**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, 2007** |
| ** **                                        |
| **OR**                                            |
| ** **                                        |                                                                                                     | ** ** |
| **o**                                             | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |

 

**For the transition periodfrom          to          **

**Commission filenumber:  001-08762**

**ITERIS, INC.**

(Exact name of registrant asspecified in its charter)

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

 

**(714)**774-5000

**(Registrant’s telephone number, including area code)**

(Former name, former address andformer fiscal year, if changed since last report)

**Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934, asamended (the “Exchange Act”) during the preceding 12 months (or for suchshorter 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 checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):**

**Large accelerated filer  **o       Acceleratedfiler  o      Non-accelerated filer  x

 

**Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).**

**Yes **o No x

As of August 13, 2007, the registrant had 32,858,572 sharesof common stock outstanding

 

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**ITERIS, INC.**

**Quarterly Reporton Form 10-QFor the Three Months Ended June 30, 2007**

**Table of Contents**
| **PART I.**  | ** ** | **FINANCIAL  INFORMATION**                                                                                        | ** ** |
|-------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
|              |       |                                                                                                              |       |
| **ITEM 1.**       | ** ** | **FINANCIAL STATEMENTS**                                                                                          | ** ** |
|              |       |                                                                                                              |       |
| ** **        | ** ** | **CONDENSED  CONSOLIDATED BALANCE SHEETS AT JUNE 30, 2007 AND MARCH 31, 2007**                               | ** ** |
| ** **        | ** ** | ** **                                                                                                        | ** ** |
| ** **        | ** ** | **UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED  JUNE 30, 2007 AND 2006** | ** ** |
|              |       |                                                                                                              |       |
| ** **        | ** ** | **UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED  JUNE 30, 2007 AND 2006** | ** ** |
|              |       |                                                                                                              |       |
| ** **        | ** ** | **NOTES TO  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**                                               | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 2.**       | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                   | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 3.**       | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                   | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 4.**       | ** ** | **CONTROLS AND  PROCEDURES**                                                                                      | ** ** |
|              |       |                                                                                                              |       |
| **PART II.** | ** ** | **OTHER INFORMATION**                                                                                             | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 1.**       | ** ** | **LEGAL PROCEEDINGS**                                                                                             | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 1A.**      | ** ** | **RISK FACTORS**                                                                                                  | ** ** |
| ** **        | ** ** | ** **                                                                                                        | ** ** |
| **ITEM 2.**       | ** ** | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                  | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 3.**       | ** ** | **DEFAULTS UPON  SENIOR SECURITIES**                                                                              | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 4.**       | ** ** | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                          | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 5.**       | ** ** | **OTHER INFORMATION**                                                                                             | ** ** |
|              |       |                                                                                                              |       |
| **ITEM 6.**       | ** ** | **EXHIBITS**                                                                                                      | ** ** |

 

Unless otherwise indicated in this report, the “Company,”“we,” “us” and “our” collectively refer to Iteris, Inc. and its formersubsidiary, Meyer, Mohaddes Associates, Inc., which was dissolved effectiveApril 2006.

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

2

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**PART I.FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

**ITERIS, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS(In thousands, except per share amounts)**
| ** **                                                                                                                                                                     | ** ** | **June 30,  2007** | ** ** | **March 31,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **(unaudited)**         | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                                                     |       |                    |       |                     |       |
| Current assets:                                                                                                                                                                |       |                    |       |                     |       |
| Cash and cash  equivalents                                                                                                                                                     | ** ** | **$**                   | **2,214**  |                     | $          | 35 |   |
| Trade accounts  receivable, net of allowance for doubtful accounts of $721 and $664 at June  30, 2007 and March 31, 2007, respectively                                    | ** ** | **9,671**               |       | 11,493                   |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                                                                                   | ** ** | **5,364**               |       | 3,689                    |       |
| Inventories, net  of reserve for inventory obsolescence of $855 and $844 at June 30, 2007 and  March 31, 2007, respectively                                               | ** ** | **5,921**               |       | 6,379                    |       |
| Deferred income  taxes                                                                                                                                                         | ** ** | **535**                 |       | 494                      |       |
| Prepaid expenses  and other current assets                                                                                                                                     | ** ** | **771**                 |       | 385                      |       |
| Total current  assets                                                                                                                                                          | ** ** | **24,476**              |       | 22,475                   |       |
| Property and  equipment, net                                                                                                                                                   | ** ** | **1,700**               |       | 1,712                    |       |
| Deferred income  taxes                                                                                                                                                         | ** ** | **2,388**               |       | 2,533                    |       |
| Intangible  assets, net of accumulated amortization of $445 and $408 at June 30, 2007 and  March 31, 2007, respectively                                                   | ** ** | **367**                 |       | 404                      |       |
| Goodwill                                                                                                                                                                       | ** ** | **27,774**              |       | 27,774                   |       |
| Other assets                                                                                                                                                                   | ** ** | **442**                 |       | 352                      |       |
| Total assets                                                                                                                                                                   | ** ** | **$**                   | **57,147** |                     | $          | 55,250 |   |
|                                                                                                                                                                           | ** ** | ** **              |       |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                 | ** ** | ** **              | ** ** | ** **               | ** ** |
| Current liabilities:                                                                                                                                                           |       |                    |       |                     |       |
| Trade accounts  payable                                                                                                                                                        | ** ** | **$**                   | **3,459**  |                     | $          | 3,542 |   |
| Accrued payroll  and related expenses                                                                                                                                          | ** ** | **3,469**               |       | 3,527                    |       |
| Accrued  liabilities                                                                                                                                                           | ** ** | **2,172**               |       | 1,618                    |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts                                                                                                   | ** ** | **840**                 |       | 847                      |       |
| Revolving line  of credit                                                                                                                                                      | ** ** | **4,437**               |       | 4,015                    |       |
| Current portion  of long-term debt                                                                                                                                             | ** ** | **1,624**               |       | 1,947                    |       |
| Total current  liabilities                                                                                                                                                     | ** ** | **16,001**              |       | 15,496                   |       |
| Non-current accrued  liabilities                                                                                                                                               | ** ** | **140**                 |       | 163                      |       |
| Deferred compensation  plan liability                                                                                                                                          | ** ** | **401**                 |       | 730                      |       |
| Long-term debt                                                                                                                                                                 | ** ** | **9,487**               |       | 9,760                    |       |
| Total  liabilities                                                                                                                                                             | ** ** | **26,029**              |       | 26,149                   |       |
| Commitments and  contingencies                                                                                                                                                 |       |                    |       |                     |       |
| Redeemable common  stock, 1,219 shares issued and outstanding at June 30, 2007 and  March 31, 2007                                                                        | ** ** | **3,414**               |       | 3,414                    |       |
| Stockholders’ equity:                                                                                                                                                     |       |                    |       |                     |       |
| Preferred stock,  $1.00 par value, 2,000 shares authorized, none issued and outstanding at June  30, 2007 and March 31, 2007                                              | ** ** | **—**              |       | —                   |       |
| Common stock,  $0.10 par value, 50,000 shares authorized, 31,513 and 30,601 shares issued or  issuable and outstanding at June 30, 2007 and March 31, 2007,  respectively | ** ** | **3,151**               |       | 3,060                    |       |
| Additional  paid-in capital                                                                                                                                                    | ** ** | **131,302**             |       | 130,425                  |       |
| Common stock  held in trust, 167 and 311 shares at June 30, 2007 and March 31, 2007, respectively                                                                         | ** ** | **(202**                | **)**      | (374                     | )          |
| Notes receivable  from employees                                                                                                                                               | ** ** | **—**              |       | (5                       | )          |
| Accumulated  deficit                                                                                                                                                           | ** ** | **(106,566**            | **)**      | (107,438                 | )          |
| Accumulated  other comprehensive income                                                                                                                                        | ** ** | **19**                  |       | 19                       |       |
| Total stockholders’  equity                                                                                                                                               | ** ** | **27,704**              |       | 25,687                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                | ** ** | **$**                   | **57,147** |                     | $          | 55,250 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

3

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**ITERIS,INC.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share amounts)**
| ** **                                           | ** ** | **Three Months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| Net sales and contract revenues: | ** ** | ** **                                      |       |   |   |
| Net sales                                            | ** ** | **$**                                           | **10,244** |   | $ | 8,600 |   |
| Contract revenues                                    | ** ** | **5,513**                                       |       | 5,216 |   |
| Total net sales and  contract revenues               | ** ** | **15,757**                                      |       | 13,816 |   |
|                                                 | ** ** | ** **                                      |       |   |   |
| Costs of net sales and contract revenues:            | ** ** | ** **                                      |       |   |   |
| Cost of net sales (a)                                | ** ** | **5,175**                                       |       | 4,758 |   |
| Cost of contract  revenues (a)                       | ** ** | **3,488**                                       |       | 3,339 |   |
| Gross profit                                         | ** ** | **7,094**                                       |       | 5,719 |   |
| Operating expenses:                                  | ** ** | ** **                                      |       |   |   |
| Selling, general and  administrative (a)             | ** ** | **4,458**                                       |       | 4,001 |   |
| Research and  development (a)                        | ** ** | **994**                                         |       | 1,003 |   |
| Deferred compensation  plan                          | ** ** | **31**                                          |       | (66 | ) |
| Amortization of intangible  assets                   | ** ** | **37**                                          |       | 36 |   |
| Total operating  expenses                            | ** ** | **5,520**                                       |       | 4,974 |   |
| Operating income                                     | ** ** | **1,574**                                       |       | 745 |   |
| Non-operating income (expense):                      | ** ** | ** **                                      |       |   |   |
| Other income (expense),  net                         | ** ** | **19**                                          |       | (690 | ) |
| Interest expense, net                                | ** ** | **(363**                                        | **)**      | (386 | ) |
| Income (loss) before income taxes                    | ** ** | **1,230**                                       |       | (331 | ) |
| Income tax (provision) benefit                       | ** ** | **(134**                                        | **)**      | 610 |   |
| Net income                                           | ** ** | **$**                                           | **1,096**  |   | $ | 279 |   |
|                                                 | ** ** | ** **                                      |       |   |   |
| Earnings per share:                                  | ** ** | ** **                                      |       |   |   |
| Basic                                                | ** ** | **$**                                           | **0.03**   |   | $ | 0.01 |   |
| Diluted                                              | ** ** | **$**                                           | **0.03**   |   | $ | 0.01 |   |
| Weighted average shares outstanding:                 | ** ** | ** **                                      |       |   |   |
| Basic                                                | ** ** | **32,089**                                      |       | 28,393 |   |
| Diluted                                              | ** ** | **34,317**                                      |       | 32,368 |   |

 

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(a)                                  Includes stock-based compensation expense as follows:
| Cost of net sales                           |   | $  | 1      |   | $      | 5   |   |
|---------------------------------------------|--------|----|--------|--------|--------|-----|--------|
| Cost of contract revenues                   |   | 3  |   | 29     |   |
| Selling, general and administrative expense |   | 59 |   | 54     |   |
| Research and  development expense           |   | 3  |   | 12     |   |
| Total                                       |   | $  | 66     |   | $      | 100 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

