Iteris
Annual Report 2008

Plain-text annual report

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K (Mark One)xxANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934 For the fiscal year ended March 31, 2008 OR ooTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE 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) Delaware95-2588496(State or Other Jurisdictionof Incorporation or Organization)(I.R.S. EmployerIdentification No.) 1700 Carnegie Ave, Santa Ana, California 92705(Address of Principal Executive Offices) (Zip Code) Registrant’s Telephone Number, Including Area Code: (949) 270-9400 Securities registered pursuant to Section 12(b) of the Act: Title of each className of each exchange on which registeredCommon Stock, $0.10 par valueAmerican Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x 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 1934during 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 filingrequirements for the past 90 days. Yes x No o Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, tothe best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer oAccelerated filer o Non-accelerated filer oSmaller reporting company x(Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x Based on the closing sale price of the registrant’s common stock on the last business day of the registrant’s most recently completed second fiscal quarter,the aggregate market value of the voting common stock held by nonaffiliates of the registrant was $48,200,000. For the purposes of this calculation, sharesowned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status isnot necessarily a conclusive determination for other purposes. As of June 10, 2008, there were 33,888,002 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates by reference certain information from the registrant’s definitive proxy statement for the 2008 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended March 31, 2008. Except with respectto information specifically incorporated by reference in this report, the registrant’s proxy statement is not deemed to be filed as a part hereof.  ITERIS, INC.ANNUAL REPORT ON FORM 10-KFOR THE FISCAL YEAR ENDED MARCH 31, 2008TABLE OF CONTENTS PART I3 ITEM 1.BUSINESS3 ITEM 1A.RISK FACTORS7 ITEM 1B.UNRESOLVED STAFF COMMENTS15 ITEM 2.PROPERTIES16 ITEM 3.LEGAL PROCEEDINGS16 ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS16 PART II17 ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES17 ITEM 6.SELECTED FINANCIAL DATA19 ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS20 ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK30 ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA30 ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE30 ITEM 9A(T).CONTROLS AND PROCEDURES30 ITEM 9B.OTHER INFORMATION31 PART III31 ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE31 ITEM 11.EXECUTIVE COMPENSATION31 ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS31 ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE31 ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES32 PART IV32 ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES32 Unless otherwise indicated in this report, the “registrant,” “we,” “us” and “our” collectively refers to Iteris, Inc. and its former subsidiary, Meyer, MohaddesAssociates, 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 propertyof their respective owners. 2 Cautionary Statement This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private SecuritiesLitigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflectmanagement’s beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in thisreport 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. Theseforward-looking statements include but are not limited to statements regarding our anticipated sales, revenue, expenses, profits, capital needs,competition, backlog and manufacturing capabilities, the practical market applications, future applications and acceptance of our products andservices, the status of our facilities and product development. These statements are not guarantees of future performance and are subject to certainrisks and uncertainties which could cause actual results to differ materially from those projected. You should not place undue reliance on theseforward-looking statements that speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We encourage you to carefully review and considerthe various disclosures made by us which describe certain factors which could affect our business, including those in “Risk Factors” in Item 1A of thisreport, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publiclyany forward-looking statement for any reason. PART I ITEM 1. BUSINESS Overview Iteris, Inc. is a leader in the traffic management market that focuses on the development and application of advanced technologies that reduce trafficcongestion, minimize the environmental impact of traffic congestion and improve the safety of surface transportation systems. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broad range of Intelligent Transportation Systems and driver safety solutions tocustomers worldwide. Our proprietary image recognition systems include Vantage and AutoVue. Vantage is a video vehicle detection system that detects the presence ofvehicles on roadways. Vantage systems are used at signalized intersections to enable a more efficient allocation of green signal time and are also used forincident detection and highway traffic data collection applications. AutoVue Lane Departure Warning (“LDW”) systems consist of a small windshieldmounted sensor that uses proprietary software to detect and warn drivers of unintended lane departures. To date, we and our strategic partner have soldapproximately 90,000 production AutoVue LDW systems for use on car and truck platforms in the North American and European markets. We believe thatour AutoVue LDW technology is a broad sensor platform that, through additional software development, may be expanded to incorporate additional safety andconvenience 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 toenable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information abouttraffic conditions. Our services include planning, design and implementation of surface transportation infrastructure systems. We perform analysis andstudy goods movement, commercial vehicle operations, travel demand forecasting and systems engineering, and identify mitigation measures to reduce trafficcongestion. These services and systems are primarily sold to local, state and national transportation agencies in the United States. Our transportationmanagement systems business is largely dependent upon governmental funding and budgetary issues. The Federal Highway Bill that was passed inAugust 2005 provided for a significant increase in transportation funding over the following six years. We believe the recent expansion of our transportationmanagement systems business was due in part to the passage of the Federal Highway Bill, combined with the expansion of transportation funds at state andlocal agencies throughout the country. The 2005 Federal Highway Bill is set to expire during 2009. We currently operate in three reportable segments: Roadway Sensors, Vehicle Sensors and Transportation Systems. The Roadway Sensors segmentincludes our Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications. TheVehicle Sensors segment is comprised of all activities related to our AutoVue LDW systems for vehicle safety. The Transportation Systems segment includestransportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry. See Note 12 to the accompanying consolidated financial statements for further discussion of our operating segments. 3 We were originally incorporated in Delaware in 1987. In October 2004, we completed a merger with our majority-owned subsidiary, Iteris, Inc. (the“Iteris Subsidiary”), and officially changed our corporate name to Iteris, Inc. Sales, Marketing and Principal Customers We sell our Vantage vehicle detection systems through indirect sales channels comprised of independent dealers in the United States and Canada whosell integrated systems and related products to the traffic management market, as well as directly to the traffic management market using a combination of ourown sales personnel and an outside sales organization. Our independent dealers are primarily responsible for sales, installation and support of Vantagesystems. These dealers maintain an inventory of demonstration traffic products from various manufacturers including our Vantage vehicle detection systemsand sell directly to government agencies and installation contractors. These dealers often have long-term arrangements with the government agencies in theirterritory for the supply of various products for the construction and renovation of traffic intersections. We hold technical training classes for dealers and endusers and maintain a full-time staff of customer support technicians to provide technical assistance when needed. Our marketing strategy for AutoVue is to establish it as the leading platform for in-vehicle video sensing for heavy trucks and passenger cars. Wesell AutoVue LDW systems directly to heavy truck manufacturers and to U.S. truck fleets, and our AutoVue LDW system is currently offered as an optionon certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner and FUSO, as well as Neoplan and MAN luxury bus and coachlines. We market the licensing of our LDW technology to manufacturers of passenger automobiles through an exclusive strategic relationship with ValeoSchalter and Sensuren GmbH (“Valeo”), an independent automotive supplier. In connection with this marketing effort, we provide specific contract engineeringservices, technical marketing and sales support to Valeo, which to date has enabled the launch of our LDW technology on three Infiniti car platforms. We planto continue to provide technical marketing and sales support to Valeo in our efforts to win new original equipment manufacturer (“OEM”) customers for thepassenger car market as well as contract engineering services related to the possible launch of new platforms that include our AutoVue LDW system. We market and sell our transportation management systems and traveler information services directly to government agencies pursuant to negotiatedcontracts that involve competitive bidding and specific qualification requirements. Most of our contracts with federal, state and municipal customers providefor cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We use selected members of our engineeringteam divided on a regional basis to serve in sales and business development functions. We do not engage in sales of transportation management systems andtraveler information services outside of the U.S. Sales of our transportation management systems contracts generally involve long lead times and requireextensive specification development, evaluation and price negotiations. A large portion of our revenues are derived from sales to federal, state and local government agencies. Our largest customer accounted for 7.3% oftotal net sales and contract revenues in the fiscal year ended March 31, 2008 (“Fiscal 2008”). Manufacturing and Materials We use contract manufacturers to build subassemblies that are used in our Vantage products. Additionally, we procure certain components fromqualified suppliers, both globally and locally, and use multi-sourcing strategies when technically and economically feasible to mitigate supply risk. Thesesubassemblies and components are delivered to our Santa Ana facility where they go through final assembly and testing prior to shipment to our customers.Our manufacturing activities are conducted in approximately 9,000 square feet of space at our Santa Ana facility. Production volume at our subcontractors isbased upon quarterly forecasts that we adjust on a monthly basis to control inventory levels. For sales of AutoVue LDW systems to the truck market, wesubcontract the manufacture of our AutoVue LDW systems to one primary manufacturer, and our internal processes are limited primarily to testing and finalverification. For AutoVue LDW sales to the passenger car market, all manufacturing will be performed by Valeo; however, we plan to continue to provideengineering support to Valeo. We currently do not manufacture any of the hardware used in the transportation management and traveler information systemsthat we design and implement. Our production facility is currently ISO 9001 certified. 4 Customer Support and Services We provide warranty service and support for our Vantage and AutoVue products, as well as follow-up service and support for which we chargeseparately. Service revenue accounted for less than 1.0% of total net sales and contract revenues for Fiscal 2008. We believe customer support is a keycompetitive factor. Backlog Our backlog of unfulfilled firm orders was approximately $26.8 million as of March 31, 2008, which was comprised of $900,000 related toRoadway Sensors, $1.3 million related to Vehicle Sensors and $24.6 million related to Transportation Systems. Substantially all of the backlog for RoadwaySensors and Vehicle Sensors is expected to be recognized as revenue in the fiscal year ending March 31, 2009 (“Fiscal 2009”), while approximately 60% ofTransportation Systems backlog is expected to be recognized as revenue in Fiscal 2009. At March 31, 2007, we had backlog of approximately $25.7 million,which was comprised of $3.5 million related to Roadway Sensors, $2.1 million related to Vehicle Sensors and $20.1 million related to TransportationSystems. All backlog as of March 31, 2007 for Roadway Sensors and Vehicle Sensors was recognized as revenue in Fiscal 2008 while 45% of March 31,2007 backlog for Transportation Systems was recognized as revenue in Fiscal 2008. Pursuant to the customary terms of our agreements with governmentcontractors and other customers, customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase ordersoften depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog intorevenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues, in particular for Roadway Sensorsand Vehicle Sensors. Product Development Most of our development activities are conducted at our principal facilities in Santa Ana, California. Our company-sponsored research anddevelopment costs and expenses were approximately $3.6 million for Fiscal 2008, $4.0 million for the fiscal year ended March 31, 2007 (“Fiscal 2007”), and$5.2 million for the fiscal year ended March 31, 2006 (“Fiscal 2006”). We expect to continue to pursue significant product development programs and incursignificant research and development expenditures. Competition We generally face significant competition in each of our target markets. Increased competition may result in price reductions, reduced gross marginsand loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. While AutoVue hashistorically been the only established commercially-available lane departure warning system used in the U.S. and in Europe in the heavy truck market, wehave recently experienced increased competition from new competitors in this market. Potential competitors of AutoVue include Delphi Automotive SystemsCorporation, NEC Corporation and Hitachi Ltd. in Japan and Robert Bosch GmbH in Europe, as well as Siemens, Continental Tavis, Visteon and Cognex,which are currently developing video sensor technologies for the vehicle industry that could be used for lane departure warning systems. In the market for ourVantage vehicle detection systems, we compete with manufacturers of other above ground video camera detection systems such as Econolite ControlProducts, Inc., Traficon, N.V., Quixote, and other non-intrusive detection devices including microwave, infrared, ultrasonic and magnetic detectors, as wellas manufacturers and installers of in-pavement inductive loop products. The transportation management and traveler information systems market is highly fragmented and is subject to evolving national and regionalquality and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advancedtransportation management and traveler information systems include national corporations such as Transcore, Siemens, Telvent Farradyne, Kimley-Horn andAssociates, Inc. and Delcan. Our competitors in transportation engineering, planning and design include major firms such as Parsons Brinkerhoff, Inc.,URS, HNTB and Parsons Transportation Group, Inc., as well as many smaller regional engineering firms. 5 In general, the markets for the products and services we offer are highly competitive and are characterized by rapidly changing technology andevolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer basesand significantly greater financial, technical, manufacturing, distribution and marketing resources than us. As a result, they may be able to adapt morequickly to new or emerging standards or technologies or to devote greater resources to the promotion and sale of their products. It is also possible that newcompetitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in ourtarget markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with abroad range of computing systems, product quality and performance, reliability, functionality, price, and service and technical support. Our failure to provideservices and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a materialadverse effect on our business, financial condition and results of operations. Intellectual Property and Proprietary Rights Our ability to compete effectively depends in part on our ability to develop and maintain the proprietary aspects of our technology. Our policy is toobtain appropriate proprietary rights protection for any potentially significant new technology acquired or developed by us. We currently hold ten U.S. patents,which expire commencing in 2012, and have six U.S. patent applications pending relating to our outdoor image processing techniques used in our AutoVuesystems. Nine of our patents relate specifically to our AutoVue technology and provide a basis for enhanced functionality for rain sensing and improvedperformance. We believe that our other patents, while important for our technology platforms, are less critical to our near term product strategy. We cannotassure you that any new patents will be granted pursuant to any outstanding or subsequent applications. In addition to patent laws, we rely on copyright and trade secret laws to protect our proprietary rights. We attempt to protect our trade secrets andother proprietary information through agreements with customers and suppliers, proprietary information agreements with our employees and consultants, andother similar measures. We do not have any material licenses or trademarks other than those relating to product names. We cannot be certain that we will besuccessful in protecting our proprietary rights. While we believe our patents, patent applications, software and other proprietary know-how have value,changing technology makes our future success dependent principally upon our employees’ technical competence and creative skills for continuing innovation. Litigation may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or todefend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significantliabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which couldhave a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual propertylitigation claim, both in legal fees and expenses, as well as from the diversion of management’s resources, regardless of whether the claim is valid, could besignificant and could have a material adverse effect on our business, financial condition and results of operations. Employees We refer to our employees as associates. As of June 9, 2008, we employed an aggregate of 268 associates, including 54 associates in generalmanagement, administration and finance; 34 associates in sales and marketing; 144 associates in engineering and product development; 23 associates inoperations, manufacturing and quality; and 13 associates in customer service. None of our associates are represented by a labor union, and we have neverexperienced a work stoppage. Government Regulation Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge ofmaterials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would requirecurtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicableenvironmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the nearfuture. Currently, compliance with foreign laws has not had a material impact on our business and is not expected to have a material impact in the near future. 6 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 inthe information incorporated by reference into this report. You should consider the following risks carefully in addition to the other informationcontained in this report and our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K, before deciding to buy, sell orhold our common stock. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties notpresently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occurs, ourbusiness, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could declineand 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. Untilrecently we have historically generated significant net losses and operating losses, and have experienced volatility in our cash flows from operations rangingfrom positive cash flows from operations of $7.6 million in Fiscal 2008 to negative cash flows from operations of $2.0 million in Fiscal 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 inOctober 2006. Furthermore, as of March 31, 2008, we had $7.8 million in subordinated convertible debentures outstanding 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 torefinance this debt. At March 31, 2008, we had $421,000 of cash and cash equivalents and relied on our line of credit to fund our operations. We may need to raiseadditional capital in the near future to fund our operations or to repay indebtedness. Such additional capital may be raised through bank borrowings, or otherdebt 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 suchadditional 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 increase revenue and net income; · increased research and development expenses and sales and marketing expenses; · our need to respond to technological advancements and our competitors’ introductions of new products or technologies; · capital improvements to new and existing facilities and enhancements to our infrastructure and systems; · potential acquisitions of businesses and product lines; · our relationships with customers and suppliers; · government budgets, political agendas and other funding issues, including potential delays in government contract awards; · our ability to successfully negotiate credit arrangements with our bank and repay our subordinated convertible debentures; and · general economic conditions, including the effects of the current economic slowdown and international conflicts. 7 If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additionalfunds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securitiesmay have rights, preferences and privileges senior to our common stock. Additional financing may not be available on favorable terms, on a timely basis, orat 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 enhanceour 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 incomein our prior three fiscal years, we experienced a net loss of $11.3 million in the year ended March 31, 2005 and significant net losses in prior years. We cannotassure 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 orannual basis in the future. