          | 197,000                |       |   |   | $ | 316,000 |   |   |

 

**7.    **Duringthe third quarter of fiscal 2006, we expanded the number of reportable segmentsfrom two to three segments. The segment financial data presented hereinpresents our three reportable segments—the manufacture and sale of productswhich Protect and Direct, the manufacture and sale of products which Inform,and the manufacture and sale of Intersection Control products. The primaryproduct lines within the Protect and Direct segment include energy-absorbingproducts such as crash cushions, truck-mounted attenuators, sand-filled barrelsand barriers as well as highway delineators. The products within this segmentabsorb and dissipate the force of impact in collisions between vehicles andfixed roadside objects as well as prevent collisions and help to control theflow of traffic by directing or guiding. The primary product lines within theInform segment include highway advisory radio systems; advanced sensingproducts which measure distance, count and classify vehicles; weather sensingsystems 

10

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and other transportationequipment. The products within this segment provide information to preventcollisions from occurring and to ease traffic congestion. The primary productlines within the Intersection Control segment include intelligent intersectioncontrol systems, pedestrian signals, video detection equipment and othertransportation equipment. The products within this segment control traffic andease traffic congestion, primarily related to intersections. Our segments arediscussed in further detail in our Annual Report on Form 10-K forthe year ended June 30, 2006.

Thefollowing table presents financial information about reported segments for thethree-month periods ended September 30, 2006 and 2005 along with the itemsnecessary to reconcile the segment information to the totals reported in theconsolidated financial statements.

| ** **                         | ** ** | **Protect and  Direct** | ** ** | **Inform** | ** ** | **Intersection  Control** | ** ** | **Unallocated  Corporate** | ** ** | **Total**   | ** ** |
|------------------------------------|------------|------------------------------|------------|------------|------------|---------------------------|------------|----------------------------|------------|-------------|------------|
| *2006*                             |       |                         |       |       |       |                      |       |                       |       |        |       |
| THREE MONTHS                       |       |                         |       |       |       |                      |       |                       |       |        |       |
| Net sales from  external customers |       | $                            | 18,676,000 |       | $          | 6,096,000                 |       | $                          | 9,389,000  |        |       |   | $ | 34,161,000 |   |
| Operating profit  (loss)           |       | 3,291,000                    |       | 786,000    |       | (10,713,000               | )          | $                          | (1,789,000 | )           | (8,425,000 | ) |
| Unallocated interest  and other    |       |                         |       |       |       |                      |       | (1,083,000                 | )          | (1,083,000  | )          |
| Total income  (loss) before taxes  |       | 3,291,000                    |       | 786,000    |       | (10,713,000               | )          | (2,872,000                 | )          | (9,508,000  | )          |
| Identifiable  assets               |       | 52,231,000                   |       | 21,505,000 |       | 21,692,000                |       | 23,190,000                 |       | 118,618,000 |       |
| *2005*                             |       |                         |       |       |       |                      |       |                       |       |        |       |
| THREE MONTHS                       |       |                         |       |       |       |                      |       |                       |       |        |       |
| Net sales from  external customers |       | $                            | 17,820,000 |       | $          | 6,432,000                 |       | $                          | 15,139,000 |        |       |   | $ | 39,391,000 |   |
| Operating profit  (loss)           |       | 2,894,000                    |       | 582,000    |       | (183,000                  | )          | $                          | (1,666,000 | )           | 1,627,000  |   |
| Unallocated  interest and other    |       |                         |       |       |       |                      |       | (1,182,000                 | )          | (1,182,000  | )          |
| Total income  (loss) before taxes  |       | 2,894,000                    |       | 582,000    |       | (183,000                  | )          | (2,848,000                 | )          | 445,000     |       |
| Identifiable assets                |       | 52,538,000                   |       | 21,217,000 |       | 51,515,000                |       | 13,002,000                 |       | 138,272,000 |       |

 

Identifiable assetsof the Intersection Control segment as of September 30, 2006 decreased to$21,692,000 from $51,515,000 as of September 30, 2005 primarily due to$13,374,000 in non-cash asset impairment charges made in the fourth quarter ofthe fiscal year ended June 30, 2006 and to the sale and write off ofassets as part of the restructuring of that segment over the last two quarters.

**8.    **Intangibleassets consist of the following:

| ** **                    | ** ** | **September 30, 2006** | ** ** | **June 30, 2006** | ** ** |
|-------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **Gross**                        | ** ** | ** **                  | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                    | ** ** | **Carrying**                     | ** ** | **Accumulated**             | ** ** | **Intangible** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Intangible** | ** ** |
| ** **                    | ** ** | **Amount**                       | ** ** | **Amortization**            | ** ** | **Assets** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Assets** | ** ** |
| Amortized intangible  assets: | * *   | * *                         | * *   |                        | * *   | * * |   | * * | * * | * * | * * |   | * * | * * |   | * * | * * |
| Patents and licenses          |       | $                                | 3,143,000  |                        |       | $ | 1,802,000 | * * |   | $ | 1,341,000 |   | $ | 3,135,000 |   |   | $ | 1,758,000 | * * |   | $ | 1,377,000 |   |
| Technology and installed base |       | 2,491,000                        |       |                        | 1,147,000  | * * |   | 1,344,000 |   | 2,491,000 |   |   | 1,097,000 | * * |   | 1,394,000 |   |
| Customer relationships        |       | 3,807,000                        |       |                        | 1,828,000  | * * |   | 1,979,000 |   | 3,807,000 |   |   | 1,698,000 | * * |   | 2,109,000 |   |
| Trade names                   |       | 2,250,000                        |       |                        | 738,000    | * * |   | 1,512,000 |   | 2,250,000 |   |   | 663,000 | * * |   | 1,587,000 |   |
| Other                         |       | 640,000                          |       |                        | 640,000    | * * |   | — |   | 640,000 |   |   | 640,000 | * * |   | — |   |
| Total                         |       | $12,331,000                      |       |                        | $6,155,000 | * * |   | $6,176,000 |   | $12,323,000 |   |   | $5,856,000 | * * |   | $ | 6,467,000 |   |
|                               |            |                                  |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Intangible amortization expense was $299,000 and$298,000 for the three months ended September 30, 2006 and 2005,respectively. The estimated amortization expense for this fiscal year ended June 30,2007 and for the four fiscal years subsequent to 2007 are as follows:$1,167,000, $1,099,000, $888,000, $775,000 and $677,000. The carrying amount ofgoodwill consists of $9,246,000 for the Inform segment and $8,139,000 for theProtect and Direct segment as of September 30, 2006 and June 30, 2006.For the Intersection Control segment, the remaining goodwill of $11,397,000 waswritten off in the fourth quarter of fiscal 2006.

