**UNITEDSTATESSECURITIES 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, 2008**                                                                            |
| ** **                                                                                                                    | ** ** | ** ** |
| **OR**                                                                                                                        |
| ** **                                                                                                                    | ** ** | ** ** |
| **o**                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                    | ** ** | ** ** |
| **For the  transition period from                  to** |
| ** **                                                                                                                    | ** ** | ** ** |
| **Commission  file number 001-08762**                                                                                         |

 

**ITERIS,INC.**

(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.) |

 

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

(Address of PrincipalExecutive Offices) (Zip Code)

 

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

 

Securities registeredpursuant to Section 12(b) of the Act:

 

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

 

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

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities 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 o No 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 is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” 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 $48,200,000. For the purposes of thiscalculation, shares owned by officers, directors and 10% stockholders known tothe registrant have been deemed to be owned by affiliates. This determinationof affiliate status is not necessarily a conclusive determination for otherpurposes.

 

As of June 10, 2008, there were 33,888,002 shares of common stockoutstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III incorporates by reference certain information from theregistrant’s definitive proxy statement for the 2008 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 31,2008. 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.**

**ANNUALREPORT ON FORM 10-K**

**FOR THEFISCAL YEAR ENDED MARCH 31, 2008**

**TABLEOF CONTENTS**

 
| **PART I**   |   | 3                                                                                                                   |
|-------------------|--------|---------------------------------------------------------------------------------------------------------------------|
|              |   |                                                                                                                |   |   |
| ITEM 1.           |   | BUSINESS                                                                                                            |   | 3 |
|              |   |                                                                                                                |   |   |
| ITEM 1A.          |   | RISK FACTORS                                                                                                        |   | 7 |
|              |   |                                                                                                                |   |   |
| ITEM 1B.          |   | UNRESOLVED STAFF  COMMENTS                                                                                          |   | 15 |
|              |   |                                                                                                                |   |   |
| ITEM  2.          |   | PROPERTIES                                                                                                          |   | 16 |
|              |   |                                                                                                                |   |   |
| ITEM 3.           |   | LEGAL PROCEEDINGS                                                                                                   |   | 16 |
|              |   |                                                                                                                |   |   |
| ITEM 4.           |   | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |   | 16 |
|              |   |                                                                                                                |   |   |
| **PART II**  |   | 17                                                                                                                  |
|              |   |                                                                                                                |   |   |
| ITEM 5.           |   | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES |   | 17 |
|              |   |                                                                                                                |   |   |
| ITEM 6.           |   | SELECTED FINANCIAL  DATA                                                                                            |   | 19 |
|              |   |                                                                                                                |   |   |
| ITEM 7.           |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         |   | 20 |
|              |   |                                                                                                                |   |   |
| ITEM 7A.          |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         |   | 30 |
|              |   |                                                                                                                |   |   |
| ITEM 8.           |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |   | 30 |
|              |   |                                                                                                                |   |   |
| ITEM 9.           |   | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |   | 30 |
|              |   |                                                                                                                |   |   |
| ITEM 9A(T).       |   | CONTROLS AND PROCEDURES                                                                                             |   | 30 |
|              |   |                                                                                                                |   |   |
| ITEM 9B.          |   | OTHER INFORMATION                                                                                                   |   | 31 |
|              |   |                                                                                                                |   |   |
| **PART III** |   | 31                                                                                                                  |
|              |   |                                                                                                                |   |   |
| ITEM 10.          |   | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |   | 31 |
|              |   |                                                                                                                |   |   |
| 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                                                                             |   | 32 |
|              |   |                                                                                                                |   |   |
| **PART IV**  |   | 32                                                                                                                  |
|              |   |                                                                                                                |   |   |
| ITEM 15.          |   | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                                         |   | 32 |
|                   |        |                                                                                                                     |  |  |  |  |  |  |

 

Unlessotherwise indicated in this report, the “registrant,” “we,” “us” and “our”collectively refers to Iteris, Inc. and its former subsidiary, Meyer,Mohaddes Associates, Inc., which was dissolved effective April 2006.

 

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

 

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**Cautionary Statement**

 

*Thisreport, including the following discussion and analysis, containsforward-looking statements (within the meaning of the Private SecuritiesLitigation Reform Act of 1995) that are based on our current expectations,estimates and projections about our business and our industry, and reflectmanagement’s beliefs and certain assumptions made by us based upon informationavailable to us as of the date of this report. When used in this report and theinformation incorporated herein by reference, the words “expect(s),” “feel(s),”“believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)” andsimilar expressions or variations of these words are intended to identifyforward-looking statements. These forward-looking statements include but arenot limited to statements regarding our anticipated sales, revenue, expenses,profits, capital needs, competition, 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 of unanticipatedevents. We encourage you to carefully review and consider the variousdisclosures made by us which describe certain factors which could affect ourbusiness, 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**

 

Iteris, Inc. is aleader in the traffic management market that focuses on the development andapplication of advanced technologies that reduce traffic congestion, minimizethe environmental impact of traffic congestion and improve the safety ofsurface transportation systems. By combining outdoor image processing, trafficengineering and information technology, we offer a broad range of IntelligentTransportation Systems and driver safety solutions to customers worldwide.

 

Our proprietary imagerecognition systems include Vantage and AutoVue. Vantage is a video vehicle detectionsystem that detects the presence of vehicles on roadways. Vantage systems areused at signalized intersections to enable a more efficient allocation of greensignal time and are also used for incident detection and highway traffic datacollection applications. AutoVue Lane Departure Warning (“LDW”) systems consistof a small windshield mounted sensor that uses proprietary software to detectand warn drivers of unintended lane departures. To date, we and our strategicpartner have sold approximately 90,000 production AutoVue LDW systems for useon car and truck platforms in the North American and European markets. Webelieve that our AutoVue LDW technology is a broad sensor platform that,through additional software development, may be expanded to incorporateadditional safety and convenience features.

 

Our transportationmanagement systems business includes transportation engineering and consultingservices focused on the planning, design, development and implementation ofsoftware-based systems that integrate sensors, video surveillance, computersand advanced communications equipment to enable public agencies to monitor,control and direct traffic flow, assist in the quick dispatch of emergencycrews and distribute real-time information about traffic conditions. Ourservices include planning, design and implementation of surface transportationinfrastructure systems.  We performanalysis and study goods movement, commercial vehicle operations, travel demandforecasting and systems engineering, and identify mitigation measures to reducetraffic congestion.  These services andsystems are primarily sold to local, state and national transportation agenciesin the United States.  Our transportationmanagement systems business is largely dependent upon governmental funding andbudgetary issues.  The Federal HighwayBill that was passed in August 2005 provided for a significant increase intransportation funding over the following six years.  We believe the recent expansion of ourtransportation management systems business was due in part to the passage ofthe Federal Highway Bill, combined with the expansion of transportation fundsat state and local agencies throughout the country. The 2005 Federal Highway Billis set to expire during 2009.

 

We currently operate in three reportable segments:Roadway Sensors, Vehicle Sensors and Transportation Systems. The RoadwaySensors segment includes our Vantage vehicle detection systems for trafficintersection control, incident detection and certain highway traffic datacollection applications.  The VehicleSensors segment is comprised of all activities related to our AutoVue LDWsystems for vehicle safety. The Transportation Systems segment includestransportation engineering and consulting services and the development oftransportation management and traveler information systems for the ITSindustry.  See Note 12 to theaccompanying consolidated financial statements for further discussion of ouroperating segments.

 

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We were originallyincorporated in Delaware in 1987.  In October 2004,we completed a merger with our majority-owned subsidiary, Iteris, Inc.(the “Iteris Subsidiary”), and officially changed our corporate name to Iteris, Inc.

 

**Sales, Marketing and Principal Customers**

 

We sell our Vantagevehicle detection systems through indirect sales channels comprised ofindependent dealers in the United States and Canada who sell integrated systemsand related products to the traffic management market, as well as directly tothe traffic management market using a combination of our own sales personneland an outside sales organization. Our independent dealers are primarilyresponsible for sales, installation and support of Vantage systems. Thesedealers maintain an inventory of demonstration traffic products from variousmanufacturers including our Vantage vehicle detection systems and sell directlyto government agencies and installation contractors. These dealers often havelong-term arrangements with the government agencies in their territory for thesupply of various products for the construction and renovation of trafficintersections. We hold technical training classes for dealers and end users andmaintain a full-time staff of customer support technicians to provide technicalassistance when needed.

 

Our marketing strategyfor AutoVue is to establish it as the leading platform for in-vehicle videosensing for heavy trucks and passenger cars. We sell AutoVue LDW systems directly to heavy truck manufacturers and toU.S. truck fleets, and our AutoVue LDW system is currently offered as an optionon certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania,Freightliner and FUSO, as well as Neoplan and MAN luxury bus and coach lines.We market the licensing of our LDW technology to manufacturers of passengerautomobiles through an exclusive strategic relationship with Valeo Schalter andSensuren GmbH (“Valeo”), an independent automotive supplier. In connection withthis marketing effort, we provide specific contract engineering services,technical marketing and sales support to Valeo, which to date has enabled thelaunch of our LDW technology on three Infiniti car platforms. We plan tocontinue to provide technical marketing and sales support to Valeo in our effortsto win new original equipment manufacturer (“OEM”) customers for the passengercar market as well as contract engineering services related to the possiblelaunch of new platforms that include our AutoVue LDW system.

 

We market and sell ourtransportation management systems and traveler information services directly togovernment agencies pursuant to negotiated contracts that involve competitivebidding and specific qualification requirements. Most of our contracts withfederal, state and municipal customers provide for cancellation orrenegotiation at the option of the customer upon reasonable notice and feespaid for modification. We use selected members of our engineering team dividedon a regional basis to serve in sales and business development functions. We donot engage in sales of transportation management systems and travelerinformation services outside of the U.S. Sales of our transportation managementsystems contracts generally involve long lead times and require extensivespecification development, evaluation and price negotiations.

 

A large portion of ourrevenues are derived from sales to federal, state and local governmentagencies.  Our largest customer accountedfor 7.3% of total net sales and contract revenues in the fiscal year ended March 31,2008 (“Fiscal 2008”).

 

**Manufacturingand Materials**

 

We use contractmanufacturers to build subassemblies that are used in our Vantage products.Additionally, we procure certain components from qualified suppliers, bothglobally and locally, and use multi-sourcing strategies when technically andeconomically feasible to mitigate supply risk. These subassemblies andcomponents are delivered to our Santa Ana facility where they go through finalassembly and testing prior to shipment to our customers. Our manufacturingactivities are conducted in approximately 9,000 square feet of space at ourSanta Ana facility. Production volume at our subcontractors is based uponquarterly forecasts that we adjust on a monthly basis to control inventorylevels. For sales of AutoVue LDW systems to the truck market, we subcontractthe manufacture of our AutoVue LDW systems to one primary manufacturer, and ourinternal processes are limited primarily to testing and final verification. ForAutoVue LDW sales to the passenger car market, all manufacturing will beperformed by Valeo; however, we plan to continue to provide engineering supportto Valeo. We currently do not manufacture any of the hardware used in thetransportation management and traveler information systems that we design andimplement. Our production facility is currently ISO 9001 certified.

 

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**CustomerSupport and Services**

 

We provide warranty service and support for ourVantage and AutoVue products, as well as follow-up service and support forwhich we charge separately. Service revenue accounted for less than 1.0% oftotal net sales and contract revenues for Fiscal 2008. We believe customersupport is a key competitive factor.

 

**Backlog**

 

Our backlog of unfulfilledfirm orders was approximately $26.8 million as of March 31, 2008, whichwas comprised of $900,000 related to Roadway Sensors, $1.3 million related toVehicle Sensors and $24.6 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 31,2009 (“Fiscal 2009”), while approximately 60% of Transportation Systems backlogis expected to be recognized as revenue in Fiscal 2009. At March 31, 2007,we had backlog of approximately $25.7 million, which was comprised of $3.5million related to Roadway Sensors, $2.1 million related to Vehicle Sensors and$20.1 million related to Transportation Systems. All backlog as of March 31,2007 for Roadway Sensors and Vehicle Sensors was recognized as revenue inFiscal 2008 while 45% of March 31, 2007 backlog for Transportation Systemswas recognized as revenue in Fiscal 2008. Pursuant to the customary terms ofour agreements with government contractors and other customers, customers cangenerally cancel or reschedule orders with little or no penalties. Leadtimes for the release of purchase orders often depend upon the scheduling andforecasting practices of our individual customers, which also can affect thetiming of the conversion of our backlog into revenues. For these reasons, amongothers, our backlog at a particular date may not be indicative of our futurerevenues, in particular for Roadway Sensors and Vehicle Sensors.

 

**ProductDevelopment**

 

Most of our developmentactivities are conducted at our principal facilities in Santa Ana, California.Our company-sponsored research and development costs and expenses wereapproximately $3.6 million for Fiscal 2008, $4.0 million for the fiscal yearended March 31, 2007 (“Fiscal 2007”), and $5.2 million for the fiscal yearended March 31, 2006 (“Fiscal 2006”). We expect to continue to pursuesignificant product development programs and incur significant research anddevelopment expenditures.

 

**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. While AutoVue has historically been theonly established commercially-available lane departure warning system used inthe U.S. and in Europe in the heavy truck market, we have recently experiencedincreased competition from new competitors in this market. Potentialcompetitors of AutoVue include Delphi Automotive Systems Corporation, NECCorporation and Hitachi Ltd. in Japan and Robert Bosch GmbH in Europe, as wellas Siemens, Continental Tavis, Visteon and Cognex, which are currentlydeveloping video sensor technologies for the vehicle industry that could beused for lane departure warning systems. In the market for our Vantage vehicledetection systems, we compete with manufacturers of other above ground videocamera detection systems such as Econolite Control Products, Inc.,Traficon, N.V., Quixote, and other non-intrusive detection devices includingmicrowave, infrared, ultrasonic and magnetic detectors, as well asmanufacturers and installers of in-pavement inductive loop products.

 

The transportationmanagement and traveler information systems market is highly fragmented and issubject to evolving national and regional quality and safety standards. Ourcompetitors vary in number, scope and breadth of the products and services theyoffer. Our competitors in advanced transportation management and travelerinformation systems include national corporations such as Transcore, Siemens,Telvent Farradyne, Kimley-Horn and Associates, Inc. and Delcan. Ourcompetitors in transportation engineering, planning and design include majorfirms such as Parsons Brinkerhoff, Inc., URS, HNTB and ParsonsTransportation Group, Inc., as well as many smaller regional engineeringfirms.

 

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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 target marketswill depend on a number of factors, including the success and timing of our newproduct development, the compatibility of our products with a broad range ofcomputing systems, product quality and performance, reliability, functionality,price, and service and technical support. Our failure to provide services anddevelop and market products that compete successfully with those of othersuppliers and consultants in our target markets would have a material adverseeffect 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, and have six****U.S. patentapplications pending relating to our outdoor image processing techniques usedin our AutoVue systems. Nine of our patents relate specifically to our AutoVuetechnology and provide a basis for enhanced functionality for rain sensing andimproved performance. We believe that our other patents, while important forour technology platforms, are less critical to our near term product strategy.We cannot assure you that any new patents will be granted pursuant to anyoutstanding 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 June 9, 2008, we employed an aggregate of 268associates, including 54 associates in general management, administration and finance;34 associates in sales and marketing; 144 associates in engineering and productdevelopment; 23 associates in operations, manufacturing and quality; and 13associates in customer service. None of our associates are represented by alabor 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 not expectedto have a material impact in the near future.

 

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

 

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

 

**We May NeedTo Raise Additional Capital In The Future, Which May Not Be Available OnTerms Acceptable To Us, Or At All. **Untilrecently we have historically generated significant net losses and operatinglosses, and have experienced volatility in our cash flows from operationsranging from positive cash flows from operations of $7.6 million in Fiscal 2008to negative cash flows from operations of $2.0 million in Fiscal 2007.Additionally, we failed to meet certain debt covenants under our prior creditagreement during two fiscal quarters, prior to the replacement of that creditfacility in October 2006. Furthermore, as of March 31, 2008, we had$7.8 million in subordinated convertible debentures outstanding that are due infull in May 2009. Should the holders of the convertible debentures notelect to convert the principal into shares of our common stock, we may need toraise additional capital to refinance this debt.

 

At March 31,2008, we had $421,000 of cash and cash equivalents and relied on our line ofcredit to fund our operations. We may need to raise additional capital in thenear future to fund our operations or to repay indebtedness. Such additionalcapital may be raised through bank borrowings, or other debt or equity financings.We cannot assure you that any additional capital will be available on a timelybasis, on acceptable terms, or at all, and such additional financing may resultin further dilution to our stockholders.

 

Ourcapital requirements will depend on many factors, including, but not limitedto:

 

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

 

·                                       ourability to control costs;

 

·                                       thesupply of key components for our products;

 

·                                       ourability to increase revenue and net income;

 

·                                       increasedresearch and development expenses and sales and marketing expenses;

 

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

 

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

 

·                                       potentialacquisitions of businesses and product lines;

 

·                                       ourrelationships with customers and suppliers;

 

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

 

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

 

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

 

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If ourcapital requirements are materially different from those currently planned, wemay need additional capital sooner than anticipated. If additional funds areraised through the issuance of equity or convertible debt securities, thepercentage ownership of our stockholders will be reduced and such securitiesmay have rights, preferences and privileges senior to our common stock.Additional financing may not be available on favorable terms, on a timelybasis, or at all. If adequate funds are not available or are not available onacceptable terms, we may be unable to continue our operations as planned,develop or enhance our products, expand our sales and marketing programs, takeadvantage of future opportunities or respond to competitive pressures.

 

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

 

**If Our Internal Controls OverFinancial Reporting Do Not Comply With The Requirements Of The Sarbanes-OxleyAct, Our Business And Stock Price Could Be Adversely Affected.**Alongwith our independent registered public accounting firm, we will be evaluatingthe effectiveness of our internal controls over financial reporting to complywith Section 404 of the Sarbanes-Oxley Act of 2002. Section 404currently requires us to evaluate the effectiveness of our internal controlsover financial reporting at the end of each fiscal year beginning in our fiscalyear ending March 31, 2008 and to include a management report assessingthe effectiveness of our internal controls over financial reporting in allannual reports beginning with our Annual Report on Form 10-K for thefiscal year ending March 31, 2008. Section 404 also requires ourindependent accountant to attest to, and report on, management’s assessment ofour internal controls over financial reporting beginning in our fiscal yearending March 31, 2009. We may not be able to complete our Section 404compliance on a timely basis, and even if we timely complete our compliancerequirements, our independent auditors may still conclude that our internalcontrols over financial reporting are not effective.

 

Ourmanagement, including our CEO and CFO, does not expect that our internalcontrols over financial reporting will prevent all errors and all fraud. Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met. Further, the design of a control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within Iteris have been or willbe detected. These inherent limitations include the realities that judgments indecision-making can be faulty and that breakdowns can occur because of simpleerror or mistake. Controls can also be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe controls. The design of any system of controls is based in part on certainassumptions about the likelihood of future events, and we cannot assure youthat any design will succeed in achieving its stated goals under all potentialfuture conditions. Over time, our controls may become inadequate because ofchanges in conditions or deterioration in the degree of compliance withpolicies or procedures. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

 

As ofMarch 31, 2005, we became aware of a material weakness in our internal controlsrelated to the accounting for the consolidation of our deferred compensationsavings plan and certain contract administration. Based on our evaluation, ourmanagement concluded that, as of March 31, 2004, our internal control overfinancial reporting was not effective due to the existence of one materialweakness. The weakness was immediately corrected. We cannot assure you that weor our independent registered public accounting firm will not identifyadditional material weaknesses in our internal controls. A material weakness isa control deficiency, or combination of control deficiencies, that results inmore than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. If our internalcontrols over financial reporting are not considered adequate, we mayexperience a loss of public confidence, which could have an adverse effect onour business and our stock price.

 

**We DependOn Government Contracts And Subcontracts, And Because Many Of Our GovernmentContracts Are Fixed Price Contracts, Higher Than Anticipated Costs Will ReduceOur Profit And Could Adversely Impact Our Operating Results.**Asignificant portion of our sales are derived from contracts with governmentalagencies, either as a general contractor, subcontractor or supplier. Governmentcontracts represented approximately 38.1%, 37.8% and 38.3% of our total netsales and contract revenues for the years ended March 31, 2008, 2007 and2006, 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:

 

·                                          longpurchase cycles or approval processes;

 

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·                                          competitivebidding and qualification requirements;

 

·                                          theimpact of international conflicts;

 

·                                          performancebond requirements;

 

·                                          changesin government policies and political agendas;

 

·                                          delaysin funding, including the delays in the allocation of funds to state and localagencies from the U.S. federal government as a result of a reduction or a delayin the passage of the 2005 Federal Highway Bill set to expire in 2009;

 

·                                          othergovernment budgetary constraints and cut-backs; and

 

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

 

Inaddition, a large number of our government contracts are fixed price contracts.As a result, we may not be able to recover any cost overruns we may incur.These fixed price contracts require us to estimate the total project cost basedon preliminary projections of the project’s requirements. The financialviability of any given project depends in large part on our ability to estimatethese costs accurately and complete the project on a timely basis. In the eventour costs on these projects exceed the fixed contractual amount, we will berequired to bear the excess costs. Such additional costs would adversely affectour financial condition and results of operations. Moreover, certain of ourgovernment contracts are subject to termination or renegotiation at theconvenience of the government, which could result in a large decline in our netsales and contract revenues in any given quarter. Our inability to address anyof the foregoing concerns or the loss or renegotiation of any materialgovernment contract could seriously harm our business, financial condition andresults of operations.

 

**New Environmental Regulations May Result In A Decline InOur AutoVue Sales and Royalties.**Environmental regulations inEurope were modified and became effective in 2006, which required morestringent emissions compliance in new trucks manufactured in Europe after 2006.These regulations caused the cost of certain trucks to increase significantlyand caused a decline in new truck sales in Europe. Similar regulations wereexacted in North America that impacted diesel engines built after January 2007.North America heavy truck sales in 2007 and the first quarter of 2008 declinedsignificantly as compared to the prior year, which we believe was at least inpart a result of large 2006 prebuys of heavy trucks made in anticipation of thenew North America emission standards.  Wemay experience a further decline in our LDW sales to truck OEMs related tothese stricter regulations. Additionally, we may experience future declines inour LDW sales to truck OEMs as a result of future regulations such as these.

