Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

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

** **

**For the quarterly period ended****September 30, 2009**

** **

**or**

** **
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

** **

**For the transition period from               to               **

** **

**Commission File Number****1-10346**

** **

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                    | ** ** | **77-0226211**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**611Industrial Way**

**Eatontown,New Jersey 07224**

(Address of principalexecutive offices) (Zip code)

 

**(732) 389-0355**

(Registrant’s telephone number, including area code)

 

**Not applicable**

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant submitted electronically and posted on its corporatewebsite, if any, every interactive data file required to be submitted andposted pursuant to Rule 405 of Regulation S-T (section 232.405 of thischapter) during the preceding 12 months (or for such shorter period thatregistrant was required to submit and post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

| Large Accelerated  Filer o             |   | Accelerated Filer o          |
|---------------------------------------------|--------|-----------------------------------|
|                                        |   |                              |
| Non-Accelerated  Filer o               |   | Smaller  Reporting Company x |
| (do not check if Smaller Reporting Company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of November 6,2009 was 10,213,412.

 

 

 

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**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009**

 
| **PART I. FINANCIAL INFORMATION**                                                                                             |                                                                                            |       |
|------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 1.**                                                                                                                        | **FINANCIAL STATEMENTS**                                                                        |       |   |
|                                                                                                                               |                                                                                            |       |
| Condensed  Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31,  2008                       |                                                                                            | 1          |
|                                                                                                                               |                                                                                            |       |
| Condensed  Consolidated Statements of Operations for the Three and Nine Months Ended  September 30, 2009 and 2008 (unaudited) |                                                                                            | 2          |
|                                                                                                                               |                                                                                            |       |
| Condensed Consolidated Statements of Stockholders’  Equity for the Nine Months Ended September 30, 2009 (unaudited)      |                                                                                            | 3          |
|                                                                                                                               |                                                                                            |       |
| Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 30, 2009 and 2008 (unaudited)            |                                                                                            | 4          |
|                                                                                                                               |                                                                                            |       |
| Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                  |                                                                                            | 6          |
|                                                                                                                               |                                                                                            |       |
| **ITEM 2.**                                                                                                                        | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | ** ** | 26 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 3.**                                                                                                                        | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                 | ** ** | 46 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 4.**                                                                                                                        | **CONTROLS AND  PROCEDURES**                                                                    |       | 46 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 4T.**                                                                                                                       | **CONTROLS AND  PROCEDURES**                                                                    |       | 46 |
|                                                                                                                               |                                                                                            |       |   |
| **PART IIOTHER INFORMATION**                                                                                                  |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 1.**                                                                                                                        | **LEGAL PROCEEDINGS**                                                                           |       | 50 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 1A.**                                                                                                                       | **RISK FACTORS**                                                                                |       | 50 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 2. **                                                                                                                  | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                |       | 52 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 3.**                                                                                                                        | **DEFAULTS UPON  SENIOR SECURITIES**                                                            |       | 52 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 4.**                                                                                                                        | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                        |       | 52 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM 5.**                                                                                                                        | **OTHER INFORMATION**                                                                           |       | 52 |
|                                                                                                                               |                                                                                            |       |   |
| **ITEM  6.**                                                                                                                       | **EXHIBITS**                                                                                    |       | 52 |
|                                                                                                                               |                                                                                            |       |   |
| **SIGNATURES**                                                                                                                     |                                                                                            | 53         |

 

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Table of Contents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**Condensed Consolidated Balance Sheets**

(in thousands,except share and per share amounts)

 
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                    |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                               |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                    |       | $                      | 3,867      |                  | $          | 3,242 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $203 at September 30, 2009  and $501 at December 31, 2008                                                          |       | 8,187                  |       | 10,333                |       |
| Inventories, net                                                                                                                                                                              |       | 11,926                 |       | 12,501                |       |
| Current deferred tax  assets                                                                                                                                                                  |       | 22                     |       | 271                   |       |
| Prepaid and other  current assets                                                                                                                                                             |       | 1,185                  |       | 1,283                 |       |
| Current assets of  discontinued operations                                                                                                                                                    |       | —                 |       | 2,724                 |       |
| Total current assets                                                                                                                                                                          |       | 25,187                 |       | 30,354                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                           |       | 2,484                  |       | 2,990                 |       |
| Goodwill                                                                                                                                                                                      |       | 14,220                 |       | 9,657                 |       |
| Intangible assets other  than goodwill, net                                                                                                                                                   |       | 5,294                  |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                                                           |       | 1,766                  |       | 2,191                 |       |
| Other assets                                                                                                                                                                                  |       | 248                    |       | 683                   |       |
| Noncurrent assets of  discontinued operations                                                                                                                                                 |       | —                 |       | 1,130                 |       |
| Total assets                                                                                                                                                                                  |       | $                      | 49,199     |                  | $          | 53,623 |   |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                          |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                              |       | $                      | 4,197      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                                                              |       | 6,279                  |       | 6,939                 |       |
| Line of credit                                                                                                                                                                                |       | 4,032                  |       | 4,084                 |       |
| Current portion of  long-term debt, net of discount of $416                                                                                                                                   |       | 8,549                  |       | 5,121                 |       |
| Notes payable to  stockholders, current portion                                                                                                                                               |       | 375                    |       | 542                   |       |
| Income taxes payable                                                                                                                                                                          |       | 662                    |       | 451                   |       |
| Other current  liabilities                                                                                                                                                                    |       | 2,068                  |       | 357                   |       |
| Current liabilities of  discontinued operations                                                                                                                                               |       | —                 |       | 664                   |       |
| Total current  liabilities                                                                                                                                                                    |       | 26,162                 |       | 22,783                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Long-term debt, net of  discount of $980 at December 31, 2008                                                                                                                            |       | 218                    |       | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                                                          |       | 2,959                  |       | 250                   |       |
| Deferred income taxes                                                                                                                                                                         |       | 1,824                  |       | 2,203                 |       |
| Warrant liability                                                                                                                                                                             |       | 641                    |       | —                |       |
| Other liabilities                                                                                                                                                                             |       | 422                    |       | 503                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                                                            |       | —                 |       | 401                   |       |
| Total liabilities                                                                                                                                                                             |       | 32,226                 |       | 39,619                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                |       |                   |       |                  |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                    |       |                   |       |                  |       |
| Preferred stock,$0.01  par value. Authorized 10,000,000 shares, zero shares issued and outstanding                                                                                            |       | —                 |       | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,213,412 and 10,204,079 shares  issued and outstanding at September 30, 2009 and December 31, 2008,  respectively |       | 126                    |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                                                   |       | 43,444                 |       | 44,806                |       |
| Accumulated deficit                                                                                                                                                                           |       | (25,030                | )          | (28,101               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                         |       | (1,567                 | )          | (2,827                | )          |
| Total stockholders’  equity                                                                                                                                                              |       | 16,973                 |       | 14,004                |       |
| Total liabilities and  stockholders’ equity                                                                                                                                              |       | $                      | 49,199     |                  | $          | 53,623 |   |

 

*Theaccompanying Notes are an integral part of these Condensed ConsolidatedFinancial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

(Unaudited)****(in thousands, except per share amounts)

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                       | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Net Sales                                                                        |       | $                      | 14,319     |                   | $          | 13,078 |   | $ | 42,802 |   | $ | 35,743 |   |
| Cost of Sales                                                                    |       | 8,998                  |       | 8,685                  |       | 27,065 |   | 24,197 |   |
| Gross profit                                                                     |       | 5,321                  |       | 4,393                  |       | 15,737 |   | 11,546 |   |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                   |       |   |   |   |   |
| Selling, general and  administrative                                             |       | 4,592                  |       | 3,522                  |       | 13,486 |   | 10,589 |   |
| Engineering and product  development                                             |       | 733                    |       | 474                    |       | 1,971 |   | 1,585 |   |
| Loss on asset  impairment                                                        |       | 619                    |       | —                 |       | 619 |   | — |   |
| Total operating  expenses                                                        |       | 5,944                  |       | 3,996                  |       | 16,076 |   | 12,174 |   |
| Income (loss) from  operations                                                   |       | (623                   | )          | 397                    |       | (339 | ) | (628 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Other income (expense):                                                          |       |                   |       |                   |       |   |   |   |   |
| Interest income                                                                  |       | 18                     |       | 38                     |       | 87 |   | 79 |   |
| Interest expense                                                                 |       | (793                   | )          | (816                   | )          | (3,191 | ) | (2,004 | ) |
| Other, net                                                                       |       | (24                    | )          | (167                   | )          | 144 |   | (64 | ) |
| Total other expense,  net                                                        |       | (799                   | )          | (945                   | )          | (2,960 | ) | (1,989 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Loss before income  taxes                                                        |       | (1,422                 | )          | (548                   | )          | (3,299 | ) | (2,617 | ) |
| Income tax provision  (benefit)                                                  |       | (238                   | )          | 313                    |       | (596 | ) | 393 |   |
| Loss from continuing  operations                                                 |       | (1,184                 | )          | (861                   | )          | (2,703 | ) | (3,010 | ) |
| Discontinued  operations:                                                        |       |                   |       |                   |       |   |   |   |   |
| Income (loss) from  discontinued operations including gain on sale of $6,995 YTD |       | (132                   | )          | 1,194                  |       | 7,156 |   | 2,190 |   |
| Tax provision (benefit)  on discontinued operations                              |       | 510                    |       | —                 |       | 1,855 |   | — |   |
| Net gain (loss) on  discontinued operations                                      |       | (642                   | )          | 1,194                  |       | 5,301 |   | 2,190 |   |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Net Income (loss)                                                                |       | $                      | (1,826     | )                      | $          | 333 |   | $ | 2,598 |   | $ | (820 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Earnings (loss) per  share:                                                      |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                            |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
| Diluted                                                                          |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Weighted average shares  outstanding                                             |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                            |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
| Diluted                                                                          |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |

 

*Theaccompanying Notes are an integral part of these Condensed ConsolidatedFinancial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

(Unaudited)****(in thousands)

* *
| ** **                                                                                          | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                          | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                          | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                          | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                                                                                |       |             |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2008                                                                  |       | 10,204           |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |
| Cumulative effect of  change in accounting principle due to adoption of updated derivative guidance |       | —           |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock option exercises                                                                              |       | 9                |       | —      |       | 7               |       | —            |       | —          |       | 7          |       |
| Stock-based  compensation                                                                           |       | —           |       | —      |       | 112             |       | —            |       | —          |       | 112        |       |
| Warrants issued for  services                                                                       |       | —           |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net income and  comprehensive income                                                                |       | —           |       | —      |       | —          |       | 2,598             |       | 1,260           |       | 3,858      |       |
| Balance at  September 30, 2009                                                                 |       | 10,213           |       | $           | 126        |            | $          | 43,444            |       | $               | (25,030    | )          | $          | (1,567 | ) | $ | 16,973 |   |

 

*Theaccompanying Notes are an integral part of these Condensed ConsolidatedFinancial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                             | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                             | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                             | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                                                                                                   |       |                   |       |   |   |
| **CASH FLOWS  FROM OPERATING ACTIVITIES**                                                                                              |       |                   |       |   |   |
| Net Income (loss)                                                                                                                      |       | $                      | 2,598      |   | $ | (820 | ) |
| Adjustments to arrive  at net loss from continuing operations                                                                          |       | (5,301                 | )          | (2,324 | ) |
| Net loss from  continuing operations                                                                                                   |       | (2,703                 | )          | (3,144 | ) |
| Reconciliation to net  cash provided by (used in) operating activities:                                                                |       |                   |       |   |   |
| Depreciation and  amortization                                                                                                         |       | 1,465                  |       | 744 |   |
| Provision for doubtful  accounts                                                                                                       |       | 84                     |       | 138 |   |
| Provision for inventory  obsolescence                                                                                                  |       | 395                    |       | 453 |   |
| Provision for warranty  reserve                                                                                                        |       | (121                   | )          | (86 | ) |
| Deferred taxes                                                                                                                         |       | (62                    | )          | (88 | ) |
| Gain on sale of assets                                                                                                                 |       | —                 |       | (94 | ) |
| Amortization of  deferred issuance costs                                                                                               |       | 616                    |       | 339 |   |
| Amortization of debt  discount                                                                                                         |       | 564                    |       | 338 |   |
| Stock-based  compensation expense                                                                                                      |       | 114                    |       | 61 |   |
| Change in common stock  warrant value                                                                                                  |       | (369                   | )          | — |   |
| Loss on impairment of  assets                                                                                                          |       | 619                    |       | — |   |
| Changes in assets and  liabilities:                                                                                                    |       |                   |       |   |   |
| Accounts receivable                                                                                                                    |       | 2,104                  |       | 374 |   |
| Inventories                                                                                                                            |       | (96                    | )          | 228 |   |
| Prepaid and other  assets                                                                                                              |       | (82                    | )          | 73 |   |
| Accounts payable and  accrued expenses                                                                                                 |       | (1,946                 | )          | (2,598 | ) |
| Operating cash flow  provided by (used in) continuing operations                                                                       |       | 582                    |       | (3,262 | ) |
| Operating cash flow  provided by discontinued operations                                                                               |       | 165                    |       | 2,644 |   |
| Net cash provided by  (used in) operating activities                                                                                   |       | 747                    |       | (618 | ) |
|                                                                                                                                   |       |                   |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                             |       |                   |       |   |   |
| Purchases of property,  plant and equipment                                                                                            |       | (32                    | )          | (41 | ) |
| Payments received on  notes receivable                                                                                                 |       | —                 |       | 40 |   |
| Purchase of ACC, net of  cash acquired                                                                                                 |       | 188                    |       | (12,356 | ) |
| Investing cash flow  provided by (used in) continuing operations                                                                       |       | 156                    |       | (12,357 | ) |
| Investing cash flow  provided by (used in) discontinued operations including proceeds from sale of  subsidiary operations, net of cash |       | 10,051                 |       | (71 | ) |
| Net cash provided by  (used in) investing activities                                                                                   |       | 10,207                 |       | (12,428 | ) |
|                                                                                                                                   |       |                   |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                             |       |                   |       |   |   |
| Proceeds from issuance  of debt                                                                                                        |       | —                 |       | 13,000 |   |
| Net borrowings (repayments)  of lines of credit                                                                                        |       | (52                    | )          | 1,815 |   |
| Repayments of long-term  debt                                                                                                          |       | (10,823                | )          | (70 | ) |
| Payments of notes to  stockholders                                                                                                     |       | (418                   | )          | (396 | ) |
| Proceeds from exercise  of stock options and warrants                                                                                  |       | 7                      |       | — |   |
| Financing cash flow  provided by (used in) continuing operations                                                                       |       | (11,286                | )          | 14,349 |   |
| Financing cash flow  used in discontinued operations                                                                                   |       | —                 |       | (71 | ) |
| Net cash provided by  (used in) financing activities                                                                                   |       | (11,286                | )          | 14,278 |   |
|                                                                                                                                   |       |                   |       |   |   |
| Effect of exchange rate  changes on cash                                                                                               |       | 778                    |       | (729 | ) |
| Net increase in cash  and cash equivalents                                                                                             |       | 446                    |       | 503 |   |
| Cash and cash  equivalents at beginning of period                                                                                      |       | 3,421                  |       | 4,764 |   |
| Cash and cash  equivalents at end of period                                                                                            |       | $                      | 3,867      |   | $ | 5,267 |   |

 

*Theaccompanying Notes are an integral part of these Condensed ConsolidatedFinancial Statements*

 

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**CondensedConsolidated Statements of Cash Flows (Continued)**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                                     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                     | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                                     | ** ** | **2009**               | ** ** | **2008** | ** ** |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND****FINANCING  ACTIVITIES:**                                                                              |       |                   |       |   |   |
| Acquisition of  equipment through capital lease                                                                                                                |       | $                      | 119        |   | $ | 453 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of updates to derivative guidance |       | $                      | 473        |   | $ | — |   |
| Issuance of notes and  accruals relating to ACC purchase adjustment                                                                                            |       | $                      | 4,278      |   | $ | — |   |

 

*The accompanying Notes are an integral part ofthese Condensed Consolidated Financial Statements*

 

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**EMRISECORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organizationand Business*

 

EMRISE Corporation (the “Company”) designs, manufactures and marketsproprietary electronic devices and communications equipment for aerospace,defense, industrial, and communications applications. The Company hasoperations in the United States (“U.S.”), England and France.  The Company conducts its business through twooperating segments: electronic devices and communications equipment. Thesubsidiaries within the electronic devices segment design, develop, manufacture and market electronic devices for defense,aerospace and industrial markets and operate out of facilities located in theU.S. and England.  Thesubsidiaries within the communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products and operate out of facilities located in the U.S. andFrance.

 

In March of 2009, the Company sold substantially all the assetsrelated to the Digitran division of the Company’s wholly-owned subsidiary,EMRISE Electronics Corporation’s (“EEC”), and all of the issued and outstandingequity interests of EEC’s wholly-owned subsidiary, XCEL Japan, Ltd.(collectively the “Digitran Operations”).  Theaccompanying financial statements include the Digitran Operations as adiscontinued operation.

 

*Basis of Presentation*

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission (“Commission”) andtherefore do not include all information and footnotes necessary for a completepresentation of the financial position, results of operations and cash flows inconformity with accounting principles generally accepted in the U.S. (“GAAP”).  The year end balance sheet was derived fromthe audited financial statements at that date, but does not include all of theinformation and footnotes required by GAAP for complete financial statements.  The unaudited condensed consolidatedfinancial statements do, however, reflect all adjustments, consisting of onlynormal recurring adjustments, which are, in the opinion of management,necessary to state fairly the financial position as of September 30, 2009and the results of operations and cash flows for the related interim periodsended September 30, 2009 and 2008. However, these results are notnecessarily indicative of results for any other interim period or for the year.The accompanying unaudited condensed consolidated financial statements shouldbe read in conjunction with the Company’s audited consolidated financialstatements included in its annual report on Form 10-K for the year ended December 31,2008 as filed with the Commission.

