Table of Contents

** **

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM10-Q/A**

 

(Mark One)

 

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

 

For the quarterlyperiod ended **June 30, 2009**

 

or

 

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

 

For the transitionperiod from                            to

 

Commission FileNumber **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.) |

 

**611 Industrial Way**

**Eatontown, New Jersey 07224**

(Address of principal executive offices) (Zip code)

 

**(732)389-0355**

(Registrant’stelephone number, including area code)

 

**Notapplicable**

(Former name,former address and former fiscal year, if changed since last 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“large accelerated filer”, “accelerated filer” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

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

 

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 August 13,2009 was 10,213,412.

 

 

 

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Table of Contents

 

**EMRISECORPORATION**

**TABLE OFCONTENTS**

**FORM 10-Q/A**

**FOR THEQUARTERLY PERIOD ENDED JUNE 30, 2009**

 
| **PART I. FINANCIAL  INFORMATION**                                                                                                      |
|-----------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                              |   |   |
| **EXPLANATORY NOTE**                                                                                                                    |   |   |
|                                                                                                                                    |   |   |
| **ITEM 1.**                                                                                                                             | **FINANCIAL STATEMENTS** |   |   |
|                                                                                                                                    |   |   |
| Condensed Consolidated  Balance Sheets as of June 30, 2009 (restated) (unaudited)  and December 31, 2008                      |   | 1 |
|                                                                                                                                    |   |   |
| Condensed  Consolidated Statements of Operations for the Three and Six Months  Ended June 30, 2009 and 2008 (restated) (unaudited) |   | 2 |
|                                                                                                                                    |   |   |
| Condensed  Consolidated Statements of Stockholders’ Equity for the  Six Months Ended June 30, 2009 (restated) (unaudited)     |   | 3 |
|                                                                                                                                    |   |   |
| Condensed  Consolidated Statements of Cash Flows for the Six Months Ended  June 30, 2009 and 2008 (restated) (unaudited)           |   | 4 |
|                                                                                                                                    |   |   |
| Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                       |   | 5 |
|                                                                                                                                    |   |   |
| **ITEM 2.**                                                                                                                             | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS** |   | 26 |
|                                                                                                                                    |   |   |   |
| **ITEM 3.**                                                                                                                             | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK** |   | 44 |
|                                                                                                                                    |   |   |   |
| **ITEM 4.**                                                                                                                             | **CONTROLS AND  PROCEDURES** |   | 45 |
|                                                                                                                                    |   |   |   |
| **ITEM 4T.**                                                                                                                            | **CONTROLS AND  PROCEDURES** |   | 45 |
| ** **                                                                                                                              |   |   |
| **PART II**                                                                                                                        |
| **OTHER INFORMATION**                                                                                                                   |
| ** **                                                                                                                              |   |   |
| **ITEM 6.**                                                                                                                             | **EXHIBITS** |   | 49 |
| ** **                                                                                                                              |   |   |
| **SIGNATURES**                                                                                                                          |   | 50 |

 

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Table of Contents

 

**EXPLANATORY NOTE**

 

The purpose of thisAmendment No. 2 to Form 10-Q (“Amendment”) is to amend our Amendment No. 1filing of a Quarterly Report on Form 10-Q for the quarterly period ended June 30,2009, filed with the Securities and Exchange Commission (“SEC”) on October 2,2009 (the “Amendment No. 1”), which amended our initial filing of aQuarterly Report on Form 10Q for the same period, filed with the SEC on August 14,2009.

 

On April 15, 2010,we filed a Current Report on Form 8-K with the SEC disclosing that ouraudit committee concluded, based on information presented by its independentregistered accounting firm, that an error in the computation and presentation ofthe Company’s income tax expense and liabilities had been made in ourhistorical financial statements.  Thechange affects primarily the classification of income tax expense/benefitbetween discontinued operations and continuing operations and, to a lesserextent, the recording of Federal alternative minimum tax.

 

EMRISE(the “Company”) is the U.S. parent of both U.S. and foreign subsidiaries.  The Company’s credit facility, which includesterm debt and a revolver, was structured such that the assets of all of theU.S. and U.K. subsidiaries were pledged as collateral and that those assetswere to be included in the borrowing base for the revolver.  Additionally, the Company’s lender requiredthat each of the foreign subsidiaries provide a guaranty on the creditfacility.  During the course of the auditof our 2009 financial statements and as a result of the structure of the creditfacility, the Company has determined that Internal Revenue Code (“IRC”) §956requires adjustment of taxable income in each of the years since the inceptionof the credit facility because the earnings and profits of the foreignsubsidiaries are considered deemed distributions to the U.S.  Although the Company has net operating losscarryforwards available to offset the resulting increases to its regulartaxable income, the Company is subject to alternative minimum tax (“AMT”)because the carryforwards do not provide a complete offset in calculating AMTincome.  The Company computed the AMT,applying the estimated foreign tax credits generated from application of IRC§956 that became available as offsets to the AMT obligation.  As a result, the Company is restating itsfinancial statements for the interim period ended June 30, 2009 (the“Restatement”).  The impact of theRestatement is to reclassify tax expense from discontinued operations tocontinuing operations and to record an incremental AMT associated with the §956income.  In light of the Restatement, the financialstatements and other financial information included in the Amendment No. 1are being restated in this Amendment. This restatement affected Item 1, Financial Statements and relateddisclosures in Item 2, Management’s Discussion and Analysis of FinancialCondition and Results of Operations as it relates to income taxes, income fromdiscontinued operations and liquidity.

 

Since the changes to our10-Q are limited to the tax related issues described above, our Form 10-Q/AAmendment No. 2 for the period ended June 30, 2009 amends andrestates Part I and Part II, Item 6 in its entirety as set forth inthis document.

 

Unless specified, thedisclosures provided in this document have not been updated for more currentinformation.  Therefore, this Amendmentshould be read in conjunction with our other filings made with the SECsubsequent to the date of the Initial Filing.

 

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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)

 
| ** **                                                                                                                                                                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                     | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                     | ** ** | **(Restated)**    | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                                     | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                     |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                     |       | $                 | 4,832      |                  | $          | 3,242 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $221 at June 30, 2009 and  $501 at December 31, 2008                                                                |       | 9,373             |       | 10,333                |       |
| Inventories, net                                                                                                                                                                               |       | 12,916            |       | 12,501                |       |
| Current deferred tax  assets                                                                                                                                                                   |       | 323               |       | 271                   |       |
| Prepaid and other  current assets                                                                                                                                                              |       | 1,302             |       | 1,283                 |       |
| Current assets of  discontinued operations                                                                                                                                                     |       | —            |       | 2,724                 |       |
| Total current assets                                                                                                                                                                           |       | 28,746            |       | 30,354                |       |
|                                                                                                                                                                                           |       |              |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                            |       | 2,761             |       | 2,990                 |       |
| Goodwill                                                                                                                                                                                       |       | 13,368            |       | 9,657                 |       |
| Intangible assets other  than goodwill, net                                                                                                                                                    |       | 6,070             |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                                                            |       | 1,798             |       | 2,191                 |       |
| Other assets                                                                                                                                                                                   |       | 302               |       | 683                   |       |
| Noncurrent assets of  discontinued operations                                                                                                                                                  |       | —            |       | 1,130                 |       |
| Total assets                                                                                                                                                                                   |       | $                 | 53,045     |                  | $          | 53,623 |   |
|                                                                                                                                                                                           |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                  |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                           |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                               |       | $                 | 5,042      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                                                               |       | 6,511             |       | 6,939                 |       |
| Line of credit                                                                                                                                                                                 |       | 5,612             |       | 4,084                 |       |
| Current portion of  long-term debt                                                                                                                                                             |       | 1,974             |       | 5,121                 |       |
| Notes payable to  stockholders, current portion                                                                                                                                                |       | 802               |       | 542                   |       |
| Income taxes payable                                                                                                                                                                           |       | 858               |       | 451                   |       |
| Other current  liabilities                                                                                                                                                                     |       | 649               |       | 357                   |       |
| Current liabilities of  discontinued operations                                                                                                                                                |       | —            |       | 664                   |       |
| Total current  liabilities                                                                                                                                                                     |       | 21,448            |       | 22,783                |       |
|                                                                                                                                                                                           |       |              |       |                  |       |
| Long-term debt, net of  discount of $505 and $980, respectively                                                                                                                                |       | 6,892             |       | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                                                           |       | 2,959             |       | 250                   |       |
| Deferred income taxes                                                                                                                                                                          |       | 1,927             |       | 2,203                 |       |
| Warrant liability                                                                                                                                                                              |       | 587               |       | —                |       |
| Other liabilities                                                                                                                                                                              |       | 449               |       | 503                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                                                             |       | —            |       | 401                   |       |
| Total liabilities                                                                                                                                                                              |       | 34,262            |       | 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  June 30,  2009 and December 31, 2008, respectively |       | 126               |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                                                    |       | 43,407            |       | 44,806                |       |
| Accumulated deficit                                                                                                                                                                            |       | (23,296           | )          | (28,101               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                          |       | (1,454            | )          | (2,827                | )          |
| Total stockholders’  equity                                                                                                                                                               |       | 18,783            |       | 14,004                |       |
| Total liabilities and  stockholders’ equity                                                                                                                                               |       | $                 | 53,045     |                  | $          | 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** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                       | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net Sales                                                                        |       | $                      | 14,270     |                 | $          | 12,022 |   | $ | 28,483 |   | $ | 22,665 |   |
| Cost of Sales                                                                    |       | 8,811                  |       | 8,309                |       | 18,067 |   | 15,512 |   |
| Gross profit                                                                     |       | 5,459                  |       | 3,713                |       | 10,416 |   | 7,153 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                 |       |   |   |   |   |
| Selling, general and  administrative                                             |       | 4,347                  |       | 3,529                |       | 8,894 |   | 7,067 |   |
| Engineering and product  development                                             |       | 716                    |       | 608                  |       | 1,238 |   | 1,111 |   |
| Total operating  expenses                                                        |       | 5,063                  |       | 4,137                |       | 10,132 |   | 8,178 |   |
| Income (loss) from  operations                                                   |       | 396                    |       | (424                 | )          | 284 |   | (1,025 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Other income (expense):                                                          |       |                   |       |                 |       |   |   |   |   |
| Interest income                                                                  |       | 23                     |       | 23                   |       | 69 |   | 41 |   |
| Interest expense                                                                 |       | (842                   | )          | (604                 | )          | (2,398 | ) | (1,188 | ) |
| Other, net                                                                       |       | 210                    |       | 120                  |       | 168 |   | 103 |   |
| Total other expense,  net                                                        |       | (609                   | )          | (461                 | )          | (2,161 | ) | (1,044 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Loss before income  taxes                                                        |       | (213                   | )          | (885                 | )          | (1,877 | ) | (2,069 | ) |
| Income tax provision  (benefit)                                                  |       | 178                    |       | (4                   | )          | 372 |   | 80 |   |
| Loss from continuing  operations                                                 |       | (391                   | )          | (881                 | )          | (2,249 | ) | (2,149 | ) |
| Discontinued  operations:                                                        |       |                   |       |                 |       |   |   |   |   |
| Income (loss) from  discontinued operations including gain on sale of $7,110 YTD |       | (114                   | )          | 625                  |       | 7,288 |   | 996 |   |
| Tax provision (benefit)  on discontinued operations                              |       | —                 |       | —               |       | 707 |   | — |   |
| Net income (loss) from discontinued  operations                                  |       | (114                   | )          | 625                  |       | 6,581 |   | 996 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net Income (loss)                                                                |       | $                      | (505       | )                    | $          | (256 | ) | $ | 4,332 |   | $ | (1,153 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Earnings (loss) per  share:                                                      |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.42 |   | $ | (0.11 | ) |
| Diluted                                                                          |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.42 |   | $ | (0.11 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares  outstanding                                             |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Diluted                                                                          |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |

 

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

 

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**EMRISE CORPORATIONCondensed Consolidated Statements of Stockholders’ Equity**

**(Restated)**

(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 EITF 07-5 |       | —            |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock option exercises                                                            |       | 9                 |       | —      |       | 7               |       | —            |       | —          |       | 7          |       |
| Stock-based  compensation                                                         |       | —            |       | —      |       | 75              |       | —            |       | —          |       | 75         |       |
| Warrants issued for  services                                                     |       | —            |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net income and  comprehensive income                                              |       | —            |       | —      |       | —          |       | 4,332             |       | 1,373           |       | 5,705      |       |
| Balance at  June 30, 2009                                                    |       | 10,213            |       | $           | 126        |            | $          | 43,407            |       | $               | (23,296    | )          | $          | (1,454 | ) | $ | 18,783 |   |

 

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

 

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**EMRISE CORPORATIONCondensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                | ** ** | **June 30,**    | ** ** |
| ** **                                                                                                                                | ** ** | **2009**             | ** ** | **2008** | ** ** |
| ** **                                                                                                                                | ** ** | **(Restated)**       | ** ** | ** ** | ** ** |
|                                                                                                                                      |       |                 |       |   |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                                 | ** ** |                 |       |   |   |
| Net Income (loss)                                                                                                                         |       | $                    | 4,332      |   | $ | (1,153 | ) |
| Adjustments to arrive  at net loss from continuing operations                                                                             |       | (6,581               | )          | (996 | ) |
| Net loss from  continuing operations                                                                                                      |       | (2,249               | )          | (2,149 | ) |
| Reconciliation to net  cash used in operating activities:                                                                                 |       |                 |       |   |   |
| Depreciation and  amortization                                                                                                            |       | 980                  |       | 506 |   |
| Provision for doubtful  accounts                                                                                                          |       | 69                   |       | (46 | ) |
| Provision for inventory  obsolescence                                                                                                     |       | 258                  |       | 522 |   |
| Provision for warranty  reserve                                                                                                           |       | (48                  | )          | 8 |   |
| Deferred taxes                                                                                                                            |       | (292                 | )          | (113 | ) |
| Amortization of  deferred issuance costs                                                                                                  |       | 519                  |       | 216 |   |
| Amortization of debt  discount                                                                                                            |       | 475                  |       | 216 |   |
| Stock-based  compensation expense                                                                                                         |       | 77                   |       | 33 |   |
| Change in common stock  warrant value                                                                                                     |       | (423                 | )          | — |   |
| Changes in assets and  liabilities:                                                                                                       |       |                 |       |   |   |
| Accounts receivable                                                                                                                       |       | 936                  |       | 559 |   |
| Inventories                                                                                                                               |       | (975                 | )          | (734 | ) |
| Prepaid and other  assets                                                                                                                 |       | (156                 | )          | (54 | ) |
| Accounts payable and  accrued expenses                                                                                                    |       | (1,011               | )          | (527 | ) |
| Operating cash flow  used in continuing operations                                                                                        |       | (1,840               | )          | (1,563 | ) |
| Operating cash flow  provided by discontinued operations                                                                                  |       | 1,331                |       | 928 |   |
| Net cash used in  operating activities                                                                                                    |       | (509                 | )          | (635 | ) |
|                                                                                                                                      |       |                 |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                                |       |                 |       |   |   |
| Purchases of property,  plant and equipment                                                                                               |       | (14                  | )          | (50 | ) |
| ACC purchase price  adjustment                                                                                                            |       | 145                  |       | — |   |
| Investing cash flow  provided by (used in) continuing operations                                                                          |       | 131                  |       | (50 | ) |
| Investing cash flow  provided by (used in) discontinued operations including proceeds from sale of  subsidiary operations, net of cash    |       | 10,050               |       | (37 | ) |
| Net cash provided by  (used in) investing activities                                                                                      |       | 10,181               |       | (87 | ) |
|                                                                                                                                      |       |                 |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                                |       |                 |       |   |   |
| Net repayments of lines  of credit                                                                                                        |       | 1,528                |       | (1,950 | ) |
| Repayments of long-term  debt                                                                                                             |       | (10,288              | )          | (143 | ) |
| Payments of notes to  stockholders                                                                                                        |       | (293                 | )          | (271 | ) |
| Proceeds from exercise  of stock options and warrants                                                                                     |       | 7                    |       | — |   |
| Net cash used in  financing activities                                                                                                    |       | (9,046               | )          | (2,364 | ) |
| Effect of exchange rate  changes on cash                                                                                                  |       | 785                  |       | 264 |   |
| Net increase (decrease)  in cash and cash equivalents                                                                                     |       | 1,411                |       | (2,822 | ) |
| Cash and cash  equivalents at beginning of period                                                                                         |       | 3,421                |       | 4,764 |   |
| Cash and cash  equivalents at end of period                                                                                               |       | $                    | 4,832      |   | $ | 1,942 |   |
|                                                                                                                                      |       |                 |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**                                                             |       |                 |       |   |   |
| Acquisition of  equipment through capital lease                                                                                           |       | $                    | 74         |   | $ | 453 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of EITF 07-5 |       | $                    | 473        |   | $ | — |   |
| Issuance of notes  relating to ACC purchase adjustment                                                                                    |       | $                    | 3,116      |   | $ | — |   |

 

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

 

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Table of Contents

 

**EMRISE CORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES, AS RESTATED**

 

*Organization and Business*

 

EMRISE Corporation(the “Company”) designs, manufactures and markets proprietary electronicdevices and communications equipment for aerospace, defense, industrial, andcommunications applications. The Company has operations in the United States(“U.S.“), England and France.  TheCompany conducts its business through two operating segments: electronicdevices and communications equipment. The subsidiaries within the electronicdevices segment design, develop,manufacture and market electronic devices for defense, aerospace and industrialmarkets and operate out of facilities located in the U.S. and England.  The subsidiaries within thecommunications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronization productsand operate out of facilities located in the U.S. and France.

