**Tableof Contents**

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** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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,  2008** |
|                                                   |                                                                                                     |
| **OR**                                                 |
|                                                   |                                                                                                     |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                        |                                                                                                          |        |  |

 

**For the transition period from    to    **

** **

**Commission file number:  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.) |
|                                     |       |                |
| **1700 Carnegie Avenue, Suite 100** | ** ** | ** **          |
| **Santa Ana, California**                | ** ** | **92705**           |
| (Address of principal executive office)  |       | (Zip Code)          |

 

**(949)**270-9400

**(Registrant’stelephone number, including area code)**

** **

** **

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

 

**Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934, as amended (the “Exchange Act”), during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.**

** **

**Yes **x  No o

** **

**Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company. See definitions of “large accelerated filer,”“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one):**

** **

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

 

**Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).**

** **

**Yes **o No x

** **

As of July 30, 2008,the registrant had 33,971,002 shares of common stock outstanding.

 

 

** **

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**Table of Contents**

** **

**ITERIS, INC.**

**Quarterly Reporton Form 10-QFor the Three Months Ended June 30, 2008**

** **

**Table of Contents**

** **
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                         | **3**      |
|-------------------|-------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                              |       |
| **ITEM 1.**       | **FINANCIAL STATEMENTS**                                                                                          | **3**      |
|              |                                                                                                              |       |
| ** **        | **CONDENSED CONSOLIDATED  BALANCE SHEETS AT JUNE 30, 2008 AND MARCH 31, 2008**                               | **3**      |
| ** **        | ** **                                                                                                        | ** ** |
| ** **        | **UNAUDITED CONDENSED  CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30,  2008 AND 2007** | **4**      |
|              |                                                                                                              |       |
| ** **        | **UNAUDITED CONDENSED  CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED JUNE 30,  2008 AND 2007** | **5**      |
|              |                                                                                                              |       |
| ** **        | **NOTES TO  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**                                               | **6**      |
|              |                                                                                                              |       |
| **ITEM 2.**       | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                   | **15**     |
|              |                                                                                                              |       |
| **ITEM 3.**       | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                   | **21**     |
|              |                                                                                                              |       |
| **ITEM 4T.**      | **CONTROLS AND  PROCEDURES**                                                                                      | **21**     |
|              |                                                                                                              |       |
| **PART II.** | **OTHER INFORMATION**                                                                                             | **21**     |
|              |                                                                                                              |       |
| **ITEM 1.**       | **LEGAL PROCEEDINGS**                                                                                             | **21**     |
|              |                                                                                                              |       |
| **ITEM 1A.**      | **RISK FACTORS**                                                                                                  | **22**     |
| ** **        | ** **                                                                                                        | ** ** |
| **ITEM 2.**       | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                  | **30**     |
|              |                                                                                                              |       |
| **ITEM 3.**       | **DEFAULTS  UPON SENIOR SECURITIES**                                                                              | **30**     |
|              |                                                                                                              |       |
| **ITEM 4.**       | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                          | **30**     |
|              |                                                                                                              |       |
| **ITEM 5.**       | **OTHER INFORMATION**                                                                                             | **30**     |
|              |                                                                                                              |       |
| **ITEM 6.**       | **EXHIBITS**                                                                                                      | **30**     |

 

Unless otherwise indicated in this report,the “Company,” “we,” “us” and “our” collectively refer to Iteris, Inc.

 

AutoVue®, Iteris®, Vantage® and eAccessTM are among the trademarks of Iteris, Inc.Any other trademarks or trade names mentioned herein are the property of theirrespective owners.

 

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**Table of Contents**

 

**PART I. FINANCIALINFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

** **

**ITERIS,INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Inthousands, except par value amounts)**

** **
| ** **                                                                                                                                                             | ** ** | **June 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                             | ** ** | **(unaudited)**         | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                                             |       |                    | ** ** |                     |       |
| Current assets:                                                                                                                                                        |       |                    | ** ** |                     |       |
| Cash and cash equivalents                                                                                                                                              | ** ** | **$**                   | **68**     | ** **               | $          | 421 |   |
| Trade accounts receivable, net of allowance  for doubtful accounts of $1,032 and $1,020 at June 30, 2008 and  March 31, 2008, respectively                   | ** ** | **16,027**              | ** ** | 13,108                   |       |
| Costs and estimated earnings in excess of  billings on uncompleted contracts                                                                                           | ** ** | **4,144**               | ** ** | 5,351                    |       |
| Inventories, net of reserve for inventory  obsolescence of $885 and $819 at June 30, 2008 and March 31, 2008,  respectively                                  | ** ** | **4,380**               | ** ** | 4,226                    |       |
| Deferred income taxes                                                                                                                                                  | ** ** | **2,541**               | ** ** | 2,541                    |       |
| Prepaid expenses and other current assets                                                                                                                              | ** ** | **451**                 | ** ** | 371                      |       |
| Total current assets                                                                                                                                                   | ** ** | **27,611**              | ** ** | 26,018                   |       |
| Property and equipment, net                                                                                                                                            | ** ** | **3,482**               | ** ** | 3,467                    |       |
| Deferred income taxes                                                                                                                                                  | ** ** | **7,807**               | ** ** | 7,807                    |       |
| Intangible assets, net                                                                                                                                                 | ** ** | **221**                 | ** ** | 257                      |       |
| Goodwill                                                                                                                                                               | ** ** | **27,774**              | ** ** | 27,774                   |       |
| Other assets                                                                                                                                                           | ** ** | **296**                 | ** ** | 322                      |       |
| Total assets                                                                                                                                                           | ** ** | **$**                   | **67,191** | ** **               | $          | 65,645 |   |
|                                                                                                                                                                   |       |                    | ** ** |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                         | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current liabilities:                                                                                                                                                   |       |                    | ** ** |                     |       |
| Trade accounts payable                                                                                                                                                 | ** ** | **$**                   | **3,552**  | ** **               | $          | 3,902 |   |
| Accrued payroll and related expenses                                                                                                                                   | ** ** | **3,507**               | ** ** | 3,825                    |       |
| Accrued liabilities                                                                                                                                                    | ** ** | **2,901**               | ** ** | 1,973                    |       |
| Billings in excess of costs and estimated  earnings on uncompleted contracts                                                                                           | ** ** | **1,306**               | ** ** | 1,126                    |       |
| Revolving line of credit                                                                                                                                               | ** ** | **—**              | ** ** | —                   |       |
| Current portion of long-term debt                                                                                                                                      | ** ** | **7,630**               | ** ** | 244                      |       |
| Total current liabilities                                                                                                                                              | ** ** | **18,896**              | ** ** | 11,070                   |       |
| Deferred rent                                                                                                                                                          | ** ** | **1,899**               | ** ** | 1,956                    |       |
| Unrecognized tax benefits                                                                                                                                              | ** ** | **1,380**               | ** ** | 1,381                    |       |
| Other non-current liabilities                                                                                                                                          | ** ** | **105**                 | ** ** | 461                      |       |
| Long-term debt                                                                                                                                                         | ** ** | **—**              | ** ** | 7,566                    |       |
| Total liabilities                                                                                                                                                      | ** ** | **22,280**              | ** ** | 22,434                   |       |
| Commitments and contingencies                                                                                                                                          |       |                    | ** ** |                     |       |
| Stockholders’ equity:                                                                                                                                             |       |                    | ** ** |                     |       |
| Preferred stock, $1.00 par value, 2,000  shares authorized, none issued and outstanding at June 30, 2008 and  March 31, 2008                                 |       | —                  | ** ** | —                   |       |
| Common stock, $0.10 par value, 70,000  shares authorized, 33,891 and 33,420 shares issued and outstanding at  June 30, 2008 and March 31, 2008, respectively | ** ** | **3,389**               | ** ** | 3,342                    |       |
| Additional paid-in capital                                                                                                                                             | ** ** | **136,333**             | ** ** | 135,516                  |       |
| Common stock held in trust, 24 and 167  shares at June 30, 2008 and March 31, 2008, respectively                                                             | ** ** | **(31**                 | **)**      | (202                     | )          |
| Accumulated deficit                                                                                                                                                    | ** ** | **(94,833**             | **)**      | (95,499                  | )          |
| Accumulated other comprehensive income                                                                                                                                 | ** ** | **53**                  | ** ** | 54                       |       |
| Total stockholders’ equity                                                                                                                                        | ** ** | **44,911**              | ** ** | 43,211                   |       |
| Total liabilities and stockholders’ equity                                                                                                                        | ** ** | **$**                   | **67,191** | ** **               | $          | 65,645 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

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**ITERIS, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except per shareamounts)**

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| Net sales and contract revenues:          |       |                                            | ** ** |   |   |
| Net sales                                 | ** ** | **$**                                           | **10,526** | ** ** | $ | 10,244 |   |
| Contract revenues                         | ** ** | **6,916**                                       | ** ** | 5,513 |   |
| Total net sales and contract revenues     | ** ** | **17,442**                                      | ** ** | 15,757 |   |
|                                      |       |                                            | ** ** |   |   |
| Costs of net sales and contract revenues: |       |                                            | ** ** |   |   |
| Cost of net sales(a)                      | ** ** | **5,267**                                       | ** ** | 5,175 |   |
| Cost of contract revenues(a)              | ** ** | **4,423**                                       | ** ** | 3,488 |   |
| Gross profit                              | ** ** | **7,752**                                       | ** ** | 7,094 |   |
| Operating expenses:                       |       |                                            | ** ** |   |   |
| Selling, general and administrative(a)    | ** ** | **5,156**                                       | ** ** | 4,489 |   |
| Research and development(a)               | ** ** | **1,210**                                       | ** ** | 994 |   |
| Amortization of intangible assets         | ** ** | **36**                                          | ** ** | 37 |   |
| Total operating expenses                  | ** ** | **6,402**                                       | ** ** | 5,520 |   |
| Operating income                          | ** ** | **1,350**                                       | ** ** | 1,574 |   |
| Non-operating income (expense):           |       |                                            | ** ** |   |   |
| Other income, net                         | ** ** | **5**                                           | ** ** | 19 |   |
| Interest expense, net                     | ** ** | **(198**                                        | **)**      | (363 | ) |
| Income before income taxes                | ** ** | **1,157**                                       | ** ** | 1,230 |   |
| Income tax provision                      | ** ** | **(491**                                        | **)**      | (134 | ) |
| Net income                                | ** ** | **$**                                           | **666**    | ** ** | $ | 1,096 |   |
|                                      |       |                                            | ** ** |   |   |
| Earnings per share:                       |       |                                            | ** ** |   |   |
| Basic                                     | ** ** | **$**                                           | **0.02**   | ** ** | $ | 0.03 |   |
| Diluted                                   | ** ** | **$**                                           | **0.02**   | ** ** | $ | 0.03 |   |
| Weighted average shares outstanding:      |       |                                            | ** ** |   |   |
| Basic                                     | ** ** | **33,618**                                      | ** ** | 32,089 |   |
| Diluted                                   | ** ** | **34,939**                                      | ** ** | 34,317 |   |

 