 

**We May ExperienceProduction Gaps Which Could Materially And Adversely Impact Our Sales AndFinancial Results And The Ultimate Acceptance Of Our Products.**Itis possible that we could experience unforeseen quality control issues or partshortages as we increase production to meet current demand for our products. Wehave historically used single suppliers for certain of our components in ourAutoVue and Vantage products. Should any such delay or disruption occur, ourfuture sales will likely be materially and adversely affected. Additionally, werely heavily on select contract manufacturers to produce many of our products.Although we believe our contract manufacturers have sufficient capacity to meetour production schedules for the foreseeable future and we believe we couldfind alternative contract manufacturing sources if necessary, we couldexperience a production gap if for any reason our contract manufacturers wereunable to meet our production requirements.

 

**We DependUpon Valeo To Market Our AutoVue Technologies For The OEM Passenger Car Market.**We have granted Valeo the exclusive right to sell andmanufacture our AutoVue LDW system to the worldwide passenger car market inexchange for royalty payments for each AutoVue unit sold. As such, the futuresuccess and broad market acceptance of our AutoVue technologies in thepassenger car market will depend upon Valeo’s ability to manufacture, marketand sell our technologies, and to convince more OEM passenger car manufacturersto adopt our technologies.  To date, wehave not generated significant royalties from Valeo’s efforts and have onlybeen designed into one car OEM product line. If Valeo does not devote considerable resources and aggressively pursueopportunities, our expansion into the passenger car market could be adverselyaffected.

 

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**We May BeUnable To Attract And Retain Key Personnel, Which Could Seriously Harm OurBusiness.**Due to the specialized nature of our business, weare highly dependent on the continued service of our executive officers andother key management, engineering and technical personnel. The loss of AbbasMohaddes, our Chief Executive Officer, or any of the other executive officersor key members of management could adversely affect our business, financial conditionor results of operations. Our success will also depend in large part upon ourability to continue to attract, retain and motivate qualified engineering andother highly skilled technical personnel. In particular, the future success ofour Transportation Systems segment will depend on our ability to hireadditional 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.

 

**If We AreUnable To Develop And Introduce New Products And Product EnhancementsSuccessfully And In A Cost-Effective And Timely Manner, Or Are Unable ToAchieve Market Acceptance Of Our New Products, Our Operating Results Would BeAdversely Affected.**We believe our revenue growth and futureoperating results will depend on our ability to complete development of newproducts and enhancements, introduce these products in a timely, cost-effectivemanner, achieve broad market acceptance of these products and enhancements, andreduce our product costs. We cannot guarantee the success of these products andwe may not be able to introduce any new products or any enhancements to ourexisting products on a timely basis, or at all. In addition, the introductionof any new products could adversely affect the sales of certain of our existingproducts.

 

Webelieve that we must continue to make substantial investments to supportongoing research and development in order to remain competitive. We need tocontinue to develop and introduce new products that incorporate the latesttechnological advancements in outdoor image processing hardware, software andcamera technologies in response to evolving customer requirements. We cannotassure you that we will be able to adequately manage product transition issues.Our business and results of operations could be adversely affected if we do notanticipate or respond adequately to technological developments or changingcustomer requirements or if we cannot adequately manage inventory issuestypically related to new product transitions and introductions. We cannotassure you that any such investments in research and development will lead toany corresponding increase in revenue.

 

Marketacceptance of our new products depends upon many factors, including our abilityto accurately predict market requirements and evolving industry standards, ourability to resolve technical challenges in a timely and cost-effective manner,qualify any new products with OEMs and achieve manufacturing efficiencies, theperceived advantages of our new products over traditional products and themarketing capabilities of our independent distributors and strategic partners,including Valeo’s ability to expand sales of AutoVue in the passenger carmarket. The success of our AutoVue system will also depend in part on thesuccess of the automotive vehicles that incorporate our technology, as well asthe success of optional equipment that OEMs bundle with our technologies.

 

Certainof the components used in our Vantage and AutoVue products may need to bere-engineered in the next 12 to 36 months as the industry is moving towards astandard of using lead-free components. We cannot assure you as to the timingof the adoption of this new standard or our ability to successfully redesignour products to incorporate compliant components and gain market acceptance ofsuch redesigned products. In addition, if the standard is adopted earlier thananticipated we may experience a shortage of Vantage and AutoVue products as aresult of potential scarcity of lead-free components.

 

Ourbusiness and results of operations could also be seriously harmed by anysignificant delays in our new product development. Certain of our new productscould contain undetected design faults and software errors or “bugs” when firstreleased by us, despite our testing. We may not discover these faults or errorsuntil after a product has been installed and used by our customers. Any faultsor errors in our existing products or in any new products may cause delays inproduct introduction and shipments, require design modifications or harmcustomer relationships, any of which could adversely affect our business andcompetitive position.

 

**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 othercompanies in our target markets including, but not limited to, large, multinationalcorporations, which include tier one automotive suppliers, and many smallerregional engineering firms. We expect such competition to increase due totechnological advancements, industry consolidations and reduced barriers toentry. Increased competition is likely to result in price reductions, reducedgross margins and loss of market share, any of which could seriously harm ourbusiness, financial condition and results of operations. In Fiscal 2007, webegan to experience more competition in our Roadway Sensors segment as theDepartment of Transportation in one of our largest sales territories moved to amulti-source contracting environment from one in which we were the solesupplier. In addition, one of the other developers of LDW systems was

 

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acquired by a largercompany during Fiscal 2007. While this developer has not been a materialcompetitor to date, we may experience more competition from this provider as aresult of its greater access to resources from its acquirer, and additionalcompetitors may enter this market in the future. Furthermore, awareness of LDWtechnology is increasing and other market players are attempting to developcompeting technologies, which may contain improvements or added features beyondthose offered by our LDW systems. Should such efforts be successful, this coulderode our ability to successfully market and sell our LDW systems to new andexisting customers.

 

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.

 

**AnEconomic Slowdown Could Lead To Reduced Or Delayed Government Funding ForTransportation Infrastructure And Initiatives And Decreased Availability OfFinancial Capital For Our Customers, Causing A Decline In Our Revenues. **Concerns about inflation,decreased consumer confidence, and reduced corporate profits and capitalspending have resulted in a downturn in worldwide economic conditions, particularlyin the United States. These unfavorable economic conditions may have a negativeimpact on customer orders (and also may result in decreased sales ofautomobiles and trucks that incorporate our LDW systems). Such concerns mayresult in cancellations and rescheduling of backlog. In addition, the recentdecline in the U.S. real estate market, particularly in new home construction,has adversely impacted new road construction and could result in a decline inRoadway Sensor and Vehicle Sensor net sales and Transportation Systems contractrevenues. Any of the foregoing economic conditions make it extremely difficultfor our customers, our suppliers and us to accurately forecast and plan futurebusiness activities and could result in a decline in our net sales and contractrevenues. If such conditions continue or worsen, our business, financialcondition and results of operations could be materially and adversely affected.

 

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

 

**OurQuarterly Operating Results Fluctuate As A Result Of Many Factors. Therefore,We May Fail To Meet Or Exceed The Expectations Of Securities Analysts AndInvestors, Which Could Cause Our Stock Price To Decline.**Ourquarterly revenues and operating results have fluctuated and are likely tocontinue to vary from quarter to quarter due to a number of factors, many ofwhich are not within our control. Factors that could affect our revenues include,among others, the following:

 

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

 

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

 

·                                          delaysin government contracts and funding from time to time;

 

·                                          declinesin new home construction and related road construction;

 

·                                          ourability to control costs;

 

·                                          ourability to raise additional capital;

 

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

 

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·                                          seasonalitydue to winter weather conditions;

 

·                                          internationalconflicts and acts of terrorism;

 

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

 

·                                          marketacceptance of the products incorporating our technologies and products;

 

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

 

·                                          theintroduction of new products by competitors;

 

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

 

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

 

·                                          theeffects of technological changes in our target markets;

 

·                                          theamount of our backlog at any given time;

 

·                                          thenature of our government contracts;

 

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

 

·                                          risksand uncertainties associated with our international business;

 

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

 

·                                          generaleconomic and political conditions.

 

Due toall of the factors listed above as well as other unforeseen factors, our futureoperating results could be below the expectations of securities analysts orinvestors. If that happens, the trading price of our common stock coulddecline. As a result of these quarterly variations, you should not rely onquarter-to-quarter comparisons of our operating results as an indication of ourfuture performance.

 

**We May EngageIn Acquisitions Of Companies Or Technologies That May Require Us ToUndertake Significant Capital Infusions And Could Result In Disruptions Of OurBusiness And Diversion Of Resources And Management Attention.**Wehave historically acquired, and may in the future acquire, complementarybusinesses, products and technologies. Acquisitions may require significantcapital infusions and, in general, acquisitions also involve a number ofspecial risks, including:

 

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

 

·                                          thefailure to retain or integrate key acquired personnel;

 

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

 

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

 

·                                          theincurrence of unforeseen obligations or liabilities;

 

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

 

·                                          increasedinterest expense and amortization of acquired intangible assets.

 

Ourcompetitors are also soliciting potential acquisition candidates, which couldboth increase the price of any acquisition targets and decrease the number ofattractive companies available for acquisition. Acquisitions may alsomaterially and adversely affect our operating results due to large write-offs,contingent liabilities, substantial depreciation, deferred compensation chargesor intangible asset amortization, or other adverse tax or accountingconsequences. We cannot assure you that we will be able to identify orconsummate any additional acquisitions, successfully integrate any acquisitionsor realize the benefits anticipated from any acquisition.

 

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

 

**If We DoNot Keep Pace With Rapid Technological Changes And Evolving Industry Standards,We Will Not Be Able To Remain Competitive And There Will Be No Demand For OurProducts.**Our markets are in general characterized by thefollowing factors:

 

·                                          rapidtechnological advances;

 

·                                          downwardprice pressure in the marketplace as technologies mature;

 

·                                          changesin customer requirements;

 

·                                          additionalqualification requirements related to new products or components;

 

·                                          frequentnew product introductions and enhancements;

 

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

 

·                                          evolvingindustry standards and changes in the regulatory environment.

 

Ourfuture success will depend upon our ability to anticipate and adapt to changesin technology and industry standards, and to effectively develop, introduce,market and gain broad acceptance of new products and product enhancementsincorporating the latest technological advancements. In particular, our LDWsystem is incorporated into automobiles and trucks that face significanttechnological changes in each model year and among different vehicle models.Accordingly, we must adapt our technology from time to time to function withsuch changes.

 

**We May NotBe Able To Adequately Protect Or Enforce Our Intellectual Property Rights,Which Could Harm Our Competitive Position.**If we are not ableto adequately protect or enforce the proprietary aspects of our technology,competitors could be able to access our proprietary technology and ourbusiness, financial condition and results of operations will likely beseriously harmed. We currently attempt to protect our technology through acombination of patent, copyright, trademark and trade secret laws, employee andthird party nondisclosure agreements and similar means. Despite our efforts,other parties may attempt to disclose, obtain or use our technologies orsystems. Our competitors may also be able to independently develop products thatare substantially equivalent or superior to our products or design around ourpatents. 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.

 

Litigation may benecessary in the future to enforce our intellectual property rights or todetermine the validity and scope of the proprietary rights of others.Litigation may also be necessary to defend against claims of infringement orinvalidity by others. An adverse outcome in litigation or any similarproceedings could subject us to significant liabilities to third parties,require us to license disputed rights from others or require us to ceasemarketing or using certain products or 

 

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technologies. We may not be able to obtain anylicenses on terms acceptable to us, or at all. We also may have to indemnifycertain customers or strategic partners if it is determined that we haveinfringed upon or misappropriated another party’s intellectual property. Any ofthese results could adversely affect our business, financial condition andresults of operations. In addition, the cost of addressing any intellectualproperty litigation claim, including legal fees and expenses, and the diversionof management’s attention and resources, regardless of whether the claim isvalid, could be significant and could seriously harm our business, financialcondition and results of operations.

 

**TheTrading Price Of Our Common Stock Is Highly Volatile.**Thetrading price of our common stock has been subject to wide fluctuations in thepast. Since January 2000, our Class A common stock (now known as ourcommon stock) has traded at prices as low as $0.45 per share and as high as$29.44 per share. The market price of our common stock could continue tofluctuate in the future in response to various factors, including, but notlimited to:

 

·                                          quarterlyvariations in operating results;

 

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

 

·                                          ourability to raise additional capital;

 

·                                          shortagesannounced by suppliers;

 

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

 

·                                          transitionsto new products or product enhancements;

 

·                                          acquisitionsof businesses, products or technologies;

 

·                                          theimpact of any litigation;

 

·                                          changesin investor perceptions;

 

·                                          governmentfunding, political agendas and other budgetary issues;

 

·                                          changesin earnings estimates or investment recommendations by securities analysts; and

 

·                                          internationalconflicts, political unrest and acts of terrorism.

 

Thestock market in general has from time to time experienced volatility, which hasoften affected the market prices of equity securities of many technologycompanies. This volatility has often been unrelated to the operatingperformance of these companies. These broad market fluctuations may adverselyaffect the market price of our common stock. In the past, companies that haveexperienced volatility in the market price of their securities have been thesubject of securities class action litigation. If we were to become the subjectof a class action lawsuit, it could result in substantial losses and divertmanagement’s attention and resources from other matters.

 

**OurInternational Business Operations May Be Threatened By Many Factors ThatAre Outside Of Our Control.**We currently market our AutoVueand Vantage products internationally and we anticipate that our internationaloperations will expand in the near future. International business operationsare subject to various inherent risks including, among others:

 

·                                          currencyfluctuations and restrictions;

 

·                                          political,social and economic instability;

 

·                                          longeraccounts receivable payment cycles;

 

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

 

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

 

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

 

·                                          difficultiesin managing and staffing international operations;

 

·                                          potentiallyadverse tax consequences; and

 

·                                          reducedprotection for intellectual property rights in some countries.

 

All ofour international sales are denominated in U.S. dollars. As a result, anincrease in the relative value of the dollar could make our products moreexpensive and potentially less price competitive in international markets. Wedo not engage in any transactions as a hedge against risks of loss due to foreigncurrency fluctuations.

 

Any ofthe factors mentioned above may adversely affect our future international salesand, consequently, affect our business, financial condition and operatingresults. 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.

 

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

 

**Some OfOur Directors, Officers And Their Affiliates Can Control The Outcome Of MattersThat Require The Approval Of Our Stockholders, And Accordingly We Will Not BeAble To Engage In Certain Transactions Without Their Approval.**Asof March 31, 2008, our officers and directors beneficially ownedapproximately 11% of the outstanding shares of our common stock (andapproximately 15% of our common stock when including options, warrants andother convertible securities held by them which are currently exercisable orconvertible or will become exercisable or convertible within 60 days afterMarch 31, 2008). As a result of their stock ownership, our management willbe able to influence the election of our directors and the outcome of corporateactions requiring stockholder approval, such as mergers and acquisitions,regardless of how our other stockholders may vote. This concentration of votingcontrol may have a significant effect in delaying, deferring or preventing achange in our management or change in control and may adversely affect thevoting or other rights of other holders of common stock.

 

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

 

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

 

Not applicable.

 

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**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, for which wecurrently pay a monthly lease rate of $102,000, exclusive of certain utilitycosts. The Santa Ana facility lease expires in 2015 and contains an option toextend the lease for an additional 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 Note 6 of Notes to Consolidated Financial Statements, included in Part IV,Item 15 of this report, is incorporated herein by reference.

 

**ITEM 4.****                             SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

No matters were submittedto a vote of our security holders during the three months ended March 31,2008.

 

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**PART II**

** **
| **ITEM 5.** | ** ** | **MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES** |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------|

 

Our common stock istraded on the American Stock Exchange (“AMEX”) under the symbol “ITI”.  The following table sets forth, for theperiods indicated, the high and low sales prices for our common stock asreported by AMEX:

 
| ** **                            | ** ** | **Common Stock** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **High**              | ** ** | **Low** | ** ** |
| **Fiscal 2008**                       |       |                  |       |   |   |
| Quarter Ended June 30, 2007      |       | $                     | 2.66       |   | $ | 2.11 |   |
| Quarter Ended September 30, 2007 |       | 2.50                  |       | 2.00 |   |
| Quarter Ended December 31, 2007  |       | 4.20                  |       | 2.18 |   |
| Quarter Ended March 31, 2008     |       | 4.06                  |       | 1.94 |   |
|                                  |       |                  |       |   |   |
| **Fiscal 2007**                       | ** ** | ** **            | ** ** | ** ** | ** ** |
| Quarter Ended June 30, 2006      |       | $                     | 2.69       |   | $ | 2.10 |   |
| Quarter Ended September 30, 2006 |       | 2.69                  |       | 2.26 |   |
| Quarter Ended December 31, 2006  |       | 2.69                  |       | 1.38 |   |
| Quarter Ended March 31, 2007     |       | 2.76                  |       | 2.15 |   |

 

On June 10, 2008,the last reported sales price of our common stock on the AMEX was $2.72.   As of June 10, 2008, we had 456 holdersof record of our common stock according to information furnished by ourtransfer 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, futureearnings, the success of our business, our capital requirements, our generalfinancial condition and future prospects, general business conditions, theconsent of our lender and such other factors as the Board of Directors may deemrelevant.

 

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**Stock Performance Graph**

 

The graph belowshows the cumulative total return on investment assuming an investment of $100on March 31, 2003 in our common stock, the NASDAQ Stock Market Index andthe same peer group used by us last year, which is made up of the remainingmembers of the index used by us in prior years, the Media General IndustryGroup 836 for Diversified Electronics, which is no longer a publishedindex.  Our common stock is currentlylisted on the AMEX under the symbol “ITI” and began trading on such exchange onDecember 9, 2004.  Our common stockwas listed on the NASDAQ SmallCap Market (now called the NASDAQ Capital Market)from April 2002 to August 2003 and quoted on the OTC Bulletin Boardfrom August 2003 to December 2004. The total stockholder return assumes reinvestment of dividends on adaily basis, although cash dividends have not been declared on our commonstock.  The stockholder returns shown inthe following graph are not necessarily indicative of future performance.

 

**COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN***

Among Iteris, Inc., The NASDAQ Composite Index

And A Peer Group

 

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* $100 invested on 3/31/03 in stock orindex-including reinvestment of dividends. Fiscal year ending March 31.

 
| ** **                      | ** ** | **Measurement Period** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **2003**                    | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
| Iteris, Inc.  Common Stock |       | 100.00                      |       | 606.06 |   | 369.70 |   | 400.00 |   | 348.48 |   | 350.00 |   |
| NASDAQ Composite                |       | 100.00                      |       | 151.01 |   | 152.38 |   | 181.06 |   | 189.63 |   | 177.49 |   |
| Peer Group                      |       | 100.00                      |       | 181.83 |   | 138.87 |   | 182.74 |   | 186.37 |   | 163.80 |   |

 

Notwithstandinganything to the contrary set forth in any of our previous or future filingsunder the Securities Act of 1933, as amended, or the Securities Exchange Act of1934, as amended, that might incorporate this report or future filings made byus under those statutes, the stock performance graph is not deemed filed withthe Securities and Exchange Commission and shall not be deemed incorporated byreference into any prior filings or into any future filings made by us underthose statutes.