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term tocompensate for any unexpected delay or decrease in anticipated revenues. As a result, we may continue to experience operating losses and net losses, whichwould 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 BusinessAnd Stock Price Could Be Adversely Affected. Along with our independent registered public accounting firm, we will be evaluating the effectiveness of ourinternal controls over financial reporting to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 currently requires us to evaluate theeffectiveness 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 amanagement report assessing the effectiveness of our internal controls over financial reporting in all annual reports beginning with our Annual Report onForm 10-K for the fiscal year ending March 31, 2008. Section 404 also requires our independent accountant to attest to, and report on, management’sassessment of our internal controls over financial reporting beginning in our fiscal year ending March 31, 2009. We may not be able to complete ourSection 404 compliance on a timely basis, and even if we timely complete our compliance requirements, our independent auditors may still conclude that ourinternal 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 allfraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectiveswill 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 consideredrelative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within Iteris have been or will be detected. These inherent limitations include the realities that judgments in decision-making canbe faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, bycollusion 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 assumptionsabout 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 deferredcompensation savings plan and certain contract administration. Based on our evaluation, our management concluded that, as of March 31, 2004, our internalcontrol over financial reporting was not effective due to the existence of one material weakness. The weakness was immediately corrected. We cannot assureyou that we or our independent registered public accounting firm will not identify additional material weaknesses in our internal controls. A material weaknessis a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected. If our internal controls over financial reporting are not considered adequate, we may experience a loss ofpublic confidence, which could have an adverse effect on our business and our stock price. 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 arederived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. Government contracts represented approximately38.1%, 37.8% and 38.3% of our total net sales and contract revenues for the years ended March 31, 2008, 2007 and 2006, respectively. We anticipate thatrevenue 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; 8 · 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 government as a resultof a reduction or a delay in the passage of the 2005 Federal Highway Bill set to expire in 2009; · 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 wemay incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financialviability 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 ourcosts on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs would adversely affect ourfinancial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of thegovernment, 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 foregoingconcerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations. New Environmental Regulations May Result In A Decline In Our AutoVue Sales and Royalties. Environmental regulations in Europe weremodified and became effective in 2006, which required more stringent emissions compliance in new trucks manufactured in Europe after 2006. Theseregulations caused the cost of certain trucks to increase significantly and caused a decline in new truck sales in Europe. Similar regulations were exacted inNorth America that impacted diesel engines built after January 2007. North America heavy truck sales in 2007 and the first quarter of 2008 declinedsignificantly as compared to the prior year, which we believe was at least in part a result of large 2006 prebuys of heavy trucks made in anticipation of thenew North America emission standards. We may experience a further decline in our LDW sales to truck OEMs related to these stricter regulations.Additionally, we may experience future declines in our LDW sales to truck OEMs as a result of future regulations such as these. We May Experience Production Gaps Which Could Materially And Adversely Impact Our Sales And Financial Results And TheUltimate Acceptance Of Our Products. It is possible that we could experience unforeseen quality control issues or part shortages as we increase productionto 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 contractmanufacturers to produce many of our products. Although we believe our contract manufacturers have sufficient capacity to meet our production schedules forthe foreseeable future and we believe we could find alternative contract manufacturing sources if necessary, we could experience a production gap if for anyreason 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 exclusiveright 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 tomanufacture, market and sell our technologies, and to convince more OEM passenger car manufacturers to adopt our technologies. To date, we have notgenerated significant royalties from Valeo’s efforts and have only been designed into one car OEM product line. If Valeo does not devote considerable resourcesand aggressively pursue opportunities, our expansion into the passenger car market could be adversely affected. 9 We May Be Unable To Attract And Retain Key Personnel, Which Could Seriously Harm Our Business. Due to the specialized nature of ourbusiness, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The lossof 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 qualifiedengineering and other highly skilled technical personnel. In particular, the future success of our Transportation Systems segment will depend on our ability tohire additional qualified engineers and planners. Competition for qualified employees, particularly development engineers, is intense. We may not be able tocontinue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss ofone 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 TimelyManner, Or Are Unable To Achieve Market Acceptance Of Our New Products, Our Operating Results Would Be Adversely Affected. We believe ourrevenue growth and future operating results will depend on our ability to complete development of new products and enhancements, introduce these products ina timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our product costs. We cannot guarantee thesuccess 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. Inaddition, 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. Weneed to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, softwareand camera technologies in response to evolving customer requirements. We cannot assure you that we will be able to adequately manage product transitionissues. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments orchanging customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannotassure 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 evolvingindustry standards, our ability to resolve technical challenges in a timely and cost-effective manner, qualify any new products with OEMs and achievemanufacturing efficiencies, the perceived advantages of our new products over traditional products and the marketing capabilities of our independentdistributors and strategic partners, including Valeo’s ability to expand sales of AutoVue in the passenger car market. The success of our AutoVue system willalso depend in part on the success of the automotive vehicles that incorporate our technology, as well as the success of optional equipment that OEMs bundlewith 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 ismoving 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 tosuccessfully redesign our products to incorporate compliant components and gain market acceptance of such redesigned products. In addition, if the standardis 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 newproducts could contain undetected design faults and software errors or “bugs” when first released by us, despite our testing. We may not discover these faultsor 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 causedelays in product introduction and shipments, require design modifications or harm customer relationships, any of which could adversely affect our businessand competitive position. The Markets In Which We Operate Are Highly Competitive And Have Many More Established Competitors, Which Could AdverselyAffect Our Sales Or The Market Acceptance Of Our Products. We compete with numerous other companies in our target markets including, but notlimited to, large, multinational corporations, which include tier one automotive suppliers, and many smaller regional engineering firms. We expect suchcompetition to increase due to technological advancements, industry consolidations and reduced barriers to entry. Increased competition is likely to result inprice reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, financial condition and results ofoperations. In Fiscal 2007, we began to experience more competition in our Roadway Sensors segment as the Department of Transportation in one of our largestsales 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 LDWsystems was 10 acquired by a larger company during Fiscal 2007. While this developer has not been a material competitor to date, we may experience more competition fromthis 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 oradded features beyond those offered by our LDW systems. Should such efforts be successful, this could erode our ability to successfully market and sell ourLDW 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 greaterresources to the development, promotion, sale and support of their products than we can. Recent consolidations of end users, distributors and manufacturersin 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 andcompetitive pressures could adversely affect our business, financial condition and results of operations. An Economic Slowdown Could Lead To Reduced Or Delayed Government Funding For Transportation Infrastructure And InitiativesAnd Decreased Availability Of Financial Capital For Our Customers, Causing A Decline In Our Revenues. Concerns about inflation, decreasedconsumer confidence, and reduced corporate profits and capital spending have resulted in a downturn in worldwide economic conditions, particularly in theUnited States. These unfavorable economic conditions may have a negative impact on customer orders (and also may result in decreased sales of automobilesand trucks that incorporate our LDW systems). Such concerns may result in cancellations and rescheduling of backlog. In addition, the recent decline in theU.S. real estate market, particularly in new home construction, has adversely impacted new road construction and could result in a decline in RoadwaySensor and Vehicle Sensor net sales and Transportation Systems contract revenues. Any of the foregoing economic conditions make it extremely difficult forour customers, our suppliers and us to accurately forecast and plan future business activities and could result in a decline in our net sales and contractrevenues. If such conditions continue or worsen, our business, financial condition and results of operations could be materially and adversely affected. 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 infunding of government contracts. Since military operations of such magnitude are not routinely included in U.S. defense budgets, supplemental legislativefunding actions are often required to finance such operations. Even when such legislation is enacted, it may not be adequate for ongoing operations, causingother government resources to be temporarily or permanently diverted. Since a significant portion of our sales are derived from contracts with governmentagencies, such diversion of funds could produce interruptions in funding or delays in receipt of our contracts, causing disruptions and adversely effecting ourrevenue and operations. Our Quarterly Operating Results Fluctuate As A Result Of Many Factors. Therefore, We May Fail To Meet Or Exceed TheExpectations Of Securities Analysts And Investors, Which Could Cause Our Stock Price To Decline. Our quarterly revenues and operating resultshave 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 thatcould 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 asincreased price competition in general; · the long lead times associated with government contracts or required by vehicle manufacturers; · delays in government contracts and funding from time to time; · 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; 11 · 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 ina 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 securitiesanalysts 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 onquarter-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 AndCould Result In Disruptions Of Our Business And Diversion Of Resources And Management Attention. We have historically acquired, and may inthe future acquire, complementary businesses, products and technologies. Acquisitions may require significant capital infusions and, in general, acquisitionsalso 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 informationsystem 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; 12 · 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 thenumber 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 benefitsanticipated from any acquisition. We Have Experienced Growth In Recent Periods. If We Fail To Manage Our Growth Effectively, We May Be Unable To Execute OurBusiness Plan And May Experience Future Weaknesses In Our Internal Controls. We have expanded our overall business. In order to achieve ourbusiness objectives, we will need to continue to expand our business and add additional qualified personnel. Such expansion has placed and is expected tocontinue to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to successfully manageour 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 RemainCompetitive 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; · additional qualification requirements related to new products or components; · frequent new product introductions and enhancements; · inventory issues related to transition to new or enhanced models; and · evolving industry standards and changes in the regulatory environment. Our future success will depend upon our ability 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 vehiclemodels. 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 andour business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through acombination 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 aresubstantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietaryrights 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 ofothers. Litigation may also be necessary to defend against claims of infringement or invalidity by others. An adverse outcome in litigation or any similarproceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or usingcertain products or 13 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 strategicpartners if it is determined that we have infringed upon or misappropriated another party’s intellectual property. Any of these results could adversely affect ourbusiness, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees andexpenses, and the diversion of management’s attention and resources, regardless of whether the claim is valid, could be significant and could seriously harmour 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 thepast. 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 from time to time experienced volatility, which has often affected the market prices of equity securities of manytechnology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations mayadversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have beenthe 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 divertmanagement’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 ourAutoVue and Vantage products internationally and we anticipate that our international operations will expand in the near future. International businessoperations 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; 14 · 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 productsmore expensive and potentially less price competitive in international markets. We do not engage in any transactions as a hedge against risks of loss due toforeign currency fluctuations. Any of the factors mentioned above may adversely affect our future international sales and, consequently, affect our business, financial conditionand operating results. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuationsresulting 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 StructureOr By Former Subsidiaries. Although we divested ourselves of all business units prior to October 2004, with the exception of our Iteris business, from timeto time we could experience unforeseen developments in contingencies related to our former subsidiaries. For example, in July 2006 we entered into a settlementagreement in connection with a lawsuit brought against Mariner Networks, Inc., one of our former subsidiaries, by one of Mariner’s suppliers, pursuant towhich 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 onOctober 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 arenot aware of any other material contingencies, it is possible that other matters could be brought against us in connection with activities related to formersubsidiaries 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 OurStockholders, And Accordingly We Will Not Be Able To Engage In Certain Transactions Without Their Approval. As of March 31, 2008, ourofficers and directors beneficially owned approximately 11% of the outstanding shares of our common stock (and approximately 15% of our common stockwhen including options, warrants and other convertible securities held by them which are currently exercisable or convertible or will become exercisable orconvertible within 60 days after March 31, 2008). As a result of their stock ownership, our management will be able to influence the election of our directorsand 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 andmay 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 could make it difficult for a third party to acquire us, even though an acquisition might be beneficial toour 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 termsof our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock withvoting, conversion and other rights and preferences superior to those of our common stock. Our future issuance of preferred stock could be used to discouragean unsolicited acquisition proposal. ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. 15 ITEM 2. PROPERTIES Our headquarters and principal operations are housed in approximately 52,000 square feet of leased space located at 1700 Carnegie Avenue, SantaAna, California, for which we currently pay a monthly lease rate of $102,000, exclusive of certain utility costs. The Santa Ana facility lease expires in 2015and contains an option to extend the lease for an additional five years at the market rate at that time. For additional information regarding our obligations under property leases, see Note 6 of Notes to Consolidated Financial Statements, included inPart IV, Item 15 of this report. ITEM 3. LEGAL PROCEEDINGS The information set forth under Note 6 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, is incorporatedherein by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our security holders during the three months ended March 31, 2008. 16 PART II ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIES Our common stock is traded on the American Stock Exchange (“AMEX”) under the symbol “ITI”. The following table sets forth, for the periodsindicated, the high and low sales prices for our common stock as reported by AMEX: Common StockHighLowFiscal 2008Quarter Ended June 30, 2007$2.66$2.11Quarter Ended September 30, 20072.502.00Quarter Ended December 31, 20074.202.18Quarter Ended March 31, 20084.061.94 Fiscal 2007Quarter Ended June 30, 2006$2.69$2.10Quarter Ended September 30, 20062.692.26Quarter Ended December 31, 20062.691.38Quarter Ended March 31, 20072.762.15 On June 10, 2008, the last reported sales price of our common stock on the AMEX was $2.72. As of June 10, 2008, we had 456 holders of recordof our common stock according to information furnished by our transfer agent. Dividend Policy We have never paid or declared cash dividends on our common stock, and have no current plans to pay such dividends in the foreseeable future. Wecurrently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of ourBoard of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capitalrequirements, our general financial condition and future prospects, general business conditions, the consent of our lender and such other factors as the Boardof Directors may deem relevant. 17 Stock Performance Graph The graph below shows the cumulative total return on investment assuming an investment of $100 on March 31, 2003 in our common stock, theNASDAQ Stock Market Index and the same peer group used by us last year, which is made up of the remaining members of the index used by us in prioryears, the Media General Industry Group 836 for Diversified Electronics, which is no longer a published index. Our common stock is currently listed on theAMEX under the symbol “ITI” and began trading on such exchange on December 9, 2004. Our common stock was listed on the NASDAQ SmallCapMarket (now called the NASDAQ Capital Market) from April 2002 to August 2003 and quoted on the OTC Bulletin Board from August 2003 toDecember 2004. The total stockholder return assumes reinvestment of dividends on a daily basis, although cash dividends have not been declared on ourcommon stock. The stockholder returns shown in the following graph are not necessarily indicative of future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*Among Iteris, Inc., The NASDAQ Composite IndexAnd A Peer Group * $100 invested on 3/31/03 in stock or index-including reinvestment of dividends. Fiscal year ending March 31. Measurement Period200320042005200620072008Iteris, Inc. Common Stock100.00606.06369.70400.00348.48350.00NASDAQ Composite100.00151.01152.38181.06189.63177.49Peer Group100.00181.83138.87182.74186.37163.80 Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities Act of 1933, as amended, or theSecurities Exchange Act of 1934, as amended, that might incorporate this report or future filings made by us under those statutes, the stock performancegraph is not deemed filed with the Securities and Exchange Commission and shall not be deemed incorporated by reference into any prior filings or into anyfuture filings made by us under those statutes. 