 

*Comprehensive Income (Loss)*

 

Comprehensive income (loss) includes all changes inequity during a period except those that resulted from investments by ordistributions to the Company’s stockholders. Other comprehensive income refers to revenues, expenses, gains andlosses that, under GAAP, are included in comprehensive income, but excludedfrom net loss as these amounts are recorded directly as an adjustment tostockholders’ equity.  The Company’sother comprehensive income consists of foreign currency translationadjustments.  The following tablereflects the components of comprehensive income (loss) (in thousands):

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                     |       |                   |       |                   |       |   |   |   |   |
| Net income (loss)                        |       | $                      | (1,826     | )                      | $          | 333 |   | $ | 2,598 |   | $ | (820 | ) |
| Other comprehensive  income (loss):      |       |                   |       |                   |       |   |   |   |   |
| Foreign currency  translation adjustment |       | (113                   | )          | (1,639                 | )          | 1,260 |   | (1,415 | ) |
| Comprehensive income  (loss)             |       | $                      | (1,939     | )                      | $          | (1,306 | ) | $ | 3,858 |   | $ | (2,235 | ) |

 

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**EMRISECORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue Recognition*

 

The Company derivesrevenues from sales of electronic devices and communications equipment productsand services.  The Company’s sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchaseprice.  The Company recognizes revenueswhen shipment of products has occurred or services have been rendered, nosignificant obligations remain on the part of the Company, and collectabilityis reasonably assured based on the Company’s credit and collections practicesand policies.

 

The Company recognizesrevenues from sales of its U.S. subsidiary, RO Associates Incorporated, and allof its U.S. communications equipment business units at the point of shipment ofthose products.  An estimate of warrantycost is recorded at the time the revenue is recognized.  Product returns are infrequent and requireprior authorization because sales are final and the Company quality tests itsproducts prior to shipment to ensure products meet the specifications of thebinding purchase orders under which those products are shipped. Normally, whena customer requests and receives authorization to return a product, the requestis accompanied by a purchase order for a repair or for a replacement product.

 

Revenue recognition forproducts and services provided by the Company’s subsidiaries in England and itsU.S. subsidiary, ACC, depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up to severalyears, with revenue deferred until each milestone defined in the contract isreached.  Production contracts providefor a specific quantity of products to be produced over a specific period oftime.  Customers issue binding purchaseorders or enter into binding agreements for the products to be produced.  The Company recognizes revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorization becausethese products are custom made to order based on binding purchase orders andare quality tested prior to shipment.  Anestimate of warranty cost is recorded at the time revenue is recognized.

 

The Company recognizesrevenues for products sold by its subsidiary in France at the point ofshipment.  Customer discounts are includedin the product price list provided to the customer.  Returns are infrequent and permitted onlywith prior authorization because these products are shipped based on bindingpurchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

Revenues from services such as repairs and modifications are recognizedwhen the service is completed and invoiced. For repairs that involve shipment of a repaired product, the Companyrecognizes repair revenues when the product is shipped back to the customer.Service revenues contribute less than 5% of total revenue and, therefore, areconsidered to be immaterial to overall financial results.

 

*Reverse Stock Split*

 

On November 19, 2008, the Company completeda 1-for-3.75 reverse split of its common stock. All common stock, stock options and warrants to purchase common stockand earnings per share amounts have been retroactively restated as if thereverse stock split occurred at the beginning of the periods presented.

 

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**EMRISECORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Income (Loss) Per Share*

 

Basic income (loss) per share is computed by dividingnet loss by the weighted average common shares outstanding during aperiod.  Diluted income (loss) per shareis based on the treasury stock method and includes the dilutive effect of stockoptions and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the loss from continuing operations incurred by theCompany for the three and nine month periods ended September 30, 2009, andthe nine month period ended September 30, 2008, the potentially dilutivecommon shares have been excluded from the loss per share computation for theseperiods because their inclusion would have been anti-dilutive.  The following table illustrates thecomputation of basic and diluted income (loss) per share (in thousands, exceptper share amounts):

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                |       |                   |       |                   |       |   |   |   |   |
| NUMERATOR:                                          |       |                   |       |                   |       |   |   |   |   |
| Net income (loss)                                   |       | $                      | (1,826     | )                      | $          | 333 |   | $ | 2,598 |   | $ | (820 | ) |
|                                                |       |                   |       |                   |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                   |       |   |   |   |   |
| Basic weighted average  common shares outstanding   |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
| Effect of dilutive  securities:                     |       |                   |       |                   |       |   |   |   |   |
| Dilutive stock options  and warrants                |       | —                 |       | —                 |       | — |   | — |   |
| Diluted weighted  average common shares outstanding |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
|                                                |       |                   |       |                   |       |   |   |   |   |
| Basic income (loss) per  share                      |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
|                                                |       |                   |       |                   |       |   |   |   |   |
| Diluted income (loss)  per share                    |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |

 

The following table shows the common stock equivalentsthat were outstanding as of September 30, 2009 and 2008, but were notincluded in the computation of diluted earnings per share as a result of theloss incurred by the Company in the three month period ended September 30,2009, and the nine month period ended September 30, 2008 or because theoptions’ or warrants’ exercise price was greater than the average market priceof the common shares and, therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **     | ** ** | **Range  of**       | ** ** |
|---------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                            | ** ** | **Number  of** | ** ** | **Exercise  Price** | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Per  Share**      | ** ** |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock options:  |       |           |       |                |       |
| As of  September 30, 2009        |       | 637,625        |       | $1.53 – $7.50  |       |
| As of  September 30, 2008        |       | 546,933        |       | $0.75 – $7.50  |       |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock warrants: |       |           |       |                |       |
| As of  September 30, 2009        |       | 1,791,079      |       | $4.31 – $6.49  |       |
| As of  September 30, 2008        |       | 1,797,867      |       | $4.13 – $6.49  |       |

 

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**EMRISECORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

**Adopted**

 

**FASB Accounting Standards Codification.****TM**  On September 30,2009, the Company adopted changes issued by the Financial Accounting StandardsBoard (“FASB”) to the authoritative hierarchy of GAAP.  These changes establish the FASB AccountingStandards CodificationTM (“Codification”)as the source of authoritative accounting principles recognized by the FASB tobe applied by nongovernmental entities in preparation of financial statementsin conformity with GAAP.  Rules andinterpretive releases of the Securities and Exchange Commission (“SEC”) under authorityof federal securities laws are also sources of authoritative GAAP for SECregistrants.  The FASB will no longerissue new standards in the form of Statements, FASB Staff Positions, orEmerging Issues Task Force Abstracts; instead the FASB will issue AccountingStandards Updates.  Accounting StandardsUpdates will not be authoritative in their own right as they will only serve toupdate the Codification.  These changesand the Codification itself do not change GAAP. Other than the manner in which new accounting guidance is referenced,the adoption of these changes had no impact on the Company’s consolidatedfinancial statements.

 

**Fair Value Measurements and Disclosure**. In January 2009, the Company adopted changes issued by the FASB tofair value accounting and reporting as it relates to non-financial assets andnon-financial liabilities that are not recognized or disclosed at fair value inthe financial statements on at least an annual basis.  These changes define fair value, establish aframework for measuring fair value under GAAP and expand disclosures about fairvalue measurements.  This guidanceapplies to other GAAP that require or permit fair value measurements and is tobe applied prospectively with limited exceptions.  The adoption of these changes, as it relatesto non-financial assets and liabilities, had no impact on the Company’sfinancial statements.

 

**Business Combinations**. On January 1, 2009, the Company adopted an update to existingaccounting standards for business combinations. The update, which retains the underlying concepts of the originalstandard in that all business combinations are still required to be accountedfor at fair value under the acquisition method of accounting, changes themethod of applying the acquisition method. Acquisition costs are no longer considered part of the fair value of anacquisition and will generally be expensed as incurred, non-controllinginterests are valued at fair value at the acquisition date, in-process researchand development is recorded at fair value as an indefinite-lived intangibleasset at the acquisition date, restructuring costs associated with a businesscombination are generally expensed subsequent to the acquisition date, andchanges in deferred tax asset valuation allowances and income tax uncertaintiesafter the acquisition date generally will affect income tax expense.

 

In April 2009, the FASB issued a further updatein relation to accounting for assets acquired and liabilities assumed in abusiness combination that arise from contingencies, which amends the previousguidance to require contingent assets acquired and liabilities assumed in abusiness combination to be recognized at fair value on the acquisition date iffair value can be reasonably estimated during the measurement period.  If fair value cannot be reasonably estimatedduring the measurement period, the contingent asset or liability would berecognized in accordance with standards and guidance on accounting forcontingencies and reasonable estimateion of the amount of a loss.  Further, this update eliminated the specificsubsequent accounting guidance for contingent assets and liabilities withoutsignificantly revising the original guidance. However, contingent consideration arrangements of an acquiree assumed bythe acquirer in a business combination would still be initially andsubsequently measured at fair value. These updates are applicable prospectively to business combinations forwhich the acquisition date is on or after January 1, 2009.  The adoption of these provisions will have animpact on accounting for any business acquired after January 1, 2009.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Derivatives and Hedging**. On January 1, 2009, the Company adopted changes issued by the FASBto disclosures about derivative instruments and hedging activities.  These changes require enhanced disclosuresabout an entity’s derivative and hedging activities, including (i) how andwhy an entity uses derivative instruments, (ii) how derivative instrumentsand related hedged items are accounted for, and (iii) how derivativeinstruments and related hedged items affect an entity’s financial position,financial performance and cash flows. Other than the required disclosures, the adoption of these changes hadno impact on the Company’s consolidated financial statements.

 

On January 1, 2009, the Company adopted an updateissued by the FASB to the accounting for instruments (or embedded features)indexed to an entity’s own stock.  Thesechanges clarify the determination of whether an instrument (or embeddedfeature) is indexed to an entity’s own stock, which would qualify as a scopeexception under previously issued guidance. The adoption of these changes resulted in the reclassification ofcertain of the Company’s outstanding warrants from stockholders’ equity toliabilities, which requires the warrants to be fair valued at each reportingperiod, with the changes in fair value recognized in the Company’s consolidatedstatement of operations.  See Note 12 -Warrants.

 

**Intangibles — Goodwill and Other**. On January 1, 2009, the Company adopted changes issued by the FASBto account for intangible assets.  Thesechanges amend the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset in order to improve the consistency between the useful life ofa recognized intangible asset outside of a business combination and the periodof expected cash flows used to measure the fair value of an intangible asset ina business combination.  The adoption ofthese changes did not have an impact on the Company’s consolidated financialstatements.

 

**Financial Instruments**. On June 30, 2009, the Company adopted an update to accountingstandards for disclosures about the fair value of financial instruments, whichrequires publicly-traded companies to provide disclosures on the fair value offinancial instruments in the interim financial statements.  Other than the required disclosures, theadoption of this update had no impact on the Company’s consolidated financialstatements.

 

**Subsequent Events**.  On June 30,2009, the Company adopted changes issued by the FASB to accounting for anddisclosure of events that occur after the balance sheet date but beforefinancial statements are issued or are available to be issued, otherwise knownas “subsequent events.”  Specifically,these changes set forth (1) the period after the balance sheet date duringwhich management of a reporting entity should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financial statements:(2) the circumstances under which an entity should recognize events ortransactions occurring after the balance sheet date in its financialsstatements; and (3) the disclosures that an entity should make aboutevents or transactions that occurred after the balance sheet date.  The adoption of these changes did not have amaterial impact on the Company’s financial statements.

 

**Issued, but not adopted**

 

**Fair Value Measurements and Disclosure**. In August 2009, the FASB issued an update to the fair valuemeasurement guidance to clarify how an entity should measure liabilities atfair value.  The update reaffirms fairvalue is based on an orderly transaction between market participants, eventhough liabilities are infrequently transferred due to contractual or otherlegal restrictions.  However, identicalliabilities traded in the active market should be used when available.  When quoted prices are not available, thequoted price of the identical liability traded as an asset, quoted prices forsimilar liabilities or similar liabilities traded as an asset, or anothervaluation approach should be used.  Thisupdate also clarifies that restrictions preventing the transfer of a liabilityshould not be considered as a separate input or adjustment in the measurementof fair value.  The Company will adopt 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

this update for fairvalue measurements of liabilities effective October 1, 2009, which it doesnot expect to have a material impact on its consolidated financial statements.

 

**Revenue Recognition**.  In October 2009,the FASB issued an update to existing guidance on revenue recognition forarrangements with multiple deliverables. This update will allow companies to allocate consideration received forqualified separate deliverables using estimated selling prices for bothdelivered and undelivered items when vendor-specific objective evidence orthird-party evidence is unavailable. Additional disclosures discussing the nature of multiple elementarrangements, the types of deliverables under the arrangements, the generaltiming of their delivery, and significant factors and estimates used todetermine estimated selling prices are required.  The Company will adopt this update for newrevenue arrangements entered into or materially modified beginning January 1,2011.  The Company is still evaluatingthe impact, if any, of the adoption of this new revenue recognition guidance onits consolidated financial statements.

 

**NOTE 2 — GOING CONCERN**

 

The accompanying consolidated financial statementshave been prepared in conformity with GAAP, which contemplate the continuationof the Company as a going concern.  TheCompany reported a net loss for the quarter ended September 30, 2009 of$1.8 million and net income for the nine months ended September 30, 2009of $2.6 million.  Included in net incomefor the nine month period was $5.3 million in income/gain (net of taxes of $1.9million) from discontinued operations related to the disposition of theCompany’s Digitran Operations (see Note 4). Absent this income/gain, the Company would have incurred a $2.7 millionnet loss for the nine months ended September 30, 2009.  The Company also reported negative workingcapital from continuing operations of $975,000 at September 30, 2009 andpositive working capital from continuing operations of $5.5 million at December 31,2008.  The Company’s current businessplan for the next 12 months requires additional funding beyond its anticipatedcash flows from operations.  These andother factors described in more detail below raise substantial doubt about theCompany’s ability to continue as a going concern.

 

The ability of the Company to continue as a goingconcern is dependent upon its ability to (i) raise $3 million (net oftransaction costs) in equity capital by December 31, 2009, (ii) repayits credit facility on or prior to its maturity on June 30, 2010, (iii) obtainalternate financing to fund the Company’s operations after June 30, 2010,and (iv) achieve profitable operations. The accompanying consolidated financial statements do not include anyadjustments that might be necessary if the Company is unable to continue as agoing concern.

 

Ifthe Company’s net losses continue, the Company may experience negative cashflow, which may prevent it from continuing operations.  Additionally, losses may result in a defaulton the Company’s debt covenants associated with its credit facility.  If the Company is not be able to attain,sustain and increase profitability on a quarterly or annual basis, the Companymay not be able to continue its operations and its stock price may decline.

 

Currently,the Company is in the process of seeking alternate financing from a number ofpossible participants, including traditional lenders, equity participants andmezzanine lenders.  The Company hasengaged financial advisors, Boenning & Scattergood, to assist in thisregard.  Although the Company remainshopeful that it will be able to successfully raise at least $3.0 million inequity capital by December 31, 2009 and secure replacement financing on orprior to June 30, 2010, when its current credit facility matures, noassurances can be made that the Company will be successful in this regard.

 

Ifthe Company cannot meet its obligations under the terms of its credit facilityand if the lender does not waive or renegotiate these obligations, then theCompany would be in default under the terms of its credit facility.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

In the event of a default and continuation of a default, the lender maylimit future availability under the Revolver (as defined in Note 10) and/oraccelerate the payment of all principal balances and accrued interest requiringthe Company to pay the entire indebtedness under the credit facilityoutstanding on that date.  As of November 1, 2009, $12.5 million wasoutstanding under the credit facility. The Company does not have the ability topay this amount if the lender accelerated the payment of the outstanding amountunder the credit facility upon a default.

 

Uponthe occurrence and during the continuation of an event of default, the lendermay also elect to increase the interest rate applicable to the outstandingbalance of the Term Loans A and B (as defined in Note 11) by four percentagepoints above the per annum interest rate that would otherwise beapplicable.  Additionally, if the lender terminates the credit facilityduring a default period or if the Company prepays the Revolver or the TermLoans prior to November 30, 2009, then the Company is subject to a penaltyequal to 2% of the outstanding principal balance of the Revolver and the TermLoans.

 

Ifthe Company is unable to (i) raise the requisite amount of equity capitalby December 31, 2009 required under the terms of the Company’s creditfacility, (ii) continue to borrow funds under the terms of the Revolver,for any reason, through June 30, 2010, or (iii) obtain alternatefinancing to replace its credit facility prior to June 30, 2010, theCompany does not believe that current and future capital resources, revenuesgenerated from operations and other existing sources of liquidity will beadequate to meet its anticipated short term, working capital and capitalexpenditures needs for the next 12 months.  Further, if for any reason,the Company is not able to continue to borrow funds under the terms of theRevolver or if it experiences a significant loss of revenue or increase incosts, then its cash flow would be negatively impacted resulting in a cash flowdeficit which, in turn, will require it to obtain additional or alternatefinancing, with little or no notice.  These potential financing needscould be met in the form of a revised debt structure with the Company’s currentlender, additional or new financing with another lender or lenders, the sale ofassets to generate cash or the sale of additional equity to raise capital. Failure to secure additional or alternate financing, if and when needed, wouldhave an adverse effect on the Company’s operations and/or ability to dobusiness after that date or could restrict the Company’s growth, limit itsdevelopment of new products, or hinder its ability to fulfill existing orfuture orders.

 

Ifthe Company is unsuccessful in securing the necessary financing to continueoperations, when needed, then the Company may be forced to seek protection under the U.S. Bankruptcy Code or be forcedinto liquidation or substantially restructuring or altering the Company’sbusiness operations and/or debt obligations.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 3 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

OnAugust 20, 2008, the Company and its wholly-owned subsidiary, EEC,acquired all of the issued and outstanding shares of common stock of CCI andall of the issued and outstanding shares of common stock of ACC not owned byCCI (the “Acquisition”).  In addition to the purchase price, the Companyis obligated to pay up to an additional $3,000,000 in cash if ACC meets certainoperating income targets for one or both of the two 12 month periods followingthe closing.  Additionally, EEC issued Subordinated Secured Contingent PromissoryNotes (the “Notes”) to each of the sellers in the aggregate principal amount of$2,000,000.  The Notes become payable if ACC meets certain operatingincome thresholds during the first and second 12 month periods after August 20,2008.  The Notes bear interest at a rate per annum equal to the primerate as reported in *The Wall StreetJournal *plus 1%. Interest accrues on the principal balance beginning August 20, 2008with interest measured as of the beginning of each quarter after thatdate.  No interest payments are dueduring the first 12 months.  Interest isdue at the beginning of each quarter after November 2009.  As of September 30, 2009, ACC had metits operating income targets associated with the Notes and as such the Companyrecorded a note payable of $2,000,000. In addition, the Company recorded additional amounts due under the Notesof $960,000 associated with a working capital adjustment pursuant to the salespurchase agreement.  The Notes, whichtotal $3.0 million as of September 30, 2009, are due on or prior to November 21,2010.

