**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**Form 10-Q**
| **(Mark****One)**                                                                                                                                                                                                | ** ** | ** **                                                                                               |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| **x**                                                                                                                                                                                                            | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**   |
|                                                                                                                                                                                                             |       |                                                                                                     |
| **For the  quarterly period ended June 30, 2006**                                                                                                                                                           |
|                                                                                                                                                                                                             |       |                                                                                                     |
| **OR**                                                                                                                                                                                                           |
| ** **                                                                                                                                                                                                       | ** ** | ** **                                                                                               |
| **o**                                                                                                                                                                                                            | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                                                                                                                                                                                       | ** ** | ** **                                                                                               |
| **For the  transition period  from              to                ** |

 

**Commissionfile number:  001-08762**

**ITERIS, INC.**

(Exactname of registrant as specified in its charter)

| **Delaware**                             |   | **95-2588496**       |
|------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of         |   | (I.R.S. Employer     |
| incorporation or  organization)          |   | Identification  No.) |
|                                     |   |                 |
| **1515  South Manchester Avenue**        |   | ** **           |
| **Anaheim,  California**                 |   | **92802**            |
| (Address of  principal executive office) |   | (Zip Code)           |

 

**(714)**774-5000

(Registrant’s telephonenumber, including area code)

(Formername, former address and former fiscal year, if changed since last report)

**Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.**

**Yes  ****x    No  ****o**

**Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):**
| **Large accelerated filer  ****o** | ** ** | **Accelerated  filer  ****o** | ** ** | **Non-accelerated  filer  ****x** |
|----------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|

 

**Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).**

**Yes  ****o    No  ****x**

As of August 10, 2006, the registrant had29,133,339 shares of common stock outstanding

 

 

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**ITERIS, INC.Quarterly Report on Form 10-QFor the Three Months Ended June 30, 2006**

**Table of Contents**
| **PART I.**  | ** ** | **FINANCIAL INFORMATION**                                                                                              | ** ** | ** ** |
|-------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|------------|
|              |       |                                                                                                                   |       |       |
| **ITEM 1.**       | ** ** | **FINANCIAL STATEMENTS**                                                                                               | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| ** **        | ** ** | **UNAUDITED  CONDENSED CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2006 AND  MARCH 31, 2006**                    | ** ** | ** ** |
| ** **        | ** ** | ** **                                                                                                             | ** ** | ** ** |
| ** **        | ** ** | **UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED  JUNE 30, 2006 AND 2005** | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| ** **        | ** ** | **UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED JUNE 30,  2006 AND 2005** | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| ** **        | ** ** | **NOTES  TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**                                                    | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 2.**       | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                        | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 3.**       | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                        | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 4.**       | ** ** | **CONTROLS AND  PROCEDURES**                                                                                           | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                                                  | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 1.**       | ** ** | **LEGAL PROCEEDINGS**                                                                                                  | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 1A.**      | ** ** | **RISK FACTORS**                                                                                                       | ** ** | ** ** |
| ** **        | ** ** | ** **                                                                                                             | ** ** | ** ** |
| **ITEM 2.**       | ** ** | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                       | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 3.**       | ** ** | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                   | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 4.**       | ** ** | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                               | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM 5.**       | ** ** | **OTHER INFORMATION**                                                                                                  | ** ** | ** ** |
|              |       |                                                                                                                   |       |       |
| **ITEM  6.**      | ** ** | **EXHIBITS**                                                                                                           | ** ** | ** ** |

 

Unless otherwiseindicated in this report, the “Company,” “we,” “us” and “our” collectivelyrefer to Iteris, Inc., formerly known as Iteris Holdings, Inc. andOdetics, Inc., and its former subsidiary, Meyer, Mohaddes Associates,Inc., which was dissolved effective April 2006.

AutoVue®, Iteris®, Vantage® and eAccessTM are among the trademarks ofIteris, Inc. Any other trademarks or trade names mentioned herein are theproperty of their respective owners.

 

2

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**PART I. FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

**ITERIS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS(In thousands, except per share amounts)**
| ** **                                                                                                                                                             | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                             | ** ** | **(unaudited)**         | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                                             |       |                    |       |                     |       |
| Current assets:                                                                                                                                                        |       |                    |       |                     |       |
| Cash and cash  equivalents                                                                                                                                             | ** ** | **$**                   | **225**    |                     | $          | 131 |   |
| Trade accounts  receivable, net of allowance for doubtful accounts of $482 and $429 at June  30, 2006 and March 31, 2006, respectively                            | ** ** | **10,512**              |       | 11,426                   |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                                                                           | ** ** | **3,585**               |       | 2,693                    |       |
| Inventories, net  of reserve for inventory obsolescence of $618 and $592 at June 30, 2006 and  March 31, 2006, respectively                                       | ** ** | **2,989**               |       | 2,814                    |       |
| Deferred income  taxes                                                                                                                                                 | ** ** | **886**                 |       | 790                      |       |
| Prepaid expenses  and other current assets                                                                                                                             | ** ** | **953**                 |       | 368                      |       |
| Total current  assets                                                                                                                                                  | ** ** | **19,150**              |       | 18,222                   |       |
| Property and  equipment, net                                                                                                                                           | ** ** | **1,795**               |       | 1,783                    |       |
| Deferred income  taxes                                                                                                                                                 | ** ** | **1,178**               |       | 818                      |       |
| Intangible  assets, net of accumulated amortization of $297 and $261 at June 30, 2006 and  March 31, 2006, respectively                                           | ** ** | **515**                 |       | 551                      |       |
| Goodwill                                                                                                                                                               | ** ** | **27,774**              |       | 27,774                   |       |
| Other assets                                                                                                                                                           | ** ** | **417**                 |       | 485                      |       |
| Total assets                                                                                                                                                           | ** ** | **$**                   | **50,829** |                     | $          | 49,633 |   |
| ** **                                                                                                                                                             | ** ** | ** **              | ** ** | ** **               | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                         | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current liabilities:                                                                                                                                                   |       |                    |       |                     |       |
| Trade accounts  payable                                                                                                                                                | ** ** | **$**                   | **3,446**  |                     | $          | 3,620 |   |
| Accrued payroll  and related expenses                                                                                                                                  | ** ** | **3,352**               |       | 3,481                    |       |
| Accrued  liabilities                                                                                                                                                   | ** ** | **2,788**               |       | 2,304                    |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts                                                                                           | ** ** | **655**                 |       | 893                      |       |
| Revolving line  of credit                                                                                                                                              | ** ** | **3,509**               |       | 2,662                    |       |
| Current portion  of long-term debt                                                                                                                                     | ** ** | **2,271**               |       | 1,969                    |       |
| Total current  liabilities                                                                                                                                             | ** ** | **16,021**              |       | 14,929                   |       |
| Non-current liabilities                                                                                                                                                | ** ** | **288**                 |       | 12                       |       |
| Deferred compensation  plan liability                                                                                                                                  | ** ** | **754**                 |       | 820                      |       |
| Deferred gain on sale  of building                                                                                                                                     | ** ** | **378**                 |       | 449                      |       |
| Long-term debt                                                                                                                                                         | ** ** | **1,536**               |       | 2,171                    |       |
| Convertible debentures,  net                                                                                                                                           | ** ** | **9,255**               |       | 9,203                    |       |
| Total  liabilities                                                                                                                                                     | ** ** | **28,232**              |       | 27,584                   |       |
| Commitments and  contingencies                                                                                                                                         |       |                    |       |                     |       |
| Redeemable common  stock, 1,219 shares issued and outstanding at June 30, 2006 and  March 31, 2006                                                                | ** ** | **3,414**               |       | 3,414                    |       |
| Stockholders’ equity:                                                                                                                                             |       |                    |       |                     |       |
| Preferred stock,  $1.00 par value, 2,000 shares authorized, none issued and outstanding at June  30, 2006 and March 31, 2006                                      |       | —                  |       | —                   |       |
| Common stock,  $0.10 par value, 50,000 shares authorized, 27,571 and 27,432 shares issued  and outstanding at June 30, 2006 and March 31, 2006, respectively | ** ** | **2,757**               |       | 2,743                    |       |
| Additional  paid-in capital                                                                                                                                            | ** ** | **126,914**             |       | 126,664                  |       |
| Common stock  held in trust, 311 shares at June 30, 2006 and March 31, 2006                                                                                       | ** ** | **(374**                | **)**      | (374                     | )          |
| Notes receivable  from employees                                                                                                                                       | ** ** | **(45**                 | **)**      | (49                      | )          |
| Accumulated  deficit                                                                                                                                                   | ** ** | **(110,077**            | **)**      | (110,356                 | )          |
| Accumulated  other comprehensive income                                                                                                                                | ** ** | **8**                   |       | 7                        |       |
| Total stockholders’  equity                                                                                                                                       | ** ** | **19,183**              |       | 18,635                   |       |
| Total liabilities and stockholders’ equity                                                                                                                        | ** ** | **$**                   | **50,829** |                     | $          | 49,633 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements.

3

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** **

**ITERIS, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)**
| ** **                                                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| Net sales and  contract revenues:                                     |       |                                            |       |   |   |
| Net sales                                                             | ** ** | **$**                                           | **8,600**  |   | $ | 7,525 |   |
| Contract revenues                                                     | ** ** | **5,216**                                       |       | 4,554 |   |
| Total net sales and contract revenues                                 | ** ** | **13,816**                                      |       | 12,079 |   |
|                                                                  |       |                                            |       |   |   |
| Costs and  expenses:                                                  |       |                                            |       |   |   |
| Cost of net sales (a)                                                 | ** ** | **4,758**                                       |       | 3,755 |   |
| Cost of contract revenues (a)                                         | ** ** | **3,339**                                       |       | 2,969 |   |
| Gross profit                                                          | ** ** | **5,719**                                       |       | 5,355 |   |
|                                                                  |       |                                            |       |   |   |
| Operating  expenses:                                                  |       |                                            |       |   |   |
| Selling, general and administrative (a)                               | ** ** | **4,001**                                       |       | 3,828 |   |
| Research and development (a)                                          | ** ** | **1,003**                                       |       | 1,746 |   |
| Deferred compensation plan                                            | ** ** | **(66**                                         | **)**      | 62 |   |
| Amortization of intangible assets                                     | ** ** | **36**                                          |       | 37 |   |
| Total operating expenses                                              | ** ** | **4,974**                                       |       | 5,673 |   |
|                                                                  |       |                                            |       |   |   |
| Operating income  (loss)                                              | ** ** | **745**                                         |       | (318 | ) |
|                                                                  |       |                                            |       |   |   |
| Other income  (expense):                                              |       |                                            |       |   |   |
| Other expense, net                                                    | ** ** | **(690**                                        | **)**      | (48 | ) |
| Interest expense, net                                                 | ** ** | **(386**                                        | **)**      | (352 | ) |
| Total other income (expense), net                                     | ** ** | **(1,076**                                      | **)**      | (400 | ) |
|                                                                  |       |                                            |       |   |   |
| Loss before  income taxes                                             | ** ** | **(331**                                        | **)**      | (718 | ) |
| Income tax  benefit (expense)                                         | ** ** | **610**                                         |       | (8 | ) |
| Net income  (loss)                                                    | ** ** | **$**                                           | **279**    |   | $ | (726 | ) |
|                                                                  |       |                                            |       |   |   |
| Earnings (loss)  per common share:                                    |       |                                            |       |   |   |
| Basic                                                                 | ** ** | **$**                                           | **0.01**   |   | $ | (0.03 | ) |
| Diluted                                                               | ** ** | **$**                                           | **0.01**   |   | $ | (0.03 | ) |
| Weighted average  common shares outstanding:                          |       |                                            |       |   |   |
| Basic                                                                 | ** ** | **28,393**                                      |       | 28,062 |   |
| Diluted                                                               | ** ** | **32,368**                                      |       | 28,062 |   |
|                                                                  |       |                                            |       |   |   |
| (a)  Includes  stock-based compensation expense as follows: |       |                                            |       |   |   |
| Cost of net sales                                                     | ** ** | **5**                                           |       | 9 |   |
| Cost of contract revenues                                             | ** ** | **29**                                          |       | 70 |   |
| Selling, general and administrative expense                           | ** ** | **54**                                          |       | 139 |   |
| Research and  development expense                                     | ** ** | **12**                                          |       | 47 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

4

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**ITERIS, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**
| ** **                                                                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities**                                             |       |                                            |       |   |   |
| Net income (loss)                                                                     | ** ** | **$**                                           | **279**    |   | $ | (726 | ) |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                            |       |   |   |
| Change in deferred tax assets                                                         | ** ** | **(456**                                        | **)**      | ─ |   |
| Depreciation and amortization of property and  equipment                              | ** ** | **130**                                         |       | 162 |   |
| Stock-based compensation                                                              | ** ** | **100**                                         |       | 265 |   |
| Amortization of deferred gain on sale—leaseback  transaction                     | ** ** | **(71**                                         | **)**      | (71 | ) |
| Amortization of debt discount                                                         | ** ** | **52**                                          |       | 52 |   |
| Amortization of intangible assets                                                     | ** ** | **36**                                          |       | 37 |   |
| Amortization of deferred financing costs                                              | ** ** | **34**                                          |       | 35 |   |
| Changes in operating assets and liabilities:                                          |       |                                            |       |   |   |
| Accounts receivable                                                                   | ** ** | **914**                                         |       | (831 | ) |
| Net costs and estimated earnings in excess of  billings                               | ** ** | **(1,130**                                      | **)**      | (419 | ) |
| Inventories                                                                           | ** ** | **(175**                                        | **)**      | 496 |   |
| Prepaid expenses and other assets                                                     | ** ** | **(551**                                        | **)**      | (168 | ) |
| Accounts payable and accrued liabilities                                              | ** ** | **239**                                         |       | (695 | ) |
| Net cash used in  operating activities                                                | ** ** | **(599**                                        | **)**      | (1,863 | ) |
|                                                                                  |       |                                            |       |   |   |
| **Cash  flows from investing activities**                                             |       |                                            |       |   |   |
| Purchases of property and equipment                                                   | ** ** | **(142**                                        | **)**      | (212 | ) |
|                                                                                  |       |                                            |       |   |   |
| **Cash  flows from financing activities**                                             |       |                                            |       |   |   |
| Proceeds from borrowings on line of credit, net                                       | ** ** | **847**                                         |       | 1,353 |   |
| Payments on long-term debt                                                            | ** ** | **(333**                                        | **)**      | (333 | ) |
| Change in checks drawn in excess of available bank  balances                          | ** ** | **153**                                         |       | 885 |   |
| Proceeds from stock option and warrant exercises                                      | ** ** | **168**                                         |       | 124 |   |
| Net cash  provided by financing activities                                            | ** ** | **835**                                         |       | 2,029 |   |
| Increase  (decrease) in cash                                                          | ** ** | **94**                                          |       | (46 | ) |
| Cash at  beginning of period                                                          | ** ** | **131**                                         |       | 46 |   |
| Cash at end of  period                                                                | ** ** | **$**                                           | **225**    |   | $ | ─ |   |
|                                                                                  |       |                                            |       |   |   |
| **Supplemental  cash flow information:**                                              | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Cash paid (received) during the period:                                               |       |                                            |       |   |   |
| Interest                                                                              | ** ** | **$**                                           | **301**    |   | $ | 254 |   |
| Income taxes                                                                          | ** ** | **40**                                          |       | 44 |   |
| **Supplemental  schedule of non-cash investing and financing activities:**       | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Fair value of  warrants issued in settlement of liabilities                           |       | —                                          |       | 28 |   |

 

See accompanyingnotes to unaudited condensed consolidated financial statements.

