Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

 

**(Mark****One)**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
|------------|------------|----------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                     |
| ** ** | ** ** | **For the quarterly period ended  September 30, 2008**                                              |
|       |       |                                                                                                     |
| ** ** | ** ** | **OR**                                                                                                   |
|       |       |                                                                                                     |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom    to**

** **

**Commission file number:  001-08762**

** **

**ITERIS, INC.**

(Exactname of registrant as specified in its charter)

 

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

 

**(949)**270-9400

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

 

 

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

 

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

** **

**Yes **x  No o

** **

**Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, a non-accelerated filer, ora smaller reporting company. See definitions of “large accelerated filer,” “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****(Do not check if a smaller reporting  company)** | ** ** | **Smaller reporting company ****x** |

 

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

** **

**Yes **o No x

** **

As of October 29,2008, the registrant had 34,172,650 shares of common stock outstanding.

 

 

 

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**ITERIS, INC.**

**Quarterly Reporton Form 10-QFor the Three and Six Months Ended September 30, 2008**

** **

**Table of Contents**

** **
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                      | **3**      |
|-------------------|--------------------------------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                                           |       |
| **ITEM 1.**       | **FINANCIAL STATEMENTS**                                                                                                       | **3**      |
|              |                                                                                                                           |       |
| ** **        | **CONDENSED CONSOLIDATED  BALANCE SHEETS AT SEPTEMBER 30, 2008 AND MARCH 31, 2008**                                       | **3**      |
| ** **        | ** **                                                                                                                     | ** ** |
| ** **        | **UNAUDITED CONDENSED  CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED  SEPTEMBER 30, 2008 AND 2007** | **4**      |
|              |                                                                                                                           |       |
| ** **        | **UNAUDITED  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED  SEPTEMBER 30, 2008 AND 2007**           | **5**      |
|              |                                                                                                                           |       |
| ** **        | **NOTES TO  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**                                                            | **6**      |
|              |                                                                                                                           |       |
| **ITEM 2.**       | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                | **15**     |
|              |                                                                                                                           |       |
| **ITEM 3.**       | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                | **21**     |
|              |                                                                                                                           |       |
| **ITEM 4T.**      | **CONTROLS AND  PROCEDURES**                                                                                                   | **21**     |
|              |                                                                                                                           |       |
| **PART II.** | **OTHER INFORMATION**                                                                                                          | **23**     |
|              |                                                                                                                           |       |
| **ITEM 1.**       | **LEGAL PROCEEDINGS**                                                                                                          | **23**     |
|              |                                                                                                                           |       |
| **ITEM 1A.**      | **RISK FACTORS**                                                                                                               | **23**     |
| ** **        | ** **                                                                                                                     | ** ** |
| **ITEM 2.**       | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                               | **31**     |
|              |                                                                                                                           |       |
| **ITEM 3.**       | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                           | **31**     |
|              |                                                                                                                           |       |
| **ITEM 4.**       | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                       | **31**     |
|              |                                                                                                                           |       |
| **ITEM 5.**       | **OTHER INFORMATION**                                                                                                          | **32**     |
|              |                                                                                                                           |       |
| **ITEM 6.**       | **EXHIBITS**                                                                                                                   | **32**     |

 

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

 

AutoVue®, Iteris®, Vantage®, eAccessTM, VersiCamTM and EdgeConnectTM are amongthe trademarks of Iteris, Inc. Any other trademarks or trade namesmentioned herein are the property of their respective owners.

 

2

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**PART I. FINANCIALINFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

** **

**ITERIS,INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                  | ** ** | **September 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **(unaudited)**              | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                                                  |       |                         |       |                     |       |
| Current assets:                                                                                                                                                             |       |                         |       |                     |       |
| Cash and cash equivalents                                                                                                                                                   | ** ** | **$**                        | **3,771**  |                     | $          | 421 |   |
| Trade accounts receivable, net of allowance  for doubtful accounts of $747 and $1,020 at September 30, 2008 and  March 31, 2008, respectively                     | ** ** | **14,634**                   |       | 13,108                   |       |
| Costs and estimated earnings in excess of  billings on uncompleted contracts                                                                                                | ** ** | **4,304**                    |       | 5,351                    |       |
| Inventories, net of reserve for inventory  obsolescence of $915 and $819 at September 30, 2008 and March 31,  2008, respectively                                  | ** ** | **4,594**                    |       | 4,226                    |       |
| Deferred income taxes                                                                                                                                                       | ** ** | **1,514**                    |       | 2,541                    |       |
| Prepaid expenses and other current assets                                                                                                                                   | ** ** | **425**                      |       | 371                      |       |
| Total current assets                                                                                                                                                        | ** ** | **29,242**                   |       | 26,018                   |       |
| Property and equipment, net                                                                                                                                                 | ** ** | **3,455**                    |       | 3,467                    |       |
| Deferred income taxes                                                                                                                                                       | ** ** | **7,807**                    |       | 7,807                    |       |
| Intangible assets, net                                                                                                                                                      | ** ** | **184**                      |       | 257                      |       |
| Goodwill                                                                                                                                                                    | ** ** | **27,774**                   |       | 27,774                   |       |
| Other assets                                                                                                                                                                | ** ** | **269**                      |       | 322                      |       |
| Total assets                                                                                                                                                                | ** ** | **$**                        | **68,731** |                     | $          | 65,645 |   |
|                                                                                                                                                                        |       |                         |       |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                              | ** ** | ** **                   | ** ** | ** **               | ** ** |
| Current liabilities:                                                                                                                                                        |       |                         |       |                     |       |
| Trade accounts payable                                                                                                                                                      | ** ** | **$**                        | **4,487**  |                     | $          | 3,902 |   |
| Accrued payroll and related expenses                                                                                                                                        | ** ** | **3,462**                    |       | 3,825                    |       |
| Accrued liabilities                                                                                                                                                         | ** ** | **2,263**                    |       | 1,973                    |       |
| Billings in excess of costs and estimated  earnings on uncompleted contracts                                                                                                | ** ** | **1,368**                    |       | 1,126                    |       |
| Current portion of long-term debt                                                                                                                                           | ** ** | **2,974**                    |       | 244                      |       |
| Total current liabilities                                                                                                                                                   | ** ** | **14,554**                   |       | 11,070                   |       |
| Deferred rent                                                                                                                                                               | ** ** | **1,830**                    |       | 1,956                    |       |
| Unrecognized tax benefits                                                                                                                                                   | ** ** | **1,379**                    |       | 1,381                    |       |
| Other non-current liabilities                                                                                                                                               | ** ** | **67**                       |       | 461                      |       |
| Long-term debt                                                                                                                                                              | ** ** | **4,686**                    |       | 7,566                    |       |
| Total liabilities                                                                                                                                                           | ** ** | **22,516**                   |       | 22,434                   |       |
| Commitments and contingencies                                                                                                                                               |       |                         |       |                     |       |
| Stockholders’ equity:                                                                                                                                                  |       |                         |       |                     |       |
| Preferred stock, $1.00 par value, 2,000  shares authorized, none issued and outstanding at September 30, 2008 and  March 31, 2008                                 |       | —                       |       | —                   |       |
| Common stock, $0.10 par value, 70,000  shares authorized, 34,012 and 33,420 shares issued and outstanding at  September 30, 2008 and March 31, 2008, respectively | ** ** | **3,401**                    |       | 3,342                    |       |
| Additional paid-in capital                                                                                                                                                  | ** ** | **136,585**                  |       | 135,516                  |       |
| Common stock held in trust, 24 and 167  shares at September 30, 2008 and March 31, 2008, respectively                                                             | ** ** | **(31**                      | **)**      | (202                     | )          |
| Accumulated deficit                                                                                                                                                         | ** ** | **(93,766**                  | **)**      | (95,499                  | )          |
| Accumulated other comprehensive income                                                                                                                                      | ** ** | **26**                       | ** ** | 54                       |       |
| Total stockholders’ equity                                                                                                                                             | ** ** | **46,215**                   | ** ** | 43,211                   |       |
| Total liabilities and stockholders’ equity                                                                                                                             | ** ** | **$**                        | **68,731** |                     | $          | 65,645 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

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**ITERIS, INC.**

**UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales and contract revenues:          |       |                                                 |       |                                               | ** ** |   | ** ** |   |   |
| Net sales                                 | ** ** | **$**                                                | **11,078** | ** **                                         | $          | 10,795 |   | **$** | **21,604** | ** ** | $ | 21,039 |   |
| Contract revenues                         | ** ** | **7,988**                                            | ** ** | 6,181                                              |       | **14,904** | ** ** | 11,694 |   |
| Total net sales and contract revenues     | ** ** | **19,066**                                           | ** ** | 16,976                                             |       | **36,508** | ** ** | 32,733 |   |
|                                      |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Costs of net sales and contract revenues: |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Cost of net sales(a)                      | ** ** | **5,886**                                            | ** ** | 5,496                                              |       | **11,153** | ** ** | 10,671 |   |
| Cost of contract revenues(a)              | ** ** | **5,305**                                            | ** ** | 4,218                                              |       | **9,728** | ** ** | 7,706 |   |
| Gross profit                              | ** ** | **7,875**                                            | ** ** | 7,262                                              |       | **15,627** | ** ** | 14,356 |   |
| Operating expenses:                       |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Selling, general and administrative(a)    | ** ** | **4,653**                                            | ** ** | 4,299                                              |       | **9,808** | ** ** | 8,788 |   |
| Research and development(a)               | ** ** | **1,122**                                            | ** ** | 627                                                |       | **2,332** | ** ** | 1,621 |   |
| Amortization of intangible assets         | ** ** | **36**                                               | ** ** | 36                                                 |       | **73** | ** ** | 73 |   |
| Total operating expenses                  | ** ** | **5,811**                                            | ** ** | 4,962                                              |       | **12,213** | ** ** | 10,482 |   |
| Operating income                          | ** ** | **2,064**                                            | ** ** | 2,300                                              |       | **3,414** | ** ** | 3,874 |   |
| Non-operating income (expense):           |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Other income, net                         | ** ** | **22**                                               | ** ** | 25                                                 |       | **27** | ** ** | 44 |   |
| Interest expense, net                     | ** ** | **(198**                                             | **)**      | (369                                               | )          | **(396** | **)** | (732 | ) |
| Income before income taxes                | ** ** | **1,888**                                            | ** ** | 1,956                                              |       | **3,045** | ** ** | 3,186 |   |
| Income tax benefit (provision)            | ** ** | **(821**                                             | **)**      | 214                                                |       | **(1,312** | **)** | 80 |   |
| Net income                                | ** ** | **$**                                                | **1,067**  | ** **                                         | $          | 2,170 |   | **$** | **1,733** | ** ** | $ | 3,266 | ** ** |
|                                      |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Earnings per share:                       |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Basic                                     | ** ** | **$**                                                | **0.03**   | ** **                                         | $          | 0.07 |   | **$** | **0.05** | ** ** | $ | 0.10 | ** ** |
| Diluted                                   | ** ** | **$**                                                | **0.03**   | ** **                                         | $          | 0.06 |   | **$** | **0.05** | ** ** | $ | 0.09 | ** ** |
| Weighted average shares outstanding:      |       |                                                 | ** ** |                                               |       |   | ** ** |   |   |
| Basic                                     | ** ** | **33,948**                                           | ** ** | 32,702                                             |       | **33,783** | ** ** | 32,396 |   |
| Diluted                                   | ** ** | **34,959**                                           |       | 34,518                                             |       | **34,949** | ** ** | 34,383 |   |

