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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-K**

 

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**(Mark One)**

 

| **x**                                              | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                               |                                                                                                     |
| **For the fiscal year ended  March 31, 2010** |
|                                               |                                                                                                     |
| **OR**                                             |
|                                               |                                                                                                     |
| **o**                                              | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from              to              **

 

**Commission file number 001-08762**

** **

****

** **

**ITERIS, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Delaware**                                                     | ** ** | **95-2588496**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization) |       | (I.R.S. Employer  Identification No.) |

 

**1700 Carnegie Ave., Santa Ana, California 92705**

(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s Telephone Number, Including Area Code: **(949) 270-9400**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of each class** | ** ** | **Name of each exchange on which registered** |
|----------------------------------------|------------|-----------------------------------------------------------------------------|
| Common Stock, $0.10 par  value         |       | NYSE Amex                                                                   |

 

Securities registeredpursuant to Section 12(g) of the Act: **None**

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act.  Yes o No x

 

Indicate by check mark if the registrant is not required to file reportspursuant to Section 13 or Section 15(d) of the Act.  Yes oNo x

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes  x  No  o

 

Indicate by a check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes  o  No  o

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Exchange Act Rule 12b-2). Yes o No x

 

Based on the closing sale price of the registrant’s common stock on thelast business day of the registrant’s most recently completed second fiscalquarter, the aggregate market value of the voting common stock held bynonaffiliates of the registrant was approximately $32,703,000. For the purposesof this calculation, shares owned by officers, directors and 10% stockholdersknown to the registrant have been deemed to be owned by affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

 

As of May 14, 2010, there were 34,331,756 shares of our commonstock outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III incorporates by reference certain information from theregistrant’s definitive proxy statement for the 2010 Annual Meeting ofStockholders, which will be filed with the Securities and Exchange Commissionnot later than 120 days after the end of the fiscal year ended March 31,2010. Except with respect to information specifically incorporated by referencein this report, the registrant’s proxy statement is not deemed to be filed as apart hereof.

 

 

 

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**ITERIS, INC.**

**ANNUAL REPORT ON FORM 10-K**

**FOR THE FISCAL YEAR ENDED MARCH 31, 2010**

**TABLE OFCONTENTS**

 
| **PART I**   |                                                                                                                          |
|-------------------|-------------------------------------------------------------------------------------------------------------------------------|
|              |                                                                                                                          |   |
| ITEM 1.           | BUSINESS                                                                                                                      | 2 |
|              |                                                                                                                          |   |
| ITEM 1A.          | RISK FACTORS                                                                                                                  | 6 |
|              |                                                                                                                          |   |
| ITEM  1B.         | UNRESOLVED  STAFF COMMENTS                                                                                                    | 15 |
|              |                                                                                                                          |   |
| ITEM 2.           | PROPERTIES                                                                                                                    | 15 |
|              |                                                                                                                          |   |
| ITEM 3.           | LEGAL  PROCEEDINGS                                                                                                            | 15 |
|              |                                                                                                                          |   |
| ITEM 4.           | (REMOVED AND  RESERVED)                                                                                                       | 15 |
|              |                                                                                                                          |   |
| **PART II**  | 16                                                                                                                            |
|              |                                                                                                                          |   |
| ITEM  5.          | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES | 16 |
|              |                                                                                                                          |   |
| ITEM 6.           | SELECTED  FINANCIAL DATA                                                                                                      | 16 |
|              |                                                                                                                          |   |
| ITEM  7.          | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                              | 16 |
|              |                                                                                                                          |   |
| ITEM  7A.         | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                   | 29 |
|              |                                                                                                                          |   |
| ITEM  8.          | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                                  | 29 |
|              |                                                                                                                          |   |
| ITEM  9.          | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                         | 29 |
|              |                                                                                                                          |   |
| ITEM  9A(T).      | CONTROLS  AND PROCEDURES                                                                                                      | 30 |
|              |                                                                                                                          |   |
| ITEM 9B.          | OTHER  INFORMATION                                                                                                            | 30 |
|              |                                                                                                                          |   |
| **PART III** | 30                                                                                                                            |
|              |                                                                                                                          |   |
| ITEM  10.         | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                                       | 30 |
|              |                                                                                                                          |   |
| ITEM 11.          | EXECUTIVE  COMPENSATION                                                                                                       | 31 |
|              |                                                                                                                          |   |
| ITEM  12.         | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED  STOCKHOLDER MATTERS                         | 31 |
|              |                                                                                                                          |   |
| ITEM  13.         | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                                    | 31 |
|              |                                                                                                                          |   |
| ITEM  14.         | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                                       | 31 |
|              |                                                                                                                          |   |
| **PART IV**  | 31                                                                                                                            |
|              |                                                                                                                          |   |
| ITEM  15.         | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                                   | 31 |

 

Unlessotherwise indicated in this report, the “Company,” “we,” “us” and “our” referto Iteris, Inc. and our wholly-owned subsidiary, Iteris Europe, GmbH.

 

AutoVue®, Iteris®,Vantage®, VantageViewTM, VersiCamTM, SafetyDirectTM and AbacusTM are among thetrademarks of Iteris, Inc. Any other trademarks or trade names mentionedherein are the property of their respective owners.

 

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**CautionaryStatement**

 

*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,” “would,” “could,” “may,” “anticipate(s),” “estimate(s)”and similar expressions or variations of these words are intended to identifyforward-looking statements. These forward-looking statements include but arenot limited to statements regarding our anticipated sales, revenue, expenses,profits, capital needs, competition, backlog and manufacturing capabilities,the practical market applications, future applications and acceptance of ourproducts and services, the status of our facilities and product development.These statements are not guarantees of future performance and are subject tocertain risks and uncertainties which could cause 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 those* in “*Risk Factors”in Item 1A of this report, before deciding to invest in our company or tomaintain or increase your investment. We undertake no obligation to revise orupdate publicly any forward-looking statement for any reason.*

 

**PART I**

 

**ITEM 1.****                            ****BUSINESS**

 

**Overview**

 

We are a leader in thetraffic management market focused on the development and application ofadvanced technologies that reduce traffic congestion and improve the safety ofsurface transportation systems infrastructure. Additionally, we believe thatour products and services, as well as sound traffic management, minimize theenvironmental impact of traffic congestion. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broadrange of Intelligent Transportation Systems (“ITS”) and driver safety solutionsto customers worldwide.

 

We were originally incorporated in Delaware in 1987.Our principal executive offices are located at 1700 Carnegie Avenue, Santa Ana,California 92705, and our telephone number at that location is (949) 270-9400.Our Internet website address is www.iteris.com. Our annual reports on Form 10-K,quarterly reports on Form 10-Q and current reports on Form 8-K,together with amendments to these reports, are available on the “Investors”section of our website, free of charge, as soon as reasonably practicable aftersuch material is electronically filed with, or furnished to, the Securities andExchange Commission (“SEC”). The inclusion of our website address in thisreport does not include or incorporate by reference into this report anyinformation on our website.

 

**Productsand Services**

 

We currently operate inthree reportable segments: Roadway Sensors, Vehicle Sensors and TransportationSystems. The Roadway Sensors segment includes, among other products, ourVantage, Versicam and Pico vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications. The Vehicle Sensors segment includes our lanedeparture warning (“LDW”) products, including our AutoVue LDW system, and iscomprised of all activities related to in-vehicle safety. The TransportationSystems segment includes transportation engineering and consulting services,and the development of transportation management and traveler informationsystems for the ITS industry. See Note 10 of Notes to Consolidated FinancialStatements, included in Part IV, Item 15 of this report, for furtherdetails on our reportable segments.

 

*Roadway Sensors.* Our Roadway Sensors segment product lineuses advanced image processing technology to capture and analyze video imagesthrough sophisticated algorithms, enabling vehicle detection and transmissionof both video images and data using a wide range of communication technologies.Our Vantage video detection systems detect vehicle presence, count, speed,occupancy and other traffic data used in traffic management systems. OurVantage systems give traffic managers the ability to mitigate roadwaycongestion by modifying traffic signal timing or detecting incidents quickly.Our VantageView software supplements our Vantage video detection systems byproviding an integrated platform to manage and “see” video detection assetsremotely over a network connection. Vantage video detection systems have beendeployed by hundreds of agencies and are currently sold through a network ofindependent dealers in the United States (“U.S.”), Asia, Latin America, Europeand the Middle East. VersiCam, our integrated camera and processor videodetection system, is a cost-efficient video detection system for smallerintersections that require only a few detection points. In December 2009,we introduced Pico, a compact video detection system that delivers superiorvehicle detection in a small and economical framework, and was developedprimarily to address international video detection needs. We anticipate thatfuture growth domestically and internationally, particularly in developingcountries, will be dependent in part on the continued adoption of above-groundvideo detection technologies, instead of in-pavement loop technology, to managetraffic.

 

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Our Roadway Sensorsproduct line also includes the Abacus family of products, which has beendesigned with a blend of artificial intelligence and video detection algorithmsthat allow either fixed or pan-tilt-zoom cameras to be used for data collectionand incident detection. Our Abacus products take advantage of the large numberof existing installed closed-circuit television video feeds monitoringroadways, tunnels and bridges and at signalized intersections. This flexibilityof using a broad range of cameras with an appropriate perspective allows foraccurate data collection without the set-up and calibration required with othersystems.

 

*Vehicle Sensors.* Our Vehicle Sensors segment addressesthe leading causes of roadway fatalities: lane change, roadway departure andrear-end collision accidents. According to the National Highway Traffic SafetyAdministration (“NHTSA”), these three crash types result in more than 60% ofthe U.S.’s annual traffic fatalities and contribute to a considerable economicloss due to injuries, property damage, and decreased productivity. Earlyestimates by the NHTSA of motor vehicle traffic fatalities in 2009 wereapproximately 34,000.

 

Wedeveloped the world’s first production LDW system and offer a proven systemthat is available as an original equipment manufacturer (“OEM”) and aftermarketoption on heavy trucks worldwide and as an option in certain passenger cars.Our LDW products utilize video detection images to detect when a vehicle beginsto drift toward an unintended lane change. When this occurs, the unitautomatically emits a distinctive rumble strip or other audible warning sound,alerting the driver to make a correction. To date, we have sold approximately79,000 LDW systems into the heavy truck market in Europe, North America andAsia. Our LDW systems are currently qualified as an option on certain heavytrucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner andFUSO, as well as Neoplan and MAN luxury bus and coach lines. In North America,our LDW systems are sold primarily to truck fleets.

 

In March 2009,the European Union (“EU”) approved a mandate that sets better standards toimprove road safety in Europe. The new mandated rules for safetytechnology includes systems such as electronic stability control, advancedemergency braking and LDW systems to be compulsory on heavy-duty trucks andbuses to further reduce accident risks. LDW systems are expected tobe mandatory in Europe on all new heavy truck models beginning in2013. We believe that in order for the 2013 EU mandatefor active safety systems to have a positive impact on our sales, we need toestablish long-term supplier agreements with our European OEM heavy truckcustomers. To date we have agreements to supply certain of our European heavytruck customers through 2012 and we are actively working on agreements withother heavy truck OEMs that extend through 2013 and beyond in order to meet theanticipated increase in demand. However, we cannot assure you that our effortswill be successful or that the expected increase in demand will occur. We believe thatthe expected 2013 EU mandate for LDW and other active safety systems, and anincreasing overall awareness of the potential benefits of LDW, helps validatethe long-term market opportunity for LDW systems in commercial vehicles. Additionally, in North America we plan to developpartnerships with other manufacturers and suppliers of safety devices for heavytrucks to jointly sell our LDW systems and provide our SafetyDirect softwaretool to North American trucking fleets.

 

Wehave entered into an exclusive license of our LDW technology to our strategicpartner, Valeo Schalter and Sensuren GmbH (“Valeo”), for the passenger carmarket, resulting in sales to date of approximately 79,300 LDW systems forpassenger cars. We and our partner have recently experienced a greater degreeof competition in the passenger car market as several passenger car OEMs haveintroduced vehicle platforms with competing LDW systems. However, Valeo continuesto pursue opportunities in the passenger car market.

 

In addition to our LDW systems, our Vehicle Sensorsportfolio includes radar-based Forward Collision Warning (“FCW”) and Blind SpotWarning (“BSW”) systems for the North American truck market. We offer the FCWand BSW features through the resale of Delphi’s radar based systems, for whichwe are the exclusive North American dealer. Our portfolio also includes ourinternally-developed SafetyDirect software system, which can provide a singlepoint of access to monitor and synchronize driver performance data on braking,stability control, following distances, and lane departure warnings forindividual drivers as well as entire fleets. SafetyDirect uses informationtransmitted from the vehicle by the fleet’s onboard mobile communicationssystem to provide fleet operators with a comprehensive view of the entirefleet, as well as the ability to drill down to detailed information onindividual drivers and events. These products, together with our LDW products,combine to create a broad suite of active safety driver assistance featuresdesigned to help reduce the number of motor vehicle crashes and the severity ofcrash-related injuries.

 

*Transportation Systems.* Our Transportation Systems segmentincludes transportation engineering and consulting services focused on theplanning, design, development and implementation of software-based systems thatintegrate sensors, video surveillance, computers and advanced communicationsequipment to enable public agencies to monitor, control and direct trafficflow, assist in the quick dispatch of emergency crews and distribute real-timeinformation about traffic conditions. Our services include planning, design andimplementation of surface transportation infrastructure systems. We performanalysis and study goods movement, commercial vehicle operations, travel demandforecasting and systems engineering, and identify mitigation measures to 

 

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reduce trafficcongestion. These services and systems have historically been primarily sold tolocal, state and national transportation agencies in the U.S.; however, duringthe fiscal year ended March 31, 2010 (“Fiscal 2010”), we began work on ourfirst overseas contracts in Abu Dhabi and Dubai, and plan to continue to pursueadditional international business. Our Transportation Systems segment islargely dependent upon governmental funding, and is affected by state and localbudgetary issues.

 

**Sales,Marketing and Principal Customers**

 

We sell our RoadwaySensors products through indirect sales channels comprised of a strong networkof independent dealers in the U.S. and Canada who sell integrated systems andrelated products to the traffic management market, as well as directly to thetraffic management market using a combination of our own sales personnel and anoutside sales organization. Our independent dealers are well-trained in, andprimarily responsible for, sales, installation, set-up and support of ourproducts, and maintain an inventory of demonstration traffic products fromvarious manufacturers including our vehicle detection systems and sell directlyto government agencies and installation contractors. These dealers often havelong-term arrangements with local government agencies in their respectiveterritories for the supply of various products for the construction andrenovation of traffic intersections, and are generally well-known suppliers ofhigh-quality ITS products to the traffic management market. We periodicallyhold technical training classes for our dealers and end users and maintain afull-time expert staff of customer support technicians throughout the U.S. toprovide technical assistance when needed. When appropriate, we have the abilityto modify or make changes to our dealer network to best suit the needs of themarket and our customer base. In the states where we sell direct, we use ourown expert staff to sell, oversee installations and set-up issues and supportour products.

 

Our marketing strategyfor our Vehicle Sensors segment is to establish our LDW products as the leadingplatform for in-vehicle video sensing for heavy trucks and passenger cars. Wesell LDW systems directly to heavy truck manufacturers and to U.S. truckfleets, and our LDW system is currently offered as an option on certain heavytrucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner andFUSO, as well as Neoplan and MAN luxury bus and coach lines. We market thelicensing of our LDW technology to manufacturers of passenger automobilesthrough an exclusive strategic relationship with Valeo. In connection with thismarketing effort, we provide specific contract engineering services, technicalmarketing and sales support to Valeo, which to date has enabled the launch ofour LDW technology on three Infiniti car platforms, with a fourth platformexpected in the summer of 2010. We plan to continue to provide technicalmarketing and sales support to Valeo in our efforts to win new OEM customersfor the passenger car market, as well as contract engineering services relatedto the possible launch of new platforms that include our LDW system.

 

We market and sell ourTransportation Systems services directly to government agencies pursuant tonegotiated contracts that involve competitive bidding and specificqualification requirements. Most of our Transportation Systems contracts arewith federal, state and municipal customers and generally provide forcancellation or renegotiation at the option of the customer upon reasonablenotice and fees paid for modification. We use selected members of ourengineering team on a regional basis to serve in sales and business developmentfunctions. Our Transportation Systems contracts generally involve long leadtimes and require extensive specification development, evaluation and pricenegotiations.

 

A large portion of ourrevenues are derived from sales to federal, state and local governmentagencies. We currently have a diverse customer base with no individual customerrepresenting greater than 10% of our total net sales and contract revenues inFiscal 2010, or in the fiscal years ended March 31, 2009 (“Fiscal 2009”)and March 31, 2008 (“Fiscal 2008”). Also refer to Note 10 of Notes toConsolidated Financial Statements, included in Part IV, Item 15 ofthis report.

 

**Manufacturing and Materials**

 

We use contractmanufacturers to build subassemblies that are used in our sensors products.Additionally, we procure certain components from qualified suppliers, bothglobally and locally, and generally use multi-sourcing strategies whentechnically and economically feasible to mitigate supply risk. Thesesubassemblies and components are delivered to our Santa Ana, California facilitywhere they go through final assembly and testing prior to shipment to ourcustomers. Certain of our key suppliers include CTS Electronics ManufacturingSolutions, Inc., SMS Technologies, Inc., Total Electronics LLC andHitachi American Ltd-UB. Our manufacturing activities are conducted inapproximately 9,000 square feet of space at our Santa Ana facility. Productionvolume at our subcontractors is based upon quarterly forecasts that wegenerally adjust on a monthly basis to control inventory levels. For LDWproducts sales to the passenger car market, all manufacturing has been and isexpected to be performed by Valeo; however, we plan to continue to provideengineering support to Valeo. We typically do not manufacture any of thehardware used in the transportation management and traveler information systemsthat we design and implement. Our production facility is currently ISO 9001certified.

 

**CustomerSupport and Services**

 

We provide warrantyservice and support for our products, as well as follow-up service and supportfor which we charge separately. Such service revenue accounted for less than1.0% of total net sales and contract revenues for each of Fiscal 2010 andFiscal 2009. We believe customer support is a key competitive factor.

 

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**Backlog**

 

Our total backlog ofunfulfilled firm orders was approximately $30.6 million as of March 31,2010, which was comprised of $1.6 million related to Roadway Sensors, $600,000related to Vehicle Sensors and $28.4 million related to Transportation Systems.Substantially all of the backlog for Roadway Sensors and Vehicle Sensors isexpected to be recognized as revenue in the fiscal year ending March 31,2011 (“Fiscal 2011”). We have historically recognized in the subsequent fiscalyear between 50% to 70% of our fiscal year end Transportation Systems backlog,and currently expect that trend to continue for Fiscal 2011. The timing andrealization of this backlog is subject to the inherent uncertainties of doingbusiness with federal, state and local governments, particularly in view ofbudgetary constraints, cut-backs and other delays or reallocations of fundingthat these entities typically face.

 

Pursuant to the customaryterms of our agreements with government contractors and other customers,customers can generally cancel or reschedule orders with little or nopenalties. Lead times for the release of purchase orders often depend upon thescheduling and forecasting practices of our individual customers, which alsocan affect the timing of the conversion of our backlog into revenues. For thesereasons, among others, our backlog at a particular date may not be indicativeof our future revenues, in particular for our Roadway Sensors and VehicleSensors segments.

 

**ProductDevelopment**

 

Most of our productdevelopment activities are conducted at our principal facilities in Santa Ana.Our research and development costs and expenses were approximately $3.7 millionfor Fiscal 2010, $4.0 million for Fiscal 2009 and $3.6 million for Fiscal 2008.We expect to continue to pursue various product development programs and incurresearch and development expenditures in future periods.

 

Webelieve our engineering and product development capabilities are a competitivestrength. We strive to continue to develop new products to meet the needs ofthe ever-changing ITS market as well as enhance and refine our existing productlines. Within the last twelve months we have introduced our VersiCam andVersiCam wireless products, Pico, Abacus and our new RZ-4 Advanced camera, aswell as our RZ-4 Advanced Wide Dynamic Range camera, which significantlyimproves video detection performance in certain harsh lighting conditions. Webelieve that developing new offerings across our segments and enhancing,refining and marketing our existing products is a key component of strongorganic growth and profitability.

 

**Competition**

 

We generally facesignificant competition in each of our target markets. Increased competitionmay result in price reductions, reduced gross margins and loss of market share,any of which could have a material adverse effect on our business, financialcondition and results of operations.

 

In the market for ourRoadway Sensors vehicle detection products, we compete with manufacturers anddistributors of other above ground video camera detection systems such as PeekTraffic Corporation, Wavetronix LLC, Econolite Control Products, Inc.,Traficon, N.V., Image Sensing Systems, Inc. and other non-intrusivedetection devices including microwave, infrared, ultrasonic and magneticdetectors, as well as manufacturers and installers of in-pavement inductiveloop products, which have historically, and currently continue to be, thepredominant detection system in this market.

 

In the market for ourVehicle Sensors systems, we believe that as a result of the expected 2013European mandate for LDW and other active safety systems, and an overallawareness of the potential benefits of LDW, that we will experience an evenhigher degree of competition from a variety of tier-one OEM suppliers and otherpotential market entrants, worldwide. Additionally, we and our strategicpartner (Valeo) have recently experienced a greater degree of competition inthe passenger car market as several passenger car OEMs have introduced vehicleplatforms with competing LDW systems. We consider competitors in this market toinclude Delphi Automotive Systems Corporation, NEC Corporation and Hitachi Ltd.in Japan and Robert Bosch GmbH in Europe, Continental Tavis, Visteon andTakata, all of which currently have developed or are developing video sensortechnologies for the vehicle industry that could be used for lane departurewarning systems.

 

The TransportationSystems market is highly fragmented and is subject to evolving national andregional quality and safety standards. Our competitors vary in number, scopeand breadth of the products and services they offer. Our competitors inadvanced Transportation Systems include national corporations such asTranscore, Siemens, Telvent Farradyne, Kimley-Horn and Associates, Inc.and Delcan. Our competitors in transportation engineering, planning and designinclude major firms such as Parsons Brinkerhoff, Inc., URS, HNTB andParsons Transportation Group, Inc., as well as many smaller regionalengineering firms.

 

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In general, the marketsfor the products and services we offer are highly competitive and arecharacterized by rapidly changing technology and evolving standards. Many ofour current and prospective competitors have longer operating histories,greater name recognition, access to larger customer bases and significantlygreater financial, technical, manufacturing, distribution and marketingresources than us. As a result, they may be able to adapt more quickly to newor emerging standards or technologies or to devote greater resources to thepromotion and sale of their products. It is also possible that new competitorsor alliances among competitors could emerge and rapidly acquire significantmarket share. We believe that our ability to compete effectively in our targetmarkets will depend on a number of factors, including the success and timing ofour new product development, the compatibility of our products with a broadrange of computing systems, product quality and performance, reliability,functionality, price and service and technical support. Our failure to provideservices and develop and market products that compete successfully with thoseof other suppliers and consultants in our target markets would have a materialadverse effect on our business, financial condition and results of operations.

 

**IntellectualProperty and Proprietary Rights**

 

Our ability to competeeffectively depends in part on our ability to develop and maintain theproprietary aspects of our technology. Our policy is to obtain appropriateproprietary rights protection for any potentially significant new technologyacquired or developed by us. We currently hold ten U.S. patents, which expirecommencing in 2012, relating to our outdoor image processing techniques used inour AutoVue LDW systems. Nine of these patents relate specifically to our LDWtechnology and provide a basis for enhanced functionality for rain sensing andimproved performance. Our other U.S. patent was issued for an ElectronicTraffic Monitor related to our Abacus product in the Roadway Sensors segment.We also have pending patent applications in Canada and the European Communityfor the Electronic Traffic Monitor. We cannot assure you that any new patentswill be granted pursuant to these or subsequent applications.

 

In addition to patentlaws, we rely on copyright and trade secret laws to protect our proprietaryrights. We attempt to protect our trade secrets and other proprietaryinformation through agreements with customers and suppliers, proprietaryinformation agreements with our employees and consultants, and other similarmeasures. We do not have any material licenses or trademarks other than thoserelating to product names. We cannot be certain that we will be successful inprotecting our proprietary rights. While we believe our patents, patentapplications, software and other proprietary know-how have value, changingtechnology makes our future success dependent principally upon our employees’technical competence and creative skills for continuing innovation.

 

Litigation may benecessary in the future to enforce our proprietary rights, to determine thevalidity and scope of the proprietary rights of others, or to defend us againstclaims of infringement or invalidity by others. An adverse outcome in suchlitigation or similar proceedings could subject us to significant liabilitiesto third parties, require disputed rights to be licensed from others or requireus to cease marketing or using certain products, any of which could have amaterial adverse effect on our business, financial condition and results ofoperations. In addition, the cost of addressing any intellectual propertylitigation claim, both in legal fees and expenses, as well as from thediversion of management’s resources, regardless of whether the claim is valid,could be significant and could have a material adverse effect on our business,financial condition and results of operations.