4

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**ITERIS, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**
| ** **                                                                                   | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| **Cash flows from operating activities**                                 | ** ** | ** **                                      |       |   |   |
| Net income                                                                                   | ** ** | **$**                                           | **1,096**  |   | $ | 279 |   |
| Adjustments to reconcile net income to net cash  provided (used in) by operating activities: |       |                                            |       |   |   |
| Change in deferred tax assets                                                                | ** ** | **104**                                         |       | (456 | ) |
| Depreciation and amortization of property and  equipment                                     | ** ** | **149**                                         |       | 130 |   |
| Stock-based compensation expense                                                             | ** ** | **66**                                          |       | 100 |   |
| Amortization of deferred gain on sale—leaseback  transaction                            | ** ** | **(71**                                         | **)**      | (71 | ) |
| Amortization of debt discount                                                                | ** ** | **52**                                          |       | 52 |   |
| Amortization of intangible assets                                                            | ** ** | **37**                                          |       | 36 |   |
| Amortization of deferred financing costs                                                     | ** ** | **35**                                          |       | 34 |   |
| Issuance of warrants for services                                                            | ** ** | ** **                                      |       |   |   |
| Changes in operating assets and liabilities:                                                 |       |                                            |       |   |   |
| Accounts receivable                                                                          | ** ** | **1,822**                                       |       | 914 |   |
| Net costs and estimated earnings in excess of  billings                                      | ** ** | **(1,682**                                      | **)**      | (1,130 | ) |
| Inventories                                                                                  | ** ** | **458**                                         |       | (175 | ) |
| Prepaid expenses and other assets                                                            | ** ** | **(511**                                        | **)**      | (551 | ) |
| Accounts payable and accrued liabilities                                                     | ** ** | **308**                                         |       | 239 |   |
| Net cash  provided by (used in) operating activities                                         | ** ** | **1,863**                                       |       | (599 | ) |
|                                                                                         |       |                                            |       |   |   |
| **Cash  flows from investing activities**                                                    |       |                                            |       |   |   |
| Purchases of property and equipment                                                          | ** ** | **(137**                                        | **)**      | (142 | ) |
|                                                                                         |       |                                            |       |   |   |
| **Cash  flows from financing activities**                                                    |       |                                            |       |   |   |
| Net borrowings on line of credit                                                             | ** ** | **422**                                         |       | 847 |   |
| Payments on long-term debt                                                                   | ** ** | **(648**                                        | **)**      | (333 | ) |
| Change in checks drawn in excess of available bank  balances                                 | ** ** | **(47**                                         | **)**      | 153 |   |
| Proceeds from stock option exercises                                                         | ** ** | **726**                                         |       | 168 |   |
| Net cash  provided by financing activities                                                   | ** ** | **453**                                         |       | 835 |   |
| Increase in cash                                                                             | ** ** | **2,179**                                       |       | 94 |   |
| Cash at  beginning of period                                                                 | ** ** | **35**                                          |       | 131 |   |
| Cash at end of  period                                                                       | ** ** | **$**                                           | **2,214**  |   | $ | 225 |   |
|                                                                                         |       |                                            |       |   |   |
| **Supplemental  cash flow information:**                                                     | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Cash paid during the period:                                                                 |       |                                            |       |   |   |
| Interest                                                                                     | ** ** | **$**                                           | **301**    |   | $ | 301 |   |
| Income taxes                                                                                 | ** ** | **48**                                          |       | 40 |   |
| ** **                                                                                   | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| **Supplemental  schedule of non-cash investing and financing activities:**              | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Fair value of  common stock issued in settlement of liabilities                              | ** ** | **$**                                           | **350**    |   | $ | — |   |
| Write-off of notes  receivable from employees                                                | ** ** | **(5**                                          | **)**      | — |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

5

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**ITERIS,INC.**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2007**

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

**Description of Business**

Iteris, Inc. is aleading provider of outdoor machine vision systems and sensors that help to optimizethe flow of traffic and enhance driver safety. Using proprietary software andIntelligent Transportation Systems (“ITS”) industry expertise, the Companyprovides video sensor systems, transportation management and travelerinformation systems and other engineering consulting services to the ITSindustry. The ITS industry is comprised of companies applying a variety oftechnologies to enable the safe and efficient movement of people and goods. TheCompany uses its outdoor image recognition software expertise to developproprietary algorithms for video sensor systems that improve vehicle safety andthe flow of traffic. Using its knowledge of the ITS industry, the Companydesigns and implements transportation management systems that help publicagencies reduce traffic congestion and provide greater access to travelerinformation.  The Company was originally incorporatedin Delaware in 1987.  On October 22,2004, the Company completed a merger with its majority-owned subsidiary,Iteris, Inc. (the “Iteris Subsidiary”), and officially changed itscorporate name from Iteris Holdings, Inc. to Iteris, Inc.

**Basis ofPresentation**

The unaudited condensed consolidated financialstatements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation and with the instructions to Securities and Exchange Commission (“SEC”)Form 10-Q and Article 10 of SEC Regulation S-X. In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments, consisting of normal recurring adjustments,necessary to present fairly the consolidated financial position of the Companyas of June 30, 2007, the consolidated results of operations for the threemonths ended June 30, 2007 and 2006, and the consolidated cash flows for thethree months ended June 30, 2007 and 2006. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States (“U.S. GAAP”)have been condensed or omitted pursuant to the rules and regulations ofthe SEC. The results of operations for the three months ended June 30, 2007,are not necessarily indicative of those to be expected for the entire year. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the Company’s Annual Report on Form 10-K for theyear ended March 31, 2007, which was filed with the SEC on June 21, 2007.

# **Use ofEstimates**

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

**Reclassifications**

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

# **RevenueRecognition**

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

6

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Contractrevenues are derived primarily from long-term contracts with governmentalagencies.  Contract revenues includecosts incurred plus a portion of estimated fees or profits determined on thepercentage of completion method of accounting based on the relationship ofcosts incurred to date to total estimated costs.  Any anticipated losses on contracts arecharged to earnings when identified. Changes in job performance and estimated profitability, including thosearising from contract penalty provisions and final contract settlements, mayresult in revisions to costs and revenues and are recognized in the period inwhich the revisions are determined. Profit incentives are included in revenue when their realization isreasonably assured.

In additionto product and contract revenue, the Company derives revenue from technologyaccess fees, the provision of specific non-recurring contract engineeringservices and royalties. Technology access fee revenues are recognized evenlyover the period in which they are earned. Non-recurring contract engineering revenues are recognized in the periodin which the related services are performed. Royalty revenues are recorded in the period in which the royalty isearned, based on unit sales of the Company’s products.  Technology access fee revenues, contractengineering revenues and royalty revenues are included in net sales in theaccompanying condensed consolidated statements of operations.

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

**Concentrationof Credit Risk**

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

**Fair Values of Financial Instruments**

The fair values of cashand cash equivalents, receivables, inventories, accounts payable and accruedexpenses approximate carrying value because of the short period of time tomaturity. The fair values of line of credit agreements and long-term debtapproximate carrying value because the related rates of interest approximatecurrent market rates.  The fair value ofconvertible debentures approximates carrying value because the effectiveinterest rate, taking into account recorded debt discounts, approximatescurrent market rates.  The estimated fairvalue of redeemable common stock was $2.9 million and $2.8 million at June 30,2007 and March 31, 2007, respectively, based on the closing price of theCompany’s common stock on those dates.

# **Inventories**

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

**Property and Equipment**

Property and equipmentare recorded at cost and are generally depreciated using the straight-linemethod over the estimated useful life ranging from three to eight years.  Leasehold improvements are depreciated over theterm of the related lease or the estimated useful life of the improvement,whichever is shorter.

**Goodwill and Long-Lived Assets**

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

7

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

**Income Taxes**

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

## **Stock-BasedCompensation**

EffectiveApril 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 themodified prospective transition method for transition to SFAS 123R.  Under the modified prospective method, SFAS123R applies to all awards granted or modified after the date of adoption.  In addition, under the modified prospectivemethod, compensation expense is recognized for all stock-based compensationawards granted prior to but not yet vested as of April 1, 2006, based ongrant-date fair values estimated in accordance with the original provisions ofSFAS No. 123, *Accounting for Stock-Based Compensation*.

**Researchand Development Expenditures**

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

**Shipping and Handling Costs**

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

**Sales Taxes**

Sales taxes are presented on a net basis (excludedfrom net sales and contract revenues) in the condensed consolidated statementsof operations.

**Warranty**

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

**Repair and Maintenance Costs**

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

8

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**Other Comprehensive Income**

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

**Recent Accounting Pronouncements**

In July 2006, the Financial Accounting Standards Board(the “FASB”) issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes* (“FIN 48”). FIN 48 applies to alltax positions accounted for under SFAS 109, and defines the confidence levelthat a tax position must meet in order to be recognized in the financialstatements. The interpretation requires that the tax effects of a position berecognized only if it is “more-likely-than-not” to be sustained by the taxingauthority as of the reporting date. If a tax position is not considered “more-likely-than-not”to be sustained then no benefits of the position are to be recognized. FIN 48requires additional disclosures and is effective as of the beginning of thefirst fiscal year beginning after December 15, 2006.  As further discussed in Note 4, the Companyadopted FIN 48 effective April 1, 2007.

In September 2006, the 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 November15, 2007, and interim periods within those fiscal years. Early application ofthe statement is encouraged. Generally, this statement will be appliedprospectively. The Company is currently evaluating the impact of SFAS 157 andexpects to adopt SFAS 157 in the first quarter of its fiscal year ending March31, 2009.

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities —Including an Amendment of FASB Statement No. 115* (“SFAS 159”). SFAS159 permits entities to choose to measure many financial instruments andcertain other items at fair value. Unrealized gains and losses on items forwhich the fair value option has been elected will be recognized in earnings ateach subsequent reporting date. SFAS 159 is effective for financial statementsissued for fiscal years beginning after November 15, 2007.  The Company is evaluating the impact that theadoption of SFAS 159 will have on its results of operations and financialcondition and expects to adopt SFAS 159 in its fiscal year ending March 31,2009.

**2. Supplemental Financial Information**

**Inventories**

Thefollowing table presents details of the Company’s inventories:
| ** **              | ** ** | **June 30,  2007** | ** ** | **March 31,  2007** | ** ** |
|-------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **              | ** ** | **(In thousands)** | ** ** |
| Materials and  supplies | ** ** | **$**                   | **4,478**  |                     | $          | 4,705 |   |
| Work in process         | ** ** | **334**                 |       | 366                      |       |
| Finished goods          | ** ** | **1,109**               |       | 1,308                    |       |
| ** **              | ** ** | **$**                   | **5,921**  |                     | $          | 6,379 |   |

**Intangible Assets**
| ** **            | ** ** | **June 30, 2007** | ** ** | **March 31, 2007**  | ** ** |
|-----------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **            | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **            | ** ** | **(In thousands)**     | ** ** |
| Developed  technology | ** ** | **$**                       | **495**    | ** **                    | **$**      | **(306** | **)** | $ | 495 |   | $ | (280 | ) |
| Patents               | ** ** | **317**                     | ** ** | **(139**                      | **)**      | 317 |   | (128 | ) |
| Total                 | ** ** | **$**                       | **812**    | ** **                    | **$**      | **(445** | **)** | $ | 812 |   | $ | (408 | ) |

 

9

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Amortizationexpense for intangible assets subject to amortization was $37,000 and $36,000for the three months ended June 30, 2007 and 2006, respectively.  Future estimated amortization expense for theremainder of the current fiscal year and the next four fiscal years is asfollows:

 
| Fiscal Year Ending March 31: | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **(In thousands)**                          | ** ** | ** ** | ** ** |
| 2008                                             |       | $          | 110        |   |
| 2009                                             |       | 147        |       |
| 2010                                             |       | 58         |       |
| 2011                                             |       | 46         |       |
| 2012                                             |       | 6          |       |
|                                             |       | $          | 367        |   |

** **

**Warranty Reserve Activity**

The following table presents activity in accrued warrantyobligations:
|                                    | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(In thousands)**                         | ** ** |
| Balance at  beginning of period    | ** ** | **$**                                           | **520**    |   | $ | 519 |   |
| Additions charged to cost of sales | ** ** | **99**                                          |       | 135 |   |
| Warranty claims                    | ** ** | **(50**                                         | **)**      | (64 | ) |
| Balance at end of  period          | ** ** | **$**                                           | **569**    |   | $ | 590 |   |