 

In March of2009, the Company sold substantially all the assets related to the Digitrandivision of the Company’s wholly-owned subsidiary, EMRISE ElectronicsCorporation’s (“EEC”), and all of the issued and outstanding equity interestsof EEC’s wholly-owned subsidiary, XCEL Japan, Ltd. (collectively the “DigitranOperations”).  The accompanying financialstatements include the Digitran Operations as a discontinued operation.

 

*Basisof Presentation*

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with the rules and regulations of the Securities and ExchangeCommission (“Commission”) and therefore do not include all information andfootnotes necessary for a complete presentation of the financial position,results of operations and cash flows in conformity with accounting principlesgenerally accepted in the U.S. (“GAAP”). The year end balance sheet was derived from the audited financialstatements at that date, but does not include all of the information andfootnotes required by GAAP for complete financial statements.  The unaudited condensed consolidated financialstatements do, however, reflect all adjustments, consisting of only normalrecurring adjustments, which are, in the opinion of management, necessary tostate fairly the financial position as of June 30, 2009 and the results ofoperations and cash flows for the related interim periods ended June 30,2009 and 2008. However, these results are not necessarily indicative of resultsfor any other interim period or for the year. The accompanying unauditedcondensed consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements included in its annualreport on Form 10-K for the year ended December 31, 2008 as filedwith the Commission.

 

*ComprehensiveIncome (Loss)*

 

Comprehensive income(loss) includes all changes in equity during a period except those thatresulted from investments by or distributions to the Company’sstockholders.  Other comprehensive incomerefers to revenues, expenses, gains and losses that, under GAAP, are includedin comprehensive income, but excluded from net loss as these amounts arerecorded directly as an adjustment to stockholders’ equity.  The Company’s other comprehensive incomeconsists of foreign currency translation adjustments.  The following table reflects the componentsof comprehensive income (loss) (in thousands):

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net income (loss)                        |       | $                      | (505       | )                    | $          | (256 | ) | $ | 4,332 |   | $ | (1,153 | ) |
| Other comprehensive  income (loss):      |       |                   |       |                 |       |   |   |   |   |
| Foreign currency translation  adjustment |       | 1,791                  |       | (3                   | )          | 1,373 |   | 223 |   |
| Comprehensive income  (loss)             |       | $                      | 1,286      |                 | $          | (259 | ) | $ | 5,705 |   | $ | (930 | ) |

 

5

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Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(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, no significantobligations remain on the part of the Company, and collectability is reasonablyassured based on the Company’s credit and collections practices and 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 toseveral years, with revenue deferred until each milestone defined in thecontract is reached.  Production contractsprovide for a specific quantity of products to be produced over a specificperiod of time.  Customers issue bindingpurchase orders or enter into binding agreements for the products to beproduced.  The Company recognizesrevenues on these orders as the products are shipped.  Returns are infrequent and permitted onlywith prior authorization because these products are custom made to order basedon binding purchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

The Company recognizesrevenues for products sold by its subsidiary in France at the point ofshipment.  Customer discounts areincluded in 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 servicessuch as repairs and modifications are recognized when the service is completedand invoiced.  For repairs that involveshipment of a repaired product, the Company recognizes repair revenues when theproduct is shipped back to the customer. Service revenues contribute less than5% of total revenue and, therefore, are considered to be immaterial to overallfinancial results.

 

*ReverseStock Split*

 

OnNovember 19, 2008, the Company completed a 1-for-3.75 reverse split of itscommon stock.  All common stock, stock optionsand warrants to purchase common stock and earnings per share amounts have beenretroactively restated as if the reverse stock split occurred at the beginningof the periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

*Income(Loss) Per Share*

 

Basic income (loss) pershare is computed by dividing net loss by the weighted average common sharesoutstanding during a period.  Dilutedincome (loss) per share is based on the treasury stock method and includes thedilutive effect of stock options and warrants outstanding during theperiod.  Common share equivalents havebeen excluded where their inclusion would be anti-dilutive.  As a result of the loss incurred by theCompany for the three month periods ended June 30, 2009 and 2008, and forthe six month period ended June 30, 2008, the potentially dilutive commonshares have been excluded from the loss per share computation because theirinclusion would have been anti-dilutive. The following table illustrates the computation of basic and dilutedincome (loss) per share (in thousands, except per share amounts):

 

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                                   |       | $                      | (505       | )                    | $          | (256 | ) | $ | 4,332 |   | $ | (1,153 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                 |       |   |   |   |   |
| Basic weighted average  common shares outstanding   |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Effect of dilutive  securities:                     |       |                   |       |                 |       |   |   |   |   |
| Dilutive stock options  and warrants                |       | —                 |       | —               |       | — |   | — |   |
| Diluted weighted  average common shares outstanding |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Basic income (loss) per  share                      |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.42 |   | $ | (0.11 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Diluted  income (loss) per share                    |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.42 |   | $ | (0.11 | ) |

 

The following table showsthe common stock equivalents that were outstanding as of June 30, 2009 and2008, but were not included in the computation of diluted earnings per share asa result of the loss incurred by the Company in the three month periods ended June 30,2009 and 2008, and for the six month period ended June 30, 2008 or becausethe options’ or warrants’ exercise price was greater than the average marketprice of the common shares and, therefore, the effect would have beenanti-dilutive:

 

 
| ** **                            | ** ** | ** **     | ** ** | **Range  of**       | ** ** |
|---------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                            | ** ** | **Number  of** | ** ** | **Exercise  Price** | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Per  Share**      | ** ** |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock options:  |       |           |       |                |       |
| As of June 30,  2009             |       | 651,000        |       | $1.53 — $7.50  |       |
| As of June 30,  2008             |       | 282,000        |       | $0.75 — $7.50  |       |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock warrants: |       |           |       |                |       |
| As of June 30,  2009             |       | 1,804,000      |       | $4.31 — $6.49  |       |
| As of June 30,  2008             |       | 1,798,000      |       | $4.13 — $6.49  |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

In February 2007,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities.” SFAS No. 159 permits anentity to irrevocably elect fair value on a contract-by-contract basis as theinitial and subsequent measurement attribute for many financial assets andliabilities and certain other items including insurance contracts. Entitieselecting the fair value option would be required to recognize changes in fairvalue in earnings and to expense upfront cost and fees associated with the itemfor which the fair value option is elected. SFAS No. 159 is effective forfiscal years beginning after November 15, 2007. The adoption of SFAS No. 159did not have a material effect on the Company’s financial condition or resultsof operations.

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.” This statementprovides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS No. 157 also emphasizes that fairvalue is a market-based measurement, not an entity-specific measurement, andsets out a fair value hierarchy, with the highest priority being quoted pricesin active markets. The required effective date of SFAS No. 157 was thefirst quarter of 2008. The adoption of SFAS No. 157 for financial assetsand liabilities did not have a material effect on the Company’s consolidatedfinancial statements, but resulted in additional disclosures containedherein.  In February 2008, the FASBissued Staff Position No. 157-2, which delayed by one year the effectivedate of SFAS No. 157 for all non-financial assets and liabilities, exceptthose that are recognized or disclosed at fair value in the financialstatements on a recurring basis.  TheCompany has evaluated the impact of the adoption of SFAS No. 157 fornon-financial assets and liabilities and has determined that the adoption ofSFAS No. 157-2 did not have a material effect on its consolidatedfinancial statements.

 

In December 2007,the FASB issued SFAS No. 141R, “Business Combinations,” which replacedSFAS No. 141, “Business Combinations.” SFAS No. 141R establishes principles and requirements fordetermining how an enterprise recognizes and measures the fair value of certainassets and liabilities acquired in a business combination, includingnoncontrolling interests, contingent consideration and certain acquiredcontingencies.  SFAS No. 141R alsorequires acquisition-related transaction expenses and restructuring costs beexpensed as incurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R iseffective for fiscal years beginning after December 15, 2008.  SFAS No. 141R will be applicableprospectively to business combinations for which the acquisition date is on orafter January 1, 2009.  SFAS No. 141Rwill have an impact on accounting for any business acquired after the effectivedate of this pronouncement.

 

In March 2008, theFASB issued SFAS No. 161, “Disclosures about Derivative Instruments andHedging Activities.” The new standard amends SFAS No. 133 and seeks toenhance disclosure about how and why a company uses derivative and hedgingactivities, how derivative instruments and related hedged items are accountedfor under SFAS No. 133 (and the interpretations of that standard) and howderivatives and hedging activities affect a company’s financial position,financial performance and cash flows. SFAS No. 161 is effective for financial statements issued forfiscal years and interim periods beginning after November 15, 2008.  The adoption of SFAS No. 161 did nothave a material effect on the Company’s consolidated financial statements.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination ofthe Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extension assumptionsused to determine the useful life of a recognized intangible asset under SFAS No. 142,“Goodwill and Other Intangible Assets” and also requires expanded disclosurerelated to the determination of intangible asset useful lives. FSP 142-3 iseffective for fiscal years beginning after December 15, 2008. Earlyadoption is prohibited. The adoption of FSP 142-3 did not have a materialeffect on the Company’s consolidated financial statements.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. The Company adopted EITF 07-5 on January 1,2009. See Note 13 **—**Warrants belowfor discussion of the impact of the adoption of EITF 07-5 on the Company’soutstanding stock warrants and its consolidated financial statements.

 

In April 2009, the FASB issued FSP No FAS 107-1and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments”(“FSP FAS 107-1 and APB 28-1”), which amends SFAS No. 107, “Disclosuresabout Fair Value of Financial Instruments,” to require disclosures about fairvalue of financial instruments in interim as well as in annual financialstatements.  FSP No. FAS 107-1 andAPB 28-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” torequire those disclosures in all interim financial results, financial positionand financial statement disclosures.  FSPFAS 107-1 and APB 28-1 is effective for periods ending after June 15,2009.  The Company has adopted FSP FAS107-1 and APB 28-1 and believes it has all of the required disclosures withinthis report.

 

In May 2009, the FASB issued SFAS No. 165,“Subsequent Events” (“SFAS No. 165”) effective for interim or annualfinancial periods ending after June 15, 2009.  For calendar year entities, SFAS No. 165became effective for the three months ended June 30, 2009.  The objective of SFAS No. 165 is toestablish general standards of accounting for and disclosure of events thatoccur after the balance sheet date but before financial statements are issuedor are available to be issued.  Inparticular, SFAS No. 165 sets forth (1) the period after the balancesheet date during which management of a reporting entity should evaluate eventsor transactions that may occur for potential recognition or disclosure in thefinancial statements: (2) the circumstances under which an entity shouldrecognize events or transactions occurring after the balance sheet date in itsfinancials statements; and (3) the disclosures that an entity should makeabout events or transactions that occurred after the balance sheet date.  The adoption of SFAS No. 165 did nothave a material impact on the Company’s financial position, results ofoperations or cash flows.

 

In June 2009, the FASB issued SFAS No. 168,“The FASB Accounting Standards CodificationTM and the Hierarchy of GenerallyAccepted Accounting Principles — a replacement of FASB Statement No. 162”(“SFAS No. 168”) to formally establish the FASB Accounting StandardsCodificationTM (the “Codification”) as the single source of authoritative,nongovernmental U.S. GAAP.  All existingaccounting standards documents are superseded as described in SFAS No. 168.  All other accounting literature not includedin the Codification is nonauthoritative. The Codification is effective for interim and annual periods endingafter September 15, 2009.  TheCompany believes the adoption of SFAS No. 168 will not have a materialimpact on its financial position, results of operations or cash flows.

 

**NOTE 2 — RESTATEMENT OFPREVIOUSLY ISSUED FINANCIAL STATEMENTS**

 

*AmendmentNo. 1, previously filed on October 2, 2009*

 

Thefinancial statements as of and for the period ended June 30, 2009 havebeen restated to correct an error in accounting treatment for certaintransactions.  The Company used $7.0million of the proceeds of the sale of the Digitran Operations on March 20, 2009 to repay aportion of the Term Loan B (as defined in Note 12 below).  The Company did not properly accelerate thepro-rata portion of the deferred financing costs and debt discount associatedwith its credit facility related to the repayment. As a result, the Company isrestating its financial statements for the interim period ended June 30, 2009. Asa result of the partial repayment on Term Loan B, a pro-rata portion of thebalance of deferred financing costs and debt discount were accelerated and are

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

reflected as a decreaseof $81,000 and an increase of $460,000 to interest expense in the accompanyingCondensed Consolidated Statements of Operations for the period ended June 30,2009.  The adjustment also impacted thenet carrying value of long term debt by $259,000 and other various balancesheet items.  Additionally, the Companyincorrectly classified the issuance of a note relating to a purchase priceadjustment on June 30, 2009 as a cash item in its financial statementsrather than a supplemental disclosure item. 

