UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

Commission file number 001-08762

ITERIS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ý  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, to the 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 to this Form 10-K ý

Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  o  No  ý

Based on the closing sale price on the OTC Bulletin Board on September 30, 2004, 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 $44,496,650.  For the purposes of this calculation, shares owned by officers, directors and 10% stockholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of June 22, 2005, there were 28,409,905 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Information required by Items 10 through 14 of Part III of this report is incorporated herein by reference to portions of the registrant’s definitive proxy statement for its 2005 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year ended March 31, 2005.  Except with respect to information specifically incorporated by reference in this report, the registrant’s proxy statement is not deemed to be filed as part hereof.

ITERIS, INC.

FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

Unless otherwise indicated in this report, the “registrant,” “we,” “us” and “our” collectively refers to Iteris, Inc. (formerly known as Iteris Holdings, Inc. and Odetics, Inc.) and its subsidiary, Meyer, Mohaddes Associates, Inc.

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

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Cautionary Statement

This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management’s beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words “expect(s),” “feel(s),” “believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)” and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include but are not limited to statements regarding our anticipated sales, revenue, expenses, profits, capital needs, competition, backlog and manufacturing capabilities, the practical market applications, future applications and acceptance of our products and services, and the status of our facilities, product development and renegotiations with our lender. These statements are not guarantees of future performance and are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including those “Risk Factors” at the end of Item 7 of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason.

PART I

ITEM 1.          BUSINESS

Overview

Iteris, Inc., formerly known as Iteris Holdings, Inc., is a leading provider of outdoor machine vision systems and sensors that optimize the flow of traffic and enhance driver safety. Using proprietary software and Intelligent Transportation Systems (“ITS”) industry expertise, we provide video sensor systems, transportation management and traveler information systems and other engineering consulting services to the ITS industry. The ITS industry is comprised of companies applying a variety of technologies to enable the safe and efficient movement of people and goods. We use our outdoor image recognition software expertise to develop proprietary algorithms for video sensor systems that improve vehicle safety and the flow of traffic. Using our knowledge of the ITS industry, we design and implement transportation management systems that help public agencies reduce traffic congestion and provide greater access to traveler information.  On October 22, 2004, we completed a merger with our majority-owned subsidiary, Iteris, Inc. (the “Iteris Subsidiary”), and officially changed our corporate name from Iteris Holdings, Inc. to Iteris, Inc. We were originally incorporated in Delaware in 1987 as Odetics, Inc. and in September 2003 changed our name to Iteris Holdings, Inc. to reflect our focus on the ITS industry and our capital structure at that time.

Our proprietary image recognition systems include AutoVue and Vantage.  AutoVue is a small windshield mounted sensor that uses proprietary software to detect and warn drivers of unintended lane departures. We have sold approximately 13,000 production AutoVue Lane Departure Warning (“LDW”) systems for use on truck platforms in the European and North American markets, and our AutoVue LDW system is currently offered as an option on certain Mercedes, MAN, Freightliner and International trucks. We believe that our AutoVue LDW technology is a broad sensor platform that, through additional software development, may be expanded to incorporate additional safety and convenience features. Vantage is a video-based vehicle sensing system that detects vehicles on roadways, enabling more efficient traffic management.  Applications include traffic signal operations, incident detection and data collection.

Our transportation management systems include the design, development and implementation of our software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions. We also offer related services that include planning and other engineering for the implementation of transportation related communications systems, analysis and studies related to goods movement and commercial vehicle operations, and parking systems designs.

We currently operate in three reportable segments: Roadway Sensors, Automotive Sensors and Systems. The Roadway Sensors segment includes our Vantage vehicle detection systems.  The Automotive Sensors segment includes our AutoVue LDW systems for vehicle safety. The Systems segment includes transportation engineering and consulting services, and the development of transportation management and traveler information systems for the ITS industry.

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Sales, Marketing and Principal Customers

We sell our Vantage vehicle detection systems primarily through indirect sales channels comprised of independent dealers in the United States and Canada who sell integrated systems and related products to the traffic management market. Our independent dealers are primarily responsible for sales, installation and support of Vantage systems. These dealers maintain an inventory of demonstration traffic products from various manufacturers including our Vantage vehicle detection systems and sell directly to government agencies and installation contractors. These dealers often have long-term arrangements with the government agencies in their territory for the supply of various products for the construction and renovation of traffic intersections. We hold technical training classes for dealers and end users 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. We sell AutoVue directly to heavy truck manufacturers and to U.S. truck fleets. We also market to the manufacturers of passenger automobiles through a strategic relationship with Valeo Schalter and Sensuren GmbH (“Valeo”), an independent automotive supplier.

We market and sell our transportation management systems and traveler information services directly to government agencies pursuant to negotiated contracts that involve competitive bidding and specific qualification requirements. Most of our contracts with federal, state and municipal customers provide for cancellation or renegotiation at the option of the customer upon reasonable notice and fees paid for modification. We use selected members of our engineering team divided on a regional basis to serve in sales and business development functions. We do not engage in sales of transportation management systems and traveler information services outside of the U.S. Sales of our transportation management systems contracts generally involve long lead times and require extensive specification development, evaluation and price negotiations.

Our largest customer accounted for 12.8% of total net sales and contract revenues in the fiscal year ended March 31, 2005 (“Fiscal 2005”).

Manufacturing and Materials

We use contract manufacturers to build subassemblies that are used in our Vantage products. Additionally, we procure certain components from qualified suppliers, both globally and locally, and use multi-sourcing strategies when technically and economically feasible to mitigate supply risk.  These subassemblies and components are delivered to our Anaheim facility where they go through final assembly and testing prior to shipment to our customers. Our manufacturing activities are conducted in approximately 8,000 square feet of space at our Anaheim facility.  Production volume at our subcontractors is based upon quarterly forecasts that we adjust on a monthly basis to control inventory. For sales of Autovue LDW systems to the truck market, we subcontract the manufacture of our AutoVue LDW systems to one manufacturer, and our internal processes are limited primarily to testing and final verification.  We are currently in the process of qualifying an additional subcontractor for the manufacture of LDW systems to mitigate production risk and handle increased demand.  For Autovue LDW sales to the passenger car market, we anticipate that all manufacturing will be done by Valeo; however, we plan to continue to provide engineering support to Valeo.  We currently do not manufacture any of the hardware used in the transportation management and traveler information systems that we design and implement. Our production facility is currently ISO 9001 certified.

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 charge separately. Service revenue accounted for less than 1.0% of total net sales and contract revenues for Fiscal 2005.  We believe customer support is a key competitive factor.

Backlog

Our backlog of unfulfilled firm orders was approximately $18.9 million as of March 31, 2005, which was comprised of $1.7 million related to Roadway Sensors, $3.4 million related to Automotive Sensors and $13.8 million related to Systems.  All backlog for Roadway Sensors and Automotive Sensors is expected to be recognized as revenue in the fiscal year ending March 31, 2006 (“Fiscal 2006”) while approximately 60.0% of Systems backlog is expected to be recognized as revenue in Fiscal 2006.  At March 31, 2004, we had backlog of approximately $21.6 million, which was comprised of $4.7 million related to Roadway Sensors, $3.9 million related to Automotive Sensors and $13.0 million related to Systems.  At March 31,

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2004, backlog for Roadway Sensors and Automotive Sensors was recognized as revenue in Fiscal 2005 while 63.8% of Systems March 31, 2004, backlog was recognized as revenue in Fiscal 2005.  Pursuant to the customary terms of our agreements with government contractors and other customers, customers can generally cancel or reschedule orders with little or no penalties. Lead times for the release of purchase orders often depend upon the scheduling and forecasting practices of our individual customers, which also can affect the timing of the conversion of our backlog into revenues. For these reasons, among others, our backlog at a particular date may not be indicative of our future revenues.

