UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
Form 10-Q
(Mark One)
⌧                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2006
OR
☐                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to
Commission file number:  001–08762
ITERIS, INC.
(Exact name of registrant as specified in its charter)
Delaware | | 95-2588496
(State or other jurisdiction of | | (I.R.S. Employer
incorporation or organization) | | Identification No.)
1515 South Manchester Avenue | |
Anaheim, California | | 92802
(Address of principal executive office) | | (Zip Code)
 
(714) 774-5000
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ⌧ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  ☐ | | Accelerated filer  ☐ | | Non-accelerated filer  ⌧
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ⌧
As of February 8, 2007, the registrant had 31,251,473 shares of common stock outstanding

ITERIS, INC.
Quarterly Report on Form 10-Q
For the Three and Nine Months Ended December 31, 2006
Table of Contents
PART I. | | FINANCIAL INFORMATION | |
ITEM 1. | | FINANCIAL STATEMENTS | |
| | UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 2006 AND MARCH 31, 2006 | |
| | UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED DECEMBER 31, 2006 AND 2005 | |
| | UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED DECEMBER 31, 2006 AND 2005 | |
| | NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS | |
ITEM 2. | | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | |
ITEM 3. | | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | |
ITEM 4. | | CONTROLS AND PROCEDURES | |
PART II. | | OTHER INFORMATION | |
ITEM 1. | | LEGAL PROCEEDINGS | |
ITEM 1A. | | RISK FACTORS | |
ITEM 2. | | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | |
ITEM 3. | | DEFAULTS UPON SENIOR SECURITIES | |
ITEM 4. | | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | |
ITEM 5. | | OTHER INFORMATION | |
ITEM 6. | | EXHIBITS | |
 
                Unless otherwise indicated in this report, the “Company,” “we,” “us” and “our” collectively refer to Iteris, Inc., formerly known as Iteris Holdings, Inc. and Odetics, Inc., and its former subsidiary, Meyer, Mohaddes Associates, Inc., which was dissolved effective April 2006.
AutoVue®, Iteris®, Vantage® and eAccess™ are among the trademarks of Iteris, Inc. Any other trademarks or trade names mentioned herein are the property of their respective owners.

PART I. FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
ITERIS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
 
| | December 31, 2006 | | March 31, 2006 |
| | (unaudited) | | |
ASSETS | | | | |
Current assets: | | | | |
Cash and cash equivalents | | $ | 167 | | $ | 131 |
Trade accounts receivable, net of allowance for doubtful accounts of $612 and $429 at December 31, 2006 and March 31, 2006, respectively | | 11,869 | | 11,426 |
Costs and estimated earnings in excess of billings on uncompleted contracts | | 3,419 | | 2,693 |
Inventories, net of reserve for inventory obsolescence of $794 and $592 at December 31, 2006 and March 31, 2006, respectively | | 6,430 | | 2,814 |
Deferred income taxes | | 854 | | 790 |
Prepaid expenses and other current assets | | 757 | | 368 |
Total current assets | | 23,496 | | 18,222 |
Property and equipment, net | | 1,689 | | 1,783 |
Deferred income taxes | | 1,266 | | 818 |
Intangible assets, net of accumulated amortization of $371 and $261 at December 31, 2006 and March 31, 2006, respectively | | 441 | | 551 |
Goodwill | | 27,774 | | 27,774 |
Other assets | | 392 | | 485 |
Total assets | | $ | 55,058 | | $ | 49,633 |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
Current liabilities: | | | | |
Trade accounts payable | | $ | 4,453 | | $ | 3,620 |
Accrued payroll and related expenses | | 3,558 | | 3,481 |
Accrued liabilities | | 1,763 | | 2,304 |
Billings in excess of costs and estimated earnings on uncompleted contracts | | 821 | | 893 |
Revolving line of credit | | 4,152 | | 2,662 |
Current portion of long-term debt | | 2,270 | | 1,969 |
Total current liabilities | | 17,017 | | 14,929 |
Non-current accrued liabilities | | 184 | | 12 |
Deferred compensation plan liability | | 760 | | 820 |
Deferred gain on sale of building | | 236 | | 449 |
Long-term debt | | 675 | | 2,171 |
Convertible debentures, net | | 9,358 | | 9,203 |
Total liabilities | | 28,230 | | 27,584 |
Commitments and contingencies | | | | |
Redeemable common stock, 1,219 shares issued and outstanding at December 31, 2006 and March 31, 2006 | | 3,414 | | 3,414 |
Stockholders’ equity: | | | | |
Preferred stock, $1.00 par value, 2,000 shares authorized, none issued and outstanding at December 31, 2006 and March 31, 2006 | | — | | — |
Common stock, $0.10 par value, 50,000 shares authorized, 29,775 and 27,432 shares issued and outstanding at December 31, 2006 and March 31, 2006, respectively | | 2,977 | | 2,743 |
Additional paid-in capital | | 129,839 | | 126,664 |
Common stock held in trust, 311 shares at December 31, 2006 and March 31, 2006 | | (374 | ) | (374 | )
Notes receivable from employees | | (5 | ) | (49 | )
Accumulated deficit | | (109,035 | ) | (110,356 | )
Accumulated other comprehensive income | | 12 | | 7 |
Total stockholders’ equity | | 23,414 | | 18,635 |
Total liabilities and stockholders’ equity | | $ | 55,058 | | $ | 49,633 |
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
2

 
ITERIS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

| | Three Months ended December 31, | | Nine Months Ended December 31 |
| | 2006 | | 2005 | | 2006 | | 2005 |
Net sales and contract revenues: | | | | | | | | |
Net sales | | $ | 8,575 | | $ | 7,276 | | $ | 26,498 | | $ | 22,776 |
Contract revenues | | 5,913 | | 4,907 | | 16,272 | | 14,201 |
Total net sales and contract revenues | | 14,488 | | 12,183 | | 42,770 | | 36,977 |
Costs and expenses: | | | | | | | | |
Cost of net sales (a) | | 4,746 | | 3,898 | | 14,800 | | 11,889 |
Cost of contract revenues (a) | | 4,066 | | 3,304 | | 10,618 | | 9,310 |
Gross profit | | 5,676 | | 4,981 | | 17,352 | | 15,778 |
Operating expenses: | | | | | | | | |
Selling, general and administrative (a) | | 3,879 | | 3,599 | | 11,865 | | 11,513 |
Research and development (a) | | 1,038 | | 1,172 | | 2,812 | | 4,288 |
Deferred compensation plan | | (29 | ) | (90 | ) | (61 | ) | (12 | )
Amortization of intangible assets | | 37 | | 37 | | 110 | | 110 |
Total operating expenses | | 4,925 | | 4,718 | | 14,726 | | 15,899 |
Operating income (loss) | | 751 | | 263 | | 2,626 | | (121 | )
Non-operating income (expense): | | | | | | | | |
Other income (expense), net | | (5 | ) | (6 | ) | (650 | ) | 32 |
Interest expense, net | | (390 | ) | (377 | ) | (1,200 | ) | (1,087 | )
Income (loss) before income taxes | | 356 | | (120 | ) | 776 | | (1,176 | )
Income tax benefit (provision) | | (46 | ) | 256 | | 545 | | 431 |
Net income (loss) | | $ | 310 | | $ | 136 | | $ | 1,321 | | $ | (745 | )
Earnings (loss) per share: | | | | | | | | |
Basic | | $ | 0.01 | | $ | 0.00 | | $ | 0.05 | | $ | (0.03 | )
Diluted | | $ | 0.01 | | $ | 0.00 | | $ | 0.04 | | $ | (0.03 | )
Weighted average shares outstanding: | | | | | | | | |
Basic | | 30,438 | | 28,246 | | 29,238 | | 28,138 |
Diluted | | 33,813 | | 32,700 | | 33,067 | | 28,138 |

(a)             Includes stock-based compensation expense as follows
Cost of net sales | | $ | 3 | | $ | 5 | | $ | 12 | | $ | 23 |
Cost of contract revenues | | $ | 8 | | $ | 35 | | $ | 56 | | $ | 172 |
Selling, general and administrative expense | | $ | 46 | | $ | 44 | | $ | 147 | | $ | 319 |
Research and development expense | | $ | 2 | | $ | 19 | | $ | 18 | | $ | 112 |
 
See accompanying notes to unaudited condensed consolidated financial statements.
3

 
ITERIS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

Nine Months Ended
December 31,

| | 2006 | | 2005 |
Cash flows from operating activities | | | | |
Net income (loss) | | $ | 1,321 | | $ | (745 | )
Adjustments to reconcile net income (loss) to net cash provided (used in) by operating activities: | | | | |
Change in deferred tax assets | | (512 | ) | (472 | )
Depreciation and amortization of property and equipment | | 405 | | 506 |
Stock-based compensation expense | | 233 | | 626 |
Amortization of deferred gain on sale—leaseback transaction | | (213 | ) | (213 | )
Amortization of debt discount | | 155 | | 155 |
Amortization of intangible assets | | 110 | | 110 |
Amortization of deferred financing costs | | 103 | | 103 |
Issuance of warrants for services | | 22 | | — |
Changes in operating assets and liabilities: | | | | |
Accounts receivable | | (443 | ) | 26 |
Net costs and estimated earnings in excess of billings | | (798 | ) | (474 | )
Inventories | | (3,616 | ) | 1,692 |
Prepaid expenses and other assets | | (399 | ) | (98 | )
Accounts payable and accrued liabilities | | 1,350 | | (275 | )
Net cash provided by (used in) operating activities | | (2,282 | ) | 941 |
Cash flows from investing activities | | | | |
Purchases of property and equipment | | (311 | ) | (716 | )
Cash flows from financing activities | | | | |
Net borrowings on line of credit | | 1,490 | | 444 |
Payments on long-term debt | | (1,195 | ) | (980 | )
Change in checks drawn in excess of available bank balances | | (651 | ) | — |
Proceeds from stock option and warrant exercises | | 2,945 | | 265 |
Proceeds from notes receivable from employees | | 40 | | — |
Net cash provided by (used in) financing activities | | 2,629 | | (271 | )
Increase (decrease) in cash | | 36 | | (46 | )
Cash at beginning of period | | 131 | | 46 |
Cash at end of period | | $ | 167 | | $ | — |
Supplemental cash flow information: | | | | |
Cash paid during the period: | | | | |
Interest | | $ | 937 | | $ | 795 |
Income taxes | | 26 | | (2 | )
Supplemental schedule of non-cash investing and financing activities: | | | | |
Fair value of common stock issued in settlement of liabilities | | $ | 213 | | $ | — |
Fair value of warrants issued in settlement of liabilities | | — | | 28 |
Retirement of treasury stock | | — | | 1 |
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
4

ITERIS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
1.  Description of Business and Summary of Significant Accounting Policies
Description of Business
Iteris, Inc., formerly known as Iteris Holdings, Inc. and Odetics, Inc. (“Iteris” or the “Company”), 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, the Company provides 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. The Company uses its outdoor image recognition software expertise to develop proprietary algorithms for video sensor systems that improve vehicle safety and the flow of traffic. Using its knowledge of the ITS industry, the Company designs and implements transportation management systems that help public agencies reduce traffic congestion and provide greater access to traveler information.  The Company was originally incorporated in Delaware in 1987 as Odetics, Inc. and in September 2003 changed its name to Iteris Holdings, Inc. to reflect its focus on the ITS industry and its capital structure at that time.  On October 22, 2004, the Company completed a merger with its majority-owned subsidiary, Iteris, Inc. (the “Iteris Subsidiary”), and officially changed its corporate name from Iteris Holdings, Inc. to Iteris, Inc.
Basis of Presentation
The unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the consolidated financial position of the Company as of December 31, 2006, the consolidated results of operations for the three and nine months ended December 31, 2006 and 2005, and the consolidated cash flows for the nine months ended December 31, 2006 and 2005. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the SEC. The results of operations for the three and nine months ended December 31, 2006, are not necessarily indicative of those to be expected for the entire year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended March 31, 2006, which was filed with the SEC on June 29, 2006.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Significant estimates made in the preparation of the consolidated financial statements include the allowance for doubtful accounts, deferred tax assets, inventory and warranty reserves, costs to complete long-term contracts, overhead rates used in cost-plus contracts, contract reserves and estimates of future cash flows used to assess the recoverability of long-lived assets, the valuation of debt and equity instruments and the realization of goodwill.
Revenue Recognition
Product revenues and related costs of sales are recognized upon the transfer of title, which generally occurs upon shipment or, if required, upon acceptance by the customer, provided that the Company believes collectibility of the net sales amount is probable.  Accordingly, at the date revenue is recognized, the significant uncertainties concerning the sale have been resolved.
5