 

The following table illustratesthe correction as it is associated with certain line items in the financialstatements (in thousands):

 

***Balance Sheet***

 
| ** **                                       | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **As  reported**        | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                    |       |   |   |   |   |
| Other current assets                             |       | $                       | 1,429      |   | $ | (127 | ) | $ | 1,302 |   |
|                                             |       |                    |       |   |   |   |   |
| Total current assets                             |       | $                       | 28,873     |   | $ | (127 | ) | $ | 28,746 |   |
|                                             |       |                    |       |   |   |   |   |
| Other assets                                     |       | $                       | 415        |   | $ | (113 | ) | $ | 302 |   |
|                                             |       |                    |       |   |   |   |   |
| Total assets                                     |       | $                       | 53,285     |   | $ | (240 | ) | $ | 53,045 |   |
|                                             |       |                    |       |   |   |   |   |
| Income taxes payable                             |       | $                       | 891        |   | $ | (125 | ) | $ | 766 |   |
|                                             |       |                    |       |   |   |   |   |
| Total current  liabilities                       |       | $                       | 21,481     |   | $ | (125 | ) | $ | 21,356 |   |
|                                             |       |                    |       |   |   |   |   |
| Long-term debt                                   |       | $                       | 6,672      |   | $ | 220 |   | $ | 6,892 |   |
|                                             |       |                    |       |   |   |   |   |
| Total liabilities                                |       | $                       | 34,075     |   | $ | 95 |   | $ | 34,170 |   |
|                                             |       |                    |       |   |   |   |   |
| Accumulated deficit                              |       | $                       | (22,869    | ) | $ | (335 | ) | $ | (23,204 | ) |
|                                             |       |                    |       |   |   |   |   |
| Total stockholder’s  equity                 |       | $                       | 19,210     |   | $ | (335 | ) | $ | 18,875 |   |
|                                             |       |                    |       |   |   |   |   |
| Total liabilities and  stockholder’s equity |       | $                       | 53,285     |   | $ | (240 | ) | $ | 53,045 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

***Statement of Operations***

 
| ** **                            | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **June 30,  2009** | ** ** | **June 30,  2009** | ** ** |
| ** **                            | ** ** | **As  reported**        | ** ** | **Adjustment**          | ** ** | **Restated** | ** ** | **As  reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
| ** **                            | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense                      |       | $                       | (923       | )                       | $          | 81 |   | $ | (842 | ) | $ | (1,938 | ) | $ | (460 | ) | $ | (2,398 | ) |
|                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Pre-tax income                        |       | $                       | (294       | )                       | $          | 81 |   | $ | (213 | ) | $ | (1,417 | ) | $ | (460 | ) | $ | (1,877 | ) |
|                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Provision (benefit) for  income taxes |       | 117                     |       | 28                      |       | 145 |   | (233 | ) | (125 | ) | (358 | ) |
|                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Net income                            |       | $                       | (514       | )                       | $          | 53 |   | $ | (461 | ) | $ | 4,759 |   | $ | (335 | ) | $ | 4,424 |   |
|                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per  share:           |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | $                       | (0.05      | )                       | $          | — |   | $ | (0.05 | ) | $ | 0.47 |   | $ | (0.04 | ) | $ | 0.43 |   |
| Diluted                               |       | $                       | (0.05      | )                       | $          | — |   | $ | (0.05 | ) | $ | 0.47 |   | $ | (0.04 | ) | $ | 0.43 |   |
|                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Weighted average shares  outstanding  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | 10,205                  |       | 10,205                  |       | 10,205 |   | 10,205 |   | 10,205 |   | 10,205 |   |
| Diluted                               |       | 10,205                  |       | 10,205                  |       | 10,205 |   | 10,205 |   | 10,205 |   | 10,205 |   |

 

***Statement of Cash Flows***

 
| ** **                                               | ** ** | **Six  Months Ended**   | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **June 30,  2009** | ** ** |
| ** **                                               | ** ** | **As  reported**        | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                     |       |                    |       |   |   |   |   |
| Net income (loss)                                        |       | $                       | 4,759      |   | $ | (335 | ) | $ | 4,424 |   |
|                                                     |       |                    |       |   |   |   |   |
| Net loss from  continuing operations                     |       | $                       | (1,184     | ) | $ | (335 | ) | $ | (1,519 | ) |
|                                                     |       |                    |       |   |   |   |   |
| Reconciliation to net  cash used in operating activities |       |                    |       |   |   |   |   |
| Amortization of  deferred issuance costs                 |       | $                       | 279        |   | $ | 240 |   | $ | 519 |   |
| Amortization of debt  discount                           |       | $                       | 255        |   | $ | 220 |   | $ | 475 |   |
|                                                     |       |                    |       |   |   |   |   |
| Changes in assets and  liabilities                       |       |                    |       |   |   |   |   |
| Accounts  payable and accrued expenses                   |       | $                       | (978       | ) | $ | (125 | ) | $ | (1,103 | ) |

 

 

*AmendmentNo. 2*

 

Thefinancial statements as of and for the period ended June 30, 2009 havebeen restated to correct an error in the computation and presentation of the Company’sincome tax expense and liabilities.  TheCompany is the U.S. parent of both U.S. and foreign subsidiaries.  The Company’s credit facility (as describedin Notes 11 and 12) was structured such that the assets of all of the U.S. andU.K. subsidiaries were pledged as collateral and that those assets be includedin the borrowing base for the revolver. Additionally, the Lender required that each of the foreign subsidiariesprovide a guaranty on the credit facility. During the audit of the Company’s 2009 financial statements and as aresult of this structure, the Company has determined that Internal Revenue Code(“IRC”) §956 requires adjustment of taxable income in each of the years sincethe inception of the credit facility. Although the Company has net operating loss carryforwards available tooffset the resulting increases to its regular taxable income, the Company issubject to alternative minimum tax (“AMT”) because the carryforwards do notprovide a complete offset in calculating AMT income.  The Company computed the AMT, applying theestimated foreign tax credits generated from application of IRC §956 thatbecame available as offsets to the AMT obligation.  As a result, the Company is restating itsfinancial statements for the interim period ended June 30, 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

2009.  The impact of this restatement is toreclassify tax expense from discontinued operations to continuing operationsand record the incremental AMT associated with the §956 income.

 

The following tableillustrates the correction as it is associated with certain line items in thefinancial statements (in thousands):

** **

***Balance Sheet***

** **
| ** **                                       | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **As reported in**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Amendment 1**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                    |       |   |   |   |   |
| Income taxes payable                             |       | $                       | 766        |   | $ | 92 |   | $ | 858 |   |
|                                             |       |                    |       |   |   |   |   |
| Total current  liabilities                       |       | $                       | 21,356     |   | $ | 92 |   | $ | 21,448 |   |
|                                             |       |                    |       |   |   |   |   |
| Total liabilities                                |       | $                       | 34,170     |   | $ | 92 |   | $ | 34,262 |   |
|                                             |       |                    |       |   |   |   |   |
| Accumulated deficit                              |       | $                       | (23,204    | ) | $ | (92 | ) | $ | (23,296 | ) |
|                                             |       |                    |       |   |   |   |   |
| Total stockholder’s  equity                 |       | $                       | 18,875     |   | $ | (92 | ) | $ | 18,783 |   |
|                                             |       |                    |       |   |   |   |   |
| Total  liabilities and stockholder’s equity |       | $                       | 53,045     |   | $ | — |   | $ | 53,045 |   |

 

***Statement of Operations***

 
| ** **                                | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended**   | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **June 30,  2009** | ** ** | **June 30,  2009** | ** ** |
| ** **                                | ** ** | **As reported in**      | ** ** | ** **              | ** ** | ** ** | ** ** | **As reported in** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Amendment 1**         | ** ** | **Adjustment**          | ** ** | **Restated** | ** ** | **Amendment 1** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                      |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Pre-tax loss                              |       | $                       | (213       | )                       | $          | — |   | $ | (213 | ) | $ | (1,877 | ) | $ | — |   | $ | (1,877 | ) |
| Provision (benefit) for  income taxes     |       | 145                     |       | 33                      |       | 178 |   | (358 | ) | 730 |   | 372 |   |
| Loss from continuing  operations          |       | (358                    | )          | (33                     | )          | (391 | ) | (1,519 | ) | (730 | ) | (2,249 | ) |
| Discontinued  operations:                 |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Income from  discontinued operations      |       | (114                    | )          | —                  |       | (114 | ) | 7,288 |   | — |   | 7,288 |   |
| Tax provision on  discontinued operations |       | (11                     | )          | 11                      |       | — |   | 1,345 |   | (638 | ) | 707 |   |
| Net gain on  discontinued operations      |       | (103                    | )          | (11                     | )          | (114 | ) | 5,943 |   | 638 |   | 6,581 |   |
|                                      |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Net income                                |       | $                       | (461       | )                       | $          | (44 | ) | $ | (505 | ) | $ | 4,424 |   | $ | (92 | ) | $ | 4,332 |   |
|                                      |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per  share:               |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Basic                                     |       | $                       | (0.05      | )                       | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.43 |   | $ | (0.01 | ) | $ | 0.42 |   |
| Diluted                                   |       | $                       | (0.05      | )                       | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.43 |   | $ | (0.01 | ) | $ | 0.42 |   |
|                                      |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Weighted average shares  outstanding      |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Basic                                     |       | 10,205                  |       | —                  |       | 10,205 |   | 10,205 |   | — |   | 10,205 |   |
| Diluted                                   |       | 10,205                  |       | —                  |       | 10,205 |   | 10,205 |   | — |   | 10,205 |   |

 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

***Statement of Cash Flows***

 
| ** **                                                       | ** ** | **Six  Months Ended**   | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **June 30,  2009** | ** ** |
| ** **                                                       | ** ** | **As  reported**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Amendment 1**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                             |       |                    |       |   |   |   |   |
| Net income (loss)                                                |       | $                       | 4,424      |   | $ | (92 | ) | $ | 4,332 |   |
| Adjustments to arrive  at net loss from continuing operations    |       | (5,943                  | )          | (638 | ) | (6,581 | ) |
| Net loss from  continuing operations                             |       | (1,519                  | )          | (730 | ) | (2,249 | ) |
|                                                             |       |                    |       |   |   |   |   |
| Changes in assets and  liabilities                               |       |                    |       |   |   |   |   |
| Accounts payable and  accrued expenses                           |       | $                       | (1,103     | ) | $ | 92 |   | $ | (1,011 | ) |
|                                                             |       |                    |       |   |   |   |   |
| Operating cash flow  provided by (used in) continuing operations |       | $                       | (1,202     | ) | $ | (638 | ) | $ | (1,840 | ) |
|                                                             |       |                    |       |   |   |   |   |
| Operating cash flow  provided by discontinued operations         |       | $                       | 693        |   | $ | 638 |   | $ | 1,331 |   |

 

**NOTE 3 — LIQUIDITY, AS RESTATED**

 

TheCompany reported a net loss for the quarter ended June 30, 2009 of $0.5million and net income for the six months ended June 30, 2009 of $4.3million.  Included in net income for thesix month period was a $6.4 million gain (net of tax of $0.7 million) on thedisposition of the Digitran Operations (see Note 5).  Absent this gain, the Company would haveincurred a $2.1 million net loss for the six months ended June 30,2009.  If the Company’s net losses continue, it mayexperience negative cash flow, which may hamper current operations and mayprevent the Company from expanding its business.  Additionally, such losses may result in adefault on the Company’s debt covenants associated with its credit facility.  The Company may be unable to attain, sustainor increase profitability on a quarterly or annual basis in the future. If theCompany does not achieve, sustain or increase profitability, its stock pricemay decline.

 

The Company has agreedwith its lender 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.  Under the terms of the Company’scredit facility, the Company is obligated to remit to its lender 50% of thefirst $3 million of net cash proceeds received and 30% of the net cash proceedsreceived in excess of the first $3 million.   Given current economic and financial market conditions, an equityraise could prove difficult.   Accordingly,no assurances can be made that the Company will be successful in raising the requiredamount of equity capital by December 31, 2009.  If the Company is successful in structuringan equity raise acceptable to the Company and its lender, the issuance ofequity securities may result in substantial dilution to the Company’sstockholders.

 

Currently, the Company isin the process of seeking alternate financing from a number of possiblelenders, including traditional lenders, private equity and mezzaninelenders.  Although the Company remainshopeful that it will be able to successfully secure replacement financing on atimely basis, no assurances can be made that the Company will be successful inthis regard.

 

The Company is obligatedto make principal payments to its lender of (i) $75,000 on September 1.2009 and October 1, 2009, (ii) $100,000 on November 1, 2009, (iii) $150,000 on December 1, 2009 and (iv) approximately $287,000  commencing on January 1, 2010 andcontinuing on the first day of each of the 10 consecutive months thereafter.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

If the Company cannotmeet or successfully renegotiate its obligations to (i) raise $3.0 millionin equity capital by December 31, 2009, (ii) make monthly principaland interest payments, and/or  (iii) achievecertain other financial covenants, or if the lender does not waive theseobligations, then the Company would be in default under the terms of its creditfacility.

 

In the event of a defaultand continuation of a default, the lender may limit future availability underthe Revolver (as defined in Note 11) and/or accelerate the payment of allprincipal balances and accrued interest requiring the Company to pay the entireindebtedness under the  credit facilityoutstanding on that date.  Upon the occurrence and during the continuationof an event of default, the lender may also elect to increase the interest rateapplicable to the outstanding balance of the Term Loans A and B (as defined inNote 10) by four percentage points above the per annum interest rate that wouldotherwise be applicable.  Any of these conditions could have a materialadverse effect on the Company’s operations and/or ability to conduct businessafter that date.  Additionally, if the lender terminates the creditfacility during a default period or if the Company prepays the Revolver or theTerm Loans 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.

 

Recent actions taken bythe Commission against Private Equity Management Group, Inc., an affiliateof the Company’s lender, including an order granted in April 2009 by afederal court freezing all assets of Private Equity Management Group, Inc.and its affiliates, including the Company’s lender, may adversely affect theCompany’s lender’s ability to continue to provide the Company funds under theterms of the Revolver.  At the request of the Commission, the federalcourt also appointed a temporary receiver of Private Equity Management Group, Inc.and the Company’s lender.  Although the Company currently believes thatthe receiver will allow the Company to continue to borrow funds under the termsof the Revolver, no assurances can be made that the receiver will allow theCompany’s lender to continue to make funds available to the Company.  If,for any reason, the receiver were to limit or terminate the Company’s abilityto continue to borrow funds under the Revolver, the Company’s cash position andits ability to continue day to day operations would be adversely affected,almost immediately.  If that were to occur, the Company would be requiredto seek additional and/or replacement financing immediately.  If the Company were unable to do so, theCompany may be forced to drastically curtail or cease operations and possiblyseek protection from its creditors under the U.S. Bankruptcy Code.

 

If the Company issuccessful in raising $3.0 million in equity capital by December 31, 2009as required by the Company’s lender under the terms of the credit facility andis able to continue to borrow funds under the terms of the Revolver, managementof the Company believes 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.

 

If, however, for any reasonincluding the reasons described above, the Company is unsuccessful in raisingadditional equity capital as required under the terms of the credit facilitythereby resulting in an event of default under the credit facility or is unableto continue to borrow funds under the terms of the Revolver, the Company doesnot believe that current and future capital resources, revenues generated fromoperations and other existing sources of liquidity will be adequate to meet itsanticipated short term, working capital and capital expenditures needs for thenext 12 months.  Further, if for any reason, the Company is not able tocontinue to borrow funds under the terms of the Revolver or if it experiences asignificant loss of revenue or increase in costs, then its cash flow would benegatively impacted resulting in a cash flow deficit which, in turn, willrequire it to obtain additional or alternate financing, with little or nonotice.  These potential financing needs could be met in the form of arevised debt structure with the Company’s current lender, additional or newfinancing with another lender or lenders, the sale of assets to generate cashor the sale of additional equity to raise capital.  Failure to secureadditional or alternate financing, if and when needed, would have an adverseeffect on the Company’s operations and/or ability to do business after thatdate or could restrict the Company’s growth, limit its development of newproducts, or hinder its ability to fulfill existing or future orders.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 4 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

On May 23, 2008, theCompany and its wholly-owned subsidiary, EEC, entered into a Stock PurchaseAgreement (the “Stock Purchase Agreement”) pursuant to which EEC agreed toacquire Custom Components, Inc. (“CCI”) and its operating subsidiary,Advanced Control Components, Inc. (“ACC”).  On August 20, 2008,the Stock Purchase Agreement was amended pursuant to Amendment No. 1 toStock Purchase Agreement (the “Amendment to Purchase Agreement,” andcollectively with the Stock Purchase Agreement, the “ACC Purchase Agreement”)to, among other things, reduce the initial purchase price for all of thecapital stock of both CCI and ACC to $12,400,000, subject to adjustments forworking capital and net cash.  Additionally, pursuant to the terms of theAmendment to Purchase Agreement, the Company is obligated to pay interest on aprincipal amount of $600,000 at a rate equal to the prime rate as reportedin *The Wall Street Journal *onAugust 20, 2008 plus 1% for the period commencing on August 20, 2008and ending on the later of November 18, 2008 or the actual date suchinterest payment is made.

 

The closing of the ACCPurchase Agreement occurred on August 20, 2008.  Under the terms ofthe ACC Purchase Agreement, EEC acquired all of the issued and outstanding sharesof common stock of CCI and all of the issued and outstanding shares of commonstock of ACC not owned by CCI (the “Acquisition”).  In addition to thepurchase price, the Company is obligated to pay up to an additional $3,000,000in cash if ACC meets certain operating income targets for one or both of thetwo 12 month periods following the closing.  Additionally, EEC issuedSubordinated Secured Contingent Promissory Notes (the “Notes”) to each of theSellers in the aggregate principal amount of $2,000,000.  The Notes becomepayable if ACC meets certain operating income thresholds during the first andsecond 12 month periods after August 20, 2008.  The Notes bearinterest at a rate per annum equal to the prime rate as reported in *The Wall Street Journal *plus 1%.  As of June 30, 2009, ACC had met itsoperating income targets associated with the Notes and as such the Companyrecorded a note payable of $2,000,000, which resulted in an adjustment to thenet assets acquired.  Additionally, theCompany recorded $1.2 million in notes payable representing an adjustment toworking capital and net cash.  TheCompany expects to record additional purchase price adjustments associated withthe contingent cash obligation when such obligation is earned.