----

| (a) Includes stock-based compensation  expense as follows: |   |   |   |   |   |
|-----------------------------------------------------------------|--------|--------|--------|--------|--------|

 
| Cost of net sales                           | ** ** | **$**  | **2**  |   | $      | 1  |   |
|---------------------------------------------|------------|--------|--------|--------|--------|----|--------|
| Cost of contract revenues                   | ** ** | **10** |   | 3      |   |
| Selling, general and administrative expense | ** ** | **77** |   | 59     |   |
| Research and development expense            | ** ** | **5**  |   | 3      |   |
| Total                                       | ** ** | **$**  | **94** |   | $      | 66 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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** **

**ITERIS, INC.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(In thousands)**

** **
| ** **                                                                                   | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| **Cash flows from operating activities**                                 |       |                                            | ** ** |   |   |
| Net income                                                                                   | ** ** | **$**                                           | **666**    | ** ** | $ | 1,096 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                            | ** ** |   |   |
| Depreciation and amortization of property  and equipment                                     | ** ** | **242**                                         | ** ** | 149 |   |
| Stock-based compensation expense                                                             | ** ** | **94**                                          | ** ** | 66 |   |
| Amortization of debt discount                                                                | ** ** | **41**                                          | ** ** | 52 |   |
| Amortization of intangible assets                                                            | ** ** | **36**                                          | ** ** | 37 |   |
| Amortization of deferred financing costs                                                     | ** ** | **27**                                          | ** ** | 35 |   |
| Change in deferred tax assets                                                                | ** ** | **—**                                      | ** ** | 104 |   |
| Amortization of deferred gain on  sale—leaseback transaction                            | ** ** | **—**                                      | ** ** | (71 | ) |
| Changes in operating assets and  liabilities:                                                |       |                                            | ** ** |   |   |
| Accounts receivable                                                                          | ** ** | **(2,919**                                      | **)**      | 1,822 |   |
| Net costs and estimated earnings in excess  of billings                                      | ** ** | **1,387**                                       | ** ** | (1,682 | ) |
| Inventories                                                                                  | ** ** | **(154**                                        | **)**      | 458 |   |
| Prepaid expenses and other assets                                                            | ** ** | **(81**                                         | **)**      | (511 | ) |
| Accounts payable and accrued liabilities                                                     | ** ** | **(5**                                          | **)**      | 308 |   |
| Net cash provided by (used in) operating  activities                                         | ** ** | **(666**                                        | **)**      | 1,863 |   |
|                                                                                         |       |                                            | ** ** |   |   |
| **Cash flows from investing activities**                                                     |       |                                            | ** ** |   |   |
| Purchases of property and equipment                                                          | ** ** | **(257**                                        | **)**      | (137 | ) |
|                                                                                         |       |                                            | ** ** |   |   |
| **Cash flows from financing activities**                                                     |       |                                            | ** ** |   |   |
| Proceeds from stock option exercises                                                         | ** ** | **514**                                         | ** ** | 726 |   |
| Change in checks drawn in excess of available  bank balances                                 | ** ** | **277**                                         | ** ** | (47 | ) |
| Payments on long-term debt                                                                   | ** ** | **(221**                                        | **)**      | (648 | ) |
| Net borrowings on line of credit                                                             | ** ** | **—**                                      | ** ** | 422 |   |
| Net cash provided by financing activities                                                    | ** ** | **570**                                         | ** ** | 453 |   |
| Increase (decrease) in cash                                                                  | ** ** | **(353**                                        | **)**      | 2,179 |   |
| Cash at beginning of period                                                                  | ** ** | **421**                                         | ** ** | 35 |   |
| Cash at end of period                                                                        | ** ** | **$**                                           | **68**     | ** ** | $ | 2,214 |   |
|                                                                                         |       |                                            | ** ** |   |   |
| **Supplemental cash flow information:**                                                      | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Cash paid during the period:                                                                 |       |                                            | ** ** |   |   |
| Interest                                                                                     | ** ** | **$**                                           | **130**    | ** ** | $ | 301 |   |
| Income taxes                                                                                 | ** ** | **187**                                         | ** ** | 48 |   |
| ** **                                                                                   | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| **Supplemental schedule of non-cash  investing and financing activities:**              | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Fair value of common stock issued in  settlement of liabilities                              | ** ** | **$**                                           | **427**    | ** ** | $ | 350 |   |
| Write-off of notes receivable from  employees                                                | ** ** | **—**                                      | ** ** | (5 | ) |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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**ITERIS,INC.**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June30, 2008**

** **

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

 

**Description of Business**

 

Iteris, Inc. is a leader in the trafficmanagement market and focuses on the development and application of advancedtechnologies that reduce traffic congestion, minimize the environmental impactof traffic congestion and improve the safety of surface transportation systems.By combining outdoor image processing, traffic engineering and informationtechnology, the Company offers a broad range of Intelligent TransportationSystems and driver safety solutions to customers worldwide. The Company wasoriginally incorporated in Delaware in 1987.

 

**Basis of Presentation**

 

The unaudited condensed consolidatedfinancial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Securities and ExchangeCommission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X. Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements contain all adjustments, consisting of normal recurringadjustments, necessary to present fairly the consolidated financial position ofthe Company as of June 30, 2008, the consolidated results of operationsfor the three months ended June 30, 2008 and 2007, and the consolidatedcash flows for the three months ended June 30, 2008 and 2007. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in the UnitedStates (“U.S. GAAP”) have been condensed or omitted pursuant to the rules andregulations of the SEC. The results of operations for the three months ended June 30,2008 are not necessarily indicative of those to be expected for the entireyear. The accompanying unaudited condensed consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended March 31, 2008, which was filed with the SEC on June 12,2008.

 

# **Use ofEstimates**

#  

The preparation of consolidated financialstatements in conformity with U.S. GAAP requires management to make certainestimates and assumptions that affect the reported amounts of assets andliabilities, disclosures of contingent assets and liabilities at the date of thefinancial statements, and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.Significant estimates made in the preparation of the consolidated financialstatements include the allowance for doubtful accounts, deferred tax assets,inventory and warranty reserves, costs to complete long-term contracts,overhead rates used in cost-plus contracts, contract reserves and estimates offuture cash flows used to assess the recoverability of long-lived assets, thevaluation of debt and equity instruments and the realization of goodwill.

 

**Reclassifications**

** **

Certain amounts in theprior period financial statements have been reclassified to conform withcurrent year presentation.

 

# **RevenueRecognition**

#  

Product revenues andrelated costs of sales are recognized upon the transfer of title, whichgenerally occurs upon shipment or, if required, upon acceptance by thecustomer, provided that the Company believes collectibility of the net salesamount is probable. Accordingly, at the date revenue is recognized, thesignificant uncertainties concerning the sale have been resolved.

 

Contract revenues arederived primarily from long-term contracts with governmental agencies. Contractrevenues include costs incurred plus a portion of estimated fees or profitsdetermined on the percentage of completion method of accounting based on therelationship of costs incurred to date to total estimated costs. Anyanticipated losses on contracts are charged to earnings when identified.Changes in job performance and estimated profitability, including those arisingfrom contract penalty provisions and final contract settlements, may result inrevisions to costs and revenues and are recognized in the period in which therevisions are determined. Profit incentives are included in revenue when theirrealization is reasonably assured.

 

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In addition to productand contract revenue, the Company derives revenue from the provision ofspecific non-recurring contract engineering services and royalties.Non-recurring contract engineering revenues are recognized in the period inwhich the related services are performed. Royalty revenues are recorded in theperiod in which the royalty is earned, based on unit sales of the Company’sproducts.  Non-recurring contractengineering revenues and royalty revenues are included in net sales in theaccompanying condensed consolidated statements of operations.

 

Revenues from follow-onservice and support, for which the Company charges separately, are recorded inthe period in which the services are performed.

 

**Concentration of Credit Risk**

 

Accounts receivable areprimarily derived from revenues earned from customers located throughout NorthAmerica and Europe. The Company generally does not require collateral or othersecurity from customers. Collectibility of receivable balances is estimatedthrough review of invoices outstanding greater than a certain period of timeand ongoing credit evaluations of customers’ financial condition. Reserves aremaintained for potential credit losses, and such losses have historically beenwithin management’s expectations.

 

**Fair Values of Financial Instruments**

 

The fair values of cash and cash equivalents,receivables, inventories, accounts payable and accrued expenses approximatecarrying value because of the short period of time to maturity. The fair valuesof line of credit agreements and long-term debt approximate carrying valuebecause the related rates of interest approximate current market rates. Thefair value of convertible debentures approximates carrying value because theeffective interest rate, taking into account recorded debt discounts,approximates current market rates.

 

# **Inventories**

#  

Inventories are stated at the lower of costor market. Cost is determined using the first-in, first-out method.

 

**Property and Equipment**

 

Property and equipment are recorded at costand are generally depreciated using the straight-line method over the estimateduseful life ranging from three to eight years. Leasehold improvements aredepreciated over the term of the related lease or the estimated useful life ofthe improvement, whichever is shorter.

 

**Goodwill and Long-Lived Assets**

 

In accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 142, *Goodwill and IntangibleAssets*, goodwill is tested for impairment on an annual basis in theCompany’s fourth fiscal quarter or more frequently if indicators of impairmentexist, of which none have been identified. The performance of the test involvesa two-step process. The first step of the impairment test involves comparingthe fair value of the Company’s reporting units with each respective reportingunit’s carrying amount, including goodwill. The Company determines the fairvalue of reporting units using the income approach. If the carrying amount of areporting unit exceeds the reporting unit’s fair value, the second step of thegoodwill impairment test is performed to determine the amount of any impairmentloss. The second step of the goodwill impairment test involves comparing theimplied fair value of the reporting unit’s goodwill with the carrying amount ofthat goodwill.

 

The Company evaluates long-lived assets forimpairment in accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets,* which requiresimpairment evaluation on long-lived assets used in operations when indicatorsof impairment are present. Reviews are performed to determine whether thecarrying value of assets is impaired, based on a comparison to undiscountedexpected 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 excessof the carrying amount over the fair value of those assets.

 

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**Income Taxes**

 

The Company utilizes the liability method ofaccounting for income taxes as set forth in SFAS No. 109, *Accounting for Income Taxes*(“SFAS 109”)*.*Underthe liability method, deferred taxes are determined based on the temporarydifferences between the financial statement and tax bases of assets andliabilities using enacted tax rates. A valuation allowance is recorded when itis more likely than not that all or a portion of the deferred tax assets willnot be realized.

 

## **Stock-Based Compensation**

##  

Effective April 1,2006, the Company adopted SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), which requires allstock-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. The Company elected to use the modified prospective transition methodfor transition to SFAS 123R. Under the modified prospective method, SFAS 123Rapplies to all awards granted or modified after the date of adoption. Inaddition, under the modified prospective method, compensation expense isrecognized for all stock-based compensation awards granted prior to but not yetvested as of April 1, 2006, based on grant-date fair values estimated inaccordance with the original provisions of SFAS No. 123, *Accounting for Stock-Based Compensation* (“SFAS 123”).

 

**Research and Development Expenditures**

 

Research and development expenditures arecharged to expense in the period in which they are incurred.

 

**Shipping and Handling Costs**

 

Shipping and handling costs are included incost of sales in the period during which products ship.

