Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

 

**(Mark****One)**

 
| **x**                                                       | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                        |                                                                                                     |
| **For the  quarterly period ended September 30, 2009** |
|                                                        |                                                                                                     |
| **OR**                                                      |
|                                                        |                                                                                                     |
| **o**                                                       | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from             to            **

 

**Commission file number:  001-08762**

** **

****

** **

**ITERIS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                              | ** ** | **95-2588496**       |
|-------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer     |
| incorporation or  organization)           |       | Identification  No.) |
|                                      |       |                 |
| **1700  Carnegie Avenue, Suite 100** | ** ** | ** **           |
| **Santa  Ana, California**                | ** ** | **92705**            |
| (Address of  principal executive office)  |       | (Zip Code)           |

 

**(949)** 270-9400

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

 

**Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934, as amended (the “Exchange Act”), during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90days.  Yes **x  No o

 

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

 

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

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

 

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

 

Asof October 26, 2009, there were 34,280,756 shares of common stockoutstanding.

 

 

 

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Table of Contents

 

**ITERIS, INC.**

**Quarterly Report on Form 10-QFor the Three and Six Months Ended September 30, 2009**

 

**Table of Contents**

 
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                                                |   | 3      |
|-------------------|---------------------------------------------------------------------------------------------------------------------------|--------|--------|
|              |                                                                                                                      |   |   |
| ITEM 1.           | FINANCIAL  STATEMENTS                                                                                                     |   | 3      |
|              |                                                                                                                      |   |   |
|              | UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AT  SEPTEMBER 30, 2009 AND MARCH 31, 2009                            |   | 3      |
|              |                                                                                                                      |   |   |
|              | UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF  OPERATIONS FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 30, 2009 AND 2008 |   | 4      |
|              |                                                                                                                      |   |   |
|              | UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED  SEPTEMBER 30, 2009 AND 2008          |   | 5      |
|              |                                                                                                                      |   |   |
|              | NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL  STATEMENTS                                                           |   | 6      |
|              |                                                                                                                      |   |   |
| ITEM 2.           | MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                               |   | 16     |
|              |                                                                                                                      |   |   |
| ITEM 3.           | QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                               |   | 26     |
|              |                                                                                                                      |   |   |
| ITEM 4T.          | CONTROLS AND PROCEDURES                                                                                                   |   | 26     |
|              |                                                                                                                      |   |   |
| **PART II.** | **OTHER  INFORMATION**                                                                                                    |   | 27     |
|              |                                                                                                                      |   |   |
| ITEM 1.           | LEGAL  PROCEEDINGS                                                                                                        |   | 27     |
|              |                                                                                                                      |   |   |
| ITEM 1A.          | RISK FACTORS                                                                                                              |   | 27     |
|              |                                                                                                                      |   |   |
| ITEM  2.          | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                              |   | 35     |
|              |                                                                                                                      |   |   |
| ITEM  3.          | DEFAULTS  UPON SENIOR SECURITIES                                                                                          |   | 35     |
|              |                                                                                                                      |   |   |
| ITEM  4.          | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                      |   | 35     |
|              |                                                                                                                      |   |   |
| ITEM 5.           | OTHER INFORMATION                                                                                                         |   | 36     |
|              |                                                                                                                      |   |   |
| ITEM 6.           | EXHIBITS                                                                                                                  |   | 36     |

 

Unless otherwise indicated in this report, the “Company,”“we,” “us” and “our” refer to Iteris, Inc. and our wholly-ownedsubsidiary, Iteris Europe GmbH.

 

AutoVue®,Iteris®, Vantage®, VersiCamTM, EdgeConnectTM, RZ4 AdvancedTM and Safety DirectTM are among thetrademarks of Iteris, Inc. Any other trademarks or trade names mentionedherein are the property of their respective owners.

 

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**PART I. FINANCIALINFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

** **

**Iteris, Inc.**

**UnauditedCondensed Consolidated Balance Sheets**

**(In thousands, except parvalue amounts)**

 
| ** **                                                                                                                                                                   | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2009**               | ** ** | **2009**           | ** ** |
| **Assets**                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **         | ** ** |
| Current  assets:                                                                                                                                                             |       |                   |       |               |       |
| Cash  and cash equivalents                                                                                                                                                   |       | $                      | 9,185      |               | $          | 6,372 |   |
| Trade  accounts receivable                                                                                                                                                   |       | 10,554                 |       | 12,448             |       |
| Costs  in excess of billings on uncompleted contracts                                                                                                                        |       | 3,926                  |       | 4,217              |       |
| Inventories                                                                                                                                                                  |       | 3,702                  |       | 5,681              |       |
| Deferred  income taxes                                                                                                                                                       |       | 3,790                  |       | 4,241              |       |
| Prepaid  expenses and other current assets                                                                                                                                   |       | 401                    |       | 272                |       |
| Total  current assets                                                                                                                                                        |       | 31,558                 |       | 33,231             |       |
| Property  and equipment, net                                                                                                                                                 |       | 2,864                  |       | 3,244              |       |
| Deferred  income taxes                                                                                                                                                       |       | 11,505                 |       | 11,505             |       |
| Intangible  assets, net                                                                                                                                                      |       | 525                    |       | 110                |       |
| Goodwill                                                                                                                                                                     |       | 27,791                 |       | 27,774             |       |
| Other  assets                                                                                                                                                                |       | 199                    |       | 202                |       |
| Total  assets                                                                                                                                                                |       | $                      | 74,442     |               | $          | 76,066 |   |
|                                                                                                                                                                         |       |                   |       |               |       |
| **Liabilities and stockholders’ equity**                                                                                                                                |       |                   |       |               |       |
| Current  liabilities:                                                                                                                                                        |       |                   |       |               |       |
| Trade  accounts payable                                                                                                                                                      |       | $                      | 2,642      |               | $          | 4,228 |   |
| Accrued  payroll and related expenses                                                                                                                                        |       | 2,765                  |       | 3,188              |       |
| Accrued  liabilities                                                                                                                                                         |       | 1,884                  |       | 1,662              |       |
| Billings  in excess of costs and estimated earnings on uncompleted contracts                                                                                                 |       | 1,362                  |       | 1,534              |       |
| Current  portion of long-term debt                                                                                                                                           |       | 2,324                  |       | 2,019              |       |
| Total  current liabilities                                                                                                                                                   |       | 10,977                 |       | 12,631             |       |
| Deferred  rent                                                                                                                                                               |       | 1,541                  |       | 1,686              |       |
| Unrecognized  tax benefits                                                                                                                                                   |       | 1,117                  |       | 1,117              |       |
| Other  non-current liabilities                                                                                                                                               |       | 112                    |       | —             |       |
| Long-term  debt                                                                                                                                                              |       | 4,384                  |       | 5,274              |       |
| Total  liabilities                                                                                                                                                           |       | 18,131                 |       | 20,708             |       |
| Commitments  and contingencies                                                                                                                                               |       |                   |       |               |       |
| Stockholders’  equity:                                                                                                                                                  |       |                   |       |               |       |
| Common  stock. $0.10 par value, 70,000 shares authorized, 34,281 and 34,205 shares issued  and outstanding at September 30, 2009 and March 31, 2009,  respectively |       | 3,428                  |       | 3,420              |       |
| Additional  paid-in capital                                                                                                                                                  |       | 137,266                |       | 136,997            |       |
| Common  stock held in trust                                                                                                                                                  |       | (31                    | )          | (31                | )          |
| Accumulated  deficit                                                                                                                                                         |       | (84,385                | )          | (85,025            | )          |
| Accumulated  other comprehensive income (loss)                                                                                                                               |       | 33                     |       | (3                 | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 56,311                 |       | 55,358             |       |
| Total  liabilities and stockholders’ equity                                                                                                                             |       | $                      | 74,442     |               | $          | 76,066 |   |

 

See accompanying notes.

 

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**Iteris, Inc.**

**Unaudited Condensed ConsolidatedStatements of Operations**

**(In thousands, except per share amounts)**

 
| ** **                                 | ** **                                             | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|--------------------------------------------|--------------------------------------------------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** **                                             | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                 | ** **                                             | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales and contract revenues:          |                                                   |                   |       |                   |       |   |   |   |   |
| Net  sales                                 |                                                   | $                      | 8,462      |                   | $          | 11,078 |   | $ | 15,395 |   | $ | 21,604 |   |
| Contract  revenues                         |                                                   | 6,403                  |       | 7,988                  |       | 14,104 |   | 14,904 |   |
| Total  net sales and contract revenues     |                                                   | 14,865                 |       | 19,066                 |       | 29,499 |   | 36,508 |   |
| Costs  of net sales and contract revenues: |                                                   |                   |       |                   |       |   |   |   |   |
| Cost  of net sales(a)                      |                                                   | 4,412                  |       | 5,886                  |       | 8,255 |   | 11,153 |   |
| Cost  of contract revenues(a)              |                                                   | 3,883                  |       | 5,305                  |       | 9,092 |   | 9,728 |   |
| Gross  profit                              |                                                   | 6,570                  |       | 7,875                  |       | 12,152 |   | 15,627 |   |
| Operating  expenses:                       |                                                   |                   |       |                   |       |   |   |   |   |
| Selling,  general and administrative(a)    |                                                   | 4,527                  |       | 4,653                  |       | 8,780 |   | 9,808 |   |
| Research  and development(a)               |                                                   | 884                    |       | 1,122                  |       | 1,848 |   | 2,332 |   |
| Amortization  of intangible assets         |                                                   | 42                     |       | 36                     |       | 86 |   | 73 |   |
| Total  operating expenses                  |                                                   | 5,453                  |       | 5,811                  |       | 10,714 |   | 12,213 |   |
| Operating  income                          |                                                   | 1,117                  |       | 2,064                  |       | 1,438 |   | 3,414 |   |
| Non-operating  income (expense):           |                                                   |                   |       |                   |       |   |   |   |   |
| Other  income (expense), net               |                                                   | (2                     | )          | 22                     |       | 17 |   | 27 |   |
| Interest  expense, net                     |                                                   | (71                    | )          | (198                   | )          | (157 | ) | (396 | ) |
| Income  before income taxes                |                                                   | 1,044                  |       | 1,888                  |       | 1,298 |   | 3,045 |   |
| Provision  for income taxes                |                                                   | (501                   | )          | (821                   | )          | (611 | ) | (1,312 | ) |
| Net  income                                |                                                   | $                      | 543        |                   | $          | 1,067 |   | $ | 687 |   | $ | 1,733 |   |
|                                       |                                                   |                   |       |                   |       |   |   |   |   |
| Earnings  per share:                       |                                                   |                   |       |                   |       |   |   |   |   |
| Basic                                      |                                                   | $                      | 0.02       |                   | $          | 0.03 |   | $ | 0.02 |   | $ | 0.05 |   |
| Diluted                                    |                                                   | $                      | 0.02       |                   | $          | 0.03 |   | $ | 0.02 |   | $ | 0.05 |   |
| Weighted  average shares outstanding:      |                                                   |                   |       |                   |       |   |   |   |   |
| Basic                                      |                                                   | 34,254                 |       | 33,948                 |       | 34,223 |   | 33,783 |   |
| Diluted                                    |                                                   | 34,435                 |       | 34,959                 |       | 34,411 |   | 34,949 |   |
|                                       |                                                   |                   |       |                   |       |   |   |   |   |
|                                            |
| (a)                                        | Includes  stock-based compensation expense as follows: |
|                                       |                                                   |                   |       |                   |       |   |   |   |   |
|                                       | Cost  of net sales                                     |                   | $          | 2                      |       | $ | 3 |   | $ | 4 |   | $ | 5 |   |
|                                       | Cost  of contract revenues                             |                   | 10         |                   | 10         |   | 20 |   | 20 |   |
|                                       | Selling,  general and administrative expense           |                   | 79         |                   | 76         |   | 150 |   | 153 |   |
|                                       | Research  and development expense                      |                   | 7          |                   | 5          |   | 13 |   | 10 |   |
|                                       | Total  stock-based compensation expense                |                   | $          | 98                     |       | $ | 94 |   | $ | 187 |   | $ | 188 |   |

 

See accompanyingnotes.

 

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**Iteris, Inc.**

**Unaudited CondensedConsolidated Statements of Cash Flows**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Cash flows from operating activities**                                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net  income                                                                        |       | $                      | 687        |   | $ | 1,733 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                   |       |   |   |
| Depreciation  of property and equipment                                            |       | 499                    |       | 498 |   |
| Stock-based  compensation                                                          |       | 187                    |       | 188 |   |
| Amortization  of intangible assets                                                 |       | 86                     |       | 73 |   |
| Amortization  of debt discounts                                                    |       | —                 |       | 82 |   |
| Amortization  of deferred financing costs                                          |       | —                 |       | 54 |   |
| Change  in deferred tax assets                                                     |       | 451                    |       | 1,027 |   |
| Changes  in operating assets and liabilities:                                      |       |                   |       |   |   |
| Accounts  receivable                                                               |       | 1,908                  |       | (1,526 | ) |
| Net  costs and estimated earnings in excess of billings                            |       | 119                    |       | 1,289 |   |
| Inventories                                                                        |       | 1,979                  |       | (368 | ) |
| Prepaid  expenses and other assets                                                 |       | (124                   | )          | (55 | ) |
| Accounts  payable and accrued expenses                                             |       | (2,126                 | )          | 389 |   |
| Net  cash provided by operating activities                                         |       | 3,666                  |       | 3,384 |   |
|                                                                               |       |                   |       |   |   |
| **Cash flows from investing activities**                                           |       |                   |       |   |   |
| Purchases  of property and equipment                                               |       | (116                   | )          | (486 | ) |
| Cash  paid for acquisition                                                         |       | (300                   | )          | — |   |
| Net  cash used in investing activities                                             |       | (416                   | )          | (486 | ) |
|                                                                               |       |                   |       |   |   |
| **Cash flows from financing activities**                                           |       |                   |       |   |   |
| Borrowings  on long-term debt                                                      |       | 750                    |       | — |   |
| Payments  on long-term debt                                                        |       | (1,335                 | )          | (232 | ) |
| Proceeds  from stock option exercises                                              |       | 90                     |       | 684 |   |
| Net  cash provided by (used in) financing activities                               |       | (495                   | )          | 452 |   |
| Effect  of exchange rate changes on cash                                           |       | 58                     |       | — |   |
| Increase  in cash and cash equivalents                                             |       | 2,813                  |       | 3,350 |   |
| Cash  and cash equivalents at beginning of period                                  |       | 6,372                  |       | 421 |   |
| Cash  and cash equivalents at end of period                                        |       | $                      | 9,185      |   | $ | 3,771 |   |
|                                                                               |       |                   |       |   |   |
| **Supplemental disclosure of non-cash investing and financing  activities:**       |       |                   |       |   |   |
| Liabilities  incurred for business combination                                     |       | $                      | 218        |   | $ | — |   |
| Fair  value of common stock issued in settlement of liabilities                    |       | —                 |       | 427 |   |

 

See accompanying notes.

 

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** **

**Iteris, Inc.**

**Notes to Unaudited CondensedConsolidated Financial Statements**

**September 30, 2009**

** **

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

 

**Description of Business**

 

Iteris, Inc.(including our subsidiary, referred to collectively in these consolidatedfinancial statements as “Iteris,” the “Company,” “we,” “our” and “us”)  is a leader in the traffic management marketfocused on the development and application of advanced technologies that reducetraffic congestion, minimize the environmental impact of traffic congestion andimprove the safety of surface transportation systems infrastructure. Bycombining outdoor image processing, traffic engineering and informationtechnology, we offer a broad range of Intelligent Transportation Systems (“ITS”)and driver safety solutions. Iteris was originally incorporated in Delaware in1987.