 

**Employees**

 

We refer to our employeesas associates. As of May 7, 2010, we employed an aggregate of 221associates, including 53 associates in general management, administration andfinance; 25 associates in sales and marketing; 116 associates in engineeringand product development; 18 associates in operations, manufacturing andquality; and 9 associates in customer service. None of our associates arerepresented by a labor union, and we have never experienced a work stoppage.

 

**GovernmentRegulation**

 

Our manufacturingoperations are subject to various federal, state and local laws andregulations, including those restricting the discharge of materials into theenvironment. We are not involved in any pending or, to our knowledge,threatened governmental proceedings, which would require curtailment of ouroperations because of such laws and regulations. We continue to expend funds inconnection with our compliance with applicable environmental regulations. Theseexpenditures have not, however, been significant in the past, and we do notexpect any significant expenditure in the near future. Currently, compliancewith foreign laws has not had a material impact on our business and is notexpected to have a material impact in the near future.

 

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

 

*Ourbusiness is subject to a number of risks, some of which are discussed below.Other risks are presented elsewhere in this report and in the informationincorporated by reference into this report. You should consider the followingrisks carefully in addition to the other information contained in this reportand our other filings with the SEC, including our subsequent reports on Forms10-Q and 8-K, before deciding to buy, sell or hold our common stock. The risksand uncertainties described below are not the only ones facing our company.Additional risks and uncertainties not presently known to us or that wecurrently 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.*

 

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

 

**Because we depend on government contracts and subcontracts, we faceadditional risks related to contracting with federal, state and localgovernments, including budgetary issues and fixed price contracts.**A significantportion of our sales are derived from contracts with governmental agencies,either as a general contractor, subcontractor or supplier. Government contractsrepresented approximately 45%, 45% and 38% of our total net sales and contractrevenues for the fiscal years ended March 31, 2010, 2009 and 2008,respectively. We anticipate that revenue from government contracts willcontinue to remain a significant portion of our net sales and contractrevenues. Government business is, in general, subject to special risks andchallenges, including:

 

·                                          delays infunding, including delays in the allocation of funds to state and localagencies from the U.S. federal government as a result of the expiration of the2005 Federal Highway Bill on October 31, 2009, as well as delays or reductionsin stimulus funds dedicated for transportation projects;

 

·                                          long purchasecycles or approval processes;

 

·                                          competitivebidding and qualification requirements;

 

·                                          the impact ofinternational conflicts;

 

·                                          performancebond requirements;

 

·                                          changes ingovernment policies and political agendas;

 

·                                          othergovernment budgetary constraints, cut-backs, delays or reallocation ofgovernment funding;

 

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

 

·                                          internationalconflicts or other military operations that could cause the temporary orpermanent diversion of government funding from transportation or otherinfrastructure projects.

 

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

 

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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 givenperiod. Our inability to address any of the foregoing concerns or the loss orrenegotiation of any material government contract could seriously harm ourbusiness, financial condition and results of operations.

 

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

 

**Themarkets in which we operate are highly competitive and have many moreestablished competitors, which could adversely affect our sales or the marketacceptance of our products.**We compete with numerous other companies in our targetmarkets including, but not limited to, large, multinational corporations, whichinclude tier-one automotive suppliers, and many smaller regional engineeringfirms. We believe that as a result of the expected 2013 European mandate forLDW and other active safety systems, and an overall awareness of the potentialbenefits of LDW, we will experience an even higher degree of competition from avariety of tier-one OEM suppliers and other potential market entrants,worldwide. We also expect such competition to increase due to technologicaladvancements, industry consolidations and reduced barriers to entry. Increasedcompetition is likely to result in loss of market share, price reductions andreduced gross margins, any of which could seriously harm our business,financial condition and results of operations. For example, a developer of LDWsystems was acquired by a large multinational organization during our Fiscal2009. This new competitor has increased its market share and could be moreaggressive in both the passenger car and heavy truck markets as a result of itsgreater access to resources and reputation in the market. Furthermore,awareness of LDW technology is increasing and other market players havedeveloped competing technologies, which may contain improvements or addedfeatures beyond those offered by our LDW systems. Additionally, from time totime, we may be required to re-compete for LDW business from our main customerbase of heavy truck OEMs. These OEMs could make a supplier change based onprice, product performance or available features. Should our competition besuccessful, this could adversely affect our ability to successfully market andsell our LDW systems to new and existing customers.

 

We compete with existing,well-established companies in our Roadway Sensors segment, both domesticallyand abroad. Certain technological barriers to entry make it difficult for newcompetitors to enter the market with competing video or other technologies;however, we are aware of new market entrants from time to time. Increasedcompetition could result in loss of market share, price reductions and reducedgross margins, any of which could seriously harm our business, financialcondition and results of operations.

 

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

 

**We may engage in acquisitions of companies or technologies thatmay require us to undertake significant capital infusions and could resultin disruptions of our business and diversion of resources and managementattention.**We completed the acquisition of certain assets ofHamilton Signal in April 2009. We have in the past acquired, and may inthe future acquire, additional complementary businesses, products, andtechnologies. Acquisitions may require significant capital infusions and, ingeneral, acquisitions also involve a number of special risks, including:

 

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

 

·                                          the failure toretain or integrate key acquired personnel;

 

·                                          the challengeof assimilating diverse business cultures, and the difficulties in integratingthe operations, technologies and information system of the acquired companies;

 

·                                          increased coststo improve managerial, operational, financial and administrative systems and toeliminate duplicative services;

 

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·                                          the incurrenceof unforeseen obligations or liabilities;

 

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

 

·                                          increasedinterest expense and amortization of acquired intangible assets.

 

Our competitors are also soliciting potential acquisitioncandidates, which could both increase the price of any acquisition targets anddecrease 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 may be unable to attract and retain key personnel, which couldseriously harm our business.**Due to the specializednature of our business, we are highly dependent on the continued service of ourexecutive officers and other key management, engineering and technicalpersonnel. The loss of any of our officers, or any of our other executives orkey members of management could adversely affect our business, financialcondition, or results of operations. Our success will also depend in large partupon our ability to continue to attract, retain and motivate qualifiedengineering and other highly skilled technical personnel. In particular, thefuture success of our Transportation Systems segment will depend on our abilityto hire additional qualified engineers and planners. Competition for qualifiedemployees, particularly development engineers, is intense. We may not be ableto continue to attract and retain sufficient numbers of such highly skilledemployees. Our inability to attract and retain additional key employees or theloss of one or more of our current key employees could adversely affect ourbusiness, financial condition and results of operations.

 

**Our profitability could beadversely affected if we are not able to maintain adequate utilization of ourTransportation Systems workforce.**The cost of providing ourTransportation Systems engineering and consulting services, including theextent to which we utilize our workforce, affects our profitability. The rateat which we utilize our workforce is affected by a number of factors,including:

 

·                                          our ability totransition employees from completed projects to new assignments and to hire andassimilate new employees;

 

·                                          our ability toforecast demand for our services and thereby maintain an appropriate headcountin our various regions;

 

·                                          our need todevote time and resources to training, business development, professionaldevelopment and other non-chargeable activities; and

 

·                                          our ability tomatch the skill sets of our employees to the needs of the marketplace.

 

**Our use of the percentage of completion method of accounting for ourcontract revenues could result in a reduction or reversal of previously recordedrevenues and profits.**A significant portion of our total net salesand contract revenues are measured and recognized using the percentage ofcompletion method of accounting. Our use of this accounting method results inrecognition of revenues and profits ratably over the life of a contract, basedgenerally on the proportion of costs incurred to date to total costs expectedto be incurred for the entire project. The effects of revisions torevenues and estimated costs are recorded when the amounts are known or can bereasonably estimated. Such revisions could occur in any period and theireffects could be material. Although we have historically made reasonablyreliable estimates of the progress towards completion of long-term engineering,program management, construction management or construction contracts, theuncertainties inherent in the estimating process make it possible for actualcosts to vary materially from estimates, including reductions or reversals ofpreviously recorded revenues and profits.

 

**Our failure to successfully bid on new contracts and renew existingcontracts could reduce our revenues and profits.**Our businessdepends on our ability to successfully bid on new contracts and renew existingcontracts with private and public sector customers. Contract proposals andnegotiations are complex and frequently involve a lengthy bidding and selectionprocess, which are affected by a number of factors, such as market conditions,financing arrangements and required governmental approvals. For example, acustomer may require us to provide a surety bond or letter of credit to protectthe client should we fail to perform under the terms of the contract. Ifnegative market conditions arise, or if we fail to secure adequate financialarrangements or the required governmental approval, we may not be able topursue particular projects, which could adversely reduce or eliminate ourprofitability.

 

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**We may experienceproduction gaps that could materially and adversely impact our sales andfinancial results and the ultimate 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 significant components in ourproducts. Should any such delay or disruption occur, or should a key supplierdiscontinue operations because of the current economic climate, our futuresales will likely be materially and adversely affected. Additionally, we relyheavily on select contract manufacturers to produce many of our products and donot have any long-term contracts to guarantee supply of such products. Althoughwe believe our contract manufacturers have sufficient capacity to meet ourproduction schedules for the foreseeable future and we believe we could findalternative contract manufacturing sources for many of our products, ifnecessary, we could experience a production gap if for any reason our contractmanufacturers were unable to meet our production requirements and our cost ofgoods sold could increase, adversely affecting our margins.

 

**If we are unable to develop and introduce new products and productenhancements successfully and in a cost-effective and timely manner, or areunable to achieve market acceptance of our new products, our operating resultswould be adversely affected.**We believe our revenue growthand future operating results will depend on our ability to complete developmentof new products and enhancements, introduce these products in a timely,cost-effective manner, achieve broad market acceptance of these products andenhancements, and reduce our production costs. We cannot guarantee the successof these products, and we may not be able to introduce any new products or anyenhancements to our existing products on a timely basis, or at all. Inaddition, the introduction of any new products could adversely affect the salesof certain of our existing products.

 

We believe that we must continue to make substantialinvestments to support ongoing research and development in order to remaincompetitive. We need to continue to develop and introduce new products thatincorporate the latest technological advancements in outdoor image processinghardware, software and camera technologies in response to evolving customerrequirements. We cannot assure you that we will be able to adequately manageproduct transition issues. Our business and results of operations could beadversely affected if we do not anticipate or respond adequately totechnological developments or changing customer requirements or if we cannotadequately manage inventory issues typically related to new product transitionsand introductions. We cannot assure you that any such investments in researchand development will lead to any corresponding increase in revenue.

 

Market acceptance of our new products depends uponmany factors, including our ability to accurately predict market requirementsand evolving industry standards, our ability to resolve technical challenges ina timely and cost-effective manner, our ability to qualify any new productswith OEMs and achieve manufacturing efficiencies, the perceived advantages ofour new products over traditional products and the marketing capabilities ofour independent distributors and strategic partners, including Valeo’s abilityto expand sales of LDW systems in the passenger car market. The success of ourLDW system will also depend in part on the success of the automotive vehiclesthat incorporate our technology, as well as the success of optional equipmentthat OEMs bundle with our technologies.

 

Certain of the components used in our products mayneed to be re-engineered in the next 12 to 36 months as the industry is movingtowards a standard of using lead-free components. We cannot assure you as toour ability to successfully redesign our products to incorporate compliantcomponents and gain market acceptance of such redesigned products. In addition,we may experience a shortage of products as a result of potential scarcity oflead-free components.

 

Our business and results of operations could also beseriously harmed by any significant delays in our new product development.Certain of our new products could contain undetected design faults and softwareerrors or “bugs” when first released by us, despite our testing. We may notdiscover these faults or errors until after a product has been installed andused by our customers. Any faults or errors in our existing products or in anynew products may cause delays in product introduction and shipments, requiredesign modifications or harm customer relationships, any of which couldadversely affect our business and competitive position.

 

**New environmental regulations may result in a decline inour Vehicle Sensors net sales.**Fromtime to time, environmental regulations are enacted, which can significantlyincrease the cost of manufacturing new vehicles as well as the cost ofmaintaining existing vehicles and truck fleets. As a result, we couldexperience a decline in sales of our Vehicle Sensors products as truck andvehicle manufacturers and fleet operators attempt to control their costs.

 

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

 

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

 

·                                          rapidtechnological advances;

 

·                                          downward pricepressure in the marketplace as technologies mature;

 

·                                          changes incustomer requirements;

 

·                                          additionalqualification requirements related to new products or components;

 

·                                          frequent newproduct introductions and enhancements;

 

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

 

·                                          evolvingindustry standards and changes in the regulatory environment.

 

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

 

**Our international business operations may be threatened by manyfactors that are outside of our control.**While we historically havehad limited international sales and operations experience, we began work on ourfirst overseas contracts in Abu Dhabi and Dubai in Fiscal 2010. We plan toexpand our international efforts in the future with respect to all three of oursegments, but cannot assure you that we will be successful in those efforts.International operations subject us to various inherent risks including, amongothers:

 

·                                          currencyfluctuations and restrictions;

 

·                                          political,social and economic instability, as well as international conflicts and acts ofterrorism;

 

·                                          longer accountsreceivable payment cycles;

 

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

 

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

 

·                                          the burdens ofcompliance with a wide variety of foreign laws and more restrictive labor lawsand obligations;

 

·                                          difficulties inmanaging and staffing international operations;

 

·                                          potentiallyadverse tax consequences; and

 

·                                          reducedprotection for intellectual property rights in some countries.

 

Substantially 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 currently engage in any transactionsas a hedge against risks of loss due to foreign currency fluctuations.

 

Any of the factors mentioned above may adverselyaffect our future international sales and, consequently, affect our business,financial condition and operating results. Additionally, as we pursue theexpansion of our international business, certain fixed and other overhead costscould outpace our revenues, thus adversely affecting our results of operations.We may likewise face local competitors in certain international markets who aremore established, have greater economies of scale and stronger customerrelationships. Furthermore, as we increase our international sales, our totalrevenues may also be affected to a greater extent by seasonal fluctuationsresulting from lower sales that typically occur during the summer months inEurope and other parts of the world.

 

**If ourinternal controls over financial reporting do not comply with the requirementsof the Sarbanes-Oxley Act, our business and stock price could be adversely affected.**Section 404 of the Sarbanes-Oxley Act of 2002 currently requiresus to evaluate the effectiveness of our internal controls over financialreporting at the end of each fiscal year and to include a management reportassessing the effectiveness of our internal controls over financial reportingin all annual reports. Currently, we expect that 

 

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beginning in our fiscal yearending March 31, 2011, our independent registered public accounting firmwill also be required to attest to, and report on, the effectiveness of ourinternal controls over financial reporting. We may not be able to complete thework required for such attestation on a timely basis, and even if we timelycomplete such requirements, our independent registered public accounting firmmay still conclude that our internal controls over financial reporting are noteffective.

 

Our management, including our CEO and CFO, does notexpect that our internal controls over financial reporting will prevent allerrors and all fraud. A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurance that the controlsystem’s objectives will be met. Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within Iteris have been or will be detected. These inherent limitations includethe realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of simple errors or mistakes. 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.

 

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

 

·                                          delays ingovernment contracts and funding from time to time and budgetary constraints atthe federal, state and local levels;

 

·                                          our ability toaccess stimulus funding, funding from a new Federal Highway Bill or otherfunding;

 

·                                          declines in newhome and commercial real estate construction and related road and otherinfrastructure construction;

 

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

 

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

 

·                                          the size, timing,rescheduling or cancellation of significant customer orders;

 

·                                          our ability to controlcosts;

 

·                                          our ability to raiseadditional capital;

 

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

 

·                                          seasonality due to winterweather conditions;

 

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

 

·                                          market acceptance of theproducts incorporating our technologies and products;

 

·                                          the introduction of newproducts by competitors;

 

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

 

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

 

·                                          the effects of technologicalchanges in our target markets;

 

·                                          the amount of our backlog atany given time;

 

·                                          the nature of our governmentcontracts;

 

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

 

·                                          risks and uncertaintiesassociated with our international business;

 

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

 

·                                          general economic andpolitical conditions; and

 

·                                          international conflicts andacts of terrorism.

 

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

 

**Wehave experienced a decline in our net sales and contract revenues over the lastfiscal year. If we fail to manage this decline effectively, we may beunable to execute our business plan and may experience future weaknessesin our operating results.**We have expanded our overall business in the past fewyears; however, we experienced a reduction in our net sales and contractrevenues in Fiscal 2010. Based on our business objectives, and in order toachieve future growth, we will need to continue to add additional qualifiedpersonnel, and invest in additional research and development and sales andmarketing activities. Our past expansion has placed, and future expansion isexpected to place, a significant strain on our managerial, administrative,operational, financial and other resources. If we are unable to manage theseactivities successfully, our growth, our business, our financial condition andour results of operations could continue to be adversely affected.

 

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

 

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

 

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

 

At March 31,2010, we had $10.4 million of cash and cash equivalents and the availability ofborrowing against our $12.0 million line of credit to fund our operations,subject to certain funded to debt to EBITDA requirements. We may need to raiseadditional capital in the near future to fund our operations or to repayindebtedness. Such additional capital may be raised through bank borrowings, orother debt or equity financings. We cannot assure you that any additionalcapital will be available on a timely basis, on acceptable terms, or at all,and such additional financing may result in further dilution to ourstockholders.

 

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

 

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

 

·                                          our ability tocontrol costs;

 

·                                          the supply ofkey components for our products;

 

·                                          our ability toincrease revenue and net income;

 

·                                          increasedresearch and development expenses and sales and marketing expenses;

 

·                                          our need torespond to technological advancements and our competitors’ introductions of newproducts or technologies;

 

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

 

·                                          potentialacquisitions of businesses and product lines;

 

·                                          ourrelationships with customers and suppliers;

 

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

 

·                                          our ability tosuccessfully negotiate credit arrangements with our bank and the state of thefinancial markets, in general; and

 

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

 

If our capital requirements are materially differentfrom those currently planned, we may need additional capital sooner thananticipated. If additional funds are raised through the issuance of equity orconvertible debt securities, the percentage ownership of our stockholders willbe reduced and such securities may have rights, preferences and privilegessenior to our common stock. Additional equity or debt financing may not beavailable on favorable terms, on a timely basis, or at all. If adequate fundsare not available 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.

 

**Priorto the fiscal year ended March 31, 2006, we historically generatedsignificant losses and may experience losses in the future.**We cannotassure you that we will be able to sustain or improve our financialperformance, or that we will be able to continue to achieve profitability on aquarterly or annual basis in the future. Our ability to maintain profitabilityin future periods could be impacted by budgetary constraints, government andpolitical agendas, economic instability and other items that are not in our control.Most of our expenses are fixed in advance. As such, we generally are unable toreduce our expenses significantly in the short-term to compensate for anyunexpected delay or decrease in anticipated revenues. As a result, we mayexperience operating losses and net losses in the future, which would make itdifficult to fund our operations and achieve our business plan, and could causethe market price of our common stock to decline.

 

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

 

·                                          quarterly variations inoperating results;

 

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

 

·                                          our ability to raiseadditional capital;

 

·                                          shortages announced bysuppliers;

 

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

 

·                                          transitions to new productsor product enhancements;

 

·                                          acquisitions of businesses,products or technologies;

 

·                                          the impact of anylitigation;

 

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·                                          changes in investorperceptions;

 

·                                          government funding,political agendas and other budgetary constraints;

 

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

 

·                                          international conflicts,political unrest and acts of terrorism.

 

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

 

**We could experience negative financial impacts arising fromdevelopments in contingencies created under our previous structure or by formersubsidiaries.**Although we divested ourselves of all business unitsprior to October 2004, from time to time we could experience unforeseendevelopments in contingencies related to our former subsidiaries. Although weare not aware of any other material contingencies, it is possible other matterscould be brought against us in connection with activities related to formersubsidiaries and that such matters could materially and adversely affect ourfinancial results and cash flows.

 

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

 

**ITEM 1B.****              ****UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2.****                       ****PROPERTIES**

 

Our headquarters andprincipal operations are housed in approximately 52,000 square feet of leasedspace located at 1700 Carnegie Avenue, Santa Ana, California. This facilitylease expires in 2015 and contains an option to extend the lease for anadditional five years at the market rate at that time.

 

For additionalinformation regarding our obligations under property leases, see Note 6 ofNotes to Consolidated Financial Statements, included in Part IV, Item 15of this report.

 

**ITEM 3.****                       ****LEGAL PROCEEDINGS**

 

The information set forthunder the heading “Litigation” under Note 6 of Notes to Consolidated FinancialStatements, included in Part IV, Item 15 of this report, is incorporatedherein by reference.

 

**ITEM 4.****                       ****(REMOVED AND RESERVED)**

 

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**PART II**

 

**ITEM 5.****                       ****MARKET FOR REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Market Information and Holders**

 

Our common stock istraded on the NYSE Amex under the symbol “ITI.” The following table sets forth, for the periods indicated, the high andlow sales prices for our common stock as reported by NYSE Amex:

 
| ** **                            | ** ** | **High**   | ** ** | **Low** | ** ** |
|---------------------------------------|------------|------------|------------|---------|------------|
| **Fiscal 2010**                       | ** ** | ** ** | ** ** |    | ** ** |
| Quarter Ended June 30, 2009      |       | $          | 1.45       |    | $          | 1.14 |   |
| Quarter Ended September 30, 2009 |       | 1.73       |       | 1.15    |       |
| Quarter Ended December 31, 2009  |       | 1.60       |       | 1.37    |       |
| Quarter Ended March 31, 2010     |       | 2.04       |       | 1.31    |       |
|                                  | ** ** | ** ** | ** ** |    | ** ** |
| **Fiscal 2009**                       |       |       |       |    |       |
| Quarter Ended June 30, 2008      |       | $          | 2.98       |    | $          | 2.14 |   |
| Quarter Ended September 30, 2008 |       | 2.45       |       | 1.65    |       |
| Quarter Ended December 31, 2008  |       | 1.83       |       | 1.16    |       |
| Quarter Ended March 31, 2009     |       | 1.50       |       | 0.98    |       |

 

On May 14, 2010, thelast reported sales price of our common stock on the NYSE Amex was $1.77.  As of May 14, 2010, we had407 holders of record of our common stock according to informationfurnished by our transfer agent.

 

**Dividend Policy**

 

We have never paid ordeclared cash dividends on our common stock, and have no current plans to paysuch dividends in the foreseeable future. We currently intend to retain anyearnings for working capital and general corporate purposes. The payment of anyfuture dividends will be at the discretion of our Board of Directors and willdepend upon a number of factors, including, but not limited to, future earnings,the success of our business, our capital requirements, our general financialcondition and future prospects, general business conditions, the consent of ourlender and such other factors as the Board of Directors may deem relevant.

 

**ITEM 6.****                       ****SELECTED FINANCIAL DATA**

 

As a smaller reportingcompany, we are not required to make any disclosure pursuant to this Item 6.

 

**ITEM 7.****                       ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

*You should read the followingdiscussion and analysis in conjunction with our Consolidated FinancialStatements and related Notes thereto included in Part IV, Item 15 of thisreport and the “Risk Factors” section in Item 1A, as well as othercautionary statements and risks described elsewhere in this report, beforedeciding to purchase, hold or sell our common stock.*

 

**Overview**

 

*General.*We are a leader in the traffic managementmarket focused on the development and application of advanced technologies thatreduce traffic congestion and improve the safety of surface transportationsystems infrastructure. Additionally, we believe our products and services, aswell as sound traffic management, minimize the environmental impact of trafficcongestion. By combining outdoor image processing, traffic engineering andinformation technology, we offer a broad range of ITS and driver safetysolutions to customers in the U.S. and internationally.

 

*BusinessSegments.*We currently operate in three reportable segments:Roadway Sensors, Vehicle Sensors and Transportation Systems. The RoadwaySensors segment includes our Vantage, VersiCam and Pico vehicle detectionsystems for traffic intersection control, incident detection and certainhighway traffic data collection applications. The Vehicle Sensors segmentincludes our LDW products and is comprised of all of our activities related toin-vehicle safety. The Transportation Systems segment includes transportationengineering and consulting services, and the development of transportationmanagement and traveler information systems for the ITS industry.

 

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Our Roadway Sensorssegment product line uses advanced image processing technology to capture andanalyze video images through sophisticated algorithms, enabling vehicledetection and transmission of both video images and data using variouscommunication technologies.