** **

**Earnings Per Share**

The following table sets forth the computation ofbasic and diluted earnings per share:
|                                                              | ** ** | **Three Months Ended  June 30,**                   | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| Numerator:                                                   |       |                                                              |       |   |   |
| Net income                                                   | ** ** | **$**                                                             | **1,096**  |   | $ | 279 |   |
|                                                         | ** ** | ** **                                                        |       |   |   |
| Denominator:                                                 | ** ** | ** **                                                        |       |   |   |
| Weighted average common  shares used in basic computation    | ** ** | **32,089**                                                        |       | 28,393 |   |
| Dilutive stock options                                       | ** ** | **2,197**                                                         |       | 3,417 |   |
| Dilutive warrants                                            | ** ** | **31**                                                            |       | 558 |   |
| Weighted average common  shares used in dilutive computation | ** ** | **34,317**                                                        |       | 32,368 |   |
|                                                         | ** ** | ** **                                                        |       |   |   |
| Earnings (loss) per share:                                   | ** ** | ** **                                                        |       |   |   |
| Basic                                                        | ** ** | **$**                                                             | **0.03**   |   | $ | 0.01 |   |
| Diluted                                                      | ** ** | **$**                                                             | **0.03**   |   | $ | 0.01 |   |

 

Thefollowing shares were excluded from the computation of diluted earnings pershare as their effect would have been anti-dilutive:
|                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|
| ** **              | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **              | ** ** | **(In thousands)**                         | ** ** |
| Stock options           | ** ** | **668**                                         |       | 525 |   |
| Warrants                | ** ** | **1,190**                                       |       | 1,380 |   |
| Convertible  debentures | ** ** | **2,729**                                       |       | 2,729 |   |

 

10

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

**Revolving Line of Credit**

InOctober 2006, the Company replaced its former credit facility and entered intoa new two-year credit facility with a different bank.  The new facility provides for combined lineof credit and bank term note borrowings of up to $8.0 million.  Under the new credit facility, the Companymay borrow against its eligible accounts receivable and eligible inventory, asdefined in the credit agreement.  Line ofcredit interest on borrowed amounts is payable monthly at the current statedprime rate plus 1.25% (9.50% at June 30, 2007). Additionally, the Company is obligated to pay an unused line fee of0.25% per annum applied to the amount by which the maximum credit amountexceeds the average daily principal balance during the preceding month. The newcredit facility requires $2,000 in monthly collateral management fees andincludes an early termination fee equal to 2% of the total facility during thefirst year of the agreement and 1% of the total facility in the second year ofthe agreement.  Additionally, the Companypaid a commitment fee of $40,000 in October 2006 and is obligated to pay anadditional $40,000 on the one-year anniversary of the facility. The new creditfacility is secured by substantially all of the assets of the Company.

OnJune 30, 2007, the available credit under the credit facility was $8.0 million,of which $2.3 million was unused.

**Long-Term Debt**

TheCompany’s long-term debt consists of the following:
| ** **                  | ** ** | **June 30,  2007** | ** ** | **March 31,  2007** | ** ** |
|-----------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **(In thousands)** | ** ** |
|                        |       |                    |       |                     |       |
| Convertible debentures, net | ** ** | **$**                   | **9,462**  |                     | $          | 9,410 |   |
| Bank term note              | ** ** | **1,258**               |       | 1,573                    |       |
| Promissory note to landlord | ** ** | **323**                 |       | 646                      |       |
| Other                       | ** ** | **68**                  |       | 78                       |       |
|                        | ** ** | **11,111**              |       | 11,707                   |       |
| Less current portion        | ** ** | **(1,624**              | **)**      | (1,947                   | )          |
|                        | ** ** | **$**                   | **9,487**  |                     | $          | 9,760 |   |

 

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

Thedebentures are due in full on May 19, 2009, provide for 6.0% annualinterest, payable quarterly, and are convertible into the Company’s commonstock at an initial conversion price of $3.61 per share, subject to certainadjustments, including adjustments for dilutive issuances.  From May 19, 2008, until the maturitydate, the Company may redeem the debentures at 110% of the principalamount.  As of June 30, 2007, $250,000 ofconvertible debentures had been converted into 69,252 shares of common stockleaving $9.9 million of the originally issued convertible debenturesoutstanding at June 30, 2007.

*Bank TermNote.*  In October 2004,the Company entered into a $5.0 million term note payable with a bank.  The note was due on May 27, 2008, andprovided for monthly principal payments of approximately $104,000.  Interest accrued at the current stated primerate plus 0.25%.  In October 2006, theterm note was assumed by the Company’s new bank as part of the Company’s new$8.0 million credit facility. The new term note is also due on May 27, 2008 andprovides for monthly principal payments of approximately $104,000.  Interest accrues under the new term note atthe current stated prime rate plus 1.25% (9.50% at June 30, 2007).  Amounts due under the term note reduce theCompany’s ability to borrow against its eligible assets on its line of credit.

Boththe new bank term note and the new line of credit are held by one bank underthe same credit agreement and are secured by substantially all of the assets ofthe Company.

*PromissoryNote to Landlord.*  TheCompany had an unsecured promissory note payable to the landlord of its Anaheimheadquarters.  Under the terms of the noteagreement, interest is payable quarterly and accrues at a rate of prime plus2.0% (10.25% at June 30, 2007).  InOctober 2006, January 2007, April 2007 and July 2007, the Company made fourrequired equal quarterly principal payments of $323,000.  As of July 1, 2007, all interest andprincipal under this note was paid in full.

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Scheduledaggregate maturities of long-term debt principal as of June 30, 2007 were asfollows:
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2008                                                 | ** ** | **$**      | **1,299**  | ** ** |
| 2009                                                 | ** ** | **350**    | ** ** |
| 2010                                                 | ** ** | **9,850**  | ** ** |
|                                                 | ** ** | **11,499** | ** ** |
| Less: unamortized debt discount                      | ** ** | **(388**   | **)**      |
|                                                 | ** ** | **$**      | **11,111** | ** ** |

 

**4.  IncomeTaxes**

On April 1, 2007, the Company adopted FIN 48.  In connection with the adoption of FIN 48,the Company recognized an adjustment of approximately $224,000 to the beginningbalance of retained earnings on its consolidated balance sheet.  The Company’s continuing practice is torecognize interest and/or penalties related to income tax matters in income taxexpense. As of June 30, 2007, the Company had recorded approximately $39,000 ofaccrued interest and penalties related to uncertain tax positions.

At April 1, 2007, the Company’s fiscal 2004 through fiscal2007 tax years remain open to examination by the Federal taxing authorities.The Company’s fiscal 2003 through fiscal 2007 tax years remain open toexamination by the state taxing authorities. However, the Company has consolidated and acquired NOLs beginning in fiscal1995 which would cause the statute of limitations to remain open for the yearin which the NOL was incurred.

**5. Commitments and Contingencies**

**Litigation and Other Contingencies**

OnJune 29, 2004, a supplier to Mariner Networks, Inc., a formersubsidiary of the Company that was discontinued in the fiscal year endedMarch 31, 2002, filed a complaint in Orange County Superior Court againstthe Company alleging various breaches of written contract claims arising out ofalleged purchase orders. The plaintiff in this lawsuit sought monetary damagesaggregating approximately $850,000 plus attorney fees and related costs.  On July 20, 2006, the Company entered into asettlement agreement in connection with this matter.  The dispute was settled in full for $688,000payable as follows:  (i) the Companyissued 88,912 shares of the Company’s common stock on August 18, 2006 valued at$213,000 based on the closing sales price of the Company’s common stock on thedate of issuance; (ii) the Company made a cash payment of $125,000 on October20, 2006; and (iii) the Company is obligated to pay $350,000 in cash in equalmonthly installments of $9,700 over three years beginning in November2006.  In connection with thissettlement, the Company recorded a charge of $688,000, representing the fairvalue of the settlement, to other expense in the accompanying condensedconsolidated statement of operations for the three months ended June 30, 2006.

In August 2007, theCompany received a complaint filed by American Signal Company against theCompany and six other defendants, in the United States District Court, MiddleDistrict of Louisiana and which alleges negligence and other charges inconnection with a contract to which the Company was a third party engineeringservice provider.  The Company isreviewing the complaint, however, does not believe that this matter willultimately have a material adverse effect on its consolidated results ofoperations, financial position or cash flows.

From time to time, theCompany has been involved in litigation relating to claims arising out of itsoperations in the normal course of business. The Company currently is not a party to any legal proceedings, theadverse outcome of which, in management’s opinion, individually or in theaggregate, would have a material adverse effect on its consolidated results ofoperations, financial position or cash flows.

12

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Furthermore, from time totime, the Company has experienced unforeseen developments in contingenciesrelated to its former subsidiaries.  Forexample, the Company has been the subject of a number of routine tax audits fortime periods and jurisdictions related to the businesses of its formersubsidiaries, some of which are still in process.  Although the development and ultimate outcomeof these and other unforeseen matters cannot be predicted with any certainty,management does not believe that the Company is presently involved in anymatters related to its former subsidiaries that would have a material adverseeffect on the Company’s consolidated results of operations, financial positionor cash flows.

**Operating Lease Commitments**

The Company has leasecommitments for facilities in various locations throughout the United States.Future commitments under these non-cancelable operating leases at June 30, 2007were as follows:
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| Remainder of 2008                                    | ** ** | **$**      | **883**    | ** ** |
| 2009                                                 | ** ** | **1,398**  | ** ** |
| 2010                                                 | ** ** | **1,391**  | ** ** |
| 2011                                                 | ** ** | **1,348**  | ** ** |
| 2012                                                 | ** ** | **1,332**  | ** ** |
| Thereafter                                           | ** ** | **3,823**  | ** ** |
| Total                                                | ** ** | **$**      | **10,175** | ** ** |

 

TheCompany subleases 10,000 square feet of space in its 94,000 square footAnaheim, California facility at a monthly rate of $10,000 to MAXxessSystems, Inc. (“MAXxess”), a former subsidiary of the Company that wassold in September 2003 and is currently owned by an investor group thatincludes one of the Company’s directors. Another member of the Company’s board of directors is the Chief ExecutiveOfficer of MAXxess.  At June 30, 2007,MAXxess owed the Company an aggregate of $229,000 related to this sublease andcertain ancillary services provided by the Company to MAXxess.  The Company previously had written offamounts aggregating $183,000 of this balance due to MAXxess’ inability to paythese obligations.  During the threemonths ended June 30, 2007, the Company wrote off all incremental amountscharged to MAXxess, which aggregated $46,000. The Company intends to pursue full payment of any and all amounts duefrom MAXxess under this sublease, which terminates in September 2007.

**Inventory Purchase Commitments**

At June 30, 2007, the Company had firm commitments to purchaseinventory in the amount of $3.2 million during the next two fiscal quarters.

**6.  Stock-Based Compensation**

TheCompany’s 1997 Stock Incentive Plan (the “Plan”) provides that options topurchase shares of the Company’s unissued common stock may be granted todirectors, associates and consultants to the Company at exercise prices whichare equal to or greater than the fair market value of the Company’s commonstock on the date of grant.  Optionsexpire ten years after the date of grant or 90 days after termination ofemployment and generally vest ratably at the rate of 25% on each of the firstfour anniversaries of the grant date. New shares are issued to satisfy stock option exercises under thePlan.  As of June 30, 2007, options topurchase 1.5 million shares of the Company’s common stock were outstandingunder the Plan.

Inconnection with the merger of the Company and the Iteris Subsidiary (Note 1),the Company assumed the 1998 Stock Incentive Plan of the Iteris Subsidiary (the“1998 Plan”) and all outstanding options granted thereunder.  As of June 30, 2007, options to purchase 3.2million shares of the Company’s common stock were outstanding under the 1998Plan.  No further options may be grantedunder the 1998 Plan.

Certainoptions granted under the 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 meet the criteria of a performancecondition under SFAS 123R.

As ofJune 30, 2007, the Company had 112,000 outstanding stock options that wereoriginally granted outside of the Plans and that were assumed by the Plan inconnection with the merger of the Company and the Iteris Subsidiary (Note 1).