 

**Basis of Presentation**

 

Our unaudited condensed consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (“U.S. GAAP”) 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 Iteris as ofSeptember 30, 2009, the consolidated results of operations for the threeand six months ended September 30, 2009 and 2008 and the consolidated cashflows for the six months ended September 30, 2009 and 2008. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with U.S. GAAP have been condensed or omitted pursuantto the rules and regulations of the SEC. The results of operations for thethree and six months ended September 30, 2009 are not necessarilyindicative of those to be expected for future quarterly periods or the entireyear. The accompanying unaudited condensed consolidated financial statementsshould be read in conjunction with our Annual Report on Form 10-K for thefiscal year ended March 31, 2009 (“fiscal 2009”), which was filed with theSEC on June 12, 2009.

 

# **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 could differ from those estimates. Significantestimates made in the preparation of the consolidated financial statementsinclude the allowance for doubtful accounts, projections of taxable income usedto assess realizability of deferred tax assets, inventory and warrantyreserves, costs to complete long-term contracts, overhead rates used incost-plus contracts, contract reserves and estimates of future cash flows usedto assess the recoverability of long-lived assets, the valuation of debt andequity instruments and the realization of goodwill.

 

# **RevenueRecognition**

#  

Product revenues andrelated costs of sales are recognized upon the transfer of title, whichgenerally occurs upon shipment or, if required, upon acceptance by thecustomer, provided that we believe collectibility of the net sales amount isprobable. Accordingly, at the date revenue is recognized, the significantuncertainties concerning the sale have been resolved.

 

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

 

We also derive revenuefrom the provision of specific non-recurring contract engineering services androyalties. Non-recurring contract engineering revenues are recognized in theperiod in which the related services are performed. Royalty revenues arerecorded in the period in which the royalty is earned based on unit sales ofcertain of our products. Non-recurring contract engineering and royaltyrevenues are included in net sales in the accompanying condensed consolidatedstatements of operations and totaled $191,000 and $439,000 for the three andsix months ended September 30, 2009, respectively, and $284,000 and$658,000 for the three and six months ended September 30, 2008,respectively.

 

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**Concentration of Credit Risk**

 

Financial instrumentsthat potentially subject us to a concentration of credit risk consistprincipally of cash and cash equivalents and trade accounts receivable.

 

Cash and cash equivalentsconsist primarily of demand deposits and money market funds maintained withseveral financial institutions. Deposits held with banks may exceed the amountof insurance provided on such deposits. Generally, these deposits may beredeemed upon demand and are maintained with high credit quality financialinstitutions and therefore have minimal credit risk.

 

Accounts receivable areprimarily derived from revenues earned from customers located throughout NorthAmerica and Europe. We generally do not require collateral or other securityfrom customers. Collectibility of receivable balances is estimated throughreview of invoices outstanding greater than a certain period of time andongoing credit evaluations of our customers’ financial condition. Reserves aremaintained for potential credit losses, and such losses have historically beenwithin management’s expectations.

 

**Fair Values of Financial Instruments**

 

Thefair value of cash and cash equivalents, receivables, accounts payable andaccrued expenses approximate carrying value because of the short period of timeto maturity. The fair value of line of credit agreements, long-term debt andconvertible debentures approximate carrying value because the related effectiverates of interest approximate current market rates available to us for debtwith similar terms and similar remaining maturities. The estimated fair valueof certain of our outstanding warrants is determined using Level 3 Inputs (seeNotes 6 and 7).

 

# **Inventories**

#  

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

 

**Property and Equipment**

 

Property and equipment are recorded at cost and aregenerally depreciated using the straight-line method over the estimated usefullife ranging from three to eight years. Leasehold improvements are depreciatedover the term of the related lease or the estimated useful life of theimprovement, whichever is shorter.

 

**Goodwill and Long-Lived Assets**

 

Goodwillis tested for impairment on an annual basis in our fourth fiscal quarter ormore frequently if indicators of impairment exist. The performance of the testinvolves a two-step process. The first step of the impairment test involvescomparing the fair value of our reporting units with each respective reportingunit’s carrying amount, including goodwill. We determine the fair value ofreporting units using the income approach. If the carrying amount of areporting unit exceeds the reporting unit’s fair value, the second step of thegoodwill impairment test is performed to determine the amount of any impairmentloss. The second step of the goodwill impairment test involves comparing theimplied fair value of the reporting unit’s goodwill with the carrying amount ofthat goodwill. We performed annual impairment assessments of the carrying valueof goodwill for each of the fiscal years ended March 31, 2009, 2008 and2007. Based on these assessments, we determined that no impairment at that timewas indicated as the estimated fair value of each of our reporting unitsexceeded its respective carrying value. We monitor the indicators for goodwillimpairment testing between annual tests. Certain adverse business conditionsimpacting one or more of our reporting units would cause us to test goodwillfor impairment. No such events occurred during the three and six months ended September 30,2009.

 

Weevaluate long-lived assets for impairment when indicators of impairment arepresent. Reviews are performed to determine whether the carrying value ofassets is impaired, based on a comparison to undiscounted expected future cashflows. If this comparison indicates that there is impairment, the impairedasset is written down to fair value, which is typically calculated usingdiscounted expected future cash flows and a discount rate based upon ourweighted average cost of capital adjusted for risks associated with the relatedoperations. Impairment is based on the excess of the carrying amount over thefair value of those assets.

 

**Income Taxes**

 

We utilize the liability method of accounting forincome taxes, whereby deferred taxes are determined based on the temporarydifferences between the financial statement and tax bases of assets andliabilities using enacted tax rates. A valuation allowance is recorded when itis more likely than not that all or a portion of the deferred tax assets will notbe realized.

 

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**Stock-Based Compensation**

 

We record stock-based compensation expense in thestatement of operations as an expense, based on the grant date fair values ofour stock-based awards, whereby such fair values are amortized over therequisite service period. The fair value of our common stock option awards isestimated on the grant date using the Black-Scholes-Merton (“BSM”)option-pricing formula, which considers, among other factors, the expected lifeof the award and the expected volatility of our stock price.

 

**Research and Development Expenditures**

 

Research and development expenditures are charged toexpense in the period in which they are 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 unaudited condensed consolidatedstatements of operations.

 

**Warranty**

 

We generally provide a one to three year warrantyfrom the original invoice date on all products, materials and workmanship.Products sold to certain original equipment manufacturer (“OEM”) customerssometimes carry longer warranties. Defective products will be either repairedor replaced, generally at our option, upon meeting certain criteria. We accruea provision 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 accrued warranty provision is included withinaccrued liabilities in the accompanying condensed consolidated balance sheets.

 

**Repair and Maintenance Costs**

 

We incur repair andmaintenance costs in the normal course of business. Should the activity resultin a permanent improvement to one of our leased facilities, the cost iscapitalized as a leasehold improvement and amortized over its useful life orthe remainder of the lease period, whichever is shorter. Non-permanent repairand maintenance costs are charged to expense as incurred.

 

**Other Comprehensive Income**

 

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

 

**Recent Accounting Pronouncements**

 

InAugust 2009, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standards Update (“ASU”) No. 2009-05, *MeasuringLiabilities at Fair Value* (“ASU 2009-05”). ASU 2009-05 amends Topic820 of the FASB Accounting Standards Codification (“ASC”) by providingadditional guidance clarifying the measurement of liabilities at fair value.The amendments prescribed by ASU 2009-05 will be effective for our fiscalquarter ending December 31, 2009 and are not expected to have a materialimpact on our consolidated financial statements.

 

InOctober 2009, the FASB issued ASU No. 2009-13, *Multiple-DeliverableRevenue Arrangements — a consensus of the FASB Emerging Issues Task Force*(“ASU2009-13”), which amends the existing multiple-element revenue arrangementsguidance currently included in ASC 605-25, *Revenue Recognition —Multiple Element Arrangements*. ASU 2009-13 provides for twosignificant changes to the existing multiple-element revenue arrangementsguidance. The first relates to the determination of when the individualdeliverables included in a multiple-element arrangement may be treated asseparate units of accounting. The second change modifies the manner in whichthe transaction consideration is allocated across the separately identifieddeliverables. The amendments prescribed by ASU 2009-13 will be effective forour fiscal year beginning April 1, 2011. Early adoption is permittedprovided that an entity retroactively applies the guidance to the beginning ofthe fiscal year of adoption. We are currently evaluating the impact that theadoption of this ASU will have on our consolidated financial statements.

 

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InOctober 2009, the FASB issued ASU No. 2009-14, *CertainRevenue Arrangements That Include Software Elements — a consensus of the FASBEmerging Issues Task Force*(“ASU 2009-14”), which amends andmodifies the scope of ASC 985-605, *Software — RevenueRecognition*, such that many tangible products that rely on softwareand other related transactions will fall outside its scope. The amendmentsprescribed by ASU 2009-14 will be effective for our fiscal year beginning April 1,2011. Early adoption is permitted provided that an entity retroactively appliesthe guidance to the beginning of the fiscal year of adoption. Additionally,adoption must occur in conjunction with the adoption of the amendments withinASU 2009-13 (described above). We are currently evaluating the impact that theadoption of this ASU will have on our consolidated financial statements.

 

**2.****                                     ****SupplementalFinancial Information**

 

**Inventories**

 

The following tablepresents details of our inventories:

 
| ** **              | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|-------------------------|------------|------------------------|------------|--------------------|------------|
| ** **              | ** ** | **2009**               | ** ** | **2009**           | ** ** |
| ** **              | ** ** | **(In thousands)**     | ** ** |
| Materials  and supplies |       | $                      | 3,013      |               | $          | 4,820 |   |
| Work  in process        |       | 123                    |       | 198                |       |
| Finished  goods         |       | 566                    |       | 663                |       |
|                    |       | $                      | 3,702      |               | $          | 5,681 |   |

 

**IntangibleAssets**

 

The following table presentsdetails of our intangible assets:

 
| ** **                                  | ** ** | **September 30, 2009** | ** ** | **March 31, 2009**       | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                  | ** ** | **(In thousands)**          | ** ** |
| Intangible  assets subject to amortization: |       |                        |       |                          |       |   |   |   |   |
| Developed  technology                       |       | $                           | 996        |                          | $          | (545 | ) | $ | 495 |   | $ | (482 | ) |
| Patents                                     |       | 317                         |       | (243                          | )          | 317 |   | (220 | ) |
| Total                                       |       | $                           | 1,313      |                          | $          | (788 | ) | $ | 812 |   | $ | (702 | ) |

 

Amortization expense forintangible assets subject to amortization was $42,000 and $86,000 for the threeand six months ended September 30, 2009 respectively, and $36,000 and$73,000 for the three and six months ended September 30, 2008,respectively. As of September 30, 2009, future estimated amortizationexpense is as follows:

 
| **Fiscal Year Ending March 31:** | ** ** | ** ** | ** ** |   |   |   |   |   |   |
|---------------------------------------|------------|------------|------------|--------|--------|--------|--------|--------|--------|
| **(In thousands)**                    | ** ** | ** ** | ** ** |   |   |   |   |   |   |
| Remainder  of 2010                    |       |       |       |   |   | $      | 73     |   |   |   |
| 2011                                  |       |       |       |   |   | 152    |   |   |   |
| 2012                                  |       |       |       |   |   | 100    |   |   |   |
| 2013                                  |       |       |       |   |   | 100    |   |   |   |
| 2014                                  |       |       |       |   |   | 100    |   |   |   |
|                                  |       |       |       |   |   | $      | 525    |   |   |   |

 

**Goodwill**

 

The following tablepresents the activity related to the carrying value of our goodwill byreportable segment for the six months ended September 30, 2009:

 

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| ** **                                                                 | ** ** | **Roadway  Sensors** | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                                                                 | ** ** | **(In thousands)**   | ** ** |
| Beginning  balance                                                         |       | $                    | 8,197      |                 | $          | 4,671                       |       | $         | 14,906     |   | $ | 27,774 |   |
| Goodwill  recorded in connection with Hamilton Signal acquisition (Note 3) |       | 17                   |       | —               |       | —                      |       | 17        |       |
| Ending  balance                                                            |       | $                    | 8,214      |                 | $          | 4,671                       |       | $         | 14,906     |   | $ | 27,791 |   |

 

**Warranty Reserve Activity**

 

The following table presents activity related to thewarranty reserve:

 
| ** **                          | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **September 30,** | ** ** |
| ** **                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In  thousands)**    | ** ** |
| Balance  at beginning of period     |       | $                      | 582        |   | $ | 494 |   |
| Additions  charged to cost of sales |       | 102                    |       | 184 |   |
| Warranty  claims                    |       | (94                    | )          | (121 | ) |
| Balance  at end of period           |       | $                      | 590        |   | $ | 557 |   |

 

**Comprehensive Income**

 

The following tablepresents the components of comprehensive income:

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                | ** ** | **(In thousands)**     | ** ** |
| Net  income                               |       | $                      | 543        |                   | $          | 1,067 |   | $ | 687 |   | $ | 1,733 |   |
| Other  comprehensive income (loss):       |       |                   |       |                   |       |   |   |   |   |
| Foreign  currency translation adjustments |       | 14                     |       | (27                    | )          | 36 |   | (28 | ) |
| Total  comprehensive income               |       | $                      | 557        |                   | $          | 1,040 |   | $ | 723 |   | $ | 1,705 |   |

 

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**EarningsPer Share**

 

The following table sets forth the computation ofbasic and diluted earnings per share:

 
| ** **                                                  | ** ** | **Three Months Ended**                       | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **September 30,**                       | ** ** | **September 30,** | ** ** |
| ** **                                                  | ** ** | **2009**                                     | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                  | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Numerator:                                                  |       |                                         |       |                   |       |   |   |   |   |
| Net  Income                                                 |       | $                                            | 543        |                   | $          | 1,067 |   | $ | 687 |   | $ | 1,733 |   |
|                                                        |       |                                         |       |                   |       |   |   |   |   |
| Denominator:                                                |       |                                         |       |                   |       |   |   |   |   |
| Weighted  average common shares used in basic computation   |       | 34,254                                       |       | 33,948                 |       | 34,223 |   | 33,783 |   |
| Dilutive  stock options                                     |       | 181                                          |       | 1,006                  |       | 188 |   | 1,160 |   |
| Dilutive  warrants                                          |       | —                                       |       | 5                      |       | — |   | 6 |   |
| Weighted  average common shares used in diluted computation |       | 34,435                                       |       | 34,959                 |       | 34,411 |   | 34,949 |   |
|                                                        |       |                                         |       |                   |       |   |   |   |   |
| Earnings  per share:                                        |       |                                         |       |                   |       |   |   |   |   |
| Basic                                                       |       | $                                            | 0.02       |                   | $          | 0.03 |   | $ | 0.02 |   | $ | 0.05 |   |
| Diluted                                                     |       | $                                            | 0.02       |                   | $          | 0.03 |   | $ | 0.02 |   | $ | 0.05 |   |

 

The following instrumentswere excluded from the computation of diluted earnings per share as theireffect would have been anti-dilutive:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|-------------------------|------------|------------------------|------------|------------------------|------------|
| ** **              | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **              | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **              | ** ** | **(In thousands)**     | ** ** |
|                    |       |                   |       |                   |       |   |   |   |   |
| Stock  options          |       | 2,451                  |       | 1,033                  |       | 2,517 |   | 775 |   |
| Warrants                |       | 336                    |       | 1,150                  |       | 414 |   | 1,150 |   |
| Convertible  debentures |       | —                 |       | 2,147                  |       | — |   | 2,147 |   |

 

**3.****                                     ****BusinessCombination**

 

OnApril 3, 2009 (the “Closing”), we completed the acquisition of certainassets of Hamilton Signal, Inc., a privately-held developer of videoprocessing algorithms enabling state and local governments to conduct real-timeanalysis on fixed and Pan-Tilt-Zoom camera feeds. The total purchaseconsideration was approximately $518,000, for which we paid $300,000 in cashupon execution of the purchase agreement, and for which, pursuant to thepurchase agreement, we are scheduled to pay an additional (i) $106,000 onthe first anniversary of the Closing and (ii) approximately $112,000 onthe second anniversary of the Closing. Pursuant to the purchase agreement, theseller became an employee of Iteris and is eligible to receive compensationbased on future net sales of certain products during the three-year periodending March 31, 2012, subject to continued employment and otherlimitations.