Contract revenues are derived primarily from long-term contracts with governmental agencies.  Contract revenues include costs incurred plus a portion of estimated fees or profits determined on the percentage of completion method of accounting based on the relationship of costs incurred to date 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 costs and revenues and are recognized in the period in which the revisions are determined.  Profit incentives are included in revenue when their realization is reasonably assured.
In addition to product and contract revenue, the Company derives revenue from technology access fees, the provision of specific non-recurring contract engineering services and royalties. Technology access fee revenues are recognized evenly over the period in which they are earned.  Non-recurring contract engineering revenues are recognized in the period in which the related services are performed.  Royalty revenues are recorded in the period in which the royalty is earned, based on unit sales of the Company’s products.  Technology access fee revenues, contract engineering revenues and royalty revenues are included in net sales in the accompanying condensed consolidated statements of operations.
Revenues from follow-on service and support, for which the Company charges separately, are recorded in the period in which the services are performed.
Concentration of Credit Risk
Accounts receivable are primarily derived from revenues earned from customers located throughout North America and Europe.  The Company generally does not require collateral or other security from customers. Collectibility of receivable balances is estimated through review of invoices outstanding greater than a certain period of time and ongoing credit evaluations of customers’ financial condition.  Reserves are maintained for potential credit losses, and such losses have historically been within management’s expectations.
Fair Values of Financial Instruments
The fair values of cash and cash equivalents, receivables, inventories, accounts payable and accrued expenses approximate carrying value because of the short period of time to maturity. The fair values of line of credit agreements and long-term debt approximate carrying value because the related rates of interest approximate current market rates.  The fair value of convertible debentures approximates carrying value because the effective interest rate, taking into account recorded debt discounts, approximates current market rates.  The estimated fair value of redeemable common stock was $2.9 million and $3.2 million at December 31, 2006 and March 31, 2006, respectively, based on the closing price of the Company’s common stock on those dates.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method.
Property and Equipment
Property and equipment are recorded at cost and are depreciated over the estimated useful life ranging from three to eight years.  Leasehold improvements are depreciated over the term of the related lease or the estimated useful life of the improvement, whichever is shorter.  Beginning April 1, 2006, the Company began depreciating property and equipment using the straight-line method of depreciation.  Prior to this date, the Company used the double declining balance method of depreciation.  As a result of this change in estimate, depreciation expense declined by $125,000 and $319,000 for the three and nine months ended December 31, 2006, respectively, resulting in no impact on earnings per share for the three months ended December 31, 2006, and a $0.01 per share impact on earnings per share for the nine months ended December 31, 2006.
Goodwill and Long-Lived Assets
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Intangible Assets , goodwill is tested for impairment on an annual basis in the Company’s fourth fiscal quarter or more frequently if indicators of impairment exist, of which none have been identified.  The performance of the test involves a two-step process.  The first step of the impairment test involves comparing the fair value of the Company’s reporting units with each respective
6

reporting unit’s carrying amount, including goodwill.  The Company determines the fair value of reporting units using the income approach.  If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the second step of the goodwill impairment test is performed to determine the amount of any impairment loss.  The second step of the goodwill impairment test involves comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill.
The Company evaluates long-lived assets for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,  which requires impairment evaluation on long-lived assets used in operations when indicators of impairment are present.  Reviews are performed to determine whether the carrying value of assets is impaired, based on a comparison to undiscounted expected future cash flows.  If this comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using discounted expected future cash flows and a discount rate based upon the Company’s weighted average cost of capital adjusted for risks associated with the related operations.  Impairment is based on the excess of the carrying amount over the fair value of those assets.
Income Taxes
The Company utilizes the liability method of accounting for income taxes as set forth in SFAS No. 109, Accounting for Income Taxes  (“SFAS 109”) .   Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates.  A valuation allowance is recorded when it is more likely than not that all or a portion of the deferred tax assets will not be realized.
Research and Development Expenditures
Research and development expenditures are charged to expense in the period incurred.
Shipping and Handling Costs
Shipping and handling costs are included in cost of sales in the period during which products ship.
Warranty
The Company generally provides a one to three year warranty from the original invoice date on all products, materials and workmanship.  Products sold to certain original equipment manufacturer (“OEM”) customers sometimes carry longer warranties. Defective products will be either repaired or replaced, generally at the Company’s option, upon meeting certain criteria. The Company accrues a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized.  The accrued warranty provision is included within accrued expenses on the accompanying condensed consolidated balance sheets.
Repair and Maintenance Costs
The Company incurs repair and maintenance costs in the normal course of business. Should the activity result in a permanent improvement to one of the Company’s leased facilities, the cost is capitalized as a leasehold improvement and amortized over its useful life or the remainder of the lease period, whichever is shorter.  Non-permanent repair and maintenance costs are charged to expense as incurred.
Reclassifications
Certain amounts in the prior period financial statements have been reclassified to conform with current year presentation.
Other Comprehensive Income
The only component of accumulated other comprehensive income is foreign currency translation adjustments.
7

Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004),  Share-Based Payment  (“SFAS 123R”), which replaces SFAS No. 123,  Accounting for Stock-Based Compensation  (“SFAS 123”), supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), and amends SFAS No. 95,  Statement of Cash Flows .  Generally, the 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).  As further discussed in Note 6, the Company adopted SFAS 123R effective April 1, 2006 using the modified prospective method.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”).  FIN 48 clarifies the accounting and reporting for income taxes recognized in accordance with SFAS 109.  This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.  The Company is currently evaluating the impact of FIN 48 and expects to adopt this Interpretation in the first quarter of its fiscal year ending March 31, 2008.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather it specifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early application of the statement is encouraged. Generally, this statement will be applied prospectively. The Company is currently evaluating the impact of SFAS 157 and expects to adopt SFAS 157 in the first quarter of its fiscal year ending March 31, 2009.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements  (“SAB 108”).  SAB 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment.  The Company is currently evaluating the impact of SAB 108 and expects to adopt SAB 108 in the first quarter of its fiscal year ending March 31, 2007.
In June 2006, the FASB ratified Emerging Issues Task Force Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (“EITF 06-3”).  The task force reached a conclusion that either method is acceptable; however, if taxes are reported on a gross basis (included as sales) a company should disclose those amounts if significant.  EITF 06-3 is effective for the first interim reporting period beginning after December 15, 2006.  The Company is currently evaluating the impact of EITF 06-3 and expects to adopt EITF 06-3 in the fourth quarter of the current fiscal year.
2.  Supplemental Financial Information
Inventories
The following table presents details of the Company’s inventories:
| | December 31, 2006 | | March 31, 2006 |
| | (In thousands) |
Materials and supplies | | $ | 4,893 | | $ | 2,258 |
Work in process | | 329 | | 217 |
Finished goods | | 1,208 | | 339 |
| | $ | 6,430 | | $ | 2,814 |
 
8

Goodwill and Intangible Assets
The following table sets forth the Company’s intangible assets that are subject to amortization:
| | December 31, 2006 | | March 31, 2006 |
| | Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
| | | | (In thousands) | | |
Developed technology | | $ | 495 | | $ | (255 | ) | $ | 495 | | $ | (179 | )
Patents | | 317 | | (116 | ) | 317 | | (82 | )
Total | | $ | 812 | | $ | (371 | ) | $ | 812 | | $ | (261 | )
 
Amortization expense for intangible assets subject to amortization was $37,000 and $110,000 for the three and nine months ended December 31, 2006, respectively, and $37,000 and $110,000 for the three and nine months ended December 31, 2005, respectively.  Future estimated amortization expense for the remainder of the current fiscal year, the next four fiscal years and thereafter is as follows:
Fiscal Year Ending March 31: | | |
(In thousands) | | |
Remainder of 2007 | | $ | 37 |
2008 | | 147 |
2009 | | 147 |
2010 | | 58 |
2011 | | 46 |
Thereafter | | 6 |
| | $ | 441 |
 
At December 31, 2006, goodwill of $27.8 million was comprised of $18.0 million associated with the October 2004 merger between the Company and its Iteris Subsidiary; $9.6 million associated with the acquisitions of the Rockwell International Transportation Systems Group, Meyer Mohaddes Associates, Inc. and the Viggen Systems Consulting Group; and $200,000 associated with the purchase of the assets of Mil-Lektron, a complementary product to the Company’s Vantage video detection business.
Warranty Reserve Activity
The following table presents activity in accrued warranty obligations:
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | | | (In thousands) | | |
Balance at beginning of period | | $ | 679 | | $ | 441 | | $ | 519 | | $ | 326 |
Additions charged to cost of sales | | 160 | | 80 | | 450 | | 345 |
Warranty claims | | (265 | ) | (92 | ) | (395 | ) | (242 | )
Balance at end of period | | $ | 574 | | $ | 429 | | $ | 574 | | $ | 429 |
 
Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted earnings (loss) per share:
9

 
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | (In thousands, except per share amounts) |
Numerator: | | | | | | | | |
Net income (loss) | | $ | 310 | | $ | 136 | | $ | 1,321 | | $ | (745 | )
Denominator: | | | | | | | | |
Weighted average common shares used in basic computation | | 30,438 | | 28,246 | | 29,238 | | 28,138 |
Dilutive stock options | | 3,342 | | 3,725 | | 3,436 | | — |
Dilutive warrants | | 33 | | 729 | | 393 | | — |
Weighted average common shares used in dilutive computation | | 33,813 | | 32,700 | | 33,067 | | 28,138 |
Earnings (loss) per share: | | | | | | | | |
Basic | | $ | 0.01 | | $ | 0.00 | | $ | 0.05 | | $ | (0.03 | )
Diluted | | $ | 0.01 | | $ | 0.00 | | $ | 0.04 | | $ | (0.03 | )
 
The following shares were excluded from the computation of diluted earnings (loss) per share as their effect would have been antidilutive:
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | (In thousands) |
Stock options | | 567 | | 532 | | 553 | | 480 |
Warrants | | 1,190 | | 1,380 | | 1,257 | | 1,226 |
Convertible debentures | | 2,729 | | 2,729 | | 2,729 | | 2,729 |
 
3.  Revolving Line of Credit and Long-Term Debt
Revolving Line of Credit
The Company renewed its line of credit agreement with its former bank in August 2005, which provided for borrowings of up to $5.0 million.  This line of credit agreement was scheduled to expire on July 31, 2006 but was extended until October 31, 2006.
In October 2006, the Company replaced its former facility and entered into a new two-year credit facility with a different bank.  The new facility provides for combined line of credit and bank term note borrowings of up to $8.0 million.  Under the new credit facility, the Company may borrow against its eligible accounts receivable and eligible inventory, as defined in the credit agreement.  Line of credit interest on borrowed amounts is payable monthly at the current stated prime rate plus 1.25%.  Additionally, the Company is obligated to pay an unused line fee of 0.25% per annum applied to the amount by which the maximum credit amount exceeds the average daily principal balance during the preceding month. The new credit facility requires $2,000 in monthly collateral management fees and includes an early termination fee equal to 2% of the total facility during the first year of the agreement and 1% of the total facility in the second year of the agreement.  Additionally, the Company paid a commitment fee of $40,000 in October 2006 and is obligated to pay an additional $40,000 on the one-year anniversary of the facility. The new credit facility is secured by substantially all of the assets of the Company.
On December 31, 2006, the available credit under the credit facility was $8.0 million, of which $2.0 million was unused.
Long-Term Debt
The Company’s long-term debt consists of the following:
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| | December 31, 2006 | | March 31, 2006 |
| | (In thousands) |
Convertible debentures, net | | $ | 9,358 | | $ | 9,203 |
Bank term note | | 1,888 | | 2,708 |
Promissory note to landlord | | 969 | | 1,292 |
Other | | 88 | | 140 |
| | 12,303 | | 13,343 |
Less current portion | | (2,270 | ) | (1,969 | )
| | $ | 10,033 | | $ | 11,374 |
 
