UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the quarterly period ended December 31, 2007

	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		(I.R.S. Employer
incorporation or organization)		Identification No.)

1700 Carnegie Avenue, Suite 100
Santa Ana, California		92705
(Address of principal executive office)		(Zip Code)

(949) 270-9400

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

Large accelerated filer o Accelerated filer o Non-accelerated filer x

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

Yes o No x

As of January 31, 2008, the registrant had 33,304,527 shares of common stock outstanding.

ITERIS, INC.

Quarterly Report on Form 10-Q
For the Three and Nine Months Ended December 31, 2007

Table of Contents

PART I.	FINANCIAL INFORMATION	3

ITEM 1.	FINANCIAL STATEMENTS	3

	CONDENSED CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 2007 AND MARCH 31, 2007	3

	UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED DECEMBER 31, 2007 AND 2006	4

	UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED DECEMBER 31, 2007 AND 2006	5

	NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	6

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	17

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		25

ITEM 4.	CONTROLS AND PROCEDURES	25

PART II.	OTHER INFORMATION	27

ITEM 1.	LEGAL PROCEEDINGS	27

ITEM 1A.	RISK FACTORS	27

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	36

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	36

ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	36

ITEM 5.	OTHER INFORMATION	36

ITEM 6.	EXHIBITS	36

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

AutoVue^®, Iteris^®, Vantage^® and eAccess™ are among the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ITERIS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

	December 31, 2007			March 31, 2007
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	679		$	35
Trade accounts receivable, net of allowance for doubtful accounts of $812 and $664 at December 31, 2007 and March 31, 2007, respectively	12,607			11,493
Costs and estimated earnings in excess of billings on uncompleted contracts	5,149			3,689
Inventories, net of reserve for inventory obsolescence of $910 and $844 at December 31, 2007 and March 31, 2007, respectively	4,400			6,379
Deferred income taxes	611			494
Prepaid expenses and other current assets	413			385
Total current assets	23,859			22,475
Property and equipment, net	3,496			1,712
Deferred income taxes	2,645			2,533
Intangible assets, net	294			404
Goodwill	27,774			27,774
Other assets	386			352
Total assets	$	58,454		$	55,250

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	3,206		$	3,542
Accrued payroll and related expenses	3,822			3,527
Accrued liabilities	2,168			1,618
Billings in excess of costs and estimated earnings on uncompleted contracts	1,199			847
Revolving line of credit	199			4,015
Current portion of long-term debt	570			1,947
Total current liabilities	11,164			15,496
Deferred rent	1,963			—
Deferred compensation plan liability	669			730
Other non-current liabilities	97			163
Long-term debt	9,565			9,760
Total liabilities	23,458			26,149
Commitments and contingencies
Redeemable common stock, none issued and outstanding at December 31, 2007 and 1,219 shares issued and outstanding at March 31, 2007	—			3,414
Stockholders’ equity:
Preferred stock, $1.00 par value, 2,000 shares authorized, none issued and outstanding at December 31, 2007 and March 31, 2007	—			—
Common stock, $0.10 par value, 70,000 and 50,000 shares authorized, 33,264 and 30,601 shares issued or issuable and outstanding, at December 31, 2007 and March 31, 2007, respectively	3,326			3,060
Additional paid-in capital	135,278			130,425
Common stock held in trust, 167 and 311 shares at December 31, 2007 and March 31, 2007, respectively	(202		)	(374		)
Notes receivable from employees	—			(5		)
Accumulated deficit	(103,442		)	(107,438		)
Accumulated other comprehensive income	36			19
Total stockholders’ equity	34,996			25,687
Total liabilities and stockholders’ equity	$	58,454		$	55,250

See accompanying notes to unaudited condensed consolidated financial statements.

ITERIS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

	Three Months Ended December 31,						Nine Months Ended December 31,
	2007			2006			2007			2006
Net sales and contract revenues:
Net sales	$	9,176		$	8,575		$	30,215		$	26,498
Contract revenues	6,187			5,913			17,881			16,272
Total net sales and contract revenues	15,363			14,488			48,096			42,770

Costs of net sales and contract revenues:
Cost of net sales(a)	4,631			4,746			15,302			14,800
Cost of contract revenues(a)	4,232			4,066			11,938			10,618
Gross profit	6,500			5,676			20,856			17,352
Operating expenses:
Selling, general and administrative(a)	4,041			3,879			12,820			11,865
Research and development(a)	1,002			1,038			2,623			2,812
Deferred compensation plan	290			(29		)	299			(61		)
Amortization of intangible assets	37			37			110			110
Total operating expenses	5,370			4,925			15,852			14,726
Operating income	1,130			751			5,004			2,626
Non-operating income (expense):
Other income (expense), net	(3		)	(5		)	41			(650		)
Interest expense, net	(314		)	(390		)	(1,046		)	(1,200		)
Income before income taxes	813			356			3,999			776
Income tax benefit (provision)	141			(46		)	221			545
Net income	$	954		$	310		$	4,220		$	1,321

Earnings per share:
Basic	$	0.03		$	0.01		$	0.13		$	0.05
Diluted	$	0.03		$	0.01		$	0.12		$	0.04
Weighted average shares outstanding:
Basic	32,914			30,438			32,568			29,238
Diluted	35,256			33,813			34,674			33,067

(a) Includes stock-based compensation expense as follows:
Cost of net sales	$	1	$	3	$	3	$	12
Cost of contract revenues	3		8		9		56
Selling, general and administrative expense	77		46		190		147
Research and development expense	1		2		5		18
Total	$	82	$	59	$	207	$	233

See accompanying notes to unaudited condensed consolidated financial statements.

ITERIS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Nine Months Ended December 31,
	2007			2006
Cash flows from operating activities
Net income	$	4,220		$	1,321
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment	443			405
Change in deferred tax assets	(229		)	(512		)
Stock-based compensation expense	207			233
Amortization of deferred gain on sale—leaseback transaction	(165		)	(213		)
Amortization of debt discount	155			155
Amortization of intangible assets	110			110
Amortization of deferred financing costs	104			103
Issuance of warrants for services	—			22
Changes in operating assets and liabilities:
Accounts receivable	(1,114		)	(443		)
Net costs and estimated earnings in excess of billings	(1,108		)	(798		)
Inventories	1,979			(3,616		)
Prepaid expenses and other assets	(166		)	(399		)
Accounts payable and accrued liabilities	928			1,350
Net cash provided by (used in) operating activities	5,364			(2,282		)

Cash flows from investing activities
Purchases of property and equipment	(455		)	(311		)

Cash flows from financing activities
Net payments on line of credit	(3,816		)	1,490
Payments on long-term debt	(1,727		)	(1,195		)
Proceeds from stock option and warrant exercises	1,325			2,945
Change in checks drawn in excess of available bank balances	(47		)	(651		)
Proceeds from notes receivable from employees	—			40
Net cash provided by (used in) financing activities	(4,265		)	2,629
Increase in cash	644			36
Cash at beginning of period	35			131
Cash at end of period	$	679		$	167

Supplemental cash flow information:
Cash paid during the period:
Interest	$	825		$	937
Income taxes	48			26

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			213
Write-off of notes receivable from employees	(5		)	—

See accompanying notes to unaudited condensed consolidated financial statements.

ITERIS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

Iteris, Inc. is a leader in the traffic management market and focuses on the development and application of advanced technologies that reduce traffic congestion, minimize the environmental impact of traffic congestion and improve the safety of surface transportation systems. By combining outdoor image processing, traffic engineering and information technology, the Company offers a broad range of Intelligent Transportation Systems and driver safety solutions to customers worldwide. The Company was originally incorporated in Delaware in 1987. On October 22, 2004, the Company completed a merger with its majority-owned subsidiary, Iteris, Inc. (the “Iteris Subsidiary”), and officially changed its corporate name from Iteris Holdings, Inc. to Iteris, Inc.

Basis of Presentation

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

Use of Estimates

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

Reclassifications

Certain amounts in the prior period financial statements have been reclassified to conform with current year presentation.

Revenue Recognition

Product revenues and related costs of sales are recognized upon the transfer of title, which generally occurs upon shipment or, if required, upon acceptance by the customer, provided that the Company believes collectibility of the net sales amount is probable. Accordingly, at the date revenue is recognized, the significant uncertainties concerning the sale have been resolved.

contract penalty provisions and final contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenue when their realization is reasonably assured.

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

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

Concentration of Credit Risk

Accounts receivable are primarily derived from revenues earned from customers located throughout North America and Europe. The Company generally does not require collateral or other security from customers. Collectibility of receivable balances is estimated through review of invoices outstanding greater than a certain period of time and ongoing credit evaluations of customers’ financial condition. Reserves are maintained for potential credit losses, and such losses have historically been within management’s expectations.

Fair Values of Financial Instruments

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

Inventories

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

Property and Equipment

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

Goodwill and Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Intangible Assets, goodwill is tested for impairment on an annual basis in the Company’s fourth fiscal quarter or more frequently if indicators of impairment exist, of which none have been identified. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair value of the Company’s reporting units with each respective reporting unit’s carrying amount, including goodwill. The Company determines the fair value of reporting units using the income approach. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the second step of the goodwill impairment test is performed to determine the amount of any impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill.

The Company evaluates long-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 operations when indicators of impairment are present. Reviews are performed to determine whether the carrying value of assets is impaired, based on a comparison to undiscounted expected future cash flows. If this comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using discounted expected future cash flows and a discount rate based upon the Company’s weighted average cost of capital adjusted for risks associated with the related operations. Impairment is based on the excess of the carrying amount over the fair value of those assets.