 

Wehave accounted for this acquisition as a business combination. We calculatedthe fair value of the assets acquired to allocate the purchase price, which issummarized as follows (in thousands):

 
| Purchased  intangible assets |   | $  | 501    |   |
|------------------------------|--------|----|--------|--------|
| Goodwill                     |   | 17 |   |
|                         |   | $  | 518    |   |

 

Thepurchased developed technology was determined to have an estimated useful lifeof five years. Our primary reasons for the acquisition were to expand ourproduct portfolio in the traffic management market and to incorporate enhancedfunctionality into and complement our Roadway Sensors technologies.

 

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Ourunaudited condensed consolidated financial statements for the three and sixmonths ended September 30, 2009 include the results of operations ofHamilton Signal commencing as of the Closing. Disclosures required for materialbusiness combinations have been limited due to the immateriality of theacquisition of Hamilton Signal to our consolidated financial statements. Nosupplemental pro forma information is presented for the acquisition due to theimmaterial effect of the acquisition on our results of operations.

 

**4.****                                     ****RevolvingLine of Credit and Long-Term Debt**

 

**RevolvingLine of Credit**

 

In October 2008, weentered into a $19.5 million credit facility with California Bank &Trust, which provides for a two-year revolving line of credit with borrowingsof up to $12.0 million and a $7.5 million 48-month term note (discussed below).Interest on borrowed amounts under the revolving line of credit are payablemonthly at a rate equal to the current stated prime rate up to the currentstated prime rate plus 0.50%, depending on aggregate deposit balancesmaintained at the bank in relation to the total loan commitment under thecredit facility (3.75% at September 30, 2009). We are obligated to pay anunused line fee of 0.25% per annum applied to the average unused portion of therevolving line of credit during the preceding month. The revolving line ofcredit does not contain any early termination fees and is secured bysubstantially all of our assets. As of September 30, 2009, no amounts wereoutstanding under the revolving line of credit portion of the facility.

 

**Long-TermDebt**

 

Our long-term debtconsists of the following:

 
| ** **                   | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                   | ** ** | **2009**               | ** ** | **2009**           | ** ** |
| ** **                   | ** ** | **(In thousands)**     | ** ** |
| Bank  term note              |       | $                      | 6,708      |               | $          | 6,543 |   |
| Convertible  debentures, net |       | —                 |       | 750                |       |
|                         |       | 6,708                  |       | 7,293              |       |
| Less  current portion        |       | (2,324                 | )          | (2,019             | )          |
|                         |       | $                      | 4,384      |               | $          | 5,274 |   |

 

*Convertible Debentures, Net.*In May 2009, we retired theremaining $750,000 of convertible debentures that were outstanding as of March 31,2009, which retirement was financed under our bank term note.

 

*Bank Term Note.*Under our current credit facility, whichwe entered into in October 2008, we may borrow up to $7.5 million in theform of a 48-month term note. Principal payments under this term note arerequired to be repaid in 48 monthly installments commencing on June 1,2009. Additionally, beginning on November 1, 2009, and on November 1of each year thereafter, we are required to pay additional principal of up to$500,000, calculated based on certain financial measures, as further defined inthe agreement. As of September 30, 2009, this additional $500,000 isincluded in the current portion of the term note. Interest on the term note ispayable monthly at a rate equal to the current stated prime rate plus 0.50% upto the current stated prime rate plus 1.00%, depending on aggregate depositbalances maintained at the bank in relation to the total loan commitment underthe credit facility (4.25% at September 30, 2009). The term note containsno early termination fees and, along with the revolving line of credit underthe same credit agreement, is secured by substantially all of our assets.

 

**5.****                                     ****Commitmentsand Contingencies**

 

**Litigation and Other Contingencies**

 

From time to time, we have been involved inlitigation relating to claims arising out of our operations in the normalcourse of business. We currently are 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 our consolidated results ofoperations, financial position or cash flows.

 

Furthermore, from time to time, we have experiencedunforeseen developments in contingencies related to our former subsidiaries.For example, we have been the subject of a number of routine tax audits fortime periods and jurisdictions related to the businesses of our formersubsidiaries, some of which are still in process. Although the development andultimate outcome of these and other unforeseen matters cannot be predicted withany certainty, our management does not believe that we are presently involvedin any matters related to our former subsidiaries that would have a materialadverse effect on our consolidated results of operations, financial position orcash flows.

 

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**Operating Lease**

 

We previously subleasedoffice space to MAXxess Systems, Inc. (“MAXxess”), one of our formersubsidiaries that we sold in September 2003 and is currently owned by aninvestor group that includes two of our directors, one of whom is the ChiefExecutive Officer of MAXxess. The sublease terminated in September 2007,at which time MAXxess owed us an aggregate of $274,000 related to this subleaseand certain related ancillary services that we provided to MAXxess. We havepreviously fully reserved for amounts owed to us by MAXxess under the terms ofthis sublease. In August 2009, MAXxess executed a promissory note in favorof Iteris for $274,000. The promissory note bears interest at a rate of 6% perannum, compounded annually, with accrued interest to be paid annually on thefirst business day of each calendar year. Payments under the note may be madein bona fide services rendered by MAXxess to Iteris to the extent such servicesand amounts are pre-approved in writing by us. All amounts outstanding underthe note will become due and payable on the earliest of August 10, 2014, achange of control in MAXxess or a financing by MAXxess resulting in grossproceeds of at least $10 million. All amounts due from MAXxess continue toremain fully reserved.

 

**6.****                                     ****Warrants**

 

The following tablesummarizes information regarding outstanding warrants to purchase our commonstock as of September 30, 2009:

 
| **Exercise Price** | ** ** | **Warrants  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** |
|--------------------|------------|---------------------------|------------|---------------------------------------------------|------------|
| ** **         | ** ** | **(In thousands)**        | ** ** | **(Years)**                                       | ** ** |
| $ 1.42        |       | 15                        |       | 3.9                                               |       |
| 3.25               |       | 246                       |       | 1.4                                               |       |
| 5.00               |       | 75                        |       | 0.8                                               |       |
|               |       | 336                       |       | 1.4                                               |       |

 

In May 2009, outstandingwarrants with a weighted average per share exercise price of $3.93 to purchaseapproximately 674,000 shares of our common stock, which were associated withour convertible debentures (see Note 4), expired unexercised. In July 2009,outstanding warrants with a per share exercise price of $5.26 to purchaseapproximately 155,000 shares of our common stock expired unexercised.

 

In connection with our adoption of certainprovisions within ASC Topic 815, *Derivatives and Hedging*,which became effective for us on April 1, 2009, we determined that certainoutstanding warrants to purchase shares of our common stock contain provisionsthat provide for a possible future adjustment to either the exercise priceand/or number of shares to be issued upon exercise. As such, beginning April 1,2009, we began recognizing these warrants as liabilities at their respectiveestimated fair values on each reporting date. The cumulative effect of thechange in accounting for these warrants of $47,000 was recognized as an adjustmentto the opening balance of accumulated deficit at April 1, 2009. Theamounts recognized in the consolidated balance sheet as a result of ouradoption on April 1, 2009 were determined based on the amounts that wouldhave been recognized if this accounting treatment had been applied from theissuance date of the warrants. At September 30, 2009, the estimated fairvalue of the warrants, which is included in accrued liabilities in theaccompanying unaudited condensed consolidated balance sheet, was $37,000. Thechange in the estimated fair value of the warrants for the three and six monthsended September 30, 2009 is included in other income in the accompanyingunaudited condensed consolidated statements of operations. We estimate the fairvalue of these warrants using the BSM option-pricing formula.

 

**7.****                                     ****FairValue Measurements**

 

ASC Topic 820, *Fair Value Measurementsand Disclosures* (“ASC 820”) defines fair value as the exchange pricethat would be received for an asset or paid to transfer a liability (an exitprice) in the principal or most advantageous market for the asset or liabilityin an orderly transaction between market participants on the measurement date.ASC 820 also establishes a fair value hierarchy that requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value. ASC 820 describes three levels of inputs thatmay be used to measure fair value:

 

Level 1: Quoted prices in an active market foridentical assets or liabilities.

 

Level 2: Observable inputs other than Level 1prices such as quoted prices for similar assets or liabilities; quoted pricesin markets that are not active; or other inputs that are observable or can becorroborated by observable market data for substantially the full term of theassets or liabilities.

 

Level 3: Unobservable inputs that are supported bylittle or no market activity and that are significant to the fair value of theassets or liabilities.

 

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At September 30, 2009, there were outstandingwarrants to purchase shares of our common stock that we classified as aliability with an estimated fair value of $37,000 (see Note 6). These warrantswere valued using Level 3 inputs because there are certain unobservable inputsassociated with them. The following table reconciles the liability for thesewarrants measured at fair value on a recurring basis using Level 3 inputs forthe six months ended September 30, 2009 (in thousands):

 
| Balance  at April 1, 2009                       |   | $   | — |   |
|------------------------------------------------------|--------|-----|--------|--------|
| Cumulative  effect of accounting change (Note 6)     |   | 47  |   |
| Gain  on change in fair value included in net income |   | (10 | )      |
| Balance  at September 30, 2009                  |   | $   | 37     |   |

 

Thisliability is included within accrued liabilities in the accompanying condensedconsolidated balance sheet as of September 30, 2009.

 

The intangible assets acquired in connection withthe Hamilton Signal acquisition (see Note 3) were recorded at fair value as ofthe acquisition date, and were estimated using the income approach, whichgenerally included the use of certain Level 3 inputs. Our non-financial assets,such as goodwill, intangible assets and property and equipment are measured atfair value on a non-recurring basis; generally when there is a transactioninvolving those assets such as a purchase transaction, a business combinationor an adjustment for impairment.

 

**8.****                                     ****Stockholders’Equity**

 

In August 2009, our Board of Directors adopteda stockholder rights plan, which calls for preferred stock purchase rights tobe distributed, as a dividend, at the rate of one Right for each share ofcommon stock held as of September 3, 2009. Each Right will entitle holdersof common stock to buy one one-thousandth of a share of Series A JuniorParticipating Preferred Stock of Iteris. Further description and terms of theRights are set forth in the Rights Agreement by and between us andComputershare Trust Company, N.A., as rights agent.

 

In connection with the stockholder rights plan, ourBoard of Directors approved the adoption of a Certificate of Designations,which created the Series A Junior Participating Preferred Stock, andlikewise authorized the filing of a Certification of Elimination to eliminatethe two series of junior participating preferred stock, which were originallycreated in April 1998 in connection with our previous stockholder rightsplan which expired in 2008.

 

**9.****                                     ****Stock-BasedCompensation**

 

A summary of activity in our stock option plans forthe six months ended September 30, 2009 is as follows:

 
| ** **                                      | ** ** | ** **         | ** ** | **Weighted** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                                      | ** ** | ** **         | ** ** | **Average**  | ** ** |
| ** **                                      | ** ** | **Number of**      | ** ** | **Exercise** | ** ** |
| ** **                                      | ** ** | **Shares**         | ** ** | **Price**    | ** ** |
| ** **                                      | ** ** | **(In thousands)** | ** ** | ** **   | ** ** |
| Options  outstanding at March 31, 2009     |       | 3,314              |       | $            | 1.92       |   |
| Granted                                         |       | 393                |       | 1.43         |       |
| Exercised                                       |       | (76                | )          | 1.19         |       |
| Forfeited                                       |       | (30                | )          | 2.49         |       |
| Expired                                         |       | (222               | )          | 1.80         |       |
| Options  outstanding at September 30, 2009 |       | 3,379              |       | $            | 1.88       |   |

 

In September 2009,our stockholders approved an amendment to increase the number of shares of ourcommon stock reserved for issuance under our 2007 Omnibus Incentive Plan by800,000 shares to a total of 1,650,000 shares. At September 30, 2009,there were 853,000 shares of common stock available for grant under this plan.

 

The per share fair valuesof stock options granted in the six months ended September 30, 2009 have beenestimated with the following weighted average assumptions:

 
| Expected  life - years                            |   |       |   | 7      |   |
|---------------------------------------------------|--------|------------|--------|--------|--------|
| Risk-free  interest rate                          |   |       |   | 3.2    | %      |
| Expected  volatility of common stock              |   |       |   | 74     | %      |
| Dividend  yield                                   |   |       |   | — |   |
| Weighted-average  grant date fair value per share |   | ** ** |   | $      | 1.01   |   |
|                                                   |        |            |        |        |        |  |

 

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At September 30,2009, there was approximately $1.1 million of total unrecognized compensationexpense related to unvested stock options. This expense is expected to berecognized over a weighted average period of approximately 3.4 years. If thereare any modifications or cancellations of the underlying unvested stockoptions, we may be required to accelerate, increase or cancel any remainingunearned stock-based compensation expense. Future stock-based compensationexpense and unearned stock-based compensation will increase to the extent thatwe issue additional stock options or other stock-based awards.

 

**10.****                              ****BusinessSegment Information**

 

We currently operate inthree reportable segments: Roadway Sensors, Vehicle Sensors and TransportationSystems. The Roadway Sensors segment includes our Vantage and VersiCam vehicledetection systems for traffic intersection control, incident detection andcertain highway traffic data collection applications. The Vehicle Sensorssegment includes our lane departure warning products and is comprised of all ofour activities related to vehicle safety. The Transportation Systems segmentincludes transportation engineering and consulting services and the developmentof transportation management and traveler information systems for the ITSindustry. The accounting policies of the reportable segments are the same asthose described in the summary of significant accounting policies. Certaincorporate expenses, including interest and amortization of certain intangibleassets, are not allocated to the segments. The reportable segments are eachmanaged separately because they manufacture and distribute distinct products orprovide services with different processes. All segment revenues are derivedfrom external customers.