 

Additionally,at September 30, 2009, the Company recorded in other current liabilities$1.0 million associated with the first 12 month measurement period for thecontingent cash obligation and $300,000 representing an adjustment to workingcapital and net cash.  This amount, whichtotals $1.3 million as of September 30, 2009 is due to the sellers on orprior to November 21, 2009.  TheCompany expects to record additional purchase price adjustments associated withthe contingent cash obligation when such obligation is earned.  The second and final 12 month measurementperiod begins August 20, 2009 and ends on August 19, 2010.  During this second measurement period, anyamounts in excess of $1 million of earnings before interest expense and incometaxes earned by ACC accrue to the sellers. The maximum amount that can accrue to the sellers is $3 million,including the $1 million that is already accrued as of September 30,2009.  All amounts accrued to the sellersafter September 30, 2009 are due in November 2010.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 4 — DISCONTINUED OPERATIONS**

 

OnMarch 20, 2009, the Company and EEC entered into an Asset and StockPurchase Agreement (the “Digitran Purchase Agreement”) with Electro SwitchCorp., a Delaware corporation (the “Buyer”) and ESC Worldwide, Inc., aMassachusetts corporation and subsidiary of Buyer (the “Stock Buyer”).  Atthe closing of the Digitran Purchase Agreement on March 20, 2009, (i) theBuyer purchased from the Company and EEC substantially all the assets relatedto EEC’s Digitran division, and (ii) the Stock Buyer purchased from EECall of the issued and outstanding equity interests of its wholly-ownedsubsidiary, XCEL Japan, Ltd., for an aggregate purchase price of approximately$11,560,000 (the “Disposition”).  Under the terms of the PurchaseAgreement, the Buyer is obligated to pay up to an additional $500,000 in cashto EEC if net sales for the fiscal year ending December 31, 2009 relatedto the businesses that were sold pursuant to the Digitran Purchase Agreementexceeds $6,835,120.

 

TheBuyer acquired all of the intellectual property, cash, accounts receivable,inventory, customer support and relationships, software and productdevelopment, and real property lease related to the Digitran division, which,prior to its acquisition, was in the business of manufacturing a line ofelectromechanical switches comprised of digital and rotary switches used forrouting electronic signals.  The Stock Buyer acquired XCEL Japan, Ltd.,which, prior to its acquisition, was engaged in the business of selling anddistributing Digitran division products in the Asia Pacific market.  EECretained all accounts payable and certain other assets and liabilities relatedto the Digitran division.  The Company continues to operate its communicationsequipment segment and the power systems radio frequency (“RF”) and microwavedevices product lines in its electronic devices segment.

 

TheDigitran Purchase Agreement contains five year noncompetition andnon-solicitation provisions covering the Company, EEC and each of theirrespective affiliates.  In addition, the Company and EEC providedcustomary indemnification rights to the Buyer and Stock Buyer in connectionwith the Disposition.

 

In connection with theCompany’s divestiture of its Digitran division, which comprised a portion ofthe Company’s electronic devices segment, the Company incurred approximately$900,000 in cash charges that were paid at closing.  The charges paid atclosing included approximately $100,000 in employee terminationcosts. Subsequent to closing, the Company paid $280,000 of previouslyaccrued costs, including a portion of the federal and state income taxliabilities, employee termination costs and transaction related employeebonuses and legal fees.  At September 30,2009, the Company estimates future cash expenditures related to the sale to beapproximately $150,000 primarily for employee termination costs and transactionrelated employee bonuses, which were accrued within “Accrued liabilities”except for income taxes, which were accrued within “Income taxes payable” inthe accompanying condensed consolidated balance sheets.   In addition, the Company has accrued $422,000related to a purchase price adjustment owed to the Buyer in connection with thetransaction.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following tablesummarizes the results from discontinued operations for the three and ninemonths ended September 30, 2009 and 2008 (in thousands):

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                         | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                         | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                               |       |                   |       |                   |       |   |   |   |   |
| Net Sales                                                          |       | $                      | —     |                   | $          | 2,609 |   | $ | 1,478 |   | $ | 6,240 |   |
|                                                               |       |                   |       |                   |       |   |   |   |   |
| Income from operations                                             |       | $                      | —     |                   | $          | 1,194 |   | $ | 178 |   | $ | 2,190 |   |
| Gain (loss) on sale of  Digitran Operations (net of tax of $1,855) |       | (642                   | )          | —                 |       | 5,301 |   | — |   |
| Net (loss) Income                                                  |       | $                      | (642       | )                      | $          | 1,194 |   | $ | 5,479 |   | $ | 2,190 |   |
|                                                               |       |                   |       |                   |       |   |   |   |   |
| (Loss) earnings per  share:                                        |       |                   |       |                   |       |   |   |   |   |
| Basic                                                              |       | $                      | (0.06      | )                      | $          | 0.12 |   | $ | 0.54 |   | $ | 0.21 |   |
| Diluted                                                            |       | $                      | (0.06      | )                      | $          | 0.12 |   | $ | 0.54 |   | $ | 0.21 |   |
|                                                               |       |                   |       |                   |       |   |   |   |   |
| Weighted average shares  outstanding                               |       |                   |       |                   |       |   |   |   |   |
| Basic                                                              |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
| Diluted                                                            |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |

 

**NOTE 5 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

·      EmployeeStock and Stock Option Plan, effective July 1, 1994;

·      1993Stock Option Plan;

·      1997Stock Incentive Plan;

·      Amendedand Restated 2000 Stock Option Plan; and

·      2007Stock Incentive Plan.

 

The board of directors does not intend to issue anyadditional options under the Employee Stock and Stock Option Plan, 1993 StockOption Plan, 1997 Stock Incentive Plan or Amended and Restated 2000 StockOption Plan.

 

Total stock-based compensation expense included inwages, salaries and related costs was $36,000 and $28,000 for the three monthsended September 30, 2009 and 2008, respectively and $114,000 and $61,000for the nine months ended September 30, 2009 and 2008, respectively.  These compensation expenses were charged toselling, general and administrative expenses. As of September 30, 2009,the Company had $271,000 of total unrecognized compensation expense related tostock option grants, which will be recognized over the remaining weightedaverage period of two years.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 6 — INVENTORIES**

 

Inventories are stated atthe lower of cost (first-in, first-out method) or market (net realizable value)and consisted of the following (in thousands):

 
| ** **        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
|              |       |                   |       |                  |       |
| Raw materials     |       | $                      | 10,223     |                  | $          | 10,093 |   |
| Work-in-process   |       | 3,134                  |       | 3,319                 |       |
| Finished goods    |       | 4,301                  |       | 4,311                 |       |
| Reserves          |       | (5,732                 | )          | (5,222                | )          |
| Total inventories |       | $                      | 11,926     |                  | $          | 12,501 |   |

 

The above table excludesnet inventories for Digitran of $1.2 million as of December 31, 2008.

 

**NOTE 7 — OPERATING SEGMENTS**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets electronic power supplies, RF and microwave devicesand subsystem assemblies. The electronic devices segment consists of EEC andits subsidiaries located in the U.S. and England, which offer the same orsimilar products to similar customers. The communications equipment segment designs, manufactures anddistributes network access products and timing and synchronizationproducts.  The communications equipmentsegment consists of operating entities CXR Larus Corporation located in theU.S. and CXR Anderson Jacobson located in France, both of which offer the sameor similar products to similar customers. Both segments operate in the U.S., European and Asian markets, but havedistinctly different customers, design and manufacturing processes andmarketing strategies.  Each segment hasdiscrete financial information and a separate management structure.

 

The Company evaluates performance based upon profit orloss from operations before income taxes exclusive of nonrecurring gains andlosses. The Company accounts for intersegment sales at pre-determined pricesnegotiated between the individual segments.

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 4), which were partof its electronic devices segment.  Thistransaction resulted in differences in the basis of segmentation from theamounts disclosed in the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K for the year ended December 31,2008.  In this report, the DigitranOperations are reported as a discontinued operation and are excluded from theelectronics devices segment.  Therefore,prior period amounts have been adjusted to conform to this presentation.  Included in the Company’s reconciliation ofsegment financial data to the consolidated amounts is unallocated corporateexpenses.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Selected financial data for each of the Company’soperating segments reconciled to the consolidated totals is shown below (inthousands):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                 |       |                   |       |                   |       |   |   |   |   |
| Electronic devices        |       | $                      | 10,987     |                   | $          | 9,915 |   | $ | 34,231 |   | $ | 25,358 |   |
| Communications  equipment |       | 3,332                  |       | 3,163                  |       | 8,571 |   | 10,385 |   |
| Discontinued Operations   |       | —                 |       | 2,609                  |       | — |   | 6,240 |   |
| Total                     |       | $                      | 14,319     |                   | $          | 15,687 |   | $ | 42,802 |   | $ | 41,983 |   |
|                      |       |                   |       |                   |       |   |   |   |   |
| Operating income (loss)   |       |                   |       |                   |       |   |   |   |   |
| Electronic devices        |       | $                      | 813        |                   | $          | 1,307 |   | $ | 4,307 |   | $ | 2,426 |   |
| Communications  equipment |       | (307                   | )          | (9                     | )          | (1,224 | ) | (81 | ) |
| Discontinued Operations   |       | —                 |       | 1,194                  |       | — |   | 2,190 |   |
| Corporate and other       |       | (1,129                 | )          | (901                   | )          | (3,422 | ) | (2,972 | ) |
| Total                     |       | $                      | (623       | )                      | $          | 1,591 |   | $ | (339 | ) | $ | 1,563 |   |

 
| ** **                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Total assets              |       |                   |       |                  |       |
| Electronic devices        |       | $                      | 37,110     |                  | $          | 34,853 |   |
| Communications  equipment |       | 8,778                  |       | 10,260                |       |
| Discontinued Operations   |       | —                 |       | 3,600                 |       |
| Corporate and other       |       | 3,311                  |       | 4,910                 |       |
| Total                     |       | $                      | 49,199     |                  | $          | 53,623 |   |

 

**NOTE 8 — GOODWILL AND OTHERINTANGIBLE ASSETS**

 

The following tablereflects changes in the Company’s goodwill balances, by segment, for the ninemonths ended September 30, 2009 (in thousands):

 
| ** **                                      | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                                      | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                                            |       |           |       |               |       |       |       |
| Balance at  December 31, 2008              |       | $              | 9,657      |               | $          | —     |       | $ | 9,657 |   |
| Purchase price  adjustment for ACC (see Note 3) |       | 4,090          |       | —             |       | 4,090      |       |
| Foreign currency  translation                   |       | 473            |       | —             |       | 473        |       |
| Balance at  September 30, 2009             |       | $              | 14,220     |               | $          | —     |       | $ | 14,220 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Other intangible assetsconsist primarily of trademarks, trade names and technology acquired.  The original cost and accumulatedamortization of these intangible assets consisted of the following (inthousands):

 
| ** **                             | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Electronic**               | ** ** | **Communications**          | ** ** | ** ** | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Devices**                  | ** ** | **Equipment**               | ** ** | **Total** | ** ** | **Devices** | ** ** | **Equipment** | ** ** | **Total** | ** ** |
|                                   |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| **Intangibles with definite lives:**   |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Technology  acquired                   |       | $                            | —     |                        | $          | 1,150 |   | $ | 1,150 |   | $ | 500 |   | $ | 1,150 |   | $ | 1,650 |   |
| Customer  relationships                |       | 2,550                        |       | 200                         |       | 2,750 |   | 2,900 |   | 200 |   | 3,100 |   |
| Trade  name                            |       | 1,570                        |       | —                      |       | 1,570 |   | 1,570 |   | — |   | 1,570 |   |
| Covenant-not-to-compete                |       | 260                          |       | —                      |       | 260 |   | 260 |   | — |   | 260 |   |
| Patents                                |       | —                       |       | —                      |       | — |   | — |   | — |   | — |   |
| Patents-in-progress                    |       | —                       |       | —                      |       | — |   | — |   | — |   | — |   |
| Backlog                                |       | 770                          |       | —                      |       | 770 |   | 770 |   | — |   | 770 |   |
|                                   |       | 5,150                        |       | 1,350                       |       | 6,500 |   | 6,000 |   | 1,350 |   | 7,350 |   |
| Accumulated  amortization              |       | (1,348                       | )          | (708                        | )          | (2,056 | ) | (974 | ) | (608 | ) | (1,582 | ) |
| Carrying  Value                        |       | 3,802                        |       | 642                         |       | 4,444 |   | 5,026 |   | 742 |   | 5,768 |   |
|                                   |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| **Intangibles with indefinite lives:** |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Trademarks  and trade names            |       | 850                          |       | —                      |       | 850 |   | 850 |   | — |   | 850 |   |
| Total  intangible assets, net          |       | $                            | 4,652      |                        | $          | 642 |   | $ | 5,294 |   | $ | 5,876 |   | $ | 742 |   | $ | 6,618 |   |

 

In accordance with FASBguidance for accounting for the impairment or disposal of long-lived assets,the Company reevaluates the carrying value of identifiable intangible andlong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying value may not be recoverable.

 

In September 2009,the Company engaged  an investmentbanking firm to evaluate the feasibility of selling RO Associates Incorporated(“RO”), a wholly-owned subsidiary of the Company that operates within  the Company’s electronic devices segment, withthe intent to gauge the level of interest from outside parties to purchase thecapital stock or all or substantially all of the assets of RO and to determinepossible values ascribed to RO by such parties in connection with such apotential sale of RO.

 

As of September 30,2009, discussions with potential buyer for RO had commenced.  However, due the historical and ongoinglosses of RO, it was uncertain as of that date whether or not any offers wouldbe received or, even if such offers were received, whether such offers would bein a value range acceptable to the Company’s Board of Directors.  As a result of the uncertainty surroundingany plan to dispose of RO and the lack of probability of being able to sell,the Company determined that it was inappropriate to classify the RO businessunit as held for sale at September 30, 2009.

 

Subsequent to September 30,2009, presentations were made to all interested buyers, and in November 2009,the Company received more than one bona fide offer to purchase substantiallyall of the assets of RO.  Based on thereceipt of these offers, the Company intends to pursue negotiations for thesale of substantially all of the assets of RO with the intent of consummatingsuch a sale of RO by December 31, 2009.

 

Asa result of the current expectation that RO would be sold before the end of theestimated useful lives of its long-lived assets, the Company performed anassessment of recoverability associated with the long-lived assets of RO.  In connection with that assessment, animpairment loss of $619,000 was recognized, which is included in the Company’sstatement of operations as “Loss on Impairment of Assets” for the three andnine months ended

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

September 30,2009, representing the write-off of long-lived assets other than goodwill andindefinite lived intangibles.

 

**NOTE 9 — INCOME TAXES**

 

The effective taxrate for the three month period ended September 30, 2009 was differentthan the 34% U.S. statutory rate primarily because the Company’s foreignentities generate a tax obligation and related tax expense as a result of theirnet income in their respective foreign locations (either England or France),which cannot be offset by U.S. tax losses or by U.S. tax loss carryforwards.

 

The Company recognizes interest and penalties relatedto uncertain tax positions in interest expense and selling, general andadministrative expense, respectively, in the condensed consolidated statementsof operations and comprehensive income. No interest or penalties wererecognized during 2008. As of September 30, 2009, the Company had nothingaccrued for interest and penalties.

 

The Company files income tax returns in the UnitedStates federal jurisdiction, the United Kingdom and France and in the statejurisdictions of California, Texas, Pennsylvania and New Jersey. The Company isno longer subject to United States federal and state tax examinations for yearsbefore 2005 and 2004, respectively, and is no longer subject to taxexaminations for the United Kingdom and Japan for years prior to 2007, and forFrance for years prior to 2005.

 

**NOTE 10 — LINE OF CREDIT**

 

The Company and itsdirect subsidiaries, EEC, CXR Larus Corporation and RO Associates Incorporated(collectively, the “Borrowers”), are parties to a Credit Agreement (as amendedfrom time to time the “Credit Agreement”) with GVEC Resource IV Inc. (the “Lender”)providing for a credit facility which includes term loans and a revolvingcredit facility and is secured by accounts receivable, other rights to paymentand general intangibles, inventories and equipment. The credit facilityincludes a revolving credit facility for up to $7,000,000 that expires on June 30,2010 (the “Revolver”).  The creditfacility also includes two term loans (see Note 11).

 

The Revolver isformula-based and which generally provides that the outstanding borrowingsunder the line of credit may not exceed an aggregate of 85% of eligibleaccounts receivable, plus 10% of the value of eligible raw materials not toexceed $600,000, plus 50% of the value of eligible finished goods inventory notto exceed $1,500,000, minus the aggregate amount of reserves that may beestablished by the Lender.  The Revolverhas a maturity date of June 30, 2010.

 

Interest on the Revolveris payable monthly.  The interest rate isvariable and is adjusted monthly based on the prime rate as published in the “MoneyRates” column of *The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5% per annum.  The interest rate in effect as of September 30,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis,including the following: EBITDA, as defined in the Credit Agreement, measuredon a fiscal quarter-end basis, must not be less than $250,000 for the periodended September 30, 2009, $550,000 for the period ended December 31,2009 and $1,450,000 for the period ended March 31, 2010; the leverageratio, as defined by the Credit Agreement, measured quarterly, must not begreater than 1.70:1.00 for the period ended September 30, 2009, 1.50:1.00for the period ended December 31, 2009 and 1.40:1.00 for the period ended March 31,2010;  and liquidity, as defined by theCredit Agreement, measured quarterly, must not be less than $2,800,000 for theperiod ended December 31, 2009 and $2,700,000 for the period ended March 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring capital expenditures (a) in excessof $600,000 for the fiscal year ending December 31, 2009, and (b) inexcess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter and the Borrowers not incurring purchase money commitments inexcess of $2 million over the life

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

of the facility.  However, if the Borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and $62,500 maybeincurred in the two fiscal quarters immediately following such fiscal quarter.The Company was in compliance with all covenants at September 30, 2009, asamended. See Note 14.

 

Asof September 30, 2009, the Company had outstanding borrowings of $4.0million under the Revolver with remaining availability under the formula-basedcalculation of $3.0 million.

 

In connection with entering into the Credit Agreement, the Borrowersissued a Revolver Loan Note dated November 30, 2007 (the “Revolver Note”)to the Lender in the principal amount of $7,000,000.  The Revolver Note is governed by the terms ofthe Credit Agreement.

 

See related Note 2 “Going Concern” and Note 11 “Debt” regardingadditional terms and conditions associated with the overall credit facility andrisks associated with this credit facility.

 

**NOTE 11 —DEBT**

 

On August 20, 2008, in connection with theacquisition of ACC and CCI as discussed in Note 3, the Borrowers and the Lenderamended the credit facility to, among other things, include ACC and CCI asBorrowers and to provide for another term loan in the principal amount of $3million (the “Term Loan C”).  The creditfacility, as so amended, provided for borrowings in the aggregate amount of $26million, including the $7 million revolving facility described in Note 10.