Income Taxes

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

Stock-Based Compensation

Effective April 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as an expense, based on their grant date fair values with such fair values amortized over the requisite service period. The Company elected to use the modified prospective transition method for transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modified after the date of adoption. In addition, under the modified prospective method, compensation expense is recognized for all stock-based compensation awards granted prior to but not yet vested as of April 1, 2006, based on grant-date fair values estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”).

Research and Development Expenditures

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

Shipping and Handling Costs

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

Sales Taxes

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

Warranty

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

Repair and Maintenance Costs

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

Other Comprehensive Income

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

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 applies to all tax positions accounted for under SFAS 109, and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The interpretation requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by

the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized. FIN 48 requires additional disclosures and is effective as of the beginning of the first fiscal year beginning after December 15, 2006. As further discussed in Note 4, the Company adopted FIN 48 effective April 1, 2007.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather it specifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Early application of the statement is encouraged. Generally, this statement will be applied prospectively. The Company is currently evaluating the impact of SFAS 157 and expects to adopt SFAS 157 in the first quarter of its fiscal year ending March 31, 2009.

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

2. Supplemental Financial Information

Inventories

The following table presents details of the Company’s inventories:

	December 31, 2007		March 31, 2007
	(In thousands)
Materials and supplies	$	3,419	$	4,705
Work in process	268		366
Finished goods	713		1,308
	$	4,400	$	6,379

Intangible Assets

	December 31, 2007					March 31, 2007
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
	(In thousands)
Developed technology	$	495	$	(356	)	$	495	$	(280	)
Patents	317		(162		)	317		(128		)
Total	$	812	$	(518	)	$	812	$	(408	)

Amortization expense for intangible assets subject to amortization was $37,000 and $110,000 for the three and nine months ended December 31, 2007, respectively, and $37,000 and $110,000 for the three and nine months ended December 31, 2006, respectively. Future estimated amortization expense for the remainder of the current fiscal year and the next four fiscal years is as follows:

Fiscal Year Ending March 31:
(In thousands)
2008	$	37
2009	147
2010	58
2011	46
2012	6
	$	294

Warranty Reserve Activity

The following table presents activity in accrued warranty obligations:

	Three Months Ended December 31,						Nine Months Ended December 31,
	2007			2006			2007			2006
	(In thousands)
Balance at beginning of period	$	489		$	679		$	520		$	519
Additions charged to cost of sales	109			160			253			450
Warranty claims	(74		)	(265		)	(249		)	(395		)
Balance at end of period	$	524		$	574		$	524		$	574

Earnings Per Share

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

	Three Months Ended December 31,				Nine Months Ended December 31,
	2007		2006		2007		2006
	(In thousands, except per share amounts)
Numerator:
Net income	$	954	$	310	$	4,220	$	1,321

Denominator:
Weighted average common shares used in basic computation	32,914		30,438		32,568		29,238
Dilutive stock options	2,329		3,342		2,086		3,436
Dilutive warrants	13		33		20		393
Weighted average common shares used in dilutive computation	35,256		33,813		34,674		33,067

Earnings per share:
Basic	$	0.03	$	0.01	$	0.13	$	0.05
Diluted	$	0.03	$	0.01	$	0.12	$	0.04

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

	Three Months Ended December 31,		Nine Months Ended December 31,
	2007	2006	2007	2006
	(In thousands)
Stock options	355	567	552	553
Warrants	1,150	1,190	1,177	1,257
Convertible debentures	2,729	2,729	2,729	2,729

3. Revolving Line of Credit and Long-Term Debt

Revolving Line of Credit

In October 2006, the Company entered into a two-year credit facility with a bank. At December 31, 2007, the facility provided for line of credit borrowings of up to $10.0 million. Under the credit facility, the Company may borrow against its eligible accounts receivable and eligible inventory, as defined in the credit agreement. Interest on borrowed amounts under the line of credit is payable monthly at the current stated prime rate plus 1.00% (8.25% at December 31, 2007). Additionally, the Company is obligated to pay an unused line fee of 0.25% per annum applied to the amount by which the maximum credit amount exceeds the average daily principal balance during the preceding month. The credit facility requires $2,000 in monthly collateral management fees and includes an early termination fee equal to 2% of the total facility during the first year of the agreement and 1% of the total facility in the second year of the agreement. The credit facility is secured by substantially all of the assets of the Company.

On December 31, 2007, the available credit under the Company’s credit facility was $9.3 million, of which $9.1 million was unused.

Long-Term Debt

The Company’s long-term debt consists of the following:

	December 31, 2007			March 31, 2007
	(In thousands)
Convertible debentures, net	$	9,565		$	9,410
Bank term note	524			1,573
Promissory note to landlord	—			646
Other	46			78
	10,135			11,707
Less current portion	(570		)	(1,947		)
	$	9,565		$	9,760

Convertible Debentures, Net. In May 2004, the Company sold and issued subordinated convertible debentures in the aggregate original principal amount of $10.1 million. In connection with the issuance of the debentures, the Company issued warrants to purchase an aggregate of 639,847 shares of its common stock, the value of which was recorded as a debt discount against the face amount of the debentures on the date of issuance and is being amortized to interest expense over the term of the convertible debentures.

The debentures are due in full on May 19, 2009, provide for 6.0% annual interest, payable quarterly, and are convertible into the Company’s common stock at an initial conversion price of $3.61 per share, subject to certain adjustments, including adjustments for dilutive issuances. From May 19, 2008, until the maturity date, the Company may redeem the debentures at 110% of the principal amount. As of December 31, 2007, $250,000 of convertible debentures had been converted into 69,252 shares of common stock leaving $9.9 million of the originally issued convertible debentures outstanding at December 31, 2007.

Bank Term Note. In October 2004, the Company entered into a $5.0 million term note payable with a bank. The note was due on May 27, 2008, and provided for monthly principal payments of approximately $104,000. In October 2006, the term note was assumed by the Company’s new bank as part of the Company’s new credit facility. The new term note is also due on May 27, 2008 and provides for monthly principal payments of approximately $104,000. Interest accrues under the new term note at an annual rate of 8.75%.

Both the bank term note and the line of credit are held by one bank under the same credit agreement and are secured by substantially all of the assets of the Company.

Promissory Note to Landlord. The Company had an unsecured promissory note payable to the landlord of its previous headquarters. Under the terms of the note agreement, interest was payable quarterly and accrued at a rate of prime plus 2.0%. In October 2006, January 2007, April 2007 and July 2007, the Company made four required equal quarterly principal payments of $323,000. As of December 31, 2007, all interest and principal under this note was paid in full.

Scheduled aggregate maturities of long-term debt principal as of December 31, 2007 were as follows:

Fiscal Year Ending March 31,
(In thousands)
2008	$	221
2009	349
2010	9,850
	10,420
Less: unamortized debt discount	(285		)
	$	10,135

4. Income Taxes

On April 1, 2007, the Company adopted FIN 48. In connection with the adoption of FIN 48, the Company recognized an adjustment of approximately $224,000 to the beginning balance of retained earnings on its condensed consolidated balance sheet. The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2007, the Company had recorded approximately $22,000 of accrued interest and penalties related to uncertain tax positions.

At April 1, 2007, the Company’s fiscal 2004 through fiscal 2007 tax years remained open to examination by the Federal taxing authorities. The Company’s fiscal 2003 through fiscal 2007 tax years remained open to examination by the state taxing authorities. However, the Company has consolidated and acquired net operating losses (“NOLs”) beginning in fiscal 1995 which would cause the statute of limitations to remain open for the year in which the NOLs were incurred.

5. Commitments and Contingencies

Litigation and Other Contingencies

On June 29, 2004, a supplier to Mariner Networks, Inc., a former subsidiary of the Company that was discontinued in the fiscal year ended March 31, 2002, filed a complaint in Orange County Superior Court against the Company alleging various breaches of written contract claims arising out of alleged purchase orders. On July 20, 2006, the Company entered into a settlement agreement in connection with this matter. The dispute was settled in full for $688,000 payable as follows: (i) the Company 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’s common stock on the date of issuance; (ii) the Company made a cash payment of $125,000 on October 20, 2006; and (iii) the Company is obligated to pay $350,000 in cash in equal monthly installments of $9,700 over three years beginning in November 2006. In connection with this settlement, the Company recorded a charge of $635,000, representing the fair value of the settlement, to other expense in the accompanying condensed consolidated statement of operations for the nine months ended December 31, 2006.

In August 2007, the Company received a complaint filed by American Signal Company against the Company and six other defendants in the United States District Court, Middle District of Louisiana, which alleges negligence and other charges in connection with a contract to which the Company was a third party engineering service provider. The Company is reviewing the complaint but does not believe that this matter will ultimately have a material adverse effect on its consolidated results of operations, financial position or cash flows.

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

Furthermore, from time to time, the Company has experienced unforeseen developments in contingencies related to its former subsidiaries. For example, the Company has been the subject of a number of routine tax audits for time periods and jurisdictions related to the businesses of its former subsidiaries, some of which are still in process. Although the development and ultimate outcome of these and other unforeseen matters cannot be predicted with any certainty, management does not believe that the Company is presently involved in any matters related to its former subsidiaries that would have a material adverse effect on the Company’s consolidated results of operations, financial position or cash flows.