 

In determining thepurchase price for the Acquisition, the Company took into account thehistorical and expected earnings and cash flow of ACC, as well as the value ofcompanies of a size and in an industry similar to ACC, comparable transactionsand the market for such companies generally. The purchase price represented a premium of approximately $4.1 millionover the recorded net worth of ACC’s assets. The acquisition occurred prior to the effective date of SFAS No. 141Rand the Company did not elect early adoption of the provisions of thisstatement.

 

In connection with theAcquisition, the Company commissioned a valuation firm to assist it indetermining the fair value of ACC’s tangible assets and the portion of thepurchase price that should be allocated to identifiable intangible assets.  The Company considered whether theAcquisition included various types of identifiable intangible assets, includingtrade names, trademarks, patents, covenants not to compete, customers, backlog,workforce, technology and software.  As aresult of the procedures performed by the valuation firm and the evaluation ofmanagement, the Company determined and recorded the value of the tangible andintangible assets in its Condensed Consolidated Balance Sheets in accordancewith the purchase price allocation.  TheCompany has estimated and recorded the identified intangible assets asfollows:  trade name of $1,570,000;covenant not to compete of $60,000; backlog of $570,000; and customerrelationships of $2,550,000.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

The following tablesummarizes the assets and liabilities assumed in connection with theAcquisition (in thousands):

 
| Accounts receivable                       |   | $      | 2,330  |   |
|-------------------------------------------|--------|--------|--------|--------|
| Inventories                               |   | 1,848  |   |
| Property and equipment                    |   | 1,545  |   |
| Intangible assets, net                    |   | 4,750  |   |
| Goodwill                                  |   | 3,928  |   |
| Other assets                              |   | 244    |   |
| Total assets acquired                     |   | 14,645 |   |
| Accounts payable and  accrued liabilities |   | (1,678 | )      |
| Other liabilities                         |   | (611   | )      |
| Total liabilities  assumed                |   | (2,289 | )      |
| Net assets acquired                       |   | $      | 12,356 |   |

 

The following tablesummarizes, on a pro forma basis, the unaudited combined results of operationsof the Company and ACC as though the Acquisition occurred as of January 1,2008.  The pro formaadjustments are based upon available information and assumptions thatmanagement believes reasonably reflect the transaction.  The Company presents the pro forma results ofoperations for informational purposes only. The pro forma results of operations are not necessarily indicative ofwhat the Company’s results of operations would have been had the Companycompleted the Acquisition as of the dates indicated.  In addition, the pro forma financialstatements do not purport to project the future financial position or operatingresults of the combined company.

 

 
| ** **                            | ** ** | **For the Three** | ** ** | **For the Six**   | ** ** |
|---------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                            | ** ** | **Months Ended**  | ** ** | **Months Ended**  | ** ** |
| ** **                            | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                            | ** ** | **2008**          | ** ** | **2008**          | ** ** |
|                                  |       |              |       |              |       |
| Net sales                             |       | $                 | 17,256     |              | $          | 32,053 |   |
|                                  |       |              |       |              |       |
| Net loss                              |       | $                 | (1,241     | )                 | $          | (3,224 | ) |
|                                  |       |              |       |              |       |
| Loss per share:                       |       |              |       |              |       |
| Basic                                 |       | $                 | (0.12      | )                 | $          | (0.32 | ) |
| Diluted                               |       | $                 | (0.12      | )                 | $          | (0.32 | ) |
|                                  |       |              |       |              |       |
| Weighted average shares  outstanding: |       |              |       |              |       |
| Basic                                 |       | 10,204            |       | 10,204            |       |
| Diluted                               |       | 10,204            |       | 10,204            |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 5 — DISCONTINUED OPERATIONS**

 

On March 20, 2009,the Company and EEC entered into an Asset and Stock Purchase Agreement (the “DigitranPurchase Agreement”) with Electro Switch Corp., a Delaware corporation (the “Buyer”)and ESC Worldwide, Inc., a Massachusetts corporation and subsidiary ofBuyer (the “Stock Buyer”).  At the closing of the Digitran PurchaseAgreement on March 20, 2009, (i) the Buyer purchased from the Companyand EEC substantially all the assets related to EEC’s Digitran division, and (ii) theStock Buyer purchased from EEC all of the issued and outstanding equityinterests of its wholly-owned subsidiary, XCEL Japan, Ltd., for an aggregatepurchase price of approximately $11,560,000 (the “Disposition”).  Underthe terms of the Purchase Agreement, the Buyer is obligated to pay up to anadditional $500,000 in cash to EEC if net sales for the fiscal year ending December 31,2009 related to the businesses that were sold pursuant to the Digitran PurchaseAgreement exceeds $6,835,120.

 

The Buyer acquired all ofthe intellectual property, cash, accounts receivable, inventory, customersupport and relationships, software and product development, and real propertylease related to the Digitran division, which, prior to its acquisition, was inthe business of manufacturing a line of electromechanical switches comprised ofdigital and rotary switches used for routing electronic signals.  TheStock Buyer acquired XCEL Japan, Ltd., which, prior to its acquisition, wasengaged in the business of selling and distributing Digitran division productsin the Asia Pacific market.  EEC retained all accounts payable and certainother assets and liabilities related to the Digitran division.  TheCompany continues to operate its communications equipment segment and the powersystems radio frequency (“RF”) and microwave devices product lines in itselectronic devices segment.

 

The Digitran PurchaseAgreement contains five year noncompetition and non-solicitation provisionscovering the Company, EEC and each of their respective affiliates.  Inaddition, the Company and EEC provided customary indemnification rights to theBuyer and Stock Buyer in connection with 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 June 30,2009, the Company estimates future cash expenditures related to the sale to beapproximately $280,000, which were accrued within “Accrued liabilities” exceptfor income taxes, which were accrued within “Income taxes payable” in theaccompanying condensed consolidated balance sheets.   In addition, the Company has accrued $308,000related to a purchase price adjustment owed to the Buyer in connection with thetransaction.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                         | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                         | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| Net Sales                                                          |       | $                      | —     |                 | $          | 2,027 |   | $ | 1,478 |   | $ | 3,631 |   |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| Income from operations                                             |       | $                      | —     |                 | $          | 625 |   | $ | 178 |   | $ | 996 |   |
| Gain (loss) on sale of  Digitran Operations   (net of tax of $707) |       | (114                   | )          | —               |       | 6,403 |   | — |   |
| Net (loss) Income                                                  |       | $                      | (114       | )                    | $          | 625 |   | $ | 6,581 |   | $ | 996 |   |

 

**NOTE 6 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·                  1993 Stock Option Plan;

·                  1997 Stock Incentive Plan;

·                  Amended and Restated 2000 Stock OptionPlan; and

·                  2007 Stock Incentive Plan.

 

The board of directorsdoes not intend to issue any additional options under the Employee Stock andStock Option Plan, 1993 Stock Option Plan, 1997 Stock Incentive Plan or Amendedand Restated 2000 Stock Option Plan.

 

Total stock-basedcompensation expense included in wages, salaries and related costs was $41,000and $11,000 for the three months ended June 30, 2009 and 2008,respectively and $75,000 and $29,000 for the six months ended June 30,2009 and 2008, respectively.  Thesecompensation expenses were charged to selling, general and administrativeexpenses. As of June 30, 2009, the Company had $307,000 of totalunrecognized compensation expense related to stock option grants, which will berecognized over the remaining weighted average period of two years.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 7 — 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):

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
|              |       |              |       |                  |       |
| Raw materials     |       | $                 | 10,776     |                  | $          | 10,093 |   |
| Work-in-process   |       | 3,405             |       | 3,319                 |       |
| Finished goods    |       | 4,385             |       | 4,311                 |       |
| Reserves          |       | (5,650            | )          | (5,222                | )          |
| Total inventories |       | $                 | 12,916     |                  | $          | 12,501 |   |

 

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

 

**NOTE 8 — OPERATING SEGMENTS, ASRESTATED**

 

The Company has tworeportable operating segments: electronic devices and communications equipment.The electronic devices segment manufactures and markets electronic powersupplies, RF and microwave devices and subsystem assemblies. The electronicdevices segment consists of EEC and its subsidiaries located in the U.S. andEngland, which offer the same or similar products to similar customers.  The communications equipment segment designs,manufactures and distributes network access products and timing andsynchronization products.  Thecommunications equipment segment consists of operating entities CXR LarusCorporation located in the U.S. and CXR Anderson Jacobson located in France,both of which offer the same or similar products to similar customers.  Both segments operate in the U.S., Europeanand Asian markets, but have distinctly different customers, design andmanufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

The Company evaluatesperformance based upon profit or loss from operations before income taxesexclusive of nonrecurring gains and losses. The Company accounts forintersegment sales at pre-determined prices negotiated between the individualsegments.

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 5), 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 with 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 CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Selected financial datafor each of the Company’s operating segments reconciled to the consolidatedtotals is shown below (in thousands):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                 |       |                   |       |                 |       |   |   |   |   |
| Electronic devices        |       | $                      | 11,649     |                 | $          | 8,160 |   | $ | 23,244 |   | $ | 15,443 |   |
| Communications  equipment |       | 2,621                  |       | 3,862                |       | 5,239 |   | 7,222 |   |
| Discontinued Operations   |       | —                 |       | 2,027                |       | — |   | 3,631 |   |
| Total                     |       | $                      | 14,270     |                 | $          | 14,049 |   | $ | 28,483 |   | $ | 26,296 |   |
|                      |       |                   |       |                 |       |   |   |   |   |
|                      |       |                   |       |                 |       |   |   |   |   |
| Operating income (loss)   |       |                   |       |                 |       |   |   |   |   |
| Electronic devices        |       | $                      | 1,932      |                 | $          | 663 |   | $ | 3,494 |   | $ | 1,116 |   |
| Communications  equipment |       | (466                   | )          | (90                  | )          | (917 | ) | (72 | ) |
| Discontinued Operations   |       | —                 |       | 625                  |       | — |   | 996 |   |
| Corporate and other       |       | (1,070                 | )          | (997                 | )          | (2,293 | ) | (2,069 | ) |
| Total                     |       | $                      | 396        |                 | $          | 201 |   | $ | 284 |   | $ | (29 | ) |

 
| ** **                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                | ** ** | **(Restated)**    | ** ** | ** **            | ** ** |
| Total assets              |       |              |       |                  |       |
| Electronic devices        |       | $                 | 35,925     |                  | $          | 34,853 |   |
| Communications  equipment |       | 8,952             |       | 10,260                |       |
| Discontinued Operations   |       | —            |       | 3,600                 |       |
| Corporate and other       |       | 8,168             |       | 4,910                 |       |
| Total                     |       | $                 | 53,045     |                  | $          | 53,623 |   |

 

**NOTE 9 — GOODWILL**

 

The following tablereflects changes in the Company’s goodwill balances, by segment, for the sixmonths ended June 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) |       | 3,116          |       | —             |       | 3,116      |       |
| Foreign currency  translation                   |       | 595            |       | —             |       | 595        |       |
| Balance at  June 30, 2009                  |       | $              | 13,368     |               | $          | —     |       | $ | 13,368 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 10 — INCOME TAXES, ASRESTATED**

 

The effective tax ratefor the three month period ended June 30, 2009 was different than the 34%U.S. statutory rate primarily because the Company’s foreign entities generate atax obligation and related tax expense as a result of their net income, whichcannot be offset by U.S. tax loss carryforwards.

 

The Company’s business issubject to regulation under a wide variety of U.S. federal, state and foreigntax laws, regulations and policies.  Themajority of the Company’s foreign subsidiaries have earnings and profits thatare reinvested indefinitely.  However,under the credit facility described in Notes 11 and 12 the foreign subsidiarieshave issued guarantees on the credit facility and, as a result, under IRC §956have been deemed to distribute these earnings to fund U.S. operations.  This has resulted in U.S. federal taxableincome and an increase in U.S. tax liability, which has been reduced throughutilization of available net operating loss carryforwards and foreign taxcredits.

 

The Company adopted FIN48, “Accounting for Uncertainty inIncome Taxes — an interpretation of FASB Statement No. 109,” on January 1,2007. The implementation of FIN 48 did not result in a material adjustment tothe Company’s liability for unrecognized income tax benefits. At the time ofadoption, and as of June 30, 2009, the Company had recorded no netunrecognized tax benefits.

 

The Company recognizesinterest and penalties related to uncertain tax positions in interest expenseand selling, general and administrative expense, respectively, in the condensedconsolidated statements of operations and comprehensive income. No interest orpenalties were recognized during 2008. As of June 30, 2009, the Companyhad nothing accrued for interest and penalties.

 

The Company files incometax returns in the United States federal jurisdiction, the United Kingdom,France and Japan and in the state jurisdictions of California, Texas,Pennsylvania and New Jersey. The Company is no longer subject to United Statesfederal and state tax examinations for years before 2005 and 2004, respectively,and is no longer subject to tax examinations for the United Kingdom and Japanfor years prior to 2007, and for France for years prior to 2005.

 

**NOTE11 — 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 one year revolving credit facility for up to $7,000,000 that may berenewed up to two times, each for a period of one year, at the Company’soption, provided that certain conditions precedent are met (the “Revolver”).  The credit facility also includes two termloans (see Note 12).

 

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 November 30, 2009 unless it is renewed, in whichcase the maturity date will be extended to November 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 June 30,2009 was the 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

minimum rate of9.5%.  The Revolver is subject to variousfinancial covenants on a consolidated basis, including the following: EBITDA,measured on a fiscal quarter-end basis, must not be less than the scheduledamount for each specified period; the debt service coverage ratio, measuredquarterly, must be greater than the lesser of the scheduled amount for eachspecific period or 1.10:1.00; the leverage ratio, measured quarterly, must notbe greater than the scheduled amount for each specified period, and liquidity,measured quarterly, must not be less than the scheduled amount for eachspecified period.  Additionally, theRevolver is subject to the Borrowers not incurring capital expenditures (a) inexcess of $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 theBorrowers not incurring unfinanced capital expenditures in excess of $62,500 inany fiscal quarter. However, if the borrowers incur unfinanced capitalexpenditures of less than $62,500 in any fiscal quarter, the difference betweenthe amount incurred in a certain fiscal quarter and $62,500 maybe incurred inthe two fiscal quarters immediately following such fiscal quarter. The Companywas in compliance with all covenants at June 30, 2009.

 

As of June 30, 2009,the Company had outstanding borrowings of $5.6 million under the Revolver withremaining availability under the formula-based calculation of $1.4 million.

 

In connection with entering into theCredit Agreement, the Borrowers issued 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 isgoverned by the terms of the Credit Agreement.

 

See related Note 3 “Liquidity” and Note12 “Long Term Debt” regarding additional terms and conditions associated withthe overall credit facility and risks associated with this credit facility.

 

**NOTE 12 — LONG-TERM DEBT, ASRESTATED**

 

On August 20, 2008,in connection with the acquisition of ACC and CCI as discussed in Note 4, theBorrowers and the Lender amended the credit facility to, among other things,include ACC and CCI as Borrowers and to provide for another term loan in theprincipal amount of $3 million (the “Term Loan C”).  The credit facility, as so amended, providedfor borrowings in the aggregate amount of $26 million, including the $7 millionrevolving facility described in Note 11.