 

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| (a) Includes stock-based compensation expense  as follows: |       |   |   |   |       |    |       |   |    |
|-----------------------------------------------------------------|------------|--------|--------|--------|------------|---------|------------|--------|---------|
| Cost of net sales                                               | ** ** | **$**  | **3**  |   | $          | 1       | ** ** | **$**  | **5**   |   | $ | 2 |   |
| Cost of contract revenues                                       | ** ** | **10** |   | 3      | ** ** | **20**  |       | 6      |    |
| Selling, general and administrative expense                     | ** ** | **76** |   | 54     | ** ** | **153** |       | 113    |    |
| Research and development expense                                | ** ** | **5**  |   | 1      | ** ** | **10**  |       | 4      |    |
| Total                                                           | ** ** | **$**  | **94** |   | $          | 59      | ** ** | **$**  | **188** |   | $ | 125 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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**ITERIS, INC.**

**UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
| **Cash flows from operating activities**                       |       |                                               |       |   |   |
| Net income                                                                         | ** ** | **$**                                              | **1,733**  | ** ** | $ | 3,266 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                               | ** ** |   |   |
| Change in deferred tax assets                                                      | ** ** | **1,027**                                          | ** ** | (167 | ) |
| Depreciation and amortization of property  and equipment                           | ** ** | **498**                                            | ** ** | 291 |   |
| Stock-based compensation expense                                                   | ** ** | **188**                                            | ** ** | 125 |   |
| Amortization of debt discount                                                      | ** ** | **82**                                             | ** ** | 104 |   |
| Amortization of intangible assets                                                  | ** ** | **73**                                             | ** ** | 73 |   |
| Amortization of deferred financing costs                                           | ** ** | **54**                                             | ** ** | 69 |   |
| Amortization of deferred gain on  sale—leaseback transaction                  |       | —                                             | ** ** | (165 | ) |
| Changes in operating assets and  liabilities:                                      |       |                                               | ** ** |   |   |
| Accounts receivable                                                                | ** ** | **(1,526**                                         | **)**      | (1,700 | ) |
| Net costs and estimated earnings in excess  of billings                            | ** ** | **1,289**                                          | ** ** | (1,381 | ) |
| Inventories                                                                        | ** ** | **(368**                                           | **)**      | 1,533 |   |
| Prepaid expenses and other assets                                                  | ** ** | **(55**                                            | **)**      | (252 | ) |
| Accounts payable and accrued liabilities                                           | ** ** | **389**                                            | ** ** | 225 |   |
| Net cash provided by operating activities                                          | ** ** | **3,384**                                          | ** ** | 2,021 |   |
|                                                                               |       |                                               | ** ** |   |   |
| **Cash flows from investing activities**                                           |       |                                               | ** ** |   |   |
| Purchases of property and equipment                                                | ** ** | **(486**                                           | **)**      | (293 | ) |
|                                                                               |       |                                               | ** ** |   |   |
| **Cash flows from financing activities**                                           |       |                                               | ** ** |   |   |
| Proceeds from stock option and warrant  exercises                                  | ** ** | **684**                                            | ** ** | 940 |   |
| Payments on long-term debt                                                         | ** ** | **(232**                                           | **)**      | (1,297 | ) |
| Net payments on line of credit                                                     |       | —                                             | ** ** | (1,494 | ) |
| Change in checks drawn in excess of  available bank balances                       |       | —                                             | ** ** | 143 |   |
| Net cash provided by (used in) financing  activities                               | ** ** | **452**                                            | ** ** | (1,708 | ) |
| Increase in cash                                                                   | ** ** | **3,350**                                          | ** ** | 20 |   |
| Cash at beginning of period                                                        | ** ** | **421**                                            | ** ** | 35 |   |
| Cash at end of period                                                              | ** ** | **$**                                              | **3,771**  | ** ** | $ | 55 |   |
|                                                                               |       |                                               | ** ** |   |   |
| **Supplemental cash flow information:**                                            | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Cash paid during the period:                                                       |       |                                               | ** ** |   |   |
| Interest                                                                           | ** ** | **$**                                              | **260**    | ** ** | $ | 590 |   |
| Income taxes                                                                       | ** ** | **187**                                            | ** ** | 48 |   |
| ** **                                                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| **Supplemental schedule of non-cash  investing and financing activities:**    | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Fair value of common stock issued in  settlement of liabilities                    | ** ** | **$**                                              | **427**    | ** ** | $ | 350 |   |
| Conversion of redeemable common stock to  common stock                             | ** ** | **—**                                         | ** ** | 3,414 |   |
| Lease incentives in connection with new  headquarters lease                        | ** ** | **—**                                         | ** ** | 1,772 |   |
| Write-off of notes receivable from  employees                                      | ** ** | **—**                                         | ** ** | (5 | ) |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

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**ITERIS,INC.**

**NOTES TOUNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**September 30,2008**

** **

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

 

**Description of Business**

 

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

 

**Basis of Presentation**

 

The unaudited condensed consolidatedfinancial statements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation and with the instructions to Securities and Exchange Commission (“SEC”)Form 10-Q and Article 10 of SEC Regulation S-X. In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments, consisting of normal recurring adjustments,necessary to present fairly the consolidated financial position of the Companyas of September 30, 2008, the consolidated results of operations for thethree and six months ended September 30, 2008 and 2007, and theconsolidated cash flows for the six months ended September 30, 2008 and2007. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States (“U.S. GAAP”) have been condensed oromitted pursuant to the rules and regulations of the SEC. The results ofoperations for the three and six months ended September 30, 2008 are notnecessarily indicative of those to be expected for the entire year. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the Company’s Annual Report on Form 10-K for theyear ended March 31, 2008, which was filed with the SEC on June 12,2008.

 

# **Use ofEstimates**

#  

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

 

**Reclassifications**

** **

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

 

# **RevenueRecognition**

#  

Product revenues andrelated costs of sales are recognized upon the transfer of title, whichgenerally occurs upon shipment or, if required, upon acceptance by the customer,provided that the Company believes 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.

 

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In addition to productand contract revenue, the Company derives revenue from the provision ofspecific non-recurring contract engineering services and royalties. Non-recurringcontract engineering revenues are recognized in the period in which the relatedservices are performed. Royalty revenues are recorded in the period in whichthe royalty is earned, based on unit sales of the Company’s products.  Non-recurring contract engineering revenuesand royalty revenues are included in net sales in the accompanying condensedconsolidated statements of operations.

 

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

 

**Concentration of Credit Risk**

 

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

 

**Fair Values of Financial Instruments**

 

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

 

# **Inventories**

#  

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

 

**Property and Equipment**

 

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

 

**Goodwill and Long-Lived Assets**

 

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

 

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

 

**Income Taxes**

 

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

 

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**Stock-BasedCompensation**

 

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

 

**Research and Development Expenditures**

 

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

 

**Shipping and Handling Costs**

 

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

 

**Sales Taxes**

 

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

 

**Warranty**

 

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

 

**Repair and Maintenance Costs**

 

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

 

**Other Comprehensive Income**

 

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

 

**Recent Accounting Pronouncements**

 

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

 

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In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assets andFinancial Assets and Financial Liabilities — including an amendment of FASBStatement No. 115.* This statement allows an entity theirrevocable option to elect fair value for the initial and subsequentmeasurement of certain financial assets and liabilities on acontract-by-contract basis. Subsequent changes in fair value of these financialassets and liabilities would be recognized in earnings when they occur. Thisstatement is effective for fiscal years beginning after November 15, 2007with earlier adoption permitted under special rules. The adoption of thisstatement did not have a material impact on the consolidated financialstatements of the Company.

 

**2. Supplemental Financial Information**

 

**Inventories**

 

The following tablepresents details of the Company’s inventories:

 
| ** **             | ** ** | **September 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **             | ** ** | **(In thousands)**      | ** ** |
| Materials and supplies | ** ** | **$**                        | **3,367**  |                     | $          | 3,031 |   |
| Work in process        | ** ** | **346**                      |       | 345                      |       |
| Finished goods         | ** ** | **881**                      |       | 850                      |       |
| ** **             |       | **$**                        | **4,594**  |                     | $          | 4,226 |   |

 

**Intangible Assets**

 
| ** **           | ** ** | **September 30, 2008** | ** ** | **March 31, 2008**  | ** ** |
|----------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Gross  Carrying  Amount**      | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **           | ** ** | **(In thousands)**          | ** ** |
| Developed technology | ** ** | **$**                            | **495**    | ** **                    | **$**      | **(431** | **)** | $ | 495 |   | $ | (381 | ) |
| Patents              | ** ** | **317**                          | ** ** | **(197**                      | **)**      | 317 |   | (174 | ) |
| Total                | ** ** | **$**                            | **812**    | ** **                    | **$**      | **(628** | **)** | $ | 812 |   | $ | (555 | ) |

 

Amortization expense for intangible assets subject to amortization was$36,000 and $73,000 for the three and six months ended September 30, 2008,respectively, and $36,000 and $73,000 for the three and six months ended September 30,2007, respectively.  Future estimatedamortization expense for the remainder of the current fiscal year and the nextthree fiscal years is as follows:

 
| **Fiscal Year Ending March 31:** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2009                                                 |       | $          | 74         |   |
| 2010                                                 |       | 58         |       |
| 2011                                                 |       | 46         |       |
| 2012                                                 |       | 6          |       |
|                                                 |       | $          | 184        |   |

 

**Warranty Reserve Activity**

 

The following table presents activity in accrued warrantyobligations:

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(In thousands)**                              | ** ** |
| Balance at beginning of period     | ** ** | **$**                                                | **529**    |                                               | $          | 569 | ** ** | **$** | **494** | ** ** | $ | 520 |   |
| Additions charged to cost of sales | ** ** | **85**                                               |       | 45                                                 | ** ** | **184** | ** ** | 144 |   |
| Warranty claims                    | ** ** | **(57**                                              | **)**      | (125                                               | )          | **(121** | **)** | (175 | ) |
| Balance at end of period           | ** ** | **$**                                                | **557**    |                                               | $          | 489 |   | **$** | **557** | ** ** | $ | 489 |   |

 

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**Earnings Per Share**

 

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

 
| ** **                                                   | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Six Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                                              | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Numerator:                                                   |       |                                                                  |       |                                               |       |   |   |   |   |
| Net income                                                   | ** ** | **$**                                                                 | **1,067**  |                                               | $          | 2,170 | ** ** | **$** | **1,733** |   | $ | 3,266 |   |
|                                                         |       |                                                                  |       |                                               |       |   |   |   |   |
| Denominator:                                                 |       |                                                                  |       |                                               |       |   |   |   |   |
| Weighted  average common shares used in basic computation    | ** ** | **33,948**                                                            |       | 32,702                                             | ** ** | **33,783** |   | 32,396 |   |
| Dilutive  stock options                                      | ** ** | **1,006**                                                             |       | 1,798                                              | ** ** | **1,160** |   | 1,963 |   |
| Dilutive  warrants                                           | ** ** | **5**                                                                 |       | 18                                                 | ** ** | **6** |   | 24 |   |
| Weighted  average common shares used in dilutive computation | ** ** | **34,959**                                                            |       | 34,518                                             | ** ** | **34,949** |   | 34,383 |   |
|                                                         |       |                                                                  |       |                                               |       |   |   |   |   |
| Earnings per  share:                                         |       |                                                                  |       |                                               |       |   |   |   |   |
| Basic                                                        | ** ** | **$**                                                                 | **0.03**   |                                               | $          | 0.07 | ** ** | **$** | **0.05** |   | $ | 0.10 |   |
| Diluted                                                      | ** ** | **$**                                                                 | **0.03**   |                                               | $          | 0.06 | ** ** | **$** | **0.05** |   | $ | 0.09 |   |