Operating Lease Commitments

In May 2007, the Company entered into an agreement to lease 52,000 square feet of space in Santa Ana, California for a term of 88 months. In September 2007, the Company relocated its headquarters and principal operations into this space. The monthly lease rate is $102,000 during the first year of the lease and increases each year thereafter, up to a maximum of $120,000 during the last year of the lease. The lease may be extended for a period of five years, at the option of the Company, at a lease rate to be based on the market lease rate for comparable property determined as of the commencement date of the extension period. Additionally, the lease agreement provides for $1.8 million in incentives in the form of tenant improvement allowances, which the Company recorded as deferred rent in its condensed consolidated balance sheet at December 31, 2007. This amount will reduce future rent expense over the term of the lease. An equal amount was capitalized as property and equipment in the condensed consolidated balance sheet at December 31, 2007, and will be depreciated over the estimated useful life of the related leasehold improvements.

The Company has lease commitments for facilities in various locations throughout the United States. Future commitments under these non-cancelable operating leases at December 31, 2007 were as follows:

Fiscal Year Ending March 31,
(In thousands)
Remainder of 2008	$	343
2009	1,488
2010	1,391
2011	1,348
2012	1,332
Thereafter	3,823
Total	$	9,725

The Company previously subleased office space to MAXxess Systems, Inc. (“MAXxess”), a former subsidiary of the Company that was sold by the Company in September 2003 and is currently owned by an investor group that includes two of the Company’s directors, one of which is the Chief Executive Officer of MAXxess. At December 31, 2007, MAXxess owed the Company an aggregate of $274,000 related to this sublease, which terminated in September 2007, and certain related ancillary services that were provided by the Company to MAXxess. The Company previously had reserved for amounts aggregating $183,000 of this balance due to MAXxess’ inability to pay these obligations. During the nine months ended December 31, 2007, the Company reserved for all incremental amounts charged to MAXxess, which aggregated $91,000.

Inventory Purchase Commitments

At December 31, 2007, the Company had firm commitments to purchase inventory in the amount of $4.1 million during the next three fiscal quarters.

6. Common Stock Warrants

On September 27, 2006, the Company issued warrants to purchase an aggregate 246,250 shares of common stock at an exercise price of $3.25 with a five year life to an existing stockholder in exchange for the early exercise of warrants to purchase an aggregate of 1,250,000 shares of common stock at an exercise price of $1.61 per share. The new warrants are immediately exercisable and are callable by the Company if the market price of the Company’s common stock trades for 20 consecutive days at a price greater than or equal to two times the exercise price of the warrants. The fair value of the new warrants was $320,000 calculated using the Black-Scholes-Merton (“BSM”) option-pricing formula. The warrants were considered a cost of raising capital and were recorded in equity.

In connection with the issuance of the new warrants, the Company is party to a registration rights agreement that contains provisions under which the Company could be subjected to liquidated damages should it fail to maintain effective registration statements for the underlying shares of common stock. These warrants have been accounted for within equity in the condensed consolidated balance sheet in accordance with EITF 00-19 Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and, accordingly, no liabilities have been recorded in connection therewith. As of December 31, 2007, no liquidated damages were payable under the provisions of the registration rights agreement associated with these warrants.

7. Redeemable Common Stock

In connection with the merger of the Iteris Subsidiary into the Company (Note 1), on May 28, 2004, the Company acquired 547,893 shares of common stock of the Iteris Subsidiary in exchange 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 to repurchase up to 100% of the shares at a purchase price of $1.438 per share. All such rights to require the repurchase of these shares expired on September 28, 2007. Because these rights were outside of the control of the Company, the Company previously had classified the $3.4 million value of the 1,219,445 shares as redeemable common stock on its condensed consolidated balance sheet. Upon the expiration of these rights, the Company reclassified $122,000 to common stock and $3.3 million to additional paid-in capital on its condensed consolidated balance sheet.

8. Stock-Based Compensation

On September 21, 2007, the Company’s stockholders approved the 2007 Omnibus Incentive Plan (the “2007 Plan”), which provides that options to purchase shares of the Company’s unissued common stock may be granted to employees, officers, consultants and directors to the Company at exercise prices which are equal to or greater than the 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 generally vest at the rate of 25% on each of the first four anniversaries of the grant date. The 2007 Plan also allows for the issuance of stock appreciation rights, restricted stock, restricted stock units and other stock-based awards based on the value of the Company’s common stock. New shares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. As of December 31, 2007, options to purchase an aggregate of 230,000 shares of common stock were outstanding under the 2007 Plan.

The Company’s 1997 Stock Incentive Plan (the “1997 Plan”) terminated in September 2007; however, all stock options outstanding under the 1997 Plan will remain outstanding pursuant to the terms of such stock options. As of December 31, 2007, options to purchase 1.5 million shares of the Company’s common stock were outstanding under the 1997 Plan.

In connection with the merger of the Company and the Iteris Subsidiary (Note 1), the Company assumed the 1998 Stock Incentive Plan of the Iteris Subsidiary (the “1998 Plan”) and all outstanding options granted thereunder. As of December 31, 2007, options to purchase 2.9 million shares of the Company’s common stock were outstanding under the 1998 Plan. No further options may be granted under the 1998 Plan.

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

A summary of activity in the Plans for the nine months ended December 31, 2007 is as follows:

	Options		Weighted Average Exercise Price		Weighted Average Remaining Life (In Years)	Aggregate Intrinsic Value
	(In thousands, except per share amounts and number of years)
Options outstanding at March 31, 2007	5,818		$	1.60	3.4	$	6,115
Granted	230		$	2.32	N/A
Exercised	(1,358	)	$	0.88	N/A
Forfeited	(26	)	$	3.04	N/A
Expired	(57	)	$	3.16	N/A
Options outstanding at December 31, 2007	4,607		$	1.82	3.8	$	3,649
Vested and expected to vest at December 31, 2007	4,504		$	1.81	3.6	$	3,649
Options exercisable at December 31, 2007	4,063		$	1.73	3.1	$	3,647
Options exercisable at December 31, 2007 pursuant to a change-in-control	4,607		$	1.82	3.8	$	3,649

At December 31, 2007, there were 620,000 shares of common stock available for grant under the 2007 Plan.

For the nine month periods ended December 31, 2007 and 2006, the Company received $1.2 million and $505,000, respectively, in cash from the exercise of stock options. Total stock-based compensation expense was $82,000 and $207,000 for the three and nine months ended December 31, 2007, respectively, and $59,000 and $233,000 for the three and nine months ended December 31, 2006, respectively. No income tax benefit was realized from activity in the Plans during the nine months ended December 31, 2007 and 2006.

At December 31, 2007, there was $1.0 million of total unrecognized compensation expense related to unvested stock options. This expense is expected to be recognized over a weighted-average period of approximately 3.4 years.

The fair value of each stock-based award is estimated on the grant date using the Black-Scholes-Merton (“BSM”) option-pricing formula. Expected volatility is based on the historical volatility of the Company’s stock price. The expected life of options granted subsequent to the adoption of SFAS 123R is derived based on the historical life of the Company’s options. The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury interest rates in effect at the time of grant. The grant date fair value of options granted was estimated using the following weighted-average assumptions:

	Three Months Ended December 31,			Nine Months Ended December 31,
	2007		2006	2007		2006

Dividend yield	0.0		N/A	0.0		0.0
Expected life — years	7.0		N/A	7.0		7.0
Risk-free interest rate	4.2	%	N/A	4.3	%	4.8	%
Expected volatility of common stock	0.85		N/A	0.85		0.89

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

	Three Months Ended December 31,				Nine Months Ended December 31,
	2007		2006		2007		2006
	(In thousands, except per share amounts)
Weighted average grant date fair value per share	$	1.82	N/A		$	1.81	$	1.86
Intrinsic value of options exercised	$	650	$	541	$	2,297	$	766
Total fair value of options vested during the period	$	33	$	104	$	210	$	621

9. Business Segment Information

The Company currently operates in three reportable segments: Roadway Sensors, Vehicle Sensors and Transportation Systems. The Roadway Sensors segment includes the Company’s Vantage vehicle detection systems for

traffic intersection control, incident detection and certain highway traffic data collection applications. The Vehicle Sensors segment includes AutoVue and is comprised of all activities related to lane departure warning systems for vehicle safety. The Transportation Systems segment includes transportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Prior to April 1, 2007, certain expenses, such as interest, amortization of certain intangibles and certain corporate expenses were not allocated to the segments. Beginning on April 1, 2007, the Company increased the portion of its corporate expenses that it allocates to its segments such that substantially all corporate expenses are allocated. Interest, amortization of certain intangibles and certain corporate expenses are still not allocated to the segments. In addition, certain assets, including cash and cash equivalents, deferred income taxes and certain long-lived and intangible assets, are not allocated to the segments. The reportable segments are each managed separately because they manufacture and distribute distinct products or provide services with different processes. All segment revenues are derived from external customers.