 

18

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

 

The following table setsforth selected consolidated financial data for each of the five fiscal yearsended March 31, 2008. The statement of operations and balance sheet datafor the years ended and as of March 31, 2008, 2007, 2006, 2005, and 2004are derived from our audited consolidated financial statements. Theaccompanying consolidated financial statements have been restated to reflectthe classification and presentation of our former subsidiaries, Broadcast, Inc.,Zyfer Inc., and MAXxess Systems, Inc., as discontinued operations for allperiods presented.  The followinginformation should be read in conjunction with “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and with ourconsolidated financial statements and the related notes thereto includedelsewhere in this report.

 
| ** **                                                                          | ** ** | **Fiscal Year Ended March 31,**                | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated Statement of Operations Data:**                                      | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales and contract revenues:                                                    |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net sales                                                                           |       | $                                                                  | 40,326     |   | $ | 36,248 |   | $ | 31,156 |   | $ | 29,062 |   | $ | 23,470 |   |
| Contract revenues                                                                   |       | 24,837                                                             |       | 22,049 |   | 19,330 |   | 17,335 |   | 21,813 |   |
| Total net sales and contract revenues                                               |       | 65,163                                                             |       | 58,297 |   | 50,486 |   | 46,397 |   | 45,283 |   |
|                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Costs of net sales and contract revenues:                                           |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cost of net sales (a)                                                               |       | 20,499                                                             |       | 19,829 |   | 16,493 |   | 15,925 |   | 12,758 |   |
| Cost of contract revenues (a)                                                       |       | 16,367                                                             |       | 14,460 |   | 12,600 |   | 13,789 |   | 14,712 |   |
| Gross profit                                                                        |       | 28,297                                                             |       | 24,008 |   | 21,393 |   | 16,683 |   | 17,813 |   |
| Operating expenses:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative (a)                                             |       | 17,289                                                             |       | 16,003 |   | 15,410 |   | 20,543 |   | 13,712 |   |
| Research and development (a)                                                        |       | 3,566                                                              |       | 4,030 |   | 5,217 |   | 6,236 |   | 3,923 |   |
| Amortization of intangible assets                                                   |       | 147                                                                |       | 147 |   | 147 |   | 114 |   | — |   |
| Disposal of fixed assets                                                            |       | —                                                             |       | — |   | — |   | 422 |   | — |   |
| Acquired in-process research and development                                        |       | —                                                             |       | — |   | — |   | 140 |   | — |   |
| Total operating expenses                                                            |       | 21,002                                                             |       | 20,180 |   | 20,774 |   | 27,455 |   | 17,635 |   |
| Operating income (loss)                                                             |       | 7,295                                                              |       | 3,828 |   | 619 |   | (10,772 | ) | 178 |   |
| Non-operating income (expense):                                                     |       |                                                               |       |   |   |   |   |   |   |   |   |
| Other income (expense), net                                                         |       | 252                                                                |       | (653 | ) | 35 |   | 1,054 |   | 1,003 |   |
| Interest expense, net                                                               |       | (1,284                                                             | )          | (1,600 | ) | (1,459 | ) | (1,178 | ) | (123 | ) |
| Income (loss) from continuing operations before income taxes and  minority interest |       | 6,263                                                              |       | 1,575 |   | (805 | ) | (10,896 | ) | 1,058 |   |
| Income tax benefit (provision)                                                      |       | 5,900                                                              |       | 1,343 |   | 885 |   | 94 |   | (100 | ) |
| Minority interest in earnings of subsidiary                                         |       | —                                                             |       | — |   | — |   | (526 | ) | (2,813 | ) |
| Income (loss) from continuing operations                                            |       | 12,163                                                             |       | 2,918 |   | 80 |   | (11,328 | ) | (1,855 | ) |
| Income from discontinued operations, net of taxes                                   |       | —                                                             |       | — |   | — |   | — |   | 1,215 |   |
| Net income (loss)                                                                   |       | $                                                                  | 12,163     |   | $ | 2,918 |   | $ | 80 |   | $ | (11,328 | ) | $ | (640 | ) |
|                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic earnings (loss) per share:                                                    |       |                                                               |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                               |       | $                                                                  | 0.37       |   | $ | 0.10 |   | $ | 0.00 |   | $ | (0.45 | ) | $ | (0.09 | ) |
| Discontinued operations                                                             |       | —                                                             |       | — |   | — |   | — |   | 0.06 |   |
| Basic earnings (loss) per share                                                     |       | $                                                                  | 0.37       |   | $ | 0.10 |   | $ | 0.00 |   | $ | (0.45 | ) | $ | (0.03 | ) |
|                                                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Diluted earnings (loss) per share:                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Continuing operations                                                               |       | $                                                                  | 0.35       |   | $ | 0.09 |   | $ | 0.00 |   | $ | (0.45 | ) | $ | (0.09 | ) |
| Discontinued operations                                                             |       | —                                                             |       | — |   | — |   | — |   | 0.06 |   |
| Diluted earnings (loss) per share                                                   |       | $                                                                  | 0.35       |   | $ | 0.09 |   | $ | 0.00 |   | $ | (0.45 | ) | $ | (0.03 | ) |
| Shares used in calculating basic earnings (loss) per share                          |       | 32,723                                                             |       | 29,698 |   | 28,182 |   | 25,284 |   | 19,454 |   |
| Shares used in calculating diluted earnings (loss) per share                        |       | 34,713                                                             |       | 33,348 |   | 32,737 |   | 25,284 |   | 19,454 |   |

 

----

(a) Includes stock-based compensationexpense as follows:
|  Cost of net sales                           |   | $   | 3      |   | $      | 13  |   | $     | 27     |   | $      | 280    |   | $ | — |   |
|---------------------------------------------------|--------|-----|--------|--------|--------|-----|--------|-------|--------|--------|--------|--------|--------|---|--------|--------|
|  Cost of contract revenues                   |   | 14  |   | 60     |   | 205 |   | 2,391 |   | — |   |
|  Selling, general and administrative expense |   | 266 |   | 195    |   | 364 |   | 7,063 |   | — |   |
|  Research and development expense            |   | 7   |   | 20     |   | 129 |   | 2,043 |   | — |   |
|  Total stock-based compensation expense      |   | $   | 290    |   | $      | 288 |   | $     | 725    |   | $      | 11,777 |   | $ | — |   |

 

19

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| ** **                                | ** ** | **At March 31,** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **2008**                   | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(in thousands)**    | ** ** |
| **Consolidated Balance Sheet Data:**      | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Working capital                           |       | $                          | 14,948     |   | $ | 6,979 |   | $ | 3,009 |   | $ | 2,197 |   | $ | 9,369 |   |
| Total assets                              |       | 65,645                     |       | 55,250 |   | 49,633 |   | 46,656 |   | 30,065 |   |
| Long-term debt (less current portion)     |       | 7,566                      |       | 9,760 |   | 11,374 |   | 10,315 |   | 891 |   |
| Accumulated deficit                       |       | (95,499                    | )          | (107,438 | ) | (110,356 | ) | (110,436 | ) | (99,108 | ) |
| Total stockholders’ equity (deficit) |       | 43,211                     |       | 25,687 |   | 18,635 |   | 17,462 |   | (1,076 | ) |
|                                           |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| **ITEM  7.** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|--------------|------------|-------------------------------------------------------------------------------------------------|

 

*Youshould read the following discussion and analysis in conjunction with ourConsolidated Financial Statements and related Notes thereto included in Part IV,Item 15 of this report and the “Risk Factors” section in Item 1A, as wellas other cautionary statements and risks described elsewhere in this report,before deciding to purchase, hold or sell our common stock.*

 

**Overview**

 

We are a leader in thetraffic management market that focuses on the development and application ofadvanced technologies that reduce traffic congestion, minimize the environmentalimpact of traffic congestion and improve the safety of surface transportationsystems. By combining outdoor image processing, traffic engineering andinformation technology, we offer a broad range of Intelligent TransportationSystems and driver safety solutions to customers worldwide.

 

We currently operate inthree reportable segments: Roadway Sensors, Vehicle Sensors and TransportationSystems. The Roadway Sensors segment includes our Vantage vehicle detectionsystems for traffic intersection control, incident detection and certainhighway traffic data collection applications. The Vehicle Sensors segment iscomprised of all activities related to our AutoVue Lane Departure Warningsystems for vehicle safety. The Transportation Systems segment includestransportation engineering and consulting services and the development oftransportation management and traveler information systems for the ITSindustry.

 

Our Vantage product is avideo vehicle detection system that detects the presence of vehicles onroadways. Vantage systems are used at signalized intersections to enable atraffic controller to more efficiently allocate green signal time and are alsoused for incident detection and highway traffic data collection applications.We sell and distribute our Vantage products primarily to commercial customersand municipal agencies.

 

Our AutoVue LDW systemsconsist of a small windshield mounted sensor that uses proprietary software todetect and warn drivers of unintended lane departures. In excess of 90,000production AutoVue units have been sold for car and truck platforms in theNorth American and European markets. Our AutoVue LDW systems are currentlyqualified as an option on certain heavy trucks, including Mercedes-Benz, MAN,Iveco, DAF, Scania, Freightliner and FUSO, as well as Neoplan and MAN luxurybus and coach lines. In North America, our LDW systems are sold primarily totruck fleets, and to date, 65 U.S. heavy truck fleets have selected our LDWsystems, representing an estimated 45,000 vehicles.

 

In September 2003,we entered into an agreement with Valeo Schalter and Sensuren GmbH (“Valeo”),pursuant to which we granted Valeo the exclusive right to sell and manufactureour AutoVue LDW systems to the worldwide passenger car market in exchange for royaltypayments for each AutoVue LDW unit sold. To date, royalty payments from Valeohave not been significant. Pursuant to this agreement, we also provide specificcontract engineering services, technical marketing and sales support to Valeoto enable the incorporation of our LDW technology on three Infiniti platforms,the FX, M and EX, where the device is offered as part of various optionpackages. Valeo is currently in discussions to provide our LDW system to otherpassenger car OEMs; however, we cannot assure you that such discussions will besuccessful. We plan to continue to provide technical marketing and salessupport to Valeo in our efforts to win new OEM customers for the passenger carmarket as well as contract engineering services related to the possible launchof new Infiniti platforms that include our LDW system. We believe that AutoVueis a broad sensor platform that, through additional software development, maybe expanded to incorporate additional safety and convenience features.

 

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

 

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traffic flow,assist 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 reducetraffic congestion. These services and systems are primarily sold to local,state and national transportation agencies in the United States. Ourtransportation management systems business is largely dependent upongovernmental funding and budgetary issues. The Federal Highway Bill that waspassed in August 2005 provided for a significant increase intransportation funding over the following six years. We believe the recentexpansion of our transportation management systems business was due in part tothe passage of the Federal Highway Bill, combined with increased transportationfunds available at state and local agencies throughout the country. The 2005Federal Highway Bill is set to expire in 2009. It is too early to determine anyimpact on future contract revenues as a result of potential delays in thepassage of future bills.

 

Prior to our fiscal yearended March 31, 2004 (“Fiscal 2004”), we operated in three segmentsconsisting of ITS, video products and telecom products. The ITS segmentconsisted of our current operations, which was previously conducted by theIteris Subsidiary. The video products segment included our former wholly-ownedsubsidiary, MAXxess Systems, Inc. (“MAXxess”), which designed andmanufactured security management systems. Our telecom products segment included our wholly-owned subsidiary, Zyfer, Inc.(“Zyfer”), which developed and manufactured timing and synchronizationproducts.  During Fiscal 2004, wecompleted the divestiture of MAXxess and Zyfer and restructured our operationsto focus on the operations of our Iteris Subsidiary.  Our financial statements for all periodspresented in this report have been restated to reflect the discontinuation ofthe operations of MAXxess and Zyfer.

 

**CriticalAccounting Policies and Estimates**

 

Management’s Discussion and Analysis of FinancialCondition and Results of Operations is based on our consolidated financialstatements included herein, which have been prepared in accordance withgenerally accepted accounting principles in the United States (“GAAP”). Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andrelated disclosures of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. On an ongoing basis, we evaluate these estimates andassumptions, including those related to the collectibility of accountsreceivable, the valuation of inventories, the recoverability of long-livedassets and goodwill, the realizability of deferred tax assets, accounting forstock-based compensation, the valuation of equity instruments, warrantyreserves and other contingencies. We base these estimates on historicalexperience and on various other factors that we believe to be reasonable underthe circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. These estimates and assumptions by their natureinvolve risks and uncertainties, and may prove to be inaccurate. In the eventthat any of our estimates or assumptions are inaccurate in any materialrespect, it could have a material adverse effect on our reported amounts ofassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.

 

The following critical accounting policies affect ourmore significant judgments and estimates used in the preparation of ourconsolidated financial statements.

 

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

 

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

 

In addition toproduct and contract revenues, we derive revenue from technology access fees,the provision of specific non-recurring contract engineering services to ourstrategic partner, Valeo, related to our AutoVue LDW systems, and royaltiesearned on unit sales of our AutoVue LDW systems by Valeo to the passenger carmarket. Technology access fee revenues are recognized evenly over the period inwhich they are earned. Non-recurring contract engineering revenues are 

 

21

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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.Technology access fee revenues, non-recurring contract engineering revenues androyalty revenues are included in net sales.

 

Revenues from follow-on service and support, for whichwe generally charge separately, are recorded in the period in which theservices are performed.

 

*Accounts Receivable.* We estimatethe collectibility of customer receivables on an ongoing basis by periodicallyreviewing invoices outstanding greater than a certain period of time. We recordreserves for receivables deemed to be at risk for collection as well as ageneral reserve based on our historical collections experience. A considerableamount of judgment is required in assessing 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.

 

*Inventory.* Inventories consist offinished goods, work-in-process and raw materials and are stated at the lowerof cost or market. We provide reserves for potentially excess and obsoleteinventory. In assessing the ultimate realization of inventories, we makejudgments as to future demand requirements and compare that with the current orcommitted inventory levels. Reserves are established for inventory levels thatexceed anticipated future demand. It is possible that reserves over and abovethose already established may be required in the future if market conditionsfor our products deteriorate.

 

*Goodwill.* Goodwill is tested forimpairment annually in our fourth fiscal quarter at the reporting unit levelunless a change in circumstances indicates that more frequent impairmentanalysis is required. Impairment, if any, is measured based on the estimatedfair value of the reporting units with the recorded goodwill. Fair value isdetermined by using the income approach methodology of valuation which utilizesdiscounted cash flows. Significant management judgment is required in theforecasts of future operating results that are used in the discounted cash flowmethod of valuation. In estimating future cash flows, we generally use thefinancial assumptions in our current budget and our current strategic plan,subject to modification as considered necessary, including sales and expensegrowth rates and the discount rates we estimate to represent our cost of funds.It is possible, however, that the plans and estimates used may be incorrect. Ifour actual results, or the plans and estimates used in future impairmentanalyses, are lower than the original estimates used to assess therecoverability of goodwill, we could incur impairment charges.

 

*Warranty.* We generally provide aone to three year warranty from the original invoice date on all products, materialsand workmanship. Defective products are either repaired or replaced, at ouroption, upon meeting certain criteria. We accrue a provision for the estimatedcosts that may be incurred for product warranties relating to a product as acomponent of cost of sales at the time revenue for that product is recognized.The accrued warranty provision is included within accrued expenses on theaccompanying consolidated balance sheets. Should our actual experience ofwarranty returns be higher than anticipated, additional warranty reserves maybe required, which may adversely affect our operating results.

 

*Income Taxes.* We recorded avaluation allowance to reduce our deferred tax assets to amounts that webelieve are more likely than not to be realized. Realization of deferred taxassets (such as net operating loss carryforwards) is dependent on futuretaxable earnings and is therefore uncertain. On a quarterly basis, we assessthe likelihood that our deferred tax asset balance will be recovered fromfuture taxable income. To the extent we believe that recovery is not likely, weestablish a valuation allowance against our deferred tax asset, increasing ourincome tax expense in the period such determination is made.

 

On an interim basis, we estimate what our anticipatedannual effective tax rate will be and record a quarterly income tax provisionin accordance with this anticipated rate. As the fiscal year progresses, werefine our estimates based upon actual events and earnings during the year.This estimation process can result in significant changes to our expectedeffective tax rate. When this occurs, we adjust the income tax provision duringthe quarter in which the change in estimate occurs so that the year-to-dateprovision reflects the expected annual rate. The changes described in thepreceding sentence and adjustments to our valuation allowance may createfluctuations in our overall effective tax rate from quarter to quarter.

 

Effective April 1, 2007, we adopted theprovisions of Financial Accounting Standards Board Interpretation No. 48, *Accounting for Uncertainty in Income Taxes – an Interpretation of FASBStatement No. 109* (“FIN 48”), which applies to all taxpositions accounted for under Statement of Financial Accounting Standards (“SFAS”)No. 109, *Accounting for Income Taxes*(“SFAS109”).  FIN 48 clarifies the accountingfor uncertainty in income taxes by establishing minimum standards for therecognition and measurement of tax positions taken or expected to be taken in atax return. Under the requirements of  

 

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FIN 48, we must review all of our tax positions andmake a determination as to whether our 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 ismore-likely-than-not to be realized upon ultimate settlement or disposition ofthe underlying issue.

 

*Stock-Based Compensation*.  We adopted SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), effective April 1,2006.  Prior to April 1, 2006, wefollowed the disclosure-only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation*(“SFAS 123”), asamended by SFAS No. 148, *Accounting for Stock-BasedCompensation — Transition and Disclosure*, and, accordingly,accounted for our stock-based compensation plans using the intrinsic valuemethod under Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB 25”), andrelated interpretations.

 

SFAS 123R requires allstock-based payments, including grants of employee stock options, to berecognized in the statement of operations as an expense, based on their grantdate fair values with such fair values amortized over the requisite serviceperiod.  We elected to utilize themodified prospective method for the transition to SFAS 123R. Under the modifiedprospective method, SFAS 123R applies to all awards granted or modified afterthe date of adoption. In addition, under the modified prospective method,compensation expense will be recognized for all stock-based compensation awardsgranted prior to but not yet vested as of April 1, 2006, based ongrant-date fair values estimated in accordance with the original provisions ofSFAS 123.

 

In implementing SFAS123R, we have used the Black-Scholes-Merton (“BSM”) option-pricing formula toestimate the fair value of stock-based awards granted subsequent to April 1,2006.  Our assumptions under the BSMformula include the following:  expectedvolatilities are based on the historical volatility of our stock price, theexpected life of options is derived based on the historical life of ouroptions, and the risk-free rate for periods within the expected life of theoption is based on the U.S. Treasury interest rates in effect at the time ofgrant.  Additionally, SFAS 123 did notrequire the estimation of forfeitures in the calculation of stock compensationexpense; however, SFAS 123R does require such estimation and upon adoption ofSFAS 123R, we changed our methodology to include an estimate offorfeitures.  Future stock-basedcompensation expense in any particular quarter or year could be affected bychanges in our assumptions or changes in market conditions.

 

23

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**Resultsof Operations**

 

The following table setsforth certain statement of operations data as a percentage of total net salesand contract revenues for the periods indicated. The following table should beread in conjunction with Management’s Discussion and Analysis of FinancialCondition and Results of Operations.

 
| ** **                                 | ** ** | **Fiscal Year Ended March 31,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                 | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales and  contract revenues:          |       |                                                |       |   |   |   |   |
| Net sales                                  |       | 61.9                                                | %          | 62.2 | % | 61.7 | % |
| Contract revenues                          |       | 38.1                                                |       | 37.8 |   | 38.3 |   |
| Total net sales and contract revenues      |       | 100.0                                               | %          | 100.0 | % | 100.0 | % |
|                                       |       |                                                |       |   |   |   |   |
| Costs of net  sales and contract revenues: |       |                                                |       |   |   |   |   |
| Cost of net sales (a)                      |       | 31.5                                                |       | 34.0 |   | 32.7 |   |
| Cost of contract revenues (a)              |       | 25.1                                                |       | 24.8 |   | 24.9 |   |
| Gross profit                               |       | 43.4                                                |       | 41.2 |   | 42.4 |   |
| Operating expenses:                        |       |                                                |       |   |   |   |   |
| Selling, general and administrative (a)    |       | 26.5                                                |       | 27.4 |   | 30.5 |   |
| Research and development (a)               |       | 5.5                                                 |       | 6.9 |   | 10.3 |   |
| Amortization of intangible assets          |       | 0.2                                                 |       | 0.3 |   | 0.3 |   |
| Total operating expenses                   |       | 32.2                                                |       | 34.6 |   | 41.1 |   |
| Operating income                           |       | 11.2                                                |       | 6.6 |   | 1.2 |   |
| Non-operating income (expense):            |       |                                                |       |   |   |   |   |
| Other income (expense), net                |       | 0.4                                                 |       | (1.1 | ) | 0.1 |   |
| Interest expense, net                      |       | (2.0                                                | )          | (2.7 | ) | (2.9 | ) |
| Income (loss) before income taxes          |       | 9.6                                                 |       | 2.7 |   | (1.6 | ) |
| Income tax benefit                         |       | 9.1                                                 |       | 2.3 |   | 1.8 |   |
| Net income                                 |       | 18.7                                                | %          | 5.0 | % | 0.2 | % |

 

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| (a) Includes  stock-based compensation expense as a percent of total net sales and contract  revenues as follows: |   |   |   |   |   |   |   |
|------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Cost of net sales                                                                                                      |   | 0.0    | %      | 0.0    | %      | 0.1    | %      |
| Cost of contract revenues                                                                                              |   | 0.0    |   | 0.1    |   | 0.4    |   |
| Selling, general and administrative expense                                                                            |   | 0.4    |   | 0.3    |   | 0.7    |   |
| Research and development expense                                                                                       |   | 0.0    |   | 0.0    |   | 0.3    |   |
| Total stock-based compensation expense                                                                                 |   | 0.4    | %      | 0.5    | %      | 1.4    | %      |

 

**Analysisof Fiscal 2008, Fiscal 2007 and Fiscal 2006 Results of Operations**

 

*NetSales and Contract Revenues*. Net sales are comprised ofRoadway Sensors sales, which are derived from sales of our Vantage videodetection systems, and Vehicle Sensors sales, which are derived from sales ofAutoVue LDW systems, technology access fees, contract engineering revenue androyalty revenue generated from AutoVue related activities.  Contractrevenues consist entirely of Transportation Systems contract revenues, whichare generated from systems integration and ITS consulting services primarilywith federal, state, county and municipal agencies. We currently have a diversecustomer base with our largest customer constituting 7.3% of total net salesand contract revenues in Fiscal 2008. Total net sales and contract revenuesincreased 11.8% to $65.2 million in Fiscal 2008 compared to $58.3 million inFiscal 2007, and increased 15.5% in Fiscal 2007 from $50.5 million in Fiscal2006.

 

Net sales increased 11.3%to $40.3 million in Fiscal 2008 compared to $36.2 million in Fiscal 2007, andincreased 16.3% in Fiscal 2007 compared to $31.2 million in Fiscal 2006. Theincrease in net sales in each of the periods reflected increased unit sales inboth Roadway Sensors and Vehicle Sensors.

 

Roadway Sensorsnet sales comprised 70.6%, 75.2% and 72.0% of net sales in Fiscal 2008, Fiscal2007 and Fiscal 2006, respectively, and increased 4.4% to $28.5 million inFiscal 2008 compared to $27.3 million in Fiscal 2007 and increased 21.5% inFiscal 2007 compared to $22.4 million in Fiscal 2006.  The majority of Roadway 

 

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Sensors net sales werederived from sales within North America. The Fiscal 2008 and Fiscal 2007 increases primarily reflect thecontinued adoption of video vehicle detection technology, such as thetechnology offered by our Vantage line of products, both domestically andinternationally.  Fiscal 2008 salesgrowth was not as strong as sales growth in Fiscal 2007 due primarily to lowersales volumes in Texas as a result of local budgetary issues, a trend that weexpect to continue for at least the next few fiscal quarters.  We continue to believe that the currentincreased rate of adoption has to some extent been due to increased governmentspending on traffic initiatives, which we believe has been at least partiallymade possible by the passage of the Federal Highway Bill in August 2005,as well as expanded sales and marketing efforts, particularly in North America.The 2005 Federal Highway Bill is set to expire in 2009.  Although we are not aware of any imminentchanges in government spending patterns, it is possible that, as a result ofsoftening macroeconomic conditions in the U.S. and the decline in the newhousing market, government funding for certain traffic initiatives and roadwayimprovement projects could be delayed or diverted to focus on other budgetaryneeds.  Should this occur, futuredomestic Roadway Sensors net sales may be adversely affected.

 

Net sales fromVehicle Sensors products and services increased 32.1% in Fiscal 2008 to $11.9million compared to $9.0 million in Fiscal 2007 and increased 3.2% in Fiscal2007 compared to $8.7 million in Fiscal 2006. The largest element of Vehicle Sensors net sales was sales of our LDWsystems to the heavy truck market, which aggregated $10.0 million in Fiscal2008, $6.4 million in Fiscal 2007 and $5.9 million in Fiscal 2006.  The increase in Fiscal 2008 net sales ofVehicle Sensors products was primarily a result of increased unit sales of ourLDW systems to European and Asian OEMs. The increase in Fiscal 2007 netsales of Vehicle Sensors products was primarily related to increased unit salesof LDW systems in the North American commercial heavy truck market, partiallyoffset by OEM volume discounts provided to our largest customer and the impactof the transition to our next generation AutoVue LDW systems for the heavytruck market in the latter part of Fiscal 2006.