18 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial data for each of the five fiscal years ended March 31, 2008. The statement of operationsand balance sheet data for the years ended and as of March 31, 2008, 2007, 2006, 2005, and 2004 are derived from our audited consolidated financialstatements. The accompanying consolidated financial statements have been restated to reflect the classification and presentation of our former subsidiaries,Broadcast, Inc., Zyfer Inc., and MAXxess Systems, Inc., as discontinued operations for all periods presented. The following information should be read inconjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statementsand the related notes thereto included elsewhere in this report. Fiscal Year Ended March 31,20082007200620052004(in thousands, except per share data)Consolidated Statement of Operations Data:Net sales and contract revenues:Net sales$40,326$36,248$31,156$29,062$23,470Contract revenues24,83722,04919,33017,33521,813Total net sales and contract revenues65,16358,29750,48646,39745,283 Costs of net sales and contract revenues:Cost of net sales (a)20,49919,82916,49315,92512,758Cost of contract revenues (a)16,36714,46012,60013,78914,712Gross profit28,29724,00821,39316,68317,813Operating expenses:Selling, general and administrative (a)17,28916,00315,41020,54313,712Research and development (a)3,5664,0305,2176,2363,923Amortization of intangible assets147147147114—Disposal of fixed assets———422—Acquired in-process research and development———140—Total operating expenses21,00220,18020,77427,45517,635Operating income (loss)7,2953,828619(10,772)178Non-operating income (expense):Other income (expense), net252(653)351,0541,003Interest expense, net(1,284)(1,600)(1,459)(1,178)(123)Income (loss) from continuing operations before incometaxes and minority interest6,2631,575(805)(10,896)1,058Income tax benefit (provision)5,9001,34388594(100)Minority interest in earnings of subsidiary———(526)(2,813)Income (loss) from continuing operations12,1632,91880(11,328)(1,855)Income from discontinued operations, net of taxes————1,215Net income (loss)$12,163$2,918$80$(11,328)$(640) Basic earnings (loss) per share:Continuing operations$0.37$0.10$0.00$(0.45)$(0.09)Discontinued operations————0.06Basic earnings (loss) per share$0.37$0.10$0.00$(0.45)$(0.03) Diluted earnings (loss) per share:Continuing operations$0.35$0.09$0.00$(0.45)$(0.09)Discontinued operations————0.06Diluted earnings (loss) per share$0.35$0.09$0.00$(0.45)$(0.03)Shares used in calculating basic earnings (loss) per share32,72329,69828,18225,28419,454Shares used in calculating diluted earnings (loss) pershare34,71333,34832,73725,28419,454 (a) Includes stock-based compensation expense as follows: Cost of net sales$3$13$27$280$— Cost of contract revenues14602052,391— Selling, general and administrative expense2661953647,063— Research and development expense7201292,043— Total stock-based compensation expense$290$288$725$11,777$— 19 At March 31,20082007200620052004(in thousands)Consolidated Balance Sheet Data:Working capital$14,948$6,979$3,009$2,197$9,369Total assets65,64555,25049,63346,65630,065Long-term debt (less current portion)7,5669,76011,37410,315891Accumulated deficit(95,499)(107,438)(110,356)(110,436)(99,108)Total stockholders’ equity (deficit)43,21125,68718,63517,462(1,076) ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes theretoincluded in Part IV, Item 15 of this report and the “Risk Factors” section in Item 1A, as well as other cautionary statements and risks describedelsewhere in this report, before deciding to purchase, hold or sell our common stock. Overview We are a leader in the traffic management market that focuses on the development and application of advanced technologies that reduce trafficcongestion, minimize the environmental impact of traffic congestion and improve the safety of surface transportation systems. By combining outdoor imageprocessing, traffic engineering and information technology, we offer a broad range of Intelligent Transportation Systems and driver safety solutions tocustomers worldwide. We currently operate in three reportable segments: Roadway Sensors, Vehicle Sensors and Transportation Systems. The Roadway Sensors segmentincludes our Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications. TheVehicle Sensors segment is comprised of all activities related to our AutoVue Lane Departure Warning systems for vehicle safety. The Transportation Systemssegment includes transportation engineering and consulting services and the development of transportation management and traveler information systems forthe ITS industry. Our Vantage product is a video vehicle detection system that detects the presence of vehicles on roadways. Vantage systems are used at signalizedintersections to enable a traffic controller to more efficiently allocate green signal time and are also used for incident detection and highway traffic datacollection 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 unintendedlane departures. In excess of 90,000 production AutoVue units have been sold for car and truck platforms in the North American and European markets. OurAutoVue LDW systems are currently qualified as an option on certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner andFUSO, as well as Neoplan and MAN luxury bus and coach lines. In North America, our LDW systems are sold primarily to truck fleets, and to date, 65U.S. heavy truck fleets have selected our LDW systems, representing an estimated 45,000 vehicles. In September 2003, we entered into an agreement with Valeo Schalter and Sensuren GmbH (“Valeo”), pursuant to which we granted Valeo theexclusive right to sell and manufacture our AutoVue LDW systems to the worldwide passenger car market in exchange for royalty payments for each AutoVueLDW unit sold. To date, royalty payments from Valeo have not been significant. Pursuant to this agreement, we also provide specific contract engineeringservices, technical marketing and sales support to Valeo to enable the incorporation of our LDW technology on three Infiniti platforms, the FX, M and EX,where the device is offered as part of various 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 ourefforts to win new OEM customers for the passenger car market as well as contract engineering services related to the possible launch of new Infiniti platformsthat include our LDW system. We believe that AutoVue is a broad sensor platform that, through additional software development, may be expanded toincorporate 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 toenable public agencies to monitor, control and direct 20 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 primarilysold to local, state and national transportation agencies in the United States. Our transportation management systems business is largely dependent upongovernmental funding and budgetary issues. The Federal Highway Bill that was passed in August 2005 provided for a significant increase in transportationfunding over the following six years. We believe the recent expansion of our transportation management systems business was due in part to the passage of theFederal Highway Bill, combined with increased transportation funds available at state and local agencies throughout the country. The 2005 Federal HighwayBill is set to expire in 2009. It is too early to determine any impact on future contract revenues as a result of potential delays in the passage of future bills. Prior to our fiscal year ended March 31, 2004 (“Fiscal 2004”), we operated in three segments consisting of ITS, video products and telecom products.The ITS segment consisted of our current operations, which was previously conducted by the Iteris Subsidiary. The video products segment included ourformer wholly-owned subsidiary, MAXxess Systems, Inc. (“MAXxess”), which designed and manufactured security management systems. Our telecomproducts segment included our wholly-owned subsidiary, Zyfer, Inc. (“Zyfer”), which developed and manufactured timing and synchronization products. During Fiscal 2004, we completed the divestiture of MAXxess and Zyfer and restructured our operations to focus on the operations of our Iteris Subsidiary. Our financial statements for all periods presented in this report have been restated to reflect the discontinuation of the operations of MAXxess and Zyfer. Critical Accounting Policies and Estimates Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements includedherein, which have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The preparation of thesefinancial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosuresof contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On anongoing basis, we evaluate these estimates and assumptions, including those related to the collectibility of accounts receivable, the valuation of inventories, therecoverability of long-lived assets and goodwill, the realizability of deferred tax assets, accounting for stock-based compensation, the valuation of equityinstruments, warranty reserves and other contingencies. We base these estimates on historical experience and on various other factors that we believe to bereasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In theevent that any of our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assetsand liabilities at the date of the financial statements and the reported amounts of 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 consolidated financialstatements. 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 isrecognized, 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 aportion of estimated fees or profits determined using the percentage of completion method of accounting based on the relationship of costs incurred to totalestimated costs. Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, includingthose arising from contract penalty provisions and final contract settlements, may result in revisions to recognized costs and revenues and are recognized in theperiod 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 engineeringservices 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 thepassenger car market. Technology access fee revenues are recognized evenly over the period in which they are earned. Non-recurring contract engineeringrevenues are 21 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 arerecognized in the period in which such sales occur. Technology access fee revenues, non-recurring contract engineering revenues and royalty revenues areincluded 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 areperformed. Accounts Receivable. We estimate the collectibility of customer receivables on an ongoing basis by periodically reviewing invoices outstandinggreater 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 historicalcollections 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 reservesfor potentially excess and obsolete inventory. In assessing the ultimate realization of inventories, we make judgments as to future demand requirements andcompare that with the current or committed inventory levels. Reserves are established for inventory levels that exceed anticipated future demand. It is possiblethat 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 circumstancesindicates that more frequent impairment analysis is required. Impairment, if any, is measured based on the estimated fair value of the reporting units with therecorded goodwill. Fair value is determined by using the income approach methodology of valuation which utilizes discounted cash flows. Significantmanagement judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. In estimating futurecash 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 estimatesused 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 assessthe 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. Defectiveproducts are either repaired or replaced, at our option, upon meeting certain criteria. We accrue a provision for the estimated costs that may be incurred forproduct 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 isincluded within accrued expenses on the accompanying consolidated balance sheets. Should our actual experience of warranty returns be higher thananticipated, 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 quarterlybasis, 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 notlikely, 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 withthis anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and earnings during the year. This estimation process canresult 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 inestimate occurs so that the year-to-date provision reflects the expected annual rate. The changes described in the preceding sentence and adjustments to ourvaluation allowance may create fluctuations in our overall effective tax rate from quarter to quarter. Effective April 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty inIncome Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”), which applies to all tax positions accounted for under Statement of FinancialAccounting Standards (“SFAS”) No. 109, Accounting for Income Taxes (“SFAS 109”). FIN 48 clarifies the accounting for uncertainty in income taxes byestablishing minimum standards for the recognition and measurement of tax positions taken or expected to be taken in a tax return. Under the requirements of 22 FIN 48, we must review all of our tax positions and make a determination as to whether our position is more-likely-than-not to be sustained upon examinationby regulatory authorities. If a tax position meets the more-likely-than-not standard, then the related tax benefit is measured based on a cumulative probabilityanalysis of the amount that is more-likely-than-not to be realized upon ultimate settlement or disposition of the underlying issue. Stock-Based Compensation. We adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), effective April 1, 2006. Prior toApril 1, 2006, we followed the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), as amended bySFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, and, accordingly, accounted for our stock-based compensationplans using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), andrelated interpretations. SFAS 123R requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as anexpense, based on their grant date fair values with such fair values amortized over the requisite service period. We elected to utilize the modified prospectivemethod for the transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modified after the date ofadoption. In addition, under the modified prospective method, compensation expense will be recognized for all stock-based compensation awards granted priorto 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. In implementing SFAS 123R, we have used the Black-Scholes-Merton (“BSM”) option-pricing formula to estimate the fair value of stock-basedawards granted subsequent to April 1, 2006. Our assumptions under the BSM formula include the following: expected volatilities are based on the historicalvolatility of our stock price, the expected life of options is derived based on the historical life of our options, and the risk-free rate for periods within theexpected life of the option is based on the U.S. Treasury interest rates in effect at the time of grant. Additionally, SFAS 123 did not require the estimation offorfeitures in the calculation of stock compensation expense; however, SFAS 123R does require such estimation and upon adoption of SFAS 123R, wechanged our methodology to include an estimate of forfeitures. Future stock-based compensation expense in any particular quarter or year could be affected bychanges in our assumptions or changes in market conditions. 23 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.The following table should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations. Fiscal Year Ended March 31,200820072006 Net sales and contract revenues:Net sales61.9%62.2%61.7%Contract revenues38.137.838.3Total net sales and contract revenues100.0%100.0%100.0% Costs of net sales and contract revenues:Cost of net sales (a)31.534.032.7Cost of contract revenues (a)25.124.824.9Gross profit43.441.242.4Operating expenses:Selling, general and administrative (a)26.527.430.5Research and development (a)5.56.910.3Amortization of intangible assets0.20.30.3Total operating expenses32.234.641.1Operating income11.26.61.2Non-operating income (expense):Other income (expense), net0.4(1.1)0.1Interest expense, net(2.0)(2.7)(2.9)Income (loss) before income taxes9.62.7(1.6)Income tax benefit9.12.31.8Net income18.7%5.0%0.2% (a) Includes stock-based compensation expense as a percent of total net sales and contract revenuesas follows:Cost of net sales0.0%0.0%0.1%Cost of contract revenues0.00.10.4Selling, general and administrative expense0.40.30.7Research and development expense0.00.00.3Total stock-based compensation expense0.4%0.5%1.4% Analysis of Fiscal 2008, Fiscal 2007 and Fiscal 2006 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 detectionsystems, and Vehicle Sensors sales, which are derived from sales of AutoVue LDW systems, technology access fees, contract engineering revenue and royaltyrevenue generated from AutoVue related activities. Contract revenues consist entirely of Transportation Systems contract revenues, which are generated fromsystems integration and ITS consulting services primarily with federal, state, county and municipal agencies. We currently have a diverse customer base withour largest customer constituting 7.3% of total net sales and contract revenues in Fiscal 2008. Total net sales and contract revenues increased 11.8% to $65.2million in Fiscal 2008 compared to $58.3 million in Fiscal 2007, and increased 15.5% in Fiscal 2007 from $50.5 million in Fiscal 2006. Net sales increased 11.3% to $40.3 million in Fiscal 2008 compared to $36.2 million in Fiscal 2007, and increased 16.3% in Fiscal 2007 comparedto $31.2 million in Fiscal 2006. The increase in net sales in each of the periods reflected increased unit sales in both Roadway Sensors and Vehicle Sensors. Roadway Sensors net sales comprised 70.6%, 75.2% and 72.0% of net sales in Fiscal 2008, Fiscal 2007 and Fiscal 2006, respectively,and increased 4.4% to $28.5 million in Fiscal 2008 compared to $27.3 million in Fiscal 2007 and increased 21.5% in Fiscal 2007 compared to$22.4 million in Fiscal 2006. The majority of Roadway 24 Sensors net sales were derived from sales within North America. The Fiscal 2008 and Fiscal 2007 increases primarily reflect the continued adoptionof video vehicle detection technology, such as the technology offered by our Vantage line of products, both domestically and internationally. Fiscal2008 sales growth was not as strong as sales growth in Fiscal 2007 due primarily to lower sales volumes in Texas as a result of local budgetaryissues, a trend that we expect to continue for at least the next few fiscal quarters. We continue to believe that the current increased rate of adoption hasto some extent been due to increased government spending on traffic initiatives, which we believe has been at least partially made possible by thepassage of the Federal Highway Bill in August 2005, as well as expanded sales and marketing efforts, particularly in North America. The 2005Federal Highway Bill is set to expire in 2009. Although we are not aware of any imminent changes in government spending patterns, it is possiblethat, as a result of softening macroeconomic conditions in the U.S. and the decline in the new housing market, government funding for certain trafficinitiatives and roadway improvement projects could be delayed or diverted to focus on other budgetary needs. Should this occur, future domesticRoadway Sensors net sales may be adversely affected. Net sales from Vehicle Sensors products and services increased 32.1% in Fiscal 2008 to $11.9 million compared to $9.0 million in Fiscal2007 and increased 3.2% in Fiscal 2007 compared to $8.7 million in Fiscal 2006. The largest element of Vehicle Sensors net sales was sales of ourLDW systems to the heavy truck market, which aggregated $10.0 million in Fiscal 2008, $6.4 million in Fiscal 2007 and $5.9 million in Fiscal2006. The increase in Fiscal 2008 net sales of Vehicle Sensors products was primarily a result of increased unit sales of our LDW systems toEuropean and Asian OEMs. The increase in Fiscal 2007 net sales of Vehicle Sensors products was primarily related to increased unit sales of LDWsystems in the North American commercial heavy truck market, partially offset by OEM volume discounts provided to our largest customer and theimpact of the transition to our next generation AutoVue LDW systems for the heavy truck market in the latter part of Fiscal 2006. Although we have experienced an overall increase in unit sales of our AutoVue LDW systems in recent fiscal years, in Fiscal 2008, webegan to experience softness in LDW unit sales to the North American truck market as a result of an overall decline in new truck sales in the U.S.driven largely by the general slowdown in the U.S. housing market and overall economy. We expect flat or declining LDW unit sales in the NorthAmerican market over at least the next several fiscal quarters due to these macroeconomic conditions. We have not experienced the same decline in netsales to our European and Asian OEM customers; however, a slowdown in international truck sales could lead to similar sluggishness in LDW unitsales internationally. Vehicle Sensors unit sales in Fiscal 2009 and beyond could also be adversely impacted by slower than expected adoption ratesof our LDW system by European and Asian OEMs and North American heavy truck fleets, as well as potential additional OEM volume discountsresulting from increased price competition as new competitors have entered this market. Additionally, recent environmental regulations in Europe andNorth America have substantially increased the cost of new commercial trucks, which could impact future truck sales volumes and, ultimately, unitsales of our LDW systems. Also included in Vehicle Sensors net sales are revenues from contract engineering services, technology access fees and royalty revenues inthe passenger car market that are derived from our strategic relationship with Valeo, which aggregated $1.9 million, $2.6 million and $2.8 millionin Fiscal 2008, Fiscal 2007 and Fiscal 2006, respectively. Such revenues were lower in Fiscal 2008 as compared to Fiscal 2007 and Fiscal 2006 as aresult of technology access fee revenue of $500,000 that was recognized in Fiscal 2007 and Fiscal 2006. Royalty revenues from Valeo for sales of ourLDW systems for the passenger car market were relatively insignificant in Fiscal 2008, Fiscal 2007 and Fiscal 2006. Our LDW systems are nowoffered as an option on three Infiniti models. While Valeo is currently in discussions to offer our LDW systems on other passenger car platforms, wecannot assure you that Valeo will be successful in these efforts. Contract revenues increased 12.6% to $24.8 million in Fiscal 2008 compared to $22.0 million in Fiscal 2007 and increased 14.1% in Fiscal 2007compared to $19.3 million in Fiscal 2006. Contract revenues are dependent upon the continued availability of funding at both the state and federal levels fromthe various departments of transportation. The Fiscal 2008 and Fiscal 2007 increases in contract revenues were largely due to increased funding at the federal,state and local levels throughout the country, as well as new contract awards. In response to the growth in our Transportation Systems segment, we increasedour Transportation Systems staff by 21% in Fiscal 2008 and 16% in Fiscal 2007. We expect to continue to increase our Transportation Systems staff inFiscal 2009. We believe the ability of our Transportation Systems business to grow and successfully win and service new contracts will be highly dependentupon our continued success in recruiting and retaining qualified personnel. All of our contract revenues are derived from work performed in North Americaunder a broad range of fixed price and cost plus fixed fee contracts. 