Convertible Debentures, Net.  In May 2004, the Company sold and issued subordinated convertible debentures in the aggregate original principal amount of $10.1 million.  In connection with the issuance of the debentures, the Company issued warrants to purchase an aggregate of 639,847 shares of its common stock, the value of which was recorded as a debt discount against the face amount of the debentures on the date of issuance and is being amortized to interest expense over the term of the convertible debentures.
The debentures are due in full on May 19, 2009, provide for 6.0% annual interest, payable quarterly, and are convertible into the Company’s common stock at an initial conversion price of $3.61 per share, subject to certain adjustments, including adjustments for dilutive issuances.  From May 19, 2007 until May 18, 2008, the debentures may be redeemed by the Company, at its option, at 120% of the principal amount; and from May 19, 2008, until the maturity date, the Company may redeem the debentures at 110% of the principal amount.  As of December 31, 2006, $250,000 of convertible debentures had been converted into 69,252 shares of common stock leaving $9.9 million of the originally issued convertible debentures outstanding at December 31, 2006.
Bank Term Note.  In October 2004, the Company entered into a $5.0 million term note payable with a bank.  The note was due on May 27, 2008, and provided for monthly principal payments of approximately $104,000.  Interest accrued at the current stated prime rate plus 0.25%.  In October 2006, the term note was assumed by the Company’s new bank as part of the Company’s new $8.0 million credit facility. The new term note is also due on May 27, 2008 and provides for monthly principal payments of approximately $104,000.  Interest accrues under the new term note at the current stated prime rate plus 1.25%.  Amounts due under the term note reduce the Company’s ability to borrow against its eligible assets on its line of credit.
Both the new bank term note and the new line of credit are held by one bank under the same credit agreement and are secured by substantially all of the assets of the Company.
Promissory Note to Landlord.  The Company has a $1.3 million unsecured promissory note payable to the landlord of its Anaheim headquarters.  Under the terms of the note agreement, interest is payable quarterly and accrues at a rate of prime plus 2.0% (10.25% at December 31, 2006).  In October 2006, the Company made the first of four required equal quarterly principal payments of $323,000.  All outstanding accrued interest and principal becomes payable in full on July 1, 2007.
Scheduled aggregate maturities of long-term debt principal as of December 31, 2006 were as follows:
Fiscal Year Ending March 31, | | |
(In thousands) | | |
Remainder of 2007 | | $ | 648 |
2008 | | 1,948 |
2009 | | 349 |
2010 | | 9,850 |
| | $ | 12,795 |
Less: unamortized debt discount | | (492 | )
| | $ | 12,303 |
 
4.  Common Stock Warrants
On September 27, 2006, the Company issued warrants to purchase an aggregate 246,250 shares of common stock at
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an exercise price of $3.25 with a five-year life to an existing shareholder in exchange for the early exercise of 1,250,000 outstanding warrants with an exercise price of $1.61.  The new warrants are immediately exercisable and are callable by the Company if the market price of the Company’s common stock trades for 20 consecutive days at a price greater than or equal to two times the exercise price of the warrants.  The fair value of the new warrants was $320,000 calculated using the Black-Scholes-Merton (“BSM”) option-pricing formula.  The warrants were considered a cost of raising capital and were recorded in equity.
In connection with the issuance of the new warrants, the Company is party to a registration rights agreement that contains provisions under which the Company could be subjected to liquidated damages should it fail to maintain effective registration statements for the underlying shares of common stock.  These warrants have been accounted for within equity in the condensed consolidated balance sheet in accordance with EITF 00-19  Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock , and, accordingly, no liabilities have been recorded in connection therewith.  As of December 31, 2006, no liquidated damages were payable under the provisions of the registration rights agreement associated with these warrants.
5.  Commitments and Contingencies
Litigation and Other Contingencies
On June 29, 2004, a supplier to Mariner Networks, Inc., a former subsidiary of the Company that was discontinued in the fiscal year ended March 31, 2002, filed a complaint in Orange County Superior Court against the Company alleging various breaches of written contract claims arising out of alleged purchase orders. The plaintiff in this lawsuit sought monetary damages aggregating approximately $850,000 plus attorney fees and related costs.  On July 20, 2006, the Company entered into a settlement agreement in connection with this matter.  The dispute was settled in full for $688,000 payable as follows:  (i) the Company issued 88,912 shares of the Company’s common stock on August 18, 2006 valued at $213,000 based on the closing sales price of the Company’s common stock on the date of issuance; (ii) the Company made a cash payment of $125,000 on October 20, 2006; and (iii) the Company is obligated to pay $350,000 in cash in equal monthly installments of $9,700 over the next three years beginning in November 2006.  In connection with this settlement, the Company has recorded a charge of $636,000, representing the fair value of the settlement, within other expense in the accompanying condensed consolidated statement of operations for the nine months ended December 31, 2006.
From time to time, the Company has been involved in litigation relating to claims arising out of its operations in the normal course of business.  The Company currently is not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on its consolidated results of operations, financial position or cash flows.
Furthermore, from time to time, the Company has experienced unforeseen developments in contingencies related to its former subsidiaries.  For example, the Company has been the subject of a number of routine tax audits for time periods and jurisdictions related to the businesses of its former subsidiaries, some of which are still in process.  Although the development and ultimate outcome of these and other unforeseen matters cannot be predicted with any certainty, management does not believe that the Company is presently involved in any matters related to its former subsidiaries that would have a material adverse effect on the Company’s consolidated results of operations, financial position or cash flows.
Operating Lease Commitments
The Company has lease commitments for facilities in various locations throughout the United States. Future commitments under these non-cancelable operating leases at December 31, 2006 were as follows:
Fiscal Year Ending March 31, | | |
(In thousands) | | |
Remainder of 2007 | | $ | 380 |
2008 | | 983 |
2009 | | 146 |
2010 | | 85 |
2011 | | 43 |
Total | | $ | 1,637 |
 
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Inventory Purchase Commitments
At December 31, 2006, the Company had firm commitments to purchase inventory in the amount of $1.5 million during the next two fiscal quarters.
6.  Stock-Based Compensation
The Company adopted SFAS 123R effective April 1, 2006.  Prior to April 1, 2006, the Company followed the disclosure-only provisions of SFAS 123, as amended by SFAS No. 148,  Accounting for Stock-Based Compensation — Transition and Disclosure , and, accordingly, accounted for its stock-based compensation plans using the intrinsic value method under APB 25 and related interpretations.
SFAS 123R requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as an expense, based on their grant date fair values with such fair values amortized over the requisite service period.  The Company elected to utilize the modified prospective method for the transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modified after the date of adoption. In addition, under the modified prospective method, compensation expense will be recognized for all stock-based compensation awards granted prior to but not yet vested as of April 1, 2006, based on grant-date fair values estimated in accordance with the original provisions of SFAS 123.  Accordingly, prior period amounts presented herein have not been restated to reflect the adoption of SFAS 123R.
The fair value concepts were not changed significantly as a result of implementing SFAS 123R; however, in adopting SFAS 123R, companies must choose among alternative valuation models and amortization assumptions. After assessing alternative valuation models and amortization assumptions, the Company continues to use both the BSM option-pricing formula and straight-line amortization of compensation expense over the requisite service period of stock option grants.  The Company will reconsider use of this model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model.  SFAS 123 did not require the estimation of forfeitures in the calculation of stock compensation expense; however, SFAS 123R does require such estimation and upon adoption of SFAS 123R, the Company changed its methodology to include an estimate of forfeitures. The adoption of SFAS 123R had no effect on cash flows from operating activities because no tax benefits are realized from stock option exercises. The adoption of SFAS 123R also had no effect on cash flows from financing activities.
The following table illustrates the impact of adopting SFAS 123R:
| | Three Months Ended December 31, 2006 | | Nine Months Ended December 31, 2006 |
| | (In thousands, except per share amounts) |
Income before income taxes | | $ | (59 | ) | $ | (153 | )
Net income | | $ | (59 | ) | $ | (153 | )
Basic earnings per share | | $ | 0.00 | | $ | (0.01 | )
Diluted earnings per share | | $ | 0.00 | | $ | 0.00 |
 
The following table illustrates the effect on net loss and net loss per share for the three and nine months ended December 31, 2005 as if the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Company’s stock option plans.  For purposes of this pro forma disclosure, the fair value of the options was estimated using the BSM option-pricing formula and amortized on a straight-line basis to expense over the options’ vesting period:
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| | Three Months Ended December 31, 2005 | | Nine Months Ended December 31, 2005 |
| | (In thousands, except per share amounts) |
Net income (loss) — as reported | | $ | 136 | | $ | (745 | )
Add: Stock-based compensation expense included in net income (loss) — as reported | | 103 | | 626 |
Deduct: Total stock-based compensation expense determined under fair value based method for all awards | | (205 | ) | (941 | )
Net income (loss) — pro forma | | $ | 34 | | $ | (1,060 | )
Basic and diluted income (loss) per share — as reported | | $ | 0.00 | | $ | (0.03 | )
Basic and diluted income (loss) per share — pro forma | | $ | 0.00 | | $ | (0.04 | )
 
The Company’s 1997 Stock Incentive Plan (the “Plan”) provides that options to purchase shares of the Company’s unissued common stock may be granted to directors, associates and consultants to the Company at exercise prices which are equal to or greater than the fair market value of the Company’s common stock on the date of grant.  Options expire ten years after the date of grant or 90 days after termination of employment and generally vest ratably at the rate of 25% on each of the first four anniversaries of the grant date.  New shares are issued to satisfy stock option exercises under the Plan.  As of December 31, 2006, options to purchase 1.5 million shares of the Company’s common stock were outstanding under the Plan.
In connection with the merger of the Company and the Iteris Subsidiary (Note 1), the Company assumed the 1998 Stock Incentive Plan of the Iteris Subsidiary (the “1998 Plan”) and all outstanding options granted thereunder.  As of December 31, 2006, options to purchase 3.8 million shares of the Company’s common stock were outstanding under the 1998 Plan.  No further options may be granted under the 1998 Plan.
Certain options granted under the Plan and the 1998 Plan (collectively, the “Plans”) provide for accelerated vesting of unvested options in the event of a change in control under certain circumstances.  These change-in-control provisions meet the criteria of a performance condition under SFAS 123R.
As of December 31, 2006, the Company had 1.3 million outstanding stock options that were originally granted outside of the Plans and that were assumed by the Plan in connection with the merger of the Company and the Iteris Subsidiary (Note 1).
A summary of activity in the Plans for the nine months ended December 31, 2006 is as follows:
| | Options | | Weighted Average Exercise Price | | Weighted Average Remaining Life (In Years) | | Aggregate Intrinsic Value |
| | (In thousands, except per share amounts) |
Options outstanding at March 31, 2006 | | 6,977 | | $ | 1.42 | | 3.97 | | |
Granted | | 169 | | $ | 2.33 | | N/A | | |
Exercised | | (548 | ) | $ | 0.92 | | N/A | | |
Forfeited | | (18 | ) | $ | 2.64 | | N/A | | |
Expired | | (24 | ) | $ | 2.50 | | N/A | | |
Options outstanding at December 31, 2006 | | 6,556 | | $ | 1.48 | | 3.5 | | $ | 7,756 |
Vested and expected to vest at December 31, 2006 | | 6,489 | | $ | 1.47 | | 3.4 | | $ | 7,745 |
Options exercisable at December 31, 2006 | | 6,151 | | $ | 1.41 | | 3.1 | | $ | 7,628 |
Options exercisable at December 31, 2006 pursuant to a change-in-control | | 6,556 | | $ | 1.48 | | 3.5 | | $ | 7,756 |
 
At December 31, 2006, there were 106,000 shares of common stock available for grant under the Plan.
For the nine month periods ended December 31, 2006 and 2005, the Company received $505,000 and $228,000, respectively, in cash from the exercise of stock options.  Total stock-based compensation expense for the three and nine months ended December 31, 2006 was $59,000 and $233,000, respectively.  No income tax benefit was realized from activity in the Plans during the nine months ended December 31, 2006 and 2005.
 