**9.    **Disclosures regarding guarantees, commitmentsand contingencies are provided below.

*Lease Commitments*

We use various leasedfacilities and equipment in our operations. The terms for these leased assetsvary depending on the lease agreements. These operating leases may includeoptions for renewal and we may guarantee the performance of our obligationsunder the leases. Annual minimum future rental payments for lease commitmentswill be approximately $3,453,000 in fiscal year 2007, a total of $4,348,000 in fiscalyears 2008 to 2009, a total of $1,242,000 in fiscal years 2010 to 2011 and$3,854,000 thereafter, for an aggregate of $12,897,000.

*Product WarrantyLiability*

Wewarrant to the original purchaser of our products that we will, at our option,repair or replace, without charge, such products if they fail due to amanufacturing defect. The term of these warranties typically varies (30 days to1 year) by product. We accrue for product warranties, when, based on availableinformation, it is probable that customers will make claims under warrantiesrelating to products that have been sold, and a reasonable estimate of thecosts can be made. Our estimated product warranty liability for the three-monthperiods ended September 30 is as follows:

| ** **                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Beginning Balance—July 1    |       | $        | 927,000    |     | $          | 2,510,000 |   |
| Current provisions, net               |       | 39,000   |       | (14,000  | )          |
| Expenditures and settlements          |       | (290,000 | )          | (180,000 | )          |
| Ending balance—September 30 |       | $        | 676,000    |     | $          | 2,316,000 |   |

 

*Legal*

We are involved in severalpending judicial proceedings for product liability and other damages arisingout of the conduct of our business. We record loss contingencies whereappropriate within the guidelines established by Statement of FAS No. 5 “Accountingfor Contingencies”. While the outcome of litigation is subject touncertainties, we believe, after consultation with counsel, that the outcome ofthese proceedings, based on current available information and after taking intoaccount the availability and limits of our insurance coverage, will not have amaterial effect on our consolidated financial condition and results ofoperations.

*ExecutiveAgreements*

We have agreements withcertain executives which are designed to retain the services of key employeesand to provide for continuity of management in the event of a termination otherthan for cause or resulting from an actual or threatened change in control ofthe Company. Upon occurrence of a termination or a triggering event after achange in control, as defined, we would be liable for payment of benefits underthese agreements, to a maximum amount of $4,886,000. 

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We have by-laws andagreements under which we indemnify our directors and officers from liabilityfor certain events or occurrences while the directors or officers are, or were,serving at the Company’s request in such capacities. The term of theindemnification period is for the director’s or officer’s lifetime. We believethat any obligations relating to this indemnification are predominantly coveredby insurance subject to certain exclusions and deductibles. Historically, wehave not made payments under these executive agreements, and no amount has beenaccrued in the accompanying consolidated financial statements.

*Indemnification ofLenders and Agents Under Credit Facilities*

Under our creditfacilities, we have agreed to indemnify our lenders under such facilitiesagainst costs or losses resulting from changes in laws and regulations whichwould increase the lenders’ costs, and from any legal action brought againstthe lenders related to the use of loan proceeds. These indemnificationsgenerally extend for the term of the credit facilities and do not provide forany limit on the maximum potential liability. Historically, we have not madeany significant indemnification payments under such agreements and no amounthas been accrued in the accompanying consolidated financial statements withrespect to these indemnification guarantees.

*Bid and PerformanceBonds*

We have entered into bidand performance related bonds associated with various contracts. Potentialpayments due under these bonds are related to our performance under theapplicable contract. The total amount of bid and performance related bonds thatwere available and undrawn was $1,077,000 at September 30, 2006 and$3,028,000 at June 30, 2006. Historically, customers have not drawn uponthese instruments due to non-performance and no amount has been accrued in theaccompanying consolidated financial statements.

*Other Commitments*

We have standby letters of credit covering potentialworkers’ compensation liabilities. The total amount of standby letters ofcredit that were outstanding at September 30, 2006 and at June 30,2006 was $1,144,000. We have included $1,187,000 in accrued liabilities forpotential workers’ compensation liabilities as of September 30, 2006.

We have certain non-cancelableroyalty agreements, which contain certain minimum payments in the aggregate of$2,510,000 through fiscal year 2012. We have included $206,000 in accruedliabilities for current obligations relating to these agreements as of September 30,2006.

**10.  **Duringthe first quarter of fiscal 2007, we sold our automated traffic enforcementproduct line to Traffipax, Inc. for maximum cash proceeds of $800,000 ofwhich we have received $345,000 through September 30, 2006. We aretransferring to Traffipax city and county contracts to provide red lightenforcement and speed enforcement services, as well as the related assets. Severalemployees of ours are being hired by Traffipax to service the transferredcontracts.

Also during the first quarter of fiscal 2007, we solda former captive manufacturing facility of the Protect and Direct segmentlocated in South Bend, Indiana. Since June 30, 2005, we had been rentingthe facility to Elkhart Plastics, Inc. Our net proceeds from the sale ofthis facility were $1,423,000.

During September 2005,we settled all claims arising from the 2003 acquisition of the Peek TrafficCorporation business with the Peek Traffic Group Limited and its affiliates(the Sellers) for $633,000 in cash, net of legal expenses. Also, as part of thesettlement, the Sellers sold to us 150,603 shares of our common stock for$3,105,000, or $20.62 per share. We had claimed damages from the Sellers of thePeek Traffic business arising from the Sellers’ breaches of representations andwarranties in the asset purchase 

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agreementand from certain liabilities of the Peek Traffic business that we did notspecifically assume or were misrepresented to us.

**11.  **Duringthe first quarter of fiscal 2007, we incurred charges of $9,215,000 aswe continued the implementation of the restructuring plan for our IntersectionControl segment, which is comprised of the legacy operations of UST and PeekTraffic, to reduce costs through the reduction of overhead by closing twofacilities and through the reduction of headcount. Included in this amount is$5,595,000 of restructuring charges recorded in operating expenses and$3,620,000 in inventory write-downs recorded in cost of sales. During fiscal2006, we recorded $5,775,000 in restructuring charges, net of proceeds receivedon the sale of assets.