 

Although we haveexperienced an overall increase in unit sales of our AutoVue LDW systems inrecent fiscal years, in Fiscal 2008, we began to experience softness in LDWunit sales to the North American truck market as a result of an overall declinein new truck sales in the U.S. driven largely by the general slowdown in theU.S. housing market and overall economy. We expect flat or declining LDW unit sales in the North American marketover at least the next several fiscal quarters due to these macroeconomicconditions.  We have not experienced thesame decline in net sales to our European and Asian OEM customers; however, aslowdown in international truck sales could lead to similar sluggishness in LDWunit sales internationally.  VehicleSensors unit sales in Fiscal 2009 and beyond could also be adversely impactedby slower than expected adoption rates of our LDW system by European and AsianOEMs and North American heavy truck fleets, as well as potential additional OEMvolume discounts resulting from increased price competition as new competitorshave entered this market.  Additionally,recent environmental regulations in Europe and North America have substantiallyincreased the cost of new commercial trucks, which could impact future trucksales volumes and, ultimately, unit sales of our LDW systems.

 

Also included inVehicle Sensors net sales are revenues from contract engineering services,technology access fees and royalty revenues in the passenger car market thatare derived from our strategic relationship with Valeo, which aggregated $1.9million, $2.6 million and $2.8 million in Fiscal 2008, Fiscal 2007 and Fiscal2006, respectively.  Such revenues werelower in Fiscal 2008 as compared to Fiscal 2007 and Fiscal 2006 as a result oftechnology access fee revenue of $500,000 that was recognized in Fiscal 2007and Fiscal 2006.  Royalty revenues fromValeo for sales of our LDW systems for the passenger car market were relativelyinsignificant in Fiscal 2008, Fiscal 2007 and Fiscal 2006.  Our LDW systems are now offered as an optionon three Infiniti models.  While Valeo iscurrently in discussions to offer our LDW systems on other passenger carplatforms, we cannot assure you that Valeo will be successful in these efforts.

 

Contract revenuesincreased 12.6% to $24.8 million in Fiscal 2008 compared to $22.0 million inFiscal 2007 and increased 14.1% in Fiscal 2007 compared to $19.3 million inFiscal 2006.  Contract revenues aredependent upon the continued availability of funding at both the state andfederal levels from the various departments of transportation.  The Fiscal 2008 and Fiscal 2007 increases incontract revenues were largely due to increased funding at the federal, stateand local levels throughout the country, as well as new contract awards.  In response to the growth in our TransportationSystems segment, we increased our Transportation Systems staff by 21% in Fiscal2008 and 16% in Fiscal 2007.  We expectto continue to increase our Transportation Systems staff in Fiscal 2009.  We believe the ability of our TransportationSystems business to grow and successfully win and service new contracts will behighly dependent upon our continued success in recruiting and retainingqualified personnel.  All of our contractrevenues are derived from work performed in North America under a broad rangeof fixed price and cost plus fixed fee contracts.

 

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*GrossProfit*. Total gross profit increased 17.9% to $28.3 millionin Fiscal 2008 compared to $24.0 million in Fiscal 2007, and increased 12.2% inFiscal 2007 compared to $21.4 million in Fiscal 2006.  Total gross profit as a percent of net salesand contract revenues increased to 43.4% in Fiscal 2008 compared to 41.2% inFiscal 2007 and decreased in Fiscal 2007 from 42.4% in Fiscal 2006.

 

Gross profit as apercentage of net sales was 49.2% in Fiscal 2008 compared to 45.3% in Fiscal2007 and 47.1% in Fiscal 2006.  Theincrease in gross profit as a percentage of net sales in Fiscal 2008 was aresult of a favorable sales mix in terms of both geography and product mix, aswell as improved production efficiencies. Gross profit as a percentage of net sales also improved in Fiscal 2008through the expansion of our Vehicle Sensors customer base, which helpedmitigate the impact of lower contractual pricing to our largest Europeancustomer.  The decrease in gross profitas a percentage of net sales in Fiscal 2007 compared to Fiscal 2006 wasprimarily due to volume discounts given to our largest Vehicle Sensors productcustomer, as well as an overall decline in unit volumes to this customer.  Fiscal 2007 gross profit as a percentage ofnet sales in our Roadway Sensors division was relatively consistent with Fiscal2006 gross profit as a percentage of net sales. Gross profit as a percentage of net sales can fluctuate in any specificquarter or year based on customer and product mix, as well as possible shiftsof engineering resources from development activities to sustaining activities,which we record as cost of goods sold. Gross profit as a percent of net sales has fluctuated over the last fiveyears from a low of 45.2% in Fiscal 2005 to a high of 49.2% in Fiscal 2008.

 

Gross profit as apercentage of contract revenues decreased to 34.1% in Fiscal 2008 compared to34.4% in Fiscal 2007 and decreased from 34.8% in Fiscal 2006. We recognizecontract revenues and related gross profit using percentage of completioncontract accounting and the underlying mix of contract activity affects therelated gross profit recognized in any given period.  The decreases in gross profit as a percent ofcontract revenues in Fiscal 2008 compared to Fiscal 2007, and in Fiscal 2007compared to Fiscal 2006 reflect a contract mix weighted more toward lowermargin contracts in those periods.  Lowermargin contracts generally have a higher proportion of sub-consulting revenuesassociated with them.

 

*Selling,General and Administrative Expense*. Selling, general andadministrative expense increased 8.0% to $17.3 million (or 26.5% of total netsales and contract revenues) in Fiscal 2008 compared to $16.0 million (or 27.4%of total net sales and contract revenues) in Fiscal 2007, and increased 3.8% inFiscal 2007 compared to $15.4 million (or 30.5% of total net sales and contractrevenues) in Fiscal 2006.  The increasein selling, general and administrative expense in Fiscal 2008 compared toFiscal 2007 was largely attributable to higher commissions and selling expensesdriven by sales growth in our Roadway Sensors segment, as well as general andadministrative expenses incurred related to our efforts to comply with theinternal control attestation requirements of the Sarbanes-Oxley Act.  In Fiscal 2009, we expect to continue toexperience increased selling, general and administrative expenses as we pursuefurther sales growth.  Furthermore, weexpect to experience further increases in general and administrative expensesas we continue our efforts to comply with the internal control attestationrequirements of the Sarbanes-Oxley Act.

 

The increase in selling,general and administrative expense in Fiscal 2007 compared to Fiscal 2006 wasmainly a result of higher commissions associated with increased Roadway Sensorsnet sales and increased sales and marketing activities in our TransportationSystems segment.  Additionally, selling,general and administrative expense included legal expenses associated with thesettlement of litigation described in Note 6 of Notes to Consolidated FinancialStatements, a severance accrual of approximately $300,000 associated with thedeparture of our former Chief Executive Officer in March 2007 and $180,000related to the write-off of past-due accounts receivable related to rent andother services provided to our former subsidiary, MAXxess (Note 6 of Notes toConsolidated Financial Statements).  Nofurther expense is expected to be incurred in connection with the aforementionedlawsuit or the severance arrangement with our former Chief ExecutiveOfficer.  We have written off allbalances receivable from MAXxess based on our accounts receivable accountingpolicy, but will continue to work with MAXxess to attempt to collect amountsdue to us.  Certain members of our Boardof Directors are part of MAXxess management and ownership.

 

*Researchand Development Expense*. Research and development expensedecreased 11.5% to $3.6 million (or 5.5% of total net sales and contractrevenues) in Fiscal 2008 compared to $4.0 million (or 6.9% of total net salesand contract revenues) in Fiscal 2007, and decreased 22.8% in Fiscal 2007compared to $5.2 million (or 10.3% of total net sales and contract revenues) inFiscal 2006.  The decrease in researchand development expense in Fiscal 2008 compared to Fiscal 2007 was primarilydue to reduced research and development activities in Vehicle Sensors as manyof our significant truck OEM customers now have production LDW units that onlyrequire minimal further development and the majority of our passenger carresearch and development efforts are funded by our strategic partner,Valeo.  This decreased spending waspartially offset by increased research and development spending in RoadwaySensors.  We believe research anddevelopment activities are crucial to our ability to continue to be a leader inour markets, and we expect our Fiscal 2009 research and developmentexpenditures to increase from Fiscal 2008 levels.

 

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The decrease in researchand development expense in Fiscal 2007 compared to Fiscal 2006 was largely aresult of higher than anticipated costs in Fiscal 2006 in Vehicle Sensors as weexpended significant development resources in qualifying the next generationLDW system with our largest customer, as well as several other heavy truck OEMs. Additionally, in Fiscal 2007, there was a shift in engineering resources fromresearch and development activities to product support activities as a resultof new product introductions and improvements in Roadway Sensors.  Costs associated with product supportactivities are included in cost of net sales rather than research anddevelopment expense.

 

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

 

*OtherIncome (Expense), Net*. Other income (expense), net reflectsthe following:

 
| ** **                            | ** ** | **Year Ended March 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(In thousands)**                 | ** ** |
| Gain on early  extinguishment of debt |       | $                                       | 224        |   | $ | — |   | $ | — |   |
| Settlement of  lawsuits               |       | —                                  |       | (635 | ) | — |   |
| Other                                 |       | 28                                      |       | (18 | ) | 35 |   |
| Other income  (expense), net          |       | $                                       | 252        |   | $ | (653 | ) | $ | 35 |   |

** **

**Otherincome (expense), net in Fiscal 2008 primarily reflects the gain of $224,000 werecognized in connection with the early retirement of $2.1 million ofconvertible debentures, which is discussed in Note 4 of Notes to ConsolidatedFinancial Statements.  Other income(expense), net in Fiscal 2007 primarily reflects $635,000 of expense recordedin connection with the settlement of litigation in July 2006, which isdiscussed in Note 6 of Notes to Consolidated Financial Statements.**

** **

*InterestExpense, Net*. Interest expense, net reflects the net ofinterest expense and interest income as follows:

 
| ** **             | ** ** | **Year Ended March 31,** | ** ** |
|------------------------|------------|-----------------------------------------|------------|
| ** **             | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **             | ** ** | **(In thousands)**                 | ** ** |
| Interest expense       |       | $                                       | (1,285     | ) | $ | (1,601 | ) | $ | (1,461 | ) |
| Interest income        |       | 1                                       |       | 1 |   | 2 |   |
| Interest  expense, net |       | $                                       | (1,284     | ) | $ | (1,600 | ) | $ | (1,459 | ) |

 

**Interestexpense, net decreased 19.8% in Fiscal 2008 compared to Fiscal 2007 andincreased 9.7% in Fiscal 2007 compared to Fiscal 2006.  The decrease in interest expense in Fiscal2008 compared to Fiscal 2007 was primarily due to a lower level of borrowingsas well as a lower interest rate on our line of credit, which bears interest ata rate indexed to the prime rate.  Theincrease in interest expense in Fiscal 2007 compared to Fiscal 2006 was mainlyrelated to the October 2006 refinancing of our bank term note and line ofcredit with a new bank, which resulted in a slightly higher interest rate onour bank borrowings.**

** **

*IncomeTaxes*. During Fiscal 2008, we recognized an income taxbenefit of $5.9 million and at March 31, 2008 our consolidated balancesheet included net deferred tax assets of $10.3 million.  The ability to record the deferred tax assetwas based on the more likely than not criteria of SFAS No. 109, *Accounting for Income Taxes*. During Fiscal 2007, we recognized an income tax benefit of $1.3 millionand at March 31, 2007, our consolidated balance sheet included netdeferred tax assets of $3.0 million.  Theincome tax benefits recorded in Fiscal 2008, Fiscal 2007 and Fiscal 2006 wereprimarily the result of a decrease in the valuation allowance recorded againstour deferred tax assets as a result of changes in estimates of the futurerealizability of these assets.  In thefuture, we may continue to record similar adjustments to our deferred tax assetvaluation allowance as our estimates are updated.  We anticipate this will cause our futureoverall effective tax rate in any given period to fluctuate from prioreffective tax rates and statutory tax rates.

 

At March 31, 2008,we had $44.7 million of federal net operating loss carryforwards and$16.6 million of state net operating loss carryforwards that begin toexpire in 2019 and 2013, respectively. Due to changes in stock ownership, ourfederal net operating loss carryforwards are subject to a Section 382limitation estimated at approximately $7.8 million annually which can beutilized to offset federal consolidated taxable income.  Although the impact cannot be preciselydetermined, we believe that our net operating loss carryforwards and thevaluation allowance we have recorded against our net deferred tax assets in ourconsolidated balance sheets will cause us to have future income tax payments andincome tax expense that are substantially lower than the income tax liabilityand income tax expense calculated using statutory tax rates.

 

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In Fiscal 2008, weadopted FIN 48.  See Notes 1 and 5 ofNotes to Consolidated Financial Statements for further discussion regarding ourimplementation of FIN 48.

 

*Stock-BasedCompensation Expense*. In Fiscal 2007, we adopted SFAS 123R using the modified prospectiveapproach.  Stock-based compensationexpense remained relatively consistent in Fiscal 2008 and Fiscal 2007 at$290,000 and $288,000, respectively.  SeeNotes 1 and 9 of Notes to Consolidated Financial Statements for additionaldiscussion regarding our implementation of SFAS 123R.

 

**Liquidityand Capital Resources**

 

*Cash Flows*

 

We have historically financed our operations with acombination of cash flows from operations, borrowings under credit facilitiesand the sale of equity securities. We currently rely on cash flows fromoperations and borrowings on a line of credit facility to fund our operations,which we believe to be sufficient to fund our operations for at least the nexttwelve months.  At March 31, 2008,we had $14.9 million in working capital, which included no borrowings on our$10.0 million line of credit and $421,000 in cash and cash equivalents, ascompared to working capital of $7.0 million at March 31, 2007, whichincluded borrowings of $4.0 million on our line of credit and $35,000 in cashand cash equivalents.  Our operationsprovided $7.6 million of cash during Fiscal 2008, primarily as a result of netincome adjusted for non-cash items within the statement of operations.  During Fiscal 2007, our operations used $2.0million of cash, primarily as a result of investments in inventory due to salesgrowth and longer lead times in procuring certain components, and an increasedlevel of net costs and estimated earnings in excess of billings due to salesgrowth and the timing of invoicing on contracts in our Transportation Systemssegment.  These were partially offset bynet income of $2.9 million.  DuringFiscal 2006, our operations provided $218,000 of cash, primarily as a result ofplanned decreases in inventory and the timing of payments on accrued expenses andpayables, which were partially offset by increases in accounts receivable andnet costs and estimated earnings in excess of billings on uncompletedcontracts, both as a result of sales growth.

 

Investing activities for Fiscal 2008, Fiscal 2007 andFiscal 2006 consisted primarily of purchases of property and equipment, whichaggregated $739,000, $488,000 and $1.3 million, respectively.  In Fiscal 2006, capital expenditures werehigher primarily due to hardware, software and related labor costs to implementa new enterprise resource management system, which was placed in service at thebeginning of Fiscal 2007.

 

Cash used in financing activities was $6.5 million inFiscal 2008, which was the net result of net payments on borrowings of $8.0million offset by cash inflows of $1.5 million from the exercise of outstandingstock options and warrants to purchase our common stock.  During Fiscal 2007, financing activitiesprovided $2.4 million of cash, which was the net result of net payments onborrowings of $1.2 million, offset by cash inflows of $3.6 million from theexercise of outstanding stock options and warrants to purchase our commonstock.  As discussed in Note 8 of Notesto Consolidated Financial Statements, approximately $2.0 million of the $3.6million in proceeds from the exercise of stock options and warrants was raisedthrough the exercise of outstanding warrants to purchase an aggregate of1,250,000 shares of our common stock. During Fiscal 2006, financing activities provided $1.1 million of cashas a result of net borrowings of $792,000 and cash inflows of $333,000 from theexercise of outstanding stock options and warrants to purchase our commonstock.

 

*Borrowings*

 

The following tablesummarizes our borrowings and long-term debt:

 
| ** **                   | ** ** | **At March 31, 2008** | ** ** |
|------------------------------|------------|--------------------------------------|------------|
| ** **                   | ** ** | **(In thousands)**              | ** ** |
| Convertible debentures,  net |       | $                                    | 7,566      |   |
| Bank term note               |       | 210                                  |       |
| Other                        |       | 34                                   |       |
|                         |       | $                                    | 7,810      |   |

 

In October 2006,we entered into a two-year credit facility with a bank which includes our lineof credit and bank term note. The credit facility provides for line of creditborrowings of up to $10.0 million against our eligible accounts 

 

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receivable and inventory, as defined in the credit agreement. The termnote provided for monthly principal payments of approximately $104,000 andmatured in May 2008. The interest rate on the line of credit is thecurrent stated prime rate plus 1.00%, and the interest rate on the bank termnote was fixed at an annual rate of 8.75%. We are obligated to pay an unusedline fee of 0.25% per annum applied to the amount by which the maximum creditamount exceeds the average daily principal balance during the preceding month.The credit facility also requires $2,000 in monthly collateral management feesand includes an early termination fee equal to 1% of the total facility. Thecredit facility is secured by substantially all of our assets. At March 31,2008, we had $8.6 million available under our credit facility, all of which wasunused.

 

**Contractual Obligations**

 

Our contractualobligations were as follows at March 31, 2008:

 
| ** **              | ** ** | **Payments Due by Period** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
| ** **              | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **(In thousands)**                   | ** ** |
| Notes payable           |       | $                                         | 244        |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 244 |   |
| Convertible  debentures |       | —                                    |       | 7,750 |   | — |   | — |   | — |   | — |   | 7,750 |   |
| Operating leases        |       | 1,594                                     |       | 1,431 |   | 1,366 |   | 1,332 |   | 1,363 |   | 2,460 |   | 9,546 |   |
| Total                   |       | $                                         | 1,838      |   | $ | 9,181 |   | $ | 1,366 |   | $ | 1,332 |   | $ | 1,363 |   | $ | 2,460 |   | $ | 17,540 |   |

 

At March 31, 2008,we had firm commitments to purchase inventory in the amount of $2.3 millionduring the first and second quarters of Fiscal 2009.

 

**OffBalance Sheet Arrangements**

 

In May 2004, we issuedsubordinated convertible debentures in an aggregate original principal amountof $10.1 million. These debentures are due in full on May 19, 2009and are convertible into shares of our common stock at a conversion price of$3.61 per share. At March 31, 2008, convertible debentures in an aggregateprincipal amount of $7.8 million remained outstanding. Because these debenturesare conventionally convertible, we have not separately accounted for theconversion feature and, accordingly, no separate amounts are presented in ourconsolidated financial statements in connection with this conversion feature.

 

At March 31, 2008,outstanding warrants to purchase an aggregate of 246,250 shares of ourcommon stock at an exercise price of $3.25 per share are callable by us if themarket price of our common stock trades for 20 consecutive days at a priceequal to or greater than two times the exercise price of the warrants. Outstandingwarrants to purchase an aggregate of 75,000 shares of our commonstock at an exercise price of $5.00 per share are callable by us if the marketprice of 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.

 

In connection with theissuance of warrants to purchase 246,250 shares of our common stock at $3.25per share, we are a party to a registration rights agreement that containsprovisions under which we could be subjected to liquidated damages should wefail to maintain effective registration statements for the shares of commonstock issuable upon exercise of certain underlying warrants. These warrantshave been accounted for within equity in our consolidated balance sheets inaccordance with EITF Issue No. 00-19, *Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*, and, accordingly, no liabilities have been recorded inconnection therewith. As of the date of this filing, no liquidated damages arepayable under the provisions of the registration rights agreement associatedwith these warrants.

 

**RecentAccounting Pronouncements**

** **

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”), which defines fair value, establishes a framework for measuringfair value, and expands disclosure about fair value measurements. SFAS 157 doesnot require any new fair value measurements; rather it specifies valuationmethods to be applied when fair value measurements are required under existingor future accounting pronouncements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. In February 2008 the FASB issued FSP 157-2, *EffectiveDate of FASB Statement No. 157*,**which delaysthe effective date of SFAS 157 for non-financial assets and liabilities tofiscal years beginning after November 15, 2008. Generally, this statement willbe applied prospectively. We are currently evaluating the impact of SFAS 157and expect to adopt SFAS 157 in the first quarter of our fiscal year ending March 31,2009.

 

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In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115* (“SFAS 159”). SFAS 159 permits entities tochoose to measure many financial instruments and certain other items at fairvalue. Unrealized gains and losses on items for which the fair value option hasbeen elected will be recognized in earnings at each subsequent reporting date.SFAS 159 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. We are evaluating the impact that the adoption of SFAS 159 will have onour results of operations and financial condition and expect to adopt SFAS 159in our fiscal year ending March 31, 2009.

 

**Seasonality**

 

We have historicallyexperienced seasonality, particularly with respect to our Roadway Sensors netsales in the third and fourth fiscal quarters due to a reduction in roadconstruction and repairs during the winter months due to inclement weatherconditions.

 

**ITEM 7A.****             QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Our exposure to interestrate risk is limited to our line of credit. Our line of credit bears interestbased on the prevailing prime rate (5.25% at March 31, 2008).  We do not believe that a 10% increase in theinterest rate on our line of credit (from 6.25% to 6.88%) would have a materialimpact on our financial position, operating results or cash flows. In addition,we believe that the carrying value of our outstanding debt approximates fairvalue.

 

**ITEM 8.****                FINANCIAL STATEMENTS AND SUPPLEMENTARYDATA**

 

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 WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

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

 

*(a)   Evaluation of disclosure controls andprocedures.*  In accordance with Rule 13a-15(b) ofthe Securities Exchange Act of 1934, as of the end of the period covered bythis Annual Report on Form 10-K, the Company’s management evaluated, withthe participation of the Company’s President and Chief Executive Officer andthe Chief Financial Officer, the effectiveness of the design and operation ofthe Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Exchange Act). Based upon their evaluation of these disclosure controls andprocedures, the President and Chief Executive Officer and the Chief FinancialOfficer have concluded that the disclosure controls and procedures wereeffective as of the date of such evaluation in ensuring that informationrequired to be disclosed in the Company’s 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 no change in the Company’sinternal control over financial reporting that occurred during the periodcovered by this Annual Report on Form 10-K that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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

 

Management of the Companyis responsible 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.