 

The credit facilityconsists of (i) the Revolver, (ii) a term loan in the principalamount of $6 million which is due November 30, 2010 (“Term Loan A”), (iii) aterm loan in the original principal amount of $10 million, which is due on November 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 requirescheduled principal and interest payments commencing September 2009 and afinal balloon payment of principal upon maturity on November 30,2010.  Term Loan C was repaid in full on March 20,2009.  At June 30, 2009, theoutstanding principle balance on Term Loan A was $5.8 million and theoutstanding principle balance on Term Loan B was $3.0 million.  As a result of the partial repayment on TermLoan B, a pro-rata portion of the balance of deferred financing costs and debtdiscount were accelerated and are reflected as an adjustment to interestexpense in the accompanying Condensed Consolidated Statements of Operations.

 

The Term Loans A and Bbear interest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5%per annum, and require interest only payments in the first year, scheduledprincipal plus interest payments in years two and three, and a final balloonpayment at the end of year three. Interest on 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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

As part of the consideration forentering into the Credit Agreement, the Company issued warrants to purchase788,000 shares of the Company’s common stock with a fair value of $1.5 million,which is accounted for as a discount to the Credit Facility and is amortizedover the term of the Credit Agreement.

 

Upon the sale ordisposition by the Borrowers or any of their subsidiaries of property orassets, the Borrowers may be obligated to prepay the Revolver and the termloans with the net cash proceeds received in connection with such sales ordispositions 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 the Company sellsassets after August 14, 2009 and prior to January 1, 2010, 75% of thenet cash proceeds of such sale must be used to prepay the Company’s outstandingobligations to the Lender.

 

If the Lender terminatesthe credit facility during a default period or if the Company prepays theRevolver or the Term Loans prior to November 30, 2009, then the Company issubject to a penalty equal to 2% of the outstanding principal balance of theRevolver and the Term Loans.  The Revolver is subject to an unused linefee of 0.5% per annum, payable monthly, on any unused portion of the revolvingcredit facility.

 

In the event of a defaultand continuation of a default, the Lender may accelerate the payment of theprincipal balance requiring the Company to pay the entire indebtednessoutstanding on that date.  Upon theoccurrence and during the continuation of an event of default, the Lender mayalso elect to increase the interest rate applicable to the outstanding balanceby four percentage points above the per annum interest rate that wouldotherwise be applicable.

 

The Borrowers have agreedwith the Lender to raise at least $3 million in net cash proceeds through thesale of stock of the Borrowers by no later than December 31, 2009.  Under the terms of the credit facility, theBorrower’s 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 3.

 

See Note 3 and Note 11 regardingadditional terms and conditions associated with the Company’s credit facilityand risks associated with this credit facility.

 

**NOTE13 — WARRANTS**

 

In connection withentering into the credit facility (discussed in Note11), the Company issued aseven year warrant to Private Equity Management Group, Inc., an affiliateof the Lender, to purchase up to 775,758 shares of the Company’s common stockon a cash or cashless basis at an exercise price of $4.13 per share.  The estimated fair value of the warrants was$1.5 million, which was calculated using the Black-Scholes pricing model.  The warrants were originally accounted for asdebt discount and the adjustment resulting from the repricing of the warrantsincreased the debt discount, which is being amortized over the remaining lifeof the credit facility.  The warrantswere previously recorded in stockholder’s equity.

 

In February 2009,the warrants were amended and reissued in conjunction with an amendment to thecredit facility.  Pursuant to the SecondAmendment to Loan Documents, the original warrant was divided into two warrants(each, a “Second Amended and Restated Warrant” and collectively, the “SecondAmended and Restated Warrants”).  Each Second Amended and Restated Warrantcovers 387,879 shares of the Company’s common stock (which amount reflects theCompany’s 1-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’s1-for-3.75 reverse split of its common stock effective November 18, 2008and a reduction from a post-split exercise price of $3.06 per share).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

The exercise price and/ornumber of shares of common stock issuable upon exercise of the warrants may beadjusted in certain circumstances, including certain issuances of securities ata price equal to less than the then current exercise price, subdivisions andstock splits, stock dividends, combinations, reorganizations,reclassifications, consolidations, mergers or sales of properties and assetsand upon issuance of certain assets or securities to holders of the Company’scommon stock, as applicable. In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 was effective for financial statements issued for fiscalyears beginning after December 15, 2008. The adoption of EITF 07-5 on January 1, 2009, resulted in thereclassification of certain of the Company’s outstanding warrants from stockholders’equity to liabilities, which requires the warrants to be fair valued at eachreporting period, with the changes in fair value recognized in the Company’sconsolidated statement of operations.

 

At January 1, 2009and June 30, 2009, the Company had warrants subject to mark to marketoutstanding to purchase 775,758 shares of common stock.  The Company computed the fair value of thewarrants using a Black-Scholes valuation model. The fair value of these warrants on the date of adoption of January 1,2009 and on June 30, 2009 was determined using the following assumptions:

 
| ** **              | ** ** | **January 1,  2009** | ** ** | **June 30,  2009** | ** ** |
|-------------------------|------------|---------------------------|------------|-------------------------|------------|
| Dividend yield          |       | None                      |       | None                    |       |
| Expected volatility     |       | 105                       | %          | 71                      | %          |
| Risk-free interest rate |       | 0.88                      | %          | 1.11                    | %          |
| Expected term           |       | 7 years                   |       | 7 years                 |       |
| Stock price             |       | $                         | 1.58       |                    | $          | 1.27 |   |
|                         |            |                           |            |                         |            |  |  |

 

On January 1, 2009,the Company recorded a cumulative effect of change in accounting principleadjustment to its accumulated deficit of $473,000 and a correspondingreclassification of these outstanding warrants from stockholders’ equity towarrant liability.  As of and for thethree and six month periods ended June 30, 2009, the change in fair valueof the warrants resulted in a $293,000 and $423,000 positive adjustment,respectively, to other income (expense) in the consolidated statement ofoperations and a corresponding decrease to the warrant liability.

 

**NOTE14 — FAIR VALUE MEASUREMENTS**

 

In September 2006,the FASB issued SFAS No. 157, which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements.  The effective date of the statement is forall entities with fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued FASBStaff Position No. 157-2, which delays the effective date of SFAS No. 157for non-financial assets and liabilities to fiscal years beginning after November 15,2008.  The delay pertains to itemsincluding, but not limited to, goodwill and other intangible assets.  The Company adopted the provisions of thestandard that were effective as of January 1, 2008.  The Company adopted the remaining provisionsof SFAS No. 157 as of January 1, 2009.

 

SFAS No. 157 definesfair value as the price that would be received to sell an asset or paid to transfera liability (an exit price) in an orderly transaction between marketparticipants and also establishes a fair value hierarchy which requires anentity to maximize the use of observable inputs and minimize the use ofunobservable inputs when measuring fair value. The fair value hierarchy distinguishes between three levels of inputsthat may be utilized when measuring fair value as follows:

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Level 1 — Inputs areunadjusted quoted prices in active markets for identical assets or liabilitiesavailable at the measurement date.

 

Level 2 — Inputs areunadjusted quoted prices for similar assets and liabilities in active markets,quoted prices for identical or similar assets and liabilities in markets thatare not active, inputs other than quoted prices that are observable, and inputsderived from or corroborated by observable market data.

 

Level 3 — Inputs that areunobservable inputs which reflect the reporting entity’s own assumptions onwhat assumptions the market participants would use in pricing the asset orliability based on the best available information.

 

As of June 30, 2009,the Company was required to apply SFAS No. 157 provisions to thederivative that is within the warrant that was issued as consideration for theCompany’s credit facility, which is discussed in Note 12 and included as adiscount 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:

 
| ** **              | ** ** | **June 30,  2009** | ** ** |
|-------------------------|------------|-------------------------|------------|
| Dividend yield          |       | None                    |       |
| Expected volatility     |       | 71                      | %          |
| Risk-free interest rate |       | 1.11                    | %          |
| Expected term           |       | 7 years                 |       |
| Stock price             |       | $                       | 1.27       |   |
|                         |            |                         |            |  |

 

The derivative ismeasured at fair value on a recurring basis using significant observable inputs(Level 2).  The amount of total gain inearnings for the period is as follows (in thousands):

 
| ** **                                 | ** ** | **Warrant  Liability** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
|                                       |       |                   |       |
| Beginning balance at  January 1, 2009 |       | $                      | 1,010      |   |
| Total gain realized in  earnings           |       | (423                   | )          |
| Ending balance at  June 30, 2009      |       | $                      | 587        |   |

 

**NOTE15 — SUBSEQUENT EVENTS**

 

In connection with thepreparation of the Company’s financial statements at June 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:

 

On August 14, 2009,the Borrowers and the Lender entered into an Amendment Number 5 to LoanDocuments (“Amendment Number 5”) pursuant to which, among other things, (i) theLender revised the principal repayment schedule for the remainder of 2009, (ii) theLender deferred the need to comply with the liquidity financial covenant until December 31,2009, (iii) the Lender agreed that to the extent the Company sells assetsafter the date of Amendment Number 5 and prior to January 1, 2010, only75% of the net cash proceeds of such sale must be used to prepay the Company’soutstanding obligations to the Lender and (iv) the Lender replaced theCompany’s requirement to raise a minimum of $2 million in equity capital on orbefore September 30, 2009 with a new requirement to raise a minimum of $3million in equity capital on or before December 31, 2009.  Under to the terms of Amendment Number 5, theCompany is obligated to remit to the Lender 50% of the first $3 million of netcash proceeds received in connection with the sale of stock and 30% of the netcash proceeds in excess of the first $3 million received.

 

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

 

**CautionaryStatement**

 

The following discussionshould be read in conjunction with our unaudited condensed consolidatedfinancial statements and the related notes thereto contained in Part I,Item 1 of this Amendment No, 1 to our Quarterly Report on Form 10-Q. Theinformation contained in this report is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis report and in our other reports filed with the Securities and ExchangeCommission, or Commission, including our Annual Report on Form 10-K forthe year ended December 31, 2008 and subsequent reports on Forms 10-Q and8-K, which discuss our business in greater detail.  This report and the following discussioncontain forward-looking statements within the meaning of Section 21E ofthe 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 fundsunder the terms of our credit facility in light of certain actions recentlytaken against Private Equity Management Group, Inc., an affiliate of ourlender by the Commission (see “ — Liquidity and Capital Resources”);

·                  exposure to and impacts of variousinternational risks including legal, business, political and economic risksassociated with our international operations, including risks associated withforeign currency translation (see “-Foreign Currency Translation”).

·                  the projected growth or contraction inthe electronic devices and communications equipment markets in which weoperate;

·                  our strategies for expanding, maintainingor contracting our presence in these markets;

·                  anticipated trends in our financialcondition and results of operations;

·                  our ability to distinguish ourselves fromour current and future competitors;

·                  our ability to secure long term purchaseorders;

·                  our ability to deliver against existingor future backlog;

·                  technical or quality issues experiencedby us, our suppliers and/or our customers;

·                  failure to comply with existing or futuregovernment or industry standards and regulations;

·                  our ability to successfully locate,acquire and integrate any possible future acquisitions;

·                  our ability to successfully support theworking capital needs of our company;

·                  the impact of current and/or futureeconomic conditions, including but not limited to the overall condition of thestock market, the overall credit market, political, economic and/or otherconstraints which are or may negatively impact the industries in which weparticipate and/or the ability for us to market the products which we sell; and

·                  our ability to successfully compete againstcompetitors that in many cases are larger than us, have access to significantlymore working capital than us and have significant resources in comparison tous.

 

We do not undertake toupdate, 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 Report on Form 10-Q for the quarterly period ended March 31,2009, and in this report could cause our financial results, including our netincome or loss or growth in net income or loss to differ materially from priorresults, which in turn could, among other things, cause the price of our commonstock to fluctuate substantially.

 

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**Recent Transactions**

 

On March 20, 2009,we completed the sale of substantially all the assets of the Digitran divisionof our wholly-owned subsidiary, EMRISE Electronics Corporation, or EEC, and allthe capital stock of ECC’s wholly-owned subsidiary, XCEL Japan Ltd., whichprimarily acted as a sales office for the Digitran division, to Electro SwitchCorp.  In this report we refer to thebusinesses of the Digitran Division and XCEL Japan, Ltd. as the “DigitranOperations,” and we refer to the sale of the Digitran division and XCEL Japan,Ltd. as the “Digitran Transaction.” Within our Digitran division we manufactured, marketed and soldelectro-mechanical digital and new patented 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, manufactureand market proprietary electronic devices and communications equipment foraerospace, defense, industrial, and communications applications. We haveoperations in the U.S., England, and France. We organize our business in two operating segments: electronic devicesand communications equipment. In the first quarter of 2009, our electronicdevices segment contributed approximately 82% of overall net sales while thecommunications segment contributed approximately 18% of overall net sales. Oursubsidiaries within our electronic devices segment design, develop, manufacture and market power supplies, radio frequency,or RF, and microwave devices for defense, aerospace and industrialmarkets.  Our subsidiaries withinour communications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronizationproducts, for communications applications in defense, public and privatenetworks and industrial markets.

 

Within our electronicdevices segment, we produce a range of power systems and RF and microwavedevices.  This segment is primarily“project” driven with the majority of revenues being derived from customproducts with long life cycles and high barriers to entry.  The majority of manufacturing and testing isperformed in-house or through sub-contract manufacturers.  Our electronic devices are used in a widerange of military airborne, seaborne and land-based systems, and in-flightentertainment systems, including the latest next generation in-flightentertainment and communications, or IFE&C, systems, such as applicationsfor mobile phone, e-mail and internet communications and real time, on-boardsatellite and broadcast TV, which are being installed in new commercialaircraft as well as being retrofitted into existing commercial aircraft.

 

Within our communicationsequipment segment, we produce a range of network access equipment, includingnetwork timing and synchronization products, for public and privatecommunications networks.  This segment is“end user product” based with a traditional cycle of internally fundeddevelopment and marketing prior to selling via direct and indirect saleschannels.  Manufacturing is primarilyoutsourced.  Our communications equipmentis used in a broad range of network applications primarily for privatecommunications networks, public communications carriers, and also for utilitycompanies and military applications, 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 date of the financial statements and the reportedamount of net sales and expenses for each period. The following represents asummary of our critical accounting policies, defined as those policies that webelieve are the most 

 

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important to theportrayal of our financial condition and results of operations and that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effects of matters that are inherentlyuncertain.

 

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

 

We derive revenues fromsales of electronic devices and communications equipment products andservices.  Our sales are based uponwritten agreements or purchase orders that identify the type and quantity ofthe item and/or services 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 depends upon thetype of contract involved. Engineering/design services contracts generally entail design andproduction of a prototype over a term of up to several years, with revenuedeferred until each milestone defined in the contract is reached.  Production contracts provide for a specificquantity of products to be produced over a specific period of time.  Customers issue binding purchase orders orenter into binding agreements for the products to be produced.  We recognize revenues on these orders as theproducts are shipped.  Returns areinfrequent and permitted only with prior authorization because these productsare custom made to order based on binding purchase orders and are qualitytested prior to shipment.  An estimate ofwarranty cost is recorded at the 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% of totalrevenue and, therefore, are considered to be immaterial to overall financialresults.

 

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***Product Warranty Liabilities***

 

Generally, our products carry a standard one-year,limited parts and labor warranty.  Incertain 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 that weexpect 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 electronic devicessegment 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 June 30,2009, our total inventory reserves amounted to $5.6 million, of which $3.9million, or 21.0% of total inventory, related to our electronic devices segmentand $1.7 million, or 9% of total inventory, related to our communicationsequipment segment.

 

The electronic devicesand 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 foreignsubsidiaries that together accounted for approximately 50.4% and 69.7% of ournet revenues, 34.8% and 58.6% of our assets and 24.2% and 53.9% of our totalliabilities as of and for the six months ended June 30, 2009 and 2008,respectively.  In preparing ourconsolidated financial statements, we are required to translate the financialstatements of our foreign subsidiaries from the functional currencies in whichthey keep their accounting records into U.S. dollars. This process results inexchange gains and losses which, under relevant accounting guidance, areincluded either within our statement of operations under the caption “otherincome (expense)” or as a separate part of our net equity under the caption“accumulated other comprehensive income (loss).”