 

The credit facilityconsists of (i) the Revolver, (ii) a term loan in the principalamount of $6 million which is due June 30, 2010 (“Term Loan A”), (iii) aterm loan in the original principal amount of $10 million, which is due on June 30,2010 (“Term Loan B”), and (iv) Term Loan C.  Term Loan A was fully funded on November 30,2007 while Term Loans B and C were fully funded on August 20, 2008 inconnection with the acquisition of ACC. Term Loan A and Term Loan B require acombined scheduled principal payment of $75,000 on October 1, 2009,$100,000 on November 1, 2009, $150,000 on December 1, 2009 andapproximately $287,000 commencing on January 1, 2010 and continuing on thefirst day of each of the 5 consecutive months thereafter.  The facility also requires monthly interestpayments and a final balloon payment of principal upon maturity on June 30,2010.  Term Loan C was repaid in full on March 20,2009.  At September 30, 2009, theoutstanding principle balance on Term Loan A was $5.8 million and theoutstanding principle balance on Term Loan B was $2.9 million.  As a result of the partial repayment on TermLoan B in March 2009, a pro-rata portion of the balance of deferredfinancing costs and debt discount were accelerated and are reflected as anadjustment to interest expense in the accompanying Condensed ConsolidatedStatements of Operations for the nine months ended September 30, 2009.

 

The Term Loans A and B bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5% perannum, and require interest only payments in the first year, scheduledprincipal plus interest payments in years two and three, and a final balloonpayment at June 30, 2010.  Intereston the Term Loans is payable monthly.  The Borrowers may make full or partialprepayment of the Term Loans provided that any such prepayment is accompaniedby the applicable prepayment premium.

 

As part of the consideration for entering into theCredit Agreement, the Company issued warrants to purchase 788,000 shares of theCompany’s common stock with a fair value of $1.5 million, which is accountedfor as a discount to the Credit Facility and is amortized over the term of theCredit Agreement.

 

Uponthe sale or disposition by the Borrowers or any of their subsidiaries ofproperty or assets, the Borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with suchsales or dispositions to the extent that the aggregate amount of net cashproceeds received, and not paid to the Lender as a prepayment, for all suchsales or dispositions exceed $150,000 in any fiscal year.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

However,to the extent theCompany sells assets after August 14, 2009 and prior to January 1,2010, 75% of the net cash proceeds of such sale must be used to prepay theCompany’s outstanding obligations to the Lender.

 

If the Lender terminates the credit facility during adefault period or if the Company prepays the Revolver or the Term Loans priorto November 30, 2009, then the Company is subject to a penalty equal to 2%of the outstanding principal balance of the Revolver and the Term Loans. The Revolver is subject to an unused line fee of 0.5% per annum, payablemonthly, on any unused portion of the revolving credit facility.

 

In the event of a default and continuation of adefault, the Lender may accelerate the payment of the principal balancerequiring the Company to pay the entire indebtedness outstanding on thatdate.  Upon the occurrence and during thecontinuation of an event of default, the Lender may also elect to increase theinterest rate applicable to the outstanding balance by four percentage pointsabove the per annum interest rate that would otherwise be applicable.

 

The Borrowers have agreed with the Lender to raise atleast $3 million in net cash proceeds through the sale of stock of theBorrowers by no later than December 31, 2009.  Under the terms of the credit facility, theBorrowers are obligated to remit to the Lender 50% of the first $3 million ofnet cash proceeds received and 30% of the net cash proceeds received in excessof the first $3 million.  See Note 2.

 

See Note 2, Note 10, and Note 14 regarding additional terms andconditions associated with the Company’s credit facility and risks associatedwith this credit facility.

 

**NOTE12 — WARRANTS**

 

In connection with entering into the credit facility (discussed inNote10), the Company issued a seven year warrant to Private Equity ManagementGroup, Inc., an affiliate of the Lender, to purchase up to 775,758 sharesof the Company’s common stock on a cash or cashless basis at an exercise priceof $4.13 per share.  The estimated fairvalue of the warrants was $1.5 million, which was calculated using theBlack-Scholes pricing model.  Thewarrants were originally accounted for as debt discount and the adjustmentresulting from the repricing of the warrants increased the debt discount, whichis being amortized over the remaining life of the credit facility.  The warrants were previously recorded instockholder’s equity.

 

In February 2009, the warrants were amended and reissued inconjunction with an amendment to the credit facility.  Pursuant to the Second Amendment to LoanDocuments, the original warrant was divided into two warrants (each, a “SecondAmended and Restated Warrant” and collectively, the “Second Amended andRestated Warrants”).  Each Second Amended and Restated Warrant covers387,879 shares of the Company’s common stock (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18,2008).  One of the Second Amended and Restated Warrants provides for anexercise price of $1.99 per share (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18,2008).  The other Second Amended and Restated Warrant provides for anexercise price of $1.80 per share (which amount reflects the Company’s 1-for-3.75reverse split of its common stock effective November 18, 2008 and areduction from a post-split exercise price of $3.06 per share).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The exercise price and/or number of shares of common stock issuableupon exercise of the warrants may be adjusted in certain circumstances, includingcertain issuances of securities at a price equal to less than the then currentexercise price, subdivisions and stock splits, stock dividends, combinations,reorganizations, reclassifications, consolidations, mergers or sales ofproperties and assets and upon issuance of certain assets or securities toholders of the Company’s common stock, as applicable. On January 1, 2009,the Company adopted updates to how instruments indexed in an entity’s own stockare accounted for, which resulted in the reclassification of certain of theCompany’s outstanding warrants from stockholders’ equity to liabilities, whichrequires the warrants to be fair valued at each reporting period, with thechanges in fair value recognized in the Company’s consolidated statement ofoperations.

 

At January 1, 2009 and September 30, 2009,the Company had warrants subject to mark to market outstanding to purchase775,758 shares of common stock.  TheCompany computed the fair value of the warrants using a Black-Scholes valuationmodel.  The fair value of these warrantson the date of adoption of January 1, 2009 and on September 30, 2009was determined using the following assumptions:

 
| ** **               | ** ** | **January 1,  2009** | ** ** | **September 30,  2009** | ** ** |
|--------------------------|------------|---------------------------|------------|------------------------------|------------|
| Dividend  yield          |       | None                      |       | None                         |       |
| Expected  volatility     |       | 105                       | %          | 70                           | %          |
| Risk-free  interest rate |       | 0.88                      | %          | 0.95                         | %          |
| Expected  term           |       | 7  years                  |       | 7  years                     |       |
| Stock  price             |       | $                         | 1.58       |                         | $          | 1.38 |   |
|                          |            |                           |            |                              |            |  |  |

 

On January 1, 2009, the Company recorded acumulative effect of change in accounting principle adjustment to itsaccumulated deficit of $473,000 and a corresponding reclassification of theseoutstanding warrants from stockholders’ equity to warrant liability.  As of and for the three and nine monthperiods ended September 30, 2009, the change in fair value of the warrantsresulted in a $53,000 expense and $369,000 income adjustment, respectively, toother income (expense) in the consolidated statement of operations and acorresponding increase or decrease to the warrant liability.

 

**NOTE 13 — FAIR VALUE MEASUREMENTS**

 

FASBguidance defines fair value as the price that would be received to sell anasset or paid to transfer a liability (an exit price) in an orderly transactionbetween market participants and also establishes a fair value hierarchy whichrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value.  The fair value hierarchy distinguishesbetween three levels of inputs that may be utilized when measuring fair valueas follows:

 

Level1 — Inputs are unadjusted quoted prices in active markets for identical assetsor liabilities available at the measurement date.

 

Level2 — Inputs are unadjusted quoted prices for similar assets and liabilities inactive markets, quoted prices for identical or similar assets and liabilitiesin markets that are not active, inputs other than quoted prices that areobservable, and inputs derived from or corroborated by observable market data.

 

Level3 — Inputs that are unobservable inputs which reflect the reporting entity’sown assumptions on what assumptions the market participants would use inpricing the asset or liability based on the best available information.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Asof September 30, 2009, the Company was required to apply updated FASB guidanceto the derivative that is within the warrant that was issued as considerationfor the Company’s credit facility, which is discussed in Note 12 and includedas a discount on the Company’s long-term debt. The derivative was valued using the Black-Scholes model.  The key inputs in the model are as follows:

 
| ** **               | ** ** | **September 30,  2009** | ** ** |
|--------------------------|------------|------------------------------|------------|
| Dividend  yield          |       | None                         |       |
| Expected  volatility     |       | 70                           | %          |
| Risk-free  interest rate |       | 0.95                         | %          |
| Expected  term           |       | 7  years                     |       |
| Stock  price             |       | $                            | 1.38       |   |
|                          |            |                              |            |  |

 

Thederivative is measured at fair value on a recurring basis using significantobservable inputs (Level 2).  The amountof total gain in earnings for the period is as follows (in thousands):

 
| ** **                                 | ** ** | **Warrant  Liability** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| Beginning  balance at January 1, 2009 |       | $                      | 1,010      |   |
| Total  gain realized in earnings           |       | (369                   | )          |
| Ending  balance at September 30, 2009 |       | $                      | 641        |   |

 

**NOTE 14 — SUBSEQUENT EVENTS**

 

Inconnection with the preparation of the Company’s financial statements at September 30,2009, subsequent events through September 30, 2009, the date the financialstatements were available for issuance, have been evaluated and the followingsubsequent events were identified:

 

*Assets Held for Sale*

 

In September 2009,the Company engaged  an investmentbanking firm to evaluate the feasibility of selling the capital stock or substantiallyall of the assets of RO and to determine possible values ascribed to RO by potentialbuyers in connection with such a potential sale of RO.

 

As of September 30,2009, discussions with a potential buyer for RO had commenced.  However, due the historical and ongoinglosses of RO, it was uncertain as of that date whether any offers would bereceived or, even if such offers were received, whether such offers would be ina value range acceptable to the Company’s Board of Directors.  As a result of the uncertainty surroundingany plan to dispose of RO and the lack of probability of a successful sale, theCompany determined that it was inappropriate to classify the RO business unitas held for sale at September 30, 2009.

 

Subsequent to September 30,2009, presentations were made to all interested buyers, and in November 2009,the Company received more than one bona fide offer to purchase substantiallyall of the assets of RO.  Based on thereceipt of these offers, the Company intends to pursue negotiations for thesale of substantially all of the assets of RO with the intent of consummatingsuch a sale of RO by December 31, 2009.

 

Asa result of the current expectation that substantially all of the assets of ROwould be sold before the end of the estimated useful lives of RO’s long-livedassets, the Company performed an assessment of recoverability on November 9,2009 associated with the

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

long-livedassets of RO.  In connection with thatassessment, an impairment loss of $619,000 was recognized, which is included inthe Company’s statement of operations as “Loss on Impairment of Assets” for thethree and nine months ended September 30, 2009, representing the write-offof long-lived assets other than goodwill or indefinite lived intangibles.

 

The Company expects toincur a loss on the sale of the RO assets in the event a sale transaction iscompleted primarily due to the allocated goodwill from the electronic devicesreporting unit.

 

RO contributed $617,000of net sales or 4.3% of the Company’s net sales and an operating loss of $162,000of the Company’s total operating loss from continuing operations of $623,000for the three months ended September 30, 2009.  RO contributed $1.9 million of net sales or4.5% of the Company’s net sales and an operating loss of $0.8 million of theCompany’s total operating loss from continuing operations of $339,000 for thenine months ended September 30, 2009. The following table reflects the major classes of assets and liabilitiesfor RO for the periods presented, including the impairment discussed above (inthousands):

 
| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Cash and cash  equivalents                  |       | $                      | —     |                  | $          | (43 | ) |
| Accounts receivable,  net                   |       | 313                    |       | 409                   |       |
| Inventory, net                              |       | 1,420                  |       | 1,960                 |       |
| Prepaids and other  current assets          |       | 18                     |       | 5                     |       |
| Total current assets                        |       | 1,751                  |       | 2,331                 |       |
|                                        |       |                   |       |                  |       |
| Property, plant and  equipment, net         |       | —                 |       | 211                   |       |
| Goodwill                                    |       | 1,218                  |       | 1,218                 |       |
| Intangible assets other  than goodwill, net |       | 350                    |       | 917                   |       |
| Total Assets                                |       | $                      | 3,319      |                  | $          | 4,677 |   |
|                                        |       |                   |       |                  |       |
| Total current  liabilities                  |       | $                      | 449        |                  | $          | 441 |   |

 

*Amendment to Credit Facility*

 

OnNovember 3, 2009, the Borrowers and the Lender entered into Amendment No. 6to Loan Documents (the “Sixth Amendment”). Pursuant to the terms of the Sixth Amendment, the Credit Agreement wasamended to change the expiration date of the Credit Agreement from November 30,2010 to  June 30, 2010.  As such, all amounts outstanding under theterms of the Credit Agreement (including unpaid principal balance and allaccrued and unpaid interest under the term loans and the Revolver (as definedbelow)) will become due and payable on June 30, 2010, and the Company willbe unable to borrow under the Revolver after that date.  All amounts outstanding under the creditfacility are classified as current liabilities as a component of either “currentportion of long-term debt” or as “line of credit” in the consolidated balancesheet at September 30, 2009.

 

Inaddition, the Borrowers and the Lender agreed to revise the schedule ofprincipal payments due pursuant to the terms of the Sixth Amendment such thatthe Borrowers are now obligated to make monthly principal payments to theLender of (i) $100,000 on November 1, 2009, (ii) $150,000 on December 1,2009 and (iii) approximately $287,000 commencing on January 1, 2010and continuing on the first day of each of the five consecutive monthsthereafter.  A balloon payment of $6.9million will be due and payable on June 30, 2010.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Further,the Borrowers and Lender agreed to revise certain of the financial covenantsrelated to the Revolver.  Under the termsof the Credit Agreement, as amended by the Sixth Amendment, the Revolver issubject to various financial covenants on a consolidated basis, including thefollowing: EBITDA, as defined in the Credit Agreement, measured on a fiscalquarter-end basis, must not be less than $250,000 for the period ended September 30,2009, $550,000 for the period ended December 31, 2009 and $1,450,000 forthe period ended March 31, 2010; the leverage ratio, as defined by theCredit Agreement, measured quarterly, must not be greater than 1.70:1.00 forthe period ended September 30, 2009, 1.50:1.00 for the period ended December 31,2009 and 1.40:1.00 for the period ended March 31, 2010; and liquidity, asdefined by the Credit Agreement, measured quarterly, must not be less than$2,800,000 for the period ended December 31, 2009 and $2,700,000 for theperiod ended March 31, 2010. Additionally, the Revolver is subject to the Borrowers not incurringcapital expenditures (a) in excess of $600,000 for the fiscal year ending December 31,2009, and (b) in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring unfinanced capital expenditures inexcess of $62,500 in any fiscal quarter and the Borrowers not incurringpurchase money commitments in excess of $2 million over the life of thefacility.  However, if the Borrowersincur unfinanced capital expenditures of less than $62,500 in any fiscalquarter, the difference between the amount incurred in a certain fiscal quarterand $62,500 maybe incurred in the two fiscal quarters immediately followingsuch fiscal quarter.

 

Pursuant to the terms of the Sixth Amendment, the Borrowers (i) paidto Private Equity Management Group, Inc. (“PEMG”) an amount equal to$100,000 upon the closing of the Sixth Amendment and (ii) agreed to pay anadditional $100,000 to PEMG on the earlier of March 31, 2010 or therepayment in full of the amounts due and payable under the terms of the CreditAgreement.  The foregoing paymentsrepresent an advisory fee to PEMG in consideration of PEMG’s advice inconnection with the Sixth Amendment.

 

OnNovember 13, 2009, the Borrowers and the Lender entered into Amendment No. 7to Loan Documents (the “Seventh Amendment”). Pursuant to the terms of the Seventh Amendment, the definition of theterm “EBITDA” in the Credit Agreement was amended such that  (i) any non-cash impairmentassociated with the write down of the long-lived assets of RO, a Borrower underthe credit facility, and (ii) any loss or non-cash impairment associatedwith the discontinuation of operations, pursuant to a sale or otherwise, of ROrecorded in the Parent’s and Subsidiaries’ consolidated financial statements inany period ending on or prior to December 31, 2009 were excludedfrom the definition of EBITDA.  Pursuantto the terms of the Seventh Amendment, the Borrowers paid to PEMG an amountequal to $15,000 upon the closing of the Seventh Amendment.

 

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

 

 

**Cautionary Statement**

 

The followingdiscussion should be read in conjunction with our unaudited condensedconsolidated financial statements and the related notes thereto contained in Part I,Item 1 of this Quarterly Report on Form 10-Q. The information contained inthis report is not a complete description of our business or the risksassociated with an investment in our common stock. We urge you to carefullyreview and consider the various disclosures made by us in this report and inour other reports filed with the Securities and Exchange Commission, orCommission, including our Annual Report on Form 10-K for the year ended December 31,2008 and subsequent reports on Forms 10-Q/A and 8-K, which discuss our businessin greater detail.  This report and thefollowing discussion contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

**·**                  our ability to continue to borrow funds under the terms of our creditfacility (see “ — Liquidity and Capital Resources”);

**·**                  our ability to raise at least $3 million in net cash proceeds through thesale of stock of the Company or its subsidiaries by no later than December 31,2009, as required by our lender under the terms of the credit facility;

**·**                  our ability to find and secure alternate financing to our current creditfacility on or before June 30, 2010;

**·**                  exposure to and impacts of various international risks including legal,business, political and economic risks associated with our internationaloperations, including risks associated with foreign currency translation (see “-ForeignCurrency Translation”);

**·**                  the projected growth or contraction in the electronic devices andcommunications equipment markets in which we operate;

**·**                  our strategies for expanding, maintaining or contracting our presence inthese markets;

**·**                  anticipated trends in our financial condition and results of operations;

**·**                  our ability to distinguish ourselves from our current and futurecompetitors;

**·**                  our ability to secure long term purchase orders;

**·**                  our ability to deliver against existing or future backlog;

**·**                  technical or quality issues experienced by us, our suppliers and/or ourcustomers;

**·**                  failure to comply with existing or future government or industrystandards and regulations;

**·**                  our ability to successfully locate, acquire and integrate any possiblefuture acquisitions;

**·**                  our ability to successfully support the working capital needs of ourcompany;

**·**                  the impact of current and/or future economic conditions, including butnot limited to the overall condition of the stock market, the overall creditmarket, political, economic and/or other constraints which are or maynegatively impact the industries in which we participate and/or the ability forus to market the products which we sell; and

**·**                  our ability to successfully compete against competitors that in manycases are larger than us, have access to significantly more working capital thanus and have significant resources in comparison to us.