 

The following table sets forth selected unauditedfinancial information for our reportable segments for the three and six monthsended September 30, 2009 and 2008:

 
| ** **                                     | ** ** | **Roadway  Sensors** | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total**  | ** ** |
|------------------------------------------------|------------|----------------------|------------|----------------------|------------|-----------------------------|------------|------------|------------|
| ** **                                     | ** ** | **(In thousands)**   | ** ** |
| **Three Months Ended September 30, 2009** | ** ** | ** **           | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Product  revenue                               |       | $                    | 7,082      |                 | $          | 1,189                       |       | $          | —     |   | $ | 8,271 |   |
| Service  and other revenue                     |       | —               |       | 191                  |       | 6,403                       |       | 6,594      |       |
| Stock-based  compensation                      |       | 10                   |       | 8                    |       | 16                          |       | 34         |       |
| Depreciation  and amortization                 |       | 57                   |       | 18                   |       | 56                          |       | 131        |       |
| Segment  income (loss)                         |       | 1,182                |       | (330                 | )          | 390                         |       | 1,242      |       |
| ** **                                     | ** ** | ** **           | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| **Three Months Ended September 30, 2008** |       |                 |       |                 |       |                        |       |       |       |
| Product  revenue                               |       | $                    | 7,617      |                 | $          | 3,177                       |       | $          | —     |   | $ | 10,794 |   |
| Service  and other revenue                     |       | —               |       | 284                  |       | 7,988                       |       | 8,272      |       |
| Stock-based  compensation                      |       | 8                    |       | 12                   |       | 13                          |       | 33         |       |
| Depreciation  and amortization                 |       | 48                   |       | 36                   |       | 64                          |       | 148        |       |
| Segment  income                                |       | 1,106                |       | 289                  |       | 738                         |       | 2,133      |       |
|                                           |       |                 |       |                 |       |                        |       |       |       |
| **Six Months Ended September 30, 2009**   |       |                 |       |                 |       |                        |       |       |       |
| Product  revenue                               |       | $                    | 12,957     |                 | $          | 1,999                       |       | $          | —     |   | $ | 14,956 |   |
| Service  and other revenue                     |       | —               |       | 439                  |       | 14,104                      |       | 14,543     |       |
| Stock-based  compensation                      |       | 18                   |       | 16                   |       | 30                          |       | 64         |       |
| Depreciation  and amortization                 |       | 119                  |       | 40                   |       | 114                         |       | 273        |       |
| Segment  income (loss)                         |       | 1,544                |       | (836                 | )          | 924                         |       | 1,632      |       |
|                                           |       |                 |       |                 |       |                        |       |       |       |
| **Six Months Ended September 30, 2008**   |       |                 |       |                 |       |                        |       |       |       |
| Product  revenue                               |       | $                    | 15,043     |                 | $          | 5,903                       |       | $          | —     |   | $ | 20,946 |   |
| Service  and other revenue                     |       | —               |       | 658                  |       | 14,904                      |       | 15,562     |       |
| Stock-based  compensation                      |       | 16                   |       | 24                   |       | 26                          |       | 66         |       |
| Depreciation  and amortization                 |       | 96                   |       | 73                   |       | 120                         |       | 289        |       |
| Segment  income                                |       | 2,114                |       | 447                  |       | 1,144                       |       | 3,705      |       |

 

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The following table reconciles segment income toconsolidated income before income taxes:

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|----------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                             | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                   | ** ** | **(In  thousands)**    |       |
| **Segment income:**                    |       |                   |       |                   |       |   |   |   |   |
| Total  income from reportable segments |       | $                      | 1,242      |                   | $          | 2,133 |   | $ | 1,632 |   | $ | 3,705 |   |
| **Unallocated amounts:**               |       |                   |       |                   |       |   |   |   |   |
| Corporate  and other expenses          |       | (125                   | )          | (69                    | )          | (194 | ) | (291 | ) |
| Other  income (expense), net           |       | (2                     | )          | 22                     |       | 17 |   | 27 |   |
| Interest  expense, net                 |       | (71                    | )          | (198                   | )          | (157 | ) | (396 | ) |
| Income  before income taxes            |       | $                      | 1,044      |                   | $          | 1,888 |   | $ | 1,298 |   | $ | 3,045 |   |

 

**11.****                              ****SubsequentEvents**

 

Wehave evaluated subsequent events through October 30, 2009, whichrepresents the date these financial statements were issued.

 
| **ITEM 2.** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

*This report, including the following discussion and analysis, containsforward-looking statements (within the meaning of the Private SecuritiesLitigation Reform Act of 1995) that are based on our current expectations,estimates and projections about our business and our industry, and reflectmanagement’s beliefs and certain assumptions made by us based upon informationavailable to us as of the date of this report. When used in this report and theinformation incorporated herein by reference, the words “expect(s),” “feel(s),”“believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)” andsimilar 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 encourageyou to carefully review and consider the various disclosures made by us whichdescribe certain factors which could affect our business, including in* “*Risk Factors” set forth in Part II, Item 1A of this report, beforedeciding to invest in our company or to maintain or increase your investment.We undertake no obligation to revise or update publicly any forward-lookingstatement for any reason, including to reflect events or circumstances afterthe date hereof or to reflect the occurrence of unanticipated events.*

 

**Overview**

 

We are a leader in the traffic management market focused on thedevelopment and application of advanced technologies that reduce trafficcongestion and improve the safety of surface transportation systemsinfrastructure. As an added benefit, our products and services minimize theenvironmental impact of traffic congestion. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broadrange of Intelligent Transportation Systems (“ITS”) and driver safety solutionsto customers worldwide.

 

Wecurrently operate in three reportable segments: Roadway Sensors, VehicleSensors, and Transportation Systems. The Roadway Sensors segment includes ourVantage and VersiCam vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications. The Vehicle Sensors segment includes our lanedeparture warning (“LDW”) products and is comprised of all of our activitiesrelated to vehicle safety. The Transportation Systems segment includestransportation engineering and consulting services, and the development oftransportation management and traveler information systems for the ITSindustry.

 

Our Roadway Sensors segment product line uses advanced image processingtechnology to capture and analyze video images through sophisticatedalgorithms, enabling vehicle detection and transmission of both video imagesand data using a wide range of communication technologies. Our Vantage videodetection systems detect vehicle presence, count, speed and other traffic dataused in traffic management systems. This gives traffic managers the ability tomitigate roadway congestion by modifying traffic signal timing or detectingincidents quickly. VersiCam, our integrated camera and processor videodetection system, is a cost-efficient video detection system for smallerintersections that require only a few detection points. Vantage video detectionsystems have been deployed by hundreds of agencies and are currently soldthrough a network of independent dealers in the United States, Asia, LatinAmerica, Europe and the Middle East.

 

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Our Vehicle Sensors segment addresses the leading cause of roadwayfatalities: rear-end, lane change, and roadway departure accidents. Wedeveloped the world’s first production LDW system and offer a proven systemthat is available as an OEM and aftermarket option on heavy trucks worldwideand as an option in passenger cars. Our LDW products utilize video detectionimages to detect when a vehicle begins to drift toward an unintended lanechange. When this occurs, the unit automatically emits a distinctive rumblestrip or other audible warning sound, alerting the driver to make a correction.To date, we have sold approximately 72,000 LDW systems into the heavy truck marketin Europe, North America and Asia. Our LDW systems are currently qualified asan option on certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF,Scania, Freightliner and FUSO, as well as Neoplan and MAN luxury bus and coachlines. In North America, our LDW systems are sold primarily to truck fleets. Webelieve that as a result the expected 2013 European mandate for LDW and otheractive safety systems, and an overall awareness of the potential benefits ofLDW, that we will experience an even higher degree of competition from avariety of tier-one OEM suppliers and other potential market entrants,worldwide. We believe that this increased competition further validates thelong term market opportunity for LDW systems in commercial vehicles. We arecurrently working with our major European OEM customer base to establishlong-term supply agreements that extend to 2013 and beyond in order to meet theanticipated increase in demand. We cannot assure you that our efforts will besuccessful. We have also licensed our LDW technology to our strategic partner,Valeo Schalter and Sensuren GmbH (“Valeo”), resulting in sales to date ofapproximately 71,000 LDW systems for passenger cars. Additionally, we and ourpartner have experienced a greater degree of competition in the passenger carmarket, further validating LDW systems in this market as well. Severalpassenger car OEM’s have recently introduced vehicle platforms with competingLDW systems. We and our partner Valeo continue to aggressively pursue opportunitiesin the passenger car market.

 

In addition to our LDW systems, our Vehicle Sensors portfolio includestechnologies such as radar-based Forward Collision Warning (“FCW”) and BlindSpot Warning (“BSW”) systems for the North American truck market. Our SafetyDirect product is a system that reports driver performance data captured by ourLDW system and that has the ability to relay this information directly to fleetoperators through integration with the truck’s existing fleet communicationssystem. We offer the FCW and BSW features through the resale of Delphi’s radarbased systems, for which we are the exclusive North American dealer, whileSafety Direct was internally developed. These products, together with our LDWproducts, combine to create a suite of active safety driver assistance featuresthat help to reduce the number of motor vehicle crashes and the severity ofcrash-related injuries.

 

OurTransportation Systems segment includes transportation engineering andconsulting services focused on the planning, design, development andimplementation of software-based systems that integrate sensors, videosurveillance, computer, and advanced communications equipment to enable publicagencies to monitor, control and direct traffic flow, assist in the quickdispatch of emergency crews and distribute real-time information about trafficconditions. Our services include planning, design and implementation of surfacetransportation infrastructure systems. We perform analysis and study goodsmovement, commercial vehicle operations, travel demand forecasting and systemsengineering, and identify mitigation measures to reduce traffic congestion.These services and systems are primarily sold to local, state, and nationaltransportation agencies in the United States.

 

OurTransportation Systems segment is largely dependent upon governmental fundingand budgetary issues. We believe the overall expansion of our TransportationSystems segment in recent years was due in part to the passage of the FederalHighway Bill in 2005, combined with increased transportation fundsavailable at state and local agencies throughout the country. The 2005 FederalHighway Bill is currently scheduled to expire on October 31, 2009, andCongress is currently in negotiations regarding future extensions. Weanticipate possible delays in the enactment of a new federal highwaybill; however, we believe the current level of funding will continue until suchtime that the new Bill is passed through Congress.

 

Despitethe federal stimulus package, many municipalities and other agencies continueto face budgetary issues, whereby in some cases, spending for new roadways, newsystems to address traffic congestion and other transportation infrastructureimprovements has been delayed. Nevertheless, we believe that the need torebuild and modernize aging transportation infrastructure will continue, and inaddition to funds available through the stimulus package and federal highwaybills, there exist a variety of other funding mechanisms that support transportationinfrastructure and related projects, including bonds, dedicated tax measuresand other alternative funding sources. At this point in time, we cannotdetermine when or if such funding sources will be availableor the extent to which we may benefit from future sources of funding fortransportation-related projects.

 

**Critical Accounting 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 accounting principlesgenerally accepted in the United States, or U.S. GAAP. The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and related disclosuresof contingent assets and 

 

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liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. On an ongoing basis, we evaluate these estimates andassumptions, including those related to the collectibility of accounts receivable,the valuation of inventories, the recoverability of long-lived assets andgoodwill, the realizability of deferred tax assets, accounting for stock-basedcompensation, the valuation of equity instruments, warranty reserves and othercontingencies. We base these estimates on our historical experience and onvarious other factors that we believe to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources. These estimates and assumptions by their nature involve risks anduncertainties, and may prove to be inaccurate. In the event that any of ourestimates or assumptions are inaccurate in any material respect, it could havea material adverse effect on our reported assets and liabilities at the date ofthe financial statements and our reported revenues and expenses during thereporting period.

 

Theaccounting policies that affect our more significant judgments and estimatesused in the preparation of our unaudited condensed consolidated financialstatements are those relating to revenue recognition, accounts receivable,inventory, goodwill, warranty, income taxes, and stock-based compensation.These policies are described in further detail in our Annual Report on Form 10-Kfor the fiscal year ended March 31, 2009 (“fiscal 2009”). There have beenno significant changes in our critical accounting policies and estimates duringthe six months ended September 30, 2009 as compared to what was previouslydisclosed in our Annual Report on Form 10-K for fiscal 2009.

 

**Recent Accounting Pronouncements**

 

Referto Note 1 of Notes to Unaudited Condensed Consolidated Financial Statements,included in Part I, Item I of this report for a discussion of recentaccounting pronouncements.

 

**Results of Operations**

 

The followingtable sets forth certain statement of operations data as a percentage of totalnet sales and contract revenues for the periods indicated:

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|--------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                 | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                       |       |                   |       |                   |       |   |   |   |   |
| Net  sales and contract revenues:          |       |                   |       |                   |       |   |   |   |   |
| Net  sales                                 |       | 56.9                   | %          | 58.1                   | %          | 52.2 | % | 59.2 | % |
| Contract  revenues                         |       | 43.1                   |       | 41.9                   |       | 47.8 |   | 40.8 |   |
| Total  net sales and contract revenues     |       | 100.0                  | %          | 100.0                  | %          | 100.0 | % | 100.0 | % |
| Costs  of net sales and contract revenues: |       |                   |       |                   |       |   |   |   |   |
| Cost  of net sales                         |       | 29.7                   |       | 30.9                   |       | 28.0 |   | 30.5 |   |
| Cost  of contract revenues                 |       | 26.1                   |       | 27.8                   |       | 30.8 |   | 26.6 |   |
| Gross  profit                              |       | 44.2                   |       | 41.3                   |       | 41.2 |   | 42.8 |   |
| Operating  expenses:                       |       |                   |       |                   |       |   |   |   |   |
| Selling,  general and administrative       |       | 30.5                   |       | 24.4                   |       | 29.8 |   | 26.9 |   |
| Research  and development                  |       | 5.9                    |       | 5.9                    |       | 6.3 |   | 6.4 |   |
| Amortization  of intangible assets         |       | 0.3                    |       | 0.2                    |       | 0.3 |   | 0.2 |   |
| Total  operating expenses                  |       | 36.7                   |       | 30.5                   |       | 36.3 |   | 33.5 |   |
| Operating  income                          |       | 7.5                    |       | 10.8                   |       | 4.9 |   | 9.4 |   |
| Non-operating  income (expense):           |       |                   |       |                   |       |   |   |   |   |
| Other  income (expense), net               |       | (0.0                   | )          | 0.1                    |       | 0.1 |   | 0.1 |   |
| Interest  expense, net                     |       | (0.5                   | )          | (1.0                   | )          | (0.5 | ) | (1.1 | ) |
| Income  before income taxes                |       | 7.0                    |       | 9.9                    |       | 4.4 |   | 8.3 |   |
| Provision  for income taxes                |       | (3.4                   | )          | (4.3                   | )          | (2.1 | ) | (3.6 | ) |
| Net  income                                |       | 3.7                    | %          | 5.6                    | %          | 2.3 | % | 4.7 | % |

 

**Analysis ofQuarterly Results of Operations**

 

*Net Sales and Contract Revenues*. Net sales are comprised of productsales from our Roadway Sensors and Vehicle Sensors segments, as well ascontract engineering revenue and royalty revenue generated from our VehicleSensors segment. Contract revenues consist entirely of TransportationSystems contract revenues, which are generated from systems integration and ITSconsulting services primarily with federal, state, county and municipal agencies.

 

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The following tables present details of our net sales and contractrevenues for the three and six months ended September 30, 2009 and 2008:

 
| ** **                             | ** ** | **Three Months Ended**                 | ** ** | ** ** | ** ** | ** **   | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|------------|------------|--------------|------------|
| ** **                             | ** ** | **September 30,**                 | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                             | ** ** | **2009**                               | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                             | ** ** | **(In thousands, except percentages)** | ** ** |
| Roadway  Sensors                       |       | $                                      | 7,082      |       | $          | 7,617        |       | $ | (535 | ) | (7.0 | )% |
| Vehicle  Sensors                       |       | 1,380                                  |       | 3,461      |       | (2,081       | )          | (60.1 | ) |
| Net sales                              |       | 8,462                                  |       | 11,078     |       | (2,616       | )          | (23.6 | ) |
| Contract  revenues                     |       | 6,403                                  |       | 7,988      |       | (1,585       | )          | (19.8 | ) |
| Total  net sales and contract revenues |       | $                                      | 14,865     |       | $          | 19,066       |       | $ | (4,201 | ) | (22.0 | ) |
|                                   |       |                                   |       |       |       |         |       |   |   |
| ** **                             | ** ** | **Six Months Ended**                   | ** ** | ** ** | ** ** | ** **   | ** ** |
| ** **                             | ** ** | **September 30,**                 | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                             | ** ** | **2009**                               | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                             | ** ** | **(In thousands, except percentages)** | ** ** |
| Roadway  Sensors                       |       | $                                      | 12,957     |       | $          | 15,043       |       | $ | (2,086 | ) | (13.9 | )% |
| Vehicle  Sensors                       |       | 2,438                                  |       | 6,561      |       | (4,123       | )          | (62.8 | ) |
| Net  sales                             |       | 15,395                                 |       | 21,604     |       | (6,209       | )          | (28.7 | ) |
| Contract  revenues                     |       | 14,104                                 |       | 14,904     |       | (800         | )          | (5.4 | ) |
| Total  net sales and contract revenues |       | $                                      | 29,499     |       | $          | 36,508       |       | $ | (7,009 | ) | (19.2 | ) |

 

We havehistorically had a diverse customer base. For the six months ended September 30,2009, one individual customer accounted for approximately 10% of our total netsales and contract revenues. In the corresponding period in the prior year, noindividual customer accounted for greater than 10% of our total net sales andcontract revenues.