 

·                  Our Vantage video detection systems detect vehicle presence, count,speed and other traffic data used in traffic management systems. Our Vantagesystems give traffic managers the ability to mitigate roadway congestion bymodifying traffic signal timing or detecting incidents quickly.

 

·                  VersiCam, our integrated camera and processor video detection system,is a cost-efficient video detection system for smaller intersections thatrequire only a few detection points.

 

·                  Pico, our compact video detection system introduced in December 2009,was developed primarily to address international video detection needs, and wasdesigned for easy installation and configuration.

 

We anticipate that futuregrowth domestically and internationally, particularly in developing countries,will be dependent in part on the continued adoption of above-ground videodetection technologies, instead of traditional in-pavement loop technology, tomanage traffic.

 

Our Vehicle Sensorssegment addresses the leading cause of roadway fatalities: lane change, roadwaydeparture and rear-end collision accidents. We developed the world’s firstproduction LDW system and offer a proven system that is available as an OEM andaftermarket option on heavy trucks worldwide and as an option in certain passengercars. Our LDW products utilize video detection images to detect when a vehiclebegins to drift toward an unintended lane change. When this occurs, the unitautomatically emits a distinctive rumble strip or other audible warning sound,alerting the driver to make a correction. We believe that as a result of theexpected 2013 EU mandate for LDW and other active safety systems, and anoverall awareness of the potential benefits of LDW, that we will experience aneven higher degree of competition from a variety of tier-one OEM suppliers andother potential market entrants, worldwide. While we believe that thisincreased competition validates the long-term market opportunity for LDWsystems in commercial vehicles, it could also adversely effect our future LDWsales and margins. We are currently working with our European OEM customer baseto establish long-term supply agreements that extend to 2013 and beyond inorder to meet the anticipated increase in demand; however, we cannot assure youthat our efforts will be successful or that the increase in demand will occur.We have entered into an exclusive license of our LDW technology to ourstrategic partner, Valeo, for the passenger car market. Additionally, we andour partner have experienced a greater degree of competition in the passengercar market. Several passenger car OEMs have recently introduced vehicleplatforms with competing LDW systems. However, Valeo continues to pursueopportunities in the passenger car market.

 

In addition to our LDWsystems, our Vehicle Sensors portfolio includes radar-based Forward CollisionWarning and Blind Spot Warning systems for the North American truck market,which were both introduced in August 2008, and our SafetyDirect product, asystem that reports driver performance data captured by our LDW system, and hasthe ability to relay this data directly to fleet operators through integrationwith the truck’s existing fleet communications system. We offer the FCW and BSWfeatures through the resale of Delphi’s radar-based systems, for which we arethe exclusive North American dealer, while SafetyDirect was internallydeveloped. These products, together with our LDW products, combine to create asuite of active safety driver assistance features focused on reducing thenumber of motor vehicle crashes and the severity of crash-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 goodsmovement, commercial vehicle operations, travel demand forecasting and systemsengineering, and identify mitigation measures to reduce traffic congestion.Historically, these services and systems have primarily been sold to local,state and national transportation agencies in the United States under a broadrange of fixed price and cost plus fixed fee contracts; however, in the currentfiscal year, we began work on our first two overseas contract awards in AbuDhabi and Dubai. We plan to continue to pursue additional internationalopportunities for our Transportation Systems segment.

 

Our Transportation Systems segment is largelydependent upon governmental funding and is affected by state and localbudgetary issues. We believe the overall expansion of our TransportationSystems segment in recent years past was due in part to the passage of theFederal Highway Bill in 2005, combined with increased transportation fundsavailable at state and local agencies throughout the country. The 2005 FederalHighway Bill expired on October 31, 2009, and Congress is currently innegotiations regarding future extensions. We anticipate delays in theenactment of a new Federal Highway Bill, and until such time as a bill becomeslaw, the allotment of transportation funds in federal, state and local budgetsmay be uncertain and we believe that prolonged uncertainty may adversely impactour net sales and contract revenues and our overall financial performance infuture periods.

 

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*Business Trends.* Looking forward, we remain cautious aboutour business, given the continued uncertain global economic conditions and thechallenging financial markets. This unfavorable environment has, and maycontinue to, negatively affect demand for our products and services for theforeseeable future. Likewise, our ability to accurately forecast businesstrends may be impaired.

 

Despite the federal stimulus package that was passedin 2009, many municipalities and other state and local agencies continue to facebudgetary issues. As a result, spending for new roadways, new systems toaddress traffic congestion and other transportation infrastructure improvementshas been delayed or eliminated in some cases. We believe that the need torebuild and modernize aging transportation infrastructure will continue, and inaddition to funds available through the stimulus package and federal highwaybills, there exist a variety of other funding mechanisms that supporttransportation infrastructure and related projects, including bonds, dedicatedsales and gas tax measures and other alternative funding sources. However, wecurrently cannot determine when or if such funding sources will beavailable or the extent to which we may benefit from future sources offunding for transportation-related projects.

 

DuringFiscal 2010, we introduced certain new products including Abacus and Pico. Wealso completed the acquisition of certain assets of Hamilton Signal, whichincluded the Abacus system, for an aggregate cash purchase price ofapproximately $518,000. This acquisition has afforded us with the opportunityto provide our customers with traffic and incident detection data from ourinstalled base of surveillance cameras.

 

**CriticalAccounting Policies and Estimates**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased on our consolidated financial statements included herein, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and related disclosures of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. On an ongoing basis, weevaluate these estimates and assumptions, including those related to thecollectibility of accounts receivable, the valuation of inventories, therecoverability of long-lived assets and goodwill, the realizability of deferredtax assets, accounting for stock-based compensation, the valuation of equityinstruments, warranty reserves and other contingencies. We base these estimateson historical experience and on various other factors that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. These estimates and assumptions bytheir nature involve risks and uncertainties, and may prove to be inaccurate.In the event that any of our estimates or assumptions are inaccurate in anymaterial respect, it could have a material adverse effect on our reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.

 

Thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statements.

 

*RevenueRecognition.* We record product revenues and related costs ofsales upon transfer of title, which is generally upon shipment or, if required,upon acceptance by the customer, provided that we believe collectibility of thenet sales amount is reasonably assured. Accordingly, at the date revenue isrecognized, the significant uncertainties concerning the sale have beenresolved.

 

Contract revenues are derived primarily fromlong-term contracts with governmental agencies. Contract revenues include costsincurred plus a portion of estimated fees or profits determined using thepercentage of completion method of accounting based on the relationship ofcosts incurred to total estimated costs. Any anticipated losses on contractsare charged to earnings when identified. Changes in job performance andestimated profitability, including those arising from contract penaltyprovisions and final contract settlements, may result in revisions torecognized 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. Under the percentage of completion method,recognition of profit is dependent upon the accuracy of a variety of estimates,including engineering progress, materials quantities, and achievement ofmilestones, incentives, penalty provisions, labor productivity, cost estimatesand others. Such estimates are based on various professional judgments wemake with respect to those factors and are subject to change as the projectproceeds and new information becomes available.

 

In addition to productand contract revenues, we derive revenue from the provision of specificnon-recurring contract engineering services to our strategic partner, Valeo,related to our LDW systems, and royalties earned on unit sales of our LDWsystems by Valeo to the passenger car market. Non-recurring contractengineering revenues are recognized in the period in which the related servicesare performed. Royalty revenues are recorded based on unit sales of ourproducts by Valeo and are recognized in the period in which such sales occur.Non-recurring contract engineering revenues and royalty revenues are includedin our net sales.

 

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Revenuesfrom follow-on service and support, for which we generally charge separately,are recorded in the period in which the services are performed and are includedin our net sales.

 

*AccountsReceivable.* We estimate the collectibility of customerreceivables on an ongoing basis by reviewing invoices outstanding greater thana certain period of time. We record an allowance for doubtful accounts forspecific receivables deemed to be at risk for collection as well as a generalallowance based on our historical collections experience. Considerable judgmentis required in assessing and estimating the ultimate realization of tradereceivables, including the current credit-worthiness of each customer. If thefinancial condition of our customers deteriorates, resulting in an impairmentof their ability to make required payments, additional allowances may berequired that could adversely affect our operating results.

 

*Inventories.* Inventoriesconsist of finished goods, work-in-process and raw materials and are stated atthe lower of cost or market. We write down the carrying value of ourinventories to net realizable value for estimated excess and obsoleteinventories in an amount equal to the difference between the cost of theinventories and their estimated realizable value. These estimates are based onmanagement’s judgments and assumptions as to future demand requirements and ourevaluation of market conditions. Demand for our products may fluctuatesignificantly over time, and actual demand and market conditions may be more orless favorable than those projected by management. In the event that actualdemand is lower than originally projected, additional inventory write-downs maybe required. Estimated inventory write-downs, once established, are notreversed until the related inventory has been sold or scrapped, so if actualmarket conditions are more favorable in the fiscal periods subsequent to thosein which we record significant write-downs, we may have higher gross marginswhen products are sold.

 

*Goodwill.* Goodwill istested for impairment annually in our fourth fiscal quarter at the reportingunit level unless a change in circumstances indicates that more frequentimpairment analysis is required. We have determined that our reporting unitsfor purposes of testing for goodwill impairment are identical to our reportablesegments for financial reporting purposes. Impairment, if any, is measuredbased on the estimated fair value of the reporting units with the recordedgoodwill. The fair value of our reporting units is determined by using theincome approach methodology of valuation which utilizes discounted cash flows.The estimated fair value of our reporting units also includes a controlpremium, which is the amount that a buyer is willing to pay over the currentmarket price of a company as indicated by the traded price per share (i.e.,market capitalization), in order to acquire a controlling interest. Significantmanagement judgment is required in the forecasts of future operating resultsthat are used in the discounted cash flow method of valuation. In estimatingfuture cash flows, we generally use the financial assumptions in our currentbudget and our current strategic plan, subject to modification as considerednecessary, including sales and expense growth rates and the discount rates weestimate to represent our cost of funds. It is possible, however, that theplans and estimates we use may be incorrect.

 

Weperformed annual impairment assessments of the carrying value of goodwill foreach of the fiscal years ended March 31, 2010, 2009 and 2008. Based onthese assessments, we determined that no impairment as of each of these dateswas indicated as the estimated fair value of each reporting unit exceeded itsrespective carrying value. At March 31, 2010, our Roadway Sensors, VehicleSensors and Transportation Systems reporting units had goodwill balances of$8.2 million, $4.7 million and $14.9 million, respectively. Based on ourassessment at March 31, 2010, the estimated fair values of our RoadwaySensors, Vehicle Sensors and Transportation Systems reporting units wereapproximately 73%, 79% and 18%, respectively, greater than their respectivecarrying values. Among other factors, the fair value of our TransportationSystems reporting unit in the future could be adversely impacted by (i) ourinability to maintain adequate utilization of our workforce, (ii) our failureto successfully bid on new contracts and renew existing contracts and (iii) governmentbudgetary issues and related delays in spending. Likewise, if our actualfinancial results, or the plans and estimates used in future goodwillimpairment analyses, are lower than the original estimates used to assess forimpairment of our goodwill, we could incur future goodwill impairment chargesin our Transportation Systems or other reporting units.

 

*Warranty.* We generallyprovide a one to three year warranty from the original invoice date on allproducts, materials and workmanship. Defective products are either repaired orreplaced, at our option, upon meeting certain criteria. We accrue a provisionfor the estimated costs that may be incurred for product warranties relating toa product as a component of cost of sales at the time revenue for that productis recognized. The accrued warranty provision is included within accruedexpenses on the accompanying consolidated balance sheets. Should our actualexperience of warranty returns be higher than anticipated, additional warrantyreserves may be required, which would adversely affect our product gross profitand our operating results.

 

*IncomeTaxes.* On a quarterly basis, we assess the likelihood that our deferred tax assetbalance will be recovered from future taxable income. Realization of deferredtax assets (such as net operating loss carryforwards) is dependent on futuretaxable earnings and is therefore uncertain. To the extent we believe thatrecovery is not likely, we establish a valuation allowance to reduce ourdeferred tax assets to amounts that we believe are more likely than not to berealized, which increases our income tax expense in the period suchdetermination is made.

 

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Onan interim basis, we estimate what our anticipated annual effective tax ratewill be, while also separately considering applicable discrete and othernon-recurring items, and record a quarterly income tax provision in accordancewith this anticipated rate. As the fiscal year progresses, we refine ourestimates based upon actual events and financial results during the year. Thisestimation process can result in significant changes to our expected effectivetax rate. When this occurs, we adjust our income tax provision during thequarter in which our estimates are refined so that the year-to-date provisionreflects the expected annual effective tax rate. These changes, along withadjustments to our deferred taxes, among others, may create fluctuations in ouroverall effective tax rate from quarter to quarter.

 

We must review all of our tax positions and make adetermination as to whether each position is more-likely-than-not to besustained upon examination by regulatory authorities. If a tax position meetsthe more-likely-than-not standard, then the related tax benefit is measuredbased on a cumulative probability analysis of the amount that is more-likely-than-notto be realized upon ultimate settlement or disposition of the underlying issue.

 

Theapplication of tax laws and regulations is subject to legal and factualinterpretation, judgment and uncertainty. Tax laws and regulations themselvesare subject to change as a result of changes in fiscal policy, changes inlegislation, the evolution of regulations and court rulings. Therefore, theactual liability for U.S. or foreign taxes may be materially differentfrom our estimates, which could result in the need to record additional taxliabilities or potentially reverse previously recorded tax liabilities.

 

*Stock-BasedCompensation*. Werecord stock-based compensation in the statement of income as an expense, basedon the estimated grant date fair value of our stock-based awards, whereby suchfair values are amortized over the requisite service period. The fair value ofour common stock option awards is estimated on the grant date using theBlack-Scholes-Merton (“BSM”) option-pricing formula. While utilizing this modelmeets established requirements, the estimated fair values generated by it maynot be indicative of the actual fair values of our common stock option awardsas it does not consider certain factors important to those awards to employees,such as continued employment and periodic vesting requirements as well aslimited transferability. Our assumptions under the BSM formula include thefollowing: (i) expected volatilities are based on the historicalvolatility of our stock price, (ii) the expected life of options isderived based on the historical life of our options, (iii) the risk-freerate for periods within the expected life of the option is based on the U.S.Treasury interest rates in effect at the time of grant and (iv) thedividend yield assumption is based on our history and expectation of dividendpayouts. Additionally, we include an estimate of forfeitures in the calculationof stock-based compensation expense. Future stock-based compensation expense inany particular quarter or year could be affected by changes in our assumptions,changes in market conditions, or to the extent that we grant additionalstock-based awards. Additionally, if there are any modifications orcancellations of the underlying unvested stock-based awards, we may be requiredto accelerate, increase or cancel any remaining unearned stock-basedcompensation expense.

 

**Recent AccountingPronouncements**

** **

Refer to Note 1 of Notes to Consolidated FinancialStatements, included in Part IV, Item 15 of this report for a discussionof recent accounting pronouncements.

 

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**Results of Operations**

 

The following table setsforth certain statement of income data as a percentage of total net sales andcontract revenues for the periods indicated. The following table should be readin conjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations.

 
| ** **                                | ** ** | **Year Ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **2010**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                      |       |                           |       |   |   |   |   |
| Net sales and contract revenues:          |       |                           |       |   |   |   |   |
| Net sales                                 |       | 54.5                           | %          | 55.4 | % | 61.9 | % |
| Contract revenues                         |       | 45.5                           |       | 44.6 |   | 38.1 |   |
| Total net sales and contract revenues     |       | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Costs of net sales and contract revenues: |       |                           |       |   |   |   |   |
| Cost of net sales                         |       | 28.4                           |       | 29.3 |   | 31.5 |   |
| Cost of contract revenues                 |       | 30.0                           |       | 30.4 |   | 25.1 |   |
| Gross profit                              |       | 41.6                           |       | 40.3 |   | 43.4 |   |
| Operating expenses:                       |       |                           |       |   |   |   |   |
| Selling, general and administrative       |       | 29.3                           |       | 26.0 |   | 26.5 |   |
| Research and development                  |       | 6.3                            |       | 5.8 |   | 5.5 |   |
| Amortization of intangible assets         |       | 0.3                            |       | 0.2 |   | 0.2 |   |
| Total operating expenses                  |       | 35.9                           |       | 32.0 |   | 32.2 |   |
| Operating income                          |       | 5.7                            |       | 8.2 |   | 11.2 |   |
| Non-operating income (expense):           |       |                           |       |   |   |   |   |
| Other income, net                         |       | 0.1                            |       | 0.2 |   | 0.4 |   |
| Interest expense, net                     |       | (0.5                           | )          | (0.9 | ) | (2.0 | ) |
| Income before income taxes                |       | 5.3                            |       | 7.5 |   | 9.6 |   |
| Benefit (provision) for income taxes      |       | (1.5                           | )          | 7.6 |   | 9.1 |   |
| Net income                                |       | 3.8                            | %          | 15.1 | % | 18.7 | % |

 

**Analysisof Fiscal 2010, Fiscal 2009 and Fiscal 2008 Results of Operations**

 

*NetSales and Contract Revenues*. Net sales are comprised of product sales from ourRoadway Sensors and Vehicle Sensors segments, as well as contract engineeringrevenue and royalty revenue generated from our Vehicle Sensorssegment. Contract revenues consist entirely of Transportation Systems contractrevenues, which are generated from systems integration and ITS engineering andconsulting services primarily with federal, state, county and municipalagencies.

 

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The followingtables present details of our net sales and contract revenues for Fiscal 2010compared to Fiscal 2009, and Fiscal 2009 compared to Fiscal 2008:

 
| ** **                            | ** ** | **Fiscal**                                            | ** ** | **Fiscal** | ** ** | ** **   | ** ** | **%**      | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                            | ** ** | **2010**                                              | ** ** | **2009**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                            | ** ** | **(In thousands, except percentages)** | ** ** |
| Roadway Sensors                       |       | $                                                     | 25,341     |       | $          | 27,197       |       | $          | (1,856     | ) | (6.8 | )% |
| Vehicle Sensors                       |       | 6,309                                                 |       | 11,230     |       | (4,921       | )          | (43.8      | )          |
| Net sales                             |       | 31,650                                                |       | 38,427     |       | (6,777       | )          | (17.6      | )          |
| Contract revenues                     |       | 26,413                                                |       | 30,932     |       | (4,519       | )          | (14.6      | )          |
| Total net sales and contract revenues |       | $                                                     | 58,063     |       | $          | 69,359       |       | $          | (11,296    | ) | (16.3 | ) |

 
| ** **                            | ** ** | **Fiscal**                                            | ** ** | **Fiscal** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|----------------|------------|------------|------------|
| ** **                            | ** ** | **2009**                                              | ** ** | **2008**   | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                            | ** ** | **(In thousands, except percentages)** | ** ** |
| Roadway Sensors                       |       | $                                                     | 27,197     |       | $          | 28,452         |       | $          | (1,255     | ) | (4.4 | )% |
| Vehicle Sensors                       |       | 11,230                                                |       | 11,874     |       | (644           | )          | (5.4       | )          |
| Net sales                             |       | 38,427                                                |       | 40,326     |       | (1,899         | )          | (4.7       | )          |
| Contract revenues                     |       | 30,932                                                |       | 24,837     |       | 6,095          |       | 24.5       |       |
| Total net sales and contract revenues |       | $                                                     | 69,359     |       | $          | 65,163         |       | $          | 4,196      |   | 6.4 |   |

 

We currently havea diverse customer base with no individual customer representing greater than10% of our total annual net sales and contract revenues for Fiscal 2010, Fiscal2009 or Fiscal 2008.

 

*RoadwaySensors*

 

Themajority of Roadway Sensors net sales were derived from sales within NorthAmerica. The sequential decreases in Roadway Sensors net sales in Fiscal 2010as compared to Fiscal 2009, and likewise Fiscal 2009 as compared to Fiscal2008, were mainly due to the ongoing effects of reduced and delayed spending oninfrastructure projects, in part due to the decline in commercial andresidential construction as well as state and local government budgetarypressures, and increased competitors in the market. While we are cautiouslyoptimistic heading into Fiscal 2011, we expect the challenging economic factorsdiscussed above, among others, may continue to adversely impact our RoadwaySensors net sales for at least the next few fiscal quarters.

 

*Vehicle Sensors*

 

The largest element ofVehicle Sensors net sales was sales of our LDW systems to the heavy truck market,which aggregated approximately $5.6 million in Fiscal 2010, $9.9 million inFiscal 2009 and $10.0 million in Fiscal 2008. Vehicle Sensors net sales havesequentially decreased over the last two fiscal years primarily due to theslowdown in our LDW unit shipments to each of our key markets, which began inthe fourth quarter of Fiscal 2009. Although we saw an encouraging increase innet sales in the second half of Fiscal 2010 as compared to the immediatelypreceding quarters, which resulted primarily from significant sales to one ofour U.S. truck fleet customers in the fourth quarter, we cannot assure you thatsuch sales levels from this or other customers will recur in subsequentperiods. We also continue to experience overall softness in our LDW unit salesto the North American truck market and to our European and Asian OEM customers.We believe this is driven largely by lower new heavy truck sales in general, aswell as the general slowdown in the U.S. and worldwide credit markets andcontinued weakness and uncertainty in the overall global economy. We anticipatethat Vehicle Sensors unit sales beyond Fiscal 2010 could continue to beadversely impacted as a result of the overall decline in sales of heavy trucksglobally and by slower than expected adoption rates of our LDW system byEuropean and Asian OEMs and North American heavy truck fleets. Additionally,future unit sales of LDW systems and unit pricing could be adversely impactedas a result of increased competition in this market. The increase incompetition in the current fiscal year contributed to a division of aninternational heavy truck customer sourcing future primary LDW unit sales to acompetitor for a specific geographic region.

 

Also included in VehicleSensors net sales are revenues from contract engineering services and royaltyrevenues in the passenger car market that are derived from our strategicrelationship with Valeo, which aggregated approximately $685,000, $1.3 millionand $1.9 million for the fiscal years ended March 31, 2010, 2009 and 2008,respectively. We have experienced year-over-year decreases in contractengineering services provided to Valeo as the pertinent engineering developmentactivities have generally reached maturity for the related vehicle platformsthat currently incorporate our LDW system. Our LDW systems are currentlyoffered as an option on three Infiniti models, with a fourth model expected bythe summer of 2010. While Valeo is promoting our LDW systems to other passengercar OEMs, we cannot assure you that Valeo will be successful in these efforts.

 

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*Contract Revenues*

 

Contractrevenues are derived from our Transportation Systems segment and are primarilydependent upon the continued availability of funding at both the state andfederal levels from the various departments of transportation. The decrease incontract revenues in Fiscal 2010 as compared to Fiscal 2009 was due primarilyto delays or reductions in funding for certain of our projects, particularly inthe Southeast region of the U.S. and in our private planning group, whichfocuses on private development consulting. The decrease is also attributable tothe timing differences on certain of our larger contracts, which contained ahigher amount of sub-consultant revenue in Fiscal 2009, but such contracts weremostly completed by the end of Fiscal 2009 and were not replaced with similarsuch contracts in the current fiscal year. In the future, we plan to pursuelarge contracts that may contain significant sub-consulting content, which willlikely contribute to variability in the timing and amount of our contractrevenues from period to period.

 

DuringFiscal 2010, we began work on our first two overseas contract awards in AbuDhabi and Dubai, for which we have recognized contract revenues to date ofapproximately $300,000. We plan to continue to pursue additional internationalopportunities for our Transportation Systems segment in the future. Among otherfactors, we believe the ability of our Transportation Systems segment to growand successfully win and service new contracts will be highly dependent uponour continued success in recruiting and retaining qualified personnel.

 

The Fiscal 2009 increasein contract revenues, as compared to Fiscal 2008, was largely a result of ourincreased sales and marketing activity across the U.S., resulting in certainsignificant new contracts that were awarded to us in Fiscal 2009. Certain ofthese new contracts contained a higher than usual amount of sub-consultingcontent, which was primarily concentrated in our contract revenues in thefourth quarter of Fiscal 2009.