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At December 31, 2006, there was $676,000 of total unrecognized compensation expense related to unvested stock options.  This expense is expected to be recognized over a weighted-average period of approximately 3.0 years.
The fair value of each stock-based award is estimated on the grant date using the BSM option-pricing formula. Expected volatility is based on the historical volatility of the Company’s stock price. The expected life of options granted subsequent to the adoption of SFAS 123R is derived based on the historical life of the Company’s options.  The risk-free interest rate for periods within the expected life of the option is based on the U.S. Treasury interest rates in effect at the time of grant. The grant date fair value of options granted was estimated using the following weighted-average assumptions:
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
Dividend yield | | N/A | | 0.0 | % | 0.0 | % | 0.0 | %
Expected life — years | | N/A | | 7.0 | | 7.0 | | 7.0 |
Risk-free interest rate | | N/A | | 5.5 | % | 4.8 | % | 5.5 | %
Expected volatility of common stock | | N/A | | 0.50 | | 0.89 | | 0.50 |

A summary of the grant date fair value and intrinsic value information is as follows:
| | Three Months Ended December 31, | | Nine Months Ended September 30, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | (In thousands, except per share amounts) |
Weighted average grant date fair value per share | | N/A | | $ | 1.53 | | $ | 1.86 | | $ | 1.79 |
Intrinsic value of options exercised | | $ | 541 | | $ | 61 | | $ | 766 | | $ | 240 |
Total fair value of options vested during the period | | $ | 104 | | $ | 146 | | $ | 621 | | $ | 1,498 |
 
7.  Business Segment Information
The Company currently operates in three reportable segments: Roadway Sensors, Automotive Sensors and Transportation Systems.  The Roadway Sensors segment includes the Company’s Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications.  The Automotive Sensors segment includes AutoVue and is comprised of all activities related to lane departure warning systems for vehicle safety.  The Transportation Systems segment includes transportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies except that certain expenses, such as interest, amortization of certain intangibles and certain corporate expenses are not allocated to the segments. In addition, certain assets, including cash and cash equivalents, deferred taxes and certain long-lived and intangible assets, are not allocated to the segments.  The reportable segments are each managed separately because they manufacture and distribute distinct products or provide services with different processes.  All segment revenues are derived from external customers.
The following table sets forth selected unaudited financial information for the Company’s reportable segments for the three and nine months ended December 31, 2006 and 2005:
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| | Roadway Sensors | | Automotive Sensors | | Transportation Systems | | Total |
| | (In thousands) |
Three Months Ended December 31, 2006 | | | | | | | | |
Product revenue from external customers | | $ | 6,499 | | $ | 1,460 | | $ | — | | $ | 7,959 |
Service and other revenue from external customers | | — | | 616 | | 5,913 | | 6,529 |
Depreciation and amortization | | 21 | | 35 | | 32 | | 88 |
Segment income (loss) | | 1,389 | | (878 | ) | 664 | | 1,175 |
Three Months Ended December 31, 2005 | | | | | | | | |
Product revenue from external customers | | $ | 5,234 | | $ | 1,401 | | $ | — | | $ | 6,635 |
Service and other revenue from external customers | | — | | 641 | | 4,907 | | 5,548 |
Depreciation and amortization | | 35 | | 52 | | 55 | | 142 |
Segment income (loss) | | 709 | | (558 | ) | 411 | | 562 |
Nine Months Ended December 31, 2006 | | | | | | | | |
Product revenue from external customers | | $ | 19,976 | | $ | 4,282 | | $ | — | | $ | 24,258 |
Service and other revenue from external customers | | — | | 2,240 | | 16,272 | | 18,512 |
Depreciation and amortization | | 60 | | 103 | | 94 | | 257 |
Segment income (loss) | | 4,491 | | (2,039 | ) | 2,029 | | 4,481 |
Nine Months Ended December 31, 2005 | | | | | | | | |
Product revenue from external customers | | $ | 16,380 | | $ | 4,600 | | $ | — | | $ | 20,980 |
Service and other revenue from external customers | | — | | 1,796 | | 14,201 | | 15,997 |
Depreciation and amortization | | 98 | | 134 | | 206 | | 438 |
Segment income (loss) | | 2,372 | | (1,866 | ) | 1,507 | | 2,013 |
 
The following table reconciles segment income to consolidated income (loss) before income taxes:
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | | | (In thousands) | | |
Total income for reportable segments | | $ | 1,175 | | $ | 562 | | $ | 4,481 | | $ | 2,013 |
Unallocated amounts: | | | | | | | | |
Corporate expenses | | (424 | ) | (299 | ) | (1,855 | ) | (2,134 | )
Other income (expense), net | | (5 | ) | (6 | ) | (650 | ) | 32 |
Interest expense, net | | (390 | ) | (377 | ) | (1,200 | ) | (1,087 | )
Income (loss) before income taxes | | $ | 356 | | $ | (120 | ) | $ | 776 | | $ | (1,176 | )
 
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ITEM 2.                    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report, including the following discussion and analysis, contains forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that are based on our current expectations, estimates and projections about our business and our industry, and reflect management’s beliefs and certain assumptions made by us based upon information available to us as of the date of this report. When used in this report and the information incorporated herein by reference, the words “expect(s),” “feel(s),” “believe(s),” “should,” “will,” “may,” “anticipate(s),” “estimate(s)” and similar expressions or variations of these words are intended to identify forward-looking statements. These forward-looking statements include but are not limited to statements regarding ouranticipated sales, revenue, expenses, profits, capital needs, competition, development plans, backlog and manufacturing capabilities, the applications for and acceptance of our products and services, and the status of our facilities and product development. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause our actual results to differ materially from those projected. You should not place undue reliance on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We encourage you to carefully review and consider the various disclosures made by us which describe certain factors which could affect our business, including in  “ Risk Factors” set forth in Part II, Item 1A of this report, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statement for any reason.
Overview
We are a 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, transportation management and traveler information systems and other engineering and consulting 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 detection system that detects the presence of vehicles on roadways.  Vantage systems are used at signalized intersections to enable a traffic controller to more efficiently allocate green signal time and are also used for incident detection and highway traffic data collection applications. We sell and distribute our Vantage products primarily to commercial customers and municipal agencies.
Our AutoVue Lane Departure Warning (“LDW”) systems consist of a small windshield mounted sensor that uses proprietary software to detect and warn drivers of unintended lane departures. Approximately 30,000 production AutoVue units have been sold for truck platforms in the North American and European markets.  Our AutoVue LDW systems are currently qualified as an option on certain heavy trucks, including Mercedes-Benz, MAN, Iveco, DAF, Scania, Freightliner and International, as well as Neoplan and MAN luxury bus and coach lines.  In North America our LDW systems are sold primarily to truck fleets, and to date, 39 U.S. heavy truck fleets have selected our LDW systems, representing an estimated 19,000 vehicles.  In September 2003, we entered into an agreement with Valeo Schalter and Sensuren GmbH (“Valeo”), pursuant to which we granted Valeo the exclusive right to sell and manufacture our AutoVue LDW systems to the worldwide passenger car market in exchange for royalty payments for each AutoVue LDW unit sold.  To date, royalty payments from Valeo have not been significant.  Pursuant to this agreement, we also provide specific contract engineering services, technical marketing and sales support to Valeo to enable the incorporation of our LDW technology on three Infiniti platforms, the FX, M and Q, where the device is offered as part of Infiniti’s technology option package.  Valeo is currently in discussions to provide our LDW system to other passenger car OEMs; however, we cannot assure you that such discussions will be successful.  We plan to continue to provide technical marketing and sales support to Valeo in our efforts to win new OEM customers for the passenger car market as well as contract engineering services related to the possible launch of new Infiniti platforms that include our LDW system.  We believe that AutoVue is a broad sensor platform that, through additional software development, may be expanded to incorporate additional safety and convenience features.
Our transportation management systems business includes transportation engineering and consulting services focused on the planning, design, development and implementation of software-based systems that integrate sensors, video surveillance, computers and advanced communications equipment to enable public agencies to monitor, control and direct traffic flow, assist in the quick dispatch of emergency crews and distribute real-time information about traffic conditions.
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Our services include planning and other engineering for the implementation of transportation infrastructure and related communications systems, analysis and study related to goods movement and commercial vehicle operations, and parking systems designs.  These services and systems are primarily sold to local, state and national transportation agencies in the United States.  Our transportation management systems business is largely dependent upon governmental funding and budgetary issues.  The Federal Highway Bill was passed in August 2005, which provided for a significant increase in transportation funding over the next six years.  We believe the recent expansion of our transportation management systems business was due in part to the passage of the Federal Highway Bill, combined with the expansion of transportation funds at state and local agencies throughout the country.
                We currently operate in three reportable segments: Roadway Sensors, Automotive Sensors and Transportation Systems. The Roadway Sensors segment includes our Vantage vehicle detection systems for traffic intersection control, incident detection and certain highway traffic data collection applications.  The Automotive Sensors segment is comprised of all activities related to our AutoVue LDW systems for vehicle safety. The Transportation Systems segment includes transportation engineering and consulting services and the development of transportation management and traveler information systems for the ITS industry.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our unaudited condensed consolidated financial statements included herein, which have been prepared in accordance with U.S generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates and assumptions, including those related to the collectibility of accounts receivable, the valuation of inventories, the recoverability of long-lived assets and goodwill, accounting for stock-based compensation related to SFAS 123R, and other contingencies. We base these estimates on our historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates and assumptions by their nature involve risks and uncertainties, and may prove to be inaccurate. In the event that any of our estimates or assumptions are inaccurate in any material respect, it could have a material adverse effect on our reported assets and liabilities at the date of the financial statements and our reported revenues and expenses during the reporting period.
The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements.
Revenue Recognition.  We record product revenues and related costs of sales upon transfer of title, which is generally upon shipment or, if required, upon acceptance by the customer, provided that we believe collectibility of the net sales amount is reasonably assured.  Accordingly, at the date revenue is recognized, the significant uncertainties concerning the sale have been resolved.
Contract revenues are derived primarily from long-term contracts with governmental agencies.  Contract revenues include costs incurred plus a portion of estimated fees or profits determined using the percentage of completion method of accounting based on the relationship of costs incurred to total estimated costs.  Any anticipated losses on contracts are charged to earnings when identified.  Changes in job performance and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to recognized costs and revenues and are recognized in the period in which the revisions are determined.  Profit incentives are included in revenue when their realization is reasonably assured.
In addition to product and contract revenues, we derive revenue from technology access fees, the provision of specific non-recurring contract engineering services related to our AutoVue LDW systems, and royalties related to unit sales of our AutoVue LDW systems by our strategic partner Valeo to the passenger car market. Technology access fee revenues are recognized evenly over the period in which they are earned.  Non-recurring contract engineering revenues are recognized in the period in which the related services are performed.  Royalty revenues are recorded based on unit sales of our products by Valeo and are recognized in the period in which such sales occur.  Technology access fee revenues, contract engineering revenues and royalty revenues are included in net sales.
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Revenues from follow-on service and support, for which we generally charge separately, are recorded in the period in which the services are performed.
Accounts Receivable.  We estimate the collectibility of customer receivables on an ongoing basis by periodically reviewing invoices outstanding greater than a certain period of time.  We record reserves for receivables deemed to be at risk for collection as well as a general reserve based on our historical collections experience.  A considerable amount of judgment is required in assessing the ultimate realization of trade receivables, including the current credit-worthiness of each customer.  If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make required payments, additional allowances may be required that could adversely affect our operating results.
Inventory. Inventories consist of finished goods, work-in-process and raw materials and are stated at the lower of cost or market.  We provide reserves for potentially excess and obsolete inventory. In assessing the ultimate realization of inventories, we make judgments as to future demand requirements and compare that with the current or committed inventory levels.  Reserves are established for inventory levels that exceed anticipated future demand.  It is possible that reserves over and above those already established may be required in the future if market conditions for our products deteriorate.
Goodwill.  Goodwill is tested for impairment annually in our fourth fiscal quarter at the reporting unit level unless a change in circumstances indicates that more frequent impairment analysis is required.  Impairment, if any, is measured based on the estimated fair value of the reporting units with the recorded goodwill.  Fair value is determined by using the income approach methodology of valuation which utilizes discounted cash flows.  Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation.  In estimating future cash flows, we generally use the financial assumptions in our current budget and our current strategic plan, subject to modification as considered necessary, including sales and expense growth rates and the discount rates we estimate to represent our cost of funds.  It is possible, however, that the plans and estimates used may be incorrect.  If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of goodwill, we could incur impairment charges.
Warranty.  We generally provide a one to three year warranty from the original invoice date on all products, materials and workmanship.  Defective products are either repaired or replaced, at our option, upon meeting certain criteria.  We accrue a provision for the estimated costs that may be incurred for product warranties relating to a product as a component of cost of sales at the time revenue for that product is recognized.  The accrued warranty provision is included within accrued expenses on the accompanying condensed consolidated balance sheets.  Should our actual experience of warranty returns be higher than anticipated, additional warranty reserves may be required, which may adversely affect our operating results.
Taxes. We recorded a valuation allowance to reduce our deferred tax assets to amounts that we believe are more likely than not to be realized. Realization of deferred tax assets (such as net operating loss carryforwards) is dependent on future taxable earnings and is therefore uncertain. On a quarterly basis, we assess the likelihood that our deferred tax asset balance will be recovered from future taxable income. To the extent we believe that recovery is not likely, we establish a valuation allowance against our deferred tax asset, increasing our income tax expense in the period such determination is made.
On an interim basis, we estimate what our anticipated annual effective tax rate will be and record a quarterly income tax provision in accordance with this anticipated rate. As the fiscal year progresses, we refine our estimates based upon actual events and earnings during the year. This estimation process can result in significant changes to our expected effective tax rate. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision reflects the expected annual rate. The changes described in the preceding sentence and adjustments to our valuation allowance may create fluctuations in our overall effective tax rate from quarter to quarter.
Stock-Based Compensation.  We adopted SFAS No. 123R (revised 2004), Share-Based Payment (“SFAS 123R”), effective April 1, 2006.  Prior to April 1, 2006, we followed the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation  (“SFAS 123”), as amended by SFAS No. 148,  Accounting for Stock-Based Compensation — Transition and Disclosure , and, accordingly, accounted for our stock-based compensation plans using the intrinsic value method under Accounting Principles Board Opinion No. 25 (“APB 25”) and related interpretations.
SFAS 123R requires all stock-based payments, including grants of employee stock options, to be recognized in the statement of operations as an expense, based on their grant date fair values with such fair values amortized over the requisite service period.  We elected to utilize the modified prospective method for the transition to SFAS 123R. Under the modified prospective method, SFAS 123R applies to all awards granted or modified after the date of adoption. In addition, under the
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modified prospective method, compensation expense will be recognized for all stock-based compensation awards granted prior to but not yet vested as of April 1, 2006, based on grant-date fair values estimated in accordance with the original provisions of SFAS 123.
                In implementing SFAS 123R, we have used the Black-Scholes-Merton (“BSM”) option-pricing formula to estimate the fair value of stock-based awards granted subsequent to April 1, 2006.  Our assumptions under the BSM formula include the following:  expected volatilities are based on the historical volatility of our stock price, the expected life of options is derived based on the historical life of our options, and the risk-free rate for periods within the expected life of the option is based on the U.S. Treasury interest rates in effect at the time of grant.  Additionally, SFAS 123 did not require the estimation of forfeitures in the calculation of stock compensation expense; however, SFAS 123R does require such estimation and upon adoption of SFAS 123R, we changed our methodology to include an estimate of forfeitures.  Future stock-based compensation expense in any particular quarter or year could be affected by changes in our assumptions or changes in market conditions.
Results of Operations
The following table sets forth certain statement of operations data as a percentage of total net sales and contract revenues for the periods indicated. The following table should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations.
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
Net sales and contract revenues: | | | | | | | | |
Net sales | | 59.2 | % | 59.7 | % | 62.0 | % | 61.6 | %
Contract revenues | | 40.8 | | 40.3 | | 38.0 | | 38.4 |
Total net sales and contract revenues | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | %
Costs and expenses: | | | | | | | | |
Cost of net sales | | 32.8 | | 32.0 | | 34.6 | | 32.2 |
Cost of contract revenues | | 28.1 | | 27.1 | | 24.8 | | 25.2 |
Gross profit | | 39.2 | | 40.9 | | 40.6 | | 42.7 |
Operating expenses: | | | | | | | | |
Selling, general and administrative | | 26.8 | | 29.5 | | 27.7 | | 31.1 |
Research and development | | 7.2 | | 9.6 | | 6.6 | | 11.6 |
Deferred compensation plan | | (0.2 | ) | (0.7 | ) | (0.1 | ) | (0.0 | )
Amortization of intangible assets | | 0.3 | | 0.3 | | 0.3 | | 0.3 |
Total operating expenses | | 34.0 | | 38.7 | | 34.4 | | 43.0 |
Operating income (loss) | | 5.2 | | 2.1 | | 6.1 | | (0.3 | )
Non-operating income (expense): | | | | | | | | |
Other income (expense), net | | (0.0 | ) | (0.0 | ) | (1.5 | ) | 0.0 |
Interest expense, net | | (2.7 | ) | (3.1 | ) | (2.8 | ) | (2.9 | )
Income (loss) before income taxes | | 2.5 | | (1.0 | ) | 1.8 | | (3.2 | )
Income tax benefit (provision) | | (0.3 | ) | 2.1 | | 1.3 | | 1.2 |
Net income (loss) | | 2.1 | % | 1.1 | % | 3.1 | % | (2.0 | )%
 