 

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*RoadwaySensors*

 

Thedecrease in Roadway Sensors net sales for the three and six months ended September 30,2009 as compared to the corresponding periods in the prior fiscal year wasmainly due to the ongoing effects of reduced and delayed spending oninfrastructure projects, in part due to the decline in commercial andresidential construction as well as state and local government budgetarypressures. We believe these factors are at least partially attributable to thecontinued weakness in the U.S. and global economy. We expect the above factors,among others, may continue to adversely impact our Roadway Sensors net salesfor at least the next few fiscal quarters. Additionally, winter weatherconditions have historically had a negative impact on Roadway Sensors net salesin our fiscal third and fourth quarters in the regions where projects can bedelayed due to such factors.

 

*VehicleSensors*

 

Thelargest element of Vehicle Sensors net sales was sales of our LDW systems tothe heavy truck market, which aggregated approximately $1.2 million and $2.0million for the three and six months ended September 30, 2009,respectively, compared to approximately $3.2 million and $5.9 million for thethree and six months ended September 30, 2008, respectively. VehicleSensors net sales decreased for the current fiscal year primarily due to theongoing slowdown in overall LDW unit shipments to each of our key markets. Wecurrently continue to experience softness in our LDW unit sales to the NorthAmerican truck market and to our European and Asian OEM customers, which webelieve is driven largely by the general slowdown in the U.S. and worldwidecredit markets and continued weakness in the overall global economy. Weanticipate that Vehicle Sensors unit sales for the remainder of the fiscal yearended March 31, 2010 (“fiscal 2010”) and beyond could also be adverselyimpacted as a result of the overall decline in sales of heavy trucks globallyand by slower than expected adoption rates of our LDW system by European andAsian OEMs and North American heavy truck fleets. Additionally, future unitsales of LDW systems could be adversely impacted as a result of increasedcompetition which contributed to a division of an international heavy truckcustomer sourcing future primary LDW unit sales to a competitor for a specificgeographic region.

 

Alsoincluded in Vehicle Sensors net sales are revenues from contract engineeringservices and royalty revenues in the passenger car market that are derived fromour strategic relationship with Valeo, which aggregated approximately $191,000and $439,000 for the three and six months ended September 30, 2009,respectively, compared to $284,000 and $658,000 for the three and six monthsended September 30, 2008, respectively.

 

*ContractRevenues*

 

Contractrevenues are primarily dependent upon the continued availability of funding atboth the state and federal levels from the various departments oftransportation. For the three months ended September 30, 2009, ourcontract revenues decreased compared to the corresponding period in the priorfiscal year largely due to a reduction in sub-consulting content revenues ascertain significant projects were completed in the current period. In thefuture, we plan to continue to pursue large contracts that may containsignificant sub-consulting content, which will likely contribute to variabilityin the timing and amount of our contract revenues from period to period. Webelieve the ability of our Transportation Systems business to grow andsuccessfully win and service new contracts will remain highly dependent uponour continued success in recruiting and retaining qualified personnel.Historically, all of our contract revenues have been derived from workperformed in North America under a broad range of fixed price and cost plusfixed fee contracts. Beginning in the second quarter of fiscal 2010, we beganwork on our first overseas contract award to assist the Abu Dhabi Department ofTransport in the development of certain ITS architecture. To date, revenuesfrom this contract have not been significant.

 

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*Gross Profit*.  The following tablespresent details of our gross profit for the three and six months ended September 30,2009 and 2008:

 
| ** **                                                          | ** ** | **Three Months Ended**                  | ** ** | ** ** | ** ** | ** **   | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                          | ** ** | **September 30,**                  | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                                                          | ** ** | **2009**                                | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                                                          | ** ** | **(In thousands, except percentages)**  | ** ** |
| Total  gross profit                                                 |       | $                                       | 6,570      | ** ** | $          | 7,875        |       | $ | (1,305 | ) | (16.6 | )% |
| Total  gross profit as a % of total net sales and contract revenues | ** ** | 44.2                                    | %          | 41.3       | %          |         |       |   |   |
| Gross  profit as a % of net sales                                   |       | 47.9                                    | %          | 46.9       | %          |         |       |   |   |
| Gross  profit as a % of contract revenues                           |       | 39.4                                    | %          | 33.6       | %          |         |       |   |   |
|                                                                |       |                                    |       |       |       |         |       |   |   |
|                                                                | ** ** | **Six  Months Ended**                   |       |       |       |         |       |
|                                                                | ** ** | **September 30,**                  |       |       |       | **%**        |       |
|                                                                | ** ** | **2009**                                | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
|                                                                |       | **(In  thousands, except percentages)** |       |
| Total  gross profit                                                 |       | $                                       | 12,152     | ** ** | $          | 15,627       |       | $ | (3,475 | ) | (22.2 | )% |
| Total  gross profit as a % of total net sales and contract revenues | ** ** | 41.2                                    | %          | 42.8       | %          |         |       |   |   |
| Gross  profit as a % of net sales                                   |       | 46.4                                    | %          | 48.4       | %          |         |       |   |   |
| Gross  profit as a % of contract revenues                           |       | 35.5                                    | %          | 34.7       | %          |         |       |   |   |

 

Ourgross margin for the three months ended September 30, 2009 increasedcompared to the corresponding period in the prior fiscal year primarily as aresult of higher margins from our Transportation Systems contract revenues, asdiscussed further below. On a fiscal year-to-date basis, the slight decline inour gross margin in the current fiscal year, as compared to the same period inthe prior fiscal year, was primarily the result of a higher mix of contractrevenues, which represented approximately 48% of our total net sales andcontract revenues thus far in the current fiscal year as compared toapproximately 41% in the same period in the prior fiscal year. Generally,contract revenues carry lower margins than our net sales.

 

Theslight increase in gross profit as a percent of net sales for the three monthsended September 30, 2009 as compared to the corresponding period in theprior year was a result of higher margins in Roadway Sensors during the currentquarter, primarily driven by our customer mix. The overall decrease in grossprofit as a percent of net sales for the six months ended September 30,2009 as compared to the corresponding period in the prior year was primarily aresult of decreased gross profit in Vehicle Sensors, which was driven by loweroverhead absorption due to the decline in sales in the current fiscal year, aswell as an increase in certain estimates for additional excess and obsoleteinventory provisions. Gross profit as a percentage of net sales can fluctuatein any specific quarter or year based on, among other factors, customer andproduct mix, competitive pricing requirements, product warranty costs andprovisions for excess and obsolete inventories, as well as possible shifts ofengineering resources from development activities to sustaining activities,which we record as cost of goods sold.

 

Werecognize contract revenues and related gross profit using percentage ofcompletion contract accounting, and the underlying mix of contract activityaffects the related gross profit recognized in any given period. The increasein gross profit as a percent of contract revenues for the three months ended September 30,2009 compared to the corresponding period in the prior year was primarily dueto a contract mix weighted more toward higher margin contracts in the currentquarter, which contained a significantly lower proportion of sub-consultingrevenues. In subsequent quarters of fiscal 2010, we expect similarly lowerlevels of sub-consulting content as a percentage of our total contractrevenues, as compared to recent prior fiscal quarters; however, due to thevariability and timing of our contracts, it has become increasingly difficultto accurately predict sub-consulting content in future periods.

 

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*Selling, General and Administrative Expense*.  Thefollowing tables present selling, general and administrative expense for thethree and six months ended September 30, 2009 and 2008:

 
|   |   |   |   |   |   |   |   |   |   |
|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

 
| ** **                           | ** ** | **Three Months Ended**                  | ** ** | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **     | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|------------------------------|------------|------------|------------|----------------|------------|
| ** **                           | ** ** | **September 30, 2009**             | ** ** | **September 30, 2008**  | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                           | ** ** | ** **                              | ** ** | **% of Net**                 | ** ** | ** ** | ** ** | **% of Net**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                              | ** ** | **Sales and**                | ** ** | ** ** | ** ** | **Sales and**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                              | ** ** | **Contract**                 | ** ** | ** ** | ** ** | **Contract**   | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                              | ** ** | **Revenues**                 | ** ** | **Amount** | ** ** | **Revenues**   | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentages)**  | ** ** |
| Salary  and personnel-related        |       | $                                       | 3,020      |                         | 20.3       | %          | $          | 3,121          |       | 16.4 | % | $ | (101 | ) | (3.2 | )% |
| Facilities,  insurance and supplies  |       | 677                                     |       | 4.6                          |       | 580        |       | 3.0            |       | 97 |   | 16.7 |   |
| Travel  and conferences              |       | 351                                     |       | 2.4                          |       | 411        |       | 2.2            |       | (60 | ) | (14.6 | ) |
| Professional  and outside services   |       | 294                                     |       | 2.0                          |       | 341        |       | 1.8            |       | (47 | ) | (13.8 | ) |
| Other                                |       | 185                                     |       | 1.2                          |       | 200        |       | 1.0            |       | (15 | ) | (7.5 | ) |
| Selling,  general and administrative |       | $                                       | 4,527      |                         | 30.5       | %          | $          | 4,653          |       | 24.4 | % | $ | (126 | ) | (2.7 | ) |
|                                 |       |                                    |       |                         |       |       |       |           |       |   |   |   |   |
|                                 |       | **Six  Months Ended**                   |       | **Six  Months Ended**        |       |       |       |           |       |
|                                 |       | **September 30,  2009**            |       | **September 30,  2008** |       |       |       |           |       |
| ** **                           | ** ** | ** **                              | ** ** | **%  of Net**                | ** ** | ** ** | ** ** | **%  of Net**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                              | ** ** | **Sales  and**               | ** ** | ** ** | ** ** | **Sales  and** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                              | ** ** | **Contract**                 | ** ** | ** ** | ** ** | **Contract**   | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                              | ** ** | **Revenues**                 | ** ** | **Amount** | ** ** | **Revenues**   | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In  thousands, except percentages)** | ** ** |
| Salary  and personnel-related        |       | $                                       | 5,907      |                         | 20.0       | %          | $          | 6,417          |       | 17.6 | % | $ | (510 | ) | (7.9 | )% |
| Facilities,  insurance and supplies  |       | 1,272                                   |       | 4.3                          |       | 1,230      |       | 3.4            |       | 42 |   | 3.4 |   |
| Travel  and conferences              |       | 696                                     |       | 2.4                          |       | 813        |       | 2.2            |       | (117 | ) | (14.4 | ) |
| Professional  and outside services   |       | 589                                     |       | 2.0                          |       | 835        |       | 2.3            |       | (246 | ) | (29.5 | ) |
| Other                                |       | 316                                     |       | 1.1                          |       | 513        |       | 1.4            |       | (197 | ) | (38.4 | ) |
| Selling,  general and administrative |       | $                                       | 8,780      |                         | 29.8       | %          | $          | 9,808          |       | 26.9 | % | $ | (1,028 | ) | (10.5 | ) |

 

Thedecreases in selling, general and administrative expense for the three and sixmonths ended September 30, 2009 compared to the corresponding periods inthe prior year were primarily due to (i) our overall reduction inheadcount from September 30, 2008 levels; (ii) lower accruals forbonuses and other incentive compensation; and (iii) the suspension of ourmatching contributions to our associates’ 401(k) accounts effective July 1,2009. During the current fiscal year, we also reduced our professional andoutside services expenses primarily as a result of our efforts to conservecosts and scale back our usage of certain of these services as well as variousefficiencies gained in our internal control assessment and other financialreporting obligations.

 

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*Research and Development Expense*.  Thefollowing tables present research and development expense for the three and sixmonths ended September 30, 2009 and 2008:

 
| ** **                            | ** ** | **Three Months Ended**                  | ** ** | **Three Months Ended**       | ** ** | ** ** | ** ** | ** **     | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|------------------------------|------------|------------|------------|----------------|------------|
| ** **                            | ** ** | **September 30, 2009**             | ** ** | **September 30, 2008**  | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **% of Net**                 | ** ** | ** ** | ** ** | **% of Net**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **Sales and**                | ** ** | ** ** | ** ** | **Sales and**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **Contract**                 | ** ** | ** ** | ** ** | **Contract**   | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **Amount**                              | ** ** | **Revenues**                 | ** ** | **Amount** | ** ** | **Revenues**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                            | ** ** | **(In thousands, except percentages)**  | ** ** |
| Salary  and personnel-related         |       | $                                       | 661        |                         | 4.4        | %          | $          | 754            |       | 4.0 | % | $ | (93 | ) | (12.3 | )% |
| Facilities,  development and supplies |       | 195                                     |       | 1.3                          |       | 301        |       | 1.6            |       | (106 | ) | (35.2 | ) |
| Other                                 |       | 28                                      |       | 0.2                          |       | 67         |       | 0.4            |       | (39 | ) | (58.2 | ) |
| Research  and development             |       | $                                       | 884        |                         | 5.9        | %          | $          | 1,122          |       | 5.9 | % | $ | (238 | ) | (21.2 | ) |
|                                  |       |                                    |       |                         |       |       |       |           |       |   |   |   |   |
| ** **                            | ** ** | **Six  Months Ended**                   | ** ** | **Six  Months Ended**        | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                            | ** ** | **September 30,  2009**            | ** ** | **September 30,  2008** | ** ** | ** ** | ** ** | ** **     | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **%  of Net**                | ** ** | ** ** | ** ** | **%  of Net**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **Sales  and**               | ** ** | ** ** | ** ** | **Sales  and** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | ** **                              | ** ** | **Contract**                 | ** ** | ** ** | ** ** | **Contract**   | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **Amount**                              | ** ** | **Revenues**                 | ** ** | **Amount** | ** ** | **Revenues**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                            | ** ** | **(In  thousands, except percentages)** | ** ** |
| Salary  and personnel-related         |       | $                                       | 1,344      |                         | 4.6        | %          | $          | 1,630          |       | 4.5 | % | $ | (286 | ) | (17.5 | )% |
| Facilities,  development and supplies |       | 431                                     |       | 1.5                          |       | 565        |       | 1.5            |       | (134 | ) | (23.7 | ) |
| Other                                 |       | 73                                      |       | 0.2                          |       | 137        |       | 0.4            |       | (64 | ) | (46.7 | ) |
| Research  and development             |       | $                                       | 1,848      |                         | 6.3        | %          | $          | 2,332          |       | 6.4 | % | $ | (484 | ) | (20.8 | ) |

 

Thedecreases in research and development expense for the three and six monthsended September 30, 2009 compared to the corresponding periods in theprior year were primarily due to lower overall engineering headcount and ashift in engineering resources to an organization more focused on new productdevelopment from one that has been historically focused on new customerqualification and manufacturing support. We believe this structure to be moreefficient. Likewise, in the prior year, we had ramped up our research anddevelopment activities in Roadway Sensors aimed at accelerating the time tomarket of certain new products. We believe that research and developmentactivities are crucial to our ability to continue to be a leader in our marketsand we currently expect our expenditures in this area for fiscal 2010 will beslightly lower to flat when compared to fiscal 2009.