Product Development

Most of our development activities are conducted at our principal facilities in Anaheim, California. Our company-sponsored research and development costs and expenses were approximately $4.2 million for Fiscal 2005, $3.9 million for the fiscal year ended March 31, 2004 (“Fiscal 2004”), and $3.9 million for the fiscal year ended March 31, 2003 (“Fiscal 2003”).  We expect to continue to pursue significant product development programs and incur significant 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 margins and loss of market share, any of which could have a material adverse effect on our business, financial condition and results of operations. We believe that AutoVue is the only commercially-available lane departure warning system used in the U.S. and in Europe in the heavy truck market.  Potential competitors of AutoVue include Delphi Automotive Systems Corporation domestically, NEC Corporation and Hitachi Ltd. in Japan and Robert Bosch GmbH in Europe, as well as Siemens, Continental Tavis and Visteon, which could be currently developing video sensor technologies for the vehicle industry that could be used for lane departure warning systems. In the market for our Vantage vehicle detection systems, we compete with manufacturers of other “above ground” video camera detection systems such as Econolite Control Products, Inc., Traficon, N.V., Quixote, and other non-intrusive detection devices including microwave, infrared, ultrasonic and magnetic detectors, as well as 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 regional quality and safety standards. Our competitors vary in number, scope and breadth of the products and services they offer. Our competitors in advanced transportation management and traveler information systems include large multi-national corporations such as Transcore, Lockheed Martin Corporation, PB Farradyne, Inc., Kimley-Horn and Associates, Inc. and National Engineering Technology, Inc. Our competitors in transportation engineering, planning and design include major firms such as Parsons Brinkerhoff, Inc. and Parsons Transportation Group, Inc., as well as many smaller regional engineering firms.

In general, the markets for the products and services offered by our businesses are highly competitive and are characterized by rapidly changing technology and evolving standards. Many of our current and prospective competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical, manufacturing, distribution and marketing resources than us. As a result, they may be able to adapt more quickly 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 new competitors or alliances among competitors could emerge and rapidly acquire significant market share. We believe that our ability to compete effectively in our target markets will depend on a number of factors, including the success and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality and performance, reliability, functionality, price, and service and technical support. Our failure to provide services and develop and market products that compete successfully with those of other suppliers and consultants in our target markets would have a material adverse 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 to obtain 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 three U.S. patent applications pending, mostly relating to our outdoor image processing techniques used in our AutoVue systems. Two of our patents relate specifically to our AutoVue technology and provide a basis for enhanced functionality for rain sensing and improved performance. We believe that our other patents, while important for our technology platforms, are less critical to our near term product strategy. We cannot assure 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 and other proprietary information through agreements with customers and suppliers, proprietary

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information agreements with our employees and consultants, and other 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 be successful 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 has been necessary in the past and may be necessary in the future to enforce our proprietary rights, to determine the validity and scope of the proprietary rights of others, or to defend us against claims of infringement or invalidity by others. An adverse outcome in such litigation or similar proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from others or require us to cease marketing or using certain products, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation 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 be significant 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 8, 2005, we employed an aggregate of 215 associates, including 48 associates in general management, administration and finance; 20 associates in sales and marketing; 113 associates in engineering and product development; 26 associates in operations, manufacturing and quality; and 8 associates in customer service. None of our associates are represented by a labor union, and we have never experienced a work stoppage.

Government Regulation

Our manufacturing operations are subject to various federal, state and local laws and regulations, including those restricting the discharge of materials into the environment. We are not involved in any pending or, to our knowledge, threatened governmental proceedings, which would require curtailment of our operations because of such laws and regulations. We continue to expend funds in connection with our compliance with applicable environmental regulations. These expenditures have not, however, been significant in the past, and we do not expect any significant expenditure in the near future. 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.

ITEM 2.          PROPERTIES

Our headquarters and principal operations consist of 88,000 square feet of space located at 1515 South Manchester Boulevard in Anaheim, California.  The Anaheim facility is leased by us under three separate agreements and houses our operations and administrative offices (approximately 78,000 dedicated square feet) and the operations of our former subsidiary, MAXxess Systems, Inc. (approximately 10,000 dedicated square feet).  Two of the three Anaheim leases representing 82,000 of the 88,000 square feet commenced on July 1, 2003 and have four year terms at a monthly lease rate of $60,000 for 65,000 square feet and $14,000 per month for 17,000 square feet.  Approximately 10,000 square feet is subleased to MAXxess at a rate of $10,000 per month.  On March 1, 2004, we entered into a third lease in Anaheim for 6,000 additional square feet at a rate of $3,000 per month.  All three Anaheim leases expire on October 31, 2007.

ITEM 3.          LEGAL PROCEEDINGS

The information set forth under Note 7 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this report, is incorporated herein by reference.

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

No matters were submitted to a vote of our security holders during the three months ended March 31, 2005.

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PART II

In October 2004, we amended our certificate of incorporation to (a) change the voting rights of our Class A common stock from one-tenth to one vote per share, (b) remove the ability to issue any further shares of Class B common stock, and (c) rename our Class A common stock as common stock. As a result, we currently have only one class of common stock outstanding, the common stock. Our Class A common stock and Class B common stock were delisted from the Nasdaq SmallCap Market in August 2003 and April 2003, respectively, and were quoted on the OTC Bulletin Board thereafter until   December 9, 2004, when our common stock began trading on the American Stock Exchange (“AMEX”) under the symbol “ITI.”

On July 13, 2005, the last reported sale price of our common stock on the AMEX was $2.78.  As of July 13, 2005, we had 599 holders of record of 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. We currently intend to retain any earnings for working capital and general corporate purposes. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon a number of factors, including, but not limited to, future earnings, the success of our business, our capital requirements, our general financial condition and future prospects, general business conditions, the consent of our lender and such other factors as the Board of Directors may deem relevant.

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ITEM 6.          SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data for each of the five fiscal years ended March 31, 2005.  The statement of operations and balance sheet data for the years ended and as of March 31, 2005, 2004, 2003, 2002 and 2001 are derived from our audited consolidated financial statements.  The accompanying consolidated financial statements have been restated to reflect the classification and presentation of our former subsidiaries, Broadcast, Inc., Zyfer Inc., Mariner Networks, Inc., Gyyr, Inc. and MAXxess Systems, Inc., as discontinued operations for all periods presented.  See Note 1 to the accompanying consolidated financial statements.  The following information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and the related notes thereto included elsewhere in this report.

The financial information for the year ended March 31, 2004 has been restated for the impact of adjustments discussed in Note 1 to the consolidated financial statements.

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You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto included in Part IV, Item 15 of this report and the “Risk Factors” section at the end of this Item 7, as well as other cautionary statements and risks described elsewhere in this report, before deciding to purchase, hold or sell our common stock.

Overview

We are a leading provider of outdoor machine vision systems and sensors that optimize the flow of traffic and enhance driver safety. Using our proprietary software and ITS industry expertise, we provide video sensor systems and transportation management systems and traveler information and other engineering services to the ITS industry. We use our outdoor image recognition software expertise to develop proprietary algorithms for video sensor systems that improve vehicle safety and the flow of traffic. Using our knowledge of the ITS industry, we design and implement transportation management systems that help public agencies reduce traffic congestion and provide greater access to traveler information.