Analysis of Quarterly Results of Operations
Net Sales and Contract Revenues.  Net sales are comprised of Roadway Sensor sales, which are derived from sales of our Vantage video detection systems; and Automotive Sensor sales, which are derived from sales of AutoVue LDW systems, technology access fees, contract engineering revenue and royalty revenue generated from AutoVue related activities.  Contract revenues consist entirely of Transportation Systems revenues, which are generated from systems integration and ITS consulting services with federal, state, county and municipal agencies. We currently have a diverse customer base with our largest customer constituting 14.0% and 11.4% of total net sales and contract revenues in the three and nine months ended December 31, 2006, respectively.
Total net sales and contract revenues increased 18.9% to $14.5 million and 15.7% to $42.8 million for the three and
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nine months ended December 31, 2006, respectively, compared to $12.2 million and $37.0 million in the corresponding periods in the prior fiscal year.  This increase was primarily driven by increased net sales in both the Roadway Sensors and Automotive Sensors businesses, as well as increased contract revenues in the Transportation Systems business, as discussed below.
                Net sales increased 17.9% to $8.6 million and 16.3% to $26.5 million for the three and nine months ended December 31, 2006, respectively, compared to $7.3 million and $22.8 million in the corresponding periods of the prior fiscal year.
$1.3 million and $3.6 million of the increase in net sales in the three and nine months ended December 31, 2006, respectively, was due to an increase in Roadway Sensors net sales over the corresponding periods in the prior year.   This increase was primarily due to higher unit sales of Roadway Sensor systems, which reflected continued positive reaction to new Vantage product offerings such as color cameras and eAccess, as well as higher governmental spending which we believe was related to the passage of the Federal Highway Bill in August 2005.
Automotive Sensors net sales increased $34,000 and $126,000 in the three and nine months ended December 31, 2006, respectively, over the corresponding periods in the prior year primarily as a result of an increase in sales of our LDW systems in the North American aftermarket and an increase in non-recurring contract engineering revenues generated in the passenger car market. Despite an increase of 8.1% in sales of our LDW systems to the heavy truck market for the three months ended December 31, 2006 compared to the same period in the prior year, sales of our LDW systems to this market have remained flat for the nine months ended December 31, 2006 compared to the same period in the prior year. The limited growth in Automotive Sensors sales in the current fiscal year has occurred largely as a result of our largest Automotive Sensors customer purchasing approximately $1.0 million of spare LDW systems in the prior year in anticipation of the changeover to the next generation LDW system.  Such purchases of spare systems did not occur in the three and nine months ended December 31, 2006, and are not expected to occur for at least the remainder of this current fiscal year.  Additionally, our largest customer benefited from volume pricing discounts which became effective January 1, 2006 and negatively impacted our net sales for Automotive Sensors.  The reduced level of sales to our largest Automotive Sensors hardware customer was offset by a 130% increase in sales of aftermarket LDW systems in North America for the nine months ended December 31, 2006.  In January 2007, we received orders for initial LDW production shipments as part of a development agreement we entered into with a large Asian heavy truck OEM.  While this OEM has indicated its intention to make our LDW system a standard feature on one of its heavy duty truck models with volumes estimated at approximately 5,000 units in the coming year, we cannot assure you that we will ultimately receive any such orders.
Royalty revenues from Valeo for sales of our LDW systems for the passenger car market remained relatively insignificant in the current quarter.  Our LDW systems are now offered as an option on three Infiniti models.  While Valeo is currently in discussions to offer our LDW systems on other passenger car platforms, we cannot assure you that Valeo will be successful in these efforts.
Contract revenues increased 20.5% to $5.9 million and 14.6% to $16.3 million for the three and nine months ended December 31, 2006, respectively, as compared to $4.9 million and $14.2 million in the corresponding periods of the prior fiscal year.  This increase was largely due to increased funding at the federal, state and local levels throughout the country.  In response to this growth in funding, we have increased our Transportation Systems staff by 16% in the nine months ended December 31, 2006.  We expect to continue to increase our Transportation Systems staff over the next couple quarters, although not at the same rate as in the nine months ended December 31, 2006.  We believe the ability of our Transportation Systems business to grow and successfully win and service new contracts will be highly dependent upon our continued success in recruiting and retaining qualified personnel.  All of our contract revenues are derived from work performed in North America under a broad range of fixed price and cost plus fixed fee contracts.  In September 2006 we were awarded a $9.8 million contract from the Federal Highway Administration (“FHWA”), which covers a period of two years beginning April 2007 and contains renewal options extending through 2012.  Although this contract is not expected to substantially affect the trend in contract revenues in our Transportation Systems business and although we cannot assure you that the full face amount of the contract will be spent or that any of the options will be exercised, we believe this contract helps to solidify our future FHWA business.
Gross Profit.  Total gross profit increased 14.0% to $5.7 million and 10.0% to $17.4 million for the three and nine
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months ended December 31, 2006, respectively, as compared to $5.0 million and $15.8 million in the corresponding periods of the prior fiscal year.  Total gross profit as a percent of net sales and contract revenues decreased to 39.2% and 40.6% for the three and nine months ended December 31, 2006, respectively, as compared to 40.9% and 42.7% in the corresponding periods of the prior fiscal year.
                Gross profit as a percent of net sales was 44.7% and 44.1% for the three and nine months ended December 31, 2006, respectively, compared to 46.4% and 47.8% in the corresponding periods of the prior fiscal year.  This decrease was primarily due to volume discounts given to our largest Automotive Sensors hardware customer, and to a lesser extent,  increased product support activities in our Roadway Sensors business, an increased level of lower margin engineering services provided to our strategic partner Valeo in the current year period and the mix of products sold in the current quarter. Gross profit as a percent of net sales generally fluctuates in any specific quarter based on customer mix. Gross profit as a percent of net sales has fluctuated over the last seven quarters from a high of 50.2% in the first quarter of our prior fiscal year to a low of 43.2% reported in our prior fiscal quarter ended September 30, 2006 mainly as a result of the above.
Gross profit as a percent of contract revenues was 31.2% and 34.7% for the three and nine months ended December 31, 2006, respectively, compared to 32.7% and 34.4% in the corresponding periods of the prior fiscal year.  We recognize contract revenues and related gross profit using percentage of completion contract accounting, and the underlying mix of contract activity affects the related gross profit recognized in any given period.  The decrease in gross profit as a percent of contract revenues in the most recent quarter reflects a contract mix weighted more toward lower margin contracts in the period.
Selling, General and Administrative Expense.  Selling, general and administrative expense increased 7.8% and 3.1% to $3.9 million and $11.9 million (or 26.8% and 27.7% of total net sales and contract revenues) in the three and nine months ended December 31, 2006, respectively, compared to $3.6 million and $11.5 million (or 29.5% and 31.1% of total net sales and contract revenues) in the corresponding periods of the prior fiscal year.  Although selling, general and administrative expense was relatively flat year-over-year in absolute dollar terms, selling, general and administrative expense for the nine months ended December 31, 2006, included higher commissions associated with increased Roadway Sensor net sales, as well as legal expenses of approximately $230,000 associated with the settlement of litigation described in Note 5 to the accompanying condensed consolidated financial statements.  No further significant legal costs are expected to be incurred related to this legal matter.  In the coming quarters, we anticipate increased selling, general and administrative expense related to our efforts to comply with the internal control attestation requirements of the Sarbanes-Oxley Act, with which we must begin to comply in April 2007.
Research and Development Expense.  Research and development expense decreased 11.4% and 34.4% to $1.0 million and $2.8 million (or 7.2% and 6.6% of total net sales and contract revenues) in the three and nine months ended December 31, 2006, respectively, compared to $1.2 million and $4.3 million (or 9.6% and 11.6% of total net sales and contract revenues) in the corresponding periods of the prior fiscal year.  The decrease in research and development expense was largely a result of higher than anticipated costs in the prior year period in Automotive Sensors as we expended significant development resources in qualifying the next generation LDW system with our largest customer.  Additionally, in the current year, there has been a slight shift in engineering resources from research and development activities to product support activities as a result of new product introductions and improvements in Roadway Sensors.  Costs associated with product support activities are included in cost of net sales rather than research and development expense.
For competitive reasons, we closely guard the confidentiality of specific development projects.
Deferred Compensation Plan Expense.  During the three and nine months ended December 31, 2006, we recorded a non-cash benefit of $29,000 and $61,000, respectively, related to the change in value of 310,510 shares of our common stock held in trust by our deferred compensation savings plan.  This compares to a non-cash benefit of $90,000 and $12,000 recorded in the three and nine month periods ended December 31, 2005, respectively.  We expect to continue to experience non-cash expense or benefit in future periods as the value of the assets held in our deferred compensation savings plan fluctuates.
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Other Income (Expense), Net.  Other income (expense), net includes the following: 
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | | | (In thousands) | | |
Settlement of lawsuit | | $ | — | | $ | — | | $ | (635 | ) | $ | — |
Other | | (5 | ) | (6 | ) | (15 | ) | 32 |
Other income (expense), net | | $ | (5 | ) | $ | (6 | ) | $ | (650 | ) | $ | 32 |
 