13

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Asummary of activity in the Plans for the three months ended June 30, 2007 is asfollows:
| ** **                                                            | ** ** | **Options**                                                           | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Life (In Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                            | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Options outstanding at March 31, 2007                                 |       | 5,818                                                                 |       | $                                      | 1.60       |                                                        | 3.4        |                                | $          | 6,115 |   |
| Granted                                                               |       | —                                                                |       | N/A                                    |       | N/A                                                         |       |                                |       |
| Exercised                                                             |       | (913                                                                  | )          | $                                      | 0.79       |                                                        | N/A        |                                |       |   |
| Forfeited                                                             |       | (17                                                                   | )          | $                                      | 3.16       |                                                        | N/A        |                                |       |   |
| Expired                                                               |       | (19                                                                   | )          | $                                      | 4.29       |                                                        | N/A        |                                |       |   |
| Options outstanding at June 30, 2007                                  |       | 4,869                                                                 |       | $                                      | 1.74       |                                                        | 3.7        |                                | $          | 4,396 |   |
| Vested and expected to vest at June 30, 2007                          |       | 4,794                                                                 |       | $                                      | 1.72       |                                                        | 3.6        |                                | $          | 4,389 |   |
| Options exercisable at June 30, 2007                                  |       | 4,418                                                                 |       | $                                      | 1.66       |                                                        | 3.2        |                                | $          | 4,296 |   |
| Options  exercisable at June 30, 2007 pursuant to a change-in-control |       | 4,869                                                                 |       | $                                      | 1.74       |                                                        | 3.7        |                                | $          | 4,396 |   |

 

AtJune 30, 2007, there were 35,000 shares of common stock available for grantunder the Plan.

Forthe three month periods ended June 30, 2007 and 2006, the Company received$726,000 and $168,000, respectively, in cash from the exercise of stockoptions.  Total stock-based compensationexpense for the three months ended June 30, 2007 and 2006, was $66,000 and$100,000, respectively.  No income taxbenefit was realized from activity in the Plans during the three months endedJune 30, 2007 and 2006.

AtJune 30, 2007, there was $778,000 of total unrecognized compensation expenserelated to unvested stock options.  Thisexpense is expected to be recognized over a weighted-average period ofapproximately 3.0 years.

The fair value of each stock-based award is estimatedon the grant date using the Black-Scholes-Merton (“BSM”) option-pricingformula. Expected volatility is based on the historical volatility of theCompany’s stock price. The expected life of options granted subsequent to theadoption of SFAS 123R is derived based on the historical life of the Company’soptions.  The risk-free interest rate forperiods within the expected life of the option is based on the U.S. Treasuryinterest rates in effect at the time of grant. The grant date fair value ofoptions granted was estimated using the following weighted-average assumptions:
|                                      | ** ** | **Three Months  Ended June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                           | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Dividend yield                       | ** ** | **N/A**                                         |       | 0.0 | % |
| Expected life — years           | ** ** | **N/A**                                         |       | 7.0 |   |
| Risk-free interest rate              | ** ** | **N/A**                                         |       | 5.0 | % |
| Expected  volatility of common stock | ** ** | **N/A**                                         |       | 0.89 |   |

 

A summary of thegrant date fair value and intrinsic value information is as follows:
|                                                       | ** ** | **Three Months  Ended June 30,**                   | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| ** **                                            | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| Weighted average grant date fair value per share      | ** ** | **N/A**                                                           |       | $ | 1.77 |   |
| Intrinsic value of options exercised                  | ** ** | **$**                                                             | **1,417**  |   | $ | 163 |   |
| Total fair value  of options vested during the period | ** ** | **$**                                                             | **47**     |   | $ | 384 |   |

 

**7.  BusinessSegment Information**

TheCompany currently operates in three reportable segments: Roadway Sensors,Automotive Sensors and Transportation Systems. The Roadway Sensors segment includes the Company’s Vantage vehicledetection systems for traffic intersection control, incident detection andcertain highway traffic data collection applications.  The Automotive Sensors segment includesAutoVue and is comprised of all activities related to lane departure warningsystems for vehicle 

14

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safety.  TheTransportation Systems segment includes transportation engineering andconsulting services and the development of transportation management andtraveler information systems for the ITS industry. The accounting policies ofthe reportable segments are the same as those described in the summary ofsignificant accounting policies. Prior to April 1, 2007, certain expenses, suchas interest, amortization of certain intangibles and certain corporate expenseswere not allocated to the segments. Beginning on April 1, 2007, the Companyincreased the portion of its corporate expenses that it allocates to itssegments such that substantially all corporate expenses are allocated.Interest, amortization of certain intangibles and certain corporate expensesare still not allocated to the segments. In addition, certain assets, includingcash and cash equivalents, deferred income taxes and certain long-lived andintangible assets, are not allocated to the segments.  The reportable segments are each managedseparately because they manufacture and distribute distinct products or provideservices with different processes.  Allsegment revenues are derived from external customers.

Thefollowing table sets forth selected unaudited financial information for theCompany’s reportable segments for the three months ended June 30, 2007 and2006:
| ** **                           | ** ** | **Roadway  Sensors**    | ** ** | **Automotive  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|-------------------------|------------|-------------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                           | ** ** | **(In thousands)** | ** ** |
| **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             |       | 6                       |       | 13                      |       | 7                           |       | 26        |       |
| Depreciation and amortization        |       | 26                      |       | 36                      |       | 31                          |       | 93        |       |
| Segment income (loss)                |       | 1,105                   |       | 50                      |       | 544                         |       | 1,699     |       |
|                                 |       |                    |       |                    |       |                        |       |      |       |
| **Three Months Ended June 30, 2006** |       |                    |       |                    |       |                        |       |      |       |
| Product revenue                      |       | $                       | 6,516      |                    | $          | 1,339                       | ** ** | **$**     | **—** |   | $ | 7,855 |   |
| Service and other revenue            |       | —                  |       | 745                     |       | 5,216                       |       | 5,961     |       |
| Stock-based compensation             |       | 19                      |       | 13                      |       | 36                          |       | 68        |       |
| Depreciation and amortization        |       | 19                      |       | 34                      |       | 28                          |       | 81        |       |
| Segment income (loss)                |       | 1,482                   |       | (653                    | )          | 622                         |       | 1,451     |       |

 

The following tablereconciles segment income to consolidated income (loss) before income taxes:
|                                      | ** ** | **Three Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                           | ** ** | **(In thousands)**                         | ** ** |
| Total income for reportable segments | ** ** | **$**                                           | **1,699**  |   | $ | 1,451 |   |
| Unallocated amounts:                 |       |                                            |       |   |   |
| Corporate expenses                   | ** ** | **(125**                                        | **)**      | (706 | ) |
| Other income (expense),  net         | ** ** | **19**                                          |       | (690 | ) |
| Interest expense, net                | ** ** | **(363**                                        | **)**      | (386 | ) |
| Income (loss)  before income taxes   | ** ** | **$**                                           | **1,230**  |   | $ | (331 | ) |

 

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

*This report, including the following discussion andanalysis, contains forward-looking statements (within the meaning of thePrivate Securities Litigation Reform Act of 1995) that are based on our currentexpectations, estimates and projections about our business and our industry,and reflect management’s beliefs and certain assumptions made by us based uponinformation available to us as of the date of this report. When used in thisreport and the information incorporated herein by reference, the words “expect(s),”“feel(s),” “believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)”and similar expressions or variations of these words are intended to identifyforward-looking statements. These forward-looking statements include but arenot limited to statements regarding our anticipated sales, revenue, expenses,profits, capital needs, competition, development plans, backlog andmanufacturing capabilities, the applications for and acceptance of our productsand services, and the status of our facilities and product development. Thesestatements are not guarantees of future performance and are subject to certainrisks and uncertainties that could cause our actual results to differmaterially from those projected. You should not place undue reliance on theseforward-looking statements that speak only as of the date hereof. We undertakeno obligation to republish revised forward-looking statements to reflect eventsor circumstances after the date hereof or to reflect the occurrence ofunanticipated events. We encourage you to carefully review and consider thevarious disclosures made by us which describe certain factors which couldaffect our business, including in* “*Risk Factors”set forth in Part II, Item 1A of this report, before deciding to invest in ourcompany or to maintain or increase your investment. We undertake no obligationto revise or update publicly any forward-looking statement for any reason.*

**Overview**

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

Our Vantage product is avideo vehicle detection system that detects the presence of vehicles onroadways.  Vantage systems are used atsignalized intersections to enable a traffic controller to more efficientlyallocate green signal time and are also used for incident detection and highwaytraffic data collection applications. We sell and distribute our Vantageproducts primarily to commercial customers and municipal agencies.

Our AutoVue LaneDeparture Warning (“LDW”) systems consist of a small windshield mounted sensorthat uses proprietary software to detect and warn drivers of unintended lanedepartures. Approximately 90,000 production AutoVue units have been sold forcar and truck platforms in the North American and European markets.  Our AutoVue LDW systems are currentlyqualified as an option on certain heavy trucks, including Mercedes-Benz, MAN,Iveco, DAF, Scania, Freightliner, International and FUSO, as well as Neoplanand MAN luxury bus and coach lines.  InNorth America our LDW systems are sold primarily to truck fleets, and to date,45 U.S. heavy truck fleets have selected our LDW systems, representing anestimated 25,000 vehicles.  InSeptember 2003, we entered into an agreement with Valeo Schalter andSensuren GmbH (“Valeo”), pursuant to which we granted Valeo the exclusive rightto sell and manufacture our AutoVue LDW systems to the worldwide passenger carmarket in exchange for royalty payments for each AutoVue LDW unit sold.  To date, royalty payments from Valeo have notbeen significant.  Pursuant to thisagreement, we also provide specific contract engineering services, technicalmarketing and sales support to Valeo to enable the incorporation of our LDWtechnology on three Infiniti platforms, the FX, M and Q, where the device isoffered as part of Infiniti’s technology option package.  Valeo is currently in discussions to provideour LDW system to other passenger car OEMs; however, we cannot assure you thatsuch discussions will be successful.  Weplan to continue to provide technical marketing and sales support to Valeo inour efforts to win new OEM customers for the passenger car market as well ascontract engineering services related to the possible launch of new Infinitiplatforms that include our LDW system. We believe that AutoVue is a broad sensor platform that, throughadditional software development, may be expanded to incorporate additionalsafety and convenience features.

Our transportationmanagement systems business includes transportation engineering and consultingservices focused on the planning, design, development and implementation ofsoftware-based systems that integrate sensors, video surveillance, computersand advanced communications equipment to enable public agencies to monitor,control and direct 

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traffic flow, assist inthe quick dispatch of emergency crews and distribute real-time informationabout traffic conditions. Our services include planning, design andimplementation of surface transportation infrastructure systems.  We perform analysis and study goods movement,commercial vehicle operations, travel demand forecasting and systemsengineering, and identify mitigation measures to reduce trafficcongestion.  These services and systemsare primarily sold to local, state and national transportation agencies in theUnited States.  Our transportationmanagement systems business is largely dependent upon governmental funding andbudgetary issues.  The Federal HighwayBill that was passed in August 2005 provided for a significant increase intransportation funding over the following six years.  We believe the recent expansion of ourtransportation management systems business was due in part to the passage ofthe Federal Highway Bill, combined with increased transportation funds availableat state and local agencies throughout the country.

We currentlyoperate in three reportable segments: Roadway Sensors, Automotive Sensors andTransportation Systems. The Roadway Sensors segment includes our Vantagevehicle detection systems for traffic intersection control, incidentdetection and certain highway traffic data collection applications.  The Automotive Sensors segment is comprisedof all activities related to our AutoVue LDW systems for vehicle safety. TheTransportation Systems segment includes transportation engineering andconsulting services and the development of transportation management andtraveler information systems for the ITS industry.

**CriticalAccounting Policies and Estimates**

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased on our unaudited condensed consolidated financial statements includedherein, which have been prepared in accordance with U.S generally acceptedaccounting principles. The preparation of these financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and related disclosures of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. On an ongoing basis, weevaluate these estimates and assumptions, including those related to thecollectibility 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 followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our unaudited condensed consolidatedfinancial statements.