 

All internalcontrol systems, no matter how well designed, have inherent limitations.Therefore, even those systems determined effective can provide only reasonableassurance with respect to financial statement preparation and presentation.

 

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We have assessedthe effectiveness of our internal controls over financial reporting as of March 31,2008. 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, 2008, our internal control over financial reportingis effective based on those criteria.

 

This annual reportdoes not include an attestation report of the Company’s independent registeredpublic accounting firm regarding internal control over financial reporting.Management’s report was not subject to attestation by the Company’s independentregistered public accounting firm pursuant to the rules of the Securitiesand Exchange Commission that permit the Company to provide only management’sreport in this annual report.

 

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

 

On June 11, 2008, weentered into a change in control agreement with James Miele, our ChiefFinancial Officer.  Pursuant to the termsof the agreement, in the event of an Involuntary Termination (as defined in theagreement) of Mr. Miele’s employment in connection with or within twelvemonths after a change in control, Mr. Miele will be entitled to receive alump sum severance payment of up to one year’s base pay and 50% of his targetbonus for the year.  In addition, Mr. Mielewill be entitled to receive reimbursement for the cost of COBRA coverage for aperiod of up to one year following the termination of his employment.  The agreement terminates on the fifthanniversary of the date of the agreement, unless earlier terminated inaccordance therewith.

 

**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 2008 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 2008 AnnualMeeting of Stockholders, is incorporated herein by reference.

 

(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 2008Annual Meeting of Stockholders is incorporated herein by reference.

 

(d)  *Corporate Governance*.The information under the caption “Corporate Governance,” appearing in our proxystatement for the 2008 Annual Meeting of Stockholders, is incorporated hereinby reference.

 

(e)  *Audit Committee*.The information under the caption “Board Meetings and Committees – AuditCommittee,” appearing in our proxy statement for the 2008 Annual Meeting ofStockholders, is incorporated herein by reference.

 

**ITEM 11.****                 EXECUTIVECOMPENSATION**

 

The information under thecaption “Executive Compensation and Other Information,” appearing in our proxystatement for the 2008 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 2008 Annual Meeting of Stockholders, is incorporatedherein by reference.

 

**ITEM 13.**                 CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE

** **

The information under thecaptions “Corporate Governance – Director Independence” and “CertainTransactions,” appearing in our proxy statement for the 2008 Annual Meeting ofStockholders, is incorporated herein by reference.

 

31

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**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 2008 Annual Meeting of Stockholders, isincorporated herein by reference.

 

**PART IV**

 

**ITEM 15.**                 EXHIBITS AND FINANCIAL STATEMENTSCHEDULES

** **

(a)               Documentsfiled as part of this report:

 

1.                 *Financial Statements.* The followingfinancial statements of Iteris, Inc. are included in a separatesection of this Annual Report on Form 10-K commencing on the pages referencedbelow:

 
| Report of Independent  Registered Public Accounting Firm                                                                              |   | 40 |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|----|
| Consolidated  Balance Sheets as of March 31, 2008 and 2007                                                                       |   | 41 |
| Consolidated Statements of Operations for the years  ended March 31, 2008, 2007 and 2006                                         |   | 43 |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the years ended March 31, 2008, 2007 and 2006 |   | 44 |
| Consolidated Statements of Cash Flows for the years  ended March 31, 2008, 2007 and 2006                                         |   | 45 |
| Notes to Consolidated Financial Statements                                                                                            |   | 46 |

 

2.                 *Financial Statement Schedules*.

 
| Schedule II — Valuation  and Qualifying Accounts |   | 63 |
|------------------------------------------------------------|--------|----|

 

All other schedules have been omitted because they arenot required or the required information is included in our consolidatedfinancial statements and notes thereto.

 

3.             *Exhibits*.

 

The following exhibits are filed herewith orincorporated by reference to the location indicated below:

 
| Exhibit  Number | ** ** | **Description**                                                                                                  | ** ** | **Where Located**                                                                                                                                                         |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      | ** ** | ** **                                                                                                       | ** ** | ** **                                                                                                                                                                     |
| 3.1             |       | Amended and Restated Certificate of Incorporation of  the registrant                                             | * *   | *Exhibit 3.1 to the registrant’s Current  Report on Form 8-K as filed with the SEC on October 28, 2004*                                                    |
|            |       |                                                                                                             |       |                                                                                                                                                                           |
| 3.2             |       | Certificate of Amendment to Amended and Restated  Certificate of Incorporation effective September 26, 2007 | * *   | *Exhibit 3.2 to the registrant’s Quarterly  Report on Form 10-Q for the quarter ended September 30, 2007 as  filed with the SEC on November 13, 2007* |
|            |       |                                                                                                             |       |                                                                                                                                                                           |
| 3.3             |       | Bylaws of 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* |

 

32

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                       | ** ** | **Where Located**                                                                                                                                                                                      |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 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*                                                                                |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 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             |       | Amended and Restated Rights Agreement, dated as of  May 10, 2004, by and between the registrant and U.S. Stock Transfer  Corporation, including exhibits thereto | * *   | *Exhibit 99.1 to the registrant’s  Registration Statement on Form 8-A/A as field with the SEC on  June 18, 2004*                                                                        |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.1*           |       | Profit Sharing Plan and Trust                                                                                                                                         | * *   | *Exhibit 10.3 to the registrant’s Amendment  No. 2 to the Registration Statement on Form S-8 (Reg.  No. 002-98656) as filed with the SEC on May 5, 1988*                      |
| ** **      | ** ** | ** **                                                                                                                                                            | ** ** | ** **                                                                                                                                                                                                  |
| 10.2*           |       | Amendment Nos. 3 and 4 to the Profit Sharing Plan  and Trust                                                                                                          | * *   | *Exhibits 4.3.1 and 4.3.2, respectively, to  Amendment No. 3 to the registrant’s Registration Statement on  Form S-3 (Reg. No. 002-86220) as filed with the SEC on  June 13, 1990* |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.3*           |       | Form of Executive Deferral Plan between the  registrant and certain employees of the registrant                                                                  | * *   | *Exhibit 10.4 to the registrant’s Annual  Report on Form 10-K for the year ended March 31, 1988*                                                                                        |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.4            |       | 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*                                                                              |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.5            |       | 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*                                           |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.6*           |       | 1997 Stock Incentive 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*                                          |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.7*           |       | Form of Notice of Grant of Stock Option                                                                                                                          | * *   | *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*                                            |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.8*           |       | Form of Stock Option Agreement                                                                                                                                   | * *   | *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*                                            |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.9*           |       | Form of Addendum to Stock Option  Agreement—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*                                            |
|            |       |                                                                                                                                                                  |       |                                                                                                                                                                                                        |
| 10.10*          |       | Form of Addendum to Stock Option  Agreement—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*                                            |

 

33

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| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                            | ** ** | **Where Located**                                                                                                                                                            |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                       | * *   | * *                                                                                                                                                                          |
| 10.11*          |       | Form of Stock Issuance Agreement                                                                                                                                                                                                                                                                                                      | * *   | *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*                  |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.12*          |       | Form of Addendum to Stock Issuance  Agreement—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*                  |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.13*          |       | Form of Notice of Grant of Automatic Stock  Option—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* |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.14*          |       | Form of Notice of Grant of Automatic Stock  Option—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*                  |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.15*          |       | Form of Automatic Stock Option Agreement.                                                                                                                                                                                                                                                                                             | * *   | *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*                 |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.16           |       | Amended and Restated Agreement of Purchase and Sale  and Escrow Instructions, dated February 19, 2002, by and between  Iteris, Inc. and 1515 South Manchester, LLC                                                                                                                                                               | * *   | *Exhibit 2.1 to the  registrant’s Current Report on Form 8-K as filed with the SEC on  June 12, 2002*                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.17*          |       | Change in Control Agreement dated May 8, 2003  by and between the registrant and Gregory A. Miner                                                                                                                                                                                                                                     | * *   | *Exhibit 10.1 to the  registrant’s Quarterly Report on Form 10-Q for the quarter ended  June 30, 2003 as filed with the SEC on August 14, 2003*          |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.18*          |       | Change in Control Agreement dated May 20, 2003  by and between the registrant and Jack E. Johnson                                                                                                                                                                                                                                     | * *   | *Exhibit 10.23 to Amendment  No. 1 to the registrant’s Registration Statement on Form S-1 as  filed with the SEC on February 17, 2004*                   |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.19*          |       | Iteris Inc. 1998 Stock Incentive Plan (as amended on  February 7, 2000)                                                                                                                                                                                                                                                               | * *   | *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*                |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.20*          |       | Form of Notice of Grant, including forms of  Option Agreement and Stock Purchase Agreement for the following directors and  executive officers: Gary Hernandez, Dr. Hartmut Marwitz, Paul E. Wright,  Jack Johnson, Richard D. Crawshaw, Gregory McKhann, Francis Memole, James S.  Miele, Abbas Mohaddes and Stephen Edwin Rowe | * *   | *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*                   |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.21*          |       | Form of Addendum to Stock Option Agreement                                                                                                                                                                                                                                                                                            | * *   | *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*                   |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.22*          |       | 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*                   |
|            |       |                                                                                                                                                                                                                                                                                                                                       |       |                                                                                                                                                                              |
| 10.23*          |       | 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*                |

 

34

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                               | ** ** | **Where Located**                                                                                                                                                           |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.24+          |       | 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*         |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.25           |       | 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.* |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.26           |       | 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.* |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.27+          |       | 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.* |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.28           |       | Loan and Security Agreement effective as of  October 16, 2006 by and between the registrant and Silicon Valley Bank                                                                                                                                      | * *   | *Exhibit 10.4 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.* |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.29           |       | Intellectual Property Security Agreement dated  October 9, 2006 by and between the registrant and Silicon Valley Bank                                                                                                                                    | * *   | *Exhibit 10.5 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.* |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.30+          |       | Settlement Agreement, effective August 15,  2006, by and between the registrant and Delta Networks, Inc.                                                                                                                                            | * *   | *Exhibit 10.1 to the registrant’s Current  Report on Form 8-K as filed with the SEC on August 21, 2006*                                                      |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.31*          |       | 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*                                                        |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.32*          |       | Separation Agreement and Release of Claims dated  March 1, 2007 by and between the registrant and Jack Johnson                                                                                                                                           | * *   | *Exhibit 10.2 to the registrant’s Current  Report on Form 8-K as filed with the SEC on March 6, 2007*                                                        |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.33           |       | 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 as filed with the SEC on August 14, 2007*                                                   |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.34           |       | 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 as filed with the SEC on August 14, 2007*                                                   |
|            |       |                                                                                                                                                                                                                                                          |       |                                                                                                                                                                             |
| 10.35           |       | Termination Agreement, dated May 30, 2007, by  and among Transportation Planning Group, Inc., Abbas Mohaddes and  Iteris, Inc.                                                                                                                 | * *   | *Exhibit 10.3 to the registrant’s Quarterly  Report on Form 10-Q as filed with the SEC on August 14, 2007*                                                   |

 

35

----

 
| Exhibit  Number | ** ** | **Description**                                                                                                                                                     | ** ** | **Where Located**                                                                                                          |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.36*          |       | 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* |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.37           |       | Amendment to Loan and Security Agreement, dated  October 17, 2007, by and between Silicon Valley Bank and  Iteris, Inc.                                   | * *   | *Exhibit 10.1 to the registrant’s Current  Report on Form 8-K as filed with the SEC on October 23, 2007*    |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.38           |       | 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*  |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.39           |       | 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*  |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.40           |       | 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*  |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.41           |       | 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*  |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 10.42*          |       | Change in Control Agreement dated June 11, 2008  by and between James S. Miele and Iteris, Inc.                                                           | * *   | *Filed Herewith*                                                                                                                |
|            |       |                                                                                                                                                                |       |                                                                                                                            |
| 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*                                                                                                                |

 

----

* Indicates a management contract or compensatory planor arrangement

+ Confidential treatment has been requested forcertain confidential portions of this exhibit pursuant to Rule 24b-2 ofthe Securities Exchange Act of 1934, as amended. In accordance with Rule 24b-2,these confidential portions have been omitted from the exhibit and filedseparately with the SEC.

 

36

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|        | ** ** | **ITERIS, INC.** |
|--------|------------|------------------|
|   |       | (Registrant)     |
|   |       |             |
|   |       | By               | /s/ ABBAS MOHADDES |
|   |       |             | Abbas Mohaddes |
|   |       |             | President and Chief Executive Officer |

 

37

----

##### ** **

##### **POWER OF ATTORNEY**

#####  

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 |       | June 11, 2008 |       |
| Abbas Mohaddes        |       | (principal executive officer)                   |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ JAMES S.  MIELE   |       | Chief Financial Officer                         |       | June 11, 2008 |       |
| James S. Miele        |       | (principal financial and accounting officer)    |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ GREGORY A.  MINER |       | Chairman of the Board                           |       | June 11, 2008 |       |
| Gregory A. Miner      |       |                                            |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ RICHARD CHAR      |       | Director                                        |       | June 11, 2008 |       |
| Richard Char          |       |                                            |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ KEVIN C. DALY     |       | Director                                        |       | June 11, 2008 |       |
| Kevin C. Daly,  Ph.D. |       |                                            |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ JOHN  SEAZHOLTZ   |       | Director                                        |       | June 11, 2008 |       |
| John Seazholtz        |       |                                            |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ JOEL SLUTZKY      |       | Director                                        |       | June 11, 2008 |       |
| Joel Slutzky          |       |                                            |       |               |       |
|                  |       |                                            |       |               |       |
| /s/ THOMAS L.  THOMAS |       | Director                                        |       | June 11, 2008 |       |
| Thomas L. Thomas      |       |                                            |       |               |       |

 

38

----

** **

**Iteris, Inc.**

 

**Index to Consolidated Financial Statements**

 
| Report of Independent Registered Public Accounting  Firm                                                                               | 40     |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                   |   |
| Consolidated Balance Sheets as of March 31, 2008  and 2007                                                                        | 41     |
|                                                                                                                                   |   |
| Consolidated Statements of Operations for the years  ended March 31, 2008, 2007, and 2006                                         | 43     |
|                                                                                                                                   |   |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the years ended March 31, 2008, 2007, and 2006 | 44     |
|                                                                                                                                   |   |
| Consolidated Statements of Cash Flows for the years  ended March 31, 2008, 2007, and 2006                                         | 45     |
|                                                                                                                                   |   |
| Notes to Consolidated Financial Statements                                                                                             | 46     |

 

39

----

** **

**Reportof Independent Registered Public Accounting Firm**

 

To the Board of Directorsand Stockholders

Iteris, Inc.

 

We have audited theconsolidated balance sheets of Iteris, Inc. as of March 31, 2008 and2007, and the related consolidated statements of operations, stockholders’equity and comprehensive income and cash flows for each of the three years inthe period ended March 31, 2008. Our audits also included the financial statement schedules of Iteris, Inc.listed in Item 15(a).  These financialstatements and financial statement schedules are the responsibility of theCompany’s management.  Our responsibilityis to express an opinion on these financial statements and schedules based onour audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Iteris, Inc. as of March 31,2008 and 2007, and the results of its operations and its cash flows for each ofthe three years in the period ended March 31, 2008, in conformity withU.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken asa whole, presents fairly in all material respects the information set forththerein.

 

As discussed in Note 1 tothe consolidated financial statements, effective April 1, 2007 the Companychanged its method of accounting for uncertainty in income taxes, and effectiveApril 1, 2006 the Company changed its method of accounting for stock-basedcompensation.

 

We were not engaged toexamine management’s assertion about the effectiveness of Iteris, Inc.’sinternal control over financial reporting as of March 31, 2008 included inthe accompanying Management’s Report On Internal Control Over FinancialReporting and, accordingly, we do not express an opinion thereon.

 
| /s/ McGladrey & Pullen, LLP |   |
|--------------------------------------|--------|
| Irvine, California                   |   |
| June 11, 2008                   |   |

 

40

----

 

**Iteris, Inc.**

 

**Consolidated Balance Sheets**

 

**(In thousands)**

 
| ** **                                                                                                                           | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                           | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Assets                                                                                                                               |       |               |       |   |   |
| Current assets:                                                                                                                      |       |               |       |   |   |
| Cash and cash  equivalents                                                                                                           |       | $                  | 421        |   | $ | 35 |   |
| Trade accounts  receivable, net of allowance for doubtful accounts of $1,020 and $664 at  March 31, 2008 and 2007, respectively |       | 13,108             |       | 11,493 |   |
| Costs and estimated  earnings in excess of billings on uncompleted contracts                                                         |       | 5,351              |       | 3,689 |   |
| Deferred income  taxes                                                                                                               |       | 2,541              |       | 494 |   |
| Inventories, net  of reserve for inventory obsolescence of $819 and $844 at March 31, 2008  and 2007, respectively              |       | 4,226              |       | 6,379 |   |
| Prepaid expenses  and other current assets                                                                                           |       | 371                |       | 385 |   |
| Total current  assets                                                                                                                |       | 26,018             |       | 22,475 |   |
|                                                                                                                                 |       |               |       |   |   |
| Property and  equipment:                                                                                                             |       |               |       |   |   |
| Leasehold  improvements                                                                                                              |       | 1,915              |       | 112 |   |
| Equipment                                                                                                                            |       | 7,356              |       | 6,830 |   |
| Accumulated  depreciation                                                                                                            |       | (5,804             | )          | (5,230 | ) |
|                                                                                                                                 |       | 3,467              |       | 1,712 |   |
|                                                                                                                                 |       |               |       |   |   |
| Deferred income  taxes                                                                                                               |       | 7,807              |       | 2,533 |   |
| Intangible  assets, net of accumulated amortization of $555 and $408 at March 31,  2008 and 2007, respectively                  |       | 257                |       | 404 |   |
| Goodwill                                                                                                                             |       | 27,774             |       | 27,774 |   |
| Other assets                                                                                                                         |       | 322                |       | 352 |   |
| Total assets                                                                                                                         |       | $                  | 65,645     |   | $ | 55,250 |   |

 

See accompanyingnotes.

 

41

----

 

**Iteris, Inc.**

** **

**ConsolidatedBalance Sheets**

 

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

 
| ** **                                                                                                  | ** ** | **March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                  | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Liabilities and  stockholders’ equity                                                                  |       |               |       |   |   |
| Current  liabilities:                                                                                       |       |               |       |   |   |
| Trade accounts  payable                                                                                     |       | $                  | 3,902      |   | $ | 3,542 |   |
| Accrued payroll  and related expenses                                                                       |       | 3,825              |       | 3,527 |   |
| Accrued  liabilities                                                                                        |       | 1,973              |       | 1,618 |   |
| Revolving line  of credit                                                                                   |       | —             |       | 4,015 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts                                |       | 1,126              |       | 847 |   |
| Current portion  of long-term debt                                                                          |       | 244                |       | 1,947 |   |
| Total current  liabilities                                                                                  |       | 11,070             |       | 15,496 |   |
|                                                                                                        |       |               |       |   |   |
| Deferred rent                                                                                               |       | 1,956              |       | — |   |
|                                                                                                        |       |               |       |   |   |
| Unrecognized tax  benefits                                                                                  |       | 1,381              |       | — |   |
|                                                                                                        |       |               |       |   |   |
| Deferred  compensation plan liability                                                                       |       | 391                |       | 730 |   |
|                                                                                                        |       |               |       |   |   |
| Other  non-current liabilities                                                                              |       | 70                 |       | 163 |   |
|                                                                                                        |       |               |       |   |   |
| Long-term debt                                                                                              |       | 7,566              |       | 9,760 |   |
|                                                                                                        |       |               |       |   |   |
| Commitments and  contingencies                                                                              |       |               |       |   |   |
|                                                                                                        |       |               |       |   |   |
| Redeemable  common stock                                                                                    |       |               |       |   |   |
| Issued and  outstanding shares — none at March 31, 2008 and 1,219 at March 31,  2007         |       | —             |       | 3,414 |   |
|                                                                                                        |       |               |       |   |   |
| Stockholders’  equity:                                                                                 |       |               |       |   |   |
| Preferred stock,  $1.00 par value:                                                                          |       |               |       |   |   |
| Authorized  shares — 2,000                                                                             |       |               |       |   |   |
| Issued and  outstanding shares — none                                                                  |       | —             |       | — |   |
| Common stock,  $.10 par value:                                                                              |       |               |       |   |   |
| Authorized  shares — 70,000 at March 31, 2008 and 50,000 at March 31, 2007                   |       |               |       |   |   |
| Issued and  outstanding shares — 33,420 at March 31, 2008 and 30,601 at  March 31, 2007      |       | 3,342              |       | 3,060 |   |
| Additional  paid-in capital                                                                                 |       | 135,516            |       | 130,425 |   |
| Common stock  held in trust — 167 shares at March 31, 2008 and 311 shares at  March 31, 2007 |       | (202               | )          | (374 | ) |
| Notes receivable  from employees                                                                            |       | —             |       | (5 | ) |
| Accumulated  deficit                                                                                        |       | (95,499            | )          | (107,438 | ) |
| Accumulated  other comprehensive income                                                                     |       | 54                 |       | 19 |   |
| Total  stockholders’ equity                                                                            |       | 43,211             |       | 25,687 |   |
| Total  liabilities and stockholders’ equity                                                            |       | $                  | 65,645     |   | $ | 55,250 |   |

 

See accompanying notes.