 

**Sales Taxes**

 

Sales taxes are presented on a net basis(excluded from net sales and contract revenues) in the unaudited condensed consolidatedstatements of operations.

 

**Warranty**

 

The Company generally provides a one to threeyear warranty from the original invoice date on all products, materials andworkmanship. Products sold to certain original equipment manufacturer (“OEM”)customers sometimes carry longer warranties. Defective products will be eitherrepaired or replaced, generally at the Company’s option, upon meeting certaincriteria. The Company accrues a provision for the estimated costs that may beincurred for product warranties relating to a product as a component of cost ofsales at the time revenue for that product is recognized. The accrued warrantyprovision is included within accrued expenses on the accompanying condensedconsolidated balance sheets.

 

**Repair and Maintenance Costs**

 

The Company incurs repairand maintenance costs in the normal course of business. Should the activityresult in a permanent improvement to one of the Company’s leased facilities,the cost is capitalized as a leasehold improvement and amortized over itsuseful life or the remainder of the lease period, whichever is shorter.Non-permanent repair and maintenance costs are charged to expense as incurred.

 

**Other Comprehensive Income**

 

The only component of accumulated othercomprehensive income is foreign currency translation adjustments.

 

**Recent Accounting Pronouncements**

 

In September 2006, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 157, *Fair Value Measurements* (“SFAS 157”), which defines fairvalue, establishes a framework for measuring fair value, and expands disclosureabout fair value measurements. SFAS 157 does not require any new fair valuemeasurements; rather it specifies valuation methods to be applied when fairvalue measurements are required under existing or future accountingpronouncements. SFAS 157 is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. In February 2008, theFASB issued FSP 157-2, *Effective Date of FASBStatement No. 157* (“FSP 157-2”), which delays the effectivedate of SFAS 157 for non-financial assets and liabilities to fiscal yearsbeginning after November 15, 2008. Generally, SFAS 157 will be appliedprospectively. In respect to financial assets and liabilities, the Companyadopted SFAS 157 in the first quarter of fiscal 2009. There was no materialimpact on the consolidated financial statements. The Company is currentlyevaluating the impact of SFAS 157 and FSP 157-2 with respect to itsnon-financial assets and liabilities and expects to adopt SFAS 157 and FSP157-2 with respect to these assets and liabilities in the first quarter of itsfiscal year ending March 31, 2010.

 

In February 2007, the FASB issued FASBStatement No. 159, *The Fair Value Option forFinancial Assets and Financial Assets and Financial Liabilities – including anamendment of FASB Statement No. 115.* This standard allows an entitythe irrevocable option to elect fair value for the initial and subsequentmeasurement of certain financial assets and liabilities on a contract-by-contractbasis. Subsequent changes in fair value of these financial assets andliabilities would be recognized in earnings when they occur. This statement iseffective for fiscal years beginning after November 15, 2007 with earlieradoption permitted under special rules. The adoption of this statement did nothave a material impact on the consolidated financial statements of the Company.

 

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**2. Supplemental Financial Information**

 

**Inventories**

 

The following tablepresents details of the Company’s inventories:

 
| ** **             | ** ** | **June 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** |
| Materials and supplies | ** ** | **$**                   | **3,656**  |                     | $          | 3,031 |   |
| Work in process        | ** ** | **160**                 |       | 345                      |       |
| Finished goods         | ** ** | **564**                 |       | 850                      |       |
| ** **             |       | **$**                   | **4,380**  |                     | $          | 4,226 |   |

 

**Intangible Assets**

 
| ** **           | ** ** | **June 30, 2008** | ** ** | **March 31, 2008**  | ** ** |
|----------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **           | ** ** | **(In thousands)**     | ** ** |
| Developed technology | ** ** | **$**                       | **495**    | ** **                    | **$**      | **(406** | **)** | $ | 495 |   | $ | (381 | ) |
| Patents              | ** ** | **317**                     | ** ** | **(185**                      | **)**      | 317 |   | (174 | ) |
| Total                | ** ** | **$**                       | **812**    | ** **                    | **$**      | **(591** | **)** | $ | 812 |   | $ | (555 | ) |

 

Amortization expense for intangible assets subject to amortization was$36,000 and $37,000 for the three months ended June 30, 2008 and 2007,respectively.  Future estimatedamortization expense for the remainder of the current fiscal year and the nextthree fiscal years is as follows:

 
| **Fiscal Year Ending March 31:** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2009                                                 |       | $          | 111        |   |
| 2010                                                 |       | 58         |       |
| 2011                                                 |       | 46         |       |
| 2012                                                 |       | 6          |       |
|                                                 |       | $          | 221        |   |

 

**Warranty Reserve Activity**

 

The following table presents activity in accrued warrantyobligations:

 
| ** **                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(In thousands)**                         | ** ** |
| Balance at beginning of period     | ** ** | **$**                                           | **494**    |   | $ | 520 |   |
| Additions charged to cost of sales | ** ** | **99**                                          | ** ** | 99 |   |
| Warranty claims                    | ** ** | **(64**                                         | **)**      | (50 | ) |
| Balance at end of period           | ** ** | **$**                                           | **529**    | ** ** | $ | 569 |   |

 

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**Earnings Per Share**

 

The following table setsforth the computation of basic and diluted earnings per share:

 
| ** **                                                   | ** ** | **Three Months Ended  June 30,**                   | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                                          | ** ** | **2007** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| Numerator:                                                   |       |                                                              |       |   |   |
| Net income                                                   | ** ** | **$**                                                             | **666**    |   | $ | 1,096 |   |
|                                                         |       |                                                              |       |   |   |
| Denominator:                                                 |       |                                                              |       |   |   |
| Weighted  average common shares used in basic computation    | ** ** | **33,618**                                                        |       | 32,089 |   |
| Dilutive  stock options                                      | ** ** | **1,314**                                                         |       | 2,197 |   |
| Dilutive  warrants                                           | ** ** | **7**                                                             |       | 31 |   |
| Weighted  average common shares used in dilutive computation | ** ** | **34,939**                                                        |       | 34,317 |   |
|                                                         |       |                                                              |       |   |   |
| Earnings per  share:                                         |       |                                                              |       |   |   |
| Basic                                                        | ** ** | **$**                                                             | **0.02**   |   | $ | 0.03 |   |
| Diluted                                                      | ** ** | **$**                                                             | **0.02**   |   | $ | 0.03 |   |

 

The following shares wereexcluded from the computation of diluted earnings per share as their effectwould have been anti-dilutive:

 
| ** **             | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------|------------|-------------------------------------------------|------------|
| ** **             | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| ** **             | ** ** | **(In thousands)**                         | ** ** |
| Stock options          | ** ** | **517**                                         |       | 668 |   |
| Warrants               | ** ** | **1,150**                                       |       | 1,190 |   |
| Convertible debentures | ** ** | **2,147**                                       |       | 2,729 |   |

 

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

 

**RevolvingLine of Credit**

 

In October 2006, theCompany entered into a two-year credit facility with a bank. At June 30,2008, the facility provided for line of credit borrowings of up to $10.0million. Under the credit facility, the Company may borrow against its eligibleaccounts receivable and eligible inventory, as defined in the credit agreement.Interest on borrowed amounts under the line of credit is payable monthly at thecurrent stated prime rate plus 1.00% (6.00% at June 30, 2008).Additionally, the Company is obligated to pay an unused line fee of 0.25% perannum applied to the amount by which the maximum credit amount exceeds theaverage daily principal balance during the preceding month. The credit facilityrequires $2,000 in monthly collateral management fees and includes an earlytermination fee equal to 2% of the total facility during the first year of theagreement and 1% of the total facility in the second year of the agreement. Thecredit facility is secured by substantially all of the assets of the Company.

 

On June 30, 2008,the available credit under the Company’s credit facility was $9.9 million, allof which was unused.

 

**Long-TermDebt**

 

The Company’s long-termdebt consists of the following:

 
| ** **                  | ** ** | **June 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
| Convertible debentures, net | ** ** | **$**                   | **7,607**  | ** **               | $          | 7,566 |   |
| Bank term note              | ** ** | **—**              | ** ** | 210                      |       |
| Other                       | ** ** | **23**                  | ** ** | 34                       |       |
| ** **                  |       | **7,630**               | ** ** | 7,810                    |       |
| Less current portion        | ** ** | **(7,630**              | **)**      | (244                     | )          |
| ** **                  |       | **$**                   | **—** |                     | $          | 7,566 |   |

 

*Convertible Debentures, Net.*InMay 2004, the Company sold and issued subordinated convertible debenturesin the aggregate original principal amount of $10.1 million. In connection withthe issuance of the debentures, the Company issued warrants to purchase anaggregate of 639,847 shares of its common stock, the value of which wasrecorded as a debt discount against the face amount of the debentures on thedate of issuance and is being amortized to interest expense over the term ofthe convertible debentures.

 

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The debentures are due infull on May 19, 2009, provide for 6.0% annual interest, payable quarterly,and are convertible into the Company’s common stock at an initial conversionprice of $3.61 per share, subject to certain adjustments, including adjustmentsfor dilutive issuances. From May 19, 2008, until the maturity date, theCompany may redeem the debentures at 110% of the principal amount. As of June 30,2008, $250,000 of convertible debentures had been converted into 69,252 sharesof common stock and $2.1 million of convertible debentures had been retiredearly leaving $7.8 million of the originally issued convertible debenturesoutstanding at June 30, 2008.

 

*Bank Term Note.*InOctober 2004, the Company entered into a $5.0 million term note payablewith a bank. The note was due on May 27, 2008, and provided for monthlyprincipal payments of approximately $104,000. In October 2006, the termnote was assumed by the Company’s new bank as part of the Company’s new creditfacility. The new term note was also due on May 27, 2008 and provided formonthly principal payments of approximately $104,000. Interest accrued underthe new term note at an annual rate of 8.75%. The final payment against this term note was made in June 2008.

 

Scheduled aggregatematurities of long-term debt principal as of June 30, 2008 were asfollows:

 
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2009                                                 | ** ** | **$**      | **23**     | ** ** |
| 2010                                                 | ** ** | **7,750**  | ** ** |
| ** **                                           | ** ** | **7,773**  | ** ** |
| Less: unamortized debt discount                      | ** ** | **(143**   | **)**      |
| ** **                                           | ** ** | **$**      | **7,630**  | ** ** |

 

**4. Commitments and Contingencies**

 

**Litigation and Other Contingencies**

 

From time to time, the Company has beeninvolved in litigation relating to claims arising out of its operations in thenormal course of business. The Company currently is not a party to any suchlegal proceedings, the adverse outcome of which, in management’s opinion,individually or in the aggregate, would have a material adverse effect on itsconsolidated results of operations, financial position or cash flows.

 

Furthermore, from time to time, the Companyhas experienced unforeseen developments in contingencies related to its formersubsidiaries. For example, the Company has been the subject of a number ofroutine tax audits for time periods and jurisdictions related to the businessesof its former subsidiaries, some of which are still in process. Although the developmentand ultimate outcome of these and other unforeseen matters cannot be predictedwith any certainty, management does not believe that the Company is presentlyinvolved in any matters related to its former subsidiaries that would have amaterial adverse effect on the Company’s consolidated results of operations,financial position or cash flows.