25 Gross Profit. Total gross profit increased 17.9% to $28.3 million in Fiscal 2008 compared to $24.0 million in Fiscal 2007, and increased 12.2% inFiscal 2007 compared to $21.4 million in Fiscal 2006. Total gross profit as a percent of net sales and contract revenues increased to 43.4% in Fiscal 2008compared to 41.2% in Fiscal 2007 and decreased in Fiscal 2007 from 42.4% in Fiscal 2006. Gross profit as a percentage of net sales was 49.2% in Fiscal 2008 compared to 45.3% in Fiscal 2007 and 47.1% in Fiscal 2006. The increase ingross profit as a percentage of net sales in Fiscal 2008 was a result of a favorable sales mix in terms of both geography and product mix, as well as improvedproduction efficiencies. Gross profit as a percentage of net sales also improved in Fiscal 2008 through the expansion of our Vehicle Sensors customer base,which helped mitigate the impact of lower contractual pricing to our largest European customer. The decrease in gross profit as a percentage of net sales inFiscal 2007 compared to Fiscal 2006 was primarily due to volume discounts given to our largest Vehicle Sensors product customer, as well as an overalldecline in unit volumes to this customer. Fiscal 2007 gross profit as a percentage of net sales in our Roadway Sensors division was relatively consistent withFiscal 2006 gross profit as a percentage of net sales. Gross profit as a percentage of net sales can fluctuate in any specific quarter or year based on customerand product mix, as well as possible shifts of engineering resources from development activities to sustaining activities, which we record as cost of goodssold. Gross profit as a percent of net sales has fluctuated over the last five years from a low of 45.2% in Fiscal 2005 to a high of 49.2% in Fiscal 2008. Gross profit as a percentage of contract revenues decreased to 34.1% in Fiscal 2008 compared to 34.4% in Fiscal 2007 and decreased from 34.8% inFiscal 2006. We recognize contract revenues and related gross profit using percentage of completion contract accounting and the underlying mix of contractactivity affects the related gross profit recognized in any given period. The decreases in gross profit as a percent of contract revenues in Fiscal 2008 comparedto Fiscal 2007, and in Fiscal 2007 compared to Fiscal 2006 reflect a contract mix weighted more toward lower margin contracts in those periods. Lowermargin contracts generally have a higher proportion of sub-consulting revenues associated with them. Selling, General and Administrative Expense. Selling, general and administrative expense increased 8.0% to $17.3 million (or 26.5% of total netsales and contract revenues) in Fiscal 2008 compared to $16.0 million (or 27.4% of total net sales and contract revenues) in Fiscal 2007, and increased 3.8%in Fiscal 2007 compared to $15.4 million (or 30.5% of total net sales and contract revenues) in Fiscal 2006. The increase in selling, general andadministrative expense in Fiscal 2008 compared to Fiscal 2007 was largely attributable to higher commissions and selling expenses driven by sales growth inour Roadway Sensors segment, as well as general and administrative expenses incurred related to our efforts to comply with the internal control attestationrequirements of the Sarbanes-Oxley Act. In Fiscal 2009, we expect to continue to experience increased selling, general and administrative expenses as wepursue further sales growth. Furthermore, we expect to experience further increases in general and administrative expenses as we continue our efforts to complywith the internal control attestation requirements of the Sarbanes-Oxley Act. The increase in selling, general and administrative expense in Fiscal 2007 compared to Fiscal 2006 was mainly a result of higher commissionsassociated with increased Roadway Sensors net sales and increased sales and marketing activities in our Transportation Systems segment. Additionally,selling, general and administrative expense included legal expenses associated with the settlement of litigation described in Note 6 of Notes to ConsolidatedFinancial Statements, a severance accrual of approximately $300,000 associated with the departure of our former Chief Executive Officer in March 2007 and$180,000 related to the write-off of past-due accounts receivable related to rent and other services provided to our former subsidiary, MAXxess (Note 6 ofNotes to Consolidated Financial Statements). No further expense is expected to be incurred in connection with the aforementioned lawsuit or the severancearrangement with our former Chief Executive Officer. We have written off all balances receivable from MAXxess based on our accounts receivable accountingpolicy, but will continue to work with MAXxess to attempt to collect amounts due to us. Certain members of our Board of Directors are part of MAXxessmanagement and ownership. Research and Development Expense. Research and development expense decreased 11.5% to $3.6 million (or 5.5% of total net sales and contractrevenues) in Fiscal 2008 compared to $4.0 million (or 6.9% of total net sales and contract revenues) in Fiscal 2007, and decreased 22.8% in Fiscal 2007compared to $5.2 million (or 10.3% of total net sales and contract revenues) in Fiscal 2006. The decrease in research and development expense in Fiscal 2008compared to Fiscal 2007 was primarily due to reduced research and development activities in Vehicle Sensors as many of our significant truck OEMcustomers now have production LDW units that only require minimal further development and the majority of our passenger car research and developmentefforts are funded by our strategic partner, Valeo. This decreased spending was partially offset by increased research and development spending in RoadwaySensors. We believe research and development activities are crucial to our ability to continue to be a leader in our markets, and we expect our Fiscal 2009research and development expenditures to increase from Fiscal 2008 levels. 26 The decrease in research and development expense in Fiscal 2007 compared to Fiscal 2006 was largely a result of higher than anticipated costs inFiscal 2006 in Vehicle Sensors as we expended significant development resources in qualifying the next generation LDW system with our largest customer, aswell as several other heavy truck OEMs. Additionally, in Fiscal 2007, there was a shift in engineering resources from research and development activities toproduct support activities as a result of new product introductions and improvements in Roadway Sensors. Costs associated with product support activitiesare included in cost of net sales rather than research and development expense. For competitive reasons, we closely guard the confidentiality of specific development projects. Other Income (Expense), Net. Other income (expense), net reflects the following: Year Ended March 31,200820072006(In thousands)Gain on early extinguishment of debt$224$—$—Settlement of lawsuits—(635)—Other28(18)35Other income (expense), net$252$(653)$35 Other income (expense), net in Fiscal 2008 primarily reflects the gain of $224,000 we recognized in connection with the early retirement of $2.1million of convertible debentures, which is discussed in Note 4 of Notes to Consolidated Financial Statements. Other income (expense), net in Fiscal 2007primarily reflects $635,000 of expense recorded in connection with the settlement of litigation in July 2006, which is discussed in Note 6 of Notes toConsolidated Financial Statements. Interest Expense, Net. Interest expense, net reflects the net of interest expense and interest income as follows: Year Ended March 31,200820072006(In thousands)Interest expense$(1,285)$(1,601)$(1,461)Interest income112Interest expense, net$(1,284)$(1,600)$(1,459) Interest expense, net decreased 19.8% in Fiscal 2008 compared to Fiscal 2007 and increased 9.7% in Fiscal 2007 compared to Fiscal 2006. Thedecrease in interest expense in Fiscal 2008 compared to Fiscal 2007 was primarily due to a lower level of borrowings as well as a lower interest rate on our lineof credit, which bears interest at a rate indexed to the prime rate. The increase in interest expense in Fiscal 2007 compared to Fiscal 2006 was mainly related tothe October 2006 refinancing of our bank term note and line of credit with a new bank, which resulted in a slightly higher interest rate on our bankborrowings. Income Taxes. During Fiscal 2008, we recognized an income tax benefit of $5.9 million and at March 31, 2008 our consolidated balance sheetincluded net deferred tax assets of $10.3 million. The ability to record the deferred tax asset was based on the more likely than not criteria of SFAS No. 109,Accounting for Income Taxes. During Fiscal 2007, we recognized an income tax benefit of $1.3 million and at March 31, 2007, our consolidated balancesheet included net deferred tax assets of $3.0 million. The income tax benefits recorded in Fiscal 2008, Fiscal 2007 and Fiscal 2006 were primarily the resultof a 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. Inthe future, we may continue to record similar adjustments to our deferred tax asset valuation allowance as our estimates are updated. We anticipate this willcause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates and statutory tax rates. At March 31, 2008, we had $44.7 million of federal net operating loss carryforwards and $16.6 million of state net operating loss carryforwardsthat begin to expire in 2019 and 2013, respectively. Due to changes in stock ownership, our federal net operating loss carryforwards are subject to aSection 382 limitation estimated at approximately $7.8 million annually which can be utilized to offset federal consolidated taxable income. Although theimpact cannot be precisely determined, we believe that our net operating loss carryforwards and the valuation allowance we have recorded against our netdeferred tax assets in our consolidated balance sheets will cause us to have future income tax payments and income tax expense that are substantially lowerthan the income tax liability and income tax expense calculated using statutory tax rates. 27 In Fiscal 2008, we adopted FIN 48. See Notes 1 and 5 of Notes to Consolidated Financial Statements for further discussion regarding ourimplementation of FIN 48. Stock-Based Compensation Expense. In Fiscal 2007, we adopted SFAS 123R using the modified prospective approach. Stock-basedcompensation expense remained relatively consistent in Fiscal 2008 and Fiscal 2007 at $290,000 and $288,000, respectively. See Notes 1 and 9 of Notes toConsolidated Financial Statements for additional discussion regarding our implementation of SFAS 123R. 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 ofequity securities. We currently rely on cash flows from operations and borrowings on a line of credit facility to fund our operations, which we believe to besufficient to fund our operations for at least the next twelve months. At March 31, 2008, we had $14.9 million in working capital, which included noborrowings on our $10.0 million line of credit and $421,000 in cash and cash equivalents, as compared to working capital of $7.0 million at March 31, 2007,which included borrowings of $4.0 million on our line of credit and $35,000 in cash and cash equivalents. Our operations provided $7.6 million of cashduring Fiscal 2008, primarily as a result of net income adjusted for non-cash items within the statement of operations. During Fiscal 2007, our operationsused $2.0 million of cash, primarily as a result of investments in inventory due to sales growth and longer lead times in procuring certain components, and anincreased level of net costs and estimated earnings in excess of billings due to sales growth and the timing of invoicing on contracts in our TransportationSystems segment. These were partially offset by net income of $2.9 million. During Fiscal 2006, our operations provided $218,000 of cash, primarily as aresult of planned decreases in inventory and the timing of payments on accrued expenses and payables, which were partially offset by increases in accountsreceivable and net costs and estimated earnings in excess of billings on uncompleted contracts, both as a result of sales growth. Investing activities for Fiscal 2008, Fiscal 2007 and Fiscal 2006 consisted primarily of purchases of property and equipment, which aggregated$739,000, $488,000 and $1.3 million, respectively. In Fiscal 2006, capital expenditures were higher primarily due to hardware, software and related laborcosts to implement a new enterprise resource management system, which was placed in service at the beginning of Fiscal 2007. Cash used in financing activities was $6.5 million in Fiscal 2008, which was the net result of net payments on borrowings of $8.0 million offset bycash inflows of $1.5 million from the exercise of outstanding stock options and warrants to purchase our common stock. During Fiscal 2007, financingactivities provided $2.4 million of cash, which was the net result of net payments on borrowings of $1.2 million, offset by cash inflows of $3.6 million fromthe exercise of outstanding stock options and warrants to purchase our common stock. As discussed in Note 8 of Notes to Consolidated Financial Statements,approximately $2.0 million of the $3.6 million in proceeds from the exercise of stock options and warrants was raised through the exercise of outstandingwarrants to purchase an aggregate of 1,250,000 shares of our common stock. During Fiscal 2006, financing activities provided $1.1 million of cash as aresult of net borrowings of $792,000 and cash inflows of $333,000 from the exercise of outstanding stock options and warrants to purchase our commonstock. Borrowings The following table summarizes our borrowings and long-term debt: At March 31, 2008(In thousands)Convertible debentures, net$7,566Bank term note210Other34$7,810 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 facilityprovides for line of credit borrowings of up to $10.0 million against our eligible accounts 28 receivable and inventory, as defined in the credit agreement. The term note provided for monthly principal payments of approximately $104,000 and maturedin 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 was fixed at anannual 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 theaverage daily principal balance during the preceding month. The credit facility also requires $2,000 in monthly collateral management fees and includes anearly termination fee equal to 1% of the total facility. The credit facility is secured by substantially all of our assets. At March 31, 2008, we had $8.6 millionavailable under our credit facility, all of which was unused. Contractual Obligations Our contractual obligations were as follows at March 31, 2008: Payments Due by Period20092010201120122013ThereafterTotal(In thousands)Notes payable$244$—$—$—$—$—$244Convertible debentures—7,750————7,750Operating leases1,5941,4311,3661,3321,3632,4609,546Total$1,838$9,181$1,366$1,332$1,363$2,460$17,540 At March 31, 2008, we had firm commitments to purchase inventory in the amount of $2.3 million during the first and second quarters of Fiscal2009. 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 infull on May 19, 2009 and are convertible into shares of our common stock at a conversion price of $3.61 per share. At March 31, 2008, convertibledebentures in an aggregate principal amount of $7.8 million remained outstanding. Because these debentures are conventionally convertible, we have notseparately accounted for the conversion feature and, accordingly, no separate amounts are presented in our consolidated financial statements in connection withthis conversion feature. At March 31, 2008, outstanding warrants to purchase an aggregate of 246,250 shares of our common stock at an exercise price of $3.25 per shareare callable by us if the market price of our common stock trades for 20 consecutive days at a price equal to or greater than two times the exercise price of thewarrants. Outstanding warrants to purchase an aggregate of 75,000 shares of our common stock at an exercise price of $5.00 per share are callable by us if themarket price of our common stock trades for 20 consecutive days at a price equal to or greater than one and a half times the exercise price of the warrants. In connection with the issuance of warrants to purchase 246,250 shares of our common stock at $3.25 per share, we are a party to a registrationrights agreement that contains provisions under which we could be subjected to liquidated damages should we fail to maintain effective registration statementsfor the shares of common stock issuable upon exercise of certain underlying warrants. These warrants have been accounted for within equity in ourconsolidated balance sheets in accordance with EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settledin, a Company’s Own Stock, and, accordingly, no liabilities have been recorded in connection therewith. As of the date of this filing, no liquidated damagesare payable under the provisions of the registration rights agreement associated with these warrants. Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a frameworkfor measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather itspecifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 iseffective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008 the FASB issued FSP 157-2,Effective Date of FASB Statement No. 157, which delays the effective date of SFAS 157 for non-financial assets and liabilities to fiscal years beginning afterNovember 15, 2008. Generally, this statement will be applied prospectively. We are currently evaluating the impact of SFAS 157 and expect to adopt SFAS157 in the first quarter of our fiscal year ending March 31, 2009. 29 In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including anAmendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other itemsat 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 reportingdate. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are evaluating the impact that theadoption 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 seasonality, particularly with respect to our Roadway Sensors net sales in the third and fourth fiscal quarters due toa reduction in road construction and repairs during the winter months due to inclement weather conditions. ITEM 7A. 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 (5.25% atMarch 31, 2008). We do not believe that a 10% increase in the interest rate on our line of credit (from 6.25% to 6.88%) would have a material impact on ourfinancial position, operating results or cash flows. In addition, we believe that the carrying value of our outstanding debt approximates fair value. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Regulation S-X are included in Part IV, Item 15 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A(T). CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934, as of the endof the period covered by this Annual Report on Form 10-K, the Company’s management evaluated, with the participation of the Company’s President andChief Executive Officer and the Chief Financial Officer, the effectiveness of the design and operation of the Company’s disclosure controls and procedures (asdefined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the President and Chief ExecutiveOfficer and the Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation in ensuringthat information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and(2) accumulated and communicated to management, including the Company’s President and Chief Executive Officer and the Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. (b) Changes in internal control. There was no change in the Company’s internal control over financial reporting that occurred during the periodcovered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, the Company’s internal control overfinancial reporting. Management’s Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controlsystem was designed to provide reasonable assurance to management and the board of directors regarding the effectiveness of our internal control processesover the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective canprovide only reasonable assurance with respect to financial statement preparation and presentation. 30 We have assessed the effectiveness of our internal controls over financial reporting as of March 31, 2008. In making this assessment, we usedthe criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Basedon our assessment, we believe that, as of March 31, 2008, our internal control over financial reporting is effective based on those criteria. This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internalcontrol over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuantto the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report. ITEM 9B. OTHER INFORMATION On June 11, 2008, we entered into a change in control agreement with James Miele, our Chief Financial Officer. Pursuant to the terms of theagreement, in the event of an Involuntary Termination (as defined in the agreement) of Mr. Miele’s employment in connection with or within twelve monthsafter a change in control, Mr. Miele will be entitled to receive a lump sum severance payment of up to one year’s base pay and 50% of his target bonus for theyear. In addition, Mr. Miele will be entitled to receive reimbursement for the cost of COBRA coverage for a period of up to one year following the termination ofhis employment. The agreement terminates on the fifth anniversary of the date of the agreement, unless earlier terminated in accordance therewith. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE (a) Identification of Directors. The information under the caption “Election of Directors,” appearing in our proxy statement for the 2008 AnnualMeeting of Stockholders, is incorporated herein by reference. (b) Identification of Executive Officers. The information under the caption “Executive Compensation and Other Information - Executive Officers,”appearing in our proxy statement for the 2008 Annual Meeting of Stockholders, is incorporated herein by reference. (c) Compliance with Section 16(a) of the Exchange Act. The information under the caption “Section 16(a) Beneficial Ownership ReportingCompliance” appearing in our proxy statement for the 2008 Annual Meeting of Stockholders is incorporated herein by reference. (d) Corporate Governance. The information under the caption “Corporate Governance,” appearing in our proxy statement for the 2008 AnnualMeeting of Stockholders, is incorporated herein by reference. (e) Audit Committee. The information under the caption “Board Meetings and Committees – Audit Committee,” appearing in our proxy statementfor the 2008 Annual Meeting of Stockholders, is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information under the caption “Executive Compensation and Other Information,” appearing in our proxy statement for the 2008 Annual Meetingof Stockholders, is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS The information under the captions “Equity Compensation Plans” and “Principal Stockholders and Common Stock Ownership of CertainBeneficial Owners and Management,” appearing in our proxy statement for the 2008 Annual Meeting of Stockholders, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information under the captions “Corporate Governance – Director Independence” and “Certain Transactions,” appearing in our proxy statementfor the 2008 Annual Meeting of Stockholders, is incorporated herein by reference. 