 

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

 
| ** **             | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **             | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **             | ** ** | **(In thousands)**                              | ** ** |
| Stock options          | ** ** | **1,033**                                            |       | 632                                                | ** ** | **775** |   | 650 |   |
| Warrants               | ** ** | **1,150**                                            |       | 1,190                                              | ** ** | **1,150** |   | 1,190 |   |
| Convertible debentures | ** ** | **2,147**                                            |       | 2,729                                              | ** ** | **2,147** |   | 2,729 |   |

 

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

 

**RevolvingLine of Credit**

 

At September 30,2008, the Company had a credit facility with a bank that provided for line ofcredit borrowings of up to $10.0 million. Under this credit facility, theCompany could borrow against its eligible accounts receivable and eligibleinventory, as defined in the credit agreement. Interest on borrowed amountsunder the line of credit was payable monthly at the current stated prime rateplus 1.00% (6.00% at September 30, 2008). Additionally, the Company wasobligated to pay an unused line fee of 0.25% per annum applied to the amount bywhich the maximum credit amount exceeded the average daily principal balanceduring the preceding month. The credit facility required $2,000 in monthlycollateral management fees and included an early termination fee equal to 2% ofthe total facility during the first year of the agreement and 1% of the totalfacility in the second year of the agreement. The credit facility was securedby substantially all of the assets of the Company.  On September 30, 2008, the availablecredit under the Company’s credit facility was $9.1 million, all of which wasunused.  This credit facility expired on October 15,2008.

 

Effective October 16,2008, the Company entered into a new two-year credit facility with a differentbank and replaced the Company’s existing credit facility.  This new credit facility provides forrevolving line of credit borrowings of up to $12.0 million.  Interest on borrowed amounts under this lineof credit will be payable monthly at a rate equal to the current stated primerate up to the current stated prime rate plus 0.50%, depending on aggregatedeposit balances maintained at the bank in relation to the total loancommitment under the credit facility. The Company is obligated to pay an unused line fee of 0.25% per annumapplied to the average unused portion of the $12.0 million revolving line ofcredit during the preceding month.  Thecredit facility does not contain any early termination fees and is secured bysubstantially all of the assets of the Company.

 

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**Long-TermDebt**

 

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

 
| ** **                  | ** ** | **September 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|-----------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **                  | ** ** | **(In thousands)**      | ** ** |
| Convertible debentures, net | ** ** | **$**                        | **7,648**  |                     | $          | 7,566 |   |
| Bank term notes             |       | —                       |       | 210                      |       |
| Other                       | ** ** | **12**                       | ** ** | 34                       |       |
| ** **                  |       | **7,660**                    |       | 7,810                    | ** ** |
| Less current portion        | ** ** | **(2,974**                   | **)**      | (244                     | )          |
| ** **                  |       | **$**                        | **4,686**  | ** **               | $          | 7,566 |   |

 

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

 

The debentures are due infull on May 18, 2009, provide for 6.0% annual interest, payable quarterly,and are convertible into the Company’s common stock at an initial conversionprice of $3.61 per share, subject to certain adjustments, including adjustmentsfor dilutive issuances. From May 19, 2008, until the maturity date, theCompany may redeem the debentures at 110% of the principal amount. As of September 30,2008, $250,000 of convertible debentures had been converted into 69,252 sharesof common stock and $2.1 million of convertible debentures had been retiredearly leaving $7.8 million of the originally issued convertible debenturesoutstanding at September 30, 2008.

 

In October 2008, theCompany paid $5.4 million to retire $5.5 million of convertible debenturesearly leaving $2.3 million of the originally issued convertible debenturesoutstanding.  $304,000 of the amount paidwas paid in cash.  The remaining $5.1million paid was financed under the Company’s new bank term note, which isdescribed further below under the caption “Bank Term Notes”.  In accordance with SFAS No. 6, *Classifications of Short-Term Obligations Expected to Be Refinanced*,the Company has classified the long-term portion of the convertible debenturesfinanced under the new term note as long-term debt in the accompanyingcondensed consolidated balance sheet at September 30, 2008.  The current portion of the convertibledebentures financed under the new term note as well as the remainingconvertible debenture balances are classified as a current liability at September 30,2008.

 

*Bank Term Notes.*InOctober 2004, the Company entered into a $5.0 million term note payablewith a bank. The note was due on May 27, 2008, and provided for monthlyprincipal payments of approximately $104,000. The final payment against this term note was made in June 2008.

 

Effective October 16,2008, the Company entered into a new credit facility with a different bank, asdescribed above.  Under this new creditfacility, the Company may borrow up to $7.5 million in the form of a 48 monthterm loan to retire all outstanding convertible debentures.  Principal payments under this term loan willnot be required until June 1, 2009. Interest on the term loan will be payable monthly at a rate equal to thecurrent stated prime rate plus 0.50% up to the current stated prime rate plus1.00%, depending on aggregate deposit balances maintained at the bank inrelation to the total loan commitment under the credit facility.  The Company paid a one-time loan commitmentfee of $28,000.  The term loan containsno early termination fees and, along with the new revolving line of creditunder the same credit agreement, is secured by substantially all of the assetsof the Company.

 

Scheduled aggregatematurities of long-term debt principal as of September 30, 2008, updatedto reflect the early retirement and refinancing of convertible debentures in October 2008,were as follows:

 
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2009                                                 | ** ** | **$**      | **332**    | ** ** |
| 2010                                                 | ** ** | **3,329**  | ** ** |
| 2011                                                 | ** ** | **1,295**  | ** ** |
| 2012                                                 | ** ** | **1,295**  | ** ** |
| 2013                                                 | ** ** | **1,295**  | ** ** |
| Thereafter                                           | ** ** | **216**    | ** ** |
| ** **                                           | ** ** | **7,762**  | ** ** |
| Less: unamortized debt discount                      | ** ** | **(102**   | **)**      |
| ** **                                           | ** ** | **$**      | **7,660**  | ** ** |

 

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**4. Commitments and Contingencies**

 

**Litigation and Other Contingencies**

 

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

 

Furthermore, from time to time, the Companyhas experienced unforeseen developments in contingencies related to its formersubsidiaries. For example, the Company has been the subject of a number ofroutine tax audits for time periods and jurisdictions related to the businessesof its former subsidiaries, some of which are still in process. Although thedevelopment and ultimate outcome of these and other unforeseen matters cannotbe predicted with any certainty, management does not believe that the Companyis presently involved in any matters related to its former subsidiaries thatwould have a material adverse effect on the Company’s consolidated results ofoperations, financial position or cash flows.

 

**Operating Lease Commitments**

 

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

 
| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| Remainder of 2009                                    | ** ** | **$**      | **946**    | ** ** |
| 2010                                                 | ** ** | **1,579**  | ** ** |
| 2011                                                 | ** ** | **1,412**  | ** ** |
| 2012                                                 | ** ** | **1,332**  | ** ** |
| 2013                                                 | ** ** | **1,363**  | ** ** |
| Thereafter                                           | ** ** | **2,460**  | ** ** |
| Total                                                | ** ** | **$**      | **9,092**  | ** ** |

 

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

 

**Inventory Purchase Commitments**

 

At September 30, 2008, the Company had firm commitments topurchase inventory in the amount of $2.7 million during the next three fiscalquarters.

 

**5. Stock-Based Compensation**

 

Under the Company’s 2007Omnibus Incentive Plan (the “2007 Plan”) options to purchase shares of theCompany’s unissued common stock may be granted to the Company’s employees,officers, consultants and directors at exercise prices which are equal to orgreater than the fair market value of the Company’s common stock on the date ofgrant. Options expire no more than ten years after the date of grant andgenerally vest at the rate of 25% on each of the first four anniversaries ofthe grant date. The 2007 Plan also allows for the issuance of stockappreciation rights, restricted stock, restricted stock units and otherstock-based awards based on the value of the Company’s common stock. New sharesare issued to satisfy stock option exercises and share issuances under the 2007Plan. As of September 30, 2008, options to purchase an aggregate of 419,000shares of common stock were outstanding under the 2007 Plan.

 

The Company’s 1997 StockIncentive Plan (the “1997 Plan”) terminated in September 2007; however,all stock options outstanding under the 1997 Plan will remain outstandingpursuant to the terms of such stock options. As of September 30, 2008,options to purchase 1.3 million shares of the Company’s common stock wereoutstanding under the 1997 Plan.

 

In connection with the October 2004merger of the Company and what was previously its majority-owned subsidiary,Iteris Inc. (the “Iteris Subsidiary”), the Company assumed the 1998 StockIncentive Plan of the Iteris Subsidiary (the “1998 Plan”) and all outstandingoptions granted thereunder. As of September 30, 2008, options to purchase2.0 million shares of the Company’s common stock were outstanding under the1998 Plan. No further options may be granted under the 1998 Plan.

 

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

 

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

 
| ** **                                                                      | ** ** | **Options**                                                                                                   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **(In thousands, except per share amounts and number of years)** | ** ** |
| Options outstanding at March 31, 2008                                      |       | 4,524                                                                                                         |       | $                                      | 1.83       |                                                             | 3.7        |                                |       |   |
| Granted                                                                         |       | 30                                                                                                            |       | 2.10                                   |       | N/A                                                              |       |                                |       |
| Exercised                                                                       |       | (592                                                                                                          | )          | 1.16                                   |       | N/A                                                              |       |                                |       |
| Forfeited                                                                       |       | —                                                                                                        |       | N/A                                    |       | N/A                                                              |       |                                |       |
| Expired                                                                         |       | (240                                                                                                          | )          | 2.84                                   |       | N/A                                                              |       |                                |       |
| Options outstanding at September 30, 2008                                  |       | 3,722                                                                                                         |       | $                                      | 1.88       |                                                             | 4.2        |                                | $          | 1,931 |   |
| Vested and expected to vest at September 30, 2008                          |       | 3,608                                                                                                         |       | $                                      | 1.86       |                                                             | 4.0        |                                | $          | 1,931 |   |
| Options exercisable at September 30, 2008                                  |       | 3,116                                                                                                         |       | $                                      | 1.77       |                                                             | 3.3        |                                | $          | 1,931 |   |
| Options exercisable at September 30, 2008 pursuant to a  change-in-control |       | 3,722                                                                                                         |       | $                                      | 1.88       |                                                             | 4.2        |                                | $          | 1,931 |   |

 

At September 30,2008, there were 431,000 shares of common stock available for grant under the2007 Plan.