 

**Operating Lease Commitments**

 

The Company has lease commitments forfacilities in various locations throughout the United States. Futurecommitments under these non-cancelable operating leases at June 30, 2008were as follows:

 
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| Remainder of 2009                                    | ** ** | **$**      | **1,398**  | ** ** |
| 2010                                                 | ** ** | **1,544**  | ** ** |
| 2011                                                 | ** ** | **1,412**  | ** ** |
| 2012                                                 | ** ** | **1,332**  | ** ** |
| 2013                                                 | ** ** | **1,363**  | ** ** |
| Thereafter                                           | ** ** | **2,460**  | ** ** |
| Total                                                | ** ** | **$**      | **9,509**  | ** ** |

 

The Company previouslysubleased office space to MAXxess Systems, Inc. (“MAXxess”), a formersubsidiary of the Company that was sold by the Company in September 2003and is currently owned by an investor group that includes three of the Company’sdirectors, one of which is the Chief Executive Officer of MAXxess. At June 30,2008, MAXxess owed the Company an aggregate of $274,000 related to thissublease, which terminated in September 2007, and certain relatedancillary services that were previously provided by the Company toMAXxess.  Although the Company has fullyreserved for amounts owed to it by MAXxess under the terms of this sublease,the Company intends to pursue full payment of any and all amounts due fromMAXxess.

 

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**Inventory Purchase Commitments**

 

At June 30, 2008, the Company had firm commitments to purchaseinventory in the amount of $1.6 million during the next three fiscal quarters.

 

**5. Stock-Based Compensation**

 

The Company’s 2007Omnibus Incentive Plan (the “2007 Plan”) provides that options to purchaseshares of the Company’s unissued common stock may be granted to employees,officers, consultants and directors to the Company at exercise prices which areequal to or greater than the fair market value of the Company’s common stock onthe date of grant. Options expire no more than ten years after the date ofgrant and generally vest at the rate of 25% on each of the first fouranniversaries of the grant date. The 2007 Plan also allows for the issuance ofstock appreciation rights, restricted stock, restricted stock units and otherstock-based awards based on the value of the Company’s common stock. New sharesare issued to satisfy stock option exercises and share issuances under the 2007Plan. As of June 30, 2008, options to purchase an aggregate of 389,000shares of common stock were outstanding under the 2007 Plan.

 

The Company’s 1997 StockIncentive Plan (the “1997 Plan”) terminated in September 2007; however,all stock options outstanding under the 1997 Plan will remain outstandingpursuant to the terms of such stock options. As of June 30, 2008, optionsto purchase 1.4 million shares of the Company’s common stock were outstandingunder the 1997 Plan.

 

In connection with the October 2004merger of the Company and what was previously its majority-owned subsidiary,Iteris Inc. (the “Iteris Subsidiary”), the Company assumed the 1998 StockIncentive Plan of the Iteris Subsidiary (the “1998 Plan”) and all outstandingoptions granted thereunder. As of June 30, 2008, options to purchase 2.2million shares of the Company’s common stock were outstanding under the 1998Plan. No further options may be granted under the 1998 Plan.

 

Certain options grantedunder the 2007 Plan, the 1997 Plan and the 1998 Plan (collectively, the “Plans”)provide for accelerated vesting of unvested options in the event of a change incontrol under certain circumstances. These change-in-control provisions meetthe criteria of a performance condition under SFAS 123R.

 

A summary of activity inthe Plans for the three months ended June 30, 2008 is as follows:

 
| ** **                                                                 | ** ** | **Options**                                                                                                   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                 | ** ** | **(In thousands, except per share amounts and number of years)** | ** ** |
| Options outstanding at March 31, 2008                                 |       | 4,524                                                                                                         |       | $                                      | 1.83       |                                                             | 3.7        |                                |       |   |
| Granted                                                                    |       | —                                                                                                        |       | N/A                                    |       | N/A                                                              |       |                                |       |
| Exercised                                                                  |       | (471                                                                                                          | )          | 1.10                                   |       | N/A                                                              |       |                                |       |
| Forfeited                                                                  |       | —                                                                                                        |       | N/A                                    |       | N/A                                                              |       |                                |       |
| Expired                                                                    |       | (30                                                                                                           | )          | 1.35                                   |       | N/A                                                              |       |                                |       |
| Options outstanding at June 30, 2008                                  |       | 4,023                                                                                                         |       | $                                      | 1.92       |                                                             | 4.1        |                                | $          | 3,875 |   |
| Vested and expected to vest at  June 30, 2008                         |       | 3,906                                                                                                         |       | $                                      | 1.91       |                                                             | 3.9        |                                | $          | 3,860 |   |
| Options exercisable at June 30, 2008                                  |       | 3,400                                                                                                         |       | $                                      | 1.82       |                                                             | 3.2        |                                | $          | 3,798 |   |
| Options exercisable at June 30, 2008  pursuant to a change-in-control |       | 4,023                                                                                                         |       | $                                      | 1.92       |                                                             | 4.1        |                                | $          | 3,875 |   |

 

At June 30, 2008,there were 461,000 shares of common stock available for grant under the 2007Plan.

 

For the three monthsended June 30, 2008 and 2007, the Company received $514,000 and $726,000,respectively, in cash from the exercise of stock options. Total stock-basedcompensation expense was $94,000 and $66,000 for the three months ended June 30,2008 and 2007, respectively.  No incometax benefit was realized from activity in the Plans during the three monthsended June 30, 2008 and 2007.

 

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At June 30, 2008,there was $1.2 million of total unrecognized compensation expense related tounvested stock options. This expense is expected to be recognized over aweighted-average period of approximately 3.4 years.

 

The fair value of eachstock-based award is estimated on the grant date using the Black-Scholes-Merton(“BSM”) option-pricing formula. Expected volatility is 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-free interest rate for periods within theexpected life of the option is based on the U.S. Treasury interest rates ineffect at the time of grant. No stock options were granted in either of thethree month periods ended June 30, 2008 on 2007.

 

A summary of the grantdate fair value and intrinsic value information is as follows:

 
| ** **                                                           | ** ** | **Three Months  Ended June 30,**                   | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                                          | ** ** | **2007** | ** ** |
| ** **                                                           | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| Weighted  average grant date fair value per share of options granted | ** ** | **N/A**                                                           |       | N/A |   |
| Intrinsic  value of options exercised                                | ** ** | **$**                                                             | **656**    |   | $ | 1,417 |   |
|                                                                      |            |                                                                   |            |  |  |  |  |

 

**6. Business Segment Information**

 

The Company currentlyoperates in three reportable segments: Roadway Sensors, Vehicle Sensors andTransportation Systems. The Roadway Sensors segment includes the Company’sVantage vehicle detection systems for traffic intersection control,incident detection and certain highway traffic data collection applications.The Vehicle Sensors segment includes AutoVue and is comprised of all activitiesrelated to lane departure warning systems for vehicle safety. TheTransportation Systems segment includes transportation engineering andconsulting services and the development of transportation management and travelerinformation systems for the ITS industry. The accounting policies of thereportable segments are the same as those described in the summary ofsignificant accounting policies except that certain expenses, such as interest,amortization of certain intangibles and certain corporate expenses are notallocated to the segments.  Thereportable segments are each managed separately because they manufacture anddistribute distinct products or provide services with different processes. Allsegment revenues are derived from external customers.

 

The following table setsforth selected unaudited financial information for the Company’s reportablesegments for the three months ended June 30, 2008 and 2007:

 
| ** **                                | ** ** | **Roadway  Sensors**    | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                                | ** ** | **(In thousands)** | ** ** |
| **Three Months Ended June 30, 2008** |       |                    |       |                 |       |                        |       |      |       |
| Product revenue                           |       | $                       | 7,426      |                 | $          | 2,726                       |       | $         | —     |   | $ | 10,152 |   |
| Service and other revenue                 |       | —                  |       | 374                  |       | 6,916                       |       | 7,290     |       |
| Stock-based compensation expense          |       | 8                       |       | 12                   |       | 13                          |       | 33        |       |
| Depreciation and amortization             |       | 48                      |       | 37                   |       | 56                          |       | 141       |       |
| Segment income                            |       | 1,008                   |       | 158                  |       | 406                         |       | 1,572     |       |
|                                      |       |                    |       |                 |       |                        |       |      |       |
| **Three Months Ended June 30, 2007** |       |                    |       |                 |       |                        |       |      |       |
| Product revenue                           |       | $                       | 7,224      |                 | $          | 2,584                       |       | $         | —     |   | $ | 9,808 |   |
| Service and other revenue                 |       | —                  |       | 436                  |       | 5,513                       |       | 5,949     |       |
| Stock-based compensation expense          |       | 6                       |       | 13                   |       | 7                           |       | 26        |       |
| Depreciation and amortization             |       | 26                      |       | 36                   |       | 31                          |       | 93        |       |
| Segment income                            |       | 1,105                   |       | 50                   |       | 544                         |       | 1,699     |       |

 

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The following tablereconciles segment income to consolidated income before income taxes:

 
| ** **                                               | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| ** **                                               | ** ** | **(In thousands)**                         | ** ** |
| Total income for reportable segments | ** ** | **$**                                           | **1,572**  | ** ** | $ | 1,699 |   |
| Unallocated  amounts:                                    |       |                                            | ** ** |   |   |
| Corporate  expenses                                      | ** ** | **(222**                                        | **)**      | (125 | ) |
| Other  income, net                                       | ** ** | **5**                                           | ** ** | 19 |   |
| Interest  expense, net                                   | ** ** | **(198**                                        | **)**      | (363 | ) |
| Income  before income taxes                              | ** ** | **$**                                           | **1,157**  | ** ** | $ | 1,230 |   |

 

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

** **

*This report, including the followingdiscussion and analysis, contains forward-looking statements (within themeaning of the Private Securities Litigation Reform Act of 1995) that are basedon our current expectations, estimates and projections about our business andour industry, and reflect management’s beliefs and certain assumptions made byus based upon information available to us as of the date of this report. Whenused in this report and the information incorporated herein by reference, thewords “expect(s),” “feel(s),” “believe(s),” “should,” “will,” “may,” “anticipate(s),”“estimate(s)” and similar expressions or variations of these words are intendedto identify forward-looking statements. These forward-looking statementsinclude but are not limited to statements regarding our anticipated sales,revenue, expenses, profits, capital needs, competition, development plans,backlog and manufacturing capabilities, the applications for and acceptance ofour products and services, and the status of our facilities and productdevelopment. These statements are not guarantees of future performance and aresubject to certain risks and uncertainties that could cause our actual resultsto differ materially from those projected. You should not place undue relianceon these forward-looking statements that speak only as of the date hereof. Weundertake no obligation to republish revised forward-looking statements toreflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events. We encourage you to carefully review andconsider the various disclosures made by us which describe certain factorswhich 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 leader in the traffic management market that focuses on thedevelopment and application of advanced technologies that reduce trafficcongestion, minimize the environmental impact of traffic congestion and improvethe safety of surface transportation systems. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broadrange of Intelligent Transportation Systems (“ITS”) and driver safety solutionsto customers worldwide.