*RevenueRecognition*.  We recordproduct revenues and related costs of sales upon transfer of title, which isgenerally upon shipment or, if required, upon acceptance by the customer,provided that we believe collectibility of the net sales amount is reasonablyassured.  Accordingly, at the daterevenue is recognized, the significant uncertainties concerning the sale havebeen resolved.

Contract revenuesare derived primarily from long-term contracts with governmental agencies.  Contract revenues include costs incurred plusa portion of estimated fees or profits determined using the percentage ofcompletion method of accounting based on the relationship of costs incurred tototal estimated costs.  Any anticipatedlosses on contracts are charged to earnings when identified.  Changes in job performance and estimatedprofitability, including those arising from contract penalty provisions andfinal contract settlements, may result in revisions to recognized costs andrevenues and are recognized in the period in which the revisions aredetermined.  Profit incentives areincluded in revenue when their realization is reasonably assured.

In addition toproduct and contract revenues, we derive revenue from technology access fees,the provision of specific non-recurring contract engineering services to our strategicpartner, Valeo, related to our AutoVue LDW systems, and royalties earned on unitsales of our AutoVue LDW systems by Valeo to the passenger car market.Technology access fee revenues are recognized evenly over the period in whichthey are earned.  Non-recurring contractengineering revenues are recognized in the period in which the related servicesare performed.  Royalty revenues are recordedbased on unit sales of our products by Valeo and are recognized in the periodin which such sales occur.  Technologyaccess fee revenues, contract engineering revenues and royalty revenues areincluded in net sales.

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Revenues fromfollow-on service and support, for which we generally charge separately, arerecorded in the period in which the services are performed.

*AccountsReceivable*.  Weestimate the collectibility of customer receivables on an ongoing basis byperiodically reviewing invoices outstanding greater than a certain period oftime.  We record reserves for receivablesdeemed to be at risk for collection as well as a general reserve based on ourhistorical collections experience.  Aconsiderable amount of judgment is required in assessing the ultimaterealization of trade receivables, including the current credit-worthiness ofeach customer.  If the financialcondition of our customers deteriorates, resulting in an impairment of theirability to make required payments, additional allowances may be required thatcould adversely affect our operating results.

*Inventory*. Inventoriesconsist of finished goods, work-in-process and raw materials and are stated atthe lower of cost or market.  We providereserves for potentially excess and obsolete inventory. In assessing theultimate realization of inventories, we make judgments as to future demandrequirements and compare that with the current or committed inventorylevels.  Reserves are established forinventory levels that exceed anticipated future demand.  It is possible that reserves over and abovethose already established may be required in the future if market conditionsfor our products deteriorate.

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

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

*IncomeTaxes.*We recorded a valuation allowance to reduce our deferredtax assets to amounts that we believe are more likely than not to be realized.Realization of deferred tax assets (such as net operating loss carryforwards)is dependent on future taxable earnings and is therefore uncertain. On aquarterly basis, we assess the likelihood that our deferred tax asset balancewill be recovered from future taxable income. To the extent we believe thatrecovery is not likely, we establish a valuation allowance against our deferredtax asset, increasing our income tax expense in the period such determinationis made.

On an interimbasis, we estimate what our anticipated annual effective tax rate will be andrecord a quarterly income tax provision in accordance with this anticipatedrate. As the fiscal year progresses, we refine our estimates based upon actualevents and earnings during the year. This estimation process can result insignificant changes to our expected effective tax rate. When this occurs, weadjust the income tax provision during the quarter in which the change inestimate occurs so that the year-to-date provision reflects the expected annualrate. The changes described in the preceding sentence and adjustments to ourvaluation allowance may create fluctuations in our overall effective tax ratefrom quarter to quarter.

Effective April 1,2007, we adopted Financial Accounting Standards Board InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes*(“FIN48”).  FIN 48 applies to all taxpositions accounted for under SFAS No. 109, *Accountingfor Income Taxes*, and defines the confidence level that a taxposition must meet in order to be recognized in the financial statements. FIN48 requires that the tax effects of a position be recognized only if it is “more-likely-than-not”to be sustained by the taxing authority as of the reporting date. If a taxposition is not considered “more-likely-than-not” to be sustained, then nobenefits of the position are to be recognized.

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*Stock-Based Compensation*.  Effective April 1, 2006, we adopted SFAS No.123 (revised 2004), *Share-Based Payment*(“SFAS 123R”), which requires all stock-based payments, including grants ofemployee stock options, to be recognized in the statement of operations as anexpense, based on their grant date fair values with such fair values amortizedover the requisite service period.  Weelected to utilize the modified prospective method for the transition to SFAS123R. Under the modified prospective method, SFAS 123R applies to all awardsgranted or modified after the date of adoption. In addition, under the modifiedprospective method, compensation expense is recognized for all stock-basedcompensation awards granted prior to but not yet vested as of April 1, 2006,based on grant-date fair values estimated in accordance with the originalprovisions of SFAS No. 123, *Accounting for Stock-BasedCompensation*.

We use the BSMoption-pricing formula to estimate the fair value of stock-based awards grantedsubsequent to April 1, 2006.  Ourassumptions under the BSM formula include the following:  expected volatilities are based on thehistorical volatility of our stock price, the expected life of options isderived based on the historical life of our options, and the risk-free interestrate for periods within the expected life of the option is based on the U.S.Treasury interest rates in effect at the time of grant.  Additionally, our calculation of stockcompensation expense under SFAS 123R includes an estimate of forfeitures basedon our historical forfeiture rate.  Future stock-based compensation expense in anyparticular quarter or year could be affected by changes in our assumptions orchanges in market conditions.

**Resultsof Operations**

The following table setsforth certain statement of operations data as a percentage of total net salesand contract revenues for the periods indicated. The following table should beread in conjunction with Management’s Discussion and Analysis of FinancialCondition and Results of Operations.
|                                           | ** ** | **Three Months  Ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| Net sales and contract revenues:          |       |                                        |       |   |   |
| Net sales                                 | ** ** | **65.0**                                    | **%**      | 62.2 | % |
| Contract revenues                         | ** ** | **35.0**                                    |       | 37.8 |   |
| Total net sales and  contract revenues    | ** ** | **100.0**                                   | **%**      | 100.0 | % |
| Costs of net sales and contract revenues: |       |                                        |       |   |   |
| Cost of net sales                         | ** ** | **32.9**                                    |       | 34.4 |   |
| Cost of contract  revenues                | ** ** | **22.1**                                    |       | 24.2 |   |
| Gross profit                              | ** ** | **45.0**                                    |       | 41.4 |   |
| Operating expenses:                       |       |                                        |       |   |   |
| Selling, general and  administrative      | ** ** | **28.3**                                    |       | 29.0 |   |
| Research and  development                 | ** ** | **6.3**                                     |       | 7.3 |   |
| Deferred compensation  plan               | ** ** | **0.2**                                     |       | (0.5 | ) |
| Amortization of  intangible assets        | ** ** | **0.2**                                     |       | 0.2 |   |
| Total operating  expenses                 | ** ** | **35.0**                                    |       | 36.0 |   |
| Operating income                          | ** ** | **10.0**                                    |       | 5.4 |   |
| Non-operating income (expense):           |       |                                        |       |   |   |
| Other income (expense),  net              | ** ** | **0.1**                                     |       | (5.0 | ) |
| Interest expense, net                     | ** ** | **(2.3**                                    | **)**      | (2.8 | ) |
| Income (loss) before income taxes         | ** ** | **7.8**                                     |       | (2.4 | ) |
| Income tax benefit (provision)            | ** ** | **(0.8**                                    | **)**      | 4.4 |   |
| Net income                                | ** ** | **7.0**                                     | **%**      | 2.0 | % |

 

**Analysisof Quarterly Results of Operations**

*NetSales and Contract Revenues*.  Net sales are comprised ofRoadway Sensors sales, which are derived from sales of our Vantage video detectionsystems; and Automotive Sensor sales, which are derived from sales of AutoVueLDW systems, technology access fees, contract engineering revenue and royaltyrevenue generated from AutoVue related activities.  Contract revenuesconsist entirely of Transportation Systems revenues, which are generated fromsystems integration and ITS consulting services with federal, state, county andmunicipal agencies. We currently have a relatively diverse customer base withour largest customer constituting 7.3% of total net sales and contract revenuesin the three months ended June 30, 2007.

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Total net salesand contract revenues increased 14.0% to $15.8 million for the three monthsended June 30, 2007, compared to $13.8 million in the corresponding period ofthe prior fiscal year.  This increase wasprimarily driven by increased net sales in both the Roadway Sensors andAutomotive Sensors segments, as well as increased contract revenues in theTransportation Systems segment, as discussed below.

Net salesincreased 19.1% to $10.2 million for the three months ended June 30, 2007,compared to $8.6 million in the corresponding period of the prior fiscal year.

Roadway Sensors net salesincreased 10.9% to $7.2 million for the three months ended June 30, 2007,versus $6.5 million in the corresponding period of the prior fiscal year.  This increase primarily reflects thecontinued adoption, primarily in North America, of video vehicle detectiontechnology such as the technology offered by our Vantage line of products.  Additionally, we believe that the currentincreased rate of adoption has to some extent been due to increased governmentspending on traffic initiatives, which we believe has been at least partiallymade possible by the passage of the Federal Highway Bill in August 2005, aswell as expanded sales and marketing efforts in North America.

Automotive Sensors netsales increased 44.9% to $3.0 million for the three months ended June 30, 2007,versus $2.1 million in the corresponding period of the prior fiscal year.  This increase was primarily a result ofincreased unit sales of our LDW systems to European and Asian OEMs and NorthAmerican heavy truck fleet customers. Sales of LDW systems to the heavy truck market increased by $1.2million, or 93.0%, over the prior year period. Also included in Automotive Sensors net sales are revenues from contractengineering services, technology access fees and royalty revenues in thepassenger car market that are derived from our partnership with Valeo, whichaggregated $436,000 and $745,000 for the three months ended June 30, 2007 and2006, respectively.

We expect sales of LDWunits to the heavy truck market to continue to increase, when compared to theprior year period, for at least the remainder of Fiscal 2008; and we expectrevenues from our strategic partnership with Valeo to decrease slightly ascompared to the prior year largely because we will not receive any technologyaccess fee revenues in Fiscal 2008. Technology access fee revenues totaled $125,000 for the three months endedJune 30, 2006 and $500,000 in Fiscal 2007. Royalty revenues from Valeo for sales of our LDW systems for thepassenger car market remained relatively insignificant in the current quarter.  Our LDW systems are now offered as an optionon three Infiniti models.  While Valeo iscurrently in discussions to offer our LDW systems on other passenger carplatforms, we cannot assure you that Valeo will be successful in these efforts.

Contract revenuesincreased 5.7% to $5.5 million for the three months ended June 30, 2007,compared to $5.2 million in the corresponding period of the prior fiscalyear.  This increase was largely due toincreased funding at the federal, state and local levels throughout the country,as well as new contract awards.  Inresponse to this growth in funding, we have increased our TransportationSystems staff by 4% in the three months ended June 30, 2007, and we expect tocontinue to increase our Transportation Systems staff over the remainder of Fiscal2008.  We believe the ability of ourTransportation Systems business to grow and successfully win and service newcontracts will be highly dependent upon our continued success in recruiting andretaining qualified personnel.  All ofour contract revenues are derived from work performed in North America under abroad range of fixed price and cost plus fixed fee contracts.

*GrossProfit*.  Total gross profit increased 24.0% to $7.1million for the three months ended June 30, 2007, as compared to $5.7 millionin the corresponding period of the prior fiscal year.  Total gross profit as a percent of net salesand contract revenues increased to 45.0% for the three months ended June 30,2007, as compared to 41.4% in the corresponding period of the prior fiscalyear.