5

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**ITERIS, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2006**

**1. Description of Business and Summary of Significant Accounting Policies**

**Description of Business**

Iteris, Inc.,formerly known as Iteris Holdings, Inc. and Odetics, Inc. (“Iteris” or the“Company”), is a leading provider of outdoor machine vision systems and sensorsthat optimize the flow of traffic and enhance driver safety. Using proprietarysoftware and Intelligent Transportation Systems (“ITS”) industry expertise, theCompany provides video sensor systems, transportation management and travelerinformation systems and other engineering consulting services to the ITSindustry. The ITS industry is comprised of companies applying a variety oftechnologies to enable the safe and efficient movement of people and goods. TheCompany uses its outdoor image recognition software expertise to developproprietary algorithms for video sensor systems that improve vehicle safety andthe flow of traffic. Using its knowledge of the ITS industry, the Companydesigns and implements transportation management systems that help publicagencies reduce traffic congestion and provide greater access to travelerinformation.  The Company was originally incorporatedin Delaware in 1987 as Odetics, Inc. and in September 2003 changedits name to Iteris Holdings, Inc. to reflect its focus on the ITS industryand its capital structure at that time. On October 22, 2004, the Company completed a merger with itsmajority-owned subsidiary, Iteris, Inc. (the “Iteris Subsidiary”), andofficially changed its corporate name from Iteris Holdings, Inc. toIteris, Inc.

**Basis ofPresentation**

The unaudited condensed consolidated financialstatements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation and with the instructions to Securities and Exchange Commission (“SEC”)Form 10-Q and Article 10 of SEC Regulation S-X. In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments, consisting of normal recurring adjustments,necessary to present fairly the consolidated financial position of the Companyas of June 30, 2006, the consolidated results of operations for the threemonths ended June 30, 2006 and 2005, and the consolidated cash flows for thethree months ended June 30, 2006 and 2005. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States (“U.S. GAAP”)have been condensed or omitted pursuant to the rules and regulations ofthe SEC. The results of operations for the three months ended June 30, 2006,are not necessarily indicative of those to be expected for the entire year. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the Company’s Annual Report on Form 10-K for theyear ended March 31, 2006, which was filed with the SEC on June 29, 2006.

# **Use ofEstimates**

The preparation of consolidated financial statementsin conformity with U.S. GAAP requires management to make certain estimates andassumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.  Significantestimates made in the preparation of the consolidated financial statementsinclude the allowance for doubtful accounts, deferred tax assets, inventory andwarranty reserves, costs to complete long-term contracts, overhead rates usedin cost-plus contracts, contract reserves and estimates of future cash flowsused to assess the recoverability of long-lived assets, the valuation of debtand equity instruments and the realization of goodwill.

# **RevenueRecognition**

Productrevenues and related costs of sales are recognized upon the transfer of title,which generally occurs upon shipment or, if required, upon acceptance by thecustomer, provided that the Company believes collectibility of the net salesamount is probable.  Accordingly, at thedate revenue is recognized, the significant uncertainties concerning the salehave been resolved.

Contractrevenues are derived primarily from long-term contracts with governmentalagencies.  Contract revenues includecosts incurred plus a portion of estimated fees or profits determined on thepercentage of completion method of accounting based on the relationship ofcosts incurred to date to total estimated costs.  Any anticipated losses on contracts arecharged to earnings when identified.  Changesin job performance and estimated profitability, including those arising fromcontract penalty provisions and final contract settlements, may result inrevisions to costs and revenues and are recognized in the period in which therevisions are determined.  Profitincentives are included in revenue when their realization is reasonablyassured.

6

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Inaddition to product and contract revenue, the Company derives revenue fromtechnology access fees, the provision of specific non-recurring contractengineering services and royalties. Technology access fee revenues are recognized evenly over the period inwhich they are earned.  Non-recurringcontract engineering revenues are recognized in the period in which the relatedservices are performed.  Royalty revenuesare recorded in the period in which the royalty is earned, based on unit salesof the Company’s products.  Technologyaccess fee revenues, contract engineering revenues and royalty revenues areincluded in net sales in the accompanying condensed consolidated statements ofoperations.

Revenuesfrom follow-on service and support, for which the Company charges separately,are recorded in the period in which the services are performed.

**Concentrationof Credit Risk**

Accountsreceivable are primarily derived from revenues earned from customers locatedthroughout North America and Europe.  TheCompany generally does not require collateral or other security from customers.Collectibility of receivable balances is estimated through review of invoicesoutstanding greater than a certain period of time and ongoing creditevaluations of customers’ financial condition. Reserves are maintained for potential credit losses, and such losseshave historically been within management’s expectations.

**Fair Values of Financial Instruments**

The fair values of cashand cash equivalents, receivables, inventories, accounts payable and accruedexpenses approximate carrying value because of the short period of time tomaturity. The fair values of line of credit agreements and long-term debtapproximate carrying value because the related rates of interest approximatecurrent market rates.  The fair value ofconvertible debentures approximates carrying value because the effectiveinterest rate, taking into account recorded debt discounts, approximatescurrent market rates.  The estimated fairvalue of redeemable common stock was $2.9 million and $3.2 million at June 30,2006 and March 31, 2006, respectively, based on the closing price of theCompany’s common stock on those dates.

# **Inventories**

Inventories are stated atthe lower of cost or market. Cost is determined using the first-in, first-outmethod.

**Property and Equipment**

Property and equipmentare recorded at cost and are depreciated over the estimated useful life rangingfrom three to eight years.  Leaseholdimprovements are depreciated over the term of the related lease or theestimated useful life of the improvement, whichever is shorter.  Beginning April 1, 2006, the Company begandepreciating property and equipment using the straight-line method ofdepreciation.  Prior to this date, theCompany used the double declining balance method of depreciation.  As a result of this change in estimate,depreciation expense declined by $80,000, with no impact on earnings per share,for the three months ended June 30, 2006.

**Goodwill and Long-Lived Assets**

In accordance with Statementof Financial Accounting Standards (“SFAS”) No. 142, *Goodwill andIntangible Assets*, goodwill is tested for impairment at thereporting unit level (operating segment or one level below an operatingsegment) on an annual basis in the Company’s fourth fiscal quarter or morefrequently if indicators of impairment exist, of which none have beenidentified.  The performance of the testinvolves a two-step process.  The firststep of the impairment test involves comparing the fair value of the Company’sreporting units with each respective reporting unit’s carrying amount,including goodwill.  The fair value ofreporting units is generally determined using the income approach.  If the carrying amount of a reporting unitexceeds the reporting unit’s fair value, the second step of the goodwillimpairment test is performed to determine the amount of any impairmentloss.  The second step of the goodwillimpairment test involves comparing the implied fair value of the reporting unit’sgoodwill with the carrying amount of that goodwill.

The Company evaluateslong-lived assets for impairment in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets,*which requires impairment evaluation on long-lived assets used in operationswhen indicators of impairment are present. Reviews are performed to determine whether the carrying value of assetsis impaired, based on a comparison to undiscounted expected future cash flows.  If this comparison indicates that there isimpairment, the impaired asset is written down to fair value, which istypically calculated using discounted expected future cash flows and a discountrate based upon the Company’s weighted average cost of capital adjusted forrisks associated with the related operations. Impairment is based on the excess of the carrying amount over the fairvalue of those assets.

7

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**Income Taxes**

The Company utilizes theliability method of accounting for income taxes as set forth in SFASNo. 109, *Accounting for Income Taxes*(“SFAS109”)*.* Under the liability method, deferred taxes are determined based on thetemporary differences between the financial statement and tax bases of assetsand liabilities using enacted tax rates. A valuation allowance is recorded when it is more likely than not thatall or a portion of the deferred tax assets will not be realized.

**Researchand Development Expenditures**

Research and development expenditures are charged toexpense in the period incurred.

**Shipping and Handling Costs**

Shipping and handling costs are included in cost ofsales in the period during which products ship.

**Warranty**

The Company generally provides a one to three yearwarranty from the original invoice date on all products, materials andworkmanship.  Products sold to certainoriginal equipment manufacturer (“OEM”) customers sometimes carry longerwarranties. Defective products will be either repaired or replaced, generallyat the Company’s option, upon meeting certain criteria. The Company accrues aprovision for the estimated costs that may be incurred for product warrantiesrelating to a product as a component of cost of sales at the time revenue forthat product is recognized.  The accruedwarranty provision is included within accrued expenses on the accompanyingcondensed consolidated balance sheets.

**Repair and Maintenance Costs**

TheCompany incurs repair and maintenance costs in the normal course of business.Should the activity result in a permanent improvement to one of the Company’sleased facilities, the cost is capitalized as a leasehold improvement andamortized over its useful life or the remainder of the lease period, whicheveris shorter.  Non-permanent repair andmaintenance costs are charged to expense as incurred.

**Reclassifications**

Certainamounts in the prior period financial statements have been reclassified toconform with current year presentation.

**Comprehensive Income**

The only component of accumulated other comprehensiveincome is foreign currency translation adjustments.

**Recent Accounting Pronouncements**

On December 16, 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), which replaces SFAS No.123, *Accounting for Stock-Based Compensation*(“SFAS 123”), supersedes Accounting Principles Board Opinion No. 25 (“APB 25”),and amends SFAS No. 95, *Statement of Cash Flows*.  Generally, the approach in SFAS 123R issimilar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based on their fair values (i.e., pro forma disclosure is no longeran alternative to financial statement recognition).  As further discussed in Note 5, the Companyadopted SFAS 123R effective April 1, 2006 using the modified prospectivemethod.

In July 2006, the FASB issued FASB Interpretation No.48, *Accounting for Uncertainty in Income Taxes*(“FIN 48”).  FIN 48 clarifies theaccounting and reporting for income taxes recognized in accordance with SFAS 109.  This Interpretation prescribes acomprehensive model for the financial statement recognition, measurement,presentation and disclosure of uncertain tax positions taken or expected to betaken in income tax returns.  The Companyis currently evaluating the impact of FIN 48 and will adopt this Interpretationin the first quarter of its fiscal year ending March 31, 2008.

8

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**2.  Supplemental Financial Information**

**Inventories**

Thefollowing table presents details of the Company’s inventories:

 
| ** **              | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** |
|-------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **              | ** ** | **(In thousands)** | ** ** |
| Materials and  supplies | ** ** | **$**                   | **2,512**  |                     | $          | 2,258 |   |
| Work in process         | ** ** | **182**                 |       | 217                      |       |
| Finished goods          | ** ** | **295**                 |       | 339                      |       |
| ** **              | ** ** | **$**                   | **2,989**  |                     | $          | 2,814 |   |

 

**Goodwill and Identifiable IntangibleAssets**

The following table sets forth the Company’sintangible assets that are subject to amortization:

 
| ** **            | ** ** | **June 30, 2006** | ** ** | **March 31, 2006**  | ** ** |
|-----------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **            | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **            | ** ** | **(In thousands)**     | ** ** |
| Developed  technology | ** ** | **$**                       | **495**    | ** **                    | **$**      | **(204** | **)** | $ | 495 |   | $ | (179 | ) |
| Patents               | ** ** | **317**                     | ** ** | **(93**                       | **)**      | 317 |   | (82 | ) |
| Total                 | ** ** | **$**                       | **812**    | ** **                    | **$**      | **(297** | **)** | $ | 812 |   | $ | (261 | ) |

 

Amortization expense for intangible assets subject toamortization was $36,000 and $37,000 for the three month periods ended June 30,2006 and June 30, 2005, respectively. Future estimated amortization expense forthe remainder of the current fiscal year, the next four fiscal years andthereafter is as follows:

 

| Fiscal Year Ending March 31: | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **(In thousands)**                          | ** ** | ** ** | ** ** |
| Remainder of  2007                               |       | $          | 110        |   |
| 2008                                             |       | 147        |       |
| 2009                                             |       | 147        |       |
| 2010                                             |       | 59         |       |
| 2011                                             |       | 46         |       |
| Thereafter                                       |       | 6          |       |
|                                             |       | $          | 515        |   |

 

At June 30, 2006, goodwill of $27.8 million wascomprised of $18.0 million associated with the October 2004 merger betweenthe Company and its Iteris Subsidiary; $9.6 million associated with theacquisitions of the Rockwell International Transportation Systems Group, MeyerMohaddes Associates, Inc. and the Viggen Systems Consulting Group; and $200,000associated with the purchase of the assets of Mil-Lektron, a complementaryproduct to the Company’s Vantage video detection business.