 

We currently operate in three reportable segments: Roadway Sensors,Vehicle Sensors and Transportation Systems. The Roadway Sensors segmentincludes our Vantage vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications. The Vehicle Sensors segment is comprised of allactivities related to our AutoVue Lane Departure Warning (“LDW”) systems forvehicle safety. The Transportation Systems segment includes transportationengineering and consulting services, and the development of transportationmanagement and traveler information systems for the ITS industry.

 

Our Vantage product is a video vehicle detection system that detectsthe presence of vehicles on roadways. Vantage systems are used at signalizedintersections to enable a traffic controller to more efficiently allocate greensignal time and are also used for incident detection and highway traffic datacollection applications. We sell and distribute our Vantage products primarilyto commercial customers and municipal agencies.

 

Our AutoVue LDW systems consist of a small windshield mounted sensorthat uses proprietary software to detect and warn drivers of unintended lanedepartures. In excess of 90,000 production AutoVue units have been sold for carand truck platforms in the North American and European markets. Our AutoVue LDWsystems are currently qualified as an option on certain heavy trucks, includingMercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner and FUSO, as well asNeoplan and MAN luxury bus and coach lines. In North America, our LDW systemsare sold primarily to truck fleets, and to date, 65 U.S. heavy truck fleetshave selected our LDW systems, representing an estimated 49,000 vehicles.

 

Our transportation management systems business includes transportationengineering and consulting services focused on the planning, design,development and implementation of software-based systems that integrate sensors,video surveillance, computers and advanced communications equipment to enablepublic agencies to monitor, control and direct traffic flow, assist in thequick dispatch of emergency crews and distribute real-time information abouttraffic conditions. Our services include planning, design and implementation ofsurface transportation infrastructure systems. We perform analysis and studygoods movement, commercial vehicle operations, travel demand forecasting andsystems engineering, and identify mitigation measures to reduce trafficcongestion. These services and systems are primarily sold to local, state andnational transportation agencies in the United States. Our transportationmanagement systems business is largely dependent upon governmental funding andbudgetary issues. The Federal Highway Bill that was passed in August 2005provided for a significant increase in transportation funding over thefollowing six years. We believe the recent expansion of our transportationmanagement systems business was due in part to the passage of the FederalHighway Bill, combined with increased transportation funds available at stateand local agencies throughout the country. The 2005 Federal Highway Bill is set to expire in 2009.  It is too early to determine any impact onfuture contract revenues as a result of potential delays in the passage offuture bills.

 

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**CriticalAccounting Policies and Estimates**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations is based on our unaudited condensed consolidated financialstatements included herein, which have been prepared in accordance with U.S generallyaccepted accounting principles. The preparation of these financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and related disclosures of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. On an ongoingbasis, we evaluate these estimates and assumptions, including those related tothe collectibility of accounts receivable, the valuation of inventories, therecoverability of long-lived assets and goodwill, the realizability of deferredtax assets, accounting for stock-based compensation, the valuation of equityinstruments, warranty reserves and other contingencies. We base these estimateson our historical experience and on various other factors that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. These estimates and assumptions bytheir nature involve risks and uncertainties, and may prove to be inaccurate.In the event that any of our estimates or assumptions are inaccurate in anymaterial respect, it could have a material adverse effect on our reportedassets and liabilities at the date of the financial statements and our reportedrevenues and expenses during the reporting period.

 

The accounting policies that affect our more significant judgments andestimates used in the preparation of our unaudited condensed consolidatedfinancial statements are those relating to revenue recognition, accountsreceivable, inventory, goodwill, warranty, income taxes and stock-basedcompensation.  These policies aredescribed in further detail in our Annual Report on Form 10-K for thefiscal year ended March 31, 2008. There have been no significant changes in our critical accountingpolicies and estimates during the three months ended June 30, 2008 ascompared to what was previously disclosed in our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2008.

 

**Recent Accounting Pronouncements**

 

In September 2006, the FASB issued SFAS 157, which defines fairvalue, establishes a framework for measuring fair value, and expands disclosureabout fair value measurements. SFAS 157 does not require any new fair valuemeasurements; rather it specifies valuation methods to be applied when fairvalue measurements are required under existing or future accountingpronouncements. SFAS 157 is effective for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. In February 2008, theFASB issued FSP 157-2, which delays the effective date of SFAS 157 fornon-financial assets and liabilities to fiscal years beginning after November 15,2008. Generally, SFAS 157 will be applied prospectively. In respect tofinancial assets and liabilities, the Company adopted SFAS 157 in the firstquarter of fiscal 2009. There was no material impact on the consolidated financialstatements. We are currently evaluating the impact of SFAS 157 and FSP 157-2 withrespect to our non-financial assets and liabilities and expect to adopt SFAS157 and FSP 157-2 with respect to these assets and liabilities in the firstquarter of our fiscal year ending March 31, 2010.

 

In February 2007, the FASB issued FASB Statement No. 159, *The Fair Value Option for Financial Assets and Financial Assets andFinancial Liabilities – including an amendment of FASB Statement No. 115*.This standard allows an entity the irrevocable option to elect fair value forthe initial and subsequent measurement of certain financial assets andliabilities on a contract-by-contract basis. Subsequent changes in fair valueof these financial assets and liabilities would be recognized in earnings whenthey occur. This statement is effective for fiscal years beginning afterNovember 15, 2007 with earlier adoption permitted under special rules. Theadoption of this statement did not have a material impact on the consolidatedfinancial statements of the Company.

 

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**Resultsof Operations**

 

The following table sets forth certain statement of operations data asa percentage of total net sales and contract revenues for the periodsindicated.

 
| ** **                                 | ** ** | **Three Months  Ended June 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| Net sales  and contract revenues:          |       |                                            | ** ** |   |   |
| Net sales                                  | ** ** | **60.3**                                        | **%**      | 65.0 | % |
| Contract  revenues                         | ** ** | **39.7**                                        | ** ** | 35.0 |   |
| Total net  sales and contract revenues     | ** ** | **100.0**                                       | **%**      | 100.0 | % |
| Costs of net  sales and contract revenues: |       |                                            | ** ** |   |   |
| Cost of net  sales                         | ** ** | **30.2**                                        | ** ** | 32.9 |   |
| Cost of  contract revenues                 | ** ** | **25.4**                                        | ** ** | 22.1 |   |
| Gross profit                               | ** ** | **44.4**                                        | ** ** | 45.0 |   |
| Operating  expenses:                       |       |                                            | ** ** |   |   |
| Selling,  general and administrative       | ** ** | **29.6**                                        | ** ** | 28.5 |   |
| Research and  development                  | ** ** | **6.9**                                         | ** ** | 6.3 |   |
| Amortization  of intangible assets         | ** ** | **0.2**                                         | ** ** | 0.2 |   |
| Total  operating expenses                  | ** ** | **36.7**                                        | ** ** | 35.0 |   |
| Operating  income                          | ** ** | **7.7**                                         | ** ** | 10.0 |   |
| Non-operating  income (expense):           |       |                                            | ** ** |   |   |
| Other  income, net                         | ** ** | **0.0**                                         | ** ** | 0.1 |   |
| Interest  expense, net                     | ** ** | **(1.1**                                        | **)**      | (2.3 | ) |
| Income  before income taxes                | ** ** | **6.6**                                         | ** ** | 7.8 |   |
| Income tax  provision                      | ** ** | **(2.8**                                        | **)**      | (0.8 | ) |
| Net income                                 | ** ** | **3.8**                                         | **%**      | 7.0 | % |

 

**Analysisof Quarterly Results of Operations**

 

*Net Sales and Contract Revenues*. Net sales are comprised of Roadway Sensors sales, which are derived from salesof our Vantage video detection systems, and Vehicle Sensor sales, which arederived from sales of AutoVue LDW systems, contract engineering revenue androyalty revenue generated from AutoVue related activities.  Contractrevenues consist entirely of Transportation Systems revenues, which aregenerated from systems integration and ITS consulting services with federal,state, county and municipal agencies. We currently have a relatively diversecustomer base with our largest customer constituting 6.2% of total net salesand contract revenues in the three months ended June 30, 2008.

 

Total net sales and contract revenues increased 10.7% to $17.4 millionfor the three months ended June 30, 2008, compared to $15.8 million in thecorresponding period of the prior fiscal year. The increase was primarilydriven by increased contract revenues, as discussed below.

 

Net sales increased 2.8% to $10.5 million for the three months ended June 30,2008, compared to $10.2 million in the corresponding period of the prior fiscalyear.

 

Roadway Sensors net sales increased 2.8% to$7.4 million for the three months ended June 30, 2008, versus $7.2 millionin the corresponding period of the prior fiscal year. The increase in RoadwaySensors net sales for the three months ended June 30, 2008 reflects thecontinued adoption of video vehicle detection technology, such as thetechnology offered by our Vantage line of products, both domestically andinternationally.  We continue to believethat the current increased rate of adoption has to some extent been due toincreased government spending on traffic initiatives, which we believe has beenat least partially made possible by the passage of the Federal Highway Bill in August 2005,as well as expanded sales and marketing efforts, particularly in North America.The 2005 Federal Highway Bill is set to expire in 2009. It is too early todetermine any impact on future Roadway Sensors revenues as a result ofpotential delays in the passage of future bills.

 

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Vehicle Sensors net sales increased 2.6% to$3.1 million for the three months ended June 30, 2008, versus $3.0 millionin the corresponding period of the prior fiscal year. This increase wasprimarily a result of increased unit sales of our LDW systems to European andAsian OEMs, offset in part, by decreased unit sales in North America. Sales of LDW systems to the heavy truck market increased by $142,000, or 5.5%,for the three month period ended June 30, 2008, when compared to thecorresponding period in the prior fiscal year. We expect sales of LDW units tothe heavy truck market to continue to increase, when compared to the prior yearperiod, for at least the remainder of calendar year 2008 due to increased salesof LDW units in Europe and Asia; however, we expect to experience either flator decreased sales to the North American heavy truck market in our next fewfiscal quarters as a result of an overall decline in new truck sales in theU.S., the general slowdown in the U.S. housing market and overall economy. Alsoincluded in Vehicle Sensors net sales are revenues from contract engineeringservices and royalty revenues in the passenger car market that are derived fromour strategic relationship with Valeo Schalter and Sensuren GmbH (“Valeo”),which aggregated $374,000 for the three months ended June 30, 2008,compared to $436,000 in the corresponding period of the prior fiscal year.

 

Contract revenues increased 25.4% to $6.9 million for the three monthsended June 30, 2008, compared to $5.5 million in the corresponding periodof the prior fiscal year. This increase was largely due to increased funding atthe federal, state and local levels throughout the country, as well as newcontract awards. In response to this growth in funding, we have increased ourTransportation Systems staff by 7% in the three months ended June 30,2008, and we expect to continue to increase our Transportation Systems staffover the remainder of fiscal 2009.  Webelieve the ability of our Transportation Systems business to grow andsuccessfully win and service new contracts will be highly dependent upon ourcontinued success in recruiting and retaining qualified personnel.  We anticipate that our contract revenues willcontinue to increase for the balance of fiscal 2009, largely as a result ofapproximately $11 million in new contracts awarded to us during the firstquarter of fiscal 2009.  All of ourcontract revenues are derived from work performed in North America under abroad range of fixed price and cost plus fixed fee contracts.