** **

**We do notundertake to update, revise or correct any forward-looking statements.**

** **

Any of the factorsdescribed above or in the “Risk Factors” sections contained in our AnnualReport on Form 10-K for the year ended December 31, 2008, ourQuarterly Reports on Form 10-Q/A for the quarterly period ended March 31,2009 and June 30, 2009, and in this report could cause our financialresults, including our 

 

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net income or loss or growth in net income or loss to differ materiallyfrom prior results, which in turn could, among other things, cause the price ofour common stock to fluctuate substantially.

 

**Recent Transactions**

 

On March 20, 2009, we completed the sale of substantially all theassets of the Digitran division of our wholly-owned subsidiary, EMRISEElectronics Corporation, or EEC, and all the capital stock of ECC’swholly-owned subsidiary, XCEL Japan Ltd., which primarily acted as a salesoffice for the Digitran division, to Electro Switch Corp.  In this report we refer to the businesses ofthe Digitran Division and XCEL Japan, Ltd. as the “Digitran Operations,” and werefer to the sale of the Digitran division and XCEL Japan, Ltd. as the “DigitranTransaction.”  Within our Digitrandivision we manufactured, marketed and sold electro-mechanical digital and newpatented technology very low profileTM rotary switchesfor the worldwide aerospace, defense and industrial markets.  Tokyo-based XCEL Japan Ltd. primarily soldDigitran’s switch product lines in Japan and other countries in Asia. Thesebusinesses were part of our electronic devices business segment.   For purposes of the following discussion andanalysis, the Digitran Operations have been removed from the prior periodcomparisons and the quarterly results of the Digitran Operations are reportedin our Consolidated Statements of Operations for all periods presented as adiscontinued operation.

 

**Business Description**

 

We design, manufacture and market proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We have operations in the U.S., England, and France.  We organize our business in two operating segments:electronic devices and communications equipment. In the first nine months of2009, our electronic devices segment contributed approximately 80% of overallnet sales while the communications segment contributed approximately 20% ofoverall net sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market powersupplies, radio frequency, or RF, and microwave devices for defense, aerospaceand industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for communications applications in defense, publicand private networks and industrial markets, including utilities and transportation.

 

Within our electronic devices segment, we produce a range of power systemsand RF and microwavedevices. This segment is primarily “project” driven with the majority ofrevenues being derived from custom products with long life cycles and highbarriers to entry.  The majority ofmanufacturing and testing is performed in-house or through sub-contractmanufacturers.  Our electronic devicesare used in a wide range of military airborne, seaborne and land-based systems,and in-flight entertainment systems, including the latest next generationin-flight entertainment and communications, or IFE&C, systems, such asapplications for mobile phone, e-mail and internet communications and realtime, on-board satellite and broadcast TV, which are being installed in newcommercial aircraft as well as being retrofitted into existing commercialaircraft.

 

Within our communications equipment segment, we produce a range ofnetwork access equipment, including network timing and synchronizationproducts, for public and private communications networks.  This segment is “end user product” based witha traditional cycle of internally funded development and marketing prior toselling via direct and indirect sales channels. Manufacturing is primarily outsourced. Our communications equipment is used in a broad range of networkapplications primarily for private communications networks, publiccommunications carriers, and also for utility companies and militaryapplications, including homeland security.

 

**Critical Accounting Policies**

** **

Our discussion andanalysis of our financial condition and results of operations is based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the U.S. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the 

 

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date of the financial statements and the reported amount of net salesand expenses for each period. The following represents a summary of ourcritical accounting policies, defined as those policies that we believe are themost important to the portrayal of our financial condition and results ofoperations and that require management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effects ofmatters that are inherently uncertain.

 

***Revenue******Recognition***

 

We derive revenues fromsales of electronic devices and communications equipment products and services.  Our sales are based upon written agreementsor purchase orders that identify the type and quantity of the item and/orservices being purchased and the purchase price.  We recognize revenues when shipment ofproducts has occurred or services have been rendered, no significantobligations remain on our part, and collectability is reasonably assured basedon our credit and collections practices and policies.

 

We recognize revenuesfrom domestic sales of our electronic devices and communications equipment atthe point of shipment of those products. An estimate of warranty cost is recorded at the time the revenue isrecognized.  Product returns areinfrequent and require prior authorization because our sales are final and wequality test our products prior to shipment to ensure the products meet thespecifications of the binding purchase orders under which those products areshipped. Normally, when a customer requests and receives authorization toreturn a product, the request is accompanied by a purchase order for a repairor for a replacement product.

 

Revenue recognition forproducts and services provided by our U.S. subsidiary, Advanced ControlComponents, Inc., or ACC, and our subsidiaries in England depend upon thetype of contract involved.  Engineering/designservices contracts generally entail design and production of a prototype over aterm of up to several years, with revenue deferred until each milestone definedin the contract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  We recognize revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

We recognize revenues forproducts sold by our subsidiary in France at the point of shipment.  Customer discounts are included in theproduct price list provided to the customer. Returns are infrequent and permitted only with prior authorizationbecause these products are shipped based on binding purchase orders and arequality tested prior to shipment.  Anestimate of warranty cost is recorded at the time revenue is recognized.

 

Revenues from servicessuch as repairs and modifications are recognized when the service is completedand invoiced.  For repairs that involveshipment of a repaired product, we recognize repair revenues when the productis shipped back to the customer. Service revenues contribute less than 5% oftotal revenue and, therefore, are considered to be immaterial to overallfinancial results.

 

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***Product Warranty Liabilities***

 

Generally, our products carry a standardone-year, limited parts and labor warranty. In certain circumstances, we provide a two-year limited parts and laborwarranty.  We offer extended warrantiesbeyond two years for an additional cost to our customers.  Products returned under warranty typicallyare tested and repaired or replaced at our option.  Historically, we have not experiencedsignificant warranty costs or returns.

 

We record a liability for estimated costs thatwe expect to incur under our basic limited warranties when product revenue isrecognized.  Factors affecting ourwarranty liability include the number of units sold, the types of productsinvolved, historical and anticipated rates of claim and historical andanticipated costs per claim.  Weperiodically assess the adequacy of our warranty liability accrual based onchanges in these factors.

 

***Inventory******Valuation***

 

Our electronicdevices segment finished goods inventories generally are built to order.  Our communications equipment inventoriesgenerally are built to forecast, which requires us to produce a larger amountof finished goods in our communications equipment business so that ourcustomers can be served promptly.  Ourproducts consist of numerous electronic and other materials, which necessitatethat we exercise detailed inventory management. We value our inventory at the lower of the actual cost to purchase ormanufacture the inventory (first-in, first-out) or the current estimated marketvalue of the inventory (net realizable value). We perform cycle counts ofinventories using an ABC inventory methodology, which groups inventory itemsinto prioritized cycle counting categories, or we conduct physical inventoriesat least once a year.  We regularlyreview inventory quantities on hand and record a provision for excess andobsolete inventory based primarily on our estimated forecast of product demandand production requirements for the next 12 to 24 months. Additionally, todetermine inventory write-down provisions, we review product line inventorylevels and individual items as necessary and periodically review assumptionsabout forecasted demand and market conditions. Any inventory that we determine to be obsolete, either in connectionwith the physical count or at other times of observation, are reserved for andsubsequently written-off.  As of September 30,2009, our total inventory reserves amounted to $5.7 million, of which $3.9million, or 22.0% of total inventory, related to our electronic devices segmentand $1.8 million, or 10% of total inventory, related to our communicationsequipment segment.

 

The electronicdevices and communications equipment industries are characterized by rapidtechnological change, frequent new product development, and rapid productobsolescence that could result in an increase in the amount of obsoleteinventory quantities on hand. Also, our estimates of future product demand mayprove to be inaccurate, in which case we may have understated or overstated theprovision required for excess and obsolete inventory. Although we make everyeffort to ensure the accuracy of our forecasts of future product demand, anysignificant unanticipated changes in demand or technological developments couldhave a significant impact on the value of our inventory and our reportedoperating results.

 

***Foreign Currency Translation***

 

We have foreign subsidiaries that together accounted for approximately51.8% and 67.1% of our net revenues, 36.4% and 29.5% of our assets and 23.3%and 20.7% of our total liabilities as of and for the nine months ended September 30,2009 and 2008, respectively.  In preparing our consolidated financialstatements, we are required to translate the financial statements of ourforeign subsidiaries from the functional currencies in which they keep theiraccounting records into U.S. dollars. This process results in exchange gainsand losses which, under relevant accounting guidance, are included eitherwithin our statement of operations under the caption “other income (expense)”or as a separate part of our net equity under the caption “accumulated othercomprehensive income (loss).”

 

Under relevantaccounting guidance, the treatment of these translation gains or losses dependsupon management’s determination of the functional currency of each subsidiary.This determination involves 

 

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consideration of relevant economic facts and circumstances affectingthe subsidiary. Generally, the currency in which the subsidiary transacts amajority of its transactions, including billings, financing, payroll and otherexpenditures, would be considered the functional currency. However, managementmust also consider any dependency of the subsidiary upon the parent and thenature of the subsidiary’s operations.

 

If managementdeems any subsidiary’s functional currency to be its local currency, then anygain or loss associated with the translation of that subsidiary’s financialstatements is included as a separate component of stockholders’ equity inaccumulated other comprehensive income (loss). However, if management deems the functional currency to be U.S. dollars,then any gain or loss associated with the translation of these financialstatements would be included in other income (expense) within our statement ofoperations.

 

If we dispose ofany of our subsidiaries, any cumulative translation gains or losses previouslyreported as a component of stockholder’s equity in accumulated othercomprehensive income (loss) would be realized into our statement of operations.If we determine that there has been a change in the functional currency of asubsidiary to U.S. dollars, then any translation gains or losses arising afterthe date of the change would be included within our statement of operations.

 

Based on ourassessment of the factors discussed above, we consider the functional currencyof each of our international subsidiaries to be each subsidiary’s localcurrency. Accordingly, we had cumulative translation losses of $1.6 million and$2.8 million that were included as part of accumulated other comprehensiveincome within our balance sheets at September 30, 2009 and December 31,2008, respectively. During the three months ended September 30, 2009 and2008, we included translation losses of $0.1 million and $1.4 million,respectively, under accumulated other comprehensive income and during the ninemonths ended September 30, 2009 and 2008, we included translation gains of$1.3 million and losses of $1.6 million, respectively, under accumulated othercomprehensive income.

 

The magnitude of these gains or losses depends upon movements in theexchange rates of the foreign currencies in which we transact business ascompared to the value of the U.S. dollar. During the three and nine monthsended September 30, 2009, these currencies include the euro and theBritish pound sterling. Any future translation gains or losses could besignificantly higher or lower than those we recorded for these periods.

 

A 2.5 millionBritish pound sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as ofSeptember 30, 2009 ($4.0 million based on the exchange rate at September 30,2009).  Exchange rate losses and gains onthe long-term portion of this loan are recorded in cumulative translation gainsor losses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

We periodicallyevaluate our intangibles, including goodwill, for potential impairment. Ourjudgments regarding the existence of impairment are based on many factorsincluding market conditions and operational performance of our acquiredbusinesses.

 

In assessing potential impairment of goodwill, we consider these factors aswell as forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under FASB guidance for goodwill and other intangible assets, we are required to analyze our goodwill forimpairment issues at least annually or more frequently if an event occurs orcircumstances change that would more likely than not reduce the fair value of areporting unit below its carrying amount. At September 30, 2009, our reported goodwill totaled $14.2million.  In assessing the potentialimpairment of goodwill, we consider forecasted financial performance of theacquired businesses to determine the fair value of the respective assets.

 

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In accordance with FASBguidance for accounting for the impairment or disposal of long-lived assets, wereevaluate the carrying value of identifiable intangible and long-lived assetsfor impairment whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. As a result of the current expectation that substantially all of theassets of our subsidiary RO Associates Incorporated, or RO, would be soldbefore the end of the estimated useful lives of its long-lived assets, we performedan assessment of recoverability associated with the long-lived assets of RO..  In connection with that assessment, animpairment loss of $619,000 was recognized, which is included in our statementof operations as “Loss on Impairment of Assets” for the three and nine monthsended September 30, 2009, representing the write-off of long-lived assetsother than goodwill and indefinite lived intangibles.

 

**Resultsof Operations**

 

**Overview**

** **

The majority ofour products are customized to the unique specifications of our customers andare subject to variable timing of delivery. Shipments of products can be accelerated or delayed due to many reasonsincluding, but not limited to, exceeding or not meeting customer contractrequirements, a change in customer timing or specifications, technology relatedissues and production related issues. Comparability of our revenues and gross profit is difficult from periodto period as most of our sales are for custom products and we typically do nothave recurring orders for standard products. Exceptions to this include certain long-term military contracts andcertain long-term telecommunications contracts.

 

Overall sales fromcontinuing operations increased $1.2 million, or 10%, in the third quarter of2009 as compared to the third quarter of 2008. Our overall net sales of $14.3 million for the third quarter of 2009reflected $2.8 million of additional net sales contributed by ACC, which weacquired on August 20, 2008, and increases from our U.S. communicationsequipment subsidiary, offset by declines in net sales at all of our other electronicdevices subsidiaries and our French communications equipment subsidiary.  While our French communication subsidiaryexperienced a decline in sales due to the impact of the global economic crisis,the declines at our other foreign units were largely due to the impact ofexchange rates between the U.S. dollar and the British pound sterling and theeuro.  Sales from continuing operationsfor the first nine months in 2009 increased $7.1 million, or 20%, compared tothe first nine months of 2008, with ACC contributing approximately $13.3million of additional net sales during the first nine months of 2009 ascompared to the same period in 2008, offset by declines in net sales at all ofour electronic devices subsidiaries and our French communications equipmentsubsidiary.

 

Overall grossprofit from continuing operations, as a percentage of sales, increased to 37.0%in the third quarter of 2009 from 33.4% in the third quarter of 2008.  The increase in gross profit as a percentageof sales was due primarily to the inclusion of ACC sales in 2009 and associatedgross margins in our results partially offset by a slight decrease in grossprofit as a percentage of sales within our communication segment as a result oflower sales volumes within that segment. Gross profit from continuing operations, as a percentage of sales,increased to 36.8% in the first nine months of 2009 compared to 32.2% for thesame period of 2008.

 

The following is adetailed discussion of our results of operations by business segment.  As a result of the sale of our DigitranOperations in March 2009, for purposes of the followingdiscussion and analysis, the Digitran Operations have been removed from theprior period comparisons.  The results ofthe Digitran Operations are reported as a discontinued operation for allperiods presented.

 

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***Comparison of the Three Months Ended September 30, 2009 to theThree Months Ended September 30, 2008***

 

**Net Sales**

 
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **September 30,**  | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                         | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                       | 10,987     |                         | $          | 9,915 |   | $ | 1,072 |   | 10.8 | % |
| *as %  of net sales*                        | * *   | *76.7*                  | *%*        | *75.8*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 3,332                   |       | 3,163                        |       | 169 |   | 5.3 | % |
| *as %  of net sales*                        | * *   | *23.3*                  | *%*        | *24.2*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 14,319                  |       | 13,078                       |       | 1,241 |   | 9.5 | % |
| Discontinued operations                     |       | —                  |       | 2,609                        |       |   |   |   |   |
| Total net sales                             |       | $                       | 14,319     |                         | $          | 15,687 |   |   |   |   |   |
|                                             |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The approximately 11%increase in sales of our electronic devices in the third quarter of 2009 ascompared to the third quarter of 2008 was primarily the result of the inclusionin the third quarter of 2009 of $4.5 million in net sales from ACC, which weacquired in August 2008, compared to only $1.7 million of ACC net salesincluded in the third quarter of 2008. This increase was partially offset by a decrease in sales at all of ourother electronic devices subsidiaries. Our U.S. power supply division had a decrease of approximately $0.1million due to economic conditions.  Theremaining decrease of $1.7 million in sales within our electronic devicessegment is related to our two electronic device foreign subsidiaries and isprimarily due to the impact of exchange rates between the British poundsterling and the U.S. dollar.  On a localcurrency basis, net sales at our foreign electronic device companies wereslightly lower in the third quarter of 2009 as compared to the same quarter in2008 due primarily to the scheduled conclusion of a large customer contractduring the fourth quarter of 2008, which contract contributed significantly tothe third quarter of 2008.  However,exchange rates between the U.S. dollar and the British pound sterlingnegatively impacted the consolidated results of our U.K. subsidiaries whentranslated into U.S. dollars.  Ourelectronic devices subsidiaries in the U.K. experienced an 8% decrease in salesin local currency, the British pound sterling, for the third quarter of 2009compared to the third quarter of 2008. However, when translated into U.S. dollars, these subsidiariesexperienced a 21% decline in net sales for the same period with the differencefrom 8% to 21% being due to the impact of exchange rates.

 

In the fourth quarter of2009, we expect net sales within our electronic devices segment to beconsistent with sales in the fourth quarter of 2008.  In 2010, we expect overall sales levelswithin our electronic devices segment to increase slightly above 2009 levels,as we attempt to continue to grow the business in a very challenging economy.  Exchange rates remain an uncertainty andcould impact our sales positively or negatively throughout 2009 as compared to2008 and into 2010 as compared to 2009. The relationship between the British pound sterling and the U.S. dollarcan have a significant impact on the results of our European electronic deviceoperations as those results are translated into U.S. dollars.

 

*Communications Equipment Segment*

 

The approximately 5%increase in sales of our communications equipment in the third quarter of 2009as compared to the third quarter of 2008 is due to a $0.3 million increase insales at our U.S. subsidiary substantially associated with test equipment salesto satisfy government contracts.  Thisincrease was partially offset by decreases at our French subsidiary where weare continuing to experience the negative impact of poor global economicconditions, especially by the French government, including the French DefenseMinistry.

 

Net sales in ourcommunications equipment segment have been, and are likely to continue to be,negatively impacted by the recent economic conditions as many of ourcommunications equipment products are capital expenditures for our customersand many companies in this industry have announced plans to reduce and/or defercapital expenditures and/or discretionary spending due to current economicconditions and continue

 

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to run their networkswith their existing equipment.  Webelieve that public communication carriers and private networks can onlymaintain this strategy for a short period of time before reinvesting in theirnetworks.  Accordingly, once globaleconomic conditions improve, we believe this segment will benefit more so thanour electronic devices segment, which has not been impacted as severely due tothe defense related nature of that segment. 

 

Net sales in this segmentare expected to increase in the fourth quarter of 2009, as compared to earlierquarters in 2009 primarily due to expected increases in sales at our U.S.subsidiary substantially associated with test equipment sales to satisfygovernment contracts already in our backlog. Moving into 2010, we expect higher sales throughout the year in thissegment as compared to 2009.  We expectincreased sales at our U.S. subsidiary due to additional scheduled and expectedtest equipment sales to satisfy government contracts already in our backlog andhigher expected sales of timing and synchronization products.  We also expect higher sales at our Frenchsubsidiary where we believe sales will improve throughout the year inconnection with a gradual improvement in the French economy, which based onrecent ordering patterns at our French subsidiary, we believe is beginning tooccur.  