Other income (expense), net for the nine months ended December 31, 2006 primarily reflects $635,000 of expense recorded in connection with the settlement of litigation in July 2006.  See Note 5 to the accompanying condensed consolidated financial statements for a description of the terms of the settlement and the additional amounts still payable in connection with the settlement.
Interest Expense, Net.  Interest expense, net includes the following:
| | Three Months Ended December 31, | | Nine Months Ended December 31, |
| | 2006 | | 2005 | | 2006 | | 2005 |
| | | | (in thousands) | | |
Interest expense | | $ | (305 | ) | $ | (292 | ) | $ | (942 | ) | $ | (829 | )
Amortization of debt discount | | (51 | ) | (51 | ) | (155 | ) | (155 | )
Amortization of deferred finance costs | | (34 | ) | (34 | ) | (103 | ) | (103 | )
Interest expense, net | | $ | (390 | ) | $ | (377 | ) | $ | (1,200 | ) | $ | (1,087 | )
Interest expense increased for the three and nine months ended December 31, 2006, respectively, compared to the corresponding periods in the prior fiscal year primarily as a result of a higher level of borrowings on our line of credit in the current year.
Income Taxes.  During the three and nine months ended December 31, 2006, we recognized income tax expense of $46,000 and an income tax benefit of $545,000, respectively, as compared to an income tax benefit of $256,000 and $431,000 in the three and nine months ended December 31, 2005, respectively.  The tax benefit recorded in the nine months ended December 31, 2006 was primarily based on a reduction in the valuation allowance recorded against our deferred tax assets as a result of changes in estimates of the future realizability of these assets.  As a result, total deferred tax assets on our consolidated balance sheet increased from $1.6 million at March 31, 2006 to $2.1 million at December 31, 2006.  In the future, we may continue to record similar adjustments to our deferred tax asset valuation allowance as our estimates are updated.  We anticipate this will cause our future overall effective tax rate in any given period to fluctuate from prior effective tax rates, estimated annual effective tax rates and statutory tax rates.
Liquidity and Capital Resources
Cash Flows
We have historically financed our operations with a combination of cash flows from operations, borrowings under credit facilities and the sale of equity securities. We currently rely on cash flows from operations and borrowings on a line of credit facility to fund our operations.  At December 31, 2006, we had $6.5 million in working capital, which included borrowings of $4.2 million on our revolving line of credit and $167,000 in cash and cash equivalents. This compares to working capital of $3.3 million at March 31, 2006, which included borrowings of $2.7 million on our revolving line of credit and $131,000 in cash and cash equivalents. Our operations used $2.3 million of cash during the nine months ended December 31, 2006, primarily as a result of investments in inventory and an increased level of accounts receivable and net costs and estimated earnings in excess of billings due to sales growth.  This was partially offset by a $1.4 million increase in accounts payable and accrued liabilities and $1.3 million in net income.  During the nine months ended December 31, 2005, our operations provided $941,000 in cash, primarily as a result of planned decreases in inventory levels, partially offset by a net decrease in accounts payable and accrued expenses and an increase in net costs and estimated earnings in excess of billings on uncompleted contracts.
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Our investing activities for the nine months ended December 31, 2006 and 2005, consisted entirely of purchases of property and equipment, which aggregated $311,000 and $716,000, respectively.
Cash provided by financing activities was $2.6 million in the nine months ended December 31, 2006, which was largely the result of $2.9 million in proceeds from the exercise of stock options and warrants to purchase our common stock offset by net borrowings of $295,000. As discussed in Note 4 to the accompanying condensed consolidated financial statements, approximately $2.0 million of the $2.9 million in proceeds from the exercise of stock options and warrants was raised through the exercise of 1,250,000 outstanding warrants.  During the nine months ended December 31, 2005, financing activities used $271,000 of cash, which was comprised of net payments on our line of credit and long-term debt of $536,000 partially offset by cash inflows of $265,000 from the exercise of outstanding stock options and warrants to purchase our common stock.
Borrowings
The following table summarizes our borrowings and long-term debt:
| | At December 31,  2006 |
| | (In thousands) |
Convertible debentures, net | | $ | 9,358 |
Bank term note | | 1,888 |
Promissory note to landlord | | 969 |
Other | | 88 |
| | $ | 12,303 |
 
In October 2006, we entered into a new two-year credit facility with our bank.  The facility provides for combined line of credit and bank term note borrowings of up to $8.0 million.  Under the new credit facility, we may borrow against our eligible accounts receivable and eligible inventory, as defined in the credit agreement.  Interest on borrowed amounts is payable monthly at the current stated prime rate plus 1.25%.  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. The new credit facility requires $2,000 in monthly collateral management fees and includes an early termination fee equal to 2% of the total facility during the first year of the agreement and 1% of the total facility in the second year of the agreement. Additionally, we paid a commitment fee of $40,000 in October 2006 and are obligated to pay an additional $40,000 on the one year anniversary of the facility. The new credit facility is secured by substantially all of the assets of the Company.  At December 31, 2006, we had $8.0 million available under our credit facility, of which $2.0 million was unused.
We believe that the cash generated from our operations, together with our new line of credit, will be sufficient to fund our operations for at least the next twelve months. However, should a shortfall occur, we may need to raise additional funds through other debt financings or the sale of equity securities.
Contractual Obligations
Our contractual obligations are as follows at December 31, 2006:
| | Payments Due by Period |
| | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | Total |
| | | | | | (In thousands) | | | | |
Line of credit | | $ | 4,152 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 4,152 |
Notes payable | | 648 | | 1,948 | | 349 | | — | | — | | 2,945 |
Convertible debentures | | — | | — | | — | | 9,850 | | — | | 9,850 |
Operating leases | | 380 | | 983 | | 146 | | 85 | | 43 | | 1,637 |
Total | | $ | 5,180 | | $ | 2,931 | | $ | 495 | | $ | 9,935 | | $ | 43 | | $ | 18,584 |
At December 31, 2006, we had firm commitments to purchase inventory in the amount of $1.5 million during our next two fiscal quarters.
 