 

*GrossProfit*. Thefollowing tables present details of our gross profit for Fiscal 2010 comparedto Fiscal 2009, and Fiscal 2009 compared to Fiscal 2008:

 
| ** **                                                          | ** ** | **Fiscal**                                            | ** ** | **Fiscal** | ** ** | ** **   | ** ** | **%**      | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                                                          | ** ** | **2010**                                              | ** ** | **2009**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                                                          | ** ** | **(In thousands, except percentages)** | ** ** |
| Total gross profit                                                  |       | $                                                     | 24,159     |       | $          | 27,919       |       | $          | (3,760     | ) | (13.5 | )% |
| Total gross profit as a % of total net sales and contract  revenues |       | 41.6                                                  | %          | 40.3       | %          |         |       |       |       |
| Gross profit as a % of net sales                                    |       | 47.9                                                  | %          | 47.1       | %          |         |       |       |       |
| Gross profit as a % of contract revenues                            |       | 34.1                                                  | %          | 31.8       | %          |         |       |       |       |
|                                                                     |            |                                                       |            |            |            |              |            |            |            |  |  |  |

 
| ** **                                                          | ** ** | **Fiscal**                                            | ** ** | **Fiscal** | ** ** | ** **   | ** ** | **%**      | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                                                          | ** ** | **2009**                                              | ** ** | **2008**   | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                                                          | ** ** | **(In thousands, except percentages)** | ** ** |
| Total gross profit                                                  |       | $                                                     | 27,919     |       | $          | 28,297       |       | $          | (378       | ) | (1.3 | )% |
| Total gross profit as a % of total net sales and contract  revenues |       | 40.3                                                  | %          | 43.4       | %          |         |       |       |       |
| Gross profit as a % of net sales                                    |       | 47.1                                                  | %          | 49.2       | %          |         |       |       |       |
| Gross profit as a % of contract revenues                            |       | 31.8                                                  | %          | 34.1       | %          |         |       |       |       |
|                                                                     |            |                                                       |            |            |            |              |            |            |            |  |  |  |

 

Thedecrease in our total gross profit for Fiscal 2010 as compared to Fiscal 2009was generally commensurate with the overall decline in total net sales andcontract revenues, as discussed above. Our total gross profit as a percent oftotal net sales and contract revenues for Fiscal 2010 increased slightlycompared to Fiscal 2009 primarily due to higher margins from our net sales,particularly Roadway Sensors, as we realized cost savings due to lower costs ofmaterials driven by improvements in our supply chain management, which weanticipate will continue in the future. The increase was also attributable, toa lesser extent, to the improvement in our Transportation Systems margins inFiscal 2010, as discussed further below.

 

Theslight increase in gross profit as a percent of net sales in Fiscal 2010 ascompared to Fiscal 2009 was due to certain materials cost savings, as discussedabove, and a favorable customer mix weighted more toward direct sales. Wegenerally enjoy higher gross margins on direct sales as compared to dealer andaftermarket sales. The increase was partially offset during the year bydecreased gross margins in Vehicle Sensors, which was largely driven by loweroverhead absorption due to the decline in sales, along with an increase incertain estimates for additional excess and obsolete inventory provisions. Thedecrease in gross profit as a percent

 

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of net sales in Fiscal 2009as compared to Fiscal 2008 was primarily a result of decreased gross profit inRoadway Sensors and was largely driven by an unfavorable customer mix weightedmore toward dealer than direct sales in Fiscal 2009. Gross profit as apercentage of net sales can fluctuate in any specific quarter or year based on,among other factors, customer and product mix, competitive pricing requirements,product warranty costs and provisions for excess and obsolete inventories, aswell as possible shifts of engineering resources from development activities tosustaining activities, which we record as cost of goods sold.

 

Werecognize contract revenues and related gross profit using percentage ofcompletion contract accounting, and the underlying mix of contract activityaffects the related gross profit recognized in any given period. The increasein gross profit as a percent of contract revenues in Fiscal 2010 compared toFiscal 2009 was primarily due to a contract mix weighted more toward highermargin contracts in the current fiscal year. Our higher margin contracts oftencontain a comparatively lower proportion of sub-consulting revenues associatedwith them. Conversely, a larger portion of our Fiscal 2009 contract revenuescontained higher sub-consulting content, as compared to Fiscal 2008, and thuscontributed to overall lower margins. Particularly, we experienced anabnormally high level of sub-consulting content related to certain newcontracts during the fourth quarter of Fiscal 2009, which contributed both tothe overall increase in contract revenues and a decrease in our gross profit.In the near term, we expect our sub-consulting content as a percentage of totalcontract revenues to be generally in line with those experienced in Fiscal2010; however, due to the variability and timing of our contracts, it hasbecome increasingly difficult to accurately predict the sub-consulting contentin our Transportation Systems contracts in future periods.

 

*Selling, General and Administrative Expense*

 

Thefollowing table presents selling, general and administrative expense for Fiscal2010 and Fiscal 2009:

 
| ** **                           | ** ** | **Fiscal 2010**                                       | ** ** | **Fiscal 2009**        | ** ** | ** ** | ** ** | ** **             | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|
| ** **                           | ** ** | ** **                                            | ** ** | **% of Net** | ** ** | ** ** | ** ** | **% of Net** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Sales and**     | ** ** | ** ** | ** ** | **Sales and**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Contract**           | ** ** | ** ** | ** ** | **Contract**           | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                                            | ** ** | **Revenues**           | ** ** | **Amount** | ** ** | **Revenues**           | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentages)** | ** ** |
| Salary  and personnel-related        |       | $                                                     | 11,262     |                   | 19.4       | %          | $          | 11,949                 |       | 17.2 | % | $ | (687 | ) | (5.7 | )% |
| Facilities,  insurance and supplies  |       | 2,444                                                 |       | 4.2                    |       | 2,378      |       | 3.4                    |       | 66 |   | 2.8 |   |
| Travel  and conferences              |       | 1,488                                                 |       | 2.6                    |       | 1,563      |       | 2.3                    |       | (75 | ) | (4.8 | ) |
| Professional  and outside services   |       | 1,038                                                 |       | 1.8                    |       | 1,302      |       | 1.9                    |       | (264 | ) | (20.3 | ) |
| Other                                |       | 772                                                   |       | 1.3                    |       | 843        |       | 1.2                    |       | (71 | ) | (8.4 | ) |
| Selling,  general and administrative |       | $                                                     | 17,004     |                   | 29.3       | %          | $          | 18,035                 |       | 26.0 | % | $ | (1,031 | ) | (5.7 | ) |

 

Thedecrease in selling, general and administrative expenses in Fiscal 2010 ascompared to Fiscal 2009 was primarily due to (i) our overall reduction inheadcount from March 31, 2009; (ii) lower accruals for bonuses andother incentive compensation primarily due to lower sales and operating profitin the current fiscal year; and (iii) the suspension of our matchingcontributions under our 401(k) plan effective July 1, 2009. We alsoreduced our professional and outside services expenses during the currentfiscal year primarily through our efforts to conserve costs and scale back ourusage of such services, along with various efficiencies gained in our internalcontrol assessment and other financial reporting obligations. In Fiscal 2011,we are currently scheduled to be subject to the requirement that ourindependent registered public accounting firm provide an attestation on theeffectiveness of our internal control over financial reporting, which we expectwill increase our professional and outside services expenses.

 

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Thefollowing table presents selling, general and administrative expense for Fiscal2009 and 2008:

 
| ** **                           | ** ** | **Fiscal 2009**                                       | ** ** | **Fiscal 2008**    | ** ** | ** ** | ** ** | ** **         | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------------|------------|
| ** **                           | ** ** | ** **                                            | ** ** | **% of Net**       | ** ** | ** ** | ** ** | **% of Net**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Sales and** | ** ** | ** ** | ** ** | **Sales and** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Contract**       | ** ** | ** ** | ** ** | **Contract**       | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                                            | ** ** | **Revenues**       | ** ** | **Amount** | ** ** | **Revenues**       | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentages)** | ** ** |
| Salary  and personnel-related        |       | $                                                     | 11,949     |               | 17.2       | %          | $          | 10,916             |       | 16.8 | % | $ | 1,033 |   | 9.5 | % |
| Facilities,  insurance and supplies  |       | 2,378                                                 |       | 3.4                |       | 2,254      |       | 3.5                |       | 124 |   | 5.5 |   |
| Travel  and conferences              |       | 1,563                                                 |       | 2.3                |       | 1,323      |       | 2.0                |       | 240 |   | 18.1 |   |
| Professional  and outside services   |       | 1,302                                                 |       | 1.9                |       | 1,734      |       | 2.7                |       | (432 | ) | (24.9 | ) |
| Other                                |       | 843                                                   |       | 1.2                |       | 1,062      |       | 1.6                |       | (219 | ) | (20.6 | ) |
| Selling,  general and administrative |       | $                                                     | 18,035     |               | 26.0       | %          | $          | 17,289             |       | 26.5 | % | $ | 746 |   | 4.3 |   |

 

Theoverall increase in selling, general and administrative expenses in Fiscal 2009was primarily driven by higher selling expenses in our Transportation Systemssegment as a result of a shift in certain of our labor resources fromproject-related activities to sales and marketing efforts, aimed at capturingadditional contract backlog. This resulted in an increase in this segment’ssales and marketing expenses to $2.8 million for Fiscal 2009 compared to $2.0million for Fiscal 2008. Our professional and outside services expenses decreasedin Fiscal 2009 primarily due to our efforts to conserve costs and scale backour usage of certain outside and professional services, as well as variousefficiencies gained in our internal control assessment and other financialreporting obligations in that year.

 

*Research and Development Expense*

 

Thefollowing table presents research and development expense for Fiscal 2010 andFiscal 2009:

 
| ** **                           | ** ** | **Fiscal 2010**                                       | ** ** | **Fiscal 2009**    | ** ** | ** ** | ** ** | ** **         | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|--------------------|------------|------------|------------|--------------------|------------|
| ** **                           | ** ** | ** **                                            | ** ** | **% of Net**       | ** ** | ** ** | ** ** | **% of Net**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Sales and** | ** ** | ** ** | ** ** | **Sales and** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                            | ** ** | **Contract**       | ** ** | ** ** | ** ** | **Contract**       | ** ** | ** ** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                                            | ** ** | **Revenues**       | ** ** | **Amount** | ** ** | **Revenues**       | ** ** | **Decrease** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentages)** | ** ** |
| Salary  and personnel-related        |       | $                                                     | 2,655      |               | 4.6        | %          | $          | 2,748              |       | 4.0 | % | $ | (93 | ) | (3.4 | )% |
| Facilties,  development and supplies |       | 883                                                   |       | 1.5                |       | 1,018      |       | 1.5                |       | (135 | ) | (13.3 | ) |
| Other                                |       | 140                                                   |       | 0.2                |       | 264        |       | 0.4                |       | (124 | ) | (47.0 | ) |
| Research  and development            |       | $                                                     | 3,678      |               | 6.3        | %          | $          | 4,030              |       | 5.8 | % | $ | (352 | ) | (8.7 | ) |

 

Thedecrease in research and development expense in Fiscal 2010 compared to Fiscal2009 was primarily due to lower overall engineering headcount and a moreefficient engineering structure as we shifted our focus to new productdevelopment from a historical focus on new customer qualification andmanufacturing support. We believe research and development activities arecrucial to our ability to continue to be a leader in our markets. Forcompetitive reasons, we closely guard the confidentiality of specificdevelopment projects. We currently expect our total research and developmentexpenditures for Fiscal 2011 to be slightly higher in absolute dollars thanthose for Fiscal 2010.

 

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Thefollowing table presents research and development expense for Fiscal 2009 and2008:

 
| ** **                           | ** ** | **Fiscal 2009**                        | ** ** | **Fiscal 2008** | ** ** | ** ** | ** ** | ** **    | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|-----------------|------------|------------|------------|---------------|------------|
| ** **                           | ** ** | ** **                             | ** ** | **% of Net**    | ** ** | ** ** | ** ** | **% of Net**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                             | ** ** | **Sales and**   | ** ** | ** ** | ** ** | **Sales and** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                             | ** ** | **Contract**    | ** ** | ** ** | ** ** | **Contract**  | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                           | ** ** | **Amount**                             | ** ** | **Revenues**    | ** ** | **Amount** | ** ** | **Revenues**  | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In thousands, except percentages)** | ** ** |
| Salary  and personnel-related        |       | $                                      | 2,748      |            | 4.0        | %          | $          | 2,294         |       | 3.5 | % | $ | 454 |   | 19.8 | % |
| Facilties,  development and supplies |       | 1,018                                  |       | 1.5             |       | 1,019      |       | 1.6           |       | (1 | ) | (0.1 | ) |
| Other                                |       | 264                                    |       | 0.4             |       | 253        |       | 0.4           |       | 11 |   | 4.3 |   |
| Research  and development            |       | $                                      | 4,030      |            | 5.8        | %          | $          | 3,566         |       | 5.5 | % | $ | 464 |   | 13.0 |   |

 

Theincrease in research and development expense in Fiscal 2009 compared to Fiscal2008 was primarily due to increased research and development activities inRoadway Sensors aimed at accelerating the time to market of certain newproducts which were introduced in Fiscal 2009.

 

*OtherIncome, Net*

 

**Otherincome, net in Fiscal 2010 was $44,000 and primarily consisted of foreigncurrency transaction gains and the net decrease in the fair value of certainoutstanding warrants. See Note 8 of Notes to Consolidated Financial Statements,included in Part IV, Item 15 of this report, for additional discussionregarding the fair value of our warrants.**

** **

**Otherincome, net in Fiscal 2009 was $116,000 and includes the net gain of $50,000that we recognized in connection with the early retirement of certain of ourconvertible debentures, as well as net foreign currency transaction gains andother miscellaneous income. Other income, net in Fiscal 2008 was $252,000 andprimarily reflected the net gain of $224,000 we recognized in connection withthe early retirement of certain convertible debentures. See Note 4 of Notes toConsolidated Financial Statements for additional discussion regarding theretirement of our convertible debentures.**

** **

*InterestExpense, Net*

 

**Netinterest expense was $264,000, $646,000 and $1.3 million in Fiscal 2010, 2009and 2008, respectively. The sequential decreases were primarily due to ourlower overall level of borrowings and lower interest rates in the currentyears.**

** **

*IncomeTaxes*

 

The following tablepresents our benefit (provision) for income taxes for Fiscal 2010, Fiscal 2009and Fiscal 2008:

 
| ** **                            | ** ** | **Year Ended March 31,**          | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **2010**                               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(In thousands, except percentages)** | ** ** |
| Benefit  (provision) for income taxes |       | $                                      | (895       | ) | $ | 5,297 |   | $ | 5,900 |   |
| Effective  tax rate                   |       | 28.9                                   | %          | (102.3 | )% | (94.2 | )% |
|                                       |            |                                        |            |  |  |  |  |  |  |  |

 

Our effective tax ratefor Fiscal 2010 was favorably impacted primarily by the recognition ofapproximately $414,000 of unrecognized tax benefits during the year due to theexpiration of certain federal and state statutes in various jurisdictions. Theincome tax benefits recorded in Fiscal 2009 and Fiscal 2008 were primarily theresult of a decrease in the valuation allowance recorded against our deferredtax assets as a result of changes in estimates of the future realizability ofthese assets. As we update our estimates in future periods, adjustments to ourdeferred tax asset and valuation allowance may be necessary. We anticipate thiswill cause our future overall effective tax rate in any given period to fluctuatefrom prior effective tax rates and statutory tax rates. We utilize theliability method of accounting for income taxes. We record net deferred taxassets to the extent that we believe these assets will more likely than not berealized. In making such determination, we consider all available positive andnegative evidence, including, but not limited to, scheduled reversals ofdeferred tax liabilities, projected future taxable income, tax planningstrategies and recent financial performance.

 

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At March 31, 2010, we had $38.5 million of federal net operatingloss carryforwards and $18.4 million of state net operating losscarryforwards that begin to expire in 2019 and 2013, respectively. Due tochanges in stock ownership, our federal net operating loss carryforwards andother federal attributes are subject to a Section 382 annual limitation.Although the impact cannot be precisely determined at this time, we believethat our net operating loss carryforwards will cause us to have future incometax payments that are substantially lower than the income tax liabilitycalculated using statutory tax rates.

 

**Liquidityand Capital Resources**

 

*Cash Flows*

 

We have historicallyfinanced our operations with a combination of cash flows from operations,borrowings under credit facilities and the sale of equity securities. Wecurrently rely on cash flows from operations and the availability of borrowingson a line of credit facility to fund our operations, which we believe to besufficient to fund our operations for at least the next twelve months. However,we may need to raise additional capital to fund potential future acquisitions andour future growth. We may raise such funds by selling equity or debt securitiesto the public or to selected investors, or by borrowing money from financialinstitutions. If we raise additional funds by issuing equity or convertibledebt securities, the ownership percentage of existing stockholders would likelybe reduced.

 

At March 31, 2010, wehad $22.6 million in working capital, which included no borrowings on our $12.0million line of credit and $10.4 million in cash and cash equivalents. Thiscompares to working capital of $20.6 million at March 31, 2009, whichincluded no borrowings on our line of credit and $6.4 million in cash and cashequivalents.

 

The following tablesummarizes our cash flows for Fiscal 2010, Fiscal 2009 and Fiscal 2008:

 
| ** **                          | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In thousands)**            | ** ** |
| **Net cash provided by (used in):** |       |                          |       |   |   |   |   |
| Operating  activities               |       | $                             | 6,484      |   | $ | 6,390 |   | $ | 7,579 |   |
| Investing  activities               |       | (594                          | )          | (795 | ) | (739 | ) |
| Financing  activities               |       | (1,857                        | )          | 413 |   | (6,454 | ) |
|                                     |            |                               |            |  |  |  |  |  |  |  |

 

*Operating Activities.*  Cash provided by our operations in Fiscal2010 was primarily the result of (i) our Fiscal 2010 net income of $2.2million; (ii) $2.5 million in non-cash items within the statement ofincome, primarily consisting of adjustments to our deferred tax assets of $1.0million, depreciation expense of $986,000 and stock-based compensation expenseof $375,000; and (iii) $1.7 million in cash resulting from changes in ouroperating assets and liabilities during the year.

 

Ournet accounts receivable decreased approximately $1.1 million from March 31,2009 to March 31, 2010 due in part to our lower net sales and contractrevenues in Fiscal 2010 as compared to Fiscal 2009 levels. During the currentfiscal year, we have also generally been successful in collecting ouroutstanding receivables within our expected payment terms. In the future, ouraccounts receivable could increase if customers delay their payments or if wegrant extended payment terms to customers, both of which are more likely tooccur during challenging economic times when our customers may face issuesgaining sufficient credit on a timely basis or on acceptable terms.

 

Inventoriesdecreased approximately $3.0 million from March 31, 2009 to March 31,2010 as we worked through higher inventory levels on-hand as of March 31,2009, which were partially due to the introduction of new Roadway Sensorsproducts and the acquisition of various components that were discontinued bythe manufacturer. During the current fiscal year, we have also focused onreducing our inventory purchases to reflect the overall reduction in our netsales and the ongoing economic slowdown. In the future, our inventory levelsare likely to continue to be determined based upon, among other factors, thelevel of purchase orders we receive from our customers, the stage at which ourproducts are in their respective product life cycles, and competitivesituations in the marketplace. We attempt to balance such considerationsagainst risk of obsolescence or potentially excess inventory levels.

 

Accountspayable decreased approximately $1.7 million from March 31, 2009 to March 31,2010 largely due to the decrease in inventory purchases throughout Fiscal 2010as compared to the prior fiscal year. The general timing of inventory and otherpurchases and vendor payments also contributed to the year-over-year decreasein our accounts payable.

 

Cash provided by ouroperations in Fiscal 2009 was primarily the result of our Fiscal 2009 netincome of $10.5 million adjusted for $3.7 million of net non-cash items withinthe statement of income, which was comprised primarily of adjustments to ourdeferred tax balances of $5.4 million, offset slightly by depreciation expenseof $1.0 million and stock-based compensation, amortization and other itemstotaling $642,000.

 

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Cash provided by ouroperations in Fiscal 2008 was primarily the result of our Fiscal 2008 netincome of $12.2 million and $1.6 million in net cash provided by changes inoperating assets and liabilities. These were partially offset by approximately$6.2 million in net non-cash items within the statement of income, whichincluded adjustments to our deferred tax balances of $7.3 million, offsetslightly by depreciation, stock compensation, amortization and other itemstotaling $1.1 million.

 

*Investing Activities. *Our investing activities forFiscal 2010 consisted of purchases of property and equipment of $294,000, aswell as $300,000 representing the initial payment for the acquisition ofHamilton Signal, Inc. In April 2010, we subsequently made our secondpayment of $106,000 for the purchase of Hamilton Signal, and we expect to makethe final payment of approximately $112,000 in April 2011. For furtherinformation on our acquisition of Hamilton Signal, Inc., refer to Note 3of Notes to Consolidated Financial Statements included in Part IV, Item 15of this report

 

Cash used in investingactivities for Fiscal 2009 and Fiscal 2008 each consisted of purchases ofcertain property and equipment of $795,000 and $739,000, respectively.

 

*Financing Activities. *Net cash used in financingactivities during Fiscal 2010 was the result of net payments on our long-termdebt of $2.0 million, which included our contractual monthly principal paymentsas well as an additional principal payment of $500,000 made in November 2009,as further discussed below under “Borrowings.” The net payments on ourlong-term debt were partially offset by $143,000 in proceeds received from theexercise of outstanding stock options to purchase shares of our common stock.Net cash provided by financing activities in Fiscal 2009 was the result of$900,000 in cash inflows from the exercise of stock options to purchase ourcommon stock, partially offset by net payments on our borrowings of $500,000.Net cash used in financing activities in Fiscal 2008 was the result of netpayments on our borrowings of $8.0 million, partially offset by cash inflows of$1.5 million from the exercise of outstanding stock options and warrants topurchase our common stock.

 

*Borrowings*

 

In October 2008,we entered into a $19.5 million credit facility with California Bank &Trust, which provides for a two-year revolving line of credit with borrowingsof up to $12.0 million and a $7.5 million 48-month term note (discussed below).Interest on borrowed amounts under the revolving line of credit are payablemonthly at a rate equal to the current stated prime rate (3.25% at March 31,2010) 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. We are obligated to pay an unused linefee of 0.25% per annum applied to the average unused portion of the revolvingline of credit during the preceding month. The revolving line of credit doesnot contain any early termination fees and is secured by substantially all ofour assets. As of March 31, 2010, no amounts were outstanding under therevolving line of credit portion of the facility. Availability under this lineof credit may be reduced or otherwise limited as a result of our obligations tocomply with certain financial covenants, as described further below.

 

As of March 31, 2010, we had outstandingborrowings of approximately $5.3 million under the term note included in ourcredit facility. Principal payments under this term note are required to berepaid in 48 monthly installments of $152,000 commencing on June 1, 2009.Additionally, beginning on November 1, 2009, and on November 1 ofeach year thereafter, we are required to repay additional principal of up to$500,000, calculated based on certain financial measures, as further defined inthe loan agreement. These additional principal payments effectively reduce thetotal number of monthly installments necessary to repay the term note. Intereston the term note is payable monthly at a rate equal to the current stated primerate plus 0.50% up to the current stated prime rate plus 1.00%, depending onaggregate deposit balances maintained at the bank in relation to the total loancommitment under the credit facility. The term note contains no earlytermination fees and, along with our revolving line of credit discussed above,is secured by substantially all of our assets.

 

In connection withour credit facility and loan agreement with California Bank & Trust,we are also required to comply with certain quarterly financial covenants.These include achieving ratios for working capital and debt service, as well asmaintaining a level of profitability, all of which are further defined in theagreement. While we believe we are currently in compliance with all suchfinancial covenants and expect to maintain compliance for the foreseeablefuture, we cannot assure you that we will not violate one or more covenants inthe future. If we were to be in violation of covenants under this agreement,our lender could choose to accelerate payment on all outstanding loan balancesand pursue its security interest in our assets. In this event, we cannot assureyou that we would be able to quickly obtain equivalent or suitable replacementfinancing on acceptable terms, or at all. If we were not able to securealternative sources of financing, such acceleration would have a materialadverse impact on our business and financial condition.

 

**Off Balance Sheet Arrangements**

 

At March 31, 2010,we had outstanding warrants to purchase an aggregate of 246,250 shares ofour common stock at an exercise price of $3.25 per share that are callable byus, for a purchase price of $0.01 per share, if the market price of our commonstock trades for 20 consecutive days at a price equal to or greater than $6.50per share. These warrants are scheduled to expire in February 2011. Wealso had outstanding warrants to purchase an aggregate of 75,000 shares ofour common stock at an exercise price of $5.00 per share that are callable byus, for an aggregate purchase price of $1.00, if the market price of our commonstock trades for 20 consecutive days at a price equal to or greater than $7.50per share. These warrants are scheduled to expire in July 2010.

 

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In connection with theissuance of warrants to purchase 246,250 shares of our common stock at $3.25per share (discussed above), we are a party to a registration rights agreementthat contains provisions under which we could be subjected to liquidateddamages should we fail to maintain effective registration statements for theshares of common stock issuable upon exercise of certain underlying warrants.Through March 31, 2009, these warrants were accounted for within equity inour consolidated balance sheets and, accordingly, no liabilities were recordedin connection therewith. Beginning April 1, 2009, as further discussed atNote 8 of Notes to Consolidated Financial Statements included in Part IV,Item 15 of this report, because these warrants contain a provision for possiblefuture adjustments to either the exercise price and/or number of shares to beissued upon exercise, we began recognizing these warrants as liabilities in ourconsolidated balance sheet with changes in their fair value recorded in ourconsolidated statement of income. As of the date of this filing, no liquidateddamages are payable under the provisions of the registration rights agreementassociated with these warrants.