Gross profit as apercent of net sales was 49.5% for the three months ended June 30, 2007,compared to 44.7% in the corresponding period of the prior fiscal year. This increase in gross profit was primarily a result of increased grossprofits in both the Roadway Sensors and Automotive Sensors segments.  In Roadway Sensors, the increase was largelydue to production efficiencies and a shift of engineering resources frommanufacturing and support projects to research and development activities.Additionally, Roadway Sensors margins were positively impacted by our sales mixin terms of both geography and product mix. The increase in Automotive Sensormargins was primarily a result of higher sales volumes that created bettercoverage of our fixed manufacturing overhead costs.  Furthermore, our Automotive Sensros customerbase has expanded, which has mitigated the gross margin impact of contractualpricing to our largest European customer. Gross profit as a percent of netsales generally fluctuates in any specific quarter based on customer mix. Grossprofit as a percent of net sales has fluctuated over the last nine quartersfrom a high of 50.2% in the first quarter of Fiscal 2006 to a low of 43.2%reported in the second quarter of Fiscal 2007, mainly as a result of customermix.

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Gross profit as apercent of contract revenues was 36.7% for the three months ended June 30,2007, compared to 36.0% in the corresponding period of the prior fiscalyear.  We recognize contract revenues and related gross profit usingpercentage of completion contract accounting, and the underlying mix ofcontract activity affects the related gross profit recognized in any givenperiod.  The increase in gross profit asa percent of contract revenues in the most recent quarter reflects a contractmix weighted more toward higher margin contracts in the period.

*Selling,General and Administrative Expense*.  Selling, generaland administrative expense increased 11.4% to $4.5 million (or 28.3% of totalnet sales and contract revenues) in the three months ended June 30, 2007,compared to $4.0 million (or 29.0% of total net sales and contract revenues) inthe corresponding period of the prior fiscal year.  This increase was largely attributable tohigher commissions and selling expenses driven by sales growth in our RoadwaySensors segment.  In the coming quarters,we anticipate increased selling, general and administrative expenses related toour efforts to comply with the internal control attestation requirements of theSarbanes-Oxley Act, with which we must begin to comply in Fiscal 2008.

*Researchand Development Expense*.  Research and developmentexpense was flat year-over year at $1.0 million (or 6.3% and 7.3% of total net sales and contract revenues for the threemonths ended June 30, 2007 and 2006, respectively).  We believe research and developmentactivities are crucial to our ability to continue to be a leader in our marketsand expect this level of research and development expenditure to continue forthe remainder of Fiscal 2008.

For competitivereasons, we closely guard the confidentiality of specific development projects.

*DeferredCompensation Plan Expense.*  During the three monthsended June 30, 2007, we incurred a non-cash charge of $31,000 related to thechange in value of 310,510 shares of our common stock held in trust by ourdeferred compensation savings plan.  Thiscompares to a non-cash benefit of $66,000 recorded in the three month periodended June 30, 2006.  In May 2007, ourformer Chief Executive Officer, who departed in March 2007, elected to receivea distribution of approximately fifty percent of his deferred compensation planbalance, representing 143,333 shares of our common stock and $10,000 in cash,all of which was paid out prior to June 30, 2007, and his remaining deferredcompensation plan balance of 143,333 shares of our common stock and $5,000 incash on the one year anniversary of this election.  As a result of this election, at June 30,2007, the trust held 167,177 shares of our common stock and $5,000 ofcash.  We expect to continue toexperience non-cash expense or benefit in future periods as the value of theassets held in our deferred compensation savings plan fluctuates.

*OtherIncome (Expense), Net.*  Other income (expense), net includes thefollowing:  
|                              | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                   | ** ** | **(In thousands)**                              | ** ** |
| Settlement of  lawsuit       | ** ** | **$**                                           | **—** |   | $ | (688 | ) |
| Other                        | ** ** | **19**                                          |       | (2 | ) |
| Other income  (expense), net | ** ** | **$**                                           | **19**     |   | $ | (690 | ) |

 

Other income(expense), net for the three months ended June 30, 2006 primarily reflects$688,000 of expense recorded in connection with the settlement of litigation inJuly 2006 related to one of our former subsidiaries.  See Note 5 to the accompanying condensedconsolidated financial statements for a description of the terms of thesettlement and the additional amounts still payable in connection with thesettlement.

*InterestExpense, Net.*  Interest expense, net includes thefollowing:
|                                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(In thousands)**                         | ** ** |
| Interest expense                        | ** ** | **$**                                           | **(276**   | **)** | $ | (300 | ) |
| Amortization of  debt discount          | ** ** | **(52**                                         | **)**      | (52 | ) |
| Amortization of  deferred finance costs | ** ** | **(35**                                         | **)**      | (34 | ) |
| Interest expense, net                   | ** ** | **$**                                           | **(363**   | **)** | $ | (386 | ) |

Interest expense decreasedfor the three months ended June 30, 2007, compared to the corresponding periodin the prior fiscal year primarily as a result of a lower level of borrowingson our line of credit in the current year.

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*Income Taxes*.  During thethree months ended June 30, 2007, we recognized income tax expense of $134,000as compared to an income tax benefit of $610,000 in the three months ended June30, 2006.  The tax expense recorded inthe three months ended June 30, 2007 was primarily based on anticipated taxesto be paid in the current year, as well as a slight increase in the valuationallowance recorded against our deferred tax assets as a result of changes inestimates of the future realizability of these assets.  Total deferred tax assets on our consolidatedbalance sheet decreased from $3.0 million at March 31, 2007 to $2.9million at June 30, 2007.  In the future,we may continue to record similar adjustments to our deferred tax assetvaluation allowance as our estimates are updated.  We anticipate this will cause our futureoverall effective tax rate in any given period to fluctuate from prioreffective tax rates, estimated annual effective tax rates and statutory taxrates.

As discussed inNotes 1 and 4 of the accompanying condensed consolidated financial statements,we adopted FIN 48 on April 1, 2007.  Inconnection with our adoption of FIN 48, we recognized an adjustment ofapproximately $224,000 to the beginning balance of retained earnings on ourconsolidated balance sheet. Additionally, there was no significant change in our income tax expensefor the three months ended June 30, 2007 as a result of our implementation ofFIN 48.

**Liquidityand Capital Resources**

*CashFlows*

We havehistorically financed our operations with a combination of cash flows from operations,borrowings under credit facilities and the sale of equity securities. Wecurrently rely on cash flows from operations and borrowings on a line of creditfacility to fund our operations.  At June30, 2007, we had $8.5 million in working capital, which included borrowings of$4.4 million on our revolving line of credit and $2.2 million in cash and cashequivalents. This compares to working capital of $7.0 million at March 31,2007, which included borrowings of $4.0 million on our revolving line of creditand $35,000 in cash and cash equivalents.

Our operatingactivities provided $1.9 million in cash during the three months ended June 30,2007, 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.  During the three monthsended June 30, 2006, our operations used $599,000 of cash, primarily as aresult of increases in prepayments, accounts payable and accrued expenses dueto the timing of payments.

Our investingactivities for the three months ended June 30, 2007 and 2006, consistedentirely of purchases of property and equipment, which aggregated $137,000 and$142,000, respectively.

Cash provided byfinancing activities was $453,000 in the three months ended June 30, 2007,which was largely the result of $726,000 in proceeds from the exercise ofoutstanding stock options to purchase our common stock, partially offset by netpayments on borrowings of $273,000. During the three months ended June 30, 2006, financing activitiesprovided $835,000 of cash, which was comprised of net borrowings of $667,000and cash inflows of $168,000 from the exercise of outstanding stock options topurchase our common stock.

*Borrowings*

The followingtable summarizes our borrowings and long-term debt:
| ** **                   | ** ** | **At June 30,  2007** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| ** **                   | ** ** | **(In thousands)**                   | ** ** |
| Convertible  debentures, net |       | $                                         | 9,462      |   |
| Line of credit               |       | 4,437                                     |       |
| Bank term note               |       | 1,258                                     |       |
| Promissory note  to landlord |       | 323                                       |       |
| Other                        |       | 68                                        |       |
|                         |       | $                                         | 15,548     |   |

 

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In October 2006, we replaced our former creditfacility and entered into a new two-year credit facility with a different bank.  The facility provides for combined line ofcredit and bank term note borrowings of up to $8.0 million.  Under the new credit facility, we may borrowagainst our eligible accounts receivable and eligible inventory, as defined inthe credit agreement.  Interest onborrowed amounts is payable monthly at the current stated prime rate plus1.25%.  Additionally, we are obligated topay an unused line fee of 0.25% per annum applied to the amount by which themaximum credit amount exceeds the average daily principal balance during thepreceding month. The new credit facility requires $2,000 in monthly collateralmanagement fees and includes an early termination fee equal to 2% of the totalfacility during the first year of the agreement and 1% of the total facility inthe second year of the agreement. Additionally, we paid a commitment fee of$40,000 in October 2006 and are obligated to pay an additional $40,000 on theone year anniversary of the facility. The new credit facility is secured bysubstantially all of the assets of the Company. At June 30, 2007, we had $8.0 million available under our creditfacility, of which $2.3 million was unused.

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. However, should a shortfall occur, we may need to raiseadditional funds through other debt financings or the sale of equitysecurities.

**ContractualObligations**

Our contractualobligations are as follows at June 30, 2007:
| ** **              | ** ** | **Payments Due by Period** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **(In thousands)**                   | ** ** |
| Lines of credit         |       | $                                         | 4,437      |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 4,437 |   |
| Notes payable           |       | 1,299                                     |       | 350 |   | — |   | — |   | — |   | — |   | 1,649 |   |
| Convertible  debentures |       | —                                    |       | — |   | 9,850 |   | — |   | — |   | — |   | 9,850 |   |
| Operating leases        |       | 883                                       |       | 1,398 |   | 1,391 |   | 1,348 |   | 1,332 |   | 3,823 |   | 10,175 |   |
| Total                   |       | $                                         | 6,619      |   | $ | 1,748 |   | $ | 11,241 |   | $ | 1,348 |   | $ | 1,332 |   | $ | 3,823 |   | $ | 26,111 |   |

At June 30, 2007, we had firm commitments to purchase inventory in theamount of $3.2 million during our next two fiscal quarters.

**Off Balance Sheet Arrangements**

In May 2004, we issuedsubordinated convertible debentures in an aggregate original principal amountof $10.1 million. These debentures are due in full on May 19, 2009 and areconvertible into shares of our common stock at an initial conversion price of$3.61 per share. At June 30, 2007, $9.9 million of these convertible debenturesremained outstanding. Because these debentures are conventionally convertible,we have not separately accounted for the conversion feature and, accordingly,no separate amounts are presented in our condensed consolidated financialstatements in connection with this conversion feature.

At June 30, 2007,outstanding warrants to purchase an aggregate of 62,500 shares of ourcommon stock at an exercise price of $1.95 per share and outstanding warrantsto purchase an aggregate of 246,250 shares of our common stock at an exerciseprice of $3.25 were callable by us if the closing sales price of our commonstock for 20 consecutive days is equal to or greater than two times theexercise price of the warrants. Outstanding warrants to purchase an aggregateof 75,000 shares of our common stock at an exercise price of $5.00 pershare were callable by us if the price of our common stock for20 consecutive days is equal to or greater than one and a half times theexercise price of the warrants.

In connection with warrantsto purchase 246,250 shares of our common stock at $3.25 per share, we are aparty to certain registration rights agreements that contain provisions underwhich we could be subjected to liquidated damages should we fail to maintaineffective registration statements for the underlying shares of commonstock.  These warrants have beenaccounted for within equity in our condensed consolidated balance sheets inaccordance with EITF 00-19, *Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*, and, accordingly, no liabilities have been recorded inconnection therewith.  As of the date ofthis filing, no liquidated damages are payable under the provisions of theregistration rights agreements associated with these warrants.