 

Although we are not aware of any imminent changes in governmentspending patterns, it is conceivable that, as a result of softeningmacroeconomic conditions in the U.S. and the decline in the new housing market,government funding for certain traffic initiatives and roadway improvementprojects could be delayed or diverted to focus on other budgetary needs.  Should this occur, it is possible that futuredomestic Roadway Sensors net sales or Transportation System contract revenues wouldbe adversely affected.

 

*Gross Profit*. Total gross profit increased 9.3% to $7.8 million for the three months ended June 30,2008, as compared to $7.1 million in the corresponding period of the priorfiscal year. Total gross profit as a percent of net sales and contract revenuesdecreased slightly to 44.4% for the three months ended June 30, 2008, ascompared to 45.0% in the corresponding period of the prior fiscal year.

 

Gross profit as a percent of net sales was 50.0% for the three monthsended June 30, 2008, compared to 49.5% in the corresponding period of theprior fiscal year. This increase in gross profit was primarily a result ofincreased gross profit in the Vehicle Sensors segment, largely as a result ofthe continued expansion of our Vehicle Sensors customer base as well asimproved production efficiencies. Roadway Sensors gross profit as a percent of net sales was relativelyflat compared to the prior year.  Grossprofit as a percent of net sales generally fluctuates in any specific quarterbased on customer mix. Gross profit as a percent of net sales has fluctuatedover the last twelve quarters from a high of 50.2% in the first quarter offiscal 2006 to a low of 39.2% reported in the third quarter of fiscal 2007.

 

Gross profit as a percent of contract revenues was 36.0% for the threemonths ended June 30, 2008, compared to 36.7% in the corresponding periodof the prior fiscal year. We recognize contract revenues and related grossprofit using percentage of completion contract accounting and the underlyingmix of contract activity affects the related gross profit recognized in anygiven period.  The decrease in grossprofit as a percent of contract revenues for the three months ended June 30,2008 reflects a contract mix weighted more toward lower margin contracts in theperiod. Lower margin contracts generally have a higher proportion ofsub-consulting revenues associated with them.

 

*Selling, General and Administrative Expense*. Selling, general and administrative expense increased 14.9% to $5.2 million (or29.6% of total net sales and contract revenues) in the three months ended June 30,2008, compared to $4.5 million (or 28.5% of total net sales and contractrevenues) in the corresponding period of the prior fiscal year.  This increase was largely attributable tohigher selling expenses in our Transportation Systems segment aimed atcapturing additional contract backlog in the current quarter as well asincreased general and administrative expenses related to our efforts to complywith the internal control attestation requirements of the Sarbanes-Oxley Act,with which we began to comply in fiscal 2008.

 

*Research and Development Expense*. Research and development expense increased 21.7% to $1.2 million (or 6.9% oftotal net sales and contract revenues) for the three months ended June 30,2008, compared to $1.0 million (or 6.3% of total net sales and contract revenues)in the corresponding period of the prior fiscal year.  This increase was primarily due to increasedresearch and development activities in Roadway Sensors aimed at acceleratingthe time to market of certain new products. We believe research and development activities are crucial to ourability to continue to be a leader in our markets, and we expect ourexpenditures in this area to continue to run at an increased level, versus theprior year, for the remainder of fiscal 2009.

 

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For competitive reasons, we closely guard the confidentiality ofspecific development projects.

* *

*Interest Expense, Net.* Interest expense, net includes the following:

 
| ** **                             | ** ** | **Three Months Ended   June 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                              | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(In thousands)**                               | ** ** |
| Interest expense                       | ** ** | **$**                                                 | **(130**   | **)** | $ | (276 | ) |
| Amortization of debt discount          | ** ** | **(41**                                               | **)**      | (52 | ) |
| Amortization of deferred finance costs | ** ** | **(27**                                               | **)**      | (35 | ) |
| Interest expense, net                  | ** ** | **$**                                                 | **(198**   | **)** | $ | (363 | ) |

 

Interest expense decreased for the three months ended June 30,2008 compared to the corresponding period in the prior fiscal year as a resultof an overall lower level of borrowings.

 

*Income Taxes*. During the three months ended June 30, 2008, we recognized income taxexpense of $491,000 as compared to income tax expense of $134,000 in thecorresponding period of the prior fiscal year, resulting in an effective taxrate of 42.4% for the three months ended June 30, 2008, versus an effectivetax rate of 10.9% in the corresponding period of the prior fiscal year.  The increase in our effective tax rate in thecurrent year period was primarily due to an adjustment of the valuationallowance recorded against our deferred tax assets in the prior year period asa result of changes in our estimates of the future realizability of theseassets.  The company analyzes its taxestimates quarterly, and should those estimates result in an increase in futuretaxable income, we may continue to record similar adjustments to our deferredtax asset valuation allowance, which totaled approximately $8.0 million at June 30,2008.  This may cause our future overalleffective tax rate in any given period to fluctuate from prior effective taxrates, estimated annual effective tax rates and statutory tax rates.

 

**Liquidityand Capital Resources**

 

*Cash Flows*

 

We have historically financed our operations with a combination of cashflows from operations, borrowings under credit facilities and the sale ofequity securities. We currently rely on cash flows from operations andborrowings on a line of credit facility to fund our operations. At June 30,2008, we had $8.7 million in working capital, which included $7.8 millionattributable to outstanding convertible debentures, no borrowings on our $10.0million line of credit and $68,000 in cash and cash equivalents. This comparesto working capital of $14.9 million at March 31, 2008, which included noborrowings on our line of credit and $421,000 in cash and cash equivalents. Thecompany is evaluating various financing alternatives to re-finance theconvertible debentures should they not convert to common stock, and expects tohave a financing structure in place before they become due in May 2009.

 

Our operating activities used $666,000 in cash during the three monthsended June 30, 2008, primarily as a result of increases in trade accountsreceivable balances, which was largely attributable to the timing of invoicingin Transportation Systems.  During thethree months ended June 30, 2007, our operations provided $1.9 million ofcash, primarily as a result of net income generated during the period as wellas, to a lesser extent, the timing of cash flows from operating assets andliabilities.

 

Our investing activities for the three months ended June 30, 2008and 2007 consisted entirely of purchases of property and equipment, whichaggregated $257,000 and $137,000, respectively.

 

Cash provided by financing activities was $570,000 in the three monthsended June 30, 2008, which was primarily the result of $514,000 inproceeds from the exercise of outstanding stock options to purchase our commonstock. During the three months ended June 30, 2007, financing activitiesprovided $453,000 of cash, which was largely the result of $726,000 in proceedsfrom the exercise of outstanding stock options to purchase our common stock,partially offset by net payments on borrowing of $273,000.

 

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*Borrowings*

 

The following table summarizes our borrowings andlong-term debt:

 
| ** **                  | ** ** | **At June 30, 2008** | ** ** |
|-----------------------------|------------|-------------------------------------|------------|
| ** **                  | ** ** | **(In thousands)**             | ** ** |
| Convertible debentures, net |       | $                                   | 7,607      |   |
| Other                       |       | 23                                  |       |
|                        |       | $                                   | 7,630      |   |

 

In October 2006, weentered into a two-year credit facility with a bank.  The credit facility provides for line ofcredit borrowings of up to $10.0 million against our eligible accountsreceivable and inventory, as defined in the credit agreement.  The interest rate on the line of credit is thecurrent stated prime rate plus 1.00%. We are obligated to pay an unused linefee of 0.25% per annum applied to the amount by which the maximum credit amountexceeds the average daily principal balance during the preceding month. Thecredit facility also requires $2,000 in monthly collateral management fees andincludes an early termination fee equal to 1% of the total facility. The creditfacility is secured by substantially all of the assets of the Company. At June 30,2008, we had $9.9 million available under our credit facility, all of which wasunused.

 

We believe that the cashgenerated from our operations, together with funds available under our creditagreement, will be sufficient to fund our operations for at least the nexttwelve months. The company is evaluating various financing alternatives and expectsto have a new credit facility to replace our current facility upon its expirationin October 2008. However, should a shortfall occur, or if we are unsuccessfulin obtaining a new credit facility, we may need to raise additional fundsthrough other debt financings or the sale of equity securities.

 

**Contractual Obligations**

 

Our contractual obligations were as follows at June 30, 2008:

 
| ** **             | ** ** | **Payments Due by Fiscal Year** | ** ** |
|------------------------|------------|-----------------------------------------------------|------------|
| ** **             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **             | ** ** | **(In thousands)**                             | ** ** |
| Notes payable          |       | $                                                   | 23         |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 23 |   |
| Convertible debentures |       | —                                              |       | 7,750 |   | — |   | — |   | — |   | — |   | 7,750 |   |
| Operating leases       |       | 1,398                                               |       | 1,544 |   | 1,412 |   | 1,332 |   | 1,363 |   | 2,460 |   | 9,509 |   |
| Total                  |       | $                                                   | 1,421      |   | $ | 9,294 |   | $ | 1,412 |   | $ | 1,332 |   | $ | 1,363 |   | $ | 2,460 |   | $ | 17,282 |   |

 

At June 30, 2008, we had firm commitments to purchase inventory inthe amount of $1.6 million during our next three fiscal quarters.

 

**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 commonstock at an initial conversion price of $3.61 per share. At June 30, 2008,$7.8 million of these convertible debentures remained outstanding. Becausethese debentures are conventionally convertible, we have not separatelyaccounted for the conversion feature and, accordingly, no separate amounts arepresented in our condensed consolidated financial statements in connection withthis conversion feature.

 

At June 30, 2008, outstanding warrants to purchase an aggregate of246,250 shares of our common stock at an exercise price of $3.25 were callableby us if the closing sales price of our common stock for 20 consecutive days isequal to or greater than two times the exercise price of the warrants.Outstanding warrants to purchase an aggregate of 75,000 shares of ourcommon stock at an exercise price of $5.00 per share were callable by us if theprice of our common stock for 20 consecutive days is equal to or greaterthan one and a half times the exercise price of the warrants.

 

In connection with warrants to purchase 246,250 shares of our commonstock at $3.25 per share, we are a party to certain registration rightsagreements that contain provisions under which we could be subjected toliquidated damages should we fail to maintain effective registration statementsfor the underlying shares of common stock. These warrants have been accountedfor within equity in our condensed consolidated balance sheets in accordancewith EITF 00-19, *Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock*,and, accordingly, no liabilities have been recorded in connection therewith. Asof the date of this filing, no liquidated damages are payable under theprovisions of the registration rights agreements associated with thesewarrants.

 

**Rule 10b5-1 Trading Plan**

 

One of our executive officers, Francis Memole,has entered into a trading plan pursuant to Rule 10b5-1(c)(1) of theSecurities Exchange Act of 1934, as amended, which covers an aggregate of103,578 shares of our common stock.

 

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**Seasonality**

 

We have historically experienced, and expectto continue to experience, seasonality, particularly with respect to ourRoadway Sensors net sales in the third and fourth fiscal quarters due to areduction in road construction or repairs during the winter months in manymarkets as a result of inclement weather conditions.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our exposure to interest rate risk is limitedto our line of credit. Our line of credit bears interest based on theprevailing prime rate (5.00% at June 30, 2008). We do not believe that a10% increase in the interest rate on our line of credit (from 6.00% to 6.60%)would have a material impact on our financial position, operating results orcash flows. In addition, we believe that the carrying value of our outstandingdebt approximates fair value.