**Warranty Reserve Activity**

The following table presentsactivity in accrued warranty obligations:

 
| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(In thousands)**                         | ** ** | ** ** | ** ** |
| Balance at  beginning of period    | ** ** | **$**                                           | **519**    |   | $ | 326 |   |
| Additions charged to cost of sales | ** ** | **135**                                         |       | 75 |   |
| Warranty claims                    | ** ** | **(64**                                         | **)**      | (59 | ) |
| Balance at end of  period          | ** ** | **$**                                           | **590**    |   | $ | 342 |   |

 

9

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**Earnings (Loss) Per Share**

Thefollowing table sets forth the computation of basic and diluted earnings (loss)per share:
| ** **                                                   | ** ** | **Three Months Ended  June 30,**                       | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Numerator:                                                   |       |                                                                  |       |   |   |
| Net income (loss)                                            | ** ** | **$**                                                                 | **279**    |   | $ | (726 | ) |
|                                                         |       |                                                                  |       |   |   |
| Denominator:                                                 |       |                                                                  |       |   |   |
| Weighted average common shares used in basic  computation    | ** ** | **28,393**                                                            |       | 28,062 |   |
| Dilutive stock options                                       | ** ** | **3,417**                                                             |       | — |   |
| Dilutive warrants                                            | ** ** | **558**                                                               |       | — |   |
| Weighted average common shares used in dilutive  computation | ** ** | **32,368**                                                            |       | 28,062 |   |
|                                                         |       |                                                                  |       |   |   |
| Basic and diluted  earnings (loss) per share                 | ** ** | **$**                                                                 | **0.01**   |   | $ | (0.03 | ) |

 

Thefollowing shares were excluded from the computation of diluted earnings (loss)per share as their effect would have been antidilutive:

 
| ** **             | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------|------------|-------------------------------------------------|------------|
| ** **             | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **             | ** ** | **(In thousands)**                         | ** ** |
| Stock options          | ** ** | **525**                                         |       | 7,323 |   |
| Warrants               | ** ** | **1,380**                                       |       | 3,624 |   |
| Convertible debentures | ** ** | **2,729**                                       |       | 2,729 |   |

 

**3. Revolving Line of Credit and Long-Term Debt**

**Revolving Line of Credit**

TheCompany renewed its line of credit agreement with its primary bank effectiveAugust 1, 2005, which provided for borrowings of up to $5.0 million.  This line of credit agreement expired on July31, 2006 but was extended until August 31, 2006.  The Company is currently in negotiations withits bank to replace this line of credit, but cannot assure that a new creditline will be obtained in a timely manner, on acceptable terms or at all.

Underthis line of credit, the Company may borrow against its eligible accountsreceivable and the value of its eligible inventory, as defined in the creditagreement. Interest on borrowed amounts is payable monthly at the currentstated prime rate plus 3.0%. Additionally, the Company is obligated to pay an unused line fee of0.25% per annum applied to the amount by which the maximum credit amountexceeds the average daily principal balance during the preceding month.

There are no monthly collateral management fees and nopre-payment or early termination fees. On June 30, 2006, the available creditunder this line of credit agreement was $4.1 million, of which $600,000 wasunused.

**Long-Term Debt**

TheCompany’s long-term debt consists of the following:

 
| ** **                   | ** ** | **June 30,  2006** | ** ** | **March 31,  2006** | ** ** |
|------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                   | ** ** | **(In thousands)** | ** ** |
| ** **                   | ** ** | ** **              | ** ** | ** **               | ** ** |
| Convertible  debentures, net | ** ** | **$**                   | **9,255**  |                     | $          | 9,203 |   |
| Bank term note               | ** ** | **2,396**               |       | 2,708                    |       |
| Promissory note  to landlord | ** ** | **1,292**               |       | 1,292                    |       |
| Other                        | ** ** | **119**                 |       | 140                      |       |
|                         | ** ** | **13,062**              |       | 13,343                   |       |
| Less current  portion        | ** ** | **(2,271**              | **)**      | (1,969                   | )          |
|                         | ** ** | **$**                   | **10,791** |                     | $          | 11,374 |   |

 

10

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*ConvertibleDebentures, Net.*  InMay 2004, the Company sold and issued subordinated convertible debentures inthe aggregate original principal amount of $10.1 million.  In connection with the issuance of thedebentures, the Company issued warrants to purchase an aggregate of 639,847shares of its common stock, the value of which was recorded as a debt discountagainst the face amount of the debentures on the date of issuance and is beingamortized to interest expense over the term of the convertible debentures.

Thedebentures are due in full on May 19, 2009, provide for 6.0% annualinterest, payable quarterly, and are convertible into the Company’s commonstock at an initial conversion price of $3.61 per share, subject to certain adjustments,including adjustments for dilutive issuances. From May 19, 2007 until May 18, 2008, the debentures may beredeemed by the Company, at its option, at 120% of the principal amount; andfrom May 19, 2008, until the maturity date, the Company may redeem thedebentures at 110% of the principal amount. As of June 30, 2006, $250,000 of convertible debentures had beenconverted into 69,252 shares of common stock leaving $9.9 million of theoriginally issued convertible debentures outstanding at June 30, 2006.

*Bank TermNote.*  In October 2004,the Company entered into a $5.0 million term note payable with a bank.  The note is due on May 27, 2008, andprovides for monthly principal payments of approximately $104,000.  Interest accrues at the current stated primerate plus 0.25% (8.50% at June 30, 2006).

Boththe bank term note and the line of credit are held by one bank under the samecredit agreement and are secured by substantially all of the assets of theCompany.

*PromissoryNote to Landlord.*  TheCompany has a $1.3 million unsecured promissory note payable to itslandlord.  Under the terms of the noteagreement, interest is payable quarterly and accrues at a rate of prime plus2.0% (10.25% at June 30, 2006). Beginning on October 1, 2006, the Company is required to make fourequal quarterly payments of principal and accrued interest.  All outstanding accrued interest andprincipal becomes payable in full on July 1, 2007.

Scheduledaggregate maturities of long-term debt principal as of June 30, 2006 were asfollows:

 

| Year Ending March 31, | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| **(In thousands)**              | ** ** | ** ** | ** ** |
| Remainder of  2007                   | ** ** | **$**      | **1,636**  | ** ** |
| 2008                                 | ** ** | **1,940**  | ** ** |
| 2009                                 | ** ** | **231**    | ** ** |
| 2010                                 | ** ** | **9,850**  | ** ** |
|                                 | ** ** | **$**      | **13,657** | ** ** |
| Less:  unamortized debt discount     | ** ** | **(595**   | **)**      |
|                                 | ** ** | **$**      | **13,062** | ** ** |

 

**4. Commitments and Contingencies**

**Litigation and Other Contingencies**

OnJune 29, 2004, a supplier to Mariner Networks, Inc., a formersubsidiary of the Company that was discontinued in the fiscal year endedMarch 31, 2002, filed a complaint in Orange County Superior Court againstthe Company alleging various breaches of written contract claims arising out ofalleged purchase orders. The plaintiff in this lawsuit sought monetary damagesaggregating approximately $850,000 plus attorney fees and related costs.  On July 20, 2006, the Company entered into apreliminary settlement in connection with this matter.  In full settlement of this dispute, theCompany agreed to pay $125,000 on or before October 20, 2006, plus anadditional $350,000 to be paid in equal monthly installments of $9,700 over threeyears beginning in November 2006. Additionally, the Company agreed to issue shares of its common stockvalued at $213,000 in August 2006, based on the closing sales price of theCompany’s common stock on the date of issuance. In connection with this settlement, the Company has recorded $688,000 toother expense in the accompanying condensed consolidated statement ofoperations for the three months ended June 30, 2006.

From time to time, theCompany has been involved in litigation relating to claims arising out of itsoperations in the normal course of business. The Company currently is not aparty to any legal proceedings, the adverse outcome of which, in management’sopinion, individually or in the aggregate, would have a material adverse effecton its consolidated results of operations, financial position or cash flows.

Furthermore, from time totime, the Company has experienced unforeseen developments in contingenciesrelated to its former subsidiaries.  Forexample, the Company has been the subject of a number of routine tax audits fortime periods and jurisdictions related to the businesses of its formersubsidiaries, some of which are still in process.  Although the development and ultimate outcomeof these and other unforeseen matters cannot be predicted with any certainty, 

11

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management does not believe that the Company ispresently involved in any matters related to its former subsidiaries that wouldhave a material adverse effect on the Company’s consolidated results ofoperations, financial position or cash flows.

**Operating Lease Commitments**

The Company has lease commitments for facilities invarious locations throughout the United States. Future commitments under thesenon-cancelable operating leases at June 30, 2006, including the lease for theCompany’s Anaheim facilities were as follows:

 

| Fiscal Year Ending March 31, | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **(In thousands)**                          | ** ** | ** ** | ** ** |
| Remainder of  2007                               | ** ** | **$**      | **1,112**  | ** ** |
| 2008                                             | ** ** | **932**    | ** ** |
| 2009                                             | ** ** | **127**    | ** ** |
| 2010                                             | ** ** | **85**     | ** ** |
| 2011                                             | ** ** | **43**     | ** ** |
| Total                                            | ** ** | **$**      | **2,299**  | ** ** |

 

**Inventory Purchase Commitments**

At June 30, 2006, the Company had firm commitments to purchaseinventory in the amount of $1.9 million during the second and third quarters ofits fiscal year ending March 31, 2007.

**5.  Stock-Based Compensation**

TheCompany adopted SFAS 123R effective April 1, 2006.  Prior to April 1, 2006, the Company followedthe disclosure-only provisions of SFAS 123, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation — Transition and Disclosure*,and, accordingly, accounted for its stock-based compensation plans using theintrinsic value method under APB 25 and related interpretations.

SFAS123R requires all stock-based payments, including grants of employee stockoptions, to be recognized in the statement of operations as an expense, basedon their grant date fair values with such fair values amortized over therequisite service period.  The Companyelected to utilize the modified prospective method for the transition to SFAS123R. Under the modified prospective method, SFAS 123R applies to all awardsgranted or modified after the date of adoption. In addition, under the modifiedprospective method, compensation expense will be recognized for all stock-basedcompensation awards granted prior to but not yet vested as of April 1, 2006,based on grant-date fair values estimated in accordance with the originalprovisions of SFAS 123.  Accordingly,prior period amounts presented herein have not been restated to reflect theadoption of SFAS 123R.

Thefair value concepts were not changed significantly as a result of implementingSFAS 123R; however, in adopting SFAS 123R, companies must choose amongalternative valuation models and amortization assumptions. After assessingalternative valuation models and amortization assumptions, the Companycontinues to use both the Black-Scholes-Merton (“BSM”) option-pricing formulaand straight-line amortization of compensation expense over the requisiteservice period of stock option grants. The Company will reconsider use of this model if additional informationbecomes available in the future that indicates another model would be moreappropriate, or if grants issued in future periods have characteristics thatcannot be reasonably estimated using this model.  SFAS 123 did not require the estimation offorfeitures in the calculation of stock compensation expense; however, SFAS123R does require such estimation and upon adoption of SFAS 123R, the Companychanged its methodology to include an estimate of forfeitures. The adoption ofSFAS 123R had no effect on cash flows from operating activities because no taxbenefits are realized from stock option exercises. The adoption of SFAS 123R alsohad no effect on cash flows from financing activities.

Thefollowing table illustrates the impact of adopting SFAS 123R as if the Companyhad continued to account for stock-based compensation under APB 25:

 
| ** **                                   | ** ** | **Three Months  Ended June 30, 2006**             | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **SFAS 123R**                                                    | ** ** | **APB 25** | ** ** |
| ** **                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Loss before  income taxes                    | ** ** | **$**                                                                 | **(331**   | **)** | $ | (276 | ) |
| Net income  (loss)                           | ** ** | **$**                                                                 | **279**    |   | $ | 334 |   |
| Basic and diluted  earnings per common share | ** ** | **$**                                                                 | **0.01**   |   | $ | 0.01 |   |

 

 

12

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Thefollowing table illustrates the effect on net loss and net loss per share forthe three months ended June 30, 2005 as if the Company had applied the fairvalue recognition provisions of SFAS 123 to options granted under the Company’sstock option plans.  For purposes of thispro forma disclosure, the fair value of the options was estimated using the BSMoption-pricing formula and amortized on a straight-line basis to expense overthe options’ vesting period:

 
| ** **                                                                                                        | ** ** | **Three Months Ended  June 30, 2005**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **(In thousands,  except per share  amounts)** | ** ** |
| Net loss — as reported                                                                                       | ** ** | $                                                             | (726       | ) |
| Add: Stock-based  employee compensation expense included in net loss — as reported                           |       | 265                                                           |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards |       | (371                                                          | )          |
| Net loss — pro forma                                                                                         | ** ** | $                                                             | (832       | ) |
|                                                                                                              |       |                                                          |       |
| Basic and diluted loss  per share — as reported                                                              |       | $                                                             | (0.03      | ) |
| Basic and diluted loss per share — pro forma                                                                 |       | $                                                             | (0.03      | ) |

 

TheCompany has one stock option plan, the 1997 Stock Incentive Plan (the “Plan”),which provides that options to purchase shares of the Company’s unissued commonstock may be granted to directors, associates and consultants to the Company atexercise prices which are equal to or greater than the fair market value of theCompany’s common stock on the date of grant. Options expire ten years after the date of grant or 90 days aftertermination of employment and generally vest ratably at the rate of 25% on eachof the first four anniversaries of the grant date.  New shares are issued to satisfy stock optionexercises under the Plan.

Inconnection with the merger of the Company and the Iteris Subsidiary (Note 1),the Company assumed all of the outstanding options under the 1998 StockIncentive Plan of the Iteris Subsidiary (the “1998 Plan”).  As of June 30, 2006, options to purchase 5.4million shares of the Company’s common stock were outstanding under the 1998Plan.  No further options may be grantedunder the 1998 Plan.