 

Under relevant accountingguidance, the treatment of these translation gains or losses depends uponmanagement’s determination of the functional currency of each subsidiary. Thisdetermination involves consideration of relevant economic facts andcircumstances affecting the subsidiary. Generally, the currency in 

 

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which the subsidiarytransacts a majority of its transactions, including billings, financing,payroll and other expenditures, would be considered the functional currency.However, management must also consider any dependency of the subsidiary uponthe parent and the nature of the subsidiary’s operations.

 

If management deems anysubsidiary’s functional currency to be its local currency, then any gain orloss associated with the translation of that subsidiary’s financial statementsis included as a separate component of stockholders’ equity in accumulatedother 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 financial statementswould be included in other income (expense) within our statement of operations.

 

If we dispose of any ofour subsidiaries, any cumulative translation gains or losses would be realizedinto our statement of operations. If we determine that there has been a changein the functional currency of a subsidiary to U.S. dollars, then anytranslation gains or losses arising after the date of the change would beincluded within our statement of operations.

 

Based on our assessmentof the factors discussed above, we consider the functional currency of each ofour international subsidiaries to be each subsidiary’s local currency.Accordingly, we had cumulative translation losses of $1.5 million and $2.8million that were included as part of accumulated other comprehensive incomewithin our balance sheets at June 30, 2009 and December 31, 2008,respectively. During the three months ended June 30, 2009 and 2008, weincluded translation gains of $1.8 million and losses of $3,000, respectively,under accumulated other comprehensive income and during the six months ended June 30,2009 and 2008, we included translation gains of $1.4 million and $223,000,respectively, under accumulated other comprehensive income.

 

Themagnitude of these gains or losses depends upon movements in the exchange ratesof the foreign currencies in which we transact business as compared to thevalue of the U.S. dollar. During the second quarter of 2009, these currenciesinclude the euro and the British pound sterling. Any future translation gainsor losses could be significantly higher or lower than those we recorded forthese periods.

 

A 2.5 million Britishpound sterling loan payable from one ofour subsidiaries in England to EMRISE was outstanding as of June 30,2009 ($4.1 million based on the exchange rate at June 30, 2009).  Exchange rate losses and gains on thelong-term portion of this loan are recorded in cumulative translation gains orlosses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

We periodically evaluateour intangibles, including goodwill, for potential impairment. Our judgmentsregarding the existence of impairment are based on many factors includingmarket conditions and operational performance of our acquired businesses.

 

In assessing potentialimpairment of goodwill, we consider these factors as well as forecastedfinancial 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 SFAS No. 142, “Goodwill and OtherIntangible Assets”, we are required to analyze our goodwill for impairmentissues at least annually or more frequently if an event occurs or circumstanceschange that would more likely than not reduce the fair value of a reportingunit below its carrying amount.  At June 30,2009, our reported goodwill totaled $13.4 million.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquiredbusinesses to determine the fair value of the respective assets.

 

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**Resultsof Operations**

 

**Overview**

 

The majority of ourproducts are customized to the unique specifications of our customers and aresubject 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 19% in the first quarter of 2009 as compared tothe first quarter of 2008.  Our overallnet sales of $14.3 million for the second quarter of 2009 reflected $5.4 millionof net sales contributed by ACC, which we acquired on August 20, 2008, anddeclines in net sales at all of our electronic devices subsidiaries and both ofour communications equipment subsidiaries. With the exception of our French communication subsidiary, whichexperienced a decline in sales largely due to the impact of the global economiccrisis, the declines at our foreign units were largely due to the impact ofexchange rates between the U.S. dollar and the British pound sterling and theeuro.

 

Overall gross profit as apercentage of sales increased to 38.3% in the second quarter of 2009 from 30.8%in the first quarter of 2008.  Theincrease in gross profit as a percentage of sales was due primarily to theinclusion of ACC sales in 2009 and associated gross margins in our resultspartially offset by a decrease in gross profit as a percentage of sales withinour communication segment as a result of lower sales volumes within thatsegment.

 

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 following discussion andanalysis, the Digitran Operations have been removed from the prior periodcomparisons and the quarterly results of the Digitran Operations are reportedas a discontinued operation for all periods presented.

 

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***Comparisonof the Three Months Ended June 30, 2009 to the Three Months Ended June 30,2008***

 

**Net Sales**

 

*Electronic Devices Segment*

 

The increase in sales ofour electronic devices in the second quarter of 2009 as compared to the secondquarter of 2008 was primarily the result of the inclusion of $5.4 million innet sales from ACC, which we acquired in August 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries, which inthe case of our U.S. power supply division is due to economic conditions, andin the case of our foreign subsidiaries, is due primarily to the impact ofexchange rates.  On a local currencybasis, net sales at our foreign electronic device companies were slightlyhigher in the second quarter of 2009 as compared to 2008.  However, exchange rates between the U.S.dollar and the British pound sterling negatively impacted the consolidated resultsof our U.K. subsidiaries when translated into U.S. dollars.

 

Throughout the remainderof 2009, we expect quarterly net sales within our electronic devices segment toincrease as compared to each comparable quarter in 2008.  This reflects the expected favorable impactof including ACC’s net sales in each quarter of 2009 as compared to only thelatter four months in 2008. Exchange rates remain an uncertainty and couldimpact our sales positively or negatively throughout the remainder of 2009 ascompared to 2008.  The relationshipbetween the British pound sterling and the U.S. dollar can have a significantimpact on the results of our European electronic device operations as thoseresults are translated into U.S. dollars.

 

*Communications Equipment Segment*

 

The decrease in sales ofour communications equipment in the second quarter of 2009 as compared to thesecond quarter of 2008 is due to an overall decrease in orders and shipmentsfor network access and timing products, especially at our French subsidiarywhere quarterly net sales were down $1.1 million due largely to generaleconomic conditions and spending reductions by the French DefenseMinistry.  Net sales at our Frenchsubsidiary were also impacted by the unfavorable effects of exchange rates in2009 as compared to 2008 between the U.S. dollar and the euro on thetranslation of the financial results of our European operations into U.S.dollars.  Sales for network access andtiming products at our U.S. subsidiary also decreased but were partially offsetby stronger sales of telecommunications test equipment.

 

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 deemed to be discretionary expendituresby our customers and many companies in this industry have announced plans toreduce capital expenditures and/or to defer discretionary spending due tocurrent economic conditions.  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. Exchange rates remain an uncertainty and could impact our sales positivelyor negatively throughout the remainder of 2009 as compared to 2008.  The relationship between the euro as comparedto the U.S. dollar can have a significant impact on the results of our Europeancommunication segment operations as those results are translated into U.S.dollars. Despite the economic impacts in our communications equipment segment,we had an unusually high backlog of orders in this segment at June 30,2009 of $0.9 million for our telecommunications test equipment primarily forthe Federal Aviation Administration and the U.S. Navy.  We expect that these orders will be deliveredin the second half of 2009.

 

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**Gross Profit**

 
| ** **                                       | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **June 30,**       | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                               | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                       | 4,593      |                         | $          | 2,182 |   | $ | 2,411 |   | 110.5 | % |
| *as a  % of net sales*                           | * *   | *39.4*                  | *%*        | *26.7*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 866                     |       | 1,531                        |       | (665 | ) | (43.4 | )% |
| *as a  % of net sales*                           | * *   | *33.0*                  | *%*        | *39.6*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 5,459                   |       | 3,713                        |       | 1,746 |   | 47.0 | % |
| *Total  gross margin from continuing operations* | * *   | *38.3*                  | *%*        | *30.9*                       | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                  |       | 1,276                        |       |   |   |   |   |
| Total gross profit                               |       | $                       | 5,459      |                         | $          | 4,989 |   |   |   |   |   |
|                                                  |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from26.7% in the second quarter of 2008 to 39.4% in the second quarter of 2009 isprimarily the result of the inclusion of higher margin products at ACC and anincrease in gross profit as a percentage of sales at one of our Europeanoperations primarily due to the impact of currency exchange rates.  Included within cost of sales for the sixmonth period ended June 30, 2009 is approximately $0.1 million ofseverance costs associated with our restructuring plan which includesreductions in headcount, outsourcing certain centralized services and areduction in facility costs and which we expect will be substantially completedby December 31, 2009.

 

We expect that during2009, overall gross margins in our electronic devices segment will remainconsistent with those gross margins reported for the second quarter of2009.  During 2009 we may experiencequarter to quarter variability due to product mix differences and resultingdifferentials associated with lower gross margins on our electronic devicesused in commercial applications as compared to gross margins on our electronicdevices used in military applications. We expect ACC to contribute positively to our gross profit throughout2009.  Exchange rates remain anuncertainty and could impact our gross profit positively or negativelythroughout the remainder of 2009.  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.

 

*Communications Equipment Segment*

 

The decrease in gross marginas a percentage of net sales for our communications equipment segment from39.6% in the second quarter of 2008 to 33.0% in the second quarter of 2009 isprimarily the result of decreased sales volume of both network access productsand timing and synchronization products due to a slow-down of purchases beingmade by our customers of these products. The most significant impact was experienced at our French subsidiary asa result of declining sales discussed above.  Gross profit, both as a percentage of sales and on an actual dollarbasis, were unfavorably impacted as a result of the changes in foreign currencyexchange rates between the U.S. dollar and the euro in the second quarter of2009 as compared to the second quarter of 2008.

 

We are hopeful during2009 that this segment will be able to return to higher gross margins, such asthose achieved throughout the latter part of 2008.  However, due to current economic conditionsand the impact such conditions are having on this segment’s sales, we are uncertainas 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 and timing of shipments.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **June 30,**       | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                                   | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                    |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                       | 4,346      |                         | $          | 3,529 |   | $ | (817 | ) | (23.2 | )% |
| *as %  of net sales*                                 | * *   | *30.5*                  | *%*        | *29.4*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 716                     |       | 608                          |       | (108 | ) | (17.8 | )% |
| *as %  of net sales*                                 | * *   | *5.0*                   | *%*        | *5.1*                        | *%*        | * * | * * | * * | * * |
| Total operating  expenses from continuing operations |       | 5,062                   |       | 4,137                        |       | (925 | ) | (22.4 | )% |
| Discontinued operations                              |       | —                  |       | 651                          |       |   |   |   |   |
| Total operating  expenses                            |       | $                       | 5,062      |                         | $          | 4,788 |   |   |   |   |   |
|                                                      |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The increase in selling,general and administrative (“SG&A”) expenses is primarily the result ofapproximately $1.2 million of additional expenses relating to ACC, which wereabsent in the results of operations for the second quarter of 2008.  Additionally, we incurred approximately $0.1million of severance costs in the second quarter of 2009 associated with therestructuring of personnel at several of our facilities.  These increases were partially offset bydecreases in selling, general and administrative expenses at nearly all of ourbusiness units, including our corporate office due primarily to reduction inwork force at nearly all of our locations.

 

During 2009, we expectSG&A expense to be higher on a quarterly basis in each quarter of 2009 ascompared to each quarter in 2008.  Theanticipated increases in 2009 over 2008 quarterly expenses is primarily due tothe inclusion of ACC’s expenses in 2009 as compared to only including suchexpense during the last four months of 2008, as well as higher anticipatedcosts relating to Sarbanes-Oxley compliance due to the fact that we are nowsubject to the Sarbanes-Oxley Act Section 404 external auditrequirements.  SG&A expense for thirdquarter of 2009 may be higher than the SG&A expenses incurred during thesecond quarter of 2009due to the inclusion of severance costs associated withour ongoing restructuring plan and anticipated Sarbanes-Oxley managementassessment related costs.  However, oversubsequent quarters, we expect SG&A expense to trend lower as compared tosecond quarter 2009 due to significant restructuring efforts at both ourbusiness units and at our corporate office.

 

*Engineering and productdevelopment*

 

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

 

During the remainder of2009, engineering and product development expenses are expected to be higherthan comparable quarters of 2008 due to the inclusion of ACC.  Amounts are expected to vary by quarterdepending on particular needs within each segment, including ongoingdevelopment efforts for our TiemPoTM product line.

 

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**Interest expense**

 

Interest expense was $0.8million for the three months ended June 30, 2009 compared to $0.6 millionfor the three months ended June 30, 2008 due to higher outstanding loanand line of credit balances and higher interest rates on portions of those loanbalances in the second quarter of 2009 as compared to the second quarter of2008.  Included in interest expense inthe second quarter of 2009 were $0.2 million of non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount compared to$0.2 million in the second quarter of 2008.

 

**Other income (expense)**

 

We recorded other incomeof $211,000 for the three months ended June 30, 2009 compared to $120,000for the same period of 2008.  Otherincome (expense) consists primarily of (1) short-term exchange rate gainsand losses associated with the volatility of the U.S. dollar to the Britishpound sterling and euro on the current portion of certain assets andliabilities and, (2) fair value adjustments on warrants during the secondquarter of 2009.  The change in the fairvalue of warrants during the second quarter of 2009 resulted in income of$293,000, which was not present in 2008. The remaining expense of $82,000 for the second quarter of 2009 waspredominantly related to short-term exchange rate losses.

 

**Income tax expense**

 

Income tax expenseamounted to $178,000 for the three months ended June 30, 2009 compared toincome tax benefit of $4,000 for the same period of 2008.  We recorded income tax expense primarily asthe result of foreign income tax on foreign earned profits in Europe and NewJersey state income taxes on income generated by ACC.

 

The Company has exhausteda significant portion of its net operation losses available to be carriedforward into future periods and, as a result, any income from operations and/orgain on sales of assets could result in significant tax obligations.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $6.7 million (net of tax of $0.7million) during the first quarter of 2009, which included a $7.2 million gainon the sale of assets.  In the secondquarter of 2009, we recorded a decreasing adjustment to the gain on the sale ofDigitran of $0.1 million associated with certain purchase price adjustmentsassociated with the transaction.  In thesecond quarter of 2008, these operations contributed comparative income of $0.6million.

 

**Net loss**

 

We reported a net loss of$0.5 million in the second quarter of 2009 and a net loss of $0.3 million inthe second quarter of 2008.  Included inour net loss for the second quarter of 2009 is $0.3 million of severance costsassociated with the restructuring of personnel at several of our facilities,and approximately $0.1 million in expense associated with the sale of DigitranOperations.  We anticipate net loss toimprove in future quarters, due in large part to the recent restructuringefforts being completed.

 

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***Comparisonof the Six Months Ended June 30, 2009 to the Six Months Ended June 30,2008***

 

**Net Sales**

 
| ** **                                  | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                          | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                  |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                     | 23,244     |                         | $          | 15,443 |   | $ | 7,801 |   | 50.5 | % |
| *as %  of net sales*                        | * *   | *81.6*                | *%*        | *68.1*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 5,239                 |       | 7,222                        |       | (1,983 | ) | (27.5 | )% |
| *as %  of net sales*                        | * *   | *18.4*                | *%*        | *31.9*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 28,483                |       | 22,665                       |       | 5,818 |   | 25.7 | % |
| Discontinued operations                     |       | —                |       | 3,631                        |       |   |   |   |   |
| Total net sales                             |       | $                     | 28,483     |                         | $          | 26,296 |   | $ | 5,818 |   |   |   |

 

*Electronic Devices Segment*

 

The increase in sales ofour electronic devices in the first half of 2009 as compared to the first halfof 2008 was primarily the result of the inclusion of $10.5 million in net salesfrom ACC, which was acquired in August 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries, which inthe case of our U.S. power supply division is due to the current globaleconomic crisis  and in the case of ourforeign subsidiaries, the decrease is due primarily to the impact of exchangerates.

 

*Communications Equipment Segment*

 

The decrease in sales ofour communications equipment in the first half of 2009 as compared to the firsthalf of 2008 is due to an overall decrease in orders and shipments for networkaccess and timing products, especially at our French subsidiary where net saleswere down $1.7 million in the first half of 2009 compared to the first half of2008 due largely to the impacts of the global economic crisis and spendingreductions by the French Defense Ministry. Net sales at our French subsidiary were also impacted by the unfavorableeffects of exchange rates in 2009 as compared to 2008 between the U.S. dollarand the euro on the translation of the financial results of our Europeanoperations into U.S. dollars.  Sales fornetwork access and timing products at our U.S. subsidiary also decreased butwere partially offset by stronger sales of telecommunications test equipment.