31 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information under the caption “Fees Paid to Independent Registered Public Accounting Firm,” appearing in our proxy statement for the 2008Annual Meeting of Stockholders, is incorporated herein by reference. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Documents filed as part of this report: 1. Financial Statements. The following financial statements of Iteris, Inc. are included in a separate section of this Annual Report onForm 10-K commencing on the pages referenced below: Report of Independent Registered Public Accounting Firm40Consolidated Balance Sheets as of March 31, 2008 and 200741Consolidated Statements of Operations for the years ended March 31, 2008, 2007 and 200643Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended March 31, 2008, 2007 and 200644Consolidated Statements of Cash Flows for the years ended March 31, 2008, 2007 and 200645Notes to Consolidated Financial Statements46 2. Financial Statement Schedules. Schedule II — Valuation and Qualifying Accounts63 All other schedules have been omitted because they are not required or the required information is included in our consolidated financial statements andnotes thereto. 3. Exhibits. The following exhibits are filed herewith or incorporated by reference to the location indicated below: ExhibitNumberDescriptionWhere Located 3.1Amended and Restated Certificate of Incorporation of theregistrantExhibit 3.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on October 28, 2004 3.2Certificate of Amendment to Amended and Restated Certificate ofIncorporation effective September 26, 2007Exhibit 3.2 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2007 as filed with the SEC onNovember 13, 2007 3.3Bylaws of the registrant, as amendedExhibit 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 3.4Certificates of Amendment to Bylaws of the registrant datedApril 24, 1998 and August 10, 2001Exhibit 3.4 to the registrant’s Annual Report on Form 10-K/A for theyear ended March 31, 2003 as filed with the SEC on July 29, 2003 3.5Certificate of Amendment to Bylaws of registrant datedSeptember 9, 2004Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2004 as filed with the SEC onNovember 15, 2004 32 ExhibitNumberDescriptionWhere Located 3.6Certificate of Amendment to Bylaws of registrant effectiveSeptember 16, 2005Exhibit 3.5 to the registrant’s Annual Report on Form 10-K for the yearended March 31, 2007 3.7Certificate of Amendment to Bylaws of registrant effectiveDecember 7, 2007Exhibit 3.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on December 13, 2007 4.1Specimen of common stock certificateExhibit 4.1 to registrant’s Registration Statement on Form 8-A as filedwith the SEC on December 8, 2004 4.2Amended and Restated Rights Agreement, dated as of May 10,2004, by and between the registrant and U.S. Stock TransferCorporation, including exhibits theretoExhibit 99.1 to the registrant’s Registration Statement on Form 8-A/A asfield with the SEC on June 18, 2004 10.1*Profit Sharing Plan and TrustExhibit 10.3 to the registrant’s Amendment No. 2 to the RegistrationStatement on Form S-8 (Reg. No. 002-98656) as filed with the SEC onMay 5, 1988 10.2*Amendment Nos. 3 and 4 to the Profit Sharing Plan and TrustExhibits 4.3.1 and 4.3.2, respectively, to Amendment No. 3 to theregistrant’s Registration Statement on Form S-3 (Reg. No. 002-86220)as filed with the SEC on June 13, 1990 10.3*Form of Executive Deferral Plan between the registrant andcertain employees of the registrantExhibit 10.4 to the registrant’s Annual Report on Form 10-K for the yearended March 31, 1988 10.4Form of Indemnity Agreement entered into by the registrant andcertain of its officers and directorsExhibit 19.4 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 1988 10.5Form of Indemnification Agreement entered into by the registrantand certain of its officers and directorsExhibit 10.5 to the registrant’s Annual Report on Form 10-K for the yearended March 31, 2004 as filed with the SEC on June 29, 2004 10.6*1997 Stock Incentive Plan (as amended on May 3, 2003, asfurther amended on December 15, 2004)Exhibit 10.32 to the registrant’s Annual Report on Form 10-K for theyear ended March 31, 2005 as filed with the SEC on July 14, 2005 10.7*Form of Notice of Grant of Stock OptionExhibit 99.2 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.8*Form of Stock Option AgreementExhibit 99.3 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.9*Form of Addendum to Stock Option Agreement—InvoluntaryTermination Following Corporate Transaction or Change inControlExhibit 99.4 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.10*Form of Addendum to Stock Option Agreement—Limited StockAppreciation RightsExhibit 99.5 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 33 ExhibitNumberDescriptionWhere Located 10.11*Form of Stock Issuance AgreementExhibit 99.6 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.12*Form of Addendum to Stock Issuance Agreement—InvoluntaryTermination Following Corporate Transaction/Change in ControlExhibit 99.7 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.13*Form of Notice of Grant of Automatic Stock Option—InitialGrantExhibit 99.8 to Exhibit 99.8 to registrant’s Registration Statement onForm S-8 (File No. 333-30396) as filed with the SEC on February 14,2000 10.14*Form of Notice of Grant of Automatic Stock Option—AnnualGrantExhibit 99.9 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-30396) as filed with the SEC on February 14, 2000 10.15*Form of Automatic Stock Option Agreement.Exhibit 99.10 to the registrant’s Registration Statement on Form S-8(File No. 333-30396) as filed with the SEC on February 19, 2000 10.16Amended and Restated Agreement of Purchase and Sale andEscrow Instructions, dated February 19, 2002, by and betweenIteris, Inc. and 1515 South Manchester, LLCExhibit 2.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on June 12, 2002 10.17*Change in Control Agreement dated May 8, 2003 by and betweenthe registrant and Gregory A. MinerExhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2003 as filed with the SEC on August 14, 2003 10.18*Change in Control Agreement dated May 20, 2003 by andbetween the registrant and Jack E. JohnsonExhibit 10.23 to Amendment No. 1 to the registrant’s RegistrationStatement on Form S-1 as filed with the SEC on February 17, 2004 10.19*Iteris Inc. 1998 Stock Incentive Plan (as amended onFebruary 7, 2000)Exhibit 10.24 to the registrant’s Annual Report on Form 10-K for theyear ended March 31, 2005 as filed with the SEC on July 14, 2005 10.20*Form of Notice of Grant, including forms of Option Agreementand Stock Purchase Agreement for the following directors andexecutive officers: Gary Hernandez, Dr. Hartmut Marwitz, PaulE. Wright, Jack Johnson, Richard D. Crawshaw, GregoryMcKhann, Francis Memole, James S. Miele, Abbas Mohaddesand Stephen Edwin RoweExhibit 99.2 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-126834) as filed with the SEC on July 22, 2005 10.21*Form of Addendum to Stock Option AgreementExhibit 99.3 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-126834) as filed with the SEC on July 22, 2005 10.22*Form of 1997 Stock Option AgreementsExhibit 99.4 to the registrant’s Registration Statement on Form S-8 (FileNo. 333-126834) as filed with the SEC on July 22, 2005 10.23*Iteris, Inc. Deferred Compensation Savings Plan and GrantorTrustExhibit 10.31 to the registrant’s Annual Report on Form 10-K for theyear ended March 31, 2005 as filed with the SEC on July 14, 2005 34 ExhibitNumberDescriptionWhere Located 10.24+Cooperative Agreement for Development, Manufacture,Marketing and Sale of Products to the Class 1 and Class 2Vehicle Markets Incorporating Iteris’ LDWS Technology (ValeoSchalter and Sensoren GmbH)Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2004 as filed with the SEC on August 16, 2004 10.25Warrant Exercise Agreement dated September 27, 2006 by andamong the registrant and Special Situations Fund III QP, L.P.,Special Situations Fund III, L.P., Special Situations CaymanFund, L.P. and Special Situations Private Equity Fund, L.P.Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 as filed with the SEC onNovember 14, 2006. 10.26Registration Rights Agreement dated September 28, 2006 by andamong the registrant and Special Situations Fund III QP, L.P.,Special Situations Fund III, L.P., Special Situations CaymanFund, L.P. and Special Situations Private Equity Fund, L.P.Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 as filed with the SEC onNovember 14, 2006. 10.27+National Intelligent Transportation Systems (ITS) ArchitectureEvolution and Support Award/Contract effective as of October 1,2006 by and between the registrant and the Federal HighwayAdministrationExhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 as filed with the SEC onNovember 14, 2006. 10.28Loan and Security Agreement effective as of October 16, 2006by and between the registrant and Silicon Valley BankExhibit 10.4 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 as filed with the SEC onNovember 14, 2006. 10.29Intellectual Property Security Agreement dated October 9, 2006by and between the registrant and Silicon Valley BankExhibit 10.5 to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 as filed with the SEC onNovember 14, 2006. 10.30+Settlement Agreement, effective August 15, 2006, by andbetween the registrant and Delta Networks, Inc.Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on August 21, 2006 10.31*Offer letter effective February 28, 2007 by and between theregistrant and Abbas MohaddesExhibit 10.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on March 6, 2007 10.32*Separation Agreement and Release of Claims dated March 1,2007 by and between the registrant and Jack JohnsonExhibit 10.2 to the registrant’s Current Report on Form 8-K as filed withthe SEC on March 6, 2007 10.33Sublease Agreement, dated September 30, 2003, by and betweenOdetics, Inc. and Maij, Inc.Exhibit 10.1 to the registrant’s Quarterly Report on Form 10-Q as filedwith the SEC on August 14, 2007 10.34Office Lease Agreement, dated May 24, 2007, by and betweenCrown Carnegie Associates, LLC and Iteris, Inc.Exhibit 10.2 to the registrant’s Quarterly Report on Form 10-Q as filedwith the SEC on August 14, 2007 10.35Termination Agreement, dated May 30, 2007, by and amongTransportation Planning Group, Inc., Abbas Mohaddes andIteris, Inc.Exhibit 10.3 to the registrant’s Quarterly Report on Form 10-Q as filedwith the SEC on August 14, 2007 35 ExhibitNumberDescriptionWhere Located 10.36*2007 Omnibus Incentive Plan and forms of agreementsAppendix A to the registrant’s Definitive Proxy Statement on Schedule14A as filed with the SEC on August 10, 2007 10.37Amendment to Loan and Security Agreement, dated October 17,2007, by and between Silicon Valley Bank and Iteris, Inc.Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on October 23, 2007 10.38Debenture Redemption Agreement, dated February 11, 2008, byand among Potomac Capital Partners, LP, Potomac CapitalInternational Ltd. and Iteris, Inc.Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on February 15, 2008 10.39Debenture Redemption Agreement, dated February 27, 2008, byand between Gruber & McBaine International and Iteris, Inc.Exhibit 10.1 to the registrant’s Current Report on Form 8-K as filed withthe SEC on February 29, 2008 10.40Debenture Redemption Agreement, dated February 27, 2008, byand between Lagunitas Partners, LP and Iteris, Inc.Exhibit 10.2 to the registrant’s Current Report on Form 8-K as filed withthe SEC on February 29, 2008 10.41Debenture Redemption Agreement, dated February 27, 2008, byand between Jon D. and Linda W. Gruber Trust and Iteris, Inc.Exhibit 10.3 to the registrant’s Current Report on Form 8-K as filed withthe SEC on February 29, 2008 10.42*Change in Control Agreement dated June 11, 2008 by andbetween James S. Miele and Iteris, Inc.Filed Herewith 21Subsidiaries of the registrantFiled Herewith 23Consent of Independent Registered Public Accounting FirmFiled Herewith 31.1Certification of the Chief Executive Officer Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002Filed Herewith 31.2Certification of the Chief Financial Officer Pursuant toSection 302 of the Sarbanes-Oxley Act of 2002Filed Herewith 32.1Certification of the Chief Executive Officer Pursuant to 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002Filed Herewith 32.2Certification of the Chief Financial Officer Pursuant to 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002Filed Herewith * Indicates a management contract or compensatory plan or arrangement+ Confidential treatment has been requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, asamended. In accordance with Rule 24b-2, these confidential portions have been omitted from the exhibit and filed separately with the SEC. 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized. ITERIS, INC.(Registrant) By/s/ ABBAS MOHADDESAbbas MohaddesPresident and Chief Executive Officer 37 POWER OF ATTORNEY We, the undersigned officers and directors of Iteris, Inc., do hereby constitute and appoint James S. Miele and Abbas Mohaddes, and each of them,our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any andall capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with theSecurities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each andevery act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby,ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtuehereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant in the capacities and on the dates indicated: SignatureTitleDate /s/ ABBAS MOHADDESDirector, President and Chief Executive OfficerJune 11, 2008Abbas Mohaddes(principal executive officer) /s/ JAMES S. MIELEChief Financial OfficerJune 11, 2008James S. Miele(principal financial and accounting officer) /s/ GREGORY A. MINERChairman of the BoardJune 11, 2008Gregory A. Miner /s/ RICHARD CHARDirectorJune 11, 2008Richard Char /s/ KEVIN C. DALYDirectorJune 11, 2008Kevin C. Daly, Ph.D. /s/ JOHN SEAZHOLTZDirectorJune 11, 2008John Seazholtz /s/ JOEL SLUTZKYDirectorJune 11, 2008Joel Slutzky /s/ THOMAS L. THOMASDirectorJune 11, 2008Thomas L. Thomas 38 Iteris, Inc. Index to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm40 Consolidated Balance Sheets as of March 31, 2008 and 200741 Consolidated Statements of Operations for the years ended March 31, 2008, 2007, and 200643 Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the years ended March 31, 2008, 2007, and 200644 Consolidated Statements of Cash Flows for the years ended March 31, 2008, 2007, and 200645 Notes to Consolidated Financial Statements46 39 Report of Independent Registered Public Accounting Firm To the Board of Directors and StockholdersIteris, Inc. We have audited the consolidated balance sheets of Iteris, Inc. as of March 31, 2008 and 2007, and the related consolidated statements of operations,stockholders’ equity and comprehensive income and cash flows for each of the three years in the period ended March 31, 2008. Our audits also included thefinancial statement schedules of Iteris, Inc. listed in Item 15(a). These financial statements and financial statement schedules are the responsibility of theCompany’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Iteris, Inc. as ofMarch 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2008, in conformitywith U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 1 to the consolidated financial statements, effective April 1, 2007 the Company changed its method of accounting for uncertainty inincome taxes, and effective April 1, 2006 the Company changed its method of accounting for stock-based compensation. We were not engaged to examine management’s assertion about the effectiveness of Iteris, Inc.’s internal control over financial reporting as of March 31, 2008included in the accompanying Management’s Report On Internal Control Over Financial Reporting and, accordingly, we do not express an opinion thereon. /s/ McGladrey & Pullen, LLPIrvine, CaliforniaJune 11, 2008 40 Iteris, Inc. Consolidated Balance Sheets (In thousands) March 31,20082007AssetsCurrent assets:Cash and cash equivalents$421$35Trade accounts receivable, net of allowance for doubtful accounts of $1,020 and $664 at March 31, 2008and 2007, respectively13,10811,493Costs and estimated earnings in excess of billings on uncompleted contracts5,3513,689Deferred income taxes2,541494Inventories, net of reserve for inventory obsolescence of $819 and $844 at March 31, 2008 and 2007,respectively4,2266,379Prepaid expenses and other current assets371385Total current assets26,01822,475 Property and equipment:Leasehold improvements1,915112Equipment7,3566,830Accumulated depreciation(5,804)(5,230)3,4671,712 Deferred income taxes7,8072,533Intangible assets, net of accumulated amortization of $555 and $408 at March 31, 2008 and 2007,respectively257404Goodwill27,77427,774Other assets322352Total assets$65,645$55,250 See accompanying notes. 41 Iteris, Inc. Consolidated Balance Sheets (In thousands, except per share amounts) March 31,20082007Liabilities and stockholders’ equityCurrent liabilities:Trade accounts payable$3,902$3,542Accrued payroll and related expenses3,8253,527Accrued liabilities1,9731,618Revolving line of credit—4,015Billings in excess of costs and estimated earnings on uncompleted contracts1,126847Current portion of long-term debt2441,947Total current liabilities11,07015,496 Deferred rent1,956— Unrecognized tax benefits1,381— Deferred compensation plan liability391730 Other non-current liabilities70163 Long-term debt7,5669,760 Commitments and contingencies Redeemable common stockIssued and outstanding shares — none at March 31, 2008 and 1,219 at March 31, 2007—3,414 Stockholders’ equity:Preferred stock, $1.00 par value:Authorized shares — 2,000Issued and outstanding shares — none——Common stock, $.10 par value:Authorized shares — 70,000 at March 31, 2008 and 50,000 at March 31, 2007Issued and outstanding shares — 33,420 at March 31, 2008 and 30,601 at March 31, 20073,3423,060Additional paid-in capital135,516130,425Common stock held in trust — 167 shares at March 31, 2008 and 311 shares at March 31, 2007(202)(374)Notes receivable from employees—(5)Accumulated deficit(95,499)(107,438)Accumulated other comprehensive income5419Total stockholders’ equity43,21125,687Total liabilities and stockholders’ equity$65,645$55,250 See accompanying notes. 42 Iteris, Inc. Consolidated Statements of Operations (In thousands, except per share amounts) Year Ended March 31,200820072006 Net sales and contract revenues:Net sales$40,326$36,248$31,156Contract revenues24,83722,04919,330Total net sales and contract revenues65,16358,29750,486 Costs of net sales and contract revenues:Cost of net sales (a)20,49919,82916,493Cost of contract revenues (a)16,36714,46012,600Gross profit28,29724,00821,393Operating expenses:Selling, general and administrative (a)17,28916,00315,410Research and development (a)3,5664,0305,217Amortization of intangible assets147147147Total operating expenses21,00220,18020,774Operating income7,2953,828619Non-operating income (expense):Other income (expense), net252(653)35Interest expense, net(1,284)(1,600)(1,459)Income (loss) before income taxes6,2631,575(805)Income tax benefit5,9001,343885Net income$12,163$2,918$80 Earnings per share:Basic$0.37$0.10$0.00Diluted$0.35$0.09$0.00 Weighted average shares outstanding:Basic32,72329,69828,182Diluted34,71333,34832,737 (a) Includes stock-based compensation expense as follows:Cost of net sales$3$13$27Cost of contract revenues1460205Selling, general and administrative expense266195364Research and development expense720129Total stock-based compensation expense$290$288$725 See accompanying notes. 43 Iteris, Inc. Consolidated Statements of Stockholders’ Equity and Comprehensive Income (In thousands) CommonStockSharesOutstandingAmountAdditionalPaid-InCapitalCommonStockHeld inTrustTreasuryStockNotesReceivableFromEmployeesAccumulatedDeficitAccumulatedOtherComprehensiveIncomeTotalStockholder’sEquityComprehensiveIncomeBalance at March 31, 200527,090$2,709$125,609$(374)$(1)$(45)$(110,436)$—$17,462Warrant exercises98928—————37Stock option exercises24425275——(4)——296Issuance of warrants——28—————28Stock-based compensation——725—————725Retirement of treasury stock——(1)—1————Foreign currency translation———————77$7Net income——————80—8080Balance at March 31, 200627,4322,743126,664(374)—(49)(110,356)718,635$87Warrant exercises1,7061702,265—————2,435Stock option exercises1,374138982—————1,120Issuance of warrants——22—————22Stock-based compensation——288—————288Issuance of common stockin connection with legalsettlement899204—————213Repayment of notesreceivable fromemployees—————44——44Foreign currency translation———————1212$12Net income——————2,918—2,9182,918Balance at March 31, 200730,6013,060130,425(374)—(5)(107,438)1925,687$2,930Conversion of redeemablecommon stock tocommon stock1,2191223,292—————3,414Stock option exercises1,5151511,223—————1,374Warrant exercises859113—————122Stock-based compensation——290—————290Issuance of shares held intrust——178172————350Write-off of notes receivablefrom employees——(5)——5———Cumulative effect ofadoption of FIN 48——————(224)—(224)Foreign currency translation———————3535$35Net income——————12,163—12,16312,163Balance at March 31, 200833,420$3,342$135,516$(202)$—$—$(95,499)$54$43,211$12,198 See accompanying notes. 44 Iteris, Inc. Consolidated Statements of Cash Flows (In thousands) Year Ended March 31,200820072006Operating activitiesNet income$12,163$2,918$80Adjustments to reconcile net income to net cash provided by (used in) operatingactivities:Change in deferred tax assets(7,321)(1,419)(948)Depreciation of property and equipment756559684Stock-based compensation290288725Gain on early extinguishment of debt(224)——Amortization of debt discounts201207207Amortization of deferred financing costs135137138Amortization of deferred gain on sale-leaseback(165)(284)(284)Amortization of intangible assets147147147Issuance of common stock in connection with legal settlement—213—Fair value of warrants issued for services—22—Changes in operating assets and liabilities:Accounts receivable(1,615)(67)(2,560)Net costs and estimated earnings in excess of billings(1,383)(1,042)(658)Inventories2,153(3,565)1,530Prepaid expenses and other assets(77)19109Accounts payable and accrued expenses2,519(182)1,048Net cash provided by (used in) operating activities7,579(2,049)218 Investing activitiesPurchases of property and equipment(739)(488)(1,258) Financing activities(Payments on) proceeds from borrowings on lines of credit, net(4,015)1,3531,717Payments on long-term debt(3,838)(1,843)(1,314)Credit facility commitment fees(50)(40)—Checks drawn in excess of available bank balances(47)(628)389Proceeds from stock option and warrant exercises1,4963,555333Proceeds from notes receivable from employees—44—Net cash provided by (used in) financing activities(6,454)2,4411,125Increase (decrease) in cash386(96)85Cash and cash equivalents at beginning of year3513146Cash and cash equivalents at end of year$421$35$131 Supplemental cash flow information:Cash paid (received) during the period:Interest$1,008$1,263$1,095Income taxes2439(2) Supplemental schedule of non-cash investing and financing activities:Conversion of redeemable common stock to common stock$3,414$—$—Lease incentives in connection with new headquarters lease1,772——Fair value of common stock issued in settlement of liabilities350——Write-off of notes receivable from employees(5)——Property and equipment financing——127Fair value of warrants issued in settlement of liabilities——28Exercises of stock options via notes receivable from employees——4Retirement of treasury stock——1 See accompanying notes. 