Under the restructuring plan, we divested anddiscontinued certain low-margin and non-core product lines primarilymanufactured in our leased facilities located in Tecate, Mexico and Santa FeSprings, California. These product lines include portable and permanentvariable message signs, tunnel lighting, illuminated street signs and in-groundloop detectors. We have moved the remaining intersection control family ofproducts, including traffic controllers, traffic signals and pedestrian signalsto our Palmetto, Florida and Bedford, Pennsylvania facilities. We are adoptingan outsourcing strategy for non-core manufacturing processes and will continueto assemble and test products. We closed the manufacturing facilities in SantaFe Springs, California and Tecate, Mexico in the first quarter of fiscal 2007.

The remaining cash portion of the plan is currentlyestimated to be approximately $4 million, net of cash to be received on thedisposal of assets, consisting principally of approximately $1 million inemployee severance and related benefit costs, $2 million in facility exitcosts, consulting expense and other related costs and $1 million in leaseobligations over the next two years. We expect implementation of the plan to becompleted by the end of our fiscal 2007 second quarter.

Activityrelated to the restructuring plan was as follows:

| ** **                               | ** ** | **Employee**         | ** ** | ** **      | ** ** | ** **         | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------|------------|----------------------|------------|-----------------|------------|--------------------|------------|------------------------|------------|------------|------------|
| ** **                               | ** ** | **Severance**        | ** ** | ** **      | ** ** | **Asset**          | ** ** | **Facility Exit** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **and Related** | ** ** | **Lease**       | ** ** | **Sales and** | ** ** | **Costs, Legal**  | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Costs**            | ** ** | **Obligations** | ** ** | **Write-offs**     | ** ** | **and Other**     | ** ** | **Total**  | ** ** |
| Accrual balance  July 1, 2005       |       |                 | $          | —          |       |               |       | $                      | —     |       |       |   | $ | — |   |   |   | $ | — |   |   | $ | — |   |
| Costs incurred                           |       |                 | 179        |            |       |               | 90         |                   |       |       | 4,571      |   |   |   | 935 |   |   | 5,775 |   |
| Cash proceeds  (payments)                |       |                 | (179       | )               |       |               | (90        | )                      |       |       | 1,500      |   |   |   | (601 | ) |   | 630 |   |
| Non-cash charges                         |       |                 |       |            |       |               |       |                   |       |       | (5,908     | ) |   |   |   |   |   | (5,908 | ) |
| Accrual balance  June 30, 2006      |       |                 | $          | —          |       |               |       | $                      | —     |       |       |   | $ | 163 |   |   |   | $ | 334 |   |   | $ | 497 |   |
| Costs incurred                           |       |                 | 1,686      |            |       |               | 1,307      |                   |       |       | 3,571      |   |   |   | 2,651 |   |   | 9,215 |   |
| Cash proceeds  (payments)                |       |                 | (556       | )               |       |               | (130       | )                      |       |       | (114       | ) |   |   | (1,540 | ) |   | (2,340 | ) |
| Non-cash charges                         |       |                 |       |            |       |               |       |                   |       |       | (3,620     | ) |   |   |   |   |   | (3,620 | ) |
| Accrual balance  September 30, 2006 |       |                 | $          | 1,130           |       |               |       | $                      | 1,177      |       |       |   | $ | — |   |   |   | $ | 1,445 |   |   | $ | 3,752 |   |
| Remaining expected plan costs            |       |                 | $          | 146             |       |               |       | —                 |       |       |       | $ | — |   |   |   | $ | 602 |   |   | $ | 748 |   |
| Total expected  plan costs               |       |                 | $          | 2,011           |       |               |       | $                      | 1,397      |       |       |   | $ | 8,142 |   |   |   | $ | 4,188 |   |   | $ | 15,738 |   |

 

Employee severance and related costs include severancepay, related benefits and retention bonuses. We expect that the total workforcereduction associated with restructuring activities initiated during fiscal 2006will be approximately 400 employees.

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**PART I—FINANCIALINFORMATION**

**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

***OVERVIEW***

Quixote Corporation (the Company, we, our or us) andits subsidiaries develop, manufacture and market highway and transportationsafety products to protect, direct and inform motorists, pedestrians and roadworkers in both domestic and international markets. Our operations arecomprised of three reportable segments within the highway and transportationsafety industry, concentrating on safety problems and designing products toprovide transportation safety solutions. Our three reportable segments are: themanufacture and sale of highway and transportation safety products whichProtect and Direct, the manufacture and sale of products and services whichInform, and the manufacture and sale of products which are used forIntersection Control. The Protect and Direct segment provides solutions forimproving safety on the roads either by minimizing the severity of crashes thatoccur or by preventing crashes from occurring by directing or guiding traffic. Theprimary product lines within the Protect and Direct segment includeenergy-absorbing products such as crash cushions, truck-mounted attenuators,sand-filled barrels and water-filled barriers, and directing and guidingproducts such as flexible post delineators and glare screen systems. The Informsegment provides solutions for improving traffic flow and safety on roads andrunways by providing information. The primary product lines within the Informsegment include advanced sensing products which measure distance, count andclassify vehicles; weather sensing systems; computerized highway advisory radiotransmitting systems; and other transportation equipment. The IntersectionControl segment provides solutions for controlling intersections, includingintelligent traffic control systems, pedestrian signals, video detectionequipment and other transportation equipment.

Our products are sold principallythrough a distribution network to customers in the highway construction andsafety business, state departments of transportation, county and localgovernments and other governmental transportation agencies. The domestic marketfor highway and transportation safety products is directly affected by federal,state and local governmental policies and budgets. A large portion of our salesis ultimately financed by funds provided to the states by the federalgovernment. Historically, these funds have covered 75% to 90% of the cost of approvedhighway safety projects on roads constructed or maintained with federalassistance. Seasonality affects our business with generally a higher level ofsales in our fourth fiscal quarter.

***RESULTS OF OPERATIONS***

Our results for the first three months of fiscal 2007were affected by the restructuring in our Intersection Control segment, asexpected. In our Protect and Direct and Inform segments, we continue to see improvedperformance driven by spending related to the passage of the federal highwayspending bill (SAFETEA-LU) enacted in August 2005. We are seeingsignificantly increased order activity in our Inform segment with backlog atrecord levels. We believe the increase in sales and order activity reflects thecontinued improvements in our industry with the highway bill in place andimproved state and municipal budgets. We were encouraged to see sales increase5% in our Protect and Direct segment and increased profitability in both theProtect and Direct and Inform segments. Sales for the Intersection Controlsegment have decreased significantly from the prior year primarily due to thesale and discontinuation of products related to our restructuring initiativefor the segment. See Note 11 and FUTURE OUTLOOK for further information.