 

Exchange rates remain anuncertainty and could impact our sales positively or negatively throughout theremainder of 2009 as compared to 2008. The relationship between the euro as compared to the U.S. dollar canhave a significant impact on the results of our European communication segmentoperations as those results are translated into U.S. dollars.

 

**Gross Profit**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                              | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                   |       |                        |       |   |   |   |   |
| Electronic devices                               |       | $                      | 4,064      |                        | $          | 3,133 |   | $ | 931 |   | 29.7 | % |
| *as a  % of net sales*                           | * *   | *37.0*                 | *%*        | *31.6*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 1,257                  |       | 1,241                       |       | 16 |   | 1.3 | % |
| *as a  % of net sales*                           | * *   | *37.7*                 | *%*        | *39.2*                      | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 5,321                  |       | 4,374                       |       | 947 |   | 21.7 | % |
| *Total  gross margin from continuing operations* | * *   | *37.2*                 | *%*        | *33.4*                      | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                 |       | 1,934                       |       |   |   |   |   |
| Total gross profit                               |       | $                      | 5,321      |                        | $          | 6,308 |   |   |   |   |   |
|                                                  |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from31.6% in the third quarter of 2008 to 37.3% in the third quarter of 2009 isprimarily the result of the inclusion of higher margin products at ACC.  These increases were offset by slightly lowergross profit, as a percentage of sales, at one of our U.K. subsidiaries, due tolower sales, change in product mix and also due to the impact of exchangerates.

 

In 2010, we expectoverall gross margins in our electronic devices segment will remain consistentor will improve slightly as compared to the gross margins achieved throughout2009.  During the remainder of 2009 and throughout2010, we may experience quarter to quarter variability in gross margin due toproduct mix differences and resulting differentials associated with lower grossmargins on our electronic devices used in commercial applications as comparedto gross margins on our electronic devices used in military applications.  Exchange rates remain an uncertainty andcould impact our gross profit positively or negatively through the remainder of2009 and throughout 2010.  Therelationship between the British pound sterling and the U.S. dollar can have asignificant impact on the results of our European electronic device operationsas those results are translated into U.S. dollars.

 

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*Communications Equipment Segment*

 

The decrease in grossmargin as a percentage of net sales for our communications equipment segmentfrom 39.2% in the third quarter of 2008 to 37.7% in the third quarter of 2009is primarily the result of declining sales at our French subsidiary, partiallyoffset by improvements in gross margins at our U.S. communicationsubsidiary.  Gross profit, both as apercentage of sales and on an actual dollar basis, were also slightlyunfavorably impacted as a result of the changes in foreign currency exchangerates between the U.S. dollar and the euro in the third quarter of 2009 ascompared to the third quarter of 2008.

 

We expect that in thefourth quarter of 2009 that this segment will continue to perform at levelsconsistent with gross margins achieved throughout 2009, but at a higher levelof net sales.  During 2010, we expectthis segment to achieve higher gross margin levels than those achievedthroughout 2009 due to higher sales volume and an anticipated change in productmix to include more products with a higher gross profit.  However, due to current economic conditionsand the impact such conditions are having on this segment’s sales, we areuncertain as to exactly when this segment will return to higher gross marginslevels.  Further, we expect that we willcontinue to experience volatility on a quarter to quarter basis due to changesin product mix, timing of shipments, and the impact of exchange rates.

 

**Operating Expenses**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                   |       |                        |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                      | 4,592      |                        | $          | 3,522 |   | $ | (1,070 | ) | (30.4 | )% |
| *as %  of net sales*                                 | * *   | *32.1*                 | *%*        | *26.9*                      | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 733                    |       | 474                         |       | (259 | ) | (54.6 | )% |
| *as %  of net sales*                                 | * *   | *5.1*                  | *%*        | *3.6*                       | *%*        | * * | * * | * * | * * |
| Loss on asset  impairment                            |       | 619                    |       | —                      |       | (619 | ) | 100.0 | % |
| Total operating  expenses from continuing operations |       | 5,944                  |       | 3,996                       |       | (1,948 | ) | (48.7 | )% |
| Discontinued operations                              |       | —                 |       | 721                         |       |   |   |   |   |
| Total operating  expenses                            |       | $                      | 5,944      |                        | $          | 4,717 |   |   |   |   |   |
|                                                      |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The increase in selling,general and administrative (“SG&A”) expenses is primarily the result ofapproximately $0.8 million of additional expenses relating to ACC, which werepresent for only a portion of the third quarter of 2008.  Additionally, we incurred approximately $0.2million of employee termination costs in the third quarter of 2009 associatedwith employee termination costs at our French subsidiary and approximately $0.1million of legal, audit and investment banking related expenses associated withour various refinancing efforts.  Theseincreases were partially offset by decreases in selling, general and administrativeexpenses at nearly all of our business units achieved in connection with ourcost reduction efforts.

 

During the fourthquarter of 2009, we expect SG&A expense to be consistent with previousquarterly expenses throughout 2009 and slightly lower as compared to the fourthquarter in 2008.  In 2010, we expectgeneral and administrative expenses to be approximately $1 million lower than2009 expenses as we realize the full impact or our significant cost reductionefforts at both our business units and at our corporate office.

 

*Engineering and productdevelopment*

 

The increase inengineering and product development costs is primarily due to the addedengineering costs at ACC in the third quarter of 2009 compared to only apartial quarter of 2008.

 

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Engineering costs duringthe fourth quarter of 2009 and throughout 2010 are expected to remainconsistent with expense levels in 2009. Amounts are expected to vary by quarter depending on particular needswithin each segment, including ongoing development efforts for our TiemPoTM product line.

 

*Loss on asset impairment*

 

As a result of thecurrent expectation that substantially all of the assets of RO will likely besold before the end of the estimated useful lives of its long-lived assets, weperformed an assessment of recoverability associated with the long-lived assetsof RO.  In connection with thatassessment, an impairment loss of $619,000 was recognized, which is included inour statement of operations as “Loss on Impairment of Assets” for the threemonths ended September 30, 2009, representing the write-off of long-livedassets other than goodwill and indefinite lived intangibles.

 

**Interest expense**

 

Interest expense was $0.8million for the three months ended September 30, 2009 compared to $0.8million for the three months ended September 30, 2008.  Included in interest expense in the thirdquarter of 2009 were $186,000 of non-cash amortization of deferred financingcosts and non-cash amortization of debt discount compared to $247,000 in thethird quarter of 2008 and $0.1 million in fees to our lender for an amendmentto our credit agreement.

 

**Other income (expense)**

 

We recorded other expenseof $24,000 for the three months ended September 30, 2009 compared to$167,000 for the same period of 2008. Other income (expense) consists primarily of (i) short-termexchange rate gains and losses associated with the volatility of the U.S.dollar to the British pound sterling and euro on the current portion of certainassets and liabilities and, (ii) fair value adjustments on warrants duringthe third quarter of 2009.  The change inthe fair value of warrants during the third quarter of 2009 resulted in expenseof $53,000, which was not present in 2008. The offsetting income of $29,000 for the third quarter of 2009 waspredominantly related to short-term exchange rate gains.

 

**Income tax expense**

 

Income tax benefitamounted to $238,000 for the three months ended September 30, 2009compared to expense of $313,000 for the same period of 2008.  We recorded an income tax benefit as theresult of losses incurred in the first quarter of 2008.  This benefit was partially offset by incometax expense primarily as the result of foreign income tax on foreign earnedprofits in Europe and New Jersey state income taxes on income generated by ACC.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reclassified theincome from our Digitran Operations to discontinued operations and recorded again (net of taxes) on the sale of the Digitran Operations.  In the third quarter of 2009, we recorded adecreasing adjustment to the gain on the sale of Digitran $0.1 millionassociated with certain purchase price adjustments associated with thetransaction and adjusted the taxes to properly reflect the portion of the taxprovision allocable to discontinued operations. In the third quarter of 2008, these operations contributed comparativeincome of $1.2 million.

 

We expect that during thefourth quarter of 2009 we may sell substantially all of the assets of RO.  Upon concluding such a transaction, we wouldreclassify RO as a discontinued operation in our consolidated financialstatements.  The reclassification of ROto discontinued operations would result in a loss from discontinued operationsas a result of reclassifying all of RO’s net losses.  Additionally, we may incur a loss on thesale, which would also be classified under discontinued operations.

 

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**Net loss**

 

We reported a net loss of$1.8 million in the third quarter of 2009 and net income of $0.3 million in thethird quarter of 2008.  Included in ournet loss for the third quarter of 2009 is $0.6 million of non-cash impairmentlosses associated with an impairment analysis performed on RO’s assets,approximately $0.2 million in severance expense associated with our costreduction efforts,  approximately $0.1million of SG&A expenses incurred in connection with our variousrefinancing efforts and $0.6 million in expense associated with the sale ofDigitran Operations, among other things described in more detail above.  We anticipate our net loss to improve infuture quarters, due in large part to the recent cost reduction efforts, whichwe anticipate being concluded during the fourth quarter of 2009.

 

***Comparison of the Nine months Ended September 30, 2009 to the Ninemonths Ended September 30, 2008***

 

**Net Sales**

 
| ** **                                  | ** ** | **Nine Months Ended**  | ** ** | **Variance**                | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                         | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                   |       |                        |       |   |   |   |   |
| Electronic devices                          |       | $                      | 34,231     |                        | $          | 25,358 |   | $ | 8,873 |   | 35.0 | % |
| *as %  of net sales*                        | * *   | *80.0*                 | *%*        | *70.9*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 8,571                  |       | 10,385                      |       | (1,814 | ) | (17.5 | )% |
| *as %  of net sales*                        | * *   | *20.0*                 | *%*        | *29.1*                      | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 42,802                 |       | 35,743                      |       | 7,059 |   | 19.7 | % |
| Discontinued operations                     |       | —                 |       | 6,240                       |       |   |   |   |   |
| Total net sales                             |       | $                      | 42,802     |                        | $          | 41,983 |   |   |   |   |   |
|                                             |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The approximately 35%increase in sales of our electronic devices in the nine months ended September 30,2009 as compared to the same period of 2008 was primarily the result of theinclusion of $15.0 million in net sales from ACC, which we acquired in August 2008,compared to only $1.7 million of ACC net sales included in the nine monthsended September 30, 2008.  Thisincrease was partially offset by a decrease in sales at all of our otherelectronic devices subsidiaries.  Netsales at our U.S. power supply division decreased approximately $1.1 millionduring the first nine months of 2009 as a result of adverse economicconditions.  The remaining decrease of$3.3 million in net sales for this segment related to our foreign subsidiaries,primarily due to the impact of exchange rates on foreign currency.  On a local currency basis, net sales at bothof our foreign electronic device companies were higher in the nine months endedSeptember 30, 2009 as compared to the same period of 2008.  However, exchange rates between the U.S.dollar and the British pound sterling negatively impacted the consolidatedresults of our U.K. subsidiaries when translated into U.S. dollars.  Our electronic devices subsidiaries in theU.K. experienced an 6% increase in sales in local currency, the British poundsterling, for the nine months ending September 30, 2009 compared to thesame period of 2008.  However, when translatedinto U.S. dollars, these subsidiaries experienced a 16% decline in net salesfor the same period with the difference from 6% to 16% being due to the impactof exchange rates.

 

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*Communications Equipment Segment*

 

The approximately 18%decrease in sales of our communications equipment in the nine months ended September 30,2009 as compared to the same period in 2008 is due to an overall decrease in ordersand shipments for network access products, especially at our Frenchsubsidiary.  Net sales at our Frenchsubsidiary were down $1.9 million in the first nine months of 2009 compared tothe first nine months of 2008 due largely to the impacts of the global economiccrisis and spending reductions, especially by the French government, includingthe French Defense Ministry.  Thesedecreases were offset slightly by higher test equipment sales in the thirdquarter of 2009 by our U.S. communications subsidiary.  Net sales at our French subsidiary were alsoslightly impacted by the unfavorable effects of exchange rates in 2009 ascompared to 2008 between the U.S. dollar and the euro on the translation of thefinancial results of our European operations into U.S. dollars.  Our French subsidiary experienced an 23%decrease in sales in local currency, the euro, for the nine months ending September 30,2009 compared to the same period of 2008. However, when translated into U.S. dollars, our French subsidiary experienceda 28% decline in net sales for the same period with the difference from 23% to28% being due to the impact of exchange rates.

 

**Gross Profit**

 
| ** **                                       | ** ** | **Nine Months Ended**  | ** ** | **Variance**                | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                              | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                   |       |                        |       |   |   |   |   |
| Electronic devices                               |       | $                      | 12,734     |                        | $          | 7,273 |   | $ | 5,461 |   | 75.1 | % |
| *as a  % of net sales*                           | * *   | *37.2*                 | *%*        | *28.7*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 3,003                  |       | 4,254                       |       | (1,251 | ) | (29.4 | )% |
| *as a  % of net sales*                           | * *   | *35.0*                 | *%*        | *41.0*                      | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 15,737                 |       | 11,527                      |       | 4,210 |   | 36.5 | % |
| *Total  gross margin from continuing operations* | * *   | *36.8*                 | *%*        | *32.2*                      | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                 |       | 4,179                       |       |   |   |   |   |
| Total gross profit                               |       | $                      | 15,737     |                        | $          | 15,706 |   |   |   |   |   |
|                                                  |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from28.7% in the first nine months of 2008 to 37.2% in the first nine months of2009 is primarily the result of the inclusion of higher margin products at ACCand an increase in gross profit as a percentage of sales at our Europeanoperations due to the effects of higher sales volumes, favorable product mixand the impacts of our cost reduction efforts resulting in lower fixed overheadmanufacturing costs..  This increase waspartially offset by a reduction in gross margin at our U.S. power supplydivision due to a write down of approximately $0.3 million of certaininventories to the lower of cost or market during the first quarter of 2009 andapproximately $0.1 million of severance costs incurred in the second quarter of2009 associated with our cost reduction efforts.

 

*Communications Equipment Segment*

 

The decrease in grossmargin for our communications equipment segment from 41.0% in the first ninemonths of 2008 to 35.0% in the first nine months of 2009 is primarily theresult of decreased sales of both network access products and timing andsynchronization products due to a slow-down of purchases being made by ourcustomers of these products.  Grossprofit, both as a percentage of net sales and on an actual dollar basis, wasalso unfavorably impacted as a result of the changes in foreign currencyexchange rates between the U.S. dollar and the euro in the first nine months of2009 as compared to the same period of 2008.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Nine Months Ended**  | ** ** | **Variance**                | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                   |       |                        |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                      | 13,486     |                        | $          | 10,589 |   | $ | (2,897 | ) | (27.4 | )% |
| *as %  of net sales*                                 | * *   | *31.5*                 | *%*        | *29.6*                      | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 1,971                  |       | 1,585                       |       | (386 | ) | (24.4 | )% |
| *as %  of net sales*                                 | * *   | *4.6*                  | *%*        | *4.4*                       | *%*        | * * | * * | * * | * * |
| Loss on asset impairment                             |       | 619                    |       | —                      |       | (619 | ) | 100.0 | % |
| Total operating  expenses from continuing operations |       | 16,076                 |       | 12,174                      |       | (3,902 | ) | (32.1 | )% |
| Discontinued operations                              |       | —                 |       | 1,970                       |       |   |   |   |   |
| Total operating  expenses                            |       | $                      | 16,076     |                        | $          | 14,144 |   |   |   |   |   |
|                                                      |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The increase in SG&Ais primarily the result of approximately $3.8 million of additional expensesrelating to ACC, which we acquired in August 2008, and therefore weincurred such expense during only a portion of the third quarter of 2008compared to the entire third quarter of 2009. These increases were partially offset by significant decreases inSG&A at most of our business units, primarily as a result of cost reductionactivities.

 

*Engineering and productdevelopment*

 

The increase inengineering and product development costs is primarily due to the addedengineering costs at ACC offset by a slight reduction in engineering costs atsome of our business units as compared to the prior year.

 

*Loss on asset impairment*

 

As a result of thecurrent expectation that substantially all of the assets of RO will likely besold before the end of the estimated useful lives of its long-lived assets, weperformed an assessment of recoverability associated with the long-lived assetsof RO.  In connection with that assessment,an impairment loss of $619,000 was recognized, which is included in ourstatement of operations as “Loss on Impairment of Assets” for the nine monthsended September 30, 2009, representing the write-off of long-lived assetsother than goodwill and indefinite lived intangibles.

 

**Interest expense**

 

Interest expense was $3.2million for the nine months ended September 30, 2009 compared to $2.0million for the nine months ended September 30, 2008.  Included in interest expense in the firstnine months of 2009 were $0.3 million in fees paid to our lender in connectionwith modifications to our credit facility in the first nine months of 2009, and$1.2 million of non-cash amortization of deferred financing costs and non-cashamortization of debt discount, including $0.5 million due to the accelerationof deferred financing costs and debt discount amortization associated with thepartial repayment of our Term Loan B in the first quarter of 2009, compared to$0.7 million of non-cash amortization in the first nine months of 2008.

 

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**Other income (expense)**

 

We recorded other incomeof $144,000 for the nine months ended September 30, 2009 compared toexpense of $64,000 for the same period of 2008. Other income (expense) consists primarily of (i) short-termexchange rate gains and losses associated with the volatility of the U.S.dollar to the British pound sterling and euro on the current portion of certainassets and liabilities and (ii) fair value adjustments on warrants.  The change in the fair value of warrantsduring the first nine months of 2009 resulted in income of $369,000, which wasnot present in 2008.  The remaining expenseof $225,000 for the nine months ended September 30, 2009 was predominantlyrelated to short-term exchange rate losses.

 

**Income tax expense**

 

Income tax benefitamounted to $596,000 for the nine months ended September 30, 2009 comparedto income tax expense of $393,000 for the same period of 2008.  We recorded an income tax benefit as theresult of losses incurred in the first nine months of 2009 relating tocontinuing operations.  This benefit waspartially offset by income tax expense incurred primarily as the result offoreign income tax on foreign earned profits in Europe and New Jersey stateincome taxes on income generated by ACC.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $5.8 million (net of $1.3 million intaxes) during the first nine months of 2009, which includes a $7.0 million gainon the sale of assets.  In the first ninemonths of 2008, these operations contributed comparative income of $2.2million.