45 Iteris, Inc.Notes to Consolidated Financial StatementsMarch 31, 2008 1. Description of Business and Summary of Significant Accounting Policies Description of Business Iteris, Inc. (the “Company”) is a leader in the traffic management market and focuses on the development and application of advanced technologiesthat reduce traffic congestion, minimize the environmental impact of traffic congestion and improve the safety of surface transportation systems. Bycombining outdoor image processing, traffic engineering and information technology, the Company offers a broad range of Intelligent Transportation Systemsand driver safety solutions to customers worldwide. The Company was originally incorporated in Delaware in 1987. In October 2004, the Companycompleted a merger with its majority-owned subsidiary, Iteris, Inc. (the “Iteris Subsidiary”), and officially changed its corporate name to Iteris, Inc. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompanyaccounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requiresmanagement to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ fromthose estimates. Significant estimates made in the preparation of the consolidated financial statements include the allowance for doubtful accounts, deferred taxassets, inventory and warranty reserves, costs to complete long-term contracts, overhead rates used in cost-plus contracts, contract reserves, the valuation ofequity instruments and estimates of future cash flows used to assess the recoverability of long-lived assets and the realization of goodwill. Reclassifications Certain reclassifications have been made to the prior year financial statements to conform to the 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, uponacceptance by the customer, provided that the Company believes collectibility of the net sales amount is reasonably assured. Accordingly, at the date revenue isrecognized, 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 aportion of estimated fees or profits determined on the percentage of completion method of accounting based on the relationship of costs incurred to totalestimated costs. Any anticipated losses on contracts are charged to earnings when identified. Changes in job performance and estimated profitability, includingthose arising from contract penalty provisions and final contract settlements, may result in revisions to costs and revenues and are recognized in the period inwhich the revisions are determined. Profit incentives are included in revenue when their realization is reasonably assured. 46 In addition to product and contract revenue, the Company derives revenue from technology access fees, the provision of specific non-recurringcontract engineering services and royalties. Technology access fee revenues are recognized evenly over the period in which they are earned. Non-recurringcontract engineering revenues are recognized in the period in which the related services are performed. Royalty revenues are recorded in the period in which theroyalty is earned, based on unit sales of the Company’s products. Technology access fee revenues, contract engineering revenues and royalty revenues areincluded in net sales in the accompanying 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 areperformed. Concentration of Credit Risk Accounts receivable are derived from revenues earned from customers located throughout North America and Europe. The Company generally doesnot require collateral or other security from customers. Collectibility of receivable balances is estimated through review of invoices outstanding greater than acertain period of time and ongoing credit evaluations of customers’ financial condition. Reserves are maintained for potential credit losses, and such losseshave historically been within management’s expectations. At March 31, 2008 and 2007, accounts receivable from governmental agencies and prime government contractors were approximately $6.4 millionand $5.2 million, respectively. No customer or government agency had a receivable balance at March 31, 2008 or 2007 greater than 10% of our total net salesand contract revenues for the years ended March 31, 2008 and 2007. Fair Values of Financial Instruments The fair value of cash and cash equivalents, receivables, inventories, accounts payable and accrued expenses approximate carrying value because ofthe short period of time to maturity. The fair value of line of credit agreements and long-term debt approximate carrying value because the related rates ofinterest approximate current market rates. The fair value of convertible debentures approximates carrying value because the effective interest rate, taking intoaccount recorded debt discounts, approximates current market rates. At March 31, 2007, the fair value of redeemable common stock was $2.8 million, basedon the closing price of the Company’s common stock on that date. Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments with initial maturities of ninety days or less. 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 depreciated over the estimated useful life ranging from three to eight years. Leaseholdimprovements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter. Beginning April 1, 2006,the Company began depreciating property and equipment using the straight-line method of depreciation, which the Company believes more closelyapproximates the usage of the underlying assets, which generally provide value evenly throughout the estimated life. Prior to this date, the Company used thedouble declining balance method of depreciation. As a result of this change in estimate, depreciation expense declined by $455,000 for the year endedMarch 31, 2007, resulting in a $0.02 per share impact on basic and diluted earnings per share. Goodwill and Long-Lived Assets In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Intangible Assets (“SFAS 142”), goodwill istested for impairment on an annual basis in the Company’s fourth fiscal quarter or more frequently if indicators of impairment exist, of which none have beenidentified. 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’sreporting units with each respective reporting unit’s carrying amount, including goodwill. The Company determines the fair value of reporting units using theincome approach. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the second step of the goodwill impairment test isperformed to determine the amount of any impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of thereporting unit’s goodwill with the carrying amount of that goodwill. 47 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 performedto determine whether the carrying value of assets is impaired, based on a comparison to undiscounted expected future cash flows. If this comparison indicatesthat there is impairment, the impaired asset is written down to fair value, which is typically calculated using discounted expected future cash flows and adiscount rate based upon the Company’s weighted average cost of capital adjusted for risks associated with the related operations. Impairment is based on theexcess 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 (“SFAS109”). Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assetsand 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 notbe realized. See Note 5. On April 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting forUncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxesby establishing minimum standards for the recognition and measurement of tax positions taken or expected to be taken in a tax return. Under the requirementsof FIN 48, the Company must review all of its tax positions and make a determination as to whether its position is more-likely-than-not to be sustained uponexamination by regulatory authorities. If a tax position meets the more-likely-than-not standard, then the related tax benefit is measured based on a cumulativeprobability analysis of the amount that is more-likely-than-not to be realized upon ultimate settlement or disposition of the underlying issue. The Company recognized the cumulative impact of the adoption of FIN 48 as a $224,000 increase to its liability for unrecognized tax benefits with acorresponding increase to its accumulated deficit balance as of April 1, 2007. As of April 1, 2007 and March 31, 2008, the Company’s gross unrecognized taxbenefits were $185,000 and $1.4 million, respectively, of which $78,000 and $88,000, respectively, if recognized, would affect the Company’s effective taxrate. The gross unrecognized tax benefits differ from the amount that would affect the Company’s effective tax rate due primarily to the impact of the valuationallowance on such differences. The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of March 31,2008 and April 1, 2007, the Company had accrued cumulatively $21,000 and $39,000 respectively, for the payment of interest and penalties. A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows (in thousands): Gross unrecognized tax benefits at April 1, 2007$185Increases in tax positions for prior year1,160Decrease in tax positions for prior year(147)Increase in tax positions for current year327Decrease in tax positions for current year—Settlements—Lapse in statute of limitation(136)Gross unrecognized tax benefits at March 31, 2008$1,389 During the next twelve months, it is reasonably possible that, as a result of the expiration of the statute of limitations, the Company may decrease theamount of its gross unrecognized tax benefits by approximately $408,000. The gross unrecognized tax benefits subject to potential decrease involve varioustiming differences. 48 The Company is subject to taxation in the United States and various states. The Company is subject to U.S. federal tax examination for fiscal taxyears ended March 31, 2005 and state as well as local income tax examination for fiscal tax years ended March 31, 2004. Stock-Based Compensation Effective April 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which replaced SFASNo. 123, Accounting for Stock-Based Compensation (“SFAS 123”), superseded Accounting Principles Board Opinion No. 25, Accounting for StockIssued to Employees (“APB 25”), and amended SFAS No. 95, Statement of Cash Flows. Prior to April 1, 2006, the Company followed the disclosure-only provisions of SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, and, accordingly,accounted for its stock-based compensation plans using the intrinsic value method under APB 25 and related interpretations. SFAS 123R requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as anexpense, based on their grant date fair values with such fair values amortized over the requisite service period. The Company elected to use the modifiedprospective transition method for transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modifiedafter the date of adoption. In addition, under the modified prospective method, compensation expense will be recognized for all stock-based compensationawards 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 SFAS123. Accordingly, prior period amounts presented herein have not been restated to reflect the adoption of SFAS 123R. The fair value concepts were not changed significantly as a result of implementing SFAS 123R; however, in adopting SFAS 123R, companies mustchoose among alternative valuation models and amortization assumptions. After assessing alternative valuation models and amortization assumptions, theCompany continued to use both the Black-Scholes-Merton (“BSM”) option-pricing formula and straight-line amortization of compensation expense over therequisite service period of stock option grants. The Company will reconsider use of this model if additional information becomes available in the future thatindicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using thismodel. SFAS 123 did not require the estimation of forfeitures in the calculation of stock compensation expense; however, SFAS 123R does require suchestimation and upon adoption of SFAS 123R, the Company changed its methodology to include an estimate of forfeitures. In addition, in accordance with SFAS 123R, SFAS 109 and EITF Topic D-32, Intraperiod Tax Allocation of the Tax Effect of Pretax Incomefrom Continuing Operations, the Company has elected to recognize excess income tax benefits from stock option exercises in additional paid-in capital only ifan incremental income tax benefit would be realized after considering all other tax attributes presently available to the Company. The Company measures thetax benefit associated with excess tax deductions related to stock-based compensation expense by multiplying the excess tax deductions by the statutory taxrates. The following table illustrates the effect on net income and earnings per share for the year ended March 31, 2006 as if the Company had applied thefair value recognition provisions of SFAS 123R to options granted under the Company’s stock option plans. For purposes of this pro forma disclosure, thefair value of the options was estimated using the BSM option-pricing formula and amortized on a straight-line basis to expense over the options’ vesting period: 49  Year Ended March 31,2006(In thousands, exceptper share amounts)Net income — as reported$80Add: Stock-based compensation expense included in net income — as reported725Deduct: Total stock-based compensation expense determined under fair value based method for allawards(1,108)Net loss — pro forma$(303) Basic and diluted earnings per share — as reported$0.00Basic and diluted loss per share — pro forma$(0.01) Research and Development Expenditures Research and development expenditures are charged to expense in the period incurred. Shipping and Handling Costs Shipping and handling costs are included as cost of sales in the period during which the products ship. Sales Taxes Sales taxes are presented on a net basis (excluded from net sales and contract revenues) in the consolidated statements of operations. Advertising Expenses Advertising costs are expensed in the period incurred and totaled $172,000, $152,000, and $185,000 in the years ended March 31, 2008, 2007 and2006, respectively. Warranty The Company generally provides a one to three year warranty from the original invoice date on all products, materials and workmanship. Productssold 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 productwarranties 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 includedwithin accrued expenses on the accompanying 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 oneof 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. Comprehensive Income The only component of accumulated other comprehensive income is foreign currency translation adjustments. Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a frameworkfor measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather itspecifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 iseffective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. In February 2008 the FASB issued FSP 157-2,Effective Date of FASB Statement No. 157, which delays the effective date of SFAS 157 for non-financial assets and liabilities to fiscal years beginning afterNovember 15, 2008. Generally, this statement will be applied prospectively. The Company is currently evaluating the impact of SFAS 157 and expects toadopt SFAS 157 in the first quarter of its fiscal year ending March 31, 2009. 50 In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including anAmendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other itemsat 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 reportingdate. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is evaluating the impact thatthe 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. Supplementary Financial Information Inventories The following table presents details regarding the Company’s inventories: March 31,20082007(In thousands)Materials and supplies$3,031$4,705Work in process345366Finished goods8501,308$4,226$6,379 Goodwill and Intangible Assets March 31, 2008March 31, 2007GrossCarryingAmountAccumulatedAmortizationGrossCarryingAmountAccumulatedAmortization(In thousands)Intangible assets subject to amortization:Developed Technology$495$(381)$495$(280)Patents317(174)317(128)Total$812$(555)$812$(408) Amortization expense for intangible assets subject to amortization was $147,000 for the years ended March 31, 2008, 2007 and 2006. Futureestimated amortization expense is as follows: Year Ending March 31:(In thousands)2009$14720105820114620126$257 At March 31, 2008, goodwill was comprised of $18.0 million associated with the October 2004 merger of the Iteris Subsidiary (Note 1); $9.6million associated with the acquisitions of the Rockwell International Transportation Systems Group, Meyer Mohaddes Associates and the Viggen SystemsConsulting Group; and $200,000 associated with the purchase of the assets of Mil-Lektron, a complementary product to the Company’s Vantage video detection business. 51 Warranty Reserve Activity The following table presents activity in accrued warranty obligations: Year Ended March 31,200820072006(In thousands)Balance at beginning of year$520$519$326Additions charged to cost of sales347630517Warranty claims(373)(629)(324) Balance at end of year$494$520$519 Earnings Per Share The following table sets forth the computation of basic and diluted income per share: Year Ended March 31,200820072006(In thousands, except per share amounts)Numerator:Net income$12,163$2,918$80 Denominator:Weighted average common shares used in basic computation32,72329,69828,182Dilutive stock options1,9733,3463,818Dilutive warrants17304737Weighted average common shares used in dilutive computation34,71333,34832,737 Earnings per share:Basic$0.37$0.10$0.00Diluted$0.35$0.09$0.00 The following shares were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive: Year Ended March 31,200820072006(In thousands) Stock options520582470Warrants1,1701,2401,265Convertible debentures2,6612,7292,729 3. Costs and Estimated Earnings on Uncompleted Contracts Costs incurred, estimated earnings and billings on uncompleted long-term contracts are as follows: 52 March 31,20082007(In thousands)Total estimated contract value$77,557$74,794 Costs incurred on uncompleted contracts$23,415$20,688Estimated earnings2,3422,06925,75722,757Less billings to date(21,532)(19,915)$4,225$2,842 Included in accompanying consolidated balance sheets:Costs and estimated earnings in excess of billings on uncompleted contracts$5,351$3,689Billings in excess of costs and estimated earnings on uncompleted contracts(1,126)(847)$4,225$2,842 Costs and estimated earnings in excess of billings at March 31, 2008 and 2007 include $828,000 and $786,000, respectively, that were not billableas certain milestone objectives specified in the contracts had not been attained. Substantially all costs and estimated earnings in excess of billings at March 31,2008 are expected to be billed and collected during the year ending March 31, 2009. 4. Revolving Line of Credit and Long-Term Debt Revolving Line of Credit In October 2006, the Company entered into a new two-year credit facility with a bank. At March 31, 2008, the facility provided line of creditborrowings of up to $10.0 million. Under the credit facility, the Company may borrow against its eligible accounts receivable and eligible inventory, asdefined 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% (6.25% atMarch 31, 2008). Additionally, the Company is obligated to pay an unused line fee of 0.25% per annum applied to the amount by which the maximum creditamount exceeds the average daily principal balance during the preceding month. The credit facility requires $2,000 in monthly collateral management fees andincludes 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 theagreement. Additionally, the Company paid commitment fees of $40,000 in October 2006 and $50,000 in October 2007. The credit facility is secured bysubstantially all of the assets of the Company. On March 31, 2008, the available credit under the credit facility was $8.6 million, all of which was unused. Long-Term Debt The Company’s long-term debt consists of the following: March 31,20082007(In thousands)Convertible debentures, net$7,566$9,410Bank term note2101,573Promissory note to landlord—646Other34787,81011,707Less current portion(244)(1,947)$7,566$9,760 53 Convertible Debentures, Net. In May 2004, the Company sold and issued subordinated convertible debentures in the aggregate original principalamount of $10.1 million. In connection with the issuance of these debentures, the Company issued detachable warrants to purchase an aggregate of 639,847shares 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 beingamortized 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 at the holder’s option intothe 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. During the year ended March 31, 2008, the Company paid $1.8 million to retire $2.1 million of convertible debentures early. In connection with thisearly retirement, the Company recorded a gain of $224,000, which is included within other income in the accompanying consolidated statement of operationsfor the year ended March 31, 2008. Additionally, $250,000 of convertible debentures were previously converted into 69,252 shares of common stock. AtMarch 31, 2008, $7.8 million of the originally issued convertible debentures remained outstanding. 