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Thefollowing table sets forth selected key operating statistics relating to theCompany’s financial results:

| ** **                                                    | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **September 30,**           | ** ** |
| ** **                                                    | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Revenues by Segment:                                          |       |                             |       |   |   |
| Protect and Direct                                            |       | $                                | 18,676,000 |   | $ | 17,820,000 |   |
| Inform                                                        |       | 6,096,000                        |       | 6,432,000 |   |
| Intersection Control                                          |       | 9,389,000                        |       | 15,139,000 |   |
|                                                          |       | $                                | 34,161,000 |   | $ | 39,391,000 |   |
| Geographic  Revenues:                                         |       |                             |       |   |   |
| Domestic                                                      |       | $                                | 29,679,000 |   | $ | 35,048,000 |   |
| International                                                 |       | 4,482,000                        |       | 4,343,000 |   |
|                                                          |       | $                                | 34,161,000 |   | $ | 39,391,000 |   |
| Operating Profit  (Loss) by Segment:                          |       |                             |       |   |   |
| Protect and Direct                                            |       | $                                | 3,291,000  |   | $ | 2,894,000 |   |
| Inform                                                        |       | 786,000                          |       | 582,000 |   |
| Intersection Control                                          |       | (10,713,000                      | )          | (183,000 | ) |
| Unallocated Corporate                                         |       | (1,789,000                       | )          | (1,666,000 | ) |
|                                                          |       | $                                | (8,425,000 | ) | $ | 1,627,000 |   |
| Gross profit percentage                                       |       | 23.5                             | %          | 27.8 | % |
| Selling and administrative expenses as a percentage  of sales |       | 29.2                             | %          | 21.6 | % |
| Diluted earnings  (loss) per share                            |       | $                                | (0.66      | ) | $ | .03 |   |

 

*Revenues*

Our net sales for the firstquarter of fiscal 2007 decreased$5,230,000, or 13%, to $34,161,000 from $39,391,000 for the first quarter lastyear. This was primarily due to the sale and discontinuation of several productlines in our Intersection Control segment related to the restructuring plan forthis segment further discussed in Note 11.

*Geographic**—*International salesfor the first quarter of fiscal 2007 increased $139,000, or 3%, to $4,482,000,compared to $4,343,000 for the first quarter last year, due to increased salesacross most major regions. International sales for the Inform segment wereparticularly strong in Canada due to the shipment of an order for weatherstations. Domestic sales for the first quarter of fiscal 2007 decreased 15% to$29,679,000 from $35,048,000 due to decreased sales in the Intersection Controlsegment.

*Protectand Direct**—Net*sales for the Protect andDirect segment for the first quarter of fiscal 2007 increased 5% to $18,676,000from $17,820,000 for the first quarter last year. The increase in sales wasprimarily due to increased sales of parts, truck mounted attenuator, delineatorand anti-icing product lines. These sales increases were offset somewhat bydecreases in sales of permanent crash cushions, barrels and Triton® Barriers. Internationalsales decreased 1% over the first quarter last year.

*Inform**—Net*sales for theInform segment for the first quarter of fiscal 2007 decreased 5%, or $336,000,to $6,096,000 from $6,432,000 for the first quarter last year primarily due tothe sale of the weather forecasting product line at the end of fiscal 2006. Ofthe decrease, $232,000 relates to the sale of the weather forecasting productline. The remaining decline was due to decreased sales of traffic and weathersensing products and services, which were partially offset by increased sales of highway advisory 

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radioproducts which doubled over the first quarter last year. Although this segmentsaw some softness in terms of shipments, order activity was strong resulting ina record backlog of $9.2 million.

*Intersection Control**—Net*sales for theIntersection Control segment for the first quarter of fiscal 2007 decreased38%, or $5,750,000, to $9,389,000 from $15,139,000 for the first quarter lastyear, primarily due to the sale and discontinuation of several product lines,including the portable and permanent variable message signs, tunnel lighting,illuminated street signs, in-ground loop detectors and automated trafficenforcement lines.

*Gross Profit Margin*

Our gross profit marginfor the first quarter of fiscal 2007 was 23.5% compared to 27.8% for thefirst quarter last year, primarily due to the write-off of $3,620,000 ofinventory in the Intersection Control segment as part of the restructuring plandiscussed in Note 11. If we exclude the $3,620,000 in inventory write-offs fromcost of sales, our consolidated gross margin for the first quarter of fiscal2007 increased to 34.1% from 27.8% last year. The gross margin for the Protectand Direct segment improved due to volume efficiencies associated with thehigher level of production, offset partially by higher freight costs. The grossprofit margin for the Inform segment improved due to favorable sales mix due toincreased sales of highway advisory radios. The gross profit margin for theIntersection Control segment decreased significantly due to the inventorywrite-offs as well as operating inefficiencies as manufacturing operationswound down in Santa Fe Springs, California and Tecate, Mexico.

*Selling andAdministrative Expenses*

Selling and administrativeexpenses for the first quarter of fiscal 2007 increased $1,468,000, or 17%, to$9,990,000 from $8,522,000 for the first quarter last year. Selling andadministrative expenses in the Protect and Direct segment increased primarilydue to higher variable costs associated with the higher sales level, increasedlegal costs related to patent defense and increased bad debt expense. Sellingand administrative expenses in the Inform segment increased primarily due tothe higher variable costs associated with higher sales of highway advisoryradio products. Selling and administrative expenses in the Intersection Controlsegment were slightly higher than the first quarter last year due to increasedbad debt expense. Selling and administrative expenses increased as a percentageof sales to 29.2% for the first quarter of 2007 from 21.6% last year due to thedecreased level of sales and the fixed cost nature of many of the expenses.

*Gain on LegalSettlement*

As further discussed inNote 10, the first quarter of last year included a gain of $633,000 resultingfrom the settlement of claims with the seller of Peek Traffic.

*Gain on Sale ofAssets*

As further discussed inNote 10, the first quarter of fiscal 2007 includes a gain on the sale of assetsof $497,000 including a gain of $236,000 related to the sale of a buildingformerly used by the Protect and Direct segment and a gain of $261,000 relatedto the sale of the automated traffic enforcement product line within theIntersection Control segment. We may record an additional gain related to the sale of theautomated enforcement product line of approximately $400,000 during the secondquarter of fiscal 2007 dependent upon the receipt of contract consents from ourcustomers. 

*Restructuring Costs*

As further discussed inNote 11, the first quarter of fiscal 2007 includes $5,595,000 in restructuringcosts for the Intersection Control segment. Included in the restructuring costsare $1,686,000 of employee severance costs, $1,307,000 of lease expense and$2,651,000 of shut-down and other related costs.