 

**ITEM 4T. 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 uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective to ensurethat information 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’s rules andforms and are effective in ensuring that information required to be disclosedby 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 fiscal quarter covered by this report, there has been nochange in our internal controls over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934) that has materiallyaffected, or is reasonably likely to materially affect, our internal controlsover financial reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

The information set forth under Note 4 of Notes to Unaudited CondensedConsolidated Financial Statements, included in Part I, Item I of thisreport, is incorporated herein by reference.

 

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**ITEM 1A.****                    RISK FACTORS**

 

*Our business is subject to a number of risks, some of whichare discussed below. Other risks are presented elsewhere in this report and in theinformation incorporated by reference into this report. You should consider thefollowing risks carefully in addition to the other information contained inthis report and our other filings with the SEC, including our annual report on Form 10-Kand subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell orhold our common stock. The risks and uncertainties described below are not theonly ones facing our company. Additional risks and uncertainties not presentlyknown to us or that we currently deem immaterial may also affect our businessoperations. If any of these risks actually occurs, our business, financialcondition or results of operations could be seriously harmed. In that event,the market price for our common stock could decline and you may lose all orpart of your investment.*

 

**We May Need To Raise Additional CapitalIn The Future, Which May Not Be Available On Terms Acceptable To Us, Or AtAll. **Untilrecently we have historically generated significant net losses and operatinglosses, and have experienced volatility in our cash flows from operationsranging from positive cash flows from operations of $7.6 million in the fiscalyear ended March 31, 2008 to negative cash flows from operations of $2.0million in the fiscal year ended March 31, 2007 (“Fiscal 2007”).Additionally, prior to the replacement of our prior credit facility in October 2006,we failed to meet certain debt covenants under that credit agreement during twofiscal quarters. Furthermore, as of June 30, 2008, we had $7.8 million insubordinated convertible debentures outstanding that are due in full in May 2009.Should the holders of the convertible debentures not elect to convert theprincipal into shares of our common stock, we may need to raise additionalcapital to refinance this debt.

 

At June 30, 2008, wehad $68,000 of cash and cash equivalents and relied on our line of credit tofund our operations. We may need to raise additional capital in the near futureto fund our operations or to repay indebtedness. Such additional capital may beraised through bank borrowings, or other debt or equity financings. We cannotassure you that any additional capital will be available on a timely basis, onacceptable terms, or at all, and such additional financing may result in furtherdilution to our stockholders.

 

Our capital requirements will depend on manyfactors, 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 increase revenue and net income;

 

·                                       increasedresearch and development expenses and sales and marketing expenses;

 

·                                       ourneed to respond to technological advancements and our competitors’introductions of new products or technologies;

 

·                                       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, including potential delaysin government contract awards;

 

·                                       ourability to successfully negotiate credit arrangements with our bank and repayour subordinated convertible debentures; and

 

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

 

If our capital requirements are materiallydifferent from 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.

 

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**If Our Internal Controls Over Financial Reporting Do Not Comply WithThe Requirements Of The Sarbanes-Oxley Act, Our Business And Stock Price CouldBe Adversely Affected. **Section 404of the Sarbanes-Oxley Act of 2002 currently requires us to evaluate theeffectiveness of our internal controls over financial reporting at the end ofeach fiscal year and to include a management report assessing the effectivenessof our internal controls over financial reporting in all annual reports. Section 404also requires our independent registered public accounting firm to attest to,and report on, management’s assessment of our internal controls over financialreporting beginning with our fiscal year ending March 31, 2010. We may notbe able to complete the work required for such attestation on a timely basis,and even if we timely complete such requirements, our independent auditors maystill conclude that our internal controls over financial reporting are noteffective.

 

Our management, including our CEO and CFO,does not expect that our internal controls over financial reporting willprevent all errors and all fraud. A control system, no matter how well designedand operated, can provide only reasonable, not absolute, assurance that thecontrol system’s objectives will be met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within Iteris 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 ofa material weakness in our internal controls related to the accounting for theconsolidation of our deferred compensation savings plan and certain contractadministration. Based on our evaluation, our management concluded that, as of March 31,2004, our internal control over financial reporting was not effective due tothe existence of one material weakness. The weakness was immediately corrected.We cannot assure you that we or our independent registered public accountingfirm will not identify additional material weaknesses in our internal controls.A material weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected. If our internal controls over financial reporting arenot considered adequate, we may experience a loss of public confidence, whichcould have an adverse effect on our business and our stock price.

 

**An Economic Slowdown Could Lead To Reduced OrDelayed Government Funding For Transportation Infrastructure And InitiativesAnd Decreased Availability Of Financial Capital For Our Customers, Causing ADecline In Our Revenues. **Concernsabout inflation, decreased consumer confidence, and reduced corporate profitsand capital spending have resulted in a downturn in worldwide economicconditions, particularly in the United States. These unfavorable economicconditions may have a negative impact on customer orders (and also may resultin decreased sales of automobiles and trucks that incorporate our LDW systems).Such concerns may result in cancellations and rescheduling of backlog. Inaddition, the recent decline in the U.S. real estate market, particularly innew home construction, has adversely impacted new road construction and couldresult in a decline in Roadway Sensor and Vehicle Sensor net sales andTransportation Systems contract revenues. Any of the foregoing economicconditions make it extremely difficult for our customers, our suppliers and usto accurately forecast and plan future business activities and could result ina decline in our net sales and contract revenues. If such conditions continueor worsen, our business, financial condition and results of operations could bematerially and adversely affected.

 

**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 Could AdverselyImpact Our Operating Results.**A significant portion ofour sales are derived from contracts with governmental agencies, either as ageneral contractor, subcontractor or supplier. Government contracts representedapproximately 38.1%, 37.8% and 38.3% of our total net sales and contractrevenues for the years ended March 31, 2008, 2007 and 2006, respectively.We anticipate that revenue from government contracts will continue to remain asignificant portion of our net sales and contract revenues. Government businessis, in general, subject to special risks and challenges, including:

 

·                                          longpurchase cycles or approval processes;

 

·                                          competitivebidding and qualification requirements;

 

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·                                          theimpact of international conflicts;

 

·                                          performancebond requirements;

 

·                                          changesin government policies and political agendas;

 

·                                          delaysin funding, including the delays in the allocation of funds to state and localagencies from the U.S. federal government as a result of a reduction or a delayin the passage of the 2005 Federal Highway Bill, which is set to expire in2009;

 

·                                          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 and contract revenues in any given quarter. Ourinability to address any of the foregoing concerns or the loss or renegotiationof any material government contract could seriously harm our business,financial condition and results of operations.

 

**We May Experience Production Gaps WhichCould Materially And Adversely Impact Our Sales And Financial Results And TheUltimate Acceptance Of Our Products.**It is possiblethat we could experience unforeseen quality control issues or part shortages aswe increase production to meet current demand for our products. We havehistorically used single suppliers for certain of our components in our AutoVueand Vantage products. Should any such delay or disruption occur, our futuresales will likely be materially and adversely affected. Additionally, we relyheavily on select contract manufacturers to produce many of our products.Although we believe our contract manufacturers have sufficient capacity to meetour production schedules for the foreseeable future and we believe we couldfind alternative contract manufacturing sources if necessary, we couldexperience a production gap if for any reason our contract manufacturers wereunable to meet our production requirements.

 

**We May Be Unable To Attract And RetainKey Personnel, Which Could Seriously Harm Our Business.**Dueto the 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 Abbas Mohaddes, our ChiefExecutive Officer, or any of the other executive officers or key members ofmanagement could adversely affect our business, financial condition or resultsof operations. Our success will also depend in large part upon our ability tocontinue to attract, retain and motivate qualified engineering and other highlyskilled technical personnel. In particular, the future success of our TransportationSystems segment will depend on our ability to hire additional qualifiedengineers and planners. Competition for qualified employees, particularlydevelopment engineers, is intense. We may not be able to continue to attractand retain sufficient numbers of such highly skilled employees. Our inabilityto attract and retain additional key employees or the loss of one or more ofour current key employees could adversely affect our business, financialcondition and results of operations.

 

**New EnvironmentalRegulations May Result In A Decline In Our AutoVue Sales and Royalties.**Environmentalregulations in Europe were modified and became effective in 2006, whichrequired more stringent emissions compliance in new trucks manufactured inEurope after 2006. These regulations caused the cost of certain trucks toincrease significantly and caused a decline in new truck sales in Europe.Similar regulations were exacted in North America that impacted diesel enginesbuilt after January 2007. North America heavy truck sales in 2007 and thefirst two quarters of 2008 declined significantly as compared to the prioryear, which we believe was at least in part a result of large 2006 prebuys ofheavy trucks made in anticipation of the new North America emission standards.  We may experience a further decline in ourLDW sales to truck OEMs related to these stricter regulations. Additionally, wemay experience future declines in our LDW sales to truck OEMs as a result offuture regulations such as these.

 

**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.**Webelieve our revenue growth and future operating results will depend on ourability to complete development of new products and enhancements, introducethese products in a timely, cost-effective manner, achieve broad marketacceptance of these products and enhancements, and reduce our product costs. Wecannot guarantee the success of these products and we may not be able tointroduce any new products or any enhancements to our existing products on atimely basis, or at all. In addition, the introduction of any new products couldadversely affect the sales of certain of our existing products.

 

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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. We cannot assure you that we will be able to adequately manageproduct transition issues. Our business and results of operations could beadversely affected if we do not anticipate or respond adequately totechnological developments or changing customer requirements or if we cannotadequately manage inventory issues typically related to new product transitionsand introductions. We cannot assure you that any such investments in researchand development will lead to any corresponding increase in revenue.

 

Market acceptance of our new products dependsupon many factors, including our ability to accurately predict marketrequirements and evolving industry standards, our ability to resolve technicalchallenges in a timely and cost-effective manner, qualify any new products withOEMs and achieve manufacturing efficiencies, the perceived advantages of ournew products 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 Vantageand AutoVue products may need to be re-engineered in the next 12 to 36 monthsas the industry is moving towards a standard of using lead-free components. Wecannot assure you as to the timing of the adoption of this new standard or ourability to successfully redesign our products to incorporate compliantcomponents and gain market acceptance of such redesigned products. In addition,if the standard is adopted earlier than anticipated we may experience ashortage of Vantage and AutoVue products as a result of potential scarcity oflead-free components.

 

Our business and results of operations couldalso be seriously harmed by any significant delays in our new productdevelopment. Certain of our new products could contain undetected design faultsand software errors or “bugs” when first released by us, despite our testing.We may not discover these faults or errors until after a product has beeninstalled and used by our customers. Any faults or errors in our existingproducts or in any new products may cause delays in product introduction andshipments, require design modifications or harm customer relationships, any ofwhich could adversely affect our business and competitive position.