Boththe Plan and the 1998 Plan (the “Plans”) provide for accelerated vesting ofunvested options in the event of a change in control under certaincircumstances.  These change in controlprovisions meet the criteria of a performance condition under SFAS 123R.

Asummary of changes in the Plans for the three months ended June 30, 2006 is asfollows:

 
| ** **                                                            | ** ** | **Options**                                                           | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Life (In Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Options  outstanding at March 31, 2006                                |       | 6,977                                                                 |       | $                                      | 1.42       |                                                        | 3.97       |                                |       |   |
| Granted                                                               |       | 105                                                                   |       | $                                      | 2.21       |                                                        | N/A        |                                |       |   |
| Exercised                                                             |       | (140                                                                  | )          | $                                      | 1.14       |                                                        | N/A        |                                |       |   |
| Forfeited                                                             |       | (17                                                                   | )          | $                                      | 2.74       |                                                        | N/A        |                                |       |   |
| Expired                                                               |       | (22                                                                   | )          | $                                      | 2.36       |                                                        | N/A        |                                |       |   |
| Options  outstanding at June 30, 2006                                 |       | 6,903                                                                 |       | $                                      | 1.43       |                                                        | 3.80       |                                | $          | 8,252 |   |
| Vested and  expected to vest at June 30, 2006                         |       | 6,766                                                                 |       | $                                      | 1.41       |                                                        | 3.70       |                                | $          | 8,202 |   |
| Options  exercisable at June 30, 2006                                 |       | 6,370                                                                 |       | $                                      | 1.37       |                                                        | 3.44       |                                | $          | 7,954 |   |
| Options exercisable  pursuant to a change in control at June 30, 2006 |       | 6,903                                                                 |       | $                                      | 1.43       |                                                        | 3.80       |                                | $          | 8,252 |   |

 

AtJune 30, 2006, there were 168,000 shares of common stock available for grantunder the Plan.

Forthe three month periods ended June 30, 2006 and 2005, the Company received$168,000 and $87,000, respectively, in cash from the exercise of stockoptions.  Total stock-based compensationexpense for the three month period ended June 30, 2006 was $100,000.  No income tax benefit was realized fromactivity in the Plans during the three month periods ended June 30, 2006 and2005.

AtJune 30, 2006, there was $788,000 of total unrecognized compensationexpense related to unvested stock options.  This expense is expected to be recognized overa weighted-average period of approximately 1.6 years.

13

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Thefair value of each stock-based award is estimated on the grant date using theBSM option-pricing formula. Expected volatilities are based on the historicalvolatility of the Company’s stock price. The expected life of options grantedsubsequent to the adoption of SFAS 123R is derived based on the historical lifeof the Company’s options.  The risk-freerate for periods within the expected life of the option is based on the U.S.Treasury interest rates in effect at the time of grant. The fair value ofoptions granted was estimated using the following weighted-average assumptions:

 

|                                      | ** ** | **Three Months  Ended June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
|                                 |       |                                            |       |   |   |
| Dividend yield                       | ** ** | **0.0**                                         |       | N/A |   |
| Expected life —  years          | ** ** | **7.0**                                         |       | N/A |   |
| Risk-free  interest rate             | ** ** | **5.0**                                         | **%**      | N/A |   |
| Expected volatility of  common stock | ** ** | **0.89**                                        |       | N/A |   |

 

A summary of thegrant-date fair value and intrinsic value information is as follows:

 

|                                                       | ** ** | **Three Months  Ended June 30,**                       | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Weighted average  grant date fair value per share     | ** ** | **$**                                                                 | **1.77**   |   | N/A |   |
| Intrinsic value  of options exercised                 | ** ** | **$**                                                                 | **163**    |   | $ | 90 |   |
| Total fair value of  options vested during the period | ** ** | **$**                                                                 | **384**    |   | $ | 473 |   |

 

**6.  BusinessSegment Information**

TheCompany currently operates in three reportable segments: Roadway Sensors,Automotive Sensors and Transportation Systems. The Roadway Sensors segment includes the Company’s Vantage vehicledetection systems for traffic intersection control and certain highwaytraffic data collection applications. The Automotive Sensors segment includes AutoVue and is comprised of allactivities related to lane departure warning systems for vehicle safety.  The Transportation Systems segment includestransportation engineering and consulting services and the development oftransportation management and traveler information systems for the ITSindustry. The accounting policies of the reportable segments are the same asthose described in the summary of significant accounting policies except thatcertain expenses, such as interest, amortization of certain intangibles andcertain corporate expenses are not allocated to the segments. In addition,certain assets including cash and cash equivalents, deferred taxes and certainlong-lived and intangible assets are not allocated to the segments.  The reportable segments are each managedseparately because they manufacture and distribute distinct products or provideservices with different processes.  Allsegment revenues are derived from external customers.

The following table sets forth selected unauditedfinancial information for the Company’s reportable segments for the three monthperiods ended June 30, 2006 and 2005:

 

|                                                    | ** ** | **Roadway  Sensors**    | ** ** | **Automotive  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| **Three  Months Ended June 30, 2006**              |       |                    |       |                    |       |                        |       |      |       |
| Product revenue  from external customers           |       | $                       | 6,516      |                    | $          | 1,339                       | ** ** | **$**     | **—** |   | $ | 7,855 |   |
| Service and  other revenue from external customers | ** ** | **—**              |       | 745                     |       | 5,216                       |       | 5,961     |       |
| Depreciation and  amortization                     |       | 19                      |       | 34                      |       | 28                          |       | 81        |       |
| Segment income  (loss)                             |       | 1,501                   |       | (640                    | )          | 658                         |       | 1,519     |       |
|                                               |       |                    |       |                    |       |                        |       |      |       |
| **Three  Months Ended June 30, 2005**              |       |                    |       |                    |       |                        |       |      |       |
| Product revenue  from external customers           |       | $                       | 5,347      |                    | $          | 1,699                       | ** ** | **$**     | **—** |   | $ | 7,046 |   |
| Service and  other revenue from external customers | ** ** | **—**              |       | 479                     |       | 4,554                       |       | 5,033     |       |
| Depreciation and  amortization                     |       | 30                      |       | 34                      |       | 83                          |       | 147       |       |
| Segment income  (loss)                             |       | 785                     |       | (700                    | )          | 496                         |       | 581       |       |
|                                               |       |                    |       |                    |       |                        |       |      |       |

 

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The following table reconciles segment income toconsolidated (loss) before income taxes:

 
| ** **                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                            | ** ** | ** **                                      | ** ** | **(In thousands)** | ** ** |
| Total income for  reportable segments | ** ** | **$**                                           | **1,519**  |   | $ | 581 |   |
| Unallocated  amounts:                 |       |                                            |       |   |   |
| Corporate expenses                    | ** ** | **(774**                                        | **)**      | (899 | ) |
| Other expense, net                    | ** ** | **(690**                                        | **)**      | (48 | ) |
| Interest expense, net                 | ** ** | **(386**                                        | **)**      | (352 | ) |
| Loss before income  taxes             | ** ** | **$**                                           | **(331**   | **)** | $ | (718 | ) |

 

 

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**ITEM2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

*This report, including the following discussion andanalysis, contains forward-looking statements (within the meaning of thePrivate Securities Litigation Reform Act of 1995) that are based on our currentexpectations, estimates and projections about our business and our industry,and reflect management’s beliefs and certain assumptions made by us based uponinformation available to us as of the date of this report. When used in thisreport and the information incorporated herein by reference, the words “expect(s),”“feel(s),” “believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)”and similar expressions or variations of these words are intended to identifyforward-looking statements. These forward-looking statements include but arenot limited to statements regarding our anticipated sales, revenue, expenses,profits, capital needs, competition, development plans, backlog andmanufacturing capabilities, the applications for and acceptance of our productsand services, the status of our facilities and product development, and theimpact of pending litigation. These statements are not guarantees of futureperformance and are subject to certain risks and uncertainties which couldcause actual results to differ materially from those projected. You should notplace undue reliance on these forward-looking statements that speak only as ofthe date hereof. We undertake no obligation to republish revised forward-lookingstatements to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated events. We encourage you to carefullyreview and consider the various disclosures made by us which describe certainfactors which could affect our business, including in* “*Risk Factors” set forth in Part II, Item 1A of this report, beforedeciding to invest in our company or to maintain or increase your investment.We undertake no obligation to revise or update publicly any forward-lookingstatement for any reason.*

**Overview**

We are a leading providerof outdoor machine vision systems and sensors that optimize the flow of trafficand enhance driver safety. Using our proprietary software and ITS industryexpertise, we provide video sensor systems, transportation management andtraveler information systems and other engineering and consulting services tothe ITS industry. We use our outdoor image recognition software expertise todevelop proprietary algorithms for video sensor systems that improve vehiclesafety and the flow of traffic. Using our knowledge of the ITS industry, wedesign and implement transportation management systems that help publicagencies reduce traffic congestion and provide greater access to travelerinformation.

Our Vantage product is a video vehicle detection system that detectsthe presence of vehicles on roadways. Vantage systems are used at signalized intersections to enable a moreefficient allocation of green signal time and are also used for incidentdetection and highway traffic data collection applications. We sell anddistribute our Vantage products primarily to commercial customers and municipalagencies.

Our AutoVue Lane Departure Warning (“LDW”) systems consist of a smallwindshield mounted sensor that uses proprietary software to detect and warndrivers of unintended lane departures. Approximately 25,000 production AutoVueunits have been sold for truck platforms in the North American and Europeanmarkets.  Our AutoVue LDW systems arecurrently offered as an option on certain Mercedes, MAN, Freightliner andInternational trucks.  InSeptember 2003, we entered into an agreement with Valeo Schalter andSensuren GmbH (“Valeo”), pursuant to which we granted Valeo the exclusive rightto sell and manufacture our AutoVue LDW systems to the worldwide passenger carmarket in exchange for royalty payments for each AutoVue LDW unit sold.  To date, royalty payments from Valeo have notbeen significant.  Pursuant to thisagreement, we also provide specific contract engineering services, technicalmarketing and sales support to Valeo to enable the launch of our LDW technologyon three Infiniti platforms, the FX, M and Q, where the device is offered aspart of the technology option package. Valeo is currently in negotiations to provide our LDW system to otherpassenger car OEMs; however, we cannot assure you that such negotiations willbe successful.  We plan to continue toprovide technical marketing and sales support to Valeo in our efforts to winnew OEM customers for the passenger car market as well as contract engineeringservices related to the possible launch of new Infiniti platforms that includeour LDW system.  We believe that AutoVueis a broad sensor platform that, through additional software development, maybe expanded to incorporate additional safety and convenience features.

Our transportation management systems businessincludes transportation engineering and consulting services focused on theplanning, design, development and implementation of software-based systems thatintegrate sensors, video surveillance, computers and advanced communicationsequipment to enable public agencies to monitor, control and direct trafficflow, assist in the quick dispatch of emergency crews and distribute real-timeinformation about traffic conditions. Our services include planning and other engineering for theimplementation of transportation infrastructure and related communicationssystems, analysis and study related to goods movement and commercial vehicleoperations, and parking systems designs. These services and systems are sold to local, state and nationaltransportation agencies in the United States. Our transportation management systems business is largely dependent upongovernmental funding and budgetary issues. The 

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Federal HighwayBill was passed in August 2005, which provides for a significant increase intransportation funding over the next six years. Our Transportation management systems business is expanding partly dueto the passage of the Federal Highway Bill combined with expansion oftransportation funds at state and local agencies throughout the country.

We currently operate in three reportable segments:Roadway Sensors, Automotive Sensors and Transportation Systems. The RoadwaySensors segment includes our Vantage vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications.  The AutomotiveSensors segment is comprised of all activities related to our AutoVue LDWsystems for vehicle safety. The Transportation Systems segment includestransportation engineering and consulting services and the development oftransportation management and traveler information systems for the ITSindustry.

**CriticalAccounting Policies and Estimates**

Management’s Discussion and Analysis of FinancialCondition and Results of Operations is based on our unaudited condensedconsolidated financial statements included herein, which have been prepared inaccordance with U.S generally accepted accounting principles. The preparationof these financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities andrelated disclosures of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. On an ongoing basis, we evaluate these estimates andassumptions, including those related to the collectibility of accountsreceivable, the valuation of inventories, the recoverability of long-livedassets and goodwill, accounting for stock-based compensation related to SFAS123R, and other contingencies. We base these estimates on historical experienceand on various other factors that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. These estimates and assumptions by their nature involverisks and uncertainties, and may prove to be inaccurate. In the event that anyof our estimates or assumptions are inaccurate in any material respect, itcould have a material adverse effect on our reported amounts of assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.

The following critical accounting policies affect ourmore significant judgments and estimates used in the preparation of ourunaudited condensed consolidated financial statements.

*Revenue Recognition*.  We record product revenues and related costsof sales upon transfer of title, which is generally upon shipment or, ifrequired, upon acceptance by the customer, provided that we believecollectibility of the net sales amount is reasonably assured.  Accordingly, at the date revenue isrecognized, the significant uncertainties concerning the sale have beenresolved.

Contract revenues are derived primarily from long-termcontracts with governmental agencies. Contract revenues include costs incurred plus a portion of estimatedfees or profits determined using the percentage of completion method ofaccounting based on the relationship of costs incurred to total estimatedcosts.  Any anticipated losses oncontracts are charged to earnings when identified.  Changes in job performance and estimatedprofitability, including those arising from contract penalty provisions andfinal contract settlements, may result in revisions to recognized costs and revenuesand are recognized in the period in which the revisions are determined.  Profit incentives are included in revenuewhen their realization is reasonably assured.

In addition to product and contract revenues, wederive revenue from technology access fees, the provision of specific non-recurringcontract engineering services related to our AutoVue LDW systems, and royaltiesrelated to unit sales of our AutoVue LDW systems by our strategic partner Valeoto the passenger car market. Technology access fee revenues are recognizedevenly over the period in which they are earned.  Non-recurring contract engineering revenuesare recognized in the period in which the related services are performed.  Royalty revenues are recorded based on unitsales of our products by Valeo and are recognized in the period in which suchsales occur.  Technology access feerevenues, contract engineering revenues and royalty revenues are included innet sales.