Our Vantage product is a video vehicle sensing system that detects the presence of vehicles at signalized intersections enabling a more efficient allocation of green signal time and has certain incident detection and highway traffic data collection applications. We sell and distribute our Vantage products primarily to commercial customers and municipal agencies.

Our AutoVue LDW systems consist of a small windshield mounted sensor that uses proprietary software to detect and warn drivers of unintended lane departures. Approximately 13,000 production AutoVue units have been sold for truck platforms in the North American and European markets.  Our AutoVue LDW systems are currently offered as an option on certain Mercedes, MAN, Freightliner and International trucks.  In September 2003, we entered into an agreement with Valeo, which granted Valeo the exclusive right to sell and manufacture our AutoVue LDW systems to the worldwide passenger car market in exchange for royalty payments for each AutoVue unit sold.  We provided specific contract engineering services, technical marketing and sales support to Valeo to enable the launch of our LDW technology on the Infiniti FX45 platform in October 2004. Additionally, our LDW system is offered on the 2006 Infiniti M35 and M45 luxury sedans as part of Infiniti’s Technology Package.  Valeo is currently in negotiations to provide our LDW system to other passenger car original equipment manufacturers (“OEMs”); however, we cannot assure you that such negotiations will be successful.  We plan to provide technical marketing and sales support to Valeo in our efforts to win new OEM customers for the passenger car market as well as contract engineering services related to the possible launch of new Infiniti platforms that include our LDW system.  We believe that AutoVue is a broad sensor platform that, through additional software development, may be expanded to incorporate additional safety and convenience features.

Our transportation management systems business includes transposition engineering and consulting services focused on the design, development, and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control, and direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions.  Our services include planning and other engineering for the implementation of transportation related communications systems, analysis and study related to goods movement and commercial vehicle operations, and parking systems designs.  These services and systems are sold to local, state, and national transportation agencies in the United States.  Our transportation management systems business is largely dependent upon governmental funding and budgetary issues. The adoption of the Federal Highway Bill has been delayed, which adversely impacted our transportation management systems business in Fiscal 2005.  Further delays in this bill or other governmental funding could materially and adversely affect our business in Fiscal 2006 as well.

We have historically operated multiple business units.  During Fiscal 2003, we operated in three business segments consisting of ITS, video products, and telecom products.  The ITS segment consisted of our current operations, the ITS business, which was previously conducted by the Iteris Subsidiary.  The video products segment consisted of our former wholly-owned subsidiaries, MAXxess Systems, Inc. (“MAXxess,” previously known as Gyyr Incorporated), which designed and manufactured security management systems, and Broadcast, Inc. (“Broadcast”), which developed and supplied software based systems to automate and control the multiple classes of equipment used in broadcast studios and satellite uplink facilities. Our telecom segment consisted of our wholly-owned subsidiary, Zyfer, Inc. (“Zyfer”), which developed and manufactured timing and synchronization products and which, prior to its incorporation, was operated as our Communications division.

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Beginning in Fiscal 2003, we began divesting certain of our business units in order to reduce our operating expenses and to focus on the operations of our Iteris Subsidiary.  These divestitures and related restructuring activities included the following transactions:

• In March 2003, we ceased the development and sale of any new Broadcast products and in September 2003, we sold the balance of our Broadcast business.

• In May 2003, we sold the assets of Zyfer for a purchase price of $2.3 million in cash and the assumption of liabilities, plus future incentive payments of up to $1.0 million in each of the twelve months ended April 30, 2004 and 2005. The amount of these future incentive payments was to be based on the revenues generated by the sale of Zyfer’s products or the license of its technologies. In October 2004, we received an incentive payment of $135,000 related to the twelve month period ended April 30, 2004.  We expect to receive information related to the incentive payment for the twelve month period ended April 30, 2005, by the end of July 2005.

• In September 2003, we sold substantially all of the assets of MAXxess to an investor group that included certain members of the MAXxess management group. The consideration for the sale consisted of the assumption of $2.7 million of liabilities, resulting in a net gain of $2.3 million on this sale.

• In May 2004, we repurchased all of the outstanding shares of Series A preferred stock of the Iteris Subsidiary for an aggregate purchase price of approximately $17.5 million in cash and we purchased 547,893 shares of the Iteris Subsidiary common stock from DaimlerChrysler Ventures GmbH (“DCV”) in consideration for the issuance of 1,219,445 shares of our common stock.  We financed the purchase price for the Iteris Subsidiary Series A preferred stock through the issuance of convertible debentures in the original principal amount of $10.1 million, a $5.0 million term note payable to our bank and $2.4 million in cash.

• In June 2004, we issued 2,639,082 shares of our common stock valued at $8.6 million at the date of issuance in exchange for an aggregate of 1,319,541 shares of common stock of the Iteris Subsidiary, which had the effect of reducing the residual minority interest in our Iteris Subsidiary to 8.1%.

• In October 2004, we merged the Iteris Subsidiary into us and the remaining minority interest in the Iteris Subsidiary (consisting of 1,228,981 shares of common stock of the Iteris Subsidiary) was converted to 2,457,962 shares of our common stock valued at $7.6 million at the merger date.  Immediately following the merger, we converted all of our outstanding Class B common stock (921,917 shares) into 1,014,108 shares of our common stock (formerly designated as Class A common stock).  In connection with this merger, we also assumed all of the outstanding options and warrants to purchase common stock of the Iteris Subsidiary, which now represent options and warrants to purchase an aggregate of 6,039,556 and 654,718 shares, respectively, of our common stock.

• In October 2004, we amended our certificate of incorporation to (a) change the voting rights of our Class A common stock from one-tenth to one vote per share, (b) remove the ability to issue any further shares of Class B common stock, and (c) rename our Class A common stock to common stock. As a result, we currently have only one class of common stock outstanding, the common stock.

Our financial statements for all periods presented in this report have been restated to reflect the discontinuation of the operations of Broadcast, Zyfer and MAXxess and the financial information for the year ended March 31, 2004 has also been restated for the impact of adjustments discussed in Note 1 of the consolidated financial statements.

We currently operate in three reportable segments: Roadway Sensors, Automotive Sensors and Systems. The Roadway Sensors segment includes our Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications.  The Automotive Sensors segment includes our AutoVue LDW systems for vehicle safety. The Systems segment includes transportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements included herein, which have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”).  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  On an ongoing basis, we evaluate these estimates and assumptions, including those related to the collectibility of

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accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill and warranty reserves.  We base these estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported amounts of assets and 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 financial statements.

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

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

In addition to product and contract revenue, we derive revenue from technology access fees, the provision of specific non-recurring contract engineering services related to our AutoVue LDW system, and royalties related to unit sales of our AutoVue LDW systems by our strategic partner Valeo to the passenger car market. Combined technology access fees and contract engineering revenues are recognized on the percentage of completion method of accounting based on the relationship of hours incurred to total estimated hours.  Royalty revenue is recorded based on unit sales of our products by Valeo and is recognized in the period in which such sales occur.  Technology access fee revenues, contract engineering revenues and royalty revenues are included in net sales in the accompanying consolidated statements of operations.

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

Accounts Receivable.  We estimate the collectibility of customer receivables on an ongoing basis by periodically reviewing invoices outstanding greater than a certain period of time.  We have recorded reserves for receivables deemed to be at risk for collection as well as a general reserve based on our historical collections experience.  A considerable amount of judgment is required in assessing the ultimate realization of trade receivables, including the current credit-worthiness of each customer.  If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make required payments, additional allowances may be required that could adversely affect our operating results.

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

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

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

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

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

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.