 

42

----

 

**Iteris, Inc.**

** **

**ConsolidatedStatements of Operations**

** **

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

 
| ** **                                 | ** ** | **Year Ended March 31,** | ** ** |
|--------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                 | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                 | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales and  contract revenues:          |       |                                    |       |   |   |   |   |
| Net sales                                  |       | $                                       | 40,326     |   | $ | 36,248 |   | $ | 31,156 |   |
| Contract  revenues                         |       | 24,837                                  |       | 22,049 |   | 19,330 |   |
| Total net sales  and contract revenues     |       | 65,163                                  |       | 58,297 |   | 50,486 |   |
|                                       |       |                                    |       |   |   |   |   |
| Costs of net  sales and contract revenues: |       |                                    |       |   |   |   |   |
| Cost of net  sales (a)                     |       | 20,499                                  |       | 19,829 |   | 16,493 |   |
| Cost of contract  revenues (a)             |       | 16,367                                  |       | 14,460 |   | 12,600 |   |
| Gross profit                               |       | 28,297                                  |       | 24,008 |   | 21,393 |   |
| Operating  expenses:                       |       |                                    |       |   |   |   |   |
| Selling, general  and administrative (a)   |       | 17,289                                  |       | 16,003 |   | 15,410 |   |
| Research and  development (a)              |       | 3,566                                   |       | 4,030 |   | 5,217 |   |
| Amortization of  intangible assets         |       | 147                                     |       | 147 |   | 147 |   |
| Total operating  expenses                  |       | 21,002                                  |       | 20,180 |   | 20,774 |   |
| Operating income                           |       | 7,295                                   |       | 3,828 |   | 619 |   |
| Non-operating  income (expense):           |       |                                    |       |   |   |   |   |
| Other income  (expense), net               |       | 252                                     |       | (653 | ) | 35 |   |
| Interest  expense, net                     |       | (1,284                                  | )          | (1,600 | ) | (1,459 | ) |
| Income (loss)  before income taxes         |       | 6,263                                   |       | 1,575 |   | (805 | ) |
| Income tax  benefit                        |       | 5,900                                   |       | 1,343 |   | 885 |   |
| Net income                                 |       | $                                       | 12,163     |   | $ | 2,918 |   | $ | 80 |   |
|                                       |       |                                    |       |   |   |   |   |
| Earnings per  share:                       |       |                                    |       |   |   |   |   |
| Basic                                      |       | $                                       | 0.37       |   | $ | 0.10 |   | $ | 0.00 |   |
| Diluted                                    |       | $                                       | 0.35       |   | $ | 0.09 |   | $ | 0.00 |   |
|                                       |       |                                    |       |   |   |   |   |
| Weighted average  shares outstanding:      |       |                                    |       |   |   |   |   |
| Basic                                      |       | 32,723                                  |       | 29,698 |   | 28,182 |   |
| Diluted                                    |       | 34,713                                  |       | 33,348 |   | 32,737 |   |

 

----

(a)   Includes stock-based compensation expense as follows:
| Cost of net  sales                           |   | $   | 3      |   | $      | 13  |   | $ | 27  |   |
|----------------------------------------------|--------|-----|--------|--------|--------|-----|--------|---|-----|--------|
| Cost of contract  revenues                   |   | 14  |   | 60     |   | 205 |   |
| Selling, general  and administrative expense |   | 266 |   | 195    |   | 364 |   |
| Research and  development expense            |   | 7   |   | 20     |   | 129 |   |
| Total  stock-based compensation expense      |   | $   | 290    |   | $      | 288 |   | $ | 725 |   |

 

See accompanying notes*.*

 

43

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** **

**Iteris, Inc.**

 

**Consolidated Statements of Stockholders’ Equity andComprehensive Income**

 

**(In thousands)**

 
| ** **                                                    | ** ** | **Common  Stock  Shares  Outstanding** | ** ** | **Amount** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Common  Stock  Held in  Trust** | ** ** | **Treasury  Stock** | ** ** | **Notes  Receivable  From  Employees** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total  Stockholder’s  Equity** | ** ** | **Comprehensive  Income** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|------------|------------|----------------------------------|------------|----------------------------------------|------------|---------------------|------------|----------------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|
| Balance at  March 31, 2005                               |       | 27,090                                 |       | $          | 2,709      |                             | $          | 125,609                                |       | $                   | (374       | )                                      | $          | (1                       | )          | $                                             | (45        | )                                     | $          | (110,436                  | )          | $ | — |   | $ | 17,462 |   |   |   |
| Warrant exercises                                             |       | 98                                     |       | 9          |       | 28                               |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 37                                    |       |                      |       |
| Stock option  exercises                                       |       | 244                                    |       | 25         |       | 275                              |       | —                                 |       | —              |       | (4                                     | )          | —                   |       | —                                        |       | 296                                   |       |                      |       |
| Issuance of  warrants                                         |       | —                                 |       | —     |       | 28                               |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 28                                    |       |                      |       |
| Stock-based  compensation                                     |       | —                                 |       | —     |       | 725                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 725                                   |       |                      |       |
| Retirement of  treasury stock                                 |       | —                                 |       | —     |       | (1                               | )          | —                                 |       | 1                   |       | —                                 |       | —                   |       | —                                        |       | —                                |       |                      |       |
| Foreign currency  translation                                 |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | —                   |       | 7                                             |       | 7                                     |       | $                         | 7          |   |
| Net income                                                    |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | 80                       |       | —                                        |       | 80                                    |       | 80                        |       |
| Balance at  March 31, 2006                               |       | 27,432                                 |       | 2,743      |       | 126,664                          |       | (374                                   | )          | —              |       | (49                                    | )          | (110,356                 | )          | 7                                             |       | 18,635                                |       | $                         | 87         |   |
| Warrant exercises                                             |       | 1,706                                  |       | 170        |       | 2,265                            |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 2,435                                 |       |                      |       |
| Stock option  exercises                                       |       | 1,374                                  |       | 138        |       | 982                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 1,120                                 |       |                      |       |
| Issuance of  warrants                                         |       | —                                 |       | —     |       | 22                               |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 22                                    |       |                      |       |
| Stock-based  compensation                                     |       | —                                 |       | —     |       | 288                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 288                                   |       |                      |       |
| Issuance of  common stock in connection with legal settlement |       | 89                                     |       | 9          |       | 204                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 213                                   |       |                      |       |
| Repayment of  notes receivable from employees                 |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | 44                                     |       | —                   |       | —                                        |       | 44                                    |       |                      |       |
| Foreign currency  translation                                 |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | —                   |       | 12                                            |       | 12                                    |       | $                         | 12         |   |
| Net income                                                    |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | 2,918                    |       | —                                        |       | 2,918                                 |       | 2,918                     |       |
| Balance at  March 31, 2007                               |       | 30,601                                 |       | 3,060      |       | 130,425                          |       | (374                                   | )          | —              |       | (5                                     | )          | (107,438                 | )          | 19                                            |       | 25,687                                |       | $                         | 2,930      |   |
| Conversion of  redeemable common stock to common stock        |       | 1,219                                  |       | 122        |       | 3,292                            |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 3,414                                 |       |                      |       |
| Stock option  exercises                                       |       | 1,515                                  |       | 151        |       | 1,223                            |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 1,374                                 |       |                      |       |
| Warrant exercises                                             |       | 85                                     |       | 9          |       | 113                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 122                                   |       |                      |       |
| Stock-based  compensation                                     |       | —                                 |       | —     |       | 290                              |       | —                                 |       | —              |       | —                                 |       | —                   |       | —                                        |       | 290                                   |       |                      |       |
| Issuance of  shares held in trust                             |       | —                                 |       | —     |       | 178                              |       | 172                                    |       | —              |       | —                                 |       | —                   |       | —                                        |       | 350                                   |       |                      |       |
| Write-off of  notes receivable from employees                 |       | —                                 |       | —     |       | (5                               | )          | —                                 |       | —              |       | 5                                      |       | —                   |       | —                                        |       | —                                |       |                      |       |
| Cumulative effect  of adoption of FIN 48                      |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | (224                     | )          | —                                        |       | (224                                  | )          |                      |       |
| Foreign currency  translation                                 |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | —                   |       | 35                                            |       | 35                                    |       | $                         | 35         |   |
| Net income                                                    |       | —                                 |       | —     |       | —                           |       | —                                 |       | —              |       | —                                 |       | 12,163                   |       | —                                        |       | 12,163                                |       | 12,163                    |       |
| Balance at  March 31, 2008                               |       | 33,420                                 |       | $          | 3,342      |                             | $          | 135,516                                |       | $                   | (202       | )                                      | $          | —                   |       | $                                             | —     |                                  | $          | (95,499                   | )          | $ | 54 |   | $ | 43,211 |   | $ | 12,198 |   |

 

See accompanying notes.

 

44

----

** **

**Iteris, Inc.**

 

**Consolidated Statements of Cash Flows**

 

**(In thousands)**

 
| ** **                                                                                   | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                   | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Operating  activities**                                                                    |       |                                    |       |   |   |   |   |
| Net income                                                                                   |       | $                                       | 12,163     |   | $ | 2,918 |   | $ | 80 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                    |       |   |   |   |   |
| Change in  deferred tax assets                                                               |       | (7,321                                  | )          | (1,419 | ) | (948 | ) |
| Depreciation of  property and equipment                                                      |       | 756                                     |       | 559 |   | 684 |   |
| Stock-based compensation                                                                     |       | 290                                     |       | 288 |   | 725 |   |
| Gain on early  extinguishment of debt                                                        |       | (224                                    | )          | — |   | — |   |
| Amortization of  debt discounts                                                              |       | 201                                     |       | 207 |   | 207 |   |
| Amortization of  deferred financing costs                                                    |       | 135                                     |       | 137 |   | 138 |   |
| Amortization of  deferred gain on sale-leaseback                                             |       | (165                                    | )          | (284 | ) | (284 | ) |
| Amortization of  intangible assets                                                           |       | 147                                     |       | 147 |   | 147 |   |
| Issuance of  common stock in connection with legal settlement                                |       | —                                  |       | 213 |   | — |   |
| Fair value of  warrants issued for services                                                  |       | —                                  |       | 22 |   | — |   |
| Changes in  operating assets and liabilities:                                                |       |                                    |       |   |   |   |   |
| Accounts  receivable                                                                         |       | (1,615                                  | )          | (67 | ) | (2,560 | ) |
| Net costs and  estimated earnings in excess of billings                                      |       | (1,383                                  | )          | (1,042 | ) | (658 | ) |
| Inventories                                                                                  |       | 2,153                                   |       | (3,565 | ) | 1,530 |   |
| Prepaid expenses  and other assets                                                           |       | (77                                     | )          | 19 |   | 109 |   |
| Accounts payable  and accrued expenses                                                       |       | 2,519                                   |       | (182 | ) | 1,048 |   |
| Net cash  provided by (used in) operating activities                                         |       | 7,579                                   |       | (2,049 | ) | 218 |   |
|                                                                                         |       |                                    |       |   |   |   |   |
| **Investing  activities**                                                                    |       |                                    |       |   |   |   |   |
| Purchases of  property and equipment                                                         |       | (739                                    | )          | (488 | ) | (1,258 | ) |
|                                                                                         |       |                                    |       |   |   |   |   |
| **Financing  activities**                                                                    |       |                                    |       |   |   |   |   |
| (Payments on)  proceeds from borrowings on lines of credit, net                              |       | (4,015                                  | )          | 1,353 |   | 1,717 |   |
| Payments on  long-term debt                                                                  |       | (3,838                                  | )          | (1,843 | ) | (1,314 | ) |
| Credit facility  commitment fees                                                             |       | (50                                     | )          | (40 | ) | — |   |
| Checks drawn in  excess of available bank balances                                           |       | (47                                     | )          | (628 | ) | 389 |   |
| Proceeds from  stock option and warrant exercises                                            |       | 1,496                                   |       | 3,555 |   | 333 |   |
| Proceeds from  notes receivable from employees                                               |       | —                                  |       | 44 |   | — |   |
| Net cash  provided by (used in) financing activities                                         |       | (6,454                                  | )          | 2,441 |   | 1,125 |   |
| Increase  (decrease) in cash                                                                 |       | 386                                     |       | (96 | ) | 85 |   |
| Cash and cash  equivalents at beginning of year                                              |       | 35                                      |       | 131 |   | 46 |   |
| Cash and cash  equivalents at end of year                                                    |       | $                                       | 421        |   | $ | 35 |   | $ | 131 |   |
|                                                                                         |       |                                    |       |   |   |   |   |
| **Supplemental  cash flow information:**                                                     | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid  (received) during the period:                                                     |       |                                    |       |   |   |   |   |
| Interest                                                                                     |       | $                                       | 1,008      |   | $ | 1,263 |   | $ | 1,095 |   |
| Income taxes                                                                                 |       | 24                                      |       | 39 |   | (2 | ) |
|                                                                                         |       |                                    |       |   |   |   |   |
| **Supplemental  schedule of non-cash investing and financing activities:**              | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Conversion of  redeemable common stock to common stock                                       |       | $                                       | 3,414      |   | $ | — |   | $ | — |   |
| Lease incentives  in connection with new headquarters lease                                  |       | 1,772                                   |       | — |   | — |   |
| Fair value of  common stock issued in settlement of liabilities                              |       | 350                                     |       | — |   | — |   |
| Write-off of  notes receivable from employees                                                |       | (5                                      | )          | — |   | — |   |
| Property and  equipment financing                                                            |       | —                                  |       | — |   | 127 |   |
| Fair value of  warrants issued in settlement of liabilities                                  |       | —                                  |       | — |   | 28 |   |
| Exercises of  stock options via notes receivable from employees                              |       | —                                  |       | — |   | 4 |   |
| Retirement of  treasury stock                                                                |       | —                                  |       | — |   | 1 |   |

 

See accompanying notes.

 

45

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**Iteris, Inc.Notes to Consolidated Financial StatementsMarch 31,2008**

 

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

 

**Descriptionof Business**

 

Iteris, Inc. (the “Company”)is a leader in the traffic management market and focuses on the development andapplication of advanced technologies that reduce traffic congestion, minimizethe environmental impact of traffic congestion and improve the safety ofsurface transportation systems.  Bycombining outdoor image processing, traffic engineering and informationtechnology, the Company offers a broad range of Intelligent TransportationSystems and driver safety solutions to customers worldwide.  The Company was originally incorporated inDelaware in 1987.  In October 2004,the Company completed a merger with its majority-owned subsidiary, Iteris, Inc.(the “Iteris Subsidiary”), and officially changed its corporate name to Iteris, Inc.

 

**Basisof Presentation**

 

The accompanying consolidated financial statements include the accountsof the Company and its subsidiaries. All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

**Useof Estimates**

 

The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement 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,deferred tax assets, inventory and warranty reserves, costs to completelong-term contracts, overhead rates used in cost-plus contracts, contractreserves, the valuation of equity instruments and estimates of future cashflows used to assess the recoverability of long-lived assets and therealization of goodwill.

 

**Reclassifications**

 

Certain reclassificationshave been made to the prior year financial statements to conform to the currentyear presentation.

 

**RevenueRecognition**

 

Product revenues and related costs of sales are recognized upon thetransfer of title, which generally occurs upon shipment or, if required, upon acceptanceby the customer, provided that the Company believes 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.

 

46

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In addition to product and contract revenue, the Company derivesrevenue from technology access fees, the provision of specific non-recurringcontract engineering services and royalties. Technology access fee revenues arerecognized evenly over the period in which they are earned. Non-recurringcontract engineering revenues are recognized in the period in which the relatedservices are performed. Royalty revenues are recorded in the period in whichthe royalty is earned, based on unit sales of the Company’s products.Technology access fee revenues, contract engineering revenues and royaltyrevenues are included in net sales in the accompanying consolidated statementsof operations.

 

Revenues from follow-on service and support, for which the Companycharges separately, are recorded in the period in which the services areperformed.

 

**Concentrationof Credit Risk**

 

Accounts receivable are derived from revenues earned from customerslocated throughout North America and Europe. The Company generally does notrequire collateral or other security from customers. Collectibility ofreceivable balances is estimated through review of invoices outstanding greaterthan a certain period of time and ongoing credit evaluations of customers’financial condition. Reserves are maintained for potential credit losses, andsuch losses have historically been within management’s expectations.

 

At March 31, 2008 and 2007, accounts receivable from governmentalagencies and prime government contractors were approximately $6.4 million and$5.2 million, respectively. No customer or government agency had a receivablebalance at March 31, 2008 or 2007 greater than 10% of our total net salesand contract revenues for the years ended March 31, 2008 and 2007.

 

**FairValues of Financial Instruments**

 

The fair value of cashand cash equivalents, receivables, inventories, accounts payable and accruedexpenses approximate carrying value because of the short period of time tomaturity. The fair value of line of credit agreements and long-term debtapproximate carrying value because the related rates of interest approximatecurrent market rates. The fair value of convertible debentures approximatescarrying value because the effective interest rate, taking into accountrecorded debt discounts, approximates current market rates. At March 31,2007, the fair value of redeemable common stock was $2.8 million, based on theclosing price of the Company’s common stock on that date.

 

**Cash andCash Equivalents**

 

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

 

**Inventories**

 

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

 

**Propertyand Equipment**

 

Property and equipmentare recorded at cost and are depreciated over the estimated useful life rangingfrom three to eight years.  Leaseholdimprovements are depreciated over the term of the related lease or theestimated useful life of the improvement, whichever is shorter.  Beginning April 1, 2006, the Companybegan depreciating property and equipment using the straight-line method ofdepreciation, which the Company believes more closely approximates the usage ofthe underlying assets, which generally provide value evenly throughout theestimated life.  Prior to this date, theCompany used the double declining balance method of depreciation.  As a result of this change in estimate,depreciation expense declined by $455,000 for the year ended March 31,2007, resulting in a $0.02 per share impact on basic and diluted earnings pershare.

 

**Goodwilland Long-Lived Assets**

 

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

 

47

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

 

**IncomeTaxes**

 

The Company utilizes theliability method of accounting for income taxes as set forth in SFAS No. 109,*Accounting for Income Taxes* (“SFAS 109”).  Under the liability method, deferred taxesare determined based on the temporary differences between the financialstatement and tax bases of assets and liabilities using enacted tax rates.  A valuation allowance is recorded when it ismore likely than not that all or a portion of the deferred tax assets will notbe realized. See Note 5.

 

On April 1, 2007,the Company adopted the provisions of Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes – an Interpretation of FASB Statement No. 109* (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes byestablishing minimum standards for the recognition and measurement of taxpositions taken or expected to be taken in a tax return. Under the requirementsof FIN 48, the Company must review all of its tax positions and make adetermination as to whether its 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 ismore-likely-than-not to be realized upon ultimate settlement or disposition ofthe underlying issue.

 

The Company recognizedthe cumulative impact of the adoption of FIN 48 as a $224,000 increase to itsliability for unrecognized tax benefits with a corresponding increase to itsaccumulated deficit balance as of April 1, 2007. As of April 1, 2007and March 31, 2008, the Company’s gross unrecognized tax benefits were$185,000 and $1.4 million, respectively, of which $78,000 and $88,000,respectively, if recognized, would affect the Company’s effective tax rate. Thegross unrecognized tax benefits differ from the amount that would affect theCompany’s effective tax rate due primarily to the impact of the valuationallowance on such differences.

 

The Company’s continuingpractice is to recognize interest and/or penalties related to income taxmatters in income tax expense.  As of March 31,2008 and April 1, 2007, the Company had accrued cumulatively $21,000 and$39,000 respectively, for the payment of interest and penalties.

 

A reconciliation of thebeginning and ending balances of the total amounts of gross unrecognized taxbenefits is as follows (in thousands):

 
| Gross  unrecognized tax benefits at April 1, 2007  |   | $      | 185    |   |
|---------------------------------------------------------|--------|--------|--------|--------|
| Increases in tax  positions for prior year              |   | 1,160  |   |
| Decrease in tax  positions for prior year               |   | (147   | )      |
| Increase in tax  positions for current year             |   | 327    |   |
| Decrease in tax  positions for current year             |   | — |   |
| Settlements                                             |   | — |   |
| Lapse in statute  of limitation                         |   | (136   | )      |
| Gross  unrecognized tax benefits at March 31, 2008 |   | $      | 1,389  |   |
|                                                         |        |        |        |        |  |

 

During the next twelvemonths, it is reasonably possible that, as a result of the expiration of thestatute of limitations, the Company may decrease the amount of its grossunrecognized tax benefits by approximately $408,000. The gross unrecognized taxbenefits subject to potential decrease involve various timing differences.

 

48

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The Company is subject totaxation in the United States and various states.  The Company is subject to U.S. federal taxexamination for fiscal tax years ended March 31, 2005 and state as well aslocal income tax examination for fiscal tax years ended March 31, 2004.

 

## **Stock-Based Compensation**

##  

Effective April 1, 2006, the Company adopted SFAS No. 123(revised 2004), *Share-Based Payment* (“SFAS 123R”),which replaced SFAS No. 123, *Accounting for Stock-BasedCompensation* (“SFAS 123”), superseded Accounting Principles BoardOpinion No. 25, *Accounting for StockIssued to Employees* (“APB 25”), and amended SFAS No. 95, *Statement of Cash Flows*. Prior to April 1, 2006, the Company followed the disclosure-onlyprovisions of SFAS 123, as amended by SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*,**and, accordingly, accounted for its stock-basedcompensation plans using the intrinsic value method under APB 25 and relatedinterpretations.

 

SFAS 123R requires all stock-based payments, including grants ofemployee stock options, to be recognized in the statement of operations as anexpense, based on their grant date fair values with such fair values amortizedover the requisite service period.  TheCompany elected to use the modified prospective transition method fortransition to SFAS 123R.  Under themodified prospective method, SFAS 123R applies to all awards granted ormodified after the date of adoption.  Inaddition, under the modified prospective method, compensation expense will berecognized for all stock-based compensation awards granted prior to but not yetvested as of April 1, 2006, based on grant-date fair values estimated inaccordance with the original provisions of SFAS 123.  Accordingly, prior period amounts presentedherein have not been restated to reflect the adoption of SFAS 123R.

 

The fair valueconcepts were not changed significantly as a result of implementing SFAS 123R;however, in adopting SFAS 123R, companies must choose among alternativevaluation models and amortization assumptions. After assessing alternativevaluation models and amortization assumptions, the Company continued to useboth the Black-Scholes-Merton (“BSM”) option-pricing formula and straight-lineamortization of compensation expense over the requisite service period of stockoption grants.  The Company willreconsider use of this model if additional information becomes available in thefuture that indicates another model would be more appropriate, or if grantsissued in future periods have characteristics that cannot be reasonablyestimated using this model.  SFAS 123 didnot require the estimation of forfeitures in the calculation of stockcompensation expense; however, SFAS 123R does require such estimation and uponadoption of SFAS 123R, the Company changed its methodology to include anestimate of forfeitures.