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*Research andDevelopment*

Research and developmentexpenditures were $1,366,000 for the first quarter of fiscal 2007 compared to$1,430,000 for the first quarter last year. The decrease of $64,000 was due todecreased expenditures in the Inform segment, which were partially offset byincreases in the Protect and Direct segment. Expenditures increased in the Protectand Direct segment due principally to outside testing of a product for thesecurity market. Expenditures remained flat in the Intersection Control segment.

*Operating Profit(Loss)*

The operating loss for thefirst quarter of fiscal 2007 was $8,425,000, compared to operating profit of$1,627,000 for the first quarter of fiscal 2006. For the first quarter offiscal 2007, operating profit for the Protect and Direct Group increased 14% to$3,291,000 from $2,894,000 for the first quarter last year due primarily to theincreased sales level, favorable sales mix and the gain on sale of assets. Operatingprofit for the Inform segment was $786,000 compared to operating profit of$582,000 for the first quarter of last year due primarily to increased sales ofhighway advisory radio products. The operating loss for the IntersectionControl segment increased to $10,713,000 from an operating loss of $183,000 forthe first quarter of last year due primarily to restructuring costs. Without the special items including the$3,620,000 in inventory write-offs and the $5,595,000 of restructuring costs inthe Intersection Control segment, the $497,000 in gain on sale of assets andlast year’s $633,000 gain on legal settlement, operating profit was $293,000 inthe current first quarter compared to operating profit of $994,000 for thefirst quarter last year. This decline in operating profit is due tomanufacturing and operating inefficiencies related to the intersection controlsegment restructuring as we wound down operations at the Santa Fe Springs,California and Tecate, Mexico facilities.

*Interest Expense*

Interest expense for thefirst quarter of fiscal 2007 decreased to $1,098,000 from $1,183,000 for thefirst quarter last year. The decrease was due to the lower average level of debtoffset somewhat by higher interest rates on our bank credit facility. Theinterest rate on our bank facility is based on prime or LIBOR, plus a margin.  Our overall weighted average interest ratewas 7.0% as of September, 2006.

*Income TaxProvision (Benefit)*

The income tax benefit forthe first quarter of fiscal 2007 was $3,613,000 representing a 38% effectiveincome tax rate.

*Net Earnings (Loss)*

The net loss for the firstquarter of fiscal 2007 was $5,895,000, or $0.66 cents per diluted share,compared to net earnings of $276,000, or $0.03 cents per diluted share, for thefirst quarter last year. Withoutthe special items including the $3,620,000 in inventory write-offs, the$5,595,000 of restructuring costs, the $497,000 in gain on sale of assets andlast year’s $633,000 gain on legal settlement, and applying a 38% effective taxrate, the net loss for the current first quarter was $490,000, or $0.06 perdiluted share, compared to a net loss for the first quarter last year of$117,000, or $0.01 per diluted share.

***FINANCIAL CONDITION***

*Liquidity and Capital Resources*

Our principal sources offunds historically have been cash flows from operations and borrowings frombanks and other sources. We had cash and cash equivalents of $920,000 as of September 30,2006 and access to additional funds of approximately $15 million under our bankcollateralized credit agreement. We believe that this bank credit facility isan important source of liquidity. The credit agreement provides 

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for a$30 million secured revolving credit facility with a $10 million sub-facilityfor letters of credit. The Company must maintain a minimum availability of $5million under the revolving credit facility. Total availability is based on aformula of eligible accounts receivable, eligible inventory, machinery andequipment and real estate. We are also required to maintain a maximum seniorleverage ratio. The covenants also limit the incurrence of additionalindebtedness, acquisitions, liens and encumbrances and other matterscustomarily restricted in such agreements. We are in compliance with thesecovenants and expect to remain in compliance through fiscal 2007. Theagreement currently expires in April 2008, but may be renewed one additionalyear on each anniversary date upon mutual consent of the Company and the bank.

Our outstanding borrowingswere $53,812,000, or 55.4% of total capitalization, as of September 30,2006, of which $8,350,000 was outstanding related to the bank credit facility. Thiscompares to $51,587,000, or 51.3% of total capitalization, as of June 30,2006, of which $6,000,000 was outstanding related to the bank credit facility. Asof September 30, 2006, we had approximately $15,000,000 in additional availabilityunder the bank credit facility. Included in long-term debt as of September 30,2006 and June 30, 2006 was $40 million in 7% Convertible SeniorSubordinated Notes due February 2025 and a $5 million five-yearsubordinated promissory note. The amount of standby letters of creditoutstanding was $1,144,000 as of both September 30, 2006 and June 30,2006.

*Cash Flows*

Cash flows used inoperations were $1,438,000 during the first three months of fiscal 2007. Thiscompares with $1,380,000 used in operations in the first three months of fiscal2006. Cash flow generated by operations was primarily derived from earningsbefore non-cash expenses such as depreciation, amortization and non-cashdisposal of inventory. The cash provided by operations in the first threemonths of fiscal 2007 was more than offset by increased working capital,including increases in inventory and other assets.

Investing activitiesprovided cash of $952,000 during the first three months of fiscal 2007,compared to using cash of $326,000 in the first three months of the prior year.Proceeds from the sale of assets provided cash of $1,768,000 during the firstthree months of fiscal 2007. Expenditures during the first three months offiscal 2007 included $808,000 for capital expenditures.

Financing activitiesprovided cash of $537,000 during the first three months of fiscal 2007,compared to $1,949,000 during the first three months of fiscal 2006. During thefirst three months of 2007, we borrowed a net $2,350,000 against ouroutstanding revolving credit facility. In addition, we paid $125,000 on notespayable. The payment of our semi-annual cash dividend used cash of $1,688,000.During the first three months of fiscal 2006 we paid $3,105,000 to purchase150,603 shares of our common stock from the sellers of Peek Traffic, recordedas treasury stock.

For fiscal 2007, weanticipate needing approximately $3,000,000 in cash for capital expenditures. Wemay require additional investments in working capital to support growth. We mayalso need additional funds to repurchase our own common stock from time to timeor to acquire businesses that complement our existing operations. As discussedin Note 11 and FUTURE OUTLOOK, we currently estimate that the remaining cashportion of the restructuring plan for the Intersection Control segment will beapproximately $4 million. Future cash expenditures will be financed eitherthrough cash on-hand, cash generated from operations, from borrowings availableunder our bank credit facility or proceeds from sales of assets or productlines to be discontinued. We currently believe that these sources of cashshould be sufficient for all planned operating and capital requirements in thenear term. If needed and available on favorable terms, we may amend existingfinancing arrangements or may enter into other debt or equity financingarrangements.