 

**The Markets In Which We Operate Are HighlyCompetitive And Have Many More Established Competitors, Which Could AdverselyAffect Our 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. In Fiscal 2007, we began to experience more competition in ourRoadway Sensors segment as the Department of Transportation in one of ourlargest sales territories moved to a multi-source contracting environment fromone in which we were the sole supplier. In addition, one of the otherdevelopers of LDW systems was acquired by a larger company during Fiscal 2007, whoin July 2008 sold its in-vehicle vision business to a multi-national manufacturerand supplier of in-vehicle saftey products. This new competitor could be moreaggressive in both the passenger car and heavy truck markets, as a result ofits greater access to resources and reputation in the market. Additional new competitorsmay enter this market in the future. Furthermore, awareness of LDW technologyis increasing and other market players are attempting to develop competingtechnologies, which may contain improvements or added features beyond thoseoffered by our LDW systems. Additionally, from time to time, we may be requiredto re-compete for LDW business from our main customer base of heavy truckOEM’s. These OEM’s could make a supplier change based on price, productperformance or available features. Should our competition be successful, thiscould erode our ability to successfully market and sell our LDW systems to newand existing customers.

 

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.

 

**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 

 

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and sell our technologies, and to convince more OEM passenger carmanufacturers to adopt our technologies. To date, we have not generated significant royalties from Valeo’sefforts and have only been designed into one car OEM product line.  If Valeo does not devote considerableresources and aggressively pursue opportunities, our expansion into thepassenger car market could be adversely affected.

 

**We Have Historically Experienced Substantial Losses And May ExperienceLosses In The Future.**Although we have achieved netincome in our prior three fiscal years, we experienced a net loss of $11.3million in the year ended March 31, 2005 and significant net losses inprior years. We cannot assure you that we will be able to sustain or improveour financial performance, or that we will be able to continue to achieveprofitability on a quarterly or annual basis in the future. Most of ourexpenses are fixed in advance. As such, we generally are unable to reduce ourexpenses significantly in the short-term to compensate for any unexpected delayor decrease in anticipated revenues. As a result, we may continue to experienceoperating losses and net losses, which would make it difficult to fund ouroperations and achieve our business plan, and could cause the market price ofour common stock to decline.

 

**If We Do Not Keep Pace With RapidTechnological Changes And Evolving Industry Standards, We Will Not Be Able ToRemain Competitive 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;

 

·                                          additionalqualification requirements related to new products or components;

 

·                                          frequentnew product introductions and enhancements;

 

·                                          inventoryissues related to transition to new or enhanced models; and

 

·                                          evolvingindustry standards and changes in the regulatory environment.

 

Our future success will depend upon ourability to anticipate and adapt to changes in technology and industrystandards, and to effectively develop, introduce, market and gain broadacceptance of new products and product enhancements incorporating the latesttechnological advancements. In particular, our LDW system is incorporated intoautomobiles and trucks that face significant technological changes in eachmodel year and among different vehicle models. Accordingly, we must adapt ourtechnology from time to time to function with such changes.

 

**We May Engage In Acquisitions OfCompanies Or Technologies That May Require Us To Undertake SignificantCapital Infusions And Could Result In Disruptions Of Our Business And DiversionOf Resources And Management Attention.**We havehistorically acquired, and may in the future acquire, complementary businesses,products and technologies. Acquisitions may require significant capitalinfusions and, in general, 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 in integratingthe operations, technologies and information system of the acquired companies;

 

·                                          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 

 

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materially and adversely affect our operating results due to largewrite-offs, contingent liabilities, substantial depreciation, deferredcompensation charges or intangible asset amortization, or other adverse tax oraccounting consequences. We cannot assure you that we will be able to identifyor consummate any additional acquisitions, successfully integrate anyacquisitions or realize the benefits anticipated from any acquisition.

 

**The SignificantMilitary Operations In The Middle East Or Elsewhere May Impact GovernmentFunding Or Consumer Spending, Causing A Decline In Our Revenues.**Inthe near term, the funding of U.S. military operations in the Middle East orelsewhere may cause disruptions in funding of government contracts. Sincemilitary operations of such magnitude are not routinely included in U.S.defense budgets, supplemental legislative funding actions are often required tofinance such operations. Even when such legislation is enacted, it may not beadequate for ongoing operations, causing other government resources to betemporarily or permanently diverted. Since a significant portion of our salesare derived from contracts with government agencies, such diversion of fundscould produce interruptions in funding or delays in receipt of our contracts,causing disruptions and adversely effecting our revenue and operations.

 

**Our Quarterly Operating Results Fluctuate AsA Result 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;

 

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

 

·                                          delaysin government contracts and funding from time to time for consulting contractsor intersection maintenace and upgrades;

 

·                                          declinesin new home construction and related road construction;

 

·                                          ourability to control costs;

 

·                                          ourability to raise additional capital;

 

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

 

·                                          seasonalitydue to winter weather conditions;

 

·                                          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;

 

·                                          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;

 

·                                          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.

 

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Due to all of the factors listed above aswell as other unforeseen factors, our future operating results could be belowthe expectations of securities analysts or investors. If that happens, thetrading price 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.

 

**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 aredenominated in U.S. dollars. As a result, an increase in the relative value ofthe dollar could make our products more expensive and potentially less pricecompetitive in international markets. We do not engage in any transactions as ahedge against risks of loss due to foreign currency fluctuations.

 

Any of the factors mentioned above mayadversely affect our future international sales and, consequently, affect ourbusiness, financial condition and operating results. Furthermore, as weincrease our international sales, our total revenues may also be affected to agreater extent by seasonal fluctuations resulting from lower sales thattypically occur during the summer months in Europe and other parts of theworld.

 

**We HaveExperienced Growth In Recent Periods. If We Fail To Manage Our GrowthEffectively, We May Be Unable To Execute Our Business Plan And May ExperienceFuture Weaknesses In Our Internal Controls.**We have expandedour overall business. In order to achieve our business objectives, we will needto continue 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.

 

**We May Not Be Able To Adequately ProtectOr Enforce Our Intellectual Property Rights, Which Could Harm Our CompetitivePosition.**If we are not able to adequately protect orenforce the proprietary aspects of our technology, competitors could be able toaccess our proprietary technology and our business, financial condition andresults of operations will likely be seriously harmed. We currently attempt toprotect our technology through a combination of patent, copyright, trademarkand trade secret laws, employee and third party nondisclosure agreements andsimilar means. Despite our efforts, other parties may attempt to disclose,obtain or use our technologies or systems. Our competitors may also be able toindependently develop products that are substantially equivalent or superior toour products or design around our patents. In addition, the laws of someforeign countries do not protect our proprietary rights as fully as do the lawsof the United States. As a result, we may not be able to protect ourproprietary rights adequately in the United States or abroad.

 

Litigation may be necessary in the future to enforce our intellectualproperty rights or to determine the validity and scope of the proprietaryrights of others. Litigation may also be necessary to defend against claims ofinfringement or invalidity by others. An adverse outcome in litigation or anysimilar proceedings could subject us to significant liabilities to thirdparties, require us to license disputed rights from others or require us tocease marketing or using certain products or technologies. We may not be ableto obtain any licenses on terms acceptable to us, or at all. We also may haveto indemnify 

 

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certaincustomers or strategic partners if it is determined that we have infringed uponor misappropriated another party’s intellectual property. Any of these resultscould adversely affect our business, financial condition and results ofoperations. In addition, the cost of addressing any intellectual propertylitigation claim, including legal fees and expenses, and the diversion ofmanagement’s attention and resources, regardless of whether the claim is valid,could be significant and could seriously harm our business, financial conditionand results of operations.

 

**The Trading Price Of Our Common Stock IsHighly Volatile.**The trading price of our common stockhas been subject 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;

 

·                                          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 from time totime experienced volatility, which has often affected the market prices ofequity securities 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.

 

**We Could Experience Negative FinancialImpacts Arising From Developments In Contingencies Created Under Our PreviousStructure Or By Former Subsidiaries.**Although wedivested ourselves of all business units prior to October 2004, with theexception of our Iteris business, from time to time we could experienceunforeseen developments in contingencies related to our former subsidiaries.For example, in July 2006 we entered into a settlement agreement inconnection with a lawsuit brought against Mariner Networks, Inc., one ofour former subsidiaries, by one of Mariner’s suppliers, pursuant to which weissued 88,912 shares of our common stock to this supplier (valued at $213,000as of the date of issuance), paid this supplier $125,000 on October 20,2006 and are required to pay an additional $350,000 in 36 equal monthlyinstallments of $9,700 through October 2009. Although we are not aware ofany other material contingencies, it is possible that other matters could bebrought against us in connection with activities related to former subsidiariesand that such matters could materially and adversely affect our financialresults 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 30,2008, our officers and directors beneficially owned approximately 11% of theoutstanding shares of our common stock (and approximately 15% of our commonstock when including options, warrants and other convertible securities held bythem which are currently exercisable or convertible or will become exercisableor convertible within 60 days after June 30, 2008). As a result oftheir stock ownership, our management will be able to influence the election ofour directors and the outcome of corporate actions requiring stockholderapproval, such as mergers and acquisitions, regardless of how our otherstockholders may vote. This concentration of voting control may have a significanteffect in delaying, deferring or preventing a change in our management orchange in control and may adversely affect the voting or other rights of otherholders of common stock.

 

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**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 could make it difficult for athird party to acquire us, even though an acquisition might be beneficial toour stockholders. Such provisions could limit the price that investors might bewilling to pay in the future for shares of our common stock. Under the terms ofour certificate of incorporation, our Board of Directors is authorized toissue, without stockholder approval, up to 2,000,000 shares of preferred stockwith voting, conversion and other rights and preferences superior to those ofour common stock. Our future issuance of preferred stock could be used todiscourage an unsolicited acquisition proposal.

 

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

 

None.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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

 

None.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

**ITEM 6. EXHIBITS**

 

The following exhibits are filed herewith or are incorporated byreference to the location indicated.

 
| **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                 |       | Certificate of Amendment to Amended and Restated Certificate of  Incorporation filed September 26, 2007 | * *   | *Exhibit 3.2 to the registrant’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2007 as filed with  the SEC on November 13, 2007* |
| * *            | * *   | * *                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.3                 |       | 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*                     |
| * *            | * *   | * *                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.4                 |       | 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*             |
| * *            | * *   | * *                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.5                 |       | 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* |
|                |       |                                                                                                         |       |                                                                                                                                                                           |
| 3.6                 |       | Certificate of Amendment to Bylaws of registrant dated  September 16, 2005                              | * *   | *Exhibit 3.5 to the registrant’s Annual Report on Form 10-K  for the year ended March 31, 2007 as filed with the SEC on June 21,  2007*               |
|                |       |                                                                                                         |       |                                                                                                                                                                           |
| 3.7                 |       | Certificate of Amendment to Bylaws of registrant dated  December 7, 2007                                | * *   | *Exhibit 3.1 to the registrant’s Current Report on Form 8-K  as filed with the SEC on December 13, 2007*                                                   |
|                |       |                                                                                                         |       |                                                                                                                                                                           |
| 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*               |

 

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| 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 Executive 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Dated: July 31, 2008 | ITERIS, INC. |
|---------------------------|--------------|
|                      | (Registrant) |
|                      |         |
|                      | By           | /S/ ABBAS MOHADDES |
|                      |         | Abbas Mohaddes |
|                      |         | 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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