 

Forcompetitive reasons, we closely guard the confidentiality of specificdevelopment projects.

 

*Interest Expense, Net.*   Net interest expense of $71,000 and $157,000for the three and six months ended September 30, 2009, respectively, waslower than the $198,000 and $396,000 for the three and six months ended September 30,2008, respectively, primarily due to the overall lower level of borrowings inthe current fiscal year, as well as lower interest rates on our term note.

 

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*Income**Taxes*.  The following tables present our provision for income taxes forthe three and six months ended September 30, 2009 and 2008:

 
| ** **                  | ** ** | **Three Months Ended**                  | ** ** | ** ** | ** ** | ** **   | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|------------|------------|--------------|------------|
| ** **                  | ** ** | **September 30,**                  | ** ** | ** ** | ** ** | **%**        | ** ** |
| ** **                  | ** ** | **2009**                                | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **(In thousands, except percentages)**  | ** ** |
| Provision  for income taxes |       | $                                       | 501        |       | $          | 821          |       | $ | (320 | ) | (39 | )% |
| Effective  tax rate         |       | 48.0                                    | %          | 43.5       | %          |         |       |   |   |
|                        |       |                                    |       |       |       |         |       |   |   |
|                        | ** ** | **Six  Months Ended**                   |       |       |       |         |       |
|                        | ** ** | **September 30,**                  | ** ** | ** ** | ** ** | **%**        |       |
|                        | ** ** | **2009**                                |       | **2008**   | ** ** | **Decrease** | ** ** | **Change** |   |
|                        |       | **(In  thousands, except percentages)** |       |
| Provision  for income taxes |       | $                                       | 611        |       | $          | 1,312        |       | $ | (701 | ) | (53 | )% |
| Effective  tax rate         |       | 47.1                                    | %          | 43.1       | %          |         |       |   |   |

 

Oureffective tax rates in the three and six months ended September 30, 2009were slightly higher than those for the corresponding periods in the prior yeardue primarily to lower estimated projected pre-tax income in the current yearcompared to the prior year and the corresponding increased impact that certainnon-deductible expenses will have on taxable income. On an interim basis, weestimate what our anticipated annual effective tax rate will be and record aquarterly income tax provision in accordance with this anticipated annual rate.As the fiscal year progresses, we refine our estimates based on actual eventsand financial results during the year. This process can result in significantchanges to our expected effective tax rate. When this occurs, we adjust ourincome tax provision during the quarter in which our estimates are refined sothat the year-to-date provision reflects the expected annual rate. Thesechanges, along with adjustments to our deferred taxes, among others, may createfluctuations in our overall effective tax rate from quarter to quarter.

 

**Liquidityand Capital Resources**

 

*CashFlows*

 

Wehave historically financed our operations with a combination of cash flows fromoperations, borrowings under credit facilities and the sale of equitysecurities. We currently rely on cash flows from operations and theavailability of borrowings on a line of credit facility to fund our operations,which we believe are sufficient to fund our operations for at least the nexttwelve months. At September 30, 2009, we had $20.6 million in workingcapital, which included no borrowings on our $12.0 million line of credit and$9.2 million in cash and cash equivalents. Our working capital at March 31,2009 was also $20.6 million and included no borrowings on our line of creditand $6.4 million in cash and cash equivalents.

 

Thefollowing table summarizes our cash flows for the six months ended September 30,2009 and 2008:

 
| ** **                          | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **September 30,** | ** ** |
| ** **                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In thousands)**     | ** ** |
| **Net cash provided by (used in):** |       |                   |       |   |   |
| Operating  activities               |       | $                      | 3,666      |   | $ | 3,384 |   |
| Investing  activities               |       | (416                   | )          | (486 | ) |
| Financing  activities               |       | (495                   | )          | 452 |   |
|                                     |            |                        |            |  |  |  |  |

 

*OperatingActivities. *Cash providedby our operations for the six months ended September 30, 2009 wasprimarily the result of (i) our net income during the period of $687,000; (ii) $1.2million in non-cash items within the statement of operations, primarilyadjustments to our deferred tax assets and depreciation expense; and (iii) $1.8million in cash resulting from changes in our operating assets and liabilitiesduring the period. Cash provided by operating activities during the six monthsended September 30, 2008 was primarily the result of our net income duringthe period of $1.7 million and adjustments to our deferred tax assets of $1.0million.

 

Our net accounts receivabledecreased approximately $1.9 million from March 31, 2009 to September 30,2009 due in part to our lower overall quarterly net sales and contract revenuesthus far in fiscal 2010 as compared to fiscal 2009 levels. We also experiencedsignificant collections of our outstanding receivables, particularly in thelatter part of the second quarter of fiscal 2010. In 

 

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the future, our accounts receivable couldincrease if, among other factors, customers delay their payments or if we grantextended payment terms to customers, both of which are more likely to occurduring challenging economic times when our customers may face issues gainingsufficient credit on a timely basis.

 

Inventories decreasedapproximately $2.0 million from March 31, 2009 to September 30, 2009as we worked through higher inventory levels on-hand as of March 31, 2009,which partially resulted from the introduction of certain new Roadway Sensorsproducts and the acquisition of certain components that were discontinued bythe manufacturer. We also focused on reducing our inventory purchases duringthis period to reflect the overall reduction in our net sales and the ongoingeconomic slowdown. In the future, our inventory levels are likely to continueto be determined based upon, among other factors, the level of purchase orderswe receive from our customers, the stage at which our products are in theirrespective product life cycles, and competitive situations in the marketplace.We attempt to balance such considerations against risk of obsolescence orpotentially excess inventory levels.

 

*InvestingActivities. *Our investingactivities for the six months ended September 30, 2009 consisted ofpurchases of property and equipment of $116,000 as well as $300,000 used forthe acquisition of Hamilton Signal. Cash used in investing activities for thesix months ended September 30, 2008 consisted entirely of purchases ofproperty and equipment of $486,000.

 

*FinancingActivities. *Net cash usedin financing activities during the six months ended September 30, 2009 wasthe result of net payments on our long-term debt of $585,000, partially offsetby $90,000 in proceeds from the exercise of outstanding stock options topurchase shares of our common stock. During the six months ended September 30,2008, cash provided by financing activities was primarily the result of$684,000 in proceeds from the exercise of outstanding stock options to purchaseshares of our common stock, partially offset by payments on long-term debt of$232,000.

 

*Borrowings*

 

In October 2008, weentered into a $19.5 million credit facility with California Bank &Trust, which provides for a two-year revolving line of credit with borrowingsof up to $12.0 million and a $7.5 million 48-month term note (discussed below).Interest on borrowed amounts under the revolving line of credit are payablemonthly at a rate equal to the current stated prime rate up to the currentstated prime rate plus 0.50%, depending on aggregate deposit balancesmaintained at the bank in relation to the total loan commitment under thecredit facility (3.75% at September 30, 2009). We are obligated to pay anunused line fee of 0.25% per annum applied to the average unused portion of therevolving line of credit during the preceding month. The revolving line ofcredit does not contain any early termination fees and is secured bysubstantially all of our assets. As of September 30, 2009, no amounts wereoutstanding under the revolving line of credit portion of the facility.

 

As of September 30,2009, we had outstanding borrowings of approximately $6.7 million under theterm note. Principal payments under this term note are required to be repaid in48 monthly installments commencing on June 1, 2009. Additionally,beginning on November 1, 2009, and on November 1 of each yearthereafter, we are required to pay additional principal of up to $500,000,calculated based on certain financial measures, as further defined in theagreement. Interest on the term note is payable monthly at a rate equal to thecurrent stated prime rate plus 0.50% up to the current stated prime rate plus1.00% (4.25% at September 30, 2009), depending on aggregate depositbalances maintained at the bank in relation to the total loan commitment underthe credit facility. The term note contains no early termination fees and,along with our revolving line of credit discussed above, is secured bysubstantially all of our assets.

 

In connection with ourcredit facility and loan agreement with California Bank & Trust, we arealso required to comply with certain quarterly financial covenants. Theseinclude achieving certain ratios for working capital and debt service, as wellas maintaining a level of profitability, all of which are further defined inthe agreement. While we believe we are currently in compliance with allfinancial covenants and expect to maintain compliance for the foreseeablefuture, we cannot assure that we will not violate one or more covenants in thefuture. If we were to be in violation of covenants under this agreement, ourlender could choose to accelerate payment on all outstanding loan balances andpursue its security interest in our assets. In this event, we cannot assure youthat we would be able to quickly obtain equivalent or suitable replacementfinancing on acceptable terms, or at all. If we were not able to securealternative sources of financing, such acceleration would have a materialadverse impact on our business and financial condition.

 

**Off Balance Sheet Arrangements**

 

At September 30, 2009, we had outstandingwarrants to purchase an aggregate of 246,250 shares of our common stock atan exercise price of $3.25 per share that are callable by us if the marketprice of our common stock trades for 20 consecutive days at a price equal to orgreater than $6.50 per share. We also had outstanding warrants to purchase anaggregate of 75,000 shares of our common stock at an exercise price of$5.00 per share that are callable by us if the market price of our common stocktrades for 20 consecutive days at a price equal to or greater than $7.50 pershare.

 

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Inconnection with the issuance of warrants to purchase 246,250 shares of ourcommon stock at $3.25 per share (discussed above), we are a party to aregistration rights agreement that contains provisions under which we could besubjected to liquidated damages should we fail to maintain effectiveregistration statements for the shares of common stock issuable upon exerciseof certain underlying warrants. Through March 31, 2009, these warrantswere accounted for within equity in our consolidated balance sheets and,accordingly, no liabilities were recorded in connection therewith. Beginning April 1,2009, as further discussed at Note 6 of Notes to Unaudited CondensedConsolidated Financial Statements included in Part I, Item 1 of thisreport, because these warrants contain a provision for possible futureadjustments to either the exercise price and/or number of shares to be issuedupon exercise, we began recognizing these warrants as liabilities in ourconsolidated balance sheet. As of the date of this filing, no liquidateddamages are payable under the provisions of the registration rights agreementassociated with these warrants.

 

**Seasonality**

 

Wehave historically experienced, and expect to continue to experienceseasonality, particularly with respect to our Roadway Sensors net sales in thethird and fourth fiscal quarters due to a reduction in road construction orrepairs during the winter months in many markets as a result of inclementweather conditions.

 

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

 

Our exposure to interest rate risk is limited to ourline of credit and our new bank term note. Our line of credit bears interestequal to the prevailing prime rate (3.25% at September 30, 2009) plus 0%to 1.0%. We do not believe that a 10% increase in the interest rate on our lineof credit or term note (from 3.25% to 4.68%) would have a material impact onour financial position, operating results or cash flows. In addition, webelieve that the carrying value of our outstanding debt under our creditfacility approximates fair value.

 

**ITEM 4T.  CONTROLS ANDPROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

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

 

**Changesin Internal Controls**

 

During the fiscal quarter covered by this report, there has been nochange in our internal controls over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934) that has materiallyaffected, or is reasonably likely to materially affect, our internal controlsover financial reporting.

 

**InherentLimitations on Internal Control**

 

Acontrol system, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met. Further, the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, no evaluationof controls can provide absolute assurance that all control issues andinstances of management override or improper acts, if any, have been detected.These inherent limitations include the realities that judgments in decisionmaking can be faulty, and that breakdowns can occur because of simple errors.Additionally, controls can be circumvented by the individual acts of somepersons, by collusion of two or more people, or by management override of thecontrol. The design of any system of controls is also based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to management override, error or improperacts may occur and not be detected. Any resulting misstatement or loss may havean adverse and material effect on our business, financial condition and resultsof operations.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

Theinformation set forth under the heading “Litigation and Other Contingencies” inNote 5 of Notes to Unaudited Condensed Consolidated Financial Statements,included in Part I, Item I of this report, is incorporated herein byreference.

 

**ITEM 1A.  RISK FACTORS**

 

*Our business is subject to a numberof risks, some of which are discussed below. Other risks are presentedelsewhere in this report and in the information incorporated by reference intothis report. You should consider the following risks carefully in addition tothe other information contained in this report and our other filings with theSEC, including our annual report on Form 10-K and subsequent reports onForms 10-Q and 8-K, before deciding to buy, sell, or hold our common stock. Therisks and uncertainties described below are not the only ones facing ourcompany. Additional risks and uncertainties not presently known to us or thatwe currently deem immaterial may also affect our business operations. If any ofthese risks actually occurs, our business, financial condition, or results ofoperations could be seriously harmed. In that event, the market price for ourcommon stock could decline and you may lose all or part of your investment.*

 

**The economic slowdown has adversely impacted real estate development,reduced and delayed government funding for transportation infrastructureprojects and initiatives and decreased availability of financial capital forour customers, all of which is adversely impacting our net sales and couldimpact our contract****revenues.******Decreased consumer spending,the failure of certain financial institutions and businesses, concerns aboutthe availability and cost of credit, and reduced corporate profits and capitalspending have resulted in a downturn in worldwide economic conditions, as wellas budgetary shortfalls increasingly present at all levels of government. Theseunfavorable economic conditions are having a negative impact on customer ordersand government funding of infrastructure projects incorporating our productsand services. Such factors have and may continue to result in cancellations andrescheduling of backlog and customer orders. In addition, the recent decline inthe U.S. real estate market, particularly in new home and commercialconstruction, is adversely impacted new road construction and is resulting inand may continue to result in flat or declining Roadway Sensor and VehicleSensor net sales in future periods and could also adversely impactTransportation Systems contract revenues. Any of the foregoing economicconditions make it extremely difficult for our customers, our suppliers and usto accurately forecast and plan future business activities. Additionally, therecontinues to be uncertainties regarding the impact of the federal stimuluspackage and the fact that the accessibility of funds appears to be takinglonger than originally anticipated, along with the expiration and extension ofthe 2005 Federal Highway Bill. If such conditions continue or worsen, ourbusiness, financial condition and results of operations could be materially andadversely affected.

 

**Because we depend on government contracts and subcontracts, we faceadditional risks related to contracting with federal, state and localgovernments, including budgetary issues and fixed price contracts.**A significantportion of our sales are derived from contracts with governmental agencies,either as a general contractor, subcontractor or supplier. Government contractsrepresented approximately 45%, 38% and 38% of our total net sales and contractrevenues for the fiscal years ended March 31, 2009, 2008 and 2007,respectively. We anticipate that revenue from government contracts willcontinue to remain a significant portion of our net sales and contractrevenues. Government business is, in general, subject to special risks andchallenges, including:

 
| · | delays in funding, including delays in the allocation of funds to  state and local agencies from the U.S. federal government as a result of the  expiration of the 2005 Federal Highway Bill, currently scheduled for  October 31, 2009, as well as delays or reductions in stimulus funds  dedicated for transportation projects; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | long purchase cycles or approval processes;                                                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | competitive bidding and qualification requirements;                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | the impact of international conflicts;                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | performance bond requirements;                                                                                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | changes in government policies and political agendas;                                                                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | other government budgetary constraints, cut-backs, delays or  reallocation of government funding;                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | milestone requirements and liquidated damage provisions for failure  to meet contract milestones; and                                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                                    |
| · | international conflicts or other military operations that could cause  the temporary or permanent diversion of government funding from  transportation or other infrastructure projects.                                                                                                                                                |

 

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Governmental budgets andplans are subject to change without warning. Certain risks of selling togovernmental entities include dependence on appropriations and administrativeallocation of funds, changes in governmental procurement legislation andregulations and other policies that may reflect political developments oragendas, significant changes in contract scheduling, intense competition forgovernment business and termination of purchase decisions for the convenienceof the governmental entity. Substantial delays in purchase decisions bygovernmental entities, and the current constraints on government budgets at thefederal, state and local level, could cause our net sales and contract revenuesand income to drop substantially or to fluctuate significantly between fiscalperiods.