The following table sets forth selected unaudited financial information for the Company’s reportable segments for the three and nine months ended December 31, 2007 and 2006:

	Roadway Sensors		Vehicle Sensors			Transportation Systems		Total
	(In thousands)
Three Months Ended December 31, 2007
Product revenue	$	6,432	$	2,281		$	—	$	8,713
Service and other revenue	—		463			6,187		6,650
Stock-based compensation expense	3		10			6		19
Depreciation and amortization	26		32			39		97
Segment income	929		167			449		1,545

Three Months Ended December 31, 2006
Product revenue	$	6,499	$	1,460		$	—	$	7,959
Service and other revenue	—		616			5,913		6,529
Stock-based compensation expense	5		14			12		31
Depreciation and amortization	21		35			32		88
Segment income (loss)	1,384		(892		)	652		1,144

Nine Months Ended December 31, 2007
Product revenue	$	21,273	$	7,630		$	—	28,903
Service and other revenue	—		1,312			17,881		19,193
Stock-based compensation expense	13		34			19		66
Depreciation and amortization	79		98			105		282
Segment income	3,725		439			1,426		5,590

Nine Months Ended December 31, 2006
Product revenue	$	19,976	$	4,282		$	—	$	24,258
Service and other revenue	—		2,240			16,272		18,512
Stock-based compensation expense	33		41			71		145
Depreciation and amortization	60		103			94		257
Segment income (loss)	4,458		(2,080		)	1,958		4,336

The following table reconciles segment income to consolidated income before income taxes:

	Three Months Ended December 31,						Nine Months Ended December 31,
	2007			2006			2007			2006
	(In thousands)
Total income for reportable segments	$	1,545		$	1,144		$	5,590		$	4,336
Unallocated amounts:
Corporate expenses	(415		)	(393		)	(586		)	(1,710		)
Other income (expense), net	(3		)	(5		)	41			(650		)
Interest expense, net	(314		)	(390		)	(1,046		)	(1,200		)
Income before income taxes	$	813		$	356		$	3,999		$	776

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

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

Overview

We are a leader in the traffic management market that focuses on the development and application of advanced technologies that reduce traffic congestion, minimize the environmental impact of traffic congestion and improve the safety of surface transportation systems. By combining outdoor image processing, traffic engineering and information technology, we offer a broad range of Intelligent Transportation Systems and driver safety solutions to customers worldwide.

We currently operate in three reportable segments: Roadway Sensors, Vehicle Sensors and Transportation Systems. The Roadway Sensors segment includes our Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications. The Vehicle Sensors segment is comprised of all activities related to our AutoVue Lane Departure Warning (“LDW”) systems for vehicle safety. The Transportation Systems segment includes transportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry.

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

Our AutoVue LDW systems consist of a small windshield mounted sensor that uses proprietary software to detect and warn drivers of unintended lane departures. In excess of 90,000 production AutoVue units have been sold for car and truck platforms in the North American and European markets. Our AutoVue LDW systems are currently qualified as an option on certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner and FUSO, as well as Neoplan and MAN luxury bus and coach lines. In North America, our LDW systems are sold primarily to truck fleets, and to date, 56 U.S. heavy truck fleets have selected our LDW systems, representing an estimated 30,000 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 manufacture our AutoVue LDW systems to the worldwide passenger car market in exchange for royalty payments for each AutoVue LDW unit sold. To date, royalty payments from Valeo have not been significant. Pursuant to this agreement, we also provide specific contract engineering services, technical marketing and sales support to Valeo to enable the incorporation of our LDW technology on four Infiniti platforms, the FX, M, Q and EX, where the device is offered as part of various option packages. Valeo is currently in discussions to provide our LDW system to other passenger car OEMs; however, we cannot assure you that such discussions will be successful. We plan to continue to provide technical marketing and sales support to Valeo in our efforts to win new OEM customers for the passenger car market as well as contract engineering services related to the possible launch of new Infiniti platforms that include our LDW system. We believe that AutoVue is a broad sensor platform that, through additional software development, may be expanded to incorporate additional safety and convenience features.

Our transportation management systems business includes transportation engineering and consulting services focused on the planning, design, development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. Our services include planning, design and implementation of surface transportation infrastructure systems. We perform analysis and study goods movement, commercial vehicle operations, travel demand forecasting and systems engineering, and identify mitigation measures to reduce traffic congestion. These services and systems are primarily sold to local, state and national transportation agencies in the United States. Our transportation management systems business is largely dependent upon governmental funding and budgetary issues. The Federal Highway Bill that was passed in August 2005 provided for a significant increase in transportation funding over the following six years. We believe the recent expansion of our transportation management systems business was due in part to the passage of the Federal Highway Bill, combined with increased transportation funds available at state and local agencies throughout the country.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our unaudited condensed consolidated financial statements included herein, which have been prepared in accordance with U.S generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to the collectibility of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for stock-based compensation, the valuation of equity instruments, warranty reserves and other contingencies. We base these estimates on our historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported assets and liabilities at the date of the financial statements and our reported revenues and expenses during the reporting period.

The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements.

Revenue Recognition. We record product revenues and related costs of sales upon transfer of title, which is generally upon shipment or, if required, upon acceptance by the customer, provided that we believe collectibility of the net sales amount is reasonably assured. Accordingly, at the date revenue is recognized, the significant uncertainties concerning the sale have been resolved.

Contract revenues are derived primarily from long-term contracts with governmental agencies. Contract revenues include costs incurred plus a portion of estimated fees or profits determined using the percentage of completion method of accounting based on the relationship of costs incurred to total estimated costs. Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to recognized costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenue when their realization is reasonably assured.

In addition to product and contract revenues, we derive revenue from technology access fees, the provision of specific non-recurring contract engineering services to our strategic partner, Valeo, related to our AutoVue LDW systems, and royalties earned on unit sales of our AutoVue LDW systems by Valeo to the passenger car market. Technology access fee revenues are recognized evenly over the period in which they are earned. Non-recurring contract engineering revenues are recognized in the period in which the related services are performed. Royalty revenues are recorded based on unit sales of our products by Valeo and are recognized in the period in which such sales occur. Technology access fee revenues, non-recurring contract engineering revenues and royalty revenues are included in net sales.

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

Accounts Receivable. We estimate the collectibility of customer receivables on an ongoing basis by periodically reviewing invoices outstanding greater than a certain period of time. We record reserves for receivables deemed to be at risk for collection as well as a general reserve based on our historical collections experience. A considerable amount of judgment

is required in assessing the ultimate realization of trade receivables, including the current credit-worthiness of each customer. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make required payments, additional allowances may be required that could adversely affect our operating results.

Inventory. Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or market. We provide reserves for potentially excess and obsolete inventory. In assessing the ultimate realization of inventories, we make judgments as to future demand requirements and compare that with the current or committed inventory levels. Reserves are established for inventory levels that exceed anticipated future demand. It is possible that reserves over and above those already established may be required in the future if market conditions for our products deteriorate.

Goodwill. Goodwill is tested for impairment annually in our fourth fiscal quarter at the reporting unit level unless a change in circumstances indicates that more frequent impairment analysis is required. Impairment, if any, is measured based on the estimated fair value of the reporting units with the recorded goodwill. Fair value is determined by using the income approach methodology of valuation which utilizes discounted cash flows. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. In estimating future cash flows, we generally use the financial assumptions in our current budget and our current strategic plan, subject to modification as considered necessary, including sales and expense growth 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. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of goodwill, we could incur impairment charges.

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

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

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

Effective April 1, 2007, we adopted FIN 48, which applies to all tax positions accounted for under SFAS 109 and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. FIN 48 requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized.

Stock-Based Compensation. Effective April 1, 2006, we adopted SFAS 123R, which requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as an expense, based on their grant date fair values with such fair values amortized over the requisite service period. We elected to utilize the modified prospective method for the transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modified after the date of adoption. In addition, under the modified prospective method, compensation expense is recognized for all stock-based compensation awards granted prior to but not yet vested as of April 1, 2006, based on grant-date fair values estimated in accordance with the original provisions of SFAS 123.

We use the BSM option-pricing formula to estimate the fair value of stock-based awards granted subsequent to April 1, 2006. Our assumptions under the BSM formula include the following: expected volatilities are based on the

historical volatility of our stock price, the expected life of options is derived based on the historical life of our options, and the risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury interest rates in effect at the time of grant. Additionally, our calculation of stock compensation expense under SFAS 123R includes an estimate of forfeitures based on our historical forfeiture rate. Future stock-based compensation expense in any particular quarter or year could be affected by changes in our assumptions or changes in market conditions.

Results of Operations

The following table sets forth certain statement of operations data as a percentage of total net sales and contract revenues for the periods indicated.

	Three Months Ended December 31,				Nine Months Ended December 31,
	2007		2006		2007		2006
Net sales and contract revenues:
Net sales	59.7	%	59.2	%	62.8	%	62.0	%
Contract revenues	40.3		40.8		37.2		38.0
Total net sales and contract revenues	100.0	%	100.0	%	100.0	%	100.0	%
Costs of net sales and contract revenues:
Cost of net sales	30.1		32.8		31.8		34.6
Cost of contract revenues	27.5		28.1		24.8		24.8
Gross profit	42.3		39.2		43.4		40.6
Operating expenses:
Selling, general and administrative	26.3		26.8		26.7		27.7
Research and development	6.5		7.2		5.5		6.6
Deferred compensation plan	1.9		(0.2	)	0.6		(0.1	)
Amortization of intangible assets	0.2		0.3		0.2		0.3
Total operating expenses	35.0		34.0		33.0		34.4
Operating income	7.4		5.2		10.4		6.1
Non-operating income (expense):
Other income (expense), net	(0.0	)	(0.0	)	0.1		(1.5	)
Interest expense, net	(2.0	)	(2.7	)	(2.2	)	(2.8	)
Income before income taxes	5.3		2.5		8.3		1.8
Income tax benefit (provision)	0.9		(0.3	)	0.5		1.3
Net income	6.2	%	2.1	%	8.8	%	3.1	%

Analysis of Quarterly Results of Operations

Net Sales and Contract Revenues. Net sales are comprised of Roadway Sensors sales, which are derived from sales of our Vantage video detection systems, and Vehicle Sensor sales, which are derived from sales of AutoVue LDW systems, technology access fees, contract engineering revenue and royalty revenue generated from AutoVue related activities. Contract revenues consist entirely of Transportation Systems revenues, which are generated from systems integration and ITS consulting services with federal, state, county and municipal agencies. We currently have a relatively diverse customer base with our largest customer constituting 7.5% and 7.0% of total net sales and contract revenues in the three and nine months ended December 31, 2007, respectively.