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Off Balance Sheet Arrangements
In May 2004, we issued subordinated convertible debentures in an aggregate original principal amount of $10.1 million. These debentures are due in full on May 19, 2009 and are convertible into shares of our common stock at an initial conversion price of $3.61 per share. At December 31, 2006, $9.9 million of these convertible debentures remained outstanding. Because these debentures are conventionally convertible, we have not separately accounted for the conversion feature and, accordingly, no separate amounts are presented in our condensed consolidated financial statements in connection with this conversion feature.
At December 31, 2006, outstanding warrants to purchase an aggregate of 62,500 shares of our common stock at an exercise price of $1.95 per share and outstanding warrants to purchase an aggregate of 246,250 shares of our common stock at an exercise price of $3.25 were callable by us if the closing sales price of our common stock for 20 consecutive days is equal to or greater than two times the exercise price of the warrants. Outstanding warrants to purchase an aggregate of 75,000 shares of our common stock at an exercise price of $5.00 per share were callable by us if the price of our common stock for 20 consecutive days is equal to or greater than one and a half times the exercise price of the warrants.
In connection with warrants to purchase 246,250 shares of our common stock at $3.25 per share, we are a party to certain registration rights agreements that contain provisions under which we could be subjected to liquidated damages should we fail to maintain effective registration statements for the underlying shares of common stock.  These warrants have been accounted for within equity in our condensed consolidated balance sheets in accordance with EITF 00-19,  Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock , and, accordingly, no liabilities have been recorded in connection therewith.  As of the date of this filing, no liquidated damages are payable under the provisions of the registration rights agreements associated with these warrants.
Recent Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”).  FIN 48 clarifies the accounting and reporting for income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes .  This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.  We are currently evaluating the impact of FIN 48 and expect to adopt this Interpretation in the first quarter of our fiscal year ending March 31, 2008.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. SFAS 157 does not require any new fair value measurements; rather it specifies valuation methods to be applied when fair value measurements are required under existing or future accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early application of the statement is encouraged. Generally, this statement will be applied prospectively.  We are currently evaluating the impact of SFAS 157 and expect to adopt SFAS 157 in the first quarter of our fiscal year ending March 31, 2009.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements  (“SAB 108”).  SAB 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment.  We are currently evaluating the impact of SAB 108 and expect to adopt SAB 108 in the first quarter of our fiscal year ending March 31, 2007.
In June 2006, the FASB ratified Emerging Issues Task Force Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (“EITF 06-3”).  The task force reached a conclusion that either method is acceptable; however, if taxes are reported on a gross basis (included as sales) a company should disclose those amounts if significant.  EITF 06-3 is effective for the first interim reporting period beginning after December 15, 2006.  We are currently evaluating the impact of EITF 06-03 and expect to adopt EITF 06-3 in the fourth quarter of our current fiscal year.
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Seasonality
We have historically experienced seasonality, particularly with respect to our Roadway Sensors net sales in the third and fourth fiscal quarters due to a reduction in road construction or repairs during the winter months due to inclement weather conditions.
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to interest rate risk is limited to our line of credit, bank term note and a promissory note to our landlord. Our line of credit, bank term note and promissory note to our landlord bear interest based on the prevailing prime rate (8.25% at December 31, 2006).  We do not believe that a 10% increase in the interest rate on our line of credit, bank term note and promissory note to our landlord (from 9.50% to 10.45% on the line of credit, from 9.50% to 10.45% on the bank term note and from 10.25% to 11.28% on the promissory note to our landlord) would have a material impact on our financial position, operating results or cash flows. In addition, we believe that the carrying value of our outstanding debt approximates fair value.
ITEM 4.  CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management necessarily applied its judgment in evaluating the cost-benefit relationship of such controls and procedures.
Changes in Internal Controls
During the 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.
Effective April 1, 2006, we implemented a new enterprise resource planning system that we believe has not resulted in any material changes in our internal controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1.  LEGAL PROCEEDINGS
The information set forth under Note 5 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item I of this report, is incorporated herein by reference.
ITEM 1A.  RISK FACTORS
Our business is subject to a number of risks, some of which are discussed below.  Other risks are presented elsewhere in this report and in our other filings with the SEC.  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 May Need To Raise Additional Capital In The Future, Which May Not Be Available 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 $590,000 in the year ended March 31, 2005 to negative cash flows from operations of $718,000 in the year ended March 31, 2004.  Additionally, we failed to meet certain debt covenants under our prior credit agreement in two of our last six fiscal quarters, but replaced that credit facility in October 2006 as further described in Note 3 to the accompanying condensed consolidated financial statements.  Furthermore, we have $9.9 million in subordinated convertible debentures that are due in full in May 2009.  Should the holders of the convertible debentures not elect to convert the principal into shares of our common stock, we may need to raise additional capital to refinance this debt.
At December 31, 2006, we had $167,000 of cash and cash equivalents and relied on our line of credit to fund our operations. We may need to raise additional capital in the near future to fund our operations or to repay indebtedness. Such additional capital may be raised through bank borrowings, or other debt or equity financings. We cannot assure you that any additional capital will be available on a timely basis, on acceptable terms, or at all, and such additional financing may result in further dilution to our stockholders.
Our capital requirements will depend on many factors, including, but not limited to:
•                                       market acceptance of our products and product enhancements, and the overall level of sales of our products;
•                                       our ability to control costs;
•                                       the supply of key components for our products;
•                                       our ability to generate net income;
•                                       increased research and development expenses;
•                                       increased sales and marketing expenses;
•                                       technological advancements and our competitors’ response to our products;
•                                       capital improvements to new and existing facilities and enhancements to our infrastructure and systems;
•                                       potential acquisitions of businesses and product lines;
•                                       our relationships with customers and suppliers;
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•                                       government budgets, political agendas and other funding issues, including potential delays in government contract awards;
•                                       our ability to successfully negotiate credit arrangements with our bank; and
•                                       general economic conditions, including the effects of the current economic slowdown and international conflicts.
If our capital requirements are materially different from those currently planned, we may need additional capital sooner than anticipated. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and such securities may have rights, preferences and privileges senior to our common stock. Additional financing may not be available on favorable terms, on a timely basis, or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to continue our operations as planned, develop or enhance our products, expand our sales and marketing programs, take advantage of future opportunities or respond to competitive pressures.
We Have Historically Experienced Substantial Losses And May Continue To Experience Losses For The Foreseeable Future.  Although we have achieved net income in recent periods, we have historically experienced significant net losses from continuing operations of $11.3 million and $1.9 million in the years ended March 31, 2005 and 2004, respectively. We cannot assure you that we will be able to sustain or improve our financial performance, or that we will be able to continue to achieve profitability on a quarterly or annual basis in the future. Most of our expenses are fixed in advance. As such, we generally are unable to reduce our expenses significantly in the short-term to compensate for any unexpected delay or decrease in anticipated revenues. As a result, we may continue to experience operating losses and net losses, which would make it difficult to fund our operations and achieve our business plan, and could cause the market price of our common stock to decline.
If Our Internal Controls Over Financial Reporting Do Not Comply With The Requirements Of The Sarbanes-Oxley Act, Our Business And Stock Price Could Be Adversely Affected.  Along with our independent registered public accounting firm, we will be evaluating the effectiveness of our internal controls over financial reporting to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 currently requires us to evaluate the effectiveness of our internal controls over financial reporting at the end of each fiscal year beginning in our fiscal year ending March 31, 2008 at the earliest, and to include a management report assessing the effectiveness of our internal controls over financial reporting in all annual reports beginning with our Annual Report on Form 10-K for the fiscal year ending March 31, 2008 at the earliest. Section 404 also requires our independent accountant to attest to, and report on, management’s assessment of our internal controls over financial reporting. We may not be able to complete our Section 404 compliance on a timely basis and even if we timely complete our compliance requirements, our independent auditors may still conclude that our internal controls over financial reporting are not effective.
Our management, including our CEO and CFO, does not expect that our internal controls over financial reporting will prevent all 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, our controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
As of March 31, 2005, we became aware of a material weakness in our internal controls related to the accounting for the consolidation of our deferred compensation savings plan and certain contract administration. We cannot assure you that we or our independent registered public accounting firm will not identify additional material weaknesses in our internal controls. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a
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remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Based on our evaluation, our management concluded that, as of March 31, 2004, our internal control over financial reporting was not effective due to the existence of one material weakness. We may experience additional material weaknesses in the future. If our internal controls over financial reporting are not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.
We May Experience Production Gaps Which Could Materially And Adversely Impact Our Sales And Financial Results And The Ultimate Acceptance Of Our Products.   It is possible that we could experience unforeseen quality control issues or part shortages as we increase production to meet current demand of our products.  We have historically used single suppliers for certain of our components in our AutoVue and Vantage products. Should any such delay or disruption occur, our future sales will likely be materially and adversely affected.  Additionally, we rely heavily on select contract manufacturers to produce many of our products.  Although we believe our contract manufacturers have sufficient capacity to meet our production schedules for the foreseeable future and we believe we could find alternative contract manufacturing sources if necessary, we could experience a production gap if for any reason our contract manufacturers were unable to meet our production requirements.
We Depend Upon Valeo To Market Our AutoVue Technologies For The OEM Passenger Car Market. We have granted Valeo the exclusive right to sell and manufacture our AutoVue LDW system to the worldwide passenger car market in exchange for royalty payments for each AutoVue unit sold. As such, the future success and broad market acceptance of our AutoVue technologies in the passenger car market will depend upon Valeo’s ability to manufacture, market and sell our technologies, and to convince more OEM passenger car manufacturers to adopt our technologies. If Valeo does not devote considerable resources and aggressively pursue opportunities, our expansion into the passenger car market could be adversely affected.
We May Be Unable To Attract And Retain Key Personnel, Which Could Seriously Harm Our Business. Due to the specialized nature of our business, we are highly dependent on the continued service of our executive officers and other key management, engineering and technical personnel. The loss of 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. In particular, the future success of our Transportation Systems business will depend on our ability to hire additional qualified engineers and planners. Competition for qualified employees, particularly development engineers, is intense. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations.
If We Are Unable To Develop And Introduce New Products And Product Enhancements Successfully And In A Cost-Effective And Timely Manner, Or Are Unable To Achieve Market Acceptance Of Our New Products, Our Operating Results Would Be Adversely Affected.  We believe our revenue growth and future operating results will depend on our ability to complete development of new products and enhancements, introduce these products in a timely, cost-effective manner, achieve broad market acceptance of these products and enhancements, and reduce our product costs. We cannot guarantee the success of these products and we may not be able to introduce any new products or any enhancements to our existing products on a timely basis, or at all. In addition, the introduction of any new products could adversely affect the sales of certain of our existing products.
We believe that we must continue to make substantial investments to support ongoing research and development in order to remain competitive. We need to continue to develop and introduce new products that incorporate the latest technological advancements in outdoor image processing hardware, software and camera technologies in response to evolving customer requirements.  We cannot assure you that we will be able to adequately manage product transition issues.  Our business and results of operations could be adversely affected if we do not anticipate or respond adequately to technological developments or changing customer requirements or if we cannot adequately manage inventory issues typically related to new product transitions and introductions. We cannot assure you that any such investments in research and development will lead to any corresponding increase in revenue.
Market acceptance of our new products depends upon many factors, including our ability to accurately predict market requirements and evolving industry standards, our ability to resolve technical challenges in a timely and cost-effective manner, qualify any new products with OEMs and achieve manufacturing efficiencies, the perceived advantages of our new
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products over traditional products and the marketing capabilities of our independent distributors and strategic partners, including Valeo’s ability to expand sales of AutoVue in the passenger car market. The success of our AutoVue system will also depend in part on the success of the automotive vehicles that incorporate our technology, as well as the success of optional equipment that OEMs bundle with our technologies.
Certain of the components used in our Vantage and AutoVue products may need to be re-engineered in the next 18 months as the industry is moving towards a standard of using lead-free components. We cannot assure you as to the timing of the adoption of this new standard or our ability to successfully redesign our products to incorporate compliant components and gain market acceptance of such redesigned products. In addition, if the standard is adopted earlier than anticipated we may experience a shortage of Vantage and AutoVue products as a result of potential scarcity of lead-free components.
Our business and results of operations could also be seriously harmed by any significant delays in our new product development. Certain of our new products could contain undetected design faults and software errors or “bugs” when first released by us, despite our testing. We may not discover these faults or errors until after a product has been installed and used by our customers. Any faults or errors in our existing products or in any new products may cause delays in product introduction and shipments, require design modifications or harm customer relationships, any of which could adversely affect our business and competitive position.
The Markets In Which We Operate Are Highly Competitive And Have Many More Established Competitors, Which Could Adversely Affect Our Sales Or The Market Acceptance Of Our Products.  We compete with numerous other companies in our target markets including, but not limited to, large, multinational corporations, which include tier one automotive suppliers, and many smaller regional engineering firms. We expect such competition to increase due to technological advancements, industry consolidations and reduced barriers to entry. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, financial condition and results of operations. We have experienced more competition in our Vantage business in fiscal 2007 as the Department of Transportation in one of our largest sales territories has recently moved to a multisource contracting environment from one in which Iteris was the sole supplier. In addition, one of the other developers of LDW systems was recently acquired by a larger company. While this developer has not been a material competitor to date, we may experience more competition from this provider as a result of its greater access to resources from its acquirer, and additional competitors may enter this market in the future.
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.
An Economic Slowdown Or The Significant Military Operations In The Middle East Or Elsewhere May Impact Government Funding Or Consumer Spending, Causing A Decline In Our Revenues.   In the near term, the funding of U.S. military operations in the Middle East or elsewhere may cause disruptions in funding of government contracts.  Since military operations of such magnitude are not routinely included in U.S. defense budgets, supplemental legislative funding actions are often required to finance such operations. Even when such legislation is enacted, it may not be adequate for ongoing operations, causing other government sources to be temporarily or permanently diverted.  Since a significant portion of our sales are derived from contracts with government agencies, such diversion of funds could produce interruptions in funding or delays in receipt of our contracts, causing disruptions and adversely effecting our revenue and operations.
Concerns about the recent international conflicts and terrorist and military actions, as well as concerns about inflation, decreased consumer confidence, and reduced corporate profits and capital spending have also resulted in a downturn in worldwide economic conditions, particularly in the United States. These unfavorable economic conditions may have a negative impact on customer orders (and also may result in decreased sales of automobiles and trucks that incorporate our LDW systems).  Such concerns may result in cancellations and rescheduling of backlog.  In addition, the recent decline in the U.S. real estate market, particularly in new home construction, could adversely impact new road construction resulting in a decline in Roadway Sensor and Automotive Sensor net sales and Transportation Systems contract revenues.  Any of the foregoing political, social and economic conditions make it extremely difficult for our customers, our suppliers and us to
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accurately forecast and plan future business activities and could result in a decline in our net sales and contract revenues. If such conditions continue or worsen, our business, financial condition and results of operations could be materially and adversely affected.
New Environmental Regulations May Result In A Decline In Our AutoVue Sales and Royalties.  Recent environmental regulations in Europe are expected to be in place during Fall 2006 which will require more stringent emissions compliance in new trucks manufactured, that could cause a decline in new truck sales in Europe in the near future.  Similar regulations have been announced in North America that may impact diesel engines built after January 2007, which could similarly impact North American OEM truck sales in general.  As a result, we may experience a decline in our LDW sales to truck OEMs related to these stricter regulations.
We Depend On Government Contracts And Subcontracts, And Because Many Of Our Government Contracts Are Fixed Price Contracts, Higher Than Anticipated Costs Will Reduce Our Profit And Could Adversely Impact Our Operating Results.  A significant portion of our sales are derived from contracts with governmental agencies, either as a general contractor, subcontractor or supplier. Government contracts represented approximately 38.3%, 37.4% and 48.2% of our total net sales and contract revenues for the years ended March 31, 2006, 2005 and 2004, 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, including the delays in the allocation of funds to state and local agencies from the U.S. transportation bill;
•                                          other government budgetary constraints and cut-backs; and
•                                          milestone requirements and liquidated damage provisions for failure to meet contract milestones
In addition, a large number of our government contracts are fixed price contracts. As a result, we may not be able to recover any cost overruns we may incur. These fixed price contracts require us to estimate the total project cost based on preliminary projections of the project’s requirements. The financial viability of any given project depends in large part on our ability to estimate these costs accurately and complete the project on a timely basis. In the event our costs on these projects exceed the fixed contractual amount, we will be required to bear the excess costs. Such additional costs would adversely affect our financial condition and results of operations. Moreover, certain of our government contracts are subject to termination or renegotiation at the convenience of the government, which could result in a large decline in our net sales and contract revenues in any given quarter. Our inability to address any of the foregoing concerns or the loss or renegotiation of any material government contract could seriously harm our business, financial condition and results of operations.
Our Quarterly Operating Results Fluctuate As A Result Of Many Factors. Therefore, We May Fail To Meet Or Exceed The Expectations Of Securities Analysts And Investors, Which Could Cause Our Stock Price To Decline.  Our quarterly revenues and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. Factors that could affect our revenues include, among others, the following:
•                                          changes in our pricing policies and the pricing policies of our suppliers and competitors, pricing concessions on volume sales, as well as increased price competition in general;
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•                                          the long lead times associated with government contracts or required by vehicle manufacturers;
•                                          delays in government contracts from time to time, including from delays in the allocation of funds to state and local agencies from the U.S. government transportation bill;
•                                          our ability to raise additional capital;
•                                          our ability to control costs;
•                                          the mix of our products and services sold in a quarter, which mix has varied and is expected to continue to vary from time to time;
•                                          seasonality due to winter weather conditions;
•                                          international conflicts and acts of terrorism;
•                                          declines in new home construction and related road construction;
•                                          our ability to develop, introduce, patent, market and gain market acceptance of new products, applications and product enhancements in a timely manner, or at all;
•                                          market acceptance of the products incorporating our technologies and products;
•                                          the size, timing, rescheduling or cancellation of significant customer orders;
•                                          the introduction of new products by competitors;
•                                          the availability and cost of components used in the manufacture of our products;
•                                          our success in expanding and implementing our sales and marketing programs;
•                                          the effects of technological changes in our target markets;
•                                          the amount of our backlog at any given time;
•                                          the nature of our government contracts;
•                                          deferrals of customer orders in anticipation of new products, applications or product enhancements;
•                                          risks and uncertainties associated with our international business;
•                                          currency fluctuations and our ability to get currency out of certain foreign countries; and
•                                          general economic and political conditions.
Due to all of the factors listed above as well as other unforeseen factors, our future operating results could be below the expectations of securities analysts or investors. If that happens, the trading price of our common stock could decline. As a result of these quarterly variations, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.
We May Engage In Acquisitions Of Companies Or Technologies That May Require Us To Undertake Significant Capital Infusions And Could Result In Disruptions Of Our Business And Diversion Of Resources And Management Attention.  We have historically acquired, and may in the future acquire, complementary businesses, products
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and technologies. Acquisitions may require significant capital infusions and, in general, acquisitions also involve a number of special risks, including:
•                                          potential disruption of our ongoing business and the diversion of our resources and management’s attention;
•                                          the failure to retain or integrate key acquired personnel;
•                                          the challenge of assimilating diverse business cultures, and the difficulties in integrating the operations, technologies and information system of the acquired companies;
•                                          increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services;
•                                          the incurrence of unforeseen obligations or liabilities;
•                                          potential impairment of relationships with employees or customers as a result of changes in management; and
•                                          increased interest expense and amortization of acquired intangible assets.
Our competitors are also soliciting potential acquisition candidates, which could both increase the price of any acquisition targets and decrease the number of attractive companies available for acquisition. Acquisitions may also materially and adversely affect our operating results due to large write-offs, contingent liabilities, substantial depreciation, deferred compensation charges or intangible asset amortization, or other adverse tax or accounting consequences. We cannot assure you that we will be able to identify or consummate any additional acquisitions, successfully integrate any acquisitions or realize the benefits anticipated from any acquisition.
We Have Experienced Growth In Recent Periods. If We Fail To Manage Our Growth Effectively, We May Be Unable To Execute Our Business Plan And May Experience Future Weaknesses In Our Internal Controls.  We have expanded our overall business, particularly in our Vantage and AutoVue product lines. In order to achieve our business objectives, we will need to continue to expand our business and add additional qualified personnel. Such expansion has placed and is expected to continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to successfully manage our growth, our business, financial condition and results of operations will be adversely affected.
To accommodate this growth, we launched a new ERP system in April 2006. Accordingly, we may experience problems commonly experienced by other companies in connection with such implementations, including but not limited to, potential bugs in the system, component or supply delays, training requirements and other integration challenges and delays. Any difficulties we might experience in connection with our new ERP system could have a material adverse effect on our financial reporting system and internal controls.
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.
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Our future success will depend upon our ability to anticipate and adapt to changes in technology and industry standards, and to effectively develop, introduce, market and gain broad acceptance of new products and product enhancements incorporating the latest technological advancements. In particular, our LDW system is incorporated into automobiles and trucks that face significant technological changes in each model year and among different vehicle models. Accordingly, we must adapt our technology from time to time to function with such changes.
We May Not Be Able To Adequately Protect Or Enforce Our Intellectual Property Rights, Which Could Harm Our Competitive Position.  If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors could be able to access our proprietary technology and our business, financial condition and results of operations will likely be seriously harmed. We currently attempt to protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements and similar means. Despite our efforts, other parties may attempt to disclose, obtain or use our technologies or systems. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or design around our patents. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. As a result, we may not be able to protect our proprietary rights adequately in the United States or abroad.
Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. An adverse outcome in litigation or any similar proceedings could subject us to significant liabilities to third parties, require us to license disputed rights from others or require us to cease marketing or using certain products or technologies. We may not be able to obtain any licenses on terms acceptable to us, or at all. We also may have to indemnify certain customers or strategic partners if it is determined that we have infringed upon or misappropriated another party’s intellectual property. Any of these results could adversely affect our business, financial condition and results of operations. In addition, the cost of addressing any intellectual property litigation claim, including legal fees and expenses, and the diversion of management’s attention and resources, regardless of whether the claim is valid, could be significant and could seriously harm our business, financial condition and results of operations.
The Trading Price Of Our Common Stock Is Highly Volatile. The trading price of our common stock has been subject to wide fluctuations in the past. Since January 2000, our Class A common stock (now known as our common stock) has traded at prices as low as $0.45 per share and as high as $29.44 per share. The market price of our common stock could continue to fluctuate in the future in response to various factors, including, but not limited to:
•                                          quarterly variations in operating results;
•                                          our ability to control costs, improve cash flow and sustain profitability;
•                                          our ability to raise additional capital;
•                                          shortages announced by suppliers;
•                                          announcements of technological innovations or new products or applications by our competitors, customers or us;
•                                          transitions to new products or product enhancements;
•                                          acquisitions of businesses, products or technologies;
•                                          the impact of any litigation;
•                                          changes in investor perceptions;
•                                          government funding, political agendas and other budgetary issues;
•                                          changes in earnings estimates or investment recommendations by securities analysts; and
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•                                          international conflicts, political unrest and acts of terrorism.
In addition, as of December 31, 2006, options to purchase an aggregate of 1.3 million shares of our common stock at a weighted average price of $0.53 per share terminate on or prior to September 30, 2007.  Our common stock has traditionally been thinly traded. The exercise of these options and the sale of a large number of shares of our common stock could cause our stock price to decline.
The stock market in general has recently experienced volatility, which has particularly affected the market prices of equity securities of many technology companies. This volatility has often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In the past, companies that have experienced volatility in the market price of their securities have been the subject of securities class action litigation. If we were to become the subject of a class action lawsuit, it could result in substantial losses and divert management’s attention and resources from other matters.
Our International Business Operations May Be Threatened By Many Factors That Are Outside Of Our Control. We currently market our AutoVue and Vantage products internationally and we anticipate that our international operations will expand in the near future. International business operations are subject to various inherent risks including, among others:
•                                          currency fluctuations and restrictions;
•                                          political, social and economic instability;
•                                          longer accounts receivable payment cycles;
•                                          import and export license requirements and restrictions of the United States and each other country in which we operate;
•                                          unexpected changes in regulatory requirements, tariffs and other trade barriers or restrictions;
•                                          the burdens of compliance with a wide variety of foreign laws and more restrictive labor laws and obligations;
•                                          difficulties in managing and staffing international operations;
•                                          potentially adverse tax consequences; and
•                                          reduced protection for intellectual property rights in some countries.
All of our international sales are denominated in U.S. dollars. As a result, an increase in the relative value of the dollar could make our products more expensive and potentially less price competitive in international markets. We do not engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations.
Any of the factors mentioned above may adversely affect our future international sales and, consequently, affect our business, financial condition and operating results. Furthermore, as we increase our international sales, our total revenues may also be affected to a greater extent by seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and other parts of the world.
We Could Experience Negative Financial Impacts Arising From Developments In Contingencies Created Under Our Previous Structure Or By Former Subsidiaries.  Although we divested ourselves of all business units, with the exception of our Iteris business, from time to time we could experience unforeseen developments in contingencies related to our former subsidiaries. For example, we recently entered into a settlement agreement in connection with a lawsuit brought against Mariner Networks, Inc., one of our former subsidiaries, by one of Mariner’s suppliers, pursuant to which we issued 88,912 shares of our common stock to this supplier (valued at $213,000 as of the date of issuance), paid this supplier $125,000 on October 20, 2006 and are required to pay an additional $350,000 in 36 equal monthly installments of $9,700
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beginning in November 2006.  Although we are not aware of any other material contingencies, it is possible that other matters could be brought against us in connection with activities related to former subsidiaries and that such matters could materially and adversely affect our financial results and cash flows.
Some Of Our Directors, Officers And Their Affiliates Can Control The Outcome Of Matters That Require The Approval Of Our Stockholders, And Accordingly We Will Not Be Able To Engage In Certain Transactions Without Their Approval.  As of December 31, 2006, our officers and directors owned approximately 14% of the outstanding shares of our common stock (and approximately 22% of our common stock when including options, warrants and other convertible securities held by them which are currently exercisable or convertible or will become exercisable or convertible within 60 days after December 31, 2006). 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.
Certain Anti-Takeover Provisions May Affect The Price Of Our Common Stock And Discourage A Third Party From Acquiring Us.  Certain provisions of our certificate of incorporation and our stockholder rights plan could make it difficult for a third party to acquire us, even though an acquisition might be beneficial to our stockholders. Such provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Under the terms of our certificate of incorporation, our Board of Directors is authorized to issue, without stockholder approval, up to 2,000,000 shares of preferred stock with voting, conversion and other rights and preferences superior to those of our common stock. Our future issuance of preferred stock could be used to discourage an unsolicited acquisition proposal. In addition, in March 1998, we adopted a stockholder rights plan and declared a dividend of preferred stock purchase rights to our stockholders. We amended this plan in May 2004. In the event a third party acquires more than 15% of the outstanding voting control of our company or 15% of our outstanding common stock, the holders of these rights will be able to purchase the junior participating preferred stock at a substantial discount off of the then current market price. The exercise of these rights and purchase of a significant amount of stock at below market prices could cause substantial dilution to a particular acquirer and discourage the acquirer from pursuing our company. The mere existence of a stockholder rights plan often delays or makes a merger, tender offer or proxy contest more difficult.
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5.  OTHER INFORMATION
None.
ITEM 6.  EXHIBITS
The following exhibits are filed herewith or are incorporated by reference to the location indicated.
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Exhibit Number | | Description | | Where Located
3.1 | | Amended and Restated Certificate of Incorporation of the registrant | | Exhibit 3.1 to the registrant’s current report on Form 8-K as filed with the SEC on October 28, 2004
3.2 | | Bylaws of registrant, as amended | | Exhibit 4.2 to the registrant’s Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993
3.3 | | Certificates of Amendment to Bylaws of the registrant dated April 24, 1998 and August 10, 2001 | | Exhibit 3.4 to the registrant’s Annual Report on Form 10-K/A for the year ended March 31, 2003 as filed with the SEC on July 29, 2003
3.4 | | Certificate of Amendment to Bylaws of registrant dated September 9, 2004 | | Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 as filed with the SEC on November 15, 2004
4.1 | | Specimen of Common Stock Certificate | | Exhibit 4.1 to the registrant’s Amendment No. 1 to the Registration Statement on Form 8-A as filed with the SEC on December 8, 2004
4.2 | | Amended and Restated Rights Agreement, dated as of May 10, 2004, by and between the registrant and U.S. Stock Transfer Corporation, including exhibits thereto | | Exhibit 99.1 to the registrant’s Registration Statement on Form 8-A/A as filed with the SEC on June 18, 2004
31.1 | | Certification of the Principal Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | | Filed herewith
31.2 | | Certification of the Principal Financial and Accounting Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | | Filed herewith
32.1 | | Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | Filed herewith
32.2 | | Certification of the Chief Financial Officer, as required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | Filed herewith