 

**Net income (loss)**

 

We reported net income of$2.6 million in the nine months ended September 30, 2009 and a net loss of$0.8 million in the same period of 2008. Included in net income in the first nine months of 2009 was a $5.3million (net of $1.9 million in taxes) income/gain on discontinued operationsassociated with the sale of our Digitran Operations, approximately $0.3 millionin inventory write downs, $0.5 million in accelerated amortization of deferred financingcosts and debt discount associated with the partial repayment of our Term LoanB in March 2009, $0.6 million of impairment losses associated with animpairment analysis performed on RO’s assets, $0.5 million of employeetermination costs associated with the cost reduction efforts at several of ourfacilities, $0.2 million in fees associated with a waiver and amendmentreceived from our lender in the first nine months of 2009 and $0.1 million ofexpenses incurred in connection with various refinancing efforts.  We anticipate net loss to improve in futureperiods, due in large part to our recent cost reduction efforts, which weanticipate being concluded during the fourth quarter of 2009.

 

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**Liquidity andCapital Resources**

 

In making anassessment of our liquidity, we believe that the items in our financialstatements that are most relevant to our ongoing operations are workingcapital, cash generated from operating activities and cash available fromfinancing activities.  During the firstnine months of 2009, we funded our daily cash flow requirements through fundsprovided by operations and through borrowings under our credit facility withGVEC Resource IV Inc. (“GVEC” or the “Lender”).  Working capital from continuing operationswas a negative $975,000 at September 30, 2009 as compared to a positive$5.5 million at December 31, 2008. Significant items that positivelyimpacted working capital from continuing operations from December 31, 2008until September 30, 2009 are (i) an increase in cash of approximately$0.5 million, (ii) accrual of $1.0 million in additional contingent cashconsideration associated with the acquisition of ACC and (iii) a decreasein accounts payable and accrued expenses of $1.9 million. Working capital fromcontinuing operations from December 31, 2008 until September 30, 2009was negatively impacted most significantly by the reclassification of our TermLoan A and B from long-term to short-term as a result of their June 30,2010 maturity date, the accrual of additional contingent cash considerationassociated with the acquisition of ACC and, to a lesser extent, a decrease inaccounts receivable from continuing operations of $2.1 million due to improvedcollections.  At September 30, 2009and December 31, 2008, we had accumulated deficitsof $25.0 million and $28.1 million, respectively, and cash and cash equivalents of$3.9 million and $3.2million, respectively.  Our cash balances are often significantlyhigher at the end of the month than at other times throughout the remainder ofthe month as a result of borrowings under our credit facility generallyoccurring toward the end of the month and timing of payments to vendors in theform of accounts payable, payroll and interest payments generally occurring atthe beginning of the month.

 

Net cash providedby operating activities during the first nine months of 2009 totaled $0.7million.  Our reported net income of $2.6million included a gain on the sale of the Digitran Operations of $5.3 million,net of taxes of $1.9 million. Significant non-cash adjustments to our net income from continuingoperations for the nine months ended September 30, 2009 include (i) theamortization of debt discount and amortization of deferred financing costswhich, on a combined basis, totaled $1.2 million, both of which are non-cashcomponents of interest expense associated with our credit facility, (ii) depreciationand amortization expense which totaled $1.5 million, (iii) a non-cashimpairment charge at our RO subsidiary for $0.6 million, and (iv) a change infair value of common stock warrants which contributed $0.4 million as non-cashcomponent of net income.  Significantuses of cash associated with operating activities during the nine month periodended September 30, 2009 included a decrease in accounts payable andaccrued liabilities by approximately $1.9 million, in part due to payments madeon previously accrued amounts related to the sale of the Digitran Operationsand timing of vendor payments.  Theprimary source of cash associated with operating activities during the ninemonth period was a decrease in accounts receivable, which decreased byapproximately $2.1 million, due primarily to increased efforts to collectoutstanding balances on a more timely basis.

 

Cash generated from our investing activities during the first nine monthsof 2009 totaled $10.2 million. This amount consisted primarily of net cash proceedsgenerated by the March 2009 sale of our Digitran Operations, all of which was used to partiallyrepay the $13 million in term debt that we incurred in connection with ourpurchase of ACC in August 2008.

 

Cash used in financing activities during the first nine months of 2009totaled $11.3 million, which consisted of $11.2 million in repayments ofprincipal owed on longterm debt and notes to stockholders, offset by $0.1 million in net borrowingson our revolving credit facility.

 

As of September 30, 2009, we had outstanding borrowings of$4.0 million under the revolving loan portion of our credit facility.  At September 30, 2009, we had remainingactual availability under a formula-based calculation of $3.0 million under thecredit facility.  Actual remaining availability representsthe additional amount we were eligible to borrow as of September 30,2009.  The full $7 million availableunder our revolving line of credit fluctuates periodically throughout eachmonth depending on timing of borrowings and repayments.

 

In addition to therevolving lines of credit, at September 30, 2009, we had long-term loansand capitalized lease and equipment loan obligations totaling $12.1 million,the current portion of which loans and obligations

 

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totaled $8.9million.  We also had $1.3 million incontingent cash payments and cash adjustments due to the sellers of ACC, which paymentsare due on or before November 21, 2009.

 

Our backlog from continuingoperations decreased to $27.2million as of September 30, 2009 ascompared to $33.0 million as of December 31,2008. The decrease is due to the reduction of backlog at all of our electronicdevices business units as we satisfied existing contracts during the first ninemonths of 2009.  We experienced a slightincrease in backlog at our U.S. communications equipment business unitassociated with new orders for telecommunications test equipment.  The amount of backlog orders representsrevenue that we anticipate recognizing in the future, as evidenced by purchaseorders and other purchase commitments received from customers, but on whichwork has not yet been initiated or with respect to which work is currently in progress.Our backlog as of September 30, 2009 was approximately 92% related to ourelectronic devices business, which business tends to provide us with longlead-times for our manufacturing processes due to the custom nature of theproducts, and approximately 8% related to our communications equipmentbusiness, which business tends to deliver standard or modified standardproducts from stock as orders are received. We believe that the majority of ourcurrent backlog will be shipped within the next 12 months.  However, there can be no assurance that wewill be successful in fulfilling such orders and commitments in a timely manneror that we will ultimately recognize as revenue the amounts reflected asbacklog.

 

We and our direct subsidiaries, EEC, CXR Larus, RO andACC are parties to a Credit Agreement, as amended, with the Lender, providingfor a credit facility in the aggregate amount of $26,000,000.  As of September 30, 2009, we owed atotal of $12.7 million under the terms of the credit facility.

 

The credit facilitycurrently consists of (i) a revolving loan for up to $7 million thatexpires on June 30, 2010 (the “Revolver”), and (ii) two term loans(Term Loan A and Term Loan B) with an aggregate net outstanding principalamount of $8.5 million as of November 1, 2009. The term loans requireremaining combined scheduled principal payment of $150,000 on December 1,2009 and approximately $287,000 commencing on January 1, 2010 andcontinuing on the first day of each of the 5 consecutive monthsthereafter.  The facility also requiresmonthly interest payments and a final balloon payment of principal uponmaturity on June 30, 2010.  Total remaining aggregate principalpayments on Term Loan A and Term Loan B are $150,000 in 2009 and $8.4 millionin 2010.

 

The Revolver isformula-based and generally provides that the outstanding borrowings under theline of credit may not exceed an aggregate of 85% of eligible accountsreceivable, plus 10% of the value of eligible raw materials not to exceed$600,000, plus 50% of the value of eligible finished goods inventory not toexceed $1,500,000, minus the aggregate amount of reserves that may beestablished by the Lender.  The Revolverhas a maturity date of June 30, 2009.

 

Interest on the Revolveris payable monthly.  The interest rate is variable and is adjusted monthlybased on the prime rate as published in the “Money Rates” column of*The Wall Street Journal* (the “Base Rate”)plus 1.25%, subject to a minimum rate of 9.5% per annum.  The Revolver issubject to various financial covenants on a consolidated basis, including thefollowing: EBITDA, as defined by the Credit Agreement, measured on a fiscalquarter-end basis, must not be less than $250,000 for the period ended September 30,2009, $550,000 for the period ended December 31, 2009 and $1,450,000 forthe period ended March 31, 2010; the leverage ratio, as defined by theCredit Agreement, measured quarterly, must not be greater than 1.70:1.00 forthe period ended September 30, 2009, 1.50:1.00 for the period ended December 31,2009 and 1.40:1.00 for the period ended March 31, 2010;  and liquidity, as defined by the CreditAgreement, measured quarterly, must not be less than $2,800,000 for the periodended December 31, 2009 and $2,700,000 for the period ended March 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring capital expenditures (a) in excessof $600,000 for the fiscal year ending December 31, 2009, and (b) inexcess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter and the borrowers not incurring purchase money commitments inexcess of $2 million over the life of the facility.  However, if the borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and 

 

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$62,500 maybe incurred inthe two fiscal quarters immediately following such fiscal quarter. The Companywas in compliance with all covenants at September 30, 2009.

 

The term loans bear interestat the Base Rate plus 4.25%, subject to a minimum rate of 12.5% per annum.  The borrowers under the credit facility may make fullor partial prepayment of the term loans provided that any such prepayment isaccompanied by the applicable prepayment premium discussed below.

 

Uponthe sale or disposition by the borrowers or any of their subsidiaries ofproperty or assets, the borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with such salesor dispositions to the extent that the aggregate amount of net cash proceedsreceived, and not paid to the Lender as a prepayment, for all such sales ordispositions exceed $150,000 in any fiscal year.  However, to the extent we sell assets after August 14,2009 and prior to January 1, 2010, only 75% of the net cash proceeds ofsuch sale must be used to prepay our outstanding obligations to the Lender.

 

To secure payment of the indebtedness of borrowersunder the credit facility, the borrowers irrevocably pledged and assigned to,and granted to the Lender a continuing security interest in all the personalproperty of the borrowers including the borrowers’ interest in any depositaccounts, the stock of each of the borrowers’ subsidiaries, the intellectualproperty owned by each of the borrowers, and the proceeds of the intellectualproperty owned by each of the borrowers.  In an event of default, theLender may, at its option, exercise any or all remedies available to it withrespect to the collateral.  In addition, certain of the borrowers’ foreignsubsidiaries have agreed to guaranty the borrowers’ performance under thecredit facility.

 

Our current business planrequires additional funding beyond our anticipated cash flows fromoperations.  These and other factorsdescribed in more detail below raise substantial doubt about our ability tocontinue as a going concern.  Our abilityto continue as a going concern is dependent upon our ability to (i) raise $3million in equity capital by December 31, 2009 as required under the terms ofour credit facility, (ii) repay our credit facility on or prior to its maturityon June 30, 2010, (iii) obtain alternate financing to fund operations afterJune 30, 2009 and (iv) achieve profitable operations. 

 

If our net losses continue, we may experience negativecash flow, which may prevent us from continuing operations.  Additionally, losses may result in a defaulton our debt covenants associated with the credit facility.  If we are not able to attain, sustain orincrease profitability on a quarterly or annual basis, we may not be able tocontinue operations and our stock price may decline.   

 

Currently, we are in the process of seeking alternatefinancing from a number of possible participants, including traditional lenders,equity participants and mezzanine lenders. We have engaged financial advisors, Boenning & Scattergood, toassist in this regard.  Although weremain hopeful that we will be able to successfully raise at least $3 millionin equity capital by December 31, 2009 and secure replacement financing on orprior to June 30, 2010, when our current credit facility matures, no assurancescan be made that we will be successful in this regard.  

 

If we cannotmeet our obligations under our credit facility and if our lender does not waiveor renegotiate these obligations, then we would be in default under the termsof our credit facility.     

 

Inthe event of a default and continuation of a default, the lender may limitfuture availability under the Revolver and/or accelerate the payment of allprincipal balances and accrued interest requiring us to pay the entireindebtedness under the credit facility outstanding on that date.  As ofNovember 1, 2009, $13.6 million was outstanding under the credit facility. Wedo not have the ability to pay this amount if the lender accelerated thepayment of the outstanding amount under the credit facility upon adefault.  

 

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Upon theoccurrence and during the continuation of an event of default, the lender mayalso elect to increase the interest rate applicable to the outstanding balanceof the Term Loans A and B by four percentage points above the per annuminterest rate that would otherwise be applicable.  Additionally, if thelender terminates the credit facility during a default period or if we prepaythe Revolver or the Term Loans prior to November 30, 2009, then we are subjectto a penalty equal to 2% of the outstanding principal balance of the Revolverand the Term Loans. 

 

If we are unable to (i) raise the requisite amount of equity capital byDecember 31, 2009 as required under the terms of our credit facility, (ii)continue to borrow funds under the terms of the Revolver, for any reason,through June 30, 2010, or (iii) obtain alternate financing to replace ourcredit facility prior to June 30, 2010, we do not believe that current and future capital resources, revenuesgenerated from operations and other existing sources of liquidity will beadequate to meet our anticipated short term, working capital and capitalexpenditures needs for the next 12 months.  Further, if for any reason, weare not able to continue to borrow funds under the terms of the Revolver or ifwe experience a significant loss of revenue or increase in costs, then our cashflow would be negatively impacted resulting in a cash flow deficit which, inturn, will require us to obtain additional or alternate financing, with littleor no notice.  These potential financing needs could be met in the form ofa revised debt structure with our current lender, additional or new financingwith another lender or lenders, the sale of assets to generate cash or the saleof additional equity to raise capital.  Failure to secure additional oralternate financing, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit the development of new products, or hinder our ability to fulfillexisting or future orders.

 

If we are unsuccessful in securing the necessaryfinancing to continue operations, when needed, then we may be forced to seek protection under the U.S.Bankruptcy Code or be forced into liquidation or substantially restructuring oraltering our business operations and/or debt obligations.

 

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**Effects of Inflation**

** **

The impact of inflation and changingprices has not been significant on the financial condition or results ofoperations of either our company or our operating subsidiaries.

 

**Impacts of NewAccounting Pronouncements**

** **

**FASB Accounting Standards Codification.****TM**  On September 30,2009, we adopted changes issued by the Financial Accounting Standards Board (“FASB”)to the authoritative hierarchy of Generally Accepted Accounting Principles (“GAAP”).  These changes establish the FASB AccountingStandards CodificationTM (“Codification”)as the source of authoritative accounting principles recognized by the FASB tobe applied by nongovernmental entities in preparation of financial statementsin conformity with GAAP.  Rules andinterpretive releases of the Securities and Exchange Commission (“SEC”) underauthority of federal securities laws are also sources of authoritative GAAP forSEC registrants.  The FASB will no longerissue new standards in the form of Statements, FASB Staff Positions, orEmerging Issues Task Force Abstracts; instead the FASB will issue AccountingStandards Updates.  Accounting StandardsUpdates will not be authoritative in their own right as they will only serve toupdate the Codification.  These changesand the Codification itself do not change GAAP. Other than the manner in which new accounting guidance is referenced,the adoption of these changes had no impact on our consolidated financialstatements.

 

**Fair Value Measurements and Disclosure**. In January 2009, we adopted changes issued by the FASB to fairvalue accounting and reporting as it relates to non-financial assets andnon-financial liabilities that are not recognized or disclosed at fair value inthe financial statements on at least an annual basis.  These changes define fair value, establish aframework for measuring fair value in GAAP and expend disclosures about fairvalue measurements.  This guidanceapplies to other GAAP that require or permit fair value measurements and is tobe applied prospectively with limited exceptions.  The adoption of these changes, as it relatesto non-financial assets and liabilities, had no impact on our financialstatements.

 

**Business Combinations**. On January 1, 2009, we adopted an update to existing accountingstandards for business combinations.  Theupdate, which retains the underlying concepts of the original standard in thatall business combinations are still required to be accounted for at fair valueunder the acquisition method of accounting, changes the method of applying theacquisition method.  Acquisition costsare no longer considered part of the fair value of an acquisition and willgenerally be expensed as incurred, non-controlling interests are valued at fairvalue at the acquisition date, in-process research and development is recordedat fair value as an indefinite-lived intangible asset at the acquisition date,restructuring costs associated with a business combination are generallyexpensed subsequent to the acquisition date, and changes in deferred tax assetvaluation allowances and income tax uncertainties after the acquisition dategenerally will affect income tax expense.

 

In April 2009, the FASB issued a further updatein relation to accounting for assets acquired and liabilities assumed in abusiness combination that arise from contingencies, which amends the previousguidance to require contingent assets acquired and liabilities assumed in abusiness combination to be recognized at fair value on the acquisition date iffair value can be reasonably estimated during the measurement period.  If fair value cannot be reasonably estimatedduring the measurement period, the contingent asset or liability would berecognized in accordance with standards and guidance on accounting forcontingencies and reasonable estimateion of the amount of a loss.  Further, this update eliminated the specificsubsequent accounting guidance for contingent assets and liabilities withoutsignificantly revising the original guidance. However, contingent consideration arrangements of an acquiree assumed bythe acquirer in a business combination would still be initially andsubsequently measured at fair value. These updates are applicable prospectively to business combinations forwhich the acquisition date is on or after January 1, 2009.  The adoption of these provisions will have animpact on accounting for any business acquired after January 1, 2009.

 

**Derivatives and Hedging**. On January 1, 2009, we adopted changes issued by the FASB todisclosures about derivative instruments and hedging activities.  These changes require enhanced disclosuresabout an entity’s 

 

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derivative and hedgingactivities, including (i) how and why an entity uses derivativeinstruments, (ii) how derivative instruments and related hedged items areaccounted for, and (iii) how derivative instruments and related hedgeditems affect an entity’s financial position, financial performance and cashflows.  Other than the requireddisclosures, the adoption of these changes had no impact on our consolidatedfinancial statements.

 

On January 1, 2009, we adopted an update issuedby the FASB to the accounting for instruments (or embedded features) indexed toan entity’s own stock.  These changesclarify the determination of whether an instrument (or embedded feature) isindexed to an entity’s own stock, which would qualify as a scope exceptionunder previously issued guidance.  Theadoption of these changes resulted in the reclassification of certain of ouroutstanding warrants from stockholders’ equity to liabilities, which requiresthe warrants to be fair valued at each reporting period, with the changes infair value recognized in our consolidated statement of operations.

 

**Intangibles — Goodwill and Other**. On January 1, 2009, we adopted changes issued by the FASB toaccount for intangible assets.  Thesechanges amend the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset in order to improve the consistency between the useful life ofa recognized intangible asset outside of a business combination and the periodof expected cash flows used to measure the fair value of an intangible asset ina business combination.  The adoption ofthese changes did not have an impact on our consolidated financial statements.

 

**Financial Instruments**. On June 30, 2009, we adopted an update to accounting standards fordisclosures about the fair value of financial instruments, which requirespublicly-traded companies to provide disclosures on the fair value of financialinstruments in the interim financial statements.  Other than the required disclosures, theadoption of this update had no impact on our consolidated financial statements.