Total net sales and contract revenues increased 6.0% to $15.4 million and 12.5% to $48.1 million for the three and nine months ended December 31, 2007, respectively, compared to $14.5 million and $42.8 million in the corresponding periods of the prior fiscal year. The increase was primarily driven by increased net sales in the Vehicle Sensors segment, as well as increased contract revenues in the Transportation Systems segment, as discussed below.

Net sales increased 7.0% to $9.2 million and 14.0% to $30.2 million for the three and nine months ended December 31, 2007, respectively, compared to $8.6 million and $26.5 million in the corresponding periods of the prior fiscal year.

Roadway Sensors net sales decreased 1.0% to $6.4 million and increased 6.5% to $21.3 million for the three and nine months ended December 31, 2007, respectively, versus $6.5 million and $20.0 million in the corresponding periods of the prior fiscal year. The decrease in Roadway Sensors net sales for the three months ended December 31, 2007 was largely due to lower sales volumes in Texas as a result of local budgetary issues, a trend that we expect to continue for at least the next few fiscal quarters. The decreased sales volumes in Texas were

largely offset by increased net sales in other regions. The increase in Roadway Sensors net sales for the nine months ended December 31, 2007 primarily reflects the continued adoption of video vehicle detection technology, such as the technology offered by our Vantage line of products, both domestically and internationally. We continue to believe that the current increased rate of adoption has to some extent been due to increased government spending on traffic initiatives, which we believe has been at least partially made possible by the passage of the Federal Highway Bill in August 2005, as well as expanded sales and marketing efforts, particularly in North America. Although we are not aware of any imminent changes in government spending patterns, it is conceivable that, as a result of softening macroeconomic conditions in the U.S., government funding for certain traffic initiatives and roadway improvement projects could be delayed or diverted to focus on other budgetary needs. Should this occur, it is possible that future domestic Roadway Sensors net sales would be adversely affected.

Vehicle Sensors net sales increased 32.2% to $2.7 million and 37.1% to $8.9 million for the three and nine months ended December 31, 2007, respectively, versus $2.1 million and $6.5 million in the corresponding periods of the prior fiscal year. This increase was primarily a result of increased unit sales of our LDW systems to European and Asian OEMs. Sales of LDW systems to the heavy truck market increased by $821,000, or 56.2%, and $3.3 million, or 78.2%, for the three and nine month periods ended December 31, 2007, respectively, when compared to the corresponding periods in the prior fiscal year. Also included in Automotive Sensors net sales are revenues from contract engineering services, technology access fees and royalty revenues in the passenger car market that are derived from our strategic relationship with Valeo, which aggregated $463,000 and $1.3 million for the three and nine months ended December 31, 2007, respectively, compared to $616,000 and $2.2 million in the corresponding periods of the prior fiscal year.

We expect sales of LDW units to the heavy truck market to continue to increase, when compared to the prior year period, for at least the remainder of fiscal 2008 due to increased sales of LDW units in Europe and Asia; however we expect to experience a decline in sales to the North American heavy truck market in our next two fiscal quarters as a result of an overall decline in new truck sales in the U.S. due to new engine emissions standards that went into effect at the beginning of the calendar year as well as due to the general slowdown in the U.S. housing market and overall economy. Additionally, we expect revenues from our strategic partnership with Valeo to decrease slightly as compared to the prior year largely because we will not receive any technology access fee revenues in fiscal 2008. Technology access fee revenues totaled $125,000 and $375,000 for the three and nine months ended December 31, 2006, respectively. Royalty revenues from Valeo for sales of our LDW systems for the passenger car market have remained relatively insignificant in the current fiscal year. Our LDW systems are now offered as an option on four Infiniti models. While Valeo is currently in discussions to offer our LDW systems on other passenger car platforms, we cannot assure you that Valeo will be successful in these efforts.

Contract revenues increased 4.6% to $6.2 million and 9.9% to $17.9 million for the three and nine months ended December 31, 2007, respectively, compared to $5.9 million and $16.3 million in the corresponding periods of the prior fiscal year. This increase was largely due to increased funding at the federal, state and local levels throughout the country, as well as new contract awards. In response to this growth in funding, we have increased our Transportation Systems staff by 15% in the nine months ended December 31, 2007, and we expect to continue to increase our Transportation Systems staff over the remainder of fiscal 2008. We believe the ability of our Transportation Systems business to grow and successfully win and service new contracts will be highly dependent upon our continued success in recruiting and retaining qualified personnel. All of our contract revenues are derived from work performed in North America under a broad range of fixed price and cost plus fixed fee contracts.

Gross Profit. Total gross profit increased 14.5% to $6.5 million and 20.2% to $20.9 million for the three and nine months ended December 31, 2007, respectively, as compared to $5.7 million and $17.4 million in the corresponding periods of the prior fiscal year. Total gross profit as a percent of net sales and contract revenues increased to 42.3% and 43.4% for the three and nine months ended December 31, 2007, respectively, as compared to 39.2% and 40.6% in the corresponding periods of the prior fiscal year.

Gross profit as a percent of net sales was 49.5% and 49.4% for the three and nine months ended December 31, 2007, respectively, compared to 44.7% and 44.1% in the corresponding periods of the prior fiscal year. This increase in gross profit was a result of increased gross profits in both the Roadway Sensors and Vehicle Sensors segments, largely as a result of a favorable sales mix in terms of both geography and product mix. Additionally, gross margins were positively impacted by improved production efficiencies. Vehicle Sensors gross margins have also improved as the customer base for our LDW systems has expanded. Through diversification of our heavy truck customer base we have been able to mitigate the gross margin impact of lower contractual pricing to our largest European customer. Gross profit as a percent of net sales generally fluctuates in any specific quarter based on customer mix. Gross profit as a percent of net sales has fluctuated over the last eleven quarters from a high of 50.2% in the first quarter of fiscal 2006 to a low of 39.2% reported in the third quarter of fiscal 2007.

Gross profit as a percent of contract revenues was 31.6% and 33.2% for the three and nine months ended December 31, 2007, respectively, compared to 31.2% and 34.7% in the corresponding periods of the prior fiscal year. We recognize contract revenues and related gross profit using percentage of completion contract accounting and the underlying mix of contract activity affects the related gross profit recognized in any given period. Gross profit during our third fiscal quarter generally tends to decrease as a percentage of contract revenues due to the larger number of company holidays during this period which reduces the number of billable days our engineers work in the third quarter. The decrease in gross profit as a percent of contract revenues for the nine months ended December 31, 2007 reflects a contract mix weighted more toward lower margin contracts in the period. Lower margin contracts generally have a higher proportion of sub-consulting revenues associated with them.

Selling, General and Administrative Expense. Selling, general and administrative expense increased 4.2% to $4.0 million (or 26.3% of total net sales and contract revenues) and 8.0% to $12.8 million (or 26.7% of total net sales and contract revenues) in the three and nine months ended December 31, 2007, respectively, compared to $3.9 million (or 26.8% of total net sales and contract revenues) and $11.9 million (or 27.7% of total net sales and contract revenues) in the corresponding periods of the prior fiscal year. The increase for the three and nine month periods ended December 31, 2007 compared to the prior year periods was largely attributable to higher commissions and selling expenses driven by sales growth in our Roadway Sensors segment. In the coming quarters, we expect to continue to experience increased selling expenses as we pursue further sales growth. Additionally, we anticipate we will incur increased general and administrative expenses related to our efforts to comply with the internal control attestation requirements of the Sarbanes-Oxley Act, with which we must begin to comply in fiscal 2008.

Research and Development Expense. Research and development expense was relatively flat at $1.0 million (or 6.5% of total net sales and contract revenues) and $2.6 million (or 5.5% of total net sales and contract revenues) for the three and nine months ended December 31, 2007, respectively, compared to $1.0 million (or 7.2% of total net sales and contract revenues) and $2.8 million (or 6.6% of total net sales and contract revenues) in the corresponding periods of the prior fiscal year. Although year-over-year our research and development expense was relatively flat, we have increased research and development spending in Roadway Sensors. This increased spending was offset by reduced research and development activities in Vehicle Sensors as many of our significant truck OEM customers now have production LDW units requiring minimal further development and the majority of our passenger car research and development efforts are funded by our strategic partner, Valeo. We believe research and development activities are crucial to our ability to continue to be a leader in our markets, and we expect our expenditures in this area to be in line with historical amounts for the remainder of fiscal 2008.