 

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**Gross Profit**

 
| ** **                                       | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                               | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                  |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                     | 8,670      |                         | $          | 4,140 |   | $ | 4,530 |   | 109.4 | % |
| *as a  % of net sales*                           | * *   | *37.3*                | *%*        | *26.8*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 1,746                 |       | 3,013                        |       | (1,267 | ) | (42.1 | )% |
| *as a  % of net sales*                           | * *   | *33.3*                | *%*        | *41.7*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 10,416                |       | 7,153                        |       | 3,263 |   | 45.6 | % |
| *Total  gross margin from continuing operations* | * *   | *36.6*                | *%*        | *31.6*                       | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                |       | 2,245                        |       |   |   |   |   |
| Total gross profit                               |       | $                     | 10,416     |                         | $          | 9,398 |   |   |   |   |   |
|                                                  |            |                       |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from26.8% in the first half of 2008 to 37.2% in the first half of 2009 is primarilythe result of the inclusion of higher margin products at ACC and an increase ingross profit as a percentage of sales at our European operations due primarilyto the effects of exchange rates between the British pound sterling and theU.S. dollar.  This increase was partiallyoffset by a reduction in gross margin at our U.S. power supply division due toa write down of approximately $0.3 million of certain inventories to the lowerof cost or market during the first quarter of 2009 and approximately $0.1million of severance costs incurred in the second quarter of2009 associatedwith our restructuring plan.

 

*Communications Equipment Segment*

 

The decrease in grossmargin for our communications equipment segment from 41.7% in the first half of2008 to 33.3% in the first half of 2009 is primarily the result of decreasedsales of both network access products and timing and synchronization productsdue to a slow-down of purchases being made by our customers of theseproducts.    Gross profit, both as apercentage of net sales and on an actual dollar basis, was  unfavorably impacted as a result of thechanges in foreign currency exchange rates between the U.S. dollar and the euroin the first half of 2009 as compared to the first half of 2008.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                                   | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                  |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                     | 8,894      |                         | $          | 7,067 |   | $ | (1,827 | ) | (25.9 | )% |
| *as %  of net sales*                                 | * *   | *31.2*                | *%*        | *31.2*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 1,238                 |       | 1,111                        |       | (127 | ) | (11.4 | )% |
| *as %  of net sales*                                 | * *   | *4.3*                 | *%*        | *4.9*                        | *%*        | * * | * * | * * | * * |
| Total operating  expenses from continuing operations |       | 10,132                |       | 8,178                        |       | (1,954 | ) | (23.9 | )% |
| Discontinued operations                              |       | —                |       | 1,249                        |       |   |   |   |   |
| Total operating  expenses                            |       | $                     | 10,132     |                         | $          | 9,427 |   |   |   |   |   |
|                                                      |            |                       |            |                              |            |  |  |  |  |  |  |  |

 

*Selling, general and administrativeexpenses*

 

The increase in SG&Ais primarily the result of approximately $2.5 million of additional expensesrelating to ACC, which were absent in the results of operations for the firsthalf of 2008.  These increases were partiallyoffset by decreases in SG&A at some of our business units, including ourcorporate office.

 

*Engineering and productdevelopment*

 

The slight 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.

 

**Interest expense**

 

Interest expense was $2.4million for the six months ended June 30, 2009 compared to $1.2 millionfor the six months ended June 30, 2008. Also affecting the increase in interest expense were higher outstandingloan and line of credit balances and higher interest rates on portions of thoseloan balances in the first half of 2009 as compared to the first half of 2008.  Included in interest expense in the firsthalf of 2009 were $0.1 million in fees associated with a waiver received fromour lender in the first quarter of 2009, and $0.9 million of non-cashamortization of deferred financing costs and non-cash amortization of debtdiscount, including $0.5 million due to the acceleration of deferred financingcosts and debt discount amortization associated with the partial repayment ofour Term Loan B, compared to $0.4 million in the first half of 2008.

 

**Other income (expense)**

 

We recorded other incomeof $168,000 for the six months ended June 30, 2009 compared to $103,000for the same period of 2008.  Otherincome (expense) consists primarily of (i) short-term exchange rate gainsand losses associated with the volatility of the U.S. dollar to the British poundsterling and euro on the current portion of certain assets and liabilities and (ii) fairvalue adjustments on warrants.  Thechange in the fair value of warrants during the first half of 2009 resulted inincome of $423,000, which was not present in 2008.  The remaining expenses of $254,000 for thesecond quarter of 2009 were predominantly related to short-term exchange ratelosses.

 

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**Income tax expense**

 

Income tax expenseamounted to $372,000 for the six months ended June 30, 2009 compared toincome tax expense of $80,000 for the same period of 2008.  We recorded income tax expense incurredprimarily as the result of foreign income tax on foreign earned profits inEurope and New Jersey state income taxes on income generated by ACC.

 

The Company has exhausteda significant portion of its net operation losses available to be carriedforward into future periods and, as a result, any income from operations and/orgain on sales of assets could result in significant tax obligations.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $6.6 million (net of $0.7 million intaxes) during the first half of 2009, which includes a $7.1 million gain on thesale of assets.  In the first half of2008, these operations contributed comparative income of $1.0 million.

 

**Net income (loss)**

 

We reported net income of$4.3 million in the first half of 2009 and a net loss of $1.2 million in thefirst half of 2008.  Included in netincome in the first half of 2009 was a $6.6 million (net of $0.7 million intaxes) gain on the sale of our Digitran Operations, approximately $0.3 millionin inventory write downs, $0.5 million in accelerated amortization of deferredfinancing costs and debt discount associated with the partial repayment of ourTerm Loan B in March 2009, $0.3 million of severance costs associated withthe restructuring of personnel at several of our facilities and $0.1 million infees associated with a waiver received from our lender in the first quarter of2009.

 

**Liquidityand Capital Resources**

 

In making an assessmentof our liquidity, we believe that the items in our financial statements thatare most relevant to our ongoing operations are working capital, cash generatedfrom operating activities and cash available from financing activities.  During the first half of 2009, we funded ourdaily cash flow requirements through funds provided by operations and throughborrowings under our credit facility with GVEC Resource IV Inc. (“GVEC” orthe “Lender”).  Working capital was $7.4million at June 30, 2009 as compared to $7.6 million at December 31,2008. Significant items that positively impacted working capital from December 31,2008 until June 30, 2009 are (i) a reduction of $3.1 million in thecurrent portion of long term debt which was associated with the sale of ourDigitran Operations in March 2009 and the subsequent repayment of longterm acquisition related debt by approximately $10 million; and (ii) anincrease in cash of approximately $1.6 million. Significant items thatnegatively impacted working capital from December 31, 2008 until June 30,2009 are (i) the sale of our Digitran Operations in March 2009, whichat December 31, 2008, had net current assets of $2.1 million; (ii) anincrease in our line of credit by $1.5 million; (iii) a decrease inaccounts receivable from continuing operations of $0.9 million due to improvedcollections; and (iv) an increase of $0.4 million in income taxes payableprimarily as a result of the taxes we paid on the gain on sale of our Digitran Operations.  At June 30, 2009 and December 31,2008, we had accumulated deficits of $23.3 million and $28.1 million,respectively, and cash and cash equivalents of $4.8 million and $3.4 million,respectively.  Our cash balances areoften significantly higher at the end of the month than at other timesthroughout the remainder of the month as a result of borrowings under ourcredit facility generally occurring toward the end of the month and timing ofpayments to vendors in the form of accounts payable, payroll and interestpayments generally occurring at the beginning of the month.

 

Net cash used inoperating activities during the first half of 2009 totaled $0.5 million.  Our reported net income of $4.3 millionincluded a gain on the sale of the Digitran Operations of $7.1 million.  Significant non-cash adjustments to our netincome for the six months ended June 30, 2009 include (i) theamortization of debt 

 

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discount and amortizationof deferred financing cost which, on a combined basis, totaled $1.0 million,both of which are non-cash components of interest expense associated with ourcredit facility, (ii) depreciation and amortization expense which totaled$1.0 million, and (iii) change in fair value of common stock warrantswhich contributed $0.4 million as non-cash component of net income.  Significant uses of cash associated withoperating activities during the six month period ended June 30, 2009included (a) an increase in inventory balances of $1.0 million in order toaccommodate future shipments of backlog, and (b) a decrease in accountspayable and accrued liabilities by approximately $1.0 million, in part due topayments made on previously accrued amounts related to the sale of the DigitranOperations and timing of vendor payments. The primary source of cash associated with operating activities duringthe six month period was a decrease in accounts receivable, which decreased byapproximately $0.9 million, due primarily to increased efforts to collectoutstanding balances on a more timely basis.

 

Cash generated from ourinvesting activities during the first half of 2009 totaled $10.2 million. Thisamount consisted primarily of net cash proceeds generated by the March 2009sale of our Digitran Operations, all of which was used to partially repay the$13 million in term debt that we incurred in connection with our purchase ofACC in August 2008.

 

Cash used in financingactivities during the first half of 2009 totaled $9.0 million, which consistedof $10.6 million in repayments of principal owed on long term debt and notes tostockholders, offset by $1.5 million in net borrowings on our revolving creditfacility.

 

As of June 30, 2009, we had outstanding borrowings of $5.6million under the revolving loan portion of our credit facility.  At June 30, 2009, we had remainingactual availability under a formula-based calculation of $1.4 million under thecredit facility.  Actual remaining availability representsthe additional amount we were eligible to borrow as of June 30, 2009.  The full $7 million available under ourrevolving line of credit fluctuates periodically throughout each monthdepending on timing of borrowings and repayments.

 

In addition to therevolving lines of credit, at June 30, 2009, we had long-term loans andcapitalized lease and equipment loan obligations totaling $14.3 million, thecurrent portion of which loans and obligations totaled $2.8 million.

 

Our backlog decreased to$27.8 million as of June 30, 2009 as compared to $34.7 million as of December 31,2008. The decrease is, in part, due to the sale of the Digitran Operations,which represented $1.5 million in backlog at December 31, 2008, and thereduction of backlog at all of our electronic devices business units as wesatisfied existing contracts during the first half of 2009.  We experienced a slight increase in backlogat our U.S. communications equipment business unit associated with new ordersfor telecommunications test equipment. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of June 30, 2009 was approximately 95% related to our electronicdevices business, which business tends to provide us with long lead-times forour manufacturing processes due to the custom nature of the products, andapproximately 5% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog willbe shipped within the next 12 months. However, there can be no assurance that we will be successful infulfilling such orders and commitments in a timely manner or that we willultimately recognize as revenue the amounts reflected as backlog.

 

On November 30,2007, we and our direct subsidiaries, EEC, CXR Larus and RO Associates enteredinto a Credit Agreement with the Lender, providing for a credit facility in theaggregate amount of $23,000,000.  On August 20,2008, in connection with the acquisition of ACC and CCI, we entered into anamendment to the credit facility to include ACC and CCI as borrowers and to,among other things, include an additional term loan in the principal amount of$3,000,000 (the “Term Loan C”).  In connection with Digitran Transactionwe repaid approximately $10 million of term debt in March 2009, includingthe Term Loan C.  As of June 30,2009, we owed a total of $14.4 million under the terms of the credit facility.

 

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The credit facilitycurrently consists of (i) a one year revolving loan for up to $7 millionthat may be renewed on November 30, 2009 for a period of one year (the “Revolver”),and (ii) two term loans (Term Loan A and Term Loan B) with an aggregatenet outstanding principal amount of $8.8 million. The term loans requirescheduled principal and interest payments commencing September 1, 2009 anda final balloon payment of principal upon maturity on November 30,2010.  Total aggregate principal payments on Term Loan A and Term Loan Bare $1.1 million in 2009 and $7.9 million in 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 November 30, 2009, unless it is renewed by theLender in which case the maturity date will be extended to November 30,2010.

 

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, includingEBITDA, measured on a fiscal quarter-end basis, must not be less than thescheduled amount for each specified period; the debt service coverage ratio,measured quarterly, must be greater than the lesser of the scheduled amount foreach specific period or 1.10:1.00; minimum liquidity above the scheduledamount, unfinanced capital expenditures not in excess of $62,500 per quarter,and the leverage ratio, measured quarterly, must not be greater than thescheduled amount for each specified period.  Additionally, the Revolver issubject to the borrowers not incurring purchase money commitments in excess of$2 million.  As of June 30, 2009, we were in compliance with all ofthese debt covenants.

 

The term loans bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5% perannum.  The borrowers under the creditfacility may make full or partial prepayment of the term loans provided thatany such prepayment is accompanied by the applicable prepayment premiumdiscussed below.

 

Upon the sale ordisposition by the borrowers or any of their subsidiaries of property orassets, the borrowers may be obligated to prepay the Revolver and the termloans with the net cash proceeds received in connection with such sales ordispositions 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 theindebtedness of borrowers under the credit facility, the borrowers irrevocablypledged and assigned to, and granted to the Lender a continuing securityinterest in all the personal property of the borrowers including the borrowers’interest in any deposit accounts, the stock of each of the borrowers’subsidiaries, the intellectual property owned by each of the borrowers, and theproceeds of the intellectual property owned by each of the borrowers.  Inan event of default, the Lender may, at its option, exercise any or allremedies available to it with respect to the collateral.  In addition,certain of the borrowers’ foreign subsidiaries have agreed to guaranty theborrowers’ performance under the credit facility.

 

We have agreed with ourLender to raise at least $3 million in net proceeds through the sale of stockof the borrowers by no later than December 31, 2009.  Under the terms of the credit facility, weare obligated to remit to our Lender 50% of the first $3 million of net cashproceeds received in connection with the sale of stock and 30% of the net cashproceeds in excess of the first $3 million received. Given current economic andfinancial market conditions, an equity raise could prove difficult.  Accordingly, no assurances can be made thatwe will be successful in this regard.  Ifwe are successful in structuring an equity raise acceptable to us and ourLender, the issuance of equity securities may result in substantial dilution toour stockholders.

 

We are obligated to makemonthly principal payments to our Lender of (i) $75,000 on September 1.2009 and October 1, 2009, (ii) $100,000 on November 1, 2009, (iii) $150,000on December 1, 2009 and (iv) 

 

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approximately $287,000commencing on January 1, 2010 and continuing on the first day of each ofthe 10 consecutive months thereafter.

 

Currently, we are in theprocess of seeking alternate financing from a number of possible lenders,including traditional lenders, private equity and mezzanine lenders.  Although we remain hopeful that we will beable to successfully secure replacement financing on a timely basis, noassurances can be made that we will be successful in this regard.

 

If we cannot meet orsuccessfully fulfill our obligations to (i) raise $3.0 million in equitycapital by December 31, 2009, (ii) make monthly principal andinterest payments, and/or (iii) achieve certain other financial covenants,or if our Lender does not waive these obligations, then we would be in defaultunder the terms of our credit facility.

 

In the event of a defaultand continuation of a default, our Lender may limit future availability underour revolving line of credit and/or accelerate the payment of all principalbalances and accrued interest requiring us to pay the entire indebtedness underthe credit facility outstanding on that date.  Upon the occurrence andduring the continuation of an event of default, the Lender may also elect toincrease the interest rate applicable to the outstanding balance of the TermLoans A and B by four percentage points above the per annum interest rate thatwould otherwise be applicable.  Any of these conditions could have a materialadverse effect on our operations and/or ability to conduct business after thatdate.  Additionally, if our Lender terminates the credit facilityduring a default period or if we prepay the Revolver or the Term Loans prior toNovember 30, 2009, then we are subject to a penalty equal to 2% of theoutstanding principal balance of the Revolver and the Term Loans.