Years Ended March 31, 2005, 2004, and 2003

Net Sales and Contract Revenues.  Net sales consist principally of sales of our Vantage video detection systems and AutoVue LDW systems, as well as technology access fees, contract engineering revenue and royalty revenue generated from AutoVue related activities.  Contract revenue consists principally of revenue derived from systems integration and ITS consulting services with state, county and municipal agencies. We currently have a diverse customer base with our largest customer constituting 12.8% of total net sales and contract revenues in Fiscal 2005. Total net sales and contract revenues increased 2.5% to $46.4 million in Fiscal 2005 compared to $45.3 million in Fiscal 2004, and increased 9.4% in Fiscal 2004 compared to $41.4 million in Fiscal 2003.  The increases were a result of increased net sales offset by decreased contract revenues, as discussed below.

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Net sales increased 23.8% to $29.1 million in Fiscal 2005 compared to $23.5 million in Fiscal 2004, and increased 22.8% in Fiscal 2004 compared to $19.1 million in Fiscal 2003.  The increase in net sales in each of the periods primarily reflected an increase in the unit sales of our Vantage vehicle detection systems and increased unit sales of our AutoVue LDW systems.  Net sales from AutoVue products increased 70.2% in Fiscal 2005 compared to Fiscal 2004, and represented 24.6% of our total net sales in Fiscal 2005 versus 17.9% of total our net sales in Fiscal 2004.  The increase in sales of AutoVue products was principally related to increased unit sales of LDW systems in the European and North American commercial heavy truck markets, and to a lesser extent, increased license fee revenue and fees for non-recurring engineering services derived from Valeo, our strategic partner for the passenger car OEM customer base. AutoVue sales in Fiscal 2006 may be adversely impacted due to potential supply issues as a new production unit for the heavy truck market is being redesigned and qualified. Vantage sales comprised 75.4%, 82.1% and 92.0% of net sales in Fiscal 2005, Fiscal 2004 and Fiscal 2003, respectively.  The majority of Vantage revenues were derived from sales within North America.  The Vantage sales growth was primarily due to increased market adoption of video-based detection technologies for traffic intersection management and our ability to obtain additional contracts with state departments of transportation.

Contract revenues decreased 20.5% to $17.3 million in Fiscal 2005 compared to $21.8 million in Fiscal 2004, and decreased 2.1% in Fiscal 2004 compared to $22.3 million in Fiscal 2003.  Contract revenues reflect a broad range of fixed price and cost plus fixed fee contracts for engineering study and design, systems integration and system implementation.  Contract revenues are dependent upon the continued availability of funding on both the state and federal levels from the various departments of transportation.  We believe the decrease in Fiscal 2005 revenues compared to Fiscal 2004 and Fiscal 2003 principally reflects budget constraints in both the federal and California markets, where a significant portion of our contract revenues have been derived during the last several years, which constraints have been exacerbated by the continued delay in the adoption of the Federal Highway Bill.  All of our contract revenue is currently derived from work performed in North America.

Gross Profit.  Total gross profit increased 8.7% to $19.4 million in Fiscal 2005 compared to $17.8 million in Fiscal 2004, and increased 5.3% from $16.9 million in Fiscal 2003 compared to Fiscal 2004. Total gross profit as a percent of net sales and contract revenues increased to 41.7% in Fiscal 2005 compared to 39.3% in Fiscal 2004 and 40.9% in Fiscal 2003.

Gross profit as a percentage of net sales was 46.2% in Fiscal 2005 compared to 45.6% in Fiscal 2004 and 51.0% in Fiscal 2003.  The 0.6% increase in gross profit in Fiscal 2005 compared to Fiscal 2004 was primarily a result of increased margins on AutoVue activities due to better overhead absorption on higher unit sales of LDW systems to the heavy truck market as well as the recognition of technology access fee revenue and royalty revenue from Valeo, both of which provide a 100% gross margin, which was somewhat offset by declining margins related to the sales of Vantage products due to lower unit pricing on large, high volume state contracts and increased price pressure in the industry.

The decrease in gross profit as a percent of net sales in Fiscal 2004 compared to 2003 primarily reflected lower unit pricing on large, high volume state contracts for Vantage products, in addition to lower gross profits realized on AutoVue products and services principally related to fewer sales of sample LDW systems which generated higher gross profits in Fiscal 2004 compared to Fiscal 2003. We expect that price pressure will continue into the foreseeable future for both our Vantage and AutoVue product lines and we are constantly analyzing various strategies to reduce the impact of further price pressure on gross profits.

Gross profit as a percent of contract revenues increased to 34.2% in Fiscal 2005 compared to 32.6% in Fiscal 2004 and 32.2% in Fiscal 2003.  We recognize contract revenues and related gross profit using percentage of completion contract accounting and the underlying mix of contract activity affects the related gross profit recognized in any given year.  The increase in Fiscal 2005 reflects a mix of higher margin contracts in Fiscal 2005 as compared to Fiscal 2004 and Fiscal 2003.

Selling, General and Administrative Expense.  Selling, general and administrative expense increased 8.7% to $14.0 million (or 30.1% of total net sales and contract revenues) in Fiscal 2005 compared to $12.8 million (or 28.4% of total net sales and contract revenues) in Fiscal 2004, and decreased 8.9% in Fiscal 2004 compared to $14.1 million (or 34.1% of total net sales and contract revenues) in Fiscal 2003.  The increase in Fiscal 2005 compared to Fiscal 2004 was principally related to $807,000 of severance charges recorded in connection with the merger and acquisition of the Iteris Subsidiary in October 2004, as well as increased costs to support expanded sales and marketing efforts for our Vantage and AutoVue products in Fiscal 2005. The decrease in Fiscal 2004 compared to Fiscal 2003 principally reflected decreased facilities lease expense related to the restructuring of lease commitments for our Anaheim facilities in June 2003, reduced further by salary expense for corporate support personnel related to the divestiture of our Broadcast, Zyfer and MAXxess Systems businesses in Fiscal 2004.

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Research and Development Expense.  Research and development expense increased 6.9% to $4.2 million (or 9.0% of total net sales and contract revenues) in Fiscal 2005 compared to $3.9 million (or 8.6% of total net sales and contract revenues) in Fiscal 2004, and increased 0.4% in Fiscal 2004 compared to $3.9 million (or 9.4% of total net sales and contract revenues) in Fiscal 2003. The increase in research and development expense in Fiscal 2005 compared to Fiscal 2004 reflects increased spending to support the development of AutoVue products, which was partially offset by decreased spending to support the development of Vantage products.  AutoVue product development primarily related to the development of the next generation LDW unit for the heavy truck market, particularly for the re-engineering and qualification for a new imager. The increases were primarily in the areas of personnel costs and related benefits and overhead, prototype material costs, and consulting fees. Vantage product development primarily reflects activities for product line extensions to support new communications platforms and to accommodate new camera designs.  The modest increase in research and development expense in Fiscal 2004 compared to Fiscal 2003 primarily reflects software algorithm development and new hardware designs for enhancements to our existing product family of Vantage video detection systems.

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

Stock-Based Compensation. On October 22, 2004, we recorded an $11.3 million charge for stock-based compensation in connection with the assumption and exchange of vested Iteris Subsidiary stock options for stock options immediately exercisable into our common stock.  This charge was based on the differences between the fair market value of our common stock on the merger date and the exercise prices of the modified stock options. Additionally, we recorded approximately $1.4 million in deferred compensation expense related to the unvested Iteris Subsidiary stock options also assumed as part of the merger, which will be amortized to stock-based compensation expense as the options vest. We amortized $508,000 of the $1.4 million of deferred compensation to stock-based compensation expense in Fiscal 2005.