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***OFF-BALANCE SHEET ARRANGEMENTSAND CONTRACTUAL OBLIGATIONS***

We are subject to certain debt obligations,guarantees, commitments and contingent liabilities further described in our AnnualReport on Form 10-K for the year ended June 30, 2006. Thefollowing table presents our contractual obligations to make future paymentsunder contracts, such as debt and lease agreements, as of September 30,2006:

| ** **                      | ** ** | ** **                        | ** ** | **Less than** | ** ** | ** **         | ** ** | ** **         | ** ** | **More than** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|
| ** **                      | ** ** | **Total**                         | ** ** | **1 Year**    | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years**   | ** ** |
| ** **                      | ** ** | **(Dollar amounts in thousands)** | ** ** |
| Long-term debt(1)               |       | $                                 | 53,812     |               |       | $                  | 453        |               |       | $                  | 5,009      |   | $ | 40,000 |   |   | $ | 8,350 |   |   |
| Estimated  interest payments(2) |       | 15,358                            |       |               | 3,761      |               |       | 7,158              |       | 3,776              |       |   | 663 |   |   |
| Operating leases                |       | 12,897                            |       |               | 3,453      |               |       | 4,348              |       | 1,242              |       |   | 3,854 |   |   |
| Minimum royalty  payments       |       | 2,510                             |       |               | 760        |               |       | 850                |       | 600                |       |   | 300 |   |   |
| Retirement award  program       |       | 759                               |       |               | 81         |               |       | 125                |       | 83                 |       |   | 470 |   |   |
| Purchase  obligations           |       | 10,966                            |       |               | 10,966     |               |       |               |       |               |       |   |   |   |   |
| Total                           |       | $                                 | 96,302     |               |       | $                  | 19,474     |               |       | $                  | 17,490     |   | $ | 45,701 |   |   | $ | 13,637 |   |   |

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(1)          Amount includes expectedcash payments on long-term debt based upon current and effective maturities aswell as expected renewals.

(2)          Amount includesestimated interest payments based on interest rates as of the current period. Interestrates on variable-rate debt are subject to change in the future. Interest isestimated based upon current and effective maturities as well as expectedrenewals of long-term debt currently outstanding.

As disclosed in thefootnotes to the consolidated financial statements, we have entered into bidand performance related bonds associated with various contracts. Potentialpayments due under these bonds are related to our performance under theapplicable contract. The total amount of bid and performance related bonds thatwere available and undrawn as of September 30, 2006 was $1,077,000. Wealso have standby letters of credit covering potential workers’ compensationliabilities. The total standby exposure relating to letters of credit as ofSeptember 30, 2006 was $1,144,000.

***FUTURE OUTLOOK***

We believe that the enactment of the federaltransportation funding legislation, SAFETEA-LU, in August 2005 iscontinuing to improve prospects for increased spending for our products infiscal 2007. State and local governments appear to be increasing spending ontransportation safety in 2007 as both national and local economies improve. Wealso expect international sales to continue to be an important driver of oursales growth. However, it is difficult to predict to what extent we will seeincreased spending for our products and there can be no assurance that eitherdomestic or international sales will continue to increase.

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As further discussed in Note 11, the restructuringplan for the Intersection Control segment is substantially complete. We havediscontinued or sold certain Intersection Control product lines, including theportable and fixed overhead sign lines, the lighting product line and theautomated enforcement line. For the remaining traffic control products withinthe Intersection Control segment, we are outsourcing manufacturing, but willcontinue to test, assemble and program operations for our newest products. Inconnection with the restructuring plan, we expect to record further cashcharges of approximately $4 million. The remaining restructuring charges,estimated at approximately $800,000, are expected to be incurred before the endof our fiscal 2007 second quarter. We expect the plan will result in annualizedoperating cost savings of approximately $5 to $6 million. However, there can beno assurance that we will achieve that level of savings. After the productrationalization, annualized revenues for the Intersection Control segment areestimated to be approximately $38 million for fiscal 2007 from$56 million for fiscal 2006.

We believe fiscal 2007 will be a transitional year forus. We expect to see continued growth in sales and profitability for theProtect and Direct and Inform segments. We are beginning to see bids for largecontracts for the Intersection Control segment after a decline in bid activityover the past couple years. Recently, we were awarded a $700,000 contract fromthe County of Los Angeles for traffic controllers. We believe that we arepositioning this segment for success in the future and that it will be a modestcontributor to our financial results for the second half of fiscal 2007.

We historically experiencefluctuation in our gross profit margin from quarter to quarter primarily due tosales volume related to seasonality, variability in product mix and changes inour competitive environment. The gross profit margins of certain acquiredproduct lines, primarily the traffic and intersection control product lines,are lower than our historical gross profit margin, which is currently adverselyaffecting our gross profit margin. We also experience rigorous pricecompetition in our Intersection Control segment and weather sensing systemproduct line. We do not believe these trends will improve in the near future.

***SIGNIFICANT ACCOUNTING POLICIES ANDCRITICAL ESTIMATES***

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of America(U.S. GAAP) requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements. Management’sestimates also affect the reported amounts of revenues and expenses during thereporting period. In addition, certain normal and recurring estimates are madeincluding estimates in determining the allowance for doubtful accountsreceivable, inventory valuation reserves, valuation allowance on deferred taxassets and health care liabilities. These estimates are made using management’sbest judgment given relevant factors and available data. Actual results coulddiffer materially from those estimates. Note 2 to our June 30, 2006consolidated financial statements includes a summary of the significantaccounting policies, methods and estimates used in the preparation of ourconsolidated financial statements. There have been no material changes inaccounting policies, methods and estimates used by management since the firstquarter of fiscal 2006. In the opinion of management, we do not have anyindividual accounting policy or use any individual estimate that is critical tothe preparation of its consolidated financial statements. In most instances, wemust use an accounting policy or method because it is the only policy or methodpermitted under U.S. GAAP. We believe the following significant accountingpolicies and methods used by us are the most important to the presentation ofour financial statements:

*Revenue Recognition:*   Revenues,net of sales incentives, are recognized when either services have been renderedor both title and risk of loss of products have been transferred tounaffiliated customers. Additionally, we ensure that collection of theresulting receivable is probable, persuasive evidence that an 

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arrangement exists, andthe revenue is fixed or determinable. Provision for estimated uncollectibleamounts and credit memos is made based upon management’s analysis of bad debtsand credit memos.