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 partof the Company’s new credit facility. The new term note was also due on May 27, 2008 and provided for monthly principal payments of approximately$104,000. Interest accrued under the new term note at an annual rate of 8.75%. The final payment against this term note was made in June 2008. Promissory Note to Landlord. The Company had an unsecured promissory note payable to the landlord of its previous headquarters. Under theterms 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 andJuly 2007, the Company made required quarterly principal payments of $323,000. As of March 31, 2008, all principal and interest under this note was paidin full. Scheduled aggregate maturities of long-term debt principal as of March 31, 2008 were as follows: Year Ending March 31,(In thousands)2009$24420107,7507,994Less: unamortized debt discount(184)$7,810 5. Income Taxes The reconciliation of the Company’s income tax benefit to taxes computed at U.S. federal statutory rates is as follows: Year Ended March 31,200820072006(In thousands)Income tax (benefit) provision at statutory rates$2,131$536$(284)State income taxes net of federal benefit(675)(147)(85)Change in valuation allowance associated with federal deferred tax assets(7,558)(1,895)(892)Compensation charges194—222Unrecognized tax benefits(133)——AMT and foreign taxes402446Other permanent differences101139108Income tax benefit$(5,900)$(1,343)$(885) 54 The components of deferred tax assets and liabilities are as follows: March 31,20082007(In thousands)Deferred tax assets:Net operating losses$16,777$18,806Credit carry forwards1641,401Deferred compensation and payroll1,3592,032Bad debt allowances and other reserves601524Acquired intangibles—67Other, net167—Total deferred tax assets19,06822,830Valuation allowance(7,887)(19,543)Net deferred tax assets11,1813,287 Deferred tax liabilities:Other, Net(490)(135)Property and equipment(160)(125)Acquired intangibles(183)—Total deferred tax liabilities(833)(260)Net deferred tax assets$10,348$3,027 Current portion of net deferred taxes$2,541$494Long-term portion of net deferred taxes7,8072,533Net deferred tax assets$10,348$3,027 The components of current and deferred federal and state income tax benefits and provisions are as follows: Year Ended March 31,200820072006(In thousands)Current income tax provisionFederal$94$25$9State40323Foreign402446Deferred income tax benefitFederal(5,011)(1,170)(812)State(1,063)(254)(131)Net income tax benefit$(5,900)$(1,343)$(885) At March 31, 2008, the Company had approximately $581,000 in federal general business credit carryforwards that begin to expire in 2014 and$818,000 in state general business credit carryforwards that can be carried forward indefinitely. The Company had $44.7 million of federal net operating losscarryforwards at March 31, 2008 that begin to expire in 2019 and $16.6 million of state net operating loss carryforwards that begin to expire in 2013. Prior to May 28, 2004, the Iteris Subsidiary was required to file a separate federal income tax return. On May 28, 2004, the Company acquired agreater than 80% ownership interest in the Iteris Subsidiary. From that date forward, income taxes are provided on a consolidated basis for federal income taxpurposes. Due to changes in stock ownership, the prior year $49.8 million of federal net operating loss carryforwards and other federal tax attributes of theCompany are subject to a Section 382 limitation estimated at approximately $7.8 million annually which can be utilized to offset federal consolidated taxableincome. To the extent such limitation is not exceeded in a particular year, the excess limitation accumulates and adds to subsequent years’ limitations. As a result of SFAS 123R, our deferred tax assets at March 31, 2008 do not include $1.9 million of excess tax benefits from employee stock optionexercises that are a component of our net operating loss carryforwards. Stockholders’ equity will be increased by $1.9 million if and when such excess taxbenefits are ultimately realized. 55 At March 31, 2008, the Company recorded a valuation allowance against its net deferred tax assets of approximately $7.9 million for that portion of deferred tax assets that it is more likely than not will not be realized. In making such determination, a review of all availablepositive and negative evidence was considered, including scheduled reversal of deferred tax liabilities, potential carryback, projected future taxable income, taxplanning strategies, and recent financial performance. Any future benefits recognized from the reduction of the valuation allowance will result in a reduction ofincome tax expense. Unremitted earnings of the Company’s foreign subsidiary have been included in the consolidated financial statements without giving effect to theUnited States taxes that may be payable on distribution to the United States because it is not anticipated that such earnings will be remitted to the UnitedStates. If remitted, the additional United States taxes would not be material. 6. Commitments and Contingencies Litigation On June 29, 2004, a supplier to Mariner Networks, Inc., a former subsidiary of the Company that was discontinued in the fiscal year endedMarch 31, 2002, filed a complaint in Orange County Superior Court against the Company alleging various breaches of written contract claims arising out ofalleged 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 theclosing 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 connectionwith this settlement, the Company recorded a charge of $635,000, representing the fair value of the settlement, within other expense in the accompanyingconsolidated statement of operations for the year ended March 31, 2007. 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. TheCompany currently is not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, wouldhave 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. Forexample, the Company has been the subject of a number of routine tax audits for time periods and jurisdictions related to the businesses of its formersubsidiaries, some of which are still in process. Although the development and ultimate outcome of these and other unforeseen matters cannot be predictedwith any certainty, management does not believe that the Company is presently involved in any matters related to its former subsidiaries that would have amaterial adverse effect on the Company’s consolidated results of operations, financial position or cash flows. Operating Leases 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. InSeptember 2007, the Company relocated its headquarters and principal operations into this space. The monthly lease rate is $102,000 during the first year ofthe 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 fiveyears, 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 theextension period. Additionally, the lease agreement provides for $1.8 million in incentives in the form of tenant improvement allowances, which the Companyrecorded as deferred rent and capitalized leasehold improvements in its consolidated balance sheet. The deferred rent amount will reduce future rent expenseover the term of the lease, and the capitalized leasehold improvements amount will be depreciated over the initial term of the lease (the estimated useful life of therelated leasehold improvements). The Company has lease commitments for facilities in various locations throughout the United States. Future minimum rental payments under thesenoncancelable operating leases at March 31, 2008 were as follows: 56 Fiscal Year Ending March 31,(In thousands)2009$1,59420101,43120111,36620121,33220131,363Thereafter2,460Total$9,546 Rent expense totaled $2.1 million, $2.2 million and $1.9 million, respectively, for the years ended March 31, 2008, 2007 and 2006. The Company previously had recorded on its consolidated balance sheet a deferred gain related to the May 2002 sale and leaseback of its priorheadquarters in Anaheim, California. The deferred gain was amortized over the term of the underlying lease, which terminated in September 2007, andresulted in a realized gain of $165,000 in the fiscal year ended March 31, 2008 and $284,000 in the fiscal years ended March 31, 2007 and 2006. The Company previously subleased office space to MAXxess Systems, Inc. (“MAXxess”), a former subsidiary of the Company that was sold bythe 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 ChiefExecutive Officer of MAXxess. At March 31, 2008, MAXxess owed the Company an aggregate of $274,000 related to this sublease, which terminated inSeptember 2007, and certain related ancillary services that were provided by the Company to MAXxess. Although the Company has fully reserved foramounts owed to it by MAXxess under the terms of this sublease, the Company intends to pursue full payment of any and all amounts due from MAXxess. Inventory Purchase Commitments At March 31, 2008, the Company had firm commitments to purchase inventory in the amount of $2.3 million during the first and second quartersof its fiscal year ending March 31, 2009. Deferred Compensation Plan In 1986, the Company adopted the Executive Deferral Plan (the “1986 Plan”) under which certain executives were able to defer a portion of theirannual compensation into the 1986 Plan. All deferred amounts earned interest, generally with no guaranteed rate of return. During the year ended March 31,2003, the Company adopted the Deferred Compensation Plan, and all assets of the 1986 Plan were transferred into the Deferred Compensation Plan. Nocompensation withholdings were deferred under the 1986 Plan or the Deferred Compensation Plan in the years ended March 31, 2008, 2007 and 2006. At March 31, 2008, the Deferred Compensation Plan held 167,177 shares of the Company’s common stock and $5,000 in cash, which theCompany has presented as an aggregated $391,000 deferred compensation plan liability in the accompanying consolidated balance sheet. At March 31, 2007,the Deferred Compensation Plan held 310,510 shares of the Company’s common stock and $15,000 in cash. Changes in the value of Company commonstock held by the Deferred Compensation Plan are determined based on changes in the quoted market price of the Company’s common stock at the close ofeach reporting period and presented within operating expenses in the accompanying consolidated statements of operations. As a result of such changes in thevalue of Company common stock, the Company recorded expense of $21,000, a benefit of $91,000 and expense of $48,000 in the years ended March 31,2008, 2007 and 2006, respectively. The original $202,000 cost basis of shares of Company common stock held in the Deferred Compensation Plan atMarch 31, 2008 has been recorded as a contra-equity account in the accompanying consolidated financial statements. On June 3, 2008, substantially all of theremaining assets of the Deferred Compensation Plan were distributed. 7. Redeemable Common Stock In connection with the merger of the Iteris Subsidiary into the Company (Note 1) in May 2004, the Company acquired 547,893 shares of common stockof 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 ofissuance. 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 purchaseprice of $1.438 per share. 57 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, theCompany previously had classified the $3.4 million value of the 1,219,445 shares as redeemable common stock on its consolidated balance sheet. Upon theexpiration of these rights, the Company reclassified $122,000 to common stock, representing the par value of the shares, and $3.3 million to additional paid-in capital on its consolidated balance sheet. 8. Stockholders’ Equity Preferred Stock The Company’s certificate of incorporation provides for the issuance of up to 2,000,000 shares of preferred stock. As of March 31, 2008 and 2007,there were no outstanding shares of preferred stock, and the Company does not have any plans to issue any shares of preferred stock. The Company’s Boardof Directors is authorized to issue from time to time such authorized but unissued shares of preferred stock in one or more series and to fix or alter thedesignations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series, including the dividend, conversion,voting, redemption and liquidation rights. Common Stock and Common Stock Warrants On September 28, 2006, the Company issued warrants to purchase an aggregate 246,250 shares of common stock at an exercise price of $3.25 witha five-year life to an existing shareholder in exchange for the early exercise of 1,250,000 outstanding warrants with an exercise price of $1.61. The newwarrants were immediately exercisable and are callable by the Company if the market price of the Company’s common stock trades for 20 consecutive days ata 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 theCompany could be subjected to liquidated damages should it fail to maintain effective registration statements for the shares of common stock issuable uponexercise of the warrants. These warrants have been accounted for within equity in the consolidated balance sheets as of March 31, 2008 and 2007 inaccordance with EITF Issue No. 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 March 31, 2008, no liquidated damages were payable under the provisionsof the registration rights agreement associated with these warrants. The following table summarizes information regarding outstanding warrants to purchase the Company’s common stock as of March 31, 2008: Range of Exercise PricesWarrants Outstandingat March 31, 2008Weighted AverageRemainingContractual Life(Years)Weighted AverageExercise Price(In thousands, except per share amounts)$1.42155.42$1.42$3.252462.91$3.25$3.61 to $4.036741.13$3.93$5.00 to $5.262301.66$5.181,1651.67$4.00 All of the warrants were exercisable at March 31, 2008. Warrants to purchase an aggregate of 246,260 shares of common stock at an exercise priceof $3.25 per share are callable by the Company if the market price of the Company’s common stock trades for 20 consecutive days at a price equal to orgreater than two times the exercise price of the warrants. Warrants to purchase an aggregate of 75,000 shares of common stock at an exercise price of $5.00 pershare are callable by the Company if the market price of the Company’s common stock trades for 20 consecutive days at a price equal to or greater than oneand a half times the exercise price of the warrants. 58 Common stock reserved for future issuance at March 31, 2008: (In thousands)Issuable under stock options plans4,985Issuable upon the exercise of warrants1,1656,150 9. Associate Benefit Plans Stock Option Plan On September 21, 2007, the Company’s stockholders approved the 2007 Omnibus Incentive Plan (the “2007 Plan”), which provides that options topurchase shares of the Company’s unissued common stock may be granted to employees, officers, consultants and directors to the Company at exerciseprices 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 yearsafter 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 issuanceof stock appreciation rights, restricted stock, restricted stock units and other stock-based awards based on the value of the Company’s common stock. Newshares are issued to satisfy stock option exercises and share issuances under the 2007 Plan. As of March 31, 2008, options to purchase an aggregate of389,000 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 the1997 Plan will remain outstanding pursuant to the terms of such stock options. As of March 31, 2008, options to purchase 1.4 million shares of theCompany’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 IterisSubsidiary (the “1998 Plan”) and all outstanding options granted thereunder. As of March 31, 2008, options to purchase 2.7 million shares of the Company’scommon 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 unvestedoptions in the event of a change in control under certain circumstances. These change-in-control provisions meet the criteria of a performance condition underSFAS 123R. A summary of activity in the Plans for the year ended March 31, 2008 is as follows: OptionsWeightedAverageExercisePriceWeightedAverageRemaining ContractualLife (Years)AggregateIntrinsic Value(In thousands, except per share amounts)Options outstanding at March 31, 20075,818$1.603.4Granted389$2.38N/AExercised(1,515)$0.90N/AForfeited(53)$2.92N/AExpired(115)$3.90N/AOptions outstanding at March 31, 20084,524$1.833.7$3,761Vested and expected to vest at March 31, 20084,400$1.813.6$3,759Options exercisable at March 31, 20083,875$1.722.8$3,750Options exercisable at March 31, 2008 pursuant to a change-in-control4,524$1.833.7$3,761 At March 31, 2008, there were 461,000 shares of common stock available for grant under the 2007 Plan. For the years ended March 31, 2008, 2007 and 2006, the Company received $1.4 million, $1.1 million and $296,000, respectively, in cash fromthe exercise of stock options. 59 Stock-Based Compensation Expense Total stock-based compensation expense for the years ended March 31, 2008, 2007 and 2006 was $290,000, $288,000, and $725,000,respectively. No income tax benefit was realized from activity in the Plans during the years ended March 31, 2008, 2007 and 2006. The fair value of each stock-based award is estimated on the grant date using the BSM option-pricing formula. Expected volatility is based on thehistorical volatility of the Company’s stock price. The expected life of options granted subsequent to the adoption of SFAS 123R is derived based on thehistorical 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 ratesin effect at the time of grant. The grant date fair value of options granted was estimated using the following weighted-average assumptions: Year Ended March 31,200820072006 Dividend yield0.0%0.0%0.0%Expected life — years7.07.07.0Risk-free interest rate3.8%4.7%5.5%Expected volatility of common stock0.80.90.5 A summary of the grant date fair value and intrinsic value information is as follows: Year Ended March 31,200820072006(In thousands, except per share amounts)Weighted average grant date fair value per share of options granted$1.83$1.92$1.77Intrinsic value of options exercised$2,555$2,288$295 At March 31, 2008, there was $1.2 million of total unrecognized compensation expense related to unvested stock options. This expense is expected tobe recognized over a weighted-average period of approximately 3.5 years. Associate Incentive Programs Under the terms of a Profit Sharing Plan, the Company may contribute to a trust fund such amounts as are determined annually by the Board ofDirectors. No contributions were made during the years ended March 31, 2008, 2007 and 2006. In May 1990, the Company adopted a 401(k) Plan as an amendment and replacement of the former Associate Stock Purchase Plan that was anadditional feature of the Profit Sharing Plan. Under the 401(k) Plan, eligible associates voluntarily contribute to the plan, up to IRS maximums, throughpayroll deductions. The Company matches up to 90% of contributions, based on years of service, up to a stated limit. Under the provisions of the401(k) Plan, associates have various investment choices, one of which is the purchase of Iteris, Inc. common stock at market price. Company matchingcontributions were approximately $401,000, $480,000, and $317,000 and for the years ended March 31, 2008, 2007, and 2006, respectively. 10. Business Segment and Geographic Information The Company currently operates in three reportable segments: Roadway Sensors, Vehicle Sensors and Transportation Systems. The RoadwaySensors segment includes Vantage vehicle detection systems for traffic intersection control and certain highway traffic data collection applications. The VehicleSensors segment is comprised of all activities related to AutoVue lane departure warning systems. The Transportation Systems segment includestransportation 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 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. The reportable segments are each managedseparately because they manufacture and distribute distinct products or provide services with different processes. All segment revenues are derived fromexternal customers. 60 Selected financial information for the Company’s reportable segments as of and for the years ended March 31, 2008, 2007 and 2006 is as follows: RoadwaySensorsVehicleSensorsTransportationSystemsTotal(In thousands)Year Ended March 31, 2008Product revenue from external customers$28,452$10,016$—$38,468Service and other revenue from external customers—1,85824,83726,695Stock-based compensation18452790Depreciation107130147384Allocated goodwill8,1974,67114,90627,774Segment income5,0625522,0947,708 Year Ended March 31, 2007Product revenue from external customers$27,261$6,408$—$33,669Service and other revenue from external customers—2,57922,04924,628Stock-based compensation375478169Depreciation82138126346Allocated goodwill8,1974,67114,90627,774Segment income (loss)6,035(2,625)2,5515,961 Year Ended March 31, 2006Product revenue from external customers$22,446$5,865$—$28,311Service and other revenue from external customers—2,84519,33022,175Stock-based compensation177101342620Depreciation132189266587Allocated goodwill8,1974,67114,90627,774Segment income (loss)3,420(2,476)1,8422,786 The Roadway Sensors segment had one customer with combined revenue representing 16.9% of total segment revenue for the year ended March 31,2008; one customer with revenue representing 26.5% of total segment revenue for the year ended March 31, 2007; and one customer with revenue representing25.9% of total segment revenue for the year ended March 31, 2006. The Vehicle Sensors segment had three customers with combined revenue representing60.9% of total segment revenue for the year ended March 31, 2008; three customers with combined revenue representing 64.2% of total segment revenue for theyear ended March 31, 2007; and two customers with combined revenue representing 70.7% of total segment revenue for the year ended March 31, 2006. TheTransportation Systems segment had one customer with revenue representing 13.3% of total segment revenue for the year ended March 31, 2007. 61 The following reconciles segment income to consolidated income (loss) before income taxes and segment assets to consolidated assets: March 31,200820072006(In thousands)Segment incomeTotal income for reportable segments$7,708$5,961$2,786Unallocated amounts:Corporate and other expenses(266)(1,986)(2,020)Amortization of intangible assets(147)(147)(147)Other income (expense), net252(653)35Interest expense, net(1,284)(1,600)(1,459)Income (loss) before income taxes$6,263$1,575$(805) The Company’s revenues are generated and the Company’s assets are held substantially in the United States. 11. Quarterly Financial Data (Unaudited) Total NetSales andContractRevenuesGrossProfitNetIncomeBasicEarningsper ShareDilutedEarningsper Share(In thousands, except per share amounts)June 30, 2007$15,757$7,094$1,096$0.03$0.03September 30, 200716,9767,2622,1700.070.06December 31, 200715,3636,5009540.030.03March 31, 200817,0677,4417,9430.240.23$65,163$28,297$12,163$0.37*$0.35* June 30, 2006$13,816$5,719$279$0.01$0.01September 30, 200614,4665,9577320.030.02December 31, 200614,4885,6763100.010.01March 31, 200715,5276,6561,5970.050.05$58,297$24,008$2,918$0.10*$0.09* * Annual per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during theperiods. 62 Schedule II Valuation and Qualifying Accounts (In thousands) DescriptionBalance atBeginning ofPeriodCharged toCosts andExpensesCharged toAccountsBalance at Endof Period Year Ended March 31, 2008Deducted from asset accounts:Allowance for doubtful accounts$664$360$(4)$1,020Reserve for inventory obsolescence844576(601)819Year Ended March 31, 2007Deducted from asset accounts:Allowance for doubtful accounts$429$220$15$664Reserve for inventory obsolescence592420(168)844Year Ended March 31, 2006Deducted from asset accounts:Allowance for doubtful accounts$239$275$(85)$429Reserve for inventory obsolescence514312(234)592 63Exhibit 10.42 CHANGE IN CONTROL AGREEMENT THIS CHANGE IN CONTROL AGREEMENT (the “Agreement”) is entered into as of June 11, 2008 (the “Effective Date”), by and betweenJames S. Miele (the “Employee”) and Iteris, Inc., a Delaware corporation (the “Corporation”). Section 1. Term of Agreement. This Agreement shall take effect on the Effective Date and shall expire on the earlier of (i) the fifth anniversary of the Effective Date, or (ii) the dateEmployee’s employment with the Corporation terminates for any reason other than an Involuntary Termination (as defined herein) that is in connection with orwithin twelve (12) months following a Change in Control. Section 2. Definitions. (a) “Change in Control” shall mean any of the following transactions effecting a change in ownership or control of thisCorporation: (i) a merger or consolidation of the Corporation with or into another entity or any other corporate reorganization, ifpersons who were not stockholders of the Corporation immediately prior to such merger, consolidation or other reorganization own immediately after suchmerger, consolidation or other reorganization 50% or more of the voting power of the outstanding securities of each of (i) the continuing or surviving entity and(ii) any direct or indirect parent corporation of such continuing or surviving entity. (ii) The sale, transfer or other disposition of all or substantially all of the Corporation’s assets; (iii) the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or aperson that directly or indirectly controls, is controlled by or in under common control with, the Corporation), of “beneficial ownership” as defined inRule 13d-3 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of securities of the Corporation representing at least 50% of thetotal combined voting power represented by the Corporation’s then outstanding voting securities. For purposes of this subsection, the term “person” shallhave the same meaning as when used in Sections 13(d) and 14(d) of the Exchange Act but shall exclude (i) a trustee or other fiduciary holding securities underan associate benefit plan of the Corporation or of a Parent or Subsidiary and (ii) a corporation owned directly or indirectly by the stockholders of theCorporation in substantially the same proportions as their ownership of the common stock of the Corporation. Notwithstanding anything to the contrary contained herein, a Change in Control be not be deemed to occur in connection with any underwrittenpublic offering of the Corporation’s securities. 