Deferred Compensation Expense (Benefit): The $868,000 non-cash charge for the change in value of common stock held in trust by our deferred compensation savings plan in Fiscal 2004 related to the estimated appreciation in value of the Iteris Subsidiary common stock held in the plan for the period ending March 31, 2004. In Fiscal 2005, the Iteris Subsidiary was merged into the Company and shares of Iteris Subsidiary common stock held in the plan were exchanged for shares of common stock of the Company. The  $484,000 non-cash benefit for deferred compensation plan expenses related to the decline in value of the Company’s common stock during Fiscal 2005. Non-cash charges or benefits for deferred compensation plan expenses will be recorded in future periods based on increases or decreases in the fair value of the Company’s common stock at the end of each reporting period. “We intend to amend this plan in the near future to prohibit diversification of any shares of our common stock held in the plan, which we believe will prevent any future deferred compensation charges or other impact on the Company’s financial statements as a result of changes in the value of our common stock held in this plan.”

Disposal of Fixed Assets. After the October 22, 2004, merger of the Iteris Subsidiary into us, we conducted a review of our property and equipment and determined that certain corporate property and equipment would not provide value to our on-going operations.  These assets primarily consisted of furniture and fixtures and computer equipment. Accordingly, we recorded a $422,000 loss on disposal of fixed assets in Fiscal 2005.

Other Income, Net.  Other income, net reflects the following:

Other income, net in Fiscal 2005 primarily reflects a $949,000 gain recognized on the settlement of litigation.  We were a beneficiary of, but not a party to, litigation between Rockwell International and the Michigan Department of Transportation. Other income, net in Fiscal 2004 and 2003 includes a gain of $970,000 and $640,000, respectively, recognized on the sale and leaseback of our Anaheim, California facility, which was consummated in May 2002.

Interest Expense, Net.  Interest expense, net reflects the net of interest expense and interest income as follows:

Interest expense increased 844.0% in Fiscal 2005 compared to Fiscal 2004 and decreased 83.8% in Fiscal 2004 compared to Fiscal 2003. The increase in Fiscal 2005 is due to additional interest expense incurred related to the $5.0 million term debt entered into by the Iteris Subsidiary on May 28, 2004 (which was assumed by us in October 2004), interest expense related to the $10.1 million convertible debentures issued by us on May 19, 2004, the amortization of debt discounts

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associated with the issuance of the convertible debentures and related warrants, and increased borrowings on our line of credit. The decrease in Fiscal 2004 compared to Fiscal 2003 reflected the sale and leaseback of our Anaheim, California facilities, and our subsequent repayment in May 2002 of a $16.4 million promissory note.

Income Taxes.  During Fiscal 2005, we recognized an income tax benefit of $94,000, and at March 31, 2005, we recorded a net deferred tax asset of $660,000.  The ability to record the deferred tax asset was based on the more likely than not criteria of Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes, since the Iteris Subsidiary had historically been profitable and had utilized all its federal net operating loss carryovers and could thus carryback and realize the reversal of future tax deductions.  During Fiscal 2004, we recognized an income tax expense of $100,000 and at March 31, 2004, we recorded a net deferred tax asset of $821,000 directly related to the profitable operations of the Iteris Subsidiary. No income tax benefit for losses incurred in Fiscal 2003 was recorded due to uncertainty as to the ultimate realization of the related benefit.

At March 31, 2005, we had $50.5 million of federal net operating loss carryforwards and $33.0 million of state net operating loss carryforwards that begin to expire in 2019 and 2005, respectively.  As a result of these net operating loss carryforwards and the valuation allowance, we have recorded against the related net deferred tax assets in our consolidated balance sheet, we believe that future income tax payments and income tax expense will be substantially lower than the income tax liability and income tax expense calculated using statutory tax rates.

Minority Interest in Earnings of Subsidiary.  Minority interest in earnings of subsidiary represents the minority stockholders’ share of the Iteris Subsidiary’s net income or loss combined with the accretion of the redemption preference of the Iteris Subsidiary’s Series A preferred stock.  The decrease in minority interest from $2.8 million in Fiscal 2004 to $526,000 in Fiscal 2005 was the result of the merger and acquisition of the Iteris Subsidiary by us. On October 22, 2004, we fully completed the merger and acquisition of the Iteris Subsidiary, and as a result, we do not anticipate incurring any further charges for minority interest.

Income (Loss) from Discontinued Operations, net of income taxes.  As discussed in the Overview to Management’s Discussion and Analysis of Financial Condition and Results of Operations, the results of operations related to certain businesses discontinued by us in Fiscal 2004 and Fiscal 2003 are reflected as discontinued operations in our consolidated financial statements.  As of the end of Fiscal 2004, we had completed all such restructuring activities so that we could focus our efforts in the ITS marketplace.

Restatement of Consolidated Financial Statements for the year ended March 31, 2004

As further discussed in Note 1 to the consolidated financial statements, we have restated our consolidated financial statements for the year ended March 31, 2004.  This restatement was necessary in order to reflect the consolidation of our deferred compensation savings plan, the principal effects of which were to increase operating expenses by a non-cash charge of $868,000 for the year ended March 31, 2004, and decrease minority interest in the earnings of the Iteris Subsidiary by $221,000 for the year ended March 31, 2004.  This restatement had no impact on our consolidated cash flows.

Liquidity and Capital Resources

During Fiscal 2005, we generated $858,000 in cash from operating activities and used this cash to partially fund our investing and financing activities.  Net cash provided by operating activities principally reflected our net loss of $11.3 million increased for non-cash charges of $11.8 million related to stock-based compensation, $1.2 million for depreciation and amortization, $296,000 in charges related to the minority interest in the Iteris Subsidiary and $422,000 related to the disposal of fixed assets, offset by a decrease of $609,000 for non-cash gains related to amortization of the deferred gain on real-estate sales and $914,000 related to the usage of cash to fund changes in operating assets and liabilities.  Most of the cash requirements for operating assets and liabilities during Fiscal 2005 related to $746,000 in cash used to purchase inventory and $485,000 used to pay income taxes.

In May 2002, we completed the sale and leaseback of our Anaheim, California facility for an aggregate sale price of $22.6 million.  Under the terms of the sale and leaseback agreement, we agreed to lease one of the two buildings located on the property for an initial ten-year period at a rate of $152,150 per month and the other building for a period of 30 months at a rate of approximately $57,553 per month. Approximately $16.4 million of the proceeds from the sale was used to repay the outstanding indebtedness and accrued interest under a promissory note that was secured by a first deed of trust on the Anaheim facility.  The balance of the proceeds was available for general working capital purposes.  The gain on the sale of the facility was approximately $8.2 million, of which $640,000 was recognized immediately and the remainder was deferred and is being amortized against rent expenses over the term of the leases.

In May 2003, we completed the sale of substantially all the assets of our wholly-owned subsidiary, Zyfer, for $2.3 million in cash plus the assumption of certain liabilities. The cash proceeds were used to fund working capital requirements and pay short-term liabilities. The asset purchase agreement provides for incentive payments to us of up to $1.0 million in each of the twelve months ended April 30, 2004 and 2005.  The amount of these incentive payments are based on the revenues generated by the sale of Zyfer’s products or the license of its technologies.  Based on the terms of the sale agreement, Zyfer has 60 days to provide us with support for the incentive payments. In October 2004, we received a payment of approximately $135,000 related to the twelve month period ended April 30, 2004.  We expect to receive information for the twelve month period ended April 30, 2005 by the end of July 2005.