**Recent Accounting Pronouncements**

In September 2006, the FASB issued SFAS 157, whichdefines fair value, establishes a framework for measuring fair value, andexpands disclosure about fair value measurements. SFAS 157 

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doesnot require any new fair value measurements; rather it specifies valuationmethods to be applied when fair value measurements are required under existingor future accounting pronouncements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. Early application of the statement is encouraged. Generally, thisstatement will be applied prospectively. We are currently evaluating the impact of SFAS 157 and expect to adoptSFAS 157 in the first quarter of our fiscal year ending March 31, 2009.

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities —Including an Amendment of FASB Statement No. 115* (“SFAS 159”). SFAS159 permits entities to choose to measure many financial instruments andcertain other items at fair value. Unrealized gains and losses on items forwhich the fair value option has been elected will be recognized in earnings ateach subsequent reporting date. SFAS 159 is effective for financial statementsissued for fiscal years beginning after November 15, 2007.  We are evaluating the impact that theadoption of SFAS 159 will have on our results of operations and financialcondition and expect to adopt SFAS 159 in our fiscal year ending March 31,2009.

**Seasonality**

We have historically experienced seasonality,particularly with respect to our Roadway Sensors net sales in the third andfourth fiscal quarters due to a reduction in road construction or repairsduring the winter months in many markets as a result of inclement weatherconditions.

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

Ourexposure to interest rate risk is limited to our line of credit, bank term noteand a promissory note to our landlord. Our line of credit, bank term note andpromissory note to our landlord bear interest based on the prevailing primerate (8.25% at June 30, 2007).  We do notbelieve that a 10% increase in the interest rate on our line of credit, bankterm note and promissory note to our landlord (from 9.50% to 10.45% on the lineof credit, from 9.50% to 10.45% on the bank term note and from 10.25% to 11.28%on the promissory note to our landlord) would have a material impact on our financialposition, operating results or cash flows. In addition, we believe that thecarrying value of our outstanding debt approximates fair value.

**ITEM 4. CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

As of the end of the period covered by this report, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and our Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures, as such term is defined in Exchange Act Rules13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective to ensure that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and are effective inensuring that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, our managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives. Our management necessarily applied its judgment inevaluating the cost-benefit relationship of such controls and procedures.

**Changesin Internal Controls**

During the fiscal quarter covered by this report,there has been no change in our internal controls over financial reporting (asdefined in Rules 13a-15(f) and 15d-15(f) under the SecuritiesExchange Act of 1934) that has materially affected, or is reasonably likely tomaterially affect, our internal controls over financial reporting.

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**PART II. OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

The informationset forth under Note 5 of Notes to Unaudited Condensed Consolidated FinancialStatements, included in Part I, Item I of this report, is incorporatedherein by reference.

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

*Ourbusiness is subject to a number of risks, some of which are discussed below.Other risks are presented elsewhere in this report and in the informationincorporated by reference into this report. You should consider the followingrisks carefully in addition to the other information contained in this reportand our other filings with the SEC, including our subsequent reports on Forms10-Q and 8-K, before deciding to buy, sell or hold our commonstock. The risks and uncertainties described below are not the only ones facingour company. Additional risks and uncertainties not presently known to us orthat we currently deem immaterial may also affect our business operations. Ifany of these risks actually occurs, our business, financial condition orresults of operations could be seriously harmed. In that event, the marketprice for our common stock could decline and you may lose all or part of yourinvestment.*

**We May Need To Raise Additional Capital InThe Future, Which May Not Be Available On Terms Acceptable To Us, Or AtAll.**We have generated significant net losses and operatinglosses in recent periods, and have experienced volatility in our cash flowsfrom operations ranging from positive cash flows from operations of $590,000 inthe year ended March 31, 2005 to negative cash flows from operations of$2.0 million in the year ended March 31, 2007.  Additionally, we failed to meet certain debtcovenants under our prior credit agreement in two of our last seven fiscalquarters, but replaced that credit facility in October 2006.  Furthermore, we have $9.9 million insubordinated convertible debentures that are due in full in May 2009.  Should the holders of the convertibledebentures not elect to convert the principal into shares of our common stock,we may need to raise additional capital to refinance this debt.

At June 30, 2007, we had $2.2 million of cash and cashequivalents and relied on our line of credit to fund our operations. We mayneed to raise additional capital in the near future to fund our operations orto repay indebtedness. Such additional capital may be raised through bankborrowings, or other debt or equity financings. We cannot assure you that anyadditional capital will be available on a timely basis, on acceptable terms, orat all, and such additional financing may result in further dilution to ourstockholders.

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

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

·                                       ourability to control costs;

·                                       thesupply of key components for our products;

·                                       ourability to generate net income;

·                                       increasedresearch and development expenses;

·                                       increasedsales and marketing expenses;

·                                       technologicaladvancements and our competitors’ response to our products;

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

·                                       potentialacquisitions of businesses and product lines;

·                                       ourrelationships with customers and suppliers;

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·                                       governmentbudgets, political agendas and other funding issues, including potential delaysin government contract awards;

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

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

If our capital requirements are materially differentfrom those currently planned, we may need additional capital sooner thananticipated. If additional funds are raised through the issuance of equity orconvertible debt securities, the percentage ownership of our stockholders willbe reduced and such securities may have rights, preferences and privilegessenior to our common stock. Additional financing may not be available on favorableterms, on a timely basis, or at all. If adequate funds are not available or arenot available on acceptable terms, we may be unable to continue our operationsas planned, develop or enhance our products, expand our sales and marketingprograms, take advantage of future opportunities or respond to competitivepressures.

**We HaveHistorically Experienced Substantial Losses And May Experience Losses In TheFuture.**Although we have achieved net income in recentperiods, we experienced a net loss of $11.3 million in the year endedMarch 31, 2005.  We cannot assureyou that we will be able to sustain or improve our financial performance, orthat we will be able to continue to achieve profitability on a quarterly orannual basis in the future. Most of our expenses are fixed in advance. As such,we generally are unable to reduce our expenses significantly in the short-termto compensate for any unexpected delay or decrease in anticipated revenues. Asa result, we may continue to experience operating losses and net losses, whichwould make it difficult to fund our operations and achieve our business plan,and could cause the market price of our common stock to decline.

**We Planto Relocate Our Corporate Headquarters in September 2007, Which Could Result inSignificant Business Disruptions. **Thelease for our current headquarters in Anaheim, California terminates inSeptember 2007.  In May 2007, we enteredinto an agreement to lease space in Santa Ana, California beginning inSeptember 2007.   We expect to relocateour headquarters to this location by the end of September 2007.  Should any portion of this relocation effortnot proceed as expected and in the timeframe planned, we could experience adisruption in our operations, which could ultimately adversely affect ourfinancial results.  

**If OurInternal Controls Over Financial Reporting Do Not Comply With The RequirementsOf The Sarbanes-Oxley Act, Our Business And Stock Price Could Be AdverselyAffected.**Along with our independent registered publicaccounting firm, we will be evaluating the effectiveness of our internalcontrols over financial reporting to comply with Section 404 of theSarbanes-Oxley Act of 2002. Section 404 currently requires us to evaluatethe effectiveness of our internal controls over financial reporting at the endof each fiscal year beginning in our fiscal year ending March 31, 2008 andto include a management report assessing the effectiveness of our internalcontrols over financial reporting in all annual reports beginning with ourAnnual Report on Form 10-K for the fiscal year ending March 31, 2008.Section 404 also requires our independent accountant to attest to, andreport on, management’s assessment of our internal controls over financialreporting beginning in our fiscal year ending March 31, 2009. We may not beable to complete our Section 404 compliance on a timely basis, and even ifwe timely complete our compliance requirements, our independent auditors maystill conclude that our internal controls over financial reporting are noteffective.

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

As of March 31, 2005, we became aware of amaterial weakness in our internal controls related to the accounting for theconsolidation of our deferred compensation savings plan and certain contractadministration. We cannot assure you that we or our independent registeredpublic accounting firm will not identify additional material weaknesses in ourinternal controls. A material weakness is a control deficiency, or combinationof control deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected. Based on our evaluation, our management concluded that,as of March 31, 2004, our internal control over financial reporting

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was not effectivedue to the existence of one material weakness. We may experience additionalmaterial weaknesses in the future. If our internal controls over financialreporting are not considered adequate, we may experience a loss of publicconfidence, which could have an adverse effect on our business and our stockprice.

**New Environmental Regulations MayResult In A Decline In Our AutoVue Sales and Royalties. **Recent environmentalregulations in Europe became effective in 2006, which required more stringentemissions compliance in new trucks manufactured in Europe after 2006.  These regulations caused the cost of certaintrucks to increase significantly and could cause a decline in new truck salesin Europe in the near future.  Similarregulations have been announced in North America that will impact dieselengines built after January 2007.  NorthAmerica heavy truck sales through the first half of 2007 have declined significantlyversus the prior year, which we believe was primarily a result of large 2006prebuys of heavy trucks made in anticipation of the new North America emissionstandards.  We may experience a declinein our LDW sales to truck OEMs related to these stricter regulations.

**We May Experience Production Gaps Which CouldMaterially And Adversely Impact Our Sales And Financial Results And TheUltimate Acceptance Of Our Products. **Itis possible that we could experience unforeseen quality control issues or partshortages as we increase production to meet current demand for ourproducts.  We have historically usedsingle suppliers for certain of our components in our AutoVue and Vantageproducts. Should any such delay or disruption occur, our future sales willlikely be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers toproduce many of our products.  Althoughwe believe our contract manufacturers have sufficient capacity to meet ourproduction schedules for the foreseeable future and we believe we could findalternative contract manufacturing sources if necessary, we could experience aproduction gap if for any reason our contract manufacturers were unable to meetour production requirements.

**We Depend Upon Valeo To Market Our AutoVueTechnologies For The OEM Passenger Car Market.**We have grantedValeo the exclusive right to sell and manufacture our AutoVue LDW system to theworldwide passenger car market in exchange for royalty payments for eachAutoVue unit sold. As such, the future success and broad market acceptance ofour AutoVue technologies in the passenger car market will depend upon Valeo’sability to manufacture, market and sell our technologies, and to convince moreOEM passenger car manufacturers to adopt our technologies. If Valeo does notdevote considerable resources and aggressively pursue opportunities, ourexpansion into the passenger car market could be adversely affected.

**We May Be Unable To Attract And Retain KeyPersonnel, Which Could Seriously Harm Our Business.**Due tothe specialized nature of our business, we are highly dependent on thecontinued service of our executive officers and other key management,engineering and technical personnel. The loss of 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 ourTransportation Systems segment will depend on our ability to hire additionalqualified engineers and planners. Competition for qualified employees,particularly development engineers, is intense. We may not be able to continueto attract and retain sufficient numbers of such highly skilled employees. Ourinability to attract and retain additional key employees or the loss of one ormore of our current key employees could adversely affect our business,financial condition and results of operations.

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

We believe that we must continue to make substantialinvestments to support ongoing research and development in order to remaincompetitive. We need to continue to develop and introduce new products thatincorporate the latest technological advancements in outdoor image processinghardware, software and camera technologies in response to evolving customerrequirements.  We cannot assure you thatwe will be able to adequately manage product transition issues.  Our business and results of operations couldbe adversely 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 depends uponmany factors, including our ability to accurately predict market requirementsand evolving industry standards, our ability to resolve technical challenges ina timely and cost-effective manner, qualify any new products with OEMs andachieve manufacturing efficiencies, the perceived advantages of our newproducts over traditional products and the marketing capabilities of ourindependent distributors and strategic partners, including Valeo’s ability toexpand sales of AutoVue in the passenger car market. The success of our AutoVuesystem will 

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also depend in part onthe success of the automotive vehicles that incorporate our technology, as wellas the success of optional equipment that OEMs bundle with our technologies.