*Inventories:*   Inventoriesare valued at the lower of cost (first-in, first-out method) or market. Actualcosts are used to value raw materials and supplies. Standard costs, whichapproximate actual costs, are used to value finished goods and work-in-process.Standard costs include raw materials, direct labor and manufacturing overhead. Provisionfor potentially obsolete or slow-moving inventory is made based on management’sanalysis of inventory levels, ages and salability.

*Long-Lived Assets:*   Long-livedassets include such items as goodwill, patents, product rights, otherintangible assets and property, plant and equipment. For purposes of evaluatingthe recoverability of long-lived assets, we assess the possibility ofobsolescence, demand, new technology, competition, and other pertinent economicfactors and trends that may have an impact on the value or remaining lives ofthese assets.

Amortized long-lived assets (including amortizedintangible assets and property, plant and equipment) held and used by us arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable in relation tofuture undiscounted cash flows of underlying asset groups. The net carryingvalue of assets not recoverable is reduced to fair value. Fair values ofamortized long-lived assets are determined based upon the performance of athird party fair value appraisal. Patents and other finite-lived intangibleassets are amortized on a straight-line or systematic method over the life ofthe patent or intangible asset.

Goodwill and other indefinite-lived intangible assetsare tested for impairment at least annually. The indefinite-lived intangibleasset impairment test is performed by comparing the fair value of theintangible asset to its carrying value in a one-step analysis. If the fairvalue of the intangible asset is less than its carrying value, the intangibleasset is written-down to its fair value. The goodwill impairment test isperformed at the reporting unit level and is a two-step analysis. First, thefair value of the reporting unit is compared to its book value. If the fairvalue of the reporting unit is less than its book value, we perform ahypothetical purchase price allocation based on the reporting unit’s fair valueto determine the implied fair value of the reporting unit’s goodwill. If theimplied fair value of the goodwill is less than its carrying value, thegoodwill is written-down to its implied fair value. Fair values are determinedusing present value techniques.

The impairment review is highly judgmental andinvolves the use of significant estimates and assumptions. These estimates andassumptions have a significant impact on the amount of any impairment chargerecorded. Estimates of fair value are primarily determined using discountedcash flow methods and are dependent upon assumptions of future sales trends,market conditions and cash flows of each reporting unit over several years. Actualcash flows in the future may differ significantly from those previouslyforecasted. Other significant assumptions include growth rates and the discountrate applicable to future cash flows.

*Share-based Compensation Expense:*   Weaccount for share-based compensation in accordance with the provisions of SFAS No. 123(R).Under the fair value recognition provisions of SFAS No. 123(R),share-based compensation cost is estimated at the grant date based on the fairvalue of the award and is recognized as expense ratably over the requisiteservice period of the award. Determining the appropriate fair value model andcalculating the fair value of share-based awards requires judgment, includingestimating stock price volatility, forfeiture rates and expected life.

*Restructuring Charges:*   Weaccount for restructuring activities in accordance with SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities.” Generally, costsassociated with the exit or disposal activity are recognized when the liabilityis incurred. Costs related to employee separation 

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arrangements requiringfuture service beyond a specified minimum retention period are recognized overthe service period.

*IncomeTaxes:*   We recognize deferred tax assets andliabilities for the expected future tax consequences of events that have beenincluded in the financial statements or tax returns. Under this method,deferred tax assets and liabilities are determined based on the differencebetween the financial statement and tax basis of assets and liabilities usingenacted tax rates in effect for the year in which the differences are expectedto reverse. In assessing the realizability of the deferred tax assets,management considers whether it is more likely than not that some portion orall of the deferred tax assets will not be realized. To the extent that anyfuture tax benefits are not expected to be fully realized, such future taxbenefits are reduced by a valuation allowance. Realization of deferred taxassets assumes that we will be able to generate sufficient taxable income sothat the assets will be realized. The factors that we consider in assessing thelikelihood of realization include the forecast of future taxable income andavailable tax planning strategies that could be implemented to realize thedeferred tax assets. We expect the deferred tax assets currently recorded to befully realizable; however there can be no assurance that an increased valuationallowance would not need to be recorded in the future.

**RECENTLY ISSUEDACCOUNTING PRONOUNCEMENTS**

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements” (SAB 108). SAB 108 provides guidance on how prioryear misstatements should be taken into consideration when quantifyingmisstatements in current year financial statements for purposes of determiningwhether the current year’s financial statements are materially misstated. SAB108 requires registrants to apply the new guidance for the first time that itidentifies material errors in existence at the beginning of the first fiscalyear ending after November 15, 2006 by correcting those errors through aone-time cumulative effect adjustment to beginning-of-year retained earnings. SAB108 becomes effective during our 2007 fiscal year. We do not expect theadoption of SAB 108 to have a material impact on our financial statements.

In September 2006, the Financial AccountingStandards Board (FASB) issued SFAS No. 157, “Fair Value Measurements”(SFAS No.157). This statement clarifies the definition of fair value,establishes a framework for measuring fair value, and expands thedisclosures on fair value measurements. SFAS No. 157 is effective forfiscal years beginning after November 15, 2007. We have not determined theeffect, if any, the adoption of this statement will have on our results ofoperations or financial position.

In September 2006, the Financial AccountingStandards Board (FASB) issued SFAS No. 158, “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans, an amendment of FASBStatements No. 87, 106, and 132(R)” (SFAS No.158). This statement requirescompanies to recognize a net liability or asset and an offsetting adjustment toaccumulated other comprehensive income to report the funded status of definedbenefit pension and other postretirement benefit plans. Additionally, SFAS No. 158requires companies to measure plan assets and obligations at their year-endbalance sheet date. Because we currently do not have any such benefit plans, wedo not expect the adoption of SFAS No. 158 to have an impact on ourresults of operations or financial position.

In July 2006, theFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 48(FIN 48), “Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109”. FIN 48 clarifies the accounting for uncertainty inincome taxes recognized in an entity’s financial statements in accordance withFASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes arecognition threshold and measurement attribute for financial statementdisclosure of tax positions taken or expected to be taken on a tax return. Additionally,FIN 48 provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure and 

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transition.FIN 48 will be effective for our 2008 fiscal year. We are evaluating the impactthat this statement will have on our results of operations and financialposition.

**FORWARD LOOKINGSTATEMENTS**

Various statements made within the Management’sDiscussion and Analysis of Financial Condition and Results of Operations andelsewhere in this report constitute “forward-looking statements” for purposesof the SEC’s “safe harbor” provisions under the Private Securities LitigationReform Act of 1995 and Rule 3b-6 under the Securities Exchange Actof 1934, as amended. Except for historical information, any statement thataddresses expectations or projections about the future, including statementsabout our strategy for growth, product development, market position,expenditures, financial results or changes in governmental legislation,policies and conditions, is a forward-looking statement.