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In July 2003, we renegotiated the terms of our existing lease for our Anaheim facilities whereby the initial lease term of ten years was reduced to four years and we were relieved of our obligation to lease both buildings.  In consideration for the restructured agreement, we paid approximately $2.5 million in cash that had been previously pledged as collateral on the lease, in addition to issuing to the lessor 425,000 shares of our common stock valued at $255,000 and a note payable for $811,000.  Under the terms of the new lease, we are only responsible for 88,000 square feet at a rate of $77,000 per month.  In addition, are subleasing 10,000 of the 88,000 square feet at our Anaheim facility for a period of four years at a rate of $10,000 per month.  The aggregate future rental payments under this sublease are $120,000 for the year ending March 31, 2006 and $70,000 for the year ending March 31, 2007.  Also, as a result of the new lease, the deferred gain on the sale of the building was adjusted to reflect the changes in the lease term.  The remaining deferred gain was $733,000 at March 31, 2005.

Also, in July 2003, we completed a private placement of 3,666,666 of our common stock to seven accredited investors for net proceeds of $1.9 million in cash. In connection with this offering, we also issued warrants to the investors to purchase up to another 366,666 shares in the aggregate at an exercise price of $1.50 per share.  The fair value of these warrants was $55,000 calculated using the Black Scholes Model.  The warrants are considered a cost of raising capital and were recorded in equity as an offset to additional paid-in capital.  The warrants expire in July 2006 and became exercisable in January 2003.  The proceeds from this transaction were used to fund our general working capital requirements.

In September 2003, we completed the sale of the assets of our MAXxess subsidiary to an investor group that included certain members of the MAXxess management group. The consideration for the sale consisted of the assumption by the buyer of $2.7 million of liabilities, resulting in a net gain to the Company of approximately $2.3 million. We did not receive any cash in this transaction.

In May 2004, we issued convertible debentures in the original principal amount of $10.1 million and entered into a $5.0 million term note with our bank.  We purchased the outstanding Series A preferred stock of the Iteris Subsidiary from DCV and Hockenheim Investment Pte. Ltd. for $17.5 million, which was comprised of $2.4 million of available cash and the proceeds from the debenture financing and the bank term note.  DCV also exchanged its outstanding Iteris Subsidiary common stock for 1,219,445 shares of our common stock (the “Exchange Shares”).  Beginning on May 28, 2005, DCV has the right to request registration of all 1,219,445 shares of our common stock held as part of this exchange.  In the event we decide not to file a registration statement to register all such shares, DCV may require us to repurchase any or all of DCV’s shares of our common stock at a purchase price of $1.438 per share.  On February 1, 2005, DCV announced that it was sold to European-based Cipio Partners for an undisclosed sum.  All repurchase and registration rights associated with the DCV shares have inured to the benefit of Cipio Partners.

The debentures are due in full in May 2009, provide for 6.0% annual interest, payable quarterly, and are convertible into our common stock at an initial conversion price of $3.61 per share, subject to certain adjustments, including adjustments for dilutive issuances.  From May 19, 2007 until May 18, 2008, the debentures may be redeemed by us, at our option, at 120% of the principal amount being redeemed; and from May 19, 2008, until the maturity date, the debentures may be redeemed at 110% of the principal amount being redeemed.

Each individual investor in the debenture financing also received two warrants to purchase shares of our common stock.  For every dollar of debenture purchased, each investor received one warrant to purchase approximately 0.03235 shares of common stock at an exercise price of $3.86 per share and a second warrant to purchase approximately 0.03100 shares of common stock at an exercise price of $4.03 per share.  The exercise prices are subject to certain adjustments, including adjustments for dilutive issuances.  The warrants to purchase 639,347 shares of common stock issued to these investors expire on May 18, 2009, and none of the warrants had been exercised at March 31, 2005.

In conjunction with the debenture financing, we also issued warrants to purchase 34,036 shares of our common stock at an exercise price of $3.61 per share as commissions related to the transaction.  These warrants also expire on May 18, 2009.

Concurrent with the issuance of the debentures, our Iteris Subsidiary entered into a $5.0 million term note payable with a bank. Proceeds from the debentures and note payable were used to purchase the Series A preferred stock of our Iteris Subsidiary as described above. The four year bank note is due and payable on May 27, 2008, and provides for monthly principal payments of $104,167. Interest accrues at the current stated prime rate plus 0.25%.

Also in May 2004, our Iteris Subsidiary renegotiated its existing line of credit agreement and entered into a new line

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of credit agreement with the same bank.  The new agreement has a one year term that expires on August 1, 2005 and a maximum available credit line of $5.0 million.  We assumed this line of credit and the $5.0 million term note described above in October 2004 in connection with our merger with the Iteris Subsidiary.  Under the terms of this agreement, we may borrow against our eligible accounts receivable and the value of our eligible inventory, as defined in such agreement. Interest on borrowed amounts is payable monthly at the prime rate (5.50% at March 31, 2005).  Additionally, we are obligated to pay an unused line fee of 0.25% per annum applied to the amount by which the maximum credit amount exceeds the average daily principal balance during the preceding month. There are no monthly collateral management fees associated with our line of credit and no pre-payment or early termination fees.  Both the term note payable and the line of credit are secured by substantially all of our assets.

In November 2004, we amended our existing lease for our Anaheim facility and increased the $860,000 note payable to the landlord by $432,000 resulting in a total payable of $1.3 million. This increase was recorded as a decrease to the deferred gain on the sale of the building.  The increase was negotiated as a settlement to release us from obligations under the existing lease related to the separation of buildings located at 1515 and 1585 S. Manchester Avenue in Anaheim, California, and other facility improvements to be made at the Anaheim location.  This note is payable in quarterly installments of principal and interest beginning on October 1, 2006 and accrues interest at the current stated prime rate plus 2.0%.

We had a cash balance of $46,000 as of March 31, 2005, and generally do not have a substantial amount of cash on hand at any given time.  In order to minimize interest expense on our line of credit, available funds are swept from our cash accounts to pay down the line of credit if a balance due exists.

Our contractual obligations are as follows at March 31, 2005:

At March 31, 2005, we had firm commitments to purchase inventory in the amount of $271,000 during the first quarter of Fiscal 2006.

Although we incurred a net loss of $11.3 million in Fiscal 2005, our operations generated positive cash of $858,000 for such fiscal year.  However, we used $625,000 of cash in investing activities and $2.8 million of available cash in financing activities and ended the year with a cash balance of $46,000. At March 31, 2005, we had a revolving line of credit with our principal bank, which expires in August 2005 and provides for available borrowings up to $5.0 million subject to a borrowing formula based upon qualified accounts receivable and inventories as defined in the credit agreement. At March 31, 2005, $4.4 million was available for borrowing subject to the borrowing base in the credit agreement, of which $3.4 million was unused.  Due to covenant violations as of March 31, 2005, we are re-negotiating the line of credit facility as well as the term loan with the bank. We believe these negotiations will be successful and that the combination of available borrowings on our line of credit and our internally generated cash flows will be sufficient to enable us to execute our operating plans and meet our obligations on a timely basis.  As discussed in Note 5 to the consolidated financial statements, the entire balance of the bank term loan is presented as a current liability in our March 31, 2005, consolidated balance sheet.

Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costs, which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material.  SFAS No. 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005.  We do not believe the adoption of SFAS No. 151 will have a material impact on our financial statements.