 

For the six month periodsended September 30, 2008 and 2007, the Company received $684,000 and$818,000, respectively, in cash from the exercise of stock options. Totalstock-based compensation expense was $94,000 and $188,000 for the three and sixmonths ended September 30, 2008, respectively, and $59,000 and $125,000for the three and six months ended September 30, 2007, respectively.  No income tax benefit was realized fromactivity in the Plans during the six months ended September 30, 2008 and2007.

 

At September 30,2008, there was $1.1 million of total unrecognized compensation expense relatedto unvested stock options. This expense is expected to be recognized over aweighted-average period of approximately 3.4 years.

 

The fair value of eachstock-based award is estimated on the grant date using the Black-Scholes-Merton(“BSM”) option-pricing formula. Expected volatility is based on the historicalvolatility of the Company’s stock price. The expected life of options grantedsubsequent to the adoption of SFAS 123R is derived based on the historical lifeof the Company’s options. The risk-free interest rate for periods within theexpected life of the option is based on the U.S. Treasury interest rates ineffect at the time of grant.

 

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

 
| ** **                                        | ** ** | **Three Months  Ended September 30,**                  | ** ** | **Six Months  Ended September 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                                              | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Weighted average grant  date fair value per share | ** ** | **$**                                                                 | **1.50**   |                                               | $          | 1.72 | ** ** | **$** | **1.50** |   | $ | 1.72 |   |
| Intrinsic value of options  exercised             | ** ** | **$**                                                                 | **99**     |                                               | $          | 230 | ** ** | **$** | **755** |   | $ | 1,647 |   |

 

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**6. Business Segment Information**

 

The Company currentlyoperates in three reportable segments: Roadway Sensors, Vehicle Sensors andTransportation Systems. The Roadway Sensors segment includes the Company’sVantage vehicle detection systems for traffic intersection control,incident detection and certain highway traffic data collection applications.The Vehicle Sensors segment includes AutoVue and is comprised of all activitiesrelated to lane departure warning systems for vehicle safety. TheTransportation Systems segment includes transportation engineering andconsulting services and the development of transportation management andtraveler information systems for the ITS industry. The accounting policies ofthe reportable segments are the same as those described in the summary ofsignificant accounting policies except that certain expenses, such as interest,amortization of certain intangibles and certain corporate expenses are not allocatedto the segments.  The reportable segmentsare each managed separately because they manufacture and distribute distinctproducts or provide services with different processes. All segment revenues arederived from external customers.

 

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

 
| ** **                                     | ** ** | **Roadway  Sensors**    | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|----------------------|------------|-----------------------------|------------|-----------|------------|
| ** **                                     | ** ** | **(In thousands)** | ** ** |
| **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     |       |
|                                           |       |                    |       |                 |       |                        |       |      |       |
| **Three Months Ended September 30, 2007** |       |                    |       |                 |       |                        |       |      |       |
| Product revenue                                |       | $                       | 7,617      |                 | $          | 2,765                       | ** ** | **$**     | **—** |   | $ | 10,382 |   |
| Service and other revenue                      |       | —                  |       | 413                  |       | 6,181                       |       | 6,594     |       |
| Stock-based compensation                       |       | 4                       |       | 11                   |       | 6                           |       | 21        |       |
| Depreciation and amortization                  |       | 27                      |       | 30                   |       | 35                          |       | 92        |       |
| Segment income                                 |       | 1,691                   |       | 222                  |       | 433                         |       | 2,346     |       |
|                                           |       |                    |       |                 |       |                        |       |      |       |
| **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     |       |
|                                           |       |                    |       |                 |       |                        |       |      |       |
| **Six Months Ended September 30, 2007**   |       |                    |       |                 |       |                        |       |      |       |
| Product revenue                                |       | $                       | 14,841     |                 | $          | 5,349                       | ** ** | **$**     | **—** |   | $ | 20,190 |   |
| Service and other revenue                      |       | —                  |       | 849                  |       | 11,694                      |       | 12,543    |       |
| Stock-based compensation                       |       | 10                      |       | 24                   |       | 13                          |       | 47        |       |
| Depreciation and amortization                  |       | 53                      |       | 66                   |       | 66                          |       | 185       |       |
| Segment income                                 |       | 2,796                   |       | 272                  |       | 977                         |       | 4,045     |       |

 

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

 
| ** **                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                            | ** ** | **(In thousands)**                              | ** ** |
| Total income for  reportable segments | ** ** | **$**                                                | **2,133**  |                                               | $          | 2,346 | ** ** | **$** | **3,705** |   | $ | 4,045 |   |
| Unallocated amounts:                  |       |                                                 |       |                                               |       |   |   |   |   |
| Corporate expenses                    | ** ** | **(69**                                              | **)**      | (46                                                | )          | **(291** | **)** | (171 | ) |
| Other income, net                     | ** ** | **22**                                               | ** ** | 25                                                 |       | **27** | ** ** | 44 |   |
| Interest expense, net                 | ** ** | **(198**                                             | **)**      | (369                                               | )          | **(396** | **)** | (732 | ) |
| Income before income taxes            | ** ** | **$**                                                | **1,888**  |                                               | $          | 1,956 | ** ** | **$** | **3,045** |   | $ | 3,186 |   |

 

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| **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 undertakeno obligation to republish revised forward-looking statements to reflect eventsor circumstances after the date hereof or to reflect the occurrence ofunanticipated events. We encourage you to carefully review and consider thevarious disclosures made by us which describe certain factors which couldaffect our business, including in* “*Risk Factors”set forth in Part II, Item 1A of this report, before deciding to invest inour company or to maintain or increase your investment. We undertake noobligation to revise or update publicly any forward-looking statement for anyreason.*

 

**Overview**

 

We are a leader in the traffic management market that focuses on thedevelopment and application of advanced technologies that reduce trafficcongestion, minimize the environmental impact of traffic congestion and improvethe safety of surface transportation systems. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broadrange of Intelligent Transportation Systems (“ITS”) and driver safety solutionsto customers worldwide.

 

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 is comprised of allactivities related to our AutoVue systems for vehicle safety. TheTransportation Systems segment includes transportation engineering andconsulting services, and the development of transportation management andtraveler information systems for the ITS industry.

 

Our Vantage product line uses advanced image processing technology tocapture and analyze video images through sophisticated algorithms, enablingvehicle detection and transmission of both video images and data using a widerange of communication technologies. Vantage video detection systems detect vehicle presence, count, speed,occupancy and other traffic data used in traffic management systems.  This gives traffic managers the ability tomitigate roadway congestion by modifying traffic signal timing or detectingincidents quickly.  VersiCam, Iteris’integrated camera and processor video detection system, is a cost-efficientalternative for smaller intersections that require only a few detectionpoints.  Vantage video detection systemsand VersiCam 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.

 

Our Vehicle Sensors segment addresses the leading cause of roadwayfatalities:  rear-end, lane change and roadwaydeparture accidents.  According to theNational Highway Traffic Safety Administration, these three crash types resultin about 27,500 of the U.S.’s 42,000 annual traffic fatalities and contributeto a considerable economic loss due to injuries, property damage and decreasedproductivity.

 

We developed the world’s first production Lane Departure Warning (LDW)system and are still the only company with a proven system in production thatis available as an OEM option in passenger cars and an OEM and aftermarketoption on heavy trucks worldwide.  TheAutoVue LDW system utilizes video detection images to detect when a vehiclebegins to drift toward an unintended lane change.  When this occurs, the unit automaticallyemits a distinctive rumble strip or other audible warning sound, alerting thedriver to make a correction.  To date wehave sold approximately 62,000 LDW systems into the heavy truck market inEurope and North America.  Our LDWsystems are currently qualified as an option on certain heavy trucks, includingMercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner and FUSO, as well asNeoplan and MAN luxury bus and coach lines. In North America, our LDW systemsare sold primarily to truck fleets, and to date, 66 U.S. heavy truck fleetshave selected our LDW systems, representing an estimated 49,000 vehicles.  Additionally, we have licensed our LDWtechnology to our strategic partner, Valeo Schalter and Sensuren GmbH, anindependent automotive supplier, resulting in sales to date of approximately69,000 LDW systems into the passenger car market.

 

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In addition to our LDW systems, we have expanded our AutoVue portfoliowith newly developed technologies such as radar-based Forward Collision Warning(FCW) and Blind Spot Warning (BSW) systems for the North American truck market,as well as Safety Direct — a system that reports real-time driver performancedata captured by our LDW system and that has the ability to relay thisinformation directly to fleet operators through integration with the truck’sexisting fleet communications system. These new products, together with the AutoVue LDW system, combine tocreate a comprehensive suite of active safety driver assistance features thathelp 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, computers 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 goods movement,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. Our transportation managementsystems business is largely dependent upon governmental funding and budgetaryissues. The Federal Highway Bill that was passed in August 2005 providedfor a significant increase in transportation funding. We believe the recentexpansion of our transportation management systems business was due in part tothe passage of the Federal Highway Bill, combined with increased transportationfunds available at state and local agencies throughout the country.  The 2005 Federal Highway Bill is set toexpire in 2009.  At this point in time,the impact on future contract revenues as a result of potential delays in thepassage of future transportation bills cannot be determined.

 

**CriticalAccounting Policies and Estimates**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased on our unaudited condensed consolidated financial statements includedherein, which have been prepared in accordance with U.S. GAAP. The preparationof these financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities andrelated disclosures of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. On an ongoing basis, we evaluate these estimates andassumptions, including those related to the collectibility of accountsreceivable, the valuation of inventories, the recoverability of long-livedassets and goodwill, the realizability of deferred tax assets, accounting forstock-based compensation, the valuation of equity instruments, warrantyreserves and other contingencies. We base these estimates on our historicalexperience and on various other factors that we believe to be reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. These estimates and assumptions by their natureinvolve risks and uncertainties, and may prove to be inaccurate. In the eventthat any of our estimates or assumptions are inaccurate in any materialrespect, it could have a material adverse effect on our reported assets andliabilities at the date of the financial statements and our reported revenuesand expenses during the reporting 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 furtherdetail in our Annual Report on Form 10-K for the fiscal year ended March 31,2008.  There have been no significantchanges in our critical accounting policies and estimates during the six monthsended September 30, 2008 as compared to what was previously disclosed inour Annual Report on Form 10-K for the fiscal year ended March 31,2008.

 

**RecentAccounting Pronouncements**

 

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

 

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InFebruary 2007, the FASB issued SFAS 159. This statement allows an entity the irrevocable option to elect fairvalue for the initial and subsequent measurement of certain financial assetsand liabilities on a contract-by-contract basis. Subsequent changes in fairvalue of these financial assets and liabilities would be recognized in earningswhen they occur. This statement is effective for fiscal years beginning after November 15,2007 with earlier adoption permitted under special rules. The adoption of thisstatement did not have a material impact on our consolidated financialstatements.