Certain of the components used in our Vantage andAutoVue products may need to be re-engineered in the next 12 to 36 months asthe 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 could also beseriously harmed by any significant delays in our new product development.Certain of our new products could contain undetected design faults and softwareerrors or “bugs” when first released by us, despite our testing. We may notdiscover these faults or errors until after a product has been installed andused by our customers. Any faults or errors in our existing products or in anynew products may cause delays in product introduction and shipments, requiredesign modifications or harm customer relationships, any of which couldadversely 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 Iteris was the sole supplier. In addition, one of the otherdevelopers of LDW systems was acquired by a larger company during Fiscal 2007.While this developer has not been a material competitor to date, we mayexperience more competition from this provider as a result of its greateraccess to resources from its acquirer, and additional competitors may enterthis market in the future.  Furthermore,awareness of LDW technology is increasing and other market players areattempting to develop competing technologies, which may contain improvements oradded features beyond those offered by our LDW systems.  Should such efforts be successful, this coulderode our ability to successfully market and sell our LDW systems.

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 adversely affectour business, financial condition and results of operations.

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

Concerns about the recent international conflicts andterrorist and military actions, as well as concerns about inflation, decreasedconsumer confidence, and reduced corporate profits and capital spending havealso resulted in a downturn in worldwide economic conditions, particularly inthe United States. These unfavorable economic conditions may have a negativeimpact on customer orders (and also may result in decreased sales ofautomobiles and trucks that incorporate our LDW systems).  Such concerns may result in cancellations andrescheduling of backlog.  In addition,the recent decline in the U.S. real estate market, particularly in new homeconstruction, could adversely impact new road construction resulting in adecline in Roadway Sensor and Automotive Sensor net sales and TransportationSystems contract revenues.  Any of the 

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foregoingpolitical, social and economic conditions make it extremely difficult for ourcustomers, our suppliers and us to accurately forecast and plan future businessactivities and could result in a decline in our net sales and contractrevenues. If such conditions continue or worsen, our business, financialcondition and results of operations could be materially 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 CouldAdversely Impact Our Operating Results.**A significant portionof our sales are derived from contracts with governmental agencies, either as ageneral contractor, subcontractor or supplier. Government contracts representedapproximately 37.8%, 38.3% and 37.4% of our total net sales and contractrevenues for the years ended March 31, 2007, 2006 and 2005, respectively.We anticipate that revenue from government contracts will continue to increasein the near future. Government business is, in general, subject to specialrisks and challenges, including:

·                                          longpurchase cycles or approval processes;

·                                          competitivebidding and qualification requirements;

·                                          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 Highway Bill;

·                                          othergovernment budgetary constraints and cut-backs; and

·                                          milestonerequirements and liquidated damage provisions for failure to meet contractmilestones.

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

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

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

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

·                                          delaysin government contracts from time to time, including from delays in theallocation of funds to state and local agencies from the U.S. Federal HighwayBill;

·                                          ourability to raise additional capital;

·                                          ourability to control costs;

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

·                                          seasonalitydue to winter weather conditions;

·                                          internationalconflicts and acts of terrorism;

·                                          declinesin new home construction and related road construction;

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

·                                          marketacceptance of the products incorporating our technologies and products;

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

·                                          theintroduction of new products by competitors;

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

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

·                                          theeffects of technological changes in our target markets;

·                                          theamount of our backlog at any given time;

·                                          thenature of our government contracts;

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

·                                          risksand uncertainties associated with our international business;

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

·                                          generaleconomic and political conditions.

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

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

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

·                                          thefailure to retain or integrate key acquired personnel;

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

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

·                                          theincurrence of unforeseen obligations or liabilities;

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

·                                          increasedinterest expense and amortization of acquired intangible assets.

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

**We Have Experienced Growth In Recent Periods. If WeFail To Manage Our Growth Effectively, We May Be Unable To Execute OurBusiness Plan And May Experience Future Weaknesses In Our InternalControls.**We have expanded our overall business. In order toachieve our business objectives, we will need to continue to expand ourbusiness and add additional qualified personnel. Such expansion has placed andis expected to continue to place, a significant strain on our managerial,administrative, operational, financial and other resources. If we are unable tosuccessfully manage our growth, our business, financial condition and resultsof operations will be adversely affected.

To accommodate this growth, we launched a new ERPsystem in April 2006. Accordingly, we may experience problems commonlyexperienced by other companies in connection with such implementations,including but not limited to, potential bugs in the system, component or supplydelays, training requirements and other integration challenges and delays. Anydifficulties we might experience in connection with our new ERP system couldhave a material adverse effect on our financial reporting system and internalcontrols.

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

·                                          rapidtechnological advances;

·                                          downwardprice pressure in the marketplace as technologies mature;

·                                          changesin customer requirements;

·                                          frequentnew product introductions and enhancements; and

·                                          evolvingindustry standards and changes in the regulatory environment.

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

**We May Not Be Able To Adequately Protect OrEnforce Our Intellectual Property Rights, Which Could Harm Our CompetitivePosition.**If we are not able to adequately protect or enforcethe proprietary aspects of our technology, competitors could be able to accessour proprietary technology and our business, financial condition and results ofoperations will likely be seriously harmed. We currently attempt to protect ourtechnology through a combination of patent, copyright, trademark and tradesecret laws, employee and third party nondisclosure agreements and similarmeans. Despite our efforts, other parties may attempt to disclose, obtain oruse 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 benecessary in the future to enforce our intellectual property rights or todetermine the validity and scope of the proprietary rights of others.Litigation may also be necessary to defend against claims of infringement orinvalidity by others. An adverse outcome in litigation or any similarproceedings could subject us to significant liabilities to third parties,require us to license disputed rights from others or require us to ceasemarketing or using certain products or technologies. We may not be able toobtain any licenses on terms acceptable to us, or at all. We also may have toindemnify certain customers or strategic partners if it is determined that wehave infringed upon or misappropriated another party’s intellectual property.Any of these results could adversely affect our business, financial conditionand results of operations. In addition, the cost of addressing any intellectualproperty litigation claim, including legal fees and expenses, and the diversionof management’s attention and resources, regardless of whether the claim isvalid, could be significant and could seriously harm our business, financialcondition and results of operations.

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

·                                          quarterlyvariations in operating results;

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

·                                          ourability to raise additional capital;

·                                          shortagesannounced by suppliers;

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

·                                          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.

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

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

·                                          currencyfluctuations and restrictions;

·                                          political,social and economic instability;

·                                          longeraccounts receivable payment cycles;

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

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

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

·                                          difficultiesin managing and staffing international operations;

·                                          potentiallyadverse tax consequences; and

·                                          reducedprotection for intellectual property rights in some countries.

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

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

**We Could Experience Negative Financial ImpactsArising From Developments In Contingencies Created Under Our Previous StructureOr By Former Subsidiaries.**Although we divested ourselves ofall business units prior to October 2004, with the exception of our Iterisbusiness, from time to time we could experience unforeseen developments incontingencies related to our former subsidiaries. For example, in July 2006 weentered into a settlement agreement in connection with a lawsuit broughtagainst Mariner Networks, Inc., one of our former subsidiaries, by one ofMariner’s suppliers, pursuant to which we issued 88,912 shares of our commonstock to this supplier (valued at $213,000 as of the date of issuance), paidthis supplier $125,000 on October 20, 2006 and are required to pay anadditional $350,000 in 36 equal monthly installments of $9,700 beginning inNovember 2006.  Although we are not awareof any 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, 2007, ourofficers and directors beneficially owned approximately 11% of the outstandingshares of our common stock (and approximately 17% of our common stock whenincluding options, warrants and 

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otherconvertible securities held by them which are currently exercisable orconvertible or will become exercisable or convertible within 60 days afterJune 30, 2007). As a result of their stock ownership, our management will beable to influence the election of our directors and the outcome of corporateactions requiring stockholder approval, such as mergers and acquisitions,regardless of how our other stockholders may vote. This concentration of votingcontrol may have a significant effect in delaying, deferring or preventing achange in our management or change in control and may adversely affect thevoting or other rights of other holders of common stock.

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

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

None.

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

None.

**ITEM5.  OTHER INFORMATION**

None.

**ITEM6.  EXHIBITS**

The followingexhibits are filed herewith or are incorporated by reference to the locationindicated.
| Exhibit  Number | ** ** | **Description**                                                                                           | ** ** | **Where Located**                                                                                                                                                              |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Amended and Restated Certificate of Incorporation of  the registrant                                      | * *   | *Exhibit 3.1 to the registrant’s current  report on Form 8-K as filed with the SEC on October 28, 2004*                                                    |
| * *        | * *   | * *                                                                                                  | * *   | * *                                                                                                                                                                       |
| 3.2             |       | Bylaws of registrant, as amended                                                                          | * *   | *Exhibit 4.2 to the registrant’s Registration  Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on  July 6, 1993*                     |
| * *        | * *   | * *                                                                                                  | * *   | * *                                                                                                                                                                       |
| 3.3             |       | Certificates of Amendment to Bylaws of the  registrant dated April 24, 1998 and August 10, 2001 | * *   | *Exhibit 3.4 to the registrant’s Annual  Report on Form 10-K/A for the year ended March 31, 2003 as filed  with the SEC on July 29, 2003*             |
| * *        | * *   | * *                                                                                                  | * *   | * *                                                                                                                                                                       |
| 3.4             |       | Certificate of Amendment to Bylaws of registrant  dated September 9, 2004                            | * *   | *Exhibit 3.1 to the registrant’s Quarterly  Report on Form 10-Q for the quarter ended September 30, 2004 as  filed with the SEC on November 15, 2004* |

 

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|          | * * | * *                                                                                                                                                              | * * | * *                                                                                                                                                         |
|----------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.1      |     | Specimen of Common Stock Certificate                                                                                                                                  | * * | *Exhibit 4.1 to the registrant’s Amendment  No. 1 to the Registration Statement on Form 8-A as filed with the  SEC on December 8, 2004* |
| * * | * * | * *                                                                                                                                                              | * * | * *                                                                                                                                                         |
| 4.2      |     | Amended and Restated Rights Agreement, dated as of  May 10, 2004, by and between the registrant and U.S. Stock Transfer  Corporation, including exhibits thereto | * * | *Exhibit 99.1 to the registrant’s  Registration Statement on Form 8-A/A as filed with the SEC on  June 18, 2004*                             |
|     |     |                                                                                                                                                                  | * * | * *                                                                                                                                                         |
| 10.1     |     | Sublease Agreement, dated September 30, 2003, by and  between Odetics, Inc. and Maij, Inc.                                                                            | * * | *Filed herewith*                                                                                                                                                 |
|     |     |                                                                                                                                                                  | * * | * *                                                                                                                                                         |
| 10.2     |     | Office Lease Agreement, dated May 24, 2007, by and  between Crown Carnegie Associates, LLC and Iteris, Inc.                                                           | * * | *Filed herewith*                                                                                                                                                 |
|     |     |                                                                                                                                                                  | * * | * *                                                                                                                                                         |
| 10.3     |     | Termination Agreement, dated May 30, 2007, by and  among Transportation Planning Group, Inc., Abbas Mohaddes and Iteris, Inc.                                         | * * | *Filed herewith*                                                                                                                                                 |
|     |     |                                                                                                                                                                  | * * | * *                                                                                                                                                         |
| 31.1     |     | Certification of the Principal Executive Officer, as  required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                         | * * | *Filed herewith*                                                                                                                                                 |
| * * | * * | * *                                                                                                                                                              | * * | * *                                                                                                                                                         |
| 31.2     |     | Certification of the Principal Financial and  Accounting Officer, as required pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                         | * * | *Filed herewith*                                                                                                                                                 |
| * * | * * | * *                                                                                                                                                              | * * | * *                                                                                                                                                         |
| 32.1     |     | Certification of the Chief Financial Officer, as  required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             | * * | *Filed herewith*                                                                                                                                                 |
| * * | * * | * *                                                                                                                                                              | * * | * *                                                                                                                                                         |
| 32.2     |     | Certification of the Chief Financial Officer, as  required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             | * * | *Filed herewith*                                                                                                                                                 |

 

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.
| Dated: August 13, 2007 |   | 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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