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

Deferred Compensation Plan Expense. During the three and nine months ended December 31, 2007, we recorded non-cash expense of $290,000 and $299,000, respectively, related to the change in value of shares of our common stock held in trust by our deferred compensation savings plan. This compares to a non-cash benefit of $29,000 and $61,000 recorded in the three and nine month periods ended December 31, 2006, respectively. In May 2007, our former Chief Executive Officer, who departed in March 2007, elected to receive a distribution of approximately fifty percent of his deferred compensation plan balance, representing 143,333 shares of our common stock and $10,000 in cash, all of which was paid out in June 2007, and his remaining deferred compensation plan balance of 143,333 shares of our common stock and $5,000 in cash on the one year anniversary of this election. As a result of this election, at December 31, 2007, the trust held 167,177 shares of our common stock and $5,000 of cash. We expect to continue to experience non-cash expense or benefit in future periods as the value of the assets held in our deferred compensation savings plan fluctuates.

Other Income (Expense), Net. Other income (expense), net includes the following:

	Three Months Ended December 31,						Nine Months Ended December 31,
	2007			2006			2007		2006
				(In thousands)
Settlement of lawsuit	$	—		$	—		$	—	$	(635	)
Other	(3		)	(5		)	41		(15		)
Other income (expense), net	$	(3	)	$	(5	)	$	41	$	(650	)

Other income (expense), net for the nine months ended December 31, 2006 primarily reflects $635,000 of expense

recorded in connection with the settlement of litigation described in Note 5 to the accompanying condensed consolidated financial statements.

Interest Expense, Net. Interest expense, net includes the following:

	Three Months Ended December 31,						Nine Months Ended December 31,
	2007			2006			2007			2006
				(in thousands)
Interest expense	$	(228	)	$	(305	)	$	(787	)	$	(942	)
Amortization of debt discount	(51		)	(51		)	(155		)	(155		)
Amortization of deferred finance costs	(35		)	(34		)	(104		)	(103		)
Interest expense, net	$	(314	)	$	(390	)	$	(1,046	)	$	(1,200	)

Interest expense decreased for the three and nine months ended December 31, 2007 compared to the corresponding periods in the prior fiscal year as a result of an overall lower level of borrowings.

Income Taxes. During the three and nine months ended December 31, 2007, we recognized an income tax benefit of $141,000 and $221,000, respectively, as compared to income tax expense of $46,000 and an income tax benefit of $545,000 in the three and nine months ended December 31, 2006, respectively. The income tax benefit recorded in the three and nine months ended December 31, 2007 was primarily based on anticipated taxes to be paid in the current year, as well as a slight decrease in the valuation allowance recorded against our deferred tax assets as a result of changes in estimates of the future realizability of these assets. Total deferred tax assets on our consolidated balance sheet increased from $3.0 million at March 31, 2007 to $3.3 million at December 31, 2007. The income tax benefit recorded during the nine months ended December 31, 2006 was also the result of a decrease in the valuation allowance recorded against our deferred tax assets. In the future, we may continue to record similar adjustments to our deferred tax asset valuation allowance as our estimates are updated. We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates, estimated annual effective tax rates and statutory tax rates.

As discussed in Notes 1 and 4 of the accompanying condensed consolidated financial statements, we adopted FIN 48 on April 1, 2007. In connection with our adoption of FIN 48, we recognized an adjustment of approximately $224,000 to the beginning balance of retained earnings on our consolidated balance sheet. Additionally, there was no significant change in our income tax expense for the three and nine months ended December 31, 2007 as a result of our implementation of FIN 48.

Liquidity and Capital Resources

Cash Flows

We have historically financed our operations with a combination of cash flows from operations, borrowings under credit facilities and the sale of equity securities. We currently rely on cash flows from operations and borrowings on a line of credit facility to fund our operations. At December 31, 2007, we had $12.7 million in working capital, which included borrowings of $199,000 on our revolving line of credit and $679,000 in cash and cash equivalents. This compares to working capital of $7.0 million at March 31, 2007, which included borrowings of $4.0 million on our revolving line of credit and $35,000 in cash and cash equivalents.

Our operating activities provided $5.4 million in cash during the nine months ended December 31, 2007, primarily as a result of net income generated during the period and net cash inflows related to operating assets and liabilities. Inventories decreased by $2.0 million from March 31, 2007, to a level more in line with what we expect inventory levels to be over the next six to twelve months. Accounts receivable and net unbilled accounts receivable each increased by $1.1 million since March 31, 2007, largely as a result of increased sales as well as the timing of invoicing in our Transportation Systems segment. Over the next several fiscal quarters, we expect net unbilled accounts receivable to decrease by ten to twenty percent, which we expect will result in increased cash inflows from operations. During the nine months ended December 31, 2006, our operations used $2.3 million of cash, primarily as a result of investments in inventory and an increased level of accounts receivable and net costs and estimated earnings in excess of billings due to sales growth. This was partially offset by a $1.4 million increase in accounts payable and accrued liabilities and $1.3 million in net income.

Our investing activities for the nine months ended December 31, 2007 and 2006 consisted entirely of purchases of property and equipment, which aggregated $455,000 and $311,000, respectively. In September 2007, we moved our corporate headquarters. As further discussed in Note 5 of the accompanying condensed consolidated financial statements, in

connection with this move, we spent $1.8 million on tenant improvements, all of which was financed by our landlord in the form of tenant improvement allowances under the lease. We do not expect significant additional investments in leasehold improvements to our facilities as substantially all major planned leasehold improvements were completed prior to December 31, 2007.

Cash used in financing activities was $4.3 million in the nine months ended December 31, 2007, which was the result of $5.6 million in net payments against borrowings, partially offset by $1.3 million in proceeds from the exercise of outstanding stock options and warrants to purchase our common stock. During the nine months ended December 31, 2006, financing activities provided $2.6 million of cash, which was primarily the result of $2.9 million in proceeds from the exercise of outstanding stock options and warrants to purchase our common stock, partially offset by $356,000 in net payments against borrowings. As discussed in Note 6 to the accompanying condensed consolidated financial statements, approximately $2.0 million of the $2.9 million in cash inflows from the exercise of outstanding stock options and warrants during the nine months ended December 31, 2006 was raised through the exercise of outstanding warrants to purchase 1,250,000 shares of common stock.

Borrowings

The following table summarizes our borrowings and long-term debt:

	At December 31, 2007
	(In thousands)
Convertible debentures, net	$	9,565
Line of credit	199
Bank term note	524
Other	46
	$	10,334

In October 2006, we entered into a two-year credit facility with a bank which includes our line of credit and bank term note. The credit facility provides for line of credit borrowings of up to $10.0 million against our eligible accounts receivable and inventory, as defined in the credit agreement. The term note provides for monthly principal payments of approximately $104,000 and matures in May 2008. The interest rate on the line of credit is the current stated prime rate plus 1.00%, and the interest rate on the bank term note is fixed at an annual rate of 8.75%. We are obligated to pay an unused line fee of 0.25% per annum applied to the amount by which the maximum credit amount exceeds the average daily principal balance during the preceding month. The credit facility also requires $2,000 in monthly collateral management fees and includes an early termination fee equal to 1% of the total facility. The credit facility is secured by substantially all of the assets of the Company. At December 31, 2007, we had $9.3 million available under our credit facility, of which $9.1 million was unused.

We believe that the cash generated from our operations, together with funds available under our credit agreement, will be sufficient to fund our operations for at least the next twelve months. However, should a shortfall occur, we may need to raise additional funds through other debt financings or the sale of equity securities.

Contractual Obligations

Our contractual obligations were as follows at December 31, 2007:

	Payments Due by Fiscal Year
	2008		2009		2010		2011		2012		Thereafter		Total
	(In thousands)
Line of credit	$	199	$	—	$	—	$	—	$	—	$	—	$	199
Notes payable	221		349		—		—		—		—		570
Convertible debentures	—		—		9,850		—		—		—		9,850
Operating leases	343		1,488		1,391		1,348		1,332		3,823		9,725
Total	$	763	$	1,837	$	11,241	$	1,348	$	1,332	$	3,823	$	20,344

At December 31, 2007, we had firm commitments to purchase inventory in the amount of $4.1 million during our next three fiscal quarters.

Off Balance Sheet Arrangements

In May 2004, we issued subordinated convertible debentures in an aggregate original principal amount of $10.1 million. These debentures are due in full on May 19, 2009 and are convertible into shares of our common stock at an initial conversion price of $3.61 per share. At December 31, 2007, $9.9 million of these convertible debentures remained outstanding. Because these debentures are conventionally convertible, we have not separately accounted for the conversion feature and, accordingly, no separate amounts are presented in our condensed consolidated financial statements in connection with this conversion feature.

At December 31, 2007, outstanding warrants to purchase an aggregate of 246,250 shares of our common stock at an exercise price of $3.25 were callable by us if the closing sales price of our common stock for 20 consecutive days is equal to or greater than two times the exercise price of the warrants. Outstanding warrants to purchase an aggregate of 75,000 shares of our common stock at an exercise price of $5.00 per share were callable by us if the price of our common stock for 20 consecutive days is equal to or greater than one and a half times the exercise price of the warrants.

In connection with warrants to purchase 246,250 shares of our common stock at $3.25 per share, we are a party to certain registration rights agreements that contain provisions under which we could be subjected to liquidated damages should we fail to maintain effective registration statements for the underlying shares of common stock. These warrants have been accounted for within equity in our condensed consolidated balance sheets in accordance with EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, and, accordingly, no liabilities have been recorded in connection therewith. As of the date of this filing, no liquidated damages are payable under the provisions of the registration rights agreements associated with these warrants.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS 157, which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather it specifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early application of the statement is encouraged. Generally, this statement will be applied prospectively. We are currently evaluating the impact of SFAS 157 and expect to adopt SFAS 157 in the first quarter of our fiscal year ending March 31, 2009.