Revenues from follow-on service and support, for whichwe charge separately, are recorded in the period in which the services areperformed.

*Accounts Receivable*.  We estimate the collectibility of customerreceivables on an ongoing basis by periodically reviewing invoices outstandinggreater than a certain period of time. We have recorded reserves for receivables deemed to be at risk forcollection as well as a general reserve based on our historical collectionsexperience.  A considerable amount ofjudgment is required in assessing the ultimate realization of trade receivables,including the current credit-worthiness of each customer.  If the financial condition of our customersdeteriorates, resulting in an impairment of their ability to make requiredpayments, additional allowances may be required that could adversely affect ouroperating results.

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*Inventory*. Inventories consist offinished goods, work-in-process and raw materials and are stated at the lowerof cost or market.  We provide reservesfor potentially excess and obsolete inventory. In assessing the ultimate realizationof inventories, we make judgments as to future demand requirements and comparethat with the current or committed inventory levels.  Reserves are established for inventory levelsthat exceed future demand.  It ispossible that reserves over and above those already established may be requiredin the future if market conditions for our products deteriorate.

*Goodwill*.  Goodwill is tested for impairment annually inthe fourth fiscal quarter at the reporting unit level unless a change incircumstances indicates that more frequent impairment analysis isrequired.  Impairment, if any, ismeasured based on the estimated fair value of the reporting units with therecorded goodwill.  Fair value isdetermined by using the income approach methodology of valuation which utilizesdiscounted cash flows.  Significantmanagement judgment is required in the forecasts of future operating resultsthat are used in the discounted cash flow method of valuation.  In estimating future cash flows, we generallyuse the financial assumptions in our current budget and our current strategicplan, subject to modification as considered necessary, including sales andexpense growth rates and the discount rates we estimate to represent our costof funds.  It is possible, however, thatthe plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in futureimpairment analyses, are lower than the original estimates used to assess therecoverability of goodwill, we could incur impairment charges.

*Warranty.*  We generally provide a one to three yearwarranty from the original invoice date on all products, materials andworkmanship.  Defective products areeither repaired or replaced, at our option, upon meeting certain criteria.  We accrue a provision for the estimated coststhat may be incurred for product warranties relating to a product as acomponent of cost of sales at the time revenue for that product isrecognized.  The accrued warrantyprovision is included within accrued expenses on the accompanying condensedconsolidated balance sheets.  Should ouractual experience of warranty returns be higher than anticipated, additionalwarranty reserves may be required, which may adversely affect our operatingresults.

*Taxes.*We recordeda valuation allowance to reduce our deferred tax assets to amounts that webelieve are more likely than not to be realized. Realization of deferred taxassets (such as net operating loss carryforwards) is dependent on futuretaxable earnings and is therefore uncertain. On a quarterly basis, we assessthe likelihood that our deferred tax asset balance will be recovered fromfuture taxable income. To the extent we believe that recovery is not likely, weestablish a valuation allowance against our deferred tax asset, increasing ourincome tax expense in the period such determination is made.

On an interim basis, we estimate what our anticipatedannual effective tax rate will be and record a quarterly income tax provisionin accordance with this anticipated rate. As the fiscal year progresses, werefine our estimates based upon actual events and earnings during the year.This estimation process can result in significant changes to our expectedeffective tax rate. When this occurs, we adjust the income tax provision duringthe quarter in which the change in estimate occurs so that the year-to-dateprovision reflects the expected annual rate. The changes described in thepreceding sentence and the recording of valuation allowances may createfluctuations in our overall effective tax rate from quarter to quarter.

*Stock-BasedCompensation*.  Weadopted SFAS No. 123R (revised 2004), *Share-Based Payment*(“SFAS 123R”), effective April 1, 2006. Prior to April 1, 2006, we followed the disclosure-only provisions ofSFAS No. 123, *Accounting for Stock-Based Compensation*(“SFAS123”), as amended by SFAS No. 148, *Accounting for Stock-BasedCompensation — Transition and Disclosure*, and, accordingly,accounted for our stock-based compensation plans using the intrinsic valuemethod under Accounting Principles Board Opinion No. 25 and relatedinterpretations. 

 

SFAS 123R requiresall stock-based payments, including grants of employee stock options, to berecognized in the statement of operations as an expense, based on their grantdate fair values with such fair values amortized over the requisite serviceperiod.  We elected to utilize themodified prospective method for the transition to SFAS 123R. Under the modifiedprospective method, SFAS 123R applies to all awards granted or modified afterthe date of adoption. In addition, under the modified prospective method,compensation expense will be recognized for all stock-based compensation awardsgranted prior to but not yet vested as of April 1, 2006, based on grant-datefair values estimated in accordance with the original provisions of SFAS 123.  

 

In implementingSFAS 123R, we have used the Black-Scholes-Merton (“BSM”) option-pricing formulato estimate the fair value of stock-based awards granted subsequent to April 1,2006.  Our assumptions under the BSMformula include the following:  expectedvolatilities are based on the historical volatility of our stock price, theexpected life of options is derived based on the historical life of ouroptions, and the risk-free rate for periods within the expected life of theoption is based on the U.S. Treasury interest rates in effect at the time ofgrant.  Additionally, SFAS 123 did notrequire the estimation of forfeitures in the calculation of stock compensationexpense; however, SFAS 123R does require such estimation and upon adoption ofSFAS 123R, we changed our methodology to include an estimate offorfeitures.  Future stock-basedcompensation expense in any particular quarter or year could be affected bychanges in our assumptions or changes in market conditions.  

 

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**Results of Operations**

The following table sets forth certain statement of operations data asa percentage of total net sales and contract revenues for the periodsindicated. The following table should be read in conjunction with Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

 
| ** **                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| Net sales and  contract revenues:     |       |                                            |       |   |   |
| Net sales                             | ** ** | **62.2**                                        | **%**      | 62.3 | % |
| Contract revenues                     | ** ** | **37.8**                                        |       | 37.7 |   |
| Total net sales and contract revenues | ** ** | **100.0**                                       |       | 100.0 |   |
| Costs and  expenses:                  |       |                                            |       |   |   |
| Cost of net sales                     | ** ** | **34.4**                                        |       | 31.1 |   |
| Cost of contract revenues             | ** ** | **24.2**                                        |       | 24.6 |   |
| Gross profit                          | ** ** | **41.4**                                        |       | 44.3 |   |
| Operating  expenses:                  |       |                                            |       |   |   |
| Selling, general and administrative   | ** ** | **29.0**                                        |       | 31.7 |   |
| Research and development              | ** ** | **7.3**                                         |       | 14.5 |   |
| Deferred compensation plan            | ** ** | **(0.5**                                        | **)**      | 0.5 |   |
| Amortization of intangible assets     | ** ** | **0.2**                                         |       | 0.3 |   |
| Total operating expenses              | ** ** | **36.0**                                        |       | 47.0 |   |
| Operating income  (loss)              | ** ** | **5.4**                                         |       | (2.6 | ) |
| Other income  (expense):              |       |                                            |       |   |   |
| Other expense, net                    | ** ** | **(5.0**                                        | **)**      | (0.4 | ) |
| Interest expense, net                 | ** ** | **(2.8**                                        | **)**      | (2.9 | ) |
| Total other income (expense), net     | ** ** | **(7.8**                                        | **)**      | (3.3 | ) |
|                                  |       |                                            |       |   |   |
| Loss before  income taxes             | ** ** | **(2.4**                                        | **)**      | (5.9 | ) |
| Income tax  benefit (expense)         | ** ** | **4.4**                                         |       | (0.1 | ) |
| Net income (loss)                     | ** ** | **2.0**                                         | **%**      | (6.0 | )% |

 

**Analysisof Quarterly Results of Operations**

*Net Sales and Contract Revenues*. Net sales are comprised of Roadway Sensor sales, which are derived from salesof our Vantage video detection systems; and Automotive Sensor sales, which arederived from sales of AutoVue LDW systems, technology access fees, contractengineering revenue and royalty revenue generated from AutoVue relatedactivities.  Contract revenues consist entirely of Transportation Systemsrevenues, which are generated from systems integration and ITS consultingservices with federal, state, county and municipal agencies. We currently havea diverse customer base with our largest customer constituting 10.7% of totalnet sales and contract revenues in the three months ended June 30, 2006.

Total net sales and contract revenues increased 14.4%to $13.8 million for the three months ended June 30, 2006, compared to $12.1million in the corresponding period in the prior fiscal year. This increase wasprimarily due to increased Roadway Sensors net sales and Transportation Systemscontract revenues offset in part by decreased Automotive Sensors net sales, asdiscussed below.

Net sales increased 14.3% to $8.6 million for thethree months ended June 30, 2006 as compared to $7.5 million in thecorresponding period of the prior fiscal year.  This increase was drivenby a 21.9% increase in Roadway Sensors net sales in the three months ended June30, 2006 over the corresponding period in the prior year as we continue toexperience positive reaction to recently introduced Vantage product offeringssuch as eAccess and color cameras as well as higher governmental spending whichwe believe is related to the passage of the Federal Highway Bill in August2005.  The increase in Roadway Sensorsnet sales was partially offset by a decrease of 4.3% in Automotive Sensors netsales, which was primarily a result of reduced sales to our largest AutoVuecustomer.  The higher level of sales inthe prior fiscal year occurred largely as a result of our largest AutoVuecustomer purchasing approximately $1.0 million of spare LDW systems in theprior year in anticipation of the changeover to the next generation LDWsystem.  $400,000 of these LDW systemswere purchased in the first quarter of the prior fiscal year and resulted inunusually high volumes for this customer in that period.  Such purchases of spare systems did not occurin the three months ended June 30, 2006, and are not expected to occur for atleast 

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the remainder ofthis current fiscal year.  Additionally,our largest customer benefited from volume pricing discount which wereeffective January 1, 2006, also contributing to the decline in our netsales for Automotive Sensors.  Thereduced level of sales to our largest AutoVue customer was somewhat offset by a150% increase in sales of aftermarket LDW systems in North America.  While we have enjoyed recent success insigning new customers in the truck market, for the reasons previously noted, wehave experienced a decline in sales from our largest Automotive Sensorshardware customers.  We cannot assure youthat this trend will not continue.

Royalty revenues from Valeo for sales of our LDWsystems for the passenger car market remained relatively insignificant in thecurrent quarter.  Our LDW systems are nowoffered as an option on three Infiniti models. While Valeo is currently in discussions to offer our LDW systems onother passenger car platforms, we cannot assure you that Valeo will besuccessful in these efforts.

Contract revenues increased 14.5% to $5.2 million forthe three months ended June 30, 2006 as compared to $4.6 million in thecorresponding period of the prior fiscal year. This increase is largely due to increased funding at the federal, stateand local levels throughout the country. In response to this growth in funding, we have increased ourTransportation Systems staff by 9% in the three months ended June 30,2006.  We expect to continue to increaseour Transportation Systems staff over the next couple quarters, although not atthe same rate as in the three months ended June 30, 2006.  We believe the ability of our TransportationSystems business to grow and successfully win and service new contracts will behighly dependent upon our continued success in recruiting and retainingqualified personnel.  All of our contractrevenues are derived from work performed in North America under a broad rangeof fixed price and cost plus fixed fee contracts.

*Gross Profit*. Total gross profit increased 6.8% to $5.7 million for the three months endedJune 30, 2006 as compared to $5.4 million in the corresponding period of theprior fiscal year.  Total gross profit asa percent of net sales and contract revenues decreased to 41.4% for the threemonths ended June 30, 2006 as compared to 44.3% for the corresponding period ofthe prior fiscal year.

Gross profit as a percent of net sales was 44.7% forthe three months ended June 30, 2006 compared to 50.1% in the correspondingperiod of the prior fiscal year.  This decrease was primarily due tovolume discounts given to our largest Automotive Sensors hardware customer,increased product support activities in our Roadway Sensors business, anincreased level of lower margin non-recurring engineering services sold to ourstrategic partner Valeo in the current year period and the mix of products soldin the current quarter. Gross profit as a percent of net sales generally fluctuatesin any specific quarter based on customer mix.

Gross profit as a percent of contract revenuesincreased to 36.0% for the three months ended June 30, 2006 compared to 34.8%in the corresponding period of the prior fiscal year.  The increase ingross profit as a percent of contract revenues was primarily due to a continuedfocus on higher margin contracts and a favorable contract mix.

*Selling, General and AdministrativeExpense*.  Selling, general and administrative expenseincreased 4.5% to $4.0 million (or 29.0% of total net sales and contractrevenues) in the three months ended June 30, 2006 compared to $3.8 million (or31.7% of total net sales and contract revenues) in the corresponding period ofthe prior fiscal year.  The increase inselling, general and administrative expenses was largely due to increased salesand marketing costs to support sales growth in Roadway Sensors andTransportation Systems, consisting primarily of higher commissions on highersales, and higher personnel costs and related expenses due to the additionalsales and support staff hired during the current quarter.  While we recently reached a preliminarysettlement in the Delta litigation, we anticipate we will incur additional legalfees in the next quarter related to the finalization of the settlement.

*Research and Development Expense*. Research and development expense decreased 42.6% to $1.0 million (or 7.3% oftotal net sales and contract revenues) in the three months ended June 30, 2006compared to $1.7 million (or 14.5% of total net sales and contract revenues) inthe corresponding period of the prior fiscal year.  The decrease in research and developmentexpense was largely a result of higher than anticipated costs in the prior yearperiod in Automotive Sensors as we expended significant development resourcesin qualifying the next generation LDW system with our largest customer.  Additionally, in the current year there hasbeen a slight shift in engineering resources from research and developmentactivities to product support activities as a result of the introduction of newproducts.

For competitive reasons, we closely guard theconfidentiality of specific development projects.