 

In addition, inaccordance with SFAS 123R, SFAS 109 and EITF Topic D-32, *Intraperiod Tax Allocation of the Tax Effect ofPretax Income from Continuing Operations*, the Company has elected torecognize excess income tax benefits from stock option exercises in additionalpaid-in capital only if an incremental income tax benefit would be realizedafter considering all other tax attributes presently available to the Company.The Company measures the tax benefit associated with excess tax deductionsrelated to stock-based compensation expense by multiplying the excess taxdeductions by the statutory tax rates.

 

The followingtable illustrates the effect on net income and earnings per share for the yearended March 31, 2006 as if the Company had applied the fair valuerecognition provisions of SFAS 123R to options granted under the Company’sstock option plans.  For purposes of thispro forma disclosure, the fair value of the options was estimated using the BSMoption-pricing formula and amortized on a straight-line basis to expense overthe options’ vesting period:

 

49

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| ** **                                                                                               | ** ** | **Year Ended March 31,**                           | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                                          | ** ** |
| ** **                                                                                               | ** ** | **(In thousands, except  per share amounts)** | ** ** |
| Net income — as  reported                                                                           |       | $                                                                 | 80         |   |
| Add: Stock-based  compensation expense included in net income — as reported                         |       | 725                                                               |       |
| Deduct: Total  stock-based compensation expense determined under fair value based method for  all awards |       | (1,108                                                            | )          |
| Net loss — pro forma                                                                                |       | $                                                                 | (303       | ) |
|                                                                                                     |       |                                                              |       |
| Basic and diluted  earnings per share — as reported                                                 |       | $                                                                 | 0.00       |   |
| Basic and diluted loss  per share — pro forma                                                       |       | $                                                                 | (0.01      | ) |

 

**Research and DevelopmentExpenditures**

 

Research anddevelopment expenditures are charged to expense in the period incurred.

 

**Shippingand Handling Costs**

 

Shipping andhandling costs are included as cost of sales in the period during which theproducts ship.

 

**Sales Taxes**

 

Sales taxes arepresented on a net basis (excluded from net sales and contract revenues) in theconsolidated statements of operations.

 

**AdvertisingExpenses**

 

Advertising costsare expensed in the period incurred and totaled $172,000, $152,000, and$185,000 in the years ended March 31, 2008, 2007 and 2006, respectively.

 

**Warranty**

 

The Company generallyprovides a one to three year warranty from the original invoice date on allproducts, materials and workmanship. Products sold to certain original equipment manufacturer (“OEM”) customerssometimes carry longer warranties. Defective products will be either repairedor replaced, generally at the Company’s option, upon meeting certain criteria.The Company accrues a provision for the estimated costs that may be incurredfor product warranties relating to a product as a component of cost of sales atthe time revenue for that product is recognized.  The accrued warranty provision is includedwithin accrued expenses on the accompanying consolidated balance sheets.

 

**Repair and Maintenance Costs**

 

The Company incursrepair and maintenance costs in the normal course of business. Should theactivity result in a permanent improvement to one of the Company’s 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.

 

**ComprehensiveIncome**

 

The only component ofaccumulated other comprehensive income is foreign currency translationadjustments.

 

**Recent Accounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”), which defines fair value, establishes a framework for measuringfair value, and expands disclosure about fair value measurements. SFAS 157 doesnot require any new fair value measurements; rather it specifies valuationmethods to be applied when fair value measurements are required under existingor future accounting pronouncements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. In February 2008 the FASB issued FSP 157-2, *EffectiveDate of FASB Statement No. 157*, which delays the effective date ofSFAS 157 for non-financial assets and liabilities to fiscal years beginningafter November 15, 2008. Generally, this statement will be appliedprospectively. The Company is currently evaluating the impact of SFAS 157 andexpects to adopt SFAS 157 in the first quarter of its fiscal year ending March 31,2009.

 

50

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

 

**2.****                                      SupplementaryFinancial Information**

 

**Inventories**

 

The followingtable presents details regarding the Company’s inventories:

 
| ** **              | ** ** | **March 31,**      | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **2008**                | ** ** | **2007** | ** ** |
| ** **              | ** ** | **(In thousands)** | ** ** |
| Materials  and supplies |       | $                       | 3,031      |   | $ | 4,705 |   |
| Work  in process        |       | 345                     |       | 366 |   |
| Finished  goods         |       | 850                     |       | 1,308 |   |
|                    |       | $                       | 4,226      |   | $ | 6,379 |   |

 

**Goodwilland Intangible Assets**

 
| ** **                                  | ** ** | **March 31, 2008** | ** ** | **March 31, 2007**  | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **Gross  Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                  | ** ** | **(In thousands)**      | ** ** |
| Intangible  assets subject to amortization: |       |                         |       |                          |       |   |   |   |   |
| Developed  Technology                       |       | $                            | 495        |                          | $          | (381 | ) | $ | 495 |   | $ | (280 | ) |
| Patents                                     |       | 317                          |       | (174                          | )          | 317 |   | (128 | ) |
| Total                                       |       | $                            | 812        |                          | $          | (555 | ) | $ | 812 |   | $ | (408 | ) |

 

Amortization expense for intangible assets subject toamortization was $147,000 for the years ended March 31, 2008, 2007 and2006. Future estimated amortization expense is as follows:

 
| **Year Ending March 31:** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|
| **(In thousands)**                  | ** ** | ** ** | ** ** |
| 2009                                     |       | $          | 147        |   |
| 2010                                     |       | 58         |       |
| 2011                                     |       | 46         |       |
| 2012                                     |       | 6          |       |
|                                     |       | $          | 257        |   |

 

At March 31, 2008, goodwill was comprised of$18.0 million associated with the October 2004 merger of the IterisSubsidiary (Note 1); $9.6 million associated with the acquisitions of theRockwell International Transportation Systems Group, Meyer Mohaddes Associatesand the Viggen Systems Consulting Group; and $200,000 associated with thepurchase of the assets of Mil-Lektron, a complementary product to the Company’s Vantage video detectionbusiness.

 

51

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**WarrantyReserve Activity**

 

Thefollowing table presents activity in accrued warranty obligations:

 
| ** **                          | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                          | ** ** | **(In thousands)**                 | ** ** |
| Balance  at beginning of year       |       | $                                       | 520        |   | $ | 519 |   | $ | 326 |   |
| Additions  charged to cost of sales |       | 347                                     |       | 630 |   | 517 |   |
| Warranty  claims                    |       | (373                                    | )          | (629 | ) | (324 | ) |
|                                |       |                                    |       |   |   |   |   |
| Balance  at end of year             |       | $                                       | 494        |   | $ | 520 |   | $ | 519 |   |

 

**EarningsPer Share**

 

The followingtable sets forth the computation of basic and diluted income per share:

 
| ** **                                                   | ** ** | **Year Ended March 31,**                               | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Numerator:                                                   |       |                                                                  |       |   |   |   |   |
| Net  income                                                  |       | $                                                                     | 12,163     |   | $ | 2,918 |   | $ | 80 |   |
|                                                         |       |                                                                  |       |   |   |   |   |
| Denominator:                                                 |       |                                                                  |       |   |   |   |   |
| Weighted  average common shares used in basic computation    |       | 32,723                                                                |       | 29,698 |   | 28,182 |   |
| Dilutive  stock options                                      |       | 1,973                                                                 |       | 3,346 |   | 3,818 |   |
| Dilutive  warrants                                           |       | 17                                                                    |       | 304 |   | 737 |   |
| Weighted  average common shares used in dilutive computation |       | 34,713                                                                |       | 33,348 |   | 32,737 |   |
|                                                         |       |                                                                  |       |   |   |   |   |
| Earnings  per share:                                         |       |                                                                  |       |   |   |   |   |
| Basic                                                        |       | $                                                                     | 0.37       |   | $ | 0.10 |   | $ | 0.00 |   |
| Diluted                                                      |       | $                                                                     | 0.35       |   | $ | 0.09 |   | $ | 0.00 |   |

 

The following shares were excluded from thecomputation of diluted earnings per share as their effect would have been anti-dilutive:

 
| ** **              | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|
| ** **              | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **              | ** ** | **(In thousands)**                 | ** ** |
|                    |       |                                    |       |   |   |   |   |
| Stock  options          |       | 520                                     |       | 582 |   | 470 |   |
| Warrants                |       | 1,170                                   |       | 1,240 |   | 1,265 |   |
| Convertible  debentures |       | 2,661                                   |       | 2,729 |   | 2,729 |   |

 

**3.****                                     Costsand Estimated Earnings on Uncompleted Contracts**

 

Costs incurred,estimated earnings and billings on uncompleted long-term contracts are asfollows:

 

52

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| ** **                                                                   | ** ** | **March 31,**      | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                   | ** ** | **2008**                | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)** | ** ** |
| Total  estimated contract value                                              |       | $                       | 77,557     |   | $ | 74,794 |   |
|                                                                         |       |                    |       |   |   |
| Costs  incurred on uncompleted contracts                                     |       | $                       | 23,415     |   | $ | 20,688 |   |
| Estimated  earnings                                                          |       | 2,342                   |       | 2,069 |   |
|                                                                         |       | 25,757                  |       | 22,757 |   |
| Less  billings to date                                                       |       | (21,532                 | )          | (19,915 | ) |
|                                                                         |       | $                       | 4,225      |   | $ | 2,842 |   |
|                                                                         |       |                    |       |   |   |
| Included  in accompanying consolidated balance sheets:                       |       |                    |       |   |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |       | $                       | 5,351      |   | $ | 3,689 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |       | (1,126                  | )          | (847 | ) |
|                                                                         |       | $                       | 4,225      |   | $ | 2,842 |   |
|                                                                              |            |                         |            |  |  |  |  |  |

 

Costs andestimated earnings in excess of billings at March 31, 2008 and 2007include $828,000 and $786,000, respectively, that were not billable as certainmilestone objectives specified in the contracts had not been attained.Substantially all costs and estimated earnings in excess of billings at March 31,2008 are expected to be billed and collected during the year ending March 31,2009.

 

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

 

**Revolving Line of Credit**

 

In October 2006, theCompany entered into a new two-year credit facility with a bank.  At March 31, 2008, the facility providedline of credit borrowings of up to $10.0 million.  Under the credit facility, the Company mayborrow against its eligible accounts receivable and eligible inventory, asdefined in the credit agreement. Interest on borrowed amounts under the line of credit is payable monthlyat the current stated prime rate plus 1.00% (6.25% at March 31,2008).  Additionally, the Company isobligated to pay an unused line fee of 0.25% per annum applied to the amount bywhich the maximum credit amount exceeds the average daily principal balanceduring the preceding month. The credit facility requires $2,000 in monthlycollateral management fees and includes an early termination fee equal to 2% ofthe total facility during the first year of the agreement and 1% of the totalfacility in the second year of the agreement. Additionally, the Company paid commitment fees of $40,000 in October 2006and $50,000 in October 2007. The credit facility is secured bysubstantially all of the assets of the Company.

 

On March 31, 2008,the available credit under the credit facility was $8.6 million, all of whichwas unused.

 

**Long-Term Debt**

 

The Company’slong-term debt consists of the following:

 
| ** **                   | ** ** | **March 31,**      | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2008**                | ** ** | **2007** | ** ** |
| ** **                   | ** ** | **(In thousands)** | ** ** |
| Convertible  debentures, net |       | $                       | 7,566      |   | $ | 9,410 |   |
| Bank  term note              |       | 210                     |       | 1,573 |   |
| Promissory  note to landlord |       | —                  |       | 646 |   |
| Other                        |       | 34                      |       | 78 |   |
|                         |       | 7,810                   |       | 11,707 |   |
| Less  current portion        |       | (244                    | )          | (1,947 | ) |
|                         |       | $                       | 7,566      |   | $ | 9,760 |   |

 

53

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*ConvertibleDebentures, Net.*In May 2004, the Company sold andissued subordinated convertible debentures in the aggregate original principalamount of $10.1 million.  In connectionwith the issuance of these debentures, the Company issued detachable warrantsto purchase an aggregate of 639,847 shares of its common stock, the value ofwhich was recorded as a debt discount against the face amount of the debentureson the date of issuance and is being amortized to interest expense over theterm of the convertible debentures.

 

The debentures aredue in full on May 19, 2009, provide for 6.0% annual interest, payablequarterly, and are convertible at the holder’s option into the Company’s commonstock at an initial conversion price of $3.61 per share, subject to certainadjustments, including adjustments for dilutive issuances. From May 19,2008, until the maturity date, the Company may redeem the debentures at 110% ofthe principal amount.

 

During the yearended March 31, 2008, the Company paid $1.8 million to retire $2.1 millionof convertible debentures early.  Inconnection with this early retirement, the Company recorded a gain of $224,000,which is included within other income in the accompanying consolidatedstatement of operations for the year ended March 31, 2008.  Additionally, $250,000 of convertibledebentures were previously converted into 69,252 shares of common stock.  At March 31, 2008, $7.8 million of theoriginally issued convertible debentures remained outstanding.

 

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

 

*Promissory Note to Landlord.*TheCompany had an unsecured promissory note payable to the landlord of itsprevious headquarters.  Under the termsof the note agreement, interest was payable quarterly and accrued at a rate ofprime plus 2.0%.  In October 2006, January 2007,April 2007 and July 2007, the Company made required quarterlyprincipal payments of $323,000.  As of March 31,2008, all principal and interest under this note was paid in full.

 

Scheduledaggregate maturities of long-term debt principal as of March 31, 2008 wereas follows:

 
| **Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|------------|------------|
| **(In thousands)**                  | ** ** | ** ** | ** ** |
| 2009                                     |       | $          | 244        |   |
| 2010                                     |       | 7,750      |       |
|                                     |       | 7,994      |       |
| Less:  unamortized debt discount         |       | (184       | )          |
|                                     |       | $          | 7,810      |   |

 

**5.****                                     IncomeTaxes**

 

The reconciliationof the Company’s income tax benefit to taxes computed at U.S. federal statutoryrates is as follows:

 
| ** **                                                                 | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                 | ** ** | **(In thousands)**                 | ** ** |
| Income  tax (benefit) provision at statutory rates                         |       | $                                       | 2,131      |   | $ | 536 |   | $ | (284 | ) |
| State  income taxes net of federal benefit                                 |       | (675                                    | )          | (147 | ) | (85 | ) |
| Change  in valuation allowance associated with federal deferred tax assets |       | (7,558                                  | )          | (1,895 | ) | (892 | ) |
| Compensation  charges                                                      |       | 194                                     |       | — |   | 222 |   |
| Unrecognized  tax benefits                                                 |       | (133                                    | )          | — |   | — |   |
| AMT  and foreign taxes                                                     |       | 40                                      |       | 24 |   | 46 |   |
| Other  permanent differences                                               |       | 101                                     |       | 139 |   | 108 |   |
| Income  tax benefit                                                        |       | $                                       | (5,900     | ) | $ | (1,343 | ) | $ | (885 | ) |

 

54

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The components ofdeferred tax assets and liabilities are as follows:

 
| ** **                               | ** ** | **March 31,**      | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2008**                | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(In thousands)** | ** ** |
| Deferred  tax assets:                    |       |                    |       |   |   |
| Net  operating losses                    |       | $                       | 16,777     |   | $ | 18,806 |   |
| Credit  carry forwards                   |       | 164                     |       | 1,401 |   |
| Deferred  compensation and payroll       |       | 1,359                   |       | 2,032 |   |
| Bad  debt allowances and other reserves  |       | 601                     |       | 524 |   |
| Acquired  intangibles                    |       | —                  |       | 67 |   |
| Other,  net                              |       | 167                     |       | — |   |
| Total  deferred tax assets               |       | 19,068                  |       | 22,830 |   |
| Valuation  allowance                     |       | (7,887                  | )          | (19,543 | ) |
| Net  deferred tax assets                 |       | 11,181                  |       | 3,287 |   |
|                                     |       |                    |       |   |   |
| Deferred  tax liabilities:               |       |                    |       |   |   |
| Other,  Net                              |       | (490                    | )          | (135 | ) |
| Property  and equipment                  |       | (160                    | )          | (125 | ) |
| Acquired  intangibles                    |       | (183                    | )          | — |   |
| Total  deferred tax liabilities          |       | (833                    | )          | (260 | ) |
| Net  deferred tax assets                 |       | $                       | 10,348     |   | $ | 3,027 |   |
|                                     |       |                    |       |   |   |
| Current  portion of net deferred taxes   |       | $                       | 2,541      |   | $ | 494 |   |
| Long-term  portion of net deferred taxes |       | 7,807                   |       | 2,533 |   |
| Net  deferred tax assets                 |       | $                       | 10,348     |   | $ | 3,027 |   |
|                                          |            |                         |            |  |  |  |  |  |  |

 

The components of currentand deferred federal and state income tax benefits and provisions are asfollows:

 
| ** **                    | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                    | ** ** | **(In thousands)**                 | ** ** |
| Current  income tax provision |       |                                    |       |   |   |   |   |
| Federal                       |       | $                                       | 94         |   | $ | 25 |   | $ | 9 |   |
| State                         |       | 40                                      |       | 32 |   | 3 |   |
| Foreign                       |       | 40                                      |       | 24 |   | 46 |   |
| Deferred  income tax benefit  |       |                                    |       |   |   |   |   |
| Federal                       |       | (5,011                                  | )          | (1,170 | ) | (812 | ) |
| State                         |       | (1,063                                  | )          | (254 | ) | (131 | ) |
| Net  income tax benefit       |       | $                                       | (5,900     | ) | $ | (1,343 | ) | $ | (885 | ) |

 

At March 31,2008, the Company had approximately $581,000 in federal general business creditcarryforwards that begin to expire in 2014 and $818,000 in state generalbusiness credit carryforwards that can be carried forward indefinitely. TheCompany had $44.7 million of federal net operating loss carryforwards at March 31,2008 that begin to expire in 2019 and $16.6 million of state net operating losscarryforwards that begin to expire in 2013.

 

Prior to May 28,2004, the Iteris Subsidiary was required to file a separate federal income taxreturn. On May 28, 2004, the Company acquired a greater than 80% ownershipinterest in the Iteris Subsidiary. From that date forward, income taxes areprovided on a consolidated basis for federal income tax purposes. Due tochanges in stock ownership, the prior year $49.8 million of federal netoperating loss carryforwards and other federal tax attributes of the Companyare subject to a Section 382 limitation estimated at approximately $7.8million annually which can be utilized to offset federal consolidated taxableincome. To the extent such limitation is not exceeded in a particular year, theexcess limitation accumulates and adds to subsequent years’ limitations.

 

As a result ofSFAS 123R, our deferred tax assets at March 31, 2008 do not include $1.9million of excess tax benefits from employee stock option exercises that are acomponent of our net operating loss carryforwards. Stockholders’ equity will beincreased by $1.9 million if and when such excess tax benefits are ultimatelyrealized.

 

55

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At March 31,2008, the Company recorded a valuation allowance against its net deferred taxassets of approximately $7.9 million for that portion of deferred tax assets that it is more likelythan not will not be realized. In making such determination, a review of allavailable positive and negative evidence was considered, including scheduledreversal of deferred tax liabilities, potential carryback, projected futuretaxable income, tax planning strategies, and recent financial performance. Anyfuture benefits recognized from the reduction of the valuation allowance willresult in a reduction of income tax expense.

 

Unremittedearnings of the Company’s foreign subsidiary have been included in theconsolidated financial statements without giving effect to the United Statestaxes that may be payable on distribution to the United States because it isnot anticipated that such earnings will be remitted to the United States.  If remitted, the additional United Statestaxes would not be material.

 

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

 

**Litigation**

 

On June 29, 2004, asupplier to Mariner Networks, Inc., a former subsidiary of the Companythat was discontinued in the fiscal year ended March 31, 2002, filed acomplaint in Orange County Superior Court against the Company alleging variousbreaches of written contract claims arising out of alleged purchaseorders.  On July 20, 2006, theCompany entered into a settlement agreement in connection with thismatter.  The dispute was settled in fullfor $688,000 payable as follows:  (i) theCompany issued 88,912 shares of the Company’s common stock on August 18,2006 valued at $213,000 based on the closing sales price of the Company’scommon stock on the date of issuance; (ii) the Company made a cash paymentof $125,000 on October 20, 2006; and (iii) the Company is obligatedto pay $350,000 in cash in equal monthly installments of $9,700 over threeyears beginning in November 2006. In connection with this settlement, the Company recorded a charge of$635,000, representing the fair value of the settlement, within other expensein the accompanying consolidated statement of operations for the year ended March 31,2007.

 

From time to time, theCompany has been involved in litigation relating to claims arising out of itsoperations in the normal course of business. The Company currently is not aparty to any legal proceedings, the adverse outcome of which, in management’sopinion, individually or in the aggregate, would have a material adverse effecton its consolidated results of operations, financial position or cash flows.

 

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

 

**Operating Leases**

 

In May 2007,the Company entered into an agreement to lease 52,000 square feet of space inSanta Ana, California for a term of 88 months. In September 2007, theCompany relocated its headquarters and principal operations into this space.The monthly lease rate is $102,000 during the first year of the lease andincreases each year thereafter, up to a maximum of $120,000 during the lastyear of the lease. The lease may be extended for a period of five years, at theoption of the Company, at a lease rate to be based on the market lease rate forcomparable property determined as of the commencement date of the extensionperiod. Additionally, the lease agreement provides for $1.8 million inincentives in the form of tenant improvement allowances, which the Companyrecorded as deferred rent and capitalized leasehold improvements in itsconsolidated balance sheet.  The deferredrent amount will reduce future rent expense over the term of the lease, and thecapitalized leasehold improvements amount will be depreciated over the initialterm of the lease (the estimated useful life of the related leaseholdimprovements).

 

The Company haslease commitments for facilities in various locations throughout the UnitedStates.  Future minimum rental payments underthese noncancelable operating leases at March 31, 2008 were as follows:

 

56

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| **Fiscal Year Ending March 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| **(In thousands)**                              | ** ** | ** ** | ** ** |
| 2009                                                 |       | $          | 1,594      |   |
| 2010                                                 |       | 1,431      |       |
| 2011                                                 |       | 1,366      |       |
| 2012                                                 |       | 1,332      |       |
| 2013                                                 |       | 1,363      |       |
| Thereafter                                           |       | 2,460      |       |
| Total                                                |       | $          | 9,546      |   |

 

Rent expensetotaled $2.1 million, $2.2 million and $1.9 million, respectively, for theyears ended March 31, 2008, 2007 and 2006.