 

**Results ofOperations**

 

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

 
| ** **                                 | ** ** | **Three Months  Ended September 30,** | ** ** | **Six Months  Ended September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                             | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales and contract  revenues:          |       |                                                 |       |                                          |       |   |   |   |   |
| Net sales                                  | ** ** | **58.1**                                             | **%**      | 63.6                                          | %          | **59.2** | **%** | 64.3 | % |
| Contract revenues                          | ** ** | **41.9**                                             | ** ** | 36.4                                          |       | **40.8** | ** ** | 35.7 |   |
| 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                          | ** ** | **30.9**                                             | ** ** | 32.4                                          |       | **30.5** | ** ** | 32.6 |   |
| Cost of contract revenues                  | ** ** | **27.8**                                             | ** ** | 24.8                                          |       | **26.6** | ** ** | 23.5 |   |
| Gross profit                               | ** ** | **41.3**                                             | ** ** | 42.8                                          |       | **42.8** | ** ** | 43.9 |   |
| Operating expenses:                        |       |                                                 | ** ** |                                          |       |   | ** ** |   |   |
| Selling, general and  administrative       | ** ** | **24.4**                                             | ** ** | 25.3                                          | ** ** | **26.9** | ** ** | 26.8 |   |
| Research and development                   | ** ** | **5.9**                                              | ** ** | 3.7                                           | ** ** | **6.4** | ** ** | 5.0 |   |
| Amortization of intangible  assets         | ** ** | **0.2**                                              | ** ** | 0.2                                           | ** ** | **0.2** | ** ** | 0.2 |   |
| Total operating expenses                   | ** ** | **30.5**                                             | ** ** | 29.2                                          | ** ** | **33.5** | ** ** | 32.0 |   |
| Operating income                           | ** ** | **10.8**                                             | ** ** | 13.5                                          | ** ** | **9.4** | ** ** | 11.8 |   |
| Non-operating income  (expense):           |       |                                                 | ** ** |                                          |       |   | ** ** |   |   |
| Other income, net                          | ** ** | **0.1**                                              | ** ** | 0.1                                           | ** ** | **0.1** | ** ** | 0.1 |   |
| Interest expense, net                      | ** ** | **(1.0**                                             | **)**      | (2.2                                          | )          | **(1.1** | **)** | (2.2 | ) |
| Income before income taxes                 | ** ** | **9.9**                                              | ** ** | 11.5                                          |       | **8.3** | ** ** | 9.7 |   |
| Income tax benefit  (provision)            | ** ** | **(4.3**                                             | **)**      | 1.3                                           |       | **(3.6** | **)** | 0.2 |   |
| Net income                                 | ** ** | **5.6**                                              | **%**      | 12.8                                          | %          | **4.7** | **%** | 10.0 | % |

 

**Analysis ofQuarterly Results of Operations**

 

*Net Sales and Contract Revenues*.  Netsales are comprised of Roadway Sensors sales, which are derived from sales ofour Vantage video detection systems, and Vehicle Sensor sales, which arederived from sales of AutoVue LDW systems, contract engineering revenue androyalty revenue generated from AutoVue related activities.  Contractrevenues consist entirely of Transportation Systems revenues, which aregenerated from systems integration and ITS consulting services with federal,state, county and municipal agencies. We currently have a relatively diversecustomer base with our largest customer constituting 10.6% and 8.5% of totalnet sales and contract revenues in the three and six months ended September 30,2008, respectively.

 

Totalnet sales and contract revenues increased 12.3% to $19.1 million and 11.5% to$36.5 million for the three and six months ended September 30, 2008,respectively, compared to $17.0 million and $32.7 million in the correspondingperiods of the prior fiscal year. The increase was primarily driven by highercontract revenues and, to a lesser extent, increased Vehicle Sensors revenues,as discussed below.

 

Netsales increased 2.6% to $11.1 million and 2.7% to $21.6 million for the threeand six months ended September 30, 2008, respectively, compared to $10.8million and $21.0 million in the corresponding periods of the prior fiscalyear.

 

RoadwaySensors net sales were flat for the three months ended September 30, 2008compared to the corresponding period of the prior fiscal year and increased 1.4%to $15.0 million for the six months ended September 30, 2008 compared to$14.8 million in the corresponding period of the prior fiscal year. Although wecontinue to experience strong acceptance of our Roadway Sensors products, thiswas largely offset in the first six months of the current fiscal year byreduced spending on infrastructure projects in select areas as a result of thedecline in commercial construction as well as local government budgetarypressures.  We expect these factors tocontinue to impact our Roadway Sensors net sales over at least the next fewfiscal quarters; however, it is difficult to determine to what extent.

 

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VehicleSensors net sales increased 8.9% to $3.5 million and 5.9% to $6.6 million forthe three and six months ended September 30, 2008, respectively, versus$3.2 million and $6.2 million in the corresponding periods of the prior fiscalyear. This increase was primarily a result of increased unit sales of our LDWsystems to European and Asian OEMs, offset in part, by decreased unit sales inNorth America.  Sales of LDW systems to the heavy truck market increased14.9% to $3.2 million and 10.4% to $5.9 million for the three and six monthperiods ended September 30, 2008, when compared to the correspondingperiods in the prior fiscal year. We expect sales of LDW units to the heavytruck market to continue to increase, when compared to the prior year period,for at least the remainder of calendar year 2008 due to increased sales of LDWunits in Europe and Asia; however, we could experience slowed growth ininternational sales of our LDW systems as a result of the recent slowdown inthe world economy and increased competition. We expect to continue to experience either flat or decreased sales tothe North American heavy truck market in our next few fiscal quarters as aresult of an overall decline in new truck sales in the U.S. and the generalslowdown in the U.S. credit markets and overall economy.  Also included in Vehicle Sensors net salesare revenues from contract engineering services and royalty revenues in thepassenger car market that are derived from our strategic relationship withValeo Schalter and Sensuren GmbH (“Valeo”), which aggregated $284,000 and$658,000 for the three and six months ended September 30, 2008,respectively, compared to $413,000 and $849,000 in the corresponding periods ofthe prior fiscal year.

 

Contractrevenues increased 29.2% to $8.0 million and 27.4% to $14.9 million for thethree and six months ended September 30, 2008, respectively, compared to$6.2 million and $11.7 million in the corresponding periods of the prior fiscalyear. This increase was largely a result of increased sales and marketingactivity across the country.  In responseto this growth, we have increased our Transportation Systems staff by 6.6% inthe six months ended September 30, 2008. We believe the ability of our Transportation Systems business to growand successfully win and service new contracts will be highly dependent uponour continued success in recruiting and retaining qualified personnel.  We anticipate that our contract revenues willcontinue to increase for the balance of fiscal 2009, largely as a result ofsignificant new contracts awarded to us during the first six months of fiscal2009.  All of our contract revenues arederived from work performed in North America under a broad range of fixed priceand cost plus fixed fee contracts.

 

Althoughwe are not aware of any significant imminent changes in government spendingpatterns, it is conceivable that, as a result of softening macroeconomicconditions in the U.S., the decline in the housing and credit markets, and theexpiration of the 2005 Federal Highway Bill in 2009, government funding forcertain traffic initiatives and roadway improvement projects could be delayedor diverted to focus on other budgetary needs. Should this occur, it is likely that future domestic Roadway Sensors netsales and Transportation System contract revenues and backlog would beadversely affected.

 

*Gross Profit*.  Total gross profitincreased 8.4% to $7.9 million and 8.9% to $15.6 million for the three and sixmonths ended September 30, 2008, respectively, as compared to $7.3 millionand $14.4 million in the corresponding periods of the prior fiscal year. Totalgross profit as a percent of net sales and contract revenues decreased slightlyto 41.3% and 42.8% for the three and six months ended September 30, 2008,respectively, as compared to 42.8% and 43.9% in the corresponding periods ofthe prior fiscal year.

 

Grossprofit as a percent of net sales was 46.9% and 48.4% for the three and sixmonths ended September 30, 2008, respectively, compared to 49.1% and 49.3%in the corresponding periods of the prior fiscal year. This decrease in grossprofit as a percent of net sales was a result of decreased gross profit in bothRoadway Sensors and Vehicle Sensors that was driven by customer mix.  We anticipate that this customer mix willremain relatively the same for the remainder of fiscal 2009.  Roadway Sensors net sales have been weightedmore toward dealer sales than direct sales in fiscal 2009, and Vehicle Sensorsnet sales have been weighted more toward OEMs than to after-market sales infiscal 2009.  Gross profit as a percentof net sales generally fluctuates in any specific quarter based on customermix. Gross profit as a percent of net sales has fluctuated over the last tenquarters from a high of 50.0% in the first quarter of fiscal 2009 to a low of43.2% reported in the second quarter of fiscal 2007.

 

Grossprofit as a percent of contract revenues was 33.6% and 34.7% for the three andsix months ended September 30, 2008, respectively, compared to 31.8% and34.1% in the corresponding periods of the prior fiscal year. We recognizecontract revenues and related gross profit using percentage of completioncontract accounting, and the underlying mix of contract activity affects therelated gross profit recognized in any given period.  The increase in gross profit as a percent ofcontract revenues for the three and six months ended September 30, 2008reflects a contract mix weighted more toward higher margin contracts in thecurrent period. Lower margin contracts generally have a higher proportion ofsub-consulting revenues associated with them.

 

*Selling, General and Administrative Expense*. Selling, general and administrative expense increased 8.2% to $4.7 million (or24.4% of total net sales and contract revenues) and 11.6% to $9.8 million (or26.9% of total net sales and contract revenues) in the three and six monthsended September 30, 2008, respectively, compared to $4.3 million (or 25.3%of total net sales and contract revenues) and $8.8 million (or 26.8% of totalnet sales and contract revenues) in the corresponding periods of the priorfiscal year.  These increases werelargely attributable to higher selling expenses in our Transportation Systemssegment aimed at capturing additional contract backlog, which increased 45% to$35.7 million during the six months ended September 30, 2008, as well asincreased sales and marketing efforts in Vehicle Sensors.

 

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*Research and Development Expense*. Research and development expense increased 78.9% to $1.1 million (or 5.9% oftotal net sales and contract revenues) and 43.9% to $2.3 million (or 6.4% oftotal net sales and contract revenues) in the three and six months ended September 30,2008, respectively, compared to $627,000 (or 3.7% of total net sales andcontract revenues) and $1.6 million (or 5.0% of total net sales and contractrevenues) in the corresponding periods of the prior fiscal year.  This increase was primarily due to increasedresearch and development activities in Roadway Sensors aimed at acceleratingthe time to market of certain new products. We believe research and development activities are crucial to our abilityto continue to be a leader in our markets, and we expect our expenditures inthis area to continue to run at an increased level, compared to the prior year,for the remainder of fiscal 2009.

 

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

 

*Interest Expense, Net.*  Interest expense, netincludes the following:

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                             | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(in thousands)**                              | ** ** |
| Interest expense                       | ** ** | **$**                                                | **(130**   | **)**                                              | $          | (283 | ) | **$** | **(260** | **)** | $ | (559 | ) |
| Amortization of debt discount          | ** ** | **(41**                                              | **)**      | (52                                                | )          | **(82** | **)** | (104 | ) |
| Amortization of deferred finance costs | ** ** | **(27**                                              | **)**      | (34                                                | )          | **(54** | **)** | (69 | ) |
| Interest expense, net                  | ** ** | **$**                                                | **(198**   | **)**                                              | $          | (369 | ) | **$** | **(396** | **)** | $ | (732 | ) |

 

Interestexpense decreased for the three and six months ended September 30, 2008compared to the corresponding period in the prior fiscal year as a result of anoverall lower level of borrowings in the current periods.