 

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 totermination or renegotiation at the convenience of the government, which couldresult in a large decline in our net sales and contract revenues in any given quarter.Our inability to address any of the foregoing concerns or the loss orrenegotiation of any material government contract could seriously harm ourbusiness, financial condition and results of operations.

 

**California state budgetary constraints may have a material adverseimpact on us.**The state of California has experienced, and iscontinuing to experience, a significant budget shortfall and other relatedbudgetary issues and constraints. The state of California has historically beenand is considered to be a key geographic region for our Roadway Sensors andTransportation Systems segments. Ongoing uncertainty as to the timing andaccessibility of federal stimulus monies to the state, changes in state fundingallocations to local agencies and municipalities, or other delays in purchasingfor, or commencement of, transportation projects has and may continue to have anegative impact on our net sales and contract revenues and our income.

 

**Themarkets in which we operate are highly competitive and have many moreestablished competitors, which could adversely affect our sales or the marketacceptance of our products.**We compete with numerous other companies in our targetmarkets including, but not limited to, large, multinational corporations, whichinclude tier-one automotive suppliers, and many smaller regional engineeringfirms. We believe that as a result the expected 2013 European mandate for LDWand other active safety systems, and an overall awareness of the potentialbenefits of LDW, that we will experience an even higher degree of competitionfrom a variety of tier-one OEM suppliers and other potential market entrants,worldwide. We also expect such competition to increase due to technologicaladvancements, industry consolidations and reduced barriers to entry. Increasedcompetition is likely to result in loss of market share, price reductions andreduced gross margins, any of which could seriously harm our business,financial condition and results of operations. For example, a developer of LDWsystems was acquired by a large multinational organization during fiscal 2009.This new competitor has increased its market share and could be more aggressivein both the passenger car and heavy truck markets, as a result of its greateraccess to resources and reputation in the market. Furthermore, awareness of LDWtechnology is increasing and other market players have developed competingtechnologies, which may contain improvements or added features beyond thoseoffered by our LDW systems. Additionally, from time to time, we may be requiredto re-compete for LDW business from our main customer base of heavy truck OEMs. TheseOEMs could make a supplier change based on price, product performance oravailable features. Should our competition be successful, this could adverselyaffect our ability to successfully market and sell our LDW systems to new andexisting customers.

 

We generally compete with existing, well-established companies in ourRoadway Sensors segment, both domestically and aboard. Certain technological barriersto entry make it difficult for new competitors to enter the market withcompeting video or other technologies; however, we are aware of new marketentrants from time to time. Increased competition could result in loss ofmarket share, price reductions and reduced gross margins, any of which couldseriously harm our business, financial condition and results of operations. Inthe fiscal year ended March 31, 2007, we began to experience morecompetition in our Roadway Sensors segment as the Department of Transportationin one of our largest sales territories moved to a multi-source contractingenvironment from one in which we were the sole supplier.

 

Manyof our competitors have far greater name recognition and greater financial,technological, marketing, and customer service resources than we do. This mayallow them to respond more quickly to new or emerging technologies and changesin customer requirements. It may also allow them to devote greater resources tothe development, promotion, sale and support of their products than we can.Recent consolidations of end users, distributors and manufacturers in ourtarget markets have exacerbated this problem. As a result of the foregoingfactors, we may not be able to compete effectively in our target markets andcompetitive pressures could adversely affect our business, financial conditionand results of operations.

 

**We may experience production gaps that could materially andadversely impact our sales and financial results and the ultimate acceptance ofour products.**It is possible that we could experience unforeseenquality control issues or part shortages as we adjust production to meetcurrent demand for our products. We have historically used single suppliers forcertain significant 

 

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components in our products. Should any suchdelay or disruption occur, or should a key supplier discontinue operationsbecause of the current economic climate, our future sales will likely bematerially and adversely affected. Additionally, we rely heavily on selectcontract manufacturers to produce many of our products and do not have anylong-term contracts to guarantee supply of such products. Although we believeour contract manufacturers have sufficient capacity to meet our productionschedules for the foreseeable future and we believe we could find alternativecontract manufacturing sources for many of our products, if necessary, we couldexperience a production gap if for any reason our contract manufacturers wereunable to meet our production requirements and our cost of goods sold couldincrease, adversely affecting our margins.

 

**We may be unable toattract and retain key personnel, which could seriously harm our business.**Due to thespecialized nature of our business, we are highly dependent on the continuedservice of our executive officers and other key management, engineering andtechnical personnel. The loss of Abbas Mohaddes, our Chief Executive Officer,or any of the other executive officers or key members of management couldadversely affect our business, financial condition, or results of operations.Our success will also depend in large part upon our ability to continue toattract, retain and motivate qualified engineering and other highly skilledtechnical personnel. In particular, the future success of our TransportationSystems segment will depend on our ability to hire additional qualifiedengineers and planners. Competition for qualified employees, particularlydevelopment engineers, is intense. We may not be able to continue to attractand retain sufficient numbers of such highly skilled employees. Our inabilityto attract and retain additional key employees or the loss of one or more ofour current key employees could adversely affect our business, financialcondition and results of operations.

 

**If we are unable to develop and introduce new products and productenhancements successfully and in a cost-effective and timely manner, or areunable to achieve market acceptance of our new products, our operating resultswould be adversely affected.**We believe our revenuegrowth and future operating results will depend on our ability to completedevelopment of new products and enhancements, introduce these products in atimely, cost-effective manner, achieve broad market acceptance of theseproducts and enhancements, and reduce our production 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 that we will be able to adequately manageproduct transition issues. Our business and results of operations could beadversely affected if we do not anticipate or respond adequately totechnological developments or changing customer requirements or if we cannotadequately manage inventory issues typically related to new product transitionsand introductions. We cannot assure you that any such investments in researchand development will lead to any corresponding increase in revenue.

 

Market acceptance of our new products 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 our independentdistributors and strategic partners, including Valeo’s ability to expand salesof LDW systems in the passenger car market. The success of our LDW system willalso depend in part on the success of the automotive vehicles that incorporateour technology, as well as the success of optional equipment that OEMs bundlewith our technologies.

 

Certain of the components used in our products mayneed to be re-engineered in the next 12 to 36 months as the industry is movingtowards a standard of using lead-free components. We cannot assure you as tothe timing of the adoption of this new standard or our ability to successfullyredesign our products to incorporate compliant components and gain marketacceptance of such redesigned products. In addition, if the standard is adoptedearlier than anticipated, we may experience a shortage of products as a resultof potential scarcity of lead-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.

 

**New environmental regulationsmay result in a decline in our Vehicle Sensors net sales.**From time to time, environmental regulations are enacted, which cansignificantly increase the cost of manufacturing new vehicles as well as thecost of maintenance of existing vehicles and truck fleets.  As a result, we could experience a decline insales of our Vehicle Sensors products as truck and vehiclemanufacturers and fleet operators attempt to control their costs.

 

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**We may engage inacquisitions of companies or technologies that may require us to undertakesignificant capital infusions and could result in disruptions of our businessand diversion of resources and management attention.**We have in thepast acquired, and may in the future acquire, complementary businesses,products, and technologies. Acquisitions may require significant capital infusionsand, in general, acquisitions also involve a number of special risks,including:

 
| · | potential disruption of  our ongoing business and the diversion of our resources and management’s  attention;                                                            |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                          |
| · | the failure to retain or integrate key acquired personnel;                                                                                                                    |
|   |                                                                                                                                                                          |
| · | the challenge of assimilating diverse business cultures, and the  difficulties in integrating the operations, technologies and information  system of the acquired companies; |
|   |                                                                                                                                                                          |
| · | increased costs to improve managerial, operational, financial and  administrative systems and to eliminate duplicative services;                                              |
|   |                                                                                                                                                                          |
| · | the incurrence of unforeseen obligations or liabilities;                                                                                                                      |
|   |                                                                                                                                                                          |
| · | potential impairment of relationships with employees or customers as  a result of changes in management; and                                                                  |
|   |                                                                                                                                                                          |
| · | increased interest 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.

 

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**We depend upon Valeo to market our LDW technologies for the OEMpassenger car market.**We have granted Valeo the exclusive right tosell and manufacture our LDW system to the worldwide passenger car market inexchange for royalty payments for each LDW unit sold. As such, the futuresuccess and broad market acceptance of our technologies in the passenger carmarket will depend upon Valeo’s ability to manufacture, market and sell ourtechnologies, and to convince more OEM passenger car manufacturers to adopt ourtechnologies. To date, we have not generated significant royalties from Valeo’sefforts and have only been designed into one car OEM product line. If Valeodoes not devote considerable resources and aggressively pursue opportunities,our expansion into the passenger car market, and our related revenues fromcontract engineering services and royalty revenues could be adversely affectedor not materialize as originally anticipated.

 

**If we do not keep pace with rapid technological changes and evolvingindustry standards, we will not be able to remain competitive and there will beno demand for our products.**Our markets are in generalcharacterized by the following factors:

 
| · | rapid technological advances;                                                 |
|--------|-------------------------------------------------------------------------------|
|   |                                                                          |
| · | downward price pressure in the marketplace as technologies mature;            |
|   |                                                                          |
| · | changes in customer requirements;                                             |
|   |                                                                          |
| · | additional qualification requirements related to new products or  components; |
|   |                                                                          |
| · | frequent new product introductions and enhancements;                          |
|   |                                                                          |
| · | inventory issues related to transition to new or enhanced models; and         |
|   |                                                                          |
| · | evolving industry standards and changes in the regulatory  environment.       |

 

Our future success will depend upon our ability toanticipate and adapt to changes in technology and industry standards, and toeffectively develop, introduce, market and gain broad acceptance of newproducts and product enhancements incorporating the latest technologicaladvancements. In particular, our LDW systems are 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.

 

**Our international businessoperations may be threatened by many factors that are outside of ourcontrol.**We currently market our products internationally andwe anticipate that our international operations may expand in the near future.International business operations are subject to various inherent risksincluding, among others:

 
| · | currency fluctuations and restrictions;                                                                                   |
|--------|---------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                      |
| · | political, social and economic instability;                                                                               |
|   |                                                                                                                      |
| · | longer accounts receivable payment cycles;                                                                                |
|   |                                                                                                                      |
| · | import and export license requirements and restrictions of the United  States and each other country in which we operate; |
|   |                                                                                                                      |
| · | unexpected changes in regulatory requirements, tariffs and other  trade barriers or restrictions;                         |
|   |                                                                                                                      |
| · | the burdens of compliance with a wide variety of foreign laws and  more restrictive labor laws and obligations;           |
|   |                                                                                                                      |
| · | difficulties in managing and staffing international operations;                                                           |
|   |                                                                                                                      |
| · | potentially adverse tax consequences; and                                                                                 |
|   |                                                                                                                      |
| · | reduced protection for intellectual property rights in some  countries.                                                   |

 

All of our international sales are denominated inU.S. dollars. As a result, an increase in the relative value of the dollarcould make our products more expensive and potentially less price competitivein international markets. We do not engage in any transactions as a hedgeagainst risks of loss due to foreign currency fluctuations.

 

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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.

 

**If ourinternal controls over financial reporting do not comply with the requirementsof the Sarbanes-Oxley Act, our business and stock price could be adverselyaffected.**Section 404 of the Sarbanes-Oxley Act of 2002currently requires us to evaluate the effectiveness of our internal controlsover financial reporting at the end of each fiscal year and to include amanagement report assessing the effectiveness of our internal controls overfinancial reporting in all annual reports. Beginning in our fiscal year ending March 31,2011, our independent registered public accounting firm will also be requiredto attest to, and report on, the effectiveness of our internal controls overfinancial reporting. We may not be able to complete the work required for suchattestation on a timely basis, and even if we timely complete suchrequirements, our independent registered public accounting firm may stillconclude that our internal controls over financial reporting are not effective.

 

Our management, including our CEO and CFO, does notexpect that our internal controls over financial reporting will prevent 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 provide absoluteassurance that all control issues and instances of fraud, if any, within Iterishave been or will be detected. These inherent limitations include the realitiesthat judgments in decision-making can be faulty and that breakdowns can occurbecause of simple errors or mistakes. Controls can also be circumvented by theindividual acts of some persons, by collusion of two or more people, or bymanagement override of the controls. The design of any system of controls isbased in part on certain assumptions about the likelihood of future events, andwe cannot assure you that any design will succeed in achieving its stated goalsunder all potential future conditions. Over time, our controls may becomeinadequate because of changes in conditions or deterioration in the degree ofcompliance with policies or procedures. Because of the inherent limitations ina cost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**We may need to raiseadditional capital in the future, which may not be available on termsacceptable to us, or at all. **Until recently,we have historically generated significant net losses and operating losses, andhave experienced volatility in our cash flows from operations from year toyear. Although we entered into a $19.5 million credit facility, effective October 2008,should we have an event of default, which includes, among other things, afailure to meet certain financial covenants and a material adverse change inthe business, the bank could choose to limit or take away our ability to borrowthese or any funds.  Should this occur,or if the credit markets further tighten, we may need or choose to raiseadditional capital to pursue acquisitions or to expand our operations.

 

At September 30,2009, we had $9.2 million of cash and cash equivalents and our entire $12.0million line of credit to fund our operations. We may need to raise additionalcapital in the near future to fund our operations or to repay indebtedness.Such additional capital may be raised through bank borrowings, or other debt orequity financings. We cannot assure you that any additional capital will beavailable on a timely basis, on acceptable terms, or at all, and suchadditional financing may result in further dilution to our stockholders.

 

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

 
| · | market acceptance of our products and product enhancements, and the  overall level of sales of our products;                |
|--------|-----------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                        |
| · | our ability to control costs;                                                                                               |
|   |                                                                                                                        |
| · | the supply of key components for our products;                                                                              |
|   |                                                                                                                        |
| · | our ability to increase revenue and net income;                                                                             |
|   |                                                                                                                        |
| · | increased research and development expenses and sales and marketing  expenses;                                              |
|   |                                                                                                                        |
| · | our need to respond to technological advancements and our  competitors’ introductions of new products or technologies; |
|   |                                                                                                                        |
| · | capital improvements to new and existing facilities and enhancements  to our infrastructure and systems;                    |
|   |                                                                                                                        |
| · | potential acquisitions of businesses and product lines;                                                                     |
|   |                                                                                                                        |
| · | our relationships with customers and suppliers;                                                                             |

 

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·                                          government budgets,political agendas and other funding issues, including potential delays ingovernment contract awards;

 

·                                          our ability to successfullynegotiate credit arrangements with our bank and repay our subordinatedconvertible debentures; and

 

·                                          general economic conditions,including the effects of the current economic slowdown and internationalconflicts.