 

Other than our operatingleases, which are further described at Note 6 of Notes to ConsolidatedFinancial Statements, included in Part IV, Item 15 of this report, we donot believe we have any other material off balance sheet arrangements at March 31,2010.

 

**Seasonality**

 

Wehave historically experienced seasonality, particularly with respect to ourRoadway Sensors net sales in the third and fourth fiscal quarters due to areduction in road construction and repairs during the winter months due toinclement weather conditions.

 

**ITEM 7A.****                                    ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**Interest Rate Risk**

 

Our exposure to interest rate risk is limited to ourline of credit and our bank term note. Our line of credit bears interest equalto the prevailing prime rate (3.25% at March 31, 2010) plus 0% to 1.0%. Wedo not believe that a 10% increase in the interest rate on our line of creditor term note would have a material impact on our financial position, operatingresults or cash flows. In addition, we believe that the carrying value of ouroutstanding debt under our credit facility approximates fair value.

 

**Foreign Currency Risk**

 

Todate, a small portion of our net sales have been denominated in Euros. Gains orlosses from foreign currency remeasurement are included in other income in ourconsolidated financial statements and to date have not been significant. We donot believe we are currently exposed to any material risk of loss from currencyexchange fluctuations. We do not currently purchase derivative financialinstruments to hedge foreign currency exchange risk, but may do so in thefuture.

 

**ITEM 8.****                                             ****FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

The financial statementsand supplementary data required by Regulation S-X are included in Part IV,Item 15 of this report.

 

**ITEM 9.****                                             ****CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

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**ITEM 9A(T).****                    ****CONTROLS AND PROCEDURES**

 

*(a)   Evaluation ofdisclosure controls and procedures.*  In accordance with Rule 13a-15(b) of theSecurities Exchange Act of 1934, as of the end of the period covered by thisAnnual Report on Form 10-K, management evaluated, with the participationof the our President and Chief Executive Officer and the Chief FinancialOfficer, the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rule 13a-15(e) under theExchange Act). Based upon their evaluation of these disclosure controls andprocedures, the President and Chief Executive Officer and the Chief FinancialOfficer have concluded that our disclosure controls and procedures wereeffective as of the date of such evaluation in ensuring that informationrequired to be disclosed in our Exchange Act reports is (1) recorded,processed, summarized and reported in a timely manner, and (2) accumulatedand communicated to management, including the Company’s President and ChiefExecutive Officer and the Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

*(b)  Changes in internal control.*    There was nochange in our internal control over financial reporting that occurred duringthe period covered by this Annual Report on Form 10-K that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**InherentLimitations on Internal Control**

 

Acontrol system, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met. Further, the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of management override or improper acts, if any, have beendetected. These inherent limitations include the realities that judgments indecision making can be faulty, and that breakdowns can occur because of simpleerrors. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The design of any system of controls is also based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Because of the inherent limitations in acost-effective control system, misstatements due to management override, erroror improper acts may occur and not be detected. Any resulting misstatement orloss may have an adverse and material effect on our business, financialcondition and results of operations.

 

**Management’s Report on InternalControl Over Financial Reporting**

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Our internal control system was designed to providereasonable assurance to management and the board of directors regarding theeffectiveness of our internal control processes over the preparation and fairpresentation of published financial statements.

 

We have assessed theeffectiveness of our internal controls over financial reporting as of March 31,2010. In making this assessment, we used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (“COSO”) inInternal Control—Integrated Framework. Based on our assessment, we believethat, as of March 31, 2010, our internal control over financial reportingis effective based on those criteria.

 

This annual report does not include an attestationreport of our independent registered public accounting firm regarding internalcontrol over financial reporting. Management’s report was not subject toattestation by our independent registered public accounting firm pursuant tothe rules of the SEC that permit us to provide only management’s report inthis annual report.

 

**ITEM 9B**.                    **OTHER INFORMATION**

 

One of our directors,Joel Slutzky, is entering into a trading plan pursuant to Rule 10b5-1(c)(1) ofthe Securities Exchange Act of 1934, as amended, as soon as practicablefollowing the filing of this report with the SEC, which trading plan covers anaggregate of 96,000 shares of our common stock to be sold by Mr. Slutzky over atwelve month period beginning July 1, 2010, at a rate of 8,000 shares permonth on the first trading day of each month (or as soon as possiblethereafter) at market price, but not less than 2% below the prior trading day’sclosing sale price if sold within the first three weeks of the applicablemonth.

 

**PART III**

 

**ITEM 10.****                     ****DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

(a)  *Identification of Directors.*Theinformation under the caption “Election of Directors,” appearing in our proxystatement for the 2010 Annual Meeting of Stockholders, is incorporated hereinby reference.

 

(b)  *Identification of Executive Officers.*Theinformation under the caption “Executive Compensation and Other Information -Executive Officers,” appearing in our proxy statement for the 2010 AnnualMeeting of Stockholders, is incorporated herein by reference.

 

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(c)  *Compliance with Section 16(a) of theExchange Act.*The information under the caption “Section 16(a) BeneficialOwnership Reporting Compliance,” appearing in our proxy statement for the 2010Annual Meeting of Stockholders, is incorporated herein by reference.

 

(d)  *Corporate Governance*.The information under the caption “Corporate Governance,” appearing in ourproxy statement for the 2010 Annual Meeting of Stockholders, is incorporatedherein by reference.

 

(e)  *Audit Committee*.The information under the caption “Board Meetings and Committees — AuditCommittee,” appearing in our proxy statement for the 2010 Annual Meeting ofStockholders, is incorporated herein by reference.

 

**ITEM 11.****                     ****EXECUTIVE COMPENSATION**

 

The information under thecaption “Executive Compensation and Other Information,” appearing in our proxystatement for the 2010 Annual Meeting of Stockholders, is incorporated hereinby reference.

 

**ITEM 12.****                  ****SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

The information under thecaptions “Equity Compensation Plans” and “Principal Stockholders and CommonStock Ownership of Certain Beneficial Owners and Management,” appearing in ourproxy statement for the 2010 Annual Meeting of Stockholders, is incorporatedherein by reference.

 

**ITEM 13.**                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, ANDDIRECTOR INDEPENDENCE

 

The information under thecaptions “Corporate Governance — Director Independence” and “CertainTransactions,” appearing in our proxy statement for the 2010 Annual Meeting ofStockholders, is incorporated herein by reference.

 

**ITEM 14.**                 PRINCIPAL ACCOUNTING FEES AND SERVICES

 

The information under thecaption “Fees Paid to Independent Registered Public Accounting Firm,” appearingin our proxy statement for the 2010 Annual Meeting of Stockholders, isincorporated herein by reference.

 

**PART IV**

 

**ITEM 15.**                 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

** **

(a)               Documents filed as part of this report:

 

1.             *FinancialStatements.* The following financial statements of Iteris, Inc.are included in a separate section of this Annual Report on Form 10-Kcommencing on the pages referenced below:

 
| Report of Independent Registered Public Accounting  Firm                                                                                         | 35 |
|--------------------------------------------------------------------------------------------------------------------------------------------------|----|
| Consolidated  Balance Sheets as of March 31, 2010 and 2009                                                                                  | 36 |
| Consolidated Statements of Income for the years ended  March 31, 2010, 2009 and 2008                                                        | 37 |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the years ended March 31, 2010,  2009 and 2008 | 38 |
| Consolidated Statements of Cash Flows for the years  ended March 31, 2010, 2009 and 2008                                                    | 39 |
| Notes to Consolidated Financial Statements                                                                                                       | 40 |

 

2.             *Exhibits*.

 

The exhibits listed on theaccompanying index to exhibits immediately following the financial statementsare filed as part of, or hereby incorporated by reference into, this report.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

 
| Dated:  May 20, 2010 | ITERIS,  INC. |
|---------------------------|---------------|
|                      | (Registrant)  |
|                      |          |
|                      | By            | /S/  ABBAS MOHADDES |
|                      |          | Abbas  Mohaddes |
|                      |          | Chief  Executive Officer |
|                      |          | (Principal  Executive Officer) |

 

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##### **POWER OFATTORNEY**

#####  

We, the undersignedofficers and directors of Iteris, Inc., do hereby constitute and appointJames S. Miele and Abbas Mohaddes, and each of them, our true and lawfulattorneys-in-fact and agents, each with full power of substitution andresubstitution, for him and in his name, place and stead, in any and allcapacities, to sign any and all amendments to this report, and to file thesame, with exhibits thereto, and other documents in connection therewith, withthe Securities and Exchange Commission, granting unto said attorneys-in-factand agents, and each of them, full power and authority to do and perform eachand every act and thing requisite or necessary to be done in and about thepremises, as fully to all intents and purposes as he might or could do inperson, hereby, ratifying and confirming all that each of saidattorneys-in-fact and agents, or his substitute or substitutes, may lawfully door cause to be done by virtue hereof.

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant in thecapacities and on the dates indicated:

 
| **Signature**         | ** ** | **Title**                                        | ** ** | **Date**          |
|-----------------------|------------|--------------------------------------------------|------------|-------------------|
|                  |       |                                             |       |              |
| /s/  ABBAS MOHADDES   |       | Director, President and  Chief Executive Officer |       | May 20, 2010 |
| Abbas  Mohaddes       |       | (principal executive  officer)                   |       |              |
|                  |       |                                             |       |              |
| /s/  JAMES S. MIELE   |       | Chief Financial Officer                          |       | May 20, 2010 |
| James  S. Miele       |       | (principal financial and  accounting officer)    |       |              |
|                  |       |                                             |       |              |
| /s/  GREGORY A. MINER |       | Chairman of the Board                            |       | May 20, 2010 |
| Gregory  A. Miner     |       |                                             |       |              |
|                  |       |                                             |       |              |
| /s/  RICHARD CHAR     |       | Director                                         |       | May 20, 2010 |
| Richard  Char         |       |                                             |       |              |
|                  |       |                                             |       |              |
| /s/  KEVIN C. DALY    |       | Director                                         |       | May 20, 2010 |
| Kevin  C. Daly, Ph.D. |       |                                             |       |              |
|                  |       |                                             |       |              |
| /s/  JOHN SEAZHOLTZ   |       | Director                                         |       | May 20, 2010 |
| John  Seazholtz       |       |                                             |       |              |
|                  |       |                                             |       |              |
| /s/  JOEL SLUTZKY     |       | Director                                         |       | May 20, 2010 |
| Joel  Slutzky         |       |                                             |       |              |
|                  |       |                                             |       |              |
| /s/  THOMAS L. THOMAS |       | Director                                         |       | May 20, 2010 |
| Thomas  L. Thomas     |       |                                             |       |              |

 

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** **

**Iteris, Inc.**

 

**Index to Consolidated Financial Statements**

 
| Report  of Independent Registered Public Accounting Firm                                                                               |   | 35     |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                   |   |   |
| Consolidated  Balance Sheets as of March 31, 2010 and 2009                                                                        |   | 36     |
|                                                                                                                                   |   |   |
| Consolidated  Statements of Income for the years ended March 31, 2010, 2009 and 2008                                              |   | 37     |
|                                                                                                                                   |   |   |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income for the years ended March 31,  2010, 2009 and 2008 |   | 38     |
|                                                                                                                                   |   |   |
| Consolidated  Statements of Cash Flows for the years ended March 31, 2010, 2009 and  2008                                         |   | 39     |
|                                                                                                                                   |   |   |
| Notes  to Consolidated Financial Statements                                                                                            |   | 40     |

 

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**Reportof Independent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders

Iteris, Inc.

 

Wehave audited the accompanying consolidated balance sheets of Iteris, Inc. andsubsidiary as of March 31, 2010 and 2009, and the related consolidatedstatements of income, stockholders’ equity and comprehensive income, and cashflows for each of the three years in the period ended March 31, 2010.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Asdiscussed in Note 8 to the consolidated financial statements, effective April 1,2009 the Company changed its method of accounting for certain common stockwarrants.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Iteris, Inc. andsubsidiary as of March 31, 2010 and 2009, and the results of theiroperations and their cash flows for each of the three years in the period endedMarch 31, 2010, in conformity with U.S. generally accepted accountingprinciples.

 

Wewere not engaged to examine the effectiveness of Iteris, Inc.’s internalcontrol over financial reporting as of March 31, 2010, and, accordingly,we do not express an opinion thereon.

 

 
| /s/  McGladrey & Pullen, LLP |   |
|---------------------------------------|--------|
| Irvine,  California                   |   |
| May 20,  2010                    |   |

 

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**Iteris, Inc.**

**Consolidated Balance Sheets**

**(In thousands, except par value)**

 
| ** **                                                                                                                         | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                         | ** ** | **2010**           | ** ** | **2009** | ** ** |
| **Assets**                                                                                                                         |       |               |       |   |   |
| Current  assets:                                                                                                                   |       |               |       |   |   |
| Cash  and cash equivalents                                                                                                         |       | $                  | 10,405     |   | $ | 6,372 |   |
| Trade  accounts receivable, net of allowance for doubtful accounts of $768 and $534  at March 31, 2010 and 2009, respectively |       | 11,311             |       | 12,448 |   |
| Costs  in excess of billings on uncompleted contracts                                                                              |       | 3,871              |       | 4,217 |   |
| Inventories                                                                                                                        |       | 2,727              |       | 5,681 |   |
| Deferred  income taxes                                                                                                             |       | 4,993              |       | 4,241 |   |
| Prepaid  expenses and other current assets                                                                                         |       | 623                |       | 272 |   |
| Total  current assets                                                                                                              |       | 33,930             |       | 33,231 |   |
| Property  and equipment, net                                                                                                       |       | 2,550              |       | 3,244 |   |
| Deferred  income taxes                                                                                                             |       | 9,739              |       | 11,505 |   |
| Intangible  assets, net                                                                                                            |       | 452                |       | 110 |   |
| Goodwill                                                                                                                           |       | 27,791             |       | 27,774 |   |
| Other  assets                                                                                                                      |       | 200                |       | 202 |   |
| Total  assets                                                                                                                      |       | $                  | 74,662     |   | $ | 76,066 |   |
|                                                                                                                               |       |               |       |   |   |
| **Liabilities and stockholders’ equity**                                                                                      |       |               |       |   |   |
| Current  liabilities:                                                                                                              |       |               |       |   |   |
| Trade  accounts payable                                                                                                            |       | $                  | 2,492      |   | $ | 4,228 |   |
| Accrued  payroll and related expenses                                                                                              |       | 2,709              |       | 3,188 |   |
| Accrued  liabilities                                                                                                               |       | 1,748              |       | 1,662 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts                                                       |       | 2,105              |       | 1,534 |   |
| Current  portion of long-term debt                                                                                                 |       | 2,324              |       | 2,019 |   |
| Total  current liabilities                                                                                                         |       | 11,378             |       | 12,631 |   |
| Deferred  rent                                                                                                                     |       | 1,386              |       | 1,686 |   |
| Unrecognized  tax benefits                                                                                                         |       | 751                |       | 1,117 |   |
| Other  non-current liabilities                                                                                                     |       | 112                |       | — |   |
| Long-term  debt                                                                                                                    |       | 2,969              |       | 5,274 |   |
| Total  liabilities                                                                                                                 |       | 16,596             |       | 20,708 |   |
| Commitments  and contingencies                                                                                                     |       |               |       |   |   |
| Stockholders’  equity:                                                                                                        |       |               |       |   |   |
| Preferred  stock, $1.00 par value:                                                                                                 |       |               |       |   |   |
| Authorized  shares - 2,000                                                                                                         |       |               |       |   |   |
| Issued  and outstanding shares - none                                                                                              |       | —             |       | — |   |
| Common  stock. $0.10 par value:                                                                                                    |       |               |       |   |   |
| Authorized  shares - 70,000 at March 31, 2010 and 2009                                                                        |       |               |       |   |   |
| Issued  and outstanding shares - 34,318 at March 31, 2010 and 34,205 at  March 31, 2009                                  |       | 3,432              |       | 3,420 |   |
| Additional  paid-in capital                                                                                                        |       | 137,503            |       | 136,997 |   |
| Common  stock held in trust                                                                                                        |       | —             |       | (31 | ) |
| Accumulated  deficit                                                                                                               |       | (82,869            | )          | (85,025 | ) |
| Accumulated  other comprehensive loss                                                                                              |       | —             |       | (3 | ) |
| Total  stockholders’ equity                                                                                                   |       | 58,066             |       | 55,358 |   |
| Total  liabilities and stockholders’ equity                                                                                   |       | $                  | 74,662     |   | $ | 76,066 |   |

 

See accompanying notes.

 

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**Iteris, Inc.**

**Consolidated Statements of Income**

**(In thousands, exceptper share amounts)**

 
| ** **                                 | ** ** | **Year Ended March 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|
| ** **                                 | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net  sales and contract revenues:          |       |                          |       |   |   |   |   |
| Net  sales                                 |       | $                             | 31,650     |   | $ | 38,427 |   | $ | 40,326 |   |
| Contract  revenues                         |       | 26,413                        |       | 30,932 |   | 24,837 |   |
| Total  net sales and contract revenues     |       | 58,063                        |       | 69,359 |   | 65,163 |   |
| Costs  of net sales and contract revenues: |       |                          |       |   |   |   |   |
| Cost  of net sales                         |       | 16,505                        |       | 20,346 |   | 20,499 |   |
| Cost  of contract revenues                 |       | 17,399                        |       | 21,094 |   | 16,367 |   |
| Gross  profit                              |       | 24,159                        |       | 27,919 |   | 28,297 |   |
| Operating  expenses:                       |       |                          |       |   |   |   |   |
| Selling,  general and administrative       |       | 17,004                        |       | 18,035 |   | 17,289 |   |
| Research  and development                  |       | 3,678                         |       | 4,030 |   | 3,566 |   |
| Amortization  of intangible assets         |       | 159                           |       | 147 |   | 147 |   |
| Total  operating expenses                  |       | 20,841                        |       | 22,212 |   | 21,002 |   |
| Operating  income                          |       | 3,318                         |       | 5,707 |   | 7,295 |   |
| Non-operating  income (expense):           |       |                          |       |   |   |   |   |
| Other  income, net                         |       | 44                            |       | 116 |   | 252 |   |
| Interest  expense, net                     |       | (264                          | )          | (646 | ) | (1,284 | ) |
| Income  before income taxes                |       | 3,098                         |       | 5,177 |   | 6,263 |   |
| Benefit  (provision) for income taxes      |       | (895                          | )          | 5,297 |   | 5,900 |   |
| Net  income                                |       | $                             | 2,203      |   | $ | 10,474 |   | $ | 12,163 |   |
|                                       |       |                          |       |   |   |   |   |
| Earnings  per share:                       |       |                          |       |   |   |   |   |
| Basic                                      |       | $                             | 0.06       |   | $ | 0.31 |   | $ | 0.37 |   |
| Diluted                                    |       | $                             | 0.06       |   | $ | 0.30 |   | $ | 0.35 |   |
| Weighted-average  shares outstanding:      |       |                          |       |   |   |   |   |
| Basic                                      |       | 34,249                        |       | 33,964 |   | 32,723 |   |
| Diluted                                    |       | 34,435                        |       | 34,638 |   | 34,713 |   |

 

See accompanyingnotes.

 

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**Iteris, Inc.**

**Consolidated Statements of Stockholders’ Equity and ComprehensiveIncome**

**(In thousands)**

 
| ** **                                                               | ** ** | **Common  Stock Shares** | ** ** | **Amount** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Common  Stock Held  in Trust** | ** ** | **Notes  Receivable   From  Employees** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholder’s  Equity** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------|------------|------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| Balance  at March 31, 2007                                          |       | 30,601                   |       | $          | 3,060      |                             | $          | 130,425                          |       | $                                       | (374       | )                        | $          | (5                                                   | )          | $                                     | (107,438   | ) | $ | 19 |   | $ | 25,687 |   |
| Cumulative  effect of adoption of new accounting for income taxes        |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | (224                     | )          | —                                               |       | (224                                  | )          |
| Conversion  of redeemable common stock to common stock                   |       | 1,219                    |       | 122        |       | 3,292                            |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 3,414                                 |       |
| Warrant  exercises                                                       |       | 85                       |       | 9          |       | 113                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 122                                   |       |
| Stock  option exercises                                                  |       | 1,515                    |       | 151        |       | 1,223                            |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 1,374                                 |       |
| Stock-based  compensation                                                |       | —                   |       | —     |       | 290                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 290                                   |       |
| Issuance  of shares held in trust                                        |       | —                   |       | —     |       | 178                              |       | 172                              |       | —                                  |       | —                   |       | —                                               |       | 350                                   |       |
| Write-off  of notes receivable from employees                            |       | —                   |       | —     |       | (5                               | )          | —                           |       | 5                                       |       | —                   |       | —                                               |       | —                                |       |
| Components  of comprehensive income:  Foreign  currency translation |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | 35                                                   |       | 35                                    |       |
| Net  income                                                              |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | 12,163                   |       | —                                               |       | 12,163                                |       |
| Comprehensive  income                                                    |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 12,198                                |       |
| Balance  at March 31, 2008                                          |       | 33,420                   |       | 3,342      |       | 135,516                          |       | (202                             | )          | —                                  |       | (95,499                  | )          | 54                                                   |       | 43,211                                |       |
| Stock  option exercises                                                  |       | 785                      |       | 78         |       | 861                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 939                                   |       |
| Stock-based  compensation                                                |       | —                   |       | —     |       | 364                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 364                                   |       |
| Issuance  of shares held in trust                                        |       | —                   |       | —     |       | 256                              |       | 171                              |       | —                                  |       | —                   |       | —                                               |       | 427                                   |       |
| Components  of comprehensive income:                                     |       |                     |       |       |       |                             |       |                             |       |                                    |       |                     |       |                                                 |       |                                  |       |
| Foreign  currency translation                                            |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | (57                                                  | )          | (57                                   | )          |
| Net  income                                                              |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | 10,474                   |       | —                                               |       | 10,474                                |       |
| Comprehensive  income                                                    |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 10,417                                |       |
| Balance  at March 31, 2009                                          |       | 34,205                   |       | 3,420      |       | 136,997                          |       | (31                              | )          | —                                  |       | (85,025                  | )          | (3                                                   | )          | 55,358                                |       |
| Cumulative  effect of adoption of change in accounting for warrants      |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | (47                      | )          | —                                               |       | (47                                   | )          |
| Stock  option exercises                                                  |       | 113                      |       | 12         |       | 131                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 143                                   |       |
| Stock-based  compensation                                                |       | —                   |       | —     |       | 375                              |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 375                                   |       |
| Issuance  of shares held in trust                                        |       | —                   |       | —     |       | —                           |       | 31                               |       | —                                  |       | —                   |       | —                                               |       | 31                                    |       |
| Components  of comprehensive income:                                     |       |                     |       |       |       |                             |       |                             |       |                                    |       |                     |       |                                                 |       |                                  |       |
| Foreign  currency translation                                            |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | 3                                                    |       | 3                                     |       |
| Net  income                                                              |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | 2,203                    |       | —                                               |       | 2,203                                 |       |
| Comprehensive  income                                                    |       | —                   |       | —     |       | —                           |       | —                           |       | —                                  |       | —                   |       | —                                               |       | 2,206                                 |       |
| Balance  at March 31, 2010                                          |       | 34,318                   |       | $          | 3,432      |                             | $          | 137,503                          |       | $                                       | —     |                     | $          | —                                               |       | $                                     | (82,869    | ) | $ | — |   | $ | 58,066 |   |

 

See accompanyingnotes.