 

Recent actions taken bythe Commission against Private Equity Management Group, Inc., an affiliateof our Lender, including an order granted in April 2009 by a federal courtfreezing all assets of Private Equity Management Group, Inc. and itsaffiliates, including our Lender, may adversely affect our Lender’s ability tocontinue to provide us funds under the terms of the Revolver.  At therequest of the Commission, the federal court also appointed a temporaryreceiver of our Lender’s agent and of our Lender.  Although we currentlybelieve that the receiver will allow us to continue to borrow funds under theterms of the Revolver, no assurances can be made that the receiver will allowour Lender to continue to make funds available to us.  If, for any reason,the receiver were to limit or terminate our ability to continue to borrow fundsunder the Revolver, our cash position and our ability to continue day to dayoperations would be adversely affected, almost immediately.  If that wereto occur, we would be required to seek additional and/or replacement financingimmediately.  If we are unable to do so,we may be forced to drastically curtail or cease operations and possibly seekprotection from our creditors under the U.S. Bankruptcy Code.

 

If we are successful inraising $3.0 million in equity capital by December 31, 2009, as requiredby our Lender, and we are able to continue to borrow funds under the terms ofthe Revolver, management believes that current and future capital resources,revenues generated from operations and other existing sources of liquidity willbe adequate to meet our anticipated short term, working capital and capitalexpenditures needs for the next 12 months. If, however, for any reason including the reasons described above, weare unsuccessful in raising additional equity capital as required by the termsof our credit facility thereby resulting in an event of default under thecredit facility or if we are unable to continue to borrow funds under the termsof the Revolver, we do not believe that current and future capital resources,revenues generated from operations and other existing sources of liquidity willbe adequate to meet our anticipated short term, working capital and capitalexpenditures needs for the next 12 months.  Further, if for any reason,including the reasons described above, we are unable to continue to borrowfunds under the terms of the Revolver or if we experience a significant loss ofrevenue or increase in costs, then our cash flow would be negatively impactedresulting in a cash flow deficit which, in turn, will require us to obtainadditional or alternate financing, with little or no notice.  These potentialfinancing needs could be met in the form of a revised debt structure with ourLender, additional or new financing with another lender or lenders, the sale ofassets to generate cash or the sale of additional equity to raise capital. Our failure to secure additional or alternate financing, if and whenneeded, would have an adverse effect on our operations and/or ability to dobusiness after that date or could restrict our growth, limit our development ofnew products, or 

 

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hinder our ability tofulfill existing or future orders; we may be forced to drastically curtail orcease operations and possibly seek protection from our creditors under the U.S. Bankruptcy Code

 

Currently, we are in theprocess of seeking alternate financing from a number of possible lenders,including traditional lenders, private equity and mezzanine lenders.  Although we remain hopeful that we will beable to successfully secure replacement financing in a timely manner, we cannotassure you that we will be successful in this regard.

 

**Effectsof Inflation**

 

The impact of inflationand changing prices has not been significant on the financial condition orresults of operations of either our company or our operating subsidiaries.

 

**Impactsof New Accounting Pronouncements**

 

In February 2007,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159permits an entity to irrevocably elect fair value on a contract-by-contractbasis as the initial and subsequent measurement attribute for many financialassets and liabilities and certain other items including insurance contracts.Entities electing the fair value option would be required to recognize changesin fair value in earnings and to expense upfront cost and fees associated withthe item for which the fair value option is elected. SFAS No. 159 iseffective for fiscal years beginning after November 15, 2007. The adoptionof SFAS No. 159 did not have a material effect on our financialcondition or results of operations.

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This statement providesa single definition of fair value, together with a framework for measuring it,and requires additional disclosure about the use of fair value to measureassets and liabilities. SFAS No. 157 also emphasizes that fair value is amarket-based measurement, not an entity-specific measurement, and sets out afair value hierarchy, with the highest priority being quoted prices in activemarkets. The required effective date of SFAS No. 157 was the first quarterof 2008. The adoption of SFAS No. 157 for financial assets and liabilitiesdid not have a material effect on our consolidated financial statements, butresulted in additional disclosures.  In February 2008,the FASB issued Staff Position No. 157-2, which delayed by one year theeffective date of SFAS No. 157 for all non-financial assets andliabilities, except those that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. The adoption of SFAS No. 157 for non-financial assets andliabilities did not have a material effect on our consolidated financialstatements.

 

In December 2007,the FASB issued SFAS No. 141R, “Business Combinations,” which replacedSFAS No. 141, “Business Combinations.” SFAS No. 141R establishes principles and requirements fordetermining how an enterprise recognizes and measures the fair value of certainassets and liabilities acquired in a business combination, includingnoncontrolling interests, contingent consideration and certain acquiredcontingencies.  SFAS No. 141R alsorequires acquisition-related transaction expenses and restructuring costs beexpensed as incurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R iseffective for fiscal years beginning after December 15, 2008. SFAS No. 141Rwill be applicable prospectively to business combinations for which theacquisition date is on or after January 1, 2009.  SFAS No. 141R will have an impact onaccounting for any business acquired after the effective date of thispronouncement.

 

In March 2008, theFASB issued SFAS No. 161, “Disclosures about Derivative Instruments andHedging Activities.” The new standard amends SFAS No. 133 and seeks toenhance disclosure about how and why a company uses derivative and hedgingactivities, how derivative instruments and related hedged items are accountedfor under SFAS No. 133 (and the interpretations of that standard) and howderivatives and hedging activities affect a company’s financial position,financial performance and cash flows. SFAS No. 161 is effective for financial statements issued forfiscal years and interim periods beginning after November 15, 2008.  The adoption of SFAS No. 161 did nothave a material effect on the Company’s consolidated financial statements.

 

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In April 2008, theFASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination ofthe Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, “Goodwill and Other Intangible Assets” and alsorequires expanded disclosure related to the determination of intangible assetuseful lives. FSP 142-3 is effective for fiscal years beginning after December 15,2008. Early adoption is prohibited. The adoption of FSP 142-3 did not have amaterial effect on our consolidated financial statements.

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. We adopted EITF 07-5 on January 1, 2009. SeeNote 12 **—**Warrants in theaccompany notes to condensed consolidated financial statements in this reportfor discussion of the impact of the adoption of EITF 07-5 on our outstandingstock warrants and our consolidated financial statements.

 

In April 2009, the FASB issued FSP No FAS 107-1and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSPFAS 107-1 and APB 28-1”), which amends SFAS No. 107, “Disclosures aboutFair Value of Financial Instruments,” to require disclosures about fair valueof financial instruments in interim as well as in annual financialstatements.  FSP No. FAS 107-1 andAPB 28-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” torequire those disclosures in all interim financial results, financial positionand financial statement disclosures.  FSPFAS 107-1 and APB 28-1 is effective for periods ending after June 15,2009.  We have adopted FSP FAS 107-1 andAPB 28-1 and believe we have all of the required disclosures within thisQuarterly report on Form 10-Q.

 

In May 2009, the FASB issued SFAS No. 165, “SubsequentEvents” (“SFAS No. 165”), effective for interim or annual financialperiods ending after June 15, 2009. For calendar year entities, SFAS No. 165 became effective for thethree months ended June 30, 2009. The objective of SFAS No. 165 is to establish general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued.  In particular, SFAS No. 165 sets forth (1) theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition 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 SFAS No. 165 did not have a material impact on ourfinancial position, results of operations or cash flows.

 

In June 2009, theFASB issued SFAS No. 168, “The FASB Accounting Standards CodificationTM andthe Hierarchy of Generally Accepted Accounting Principles — a replacement ofFASB Statement No. 162” (“SFAS No. 168”) to formally establish theFASB Accounting Standards CodificationTM (the “Codification”) as the singlesource of authoritative, nongovernmental U.S. GAAP.  All existing accounting standards documentsare superseded as described in SFAS No. 168.  All other accounting literature not includedin the Codification is nonauthoritative. The Codification is effective for interim and annual periods endingafter September 15, 2009.  Webelieve the adoption of SFAS No. 168 will not have a material impact onour financial position, results of operations or cash flows.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK.**

 

Not applicable.

 

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**ITEM 4.****                                                    ****CONTROLS AND PROCEDURES.**

 

Not applicable.

 

**ITEM 4T.****                                            ****CONTROLS AND PROCEDURES.**

 

***Evaluationof Disclosure Controls and Procedures***

 

We conducted anevaluation under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, ourprincipal accounting officer, of the effectiveness of the design and operationof our disclosure controls and procedures. The term “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 and proceduresalso include, without limitation, controls and procedures designed to ensurethat information required to be disclosed by a company in the reports that itfiles or submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal executive and principal financialofficers, or persons performing similar functions, as appropriate, to allowtimely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded as of June 30, 2009 that our disclosure controls andprocedures were not effective at the reasonable assurance level due to thematerial weaknesses discussed below.

 

In light of the four material weaknesses described below,we performed additional analysis and other post-closing procedures to ensurethat our consolidated financial statements were prepared in accordance withgenerally accepted accounting principles. Accordingly, we believe that the consolidated financial statements includedin this report fairly present, in all material respects, our financialcondition, results of operations and cash flows for the periods presented.

 

Our Chief ExecutiveOfficer and Chief Financial Officer concluded that as of June 30, 2009 thefollowing five material weaknesses existed:

 

(1)                                  We did not effectively implementcomprehensive 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 not maintain effective controlsover recording and reporting the acceleration of certain components of ourcredit facility and the classification of the issuance of a note relating to apurchase price adjustment.

 

(5)                                  We did not maintain a sufficient level ofresources within our accounting department.

 

If not remediated, these material weaknesses could resultin one or more material misstatements in our reported financial statements in afuture annual or interim period.

 

***InherentLimitations on the Effectiveness of Controls***

 

Management does notexpect that 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 

 

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met. Further, the designof a control system must reflect the fact that there are resource constraints,and the benefits of controls must be considered relative to their costs.Because of the inherent limitations in a cost-effective control system, noevaluation of internal control over financial reporting can provide absoluteassurance that misstatements due to error or fraud will not occur or that allcontrol issues and instances of fraud, if any, have been or will be detected.

 

These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of a simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controls effectiveness to futureperiods are subject to risks. Over time, controls may become inadequate becauseof changes in conditions or deterioration in the degree of compliance withpolicies or procedures.

 

***MaterialWeaknesses and Related Remediation Initiatives***

 

Set forth below is asummary of the various significant deficiencies which caused management toconclude that we had the four material weaknesses identified above.  Through the efforts of management, externalconsultants and our Audit Committee, we are currently in the process ofexecuting specific action plans to remediate the material weaknesses identifiedabove and discussed more fully below.  Weexpect to complete these various action plans by December 31, 2009.  If we are able to complete these actions bythat date, we anticipate that all control deficiencies and material weaknesseswill be remediated by March 31, 2010.

 

(1)           We did not effectively implementcomprehensive entity-level internal controls, as evidenced by the followingcontrol deficiencies:

 

·                  EntityLevel Internal Control Evaluation.  Wedid not formally consider entity-wide controls that are pervasive across ourcompany when considering whether control activities are sufficient to addressidentified risks.

 

·                  FraudConsiderations.  We did not conductregular formalized assessments to consider risk factors that influence thelikelihood of someone committing a fraud and the impact of a fraud on ourfinancial reporting.

 

·                  ObjectiveEvaluation of Internal Controls.  We didnot use an internal audit function or other objective party to provide anobjective perspective on key elements of the internal control system.

 

·                  ExternalCommunication.  We lacked formal policiesand procedures regarding how and when matters affecting the achievement offinancial reporting objectives are communicated with outside parties.

 

·                  Assessmentof Information Technology.  We did notformally evaluate the extent of the needed information technology controls inrelation to our assessment of processes and systems supporting financialreporting.

 

·                  InformationTechnology.  We did not have sufficientinformation technology controls, where applicable, designed and implemented tosupport the achievement of financial reporting objectives.

 

·                  Ongoing andSeparate Evaluations.  We did noteffectively create and maintain effective evaluations on the progress of ourremediation efforts nor the constant evaluations of the operating effectivenessof our internal controls over financial reporting.

 

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·                  ReportingDeficiencies.  We did not perform timelyand sufficient internal or external reporting of our progress and evaluation ofprior year material weaknesses or the current fiscal year internal controldeficiencies.

 

(2)           We didnot maintain effective controls over changes to critical financial reportingapplications and over access to these applications and related data, asevidenced by the fact that certain of our personnel had unrestricted access tovarious financial application programs and data beyond the requirements oftheir individual job responsibilities. This control deficiency could result ina material misstatement of significant accounts or disclosures, including thosedescribed above, that could result in a material misstatement of our interim orannual consolidated financial statements that would not be prevented ordetected.

 

(3)           We didnot maintain a sufficient level of information technology personnel to executegeneral computing controls over our information technology structure, whichinclude the implementation and assessment of information technology policiesand procedures. This control deficiency did not result in an audit adjustmentto our 2008 interim or annual consolidated financial statements, but couldresult in a material misstatement of significant accounts or disclosures, whichwould not have been prevented or detected.

 

(4)           We did not maintain effective controlsover recording and reporting the acceleration of certain components of ourcredit facility and the classification of the issuance of a note relating to apurchase price adjustment.  As a result of a review of our historical financialstatements, management concluded that our controls over (a) recording theacceleration of certain components of our credit facility and (b) classifyingthe issuance of a note relating to a purchase price adjustment were not inaccordance with generally accepted accounting principles.  Based upon this conclusion, our AuditCommittee and senior management decided, in the third quarter of 2009, torestate our historical financial statements for each of the quarterly periodsended 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.

 

(5)           We are arelatively complex company with operations conducted in multiple countries,multiple currencies and multiple languages.  We have divested fourseparate operations in the past 18 months, acquired a large subsidiary duringthe same time, and we are in the process of divesting additional assets inorder to repay our current obligations.  All of these transactions giverise to complex accounting and tax treatments.  Our finance team is a relatively small butexperienced staff. Although we believe the accounting staff are qualified toperform their functions, due to reasons above, the quantity of staff may beinsufficient to deal with the work load and complexities created, which couldresult in material misstatements to our financial statements.

 

***Remediationof Internal Control Deficiencies and Expenditures***

 

The above materialweaknesses resulted in adjustments to our consolidated financial statements forthe quarter ended June 30, 2009.  Inaddition,, it is reasonably possible that, if not remediated, one or more ofthe material weaknesses described above could result in a material misstatementin our reported financial statements that might result in a materialmisstatement in a future annual or interim period.

 

In addition to thedeveloping specific action plans for each of the above material weaknesses, weare taking steps to unify the financial reporting of all of our divisions.  Accordingly, we are planning to implement acentralized consolidation software package which we believe will facilitatethis process and will assist in the remediation of many of the above listeddeficiencies.

 

In addition, our auditcommittee has authorized the hiring of additional temporary staff and/or theuse of financial and information technology consultants, as necessary, toensure that we have the depth and experience to remediate the above listedmaterial weaknesses, including the implementation and monitoring of theappropriate 

 

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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 late 2009 or early2010.  We cannot guarantee that theactual costs to remediate these deficiencies will not exceed this amount.

 

Through these steps, webelieve that we are addressing the deficiencies that affected our internalcontrol over financial reporting as of June 30, 2009. Because the remedialactions require hiring of additional personnel, upgrading certain of ourinformation technology systems, and relying extensively on manual review andapproval, the successful operation of these controls for at least severalquarters may be required before management may be able to conclude that thematerial weakness has been remediated. We intend to continue to evaluate and strengthen our internal controlover financial reporting systems. These efforts require significant time andresources.  If we are unable to establishadequate internal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by our independentregistered public accounting firm, which in turn may have a material adverseeffect on our ability to prepare financial statements in accordance with GAAPand to comply with our Commission reporting obligations.

 

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

 

There has been no changein our internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II — OTHER INFORMATION**

 

**ITEM 6.****                                                    ****EXHIBITS.**

 
| **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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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                  | EMRISE CORPORATION |
|-----------------------|--------------------|
|                  |               |   |
| Dated: April 15, 2010 | By:                | /S/ CARMINE T. OLIVA |
|                  |               | Carmine T. Oliva, |
|                  |               | Chief Executive Officer |
|                  |               |   |
|                  |               |   |
|                  |               |   |
| Dated: April 15, 2010 | By:                | /S/ D. JOHN DONOVAN |
|                  |               | D. John Donovan, Chief  Financial Officer (principal |
|                  |               | financial and  accounting officer) |

 

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**INDEX TO EXHIBITS ATTACHED TO THIS 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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