 

The Companypreviously had recorded on its consolidated balance sheet a deferred gainrelated to the May 2002 sale and leaseback of its prior headquarters inAnaheim, California.  The deferred gainwas amortized over the term of the underlying lease, which terminated in September 2007,and resulted in a realized gain of $165,000 in the fiscal year ended March 31,2008 and $284,000 in the fiscal years ended March 31, 2007 and 2006.

 

The Companypreviously subleased office space to MAXxess Systems, Inc. (“MAXxess”), aformer subsidiary of the Company that was sold by the Company in September 2003and is currently owned by an investor group that includes two of the Company’sdirectors, one of which is the Chief Executive Officer of MAXxess. At March 31,2008, MAXxess owed the Company an aggregate of $274,000 related to thissublease, which terminated in September 2007, and certain relatedancillary services that were provided by the Company to MAXxess.  Although the Company has fully reserved foramounts owed to it by MAXxess under the terms of this sublease, the Companyintends to pursue full payment of any and all amounts due from MAXxess.

 

**Inventory Purchase Commitments**

 

At March 31,2008, the Company had firm commitments to purchase inventory in the amount of$2.3 million during the first and second quarters of its fiscal year ending March 31,2009.

 

**DeferredCompensation Plan**

 

In 1986, the Companyadopted 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 year ended March 31,2003, the Company adopted the Deferred Compensation Plan, and all assets of the1986 Plan were transferred into the Deferred Compensation Plan.  No compensation withholdings were deferredunder the 1986 Plan or the Deferred Compensation Plan in the years ended March 31,2008, 2007 and 2006.

 

At March 31,2008, the Deferred Compensation Plan held 167,177 shares of the Company’scommon stock and $5,000 in cash, which the Company has presented as anaggregated $391,000 deferred compensation plan liability in the accompanyingconsolidated balance sheet. At March 31, 2007, the Deferred CompensationPlan held 310,510 shares of the Company’s common stock and $15,000 incash.  Changes in the value of Companycommon stock held by the Deferred Compensation Plan are determined based onchanges in the quoted market price of the Company’s common stock at the closeof each reporting period and presented within operating expenses in the accompanyingconsolidated statements of operations. As a result of such changes in the valueof Company common stock, the Company recorded expense of $21,000, a benefit of$91,000 and expense of $48,000 in the years ended March 31, 2008, 2007 and2006, respectively.  The original$202,000 cost basis of shares of Company common stock held in the DeferredCompensation Plan at March 31, 2008 has been recorded as a contra-equityaccount in the accompanying consolidated financial statements.  On June 3, 2008, substantially all of theremaining assets of the Deferred Compensation Plan were distributed.

 

**7.****                                     RedeemableCommon Stock**

 

In connection with themerger of the Iteris Subsidiary into the Company (Note 1) in May 2004, theCompany acquired 547,893 shares of common stock of the Iteris Subsidiary inexchange for the issuance of 1,219,445 shares of the Company’s common stock,which was valued at $3.4 million at the date of issuance. Beginning on May 28,2007, the holder of these shares had the right to require the Company torepurchase up to 100% of the shares at a purchase price of $1.438 per share. 

 

57

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All such rights torequire the repurchase of these shares expired on September 28, 2007.Because these rights were outside of the control of the Company, the Companypreviously had classified the $3.4 million value of the 1,219,445 shares asredeemable common stock on its consolidated balance sheet. Upon the expirationof these rights, the Company reclassified $122,000 to common stock,representing the par value of the shares, and $3.3 million to additionalpaid-in capital on its consolidated balance sheet.

 

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

 

**Preferred Stock**

 

The Company’scertificate of incorporation provides for the issuance of up to 2,000,000shares of preferred stock. As of March 31, 2008 and 2007, there were nooutstanding shares of preferred stock, and the Company does not have any plansto issue any shares of preferred stock. The Company’s Board of Directors isauthorized to issue from time to time such authorized but unissued shares ofpreferred stock in one or more series and to fix or alter the designations,preferences, rights and any qualifications, limitations or restrictions of theshares of each such series, including the dividend, conversion, voting,redemption and liquidation rights.

 

**Common Stock and Common StockWarrants**

 

On September 28,2006, the Company issued warrants to purchase an aggregate 246,250 shares ofcommon stock at an exercise price of $3.25 with a five-year life to an existingshareholder in exchange for the early exercise of 1,250,000 outstandingwarrants with an exercise price of $1.61. The new warrants were immediately exercisable and are callable by the Companyif the market price of the Company’s common stock trades for 20 consecutivedays at a price greater than or equal to two times the exercise price of thewarrants.  The fair value of the newwarrants was $320,000 calculated using the Black-Scholes-Merton (“BSM”)option-pricing formula.  The warrantswere considered a cost of raising capital and were recorded in equity.

 

In connection with theissuance of the new warrants, the Company is party to a registration rightsagreement that contains provisions under which the Company could be subjectedto liquidated damages should it fail to maintain effective registrationstatements for the shares of common stock issuable upon exercise of thewarrants.  These warrants have beenaccounted for within equity in the consolidated balance sheets as of March 31,2008 and 2007 in accordance with EITF Issue No. 00-19 *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock*, and, accordingly, no liabilities have beenrecorded in connection therewith.  As of March 31,2008, no liquidated damages were payable under the provisions of theregistration rights agreement associated with these warrants.

 

The followingtable summarizes information regarding outstanding warrants to purchase theCompany’s common stock as of March 31, 2008:

 
| **Range of Exercise Prices** | ** ** | **Warrants Outstanding  at March 31, 2008**       | ** ** | **Weighted Average  Remaining  Contractual Life  (Years)** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **(In thousands, except per share amounts)** | ** ** |
| $1.42                                       |       | 15                                                                    |       | 5.42                                                                 |       | $                                              | 1.42       |   |
| $3.25                                       |       | 246                                                                   |       | 2.91                                                                 |       | $                                              | 3.25       |   |
| $3.61 to $4.03                    |       | 674                                                                   |       | 1.13                                                                 |       | $                                              | 3.93       |   |
| $5.00 to $5.26                    |       | 230                                                                   |       | 1.66                                                                 |       | $                                              | 5.18       |   |
|                                        |       | 1,165                                                                 |       | 1.67                                                                 |       | $                                              | 4.00       |   |

 

All of thewarrants were exercisable at March 31, 2008.  Warrants to purchase an aggregate of246,260 shares of common stock at an exercise price of $3.25 per share arecallable by the Company if the market price of the Company’s 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 the Company if the market price of the Company’s common stocktrades for 20 consecutive days at a price equal to or greater than one anda half times the exercise price of the warrants.

 

58

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Common stock reserved forfuture issuance at March 31, 2008:

 
| ** **                              | ** ** | **(In thousands)** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| Issuable  under stock options plans     |       | 4,985                   |       |
| Issuable  upon the exercise of warrants |       | 1,165                   |       |
|                                    |       | 6,150                   |       |

 

**9.****                                     AssociateBenefit Plans**

 

**StockOption Plan**

 

On September 21,2007, the Company’s stockholders approved the 2007 Omnibus Incentive Plan (the “2007Plan”), which provides that options to purchase shares of the Company’sunissued common stock may be granted to employees, officers, consultants anddirectors to the Company at exercise prices which are equal to or greater thanthe fair market value of the Company’s common stock on the date of grant.Options expire no more than ten years after the date of grant and generallyvest at the rate of 25% on each of the first four anniversaries of the grantdate. The 2007 Plan also allows for the issuance of stock appreciation rights,restricted stock, restricted stock units and other stock-based awards based onthe value of the Company’s common stock. New shares are issued to satisfy stockoption exercises and share issuances under the 2007 Plan. As of March 31,2008, options to purchase an aggregate of 389,000 shares of common stock wereoutstanding under the 2007 Plan.

 

The Company’s 1997 StockIncentive Plan (the “1997 Plan”) terminated in September 2007; however,all stock options outstanding under the 1997 Plan will remain outstandingpursuant to the terms of such stock options. As of March 31, 2008, optionsto purchase 1.4 million shares of the Company’s common stock were outstandingunder the 1997 Plan.

 

In connection with themerger of the Company and the Iteris Subsidiary (Note 1), the Company assumedthe 1998 Stock Incentive Plan of the Iteris Subsidiary (the “1998 Plan”) andall outstanding options granted thereunder. As of March 31, 2008, optionsto purchase 2.7 million shares of the Company’s common stock were outstandingunder the 1998 Plan. No further options may be granted under the 1998 Plan.

 

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

 

A summary of activity inthe Plans for the year ended March 31, 2008 is as follows:

 
| ** **                                                                  | ** ** | **Options**                                                           | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
|                                                                        |       | **(In thousands, except per share amounts)** |       |
| Options outstanding at  March 31, 2007                                 |       | 5,818                                                                 |       | $1.60                                  |       | 3.4                                                             |       |                                |       |
| Granted                                                                     |       | 389                                                                   |       | $2.38                                  |       | N/A                                                             |       |                                |       |
| Exercised                                                                   |       | (1,515                                                                | )          | $0.90                                  |       | N/A                                                             |       |                                |       |
| Forfeited                                                                   |       | (53                                                                   | )          | $2.92                                  |       | N/A                                                             |       |                                |       |
| Expired                                                                     |       | (115                                                                  | )          | $3.90                                  |       | N/A                                                             |       |                                |       |
| Options outstanding at  March 31, 2008                                 |       | 4,524                                                                 |       | $1.83                                  |       | 3.7                                                             |       | $3,761                              |       |
| Vested and expected to  vest at March 31, 2008                         |       | 4,400                                                                 |       | $1.81                                  |       | 3.6                                                             |       | $3,759                              |       |
| Options exercisable at  March 31, 2008                                 |       | 3,875                                                                 |       | $1.72                                  |       | 2.8                                                             |       | $3,750                              |       |
| Options exercisable at  March 31, 2008 pursuant to a change-in-control |       | 4,524                                                                 |       | $1.83                                  |       | 3.7                                                             |       | $3,761                              |       |

 

At March 31, 2008,there were 461,000 shares of common stock available for grant under the 2007Plan.

 

For the years ended March 31,2008, 2007 and 2006, the Company received $1.4 million, $1.1 million and$296,000, respectively, in cash from the exercise of stock options.

 

59

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**Stock-Based Compensation Expense**

 

Total stock-basedcompensation expense for the years ended March 31, 2008, 2007 and 2006 was$290,000, $288,000, and $725,000, respectively. No income tax benefit was realized from activity in the Plans during theyears ended March 31, 2008, 2007 and 2006.

 

The fair value ofeach stock-based award is estimated on the grant date using the BSMoption-pricing formula. Expected volatility is based on the historicalvolatility of the Company’s stock price. The expected life of options grantedsubsequent to the adoption of SFAS 123R is derived based on the historical lifeof the Company’s options.  The risk-freeinterest rate for periods within the expected life of the option is based onthe U.S. Treasury interest rates in effect at the time of grant. The grant datefair value of options granted was estimated using the following weighted-averageassumptions:

 
| ** **                           | ** ** | **Year Ended March 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                           | ** ** | **2008**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                    |       |   |   |   |   |
| Dividend  yield                      |       | 0.0                                     | %          | 0.0 | % | 0.0 | % |
| Expected  life — years          |       | 7.0                                     |       | 7.0 |   | 7.0 |   |
| Risk-free  interest rate             |       | 3.8                                     | %          | 4.7 | % | 5.5 | % |
| Expected  volatility of common stock |       | 0.8                                     |       | 0.9 |   | 0.5 |   |

 

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

 
| ** **                                                           | ** ** | **Year Ended March 31,**                               | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Weighted  average grant date fair value per share of options granted |       | $                                                                     | 1.83       |   | $ | 1.92 |   | $ | 1.77 |   |
| Intrinsic  value of options exercised                                |       | $                                                                     | 2,555      |   | $ | 2,288 |   | $ | 295 |   |

 

At March 31, 2008,there was $1.2 million of total unrecognized compensation expense related tounvested stock options.  This expense isexpected to be recognized over a weighted-average period of approximately 3.5years.

 

**Associate Incentive Programs**

 

Under the terms ofa Profit Sharing Plan, the Company may contribute to a trust fund such amountsas are determined annually by the Board of Directors. No contributions weremade during the years ended March 31, 2008, 2007 and 2006.

 

In May 1990,the Company adopted a 401(k) Plan as an amendment and replacement of theformer Associate Stock Purchase Plan that was an additional feature of theProfit Sharing Plan. Under the 401(k) Plan, eligible associatesvoluntarily contribute to the plan, up to IRS maximums, through payrolldeductions. The Company matches up to 90% of contributions, based on years ofservice, up to a stated limit. Under the provisions of the 401(k) Plan,associates have various investment choices, one of which is the purchase ofIteris, Inc. common stock at market price. Company matching contributionswere approximately $401,000, $480,000, and $317,000 and for the years ended March 31,2008, 2007, and 2006, respectively.

 

**10.****                              BusinessSegment and Geographic Information**

 

The Companycurrently operates in three reportable segments: Roadway Sensors, VehicleSensors and Transportation Systems. The Roadway Sensors segment includesVantage vehicle detection systems for traffic intersection control andcertain highway traffic data collection applications. The Vehicle Sensorssegment is comprised of all activities related to AutoVue lane departurewarning systems. The Transportation Systems segment includes transportationengineering and consulting services and the development of transportationmanagement and traveler information systems for the ITS industry. Theaccounting policies of the reportable segments are the same as those describedin the summary of significant accounting policies.  Prior to April 1, 2007, certainexpenses, such as interest, amortization of certain intangibles and certaincorporate expenses were not allocated to the segments. Beginning April 1,2007, the Company increased the portion of its corporate expenses that itallocates to its segments such that substantially all corporate expenses areallocated.  Interest, amortization ofcertain intangibles and certain corporate expenses are still not allocated tothe segments. The reportable segments are each managed separately because theymanufacture and distribute distinct products or provide services with differentprocesses. All segment revenues are derived from external customers.

 

60

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Selected financialinformation for the Company’s reportable segments as of and for the years endedMarch 31, 2008, 2007 and 2006 is as follows:

 
| ** **                                         | ** ** | **Roadway  Sensors**    | ** ** | **Vehicle  Sensors** | ** ** | **Transportation  Systems** | ** ** | **Total**  | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|----------------------|------------|-----------------------------|------------|------------|------------|
| ** **                                         | ** ** | **(In thousands)** | ** ** |
| **Year Ended March 31, 2008**                 | ** ** | ** **              | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Product  revenue from external customers           |       | $                       | 28,452     |                 | $          | 10,016                      |       | $          | —     |   | $ | 38,468 |   |
| Service  and other revenue from external customers |       | —                  |       | 1,858                |       | 24,837                      |       | 26,695     |       |
| Stock-based  compensation                          |       | 18                      |       | 45                   |       | 27                          |       | 90         |       |
| Depreciation                                       |       | 107                     |       | 130                  |       | 147                         |       | 384        |       |
| Allocated  goodwill                                |       | 8,197                   |       | 4,671                |       | 14,906                      |       | 27,774     |       |
| Segment  income                                    |       | 5,062                   |       | 552                  |       | 2,094                       |       | 7,708      |       |
|                                               |       |                    |       |                 |       |                        |       |       |       |
| **Year Ended March 31, 2007**                 | ** ** | ** **              | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Product  revenue from external customers           |       | $                       | 27,261     |                 | $          | 6,408                       |       | $          | —     |   | $ | 33,669 |   |
| Service  and other revenue from external customers |       | —                  |       | 2,579                |       | 22,049                      |       | 24,628     |       |
| Stock-based  compensation                          |       | 37                      |       | 54                   |       | 78                          |       | 169        |       |
| Depreciation                                       |       | 82                      |       | 138                  |       | 126                         |       | 346        |       |
| Allocated  goodwill                                |       | 8,197                   |       | 4,671                |       | 14,906                      |       | 27,774     |       |
| Segment  income (loss)                             |       | 6,035                   |       | (2,625               | )          | 2,551                       |       | 5,961      |       |
|                                               |       |                    |       |                 |       |                        |       |       |       |
| **Year Ended March 31, 2006**                 | ** ** | ** **              | ** ** | ** **           | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Product  revenue from external customers           |       | $                       | 22,446     |                 | $          | 5,865                       |       | $          | —     |   | $ | 28,311 |   |
| Service  and other revenue from external customers |       | —                  |       | 2,845                |       | 19,330                      |       | 22,175     |       |
| Stock-based  compensation                          |       | 177                     |       | 101                  |       | 342                         |       | 620        |       |
| Depreciation                                       |       | 132                     |       | 189                  |       | 266                         |       | 587        |       |
| Allocated  goodwill                                |       | 8,197                   |       | 4,671                |       | 14,906                      |       | 27,774     |       |
| Segment  income (loss)                             |       | 3,420                   |       | (2,476               | )          | 1,842                       |       | 2,786      |       |

 

The RoadwaySensors segment had one customer with combined revenue representing 16.9% oftotal segment revenue for the year ended March 31, 2008; one customer withrevenue representing 26.5% of total segment revenue for the year ended March 31,2007; and one customer with revenue representing 25.9% of total segment revenuefor the year ended March 31, 2006. The Vehicle Sensors segment had threecustomers with combined revenue representing 60.9% of total segment revenue forthe year ended March 31, 2008; three customers with combined revenuerepresenting 64.2% of total segment revenue for the year ended March 31,2007; and two customers with combined revenue representing 70.7% of totalsegment revenue for the year ended March 31, 2006. The TransportationSystems segment had one customer with revenue representing 13.3% of totalsegment revenue for the year ended March 31, 2007.

 

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The followingreconciles segment income to consolidated income (loss) before income taxes andsegment assets to consolidated assets:

 
| ** **                            | ** ** | **March 31,**      | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2008**                | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Segment  income                       |       |                    |       |   |   |   |   |
| Total  income for reportable segments |       | $                       | 7,708      |   | $ | 5,961 |   | $ | 2,786 |   |
| Unallocated  amounts:                 |       |                    |       |   |   |   |   |
| Corporate  and other expenses         |       | (266                    | )          | (1,986 | ) | (2,020 | ) |
| Amortization  of intangible assets    |       | (147                    | )          | (147 | ) | (147 | ) |
| Other  income (expense), net          |       | 252                     |       | (653 | ) | 35 |   |
| Interest  expense, net                |       | (1,284                  | )          | (1,600 | ) | (1,459 | ) |
| Income  (loss) before income taxes    |       | $                       | 6,263      |   | $ | 1,575 |   | $ | (805 | ) |

 

The Company’s revenues are generated and theCompany’s assets are held substantially in the United States.

 

**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)** | ** ** |
| June 30,  2007      |       | $                                                                     | 15,757     |              | $          | 7,094           |       | $                                   | 1,096      |                                  | $          | 0.03 |   | $ | 0.03 |   |
| September 30,  2007 |       | 16,976                                                                |       | 7,262             |       | 2,170           |       | 0.07                                |       | 0.06                                  |       |
| December 31,  2007  |       | 15,363                                                                |       | 6,500             |       | 954             |       | 0.03                                |       | 0.03                                  |       |
| March 31,  2008     |       | 17,067                                                                |       | 7,441             |       | 7,943           |       | 0.24                                |       | 0.23                                  |       |
|                     |       | $                                                                     | 65,163     |              | $          | 28,297          |       | $                                   | 12,163     |                                  | $          | 0.37 | * | $ | 0.35 | * |
|                     |       |                                                                  |       |              |       |            |       |                                |       |                                  |       |
| June 30,  2006      |       | $                                                                     | 13,816     |              | $          | 5,719           |       | $                                   | 279        |                                  | $          | 0.01 |   | $ | 0.01 |   |
| September 30,  2006 |       | 14,466                                                                |       | 5,957             |       | 732             |       | 0.03                                |       | 0.02                                  |       |
| December 31,  2006  |       | 14,488                                                                |       | 5,676             |       | 310             |       | 0.01                                |       | 0.01                                  |       |
| March 31,  2007     |       | 15,527                                                                |       | 6,656             |       | 1,597           |       | 0.05                                |       | 0.05                                  |       |
|                     |       | $                                                                     | 58,297     |              | $          | 24,008          |       | $                                   | 2,918      |                                  | $          | 0.10 | * | $ | 0.09 | * |

 

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*            Annual per shareamounts may not agree to the sum of the quarterly per share amounts due todifferences between average shares outstanding during the periods.

 

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**Schedule II**

 

**Valuationand Qualifying Accounts (In thousands)**

 
| **Description**                     | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged to  Accounts** | ** ** | **Balance at End  of Period** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------|------------|----------------------------------------------|------------|
| ** **                          | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** **                    | ** ** | ** **                                   | ** ** |
| **Year Ended March 31, 2008**  | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** **                    | ** ** | ** **                                   | ** ** |
| Deducted  from asset accounts:      |       |                                           |       |                                          |       |                          |       |                                         |       |
| Allowance  for doubtful accounts    |       | $                                              | 664        |                                          | $          | 360                           |       | $                                            | (4         | ) | $ | 1,020 |   |
| Reserve  for inventory obsolescence |       | 844                                            |       | 576                                           |       | (601                          | )          | 819                                          |       |
| **Year Ended March 31, 2007**  | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** **                    | ** ** | ** **                                   | ** ** |
| Deducted  from asset accounts:      |       |                                           |       |                                          |       |                          |       |                                         |       |
| Allowance  for doubtful accounts    |       | $                                              | 429        |                                          | $          | 220                           |       | $                                            | 15         |   | $ | 664 |   |
| Reserve  for inventory obsolescence |       | 592                                            |       | 420                                           |       | (168                          | )          | 844                                          |       |
| **Year Ended March 31, 2006**  | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** **                    | ** ** | ** **                                   | ** ** |
| Deducted  from asset accounts:      |       |                                           |       |                                          |       |                          |       |                                         |       |
| Allowance  for doubtful accounts    |       | $                                              | 239        |                                          | $          | 275                           |       | $                                            | (85        | ) | $ | 429 |   |
| Reserve  for inventory obsolescence |       | 514                                            |       | 312                                           |       | (234                          | )          | 592                                          |       |

 

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