 

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**Iteris, Inc.**

**Consolidated Statements of Cash Flows**

**(In thousands)**

 
| ** **                                                                         | ** ** | **Year Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Cash flows from operating activities**                                           |       |                          |       |   |   |   |   |
| Net  income                                                                        |       | $                             | 2,203      |   | $ | 10,474 |   | $ | 12,163 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                          |       |   |   |   |   |
| Change  in deferred tax assets                                                     |       | 1,014                         |       | (5,398 | ) | (7,321 | ) |
| Depreciation  of property and equipment                                            |       | 986                           |       | 1,018 |   | 756 |   |
| Stock-based  compensation                                                          |       | 375                           |       | 364 |   | 290 |   |
| Amortization  of intangible assets                                                 |       | 159                           |       | 147 |   | 147 |   |
| Gain  on early extinguishment of debt                                              |       | —                        |       | (50 | ) | (224 | ) |
| Amortization  of debt discounts                                                    |       | —                        |       | 109 |   | 201 |   |
| Amortization  of deferred financing costs                                          |       | —                        |       | 72 |   | 135 |   |
| Amortization  of deferred gain on sale-leaseback                                   |       | —                        |       | — |   | (165 | ) |
| Changes  in operating assets and liabilities:                                      |       |                          |       |   |   |   |   |
| Accounts  receivable                                                               |       | 1,137                         |       | 660 |   | (1,615 | ) |
| Net  costs and estimated earnings in excess of billings                            |       | 917                           |       | 1,542 |   | (1,383 | ) |
| Inventories                                                                        |       | 2,954                         |       | (1,455 | ) | 2,153 |   |
| Prepaid  expenses and other assets                                                 |       | (350                          | )          | 97 |   | (77 | ) |
| Accounts  payable and accrued expenses                                             |       | (2,911                        | )          | (1,190 | ) | 2,519 |   |
| Net  cash provided by operating activities                                         |       | 6,484                         |       | 6,390 |   | 7,579 |   |
|                                                                               |       |                          |       |   |   |   |   |
| **Cash flows from investing activities**                                           |       |                          |       |   |   |   |   |
| Purchases  of property and equipment                                               |       | (294                          | )          | (795 | ) | (739 | ) |
| Cash  paid for business combination                                                |       | (300                          | )          | — |   | — |   |
| Net  cash used in investing activities                                             |       | (594                          | )          | (795 | ) | (739 | ) |
|                                                                               |       |                          |       |   |   |   |   |
| **Cash flows from financing activities**                                           |       |                          |       |   |   |   |   |
| Payments  on borrowings on lines of credit, net                                    |       | —                        |       | — |   | (4,015 | ) |
| Borrowings  on long-term debt                                                      |       | 750                           |       | 6,543 |   | — |   |
| Payments  on long-term debt                                                        |       | (2,750                        | )          | (7,069 | ) | (3,838 | ) |
| Proceeds  from stock option exercises                                              |       | 143                           |       | 939 |   | 1,374 |   |
| Proceeds  from warrant exercises                                                   |       | —                        |       | — |   | 122 |   |
| Credit  facility commitment fees                                                   |       | —                        |       | — |   | (50 | ) |
| Checks  drawn in excess of available bank balances                                 |       | —                        |       | — |   | (47 | ) |
| Net  cash provided by (used in) financing activities                               |       | (1,857                        | )          | 413 |   | (6,454 | ) |
| Effect  of exchange rate changes on cash                                           |       | —                        |       | (57 | ) | — |   |
| Increase  in cash and cash equivalents                                             |       | 4,033                         |       | 5,951 |   | 386 |   |
| Cash  and cash equivalents at beginning of year                                    |       | 6,372                         |       | 421 |   | 35 |   |
| Cash  and cash equivalents at end of year                                          |       | $                             | 10,405     |   | $ | 6,372 |   | $ | 421 |   |
| ** **                                                                         |       |                          |       |   |   |   |   |
| **Supplemental cash flow information:**                                            |       |                          |       |   |   |   |   |
| Cash  paid during the year for:                                                    |       |                          |       |   |   |   |   |
| Interest                                                                           |       | $                             | 306        |   | $ | 545 |   | $ | 1,008 |   |
| Income  taxes                                                                      |       | 159                           |       | 462 |   | 24 |   |
|                                                                               |       |                          |       |   |   |   |   |
| **Supplemental schedule of non-cash investing and financing  activities:**         |       |                          |       |   |   |   |   |
| Liabilities  incurred for business combination                                     |       | $                             | 218        |   | $ | — |   | $ | — |   |
| Fair  value of common stock issued in settlement of liabilities                    |       | 31                            |       | 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 accompanyingnotes.

 

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**Iteris, Inc.**

**Notes to Consolidated Financial Statements**

**March 31, 2010**

 

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

 

**Description of Business**

 

Iteris, Inc.(including our subsidiary, referred to collectively in these consolidatedfinancial statements as “Iteris,” “the Company,” “we,” “our” and “us”)  is a leader in the traffic management marketfocused on the development and application of advanced technologies that reducetraffic congestion, minimize the environmental impact of traffic congestion andimprove the safety of surface transportation systems infrastructure. Bycombining outdoor image processing, traffic engineering and informationtechnology, we offer a broad range of Intelligent Transportation Systems (“ITS”)and driver safety solutions to customers worldwide.  Iteris was originally incorporated inDelaware in 1987.

 

**Basis of Presentation**

 

Ourconsolidated financial statements include the accounts of Iteris and oursubsidiary, Iteris Europe GmbH. All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

**Use of Estimates**

 

The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States requires ourmanagement to make certain estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements, and reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates. Significant estimates made in the preparation of theconsolidated financial statements include the allowance for doubtful accounts,projections of taxable income used to assess realizability of deferred taxassets, inventory and warranty reserves, costs to complete long-term contracts,indirect cost rates used in cost-plus contracts, contract reserves, thevaluation of debt and equity instruments and estimates of future cash flowsused to assess the recoverability of long-lived assets and the impairment ofgoodwill.

 

**Reclassifications**

 

Certainreclassifications have been made to the prior year financial statements toconform to the current year presentation.

 

**Revenue Recognition**

 

Product revenues and related costs of sales are recognized upon thetransfer of title, which generally occurs upon shipment or, if required, uponacceptance by the customer, provided that we believe collectibility of the netsales amount is reasonably assured. Accordingly, at the date revenue isrecognized, the significant uncertainties concerning the sale have beenresolved.

 

Contract revenues are derived primarily from long-term contracts withgovernmental agencies. Contract revenues include costs incurred plus a portionof estimated fees or profits determined on the percentage of completion methodof accounting based on the relationship of costs incurred to total estimatedcosts. Any anticipated losses on contracts are charged to earnings whenidentified. Changes in job performance and estimated profitability, includingthose arising from contract penalty provisions and final contract settlements,may result in revisions to costs and revenues and are recognized in the periodin which the revisions are determined. Profit incentives are included inrevenue when their realization is reasonably assured. Costs and estimatedearnings in excess of billings at March 31, 2010 and 2009 include $635,000and $684,000, respectively, that were not billable as certain milestoneobjectives specified in the contracts had not been attained. Substantially allcosts and estimated earnings in excess of billings at March 31, 2010 areexpected to be billed and collected during the fiscal year ending March 31,2011.

 

We also deriverevenue from the provision of specific non-recurring contract engineeringservices and royalties. Non-recurring contract engineering revenues arerecognized in the period in which the related services are performed. Royaltyrevenues are recorded in the period in which the royalty is earned based onunit sales of certain of our products. Non-recurring contract engineering androyalty revenues are included in net sales in the accompanying consolidatedstatements of income and totaled $685,000, $1.3 million and $1.9 million forthe fiscal years ending March 31, 2010, 2009 and 2008, respectively.

 

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**Foreign Currency**

 

We have determined thatthe functional currency of our subsidiary in Europe is the United States(“U.S.”) dollar. Local currency financial statements are remeasured into U.S.dollars at the exchange rate in effect as of the balance sheet date formonetary assets and liabilities and the historical exchange rate fornonmonetary assets and liabilities. Revenues and expenses are remeasured usingthe average exchange rate for the period, except items related to nonmonetaryassets and liabilities, which are remeasured using historical exchange rates.Remeasurement gains and losses are reported in “other income, net” in theconsolidated statements of income.

 

**Concentration of Credit Risk**

 

Financial instruments that potentially subject us to a concentration ofcredit risk consist principally of cash and cash equivalents and trade accountsreceivable.

 

Cash and cash equivalents consist primarily of demand deposits andmoney market funds maintained with several financial institutions. Depositsheld with banks may exceed the amount of insurance provided on such deposits.Generally, these deposits may be redeemed upon demand and are maintained withhigh credit quality financial institutions and therefore have minimal creditrisk.

 

Our accounts receivable are primarily derived from revenues earned fromcustomers located throughout North America and Europe. We generally do notrequire collateral or other security from customers. We maintain an allowancefor doubtful accounts for potential credit losses, which losses havehistorically been within management’s expectations.

 

**Fair Values of Financial Instruments**

 

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

 

**Cash and Cash Equivalents**

 

Cash and cash equivalents consist of cash and short-term investmentswith initial maturities of ninety days or less.

 

**Allowance for Doubtful Accounts**

 

The collectability of our accounts receivable is evaluated throughreview of invoices outstanding greater than a certain period of time andongoing credit evaluations of our customers’ financial condition. In caseswhere we are aware of circumstances that may impair a specific customer’sability to meet its financial obligations subsequent to the original sale, wewill record an allowance against amounts due, and thereby reduce the netrecognized receivable to the amount we reasonably believe will be collected. Wealso maintain an allowance based on our historical collections experience. Whenwe determine that collection is not likely, we write off accounts receivableagainst the allowance for doubtful accounts.

 

**Costs in Excess of Billings on Uncompleted Contracts**

 

Costs in excess of billings on uncompleted contracts in theaccompanying consolidated balance sheets represent unbilled amounts earned andreimbursable under services sales arrangements. At any given period-end, alarge portion of the balance in this account represents the accumulation oflabor, materials and other costs that have not been billed due to timing,whereby the accumulation of each month’s costs are not administratively billeduntil the subsequent month. Also included are amounts that become billableaccording to contract terms, which usually consider the passage of time,achievement of milestones or completion of the project. Generally, suchunbilled amounts will be billed and collected within the next twelve months.

 

**Billings in Excess of Costs and Estimated Earnings on UncompletedContracts**

 

Billings in excess of costs and estimated earnings on uncompletedcontracts in the accompanying consolidated balance sheets is comprised of cashcollected from customers and billings to customers on contracts in advance ofwork performed, advance payments negotiated as a contract condition, estimatedlosses on uncompleted contracts, project-related legal liabilities and otherproject-related reserves. The majority of the unearned amounts will beearned within the next twelve months.

 

We record provisions for estimated losses on uncompleted contracts inthe period in which such losses become known. The cumulative effects ofrevisions to contract revenues and estimated completion costs are recorded inthe accounting period in which the amounts become evident and can be reasonablyestimated. These revisions can include such items as the effects of changeorders and claims, warranty claims, liquidated damages or other contractualpenalties, adjustments for audit findings on U.S. or other government contractsand contract closeout settlements.

 

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**Inventories**

 

Inventoriesare stated at the lower of cost or market. Cost is determined using the first-in,first-out method.

 

**Property and Equipment**

 

Propertyand equipment are recorded at cost and are depreciated using the straight-linemethod over the estimated useful life ranging from three to eight years.Leasehold improvements are depreciated over the term of the related lease orthe estimated useful life of the improvement, whichever is shorter.

 

**Goodwill and Long-Lived Assets**

 

Goodwillis tested for impairment on an annual basis in our fourth fiscal quarter ormore frequently if indicators of impairment exist. The performance of the testinvolves a two-step process. The first step of the impairment test involvescomparing the fair value of our reporting units with each respective reportingunit’s carrying amount, including goodwill. We determine the fair value ofreporting units using the income approach with a reconciliation of the totalreporting unit fair value to our total market capitalization. If the carryingamount of a reporting unit exceeds the reporting unit’s fair value, the secondstep of the goodwill impairment test is performed to determine the amount ofany impairment loss. The second step of the goodwill impairment test involvescomparing the implied fair value of the reporting unit’s goodwill with thecarrying amount of that goodwill and an impairment charge is recorded for anyexcess carrying amount over fair value. We performed annual impairmentassessments of the carrying value of goodwill for each of the fiscal yearsended March 31, 2010, 2009 and 2008. Based on these assessments, we determinedthat no impairment as of each of these dates was indicated as the estimatedfair value of each of our reporting units exceeded its respective carryingvalue. We monitor the indicators for goodwill impairment testing between annualtests. Certain adverse business conditions impacting one or more reportingunits would cause us to test goodwill for impairment on an interim basis.

 

Wealso evaluate long-lived assets for impairment which requires impairmentevaluation on long-lived assets used in operations when indicators ofimpairment are present.  Reviews areperformed to determine whether the carrying value of assets is impaired, basedon a comparison of undiscounted expected future cash flows to the carryingvalue of the related net assets.  If thiscomparison indicates that there is impairment, the impaired asset is writtendown to fair value, which is typically calculated using discounted expectedfuture cash flows and a discount rate based upon our weighted average cost ofcapital adjusted for risks associated with the related operations.  Impairment is based on the excess of thecarrying amount over the fair value of those assets.

 

**Income Taxes**

 

We utilize the liabilitymethod of accounting for income taxes, whereby deferred taxes are determinedbased on the temporary differences between the financial statement and taxbases of assets and liabilities using enacted tax rates. A valuation allowanceis recorded when it is more likely than not that all or a portion of thedeferred tax assets will not be realized.

 

Wemust review all of our tax positions and make a determination as to whethereach position is more-likely-than-not to be sustained upon examination bytaxing authorities. If a tax position meets the more-likely-than-not standard,then the related tax benefit is measured based on a cumulative probabilityanalysis of the amount that is more-likely-than-not to be realized uponeffective settlement or disposition of the underlying issue.

 

## **Stock-BasedCompensation**

 

We record stock-based compensation in the consolidatedstatements of income as an expense, based on the grant date fair values of ourstock-based awards, whereby such fair values are amortized over the requisiteservice period. The fair value of our common stock option awards is estimatedon the grant date using the Black-Scholes-Merton (“BSM”) option-pricingformula, which considers, among other factors, the expected life of the awardand the expected volatility of our stock price.

 

**Research and Development Expenditures**

 

Research and development expenditures are charged to expensein the period incurred.

 

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**Shipping and Handling Costs**

 

Shipping and handling costs are included as cost of sales in the periodduring which the products ship.

 

**Sales Taxes**

 

Sales taxes are presented on a net basis (excluded from net sales andcontract revenues) in the consolidated statements of income.

 

**Advertising Expenses**

 

Advertising costs are expensed in the period incurred and totaled$153,000, $202,000 and $172,000 in the fiscal years ended March 31, 2010,2009 and 2008, respectively.

 

**Warranty**

 

We generallyprovide a one to three year warranty from the original invoice date on allproducts, materials and workmanship. Products sold to certain original equipment manufacturer customerssometimes carry longer warranties. Defective products will be either repairedor replaced, generally at our option, upon meeting certain criteria. We accruea provision for the estimated costs that may be incurred for product warrantiesrelating to a product as a component of cost of sales at the time revenue forthat product is recognized.  The accruedwarranty provision is included within accrued expenses in the accompanyingconsolidated balance sheets.

 

**Repair and Maintenance Costs**

 

We incur repair and maintenance costs in the normal course of business.Should the activity result in a permanent improvement to one of our leasedfacilities, the cost is capitalized as a leasehold improvement and amortizedover its useful life or the remainder of the lease period, whichever isshorter. Non-permanent repair and maintenance costs are charged to expense asincurred.

 

**Recent Accounting Pronouncements**

 

InOctober 2009, the Financial Accounting Standards Board (“FASB”) issuedAccounting Standards Update (“ASU”) No. 2009-13, *Multiple-DeliverableRevenue Arrangements*(“ASU 2009-13”), which amends the existingmultiple-element revenue arrangements guidance currently included in AccountingStandards Codification (“ASC”) 605-25, *Revenue Recognition —Multiple Element Arrangements*. ASU 2009-13 provides for twosignificant changes to the existing multiple-element revenue arrangementsguidance. The first relates to the determination of when the individualdeliverables included in a multiple-element arrangement may be treated asseparate units of accounting. The second change modifies the manner in whichthe transaction consideration is allocated across the separately identifieddeliverables. We plan to adopt the amendments prescribed by ASU 2009-13 for ourfiscal year beginning April 1, 2010. We do not expect that the adoption ofthis ASU will have a material impact on our consolidated financial statements.

 

In October 2009, theFASB issued ASU No. 2009-14, *Certain RevenueArrangements That Include Software Elements*(“ASU 2009-14”), whichamends and modifies the scope of ASC 985-605, *Software —Revenue Recognition*, such that many sales transactions of tangibleproducts that include software and other related transactions will fall outsideits scope. We plan to adopt the amendments prescribed by ASU 2009-14 for ourfiscal year beginning April 1, 2010. We do not expect that the adoption ofthis ASU will have a material impact on our consolidated financial statements.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, *ImprovingDisclosures about Fair Value Measurements* (“ASU 2010-06”), whichamends ASC Topic 820,*Fair Value Measurements and Disclosures*(“ASC 820”) to require various additional disclosures regarding fair valuemeasurements and also clarify certain existing disclosure requirements.Additional requirements include disclosing (i) the amounts of significanttransfers between Level 1 and Level 2 of the fair value hierarchy, (ii) thereasons for any transfers in or out of Level 3 and (iii) information inthe reconciliation of recurring Level 3 measurements about purchases, sales,issuances and settlements on a gross basis. ASU 2010-06 does not change any accountingrequirements, but is expected to have a significant effect on the disclosuresof entities that measure assets and liabilities at fair value. The amendmentsprescribed by ASU 2010-06 became effective for our fiscal quarter ending March 31,2010, except for the requirements described in item (iii) above, whichwill be effective for our fiscal year beginning April 1, 2011. Theadoption of this ASU did not have a material impact on our consolidatedfinancial statements.

 

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**2.****            ****Supplementary Financial Information**

 

**Inventories**

 

The following table presents details regarding our inventories:

 
| ** **              | ** ** | **March 31,** | ** ** |
|-------------------------|------------|--------------------|------------|
| ** **              | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **              | ** ** | **(In thousands)** | ** ** |
| Materials  and supplies |       | $                  | 2,292      |   | $ | 4,820 |   |
| Work  in process        |       | 49                 |       | 198 |   |
| Finished  goods         |       | 386                |       | 663 |   |
|                    |       | $                  | 2,727      |   | $ | 5,681 |   |

 

**Property and Equipment**

 

The following tablepresents details of our property and equipment:

 
| ** **                | ** ** | **March 31,** | ** ** |
|---------------------------|------------|--------------------|------------|
| ** **                | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                | ** ** | **(In thousands)** | ** ** |
| Equipment                 |       | $                  | 8,334      |   | $ | 8,136 |   |
| Leasehold  improvements   |       | 1,940              |       | 1,930 |   |
| Accumulated  depreciation |       | (7,724             | )          | (6,822 | ) |
|                      |       | $                  | 2,550      |   | $ | 3,244 |   |

 

**Intangible Assets**

 

The following table presents details regarding ourintangible assets:

 
| ** **                                  | ** ** | **March 31, 2010**     | ** ** | **March 31, 2009**       | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                  | ** ** | **(In thousands)**          | ** ** |
| Intangible  assets subject to amortization: |       |                        |       |                          |       |   |   |   |   |
| Developed  technology                       |       | $                           | 996        |                          | $          | (595 | ) | $ | 495 |   | $ | (482 | ) |
| Patents                                     |       | 317                         |       | (266                          | )          | 317 |   | (220 | ) |
| Total                                       |       | $                           | 1,313      |                          | $          | (861 | ) | $ | 812 |   | $ | (702 | ) |

 

Amortization expense forintangible assets subject to amortization was $159,000, $147,000, and $147,000for the fiscal years ended March 31, 2010, 2009 and 2008, respectively.Future estimated amortization expense is as follows:

 
| **Year Ending March 31:** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| **(In thousands)**             | ** ** | ** ** | ** ** |
| 2011                           |       | 146        |       |
| 2012                           |       | 106        |       |
| 2013                           |       | 100        |       |
| 2014                           |       | 100        |       |
|                           |       | $          | 452        |   |
|                                |            |            |            |  |

 

Ifwe acquire additional intangible assets in future periods, our amortizationexpense will increase.

 

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**Goodwill**

 

The following tablepresents the activity related to the carrying value of our goodwill by reportablesegment for the fiscal year ended March 31, 2010:

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

 

**Warranty Reserve Activity**

 

The following table presents activity with respect to thewarranty reserve:

 
| ** **                          | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(In thousands)**            | ** ** |
| Balance  at beginning of year       |       | $                             | 582        |   | $ | 494 |   | $ | 520 |   |
| Additions  charged to cost of sales |       | 221                           |       | 342 |   | 347 |   |
| Warranty  claims                    |       | (335                          | )          | (254 | ) | (373 | ) |
| Balance  at end of year             |       | $                             | 468        |   | $ | 582 |   | $ | 494 |   |

 

**Earnings Per Share**

 

The following table sets forth the computation of basic and dilutedearnings per share:

 
| ** **                                                  | ** ** | **Year Ended March 31,**                 | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                  | ** ** | **2010**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                  | ** ** | **(In  thousands, except per share amounts)** | ** ** |
| Numerator:                                                  | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  income                                                 |       | $                                             | 2,203      |   | $ | 10,474 |   | $ | 12,163 |   |
|                                                        |       |                                          |       |   |   |   |   |
| Denominator:                                                |       |                                          |       |   |   |   |   |
| Weighted  average common shares used in basic computation   |       | 34,249                                        |       | 33,964 |   | 32,723 |   |
| Dilutive  stock options                                     |       | 185                                           |       | 671 |   | 1,973 |   |
| Dilutive  warrants                                          |       | 1                                             |       | 3 |   | 17 |   |
| Weighted  average common shares used in diluted computation |       | 34,435                                        |       | 34,638 |   | 34,713 |   |
|                                                        |       |                                          |       |   |   |   |   |
| Earnings  per share:                                        |       |                                          |       |   |   |   |   |
| Basic                                                       |       | $                                             | 0.06       |   | $ | 0.31 |   | $ | 0.37 |   |
| Diluted                                                     |       | $                                             | 0.06       |   | $ | 0.30 |   | $ | 0.35 |   |

 

Thefollowing instruments were excluded from the computation of diluted earningsper share as their effect would have been anti-dilutive:

 
| ** **              | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------|------------|-------------------------------|------------|
| ** **              | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **              | ** ** | **(In thousands)**            | ** ** |
| Stock  options          |       | 1,790                         |       | 1,518 |   | 520 |   |
| Warrants                |       | 371                           |       | 1,158 |   | 1,170 |   |
| Convertible  debentures |       | —                        |       | 1,281 |   | 2,661 |   |

 

 

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** **

**3.****           ****Business Combination**

 

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

 

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

 
| Developed  technology |   | $  | 501    |   |
|-----------------------|--------|----|--------|--------|
| Goodwill              |   | 17 |   |
|                  |   | $  | 518    |   |

 

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

 

Ourconsolidated financial statements for the fiscal year ended March 31, 2010include the results of operations of Hamilton Signal commencing as of theClosing. Disclosures required for material business combinations have beenlimited due to the immateriality of the acquisition of Hamilton Signal to ourconsolidated financial statements. No supplemental pro forma information ispresented for the acquisition due to the immaterial effect of the acquisitionon our results of operations.

 

**4.****           ****Revolving Line of Credit andLong-Term Debt**

 

**Revolving Line of Credit**

 

Prior to October 16, 2008, we had a creditfacility with a bank that provided for line of credit borrowings of up to $10.0million. Under this credit facility, we could borrow against our eligibleaccounts receivable and eligible inventory, as defined in the credit agreement.Interest on borrowed amounts under the line of credit was payable monthly atthe current stated prime rate plus 1.00%. Additionally, we were obligated topay an unused line fee of 0.25% per annum applied to the amount by which themaximum credit amount exceeded the average daily principal balance during thepreceding month. The credit facility required $2,000 in monthly collateralmanagement fees and included an early termination fee equal to 2% of the totalfacility during the first year of the agreement and 1% of the total facility inthe second year of the agreement. This credit facility was secured bysubstantially all of our assets and expired on October 15, 2008.

 

Effective October 16,2008, we entered into a new $19.5 million credit facility with a differentbank, which replaced the credit facility discussed above. This new creditfacility provides for a two-year revolving line of credit with borrowings of upto $12.0 million and a $7.5 million 48-month term note (discussed below).Interest on borrowed amounts under the revolving line of credit are payablemonthly at a rate equal to the current stated prime rate (3.25% at March 31,2010) 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. We are obligated to pay an unused linefee of 0.25% per annum applied to the average unused portion of the revolvingline of credit during the preceding month. The revolving line of credit doesnot contain any early termination fees and is secured by substantially all ofour assets. As of March 31, 2010, no amounts were borrowed under therevolving line of credit portion of the facility. Availability under this lineof credit may be reduced or otherwise limited as a result of our obligations tocomply with certain financial covenants.