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which replaced SFAS No. 123, Accounting for Stock-Based Compensation, supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows.  Generally, the

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approach in SFAS 123R is similar to the approach described in SFAS 123.  However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition).  In accordance with SEC Release No. 33-8568, SFAS 123R will become effective for us beginning April 1, 2006.  We are currently assessing the impact of SFAS 123R.  As of the date of this filing, no decisions have been made as to whether we will apply the modified prospective or retrospective transition method of application.

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RISK FACTORS

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

We Have Experienced Substantial Losses And May Continue To Experience Losses For The Foreseeable Future.  We experienced net losses from continuing operations of $11.3 million, $1.9 million and $5.3 million in the years ended March 31, 2005, 2004, and 2003, respectively.  While we have divested all of our other business units and merged with our Iteris Subsidiary, we cannot assure you that our efforts to downsize our operations or reduce our operating expenses will improve our financial performance, or that we will be able to achieve profitability on a quarterly or annual basis in the future. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. As a result, we may continue to experience operating losses and net losses, which would make it difficult to fund our operations and achieve our business plan, and could cause the market price of our common stock to decline.

We May Need To Raise Additional Capital In The Future, But We May Not Be Able To Secure Adequate Funds On Terms Acceptable To Us, Or At All.  We have generated significant net losses and operating losses in recent periods, and have experienced volatility in our cash flows from operations ranging from positive cash flows from operations of $858,000 in the year ended March 31, 2005, to negative cash flows from operations of $718,000 and $4.8 million in the years ended March 31, 2004, and 2003, respectively.  While we completed a $10.1 million convertible debenture financing and our Iteris Subsidiary closed a $5.0 million term loan in May 2004, the majority of the proceeds from such financings were used to purchase the Series A preferred stock of our Iteris Subsidiary held by outside investors.

As further described in Note 5 to the consolidated financial statements, we failed to meet some of our debt covenants under our current credit agreement with our bank.  At March 31, 2005, we had $4.0 million in term debt and $945,000 in revolving credit outstanding in connection with this credit agreement.  Although we are currently in negotiations to restructure this credit facility, we cannot assure you that we will be able to complete this restructuring under acceptable terms, or at all.

We may raise additional capital in the near future to fund our operations or to repay indebtedness.  Such additional capital may be raised through bank borrowings, or other debt or equity financings.  We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all.

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

•      our ability to successfully renegotiate a new credit arrangement with our bank;

•      our ability to control costs;

•      market acceptance of our products and the overall level of sales of our products;

•      our ability to generate operating income;

•      increased research and development funding;

•      increased sales and marketing expenses;

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

•      capital improvements to new and existing facilities;

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•      potential acquisitions of businesses and product lines;

•      our relationships with customers and suppliers; and

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

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

If Our Internal Controls Over Financial Reporting Do Not Comply With The Requirements Of The Sarbanes-Oxley Act, Our Business And Stock Price Could Be Adversely Affected. We and our independent registered public accounting firm are evaluating the effectiveness of our internal controls over financial reporting to comply with Section 404 of the Sarbanes-Oxley Act of 2002.  Section 404 requires us to evaluate the effectiveness of our internal controls over financial reporting as the end of each fiscal year beginning in Fiscal 2006, and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports beginning with our Annual Report on Form 10-K for the fiscal year ending March 31, 2006.  Section 404 also requires our independent accountant to attest to, and report on, management’s assessment of our internal controls over financial reporting.

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

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

We Rely On A Single Manufacturer For Our AutoVue LDW Systems And May Experience Supply Issues For This Product Which Could Materially And Adversely Impact Our Sales And Ultimate Market Acceptance Of AutoVue.  We outsource the manufacture of our AutoVue product line to a single manufacturer. We are currently negotiating with a second supplier for the AutoVue product line. This manufacturer may not be able to produce sufficient quantities of this product in a timely manner or at a reasonable cost, which could materially and adversely affect our ability to launch or gain market acceptance of AutoVue. We are currently experiencing shortages on certain components used in the manufacture of AutoVue LDW units sold to the heavy truck market and must design and qualify a next generation system before our existing supplies are exhausted. AutoVue production availability may also be impacted by long lead times on replacement components or an inability to design these new components into production units. Based on current sales and unit forecasts, we believe we currently have a four month supply of these components on hand. We are searching world-wide supply sources to acquire additional components, but we cannot assure you that we will be able to obtain sufficient quantities of these components or that such components will be available on a timely basis.  Should we not be able to procure these components before our current inventory is depleted or we engineer and qualify a next generation system, we could experience a shortfall in revenues for a brief period of time until such components can be located or the qualification of a new component is complete.

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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 were derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. Government contracts represented approximately 37.4%, 48.2% and 53.8% of our total net sales and contract revenues for the years ended March 31, 2005, 2004 and 2003, respectively. We anticipate that revenue from government contracts will continue to increase in the near future. Government business is, in general, subject to special risks and challenges, including:

•      long purchase cycles or approval processes;

•      competitive bidding and qualification requirements;

•      the impact of international conflicts;

•      performance bond requirements;

•      changes in government policies and political agendas;

•      delays in funding, budgetary constraints and cut-backs; and

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

In addition, a large number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur.  These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements.  The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis.  In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs.  Such additional costs would adversely affect our financial condition and results of operations.  Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our net sales in any given quarter.  Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations.

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

We believe that we must continue to make substantial investments to support ongoing research and development in order to remain competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in response to evolving customer requirements. Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue.

Market acceptance of our new products depends upon many factors, including our ability to accurately predict market requirements and evolving industry standards, our ability to resolve technical challenges in a timely and cost-effective manner and achieve manufacturing efficiencies, the perceived advantages of our new products over traditional products and the marketing capabilities of our independent distributors and strategic partners.  In particular, we have granted Valeo the exclusive right to sell and manufacture our AutoVue lane departure warning system to the worldwide passenger market in exchange for royalty payments for each AutoVue unit sold.  As such, the future success and broad market acceptance of our AutoVue technologies will depend upon Valeo’s ability to manufacture, market and sell our technologies, and to convince more OEM passenger car manufacturers to adopt our technologies.  The success of our AutoVue system will also depend in part on the success of the automotive vehicles that incorporate our technology, as well as the success of optional equipment that OEMs bundle with our technologies.

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

An Economic Slowdown And Related Uncertainties Could Adversely Impact The Demand For Our Products.  Concerns about inflation, decreased consumer confidence, reduced corporate profits and capital spending, and recent international conflicts and terrorist and military actions have resulted in a downturn in worldwide economic conditions, particularly in the United States.  These unfavorable economic conditions may have a negative impact on customer orders, cancellations and rescheduling of backlog. In addition, recent political and social turmoil related to international conflicts and terrorist acts can be expected to put further pressure on economic conditions in the U.S. and worldwide.  These political, social and economic conditions make it extremely difficult for our customers, our suppliers and us to accurately forecast and plan future business activities.  If such conditions continue or worsen, our business, financial condition and results of operations will likely be materially and adversely affected.

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

•      our ability to raise additional capital;

•      our ability to control costs;

•      international conflicts and acts of terrorism;

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

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

•      the introduction of new products by competitors;

•      the availability of components used in the manufacture of our products;

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

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

•      continued delays in the passage of the six year transportation bill by the U.S. government;

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

•      the effects of technological changes in our target markets;

•      our relatively small level of backlog at any given time;

•      seasonality due to winter weather conditions;

•      the mix of our sales;

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

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•      risks and uncertainties associated with our international business;

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

•      general economic and political conditions.

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

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

•      rapid technological advances;

•      downward price pressure in the marketplace as technologies mature;

•      changes in customer requirements;

•      frequent new product introductions and enhancements; and

•      evolving industry standards and changes in the regulatory environment.

Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements.

We Have Adopted A New Operating Strategy, Which Is Untried And Exposes Us To New Risks.  We recently divested ourselves of all of our other business units and merged with our Iteris Subsidiary and significantly scaled back our operations in order to focus on the ITS business.  We have abandoned our strategy of incubating emerging companies, which historically required us to make significant investments in new business units.  Our current business strategy is narrow and untried, and we cannot assure you that our new business strategy or the continued execution of this business will be successful.

The Markets In Which We Operate Are Highly Competitive And Have Many More Established Competitors, Which Could Adversely Affect Our Sales Or The Market Acceptance Of Our Products.  We compete with numerous other companies in our target markets including, but not limited to, large, multinational corporations and many smaller regional engineering firms. We expect such competition to increase due to technological advancements, industry consolidations and reduced barriers to entry. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, financial condition and results of operations. Many of our competitors have far greater name recognition and greater financial, technological, marketing and customer service resources than we do. This may allow them to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to devote greater resources to the development, promotion, sale and support of their products than we can. Recent consolidations of end users, distributors and manufacturers in our target markets have exacerbated this problem. As a result of the foregoing factors, we may not be able to compete effectively in our target markets and competitive pressures could adversely affect our business, financial condition and results of operations.

We May Be Unable To Attract And Retain Key Personnel, Which Could Seriously Harm Our Business.  Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel, particularly Jack Johnson.  In connection with the roll-up merger of the Iteris Subsidiary, Mr. Johnson became our Chief Executive Officer and Mr. James Miele, the former Controller of our Iteris Subsidiary, was promoted to serve as our Chief Financial Officer. The loss of either of these individuals or of any of our executive officers or key members of management could adversely affect our business, financial condition or results of operations.  Our success will also depend in large part upon our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. Competition for employees, particularly development engineers, is intense.  We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees.  Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations.

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

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

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

•      quarterly variations in operating results;

•      our ability to control costs and improve cash flow;

•      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;

•      acquisitions of businesses, products or technologies;

•      the impact of any litigation;

•      changes in investor perceptions;

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

•      international conflicts, political unrest and acts of terrorism.

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

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

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

•      the failure to retain or integrate key acquired personnel;

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

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

•      the incurrence of unforeseen obligations or liabilities;

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

•      increased interest expense and amortization of acquired intangible assets.

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

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

•      currency fluctuations and restrictions;

•      political, social and economic instability;

•      reduced protection for intellectual property rights in some countries;

•      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;

•      longer accounts receivable payment cycles;

•      difficulties in managing and staffing international operations;

•      potentially adverse tax consequences; and

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

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

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

Some Of Our Directors, Officers And Their Affiliates Can Control The Outcome Of Matters That Require The Approval Of Our Stockholders, And Accordingly We Will Not Be Able To Engage In Certain Transactions Without Their Approval.  As of March 31, 2005, our officers and directors owned approximately 16% of the outstanding shares of our common stock (and approximately 25% of our common stock when including options, warrants and other convertible securities held by them which are currently exercisable or convertible or will become exercisable or convertible within 60 days after March 31, 2005). As a result of their stock ownership, our management will be able to significantly influence the election of our directors and the outcome of corporate actions requiring stockholder approval, such as mergers and acquisitions, regardless of how our other stockholders may vote. This concentration of voting control may have a significant effect in delaying, deferring or preventing a change in our management or change in control and may adversely affect the voting or other rights of other holders of common stock.

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Certain Anti-Takeover Provisions May Affect The Price Of Our Common Stock And Discourage A Third Party From Acquiring Us.  Certain provisions of our certificate of incorporation and our stockholder rights plan could make it difficult for a third party to acquire us, even though an acquisition might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. Our future issuance of preferred stock could be used to discourage an unsolicited acquisition proposal. In addition, in March 1998, we adopted a stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. We amended this plan in May 2004. In the event a third party acquires more than 15% of the outstanding voting control of our company or 15% of our outstanding common stock, the holders of these rights will be able to purchase the junior participating preferred stock at a substantial discount off of the then current market price. The exercise of these rights and purchase of a significant amount of stock at below market prices could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a merger, tender offer or proxy contest more difficult.

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ITEM 7A.       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk is limited to our lines of credit. Our lines of credit bear interest based on the prevailing prime rate (5.50% at March 31, 2005). A 10% increase in the interest rate on our line of credit (from 5.50% to 6.05%) would not have a material impact on our financial position, operating results, or cash flows. In addition, we believe that the carrying value of our outstanding debt approximates fair value.

ITEM 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

On a Form 8-K filed with the Securities and Exchange Commission on October 12, 2004, as amended on November 12, 2004, we previously reported our decision to dismiss our former independent registered public accounting firm, Ernst & Young LLP, effective October 5, 2004 and appoint McGladrey & Pullen, LLP as its new independent registered public accounting firm, to perform auditing services beginning with the second fiscal quarter ended September 30, 2004. 

ITEM 9A.       CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting and concluded that our disclosure controls and procedures were ineffective in timely alerting them to the material information involving transactions occurring in the normal course of business relating to us required to be included in the reports we file or submit under the Securities Exchange Act of 1934.  The Company concluded that it has a material weakness related to the administration and proper accounting for certain types of its contracts and agreements.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.  The material weakness described above resulted in improper accounting treatment for the Iteris Subsidiary’s Deferred Compensation Savings Plan. The material weakness resulted in restatement to our 2004 financial statements with respect to deferred compensation expense and compensation saving plan liabilities.

Management’s Response and Plan for Improvement

Management has responded to the identification of the material weakness related to the consolidation and proper accounting for the Plan in the 2004 financial statements by performing additional accounting, financial analysis and managerial review of procedures in order to ensure that the financial information contained in our Annual Report on Form 10-K is reliable.  Additionally, we intend to amend the Plan to clarify its original intent and prohibit diversification of any shares of Company common stock held in the plan, which we believe will prevent any compensation charges or other impact on our financial statements as a result of changes in the value of the Company’s common stock held in the Plan.

Changes in Internal Controls

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

ITEM 9B.       OTHER INFORMATION

None.

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PART III

ITEM 10.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a)  Identification of Directors. The information under the caption “Election of Directors,” appearing in our proxy statement for the 2005 Annual Meeting of Stockholders, is incorporated herein by reference.

(b)  Identification of Executive Officers. The information under the caption “Executive Officers,” appearing in our proxy statement for the 2005 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 Reporting Compliance appearing in our proxy statement for the 2005 Annual Meeting of Stockholders is incorporated herein by reference.

(d)  Code of Ethics.  The information under the caption “Corporate Governance,” appearing in our proxy statement for the 2005 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 2005 Annual Meeting of Stockholders, is incorporated herein by reference.

ITEM 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information under the captions “Equity Compensation Plans” and “Principal Stockholders and Common Stock Ownership of Certain Beneficial Owners and Management,” appearing in our proxy statement for the 2005 Annual Meeting of Stockholders, is incorporated herein by reference.

ITEM 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information under the caption “Certain Transactions,” appearing in our proxy statement for the 2005 Annual Meeting of Stockholders, is incorporated herein by reference.

ITEM 14.       PRINCIPAL ACCOUNTING FEES AND SERVICES

The information under the caption “Fees Paid to Independent Auditors,” appearing in our proxy statement for the 2005 Annual 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 on Form 10-K commencing on the pages referenced below:

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2.             Financial Statement Schedules.

All other schedules have been omitted because they are not required or the required information is included in our consolidated financial statements and notes thereto.

3.             Exhibits.

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

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31

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