 

*Income**Taxes*.  During the three and six months ended September 30, 2008,we recognized income tax expense of $821,000 and $1.3 million, respectively, ascompared to an income tax benefit of $214,000 and $80,000 in the three and sixmonths ended September 30, 2007, respectively.  The increase in income tax expense and oureffective tax rate in the current year periods was primarily due to anadjustment of the valuation allowance recorded against our deferred tax assetsin the prior year periods as a result of changes in our estimates of the futurerealizability of these assets.  Weanalyze our tax estimates quarterly, and should those estimates result in anincrease in future taxable income, we may continue to record similaradjustments to our deferred tax asset valuation allowance, which totaledapproximately $8.0 million at September 30, 2008.  This may cause our future overall effectivetax rate in any given period to fluctuate from prior effective tax rates,estimated annual effective tax rates and statutory tax rates.

 

**Liquidityand Capital Resources**

 

*CashFlows*

 

Wehave historically financed our operations with a combination of cash flows fromoperations, borrowings under credit facilities and the sale of debt and equitysecurities. We currently rely on cash flows from operations and borrowings on aline of credit facility to fund our operations. At September 30, 2008, wehad $14.7 million in working capital, no borrowings on our $10.0 million lineof credit and $3.8 million in cash and cash equivalents. This compares toworking capital of $14.9 million at March 31, 2008, which included noborrowings on our line of credit and $421,000 in cash and cash equivalents.

 

Ouroperating activities provided $3.4 million in cash during the six months ended September 30,2008, primarily as a result of net income generated during the period and theusage of deferred tax assets.  We expectto continue to utilize our deferred tax assets to significantly reduce cash taxpayments in future quarters.  Accountsreceivable increased during the six months ended September 30, 2008 by$1.5 million primarily due to sales growth and the timing of invoicing forconsulting services provided by Transportation Systems.  Net unbilled accounts receivable alsodecreased by $1.3 million during the six months ended September 30, 2008as a result of the timing of invoicing in Transportation Systems.  Inventories increased slightly in support ofsales growth as well as the introduction of new products by RoadwaySensors.  We expect inventories to continueto increase for the remainder of fiscal 2009. During the six months ended September 30, 2007, our operationsprovided $2.0 million of cash, primarily as a result of net income generatedduring the period partially offset by net cash outflows related to operatingassets and liabilities.  Accounts receivableand net unbilled accounts receivable increased by $1.7 million and $1.4million, respectively, during the six months ended September 30, 2007largely as a result of increased sales as well as the timing of invoicing inTransportation Systems.  Inventoriesdecreased during the six months ended September 30, 2007 by $1.5 millionas a result of planned decreases in inventory levels.

 

Ourinvesting activities for the six months ended September 30, 2008 and 2007consisted entirely of purchases of property and equipment, which aggregated$486,000 and $293,000, respectively.

 

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Cashprovided by financing activities was $452,000 in the six months ended September 30,2008, which was primarily the result of $684,000 in proceeds from the exerciseof outstanding stock options to purchase our common stock. During the sixmonths ended September 30, 2007, financing activities used $1.7 million ofcash, which was the result of $2.6 million in net payments against borrowings,partially offset by $940,000 in proceeds from the exercise of outstanding stockoptions and warrants to purchase our common stock.

 

*Borrowings*

 

The following table summarizes our borrowings andlong-term debt:

 
| ** **                  | ** ** | **At September  30, 2008** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **(In thousands)**              | ** ** |
| Convertible debentures, net |       | $                                    | 7,648      |   |
| Other                       |       | 12                                   |       |
|                        |       | $                                    | 7,660      |   |

 

At September 30,2008, we had a credit facility with Silicon Valley Bank that provided for lineof credit borrowings of up to $10.0 million. Under this credit facility, we could borrow against eligible accountsreceivable and eligible inventory, as defined in the credit agreement. Intereston borrowed amounts under the line of credit was payable monthly at the currentstated prime rate plus 1.00%. Additionally, we were obligated to pay an unusedline fee of 0.25% per annum applied to the amount by which the maximum creditamount exceeded the average daily principal balance during the preceding month.The credit facility required $2,000 in monthly collateral management fees andincluded an early termination fee equal to 2% of the total facility during thefirst year of the agreement and 1% of the total facility in the second year ofthe agreement. The credit facility was secured by substantially all of ourassets.  On September 30, 2008, theavailable credit under this credit facility was $9.1 million, all of which wasunused.  This credit facility expired on October 15,2008.

 

Effective October 16,2008, we entered into a new two-year $19.5 million credit facility withCalifornia Bank & Trust, which replaced our existing $10.0 millioncredit facility.  This new creditfacility provides for revolving line of credit borrowings of up to $12.0million.  Interest on borrowed amountsunder this line of credit will be payable monthly at a rate equal to thecurrent stated prime rate up to the current stated prime rate plus 0.50%,depending on aggregate deposit balances maintained at the bank in relation tothe total loan commitment under the credit facility.  We are obligated to pay an unused line fee of0.25% per annum applied to the average unused portion of the $12.0 millionrevolving line of credit during the preceding month.

 

Under this new creditfacility, we may also borrow up to an additional $7.5 million in the form of a48 month term loan to retire all outstanding convertible debentures.  Principal payments under this term loan willnot be required until June 1, 2009. Interest on the term loan will be payable monthly at a rate equal to thecurrent stated prime rate plus 0.50% up to the current stated prime rate plus1.00%, depending on aggregate deposit balances maintained at the bank inrelation to the total loan commitment under the credit facility.  In October 2008, we paid a one-time loancommitment fee of $28,000 in connection with the term loan portion of thecredit facility.  The new credit facilitycontains no early termination fees and is secured by substantially all of ourassets.  In connection with the earlyretirement of $5.5 million of our convertible debentures in October 2008, weborrowed $5.1 million under the term note.

 

We believe that the cashgenerated from our operations, together with funds available under our creditagreement, will be sufficient to fund our operations for at least the nexttwelve months. However, should a shortfall occur, we may need to raiseadditional funds through other debt or equity financings.

 

**Contractual Obligations**

 

Ourcontractual obligations at September 30, 2008, updated to reflect theearly retirement and refinancing of convertible debentures in October 2008,were as follows:

 
| ** **             | ** ** | **Payments Due by Fiscal Year** | ** ** |
|------------------------|------------|-----------------------------------------------------|------------|
| ** **             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **             | ** ** | **(In thousands)**                             | ** ** |
| Notes payable          |       | $                                                   | 12         |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 12 |   |
| Convertible debentures |       | 320                                                 |       | 3,329 |   | 1,295 |   | 1,295 |   | 1,295 |   | 216 |   | 7,750 |   |
| Operating leases       |       | 946                                                 |       | 1,579 |   | 1,412 |   | 1,332 |   | 1,363 |   | 2,460 |   | 9,092 |   |
| Total                  |       | $                                                   | 1,278      |   | $ | 4,908 |   | $ | 2,707 |   | $ | 2,627 |   | $ | 2,658 |   | $ | 2,676 |   | $ | 16,854 |   |

 

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At September 30, 2008, we had firm commitments to purchaseinventory in the amount of $2.7 million during our next three fiscal quarters.

 

**Off Balance Sheet Arrangements**

 

In May 2004, we issued subordinated convertible debentures in anaggregate original principal amount of $10.1 million. These debentures aredue in full on May 18, 2009 and are convertible into shares of our commonstock at an initial conversion price of $3.61 per share. At September 30,2008, $7.8 million of these convertible debentures remained outstanding; and inOctober 2008, $5.5 million of these convertible debentures were retiredearly leaving $2.3 million of the originally issued convertible debenturesoutstanding.  Because these debenturesare conventionally convertible, we have not separately accounted for theconversion feature and, accordingly, no separate amounts are presented in ourcondensed consolidated financial statements in connection with this conversionfeature.

 

At September 30, 2008, outstanding warrants to purchase anaggregate of 246,250 shares of our common stock at an exercise price of $3.25per share were callable by us if the closing sales price of our common stockfor 20 consecutive days is equal to or greater than two times the exerciseprice of the warrants. Outstanding warrants to purchase an aggregate of75,000 shares of our common stock at an exercise price of $5.00 per sharewere callable by us if the price of our common stock for 20 consecutivedays is equal to or greater than one and a half times the exercise price of thewarrants.

 

In connection with warrants to purchase 246,250 shares of our commonstock at an exercise price of $3.25 per share, we are a party to certainregistration rights agreements that contain provisions under which we could besubjected to liquidated damages should we fail to maintain effectiveregistration statements for the underlying shares of common stock. Thesewarrants have been accounted for within equity in our condensed consolidatedbalance sheets in accordance with EITF 00-19, *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock*, and, accordingly, no liabilities have beenrecorded in connection therewith. As of the date of this filing, no liquidateddamages are payable under the provisions of the registration rights agreementsassociated with these warrants.

 

**Seasonality**

 

We have historically experienced, and expect to continue to experience,seasonality, 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 limitedto our line of credit and our new bank term note. Our line of credit bearsinterest based on the prevailing prime rate (5.00% at September 30, 2008).We do not believe that a 10% increase in the interest rate on our line ofcredit or bank term note (6.00% to 6.60%) would have a material impact on ourfinancial position, operating results or cash flows. In addition, we believethat the carrying value of our outstanding debt approximates fair value.

 

**ITEM 4T. CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

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

 

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**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.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

The information set forth under the heading “Litigation and OtherContingencies” in Note 4 of Notes to Unaudited Condensed Consolidated FinancialStatements, included in Part I, Item I of this report, is incorporatedherein by reference.

 

**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.*

 

**An Economic Slowdown Could Lead To Reduced OrDelayed Government Funding For Transportation Infrastructure And InitiativesAnd Decreased Availability Of Financial Capital For Our Customers, Causing ADecline In Our Revenues. **Concernsabout decreased consumer confidence, the availability and cost of credit, andreduced corporate profits and capital spending have resulted in a downturn inworldwide economic conditions. These unfavorable economic conditions may have anegative impact on customer orders and government funding of infrastructureprojects incorporating our products and services. Such concerns may result incancellations and rescheduling of backlog. In addition, the recent decline inthe U.S. real estate market, particularly in new home construction, hasadversely impacted new road construction and could result in a decline inRoadway Sensor and Vehicle Sensor net sales and Transportation Systems contractrevenues. Any of the foregoing economic conditions make it extremely difficultfor our customers, our suppliers and us to accurately forecast and plan futurebusiness activities and could result in a decline in our net sales and contractrevenues. If such conditions continue or worsen, our business, financialcondition and results of operations could be materially and adversely affected.

 

**Current BudgetaryConstraints And The Significant Military Operations In The Middle East OrElsewhere May Impact Government Funding Or Consumer Spending, Causing A DeclineIn Our Revenues.**In the near term, the funding of U.S.military operations in the Middle East or elsewhere may cause disruptions infunding of government contracts. Since military operations of such magnitudeare not routinely included in U.S. defense budgets, supplemental legislativefunding actions are often required to finance such operations. Even when suchlegislation is enacted, it may not be adequate for ongoing operations, causingother government resources to be temporarily or permanently diverted. Since asignificant portion of our sales are derived from contracts with governmentagencies, such diversion of funds could produce interruptions in funding ordelays in receipt of our contracts, causing disruptions and adversely effectingour revenue and operations.