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

Seasonality

We have historically experienced, and expect to continue to experience, seasonality, particularly with respect to our Roadway Sensors net sales in the third and fourth fiscal quarters due to a reduction in road construction or repairs during the winter months in many markets as a result of inclement weather conditions.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk is limited to our line of credit. Our line of credit bears interest based on the prevailing prime rate (7.25% at December 31, 2007). We do not believe that a 10% increase in the interest rate on our line of credit (from 8.25% to 9.08%) would have a material impact on our financial position, operating results or cash flows. In addition, we believe that the carrying value of our outstanding debt approximates fair value.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the

participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Exchange Act Rules 13a-15(e) and
15d-15(e). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management necessarily applied its judgment in evaluating the cost-benefit relationship of such controls and procedures.

Changes in Internal Controls

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

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information set forth under Note 5 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item I of this report, is incorporated herein by reference.

ITEM 1A. RISK FACTORS

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

We May Need To Raise Additional Capital In The Future, Which May Not Be Available On Terms Acceptable To Us, Or At All. We have historically generated significant net losses and operating losses and have experienced volatility in our cash flows from operations ranging from positive cash flows from operations of $590,000 in the year ended March 31, 2005 to negative cash flows from operations of $2.0 million in the year ended March 31, 2007. Additionally, we failed to meet certain debt covenants under our prior credit agreement during two fiscal quarters, prior to the replacement of that credit facility in October 2006. Furthermore, we have $9.9 million in subordinated convertible debentures that are due in full in May 2009. Should the holders of the convertible debentures not elect to convert the principal into shares of our common stock, we may need to raise additional capital to refinance this debt.

At December 31, 2007, we had $679,000 of cash and cash equivalents and relied on our line of credit to fund our operations. We may need to raise additional capital in the near future to fund our operations or to repay indebtedness. Such additional capital 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 timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders.

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

· market acceptance of our products and product enhancements, and the overall level of sales of our products;

· our ability to control costs;

· the supply of key components for our products;

· our ability to generate net income;

· increased research and development expenses;

· increased sales and marketing expenses;

· technological advancements and our competitors’ response to our products;

· capital improvements to new and existing facilities and enhancements to our infrastructure and systems;

· potential acquisitions of businesses and product lines;

· our relationships with customers and suppliers;

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

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

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

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

We Have Historically Experienced Substantial Losses And May Experience Losses In The Future. Although we have achieved net income in recent periods, we experienced a net loss of $11.3 million in the year ended March 31, 2005. We cannot assure you that we will be able to sustain or improve our financial performance, or that we will be able to continue to achieve profitability on a quarterly or annual basis in the future. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. As a result, we may continue to experience operating losses and net losses, which would make it difficult to fund our operations and achieve our business plan, and could cause the market price of our common stock to decline.

If Our Internal Controls Over Financial Reporting Do Not Comply With The Requirements Of The Sarbanes-Oxley Act, Our Business And Stock Price Could Be Adversely Affected. Along with our independent registered public accounting firm, we will be evaluating the effectiveness of our internal controls over financial reporting to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year beginning in our fiscal year ending March 31, 2008 and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports beginning with our Annual Report on Form 10-K for the fiscal year ending March 31, 2008. Section 404 also requires our independent accountant to attest to, and report on, management’s assessment of our internal controls over financial reporting beginning in our fiscal year ending March 31, 2009. We may not be able to complete our Section 404 compliance on a timely basis, and even if we timely complete our compliance requirements, our independent auditors may still conclude that our internal controls over financial reporting are not effective.

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

As of March 31, 2005, we became aware of a material weakness in our internal controls related to the accounting for the consolidation of our deferred compensation savings plan and certain contract administration. We cannot assure you that we or our independent registered public accounting firm will not identify additional material weaknesses in our internal controls. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Based on our evaluation, our management concluded that, as of March 31, 2004, our internal control over financial reporting was not effective due to the existence of one material weakness. We may experience additional material weaknesses in the future. If our internal controls over financial reporting are not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.

New Environmental Regulations May Result In A Decline In Our AutoVue Sales and Royalties. Recent environmental regulations in Europe became effective in 2006, which required more stringent emissions compliance in new trucks manufactured in Europe after 2006. These regulations caused the cost of certain trucks to increase significantly and could cause a decline in new truck sales in Europe in the near future. Similar regulations have been announced in North America that will impact diesel engines built after January 2007. North America heavy truck sales through the first three quarters of 2007 have declined significantly as compared to the prior year, which we believe was primarily a result of large 2006 prebuys of heavy trucks made in anticipation of the new North America emission standards. We may experience a decline in our LDW sales to truck OEMs related to these stricter regulations.

We May Experience Production Gaps Which Could Materially And Adversely Impact Our Sales And Financial Results And The Ultimate Acceptance Of Our Products. It is possible that we could experience unforeseen quality control issues or part shortages as we increase production to meet current demand for our products. We have historically used single suppliers for certain of our components in our AutoVue and Vantage products. Should any such delay or disruption occur, our future sales will likely be materially and adversely affected. Additionally, we rely heavily on select contract manufacturers to produce many of our products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources if necessary, we could experience a production gap if for any reason our contract manufacturers were unable to meet our production requirements.

We Depend Upon Valeo To Market Our AutoVue Technologies For The OEM Passenger Car Market. We have granted Valeo the exclusive right to sell and manufacture our AutoVue LDW system to the worldwide passenger car market in exchange for royalty payments for each AutoVue unit sold. As such, the future success and broad market acceptance of our AutoVue technologies in the passenger car market will depend upon Valeo’s ability to manufacture, market and sell our technologies, and to convince more OEM passenger car manufacturers to adopt our technologies. If Valeo does not devote considerable resources and aggressively pursue opportunities, our expansion into the passenger car market could be adversely affected.

We May Be Unable To Attract And Retain Key Personnel, Which Could Seriously Harm Our Business. Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The loss of Abbas Mohaddes, our Chief Executive Officer, or any of the other executive officers or key members of management could adversely affect our business, financial condition or results of operations. Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. In particular, the future success of our Transportation Systems segment will depend on our ability to hire additional qualified engineers and planners. Competition for qualified employees, particularly development engineers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations.

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

We believe that we must continue to make substantial investments to support ongoing research and development in order to remain competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in response to evolving customer requirements. We cannot assure 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 not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue.

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

Certain of the components used in our Vantage and AutoVue products may need to be re-engineered in the next 12 to 36 months as the industry is moving towards a standard of using lead-free components. We cannot assure you as to the timing of the adoption of this new standard or our ability to successfully redesign our products to incorporate compliant components and gain market acceptance of such redesigned products. In addition, if the standard is adopted earlier than anticipated we may experience a shortage of Vantage and AutoVue products as a result of potential scarcity of lead-free components.

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

The Markets In Which We Operate Are Highly Competitive And Have Many More Established Competitors, Which Could Adversely Affect Our Sales Or The Market Acceptance Of Our Products. We compete with numerous other companies in our target markets including, but not limited to, large, multinational corporations, which include tier one automotive suppliers, and many smaller regional engineering firms. We expect such competition to increase due to technological advancements, industry consolidations and reduced barriers to entry. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, financial condition and results of operations. In fiscal 2007, we began to experience more competition in our Roadway Sensors segment as the Department of Transportation in one of our largest sales territories moved to a multi-source contracting environment from one in which we were the sole supplier. In addition, one of the other developers of LDW systems was acquired by a larger company during fiscal 2007. While this developer has not been a material competitor to date, we may experience more competition from this provider as a result of its greater access to resources from its acquirer, and additional competitors may enter this market in the future. Furthermore, awareness of LDW technology is increasing and other market players are attempting to develop competing technologies, which may contain improvements or added features beyond those offered by our LDW systems. Should such efforts be successful, this could erode our ability to successfully market and sell our LDW systems to new and existing customers.

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

The Significant Military Operations In The Middle East Or Elsewhere May Impact Government Funding Or Consumer Spending, Causing A Decline In Our Revenues. In the near term, the funding of U.S. military operations in the Middle East or elsewhere may cause disruptions in funding of government contracts. Since military operations of such magnitude are not routinely included in U.S. defense budgets, supplemental legislative funding actions are often required to finance such operations. Even when such legislation is enacted, it may not be adequate for ongoing operations, causing other government resources to be temporarily or permanently diverted. Since a significant portion of our sales are derived from contracts with government agencies, such diversion of funds could produce interruptions in funding or delays in receipt of our contracts, causing disruptions and adversely effecting our revenue and operations.

An Economic Slowdown Could Lead To Reduced Or Delayed Government Funding For Transportation Infrastructure And Initiatives And Decreased Availability Of Financial Capital For Our Customers, Causing A Decline In Our Revenues. Concerns about inflation, decreased consumer confidence, and reduced corporate profits and capital spending have resulted in a downturn in worldwide economic conditions, particularly in the United States. These unfavorable economic conditions may have a negative impact on customer orders (and also may result in decreased sales of automobiles and trucks that incorporate our LDW systems). Such concerns may result in cancellations and rescheduling of backlog. In addition, the recent decline in

the U.S. real estate market, particularly in new home construction, could adversely impact new road construction resulting in a decline in Roadway Sensor and Vehicle Sensor net sales and Transportation Systems contract revenues. Any of the foregoing economic conditions make it extremely difficult for our customers, our suppliers and us to accurately forecast and plan future business activities and could result in a decline in our net sales and contract revenues. If such conditions continue or worsen, our business, financial condition and results of operations could be materially and adversely affected.