*Deferred Compensation Plan Expense.*  Duringthe three month period ended June 30, 2006, we recorded a non-cash benefit of$66,000 related to the depreciation in value of 310,510 shares of our commonstock held in trust by our deferred compensation savings plan.  This compares to a non-cash expense of $62,000recorded in the three month period ended June 30, 2005.  We expect to continue to experience non-cashexpense or benefit in future periods as the value of the assets held in ourdeferred compensation savings plan fluctuates.

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*Other Income (Expense), Net*. Other expense, net reflects the following:

|                        | ** ** | **Three Months Ended  June 30, 2006** | ** ** |
|------------------------|------------|-----------------------------------------------------------|------------|
| ** **             | ** ** | **2006**                                                  | ** ** | **2005** | ** ** |
| ** **             | ** ** | **(In thousands)**                                   | ** ** |
| Settlement of  lawsuit | ** ** | **$**                                                     | **(688**   | **)** | $ | — |   |
| Other                  | ** ** | **(2**                                                    | **)**      | (48 | ) |
| Other expense,  net    | ** ** | **$**                                                     | **(690**   | **)** | $ | (48 | ) |

 

Other expense, net for the three months ended June 30,2006 primarily reflects $688,000 of expense recorded in connection with thesettlement of litigation described in Note 4 to the accompanying condensedconsolidated financial statements.

Interest expense, net reflects the following:

 

|                                         | ** ** | **Three Months Ended  June 30, 2006** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                                  | ** ** | **2005** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                   | ** ** |
| Interest expense                        | ** ** | **$**                                                     | **(300**   | **)** | $ | (265 | ) |
| Amortization of  debt discount          | ** ** | **(52**                                                   | **)**      | (52 | ) |
| Amortization of  deferred finance costs | ** ** | **(34**                                                   | **)**      | (35 | ) |
| Interest expense, net                   | ** ** | **$**                                                     | **(386**   | **)** | $ | (352 | ) |

 

Interest expense increased 9.7% for the three monthperiod ended June 30, 2006 compared to the corresponding period in the priorfiscal year primarily as a result of a higher level of borrowings on our lineof credit in the current year.

*IncomeTaxes*.  During the three months ended June 30, 2006, werecognized an income tax benefit of $610,000, as compared to income tax expenseof $8,000 in the three months ended June 30, 2005.  The tax benefit recorded in the three monthsended June 30, 2006 reflects a tax benefit of $154,000 based on an estimatedannual effective tax rate of 47.3% applied to the pre-tax losses for the threemonths ended June 30, 2006, as well as a $456,000 reduction in the valuationallowance recorded against our deferred tax assets as a result of changes inestimates of the future realizability of these assets.  As a result, total deferred tax assets on ourconsolidated balance sheet increased from $1.6 million at March 31, 2006to $2.1 million at June 30, 2006.  In thefuture, we may continue to record similar adjustments to our deferred tax assetvaluation allowance as our estimates are updated.  We anticipate this will cause our futureeffective tax rate in any given period to fluctuate from prior effective taxrates, estimated effective tax rates and statutory tax rates.

**Liquidityand Capital Resources**

*Cash Flows*

We havehistorically financed our operations with a combination of cash flows fromoperations, borrowings under credit facilities and the sale of equitysecurities. We currently rely on cash flows from operations and borrowings on aline of credit facility to fund our operations. At June 30, 2006, we had $3.1 million in working capital, which includedborrowings of $3.5 million on our revolving line of credit and $225,000 in cashand cash equivalents. This compares to working capital of $3.3 million atMarch 31, 2006, which included borrowings of $2.7 million on our revolvingline of credit and $131,000 in cash and cash equivalents. Our operations used$599,000 of cash during the three months ended June 30, 2006, primarily as aresult of increases in prepayments, accounts payable and accrued expenses dueto the timing of payments.  Additionally,inventory levels increased slightly to support sales growth.  During the three months ended June 30, 2005,we used $1.9 million in cash, primarily as a result of a higher level of openaccounts receivable driven by sales growth and increased accounts payable andaccrued expenses due to the timing of payments, partially offset by planneddecreases in inventory levels.

Our investingactivities for the three months ended June 30, 2006 and 2005 consisted entirelyof purchases of property and equipment, which aggregated $142,000 and $212,000,respectively.

Cash provided byfinancing activities was $835,000 in the three months ended June 30, 2006,which was the result of net borrowings of $667,000 and cash inflows of $168,000from the exercise of outstanding stock options to purchase our common stock.During the three months ended June 30, 2005, financing activities provided $2.0million of cash, which was comprised of net borrowings of $1.9 million and cashinflows of $124,000 from the exercise of outstanding stock options and warrantsto purchase our common stock.

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*Borrowings*

The following tablesummarizes our borrowings and long-term debt:

 

|                              | ** ** | **At June 30, 2006** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **(In thousands)**             | ** ** |
| Convertible  debentures, net |       | $                                   | 9,255      |   |
| Bank term note               |       | 2,396                               |       |
| Promissory note  to landlord |       | 1,292                               |       |
| Other                        |       | 119                                 |       |
|                         |       | $                                   | 13,062     |   |

 

We renewed our credit agreement with our bankeffective August 1, 2005.  This creditagreement expired on July 31, 2006, but was extended until August 31, 2006, andprovides for borrowings of up to $5.0 million subject to a borrowing formulabased upon qualified accounts receivable and inventories as defined in thecredit agreement.  At June 30, 2006, wehad $4.1 million available under the revolving line of credit, of which$600,000 was unused.  We are in theprocess of renegotiating with our bank for a new line of credit but cannotassure you that we will be successful in securing a new line on a timely basis,on favorable terms, or at all.  If ourline of credit is renewed, we believe that the cash generated from ouroperations, together with our line of credit, will be sufficient to fund ouroperations for at least the next twelve months. However, should a shortfalloccur, we believe we could obtain additional funds through additionalborrowings or the sale of equity securities.

**Contractual Obligations**

Our contractual obligations are as follows at June 30,2006:

 
| ** **              | ** ** | **Payments Due by Period** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **(In thousands)**                   | ** ** |
| Lines of credit         |       | $                                         | 3,509      |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 3,509 |   |
| Notes payable           |       | 1,636                                     |       | 1,940 |   | 231 |   | — |   | — |   | 3,807 |   |
| Convertible  debentures |       | —                                    |       | — |   | — |   | 9,850 |   | — |   | 9,850 |   |
| Operating leases        |       | 1,112                                     |       | 932 |   | 127 |   | 85 |   | 43 |   | 2,299 |   |
| Total                   |       | $                                         | 6,257      |   | $ | 2,872 |   | $ | 358 |   | $ | 9,935 |   | $ | 43 |   | $ | 19,465 |   |

 

At June 30, 2006, we had firm commitments to purchase inventory inthe amount of $1.9 million during the second and third quarters of the fiscalyear ending March 31, 2007.

**Off Balance Sheet Arrangements**

In May 2004 we issued subordinated convertible debentures in anaggregate original principal amount of $10.1 million. These debentures aredue in full on May 19, 2009 and are convertible into shares of our common stockat a conversion price of $3.61 per share. At June 30, 2006, $9.9 million ofthese convertible debentures remained outstanding. Because these debentures areconventionally convertible, we have not separately accounted for the conversionfeature and, accordingly, no separate amounts are presented in our condensedconsolidated financial statements in connection with this conversion feature.

At June 30, 2006, outstanding warrants to purchase 1,250,000 shares ofour common stock at an exercise price of $1.64 per share and outstandingwarrants to purchase an aggregate of 62,500 shares of common stock at anexercise price of $1.95 per share are callable by us if the closing sales priceof our common stock for 20 consecutive days is equal to or greater than twotimes the exercise price of the warrants. Outstanding warrants to purchase anaggregate of 75,000 shares of our common stock at an exercise price of$5.00 per share are callable by us if the price of our common stock for20 consecutive days is equal to or greater than one and a half times theexercise price of the warrants.

In connection with the issuance of warrants to purchase 1,250,000shares of our common stock at $1.64 per share, we are a party to certainregistration rights agreements that contain provisions under which we could besubjected to liquidated damages should we fail to maintain effectiveregistration statements for the underlying shares of common stock.  These warrants have been accounted for withinequity in our condensed consolidated balance sheets in accordance with EITF00-19, *Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock*, and,accordingly, no liabilities have been recorded in connection therewith.  As of the date of this filing, no liquidateddamages are payable under the provisions of the registration rights agreementsassociated with these warrants.

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**Recent Accounting Pronouncements**

In July 2006, the FASB issued FASB Interpretation No.48, *Accounting for Uncertainty in Income Taxes*(“FIN 48”).  FIN 48 clarifies theaccounting and reporting for income taxes recognized in accordance with SFASNo. 109, *Accounting for Income Taxes*.  This Interpretation prescribes acomprehensive model for the financial statement recognition, measurement,presentation and disclosure of uncertain tax positions taken or expected to betaken in income tax returns.  We are currentlyevaluating the impact of FIN 48 and will adopt this Interpretation in the firstquarter of our fiscal year ending March 31, 2008.

 

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

Ourexposure to interest rate risk is limited to our line of credit, bank term noteand a promissory note to our landlord. Our line of credit, bank term note andpromissory note to our landlord bear interest based on the prevailing primerate (8.25% at June 30, 2006).  We do notbelieve that a 10% increase in the interest rate on our line of credit, bankterm note and promissory note to our landlord (from 11.25% to 12.38% on theline of credit, from 8.50% to 9.35% on the bank term note and from 10.25% to11.28% on the promissory note to our landlord) would not have a material impacton our financial position, operating results, or cash flows. In addition, webelieve that the carrying value of our outstanding debt approximates fairvalue.

**ITEM 4.  CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

As of the end of theperiod covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures, as such term isdefined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective to ensure thatinformation required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’srules and forms and are effective in ensuring that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure. In designing and evaluating the disclosurecontrols and procedures, our management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives. Ourmanagement necessarily applied its judgment in evaluating the cost-benefitrelationship of such controls and procedures.

**Changesin Internal Controls**

During the most recentcompleted fiscal quarter covered by this report, there has been no change inour internal controls over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934) that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrols over financial reporting.

Effective April 1, 2006, weimplemented a new enterprise resource planning system that thus for has notresulted in any material changes in our internal controls over financialreporting.

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**PART II. OTHER INFORMATION**

**ITEM 1.  LEGAL PROCEEDINGS**

The information set forth under Note 4 of Notes toUnaudited Condensed Consolidated Financial Statements, included in Part I,Item I of this report, is incorporated herein by reference.

**ITEM 1A.  RISK FACTORS**

*Our business is subject to a numberof risks, some of which are discussed below. Other risks are presented elsewhere in this report and in our otherfilings with the SEC.  You shouldconsider the following risks carefully in addition to the other informationcontained in this report and our other filings with the SEC, including oursubsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell or holdour common stock. The risks and uncertainties described below are not the onlyones facing our company.  Additionalrisks and uncertainties not presently known to us or that we currently deemimmaterial may also affect our business operations.  If any of these risks actually occurs, ourbusiness, financial condition or results of operations could be seriouslyharmed.  In that event, the market pricefor our common stock could decline and you may lose all or part of yourinvestment.*

**We HaveExperienced Substantial Losses And May Continue To Experience Losses ForThe Foreseeable Future.**Although we had net income of $80,000from continuing operations in the year ended March 31, 2006, we experiencednet losses from continuing operations of $11.3 million and $1.9 million in theyears ended March 31, 2005 and 2004, respectively. While we have divestedother business units, we cannot assure you that our efforts to downsize ouroperations or reduce our operating expenses will improve our financialperformance, or that we will be able to achieve profitability on a quarterly orannual basis in the future. Most of our expenses are fixed in advance. As such,we generally are unable to reduce our expenses significantly in the short-termto compensate for any unexpected delay or decrease in anticipated revenues. Asa result, we may continue to experience operating losses and net losses, whichwould make it difficult to fund our operations and achieve our business plan,and could cause the market price of our common stock to decline.

**We May Need To Raise Additional Capital InThe Future, Which May Not Be Available On Terms Acceptable To Us, Or AtAll.**We have generated significant net losses and operatinglosses in recent periods, and have experienced volatility in our cash flowsfrom operations ranging from positive cash flows from operations of $590,000 inthe year ended March 31, 2005 to negative cash flows from operations of$718,000 in the year ended March 31, 2004 and $599,000 in the three monthsended June 30, 2006. Additionally, we failed to meet certain debt covenantsunder our credit agreement with our bank in two of our last five fiscalquarters.  Our line of credit under thiscredit agreement expired on July 31, 2006. Although the line of credit agreement has been extended until August 31,2006 and we are currently negotiating with our bank to replace the line ofcredit, we cannot assure you that we will be able to renew this line of creditfacility on acceptable terms, in a timely manner or at all.

At June 30, 2006, we had $225,000 of cash and cashequivalents and an outstanding balance of $3.5 million on our line of credit,which line of credit is used to fund our operations. We may need to raiseadditional capital in the near future to fund our operations or to repayindebtedness. Such additional capital may be raised through bank borrowings, orother debt or equity financings. We cannot assure you that any additionalcapital will be available on a timely basis, on acceptable terms, or at all,and such additional financing may result in further dilution to ourstockholders.

Our capital requirements will depend on many factors,including, but not limited to:

·                                       marketacceptance of our products and product enhancements, and the overall level ofsales of our products;

·                                       ourability to control costs;

·                                       thesupply of key components for our products;

·                                       ourability to generate net income;

·                                       increasedresearch and development expenses;

·                                       increasedsales and marketing expenses;

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·                                       technologicaladvancements and our competitors’ response to our products;

·                                       capitalimprovements to new and existing facilities and enhancements to ourinfrastructure and systems;

·                                       potentialacquisitions of businesses and product lines;

·                                       ourrelationships with customers and suppliers;

·                                       governmentbudgets, political agendas and other funding issues;

·                                       ourability to successfully negotiate credit arrangements with our bank; and

·                                       generaleconomic conditions, including the effects of the current economic slowdown andinternational conflicts.