Readers are cautioned notto place undue reliance on these forward-looking statements and that allforward-looking statements involve risks and uncertainties, including thosedetailed in our public filings with the SEC, news releases and othercommunications, which speak only as of the dates of those filings orcommunications. We do not undertake any obligation to release publicly anyrevisions to these forward-looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence of unanticipatedevents. There can be no assurance that actual results will not differmaterially from our expectations. Factors which could cause materiallydifferent results include, among others, uncertainties related to continuedfederal, state and municipal funding for highways and risks related toreductions in government expenditures; the successful completion, integrationand rationalization of acquisitions; the ability to generate sufficient futurecash flows to be in compliance with financing agreements; the introduction andacceptance of our products and services; an unfavorable change in product salesmix; seasonality along with the extent and timing of the award of largecontracts; the cyclical nature of our governmental markets; competitive andpricing pressures; increasing raw material costs; excess manufacturingcapacity; weather conditions and natural disasters; acts of war and terroristactivities; the possible impairment of goodwill and other intangible assets;and general economic conditions.

**ITEM 3.**                Quantitative and Qualitative Disclosures aboutMarket Risk

Item 7.A. of our Annual Report on Form 10-Kfor the year ended June 30, 2006 presents information regardingQuantitative and Qualitative Disclosures about Market Risk.

We are exposed to market risk from fluctuations ininterest rates on our revolving credit agreement. Our exposure to fluctuationsin interest rates was reduced when we issued $40 million of fixed ratedconvertible debt and used the proceeds to pay down variable rate bank debtissued pursuant to our revolving credit agreement in the third quarter offiscal 2005. We had managed our exposure to interest rate fluctuationsbeginning in fiscal 2004 through the use of derivative instruments in the formof non-trading interest rate swaps, but our interest rate swap agreementwas liquidated in the third quarter of fiscal 2005.

Substantially all of ourbusiness is transacted in U. S. dollars. We continue to evaluate the use ofderivative financial instruments to manage the effects of foreign currencyexchange rates changes. We do not believe we are currently exposed to anymaterial risk of loss from currency exchange fluctuations.

**ITEM 4.**                Controls and Procedures

(a)                    Evaluation ofDisclosure Controls and Procedures

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in the Company’sreports under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and 

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forms, and that suchinformation is accumulated and communicated to management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosures. The design of any systemof disclosure controls and procedures is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any disclosure controls and procedures will succeed in achievingtheir stated goals under all potential future conditions.

Our management,under the supervision of and with the participation of the Company’s ChiefExecutive Officer and Chief Financial Officer, has evaluated the effectivenessof the Company’s disclosure controls and procedures, as such term is defined inRules 13a-15(e) and 15d-15(e) under the ExchangeAct, as of the end of the period covered by this report. Based on theevaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer concluded that solely as a result of the material weakness at the SantaFe Springs and Tecate, Mexico facilities within our Intersection ControlSegment as described below at paragraph (b), our disclosure controls andprocedures were not effective as of the end of the period covered by thisQuarterly Report on Form 10-Q, September 30, 2006. However, weperformed analysis and other procedures to ensure that our consolidatedfinancial statements were prepared in accordance with accounting principlesgenerally accepted in the United States. Accordingly, we believe that (i) thefinancial statements filed fairly present in all material respects the Company’sfinancial condition, results of operations and cash flow for the periodspresented, and (ii) this report does not contain any untrue statement of amaterial fact or omit a material fact necessary to make the statements, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this report.

(b)      Management’s Report on Internal Controls Over FinancialReporting

There have been no changes in our internal controlover financial reporting identified in connection with the evaluation thatoccurred during this fiscal quarter that has materially affected, or isreasonably likely to affect, our internal control over financial reporting.

Based on our assessment of our internal control overfinancial reporting for the last fiscal year, we determined that a materialweakness existed in our internal controls over certain financial reportingcontrols as of June 30, 2006. Specifically, a number of control breakdownsin the operations at two facilities within our Intersection Control segmentcomprised of U.S. Traffic Corporation (UST) and Peek Traffic Corporation wereidentified. The control breakdowns were noted in financial reporting, revenue, expenditures,inventory and capital assets, which resulted in a few misstatements identifiedby our external auditors, Grant Thornton LLP. These control deficienciesrepresented a material weakness in internal control over financial reporting onthe basis that there is more than a remote likelihood that a materialmisstatement of our annual or interim financial statements would not beprevented or detected by our internal control over financial reporting.Accordingly, we concluded that, as of June 30, 2006, our internal controlover financial reporting was not effective based on the criteria set forth byCommittee of Sponsoring Organizations of the Treadway Commission.

A comprehensive, detailed remediation plan was notdeveloped as the facilities in Santa Fe Springs and Tecate, Mexico ceasedmanufacturing operations during the first quarter of fiscal 2007 as part of therestructuring plan described in Note 11. By the end of the second quarter offiscal 2007, the facilities responsible for the control breakdowns will nolonger be operating, which will result in the remediation of this materialcontrol weakness.

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**PART II—OTHER INFORMATION**

There is no informationrequired to be reported under any items except as indicated below:

**Item 1.**                        LegalProceedings

We are involved in severalpending judicial proceedings for product liability and other damages arisingout of the conduct of our business. While the outcome of litigation is subjectto uncertainties, we believe, after consultation with counsel, that the outcomeof these proceedings, based on current available information and after takinginto account the availability and limits of our insurance coverage, will nothave a material effect on our consolidated financial condition and results ofoperations.

**Item 6.**                        Exhibits

(a)   Exhibits

31            Certification pursuantto Section 302 of the Sarbanes-Oxley Act of 2002

32            Certification pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2006 to be signed on its behalf by the undersigned thereuntoduly authorized.

|        | **QUIXOTE  CORPORATION**                                 |
|--------|----------------------------------------------------------|
| DATED: | November 9, 2006                                    |   |   | /s/ DANIEL  P. GOREY |
|   | DANIEL P. GOREY                                          |
|   | *Chief Financial Officer, Vice  President and Treasurer* |
|   | *(Chief Financial & Accounting Officer)*        |
|        |                                                          |  |  |  |  |

 

 

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**EXHIBIT INDEX**

Exhibits:

31            Certification pursuantto Section 302 of the Sarbanes-Oxley Act of 2002

32            Certification pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

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