 
37

 
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: February 12, 2007 | | ITERIS, INC. | |
| | (Registrant) | |
| | By | | /s/ JACK JOHNSON
| | | | Jack Johnson
| | | | Chief Executive Officer
| | | | (Principal Executive Officer)
| | By | | /s/ JAMES S. MIELE
| | | | James S. Miele
| | | | Chief Financial Officer
| | | | (Principal Financial and Accounting Officer)
 
38

EXHIBIT 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Jack Johnson, certify that:
1.             I have reviewed this quarterly report on Form 10-Q of Iteris, Inc.;
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.             The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: February 12, 2007 | |
| | /s/ JACK JOHNSON
| | Jack Johnson
| | Chief Executive Officer
| | (Principal Executive Officer)

EXHIBIT 31.2
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, James S. Miele, certify that:
1.             I have reviewed this quarterly report on Form 10-Q of Iteris, Inc.;
2.             Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.             The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)           Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c)           Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: February 12, 2007 | |
| | /s/ JAMES S. MIELE
| | James S. Miele
| | Chief Financial Officer
| | (Principal Financial and Accounting Officer)

EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Iteris, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jack Johnson, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.                                       The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.                                       The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
| | /s/ JACK JOHNSON | |
| | Jack Johnson | |
| | Chief Executive Officer | |
| | February 12, 2007 | |
 
A signed original of this written statement required by Section 906, or any other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. §1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Iteris, Inc. (the “Company”) on Form 10-Q for the quarter ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James S. Miele, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.                                       The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.                                       The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
| | /s/ JAMES S. MIELE | |
| | James S. Miele | |
| | Chief Financial Officer | |
| | February 12, 2007 | |
 
A signed original of this written statement required by Section 906, or any other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.