We Depend On Government Contracts And Subcontracts, And Because Many Of Our Government Contracts Are Fixed Price Contracts, Higher Than Anticipated Costs Will Reduce Our Profit And Could Adversely Impact Our Operating Results. A significant portion of our sales are derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. Government contracts represented approximately 37.8%, 38.3% and 37.4% of our total net sales and contract revenues for the years ended March 31, 2007, 2006 and 2005, respectively. We anticipate that revenue from government contracts will continue to remain a significant portion of our net sales and contract revenues. Government business is, in general, subject to special risks and challenges, including:

· long purchase cycles or approval processes;

· competitive bidding and qualification requirements;

· the impact of international conflicts;

· performance bond requirements;

· changes in government policies and political agendas;

· delays in funding, including the delays in the allocation of funds to state and local agencies from the U.S. Federal Highway Bill;

· other government budgetary constraints and cut-backs; and

· milestone requirements and liquidated damage provisions for failure to meet contract milestones.

In addition, a large number of our 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 based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs would adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our net sales and contract revenues in any given quarter. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations.

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

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

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

· delays in government contracts from time to time, including from delays in the allocation of funds to state and local agencies from the U.S. Federal Highway Bill;

· declines in new home construction and related road construction;

· our ability to control costs;

· our ability to raise additional capital;

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

· seasonality due to winter weather conditions;

· international conflicts and acts of terrorism;

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

· market acceptance of the products incorporating our technologies and products;

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

· the introduction of new products by competitors;

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

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

· the effects of technological changes in our target markets;

· the amount of our backlog at any given time;

· the nature of our government contracts;

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

· risks and uncertainties associated with our international business;

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

· general economic and political conditions.

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

We May Engage In Acquisitions Of Companies Or Technologies That May Require Us To Undertake Significant Capital Infusions And Could Result In Disruptions Of Our Business And Diversion Of Resources And Management Attention. We have historically acquired, and may in the future acquire, complementary businesses, products and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including:

· potential disruption of our ongoing business and the diversion of our resources and management’s attention;

· the failure to retain or integrate key acquired personnel;

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

· increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services;

· the incurrence of unforeseen obligations or liabilities;

· potential impairment of relationships with employees or customers as a result of changes in management; and

· increased interest expense and amortization of acquired intangible assets.

Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully integrate any acquisitions or realize the benefits anticipated from any acquisition.

We Have Experienced Growth In Recent Periods. If We Fail To Manage Our Growth Effectively, We May Be Unable To Execute Our Business Plan And May Experience Future Weaknesses In Our Internal Controls. We have expanded our overall business. In order to achieve our business objectives, we will need to continue to expand our business and add additional qualified personnel. Such expansion has placed and is expected to continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to successfully manage our growth, our business, financial condition and results of operations will be adversely affected.

If We Do Not 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 Our Products. Our markets are in general characterized by the following factors:

· rapid technological advances;

· downward price pressure in the marketplace as technologies mature;

· changes in customer requirements;

· frequent new product introductions and enhancements; and

· evolving industry standards and changes in the regulatory environment.

Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. In particular, our LDW system is incorporated into automobiles and trucks that face significant technological changes in each model year and among different vehicle models. Accordingly, we must adapt our technology from time to time to function with such changes.

We May Not Be Able To Adequately Protect Or Enforce Our Intellectual Property Rights, Which Could Harm Our Competitive Position. If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors could be able to access our proprietary technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary 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 United States or abroad.

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

The Trading Price Of Our Common Stock Is Highly Volatile. The trading price of our common stock has been subject to wide fluctuations in the past. Since January 2000, our Class A common stock (now known as our common 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 to fluctuate in the future in response to various factors, including, but not limited to:

· quarterly variations in operating results;

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

· our ability to raise additional capital;

· shortages announced by suppliers;

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

· transitions to new products or product enhancements;

· acquisitions of businesses, products or technologies;

· the impact of any litigation;

· changes in investor perceptions;

· government funding, political agendas and other budgetary issues;

· changes in earnings estimates or investment recommendations by securities analysts; and

· international conflicts, political unrest and acts of terrorism.

The stock market in general has recently experienced volatility, which has particularly affected the market prices of equity securities of many technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management’s attention and resources from other matters.

Our International Business Operations May Be Threatened By Many Factors That Are Outside Of Our Control. We currently market our AutoVue and Vantage products internationally and we anticipate that our international operations will expand in the near future. International business operations are subject to various inherent risks including, among others:

· currency fluctuations and restrictions;

· political, social and economic instability;

· longer accounts receivable payment cycles;

· import and export license requirements and restrictions of the United States and each other country in which we operate;

· unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions;

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

· difficulties in managing and staffing international operations;

· potentially adverse tax consequences; and

· reduced protection for intellectual property rights in some countries.

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

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

We Could Experience Negative Financial Impacts Arising From Developments In Contingencies Created Under Our Previous Structure Or By Former Subsidiaries. Although we divested ourselves of all business units prior to October 2004, with the exception of our Iteris business, from time to time we could experience unforeseen developments in contingencies related to our former subsidiaries. For example, in July 2006 we entered into a settlement agreement in connection with a lawsuit brought against Mariner Networks, Inc., one of our former subsidiaries, by one of Mariner’s suppliers, pursuant to which we issued 88,912 shares of our common stock to this supplier (valued at $213,000 as 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 installments of $9,700 beginning in November 2006. Although we are not aware of any other material contingencies, it is possible that other matters could be brought against us in connection with activities related to former subsidiaries and that such matters could materially and adversely affect our financial results and cash flows.

Some Of Our Directors, Officers And Their Affiliates Can Control The Outcome Of Matters That Require The Approval Of Our Stockholders, And Accordingly We Will Not Be Able To Engage In Certain Transactions Without Their Approval. As of December 31, 2007, our officers and directors beneficially owned approximately 11% of the outstanding shares of our common stock (and approximately 16% of our common stock when including options, warrants and other convertible securities held by them which are currently exercisable or convertible or will become exercisable or convertible within 60 days after December 31, 2007). As a result of their stock ownership, our management will be able to influence the election of our directors and the outcome of corporate actions requiring stockholder approval, such as mergers and acquisitions, regardless of how our other stockholders may vote. This concentration of voting control may have a significant effect in delaying, deferring or preventing a change in our management or change in control and may adversely affect the voting or other rights of other holders of common stock.

Certain Anti-Takeover Provisions May Affect The Price Of Our Common Stock And Discourage A Third Party From Acquiring Us. Certain provisions of our certificate of incorporation and our stockholder rights plan could make it difficult for a third party to acquire us, even though an acquisition might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. Our future issuance of preferred stock could be used to discourage an unsolicited acquisition proposal. In addition, in March 1998, we adopted a stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. We amended this plan in May 2004. In the event a third party acquires more than 15% of the outstanding voting control of our company or 15% of our outstanding common stock, the holders of these rights will be able to purchase

the junior participating preferred stock at a substantial discount off of the then current market price. The exercise of these rights and purchase of a significant amount of stock at below market prices could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a merger, tender offer or proxy contest more difficult.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

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

Exhibit Number	Description	Where Located
3.1	Amended and Restated Certificate of Incorporation of the registrant	Exhibit 3.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on October 28, 2004

3.2	Certificate of Amendment to Amended and Restated Certificate of Incorporation filed September 26, 2007	Exhibit 3.2 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 as filed with the SEC on November 13, 2007

3.3	Bylaws of registrant, as amended	Exhibit 4.2 to the registrant’s Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993

3.4	Certificates of Amendment to Bylaws of the registrant dated April 24, 1998 and August 10, 2001	Exhibit 3.4 to the registrant’s Annual Report on Form 10-K/A for the year ended March 31, 2003 as filed with the SEC on July 29, 2003

3.5	Certificate of Amendment to Bylaws of registrant dated September 9, 2004	Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 as filed with the SEC on November 15, 2004

3.6	Certificate of Amendment to Bylaws of registrant dated December 7, 2007	Exhibit 3.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on December 13, 2007

4.1	Specimen of Common Stock Certificate	Exhibit 4.1 to the registrant’s Amendment No. 1 to the Registration Statement on Form 8-A as filed with the SEC on December 8, 2004

4.2	Amended and Restated Rights Agreement, dated as of May 10, 2004, by and between the registrant and U.S. Stock Transfer Corporation, including exhibits thereto	Exhibit 99.1 to the registrant’s Registration Statement on Form 8-A/A as filed with the SEC on June 18, 2004

10.1	Amendment to Loan and Security Agreement, dated October 17, 2007, by and between Silicon Valley Bank and the registrant	Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed with the SEC on October 23, 2007

31.1	Certification of the Principal Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

31.2	Certification of the Principal Financial and Accounting Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

32.1	Certification of the Chief Executive Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith

32.2	Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: February 1, 2008	ITERIS, INC.
	(Registrant)

	By		/S/ ABBAS MOHADDES
			Abbas Mohaddes
		Chief Executive Officer
		(Principal Executive Officer)


	By	/S/ JAMES S. MIELE
		James S. Miele
		Chief Financial Officer
		(Principal Financial and Accounting Officer)