 

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**Long-Term Debt**

 

Our long-term debt consists of the following:

 
| ** **                   | ** ** | **March 31,** | ** ** |
|------------------------------|------------|--------------------|------------|
| ** **                   | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                   | ** ** | **(In thousands)** | ** ** |
| Bank  term note              |       | $                  | 5,293      |   | $ | 6,543 |   |
| Convertible  debentures, net |       | —             |       | 750 |   |
|                         |       | 5,293              |       | 7,293 |   |
| Less  current portion        |       | (2,324             | )          | (2,019 | ) |
|                         |       | $                  | 2,969      |   | $ | 5,274 |   |

 

*ConvertibleDebentures, Net.*InMay 2004, we sold and issued subordinated convertible debentures in theaggregate original principal amount of $10.1 million. In connection with theissuance of the debentures, we issued warrants to purchase an aggregate of639,847 shares of our common stock, the value of which was recorded as a debtdiscount against the face amount of the debentures on the date of issuance andhas been amortized to interest expense over the term of the convertibledebentures.

 

The debentureswere due in full on May 19, 2009, provided for 6.0% annual interest,payable quarterly, and were convertible into our common stock at an initialconversion price of $3.61 per share, subject to certain adjustments, includingadjustments for dilutive issuances. From May 19, 2008 until the maturitydate, we were permitted to redeem the debentures at 110% of the principalamount. During the period that the debentures were outstanding, $250,000 ofdebentures had been converted into 69,252 shares of our common stock.

 

During the fiscalyear ended March 31, 2008, at the holders’ request, we paid $1.8 millionin cash to retire $2.1 million of convertible debentures early, for which werecorded a net gain of $224,000. During the fiscal year ended March 31,2009, we early-retired an additional $7.0 million of outstanding convertibledebentures, also at the holders’ request, for a net gain of approximately$50,000. For this retirement we used $300,000 of our cash and financed $6.5million under our bank term note, which is described below under the caption “BankTerm Notes.” The net gains above were recorded within “other income, net” fortheir respective fiscal years within the accompanying consolidated statementsof income.

 

In May 2009,we retired the remaining $750,000 of convertible debentures. The retirement wasfinanced under our bank term note.

 

*Bank TermNotes.*In October 2004,we entered into a $5.0 million term note payable with a bank. The note was dueon May 27, 2008, and provided for monthly principal payments ofapproximately $104,000.  The finalpayment against this term note was made in June 2008.

 

Effective October 16,2008, we entered into a new $19.5 million credit facility with a differentbank, as described above.  Under thiscredit facility, we may borrow up to $7.5 million in the form of a 48-monthterm note. As of March 31, 2010, we had outstanding borrowings ofapproximately $5.3 million under the term note. Principal payments under thisterm note are required to be repaid in 48 monthly installments of $152,000commencing on June 1, 2009. Additionally, beginning on November 1,2009, and on November 1 of each year thereafter, we are required to repayadditional principal of up to $500,000, calculated based on certain financialmeasures, as further defined in the agreement. These additional principalpayments effectively reduce the total number of monthly installments necessaryto repay the term note. As of March 31, 2010, an additional $500,000 wasincluded in the current portion of the term note, representing the amount weestimate will be due on November 1, 2010. Interest on the term note ispayable monthly at a rate equal to the current stated prime rate plus 0.50% upto the current stated prime rate plus 1.00%, depending on aggregate depositbalances maintained at the bank in relation to the total loan commitment underthe credit facility. The term note contains no early termination fees and,along with the revolving line of credit under the same credit agreement, issecured by substantially all of our assets.

 

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Scheduled aggregate maturities of long-term debt principal as of March 31,2010 were as follows:

 
| **Year Ending March 31:** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| **(In thousands)**             | ** ** | ** ** | ** ** |
| 2011                           |       | $          | 2,324      |   |
| 2012                           |       | 2,324      |       |
| 2013                           |       | 645        |       |
|                           |       | $          | 5,293      |   |

 

**5.****           ****Income Taxes**

 

For financial reporting purposes, income before income taxes includesthe following components:

 
| ** **     | ** ** | **Year Ended March 31,** | ** ** |
|----------------|------------|-------------------------------|------------|
| ** **     | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **     | ** ** | **(In thousands)**            | ** ** |
| United  States |       | $                             | 3,177      |   | $ | 4,927 |   | $ | 6,119 |   |
| Foreign        |       | (79                           | )          | 250 |   | 144 |   |
|           |       | $                             | 3,098      |   | $ | 5,177 |   | $ | 6,263 |   |

 

The reconciliation of our income tax provision (benefit) to taxescomputed at U.S. federal statutory rates is as follows:

 
| ** **                                                                 | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                 | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**            | ** ** |
| Income  tax provision at statutory rates                                   |       | $                             | 1,053      |   | $ | 1,761 |   | $ | 2,131 |   |
| State  income taxes net of federal benefit                                 |       | 183                           |       | 57 |   | (675 | ) |
| Change  in valuation allowance associated with federal deferred tax assets |       | —                        |       | (6,915 | ) | (7,558 | ) |
| Compensation  charges                                                      |       | (12                           | )          | (4 | ) | 194 |   |
| Unrecognized  tax benefits                                                 |       | (362                          | )          | (290 | ) | (133 | ) |
| Other                                                                      |       | 33                            |       | 94 |   | 141 |   |
| Provision  (benefit) for income taxes                                      |       | $                             | 895        |   | $ | (5,297 | ) | $ | (5,900 | ) |

 

The components of deferred tax assets and liabilities are as follows:

 
| ** **                             | ** ** | **March 31,** | ** ** |
|----------------------------------------|------------|--------------------|------------|
| ** **                             | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                             | ** ** | **(In thousands)** | ** ** |
| Deferred  tax assets:                  |       |               |       |   |   |
| Net  operating losses                  |       | $                  | 13,273     |   | $ | 13,942 |   |
| Credit  carry forwards                 |       | 272                |       | 247 |   |
| Deferred  compensation and payroll     |       | 691                |       | 1,035 |   |
| Bad  debt allowance and other reserves |       | 796                |       | 672 |   |
| Property  and equipment                |       | 42                 |       | — |   |
| Other,  net                            |       | 167                |       | 295 |   |
| Total  deferred tax assets             |       | 15,241             |       | 16,191 |   |
| Deferred  tax liabilities:             |       |               |       |   |   |
| Property  and equipment                |       | —             |       | (104 | ) |
| Acquired  intangibles                  |       | (509               | )          | (341 | ) |
| Total  deferred tax liabilities        |       | (509               | )          | (445 | ) |
| Net  deferred tax assets               |       | $                  | 14,732     |   | $ | 15,746 |   |

 

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The components of current and deferred federal andstate income tax provisions and (benefits) are as follows:

 
| ** **                                | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                | ** ** | **(In thousands)**            | ** ** |
| Current  income tax provision (benefit):  |       |                          |       |   |   |   |   |
| Federal                                   |       | $                             | (234       | ) | $ | (200 | ) | $ | 94 |   |
| State                                     |       | 126                           |       | 223 |   | 40 |   |
| Foreign                                   |       | (11                           | )          | 78 |   | 40 |   |
| Deferred  income tax provision (benefit): |       |                          |       |   |   |   |   |
| Federal                                   |       | 862                           |       | (5,261 | ) | (5,011 | ) |
| State                                     |       | 152                           |       | (137 | ) | (1,063 | ) |
| Net  income tax provision (benefit)       |       | $                             | 895        |   | $ | (5,297 | ) | $ | (5,900 | ) |

 

At March 31, 2010, we had approximately $260,000 in federalalternative minimum tax credit carryforwards and $30,000 in state alternativeminimum tax credit carryforwards that can be carried forward indefinitely. Wehad $38.5 million of federal net operating loss carryforwards at March 31,2010 that begin to expire in 2019. We also had $18.5 million of state netoperating loss carryforwards at March 31, 2010, of which, $10.2 millionare scheduled to expire in 2013, $7.9 million are scheduled to expire in 2014and $400,000 are scheduled to expire in 2016.

 

In May 2004, we acquired a greater than 80% ownership interest ina former subsidiary and, from that date forward our income taxes are providedon a consolidated basis for federal income tax purposes. Due to changes instock ownership, our federal net operating loss carryforwards of approximately$38.5 million and other federal attributes are subject to a Section 382annual limitation.

 

Our deferred tax assets at March 31, 2010 do not include $2.4million of excess tax benefits from employee stock option exercises that are acomponent of our net operating loss carryforwards. If and when such excess tax benefitsare realized, stockholders’ equity will be adjusted.

 

At March 31, 2010, we determined that it is more likely than notthat our deferred tax assets will be realized. In making such determination, wereviewed all available positive and negative evidence, including reversal ofdeferred tax liabilities, potential carrybacks, projected future taxableincome, tax planning strategies and recent financial performance.

 

Unremitted earnings of our foreign subsidiary have been included in theconsolidated financial statements without giving effect to the U.S. taxes thatmay be payable on distribution to the U.S. because it is not anticipated thatsuch earnings will be remitted to the U.S. If remitted, the additional U.S.taxes would not be material.

 

**Unrecognized Tax Benefits**

 

Asof April 1, 2007, we recognized the cumulative impact of our adoption ofnew accounting guidance for uncertainty in income taxes as a $224,000 increaseto our liability for unrecognized tax benefits with a corresponding increase toour accumulated deficit. As of March 31, 2010 and 2009, our grossunrecognized tax benefits were $2.1 million and $2.5 million, respectively, ofwhich $1.7 million and $2.0 million, respectively, if recognized, would affectour effective tax rate.

 

Ourcontinuing practice is to recognize interest and/or penalties related to incometax matters in income tax expense. As of March 31, 2010 and 2009, we hadaccrued cumulatively $40,000 and $39,000, respectively, for the payment ofpotential interest and penalties.

 

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Areconciliation of the beginning and ending balances of the total amounts ofgross unrecognized tax benefits is as follows (in thousands):

 
| Increases  in tax positions for prior year              |   | 1,160 |   |
|---------------------------------------------------------|--------|-------|--------|
| Decreases  in tax positions for prior year              |   | (147  | )      |
| Increases  in tax positions for current year            |   | 327   |   |
| Lapse  in statute of limitations                        |   | (136  | )      |
| Gross  unrecognized tax benefits at March 31, 2008 |   | 2,788 |   |
| Increases  in tax positions for prior year              |   | 155   |   |
| Decreases  in tax positions for prior year              |   | (36   | )      |
| Increases  in tax positions for current year            |   | 22    |   |
| Lapse  in statute of limitations                        |   | (404  | )      |
| Gross  unrecognized tax benefits at March 31, 2009 |   | 2,525 |   |
| Increases  in tax positions for prior year              |   | 93    |   |
| Decreases  in tax positions for current year            |   | (51   | )      |
| Lapse  in statute of limitations                        |   | (414  | )      |
| Gross  unrecognized tax benefits at March 31, 2010 |   | $     | 2,153  |   |
|                                                         |        |       |        |  |

 

Weanticipate a decrease in gross unrecognized tax benefits of approximately$330,000 within the next twelve months based on federal and state statuteexpirations in various jurisdictions.

 

Weare subject to taxation in the U.S. and various states. We are subject to U.S.federal tax examination for fiscal tax years ended March 31, 2007 orlater, and state and local income tax examination for fiscal tax years ended March 31,2006 or later.

 

**6.****           ****Commitmentsand Contingencies**

 

**Litigation and OtherContingencies**

 

From time to time, we havebeen involved in litigation relating to claims arising out of our operations inthe normal course of business. We currently are not a party to any legalproceedings, the adverse outcome of which, in management’s opinion,individually or in the aggregate, would have a material adverse effect on ourconsolidated results of operations, financial position or cash flows.

 

Furthermore, from time to time, we have experiencedunforeseen developments in contingencies related to our former subsidiaries.For example, we have been the subject of a number of routine tax audits fortime periods and jurisdictions related to the businesses of our formersubsidiaries. Although the development and ultimate outcome of these types ofunforeseen matters cannot be anticipated or predicted with any certainty, ourmanagement does not believe that we are presently involved in any mattersrelated to our former subsidiaries that would have a material adverse effect onour consolidated results of operations, financial position or cash flows.

 

**Operating Leases**

 

In May 2007, weentered into an agreement to lease 52,000 square feet of office space in SantaAna, California for a term of 88 months. In September 2007, we relocatedour headquarters and principal operations into this space. The monthly leaserate was $102,000 during the first year of the lease and increases each yearthereafter, up to a maximum of $120,000 during the last year of the lease. Thelease may be extended for a period of five years, at our option, at a leaserate to be based on the market lease rate for comparable property determined asof the commencement date of the extension period. Additionally, the leaseagreement provided for $1.8 million in incentives in the form of tenantimprovement allowances, which we recorded as deferred rent and capitalizedleasehold improvements in our consolidated balance sheet. The deferred rentamount reduces monthly rent expense over the term of the lease, and thecapitalized leasehold improvements amount are being depreciated over the initialterm of the lease (the estimated useful life of the related leaseholdimprovements).

 

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We have lease commitments for facilities in various locationsthroughout the U.S. as well as certain other equipment. Future minimum rentalpayments under these noncancelable operating leases at March 31, 2010 wereas follows:

 
| **Year Ending March 31:** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| **(In thousands)**             | ** ** | ** ** | ** ** |
| 2011                           |       | $          | 1,837      |   |
| 2012                           |       | 1,529      |       |
| 2013                           |       | 1,418      |       |
| 2014                           |       | 1,416      |       |
| 2015                           |       | 1,064      |       |
|                           |       | $          | 7,264      |   |

 

Rent expense totaled $1.9 million, $1.8 million and $2.1 million forthe fiscal years ended March 31, 2010, 2009 and 2008, respectively.

 

We previously recorded on our consolidated balance sheet a deferredgain related to the May 2002 sale and leaseback of our prior headquartersin Anaheim, California. The deferred gain was amortized over the term of theunderlying lease, which terminated in September 2007. For the fiscal yearended March 31, 2008, we recorded a realized gain of $165,000 pertainingto this deferred gain which was recorded as a reduction to rent expense.

 

**Related Party Transaction**

 

We previouslysubleased office space to MAXxess Systems, Inc. (“MAXxess”), one of ourformer subsidiaries that we sold in September 2003 and is currently ownedby an investor group that includes two of our directors, one of whom is theChief Executive Officer of MAXxess. The sublease terminated in September 2007,at which time MAXxess owed us an aggregate of $274,000 related to this subleaseand certain related ancillary services that we provided to MAXxess. We havepreviously fully reserved for amounts owed to us by MAXxess under the terms ofthis sublease. In August 2009, MAXxess executed a promissory note payableto Iteris for $274,000. The promissory note bears interest at a rate of 6% perannum, compounded annually, with accrued interest to be paid annually on thefirst business day of each calendar year. Payments under the note may be madein bona fide services rendered by MAXxess to Iteris to the extent such servicesand amounts are pre-approved in writing by us. All amounts outstanding underthe note will become due and payable on the earliest of (i) August 10,2014, (ii) a change of control in MAXxess, or (iii) a financing byMAXxess resulting in gross proceeds of at least $10 million. As of March 31,2010, the entire $274,000 principal balance was outstanding and payable toIteris and remains fully reserved.

 

**Inventory Purchase Commitments**

 

At March 31, 2010, we had firm commitments to purchaseapproximately $1.2 million of inventory, primarily during the first and secondquarters of our fiscal year ending March 31, 2011.

 

**Deferred Compensation Plan**

 

In 1986, weadopted the Executive Deferral Plan (the “1986 Plan”) under which certainexecutives were able to defer a portion of their annual compensation into the1986 Plan. All deferred amounts earned interest, generally with no guaranteedrate of return.  During the fiscal yearended March 31, 2003, we adopted the Deferred Compensation Plan, and allassets of the 1986 Plan were transferred into the Deferred Compensation Plan(the “Plan”). No compensation withholdings were deferred under the 1986 Plan orthe Plan in the fiscal years ended March 31, 2010, 2009 and 2008.

 

Shares of our common stock that were held in the Plan were recorded asa liability in our consolidated balance sheets based on the quoted market priceof our common stock at the close of each reporting period. Changes in the valueof our common stock between reporting periods have been presented withinoperating expenses in the accompanying consolidated statements of income. As aresult of such changes in the value of Iteris common stock, we recordedexpenses of $72,000 and $21,000 in the fiscal years ended March 31, 2009and 2008, respectively. During the fiscal year ended March 31, 2009, wedistributed from the plan to its owner, approximately 143,000 shares with atotal fair market value at the distribution date of approximately $427,000. Asof March 31, 2009, the Plan held 23,844 shares of our common stock. In December 2009,we distributed these remaining shares to their respective owners, whicheffectively terminated the Plan, along with the corresponding trust in whichthe assets were held. As of March 31, 2010, the original $31,000 costbasis of the 23,844 shares, which was previously recorded as a contra-equityaccount, along with the corresponding liability, were no longer recorded on ourconsolidated balance sheet.

 

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

 

We measure fair value as the exchange price that wouldbe received for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date. Fair valuemeasurements are based on a three-tier hierarchy that prioritizes the inputsused to measure fair value. These tiers include: Level 1, defined as observableinputs such as quoted prices in active markets for identical assets andliabilities; Level 2, defined as observable inputs other than Level 1 pricessuch as quoted prices for similar assets or liabilities or prices quoted ininactive markets; and Level 3, defined as unobservable inputs for which littleor no market data exists, therefore requiring an entity to develop its ownassumptions.

 

At March 31, 2010, there were outstandingwarrants to purchase shares of our common stock that were classified as aliability with an estimated fair value of $27,000 (see Note 8). These warrantswere valued using Level 3 inputs because there are unobservable inputsassociated with them. The following table reconciles the liability for thesewarrants measured at fair value on a recurring basis using Level 3 inputs forthe fiscal year ended March 31, 2010 (in thousands):

 
| Balance  at April 1, 2009                       |   | $   | — |   |
|------------------------------------------------------|--------|-----|--------|--------|
| Cumulative  effect of accounting change (Note 8)     |   | 47  |   |
| Gain  on change in fair value included in net income |   | (20 | )      |
| Balance  at March 31, 2010                      |   | $   | 27     |   |

 

Thisliability is included within accrued liabilities in the accompanyingconsolidated balance sheet as of March 31, 2010.

 

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

 

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

 

**Preferred Stock**

 

Our certificate of incorporation provides for the issuance of up to2,000,000 shares of preferred stock. As of March 31, 2010 and 2009, therewere no outstanding shares of preferred stock, and we do not currently haveplans to issue any shares of preferred stock.

 

In August 2009, our Board of Directors adopteda stockholder rights plan, which calls for preferred stock purchase rights(each, a “Right”) to be distributed, as a dividend, at the rate of one Rightfor each share of common stock held as of September 3, 2009. Each Rightwill entitle holders of common stock to buy one one-thousandth of one share of Series AJunior Participating Preferred Stock of Iteris. A further description and termsof the Rights are set forth in the Rights Agreement dated August 20, 2009by and between Iteris and Computershare Trust Company, N.A., as rights agent.In connection with the stockholder rights plan, our Board of Directors approvedthe adoption of a Certificate of Designations, which created the Series AJunior Participating Preferred Stock, and likewise authorized the filing of aCertification of Elimination to eliminate the two series of juniorparticipating preferred stock, which were originally created in April 1998in connection with our previous stockholder rights plan which expired in 2008.

 

Our Board of Directors is authorized to issue from time to time suchauthorized but unissued shares of preferred stock in one or more series and tofix or alter the designations, preferences, rights and any qualifications,limitations or restrictions of the shares of each such series, including thedividend, conversion, voting, redemption and liquidation rights.

 

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**Common Stock Warrants**

 

The following table summarizes information regarding outstandingwarrants to purchase our common stock as of March 31, 2010:

 
| **Exercise Price** | ** ** | **Warrants  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** |
|--------------------|------------|---------------------------|------------|---------------------------------------------------|------------|
| ** **         | ** ** | **(In thousands)**        | ** ** | **(Years)**                                       | ** ** |
| $                  | 1.42       |                      | 15         |                                              | 3.4        |   |
| $                  | 3.25       |                      | 246        |                                              | 0.9        |   |
| $                  | 5.00       |                      | 75         |                                              | 0.3        |   |
|               |       | 336                       |       | 0.9                                               |       |

 

All of the outstanding warrants were exercisable at March 31,2010. Upon the exercise of warrants, we issue new shares of common stock fromour authorized shares. Warrants to purchase an aggregate of 246,260 sharesof common stock at an exercise price of $3.25 per share are callable by us, fora purchase price of $0.01 per share, if the market price of our common stocktrades for 20 consecutive days at a price equal to or greater than two timesthe exercise price of the warrants. Warrants to purchase an aggregate of75,000 shares of common stock at an exercise price of $5.00 per share arecallable by us, for an aggregate purchase price of $1.00, if the market priceof our common stock trades for 20 consecutive days at a price equal to orgreater than one and a half times the exercise price of the warrants. Inconnection with the issuance of warrants to purchase an aggregate of 246,250shares of our common stock in September 2006, we are party to aregistration rights agreement that contains provisions under which we could besubjected to liquidated damages should we fail to maintain effectiveregistration statements for the shares of common stock issuable upon exerciseof the warrants. As of March 31, 2010, no liquidated damages were payableunder the provisions of the registration rights agreement associated with thesewarrants.

 

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

 

In connection with our adoption of certainprovisions of accounting for derivatives, which became effective for us on April 1,2009, we determined that certain outstanding warrants to purchase shares of ourcommon stock contain provisions that provide for a possible future adjustmentto either the exercise price and/or number of shares to be issued upon exercise.As such, beginning April 1, 2009, we began recognizing these warrants asliabilities at their respective estimated fair values on each reporting date.The cumulative effect of the change in accounting for these warrants of $47,000was recognized as an adjustment to the opening balance of accumulated deficitat April 1, 2009. The amounts recognized in the consolidated balance sheetas a result of our adoption on April 1, 2009 were determined based on theamounts that would have been recognized if this accounting treatment had beenapplied from the issuance date of the warrants. At March 31, 2010, theestimated fair value of the warrants was $27,000. The change in the estimatedfair value of the warrants for the fiscal year ended March 31, 2010 isincluded in “other income, net” in the accompanying consolidated statement ofincome. These warrants are scheduled to expire in February 2011. Weestimate the fair value of these warrants using the BSM option-pricing formula.

 

**Common Stock**

 

The following summarizes common stock reserved forfuture issuance at March 31, 2010:

 
| ** **                                          | ** ** | **(In thousands)** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| Shares  issuable under stock options plans (Note 9) |       | 4,100              |       |
| Shares  issuable under the exercise of warrants     |       | 336                |       |
|                                                |       | 4,436              |       |

 

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**9.****           ****Employee Benefit Plans**

 

**Stock Option Plans**

 

In September 2007,our stockholders approved the 2007 Omnibus Incentive Plan (the “2007 Plan”),which provides that options to purchase shares of our unissued common stock maybe granted to our employees, officers, consultants and directors at exerciseprices which are equal to or greater than the market value of our common stockon the date of grant. Options expire no more than ten years after the date ofgrant and generally vest at the rate of 25% on each of the first fouranniversaries of the grant date. The 2007 Plan also allows for the issuance ofstock appreciation rights, restricted stock, restricted stock units and otherstock-based awards based on the value of our common stock. New shares areissued to satisfy stock option exercises and share issuances under the 2007Plan. As of March 31, 2010, options to purchase approximately 768,000shares of common stock were outstanding under the 2007 Plan.

 

Our 1997 StockIncentive Plan (the “1997 Plan”) terminated in September 2007; however,all stock options outstanding under the 1997 Plan remain outstanding pursuantto the terms of such stock options. As of March 31, 2010, options topurchase approximately 1.1 million shares of our common stock were outstandingunder the 1997 Plan. No further options may be granted under the 1997 Plan.

 

In connection withour merger with the Iteris Subsidiary in 2004, we assumed the 1998 StockIncentive Plan (the “1998 Plan”) of the Iteris Subsidiary and all outstandingoptions granted thereunder. As of March 31, 2010, options to purchaseapproximately 1.3 million shares of our common stock were outstanding under the1998 Plan. No further options may be granted under the 1998 Plan.

 

Certain optionsgranted under the 2007 Plan, the 1997 Plan and the 1998 Plan (collectively, the“Plans”) provide for accelerated vesting of unvested options in the event of achange in control under certain circumstances.