 

**We Depend On Government Contracts AndSubcontracts, And Because Many Of Our Government Contracts Are Fixed PriceContracts, Higher Than Anticipated Costs Will Reduce Our Profit And CouldAdversely Impact Our Operating Results.**A significantportion of our sales are derived from contracts with governmental agencies,either as a general contractor, subcontractor or supplier. Government contractsrepresented approximately 38.1%, 37.8% and 38.3% of our total net sales andcontract revenues for the years ended March 31, 2008, 2007 and 2006,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:

 
| · |   | long purchase cycles or approval processes;                                                                                                                                                            |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| · |   | competitive bidding and qualification  requirements;                                                                                                                                                   |
|   |   |                                                                                                                                                                                                   |
| · |   | the impact of international conflicts;                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                   |
| · |   | 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 in  2009; |
|   |   |                                                                                                                                                                                                   |
| · |   | performance bond requirements;                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                   |
| · |   | changes in government policies and  political agendas;                                                                                                                                                 |

 

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| · |   | other government budgetary constraints and  cut-backs; and                                        |
|--------|--------|---------------------------------------------------------------------------------------------------|
|   |   |                                                                                              |
| · |   | milestone requirements and liquidated  damage provisions for failure to meet contract milestones. |

 

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 givenquarter. 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.

 

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

 

**We May Be Unable To Attract And RetainKey Personnel, Which Could Seriously Harm Our Business.**Dueto the specialized nature of our business, we are highly dependent on thecontinued service of our executive officers and other key management,engineering and technical personnel. The loss of Abbas Mohaddes, our ChiefExecutive Officer, or any of the other executive officers or key members ofmanagement could adversely affect our business, financial condition or resultsof operations. Our success will also depend in large part upon our ability tocontinue to attract, retain and motivate qualified engineering and other highlyskilled technical personnel. In particular, the future success of ourTransportation Systems segment will depend on our ability to hire additionalqualified engineers and planners. Competition for qualified employees,particularly development engineers, is intense. We may not be able to continueto attract and retain sufficient numbers of such highly skilled employees. Ourinability to attract and retain additional key employees or the loss of one ormore of our current key employees could adversely affect our business,financial condition and results of operations.

 

**The Markets In Which We Operate Are HighlyCompetitive And Have Many More Established Competitors, Which Could AdverselyAffect Our Sales Or The Market Acceptance Of Our Products.**Wecompete with numerous other companies in our target markets including, but notlimited to, large, multinational corporations, which include tier oneautomotive suppliers, and many smaller regional engineering firms. We expectsuch competition to increase due to technological advancements, industryconsolidations and reduced barriers to entry. Increased competition is likelyto result in price reductions, reduced gross margins and loss of market share,any of which could seriously harm our business, financial condition and resultsof operations. In fiscal 2007, we began to experience more competition in ourRoadway Sensors segment as the Department of Transportation in one of ourlargest sales territories moved to a multi-source contracting environment fromone in which we were the sole supplier. In addition, one of the otherdevelopers of LDW systems was acquired by a larger company during fiscal 2007,who in July 2008 sold its in-vehicle vision business to a multi-nationalmanufacturer and supplier of in-vehicle safety products. This new competitorcould be more aggressive in both the passenger car and heavy truck markets, asa result of its greater access to resources and reputation in the market.Additional new competitors may enter this market in the future. Furthermore,awareness of LDW technology is increasing and other market players areattempting to develop competing technologies, which may contain improvements oradded features beyond those offered by our LDW systems. Additionally, from timeto time, we may be required to re-compete for LDW business from our maincustomer base of heavy truck OEMs. These OEMs could make a supplier changebased on price, product performance or available features. Should ourcompetition be successful, this could erode our ability to successfully marketand sell our LDW systems to new and existing customers.

 

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

 

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**If We Are Unable To Develop And Introduce NewProducts And Product Enhancements Successfully And In A Cost-Effective AndTimely Manner, Or Are Unable To Achieve Market Acceptance Of Our New Products,Our Operating Results Would Be Adversely Affected.**Webelieve our revenue growth and future operating results will depend on ourability to complete development of new products and enhancements, introducethese products in a timely, cost-effective manner, achieve broad marketacceptance of these products and enhancements, and reduce our product costs. Wecannot guarantee the success of these products and we may not be able tointroduce any new products or any enhancements to our existing products on atimely basis, or at all. In addition, the introduction of any new productscould adversely affect the sales of certain of our existing products.

 

We believe that we must continue to makesubstantial investments to support ongoing research and development in order toremain competitive. We need to continue to develop and introduce new productsthat incorporate the latest technological advancements in outdoor imageprocessing hardware, software and camera technologies in response to evolvingcustomer requirements. We cannot assure you that we will be able to adequatelymanage product transition issues. Our business and results of operations couldbe adversely affected if we do not anticipate or respond adequately totechnological developments or changing customer requirements or if we cannotadequately manage inventory issues typically related to new product transitionsand introductions. We cannot assure you that any such investments in researchand development will lead to any corresponding increase in revenue.

 

Market acceptance of our new products dependsupon many factors, including our ability to accurately predict marketrequirements and evolving industry standards, our ability to resolve technicalchallenges in a timely and cost-effective manner, qualify any new products withOEMs and achieve manufacturing efficiencies, the perceived advantages of ournew products over traditional products and the marketing capabilities of ourindependent distributors and strategic partners, including Valeo’s ability toexpand sales of AutoVue in the passenger car market. The success of our AutoVuesystem will also depend in part on the success of the automotive vehicles thatincorporate our technology, as well as the success of optional equipment that OEMsbundle with our technologies.

 

Certain of the components used in our Vantageand AutoVue products may need to be re-engineered in the next 12 to 36 monthsas the industry is moving towards a standard of using lead-free components. Wecannot assure you as to the timing of the adoption of this new standard or ourability to successfully redesign our products to incorporate compliantcomponents and gain market acceptance of such redesigned products. In addition,if the standard is adopted earlier than anticipated we may experience ashortage of Vantage and AutoVue products as a result of potential scarcity oflead-free components.

 

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

 

**New EnvironmentalRegulations May Result In A Decline In Our Vehicle Sensors Net Sales.**From time to time, environmental regulationsare enacted, which can significantly increase the cost of manufacturing newvehicles as well as the cost of maintenance of existing vehicles and truckfleets.  As a result, we could experiencea decline in sales of our Vehicle Sensors products as truck and vehiclemanufacturers and fleet operators attempt to control their costs.

 

**We May Engage In Acquisitions Of CompaniesOr Technologies That May Require Us To Undertake Significant CapitalInfusions And Could Result In Disruptions Of Our Business And Diversion OfResources And Management Attention.**We havehistorically acquired, and may in the future acquire, complementary businesses,products and technologies. Acquisitions may require significant capitalinfusions and, in general, acquisitions also involve a number of special risks,including:

 
| · |   | 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;                                                                                                                     |

 

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

 

**We Depend Upon Valeo To Market Our AutoVue TechnologiesFor The OEM Passenger Car Market.**We have grantedValeo the exclusive right to sell and manufacture our AutoVue LDW system to theworldwide passenger car market in exchange for royalty payments for eachAutoVue unit sold. As such, the future success and broad market acceptance ofour AutoVue technologies in the passenger car market will depend upon Valeo’sability to manufacture market and sell our technologies, and to convince moreOEM passenger car manufacturers to adopt our technologies.  To date, we have not generated significantroyalties from Valeo’s efforts and have only been designed into one car OEMproduct line.  If Valeo does not devoteconsiderable resources and aggressively pursue opportunities, our expansioninto the passenger car market could be adversely affected.

 

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

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

 

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

 
| · |   | 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;                         |

 

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

 

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

 

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

 

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

 

As of March 31, 2005, we became aware ofa material weakness in our internal controls related to the accounting for theconsolidation of our deferred compensation savings plan and certain contractadministration. Based on our evaluation, our management concluded that, as of March 31,2004, our internal control over financial reporting was not effective due tothe existence of one material weakness. The weakness was immediately corrected.We cannot assure you that we or our independent registered public accountingfirm will not identify additional material weaknesses in our internal controls.A material weakness is a control deficiency, or combination of controldeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not be preventedor detected. If our internal controls over financial reporting are notconsidered adequate, we may experience a loss of public confidence, which couldhave an adverse effect on our business and our stock price.

 

**We May Need To Raise Additional CapitalIn The Future, Which May Not Be Available On Terms Acceptable To Us, Or AtAll. **Untilrecently, we have historically generated significant net losses and operatinglosses, and have experienced volatility in our cash flows from operationsranging from positive cash flows from operations of $7.6 million in the fiscalyear ended March 31, 2008 to negative cash flows from operations of $2.0million in the fiscal year ended March 31, 2007. Additionally, as of September 30,2008, we had $7.8 million in subordinated convertible debentures outstandingthat are due in full in May 2009. Although we entered into a new creditagreement, effective October 16, 2008, that provides for up to $7.5million to be utilized to retire all outstanding convertible debentures, shouldwe have an event of default, which includes a failure to meet certain financialcovenants and a material adverse change in the business, the bank could chooseto limit or take away our ability to borrow these or any funds.  Should this occur and the holders of theconvertible debentures not elect to convert the principal into shares of ourcommon stock, we may need to raise additional capital to refinance this debt.

 

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At September 30,2008, we had $3.8 million of cash and cash equivalents and relied partly on ourline of credit to fund our operations. We may need to raise additional capitalin the near future to fund our operations or to repay indebtedness. Suchadditional 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;                                                                                 |
|   |   |                                                                                                                             |
| · |   | government budgets, political agendas and  other funding issues, including potential delays in government contract  awards;      |
|   |   |                                                                                                                             |
| · |   | our ability to successfully negotiate  credit arrangements with our bank and repay our subordinated convertible  debentures; and |
|   |   |                                                                                                                             |
| · |   | general economic conditions, including the  effects of the current economic slowdown and international conflicts.                |

 

If our capital requirements are materiallydifferent from those currently planned, we may need additional capital soonerthan anticipated. If additional funds are raised through the issuance of equityor convertible debt securities, the percentage ownership of our stockholderswill be 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 AsA Result Of Many Factors. Therefore, We May Fail To Meet Or Exceed TheExpectations Of Securities Analysts And Investors, Which Could Cause Our StockPrice To Decline.**Our quarterly revenues and operatingresults have fluctuated and are likely to continue to vary from quarter toquarter due to a number of factors, many of which are not within our control.Factors that could affect our revenues include, among others, the following:

 
| · |   | changes in our pricing policies and the  pricing policies of our suppliers and competitors, pricing concessions on  volume sales, as well as increased price competition in general; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                 |
| · |   | the long lead times associated with  government contracts or required by vehicle manufacturers;                                                                                      |
|   |   |                                                                                                                                                                                 |
| · |   | the size, timing, rescheduling or  cancellation of significant customer orders;                                                                                                      |
|   |   |                                                                                                                                                                                 |
| · |   | delays in government contracts and funding  from time to time and budgetary constraints at the federal, state and local  levels;                                                     |

 