If our capital requirements are materially differentfrom those currently planned, we may need additional capital sooner thananticipated. If additional funds are raised through the issuance of equity orconvertible debt securities, the percentage ownership of our stockholders willbe reduced and such securities may have rights, preferences and privilegessenior to our common stock. Additional financing may not be available onfavorable terms, on a timely basis, or at all. If adequate funds are notavailable or are not available on acceptable terms, we may be unable tocontinue our operations as planned, develop or enhance our products, expand oursales and marketing programs, take advantage of future opportunities or respondto competitive pressures.

**If OurInternal Controls Over Financial Reporting Do Not Comply With The RequirementsOf The Sarbanes-Oxley Act, Our Business And Stock Price Could Be AdverselyAffected.**Along with our independent registered publicaccounting firm, we will be evaluating the effectiveness of our internalcontrols over financial reporting to comply with Section 404 of theSarbanes-Oxley Act of 2002. Section 404 currently requires us to evaluatethe effectiveness of our internal controls over financial reporting at the endof each fiscal year beginning in our fiscal year ending March 31, 2008 atthe earliest, and to include a management report assessing the effectiveness ofour internal controls over financial reporting in all annual reports beginningwith our Annual Report on Form 10-K for the fiscal year endingMarch 31, 2008 at the earliest. Section 404 also requires ourindependent accountant to attest to, and report on, management’s assessment ofour internal controls over financial reporting. We may not be able to completeour Section 404 compliance on a timely basis and even if we timelycomplete our compliance requirements, our independent auditors may stillconclude that our internal controls over financial reporting are not effective.

Our management, including our CEO and CFO, does notexpect that our internal controls over financial reporting will prevent allerror and all fraud. A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurance that the controlsystem’s objectives will be met. Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the company have been, or will be detected. These inherent limitationsinclude the realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of simple error or mistake. Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls. The design of anysystem of controls is based in part on certain assumptions about the likelihoodof future events, and we cannot assure you that any design will succeed inachieving its stated goals under all potential future conditions. Over time,our controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures. Becauseof the inherent limitations in a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected.

As of March 31, 2005, we became aware of amaterial weakness in our internal controls related to the accounting for theconsolidation of our deferred compensation savings plan and certain contractadministration. We cannot assure you that we or our independent registeredpublic accounting firm will not identify additional material weaknesses in ourinternal controls. A material weakness is a control deficiency, or combinationof control deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected. Based on our evaluation, our management concluded that,as of March 31, 2004, our internal control over financial reporting wasnot effective due to the existence of one material weakness. We may experienceadditional material weaknesses in the future. If our internal controls overfinancial reporting are not considered adequate, we may experience a loss ofpublic confidence, which could have an adverse effect on our business and ourstock price.

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**We May Experience Production Gaps Which CouldMaterially And Adversely Impact Our Sales And Financial Results And TheUltimate Acceptance Of AutoVue. **Itis possible that we could experience unforeseen quality control issues or partshortages as we ramp up to full production to meet current demand of our LDWsystems. Should any such delay or disruption occur while increasing productionof our LDW systems, our future sales will likely be materially and adverselyaffected.

**We Depend Upon Valeo To Market Our AutoVueTechnologies For The OEM Passenger Car Market.**We havegranted Valeo the exclusive right to sell and manufacture our AutoVue LDWsystem to the worldwide passenger car market in exchange for royalty paymentsfor each AutoVue unit sold. As such, the future success and broad marketacceptance of our AutoVue technologies in the passenger car market will dependupon Valeo’s ability to manufacture, market and sell our technologies, and toconvince more OEM passenger car manufacturers to adopt our technologies. IfValeo does not devote considerable resources and aggressively pursueopportunities, our expansion into the passenger car market could be adverselyaffected.

**We May Be Unable To Attract And Retain KeyPersonnel, Which Could Seriously Harm Our Business.**Due tothe specialized nature of our business, we are highly dependent on thecontinued service of our executive officers and other key management,engineering and technical personnel. The loss of any of our executive officersor key members of management could adversely affect our business, financialcondition or results of operations. Our success will also depend in large partupon our ability to continue to attract, retain and motivate qualifiedengineering and other highly skilled technical personnel. In particular, thefuture success of our Transportation Systems business will depend on ourability to hire additional qualified engineers and planners. Competition forqualified employees, particularly development engineers, is intense. We may notbe able to continue to attract and retain sufficient numbers of such highlyskilled employees. Our inability to attract and retain additional key employeesor the loss of one or more of our current key employees could adversely affectour business, financial condition and results of operations.

**If We Are Unable To Develop And Introduce NewProducts And Product Enhancements Successfully And In A Cost-Effective AndTimely Manner, Or Are Unable To Achieve Market Acceptance Of Our New Products,Our Operating Results Would Be Adversely Affected.**We believeour revenue growth and future operating results will depend on our ability tocomplete development of new products and enhancements, introduce these productsin a timely, cost-effective manner, achieve broad market acceptance of theseproducts and enhancements, and reduce our product costs. We cannot guaranteethe success of these products and we may not be able to introduce any newproducts or any enhancements to our existing products on a timely basis, or atall. In addition, the introduction of any new products could adversely affectthe sales of certain of our existing products.

We believe that we must continue to make substantialinvestments to support ongoing research and development in order to remaincompetitive. We need to continue to develop and introduce new products thatincorporate the latest technological advancements in outdoor image processinghardware, software and camera technologies in response to evolving customerrequirements. Our business and results of operations could be adverselyaffected if we do not anticipate or respond adequately to technologicaldevelopments or changing customer requirements. We cannot assure you that anysuch investments in research and development will lead to any correspondingincrease in revenue.

Market acceptance of our new products depends uponmany factors, including our ability to accurately predict market requirementsand evolving industry standards, our ability to resolve technical challenges ina timely and cost-effective manner, qualify any new products with OEMs andachieve manufacturing efficiencies, the perceived advantages of our newproducts over traditional products and the marketing capabilities of ourindependent distributors and strategic partners, including Valeo’s ability toexpand sales of AutoVue in the passenger car market. The success of our AutoVuesystem will also depend in part on the success of the automotive vehicles thatincorporate our technology, as well as the success of optional equipment thatOEMs bundle with our technologies.

Certain of the components used in our Vantage andAutoVue products may need to be re-engineered in the next 18 months as theindustry is moving towards a standard of using lead-free components. We cannotassure you as to the timing of the adoption of this new standard or our abilityto successfully redesign our products to incorporate compliant components 

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andgain market acceptance of such redesigned products. In addition, if thestandard is adopted earlier than anticipated we may experience a shortage ofVantage and AutoVue products as a result of potential scarcity of lead-freecomponents.

Our business andresults of operations could also be seriously harmed by any significant delaysin our new product development. Certain of our new products could containundetected design faults and software errors or “bugs” when first released byus, despite our testing. We may not discover these faults or errors until aftera product has been installed and used by our customers. Any faults or errors inour existing products or in any new products may cause delays in productintroduction and shipments, require design modifications or harm customerrelationships, any of which could adversely affect our business and competitiveposition.

**The Markets In Which We Operate Are HighlyCompetitive And Have Many More Established Competitors, Which Could Adversely AffectOur Sales Or The Market Acceptance Of Our Products.**Wecompete with numerous other companies in our target markets including, but notlimited to, large, multinational corporations, which include tier oneautomotive suppliers, and many smaller regional engineering firms. We expectsuch competition to increase due to technological advancements, industryconsolidations and reduced barriers to entry. Increased competition is likelyto result in price reductions, reduced gross margins and loss of market share,any of which could seriously harm our business, financial condition and resultsof operations. We may experience more competition in our Vantage business inFiscal 2007 as the department of transportation in one of our largest salesterritories is moving to a multisource contracting environment from one inwhich Iteris is the preferred supplier. In addition, one of the otherdevelopers of LDW systems was recently acquired by a larger company. While thisdeveloper has not been a material competitor to date, we may experience morecompetition from this provider as a result of its greater access to resourcesfrom its acquirer, and additional competitors may enter this market in thefuture.

Many of our competitors have far greater namerecognition and greater financial, technological, marketing and customerservice resources than we do. This may allow them to respond more quickly tonew or emerging technologies and changes in customer requirements. It may alsoallow them to devote greater resources to the development, promotion, sale andsupport of their products than we can. Recent consolidations of end users,distributors and manufacturers in our target markets have exacerbated thisproblem. As a result of the foregoing factors, we may not be able to competeeffectively in our target markets and competitive pressures could adverselyaffect our business, financial condition and results of operations.

**An Economic Slowdown Or TheSignificant Military Operations In The Middle East Or Elsewhere May ImpactGovernment Funding Or Consumer Spending, Causing A Decline In Our Revenues.** In the near term, the funding of U.S. militaryoperations in the Middle East or elsewhere may cause disruptions in funding ofgovernment contracts.  Since militaryoperations of such magnitude are not routinely included in U.S. defensebudgets, supplemental legislative funding actions are often required to financesuch operations. Even when such legislation is enacted, it may not be adequatefor ongoing operations, causing other government sources to be temporarily orpermanently diverted.  Since asignificant portion of our sales are derived from contracts with governmentagencies, such diversion of funds could produce interruptions in funding ordelays in receipt of our contracts, causing disruptions and adversely effectingour revenue and operations. 

Concerns about the recent international conflicts andterrorist and military actions, as well as concerns about inflation, decreasedconsumer confidence, and reduced corporate profits and capital spending havealso resulted in a downturn in worldwide economic conditions, particularly inthe United States. These unfavorable economic conditions may have a negativeimpact on customer orders (and also may result in decreased sales ofautomobiles and trucks that incorporate our LDW systems).  Such concerns may result in cancellations andrescheduling of backlog.  Thesepolitical, social and economic conditions make it extremely difficult for ourcustomers, our suppliers and us to accurately forecast and plan future businessactivities. If such conditions continue or worsen, our business, financialcondition and results of operations could be materially and adversely affected.

**New Environmental Regulations MayResult In A Decline In Our AutoVue Sales and Royalties. **Recent environmentalregulations in Europe are expected to be in place during Fall 2006 which willrequire more stringent emissions compliance in new trucks manufactured, thatcould cause a decline in new truck sales in Europe in the near future.  Similar regulations have been announced inNorth America that may impact diesel engines built after January 2007, whichcould similarly impact North American OEM truck sales in general.  As a result, we may experience a decline inour LDW sales to truck OEMs related to these stricter regulations.

**We Depend On Government Contracts AndSubcontracts, And Because Many Of Our Government Contracts Are Fixed PriceContracts, Higher Than Anticipated Costs Will Reduce Our Profit And CouldAdversely Impact Our Operating Results.**A significant portionof our sales were derived from contracts with governmental agencies, either asa general contractor, subcontractor or supplier. Government contractsrepresented approximately 38.3%, 37.4% and 48.2% of our total net sales andcontract revenues for the years ended March 31, 2006, 2005 and 2004,respectively. We anticipate that revenue from government contracts willcontinue to increase in the near future. Government business is, in general,subject to special risks and challenges, including:

·                                          longpurchase cycles or approval processes;

·                                          competitivebidding and qualification requirements;

·                                          theimpact of international conflicts;

·                                          performancebond requirements;

·                                          changesin government policies and political agendas;

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·                                          delaysin funding, including the delays in the allocation of funds to state and localagencies from the U.S. transportation bill;

·                                          othergovernment budgetary constraints and cut-backs; and

·                                          milestonerequirements and liquidated damage provisions for failure to meet contractmilestones

In addition, a large number of our governmentcontracts are fixed price contracts. As a result, we may not be able to recoverany cost overruns we may incur. These fixed price contracts require us toestimate the total project cost based on preliminary projections of the project’srequirements. The financial viability of any given project depends in largepart on our ability to estimate these costs accurately and complete the projecton a timely basis. In the event our costs on these projects exceed the fixedcontractual amount, we will be required to bear the excess costs. Suchadditional costs would adversely affect our financial condition and results ofoperations. Moreover, certain of our government contracts are subject to terminationor renegotiation at the convenience of the government, which could result in alarge decline in our net sales in any given quarter. Our inability to addressany of the foregoing concerns or the loss or renegotiation of any materialgovernment contract could seriously harm our business, financial condition andresults of operations.

**Our Quarterly Operating Results Fluctuate As AResult Of Many Factors. Therefore, We May Fail To Meet Or Exceed TheExpectations Of Securities Analysts And Investors, Which Could Cause Our StockPrice To Decline.**Our quarterly revenues and operatingresults have fluctuated and are likely to continue to vary from quarter toquarter due to a number of factors, many of which are not within our control.Factors that could affect our revenues include, among others, the following:

·                                          changesin our pricing policies and the pricing policies of our suppliers andcompetitors, pricing concessions on volume sales, as well as increased pricecompetition in general;

·                                          thelong lead times associated with government contracts or required by vehiclemanufacturers;

·                                          delaysin the allocation of funds to state and local agencies from the U.S. governmenttransportation bill;

·                                          ourability to raise additional capital;

·                                          ourability to control costs;

·                                          themix of our products and services sold in a quarter, which mix has varied and isexpected to continue to vary from time to time;

·                                          internationalconflicts and acts of terrorism;

·                                          ourability to develop, introduce, patent, market and gain market acceptance of newproducts, applications and product enhancements in a timely manner, or at all;

·                                          marketacceptance of the products incorporating our technologies and products;

·                                          thesize, timing, rescheduling or cancellation of significant customer orders;

·                                          theintroduction of new products by competitors;

·                                          theavailability and cost of components used in the manufacture of our products;

·                                          oursuccess in expanding and implementing our sales and marketing programs;

·                                          theeffects of technological changes in our target markets;

·                                          theamount of our backlog at any given time;

·                                          seasonalitydue to winter weather conditions;

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·                                          thenature of our government contracts;

·                                          deferralsof customer orders in anticipation of new products, applications or productenhancements;

·                                          risksand uncertainties associated with our international business;

·                                          currencyfluctuations and our ability to get currency out of certain foreign countries;and

·                                          generaleconomic and political conditions.