 

**Subsequent Events**.  On June 30,2009, we adopted changes issued by the FASB to accounting for and disclosure ofevents that occur after the balance sheet date but before financial statementsare issued or are available to be issued, otherwise known as “subsequentevents.”  Specifically, these changes setforth (1) the period after the balance sheet date during which managementof a reporting entity should evaluate events or transactions that may occur forpotential recognition or disclosure in the financial statements: (2) thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financials statements; and (3) thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date. The adoption of these changes did not have a material impact on ourfinancial statements.

 

**Fair Value Measurements and Disclosure**. In August 2009, the FASB issued an update to the fair valuemeasurement guidance to clarify how an entity should measure liabilities atfair value.  The update reaffirms fairvalue is based on an orderly transaction between market participants, eventhough liabilities are infrequently transferred due to contractual or otherlegal restrictions.  However, identicalliabilities traded in the active market should be used when available.  When quoted prices are not available, thequoted price of the identical liability traded as an asset, quoted prices forsimilar liabilities or similar liabilities traded as an asset, or anothervaluation approach should be used.  Thisupdate also clarifies that restrictions preventing the transfer of a liabilityshould not be considered as a separate input or adjustment in the measurementof fair value.  We will adopt this updatefor fair value measurements of liabilities effective October 1, 2009,which we do not expect to have a material impact on our consolidated financialstatements.

 

**Revenue Recognition**.  In October 2009,the FASB issued an update to existing guidance on revenue recognition forarrangements with multiple deliverables. This update will allow companies to allocate consideration received forqualified separate deliverables using estimated selling prices for bothdelivered and undelivered items when vendor-specific objective evidence orthird-party evidence is unavailable. Additional disclosures discussing the nature of multiple elementarrangements, the types of deliverables under the arrangements, the generaltiming of their deliver, and significant factors and estimates used todetermine estimated selling prices are required.  We will adopt this update for new revenuearrangements entered into or 

 

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materially modifiedbeginning January 1, 2011.  We arestill evaluating the impact, if any, this update may have on our consolidatedfinancial statements.

** **

**ITEM 3.               QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

 

Not applicable.

 

**ITEM 4.               CONTROLS ANDPROCEDURES.**

 

Not applicable.

 

**ITEM 4T.            CONTROLS ANDPROCEDURES.**

 

***Evaluation of Disclosure Controls and Procedures***

*** ***

We conducted an evaluationunder the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, our principalaccounting officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures.  Theterm “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (“ExchangeAct”), means controls and other procedures of a company that are designed toensure that information required to be disclosed by the company in the reportsit files or submits under the Exchange Act is recorded, processed, summarizedand reported, within the time periods specified in the Commission’s rules andforms.  Disclosure controls andprocedures also include, without limitation, controls and procedures designedto ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, or persons performing similar functions, as appropriate, toallow timely decisions regarding required disclosure.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded as of September 30, 2009that our disclosure controls and procedures were not effective at thereasonable assurance level due to the material weaknesses discussed below.

 

Inlight of the four material weaknesses described below, we performed additionalanalysis and other post-closing procedures to ensure that our consolidatedfinancial statements were prepared in accordance with generally acceptedaccounting principles.  Accordingly, webelieve that the consolidated financial statements included in this reportfairly present, in all material respects, our financial condition, results ofoperations and cash flows for the periods presented.

 

Our Chief Executive Officerand Chief Financial Officer concluded that as of September 30, 2009 the followingfour material weaknesses existed:

 

(1)                               We did noteffectively implement comprehensive entity-level internal controls.

 

(2)                               We did not maintain effective controlsover changes to critical financial reporting applications and over access tothese applications and related data.

 

(3)                               We did not maintain a sufficient level ofinformation technology personnel to execute general computing controls over ourinformation technology structure.

 

(4)                               We did notmaintain effective controls over recording and reporting the acceleration ofcertain components of our credit facility and the classification of theissuance of a note relating to a purchase price adjustment.

 

Ifnot remediated, these material weaknesses could result in one or more materialmisstatements in our reported financial statements in a future annual orinterim period.

 

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***Inherent Limitations on the Effectiveness of Controls***

*** ***

Management does not expectthat our disclosure controls and procedures or our internal control overfinancial reporting will prevent or detect all errors and all fraud. A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the control systems are met.Further, the design of a control system must reflect the fact that there areresource constraints, and the benefits of controls must be considered relative totheir costs. Because of the inherent limitations in a cost-effective controlsystem, no evaluation of internal control over financial reporting can provideabsolute assurance that misstatements due to error or fraud will not occur orthat all control issues and instances of fraud, if any, have been or will bedetected.

 

These inherent limitationsinclude the realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of a simple error or mistake. Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls. The design of anysystem of controls is based in part on certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Projectionsof any evaluation of controls effectiveness to future periods are subject torisks. Over time, controls may become inadequate because of changes inconditions or deterioration in the degree of compliance with policies orprocedures.

 

***Material Weaknesses and Related Remediation Initiatives***

*** ***

Set forth below is a summary of the varioussignificant deficiencies which caused management to conclude that we had thefour material weaknesses identified above. Through the efforts of management, external consultants and our AuditCommittee, we are currently in the process of executing specific action plansto remediate the material weaknesses identified above and discussed more fullybelow.  We expect to complete thesevarious action plans by March 31, 2010. If we are able to complete these actions by that date, we anticipatethat all control deficiencies and material weaknesses will be remediated by June 30,2010.

 

(1)           We did not effectively implement comprehensiveentity-level internal controls, as evidenced by the following control deficiencies:

 

·                  Entity Level Internal Control Evaluation.  We did not formally consider entity-widecontrols that are pervasive across our company when considering whether controlactivities are sufficient to address identified risks.

 

·                  Fraud Considerations. We did not conduct regular formalized assessments to consider riskfactors that influence the likelihood of someone committing a fraud and theimpact of a fraud on our financial reporting.

 

·                  Objective Evaluation of Internal Controls.  We did not use an internal audit function orother objective party to provide an objective perspective on key elements ofthe internal control system.

 

·                  External Communication. We lacked formal policies and procedures regarding how and when mattersaffecting the achievement of financial reporting objectives are communicatedwith outside parties.

 

·                  Assessment of Information Technology.  We did not formally evaluate the extent ofthe needed information technology controls in relation to our assessment ofprocesses and systems supporting financial reporting.

 

·                  Information Technology. We did not have sufficient information technology controls, whereapplicable, designed and implemented to support the achievement of financialreporting objectives.

 

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·                  Ongoing and Separate Evaluations.  We did not effectively create and maintaineffective evaluations on the progress of our remediation efforts nor theconstant evaluations of the operating effectiveness of our internal controlsover financial reporting.

 

·                  Reporting Deficiencies. We did not perform timely and sufficient internal or external reportingof our progress and evaluation of prior year material weaknesses or the currentfiscal year internal control deficiencies.

 

(2)           We did not maintain effectivecontrols over changes to critical financial reporting applications and overaccess to these applications and related data, as evidenced by the fact thatcertain of our personnel had unrestricted access to various financialapplication programs and data beyond the requirements of their individual jobresponsibilities. This control deficiency could result in a materialmisstatement of significant accounts or disclosures, including those describedabove, that could result in a material misstatement of our interim or annualconsolidated financial statements that would not be prevented or detected.

 

(3)           We did not maintain a sufficientlevel of information technology personnel to execute general computing controlsover our information technology structure, which include the implementation andassessment of information technology policies and procedures. This controldeficiency did not result in an audit adjustment to our 2008 interim or annualconsolidated financial statements, but could result in a material misstatementof significant accounts or disclosures, which would not have been prevented ordetected.

 

(4)           We did not maintaineffective controls over recording and reporting the acceleration of certaincomponents of our credit facility and the classification of the issuance of anote relating to a purchase price adjustment.  As a result of a review ofour historical financial statements, management concluded that our controlsover (a) recording the acceleration of certain components of our creditfacility and (b) classifying the issuance of a note relating to a purchaseprice adjustment were not in accordance with GAAP.  Based upon this conclusion, the AuditCommittee of our board of directors and our senior management decided, in thethird quarter of 2009, to restate our historical financial statements for eachof the quarterly periods ended March 31, 2009 and June 30, 2009.  Management evaluated the impact of thisrestatement on our assessment of our disclosure controls and procedures andconcluded that the control deficiency that resulted in the incorrect (a) recordingof the acceleration of certain components of our credit facility and (b) classificationof the issuance of a note relating to a purchase price adjustment represented amaterial weakness.

 

***Remediation of Internal Control Deficiencies and Expenditures***

*** ***

The above material weaknesses resulted in adjustmentsto our consolidated financial statements for the quarter ended March 31,2009 and June 30, 2009.  Inaddition, it is reasonably possible that, if not remediated, one or more of thematerial weaknesses described above could result in a material misstatement inour reported financial statements that might result in a material misstatementin a future annual or interim period.

 

In addition to the developing specific action plansfor each of the above material weaknesses, we are taking steps to unify thefinancial reporting of all of our divisions. Accordingly, we are planning to implement a centralized consolidationsoftware package which we believe will facilitate this process and will assistin the remediation of many of the above listed deficiencies.

 

In addition, our audit committee has authorized thehiring of additional temporary staff and/or the use of financial andinformation technology consultants, as necessary, to ensure that we have thedepth and experience to remediate the above listed material weaknesses,including the implementation and monitoring of the appropriate level of controlprocedures related to all of our manufacturing locations and our corporateoffices.  The audit committee will alsowork directly with management and outside consultants, as necessary to ensurethat board level deficiencies are addressed. We are uncertain at this time of the costs to remediate all of the abovelisted material weaknesses, however, we anticipate the cost to be in the rangeof $200,000 to $400,000 (including the cost of the consolidation softwaredescribed above), most of which costs we expect to incur in the first half of2010.  We cannot guarantee that theactual costs to remediate these deficiencies will not exceed this amount.

 

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Through these steps, we believe that we are addressingthe deficiencies that affected our internal control over financial reporting asof September 30, 2009. Because the remedial actions require hiring ofadditional personnel, upgrading certain of our information technology systems,and relying extensively on manual review and approval, the successful operationof these controls for at least several quarters may be required beforemanagement may be able to conclude that the material weakness has beenremediated.  We intend to continue toevaluate and strengthen our internal control over financial reporting systems.These efforts require significant time and resources.  If we are unable to establish adequateinternal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by ourindependent registered public accounting firm, which in turn may have a materialadverse effect on our ability to prepare financial statements in accordancewith GAAP and to comply with our Commission reporting obligations.

 

***Changesin Internal Control over Financial Reporting***

 

There has been no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during the most recently completed fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.                 LEGAL PROCEEDINGS.**

 

Various legal actions and claims may arise against usin the ordinary course of business. In the opinion of management, the ultimateresolution of such possible legal actions and claims will not have a materialadverse effect on our consolidated financial position or our results ofoperations.

 

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

 

Item 1A of Part I of our Form 10-K for theyear ended December 31, 2008 summarizes various material risks thatinvestors should carefully consider before deciding to buy or maintain aninvestment in our common stock.  Any ofthose risks and the additional risk factor described below, if they actuallyoccur, would likely harm our business, financial condition and results ofoperations and could cause the trading price of our common stock to decline.

 

***There issubstantial doubt as to our ability to continue as a going concern.  If we are unable to restructure ourindebtedness and/or raise additional capital in a timely manner, we may******voluntarily seek, or be******forced to seek, protection under the U.S. Bankruptcy Code or be forcedinto liquidation or to substantially restructue or alter our businessoperations and/or debt obligations******.***

 

Our ability to continue as a going concern is dependent upon ourability to (i) raise $3 million in additional capital by December 31,2009, (ii) pay off our credit facility prior to its maturity on June 30,2010, (iii) obtain alternate financing to fund operations after June 30,2010, and (iv) achieve profitable operations.

 

In addition, ifwe default on the terms of our credit facility, our lender may limit futureavailability under the Revolver and/or accelerate the payment of all principalbalances and accrued interest requiring us to pay the entire indebtedness underthe credit facility.

 

If we are (a) notbe able to attain, sustain or increase profitability on a quarterly or annualbasis, (b) not able to obtain alternate financing prior to June 30,2010, or (c) default under the terms of the credit facility and the ourlender were to limit future availability under the Revolver and/or acceleratethe payment of all principal balances and accrued interest requiring us to paythe entire indebtedness under the credit facility, then our ability to continueoperations will be adversely affected and we may voluntarily seek, or be forced to seek, protection under the U.S.Bankruptcy Code or be forced into liquidation or to substantially restructureor alter our business operations and/or debt obligations.  In addition, due to any or all of the reasonsdiscussed above, we may cease to continue as a going concern.

 

If we cease to continue as a going concern, due to lack of availablecapital or otherwise, you may lose your entire investment in our company.

 

***Recentactions taken by the Commission against an affiliate of our lender mayadversely affect our ability to continue to borrow funds under the terms of ourrevolving credit facility with our lender. If our lender limits or terminates our ability to borrow funds under therevolving credit facility, our cash position and our ability to continue day tooperations would be adversely affected, almost immediately.***

 

Recent actions taken by theCommission against PrivateEquity Management Group, Inc., an affiliate of our lenderand our lender, including an order granted in April 2009 by a federalcourt freezing all assets of Private Equity Management Group, Inc. and its affiliates,including our lender, may adversely affect our lender’s ability to continue toprovide us funds under the terms of our revolving credit facility.  At the request of the Commission, the federalcourt also appointed a temporary receiver of our lender’s agent and of ourlender.  If, for any reason, the receiverwere to limit or terminate our ability to continue to borrow funds under ourrevolving credit facility, our cash position and our ability to continue day today operations would be adversely affected, almost immediately.  If that were to occur, we would be requiredto seek additional and/or replacement financing 

 

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immediately.  If we are unable to do so, we may be forcedto drastically curtail or cease operations and possibly seek protection fromour creditors under the U. S. Bankruptcy Code.

 

***Wehave material weaknesses in our internal control over financial reportingstructure which has resulted in the restatement of our financial statements forthe quarterly periods ended March 31, 2009 and June 30, 2009, andwhich, until remedied, may cause errors in our financial statements that couldrequire restatements of our financial statements and investors may loseconfidence in our reported financial information, which could lead to a declinein our stock price.***

 

We have identified four materialweaknesses****in our internal control over financialreporting and cannot assure you that additional material weaknesses will not beidentified in the future.  Management hasconcluded that (i) we did not effectively implement comprehensiveentity-level internal controls; (ii) we did not maintain effective controls over changes tocritical financial reporting applications and over access to these applicationsand related data; (iii) we did not maintain a sufficient level ofinformation technology personnel to execute general computing controls over ourinformation technology structure; and (iv) we did not maintaineffective controls over recording and reporting the acceleration of certaincomponents of our credit facility and the classification of the issuance of anote relating to a purchase price adjustment represented material weaknesses inour internal control over financial reporting. As a result of these material weaknesses, we restated our financialstatements for the quarterly periods ended March 31, 2009 and June 30,2009.  If our internal control overfinancial reporting or disclosure controls and procedures are not effective,there may be errors in our financial statements that could require additionalrestatements and investors may lose confidence in our reported financialinformation, which could lead to a decline in our stock price.

 

Section 404 of theSarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of ourinternal control over financial reporting as of the end of each year, and toinclude a management report assessing the effectiveness of our internal controlover financial reporting in each Annual Report on Form 10-K.

 

Our management, including our ChiefExecutive Officer and Chief Financial Officer, does not expect that ourinternal control over financial reporting will prevent all error and all fraud.A control system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met. Further, the design of a control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe controls. Over time, controls may become inadequate because changes inconditions or deterioration in the degree of compliance with policies orprocedures may occur. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

 

As a result, we cannot assure youthat significant deficiencies or material weaknesses in our internal controlover financial reporting will not be identified in the future. Any failure tomaintain or implement required new or improved controls, or any difficulties weencounter in their implementation, could result in significant deficiencies ormaterial weaknesses, cause us to fail to timely meet our periodic reportingobligations, or result in material misstatements in our financial statements.Any such failure could also adversely affect the results of periodic managementevaluations regarding disclosure controls and the effectiveness of our internalcontrol over financial reporting required under Section 404 of theSarbanes-Oxley Act of 2002 and the rules promulgated thereunder. Theexistence of a material weakness could result in errors in our financialstatements that could result in a restatement of financial statements, cause usto fail to timely meet our reporting obligations and cause investors to loseconfidence in our reported financial information, leading to a decline in ourstock price.

 

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**ITEM 2.                 UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

 

**Unregistered Sales of Equity Securities**

 

None.

 

**Dividends**

 

We have not declared or paid any cash dividends on ourcapital stock in the past, and we do not anticipate declaring or paying cashdividends on our common stock in the foreseeable future.  We will pay dividends on our common stockonly if and when declared by our board of directors.  Our board of directors’ ability to declare adividend is subject to restrictions imposed by Delaware law.  In determining whether to declare dividends,the board of directors will consider these restrictions as well as ourfinancial condition, results of operations, working capital requirements,future prospects and other factors it considers relevant.

 

**ITEM 3.                 DEFAULTSUPON SENIOR SECURITIES.**

 

None.

 

**ITEM 4.                 SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None.

 

**ITEM 5.                 OTHERINFORMATION.**

 

None.

 

**ITEM 6.                 EXHIBITS.**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                     |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                |
| 10.1       |       | Amendment Number 5 to  Loan Documents, dated August 14, 2009, by and among EMRISE Corporation,  EMRISE Electronics Corporation, CXR Larus Corporation, RO Associates  Incorporated, Advanced Control Components, Inc., Custom Control  Components, Inc. and GVEC Resource IV Inc.(1) |
|       |       |                                                                                                                                                                                                                                                                                                |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                |
| 32.1       |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                      |

 

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(1) Filed as an exhibitto the Registrant’s quarterly report on Form 10-Q for June 30, 2009filed with the Securities and Exchange Commission on August 14, 2009 andincorporated herein by reference.

 

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**SIGNATURES**

 

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

 
|                           | EMRISE CORPORATION |
|--------------------------------|--------------------|
|                           |               |   |
| Dated:  November 16, 2009 | By:                | /S/  CARMINE T. OLIVA |
|                           |               | Carmine  T. Oliva, |
|                           |               | Chief  Executive Officer |
|                           |               |   |
|                           |               |   |
| Dated:  November 16, 2009 | By:                | /S/  D. JOHN DONOVAN |
|                           |               | D.  John Donovan, Chief Financial Officer (principal financial and accounting  officer) |

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                    |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                               |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 32.1       |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                     |

 

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