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| · |   | declines in new home construction and  related road and other infrastructure construction;                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                 |
| · |   | our ability to control costs;                                                                                                                                        |
|   |   |                                                                                                                                                                 |
| · |   | our ability to raise additional capital;                                                                                                                             |
|   |   |                                                                                                                                                                 |
| · |   | the mix of our products and services sold  in a quarter, which mix has varied and is expected to continue to vary from  time to time;                                |
|   |   |                                                                                                                                                                 |
| · |   | seasonality due to winter weather  conditions;                                                                                                                       |
|   |   |                                                                                                                                                                 |
| · |   | international conflicts and acts 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 the products  incorporating our technologies and products;                                                                                      |
|   |   |                                                                                                                                                                 |
| · |   | the introduction of new products by  competitors;                                                                                                                    |
|   |   |                                                                                                                                                                 |
| · |   | the availability and cost of components  used in the manufacture of our products;                                                                                    |
|   |   |                                                                                                                                                                 |
| · |   | our success in expanding and implementing  our sales and marketing programs;                                                                                         |
|   |   |                                                                                                                                                                 |
| · |   | the effects of technological changes in our  target markets;                                                                                                         |
|   |   |                                                                                                                                                                 |
| · |   | the amount of our backlog at any given  time;                                                                                                                        |
|   |   |                                                                                                                                                                 |
| · |   | the nature of our government contracts;                                                                                                                              |
|   |   |                                                                                                                                                                 |
| · |   | deferrals of customer orders in  anticipation of new products, applications or product enhancements;                                                                 |
|   |   |                                                                                                                                                                 |
| · |   | risks and uncertainties associated with our  international business;                                                                                                 |
|   |   |                                                                                                                                                                 |
| · |   | currency fluctuations and our ability to  get currency out of certain foreign countries; and                                                                         |
|   |   |                                                                                                                                                                 |
| · |   | general economic and political conditions.                                                                                                                           |

 

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

 

**We HaveExperienced Growth In Recent Periods. If We Fail To Manage Our Growth Effectively,We May Be Unable To Execute Our Business Plan And May ExperienceFuture Weaknesses In Our Internal Controls.**We have expandedour overall business. In order to achieve our business objectives, we will needto continue to expand our business and add additional qualified personnel. Suchexpansion has placed and is expected to continue to place, a significant strainon our managerial, administrative, operational, financial and other resources.If we are unable to successfully manage our growth, our business, financialcondition and results of operations will be adversely affected.

 

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

 

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Litigation may be necessary in the future to enforce our intellectualproperty rights or to determine the validity and scope of the proprietaryrights of others. Litigation may also be necessary to defend against claims ofinfringement or invalidity by others. An adverse outcome in litigation or anysimilar proceedings could subject us to significant liabilities to thirdparties, require us to license disputed rights from others or require us tocease marketing or using certain products or technologies. We may not be ableto obtain any licenses on terms acceptable to us, or at all. We also may haveto indemnify certain customers or strategic partners if it is determined thatwe have infringed upon or misappropriated another party’s intellectualproperty. Any of these results could adversely affect our business, financialcondition and results of operations. In addition, the cost of addressing anyintellectual property litigation claim, including legal fees and expenses, andthe diversion of management’s attention and resources, regardless of whetherthe claim is valid, could be significant and could seriously harm our business,financial condition and results of operations.

 

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

 

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

 
| · |   | quarterly variations in operating results;                                                                       |
|--------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                             |
| · |   | our ability to control costs, improve cash  flow and sustain profitability;                                      |
|   |   |                                                                                                             |
| · |   | our ability to raise additional capital;                                                                         |
|   |   |                                                                                                             |
| · |   | shortages announced by suppliers;                                                                                |
|   |   |                                                                                                             |
| · |   | announcements of technological innovations  or new products or applications by our competitors, customers or us; |
|   |   |                                                                                                             |
| · |   | transitions to new products or product  enhancements;                                                            |
|   |   |                                                                                                             |
| · |   | acquisitions of businesses, products or  technologies;                                                           |
|   |   |                                                                                                             |
| · |   | the impact of any litigation;                                                                                    |
|   |   |                                                                                                             |
| · |   | changes in investor perceptions;                                                                                 |
|   |   |                                                                                                             |
| · |   | government funding, political agendas and  other budgetary constraints;                                          |
|   |   |                                                                                                             |
| · |   | changes in earnings estimates or investment  recommendations by securities analysts; and                         |
|   |   |                                                                                                             |
| · |   | international conflicts, political unrest and  acts of terrorism.                                                |

 

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

 

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**We Could Experience Negative FinancialImpacts Arising From Developments In Contingencies Created Under Our PreviousStructure Or By Former Subsidiaries.**Although wedivested ourselves of all business units prior to October 2004, with theexception of our Iteris business, from time to time we could experienceunforeseen developments in contingencies related to our former subsidiaries.For example, in July 2006 we entered into a settlement agreement inconnection with a lawsuit brought against Mariner Networks, Inc., one ofour former subsidiaries, by one of Mariner’s suppliers, pursuant to which weissued 88,912 shares of our common stock to this supplier (valued at $213,000as of the date of issuance), paid this supplier $125,000 on October 20,2006 and are required to pay an additional $350,000 in 36 equal monthlyinstallments of $9,700 through October 2009. Although we are not aware ofany other material contingencies, it is possible that other matters could bebrought against us in connection with activities related to former subsidiariesand that such matters could materially and adversely affect our financialresults and cash flows.

 

**Some Of Our Directors, Officers And TheirAffiliates Can Control The Outcome Of Matters That Require The Approval Of OurStockholders, And Accordingly We Will Not Be Able To Engage In CertainTransactions Without Their Approval.**As of September 30,2008, our officers and directors beneficially owned approximately 11% of theoutstanding shares of our common stock (and approximately 15% of our commonstock when including options, warrants and other convertible securities held bythem which are currently exercisable or convertible or will become exercisableor convertible within 60 days after September 30, 2008). As a resultof their stock ownership, our management will be able to influence the electionof our directors and the outcome of corporate actions requiring stockholderapproval, such as mergers and acquisitions, regardless of how our otherstockholders may vote. This concentration of voting control may have asignificant effect in delaying, deferring or preventing a change in ourmanagement or change in control and may adversely affect the voting or otherrights of other holders of common stock.

 

**Certain Anti-Takeover Provisions May AffectThe Price Of Our Common Stock And Discourage A Third Party From Acquiring Us.**Certainprovisions of our certificate of incorporation could make it difficult for a thirdparty to acquire us, even though an acquisition might be beneficial to ourstockholders. Such provisions could limit the price that investors might bewilling to pay in the future for shares of our common stock. Under the terms ofour certificate of incorporation, our Board of Directors is authorized toissue, without stockholder approval, up to 2,000,000 shares of preferred stockwith voting, conversion and other rights and preferences superior to those ofour common stock. Our future issuance of preferred stock could be used todiscourage an unsolicited acquisition proposal.

 

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

 

None.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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

 

In connection with our Annual Meeting of Stockholders held on September 19,2008, the following proxies were tabulated representing 24,090,544 shares ofour common stock or 70.9% of the outstanding shares as of the record date forthe meeting:

 

**Proposal I**:**Election of the Board of Directors**

 
| **Director Nominee** | ** ** | **Total Votes for  Each Director** | ** ** | **Total Votes Withheld from  Each Director** | ** ** |
|---------------------------|------------|---------------------------------------------------|------------|------------------------------------------------------------------|------------|
| Richard J. Char           |       | 23,571,392                                        |       | 519,152                                                          |       |
| Kevin C. Daly, Ph.D.      |       | 22,649,943                                        |       | 1,440,601                                                        |       |
| Gregory A. Miner          |       | 23,360,150                                        |       | 730,394                                                          |       |
| Abbas Mohaddes            |       | 23,558,571                                        |       | 531,973                                                          |       |
| John W. Seazholtz         |       | 23,537,788                                        |       | 552,756                                                          |       |
| Joel Slutzky              |       | 22,005,717                                        |       | 2,084,827                                                        |       |
| Thomas L. Thomas          |       | 23,538,288                                        |       | 552,256                                                          |       |

 

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**Proposal II: Ratification of McGladrey &Pullen, LLP as the independent auditors of Iteris for the fiscal year ending March 31,2009:**

 
| ** ** | ** ** | **Shares of Common Stock** | ** ** |
|------------|------------|-------------------------------------------|------------|
| For        |       | 23,863,263                                |       |
| Against    |       | 187,049                                   |       |
| Abstain    |       | 40,232                                    |       |
| Non-votes  |       | —                                    |       |

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

**ITEM 6. EXHIBITS**

 

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

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                              | ** ** | **Where Located**                                                                                                                                                         |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Amended and Restated Certificate of Incorporation of the registrant                                                                          | * *   | *Exhibit 3.1 to the registrant’s Current Report on Form 8-K  as filed with the SEC on October 28, 2004*                                                    |
| * *            | * *   | * *                                                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.2                 |       | Certificate of Amendment to Amended and Restated Certificate of  Incorporation filed September 26, 2007                                 | * *   | *Exhibit 3.2 to the registrant’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2007 as filed with  the SEC on November 13, 2007* |
| * *            | * *   | * *                                                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.3                 |       | Bylaws of registrant, as amended                                                                                                             | * *   | *Exhibit 4.2 to the registrant’s Registration Statement on  Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6,  1993*                     |
| * *            | * *   | * *                                                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.4                 |       | Certificates of Amendment to Bylaws of the registrant dated  April 24, 1998 and August 10, 2001                                    | * *   | *Exhibit 3.4 to the registrant’s Annual Report on  Form 10-K/A for the year ended March 31, 2003 as filed with the SEC  on July 29, 2003*             |
| * *            | * *   | * *                                                                                                                                     | * *   | * *                                                                                                                                                                       |
| 3.5                 |       | Certificate of Amendment to Bylaws of registrant dated  September 9, 2004                                                               | * *   | *Exhibit 3.1 to the registrant’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2004 as filed with  the SEC on November 15, 2004* |
|                |       |                                                                                                                                         |       |                                                                                                                                                                           |
| 3.6                 |       | Certificate of Amendment to Bylaws of registrant dated  September 16, 2005                                                              | * *   | *Exhibit 3.5 to the registrant’s Annual Report on Form 10-K  for the year ended March 31, 2007 as filed with the SEC on June 21,  2007*               |
|                |       |                                                                                                                                         |       |                                                                                                                                                                           |
| 3.7                 |       | Certificate of Amendment to Bylaws of registrant dated  December 7, 2007                                                                | * *   | *Exhibit 3.1 to the registrant’s Current Report on Form 8-K  as filed with the SEC on December 13, 2007*                                                   |
|                |       |                                                                                                                                         |       |                                                                                                                                                                           |
| 4.1                 |       | Specimen of Common Stock Certificate                                                                                                         | * *   | *Exhibit 4.1 to the registrant’s Amendment No. 1 to the  Registration Statement on Form 8-A as filed with the SEC on  December 8, 2004*               |
|                |       |                                                                                                                                         |       |                                                                                                                                                                           |
| 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 31, 2008 | ITERIS, INC. |
|------------------------------|--------------|
|                         | (Registrant) |
|                         |         |
|                         | By           | /S/ ABBAS MOHADDES |
|                         |         | Abbas Mohaddes |
|                         |         | Chief Executive Officer |
|                         |         | (Principal Executive Officer) |
|                         |         |
|                         |         |
|                         | By           | /S/ JAMES S. MIELE |
|                         |         | James S. Miele |
|                         |         | Chief Financial Officer |
|                         |         | (Principal Financial and Accounting Officer) |

 

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