1 (b) “Involuntary Termination” shall mean the termination of the Service of any individual which occurs by reason of: (i) Employee’s involuntary dismissal or discharge by the Corporation for reasons other than Misconduct, or (ii) Employee’s voluntary resignation following (A) a change in his position with the Corporation which materiallyreduces his level of responsibility, (B) a material reduction in his level of compensation (including base salary, fringe benefits and participation in bonus orincentive programs) or (C) a relocation of Employee’s place of employment by more than fifty (50) miles, provided and only if such change, reduction orrelocation is effected by the Corporation without the Employee’s consent. Notwithstanding the foregoing, an Involuntary Termination shall only be found toexist if Employee has provided written notice to the Corporation within 90 days of the existence of an event under (A), (B) or (C), and the Corporation does notcure such event within 30 days following the receipt of such notice from Employee. For avoidance of doubt, a 5% reduction in the combined level of basesalary and annual target bonus opportunity shall constitute a material reduction for purposes of (A) above. (c) “Misconduct” shall mean (i) the misappropriation of the Corporation’s funds or property, or any attempt by Employee tosecure any personal profit related to the business or business opportunities of the Corporation without the informed, written approval of the Audit Committeeof the Corporation’s Board of Directors; (ii) any unauthorized use or disclosure by such person of confidential information or trade secrets of the Corporation(or any Parent or Subsidiary); (iii) gross negligence or reckless or willful misconduct in the performance of Employee’s duties; (iv) the failure to perform, orcontinuing neglect in the performance of, duties assigned to Employee for at least ten (10) days after receipt by Employee from the Corporation of prior writtennotice of such failure or neglect; (v) the conviction of, or plea of nolo contendre to, any felony or misdemeanor involving moral turpitude or fraud; or (vi) anyother misconduct by Employee that the Board determines in good faith has had a material adverse effect upon the business or reputation of the Corporation. (d) “Annual Base Pay” shall mean Employee’s base salary at the highest rate in effect at any regularly scheduled payroll periodpreceding the occurrence of the Change in Control and does not include, for example, bonuses, overtime compensation, incentive pay, sales commissions orexpense allowances. (e) “Target Bonus” shall mean the bonus potential established for the Employee by the Corporation for the applicable fiscal year. Section 3. Severance Payment; Employment at Will. (a) Entitlement to Payment. Employee’s employment with the Corporation is at will, which means that it is not for aspecific term and may be 2 terminated by either the Corporation or the Employee, at any time, for an reason, without advance notice. Similarly, the Corporation may change the termsand conditions of Employee’s employment at any time, for any reason, without notice. Notwithstanding the foregoing, subject to Section 9, the Employeeshall be entitled to receive a severance payment from the Corporation under this Agreement (the “Severance Payment”) if, the Employee is InvoluntarilyTerminated in connection with or within twelve (12) months after a Change in Control. Employee understands, agrees and acknowledges that as a conditionprecedent to receiving any of the Severance Payments and other benefits set forth in this Agreement, Employee agrees to sign a Release in accordance withSection 9 herein. (b) Time and Amount of Payment The Severance Payment shall be paid in one lump sum starting with the nextnormally scheduled payroll date of the Corporation following the latest of the following dates: (i) Employee’s last day of employment, (ii) the date theCorporation receives Employee’s signed general release of all claims pursuant to Section 9, or (iii) the date the revocation period (if any) specified in the generalrelease of all claims expires. The amount of the Severance Payment shall be equal to the following: · 100% of the Employee’s Annual Base Pay, plus· 50% of Employee’s Target Bonus for the current fiscal year Notwithstanding the foregoing, in the event the Involuntary Termination is the result of Employee’s voluntary termination of employment with the Corporationand such termination does not occur within the first six months following the completion of the transaction giving rise to the Change in Control, Employeeshall only be entitled to 50% of Employee’s Annual Base Pay and 25% of Employee’s Target Bonus. Payments made under this Agreement shall not be treatedas “compensation” for purposes of the 401(k) Profit Sharing Plan. Employee will also receive his unpaid salary through his termination date and a lump sumpayment for all accrued and unused vacation (through the termination date) in a final paycheck provided on his last day of work. This Severance Payment isintended to qualify as an involuntary separation pay arrangement that is exempt from application of Section 409A of the Internal Revenue Code of 1986, asamended (the “Code”) because all severance payments are treated as paid on account of an involuntary separation (including a voluntary separation for goodreason) and paid in a lump sum within the “short-term deferral” period following the time the Employee obtains a vested right to such payments. (c) Mitigation and Reemployment. The Employee shall not be required to mitigate the amount of any paymentcontemplated by this Section 3 (whether by seeking new employment or in any other manner), nor shall any such payment be reduced by any earnings that theEmployee may receive from any other source. 3 Section 4. Payments Unfunded and Non-Assignable. (a) No Funding. Any payments to be made under Section 4 shall represent an unfunded and unsecured obligation ofthe Corporation, which shall represent an unfunded and unsecured obligation of the Corporation’s general assets. The Employee shall be considered a generalcreditor of the Corporation and shall have no rights to any segregated funds or property of the Corporation. (b) No Assignment. The Employee’s right to payments under this Agreement shall not be made subject to option orassignment, either by voluntary or involuntary assignment or by operation of law, including (without limitation) bankruptcy, garnishment, attachment orother creditor’s process, and any action in violation of this Section 4(b) shall be void. Section 5. Group Insurance Coverage. If the Employee becomes entitled to a Severance Payment under this Agreement, then theCorporation shall continue to provide continued group health coverage, as otherwise required under applicable stated continuation law and the ConsolidatedOmnibus Budget Reconciliation Act of 1986, as amended and all applicable regulations (“COBRA”). Provided that the Employee makes the necessaryCOBRA elections and payments, the Corporation shall reimburse Employee for the total applicable premium costs paid by Employee for such health COBRAcontinuation coverage for Employee (and if applicable Employee’s dependents) until the earlier of (i) twelve months after the termination of Employee’semployment, or (ii) the maximum COBRA period. The Corporation’s obligation to reimburse premiums under this Section shall cease when the Employeeobtains new employment offering healthcare benefits. Section 6. Tax Effect of Payments. (a) The amount of any cash payment to be received by Employee pursuant to Section 2 of this Agreement shall bereduced (but not below zero) to the extent required so that no portion of any payment or benefit in the nature of compensation received or to be received byEmployee (whether payable pursuant to the terms of this Agreement or pursuant to any other plan, contract, agreement or arrangement with the Corporation orany other person) (Such payments or benefits are referred to collectively as the “Total Payments”) shall be treated as an “excess parachute payment” withinthe meaning of Section 280G(b)(1) of the Code. (b) The determination of whether any reduction in payments is required pursuant to Section 6(a) of this Agreement shallbe made in writing by the Corporation’s independent public accountants, or such other independent accounting firm or tax advisors selected by theCorporation in its sole discretion (the “Accounting Firm”), whose determination shall be conclusive and binding upon Employee and the Corporation for allpurposes under this Agreement. For the purposes of making the calculations required by this Section 6, the Accounting Firm may make reasonableassumptions and approximations and may rely on reasonable, good faith interpretations concerning the application of Section 280G and 4999 of the Code,applicable regulations and other authority. The Corporation and the Employee shall furnish to the Accounting 4 Firm such information and documents as the Accounting Firm may reasonably request in order to make a determination under this Section. The AccountingFirm shall provide detailed supporting calculations, in writing, to both the Corporation and the Employee of determinations made pursuant to this Section 6. The Corporation shall bear all of the costs that the Accounting Firm may reasonably incur in connection with any calculations contemplated by this section. (c) In the event of any uncertainty as to whether a reduction in payments to Employee is required pursuant to Section 6(a) ofthis Agreement, the Corporation shall initially make the payment to Employee, and Employee shall be required to refund to the Corporation any amountsultimately determined not to have been payable under the terms of this Agreement. Section 7. Successors. (a) Corporation’s Successors. The Corporation shall require any successor (whether direct or indirect and whether bypurchase, lease, merger, consolidation, liquidation or otherwise) to all or substantially all of the Corporation’s business and/or assets or, any successor as aresult of a “Change in Control” as defined by Section 2 (a) to assume this Agreement and to agree expressly and in writing to perform this Agreement in thesame manner and to the same extent as the Corporation would have been required to perform it in the absence of a succession. The Corporation’s failure toobtain such an assumption prior to the effectiveness of a succession shall be a breach of this Agreement and shall result in Employee’s InvoluntaryTermination hereunder. For all purposes under this Agreement, the term “Corporation” shall include any successor to the Corporation’s business and/orassets that executes and delivers the assumption agreement described in this Section 7(a) or that becomes bound by this Agreement by operation of law. (b) Employee’s Successors. This Agreement and all rights of the Employee hereunder shall inure to the benefit of, andbe enforceable by, the Employee’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. Section 8. Miscellaneous Previsions (a) No Waivers. No provision of this Agreement shall be modified, waived or discharged unless the modification,waiver or discharge is agreed to in writing and signed by the Employee and by an authorized officer of the Corporation (other than the Employee). No waiverby either party of any breach of, or of compliance with, any condition or provision or of the same condition or provision at another time. (b) Choice of Law. The validity, interpretation, construction and performance of this Agreement shall be governed bythe laws of the State of California. 5 (c) Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect thevalidity or enforceability of any other provision hereof, which shall remain in full force and effect. (d) Arbitration. Except for responsibilities assigned to the Accounting Firm under Section 6, and except for the right ofthe Corporation and the Employee to seek injunctive relief in court, any controversy, claim or dispute of any type arising under or relating to Employee’semployment or the provisions of this Agreement shall be resolved in accordance with this Section 8(d) of this Agreement, regarding resolution of disputes,which will be the sole and exclusive procedure for the resolution of any such disputes. This Agreement shall be enforced in accordance with the FederalArbitration Act, the enforcement provisions of which are incorporated by this reference. Matters subject to those provisions include, without limitation, claimsor disputes based on statute, contract, common law and tort and will include, for example, matters pertaining to termination, discrimination, harassment,compensation and benefits. Matters to be resolved under these procedures also include claims and disputes arising out of statues such as the Fair LaborStandards Act, Title VII of the Civil Rights Act, the Age Discrimination in Employment Act, the California Labor Code, and the California Fair Employmentand Housing Act. Nothing contained in this provision is intended to restrict Employee from submitting any matter to an administrative agency withjurisdiction over such matter. (1) Mediation. The Corporation and Employee will make a good faith attempt to resolve any and all claimsand disputes relating to the subject matter of this Agreement through good faith negotiations. If such claims and disputes cannot be settled through negotiation,the Corporation and Employee agree to submit them to mediation in Orange County, California before resorting to arbitration or any other dispute resolutionprocedure. The mediation of any such claim or dispute must be conducted in accordance with the then current JAMS procedures for the resolution ofemployment disputes by mediation, by a mediator who has both training and experience as a mediator of general employment and commercial matters. If theparties to this Agreement cannot agree on a mediator, then the mediator will be selected by JAMS in accordance with JAMS’ strike list method. Within thirty(30) days after the selection of the mediator for one mediation session of at least four (4) hours. If the claim or dispute cannot be settled during such mediationsession or mutually agreed continuation of the session, either the Corporation or Employee may give the mediator and the other party to the claim or disputewritten notice declaring the end of the mediation process. All discussion connection with this mediation provision will be confidential and treated ascompromise and settlement discussions. Nothing disclosed in any such discussion, which is not independently discoverable, may be used for any purposein any later proceeding. The mediator’s fees will be paid in equal portions by the Corporation and the Employee, unless the Corporation agrees to pay all suchfees. (2) Arbitration. If a claim or dispute relating to the subject matter of this Agreement has not been resolved inaccordance with Section 8(d)(1) above, then the claim or dispute will be determined by arbitration in accordance with the then 6 current JAMS employment arbitration rules and procedures, except as modified herein. The arbitration will be conducted in Orange County, California by asole neutral arbitrator who has training and experience as an arbitrator of general employment and commercial matters. If the Corporation and Employeecannot agree on an arbitrator, then the arbitrator will be selected by JAMS in accordance with Rule 12 of the JAMS employment arbitration rules andprocedures. No person who has served as a mediator under the mediation provision above, however, may be selected as the arbitrator for the same claim ordispute. Reasonable discovery will be permitted and the arbitrator may decide any issue as to discovery. The arbitrator may decide any issue as to whether oras to the extent to which any dispute is subject to the dispute resolution provisions in Section 8, and the arbitrator may award any relief permitted by law. Thearbitrator must base the arbitration award on the provisions of Section 8 of this Agreement and applicable law and must render the award in writing, includingan explanation of the reasons for the award. Judgment upon the award may be entered by any court having jurisdiction of the matter, and the decision of thearbitrator will be final and binding. The parties hereto hereby waive to the fullest extent permitted by law any rights to appeal or to review such award by anycourt. The statute of limitations applicable to the commencement of a lawsuit will apply to the commencement of an arbitration under Section 8(d)(2) of theAgreement. A the request of any party, the arbitrator, attorneys, parties to the arbitration, witnesses, experts, court reporters or other persons present at thearbitration shall agree in writing to maintain the strict confidentiality of the arbitration proceedings. The arbitrator’s fees will be paid in full by theCorporation, unless Employee agrees in writing to pay some or all of such fees. Section 9. Release and Waiver of Claims. In consideration for Employee’s receipt of the Severance Payments or other benefits as specifiedin this Agreement, to which Employee is not otherwise entitled, Employee agrees to sign and agree to the terms of a broad, confidential release of all claims,causes of action, judgments, damages, liabilities, demands or any other claims Employee or Employee’s heirs, assigns and agents may now or hereafter haveagainst the Corporation, its subsidiaries and other related entities, and their respective employees, stockholders, directors, attorneys, accountants, successorsand assigns or other agents in the form and manner required by the Corporation (the “Release”). Execution of the Release is a condition precedent forqualifying to receive any Severance Payments or other benefits as set forth in this Agreement. Employee further understands and acknowledges that ifEmployee refuses to sign the Release provided by the Corporation, or attempts to revoke such a Release, to the extent permitted by its terms, Employee shall bedisqualified from receiving Severance Payments or any other benefits provided by this Agreement. Section 10. Notices. All notices, demands and other communications required or permitted to be sent or given hereunder shall be in writingand will be duly given and effective (i) if delivered in person or by a reputable courier service, upon such deliver; (ii) if sent by first class US mail, on thefourth business day following its mailing, certified mail, postage prepaid and return receipt requested; or (iii) if sent by overnight mail, on the business dayfollowing its mailing provided that the delivery charges are prepaid. The addresses of the parties for the purposes of notice are set forth below. Each party 7 may change its address from time to time upon ten days prior notice given in accordance with this Section. Notice to the Corporation:Iteris, Inc.1700 Carnegie Avenue, Suite 100Santa Ana, CA 92705-5551Attn: Chief Executive Officer Notice to Employee:Jim Miele 8 IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Corporation by its duly authorized officer,as of the day and year first above written. ITERIS, INC. By: /s/ABBAS MOHADDES Abbas Mohaddes, Chief Executive Officer /s/ JAMES S. MIELEJAMES S. MIELE 9Exhibit 21 LIST OF SUBSIDIARIES SubsidiaryJurisdiction ofIncorporation Iteris Europe GmbHGermany Exhibit 23 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in the previously filed Registration Statements (File Nos. 333-121942, 333-136739, and 333-138735) on Form S-3and (File Nos. 333-146459, 333-126834, 333-75728, 333-05735, 333-44907 and 333-30396) on Form S-8 of Iteris, Inc. of our report dated June 11, 2008relating to our audit of the consolidated financial statements and financial statement schedule, which appear in this Annual Report on Form 10-K of Iteris, Inc.for the year ended March 31, 2008. /s/ McGladrey & Pullen, LLPIrvine, CaliforniaJune 11, 2008 Exhibit 31.1 CERTIFICATION PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Abbas Mohaddes, certify that: 1. I have reviewed this annual report on Form 10-K of Iteris, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theregistrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated Subsidiary, is made known to us by otherswithin those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; and (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date: June 11, 2008 /s/ ABBAS MOHADDESAbbas MohaddesChief Executive Officer(Principal Executive Officer) Exhibit 31.2 CERTIFICATION PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, James S. Miele, certify that: 1. I have reviewed this annual report on Form 10-K of Iteris, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respectsthe financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theregistrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated Subsidiary, is made known to us by otherswithin those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; and (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s mostrecent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, tothe registrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date: June 11, 2008 /s/ JAMES S. MIELEJames S. MieleChief Financial Officer(Principal Financial Officer) Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. §1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Iteris, Inc. (the “Company”) on Form 10-K for the fiscal year ended March 31, 2008, as filed with theSecurities and Exchange Commission (the “Report”), I, Abbas Mohaddes, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: June 11, 2008 /s/ ABBAS MOHADDESAbbas MohaddesChief Executive Officer A signed original of this written statement required by Section 906, or any other document authenticating, acknowledging, or otherwise adopting thesignature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company andwill be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. §1350, AS ADOPTEDPURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Iteris, Inc. (the “Company”) on Form 10-K for the fiscal year ended March 31, 2008 as filed with theSecurities and Exchange Commission (the “Report”), I, James S. Miele, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: June 11, 2008 /s/ JAMES S. MIELEJames S. Miele,Chief Financial Officer A signed original of this written statement required by Section 906, or any other document authenticating, acknowledging, or otherwise adopting thesignature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company andwill be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 

Continue reading text version or see original annual report in PDF format above