Due to all of the factors listed above as well asother unforeseen factors, our future operating results could be below theexpectations of securities analysts or investors. If that happens, the tradingprice of our common stock could decline. As a result of these quarterlyvariations, you should not rely on quarter-to-quarter comparisons of ouroperating results as an indication of our future performance.

**We May Engage In Acquisitions Of Companies OrTechnologies That May Require Us To Undertake Significant CapitalInfusions And Could Result In Disruptions Of Our Business And Diversion OfResources And Management Attention.**We have historicallyacquired, and may in the future acquire, complementary businesses, products andtechnologies. Acquisitions may require significant capital infusions and, ingeneral, acquisitions also involve a number of special risks, including:

·                                          potentialdisruption of our ongoing business and the diversion of our resources andmanagement’s attention;

·                                          thefailure to retain or integrate key acquired personnel;

·                                          thechallenge of assimilating diverse business cultures, and the difficulties inintegrating the operations, technologies and information system of the acquiredcompanies;

·                                          increasedcosts to improve managerial, operational, financial and administrative systemsand to eliminate duplicative services;

·                                          theincurrence of unforeseen obligations or liabilities;

·                                          potentialimpairment of relationships with employees or customers as a result of changesin management; and

·                                          increasedinterest expense and amortization of acquired intangible assets.

Our competitors are also soliciting potentialacquisition candidates, which could both increase the price of any acquisitiontargets and decrease the number of attractive companies available foracquisition. Acquisitions may also materially and adversely affect ouroperating results due to large write-offs, contingent liabilities, substantialdepreciation, deferred compensation charges or intangible asset amortization,or other adverse tax or accounting consequences. We cannot assure you that wewill be able to identify or consummate any additional acquisitions,successfully integrate any acquisitions or realize the benefits anticipatedfrom any acquisition.

**WeHave Experienced Growth In Recent Periods. If We Fail To Manage Our GrowthEffectively, We May Be Unable To Execute Our Business Plan AndMay Experience Future Weaknesses In Our Internal Controls.**Wehave expanded our overall business, particularly in our Vantage and AutoVueproduct lines. In order to achieve our business objectives, we will need tocontinue to expand our business and add additional qualified personnel. Suchexpansion has placed and is expected to continue to place, a significant strainon our managerial, administrative, operational, financial and other resources.If we are unable to successfully manage our growth, our business, financialcondition and results of operations will be adversely affected.

Toaccommodate this growth, we launched a new ERP system in April 2006.Accordingly, we may experience problems commonly experienced by other companiesin connection with such implementations, including but not limited to,potential bugs in the system, component or supply delays, training requirementsand other integration challenges and delays. Any difficulties we mightexperience in connection with our new ERP system could have a material adverseeffect on our financial reporting system and internal controls.

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**If We Do Not Keep Pace With Rapid TechnologicalChanges And Evolving Industry Standards, We Will Not Be Able To RemainCompetitive And There Will Be No Demand For Our Products.**Ourmarkets are in general characterized by the following factors:

·                                          rapidtechnological advances;

·                                          downwardprice pressure in the marketplace as technologies mature;

·                                          changesin customer requirements;

·                                          frequentnew product introductions and enhancements; and

·                                          evolvingindustry standards and changes in the regulatory environment.

Our future success will depend upon our ability toanticipate and adapt to changes in technology and industry standards, and toeffectively develop, introduce, market and gain broad acceptance of newproducts and product enhancements incorporating the latest technologicaladvancements. In particular, our LDW system is incorporated into automobilesand trucks that face significant technological changes in each model year andamong different vehicle models. Accordingly, we must adapt our technology fromtime to time to function with such changes.

**We May Not Be Able To Adequately Protect OrEnforce Our Intellectual Property Rights, Which Could Harm Our CompetitivePosition.**If we are not able to adequately protect or enforcethe proprietary aspects of our technology, competitors could be able to accessour proprietary technology and our business, financial condition and results ofoperations will likely be seriously harmed. We currently attempt to protect ourtechnology through a combination of patent, copyright, trademark and tradesecret laws, employee and third party nondisclosure agreements and similar means.Despite our efforts, other parties may attempt to disclose, obtain or use ourtechnologies or systems. Our competitors may also be able to independentlydevelop products that are substantially equivalent or superior to our productsor design around our patents. In addition, the laws of some foreign countriesdo not protect our proprietary rights as fully as do the laws of the UnitedStates. As a result, we may not be able to protect our proprietary rightsadequately in the United States or abroad.

Litigation may benecessary in the future to enforce our intellectual property rights or todetermine the validity and scope of the proprietary rights of others.Litigation may also be necessary to defend against claims of infringement orinvalidity by others. An adverse outcome in litigation or any similarproceedings could subject us to significant liabilities to third parties,require us to license disputed rights from others or require us to ceasemarketing or using certain products or technologies. We may not be able toobtain any licenses on terms acceptable to us, or at all. We also may have toindemnify certain customers or strategic partners if it is determined that wehave infringed upon or misappropriated another party’s intellectual property.Any of these results could adversely affect our business, financial conditionand results of operations. In addition, the cost of addressing any intellectualproperty litigation claim, including legal fees and expenses, and the diversionof management’s attention and resources, regardless of whether the claim isvalid, could be significant and could seriously harm our business, financialcondition and results of operations.

**The Trading Price Of Our Common Stock Is HighlyVolatile.**The trading price of our common stock has beensubject to wide fluctuations in the past. Since January 2000, ourClass A common stock (now known as our common stock) has traded at pricesas low as $0.45 per share and as high as $29.44 per share. The market price ofour common stock could continue to fluctuate in the future in response tovarious factors, including, but not limited to:

·                                          quarterlyvariations in operating results;

·                                          ourability to control costs, improve cash flow and sustain profitability;

·                                          ourability to raise additional capital;

·                                          shortagesannounced by suppliers;

·                                          announcementsof technological innovations or new products or applications by ourcompetitors, customers or us;

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·                                          transitionsto new products or product enhancements;

·                                          acquisitionsof businesses, products or technologies;

·                                          theimpact of any litigation;

·                                          changesin investor perceptions;

·                                          governmentfunding, political agendas and other budgetary issues;

·                                          changesin earnings estimates or investment recommendations by securities analysts; and

·                                          internationalconflicts, political unrest and acts of terrorism.

The stock market in general has recently experiencedvolatility, which has particularly affected the market prices of equitysecurities of many technology companies. This volatility has often beenunrelated to the operating performance of these companies. These broad marketfluctuations may adversely affect the market price of our common stock. In thepast, companies that have experienced volatility in the market price of theirsecurities have been the subject of securities class action litigation. If wewere to become the subject of a class action lawsuit, it could result insubstantial losses and divert management’s attention and resources from othermatters.

**Our International Business Operations May BeThreatened By Many Factors That Are Outside Of Our Control.**Wecurrently market our AutoVue and Vantage products internationally and weanticipate that our international operations will expand in the near future.International business operations are subject to various inherent risksincluding, among others:

·                                          currencyfluctuations and restrictions;

·                                          political,social and economic instability;

·                                          longeraccounts receivable payment cycles;

·                                          importand export license requirements and restrictions of the United States and eachother country in which we operate;

·                                          unexpectedchanges in regulatory requirements, tariffs and other trade barriers orrestrictions;

·                                          theburdens of compliance with a wide variety of foreign laws and more restrictivelabor laws and obligations;

·                                          difficultiesin managing and staffing international operations;

·                                          potentiallyadverse tax consequences; and

·                                          reducedprotection for intellectual property rights in some countries.

All of our international sales are denominated in U.S.dollars. As a result, an increase in the relative value of the dollar couldmake our products more expensive and potentially less price competitive ininternational markets. We do not engage in any transactions as a hedge againstrisks of loss due to foreign currency fluctuations.

Any of the factors mentioned above may adverselyaffect our future international sales and, consequently, affect our business,financial condition and operating results. Furthermore, as we increase ourinternational sales, our total revenues may also be affected to a greaterextent by seasonal fluctuations resulting from lower sales that typically occurduring the summer months in Europe and other parts of the world.

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**We Could Experience Negative Financial ImpactsArising From Developments In Contingencies Created Under Our Previous StructureOr By Former Subsidiaries.**Although we divested ourselves ofall business units, with the exception of our Iteris business, from time totime we could experience unforeseen developments in contingencies related toour former subsidiaries. For example, we recently entered into a preliminarysettlement agreement in connection with a lawsuit brought against MarinerNetworks, Inc., one of our former subsidiaries, by one of Mariner’ssuppliers, pursuant to which we will be required to issue $213,000 of ourcommon stock to this supplier and pay $125,000 on or before October 20, 2006and an additional $350,000 in 36 equal monthly installments of $9,700 beginningin November 2006.  Although we are notaware of any other material contingencies, it is possible that other matterscould be brought against us in connection with activities related to formersubsidiaries and that such matters could materially and adversely affect ourfinancial results and cash flows.

**Some Of Our Directors, Officers And TheirAffiliates Can Control The Outcome Of Matters That Require The Approval Of OurStockholders, And Accordingly We Will Not Be Able To Engage In CertainTransactions Without Their Approval.**As of June 30, 2006, ourofficers and directors owned approximately 16% of the outstanding shares of ourcommon stock (and approximately 25% of our common stock when including options,warrants and other convertible securities held by them which are currentlyexercisable or convertible or will become exercisable or convertible within60 days after June 30, 2006). As a result of their stock ownership, ourmanagement will be able to significantly influence the election of ourdirectors and the outcome of corporate actions requiring stockholder approval,such as mergers and acquisitions, regardless of how our other stockholders mayvote. This concentration of voting control may have a significant effect indelaying, deferring or preventing a change in our management or change incontrol and may adversely affect the voting or other rights of other holders ofcommon stock.

**Certain Anti-Takeover Provisions May AffectThe Price Of Our Common Stock And Discourage A Third Party From Acquiring Us.**Certainprovisions of our certificate of incorporation and our stockholder rights plancould make it difficult for a third party to acquire us, even though anacquisition might be beneficial to our stockholders. Such provisions couldlimit the price that investors might be willing to pay in the future for sharesof our common stock. Under the terms of our certificate of incorporation, ourBoard of Directors is authorized to issue, without stockholder approval, up to2,000,000 shares of preferred stock with voting, conversion and other rightsand preferences superior to those of our common stock. Our future issuance ofpreferred stock could be used to discourage an unsolicited acquisitionproposal. In addition, in March 1998, we adopted a stockholder rights planand declared a dividend of preferred stock purchase rights to our stockholders.We amended this plan in May 2004. In the event a third party acquires morethan 15% of the outstanding voting control of our company or 15% of ouroutstanding common stock, the holders of these rights will be able to purchasethe junior participating preferred stock at a substantial discount off of thethen current market price. The exercise of these rights and purchase of asignificant amount of stock at below market prices could cause substantialdilution to a particular acquirer and discourage the acquirer from pursuing ourcompany. The mere existence of a stockholder rights plan often delays or makesa merger, tender offer or proxy contest more difficult.

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5. OTHER INFORMATION**

None.

**ITEM 6. EXHIBITS**

Thefollowing exhibits are filed herewith or are incorporated by reference to thelocation indicated.

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| Exhibit Number | ** ** | **Description**                                                                                                                                                       | ** ** | **Where Located**                                                                                                                                                              |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1            |       | Amended and Restated Certificate of Incorporation of  the registrant                                                                                                  | * *   | *Exhibit 3.1 to the registrant’s current  report on Form 8-K as filed with the SEC on October 28, 2004*                                                    |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 3.2            |       | Bylaws of registrant, as amended                                                                                                                                      | * *   | *Exhibit 4.2 to the registrant’s Registration  Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on  July 6, 1993*                     |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 3.3            |       | Certificates of Amendment to Bylaws of the  registrant dated April 24, 1998 and August 10, 2001                                                             | * *   | *Exhibit 3.4 to the registrant’s Annual  Report on Form 10-K/A for the year ended March 31, 2003 as filed  with the SEC on July 29, 2003*             |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 3.4            |       | Certificate of Amendment to Bylaws of registrant  dated September 9, 2004                                                                                        | * *   | *Exhibit 3.1 to the registrant’s Quarterly  Report on Form 10-Q for the quarter ended September 30, 2004 as  filed with the SEC on November 15, 2004* |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 4.1            |       | Specimen of Common Stock Certificate                                                                                                                                  | * *   | *Exhibit 4.1 to the registrant’s Amendment  No. 1 to the Registration Statement on Form 8-A as filed with the  SEC on December 8, 2004*               |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 4.2            |       | Amended and Restated Rights Agreement, dated as of  May 10, 2004, by and between the registrant and U.S. Stock Transfer  Corporation, including exhibits thereto | * *   | *Exhibit 99.1 to the registrant’s  Registration Statement on Form 8-A/A as filed with the SEC on  June 18, 2004*                                           |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 31.1           |       | Certification of the Principal Executive Officer, as  required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                         | * *   | *Filed herewith*                                                                                                                                                               |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 31.2           |       | Certification of the Principal Financial and  Accounting Officer, as required pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                         | * *   | *Filed herewith*                                                                                                                                                               |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 32.1           |       | Certification of the Chief Financial Officer, as  required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             | * *   | *Filed herewith*                                                                                                                                                               |
| * *       | * *   | * *                                                                                                                                                              | * *   | * *                                                                                                                                                                       |
| 32.2           |       | Certification of the Chief Financial Officer, as  required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             | * *   | *Filed herewith*                                                                                                                                                               |

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
| Dated: August 14, 2006 |   | ITERIS, INC. |
|------------------------|--------|--------------|
|                   |   | (Registrant) |
|                   |   |         |   |   |
|                   |   | By           |   | /s/ JACK JOHNSON |
|                   |   |         |   | Jack Johnson |
|                   |   |         |   | Chief Executive Officer |
|                   |   |         |   | (Principal Executive Officer) |
|                   |   |         |   |   |
|                   |   |         |   |   |
|                   |   | By           |   | /s/ JAMES S. MIELE |
|                   |   |         |   | James S. Miele |
|                   |   |         |   | Chief Financial Officer |
|                   |   |         |   | (Principal Financial and Accounting Officer) |

 

 

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