 

A summary ofactivity in the Plans for the fiscal year ended March 31, 2010 is asfollows:

 
| ** **                                                                                     | ** ** | **Options**        | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** | **Weigthed  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                     | ** ** | **(In thousands)** | ** ** | ** **                                        | ** ** | **(Years)**                                         | ** ** | **(In thousands)**              | ** ** |
| Options  outstanding at March 31, 2009                                                    |       | 3,314              |       | $                                                 | 1.92       |                                                |       |                            |       |   |
| Granted                                                                                        |       | 393                |       | 1.43                                              |       |                                                |       |                            |       |
| Exercised                                                                                      |       | (113               | )          | 1.26                                              |       |                                                |       |                            |       |
| Forfeited                                                                                      |       | (47                | )          | 2.30                                              |       |                                                |       |                            |       |
| Expired                                                                                        |       | (329               | )          | 3.01                                              |       |                                                |       |                            |       |
| Options  outstanding at March 31, 2010                                                    |       | 3,218              |       | $                                                 | 1.77       |                                                | 4.0        |                            | $          | 550 |   |
| Options  exercisable at March 31, 2010                                                    |       | 2,581              |       | $                                                 | 1.76       |                                                | 2.9        |                            | $          | 518 |   |
| Vested  and expected to vest at March 31, 2010                                            |       | 3,106              |       | $                                                 | 1.77       |                                                | 3.8        |                            | $          | 543 |   |
| Options  exercisable at March 31, 2010 pursuant    to a change-in-control  |       | 3,218         |       | $                                                 | 1.77  |                                                | 4.0   |                            | $          | 550  |   |

 

In September 2009,our stockholders approved an amendment to increase the number of shares of ourcommon stock authorized and reserved for issuance under the 2007 Plan by800,000 shares to a total of 1,650,000 shares. At March 31, 2010, therewere approximately 882,000 shares of common stock available for grant underthis plan.

 

**Stock-Based Compensation**

 

The followingtable presents stock-based compensation expense that is included in eachfunctional line item on our consolidated statements of income:

 
| ** **                                   | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------|------------|-------------------------------|------------|
| ** **                                   | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                   | ** ** | **(In thousands)**            | ** ** |
| Cost  of net sales                           |       | $                             | 9          |   | $ | 9 |   | $ | 3 |   |
| Cost  of contract revenues                   |       | 39                            |       | 38 |   | 14 |   |
| Selling,  general and administrative expense |       | 300                           |       | 297 |   | 266 |   |
| Research  and development expense            |       | 27                            |       | 20 |   | 7 |   |
|                                         |       | $                             | 375        |   | $ | 364 |   | $ | 290 |   |

 

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At March 31,2010, there was approximately $848,000 of total unrecognized compensationexpense related to unvested stock options. This expense is expected to berecognized over a weighted-average period of approximately 3.2 years. If thereare any modifications or cancellations of the underlying unvested stockoptions, we may be required to accelerate, increase or cancel any remainingunearned stock-based compensation expense. Future stock-based compensationexpense and unearned stock-based compensation will increase to the extent thatwe issue additional stock options or other stock-based awards.

 

The grant date fair value of stock options granted was estimated usingthe following weighted-average assumptions:

 
| ** **                           | ** ** | **Year Ended March 31,** | ** ** |
|--------------------------------------|------------|-------------------------------|------------|
| ** **                           | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                 |       |                          |       |   |   |   |   |
| Expected  life - years               |       | 7.0                           |       | 7.0 |   | 7.0 |   |
| Risk-free  interest rate             |       | 3.2                           | %          | 3.3 | % | 3.8 | % |
| Expected  volatility of common stock |       | 74                            | %          | 75 | % | 80 | % |
| Dividend  yield                      |       | —                        | %          | — | % | — | % |

 

A summary of certain fair value and intrinsic valueinformation pertaining to our stock options is as follows:

 
| ** **                                                               | ** ** | **Year Ended March 31,**                | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                                     | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                               | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Weighted  average grant date fair value per share of****options  granted | ** ** | $                                            | 1.01       | ** ** | $ | 1.50 | ** ** | $ | 1.83 | ** ** |
| Intrinsic  value of options exercised                                    |       | 28                                           |       | 771 |   | 2,555 |   |
|                                                                          |            |                                              |            |  |  |  |  |  |  |  |

 

**Employee Incentive Programs**

 

Under the terms of a Profit Sharing Plan, we may contribute to a trustfund such amounts as are determined annually by the Board of Directors. Nocontributions were made during the years ended March 31, 2010, 2009 and2008.

 

In May 1990, we adopted a 401(k) Plan as an amendment andreplacement of the former Associate Stock Purchase Plan that was an additionalfeature of the Profit Sharing Plan. Under the 401(k) Plan, eligibleassociates voluntarily contribute to the plan, up to IRS maximums, throughpayroll deductions. Under the provisions of the 401(k) Plan, associateshave various investment choices, one of which is the purchase of Iteris commonstock at market price. We match up to 90% of contributions, based on years ofservice, up to a stated limit. Beginning July 1, 2009, we temporarilysuspended our matching contributions to the 401(k) Plan. Our matchingcontributions were approximately $220,000, $753,000 and $401,000 for the fiscalyears ended March 31, 2010, 2009 and 2008, respectively. Beginning in April 2010,we reinstituted certain limited matching contributions to the 401(k) Plan.

 

**10.****         ****Business Segments,Significant Customer and Geographic Information**

 

We currently operate in three reportable segments: Roadway Sensors,Vehicle Sensors and Transportation Systems. The Roadway Sensors segmentincludes our Vantage and VersiCam vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications. This segment also includes our Pico compact videodetection system, which was designed primarily to respond to internationalvideo detection needs. The Vehicle Sensors segment includes our lane departurewarning products and is comprised of all of our activities related to vehiclesafety. The Transportation Systems segment includes transportation engineeringand consulting 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. Certain corporate expenses, including interestand amortization of intangible assets, are not allocated to the segments. Thereportable segments are each managed separately because they manufacture anddistribute distinct products or provide services with different processes. Allsegment revenues are derived from external customers. Segment assets are notdisclosed because the discrete financial information provided to and reviewedby our chief operating decision maker does not separately identify segmentassets.

 

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Selected financial information for our reportable segments for thefiscal years ended March 31, 2010, 2009 and 2008 is as follows:

 
| ** **                         | ** ** | **Roadway  Sensors** | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total**  | ** ** |
|------------------------------------|------------|----------------------|------------|----------------------|------------|-----------------------------|------------|------------|------------|
| ** **                         | ** ** | **(In thousands)**   | ** ** |
| **Year Ended March 31, 2010** | ** ** | ** **           | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Product  revenue                   |       | $                    | 25,341     |                 | $          | 5,624                       |       | $          | —     |   | $ | 30,965 |   |
| Service  and other revenue         |       | —               |       | 685                  |       | 26,413                      |       | 27,098     |       |
| Stock-based  compensation          |       | 37                   |       | 30                   |       | 61                          |       | 128        |       |
| Depreciation  and amortization     |       | 234                  |       | 83                   |       | 221                         |       | 538        |       |
| Allocated  goodwill                |       | 8,214                |       | 4,671                |       | 14,906                      |       | 27,791     |       |
| Segment  income (loss)             |       | 3,158                |       | (894                 | )          | 1,445                       |       | 3,709      |       |
| ** **                         | ** ** | ** **           | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| **Year Ended March 31, 2009** |       |                 |       |                 |       |                        |       |       |       |
| Product  revenue                   |       | $                    | 27,197     |                 | $          | 9,913                       |       | $          | —     |   | $ | 37,110 |   |
| Service  and other revenue         |       | —               |       | 1,317                |       | 30,932                      |       | 32,249     |       |
| Stock-based  compensation          |       | 30                   |       | 48                   |       | 50                          |       | 128        |       |
| Depreciation  and amortization     |       | 198                  |       | 137                  |       | 249                         |       | 584        |       |
| Allocated  goodwill                |       | 8,197                |       | 4,671                |       | 14,906                      |       | 27,774     |       |
| Segment  income                    |       | 3,415                |       | 569                  |       | 2,216                       |       | 6,200      |       |
|                               |       |                 |       |                 |       |                        |       |       |       |
| **Year Ended March 31, 2008** |       |                 |       |                 |       |                        |       |       |       |
| Product  revenue                   |       | $                    | 28,452     |                 | $          | 10,016                      |       | $          | —     |   | $ | 38,468 |   |
| Service  and other revenue         |       | —               |       | 1,858                |       | 24,837                      |       | 26,695     |       |
| Stock-based  compensation          |       | 18                   |       | 45                   |       | 27                          |       | 90         |       |
| Depreciation  and amortization     |       | 107                  |       | 130                  |       | 147                         |       | 384        |       |
| Allocated  goodwill                |       | 8,197                |       | 4,671                |       | 14,906                      |       | 27,774     |       |
| Segment  income                    |       | 5,062                |       | 552                  |       | 2,094                       |       | 7,708      |       |

 

The following reconciles segment income to consolidated income beforeincome taxes:

 
| ** **                             | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **2010**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                             | ** ** | **(In thousands)**            | ** ** |
| **Segment income:**                    |       |                          |       |   |   |   |   |
| Total  income from reportable segments |       | $                             | 3,709      |   | $ | 6,200 |   | $ | 7,708 |   |
| **Unallocated amounts:**               |       |                          |       |   |   |   |   |
| Corporate  and other expenses          |       | (232                          | )          | (346 | ) | (266 | ) |
| Amortization  of intangible assets     |       | (159                          | )          | (147 | ) | (147 | ) |
| Other  income, net                     |       | 44                            |       | 116 |   | 252 |   |
| Interest  expense, net                 |       | (264                          | )          | (646 | ) | (1,284 | ) |
| Income  before income taxes            |       | $                             | 3,098      |   | $ | 5,177 |   | $ | 6,263 |   |

 

**Significant Customer and Geographic Information**

 

No single customer accounted for more than 10% of our total net salesand contract revenues for each of the fiscal years ended March 31, 2010, 2009and 2008.

 

No individual customer or government agency had a receivable balance atMarch 31, 2010 or 2009 greater than 10% of our total trade accountsreceivable balances as of March 31, 2010 and 2009, respectively.

 

Our total net sales and contract revenues derived from either shipmentsto, or contract, service and other revenues from external customers locatedoutside the U.S. approximated 8%, 15% and 12% for the fiscal years ended March 31,2010, 2009 and 2008, respectively.

 

Substantially all of our long-lived assets are held in the U.S.

 

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**11.**          Quarterly Financial Data (Unaudited)

 
| ** **               | ** ** | **Total Net  Sales and  Contract  Revenues** | ** ** | **Gross Profit** | ** ** | **Net  Income** | ** ** | **Basic  Earnings  per Share** | ** ** | **Diluted  Earnings  per Share** | ** ** |
|--------------------------|------------|----------------------------------------------|------------|------------------|------------|-----------------|------------|--------------------------------|------------|----------------------------------|------------|
| ** **               |       | **(In thousands, except per share amounts)** |       |
| **Quarter Ended:**       | ** ** | ** **                                   | ** ** | ** **       | ** ** | ** **      | ** ** | ** **                     | ** ** | ** **                       | ** ** |
| June 30,  2009      |       | $                                            | 14,634     |             | $          | 5,582           |       | $                              | 144        |                             | $          | 0.00 |   | $ | 0.00 |   |
| September 30,  2009 |       | 14,865                                       |       | 6,570            |       | 543             |       | 0.02                           |       | 0.02                             |       |
| December 31,  2009  |       | 13,577                                       |       | 5,535            |       | 709             |       | 0.02                           |       | 0.02                             |       |
| March 31,  2010     |       | 14,987                                       |       | 6,472            |       | 807             |       | 0.02                           |       | 0.02                             |       |
|                     |       | $                                            | 58,063     |             | $          | 24,159          |       | $                              | 2,203      |                             | $          | 0.06 | * | $ | 0.06 | * |
|                     |       |                                         |       |             |       |            |       |                           |       |                             |       |
| June 30,  2008      |       | $                                            | 17,442     |             | $          | 7,752           |       | $                              | 666        |                             | $          | 0.02 |   | $ | 0.02 |   |
| September 30,  2008 |       | 19,066                                       |       | 7,875            |       | 1,067           |       | 0.03                           |       | 0.03                             |       |
| December 31,  2008  |       | 16,462                                       |       | 6,504            |       | 741             |       | 0.02                           |       | 0.02                             |       |
| March 31,  2009     |       | 16,389                                       |       | 5,788            |       | 8,000           |       | 0.23                           |       | 0.23                             |       |
|                     |       | $                                            | 69,359     |             | $          | 27,919          |       | $                              | 10,474     |                             | $          | 0.31 | * | $ | 0.30 | * |

 

----

*            Annual per share amounts may not agree to the sum ofthe quarterly per share amounts due to differences between average sharesoutstanding during the periods.

 

**Exhibit Index**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                            | ** ** | **Where Located**                                                                                                                                                         |
|---------------------|------------|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                 | ** ** | ** **                                                                                                                                                                     |
| 3.1                 |       | Restated Certificate of  Incorporation of the registrant                                                   | * *   | *Exhibit 3.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2009 as filed with the SEC on October 30, 2009*  |
|                |       |                                                                                                       |       |                                                                                                                                                                           |
| 3.2                 |       | Certificate of  Designations of Series A Junior Participating Preferred Stock                         | * *   | *Exhibit 3.2  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2009 as filed with the SEC on October 30, 2009*  |
|                |       |                                                                                                       |       |                                                                                                                                                                           |
| 3.3                 |       | Bylaws of the 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 effective September 16, 2005                        | * *   | *Exhibit 3.5  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2007*                                                           |
|                |       |                                                                                                       |       |                                                                                                                                                                           |
| 3.7                 |       | Certificate  of Amendment to Bylaws of registrant effective December 7, 2007                          | * *   | *Exhibit 3.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  December 13, 2007*                                                  |
|                |       |                                                                                                       | * *   | * *                                                                                                                                                                       |
| 3.8                 |       | Certificate  of Amendment to Bylaws of registrant, effective August 20, 2009                          | * *   | *Exhibit 3.3  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                                    |

 

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| 4.1    |   | Specimen  of common stock certificate                                                                                                                                                                                                                                                                                                  | * * | *Exhibit 4.1  to registrant’s Registration Statement on Form 8-A as filed with the SEC  on December 8, 2004*                                                  |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 4.2    |   | Rights  Agreement dated August 20, 2009 between the registrant and Computershare  Trust Company, N.A., which includes the form of Certificate of Designations  for the Series A Junior Participating Preferred Stock, the form of Right  Certificate, and Summary of Rights to Purchase Preferred Stock as exhibits  thereto | * * | *Exhibit 4.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  August 21, 2009*                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.1   |   | Form of  Indemnity Agreement entered into by the registrant and certain of its  officers and directors                                                                                                                                                                                                                            | * * | *Exhibit 19.4  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 1988*                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.2   |   | Form of  Indemnification Agreement entered into by the registrant and certain of its  officers and directors                                                                                                                                                                                                                      | * * | *Exhibit 10.5  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2004 as filed with the SEC on June 29, 2004*                 |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.3*  |   | 1997  Stock Incentive Plan (the “1997 Plan”) as amended on May 3, 2003, as  further amended on December 15, 2004                                                                                                                                                                                                   | * * | *Exhibit 10.32  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2005 as filed with the SEC on July 14, 2005*                |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.4*  |   | Form of Notice of  Grant of Stock Option for 1997 Plan                                                                                                                                                                                                                                                                            | * * | *Exhibit 99.2  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.5*  |   | Form of  Stock Option Agreement for the 1997 Plan                                                                                                                                                                                                                                                                                 | * * | *Exhibit 99.3  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.6*  |   | Form of  Addendum to Stock Option Agreement for 1997 Plan—Involuntary Termination  Following Corporate Transaction or Change in Control                                                                                                                                                                                      | * * | *Exhibit 99.4  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   |     |                                                                                                                                                                              |
| 10.7*  |   | Form of  Addendum to Stock Option Agreement for 1997 Plan—Limited Stock Appreciation  Rights                                                                                                                                                                                                                                 | * * | *Exhibit 99.5  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.8*  |   | Form of  Stock Issuance Agreement for 1997 Plan                                                                                                                                                                                                                                                                                   | * * | *Exhibit 99.6  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.9*  |   | Form of  Addendum to Stock Issuance Agreement for 1997 Plan—Involuntary Termination  Following Corporate Transaction/Change in Control                                                                                                                                                                                       | * * | *Exhibit 99.7  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.10* |   | Form of  Notice of Grant of Automatic Stock Option for 1997 Plan—Initial Grant                                                                                                                                                                                                                                               | * * | *Exhibit 99.8  to Exhibit 99.8 to registrant’s Registration Statement on Form S-8  (File No. 333-30396) as filed with the SEC on February 14, 2000* |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.11* |   | Form of  Notice of Grant of Automatic Stock Option for 1997 Plan—Annual Grant                                                                                                                                                                                                                                                | * * | *Exhibit 99.9  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 14, 2000*                  |
|   |   |                                                                                                                                                                                                                                                                                                                                   | * * | * *                                                                                                                                                                          |
| 10.12* |   | Form of  Automatic Stock Option Agreement for 1997 Plan                                                                                                                                                                                                                                                                           | * * | *Exhibit 99.10  to the registrant’s Registration Statement on Form S-8 (File  No. 333-30396) as filed with the SEC on February 19, 2000*                 |

 

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| 10.13* |   | Iteris  Inc. 1998 Stock Incentive Plan (as amended on February 7, 2000) (“1998  Plan”)                                                                                                                                                          | * * | *Exhibit 10.24  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2005 as filed with the SEC on July 14, 2005*               |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.14* |   | Form of  Notice of Grant for 1998 Plan, including forms of Option Agreement and Stock  Purchase Agreement for the following directors and executive officers: Gregory  McKhann, James S. Miele and Abbas Mohaddes                                         | * * | *Exhibit 99.2  to the registrant’s Registration Statement on Form S-8 (File  No. 333-126834) as filed with the SEC on July 22, 2005*                    |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.15* |   | Form of  Addendum to Stock Option Agreement for 1998 Plan                                                                                                                                                                                                 | * * | *Exhibit 99.3  to the registrant’s Registration Statement on Form S-8 (File  No. 333-126834) as filed with the SEC on July 22, 2005*                    |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.16* |   | Form of  1997 Stock Option Agreements                                                                                                                                                                                                                     | * * | *Exhibit 99.4  to the registrant’s Registration Statement on Form S-8 (File No. 333-126834)  as filed with the SEC on July 22, 2005*                    |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.17* |   | Iteris, Inc.  Deferred Compensation Savings Plan and Grantor Trust                                                                                                                                                                                        | * * | *Exhibit 10.31  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2005 as filed with the SEC on July 14, 2005*               |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.18+ |   | Cooperative  Agreement for Development, Manufacture, Marketing and Sale of Products to the  Class 1 and Class 2 Vehicle Markets Incorporating Iteris’ LDWS  Technology (Valeo Schalter and Sensoren GmbH)                                       | * * | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2004 as filed with the SEC on August 16, 2004*         |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.19  |   | Warrant  Exercise Agreement dated September 27, 2006 by and among the registrant  and Special Situations Fund III QP, L.P., Special Situations Fund III, L.P.,  Special Situations Cayman Fund, L.P. and Special Situations Private Equity  Fund, L.P.    | * * | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2006 as filed with the SEC on November 14, 2006.* |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.20  |   | Registration  Rights Agreement dated September 28, 2006 by and among the registrant  and Special Situations Fund III QP, L.P., Special Situations Fund III, L.P.,  Special Situations Cayman Fund, L.P. and Special Situations Private Equity  Fund, L.P. | * * | *Exhibit 10.2  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2006 as filed with the SEC on November 14, 2006.* |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.21+ |   | National  Intelligent Transportation Systems (ITS) Architecture Evolution and Support  Award/Contract effective as of October 1, 2006 by and between the  registrant and the Federal Highway Administration                                               | * * | *Exhibit 10.3  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  September 30, 2006 as filed with the SEC on November 14, 2006.* |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.22* |   | Offer  letter effective February 28, 2007 by and between the registrant and  Abbas Mohaddes                                                                                                                                                               | * * | *Exhibit 10.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  March 6, 2007*                                                       |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.23  |   | Sublease  Agreement, dated September 30, 2003, by and between Odetics, Inc.  and Maij, Inc.                                                                                                                                                     | * * | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2007 as filed with the SEC on August 14, 2007*         |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.24  |   | Office  Lease Agreement, dated May 24, 2007, by and between Crown Carnegie  Associates, LLC and Iteris, Inc.                                                                                                                                         | * * | *Exhibit 10.2  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2007 as filed with the SEC on August 14, 2007*         |
|   |   |                                                                                                                                                                                                                                                           | * * | * *                                                                                                                                                                         |
| 10.25* |   | 2007  Omnibus Incentive Plan and forms of agreements                                                                                                                                                                                                           | * * | *Appendix  A to the registrant’s Definitive Proxy Statement on Schedule 14A as filed  with the SEC on August 10, 2007*                                                 |

 

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| 10.26      |       | Debenture  Redemption Agreement, dated February 11, 2008, by and among Potomac  Capital Partners, LP, Potomac Capital International Ltd. and  Iteris, Inc.                               | * *   | *Exhibit 10.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  February 15, 2008*                                                 |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.27      |       | Debenture  Redemption Agreement, dated February 27, 2008, by and between  Gruber & McBaine International and Iteris, Inc.                                                       | * *   | *Exhibit 10.1  to the registrant’s Current Report on Form 8-K as filed with the SEC on  February 29, 2008*                                                 |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.28      |       | Debenture  Redemption Agreement, dated February 27, 2008, by and between Lagunitas  Partners, LP and Iteris, Inc.                                                                        | * *   | *Exhibit 10.2  to the registrant’s Current Report on Form 8-K as filed with the SEC on  February 29, 2008*                                                 |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.29      |       | Debenture  Redemption Agreement, dated February 27, 2008, by and between Jon D. and  Linda W. Gruber Trust and Iteris, Inc.                                                              | * *   | *Exhibit 10.3  to the registrant’s Current Report on Form 8-K as filed with the SEC on  February 29, 2008*                                                 |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.30*     |       | Change  in Control Agreement dated June 11, 2008 by and between James S. Miele  and Iteris, Inc.                                                                                         | * *   | *Exhibit 10.42  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2008 as filed with the SEC on June 12, 2008*             |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.31      |       | Amended  and Restated Loan and Security Agreement dated February 4, 2009 by and  between California Bank & Trust and the registrant                                                  | * *   | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2008 as filed with the SEC on February 13, 2009* |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.32      |       | Debenture  Redemption Agreement, dated October 17, 2008, by and between the  registrant and certain affiliates of Bryant R. Riley                                                             | * *   | *Exhibit 10.2  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2008 as filed with the SEC on February 13, 2009* |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.33      |       | Debenture  Redemption Agreement, dated October 27, 2008, by and between the  registrant and each of Lloyd I. Miller, III, Lloyd I. Miller Trust A-4,  Milfam I, L.P. and Milfam II, L.P. | * *   | *Exhibit 10.3  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2008 as filed with the SEC on February 13, 2009* |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.34      |       | Debenture  Redemption Agreement, dated January 9, 2009, by and between the  registrant and each of Irvin Kessler and Provident Premier Master Fund Ltd.                                       | * *   | *Exhibit 10.4  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  December 31, 2008 as filed with the SEC on February 13, 2009* |
| ** ** | ** ** | ** **                                                                                                                                                                                         | ** ** | ** **                                                                                                                                                                     |
| 10.35      |       | Separation  Agreement and Release of All Claims, dated May 20, 2009, by and between  Francis Memole and the registrant                                                                        | * *   | *Exhibit 10.45  to the registrant’s Annual Report on Form 10-K for the year ended  March 31, 2009 as filed with the SEC on June 12, 2009*             |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 10.36      |       | Unsecured  Promissory Note dated August 10, 2009 executed by MAXxess  Systems, Inc.                                                                                                      | * *   | *Exhibit 10.1  to the registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2009 as filed with the SEC on August 11, 2009*       |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 21         |       | Subsidiaries  of the registrant                                                                                                                                                                    | * *   | *Filed  Herewith*                                                                                                                                                              |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 23         |       | Consent  of Independent Registered Public Accounting Firm                                                                                                                                          | * *   | *Filed  Herewith*                                                                                                                                                              |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 31.1       |       | Certification of the Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                      | * *   | *Filed  Herewith*                                                                                                                                                              |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 31.2       |       | Certification  of the Chief Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                      | * *   | *Filed  Herewith*                                                                                                                                                              |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 32.1       |       | Certification  of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                  | * *   | *Filed  Herewith*                                                                                                                                                              |
|       |       |                                                                                                                                                                                               | * *   | * *                                                                                                                                                                       |
| 32.2       |       | Certification  of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                  | * *   | *Filed  Herewith*                                                                                                                                                              |

 

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* Indicates a managementcontract or compensatory plan or arrangement

+ Confidential treatment hasbeen requested for certain confidential portions of this exhibit pursuant to Rule 24b-2of the Securities Exchange Act of 1934, as amended. In accordance with Rule 24b-2,these confidential portions have been omitted from the exhibit and filed separatelywith the SEC.

 

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