 

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

 

**Our quarterly operating results fluctuate as a result of many factors.Therefore, we may fail to meet or exceed the expectations of securitiesanalysts and investors, which could cause our stock price to decline.**Our quarterlyrevenues and operating results have fluctuated and are likely to continue tovary from quarter to quarter due to a number of factors, many of which are notwithin our control. Factors that could affect our revenues include, amongothers, the following:

 

·                                          delays in governmentcontracts and funding from time to time and budgetary constraints at thefederal, state and local levels, including stimulus and other funding;

 

·                                          declines in new home andcommercial real estate construction and related road and other infrastructureconstruction;

 

·                                          changes in our pricingpolicies and the pricing policies of our suppliers and competitors, pricingconcessions on volume sales, as well as increased price competition in general;

 

·                                          the long lead timesassociated with government contracts or required by vehicle manufacturers;

 

·                                          the size, timing, reschedulingor cancellation of significant customer orders;

 

·                                          our ability to controlcosts;

 

·                                          our ability to raiseadditional capital;

 

·                                          the mix of our products andservices sold in a quarter, which mix has varied and is expected to continue tovary from time to time;

 

·                                          seasonality due to winterweather conditions;

 

·                                          international conflicts andacts of terrorism;

 

·                                          our ability to develop,introduce, patent, market and gain market acceptance of new products,applications and product enhancements in a timely manner, or at all;

 

·                                          market acceptance of theproducts incorporating our technologies and products;

 

·                                          the introduction of newproducts by competitors;

 

·                                          the availability and cost ofcomponents used in the manufacture of our products;

 

·                                          our success in expanding andimplementing our sales and marketing programs;

 

·                                          the effects of technologicalchanges in our target markets;

 

·                                          the amount of our backlog atany given time;

 

·                                          the nature of our governmentcontracts;

 

·                                          deferrals of customer ordersin anticipation of new products, applications or product enhancements;

 

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·                                          risks and uncertaintiesassociated with our international business;

 

·                                          currency fluctuations andour ability to get currency out of certain foreign countries; and

 

·                                          general economic andpolitical conditions.

 

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

 

**We haveexperienced growth in recent years. If we fail to manage our growtheffectively, we may be unable to execute our business plan andmay experience future weaknesses in our internal controls.**We have expanded our overall business inthe past few years. In order to achieve our business objectives, we will needto continue to expand our business and add additional qualified personnel. Suchexpansion has placed and is expected to continue to place, a significant strainon our managerial, administrative, operational, financial and other resources.If we are unable to successfully manage our growth, our business, financialcondition and results of operations will be adversely affected.

 

**We may not be able toadequately protect or enforce our intellectual property rights, which couldharm our competitive position.**If we are not able toadequately protect or enforce the proprietary aspects of our technology,competitors could be able to access our proprietary technology and ourbusiness, financial condition and results of operations will likely beseriously harmed. We currently attempt to protect our technology through acombination of patent, copyright, trademark and trade secret laws, employee andthird party nondisclosure agreements and similar means. Despite our efforts,other parties may attempt to disclose, obtain or use our technologies orsystems. Our competitors may also be able to independently develop productsthat are substantially equivalent or superior to our products or design aroundour patents. In addition, the laws of some foreign countries do not protect ourproprietary rights as fully as do the laws of the United States. As a result,we may not be able to protect our proprietary rights adequately in the UnitedStates or abroad.

 

Litigationmay be necessary in the future to enforce our intellectual property rights orto determine 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 cease marketingor using certain products or technologies. We may not be able to obtain anylicenses on terms acceptable to us, or at all. We also may have to indemnifycertain customers or strategic partners if it is determined that we haveinfringed upon or misappropriated another party’s intellectual property. Any ofthese results could adversely affect our business, financial condition andresults 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.

 

**We havehistorically experienced substantial losses and may experience losses inthe future.**Although we have achieved net income in our pastfour fiscal years, we experienced a net loss of $11.3 million in the year endedMarch 31, 2005 and significant net losses in prior years. 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 experience operating losses and net losses in the future,which would make it difficult to fund our operations and achieve our businessplan, and could cause the market price of our common stock to decline.

 

**The trading price of our common stock is highly volatile.**The tradingprice of our common stock has been subject to wide fluctuations in the past.Since January 2001, our Class A common stock (now known as our commonstock) has traded at prices as low as $0.45 per share and as high as $8.00 pershare. The market price of our common stock could continue to fluctuate in thefuture in response to various factors, including, but not limited to:

 

·                                          quarterly variations inoperating results;

 

·                                          our ability to controlcosts, improve cash flow and sustain profitability;

 

·                                          our ability to raiseadditional capital;

 

·                                          shortages announced bysuppliers;

 

·                                          announcements oftechnological innovations or new products or applications by our competitors,customers or us;

 

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·                                          transitions to new productsor product enhancements;

 

·                                          acquisitions of businesses,products or technologies;

 

·                                          the impact of anylitigation;

 

·                                          changes in investorperceptions;

 

·                                          government funding,political agendas and other budgetary constraints;

 

·                                          changes in earningsestimates or investment recommendations by securities analysts; and

 

·                                          international conflicts,political unrest and acts of terrorism.

 

The stock market in general has from time to timeexperienced volatility, which has often 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.

 

**We could experience negative financial impacts arising fromdevelopments in contingencies created under our previous structure or by formersubsidiaries.**Although we divested ourselves of all business unitsprior to October 2004, from time to time we could experience unforeseendevelopments in contingencies related to our former subsidiaries. For example,in July 2006 we entered into a settlement agreement in connection with alawsuit brought against Mariner Networks, Inc., one of our formersubsidiaries, by one of Mariner’s suppliers, pursuant to which we issued 88,912shares of our common stock to this supplier (valued at $213,000 as of the dateof issuance) and paid $475,000 in cash. Although we are not aware of any othermaterial contingencies, it is possible other matters could be brought againstus in connection with activities related to former subsidiaries and that suchmatters could materially and adversely affect our financial results and cashflows.

 

**Certain provisions of theCompany’s charter documents may discourage a third party from acquiring usand may adversely affect the price of our common stock.**Certainprovisions of our certificate of incorporation could make it difficult for athird party to acquire us, even though an acquisition might be beneficial toour stockholders. Such provisions could limit the price that investors might bewilling to pay in the future for shares of our common stock. Under the terms ofour certificate of incorporation, our Board of Directors is authorized toissue, without stockholder approval, up to 2,000,000 shares of preferred stockwith voting, conversion and other rights and preferences superior to those ofour common stock. In addition, in August 2009, we adopted a stockholderrights plan and declared a dividend of preferred stock purchase rights to ourstockholders.  Generally, the stockholderrights plan provides that if a person or group acquires 15% or more of ourcommon stock, subject to certain exceptions and under certain circumstances,the rights may be exchanged by us for common stock or the holders of therights, other than the acquiring person or group, could acquire additionalshares of our capital stock at a discount off of the then current marketprice.  Such exchanges or exercise ofrights could cause substantial dilution to a particular acquirer and discouragethe acquirer from pursuing our company. The mere existence of a stockholderrights plan often delays or makes a merger, tender offer or proxy contest moredifficult.

 

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

 

None.

 

**ITEM 3.  DEFAULTS UPON SENIORSECURITIES**

 

None.

 

**ITEM 4.  SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

Inconnection with our Annual Meeting of Stockholders held on September 18,2009, the following proxies were tabulated representing 23,675,074 shares ofour common stock, or 69.1% of the outstanding shares as of the record date forthe meeting:

 

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**ProposalI: Election of the Board of Directors**

** **
| **Director Nominee**  | ** ** | **Total Votes for Each Director** | ** ** | **Total Votes Withheld   from Each Director** | ** ** |
|-----------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|
| Richard  J. Char      |       | 22,575,356                        |       | 1,099,718                                     |       |
| Kevin  C. Daly, Ph.D. |       | 22,380,759                        |       | 1,294,315                                     |       |
| Gregory  A. Miner     |       | 22,371,144                        |       | 1,303,930                                     |       |
| Abbas  Mohaddes       |       | 22,567,287                        |       | 1,107,787                                     |       |
| John  W. Seazholtz    |       | 22,475,220                        |       | 1,199,854                                     |       |
| Joel  Slutzky         |       | 20,420,415                        |       | 3,254,659                                     |       |
| Thomas  L. Thomas     |       | 22,417,314                        |       | 1,257,760                                     |       |

 

**ProposalII: Approval of an amendment to the 2007 Omnibus Incentive Plan to increase thenumber of shares of common stock authorized under the plan by an additional800,000 shares, to 1,650,000 shares**

** **
| ** ** | ** ** | **Shares of Common Stock** | ** ** |
|------------|------------|----------------------------|------------|
| For        |       | 11,575,269                 |       |
| Against    |       | 962,285                    |       |
| Abstain    |       | 81,824                     |       |
| Non-votes  |       | 10,873,696                 |       |

 

**ProposalIII: Ratification of McGladrey & Pullen, LLP as the independentauditors of Iteris for the fiscal year ending March 31, 2010**

** **
| ** ** | ** ** | **Shares of Common Stock** | ** ** |
|------------|------------|----------------------------|------------|
| For        |       | 23,461,419                 |       |
| Against    |       | 58,113                     |       |
| Abstain    |       | 155,542                    |       |
| Non-votes  |       | —                     |       |

 

**ITEM 5.  OTHER INFORMATION**

 

One of our executiveofficers, James S. Miele, has entered into a trading plan pursuant to Rule 10b5-1(c)(1) ofthe Securities Exchange Act of 1934, as amended, which covers an aggregate of40,000 shares of our common stock to be sold at prices ranging from   $2.60 to $3.10. The option shares are set toexpire on September 26, 2011.

 

**ITEM 6.  EXHIBITS**

 

The following exhibits are filed herewith or areincorporated by reference to the location indicated.

 
| **Exhibit  Number** | ** ** | **Description**                                                                                            | ** ** | **Where Located**                                                                                                                                                         |
|---------------------|------------|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Restated Certificate of  Incorporation of the registrant                                                   | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                   | * *   | * *                                                                                                                                                                       |
| 3.2                 |       | Certificate of  Designations of Series A Junior Participating Preferred Stock                         | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                   | * *   | * *                                                                                                                                                                       |
| 3.3                 |       | Bylaws of registrant, as  amended                                                                          | * *   | *Exhibit 4.2  to the registrant’s Registration Statement on Form S-1 (Reg.  No. 033-67932) as filed with the SEC on July 6, 1993*                     |
| * *            | * *   | * *                                                                                                   | * *   | * *                                                                                                                                                                       |
| 3.4                 |       | Certificates  of Amendment to Bylaws of the registrant dated April 24, 1998 and  August 10, 2001 | * *   | *Exhibit 3.4  to the registrant’s Annual Report on Form 10-K/A for the year ended  March 31, 2003 as filed with the SEC on July 29, 2003*             |
| * *            | * *   | * *                                                                                                   | * *   | * *                                                                                                                                                                       |
| 3.5                 |       | Certificate  of Amendment to Bylaws of registrant dated September 9, 2004                             | * *   | *Exhibit 3.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2004 as filed with the SEC on November 15, 2004* |
|                |       |                                                                                                       |       |                                                                                                                                                                           |
| 3.6                 |       | Certificate  of Amendment to Bylaws of registrant dated September 16, 2005                            | * *   | *Exhibit 3.5  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2007 as filed with the SEC on June 21, 2007*               |

 

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| 3.7      |     | Certificate  of Amendment to Bylaws of registrant dated December 7, 2007                                                                 | * * | *Exhibit 3.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  December 13, 2007*                                            |
|----------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |     |                                                                                                                                          |     |                                                                                                                                                                     |
| 3.8      |     | Certificate  of Amendment to Bylaws of registrant, effective August 20, 2009                                                             | * * | *Exhibit 3.3  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                              |
|     |     |                                                                                                                                          |     |                                                                                                                                                                     |
| 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      |     | Rights  Agreement dated August 20, 2009 between the registrant and Computershare  Trust Company, N.A., including exhibits thereto        | * * | *Exhibit 4.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                              |
|     |     |                                                                                                                                          |     |                                                                                                                                                                     |
| 10.1     |     | Unsecured  Promissory Note dated August 10, 2009 executed by MAXxess  Systems, Inc.                                                 | * * | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2009 as filed with the SEC on August 11, 2009* |
|     |     |                                                                                                                                          |     |                                                                                                                                                                     |
| 31.1     |     | Certification  of the Principal Executive Officer, as required pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                | * * | *Filed  herewith*                                                                                                                                                        |
| * * | * * | * *                                                                                                                                      | * * | * *                                                                                                                                                                 |
| 31.2     |     | Certification  of the Principal Financial and Accounting Officer, as required pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 | * * | *Filed  herewith*                                                                                                                                                        |
| * * | * * | * *                                                                                                                                      | * * | * *                                                                                                                                                                 |
| 32.1     |     | Certification  of the Chief Executive Officer, as required pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                    | * * | *Filed  herewith*                                                                                                                                                        |
| * * | * * | * *                                                                                                                                      | * * | * *                                                                                                                                                                 |
| 32.2     |     | Certification  of the Chief Financial Officer, as required pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                    | * * | *Filed  herewith*                                                                                                                                                        |

 

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**SIGNATURES**

 

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

 
| Dated:  October 30, 2009 | 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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** **

**Exhibit Index**

** **
| **Exhibit  Number** | ** ** | **Description**                                                                                                                               | ** ** | **Where Located**                                                                                                                                                         |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Restated Certificate of  Incorporation of the registrant                                                                                      | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 3.2                 |       | Certificate of  Designations of Series A Junior Participating Preferred Stock                                                            | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 3.3                 |       | Bylaws of registrant, as  amended                                                                                                             | * *   | *Exhibit 4.2  to the registrant’s Registration Statement on Form S-1 (Reg.  No. 033-67932) as filed with the SEC on July 6, 1993*                     |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 3.4                 |       | Certificates  of Amendment to Bylaws of the registrant dated April 24, 1998 and  August 10, 2001                                    | * *   | *Exhibit 3.4  to the registrant’s Annual Report on Form 10-K/A for the year ended  March 31, 2003 as filed with the SEC on July 29, 2003*             |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 3.5                 |       | Certificate  of Amendment to Bylaws of registrant dated September 9, 2004                                                                | * *   | *Exhibit 3.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2004 as filed with the SEC on November 15, 2004* |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 3.6                 |       | Certificate  of Amendment to Bylaws of registrant dated September 16, 2005                                                               | * *   | *Exhibit 3.5  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2007 as filed with the SEC on June 21, 2007*               |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 3.7                 |       | Certificate  of Amendment to Bylaws of registrant dated December 7, 2007                                                                 | * *   | *Exhibit 3.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  December 13, 2007*                                                  |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 3.8                 |       | Certificate  of Amendment to Bylaws of registrant, effective August 20, 2009                                                             | * *   | *Exhibit 3.3  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                                    |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 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                 |       | Rights  Agreement dated August 20, 2009 between the registrant and Computershare  Trust Company, N.A., including exhibits thereto        | * *   | *Exhibit 4.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                                    |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 10.1                |       | Unsecured  Promissory Note dated August 10, 2009 executed by MAXxess  Systems, Inc.                                                 | * *   | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2009 as filed with the SEC on August 11, 2009*       |
|                |       |                                                                                                                                          |       |                                                                                                                                                                           |
| 31.1                |       | Certification  of the Principal Executive Officer, as required pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 31.2                |       | Certification  of the Principal Financial and Accounting Officer, as required pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 32.1                |       | Certification  of the Chief Executive Officer, as required pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                    | * *   | *Filed  herewith*                                                                                                                                                              |
| * *            | * *   | * *                                                                                                                                      | * *   | * *                                                                                                                                                                       |
| 32.2                |       | Certification  of the Chief Financial Officer, as required pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                    | * *   | *Filed  herewith*                                                                                                                                                              |

 

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